Case Name: CRANE CO. v. FIDELITY TRUST CO. et al.
Court: United States Court of Appeals for the Ninth Circuit
Jurisdiction: United States
Decision Date: 1916-12-04
Citations: 238 F. 693
Docket Number: No. 2768
Parties: CRANE CO. v. FIDELITY TRUST CO. et al.
Judges: Before GILBERT, ROSS, and HUNT,' Circuit Judges.
Reporter: Federal Reporter
Volume: 238
Pages: 693–705

Head Matter:
CRANE CO. v. FIDELITY TRUST CO. et al.
(Circuit Court of Appeals, Ninth Circuit.
December 4, 1916.)
No. 2768
1. RECEIVERS <&wkey;158(2) — Payment oe Claims — Priority oe Unsecured Debts to Pre-existing Liens.
It is the exception and not the rule that prior recorded liens may be displaced by general and unsecured claims, and while circumstances may exist which make it practically necessary to the business of a public service corporation and the preservation of its property that pre-existing debts of certain classes should be paid by its receiver out of the earnings of the receivership, or even out of the corpus of the property, the discretion to make such payments should be exercised with very great care. In general, only claims which were a part of the general current expenses of the ordinary operation of the mortgaged property in the usual course of business of the mortgagor, as distinguished from those for permanent additions or improvements, should be given such preference, and this rule should not be disregarded, except as a, matter of business policy, where such preferential payment is necessary to keep the corporation a going concern in the hands of the receiver, or to prevent a loss at least equal to the amount of the payment.
[Ed. Note. — For other cases, see Receivers, Cent. Dig. § 303; Dec. Dig. &wkey;158(2).]
2. Receivers <&wkey;158(2) — Payment oe Claims — Priority of Unsecured Debts to Pre-existing Liens — “Construction Items” — “Reconstruction”— “Repairs.”
Claims against a public service corporation arising within a limited time before a receivership, which may be given preference over a prior mortgage as for current operating expenses, do not include those for service extensions of a water, gas, or electric light system, which are not to be considered as “repairs,” but rather as “construction items,” nor for additional equipment or replacement of worn-out equipment, which should be classified as “reconstruction.”
[Ed. Note. — For other cases, see Receivers, Cent. Dig. § 303; Dec. Dig. &wkey;158(2).
For other definitions, see Words and Phrases, First and Second Series, Reconstruction; Repairs.]
3. Receivers <&wkey;159 — Payment oe Claims — Priority oe Unsecured Debts to Pre-existing Liens — Diversion oe Income.
' The -payment of interest to bondholders of a corporation, who are entitled to such payment in priority to claims of supply creditors, is not a diversion of income. '
[Ed. Note. — For other cases, see Receivers, Cent. Dig. §§ 307, 308; Dec. Dig. &wkey;>159.]
Gilbert, Circuit Judge, dissenting.
Appeal from the District Court of the United States for the Southern Division of the Western District of Washington; Edward E. Cush-man, Judge.
Suit in equity by the Fidelity Trust Company, trustee, against the Washington-Oregon Corporation, Willis D. Hoag, its receiver,' and others, in which the Crane Company intervened. From a decree denying it priority, the Crane Company appeals.
Affirmed.
See, also, 217 Fed. 588.
Maurice W. Seitz, of Portland, Or., for appellant.
Randolph W. Childs, of Philadelphia, Pa. (Maurice A. Eanghprne, Frederic D. Metzger, and E. M. Hayden, all of Tacoma, Wash., of counsel), for .appellees.
Before GILBERT, ROSS, and HUNT,' Circuit Judges.
Rehearing denied February 13, 1917.

Opinion:
HUNT, Circuit Judge.
The Crane Company, appellant, from time to time between January 1, 1911, and May 31, 1914, sold certain water pipes, fittings, and gas and water equipment to the Washington-Oregon Corporation engaged in the operation of electric railway systems and light and water systems in Washington and Oregon. In May, 1911, the Washington-Oregon Corporation made a mortgage and deed of trust to Fidelity Trust Company, as trustee, to secure a bond issue of Washington-Oregon Corporation for $5,000,000, the bonds to bear 6 per cent, interest, interest maturing on the 1st of April and the 1st of November in each year; the mortgage constituting a -lien upon all property of every nature and description then owned by Washington-Oregon Corporation and thereafter acquired by it, and upon the rents, issues, and profits of all of such property. The mortgage was duly recorded. Interest was paid upon the bonds issued under the mortgage up to November 1, 1913, but the defendant corporation defaulted in the interest due on April 1, 1914. Foreclosure proceeding was instituted, , a receiver was appointed, and the possession of the property passed to the receiver on July 31, 1914. The Crane Company intervened in the foreclosure proceedings, and asked that its claim for $11,-146.67 be declared prior to the mortgage debt, and that-the claim be paid'out of the proceeds of the mortgage property, or out of the income of the receivership. The receiver and the complainant answered intervener's petition, and the cause was submitted upon a stipulated statement of facts.
In the stipulation it was agreed that on June 1, 1914, a balance was struck between Crane Company and Washington-Oregon Corporation,- and that the Oregon-Washington Corporation was found to owe the Crane Company $13,225.25; that to evidence this debt the Washington-Oregon. Corporation made six promissory notes, payable at different times, to the order of Crane Company; that one of the notes was thereafter paid on June 7,1914; that the merchandise' which was^ furnished by the Crane Company and unpaid for consisted of material furnished for public service corporations at different places in Oregon "and Washington; that the materials furnished by the Crane Corqpany, and the credits extended, to the Washington-Oregon Corporation, were in reliance on the part of the Crane Company that the same would be paid out of the current earnings of the Washington-Oregon Corporation, and that the current income would be applied to the payment for such materials, and that- to that end the Crane Company permitted the account to continue as a running account and to accept payments from time to time as the Washington-Oregon Corporation declared its ability to make such payments; that the interest was paid on outstanding bonds covered by the mortgage sought to be foreclosed for the two years immediately prior to the receivership; that during the period within which Crane Company's claim accrued, and thereafter, there were actual operating net earnings in excess -of the interest of the Washington-Oregon Corporation due and paid by the Washington-Oregon Corporation during said period, on the first consolidated mortgage bonds covered by the foreclosure suit, and in excess of the Crane Company's claim.
The District Court denied all preferences, except for material furnished within six months prior to the appointment of the receiver, and decreed that there was no equity in the claim of intervener for preferential payment over the claims of the mortgage bondholders, save to the extent of $56.03. The 'Crane Company appeals from the decree.
The claims of the Crane Company may be classified as follows: (1) Service extensions, such as gas equipment for service connections, and water equipment for service connections; (2) main extensions, for water main extensions to different places; (3) betterments, such as hydrant systems, wood gates, and water valves; (4) reconstruction, water mains and pipes to replace certain old mains; (5) repairs, miscellaneous items in the way of water equipment.
In Moore et al. v. Donahoo et al., 217 Fed. 177, 133 C. C. A. 171, this court recently considered the question whether claims for current supplies which are necessary to the maintenance of the property of a public service corporation to keep it in operation should be paid out of the current income in preference to the bonds upon the assumption that the lien of the mortgage attaches only to the residue of the income remaining after the payment of the operating expenses, or should such claims displace the vested lien of the mortgage upon the body of the estate because the claimants by their labor and supplies have rendered necessary .assistance in continuing the operation of the property, thus enabling the debtor to discharge its obligations to the public.
The question was regarded as conclusively determined by the Supreme Court in Gregg v. Metropolitan Trust Co., 197 U. S. 183, 25 Sup. Ct. 415, 49 L. Ed. 717. Inasmuch as the facts of the Gregg Case are stated in the opinion of the court in Moore v. Donahoo, we need not repeat them. But as specially pertinent we quote the following language from Gregg v. Metropolitan Trust Co., supra:
"There are no special circumstances affecting the claim as a wli'ole, and if it is charged on the corpus it can he only by laying down a general rule that such claims for supplies are entitled to precedence over a lien expressly created by a mortgage recorded before the contracts for supplies were made. An impression that such a general rule was to be deduced from the decisions of this court led to an evidently unwilling application of it in New England R. Co. v. Carnegie Steel Co., 75 Fed. 54, 58 [21 C. C. A. 219], and perhaps in other cases. But we are of opinion, for reasons that need no further statement (Kneeland v. American Loan & Trust Co., 136 U. S. 89, 97 [11 Sup. Ct. 426, 34 L. Ed. 1052]), that the general rule is the other way, and has been recognized as being the other way by this court."
It is well recognized that there may be exceptional cases arise where preferences should be considered and a receiver authorized to pay past debts and charge the same against the corpus of the fund, where fail ure to make such payment would result in injury to, or would make it difficult to carry on, the business of the estate. An instance is given in Miltenberger v. Logansport, etc., Ry. Co., 106 U. S. 286, 1 Sup. Ct. 140, 27 L. Ed. 117. But Justice Holmes.points out in the Gregg Case:
"The ground of such allowance as was made was not merely that the supplies were necessary for the preservation of the road, but that the payment was necessary to the business of the road — a very different proposition."
The decision in Moore v. Donahoo conformed to the principle recognized in this circuit in the earlier case of Spencer et al. v. Taylor Creek Ditch Co. et. al., 194 Fed. 635, 114 C. C. A. 407, where Judge Morrow, writing for the court, traced the doctrine of Fosdick v. Schali, 99 U. S. 235, 25 L. Ed. 339, through Kneeland v. American Loan & Trust Co., supra, to Gregg v. Metropolitan Trust Co., supra, and held it to be the exception and not the rule that priority of liens can be displaced by general and unsecured claims.
We agree that the six months rule is not inflexible. The reason that six months is frequently taken as the limited time within which preferential claims must accrue is because usually a six months interval passes between tire dates when installments of interest upon bonds fall due, and because mortgages often provide that, when an installment of interest is paid, current expenses to that time have either been paid or funds to pay them have been lawfully provided. But tire law as laid down by the Supreme Court is that, while circumstances may exist which make it practically necessary to the business of a concern and the preservation of the property that pre-existing debts of certain classes should be paid by the receiver out of the earnings of the receivership, or even out of the corpus of the property, the discretion to make such preferential payments should be exercised with very great care. Westinghouse Air Brake Co. v. Kansas City Southern Ry. Co., 137 Fed. 26, 71 C. C. A. 1; High on Receivers (3d Ed.) § 394a; Street's Federal Equity Practice, § 2750 (1909).
In Illinois Trust & Savings Bank v. Doud et al., 105 Fed. 123, 44 C. C. A. 389, 52 L. R. A. 481 (Court of Appeals for the Eighth Circuit), the court, after a very elaborate review of the decisions of the Supreme Court prior to 1901, used this language with respect to the limitations applicable to the class of claims entitled to equitable preference:
"The test of the preferential equity of a claim is its consideration. If its consideration was a current expense of the operation of the mortgaged property, which inured to its benefit, and which was incurred in the ordinary course of its business, within a limited time anterior to the appointment of the receiver, the claim may be preferred. The Supreme Court has refused to apply the principle of the civil and maritime laws of awarding priority to the last creditor who furnished necessary repairs and supplies to a vessel to the distribution of the proceeds of the foreclosure of mortgages of quasi public corporations. Railroad Co. v. Cowdrey, 11 Wall. 459, 474, 482, 20 L. Ed. 199; Thompson v. Railroad Co., 132 U. S. 68, 74, 10 Sup. Ct. 29, 33 L. Ed. 256. If the consideration of a claim is not a part of the current expenses of the ordinary operation of the mortgaged property, but is a part of the expense of constructing a permanent addition or improvement to it, out of the ordinary course of its operation, neither the fact that it tended to conserve and improve the property and increase the security of the mortgagee, nor the fact that it was necessary to keep the mortgagor a going concern, nor the fact that the mortgagor pledged or mortgaged the current income to secure it, will give the claim a preferential equity over the lien of a prior mortgage."
In Rodger Ballast Car Co. v. Omaha, K. C. & E. R. Co. et al., 154 Fed. 629, 83 C. C. A. 403, the same court carried its examination of decisions down to 1907; and in the recent case of Love et al. v. North American Co. et al., 229 Fed. 103, 143 C. C. A. 379, speaking through Judge Carland, said:
"The class of claims which under the decisions of the Supreme Court may lawfully receive an equitable preference in payment out of the income or out of the corpus of the property of a mortgaged railroad over the bondholders secured by a prior mortgage is limited to claims incurred for the current expenses of the ordinary operation of the mortgaged property in the usual course of the business of the mortgagor. The test of the preferential equity of a claim is its consideration. If its consideration was a current expense of the ordinary operation of the property of the mortgagor incurred in the usual course of its business, for labor, supplies, and like things, necessary for th'e operation of the railroad, within a limited time, usually not exceeding six months anterior to the appointment of the receiver, the claim may be preferred in payment; otherwise, it may not be."
In thus stating the law the court cites many federal decisions, including Chicago & A. R. Co. v. U. S. & Mex. Trust Co. et al., 225 Fed. 940, 141 C. C. A. 64, and Martin Metal Mfg. Co. v. Same, 225 Fed. 961, 141 C. C. A. 85.
In Chicago & A. R. Co. v. U. S. & Mex. Trust Co. et al., supra, the court held that the claim of preference to payment out of the corpus of the mortgaged property, because it was founded on services rendered which were absolutely necessary to the business of the railway to keep the road a going concern, so that the company's property would be preserved and its public duty discharged, was without ground, because in Gregg v. Metropolitan Trust Co., supra, the Supreme Court had decided that even a claim of such nature accruing within six months prior to the receivership may not be preferred in payment out of the corpus of the mortgaged property to the claims of the bondholders secured thereon in the absence of a diversion of income, found to be lacking. Judge Sanborn carefully considered the decisions of the Supreme Court as bearing upon two particular grounds: First, the diversion of income; and, second, the.necessity or business policy of immediate payment — these two grounds being those upon which claims for current expenses for necessities of operation have been paid out of the corpus of the property. But the learned judge points out that Miltenberger v. Logansport, etc., Ry. Co., supra, and Union Trust Co. v. Illinois Midland Co., 117 U. S. 434, 6 Sup. Ct. 809, 29 L. Ed. 963, in both of which cases claims were allowed as necessary for immediate payment, were decided 15 years before the beginning of the series of decisions found in Kneeland v. American Loan & Trust Co., supra, Morgan's Co. v. Texas Central Ry., 137 U. S. 171, 11 Sup. Ct. 61, 34 L. Ed. 625, Thompson v. Valley R. R. Co., supra, Thomas v. Western Car Co., 149 U. S. 95, 13 Sup. Ct. 824, 37 L. Ed. 663, Southern Ry. Co. v. Carnegie Steel Co., 176 U. S. 257, 20 Sup. Ct. 347, 44 L. Ed. 458, Lackawanna Iron & Coal Co. v. Farmers' Loan & Trust Co., 176 U. S. 298, 20 Sup. Ct. 363, 44 L. Ed. 475, and Gregg v. Metropolitan Trust Co., supra. And Moore v. Donahoo, supra, decided by this court, was cited by tire court to sustain the proposition that, if a claim for the current expenses of the necessities of the operation of a railroad is payable in preference to the claims of secured bondholders out of the corpus of the property in any case in the absence of diversion of the income from such expenses, it is only when such preferential payment is necessary to keep the railroad a going concern, or when its preferential payment is necessary to prevent a loss at least equal to the amount of the payment. These cases, we believe, correctly state the general doctrine which must control our decision, and under it materials for extensions and betterments, as included in certain detailed lists incorporated in the record in the present case, must be declared not entitled to preference. •
With respect to service extensions, we believe they are not to be considered as repairs, but rather as construction items. , Worn-out equipment, when replaced on an extensive scale, ought not to be classified as repairs, but as reconstruction. Additions to equipment are not current operating charges. Lackawanna Iron & Coal Co. v. Farmers' Loan & Trust Co., supra; Central Trust Co. of N. Y. v. Colorado, etc., Co. (D. C.) 200 Fed. 85; Toledo, etc., R. R. Co. v. Hamilton, 134 U. S. 296, 10 Sup. Ct. 546, 33 L. Ed. 905; International Trust Co. v. Townsend, etc., Co., 95 Fed. 850, 37 C. C. A. 396; Reyburn v. Consumers' G., F. & L. Co. (C. C.) 29 Fed. 561. In the last case the court disallowed a claim for meters, because meters are not a current necessity, but equipment constituting additions or extensions of the business.
The payment of interest to bondholders entitled to the payment of interest in priority to the claims of creditors claiming is not a diversion. Central Trust Co. v. East Tenn., V. & G. R. Co., 80 Fed. 624, 26 C. C. A. 30.
Without carrying the discussion further, it is enough to say,that in the present case the only goods furnished within the six months period were those of the value of $56.03 allowed by the lower court. The Crane Company stands, we think, as a creditor which sold goods to the Washington-Oregon Corporation with the expectation of realizing profits as in ordinary commercial transactions. It extended credit to the corporation, whereas the bondholders lent money to the corporation, looking solely to the security of the mortgage given by the corporation upon all of its then owned and after-acquired property and the income thereof. The Crane Company permitted its claim to run for a long time, part of it for several years; but the bondholders brought proceedings in foreclosure within a month of the time when their right to foreclosure accrued.
The Crane Company, having sold materials which do not fairly constitute operating supplies necessary to the business of the Washington-Oregon Corporation, and having sold them prior to that time preceding the appointment of the receiver within which courts of equity have announced that priority claims would accrue, and having shown no special equity upon which they can rest the right of preference, must fail as against the,contract rights of the bondholders secured by the mortgage.
The decree is affirmed.
«®cs>For other cases see same topic & KEY-NUMBER in all Key-Numbered Digests & Indexes