Popular Science Monthly/Volume 32/December 1887/The Dangers of Receiverships
PERHAPS no question of the day is exercising a more important influence on the investments of the country than this question of receiverships, and certainly none is of more importance to the investor in corporation securities, whether it be in their stocks or bonds; for, with the present readiness of our courts to appoint receivers on the slightest excuse, and to hold the properties indefinitely, no one can tell when his property may be taken out of his hands, nor, when so taken, how it will be administered. In fact, this readiness of the courts to appoint receivers, is taken advantage of to wreck corporations in the interest of one class of creditors to the injury of all others, and under it unscrupulous speculators have and are to-day using the mantle of justice to accomplish their ends.
But, as mere assertions prove nothing, it is the purpose of this article to review some of the results that have been reached by this means, not from the standpoint of a lawyer, but from that of a citizen, who has had some experience in this line. It is the view of the writer that the only excuse for a court stepping in to prevent creditors from enforcing their rights is that, pending litigation to dose up a corporation and determine the exact rights of all creditors, the law will appoint receivers to conserve the property; in other words, the court will conserve the property as a whole, until it can determine just what are the rights and equities of all parties concerned, and then make a distribution accordingly, unless in the mean time the corporation shall be shown to be solvent. In the case of an assignee taking possession of an insolvent estate, the law prevents creditors from selling the property piecemeal, making it the duty of the assignee to dispose of it and distribute the proceeds equitably; in fact, he may, with propriety go further: for instance, if part of the property in his charge was a warehouse, stored with goods, from which the roof were blown, there is no doubt he would be sustained in using funds in his hands to put on a new roof, as it is self-evident that such an expenditure is for the benefit of the creditors. The court may, if part of the estate is a factory filled with partly-finished goods, go further, and authorize the assignee to finish the same. But what would be thought of the assignee who went beyond this; who used the funds in his hands not only to mend roofs and finish goods, but to build new mills; who paid interest to some creditors and refused others; who, in a word, treated the property as though it were his own? Would he not be brought up with a sharp turn, and either displaced or made distinctly to understand that he was exceeding his authority, and would be held personally responsible? And are not the duties of an assignee, and that of a court taking possession of an insolvent estate, essentially the same? I think they are, and that our courts in the license they have allowed their officers, the receivers, have gradually but surely been drifting away from both the law and equity.
It is held that receivers' certificates are a lien preceding all mortgages, and were receivers restricted to the lines I have laid down, there would be some plausibility in the argument, as, if the money so raised were only used for what is absolutely essential to conserve the property, and is manifestly for the benefit of all, it may be just that all should bear the burden. But even this is an open question, as, what might be essential to a junior creditor, may not be so to one at the head of the line. For instance, in the case of a railroad, with a first mortgage of $5,000,000, and subsequent mortgages amounting to more than $100,000,000, it can hardly be claimed that the $5,000,000 would be imperiled were even so essential a thing as a bridge left unbuilt if it fell down, as it is plain, if the court use proper diligence in deciding the case, a decision must be reached, and a sale had before their margin of safety is gone, and by consequence it would seem but justice that receivers' certificates should only take rank as a lien preceding the class of creditors who ask for the appointment of receivers; and that this would work no hardship is self-evident, as, if those certificates were not marketable and the work really essential, the next preceding class of creditors would, in their own interest, make the application; it is true that the answer to this is that the trustees of all preceding mortgages are sometimes (perhaps always) notified of the application for permission to issue certificates, and that if they, as the official representatives of the mortgagees, do not object, the court has a right to suppose there is no objection to the certificates becoming a lien preceding their mortgages; and while this is technically true, still it is unfortunately a fact that the average trustee will not act until compelled to do so by the bondholders, and frequently the first the latter know of the application is, that the certificates are issued and the damage done.
The next point to which I wish to call attention is the facility with which mortgage creditors may be injured by receiverships as at present conducted. For instance, in a large corporation in Pennsylvania, which had been for years in the hands of receivers, only going out of the custody of the court for a few months, to again return to it, the first set of receivers used the earnings of the company to purchase rolling-stock, which, when they were discharged, should have belonged to the company, but which, by a species of sophistication more legal than equitable, they managed to place in a car-trust, and when the court again took charge, the new receivers began their duties by issuing several millions of certificates, much of which money was used to pay debts contracted during the very few months the property was out of the hands of the court; and while these certificates are claimed to be a lien, ahead of the mortgages, some of this property was real estate which the mortgages did not cover.
Now, as regards the consistency of receivers, this very same corporation furnished a striking example, viz.: when the receivers first took charge, they insisted, despite many protests, on doing the following things:
1. Paying part of the principal and all of the interest on the floating debt.
2. Paying the guarantees on leased lines.
In reference to item No. 1, after much work, caused largely by the active opposition of the receivers, the court was persuaded to order that nothing should be paid on the principal, but allowed the continuance of payments of interest, the result being that a man who loaned the company, say, fifty per cent on its fifth mortgage, got his interest, while the holder of the first mortgage of the company would go without, and the holders of the subsequent mortgages get nothing, and have millions of coupons piled up ahead of them; and in this connection it would be well to take note of the peculiar preference our courts give to creditors who loan on collateral security, paying them interest when all others are refused, and allowing them to sell, no matter at what sacrifice to the debtor, the collaterals in their hands, while other creditors with equal if not superior rights are not allowed to enforce theirs.
In reference to item No. 2, we find these same receivers coming into court and protesting that they must pay the rentals of leased lines, no matter who suffers, and the next year not only refusing to pay some of these rentals, but, in some cases, asking permission to abandon the lines altogether.
But perhaps the most startling anomaly will be found in the case of two large corporations, one in Pennsylvania and the other in New Jersey, and both in the hands of the same court, where we find the receivers, in one instance, paying the interest on all their bonds, and neglecting to pay the over-due principal on their car-trusts, while the other company defaults on all its bonds, and pays both principal and interest of its car-trusts. One of these decisions is probably right, but it does not require a lawyer to decide that both can not be, especially as in both cases the officials testified that the equipment was essential to its operation. Then, again, for some reason or other—probably that their jurisdiction extends over more than one State—most of the applications for receivers are made in the United States courts, perhaps, as in a recent instance, on the application of a man to whom the company owe a few thousands, when we have the ridiculous condition of affairs that those owning millions of the property, and even the trustees of the mortgages, have no legal status before the tribunal that is managing their property, because they, being citizens of the State in which the company has its domicile, have no standing in a Federal court, and, even did they have such standing, it is extremely difficult to get a court to find fault with or dismiss a receiver, firstly, because the receiver, being in possession of the books, it is difficult to get the evidence to show incapacity or misdoing, and, secondly, because for the court to do so would be to admit that it had erred in selecting the receiver, which courts, being human, do not like to do.
There is another danger about receiverships, viz.: if receivers are allowed to pay interest on floating debt, and continue payments to guaranteed and leased lines while defaulting on the securities of their own company, it can readily be seen that no better means could well be devised for unscrupulous men to wreck corporations, as all they have to do is to get themselves elected directors, make a few bad leases, loan the company's money to make gaudy reports until they sell their stock; then apply for a receiver, continue to pay the leased lines, until they freeze everybody out, and then, when they have bought in the securities at their own figures, sell out the property, and thus cancel the bad leases. Unfortunately, just this practice is the one by which some of the largest fortunes of the day have been made, and that it is well understood, the following remark of a prominent Wall Street operator will show, who said to a bondholder of a company that was in the hands of a receiver, "If you don't let us reorganize this property to suit the stockholders, we will keep it in the hands of the court for seven years!" If the court managed it well and fairly to all interests, the threat would have amounted to nothing; but, as some years of experience had shown just the contrary, it was a serious matter, and the bondholders had to yield, feeling that the terms, hard and unjust as they were, were preferable to further management by the court.
It will probably be asked. What is the cure for these troubles? which I confess is not so easy to answer; but I think the adoption of the following would go far to help matters:
1. Receivers' certificates should only take rank as a lien preceding the class of creditors on whose application the receivers are appointed, and should only be issued to raise money to conserve the property, and not for betterments.
2. As soon as receivers are appointed, the court should call a meeting of the mortgage creditors, to learn if the receiver selected is satisfactory.
3. The court should see that all proceedings under which receivers are appointed are prosecuted to an end with the utmost diligence, and, failing this, at once discharge the receivers.
4. As it is evident that our courts, as at present constituted, have neither the time nor the ability to manage large corporations, and hence must rely on their officers, the receivers, there should be a new court, part of whose judges should be business men, to whom all such applications should be made.
5. The protection of this court should extend to collaterals of the insolvent debtor which are pledged for loans, as there is no good reason why this class of creditors should be allowed to sacrifice the property of the debtor when all others are stopped.
It is not intended in this article to reflect on the judiciary, who probably have done the best they could under circumstances really foreign to their training and duties, and who have naturally left matters pretty much to their officers, the receivers; nor is it meant to imply that, in some cases, the timely protection of the court has not been of great advantage to the creditors; but when, as in the case of the Logansport, Crawfordsville, and Southwestern Railroad Company, we see the first-mortgage bondholders deprived of the management of their property, and it so loaded with receivers' certificates that when it is sold they swallow up every cent; when, as in the case of the Vicksburg and Meridian Railroad Company, we find the receiver not only buying new rails, but changing the gauge of the whole line; when, in cases nearer home, we find receivers using the bondholders' money to pay leased lines, and issuing car-trusts to increase the equipment, is it not time to call a halt, and ask both the courts and the people to consider what they are doing?