Opinion ID: 1142705
Heading Depth: 2
Heading Rank: 1

Heading: Gray's Duty of Care

Text: By law, officer Gray owed USB two principal duties: a duty of care and a duty of loyalty and fair dealing. These duties differ in nature and content, though they doubtless intersect and overlap. The law demands these duties of bank officers the same as officers of other corporations, and there is a bit of lore born no doubt of thought of failed banks and helpless widows that we ought demand more of bank officers than one who runs a foundry or a pest control company. See 1 Malloy, The Corporate Law of Banks, § 3.2.6, n. 1 (1988); 10 Am.Jur.2d, Banks, § 172, p. 161 (1963). We begin with the duty of care, which we find appropriately articulated as follows: A director or officer has a duty to the corporation to perform the director's or officer's functions in good faith, in a manner that he or she reasonably believes to be in the best interests of the corporation, and with the care that an ordinarily prudent person would reasonably be expected to exercise in a like position and under similar circumstances... . (1) The duty in Subsection (a) includes the obligation to make, or cause to be made, an inquiry when, but only when, the circumstances would alert a reasonable director or officer to the need therefor. The extent of such inquiry shall be such as the director or officer reasonably believes to be necessary. Principles of Corporate Governance, § 4.01(a). See Derouen v. Murray, 604 So.2d 1086, 1092 (Miss. 1992). We long ago recognized this duty in a banking setting and said an officer who very negligently makes unreasonably risky loans may on his borrowers' default be held personally to make good the bank's loss. Boyd v. Applewhite, 121 Miss. 879, 908-09, 84 So. 16, 26 (1920). Today, we accept that a loan officer has broad discretion but in exercising that discretion he must reasonably assess a risk and, if he fails in this, may expect to have each loan judicially scrutinized for borrower solvency, responsibility and adequate security. 1 Schlichting, Rice, Cooper, Banking Law, § 6.15, pp. 6-86 (1989). An agent is liable to his principal for losses proximately caused when the agent substantially deviates from his principal's instructions. The same rule applies to bank loan officers. Shaw v. McShane, 33 S.W.2d 277 (Tex.Civ.App. 1930). An officer who violates substantially his bank's loan policies and lending limits may be held for losses caused thereby. Mechem on Agency, § 1295, p. 939 (2nd Ed. 1914). All of this is informed by the customs and usages of the banking community, 1 Schlichting, Rice, Cooper, Banking Law, § 6.15[9], pp. 6-102 (1989), and in this we understand the admonition that bank officers are held to a higher duty of care than the officers of other corporations. Banking customs and usages flesh out a like position and under similar circumstances within the duty. [6] See Hoehn v. Crews, 144 F.2d 665, 673 (10th Cir.1944). His faults so measured, the officer is accountable for the losses they cause. Bates v. Dresser, 251 U.S. 524, 531, 40 S.Ct. 247, 249, 64 L.Ed. 388, 395 (1920). A person charging an officer with breach of his duty of care has the burden of production and persuasion on the issues of breach, cause, and damage to the corporation. Principles of Corporate Governance, § 4.01(d). The duty of care is subject to a well-settled common law defense, known as the business judgment rule. That rule has recently been stated with care: A director or officer who makes a business judgment in good faith fulfills the duty ... [of care] if the director or officer: (1) is not interested ... in the subject of the business judgment; (2) is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and (3) rationally believes that the business judgment is in the best interests of the corporation. Principles of Corporate Governance, § 4.01(c). See Miss. Code Ann. § 79-4-8.42 (rev. 1989); see also, Home Telephone Company v. Darley, 355 F. Supp. 992, 1000 (N.D.Miss. 1973). As with the duty itself, the business judgment rule imports an objective standard. Regarding Gray's duty of care to USB, the Chancery Court found, via USB's drafting services: 24. Gray's loan limit as the president in charge of the Branch was $75,000.00 in aggregate unsecured loans, and $150,000.00 in aggregate secured loans to any one borrower; hence, the three $150,000.00 unsecured LR & K loans and the unsecured $100,000.00 Bigelow letter of credit exceeded Gray's lending authority. 25. While Gray denies that anyone specifically told him what his loan authority was on and after July 2, 1984, the Court finds that due to his position of trust and because of his experience in lending, audit and operations, if Gray did not know, he was obligated to know and should have known the extent of his lending authority before advancing any loan to anyone. The Court's finding regarding a bank officer's duty to ask is supported factually by the testimony of every banker/witness, other than Gray, who testified at trial, including Mr. Ishee, an officer of ... [BOM]. ..... 29. USB's banking expert, Mr. Ed Neeley, opined that Gray's handling of the Piecara transactions violated sound banking practices and was imprudent. Mr. Neeley testified to the same effect, about the LR & K and Bigelow transactions. Mr. Neeley's opinions were uncontradicted. The Court notes significantly that no experts testified in justification of Gray's conduct in any of the three transactions in this case. The Court accepts Mr. Neeley's testimony as credible and agrees with the opinions advanced at trial. From these findings, the Chancery Court held Gray had breached his duty of care. The Court can only conclude that Gray negligently extended credit to Messrs. Bigelow, Lowery, Riggan, Kantor and Piecara ... when he knew or should have known these men were insolvent, in the sense they could not pay their debts when due. Moreover, he took no collateral whatsoever and violated USB's loan policy.
The evidence supporting these findings regarding Gray's handling of the LK & R transactions in July of 1984 is quite substantial. It will be recalled that on June 5, 1984, acting for BOM, Gray honored the LK & R letter of credit and paid the $400,000.00 to First South. On June 26, 1984, LK & R executed a $400,000.00 unsecured note payable to BOM maturing on September 4, 1984, with interest at date at fourteen percent per annum. This note was outstanding on July 2, 1984, and was not assumed by USB. Because it was in conditional liability/letter of credit form at the time USB was reviewing Branch loans, it was not considered for purchase, although, in fact, USB had designated for purchase certain other individual loans of Lowery and Riggan. What is critical is that on July 23, 1984, James R. Gray, in his new capacity as president of USB's Branch, determined that he would transfer the LK & R loan to USB by paying BOM and obtaining new notes from LK & R in favor of USB. There is substantial evidence that at the time, Gray knew, or reasonably should have known, that Lowery, Kantor and Riggan were in financial distress and were likely unable to meet their obligations in a timely fashion. See, e.g., Miss. Code Ann. § 75-1-201(23) (rev. 1989) (defining insolvency). Evidence undergirding this conclusion included that the Lowery-and-Riggan-guaranteed $3,200,000.00 Belvedere loan with First South was in default in June of 1984. At the time Gray honored the BOM-to-First South letter of credit, Lowery, Kantor and Riggan had represented they would repay BOM the $400,000.00 within a few weeks. That they were unable to do so should have told Gray something. Moreover, Gray knew that Lowery, Kantor and Riggan had guaranteed the $15,350,000.00 Wagner Place loan with First South, which was then in default, liabilities for which were not reflected on the financial statements of either of them. Gray further knew that some $1,200,000.00 in unsatisfied materialmen's and other construction liens had been placed against the Wagner Place project in Memphis, thus halting that project's sale and development, as well as LK & R's cash flow. Notwithstanding, Gray unilaterally and without authority loaned LK & R unsecured $450,000.00 of USB's funds. The LK & R notes were not paid when due, and USB renewed them several times. In the USB-drafted findings of fact, the Court found that Despite reasonable collection efforts, at the present time the respective $150,000 notes to Lowery, Riggan, and Kantor, aggregating $450,000.00 plus interest, are unpaid and have been charged off in full. Money has been collected from each borrower but has been applied in accordance with the law or the borrower's instructions to earlier obligations of the borrowers to USB. The unpaid principal remains $450,000.00. Interest at the prime rate is $157,539.03 through October 17, 1988. The total debt is $607,539.03. Later, the Court somewhat gratuitously holds Gray's acts ... reckless[ [7] ] and tantamount to gross negligence as a predicate to assessing Gray with USB's attorneys fees and legal expenses. For the moment, we find no grounds for disturbing the Chancery Court's conclusion that, in his handling of the LK & R matter, Gray breached his duty of care, causing USB a substantial loss.
Gray says he did not know if USB selected the Bigelow letter of credit when it was selecting the loans to purchase. BOM's President Ishee and CEO Martin handled those matters; Gray did not. Gray kept the letters of credit in a file behind his secretary's desk. He had no discussions with USB's higher ups about letters of credit. When Bigelow fell into arrears on his payments to Heller, he approached Gray. On July 31, 1984, Gray made Bigelow an unsecured loan of $20,000.00 and wired $12,830.00 to Heller, which was more than due. Gray says he was relying on Bigelow's mother's property in Kentucky and an inheritance from his grandmother, but did not verify these properties. In October, Gray loaned Bigelow another $20,000.00 unsecured, knowing the land in Kentucky was not attached. By January these unsecured loans totaled $61,857.40. Our principal concern is the new $100,000.00 letter of credit Gray had USB issue without security on January 11, 1985. Gray says he did this because Heller asked him to do so. He was worried Heller was going to call in the BOM letter of credit. I issued the [new USB] letter of credit because there was a possibility it would be called, but I issued the letter from USB with the assumption that if it was called then USB would have to pay it. Gray did not clear that assumption with anyone at USB. He just did it. The evidence is more than adequate that Gray breached his duty of care in handling the Bigelow matter, causing USB substantial losses.
Gray's defaults in the Piecara loans are equally apparent. To be sure, there is nothing per se improper about a banker securing a credit by taking a security interest in contract rights or an assignment of accounts or the like. [8] We are unimpressed with USB's constant carping that such collateral was worthless until Piecara performed and that Gray was somehow supposed to have confirmed that Piecara had earned payments under his subcontract before he released loan proceeds. On the other hand, there are risks associated with this receivables form of collateral not associated with more tangible security, and a prudent loan officer must reasonably assess and control these risks. These risks are exacerbated where, as here, the subcontract is to be performed some 1500 miles away. Here Gray's defaults become apparent. He made no inquiry of the financial responsibility of the prime contractor or the owner. A prudent loan officer taking such collateral will give notice of his bank's interests to the prime contractor and the owner and demand that all payments due under the subcontract be routed through the bank. Gray did none of this, nor did he monitor performance of the subcontract and have Piecara remit as his company was paid. Gray failed to perfect USB's security interest, a matter no doubt controlled by the Uniform Commercial Code as enacted in Arizona and any other applicable jurisdiction. Moreover, it appears clear the value of his collateral was far below what prudently should have been required for a credit of this size. We accept the Chancery Court's holding Gray breached his duty of care to USB in handling the Piecara loans.