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Kavanaugh v. Gould

Supreme Court of New York, Appellate Division

November 15, 1911

CHARLES H. KAVANAUGH, Who Sues on Behalf of Himself and All Other Stockholders of the COMMONWEALTH TRUST COMPANY OF NEW YORK (Formerly the TRUST COMPANY OF THE REPUBLIC) Who Are Situated Similarly with Himself, Respondent,

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APPEAL by the defendants, George J. Gould and another, from a judgment of the Supreme Court in favor of the plaintiff, entered in the office of the clerk of the county of Saratoga on the 3d day of January, 1910, upon the decision of the court, rendered after a trial before the court without a jury at the Saratoga Trial Term, requiring the said defendants to pay to the Commonwealth Trust Company certain sums of money claimed to have been lost to said company by reason of their negligence as trustees of the Trust Company of the Republic of which the Commonwealth Trust Company was a reorganization.

The plaintiff has brought this action in behalf of himself and other stockholders of the Trust Company of the Republic against certain of the directors of said trust company to compel said directors to restore to the company moneys claimed to have been lost through their negligence. The action is brought upon the allegation of a neglect and refusal of the trust company itself to sue.

Early in 1902 the Trust Company of the Republic was incorporated. Both the defendants Gould and Satterlee, soon after its incorporation, were elected and qualified as directors. Satterlee became a member of the executive committee. Upon July twenty-fourth said trust company loaned to J. G. White & Co., upon their promissory note, the sum of $37,500. This note was secured by an assignment of rights under an underwriting agreement in bonds, to be issued by the United States Shipbuilding Company, to the amount of $32,000. On July twenty-fifth said trust company loaned to E. G. Bruckman the sum of $90,000 upon his individual note, secured by an interest in a similar underwriting agreement, in bonds of the shipbuilding company to the amount of $113,400. Upon August first said trust company loaned to J. G. White & Co. $33,750 upon their promissory note, secured by their interest in a similar underwriting agreement for bonds of the said

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shipbuilding company to the amount of $50,000. Upon August twenty-ninth said trust company loaned to J. G. White & Co. $28,500 upon bonds of said shipbuilding company of the par value of $38,000. Upon October second said trust company loaned to Wheeler & Jones $12,000, and upon October fourth to W. A. Bailey the sum of $12,000. These loans were upon the promissory notes of the respective parties, secured by bonds of the said shipbuilding company of the par value of $33,600. Upon December twenty-third said trust company loaned to J. G. White & Co. $34,200 upon their promissory note, secured by bonds of the said shipbuilding company of the par value of $46,000. Upon January 6, 1903, said trust company loaned to W. A. Bailey the sum of $21,600 and to Wheeler & Jones the sum of $21,800 upon their promissory notes respectively, secured by bonds of the said shipbuilding company of the par value of $60,400. For the losses incurred upon these loans, as well as for a loss incurred by reason of $35,000 paid to the president, Dresser, upon September 25, 1902, the judgment against the defendant Satterlee is based. Inasmuch, however, as the defendant Gould resigned as director upon October 29, 1902, he has not been held liable for the loss upon the notes that were thereafter executed.

It was proposed by men interested in the United States Shipbuilding Company to purchase the principal shipyards in various parts of the country. The financial scheme of this shipbuilding company was to execute a first mortgage for $16,000,000 as security for bonds of $1,000 aggregating an equal amount. Of these bonds, $5,500,000 were to be withdrawn from public issue for disposal under vendors and subscribers' contract; $1,500,000 thereof were to be reserved in the treasury of the company, and the balance, or $9,000,000, thereof, bearing interest at five per cent, were to be offered for public subscription and the proceeds used to pay for the several plants to be acquired. The $9,000,000 issue of bonds was to be offered for public subscription at not less than ninety-five per cent, and the Trust Company of the Republic was authorized to receive applications for these bonds at that price. The prospectus issued by this shipbuilding company named the trust company as the bankers and transfer agents, while the

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Mercantile Trust Company was named as the trustee for the bondholders. The Bethlehem Steel Company was not one of the concerns which it was first proposed to purchase and make part of the shipbuilding company, and was not mentioned in the prospectus. Thereafter, however, arrangements were made for its purchase and consolidation. Upon August eleventh and twelfth these properties were passed over to the shipbuilding company upon payment of the several sums named in the options which had been theretofore held. Prior to this time, however, many of the bonds had been provided for by various underwriting agreements, and all of these notes upon which loss occurred were notes for moneys to pay upon or complete those underwriting agreements. The moneys were not handed over to the several makers of the notes, but were passed to the account of the United States Shipbuilding Company upon the books of the Republic Trust Company. It had been theretofore agreed upon that the Republic Trust Company should hold the deposits and be the fiscal agent of the United States Shipbuilding Company. This shipbuilding company progressed until sometime in the latter part of 1903, when it became embarrassed, and a reorganization was had and stock and bonds of the Bethelem Steel Company were substituted upon these loans for these shipbuilding bonds. Sometime after January 26, 1903, all of the makers of these notes were released from personal liability by the Republic Trust Company. The collateral upon the notes proved of little value and the Republic Trust Company lost upwards of $300,000 thereupon, and this in the main forms the basis of the judgment against these defendants. The judgment as entered runs against other defendants who are not represented upon this appeal. Further facts appear in the opinion.


Rush Taggart, for the appellant Gould.

J. Langdon Ward [Lewis E. Carr of counsel], for the appellant Satterlee.

Alton B. Parker and Theodor Megaarden, for the Trust Companies Association of the State of New York, intervening.

Edgar T. Brackett, for the respondent.

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In Cassidy v. Uhlmann (170 N.Y. 505) the opinion in part reads: 'The board of directors of a bank has the general superintendence and active management of all its concerns, and, for all practical purposes, the board is the corporation. As a general rule a board of directors must act as a board. But, since directors do not exercise a delegated authority in the sense which applies to other officers and agents, it is clear that a board of directors may delegate some of its powers to committees and individuals selected from the board. This is common practice in the management of banks as well as other corporations. Since a board of bank directors is composed of individuals it is manifest that each director sustains a distinct relation, not only to his bank, but to its stockholders and depositors. For obvious reasons the duties which attach to this relation cannot be precisely defined. They cannot be the same under all circumstances; nor can they be imposed with unvarying exactness upon all directors alike.' By the evidence of the plaintiff's witness Krech it appears to be the custom of banks in New York city to intrust to the executive committee of the board the supervision of the detail management of the corporation. The directors generally not upon the executive committee are not supposed to have knowledge of the details of the business management of the corporation which are not submitted to them. In other words, it is not their custom to actively search the individual transactions in a bank that they may learn the responsibility of its debtors, or the nature or value of the collateral. This they intrust, first, to the executive officers of the bank, who are carefully chosen and paid for their services; secondly, to the supervision of the executive committee of their body, which is chosen with a special reference to this duty, and to which committee must be reported weekly all the transactions of the bank.

This custom, however, does not relieve directors generally of all responsibility. If the by-laws require monthly meetings they must make diligent effort to be present thereat. They must give their best efforts to advance the interest of the corporation, both by advice and counsel and by active work on behalf of the corporation when such work may be assigned to

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them. If at their meetings, or otherwise, information should come to them of irregularity in the proceedings of the bank they are bound to take steps to correct those irregularities. The law has no place for dummy directors. They are bound generally to use every effort that a prudent business man would use in supervising his own affairs, with the right, however, ordinarily to rely upon the vigilance of the executive committee to ascertain and report any irregularity or improvident acts in its management. And this custom is but the outgrowth of the necessities of the situation. In the first place it is not a practical proposition to commit the supervision of the details to twenty-five men. A smaller number would do the work more efficiently. Responsibility would be greater because not so scattered. Again, business men of New York are probably the busiest men in the world. They have large business enterprises in which their first interest lies and to which their first duty belongs. Most of them are directors of more than one corporation, and some of them of many. If they are compelled to supervise the detail management of each corporation in which they are directors, or if they are deemed to have constructive knowledge of such facts as would be acquired by such supervision, it would be wholly impossible for them to accept such a trust. They cannot give the time to watch the small every-day transactions of the corporation, and if chargeable with such knowledge as would be acquired therefrom the risk is too great for them to run. They are then in effect made answerable for the neglect of the executive committee to which is given this duty of supervision. Plaintiff's contention is that they must not then accept the position of director. The obvious answer to this contention is that the corporation cannot afford to lose them. One of the best assets of a corporation is the advice and assistance of men of business experience and of large business connections upon its board. Their advice and assistance are of inestimable value in all emergencies and in determining the policies of the corporations and in counsel upon the more important questions that arise. Any construction of the law that would make it impossible for such men to accept positions upon various boards of directors would

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seriously impair both the effectiveness and stability of corporations, in fact be little less than calamitous.

But plaintiff contends further that this rule of responsibility leaves the stockholder at the mercy of the executive officers of the corporation. Not at all. To the members of the executive committee is assigned the duty of detail supervision. With this duty they are bound to be on their guard to detect any irregularities or improvident acts on the part of the executive officers. They are required to scan critically the detailed reports which are made to them by such officers. The diligence required of them is, therefore, greater and the rule of their liability more strict than that of a director not a member of that committee, for to them not only do the stockholders look for protection, but the directors themselves, and upon their fidelity to their commission all parties must rely. Moreover, twice each year an expert examination is made of the condition of the trust company, and of its results all directors must take cognizance. Plaintiff's assertion that the directors may delegate to the executive committee their work but not their responsibility is not in accord with the law of this State. If they may delegate the work they are not responsible for its negligent performance, and this principle is not new to the law of trusts. It is ruled in New York State that a trustee is not liable for the breach of trust of his cotrustee of which he was not cognizant, or in which he did not participate, as to property which comes lawfully into his cotrustee's hands. He may passively allow his cotrustee to take full control and yet not be liable for his devastavit. The responsibility is more strictly held in England and in Pennsylvania. In 1 Perry on Trusts (6th ed. p. 667, note 'A') it is said: 'In the administration and management of the affairs of a trust it is usually impracticable for every trustee to actually participate in every act. To some extent they may delegate to each other the merely ministerial duties of management, and each is entitled to rely upon the honesty and prudence of the other unless he has notice of facts which should lead him to distrust the other.' In Croft v. Williams (88 N.Y. 388) the opinion in part reads: 'One, therefore, may sit passive and see the other receive funds of the estate, and making no objection be deemed to assent, but

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that does not make him responsible for what has been received. He must in some manner know and assent to the misapplication, he must be a consenting party to the waste, or neglect some duty consequent upon his knowledge of a misapplication intended or in progress. ( Williams v. Nixon, 2 Beav. 472.) A wrong done or a duty omitted must lie at the foundation of his liability.' In Sutherland v. Brush (7 Johns. Ch. 22) I quote from the opinion: 'The defendant P. is not responsible for the devastavit of his coexecutor C., any further than he is shown to have been knowing and assenting, at the time, to such devastavit or misapplication of the assets of the estate. Both the executors could not, with any kind of convenience, jointly possess and hold all the assets. The assets must, from the necessity and reason of the case, have been distributed between the executors for the purpose of collection and security; and it appears to be settled, and upon very just principles, that one executor shall not be chargeable with the waste of the other, except so far as he concurred therein; and that merely permitting the other to possess the assets, without going further, and concurring in the application of them, does not render him answerable for the receipts of the other.' This rule is further held in Cocks v. Haviland (124 N.Y. 431); Wilmerding v. McKesson (103 id. 340); Ormiston v. Olcott (84 id. 346). While these cases are not precisely analogous to the case at bar they establish the rule that among trustees there may be a division of duties arising out of the necessities of the case, and after that division one trustee is not responsible without knowledge for the acts of his cotrustee. As applied to the case at bar, as far as these directors are trustees for these stockholders, a division may be made both of duty and responsibility, and the directors generally are not liable for the negligence of the members of the executive committee, as they would in effect so be if they were chargeable with all the knowledge which might be imputable to a member of the executive committee, by reason of his supervision of the detail management of the corporation.

This distinction between the diligence required of a director generally and a member of the executive committee is not only shown by the evidence in the case to be the custom in banks in

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the city of New York, not only does it appear to be a reasonable and sane distinction, but it is clearly recognized in the by-laws of this corporation itself, which were made by these very stockholders here complaining, and afterwards ratified by the board of directors. In fact these stockholders might make any requirement that they should see fit in their by-laws regulating the duties of the directors, which would be binding upon the directors, and are not subject to modification or veto by the directors themselves. Those by-laws provide for the executive committee to be composed of six members of the board of directors in addition to the president. To that executive committee is given all the powers of the board of directors when the board is not in session, except the power to fill a vacancy in the board. The assent of that executive committee is required 'for all investments that shall be made of the funds of the company in stocks, personal securities and bonds and mortgages, and for the disposal of the same, and of the funds of all special trusts.' No guardianship, receivership or other special trust can be accepted by the president without either their approbation or that of the board of directors, unless it be ordered by a court or surrogate having jurisdiction. The executive committee may in its discretion authorize the president generally to make investments in such securities as are authorized by the charter of the company, and to dispose of such securities, without previously consulting as to details with the committee; but all such transactions shall be reported to the committee at its next meeting. No disbursements, except for current expenses or for an amount not to exceed $200, shall be made without being reported to the executive committee for approval. The executive committee is required to meet at the main office of the company on Tuesday of each week, and also ...

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