Opinion ID: 1544271
Heading Depth: 1
Heading Rank: 1

Heading: Kentucky Wagon Manufacturing Company

Text: The District Court found that the loss to the Bank between March 30, 1926, and November 16, 1930, resulting from money supplied by it to Kentucky Wagon Manufacturing Company, herein called Wagon Company, was $991,283.57. This finding is undisputed. The Master found in substance that the expenditure of this large sum was improvident. He said: The amounts expended got to be enormous in comparison with the debts to be saved. He found that between August 8, 1924, and November 16, 1930, the Bank advanced $1,215,419.27 in excess of what it had received from the operation of the property. It cannot be doubted that these expenditures were improvident and wasteful. Appellants, directors of the Bank, during the period involved, do not contend otherwise. The District Court found that they made no effort to terminate these expenditures and this is true. Their defense was that they did not know that these overdrafts were being allowed; that Brown, the President of the Bank, Jones, the Cashier, and certain other executive officers concealed this information from them. We held that the overdrafts were so concealed. This was true in the sense that the directors trusted in the integrity of these men and were deceived, but this does not necessarily foreclose the question whether appellants were chargeable with common law negligence. In Briggs v. Spaulding, 141 U.S. 132, 11 S.Ct. 924, 35 L.Ed. 662: the court said, at page 152, 11 S.Ct. at page 931, In any view the degree of care to which these defendants were bound is that which ordinarily prudent and diligent men would exercise under similar circumstances, and in determining that the restrictions of the statute and the usages of business should be taken into account. What may be negligence in one case may not be want of ordinary care in another, and the question of negligence is therefore ultimately a question of fact, to be determined under all the circumstances. This statement of the law was approved in Bowerman v. Hamner, 250 U.S. 504, 39 S.Ct. 549, 63 L.Ed. 1113. It is unnecessary to recite the history of the Wagon Company prior to 1924. This is set forth in the original opinion. It is enough to say that at that time over $900,000 of the Bank's money loaned to the Wagon Company was endangered. The directors then on the Board knew this and those who became members in 1927 as a result of the unification with the Louisville Trust Company knew that this indebtedness, after large charge-offs for worthlessness, was then at least around $440,000. It was their duty to salvage this money and the care required of them was commensurate with the danger of its loss. After the Bank had acquired ownership of the Wagon Company the directors knew that it was without operating funds and yet these large overdrafts were permitted. The Wagon Company account was primarily in charge of Brown who authorized the overdrafts. They were made in the form of checks approved either by Jones or Angermeier, both of whom were on the Board of the Wagon Company, placed there by Brown and controlled by him. These checks in varying amounts were honored, almost daily, from August, 1924, until the Bank closed. The amounts thus advanced averaged about $200,000 yearly and were settled semi-annually by unsecured notes of the Wagon Company just before the due date of the Bank's report to the Comptroller. By this method the Bank advanced $1,210,360.33. The Wagon Company account was discussed and considered by the Board at its weekly meetings and Brown, Jones and Angermeier would report that the Company was making its way or breaking even or making a little money or losing a little and that no new money was being invested. Under the facts as stated and presently to be stated we do not think that appellants are justified in saying that they were uninformed of what was taking place. Directors of a national bank are not required to maintain a system of espionage over the acts and conduct of its officers. Briggs v. Spaulding, supra, 141 U.S. 132, at page 162, 11 S.Ct. 924, 35 L.Ed. 662. The business of a bank may be entrusted to them upon the assumption that they are honest and faithful but they are not to be regarded as infallible. Warner v. Penoyer, 2 Cir., 91 F. 587, 590, 592, 44 L.R.A. 761. As pointed out in Gibbons v. Anderson, C. C., 80 F. 345, 349, it is not unusual for banks to meet disaster through the malfeasance of trusted officials. This is one of the dangers to be apprehended and guarded against. For this reason the law requires and depositors have a right to expect that directors should retain and maintain a reasonable control and supervision over the affairs of the Bank, especially its larger and more important ones, to the end that they may keep themselves informed of its condition. Briggs v. Spaulding, supra; Bowerman v. Hamner, supra; Gibbons v. Anderson, supra; Warner v. Penoyer, supra; Wheeler v. Aiken County Loan & Savings Bank, C.C., 75 F. 781. In the discharge of this duty the directors are required not only in the observance of their official oath but by common law (Martin v. Webb, 110 U.S. 7, 15, 3 S.Ct. 428, 28 L.Ed. 49) to use ordinary diligence; and by ordinary diligence is meant, that degree of care demanded by the circumstances. They have their own responsibilities which they may not put aside. They must keep in mind that a national bank is not a private corporation in which stockholders alone are interested. It is a quasi governmental agency (Farmers' & Mechanics Nat. Bank v. Dearing, 91 U.S. 29, 23 L.Ed. 196), and one of its principal purposes among others is to hold and safekeep the money of its depositors. We think it may be fairly assumed, that if appellants had maintained any reasonable method of supervision over the Wagon Company account or over the general affairs of the Bank, these large and wasteful overdrafts occurring almost daily over a period of six years and periodically converted into unsecured notes which were in turn periodically renewed, would certainly have been discovered. See Williams v. McKay, 40 N.J.Eq. 189, 53 Am.Rep. 775; and Williams v. McKay, 46 N.J.Eq. 25, 18 A. 824. But, this inference aside, there are certain undisputed facts which confronted appellants in 1919. The by-laws of the Bank provided that there should be a Chairman of the Board who should be the principal executive officer of the Bank. Mr. Fenley was Chairman until his resignation in January, 1921. The position was then abolished and its duties combined with those of President Brown. This naturally increased the hazard of one-man control and was a well recognized danger to be guarded against. In 1919, that the Board might have a clearer insight into the Bank's affairs, it appointed an examining committee consisting of three non-officer directors. A similar committee was appointed for the years 1920, 1921 and 1923. These committees functioned efficiently and made valuable and comprehensive reports but were discontinued in April, 1923, and thereafter no such committee was ever appointed and no representative of the Board ever examined the affairs of the Bank or audited the business. As late as May, 1930, when the directors were confronted with a true picture of the Bank's deplorable condition, they passed a resolution to appoint such committee but it was never appointed. In 1922, the Board provided an Auditor but he was not a director. Brown employed him and fixed his salary. His duties in a Bank of its size where at least 150 bookkeepers were making daily records were of course important. These duties were to audit all the records of the Bank, see that the proper records were kept, make annual checks, quarterly checks of all accounts, make reports and checks of General Ledger items, etc. He served as Auditor until January 15, 1930, and from that time as Cashier and Auditor until the close of the Bank. He made an audit of some of the departments monthly and all of them quarterly. He was required to and did report to the Cashier only. The Board never called upon him to report and it does not appear that any director ever saw a report. The discontinuance of the Examining Committee standing alone was negligence. It was the duty of the Board in the management of the affairs of the Bank to cause examinations to be made of its books and papers. Bowerman v. Hamner, supra (250 U.S. 504, at page 513, 39 S.Ct. 549, 63 L.Ed. 1113); Gamble v. Brown, 4 Cir., 29 F.2d 366, 371; Rankin v. Cooper, C.C., 149 F. 1010, 1013. This should have been done that the Board might know, as it was its duty to know, the condition of the Bank and the way and manner in which it was being conducted. It is said that the audits furnished greater protection to the Bank than the reports of the Examining Committee would have furnished. But a system by which the reports of the Auditor, however faithfully assembled, were made to the Cashier alone, was palpably faulty. It was adopted against the recommendation of a national bank examiner and hindered rather than helped the directors in the discharge of their duties. It made the way easy for Brown. The Bank had a loan committee of eight of its officers. It never reported to the Board over their signatures as to the condition of the loans. A mimeographed copy of the list of loans for each preceding week was submitted to each member of the Board at their weekly meetings. These lists set out the amounts of each individual loan, the name of the borrower and of the endorser, if any, the collateral, if any, and if the note was a renewal, the amount that had been paid, if any, on the pre-existing loan. This was about all. The directors did not know what particular officer or employee of the Bank made up these loan lists, and what is more important, they did not know what should have been easily ascertained, i. e., that Brown was making large loans upon his own initiative. Laying aside the probable effect of combining the office of Chairman of the Board with that of the President, it is manifest that if the appointment of examining committees, a commonly known safeguard, had not been discontinued, or if the Board had required the loan committee to make comprehensive and intelligent reports, or required the Auditor to report directly to it, the overdrafts and loans to the Wagon Company would have been discovered and no doubt terminated at the outset. Moreover, Humphrey Robinson & Company, Clearing House Accountants, made a complete audit of the business of the Bank at the close of each year, filed a copy of their report with it and sent a notice thereof to each director. National Bank Examiners made an examination semi-annually and forwarded their reports to the Comptroller of the Treasury, leaving a copy with the Bank. The record is replete with copies of letters from the Comptroller's office from 1919 until the close of the Bank concerning these reports. Some of these letters were addressed directly to the Board, others to the President, and others to various officers of the Bank. It is not practical here to go into detail touching the contents of either the letters or the reports. It is enough to say that the reports exhibited the ruinous condition of the Bank in general and of the Wagon Company account in particular and the Examiner's reports invariably criticized the handling of it and especially the excessive overdrafts. The letters also complained of the unsatisfactory management of the Bank's affairs in many particulars and urged immediate corrective measures. Very few of these letters ever came to the attention of the Board. The probability that communications from the Comptroller were being suppressed does not seem to have occurred to any members of the Board. The reports were brought to the Board meetings and Brown, as the presiding officer, was permitted to read them. Pretending to read them as a whole, he designedly omitted the portions thereof which disclosed the perilous condition of the Bank and particularly of the Wagon Company account, due to the misdoings of himself and his subordinates. He systematically perpetrated this deception throughout the years involved. Appellants advance their consequent lack of knowledge as a defense. Obviously it is not sufficient. Ignorance under such circumstances is not an excuse. Shea v. Mabry, 1 Lea, Tenn., 319, 342. It was their duty to know the facts. They had the means of knowledge literally before them and they would have known had they exercised the control and supervision over the Bank and its officers which the law requires. They cannot    shut their eyes to what is going on around them. Martin v. Webb, supra, 110 U.S. at page 15, 3 S.Ct. at page 433. They might have examined these reports for themselves. It was said in Goess v. Ehret, 2 Cir., 85 F.2d 109, that this was the minimum required of a director. In the alternative the Board might reasonably have adopted a common custom and one practiced in this particular Bank prior to Brown's incumbency and in the Louisville Trust Company prior to the unification, of having a committee of their number to examine and report upon such reports. Ordinary prudence demanded something more. They were not required to proceed as if Brown were under suspicion but they had their own duties of oversight and supervision to perform. In Lippitt v. Ashley, 89 Conn. 451, 94 A. 995, it is said [page 1000]: This duty of supervision is not performed by reposing confidence in such officers, however worthy of confidence they may seem to be. The history of the business, known to every bank director, shows that confidence without supervision has often proved to be a temptation and an opportunity. See also Fletcher v. Eagle, 74 Ark. 585, 86 S.W. 810, 109 Am.St.Rep. 100; Gibbons v. Anderson, supra; Campbell v. Watson, 62 N.J.Eq. 396, 50 A. 120. Appellants say that it was common procedure at bank directors' meetings generally for the president to read the reports but this defense is not conclusive in character in a case where the custom is a dangerous one. The Bank made quarterly statements to the Comptroller, attested by three directors, of its condition beginning March 31, 1924, and continuing to its close, and kept copies. It printed and distributed among its customers and friends about two thousand copies of each statement. The statements carried overdrafts varying from $3,157.78 on December 31, 1927, to $434,185.25 on October 10, 1927. Three were more than $200,000 and three for more than $100,000. These abnormal amounts became the subject of comment and criticism by the Comptroller, the Examiners and other banks, and noticeably affected the business. Yet the record discloses that no director except those attesting the statements ever examined one of them and they only formally and perfunctorily. Contrary to the conclusion of the Master, we think that the losses on the Wagon Company account were due proximately to the failure of appellants, who were directors during the period of its continuance, to maintain proper control and supervision over the affairs of the Bank. We recognize here, as we did in the former opinion where we were dealing with the statutory liability of directors, that there are certain inferences in favor of the Master's findings. But the order of reference reserved full power to review, amend or set aside any of the Master's findings of fact as well as his conclusions of law; and provided that his findings should be advisory only and not in any degree or to any extent binding upon the independent judgment of the court. It follows that the decrees against such appellants for losses upon this account are affirmed except as hereinafter indicated. It is urged that such finding should not apply to director Crawford because of a different factual situation as to him. He became a director on June 10, 1927, soon after the unification of the Bank with the Louisville Trust Company, of which he had been a director. While on its Board he served as a member of a committee to consider the matter of affiliation. In the discharge of his duties as such committeeman he had taken steps to ascertain the status of the Wagon Company item, the only one in which he is involved. He knew that the Comptroller had approved a 60% stock dividend by the Bank in aid of the affiliation and had congratulated the President of the Trust Company upon the unification. He knew further that Humphrey Robinson & Company had made a most favorable report of the Bank's condition to the Trust Company. Such were the circumstances as they appeared to him when he became a member of the Board of the Bank and attended its meeting of June 24, 1927. At this meeting when Brown announced that he had the last Bank Examiner's report, a member, formerly a member of the Board of the Trust Company, moved, according to the custom which had prevailed with the Trust Company, that the report be referred to a committee for report thereon. But Brown stated that while that was the practice of the Trust Company the Bank handled the reports in a different way; that the practice was to read the report; and with that explanation he read it, reading portions thereof incorrectly and omitting material and important portions altogether. He stated, untruthfully, that he was reading all the criticisms contained in it. The members, including Crawford, accepted it, as read, without comment. No further attention was given it. On June 30th, the Deputy Comptroller wrote directly to the Board and criticized in several particulars the condition of the Bank as reflected by this report. He referred especially to unwarranted overdrafts; and the unsatisfactory condition of the Wagon Company account. The Board never received this letter. After the Bank closed, the Examiner's report was found and it disclosed a disastrous condition. It revealed that the Wagon Company owed the Bank $1,002,930.59, which it described as slow, doubtful and worthless paper; and recommended that $100,000 be charged off. The report further disclosed an overdraft of the Wagon Company, more than six months old, of $229,092.54; that Brown himself was overdrawn $30,993.44 and that the Herald Post Company, owned by him, was overdrawn $74,917.82. It was the duty of the Board to ascertain the contents of this report when it was presented. The slightest effort would have made them available but it blindly entrusted the entire matter to Brown and his subordinates. Brown was in fact directing the directors as to how the report should be handled. See Armstrong v. Chemical Nat. Bank, 6 Cir., 83 F. 556, wherein in a somewhat similar situation the court said [page 570]: The subordinates in the bank    recognized Harper as the manager, not only of the bank, but of the directors.    Upon such a record directors are not permitted to excuse themselves by saying that they were deceived. See Auten v. U. S. Nat. Bank, 174 U.S. 125, 147, 19 S.Ct. 628, 43 L.Ed. 920; Lowndes v. City Nat. Bank, 82 Conn. 8, 72 A. 150, 22 L.R.A., N.S., 408. But Crawford does not rest his case solely upon this ground. Because of professional engagements he did not attend the last three weekly board meetings in July and was absent on his vacation in September. But some time soon after the incident of June 24th he became suspicious of Brown and in a board meeting made inquiry of him about the Wagon Company matter. The response was unsatisfactory. On a second similar occasion he again asked Brown about the same matter and for the second time received an unsatisfactory reply. After the meeting he told Brown that he was not getting the information he was entitled to. Brown then made about the same reply he had made in the meeting. Crawford then asked Brown, What about the Herald Post? This was Brown's newspaper which was largely indebted to the Bank. Brown replied that this loan was satisfactory to the executive officers, to which Crawford responded that it was not satisfactory to him. Crawford then resigned on December 12th, having served only six months. The question is, whether he was negligent with reference to the Wagon Company matter during his short service. We think that the weight of the evidence does not show that he was. He was not unmindful of his obligations as a director. The disturbing question with him was whether in the interest of the Bank he should take action which would result either in confirming or dispelling his suspicion, or whether he should resign. It is easy to see that from his standpoint the first alternative might have resulted in greater harm than benefit. We cannot say that his failure to act was due to negligence as distinguished from sound judgment and the bill must be dismissed as to him. A special defense is made by the Executor of the Estate of Alexander P. Humphrey. Judge Humphrey was a director from February 3, 1919, to January 10, 1928. He attended the board meetings regularly until December 5, 1925, when a personal injury kept him away until September 24, 1926. He attended regularly from the last mentioned date to January 7, 1927. He was then in Florida until February 11. He attended the meetings from February 11 to May 20, 1927, but during this period he was feeble and was accompanied by a servant. He could hear ordinary conversation and without sight in one eye, could read rapidly but never read what could be read to him. On account of his advanced age and physical condition he never attended a board meeting after May 20, 1927, and resigned in January, 1928. The decree charged his estate with the advancements made to the Wagon Company from March 30, 1926, to January 9, 1928, the day before his resignation. It is urged that the estate should not in any event be held liable for such advancements made during the periods of his prolonged absences from the board meetings. The Master found that Judge Humphrey was not negligent in staying away from the Board meetings between May 20, 1927, the time of his physical collapse, and January 9, 1928, when he resigned. We concur in this finding. He is not chargeable with neglect of duty which he was physically unable to perform. Nor is he to be held because he did not resign earlier (Briggs v. Spaulding, supra  141 U.S. 132, at page 155, 11 S.Ct. 924, 35 L. Ed. 662), but there is no escape from the conclusion that during his long and active service upon the Board a faulty system of administration and supervision was created and maintained which Brown and his underlings were permitted to take advantage of. (We need not repeat a statement of the facts.) Negligence in this regard combined and concurring with the continuance of these practices by those remaining upon the Board after May 20, 1927, was the proximate cause of the Wagon Company losses. It is unpleasant to dwell upon the misfortunes of upright, honest men. It is enough to say that we find no sound reason to exclude the Humphrey estate from the common law liability against appellants for the advancements made to the Wagon Company.