Opinion
11-12-1898
BIRD v. MAGOWAN et al.
John T. Bird, pro se. William M. Lanning, for defendant William P. Hayes. Edwin Robert Walker, for defendant Frank A. Magowan. John H. Backes and Barton B. Hutchinson, for defendants Allen Magowan and Sarah J. Magowan.
Bill by John T. Bird, as receiver of the Trenton Rubber Company, against Allen Magowan and others. Decree for complainant.
John T. Bird, pro se.
William M. Lanning, for defendant William P. Hayes.
Edwin Robert Walker, for defendant Frank A. Magowan. John H. Backes and Barton B. Hutchinson, for defendants Allen Magowan and Sarah J. Magowan.
REED, V. C. This bill is filed by the receiver of the Trenton Rubber Company against three directors of the corporation. The charges are that Frank A. Magowan abstracted large sums of money belonging to this corporation, and diverted them from corporate uses to his personal use, that William P. Hayes was cognizant of and aided such diversion, and that Allen Magowan knew or should have known of it and prevented it The corporation was organized in 1886, when Frank A. Magowan, William P. Hayes, and one Alpaugh were elected directors. Mr. Alpaugh died in 1892, when Allen Magowan was elected, in his place, a director, as well as vice president. Later, William P. Hayes was elected treasurer. These three continued directors up to August 2, 1895, when the company went into the hands of a receiver. On September 26. 1895. the receiver was discharged, and the company continued business until the appointment of the present receiver.
The first question is in regard to the liability of Frank A. Magowan. He owned substantially all the stock in the corporation, and controlled the business. He freely used the checks and notes of the company to pay his personal debts, and the only perplexity is in limiting the amount of his abstractions. The two sources of information in evidence are the books of the company and the checks and notes of the company now in the hands of the receiver. The books show two accounts against Frank A. Magowan,—the first a general account, running from January 3, 1893, to August 1, 1895; and the second, what is termed a "special account," running from September 27, 1895, to March 31, 1897. The two accounts are of precisely the same character. The interval between these two accounts (that is, from August 1, 1895, to September 27, 1895) constituted the period during which the company was in the hands of the former receiver. The first item of the general account is a charge of $83,000, under date of September——, 1893, brought over from an old ledger. This ledger cannot now be found. This account is increased by charges up to August, 1895, when the total amounted to $270,432.09. The charges in this account were for all checks and notes which do not appear upon their face to be for the benefit of the company. In respect to them, Mr. Hayes, who kept the books, says that, when he did not know where to place the charge, he put it to the account of Frank A. Magowan. F. A. Magowan knew of the existence of this account, and sometimes, as Mr. Hayes says, would challenge its accuracy, but, except in some unimportant particulars, permitted it to stand unchanged. He never went over the accounts and indicated what items should have been charged to the expense of the corporation, and what were properly charged as his personal disbursements. The accounts, therefore, standing in this form, unchanged, are evidential as admissions. Standing as they did upon the books of the company, of which he should have had, and did have, knowledge, it was his duty to explain in what degree the charges do him an injustice. He now admits that a part of the checks, to the amount of $10,875.57, are properly charged to his personal account; and some of the checks and notes, upon their face, show that they were drawn in payment of purely personal debts. Many of the checks are drawn to F. A. Magowan's order, and the cash arising from them was used by him; and others were drawn in favor of hotels in New York City, and hotels, restaurants, cigar dealers, hatters, grocers, insurance agents, etc., in the city of Trenton. As to most of these checks, the only explanation which F. A. Magowan gives is that they, or the money derived from them, was used in the interests of the company. Now, it is probable that some of these checks were entirely, and others partly, used for corporate purposes. The lavish expenditures of money in the entertainment of customers and their agents, and in giving Christmas presents to agents, employes, and customers, and the other indicated ways, although it may have been ill advised, may come within the category of corporate expenses. But included within these amounts of checks and notes charged up to his personal account there are those already mentioned, admittedly given for personal debts. Then there are others given in payment of material men and others in the construction of his private residence, and others, such as the check to Redfern & Co., which were obviously in payment of private debts. Besides the checks drawn in favor of third parties, there is a series of checks drawn by the company, through William P. Hayes, treasurer, in favor of Frank A. Magowan, per William P. Hayes, attorney, and indorsed for deposit by him. These checks run from January 4, 1893, to February 29, 1890. Sixteen checks were drawn in January, 1893, amounting to $3,655; 8 checks were drawn in February, 1893, amounting to $3,340; 11 checks were drawn in March, amounting to $4,720; 16 checks were drawn in April, amounting to $6,150; 11 checks were drawn in May, amounting to $1,775; 5 checks were drawn in June, amounting to $4,650; 6 checks were drawn in July, amounting to $2,295; 13 checks were drawn in August, amounting to $4,745; 9 checks were drawn in September, amounting to $4,615; 7 checks were drawn in October, amounting to $2,080; 3 checks were drawn in November, amounting to $2,250; 15 checks were drawn in December, amounting to $2,830; the total so drawn during the year amounting to $43,255. In the year 1894 there were 16 checks drawn in January, amounting to $6,958. A further particularization of the checks so drawn, by date and amount, is unnecessary. The footing of the amounts so drawn up to February 29, 1895, is $89,968. But these are only a part of the checks drawn in favor of Frank A. Magowan personally. There is also a line of checks, running through the same period, drawn by Frank A. Magowan, as president, to himself, and indorsed by himself personally. In February, 1893, they amounted to $115; in March, 1893, they amounted to $25; in April, 1893, they amounted to $250; in June, 1893, they amounted to $100; in July, 1893, they amounted to $1,335; in August, 1893, they amounted to $1,038.70; in September, 1893, they amounted to $1,060; in October, 1893, they amounted to $2,415; in November, 1893, they amounted to $1,000; in December, 1893, they amounted to $370. The total of these checks, up to February 3, 1895, is $60,221. Now, there is little to be gained by entering into a nice discussion as to the probability of this or that check having been used for the benefit of the company. I am satisfied that a large portion of the money represented by those two classes of checks was squandered by Frank A. Magowan for purely personal purposes. Taking into consideration the checks admittedly given for personal purposes, and those which upon their face appear to have been so given, and conceding a possibility that a part of the two classes of checks was used for corporate purposes, I will fix the amount of the assets of the corporation which Frank A. Magowan diverted from corporate uses at $150,000.
The next question is in regard to the liability of Mr. William P. Hayes and Mr. Allen Magowan. Both of these gentlemen were nominally directors of the corporation, but really only acted as employés of Frank A. Magowan. Mr. Hayes, as treasurer, signed all checks that Frank A. Magowan wished signed, and in favor of any person that Frank A. Magowan indicated. Apart from using his official name to make or indorse commercial paper for the company, Mr. Hayes' function was that of a bookkeeper merely. He exercised no more control over the business than if he had been, as he was, a mere servant of the president. Mr. Allen Magowan was engaged as superintendent of the manufacturing part of the business, and never had anyknowledge of the condition of the company's finances. There was never any settlement of accounts, and no one knew definitely what the condition of the company was at any particular date. In regard to the duty which both Mr. Hayes and Allen Magowan owed to the corporation itself, the former was grossly, and the latter in a degree, negligent The whole affair was substantially the private business of Frank A. Magowan, under a corporate guise. As a matter of fact, he had never paid for his stock. He was permitted by the other directors to run the business as he pleased. He was concerned in other corporations, and the funds of each were used to keep up the credit of the others at his own will. The directors placed no checks upon his actions, but permitted him to carry the business along in the reckless manner which these accounts indicate. Now, while Frank A. Magowan is answerable for the funds of this company which he applied to his own personal uses, the other directors are responsible for their negligence in permitting him to do so. The query arises to whom, and in what degree, their responsibility exists. Now, the rule is settled in the English equity courts that directors of a corporation are agents of the owners of the corporate property, and are responsible to them, but they are not the agents of the creditors of the owners of the corporate property. Directors are no more liable to the creditors of the corporation than is the agent of a private person responsible to his creditors for their own mismanagement or extravagance, or for the mismanagement or extravagance of the owner, or of another agent of the owner. By the American doctrine, however, when the company becomes insolvent, and the necessity and duty of winding up the affairs of the corporation and of distributing these assets among its creditors supervenes, then a new duty springs into existence,—the duty to use all reasonable care and diligence in preserving the property for that purpose. The directors then become trustees for the creditors. This is the law of this court, for Vice Chancellor Pitney, in the case of Landis v. Hotel Co. (N. J. Ch.) 31 Atl. 755, after an exhaustive review of the cases in England and in this country, held that the directors of a corporation stand in the posture of trustees only for stockholders, or those who stand in the attitude of shareholders, in the corporate property; that they are not trustees for creditors in transacting the ordinary business of the company, but only become such when dealing with the property of an insolvent company. It is clear, taking into account the character of this corporation and the amount of its debts and assets, that, as against the last-named two directors, the receiver represents the creditors only. The duty, therefore, to the creditors, sprang into existence when the corporation became insolvent. I am of the opinion, however, that this duty may arise before actual steps, either voluntary or involuntary, have been taken to wind up a corporate business. I think that when such a condition of corporate affairs confronts the directors that it is obvious that the company is insolvent, and the statutory duty enjoined and the restraint imposed by sections 63 and 64 of the corporation act come into play, then the duty of the directors to the creditors begins. If the occurrence of this known condition of the company is the inception of the duty, then the question is, at what point of time did this duty begin in the present case? I think that, from the time the corporation was discharged from the hands of the first receiver, it was evident to the directors that the company was insolvent. It did not pay its debts, but, instead of paying them, it got an extension. The course taken by the creditors in consenting to the withdrawal of the receiver was induced by the hope that there was a likelihood of realizing more on their debts, by permitting the business to be continued, than by then forcing the company into liquidation. The whole transaction consisted of a general extension, by the terms of which the payment of the debts was prolonged for a period of two years. Every person connected with the corporation knew, or should have known, the details of this arrangement. It must have been obvious to the directors, during this period, that any diversion of the assets of the company was an abstraction of funds, all of which would be necessary to liquidate the debts of the concern. The condition of the company during this period, to the knowledge of the directors, as to every one else, was one of insolvency. Now, during the period from September 27 to October 21, 1895, Mr. Hayes, as treasurer, drew checks to F. A. Magowan, which he charged to the latter's "special account," to the amount of $3,600. There is nothing to show that any of these checks went to the use of the company, except F. A. Magowan's general statement. He says that the money was used to repay loans, or to buy up claims of those who would not join in the extension. The checks, it will be observed, are for a round sum; and, in the light of the other testimony, this general statement, unaccompanied by any verifying details, is not credible. No explanation, so far as appears, was made to Mr. Hayes of the corporate purpose, or of any corporate purposes, to which these sums were to be devoted. He drew the checks, as he had theretofore done, during the entire period of his directorship, at the request of F. A. Magowan, without an attempt to exercise any supervision over the expenditure of the money raised by them. Mr. Hayes, indeed, says that he thinks that this "special account" was balanced when his connection with the company ceased. But the books do not show a balance, nor is it shown how the account is balanced. The presumption arising from the private character of the special account is not rebutted by anything in the testimony. In my judgment, Mr. Hayes is responsible for the diversion of the sum of $3,600. I am also constrained to the conclusion that Allen Magowan is also chargeable with negligence in permitting these transactions to continue. I do not think that he had any actual knowledge of what was transpiring, but, as a director, he was bound to know the condition of the books. As I have already observed, the company had once before been declared insolvent. It had only resumed business permissively under an extension. This much he knew. He knew that the company should have made money. He says he thought it was making money. He should have inquired what had brought it to bankruptcy. An inspection of the books would have disclosed the cause. It would have appeared that the drafts upon the company for money drawn by his son for private, purposes were so extravagant that no company could live on under the drain. Upon the resumption of business he owed a duty to the creditors, the great body of whom had joined in granting this extension, to see that this illegal use of the company's assets and credits should cease. He took no measures to prevent its continuance, and I therefore have to conclude that for the drafts drawn by Mr. Hayes in favor of F. A. Magowan personally, after the resumption of business under the extension, he is responsible. But the checks already mentioned as drawn by Mr. Hayes were not all of the checks drawn in favor of F. A. Magowan during the business period of the corporation) between the receiverships. After Mr. Hayes had ceased to be treasurer and director, and Mr. Charles Garcine assumed the vacant position, the latter proceeded to draw checks to his own order, or to the order of F. A. Magowan, which were charged to the "special account" of the latter, the amount of which checks was $6,517.01. In addition to these, checks were drawn by Mr. Garcine to Mary E. Magowan, the wife of F. A, Magowan, amounting to $6,873.00. The total of the two classes of checks Is $13,390.07. This makes a total of $16,990.07, for which, in my judgment, Allen Magowan is responsible.
The bill prays further relief. It sets out, and it is proved, that Allen Magowan is without property; that in August, 1895, about the time of the appointment of the first receiver, he assigned to his wife, Sarah J. Magowan, all the property he then possessed. The bill further charges that Allen Magowan filed with the present receiver a claim against this corporation for debts due him amounting to $37,619.33, and that he had, since filing it, assigned this claim to his wife, with the intent to defeat his creditors and the creditors of the Trenton Rubber Company. There is a special prayer that Sarah J. Magowan may be decreed to hold the said claim subject to the equities of the receiver, arising from the negligence of Allen Magowan, against the amount which may be found due Allen Magowan on his said claim. It appears that nothing in the way of valuable consideration passed to Allen Magowan at the time of this assignment. All that appears is that Sarah J. Magowan had permitted property which had been given her by her husband to be used in the interests of the Trenton Rubber Company. In regard to this feature of the case, it appears that, in the answer made by Sarah J. Magowan and Allen Magowan, they say that the bill of complaint alleged no facts which entitled the receiver to relief against Sarah J. Magowan, and she prays the benefit of the answer as though she had demurred. This is ineffective as a demurrer. The parties, having answered in full, cannot include in the answer a demurrer to all or part of the bill. Veghte v. Power Co., 19 N. J. Eq. 142. Nevertheless, I do not see how this phase of complainant's case can be settled in this suit. No offset can be decreed against the claim now held by Mrs. Magowan; for when this bill was filed there was no liquidated amount due to the receiver from Allen Magowan, but only a claim for damages, which could not be set off against the other claim, even if the latter was held by Mr. Magowan. Duncan v. Lyon, 3 Johns. Ch. 357. When Mrs. Magowan took the claim, it was not subject to any equitable set-off. Nor did there exist any ground for a decree reducing or extinguishing the claim under the doctrine of recoupment; for, so far as appears, the damages now found against Allen Magowan did not grow out of the same transaction as that from which the claim of Magowan sprang. The only ground for asserting jurisdiction is that, Allen Magowan being irresponsible, this court will annul the assignment of his claim to his wife, as fraudulent, and apply so much of it as may be necessary to the payment of the decree against Allen Magowan. But this course would be equivalent to decreeing a set-off against the claim, or the seizure of it, as an equitable asset of Allen Magowan, to pay a decree against him, before judgment and execution. I think this part of the relief asked for was prematurely sought in this suit. After the decree against Allen Magowan is signed, then, on a proceeding to set off the amount of it against the claim assigned to Mrs. Magowan, the questions raised upon this branch of the cause can be determined.