Mechanics & Metals Nat. Bank v. Smith (21 F.2d 128, 1927)

ELLIOTT, District Judge.

I have been very greatly interested in the issues presented in Re Mechanics & Metals National Bank, Plaintiff, v. Fred R. Smith, as Superintendent of Banks of the State of South Dakota, and the Sioux Falls Trust & Savings Bank of Sioux Falls, S. D., defendants.

The facts in this case are stipulated, and in substance are that the plaintiff is a national bank of New York City j that the Sioux Falls Trust & Savings Bank of Sioux Falls, at the times named in -the complaint, was a South Dakota state banking corporation, located and doing business at Sioux Falls, S. D.; that on January 14, 1924, the affairs of said defendant bank were taken over by the defendant superintendent of banks of the state of South Dakota, and said superintendent ever since has been and now is in possession of the assets of said bank for the purpose of liquidation; the plaintiff bank filed its claim against the defendant bank, which claim was rejected by the superintendent of banks of the state of South Dakota. This suit is brought for the purpose of recovering upon the claim of the plaintiff against the Sioux Falls Trust & Savings Bank, the plaintiff claiming it is entitled to an allowance of all of the money represented by bills payable as hereinafter set forth, and also the entire amount of the notes rediscounted, being a total of $532,283.16; the plaintiff conceding that there is a credit to be applied of $41,-634.27.

It is stipulated: That “between the 28th day of August, 1923, and the 24th day of December, 1923, the Sioux Falls Trust & Savings Bank in due course of business rediscounted with the plaintiff, Mechanics & Metals National Bank of New York, various promissory notes. That some of said notes contained in the body thereof a clause providing : ‘The makers, indorsers, and guarantors hereon specially waive presentment for payment, protest, and notice of protest for nonpayment of this note, and consent to any extension or extensions of time of payment hereon which may be given ‘by the said payee or its assigns to the makers, indorsers, or guarantors hereof, or to either of said makers, indorsers, or guarantors.’ And they are indorsed with the straight indorsement of the said Sioux Falls Trust & Savings Bank.”

It is further stipulated that others of the notes were collateral form notes containing in the body of the note the provision above quoted. It is further stipulated “that upon the 14th day of January, 1924, there was held by the plaintiff such rediscounted notes to the aggregate amount of $282,283.16.” And there follows a list containing the names of the several makers of the notes, the dates of the notes, maturity, and the original amounts. It is further stipulated that “these rediscounts were made at different times between the 28th day of August, 1923, and the 24th day of December, 1923.”

It is further stipulated “that on or about the 28th day of December, 1923, the Mechanics & Metals National Bank loaned to the Sioux Falls Trust & Savings Bank the sum of $250,000, for which a note in that amount was executed and delivered as set out in paragraph 5 of plaintiff’s complaint; that as collateral security for the payment of the said note of $250,000 there was pledged by defendant Sioux Falls Trust & Savings Bank, with plaintiff, various promissory notes aggregating -the sum of $175,995.24, also various tax sale certificates, aggregating the sum of $52,-737.54, and also various city and county warrants aggregating the sum of $75,051.48,” with a list of the names, amounts, dates, etc., as set out in the complaint.

It is further stipulated “that on the 14th day of January, 1924, there was due and owing from the defendant, Sioux Falls Trust & Savings Bank, to the plaintiff bank, for notes redicounted under the indorsement of the said Sioux Falls Trust & Savings Bank, as aforesaid, the sum of $282,283.16, and for bills payable as aforesaid1 the sum of $250,-000, making a total of $532,283.16, and that there was at that time in possession of the plaintiff in an open account a balance in favor of the defendant Sioux Falls Trust & Savings Bank, upon the books of the plaintiff, in the sum of $41,634.27.”

There follow certain stipulations with reference to payments that had been made that are not in dispute here and do not necessarily affect the issues submitted. There is also attached to the stipulation a schedule of all collections that have been made, both upon the notes rediscounted to the plaintiff bank, and also upon the collateral notes, and upon this there is no dispute,, it being stipulated by counsel that upon the announcement of the law applicable computations can and will be made by counsel in accordance therewith.

The court finds the note for $250,000 set forth in full in the complaint, and defendants admit upon the trial that such note was given. This note is as follows:

“250,000.00. New York, December 28, 1923.

“March 10, 1924, after date, for value received, the undersigned jointly and severally promise to pay to the order of Mechanics & Metals National Bank of the city of New York (hereinafter called the bank), at its banking office in New York City, two hundred and fifty thousand dollars, in United States gold coin or its equivalent, having deposited with the bank as collateral security for the payment of this note or any note given in extension or renewal thereof, as well as for the payment of any other obligation or liability, direct or contingent, of the undersigned or any of them, to the bank, due or becoming due, whether not existing or hereafter arising.”

Then follows the provision of the note for the carrying into effect the collection and application of the proceeds of the collateral notes to the payment of the $250,000. It was also provided, in substance, that after the payment of the $250,000, to appropriate and apply the proceeds of said collateral to the payment or extinguishment of any of the obligations or liability of the defendant bank then owing or thereafter contracted, and whether then due or not due, and provided further that “any of the moneys then or thereafter in the hands of the plaintiff bank, on deposit or otherwise, to the credit of or belonging to the undersigned or any of them, might be appropriated and applied by the plaintiff bank to any obligation of the defendant, whether due or not, whether the liability was primary or contingent.”

The defendants object to the claim that was presented by the plaintiff bank for the total sum as above stated, and urge:

First. That the $250,000 borrowed by the defendant bank of the plaintiff bank, and evidenced by'the note of $250,000, is a legitimate claim, upon the filing of a claim for that sum, and offers to allow the same. Defendants further concede that the collateral security in the hands of the plaintiff bank is legitimately held as security for the payment of said $250,000.

Second. The defendants object to the claim that was presented for the various notes .that were rediscounted at different times between the 23d day of August, 1923, and the 24th dáy of December, 1923, for the reason that the plaintiff simply presented one claim against the defendant bank for the entire principal sum of all of the rediscounts and money borrowed.

In this connection defendant insists that each note discounted by the defendant bank constituted a sepárate and distinct transaction and constitutes a claim against the defendant bank, and that there are as many claims upon rediscounted paper, against the defendant bank, as there were notes rediscounted, executed by different makers. Plaintiff contends that the rediscounting of these notes in the manner above set forth, by the defendant, upon these various dates, constituted a borrowing of money; that the purpose and effect of the transactions between these two banks was that the New York bank furnished the Sioux Falls bank money to be used in the business of the latter, whether it was furnished by the giving of a promissory note by the defendant bank, or the rediscount of paper with the indorsement and guaranty of the de- ■ fendant' bank, and urges that in either case the plaintiff bank loaned a specific amount to the defendant bank, and that the loan was secured either by collateral given for the payment of the obligation of the defendant bánk, or by the transfer to the plaintiff bank of-security owned by the defendant bank, with its indorsement or guaranty upon it.

Plaintiff urges .that in either case the transaction was a loan pure and simple, and ' that this was the intention of the parties to the transactions, and urges that this, upon the stipulated facts, was the légal effect of these, transactions, and that therefore, at the date of the failure of the defendant bank, January 14,1924, there was owing to the plaintiff bank the sum of $532,283.16, from which should be deducted the sum of $41,634.27, the balance in the hands of the plaintiff bank belonging to the defendant bank, thus leaving a net indebtedness due plaintiff bank of $490,648.89, and asks that plaintiff’s claim be allowed therefor, regardless of the collateral coHeeted subsequent to the date of the closing of defendant bank. Plaintiff fqrthér urges that it is entitled to hold the collateral securities held by it as security for the $250,000 for the payment as well of the indebtedness represented by the rediscounted notes. The defendant admits the provisions of the promissory note for $250,000, and that they included authority to the plaintiff to make application of the proceeds of the collateral notes to the payment of the rediscounted notes.

Defendant, however, questions the validity of this attempted transfer of these collateral notes to the payment’ of the rediscounts and urges that it is a violation of section 8984 of the Revised Code 1919, as amended by chapter 124, Session Laws of 1919, which, defendant urges, makes a distinction between bills, payable and rediscounted paper. Said chapter 124 provides that:

“No bank, banker or bank officer shall give, preference to any depositor or creditor by pledging the assets of the bank as collateral security.” And: “Provided, further, that any bank may borrow for temporary purposes and may pledge the assets of the bank, not ■ exceeding fifty per cent, in excess of the amount borrowed, as collateral security therefor: Provided, further, that whenever a bank issues its bills payable for borrowed money, it shall within five days after the execution thereof forward to the superintend-, ent of banks a duly verified copy of such bills ■ payable and of such collateral pledge of security as may have been issued therewith.”

Nothing contained in this section shall prevent any bank from rediscounting in good faith and indorsing any of its negotiable pa-’ per: Provided, that whenever it shall appear that a bank is rediscounting habitually-for the purpose of reloaning, the superintendent may require such-bank to recall such re-discounts.”

“In all cases where money is borrowed a bank shall issue its ‘bills payable’ and shall show the true amount of borrowed money on. its books, and in all reports and statements re-’ quired by the provisions of this chapter, under ‘Bills Payable.’ ”.

Plaintiff urges that there is nothing in these provisions of the South Dakota statute which prohibits the pledging of collaterals as( security for the payment of rediscount notes,, and that a proper construction of the statute discloses .that it confers authority on banks in South Dakota to make such pledges of col-laterals. In this connection plaintiff urges that the authorities are uniform to the effect that rediscounting and indorsing negotiable paper is simply a form of borrowing money. That said section 8984 expressly authorizes, banks to borrow money and to pledge their assets as collateral security for the money bor-' rowed, and that the statute above quoted expressly authorized rediscounting and indorsing of negotiable paper, and gives the legislative stamp of approval to the method of borrowing long employed in the banking business. Counsel for plaintiff then eites the holdings of the courts, starting with Fleckner v. Bank of U. S., 8 Wheat. 338, 5 L. Ed. 631, to the effect that “by the language of the commercial world, and the settled practice of banks, a discount by a bank means, ex vi termini, a deduction or drawback made upon its advances or loans of money, upon negotiable paper, or other evidences of debt, payable at a future day, which are transferred to the bank,” and urges that the decision in this case turns upon the doctrine that the rediscounting of commercial paper was only one form of loaning money by banks. Subsequent cases cited by plaintiff refer to the ease of Fleckner v. Bank of U. S., supra.

I have with care attempted to analyze all of these authorities, and am impressed that this determination reached by the courts was under circumstances differing materially from the situation that is presented in the case at bar. In none of the cases cited by plaintiff was there a state statute to interpret. The real question presented here is an interpretation of this statute of the state of Sduth Dakota above set forth. It is clear that this statute expresses the policy of the state, and I am of the opinion that a contract against the settled public policy of the state will not be enforced, although it may be valid at the place where the contract was made. It is, therefore, no sufficient answer to defendants’ position to say that the contract is valid in New York where it was made. Swann v. Swann (C. C.) 21 E. 299; 12 C. J. 438. The only authentic admissible evidence of the public policy of the state on any given subject are its Constitution, laws, and judicial decisions. It is conceded that the defendant bank was, at the dates in question, organized and existing as a state bank under and by virtue of the general banking laws of the state of South ■Dakota. There is no question but that the statutes of the state at the times named were as above set forth. It appears, therefore, that the statutes of the state of South Dakota specifically prescribe that no bank, banker, or bank officer shall give preference to any depositor or creditor by pledging the assets of the bank as collateral security.

The same statute also provides that any bank may borrow money for temporary purposes and may pledge the assets of the bank, and in the same section prescribes the duty of the bank when it issues its bills payable for borrowed money, and requires that the same shall be reported to the superintendent of banks within five days after the execution of the note, with a copy of the bills payable and of the collateral pledged as security for the payment thereof. The statute goes further than that, and specifically recognizes the re-discounting of paper as an act separate and apart from the borrowing of money that has been provided for in the preceding section, and provides “that nothing contained in this section shall prevent any bank from rediscounting in good faith and indorsing any of its negotiable paper,” with further provisions with reference to the power of the superintendent to recall such rediscounts. I am impressed that a reading of the' provisions of the statutes of the state of South Dakota preclude the application to transactions by state banks in this state of the interpretation urged by plaintiff and sustained by authorities going back to In re Eleekner, supra.

There is nothing in the stipulation of facts that takes this rediscounting of paper out of the ordinary terms of “rediscounting in good faith and indorsing” as used in the South Dakota statute above quoted. A fair interpretation of these provisions of the South Dakota statute is made clearer by the further provision of the chapter above quoted, which provides:

“In all eases where money is borrowed a bank shall issue its ‘bills payable’ and shall show the true amount of borrowed money on its books, and in all reports and statements required by the provisions of this chapter, under ‘Bills Payable.’ ”

. As I have devoted time to this statute, I can find little to encourage one to question its meaning, and can find no foundation upon which to rest a finding that in this state rediscounting paper is merely a method of borrowing money. My attention is called to chapter 92 of the Laws of 1925, which provides :

“Nothing in this section shall prevent any bank from rediscounting in good faith and indorsing any of its negotiable paper, providing however, that except as it may otherwise be required by the rules of the federal reserve banks it shall be unlawful for any bank to pledge any of its assets as collateral security for the payment of such rediscounts, and any agreement or pledge whereby any of the assets of any bank shall be pledged as security for such rediscounts, shall be null and void.”

This emphasizes the plain interpretation of the preceding sections. It is a matter of general information that this amendment was thought necessary because of the requirements of the Federal Reserve Bank that collateral be put up to secure rediscounted paper. Our statutes as they stood prior to that time absolutely prohibited this practice, and in order to allow the banks of the state to re-discount their paper with the Federal Reserve Bank and put up collateral, this amendment was made to the statute. I am convinced that under the old law a South Dakota bank had no right to put up collateral to any rediscount, and therefore it could not sell its paper to the Federal Reserve Bank, and this amendment was passed .for the sole purpose of allowing banks to sell notes and rediscounts to the Federal Reserve Bank and put up collateral therefor.

The construction to be placed upon these statutes of the state of South Dakota is not an open question. The Supreme Court of the state of South Dakota, in Re Hirning, as Superintendent of Banks, v. Toohey, City Treasurer, 207 N. W. 462, was first called upon to construe this statute. This is a case brought by the banking department of the state, in charge of a state bank, to recover assets theretofore turned over to the defendant, Toohey, as treasurer of the city of Sioux Falls, to secure a deposit of city funds. The city had a large deposit at the time of taking the securities, secured by personal bonds of the officers of the bank. They requested additional security, and at a meeting of the directors of the bank it was promised, and the notes pledged and delivered. Evidence was introduced outlining the bank’s troubles and Toohey’s knowledge of the bank’s difficulties at the time he took additional security, and at the close of the testimony the trial court directed a verdict for plaintiff. Upon appeal, the question at issue was whether or not assigning the securities constituted a preference, unless the bank was actually insolvent at the time of the transaction. It was further contended in this case that there was no evidence that the bank was actually insolvent. The court then determines the question in the following language:

“We think the word ‘preference,’ as used in section 8984, .is intended -in its popular sense, and not in a technical sense. The section, read as a whole, indicates an intention to prohibit the pledging of the assets of a bank, except in certain specified instances, named in the several provisos, and to exclude all others without regard to the solvency of the bank at the time of the transaction.' The section is a part of the law governing the organization and management of banks. It is intended to govern or control solvent and going banks. It is therefore immaterial in this case whether or not the bank was actually insolvent, constructively insolvent or solvent; the pledging of the bank’s assets was illegal and void.”

My attention was called on the part of the counsel for the plaintiff to.the fact that there was a motion for rehearing pending at the time the case at bar was briefed. Under date of November 15, 1926, the motion for rehearing was denied by the Supreme Court, and is reported in 210 N. W. 723. The court there expresses itself with reference to the section in question here as follows: “Section 8984 is a part of the Banking Act applicable to state banks only, and its evident purpose is. to control banks and banking operations., One