Wharton v. Clements

This bill contests the validity óf a judgment confessed by the firm of J. F. Clements & Co., to indemnify the defendants, who were sureties of Clements as deputy *216collector of internal revenue, against such 'loss as might accrue to.them from his conversion of the public revenue to the use of the firm.

The purpose for which the judgment to the sureties was confessed did not appear by testimony, but it is set forth in the answer. Notwithstanding an objection to the contrary, the answer is, on this point, responsive, and there is no evidence against it. I, therefore, have accepted its statements as part of the case above set forth. The complainants’ counsel insisted that because the bond is charged to be fraudulent, the defendants’ denial by answer should not be admitted, but that only by testimony can a sufficient consideration be shewn. 'To this point cases in 3 P. Wms. 228, and 2 Ves. Sr., 516 were cited; but they do not sustain it. The case in' Ves. Sr. bears no relation to the subject. In 3 P. Wms. 228, it was held that 'prima facie, a bond or mortgage was evidence of a debt, but that, where there were’ “manifest signs of fraud,” i. e., signs manifest by some evidence supporting the charge in the bill, the obligee should be put to the proof of actual consideration or payment.

This decision refers to the onus and not to the mode of proof. It holds the obligee in a bond which has been by evidence brought under suspicion of fraud, to shew a sufficient consideration for the bond, but it does not decide that the consideration, when required to be shewn, may not be proved as any other fact in issue might be, i, e., by answer, if responsive and uncontradicted, as well as by any other kind of evidence. On the other hand, there are decisions directly to this point, which holds that the answer, if responsive, is evidence, although against a bill charging fraud, and may, if not overcome by counter-proof, establish the defense. 2 Dan. Ch. Pr. 984, note; 8 Gill & J. 171 ; 1 Wend. 583, 596, and 619; 3 Paige, 557.

We now reach the main subject of controversy, which embraces two objections taken to the validity of the judgment confessed to the defendants.

*217The first and principal objection, taken in argument, is that the judgment was without consideration to the firm of J. F. Clements & Co., and was void as against the partnership creditors. That it was without consideration has been urged on the ground that the firm did not, by receiving and using the money collected by Clements, and for the due application of which the sureties were bound, incur any partnership debt or liability to the sureties, forming a consideration for the bond ; that, on the contrary, the firm as it received the money from Clements, became debtor to him alone ;.that the only remedy of the sureties was against Clements; that between the firm and the sureties there was no privity.

The fallacy of this objection lies in its assuming that the public revenue converted to the use of the partnership was the money of Clements : as if he had borrowed a sum of money on his own credit and put it into the business ; in which case, unquestionably, the firm would have been indebted to him only, and not to the person from whom he borrowed. So, if the collection of the public revenue were farmed out to a collector, who, paying to the Government a stipulated sum, should become entitled to collect the taxes for his reimbursement; in such case, the taxes, when collected, would be his own property, and if put into the business of a partnership of which he might be a member, would create no liability on the part of the firm, except to himself. But in the present case, the money used by J. F. Clements & Co. was in Clements’ hand, as the mere agent of the Collector of Internal Revenue, whose money it was, that is, as between the collector and Clements, though ultimately it was payable to the United States Government. It was a trust fund. Now it is a rule, that the rights of a cestui que trust adhere to the trust property or fund, and follow it info whosesoever hands it may come, except those of a bona fide purchaser for value and without notice. It was forcibly said by Lord Ellen-borough, that “an abuse of trust can confer no rights on *218“the party abusing it, nor on those who claim in privity with him3 M. & S. 574. If the subject-matter of the trust be lands or chattels, such as can be identified, they may be followed and recovered in specie; if it be money, that is, converted by the trustee, whoever receives it with knowledge of the trust, or without a valuable consideration, becomes a debtor to the cestui que trust. Or, if the money has been used in the purchase of property, say of lands, the cestui que trust may, at his election, either take the property (2 Dyer 160 ; Amb. 409;) or he may follow the money into the hands of the vendor, holding the vendor as his debtor. This is a settled rule, founded upon the most obvious necessity, that of preventing the facilities there would otherwise be given for the fraudulent conversion of trust property. The rule is enforced at law whenever the circumstances raise a legal cause of action. In courts of equity, relief is given universally. It is one of the various applications of the equitable doctrine of implied trusts : See at large 2 Story's Eq. Jur.', §§ 1257-8 ; Lewin on Trusts (201-2) 24 Law Lib.; Oliver vs. Piatt, 3 How. S. C. Rep. 333. Among the cases to which this rule has been applied, there are some in which the party receiving trust-money, knowing it to be such, has been held liable as a debtor directly to the cestui que trust. Some of these may be noticed.

In Smith vs. Jameson, 5 T. R. 601, Robert Jameson, while a partner in business with Thomas Jameson, was also one of the assignees in bankruptcy of Lewis and Potter. As assignee of the bankrupt he received 2563/., which he brought into his partnership with the privity of his partner Thomas Jameson. The partnership was dissolved, and all of its effects and credits assigned to Robert, he assuming the debts. After this a commission of bankruptcy issued against Robert and Thomas Jameson, and Robert was removed, as one of the assignees of Lewis & Potter. His co-assignees then claimed to prove the 25631. against the estate of Robert and Thomas Jameson under the commis*219sion of bankruptcy against them. The Lord Chancellor directed this action at law to try the question whether the assignees of Lewis & Potter could maintain an action against the partnership of Robert and Thomas Jameson for the sums received by Robert, as assignee of Lewis & Potter’s estate, and appropriated by him to his own partnership. It was admitted that the partners, by receiving the money, became indebted to the estate of Lewis & Potter, but insisted that the assignment of the partnership effects by Thomas Jameson to Robert, while the latter continued to be an assignee of Lewis & Potter, was discharged. This objection the court overruled, and the assignee recovered.

In Stone vs. Marsh, 6 B. & C. 551, one of several trustees of stock under a will, by means of a forged power of attorney, sold the stock, and the proceeds were carried into the business of a firm of which he was a partner. Upon an issue out of Chancery to inquire whether the partnership which received the money Was indebted for it to the trustees, it was so held by Lord Tenterden, who also seems to-have considered it immaterial whether or not the other partners were ignorant of the fraud.

In Hutchinson vs. Smith, 7 Paige, 26, one Smith, the treasurer of Monroe county, commencing business in January 1827, used moneyin his hands as county treasurer, in the purchase of a stock of goods. Soon afterwards he took into partnership with him, Phelps, whose interest in the stock and business, it was agreed, should be estimated from January. Phelps entered the firm, knowing that the county funds had been put into the business. In July, Smith died. The firm was then, as it was afterwards ascertained, insolvent. Phelps, the surviving partner, assigned all the partnership property to a creditor for the payment of the debts, preferring some ; and among other preferred debts was the obligation to the county, which was included at the instance of the sureties on the treasurer’s bond. The funds assigned proving insufficient to *220pay all the debts of the firm, the non-preferred creditors filed their bill to set aside the assignment, and, among other grounds, objected that the debt due to the county was the private debt of Smith, .for which the partnership was not liable; But the Vice-Chancellor and, on appeal, the Chancellor, held it to be a partnership debt, and properly provided for by the assignment.

In Richardson vs. French, 4 Metc. 577, the same principle was applied to the case of a partnership, into which one of the partners, being also an administrator, brought funds from the estate of his intestate. See further, Collyer on Partn. § 391, and cases cited.

We see, then, that the firm of J. F. Clements & Co., by using, with the knowledge of both partners, the funds held by Clements as deputy collector, became debtors to the United States collector. A bond of the firm securing the money to him, would have been, unquestionably, valid as a partnership obligation. Next, we inquire, how stood the sureties ? Did there arise out of this transaction any liability on the part of the firm to them, forming a sufficient consideration for this judgment ? Now, had the sureties before taking the judgment (as they have since done) made good, to the United States collector, Clements’ defalcation, they would have succeeded, in equity, to the exact position of the collector, before stated, as a creditor oí the firm. In equity, sureties, upon payment of the debt or performance of the duty of their principal, are subrogated to all rights, securities, and remedies of the creditor as means of indemnifying themselves, except only that under the English decisions, sureties paying the debt cannot take an assignment of the instrument upon which they are bound ; which right, however, is conceded to them under the American decisions, and in this state it is given by statute. Rev. Code. Chap. 65. But when this judgment was confessed, the sureties had paid nothing, and whether, in fact, they would sustain any loss, was con*221tingent, until the collector should elect to take his remedy against them rather than against Clements or the firm. Could they, in that position, take a bond of indemnity? And, if any, could they take an absolute bond for the payment of money, such as the bond upon which this judgment was confessed ? There can be no doubt on these points. By force of the defalcation alone, and before any payment was made by the sureties, their liability to pay became fixed, although whether this liability would be-enforced might for a time remain uncertain. So also, the firm of J. F. Clements & Co., by the very act of converting to its own use the trust-funds for which the sureties were bound, incurred a liability directly to the sureties ; a liability, first, to answer to them in the event of their loss, according to the equitable doctrine of subrogation, in the same manner and to the same extent in which they stood responsible to the collector ; and, second, (as it seems to be now settled,) even before any loss had accrued to the sureties, the firm might have been brought into a court of equity and compelled to exonerate the sureties by paying the debt: 1 Story Eq. Jur., §§ 327, 639, 730; Lord Chancellor in Nesbit vs Smith, 2 Bro. C. C. [582] and note (a); Cox vs. Tyson, 1 Turn. & Russ. 393 ; Hays vs. Ward, 4 Johns. Ch. 132 ; 1 Lead. Cas. in Eq. 87.

Such is the right of a surety as against his principal. The same right these sureties had against J. F. Clements & Co., because the firm, as well as Clements, individually, were bound to exonerate the sureties. Thus the firm were, by the very act of using this money, brought under an obligation to indemnify the sureties ; not only to make good in the future such loss as might in the event be sustained, but to exonerate the sureties, if so required, at once. Clearly, then, it was both their right and duty, promptly, to indemnify the sureties. In what form, we next inquire, might this be done ? Might it be an absolute bond for the payment of a sum of money estimated as sufficient to cover the loss ? This was controverted in the *222argument. But the validity of a money-bond as a mode of indemnifying sureties, has been affirmed by the Court of Errors and Appeals in Tunnell vs. Jefferson, 5 Harring. 206. There, a judgment-bond for $15,000 had been given by Tunnell to certain trustees, in trust, to apply the proceeds towards indemnifying the sureties of Tunnell as administrator of Miers Burton, deceased, and as guardian of his children. The Chancellor (Johns) sustained the precise objection here made, that sureties, before actual payment of the debt for which they are bound, cannot take as an indemnity an absolute bond for the payment of money, but only a bond with a collateral condition to indemnify them, upon which judgment might be entered by virtue of a warrant of attorney, so as to effect a lien on real estate, but without the power to take execution until the damages should be ascertained through a verdict or an inquisition upon breaches of condition assigned. The Court of Errors and Appeals held the contrary, sustaining the right of the surety to take for his indemnity an absolute bond before payment of the money or performance of the duty for which he stood liable ; before even the time fixed for payment or performance, by the principal, had arrived. That decision is conclusive. See, also, Toissant vs. Martinnant, 2 T. R. 100; Penney vs. Foy 8 B. & C. 11, 16.

What remedy a court of equity would afford to compel sureties, holding such a bond, to pay the debt against which they are indemnified, before taking the proceeds of an execution under the bond, or to compel them to refund after having taken the proceeds, if they should not ultimately be damnified, is a question which does not affect the original validity of an indemnifying bond ; ñor can any such question arise here since these sureties have already sustained the loss against which this bond was executed to indemnify them.

The second objection to this bond was, that it gave a preference to the sureties against other creditors, in *223contemplation of the insolvency of the firm, and, therefore, that it is void under our statute of insolvency. Rer. Code, Chap. 132. Sec. 4. The statutory provision supposed to be violated, is in these words ; “If any person in “ contemplation of insolvency, or in contemplation of “taking the benefit of any of the insolvent laws of “this State, shall make an assignment of his estate or_ “effects for the benefit of creditors, and by such assign“ment, either under its provisions or otherwise, shall prefer “any creditor to others, or shall in or by such assignment “secure or pay to any creditor a greater proportion of his “debt or demand than shall be paid or secured to all his “creditors, every such assignment, so giving a preference, “ shall be void, &c.”

The prohibition of this clause against a preference among creditors applies only to cases in which an assignment for the benefit of creditors is made, whether made “ in contemplation of insolvency or in contemplation of tak- “ ing the benefit of the insolvent laws.-’ Both the terms and the policy of the Statute are clear ; what it requires is the equal distribution among all creditors of the debtor’s effects, under an assignment made for the benefit of creditors,without, however, restraining the debtor, if he makes no assignment, from exercising his general right to prefer one creditor.to others, even though he may be in failing circumstances, or though the preference be given in direct contemplation of actual insolvency. Where no assignment is made, the law puts the creditors upon their diligence and gives to each the benefit of his diligence. This construction of the law has been uniformly acted upon since its passage in 1826, and has been several times adjudged by the Court of Errors and Appeals. In Newells vs. Morgan, 2 Harring. 228, the same objection was taken to a judgment given to a creditor in contemplation of insolvency. The judgment was sustained though without any notice taken by the Court of the objection. In Waters vs. Comly, 3 Harring. 117, the subject was more fully considered. There, a firm, *224being indebted and in failing circumstances, executed a judgment bond in a large amount exceeding their assets. It was taken in the name of one creditor but in trust for certain preferred creditors named in a schedule. The Chancellor, and on appeal, a majority of the Court, held the judgment to be an evasion of the Statute, on the ground that a judgment, so given, covering all the debtor’s assets, and in trust for the benefit of a number of preferred creditors, who were not parties to it, nor cognizant of it, was equivalent to a formal assignment with preferences given under it ; but the Court did not deny the válidity of preferences given by debtors in the ordinary mode. The construction given to this Statute, in the elaborate opinion of Judge Harrington,has always been held and acted upon, and on the general question it was not controverted by the opinion of the majority of the Court in that case. In Tunnell vs. Jefferson, 5 Harring. 206, the Statute received the same construction, which now must be taken to be settled and beyond discussion. The case before us is the ordinary one of a debtor’s preferring certain creditors without, however, making any assignment for the benefit of his creditors at large, and therefore such preference, even though given in contemplation of insolvency, is not forbidden by the Statute.

It results that the judgment confessed by J. F.Clements & Co., to the sureties of Clements, is valid as an obligation of the firm, and the defendants are entitled against the partnership creditors to the fruits of their execution.

Bill dismissed, and the injunction dissolved.

Note. — This case is also reported in 8 Am. Law Reg. (iV. S.) 299.