Opinion
No. 27904
Decided July 10, 1940.
Banks and trust companies — Self-dealing and disloyalty as trustee — Land trust certificates issued to liquidate mortgage inadequately secured — Transaction void as to certificate holders — Class action maintainable, when.
1. A transaction, whereby a land company purchases a tract of land and borrows the full purchase price and additional sums from a bank which takes title to the land in its name as security for the loan, later deeds the land to itself as trustee, participates with the land company in creating a trust in which the land is made the basis of security for the issuance of land trust certificates in an amount more than 50 per cent in excess of the purchase price of the land and more than double the loanable value under its own appraisement, participates with the land company in the sale of such certificates through a broker without disclosing to the purchasers of such certificates information within its knowledge affecting the value of such certificates, and distributes the proceeds of such sale by repaying to itself its loan in excess of the purchase price of the land and distributes the remainder of the proceeds of the sale of the land trust certificates to the land company and its nominees, constitutes such self-dealing and disloyalty on the part of the bank as trustee, as to make the transaction and trust created in connection therewith void as to the holders of such land trust certificates.
2. Where a number of persons have separate and individual claims and rights of action against the same party, but all such claims arise from a common source and represent a like interest, the whole matter may be litigated in a single action brought by all of the claimants as co-plaintiffs, or, in case the parties are numerous making it impracticable to bring them all before the court, by one or more of them suing for himself or themselves and on behalf of the other claimants.
APPEAL from the Court of Appeals of Cuyahoga county.
Harry W. Haggerty, as the holder of land trust certificates of The General Outdoor Advertising Company land trust, of which The Union Trust Company of Cleveland was trustee, brought this action on behalf of himself and other holders of similar certificates against the Superintendent of Banks in charge of the liquidation of The Union Trust Company in the Common Pleas Court of Cuyahoga county to recover a judgment for $226,745, to declare the trust void, to set aside the sale of the property to the trust, and to hold the money invested in the property for the benefit of the certificate holders.
The Common Pleas Court held the trust invalid and granted the relief prayed for. The Court of Appeals appointed a master who, upon the instruction of the court, heard the evidence de novo. He made a report consisting of a finding of facts and conclusions of law, likewise holding that the trust was invalid and that the plaintiff was entitled to the relief sought.
Upon motion to confirm this report, the Court of Appeals of the Ninth Appellate District, sitting by designation in the Eighth Appellate District, made an independent finding of facts and found as a conclusion of law that the report of the master should not be confirmed and that the plaintiff was not entitled to the relief prayed for in his petition. ( 63 Ohio App. 300.)
This case is now in this court on appeal by reason of an allowance of a motion requiring the Court of Appeals to certify its record to this court for review and final determination.
Upon examination of the Court of Appeals' finding of facts it is to be observed that such finding is in the nature of meager conclusions of fact without detail as established by the evidence. Since the facts are substantially undisputed, this court has, in reaching its conclusions, considered the entire record.
Between the years 1923 and 1926, The Ontario Street Land Company, hereinafter called the land company, and The Union Trust Company, hereinafter called the bank, collaborated in creating land trust issues. The land company found the property, while the bank loaned the money for its purchase, took title in its name, and later declared itself trustee for the issue of securities, the sale of which furnished the money to repay its loan.
Pursuant to this plan of operation, between June 30 and August 17, 1923, the land company purchased four contiguous parcels of real estate on Sumner avenue in Cleveland. The land company did not take title in itself but had the deeds made direct to the bank from which it borrowed, on a 90-day note, $130,000 to pay the purchase price of the parcels in a total sum of $126,990. This was all done under a holding title agreement between the land company and the bank.
In February, 1924, the loan of $130,000 was paid off, but the bank continued to hold title to the property. In June, 1924, at the instance of the land company, the bank leased the four contiguous parcels of land to Thomas Cusack for 99 years for an annual rental of $14,000, the lessee agreeing to construct on the land a $100,000 mercantile building, with the right on the part of the lessee to assign the lease as soon as the building was completed. This property comprising the four parcels of real estate above referred to will hereinafter be designated as the Cusack tract. Cusack assigned the lease to the Carnegie-Twelfth Company which spent $100,000 in erecting buildings on the land, upon which it placed a bond issue of $110,000 secured by its leasehold estate. The Carnegie-Twelfth Company, a subsidiary of The General Outdoor Advertising Company, then sublet the premises to the latter company.
Commencing July, 1924, other loans, for which the Cusack parcel was held by the bank as part security, were made to the land company aggregating at times $150,000. On July 21, 1926, payment of these loans in the aggregate just mentioned was effected by making a new loan from the bank for $240,000 on a 90-day note secured by the Cusack property and two other parcels of real estate which likewise had been deeded by the land company to the bank. The bank's own appraisement of these three properties was as follows: Cusack tract $164,520; vacant lots on Oregon avenue $92,000; vacant lots on Sumner avenue $110,000, or a total of $366,520. It was a rule of the bank that the maximum loan to be made on real estate was 60 per cent on the value of improved property and 40 per cent of the value of unimproved property, the application of which rule would have permitted a maximum loan on these properties of $179,521, or a maximum loan of $98,712 on the Cusack parcel.
The proceeds of the $240,000 loan of July 21, 1936, were disbursed as follows:
To The Ontario Street Land Company ........ $46,003.37 To the mortgage loan department of the bank $150,000 plus interest in the sum of $2,708.33, or a total of ................ 152,708.33 To the corporate trust department of the bank .................................... 1,592.30 To the bank as discount on the $240,000 note 3,600.00 To pay notes of the Commercial Credit Cor- poration, which was indebted to the bank in the amount of ........................ 36,096.00
As early as December, 1925, the bank conferred with the land company with reference to a land trust certificate issue on the Cusack parcel, and trust certificates were prepared, but the proposed purchaser of the issue failed to take them and the deal fell through. On or about July 30, 1926, arrangements were made to put out a new issue of certificates through The Philip H. Collins Company, as brokers. There were to be 456 certificates having a stated value of $228,000 for which the broker was to pay the sum of $216,000 plus accrued interest to the land company. The certificates were ultimately sold to the public for $230,280 or $505 per certificate. The bank became the escrow agent under this arrangement and received the purchase money for the certificates as they were surrendered to the purchaser. The bank disbursed the funds including the payment of $150,000 to itself on its loan.
A declaration of trust for this issue was dated August 1, 1926, and recorded August 23, 1926. The property was deeded by the bank to itself as trustee by special warranty deed, and the land company, to release its equitable interest in the property, executed a quitclaim deed to the bank which was not recorded. By the declaration of trust, the trustee was authorized to issue and there was issued to the land company a transferrable option certificate which entitled it to repurchase the fee title of the Cusack parcel subject to the 99-year lease, for an amount equal to $525 per trust certificate then outstanding.
An officer of the bank, who was also a lawyer, performed the legal service for the bank and had charge of the issuance of the certificates for the bank. He conferred with counsel for the broker in the preparation of the legal documents. On August 18, 1926, the land company requested the bank to take steps necessary for the issuance of the land trust certificates.
The trust certificates bore the heading "Land Trust Certificates of Equitable Ownership in Carnegie-Twelfth property located in Cleveland, Ohio, subleased to The General Outdoor Advertising Company," the name of the latter, a nationally known company of high repute, appearing in large type in a prominent position on the certificate. The significance of this form of certificate appears in the fact that the bank previously had had certificates printed under the name "Carnegie-Twelfth Company" but these were cremated and new certificates bearing the name of The General Outdoor Advertising Company were substituted in the form above stated.
A delay occurred in order to reinstate the corporate charter of the Carnegie-Twelfth Company, lessee, whose real estate taxes were also in default. On October 13, 1926, the certificates were issued to the land company and by it immediately turned over through the broker to the bank for reissuance. Thirty of these certificates were sold to the plaintiff. From the proceeds of such sales the bank paid on its own loan of $240,000, the sum of $150,000 and released the Cusack parcel. It also paid its own fee, attorneys' fees and $61,465.45 to the land company.
The proceeds of a loan of $40,000 made by the bank to the land company under date of May 25, 1926, which was one of the predecessor loans to the consolidated loan of $240,000, did not go into the purchase of additional real estate as additional security for the loan, but went into the bank to the account of J.R. Nutt, president of that bank.
In December, 1925, Mr. Nutt made a verbal agreement to sell his home in Florida to Jay E. Latimer, president of The Ontario Street Land Company, for $40,000 and gave immediate possession. The deed for this property was made on May 24, 1926, to J.E. Latimer, Jr., at the dictation of Jay E. Latimer. On May 25, Jay E. Latimer, as president of the land company, gave written instructions to the bank to pay to Mr. Nutt the proceeds of the $40,000 loan from the bank to the land company, and a check for that amount was deposited by the bank to Mr. Nutt's amount. The deed remained in Mr. Nutt's hands for some months thereafter and was recorded in Florida on October 26, 1926. Mr. Nutt, as president of the bank, had from time to time approved the various loans of the bank to the land company.
A circular and prospectus issued by the broker for the purpose of selling land trust certificates on the Cusack parcel, stated that the property was under sublease to The General Outdoor Advertising Company at $36,000 a year, "more than two and one-half times the amount necessary to pay the rental to be distributed to the holders of these certificates," when it was known to the bank that this sublease, which it had been advised in writing by its counsel to record but which it did not record, had only four years to run. On February 17, 1927, the bank consented to an assignment of the underlying lease from the Carnegie-Twelfth Company to The General Outdoor Advertising Company. In May, 1929, The General Outdoor Advertising Company assigned the lease to Central Outdoor Advertising Company, which latter company in February, 1932, assigned the lease to a corporation without financial responsibility, after which no rentals were paid and in August, 1932, the bank accepted a quitclaim deed from this corporation, releasing it from future obligations to pay rent, with the result, it is claimed, that The General Outdoor Advertising Company was absolved from the further payment of rentals.
The plaintiff in his petition alleges that the bank attempted to create a trust in which it had a substantial interest and for which it received a substantial portion of the proceeds of the sale of land trust certificates, and that the entire conduct of the bank in attempting to create and administer the purported trust was illegal, without authority and void, because the statutes of Ohio did not authorize it to act in the dual capacity of settlor and trustee by creating a trust out of its own property and selling interests therein to the public.
Messrs. Horwitz, Kiefer Harmel, Messrs. Rocker Schwartz, Mr. George B. Harris and Messrs. Buckingham, Doolittle Thomas, for appellant.
Mr. Thomas J. Herbert, attorney general, Mr. Eugene S. Lindemann, Messrs. Carr Hanna, Mr. Edwin W. Brouse and Mr. Harold H. Gorman, for appellee.
The question for determination in this case is whether the bank created or participated in the creation of a trust and in the sale to the public of participation certificates under such trust in property upon which it had a mortgage inadequately secured, for the purpose of liquidating such mortgage lien through the proceeds of the sale of such certificates. If the answer is in the affirmative, the principles announced in the case of Ulmer v. Fulton, Supt. of Bks., 129 Ohio St. 323, 195 N.E. 557, 97 A. L. R., 1170, apply, to the effect that a bank or trust company is not authorized to create trusts out of its own property or property in which it has a substantial interest, or to sell participating land trust certificates therein to the public.
It is self-evident that the answer to the query depends upon the interpretation to be placed upon the undisputed facts presented in this case. The trial judge who heard the case in the Common Pleas Court upon an agreed statement of facts found that on a basis of form the bank, while holding the legal title to the real estate in question, attempted to create a trust therein, became at the same time settlor and trustee, and then proceeded to sell the trust certificates to the public; and, on the basis of substance, the trial judge found that the respective interests of the bank and the land company in the transaction were withheld from the public, that the paramount interest on the part of the bank was to secure the repayment of its loan from the proceeds of the sale of the certificates, and that it assisted in such sale but again withheld information which it had and which the purchaser was entitled to have from it as trustee concerning the property which was the basis of the security for the certificates so sold.
The master appointed by the Court of Appeals reheard the testimony in great detail and summarized his findings, in part, as follows:
"The Ontario Street Land Company and The Union Trust Company were actively engaged in the business of creating land trust issues for their mutual benefit. The Ontario Street Land Company found the property, the bank lent the money for its purchase and took title in preparation for declaring itself trustee when the money was forthcoming to pay its loan. Several prospective issues were in the process of creation simultaneously. The bank's business was lending money and as a trust company in acting as trustee, legitimate activities when exercised separately but fraught with danger when combined in one enterprise — danger, not to the bank, but to the cestuis que trust to whom the certificates were sold. * * *
"While it cannot be said that the bank originally found itself holding a bad loan and contrived the land trust issue on the Cusack parcel to bail itself out, there is no doubt that after the land trust issue was fully planned and partly consummated in the early part of 1926, the bank pumped additional sums of money into the picture relying upon the sale of the land trust issue for reimbursement, that advantage was taken of the setup in May 1926, to make the $40,000 loan without added security, to enable Mr. Nutt, the bank's president, to obtain payment for the sale of his Florida residence and in July 1926, to inflate the loan to $240,000 without new security, thus procuring payment to the bank of the $36,000 loan of The National Commercial Credit Corporation and advancing $46,003.37 more to The Ontario Street Land Company — all in evident anticipation of receiving the proceeds of the sale of the land trust certificate issue. There then was a period from July 21, 1926 (the date of the $240,000 loan), to October 13, 1926 (the date of the sale of the land trust issue), when the bank had got itself into an over-extended position, its loan was inadequately secured — transfer of the loan on real estate only from the real estate loan department to the collateral loan department was an indication of the inadequate security — and it was then of prime importance to the bank to have the land trust certificates sold. The bank then declared itself trustee of the Cusack parcel passing its own property into the trust estate, its own property because in equity it had a mortgage on the Cusack parcel, a property right which the bank itself seems to have valued at $150,000."
This court has made an independent examination of the record and is unable to agree with the finding of facts made by the Court of Appeals and consequently unable to follow its conclusions of law. The defendants claim that the principles enunciated in the case of Ulmer v. Fulton, supra, do not apply here for the reasons (1) that the bank did not create the trust: (2) that the trust was not created out of the bank's property and (3) that the bank did not sell any certificates of the trust issue. These claims will now be noticed.
There is ample evidence in the record that the bank was in the trust business and was active in the creation of this trust. For some time it had collaborated with the land company in the creation of similar trusts. The land company in the case, as in others, found the properties to become the security for the trusts, but the bank furnished the entire purchase price as a loan, taking title in its own name until such time as the trust could be created and the securities sold. Its own attorneys assisted in the preparation of the legal documents. It became the trustee of the trust and executed the certificates under its own name as trustee. In fact, the bank in its answer in this case admits that it created the trust. The officers of the land company cooperated, but the bank was the moving spirit in the matter and bore the entire financial responsibility. It is quite evident that it did not enter into this transaction for the purpose of a loan to the extent of the full purchase price of the property, but only with the purpose of recouping its money by the creation of the trust, becoming the trustee and operating the trust as a part of its business. On no other rational basis, than that it entered into the arrangement for the purpose of creating a trust, can its conduct be explained.
What interest did the bank have in this property? As a matter of form, it became the owner of the fee and furnished the full purchase price for its acquisition. If it took the fee title in lieu of a mortgage to secure a loan which it made to the land company for the purchase price of the property, it well knew that it was violating the banking laws of this state. Section 710-112, General Code, provides that: "Loans by banks upon mortgage notes shall be made upon first mortgage upon real estate situated in this state, or in states contiguous thereto, and shall not exceed forty per cent (40 per cent) of the value of such real estate if unimproved and sixty per cent (60 per cent) of such value if improved. * * *"
A series of transactions occurred by which the bank's loan on this and other property was increased to $240,000. It was decided that at least $150,000 of this amount should be secured by the Cusack parcel which afterwards became the trust property. This was far in excess of the purchase price of the property. Up to this point the land company did not have a dollar of its own invested in the property. It had no equity unless the property could be marketed for more than $150,000. The security was evidently unsatisfactory to the bank. It evidently regarded its loan as inadequately secured, at least it was not such a loan as the state banking department could approve under the law. It is significant also that the trust certificates were not purchased by the bank either for itself as an investment or for any of its trusts, but were sold to the public which was unacquainted with their origin and history. It seems to the court that the bank had such a substantial and well-nigh exclusive interest in the property that in creating and disposing of the certificates it was transferring its own property to others through the medium of a trust. The interest of the land company was only nominal at the time the issue was created, and only became substantial when the certificates were sold for a sum which, under all the facts, appeared to be approximately 50 per cent greater than the real value of the property.
A trustee must not sell to himself as trustee, property in which he has a personal interest of such substantial nature that it might affect his judgment. Restatement of Law of Trusts, 435, Section 170, comment h; Cornet v. Cornet, 269 Mo., 298, 323, 190 S.W. 333. He may pay off to himself indebtedness secured by lien on the property only provided such debt is not in distress or inadequately secured. In re Estate of Binder, ante, 26, 36. He cannot purchase for the trust, property which he owns jointly with others. Magruder v. Drury, 235 U.S. 106, 59 L.Ed., 151, 35 S.Ct., 77. What a fiduciary may not do singly he may not participate in doing. Cox, Admr., v. John, 32 Ohio St. 532; Magruder v. Drury, supra.
The defendants claim that before any land trust certificates were issued by the trustee, a sum more than sufficient to secure the release of the lien of the bank upon the premises was paid into the escrow of which the bank was escrow agent; that when the sum of $150,000, upon the order of the land company, was paid to the bank by itself as escrow agent, its lien upon the premises in question was released and a certificate for the entire number of trust shares was issued by the bank as trustee to the land company as beneficiary; that then and only then did the land trust indenture become operative; and that as a consequence, at the time the trust in question became effective, the bank had no interest in the premises which constituted the corpus of the trust, except as trustee under the trust indenture.
However, the fact is that simultaneously with the surrender of its lien on October 13, 1926, the bank received and knew it was receiving on its loan the sum of $150,000 directly or indirectly from the individual certificate holders who purchased the certificates and who were becoming its beneficiaries under the trust. These facts are established by written instructions given to the bank's trust department by its vice president in these words: "Deliver one certificate for the whole 456 shares to The Ontario Street Land Company. It will assign to Collins company, who will have reissued, putting up with loan," and by the admissions of its own answer in this case that "prior to August 1st, 1926, the date of said agreement and declaration of trust, The Ontario Street Land Company, the equitable owner of said land, owed said bank the sum of two hundred forty thousand ($240,000) dollars which it had theretofore borrowed from the bank and which was then unpaid and that out of the proceeds of the sale of said land trust certificates by the underwriter, it, as escrow agent, as aforsesaid, disbursed said funds by applying one hundred fifty thousand ($150,000) dollars thereof upon said obligation of two hundred forty thousand ($240,000) dollars and paid substantially all of the balance to The Ontario Street Land Company:" (Italics ours.)
The record shows that the bank was financially interested in the issuance and disposal of the certificates and applied the money arising therefrom to the liquidation of its loan. The whole record discloses a clear case of self-dealing and a lack of loyalty to the beneficiaries of the trust for which the bank was trustee. It well knew that these certificates were being sold to the purchasing public at prices which were above the value of the securities upon which they were predicated and that it was profiting thereby in the liquidation of its loan.
The Court of Appeals held that the plaintiff could not maintain a class suit for others as well as himself, unless authority was shown in him from such others to file their claims with the Superintendent of Banks and to represent them in the action to declare the transaction void. Class suits are allowed where the parties are numerous or have a common interest or both. Where a number of persons have separate and individual rights of action against the same party but all such rights of action arise from a common source and represent a like interest, the whole matter may be litigated in a single suit brought by all claimants as co-plaintiffs, or, in case the parties are numerous making it impracticable to bring them all before the court, by one or more of them suing for himself or themselves and on behalf of the others. When Haggerty brought this suit to set aside the transfer by the trustee of the common fund from the sale of certificates to the purchase of property now held in the trust, his interest in so acting was common to that of every other certificate holder in protecting the fund in which each had a proportionate share, and in having the trustee restore the fund received from the certificate holders against which each certificate holder may assert his individual right. Ulmer v. Fulton, supra; Peterson v. Donnelley, 33 Cal.App.2d 133, 91 P.2d 123; Pacific American Gasoline Co. of Texas v. Miller (Tex.Civ.App.), 76 S.W.2d 833; Black v. Elkcorn Coal Corp., 233 Ky. 588, 26 S.W.2d 481.
The judgment of the Court of Appeals is reversed.
Judgment reversed.
WEYGANDT, C.J., ZIMMERMAN and MATTHIAS, JJ., concur.
DAY and WILLIAMS, JJ., dissent.
This case is governed by well-known principles of the common law. The relation between the owners of the land trust certificates and the trustee arose out of contract. When did the confidential relation begin and what was its scope? In buying the certificates the buyers and seller dealt at arm's length and the doctrine of caveat emptor applied. From the time the buyers acquired the certificates a trust relation existed and the buyers, the cestuis que trustent, were entitled to have the trustee perform faithfully all duties and discharge all obligations resting on it as trustee under the trust agreement. With respect to the performance of that particular contract of trust there was no breach of trust whatsoever and no self-dealing. The fact that the trustee previously had an indebtedness chargeable on the land which became the trust res is beside the question, for one owning land or an interest therein may sell it or participate in its sale under an agreement to hold the land thereafter under a trust arrangement by which he collects rents, manages the property and distributes the proceeds to the cestuis and the trust relation does not arise until the sale agreement is complete. Such a contract of trust so long as it is not tainted by fraud or other illegality is binding. The contract of trust herein was not so tainted. The difficulty seems to lie in an endeavor to extend the responsibility of the trustee beyond the terms of the contract of trust. The trust company in the selling of the land which it held as security for a debt was not acting as a trustee but in its own right and there was no self-dealing by the trustee in so doing since such malfeasance could only occur in connection with performance of duties imposed by the trust agreement.
For these reasons the judgment should be affirmed.
DAY, J., concurs in the foregoing dissenting opinion.