Litwin v.
Allen Is a director liable for loss or damage other than what was
Supreme Court of New York 25 N.Y.S.2d 667 (1940)
Brief Fact Summary.
Stockholders (Plaintiff) brought a derivative action against
Trust Company (Defendant), its subsidiary, Guaranty
Company (Defendant), and J.P. Morgan & Co. (Defendant) for
a loss resulting from a bond transaction.
Synopsis of Rule of Law.
A director is not liable for loss or damage other than what
was proximately caused by his own acts or omissions in
breach of his duty. s resulting from a bond transaction.
Facts.
On October 16, 1930, Trust Company (Defendant) and its
subsidiary, Guaranty Company (Defendant), agreed to
participate in the purchase of $3,000,000 in Missouri Pacific
Convertible Debentures, through the firm of J.P. Morgan & Co.
(Defendant), at par, with an option to the seller, Alleghany
Corporation, to repurchase them at the same price at any
time within six months. The purpose of the purchase was to
enable Alleghany to raise money to pay for particular
properties without going over its borrowing limit. The only
purpose served by the option therefore, was to make the
transaction conform as closely as possible to a loan without
the usual incidents of a loan transaction. The decision to
purchase was made after the October 1929 stock market
crash when the market was in a slight upswing that started in
April 1930. After October 1930, there was another sharp and
unexpected drop in the market. Guaranty (Defendant) and
Trust (Defendant) could not sell any of the bonds until
October 8, 1931, and the last were not sold until December
28, 1937, which resulted in a loss of $2,250,000.
Stockholders (Plaintiff) brought a derivative action to hold the
directors liable for the loss.
Issue.
proximately caused by his own acts or omissions in breach of
his duty?
Held.
(Shientag, J.) No. Directors stand in a fiduciary relationship
to their company. They are bound by rules of conscientious
fairness, morality, and honesty, which are imposed by the
law as guidelines for those who are under fiduciary
obligations. A director owes a loyalty to his corporation that
is undivided and an allegiance uninfluenced by no
consideration other than the welfare of the corporation. He
must conduct the corporations business with the same
degree of care and fidelity, as an ordinary prudent man
would exercise when managing his own affairs of similar size
and importance. A director of a bank is held to stricter
accountability. He must use that degree of care ordinarily
exercised by prudent bankers, and, if he does so, he will be
absolved from liability even though his opinion may turn out
to be mistaken and his judgment faulty. The facts in
existence at the time of their occurrence must be considered
when determining liability. In this case, the first question was
whether the bond purchase was ultra vires. It would seem
that if it is against public policy for a bank, anxious to dispose
of some of its securities, to agree to buy them back at the
same price, it is even more so where a bank purchases
securities and gives the seller the option to buy them back at
the same price, thereby incurring the entire risk of loss with
no possibility of gain other than the interest derived from the
securities during the period the bank holds them.
Therefore, regarding the price of securities, the bank
inevitably assumed any risk of heavy loss, and any sharp rise
was assured to benefit the seller. Trust (Defendant) could not
avoid liability by having an agreement with its subsidiary,
Guaranty (Defendant), for Guaranty (Defendant) to take any
loss, should it occur. In this case, the entire arrangement
was so improvident, so risky, so unusual and unnecessary as
to be contrary to fundamental conceptions of prudent
banking practice. Therefore, the directors must be held
personally liable. The second question, in this case, was
whether they were liable for the entire 81 percent loss or
whether their liability was limited to the percentage lost
during the six-month option period. A director is not liable
for loss or damage other than what was proximately caused
by his own acts or omissions in breach of his duty. Only the
option was tainted with improvidence. When the option
expired, any loss that followed was the result of the directors
independent business judgment for which they should not be
held.
Discussion.
In general, hesitation exists to hold directors liable for
questionable conduct. The main fear is that the directors
financial liabilities may be devastating. Though the chance
of such liabilities being imposed may be small, it is feared
that qualified persons will be discouraged from serving as
directors. In addition, directors may be overly cautious and
pass up a desirable business risk out of fear of being held for
any loss that might result. The fear of directors personal
liability is often cited to justify broad indemnification and
insurance provisions and for the adoption of state statutes
defining the scope of directors duties.
FACTS V2
Alleghany Corporation held $23,500,000 in unsecured bonds
in Missouri Pacific. Alleghany purchased several properties,
and in 1930 still owed over $10,000,000 on the purchase
price. Alleghany was unable to borrow the money, and
instead, on November 18, 1930, sold $10,000,000 in its
Missouri Pacific bonds to banking firm J.P. Morgan & Co. for
cash at par value, with an option for Alleghany to buy back
the bonds within six months for the price at which they were
sold to J.P. Morgan. Guaranty Trust Company (Trust Company)
made a written commitment to J.P. Morgan to participate in
the purchase, and Guaranty Company of New York (Guaranty
Company), a subsidiary of Trust Company, agreed to take
over the bonds upon expiration of the six month repurchase
option, if Alleghany failed to exercise the option. The bonds
had already been steadily declining in value in 1930. On
November 5, 1930, when the board of directors of Trust
Company approved the transaction, the bonds were selling at
102 7/8. On November 18, 1930, when the board of directors
of Guaranty Company approved their commitment, the bonds
were valued at 98 5/8. On April 16, 1931, when the six month
repurchase option expired, the bonds were selling at 86 high
and 81 low. Guaranty Company took them over from Trust
Company at par and carried them on its books as an
investment. Shareholders owning 36 out of 900,000 shares of
stock in Trust Company (plaintiffs) have brought a derivative
suit against the directors of Trust Company and Guaranty
Company, and members of J.P. Morgan (defendants), seeking
to impose liability for losses resulting from the transaction.
HELD V2
DISCUSSION
The court held trust company had no interest in third-party
corporation; thus, defendant officers had not breached their
duty.
Plaintiffs also charged defendant officers' bond acquisition on
trust company's behalf constituted an improper loan to third-
party corporation.
The court held that the bonds were purchased negligently
but that the applicable statute of limitations prevented
recovery against three defendant officers.
Plaintiffs also claimed defendant officers negligently
extended a loan to a third-party company and then
improperly auctioned the loan's collateral due to improper
influence from defendant banking firm.
The court followed the rule that allowed deference to
business decisions, and held defendant directors properly
extended the loan using information they possessed and that
their auction of the loan's collateral was equitable.
CONCLUSION
The court entered partial judgment in favor of plaintiffs as to purchase. The court entered judgment in favor of defendants
their claim involving the improper purchase of bonds, due to as to plaintiffs' other claims.
defendant officers' negligence in approving the bond