A corporation, acting in good faith and without any purpose of
defrauding its creditors, but with the sole object of continuing a
business which promises to be successful, may give a mortgage to
directors who have lent their credit to it in order to induce a
continuance of that credit and to obtain renewals of maturing paper
at a time when the corporation, although it may not be then in fact
possessed of assets equal at cash prices to its indebtedness, is in
fact a going concern, and is intending and is expecting to continue
in business.
Under the circumstances detailed in the statement of facts and
in the opinion of the court in this case, it is
held that
the mortgage given by the Sanford Fork and Tool Company, by special
direction of its stockholders, to its directors to secure them for
endorsing and for continuing to endorse the paper of the company is
valid.
This was a suit commenced in the Circuit Court of the United
States for the District of Indiana by the appellees, creditors of
the Sanford Fork & Tool Company, to set aside a mortgage given
by such company to secure certain of the directors and stockholders
of the company for endorsements made by them of the company's
paper. No proofs were taken, and the case was disposed of on the
bill and answer, and a decree entered in favor of the plaintiffs
adjudging such mortgage invalid as against them. The facts
disclosed by the pleadings are as follows: the Sanford Fork &
Tool Company was a corporation organized under the laws of the
State of Indiana, doing business at the City of Terre Haute in that
state. Its capital stock at first was $100,000, but afterwards
increased to $150,000. It commenced business in 1888, and continued
as a going concern for about eighteen months, and up to May 13,
1890 at which time it failed, and its property passed
Page 157 U. S. 313
into the possession of one of the defendants John W. Davis as
receiver. The plaintiffs were creditors of the company whose claims
all accrued prior to March 17, 1890, at which time the mortgage
complained of was executed. The defendants McKeen, Hulman, Nixon,
Minshall, Kidder, and Mayer were each stockholders, and the first
five constituted the board of directors of the company. Early in
its history, and on July 2, 1888, the company had executed a deed
of trust to one Deming, as trustee, to secure an issue then made of
$50,000 of its ten-year negotiable bonds. This trust deed conveyed
as security the manufacturing plant of the corporation, a tract of
about three acres in the City of Terre Haute, with the buildings
and appurtenances.
Being a comparatively new enterprise, the company, in addition
to the means derived from its capital stock and its bonded
indebtedness, required large sums of money to enable it to
successfully carry on and develop its business and to obtain this
money it executed during the fall and winter of 1889-90, and
between September 18, 1889, and March 3, 1890, its ten promissory
notes, amounting in the aggregate to the sum of $69,000, which
notes were endorsed by the six parties named above as directors and
stockholders, the notes being severally as follows:
1. Executed to the Terre Haute Savings Bank, for $5,000, dated
September 18, 1889, due in five months, and endorsed by McKeen,
Hulman, Kidder, and Nixon.
2. To the same bank, same date, due in six months, for the same
amount, and endorsed by the same parties.
3. Executed to Nixon, dated December 14, 1889, due March 15,
1890, for $15,000, endorsed by Nixon, Hulman, and Kidder, and held
by the Vigo County National Bank.
4. Executed to Nixon, dated January 21, 1890, due in sixty days,
for $5,000, endorsed by Nixon, McKeen, Hulman, and Kidder, and held
by the Terre Haute Savings Bank.
5. Executed to Minshall, dated January 21, 1890, due in thirty
days, for $4,000, endorsed by Minshall, Hulman, McKeen, and Kidder,
and held by the First National Bank of Brazil.
6. Executed January 30, 1890, to Nixon, due in ninety days,
Page 157 U. S. 314
for $15,000, endorsed by Nixon, Kidder, McKeen, Mayer, and
Hulman, and held by the Vigo County National Bank.
7. Executed February 5, 1890, to Nixon, due in sixty days, for
$5,000, and endorsed by Nixon, Minshall, McKeen, Hulman, and
Kidder, and held by the Vigo County National Bank.
8. Executed February 2, 1890, to Nixon, due in thirty days, for
$5,000, endorsed by Nixon, Minshall, McKeen, Hulman, and Kidder,
and held by the Vigo County National Bank.
9. Executed March 3, 1890, to Nixon, due in sixty days, for
$5,000, endorsed by Nixon, Kidder, Hulman, Minshall, and McKeen,
and held by the Terre Haute Savings Bank.
10. Executed March 3, 1890, to the Terre Haute Savings Bank, due
in sixty days, for $5,000, endorsed by Nixon, Kidder, Hulman,
Minshall, and McKeen.
All the money received from these notes was expended upon and
went directly into the property and material of the tool company.
At the time these directors and stockholders endorsed these notes,
the tool company was a going concern, in full operation, with
property and means "amply sufficient to pay all of its
indebtedness, if its property was worth what it had cost in cash."
They believed that such property was worth what it had cost in
cash, that the corporation was
"solvent, and capable of becoming an independent and profitable
manufacturing institution as soon as it could win its way to a
favorable market for its manufactured products."
As these notes thus endorsed began to mature, the directors
found that the company was unable to pay them, and required a
renewal or an extension. Thereupon, on March 1, 1890, they called a
special meeting of the stockholders, which was held on March 15. At
this meeting, out of a total of 3,000 shares, 2,250 were
represented, and a resolution was passed authorizing the directors
to execute a mortgage or mortgages upon all or any part of the
property of the corporation, to secure any new indebtedness that
might be incurred or the renewal and extension of any present
indebtedness or liability of the corporation. Thereupon, the
directors having taken suitable action, the mortgage in controversy
was executed conveying to Buena V.
Page 157 U. S. 315
Marshall, as trustee, the property described in the trust deed
hereinbefore referred to, to-wit, the company's manufacturing
plant, to indemnity the six endorsers for their endorsements of the
notes, or renewals thereof, or on account of any moneys thereafter
advanced by them. Relying upon such security, the endorsers above
named either paid or procured renewals of the several notes, and in
addition two of them endorsed and subsequently paid other paper of
the company to the amount of $6,000. This mortgage was not recorded
until May 1, 1890. At the time of its execution and delivery, as at
the time of the endorsements hereinbefore mentioned, the company
"was in full operation as a going concern," with ample means to pay
its indebtedness, if the cash cost of its property could be
obtained therefor. The endorsers believed that "the property was
worth what it had cost in cash, and believed the corporation to be
solvent," and in fact the corporation continued to be
"a going concern, and carried on its business in the usual way,
and met all its obligations (other than the notes embraced in the
indemnity mortgage) as they matured in the usual course of
business,"
until the appointment of a receiver, on May 13, 1890, during
which time it paid out for current expenses and maturing
obligations $30,000 or over. The endorsers
"believed that it was only necessary to tide the corporation
over a temporary embarrassment until it could succeed in
establishing a favorable footing in the market for the sale of its
manufactured products."
They accepted the indemnity mortgage in good faith, with
knowledge that all the money obtained by means of the notes upon
which they had become liable as endorsers had been properly
appropriated to and gone into the property and material of the
company.
At the date of the execution of this mortgage, the tool company
was indebted in the sum of $275,000. The value of its property at
that time does not appear, but after the appointment of a receiver,
it was appraised, the manufacturing plant -- the property described
in the trust deed and mortgage -- being appraised at $116,055.39,
the other and unencumbered property at $88,390.85.
Page 157 U. S. 316
MR. JUSTICE BREWER, after stating the facts in the foregoing
language, delivered the opinion of the Court.
In the absence of any testimony, and in the manner in which this
case was submitted for decision, it must be assumed that the
matters alleged in the bill and not denied in the answer, and the
new matters set forth in the answer, are true. And the question
which arises is whether, upon these admitted facts, the decree in
favor of the plaintiffs can be sustained.
The manufacturing business in which the corporation was engaged
was a new enterprise. It had been carried on for only about
eighteen months. In that business had been invested nearly
$300,000, and the property possessed by the corporation was, at its
cost price, equal to the entire indebtedness. It thus appears that
there had been no waste, mismanagement, or loss. Not a dollar of
the indebtedness was held by any director or stockholder, but the
personal credit of the six directors and stockholders had been
loaned to the company to the extent of $69,000. The corporation was
still a going concern. There was no purpose of abandoning the
business. The endorsers believed that if the corporation could be
tided over its temporary embarrassment, it could be made
successful. The stockholders authorized the mortgage. It was given
only upon part of the property, and that part already encumbered by
a $50,000 trust deed. The value of this property was, according to
the subsequent appraisement, much below the sums secured by the
trust deed and the mortgage. In addition, the corporation had
nearly $90,000 of unencumbered property to apply in satisfaction of
the claims of its creditors. The mortgage was not given simply as
security for a past indebtedness, but to induce the
Page 157 U. S. 317
endorsers to obtain for the corporation a renewal or extension
of its obligations and to make further endorsements. In reliance
upon this mortgage, the endorsers secured renewals or extensions,
or themselves took up the notes they had endorsed, and at the same
time lent the credit of their names to new paper of the company.
Thus they prevented a suspension of the business and enabled the
corporation to continue its operations, and did so believing that
by such continuance the corporation would be enabled to work itself
out of its temporary difficulties. All this was done in the utmost
good faith.
Under these circumstances, should the transaction be condemned
and the mortgage held void as against creditors? This question, we
think, must be answered in the negative. It is said that the
directors of a corporation stand in a fiduciary relation to both
the stockholders and the creditors. Whatever may be the extent of
the fiduciary obligations of directors to stockholders, there can
be no pretense in this case of a breach thereof. The mortgage was
expressly authorized by the stockholders, and they cannot claim
that the directors in executing the instrument, which they had
themselves authorized, were guilty of any breach of duty to them.
It is often said that the directors may not take advantage of their
position and power to secure personal advantage to themselves, but
that proposition has no application here, for the corporation
itself directed this mortgage. It was an application by the debtor
of its property to secure certain of its creditors, and not the act
of the agents of a debtor to protect themselves. The case involves
no breach of trust on the part of the agent towards the principal,
but more closely resembles the case of an individual debtor giving
preferences to certain of his friends, and the general rule is
that, in the absence of statute, a debtor has such
jus
disponendi in respect to his property that, although
insolvent, and contemplating a cessation of business, and the
surrender of his property to his creditors, he may lawfully prefer
certain of them, even though thereby others receive no payment.
But, passing from the relations of directors to the
corporation
Page 157 U. S. 318
and its stockholders, it is one of the vexed questions of the
law as to how far the duty of a corporation and its directors to
creditors interferes with the otherwise conceded power of a debtor
to prefer certain of his creditors. Into a discussion of this
question in its length and breadth we deem it unnecessary now to
enter, for the facts of this case remove many of the embarrassments
that often attend such questions. This is not like the case of
Sutton Manufacturing Co. v. Hutchinson, 63 F. 496, decided
by the United States Court of Appeals for the Seventh Circuit, in
which the directors of a corporation, insolvent, and intending to
discontinue business, gave a mortgage to secure certain of their
number who happened to be creditors, and thus attempted to secure a
preference in behalf of themselves. Nor is it the case of the
directors of a corporation in fact insolvent, though continuing and
expecting to continue in business, executing a mortgage on the
property of the corporation to simply secure themselves for a past
indebtedness; for here the corporation, although insolvent within
the rule which declares that insolvency exists when a debtor has
not property sufficient to pay his debts, was still a going
concern, and intending to continue its business, and the mortgage
was executed not simply to secure directors and stockholders for
past indebtedness, but to induce them to procure a renewal or
extension of paper of the company then maturing or about to mature,
and also to obtain further advances of credit.
Will it be doubted that, if this mortgage had been given
directly to the holders of these notes, it would have been valid?
Are creditors who are neither stockholders or directors, but
strangers to a corporation, disabled from taking security from the
corporation by reason of the fact that upon the paper they hold
there is also the endorsement of certain of the directors or
stockholders? Must, as a matter of law, such creditors be content
to share equally with the other creditors of the corporation,
because, forsooth, they have also the guaranty of some of the
directors or stockholders, whose guaranty may or may not be worth
anything?
But even that is not this case, for here the corporation was
Page 157 U. S. 319
a going concern, and intending to continue in business, and the
mortgage was given with a view of enabling it to so continue, and
to prevent creditors whose debts were maturing from invoking the
aid of the courts to put a stop thereto. Can it be that if at any
given time in the history of a corporation engaged in business, the
market value of its property is in fact less than the amount of its
indebtedness, the directors, no matter what they believe as to such
value, or what their expectations as to the success of the
business, act at their own peril in taking to themselves indemnity
for the further use of their credit in behalf of the corporation?
Is it a duty resting upon them to immediately stop business, and
close up the affairs of the corporation? Surely, a doctrine like
that would stand in the way of the development of almost any new
enterprise. It is a familiar fact that in the early days of any
manufacturing establishment, and before its business has become
fully developed, the value of the plant is less than the amount of
money which it has cost; and, if the directors cannot indemnify
themselves for the continued use of their personal credit for the
benefit of the corporation, many such enterprises must stop in
their very beginning.
It is worthy of note, too, that these directors placed the
encumbrance not on the entire property of the corporation, but only
upon that part which ordinarily shows the greatest difference
between value and cost, to-wit, the building and the machinery --
property, too, which was already encumbered for a large sum,
leaving free all the unencumbered property of the corporation to
answer to the claims of creditors.
Of course, an underlying fact, expressly stated to have existed
in these transactions, is good faith. Carrying on business after
the giving of an indemnifying mortgage, with a knowledge of
insolvency, with the expectation of soon winding up the affairs of
the corporation, and only for the sake of giving an appearance of
good faith, leaves the transaction precisely as though the mortgage
was executed at the moment of distribution, and with the view of a
personal preference.
Page 157 U. S. 320
Again, not only was the corporation a going concern, not only
did the directors expect and intend that it should continue, and
believe that its continuance would bring financial success, but, as
appears, they did continue the business for two months, and during
that time paid out in the ordinary management of its affairs and in
discharge of its debts over $30,000, without appropriating a single
dollar to the payment of the claims for the endorsement of which
they had taken this indemnity.
We are of opinion that these facts clearly and fully distinguish
this case from many which have been cited, in which the action of
the directors of a corporation in securing to themselves of a
corporation in securing extremities has been adjudged void, and
that it is going too far to hold that a corporation may not give a
mortgage to its directors who have lent their credit to it, to
induce a continuance of the loan of that credit, and obtain
renewals of maturing paper at a time when the corporation, though
not in fact possessed of assets equal to its indebtedness, is a
going concern, and is intending and expecting to continue in
business. We are therefore of opinion that the circuit court erred,
and the decree will be
Reversed, and the case remanded for further proceedings not
inconsistent with this opinion.
