G.R. No. 32576, November 6, 1930
FULTON IRON WORKS CO., plaintiff-appellee, vs. CHINA BANKING CORPORATION, ET AL., defendants. CHINA BANKING CORPORATION, appellant.

FACTS

Fulton Iron Works Co. (plaintiff) engaged attorney S.C. Schwarzkopf to collect a debt from Binalbagan Estate, Inc. Schwarzkopf collected payments on behalf of the plaintiff, depositing them into accounts with China Banking Corporation (defendant bank). He deposited:
1. A check for ₱10,000 payable to “Sydney C. Schwarzkopf” into a personal account (No. 2 account).
2. A check for ₱61,237.50 payable to “S. C. Schwarzkopf, Attorney-in-Fact, Fulton Iron Works Co., or order” into a new account titled “S. C. Schwarzkopf, Attorney-in-Fact, Fulton Iron Works Co.” (third account).
Schwarzkopf later transferred ₱25,000 from the third account to his personal No. 2 account, which he used to pay his personal debt to the bank and for other personal expenses. He also remitted $15,000 (approx. ₱30,000) to the plaintiff from the third account. The plaintiff sued both Schwarzkopf and the bank for the misappropriated funds. The trial court absolved Schwarzkopf (due to prior criminal conviction and indemnity order) but held the bank liable for ₱127,200.36. The bank appealed.

ISSUE

Is China Banking Corporation liable for the misappropriation of trust funds deposited by Schwarzkopf?

RULING

The Supreme Court modified the trial court’s decision.
1. For the ₱10,000 deposit: The bank is not liable. The check was payable to Schwarzkopf personally, and the bank had no notice that the funds belonged to another. A bank is justified in paying out deposits to the depositor unless it has knowledge of a third party’s claim.
2. For the ₱61,237.50 deposit: The bank is liable for ₱22,144.39. The check was payable to Schwarzkopf in a fiduciary capacity (“Attorney-in-Fact”), putting the bank on notice that the funds were held in trust. The bank became liable when it allowed Schwarzkopf to transfer ₱25,000 from this trust account to his personal account and then applied part of it to pay his personal debt to the bank. This constituted a misapplication of trust funds with the bank’s knowledge. However, the bank is not liable for the remainder of the funds that Schwarzkopf subsequently misappropriated from his personal account, as there was no proof of the bank’s complicity in those later acts.
The Court reduced the bank’s liability to ₱22,144.39 with interest from the filing of the complaint.