
    RAHT v. ATTRILL.
    N. Y. Court of Appeals;
    
    October, 1887.
    
      [Affirming, with modification in form, 42 Hun, 414.]
    1. Mortgage; lien attaches to improvements. The lien of a /mortgage attaches not only to the land in the condition in which it was at the time of its execution, but as changed or improved by accretions or by labor expended upon it while the mortgage is in existence; and creditors having debts created for money, labor or materials used in improving the mortgaged property, acquire on that account no legal or equitable claim to displace or subordinate the lien of the mortgage for their protection.
    2. Seceiver’s certificates ; priority of mortgage.] The fact that a corporar tion, at the time of the appointment of a receiver of its property in an action for its dissolution, is in serious financial embarrassment, without means to pay for work and materials used in improving its property, or to continue the work, does not justify an order of court authorizing the receiver to issue certificates, for its debts for work and labor which shall be a lien upon the property prior to the lien of a mortgage given thereon before such indebtedness was incurred. Such claims are not to be preferred as debts incurred for the benefit and protection of the property in the receiver’s hands.- So held, in surplus money proceedings in foreclosure.
    
    3. The same ; expense of preservation of property. ] Nor are such claims brought within the rule that gives expenses incurred in the preservation of the property a first lien thereon, by reason of the further-facts that a large number of the unpaid workmen, who had continued work under promises of payment, which had been broken, had reached a state of absolute destitution, and, in many cases, of starvation; and that, at the timé the order was made had stopped working, but remained on'the premises and had become riotous in their language and demeanor, and threatened, unless paid, to burn the hotel and other erections' and property upon the mortgaged premises.
    4. Former -adjudication; order for issue of certificates with pi'iority of lien, upon whom binding.] An order authorizing the issue of receiver’s certificates of indebtedness with a prior lien upon the corporate property, made upon the receiver’s application in an action
    1 between a stockholder and the corporation, without notice to the holders of corporate bonds secured by a trust' mortgage of the corporation, or to its trustee, is not binding upon the bondholders as an adjudication, and does not estop them from contesting, in proceedings as to surplus moneys on foreclosure of the mortgage, the validity of the order giving the receiver’s certificates a prior lien.
    5. Estoppel to contest priority of receiver’s certificates ; failure of lienor to object when issued.] The bondholders are not estopped from contesting the validity of the order of court giving the receiver’s certificates priority over the mortgage, by the fact that the trustee of the mortgage knew that a receiver had been appointed, and did not intervene to prevent the issuing of the certificates ; nor by the fact that the trustee, as a director and stockholder of the company, participated in the action of the meetings of the directors and stockholders in which the order for the issuing of the certificates was approved.
    
    6. Surplus money proceedings in foreclosure ; what liens may be adjusted.} In surplus money proceedings in foreclosure of a corporate mortgage, to determine the amount and priority of liens upon the surplus, expenses, incurred by a committee acting pursuant to a scheme for the reorganization pf the corporation, and for which bonds and other securities held by corporate creditors were pledged, may be adjusted, and the claim to a lien therefor, under a clause in the reorganization agreement, determined and enforced, 
    
    Appeal from an order of the general term, second Department, reversing an order of the special term which
    
      confirmed a referee’s report, and directed as to the distribution of surplus moneys in foreclosure.
    Oharles Baht, as. executor, &c., of Julius E. Baht, de- ' ceased, brought this action against Henry Y. Attrill, the Bockaway. Beach Improvement Company (Limited), and others, to foreclose a mortgage for $72,000, given by defendant Attrill and assigned by the mortgagee to the plaintiff, covering certain real estate at Bockway Beach in the State of Hew York.
    The Bockway Beach Improvement Company (Limited) was organized as a business corporation under the Business Corpor ations 'Act (L. 1875, c. 611), and became the purchaser of the premises covered by the said mortgage and subject thereto, March 1, 1880, and on the same day the corporation executed a second mortgage thereon to William K. Soutter as trustee to secure payment of an issue of $700,000 of bonds; and the company immediately proceeded to the erection of a large hotel upon the premises.
    The corporation becoming financially involved, on or about July 30,1880, Attrill, the defendant herein, on behalf of himself and other stockholders brought an action against the corporation for its dissolution, and on August 2,1880, an Order was made therein appointing John A. Bice receiver of all the property and effects of the company to take possession of and administer the same for the benefit of all concerned.
    On August 3,1880, an affidavit of the general manager of the company was presented to the coürt, stating: “ That the defendant is now building a large hotel at Bockaway Beach, in said State; that a large number of workmen have been employed thereon, to the number at one time of nearly two thousand; that, owing to delay in paying them, they all, a short time ago,- refused to work, and more than one-half have left; that about eight hundred resumed work and are now working under a promise by the said company that they shall be soon paid; that no provision has been made for their payment, and this deponent is satisfied that no provision can be made by the said company in its present condition; that if not paid, the men will stop work, and this deponent fears there will be a serious disturbance; that it is imperative that the receiver in this cause should be authorized to borrow the amount needed to pay the said Avorkmen; that about $100,000 will be required for' that purpose, which can be borrowed upon receiver’s certificates duly authorized.”
    Upon this affidavit, an exporte order was made August 17, 1880, by which the receiver was “ authorized to" issue receiver’s certificates to the amount of $110,000, to be paid to the employees of said company, the said certificates to be a first lien upon all the property of said company in the hands of said receiver and prior to the mortgage by the said company to William K. Soutter, trustee, of $700,000, executed April 13, 1880, and the interest on said mortgage.” Under this order the receiver issued certificates in the form prescribed therein, declaring on their face that they were a debt of the receiver incurred for the benefit and protection of the property in his hands, and a first lien thereon prior to the mortgage to William IL Soutter, trustee, and to the interest thereon; and, from time to time thereafter, orders of a similar character were obtained also authorizing the receiver to issue certificates Avith a prior lien over the Soutter mortgage.
    In May, 1881, while the suit brought by Attrill for dissolution was pending, an action was commenced by the attorney-general to dissolve the corporation, and in that action an answer was interposed, but no further proceedings were had. Thereafter, in September, 1881, this action was commenced, to foreclose the purchase money mortgage of $72,000, and, pursuant to a decree of sale therein, the hotel property was sold, realizing a surplus" of $86,283.39, the 'distribution' of which is the subject of the present controversy.
    The expenses of reorganization, referred to in the opinion arose out óf the following facts: In the autumn of 1882, a scheme for the reorganization of the company was set on foot, under which all parties holding Hens, certificates or claims against the property, upon the terms named in a reorganization agreement, were invited to assist in the reorganization of the property and to complete the work. Certain persons were appointed trustees under the reorganization scheme, and a large number of the holders of the bonds secured by the Soutter mortgage, a large number of holders of receiver’s certificates, of lienors, and other claimants became parties thereto. For a period of one year or thereabouts, efforts were made to reorganize the company, the plan being to seH the property, to purchase the same, and effect a reorganization, allowing all claims a representation. Such efforts were not successful, arid were finally abandoned in the autumn of 1882. The securities deposited with the trustees under the reorganization agreement remained in their hands, and it was claimed that such of the same as should be adjudged to have a claim upon the surplus, were liable for certain expenses incurred in reorganization, under a clause in the reorganization agreement to that effect.
    IJpon the hearing before the referee appointed to ascertain and report as to the several liens upon the surplus moneys and their .priorities, the holders of receiver’s certificates sought to sustain their claim to priority over the Soutter mortgage by evidence that, at the time the order was made, the workmen were in a state of riot threatening to fire and destroy the hotel; that they refused to take the receiver’s certificates, and mobbed three or four men who had done so; and that the property was in great peril; that, at a mass meeting of the workmen, they consented that one McDonald should negotiate $110,000 receiver’s certificates, which he subsequently did, to the claimants in these proceedings. This evidence was admitted against objection.
    The referee reported in favor of the receiver’s certificates as a lien superior to the lien of the Soutter mortgage.
    
      The special term confirmed his report; and held that the bondholders were bound by the order by reason of the fact that the trustee, in his capacity as a director of the corporation was an assenting party to the proceedings which approved their issuance, and that the evidence showed exigencies which justified the order giving the receiver’s certificates priority.
    
      The supreme couH a general term, upon appeal, reversed the decision below, holding that the case of Metropolitan Trust Oo. <o. Tonawanda Valley &c. R. R. Co. (103 IT. Y. 245), was conclusive against the right of the court to postpone the lien of the mortgage to the receiver’s certificates, and that the facts were insufficient to show that the trustee, as such, consented to the issue of the certificates.
    The general term thereupon sustained the exceptions of the bondholders and of the trustee to the referee’s report postponing their hen to the lien of the receiver’s certificates, set aside the receiver’s report, vacated the order of reference, and appointed a new referee, “to ascertain the amount due to any person or person's, which is a lien upon such surplus moneys herein, and also as to the priorities of the several liens and claims to said surplus moneys, in accordance with the opinion of this court, to the exclusion of all receiver’s certificates, it appearing that the claims of the bondholders will absorb the fund.” Adding: “And it is further ordered, that said referee summon before him, on this reference herein, every party who has appeared in this action, and every person who has duly filed Ms notice of his claim to such surplus moneys, and that he, the said referee, cause them to have the usual notice of' all subsequent proceedings, and report thereon, with all convenient speed• and the judgment directed “that the referee pass upon the question as to the liability of the fund to pay the expenses of the unsuccessful attempt to reorganize.” Decision reported in 42 Man, 414.
    From this judgment the holders of the receiver’s certificates and various other lienors took this appeal.
    
      John L. Gadwalader (Strong d> Cad/walader, attorneys), for holders of receiver’s certificates, appellants.
    
      Cla/rence D. Ashley, for other appellants.
    
      James Mo Harnee ( Worh & MoHamee, attorneys), for other appellants.
    
      Ed/mard S. Chinch, for other appellants.
    
      Merman Aa/ron, for other appellants.
    
      Boswell W. Keene,, for other appellants.
    
      Thomas M. Wheeler, for other respondents.
    
      Lewis Sanders, for other respondents.
    
      Vanderpoel, Creen de Cuming, for the trustee, respondent.
    
      
       By statute (L. 1885, c. 376) the receiver of an insolvent railroad corporation is obliged to pay the wages of employees in preference to all other debts or claims, no distinction being made between wages earned before and tliose earned after the receiver’s appointment.
      The law as to receiver’s certificates, with a full collection of authorities, is to be found in the recent work of Charles Fisk Beach, Jr., on the Law of Receivers, see chap. 11, §§ 879, 402.
      As to the distinction between statutory and common-law receivers, see Note on Statutory Receivers, 19 Abb. N. C. 359, and Herring v. N.Y., Lake Erie, etc. R. R. Co., Id. 340, and following cases.
    
    
      
       See Herring v. N. Y. Lake Erie, etc. R. R. Co., 19 Abb. N. C. 340.
    
    
      
       See N. Y. Life Ins. Co. v. Mayer, 19 Abb. N. C. 92, and Delafield v. White, Id. 104.
    
   Andrews, J.

The scheme set on foot by the principal stockholder, with the consent of a majority of the Bock-away Beach Improvement Company for the administration of its affairs, and for the completion, finishing and operating the hotel through the instrumentality of a receiver appointed by the court, has proved a signal and disastrous failure. The receiver was appointed August 2,1880, within six months after the organization of the company. Prior to that date, the company had expended more than $350,000 raised on the sale and hypothecation of its bonds, secured by the trust mortgage to Soutter, leaving the hotel building and structures but partially completed, and had exhausted all its available means, and was indebted in the sum of nearly $300,000 for labor, materials and furniture, which it had no means to pay. The receiver, a few days after his appointment, made his first application to borrow money on receiver’s certificates, and on 17th day of August an order was made ese parte, at special term, authorizing him to borrow $130,000 for the “purpose of paying the employees of said company,” and to issué therefor certificates containing on their face a declaration that the debt represented thereby was “a debt of the receiver incurred for the benefit and protection of the property in his hands, and a first lien thereon prior to the mortgage to William K. Soutter, trustee, for $700,000, executed April 1,1880, and to the interest on said mortgage.”

From time to time thereafter, and up to May, 1881, orders of a- similar character were obtained, authorizing the issuing of further certificates for money “to furnish, finish and operate the hotel,” also with priority of lien over the Soutter mortgage. Certificates were issued under the various orders to the amount in all of between $350,000 and $400,000, the proceeds of which presumably were used to carry forward the hotel enterprise. In May, 1881, while the Attrill suit, in which the orders were granted,' was pending, an action was commenced by the attorney general to dissolve the corporation. Thereafter, in September, 1881, an action was commenced by Eaht, executor, to foreclose the original purchase money mortgage of $72,000, which went to a decree April 10, 1882, and under which the hotel property was sold January 31, 1883, making a surplus of $86,283.39, the distribution of which is the subject of the present controversy.

It will be seen from this general statement that the efforts of the receiver to administer the property “ for the benefit of all concerned,” were terminated, after a million dollars had been expended in improving it, in a sale of the whole property of the corporation for a sum of less then $200,000, and all that is left from the wreck for the payment of creditors, whose aggregate claims exceed $800,000, is the salvage of $86,000.

TMs case illustrates what I apprehend has been the common experience where a court, departing from its appropriate judicial function, has undertaken to manage and carry on the business of a failing and insolvent corporation.

The principalcontroversy is between the mortgage creditors under the Soutter mortgage and the holders of the $110,000 of certificates issued under the order of August 17, 1880. There is a controversy between the holders of the different classes of certificates. The holders of certificates issued under the orders subsequent to August 17, 1880, insist that they are entitled to share ratably in the surplus with the holders of the certificates first issued, which' claim has been adjudicated against' them in this action. The question becomes unimportant if it shall be held that the mortgage creditors have the first lien on the fund in question, as their claims largely exceed the whole surplus. Except for the provision in the order of August 17, 1880, giving to the certificates issued thereunder priority of lien to the Soutter mortgage, there of course could be no question as to the right of the bondholders to a preference.

As between creditors by mortgage and general creditors, the former are entitled to priority of payment out of the mortgagéd property by their contract and by the law of the land. The law recognizes the validity of contracts of mortgage, and enforces them, subject to certain regulations for the protection of subsequent purchasers or incumbrancers. The lien of the mortgage attaches not only to the land in the condition in which it was at the time of the execution of the mortgage, but as changed or improved by accretions, or by labor expended upon it while the mortgage is in existence. Creditors having debts created for money, labor or materials used in improving the mortgaged property, acquire on that account no legal or equitable claim to displace or subordinate the lien of the mortgage for their protection.

The order of August 11,1880, assumes to create a prior equitable lien in favor of the holders of certificates. This is put in the order on the ground that the debt authorized was for the benefit and protection of the property. There are no facts recited in the order, nor were any presented to the court in the affidavit upon which the order was granted, which offered the slightest justification for subverting and postponing the prior legal lien of the mortgage creditors, without their consent, to the debts ordered to be created by the order. The fact that the company was owing debts for labor created no equity for their payment in preference to the bondholders. In view of our decision in the case of Metropolitan Trust Co. v. Tonawanda Valley & Cuba R. R. Co. (103 N. Y. 245), it is needless to say, that however meritorious these claims were, this of itself presented no reason or justification for paying them -out of the property of the bondholders by depriving them of the security pledged to them before the labor debts were contracted.

The affidavit upon which the order of August 11 was based shows that the company was in serious financial embarrassment, but falls far short of disclosing any extraordinary emergency which called for extraordinary methods for the preservation of its property.

But the validity of the order of August 11, so far as it assumes to give priority to holders of certificates to be issued thereunder, was sought to be supported on the inquiry before the referee in the surplus money proceedings, ■on a ground which was not presented to the court when the order was granted. This ground, as stated in the report of the referee, is, in substance, that a large number of workmen, comprising eight hundred or a thousand men, whose wages during May, June and July were in arrears, but who had continued work under promises of payment, all of which had been broken, had reached a state of absolute destitution, and in many cases of starvation, and that, at the time the order was made, they had stopped working, but remained on the premises and had become riotous in their language and demeanor and threatened, unless paid, to burn the hotel building and erections and personal property therein, and the referee found that but for the action of the bankers who took the certificates and advanced the funds by which the receiver was enabled to pay off the arrears of wages, the hotel and other property of the company would in all probability have been destroyed or seriously injured.”

The question presented is, whether these circumstances justified, or, if presented to the court, would have justified the order preferring advances made thereunder to the lien of the mortgage.

Before coming to this question, however, it is to be observed that the order was granted in a suit to which neither the trustee of the mortgage nor the bondholders-were at the time parties, and without, so far as appears,, any notice of the application for the order having been given to them or any of them. The original parties to the suit were Attrill, the principal stockholder of the company, who was plaintiff, and the corporation, The Bock-away Beach Improvement Company, which was sole defendant. On the 13th of August, 1880, an order was-made on the apphcation of the receiver enjoining certain bondholders named from selling or transferring bonds issued under the Soutter mortgage, held by them in pledge, which order was served on the persons and firms named therein. But, so far as appears, they were not then made parties to the action, and the order was doubtless procured to arrest the apprehended danger of a sacrifice of the bonds by the pledgees referred to in the complaint. This-order gives no intimation of an intention to apply for an order authorizing the issue of receiver’s certificates. Soutter, the trustee under the mortgage, was made a party defendant at a subsequent stage of the action, but after the certificates under the order of August 11 were issued and' the advances made. The granting of the order of August 17, without notice to the mortgagee or to the bondholders, did not bind them as an adjudication, assuming that the court had jurisdiction to appoint a receiver in the Attrill action—a point which will be assumed without examination. The bondholders, or their trustee, were entitled by the plainest rules of law and justice to notice and the right to be heard, before their rights under the mortgage could be affected, and it was open to them on the hearing before the referee to contest both on the facts and the law the order of August 17.

As was said by Blatchrord, J., in Union Trust Co. v. Illinois Midland Co. (117 TI. 8. 434 and 456), “ The receiver or those lending money to him on certificates issued on orders made without prior notice to parties interested, take the risk of the final action of the court in regard to the loans.”

On the merits we are of opinion that a case was not made out, either before the court which granted the order, or before the referee on this reference, which within any recognized doctrine regulating or defining the powers of a court of equity in the administration of property through a receiver, justified the order of August 17, postponing the lien of the Soutter mortgage.

The power of a court to appoint a receiver when a proper case is presented, is undoubted. It rests in the sound discretion of the court. The power itself and the object of its exercise were stated long since with admirable clearness by Lord Hardwicks, in Skip v. Harwood (3 Aik. 564): “ It is a discretionary power exercised by the court with as great utility to the subject as any authority which belongs to it; and it is provisional only for the more speedy getting of a party’s estate and securing it for the benefit of such person who shall appear to be entitled, and it does not at all affect the right.” The act of the court in taking charge of property through a receiver is attended with certain necessary expenses of its care and custody, and it has become the settled rule that expenses of realization and also certain expenses which are called expenses of preservation, may be incurred under the order of the court on the credit of the property; and it follows from necessity, in order to the effectual administration of the trust assumed by the court, that these expenses should be paid out of the income, or, when necessary, out of the corpus of the property before distribution, or before the court passes over the property to those adjudged to be entitled.

It is claimed that the money advanced in this case to protect the property from an incendiary burning, created a debt for preservation, -which may be preferred to the claim of the bondholders. We are of a contrary opinion. Ho doubt a serious emergency existed, growing out of the discontent and riotous disposition of the workmen. But the State primarily assumes the duty of the preservation of public order and the repression and punishment of crime. It enacts laws, • constitutes courts and commissions officers to this end. It especially makes provision intended to prevent riots, and it seeks to insure prompt action on the part of local officers and communities by imposing upon the latter pecuniary responsibility for injuries to property caused by riotous assemblages. In this case, no attempt, so far as appears, was made by the receiver or by the company to secure the intervention of the public authorities to suppress the apprehended disturbance, or to arrest those who threatened to burn the property of the company. It clearly ought not to have been assumed that the ordinary agencies of the law were inadequate to the situation, or that the law, operating through its regularly appointed channels, was impotent to control the situation.

It would be difficult to define, by a rule applicable in every case, what are expenses of preservation which may be incurred by a receiver by authority of the court. It was said by James, L. J., in Regent’s Canal Iron Works Co. (L. R. 3 Ch. Div. 427), that “the only costs for the preservation of the property would be such things as the repairing of the property, paying rates and taxes, which would be necessary to prevent any forfeiture, or putting a person in to take care of the property.” Wherever the true limit is, we think it does not include the expenditure authorized by the order of August 17, and that such an expenditure is and ought to be excluded from the definition. There must be something approaching a demonstrable necessity to justify such an infringement of the rights of the mortgagees as was attempted in this case.

We have not lost sight of the recent very important cases decided in the supreme court of the United States, involving the question of the power which may be vested by the court in receivers of insolvent railroad corporations, and the right of the court to provide for the payment of certain debts contracted before or after the appointment of a receiver, out of income, and if that is inadequate, out of the corpus of the property. These cases and decisions are the outcome of the growth of railroad enterprises and business within a comparatively recent period.

It has been held that under special circumstances the court may direct the payment of ante-receivership debts for labor or supplies contracted within a limited period before the insolvency, the adjustment and payment of traffic balances in favor of connecting roads, and may direct the receiver to operate the road pending the foreclosure, and to that end purchase necessary rolling stock for the use of the road and make repairs and improvements thereon, the expense of which shall be a charge on the property in priority to legal liens (Wallace v. Loomis, 97 U. S. 146; Fosdick v. Schall, 99 Id. 235; Barton v. Barbour, 104 Id. 126; Miltenberger v. Logansport Railway Co., 106 Id. 286; Union Trust Co. v. Souther, 107 Id. 591; Burnham v. Bowen, 111 Id. 776; Union Trust Co. v. 111. Midland R. R. Co., supra).

It cannot be successfully denied that the decisions in these cases vest in the courts a very broad and comprehensive jurisdiction over insolvent railroad corporations and their property. It will be found, on examining these cases, that the jurisdiction asserted by the court therein is largely based upon the public character of railroad corporations, the public interest in their continued and successful operation, the peculiar character aad terms of railroad mortgages, and upon other special grounds not applicable to ordinary private corporations.

It was said, by Waite, Ch. J., in Fosdick v. Schall, that “railroadmortgages and the rights of railroad mortgagees are comparatively new in the history of judicial proceedings. They are peculiar in their character and affect peculiar interestsand it was said in Barton v. Barbour, “ the new and changed condition of things which is presented by the insolvency of such a corporation as a railroad company, has rendered necessary the exercise of large and modified forms of control of its property by the courts charged with the settlement of its affairs and the disposition of its assets.” These cases furnish, we think, no authority for upholding the order of August 17, or for subverting the priority of lien, which, according to the general rules of law, the bondholders acquired through the trust mortgage on the property of the company. It would be unwise, we think, to extend the power of the court, in dealing Avith property in the hands of receivers, to the practical subversion or destruction of vested interests, as Avould be the case in this instance if the order of August 17 should be sustained. It is best for all that the integrity of contracts should be strictly guarded and maintained, and that a rigid, rather than a liberal, construction of the power of the court to subject property in the hands of receivers to charges to the prejudice of creditors should be adopted.

There is no ground for alleging an estoppel against the bondholders barring their right to a review of the action of the court. The claim of estoppel is based upon the assumed fact that the trustee knew that a receiver had been appointed, and did not intervene to prevent the issuing of the certificates. The trustee at the time was not a party to the action, and had no notice of the application for the order, or of the issuing of the certificates, until after. He was designated as a trustee by the company before the bonds were issued, and was one of the directors of the corporation, positions which might bring his duty and interest into conflict. It would be most unjust under the circumstances to conclude the bondholders by his inaction, or for the reason that after the advances on the certificates had been made, he, as one of the board of directors and as a stockholder of the company, participated in the action of meetings of directors and stockholders in which the order for the issuing of certificates was approved.

We perceive no valid reason why the expenses incurred by the reorganization committee under the reorganization scheme of 1881, and for which it is claimed a large portion of the bonds and other securities were pledged, may not be adjusted in this proceeding, and the hen therefor, if any, be enforced. It is claimed that in any event there are certain expenses of the receivership chargeable against the fund in court. We do not perceive upon the facts presented that this claim has any foundation. However, we think a proper disposition of the appeal will be made by modifying the order of the general term so as to make the reversal of the order of the special term absolute, leaving the parties to apply for a new reference as they may be advised, on which all questions, except that of priority between the bondholders and creditors holding certificates, may be considered.

All concurred. 
      
       The remittitur as settled, allowed any party to apply for a reference, and any party to raise any questknqnot actually here decided: and any holder of receiver’s certificates to prove an estoppel in pais against individual holders of bonds, and that parties having received any of the fund under -the order below, need only account for sums actually received with interest.
     