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[EDITORS' NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.] *Page 173 The main proposition upon which this action is sought to be maintained is that the relation created between the New York Greenwood Lake railway and the holders of the income bonds, in respect to the earnings of the railroad, was fiduciary, and that, under the general equitable rule which permits a cestui quetrust to maintain an action against the trustee for an accounting in respect to the trust fund, the plaintiff may maintain this action, without showing any misappropriation or wrong doing by the company or its directors. This proposition upon the facts disclosed in the complaint fails, we think, in its primary and essential assumption, that a trust relation between the company and the bondholders was created by the contract between the parties.
The obligation of the company to pay the principal of the bonds at maturity was absolute, but it assumed to pay the interest only out of the earnings of the company. The proviso which follows the covenant in respect to the payment *Page 177 of interest, had two general objects, viz., to limit the scope of the prior general covenant to pay interest on bonds out of the earnings, to such earnings as should be made during the six months' period, or such as should have accumulated during the current year, "over and above all expenses, including necessary repairs," and next to constitute the board of directors of the company the tribunal to determine whether there were earnings in excess of the charges first to be paid, applicable to the payment of interest. The language is as follows: "Provided always, nevertheless, that no more interest shall be payable by virtue hereof than shall be certified by the board of directors for the time being, to have been by said corporation earned over and above all expenses attending necessary repairs during the six months ending one month before such time fixed for such half-yearly payments, or theretofore to have accumulated during the current year so as altogether to make enough to pay at the rate of six per cent per annum, and in default of said certificates, no interest shall be payable." In substance, the current interest was to be paid out of the current earnings, and then so far only as the board of directors should certify that interest had been earned "over and above all expenses, including necessary repairs." The claim that the contract, by designating a fund out of which the interest was to be paid, operated as an equitable assignment of the fund so designated to the bond creditors, or created an equitable lien thereon in their favor, so that when any sum had been earned applicable to the payment of interest, it constituted a trust fund in the hands of the company for the benefit of the bondholders, is opposed to the authorities in this state. This is not the case of the administration in a court of equity of the estate of an insolvent corporation. If that was the condition and the question was presented as between bond creditors and other creditors of the corporation, as to the distribution of surplus earnings specially devoted by the contract with the bond creditors to the payment of interest on the bonds, it may be that in that case the court would *Page 178 award to the bondholders an equitable preference by reason of the contract. But the question here is between a solvent corporation and the bondholders, and the only ground in support of the claim that a fiduciary relation was established by the contract between the corporation and the bondholders, or that the surplus earnings became a trust fund in the hands of the corporation for the benefit of the bondholders, is the promise of the corporation implied in the contract, that when the existence of surplus earnings was ascertained and certified by the board of directors, it would apply them to the payment of interest on the bonds. The substance of the contract between the corporation and the bondholders is that the interest should be paid out of a particular fund, when it should come into existence and be ascertained in the manner provided in the contract. The earnings of the corporation when received would, of necessity, become the property of the corporation. They might be wholly absorbed in paying expenses and repairing and operating the road. If there was a surplus beyond what was required for these purposes, ascertained as provided in the contract, the corporation obligated itself to apply it to the payment of interest on the bonds. But until the surplus was ascertained and applied by the corporation to the payment of interest, it remained the absolute owner of the fund, and it was subject to disposition for any corporate purpose by the board of directors. The corporation was, by its contract, obligated to apply it to the payment of interest on the bonds, and a breach of the contract would subject it to liability to the bondholders, and such remedies would be open to them as the law affords for breach of contract in other cases. But the bondholders acquired no title, legal or equitable, to the fund itself. A disregard of the contract by the corporation, or a diversion of the surplus to any other purpose, would be a flagrant breach of confidence reposed in the corporation by the bondholders. But the rights and obligations of the parties rested in contract. There was no appropriation of the fund out of which *Page 179 the interest was to be paid, in any sense which worked a transfer of the legal or equitable title thereto, to the bondholders, when it should come into existence and before it had been set apart by the action of the directors to the payment of interest. It is the settled doctrine in this state "that an agreement, either by parol or in writing, to pay a debt out of a designated fund, does not give an equitable lien upon the fund, or operate as an equitable assignment thereof." (EARL, J., Williams v.Ingersoll, 89 N.Y. 508, and cases cited.) In Trist v. Child (21 Wall. 441), the court, referring to this subject, said: "But a mere agreement to pay out of such fund is not sufficient. Something more is necessary. There must be an application of the fund pro tanto, either by giving an order, or by transferring it otherwise in such a manner that the holder is authorized to pay the amount directly to the creditor, without the further intervention of the debtor." The question has usually arisen where the debtor promised his creditor to pay his debt out of a claim he held, or which should accrue in his favor against a third person, the primary liability of the debtor continuing.
In this case, the promise to pay the interest on the bonds out of surplus earnings, when the amount was ascertained, was made at the inception of the bonds, and was the security the bondholders had for its payment, no general liability therefor being assumed by the corporation. But these circumstances do not, we think, distinguish the case in principle from the cases cited. The corporation was bound to act in the utmost good faith towards the bondholders. They relied, as they had a right to rely, upon its faithful performance of the contract, and if it failed to apply the surplus when certified, or if its board of directors wrongfully refused to certify, when there was a surplus applicable to the payment of interest, an action would lie against the corporation in behalf of the bondholders, for damages, measured by the amount of interest of which they had been wrongfully deprived. This court, in Boardman v. LakeShore Mich. S. Railway Co. (84 N.Y. 157), sustained a judgment which enforced *Page 180 a contract between the company and the holders of guaranteed stock, to make preferential dividends out of the net earnings, but there is no intimation in the opinion that the holders of such stock acquired by force of the contract an equitable lien on the earnings, or that the agreement operated as an equitable assignment of the fund out of which the dividends were to be paid. The case of Uhlman v. New York Life Ins. Co. (109 N.Y. 421), which dealt with the relation of tontine policyholders to the insurance company, where the contract upon which it was claimed that a fiduciary relation was created between the company and the holders of such policies, as to the tontine fund, was stronger in support of the claim made in that case than is the contract upon which the similar claim is made in this case, the court rejected the claim made, and held that the relation was that of debtor and creditor only. Our conclusion upon the point now under consideration is, that this action cannot be maintained on the theory that there was a fiduciary relation created by the contract between the New York Greenwood Lake Railway Company and the bondholders, in respect of the fund out of which the interest was payable. The claim of the bondholders under the contract is legal and not equitable, and if any right to equitable relief in the nature of an accounting exists, it must be found in circumstances outside of the contract relation between the parties.
It remains to consider whether the complaint discloses any breach of the contract between the defendant corporation and the bondholders. Unless facts are stated showing that the contract has been violated by the corporation, there can be no ground for either legal or equitable relief. In ascertaining the meaning of the contract, the same rules of construction apply as in other cases. The words are to be interpreted according to their natural and legal import. No strained construction is to be placed upon them to meet a supposed hardship, or to relieve either party from a situation which, if it had been foreseen, might have been provided for, but for which no provision was made. If an ambiguity exists in any *Page 181 of the terms of the contract, resort may be had to circumstances constituting the res gestæ, which tend to explain their meaning.
It is manifest that as the bondholders were, by the contract, to receive interest only in case there were earnings of the corporation remaining "over and above all expenses, including necessary repairs," any application of the earnings to any purpose other than the purposes embraced within the phrase quoted, before reserving sufficient to pay the interest on the bonds, would constitute a breach of the contract. We assent to the argument that the restriction of the right of the corporation to apply the gross earnings to certain designated purposes, was an essential element of the security of the bondholders. The bonds were offered to the public and were purchased upon the faith of the contract therein stated. The security for the payment of interest on the bonds was at best precarious, and although it may be assumed that the price of the bonds in the market was affected by this circumstance, it is but the dictate of obvious justice that such security as was afforded should not be permitted to be impaired by dealings of the corporation with the earnings, not justified by the fair construction of the contract with the bondholders. But the point now before us is whether the complaint discloses that the corporation has received earnings applicable under the contract to the payment of interest, which it either wrongfully retains and refuses to apply, or has applied to purposes not within the fair meaning of the words, "all expenses, including necessary repairs."
There is a question somewhat preliminary which will first be noticed. It is claimed, in behalf of the defendant, that assuming that earnings have been made applicable to the payment of interest on the bonds, it is by the contract a condition precedent to the right of the bondholders to maintain an action, that the board of directors should certify to the fact and the amount, the language of the bonds being, "in default of such certificates no interest shall be payable." This point is, we think, sufficiently met by the averment in the *Page 182 complaint that the "board of directors have wrongfully neglected and refused to certify that said interest, or any interest whatever, has at any time been earned," which follows a general averment of the receipt of earnings applicable to the payment of interest. It was necessary for the plaintiffs to show that the required certificate had been made, or had been demanded and wrongfully refused. It would be a very unreasonable construction of the contract that the bondholders are concluded by the omission of the board of directors to certify, although there were earnings in excess of the fair charges against them, applicable to the payment of interest. The wrongful withholding of a certificate when demanded satisfies the condition precedent, and this is especially true where the alleged condition precedent is some act of the party who is liable to pay. In such case his wrongful inaction is no obstacle to a recovery. (Doll v.Noble, 116 N.Y. 230, and cases cited.) The allegation of refusal to make the certificate implies a prior demand, and on demurrer is equivalent to an allegation of demand and refusal. (Marie v. Garrison, 83 N.Y. 14; Abbott's Trial Brief, § 220.).
But we concur in the opinion of the General Term, that the complaint is fatally defective in that it does not show that there were earnings applicable to the payment of interest on the bonds, which had either been retained by the corporation or applied to other purposes. The averment in the 10th paragraph in the complaint, that earnings had been made by the corporation "over and above its operating expenses, including necessary repairs and including all expenses properly chargeable or payable out of gross earnings," sufficient to pay the interest, and the averment in the 11th paragraph, that the "legitimate operating expenses of the corporation, including necessary repairs and all other expenses properly chargeable," etc., before paying interest, did not exceed seventy per cent of the gross receipts, standing alone, are simply averments that in the opinion of the pleader the expenses "properly chargeable," when deducted from the gross earnings, would leave sufficient to pay the interest. If the pleader had stopped *Page 183 with these averments, we think the allegations would have been plainly insufficient to show that there were earnings applicable to interest. The question, what expenses were "properly chargeable," is a question of law, and the necessary facts should have been averred, so that the court could see that the company had appropriated earnings to purposes excluded by the language of the bonds. The pleader, apparently recognizing the necessity, proceeded in the latter part of the 11th paragraph to specify the instances of misapplication, prefacing the specification with the language: "Among other diversions," etc. The pleading is, we think, to be treated as if the acts specified were the grounds of the complaint of misapplication and diversion which the plaintiff charges. It is to be observed that it was not the intention of the parties to the contract to withdraw the general management of the affairs and business of the corporation from the board of directors. The power of control by the board was left unimpaired up to the point that its exercise did not interfere with the rights of bondholders to have the earnings applied to paying the interest on the bonds after defraying "all expenses, including necessary repairs." The fullest discretion was reposed in the board of directors consistent with the limitation for the benefit of the bondholders, and it was left to the board to ascertain and determine whether any earnings had been made applicable to the payment of interest. The board was bound to act in good faith, but any expenditures incurred which by fair construction came within the permitted charges, were conclusive upon the bondholders. It was for the board to determine, in the first instance, what repairs were necessary, and a mistake in judgment as to the necessity or extent of repairs directed, would afford no ground of complaint by the bondholders. The court could not review this discretion, provided there was room for difference of opinion as to their wisdom or necessity. The application of earnings to re-building the road might in many cases constitute necessary repairs. The improvement of the roadway, the re-laying of the track with new rails, the erection of new buildings, bridges or structures, the construction of *Page 184 new sidings, and the general improvement of the road, to insure its safety, and to accommodate a growing business, may constitute necessary repairs, and the board of directors, acting in good faith, might so determine, and the contract does not withdraw these matters from the determination of the governing body of the corporation. There is no charge of bad faith, nor that the corporation or the board have applied any of the earnings to private uses. The allegation in the complaint that various acts enumerated were "wrongful" or "improvident," are not allegations of fact, but of law, and are not admitted by the demurrer, and the allegation that the "re-building" and the "building of new railway and structures," were not necessary for the maintenance and operation of the railway, does not show that what was done did not constitute "necessary repairs," and so was within the discretion of the board of directors.
The leasing of the Watchung railroad by the defendant corporation is charged as having entailed a loss in each year to the lessee, "amounting in 1888 to $10,474.02, and in 1889 to $9,493.98." It is not claimed that the lease was not authorized by the charter of the defendant corporation, nor does it appear that the direct loss was not more than made up by the advantage derived by the main line from the transaction. The general question of the relation between "income bondholders" and a railroad corporation, under a contract quite similar to the one now in question, was exhaustively considered by this court in the case of Day v. Ogdensburg L.C.R.R. Co. (107 N.Y. 129), and the opinion of Judge DANFORTH in that case is very pertinent upon the question raised by this discussion, as to what may be done by a board of directors in charging income, consistently with the rights of the bondholders.
Our conclusion is that the demurrer to the complaint was well taken and the judgment should, therefore, be affirmed.
All concur.
Judgment affirmed. *Page 185