Litwin v. Allen

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

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