DUTIES OF DIRECTORS AND CONTROLLING STOCKHOLDERS

DUTY OF DILIGENCE: BUSINESS JUDGEMENTS RULE

61 F. Supp. 905 (E.D. Pa. 1945) - Otis & Co. v. Pennsylvania R. Co.
KALODNER, District Judge
SUMMARY
Petitioner Otis & Co. ("Otis") is a stockholder of respondent Pennsylvania Railroad Co. ("PRR"). PRR thought that it would
be a good idea to refinance its current outstanding bonds (Series A bonds) through selling new bonds, the Series D bonds,
at the best obtainable price. Due to this, Otis brought a derivative suit against PRR, seeking to hold liable PRR's officers and
directors as well as to hold liable the officers and directors of Pennsylvania, Ohio and Detroit Railroad Co. ("POD"), a wholly-
owned subsidiary of PRR.

Otis claims that the companies and its directors failed and refused to exercise ordinary care and judgement in the sale of the
Series D bonds as PRR and POD kept secret the bond issue and refused to deal with any investment house other than
Kuhn, Loeb & Co. ("KLC"). Otis claims that the companies should have opened the bond issue to other players through
competitive bidding and alleged that some directors could have been influenced by their positions (also as directors) in
several institutions which had agreements with KLC.

The District Court here held that using the "business judgement rule" ("BJR") it is clear that the officers and directors of PRR
and POD acted honestly and in good faith and merely exercised their judgement for the best interests of the railroads. There
is no requirement under the law that they are to subject the issue of the bonds to competitive bidding. Not doing so is well
within their discretion and they had the right to negotiate privately with KLC, a firm which they had the confidence of years of
satisfactory banking relations which was well acquainted with their financial situation.

DOCTRINE
Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge the duties of
their respective positions in good faith and with that diligence, care and skill which ordinarily prudent men would exercise
under similar circumstances in their personal business affairs.

the courts say that they will not interfere in matters of business judgment, it is presupposed that reasonable diligence has
in fact been exercised. A director cannot close his eyes to what is going on about him in the conduct of the business of the
corporation and have it said that he is exercising business judgment. Courts have properly decided to give directors a wide
latitude in the management of the affairs of a corporation provided always that judgment, and that means an honest,
unbiased judgment, is reasonably exercised by them. (Business Judgement Rule)

What constitutes negligence depends upon the circumstances of the case. xxx negligence must be determined as of
the time of the transaction. xxx mistakes or errors in the exercise of honest business judgment do not subject the officers
and directors to liability for negligence in the discharge of their appointed duties. The directors are entrusted with the
management of the affairs of the railroad. If in the course of management they arrive at a decision for which there is a
reasonable basis, and they acted in good faith, as the result of their independent judgment, and uninfluenced by any
consideration other than what they honestly believe to be for the best interests of the railroad, it is not the function of the
court to say that it would have acted differently and to charge the directors for any loss or expenditures incurred

FACTS
1. Petitioner Otis & Co. ("Otis") is a stockholder in the Pennsylvania Railroad Co. ("PRR") while Pennsylvania, Ohio and
Detroit Railroad Co. ("POD") is a wholly-owned subsidiary of PRR.
2. PRR directly or indirectly owns the capital stock of POD. In 1943, POD had an outstanding total of $28,483,000 "Series
A" bonds which were to mature in 1977, with an interest rate of 4.5% payable semi-annually.
3. The president of PRR, Mr. Clement, together with Mr. Pabst, VP of Finance for PRR and president of POD. had been
considering the possibility of refinancing i the Series A bonds.
4. In the latter part of 1943, the bond market became favorable for refinancing, hence Clement directed Pabst to contact
Kuhn Loeb & Co. ("KLC") to determine whether they could sell a price less than par and whether their idea of
refinancing was sound.
5. On the following day, the directors of POD adopted a resolution authorizing the sale of new "Series D" bonds at the
best obtainable price, and sold the same to KLC subject to the approval of the Interstate Commerce Commission
("ICC").
6. The Series D bonds, other than having a lower interest rate (3.75%), also had a sinking fund provision which made
them callable at $103 + accrued interest.
7. However, before the contract of sale of KLC was executed, Mr. Claflin, representing Halsey, Stuart & Co. Inc. ("HSC")
visited Pabst, trying to find out whether there would indeed be a refinancing of the Series A bonds but Pabst declined to
give any info, and even said that he did not think that HSC is likely to have an opportunity to bid if ever they was going
to be a refunding.
8. HSC, together with Otis sent telegrams to Clement and the other PRR directors requesting for an opportunity to submit
a competitive bid for the Series A bonds. Clement eventually answered and advised the latter that the "railroad has
transacted business in a very satisfactory way" and that they considered what was the "best interest of the railroad."
9. PRR and POD applied for the approval of the Series D bonds with the ICC. Otis was then granted leave to intervene in
this application but HSC was not.
a. Otis contends that under the circumstances, competitive bidding should be imperative and that application
should be denied since savings would be greater if a higher price would have been received for the bonds.
b. Also, the failure of PRR to consult with more than one banker (a failure to "shop around") was a disservice to
the stockholders.
10. Though a majority of the ICC Commissioners were convinced that PRR and POD did NOT receive the best possible
price for the bonds, they still held that competitive bidding was NOT appropriate.
11. The ICC also found that the KLC transaction was an "arms-length dealing" and the offers submitted by HSC, a rival
investment company, did not have adequate consideration.
12. Hence due to the debt reduction (according to the ICC report, the refinancing would result in a net saving of
$7,584,664.70 plus a tax saving of $1,500,000) that will be achieved in the proposition of PRR and POD, the ICC
approved their application.
13. Hence, Otis filed a complaint with the Pennsylvania District Court.

ISSUE with HOLDING

1. WON defendants failed and refused to exercise ordinary care and judgement in the Series D bonds sale. – NO. Such
is well within their business judgement.
a. Since the allegations of the complaint deal solely with the internal affairs of the two corporations, the liability of
the respective officers and directors must be determined under the corporation laws of the states wherein the
associations were organized.
b. Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge
the duties of their respective positions in good faith and with that diligence, care and skill which ordinarily
prudent men would exercise under similar circumstances in their personal business affairs.
c. The question is frequently asked, how does the operation of the so-called `business judgment rule' tie in with
the concept of negligence?
i. There is no conflict between the two. When the courts say that they will not interfere in matters of
business judgment, it is presupposed that judgment reasonable diligence has in fact been exercised.
ii. A director cannot close his eyes to what is going on about him in the conduct of the business of the
corporation and have it said that he is exercising business judgment. Courts have properly
decided to give directors a wide latitude in the management of the affairs of a corporation
provided always that judgment, and that means an honest, unbiased judgment, is reasonably
exercised by them
d. Negligence depends upon the circumstances of the case, South Penn Collieries v. Sproul, supra; that the
court will not interfere with the internal management of corporations, and therefore will not substitute its
judgment for that of the officers and directors, Bowman v. Gum, Inc., 1937, 327 Pa. 403, 193 A. 271; and,
what is a rule of reason, that negligence must be determined as of the time of the transaction. It is also clearly
established that mistakes or errors in the exercise of honest business judgment do not subject the officers and
directors to liability for negligence in the discharge of their appointed duties.
e. There can be no doubt that the officers and directors of both PRR and POD. acted honestly, in good faith, and
sought to exercise their judgment for the best interests of the respective railroads. There is no contention here
that fraud was present; indeed, the allegations in the complaint contain only a faint suggestion of bad faith,
calling to the attention of the court that the officers and directors were influenced because of their position as
directors or officers of several companies which had made purchase and sale agreements with KLC.
f. It was the duty of the officers, in the course of business, to be on the alert for an opportunity for refunding an
outstanding bond obligation in a manner which would result in a saving to their business, and there is no
question that the management of the defendant corporations did seize an opportune time for the refunding
operation.
i. Clement, the president, and Pabst, the vice president in charge of finance and corporate relations,
were obviously well acquainted with the finances of the railroad.
g. The mere fact that the parties did not do competitive bidding does not, of itself, afford a basis of liability.
i. The defendants unquestionably had the right to negotiate privately with KLC. Although there is no
charge of bad faith, or conspiracy, it seems clear that in choosing that firm, the defendants were
following another custom in railroad history.
ii. KLC has long been "the" banking house to PRR In dealing with KLC the defendants were dealing
with a firm in which they had the confidence of years of satisfactory banking relations and which
was well acquainted with their financial situation, structure and requirements.
iii. Although the Commission felt no special advice was necessary, the record of the Commission's
proceedings reveals that from time to time KLC did advise the railroad company as to their estimate
of the market, what it might absorb, the trend, and the terms of bonds and similar matters.
iv. Failure to foresee what at best is uncertain does not constitute negligence or mismanagement: what
the market would absorb and the terms and conditions that would meet with greatest success were,
at the time the issue involved here was planned, at most a matter of judgment.
v. If the defendants used their honest business judgment, as I am convinced they did, they cannot be
liable for failing to accurately foretell the welcome the market would give their efforts. I am of the
opinion no more was required of the individual defendants.
DISPOSITIVE PORTION
The various directors were aware of the proposed transaction and its course of conduct; copies of telegrams and letters from
Halsey, Stuart & Co., and Otis & Co. were sent to them; in any event they had a right to rely on the information supplied by,
and the good faith judgment of, those in whose hands the conduct of the everyday affairs of the corporation was placed.

For the reasons stated, the defendants' motion for summary judgment is granted.

OTHER NOTES
Please note that I did not include any procedural issues anymore since Sir seems agitated whenever people discuss
procedural issues. Suffice to say that:

This is a proper case for summary judgement since there is no substantial conflict concerning the evidentiary facts, but
only as to the inferences to be drawn therefrom, this is a proper case for summary judgment.

Requirements for "business judgement rule" to free the directors of any liability for any loss or expenditures incurred
resulting from the decision (1) Decision made must have a reasonable basis;(2) Directors must have acted in good faith, i.e.
(a) Decision made must be the result of the directors’ independent judgment; and (b) Decision made must be uninfluenced
by any consideration other than what the directors honestly believed to be for the best interests of the company.

i
Process of retiring or redeeming an outstanding bond issue at maturity by using the proceeds from a new debt issue. The new issue is almost always
issued at a lower rate of interest than the refunded one, to ensure significant reduction in interest expense for the issuer (Investopedia).

ULTRA VIRES DOCTRINE (SEC. 45); TYPES; BASIS; BUSINESS

JUDGEMENT RULE; DOCTRINE OF APPARENT AUTHORITY

MONTELIBANO ET AL vs.BACOLOD-MURCIA MILLING CO., INC.

G.R. No. L-15092

May 18, 1962

FACTS: Montelibano et al. are sugar planters adhered to the Bacolod-Murcia

Milling Co., Inc’s sugar central mill under identical milling contracts originally
executed in 1919. In 1936, it was proposed to execute amended milling contracts,
increasing the planters’ share of the manufactured sugar, besides other concessions.
To this effect, a printed Amended Milling Contract form was drawn up.
The Board of Directors of Bacolod-Murcia Milling Co., Inc. adopted
a resolution granting further concessions to the planters over and above those
contained in the printed Amended Milling Contract on August 10, 1936.
The printed Amended Milling Contract was signed by the Appellants on September
10, 1936, but a copy of the resolution was not attached to the printed contract until
April 17, 1937.
In 1953, the appellants initiated an action, contending that 3 Negros sugar centrals had
already granted increased participation to their planters, and that under paragraph 9 of
the resolution of August 20, 1936, the appellee had become obligated to grant similar
concessions to the appellants herein.
The Bacolod-Murcia Milling Co., inc., resisted the claim, urging that the resolution in
question was null and void ab initio, being in effect a donation that was ultra
vires and beyond the powers of the corporate directors to adopt.
ISSUE: Was the act of the BOD ultra vires?
HELD: NO (The Bacolod-Murcia Milling Co., Inc. is ordered to pay appellants the
increase of participation in the milled sugar in accordance with paragraph 9 of the
Resolution of August 20, 1936.)
As the resolution in question was passed in good faith by the board of directors, it is
valid and binding, and whether or not it will cause losses or decrease the profits of the
central, the court has no authority to review them.
Xx It is a well-known rule of law that questions of policy or of management are left
solely to the honest decision of officers and directors of a corporation, and the court is
without authority to substitute its judgment of the board of directors; the board is the
business manager of the corporation, and so long as it acts in good faith its orders are
not reviewable by the courts.
__
It must be remembered that the controverted resolution was adopted by appellee
corporation as a supplement to, or further amendment of, the proposed milling
contract, and that it was approved on August 20, 1936, twenty-one days prior to the
signing by appellants on September 10, of the Amended Milling Contract itself; so
that when the Milling Contract was executed, the concessions granted by the disputed
resolution had been already incorporated into its terms.
Montelibano vs Bacolod-Murcia Milling (1962)

February 14, 2013 markerwins Corporation Law, Mercantile Lawcorpo, merc

Facts: Plaintiffs-appellants, Alfredo Montelibano, Alejandro

Montelibano, and the Limited co-partnership Gonzaga and Company,
had been and are sugar planters adhered to the defendant-appellee’s
sugar central mill under identical milling contracts. Originally
executed in 1919, said contracts were stipulated to be in force for 30
years starting with the 1920-21 crop, and provided that the resulting
product should be divided in the ratio of 45% for the mill and 55% for
the planters. Sometime in 1936, it was proposed to execute amended
milling contracts, increasing the planters’ share to 60% of the
manufactured sugar and resulting molasses, besides other
concessions, but extending the operation of the milling contract from
the original 30 years to 45 years. The Board of Directors of the
appellee Bacolod-Murcia Milling Co., Inc., adopted a resolution
granting further concessions to the planters over and above those
contained in the printed Amended Milling Contract. The appellants
initiated the present action, contending that three Negros sugar
centrals with a total annual production exceeding one-third of the
production of all the sugar central mills in the province, had already
granted increased participation (of 62.5%)to their planters, and that
under the resolution the appellee had become obligated to grant
similar concessions to the plaintiffs. The appellee Bacolod-Murcia
Milling Co., inc., resisted the claim, and defended by urging that the
stipulations contained in the resolution were made without
consideration; that the resolution in question was, therefore, null and
void ab initio, being in effect a donation that was ultra vires and
beyond the powers of the corporate directors to adopt.
Issue: WON the board resolution is an ultra vires act and in effect a
donation from the board of directors?
Held: No. There can be no doubt that the directors of the appellee
company had authority to modify the proposed terms of the Amended
Milling Contract for the purpose of making its terms more acceptable
to the other contracting parties. As the resolution in question was
passed in good faith by the board of directors, it is valid and binding,
and whether or not it will cause losses or decrease the profits of the
central, the court has no authority to review them. Whether the
business of a corporation should be operated at a loss during
depression, or close down at a smaller loss, is a purely business and
economic problem to be determined by the directors of the
corporation and not by the court. The appellee Bacolod-Murcia Milling
Company is, under the terms of its Resolution of August 20, 1936,
duty bound to grant similar increases to plaintiffs-appellants herein.
Philippine Stock Exchange Inc. vs Court of Appeals
281 SCRA 232 [GR No. 125469 October 27, 1997]

Facts: The Puerto Azul Land Inc. (PALI), a domestic real estate corporation, had sought to offer its shares to the
public in order to raise funds allegedly to develop its properties and pay its loans with several banking institutions.
In January, 1995, PALI was issued a permit to sell its shares to the public by the Securities and Exchange
Commission (SEC). To facilitate the trading of its shares among investors, PALI sought to course the trading of its
shares through the Philippine Stock Exchange Inc. (PSEi), for which purpose it filed with the said stock exchange an
application to list its shares, with supporting documents attached pending the approval of the PALI’s listing
application, a letter was received by PSE from the heirs of Ferdinand Marcos to which the latter claims to be the
legal and beneficial owner of some of the properties forming part of PALI’s assets. As a result, PSE denied PALI’s
application which caused the latter to file a complaint before the SEC. The SEC issued an order to PSE to grant
listing application of PALI on the ground that PALI have certificate of title over its assets and properties and that
PALI have complied with all the requirements to enlist with PSE.

Issue: Whether or not the denial of PALI’s application is proper.

Held: Yes. This is in accord with the “Business Judgement Rule” whereby the SEC and the courts are barred from
intruding into business judgements of corporations, when the same are made in good faith. The same rule precludes
the reversal of the decision of the PSE, to which PALI had previously agreed to comply, the PSE retains the
discretion to accept of reject applications for listing. Thus, even if an issuer has complied with the PSE listing rules
and requirements, PSE retains the discretion to accept or reject the issuer’s listing application if the PSE determines
that the listing shall not serve the interests of the investing public.

It is undeniable that the petitioner PSE is not an ordinary corporation, in that although it is clothed with the markings
of a corporate entity, it functions as the primary channel through which the vessels of capital trade ply. The PSEi’s
relevance to the continued operation and filtration of the securities transaction in the country gives it a distinct color
of importance such that government intervention in its affairs becomes justified, if not necessarily. Indeed, as the
only operational stock exchange in the country today, the PSE enjoys monopoly of securities transactions, and as
such it yields a monopoly of securities transactions, and as such, it yields an immerse influence upon the country’s
economy.

The SEC’s power to look into the subject ruling of the PSE, therefore, may be implied from or be considered as
necessary or incidental to the carrying out of the SEC’s express power to insure fair dealing in securities traded upon
a stock exchange or to ensure the fair administration of such exchange. It is likewise, observed that the principal
function of the SEC is the supervision and control over corporations, partnerships and associations with the end in
view that investment in these entities may be encouraged and protected and their activities for the promotion of
economic development.

A corporation is but an association of individuals, allowed to transact under an assumed corporate name, and with a
distinct legal personality. In organizing itself as a collective body, it waives no constitutional immunities and
requisites appropriate to such a body as to its corporate and management decisions, therefore, the state will generally
not interfere with the same. Questions of policy and management are left to the honest decision of the officers and
directors of a corporation, and the courts are without authority to substitute their judgements for the judgement of
the board of directors. The board is the business manager of the corporation and so long as it acts in good faith, its
orders are not reviewable by the courts.

In matters of application for listing in the market the SEC may exercise such power only if the PSE’s judgement is
attended by bad faith.

The petitioner was in the right when it refused application of PALI, for a contrary ruling was not to the best interest
of the general public.

Citation. Litwin v. Allen, 25 N.Y.S.2d 667, 1940 N.Y. Misc. LEXIS 2596 (N.Y. Sup. Ct.
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.

Is a director liable for loss or damage other than what was 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
corporation’s 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 director’s 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.

Citation. Litwin v. Allen, 25 N.Y.S.2d 667, 1940 N.Y. Misc. LEXIS 2596 (N.Y. Sup. Ct.
1940)

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.

WALKER VS. MAN, ET. AL. (253 N.Y.S. 458; 1931)

FACTS: Frederick Southack and Alwyn Ball loaned Avram $20T evidenced by a promissory note
executed by Avram and endorsed by Lacey. The loan was not authorized by any meeting of the board of
directors and was not for the benefit of the corporation. The note was dishonored but defendant-directors
did not protest the note for non-payment; thus, Lacey, the indorser who was financially capable of
meeting the obligation, was subsequently discharged.

HELD: Directors are charged not with misfeasance, but with non-feasance, not only with doing
wrongful acts and committing waste, but with acquiescing and confirming the wrong doing of others, and
with doing nothing to retrieve the waste. Directors have the duty to attempt to prevent wrongdoing by
their co-directors, and if wrong is committed, to rectify it. If the defendant knew that an unauthorized loan
was made and did not take steps to salvage the loan, he is chargeable with negligence and is
accountable for his conduct.
Steinberg v. Velasco, 52 Phil. 953 [1929]

FACTS:

Plaintiff is the receiver of the Sibuguey Trading Company, a domestic corporation. The
defendants are residents of the Philippine Islands and
Sibuguey Trading Company Inc. had an authorized capital stock of P20,000 divided into 2,000
shares of the par value of P10 each, which only P10,030 was subscribed and paid. Ganzon and
Mendaros are directors of the corporation.
During the meeting of the Board of Directors of said corporation, knowing very well of the face
value of the corporation previously stated, the defendants Ganzon along with other officers of the board
passed a resolution authorizing the purchase by the corporation of large portion of its own capital stock in
the total amount of P3,300 for 330 shares, par value at P10 each. at the time the purchase was made, the
corporation was indebted in the sum of P13,807.50, and that according to its books, it had accounts
receivable in the sum of P19,126.02.
On September 11, 1923, when the petition was filed for its dissolution upon the ground that it was
insolvent, its accounts payable amounted to P9,241.19, and its accounts receivable P12,512.47, or an
apparent asset of P3,271.28 surplus over its liabilities. Seeing this as profits, the board approved the
distribution of its dividends in the amount of P3,000. However, the payment of such dividends shall be in
installment, so that, according to the Board, the financial standing of the corporation may not be impaired.
All of this acts, as alleged by plaintiff, is to the detriment and prejudice of corporation’s creditors.

ISSUE:

Whether or not the defendant-officers of the corporation acted in grossly negligent.

HELD:

The officers acted negligently and are liable. The court cited the following:
 “Upon each of those points, the rule is well stated in Ruling Case Law, vol. 7, p. 473, section 454
where it is said:

General Duty to Exercise Reasonable Care. — The directors of a corporation are bound
to care for its property and manage its affairs in good faith, and for a violation of these duties
resulting in waste of its assets or injury to the property they are liable to account the same as
other trustees. Are there can be no doubt that if they do acts clearly beyond their power, whereby
loss ensues to the corporation, or dispose of its property or pay away its money without authority,
they will be required to make good the loss out of their private estates. This is the rule where the
disposition made of money or property of the corporation is one either not within the lawful power
of the corporation, or, if within the authority of the particular officer or officers.

And section 458 which says:

Want of Knowledge, Skill, or Competency. — It has been said that directors are not liable
for losses resulting to the corporation from want of knowledge on their part; or for mistake of
judgment, provided they were honest, and provided they are fairly within the scope of the powers
and discretion confided to the managing body. But the acceptance of the office of a director of a
corporation implies a competent knowledge of the duties assumed, and directors cannot excuse
imprudence on the ground of their ignorance or inexperience; and if they commit an error of
judgment through mere recklessness or want of ordinary prudence or skill, they may be held
liable for the consequences. Like a mandatory, to whom he has been likened, a director is bound
not only to exercise proper care and diligence, but ordinary skill and judgment. As he is bound to
exercise ordinary skill and judgment, he cannot set up that he did not possess them.”

The court held that if in truth and in fact the corporation had an actual bona fide surplus of P3,000
over and above all of its debt and liabilities, the payment of the P3,000 in dividends would not in the least
impair the financial condition of the corporation or prejudice the interests of its creditors.

It is very apparent that on June 24, 1922, the board of directors acted on assumption that,
because it appeared from the books of the corporation that it had accounts receivable of the face value of
P19,126.02, therefore it had a surplus over and above its debts and liabilities. But as stated there is no
stipulation as to the actual cash value of those accounts, and it does appear from the stipulation that on
February 28, 1924, P12,512.47 of those accounts had but little, if any, value, and it must be conceded
that, in the purchase of its own stock to the amount of P3,300 and in declaring the dividends to the
amount of P3,000, the real assets of the corporation were diminished P6,300. It also appears from
paragraph 4 of the stipulation that the corporation had a "surplus profit" of P3,314.72 only. It is further
stipulated that the dividends should "be made in installments so as not to effect financial condition of the
corporation." In other words, that the corporation did not then have an actual bona fide surplus from which
the dividends could be paid, and that the payment of them in full at the time would "affect the financial
condition of the corporation."

It is, indeed, peculiar that the action of the board in purchasing the stock from the corporation and
in declaring the dividends on the stock was all done at the same meeting of the board of directors, and it
appears in those minutes that the both Ganzon and Mendaros were formerly directors and resigned
before the board approved the purchase and declared the dividends, and that out of the whole 330
shares purchased, Ganzon, sold 100 and Mendaros 200, or a total of 300 shares out of the 330, which
 were purchased by the corporation, and for which it paid P3,300. In other words, that the directors were
permitted to resign so that they could sell their stock to the corporation. As stated, the authorized capital
stock was P20,000 divided into 2,000 shares of the par value of P10 each, which only P10,030 was
subscribed and paid. Deducting the P3,300 paid for the purchase of the stock, there would be left P7,000
of paid up stock, from which deduct P3,000 paid in dividends, there would be left P4,000 only. In this
situation and upon this state of facts, it is very apparent that the directors did not act in good faith or that
they were grossly ignorant of their duties.

Creditors of a corporation have the right to assume that so long as there are outstanding debts
and liabilities, the board of directors will not use the assets of the corporation to purchase its own stock,
and that it will not declare dividends to stockholders when the corporation is insolvent.

The judgment of the lower court is reversed (in favor of plaintiff).

Barnes, Plaintiff AUTHOR: BONDOC

v.
Andrews, Defendant

TOPIC: Duty of Diligence: Business judgment rule

PONENTE: Street J.
FACTS:

Earl Barnes, as a receiver of the Liberty Starter Corporation filed a suit against Charles Lee Andrews.

Liberty Starter Corporation was organized under the laws of New York to manufacture starters for Ford motors and aeroplanes. On October 9, 1919, a year after its organization, defendant took offices as a
director, and served until he resigned on June 21, 1920. During that period over $500,000 was raised by sale of stocks of company. Officers and employees were hired and a factory was already erected when
defendant Andrews took office. Starter parts were made, but delays were experienced in its production as a “whole”, and the the funds of the company were depleted by running charges.

During the incumbency of defendant, there had been only 2 meetings of directors, one defendant Andrews was able to attend, but the other he was forced to be absent due to his mother’s death. Also,
defendant was a friend of the President, who induced him as the largest stockholder to be come a director, and his only attention to the affairs of the company consisted of talks with the president.

After defendant resigned, the company continued its business. However, when plaintiff was appointed as receiver he found the company without funds, and realized only a small amount in sale if its assets.

The theory of the bill (in equity) was that defendant failed to give adequate attention to the affairs of the company, which was conducted incompetently and without regard to the waste of salaries during the
period, before the production. That this period was prolonged by the incompetence of the factory manager, and disagreement between defendant and the engineer. More money was paid in the engineer
that his contract, and money was spend upon fraudulent circulars to induce the purchase of stocks.
ISSUE(S):

WON defendant Andrews may be held liable for misprision of office

HELD: Yes.

RATIO:

Defendant cannot be charged with neglect in attending the director’s meeting because there are only 2 meeting and one of which he was able to attend. His liability only depends upon his failure to keep
advised of the conduct of the corporate affairs.

Directors must give reasonable attention to the corporate business. Directors have individual duty to keep themselves informed and it is this duty which the defendant failed to perform.

All defendant did was to talk to Maynard (President) as they met. But he did not press him for details as he should. Andrews was bound to inform himself of what was going on with the company; and if he had
done so he would have learned that there were delays in the production which put the company in serious peril. Having accepted a post of confidence, he was charged with duty to learn whether the compan
was moving to production, and why it was not, and to consider what could be done to avoid conflicts among the personnel or their incompetence.

However, SC said that Andrews cannot be blame for the collapse of the company. Defendant is not subject to the burden of proving that the collapse would have happened, whether he has done his duty or
not. Because no man would take an office, if the law imposed upon them the guarantee of the success of their company. Plaintiff Barnes must show that, had Andrewes done his duty he could have made the
company prosper, or at least could have prevented its fall. Plaintiff must show what sum could have save the company. But this plaintiff failed to do.

Hence, considering that there is no evidence that defendant’s neglect caused any losses to the company, and that if there were, the loss cannot be ascertained. Defendant Andrew is not liable for the fall of
the company.

The bill is dismissed, without cost.

CASE LAW/ DOCTRINE:

Directors must give reasonable attention to the corporate business. Directors have individual duty to keep themselves informed and it is this duty which the defendant failed to perform.
DISSENTING/CONCURRING OPINION(S):

Pool v. Pool, 22 So. 2d 131

This case was remanded by us on the former appeal to enable plaintiff to amend his petition so as to show certain
facts which he claimed to have in his possession. The nature of the suit was set out in our former opinion. Without
again restating the allegations made in the original petition or setting out in detail the allegations made by plaintiff in
his supplemental petition filed after the case was remanded, it is sufficient to say that he claims to recover from the
three defendants the surtax which he was compelled to pay as his pro rata part of the surtax assessed against the S.
D. Pool Realty Company by the Federal Government on account of the failure of the corporation to distribute its
earnings for 1938 before the end of that year. The allegations of his petitions may be summarized as follows:
The said Pool Company was a holding corporation consisting of plaintiff and his brother, S.D. Pool, together with his
three sisters, Mrs. Farrell, Mrs. D'Aquin and Mrs. Jarreau, each owning 20 per cent of the stock of the Company; the
three defendants, Stephen D. Pool, Mrs. Farrell and Mrs. D'Aquin, as directors and officers of the corporation, were
guilty of negligence, ineptness and deceit, and conspired to oust plaintiff and his sister, Mrs. Jarreau, and take control
of the corporation for their own advantage; because of the various acts on the part of said S.D. Pool, concurred in by
the other two defendants, the dividends due the said corporation by the Times Picayune Publishing Company during
the year 1938, amounting to the sum of $4200, were not received and distributed during that year, by reason of which
the corporation was assessed with and required to pay a surtax on its undistributed profits for that year under the
Revenue Act of 1938, 26 U.S.C.A. Int.Rev.Acts, p. 1001 et seq., which assessment was made against the
stockholders after the liquidation of the corporation, and plaintiff, as a stockholder, was forced to pay his pro rata part
of said tax, which amount so paid by him he now seeks to recover from the three defendants.
In their answer the defendants admit that each of the stockholders of the Pool Company was required to pay a surtax
for the corporation because of the failure to distribute the earnings of the Company in 1938, but they deny that they
were guilty of any negligence or wrong doing which caused this tax to be assessed against the stockholders of the
Company. They allege that plaintiff was a director and secretary of the corporation in 1938, and his acts caused the
Times Picayune to withhold the dividends during 1938, and the various letters written by plaintiff and by S.D. Pool to
the Times Picayune are referred to in the answer, as well as the letters from the Times Picayune and its attorneys
giving its reason for withholding the dividends. They admit that they were directors of the corporation in January,
1939, and so advised the Times Picayune, and asked for and received the dividends due the Company in January,
1939. They allege that they employed a certified public accountant and an attorney to handle the tax matters and the
legal affairs of the Company and took their advice and acted in good faith in all matters pertaining to the affairs of the
corporation.
The trial judge dismissed plaintiff's suit, and he has appealed.
The acts of the defendants on which the plaintiff seeks to hold them liable for the surtax which he had to pay as a
stockholder of the Pool corporation may be divided into what was done in 1938 and what was done or not done by
them after they were elected directors in January, 1939.
The charter of the corporation provided for the election of a board of three directors in January of each year. At the
stockholders meeting in January, 1938, at which it appears all the stockholders were present, all five of the
stockholders were elected as directors, notwithstanding the charter provided for only three directors. Plaintiff was
elected secretary of the corporation. Soon after this meeting, it seems that friction arose among the stockholders,
particularly between plaintiff and his brother, S.D. Pool.
The domicile of the corporation was fixed in the charter at 2341 Esplanade Avenue, New Orleans, which seems to
have been the home of the parents of the stockholders. Some time in the early part of 1938, Robert E. Pool
suggested that the business of the corporation be transacted by him as secretary at his home in Ventress, Louisiana,
but the three defendants, in a letter addressed to plaintiff on February 15, 1938, objected to the books of the
corporation being carried to Ventress, and insisted that these books be kept and all business of the corporation be
transacted at its domicile in New Orleans. Shortly after this controversy arose, plaintiff demanded that S.D. Pool
resign as vice president and director of the corporation, which the latter refused to do.
On April 16, 1938, plaintiff, in his capacity as secretary of the S. D. Pool Realty Company, wrote the Times Picayune
requesting that it send all future dividends, reports, notices, etc. to him as secretary of the corporation at Ventress,
Louisiana, to which the Times Picayune replied that the domicile of the corporation was at 2341 Esplanade Avenue,
New Orleans, and "under the law we are obliged to send communications to that address". On June 22, 1938, S.D.
Pool, acting in his capacity as vice president and acting president, wrote the Times Picayune to ignore the request of
plaintiff as secretary to have all notices, etc., sent to his address at Ventress, as his action was not authorized by the
board of directors, and requested that all communications to the Company be sent to the address of its domicile. On
June 30, 1938, the attorneys for the Times Picayune, to whom the matter had been referred, wrote to plaintiff that, in
view of the dispute between plaintiff and his brother, the Times Picayune was advised to hold the check representing
the dividend payable July 1st and not to deliver same until the matter had been settled between the parties or by
judgment of court.
Matters rocked along in this unsettled state with the controversy continued and the dividend checks still held up by
the Times Picayune when, on December 9, 1938, S.D. Pool, acting as vice president, sent a notice to plaintiff to be
present at the annual stockholders meeting to be held at the domicile of the Company on January 3, 1939. And on
December 30, 1938, S.D. Pool, as vice president, wrote the Times Picayune the letter which we quoted in our former
opinion, referring to the conflicting instructions given in regard to the address to which the dividends should be sent,
and requesting the Times Picayune to hold all dividend checks until further instructions after the stockholders meeting
which had been called to be held on January 3rd following.
Under these circumstances, no dividend checks were sent out to the Pool Company during the year 1938.
It will be seen from what is said above that the dividend checks were not received from the Times Picayune because
of the advice of its attorneys not to send out the checks until the affairs of the company had been straightened out.
Mr. Nicholson, President of the Times Picayune Publishing Company, testified that it was on the advice of its
attorneys that the dividends were withheld and not because of the letter *Page 133 written by S.D. Pool on Dec. 30,
1938. The dividends would not have been received by the Pool Company in 1938 had S.D. Pool not written this letter.
It was the dispute among the directors and stockholders that caused the dividends to be held up and as plaintiff was
a director and secretary of the Pool Company in 1938, it was as much his duty to see that the dividends due the
Company were received and distributed as it was the duty of the other directors. Plaintiff made no effort to have the
controversy settled, and so far as the record shows, he was as much the cause of the unhappy condition in the
Company as was any of the other stockholders.
On this second appeal, plaintiff puts considerable stress on his contention that the defendants as directors of the Pool
Company after January, 1939, had until March 15th of that year in which to distribute the 1938 dividends and avoid
the surtax; that they admit receiving the dividends from the Times Picayune in January, 1939, and he contends they
were negligent in failing to perform their duties as directors in that they failed to distribute these dividends before
March 15, 1939, as they could have done under Section 405(c) of the Revenue Act of 1938, 26 U.S.C.A.
Int.Rev.Acts, page 1133, and thereby avoided the surtax levy against the corporation.
[1, 2] We do not deem it necessary to pass on the doubtful question of whether or not, under the above Section of the
Revenue Act of 1938, the Pool Company could have distributed the dividends received from the Times Picayune at
any time before March 15, 1939, and avoided the surtax assessment. The law on this point is very complicated and
involved. The defendants as directors were only required to exercise reasonable care and diligence and act in good
faith and with that judgment and discretion which ordinarily prudent men exercise under similar circumstances. They
employed a certified public accountant to make the income tax returns of the Company for 1938 and also had the
advice of an attorney in connection with its legal affairs. The defendants did not know that these dividends had to be
distributed before March 15, 1939 (if this could have been done), in order to avoid the surtax. They had a right to rely
on the advice and suggestion of the public accountant and the attorney whom they had employed to look after these
legal and technical matters.
While the plaintiff claims that he knew that these dividends had to be distributed before March 15, 1939, in order to
avoid the surtax, yet he admits that he never advised any of the defendants of this fact, notwithstanding he was a
stockholder and had as much at stake as any of the defendants. It was to the interest of all the stockholders to avoid
paying this surtax, and it is hardly conceivable that the defendants would have refused to distribute these dividends
had they been advised or had known that a failure to do so would subject them as well as plaintiff to this loss.
Finding no error in the judgment appealed from, the same is hereby affirmed at the cost of plaintiff.