1. The ratification by one of the unauthorized act of another
operates upon the act ratified precisely as though authority to do
the act had been previously given, except where the rights of third
parties have intervened between the act and the ratification. The
retroactive efficacy of the ratification is only subject to this
qualification, that intervening rights of third persons are not
defeated by the ratification.
2. An exchange of values may be made at any time, though one of
the parties to the transaction be insolvent. There is nothing in
the Bankrupt Act which prevents an insolvent from dealing with his
property -- selling or exchanging it for other property -- at any
time before proceedings in bankruptcy are taken by or against him,
provided such dealing be conducted without any purpose to defraud
or delay his creditors or to give preference to anyone, and does
not impair the value of his estate.
3. Accordingly, where a depositary of certain government bonds
used some of them without the permission of the owner and
substituted in their place a bond and mortgage, and the owner of
the bonds upon hearing of the transaction ratified it,
held that the creditors of the depositary, who had become
insolvent when such approval was made; could not complain of the
transaction, there being no pretense that the property substituted
was less valuable than that taken, or that the estate of the
bankrupt was less available to his creditors.
4. The trustees of a bankrupt take his property subject to all
legal and equitable claims of others. They are affected by all the
equities which can be urged against him.
5. Where property held upon any trust to keep, or use, or invest
it in a particular way is misapplied by the trustee and converted
into different property, or is sold and the proceeds are thus
invested, the property may be followed wherever it can be traced
through its transformations, and will be subject, when found in its
new form, to the rights of the original owner or
cestui que
trust. It does not alter the case that the newly acquired
property, instead of being purchased with the proceeds of the
original property, is obtained by a direct exchange for it.
Cook and others, trustees in bankruptcy of the estate of Homans,
filed a bill in equity in the court below to set aside the transfer
of a certain note for $7,000, secured by mortgage, alleged to have
been made by the said Homans to the defendant, Tullis, in violation
of the provisions of the Bankrupt
Page 85 U. S. 333
Act, and to compel an assignment of the note and mortgage to
them.
It appeared from the record that in August, 1869, and for two
years before, Homans, the bankrupt, was engaged in business as a
banker in Cincinnati, in the State of Ohio; that on several
occasions during this period he had purchased bonds of the United
States for the defendant Tullis; that these bonds were left with
him on special deposit for safekeeping; that the bonds were
enclosed in envelopes and kept in a package by themselves, marked
with the name of Tullis and placed in a separate box; that on one
occasion, about eighteen months before his failure, Homans had been
permitted by the defendant to use $20,000 of the bonds thus
purchased, upon condition of substituting for them in the package
an equivalent in amount in bills receivable and agreeing to replace
the bonds when called for; that the bonds thus used were
subsequently replaced; that on another occasion, about a year
afterwards, in March, 1869, he took, without any such permission,
from the package and used $6,000 of the bonds, substituting in
their place an equivalent amount in bills receivable; that in April
following, he removed these bills receivable and substituted in
their place, for the bonds taken, a note and mortgage belonging to
him, of one Hardesty, for $7,000, the note bearing date April 17,
1869, and payable in ninety days, and the mortgage being on real
property; that this note was not paid at maturity, and in August
following was placed by Homans, with the mortgage, in the hands of
attorneys with instructions to give notice to the maker of the note
that if it were not paid by the beginning of the next term of the
court, proceedings by suit would be taken for its collection; that
Homans failed on the 26th of August, 1869; that soon afterwards
Tullis was informed of the substitution of the note and mortgage
for his bonds and that thereupon he signified his acceptance of the
same and his satisfaction with the transaction, and directed
proceedings to be commenced by the attorneys, in whose hands the
papers had been placed, for the foreclosure of the mortgage.
Page 85 U. S. 334
It further appeared from the record that, on the 20th of
September following, Homans was adjudged a bankrupt upon a petition
in involuntary bankruptcy, filed on the 13th of the month, and that
in December afterwards the complainants were appointed trustees of
his estate.
The deposition of Homans was taken in the case, and he stated in
explanation of his conduct in appropriating the bonds in question,
that as on a former occasion Tullis had consented to his using a
much larger amount, he inferred that there would be no objection to
his using a smaller amount if it could be done without risk to
Tullis; that at this time he was carrying on his business as usual,
and did not apprehend insolvency or bankruptcy; that he did not
think it necessary when he placed the note and mortgage with his
attorneys to give them notice that they belonged in Tullis's
package, and did not do so until the day of his failure, when,
remembering the omission, he gave them notice to that effect, and
directed them to account to Tullis for $6,000 of the note, stating
that this proportion of it belonged to him. It did not appear that
Tullis had any knowledge leading him to suppose that Homans, until
the day of his failure, was insolvent, or contemplated
insolvency.
The trustees of Homans by this suit sought, as already said, to
set aside the transfer to the defendant of the note and mortgage,
and to obtain possession of the same, on the alleged ground that
the transfer was made for the purpose of giving the defendant a
preference over the other creditors of the bankrupt, and preventing
a distribution of the proceeds of the note equally among his
creditors, in violation of the provisions of the Bankrupt Act.
The provisions relied on by the trustees are in the thirtieth
section of the act (by the forty-third made applicable to
trustees), and in these words: [
Footnote 1]
"If any person, being insolvent, or in contemplation of
insolvency, within four months before the filing of the petition by
or against him, with a view to give a preference to any creditor
or
Page 85 U. S. 335
person having a claim against him, . . . makes any payment,
pledge, assignment, transfer or conveyance of any part of his
property, either directly or indirectly, . . . the person receiving
such payment, pledge, assignment, transfer or conveyance, or to be
benefited thereby, . . . having reasonable cause to believe such
person is insolvent, and that such . . . payment, pledge,
assignment or conveyance is made in fraud of the provisions of this
act, the same shall be void, and the assignee may recover the
property, or the value of it, from the person so receiving it or so
to be benefited."
The court below adjudged that the defendant was entitled to
$6,000 of the proceeds of the note of Hardesty, and that he held
the balance of the proceeds as trustee for the complainants, and
entered a decree to that effect. From that decree the complainants
appealed to this Court.
Page 85 U. S. 337
MR. JUSTICE FIELD, after stating the facts of the case,
delivered the opinion of the Court as follows:
It is evident from the statement of the transaction that the
transfer by Homans to the defendant of the note and mortgage of
Hardesty does not present a case of preference made by a bankrupt
to one creditor over another within the meaning of the Bankrupt
Act. It was not a transfer to prefer a creditor. There was no debt
at the time to the defendant to be preferred. The transaction was
not one of borrowing. There was no loan made nor credit given. It
was the case of an exchange of one species of property for another,
made by one party without authority from the other and subsequently
ratified by the latter, or it was the case of the conversion to his
use by the depositary of property in his hands and his substituting
property equivalent in value as the investment of the property
converted.
This suit must proceed, therefore, if at all, not on the ground
of an alleged preference to a creditor in violation of the Bankrupt
Act, but upon the ground that the title to the note and mortgage
never passed from the bankrupt, because the ratification of his
unauthorized transaction was not made until after the period when
the rights of the trustees attached, or on the ground that the note
and mortgage never
Page 85 U. S. 338
became subject in the hands of the bankrupt to the claim of the
defendant as the investment of the latter's property, because the
bonds appropriated were not first sold and their proceeds used in
the purchase of the note and mortgage.
Both of these grounds were urged by counsel of the appellants,
and it is on their disposition that the case must be
determined.
The substitution of the note and mortgage in place of the bonds
was approved by the defendant immediately upon being made
acquainted with the facts. This approval constituted a ratification
of the transaction. The general rule as to the effect of a
ratification by one of the unauthorized act of another respecting
the property of the former is well settled. The ratification
operates upon the act ratified precisely as though authority to do
the act had been previously given, except where the rights of third
parties have intervened between the act and the ratification. The
retroactive efficacy of the ratification is subject to this
qualification. The intervening rights of third persons cannot be
defeated by the ratification. In other words, it is essential that
the party ratifying should be able not merely to do the act
ratified at the time the act was done, but also at the time the
ratification was made. As said in one of the cases cited by
counsel,
"the ratification is the first proceeding by which he (the
principal ratifying) becomes a party to the transaction, and he
cannot acquire or confer the rights resulting from that transaction
unless in a position to enter directly upon a similar transaction
himself. Thus, if an individual pretending to be the agent of
another should enter into a contract for the sale of land of his
assumed principal, it would be impossible for the latter to ratify
the contract if, between its date and the attempted ratification,
he had himself disposed of the property. He could not defeat the
intermediate sale made by himself, and impart validity to the sale
made by the pretended agent, for his power over the property or to
contract for its sale would be gone. [
Footnote 2]"
On the same principle
Page 85 U. S. 339
liens by attachment or judgment upon the property of a debtor
are not affected by his subsequent ratification of a previous
unauthorized transfer of the property. [
Footnote 3]
The question, therefore, in this case is whether any rights of
third parties did thus intervene between the act of substitution
made by Homans and its adoption and ratification by Tullis, which
defeated the retroactive efficacy of the ratification. And the test
is, as already indicated, could the parties have made the
transaction at the time of the ratification without contravening
the provisions of the Bankrupt Act? It is asserted by the
appellants that the rights of the trustees extend not only to all
property of the bankrupt in his possession when proceedings in
bankruptcy were instituted against him, but also to all property
transferred by the bankrupt within four months previously to a
creditor in order to give him a preference over other creditors, or
transferred by the bankrupt within six months previously to anyone
to defeat or evade the operation of the Bankrupt Act, the grantee
in both cases knowing or having reasonable cause to believe that
the grantor was at the time insolvent or that he then contemplated
insolvency. Admitting this to be so, it does not follow that the
trustees acquired any right to the note and mortgage in question.
They were not transferred to the defendant, as already stated, to
give a preference to one creditor of the bankrupt over another, for
the defendant was not a creditor of Homans at the time, nor were
they transferred to him to evade or defeat any of the provisions of
the Bankrupt Act; the transaction was neither designed nor
calculated to have any such effect. Homans was not insolvent at the
time, nor did he contemplate insolvency. But even if he had been
then insolvent, the transaction would not have been the subject of
just complaint on the part of his creditors, if made with the
approval of the defendant whose bonds were taken. There is no
pretense that the property substituted was not equally valuable
Page 85 U. S. 340
with that taken, or that the estate of the bankrupt was any the
less available to his creditors. A fair exchange of values may be
made at any time, even if one of the parties to the transaction be
insolvent. There is nothing in the Bankrupt Act, either in its
language or object, which prevents an insolvent from dealing with
his property, selling or exchanging it for other property at any
time before proceedings in bankruptcy are taken by or against him,
provided such dealing be conducted without any purpose to defraud
or delay his creditors or give preference to anyone, and does not
impair the value of his estate. An insolvent is not bound, in the
misfortune of his insolvency, to abandon all dealing with his
property; his creditors can only complain if he waste his estate or
give preference in its disposition to one over another. His dealing
will stand if it leave his estate in as good plight and condition
as previously.
We do not think, therefore, that the rights of the trustees,
though relating back four months so as to avoid preferences to
creditors and six months to avoid transfers to others in fraud of
the act, and thus going back of the ratification, touched the
transaction in question or prevented the ratification from having
complete retroactive efficacy.
The position of counsel that the ratification, if sustained,
only extended to the conversion of the bonds and merely operated to
deprive the transaction of its tortious aspect, all else consisting
of dealings by Homans with his own property, is not tenable. The
answer to its is that the ratification was of the whole transaction
taken together; that of the appropriation of the bonds upon
substituting an equivalent in value for them, not of a part without
the rest, not of the appropriation without the substitution.
Nor do we perceive the force of the objection to the validity of
the transaction, because Homans intended to limit the transfer to
the value of the bonds, to-wit, six thousand dollars. The transfer
was in form of the whole note, with a reservation to himself of the
surplus over the amount of the bonds received from its proceeds.
The note being indivisible, the legal title to a part could only be
made by a
Page 85 U. S. 341
transfer of the instrument itself. The reservation of the
surplus was not forbidden by any rule of law, and a court of equity
would, and in this case has, given effect to it.
But if we lay aside the doctrine of ratification as inapplicable
and assume that the transaction could not have been made by the
parties after the failure of Homans, and therefore that the
previous substitution could not then have been ratified, and treat
the case as one of simple misappropriation of property of the
defendant, still the trustees must fail in their suit. They took
the property of the bankrupt subject to all legal and equitable
claims of others. They were affected by all the equities which
could be urged against him. Now it is a rule of equity
jurisprudence, perfectly well settled and of universal application,
that where property held upon any trust to keep or use or invest it
in a particular way is misapplied by the trustee and converted into
different property, or is sold and the proceeds are thus invested,
the property may be followed wherever it can be traced through its
transformations, and will be subject, when found in its new form,
to the rights of the original owner or
cestui que
trust.
In the case of
Taylor v. Plumer, [
Footnote 4] this doctrine is well illustrated.
There, a draft for money was entrusted to a broker to buy exchequer
bills for his principal, and the broker received the money and
misapplied it by purchasing American stock and bullion, intending
to abscond with them, and did abscond, but was taken before he
quitted England. Thereupon he surrendered the stock and bullion to
his principal, who sold the whole and received the proceeds. The
broker became bankrupt on the day he received and misapplied the
money, and his assignees sued for the proceeds of the stock and
bullion. But the court decided that the principal was entitled to
the proceeds as against the assignees, holding that if property in
its original state and form is covered with a trust in favor of the
principal, no change of that state and form can divest
Page 85 U. S. 342
it of such trust and give to the trustee, or those who represent
him in right, any more valid claim in respect to it than he
previously had, and that it makes no difference in reason or law
into what other form, different from the original, the change may
have been made, for the product of, or substitution for, the
original thing still follows the nature of the thing itself, as
long as it can be ascertained to be such, and that the right only
ceases when the means of ascertainment fail.
It is contended that the doctrine of this case does not apply
because the note and mortgage were not purchased with the proceeds
of the bonds taken, but were substituted for them. We do not think
this fact takes the present case from the principle upon which the
other proceeds, that property acquired by a wrongful appropriation
of other property covered by a trust is itself subject to the same
trust. It cannot alter the case that the newly acquired property,
instead of being purchased with the proceeds of the original
property, is obtained by a direct exchange for it. The real
question in both cases is what has taken the place of the property
in its original form? Whenever that can be ascertained, the
property in the changed form may be claimed by the original owner
or the
cestui que trust, and assignees and trustees in
bankruptcy can acquire no interest in the property in its changed
form which will defeat his rights in a court of equity.
Decree affirmed.
MR. JUSTICE MILLER dissented.
[
Footnote 1]
14 Stat. at Large 534.
[
Footnote 2]
McCracken v. City of San Francisco, 16 Cal. 624.
[
Footnote 3]
Taylor v. Robinson, 14 Cal. 396;
Wood v.
McCain, 7 Ala. 806;
Bird v. Brown, 4 Exchequer
799.
[
Footnote 4]
3 Maule & Selwyn 562.
