Kohn v. Sacramento Electric, Gas Ry. Co. , 168 Cal. 1 ( 1914 )

This is an appeal from a judgment in favor of the plaintiff and certain cross-complainants in an action based upon the bonds and interest coupons of the Sacramento Electric, Gas and Railway Company secured by a mortgage upon the real and personal property of said corporation. California Gas and Electric Corporation and Pacific Gas and Electric Company were made defendants because they successively acquired the interests of the Sacramento Electric, Gas and Railway Company, the California Gas and Electric Corporation having been also absorbed by the Pacific Company. The interests of the two respondent banks and of the plaintiff Mr. Kohn are practically identical, all depending upon possession and ownership of bonds and coupons. The Mercantile Trust Company appears as the successor of California Safe Deposit and Trust Company, an insolvent corporation, of which the Mercantile has become the trustee.

There is no substantial dispute regarding the facts. Sacramento Electric, Gas and Railway Company issued two thousand five hundred bonds of the par value of one thousand dollars each and they each had semi-annual interest coupons attached. Concurrently with the execution of these bonds and to secure their payment, the Sacramento Company executed and delivered to the California Safe Deposit and Trust Company a trust mortgage, hypothecating certain street railways, franchises, lands, and other property. Indorsed upon each of two thousand and seventy of these bonds bearing serial numbers from one to two thousand and seventy was a certificate by said California Safe Deposit and Trust Company that such bond was one of the aforesaid twenty-five hundred bonds secured by the mortgage therein mentioned. Pursuant to the provisions contained in said trust mortgage eighteen hundred and five of said bonds, bearing serial numbers from one to eighteen hundred and five were duly issued and sold. Two hundred and sixty-five of said bonds, bearing serial numbers from eighteen hundred and six to two thousand and seventy, both numbers included, were delivered to said California Safe Deposit and Trust Company, as trustee, upon a special trust for the purpose of retiring three hundred and fifteen outstanding bonds of the Central Electric Railway Company which had been absorbed by the Sacramento Company. J. Dalzell Brown, an officer of the California Safe Deposit and Trust Company, feloniously took sixty-five of these bonds from said corporation, and through the offices of Allen Griffiths obtained certain loans nominally for said Griffiths, but really for Brown's benefit. In this way twenty-five thousand dollars were paid by the plaintiff Isaack Kohn, upon the security of twenty-five of these bonds and coupons which Brown had thus dishonestly obtained. Twenty of the bonds were deposited with the Western National Bank of San Francisco to secure a loan of seventeen thousand five hundred dollars borrowed by Griffiths for and by direction of Brown, and the remaining twenty bonds were delivered to the Mutual Savings Bank as collateral security for another loan to Griffiths for Brown. None of this borrowed money ever was credited in any manner to the Sacramento Electric, Gas and Railway Company or to any of the appellants. When Mr. Kohn accepted the bonds from Griffiths he made no investigation regarding them except that he asked Griffiths if the bonds were his own or the property of a banking corporation of which Griffiths was an officer. Griffiths replied that the bonds were his own. Neither of the other respondents made any inquiry regarding the bonds at or before the time of taking said securities. To them Griffiths represented, as he did to Kohn, that he owned the bonds. To the respondents from time to time he paid interest upon the promissory notes which he had given them and received the coupons for accrued interest up to and including November 1, 1907. At the time this action was commenced there were due to the respondents from Griffiths upon his promissory notes the following sums: To respondent Kohn twenty-five thousand dollars with interest from October 22, 1907; to respondent Western National Bank twelve thousand five hundred dollars with interest from September 30, 1907; and to respondent Mutual Savings Bank fourteen thousand five hundred dollars with interest from October 29, 1907. About May 1, 1908, the respondents demanded payment upon the sixty-five bonds held by them as collateral security for the notes of Griffiths and payment was refused by the Sacramento Electric, Gas and Railway Company. In 1908 and before the commencement of this action Mercantile Trust Company of San Francisco was appointed trustee under the trust mortgage, succeeding California Safe Deposit and Trust Company which had been declared insolvent. In 1908 Sacramento Electric, Gas and Railway Company notified respondents that the bonds had been feloniously taken from the custody of the California Safe Deposit and Trust Company. The respondents proceeded to foreclose the pledges made by Griffiths and bought in the bonds themselves at the foreclosure sale. The court found, however, that they were pledgees, not owners. The court also found that "at all times mentioned herein, the bonds and coupons thereto attached, of the kind issued as aforesaid, by Sacramento Electric, Gas and Railway Company, when certified to by the trustee under the trust mortgage or deed of trust, are and were treated and dealt in as negotiable instruments by the mercantile world generally and more particularly by bankers and bond buyers and such is and has, at all times been the usage of the mercantile world in California"; that it was the intent of the Sacramento Electric, Gas and Railway Company that the bonds and coupons should be negotiable; that said corporation always so considered them; and that respondents had each acted with reliance upon the representations contained in the bonds and coupons and upon the said usage of the mercantile world. The superior court's conclusions of law were that the bonds are negotiable instruments; that respondents hold them as pledges subject to the amounts owed by Griffiths to respondents; that the Mercantile Trust Company is entitled to the possession of the said bonds subject only to the lien of the pledges upon which they are held by the respondents; that each of the appellants has the right to redeem the bonds by paying to respondents the amount still owed to the latter by Griffiths on his promissory notes; that respondents are entitled to the foreclosure of the trust mortgage to enforce payment of all coupons and bonds unless appellants shall exercise their right to redeem; and that appellants are entitled to judgment for the surrender and delivery of the sixty-five bonds and interest coupons upon effecting redemption from the said lien.

The bonds and coupons are upon their faces payable to bearer. It is set forth upon the bonds that the payment of principal and interest is secured by a mortgage, the date of which is given, and the names of the mortgagor and the trustee are given as well as a general reference to the mortgaged property. Each bond also contains the following statement: "This bond is issued subject to all the provisions contained in said mortgage." The bond contains a provision that upon default in the payment of interest or default in the payment of taxes or of any agreement or promise set forth in the mortgage, if such default or defaults continue for the time specified in the mortgage, the principal of the bond shall at the option of the trustee or the holders of a majority of the outstanding bonds become immediately due and payable. By the terms of the mortgage itself similar optional rights of declaring the principal due, after default, are given and the mortgage gives to the holders of eighty per cent of the outstanding bonds the optional right to waive "any default on the part of the Electric Company."

It is the contention of appellants that the bonds, being supported by a mortgage containing conditions not certain of fulfillment and notice of the mortgage and its conditions appearing upon the bonds and coupons themselves, the bonds are not and cannot be negotiable instruments. In other words appellants rely upon the rule announced in Meyer v. Weber,133 Cal. 685, [65 P. 1110], and emphasized in later decisions, notably National Hardwood Co. v. Sherwood, 165 Cal. 5, [130 P. 881], that a note secured by a mortgage on land, both being executed at the same time as part of one transaction, is not negotiable in law, even if negotiable in form, where the purchaser takes it with knowledge of the existence of the mortgage. It is the belief of counsel for appellants that bonds come under the same rule. Both promissory notes and bonds are listed by the code as among the six classes of negotiable instruments (Civ. Code, sec. 3095), yet a promissory note loses its negotiability when conditions not certain of fulfillment are introduced into it. (Civ. Code, sec. 3088) There is no essential difference between the two kinds of instruments and we see no escape from the logic of the position of appellants that a bond like a note, if dependent upon a mortgage, is subject to all equitable defenses against a holder with notice. The bonds sued upon are payable not upon the general credit of the maker (Civ. Code, sec. 3088), but out of a specific fund, for it is provided that neither the trustee nor any bondholder shall have recourse to any personal, statutory, or constitutional liability against any stockholder, director, or officer of the Sacramento Electric, Gas and Railway Company; that the trustee or bondholder shall look for payment "solely to the corporate assets and franchises of the mortgagor"; and that these assets shall not embrace claims enforceable by creditors, a receiver or the mortgagor itself against a stockholder, director, or officer of that corporation or against a stockholder by reason of any alleged insufficiency in the payment for shares of stock. Such provisions are at war with the idea of negotiability. It is argued that this part of the contract absolving stockholders from individual liability is unconstitutional, but we are of the opinion that a stockholder's liability may be waived by contract.(Wells v. Black, 117 Cal. 161, [59 Am. St. Rep. 162, 37 L.R.A. 619, 48 P. 1090].)

It is argued that bonds have been so long treated as negotiable instruments that the courts must respect the custom of the country and must make the letter of the statutes bend to it. Custom is often very important, it is true, in assisting courts to interpret statutes properly, but it never overcomes the positive provisions of statutes. Section 3093 of the Civil Code provides that a negotiable instrument must not contain any contract other than such as are permitted by the sections of title XV, chapter I, article I of that code. The bonds here considered are not negotiable under the law merchant in view of that test. There are many expressions in statutes and opinions to the effect that bonds are now generally treated as negotiable instruments, but many of these statements have reference to the abolition of the old distinction between sealed and unsealed instruments. In Comstock v. Breed, 12 Cal. 288, it was declared that the old unmeaning distinction between sealed and unsealed instruments had been determined by statute and that it was "the design of the legislature to place bonds and notes on the same footing in respect to defenses." It is true that the old common law rule with reference to assignability of things in action has long since been abrogated and has been succeeded by one more liberal which, while it permits securities to pass from hand to hand in business transactions does not make them negotiable to the extent of cutting off the equities of their makers. Section 1459 of the Civil Code thus formulates the modern rule: "A non-negotiable written contract for the payment of money or personal property may be transferred by indorsement, in like manner with negotiable instruments. Such indorsement shall transfer all the rights of the assignor under the instrument to the assignee, subject to all equities and defenses existing in favor of the maker at the time of the indorsement." Certificates of mining stock and controller's warrants pass readily from hand to hand by assignment, yet the transferee takes them subject to all legal and equitable defenses. (Barstow v. The Savage Mining Co.,64 Cal. 392, [49 Am. Rep. 705, 1 P. 349]; Craig v. Hesperia Landand Water Co., 113 Cal. 13, [54 Am. St. Rep. 316, 35 L.R.A. 306, 45 P. 10]; National Bank of D.O. Mills Co. v. Herold, 74 Cal. 606, [5 Am. St. Rep. 476, 16 P. 507]; Wall v. Monroe,103 U.S. 77, [26 L. Ed. 430].) It has been decided by the supreme court of the United States that purchasers of municipal bonds are bound to take notice of all of the recitals therein. (McClure v. Townshipof Oxford, 94 U.S. 432, [24 L. Ed. 129].) There seems to be no good reason why bonds should be placed in a class governed by different principles than those applicable to notes.

Counsel for the appellants cite with confidence the case ofMcClelland v. Norfolk Southern R.R. Co., 110 N.Y. 471, [6 Am. St. Rep. 397, 1 L.R.A. 299, 18 N.E. 237]. That case greatly resembled the one at bar. It was a suit on certain coupons to which an equitable defense was interposed. The bonds from which the coupons were cut showed that they depended upon a certain mortgage and the mortgage contained provision for declaring the principal of the bonds due in case of certain defaults, or for postponing all payments of interest or waiving any default upon the option of a majority in interest of the holders of the bonds. The court stated the general rule that bonds payable to bearer are deemed negotiable, but declared that when such instruments contain special stipulations and the payment of them is subject to contingencies not within the control of the holders, they lose their character as negotiable instruments and are open to any defense existing as between the original parties to the instrument. With the reasoning of the opinion in that case we fully agree. Respondents insist that the later case of Hibbs v.Brown, 190 N.Y. 172, [82 N.E. 1108], virtually overruledMcClelland v. Norfolk Southern R.R. Co., but an examination of that case shows that it is not at all in conflict with the earlier decision. It was held that the authorization in the mortgage for the waiver of default in the payment of interest coupons only related to and controlled procedure under the trust indenture itself for the purpose of enforcing payment of coupons and did not for any other purpose work or permit a postponement of the time of payment. It was also held in that case that the bonds had been issued upon the general credit of the corporation and that the exemption of the stockholders from individual liability did not render the other assets of the corporation a special fund and thus make the bonds non-negotiable. That case also announces the rule that courts may not override the terms of a statute when finally interpreted, and we feel committed to the interpretation of the pertinent sections of the Civil Code as given in Meyer v. Weber, 133 Cal. 685, [65 P. 1110]; NationalHardwood Co. v. Sherwood, 165 Cal. 1, [130 P. 881], and Taylor v. Jones, 165 Cal. 108, 111, [131 P. 114].

If the bonds had been stolen from the vaults of the Sacramento Company and negotiated, that company would have a complete defense against the holder. But respondents insist that, having intrusted the California Safe Deposit and Trust Company with the bonds under circumstances clothing that company with apparent power of complete disposition thereof, the Sacramento Electric, Gas and Railway Company is estopped to deny the authority of an officer of that company to dispose of them. There are many authorities supporting the doctrine that where one of two innocent persons must suffer the loss should be borne by the one whose conduct made possible the fraud or crime by which the other was deceived. The very recent case of National Safe Deposit andTrust Co. v. Hibbs, 229 U.S. 391, [57 L. Ed. 1241, 33 Sup. Ct. Rep. 818], is cited in that behalf. In that case Meyers, a trusted employee of the Safe Deposit Company, with the consent of that corporation, obtained certain stock certificates which had been deposited by one Kelley as collateral security for a loan. Each certificate contained an assignment with power of attorney to transfer the stock upon the books of the company. This was signed by Kelley, whose signature was duly attested. It was customary, in the usual course of business, for Myers to procure from one of the officers of the bank and to deliver to any customer paying a loan the collateral security pledged for such loan. At his own request he obtained possession of the certificates belonging to Kelley and by means of the assignment in blank sold them through the offices of a broker, to Hibbs. The pledgee sued the latter and the supreme court of the United States held that the loss should not fall upon the purchaser in good faith. In that case, however, the court found that the broker obtained the certificates "with all the indicia of ownership" from one "who had possession with the bank's consent and who brought the certificates to him apparently clothed with the full ownership thereof." After discussing the principle that an instrument indorsed in blank and stolen before it had been transferred would be taken subject to the equities, Mr. Justice Day, who handed down the opinion of the court, used this language: "The qualification of the rule, as not applying when the instrument is stolen, is not based upon the name of the agent's crime, but upon the fact that, in the ordinary and typical case of theft, the owner has not intrusted the agent with the document, and therefore is not considered to have done enough to be estopped as against a purchaser in good faith. He certainly has not done enough if the estoppel is based upon the principle that, when one of two innocent persons is to suffer, the sufferer should be the one whose confidence put into the hands of the wrongdoer the means of doing the wrong. But in the case like the present, the agent has been intrusted with the converted property, and it is totally immaterial whether, by a stretch which extends largely beyond the true field of trespass, his wrong has been brought within the criminal law or not. The ground of the estoppel is present, and the estoppel arises. The distinction is not new. On the one side are cases like Knox v.Eden Musee American Co., 148 N.Y. 441, [31 L.R.A. 779, 51 Am. St. Rep. 700, 42 N.E. 988], where an agent or servant simply hadaccess to a document remaining in the possession of the owner; on the other cases like Pennsylvania R. Co.'s Appeal, 86 Pa. 80, where possession is intrusted to the agent for one purpose and he uses it for another. It cannot matter in the latter class that the agent intended the fraud from the outset." In the case at bar Brown was not intrusted with these special bonds. The California Safe Deposit and Trust Company was the trustee. True, Brown was an officer of that corporation, but he did not take the bonds with the consent either of the bank or the Electric Company. Neither did the bonds bear "every evidence of title and transferability upon them," but they bore the recitals that they were secured by a mortgage and subject to all the provisions of said mortgage. The purchaser was thus put upon his inquiry. If he had made some investigation and had been informed by the Electric Company that Brown was clothed with full power to act for that corporation he might then invoke the rule that the more negligent of two innocent persons must suffer for the wrongful act of a third. (Civ. Code, sec. 3543; Helmer v. Parsons, 18 Cal.App. 452 [123 P. 356].)

This distinction is well settled in California. One of the leading cases on the subject is Barstow v. Savage Mining Co.,64 Cal. 389, [49 Am. Rep. 705, 1 P. 349], in which it is held that a thief may not impart title to non-negotiable instruments like certificates of stock. It was there declared that the court was of the opinion "that the principle that the thief of the stolen property (it not being money or negotiable securities), can pass no title, should be maintained, unless the facts presented by a case should bring it within the law as stated in McNeil v. TenthNational Bank, 46 N.Y. 325, [7 Am. Rep. 341]: ``When the owner of property confers upon another an apparent title to or power of disposition over it, he is estopped from asserting his title as against an innocent third party who has dealt with the apparent owner in reference thereto, without knowledge of the claims of the true owner.'" (See, also, Swim v. Wilson, 90 Cal. 127, [25 Am. St. Rep. 110, 13 L.R.A. 605, 27 P. 33]; Coolidge v. Austin,22 Cal.App. 337, [134 P. 357].) Upon the facts in this case and under the authorities cited above we cannot see that respondents may avail themselves of the doctrine of estoppel.

No other alleged errors require particular attention except the contention that the intent of the payer was to make the bonds negotiable. There was some evidence regarding such intent, but it was not sufficient to nullify the terms of the instruments themselves. The fact that an officer of the company believed the bonds to be negotiable does not alter their terms, which were ample notice to all persons who might purchase any of the securities, that they were subject to all of the provisions of the mortgage.

The judgment is reversed.

Henshaw, J., and Lorigan, J., concurred.

Hearing in Bank denied.