American Surety Co. v. First Nat. Bank

• Decision Date: 09 March 1944
• Docket Number: No. 5191.,5191.
• Parties: AMERICAN SURETY CO. OF NEW YORK v. FIRST NAT. BANK IN WEST UNION, W. VA.
• Court: U.S. Court of Appeals — Fourth Circuit

141 F.2d 411 (1944)

AMERICAN SURETY CO. OF NEW YORK v. FIRST NAT. BANK IN WEST UNION, W. VA.

No. 5191.

Circuit Court of Appeals, Fourth Circuit.

March 9, 1944.

Walter Higgins, of New York City (Robert R. Wilson, of Clarksburg, W. Va., and Royal F. Shepard, of New York City, on the brief), for appellant.

Samuel A. Powell, of Harrisville, W.Va., for appellee.

Before PARKER and DOBIE, Circuit Judges, and WYCHE, District Judge.

PARKER, Circuit Judge.

This is an appeal from a judgment for defendant in an action instituted against a bank to recover on account of loss of funds of a bankrupt estate misappropriated by a trustee in bankruptcy. Plaintiff is the surety on the trustee's bond and holds by assignment all rights of the bankrupt estate as against the bank. The bank, which was not a designated depository of bankruptcy funds, allowed the trustee to deposit to his individual account certain checks belonging to the bankrupt estate and withdraw the fund so created by checks given for personal purposes. It also received from him certain other checks, payable to him as trustee, for which it paid him in cash. The case was heard by the judge without a jury; and from adverse findings and judgment, the plaintiff has appealed.

The facts are practically undisputed. The trustee was a young lawyer with an apparently flourishing law business in a small town in rural West Virginia. Since 1934 he had maintained a personal account in defendant bank, which was not designated as a depository of bankruptcy funds. In 1934 he was appointed trustee of the estate of one Eli Nutter, bankrupt, and ordinarily thereafter deposited funds belonging to the estate in a Clarksburg bank which had been designated as a depository. On or about August 27, 1937, however, he received from the Pittsburgh-West Virginia Gas Company six checks totaling the sum of $4,050, representing gas royalties due the estate, all of which were payable to him as "trustee in bankruptcy of Eli Nutter," and all of which he indorsed as trustee in bankruptcy and deposited to his personal credit in his personal account with the defendant bank.

At the time of this deposit, the trustee had no balance whatever to his credit in his account with the bank and had not had such balance for ten days or more. The deposit was not an ordinary one, but was four times as large as any that had theretofore been made in that account and stood out in sharp contrast with the other deposits, which were for very much smaller sums, only two other deposits in the history of the account being for as much as $1,000. On the day following the deposit, he drew a check against it in the sum of $701 in repayment of another fund which he had embezzled, and the remainder of the deposit was gradually checked out by checks drawn against it by the trustee and his wife until on December 6, 1937 the credit balance was entirely exhausted. During this period only one deposit had been made in the account, a deposit of $33.80 on September 10th. The cashier of the bank had served in a bank designated as a bankruptcy depository and was familiar with the limitations applying to the deposit and withdrawal of bankruptcy funds.

During the period that this deposit was being checked out by the trustee, he received checks aggregating the sum of $600, payable to him as trustee in bankruptcy of Nutter, and checks aggregating $193.62, payable to him simply as trustee, for all of which he received cash from the bank. None of these checks was deposited in the bank, however; and there is nothing in the evidence to indicate knowledge on the part of the bank's officers that any misappropriation of the proceeds by the trustee was intended.

The judge below was of opinion that there was no liability on the part of the bank either with respect to the checks cashed or those deposited in the personal account of the trustee, on the theory that, under the law as declared by the courts of West Virginia, it was essential to liability on the part of the bank that it should have participated in the misappropriation or with knowledge reaped some benefit therefrom, and that there was no evidence of such participation or benefit. The decision was based upon the decisions of the Supreme Court of Appeals of West Virginia in United States Fidelity & Guaranty Co. v. Home Bank, 77 W.Va. 665, 88 S.E. 109, and United States Fidelity & Guaranty Co. v. Hood, 122 W.Va. 157, 7 S.E.2d 872.

We would be in accord with the conclusions reached by the court below if the only principles here applicable were those controlling in the case of deposit and withdrawal of funds by an ordinary fiduciary, where nothing in the law forbids the deposit of the trust funds in the personal account of the trustee or in the bank in which the deposit is made. See our decision in Bank of Vass v. Arkenburgh, 4 Cir., 55 F.2d 130, and cases there cited. In such case the deposit does not of itself constitute a breach of trust on the part of the trustee of which the bank has notice. In the case of the deposit here involved, however, we think it clear that the deposit itself constituted a breach of trust on the part of the trustee of which the bank had ample notice, and that, upon the receipt of the deposit under such circumstances, the bank became a trustee ex maleficio of the amount so received and liable therefor as a trustee to the estate of the bankrupt. The rule applicable is that stated in A. L. I. Restatement of the Law of Trusts, sec. 324, Comment b, as follows:

"If a trustee commits a breach of trust in depositing trust funds in a bank and the bank when it receives the funds has notice of the breach of trust, the bank is liable for participation in the breach of trust, and is chargeable as a constructive trustee of the funds.

"Thus, if a bank receives on deposit funds which it knows are trust funds and which it knows that the trustee is forbidden by the terms of the trust to deposit in the bank, it is liable for participation in the breach of trust, and is chargeable as a constructive trustee of the funds deposited."

There can be no question, we think, that the trustee in bankruptcy was guilty of a breach of his trust in making a deposit of funds belonging to the estate in his private account in a bank not designated as a depository. By section 61 of the Bankruptcy Act, 11 U.S.C.A. § 101, it is provided that courts of bankruptcy "shall designate, by order, banking institutions as depositories for the money of bankrupt estates." By section 47 of the act, 11 U.S. C.A. § 75, it is made the duty of trustees to "deposit all money received by them in designated depositories" and to "disburse money only by check or draft on such depositories." And General Order No. 29, 11 U.S.C.A. following section 53, prescribed by the Supreme Court pursuant to the provisions of the act, provides that money may not be drawn from a depository except by check countersigned by the judge or referee in bankruptcy or upon order of the judge. It is perfectly clear that the purpose of these provisions was to protect the funds of bankrupt estates, not merely to designate banks in which trustees might deposit funds without incurring personal liability, and that their effect was to forbid the deposit of bankruptcy funds in a bank which is not a designated depository or in an account from which they can be drawn without the counter-signature required by the general order.

And it is equally clear, we think, that the bank took the deposit of bankruptcy funds not merely with notice, but with notice so full as to leave no doubt that there was actual knowledge on the part of the bank's officers of the breach of trust of which the trustee was guilty in making the deposit. The checks were payable to the trustee as "trustee in bankruptcy of Eli Nutter" and were so endorsed. The fact that they covered funds belonging to the bankrupt estate was thus not a mere matter of notation on the checks which the bank was without obligation to notice, but was incorporated as a limitation upon the right of the trustee to receive payment, of which the bank was bound to take notice in accepting the checks. The rule is established by the great weight of authority that "where there are words indicating a representative or fiduciary character following the name of a payee, indorser, or indorsee on commercial paper deposited in a bank, the bank is chargeable with notice of the trust character of the instrument." 7 Am.Jur. 373; A.L.I. Restatement of the Law of Trusts sec. 297 o; Note, 61 A.L.R. 1399 et seq. When to the fact that the checks were payable to the trustee in bankruptcy in his capacity as trustee is added the fact that the deposit was four times as great as any other made by the trustee in the entire history of his account, that the account had been exhausted at the time of the deposit, and that the bank was a small one with only four employees in a rural community, it is impossible to escape the conclusion that the bank had knowledge as well as notice that the deposit consisted of bankruptcy funds, which the trustee had no right to deposit except in an authorized depository. This is virtually admitted by the cashier in the following passage occurring in his testimony: "The Court: Mr. Freeman, as I understand your testimony, you testified at first that when these checks came in and you saw them, that you knew that they were bankruptcy funds, represented by the check. A. They indicated that they were bankruptcy funds." The cashier was an experienced banker and knew of the restrictions applicable to the deposit of bankruptcy funds. He testified that he thought that the restrictions would not prevent the acceptance by an unauthorized bank of bankruptcy funds provided they were deposited by the trustee to his personal account. He evidently overlooked the inherent breach of trust involved in such a deposit by the trustee. The safeguards so carefully erected for protecting the deposit and withdrawal of bankruptcy...