New Jersey Title Guarantee & Trust Co. v. McGrath

This is the second appearance of this case in this court. SeeTitle Guarantee Trust Co. v. McGrath, 239 Mich. 404. There has again been a verdict directed for defendant, both parties having treated the case as presenting questions of law alone. We briefly dispose of the questions which do not go to the main questions. The court correctly held that Mr. Ward, who was associated with Mr. Reilley in the defense, but who had not formally entered his appearance, could participate in the trial. The trial court excluded testimony taken by deposition which should have been received, but as the ultimate facts are without dispute and control the propriety of the directed verdict, such rulings do not call for reversal.

Undisputed, the following facts appear: Defendant purchased of the Lynch Construction Company its stock, which had not been approved by the Michigan Securities Commission, and paid $500 by check and gave his 90-day note for $4,500 on June 9, 1923. The Lynch Construction Company indorsed the note, discounted it with plaintiff, and its account was credited with the proceeds; at no time before the maturity of the note was the company's account drawn down below the face of the note, but there was drawn from the account before maturity the amount of the balance on the date of purchase together with the face of the note; but many deposits were made and the balance kept at a substantial sum. When due, $1,000 was paid, and a renewal note for the balance was given, due in 90 days. The state of the account continued as before. When the renewal note fell due another $1,000 was paid and another renewal note was given for the balance. On December 31, 1923, before this note became due, the Construction company's account was overdrawn $960.91. Plaintiff had no actual knowledge of the consideration of the original note. It is conceded that the consideration of the original note failed; it was given for stock sold in violation of a penal statute, no stock was ever delivered to defendant, and the stock eventually proved to be worthless; in the hands of the Construction company or of one not a bona fide purchaser, the note was not enforceable. The question presented, therefore, is whether plaintiff under the facts stated is as matter of law a bona fide holder — a holder in due course.

Plaintiff's counsel do not controvert the rule that the passing of credit to the account of the payee of the note upon its discount does not alone make the plaintiff a holder in due course, that such credit must be exhausted before value has been paid. They do urge, however, that it is not necessary in order to make the bank a holder for value that the credit should be exhausted before the maturity of the note, but insist that, if exhausted at any time before the bank has actual knowledge of the equities of the parties, and irrespective of renewals or the number thereof, it is a holder in due course. Hence they insist that when the account of the Construction company was overdrawn on December 31, 1923, when they were holders of the second renewal note, that they became bona fide holders of this note. They also insist, and this is the main and most interesting question in the case, that we should adopt the rule of "first money in, first money out," and that inasmuch as the Construction company within a few days after the note was discounted withdrew more than its balance on the date of purchase plus the amount of the note, the payee had exhausted the account in contemplation of the law, although by new deposits its account had remained substantially static, and it was, therefore, a holder in due course.

National Bank of Commerce v. Armbruster, 42 Okla. 656 (142 P. 393), sustains the contention of plaintiff's counsel that withdrawal of the funds before the maturity of the note was not necessary in order to constitute plaintiff a bona fide holder. But this court has entertained the opposite view. Indeed, what was said when the case was here before and which made the law of the case, is to the contrary. It was there said by Chief Justice SHARPE, speaking for the court:

"If plaintiff discounted the note and credited the Lynch Construction Company's account with the proceeds, it was necessary, in view of the defense, for plaintiff to show that the Lynch Construction Company had exhausted that credit at the maturity of the note. Central Savings Bank v. Stotter,207 Mich. 329; Republic National Bank v. Bobo, 227 Mich. 6; 3 R. C. L. p. 1055.

"It being necessary for plaintiff to show the credit had been exhausted at the maturity of the note, in order to be abona fide holder for value, the question arises whether the manner in which plaintiff sought to show it was competent."

This was in consonance with the former holdings of the court. In Drovers' National Bank v. Blue, 110 Mich. 31 (64 Am. St. Rep. 327), it was held (quoting from the syllabus):

"A bank which discounts a note for a customer, crediting the proceeds thereof to his account, is not a bona fide purchaser for value, unless such credit was drawn upon before the maturity of the note, and before notice of facts invalidating it in the hands of the payee."

The same holding will be found in Central Savings Bank Trust Co. v. Stotter, 207 Mich. 329, where the headnote is in the identical language used in the Blue Case. Unless we disregard these holdings, or unless we accept plaintiff's contention on the main question, it must be here held that when the original note matured, plaintiff was not a holder of it in due course, was not a bona fide purchaser, and under the admitted facts could not recover on it. Plaintiff stood in the shoes of the payee only, and as he could not recover, neither could it. In Anderson v. Engard, 236 Mich. 221, it was held:

"It does not need the citation of authorities to demonstrate that as between the parties, as here, the same defenses are open to defendant in an action on the renewal note as would be open to him in an action brought on the original note."

Where the holder is not a bona fide holder, but has the rights and only the rights of the original payee, such holder is, of course, subject to this rule. It was not claimed in the court below and is not here claimed by plaintiff that the renewal notes were. given or received in payment of the earlier notes. Indeed, the contrary was and is claimed. It doubtless was obvious to plaintiff's counsel, as I think it should be to us, that it ought not to be held that the renewal notes were given in payment of prior notes and in discharge of the original obligation as concluded by Mr. Justice SHARPE, and at the same time and in the same breath to hold that they were not payment of the original notes, but that the original obligation continued unabated as concluded by the Chief Justice. Quite likely plaintiff's counsel concluded that he could not successfully urge both inconsistent positions, and it is also quite likely that he had read the opinion in Molsons Bank v.Berman, 224 Mich. 606 (35 A.L.R. 1289), and the authorities there cited. Be that as it may, he elected to urge the rule laid down by the Oklahoma court and did not urge the doctrine of payment. At some length plaintiff's counsel urge that the renewal notes were not payment, and this under the following head:

"Where a note is given merely in renewal of another note the renewal does not extinguish the original debt or in any way change the debt except by postponing the time for payment."

I do not think we should reverse the case on a question not urged by appellant either in the court below or here.

This brings us to the final contention of plaintiff, that we should adopt the rule of "first money in, first money out," and hold that the bank had paid value and become a holder in due course when its customer had checked out a sum equal to the balance on the date of discount plus the amount of the discounted note irrespective of the amount or state of the daily balances. Some States have adopted this rule:Fox v. Bank of Kansas City, 30 Kan. 441 (1 P. 789); FirstNational Bank v. McNairy, 122 Minn. 215 (142 N.W. 139); Bank v.McNair, 114 N.C. 335 (19 S.E. 361); First National Bank v.Court, 183 Wis. 203 (197 N.W. 798); Merchants' National Bank v.Santa Maria Sugar Co., 162 App. Div. 248 (147 N.Y. Supp. 498);Howells State Bank v. Hekrdle, 113 Neb. 561 (203 N.W. 1005). See notes, 6 A.L.R. 262, and 24 A.L.R. 901.

We have spent several days in independent research on this question. Most of the courts holding as plaintiff asks us to hold, to say the least, were obliged to modify their earlier views as embodied in their earlier decisions. The other cases in the main hark back to the Kansas case. The New York court seems to rely in part on Fredonia National Bank v. Tommei,131 Mich. 674, as so holding. That case does not so hold, nor does it even approximate such a holding. In that case the customer had completely exhausted the credit before the maturity of the note. This made the bank a holder for value. Its status, having been fixed, did not change because the customer deposited more money to the credit of his account. This was what was held and all that was held in that case. We shall not discuss the cases further. That work has been ably done by Chief Justice Anderson in National Bankof Commerce v. Morgan, 207 Ala. 65 (92 So. 10, 24 A.L.R. 897), in an exhaustive opinion which considers and discusses the cases, and concludes:

"While entertaining a most profound respect for the courts holding contrary to our conclusion, we think our position the more just and equitable, in view of the fact that a bank has the right to apply all unchecked-against deposits to the debts due it by the depositor. Morse on Banking, § 324; Lehman Bros. v. Tallassee Co., 64 Ala. (567) 595; Batson v. Alexander CityBank, 179 Ala. 490 (60 So. 313). This holding cannot, therefore, be of serious detriment to banks, while a contrary view might result in furnishing a weapon to the negotiator of notes and bills against their creditors or persons having a right or equity in or against the instruments so negotiated."

Does the due administration of the law require this court to modify its former holdings, to ingraft new exceptions on rules that for decades have worked out justice to litigants at this bar? Do not the present rules on this subject afford such ample protection for all parties dealing in commercial paper as to render their change at this late day undesirable? If a bank has paid value for a discounted note by means of the withdrawal of the payee's account, it is a bona fide purchaser and may recover on the note freed from defenses available against the payee. If the account has not been drawn down the bank has funds in its hands belonging to the payee and indorser which it may apply to the extinguishment of the indebtedness. Under the present rules on this subject, the payee who has obtained the discounted note by fraud or without consideration is the one upon whom the loss must fall, unless there is an actual sale with present payment. Under the proposed rule as a practical proposition, no defense can ever be successfully made upon a note which had been discounted at a bank, and the banks would unwittingly become clearance houses for the holders of fraudulent paper, for paper given without consideration and unenforceable between the parties or holders not in due course. We are not persuaded that we should accept the rule urged upon us by plaintiff. The language of the supreme court of Texas inVan Winkle Gin Co. v. Citizens' Bank, 89 Tex. 147 (33 S.W. 862), is quite pertinent. It was there said:

"But while the law protects the innocent holder at the expense of the negligent but innocent acceptor, it does not permit the former to use his vantage ground for the purpose of going beyond his protection and wilfully inflicting on the latter a wrong in order to favor the fraudulent indorser. * * *

"Whether the doctrine upon which the courts allow the innocent holder of commercial paper to recover against the negligent but innocent acceptor maker is based upon broad principles of public policy intended to foster commerce, or upon the principles of an equitable estoppel, or both, it is clear that it extends no further than is necessary to the complete protection of the innocent holder, and cannot be extended so as to allow such holder to pervert the equitable principles upon which it is based for the purpose of aiding one party to a commercial instrument in obtaining an undue advantage over another."

The judgment should be affirmed.

WIEST and McDONALD, JJ., concurred with FELLOWS, J.