
    The Glens Falls National Bank, Plaintiff, v. Jane C. Van Nostrand, Defendant.
    (Supreme Court, Warren Special Term,
    October, 1903.)
    Composition agreement — Secret preference against public policy — Preference distinct from composition — Status of innocent party to the preference.
    A written guaranty, of a debt due a bank by an insolvent firm as endorser of a certain note held by the bank, procured by the firm of a third person to induce and inducing the bank to cancel the endorsement on the note and sign for the balance of its claim a compromise agreement of the firm's creditors — the transaction not being made known to the other firm creditors — is a secret preference to the bank and void as against public policy, even though the composition finally failed because of the refusal of some other creditors to sign the agreement therefor.
    A valid composition is not essential to render invalid an agreement for a preference, the law regarding the composition and the preference as independent transactions.
    Where the guarantor in her answer, to the bank’s action to enforce the guaranty and also sell stock deposited by her with it as collateral security for the performance of the guaranty, demanded the return of both guaranty and stock the court granted her that relief holding that there was nothing to show that she had notice that they were to form the consideration of an illegal transaction, and that in any event the bank had no title to either.
    Action upon an agreement of guaranty.
    Louis M. Brown (Edgar T. Brackett, of counsel), for plaintiff.
    William Ives Washburn, for defendant.
   Spencer, J.

In May, 1901, the firm of Samuel D. Davis & Oo., bankers, issued a circular letter to their creditors by which it appeared that their liabilities exceeded their assets by $1,324,012.81. It contained a proposition to compromise their debts at ten cents on the dollar, conditioned upon its acceptance by all their creditors. They owed the plaintiff $54,750. A part of this debt consisted of a past due, protested promissory note, made by the Railroad Equipment Co., indorsed by Samuel D. Davis & Co., and upon which there remained unpaid, the sum of $7,750. A large number of the creditors signed the composition agreement, but the plaintiff declined to do so. Thereupon Samuel D. Davis & Co., in order to induce the plaintiff to join the composition, agreed with the plaintiff that if the latter would cancel the firm’s indorsement upon the note of the Railroad Equipment Co. and sign the composition as to the remainder of its claim, they would obtain from the defendant her agreement to guarantee the payment of said Railroad' Equipment Co.’s note. The plaintiff accepted this offer, and thereupon canceled the indorsement of Samuel D. Davis & Co. upon the Railroad Equipment Co.’s note, signed the composition agreement as to the balance of its claim, and received from Samuel D. Davis '& Co. the following paper, signed by the defendant, to wit:

In consideration of the Glens Falls National Bank, erasing and canceling the indorsement of Samuel D. Davis & Co. on a promissory note, owned by said bank, made by the Railroad Equipment Co. for twenty thousand dollars ($20,000), payable to the order of Post & Pomeroy, and indorsed by them, and also by said .Samuel D. Davis & Co.; and also in consideration of the sum of one dollar to me in hand paid by said bank, the receipt whereof is hereby admitted, I, Jane C. Van Nostrand, guarantee the payment to said bank of the balance, both principal and interest, owing and unpaid on said promissory note within one year from the date hereof; and I also turn over to said bank two hundred (200) shares of the capital stock of the White Knob Copper Company, Limited, as collateral security for the performance of this guarantee, represented by certificates Nos. A.555 and A.1759, 100 shares each.

“ (Signed), Jane C. Van Nostband.”

This transaction was not made known to the other creditors. Samuel D. Davis & Co. failed to procure the acceptance of their offer of compromise by all their creditors and the composition, for that reason, never went into effect.

The plaintiff brings this action against the defendant upon the agreement executed by her, asking for a sale of the stock deposited, the application of the proceeds to the payment of the note, and judgment for deficiency.

The defendant resists, claiming: First. That she delivered the agreement upon the condition that it was to be returned to her in case the composition failed; and second, that the agreement is illegal, it having been delivered and received by the' plaintiff as a secret preference to induce the plaintiff to sign the composition.

I think the testimony fails to support the defendant’s contention that she delivered the agreement conditionally, and the second defense is the only one that remains.

The taking of a secret preference by a creditor joining in a composition agreement does not nullify the composition. The debtor and the preferred creditor both remain bound by its terms. Fon-preferred creditors may rescind if the secret agreement for preference has been executed; but so long as such agreement remains executory, it is unenforceable because of its illegality and cannot be employed for any purpose. This is in substance the decision of the Court of Appeals in the case of Hanover Nat. Bank v. Blake, 142 N. Y. 404, and must be regarded as the settled law of the land.

In most of the cases where this question has been discussed the agreements have been between the debtor and creditor alone. In such cases, the agreements are held void on the ground that they are fraudulent as to the other creditors of the debtors. Brady v. Cole, 4 Sandf. 79 ; Russell v. Rogers, 10 Wend. 473; Fellows v. Stevens, 24 id. 294; Bliss v. Matteson, 45 N. Y. 22; Adams v. Outhouse, id. 318.

This rule has also been applied where the consideration for the preference has been furnished by third parties, either with or without the knowledge and concurrence of the debtor.

Thus in Pinneo v. Higgins, 12 Abb. Pr. 334, the plaintiff, one of the creditors of an insolvent firm, put off signing the composition agreement until all the other creditors had signed, and thereupon refused unless the defendant — a third party — indorsed the debtor’s notes given in pursuance of the composition. In an action upon the indorsement, it was held that the agreement was fraudulent and that the plaintiff could not recover.

Also in Babcock v. Dill, 43 Barb. 577, an insolvent debtor effected a composition with his creditors. The defendant, without his knowledge, gave his own note to one of the creditors to induce the latter to sign the composition. The note was held to be fraudulent and void.

But in the more recent decisions, especially in the Court of Appeals, where this subject has been considered, the court has not put its decisions solely upon the ground of fraud, but has regarded the contracts as against public policy and refused to lend its assistance to their enforcement.

Thus in Solinger v. Earle, 82 N. Y. 393, the preference, took the form of a negotiable note, made by a third party. It was, however, transferred before it became due, and the maker was compelled to pay. He thereupon brought suit against the preferred creditor to recover back the amount so paid. It was held that the action could not be maintained on the ground that the plaintiff was a party to the illegal transaction and having voluntarily paid the note, could not, according to the general principles applicable to executed contracts void for illegality, maintain an action to recover back the money paid. In this connection, Andrews, J., speaking for the court, says: “ If the defendants here were plaintiffs seeking to enforce the note, it is clear they could not recover. The illegality of the consideration upon well settled principles would be a good defense. The plaintiff, although he was cognizant of the fraud, and an active participator in it, would, nevertheless, be allowed to allege the fraud to defeat the action, not, it is true, out of any tenderness for him, but because courts do not sit to give relief by way of enforcing illegal contracts, on the application of a party to the illegality.”

In the case of White v. Kuntz, 107 N. Y. 518, the plaintiff was the preferred creditor seeking to enforce an agreement made by a third party to purchase the notes taken by the plaintiff upon the terms of the composition, and which agreement was made to induce the plaintiff to enter into the composition. It was there held that the plaintiff could not recover, Judge Earl, speaking for the court, saying: “ The plaintiff upon familiar principles could not come into court and ask to have the agreement canceled. That agreement was fraudulent and void, and the parties thereto were in pari delicto and the courts would not aid either of them to enforce or cancel it.”

In Almon v. Hamilton, 100 N. Y. 527, Judge Andrews in speaking of secret preferences, says, “ a party to a composition between a debtor and his creditors, or who assents thereto, is not permitted to make a secret reservation of a part of his claim, from the operation of the compromise, or stipulate for a secret advantage over the other creditors. The law exacts of all the parties to a composition the most scrupulous good faith. It enforces a wholesome morality and inculcates the principles of honest and fair dealing, by defeating any advantage attempted to be gained, either by working upon the necessities of the debtor, or by colluding with him It will not permit a part of debt withheld from the arrangement, to be enforced, and it will compel the cancellation of securities, received in violation of the principle of equality. The- doctrine is based upon public policy, and the principles of commercial honor, and we should be very unwilling to weaken it by nice distinctions.”

We need not search further for the rule that should be applied to the case at bar. The testimony raises no doubt, in my mind, but that the agreement for the cancellation of the indorsement of Samuel D. Davis & Oo. upon the Railroad Equipment Oo. note, and the substitution of the defendant’s agreement in its place, was a secret agreement between the plaintiff and ¡Samuel D. Davis & Oo. It was not divulged. Failure to communicate a fact which another is entitled to know, is a suppression, especially when the one who fails to publish, obtains an advantage by so doing. Whether the negligence of the plaintiff, in its acceptance of the composition, to correctly describe its claim, was accidental or intentional, need not be decided. In either event such description was misleading to the other creditors, and the plaintiff must be held responsible for that description. The circular letter stated that the plaintiff’s claim amounted to $51,625, whereas, the plaintiff’s acceptance represented the aggregate of its claim which it subjected to the composition agreement at the sum of $64,075 ; thereby indicating, not that it had withheld a part of its claims mentioned in the circular letter from the terms of the composition, but indicating that it had included therein claims in addition to those described in the circular letter.

Eeither can there be any doubt from the testimony but that it was the additional security, believed to have been secured by reason of the defendant’s guaranty, which induced the plaintiff to join the composition. A preference was at all times insisted upon by the plaintiff. The only difficulty which the parties seemed to encounter was in regard to the form such preference should take.

The contention of the plaintiff, that inasmuch as the composition agreement was never consummated no fraud was in fact perpetrated upon any one, is a bold proposition; but whether sound or otherwise, has no application here. As we have seen an agreement for a secret preference does not nullify the composition to which it is related. They • are treated as separate and independent transactions. Hanover Nat. Bank v. Blake, 145 N. Y. 404. The invalidity of one does not affect the validity of the other. A valid and binding composition is not essential to render invalid an agreement for a preference. The invalidity of the secret preference springs from the character of the transaction itself — a transaction in violation of commercial integrity and ordinary business morality. It is a kind of over-reaching which honesty and fair dealing condemn.

The plaintiff’s further contention that the defendant’s agreement was not to guarantee the debt or obligation of the insolvent debtor, but to guarantee the debt of a third party, to wit, the Eailroad Equipment Go. is specious. I cannot see how such fact changes in any way the actual thing sought to be accomplished, to wit, a preference to the plaintiff. The bane of the transaction lies in the giving of the preference without the knowledge or consent of the other creditors, and when that exists, whatever may be its form, it renders the agreement for preference illegal and void.

The argument by plaintiff that it did not withhold any part of its claim from the composition, but in fact subjected it all thereto, because the Samuel D. Davis & Cb. indorsement on the Eailroad Equipment Go. note was canceled when it signed the composition, is sophistical .to the last degree. They were parts of the same transaction. The distinction attempted is artful but altogether too fine for practical purposes. It magnifies the form and destroys the essence of the deed.

The conclusion at which I have arrived on this branch of the case, is that the plaintiff received and still holds the defendant’s agreement and stock in pursuance of an agreement between it and Samuel D. Davis & Go., which agreement was and is void as against public policy, and that the court should deny its aid to the plaintiff in its effort to enforce the defendant’s agreement for a sale of the stock, and for a judgment for deficiency against her.

The defendant by her answer demands judgment for a return of her agreement and the stock pledged as security therefor. Should the court grant her relief ? As before stated, the testimony fails to support her claim that the agreement and stock were delivered upon the condition that the composition went through. Neither is there any evidence to support the contention that the agreement and stock were obtained from her by duress within the English rule of Smith v. Bromley as limited in Solinger v. Earle, 82 N. Y. 393. But it cannot be said, as in the case last referred to, that she was a party to the illegal transaction. She has not done anything from which she may be regarded as in pari delicto in the transaction between, the plaintiff and Samuel D. Davis & Co. Apart from the secret agreement for preference between plaintiff and Samuel D. Davis & Co., her agreement was a proper and legal one. There is no evidence from which it can be found or inferred that she had notice that her agreement and stock were to form the consideration of an illegal transaction. By means of that transaction, the plaintiff acquired no title to her stock or any enforceable rights under her agreement. Why then should she not be entitled to a return of such agreement and stock 1 I can find no reason for denying the aid of the court in accomplishing that' result.

Let findings be prepared in accordance with the views herein expressed and judgment entered for the defendant dismissing the complaint and for a return of the defendant’s guaranty agreement together with the stock delivered as collateral thereto, with costs of the action.

Judgment accordingly.  