Case ID: nys_5/html/0623-02.html
Source: Caselaw Access Project
Author: {"author": "Daniels, J.", "license": "Public Domain", "url": "https://static.case.law/"}
Date Created: 2024-08-24T03:29:51.129683

Barr et al. v. New York, L. E. & W. R. Co. et al.
    
    
      (Supreme Court, General Term, First Department.
    
    May 24, 1889.)
    1. Corporations—Duties of Directors.
    Pour persons who were common directors in two different railroad corporations became the assignees of a construction contract made by one of the companies, by which they became entitled to receive its stocks and bonds, and by which they made a large profit. Subsequently, acting for the two companies, they executed a lease of the road and franchises of the company whose bonds and stocks they held under the construction contract to the other company, which bound itself to pay as rental certain sums to meet the interest on the bonds and dividends on the stocks, and which interest and dividends the lessee company guarantied. Meld, that the lease was an attempt by the directors to impose obligations upon the lessee company for their own private benefit, and was therefore invalid.
    3. Same.
    No formal rescission of the lease was necessary to entitle the lessee company to avail itself of the invalidity.
    3. Same—Ratification of Contract.
    The fact that the lessee company has retained possession of and continued to operate the road under the lease does not amount to a ratification, nor prevent it from making the defense of invalidity, in a suit by a stockholder of the lessor company to compel payment of the rent.
    
      Appeal from special term, New York county.
    Argued before Van Brunt, P. J., and Brady and Daniels, JJ.
    
      Flihu Root and Samuel B. Clarke, for appellants. MaoFarland, Board-man c6 Platt, for respondents.
   Daniels, J.

The action was brought" by the plaintiffs, as owners of" shares of stock in the Suspension Bridge & Erie Junction Railroad Company,, whose railroad connected the- Erie Railroad at Buffalo with the Great Western! Railroad of Canada at Suspension Bridge, to enforce the performance of a-lease made between that company and the Erie Railway Company, and for the payment of the rent reserved in the lease. Both of these- companies had passed under substantially the same management, which was identical in the way of interest; and for that reason procéedings by the Suspension Bridge & Erie Junction Railroad Company had not been taken to secure the payment, of the entire rental reserved in the lease. So much of it as had not been paid was required to make the dividend on the stock of the Suspension Bridge-Company, which the plaintiff's claim should be made. The Erie Railway Company had passed out of existence before the suit was commenced, and the receiver of its property had, pursuant to a judgment and sale under a. mortgage foreclosure, transferred his possession to the defendant the New York, Lake Erie & Western Railroad Company. That company, under the-reorganization pursuant to the sale, had become charged with the performance of this preceding obligation of the Erie Railway Company, so far as. it had been binding on that company, and of the receiver, so far as he became bound to perform it. The lease, upon whose validity the right of the plaintiffs to maintain the action depended, was executed by the Erie Railway Company and the Suspension Bridge & Erie Junction Railroad Company on the 13th of July, 1870; and it leased the road of the latter company to the former, for whose business it had been constructed, with all its rights, franchises, privileges, and estate, for the period of its corporate existence, which was the term of 500 years. The Erie Railway Company, in consideration of the lease, agreed to pay, by way of rent, an amount equal to 30 per cent, of the gross earnings of the leased road, not to be less than the-sum of $52,500, semi-annually. This rental corresponded in amount with the interest which would accrue on the bonds which the Suspension Bridge- & Erie Junction Railroad Company had, by a resolution of its board of directors adopted on the 28tli of May, 1870, resolved to issue, amounting-to the sum of $1,000,000, and to an equal dividend upon the stock of the same company, which was not to exceed the sum of $500,000. The rental was intended to be used in making those payments, and it was paid, as it. was stipulated for by the lease, for about two years after it was executed. But subsequent to that time no more than the sum of $70,000 a year has-been paid, which was necessary and used to pay the interest upon the $1,000,-000 in amount of the bonds of the Suspension Bridge So Erie Junction Railroad Company. The interest on those bonds had been guarantied by the Erie Railway Company, and to meet and perform the terms, of this guaranty the appropriation of the sum of $70,000 annually had become necessary. The-latter company had also guarantied the payment of a semi-annual dividend of 3 j- per cent, on the stock of the Suspension Bridge & Erie J unction Railroad Company, but all the shares of this stock were afterwards acquired by the Erie Railway Company by purchase, except those belonging to the plaintiffs, and a small number of other shares. The New York, Lake Erie & Western Railroad Company justified the omission, and refusal to pay the additional rental, on the ground that the obligation to pay it had been illegally entered into, and was opposed to the policy of the law.

The foundation upon which this objection rested was the identity, to a certain extent, of the directors in the Suspension Bridge & Erie Junction Railroad Company and the Erie Railway Company, and the interest of at least four of these common directors in the stock and bonds of the Suspension Bridge & Erie Junction Railroad Company, which was to be promoted by the payment of the proportionate part of the rental reserved in the lease now under consideration. Prior to tile time when the lease was made a contract was made and executed by the directors of the Suspension Bridge & Erie Junction Railroad Company to build its railroad, and receive therefor the $1,000,000 in its bonds, and the $500,000 in its stock. This contract was subscribed by these parties on the 18th of May, 1870. But nothing seems to have been done under this agreement; for on the 7th of June, 1870, the company entered into an agreement with Mortimer Smith to build and construct the railway for tile same consideration. And on the same day an agreement was made by the directors of the Suspension Bridge & Erie Junction Railroad Company with Smith to purchase and receive from him the stock and bonds already mentioned as he should receive them from the Suspension Bridge & Erie J unction Railroad Company, and to pay him therefor in monthly payments the amount of money actually expended on his contract, proportionately corresponding to the bonds and stock received. These four persons, viz., James Fisk, Jr., Henry Thompson, Hugh Smith, and William M. Tweed, who were directors in each of the companies, were parties to and subscribed this agreement; and on the 27th of June, 1870, Mortimer Smith assigned to them and others his contract for the construction of the railway, by which they became entitled, for the performance of his agreement, to the bonds and stock which would otherwise have been delivered to him; and it was after these persons had in this manner become entitled to proportionate parts of the stocks and bonds of the Suspension Bridge & Erie Railroad Company that the lease in controversy was executed by the Erie Railway Company.

Before the assignment of this contract by Smith, on the 8th day of June, 1870, a special meeting of the directors of the Erie Railway Company v/as held, at which a resolution was adopted authorizing the president of the company to execute under its corporate seal all contracts necessary for the lease of the road of the Suspension Bridge & Erie Junction Railroad Company, and to equip and run the same, etc.; and it does not appear that either one of the directors of the company was absent from this meeting, or dissented from the adoption of this resolution. The cost of building and constructing the railroad was about $850,000, leaving to the parties agreeing to receive the $1,000,-000 in bonds guarantied by the Erie Railway Company, through the completion of their agreement, a net gain of about $150,000, together with the $500,-000 in stock. These directors were accordingly interested in obtaining the lease from the Erie Railway Company, which it has been insisted as the ground of this action that the Hew York, Lake Erie & Western Railroad Company should be obliged to perform by the payment of the full amount of rent reserved in it. They were instrumental, so far as their action extended, in bringing about the creation of this obligation; and, to the extent to which it afforded or would secure profit and advantage to them, it interfered with and prevented the disinterested performance of their duty to the Erie Railway Company, and imposed an obligation upon that company for their benefit. And as they were directors in that company, as well as in the Suspension Bridge & Erie Junction Railroad Company, they were disabled from creating, or contributing by their action to the creation of, this obligation; for directors of a corporation sustain the substantial relations to it of trustees, who are bound to devote themselves disinterestedly to the advancement of the interests and prosperity of the company. They have no right, legally or morally, to contribute to the creation of an obligation on the part of the corporation they represent which shall directly or indirectly result in a profit or advantage to themselves; but they are required to be governed solely by the motive of doing that which will best promote the prosperity and interest of the corporation whose affairs they are selected to manage. If they fail to observe this obligation, the law will not speculate to ascertain whether the company whose interests may be affected in this manner by its directors has been actually injured or not. But it' will condemn the contract or obligation brought about in this manner, and prevent these persons, and all others claiming its benefit or advantage under them, or from their acts, from maintaining or enforcing the agreement.

This action can be no otherwise sustained than by maintaining the validity of this lease, and justifying the misconduct of these directors in imposing a burden upon the corporation represented by them for their benefit; and that the courts will not do to aid and assist stockholders in another company claiming to be entitled through the misconduct of the common directors' to the advantages of such a contract as this action has been founded upon. This general subject was examined, and the rule sustained as broadly as it has been stated, in Munson v. Railroad Co., 103 N. Y. 58, 8 N. E. Rep. 355; and also in Wardell v. Railroad Co., 103 U. S. 651. An agreement entered into and brought into existence as this lease was is directly condemned by the rule which these authorities sustain; and it not only disables the Suspension Bridge & Erie Junction Railroad Company from enforcing it against the Erie Railway Company and its successor, but the same disability attached to the plaintiffs as stockholders in the former company, whose rights alone they have undertaken to enforce to maintain this action. They stand in the position of this company, and can obtain no other or greater advantages than the company itself was entitled to in the way of enforcing the payment of this rental. The contract was in conflict with the law as it has been constantly enforced against trustees who are not permitted to deal for their own benefit with the subject of the trust. Agreements entered into, or transactions consummated, for that object, have constantly and uniformly been condemned; and, where a contract may be entered into by the directors of a corporation which is offensive to this principle of the law, there no action can be maintained upon it, but it stands precisely the same as all other illegal agreements which the courts will not aid the parties or their privies in enforcing. Bell v. Leggett, 7 N. Y. 176; Sedgwick v. Stanton, 14 N. Y. 289.

The law relating to the rescission of agreements fraudulently induced has no application to this case; for the plaintiffs’ disability to maintain the action does not depend upon the circumstance of a formal rescission of the lease, either by the Erie Railway Company or the Yew York, Lake Erie & Western Railroad Company. The agreement itself created no binding obligation; and for that reason no rescission of it was required to entitle the parties proceeded against to avail themselves of this advantage. Yeither can the agreement to pay this rental be enforced because of the fact that the Erie Railway Company and its receiver, .and the Yew York, Lake Erie & Western Railroad Company as his successor, have retained possession, and continued to operate the railroad of the Suspension Bridge & Erie Junction Company; for the principle which has been applied upon the force of that circumstance securing the performance of the obligation of the other party, entered into without actual authority, can have no force or effect over this controversy. Where the sole objection is that an agreement is entered into by a corporation without authority, it is bound to pay the equivalent of the advantage secured by it as long as that advantage is enjoyed under the agreement. But this ease does not rest upon an agreement made extrinsic to the authority of the railroad companies. Each company did have the power to enter into this contract. But it is the manner in which it was brought about by the co-operation of the common directors, who were acting largely for the promotion of their interests in the creation of this agreement, that the law interferes and pronounces its condemnation upon it. The agreement itself as a contract is incapable of performance through the instrumentality of courts of justice; and the only remedy which either the Suspension Bridge & Erie Junction Railroad Company or its stockholders have is an action for an accounting against the Yew York, Lake Erie & Western Railroad Company for the earnings of the railroad itself. That does not appear to have been required, and, if it had been upon the trial of the action, no ground to support it was presented by the evidence, for the $70,000 a year paid for the use of the railroad appears to have exceeded the amount of its earnings for which the Yew York, Lake Erie & Western Railroad Company would be bound to account. The judgment should therefore be affirmed, with costs. All concur.