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copy '3G1 f e d e r a l e z s l e v 2 ba1ik Of ka2tsas c i t y X-4978 October 8, 1927. \ Hon, Walter "Wyatt, General Counsel, Federal Reserve Board, Washington, B.C. My dear Mr. Wyatt: There i s sent you herewith, copy of opinion which was r e c e n t l y handed, down "by the Supreme Court of Kansas i n the case of Colorado and Southern Railroad Company v s . William Docking, Receiver of the American State Bank, et a l , I knew nothing of t h i s case u n t i l I came across i t i n the advance sheets of the Kansas Reports. I t announced a conclusion of law which i s of some importance, at l e a s t i n s o f a r as the Federal Reserve Bank of Kansas City i s concerned. I consider the d e c i s i o n erroneousj and am i now planning to have the question again presented tb the ddurt i n a case i n which the whole matter can he thoroughly gone into* You w i l l observe that the coufct h e l d that a request to remit by draft which accompanied B cftfch l e t t e r forwarded by the Federal Reserve Bank of Kansas City to a c o l l e c t i n g bank, changed the r e l a t i o n s h i p of p r i n c i p a l and agent which would otherwise have e x i s t e d between the Federal Reserve Bank and the c o l l e c t i n g bank, to that of c r e d i t o r and debtor. The a c t i o n was by the owner « f an item which was i n the cash l e t t e r , to e s t a b l i s h a p r e f e r r e d claim a g a i n s t the c o l l e c t i n g bank, which had f a i l e d wi^iout accounting f o r the item i n actual funds. The preference was denied by reason of the d i r e c t i o n to remit by d r a f t , which, i n the opinion of the court, destroyed the f i d u c i a r y r e l a t i o n s h i p necessary f o r the e x i s t e n c e of a p r e f e r e n c e . In view of t h i s d e c i s i o n , the Federal Reserve Bank of Kansas City has now eliminated d i r e c t i o n s Of t h i s kind from i t s cash and c o l l e c t i o n l e t t e r s . Yours very t r u l y , HGL:CR. (Sgd.) H.G. Leedy. X-4978-a COPY SUPREME COURT OF KANSAS. 'No. 27, 350. THE COLORADO & SOUTHS RAILWAY COMPANY, Appellee, v . WILLIAM DOCKING, REC2IVER OF THE AiiERICAN STATE BANK, and THE RESERVE STATE BANK, Appellants. Syllabus by The Court. 1. BANKS and. BANKING—Insolvency—Preferred Claim—Cashier's Check Covering C o l l e c t i o n . Where a bank received a d r a f t for c o l l e c t i o n and return with i n s t r u c t i o n s to remit by draft on Kansas City, makes the c o l l e c t i o n the same day through a l o c a l c l e a r i n g house and immediately sends the bank the c o l l e c t i o n item, a c a s h i e r ' s check covering the same, and the c o l l e c t i n g bank f a i l s the same day and the check i s returned to the r e c e i v e r of such bank, the r e l a t i o n of the c o l l e c t i n g bank to the owner of the c o l l e c t i o n item i s that of debtor and c r e d i t o r and the item i s not a t r u s t fund. 2. SAME—Insolvency—Preferred Claims—Transactions Made With Knowledge of Insolvency. Where the above t r a n s a c t i o n took p l a c e while the bank was i n an i n s o l v e n t condition, being one of many other similar transa c t i o n s taking p l a c e at the same time and as a usual and ordinary l i n e of banking b u s i n e s s , i t i s not such a fraudulent t r a n s a c t i o n as to make the c o l l e c t e d item a t r u s t fund, even i f the o f f i c e r s of the bank knew of i t s i n s o l v e n t c o n d i t i o n . Appeal from Sedgwick d i s t r i c t court, d i v i s i o n No. 1; J. EVERETT ALEXANDER, judge. Opinion f i l e d July 9, 1927; Reversed. C.H. Brooks, Willard Brooks and Howar<| T. Fleeson, a l l of Wichita, f o r the a p p e l l a n t s . Chester I . Long, J.D. Houston, Austin M. Cowan, Claude I . Depew, James Gr. Norton and W . E . Stanley, a l l ' of Wichita, f o r the a p p e l l e e ; J.L. Rice and E.B. Evans, both of Denver, Colo., of counsel. The opinion of the court was -delivered by HUTCHISON, J; This a c t i o n was brought by the p l a i n t i f f a f t e r the f a i l u r e of the American S t a t e Bank i n Wichita and the appointment of a, r e c e i v e r , to e s t a b l i s h a preferential- claim against the r e c e i v e r and against the Reserve State Bank, which purchased from the r e c e i v e r some of the a s s e t s of the American S t a t e Bank. The only defense in the case by the r e c e i v e r and the Reserve S t a t e Bank was on the question of tho claim being preferred, i t being admitted that the p l a i n t i f f had a common claim a g a i n s t the r e c e i v e r X-4978-a -2- '363 in the amount a l l e g e d . A jury was empaneled, "bat upon making the admission j u s t mentioned, during the course of the t r i a l the jury was discharged and the case was t r i e d to the court, who made extensive f i n d i n g s of f a c t and concluded the claim to he a p r e f e r e n t i a l one and rendered judgment accordingly i n favor of the p l a i n t i f f and a g a i n s t the defendant r e c e i v e r and the Reserve State Bank, from which judgment the r e c e i v e r and the Reserve S t a t e Bank appeal. In June, 1923, the Kansas City, Mexico & Orient Railway company was indebted to the Colorado & Southern Railway Company in 'the sum of $1,501, for which indebtedness the Colorado & Southern Railway Company drew i t s draft on the Orient railway company and deposited the draft i n the Colorado National Bank, of Denver, Colo., for c o l l e c t i o n and c r e d i t . The deposit s l i v i s s u e d "by the Denver "bank showed that c r e d i t was given to the p l a i n t i f f cond i t i o n a l l y , the bank reserving the r i g h t to charge back to the depositor a l l unpaid items or returns. The Colorado bank on the same day i n due course of business forwarded the item to the New England National Bank, of Kansaa City, k o . , for c o l l e c t i o n and c r e d i t , which bank i n due course forwarded the item to the Federal Reserve Bank, of Kansas City, Mo., f o r c o l l e c t i o n and c r e d i t . On June 16, 1923, the Federal Reserve Bank i n due course forwarded t h i s item to the American S t a t e Bank, of Wichita, for c o l l e c t i o n s and r e t u r n s . Some of the i n s t r u c t i o n s given i n the l e t t e r of transmittal were the f o l l o w i n g : 11 Do not remit f o r t h i s c o l l e c t i o n u n l e s s i t i s a c t u a l l y paid. 11 "Please remit by draft on Kansas City" . The draft was duly r e c e i v e d by the American State Bank on June 18, 1923, and a t 11 o ' c l o c k that day the s a i d bank presented i t at the meeting of the Wichita c l e a r i n g house, together with other items, and was given c r e d i t f o r the f u l l amount thereof on the settlement sheet of the c l e a r i n g house, i t being by previous arrangement of the Orient Railway Company cared f o r by the Fourth National Bank, of Wichita, and i n such settlement the American State Bank was required to 11 put up11 a d i f f e r e n c e of over $17,000, the amount of i t s d e b i t s exceeding the amount of t h i s and other c r e d i t s by that amount i n that day* s b u s i n e s s . Upon r e c e i v i n g c r e d i t for t h i s draft i n t h i s manner on June 18 at 11 o ' c l o c k , the cashier of the American S t a t e Bank immediately drew a cashier 1 s check on i t s e l f payable to "ourselves" for the sum of more than $18*000 i n payment of c o l l e c t i o n s which i t had received that day from the Federal Reserve Bank, which included the draft i n question of $1,501. The American State Bank c l o s e d i t s doors a t 3 o ' c l o c k on the afternoon of that day and never reopened. The c a s h i e r ' s check for more than $18,000 sent to the Federal Reserve Bank, not being indorsed by any of the o f f i c e r s of the American S t a t e Bank and the bank having f a i l e d before the check could be presented f o r payment, was returned to the deputy bank commissioner i n charge of the American State Bank on June I S , and the r e c e i v e r of s a i d bank had s a i d check i n h i s "berrtds a t the tjoae of the t r i a l . A l a r g e ' share of the a s s e t s of the American State Bank were s o l d to the Reserve State Bank when i t was organized. In the t r i a l of the i a s e i t was admitted that the American State Bank was i n s o l v e n t on Juno 18, 1923, and had been insolvent f o r one week prior t h e r e t o . Two of the f i n d i n g s of the court on t h i s question are as f o l l o w s : "13. On June 18, 1523, The American State Bank was i n s o l v e n t and had been i n an i n s o l v e n t condition f o r one week prior t h e r e t o . " "15. That the insolvency of the American S t a t e Bank was known to the o f f i c e r s of s a i d bank on June 18, 1923, at the time i t X-4978-c. -3accepted, the draft in question for c o l l e c t i o n . " There i s only one question here for determination, and th^t i s whether the $1,501 item so c o l l e c t e d by the American S t a t e Bank an_4 attempted to be remitted to the Federal Reserve Bank by the c a s h i e r ' s check was a p r e f e r r e d claim a g a i n s t the a s s e t s of the American S t a t e Bank and i t s r e c e i v e r . Our court has frequently h e l d that there are two d i s t i n c t steps to be taken i n reaching a d e c i s i o n as to whether a claim a g a i n s t the a s s e t s of an i n s o l v e n t bank i s e n t i t l e d to be p r e f e r r e d ; "Before a claim can bo allowed as a p r e f e r r e d claim ag a i n s t the r e c e i v o r of an i n s o l v e n t bonk, i t i s necessary to e s t a b l i s h , f i r s t , that the claim i n question i s a t r u s t fund; and, second, that the fund i n some form was a part of the a s s e t s of the bank which passed i n t o the hands of the r e c e i v e r . " ( S t a t e Bank v. S t a t e Bank, 114 Kan. 463, s y l . 1, 218 Pac. 1000. See, a l s o , Nelson v. Paxton, Receiver, 113 Kan. 394, 214 Pac. 7 8 4 . ) The same two stops arc necessary whore the fund become^ a t r u s t fund on account of fraud or fraudulent inducement. (Investment Co. v. Bank, 98 Kan. 412, 158 Pac. 68; Kirby v. Wait, 120 Kan. 400, 243 Pac. 1080.) A fund w i l l not n e c e s s a r i l y become a t r u s t fund simply because the a s s e t s reaching the hands of the receiver have been augmented by the t r a n s a c t i o n . This i s simply a f e a t u r e to be considered separately and apart from the f i r s t e s s e n t i a l as to nrofcrence and a f t e r i t has f i r s t been determined that the fund i s a sacred rr t r u s t fund, c i t h e r on account of the r e l a t i o n s h i p of the o a r t i e s to the t r a n s a c t i o n as p r i n c i p a l and a gent, debtor and c r e d i t o r , or t r u s t e e and c e s t u i que t r u s t , or on account of the fraudulent conduct of the o f f i c e r s of the bank. Then i n proper sequence a r i s e s the second question, Did the t r a n s a c t i o n augment the a s s e t s reaching the hands of the receiver? I t can r e a d i l y be seen that many a t r u s t fund w i l l f a i l of preference because i t does not augment the a s s e t s reaching the hands of the r e c e i v e r , and, on the other hand, many a case can e x i s t where there i s no question about the a s s e t s being augmented; but that can a v a i l nothing toward a preference u n l e s s i t has already been found to be a t r u s t fund. In nearly a l l of the e a r l i e r cases c i t e d in t h i s connection only one of these elements was involved or considered, the t r u s t fund feature was conceded, agency admitted, e t c . Such capes a f f o r d only comparative help, whereas in t h i s both elements are c o n t e s t e d . The d r a f t i n question i n making i t s t r i p from Denver to Wichita v i a Kansas City, Mo., passed through several banlfs f o r c o l l e c t i o n and c r e d i t , and undoubtedly the r e l a t i o n of one to the other, up to and including the American S t a t e Bank, i n turn was that of p r i n c i p a l 'ind agent, and that r e l a t i o n might s t i l l have been maintained had i t not been f o r the order of the Federal Reserve Bank requiring remittance to be by draft on Kansas City. This interrupted that r e l a t i o n s h i p by making the Wichita bank a debtor. This d i r e c t i o n was disregarded to the extent of u s i n g a c a s h i e r ' s check i n s t e a d of d r a f t on Kansas City, which made the s i t u a t i o n no b e t t e r . Immediately, of n e c e s s i t y , the funds c o l l e c t e d became a part of the funds o f the c o l l e c t i n g bank and wore mixed with i t s funds, thus l o s i n g for them any claim of being a s p e c i a l fund. a- 'V: T'8-r > -4— "The general rule i s that the t i t l e to comir.crci.al paper received f o r c o l l e c t i o n "by a bank and forwarded to i t s correspondent i n the usual course of "business docs not vest in such correspondent. The r e l a t i o n "between the two banks, as between the depositor and the f o r warding bank, i s thrt of principal a:xd agent merely. The correspondent bank r e c e i v e s such paper as an agert for c o l l e c t i o n , and the t i t l e door, not p a s s . When, however, the paper has once been c o l l e c t e d by the correspondent bank, and i t has received the proceeds t h e r e f o r , the r e l a t i o n between the r e m i t t i n g bank and i t s e l f i s changed from that of p r i n c i p a l and agent to that of debtor ana c r e d i t o r , and the t i t l e to such proceeds w i l l , in the absence of an agreement to the contrary, v e s t i n the correspondent bank. The bonks are presumed to contract in view of the well-known and e s t a b l i s h e d custom of banks, when a c t i n g as c o l l e c t i n g agents f o r other banks, or, indeed, f o r any customer, to put a l l c o l l e c t i o n s made by them into the general fund of the bank, u n l e s s d i r e c t e d to make of them a s p e c i a l d e p o s i t , and use them from hour to hour and from day to day in the transaction of t h e i r current business." (3 E. C. L 6 3 6 . ) "As a general r u l e , the proceeds of paper c o l l e c t e d by a bank becomes the property of the bank and a part of i t s general fund, and the bank becomes a debtor to the owner of the paper f o r the amount c o l l e c t e d , l e s s the charges f o r c o l l e c t i o n ; and i t f o l l o w s that, on the insolvency of the c o l l e c t i n g bank, there i s no preference in favor of the owner of the paper or of a forwarding bank with respect to the proceeds. 1 1 (7 C. J. 6 1 6 . ) Both the t e x t s s t a t e the r u l e i n subsequent paragraphs to those above quoted as being d i f f e r e n t where the paper i s deposited f o r c o l l e c t i o n only or f o r c o l l e c t i o n under express d i r e c t i o n s to c o l l e c t and remit. Such express d i r e c t i o n s are.more or l e s s common where the bank i s suspected of being i n f a i l i n g condition, and they u s u a l l y designate remittance i n currency. "Any agreement or understanding or course of dealing whereby the bank i s to use the i d e n t i c a l moneys c o l l e c t e d and s u b s t i t u t e i t s own o b l i g a t i o n in i t s stead, destroys a l l idea o f ' t r u s t . 1 1 (Akin v. Jones, 93 Tenn. 353, 3 6 2 . ) This t r a n s a c t i o n was handled in the usuf.1 and ordinary way of making c o l l e c t i o n s through banks, with the r e l a t i o n s h i p of p r i n c i p a l and agent e x i s t i n g u n t i l the c o l l e c t i o n was made; then the bank by i t s own o b l i g a t i o n i n the form of a c a s h i e r ' s check acknowledged i t s e l f to be indebted to the Kansas City correspondent f o r the bdftpfit of the p l a i n t i f f h e r e i n and the r e l a t i o n of debtor and c r e d i t o r arose, which i s i n c o n s i s t e n t with the idea of the c o l l e c t i o n being a t r u s t fund. "Where a bank r e c e i v e s payment of a note placed with i t by the owner for c o l l e c t i o n , and upon request of tho owner d e l i v e r s him a c a s h i e r 1 s check f o r the amount, there being then cash on hand s u f f i c i e n t to meet i t , tho p o s i t i o n of the owner, becomes that of a r X-4978-a c r e d i t o r of the "bank, e n t i t l e d to no 'oreiercr.ce over ordinary c r e d i t ors upon the f a i l u r e of the bank l e a v i n g unpaid a d r a f t , which wargiven by i t on presentation of the check." (Massey-Harris Harvester Co. v. F i r s t S t a t e Bank, 122 Kan. 483, s y l . , 252 Pac. 2 4 7 . ) The same or similar views are expressed in. the' f o l l o w i n g rocent Kansas c a s e s : Clark v. Bank, 72 Kan. 1, 82 Pac. 582; S t a t e Bank. v. State Bank, supra; El Dorado Nat'1 Bank v. Butler County State Bank, 120 Kan. 109, 242 pac. 475; Guymon-Petro Mercantile Co. v. Farmers State Bank, 120 Kan. 233, 243 Pac. 321; F i r s t Nat'1 Bank. v. Farmers State Bank, 120 Kan. 706, 244 Pac. 1038. I t was admitted in the t r i a l of the case that the bank was insplvent at the time t h i s transaction occurred, and had been i n s o l v e n t f o r a week p r i o r t h e r e t o , and the court found that the insolvency of the bank was known to i t s o f f i c e r s p r i o r to the acceptance of the draft f o r c o l l e c t i o n . Thepre i s considerable controversy as to the s u f f i c i e n c y of proof f o r t h i s f i n d i n g . I t i s claimed that the only evidence that was introduced on that subject was an u n v e r i f i e d pleading from the f i l e s of the d i s t r i c t court f i l e d p r i o r to the t r a n s a c t i o n a l l e g i n g the bank to be i n s o l v e n t and that such was inadmissible. Without attempting to decide the question of the a d m i s s i b i l i t y of t h i s testimony and the weight that should be given to i t , we think that t h i s being a usual and ordinary d a i l y t r a n s a c t i o n of a bank and the f a c t that the check was sent immediately a f t e r and on the same day the draft was r e c e i v e d and paid, goes to show with or without the knowledge of insolvency that the o f f i c e r s of the bank wore t r y i n g to keep i t going, and the s i t u a t i o n i s very d i f f e r e n t from that where a deposit i s r e c e i v e d when the bank i s known t o the o f f i c e r s to b e ' i n s o l v e n t . This t r a n s a c t i o n , i f consummated, would not have enriched or b e n e f i t e d the condition of tho bank, whereas a deposit would be wholly onc-sidecL and without any immediate o b l i g a t i o n s whatever except to meet the checks of the d e p o s i t o r . In the case of F i r s t National Bank v„ Farpers S t a t e Bank, 119 Kan. 198, 237 Pac. 652, the i n s o l v e n t bank asked a neighboring bank f o r $1,000 in currency because i t was short on currency, end gave i t s c a s h i e r ' s check, with the understanding that i t would be paid in four or f i v e days. In the meantime the bank f a i l e d . The court h e l d t h i s was not of a f i d u c i a r y or t r u s t character, and therefore was not a t r u s t fund l i a b l e to p. ^reference because of the fraudulent conduct of the o f f i c e r s of the f a i l ing bank. "A bank i s g u i l t y of fraud, on a general depositor i n accepting h i s deposit a f t e r the bank has become h o p e l e s s l y i n s o l v e n t and has committed an a c t of insolvency, and the depositor yay recover from the r e c e i v e r of the bank to the extent the deposit augmented the funds coming into tho hands of the r e c e i v e r / ' (Eime v. |»add, 112 Kan. 603, s y l . , 211 Pac. 6 2 8 . ) 11 The general r u l e i s to the e f f e c t that acceptance of general d e p o s i t s by a bank which i s h o p e l e s s l y insolvent to the knowledge of i t s o f f i c e r s c o n s t i t u t e s such a fraud as w i l l e n t i t l e the unsusp e c t i n g depositor to r e s c i n d and recover back the money, or give him a p r e f e r e n t i a l claim, or create a t r u s t ex m a l e f i c i o , provided other c o n d i t i o n s sometimes h e l d e s s e n t i a l to a recovery, such as X-4978-a -6- 367 augmentation of a s s e t s , i d e n t i f i c a t i o n s , e t c . , can "be s a t i s f i e d . 1 1 (20 A- L. E. 1206. See, a l s o , City of Spring H i l l v. Paxton, Receiver, 115 Kan. 412, 223 Pac. 2 8 3 . ) The record hero shows that t h i s was one of many s i m i l a r transa c t i o n s the same day, and that the check sent out was f o r $18,000, a l l of which would tend to show that i t was being done in the usual and ordinary course of "business and not with a plan or design to fraudulently acquire the "benefit of t h i s c o l l e c t i o n . 16-e t h e r e f o r e conclude that the r e l a t i o n of the p a r t i e s i s that of debtor and c r e d i t o r and not t r u s t e e and c e s t u i que t r u s t , and that the fund in question was not a t r u s t fund. This conclusion makes i t unnecessary f o r us to consider the second element as hereinbefore described i n f i n d i n g a claim to be p r e f e r i n t i a l , v i z . , whether or not the funds i n question reached the hands of the r e c e i v e r . With reference to the question of i n t e r e s t , the p l a i n t i f f i s e n t i t l e d to i n t e r e s t on i t s common claim from the date the bank c o l l e c t e d the claim. R. S. 41-101 provides: "Creditors s h a l l be allowed to r e c e i v e i n t e r e s t at the r a t e of s i x per cent per annum, when no other rate of i n t e r e s t i s agreed upon, f o r any money a f t e r it'becomes due; f o r money l e n t or money due on settlement of account, from the day of l i q u i d a t i n g the same and a s c e r t a i n i n g the balance." In the case of Turner v. Otis, 30 Kan. 1, 1 Pac. 19, i t was h e l d i n the d i s s o l u t i o n of a partnership: "Where a settlement i s corrected by charging the defendant with a c e r t a i n amount which he had wrongfully c o l l e c t e d and withheld, such amount should carry i n t e r e s t from the time of c o l l e c t i o n . " ( S y l . 2, See, a l s o , City of Spring H i l l v. Paxton, Receiver, supra; Honer v . S t a t e Bank, 114 Kan. 123, 216 Pag. 8 2 2 . ) The judgment of the d i s t r i c t court i s reversed and the cause remanded, with i n s t r u c t i o n s to render judgment in favor of the p l a i n t i f f for $1,501 and i n t e r e s t thereon, but that such claim s h a l l not be e n t i t l e d to preference i n the d i s t r i b u t i o n of the a s s e t s or e n t i t l e d to any p r i o r i t y with reference to the a s s e t s purchased from the r e c e i v e r of the American State Bank by the Reserve State Bank..
@FedFRASER