CHAPTER 16

COLLATERAL SECURITY

Section

535. As between the original parties-Renewal notes.

536. Holder of collateral, for contemporaneous obligation, as holder in due course.

537. Collateral for pre-existing debt-Holder in due course. 538. Surety-Guaranty-Indemnity.

539. Accommodation paper-Maker-Bona fide holder. 540. Accommodation paper-Indorser-Bona fide holder.

541.

542.

543.

544.

Bills-Accommodation acceptor.

Form of assignment, when immaterial-Bona fide holder. When note not collateral security but independent obligation.

Note payable to order, assigned but not indorsed. 545. Agreements and conditions.

546.

Security for performance of illegal contract.

547. Note secured by mortgage-Mortgagee against makerSurety.

548.

549.

Note secured by mortgage or other instrument-Bona fide holder-Pledgee.

Note secured by mortgage or other instrument-Knowledge or notice.

550. Transferee of note and mortgage-Payment of or collateral security for pre-existing debt.

551. Receiving or surrendering collateral-Exhausting collateral.

552. Paper given or indorsed for specific purpose—Principal

and agent.

553. Defenses arising subsequent to indorsement-Bona fide holders.

554. Defense in action against indorser of collateral.

555. Paper held as collateral without indorsement-Defenses.

Section

556. Defenses available against collateral paper.

557. Transferee after maturity by pledgee of collateral. 558. Transfer after maturity-Priority of transfer-Different notes of different persons.

559. Pledgor and pledgee-Laches, negligence or tortious acts-Statute of limitations.

560. Renewals-Continuance of security-Extinguishment of

debt.

561. Right of holder of collateral to sue thereon.

562. Extent of recovery-Bona fide holder.

563. Extent of recovery-Collateral security for pre-existing debt.

564. Extent of recovery-Accommodation paper.

§ 535. As between the original parties-Renewal notes.1— All notes representing the same debt may be outstanding, as where a renewal note is executed without delivering up to the maker the original note, and without any agreement or understanding between the parties that the renewal note is to operate as payment and extinguishment of the original note. In such case the only difficulty presented, and on which the courts are divided in opinion, is as to which note is to be treated as collateral, some holding that the renewal note is collateral to the original, and others holding that the original note is collateral to the renewal note. Upon the principle that any instrument, though absolute upon its face, may be shown by parol to be a security only, it is competent, in an action by an indorsee from the payee of the note as collateral security, to show that the payee had himself taken the note as collateral security merely

1 As to collateral security for preexisting debt-bona fide holders, and as to payment of pre-existing debt, see chapter on "Effect of Conditions or Agreements."

2 Dies v. Wilson County Bank, 129 Tenn. 89, 165 S. W. 248, Ann. Cas. 1915A, 1090; Keyser v. Hinkle, 127 Mo. App. 62, 106 S. W. 98. A bank holding notes as trustee is not holder for

value under the rule relating to holders of collateral. Gulbranson-Dickinson Co. v. Hopkins, 170 Wis. 326, 175 N. W. 93. Where a note when executed had a notation on its margin stating that it was given as security for certain stock, it is sufficient to give character to the note as collateral security. Scholbe v. Schuchardt, 292 Ill. 529, 127 N. E. 169, revg. 212 Ill. App. 663.

for the repayment of a loan or advances, and the plaintiffs having taken the note after maturity and as collateral for a prior indebtedness they had no better rights than the payee, and were subject to the defenses of the maker against the payee, so that their recovery was limited to the payee's interest. So it may be shown that, as between the original parties, the note was given to be used as collateral. But it is also decided that in an action by the payee against the maker a plea which sets. up the execution and delivery of the notes as collateral security is subject to demurrer. Again, notes may be validly transferred as security for indorsements previously made. In case collateral has been given for notes, one of which is subsequently destroyed, the collateral remains as security for the remaining note. And it is no defense against a bona fide holder of a note as collateral that the maker before maturity paid the same to the payee and indorser.8 So, where a holder. of collateral makes a pretended sale of the same to himself, the sale is a nullity, and the collateral remains as security in favor of one secondarily liable on the note secured. And, where the payee of a note receives general collateral from the

3 Kelly v. Ferguson, 46 How. Prac. (N. Y.) 411.

4 McCrady v. Jones, 36 S. Car. 136, 15 S. E. 430.

5 Moore v. Prussing, 165 Ill. 319, 46 N. E. 184. The court said: "The second plea attempted to set up that the execution and delivery of the notes were as collateral security merely, and set up substantially the same facts as pleaded in the plea failure of consideration. Whilst a person signing a note has a right to prove by parol the capacity in which he signs the paper, and such proof is not an attempt to vary the terms of the written instrument, yet where the note is accepted as a separate and independent contract an attempt to vary the terms of the contract by parol is not admissible, and the plea attempting to set up that the note signed was accepted as collateral security could not change the legal

effect of the instrument, as a liability would exist according to the terms of the contract, and the attempt to set up such an agreement constituted no defense. As the sole makers of the note, defendants can not show that they only signed as sureties. To permit proof of that fact would be to vary by parol the contract itself and contradict its terms. Harris v. Galbraith, 43 Ill 309; Miller v. Wells, 46 Ill. 46.❞

6 Noyes v. Landon, 59 Vt. 569, 10 Atl. 342. As to becoming absolute owner of accommodation note pledged as collateral, see Beacon Trust Co. v. Robbins, 173 Mass. 261, 53 N. E. 868.

7 Sherman v. Connecticut Mut. Life Ins. Co., 222 Mass. 159, 110 N. E. 159. 8 Bank of Cumming v. Mason, 22 Ga. App. 33, 95 S. E. 307.

9 Broderick v. Lucas (Mo. App.), 182 S. W. 154.

maker as security, not only for the payment of the note, but also for the payment of any other liability to the holder which may thereafter be contracted, the holder may, after payment of the note, apply the collateral to the payment of other obligations by the maker of the note to the holder. 10 Again, where a note is indorsed as collateral for the price of a threshing machine, in an action against the maker thereon by the pledgee, the maker can not set up in defense that the purchaser of the machine had undertaken to do his threshing, but because of the inferior condition of the machine it broke down and caused defendants damage in excess of the amount of the note, since the purchaser of the machine alone can complain of its defective condition.11 After payment of the secured notes, the creditor is no longer entitled to possession of the collateral.12

§ 536. Holder of collateral for contemporaneous obligation, as holder in due course.-The indorsee of commercial paper who takes the same as collateral security before maturity, for a debt created concurrently when such instrument is executed without notice of any infirmity in the paper or defect in the title of the indorser, is a holder in due course and for value, and holds the same free from any defense which might have existed in an action by the prior holder of holders, the same as though he were a purchaser in due course of such paper.18 So,

10 Oleon v. Rosenbloom, 247 Pa. 250, 93 Atl. 473, L. R. A. 1915F, 968, Ann. Cas. 1916B, 233.

11 M. Rumley Co. V. Koetter (Okla.), 178 Pac. 116.

12 Ollis v. Farmers & Merchants Bank (Mo. App.), 201 S. W. 947.

13 Harrison v. Morgan Curry Co., 115 Ark. 44, 170 S. W. 578; Burnham Loan & Inv. Co. v. Sethman, 64 Colo. 189, 171 Pac. 884, L. R. A. 1918F, 1158; McDaniel v. Bank of Bethlehem, 22 Ga. App. 223, 95 S. E. 724; Bank of Sparta v. Butts, 4 Ga. App. 308, 61 S. E. 298, 300 (warehouse receipts); Justice v. Stonecipher, 188 Ill. App. 370, affd. 267 I11. 448, 108 N. E. 722; Anderson v. Keystone Chemical

Supply Co., 293 Ill. 468, 127 N. E. 668;
Gigoux v. Moore, 105 Kans. 361, 184
Pac. 637; Farmers & Merchants State
Bank v. Beal, 102 Kans. 481, 170 Pac.
1007; First Nat. Bank v. John Mc-
Grath & Sons Co., 111 Miss. 872, 72 So.
701; Miller v. Chinn (Mo. App.), 195
S. W. 552; Farmers Bank of Lyons v.
Dixon, 91 Nebr. 652, 136 N. W. 845;
Second Nat. Bank v. Werner, 19 N.
Dak. 485, 126 N. W. 100; Bailey v.
Inland Empire Co., 75 Ore. 309, 146
Pac. 991; Houston v. McCaslin, 65 Pa.
Super. Ct. 28; Union Nat. Bank of
Columbia v. Cook, 110 S. Car. 99, 95
S. E. 484; Citizens Trust & Sav. Bank
v. Empey, 34 S. Dak. 361, 148 N. W.
606; Masterson v. Ross (Tex. Civ.

where a note is substituted for other collateral, the holder of such collateral note holds in the same right as a purchaser for value. 14 It is a conceded rule that a transferee is a holder for value where the negotiable paper is received as collateral security for a present or contemporaneous loan, or for fresh advances, or upon a new consideration afterwards, in due course, without notice and in good faith.15 Or, to state the rule