author: Lehman, J. Finch, J.

text:
    Lulu M. Geer, Respondent, v. Union Mutual Life Insurance Company, Appellant. (Actions 1 and 2.)

      Argued December 3, 1936;
    decided March 9, 1937.

      Jerome K. Cheney for appellant.
    It is entirely reasonable that the insurer should ask for and be entitled to receive full and complete information about specific diseases and ailments previously suffered by the applicant, about the number of times within a specified period the applicant has consulted a physician and the ailment which occasioned the consultation and the facts about any hospital treatment the applicant may have received. The nature of such inquiries establish their materiality. Such pertinent facts are material to the risk and to the life insurance contract. (Anderson v. Æna Life Ins. Co., 265 N. Y. 376; Keck v. Metropolitan Life Ins. Co., 238 App. Div. 538; 264 N. Y. 422; Jenkins v. John Hancock Mut. Life Ins. Co., 257 N. Y. 289; Minsker v. John Hancock Mut. Life Ins. Co., 254 N. Y. 333; Travelers Ins. Co. v. Pomerantz, 246 N. Y. 63; Saad v. New York Life Ins. Co., 201 App. Div. 544; 235 N. Y. 550; Samson v. Metropolitan Life Ins. Co., 290 N. Y. Supp. 161; New York Life Ins. Co. v. Breen, 242 App. Div. 453; Schrader v. John Hancock Mut. Life Ins. Co., 232 App. Div. 644; Klapholtz v. New York Life Ins. Co., 218 App. Div. 695; Grubiak v. John Hancock Mut. Life Ins. Co., 212 App. Div. 126; Gretsinger v. Metropolitan Life Ins. Co., 206 App. Div. 766; Tunnard v. Supreme Council, Royal Arcanum, 201 App. Div. 746.) A material misrepresentation voids the policy although innocently made. (E. D. P. Dye Works v. Travelers Ins. Co., 234 N. Y. 441.)

      George R. Fearon, Henry R. Follett and M. Harold Dwyer for respondent.
    The question as to whether the alleged misrepresentations contained in the applications were material to the risk was properly submitted to the jury. (Nowak v. Brotherhood of American Yeomen, 249 N. Y. 78; E. D. P. Dye Works v. Travelers Ins. Co., 234 N. Y. 441; Krauza v. Golden Seal Assurance Society, 221 App. Div. 380; 247 N. Y. 536; Cushman v. United States Life Ins. Co., 70 N. Y. 72; Keck v. Metropolitan Life Ins. Co., 238 App. Div. 538; 264 N. Y. 422; Minsker v. John Hancock Mut. Life Ins. Co., 254 N. Y. 333; Anderson v. Æna Life Ins. Co., 241 App. Div. 792; 265 N. Y. 376; Saad v. New York Life Ins. Co., 201 App. Div. 544; 235 N. Y. 550; Klapholtz v. N. Y. Life Ins. Co., 218 App. Div. 695; Grubiak v. John Hancock Mut. Life

      Ins. Co., 212 App. Div. 126; New York Life Ins. Co. v. Breen, 242 App. Div. 453; Travelers Ins. Co. v. Pomerantz, 246 N. Y. 63; Jenkins v. John Hancock Mut. Life Ins. Co., 257 N. Y. 289).
   Lehman, J.

The decedent in his application for insurance answered “ No ” to the question: Have you had any treatment within the last five years at any dispensary, hospital or sanitarium;” and in answer to the direction, “ Give name and address of each physician consulted by you during the past ten years, and cause for consultation,” the decedent stated: “ Dr. N. G. Darling, 31 North State Street, Chicago, IH., Nervousness.” The evidence shows that on October 4, 1928, the decedent visited Dr. Spire. Dr. Spire testified that according to notes made at that time, the decedent told him, Returned from a long trip five days ago, had some coughing, felt bad the following day, took a laxative, has just a little hacking cough, his work takes him to large cities, has been nervous for the past six months, last April had influenza in Chicago. Has gained in weight past summer following that * * * illness.” The physician examined the decedent at that time. He had a temperature of 102°. The physician treated him then but did not see him again till October 11th, one week later. Dr. Spire then sent him to the Syracuse General Hospital where he remained till October 26th. Dr. Spire diagnosed the decedent’s ailment as para-typhoid and treated him for that ailment at the hospital, and after discharge from the hospital until December 17th, 1928, though the X-ray examination and the tests made at the hospital were negative and failed to show that the plaintiff was suffering from that disease. The hospital record, under the heading “ Past History,” states in part: “Felt badly and coughed. About Sept. 30/28 gradually became worse with no outstanding symptoms except cough and tired feeling. Had influenza in April /28 from which he never fully recovered.” In 1932 the decedent again consulted Dr. Spire on two occasions. Then Dr. Spire diagnosed his ailment as nervousness.

Section 58 of the Insurance Law (Cons. Laws, ch. 28) provides that all statements purporting to be made by the insured [in an application attached to the policy of life insurance] shall in the absence of fraud be deemed representations and not warranties.” The effect of the statute is that a misstatement, even though stated in the form of a warranty, if made in good faith and without this element of fraud passed into the same class as an ordinary representation and became a defense to the policy only if it was material. On the other hand, the effect of a misrepresentation was left unchanged by the statute. If material it constituted a defense although made innocently and without any feature of fraud; it was sufficient that it was material as an inducement for the issue of the policy, and was untrue.” (Eastern District P. D. Works, Inc., v. Travelers Ins. Co., 234 N. Y. 441, 449.) Here, though the evidence conclusively establishes that the decedent in his application failed to disclose that he had consulted Dr. Spire or had been treated at a hospital within five years of the date of the application, the court submitted to the jury the question whether the decedent had in his application made a material misrepresentation. The jury decided that no material misrepresentation was made. The question presented is whether, upon the evidence, it conclusively appears that there was a material misrepresentation.

A life insurance company is free to choose the risks which it will assume. An applicant for life insurance is required to answer certain questions which are prepared for the purpose of facilitating the examination and appraisal by the company of the insurability of the risk. In effect the company states to the applicant that the answers to those questions are intended to guide the company in deciding whether to accept or reject the application. By posing the question the insurer has indicated “ that it wanted to know the facts and that it intended and expected the applicant to speak the truth so that it might acquire information concerning them. Any misrepresentation which defeats or seriously interferes with the exercise of such a right cannot truly be said to be an immaterial one.” (Travelers Ins. Co. v. Pomerantz, 246 N. Y. 63, 68.)

No method has been devised by which the processes of the human mind can be charted and the force of inducement mechanically measured. The materiality of a representation may then depend upon the idiosyncrasies or the individuality of the person who acts upon the representation, and often must be determined as a question of fact by the trier of the facts. Nevertheless at times, departure in a representation from an accurate statement of .the truth may be so slight that we may confidently say that the difference could not affect decision of any reasonable person. Then as a matter of law the misrepresentation is not material. On the other hand, where an applicant for insurance has notice that before the insurance company will act upon the application, it demands that specified information shall be furnished for the purpose of enabling it to determine whether the risk should be accepted, any untrue representation, however innocent, which either by affirmation of an untruth or suppression of the truth, substantially thwarts the purpose for which the information is demanded and induces action which the insurance company might otherwise not have taken, is material as matter of law. The question in such case is not whether the insurance company might perhaps have decided to issue the policy even if it had been apprised of the truth, the question is whether failure to state the truth where there was duty to speak prevented the insurance company from exercising its choice of whether to accept or reject.the application'upon a disclosure of all the facts which might reasonably affect its choice. (Jenkins v. John Hancock Mut. Life Ins. Co., 257 N. Y. 289. Cf. Keck v. Metropolitan Life Ins. Co., 238 App. Div. 538; affd., 264 N. Y. 422.)

That does not mean that every failure to disclose each occasion upon which the applicant has visited or consulted a physician constitutes a misrepresentation, material or otherwise. A reasonable construction of a question in an application blank which calls for information about consultations with physicians or about medical treatments, may limit the scope of the question to consultations or treatments for ailments which are not trivial and exclude the applicant’s “ visits for medical advice for such minor ills as constipation or common cold in the head, which are readily relieved by simple remedies and do not impair his general health.” (Jenkins v. John Hancock Mut. Life Ins. Co., supra, p. 293. Cf. Travelers Ins. Co. v. Pomerantz, 246 N. Y. 63.) In such case the decision that failure to disclose a visit for medical advice creates no fatal infirmity in the policy of insurance thereafter issued rests upon construction of the application and determination that failure to disclose such a visit constitutes no suppression of the truth and, thus, no false representation that there had not been such a visit rather than upon determination that, though a false representation was made it was not material. True, the test of whether the ailments, for which medical advice or treatment was sought, were trivial, may be decisive in either view of the question, and there may in most cases be no occasion to draw such distinctions. As Judge Finch points out, an applicant may hardly be expected to remember each occasion upon which he sought medical advice for a trivial ailment which passed away leaving no permanent effect; and a question in an application blank may not reasonably be construed as calling for information, which the person to whom the question is posed could not be expected to remember. That proposition is self-evident. Equally clear is the proposition that a failure by the applicant to disclose a visit which the applicant could not reasonably be expected to remember could not mislead the insurance company and, therefore, would not be a material misrepresentation. Thus in a case where the courts have held that the medical visit was for advice in regard to an ailment so trivial that an applicant was not called upon to remember or to give information concerning it, the courts have not always kept distinct, in word or thought, the grounds upon which failure to disclose information concerning medical visits might be regarded as inconsequential.

In this case the situtation is quite different. We have an admission or statement made by the decedent to a physician whom he consulted in October, 1928, that the previous April he had an attack of influenza from which, it appears, he had not at that time recovered. We have conclusive proof that at that time the decedent was sent to a hospital where he remained for two weeks; that his physician diagnosed the decedent’s ailment as para-typhoid and continued to treat him for almost two months after his discharge from the hospital, and that shortly before he signed the application, the decedent twice consulted the same physician for a nervous condition. It is quite possible, as Judge Finch says, that none of the ailments for which the decedent consulted physicians and received hospital treatment permanently affected the decedent’s health or made him a less desirable insurance risk. Even so, it can certainly not be said that the applicant could not reasonably be expected to disclose information about such consultation or hospital treatment. By no possible construction of the questions in the application blank can it be said reasonably that the question did not call for such information. Hence failure to disclose information called for by the question constitutes a representation that there had been no such consultation or hospital treatment. (Anderson v. Æna Life Ins. Co., 266 N. Y. 376, and cases there cited.) Thus in this case the only question is whether the representation, though false, was material to the risk as matter of law.

In Jenkins v. John Hancock Mut. Life Ins. Co. (supra, p. 293) we said that the question plainly indicated that “ the insurer wished to know the details of any professional treatment * * * in order to decide whether it would issue a policy. The insurer did not make this a trivial inquiry, limited to cases where the patient was kept from work by the malady. It was made material to the risk. The insurer so determined and it was not for the insured to pass it over as trifling.” To sustain the judgment in this case we must hold that though the insured might not “ pass it over as trifling ” the jury might do so.

Any decision that a misrepresentation is not material must of course be based upon a holding, as question either of law or of fact, that the departure from the truth was not a factor which deprived a person of freedom of action and did not induce a choice which otherwise might not have been made. In no case which has been called to our attention has a court of this or other jurisdiction enforced a policy where information demanded by an insurance company “ in order to decide whether it would issue a policy ” and which might reasonably be considered a factor in arriving at a choice has been withheld. The question in such case is not whether the company might have issued the policy even if the information had been furnished; the question in each case is whether the company has been induced to accept an application which it might otherwise have refused. “ Any misrepresentation which defeats or seriously interferes with the exercise of such a right cannot truly be said to be an immaterial one.” (Travelers Ins. Co. v. Pomerantz, supra, p. 68.) There we held that proof of the withholding of information concerning medical consultations, though called for by a question in an application blank, requires in the absence of denial or .explanation a finding of material misrepresentation.

That case has been followed in a number of later cases. Attempt is made to distinguish those cases on the ground that in all those cases the plaintiff, seeking recovery upon the policy, by claim of privilege arising from the relation of physician and patient, prevented the defendant from showing the nature of the ailment for which a physician was consulted, while here the plaintiff waived the privilege and invited disclosure. The fact that in those cases the plaintiff claimed the benefit of a privilege accorded by law, could, it is plain, not change the effect of a misrepresentation or shift the burden of showing that the misrepresentation was material. The only distinction, then, between those cases and the present case is that here the nature of the ailment is disclosed, while there it rested upon inference. The rule of law to be applied • is the same in both cases. That rule is that where an applicant for insurance withholds information called for by question in an application blank, concerning medical advice for ailments which are not “ mere temporary disorders having no bearing upon general health the inquiry was not to be passed over as trivial. It was made material to the risk.” (Anderson v. Ætna Life Ins. Co., 265 N. Y. 376, 380.)

The salient features of the problem presented in this case are these: The insurance company did not agree that a jury might decide what risks the company should accept. It reserved that choice to itself, and in order to determine whether in a given case it should exercise that choice, it required certain information of each applicant. Here the applicant gave erroneous information, and the insurance company acted upon the information it received. If the truth had been disclosed it might prehaps have rejected the application or it might have accepted it. No person can say with any degree of certainty what action it would have taken, but it cannot be doubted that the erroneous statement deprived the company of its freedom of choice and that it acted upon a statement of facts which did not exist and if the truth had been disclosed, it might, reasonably, have acted differently. It follows then that the representation was material as matter of law.

Nothing said in this opinion should be construed as an approval of any argument that because the company by asking questions signifies that it will consider the answers in determining whether to issue the policy, it follows that any misrepresentation in the answer, however innocently made, is material as matter of law. To correct the misunderstanding apparent in the opinion of Pinch, J., I collate, though with new italics, what has been previously said on that point in this opinion. Misrepresentation in an answer, by affirmation of an untruth or by suppression of the truth, is material where it “ substantially thwarts the purpose for which the information is demanded and induces action which the insurance company might otherwise not have taken.” The test is whether “ failure to state the truth where there was duty to speak prevented the insurance company from exercising its choice of whether to accept or reject the application upon a disclosure of all the facts which might reasonably affect its choice.” The question is not whether the company might have issued the policy even if the information had been furnished; the question in each case is whether the company has been induced to accept an application which it might otherwise have refused.”

There has never been any contention, dictum or decision in this court that if an insurance company evinces interest in the subject it thereby becomes material and no such contention is made in this opinion. The inquiry is made material to the risk. The insurer so determined, and it was not for the insured to pass it over as trifling ” (Jenkins v. John Hancock Mut. Life Ins. Co., 257 N. Y. 289); but innocent failure to give true answer to the material ” inquiry is itself material only where it “ defeats or seriously interferes with the exercise of such a right [i. e., to accept or reject the application].” Such a misrepresentation cannot defeat or seriously affect the insurance company’s right to reject the application where a disclosure of all the facts could not “ reasonably ” affect the choice of the insurer. Thus though the formulation of the test is somewhat different from that approved in Penn Mut. Life Ins. Co. v. Mechanics’ Sav. Bank & Trust Co. (72 Fed. Rep. 413) and Mutual Life Ins. Co. v. Ontario Metal Products Co., ([1925] App. Cas. 344), the test is essentially the same. Under each test materiality is a matter of degree and a misrepresentation through concealment of a fact in regard to a condition of health or physicians consulted, is material where it appears that a reasonable insurer would be induced by the misrepresentation to take action which he might not have taken if the truth had been disclosed.

In Mutual Life Ins. Co. v. Ontario Metal Products Co. (supra), which is said to be precisely in point, it appeared that the misrepresentation consisted in failure to disclose treatment for a temporary disorder which was not a disease, did not cause the applicant to lose a single day of work and was due only to overwork or lack of exercise. As said earlier in this opinion, the rule in this State is that where an applicant for insurance withholds information called for by questions in an application blank concerning medical advice for ailments which are not mere temporary disorders, having no bearing upon general health the inquiry was not to be passed over as trivial. It was made material to the risk.” (Anderson v. Ætna Life Ins. Co., supra.) In all the cases cited in the opinion of Finch, J., or in the brief of the respondents, the misrepresentation either did not refer to health or medical treatment, or referred to mere temporary disorders having no bearing upon general health.” None of them are inconsistent with what was said in the Anderson case or is said in this opinion.

The judgments should be reversed and the complaints dismissed, with costs in all courts.

Finch, J.

(dissenting). The decedent, George H. Geer, applied for and obtained from the defendant two life insurance policies in 1932. His application contained the following questions and answers, photostatic copies of which were attached to the policies:

“ 5. Have you ever had, or been told by a physician you had — (underline any disease had) ****** *

B. Cough or Hoarseness (Chronic or Persistent), Asthma, Spitting of Blood, Pleurisy, Pneumonia, or any Disease of the Respiratory Organs?

“ B. No.

*******

“ D. Diarrhoea, Dysentery, Dyspepsia (chronic), Jaundice, Liver Disease, Colic (severe), Gallstones, Fistula, Peritonitis, Ulcer of stomach or bowel, or any disease of the Abdominal Organs?

“ D. No.

*******

“ M. Have you had any treatment within the last five years at any dispensary, hospital or sanatorium? If yes, give dates, duration, name of ailment and name of institution.

“ M. No. Right mastiodictomy — 9 yr. ago — Syr. Memorial Hospital — complete recovery few weeks.

Dr. T. H. Halstead, Syracuse, N. Y.

* * * * * * *

Give name and address of each physician consulted by you during the past ten years, and cause for consultation. Dr. N. G. Darling, 31 North State St. Chicago, 111. Nervousness.”

The policies contained a two-year incontestable clause but before the expiration of the period the insured died as the result of inhaling carbon monoxide gas. The plaintiff, the beneficiary under the policies, brought actions upon them. The insurance company set up as a defense that the insured had had consultations with physicians which were not revealed in the application. The plaintiff waived her right to claim the physician-patient privilege and permitted the introduction of evidence of such consultations with physicians and on her own behalf introduced evidence to show that in 1932 the insured had twice consulted a Dr. Spire at his home and the doctor had diagnosed the malady as mere nervousness; that in 1928 he had visited Dr. Spire and that at that time the doctor thought the insured had paratyphoid and sent him to a hospital; that an X-ray and other tests were taken but the results were negative and that the hospital charts do not show symptoms of paratyphoid; that in the course of his 1928 visit the insured had told Dr. Spire that he had had influenza during the previous year.

The trial court submitted to the jury the question whether the omissions from the answers in the application were material to the risk. The jury returned a verdict in favor of the plaintiff. The County Court and the Appellate Division have affirmed the judgment entered thereon and the Appellate Division has granted leave to appeal to this court.

The appellant maintains that the omissions in the answer are material as a matter of law and that, therefore, the complaint should have been dismissed.

Section 58 of the Insurance Law (Cons. Laws, ch. 28) provides that unless a copy of the application is attached to the policy it shall not be incorporated therein by reference and that all statements purporting to be made by the insured although attached to the policy shall in the absence of fraud be deemed representations and not warranties. A false warranty ipso facto vitiates the policy whether or not it is material. (See Eastern District P. D. Works, Inc., v. Travelers Ins. Co., 234 N. Y. 441, 449; 63 A. L. R. 846.) It is argued, however, that any omission in an answer to a question concerning consultation with physicians is material as a matter of law. Such a rule would lead to manifest injustice. Under it a policy could be vitiated because the insured had forgotten a visit to the doctor many years earlier for the treatment of a slight cold, or failed to disclose a consultation with a physician which had revealed that the insured was in good health. Unless the insured kept a detailed diary or journal he would never be certain that a casual visit to a physician might not be availed of to set his policy aside. Nor does the rule contended for by the defendant accord with the law of decided cases. Omissions or misrepresentations concerning health or visits to "a physician are not conclusively presumed to be material except under special circumstances. (4 Couch, Cyclopedia of Insurance Law, § 885-e; 4 Cooley’s Briefs on the Law of Insurance [2d ed.], pp. 3301, 3394 et seq.; Genung v. Metropolitan Life Ins. Co., 60 App. Div. 424; Higbie v. Guardian Mutual Life Ins. Co., 53 N. Y. 603; Murphy v. Union Central Life Ins. Co., 255 N. Y. 617; Eastern District P. D. Works, Inc., v. Travelers Ins. Co., 234 N. Y. 441; Nowak v. Brotherhood of American Yeomen, 249 N. Y. 78.) Thus in Jenkins v. John Hancock Mut. Life Ins. Co. (257 N. Y. 289, at p. 293), this court said: It is a strict but humane ruling that when the insurer asks the applicant to say merely whether he has consulted a physician for any disease or disorder not enumerated in the list, the insured, if in good health at the time, need not recall his visits for medical advice for such minor ills as constipation or common cold in the head, which are readily relieved by simple remedies and do not impair his general health.” Similarly in Travelers Ins. Co. v. Pomerantz (246 N. Y. 63, at p. 68) this court said: “ The words ‘ deformity ’ or ‘ infirmity ’ as used in connection with applications for insurance are, of course, construed to mean deformities or infirmities of such a substantial character as, if known, would have been hable to deter an insurer from issuing a policy. (Eastern District P. D. Works, Inc., v. Travelers Ins. Co., 234 N. Y. 441, 453, 454.) The same principle must be true respecting medical or surgical attention. The attention to which reference is made in statement 12 must be not for a trivial indisposition but for some substantial illness, sickness, injury or disease. * *

It is argued that where an insurance company by specific questions requests information, any untrue representation or concealment in the answer, however innocent, is material as a matter of law, and that the test is net whether the insurance company would have issued the policy if it had been apprised of the truth, but whether it had an opportunity to exercise its choice upon a disclosure of all the facts. The cases in which it has been held that failure to mention colds or other minor ailments did not vitiate the policy properly are based, it is asserted, not on the theory that the misrepresentation was material, but on the ground that the questions were not intended to elicit such information.

To restate the contention, as I understand it, it is this: An insurance company is entitled to exercise its will freely in determining whether to issue an insurance policy, that for this reason it may ask questions in its application blank; that by asking these questions, it signifies that it will consider the answers in determining whether to issue the policy; and that, therefore, any misrepresentation in the answer, however innocently made, is material as a matter of law. Just how far does this go? Suppose the application should ask the insured whether he had ever suffered from a common cold. By asking the question, has it made the answer material as a matter of law? Or suppose the question concerning consultation with physicians concludes with the phrase “ whether concerning a cold or any ailment no matter how slight.” Surely it could not be argued that such a question was not intended to elicit answers concerning common colds, constipation or other minor ailments. • The answer, therefore, would be material as a matter of law.

Section 58 of the Insurance Law bars such a ruling. It was enacted for the benefit of the insured, and expressly provides that statements in an insurance policy shall in the absence of fraud be deemed representations and not warranties.” A misrepresentation, as noted above, does not invalidate a policy unless it is. material. It is argued that merely by asking a specific question, the insurance company can make the answer thereto material. This would enable insurance companies to destroy completely the efficacy of section 58. By asking specific questions, they could change in effect the replies which the statute states shall be deemed representations into warranties.

The contention that answers to questions in the application concerning health are material as a matter of law, is based upon the theory that if an insurance company evinces interest in the subject it thereby becomes material. That is not the true test. To use the words of Judge, later Chief Justice, Taft, “A fair test of the materiality of a fact is found, therefore, in the answer to the question whether reasonably careful and intelligent men would have regarded the fact, communicated at the time of effecting the insurance, as substantially increasing the chances of the loss insured against.” (Penn Mut. Life Ins. Co. v. Mechanics Sav. Bank & Trust Co., 72 Fed. Rep. 413, at p. 429.) Cases there are which have applied other tests, but the test quoted is supported, it is submitted, by the better reasoned authorities. (Ward v. Standard Acc. Ins. Co., 30 Fed. Rep. [2d] 328; Miller v. Maryland Casualty Co., 193 Fed. Rep. 343; Coff v. Mutual Life Ins. Co., 131 La. 98; McCaffrey v. Knights & Ladies of Columbia, 213 Penn. St. 609; Howell v. American Nat. Ins. Co., 189 N. C. 212; Lee v. Metropolitan Life Ins. Co., 158 Ga. 517; Etter v. National Life & Acc. Ins. Co., 228 Ky. 399; Standard Acc. Ins. Co. v. Walker, 127 Va. 140. See Eastern District P. D. Works, Inc., v. Travelers Ins. Co., 234 N. Y. 441, 453; Columbia Ins. Co. v. Lawrence, 35 U. S. [10 Pet.] 507, 516, per Story, J.; McLanahan v. Universal Ins. Co., 26 U. S. [1 Pet.] 170; Hancock v. Knights of Security, 303 Ill. 66, 71; Mutual Benefit Life Ins. Co. v. Miller, 39 Ind. 475, 486; 3 Joyce on The Law of Insurance [2d ed.], § 1892;4 Couch, Cyclopedia of Insurance Law, § 829. See, also, N. Y. Firemen Ins. Co. v. Walden, 12 Johns. 513, per Chancellor Kent.)

The Judicial Committee of the Privy Council recently has had occasion to pass on a case precisely in point. That case arose in the Province of Ontario, which at that time had a statute equivalent to our section 58. The language of the opinion in Mutual Life Ins. Co. v. Ontario Metal Products Co. ([1925] App. Cas. 344), a case in which the insured failed to state that he had consulted a doctor who had prescribed hypodermic injections of a tonic and that such hypodermic injections had been made at the doctor’s office irregularly over a period of three years, is so apposite that I quote at length: The main difference of judicial opinion centers round the question what is the test of materiality? Mignault, J., thought that the test is not what the insurers would have done but for the misrepresentation or concealment, but what any reasonable man would have considered material to tell them when the questions were put to the insured.’ Their Lordships are unable to assent to this definition. It is the insurers who propound the questions stated in the application form, and the materiality or otherwise of a misrepresentation or concealment must be considered in relation to their acceptance of the risk. On the other hand, it was argued that the test of materiality is to be determined by reference to the questions; that the Insurance Company had by putting the question shown that it was important for them to know whether the proposer had been in the hands of a medical man within five years of his application, and, if so, to have had the opportunity of interviewing such medical man before accepting the risk. The question was therefore, they contended, a material one, and the failure to answer it truthfully avoids the contract. Now if this were the true test to be applied there would be no appreciable difference between a policy of insurance subject to s. 156 of the Ontario Insurance Act, and one in the form hitherto usual in the United Kingdom. All of the questions may be presumed to be of importance to the insurer who causes them to be put, and any inaccuracy, however unimportant in the answers, would, in this view, avoid the policy. Suppose, for example, that the insured had consulted a doctor for a headache or a cold on a single occasion and had concealed or forgotten the fact, could such a concealment be regarded as material to the contract? Faced with a difficulty of this kind, the appellants’ counsel frankly conceded that materiality must always be a question of degree, and therefore to be determined by the Court, and suggested that the test was whether, if the fact concealed had been disclosed, the insurers would have acted differently, either by declining the risk at the proposed premium or at least by delaying consideration of its acceptance until they had consulted Dr. Fierheller. If the former proposition were established in the sense that a reasonable insurer would have so acted, materiality would, their Lordships think, be established, but not in the latter if the difference of action would have been delay and delay alone. In their view, it is a question of fact in each case whether, if the matters concealed or misrepresented had been truly disclosed, they would, on a fair consideration of the evidence, have influenced a reasonable insurer to decline the risk or to have stipulated for a higher premium ” (pp. 350, 351, 352). (Italics interpolated.)

The defendant relies upon several cases containing language which, when taken out of its context, seems to support the argument that all misrepresentations or omissions concerning health and consultations with physicians are material as a matter of law. An examination of these cases reveals that they involve special circumstances which readily distinguish them, and that the language contained in them is not intended to cover all cases of misrepresentation or omission.

In Minsker v. John Hancock Mut. Life Ins. Co. (254 N. Y. 333) the insured answered in the negative questions asking whether he had been treated in a hospital or other institution. The insurance company showed that actually he did receive medical advice on three different occasions within a few months before the application was signed, and that he had been ill and attended a clinic. Thereupon counsel for the petitioner, relying upon the privilege granted by section 352 of the Civil Practice Act, objected to the admission of evidence concerning the illnesses or diseases for the treatment of which the physicians had been consulted. This court concluded that where it is shown that the insured had had consultations with physicians which he failed to reveal in his application, and the beneficiary refuses to permit the admission of evidence concerning the maladies treated, the omission is material as a matter of law. The same question was involved in Travelers Ins. Co. v. Pomerantz (246 N. Y. 63). In that case it was pointed out that the insurance company had produced evidence sufficient to show that the facts concerning which the misrepresentations were made were such as, if fully known, might have deterred it from accepting the insured as a risk. Once it was shown that the insured had failed to disclose that he had consulted physicians, and the privilege arising from his relation to his physicians was asserted whereby the insurance company Was prevented from disclosing the diagnoses and nature of the treatment, the plaintiff could not be heard to claim that a prima facie case of materiality had not been made out. The cases of Anderson v. Ætna Life Ins. Co. (265 N. Y. 376) and Keck v. Metropolitan Life Ins. Co. (238 App. Div. 538; affd., 264 N. Y. 422) also involved a refusal to waive privilege on the part of the beneficiary or the insured. Obviously the courts could not permit the insured or the beneficiary to argue that the omission or misrepresentation was not material while he prevented the insurance company from showing its materiality. Statements in Nowak v. Brotherhood of American Yeomen (252 N. Y. 465) were dicta intended to allude to the situation just discussed.

In the case at bar the plaintiff waived the privilege and permitted the admission of all evidence concerning the consultations of the insured with the physician. The question of materiality under such circumstances must be considered and the evidence analyzed. It must be dealt with upon the trial as is any other question of fact. The evidence might reveal that the insured was suffering from some disease of so serious a nature that the court could decide as a matter of law that it was material. It might be shown that the omission was of a condition so trivial as to justify holding as a matter of law that it was not material. Or the evidence might reveal that the ailment fell within that intermediate zone between materiality and immateriality which would make the question one of fact for the jury. (4 Couch, Cyclopedia of Insurance Law, § 885e; 4 Cooley’s Briefs on the Law of Insurance [2d ed.], pp. 3301, 3394 et seq.; 3 Joyce on Insurance [2d ed.], § 1898; Sebring v. Fidelity-Phenix Fire Ins. Co., 255 N. Y. 382; Genung v. Metropolitan Life Ins. Co., 60 App. Div. 424; Miller v. Maryland Casualty Co., 193 Fed. Rep. 343. See Maryland Ins. Co. v. Rugan’s Admr., 10 U. S. [6 Cranch] 338, per Marshall, Ch. J.)

Are the ailments revealed in the case at bar of such a serious nature that it must be held as a matter of law that they are material? It does not seem to me that they are. There was no direct proof that the insured had ever had influenza. There was merely the statement by the doctor that the insured had told him that he had suffered from the disease. In addition, the record contains evidence that except during an epidemic period, influenza is merely a severe cold and there is no showing upon this record that it amounted to more than the latter. Nor is it material as a matter of law that the insured mistakenly thought he was ill and consulted a doctor and it turned out to be merely nervousness. As to the para-typhoid, Dr. Spire stated that he thought the insured had paratyphoid. The tests taken, however, returned a negative result and the symptoms shown by the hospital charts do not reveal para-typhoid. A jury might very well find that the insured never suffered from that disease. Moreover, para-typhoid does not seem to be a serious disease, there apparently never having been a case of mortality therefrom. It is submitted that the trial judge properly submitted the question of materiality to the jury.

The judgments in favor of the plaintiff should be affirmed, with costs.

Crane, Ch. J., O’Brien, Hubbs and Loughran, JJ., concur with Lehman, J.; Finch, J., dissents in opinion in which Rippey, J., concurs.

Judgments reversed, etc.


source: Caselaw Access Project

author: Lehman, J.

license: Public Domain

text:
    William R. White, as Superintendent of Banks of the State of New York, Appellant, v. Leonard Bevilacqua, Respondent.

      Argued January 25, 1937;
    decided March 9, 1937.

      Francis T. Findlay for appellant.
    Money collected from the defendant by virtue of funds pledged under the agreement does not bar the Superintendent from enforcing his liability under the stock assessment. (Sowles v. Wittens, 39 Fed. Rep. 403; Reed v. Mobley, 172 Ga. 116; Delano v. Butler, 118 U. S. 634; Huff v. Page, 2 Fed. Rep. [2d] 541; 269 U. S. 587; Andrews v. Blair, 124 Ohio St. 348; Baird v. Eidswing, 59 N. D. 484; Bay Parkway Nat. Bank v. Shalom, 270 N. Y. 172; Baumann v. Citizens Trust Co., 248 App. Div. 9; Sickels v. Herold, 15 Misc. Rep. 116; 149 N. Y. 332; Hurd v. Kelly, 78 N. Y. 588; First Nat. Bank v. Tisdale, 84 N. Y. 655; Union Bank
      v. Sullivan, 214 N. Y. 332.) There is no right of setoff. (Leary v. Capitol Trust Co., 238 App. Div. 661; 263 N. Y. 640; Baumann v. Citizens Trust Co., 248 App. Div. 9; United States Trust Co. v. United States Fire Ins. Co., 18 N. Y. 199; Richards v. Schwab, 101 Misc. Rep. 128; Van Tuyl v. Schwab, 165 App. Div. 412; Delano v. Butler, 118 U. S. 634; Duke v. Force, 208 Pac. Rep. 67; Reimers v. Larson, 202 N. W. Rep. 653; Citizens Bank v. Docking, 120 Kan. 523; Andrew v. Farmers Trust & Sav. Bank, 213 N. W. Rep. 925.)

      George A. Orr for respondent.
    Equitable principles demand that defendant’s voluntary contribution to the depositors of the bank be set off against the statutory assessment levied upon his stock holdings. (Mosler Safe Co. v. Guardian Trust Co., 153 App. Div. 117; 208 N. Y. 524; Mathez v. Neidig, 72 N. Y. 100; Union Bank of Brooklyn v. Sullivan, 214 N. Y. 332; Queensboro Nat. Bank v. Kelley, 220 App. Div. 515; Sowles v. Witters, 39 Fed. Rep. 403; Cole v. Adams, 101 Neb. 21; Korbly v. Springfield, 245 U. S. 330; Broderick v. Britting, 147 Misc. Rep. 363; Burns v. Lopez, 256 N. Y. 123.) Setoff is defendant’s proper remedy, since the debts are mutual between the same parties in the same right. (Lawrence v. Fox, 20 N. Y. 268; Seaver v. Ransome, 224 N. Y. 233; Burns v. Lopez, 256 N. Y. 123.)
   Lehman, J.

In March, 1933, the Superintendent of Banks took possession of the business and assets of East Side Bank of Niagara Falls and has proceeded to liquidate the affairs of the bank. The defendant is a stockholder of the bank. In an action brought by the Superintendent of Banks to enforce the liability, imposed at that time by the Constitution of the State and by the Banking Law (Cons. Laws, ch. 2) (§ 120), upon all stockholders of insolvent banks, the defendant has been permitted to offset against his liability, otherwise conceded, a payment, larger than the statutory liability, which was made to the bank in November, 1931, under an agreement by which the money so paid was “to be held by said East Side Bank for the better security of the depositors of said East Side Bank.”

From the stipulated facts and the findings of the judge at Special Term, made in accordance therewith, it appears that in October, 1931, the bank received a communication from the Banking Department advising it that its capital of $150,000 was impaired and that “ it would be necessary to consider means to correct the situation.” The suggestion was made that an agreement of guaranty in the sum of $50,000 be executed. A form of agreement which would be required for such purpose by the Banking Department was delivered by the Department to representatives of the bank. At a meeting of the board of directors of the bank, a resolution was passed that “ an agreement of guaranty in the sum of $50,000 be executed by the directors, as suggested by the Banking Department.” The defendant was a director of the bank and present at the meeting. He executed the agreement together with other directors and three stockholders of the bank, who were not directors. Pursuant to that agreement, the defendant “ deposited with said East Side Bank a certificate of deposit on the said East Side Bank for the sum of $3,333.33, and the said Bank, with the approval of the plaintiff, received and accepted said certificate of deposit as collateral security for the payment of the liability of this defendant upon said agreement of guaranty]”

The defendant voluntarily executed the agreement and deposited the security for the purpose of meeting the objections of the Banking Department that the capital of the bank was impaired. If the payment had been made pursuant to an assessment lawfully levied against the stockholders to repair capital before liquidation, and the funds had been used by the bank, concededly the amount so paid could not be offset against a statutory assessment made in liquidation proceedings. (Delano v. Butler, 118 U. S. 634.) It is said, however, that the case is different where moneys are advanced voluntarily to restore the impaired capital, but do not become part of that capital and are still intact when liquidation is commenced.

In considering the validity of the suggested distinction, and, even more, its application to the facts in this case, we must bear in mind certain well-established principles. The first principle is that, in strict sense, there cannot be a setoff, either legal or equitable, unless there are actually two demands or claims in existence; otherwise, it is obvious one claim or demand cannot be set off against another. Here we have a claim of the plaintiff against the defendant to enforce the statutory stockholder’s liability; but what claim or demand has the defendant against the bank or its liquidator for repayment of the money paid under his voluntary agreement? The validity of that agreement is not challenged. It has been carried out and has served its intended purpose. The purpose of the agreement was to provide security to the depositors which would furnish them with adequate protection in spite of impairment of the bank’s capital, and thus meet the objections of the Banking Department. The agreement was to continue in force and effect until the securities * * * have appreciated sufficiently in the opinion” of the New York State Banking Department to protect said depositors of said East Side Bank.” That time has not come and can never come. The parties provided, in contemplation of such contingency, that in case of a possible liquidation of said East Side Bank these securities or cash deposited hereunder shall be applied, if necessary, to the payment of the depositors of said East Side Bank, and any balance remaining, after said depositors have been paid in full, shall be returned to the parties hereto pro rata, and any deficiency arising by reason of the application of said securities or cash to the payment of said depositors shall be repaid to the parties hereto by said East Side Bank out of any funds of said East Side Bank remaining after said depositors have been paid in full.” The defendant does not contend that the bank or its liquidator has failed to use the amount paid by the defendant in manner authorized by the agreement, or that the defendant has any claim or demand against the bank or the liquidator for the return of the money so paid. Indeed, in the respondent’s brief it is stated: respondent neither has nor asserts any claim against the Bank.” It should be obvious that if the respondent “ neither has nor asserts any claim against the Bank,” neither the legal or equitable doctrine of set-off can apply.

In truth, if the defendant is entitled to offset his voluntary payment made to the bank when the bank was still doing business, against his statutory liability to depositors upon subsequent liquidation of the bank, it is not upon the theory of technical set-off but upon the theory that it constitutes a voluntary payment of his statutory liability. An analysis of the cases relied upon by the defendant will show that only upon that theory has a stockholder been permitted to offset against his statutory liability to depositors upon liquidation of a bank, payments made before liquidation was begun. (Cf. Mosler Safe Co. v. Guardian Trust Co., 153 App. Div. 117; affd., 208 N. Y. 524.) Only upon that theory, too, can a logical or practical basis be found for the rule approved by the Appellate Division in its opinion in this case that the test of a stockholder’s right to set off the payment of a prior assessment on his stock seems to depend upon the purpose and use of such a payment, that is, whether it be for the operation of the bank or for the benefit of creditors in liquidation proceedings.” (41 Yale Law Journal, 583, 589.)

In determining whether the security given to the bank constitutes payment of the statutory liability of a stockholder for the debts of the bank which remain unpaid after liquidation of its assets, we must again bear in mind well-established principles of law concerning what constitutes payment of such an obligation. The State has decreed the stockholder’s liability for the purpose of creating a fund for the protection of depositors and creditors beyond and in addition to the capital of the bank exhausted by its unsuccessful operation. The liability arises independently of any fault of the stockholder, and courts of equity have no power to exonerate any stockholder from that liability because of hardship or of previous sacrifice by the stockholder for the benefit of creditors. (Baumann v. Citizens Trust Co., 248 App. Div. 9.) The obligation is not owed to the bank but to the creditors or to the liquidator acting for them. A payment made to the bank for the use of the bank, to correct impairment of the capital of the bank, may, perhaps, be treated as a payment to be applied upon statutory liability to the creditors of the bank when the moneys paid are not used, as intended, to correct such impairment of capital and are not commingled with the general assets but are kept separate and are intact when liquidation is commenced. Such funds cannot be so applied when they are paid by the stockholders and received and used by the bank upon the understanding that they are the price paid for the privilege of continuing its business, in the hope of saving their investment.” (Delano v. Butler, 118 U. S. 634, 654.)

In this case, quite clearly the payment was made as the means whereby the impairment of the bank’s capital would be restored. So the agreement states, and upon that point all are agreed. The defendant and the other persons who joined with him in signing the guaranty and in furnishing the collateral security called for by the guaranty did not transfer to the bank ownership in that collateral security; but they did give to the bank the right to hold that collateral security for the protection of the depositors of the bank until the impairment, of the bank’s capital should be repaired by appreciation of the securities owned by the bank so that in the opinion of the Banking Department no further protection for creditors would be necessary; and, in case of possible liquidation of the bank, prior to that time, the securities deposited might be applied, if necessary, to the payment of the depositors of the bank. It appears from the stipulated statement of facts that when the bank received from the defendant the certificate of deposit on itself “ the cash represented by said certificate of deposit went into the funds of the Bank, and said certificate of deposit was carried on the books of the Bank as a liability of said Bank. The certificate itself was held by the Bank for the purposes specified in the guaranty agreement and not used by the Bank for any other purpose.” The certificate of deposit having been received only as collateral security under the guaranty agreement remained a liability of the bank when the “ cash represented by said certificate of deposit went into the funds of the bank ” and must be shown as a liability upon the books of the bank. None the less the collateral security was received and used to repair the inroads upon the bank’s capital. It is a reasonable inference that the guaranty was signed and the collateral security delivered as the price of the privilege of continuing the bank’s business without new contributions of capital or assessment upon its stockholders; but even if that inference be challenged, it is certainly true that the parties agreed that while the bank remained open the collateral security delivered to it should be held subject to the risk of the bank’s business until the bank’s capital was fully restored, or until the bank was liquidated and the collateral applied to payment of those who might be depositors at that time. Perhaps it should here be noted that before the agreement was executed and the collateral security delivered, the Banking Department had refused to accede to the suggestion that the “ amount of this guarantee pledged by each individual guarantor could be offset against his double liability as a stockholder if, in the future, said liability should be enforced.” In this respect this case differs from such cases as Matter of Central Bank (242 App. Div. 747), where the Banking Department expressly agreed to accept the pledge upon that understanding.

The situation may be summed up briefly as follows: For fifteen months the bank continued, after delivery of the collateral, to do business. At the end of that time the assets of the bank were, it appears, insufficient to pay its creditors. The impaired capital was completely lost. Though the collateral delivered did not become part of the assets of the bank, yet the primary purpose of the collateral was to restore the impaired financial condition of the bank, and, consequently, was intended for use in the operation of the bank, and only incidentally was it intended for the benefit of the creditors of the bank in case the operation proved unsuccessful. Again, though the collateral delivered did not become part of the assets of the bank, since it remained at the risk of The business of the bank for fifteen months, it cannot be said that when the bank was closed and compelled to liquidate at the end of that period, the collateral was still intact. In practical effect it was depleted to the extent of any losses suffered by the bank during that period.

When the bank was liquidated, the assets of the bank constituted the primary fund from which the creditors might be paid. When that was exhausted, the collateral deposited with the bank under the guaranty agreement might be “ applied, if necessary, to the payment of the depositors of the bank as if that collateral had been part of the assets of the bank. When that was exhausted, resort might be had to the statutory liability of the stockholders. The guaranty agreement signed by the defendant was intended and was used for the protection of the depositors of the bank during the fifteen months in which the bank continued to do business. The collateral deposited as security under the guaranty agreement was at that time depleted by its use for the very purpose for wMch it was intended. The defendant and the other persons who had deposited the collateral no longer had any claim upon it. It was no longer available as an offset to their conceded statutory liability. Even under the tests suggested by the defendant he is not entitled to exoneration from his statutory liability.

The judgments should be reversed, with costs in all courts, and judgment directed in favor of the plaintiff for the relief demanded in the complaint.

Crane, Ch. J., O’Brien, Loughran, Finch and Rippey, JJ., concur; Hubbs, J., taking no part.

Judgment accordingly.


text:
    Jessica L. Hawthorne et al., as Agents of the Court to Execute a Trust, Appellants, v. George C. Smith, Jr., et al., as Executors of Ormond G. Smith, Deceased, et al., Respondents.

      Argued January 25, 1937;
    decided March 9, 1937.

      Max J. Rubin, Frank E. Karelsen, Jr., and Frederick Baum for appellants.
    The trust indenture provides for a valid disposition of the entire net income to the infant beneficiary. Section 63 of the Real Property Law (Cons. Laws, ch. 50) is, therefore, inapplicable and appellants are entitled to an accounting on the basis that title to the entire trust income vested in their beneficiary subject to the trustee’s power to apply income as he deemed wise during the beneficiary’s minority. (Morris v. Morris, 272 N. Y. 110; Matter of Hoyt, 116 App. Div. 217; 189 N. Y. 511; Crawford v. Dexter, 178 App. Div. 764; 224 N. Y. 586; Hill v. Guaranty Trust Co., 163 App. Div. 374.) During the minority of the infant beneficiary the trust provision for accumulation of the income is lawful, for the accumulation could all be expended for the infant. The accumulation being lawful and enforceable during minority, section 16 of the Personal Property Law (Cons. Laws, ch. 41) requires that at the infant’s majority it be paid not to an adult, but to the infant beneficiary. Section 63 of the Real Property Law is, therefore, inapplicable for this reason and appellants are entitled to an accounting on the basis that title to the entire trust income vested in their beneficiary, subject to the trustee’s power to apply income as he deemed wise during the beneficiary’s minority. (Morris v. Morris, 272 N. Y. 110.) The settlor’s valid direction as to the disposition of trust income during the trust period is frustrated under the decision of the courts below, but is effectuated under appellants’ construction. (Manice v. Manice, 43 N. Y. 303; Matter of Hoffman, 201 N. Y. 247; Morris v. Sickly, 133 N. Y. 456.)

      Lester S. Holmes and Patrick M. Casey for George C. Smith, Jr., et al., as executors, et al., respondents.
    The clear and unambiguous intention of the settlor, as gathered from the specific terms and the whole tenor of the instrument, is that she did not make a present unqualified gift of the large surplus income she anticipated to her son. (Herzog v. T. G. & T. Co., 177 N. Y. 86; Cent. Tr. Co. v. Egleston, 185 N. Y. 23; Matter of Tamargo, 220 N. Y. 225; McDermott v. Lawyers Mtg. Co., 232 N. Y. 336; Donovan v. Van De Mark, 78 N. Y. 244; Smith v. Van Nostrand,
      64 N. Y. 278; Matter of Stevens, 241 App. Div. 490; 265 N. Y. 524; Matter of McCormick, 22 Misc. Rep. 309; 40 App. Div. 73; 163 N. Y. 551; New York Trust Co. v. Black, 178 App. Div. 4; 223 N. Y. 703; Matter of Shea, 234 App. Div. 176; Van Kleeck v. Dutch Reformed Church, 20 Wend. 437; Van Nostrand v. Moore, 52 N. Y. 12; Matter of Hoyt, 160 N. Y. 607; Cochrane v. Schell, 140 N. Y. 516; Delaney v. Van Aulen, 84 N. Y. 16; Woodruff v. Woodruff, 54 App. Div. 414; Sherman v. Skuse, 166 N. Y. 345.) The construction which appellants ruge would not only defeat but would actually reverse the settlor’s intention. (Matter of T. G. & T. Co., 195 N. Y. 344; First Nat. B. & Tr. Co. v. Palmer, 261 N. Y. 13; Central Tr. Co. v. Egleston, 185 N. Y. 23; Matter of Durand, 250 N. Y. 45; Matter of Lyons, 271 N. Y. 204; Matter of Horner, 237 N. Y. 489; Bailey v. Buffalo L., T. & S. D. Co., 213 N. Y. 525.) The expressed intention of the settlor cannot be carried out legally; the unexpended income was not legally disposed of and no valid direction for its accumulation was given; it passed under the statute to the persons presumptively entitled to the next eventual estate. (Cochrane v. Schell, 140 N. Y. 516; Matter of Durand, 250 N. Y. 45; Manice v. Manice, 43 N. Y. 303; Matter of Harteau, 204 N. Y. 292; People ex rel. Kirkman v. Van Amringe, 266 N. Y. 277; Kilpatrick v. Johnson, 15 N. Y. 322; Craig v. Craig, 3 Barb. Ch. 78; United States Trust Co. v. Soher, 178 N. Y. 442; Matter of Van Doren. 77 Misc. Rep. 44; Matter of Murphy, 213 App. Div. 319.)

      William Huck, Jr., and Paul McDermott for Street & Smith Publications, Inc., respondent.
    There is no evidence to support any judgment against the respondent corporation. (Merchants Nat. Bank v. Clark, 139 N. Y. 314; Corrigan v. Bobbs-Merrill Co., 228 N. Y. 58; Bank of United States v. Davis, 2 Hill, 463; President, etc., v. v. Cornen, 37 N. Y. 320; Casco Nat. Bank v. Clark, 139 N. Y. 307; Atlantic State Bank v. Savery, 82 N. Y. 291.)
   Lehman, J.

In December, 1921, Grace H. Smith and her husband, Ormond G. Smith, executed a trust indenture which provided:

Whereas, the said Grace H. Smith is the owner and holder of the following securities, to wit: Five thousand eight hundred and thirty-five (5835) shares of stock of Street & Smith, Incorporated, and

“ Whereas, the said Grace H. Smith is desirous of making a provision and settlement for the benefit of her son Gerald Hewitt Smith, now a minor, by the conveyance in trust of the property above mentioned, subject, however, to the trust and powers herein contained,

" Now this indenture witnesseth,

That said Grace H. Smith, in consideration of One Dollar and other good and valuable considerations, the receipt whereof by Ormond G. Smith is hereby acknowledged, does hereby sell, assign, transfer and set over unto the party of the second part, his successor or successors, the said Five thousand eight hundred and thirty-five (5835) shares of stock of the said above named corporation, in trust, nevertheless, to hold, invest and reinvest the principal thereof; to collect the income and profits therefrom and to expend on behalf of the said Gerald Hewitt Smith, for his care, maintenance, travel, education and general benefit the whole or such portion of the net yearly income therefrom as in the judgment of the said trustee shall be wise and expedient, until he shall arrive at the age of twenty-one years.”

The indenture further provided that upon the arrival of the said Gerald H. Smith at the age of twenty-one years the “ principal of said trust herein created, together with all accumulations and unexpended and undistributed income ” should be paid over to Ormond G. Smith, or if at that time the said Ormond G. Smith should be dead, to Grace H. Smith or her estate.

In 1921, when the trust indenture was executed, Gerald H. Smith, the settlor’s son, for whom the trust was created, was nine years old and was living with his parents, Ormond G. Smith and Grace H. Smith. They enjoyed a large income and out of that income paid the expenses of the home and for the care and education of their son. Grace H. Smith died on January 13, 1923, leaving a last will and testament executed on the same day as the trust indenture. In that will she provided that all her property should go to her husband, Ormond G. Smith, and named him as her sole executor. Ormond G. Smith died on April 17, 1933. Until his death he used none of the income of the trust fund for the benefit of bis son, and the court has found upon unchallenged evidence that he, personally, fully and completely provided for the care, maintenance, travel, education and general benefit of his said son and maintained him in the luxury and comfort which great wealth made possible.”

The trust terminated when Gerald H. Smith arrived at the age of twenty-one years, six months after the death of his father, Ormond G. Smith. In the interval no trustee was appointed to carry out the provisions of the trust. Gerald H. Smith was the sole heir at law and next of kin of his father, Ormond G. Smith, and under the will of his father the entire residuary estate of his father, of the value of approximately $3,000,000, is held in trust for Gerald H. Smith, the principal to be paid in the future either to him or to his issue.

There has never been any accounting by Ormond G. Smith as trustee under the trust indenture, or by the executors of his estate. The plaintiffs were appointed agents of the Supreme. Court to execute the trust with power expressly conferred upon them to recover from and/or to require an accounting from the person or persons, corporation or corporations having possession and control of the assets constituting the principal and/or income of said trust, all or any of said assets.” Accordingly the plaintiffs have demanded that the principal of the trust and all the income derived therefrom be paid over to them and have brought this action to compel the executors under the last will and testament of Ormond G. Smith to make and file an account. They ask also incidental relief against the corporate defendants. The complaint has been dismissed on the ground that at the termination of the trust, all the principal and the unexpended income of the trust fund belongs to the estate of Ormond G. Smith, and that it would be a futile thing for the executors of the estate to account for moneys to which they alone are entitled.

If the courts can give effect to the intention of the settlor embodied in the provisions of the trust indenture, there can be no doubt that the estate of the deceased trustee is entitled to the principal of the trust fund, together with the income derived therefrom during the trust period. In plain terms the settlor so provided. Though the settlor created a trust in the stock for the benefit of her son and provided that until the beneficiary of the trust arrived at the age of twenty-one years, the trustee might expend the whole net yearly income therefrom for his care, maintenance, travel, education and general benefit,” yet she left to the trustee full discretion as to whether he should expend the whole of the income for that purpose or only such portion of the income as in his judgment “ shall be wise and expedient.” She did not provide, as she might have done, that the unexpended income should belong to the beneficiary as it accrued, nor did she provide, as she might have done, that the unexpended income should be accumulated for the benefit of her infant son during his minority, to be paid over to the beneficiary when he arrived at the age of twenty-one years. She provided, on the contrary, that unexpended income, if any, should be accumulated until the termination of the trust and that such accumulated and unexpended income should then be paid to her husband, or to herself or to her estate as the case might be, in accordance with contingencies set forth in the indenture.

A direction for the accumulation of income, unless for the benefit of one or more minors, is invalid under the provisions of section 16 of the Personal Property Law (Cons. Laws, ch. 41), formerly 1 Revised Statutes (1st ed.), p. 726, sections 37 and 38. To the extent then that the indenture provides that the trustee may accumulate unexpended income for the benefit of adults and directs that at t he termination of the trust such accumulated income shall be paid with the principal to the adult remainderman, the indenture is invalid. That invalidity does not, however, affect the other provisions of the trust indenture. The statute contemplates that there may be an unlawful direction for accumulation contained in a will or other instrument, but it applies the remedy. It makes the direction void. (1 Rev. St. 726, § 38.) It does not avoid the instrument containing the unlawful direction, although this would be the consequence if it subserved no purpose except to provide for the unlawful accumulation. But limitations of the estate, not depending upon the unlawful accumulations, are unaffected. * * * The surplus income to which the unlawful direction relates, will pass under the rules of the common law, or under section 40 of the statute. (1 Rev. St. 726, § 40.) In this way the purpose of the statute limiting accumulations is effected, and a testator has no motive to transgress its provisions.” (Cochrane v. Schell, 140 N. Y. 516, 535.)

We apply the law as laid down in that opinion to the facts in this case. Section 63 of the Real Property Law (Cons. Laws, ch. 50) (derived from 1 Rev. St. [1st ed.] p. 726, § 40) provides that: When, in consequence of a valid limitation of an expectant estate, there is a suspension of the power of alienation, or of the ownership, during the continuance of which the rents and profits are undisposed of, and no valid direction for their accumulation is given, such rents and profits shall belong to the persons presumptively entitled to the next eventual estate.” The courts below have held that since the direction to accumulate unexpended income and to pay the accumulations to another person than the infant beneficiary is void, such unexpended income belongs to the person presumptively entitled to the next eventual estate,” and in this case must be paid to the estate of Ormond G. Smith. Thus the courts have held that by operation of law, through application of the provisions of section 63 of the Real Property Law, the accumulated income belongs to the person to whom the settlor directed it should be paid, though the statute declares that such direction is void. Though the courts below have used the formula approved in Cochrane v. Schell (supra), the result is entirely different. In that case the court could truly say that “ in this way the purpose of the statute limiting accumulations is effected, and a testator has no motive to transgress its provisions.” In the instant case it appears that in this way the purpose of the statute limiting accumulations is thwarted and the settlor’s intentions to transgress its provisions have been made effective.

In testing the correctness of the result, we must bear in mind that the prohibition of section 16 of the Personal Property Law is directed against the accumulation of income except for the benefit of a minor. Invalidity arises at the moment when the direction to accumulate is intended to take effect; it is not postponed till the time comes for distribution of the accumulation. Accordingly the application of section 63 is limited to the disposition of income where “ the rents and profits are undisposed of, and no valid direction for their accumulation is given.” In this case, then, the primary question is whether the trust indenture contains either a valid disposition of the income of the trust fund or a valid direction for its accumulation during the minority of the beneficiary. If it does, then section 63 of the Real Property Law has no application.

The justice at Special Term has found that:

49. That at the time of the creation of the said trust the said Grace H. Smith must have contemplated that the income of the said trust would be very large and must have reasonably anticipated and expected that the dividends upon the said 5,835 shares of the stock of Street & Smith, Inc., which were about to become the principal of said trust would in the future probably amount to $60,000 per annum.

50. That at the time of the creation of the said trust the said Grace H. Smith contemplated that the whole or a greater portion of the income of the said trust could not be wisely and expediently expended on behalf of the said Gerald H. Smith for the particular purposes specified in the trust indenture and that there would be a large surplus of unexpended income.”

We accept those findings. They are fully sustained by the evidence.

In spite of the fact that the settlor must have reasonably anticipated and expected that the dividends ” upon the stock placed in trust would in the future probably amount to $60,000 per annum ” and that there would be “ a large surplus of unexpended income ” even after all that portion of the income which could be wisely and expediently expended on behalf of the said Gerald H. Smith ” had been used for that purpose, the settlor chose to place all the stock in trust, and not only to provide that the trustee in his discretion might expend the whole of the income for the benefit of the infant beneficiary, but, also, to direct, by necessary implication if not in express terms, that the surplus income, not expended in any year, should be accumulated and held for the same use and purpose during the minority of the infant and the continuance of the trust created for his benefit. The infant beneficiary would have been entitled to the entire income derived from the trust created for his benefit if the trust indenture had not provided that unexpended income should at the termination of the trust be paid to another, and then there would have been no unlawful accumulation but a valid disposition of all the “ rents and profits ” of the property within the meaning of the statute. In such case the income would not pass by operation of law under section 63 of the Heal Property Law “ to the person presumptively entitled to the next eventual estate.” (Matter of Hoyt, 116 App. Div. 217; affd., 189 N. Y. 511.) Again, though there is no present gift of the unexpended income of the trust fund, the settlor might have made a valid direction for accumulation of that income, during the minority of the infant and for his benefit. Invalidity then in this case is due only to the settlor’s direction that the accumulated income which was not expended during the minority of the infant beneficiary should belong to another at the termination of the trust. (Cf. Morris v. Morris, 272 N. Y. 110.)

It cannot be doubted that in creating the trust and directing that the trustee might expend the whole income for the benefit of the settlor’s son and in directing that the unexpended income should be held and accumulated during the infancy of the beneficiary, the primary purpose of the settlor was to provide for and benefit the infant beneficiary. The settlor so stated in the indenture. Indeed, if the primary purpose of the settlor in creating the trust and providing for the accumulation of unexpended income was not to benefit the settlor’s infant son, the validity of the entire trust might, perhaps, be subject to challenge. (Cf. Cochrane v. Schell, supra.) We may not impute an unlawful purpose to the settlor. (Matter of Hoyt, supra; Morris v. Morris, supra.)

If it is possible to sever the lawful from the unlawful, the primary lawful purpose of the settlor should not be thwarted because it is combined with an unlawful direction. It may be well, at this point, to sum up the factors which enter into the problem. The settlor placed her stock in trust during the minority of her son in order that at any time during the continuance of the trust the trustee might expend for the benefit of the minor the whole income, derived from the stock or such part thereof as the trustee might deem wise and expedient. No part of the income might during the minority of the beneficiary be used for any other purpose. No other person might during the minority derive benefit from the income so accumulated. The direction, express or implied, for the accumulation of income was limited to the income which the trustee had not yet expended for the infant. The purpose of the direction was to enable the trustee to hold and accumulate the unexpended income in order that he might expend it for the infant thereafter if he thought such expenditure wise and expedient. The attempted gifts, to take effect when the trust ceased, of the unexpended income, if any, which had been accumulated during the minority of the beneficiary of the trust was, of course, intended to benefit the person who would receive the gift; but the direction to hold and accumulate unexpended income so that it might be expended for the benefit of the infant if the trustee thought such expenditure wise and expedient was certainly not intended.

Except for that attempted gift the infant beneficiary would under the terms of the trust have been entitled to all the unexpended income which the trustee had accumulated for his benefit. The direction to pay the accumulated dividends to a person other than the infant was a futile gesture. The law made it void and the courts may not give it effect. The other provisions of the trust indenture remain valid, and under these provisions the whole income of the trust fund passed to the trustee to be expended or held for the benefit of the minor. The courts cannot give effect to every part of the trust indenture, for in part it is invalid. By excising the unlawful direction to pay to an adult income accumulated under the trust created for the benefit of an infant, the courts can give full effect to the primary purpose of the settlor in establishing a trust for the benefit of her infant son, and in providing that the whole income derived from the trust property should be held by the trustee in order that he might use the whole or any portion thereof which he thought wise or expedient. As in Cochrane v. Schell (supra), in' this way the purpose of the statute limiting accumulation is effected and the settlor has no motive to transgress its provisions. The settlor has plainly indicoted that the infant should have the full benefit of all the income derived from the stock except in so far as, by gift to take effect when the infant arrives at the age of twenty-one, the settlor attempted to transfer to the remainderman income derived from that stock, placed in trust for the benefit of the minor and which had been held and accumulated so that it might be used for the benefit of the minor. In similar circumstances we have recently held that the infant becomes the equitable owner of the entire income derived by the trustee from the trust created for the benefit of the infant and that an invalid direction to pay to another at the termination of the trust the unexpended income accumulated by the trustee during the minority of the infant beneficiary does not divest the infant of such equitable ownership. In such case section 63 of the Real Property Law has no application. The unexpended income belongs to the infant for whose benefit the trust was created and the income was collected, held and accumulated, and does not belong to the person “ presumptively entitled to the next eventual estate.” (Morris v. Morris, supra.)

For these reasons the complamt should not have been dismissed. The executors of the deceased trustee should be required to account for and pay over to the plaintiffs the income, but not the principal, of the trust, including therein the proper proportion of the dividends paid by the respondent, Street & Smith Publications, Inc., during the years 1930-1933. The plaintiffs have not established a cause of action against the corporate defendants, and the judgment in their favor should be affirmed. They are not necessary parties to the accounting.

The judgment should be reversed, with one bill of costs payable out of the trust fund to each party or group of parties, aippearing separately, and the case remitted to the Special. Term for further proceedings in accordance with this opinion.

O’Brien, Loughran, Finch and Rippey, JJ., concur; Crane, Ch. J., and Hitbbs, J., taking no part.

Judgment accordingly.


author: Loughran, J.

text:
    City Bank Farmers Trust Company, Individually and as Trustee, Respondent, v. Barbara G. Wylie et al., Respondents, and Chase National Bank of the City of New York, as Administrator of the Estate of Sims G. Wylie, Deceased, Appellant.
    Argued January 13, 1937;
    decided March 16, 1937.

      William Byrd and Thomas A.

      Ryan for appellant. When a trustee receives an apportionable stock dividend, the number of shares to be allocated to income is that proportion of the total number of shares received by the trustee which the undistributed true earnings of the corporation during the period in question bear to the intrinsic value of the total number of shares comprising the dividend. This rule requires the allocation of 96.8 shares of the stock dividend here involved to income. (Matter of Harteau, 204 N. Y. 292; Thayer v. Burr, 201 N. Y. 155.) For the purpose of calculating the true undistributed earnings of the power company during the designated period the undistributed surplus earned during the designated period should be augmented by a sum representing the power company’s share of depreciation reserves of its subsidiary companies earned subsequent to March 23, 1921, and restored to surplus by the board of directors in February, 1925, following the engineers’ appraisal. (Bourne v. Bourne, 240 N. Y. 172.) An allocation to income of 96.8 shares out of the stock dividend of 374.4 shares of the power company should have been made. (Matter of Osborne, 209 N. Y. 450; Bourne v. Bourne, 240 N. Y. 172; Robertson v. deBrulatour, 188 N. Y. 301; Matter of Harteau, 204 N. Y. 292; Thayer v. Burr, 201 N. Y. 155; United States Trust Co. v. Heye, 224 N. Y. 242; Macy v. Ladd, 227 N. Y. 670; Pratt v. Ladd, 253 N. Y. 213; Matter of Hagen, 262 N. Y. 301; Matter of Enz, 204 App. Div. 634; 237 N. Y. 577; Matter of Jackson, 258 N. Y. 281.)

      George F. Losche, Walter E. Cooper, Charles H. Birdsall and Liston C. Bertram for respondents.
    The life tenant should be charged to the extent that the corpus of the trust was depleted by the dilution in the value of the power company stock resulting from the issuance of additional stock at par. (Matter of Hagen, 262 N. Y. 301; Baker v. Thompson, 181 App. Div. 469; 224 N. Y. 592; Matter of Osborne, 209 N. Y. 450; Bourne v. Bourne, 240 N. Y. 172; Morton v. Horton, 189 N. Y. 398; Matter of Deth v. Castimore, 245 App. Div. 156; Equitable Trust Co. v. Prentice, 250 N. Y. 1; Pratt v. Ladd, 253 N. Y. 213; McLouth v. Hunt, 154 N. Y. 179; Matter of Stevens, 187 N. Y. 471; Furniss v. Cruikshank, 191 App. Div. 450; 230 N. Y. 495.) The corporation properly gave effect to the reserve for depreciation even though it transferred the same to surplus, and the integrity of the corpus of the trust was thereby preserved. (City of Knoxville v. Knoxville Water Co., 212 U. S. 1; The Minnesota Rate Cases, 230 U. S. 352; Chesapeake & Ohio R. Co. v. United States, 5 Fed. Supp. 7; McLouth v. Hunt, 154 N. Y. 179.)
   Loughran, J.

This is an action by a trustee for judicial settlement of its account.

The trust was established by an instrument dated July 6, 1910. We are not concerned with its administration at any time antecedent to March 23, 1921. On that date its capital consisted of 300 shares of the stock of a utility holding company (hereinafter called the corporation) having a number of subsidiaries. On December 28, 1921, the trustee received a stock dividend of 20 per cent or 60 shares of the corporation, and on December 15, 1922, another stock dividend of 30 per cent or 108 shares. By judgment for the judicial settlement of the account of the trustee to March 22, 1923 (the beginning of the period covered by the account now before us), the 168 shares produced by those two stock dividends were allocated 12 shares to principal and 156 shares to income.

With the capital of the trust thus 312 shares, the trustee received on February 25, 1925, 374.4 additional shares out of a stock dividend of 120 per cent declared by the corporation on February 11, 1925. A judgment allocating those shares 358.1 to principal and 16.3 shares to income is in that aspect challenged on this appeal. The life beneficiary of the trust died on March 25, 1925. Appellant is his administrator. The respondents are the trustee and remaindermen. The controversy has two distinct phases.

(1) On January 25, 1925, the corporation offered to its stockholders the right to subscribe pro rata to an issue of 50,000 new shares of its capital stock at par-of $100 a share. The trustee did not subscribe but sold its rights so to do and properly credited the proceeds to principal. (Baker v. Thompson, 224 N. Y. 592.) The effect of that decision of the trustee was two-fold. On one hand, the capital of the trust was increased by the cash which the trustee received on the sale of its rights. On the other hand, the capital of the trust was decreased or. diluted, because the purchasers of the new shares contributed to the capital account of the corporation only $100 per share, whereas the intrinsic or book value of each of its shares theretofore was largely in excess of $100. The first question to be determined is by whom any resulting loss Ho the trust capital shall be borne.

It has been held below that the remaindermen had an inchoate right to have a dilution so resulting in the capital value of the trust made up out of the 374.4 dividend shares paid to the trustee after the 50,000 new shares had been issued by the corporation. On that basis, some part of the 374.4 dividend shares was to that end to be allocated to the principal of the trust and it has been so decided. This result, it was thought, was dictated by the doctrine that the capital of a trust fund is to be preserved intact in accordance with the intention of the founder of the trust. (See Matter of Osborne, 209 N. Y. 450.) We think that doctrine does not sanction the conclusion that the trust capital may recapture out of a future stock dividend a realized loss that had resulted because the trustee did not exercise its rights to participate in new shares of the corporation whose shares were in the trust.

The argument of the respondents overlooks the nature and incidents of each of several transactions to which that argument is addressed. It is not inevitable that the proceeds of a sale of rights to subscribe to stock will be less than the difference between the intrinsic value of the seller’s old shares and the intrinsic value of his diluted shares. It may well be that after new capital comes into a corporation its shares, though greater in number, will have a higher market value than before. The value of this trustee’s rights was not measurable by the difference between the subscription price and the intrinsic value of its 312 shares prior to dilution. The value of such a right is measured by the relationship between the cost of exercising it and the market value of the shares thereby procurable. The record does not show the price received by the trustee for its rights. There is no criticism of its failure to subscribe. In such a situation a trustee would perhaps be wise in concluding not to adventure new cash in the fortunes of the corporation and at the same time to retain a diluted share interest in an enterprise that was to be better financed by new cash to be contributed by others. For all that here appears, the resources of the trust were inadequate for exercise of the rights by the trustee. In any case, however, the amount received from sale of the rights did not represent the difference between the former book value of the shares in the trust and the book value of its diluted shares. Rather the proceeds of the rights constituted an increment exfcrinsically added to the trust capital and consideration of that element should, therefore, be here excluded.

When the project for the increase of the capital of the corporation was completed the total share issue became 342,016, having theretofore been 292,016. It was on this aggregate of 342,016 issued shares that the stock dividend in question was thereafter declared and paid. Because the trustee did not take any of the new 50,000 share issue, the 312 shares in the trust represented, of course, a reduced fraction of the net worth of the corporation. But any consequent diminution of value in the trust capital, since it was occasioned by the decision of the trustee not to subscribe for the new shares but to sell the rights, was a loss then and there realized and thereupon defined and fixed as such. No part of such a loss should have been restored out of the stock dividend which was subsequently declared and had no relation thereto. Accordingly, we hold that the contrary ruling of the courts below was unwarranted, and that the capital value of the trust that was to be protected in the allocation of the 374.4 dividend shares was 312 shares of a corporation having 342,016 issued shares. As we turn from this branch of the case, it may be noticed that section 10 of the Personal Property Law (Cons. Laws, ch. 41) was amended and section 17-a of the statute was enacted after this trust was set up, and have here no application.

(2) A wholly separate problem is presented on this record which makes it necessary to consider certain corporate transactions in the form in which they were recorded.

In preparation for the capitalization of items on the books of the corporation and its subsidiaries, engineers made a study of the plants and properties of the several companies and of accounts which (except for that about to be discussed) are conceded to be items of capital increment. Following this' study, entries were made in the books of the corporation which increased the book surplus by $34,117,565.43. When the prior surplus is taken into account, the effect was to create a surplus having a balance of $42,744,920.19 when the corporation declared the stock dividend of 120 per cent on February 11, 1925. The number of shares issued for payment of this dividend was 410,419.2 shares. 1 Thereby the whole surplus account was distributed to the stockholders except for a remaining balance of $1,703,000.19. That is to say, the issuance of the 410,419.2 dividend shares (each of a par of $100) resulted in taking out of the surplus account of the corporation $41,041,920, and increased the corporation’s capital stock account by the same amount.

The item over which controversy arises on this branch of the case is entered on the corporation’s books as its proportion of amounts carried to surplus by ” its named subsidiaries, by entries charging off reserves for depreciation previously deducted from earnings . . . . $6,642,639.12.”

The respondents contend and the courts below have held in effect that the entire surplus account set up on the books after the engineers’ study was true capital and distributable as such. We think that to the extent of the item of $6,642,639.12 the surplus account represented earned surplus, i. e., income, and that the $34,117,565.43 increase in surplus recommended by the engineers and entered in the corporation’s books represented capital increment only to the extent of $27,474,926.31.

It is clear from the engineers’ report that as to the item of $6,642,639.12 there was a determination, later adopted by the corporation, that the earnings of its subsidiaries had been transferred to reserves in excess of actual needs. This item was transferred to the capital stock account through the surplus account into which it had gone as a transfer of earnings, and is accordingly in the same category as if it has always been in the surplus account as earned surplus. Much of that surplus had been earned before the 300 shares of the corporation went into this trust. It is apparently conceded that 27.2 of the dividend shares in question represent subsequent earnings. Assuming the correctness of that concession, the allocation to trust income should be increased by that number of shares.

The judgment of the Appellate Division should be reversed and that of the Special Term modified by allocating the stock dividend of 374.4 shares of the corporation received by the trustee on February 25, 1925, in accordance with this opinion and, as so modified, affirmed, with costs in this court to all parties, payable out of the fund.

Crane, Ch. J., Lehman, O’Brien, Hubbs and Rippey, JJ., concur; Finch, J., taking no part.

Judgment accordingly.