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We have stated the facts with great fullness, so that the effect of our decision can be seen, but we shall be brief in announcing our conclusions and in giving our reasons, because the most of the questions have been so fully discussed, both by the General Term and by the referee, as to leave little to be said by us.
The referee found, in accordance with the contention of the defendants, that eleven of the notes in question were accommodation paper, and, as the plaintiff neither excepted nor appealed, both parties must accept that conclusion as unassailable on this review. The twelfth note, however, was not accommodation paper, because it was not held like the others as a memorandum or security, and there was a complete exchange of notes for the purpose of raising money. (Newman v. Frost,52 N.Y. 422; Dowe v. Schutt, 2 Denio, 621; Rice v. Mather, 3 Wend. 62.) The moment that the Messrs. Smith used the counterpart of their own note, both notes were ipso facto converted into business paper, and the makers of each became liable as principal debtors. That act completed an actual exchange of notes for the mutual accommodation of the respective makers, and each note constituted a good consideration for the other. (Rice v.Grange, 131 N.Y. 149.) The promise to notify was merely for convenience, and the failure to give notice was not vital, as the use of the note intrusted to the Messrs. Smith as security, in pursuance of the right reserved by them to do so, effected the change from accommodation into business paper and made it their duty to pay it. It was, however, the duty of Wainwright Bryant to pay the other eleven, as to which the Messrs. Smith were simply sureties, of which fact the plaintiff, through its president, had notice, as the referee found and was warranted by the evidence in
finding. The existence of that relation between the original parties to the paper, and knowledge thereof by the plaintiff, entitled the makers, upon payment of the debt, to all the rights, remedies and securities that the plaintiff had with reference to the notes. (Hayes v. Ward, 4 Johns. Ch. 123; Grow v.Garlock, 97 N.Y. 81; Brandt on Suretyship, § 298.) There is a sharp contest between the parties as to the nature of the judgment note of the plaintiff and the judgment rendered thereon. The plaintiff contends that they were collateral security, as that term is ordinarily understood, while the defendants contend that the notes upon which Wainwright Bryant were indebted to the bank and the judgment note were different forms of contractual obligations for the same aggregate amount of money, each obligation being supported by the same consideration. It was within the power of the contracting parties to agree that the judgment note should be collateral security, especially since it is found as a fact that the law of the state where the transaction took place permits such a contract. The referee further found that the note upon which said judgment was rendered was given to the plaintiff, "as collateral security for such notes then held by the plaintiff, on which the said defendants, Wainwright Bryant, were liable as makers and indorsers * * * to secure the plaintiff against loss upon such notes." This finding was not excepted to by the defendants Smith, who are, therefore, not in a position to challenge it as having no support in the evidence, which, when carefully examined, clearly sustains the finding. The judgment note was a separate and supplementary contract, designed to secure the performance of numerous prior contracts entered into by Wainwright Bryant, and, in order to be adequate, was made for the amount of those contracts when added together. It was not received in payment of the principal debt, nor as a substitute therefor, and it was not an additional right to which the bank was entitled, but merely a concurrent security, voluntarily given by the principal debtors, to secure a precedent debt, and intended to increase the means of the creditor to realize the principal debt
which it was given to secure. (Munn v. M'Donald, 10 Watts [Pa.], 270.) There was no merger of the notes held by the bank against the Messrs. Smith and others upon which Wainwright
Bryant were liable, in the judgment rendered upon the judgment note given as collateral, because the judgment was founded on that note and was necessarily a security of the same general nature. While the entry of judgment permitted the seizure and sale of property, the avails of the sale were still collateral security, although converted into money in readiness to be applied upon the original indebtedness. The object of the judgment note was to furnish a security, due at once, in convenient form to put in judgment immediately, for the purpose of obtaining a lien upon the property of Wainwright Bryant as collateral security to their indebtedness to the bank, existing in the form of many different notes that were not yet due, and this, as it is expressly found, is sanctioned by the laws of Pennsylvania. The original indebtedness still existed unmerged and unchanged, except so far as the proceeds of the sale were applied, or should have been applied, thereon.
The plaintiff owed the defendants the duty of dealing in good faith with its judgment, which it held not simply for its own security, but for the indemnity of the sureties also, and to do no act to impair such security to the prejudice of their rights. Under the circumstances, this duty was not an active, but a negative duty, as the bank was simply bound not to cancel, waste or impair its security. (Board of Supervisors v. Otis,62 N.Y. 88; First National Bank v. Wood, 71 N.Y. 405; Mayhew
v. Crickett, 2 Swanst. 185.) If the sureties wished to control the judgment it was their duty to pay the debt and obtain subrogation pro tanto to the collateral. After all was collected on the judgment that was shown to be collectible, the bank assigned it to Mr. Simpson for the purpose, as the referee found, of enabling him to obtain a deed of the premises sold under the execution by crediting him thereon with the bank's share of the purchase price without actual payment thereof to the sheriff, and upon the understanding that he was to pay the
bank its proper share of the proceeds. Simpson also, as the referee further found, assumed a position at the time of accountability to the bank, the exact nature of which was not then defined. Subsequently, however, it was defined by an arrangement between the bank and Mr. Simpson by which he agreed to pay it the full amount of its unsecured claims against Wainwright Bryant, including the notes in question, out of the proceeds of the sale of both the real and personal property sold under the execution and purchased by Simpson, after he had realized enough to pay Wainwright Bryant's indebtedness to him. The real nature of the transaction, therefore, was that the bank exchanged its judgment for Simpson's agreement to pay it the full amount of its claim against Wainwright Bryant in the manner stated. There was no surrender, but a substitution of securities. One kind of collateral was exchanged for another, and there is neither finding nor evidence of bad faith, or that the substituted security was worth less than the judgment. The admission in the amended answer is that all of Wainwright
Bryant's property had been exhausted, and that they were insolvent. Hence the judgment of the bank was worth nothing, unless in the future they should acquire property that might be seized and sold. Under these circumstances, the referee could not find as matter of fact, and we cannot hold as matter of law, that the substituted security was worth less than the naked judgment against the insolvent debtors. The sureties were not injured in fact, nor were they injured in law, unless the exchange, under any circumstances, of one collateral security for another, is so inconsistent with the legal rights of a surety as to raise a conclusive presumption of injury therefrom. No authority has been cited, and we have been able to find none, holding that a surety may not in good faith endeavor to better his situation by exchanging one kind of collateral for another that he regards as more valuable. If a bank holds bonds of doubtful value as security for a note made by sureties for the principal debtor, may it not exchange those bonds for others that it regards of greater value without releasing the sureties? If it
cannot, the law deprives it of the right to make the best use of its collateral that it can, and compels it to refrain from trying to better its condition, lest, although acting honestly and for what it regards as its own interest as well as the interest of the sureties, it may make a mistake to their detriment. The rule that a surety is discharged pro tanto through the surrender of security by the creditor does not rest on contract, but upon the equitable principle that the property of the debtor, pledged for the payment of the debt, should be applied on the debt. In such a case the surety is discharged to the extent that he is injured. A diversion of security which results in no injury to the surety does not affect his liability, for payment of the debt with the accompanying right of subrogation would be of no value. (Blydenburgh v. Bingham, 38 N.Y. 371.) In this case it was held that the relation of the creditor to the property released must possess more than a suppositious or imaginary value and advantage in order that the release shall discharge the surety from liability. The release of part of certain real estate, in order to make a title to one who purchased it for full value, upon condition that the purchase money should be applied to the extinguishment of a mortgage that was a prior lien upon the whole estate, was not held to release a surety, because the transaction bettered his condition rather than otherwise. (Neff's Appeal, 9 Watts Serg. 36.) So the surrender of a life policy, held as collateral, upon receipt of its present value, after the principal had become bankrupt, and it was doubtful whether he would keep up the policy, did not discharge the surety. (Coates
v. Coates, 33 Beavan, 249.) Where a creditor released a levy on property of the principal debtor worth $90, in consideration of an order worth $100, that could not have been reached by the execution, it was held that the surety was not discharged because he was benefited by the transaction. (Thomas v. Cleveland,33 Mo. 126. See, also, Commercial Bank v. Western Reserve Bank,11 Ohio, 444; Moss v. Pettingill, 3 Minn. 217; Moss v.Croft, 10 Mo. 720.)
The admitted insolvency of the principal debtors, and the sale of all their property, met the burden of proof that the law cast upon the plaintiff of showing that the judgment assigned to Simpson was worthless. The inclusion of the personal property, in which the bank had no interest, in the agreement, gave the sureties an advantage that they did not have before. As the effect of the release of collaterals is measured by the injury done to the surety, a substitution of one security for another, when made in good faith and apparently for the benefit of all concerned, should be governed by the same rule.
In view of the opinions below, we think that no further expression of consideration by us is called for, and that the judgment should be affirmed, with costs.
BARTLETT, HAIGHT and MARTIN, JJ., concur; PARKER, Ch. J., not sitting; O'BRIEN, J., not voting; GRAY, J., absent.
Judgment affirmed.