Court Opinion

ID: 9637041
Source: CourtListenerOpinion
Date Created: 2023-08-22 14:54:18.115122+00
Date Added: 2024-06-11T18:09:52.448011
License: Public Domain

SOPER, Circuit Judge
(dissenting).
There is no escape from the rule of Erie Railroad Company v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, 114 A.L.R. *2741487, that a federal court, exercising jurisdiction in a case on the ground of diversity of citizenship, must apply the law of the State in which it sits. The rule is endowed with all the vigor that comes from a recent decision that upset the precedents of a century, and it has been reenforced by the admonition that in such a situation “the federal courts must now search for and apply the entire body of substantive law governing an identical action in the state courts”; Ruhlin v. New York Life Ins. Co., 304 U.S. 202, 209, 58 S.Ct. 860, 862, 82 L.Ed. 1290; “and must apply it rather than to prescribe a different rule, however superior it may appear from the viewpoint of ‘general law’ and however much the state rule may have departed from prior decisions of the federal courts.” West v. American T. & T. Co., 311 U.S. 223, 237, 61 S.Ct. 179, 183, 85 L.Ed. 139, 132 A.L.R. 956.
We are obliged in the pending case to search for and apply the Maryland law in the interpretation of a trust indenture from a railroad company to a trustee to secure an issue of mortgage bonds, and to construe a clause of the contract that is without precise precedent in judicial decision in Maryland or elsewhere, so far as search of the authorities has disclosed. Certain bonds and stocks were pledged with the trustee by the Railroad Company as security for the mortgage debt, including 4,450 shares of the Richmond-Washington Company, one-sixth of the outstanding stock of a holding company which owned the Richmond, Fredericksburg and Potomac Railroad. As to these securities the mortgage provided in effect in Article 3 Section 1 that unless the Railroad Company should be in default in the payment of some interest upon its bonds for a period of six months, the trustee should not be entitled to collect the interest of any of the bonds or claims or indebtedness pledged with the trustee, and the Railroad Company should be entitled to receive all interest paid or dividends declared in respect of any bonds or stocks so pledged. Article 9 of the mortgage provided that until some default, the Railroad Company should be permitted to retain actual possession of the mortgaged premises and manage and operate and use the same, and collect and receive the earnings, income, rents and profits thereof.. It is plain from these provisions of the contract and from the continued operation of the mortgaged property by the mortgagor, that the Railroad Company was expected to hold and operate the railroad and to enjoy the income from its operation and its. investments until default, while the trustee was to hold the tangible property and securities described in the mortgage as a pledge to ensure the payment of the mortgage debt.
It was under these circumstances and before any default on the part of the Railroad Company had occurred, that the Richmond-Washington Company declared a stock dividend of 50 per cent, which amounted to 2,225 shares, on the holdings of the Railroad Company, and was delivered to it. The dividend was based on earnings which had accrued subsequent to the delivery of the stock in pledge to the trustee named in the mortgage. Now that the Railroad Company is in the hands of receivers, the question has arisen as to whether this dividend belongs, to the trustee under the mortgage, as the representative of the bondholders, or to the receivers of the Railroad Company subject to the claims of other secured or general creditors.
We are not aided in answering this question by the general rule in Maryland and elsewhere that a dividend accruing upon pledged stock belongs to the pledgee; for a contrary provision has been made in the terms of the contract. We must determine whether under the Maryland law the provision of the contract, that the Railroad Company until default is entitled to dividends on the pledged stock, covers the stock dividend in this case. We are told that the stock dividend does not fall within the terms of the contract because a stock dividend is not a true dividend. The leading authorities cited for the rule in the opinion of the court in the pending case are the well known decisions of Gibbons v. Mahon, 136 U.S. 549, 10 S.Ct. 1057, 34 L.Ed. 525, and Eisner v. Macomber, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, 9 A.L.R. 1570. These decisions are based upon the logical theory that a stock dividend really takes nothing from the property of the corporation and adds nothing to the interest of the stockholders; that it is not a realization of profits by the stockholders but a transfer of surplus, to capital so as to be no longer distributable; while an ordinary dividend is a distribution of profits which the corporation malees and the stockholder realizes. Moreover, it is said that *275the stock dividend in the pending case cannot fairly be described as a dividend payable to the Railroad Company within .the meaning of the contract, because otherwise the interest of the Railroad Company in the Richmond-Washington Company, that originally amounted to a one-sixth interest, would be reduced to a one-ninth interest, and the security of the bondholders would be impaired.
These authorities and others like them, present the reasoning upon which is founded the so-called Massachusetts rule governing the apportionment of dividends between life tenant and remainderman under a trust set up by a will or deed. This rule is that stock dividends, regardless of their source, are invariably treated as corpus, and cash dividends are classified as income. If it is applied by analogy to the facts of the pending case, we must hold that the stock dividend in question belongs to the trustee under the mortgage. But the Massachusetts rule, although favored in the federal courts and in other jurisdictions, is not recognized in the law of Maryland. By a long line of decisions of the Court of Appeals of Maryland, a different theory known as the Pennsylvania rule was firmly embedded in the law of the State when the mortgage under consideration was executed in 1900 and there remained until it was repealed by Chapter 580 of the Laws of Maryland of 1939.
The Maryland cases involving stock dividends are: Thomas v. Gregg, 78 Md. 545, 28 A. 565, 44 Am.St.Rep. 310; Atlantic Coast Line Dividend Cases, 102 Md. 73, 61 A. 295; Coudon v. Updegraf, 117 Md. 71, 83 A. 145; Northern Central Dividend Cases, 126 Md. 16, 94 A. 338; Miller v. Safe Deposit & Trust Company, 127 Md. 610, 96 A. 766; Baldwin v. Baldwin, 159 Md. 175, 150 A. 282.
The cash dividend cases are: Quinn v. Safe Deposit & Trust Company, 93 Md. 285, 48 A. 835, 53 L.R.A. 169; Ex parte Humbird, 114 Md. 627, 80 A. 209; Foard v. Safe Deposit & Trust Co., 122 Md. 476, 89 A. 724; Washington County Hospital Ass’n v. Hagerstown Trust Co., 124 Md. 1, 91 A. 787, L.R.A.1915A, 738; Krug v. Mercantile Trust & Deposit Co., 133 Md. 110, 104 A. 414. See, also, Girdwood v. Safe Deposit & Trust Co., 143 Md. 245, 122 A. 132; Zell v. Safe Deposit & Trust Co., 173 Md. 518, 196 A. 298; and Heyn v. Fidelity Trust Co., 174 Md. 639, 197 A. 292, 1 A.2d 83, 739.
In Smith v. Hooper, 95 Md. 16, 51 A. 844, 54 A. 95, the court held that very large capital gains from the investment of the corpus of a trust estate should not be treated as income payable to the life tenant within the meaning of that term as used in the will creating the trust. It was not a dividend case. Certain expressions in the opinion of the court, including a reference to Gibbons v. Mahon, seem out of line with the Pennsylvania rule, but the decision did not shake the court’s adherence to that rule, as an examination of the cases listed above will show. They are reviewed in the exhaustive opinion of Judge Offutt in Heyn v. Fidelity Trust Co., 174 Md. 639, 659-665, 197 A. 292, 1 A.2d 83, 739. He summed up the governing principle in the following words (174 Md. at page 664, 1 A.2d at page 90) : “Insofar as any general principle may be deduced from these cases, it is, that where after the beginning of a trust holding stock for successive beneficiaries, a dividend is declared on that stock, if the dividend is payable from profits accumulated in the trust period, whether payable in cash or in stock, it is income and payable for the use of the life tenant, but if paid from surplus accumulated prior to the trust period from profits, the sale of the company’s property (where such sales are not in the ordinary course of its business) or from any other source, and the dividend lessens the book or dollar value which the shares had when the trust began, to the extent necessary to restore that value the dividend is to be treated as capital and paid into the corpus of the trust estate. And that the declaration of the corporation as to whether the dividend represents earnings binds the parties to this case. Northern Central Dividend Cases, supra.”
The Pennsylvania rule formerly prevailed in New York. It was analyzed by Cardozo, C. J. in Equitable Trust Co. v. Prentice, 250 N.Y. 1, 7, 164 N.E. 723, 63 A.L.R. 263, as follows: “The rule in this state was settled, until changed in 1926 as to subsequent trusts by an amendment of the statute * * * that as between life beneficiary and remainderman a stock dividend would be reckoned as principal or income according to the origin of the surplus out of which it was declared. To the extent that it distributed a surplus existing at the creation of the trust, it would be allocated to principal; *276to the extent that it distributed a surplus earned thereafter, it would be allocated to income. * * * The search in all these cases was to find the intention of the founder of the trust and then to give effect to it.' What is income for a corporation may not be income for a shareholder. * * * What is principal for a shareholder, when taken in his own right, may be income, when held in trust to be divided among others. So, at least, the cases hold. The thought back of them is this: A surplus in the treasury of a corporation, even though not income for the shareholder, is potentially a fund that may be converted into income. The ‘declaration of a stock dividend destroys this potential income, and turns the surplus into capital. The effect may be at times to thwart the plan of apportionment between life tenant and remainderman, as conceived at the foundation. A founder of a trust has conveyed shares to a trustee, to pay the income to wife or child for life, with remainder upon death to others. Did he mean in thus apportioning his estate that potential income might be cut down through the vote of the corporate managers, so that the beneficiary never could resort to it, and principal increased to the profit of remaindermen, perhaps unknown or unborn? We have thought that intention would be best promoted if the fund thus permanently diverted were included in a gift of income. Very likely the word 'dividend’ has had a part in shaping the conclusion, for in their typical or common form dividends are income, like other recurrent gains (Lynch v. Hornby, 247 U.S. 339, 344, 38 S.Ct. 543, 62 L.Ed. 1149), and one steps readily into the assumption that the equivalence is absolute.”
The prevailing rule as to the disposition of extraordinary dividends between life tenant and remainderman, under the terms of a trust, is set out in the Restatement of the Law of Trusts, Vol. 1, Section 236, as follows:
“Except as otherwise provided by the terms of the trust, if shares of stock of a corporation are held in trust to pay the income to a beneficiary for a designated period and thereafter to pay the principal to another beneficiary,
* * • * * *
“(b) extraordinary dividends declared during the period, whether in cash of in shares of the corporation or in other property, are income to. the extent and only to the extent that they are declared out of earnings of the corporation which accrued subsequent to the creation of the trust or the acquisition of the shares, by the trustee
If this rule is applied in the pending controversy, the stock dividend will go to the Railroad' Company, for-the source of the dividend was income of the.Richmond-Washington Company that had accumulated after the pledge of the stock was made, and the result will be that the Railroad Company will have the benefit of this income while the pledged stock remaining in the hands of the mortgage trustee will still be maintained at its original value.
But we are told that we are not obliged by Erie Railroad Company v. Tompkins to apply to the facts of the pending case the Maryland rule in respect to the respective rights of life tenant and remainderman in stock dividends, because thereby we should merely be reasoning from analogy and indulging in vain speculation as to what the Maryland court would decide if a case like ours should come before it. This warning, however, does not solve our difficulty or release us from the obligation to apply the law of Maryland. If the case is to be decided, we must have recourse to general principles or pertinent analogies, for there is no other guide. Indeed this court, itself, in passing upon the pending appeals follows this course. It cites in support of its conclusion in favor of the mortgage trustee Gibbons v. Mahon, 136 U.S. 549, 10 S.Ct. 1057, 34 L.Ed. 525, which involved the construction of a will that bequeathed corporate stock in trust to pay the dividends to a daughter of the 'testator during her lifetime, with a direction that upon her death the stock should revert to the estate of the trustee, and held that a stock dividend based upon earnings accumulated before and after the death of the testator did not go • to the life tenant.
Similarly, the opinion in the pending case cites Hayes v. St. Louis Union Trust Co., 317 Mo. 1028, 298 S.W. 91, 56 A.L.R. 1276, that adopted the Massachusetts rule and decided a controversy over a stock dividend in favor of the remainderman in a trust under a will. Again, we find a citation from Virginia in Kaufman v. Charlottesville Woolen Mills Co., 93 Va. 673, 25 S.E. 1003, and a citation from North Carolina *277in Lancaster Trust Co. v. Mason, 152 N.C. 660, 68 S.E. 235, 136 Am.St.Rep. 851, which related not to a pledge but to a sale of stock, and based their conclusions, that a reservation of dividends to the seller in the contract did not cover a stock dividend, on the reasoning of Gibbons v. Mahon, in which, as we have seen, the federal or Massachusetts rule was applied. In the Virginia case, Gibbons v. Mahon was cited for the express reason that it was analogous to the case at bar. The Supreme Court of the United States set the same example of reasoning by analogy in this field when it decided in Eisner v. Macomber, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, 9 A.L.R. 1570, a tax case, that a stock dividend is not income, and based its decision on the reasoning of Gibbons v. Mahon.
We have, no call to demonstrate that these authorities announce unsound doctrine. That is not our province or responsibility; that has been done by the Court of Appeals of Maryland to its own satisfaction, and we have no alternative but to follow its deliverances. It is certain that we do not follow them, if we give preference to the contrary decisions of the courts of Missouri or Virginia or North Carolina or the United States.
No difficulty is experienced in applying the Maryland philosophy to the circumstances of the pending case. The parties to the mortgage intended that the Railroad Company should have the income from the pledged property. The word “dividend” was used to carry out this purpose, and if the dividend in suit represented income, it should go to the Railroad Company just as income from a testamentary trust estate goes to the life tenant. Judge Cardozo in the passage quoted above from his opinion in Equitable Trust Co. v. Prentice, shows that the term “dividend” ordinarily connotes income; and the court in Gibbons v. Mahon, 136 U.S. 567, 10 S.Ct. 1062, 34 L.Ed. 525, gave the same interpretation to the word in the case of a testamentary trust, although the conclusion was reached, under the Massachusetts rule, that a stock dividend was not income. The court said: “Upon the face of the will, it is manifest that the testatrix used the word ‘dividends’ as having the same scope and meaning as ‘income’ and ‘interest,’ and nothing more; and intended that the plaintiff, as equitable legatee for life, should take the income, and the income only, of the shares owned by the testatrix at the time of her death; and that the whole capital of those shares, unimpaired, should go to the defendant, as legatee in remainder.”
In Maryland, the opposite result would have been reached as to so much of the dividend as represented surplus that had accumulated when the trust came into being. The Court of Appeals takes the view that the conversion of accumulated income into capital by the declaration of a stock dividend does not impair the right of the life tenant to the income or defeat the purpose of the settlor of the trust.
It is true that an award of the stock dividend to the Railroad Company in this case would reduce the proportionate control held by the pledgee in the Richmond-Washington Company. But exactly the same impairment of the principal of a trust estate occurs when a stock dividend is given to the life tenant, and it cannot be that the rights of a pledgee are more sacred than those of a remainderman. The latter is sufficiently protected in the eye of the Maryland law if the value of the capital and accumulated surplus at the beginning of the trust is preserved in the principal of the trust estate. The same line of reasoning should govern us in our decision upon the pending appeal.