Case Name: Charles Wyllys Cass and James Dunbar Cass, Respondents, v. Realty Securities Company and Others, Appellants, Impleaded with Title Guarantee and Trust Company and Frank M. Hutchinson
Court: New York Supreme Court, Appellate Division
Jurisdiction: New York
Decision Date: 1911-12-29
Citations: 148 A.D. 96
Docket Number: 
Parties: Charles Wyllys Cass and James Dunbar Cass, Respondents, v. Realty Securities Company and Others, Appellants, Impleaded with Title Guarantee and Trust Company and Frank M. Hutchinson.
Judges: 
Reporter: Appellate Division Reports
Volume: 148
Pages: 96–109

Head Matter:
Charles Wyllys Cass and James Dunbar Cass, Respondents, v. Realty Securities Company and Others, Appellants, Impleaded with Title Guarantee and Trust Company and Frank M. Hutchinson.
First Department,
December 29, 1911.
Pleading—joinder of action against corporation with, action against directors individually — complaint not stating cause of action against directors for misapplying assets in violation of lien of mortgage —■ liability of directors to bondholders —error of judgment — conclusions of law—bonds and stock distinguished — scrip entitling, holder to share in profits.
An action by one owning bonds issued by a corporation and secured by a junior mortgage upon its property cannot join a cause of action against the corporation to recover the proceeds of a sale of the mortgaged property under the senior mortgage with an action against the directors of the corporation individually to recover the proceeds of said sale which are alleged to have been wrongfully paid to the general creditors of the corporation in violation of the lien of the junior mortgage.
The directors of a corporation as individuals owe no direct duty to an owner of its bonds, the contract of the bondholder being with the corporation itself. Hence, such bondholder cannot maintain an action against the directors personally for disposing of the proceeds of the sale of the corporate property under a prior mortgage without first exhausting his remedies against the corporation.
Moreover, as any action of the bondholder against the directors is derivative, and must be prosécuted in the right of the corporation, an individual action against them does not lie where it does not appear that the corporation itself has suffered from their acts.
Directors are not liable for mere errors of judgment if they act without corrupt intent, and this is true whether the mistake of judgment be one of law or fact. Hence, an action by such bondholder does not lie against the directors individually where by mistake they have paid the proceeds of a sale under a prior mortgage to the general creditors of the company in alleged violation of the lien of the junior mortgage.
This is true although the bondholder charges the directors with a conspiracy to defraud the corporation and "its bondholders, and makes charges of fraud and mismanagement, if the allegations are mere conclusions of the pleader, owing to the fact that no specific facts supporting them are stated.
The mere fact that an instrument is called a bond does not determine its character.
A bond is an obligation to pay a fixed sum, with interest, and the payment may or may not be secured.
Stock, as distinguished from bonds, confers upon the holder part ownership of the assets of the corporation and a right to dividends from surplus profits and to share in the assets on dissolution.
A stockholder, whether common or preferred, cannot have a lien on the property of the corporation even though the stock by its terms creates a lien.
Hence, where an instrument called a bond entitled the holder to a proportionate share in the surplus income of the corporation, if any, it is not a bond, but is a certificate of stock.
The court cannot hold such instrument to be a valid bond by disregarding the provision allowing the holder to share in surplus income. Latjg-hlijST, J., dissented, with opinion.
Appeal by the defendants, the Realty Securities Company and others, 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 6th day of June, 1911, overruling the appellants’ demurrers to the complaint and granting the plaintiffs’ motion for judgment on the pleadings.
Grenville Clark [Elihu Root, Jr., and Alfred C. Intemann with him on the brief], for the appellants.
Walter H. Bond, for the respondents.

Opinion:
Scott, J.:
The plaintiffs, claiming to own bonds issued by the Realty Securities Company which were secured by a junior hen upon certain real estate, complain that defendants, other than the Title Guarantee and Trust Company, have diverted a part of the net proceeds of the sale of the mortgaged property to the payment of the general creditors of the securities company, and threaten so to devote what remains of said net proceeds. Their claim is that their lien attached to the net procéeds, after satisfaction of the prior Hens, and that their right thereto was superior to that of the general creditors. The relief sought is that a receiver he appointed of the assets of the securities company; that an accounting he had Of the management, application and disposition by the individual defendants (who are directors of the securities company), and particularly in regard to the proceeds of the sale of mortgaged property; that the said defendants be required, to pay to the receiver any moneys or the value of any property which they have wrongfully, illegally and improperly paid out or transferred or lost Or wasted; that the securities company and the individual defendants be enjoined from paying out any moneys of the company for any purpose, except under the order of the court; and that the assets of the company be collected and marshaled.
The amount said to be due upon the whole issue of bonds, and which plaintiffs seek to recover, is for unpaid' interest and much exceeds in amount the net proceeds of the sale of the mortgaged property, which is stated at $33,000, of which $20,000 has been paid to general creditors and $13,000 is still in possession of the securities company. The plaintiffs' contention is that their Hen upon the property was transferred and attached to the net proceeds of the sale of the mortgaged premises; that their, right thereto was superior to that of the general creditors, and hence that the appropriation of any part of it to the payment of the claims of general creditors was unlawful. The demurrer, besides' other grounds, challenges the complaint for general insufficiency and for misjoinder of causes of action. I think that there can be no doubt that the plaintiffs have attempted to set forth at least two causes of action. If so, the complaint is obnoxious to the demurrer whether either or both have been well, pleaded.. There is a cause of action against the securities company to recover the $13,000, part of the proceeds of sale of the mortgaged property still remaining in its hands. To this action the individual directors are not proper parties. There is also a cause of action attempted to' be set out against the individual directors to recover moneys or properties said to have been lost, disposed.of or wasted in consequence by their wrong. These two causes of action rest upon wholly different principles and must be sus tained by quite different facts. They are incapable of joinder in one complaint. It may also be, as claimed by appellants, that there are two causes of action united against the company, one legal and one equitable, but it is sufficient for present purposes to treat the complaint as containing only the two causes of action above mentioned. /
So far as concerns the individual directors the complaint does not, in my opinion, state a cause of action. The directors as individuals owed no duty directly to the plaintiffs. " The plaintiffs' contract was with the securities company, and its claim is against that company; consequently whatever right it may have to proceed directly against the directors is a derivative •one, and must be prosecuted in the right of the company. In other words, they cannot obtain any relief which the company could not obtain if it sued. Plaintiffs have not, I think, qualified to sue the directors because they have not yet exhausted the remedies against the company, but, passing that point, it seems clear that no action will he in right of the company because it does not appear that the company has suffered from anything which the directors have done. They have simply paid one class of creditors, instead of another. Furthermore it is not alleged that the individual directors, even if they have paid general creditors with moneys upon which plaintiffs had ' an equitable lien, have been guilty of anything more than an honest mistake. It is well settled that directors are not liable for mere errors of judgment if they act without corrupt intent. (People v. Equitable Life Assurance Society, 124 App. Div. 731, and cases there cited.) And this is equally true whether the mistake of judgment refers to the law or the facts: It was
so held in Seymour v. Spring Forest Cemetery Assn. (4 App. Div. 359; affd. on opinion below, 157 N. Y. 697), wherein the claim against the directors was quite similar to that embraced in this complaint, to wit, that the directors had failed to apply to the proper purpose certain funds of the association. I do not overlook the fact that the complaint charges the directors with having entered into a scheme or plot to injure and defraud the securities company and its bondholders, and also contains other general charges of fraud and mismanagement. All these, however, are merely the conclusions of the pleader and are of no moment except as supported by specification of wrongful acts, and when we look for the specification we find nothing more than an allegation that the directors have paid or caused to be paid a part of the proceeds of the mortgaged property to the general creditors of the company, instead of reserving it for plaintiffs. I am, therefore, clearly of the opinion that the complaint attempts to set up two causes of action which cannot properly be joined, and that the complaint does not state facts sufficient to constitute a cause of action against the individual defendants.
I am also of the opinion that the securities upon which plaintiff claims, although denominated bonds, and drawn in that general form, are in effect nothing more than a species of preferred stock. The fact that the instrument is called a bond is not determinative of its character, for it is our duty to look to the substance of things, and there are many cases wherein securities denominated bonds have been held to be stock, and vice versa. (Burt v. Battle, 31 Ohio St. 116; Hilson Co. v. State Board of Assessors, 80 Atl. Rep. 929.) The distinguishing feature of a bond is that it is an obligation to pay a fixed sum, with stated interest. It may or may not be secured, but if it is, and the security proves to be insufficient, the indebtedness is not thereby wiped out. The distinguishing feature of stock is that it confers upon the holder a part ownership-of the assets and right to participate according to the amount of his stock in the surplus profits of the corporation, and ultimately, on its dissolution, in the assets remaining after the payment of its debts. (Burrall v. Bushwick R. R. Co., 75 N. Y. 211; Plimpton v. Bigelow, 93 id. 592.) It is fundamental that a stockholder, whether common or preferred, cannot have a lien on the property of the corporation, even though the stock by its terms is accorded a lien. (Cook Corp. [6th ed.] § 271; Warren v. King, 108 U. S. 389.) The securities upon which plaintiffs claim partake in a marked degree of the distinguishing characteristics of stock. It is true that they contain a promise to pay a stated sum óf money at a fixed time, and to pay meanwhile a stated rate of interest, but these obligations are qualified by what follows. It is provided that after the payment of certain fixed dividends on the common and preferred stock, the holders of the bonds in suit are " entitled tó a proportionate share in the surplus income, if any." So upon the liquidation of the company the holders of the bonds are entitled to share, after certain payments have been made, in the surplus capital of the corporation, and finally the bond will be satisfied, not only upon payment of its face value, but upon payment of a ratable proportion of the assets, whether more or less than the amount called for on its face. All these features are characteristic of stock and quite foreign to the accepted definition of al bond. In short the attempt seems to have been to devise a form of security which should possess all the attributes of stock, including a right to share ratably in the profits ánd increase in value, and at the same time to preserve a specific lien upon the company's assets which should be superior to the claims of creditors. This cannot lawfully be done for the two things are inherently inconsistent. It is said that we can sever the good from the bad, and disregard the features which assimilate these securities to stock, retaining and.affirming their validity as bonds. This, as it seems to me, would be to make a new contract for the parties.
The order overruling the demurrer should be reversed, with ten dollars costs and disbursements to the appellants, and the demurrer sustained, with ten dollars costs, with leave to the plaintiffs to amend upon payment within twenty days of costs in this court and the court below.
Ingraham, P. J., Clarke and Miller, JJ., concurred; Laughlin, J., dissented.