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District Court of Appeal, Second District, Division 2, California.


Civ. 10639.

Decided: November 13, 1935

Freston & Files and Ralph E. Lewis, all of Los Angeles, Louis Ferrari, of San Francisco, and Edmund Nelson, O'Melveny, Tuller & Myers, and Louis W. Myers, all of Los Angeles, for appellant. G. C. De Garmo and W. M. Crane, both of Los Angeles, for respondents.

This is an appeal from a judgment in favor of the plaintiff in an action brought in two counts, the first for rescission, and the second for money had and received. The defendant bank is and was a national bank acting as the trustee under an express trust, the corpus of which consisted of a note and a trust deed executed by the Arcady Apartment Hotel Company, which lien was junior to a $1,325,000 bond issue on the hotel property. In its capacity as trustee, and on order of Arcady, the bank between the years 1925 and 1929 executed and delivered so-called participation certificates evidencing fractional interests in the basic note. The certificates so executed and delivered aggregated on their face approximately one-half million dollars.

The circumstances under which the bank executed the participation certificates were as follows: The Arcady owned real property situated on Wilshire boulevard in Los Angeles and desired to finance the construction of a twelve-story apartment hotel thereon. It first executed a deed of trust constituting a first lien on the property to secure a bond issue of $1,325,000. This was in the nature of a construction loan and its validity is not in dispute, its existence as a first lien being the only point of importance. More money was necessary to complete the erection and equipment of the proposed hotel. To meet this situation Arcady negotiated with and obtained from each of the contractors and materialmen concerned with the erection of the building an agreement to accept in part payment of their compensation (usually 20 per cent. thereof) a second lien upon the property subject to the bond encumbrance. To effectuate this arrangement Arcady executed to the order of L. L. Adams its promissory note in the sum of $600,000 and secured said note by a second trust deed upon the property and expressly stated that it was junior to the trust deed securing the bond issue. This note and trust deed was transferred to the bank. The bank there-upon executed a declaration of trust, which was approved by Arcady and which recited that the bank held the said note and trust deed in trust for the purpose of issuing participation certificates thereon, each of which would represent an interest in the basic note; the proportionate interest being disclosed on the face of the respective certificates. Originally all certificates were issued only to creditors of Arcady and they were all issued pursuant to contracts entered into before the particular certificates were issued. These contracts were all made with parties who were in a position to furnish labor, services, or materials in the construction of the hotel. The certificates were in this manner issued only to creditors of Arcady and the creditors were persons who had agreed to accept the certificates before they became creditors. Certain of the creditors, including the plaintiff's assignor, after receiving the certificates disposed of them to third persons who had no original connection with the transaction. These assignees surrendered their original certificates to the bank for cancellation and received new certificates in their own names. The hotel building was completed as agreed and was put into use. Early in 1931 the plaintiff discovered for the first time that no permit had been issued for the certificates held by it and served notice of rescission upon the bank and brought this action. It was stipulated by the parties and the trial court found it to be a fact that the bank had at all times acted in the utmost good faith and merely in the position of trustee under such express trust and as registrar of the certificates. It did not receive and did not handle any money or funds or other property at all in connection with the issuance of said certificates and at no time received or was paid anything other than the usual and reasonable compensation for its services in acting as trustee or registrar.

The basis for this action is the fact that no permit was obtained from the commissioner of corporations for the issuance or sale of these participation certificates. It was specifically found by the trial court that prior to the issuance of the certificates, representatives of the Arcady, the bank, and other interested parties discussed with the commissioner of corporations the question of the necessity of obtaining such a permit and were informed by such officer that no permit was required. The court also found that the bank did not at the time of the issuance of any such certificates make any express representations whatsoever with regard to the validity, genuineness or value of the certificates. The court likewise found that the trust indenture contained an express statement that the bank as trustee assumed no responsibility as to the validity of the trust or the participation certificates issued thereunder. The trial court concluded, however, that the bank by participating in the transaction did, as a matter of law, represent and warrant that each of the certificates was valid, legal and genuine. The court also concluded that a permit from the corporation commissioner was necessary to their validity and as none had been obtained they were void, and gave judgment against the bank for the face value of the certificates.

The complaint alleges that the certificates were void in consequence of the lack of a permit from the commissioner of corporations. It is obvious from reading the complaint and also from a perusal of the record that there is no causal connection whatever between the failure to obtain a permit from the commissioner of corporations and whatever loss was suffered by the plaintiff. The actual cause of the loss to the plaintiff was entirely extraneous to the lack of a permit, such as shrinkage in value of the mortgaged property incident to the depression rendering a second lien of little value. If a permit had been obtained, the shrinkage and loss would have occurred in precisely the same manner and to the same extent that it did occur, and the presence of the permit would not have obviated the loss. Under the allegations of the complaint then, the complaint states a cause of action if it was necessary to obtain a permit from the commissioner of corporations for the issuance of the certificates; if it was not necessary to obtain such permit, the complaint fails to state a cause of action.

It is the contention of the defendant on this appeal that as a national banking association it was not required to obtain a permit under the terms of the law as it existed at the time in question; that the certificates were not in any event offered and sold to the public within the purview of the act; that the bank had never received any money or other thing of value from any person to whom certificates were issued or from the plaintiff and hence could not be held on the basis of money had and received; that since the bank never received anything of value whatsoever, the bank cannot be held liable to the plaintiff in money in an action for rescission, and that an action for rescission will not lie against a defendant who was never a party to the contract sought to be rescinded; that the bank cannot be held liable on any theory of fraud in the face of the finding that the bank had used the utmost good faith throughout and had in the trust indenture itself made no warranties or representations whatsoever concerning the validity of the certificates; that the plaintiff was not one of those who could raise the question of the constitutionality of the subsection exempting national banks at it was not one of the class of corporations discriminated against.

It is contended by the plaintiff, however, that national banks acting in their proprietary capacity as trustees were subject to the Corporate Securities Act during the period involved even though the statute purportedly excepted them from its operation; that if, during the period involved, the Corporate Securities Act (St. 1917, p. 673, as amended) exempted national banks acting as trustees from its operation but applied to state banks and trust companies so acting, an unconstitutional discrimination resulted which left both groups subject to the statute; that the form of the complaint permits money judgments against the defendant as one of the participants in the violation of the Corporate Securities Act; that all who participate in a violation of the Corporate Securities Act, regardless of their receipt of any benefit, are joint tort-feasors and liable to reimburse the purchaser of the void security; that the good faith of the defendant is no defense, and that the provisions of the trust declaration cannot exempt the defendant from liability; and that the securities involved required a permit for their lawful issuance and sale, and, likewise, for their reissuance; that an offering to the public of the securities was not required and that the defendant sold the securities within the statutory definition of sale.

The facts in this case are set forth very fully and the contentions of both parties upon appeal are set forth, for the reason that this case went originally by direct appeal to the Supreme Court and was transferred, along with several others, for decision to this court and for the further reason that the question involved is a matter of great importance at this time in the state of California, having arisen in many cases which are now on appeal in this and other courts of the state, involving as it does the very existence of many of the banks of California, both state and national.

In 1925 the Legislature amended the Corporate Securities Act in certain particulars so that section 2 of that act read in part as follows (St. 1925, p. 962):

“The following words have in this act the signification attached to them in this section, unless otherwise apparent from the context: * * *

“3. The word ‘company’ includes all domestic and foreign private corporations, associations, joint stock companies, and partnerships, of every kind, trustees, as hereinafter defined, and also individuals as hereinafter defined; excepting therefrom:

“(a) All national banking associations and other corporations organized and existing under and by virtue of the acts of the congress of the United States;

“(b) All public utilities subject to the jurisdiction, control, and regulation of the railroad commission of this state;

“(c) All corporations now or hereafter organized under the laws of this state for the purpose of conducting the business of banking within this state and all corporations transacting insurance business within this state, when such corporations are issuing securities of their own issue against their own assets.” (The final clause of this subsection was added in 1923.)

(d) (All corporations under building and loan supervision); and

(e) (Certain corporations otherwise regulated by law.)

Subsection (a) of subdivision 3 of section 2, which exempts national banks from the operations of the act, remained the same from 1917 to 1929. This precise portion of the act was recently considered by the Supreme Court in the case of Young v. Three For One Oil Royalties, 1 Cal. (2d) 639, 36 P.(2d) 1065, 1067. In that case counsel for the respective parties together with a large number of other attorneys as amici curiæ appeared and filed briefs, and a comprehensive discussion and analysis of the question was presented to the court. That case is controlling herein for it is on all fours in every essential respect except as to the dates of the transactions involved. The Young Case considered the Corporate Securities Act as it stood prior to 1923, but subsection (a), which was there construed by the court, was and remained exactly the same and absolutely unchanged throughout the period involved in the instant case. A national bank acting as a trustee is the defendant party in each instance. The essential fact that no permit had been obtained from the corporation commissioner is the basis of the controversy both in the Young Case and in the instant case. The decision is most definite that under the language of said subsection (a), national banks were exempt from the requirement of obtaining a permit from the commissioner of corporations prior to the issuance of such certificates. We quote from the opinion in that case as follows: “Appellant * * * contends that when a national bank issues securities other than its own, that is, as in the present instance, when it acts in the capacity of a trustee in issuing securities of other corporations or individuals, the exception above noted does not apply. On the other hand, the respondents contend that the section of the act is clear and unambiguous, and means just what its plain language imports–that is, that a national bank as such is excepted from the definition of ‘company’ and that while acting as such, either in issuing its own securities or as a trustee in issuing those of other persons or corporations, it is not required to secure a permit before taking such action. It was held in the case of In re Flesher, 81 Cal.App. 128, 252 P. 1057, 1059, in construing the Corporate Securities Act, that it was ‘the legislative intent to exclude from the definitive words of the section all corporations subject to some other supervisory power of the state.’ Under this construction of the act, national banks were assumed to belong to those classes of corporations excepted from the operation of the act.”

It is the contention of the plaintiff that during the period from 1923 to 1929 the Corporate Securities Act purported to wholly except national banks from its operation, but especially subjected state banks to its provisions whenever they were not issuing certificates of their own issue against their own assets (Stats. 1923, § 2, subd. 3, [a] and [c], p. 87); that the Legislature manifestly intended to regulate national banks and that the exemption clause operated to remove them from the application of the statute only while they were discharging their functions as federal instrumentalities, for otherwise during that period the national banks were left completely unsupervised; and that a construction of the statute in opposition to this contention would result in an unconstitutional discrimination in favor of national banks against state banks. (See article by Judge Emmet H. Wilson in American Bar Journal, July, 1934, at page 399.) The plaintiff also contends that “a complete exemption of national banks from the statute would defeat the very purpose for which it was enacted by permitting the state to be flooded with worthless or questionable securities issued and sold through national banks * * *.” In making these contentions the plaintiff admits, “We are not unmindful of the recent ruling of this court in said cause of Young v. Three For One Oil Royalties, supra, which as far as it goes is adverse to respondents' contentions.”

We do not agree with the plaintiff's contention that such a construction would permit the state to be flooded with worthless or questionable securities. It is common knowledge that the state was not during the years in question flooded by worthless or questionable securities issued by national banks, although it was assumed by all, including the commissioner of corporations (as admitted in the briefs) that said banks were not required to obtain permits during that period. Neither would the state have been flooded with worthless or questionable securities if state banks had the same privilege under the operation of the said statute. In any event, the Corporate Securities Act is no longer needed to protect the public against the issue of worthless or questionable securities during the years 1923 to 1929. Those years are now washed up on the sands of time. In 1929 the Legislature changed the entire scheme of exemptions (St. 1929, p. 1253, § 2(b). By amendment the act was made applicable to all private corporations for profit and the exemptions were made to apply instead to various classes of securities.

Neither do we agree with the contention of the plaintiff that state banks were subject to the operation of the law during the period from 1923 to 1929 and that therefore the exemption of national banks resulted in a discrimination against state banks which made unconstitutional the clause exempting national banks. In the first place it would be as reasonable, much more so indeed, to contend that the clause with respect to state banks would be the one made unconstitutional rather than the one with regard to national banks. Assuming that the provisions of the act as above quoted required state banks to obtain a permit to issue securities while at the same time exempting national banks from this requirement, the reasoning would be as follows: That the act permits national banks to do business in this state on more favorable terms than state banks; that such favoritism is contrary to section 15 of article 12 of the Constitution of California, which reads as follows: “No corporation organized outside the limits of this state, shall be allowed to transact business within this state on more favorable conditions than are prescribed by law to similar corporations organized under the laws of this state.” That this fundamental safeguard of the Constitution is attempted to be subverted by placing a burden upon domestic corporations to which foreign corporations are not subject, the latter thus being given negatively a privilege denied the former (Young v. Three For One Oil Royalties, supra) and one or the other of the provisions is unconstitutional; that the provision of the act with regard to national banks is clear and unequivocal while the provision of the act with regard to state banks is subject to two reasonable interpretations; that the amendment with reference to state banks was passed last in respect of time and is the one which caused the unfair discrimination, and that if either must be held to be unconstitutional it is the latter; and, finally, that this discrimination against state banks being void and unconstitutional such banks continued to enjoy the same exemption as national banks before the enactment of said unconstitutional provision.

This reasoning is very persuasive and we would adopt it as controlling in this case if it were not that by doing so we would overlook one of the fundamental rules of statutory construction, which is that unconstitutional effect should not be given to a statute if another construction is reasonably discoverable from its language. In re Estate of Potter, 188 Cal. 55, 204 P. 826. “A presumption of constitutionality protects every legislative act. * * * It will be given a construction consistent with validity if at all possible.” People v. Globe, etc., Co., 211 Cal. 121, 294 P. 3, 5.

Let us examine more carefully the language of the Corporate Securities Act above quoted in order to see if there is not a reasonable interpretation which will save its constitutionality. It will be observed that if the final clause of said paragraph (c) is confined in its application to corporations transacting insurance business within this state, then there is no discrimination against state banks in the provisions of said act, for by its very terms as so construed the act exempts “all corporations now or hereafter organized under the laws of this state for the purpose of conducting the business of banking within this state.” Prior to the enactment of the final clause of said paragraph (c) certain corporations transacting insurance business within this state had commenced on a large scale the issuing of so-called mortgage insurance certificates of their own issue against their own assets. This construction of the statute is much more reasonable than a construction which forces a discrimination so violent that certain acts if committed by officers of state banks are criminal while the identical acts if committed by officers of national banks are lawful, and which would construe the act to apply to state banks, a class of corporations which was already under the strict supervision of the state, whereas our Supreme Court has already held in construing the act that “it was ‘the legislative intent to exclude from the definitive words of the section all corporations subject to some other supervisory power of the state.”’ Young v. Three For One Royalties, supra, and In re Flesher, 81 Cal.App. 128, 252 P. 1057.

In construing statutes courts will sometimes consider other statutes, passed by the Legislature, to ascertain the legislative intent, especially in support of the presumption of constitutionality. People v. Globe, etc., Milling Co., 211 Cal. 121, 127, 294 P. 3; In re Washer, 200 Cal. 598, 254 P. 951. This should be especially true as to acts passed at the same session. In this connection we should remember that at the same session of the Legislature at which said subsection (c) was enacted, an amendment to the California Bank Act (St. 1909, p. 87, as amended) extending to national banking associations the privilege of doing a trust business in the state of California was enacted. Section 49a, St. 1923, p. 57. In doing so the Legislature conditioned the privilege with the words, “provided that the particular conditions and restrictions prescribed for banks of this state for the exercise of like privilege are imposed upon and complied with by such national banking associations.” This provision denying to national banks any favoritism over state banks became effective on the same day said provisions of the Corporate Securities Act became effective, and this weighs heavily in favor of the contention that the Legislature had no intention of granting discriminations in favor of national banks against state banks.

The intention of the Legislature as above construed possibly would have been clearer if the comma (,) had been placed in said paragraph (c) after the first use of the phrase “within this state,” rather than after the second use of the same phrase. But a comma is not necessary. And, in any event, a failure to punctuate may be and sometimes must be disregarded. In re Sekuguchi, 123 Cal.App. 537, 11 P.(2d) 655, citing 23 Cal.Jur. 733. The omission of a comma should not be allowed to thwart this just and reasonable construction of the statute. The construction which confines the application of the final clause of paragraph (c) to corporations transacting insurance business within the state will save the legislation within constitutional limitations.

During the conferences of this court upon this case the question has arisen: Has not the Supreme Court in Young v. Three For One Royalties, supra, already construed the provisions of the amendment of 1923 to the Corporate Securities Act at variance with the one which is found in this opinion? And attention is called to the following language: “In 1923, but after the sale of the certificates now owned by appellant, the Legislature amended said act so as to except state banks from the terms of said act only ‘when such corporations are issuing securities of their own issue against their own assets.”’ It is sufficient to say that the amendment of 1923 was not before the court for interpretation and that said language is pure dictum. Fortunately this very statement is made in a later part of the opinion: “But with the provisions of the act in force after such amendment we are not concerned as the rights of the parties herein are governed by the terms of the act before such amendment.” And later, “Nevertheless, we are urged by the respondents and a number of amici curiæ appearing herein to decide this question as a large number of cases involving state trust companies are now pending in the courts awaiting a decision of this question. Notwithstanding this request, we have decided to leave this question for future action. We have reached this conclusion for the reason that any decision that we might render herein, if adverse to the respondents, would be dictum pure and simple.”

Finally it is contended that if the Corporate Securities Act during the period in question were so construed that national banks were exempt and that state banks were not exempt, still the provisions would be constitutional for the reason that the classification of banks in the Corporate Securities Act into state banks and national banks is based on a rational ground of differentiation, and that unless a classification is manifestly without support in reason, the conclusion of the Legislature with reference thereto will be sustained (Western Indemnity Co. v. Pillsbury, 170 Cal. 686, 151 P. 398, and In re Stephan, 170 Cal. 48, 148 P. 196, Ann.Cas. 1916E, 617), and that there is a sufficient distinction between state and national banks so that the legislative classification in this statute is not palpably arbitrary. Yes, and so what! The provisions of section 15 of article 12 of the Constitution, above quoted, contemplate such classification, and then declare that the one class shall not be allowed to transact business within this state on more favorable conditions than are prescribed by law to the other.

Under our construction of the law it was not necessary for the bank to have obtained a permit in order to issue the securities, and the securities were not void. The second cause of action is merely a repetition of the cause of action set forth in the first count. Since it was essential to plaintiff's recovery that the certificates be void, the judgment should be for the defendant.

Judgment reversed.

We concur in the judgment on the one ground stated in the opinion that the statute is unconstitutional for the reason that it permits corporations organized outside of California to transact business in the state on more favorable conditions than California corporations.

CRAIL, Presiding Justice.

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