of the Pacific Company received nearly $3,000,000. Part it used for the benefit of the lessor company, and part it appropriated to its own benefit. Can it do this and let the lessor company's debt go unpaid? Equity answers this question in the negative."

Nor is the appellant relieved from the application of that doctrine by the fact that, after taking possession under the lease, the railroad company spent for betterments and extension of the Coeur d'Alene Railroad a sum of money in excess of the amount of the bonds so diverted. Answering a similar proposition in the case above cited, the court said:

"The misappropriation gave to the bank at the time at which it was made the right to pursue the misappropriated proceeds into the hands of the Milwaukee Company. That right the Milwaukee Company could not thereafter defeat by spending money on the property of the Pacific Company; and it was unnecessary to enter into any inquiry as to the reasons for this subsequent expenditure, or as to how far the necessities of its own business on the through line from Chicago to Omaha compelled further improvements on that portion of the line east of the Mississippi river."

Having reached the conclusion that the sum due the appellee became a debt of the railroad company, the question arises whether the railway company has succeeded to the obligation to pay it. One of the grounds on which it is asserted that the obligation rests is that the foreclosure proceedings by and through which the railway company acquired the property of the railroad company were in equity fraudulent as to the appellee because consummated pursuant to a previous collusive agreement between the bondholders and the stockholders of the railroad company, whereby the latter were permitted to retain an interest in the property acquired by the railway company on the foreclosure. In Louisville Trust Co. v. Louisville, etc., Ry., 174 U. S. 674, 19 Sup. Ct. 827, 43 L. Ed. 1130, the court said:

"Assuming that foreclosure proceedings may be carried on, to some extent at least, in the interests and for the benefit of both mortgagee and mortgagor (that is, bondholder and stockholder), we observe that no such proceedings can be rightfully carried to consummation which recognize and preserve any interest in the stockholders without also recognizing and preserving the interests not merely of the mortgagee, but of every creditor of the corporation. In other words, if the bondholder wishes to foreclose and exclude inferior lienholders or general unsecured creditors and stockholders, he may do so; but a foreclosure which attempts to preserve any interest or right in the mortgagor in the property after the sale must necessarily secure and preserve the prior rights of general creditors thereof. This is based upon the familiar rule that the stockholder's interest in the property is subordinate to the rights of creditors; first of secured, and then of unsecured, creditors. And any arrangement of the parties by which the subordinate rights and interests of the stockholders are attempted to be secured at the expense of the prior rights of either class of creditors comes within judicial denunciation."

Does the evidence show that the foreclosure proceedings were had under an understanding or agreement, whereby there was to be and was recognized and preserved any interest in the stockholders of the railroad company in the property? There is no question but that the foreclosure decree was entered upon the consent of all the parties to the suit. The suit had been commenced on October 18, 1893. It had rested upon the demurrer of the railroad company since April 2, 1894. On April 27, 1896, the date of the decree, the railroad company filed

its answer admitting the allegations of the bill of complaint and setting forth the facts necessary to permit a decree without reference to a master. The interveners allied with the railroad company did the same thing, and on the same date. Up to that time there had been resistance to the foreclosure on the part of the railroad company. In 1893, after the railroad company had gone into the hands of receivers, and a new board of directors had been elected, the company filed a petition for the removal of the receivers, alleging that it was through the mismanagement of the former executive officers of the railroad. company, who subsequently had been appointed receivers, that the company had become involved in financial difficulties. In January, 1894, the directors issued to the stockholders a printed circular reiterating such charges of mismanagement, calling upon the stockholders to protect their interests, advising them that, if properly protected, they "can secure equitable terms in any reorganization," and stating that the directors "propose to secure justice for the stock," by bringing suits for the recovery of large sums of money improperly spent, and diverted, and suggesting that stockholders contribute $12.50 per hundred shares to support the measures thus indicated. The general and harmonious assent to the foreclosure decree was the result of the reorganization scheme promulgated March 16, 1896, whereby the railroad was to be bought at foreclosure by a new company, which was to retire the old bonds with new ones and retire the stock of the railroad company by issuing in exchange therefor shares in the new company. As consideration for shares of the new company, holders of preferred stock of the old company were to pay $10 per share for new preferred and common stock, and holders of the common stock were required to pay $15 per share for common stock in the new company, and stockholders were allowed stock in the new company upon these_terms, only on condition that they surrendered their stock in the old. The reorganization scheme was an agreement made by the reorganization committee as party of the first part; the Mercantile Trust Company, party of the second part; J. P. Morgan & Co., party of the third part; the holders of mortgage bonds of the railroad company, holders of certificates of the Mercantile Trust Company for general second, general third, and consolidated mortgage bonds, holders of collateral trust notes and dividend certificates of the railroad company and the mortgage bonds of various branch railroads of the railroad company, and holders of the preferred and common stock of the railroad company, "who shall become parties to this agreement," parties of the fourth part; the Deutsche Bank of Berlin, as depositary, party of the fifth part; and a committee, on behalf of various interests in the railroad company, called the Protective Committee, "in evidence of their active support of the reorganization thereof, according to the plan provided herein," parties of the sixth part.

It is evident that the scheme was inspired by the desire to maintain the integrity of the railroad system. There were many difficulties in the way of accomplishing this. There were 15 subsidiary roads controlled by as many different corporations and subject to liens of different ranks, which were held by numerous bondholders. There were holders of first mortgage bonds on distinct portions of the system and

holders of general mortgage bonds upon the whole system and numerous stockholders whom it was desired to protect and whom, on account of the complication of the situation, it was decided to protect by allowing them a substantial interest in the reorganized company. Counsel for the appellant admit that only by the plan adopted or one substantially similar could the property have been placed upon a sound financial basis.

It is shown that the agreement was carried out according to its terms, that the new company was acquired and its name was changed to Northern Pacific Railway Company, that it became the purchaser of the property at the foreclosure sale, that it paid therefor the old bonds which had been vested in it under the reorganization, and issued its own stock for delivery to the stockholders who complied with the terms of the reorganization scheme. After the foreclosure decree, and in July, 1896, an agreement was made between the railway company and J. P. Morgan & Co., whereby the former was to issue and deliver to the latter $75,000,000 in preferred stock, $80,000,000 in common stock, $130,000,000 in prior lien bonds, and $60,000,000 in general lien bonds, amounting in all to $345,000,000. The agreement stipulated that the said securities were of that value, and it provided that the securities and properties theretofore or thereafter received by J. P. Morgan & Co. pursuant to the agreement should be vested in the railway company, and it declared that it was the intention of the agreement and of the parties thereto that the railway company should become and be the suitable agency contemplated in said plan and agreement for the ownership and operation of the properties acquired and to be acquired pursuant to said plan and agreement. The evidence shows that this plan also was fully carried out. In brief, the bondholders received new bonds secured by the same property and permitted their old bonds to be used for the purpose of foreclosure, and to enable the stockholders to buy the property for their own use, the same to be held by a new company, composed of the stockholders of the old.

But it is urged that the appellant's answer denies, and that the evidence fails to show any fraudulent intent on the part of those who were engaged in the reorganization scheme, and the transactions which attended and followed it, that the reorganization agreement required stockholders of the railroad company as a condition to the issuance to them of stock in the new company to pay on the exchange of preferred stock $10 per share, and on the exchange of common stock $15 per share, and that this was as much as the new stock was worth, and that the transaction was in effect a purchase of the new stock at no less than its actual value. So far as the intent is concerned, it may be conceded that there is absence of evidence of actual fraudulent intention. But where the effect of such a transaction is to exclude creditors from recourse to property which should have been subject to their claims, the law will hold it fraudulent as to them, no matter what may have been the actual purpose thereof. Nor are we convinced that the transaction whereby the new stock was issued was in effect a subscription to and a payment for new stock at its full value. It is not in evidence that any outsiders were allowed to take stock in

the new company at those figures, and it is a significant fact that preferred stockholders were given the right to exchange on the payment of the $10 per share, while the common stockholders were required to pay $15. The evidence is that the preferred shares were at all times of twice the value of the common. In the agreement of July, 1896, it was stipulated that the value of the property transferred to the new company was $311,000,000. It is not disputed that the railroad company's property had cost, up to August 31, 1896, $241,067,769.91. Its bonded indebtedness, principal and interest, was $152,334,450.50. The first trial balance of the receivers shows that the stocks and bonds and securities of other companies owned by the railroad company at the time it went into the hands of the receivers was $128,609,536.30, and that the contingent liabilities for branch roads was $45,144,000.

Again, it is to be observed that the railway company bid the property in for $12,500,000, subject to liens of mortgages superior to those on which the foreclosure was had, aggregating about the sum of $414,000,000, and subject to receiver's certificates and costs of about $5,000,000, making the total cost to the railway company about $61,500,000. In addition to this, it acquired the $3,500,000 cash which was turned over to it. By the cancellation of the $12,500,000 of mortgage bonds used in payment for the property at the foreclosure sale, there was left in the hands of the reorganization committee about $87,000,000 in uncanceled bonds which were afterwards turned over to the railway company. They formed the principal portion of the claim which the railway company presented against the unmortgaged assets of the railroad company. From these figures it will be seen that, if the cost of the company's property represented its full value, it had an excess of assets over liabilities of $88,733,319.41. We are of the opinion that the market price of the stock at that time, owing to the attendant conditions, should not be taken as the measure of its value. The first year after the reorganization the railway company earned a surplus of $489,828.90. Out of the earnings of the second year, dividends of $3,000,000 were paid, $811,709.35 were spent in betterments on the road, and a surplus of $2,897,847.60 was set aside. From that time the earnings of the road were greatly increased. These facts, together with the evident solicitude of the Protective Committee to protect the stock, and the fact that the stockholders deemed it to their advantage to avail themselves of the protection, lead to the conclusion that by the foreclosure, the reorganization, and the transfer of the property to the railway company, a substantial benefit was secured to the stockholders of the railroad company. In the circular of January, 1894, it was said:

"If properly protected, stockholders can secure equitable terms in any reorganization. Let the law and the terms of the bonds be what they may, the fact is that an actual foreclosure of the consolidated mortgage and the sale of the road would involve so much time and trouble as to make it practically impossible. The question as to the land grant, the claims of holders of preferred stock and others of equal importance, make it essential that the rights of the stockholders be not ignored. * * While recognizing the superior claims of the bonds, the directors propose to secure justice for the stock." From a consideration of the proceedings in the foreclosure suit, whereby was evidenced the general assent of all parties in interest to

*

a decree of foreclosure, and the antecedent, concurrent, and subsequent documents and agreements, the conclusion seems inevitable that the parties to the agreement aimed to and did avoid the "actual foreclosure" which was deprecated in the circular, and that the foreclosure which was had was a foreclosure in form and not in substance, that it was but the means adopted for reorganization, to take the road and the property out of the hands of the receivers, to protect the lienholders, to relieve the property of the burden of the unsecured indebtedness, and also to protect the stockholders, and that it did in fact. produce all these results.

But the appellant contends that no agreement of any kind for sale of the stock of the railway company or any part thereof to the stockholders of the railroad company was proposed or made until after the publication of the plan and until after the syndicate subscribers by their contract had become bound to purchase the stock. We think this statement is not altogether sustained by the record. It is true that the appellant so alleged the facts in its answer to the bill, and, inasmuch as by the bill an answer under oath was not waived, the answer which was made under oath became evidence of the facts well pleaded therein. But the answer as to this particular matter may be regarded, not as a statement of the facts, but as the construction which the appellant placed thereon. We are not precluded from resorting to the agreement of reorganization and other papers to determine what is their purport and effect. We find nothing therein to indicate that the syndicate subscribers ever by contract became bound to purchase the stock. In the plan of March 16, 1896, it is recited that a syndicate has been formed to provide the cash estimated to be necessary to carry out the terms of the plan of reorganization, and to furnish the new company with cash for working capital in the further sum of $5,000,000 for the use and betterment of its property; but the instrument is silent as to the method by which such funds were to be obtained, and it clearly contemplates the issuance of new stock to the holders of the old, and by various provisions recognizes the rights of the stockholders of the old company, and makes provision for their protection.

But assuming it to be true that the syndicate subscribers did become bound to purchase the stock, that fact does not materially alter the complexion of the transaction. If they became so bound, theirs was a contingent liability only-a liability which, in view of the value of the contemplated holdings of the new company, they might safely incur. The important fact is that the syndicate did not in fact purchase the new stock, and that the right of the stockholders of the old company to acquire the same was recognized from the first. The stockholders were represented by the Protective Committee in the reorganization scheme. They came into the scheme, and they became the owners of the new stock in pursuance thereof. In brief, by the reorganization the property of the old company was transferred to the new, and the stockholders of the old company became the stockholders of the new, having at all times retained an interest as stockholders. Under this state of facts, the appellee has the right to look to the new company for the payment of his judgment. In Railroad Company v. Howard, 7 Wall. 392,1 it was held that a sale under foreclosure of

19 L. Ed. 117.