
    The Merchants’ National Bank of Syracuse, Respondent, v. George F. Comstock, Appellant.
    An accommodation indorser of a note, which is diverted from the purpose for which it is made and indorsed, and is transferred by the maker as security for a precedent debt, cannot avail himself of the defence of the misappropriation of the note as against one who has received it from the original transferree, in the usual course of business for value, before maturity, without notice of such defence; the latter is within the protection accorded by the law-merchant to all bona fide holders for value; and, where, in such case, the original transferree of the note receives it, without knowledge of any restriction upon the rights of the makers in its use, and transfers it for value to a banking corporation, of which he is director, the fact that he took it for a precedent debt does not affect the title of the bank. The note is negotiable in his hands and his title perfect, save as against the indorser and as resulting from the diversion, and that is cured by a transfer to a bona fide purchaser.
    Defendant indorsed sundry notes of J. & G-. for the accommodation of that firm. He held as security mortgages upon real property conditioned for the payment of any and all bills or notes indorsed by him, and to indemnify him against his indorsements. J. & Q-. became insolvent and were declared bankrupts. Plaintiff, the holder of one of said notes, proved the same before the register in bankruptcy as a debt against said bankrupts for the full amount as an unsecured claim, mentioning, however, the fact of the indorsement. In an action upon the note it was claimed by defendant that plaintiff, under the provisions of the twentieth section of the bankrupt act of 1867 (14 U. S. Stat. at Large, 517), prescribing the rule for the proof of debts secured in whole or in part by " 'mortgage, etc., by so proving the note relinquished and discharged the security pro tanto, and by means thereof defendant’s liability was discharged. Held, that plaintiff, hy so proving its debt, released all right and claim to the mortgages, as well at law as in equity, and could not thereafter make any claim, either under the mortgages directly or as creating a trust for its benefit, but that this did not impair or affect defendant’s interest in the securities, or his right to enforce them for his indemnity, and that therefore defendant was not released from his liability.
    (Submitted October 10, 1873;
    decided November 11, 1873.)
    Appeal from judgment of the General Term of the Supreme Court in the fourth judicial department, affirming a judgment in favor of plaintiff entered upon the report of a referee.
    This action was against defendant, as indorser of a promissory note for $2,500, dated March 25, 1871, made by the firm of Jay cox & Green. The facts, as found by the referee, are substantially as follows:
    The promissory note set forth in question was made by the firm of Jay cox & Green, and indorsed by the defendant for their accommodation, for the purpose of taking up a prior note indorsed by him. And it was expressly agreed that the said note should not be negotiated or used for any purpose except to take up and cancel such prior note. Instead of being so used, it was delivered by the makers to one George P. Hier, of Syracuse, as collateral security for a loan of money by him previously made to the makers. Afterward and before the maturity of the note, Hier had it discounted for his benefit at the plaintiff’s bank, and he received the proceeds. Hier was a director in the said bank, but neither he nor the bank had actual notice of the understanding and agreement herein above-mentioned under which the defendant indorsed the said note. On or about the 5th day of December, 1871 (before the making and indorsement of said note), the said Jay cox & Green executed to the defendant a bond together with a mortgage of real estate owned by them, for the security and protection of said Comstock, as their accommodation indorser. The said bond and mortgage were each conditioned that the said “ Jaycox & Green shall and do well and so truly pay, or cause to be paid, all the notes, bills or drafts made by the firm of Jaycox & Green, heretofore indorsed by the said George F. Comstock, or which shall hereafter be indorsed by him, as the said notes, bills and drafts shall become due to the holders thereof, and shall also well and truly pay unto the said Comstock, his executors, administrators or assigns, all sums of money which he shall be obliged to pay or shall pay on account of' any liability whatsoever for the said firm of Jaycox & Green, and shall fully indemnify him against all such liability, and against all cost, damage and expense arising on account of any such liability; provided, however, that the sum total of any such bills, notes, drafts and liabilities shall not at any time exceed seventy-five thousand dollars.” Neither the said George P. Hier, when he received said note, nor the plaintiff’s bank when they discounted it, knew of the existence of the said mortgage. . On or about the 16th day of April, 1872, the said firm of Jaycox & Green became and on their own petition were adjudged bankrupts by the District Court of the United States, in the northern district of New York; the said promissory note, and a large amount of other notes of said firm, so indorsed, as aforesaid, and not yet due, being then outstanding. Afterward, on the 15th day of July, 1872, the plaintiff, then holding the said note, appeared before the register in bankruptcy, in Syracuse, having charge of the matter, and in due form proved the same as a debt against the estate of the said bankrupts, without mentioning or referring in their proofs to the security so taken by defendant, but mentioning the fact that such note was indorsed by said Comstock. At the time of making such proof the said plaintiffs had learned the fact that the said Comstock had taken such security for his protection. Such proof was made without the knowledge of said Comstock, but without any intention of affecting in any manner his liability as indorser or the security so held by him.
    The referee directed judgment for the amount of the note, and judgment was rendered accordingly.
    
      
      A. R. Green for the appellant.
    
      L. W. Rail for the respondent.
   Allen, J.

The fact that the note in suit, of which the defendant was an accommodation indorser as the surety for the makers, was diverted from the purpose for which it was made and indorsed, to the prejudice of the indorser, is fully met and overcome as a defence by the fact, also proved, that the plaintiff became the holder and owner of the note before its maturity for value actually paid, and without notice of any defence to the note, or defect in the title of its immediate indorser. Although the immediate transferree of the note from the makers received it as collateral security for the payment of a precedent debt, and therefore, not being a holder for value, held it subject to all equities as well as legal defences of the surety indorser, his possession of and title to the note was good as against the maker and his indorser; the plaintiff, receiving it in the usual course of business, and for value, is within the protection accorded by the law-merchant to all bona fide holders for value of negotiable instruments, and, as against the plaintiff, the defence that the note was misappropriated by the principal debtor is unavailing to the indorser.

The case does not show that Hier, who transferred the note to the plaintiff, had any notice or knowledge of any restriction upon the right of the makers in the use of the note for their benefit, or that it was made for a special purpose, and it is therefore immaterial to inquire whether the knowledge of Hier is in law the knowledge of the plaintiff, a banking corporation, of which he was a director. The mere fact that he had taken the note for a precedent debt did not make it non-negotiable in his hands, or affect the title of the plaintiff parting with value for it. There is no complaint that, as between the makers and Hier, the latter had not the legal right to treat and use or transfer the note as his own, so that there was no defect in his title other than as against the indorser and as resulting from the diversion of it from its proper channel and use, and that was cured by a transfer to a bona fide purchaser for value.

The only other defence interposed rests upon the fact that the holder of the notes has proved the debt in bankruptcy against the makers for the full amount, as an unsecured claim, which it is claimed operated to release and discharge certain securities for the payment of the debt, by means whereof the defendant, as the surety of the makers, was discharged and released from his liability as indorser. The operation and effect of the proof of the debt in the form suggested upon the securities, and the rights of the plaintiff and the other creditors respectively in the bankruptcy proceedings, were presented in a somewhat different form, and under different aspects, and were considered by Judge Hall, in the District Court of the United States for the northern district of New York, in an elaborate and very able opinion, a copy of which has been furnished us. The questions in that court and in this are so radically different that the decision in the former cannot control here ; but the opinion is, nevertheless, valuable as collating the authorities, and enunciating, with great distinctness, the precise status of the plaintiff in respect to the securities in question, and its legal and equitable rights in respect to them, and the results logically and legally following the omission to recognize their existence, or claim any rights under them in making proof of the debt. The securities referred to were not to the creditors directly, but were by mortgages upon real property to the defendant, conditioned for the payment of any and all bills or notes indorsed by him, and to indemnify him against his indorsements for the makers of the note in suit subsequently becoming bankrupt as a firm, and as individuals. Neither the plaintiff, nor any holder of this or any of the indorsed notes secured by these mortgages, so far as appears, had at the time any knowledge of the taking of the securities, or has since affirmed the same as a security for their benefit, or made any claim to them or any benefit from them. No proceedings have been taken, or claim made, to establish and declare the mortgages to be liens or securities for the benefit of the creditors, either as a trust or otherwise.

It is shown very conclusively by Judge Hall, and by the authorities cited by him, that creditors, holding notes secured by these mortgages, were certainly, after the notes had become due, in equity entitled to the benefit of them, and to have them declared a trust fund for the payment directly to them of the debts intended to be secured, and to compel an application of the securities to that purpose. (Maure v. Harrison, 1 Eq. Cas. Ab., 93; Moses v. Murgatroyd, 1 J. C. R., 119; Pratt v. Adams, 7 Paige, 615; Story Eq. Jur., § 638.)

There can be no doubt that the learned judge was entirely right in holding as he did that this equity was a substantial right well recognized both at law and equity, and somewhat analogous in legal effect for the purposes of that investigation and the decision of the questions then before the court, too, although not in any sense the equivalent of a security directly to the creditor, and was within the equity, although not within the terms of the twentieth section of the bankrupt act of the Hnited States, of March 2, 1867, which prescribes the rule for the proof of debts secured in whole or in part by a mortgage or pledge of real or personal property. It necessarily followed the reasoning of the learned judge, as was adjudged, that the creditor, by proving his debt for the full amount, without taking notice of the security named, had released all right and claim to them, as well at law as in equity, and could not thereafter make any claim to a lien of any kind, whether under the mortgages directly or as a trust for the benefit of the holders of the notes. (In re Bloss, 4 Bank Reg., 37; In re Brand, 3 id., 85 ; The New Bedford Inst. for Savings v. Fairhaven Bank, 9 Allen, 175.) These and many other authorities are referred to by Judge Hall in support of his judgment. But it by no means follows that the surety is discharged from his liability as indorser. The plaintiff has done no act affecting the securities to the defendant, but has merely declined to claim or take any benefit under them, and, if Judge Haul is correct, in legal effect, released the equities it might have claimed. The securities were taken by the defendant and primarily for his benefit, and the creditors were not parties to the transaction. The validity of the securities did not depend upon any ratification or affirmance by the plaintiff or other person. It was a completed and valid transaction between the defendant and his principals, and it was only in equity and upon a direct proceeding for that purpose that the creditors could be subrogated to his rights over the securities, and, in any event, they must have been applied in the first instance to his indemnity. (Eastman v. Foster, 8 Met., 19.) It was optional with the plaintiff to seek and take the benefit of any trust or equitable lien which the law would have given it, or to waive such right and rest content with the personal responsibility of the indorser and the security of the indorsement. The plaintiff could not be coerced to avail itself of the securities. Standing aloof from the transaction the plaintiff has not, in any manner or to any extent, affected the securities held by the indorser, or his right to enforce them for his indemnity; and all the court in bankruptcy has declared is that, by omitting to assert the equitable rights which it had before proving the debt as unsecured, it shall not now, as against other creditors, be permitted to assert such equities. The plaintiff is left to its remedy against the indorser, and the latter has the benefit of his securities, and to every other legal and equitable right against the makers and their estate. The rights of the indorser have not been impaired or affected by the act of the plaintiff and the proof of the debt as unsecured. It was unsecured to the plaintiff except by the indorsement of the defendant. There was no mortgage, lien or pledge of the property of the bankrupt to the plaintiff, and the security to the defendant was not released, and could not be released by any act of the plaintiff. The defendant has the right to enforce his security, and should he pay the debt, to share, by subrogation to the plaintiff’s rights, in the distribution of the assets of the bankrupt. (Thornton v. McKewan, 1 Hem. & Miller, 525 ; Ex parte Hope, 3 Mont., D. & De Gex., 720 ; In re Babcock, 3 Story, 393; Richardson v. City Bank, 11 Gray, 26 1; Meed v. Nelson, 9 id., 55.) But it suffices that the defendant was not affected by the proof of the debt as unsecured, and that, therefore, the defendant was not released from his liability.

The judgment must be affirmed.

All concur.

Judgment affirmed.  