Pulaski County v. Ben Hur Life Ass'n of Crawfordsville, Ind.

• Decision Date: 21 January 1941
• Parties: PULASKI COUNTY et al. v. BEN HUR LIFE ASS'N OF CRAWFORDSVILLE, IND., et al.
• Court: Kentucky Court of Appeals

149 S.W.2d 738

286 Ky. 119

PULASKI COUNTY et al. v. BEN HUR LIFE ASS'N OF CRAWFORDSVILLE, IND., et al.

Court of Appeals of Kentucky

January 21, 1941

Rehearing Denied April 29, 1941.

Appeal from Circuit Court, Pulaski County; J. S. Sandusky, Judge.

Consolidated suit by the Ben Hur Life Association of Crawfordsville, Ind and others against Pulaski County, Ky. and others, to recover a judgment against the county on certain road and bridge bonds and to enforce payment of the judgment. Judgment for plaintiffs, and defendants appeal.

Reversed and remanded.

W. R Jones, Lawrence S. Hail, and R. C. Tartar, all of Somerset for appellants.

Woodward, Dawson & Hobson, of Louisville, B. J. Bethurum, of Somerset, S. S. Willis, of Ashland, S.D. Rouse, of Covington, Harvey & McIntyre, of Maysville, George W. Meuth, of Washington, D. C., Robert H. Winn, of Mt. Sterling, and W. H. Crutcher, Jr., Grafton & Grafton, Stites & Stites, and Carroll, McElwain & Ballantine, all of Louisville, for appellees.

STANLEY Commissioner.

Two important questions are presented by the appeal. One is whether bonds issued by a county for the construction of roads and bridges under the authority of Section 157a of the Constitution of Kentucky and Section 4307 of the Statutes are negotiable instruments so as to divest the maker of the right to rely on the defective title of the predecessor of a purchaser for value. The other question is the criterion to be used for determining whether an issue of bonds exceeded the county's authority, and, if so, the effect of an overissue. This is a consolidated suit by owners of seven matured bonds and of interest coupons on others to recover judgment against Pulaski County and to enforce its payment. The circuit court granted the relief asked.

The county contends: (1) The contract by which the bonds were sold by the county to plaintiffs' predecessor in title was procured by fraud and deceit and the sale was without consideration; that the bonds are non-negotiable, hence the plaintiffs are not holders in due course and the remedy against the original purchaser is available; and (2) the bonds are invalid because issued in excess of constitutional limitations.

By a referendum election held under the provisions of Section 157a of the Constitution of Kentucky and Section 4307 of the Statutes, bonds in the amount of $300,000 were authorized but only $280,000 were issued and sold. They are serial bonds extending over a period of thirty years. Pulaski County had previously issued bonds of the same class for the same amount under a different referendum (see Denton v. Pulaski County, 170 Ky. 33, 185 S.W. 481) and $203,500 of that issue were outstanding at the time these bonds were sold. The principal sum to be liquidated by the special levy of 20 cents on the $100 of taxable property authorized by the cited sections of the Constitution and Statutes was, therefore, $483,500.

As a part of its bid to purchase the bonds Caldwell & Company, a brokerage institution of Nashville, Tennessee, proposed that upon their delivery the proceeds should be deposited with it and withdrawn by the county from time to time as the road construction progressed. It agreed to pay the same interest on the deposits that the bonds bore, namely, 4 3/4 per cent. As security it would give the county a good indemnifying bond and in addition place with the Bank of Tennessee, as trustee, collateral securities of an amount at least equal to the deposit. The proposition was duly accepted by the fiscal court of Pulaski County on September 30, 1930. The bonds were delivered to Caldwell & Company on or about October 18th and that company gave the county a passbook or certificate evidencing the deposit. The collateral placed with the Bank of Tennessee was of the face value of $600,000, but with the exception of a few shares of stock in a small railroad company the securities were of concerns promoted or financed by Caldwell & Company. These included $214,500 of bondholders' certificates secured by the mortgage on a hotel in East St. Louis, Illinois. Early in November, without the county having drawn on the deposit, both Caldwell & Company and the Bank of Tennessee were closed as insolvent. The $600,000 collateral was turned over to the officials of Pulaski County by an order of the United States District Court at the appraised value of $15,000. To secure the contract of purchase of the bonds, Caldwell & Company represented to the county that it was the strongest and soundest financial institution in the So. The county officials were not negligent, for they found the concern given the highest rating in Dun & Bradstreet, and otherwise learned of its good reputation in financial circles. The Bank of Tennessee proved to have been only the alter ego of Caldwell & Company. Though outwardly sound and solid, both institutions were empty shells. The general creditors of Caldwell & Company received only one-half cent on the dollar. A former vice president of that company, Carter, testified that it had been insolvent for some time as its officers well knew. In order to carry on, the company had purchased bonds and securities for more than their actual worth where contracts could be secured similar to that made with Pulaski County, whereby the proceeds not being immediately payable were left with the company. He had opposed this method of doing business because of the precarious condition of the concern, and had tried to get Rogers Caldwell, the principal and practically the sole owner of the company, to stop the practice. When the Pulaski County contract was made Carter refused to sign the indemnifying bond and went to Caldwell with a remonstrance because the county was dealing with the company in good faith and the transaction was not an honest one. However, Rogers Caldwell approved the transaction and it was consummated in the manner stated. All of this stands admitted. Carter estimated the value of the collateral at the time pledged to be about $80,000 instead of at least $280,000, the amount of the deposit. At that time the hotel bondholders' certificates were worth perhaps 10 cents on the dollar.

The Pulaski County bonds were promptly sold and put in the hands of the public by Caldwell & Company. Within less than three weeks the institution closed and Pulaski County found the "cupboard bare," or almost so. That the title to the bonds was obtained by Caldwell & Company by fraud is certain. The contract was the equivalent of a sale on credit and was beyond the authority of the fiscal court to make. Webster County v. Hall, 275 Ky. 54, 120 S.W.2d 756. But this fact does not seem to enter into the case. Nor is this a case where the purchaser had merely failed to pay an obligation given for the bonds. The whole transaction was permeated by fraud on the part of the purchaser, and, as proved, the contract would not have been made or entered into but for its deception and fraud. The decision rests on the premise, therefore, that fraud vitiated the contract and that the title of Caldwell & Company to the bonds was defective.

The plaintiffs proved their innocence of actual notice of the defect in title of Caldwell & Company. Their title is immune from attack and the county must be held liable to them as innocent holders for value, or bona fide holders in due course, unless the bonds are non-negotiable in respect of being subject to the defense stated, which was unquestionably available against the original purchaser.

The Negotiable Instruments Act is applicable to municipal bonds and its definitions and provisions must be looked to in determining whether a particular issue or bond is negotiable in the technical sense pertinent to our present consideration. Jones, Bonds & Bond Securities, Sections 285, 287, 672; Hunter v. City of Louisville, 208 Ky. 326, 270 S.W. 841; Cf. Gayle v. Greasy Creek Coal & Land Company, 249 Ky. 251, 60 S.W.2d 599. Our particular concern is whether the bonds involved are unconditional promises to pay, the other features of a negotiable instrument being clear and certain. Section 3720b-1, Kentucky Statutes, requires that a negotiable instrument shall contain an unconditional promise or order to pay a sum certain in money. Section 3720b-3, Kentucky Statutes, which is Section 3 of the Uniform Negotiable Instruments Act, is quoted for ready reference:

"An unqualified order or promise to pay is unconditional within the meaning of this act, though coupled with it:

"(1) An indication of a particular fund, out of which reimbursement is to be made, or a particular account to be debited with the amount; or

"(2) A statement of the transaction which gives rise to the instrument.

"But an order or promise to pay out of a particular fund is not unconditional."

The determination of the character of a bond is sometimes difficult because of the question whether its peculiar terms and conditions contain (1) only an indication of a particular fund out of which payment is to be made or a particular account to be charged with the amount, or (2) a promise to pay it only out of a special or particular fund. The first class, in which negotiability is preserved, is where the reference to the source of revenue is collateral. Illustrative are bonds payable at all events by the municipality but issued under authority of a statute providing for a special tax for the sinking fund and interest, and the instrument indicates that source of funds and security, or perhaps only contains a statement of the transaction which gives rise to the issuance of the bonds. The second class of bonds are those payable exclusively out of a particular fund to be derived from designated sources which may dry up before they have yielded proceeds enough to liquidate the full amount of...