D'Oench, Duhme & Co. v. Federal Deposit Insurance

315 U.S. 447, 62 S. Ct. 676, 86 L. Ed. 956, 1942 U.S. LEXIS 1067

• Court: Supreme Court of the United States
• Decided: March 30, 1942
• Docket: 206
• Status: Published

Opinions

Me. Justice Douglas

delivered the opinion of the Court.

Respondent instituted this suit in the United States District Court for the Eastern Division of the Eastern District of Missouri on a demand note for $5000, executed by petitioner in 1933 and payable to the Belleville Bank & Trust Co., Belleville, Illinois. Respondent insured that bank January 1,1934; and it acquired the note in 1938 as part of the collateral securing a loan of over $1,000,000 to the bank, made in connection with the assumption of the latter’s deposit liabilities by another bank. Since 1935 the note had been among the charged off assets of the bank. The note was executed by petitioner in renewal of notes which it had executed in 1926. Petitioner, who was engaged in the securities business at St. Louis, Missouri, had sold the bank certain bonds which later defaulted. The original notes were executed to enable the bank to carry the notes and not show any past due bonds. Proceeds of the bonds were to be credited on the notes.¹ The receipts for the notes contained the statement, “This note is given with the understanding it will not be called for payment. All interest payments to be repaid.” Respondent had no knowledge of the existence of the receipts until after demand for payment on the renewal note was made in 1938. Certain interest payments on the notes were made prior to renewal for the purpose of keeping them “as live paper.” Petitioner’s president, who signed the original notes, knew that they were executed so that the past due bonds would not appear among the assets of the bank, and that the purpose of the interest payments was “to keep the notes alive.” The original notes were signed in St. Louis, Missouri, were payable at petitioner’s office there, and were delivered to the payee in Illinois. The evidence does not disclose where the note sued upon was signed, though it was dated at Belleville, Illinois, and payable to the bank there.

The main point of controversy here revolves around the question as to what law is applicable. The District Court held that Illinois law was applicable and that petitioner was liable. The Circuit Court of Appeals applied “general law” to determine that the note was an Illinois rather than a Missouri contract; and it decided that, under Illinois law, respondent was the equivalent of a holder in due course and entitled to recover. 117 F. 2d 491. Petitioner contends that, under the rule of Klaxon Co. v. Stentor Electric Mfg. Co., 313 U. S. 487, a federal court sitting in Missouri must apply Missouri’s conflict of law rules; that if, as was the case here, Illinois law was not pleaded or proved, a Missouri court would have ascertained Illinois law from Missouri decisions, since in such a case Illinois law would be presumed to be the same as the Missouri law; and that the District Court was bound to follow that same course. We granted the petition for certiorari because of the asserted conflict between the decision below and Klaxon Co. v. Stentor Electric Mfg. Co., supra.

We held in the latter decision that a failure of a federal court in a diversity of citizenship case to follow the forum’s conflict of laws rules “would do violence to the principle of uniformity within a state” upon which Erie R. Co. v. Tompkins, 304 U. S. 64, was based. 313 U. S. at p. 496. The jurisdiction of the District Court in this case, however, is not based on diversity of citizenship'. Respondent, a federal corporation, brings this suit under an Act of Congress authorizing it to sue or be sued “in any court of law or equity, State or Federal.”² Sec. 12B, Federal Reserve Act; 12 U. S. C. § 264 (j); 48 Stat. 162, 168, 172; 49 Stat. 684, 692. And see 28 U. S. C. § 42, 43 Stat. 941. Whether the rule of the Klaxon case applies where federal jurisdiction is not based on diversity of citizenship', we need not decide. For we are of the view that the liability of petitioner on the note involves decision of a federal, not a state, question under the rule of Deitrick v. Greaney, 309 U. S. 190.

Petitioner in its answer alleged that the note was given without any consideration whatever and with the understanding that no suit would be brought thereon; and that respondent was not a holder in due course. Respondent in its reply alleged that petitioner was estopped to assert those defenses on the grounds that the note was executed for the purpose of permitting the bank to avoid having its records show any past due bonds; that this constituted a misrepresentation which would deceive the creditors of the bank, the state banking authorities and respondent; that petitioner participated in the misrepresentation not only by reason of its knowledge as1 to the purpose which the note would serve but also by reason of its payment of interest in order to make the notes appear as a good asset. The District Court held that respondent was an innocent holder of the note in good faith and for value and that petitioner was estopped to assert want of consideration as a defense.

Sec. 12 B (s) of the Federal Reserve Act, 12 U. S. C. § 264 (s), provides that “Whoever, for the purpose of obtaining any loan from the Corporation ... or for the purpose of influencing in any way the action of the Corporation under this section, makes any statement, knowing it to be false, or wilfully overvalues any security, shall be punished by a fine of not more than $5,000, or by imprisonment for not more than two years, or both.” Subdivision (y) of the same section provided, at the time respondent insured the Belleville bank,³ that such a state bank “with the approval of the authority having supervision” of the bank and on “certification” to respondent “by such authority” that the bank “is in solvent condition” shall “after examination by, and with the approval of” the respondent be entitled to insurance.⁴

These provisions reveal a federal policy to protect respondent, and the public funds which it administers, against misrepresentations as to the securities or other assets in the portfolios of the banks which respondent insures or to which it makes loans. If petitioner and the bank had arranged to use the note for the express purpose of deceiving respondent on insurance of the bank, or on the making of the loan, the case would be on all fours with Deitrick v. Greaney, supra. In that case, the defendant, for the purpose of concealing a national bank’s acquisition of its own stock, had the shares held by a straw man and executed a note to the bank, it being agreed that the shares were to be held for the bank and that he was not to be liable on the note. We held as a matter of federal law, based on the policy of the National Banking Act to prevent the impairment of a bank’s capital resources by prohibiting such acquisitions, that the defendant could not rely on his own wrongful act to defeat the obligation of the note as against the receiver of the bank. The defendant’s act was itself a violation of the statute. 309 U. S. p. 198. But the reach of the rule which prevents an accommodation maker of a note from setting up the defense of no consideration against a bank or its receiver or creditors is not delimited to those instances where he has committed a statutory offense. As indicated by the cases cited in the Deitrick case (309 U. S. p. 198), an accommodation maker is not allowed that defense as against the receiver of the bank and its creditors, or at times even as against the bank itself, where his act contravenes a general policy to protect the institution of banking from such secret agreements. In some of those cases, the accommodation maker was party to the scheme of deception, in the sense that he had full knowledge of the intended use of the paper. Putnam v. Chase, 106 Ore. 440, 212 P. 365; Vallely v. Devaney, 49 N. D. 1107, 194 N. W. 903; Niblack v. Farley, 286 Ill. 536, 122 N. E. 160; Cedar State Bank v. Olson, 116 Kan. 320, 226 P. 995; Bay Parkway Nat. Bank v. Shalom, 270 N. Y. 172, 200 N. E. 685; German-American Finance Corp. v. Merchants & Mfrs. State Bank, 177 Minn. 529, 225 N. W. 891. In others he had “no positive idea of committing any fraud upon any one.” Denny v. Fishter, 238 Ky. 127, 129, 36 S. W. 2d 864, 865; Iglehart v. Todd, 203 Ind. 427, 442, 178 N. E. 685; Mount Vernon Trust Co. v. Bergoff, 272 N. Y. 192, 5 N. E. 2d 196. And see Pauly v. O’Brien, 69 F. 460; Williston on Contracts (Rev. Ed.) § 1632. Yet, he has not been allowed to escape liability on the note as against the receiver even though he was “very ignorant and ill-informed of the character of the transaction.” Rinaldi v. Young, 67 App. D. C. 305, 307, 92 F. 2d 229, 231. Indeed, recovery was allowed by the bank itself in Mount Vernon Trust Co. v. Bergoff, supra, where the court said (272 N. Y. p. 196, 5 N. E. 2d 197): “The defendant may not have intended to deceive any person, but when she executed and delivered to the plaintiff bank an instrument in the form of a note, she was chargeable with knowledge that, for the accommodation of the bank, she was aiding the bank to conceal the actual transaction. Public policy requires that a person who, for the accommodation of the bank executes an instrument which is in form a binding obligation, should be estopped from thereafter asserting that simultaneously the parties agreed that the instrument should not be enforced.”

Furthermore, the fact that creditors may not have been deceived or specifically injured is irrelevant. As we held in the Deitrick case (309 U. S. p. 198), it is the “evil tendency” of the acts to contravene the policy governing banking transactions which lies at the root of the rule. See 7 Zollman, Banks & Banking (1936) § 4783.

Those principles are applicable here, because of the federal policy evidenced in this Act to protect respondent, a federal corporation, from misrepresentations made to induce or influence the action of respondent, including misstatements as to the genuineness or integrity of securities in the portfolios of banks which it insures or to which it makes loans. Those principles call for an affirmance of the judgment below.

Petitioner, at the time it executed the renewal note in 1933, did not know that it was to be used to deceive respondent, as the Act creating respondent was not passed until later. But the permission which it gave the bank to carry the note as a real asset was a continuing one and not revoked. That permission must be presumed to have included authority for the bank to treat the note as genuine for purposes of examination at the hands of the public authorities as well as for its general banking activities.

Respondent insured the bank in 1934. The loan was made in 1938 to satisfy respondent’s liability to the depositors of the bank under that insurance agreement. Respondent was authorized to insure such a bank only on a certificate from the state authority that the bank was solvent. We assume that such certificate was given, for to assume otherwise would be to infer that respondent did not discharge its statutory duties. The genuineness of assets ostensibly held by a bank is certainly germane to a determination of solvency. Clearly respondent is a member of the creditor class which the banking authorities were intended to protect. Plainly one who gives such a note to a bank with a secret agreement that it will not be enforced must be presumed to know that it will conceal the truth from the vigilant eyes of the bank examiners. If the bank had wilfully padded the bank’s assets with the spurious note in order to obtain insurance from respondent, there seems no doubt but that § 12 B (s) would have been violated. Moreover, as we have seen, the inability of an accommodation maker to plead the defense of no consideration does not depend on his commission of a penal offense. The test is whether the note was designed to deceive the creditors or the public authority, or would tend to have that effect. It would be sufficient in this type of case that the maker lent himself to a scheme or arrangement whereby the banking authority on which respondent relied in insuring the bank was or was likely to be misled. As we have said, petitioner’s authority to the bank to use this note was a continuing one.' The use to which it was put was not unusual but within the normal scope of banking activities. The fact that the note was charged off by the bank subsequent to the time when respondent insured the bank and prior to the time when it acquired the note under the loan is immaterial. A note may be nonetheless an asset though it is charged off. And respondent is suing here to protect its rights as an insurer, a relationship with the bank which was created prior to the time when the note was charged off. The fact that subsequently respondent learned that the note had been charged off certainly was not notice that the note was spurious. It is indeed clear that at no time prior to the demand for payment did respondent know that the note was not genuine: It needs no argument to demonstrate that the integrity of ostensible assets has a direct relation to solvency. And it is no more a defense here than it was in the Deitrick' case that no damage was shown to have resulted from the fraudulent or unlawful act. The federal policy expressed in the Act, like its counterpart in state law, is not dependent on proof of loss or damage caused by the fraudulent practice.

Though petitioner was not a participant in this particular transaction and, so far as appears, was ignorant of it, nevertheless it was responsible for the creation of the false status of the note in the hands of the bank. It therefore cannot be heard to assert that the federal policy to protect respondent against such fraudulent practices should not bar its defense to the note. Criminal penalties are m> more the sole sanctions of the federal policy expressed in this Act than were the criminal penalties imposed on the agreement in the Deitrick case. If the secret agreement were allowed as a defense in this case the maker of the note would be enabled to defeat the purpose of the statute by taking advantage of an undisclosed and fraudulent arrangement which the statute condemns and which the maker of the note made possible. The federal policy under this Act of protecting respondent in its various functions against such arrangements is no less clear or emphatic than the federal policy of outlawing purchases by a bank of its own stock involved in the Deitrick case. Cf. Rinaldi v. Young, supra; Federal Deposit Ins. Corp. v. Woods, 34 F. Supp. 296.

Affirmed.

Me. Justice Roberts did not participate in the consideration or decision of this case.

1 The bank sold some of the bonds in 1937 for $100 and credited this amount to interest due on the note. This credit paid interest to May 1, 1933. No later payments were made on the note.

2 That subdivision of the Act further provides: “All suits of a civil nature at common law or in equity to which the Corporation shall be a party shall be deemed to arise under the laws of the United States: Provided, That any such suit to which the Corporation is a party in its capacity as receiver of a State bank and which involves only the rights or obligations of depositors, creditors, stockholders and such State bank under State law shall not be deemed to arise under the laws of the United States.” And see S. Rep. No. 1007, 74th Cong., 1st Sess., p. 5.

3 These provisions of subdivision (y) were dropped when § 12 B was amended by the Banking Act of 1935. 49 Stat. 684. See S. Rep. No. 1007, 74th Cong., 1st Sess., p. 9.

4 Subdivision (y) also gave respondent power to prescribe rules and regulations for the further examination of such bank. Though subdivision (y) was revised in 1935, as indicated in note 3, supra, subdivision (k) (2) of the amended Act gave respondent’s examiners power “to make a thorough examination of all the affairs” of such banks and in doing so “to administer oaths and to examine and take and preserve the testimony of any of the officers and agents thereof.” They were directed to make a “full and detailed report of the condition of the bank to the Corporation.” 12 U. S. C. § 264 (k) (2).