Case Name: Francis Sherwood Male, as Trustee for Gilbert W. Chapin, Appellant, v. The Atchison, Topeka and Santa Fe Railway Company, Respondent, Impleaded with Atlantic and Pacific Railroad Company, Defendant
Court: New York Supreme Court, Appellate Division
Jurisdiction: New York
Decision Date: 1917-07-13
Citations: 179 A.D. 87
Docket Number: 
Parties: Francis Sherwood Male, as Trustee for Gilbert W. Chapin, Appellant, v. The Atchison, Topeka and Santa Fe Railway Company, Respondent, Impleaded with Atlantic and Pacific Railroad Company, Defendant.
Judges: 
Reporter: Appellate Division Reports
Volume: 179
Pages: 87–105

Head Matter:
Francis Sherwood Male, as Trustee for Gilbert W. Chapin, Appellant, v. The Atchison, Topeka and Santa Fe Railway Company, Respondent, Impleaded with Atlantic and Pacific Railroad Company, Defendant.
First Department,
July 13, 1917.
Corporations — railroads — action to enforce payment of bonds — rights of purchaser at judicial sale in absence of fraud — guaranty — subrogation — effect of.payment by guarantor — laches.
In an action against the Atlantic Railroad Company and the old Atchison Railroad Company to recover the principal of income bonds issued by the first company with interest thereon it appeared from the complaint that the Atlantic Company owned a franchise to build a road from its initial terminus through Albuquerque, N. M., to the Pacific coast but was without funds; that the old Atchison and Frisco Companies owned more than seven-eighths of the capital stock of the Atlantic Company; that the old Atchison being desirous of extending its road from Albuquerque west to the Pacific coast but being unable to do so under its charter, it was proposed that the old Atchison and the Frisco Companies should sell the securities of the Atlantic Company to enable it to build its road westward. This was done pursuant to an agreement between the three companies under which the Atlantic Company issued three series of bonds; first mortgage; second mortgage and income bonds. The old Atchison and Frisco Companies guaranteed the payment of the first mortgage bonds and paid the interest thereon receiving for their advances second mortgage bonds of the Atlantic Company. Subsequently actions were brought to foreclose certain mortgage hens upon the property of the old Atchison and Frisco Companies and later an action was brought by the trustees of the second mortgage on the Atlantic Company’s property and the same receivers were appointed in each action. The stock of the Atlantic Company having become worthless, the new Atchison Company, a reorganization of the old Atchison Company, went through the form of selling and transferring all such stock owned by it, and on the same day purchased and received from the owners thereof the entire issue of the first mortgage bonds of the Atlantic Company, and it was agreed that thereby the new Atchison Company should be released from all obligations under the old Atchison Company’s guaranty of the • payment of the same. The new Atchison Company then proceeded to enforce decrees of foreclosure and sale against the property of the Atlantic Company from the income of which the income bonds were to be paid and subsequently purchased said property.
There was no diversion of assets of the Atlantic Company, no collusive foreclosure, and no violation of any duty that the old or new Atchison Company owed to the stockholders or creditors of the Atlantic Company. The sole charge is that the road was constructed for the use and benefit of the Atchison Company.
Held, that as the agreement between the companies was made prior to the issuance of the income bonds and said bonds were issued in furtherance of the agreement the plaintiffs as holders thereof are not in a position to attack the agreement under which they were issued, in an action to enforce payment on the bonds.
This ease comes within the rule that in the absence of fraud the purchaser on a judicial sale in a foreclosure action obtains title free from all claims of subsequent honors who were parties to the action and of all unsecured creditors of the owner.
The plaintiff not being a stockholder or creditor of the old Atchison Company has no interest in the process of its reorganization.
A guarantor has the right in protection of his own interest to pay the obligation and thereby become subrogated to the rights of the original holder to enforce the security which he held.
Payment by a guarantor does not discharge the debt as between the debtor and the guarantor.
Plaintiffs in this ease are chargeable with gross laches that is not excused by any statement of fact in the complaint, which should be dismissed. Dowling, J., dissented, with opinion.
Appeal by the plaintiff, Francis Sherwood Male, as trustee, from an order of the Supreme Court, made at the New York Special Term and entered in the office of the clerk of the county of New York on the 9th day of March, 1916, granting respondent’s motion for judgment on the pleadings, consisting of an amended complaint and demurrer thereto, and dismissing the amended complaint, and also from the judgment entered in said clerk’s office on the 16th day of March, 1916, dismissing the amended complaint pursuant to said order.
William G. Cooke [Howard O. Wood with him on the brief], for the appellant.
Walker D. Hines [A. S. H. Bristow with him on the brief], for the respondent.

Opinion:
Page, J.:
The complaint is quite fully set forth in the opinion of Mr. Justice Dowling; therefore, only incidental reference need be made to it herein. For convenience and brevity, the various railroad corporations will in this opinion be designated, as in the complaint, the Atchison, Topeka and Santa Fe Railroad Company, as the old Atchison; the Atchison, Topeka and Santa Fe Railway Company, as the new Atchison; the Atlantic and Pacific Railroad Company, as the Atlantic Company; and the St. Louis and San Francisco Company, as the Frisco Company.
The plaintiff's theories of his rights to recover are: I. That the old Atchison Company had made itself liable in equity for the principal and interest of the income bonds, and upon reorganization the new Atchison Company succeeded to and was charged with that liability, for the reasons set forth in Northern Pacific Railway v. Boyd (228 U. S. 482). II. That if the income bonds be regarded as an obligation of the Atlantic Company solely, and for which the old Atchison Company was not charged with liability, the new Atchison is hable; for the reason that the new Atchison reorganization involved and included, in purpose and effect, the acquisition by the new Atchison of the property of both the old Atchison and the Atlantic, so that the new Atchison became hable for the debts of both, under the authority of Kansas City Railway v. Guardian Trust Co. (240 U. S. 166). III. That the sale under foreclosure of the Atlantic Company's property was void as against the holders of the income bonds, and that the new Atchison Company holds the property so sold subject to the claims of the plaintiff.
I. There was no contractual liability of the old Atchison Company to the holders of the income bonds of the Atlantic Company. They are the obligations of the Atlantic Company, payable out of the net earnings of the western division of the Atlantic Company. Neither the principal nor interest was guaranteed by the old Atchison Company. The appellant seeks to predicate liability upon the fact that a large percentage of the stock of the Atlantic Company was held by the old Atchison which, with the stock of the Atlantic Company held by the Frisco Company, gave a majority holding in these two companies. A majority of the stopk of the Frisco Company was also held by the old Atchison Company. As the three companies had a harmonious management, and the western division of the Atlantic and the line of the Frisco were operated by the old Atchison Company, the appellant argues that the old Atchison Company held the property in trust for its creditors and that an equitable lien in favor of the holders of the income bonds became impressed on the property.
Conceding that the old Atchison Company, through its controlling interest in the Frisco Company, was able to elect the directors and officers of the Atlantic Company, the obligation that rested on the old . Atchison Company was that of a majority stockholder and occupies to the minority stockholders the same trust relation that the corporation itself bears to its stockholders. It cannot ." divert the income of its business, refuse business which would enable the defaulting company to pay its interest, and then institute an action in equity to enforce its obligations, for the avowed purpose of obtaining entire control of its property to the injury of the minority stockholders. Such a course of action is clearly opposed to the true interests of the corporation itself, plainly discloses that one thus acting was not influenced by any honest desire to secure such interests, but that its action was to serve an outside purpose, regardless of consequences to the debtor company, and in a manner inconsistent with its interest and the interest of its minority stockholders." (Farmers' Loan & Trust Co. v. New York & Northern R. Co., 150 N. Y. 410, 431, and cases cited.) To an extent, the same obligation of good faith and fair dealing are requisite in relation to the creditors of the corporation, and the corporation may not enter into a combination, the object of which is to financially embarrass the debtor corporation and thus bring about a foreclosure of a mortgage and by a combination, the object of which is to divest the corporation of its property and seek it for itself at the expense of the corporation, its stockholders or its creditors. (Jackson v. Ludeling, 21 Wall. 616.) When it appears that the controlling corporation has devised a scheme with this object in view, a court of equity will look beyond the forms of the transactions which have been used to cloak the design and will afford relief to those whom the purpose was to defraud. A striking illustration of such action will be found in Northern Pacific Railway v. Boyd (supra). Boyd's claim was primarily against the Cceur D'Alene Railroad and Navigation Company, the capital stock of which was nearly all owned by the Northern Pacific Railway Company. The latter company fraudulently diverted $465,000 of the assets of the former company, and the court held that the Northern Pacific Railroad Company remained liable for that sum until it was restored to the true owner, and that this diversion rendered the said company hable in equity for the payment of Boyd's judgment. Thereafter, a suit was brought to foreclose a mortgage upon the property of the Northern Pacific Railroad Company and a decree of foreclosure and sale was entered upon the consent of the railroad company, and the property bought by a reorganization committee of the railroad. Stock in the new corporation, Northern Pacific Railway Company, was exchanged for stock in the Northern Pacific Railroad Company. The court said (p. 506): "As between the parties and the public generally, the sale was valid. As against creditors, it was a mere form. Though the Northern Pacific Railroad was divested of the legal title, the old stockholders were still owners of the same railroad, encumbered by the same debts. The circumlocution did not better their title against Boyd as a non-assenting creditor. They had changed the name but not the relation. The property in the hands of the former owners, under a new charter, was as much subject to any existing liability as that of a defendant who buys his own property at a tax sale." And the court held that, in equity, Boyd could recover his judgment from the new corporation. It thus appears that the liability of the company to Boyd grew out of the fraudulent diversion of the assets of the Cceur D'Alene Company.
In the instant case there is not a single allegation of fact tending to show any fraudulent dealing with the assets of the Atlantic Company. Briefly summarized, it appears: That the Atlantic Company owned a franchise to build a road from its initial terminus through Albuquerque, N. M., to the Pacific coast; that it was without funds; the old Atchison's road extended to Albuquerque, and it was proposed that the old Atchison and the Frisco should sell the securities of the Atlantic Company to enable it to build its line from Albuquerque westward. This was done pursuant to an agreement between the three companies, the terms of which are not set forth, nor is it. material to this consideration. The old Atchison and the Frisco guaranteed the payment of the first mortgage bonds, principal and interest, and paid the interest thereon, receiving for their advances second .mortgage bonds of the Atlantic Company.
n There is no claim that the agreement between the companies was not kept in good faith, nor is there any allegation charging that the old Atchison diverted any of the income or business from the Atlantic Company or diverted any of its assets. The sole charge is that the road was constructed for the use and benefit of the Atchison Company; but as the agreement was made prior to the issuance of the income bonds, and these bonds were issued in furtherance of that agreement, these plaintiffs as holders of said bonds are not in position to attack the agreement under which they were issued in an action brought to enforce payment of the bonds.
In 1893 actions were brought to foreclose certain mortgage liens upon the property of the old Atchison and the Frisco Company respectively, and the same receivers were appointed by the different courts for both companies. In 1894 an action was brought by the trustee of the second mortgage on the Atlantic Company's western division, and the same receivers were appointed; the declared purpose being to maintain a harmony of operation to secure the best results for all interested in the property. Until these various properties passed into the hands of receivers, the interest on the first mortgage appears to have been paid. It is not claimed by the plaintiff that these foreclosures were collusively brought or not justified by the then condition of the roads and the financial stress of the times. Pending the suit to foreclose the mortgage on the old Atchison, a plan of reorganization was entered into by nearly all the owners of stock and bonds in that company, and a reorganization committee appointed, a sale of the property of the company was had, and the property bought by the reorganization committee on the 10th day of December, 1895. In September, 1895, the trustee of the first mortgage of the Atlantic Company brought suits to foreclose that mortgage, which resulted in decrees of foreclosure on April 10, 1896, June 1, 1896, and December 22, 1896. It is alleged in the complaint that all the first mortgage bonds were held by persons whose interests were other than the old Atchison Company, and that the suits were brought and prosecuted contrary to the wishes and efforts of the old Atchison Company, and " that the new Atchison Company resisted said foreclosure decrees by every lawful means in its power." The stock of the Atlantic Company had now become worthless, but it is alleged that on January 28, 1897, the new Atchison Company went through the form of selling and transferring all such stock owned by it, and on the same day purchased and received from the owners thereof, the entire issue of the first mortgage bonds of the Atlantic Company, and it was agreed that thereby the new Atchison Company should be released from all obligation under the old Atchison Company's guaranty of the payment of the same. The new Atchison Company thereupon proceeded to enforce the decrees of foreclosure and sale, and on the 3d day of May, 1897, the western division of the Atlantic Company with all its property and appurtenances was sold under such decree and was purchased by the members of the reorganization committee, who transferred it to a corporation all of whose stock was held by the new Atchison Company. This corporation shortly thereafter conveyed the same to the new Atchison Company. There is no similarity in these facts to the transaction reviewed in the Boyd Case (supra). In the instant case there was no diversion of assets of the Atlantic Company, no collusive foreclosure, and no violation of any duty that the old or new Atchison Company owed to the stockholders or creditors of the Atlantic Company. The property of the Atlantic Company was sold pursuant to a decree, the obtaining of which was not consented to nor a part of any plan or design of the Atchison Company to obtain the.property of the Atlantic Company, but was resisted by the new Atchison Company by every lawful means in its power. The instant case comes within the general and well-settled rule, that in the absence of fraud the purchaser on a judicial sale in a foreclosure action obtains title free from all claims of subsequent lienors who were parties to the action and of all unsecured creditors of the owner. This rule is recognized by the court in the Boyd case (p. 502), but it is demonstrated that that case is an exception to the rule. The reasons for the rule and the exception are admirably stated by Judge Gardiner in Candee v. Lord (2 N. Y. 269, 274). It is not necessary to consider the Atchison reorganization.
II. The plaintiff not being either a stockholder or creditor of the old Atchison, has no interest in the process of its reorganization. As we have stated hereinbefore, there was no scheme or plan for obtaining the property of the Atlantic Company, pursuant to which the Atchison Company procured the Atlantic Company nor did the stockholders of the Atlantic Company participate in the reorganization. The new Atchison received nothing, either directly or by way of allowance for its stockholdings in the Atlantic. That interest was extinguished by the foreclosure. In buying the first mortgage bonds, it did not act as a stockholder or in protection of its stock interest but solely in recognition of the liability of the old Atchison to pay the bonds by reason of its guaranty, which would have subjected the new Atchison to a claim for any deficiency that might arise. One so situated has the right, in protection of his own interest, to pay the obligation and thereby becomes subrogated to the rights of the original holder to enforce the security which he held. Kansas City Railway v. Guardian Trust Co. (supra) has no application to the instant case. Even if the Atchison Company was a stockholder of the Atlantic at the time it purchased the first. mortgage bonds, it nevertheless had an absolute right to protect itself from loss under its guaranty and to enforce the security in its own behalf and to acquire the property by the usual and lawfully settled procedure, and if there was no fraud, there being no trust relation, the new Atchison Company holds the property of the Atlantic Company free from all claim of its creditors.
III. The plaintiff finally contends that the judgment of foreclosure and sale was void, because the purchase of the bonds by the Atchison Company was a payment of the debt, and thereby the mortgage was satisfied and the subsequent sale was void and of no effect. It is sufficient answer to this contention to call attention to the fact that the debt was of the Atchison Company, payment of which was guaranteed by the old Atchison Company. Payment by a guarantor does not discharge the debt as between the debtor and the guarantor. The latter becomes subrogated to the rights of the original creditor
The plaintiff is chargeable with gross laches that is not excused by any statement of fact in the complaint.
The judgment should be affirmed, with costs.
Clarke, P. J., Laughlin and Smith, JJ., concurred; Dowling, J., dissented.