State ex rel. Sorensen v. Farmers State Bank

237 N.W. 857, 121 Neb. 532, 82 A.L.R. 7, 1931 Neb. LEXIS 204

• Court: Nebraska Supreme Court
• Decided: July 17, 1931
• Docket: No. 27376
• Status: Published

Opinions

Rose, J.

In a proceeding in the district court for Polk county to wind up the affairs of the Farmers State Bank, an insolvent banking corporation, Edward A. Lindquist intervened and presented a petition for the allowance of $4,500 as a preferred claim payable in full out of the general mass of assets in control of the receiver.

The claim as pleaded arose in the following manner: For a valuable consideration intervener executed and delivered to the Farmers State Bank, July 3, 1928, his promissory note for $4,500, payable October 1, 1928, and that bank sold and delivered it to the Harvard State Bank. To pay the note by renewal, intervener executed and delivered a new note to the Farmers State Bank for $4,500, October 5, 1928, and the latter sold and delivered' it to the First National Bank of Stromsburg; received for it $4,500, and failed to pay therewith the original note; converted the $4,500 received for the renewal note, without the knowledge or consent of intervener; augmented to that extent the funds in the Farmers State Bank; mingled the converted proceeds of the renewal note with bank assets which fell into the hands of the receiver. Intervener prayed for an order restoring his converted funds and directing the receiver to pay them in full. The answer of the receiver to the petition of intervener was a general denial. A trial of the issues resulted in a judgment granting intervener the relief prayed by him. The receiver appealed to the supreme court.

It is argued that the judgment of the district court is erroneous for the reason that, subject to taxes, the statute gives priority to unsecured depositors in state banks and makes their claims first liens on all assets of the insolvent bank from the time it was closed. Comp. St. 1929, sec. 8-1,102. The argument on this point was ably presented in good faith, but is not conclusive, if the converted proceeds of intervener’s note were never assets belonging to the bank, within the meaning of the statute. The transactions in which the bank procured, converted, mingled and used the funds of intervener are material factors in the present inquiry. There is no dispute about any essential fact. Intervener entrusted his renewal note to the Farmers State Bank for the sole purpose of paying the original note. The renewal note was accepted by the Farmers State Bank, hereinafter called “the bank,” payee in both notes, for that identical purpose and' could not lawfully be otherwise used. The bank thus became a trustee to pay the original note with the renewal note and to return the former note to the intervener. It betrayed its trust; sold the renewal note; took the proceeds — $4,500; converted the funds without the knowledge or consent of intervener, the beneficial owner; put the equivalent of intervener’s proceeds in money in the bank and made the bank books show an increase in its cash and its sight exchange to the extent of $4,500; used the converted funds in the regular course of the banking business; failed to pay the original note and refused to restore to intervener any part of the proceeds of the renewal note. Intervener paid his original note, but did not ratify any unlawful act of the bank, his trustee, in regard to the renewal note, or condone the betrayal of trust, or. demand the converted proceeds as deposits. In relation to these funds he was not a depositor. He did not participate in any dishonest or unlawful act. He did not make any agreement authorizing the bank, his trustee, to use his credit or proceeds or money in the banking business. His property was not impounded on any mesne or final process known to the law. By the illegal acts of his trustee, intervener did not lose his title to his own property or his equitable right to follow and reclaim it in a changed form. The bank never acquired intervener’s title nor a right to use his credit or proceeds or money in the banking business. In equity his converted property was never a bank asset to which depositors had a right to resort for payment of their general deposits. It was the continuing duty of the bank as a trustee, from the moment intervener’s property or its equivalent in money was unlawfully put into its tills, to disclose that fact to the beneficiary and restore it ,'to him or apply it to the specific use for which it was intended. To that standard of accountability equity holds the trustee.

A bank which exercises power emanating from the state by means of legislation and a public charter has ho immunity from obligation, duty or business rectitude, while acting in a fiduciary cápácity. Contrary to the terms of 'a trust, a bank has no authority to convert trust property or the equivalent thereof, or to deposit it to its own credit, or to mingle it with bank assets, or to use it in the general course of the banking business, or to deprive the beneficial owner of it, or to create a fund, by betrayal of trust, to pay general depositors in the event of insolvency. The trust fund, in its original or changed form, belongs to the beneficial owner, and it is the duty of a court of equity, upon proper pleading and proof, to restore the fund to him.

If the statute is construed to authorize the receiver to appropriate any part of intervener’s trust funds to the claims of general depositors, it will prevent the exercise of chancery power conferred upon district courts by the Constitution of Nebraska and to that extent will be void. Lack of legislative power to limit chancery jurisdiction was illuminated in a recent opinion by Judge Eberly, who said:

“It may be said that, by the terms of the Constitution, district courts in Nebraska are vested with ‘chancery jurisdiction.’ Const. art. V, sec. 9. This we have construed as vesting district courts with equity jurisdiction which they may exercise without legislative enactment. Matteson v. Creighton University, 105 Neb. 219. Indeed, this court is committed to the view that, not only is equity jurisdiction conferred by the terms of the Constitution, but as thus conferred it is beyond the power of the legislature to limit or control. That, while the legislature may grant such other jurisdiction as it may deem proper, it cannot limit or take from such courts their broad and general jurisdiction which the Constitution has conferred upon them.” Burnham v. Bennison, ante, p. 291.

It has been held that the proceeds of crime, when deposited in a bank by the criminal, may be recovered by the owner as deposits. State v. Dunbar State Bank, 120 Neb. 325. This is not, however, the exclusive remedy. Under equity jurisdiction, which is beyond the power of the legislature to limit or control, it has been determined in repeated decisions that the beneficiary of a trust may refuse to ratify an unauthorized deposit, and that he may elect to follow and reclaim his converted trust property, even in changed forms, though mingled by the trustee with his own assets or estate. State v. Bank of Commerce, 61 Neb. 181; City of Lincoln v. Morrison, 64 Neb. 822; Tarnow v. Carmichael, 82 Neb. 1; Logan v. Aabel, 90 Neb. 754; Central Nat. Bank v. First Nat. Bank, 115 Neb. 472.

The statute, therefore, does not make unlawfully converted trust property which has been traced into general assets of an insolvent bank as trustee available to general depositors for the payment of their deposits. Such funds augment the mass of assets in the bank, but are not assets of the bank in the hands of the receiver within the meaning of the statute, since they are assets belonging to the beneficial owner, and not to the bank.

The decree preferring the claim of intervener over claims of general depositors is also assailed on the ground that he did • not trace the converted proceeds of the renewal note into any specific property or asset in the hands of the receiver. The rule invoked by the receiver was stated as follows:

“A cestui que trust, who seeks a preference out of the estate of an insolvent national bank in the hands of a receiver, must clearly prove that the trust property, or its proceeds, went into a specific fund or property which came into his hands.” Central Nat. Bank v. First Nat. Bank, 117 Neb. 161. See, also, Central Nat. Bank v. First Nat. Bank, 115 Neb. 444.

On the contrary, intervener relies on the rule stated in the dissenting opinion in Central Nat. Bank v. First Nat. Bank, 115 Neb. 451, which was subsequently adopted by the majority in Central Nat. Bank v. First Nat. Bank, 115 Neb. 472. That majority opinion stated the fundamental rule of equity as follows:

“Where the form of trust property is changed by a fiduciary and the resulting proceeds are wrongfully mingled by him with the mass of assets comprising his insolvent estate, the beneficiary of the trust, in a proper case, may resort to the mass for redress, if augmented by the trust property.” Central Nat. Bank v. First Nat. Bank, 115 Neb. 472.

This latter rule of equity, owing to a subsequent change in the personnel of the supreme court, was rejected in an opinion by a majority of one as being at variance with the interpretation of United States courts in administering federal laws applicable to national banks — laws then under consideration. In receding from the rule of equity last quoted, when applicable to a national bank only, the judge who declined to follow it said in his opinion:

“The writer has been very reluctantly driven to the foregoing conclusions as to national banks, but withholds commitment as to trust funds not imperatively ruled by federal law.” Central Nat. Bank v. First Nat. Bank, 117 Neb. 161.

As applied to state banks under the Constitution and laws of Nebraska, the majority opinion reported in Central Nat. Bank v. First Nat. Bank, 115 Neb. 472, has never been overruled. The present record presents this question: Which of the divergent rules shall be applied in administering trust funds unlawfully mingled by a state bank as-trustee with the mass of its general assets? Shall the rule formulated under equity power conferred by the Constitution of Nebraska and state legislation relating to state banks be abandoned for the so-called “federal rule” applied by some of the federal courts in winding up the affairs of insolvent national banks under the acts of congress? The affairs of our insolvent state banks should be wound up and the assets distributed under the laws of Nebraska in the light of equity power conferred by the state Constitution upon state courts.

In the suit now under consideration, the bank, as trustee, converted $4,500 belonging to intervener, unlawfully mingled the trust funds belonging to him with the assets of the bank, illegally used the funds in the regular course of the banking business, became insolvent, and went into the hands of a receiver without executing the trust or refunding the money. Intervener traced his trust funds into the general assets of the bank. They augmented the mass of assets in the bank to the extent of $4,500, but that amount of the mingled funds was an asset belonging to intervener, and not an asset of the bank. Conceding that the identical trust funds were paid out in the regular course of the banking business, they paid obligations or debts of the bank to the extent of $4,500, and thus reduced its general indebtedness. Except for the unlawful use of the trust funds, the outstanding obligations of the bank, when the receiver took charge, would have been greater by $4,500. The general depositors have no valid claim on the trust funds, whether they remained in the bank or reduced bank debts by unlawful payment. In equity the effect is the same. General depositors are not entitled to the fruits of the bank’s betrayal of trust. Intervener is not in the same class with them. Their deposits gave the bank lawful control of their deposited money in the regular course of the banking business. The proceeds of intervener’s renewal note could only have been lawfully used by the bank in paying the original note. Under the circumstances, equity charges the mass of assets with the trust funds. The doctrine requiring the beneficiary of a trust to trace his trust funds into some specific asset or property in the estate of the trustee or in the hands of his receiver as a condition of reclaiming them did not originate in any moral philosophy or in any sound principle of equity jurisprudence. The defense of that doctrine lacks cogent reasons and involves a resort to opinions reiterating initial fallacies. The following excerpt from Windstanley v. Second Nat. Bank, 13 Ind. App. 544, was unanimously adopted in an opinion by Judge Letton:

“The true owner of property has the right to have his property restored to him, not as a debt due and owing, but because it is his property wrongfully withheld. As between the cestuis que trustent and the trustee and all persons claiming under the trustee, except purchasers for value and without notice, all the property belonging to the trust, however much it may have been changed in its form or its nature or character, and all the fruits of such property, whether in its original or altered state, continues to be subject to and affected by the trust. * * * It was formerly held that these rules came to an end the moment the means of ascertaining the identity of the trust property failed. * * * In the case of trust moneys commingled by the trustee with his own moneys, it was held that money has no earmarks, and when so commingled the whole became an indistinguishable mass and the means of ascertainment failed. But equity, adapting itself to the exigencies of such conditions, finally determined that the whole mass of money with which the trust funds were commingled should be treated as a trust.” Logan v. Aabel, 90 Neb. 754.

The opinion adopting the foregoing language has never been overruled and is in harmony with views expressed by a former chief justice of the supreme court of the United States, who said:

“Formerly the equitable right of following misapplied money or other property into the hands of the parties receiving it depended upon the ability of identifying it; the equity attaching only to the very property misapplied. This right was first extended to the proceeds of the property, namely, to that which was procured in place of it by exchange, purchase, or sale. But if it became confused with other property of the same kind, so as not to be distinguishable, without any fault on the part of the possessor, the equity was lost. Finally, however, it has been held as the better doctrine that confusion does not destroy the equity entirely, but converts it into a charge upon the entire mass, giving to the party injured by the unlawful diversion a priority of right over the other creditors of the possessor.” Peters v. Bain, 133 U. S. 670, 693.

The money in the hands of the receiver for distribution in the present instance is now greater to the extent of $4,500 on account of the conversion and the other unlawful acts of the bank as trustee. In equity the depositors do not have a valid claim for the amount of these trust funds. Equitably they belong to intervener and the district court wisely ordered the receiver to pay them in full. This procedure is adopted in administering the Nebraska laws applicable to state banks, rather than the federal laws applicable to national banks as interpreted in Central Nat. Bank v. First Nat. Bank, 117 Neb. 161.

Affirmed.

Paine, J., concurs in the result.