
    Edward J. Patterson and Others, Suing on Their Own Behalf and on Behalf of All Other Bondholders Similarly Situated under the Trust Mortgage Given by the Metropolitan Real Estate Improvement Company to the Guardian Trust Company of New York, etc., Appellants, v. Guardian Trust Company of New York, Respondent.
    Third Department,
    May 3, 1911.
    Mortgage — implied covenant of trustee to extinguish prior mortgages — breach of implied covenant by allowing mortgagor to use funds — liability of trustee to bondholders.
    A trust mortgage - executed to- secure the payment of bonds to be issued to the mortgagor and to he paid for in ten equal annual installments, provided that the mortgagor intended to pay off prior mortgages with the proceeds of the sale of the bónds and would during the third and fourth year of the mortgage pay certain sums to the trustee, which on Its part agreed to apply the moneys to the payment and satisfaction of the prior mortgages. A portion of the bonds, with the knowledge and consent of the trustee, were issued and sold as paid-up bonds and were certified as such to the trustee, which, having received the money, suffered the mortgagor to withdraw it instead of applying it to the payment of the prior mortgages.
    
      Held, that there was an implied covenant upon the part of the trustee to aPPly the moneys received from the sale of the bonds to the extinguishment of the prior mortgages, and, having violated such covenant, it was hable to a holder of bonds issued as paid up where the property covered by the mortgage was sold on foreclosure of the prior mortgages which the trustee had failed to pay. t
    
    Although a party does not in express terms undertake to do a particular act, a covenant to do it will be implied and read into an instrument if, from the text of the agreement or the surrounding circumstances, it be manifest that the parties so intendéd, and for a non-performance of the act an action of covenant will lie.
    Houghton, J., dissented, with opinion.
    ' Appeal by the plaintiffs, Edward J. Patterson and others, 'from, an interlocutory judgment- of the Supreme Court in favor of the defendant, entered in the office of the clerk of the county of Broome on the 4th day of November, 1910, upon the decision of the court, rendered after a trial at the Broome Special Term, sustaining the defendant’s demurrer to the complaint.
    
      
      S. Mack Smith, for the appellants.
    
      Henry D. Hotchkiss and Joseph Diehl Fackenthal, for the respondent.
   Sewell, J.:

The defendant interposed a demurrer to the complaint upon the ground that it does not- state facts sufficient to constitute a cause of action. The complaint alleges, among other things, that the Metropolitan Eeal Estate Improvement Company is a foreign corporation and that the defendant is a domestic corporation, having power under its charter to act as trustee under a mortgage; that on the 24th day of November, 1905, the Metropolitan Eeal Estate Improvement Company executed and delivered to the defendant, the trustee therein, a mortgage upon a tract of land in the city of Yonkers to secure the payment of 2,000 bonds of $500 each, to be issued by the improvement company, and to be paid for in ten equal annual installments, and that at the time of the execution of the mortgage the property was incumbered by existing mortgages to the amount of $263,400.

The mortgage as pleaded provides that “ Whereas it is desired and intended to pay off the said mortgages, and each of them, out of the proceeds of the sale of the bonds herein described, now, therefore, it is hereby agreed by the said company that during-the third year of the life of this trust mortgage it will pay to the Guardian Trust .Company as trustee the sum of $60,000, and during the fourth year of the life of this mortgage the sum of $100,000, and such further sum or sums as may be necessary to pay the principal and interest due On said mortgage, and to procure the discharge and satisfaction thereof, and the said Guardian Trust Company as trustee hereby agrees to apply such payments when so made to the payment and satisfaction of the said mortgages. ” The mortgage also provides that the bonds secured by the mortgage shall be signed by the president of the company and have the corporate seal affixed and attested by the secretary, and that none of the bonds shall be issued or be of any binding force until the same are authenticated b«y a certificate of the trustee, “that the within bond is one of .the series of bonds described in the trust deed0or mortgage therein described.” It further provides that the bonds shall be delivered by the trustee only to the treasurer of the company, and then “only upon the written order of that company, signed by its president; ” that none of them shall be valid until the first annual installment of fifty dollars has been paid to the improvement company, and that all payments “ are due at the Metropolitan Beal Estate Improvement Company’s office, in the city of New York,” and that “upon the payment of each installment on this bond the holder is entitled to receipt signed by the president, the vice-president or treasurer” of the improvement company, which must be attached to the bond and shall be conclusive evidence of such payment and the- amount thereof.

The complaint also alleges that of the 2,000 bonds secured by the mortgage, more than 800 were issued and sold with the knowledge and consent of the defendant as paid-up bonds; that they were certified as paid-up bonds by the defendant as trustee; that there was paid therefor the sum of $400,000; that the defendant was the depositary of the moneys received from the sale of the bonds, and suffered the said Metropolitan Beal Estate Improvement Company to withdraw and misapply the moneys “without applying the same to the payment of said ■underlying indebtedness.”

It further alleges that no part of the principal of the underlying mortgages was paid the defendant except one held by Bandolph Lowerre to secure the sum of $8,400; that in the year 1908 two of the mortgages, on which there was then, due the sum of $80,000, were foreclosed, and the real property described in the trust mortgage was sold for less than the amount due upon the underlying indebtedness, and the defendant as trustee was divested of all right therein; that the Metropolitan Beal Estate Improvement Company is insolvent; that the plaintiffs are the owners and holders of three of the bonds certified by the defendant as paid-up bonds,. and that this action is brought on behalf of all the bondholders who may desire to come in and contribute to the expense thereof.

It is also‘alleged that by and under the terms of the trust mortgage it became- and was the duty of the defendant as trustee, and as the representative of the plaintiffs, to compel the application of the moneys received from said paid-up bonds to the payment of the underlying indebtedness, and that it violated its covenants and agreements by failing to apply the moneys received from the sale of the bonds to the payment of the underlying indebtedness, as provided in the mortgage, and in knowingly suffering and permitting the company to misapply the proceeds and appropriate the moneys without applying the same to the payment of the underlying indebtedness.

' In Davidge v. Guardian Trust Co. (136 App. Div. 78) this court in construing the .mortgage now before us held that the fair intent of the provision for the payment of the prior mortgages was “that after three years’ installments had been paid, the trustee must commence to reduce the prior incumbrances and pay $60,000 thereupon, and after four installments had been paid the trustee should pay such further sum as was necessary to satisfy the mortgage.”-

We still are of the opinion that the use of the words “third year ” and “ fourth year ” in this provision is only important as indicating from which installments the prior mortgages were to be paid and as showing that, according to the scheme of the mortgage, the improvement company could not collect, and was not entitled to receive, more than $200 on each bond without providing for the payment of the prior mortgages.

The charge in the complaint is that the defendant rested under the implied covenant, as well as the legal duty, to apply the proceeds of the bonds deposited with it to the .payment of the prior mortgages, or if it had no right to make such appropriation without the authority or consent of the company to withhold the proceeds and prevent their use or disposition for any other purpose. ■

It. has 1/een repeatedly held that, although a party does not in express terms undertake to do a particular act, a covenant to do it will be implied and read into an ■ instrument, if from the text of the agreement or the surrounding circumstances it is manifest that the--parties so intended, and that for a non-performance of the act an action of covenant will lie. (Booth v. Cleveland Mill Co., 74 N. Y. 15; Morgan v. Mayor, 160 id. 516.) It seems to us clear, from the inference naturally derivable from the provisions of the mortgage, the disclosed purposes of the parties in making the mortgage, and the result they sought to accomplish, that it was not intended that the defendant should be a mere dummy, or that it should be charged with no duty in respect to tíre preservation or.protection of the proceeds of the bonds until" they were actually paid to it by the company to be applied upon the prior mortgages.

In accepting the trust and becoming a mortgagee in trust for the benefit of the bondholders, the defendant undoubtedly undertook to discharge the duty and exercise the care and diligence which would naturally be expected of an intelligent person acting in like circumstances to protect his own mortgage. (King v. Talbot, 40 N. Y. 76.) It is conceded that this was not done. The scheme of the mortgage was departed from and 800 of the 2,000 bonds were issued and sold as paid-up bonds, and were certified as paid-up bonds by the defendant. The sum of $400,000, paid therefor, was deposited with the defendant and was in its possession and under its control. It had complete knowledge of the provisions of the mortgage which required the prior liens to be fully paid before the fifth installment became. due. It knew that the payment of the prior liens was one of the purposes for which the mortgage was made and the bonds were issued. It Imew or was chargeable with knowing, not only that it was vested with certain legal rights against the improvement company, but that it had a lien or equity in the .nature of a trust which gave it the right to retain possession of enough of the' proceeds to pay the prior mortgage, and to subject it to that purpose, if it did not have the power to make the appropriation. It would seem too clear for argument that the plainest principles of justice require the implication of a covenant imposing upon the defendant the obligation to exercise ordinary vigilance and intelligence in protecting the proceeds of the bonds, and to see that they are applied to the payment of the prior mortgages. If we are right in this conclusion, it is evident that the complaint states a cause of action for the breach of the covenant.

We, therefore, are of the opinion that the interlocutory judgment should be reversed, with costs, and the demurrer overruled, with costs, but with leave to the defendant tó withdraw the demurrer and answer upon payment of the costs' of the appeal and of the demurrer.

All concurred, except Houghton,'J., dissenting in opinion; Betts, J., not sitting. . ■ • .

Houghton, J. (dissenting):

I think the complaint does not state facts sufficient to constitute a cause "of action against the defendant, and that the interlocutory judgment sustaining the defendant’s demurrer should be affirmed’ ...

I do not understand the decision of this court in Davidge v. Guardian Trust Co. (136 App. Div. 78) to be controlling upon the question presented upon this appeal. The only question decided in that case was whether or not an officer of the defendant falsely represented, to the damage of a bondholder, that the mortgage in question was a first lien when in fact it was not. In the course of the opinion-it was stated that it was the duty of the defendant as trustee under the mortgage, when three or more installments on the bonds had been paid, to begin to apply the subsequent installments to the liquidation of the first mortgages upon the property. This statement was by way of argument and obiter, so far as the precise question presented for decision was involved, and, therefore, it seems to me, should not be regarded as controlling our decision in the present case.

Treating the obligation of the defendant as trustee under the mortgage as an open question, I do not think the defendant was under the express or implied obligation to liquidate and satisfy any of the prior mortgages upon the real property, except as the money was paid to it by the Metropolitan Beal Estate Improvement Company • for that particular purpose. There is no allegation in the complaint that moneys were paid by the real estate company to the defendant for such purpose. The burden of the complaint is that the defendant knew, actually,. or in law, that the real estate company was selling bonds upon which the ten full installments had been paid without paying over to the defendant any of the money so received for the purpose of liquidating and satisfying the first mortgages upon the property j and that in some ■ way not pointed out it was the duty of the defendant to stop such procedure.

' The mortgage is made a part of the complaint, and although there is an allegation that it was the duty of the defendant to see to it that moneys were applied for the satisfaction of the prior mortgages, this allegation is controlled and limited by the provisions of the mortgage itself. Looking to the mortgage to ascertain the duties of the defendant, we find in the recitals that it is the intention of the real estate company in giving the mortgage to the defendant to issue bonds payable in ten annual installments. There is nothing in the instrument, however, prohibiting a purchaser from paying all the installments at one time. All moneys paid for bonds were to be paid to the real estate company at its place of business. The only prescribed duty of the defendant with respect to the bonds is tó certify . that each was one of a series of bpnds described in the trust deed, and after certifying it was compelled to deliver the bonds, not to the purchaser, but only to the treasurer of the real estate company upon an order signed by the president and attested by its secretary with its-corporate seal. The defendant as trustee, therefore, had no control over the sale of the bonds or the receipt of any proceeds from such sale, and the allegation of the complaint that such proceeds were deposited with the defendant, and the claim that it should have withheld from such deposit made with it, not as trustee but as banker, sufficient to pay the prior mortgages upon the. real property, seems to me wholly untenable in view of the particular provision of the mortgage, made a part of the complaint and by which we must be guided with respect to the defendant’s duty as trustee in regard to paying the existing mortgages upon the property. Such provision reads as follows:

“ Twentieth. Whereas there are now existing mortgages which are lien upon the property. or. a portion thereof herein-before described and upon which this mortgage is given and intended to become a lien before the maturity of the said existing mortgages, which said mortgages are as follows: [describing them]. Whereas, it is desired and intended to pay off the said mortgages and each of them out of the proceeds of the sale of the bonds herein described, now, Therefore, it is hereby agreed by the said company [real estate company] that during the third year of the life of this trust mortgage it will pay to the Guardian Trust Company as Trustee the sum of $60,000, and during the fourth year of the life of this mortgage the sum of $100,000, and such further sum or sums as may he necessary to pay the principal and interest due on said mortgage and to procure the discharge and satisfaction thereof, and the said Guardian Trust Company as Trustee hereby agrees to apply such payments when so made to the payment and satisfaction of the said mortgages. That it will make such applicátion of such payments pro rata, unless' the order of such application shall be differently directed by said company [real estate company], in which, case it will make such application of such payments as directed by such company.”

There is no allegation or claim that any part of the $60,000 or of the- $100,000 above mentioned was ever paid to the-defendant for the purpose of liquidating the • first mortgages upon the property. . If such moneys had been paid to it and it had failed to apply them of course ‘it would he liable. The ground of complaint is that the defendant trustee having on deposit moneys belonging to the- real estate company as banker, knowing or having reason to know that inore than three-tenths payments on the bonds had. been paid, and that in fact • all installments had been paid, did not in some way throttle the real estate company and compel it to pay over to the defendant as trustee the $60,000 and the $100,000 .for the purpose of satisfying the prior mortgages. The duty of the defendant as specifically stated certainly required it only .to pay over moneys in satisfaction of the prior' mortgages when such moneys were paid to it for that purpose. This duty is* so explicitly stated that to my mind there is no room' for implying any further duty. By' the trust mortgage the defendant did not agree to watch out for bondholders and see that the real estate company , did its duty toward the purchasers of its bonds by liquidating and .satisfying- the prior hens upon the property.. The obligation which it assumed was the ordinary one of trustee of .a trust mortgage. It had no control over the proceeds derived from sale of the bonds. The fact that such proceeds were’deposited with it as hanker gave the defendant no right to confiscate súch proceeds for the purpose of paying prior mortgages, . If had no more right to do that than it would have had if the money had been deposited in any other bank. It could only pay the first mortgages when the money was paid by the real estate company to it for that purpose, and having no right to make any such payment from general funds on deposit it violated no duty by not doing so.

In addition, if it ever was the duty of the defendant to confiscate any money it could get hold of for the purpose of satisfying the prior mortgages, still the time never arrived when it became its duty so to do. ■ Clearly no such duty arose until some time during the third year of the life of the trust mortgage. The term “third year,”-as used in the mortgage, cannot mean “third installment.” The mortgage was executed the 24th day of November, 1905. If the defendant was under any obligation to see to it that the first mortgages were satisfied, it manifestly had the whole of the year beginning November 24, 1908. The complaint alleges that the bonds. in controversy were sold in 1906 and 1907 and that the real estate company was insolvent ever since the year 1907, and that in or about the year 1908 the prior mortgages were foreclosed and the property sold for less than the amount of the prior mortgages, thereby wholly cutting off the trust mortgage.. The date of such sale in 1908 is not stated, but it is fair to assume from the other allegations of the complaint that it was prior to the twenty-fourth of November, and in any event the defendant had more than ten months of the year beginning November 24, 1908, in which to perform its obligation of paying off the prior mortgages, if any such obligation existed. The allegations of the complaint show that it was powerless to do this because the real estate company was insolvent the year previous, and, therefore, could not have had on deposit any •money which the defendant could appropriate for the paying of such prior mortgages.

For these reasons I think the interlocutory judgment was right and should be affirmed.

Interlocutory judgment reversed, with costs, and demurrer overruled, with costs, with leave to defendant to withdraw demurrer and answer upon payment of costs of demurrer and of this appeal.  