Litwin v. Allen

Brief Fact Summary. This is a stockholders derivative suit against the directors of Guaranty Trust Company, (Trust), its subsidiary Guaranty Company of New York, (Guaranty), and J.P. Morgan & Co., (J.P.).

Synopsis of Rule of Law. Directors of a corporation have a duty to act with honesty diligence and prudence. 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.

Facts. This is a stockholders derivative suit against the directors of Guaranty Trust Company, (Trust), its subsidiary Guaranty Company of New York, (Guaranty), and J.P. Morgan & Co., (J.P.). The complaint alleges the directors breached their duty of care when they entered into the Missouri Pacific Bond Transaction. Alleghany Corporation, (Alleghany), had purchased certain properties the balance on which was $10,500,000 due on October 16. Alleghany needed money to make the payment but because of certain borrowing limitations in its charter, could not borrow the money. To overcome this limitation and to enable Alleghany to complete the purchase, Alleghany was to sell some of the securities it held. Alleghany held debentures, which were unsecured and subordinate to other Missouri Pacific bond issues.
J.P. purchased $10 million of these bonds at par giving an option to Alleghany to buy them back within six months for the price paid. Trust committed to participate in the bond purchase and Guaranty committed itself to Trust to take up the bonds if Alleghany failed to exercise its option to repurchase. In October of 1929, the stock market crashed.

Issue.
Whether the directors breached a duty of care with respect to the Missouri Pacific Bond Transaction.

Whether the directors should be liable for the total loss suffered when the bonds were ultimately sold at an 81% loss.

Whether all of the directors shall be liable for the breach of the duty of care.

Held.
The directors plainly failed to bestow the care which the situation demanded because the entire arrangement was so improvident, risky unusual and unnecessary as to be contrary to the fundamental conceptions of prudent banking practice.

No. The directors should only be liable for the portion of the loss which accrued within the six month option period

No. All the directors who were present and voted at the relevant meetings are liable.

Discussion.
It is against public policy for a bank to for a bank to purchase securities and give 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 in the interim. Any benefit of a rise in price is assured to the seller and any risk of heavy loss s inevitably assumed by the bank.

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. Once the option had expired, there was nothing to prevent the directors of the Company that had taken over the bonds in accordance with its agreement from selling them. Any loss that incurred after the option had expired was a result of the directors’ independent business judgment in holding them. The further loss should not be laid at the door of the improper but expired repurchase option.

The ratification by the directors is equivalent to prior acquiescence and should result in liability. The ratification prevented a possible later rescission on the ground that the directors did not authorize it.