Munson v. Syracuse, Geneva & Corning R. R. Co. , 3 N.Y. St. Rep. 31 ( 1886 )

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[EDITORS' NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.] We think it would be difficult to affirm the judgment of the court below, dismissing the complaint, if in order to do so it was necessary to uphold the proposition that the original contract of August 13, 1875, between the plaintiffs and Magee, was invalid either because Munson, one of the plaintiffs, was at the time of entering into the contract, a director of the Sodus Bay and Corning Railroad Company, or for the reason that the contract violated the rule which prohibits combinations to prevent competition at a judicial or other public sale. The situation was briefly this. The Sodus Bay and Corning Railroad Company was organized in 1871, to construct and operate a railroad from Corning, in the county of Steuben, to Sodus Bay in the county of Wayne, a distance of about eighty-six miles, passing through the counties of Schuyler, Yates and Ontario, by way of Savona, Penn Yan and Geneva. Of this road the plaintiff Munson was president and a director. In 1872, the corporation created a mortgage on its projected road, its franchises and property for $1,500,000, to secure a contemplated issue of bonds to that amount, to be used in the construction of the road. It proceeded to secure rights of way over a portion of its line, graded about thirty miles of its track between Savona and Geneva, and expended in the aggregate in securing titles and in the prosecution of the work, the sum of $250,000. It issued bonds under the mortgage, to the amount of $257,000, from the proceeds of which the expenditures were made. At the date of the contract between the plaintiffs and Magee, August 13, 1875, the plaintiffs held and controlled of these bonds, $241,000 in amount, the remaining $16,000 being in the hands of a former treasurer of the company, whose title thereto seems to have been disputed, but who subsequently received a dividend thereon from the proceeds of the mortgage sale. The title of the plaintiffs to the $241,000 of bonds, was not questioned, and there is no suggestion that they were not bona fide holders for value, or that the bonds did not represent a valid debt against the company for their full amount. In January, 1874, the company became insolvent. It defaulted in the payment of the interest on its bonds at that date, and in the spring of 1875, all operations on the road were suspended, and the further prosecution of the enterprise was practically abandoned. In short when the contract of August 13, 1875, was made the company was hopelessly bankrupt, the work had stopped, the interest on its bonds had been unpaid for eighteen months, and practically its whole property consisted of disconnected rights of way over a portion of its route, and a road-bed partially graded between Savona and Geneva, and whatever property it had of any value was acquired through the means furnished by the holders of the bonds. Under these circumstances the parties entered into the contract of August 13, 1875. It recites that the plaintiffs own and represent $241,000 of the bonds of the Sodus Bay and Corning Railroad Company, and that Magee, the other party to the contract, represents the persons and interests proposing to organize another railroad company for the construction of a railroad from the vicinity of Corning to Geneva. The parties of the first part (the plaintiffs) agree to proceed at once to secure the foreclosure of the mortgage, and to purchase on the foreclosure sale, the property, rights of way, franchises and interests covered thereby, and convey the same to Magee or to the railroad company proposed to be organized. Magee, the other party to the contract, agrees to deliver or cause to be delivered, to Munson and his associates in payment for the said property, rights of way and franchises, first mortgage bonds of the proposed railway company, to the amount of fifty per cent of the principal and interest, of the bonds of the Sodus Bay and Corning Railroad Company, held by them. The contract contains other stipulations not now necessary to mention. In the view we take of another question in the case, we deem it unnecessary to determine whether the contract of August 13, 1875, was valid as between the original parties thereto, that is, whether the plaintiff Munson, in entering into the contract, violated any duty owing by him to the corporation of which he was a director, or whether the contract as a whole, was, on the part of Munson and his associates, any thing more than a legitimate arrangement to protect their interests as bondholders, and to make the mortgage security available for the payment of a part of the mortgage debt. The contract was not by or with the Sodus Bay and Corning Railroad Company, and assuming that the question as to the validity of the original contract can be raised in this action, we are not prepared, without further consideration, to condemn the transaction on either of the grounds suggested. (Duncomb v. N.Y., H. N.R.R. Co., 84 N.Y. 190; Marie v. Garrison, 83 id. 14; Harpending v. Munson, 91 id. 650.)

But this action is not brought to enforce the contract of August 13, 1875, against the defendant Magee. It is an action to compel the specific performance by the defendant corporation, of the undertaking of Magee in that contract, to deliver the bonds of the new company as therein provided, founded upon the assumption by the new company of that obligation, by resolution of its board of directors, passed August 13, 1875, and also upon the subsequent contract of September 14, 1875, made between the company and the plaintiffs, which in its primary provision substituted the company in the place of Magee as the party of the second part in the contract of August 13, 1875. The action in its entire scope is framed to enforce the obligation of the defendant corporation, under its contract of assumption. It was tried upon this theory, the exceptions point to this as the ground of the action, and Magee is joined as defendant and in the demand of relief, as the custodian of bonds of the company which the plaintiffs claimed he should be adjudged to deliver to them, by the judgment in the action. Throughout the trial the action was treated, as an action against the defendant corporation upon its contract, and in no respect as an action against Magee, to enforce a liability against him under the contract of August 13, 1875. The plaintiffs therefore are compelled to meet the question, whether upon principles of equity they are entitled to the aid of the court to enforce an executory contract between themselves on the one side, and the defendant corporation on the other, for the sale of the property of the former, and in a case where one of the plaintiffs at the time the contract was made, was a director of the purchasing corporation and took part in making the contract upon which the action is brought. For a proper understanding of the situation, a few additional facts need to be stated. On the 26th of August, 1875, Magee and his associates organized a railroad company, to construct a railroad from Corning to Geneva, as contemplated by the contract of August 13, 1875. The plaintiff Munson was one of the promoters and became a director and stockholder, and was the first president of the corporation. On the 31st of August, 1875, Magee executed a written assignment to the new corporation, The Syracuse, Geneva and Corning Railway Company, of his rights under the contract with the plaintiffs of August 13, 1875, and the board of directors at a meeting on the same day, in which the plaintiff Munson participated, passed a resolution assuming the contract on the part of Magee, and agreeing to perform it, except in one particular not now material to be mentioned. On the 14th of September, 1875, the contract before referred to of that date, was entered into between the plaintiffs and the new corporation, and was executed individually by each of the plaintiffs, and on the part of the corporation, by the plaintiff Munson, as president. The proceedings of the board of directors indicate that when the resolution of August 31, 1875, was passed, and for two or three months thereafter, the company contemplated building its road to Geneva on the same line substantially as that of the Sodus Bay and Corning Railroad Company, but in December, 1875, it located an entirely new line, not coincident in any part with the line originally contemplated, upon which new line its road was subsequently built. It is found, and the evidence supports the finding, that the best interests of the company were promoted by adopting its present route. The plaintiffs procured a foreclosure of the mortgage and purchased the property, as they had agreed, and subsequently, in 1877, tendered a deed thereof to the defendant corporation, and demanded the delivery of the bonds, which was refused.

In determining the legal question presented, it is proper to say that there is no evidence of any actual fraud or collusion on the part of any of the parties to the original contract of August 13, 1875, or that the contract of assumption was induced by any improper appliances or motives whatever. It is plain that Magee and his associates, when they entered into the original contract, contemplated building the proposed road on the line of the Sodus Bay and Corning Railroad Company, and that the contract was made with a view of acquiring for the new road, the rights of way and other property of that corporation. It is equally plain that the contract of assumption was entered into by the new corporation with the same expectation and for the same purpose. If the contract was otherwise unobjectionable, it could not, we think, be assailed on the ground that it was a contract outside of the power of the defendant corporation. The statute authorizes a railroad corporation to acquire land for its track and other necessary purposes, by voluntary purchase or by condemnation (Laws of 1850, chap. 140, §§ 14, 15), and an agreement made on the purchase of rights of way, to pay therefor in bonds of the purchasing corporation, secured by a mortgage on its property, is clearly we think within the implied, if not within the express powers of a railroad corporation. (§ 28, subd. 10.) The contract made between the defendant corporation and the plaintiffs, was in substance a contract to purchase rights of way, and although the defendants' line was not formally located on the line proposed to be purchased, and was in fact subsequently located on a different line, this change of purpose did not, we think, affect the question of corporate power.

But we are of opinion that the contract of September 14, 1875, is repugnant to the great rule of law which invalidates all contracts made by a trustee or fiduciary, in which he is personally interested, at the election of the party he represents. There is no controversy as to the facts bringing the case as to Munson within the operation of the rule. He and his associates were dealing with a corporation in which Munson was a director, in a matter where the interests of the contracting parties were or might be in conflict. The contract bound the corporation to purchase, and Munson, as one of the directors, participated in the action of the corporation in assuming the obligation, and in binding itself to pay the price primarily agreed upon between the plaintiffs and Magee. He stood in the attitude of selling as owner and purchasing as trustee. The law permits no one to act in such inconsistent relations. It does not stop to inquire whether the contract or transaction was fair or unfair. It stops the inquiry when the relation is disclosed, and sets aside the transaction or refuses to enforce it, at the instance of the party whom the fiduciary undertook to represent, without undertaking to deal with the question of abstract justice in the particular case. It prevents frauds by making them as far as may be impossible, knowing that real motives often elude the most searching inquiry, and it leaves neither to judge nor jury the right to determine upon a consideration of its advantages or disadvantages, whether a contract made under such circumstances shall stand or fall. It can make no difference in the application of the rule in this case, that Munson's associates were not themselves disabled from contracting with the corporation, or that Munson was only one of ten directors who voted in favor of the contract. The contract on its face, notified Munson's associates of his relation to the corporation, and that the contract was subject to be defeated on that ground, and on the other hand a corporation in order to defeat a contract entered into by directors, in which one or more of them had a private interest, is not bound to show that the influence of the director or directors having the private interest, determined the action of the board. The law cannot accurately measure the influence of a trustee with his associates, nor will it enter into the inquiry, in an action by the trustee in his private capacity, to enforce the contract in the making of which he participated. The value of the rule of equity, to which we have adverted, lies to a great extent in its stubbornness and inflexibility. Its rigidity gives it one of its chief uses as a preventive or discouraging influence, because it weakens the temptation to dishonesty or unfair dealing on the part of trustees, by vitiating, without attempt at discrimination, all transactions in which they assume the dual character of principal and representative.

The rule has been declared and enforced in a great variety of cases, but in none perhaps with more vigor and completeness, both upon principle and authority, than in the leading case ofDavoue v. Fanning (2 Johns. Ch. 251, 252). But the case ofAberdeen Railway Company v. Blakie and others (2 Eq. 1281), decided by the House of Lords, is in many of its features similar to the present one. In that case it appeared that the plaintiffs were a manufacturing firm, and that one of them was also a manager of the Aberdeen Railway Company, the defendant, and the chairman of the board. At a meeting of the managers, they by resolution authorized their engineer to contract for iron chairs needed by the company. The agent contracted with the plaintiffs' firm. It did not appear that the member of the firm, who was also a manager and the chairman of the company, intermeddled with the dealing on either side, further than that it may be assumed he was at the meeting which authorized the engineer to procure a supply of chairs. The plaintiffs brought their suit to enforce specifically the performance of the contract, or in the alternative to recover damages for its non-performance. After a decision in their favor in the lower court, the company appealed to the House of Lords, where the ruling was unanimously reversed on the ground that the contract was condemned by the rules of equity, as having been made between the company of which one of the plaintiffs was a manager, and a private firm of which he was a member. The opinions of Lord Chancellor CRANWORTH and of Lord BROUGHAM vindicate upon impregnable grounds the general rule and its application to the particular case.

We have designedly omitted up to this time, special reference to a circumstance which it is claimed takes the case out of the operation of the general equitable rule. That is, that the contract with the defendant corporation, was not on the part of the plaintiffs a fresh dealing in respect to the sale of their interest in the property of the Sodus Bay and Corning Railroad Company, but was simply a substitution in the place of Magee, of the corporation organized by him and his associates, for the purpose of carrying out the original arrangement. But the promoters of a corporation are not the corporation. The legal body is distinct from the individuals who compose it. The statute confers no authority upon the promoters of a corporation to enter into preliminary contracts binding the corporation when it shall come into existence. Such contracts may bind the individuals who make them. If adopted by the corporation, and they are within the corporate powers, and are not otherwise subject to objection, they may become the contracts of the corporation and enforceable as such. In respect to contracts of promoters Judge REDFIELD says: "The promoters are in no sense identical with the corporation, nor do they represent it in any relation of agency, and their contracts could, of course, only bind the company so far as they should be subsequently adopted by it, as their successors." (1 Redf. on Railways, 9.) But the corporation is at liberty to refuse to sanction them, and if its sanction is obtained by the act or co-operation of directors who have a private interest, we perceive no reason why, under the general rule, the corporation may not resist an action for specific performance, at least in a case where it has not accepted the consideration and taken the benefit.

It is claimed that the general policy of the law in this State sanctions the contract in question, and we are referred to chapter 710, Laws of 1873, which authorizes the purchaser, or the grantee of the purchaser of the real estate, tracks and fixtures of a railroad corporation sold under a mortgage or decree, to associate with him other persons and form a new corporation to maintain and operate the road. But the transaction in question was not in any proper sense an arrangement for the reorganization of an existing railroad. It was not contemplated that the new corporation should operate or maintain the road of the old corporation. The line of the new corporation, by its articles, extended only from Corning to Geneva, whereas the route of the old corporation was from Corning to Sodus Bay. When the contract was made, the enterprise of building the Sodus Bay and Corning road had been commenced, but the road had not been built. Its route had only in part been located, and the great burden and expense of the undertaking was yet to be incurred. The case is not in terms within the act of 1873, nor as we think within its spirit and intent.

These views lead to an affirmance of the judgment.

All concur, except RAPALLO and FINCH, JJ., not voting.

Judgment affirmed.