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COPY QEBiBLB X-6600 March 18, 1930. MEMOHAIOTM FOR MR. AWAIT AND MR. POUTS: In re; Scope of application of decision of Supreme Court in case of Early, Receiver, vs Federal Reserve Bank of Richmond, rendered March 12, 1930. 1. An examination of the opinion rendered in the above entitled case clearly indicates that the scope of its application should be restricted to cases where the insolvent drawee "bank had, "by the terms of the collection circular issued by the Reserve Bank, giv.en the Reserve Bank authority to charge its account with the amount of a collected cash letter. The pertinent portions of the opinion, first summarizing the facts and then stating the "basis of the decision, are as follows: "This is a suit "brought "by the receiver of a national bank in South Carolina, a member of the Federal Reserve System, to recover the reserve balance of that bapk in the hands of the Federal Reserve Bank of Richmond at the end of business on October 9, 1926, when the South Carolina Bank, being insolvent, closed its doors. Other matters .tried below are not in question here. The Richmond Bank claims the right to retain the balance on the following facts. As authorized by agreement, on October 7 it forwarded to the South Carolina Bank checks drawn upon the latter which the Richmond Bank had received for collection. Thtee checks were received the next day, marked paid and charged to the accounts of the drawers. Other checks were forwarded on October 8 and marked paid and charged to the drawers by the South Carolina Bank on October 9. After notice of the failure the Richmond Bank on October 11 charged the account of the South Carolina Bank with the amount of the checks forwarded on October 7 and the next day charged what was left with the amount sent on October 8. "The relations between the t«n "RawVg were fixed by the following terms of a circular of the Richmond Bank which was authorized by lfw and agreed to by- the other. ' Checks received by us drawn on our member banks will be forwarded in cash letters direct to such banks and each member bank will be required either to remit therefor in immediately available funds or to provide funds available to us to meet such cash letters within the agreed transit time to and from the member bank. Therefore. tb* ammmt of any cash letter to a member bank is chargeable nat. available funds in the reserve account of such member at the expiration of such transit time, which date will be shown on each cash letter. The right is reserved. X-6600 Memorandum - Page Two. ij>ksS however, to charge a cash letter to the reserve account Of a member bank at anv time when in any particular case we deem it necessary to do so." The transit time or time allowed for collection in this case was three days, and had not expired, when the South Carolina Bank closed its doors. The Circuit Court of Appeals sustained the claim of the Richmond Bank. 30 F. (2) 198. A. writ of certiorari was granted by this Court. "The petitioner contends that his bank had until the end of the transit time to remit or to provide funds to meet the cash letters, that until then the Richmond Bank had a bare power of attorney to charge the reserve fund, arid that the power was revoked by the insolvency of the petitioner's bank. He denies that the reserve fund was subject to any lien until that date, and calls attention to the right of his bank to draw checks against that fund reserved to it by the law. Code, Tit. 12. pg. 464. "All parties mast be taken to have dealt upon the terms of the circular that we have quoted. The right of the South Carolina Bank to draw against its reserve account was subject to the right of the Richmond Bank that held the account to charge it with a cash letter whenever deemed necessary." * * * * * * * * * * * * * * * The fact that the fund might be diminished by drafts of the South Carolina Bank does not invalidate the lien, any more than the right of a depositor to draw against hi is account invalidates a banker's lien, not to sneak- of the paramount power of the Richmond Bank mentioned above." 2. It will be noted from the foregoing that the Supreme Court held that: (a) The relations between the insolvent bank and the Reserve Bank were fixed by the collection circular; (b) The collection circular gave the Richmond bank a right to charge the account of the insolvent bank, and that the right of the insolvent bank to draw against its reserve deposit "was subject to the right of the Richmond Bank that held the account to charge it with a cash letter whenever deemed necessary." (c) That the reserved right under the collection circular to charge the account at any time constituted a lien in favor of the depositors of the Reserve Bank. 3. The reserve deposit of a member bank is in the same category as a deposit in any other bank so far as the issues here involved are Memorandum - Page Three X-6600 >xoo concerned in that the Reserve Bank cannot charge the deposit without the express authority of the member "bank (except, of course, in cases of offset hereinafter discussed). In the Federal Reserve Bank of Richmond case,, the authority to charge the account was given by the collection contract. It follows that where the collection contract does not give such authority to charge the account, the authority cannot he exercised. It is understood that the collection contracts of the majority of the Reserve Banks omit the provision for charging the reserve deposit, and utilize the remittance method of payment for cash letters, that is to say, the collecting "bank is supposed to remit or send cash to the Reserve Bank in payment of the cash letters. Consequently, where the collection contract omits provision for the charging method and utilizes the remittance method, and the collecting "bank has suspended /before remittance or payment to the Reserve Bank has "been made, the Reserve Bank cannot thea charge the deposit account of the insolvent "honV "because the yxthority to ea charge the account is not contained in the collection circular and, as indicated, the right to charge is dependent upon previously given authority to charge. 4. The Reserve Bank cannot charge the deposit of the insolvent member hank with the amount of an unpaid cash letter, on any theory of offset. Offset requires mutuality of debits and credits. Under numbered paragraph 1 of Section 5 of Regulation J, Series of 1924, of the Reserve Board, a Reserve Bank acts "only as agent of the bank from which it receives * * *" the checks for collection, and consequently it follows that when the insolvent drawee bank to whom the cash letter is sent, has made collection of the items, it owes the amounts collected to the depositors of the Reserve Bank and not to the Reserve Bank, and if remittance is made to the Reserve Bank the Reserve Bank receives the remittance as agent of its depositors. From this it follows that the Reserve Bank cannot offset the amount which the Reserve Bank owes to the insolvent bank against the amount which the insolvent bank owes to the depositors of the Reserve Bank. This was clearly recognized in the opinion of the Circuit Court of .Appeals in the Federal Reserve Bank of Richmond case in disposing of the contention of the Reserve Bank that the cash surrender value of the stock owned by the member bank in the Reserve Bank, and which the Reserve Bank therefore owed to the insolvent bank, was subject to offset upon the amount of the unpaid cash letters, the language of the Circuit Court of Appeals in that connection being as follows; "On the second question, we do not think that the Reserve Bank has the right to set off the balance due by the insolvent bank on the checks against its stock liarbility. The Reserve Bank was not the owner of these checks. It was merely an agent for collection; and although it credited them to the accounts of the forwarding banks, this was upon agreement that they might be charged back if not collected, and the second lot of checks has been charged back. The stock liability is a liability created by statute Which provieds that it "shall be first applied to all debts of the insolvent member bank to the Federal Reserve Bank, Memorandum - Page Four. X-6600 5 and the "balance, if any, shall be paid to the receiver of the insolvent bank.1 12 TJ. S. C. A. 288. It is perfectly clear that the liability of the insolvent member bank for these checks is a liability owing to the owners of the checks in which the Reserve Bank is not interested except as collection agent, and is not 'a debt of the insolvent member bank to the Federal Reserve Bank' within the mean* ing of the statute, "Even in the absence of a statutory direction as to how the liability*should be applied, a set off of checks held for collection against such a liability would not be allowed, for the reason that demands to be set off against each other must be mutual, that is they must be due to and from the same parties, and in the same capacity. 14 R.C.L. 656; 24 R.C.L. 858; Morse on Banks and Banking (6th Ed.), 334; Bank of the Metropolis v. New England Bank, 6 Howard 212; Smith v. Bath 1. & B. Ass'n._ Me. 136 Atl. 284, 50 A.L.R. 526; Yardley v. Clothier, 51 Fed. 506. * *" It follows that if the Reserve Bank cannot offset the amount which it owes for the cash surrender value, of reserve stock, it cannot offset the amount which it owes for the reserve deposit, inasmuch as each represents money owing by the Reserve Bank to the insolvent bank. Neither the Circuit Court of Appeals nor the Supreme Court allowed the deposit balance of the insolvent bank to be applied on the cash letters by way of offset, but both Courts allowed it by reason of the authority to charge given in the collection circular and the lien resulting therefrom. 5. Where the insolvent bank has, prior to suspension, issued to the Reserve Bank a remittance draft, either on the Reserve Bank, or upon some correspondent bank, and suspension occurs prior to the draft being paid., the authority of the drawee bank to pay the draft is revoked by the intervening suspension, just as the authority of a bank, in ordinary course, to pay a check drawn upon it, is revoked by the bankruptcy of the drawer of the check. The remittance draft so issued by the insolvent bank is merely evidence of the debt which the draft represents, and constitutes no more than authority upon the drawee bank to pay that debt. The revocation of the authority by suspension leaves the debt unpaid, and the one to whom the debt is owing has the right to file claim against the insolvent bank. Hence it follows that where the Reserve Bank holds an unpaid draft covering cash letter items, the Reserve Bank has no right to charge the account of the insolvent bank with the amount of said draft, assuming, of course, that the Reserve Bank was not the owner of the items contained in the cash letter, but had received the items as a collection agent and had so transmitted them to the insolvent bank. 6. It is now thoroughly well settled that at suspension the assets of an insolvent bapk accrue to the receiver for the benefit Memorandum - Page Five. X-6600 5t>l of all the creditors, subject, of course, to proper claims for preference , and rights of set off. Hence it follows that the "balance of an insolvent bank in a Reserve Bank accrues to the receiver, at suspension, subject to proper preference claims and rights of set off, and such balances should be paid by the Reserve Bank to the receiver. 7. A number of cases involving deposit balances with Reserve Banks have been held in abeyance pending the outcome of the Federal Reserve Bank of Richmond case. I recommend as to such cases as follows: (a) Each case should be disposed of in the light of the special facts and circumstances therein existing and should be submitted to this office for consideration* (b) Where the collection contract gives the Beaerve Bank the right to charge the account of the insolvent bank in the same manner provided in the Federal Reserve Bank of Richmond case, • the right to charge the account for items in unpaid cash letters based thereon should be recognized, (c) Where no such right to charge the account is contained in the collection contract, the right to charge the account should be denied and appropriate measures should be taken by the receiver to obtain the withheld reserve deposit balance. (d) Where an unpaid remittance draft is outstanding covering cash letter items which had been transmitted by the Reserve Bank, the right of the Reserve Bank to charge the unpaid draft to the reserve deposit account of the insolvent bank should be denied and appropriate measures should be taken by the Receiver to recover the deposit. (Signed) George P. Barse. , General Counsel, Division of Insolvent National Banks.
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