Searching over 5,500,000 cases.

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

Michelsen v. Penney

decided: March 19, 1943.


Appeal from the District Court of the United States for the Southern District of New York. Action by Hamilton Michelsen, Wilbur Veitch, and Thomas H. Newman, individually and on behalf of other depositors of City National Bank in Miami, Miami, Florida, against James C. Penney to recover for losses sustained by reason of the defendant's alleged negligence as a director of the bank, wherein C. H. Bancroft, later succeeded by R. C. Parsons, intervened as receiver of the bank. From a judgment overruling the recommendation of a special master for dismissal of the complaint and granting damages to the receiver in the total sum of $2,424,301.99, D.C.S.D.N.Y., 41 F. Supp. 603, all parties appeal. Reversed in part and remanded. See, also, D.C.S.D.N.Y., 10 F. Supp. 537.

Before Augustus N. Hand, Clark, and Frank, Circuit Judges.

Author: Clark

CLARK, Circuit Judge.

This is an action by the members of a depositors' committee, for themselves and other depositors, of City National Bank in Miami, Miami, Florida, against James C. Penney, the chairman of the board of directors of the bank, to recover for losses claimed to have been caused it by his violation of duty as a director. A successor receiver to the original receiver who had been appointed on the bank's failure in December, 1930, was allowed to intervene; and he and, upon his death, his successor, the present receiver of the bank, have joined forces with plaintiffs to urge recovery. A special master, appointed by the district court, held extensive hearings and then submitted his report, with detailed findings and the recommendation that the complaint be dismissed. The district court, however, sustained exceptions to the master's report, made its own extensive findings, supported by a careful opinion, 41 F. Supp. 603, and gave judgment in favor of the receiver for a substantial recovery. All parties have appealed, the plaintiffs and the receiver because they believe the recovery allowed was too small, the defendant because he thinks no recovery, or at the least a lesser one, should have been granted. In our view of the case, which is that a lesser recovery should be granted, a rather detailed review of the history of this failed national bank becomes necessary.

City National Bank and Trust Company of Miami, the predecessor of City National Bank in Miami, was formed in 1925. Shortly thereafter, upon the collapse of the Florida real estate boom, it took over the assets of two failed banks, upon a guarantee of their quality from two going banks, the First National Bank of Miami and the Bank of Bay Biscayne. As losses were realized upon large real estate investments thus inherited, the bank was compelled to seek new capital funds. In 1926 it successfully negotiated with various New York and Florida banks for a "pool loan" of $5,000,000, secured by a trust agreement pledging all its assets. This loan, however, proved to be a mere palliative. Again in financial straits in 1927, the bank sought the aid of defendant, James C. Penney, head of J. C. Penney Company, a nationwide retail dry goods and clothing chain store organization, and himself a heavy investor in Florida real estate through the J. C. Penney-Gwinn Corporation, of whose capital stock ten-elevenths was owned by him and one-eleventh by his personal attorney, Ralph W. Gwinn.

Penney arranged a syndicate loan of $1,000,000, which came to the City National Bank and Trust Company through its merger with the newly organized City National Bank in Miami, to whose capitalization the loan was applied. As one feature of the merger, doubtful assets of the City National Bank and Trust Company in the amount of $1,500,000 were charged off against its surplus of $500,000, and against its stated capital of $2,000,000. The $1,000,000 balance in the capital account was transferred to the new bank. Thus, the latter began operations with a stated capital of $1,000,000, represented by 10,000 shares of $100 par value each, and a surplus of like amount. The syndicate members had complete stock control of the bank, however, for, in addition to 5,000 shares received by them in return for their loan, the stockholders of the old bank gave them a bonus of 298 shares of the new organization and Penney-Gwinn Corporation purchased the equivalent of 405 shares from the stockholders of the old bank. In the syndicate, Penney-Gwinn became and was recognized as the dominant factor.

After the organization of the bank, defendant was elected a director and chairman of the Board; Saunders, agent and resident manager of Penney-Gwinn in Florida, became a director and vice-chairman of the Board; and Lewis, a vice-president and a director of Penney-Gwinn, became a director. In order that Saunders and Lewis might appear to comply with the National Bank Act, 12 U.S.C.A. § 72, requiring a national bank director to be a bona fide stockholder in his bank, Penney-Gwinn transferred qualifying shares to their names and received in return from each a noninterest-bearing note, wherein the maker reserved the right to deliver in payment of the note the equivalent number of shares of City National Bank in Miami at its then par value. Other directors were also qualified at various times in this fashion.

Immediately after the bank began business, its entire capital and surplus were applied to reduce the old "pool loan" contracted by the former City National Bank and Trust Company. These and other payments on the "pool loan," until it was wiped out in July 26, 1929, plus recurring losses on investments, so reduced the bank's capital that it was forced from the outset to resort to borrowings, principally from its largest stockholders. In fact throughout its life its borrowings generally exceeded the limit permitted by the National Bank Act, 12 U.S.C.A. § 82.

In addition, the bank underwent two recapitalizations. By the first, occurring February 20, 1929, doubtful assets in the amount of $1,000,000 were charged off against capital and surplus, each being reduced by one-half, and authorized capital stock was increased to 40,000 shares at $25 par value. The existing stockholders received two shares for every one of the old stock, and the balance of 20,000 shares was sold at $50 per share. Penney-Gwinn made purchases to the extent of $492,662.50. Capital and surplus thus were restored to $1,000,000 each.

By the second recapitalization, occurring April 4, 1930, and involving the controverted Tarrier transaction, the bank erased doubtful assets of $2,000,000 from its balance sheet. First, each stockholder contributed one-half of his holdings, permitting a reduction of capital and surplus to $500,000 each and producing a $1,000,000 offset. Next, the Tarrier Company of Delaware, a corporation organized for the purpose, contributed a second $1,000,000 offset, together with all its common stock, in return for such bank assets as had theretofore been charged off or which were regarded as doubtful. The Tarrier Company had an authorized capital of $1,000,000 par value preferred stock and 100 shares no par common stock. Penney and Penney-Gwinn had purchased preferred stock in the amount of $403,981.25, one C. M. Keyes had taken $159,082.50 worth of such stock, and the bank had lent the company $436,936.25 on security furnished by Penney-Gwinn. The bank's loan was ultimately paid off by Penney-Gwinn.

But matters went from bad to worse. On June 11, 1930, the failure of the Bank of Bay Biscayne precipitated a run on the City National Bank. Defendant and Penney-Gwinn lent the bank $880,000 by way of deposit, to tide it over the crisis, with the understanding that the money was to be repaid with interest as soon as the emergency was over. This expedient was successful, the bank survived the run, and by July 7, 1930, the loan had been repaid with interest, apparently in the real belief that the crisis had passed. At least the Penney-Gwinn deposits in the bank were increased from $171,602.13 on July 7, 1930, to $485,500.87 on December 20, 1930. On December 20, however, another run began and the bank was compelled to close. The Comptroller of the Currency, on December 23, 1930, announced its insolvency and appointed H. J. Spurway as receiver. The depositors at the time of closing numbered some 5,700, and were owed $5,996,970.02. They have since received liquidating dividends totalling 40 per cent.

The parties have been at variance as to the respective weight to be accorded to the two lengthy findings of fact now before us, the master's and the district court's respectively. While it is the master's findings of fact which are to be accepted "unless clearly erroneous," F.R.C.P. 53(e)(2), and the question is the same in this court as it was in the district court, Morris Plan Industrial Bank v. Henderson, 2 Cir., 131 F.2d 975, yet for the most part we find it unnecessary to direct our attention to these differences between the tribunals below. In the main, there is agreement on the basic facts, and dispute only as to the conclusions and inferences to be drawn from them and the legal principles applicable. As will appear, we differ from both the master and the district court as to certain of these conclusions and principles. The master's recommendation of dismissal was based upon his view that as to all losses but one for which defendant was claimed to be responsible, liability was not proved, and that as to the one proved, recovery was barred by the statute of limitations. On the other hand, the district court found the statute of limitations not a bar, and, while finding liability for a considerable number of specific losses--though not to the extent claimed by plaintiffs--also ruled alternatively that defendant was generally responsible for the bank's losses, by reason of his designation of dummy directors for the bank. Defendant, in addition to his defense of the statute of limitations and his contentions that the specific losses in issue were for the most part not the result of improper banking practices, relies also on his lack of knowledge of each transaction. We shall, therefore, discuss first the general issues of the statute of limitations and of the standard of responsibility by which defendant's conduct is to be judged, and shall then consider each specific transaction which is in dispute.

Defendant points out that he and his corporation, Penney-Gwinn, by this bank's failure, have lost very large sums of money which from his point of view and in substantial effect were donations made to the bank to keep it running, in the interest of the depositors, without personal gain of any kind, whether by way of dividends or otherwise. Moreover, it is a fact that the claims against him are not based upon intentional or wilful wrongdoing, but rest in final analysis on his inattention to duty. The picture of the bank disclosed by the record is that of a comparatively small institution, which during its brief existence engaged in a continuing struggle against the deepening gloom of the Florida real estate depression. Hindsight suggests that it was doomed from the beginning. Nevertheless, certain of the losses should never have been incurred. One cannot be a national bank director in absentia, and we cannot condone defendant's failure to attend to the duties of an office voluntarily accepted or relieve him of responsibility for losses to the avoidance of which he should have devoted his best thought and endeavor.

1. Statute of Limitations. The appropriate statute of limitations is the New York Civil Practice Act, § 49(4), limiting to three years actions against bank directors to enforce a liability created by the common law or by statute and providing that the "cause of action is not deemed to have accrued until the discovery by the plaintiff of the facts under which * * * the liability was created." Platt v. Wilmot, 193 U.S. 602, 24 S. Ct. 542, 48 L. Ed. 809; Russell v. Todd, 309 U.S. 280, 290-294, 60 S. Ct. 527, 532-534, 84 L. Ed. 754. It seems that under this statute the bank is the plaintiff and the complainant depositors are considered to bring the suit on its behalf. Mencher v. Richards, 256 A.D. 280, 9 N.Y.S.2d 990; Chance v. Guaranty Trust Co. of New York, 257 A.D. 1006, 13 N.Y.S.2d 785, affirmed 173 Misc. 754, 20 N.Y.S.2d 635, affirmed 282 N.Y. 656, 26 N.E.2d 802; Van Schaick v. Aron, 170 Misc. 520, 10 N.Y.S.2d 550; Hifler v. Calmac Oil & Gas Corp., Sup., 10 N.Y.S.2d 531, affirmed 258 A.D. 78, 16 N.Y.S.2d 104; Van Schaick v. Cronin, 237 A.D. 7, 260 N.Y.S. 685; see Limitation of Actions in New York in Stockholders' Derivative Suits Against Directors, 54 Harv. L. Rev. 1040, 1044; The Statute of Limitations in Suits to Remedy Corporate Abuse, 41 Col. L. Rev. 686, 694.*fn1

An original bill of complaint alleging both fraud and deceit and misfeasance and nonfeasance in office was filed by plaintiffs on December 13, 1933. It was dismissed for misjoinder of legal and equitable causes of action, with leave to serve an amended bill of complaint. Michelsen v. Penney, D.C.S.D.N.Y., 10 F. Supp. 537. On August 31, 1934, an amended bill for this action was served. Shortly thereafter Bancroft, who had succeeded Spurway as receiver in April, was allowed to intervene. Still later, in May, 1935, the court permitted plaintiffs to file a supplementary and amended complaint which prayed for judgment to the receiver, Bancroft; and this he completely and promptly accepted as the basis of his own prayer to the same effect.

The original bill first alleged without particulars that a total loss of $3,000,000 suffered by the bank and otherwise unaccounted for had been occasioned by defendant's negligence and violation of the National Bank Acts, "as hereinafter more particularly set forth and otherwise," and then specifically complained of certain transactions involving City National Building, Inc., Coral Gables, Inc., and preferential payments to defendant. The amended bill elaborated "otherwise" to "in other manners and by other means peculiarly within the knowledge of the defendant, James C. Penney, and wholly unknown to the plaintiffs." The supplemental and amended complaint, filed after motions made by defendant and covering forty-five printed pages, set forth with more detail than the present federal rules contemplate not only the transactions particularly described before, but also others allegedly contributing to the $3,000,000 bank deficit and occasioned by defendant's negligence and violation of statutory obligations.

Defendant contends that the statutory period should be reckoned from the date the alleged wrongs were committed against the bank--in every instance prior to December 13, 1930--and that, therefore, even the original complaint is barred. He contends, further, that even if the prescriptive period is reckoned from the date of the appointment of a receiver, at least the supplementary and amended complaint is barred.

Under the general rule, to which New York has apparently adhered, notwithstanding the provision that the cause accrues only upon discovery of the facts, the prescriptive period ordinarily runs from the time alleged wrongs are committed. Chance v. Guaranty Trust Co. of New York, supra; see The Statute of Limitations in Stockholders' Derivative Suits Against Directors, 39 Col. L. Rev. 842, 852. But the statute is tolled while a corporate plaintiff continues under the domination of the wrongdoers. See The Statute of Limitations in Stockholders' Derivative Suits Against Directors, 39 Col. L. Rev. 842, 854. Here there is no dispute of the district court's finding that "at all times during the existence of City National Bank in Miami the defendant Penney through his agents and improperly qualified directors dominated and controlled said bank, its directors and its officers." So, at the earliest, the three-year period began to run from the date of the appointment of Receiver Spurway, December 23, 1930. Then defendant's domination of the bank ceased and notice of defendant's wrongs for the first time became imputable to the bank.*fn2 Accordingly, § 49(4) is no bar to the original and amended complaints.

Discovery of the facts must, however, be attributed to plaintiffs as of that time. That the receiver may have kept his mind closed to any actual knowledge of the wrongs and refused to institute suit upon plaintiffs' request was immaterial. Since in fact he was given sufficient notice to put him on inquiry of the wrongs to the bank and he failed to inquire, he was charged with discovery, Wood v. Carpenter, 101 U.S. 135, 25 L. Ed. 807; Higgins v. Crouse, 147 N.Y. 411, 42 N.E. 6, 70 N.Y.St.Rep. 50, and through him the bank, the "plaintiff," was charged. And further it would avail the depositors nothing on this score to consider them the plaintiffs within § 49(4).*fn3 The receiver was their representative as well as the representative of the stockholders. See Loughman v. Pitz, D.C.E.D.N.Y., 36 F. Supp. 302, 305; 16 Fletcher, Cyc. Corp., 1931, 343, 379. Hence the general principles imputing knowledge from the agency relationship apply. Of course, had there been collusion between the receiver and the defendant the statute of limitations might have been tolled. Cf. Baker v. Schofield, 243 U.S. 114, 37 S. Ct. 333, 61 L. Ed. 626. But the district court found that the receiver was merely remiss in his duties in failing to bring suit, and there appears to be no occasion for disturbing that finding.

The amended and supplementary complaint is saved, however, by the doctrine of relation back. As a matter of pleading, the original complaint clearly gave defendant notice that he would be held for all acts of negligence. It charged him with negligence generally and with a resultant three-million-dollar loss "as hereinafter more particularly set forth and otherwise." The amended complaint elaborated upon this, alleging that the loss was occasioned by means known only to defendant. Certain acts of negligence were specified. But these did not anywhere near account for the total loss, and defendant was bound to realize that he would be held for every possible act of mismanagement. Cf. New York Cent. & H. R. R. Co. v. Kinney, 260 U.S. 340, 43 S. Ct. 122, 67 L. Ed. 294.*fn4 The amended and supplementary complaint merely made specific what had already been alleged generally; the cause of action was not changed; and relation back under F.R.C.P. 15(c), and the earlier law it codifies, therefore followed. Maty v. Grasselli Chem. Co., 303 U.S. 197, 58 S. Ct. 507, 82 L. Ed. 745; United States v. Memphis Cotton Oil Co., 288 U.S. 62, 53 S. Ct. 278, 77 L. Ed. 619; Glint Factors v. Schnapp, 2 Cir., 126 F.2d 207; International Ladies' Garment Workers' Union v. Donnelly Garment Co., 8 Cir., 121 F.2d 561; 1 Moore's Federal Practice 789-803, 810; 2 Fed. Rules Serv. 653; 5 Fed. Rules Serv. 815; and see, also, Elliott v. Mosgrove, 162 Or. 540, 93 P.2d 1070; Original Ballet Russe, Ltd., v. Ballet Theatre, Inc., 2 Cir., 132 F.2d .

2. Basis of Defendant's Liability. This case has developed the most divergent views as to the standard of liability by which defendant's conduct as a bank director must be judged. They range from plaintiffs' contention, which was adopted by the district court as its first ground of decision, that defendant was liable as an insurer for bank losses because of his acts in enabling certain directors to qualify without bona fide ownership of stock, to defendant's claim, substantially adopted by the master, that though he might be held for common-law negligence, yet he was not liable for any losses resulting from statutory violations, since he did not "knowingly" participate in or permit them. Since defendant was unwilling to concede proof of negligence, except as to a single claim (which he contended to be barred by the statute of limitations), his view of the law would pretty much protect him from responsibility for the losses.

All concede that under the authorities there are two bases of liability--one at common law for failure to exercise that degree of care which ordinarily diligent and prudent men would exercise under the circumstances, Bowerman v. Hamner, 250 U.S. 504, 513, 39 S. Ct. 549, 63 L. Ed. 1113, and one under the National Bank Act. By 12 U.S.C.A. § 93, substantially unchanged from the original Act of 1864, 13 Stat. 99, 116, it is provided that directors who "shall knowingly violate, or knowingly permit" any of the bank's officers or agents to violate any provisions of the Act shall be personally liable for all damages which the bank, its shareholders, or any other person, shall have sustained "in consequence of such violation."*fn5 In Yates v. Jones National Bank, 206 U.S. 158, 180, 27 S. Ct. 638, 51 L. Ed. 1002, it was said that for a liability resting on the statute "proof of something more than negligence is required; that is, that the violation must in effect be intentional." The decision in Thomas v. Taylor, 224 U.S. 73, 82, 32 S. Ct. 403, 56 L. Ed. 673, added the qualification: "There is 'in effect' an intentional violation of a statute when one deliberately refuses to examine that which it is his duty to examine." This qualification has since been repeated as a part of the rule. Jones National Bank v. Yates, 240 U.S. 541, 36 S. Ct. 429, 60 L. Ed. 788; Corsicana National Bank v. Johnson, 251 U.S. 68, 71, 40 S. Ct. 82, 64 L. Ed. 141; Federal Deposit Ins. Corp. v. Mason, 3 Cir., 115 F.2d 548, 550. More recently the court has limited earlier decisions to hold that a defense of estoppel which a director might have against the bank as to a violation of the Act will not be good as against the receiver, saying that "it is the evil tendency of the prohibited acts at which the statute is aimed, and its aid, in condemnation of them, and in preventing the consequences which the Act was designed to prevent, may be invoked by the receiver representing the creditors for whose benefit the statute was enacted." Deitrick v. Greaney, 309 U.S. 190, 198, 60 S. Ct. 480, 84 L. Ed. 694.

In the Bowerman case the Court had occasion to define the common-law duty of a bank director. In that case Bowerman, who lived 200 miles away from the bank, had never attended a director's meeting or examined any of the books or papers of the bank. The Court said it was "beyond discussion" that he "did not exercise the diligence which prudent men would usually exercise in ascertaining the condition of the business of the bank, or a reasonable control and supervision over its affairs and officers. * * * He cannot be shielded from liability because of want of knowledge of wrongdoing on his part, since that ignorance was the result of gross inattention in the discharge of his voluntarily assumed and sworn duty." 250 U.S. at page 513, 39 S. Ct. 549, 63 L. Ed. at page 1119.

The similarity of that case to the case at bar is striking. Here the master and the court were in agreement as to not merely defendant's utter incompetence, but also his complete neglect of duty, as a bank director. He had no special knowledge or experience for the position, and not only did nothing to fit himself for it, but failed in the obvious duties of attendance at meetings of the Board of which he was chairman. Of thirty-one regular and special meetings of the Board during his directorship, he attended only three--two in 1928 and one in 1930. He also attended a meeting of the Loan and Discount Committee in 1930. His excuses of ill health on the part of himself and his wife were properly discounted--especially in the light of his other manifold activities. And at most they should have led him to resign, not to continue in a relation which would mislead the public. See Rankin v. Cooper, C.C.W.D.Ark., 149 F. 1010, 1016. As the master said, with the court's concurrence, "The conclusion is inescapable that defendant Penney treated the bank's business as of secondary consequence." 41 F. Supp. at page 616. But "his oath forbade his abandoning the conduct of the business to" the other bank officers. See L. Hand, J., in Goess v. Ehret, 2 Cir., 85 F.2d 109, 110. Indeed, defendant concedes his liability for the Board's negligence, for he says in his brief that "save as the Statute of Limitations affords a defense, appellant Penney does not dispute his liability if negligent acts of the Board are shown to have caused damage to the bank."

This concession of defendant loses substantially the greater part of its effect when it is coupled with the contention that any act of the Board which violates the National Bank Act is subject to the exclusive remedy contained in the statute, which in turn shields him from liability because of his lack of knowledge. As pointed out below, even on so strict a view, he must be charged with a greater knowledge of the bank's affairs than this contention admits; but we do not believe it is a correct, or at least a complete, statement of the appropriate standard. Its logical conclusion would be that as proper banking practices come more and more--in accordance with present trends--to be the subject of statutory enactment, a director inattentive to duty will secure greater and greater exemption from liability. Thus, the scope of the Bowerman rule would be small and would be constantly decreasing. Actually, as the decision below makes additionally clear, McCormick v. King, 9 Cir., 241 F. 737, losses for which Bowerman and other bank officers were held were in violation of the Act (now 12 U.S.C.A. 84); but that did not prevent an assessment of a liability more extensive than the statute against them. The principle is also made clear in the case against the directors of the National Bank of Kentucky. In Atherton v. Anderson, 6 Cir., 86 F.2d 518, the circuit court of appeals conceived itself limited to a consideration of losses due to statutory violations, not to common-law negligence, since the receiver had not appealed from a decree generally favorable to him. Hence it reversed the greater part of the recovery allowed below. But the Supreme Court held that the court should have considered the common-law grounds, 302 U.S. 643, 58 S. Ct. 53, 82 L. Ed. 500. Hence on rehearing the circuit court granted most of the recovery allowed below, finding common-law negligence both in cases specifically covered by statute and in cases not so covered. Atherton v. Anderson, 6 Cir., 99 F.2d 883. It should be noted that in that case, as well as in Federal Deposit Ins. Corp. v. Mason, supra, the directors' inattention to duty was not so gross as that of defendant here.

In the light of this trend towards increasing responsibility of bank fiduciaries, we do not think we are justified in holding that the statutes extend the area of protection accorded a director. It is true, as it is appropriate, that a director conscientiously carrying out the duties of his office cannot be held for statutory violations of which he neither has nor should have knowledge. There the statute is the only measure of responsibility. But where he has substantially abdicated the responsibilities of his office, then the common-law principle--which is in addition to the statutory rules--operates to make him liable for losses improperly incurred by his co-officers to whom he has abandoned the operation of the bank. In fixing those losses, there seems no reason why the statutory standards should not have their ordinary function in determining what are allowable and what are prohibited bank practices. We may say, in accordance with the usual rule, Restatement, Torts, §§ 285, 286, that a legislative enactment, made for the benefit of persons suffering loss, of a standard of due care is to be considered a controlling test of negligence. Or even if it is thought necessary to couch the result in terms of the qualification of the statutory remedy as interpreted by the Supreme Court cases cited above, we may conclude, at least as to the type of matters which we have before us in this case, that there is "in effect" an intentional violation of the appropriate requirements by a deliberate refusal to investigate that which was defendant's duty to investigate. On either rationale, defendant is to be held liable for the losses improperly incurred by his colleagues in the bank.

Each standard of liability still requires, however, a causal connection between the act interdicted and the loss. It is because of that requirement that we do not agree with the district court in holding defendant as an insurer by reason of the qualification of dummy directors. That there was a violation of statute seems clear. 12 U.S.C.A. § 72 requires every director of a bank such as this to "own in his own right" shares of the bank's capital stock of which the aggregate par value shall not be less than $1,000, and provides that a director ceasing to own the required shares "shall thereby vacate his place." To all intents and purposes, Penney-Gwinn was the substantial owner of the stock who had supplied the money and who took the risk of loss; indeed, Penney-Gwinn ultimately paid the assessment levied on these shares of stock. But that violation of itself does not show loss to the bank. It was not shown, for example, that irresponsible or untrustworthy men were placed on the Board and that they proceeded forthwith to loot the bank's exchequer. On the contrary, the evidence supports the conclusion that the directors were all known and esteemed business men. Conceivably there may arise cases where specific losses can be traced to a violation of this statute, but that is not the present case.

Stress is placed upon the word "thereby" in the statutory command that an unqualified director shall vacate his office. But the statute does not show a clear intent to declare the office vacant on the mere happening of the disqualifying condition; and the case of Briggs v. Spaulding, 141 U.S. 132, 152, 11 S. Ct. 924, 35 L. Ed. 662, 670, suggests the contrary in its careful examination of the effect of an oral resignation of a director who had surrendered his stock. See the same case below, Movius v. Lee, C.C.N.D.N.Y., 30 F. 298, 301. And even if automatic vacation of office should have resulted, or even if the number of directors fell below the statutory requirement of five, 12 U.S.C.A. § 71, it is not apparent why an insurer's liability would then result. The very lack of effective means of enforcing proper qualifications of directors may have been the reason for the passage in 1933 of provisions for the appointment of a receiver by the Comptroller of the Currency, 12 U.S.C.A. § 71a, and for removal of a director by the Board of Governors of the Federal Reserve System upon certification by the Comptroller of continuous violation of law. 12 U.S.C.A. § 77. Now at least means of control are adequate. At any rate, the violent remedy of holding directors as insurers of their bank's success for breaches of the requirements for their qualification which are not shown to have caused loss seems of the kind which would defeat its own purpose by making prudent and responsible men loath to accept directorates, to the community's loss in lack of men of caliber for these positions of trust. Cf. Yates v. Jones Nat. Bank, supra, 206 U.S. at page 179.

It may be added that if general liability were to be assessed because of this situation, it would be difficult to know where to begin and even more where to leave off in computing damage. If liability exists beyond that for the specific acts which we are about to examine, there would seem no stopping point short of complete responsibility for all disappointed expectations in the bank, even those of stockholders for at least principal, if not for profits. In this regard plaintiffs' actual contention is not overclear. Their most explicit statements are to be found in their respective notices of appeal, where they claim for violation of § 72 the "losses and damages sustained by the City National Bank in Miami and the amount of" the bank's obligations outstanding when it failed, with interest, but less liquidating dividends. The use of "and" here is confusing, for obviously they cannot expect to add together both all losses and all unpaid obligations. Probably "in" is meant, and the claim is intended to be for the amount, less stockholders' claims, for which the bank failed. But this, too, is an illogical stopping point, leaving possibly negligent losses unchallenged. Or if all losses are claimed, even on proper, but unfortunate, loans, then the bank would enjoy a guaranty so unusual that it would be immune from the normal losses which must come to even a well-run bank. It is significant that the district court in last analysis did not go as far as its first conclusion seemed to carry it. Actually it allowed recovery on this ground only for the losses it had otherwise found due upon a careful analysis of each specific claim. Indeed, except for plaintiffs' extreme claim, the issue tends to be academic; for we see no formula less than that which would cause us to change the conclusions we are reaching in all the specific matters brought before us on these appeals. And, we might add, this would still be true if the basis of the formula is stated in terms of an increased burden of proof upon defendant; the instances where we deny recovery are those where upon all the evidence we find the directors' actions not improper.

We therefore reject any claim for damage beyond that sustained in the specific matters we now discuss.

3. The City National Building Transactions. Liability is asserted against defendant on two counts in connection with City National Building, Inc.--one for alleged negligence in improvidently investing the bank's money in preferred stock of City National Building, Inc., the other for alleged negligence in unnecessarily paying City National Building, Inc., an excessive rent for the bank's premises. The two acts arise from the same set of transactions, as follows:

In 1925, Miami Bank and Trust Company, wishing to obtain its own banking premises, organized Miami Stockholders Company. It distributed the capital stock of the latter to its own stockholders and then proceeded to lend the company $450,000 to acquire the desired property, taking back a note of an equivalent amount, secured by a purchase-money mortgage on the property. The funds for a new building to be erected on the property were supplied by a bond issue of $650,000, secured by a first mortgage upon the entire property superior to the bank's purchase-money mortgage. The bank took a ten-year lease covering the ground floors in the new building at a rental of 36,000 per year. Pursuant to a provision in the lease that the lessor would rent to the bank additional space in the ten-story building, the bank also took possession of the second floor without, however, executing any new lease, agreement, or instrument in writing. It paid an annual rental of $17,000 for the space.

In June, 1926, City National Bank and Trust Company of Miami acquired the assets of the Miami Bank, succeeding both to the lease and to the second mortgage of $435,000. It also took over a note of Miami Stockholders for $120,250, secured by a second mortgage on property known as the Prince Edward Apartments.

When City National Bank and Trust Company of Miami merged with the City National Bank in Miami in February, 1928, the notes, the mortgages, and the lease again changed hands. At this time the first mortgage on the Prince Edward Apartments had been foreclosed, and the interest of the second mortgagee wiped out. The second mortgage on the bank premises was also in default; and in March, 1928, City National Bank began a foreclosure proceeding. This was not pressed, however, but by agreement which became effective by May 8, 1928, City National Building, Inc., was organized with 13,000 shares of $100 par value preferred stock and with 100 shares of common stock, 51 per cent of which was distributed to City National Bank, and 49 per cent to Miami Stockholders. Miami Stockholders transferred its equity in the bank premises to City National Building, Inc., and City National Bank exchanged the notes and mortgages which it held against Miami Stockholders for an equivalent par value of preferred stock. Thus far City National Bank had lost nothing. Stock of doubtful or no value had been merely substituted for notes of like value.

But underlying these financial manipulations was the assumption that City National Bank should itself pay off the first mortgage on the bank premises, taking in satisfaction additional preferred stock of City National Building, Inc. At this time, $647,000 was still owed on the mortgage, $77,000 being due immediately. Accordingly, at the outset, the bank paid $77,000 to the trustee of the mortgage and subsequently, until it failed, paid $108,000 more on the mortgage and $58,000 for another new building--a grand total of $243,000--in satisfaction of which preferred stock at par was received. There has been a recoupment upon this stock of only $17,320.30. A loss of $225,679.70 was thus incurred.

In addition, City National Bank, after taking over the banking headquarters of City National Bank and Trust Company, continued to pay the annual rental of $53,000 which the Miami Bank first undertook to pay, and which City National Bank and Trust Company had assumed to pay under its assignment of the lease. This occurred notwithstanding the fact that both Miami Stockholders and the directors of City National Bank had contemplated, and urged upon the Comptroller of the Currency as a basis for his approval of this project, that the bank through its stock control of City National Building, Inc., would cancel the old lease and execute another at a fair annual rental of $20,000. Thus, the bank paid an excessive rent of $33,000 per year throughout its life, sustaining a loss of $88,000.04.

The master and the district court agreed that the directors, including defendant, were negligent in that they acquired title to the bank premises through City National Building, Inc., without obtaining an appraisal of the property and upon the assumption that its value was still the equivalent of its cost at the height of the Florida real estate boom. The district court found that "an honest appraisal obtained at the time would have shown the building worth much less than the principal amount of the first mortgage," also that "had a competent examining committee appointed as provided by the by-laws and as directed by the National Bank Examiner properly functioned, such a committee, in evaluating the assets of the bank, would have found that the property, free and clear of all encumbrances, was not worth more than $400,000." And the master agreed that $400,000 was the fair market value of the land and bank building in May, 1928.

Some of the directors holding office at the time testified that they judged the property was worth upward of a million dollars; but it appeared that in many cases these estimates were based not on what the directors thought the building would be worth on the market, but on what they felt it was worth to the bank. But a finding of the master, in which the district court concurred, rejected any good-will value: "The bank had occupied its then quarters less than two years. The Flagler Street end of the building was by all accounts ramshackle and a wooden fire-trap. The failure of banks in the neighboring business section made other sites available. It is impossible to believe that the bank would have sustained any loss of goodwill in moving to one of them." Furthermore, it appeared that, while some of the directors questioned the acquisition of the property on the ground that "it would not pay," no disinterested appraisal was ever sought. The directors blindly voted to expend $647,000 to take over a first mortgage on property fairly appraised at little more than $400,000.

The master nevertheless held that the directors incurred no liability for this action because, while their failure to investigate was undoubtedly negligent, even had they investigated they might reasonably have foreseen no harm to the bank from the acquisition. He reasoned that the bank was liable on the original lease to pay an annual rental of $53,000 for the balance of its term--some seven and one-half years--and that this was $33,000 more than a fair annual rental for the property. By adding the total excessive rent of $247,000, which would have to be paid over the balance of the lease term, to the fair market value of the building, based on a fair economic rent, the property could be accorded a value of $647,000.

This rationale can only be made applicable, however, by a process of oversimplification whereby the intervening landlord-mortgagor drops out, and the bank in effect buys for $647,000 the building and the burdensome lease against it, which it is further assumed the first mortgagee can enforce. Clearly as to the financially irresponsible Miami Stockholders the rationale will not suffice. It owed the bank a total of overdue indebtedness of $555,250--$435,000 secured by the second mortgage on the bank building, and $120,250 secured by the second mortgage already determined to be worthless on the Prince Edward Apartments. Faced with this overwhelming claim, it was practically in no position to oppose the bank's demand for a new lease at a reasonable rental which would eliminate the abnormal increment of value attributed to the property. The bank could have foreclosed this interest, as it had already started to do, or use it otherwise to secure appropriate adjustments. True, Miami Stockholders ...

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.