SOME LEGAL PHASES OF CORPORATE FINANCING, REORGANIZATION, AND REGULATION PREPARATION OF CORPORATE BONDS, MORTGAGES, COLLATERAL TRUSTS AND DEBENTURE INDENTURES Papers read February 9 and February 16, 1916, before The Association of the Bar of the City of New York by Francis Lynde Stetson1 THE papers to be presented by me in the present series are intended not as treatises, but rather for practical guidance in the preparation and examination of corporate bonds and mortgages, collateral trusts and debenture indentures. They are related to and arise out of the activities of corporations organized for the transaction of business, usually the business of transportation. This evening, after a general introduction, the paper will deal only with the subject of corporate bonds and mortgages and deeds of trust, strictly so called, the consideration of collateral trusts and debentures having been assigned to the evening of February 16th. The Historical Development of the Corporate Bond and Mortgage The conditions and objects of the law concerning corporate bonds and mortgages may be presented conveniently as the 1 At the very outset it is proper that I should state that except for the promised and abundant coöperation of my friend and associate Mr. George H. Gardiner I should have been unable to accept the invitation to read before this Association the papers to which without reserve he has contributed from his large experience. same has been developed in connection with railroad corporations, particularly as created or regulated by the statutes of our own state, to which your attention is first invited. It is difficult to realize that less than a century has elapsed since the enactment of the first railroad charter in this State, viz., that of the Mohawk & Hudson Railroad Company, incorporated April 17, 1826,1 to construct and operate a railroad eighteen miles long from Albany to Schenectady. This charter authorized a capital stock not exceeding $500,000, and reserved to the state the right within five years from completion to take over the railroad at cost and interest. An expenditure in excess of the authorized capital could hardly have been anticipated, for the act contained no grant of power to mortgage. But, as has been usual in later experience, the original estimate of cost proved inadequate; and eight years later acts were passed increasing the stock, and authorizing a mortgage for not more than $250,000, and also the conversion of the loan into stock at par within two years after the passage of the act. This chapter 39 of 1834 is the earliest New York act in which I have found provisions expressly authorizing a railroad mortgage or the conversion of a loan into stock; but in the next decade the charter of the Hudson River Railroad Company, enacted May 12, 1846,2 gave such powers more freely and with much elaboration, subject, however, to the limitations that the $2,000,000 mortgage thereby authorized should not cover the personal property, should always be $500,000 less than the paid-up capital stock, and that the whole capital represented by the stock and the bonds should not exceed $6,000,000. Just before this time Mr. Charles O'Conor had been arguing before Vice-Chancellor Sandford, with boldness and great subtlety, but unsuccessfully, that such a limitation upon capital constituted a limitation also upon the total amount of property that a corporation might own, and that bonds issued in payment for property, thereby exceeding that amount, were void and 1 Laws of N. Y. 1826, Chap. 253. 2 Ibid. 1846, Chap. 216. unenforcible; in other words, that the power to borrow money and to acquire property must be construed as being confined within the limits of the total authorized capital of the corporation. Had the courts sustained Mr. O'Conor in his contention in February, 1844, in the case of Barry v. Merchants' Exchange Company, the history of corporate enterprise in this State would have been very different from what it has been, unless, as the exigencies of events would have required, relief had been obtained from the legislature. The importance of this decision of Vice-Chancellor Sandford, as the first adjudication in this State of the right of a corporation to borrow, even in the absence of express statutory authority, was considered later at length in the luminous and eloquent opinion of Judge Comstock in the great case of Curtis v. Leavitt.2 The conclusion was there reached "that corporations, along with their specific" powers, take all the reasonable means of execution, all that are "adapted to the end in view," and that it is within the power of corporations generally to issue bonds or notes when no prohibitory or restraining statute is violated and the purpose or occasion of making them is lawful. The establishment of these principles, almost platitudinous now, involved at the outset battles royal between the keenest intellects of this bar, Beardsley, Bidwell, Bronson, B. F. Butler, Cutting, Duer, Hill, William Kent, Lord, Noyes, and O'Conor. But the adjudicated power to issue bonds or notes did not, without express authority, carry the power also to secure the same by lien or mortgage upon the public franchises of the corporation,3 nor were such franchises ordinarily subject to seizure and sale under execution. This necessary power to mortgage was granted by the legislature of New York with great hesitation and many limitations, by special acts from time to time up to 11 Sandf. Ch. (N. Y.) 280-312; 1844. 15 N. Y. 1, 51-62; 1857. 3 Carpenter v. Black Hawk Gold Mining Co., 65 N. Y. 43-50; 1875. Chicago, 152 U. S. 191–199; 1893. • Gue v. Tide Water Canal Co., 24 How. (U. S.) 257–263; 1860. Snell v. April 2, 1850, when by the great general railroad law of that year (Chapter 140),1 which with some enlargements is substantially our present law, there was granted to railroad companies generally power "to mortgage their corporate property and franchises to secure the payment of any debt contracted by the company" for completing, finishing or operating their railroad, with the right to confer on the holders of bonds the right to convert the principal due or owing thereon into stock of the company. Now the mortgaging power has been granted throughout the United States, by statutes which vary so widely and contain so many special restrictions, that no one should address himself to the preparation or approval of a mortgage upon any railroad without first studying carefully the pertinent provisions of law in every state through which the railroad runs. Tedious and even meticulous examination beforehand of the constitution and the statutes, both general and special, of the several states in question, may be rewarded by relief from that particular form of subsequent misery which Tom Moore declared to be Hell, that is, "truth known too late." From this summary indication of the fundamental legal requirements for a valid corporate mortgage or deed of trust we may proceed to a consideration of such instruments and of the bonds or debentures supposed to be secured by such instru ments. In the year 1825 occurred two events of momentous importance in the subsequent history of the world and of corporate obligations-the opening of George Stephenson's railroad from Darlington to Stockton-on-Tees and of De Witt Clinton's canal from Lake Erie to the Hudson River. Immediately, throughout our Atlantic States, there developed an excited and even frenzied demand both for canals and for railroads. In New York the demand, as in the case of the Mohawk & Hudson and its later connections west to Buffalo, was for competition with the canal, and as in the case of the New York and 1 Laws of N. Y. 1850, Chap. 140. Erie Railroad, chartered April 24th, 1832,1 to run through the southern tier of counties, as compensation to them for the State's canal construction through central New York.2 Charters almost without number were followed by preliminary surveys, resulting in disappointments or disasters. Scheme followed scheme defiant of natural conditions or sound finance, and bubbles burst in bankruptcies, until appeals for aid, beyond the inadequate returns from issues of unsecured capital stock, were pressed most urgently upon the State and upon the general public. In 1834, the Baltimore & Ohio Railroad Company obtained from the State of Maryland considerable loans, for the repayment of which it gave back a mortgage upon its railroad, following the example of the New York and Lake Erie Railroad Company, which, in 1833, by mortgaging its railroad to the State of New York, obtained for certain of its stock the guaranty of the State. But in each case the aid thus obtained proved inadequate, and then came into operation the American form of corporate bonds secured by mortgage upon the railroad property and franchises, involving foreclosure and sale in case of default, after the familiar form of a mortgage on real estate. The first of such mortgages was that of the Baltimore & Ohio Railroad in 1846, and the next, that of the New York and Erie Railroad dated July 1, 1847, to secure $3,000,000 bonds of which there 1 The expectations centering upon the New York and Erie Railroad were thus stated in the first number of the American Railroad Journal, published January 2, 1832: "With such a Railroad intersected at convenient distances by other railroads running from the Erie Canal and one from Ogdensburgh to Syracuse or Utica almost every county in the State would be brought within twenty-four hours of New York. It would prevent a recurrence of the state of things which now exists in this city. There would not then be, as there now is, thousands of barrels of flour and other kinds of produce in proportion frozen up in canal boats, and in sloops on the Hudson; salt would not be now selling in Albany for two dollars and fifty cents per bushel, and pork at two dollars per hundred for want of salt to save it, while in this city it is worth from five to seven dollars. Coal would not sell here for fifteen or sixteen dollars per ton, . . . as has been the case for two or three weeks past, if railroads were in general use." 2 Laws of N. Y. 1832, Chap. 224. |