Story Case

The Western Malt Company borrowed $2,000 on May 1, 1915, from the first National Bank of Springfield, giving its own note, due in six months, and indorsed by Simon Fuller, a director of the company, by way of surety. On September 25, 1915, the Western Malt Company deposited two notes, amounting to $3,000, for collection with the First National Bank. The bank forwarded the notes to New Orleans, where they were paid by the Malt Compound Company, the maker, on October 1,1915. Payment was made to the Southern National Bank, which forwarded the money to its correspondent bank in Chicago, and the latter paid the amount to the Springfield bank on October 4, 1915. The Springfield bank credited the account of the Western Malt Company with this sum, and the company checked out $2,600 on October 5. The note for $2,000, made by the Western Malt Company, was not paid on October 1, 1915, when due; the bank notified Fuller in due course, but made no effort to collect the amount from either the company or Fuller. On October 10, the Western Malt Company failed, and was put into the hands of receivers. The bank now attempts to collect the full amount of the notes from Fuller, who refused to pay, on the ground that the bank should have applied $2,000 out of the money received on the New Orleans collection in payment of the note. Does this constitute a good defense for Fuller?

Ruling Court Case. National Bank Of Newburgh Vs. Smith, Volume 66 New York Reports, Page 271; Volume 23 American Reports, Page 43

Thomas George executed a promissory note for $500. It was indorsed by Smith, and then discounted by the National Bank of Newburgh. The note fell due on February 17, and was not paid. It was duly protested by the bank, and the proper notice was served on Smith. At the time of maturity, George had $10.43 on deposit at the bank. On March 2 following, he deposited $500 in the bank. It was credited to his account. No instructions were given as to the application of this money. The note now past due was not charged to his account, it being the practice of the bank not to so charge unless the account will cover the entire note at the time it falls due. On March 4, another note made by George, payable at the National Bank of Newburgh, maturing on that day, was presented for payment. It was paid by the bank and charged up to George's account.

The $500 note, falling due on February 17, was never paid by George, and this action was brought against Smith, as indorser. The latter contended that as indorser of a promissory note he was surety as to the bank, and that, therefore, the bank was bound to apply to the payment of the note all funds under its control until the note was paid. The bank contended that it was optional with the bank whether or not to apply the deposit of March 2 in payment of the note in suit, and that Smith's liability became fixed by the protest at the time of maturity, and could not be discharged by any dealings between the maker and the bank which did not deprive Smith of his remedy against the maker of the note.

Decision rendered by the entire court: The question is not presented in this case whether the rights of the parties would have been changed if the maker of the note had to his credit a deposit sufficient to meet the note when it matured. At the time the note in suit was protested, the liability of Smith, as indorser, was fixed, for there were no funds appropriated to pav the note. The general deposit of funds afterwards without regard to the note, did not operate as payment. In the absence of an express direction or an agreement to that effect, it was optional with the bank whether or not it should apply the money upon the note in suit, and it was under no legal obligation to do so. Judgment was for the bank.

Ruling Law. Story Case Answer

It has been explained that, in accordance with the general rule, a surety is discharged if the creditor possesses an opportunity for satisfying his debt against the principal, and subsequently, releases this security or loses it through his own negligence. The rule, however, is not uniformly applied to bank deposits held in the name of the principal, where the bank, at the same time, is the creditor. The bank's failure to use the deposit toward payment of the obligation, will not discharge the surety. This is the rule in most states. It is based on the theory that the bank made a contract with the depositor at the time of the deposit, that it will honor checks drawn by him. It is the rule, however, that the bank has the option of using the deposit in payment of the note, except when the deposit has been made by the principal for a special purpose.

In Arkansas and Pennsylvania, it has been held that the bank must apply the deposit in payment of the note, provided that on the day the obligation falls due there is sufficient to pay the debt in full, otherwise the surety is discharged. This was held to be the rule in Dawson vs. Real Estate Bank, Volume 5 Arkansas Reports, Page 283; McDowell vs. Bank of Welmington, Volume 1 Harrington Reports, Page 369; and Commercial National Bank vs. Henninger, Volume 105 Pennsylvania Reports, Page 496. In Wisconsin it is the rule that the bank must apply any sum on deposit belonging to the debtor, no matter how small the amount. If it does not, the surety is discharged to the extent of the deposit.

All states agree, however, that a bank has no right to apply the deposit on a note which it holds for collection only, since this is for a special purpose. Especially is this true if the money has been received after the note of the bank became due. For this reason, in the Story Case, the defense of Fuller is not effective.