#### D. W. WHITFORD v. O. W. LANE, Receiver of the POLLOCKSVILLE BANKING & TRUST COMPANY, NEW BERN BANKING & TRUST COMPANY, and the EASTERN BANK & TRUST COMPANY.

(Filed 28 October, 1925.)

1. Bills and Notes — Negotiable Instruments — Bailment—Special Contract.

The relation of bailor and bailee for hire is established where the owner of government 'bonds for a consideration loans them to a bank under an agreement for their return at a time specified, but where the *344known purpose is to enable tbe bank to secure a loan by using these bonds as collateral to its note, it is upon a special contract that in tbe event of tbe failure of tbe bank to return tbe bonds, it would be liable in damages to tbe owner for tbe loss be may sustain by reason of 'tbe failure of tbe maker of tbe note to pay it.

3. Same* — Equity—Marshaling1 Assets — Exoneration.

Tbe owner of government bonds loaned tbem upon consideration to a bank for tbe purpose of its bypotbecating tbem as collateral to a note given for money borrowed by it from another bank, its note containing the stipulation that collateral securities to the note may be considered as collateral to other notes of tbe maker, etc., with knowledge of tbe lending bank of tbe purpose for which the- bonds were loaned; and without tbe knowledge or consent of the owner that it was used for other purposes this note was later included in a larger note with other collateral of tbe borrowing bank, and upon default in payment: *Held,*the lending bank was required to marshal tbe assets from tbe further collateral of the borrowing bank, to tbe exoneration *pro tanto*of tbe bonds specially loaned.

Appeal by both plaintiff and defendants from *Barnhill, J.,*at March Term, 1925, of JoNes.

Action by plaintiff to recover of defendant ten Liberty Loan Bonds of tbe'par value of $10,000, or in lieu thereof, the value of said bonds.

On 5 February, 1921, plaintiff, owner of said bonds, delivered the same to the Pollocksville Banking & Trust Company, under an agreement in writing by which the said Pollocksville Banking & Trust Company agreed to return the said bonds to plaintiff on or before 1 January, 1922. Subsequently Pollocksville Banking & Trust Company transferred said bonds to the New Bern Banking & Trust Company as collateral security for the payment of its note to the said New Bern Banking & Trust Company for $26,000 for money loaned to it. Upon default in the payment of the said note, New Bern Banking & Trust Company sold the said bonds and other bonds held by it as collateral for said note, and out of the proceeds of the said sale, paid said note and accrued interest. Said company thereupon applied the excess of the proceeds of the said sale, to wit, the sum of $4,644.83, as a payment on other indebtedness then due it by Pollocksville Banking & Trust Company.

After 1 January, 1922, plaintiff demanded of defendant, O. *W.*Lane, who had been appointed receiver of Pollocksville Banking & Trust Company.and of New Bern Banking & Trust Company, the return of said bonds in accordance with the agreement under which they were delivered by plaintiff to Pollocksville Banking & Trust Company. He alleges that New Bern Banking & Trust Company, which had changed its name and was doing business under the name of the Eastern Bank & Trust Company, wrongfully converted said bonds to its own use; *345be demanded judgment that in event same could not be-returned tbat be recover of tbe said Eastern Bank & Trust Company tbe value of said bonds, so wrongfully converted by it.

From tbe judgment rendered, botb plaintiff and defendants appealed to tbe Supreme Court.

*Moore & Durm for plaintiff.*

*J. K. Warren for O. W. Lane, receiver.*

*Ward & Ward for Eastern Bank & Trust Company.*

CoNNOR, J.

On 5 February, 1921, plaintiff, D. *W.*Wbitford, owned and bad in bis possession ten Liberty Loan Bonds of tbe United States of America of tbe par value of $10,000. On said date be delivered said bonds to tbe Pollocksville Banking & Trust Company, a corporation engaged in tbe business of banking, in tbis State, pursuant to an agreement witb respect to said bonds, in writing, signed by botb parties. In said agreement, Pollocksville Banking & Trust Company agreed to return said bonds to plaintiff on or before 1 January, 1922. Said company procured tbe loan of said bonds by plaintiff to it for tbe purpose of using same as collateral for money wbicb it tben contemplated borrowing. Tbis purpose, tbe jury bas found, was known to plaintiff at tbe time be delivered said bonds to Pollocksville Banking & Trust Company.

On said date Pollocksville Bank & Trust Company deposited said bonds witb tbe New Bern Banking & Trust Company, a corporation engaged in tbe business of banking, in tbis State, as collateral security for a loan of $8,000, contemporaneously made to it by said New Bern Banking & Trust Company. On 25 May, 1921, tbe note for tbis loan, wbicb was tben past due, was consolidated witb other notes tben .held by New Bern Banking & Trust Company into one note, for $26,000; as security for tbis consolidated note, wbicb was due on 24 July, 1921, Pollocksville Banking & Trust Company deposited Liberty Loan Bonds, of tbe par value of $23,000 wbicb it owned, but wbicb bad been theretofore deposited by it witb New Bern Banking & Trust Company as collateral security together witb tbe bonds wbicb bad been delivered to it by plaintiff, under tbe agreement aforesaid, of tbe par value of $10,000, making tbe total security for said note of $26,000, Liberty Loan Bonds of tbe par value of $33,200.

Tbe note for $26,000 was not paid at maturity. On 22 October, 1921, under tbe power of sale contained in tbe note, New Bern Banking & Trust Company sold all said bonds, receiving therefor tbe sum of $31,039.16. From said sum New Bern Banking & Trust Company paid tbe note for $26,000 and accrued interest — $394.33—leaving in its bands an excess of $4,644.83.

*346At the date of the loan of $8,000, to wit, 5 February, 1921, and also at the date of the note for $26,000, to wit, 25 May, 1921, the Pollocks-ville Banking & Trust Company was indebted to New Bern Banking & Trust Company in a large sum, as evidenced by notes, not including the notes specifically secured by Liberty Loan Bonds; this indebtedness was secured by the assignment and deposit of various notes and other securities, the face value of which largely exceeded the amount of the indebtedness. This indebtedness was past due on 22 October, 1921, and New Bern Banking & Trust Company applied the sum of $4,644.83, the excess in its hands from the sale of the Liberty Loan Bonds, including the bonds which plaintiff had delivered to Pollocks-ville Banking & Trust Company under the agreement aforesaid, as a payment on this indebtedness. New Bern Banking & Trust Company has collected large sums of money on the notes and securities, which were assigned and deposited with it by Pollocksville Banking &• Trust Company as collateral for its indebtedness. It now has in hand many of said notes and securities; a balance remains due on the indebtedness of the Pollocksville Banking & Trust Company to New Bern Banking & Trust Company, now doing business under the name of Eastern Bank & Trust Company; as security for said balance, Eastern Bank & Trust Company holds collateral now in its hands and uncollected, deposited by Pollocksville Banking & Trust Company with it, the face value of said collateral being largely in excess of the balance due on its indebtedness.

The jury has found as a fact that at the time plaintiff loaned the bonds to the Pollocksville Banking & Trust Company he knew of the purpose of said company to use the same as collateral security 'for loans which it then contemplated procuring to be made to it, and that with this knowledge he delivered said bonds to the Pollocksville Banking & Trust Company.

The jury has further found as a fact that when the New Bern Banking & Trust Company accepted said bonds as collateral security for the loan made by it to Pollocksville Banking & Trust Company, it knew that the bonds had been delivered by plaintiff to Pollocksville Banking & Trust Company under the agreement in writing -for the purpose aforesaid and that it was therefore not a purchaser of said bonds, for value, before maturity, without notice of any defect or infirmity in the title to said bonds of the Pollocksville Banking & Trust Company.

These facts are determinative of the rights and obligations of the parties to this action, with respect to said bonds or to the proceeds of. the sale of the same.

Upon the facts found by the jury and upon admissions made in the pleadings and on the trial of the action, the court was of the opinion *347and so held that New Bern Banking & Trust Company had the right to sell the bonds held by it and delivered by plaintiff to Pollocksville Banking & Trust Company, upon default in the payment of the note specifically secured by said bonds, and to apply the proceeds of said sale to the payment of said note, after having first exhausted the proceeds of the sale of the Liberty Loan Bonds owned by Pollocksville Banking & Trust Company and also held by New Bern Banking & Trust Company as security for said note.

The court was further of opinion, and so held, that the application of the excess remaining in its hands from the sale of said bonds, to wit, $4,644.83, as a payment on indebtedness of Pollocksville Banking & Trust Company, not specifically secured by said bonds, was without authority and that plaintiff is entitled to recover of New Bern Banking & Trust Company (now Eastern Bank & Trust Company), the said sum of $4,644.83, wrongfully applied as such payment.

The court was of the opinion, and so held, that plaintiff was entitled to an accounting with New Bern Banking & Trust Company (now Eastern Bank & Trust Company), to the end that proceeds from collection of notes and securities in its hands, as collateral for indebtedness due to it by Pollocksville Banking & Trust Company, after the payment of said indebtedness, might be applied in exoneration of the bonds loaned by plaintiff to Pollocksville Banking & Trust Company, under the agreement of which New Bern Banking & Trust Company had notice at time said bonds were deposited with it.

Judgment was therefore rendered that plaintiff recover of defendant, Eastern Bank & Trust Company, the sum of $4,644.83, with interest at 6 per cent from 22 October, 1921, and the costs of the action' to be taxed by the clerk.

It was further ordered that the action be retained to the end that the equities between the parties may be adjusted by the court when the accounting ordered has been made.

Plaintiff assigns as error the submission by the court to the jury of the second issue, which was as follows:

> “2. Did the plaintiff have knowledge at the time he loaned the bonds, set out in the agreement and described in the complaint, that the Pollocksville Banking & Trust Company was borrowing same for the purpose of depositing them as collateral security?”

The relationship between, plaintiff and the Pollocksville Banking & Trust Company, with respect to said bonds, under their agreement was that of bailor and bailee for mutual benefit; the company agreed to pay to plaintiff, for the use of the bonds, the sum of $50 per month; the consideration for this agreement was the right to use said bonds from 5 February, 1921, to 1 January, 1922; the company agreed to *348return the bqnds to plaintiff on the latter date; however, it is apparent from the terms of the agreement, that both parties contemplated, as a probable contingency, the company’s inability to return said bonds; the company transferred and assigned to the plaintiff two notes, aggregating $10,000, directing, if it failed in any respect to comply with its agreement, that plaintiff should collect said notes and retain the proceeds thereof; it is expressly provided that his right to do this is “in addition to his right to- sue for the return of the bonds.”

As between plaintiff and the Pollocksville Banking & Trust Company, plaintiff was entitled on 1 January, 1922, to the return of the bonds, or -to the payment of their value as damages for the breach of the company’s contract to return them. New Bern Banking & Trust Company (now Eastern Bank & Trust Company), however, is not a party to this bailment. It is the assignee and transferee of the bailee. In paragraph 2 of its amended answer it says that “at the time of the loaning of the bonds in controversy by plaintiff to Pollocksville Banking & Trust Company, it was understood as a part of the transaction that the loan of the bonds was being made so that Pollocksville Banking & Trust Company could hypothecate them and borrow money on them.”

This is an allegation of a special contract between the bailor and the bailee, affecting the rights of a creditor of the bailee who loaned money and took the bonds as collateral security for the loan. Without the special contract as alleged, the bailee had no authority to sell or pledge the bonds, and a creditor, although an innocent purchaser for value, acquired no title to the bonds as against the bailor. 3 R. C. L., 142. If, however, the bailor, with knowledge that the bailee was borrowing the bonds for the purpose of transferring and assigning them to a-creditor as collateral security, delivered them to the bailee, who thereafter assigned and transferred them as collateral security for a loan, he was estopped from asserting title to said bonds against such bona fide creditor. 3 R. C. L., 143.

The issue submitted arises upon the pleadings. There was no error in submitting the second issue, and the exception cannot be sustained.

Plaintiff’s assignments of error, presenting his contention that New Bern Banking & Trust Company held the bonds subject to the right of plaintiff, as against Pollocksville Banking & Trust Company, to the return of the bonds on 1 January, 1922, cannot be sustained. This contention is inconsistent with the understanding between plaintiff and Pollocksville Banking & Trust Company that the latter contemplated using the bonds as collateral security. The bonds were in the rightful possession of New Bern Banking & Trust Company and said company had authority to sell the same and apply the proceeds of the sale to *349tbe payment of tbe loan, wbicb tbis company made upon 'tbe security of said bonds. As against New Bern Banking & Trust Company, plaintiff is not entitled to tbe return of said bonds nor to so much of tbe proceeds of their sale as was required to pay its loan. *Clark v. Whitehurst,*171 N. C., 1, cited by plaintiff, bas no application to tbis case. See *Newsome v. Bank,*169 N. C., 534, where it is beld by tbis Court that tbe owner of notes, deposited as collateral for tbe debt of another, is entitled to tbe return of tbe notes upon tbe payment of tbe debt, or to tbe excess from tbe proceeds of tbe collection of tbe notes, if tbe debt bas been paid therefrom.

In tbe note executed by Pollocksville Banking & Trust Company payable to tbe order of New Bern Banking & Trust Company, dated 25 May, 1921, it is provided that “said collateral may from time to time, by mutual consent, be exchanged for others, wbicb shall also be held by said company'on tbe terms above set forth; and that if we shall come under any other liability or enter into any other engagement with said company, while it is tbe bolder of tbis obligation, then tbe proceeds of tbe sale of tbe above securities may be applied either on tbis note or on any other liabilities or engagements beld by said company, as its president or cashier may elect.”

There is no evidence that Pollocksville Banking & Trust Company came under any other liability to or entered into any other engagement with New Bern Banking & Trust Company, after 25 May, 1921; it therefore beld tbe bonds as security for tbis note only; it was without authority to apply said bonds or any part of tbe proceeds of tbe sale of tbe same except as a payment on tbe note for wbicb they were specifically pledged. Colebrook on Collateral Securities, sec. 97.

New Bern Banking & Trust Company beld as specific security for tbe note executed by Pollocksville Banking & Trust Company (1) bonds owned by its debtor, (2) bonds owned by plaintiff. Clearly, tbe bonds owned by tbe debtor must first be applied to tbe payment of tbe debt, in exoneration of tbe bonds owned by plaintiff. 6 Pomeroy Eq. Jur., sec. 912-2.

If in addition to tbe specific security for tbis note, tbe New Bern Banking & Trust Company beld securities, tbe property of Pollocksville Banking & Trust Company, as specific security for other indebtedness of Pollocksville Banking & Trust Company and also as general security for all its indebtedness to New Bern Banking & Trust Company, after tbe payment of tbe indebtedness for wbicb these securities were specifically pledged, tbe remainder of tbe ’’ securities should be applied in exoneration of bonds of plaintiff, upon well-settled principles of equity for tbe protection of a surety. Tbe bonds of tbe plaintiff are secondarily liable for tbe payment of tbe note; securities owned by tbe *350debtor and transferred to a creditor as general collateral and beld as such, are and should be primarily liable for the payment of all indebtedness of the debtor to the creditor in exoneration of collateral owned by a third person and specifically pledged by the debtor with the consent of the owner. Plaintiff as owner of the bonds, secondarily liable, is entitled to be subrogated to the rights of the creditor in and to securities of the debtor which are primarily liable for the indebtedness. In order to ascertain the facts with respect to these matters, an accounting was properly ordered by his Honor.

If upon such accounting it shall appear that Eastern Bank & Trust Company now has in hand any collateral, or proceeds of any collateral, sold or collected by it, owned by Pollocksville Banking & Trust Company, and transferred as security for its indebtedness to New Bern Banking & Trust Company, plaintiff will be entitled to the application of same, under orders of the court, to the full exoneration of his bonds. Both plaintiff and Eastern Bank & Trust Company are creditors of Pollocksville Banking & Trust Company, and plaintiff is entitled to the equitable remedy of marshaling. with respect to securities held by Eastern Bank & Trust Company. Eaton on Equity, p. 513; *Harris v. Cheshire,*189 N. C., 219.

*We*have carefully examined defendant’s assignments of error. They cannot be sustained. The judgment is supported by well-settled principles, and is in accord with the authorities. There is

No error.