
    The People of the State of New York ex rel. The Westchester Street Railroad Company and the New York, New Haven and Hartford Railroad Company v. Public Service Commission for the Second District of the State of New York and Frank W. Stevens and Others.
    Third Department,
    July 8, 1913.
    Public service corporations—railroads — sale of railroad property and franchises on foreclosure — application to Public Service Commission to issue stock —statutes construed— constitutional law—impairment of rights of mortgagee — when stock may be issued for purchase price — valuation of railroad property.
    
      It seems, that the statute contemplates that a person who purchases the franchises and property of a railroad company may organize a corporation to take over the same and the purchase price may be financed by an issue of stock, bonds, or other securities. This, because a railroad can only be operated by a corporation.
    
      It seems, that the right of a corporation to which the property and franchises of a railroad company have been transferred after sale on foreclosure to capitalize the purchase price cannot be impaired by section 55 of the Public Service Commissions Law, subsequently enacted, providing that such franchises cannot be capitalized.
    On an application by a railroad corporation to issue stock, the Public Service Commission should take into consideration the amount paid for the franchises and property acquired by the company upon bona fide competitive bids at a public sale on the foreclosure of a mortgage thereon.
    Section 55 of the Stock Corporation Law permitting stock to be issued for the value of property purchased by a corporation, etc., is not repealed by section 55 of the Public Service Commissions Law. which in substance provides that before a public service corporation may issue stock it must be authorized to do so by the Public Service Commission and the amount of the issue determined. The purpose of the latter statute is to prevent the issue of watered or fictitious securities.
    Where the franchises and property of a railroad are sold on foreclosure, the cost to the purchaser is a fair basis of capitalization and the honest judgmeBtrdfThe directors of the purchasing corporation is binding on the Public Service Commission where the good faith of the transaction is established.
    The Public Service Commission in determining the amount of stock which a railroad corporation may issue should take into consideration its earning power at reasonable rates, for the Commission may increase as well as lower the rates, which must be reasonable both to the public and to the corporation.
    Evidence examined, and held, that under all the circumstances a corporation which purchased the property and franchises of a railroad company sold on foreclosure was entitled to issue stock for the purchase price.
    Certiorari issued out of the Supreme Court and attested on the 18th day of February, 1913, directed to the Public Service Commission for the Second District of the State of New York and the members thereof, commanding them to certify and return to the office of the clerk of the county of Albany all and singular their proceedings had in permitting the Westchester Street Railroad Company to issue $434,000 of stock, and denying its application for a larger issue.
    
      Krauthoff, Harmon & Mathewson, attorneys [ William Greenough and Charles F. Mathewson of counsel], for the relator.
    
      Ledyard P. Hale, for the respondent.
   Kellogg, J.:

The Tarrytown, White Plains and Mamaroneck Street Railroad Company’s property, rights and franchises were sold at a foreclosure sale by a judgment of the Supreme Court for $882,400.73 to one Sutro, who was acting for the New York, New Haven and Hartford Railroad Company. The New Haven Company was the owner of the greater part of the bonds secured by the mortgage foreclosed. Sutro incurred certain legal and other expenses in connection with the purchase amounting to $29,622.68, making the net cost of the railroad to him $912,023.41.

The purchaser and his associates filed the certificate contemplated by section 9 of the Stock Corporation Law (Consol. Laws, chap. 59; Laws of 1909, chap. 61), and formed the Westchester Street Bailroad Company, and upon proper conveyances under that section that company became vested with and entitled to exercise all the rights, privileges and franchises which formerly belonged to the mortgagor. The mortgage was made pursuant to subdivision 10 of section 4 of the former Bailroad Law, which authorizes a company to mortgage its property and franchises.

The Commission refused to allow stock to issue for the cost of the purchase, and limited the issue to $434,000. It valued the property at $400,000, although it was conceded that its reproductive value, less depreciation, was $445,693.98, and in addition to the value it placed upon the property it allowed $34,000 to cover expenses connected with the purchase and with that application. While it concedes that the purchase was made in good faith on competitive bidding, and that the sale was in all respects fair, it bases its valuation, in a great part, upon the ground that the property was weighed down by a five-cent fare franchise which was binding upon the purchaser (See Public Service Com. v. Westchester St. R. R. Co., 151 App. Div. 914; affd. later in 206 N. Y. 209), and that by reason of such a rate the property could not be operated at a profit and that a part of the purchase price represented the franchises which under section 55 of the Public Service Commissions Law (Laws of 1907, chap. 429; Consol. Laws, chap. 48; Laws of 1910, chap. 480) cannot be capitalized.

The laws of the State contemplate that a railroad shall be operated by a railroad company. (Trojan Railway Co. v. City of Troy, 125 App. Div. 362; Village of Phœnix v. Gannon, 195 N. Y. 471.) It was, therefore, necessary for Sutro to form a new company by filing the certificate and turning the property over to it. Such a company has no property, and no means with which to finance the purchase, except an issue of stock, bonds or securities. The mortgaged property, aside from a nominal scrap value, is only salable to or for a railroad company. The statute, therefore, contemplates that a purchaser under the mortgage may organize a corporation to take over the property, and that the purchase price may be financed by an issue of stock, bonds or other proper securities. Otherwise the result would follow that the mortgagee would be deprived of a substantial part of the security by reason of the fact that the mortgaged franchises cannot be purchased as no one is authorized to use and pay for them. The result in this case would be that the New Haven Company, by having made the purchase, is paying nearly $500,000 for the privilege of giving the public the benefit of a railroad service. If it can only receive stock for about half of the purchase price, because in the opinion of the Commission the property is not worth the price paid, it is in serious trouble, for it cannot in its accounts and reports value the stock at double its par value. If the decision of the Commission is right there would be no purchaser for railroad property sold upon a mortgage sale as it would not be known what value the Public Service Commission might put upon the property. The statutory right to mortgage carries with it the right to make available the mortgaged property with every incident fairly necessary for that purpose, and as the property can be purchased for no practical use other than as a railroad, the right to capitalize the purchase price cannot be impaired, after the mortgage, by a statutory provision declaring that the franchise may not be capitalized. The company is not asking the capitalization of a franchise; it is asking that it may issue stock for the cost of the property on the foreclosure sale. If we were compelled to hold otherwise, this mortgage having been issued prior to the Public Service Commissions Law, it would follow that the limitation of the right to capitalize its franchise would be invalid and ineffectual as interfering with the property rights under the mortgage.

The capitalization of a corporation is not in all cases restricted to the value of the corporate property as the Commission sees it. “ But there is no provision in the Public Service Commissions Law that the securities issued shall in no instance exceed the value of the property. Indeed it contains no express provision to that effect at all, though doubtless it was intended by the law to prevent the issue of fictitious or ‘ watered ’ securities, and the Stock Corporation Law (§ 55) forbids the issue of stock or bonds except for money or labor or property at their respective values. ” (People ex rel. Third Ave. R. Co. v. P. S. Comm., 203 N. Y. 299, 309.) The reasoning of Chief Judge Cullen in that case applies with great force to the questions under consideration. There the Court of Appeals held that the new company was entitled to a capitalization equal to the obligations of the old company which are represented in the new. Chapter 289 of the Laws of 1912 (adding to Pub. Ser. Comm. Law, § 55a) was intended to change that rule so that the former capitalization would not be the measure for new capital. But if we are right in the position taken that enactment cannot affect the question involved here. We must construe the statutes enacted since the mortgage as not violating property rights, but if such construction cannot be given we must still see that vested property rights shall not be impaired by them. By the terms of the latter statute the Commission may fix the fair value, taking into consideration the original cost of construction, duplication cost, present condition, earning power at reasonable rates, and all other relevant matters, etc. Certainly the fact of a sale upon bona fide competitive bids at public sale upon foreclosure of a preceding mortgage are relevant matters to be taken into consideration.

Section 55 of the Stock Corporation Law permits stock to be issued for the value of property purchased, and declares that such stock shall be full paid and, in the absence of fraud in the transaction, the judgment of the directors as to the value of such property purchased shall be conclusive.

Section 55 of the Public Service Commissions Law does not destroy that provision. The two sections may be read in harmony. The latter, in substance, requires, so far as it relates to an issue of stock for property purchased, that there must be an order of the Commission authorizing the issue, stating the amount, the purposes to which it is to be applied, and that in the opinion of the Commission the property to be paid for by the issuing of stock is or has been reasonably required for the necessary purposes of the company. The requirement that the Commission shall approve of the issue and the purposes for which it is issued was undoubtedly to prevent the issue by the company of watered or fictitious securities. An issue of stock for the purchase price at a public sale of necessary property is not watered or fictitious stock, and is not within the evil intended to be guarded against by this section. The authorization of the Commission to an issue of stock does not carry with it the certificate of the State or the Commission that the property back of the stock is worth the amount thereof. It indicates merely that the stock is issued for a proper purpose, and if for property purchased, that it was an honest purchase, and for the necessary and proper use of the corporation. The franchises purchased, by the authority to mortgage and by the sale, were property, and all of the property purchased was actually necessary for the use of the company. When the good faith of the transaction was established, the honest judgment of the directors, under the circumstances, was binding on the Commission, and the cost to the purchaser was the fair basis of capitalization.

There are other considerations which call for a reversal of the determination. The Commission should have taken into consideration, in valuing the property, its earning power at reasonable rates. The power of the Public Service Commission to fix reasonable rates involves the right to increase as well as to lower rates. The rates are to be reasonable to the public and reasonable to the corporation. (City of Troy v. United Traction Co., 134 App. Div. 756; People ex rel. D. & H. Co. v. Pub. Ser. Com., 140 id. 839; People ex rel. Bridge Operating Co. v. P. S. Com., 153 id. 129, 137; Home Telephone Co. v. Los Angeles, 211 U. S. 265; Murray v. Pocatello, 226 id. 318.)

The Commission entirely overlooked the physical position of this railroad property with reference to the city of New York, which is growing rapidly towards the territory served, and the rapidly increasing traffic in the territory, and that the conditions existing at the sale which influenced the bidding are permanent; that the lines of the company connect with the lines owned by other important railway companies to which it is valuable as a feeder, which companies were both active competitors for the property on the sale, and naturally would be competitors upon any future sale. The bidding did not result from the mere whim or fancy or bad judgment of the bidders, but arose from permanent conditions which made the property valuable. It was proper to deduct from the estimated reproductive cost proper depreciation resulting from age and use; also if age and use in any way appreciated the value of the property, that should have been considered. The fact that the property was bought as a going concern evidently saved some engineering expenses, interest and much delay. A settled roadbed perhaps is more valuable than one recently graded. The purchase price at public sale is very satisfactory evidence of the value of property, but is not always conclusive. It is evident in this case .that in one sense the bidding proceeded upon a false basis. At the first hearing, the evidence of a competent expert, which was not questioned, indicated that the reproductive value of the physical property was $679,567.84. Later, and after the lines had been in part rebuilt, it was found that some of the property which had been given a substantial value was practically worthless, and that the property as a whole was not in. the condition in which it had seemed to be at the time of the first valuation, and that the actual reproductive value of the property was $445,693.98. In other words, the property was found to be $233,873.86 less valuable than it appeared to be at the time of the bidding. In no other respect can the judgment of the directors of the New Haven Company or the Westchester Company in making the purchase be questioned. But we hold that under all the circumstances the purchaser was entitled to stock for the cost of the purchase.

The order is, therefore, reversed upon law and the facts, with costs, and the matter remitted to the Commission for its further action.

The finding of fact disapproved of as against the evidence is that the value of the property is only $400,000.

All concurred.

Determination reversed on law and facts, with $50 costs and disbursements, and matter remitted to Commission for further consideration in accordance with the opinion herein. The find, ing of fact disapproved of as against the evidence is the finding that the value of the property is only $400.000.  