American Surety Co. of N.Y. v. Clarke

Under the admitted facts a case of conventional subrogation, as distinguished from legal subrogation, is here presented. The appellant rests its claim of right to subrogation, pro tanto, to the claim of the county against the insolvent bank and its receiver, upon the conventional, or contractual, subrogation provided for by the express terms of the bond.

Stearns on Suretyship, third edition, section 260, andGrantham v. Nunn, 187 N.C. 394, 121 S.E. 662, clearly distinguish between legal subrogation and conventional subrogation. Under the former, given only upon equitable grounds, and without contract between the parties, subrogation to the creditor's securities is not allowed unless the debt has been paid in full. Such, however, is not the rule of subrogation where an agreement of the parties is involved and they have otherwise agreed. In other words, as the courts say, the doctrine of subrogation cannot be invoked to defeat contract obligations. Where they exist the contract obligations control. There is in such event conventional subrogation. (See, also, Journal Publishing Co. v.Barber, 165 N.C. 478, 81 S.E. 694; Harrison v. Harrison,149 Tenn. 601, 259 S.W. 906, 32 A.L.R. 563; Morrow v. UnitedStates Mortgage Co., 96 Ind. 21; Blue Island First SecuritiesCo. v. Irrgang, 252 Ill. App. 290.)

In 9 A.L.R. 1607, cited as an authority to sustain the decision in Harrison v. Harrison, supra, the author says that "where there is a conventional subrogation, resulting from an express agreement with the creditor to the effect that the security held by him shall be assigned to the person paying, or shall be kept alive for his benefit, it is no objection that it extends to a part only of the debt." This is stated as a distinct and recognized exception to the general rule of subrogation that a person is not entitled to be subrogated to the rights of a creditor until the claim of the creditor against the debtor has been paid in full.

Opposing counsel has very evidently relied upon the doctrine of legal subrogation to support, in part, his position in this case, overlooking, or disregarding, the fact that the doctrine of legal subrogation is not involved. Here reliance is placed by the appellant upon conventional subrogation only — not legal subrogation. To deny to the appellant the recovery here claimed would be to repudiate a contract that the parties made. Clearly, the reason back of the rule that, in proper conventional subrogation cases, payment of the creditor in full is not a condition precedent to recovery is found in the fact that parties may contract as they please, and that when they have done so courts will not interfere. Such is the situation in the case at bar.

It follows that the surety company is the legal owner of the claim presented against the receiver and for which the certificate of proof of claim was issued; and that, as such owner, it is a general creditor of the bank and entitled to sharepro rata with other general creditors in the distribution of the assets of the bank. In this connection attention should be called to the leading case of Merrill v. National Bank of Jacksonville,173 U.S. 131, 19 Sup. Ct. Rep. 360, 43 L. Ed. 640. There the court holds, in substance, that a secured creditor of an insolvent bank may prove and receive dividends upon the face of his claim, as it stood at the time of the declaration of insolvency, without crediting either his collaterals or collections made therefrom after such declaration, subject always to the proviso that dividends must cease when from them and from collateral realized the claim has been paid in full. The court declined to adopt the bankruptcy rule requiring the holder of collateral security to exhaust it and credit the proceeds on his claim, or else to surrender it, before proving his claim. The statute under consideration by the court there provides for ratable dividends. That rule should be applied in this case.

In Detroit Trust Co. v. State Bank of Michigan, 150 Mich. 530,114 N.W. 327, 329, the court says: "Nothing appears to be better settled by the decisions than that the effect, upon the creditor, of the taking over by the receiver of the general assets of the debtor is to substitute for the right of action,in personam, theretofore existing, a right to a proportional share of the impounded assets — a right to receive such a part thereof as its total proved demand bears to the total of all demands, unaffected by the fact that it holds security for a part or for all of its debt." (See, also, Corbett v. Joannes,125 Wis. 370, 104 N.W. 69; Findlay v. Hosmer, 2 Conn. 350;Hendrie v. Graham, 14 Colo. App. 13, 17, 59 P. 219; Matterof Bates, 118 Ill. 524, 9 N.E. 257, 59 Am. Rep. 383; Fishback v. Ambrose, 13 Ky. Law Rep. 303; Mead v. Randall, 68 Minn. 233,71 N.W. 31; Bank Commrs. v. Security Trust Co., 70 N.H. 536,542, 42 A. 113; Kellogg v. Miller, 22 Or. 406,30 P. 229, 29 Am. St. Rep. 618; Central Bank, etc., v. Jarrett,195 N.C. 798, 143 S.E. 827; Buttler v. Commonwealth Tobacco Co.,73 N.J. Eq. 205, 208, 67 A. 514; People v. E. Remington Sons, 121 N.Y. 328, 24 N.E. 793, 8 L.R.A. 458; Morris v.Olwine, 22 Pa. St. 441; Greene v. Jackson Bank,18 R.I. 779, 30 A. 963; Atlantic Phosphate Co. v. Law, 45 S.C. 606, 23 S.E. 955; Kauffman v. Hudson, 65 Tex. 716; Williams v.Overholt, 46 W. Va. 339, 33 S.E. 226; Putnam v. Russell,17 Vt. 54, 42 Am. Dec. 478; London etc. Bank v. Willamette etc.Co., 80 Fed. 226.)

In the light of the foregoing authorities a claim in a receivership, when secured by collateral and whether the collateral has been realized upon or not, is liquidated for the purpose of a dividend. Furthermore, the law, as declared supra, does not permit the court handling the receivership to make any distinction for the purposes of a dividend between secured and unsecured claims. The dividends must be paid ratably upon all claims whether secured or not. Appellant concedes that there can be no "legal" subrogation of a surety until the claim of the secured creditor is satisfied in full. But it contends that there may be a contractual or "conventional" subrogation before the creditor is paid in full and that under the terms of its bond to the county treasurer, approved by the board of county commissioners, there was such a contract between the county and itself as surety. This, of course, implies that a county, through its board of county commissioners, has the same freedom of contract as an individual, whereas such is not the case. The board is restricted by law and all who deal with it are chargeable with notice of such limitations upon its powers. This is well settled. (Franzke v.Fergus County, 76 Mont. 150, 245 P. 962; Judith Basin Countyex rel. Vralsted v. Livingston, 89 Mont. 438, 298 P. 356.)

Counsel for appellant say in their brief the reason back of the rule they contend for is "that parties may contract as they please, and that when they have done so courts will not interfere." That rule is undoubtedly correct as between private parties dealing with private rights and private property, but we submit that it is not correct as between public officials dealing with public rights and public property. "Conventional subrogation depends upon a lawful contract and occurs when one having no interest in or relation to the matter pays the debt of another and by agreement is entitled to the securities and rights of the creditor so paid." (25 R.C.L. 1312.)

Every case cited by appellant has to do with transactions between private parties. Public funds were not involved in any of them, and it is submitted, other reasons aside, that it would be against public policy to permit county commissioners to contract with any surety, individual or corporate, for subrogation to any part of the security for public funds until the public treasury is fully made good.

The bond given by appellant expressly provides for subrogation but, we submit, its provisions add nothing to the subrogation which the law gives, to-wit, the right to resort to securities held by the obligee after he has been fully paid. Any other construction does not "insure the safety and prompt payment of all such deposits" nor insure such payment at all, so that there should be read into the subrogation clause the proviso that the deposit shall be fully made good before any subrogation is allowable. If it is to be otherwise public funds deposited in banks are no more secure than private funds, and county commissioners may deal with public funds in that respect as if they were private funds. We urge that no such authority is found in the law and that county commissioners are not permitted to make so-called "conventional" subrogation contracts, whereby a surety company which undertakes to secure the safety of public funds may compete with the public treasury for reimbursement. There is nothing in the subrogation clause relied upon by appellant which expressly provides that it shall have subrogation before the debt to the county is paid in full, and where claim of such right is made "the contract should be so certain as to admit of no doubt on that question." (25 R.C.L. 1318.) Such a provision should not be put into the contract by implication, even though it be held that the county had the power to, and did regularly and lawfully make, and act under, such a contract.

It is submitted, too, that to hold that counties may make such a contract is "contrary to the policy of express law" (sec. 7553, Rev. Codes 1921) and decidedly inimical to the public welfare — affects it "adversely" (Simpson v. Silver Bow County,87 Mont. 83, 285 P. 195), in that it tends to impair the safety of the public revenue and losses incurred are reflected in increased taxation. This is an appeal by plaintiff, American Surety Company of New York, from a judgment in favor of the defendant, Clarke, receiver.

Being desirous of becoming a depositary of county funds, the Home State Bank of Manhattan, Montana, and the surety company executed a surety bond to W.D. Bell as county treasurer of Gallatin county, Montana, in the sum of $8,000. The bond contained these provisions, among others:

"Now, therefore, the condition of the above obligation is such that, if the above bounden principal shall in due course pay on legal demand made during the term of this bond, all moneys deposited hereunder with it for account of the obligee, together with interest at the rate agreed upon, then this obligation shall be null and void; otherwise to remain in full force and effect."

"Fifth: That in case of payment of a loss on account of a default hereunder the surety shall be subrogated to such proportion of all the rights of the obligee growing out of such loss, including dividends paid and to be paid out of the estate of the principal, as the amount so paid by the surety bears to the total deposit hereunder at the time of such default, and simultaneously with such payment the obligee shall execute all papers required by the surety and render all assistance, not pecuniary, to secure to the surety the rights herein provided for."

Pursuant to court action, on July 31, 1924, the bank was declared insolvent, and George K. Clarke was appointed its receiver. When the bank closed, the county treasurer had on deposit therein county funds in the sum of $20,804.34, for which the treasurer filed a claim in behalf of Gallatin county, and in due time a receiver's certificate of proof of the claim was issued to him. The deposit was secured by personal bonds in the aggregate sum of $15,500, in addition to the $8,000 surety bond, and also by collateral notes which were the property of the bank. When the case was tried, the treasurer had collected $4,179 only on account of the notes; he still held notes of the face value, without interest, of $9,046.14. The county has not been paid in full.

The surety company on demand paid to the county treasurer the penal sum of the bond, $8,000, but, by some arrangement which is not clear upon the record, the county treasurer paid back to the surety company the sum of $917.88. Thus the surety company actually paid the sum of $7,082.12 only. The original receiver's certificate, which was issued to the county treasurer for the claim of the county, was, at the request of the surety company, divided; the original certificate was canceled, and in lieu thereof two new certificates were issued, one for $13,668 and interest to the treasurer, and the other to the surety company for $7,054.89 and interest.

Whether material or not, during the negotiations between the representative of the surety company and the treasurer looking to the division of the certificate, the representative assured the treasurer that the surety company did not seek to take any advantage whatever under the new arrangement.

In 1928 the receiver was authorized by the court to pay to the general creditors a dividend of ten per cent. with a restriction which excluded the surety company from participating in the distribution. Thereafter the surety company asked and was granted leave to sue the receiver to test its right to share in the dividend under the terms of the receiver's certificate. Hence this suit.

Some questions of practice are presented, but we pass these in order to reach the main question.

Counsel for the plaintiff surety company recognize the rule that a surety may not claim subrogation against an insolvent debtor until the creditor is paid in full (Jenkins v. NationalSurety Co., 277 U.S. 258, 48 Sup. Ct. Rep. 445, 72 L. Ed. 874;Knaffl v. Knoxville Banking Trust Co., 133 Tenn. 655,182 S.W. 232, Ann. Cas. 1917C, 1181; 25 R.C.L. 1318; 60 C.J. 745), but assert that that rule applies to what they term legal subrogation, contending that plaintiff's claim rests upon conventional subrogation arising from the contractual provision (Fifth) in the bond. They quote from Stearns on Suretyship, third edition, section 260: "Conventional subrogation is the substitution of the surety in place of the creditor by agreement as distinguished from subrogation by operation of law where no such agreement is made. * * * Equitable subrogation cannot be enforced until the entire debt is paid, but conventional subrogation arises at such time, and for such part of the debt, as the parties in their agreement shall stipulate."

Under the doctrine of equitable subrogation, a pro tanto[1] assignment or subrogation will not be allowed. The reason is that subrogation is a creature of equity, and will never be allowed to the prejudice of the creditor. (Knaffl v. KnoxvilleBanking Trust Co., supra.) If subrogation pro tanto be allowed, it would operate to place the surety upon a footing of equality with the holders of the unpaid part of the debt; and, if the property be insufficient to pay the remainder of the debt for which the surety is bound, "the loss would logically fall proportionately upon the creditor and upon the surety. Such a result would be grossly inequitable." (25 R.C.L. 1318; NewJersey Midland R. Co. v. Wortendyke, 27 N.J. Eq. 658.)

In the absence of contract, it is clear that the plaintiff[2] would not be entitled to subrogation pro tanto, which brings us directly to the question whether the board of county commissioners had the authority to agree to the provisions of provision Fifth.

Section 4767, Revised Codes 1921, as amended by Chapter 89, section 1, Laws of 1923, provides in part that it shall be the duty of the county treasurer to deposit all public moneys in his possession and under his control in a solvent bank or banks located in his county, subject to national supervision or state examination, which the board of county commissioners of his county may designate, and no other. The treasurer shall take from such bank such security as the board of county commissioners "may prescribe, approve and deem fully sufficient and necessary to insure the safety and prompt payment of all such deposits on demand together with the interest thereon. Such securities shall consist of bonds of some surety company empowered to do business in the State of Montana, government bonds or securities, state bonds or warrants, county bonds or warrants, or such other bonds or securities which are supported by general public taxation, (or personal bonds). * * *"

The statute became part of the contract, and it must be held that the parties had it in contemplation when the bond was executed and delivered. (Home State Bank v. Swartz, 72 Mont. 425,234 P. 281.) "The applicable statute is as much a part of the bond as if expressly written into it." (State v. Rosman,84 Mont. 207, 274 P. 850, 852; Kelsey v. School District,84 Mont. 453, 276 P. 26; American Surety Co. v. Butler,86 Mont. 584, 284 P. 1011.)

The authority of the board of county commissioners rests upon statutory powers expressly granted or upon powers necessarily implied from those granted, and persons who deal with the board are charged with notice of its limitations. (Stange v. Esval,67 Mont. 301, 215 P. 807.)

Conceding that the language "such security as the board of[3, 4] county commissioners * * * may prescribe, approve and deem fully sufficient and necessary to insure the safety and prompt payment of all such deposits on demand together with the interest thereon," reposes in the county commissioners some discretionary power, the controlling purpose of the statute is expressed in the requirement that the security shall "insure the safety and prompt payment of all such deposits on demand."

It is not within the contemplation of the statute that the county commissioners may agree with a surety company which undertakes to secure the prompt payment of county funds deposited in a bank that upon the bank's failure, and before the county is paid in full, the surety company shall share with the county in dividends paid by the receiver of the insolvent bank. Such a course would decrease the county's dividends by the proportionate share received by the surety, and would affect adversely the public welfare, in that it would tend to impair the public revenue, eventually entailing increased taxation. This would be contrary to public policy. (State v. Gateway Mortuaries,87 Mont. 225, 287 P. 156, 68 A.L.R. 1512; Spaulding v.Maillet, 57 Mont. 318, 188 P. 377.)

The policy of the law commands that the board receive only such securities as will insure the safety and prompt payment of county deposits. Permitting conventional subrogation in such case would permit a surety company which undertakes to secure the safety of the public funds to compete with the public treasury for reimbursement; thus the plaintiff under provision Fifth would be enabled indirectly to avoid a part of its liability on the bond.

The principle which forbids a surety from securing by independent contract with the debtor indemnity at the expense of the creditor whose claim he has undertaken to secure forbids subrogation here before the creditor is paid in full. (Jenkins v. National Surety Co., supra; Knaffl v. Knoxville Banking Trust Co., supra; Olsness v. Baird, 52 N.D. 1. 201 N.W. 993;Maryland Casualty Co. v. Fouts, (C.C.A.) 11 F.2d 71, 46 A.L.R. 852; United States Fidelity Guaranty Co. v.Centropolis Bank, (C.C.A.) 17 F.2d 913, 53 A.L.R. 295.)

The judgment is affirmed.

ASSOCIATE JUSTICES ANGSTMAN, MATTHEWS, STEWART and ANDERSON concur.

Rehearing denied April 15, 1933.