In Savage v. Miller, 56 N. J. Eq. 437, 36 Atl. 578, 39 Atl. 665, the court of appeals held a mortgage given to secure several distinct items of indebtedness to be valid as to some of them and invalid as to others.Summary of this case from Reed v. Helois Carbide Specialty Co.
John Griffin and P. H. Gilhooley, for complainant . William H. Corbin, for defendants.
Bill by Edward S. Savage, receiver of the Johnson Railroad Signal Company, against George W. Miller, trustee, and others, to test the validity of a mortgage.
This bill is filed by the receiver of an insolvent corporation, to test the validity of certain preferences made by the corporation, by its mortgage to a trustee, to secure the payment of certain of its creditors. The corporation was decreed to be insolvent on February 4, 1895, and the complainant was appointed receiver, and has sold the property of the corporation. The question is whether the assets in his hands should be primarily applied to the liquidation of the debts which were secured by the mortgage mentioned. On January 18, 1895, the Johnson Railroad Signal Company was largely indebted. The affairs of the company had reached a critical stage; so desperate, indeed, that there was no reasonable ground for believing that it could surmount the financial difficulties that threatened it. There was a glimmer of hope that, if the unsecured creditors would extend their credit, the business of the corporation might be tided over its troubles. Those creditors, however, did not take this course; but, instead, one of them, to whom salary was due, promptly filed a bill in the suit in which the corporation was declared insolvent. The events connected with the execution of the mortgage were these: On January 14th a meeting of the board of directors was called to convene on January 16th, and on the 16th the meeting was adjourned to January 18th. At the session held on the last-mentioned date, there were present three persons as directors, namely, George W. Miller, William P. Hall, and Winfield S. Gilmore. They ordered that a mortgage be executed upon all the real and personal property of the corporation to one of themselves, George W. Miller, as trustee, to secure the payment of certain specified debts. The first of these debts was in the shape of a note made by the corporation to the order of itself. It was dated January 18, 1895 (the day of the meeting), and was given for the sum of $2,500, payable on demand. This note was made for, and delivered to, George W. Miller, one of the directors, for past services rendered to the corporation as its legal adviser, and for past disbursements made for the benefit of the company. Mr. Miller delivered this note to Mrs. Georgianna M. Johnson, to pay a debt which he owed to her for moneys which she had advanced to him. Mrs. Georgianna M. Johnson was the daughter of Mr. Miller. The second of these debts was in the shape of a note, dated December 17, 1894, made by the company to the Union County Bank, for $5,000, payable three months after date. This note was given in renewal of another note, which had been made in consideration of money loaned by the bank to the corporation. The existing note was indorsed by William P. Hall, William S. Gilmore, and George S. Miller, each of whom, as already observed, was a director of the corporation, and, apsuch, voted to make the mortgage. The third of these debts was in the shape of a note dated December 7, 1893, by which the corporation promised to pay, one day after date, to the order of Georgianna M. Johnson, the sum of $6,143. The history of this debt seems to be this: Charles R. Johnson, the husband of Georgianna M. Johnson, had beer the promoter and the president, as well as a director, of the Johnson Railway Signal Company, the insolvent corporation. He died, leaving his widow, Georgianna M. Johnson, the executrix of his will. During his lifetime he had advanced cash to the corporation, and, after his death, this note was given to his executrix for such advances. George W. Miller, as already observed, was the father of Mrs. Johnson, and her representative in this transaction, acting in her interest, while he was at the same time the attorney of the corporation. The fourth of these debts was in the shape of a note given by the company, for the sum of $29,205.53. The note is dated January 18, 1895, and is payable on demand, to the order of the company. It was indorsed by the company, and delivered to Mrs. Georgianna M. Johnson, executrix of Charles R. Johnson, deceased. The history of this note was this: Charles R. Johnson, in 1892, had sold 730 shares, which he then owned, of the stock of the Johnson Railway Signal Company, to a corporation known as the Hall Signal Company, for the sum of $110,000. This consideration was still unpaid on January 18, 1895, the date of the meeting of the directors, and the making of the note. The Hall Signal Company, at that time, was a creditor of the Johnson Railway Signal Company, for money which it had advanced to the latter company, to the amount of $29,205.53. At the meeting of the board of directors held on January 18th, William P. Hall, who was the president of the Hall Signal Company, was present as a director of the Johnson Railway Signal Company, of which he was also vice president. By an arrangement then made or then consummated, it was agreed that the amount due from the Johnson Railway Signal Company to the Hall Signal Company should be paid over to Mrs. Georgianna M. Johnson, executrix, in part payment of the amount due by the Hall Signal Company to the estate of C. R. Johnson, for the 730 shares of stock. The note was therefore delivered to Mr. Miller for Mrs. Johnson, and then presumably to her, after its indorsement by the Johnson Railway Signal Company, but not indorsed by the Hall Signal Company. Mr. Miller, the father of Georgianna M. Johnson, also represented her in this transaction. The fifth and last of these debts was in the shape of a note for $8,600, made to one Frederick Kernachan, administrator. Nothing whatever in the testimittee,appears to throw any light upon the original of this debt, or the relation of Mr. Kernachan to the corporation.
John Griffin and P. H. Gilhooley, for complainant .
William H. Corbin, for defendants.
REED, V. C. (after stating the facts). The mortgage is attacked by the receiver, upon the ground that the directors of this insolvent company had such an interest in the payment of the debts secured by it that the preferences so created are voidable. The execution of the mortgage was directed by the votes of three directors of a board of five. The votes of all the three, in favor of the mortgage, were essential to a legal expression of the corporate will. If any one of these three directors was disqualified, by reason of his adverse interest, from joining in the action of the board, the execution of the mortgage was an unauthorized act. The question, therefore, as to what would have been the consequence if the mortgage had been supported by the votes of a majority of the board, apart from the votes of interested directors, is not presented for solution. I will take up each of the five debts, in the order in which I have stated them.
The company was, as I have already observed, insolvent at the moment when the mortgage was created. The debts secured were only part of the general debts then existing. The preferences, if valid, will exhaust the assets. That the directors of an insolvent company could, previous to the act of March 5, 1895, prefer some of its creditors, to the exclusion of others, was decided by the court of errors in the cases of Wilkinson v. Bauerle, 41 N. J. Eq. 635, 7 Atl. 514, and Vail v. Jameson, 41 N. J. Eq. 648, 7 Atl. 520. In the subsequent case of Montgomery v. Phillips, 53 N. J. Eq. 203, 31 Atl. 622, decided in the same court, the court, while recognizing the general power of an insolvent corporation to prefer creditors, circumscribed the generality of the rule, by holding that, if the directors were themselves the creditors who were preferred, then their interest as creditors was inimical to their duties as trustees for all the creditors, and their act in making such preferences was voidable. Under the doctrine declared in the last-mentioned case, the mortgage now questioned, so far as it secures the note for $2,500 given to George W. Miller, and by him passed to Georgianna M. Johnson, is clearly voidable. It was made to secure an antecedent debt due to Mr. Miller, one of the directors of the company.
The next one of the debts so secured was that of the Union County Bank. Upon the note which the bank held as evidence of this debt the three acting directors were indorsers. The mortgage was made to secure the bank, and not made directly to the indorsers, to secure them against their liability as such. I am at a loss to perceive how this fact can create a difference in the attitude of the directors towards this debt. The principle upon which Montgomery v. Phillips was decided was that the directors were trustees for all the creditors, and that, as trustees, their conduct in the distribution of the property of the company among its creditors should not be influenced by any personal interest adverse to the interest of the general body of creditors whom they represented. It applied to the directors of an insolvent corporation, as trustees, the same restrictive doctrine that is applicable to all trustees. 1 Perry, Trusts, § 207. Now, it is transparent that the effect of the mortgage, so far as it subserves the interests of the indorsing directors, was exactly the same as if it had been made directly to them, to secure them against their liability as indorsers. The fact of the corporation's insolvency led necessarily to a certainty that these directors would be called upon to pay a part of the note; and whether the property of the corporation should be used to pay the entire debt due the bank, or whether it should be used to reimburse the indorsers, in case they became liable to pay the bank, did not matter. The relief which they received from the burden of their contract, as indorsers, was exactly the same whether the mortgage was made in the one or in the other form. Nor does the fact that the directors of the bank are not otherwise interested in that institution, and so would not in that way profit by the payment of this debt, remove the act of the directors from the control of the rule mentioned. The bank had no right to a preference; it was only an act of grace on the part of the directors. The voidability of the directors' acts does not spring from the fact that the trustees had a common interest in the two corporations, but arises from the fact that they were serving their own interest in making the preference. It is the bias, which destroyed that judicial discretion which should control them when dealing with the assets of the corporation, that invalidates their act. Upon principle, then, I am unable to perceive how it is possible to condemn a mortgage made to an indorser, and to approve of a mortgage so made as to benefit the indorser in exactly the same degree. In Lippincott v. Carriage Co.; 25 Fed. 585, it was held that the votes of two directors, who assisted in authorizing the making of a mortgage to secure a note upon which they were indorsers, were nullities. I am aware that in Montgomery v. Phillips this apparently inevitable conclusion does not seem to have been carried to a legitimate result, for in that case the assignment to the bank of the accounts of the corporation, for the purpose of paying a note discounted by the bank, and indorsed by a director, would come under the ban of this rule. But the attack upon the assignment in that case was made solely upon an other ground, which ground is set out in theopinion. Only the chattel mortgage in that case was attacked, upon the ground that it was made by a director to secure himself. The rule laid down by the court was, through oversight, not applied to the assignment of the bank accounts. So, in Wilkinson v. Bauerle, supra, the question discussed was whether the directors of an insolvent company could secure creditors. The exception which limits this general rule was not discussed.
The third debt secured is the $6,143 note, held by Georgianna M. Johnson, as executrix of her husband, to whom the money had been due. George W. Miller, who prepared the mortgage, and was one of the voting directors, as already remarked, was her father, and was in the transaction, looking after her interests. His position, both as attorney and relative of Georgianna M. Johnson, was entirely inconsistent with his position as trustee, representing the general creditors of the company. I adopt the language of the court in Adams v. Milling Co., 35 Fed. 435, as sound and singularly pertinent: "If the directors of an insolvent corporation, in the distribution of its assets, pay a certain creditor in full, to the exclusion of others, the choice ought not to be influenced solely by relationship existing between the directors and the creditor so preferred, or by other considerations of a purely selfish nature. In the present case it was the estate of a deceased director and president of the corporation that was preferred. The majority of the board were brothers of the deceased. One of them was agent for the estate, and controlled and voted its stock at corporate meetings." The preference was set aside.
The fourth debt secured is the note given to pay the Hall Signal Company for advances previously made by the latter company to the insolvent corporation. This note was turned over to Georgianna M. Johnson, in part payment of the debt which the Hall Signal Company owed her husband's estate. Mr. Hall, one of the directors, and acting vice president of the insolvent corporation, was a stockholder and director of the Hall Signal Company. This, as a matter of course, unfitted him for acting as trustee in this transaction. Besides this interest of Mr. Hall, which disqualified him from voting for the execution of the mortgage to secure this note, Mr. Miller stands in the same posture in regard to this as he does in respect to the preceding note. The mortgage, so far as it preferred this note, is a nullity.
The last of the preferred creditors is Kernachan. There is nothing in the testimony to show that any of the directors who voted for the execution of this mortgage were interested in the payment of this debt in any way distinct from their interest in the payment of the debts of the general creditors. There is nothing, therefore, to invalidate the mortgage, so far as it secures the payment of the Kernachan debt, flowing from the relation of the directors with Kernachan.
But it is insisted that the mortgage is void in toto, because it was ordered by persons who were not legal directors of the corporation. It appears that the by-laws originally provided for the election of directors at the annual meeting of stockholders, and for the amendment of the by-laws at an annual or a special meeting called for that purpose. The board of directors themselves, without authority, amended the by-laws regulating the election of directors so that the board could appoint to fill vacancies, and, in pursuance of such amended by-laws, appointed two of the directors, who ordered this mortgage. These appointees remained in office from 1890 till January 18, 1895. In the meantime, stockholders' meetings were held. The right of these appointees to hold their offices was not questioned, but, on the contrary, recognized. They were held out, by the assent of the stockholders, as the agents of the corporation. They were directors de facto. The equitable rights of the cestuis que trustent under the mortgages are not affected by the irregularity in the manner of their appointment.
The remaining feature of the cause which has presented itself is this, viz.: Is the mortgage so tainted by the general purpose of the directors who ordered its execution as to avoid it in toto? If it had appeared in the ease that the preference of the Kernachan debt was essential to a successful carrying out of the scheme to prefer the other creditors, there would have been force in the notion that the same condition of mental bias which induced the preference of the directors induced the preference of Kernachan. But nothing whatever appears in the case to show that the Kernachan debt was in any way related to the other debts, or why Kernachan was included in the list of preferred creditors. The mortgage should be decreed void so far as it secures the debts, other than that of Kernachan.