UNITED STATES TRUST CO. v. WESTERN CONTRACT CO. ECHOLS et al. v. CENTRAL TRUST CO. OF NEW YORK; WESTERN CONTRACT CO. v. ECHOLS et al.; BROWN et al. v. WESTERN CONTRACT CO., 81 F. 454

TAFT, Circuit Judge (after stating the facts as above). The decree of the circuit court in dismissing the intervening petition of the receivers of the Chesapeake Company, in so far as it sought a lien on either statutory or equitable grounds for their claim against the Valley Company prior to that of the mortgage bonds on the corpus of the Ohio Valley Railroad, was clearly right. The Chesapeake Company was not the supplier of materials or a contractor. By its agent and lessee, the Newport News Company, it assumed the operation of the railroad of the Valley Company.

All the earnings of the Valley Company and of the Newport News Company were deposited in a common fund, which, for convenience, was designated as the bank account of tlie latter company. Out of this common fund wages were paid and supplies were purchased generally in the name of the Newport News Company, but really for the benefit of both.

By proper charges upon the books, it was made to appear how much more money out of the common fund was devoted to the operation of the Valley road than was received from its operation, and the balance struck doubtless correctly showed the amount due from the Valley Company to the Chesapeake Company, but the balance shown was not really for supplies and labor furnished, but was for money advanced, and for that no lien exists either by the Kentucky statute, or on principles of equity. The case at bar is in this respect very much like that of Morgan’s L. & T. R & S. S. Co. v. Texas Cent. Ry. Co., 137 U.

S. 171, 11 Sup. Ct. 61. In that case the complainant was the assignee of a large claim of the Houston Company against the Texas Central Company, and the bill was filed to establish the priority of the claim as a lien on the railroad of the Texas Company over that of the two mortgages on the ground that the claim arose for supplies and labor furnished to the Texas Company. One paragraph of the opinion of the Chief Justice in delivering the judgment of the court shows clearly the likeness of the case to that at the bar, and the true ground for denying the lien sought. After referring to Fosdick v. Schall, 99 U.

S. 235, and subsequent authorities upon the question of equitable liens for supplies, the chief justice said: “In tbe light of these decisions, the inquiry before us is whether these bondholders are to be postponed in respect to the proceeds of the sale of the corpus of the property upon which their lien is first and paramount, to this claim of the Houston Company, upon the ground of the particular application of these moneys, or that they supplied a diversion by the officers of the Texas Company equitably binding as such upon the bondholders.

Now, if these advances were made generally, as needed by the Texas Company, it matters not whether they were devoted to the payment of running expenses or not. Tie relation of debtor and creditor existed, and no equity could arise in favor of the creditor as against other creditors holding security prior in time, by reason of the voluntary application the debtor might make of the money borrowed. We repeat that, so far as appears, the money advanced to one road by the other was simply a loan.

The account between the companies was a running account, and the balance was only a balance for cash advances made from time to time. Moneys received from the operation of the Texas road and moneys received from the Houston Company all went into a common fund, from which payments were made for expenses, taxes, and so on.

It is also shown that the Texas Company and the Houston Company had the same fiscal agent in New York, who paid the coupons of both; that the management of the Texas Company was, during its entire existence, in the hands of the same officers and directors who managed the Houston Company; that these officers derived their compensation from the Houston Company; that all receipts from the Texas Company were first received by the Houston Company, and then transferred on the books to the treasurer of both companies as treasurer of the Texas Company; that whenever there was a deficit of funds on the part of the Texas Company, such deficit was made up by the Houston Company; and that the latter company received and disbursed everything.

Under such circumstances it cannot be maintained, against the first mortgage bondholders, that a balance of such a running account of five years’ duration represents money so applied to the Current expenses of the road, or so diverted therefrom to the payment of interest on the bonds, as to carry with it a superior equity for repayment.” The case cannot be distinguished from the one at bar.. The decree of the circuit court in this regard is affirmed.

We think that no error can be predicated on the failure of the circuit court to enter a decree for money in favor of the receivers of the Chesapeake Company against the Valley Company. The main action was the foreclosure of a mortgage, and the intervening petition of the receivers was allowed to be filed because it asserted a lien on the property of the railroad prior in right to that of the foreclosing mortgagee. If they had no lien, the receivers were entitled to no relief, whatever.

There is little or no analogy between this case and that in which a foreclosing mortgagee is allowed a judgment for the deficiency on his claim after the application to his debt of the proceeds of the sale of the mortgaged property. In such a case, a court of equity acquires jurisdiction by reason of the necessity for the foreclosure proceedings, and the judgment for the deficiency is a mere incident, necessary to a complete adjustment of the rights of the parties.

Until especially conferred by one of the equity rules, n federal court of equity had no power to enter judgment for a deficiency, even in case of a foreclosure. In the case at bar, there is found to he no lien at all, and there is, therefore, no deficiency of assets in the sense in which that term is understood in a foreclosure suit. If a decree had been rendered for money only, it would seem that the court’s jurisdiction to render the decree could hardly have been sustained, because the right to a trial by jury upon such an issue would thus have been denied to the debtor company.

Without deciding more, however, we hold that it was at least within the discretion of the circuit court, after finding that the receivers of the Chesapeake Company were not entitled to a lien for their claim, to decline to enter a decree for money only. We come now to consider the second count of the intervening petition of these receivers.

They thereby seek to subject certain of the mortgage bonds issued by the Valley Company, and included in the foreclosure proceeding which belong to the Contract Company, and are on deposit with the Columbia Finance & Trust Company, to the satisfaction of a claim made by the receivers against the Contract Company under the contract executed March, 1891, by and between that company and the Chesapeake Company.

Had objection been made to the petition on the ground that it'was multifarious, it might have presented some difficulty; hut no such objection was made, and, as the court undoubtedly had jurisdiction of both causes of action stated in the petition, the defect in the petition, if any, was clearly waived, as the circuit court held. The claim of the receivers of the Chesapeake Company is based upon the alleged diversion of the subsequent earnings of the Ohio Valley road to pay sis floating debts and its Car Trust obligations incurred prior to the making of the contract of March 6, 1891.

The objections,urged to this claim are: First, that payments out of the subsequent earnings of the Valley road to take up its prior debts could give the Chesapeake Company no right to reimbursement therefor; second, that no earnings were used to pay floating debts; and, third, that the whole claim is more than set off by the amount due from the Chesapeake Gompany on its defaulted guaranty of interest.

By the contract of March 6, 1891, the Contract Company delivered to the Chesapeake Company 60 per cent, of the stock of the Valley Company, and guarantied that the floating indebtedness of the Valley Company should not exceed $30,000, and that the Car Trust debts should not exceed $86,000, and provided for the payment of these debts by depositing with the Columbia Company as trustee bonds equal in par value to these respective amounts, and stipulated that the Chesapeake Company might sell the bonds at a price equal to and not less than 90 per cent, of par, and deposit the proceeds with the trustee, to he drawn against by the Valley Company for payment of the floating indebtedness of the Car Trust obligations, or for repayment of amounts paid on account of either the floating or the Car Trust debt.

In consideration of this, the Chesapeake Company agreed to guaranty the payment, principal and interest, of the Valley Company’s mortgage bonds, aggregating $2,162,600; and further agreed to deposit, as security for the performance of this guaranty for seven years, the 60 per cent, of the capital stock of the Valley Company with the Columbia Company ■ as trustee, and stipulated that in case of default on its guaranty during those seven years the trustee should, on demand,' deliver back the stock to the 'Contract Company, but that until such default the Chesapeake Company should be deemed the owner of the stock; and that, if no default occurred during the seven years, then, at the expiration thereof, the stock should be redelivered by the trustee to the Railroad Company.

By a third

article it was provided that expenses should be prorated between the two railroads, the Valley and the Chesapeake, on a mileage basis, and that the earnings should be apportioned as if the roads were separate. The supplementary contract made provision for a representation of tie minority stockholders in the board of directors of the Valley Company.

Looking at this contract in the light of the circumstances and the subsequent conduct of the parties, it is manifest that it was expected that the Chesapeake Company, or its agent and lessee, the Newport News Company, should operate the Valley road as a part of the Chesapeake, Ohio & Southwestern system; that by bookkeeping its earnings and expenses should be kept separate from those of the Chesapeakfe road, but that otherwise the roads should be treated as if one.

It was evidently in the contemplation of the parties that the floating debt and the Car Trust notes might have to be taken up before the. bonds were sold, and it was intended that the proceeds of the bonds when sold should replace the sums thus expended. This is clearly shown by the words “for repayments of amounts paid on account of such Car Trust obligations or such indebtedness or liabilities” used to specify the object to which the proceeds of the bonds were to be devoted.

It was plainly intended that by the use of the bonds the indebtedness of the Valley Company should be paid, and that its future earnings should not be burdened with such an obligation. The primary advantage to the Chesapeake Company in this arrangement was that it rendered more probable the payment of the interest on the guaranty bonds, or some part of it, out of the earnings of the Valley road, and thus reduced the probable burden of the guaranty. The Chesapeake Company had in fact to pay a large part of the interest which was paid on the guarantied mortgage bonds.

Hence it follows that every dollar of the earnings of the Valley road after April 1, 1891, used to pay the old floating debt of the Car Trust notes increased the amount which the Chesapeake Company had to pay as interest upon the bonds.

We fully concur with the circuit court, therefore, in the view that the diversion of the Ohio Valley earnings to pay the old debts of the company was equivalent to a direct advance of that amount out of the treasury of the Chesapeake Company, and that if, for such advances, the Chesapeake Company would be entitled to repayment out of the proceeds of tlie bonds deposited under the contract of March 6, 185)1, ¡hen it is equally entitled to reimbnrsement for a diversion of viie earnings of the Valley road to the same purposes. And now, what is t lie amount of this diversion?

It appears that of (lie iioatiug debt, $10,035).13 was paid by the Valley Company after April 1,1891. It is said this was not paid out of the earnings of the Valley road, or by the Chesapeake Company, because there was on hand in possession of the Valley Company certain resources or “quick assets” amounting to $18,362.62, which were properly applicable to the payment of the floating debt. Of these so-called resources the $4,310 was really money in the hands of agents, and like accounts.

It is not unreasonable to suppose that in treating and referring to the floating debt of the Valley Company the parties to the contract intended that such cash assets should be deducted from the gross amount, and that only the net results afier the deduction should be regarded as the floating debt. At all events, as these assets were collected and expended, they may be presumed to have been applied to the old debts, and the diversion of the earnings was by so much less than the amount of the old debts paid.

The remainder of the so-called resources, amounting to $14,052.37, was made up of $12,-452.37, known as the “Southern extension account,” which was the amount expended by the Valley Company in making maps and a survey for an extension of the Valley road, and $1,600 paid for a quarry purchased to ballast the road. We are at a loss to see how such items could be used to reduce the liabilities provided for in the contract of March 6, 1891.

The maps and surveys and' the quarry were a part of the Valley Company’s property as much as the rails or the stations of the road, and could not, we think, within the contemplation of the parties, figure on either side of the account in making a statement of the floating debt. We are constrained to differ with the court below in treating either the extension account: or the quarry as a quick asset or resource to reduce the amount of floating debt, paid out of earnings. The -result is that earnings of the Valley Company were diverted to pay the old floating debt to tin* amount of $5,726.64.

It also appears from the master’s report that through its agent, the Newport News Company, and by direct? payment, the Chesapeake Company also advanced $1,926.61 to pay off part of this floating debt. It also appears that out of the earnings of the Ohio Valley road Oar Trust notes for $24,462.58 were paid. By the terms of the contract, we think the Chesapeake Company was entitled to reimbursement from the proceeds of the bonds deposited to pay the floating and Car Trust debts, thus shown to be $32,115.83.

But the provision thus made for their payment contained a limitation, to wit, that the bonds could be sold at not hiss riian 90 cents on the dollar. This requires, as the circuit court held, that only the number of bonds can be used in reimbursing the Chesapeake Company which would, at 90 per cent, of par, pay the debt. It appears that interest was collected by the trustee on the bonds held by him on deposit. We agree with the circuit court that those having a lien or claim upon the bonds may appropriate the interest on the bonds as an incident thereof.

It is vigorously pressed upon the court that as against this claim by the Chesapeake Company upon these bonds, the Contract Company, the owner of them, may set off the amount due from the Chesapeake Company to the Contract Company on its defaulted guaranty. The circuit court was of opinion that as the claim of the Contract Company against the Chesapeake Company was in personam, and the claim of the latter company against the bonds was in rem, there could he no set-off.

In courts of the United States sitting in equity the most liberal rules prevail in the allowance of set-offs to avoid injustice and circuity of action. Scott v. Armstrong, 146 U. S. 507, 13 Sup. Ct. 148; North Chicago Rolling Mill Co. v. St. Louis Ore & Steel Co., 152 U. S. 615, 14 Sup. Ct. 715.

In the latter case the court says: “Cross demands and counterclaims, whether arising out of the same or wholly disconnected transactions, and whether liquidated or unliquidated, may be enforced by way of set-off whenever the circumstances are such as to waN rant the interference of equity to prevent wrong and injustice.” In New Jersey (White v. Williams, 3 N. J. Eq. 376; Dudley v. Bergen, 23 N. J. Eq. 401; Dolman v. Cook, 14 N. J. Eq. 68; Bird v.

Davis, Id. 471) it is held that a foreclosure of a mortgage is a proceeding in rem, and that the mortgagor cannot, therefore, be permitted to set off in-such an action a claim then due him from the mortgagee. This rule ñnds little or no snjiport in other states, and we cannot understand the justice of it. If A. has a claim against B. which he is trying to enforce, we can understand why B. should not be permitted to set off against it a claim in rem in the nature of a lien or otherwise against property owned by A. for which A. is not personally liable. In such a case, there is no mutuality.

B.’s only mode of enforcing his claim is by appropriation and sale of A.’s property, and it may be that B. will not thus realize enough to satisfy his claim. A., of course, cannot be held for the deficiency. B. cannot, therefore, he permitted to set off his lien claim as if A. owned it personally. But the reverse is not true. If B. is enforcing a lien against A.’s property, A. can remove the lien by paying to B. the amount secured by it. If so, why may he not be permitted to cancel the lien by forgiving B. the debt B. owes him; i. e. by setting it off? We are clearly of opinion that he may do so.

Justice is thereby done, and circuity of action is avoided. But, while we differ with the court below as to the law of set-off of claims, one in personam and one in rem, we concur in the conclusion reached by it upon the other ground upon which the decree appealed from was based, namely, that under the circumstances of this case there was nothing due from the Chesapeake Company to the Contract Company which the latter could set off.

We think that the action of the Contract Company in taking back the stock ended the obligation of the Chesapeake Company upon its guaranty of the bonds of the Ohio Valley so far as the contract of March 6,1891, was concerned. Of course, it could have no effect upon the guaranty indorsed on the bonds held .by purchasers without notice, but, as between the parties to the contract of March 6, 1891, we must hold that the effect of the retaking of the stock by the Contract Com¡tany was j.o cancel the contract as to the part of it executory and unperformed.

It is said that there is nothing expressed in the contract to warrant such a conclusion. This may toe conceded, but the circumstances and the real nature of the contract leave no doubt in our minds tiiai the conclusion is in accordance with the intention of the parties. The contract between tiie parties, shortly stated, was that if the Coniract Company would give the Chesapeake Company control of the A’alley road, the latter would guaranty the Valley bonds, of which the Contract Company was a large holder.

On a single default in the payment of interest the Contrae I, Company reserved the right to resume control of the Valley road, not temporarily, but forever. Under the contract the reciprocal benefits to the parties were concurrent, — control of the road on one side, receipt of interest on the oilier. Any ¡lower reserved in the coniract given to one to withdraw' one of these concurrent benefit a forever would seem, upon its exercise, to be consistent only with (he release of the eorrespondingobligationof the other party.

It is true that the Chesapeake Company must have, known ¡hat, even though control of the Valiev road might be withdrawn by retaking the stock upon default in the guaranty, it would not escape from its obligation upon bonds already sold to purchasers without notice. But this was an unavoidable incident to making a guaranty at all, and cannot, we think, change the view to be taken of the intention of the parties as to the binding force of the obligation of guaranty as between them after the Contract Company should resume possession forever of the only consideration inducing the guaranty.

It is said that the Chesapeake Company has had con trol of the road for two years. That is true, but the Contract Company has had its interest. The road was improved by the new management, and, what is the most important benefit to the Contract Company, and that which doubtless led it into the contract, it has sold more than half a, million of the Valley bonds at a price probably much increased by the indorsement of guaranty. But it is said, if the retaking of the slock rescinds the contract, how can the stipulations of the Coniract Company as to the deposited bonds be enforced against it?

Courts, in giving effect to rescissions, always, if possible, preserve vested interests and avoid a forfeiture. Railroad Co. v. Howard, 13 How. 307, 340. The stipulations as to the payment of the debts of the Ohio Valley Company were merely preliminary, and were inserted to clear the held of negotiation and contract for the concurrent operation of the two reciprocal benefits which the contract was intended to confer, each as an inducement for the other,- — the control of the road on the one hand, the guaranty of the bonds on the other.

The Chesapeake Company wished to be sure that the then debts of the Valley Company would not embarrass it in obtaining from the earnings of that road enough to pay the interest the Chesapeake Company had ¡piaran tied to ¡jay, and the Contract Company accordingly provided for the debts by devoting to their payment bonds which it owned by depositing the bonds with a trustee for the purpose, and by expressly stipulating that money advanced to pay these debts of the Valley Company should be repaid from the proceeds of the bonds when sold.

When the bonds were deposited, and advances were made on tbe fail'll of them, the contract, so far as the Contract Company was concerned, was executed, the interest of the Bailroad Company making the advances became fixed, the trustee holding the bonds became its trastee, and its rights in the bonds were as completely vested as if it had manual possession of them under pledge for a loan.

We have already pointed out that a diversion of the earnings of the Valley Company to pay these debts amounted, in effect, to an advance by the Chesapeake Company to pay them, because of the increase of the amount of interest on the guarantied bonds of the Valley Company which the Chesapeake Company was obliged to pay.

To the extent that the debts and Car Trust notes of the Valley Company were paid, we think the contract executed, and that no subsequent rescission could or should affect the vested interest in the deposited bonds acquired by the Chesapeake Company through such payments. ' It is suggested that the unsoundness of our conclusion will appear if we suppose that the Chesapeake Company had failed to- pay the first installment of the guarantied interest.

It is asked whether, in. such a case, it would be equitable, after the Contract Company had retaken the stock, to allow the Chesapeake Company to have the bonds of the Contract Company sold, and to- put the proceeds thereof in its pocket. . Certainly it would hot, except to the extent to which the Chesapeake Company had “directly expended its own money to pay such debts.

As the Chesapeake Company in such a case would have'paid no interest, the diversion of the earnings of the Valley Company to pay its old debts would give the Chesapeake Company no equity or right toi be reimbursed out of the deposited bonds for such diversion.

It is because the Chesapeake Company has paid a large amount of the guarantied interest, far in excess of the earnings of the Valley Company diverted, that the Chesapeake' Company has a standing here to ask reimbursement equal to the diversion out of the bonds which were appropriated by contract, and actual deposit with a trustee to that specific purpose, before either the interest was paid or the earnings were diverted.

The next question is whether the United States Trust Company, as the assignee of the Newport News & Mississippi Valley Company, is entitled to subject part of the 86 bonds deposited under the contract of March 6, 1891, to meet Car Trust obligations, to the payment of the amount advanced by the Newport News Company when operating the Valley Eoad to discharge a large amount of those Car Trust obligations. It is conceded that the amount thus advanced was $49,898.33. The Chesapeake Company objects to the consideration of this appeal on the ground that it was not made a party thereto.

An examination of the record shows an appeal allowed to the United States Trust Company without mention of the appellees. This was one of four appeals from the same decree. The record further contains a waiver in one instrument by all parties to the action below of the issuing of citations on "all the appeals.” The record was made up as if in one appeal. Under these circumstances we must hold that all the parties to the action below have appeared as parties to all llie appeals now under consideration.

It is true that the appeal bond oí the United States Trust Company runs to the Western Contract Company alone as obligee, but this defect in the appeal bond' cannot prevent the attaching of jurisdiction of all the parties appearing and waiving process. The giving and acceptance of an appeal bond is not jurisdictional. It is merely modal, and a defect in it is only an irregularity. Brown v. McConnell, 124 U. S. 489, 8 Sup. Ct. 559.

The learned judge at the circuit held that the United States Trust Company was not entitled To share in the security of the deposited bonds for the advances made by its assignor, the Newport News Company, to pay 'Car Trust obligations because it was a volunteer, and could not be subrogated, therefore, to the rights of the Chesapeake* Company in respect of such security. We find ourselves unable to concur in'this view.

The Newport News Company, it seems to us, was nothing but the agent of the Chesapeake Company in making these advances, and it is in evidence that it made them at the request of the Chesapeake Company.

It is true that there is nothing to show that the advances were ever charged on the books of account against the Chesapeake ‘Company by the Newport, News Company, but we must infer, in the absence of any averment to the contrary in any pleading by the receivers of the Chesapeake Company, that in the adjustment of affairs between the Newport News and the Chesapeake Companies at the cancellation of the lease, the latter company was permitted to become the real owner of the claim for these advances against the bonds, for a valuable consideration.

Inasmuch as these advances were made for the Chesapeake Company, and at its request, the agent making them, and subsequently acquiring title to the debt based on them, has as much right to avail itself of the security deposited to secure repayment of them as the Chesapeake Company would have were it still the owner of the claim therefor. It is not:, strictly speaking, a question of subrogation, as we view it.

When these advances were made, they were the advances of the Chesapeake Company, and the security to repay them as an incident to the debt thus created between the Valley Company and the Chesapeake Company then attached, and passed with that debt into the hands of any assignee thereof.

The mode of determining how many bonds and how much accrued interest are available as security for these advances must be the same as that followed with respect to the claim of the receivers of the Chesapeake Company; that is, the United States Trust Company shall be allowed as many bonds held by the trustee for 'Car Trust obligations as would be needed if sold at 90 per cent, of par to pay off the advances made. The accrued interest on these bonds which was paid in cash to* the trustee, and is now held by him, is also to be appropriated to pay these advances as part of the security. The appeal of S. S.

Brown and others from that part of the decree below dismissing their intervening petition in which they, as creditors of the Valley Company, sought to take advantage of the same bond clause of the contract of March 6, .189.1, under which we have held that relief may be granted to the Chesapeake Company and the United States Trust Company, can be very shortly disposed of. The claims of the petitioners were part of the floating debt of the Valley Company contracted before the making of the agreement of March 6, 1891.

That agreement was made for the benefit of the Ch.esapeake Company to secure any advances made by it or on its account or at its expense to pay the floating debt. It was not made for the benefit of the owners of the floating debt or the Car Trust notes. The petitioners, even if they might otherwise have taken advantage of-the clause, have not changed their position, or advanced money on the faith of the security of the bond clause; and therefore, in no aspect of the case can they enjoy the security afforded thereby.

It is true that where A. makes a contract with B. for the benefit of C., C. may usually sue on it, and enforce its obligations against B. It is also true that under certain circumstances where C. is compelled to- discharge an obligation of A. to B., C. may have the benefit of the same security for reimbursement as A. would have had, on principles of subrogation.

But neither of these principles applies in favor of Brown and his fellow petitioners — First, because the bond clause on which they rely was not made for their benefit; and, second, because they have not discharged any obligation for the benefit of the Chesapeake Company. The decree of the circuit court is in part affirmed and in part reversed,' and the case is remanded to the circuit court with instructions to set aside the decree as entered and to enter a modified decree in accordance with this opinion.

The costs of the appeal will be assessed one-half against the receivers of the Chesapeake Company and one-half against the Contract Company and S. S. Brown and other petitioners.