Appeal from a judgment of the United States District Court for the Southern District of New York, Pierce, J. Reversed. Under New York Insurance Law, where a bankrupt's guarantor had discharged the claim of an injured person against the bankrupt, it was error to reduce the guarantor's claim against the bankrupt's insurer by the amount of collateral held by the guarantor.
Friendly, Hays and Mulligan, Circuit Judges.
On this appeal is presented the novel but narrow question whether, under the New York law of insurance, the estate of a bankrupt insured which has sustained loss otherwise within the scope of its policy of indemnity has a right to the proceeds of the policy which is superior to the right of a third person with an unsatisfied claim against the insured within the scope of the insurance agreement. We hold that New York Insurance Law § 167(1) requires that the relative rights of the insured and such a third person to the policy's proceeds depend on their relative contribution to the loss sustained by the person injured in the first instance by the event insured against.*fn1
F. O. Baroff Co., the debtor, formerly a broker-dealer in the securities industry, entered into a contract with the appellant American Bank & Trust Co., itself now defunct,*fn2 pursuant to which the Bank was to provide loans to Baroff and to "clear" securities traded by Baroff. As part of the arrangement, Baroff pledged negotiable securities as collateral for its obligations to the Bank.
In July, 1970, Baroff obtained from the Insurance Company of North America a policy of indemnity called a "Broker's Blanket Bond." Pursuant to the policy, Baroff was to be indemnified against losses which it sustained resulting from, inter alia, theft or fraud by its employees or the sale by it of forged securities. In April, 1971, precisely such untoward events occurred. As part of a fraudulent scheme in which Baroff employees participated and for which they were convicted, stolen securities belonging to Mrs. Esther Corey and bearing her forged indorsements were received by Baroff. Baroff, in turn, indorsed the securities and transmitted them to the Bank for clearance. As part of its agreement to clear securities sold by Baroff, the Bank indorsed the securities and guaranteed prior indorsements.
As a result of the receipt, sale and indorsement of the stolen securities, the Bank as well as Baroff became liable to Mrs. Corey. In December of 1971, before being placed in liquidation, Baroff directly paid Corey accrued dividends on the stolen securities, in the amount of $5,128.54. In addition, Baroff paid $9,240.87 to Loeb Rhoades & Co. to arrange redelivery of securities to Mrs. Corey.
In January of 1972, Baroff was placed in liquidation pursuant to the Securities Investor Protection Act of 1970, 15 U.S.C. §§ 78aaa et seq., a status tantamount to bankruptcy. See id. § 78fff(c)(1); In re Weis Securities, Inc., 542 F.2d 840 (2d Cir. 1976). After Baroff had been placed in liquidation, Mrs. Corey compromised her claim against the Bank by a settlement of $180,449.58.
The Bank, of course, by virtue of its payments to Mrs. Corey, became subrogated to her claims against Baroff.*fn3 The latter, however, was already in liquidation; thus the Bank could not simply sue Baroff, obtain a judgment, and procure its execution. Instead, the Bank obtained from Baroff's Trustee the release of the escrowed proceeds of the securities which Baroff had pledged as collateral to the Bank. Thereby, the Bank realized $79,321.62.
Since Baroff's unsatisfied liability to the Bank remained in excess of $100,000, the Bank sought from the Trustee the entire proceeds of the Broker's Blanket Bond, $100,000, which had been paid to the Trustee by the Insurance Company of North America. The Trustee refused to pay the Bank the full $100,000. Rather, the Trustee concluded that, under section 167(1) of the New York Insurance Law, the bankrupt's estate was entitled to retain $93,691.03 (the sum of the $5,128.54 paid directly to Mrs. Corey, the $9,240.87 paid to Loeb Rhoades to arrange redelivery of securities to Mrs. Corey, and the $79,321.62 proceeds of the securities which were collateral for Baroff's obligations to the Bank), which the Trustee considered to be the loss to Baroff resulting from its receipt of the stolen securities. The Trustee, however, relinquished to the Bank $6,308.97, the balance of the $100,000 proceeds of the Broker's Blanket Bond. The bankruptcy court and the district court sustained the Trustee's refusal to allow the Bank any greater share of the $100,000 proceeds.
Section 167(1)(a) of the New York Insurance Law provides that each policy insuring against liability must include:
"A provision that the insolvency or bankruptcy of the person insured, or the insolvency of his estate, shall not release the insurer from the payment of damages for injury sustained or loss occasioned during the life of and within the coverage of such policy or contract."*fn4
The Trustee contends that Baroff, despite its bankruptcy and the terms of section 167(1)(a), was entitled to recover its losses of $93,691.03. The Trustee reasons that section 167(1) was enacted by the Legislature in response to a specific evil. Prior to enactment of the predecessor to section 167(1), Consol. L., c.33 § 109 (1909), added by Sess.L., c.524 (1917), courts held that in the event of his bankruptcy, the insured, although liable to a third person, suffered no loss since he was unable to pay the one he had injured. Because the insured had not sustained a loss, the insurance company had no liability to the insured. See Harris v. Standard Accident & Ins. Co., 297 F.2d 627 (2d Cir. 1961), cert. denied, 369 U.S. 843, 7 L. Ed. 2d 847, 82 S. Ct. 875 (1962) (insurer had no obligation to insured who, because of bankruptcy, suffered no loss). Although the insured had done injury to a third person within the scope of the policy, the third person, lacking privity of contract with the insurer, was left to suffer his injuries without recourse against the insurance company, which in a sense thereby realized a windfall. In enacting what is now section 167(1) the Legislature sought to remedy this evil. See Merchants Mutual Automobile Liability Ins. Co. v. Smart, 267 U.S. 126, 130, 69 L. Ed. 538, 45 S. Ct. 320 (1925); Coleman v. New Amsterdam Casualty Co., 247 N.Y. 271, 275, 160 N.E. 367, 369, 72 A.L.R. 1443, 1445-46 (1928); cf. Roth v. National Automobile Mutual Casualty Co., 202 App. Div. 667, 669, 195 N.Y.S. 865, 867 (1st Dept. 1922). The Trustee argues that section 167(1) was not intended to affect Baroff's right to the $93,691.03, since Baroff sustained losses in that amount within the scope of the Broker's Blanket Bond and thus the insurer would have been obliged to pay that amount despite Baroff's bankruptcy. In other words, since in the instant case the "bankruptcy of the person insured" would not even apart from the operation of section 167 have "release[d] the insurer from the payment of damages for injury sustained or loss occasioned . . ." of $93,691.03, section 167 need be called into action only to render the insurance company liable for the $6,308.97 balance of the $100,000 face value of the Broker's Blanket Bond.
We conclude, however, that the New York Legislature did not intend the effect of section 167 to be so narrowly circumscribed by the goal of avoiding insurer's "windfalls." Merchants Mutual Automobile Liability Insurance Co. v. Smart and Coleman v. New Amsterdam Casualty Co., supra, indeed offer some support for the Trustee's argument that section 167 was designed by the Legislature to avoid "windfalls" to insurance companies resulting from bankruptcy or insolvency of their insureds. But, in the great majority of cases, to say that the insurance company has received a "windfall" is as much as to say that a third person wronged by the insured and otherwise entitled to the proceeds of insurance has been deprived of the benefits of the insurance on account of his malefactor's bankruptcy or insolvency. See Harris v. Standard Accident & Ins. Co., supra, 297 F.2d at 631 (section 167 prompted by philosophy that "having received the premiums the insurance company should not avoid liability to a person injured. . . merely because the insured was unable to pay" [emphasis supplied]). Here, Baroff wronged Mrs. Corey. The Bank became subrogated to her rights. Baroff's wrong was within the scope of the Broker's Blanket Bond. Had it not been for the bankruptcy, the Bank would have recovered from Baroff the entire amount of the settlement with Mrs. Corey. Section 167, we hold, was intended by the Legislature to mitigate the effects of an insured person's ...