Story Case

The Brunswick and Florida Railroad issued its bonds without securing them by mortgage. Subsequently, it issued other bonds, specially providing for a trust deed security. When default was made on all the bonds, the holders of the first bonds claimed that, under the charter of the company, these bonds became a first lien upon all of its property. The charter-clause, upon which this claim was based, provided that "it should be lawful for the board of directors to direct the president and secretary to issue bonds of said company, which shall be binding on the property of said company, and such other property belonging to the stockholders as they may pledge to said company." The subsequent bondholders contended that these words were not sufficiently definite to give a statutory lien upon the company's property, superior to or equal to their own mortgage. In a conflict between the respective bondholders, what should be decided?

Ruling Court Case. Union Pacific Railroad Company Vs. United States, Volume 91 United States Reports, Page 72

The Union Pacific Railroad Company brought this suit against the United States in the Court of Claims, to recover one half of the amount due for the transportation of mails, troops, and supplies for the United States. The claim having been allowed, the government appealed to the Supreme Court. It was the contention of the United States that, although the sum claimed had in fact become due to the railroad company, as alleged, still the company was indebted to the United States for a larger amount, on account of interest paid by the United States upon bonds issued for the benefit of the railroad. The basis of this contention will appear from a survey of the facts incident to the creation of the company and the construction of the road.

In 1862, during the Civil War, there was great alarm through the country over the possible danger to the citizens and territory on the Pacific Coast because of impending complications with England. In addition it was realized that the great western prairies, without means of transit, isolated the newly settled California and left it without the protection that a government owes its people and without the communication which was essential to its full development. With a railroad across the continent, not only would the military necessities be provided for, but the territory between could be settled and the wealth and power of the country increased. Congress, therefore, yielding to the popular sentiment that would almost have supported construction and operation by the government itself, incorporated a private company to which it gave its aid. At that date especially, and even today, the construction of two thousand miles of railroad across unpopulated and unproductive country was an enterprise too stupendous for individual capital, even through co-operation. It was a work of national necessity and required national assistance.

The law that was passed, with its later amendments, provided that the United States would issue $100,000,-000 in its bonds, with interest at five per cent, to provide the capital. Large grants of land were also made to the company as an inducement to investors, who were offered the chance of sharing in the creation of land values along the road. The company was required to keep the line and the telegraph line in good condition, and to give precedence, when necessary, to the transportation of troops, mail, and supplies for the government. The company was obliged to repay to the United States in thirty years, when the bonds matured, the principal and interest. The statute made this obligation a first lien upon the lands and property of the company, so that, in case payment at maturity should not be made, the railroad would be forfeited to the government, and provided that after the completion of the road five per cent of its net earnings should be applied each year to the payment of the bonds. It was further provided that one-half of the compensation due to the company from the United States for services performed should be retained and credited to the obligation.

It was the contention of the Union Pacific Railroad company that the statute fully provided for the present case, and settled that the company was entitled to be paid in money, one-half of the charges for transportation. The defense of the government was, however, that the law applied only to the discharge of the principal indebtedness, for which purpose one-half of the amount due was to be retained, and that the other half could be kept, by reason of the common rules of set-off to apply to the separate obligation arising from the payment of interest. The company answered that there was no obligation imposed upon it to pay the interest upon the bonds at each six months' period when it became due, but that its only obligation was to repay the entire sum of principal and interest at maturity, after thirty years. On this basis the company was not at this time indebted by reason of the interest paid, but for the government it was argued that the liability to pay the interest arose before the maturity of the bonds and at every interest date.

The court upheld the railroad company. In an opinion by Mr. Justice Davis, the language of the statutes was examined and explained, and it was decided that the purpose was to postpone the necessity for settlement until the end of the thirty-year period. During that time the company was to have the use of the capital, and the government was to pay the interest. Except for the five per cent of earnings to be put aside each year, and for the one-half of claims against the United States which was to be retained, there was to be no liability. That implied that the other half of the claim was to be collectible, and the court, accordingly, gave judgment for the claimant, the Union Pacifies Railroad Company. But the mortgage to the United States to receive the repayment of the amount of bonds issued and delivered to the company to aid in the construction of the road was in no way disturbed.

Ruling Law. Story Case Answer

A mortgage may be created by statute, without the terms of the mortgage being expressed in the bonds or other debentures issued. The statute, however, must clearly provide for a lien, and the bonds must refer to the act as showing an intention on the part of the contracting parties to carry the benefit of the lien. Thus, where an act authorized a canal company to borrow money on its bonds, which should "take precedence and have priority of lien on the said canal and tolls thereon, and other property of the said company, over all claims," and the company issued bonds which were silent as to a trust deed, but recited the act, it was held that the bondholders were entitled to the charge upon the canal and its tolls, and the appointment of a receiver upon default.

A statutory mortgage is, in substance, similar to one executed by deed. The generality of the language giving the mortgage is no objection to the validity of the mortgage in either case. For instance, the word "property," if the statute so provides, is sufficiently definite, and yet so comprehensive as to cover all franchises and lands of a company, including that which it may not be using for its specific business, or which it may subsequently acquire.

As stated, however, the statutory lien exists only when the statute clearly gives a lien. The Story Case is based upon Brunswick and Albany Railroad Company vs. Hughes, Volume 52 Georgia Reports, Page 557, where the court held that the words of the statute were not sufficiently clear in expressing an intention to give a mortgage. Therefore, the first bondholders were mere insecured creditors, who have rights only after secured creditors were paid.