IN

DRASTIC PLEDGE AGREEMENTS

this article are considered: the restrictive safeguards against misuse of the pledge which circumscribed the common law pledgee; to what extent these limitations have been and may be overcome by agreement in the modern instrument of pledge; instances in which broad powers therein conferred have suggested to the grantee opportunities for improper advantage to himself, and how the courts have interposed to prevent fruition of such schemes.

The duties imposed by law on a pledgee, with respect to security left with him, are designed to prevent loss, fraud or oppression.1 Thus, by way of example, he must keep the pawn and not use it,2 unless it would be the better for use. He may not sell it before default, and no evidence of custom to the contrary can justify him in so doing; 5 nor may he repledge it."

In early times, the pledge could not be foreclosed except under judicial process," and this rule still prevails in other systems of law. It has long been authoritatively adjudged, however, in our own, that the pledgee, on default, may sell the pledge, without judicial intervention, at public sale; provided, in the case of obligations not maturing at a time certain, he makes demand for payment, and in all cases, also makes demand for redemption,

1 Union Trust Co. v. Rigdon, 93 Ill. 458, 468–9 (1879).

2 JONES, COLLATERAL SECURITIES, 3 ed., 598, § 501; Lawrence v. Maxwell, 53 N. Y. 19-22 (1873); Union Trust Co. v. Rigdon, supra, p. 465.

3 I CHITTY'S BL. COMM., 19 London ed., 451 n.

4 Commonwealth v. Althause, 207 Mass. 32, 42, 93 N. E. 202, 204 (1910). Markham v. Jaudon, 41 N. Y. 235 (1869); Oregon, etc. Co. v. Hilmers, 20 Fed. 717 (1884).

• Warfield v. Adams, 215 Mass. 506, 515, 102 N. E. 706, 710 (1913); Skiff v. Stoddard, 63 Conn. 198, 218, 26 Atl. 874, 880 (1893); Wood v. Fisk, 109 N. E. (N. Y.) 177 (1915).

7 Cortelyou. Lansing, 2 Caines Cas. (N. Y.) 200, 202 (1805), per Chancellor Kent; Wilson v. Little, 1 Sandf. (N. Y.) 351, 357 (1848); Smith v. Shippers' Oil Co., 120 La. 640, 658, 45 So. 533, 539 (1907).

8 Cortelyou v. Lansing, supra.

• Wheeler v. Newbould, 16 N. Y. 392, 401-2 (1857); JONES, COLLATERAL SECURITIES, 3 ed., 724, § 602.

giving reasonable notice of time and place of intended sale.10 But if the debtor cannot be found, or for other reason this demand or notice cannot be given, it is still the law, that the pledge must be realized on through judicial order.11

Nor may every species of security be sold, even now. The creditor holding an obligation secured by choses in action, such as notes, non-negotiable bonds or mortgages, may sell the principal indebtedness, and the securities will pass with it as an incident. He may not, however, dispose of the choses in action apart from the obligation they secure; his duty is to collect them.12

Finally, the pledgee, standing in a relation of trust to the pledgor, is affected by the rule that a trustee may not purchase, directly or indirectly, at his own sale.13

All this is apt to hamper a desirable use of the pledge and unduly to retard quick collection of the debt. Accordingly, it has become customary to make special contracts removing these disabilities; giving the pledgee the right to use the collateral security as his own, being responsible only for return of a like amount of the kind deposited; allowing public or private sale, free from right of redemption, without demand, notice or advertisement; authorizing the pledgee to bid as any other bidder would, to purchase at market price and to account only for the proceeds obtained, less expenses.14

The validity of such instruments will first be considered. As a general rule, such agreements are enforcible to the extent that they

10 Franklin Nat. Bank v. Newcombe, 1 App. Div. 294, 297-8, 37 N. Y. Supp. 271, 273-4 (1896), per Van Brunt, J.; affirmed, 157 N. Y. 699, 51 N. E. 1090 (1898); Chouteau v. Allen, 70 Mo. 290 (1879); JONES, COLLATERAL SECURITIES, 3 ed., 728, § 607.

11 Wheeler v. Newbould, 16 N. Y. 392, 400 (1857); Bates v. Wiles, 1 Handy (Ohio) 532, 535-6 (1854).

12 Peacock v. Phillips, 247 Ill. 467, 93 N. E. 415 (1910); Wheeler v. Newbould, supra, pp. 398-9.

13 Stebbins v. Michigan, etc. Truck Co., 212 Fed. 19, 29 (1914); Glidden v. Mechanics' Nat. Bank, 53 Oh. St. 588, 599, 42 N. E. 995, 997 (1895); Appleton v. Turnbull, 84 Me. 72, 80, 24 Atl. 592, 594 (1891). But, see, Fidelity Ins., etc. Co. v. Roanoke Iron Co., 81 Fed. 439 (1896).

14 For examples of such notes, see, McDougall v. Hazelton Tripod-Boiler Co., 88 Fed. 217, 218-9 (1898); Dibert v. D'Arcy, 248 Mo. 617, 626-8, 154 S. W. 1116, 1118 (1913); Williams v. United States Trust Co., 133 N. Y. 660, 661, 31 N. E. 29 (1892); Smith v. Shippers' Oil Co., 120 La. 640, 654, 45 So. 533, 538 (1907); Torrance v. Third Nat. Bank of Pittsburgh, 210 Fed. 806–7 (1914).

fairly facilitate collection of the creditor's due.15 When, however, they provide for a forfeiture of the security, they are, like all other agreements for a penalty, invalid, on grounds of public policy.16

But such agreements, even when upheld, are regarded by the courts with suspicion and dislike. Their attitude is thus expressed by Judge Taft:

"A court of equity scrutinizes with great care the contracts made between pledgee and pledgor, as to the transfer of title to the pledgee, and does not hesitate to set aside such a contract if there is any ground for thinking that it is a harsh contract, and one brought about by the position of vantage that the pledgee occupies with reference to the pledgor." 17

It may be questioned whether this is not too strong a general statement; though correct if applied to the facts in that case, which involved an attempt to require payment of an exorbitant sum for the redemption of securities.

In Ohio National Bank of Wash. v. Central Construction Co.,18 a secured note allowing immediate sale on non-payment, or sale within ten days after unsuccessful demand for additional collateral, was described as harsh and incongruous in its provisions,19 and the intimation was, that giving the right to sell at stock exchange, or own bank, at public or private sale, without notice of any kind, of time, place, or manner of sale, with power in the pledgee to become purchaser, ought to be declared void.20

Notwithstanding, however, such agreements may appear in some aspects harsh and drastic, the courts should, and do, attempt to carry out rather than strike down such compacts, preserving the rights of the pledgor by strict construction and by requiring exercise, in his behalf, of the utmost good faith.

Passing, then, from consideration of questions of validity, to inquiry into the justifications for strict construction, one reason given is, that ordinarily the pledgee frames the pledge instrument, 15 In re Mertens, 144 Fed. 818, 821 (1906); affirmed, as Hiscock v. Varick Bank of New York, 206 U. S. 28, 38 (1907); Farmers' Loan & Trust Co. v. Toledo & S. H. R. Co., 54 Fed. 759, 774 (1893).

16 West v. Guaranty Trust Co. of New York, 83 Misc. 609, 145 N. Y. Supp. 634 (1914); Smith v. Shippers' Oil Co., 120 La. 640, 658, 45 So. 533, 539 (1907).

17 Ritchie v. McMullen, 79 Fed. 522, 557-8 (1897).

18 17 D. C. App. 524 (1901).

19 Ibid., p. 543.

20 Ibid., p. 544.

and therefore the general principle that ambiguous words are construed against the user, applies. Bankers and brokers have regular printed forms of "collateral notes" the language of which, if equivocal, is to be read unfavorably to the draftsman.21 In Torrance v. Third National Bank of Pittsburgh,22 the Court, Judge Gray writing the opinion, decided that makers of a joint and several note, pledging security which they owned jointly, for payment of the note, "or any other liabilities of the undersigned. authorized use of the collateral security only for obligations jointly incurred, and hence not in settlement of indebtedness incurred as indorsers. The Court, after saying that the terms of a pledge, "must be construed with a certain measure of strictness," 23 added that it was for the bank which framed the pledge to have made the meaning insisted upon by it clear "by . . . making the clause read: 'any other liability or liabilities of the undersigned or either of them.""

A second reason for interpreting such instruments rigorously against the pledgee is, that a trust created and defined by contract will be viewed favorably to the beneficiary.24 Affecting equities of redemption, it must "be construed benignantly for the debtor - as benignantly for him as may consist with security of the creditors." 25

Courts not only scan such instruments with great strictness,26 but are alert to discern a waiver of right to proceed according to the letter of the contract. Mere indulgence may detract from the creditor's rights, and no consideration is necessary for the waiver.27

21 Union Nat. Bank v. Forsyth, 50 La. Ann. 770, 778, 23 So. 917, 920 (1898); Mt. Vernon Refrigerating Co. v. Wolf Co., 188 Fed. 164, 168 (1911); writ of certiorari refused, 225 U. S. 711 (1912).

24 Dibert v. D'Arcy, 248 Mo. 617, 647, 154 S. W. 1116, 1125 (1913). 25 Sparhawk v. Drexel, 22 Fed. Cas. 860, 866 bot. right col. (1874).

26 For example, see, Smith v. Shippers' Oil Co., 120 La. 640, 45 So. 533 (1907), where promise in note was limited by attached agreement respecting collateral; Warfield v. Adams, 215 Mass. 506, 102 N. E. 706 (1913), 7th par. syl., holder in collateral agreement confined to first holder. Contra, Mulert v. National Bank of Tarentum, 210 Fed. 857 (1913); Commonwealth v. Althause, 207 Mass. 32, 93 N. E. 202 (1910), right given to "use" collateral security pledged, means, use as pledge, and not to sell, before default. See, also, Kennedy v. Broderick, 216 Fed. 137 (1914).

27 Toplitz v. Bauer, 161 N. Y. 325, 331-2, 55 N. E. 1059, 1060-1 (1900); Hill v. Alber, 261 Ill. 124, 103 N. E. 612 (1913).

It is to be doubted whether provisions favorable to the pledgee, waived or suspended, can be restored to him, in absence of agreement that waiver of one default shall not be deemed a waiver of successive defaults. The pledgee gets his right to act upon default or within a reasonable time thereafter, and, in the absence of agreement, cannot exercise his power at other times. If the power can be restored to him at all, it must be only upon definite and reasonable notice of intention to avail himself of it.28

Supplementary to canons of construction and waiver unfavorable to the pledgee, probably the most important of all the rules enforced in behalf of the pledgor is that requiring of the pledgee the strictest good faith in performance of the agreement on his part, and the insistence that he cannot shelter himself behind a bare literal compliance with the powers conferred, but must exercise them for the benefit of the pledgor as well as for himself.29 This is particularly true where the pledgee is enabled by agreement to become purchaser. As well expressed in a recent case, he is still "trustee to sell' not to buy, though with the privilege of buying, if fairly sold.” 30

The foregoing principles of strict construction, waiver and good faith have been variously applied in decisions relating to time, place, advertisement, notice, announcement and method of sale, and obligation of pledgee, when purchaser, to account for full value of securities.

The courts jealously guard the obligor's right to receive effective notice and are astute in finding it to exist, unless it has been taken away in unmistakable terms. Thus, should a pledgee be authorized to sell on default "in the best way he could," this would not relieve him of the duty to exercise the power only upon reasonable notice to redeem and of the time and place of the prospective sale. A mere general notice to the debtor of intention to sell would be insufficient.31

Clearly this must be so; since, for the debtor to be present at the sale in person or by agent, is a protection, the benefit of which

28 Fox v. Grange, 261 Ill. 116, 103 N. E. 576 (1913).

29 Turner v. Metropolitan Trust Co. of City of New York, 207 Fed. 496, 501 (1913); Bon v. Graves, 216 Mass. 440, 446, 103 N. E. 1023, 1026 (1914); King v. Boerne State Bank, 159 S. W. (Tex.) 433 (1913).

30 Dibert v. Wernicke, 214 Fed. 673, 681 (1914).

31 Goldsmidt v. First Methodist Church, 25 Minn. 202 (1878).