Case Digest: Fulton Iron Works Co. v. China Banking Corporation, G.R. No. 32576, November 6, 1930

Commercial Law | Bank Deposit

Facts:

• In March 1921, Fulton Iron Works, a Delaware corporation, sold machinery for sugar mill to Binalbagan Estate, Inc., a Philippine corporation.
• Three promissory notes totaling $80,000 were executed by Binalbagan Estate, Inc., but none were paid since it went under the administration of the Philippine National Bank.
• Fulton Iron Works Co. hired a Manila law firm, where Sydney C. Schwarzkopf was a member and was in a visit in United States, to secure the debt. 
• When Schwarzkopf returned to Manila, and the law firm dissolved and he alone was concerned in the matter.
• Schwarzkopf opened a personal account in the China Banking Corporation.
• He received a check for P10,000 from the Philippine Sugar Centrals Agency, which he deposited into a new account ("No. 2 account") with the bank.
• This money was used by Schwarzkopf for personal expenses, with no proof that the bank was aware it belonged to someone else.
• In April 1922, Schwarzkopf received a check for P61,237.50, also from the Philippine Sugar Centrals Agency.
• He deposited this into a new account titled "S. C. Schwarzkopf, Attorney-in-Fact, Fulton Iron Works Co." with the defendant bank.
• During the next two months, this account accumulated an additional P130.
• The No. 2 account became depleted over time.
• The bank manager, aware of funds in Schwarzkopf's third account, extended a credit of P25,000 to cover the overdraft.
• By June 1922, the No. 2 account was overdrawn by P22,144.39, nearing the credit limit.
• The bank manager intervened, urging Schwarzkopf to settle the overdraft.
• Schwarzkopf transferred P61,360.81 from his special account as plaintiff's attorney-in-fact to the No. 2 account via check.
• This transfer cleared the overdraft and left a credit balance of nearly P40,000 in the No. 2 account.
• Schwarzkopf then purchased a $15,000 draft on New York, costing him P30,375.02.
• This draft was transmitted by mail to the Fulton Iron Works, marking the only remittance Schwarzkopf made to his client.
• Schwarzkopf collected a third check from the Philippine National Bank for P104,959.60, payable to him as attorney-in-fact for Fulton Iron Works Co.
• Upon receiving the check, Schwarzkopf indorsed it properly and deposited it into his personal account No. 2.
• Over the following months, Schwarzkopf withdrew the entire amount from his account No. 2 through self-written checks, thereby misappropriating the funds for personal use.
• Fulton Iron Works Co. filed a complaint against China Banking Corporation and S. C. Schwarzkopf for the sum of P131,197.10, with interest, alleging misappropriation of funds deposited in the bank by Schwarzkopf.
• The amount is part of a larger sum of money (P176, 197.10) belonging to the plaintiff which had been deposited in the defendant bank by Schwarzkopf and which had been misappropriated and embezzled by him, with the full knowledge and consent of the defendant bank.

CFI-Manila: Absolved Schwarckopf from the complaint but ruled in favor of Fulton Iron Works Co., to recover of the defendant bank the sum of P127,200.36, with lawful interest from the filing of the complaint.

• Reason: In two prior criminal proceedings he had been convicted of the offense of estafa, based upon his misappropriated of the same money, and in said proceedings the obligation to indemnify the plaintiff had been imposed upon him in the amount of P146,197.40. 

Issue: 

• Whether the defendant bank is liable to the plaintiff for the sum of P22,144.39 which was thus applied to the payment of Schwarzkopf's personal indebtedness resulting from his overdraft in the No. 2 account. YES

Held:

A depositor is presumed to be the owner of funds standing in his name in a bank deposit; and where a bank is not chargeable with notice that the money deposited in such account is the property of some other person than the depositor, the bank is justified in paying out the money to the depositor or upon his order, and cannot be liable to any other person as the true owner. It is hardly necessary to cite authority upon a proposition so manifestly in accord with the usage and the common sense of the commercial community. The proposition stated is implicit in all the cases concerned with the question of the liability of a bank to its depositors and other persons claiming an interest in the deposits.

Upon this point the first thing to be noted is that the very form in which the third account was carried on the books of the defendant bank was sufficient to charge the bank with notice of the fact that the money deposited in said account belonged to the Fulton Iron Works Co. and not to Schwarzkopf. It is commonly said, and truly said in a legal sense, that money has no earmarks. But bank accounts and commercial paper can have earmarks, and these earmarks consist of the word or words which infallibly convey to the mind notice that the money or credit represented by the account with which they are associated or the instrument upon which they are written rightfully belongs to some other person than the one having control thereof. A bank cannot permit, much less require, a depositor who is in control of a trust fund to apply any part of the same to his individual indebtedness to the bank. The decisions to this effect are uniformly accordant and it is believed no creditable authority to the contrary can be produced from any source. The expression "trust fund," in this connection, is not a technical term, and is applied in a loose sense to indicate the situation where a bank account or negotiable securities of any sort are under the control of a person other than the true owner. 

Upon the facts before us it is evident that when credit to the extent of P25,000 was conceded to Schwarzkopf in his personal account No. 2, the eye of the banker was fixed upon the large amount then upon deposit to Schwarkopf's credit in his account as attorney-in-fact; but of course, if a bank cannot apply the money in such an account, or even permit it to be applied, to the personal indebtedness of the fiduciary depositor, it is not permissible for the bank to extend personal credit to such depositor upon the faith of the trust account. From any point that the matter be viewed, the liability of the bank is clear to the extent of P22144.39 this being the amount derived from Schwarkopf's account as attorney-in-fact which was absorbed by his overdraft in account No. 2 when the transfer of the balance in the former account to the latter account was effected, in the manner already stated.

We next proceed to consider the disposition made of the proceeds of the third check collected by Schwarzkopf upon account of plaintiff's claim against the Binalbagan Estate, Inc., from the Philippine National Bank

It will be noted that the money thus squandered comprised not only the proceeds of the check last mentioned but the residue, consisting of a few thousand pesos, which had been left in No. 2 account after the overdraft had been paid and Schwarzkopf had remitted the draft of $15,000 to his principal in the United States. We consider that, from a legal point of view, the situation with respect to this money is precisely the same as that presented with respect to the money which came into the account later by deposit of the check for P104,959.60 above mentioned, because as to both funds, liability is sought to be fixed upon the bank by reason of its knowledge of the source from which said funds were derived; and in this connection it should be noted that there is no proof showing that the defendant bank had any knowledge of the misappropriation of this money by Schwarzkopf other than such as might have been derived from an inspection of its own books and the checks by which the money was paid in and paid out.

The feature of the case now under consideration brings us, it must be admitted, into debatable territory, but a discriminating analysis of the legal principles involved leads to the conclusion that the defendant cannot be held liable for money paid out by it in ordinary course on checks, in regular form, drawn by Schwarzkopf on the No. 2 account.

The specialized function of bank is to serve as a place of deposit for money, to keep it safely while on deposit, and to pay it out, upon demand to the person who effected the deposit or upon his order. A bank is not a guardian of trust funds deposited with it in the sense that it must see to their proper application nor is it its business to pry into the uses to which moneys on deposit in its vault are being put; and so long as it serves its function and pays the money out in good faith to the person who deposited it, or upon his order, without knowledge or notice that it is in fact assisting in the misappropriation of the fund, the bank will be protected. As is well said by the author of the monographic article on Banks and Banking in Ruling Case Law, It would seriously interfere with commercial transactions to charge banks with the duty of supervising the administration of trust funds, when, in due course of business, they receive checks and drafts in proper form drawn upon such funds in their custody. The law imposes no such duty upon them

There are, it is true, decisions from a few courts, deservedly held in high esteem, to the effect that a bank makes itself an effective accomplice in the conversion of a trust fund when, with notice of the character of such fund, it permits the person in control thereof to deposit it in his personal account. But the decided weight of judicial authority is to the contrary; and it is generally held that the mere act of a bank in entering a trust fund to the personal account of the fiduciary, knowing it to be a trust fund, will not make the bank liable in case of the subsequent misappropriation of the money by the fiduciary. 

The bank has the right to presume that the fiduciary will apply a trust fund to its proper purpose, and at any rate the bank is not required to send a courier with the money to see that it reaches a proper destination.

In the case before us an intimate study of the checks which came into the defendant bank against account No. 2 over a series of months, would have led a discerning person to the conclusion that the plaintiff's money was being squandered, but such an inference could not legitimately have been drawn from the first few checks which were drawn upon the fund, and it would be hard to say just where the bank, supposing its suspicions to have been aroused, should have intervened. No such a duty is imposed. Of course, when the bank became a party to the application of part of the plaintiff's money to the satisfaction of the overdraft in No. 2 account, it was directly chargeable with knowledge of the misappropriation of the fund to the extent of the overdraft and that fact, as we have already said, made the bank liable. But this rule cannot be extented to subsequent acts of malversation and misappropriation committed by the fiduciary against the real owner of the fund.

Furthermore, it is undeniable that a bank may incur liability by assisting the fiduciary to accomplish a misappropriation, although the bank does not actually profit by the misappropriation. A decision illustrating this aspect of the law is found in Washborn vs. Linscott State Bank (87 Kan., 698), where a bank, to help the treasurer of a lodge to conceal his defalcations, permitted him to overdraw, and when his account were to be audited, issued to him a deposit certificate for the shortage, payable to the lodge. After the audit was made, the certificate was returned and cancelled, and the shortage reappeared. The court held that a loan had been made to the treasurer personally, and that the bank became liable to the lodge upon cancelling the deposit certificate. 

Our discussion of this phase of the case should not be concluded without reference to Bischoff vs. Yorville Bank (218 N. Y., 106), which undoubtedly affords some support to the contention of the appellee that the defendant bank is liable not only for the proceeds of the last check collected by Schwarzkopf, but for all of the money which was transferred to account No. 2 from the account of Schawarzkopf as attorney-in-fact. This decision comes, it must be admitted, from a court of high repute. But we are unable to accept the court's conclusions, as applicable to the facts before us. In the case mentioned it appeared that an executor, named Poggenburg, having money on deposit in a certain bank to his credit as executor, gradually withdrew about $13,000 from said deposit by checks drawn by him, over a long period of time, in the character of executor. These checks were indorsed by Poggenburg in his own name simply and deposited in the defendant Yorkville Bank to his personal credit. At the inception of this series of transactions Poggenburg was indebted by note to the defendant and payments were made on this note and other notes thereafter executed in favor of the bank, out of the funds transferred as above stated. The court held, upon the facts before, it that the defendant knew at all times that the credits created by the various deposits through checks of the executor were assets pertaining to the estate of which Poggenburg was executor; and from this fact, in connection with the misapplication of part of the money to the payment of the personal notes of Poggenburg, the court held that the defendant bank was liable to the extent of the whole amount misappropriated by means of the personal account.

It will be noted that this decision was made in third instance, after a trial in first instance possibly before a jury and after the judgment against the bank been affirmed upon appeal in the appellate division of the Supreme Court. The prior history of the case was therefore such as to entitle the findings of fact of the two prior courts of great weight, and these courts had found in effect that the defendant bank had acted in bad faith. If not explicable upon this ground, the decision in the Court of Appeals must be considered a unique variant from accepted doctrine in this that while repudiating the idea, favored by a few courts that the act of depositing a trust fund in the personal accounts of the fiduciary is an effective act of conversion on the part both of bank and fiduciary, the court nevertheless held that the act of the bank in permitting the application of part of the money to the personal indebtedness of the fiduciary afforded a sufficient basis for finding the bank to have been an accomplice in the subsequent misapplication, by the fiduciary, of other portions of the deposit. We can accede to the first of these propositions but not to the second. In this connection we refer to the Annotation appended to Allen vs. Puritan Trust Co. (L. R. A. 1915C, 518, 529), where the pertinent cases are analyzed and the conclusion stated that, by the weight of authority, the placing of a trust fund in the personal account of the fiduciary does not make the bank liable for a subsequent misappropriation of the money by the former. For the rest it is enough to say that there is no proof in this case that the defendant bank had any guilty connection in fact with the dishonest acts of Schwarzkopf, in squandering the contents of the No. 2 account after he had made his remittance of $15,000 to his principal.

In conclusion we ought to add that the legal principles involved in this decision are not directly deducible from the provisions of the Negotiable Instruments Law, which is in force in this jurisdiction (Act No. 2031); and there is no provision of the Civil Code or Code of Commerce directly bearing upon the point under consideration. The liability of the defendant bank, to the extent recognized in this decision proceeds upon the fundamental idea that a creditor cannot apply to the obligation of his debtor money which as he knows belongs to another, without the consent of the latter, — a principle implicit in all law. We note that the attorneys for the appellant bank have suggested in their brief that, supposing the bank to have been an accomplice of Schwarzkopf in the misappropriation of the plaintiff's money, its subsidiary liability was extinguished as a result of the criminal proceedings against Schwarzkopf. This suggestion is clearly untenable, with respect to the liability which is fixed upon the bank by this decision.

From what has been said it follows that the appealed judgment must be modified and the same is hereby modified by reducing the amount of the judgment against the bank to the sum of P22,144.39 with lawful interest from June 23, 1926 until date of payment, without pronouncement as to costs. So ordered.