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OVERFIELD v. PENNROAD CORP.

December 20, 1941

OVERFIELD
v.
PENNROAD CORPORATION et al.; WEIGLE v. SAME



The opinion of the court was delivered by: WELSH

This matter involves two complaints, one by Ione M. Overfield and the other by Grace Stein Weigle. They are substantially the same, in that they are derivative stockholders' suits brought on behalf of Pennroad against the Pennsylvania Railroad and the former directors of Pennroad. Jurisdiction in both actions is based on diversity of citizenship. The complaints allege an interlocking relationship between the individual defendants as directors and officers of the Pennroad and of Pennsylvania. They include and set forth letters dated April 24, 1929, to Pennsylvania stockholders, a voting trust agreement dated May 1, 1929, and aver that sales of Pennroad voting trust certificates of over $141,000,000 were made. It is charged that Pennsylvania, through its officers and agents and by means of the said voting trust agreement, took and retained control of Pennroad although it invested nothing in Pennroad securities.

The Weigle bill describes eight large purchases alleged to have been made pursuant to a premeditated and preconcerted fraudulent scheme to use the funds and powers of Pennroad for the benefit of the Pennsylvania, each of which are alleged to constitute a separate cause of action. The Overfield complaint originally involved only one of the investments complained of in the Weigle suit but was subsequently amended, with leave of court to include all of the charges of the Weigle bill. 39 F.Supp. 482.

 As the record now stands the bills in the Weigle and the Overfield suits both contain, in addition to the allegations as to jurisdiction and to the general course of dealing between Pennsylvania and Pennroad, complaints based upon the following particular investments and transactions: The purchase by Pennroad of the

 (1) stock and other securities of the Detroit, Toledo and Ironton Railroad for $36,000,000.

 (2) substantially all of the stock of Canton Company for $13,432,817.90.

 (3) 220,000 shares of the stock of the Pittsburgh and West Virginia Railway at $170 per share.

 (4) 402,119 shares of Seaboard Airline Railway for $4,523,838.75.

 (5) 10,000 shares of Lehigh valley at a price largely in excess of its investment value.

 (6) 148,800 shares of common and 1,200 shares of preferred stock of the New York, New Haven & Hartford Railroad Company for $17,301,851.25 and $149,300, respectively.

 (7) securities of the Boston & Maine Railroad Company for $23,637,708.38, and

 (8) the promotion by Pennroad in June, 1929, of National Freight Company, and the furnishing of its capital in the original amount of $2,300,000, and finally a total of over $4,000,000.

 As to all of these investments, it is alleged that they had a special value to Pennsylvania apart from and value of the same as an investment to Pennroad, and that Pennsylvania fraudulently caused Pennroad to make such investments for its own benefit. In particular, it is alleged that Pennsylvania had previously considered purchasing the Detroit, Toledo & Ironton Railroad and had abandoned negotiations, but through its domination caused Pennroad to make the purchase at a price which Pennsylvania had considered excessive in the absence of certain assurances as to continuation of Ford freight traffic. Pennsylvania had likewise previously considered the purchase of the Canton Company for the express purpose of securing control of the Canton Railroad but had concluded that the special value of Canton Company to Pennsylvania as a traffic producing agency would not exceed $9,500,000. Upon discovering that Canton was about to be sold to a competing railroad, Pennsylvania directed its banking agents to purchase the Canton Company for Pennroad and that they did so at an excessive price. It is also alleged that prior to the purchase of the Pittsburgh and West Virginia by Pennroad, Pennsylvania deemed the acquisition of that company necessary to prevent it going to a competitor and thereby injuring Pennsylvania's strategic and competitive position, that the price paid by Pennroad as directed by Pennsylvania was greatly in excess of the intrinsic value, and that an enormous loss to Pennroad resulted. It is alleged that the purpose of Pennsylvania in causing the purchase of Seaboard Airline stock was to improve and strengthen the strategic position of Pennsylvania as a competitor for traffic of the Seaboard exchanged at Washington, and that the price paid was out of proportion to the real value of the stock and that the result was a complete loss to Pennroad, although Pennsylvania continuously enjoyed substantial benefits therefrom. It is alleged that the purchase of Lehigh Valley stock was to further secure Pennsylvania's control of that railroad so that in consolidation plans then pending, Pennsylvania might exercise complete domination over the Lehigh Valley, that Pennsylvania did so benefit, and that Pennroad suffered large losses by reason of said purchase. As to the New York, New Haven & Hartford, it is charged that Pennsylvania caused Pennroad to make this purchase to secure for Pennsylvania a working control of the New York, New Haven & Hartford for the improvement of Pennsylvania's strategic and competitive position. Pennsylvania had previously purchased 200,000 shares of that company. The purchases made by Pennroad inflated the market value beyond a normal investment level, made the cost of the stock considerably in excess of its investment value and caused Pennroad severe losses while greatly benefitting Pennsylvania. The purchase of the Boston & Maine was made in pursuance of Pennsylvania's desire to dominate New England railroad operations and for that purpose it caused Pennroad to purchase the stock at a price much higher than the investment value.

 As to the National Freight Company, it is alleged that by promoting and causing Pennroad to make the capital investment in that company, Pennsylvania acquired control of the routing of less than carload lot traffic within its territory; that prior to organization of Pennroad, Pennsylvania had planned to accomplish the same results through an owned subsidiary or affiliate of Pennsylvania, but in May, 1929, Pennsylvania decided to cause Pennroad to put up all of the money, take all of the chances and losses, while Pennsylvania retained profits, advantages and benefits of the project without risk. Pennroad assumed responsibility for all financial requirements of the company, including the cost of leases from Pennsylvania, with the understanding that all traffic secured should be routed over the Pennsylvania lines. It is alleged that from the beginning and for a period of about four years National Freight suffered constant heavy losses all of which were paid by Pennroad, while during the same period the freight company continued to pay rentals and furnish Pennsylvania a large and profitable volume of traffic. Pennsylvania was advised by Pennroad of the losses and thereafter Pennsylvania made some efforts to lighten those losses without giving up any benefits. In March of 1933, Pennsylvania concluded to abandon the venture and so advised Pennroad, whereupon Pennroad sold the National Freight Company for $400,000 represented by notes which were sold for $381,000, resulting in a loss of over $4,000,000 to Pennroad, while Pennsylvania received freight revenues and rentals in excess of $5,000,000.

 It is alleged that the defendants, except Wayne who was not originally a director, conspired and created the fraudulent scheme to cause Pennroad to make the investments complained of for the benefit of Pennsylvania and that the defendants concealed the scheme from Pennroad certificate holders. Plaintiffs aver that they did not learn of the facts concerning those investments until 1938 after the Wheeler investigation, and charge that the transactions complained of constitute reckless and wanton disregard by the defendants to their duties arising from dual relationships and conflicting interests.

 The prayers of the complaints are that the defendants by jointly and severally held liable for all losses incurred by Pennroad, that Pennsylvania be adjudged liable for reimbursement to Pennroad for all benefits received by Pennsylvania by reason of the transactions described, that Pennsylvania account for and pay to Pennroad all gains and profits accruing to it from the said transactions, that an account be stated showing the losses suffered by Pennroad through its participation in the said transactions and that a judgment be entered in favor of Pennroad and against the defendants for such losses.

 The various defendants filed answers to the Weigle complaint, which answers have been, with leave of court, taken as the answers to the Overfield complaint as amended.

 The answers of Pennsylvania admit the averments of the complaint with regard to jurisdiction and relationship of the various defendants and the authenticity of the plaintiffs' exhibits. It acknowledges that 5,800,000 shares of Pennroad stock were issued to the voting trustees and that the voting trustees' certificates were offered at $15 per share, a large percentage of them having been subscribed for by stockholders of Pennsylvania. The incorporators of Pennroad subscribed for 67 shares, and that of the eight directors constituting the original board of Pennroad seven were members of the board of Pennsylvania. Mr. Lee, director and president of Pennroad, had resigned as treasurer of Pennsylvania, and Mr. Ogden, vice-president and treasurer of Pennroad, and subordinate officers of Pennroad had been employees of Pennsylvania. It is admitted that the voting trustees were persons who were also at that time the president and two directors of the Pennsylvania. It is further admitted that prior to the organization of Pennroad persons who were then officers of the Pennsylvania had conducted negotiations with the owners of Detroit, Toledo & Ironton looking to the possible purchase of its securities, but it is averred that the Pennsylvania was not intended to be the purchaser of such securities. Consideration by the Pennsylvania officials and directors had been given to the possible terms upon which the Canton Company could be acquired and to the value of the stock and property of that company, but the discussions and negotiations were terminated without any agreement to purchase such property by or on behalf of the Pennsylvania having been made. It is admitted that for some time prior to the organization of Pennroad, Pittsburgh & West Virginia had occupied a position of strategic importance as a railroad and that the control of the company had come to be of substantial value to any purchaser; that Pennsylvania had purchased and sold for its own account stock of the New York, New Haven & Hartford and that the National Freight Company had leased railroad facilities from Pennsylvania and paid rentals for the same, and had furnished to Pennsylvania a volume of freight traffic.

 The answers of the Pennsylvania set forth additional separate defenses to the effect that plaintiffs had shown insufficient excuse to demand that Pennroad bring suit in compliance with the requisites of the rules of court governing secondary actions by stockholders; that the plaintiffs had waived any possible rights by estoppel and laches, and that the complaint fails to state a claim upon which relief can be granted.

 The Pennroad Corporation filed its answer acknowledging the sale of its shares to the public at prices ranging from $15 to $17 from which Pennroad received the gross sum of $54,285,000 and that trust certificates therefor were issued by the voting trustees. It acknowledges the purchases and investments alleged in the bill, and that its board of directors on June 2, 1929, decided to promote a freight forwarding company. Thereafter Pennroad formed the National Freight Company and supplied it with capital in the amount of $2,300,000 and from the beginning and continuously thereafter the freight company suffered constant heavy losses. On March 30, 1933, Pennroad sold the freight company for $400,000 in notes, which notes were sold for $381,000. Pennroad denies knowledge or asserts the immateriality of all other allegations in the bill of complaint. Pennroad affirmatively declares that since incorporation it had functioned as an independent organization in furtherance of its own powers and interests. All purchases were bona fide for value and made in the interest and exercise of reasonable care and prudence in the light of the then prevailing conditions. Certificate holders had instituted and thereatened suits similar to the one at bar, but the present board believes the transactions complained of were properly made, and, in fairness to the stockholders generally, it should not spend large sums to prosecute such suit, the results of which would be doubtful. It is declared that the policy of Pennroad and its board in this and such other cases is not to assume an adverse attitude except to oppose efforts to dishonor the names or to question the performance of duties by its deceased and former directors or to impugn the good faith of its present directors and management.

 The individual defendants in their respective answers defend on the ground that the claimants have shown no claim upon which relief could be granted, and aver that laches and the statute of limitations preclude any possible recovery; plaintiffs had not shown sufficient excuse for failure to demand that Pennroad bring suit in compliance with the requirements of the rules governing the bringing of secondary actions by stockholders, and that the complaint is defective in that it fails to allege bad faith of the present directors, or to aver personal interest accruing to the defendants by reason of the acts complained of. The answers further aver that Levi L. Rue, W. W. Atterbury and Richard D. Mellon are deceased. The answer of Joseph Wayne, Jr., avers also that he has been a director only since March 11, 1931, and did not participate in the matters complained of by the plaintiffs. The complaints in both of the pending suits being substantially the same, the admissions, denials, averments and separate defenses are accepted as responsive and form the basis of the issues in both cases.

 The primary question suggested by an examination of the pleadings grows out of the relationship between Pennsylvania Railroad and Pennroad. If Pennsylvania was in a position to exercise domination and control over Pennroad and its investments, and did in fact dominate and control Pennroad's investments and operations, then certain fiduciary obligations devolved upon the Pennsylvania, the performance of which might make it accountable if losses were suffered. An appreciation of the issues must be based upon a review of the conditions which prompted the formation of Pennroad, its purposes, the plan of its organization and the actions of the parties responsible for its creation.

 For many years prior to 1929 the Pennsylvania Railroad officers and directors believed that in order to extend their railroad's empire it must be prepared financially and otherwise to find a means of controlling other railroads, and that it was then necessary to start acquiring stock in the railroads the Pennsylvania Railroad desired to have in its system. Pennsylvania Railroad had begun investigations of and negotiations looking to acquisition of an interest in railroad properties which it desired, and the Pennsylvania Company, a wholly-owned subsidiary, then had under consideration the acquisition of the Detroit, Toledo & Ironton and the Pittsburgh & West Virginia Railroads. These routes had been allocated to other carriers in the tentative plan of consolidation of the Interstate Commerce Commission promulgated in 1921 pursuant to the requirements of the Transportation Act, 49 U.S.C.A. § 71 et seq. Pennsylvania wished to secure control of these railroads in order to preclude the possibility of their allocation to other systems. Pennsylvania officials had been negotiating for the purchase of Detroit, Toledo & Ironton since February, 1928, and had reached the final stage of negotiation on March 22, 1929, when Messrs. County and Ford signed a memorandum of understanding to the effect that Pennsylvania Railroad's subsidiary, Pennsylvania Company, would arrange for the purchase for $36,000,000, $15,000,000 of which was to be paid on April 30, 1929.

 It was decided not to use the subsidiary, Pennsylvania Company, inasmuch as the Pennsylvania Railroad would be required to report to the Interstate Commerce Commission its railroad stock acquisitions and interests through the Pennsylvania Company. The officials of the Pennsylvania Railroad sought other means of acquiring the Detroit, Toledo & Ironton stock which would eliminate the necessity of reporting the acquisition to the Commission. They were also aware that the Clayton Anti-Trust Act, 15 U.S.C.A. §§ 12-27, made it hazardous for the Pennsylvania Railroad or the subsidiary, Pennsylvania Company, to acquire control of other railroads where the effect might be to lessen competition.

 Pennsylvania Railroad had also been interested in acquiring Canton Company and had been actively negotiating therefor but had discontinued because it deemed the price asked was excessive.

 Beginning with an initial purchase of 10,000 shares of New Haven in 1904, Pennsylvania had by subsequent purchases increased its holdings in 1928 to 73,000 shares, and a Pennsylvania director had since 1906 served on the New Haven board. The subsidiary, Pennsylvania Company, had acquired stock of the Lehigh Valley and Wabash Railroads and it may be properly said that the Pennsylvania Railroad and its affiliates had been actively seeking means for extending its system and increasing its business through relationships with other lines.

 Mr. County explained that railroad consolidations were being actively undertaken following the formulation of a tentative plan by the Interstate Commerce Commission in 1921 which was followed by three years of hearings. From 1924 to 1929 there was no definite plan under consideration and during that time the railroads themselves could not agree upon any plan. There arose serious questions by the Pennsylvania Railroad stockholders as to what was being done to protect their investment as against purchases of railroad interests then being made by other railroad companies. This question persisted in and out of the management and was deemed important. It was Mr. County's especial duty to be the guardian of the investments of Pennsylvania stockholders and he had continuously discussed with the directors what action the Pennsylvania could take to protect the interests of its stockholders, property and business relations with other roads.

 They were aware that purchases of railroad securities were being made by other railroads and their subsidiary investment companies, but there seemed to be no protection available to anyone in respect to a consolidation or protective plan. The railroad did not have the ability to effect leases or consolidations because they could not be concluded without the consent of the Interstate Commerce Commission, and that Commission would not approve of consolidations because such consolidations would tie up the final plan when it should be adopted. The Pennsylvania stockholders and management were considerably disturbed by these conditions. Pennsylvania had also sought some suitable alignment or allocation of roads to Pennsylvania to protect the relations that had existed with other roads but without results.

 Faced by this problem conferences were had with the bankers and officials of Pennsylvania Railroad who sought to work out a possible plan to utilize the Pennsylvania Company, an investment corporation whose stock was wholly owned by Pennsylvania Railroad. After full discussion, the conclusion was reached that the only satisfactory way to accomplish the purpose was through the incorporation of a separate investment company to be owned by the stockholders of Pennsylvania. In developing the plan, the bankers and Pennsylvania directors believed it desirable that the corporation should have the utmost liberty to engage in road, air and water transportation or shipping, and that broad charter powers should be provided. It was then decided to form a Delaware corporation and to extend to the Pennsylvania Railroad stockholders the right to subscribe the capital necessary to accomplish its purposes.

 Complete arrangements for the formation of Pennroad were made by Pennsylvania officials prior to April 24, 1929. On March 27, 1929, Kuhn Loeb & Company submitted a plan for the formation of the new company and thereafter worked with Mr. County on the development of the plan. On March 28, 1929, Mr. County advised General Atterbury that "the situation may require formation of a new company which will develop fully and be ready about the end of next week", and on April 6, 1929, he submitted a further most illuminating memorandum stating, "I have considered some means of more adequately meeting our increasing corporate activities and financial interests by supplementing (italics supplied) the powers of the Pennsylvania Railroad and the Pennsylvania Company."

 By April 17, 1929, the charter and bylaws had been prepared and a form of circular letter was under discussion. The following day a draft of the charter and bylaws was sent to Mr. Morris by Mr. County with the statement "for the protection of the company to prevent losing control, especially in the early days under a diversified ownership, a voting trust seems the only way * * *. The voting trustees would be our own people. The first directors of the corporation suggested would be our finance committee, including General Atterbury and myself." Mr. County on April 23, 1929, instructed the Wilmington Trust Company to advance $21,050 to cover the filing fees in connection with the filing of the charter by the incorporating company and requested that this be carried as an advance to Mr. Lee.

 With that background Pennroad was incorporated by persons officially connected with Pennsylvania on April 24, 1929 as an investment company with authorized capital of 10,000,000 no par value shares. The charter provided that the directors should be divided into three classes, each containing one-third of the board, and that at annual meetings only one-third of the directors would be elected for terms of three years. It provided that the corporation should not be required to make public or known to stockholders any statement concerning its assets or liabilities and the by-laws denied stockholders any right to inspect books except as conferred by law unless authorized by the board, the executive committee or the stockholders. The meeting of incorporators was held at noon on April 24, 1929, and Messrs. Atterbury, Morris, Ingersoll, Rue, Cooke, Mellon, County and Lee were elected directors. They were also directors of Pennsylvania and constituted almost the full membership of the finance committee of Pennsylvania. General Atterbury was president, and Mr. County vice president in charge of finance of Pennsylvania. At the first meeting of the board of Pennroad held on the same date, Mr. Lee was elected president, Mr. Ogden vice president and treasurer and Mr. Moyer secretary and assistant treasurer. Mr. Lee had been with the Pennsylvania for thirty years and was then treasurer, his superior officer being Mr. County. Mr. Ogden had been employed twenty-three years by the Pennsylvania and was serving in the treasury department under the supervision of Mr. County. Mr. Moyer had been assistant to the president of Pennsylvania. The board authorized the issuance of 5,800,000 shares of Pennroad stock to be placed under a ten-year voting trust with Messrs. Atterbury, Morris and Cooke as voting trustees. The certificates were to be offered at $15 and a proposed circular letter affording the stockholders of Pennsylvania the opportunity to subscribe to the voting trust certificates was approved at the same meeting, which letter was mailed to Pennsylvania stockholders on April 27, 1929.

 The voting trust agreement dated May 1, 1929, recited that the stockholders deemed it for the best interest of the corporation and of the holders of the common stock that there shall be a continuity and stability of policy and management and to that end the voting trust should be created. The agreement provided that the voting trustees shall possess and exercise all rights and powers of absolute owners of such stock, including the right to vote for every purpose and to consent to any act of the corporation. The trustees were exonerated from liability for wrongful conduct, except individual malfeasance. The trust agreement provided for the election of successors by surviving trustees, and gave them power to propose amendments.

 At the time of the organization of Pennroad, 67 shares were issued to the incorporators who were acting under the directions of the officials of Pennsylvania Railroad responsible for the formation of the corporation. These shares were transferred by the original subscribers to former employees of Pennsylvania, Messrs. Andrews, Hebden and Ogden, the latter having advanced the consideration. They were therefore the sole stockholders when the voting trust agreements were effected. The stock initially subscribed was later sold at a profit, and upon advice of counsel the profit was turned into Pennroad inasmuch as the subscribers were merely nominees.

 Simultaneously and as part of the process of promoting Pennroad, there was prepared and sent to about 157,000 stockholders of Pennsylvania Railroad, introducing the new Pennroad, its plan of organization and purpose, and inviting subscriptions to its capital. These letters dated April 24, 1929, were sent out by President Atterbury of Pennsylvania Railroad and President Lee of Pennroad. In Mr. Atterbury's letter he stated "Your directors (italics supplied) have given earnest consideration to recent developments in the field of transportation and have reached the conclusion that it will be of material advantage to this company and to its stockholders, for the stockholders to unite in establishing a corporation so organized that it may make investments and take advantage of opportunities on a much broader basis than is possible under the limited powers of a railroad company. Your directors are of the opinion that such an independent instrumentality is needed to protect your interests and those of your company." This was followed by a statement of the incorporation of Pennroad.

 Mr. Lee's letter declared that "in furtherance of the purpose for which the corporation has been organized and in order to secure continuity of management, all the stock now being issued will be placed in a Voting Trust, under which Messrs. W. W. Atterbury, Effingham B. Morris and Jay Cooke have consented to act as Voting Trustees." "The first board of directors of the corporation consist of" the seven persons named, "all of whom are directors of the Pennsylvania Railroad Company, and Mr. Henry H. Lee, the president of the corporation."

 The letters directed that payment on subscriptions be made at the office of the Treasury Department of the Pennsylvania Railroad, Broad Street Station. The mailing was handled under the direction of 60 Pennsylvania Railroad employees and several hundred temporary assistants, and the expense amounting to $106,000 was advanced by the Pennsylvania and later assumed by Pennroad.

 As subscriptions were received the shares were issued to the voting trustees who in turn caused the transfer agent to issue voting trust certificates to the subscribers. Warrants and certificates were quoted on stock exchanges after April 25, 1929, on a "when issued" basis and were admitted to unlisted trading privileges on the New York Curb, followed by a regular listing on June 17, 1929. Listings were also made on other exchanges.

 Prior to the formation of Pennroad the officials of Pennsylvania Railroad had arranged underwriting commitments between Pennroad and the bankers, Kuhn Loeb & Company, which were set forth in an agreement consummated simultaneously with the incorporation and organization of Pennroad on April 24, 1929. The underwriting agreement provided that Kuhn Loeb should purchase 250,000 shares of the initial offering upon condition that 85% of the issue be subscribed by others.They were also granted an option to purchase 500,000 shares on or before July 1, 1932, in units of 125,000 shares at $16 to $19 per share. Total shares issued at that time were 6,050,000, and proceeds of $91,125,000. Kuhn Loeb took substantially all of its allotment at the times and prices fixed, during part of which time like certificates were being sold on the open market at upwards of $30, enabling them to resell their holdings at a profit.

 On May 2, 1929 when certificates were selling on a "when issued" basis at $22, certain directors and officers of Pennsylvania were afforded the privilege of designating persons not Pennsylvania Railroad stockholders to whom an opportunity might be given to subscribe for Pennroad certificates at $15, to the extent of 100,000 shares. The directors and officers of the Pennsylvania submitted a list of names of subscribers including important officials and a number of important shippers. Mr. County declared "they were good traffic producers. They were friends. They were located right on the railroad." The preferred list subscribers were, however, finally limited to 23,963 shares because the volume of other subscriptions left only that number available. Some of the persons on the list refused to accept their reduced allotment, having sold their shares short, and thereafter Pennroad was induced to pay $22,255 to such persons in settlement of the losses they had sustained.

 Prior to May 20, 1929, Pennroad had received no funds from the issuance of its stock. Meanwhile operations were financed by a loan of $500,000 effected on April 27, 1929 by the officers of Pennroad on a note without security and without prior authorization by the board of directors. The loan, however, was ratified by the board on April 29, 1929. The board also authorized the officers to borrow other large sums from banks identified as depositories of Pennsylvania, $15,000,000 of which was borrowed on April 29, 1929, without endorsements or collateral to enable Pennroad to make payment in that amount on account of the purchase of Detroit, Toledo & Ironton securities in accordance with the prior understanding had between the officials of Pennsylvania and Edsel Ford on March 22, 1929.

 The facts, circumstances and elements entering into the formation of Pennroad are claimed by the defendants to establish a wholly independent investment corporation for the acts of which Pennsylvania Railroad is in no way responsible. The plaintiffs insist that it was an agency, adjunct or instrumentality of Pennsylvania Railroad designed and operated by Pennsylvania Railroad and its directors to serve the interest of the railroad, that it functioned as such and that the losses resulting to Pennroad investors must be charged to Pennsylvania Railroad. The collateral plans, negotiations, conferences and understandings between the parties involved are important to a full appreciation of the problem and the relationship between Pennsylvania Railroad and the Pennroad.

 It is significant that the three voting trustees were members of the Pennsylvania's finance committee and of its special committee on railroad consolidation, and that under the voting trust holders of trust certificates after once accepting the trustees, were precluded for a period of at least ten years from taking part in its management; nor could the agreement be amended or terminated by the voting trust certificate holders for such period. The purpose of this trust arrangement as explained by Mr. County was "for the protection of the company and to prevent losing control." This purpose was recognized by Mr. Percival Roberts, a Pennsylvania director, as a means whereby "the interests of the Pennsylvania Railroad may be protected" as indicated in his letter to Pennsylvania Railroad President Atterbury dated April 25, 1929, following the organization meeting. To this, Mr. Atterbury replied that "the voting trust * * * can be only for ten years, but before that time comes we can get some additional protection, such as convertible preferred stock, through which suitable control may be longer retained." From such statements it may be found that the purpose of the voting trust was to insure that for at least ten years the Pennsylvania Railroad could maintain control of Pennroad through the loyalty of its designated trustees and that Pennroad investors would be subjected to the will of trustee and directors owing their appointment and election to Pennsylvania. The only difference of opinion among the directors of Pennsylvania Railroad was as to the efficiency of the means of accomplishing that very purpose.

 The plans of the officials responsible for the formation of Pennroad also included and provided for the designation and election of its directors and officers prior to the organization of the company. All of its original directors were officers or directors of Pennsylvania. General Atterbury was the chief executive, and Mr. County second principal executive of Pennsylvania, and were in a dominating position as members of the board of Pennroad. Messrs. Atterbury and County had long been in the services of and were paid by Pennsylvania. Messrs. Lee, president, and Ogden, treasurer, owed their appointments to their superior officials of the Pennsylvania with whom they had served for many years. Mr. Ogden was not consulted nor was he informed that he was to become Vice President of Pennroad until after his election. Judge Heiserman, vice president and general counsel of Pennsylvania, acted in the capacity of general counsel for Pennroad from the time of its organization, although he received no compensation as such until his retirement from Pennsylvania Railroad in 1932. After his retirement, his allegiance to the Pennsylvania continued inasmuch as he thereafter served as its special counsel at an annual salary. Judge Heiserman said that Pennroad "was at that time supposed to be a cooperative venture. Pennsylvania Railroad people organized it, certain officers organized the Pennroad Corporation, and as counsel for the Pennsylvania Railroad I was called from time to time to attend to any legal matters for the Pennroad Corporation just as other officers were * * *." "I was paid by the Pennsylvania Railroad and whatever I did for the Pennroad Company * * * was without pay from the Pennroad Corporation." The question naturally arises whether Pennroad, as an alleged "independent" corporation could actually be such under this arrangement.

 The interlocking relationship of officers and directors was so set up that it had all of the potentialities of domination and control. Whether these directors and officers did or could insulate themselves from consideration of Pennsylvania's welfare as their primary objective and whether they acted wholly in the interest of Pennroad must be judged in the light of normal human experience. In view of the leadership by General Atterbury and Mr. County and acquiescence in that leadership by the others, it seems there is a clear inference of domination by the chief executive officers of Pennsylvania over the other directors and officers of Pennroad. The record indicates that those officers of Pennsylvania conceived the plan and designed the organization in the course of and fulfillment of their duties to Pennsylvania Railroad and that a large number of Pennsylvania directors received their first knowledge of Pennroad from the newspapers on April 25, 1929. Mr. Percival Roberts, long a Pennsylvania director, criticized the speed and secrecy surrounding the organization of Pennroad by the Pennsylvania Railroad officers and directors in two letters. He pointed out to President Atterbury at the outset the inherent conflict of interests between the Pennsylvania in its managerial control of Pennroad, and the interests of Pennroad certificate holders, and recognized that the voting trust was adopted in order that "the interests of the Pennsylvania Railroad may be protected", because of the "necessity or desirability of expansion at this time to preserve the integrity of the Pennsylvania property." He questioned "the ability of the proposed instrumentality to accomplish its intended purpose" and made it clear that the representation of Pennroad as an independent instrumentality had no basis in fact. Mr. Roberts expressed the belief that the independence of such instrumentality would not long remain under the voting trust setup, and that if a conflict of interest should arise between the management and certificate holders, the courts would in all probability sustain the stockholders. Referring to the directors' meeting of April 24, 1929, he declared "frankly I am disappointed that such a situation arose as we had yesterday. For a large number of your directors to obtain their first information concerning the organization of so important a project as the proposed Pennroad Corporation from a reasonably correct detailed report in the public press savors too strongly of the rubber stamp to be palatable. * * *"

 "The proposed corporation is separate and distinct from Pennsylvania Railroad, but organized for the purpose of enabling investments to be made for the benefit of the latter company, which it cannot legally accomplish in its own name * * * that the interests of the Pennsylvania Railroad may be protected, a voting trust is proposed for a period of ten years, the first trustees nominated being officials of the Pennsylvania Railroad Company. * * *

 "If the purposes of the company are of a temporary nature so that the company's assets can be distributed and the corporation dissolved prior to the termination of the voting trust, well and good, but suppose * * * the voting trust is terminated and the shareholders of the Pennroad Corporation take over the management of their property without regard to the interests of the Pennsylvania Railroad Company." Mr. Roberts further declared, "I make no criticism as to the necessity or desirability of expansion at this time to preserve the integrity of the Pennsylvania property. I only question the ability of the proposed instrumentality to accomplish the intended purpose. * * * Your directors are of the opinion that such an independent instrumentality is needed to protect your interests and those of your company * * * and in order to insure continuity of management, all of the stock now being issued will be placed in the voting trust. * * *"

 These expressions confirm the impression that the promotion was primarily undertaken by and on behalf of Pennsylvania Railroad and that its officers did not proceed in ignorance of the dangerous possibilities. The chief executives were put on notice that there was a fundamental vice in the scheme, and that their object of obtaining control of railroad properties by such means for the benefit of the Pennsylvania could not be attained without the sacrifice of the conflicting interests of the Pennroad and its certificate holders.

 The defendants have, throughout the litigation, insisted that a distinction be made between the Pennsylvania Railroad and the stockholders of Pennsylvania Railroad, and that an important difference exists between serving the purposes of the stockholders and serving the purposes of the railroad so far as the legal effect of the actions here involved are concerned. The evidence, however, shows beyond doubt that members of the governing board and official management of Pennsylvania Railroad had recognized the necessity and conceived the plan of expanding the realm of the Pennsylvania Railroad which included as an essential element the organization of Pennroad. That the Pennroad was created as an instrumentality to achieve the desired ends sought by the railroad is confirmed by the Pennsylvania Railroad's letter to stockholders advising them of the conclusion reached by their directors that a material advantage to their company and its stockholders would result from the formation of Pennroad with the view to making investments not legally possible under the limitations imposed upon railroads. The opinion was further expressed in the letter that such corporation was an independent instrumentality necessary to protect the interests of the stockholders and the railroad in the matter of railroad investments.

 It seems obvious therefore that the Pennroad was designed and organized primarily to serve such purpose of the Pennsylvania Railroad, which was in effect the parent company, in spite of the fact that it had no financial investment in Pennroad. The benefit was intended to be derived through a purported independent instrumentality but which was in fact a creature of Pennsylvania Railroad whose operations would be carried on in violation of the national policy of Congress as embodied in the Transportation Act. It was designed to be used by Pennsylvania Railroad to circumvent the jurisdiction of the Interstate Commerce Commission and in effect nullify the system of railroad regulations established under the legislative acts of the Congress.

 Pennsylvania Railroad was in a position to dominate Pennroad as completely as it was able to control its wholly-owned subsidiary, Pennsylvania Company. By reason of the voting trust arrangement, the interlocking directorates, the designation of official and subordinate personnel and their long history of loyalty to Pennsylvania Railroad service and purpose out of which the plan evolved, Pennsylvania Railroad was given, as a practical if not technical matter, full and complete power over the policies, investments and other acts of the Pennroad Corporation. The exercise of such control is demonstrated in many instances and particularly in several transactions not complained of in this suit. In the matter of Universal Fruit Company, Pennroad, at the suggestion of the railroad officials who were also directors of Pennroad, made two loans without prior authorization of the board, the acknowledged purpose of which was to benefit the railroad by accommodating its shippers in the interest of retaining their good will and freight business while the risk was borne entirely by Pennroad. A like accommodation was granted by Pennroad to the Gerrard Company for the same purpose, and when the loan went bad it was taken over by a Pennsylvania Railroad wholly-owned subsidiary. Pennroad also purchased Raritan Railroad stock at $150 per share. It was acknowledged that Raritan constituted a valuable feeder line to Pennsylvania Railroad, which had been the subject of negotiations for purchase by Pennsylvania Railroad, that the purchase was made to improve Pennsylvania Railroad's competitive and consolidation position and that Pennroad intended to sell its interest therein to Pennsylvania Railroad. This purpose was not accomplished, however, because the Central Railroad of New Jersey bought the controlling interest in Raritan and blocked Pennsylvania Railroad's plan to obtain control. Pennroad's holdings of Raritan stock were sold to other purchasers at a profit, but it is believed that these transactions clearly demonstrate the actual operation of Pennroad in the interest of Pennsylvania Railroad without regard to the risks involved, and that Pennroad was actually an operating instrumentality of Pennsylvania Railroad and not independent in any accepted sense of the term.

 The matters which more clearly than all others typify and characterize the relationship that existed demonstrate the potential and actual domination and control, the plans and purposes of Pennsylvania Railroad, and the fact that Pennroad was not an independent investment project but merely an agency or instrumentality of Pennsylvania Railroad, are the National Freight transactions.

 It is charged that Pennsylvania Railroad caused and induced Pennroad to engage in the forwarding business for the Pennsylvania Railroad upon the advice of the railroad officials; that the forwarding company had been originally planned and designed to meet the freight traffic problem which then confronted the railroad and that the forwarding company was organized and did operate wholly as a subsidiary of Pennsylvania Railroad. As a result its operation was at the sole cost, risk and loss of Pennroad, while at the same time Pennsylvania Railroad enjoyed the benefits of the freight traffic produced and the rentals of its facilities. It is contended that the forwarding company promotion and operation constituted a fraud upon Pennroad and its certificate holders in that they were conceived and carried out in reckless and wanton disregard of Pennsylvania Railroad's duties and obligations as a fiduciary and that the individual defendants participated in its perpetration.Defendants' denial of the charges rests solely upon the contention that the freight forwarding project held prospects of profit to the Pennroad and its certificate holders which justified the venture as an independent investment of Pennroad in a promising field of business.

 In the spring of 1929, Pennsylvania Railroad management had become convinced that a crucial condition then existed with the "less than carload" traffic business of the railroad. The chief executive believed it indispensible for the railroad to own or control a freight forwarding company which would operate in the Pennsylvania Railroad territory. The problem had become urgent because the New York Central had acquired a controlling interest in U.S. Freight Company which carried with it the control of the Universal Freight and thereby disrupted the plans of Pennsylvania Railroad for a national cooperative forwarding company. They deemed it essential to immediately put into the field a forwarding company operating under the auspices of Pennsylvania Railroad in order to offset the competition of New York Central operating through Universal Freight and to forestall the prospective competition of other forwarding companies operating with other railroad lines.

 On May 13, 1929, Vice President Deasy in charge of operations of Pennsylvania Railroad at the instance of Mr. Clement proposed a plan for getting the railroad into the forwarding business by suggesting that a company be formed to purchase forwarding companies not associated with the U.S. Freight, and that it be financed by the sale of stock to railroads having a common interest. After further consideration of the plan and necessities, Mr. County on May 28, 1929, asked Mr. Clement to have a study made of the problem with the view to taking action immediately if the forwarding companies in the territory would not cooperate or if the prices asked for interest of such concerns continued to be excessive. On June 6, 1929, Mr. Clement submitted the outlines of a plan for the formation of a new forwarding company to be formed and financed by Pennsylvania Railroad. It stated that the railroad departments interested had agreed upon the name National Freight Company and contemplated that the Pennsylvania Railroad through its subsidiaries or affiliates should own all of the stock representing an anticipated capital requirement of about $800,000.

 This plan had of course come to the attention of Pennsylvania Railroad's general counsel, whereupon Mr. County received a specific direction that the Pennsylvania Railroad must be kept out of the freight forwarding business until the way was clear with the Interstate Commerce Commission. The subsidiary, Pennsylvania Company, was likewise disqualified to act and a substitute was sought. Messrs. Atterbury, County and Deasy, however, believed that means could be found to meet the legal obstacles and to enable the railroad to organize, direct and control a freight forwarding enterprise. Mr. County proposed to Mr. Atterbury, and it was agreed, that Pennroad should take over the freight forwarding program instead of Pennsylvania Railroad or ...


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