Grace v. Sterling, Grace & Co.

• Decision Date: 30 April 1968
• Citation: 30 A.D.2d 61,289 N.Y.S.2d 632
• Parties: , 5 UCC Rep.Serv. 297 Lorraine G. GRACE, Plaintiff-Respondent-Appellant, v. STERLING, GRACE & COMPANY, Defendant-Appellant-Respondent, and the Cleveland Trust Company, Defendant-Respondent-Appellant.
• Court: New York Supreme Court — Appellate Division

Page 632

289 N.Y.S.2d 632

30 A.D.2d 61, 5 UCC Rep.Serv. 297

Lorraine G. GRACE, Plaintiff-Respondent-Appellant, v. STERLING, GRACE & COMPANY, Defendant-Appellant-Respondent, and the Cleveland Trust Company,

Defendant-Respondent-Appellant.

Supreme Court, Appellate Division, First Department.

April 30, 1968.

Louis P. Neustein, New York City, of counsel (Neustein & Kraut, New York City), for appellant Lorraine G. Grace.

Sydney J. Schwartz, New York City, for appellant Sterling, Grace & Company.

John F. Cannon, New York City, of counsel (Robert P. Borsody, New York City, on the brief; Sullivan & Cromwell, New York City), for appellant The Cleveland Trust Company.

Before EAGER, J.P., and STEUER, CAPOZZOLI, McGIVERN and McNALLY, JJ.

EAGER, Justice Presiding.

This action was brought to recover damages for the loss sustained by the owner of certain convertible debentures by reason of a failure to convert them into stock prior to their redemption date, and all parties appeal from an order and judgment entered upon a determination of plaintiff's motion and defendants' cross motions for summary judgment.

Plaintiff was the owner of $25,000 4 1/4% Convertible bearer (coupon) debentures of Gardner-Denver Company due October 1, 1976. She was a customer of defendant Sterling, Grace & Company (Sterling), a copartnership (a stock broker), of which her husband was a member. On or shortly prior to December 21, 1962, the plaintiff pledged the Gardner-Denver debentures, together with other securities, to Sterling as security for an indebtedness owing by her. Shortly thereafter and pursuant to the authority of plaintiff, Sterling repledged the Gardner-Denver bonds along with other securities to defendant Cleveland Trust Company (Cleveland) as collateral security for a $550,000 loan to Sterling. Cleveland had made and did make other loans to Sterling, and the securities, which were held as collateral for all the several loans, were deposited by Cleveland with Irving Trust Company in New York City. Cleveland's banking office was in Cleveland, Ohio, and the custodian arrangement with Irving Trust Company was entered into for the purpose of enabling Sterling to readily substitute securities which were the subject of its pledges with Cleveland, such substitution, however, to be effected solely upon instructions from Cleveland. Incidentally, the custodian agreement between Irving Trust Company and Cleveland provided that the former would 'not endeavor to keep (Cleveland) informed of changes affecting the collateral, such as conversions, rights to subscribe, collection of dividends, etc.'

The said 1976 debentures of the Gardner-Denver Company contained provisions whereby they could be converted prior to redemption into common stock of the company. In August and September 1964, while the plaintiff was traveling abroad, the Gardner-Denver Company duly gave notice, with proper publication thereof, that the debentures would be called for redemption on October 1, 1964. The debentures were then in the possession of Cleveland, held by its custodian, Irving Trust Company. It appears that, if the debentures had on or shortly prior to such date been converted into common stock in accordance with the conversion privileges, the plaintiff would have received stock valued on the market at nearly twice the face value of the debentures. They were, however, not converted and the plaintiff accordingly sustained a substantial loss.

The plaintiff alleges that her damages were occasioned by the negligence of defendants Sterling and Cleveland and each of said defendants alleges a cross-claim for recovery over against the other.

Special Term held that, on the undisputed facts, Sterling had violated its duty as pledgee to exercise reasonable care with respect to the securities and awarded judgment against it in favor of plaintiff. This court unanimously concludes that the record as a matter of law supports the liability of Sterling.

Special Term held, however, that as a matter of law plaintiff had no cause of action against Cleveland, placing the holding upon the ground of lack of privity between her and such defendant as a sub-pledgee. The majority of this court does not agree with such holding.

Under the common law and by statutory provision, Cleveland, holding the debentures as a pledgee, albeit a sub-pledgee from a pledgee, was under the duty to exercise reasonable care for the preservation and protection of their value.

Section 9--207 of the Uniform Commercial Code provides as follows:

'(1) A secured party must use reasonable care in the custody and preservation of collateral in his possession. * * *

'(3) A secured party is liable for any loss caused by his failure to meet any obligation imposed by the preceding subsections but does not lose his security interest.'

Cleveland, repledgee of the debentures from Sterling, was a lender of money in whose favor there existed a security interest and, therefore, was a 'secured party' under the duty of exercising reasonable care for the preservation and protection of the collateral held by it (Uniform Commercial Code, § 9--105(1) (i)).

Furthermore, at common law, and independent of the statutory provisions aforesaid, a pledgee, considered a bailee, is held bound to exercise ordinary care for the protection and preservation of the subject matter of the pledge. (See Restatement, Security, § 17, comment B; 53 N.Y.Jur., Secured Transactions, § 84; Willets v. Hatch, 132 N.Y. 41, 46, 30 N.E. 251, 253; Ouderkirk v. Central Nat. Bank of Troy, 119 N.Y. 263, 23 N.E. 875; Cutting v. Marlor, 78 N.Y. 454; Hazard v. Wells, 2 Abb.N.Cas. 444; Fleming v. Northampton Nat. Bank, 62 How.Pr. 177.)

Where commercial paper or other securities are placed in the custody and control of the pledgee, it is clear that his responsibility is not limited solely to the physical preservation of the same. His responsibilities extend to the exercise of such care as a reasonably prudent pledgee would exercise under like circumstances to protect and preserve the validity and value of the securities. This is the rule at common law and also under the Uniform Commercial Code. (For definition of 'collateral' as used in § 9--207(1), see § 9--105 and Official Comment 3 thereto.) Thus, where bearer or negotiable instruments, taken as collateral, mature before the payment of the secured indebtedness, the pledgee is required, prior to, on or following the due date, to take such action as reasonable prudence suggests to preserve the value of the collateral, such as the giving of proper notice to parties contingently liable and the taking of necessary steps to collect the instruments. (See Easton v. German-American Bank of New York, 2 Cir., 24 F. 523, affd. 127 U.S. 532, 8 S.Ct. 1297, 32 L.Ed. 210; Hazard v. Wells, supra; 53 N.Y.Jur., Secured Transactions, § 84, supra; Brown on Personal Property (2nd ed.), § 134, p. 674; Schouler, Law of Bailments (3rd ed.), § 206. See, also, Restatement, Security, § 18; 51 A.L.R. 609.) By analogy, it follows that where pledged convertible debentures are called at par and thereby become payable while in the control of a pledgee, he may be required in the exercise of reasonable care to do more than just stand by and wait for payment of the face value of the securities.

The absence of a contractual relationship between Cleveland and the plaintiff does not as a matter of law absolve Cleveland from responsibility. Lack of privity does not constitute a defense to the cause of action alleged by plaintiff, as owner of the debentures. The duty which is imposed by law upon a pledgee to exercise reasonable care in the preservation and protection of the collateral is not a contractual obligation. Although arising in connection with a contractual relationship, the duty exists as an incident to the possession and control of the goods or securities by the pledgee. The contractual relationship creates the pledgee's right to possession of the collateral but his responsibilities under the law arise from his taking and maintaining such possession. 'While the relationship so created is basic, the legal duty is not a matter of contract; rather it is imposed by law.' (8 Am.Jur., 2d, Bailments, § 198, p. 1084. See, also, 8 C.J.S. Bailments § 26.)

There is nothing anomalous in a general rule which imposes upon the holder of personal property the duty to exercise ordinary care to guard against a reasonably foreseeable loss to the owner thereof, whoever he may be. (See 65 C.J.S. Negligence § 4(11). Cf. MacPherson v. Buick Motor Co., 217 N.Y. 382, 393, 111 N.E. 1050, 1054.) In any event, where the gravamen of a cause of action against a bailee (including a pledgee) is grounded in negligence, the existence of privity is not considered an essential element thereof. It is settled that where a bailee of goods or securities re-bails, re-pledges, or on some other contractual basis delivers possession of the same to another, and the latter is guilty of negligence or other misfeasance resulting in the loss of or injury to the property, the latter is liable directly to the owner who was the original bailor. 'The bailee who is careless in the keeping of the goods which he receives as those of A, does not escape liability though the deposit may have been made by B.' (Glanzer v. Shepard (Cardozo, J.), 233 N.Y. 236, 239, 135 N.E. 275, 276.) The owner and original bailor, although not entitled to possession, may sue the third party who received the goods from the owner's bailee and who has negligently or tortiously injured, lost or converted the same. (Berger v. 34th Street Garage, 274 App.Div. 414, 417, 84 N.Y.S.2d 348, 351, citing Holmes, Common Law, pp. 164, et seq. 'It is (the owner's) property which is injured, and he is entitled to redress.' (Berger v. 34th Street Garage, supra, p. 419, 84 N.Y.S.2d p. 353). Either the general owner or the bailee or pledgee having the special property may sue; Such 'right to sue is indispensable to...