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APPEAL by the defendant, The Brooklyn City Railroad Company, from a judgment of the Supreme Court in favor of the plaintiff, entered in the office of the clerk of the county of Kings on the 3d day of March, 1910, upon the report of a referee for $3,367,330.18, in an action to recover damages for breach of contract.
For many years from February, 1893, the defendant had been engaged in the successful operation of street surface railroads in the city of Brooklyn, N.Y. At that time, and while engaged in converting the roads into an electric system, it entered into an agreement to lease its roads to the plaintiff, a corporation organized under the laws of the State of New York, with a capital stock of $200,000, a bonded indebtedness of $250,000, the owner of a railroad about one-half mile in length, for the term of 999 years. The lease was delivered pursuant to agreement April 17, 1893, conditioned among other things that 'The rental equal to ten per cent net per annum on the capital stock of the lessor, as hereinbefore provided, shall be paid quarterly on the first day of July, October, January and April, in each and every year. The rental equal to the interest on the bonded indebtedness of the lessor on bonds issued or assumed by it shall be paid by the lessee to the lessor from time to time at least five days before the semi-annual interest shall become due and payable by the terms of said bonds respectively. The lessee also covenants and agrees to pay to the lessor during the term herein demised as rental the interest on all bonds at any time hereafter outstanding issued by the lessor, not in excess of $6,925,000, either in renewal or extension of or for the purpose of the redemption,
payment or discharge of the said bonds issued or assumed by said lessor, and to make such payment to the lessor at least five days before the semi-annual interest shall by the terms of said bonds respectively become due and payable. For all of the aforesaid payments well and truly to be made during the term by this lease demised, the said lessee hereby binds itself and its successor or successors firmly by these presents. * * * The lessee further covenants and agrees that it shall not have the right to and will not make or construct any extensions, additions, branches and improvements, or furnish any equipments to the said railroad and railroads and properties by this lease demised to be paid for out of its own funds other than such as shall be necessary to keep said railroads and properties in good condition and repair, and to preserve efficiency in the operation of said railroad until after the said unissued stock and bonds of the lessor shall have been issued and the proceeds realized upon the sale of said stock and bonds shall have been expended as in this lease provided, and that it will not construct or apply for the right to construct any extension or branch of said railroad or railroads without first obtaining the consent in writing of the lessor thereto. * * * The lessee further covenants and agrees that it will proceed faithfully and diligently with the work of converting the said railroad and railroads into an electric railroad, or into such other kind of railroad as shall be approved by the lessor and lessee; and that in the event that the said moneys belonging to the lessor, on hand at the date this lease takes effect, after the deductions aforesaid and the proceeds of said stock and bonds of said lessor authorized to be issued, but unissued, shall be insufficient to pay and discharge the cost of converting the said railroad and railroads of the lessor into an electric railroad, or into such other kind of railroad as may be agreed upon by the lessor and lessee, that then and in that event the lessee will forthwith furnish and supply all such sums of money, materials and supplies as may be requisite and necessary for that purpose, and will proceed faithfully and diligently with the work of constructing and converting said railroad and railroads into an electric road or such other kind of railroad as may be agreed upon by the lessor and lessee. * * * The lessee further covenants and agrees to deposit or cause to be
deposited in the Brooklyn Trust Company, or such company or companies, as trustee, as may be designated by the lessor, on the date of the delivery of this lease and prior to the date of delivery of possession thereunder, the sum of four million dollars ($4,000,000) as a guarantee and security for the performance by it of each and every covenant contained in this lease on its part to be kept and performed, which sum of four million dollars ($4,000,000) shall be invested in Brooklyn City or New York City, or United States Government bonds, or in such other securities and mortgages as shall be approved by the lessor and the lessee, all of which securities and mortgages shall be deposited with the said trustee or trustees. * * * It is mutually covenanted and agreed between the lessor and lessee that this lease shall not be binding or valid as to either of the parties hereto until approved by the vote of the stockholders of the lessor and lessee as required by law, and that if so approved, this lease shall be delivered to the lessee at such time and upon such terms and conditions as shall be agreed upon by the Boards of Directors of said lessor and lessee, but notwithstanding such approval and delivery, this lease shall not go into effect nor shall the lessee be entitled to enter into possession of the premses and property by this lease demised until said four million dollars ($4,000,000) shall have been actually deposited either in cash or in securities, or both, pursuant to the terms of this lease, with said Brooklyn Trust Company or companies designated by said lessor and lessee, nor until a certificate of said Brooklyn Trust Company or such companies to that effect is endorsed hereon or attached hereto, which certificate shall be duly executed by said Trust Company or companies under its or their corporate seals, and shall state that said four million dollars ($4,000,000), or such portion thereof as they respectively hold, is held upon the trusts and subject to the terms, covenants and stipulations and conditions in this lease contained with respect thereto.'
On the 10th day of March, 1893, the Long Island Traction Company was incorporated under the laws of the State of Virginia, with an authorized capital of $30,000,000, with power to own and hold the capital stock of other corporations. On April 6, 1893, Samuel B. Lawrence, representing a syndicate, made an offer in writing to the Long Island Traction Company
that he would purchase the entire $30,000,000 of capital stock of the Long Island Traction Company by paying the $4,000,000 in cash to form the proposed guaranty fund under the lease, such payment to be made simultaneously with the delivery of possession of the leased property, and by transferring to the Long Island Traction Company the entire capital stock of the plaintiff of the par value of $200,000, and by procuring an agreement to be made between the Long Island Traction Company and plaintiff to the effect that all the net earnings of the plaintiff, after paying ten per cent upon its capital stock, should belong to the Long Island Traction Company, and that he would pay to the plaintiff so much as might remain out of a fund of $500,000 after paying expenses of incorporation and other miscellaneous expenses. An agreement was subsequently executed and delivered between the Long Island Traction Company and the plaintiff, which provided that the Long Island Traction Company should deposit the $4,000,000 guaranty fund provided by the lease, and that if at any time such $4,000,000 fund should no longer be subject to the terms of the lease, then it should be paid over to the Long Island Traction Company. On June 6, 1893, evidence was furnished to plaintiff and defendant that said $4,000,000 guaranty fund had been deposited as provided by the lease, and on the same date the plaintiff entered into possession of the demised property. From the time when the agreement was executed to the date of the delivery of the possession of the roads to the plaintiff, the work of conversion was carried on by the defendant and was afterwards continued by the plaintiff.
By article V of the lease the defendant agreed to issue $3,000,000 'of its capital stock now unissued, but authorized to be issued, within six months after the delivery of this lease; and to sell and dispose of the same at par, and also to issue three million dollars ($3,000,000) of its bonds, now unissued, but authorized to be issued, which said bonds shall be issued from time to time, as requested by said lessee, and shall be sold or disposed of for the highest price bid or offered therefor, and the proceeds of said stock and bonds, less any premium realized or received on the sale of the said bonds, shall be expended by the lessor in payment, at the request of the lessee, from time to
time, of the cost of converting the railroads of the lessor into an electric railroad.' The said $3,000,000 of stock and the said $3,000,000 of bonds were issued subsequent to the sixth day of June and sold after the lease took effect, and the net amount of the proceeds thereof, after deducting the premium received on the bonds, was $6,000,000. The cost of conversion work done after June 6, 1893, and before October 26, 1894, by the lessee, was more than $6,000,000. This action was brought to recover an alleged unexpended portion of $6,000,000, which the lessor agreed to furnish for such purpose.
In the early summer of 1894 the plaintiff was in need of a large sum of money for conversion purposes, and after some negotiations with defendant, and on the 17th of August, 1894, certain officers of the Long Island Traction Company, of the plaintiff and of the defendant, signed a paper known in the action as the tripartite agreement. The referee finds: 'That during the year 1894 there was an examination of the accounts of the plaintiff and the defendant which led up to and embraced the so-called tripartite agreement attached to the Answer of the defendant and marked Exhibit 'A.' That at the time of the execution of said tripartite agreement both corporations, the plaintiff and defendant, were controlled by substantially the same interests and set of men, and that the alleged adjustment of accounts between the Companies was made from the book entries appearing upon the books of account of the plaintiff and defendant respectively, and that upon such books of account appeared and was taken into consideration moneys expended by the defendant in the construction and in converting its road into an electric railroad prior to June 6, 1893; and there also appeared upon such books, and were taken into consideration upon such accounting, many items charged to construction which were not properly so charged, and the moneys therein set forth had not been expended for the purposes of construction or converting the railroad in question into an electric railroad and such books of account did not exhibit a true and correct statement of accounts between the plaintiff and defendant of moneys that had been expended for the purposes of constructing and transforming the said railroad into an electric railroad.'
The tripartite agreement contained the following recital: 'Whereas, said Heights Company is indebted to said Brooklyn Company in large sums of money for advances made to it by said Brooklyn Company in and about conversion of said demised railroads into an electric railroad and the equipment of the same as such,' in anticipation of the sale of certain real estate and personal property of the Brooklyn company which under the terms of the lease was to be sold and the proceeds applied to the conversion and equipment. The referee found at the request of the defendant that 'The sum of $308,340.35, the amount of the promissory note provided for in the tripartite agreement was computed between those who assumed to represent the plaintiff and the defendant.' He also found that the note was without consideration and 'neither during the year 1894 nor at any other time, was there an accounting and settlement between the plaintiff and defendant, nor an accord and satisfaction of the cause of action set up in the complaint herein.'
Charles F. Brown and Alexander B. Siegel [Edward M. Shepard and William C. Trull with them on the brief], for the appellant.
Edward W. Hatch, Charles A. Collin, John L. Wells and C. A. Severance [George D. Yeomans with them on the brief], for the respondent.
The facts presented are so interesting, the arguments of counsel so elaborate and the amount involved in this controversy so great, that we feel called upon to give full expression of our views upon the important issues involved.
If the tripartite agreement constituted an accord and satisfaction, as is so ably contended by counsel for appellant, the judgment must be reversed and this action ended. It may be well, therefore, to take up the immediate consideration of that paper.
The defendant claims that the agreement constitutes a valid binding accord and satisfaction of each and every matter upon which the plaintiff relies to support the recovery which has been had. The learned referee found that at the time of the making
and execution of said agreement, and from the month of February, 1894, down to about January 14, 1896, plaintiff was controlled by a board of directors and officers, substantially all of whom were largely interested as stockholders in the defendant, and were disqualified from representing the plaintiff in any matter in which the defendant was interested. Also that the president and secretary of the plaintiff, signing said agreement on its behalf, were both largely interested in the stock of the defendant. And he found as a conclusion of law: 'That there had been no accord and satisfaction between the plaintiff and defendant of the claims, demands and accounts of said parties by and against each other.'
The defendant did not in terms plead the agreement as an accord and satisfaction in its answer, nor claim that it constituted a technical accord and satisfaction upon the trial. Its claim in this respect was that the making of the agreement, the acts done thereunder, and the entire transaction connected therewith constituted the instrument in legal effect an accord and satisfaction.
We think that the entire transaction is to be considered, and if what was done requires the conclusion that there was a binding accord and satisfaction the question is fairly presented, and as the facts are pleaded force and effect should be given thereto even though no express language designates the tripartite agreement as an accord and satisfaction. It is upon this assumption that we consider its effect. The finding by the referee that at the time of the execution of the tripartite agreement the board of directors and the officers of the plaintiff were largely interested in the defendant, is abundantly sustained by the evidence, which justifies the conclusion that, at all times from the date of the lease until January, 1896, when the plaintiff came under an impartial control, the defendant exercised a controlling interest in its affairs and management. From the date of the lease in February, 1893, to the sixth day of June following, when the transfer of possession of the property took place, the defendant was in absolute control. On the last-named date, while in form a change in possession and management took place, yet it is evident that such change was scarcely more than colorable and the defendant
remained the dominating factor in control and management. This is established by the testimony of Mr. Lewis, who was at that time the president of the defendant, was a large holder of its stock and had been identified with it since 1868. He was first elected its president in December, 1886, and served as such officer until February 21, 1894. On that day he resigned to accept the presidency of the plaintiff. In his announcement of such fact to the board of directors he stated 'that he so acted in order to be enabled to accept the office of president of the Brooklyn Heights Railroad Company and the Long Island Traction Company, that while he certainly felt regret to resign as President and Director of the Brooklyn City Railroad Company, the three institutions were so intimately connected in their interests and relations that he did not regret his resignation in the sense in which that term is ordinarily understood, but rather in the nature of a change of situation, as he would always have the interests of the Brooklyn City Railroad Company just as much at heart.' The subsequent membership of the directorate of the plaintiff, taken from the board of directors of the defendant, in large part, shows that it was intended that the interest of the defendant should be a paramount consideration. The character of the transaction and the very large interest which the defendant had at stake easily accounts for this action. As was natural under the circumstances, Mr. Lewis continued the management of the plaintiff in practically the same offices with little change, and as he says, he operated the railroad just the same as he had before the 6th of June, 1893. He surrounded himself with directors taken from the defendant's board. So common was this practice that when Mr. Lewis was asked to name the members of the joint committee of the two boards of directors who were considering the plaintiff's financial necessities in 1894 he stated: 'I don't recollect distinctly, without looking at the records, whether either of those gentlemen, Mr. Legget and Mr. White, were in the Heights Company, for the reason that we took certain men out of one company and put them in the other, and made distinct boards between the Brooklyn City and Brooklyn Heights.' He made Mr. Bogardus, who had charge of the accounts of the defendant, a like accountant for the plaintiff, and for a
time he was made general manager, and was also secretary and assistant treasurer and treasurer of the plaintiff, and much of the time acted for both companies. Mr. Swin, who had been assistant secretary and secretary of the defendant, was in 1893 elected assistant secretary and treasurer of the plaintiff, and he continued to act in such capacity until April, 1894. Both Mr. Bogardus and Mr. Swin were stockholders of the defendant at this time, and were interested in the defendant. For a part of the time in 1893 and 1894 Mr. Lewis was an officer of both companies. It is apparent from the relation of these various persons to the defendant that not only was there a pecuniary interest as stockholders of the defendant, but there was an active interest in the whole situation. The defendant not only had the guaranty fund of $4,000,000 as security for the performance of the lease (as well as other property of large value), but it also had an interest in the expenditure of the money, the proceeds of the stock and bonds provided by article V of the lease, and also of such fresh money as might be furnished by the plaintiff independent of such source. In the event of a default by the plaintiff in the performance of the covenants of the lease, the whole of this very large amount became forfeited to the defendant. There was, therefore, not only an interest in what could be reaped from the continuance of the lease, but there was the great increment to accrue to the defendant if the plaintiff should default under the covenants of the lease. This situation created a condition which made it highly improper for the persons thus interested in the defendant to be in the active control and management of the plaintiff. The law condemns such relation. The leading case in this State upon the subject is that of Munson v. S., G. & C. R. R. Co. (103 N.Y. 58, 74), in which it was held that, when the adverse interest is made to appear, the law invalidates all contracts made by the trustee or fiduciary in which the latter was personally interested at the election of the party who was represented by him or them. The court said: '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.' And this rule is applied, even though there be no suggestion of actual fraud in the transaction. The rule announced in that case is the settled law of this State ( Barr v. N.Y. , L. E. & W. R. R. Co., 125 N.Y. 263), and is so uniformly adopted in nearly all jurisdictions that there exists no need to cite further authority in its support. It is quite probable that interest may be so remote in a given case as not to call for the application of the rule above announced. Mr. Morawetz makes distinction in this language: 'A merely nominal or a naked legal interest in the subject-matter of a transaction would not disqualify an agent from representing his principal in the transaction, if there is no temptation to the agent to obtain an advantage at the expense of the principal.' (Morawetz Priv. Corp. § 521.)
The Court of Appeals in Beveridge v. N.Y. E. R. R. Co. (112 N.Y. 1, 28) recognized that an interest might be so slight and free of any taint of possible wrongdoing as not to call for its undoing. The court uses this language: 'The appeal to equity, when the acts complained of are within the powers of directors and apparently uninfluenced by corrupt motives or personal interests adverse to those of stockholders, ought, at least, to be justified by some showing that these acts were improper within the belief of a fair proportion of the body of stockholders.'
These exceptions, if they may be so characterized, only accentuate the rule to be applied when the adverse interest appears. The acts here complained of are condemned by the terms of the exception, for there existed not only the clear adverse interest, but as a result of their actions the directors and officers of the plaintiff as stockholders of the defendant might receive a very large pecuniary benefit. We experience no difficulty in reaching the conclusion upon this branch of the case that the referee's findings were abundantly sustained by the evidence.
It is claimed by the defendant that, even though this conclusion be correct, yet as the traction company was the owner of all the shares of the plaintiff's stock and authorized the execution
of the tripartite agreement, the same became binding against the plaintiff, even though the directors had an adverse interest. This is only another form of stating that the stockholders of the plaintiff have ratified the transaction, and, therefore, have cured any defect which may have existed.
It is a sound proposition, I think, that the stockholders of a corporation may ratify an act which they or the corporation might avoid. The act of ratification must be founded upon knowledge of the situation or upon acquiescence in the action after knowledge or in the retention of benefits derived from the voidable action. This principle is well recognized. ( Barr v. N.Y. , L. E. & W. R. R. Co., supra; Continental Ins. Co. v. N.Y. & H. R. R. Co., 187 N.Y. 225.)
We are, therefore, to see if this rule of law is applicable to the present facts. The referee found that 'On February 14th, 1893, Hollins & Co. were the owners of all the capital stock of the plaintiff.' While this in a general sense was true, yet it is apparent that the finding in a literal sense is not in accordance with the facts. It is true that the witness Burke stated that Hollins & Co. before February 14, 1893, had bought and owned all of plaintiff's capital stock, yet it is quite evident when the undisputed evidence is considered that the statement is not accurate. Mr. Lewis stated: 'When the negotiations first began, the stock of the Heights Company was owned by stockholders, not comprising Hollins & Company. When the lease was executed it was owned by Hollins & Company and their representatives.'
At this time there were thirteen directors of the plaintiff, and the law then required 'the directors of every stock corporation shall be chosen from the stockholders; * * * and if a director shall cease to be a stockholder his office shall become vacant.' (Stock Corp. Law [Gen. Laws, chap. 36; Laws of 1890, chap. 564], § 20, as amd. by Laws of 1892, chap. 688.) The directors of the plaintiff at this time were in office and must be assumed to have been qualified as the law required.
Mr. Hollins testified: 'We were at the time of obtaining the lease or previous thereto, the owners and controllers of the stock of the Brooklyn Heights Railroad Company.'
In the offer of Mr. Lawrence to purchase the stock of the Long Island Traction Company it was recited that the capital stock of the Brooklyn Heights Company was under the control of the New York Guaranty and Indemnity Company, 1,935 shares 'of which it will deliver to this company when the Brooklyn Heights Railroad Company takes possession of the leased railroads of the Brooklyn City Railroad Company, and as to sixty-five of which option to purchase will be given.'
The agreement of April seventh between the traction company, the indemnity company and Lawrence, contained an agreement upon the part of Lawrence to transfer to the traction company 1,935 shares of the capital stock of the Brooklyn Heights Railroad Company, and to transfer to the Long Island Traction Company the accompanying option to purchase the remaining 65 shares of stock of the Brooklyn Heights Railroad Company when the latter entered into possession of the leased property. It is, therefore, evident that 65 shares of the capital stock was not held by Lawrence or the traction company. The directors must have held some of it. The testimony of Hollins was undoubtedly quite accurate when he stated that his firm owned and controlled all of the capital stock of the plaintiff. It is possible that at the date of the lease the directors of the plaintiff were acting for Hollins & Co. and in their interest; but this did not interfere with the legal ownership of the stock which was necessary for them to own in order legally to act as directors, nor did it change such relations that Hollins held or could compel delivery of options for such stock or compel delivery of such stock to his firm. It is, therefore, evident that Hollins & Co. were only the legal owners of 1,935 shares of the plaintiff's capital stock at the time of execution of the lease. There is no evidence that Hollins & Co. or the traction company thereafter acquired these 65 shares of stock. On the contrary, it is certain that such shares of stock were at all times retained to qualify the directors of the plaintiff. When the traction company joined in the execution of the tripartite agreement it was not the sole stockholder of the plaintiff and could not bind those stockholders who held stock that it did not own. The contention that the tripartite agreement was ratified by all of the stockholders of the
defendant cannot be sustained in view of this situation, as the same was not ratified by all of the stockholders of the plaintiff, which was necessary to cure the voidable character of the agreement.
But if we assume that the traction company was the legal owner of all the capital stock of the plaintiff, and give literal effect to the finding of the learned referee in this respect, the result is not different. The referee found (plaintiff's request 52): 'That the stockholders of said Long Island Traction Company never ratified or approved the said tripartite agreement. They never ratified or confirmed the action of its said Board of Directors in approving of the same.' Also, the 53d request: 'That the execution of said tripartite agreement was never attempted to be authorized in any manner by the plaintiff or said Long Island Traction Company, except by the votes of said Board of Directors.'
These findings are supported by the testimony.
The action which is relied on to support the claim of ratification does not commend itself to the court as being founded in good conscience or equity. It appeared that the plaintiff and the traction company were controlled by a common board of directors. The referee so found at the defendant's request. We thus have a situation presented where the board of directors of the plaintiff were disqualified from acting for the plaintiff by reason of an adverse interest in the defendant, yet it is argued that this same board at the same time could act for the traction company, create a valid obligation against it in favor of the same defendant in which it had a pecuniary interest, and by such act ratify and confirm its former illegal action when acting for the plaintiff and thus validate the whole. This common board of directors was disqualified from acting for either the plaintiff or the traction company; they were alike disqualified as to each by reason of the interest which they had in the defendant, and they could not by doing two wrongs make one right. Both the plaintiff and ...