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Borough of Totowa v. American Surety Co.

Decided: February 18, 1963.


For modification -- Chief Justice Weintraub, and Justices Jacobs, Francis, Proctor, Hall and Haneman. Dissenting in part -- Justice Schettino. The opinion of the court was delivered by Weintraub, C.J. Schettino, J. (dissenting in part).


This is an action by the Borough of Totowa against American Surety Company of New York upon official bonds executed as surety for Wilbur Henry Hawthorne, tax collector, treasurer, and water registrar of the Borough. The case was tried without a jury. Both parties appealed from the judgment. We certified the matter before the Appellate Division heard it.

The pertinent facts are stated in connection with each of the issues.


The first issue concerns the application of certain payments made by Hawthorne to the Borough.

Hawthorne's peculations spanned an extensive period. Although defendant was surety throughout, it urged, and plaintiff did not disagree, that by reason of N.J.S. 2A:14-17 it

could be held only upon bonds dated within nine years of suit. Waterford v. Maryland Casualty Co., 119 N.J. Eq. 92 (E. & A. 1935). As to Hawthorne, however, the statute of limitations, N.J.S. 2A:14-4, permitted suit within 16 years after the accrual of the cause of action upon these same bonds signed by him as principal. Accordingly Hawthorne was liable for sums in excess of those for which the surety could be held.

The surety thus remained liable upon two bonds, one dated December 12, 1949, for the period 1950 through 1953, and the other for the following four years. During the probe of his official conduct, Hawthorne sent to the Borough two payments which equalled the shortages revealed to that point. The surety contended that Hawthorne directed the Borough to apply those payments to the shortages for which the surety was liable, whereas the Borough contended it had properly applied the payments to the earlier losses. The trial court found for the surety.

The decisive facts were presented wholly by a stipulation. From it we find that on September 23, 1955 the Mayor and Council received a letter report of an audit showing shortages, whereupon Hawthorne was suspended. The auditor's letter report of October 13, 1955 stated an analysis of "recorded cash receipts and deposits for the years 1952, 1953, 1954 and 1955 to September 26" showed a shortage of $13,492.48. It added that "A separate report will be rendered as to the situation with regard to our investigation of the other section of accounts, and as to whatever may turn up re: circularization."

The stipulation states the Borough advised Hawthorne's attorney that the audit revealed a shortage in the above amount during the stated period, whereupon the attorney sent the Borough a check in that sum with a letter saying that "it has been indicated to me * * * that an audit * * * shows a deficit of $13,492.48" and that:

"It is my understanding that a 100% circularization will be made of the taxpayers of the Borough of Totowa for at least the year of

1954. It is possible that further irregularities may come to light. These may result in an overage or a further increase of the present apparent deficiency. Please be advised that if there is any such overage we will expect to be credited therewith; but if there is an increase in the present apparent deficiency, my client stands willing and ready to supplement the present check with any necessary moneys to meet a further deficit.

Two cardinal principles are involved in the present controversy:

1. My client will not permit the taxpayers of the Borough or the Bonding Company to suffer any loss by reason of any irregularities during his incumbency of the office of Collector-Treasurer of the Borough of Totowa.

2. We will ask for and will expect to be granted the right to have auditors selected by us to check the accuracy of the statements that by reason of the time element we are perforce accepting as accurate. Incidental to the second point, no reflection is being cast upon the present auditor of the Borough; but prior statements as to the amount of total shortage are in such contrast to the amount supposedly found to be final, that my client feels he is entitled to this reservation of the right to check upon the examination made by the auditor until the audit presently being made is completed."

The Borough resolved that this check "be accepted, subject to the Auditor's final report," and that the attorney for Hawthorne be permitted to have the books examined by an independent auditor.

In May 1956 the Borough advised Hawthorne's attorney that the audit then showed a further shortage of $7,205.35. It is not clear whether the auditor's statement itself was sent to the attorney but that statement showed a total due of $20,747.83, less the payment of $13,492.48 referred to above and a $50 item of no immediate moment. The statement concluded, "Note this amount does not include any moneys due which may show up due to the circularization of outstanding delinquent items as of September 26, 1955." In response the attorney for Hawthorne sent a check for $7,205.35, saying:

"It has been indicated to me, as attorney of Wilbur Hawthorne, former Collector-Treasurer of the Borough of Totowa, that a continuation of the audit of the books of the Borough as of the present date shows a further apparent discrepancy of $7,205.35. In keeping with the promise I made to you in my letter of November 14, 1955,

wherein I stated that if there was an increase in the then apparent deficiency my client stood willing and ready to supplement the check that he presented on that date with any necessary funds to meet a further deficit, I am turning over to you with this letter, a check of our firm's special account in the aforestated sum of $7,205.35."

Counsel again reserved the right of independent examination.

From the foregoing the trial court found the two payments were appropriated by Hawthorne to the losses in the years to which the audit report referred and thus reduced the surety's liability.

In so holding, the trial court expressed two thoughts. One was that to apply the payments to any year prior to 1950 would revive the surety's liability upon earlier bonds as to which the statute of limitations had run, and that such revival against a surety could not be accomplished by a payment by the principal. Restatement of Security § 120 (1941). As to this, we agree the surety could not be deprived of its defense by the principal's part payment, but the Borough's position does not depend upon the revival of the surety's liability upon earlier bonds. The Borough concedes the surety cannot thus be held; rather it contends the payments reduced Hawthorne's liability on the earlier bonds leaving the amount of the surety's liability upon the later bonds unaffected. We think the subject of revival of the surety's liability is not involved.

The correctness of the result therefore depends upon the second aspect of the trial court's approach, to wit, that Hawthorne had the right to apply the payments to such defalcations as he chose and in fact did apply the payments to the years mentioned in the audit statements.

The usual rules may be summarized as follows: A debtor may direct to which of several debts his payment shall be applied, and if the debtor does not manifest to his creditor his intention thus to apply, the creditor may apply it to his own advantage, such as to an unsecured debt rather than a secured one or to the oldest item. Hickey v. First National Bank of Lyndhurst, 110 N.J. Eq. 52 (E. & A. 1932); Grover

v. Board of Education of Twp. of Franklin, 102 N.J. Eq. 415, 417-418 (Ch. 1928), affirmed o.b. 104 N.J. Eq. 197 (E. & A. 1929); State v. Sooy, 39 N.J.L. 539, 545-546 (Sup. Ct. 1877), affirmed 41 N.J.L. 394 (E. & A. 1879); 6 Williston, Contracts (rev. ed. 1938) §§ 1795-99, pp. 5104-15; Annot., 57 A.L.R. 2 d 855, 859 (1958); Restatement of Security § 142 (1941). A surety cannot complain that the debtor's funds were appropriated by the debtor or the creditor to a debt other than the one upon which the surety is bound, but if either does apply the payment to such debt, the surety cannot be deprived of its benefit by subsequent action of the debtor or creditor or both. Annot., 57 A.L.R. 2 d 855, 865 (1958). And if neither the debtor nor creditor applies the payment, the court will apply it as justice requires, and, according to the majority view in this country, will apply the payment to the advantage of the creditor, and hence, in the absence of supervening equities, to the oldest or to the least secured item. Long v. Republic Varnish Enamel & Lacquer Co., 115 N.J. Eq. 212, 216-217 (E. & A. 1934); Grover v. Board of Education of Twp. of Franklin, supra (102 N.J. Eq., at p. 424); Naidech v. Hempfling, 127 N.J.L. 430, 432 (Sup. Ct. 1941); 6 Williston, Contracts (rev. ed. 1938) §§ 1800-01, pp. 5115-17; Annot., 57 A.L.R. 2 d 855, 866 (1958).

The Borough contends the rule enabling a debtor to choose should be limited to conventional obligations voluntarily created, and that an embezzler should not be so privileged. We need not decide that question for the reason that we cannot find in the letters of Hawthorne's counsel the communication of an intent to apply the payments to any particular phase of the total liability. On the contrary the letters treat Hawthorne's obligation as a single account, the final amount of which was unknown and was subject to adjustment as the continuing audit on behalf of the Borough or an audit on behalf of Hawthorne might require.

Hawthorne was scarcely of a mind to dictate the application of his payments. He must have been a worried man,

eager to have the Borough accept the assurance stated in the letter that the taxpayers would suffer no loss and hopeful that that assurance and the payments made would obviate or lessen the penal sanctions which lay ahead. Nowhere do his attorney's letters suggest that his obligation consisted of multiple liabilities and that he was choosing to pay some particular ones. Hawthorne, who must have known that the preliminary figure did not approach the total, doubtless hoped the investigation would be incomplete. He would hardly say to the Borough that his shortages exceeded what the audit had thus far revealed and that he was deliberately paying the specific items uncovered rather than those not yet discovered. The only position he could sensibly take was that he would make good the losses whatever they were found to be and that his payments be accepted on account. We find no more in the letters. The Borough was accordingly correct in deeming the payments to have been unconditional and in applying them to items prior to 1950.


The next question is whether the surety is liable for losses arising out of false tax search certificates issued by Hawthorne. The surety's position, with which the trial court agreed, is that in issuing those certificates Hawthorne was not discharging a duty of any office within the coverage of the bonds.

The facts are these: Hawthorne was elected collector in 1941 and thereafter re-elected for successive terms running through the date of his resignation, November 14, 1955. Hawthorne also held two additional offices under resolutions of the Borough Council, the office of treasurer*fn1 being so held from 1941, and the office of water registrar from 1944. Each year, beginning in 1946, ...

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