| Ark. | May 28, 1917
(after stating the facts). Section 8, Article 12 of our Constitution provides, “No private corporation shall issue stocks or bonds except for money or property actually received or labor done.”
The management of the affairs of every business corporation is under the care and control of its board of directors. The above plain provision of our Constitution is for the protection of stockholders, as well as creditors and all who are interested in the financial affairs of private corporations. This wholesome provision of our Constitution is a guarantee to all who are financially interested in private business corporations, against the issuance of what is termed “watered stock,” that is “stock which purports to be paid in full but which, in fact, has not been paid for.”
Stock was issued to various persons in the sum of about $14,000 and notes accepted in payment therefor, which had not been collected at the time the bank went into liquidation. If the directors, as the governing board having the sole management of the issuance of this stock, had observed the plain mandate of the Constitution, they would have had in the treasury of the bank the above sum, which the bank would have had as part of its working capital, or else they would have had the stock itself, and the public could not have been misled as to the actual available capital of the bank. The above sum was almost a third of the purported capital of the bank, which, the bank did not have the use of. But notwithstanding this fact, the president and cashier, or secretary, of the bank, in their first annual statement, reported a paid-up capital of over $40,000, and in the three succeeding statements reported a paid-up capital stock of $50,000.
The same principle governs with reference to the annual report required to be filed by the president and secretary, showing the condition of the affairs of the corporation. They must be true and correct reports.
The above doctrine for the protection of creditors under our statute was also extended, in the case of Bank of Des Arc v. Moody, 110 Ark. 40, 41, to cover the liability of directors to stockholders. In the latter case it was alleged that the directors “negligently and purposely failed and neglected to give attention to, or take any .control in, the management of said bank and its affairs, and allowed the cashier to carelessly dissipate the assets in making bad loans.” The court said: “This charge is sustained by the evidence,” and that “under the doctrine laid down by this court in the case of Bailey v. O’Neal, 92 Ark. 327" date_filed="1909-11-08" court="Ark." case_name="Bailey v. O'Neal">92 Ark. 327, this rendered the directors liable . not only to the creditors who were defeated in the enforcement of their rights against the bank, but also as to the stockholders whose stock was rendered worthless on account of the losses sustained by the bank.”
Bailey v. O’Neal, supra, was a. suit by creditors against directors, and the liability was there determined and fixed with reference to statutes creating it in favor of creditors of corporations against directors, and it was there held that under the statutes the directors were liable for intentional acts of negligence. The case of Bank of Des Arc v. Moody, supra, was a suit by stockholders against directors. While the case was correctly decided upon the undisputed evidence, it was not accurate, as we shall see, to ground the decision upon the doctrine announced in Bailey v. O’Neal, supra.
It is contended by counsel for the appellants that if the directors were guilty of no fraud or gross negligence themselves that they would not be liable as directors for any fraudulent conduct, or any negligent acts of the president and cashier of the bank.
We are thus brought to a,consideration of the question of what is the duty of directors to stockholders. We have no statute expressly defining such duties and prescribing liability for failure to discharge such duties, as in case of creditors. The statute, however, in broad terms, as we have seen, places the “stock, property, affairs and business of such corporations ’ ’ under the care of their board of directors, to be managed by them.
The statute creates a relation and confers a power which necessarily carry with them corresponding duties and liabilities, independent of any statute specifically defining or limiting those duties and liabilities; and, in the absence of any statute, they must be ascertained and controlled by common, law rules applicable generally to such relations and powers.
In Bosworth v. Allen, 168 N.Y. 157" date_filed="1901-10-01" court="NY" case_name="Bosworth v. . Allen">168 N. Y. 157, 164, Mr. Justice Yann, speaking of directors, said: “Clothed with the power of controlling the property and managing the affairs of the corporation, without let or hindrance, as to third persons they were its agents, but as to the corporation, itself, equity holds them liable as trustees. * * * For all practical purposes they are trustees when called upon in equity to account for their official conduct.” See also Delano v. Case, 2 Am. St. Rep. 81.
In Briggs v. Spaulding, 141 U.S. 132" date_filed="1891-05-25" court="SCOTUS" case_name="Briggs v. Spaulding">141 U. S. 132, 147, Chief Justice Fuller, speaking for the court, said: “Bank directors are often styled trustees, but not in any technical sense. The relation between the corporation and them is-rather that of principal and agent, certainly so far as creditors are concerned, between whom and the corporation the relation is that of contract and not of trust. But, undoubtedly, under circumstances, they may be treated as occupying the position of trustees to cestui que trust."
We deem it unnecessary to attempt to define the precise relation of the board of directors to stockholders. As the directors are chosen by the stockholders, and under the law, are given the care of the ‘ ‘ stock and property” and plenary power to manage the “affairs and business” of the corporation in which the stockholders have invested their money, their selection imports a very high degree of trust and confidence reposed in them by the stockholders. Therefore* the relation, with its powers and duties, at least in equity, perhaps approaches more nearly the relation of that of the active trustee to his cestui que trust than that of the ordinary relation of agent to his principal. But, be that as it may, there is no uncertainty, according to the great weight of authority, as to the duty of the director to stockholders and the resultant liability for a failure to discharge that duty.
In Briggs v. Spaulding, supra, the court had under consideration the Revised Statutes of the United States empowering a national banking association “to exercise by its board of directors, or duly authorized officers or agents, subject to law, all such incidental powers as shall be necessary to carry on the business of banking,” etc. Chief Justice Fuller, speaking for the court, in the course of his opinion, said: ‘ ‘ The corporation had power to carry on its business through its officers. And although no formal resolution authorized the president to transact the business, yet in view of the- practice of fourteen years or more, we think it must be held that he was duly authorized to do so. It does not follow that the executive officers should have been left to control the business of the bank absolutely and without supervision, or that the statute furnishes a justification for the pursuit of that course.”
And he concludes his exhaustive opinion as follows: “Without reviewing the various decisions on the subject, we hold that directors must exercise ordinary care and prudence in the administration of the affairs, of a bank, and that this includes something more than officiating as figureheads. They are entitled under the law to commit the banking business, as defined, to their duly authorized officers, but this does not absolve them from the duty of reasonable supervision, nor ought they to be permitted to be shielded from liability because of want of knowledge of wrongdoing, if that ignorance is the result of gross inattention.”
Note that this language was based on a statute which empowered banking associations to exercise, by their “boards of directors or duly authorized officers or agents,” all powers necessary to carry on the business of banking. Even under this statute, which vested the power in the “board of directors, or duly authorized officers or agents,” the court said that the directors were not absolved from the duty of reasonable supervision over them. But our statute contains no alternative provision. It vests the exclusive power in the directors to manage the affairs and business of corporations. The opinion, for the most part, is an admirable statement of the law, but we can not subscribe to the language of the concluding paragraph above quoted which seems to imply that directors may be shielded from liability because of want of knowledge of wrongdoing on the part of their duly authorized officers, unless their ignorance of such wrongdoing is the result of gross inattention. We approve, rather, of the doctrine announced by Mr. Justice Harlan, in that case, speaking for himself and the other dissenting judges, as follows:
Again, he says: “When one deposits money in a. savings bank, or takes stock in a corporation, thus divesting himself of the immediate control of his property, he expects and has the right to expect, that the trustees or directors, who are chosen to take his place in the management and control of his property, will exercise ordinary care and prudence in the trust committed to them —the same degree of care and prudence that men prompted by self-interest generally exercise in their own affairs. When one voluntarily takes the position of trustee or director of a corporation, good faith, exact justice, and public policy unite in requiring of him such degree of care and prudence.”
In addition to the authorities cited by Mr. Justice Harlan see the following well considered cases cited in the briefs of Daniel Hon and of H. C. Mechem for the appellees: Warren v. Robinson, 19 Utah 289" date_filed="1899-04-26" court="Utah" case_name="Warren v. Robison">19 Utah 289, 75 Am. St. Rep. 734; Union National Bank v. Hill, 148 Mo. 380" date_filed="1899-03-07" court="Mo." case_name="Union National Bank v. Hill">148 Mo. 380, 71 Am. St. Rep. 615; Coddington v. Canaday (Ind.), 61 N.E. 567" date_filed="1901-10-10" court="Ind." case_name="Coddington v. Canaday">61 N. E. 567; Solomon et al. v. Bates et al., (N. C.) 24 S.E. 478" date_filed="1896-02-05" court="N.C." case_name="Solomon v. . Bates">24 S. E. 478; See also 21 A. & E. Enc. Law 875-6; 7 R. C. L., p. 473, § 454 et seq. 459, inclusive.
The duties of directors are perhaps nowhere better stated than in a syllabus, showing the holding of the court, in Wallace v. Lincoln Savings Bank, 89 Tenn. 631, as follows: “Bank directors are held to the exercise of only ordinary care and diligence in the discharge of their duties. They are not required to give their whole time and attention to the performance of these duties, but only so much as, under the special circumstances of each particular case, may be demanded for the reasonable protection of the interests committed to their care. They are not insurers of the fidelity or capacity of the cashier or other agents to whom the business and assets of the bank may be intrusted, but are required to exercise due care in their selection and proper supervision over their action.”
Even if no higher degree of care were exacted of directors toward stockholders than that required of them toward creditors, under the statute, that is, that they should be guilty of no intentional acts of negligence, or, no connected acts from which intentional or gross negligence could be inferred, as held by us in Bailey v. O’Neal, supra, and other cases, still the appellants, under the facts of this record, could not escape liability. But, in view of the far-reaching importance of the subject, and in order that there may be no misapprehension on the part of directors as to what their duties are, we have set down above the correct standard of duty for them in order that the issue of liability or nonliability in any given ease may be measured thereby. As to whether or not the directors are negligent must depend upon the peculiar facts and circumstances of each particular case when judged by the above- rules.
These false statements as to the paid-up capital went into every financial statement that was filed after the first year. Now, the directors knew, of course, that there was not a paid-up capital of $50,000, for they issued stock and took notes for same, which they knew had not been paid. In the exercise of ordinary care they could have known, too, that the financial' statements were padded to show a false value on furniture and fixtures, and that this was done to mislead the public.
The transactions involved in the loans negotiated by Halstead, by, which Halstead, a pawnbroker, loaned small amounts to three or four hundred different people, taking their notes payable to German, and discounting these notes to the bank with the understanding that the bank was to have one-half of the amount that Halstead had charged for the loans, virtually put the bank in. partnership with Halstead in the pawnbrokerage business. This arrangement between the cashier and Hal-stead and German thus enabled Halstead and German to exploit the necessities of the poor by unconscionable contracts with them, which the testimony of Dowd showed to be loans at exorbitant rates of interest, above ten per cent, per annum. These notes, therefore, were usurious and void. While the cashier testified that the directors knew ‘ ‘ that we were making these loans, ’ ’ and that they held a meeting of the directors when about $6,000 of that paper was on hand, and that no criticism was made of any of them, the testimony of other directors shows that these transactions had been running on for several months and had reached the sum of about $6,000 before Pyle’s attention was called to their questionable character. However, after that he was permitted to continue them until they had reached the sum of $13,509.00. This was not only unusual, but a disreputable piece of business for any bank to be engaged in. The numerous borrowers who were fleeced by the methods of these pawnbrokers through money furnished by the bank would naturally cause such methods to become widely known throughout the community, and nothing could have been more potential to the destruction of the confidence of the public in the integrity of the institution and the efficiency of its officers and governing board. Morton testified that “the $11,000 Halstead loan was one of the contributing causes of the failure;” that, “the day and night banks throughout the country had come into discredit; a good many of the officers of these banks were under indictment, and a good many of the banks had gone to the wall; that created a fever of distrust all over, the country, and we were trying to obviate that by changing the name.”
The testimony indicates that it was not the name but the conduct of their officers that was bringing these banks to grief, and therefore the directors of the Day and Night Bank at Fort Smith should have given their attention not merely to the change of name, but also especially to a change of the methods of business pursued by their cashier Pyle. The testimony of experienced bankers, Morton and Dowd, tended strongly to prove that one of the principal factors in the wreckage of this institution was the reckless conduct of its cashier in making worthless loans.
While the proof tends to show that the directors exercised all the care that ordinary prudence required of them in the selection of Pyle as cashier, yet their duty, as shown by the above authorities, did not end there. They could not turn over to him, without supervision and restraint, the important matter of making loans for the bank, upon which its financial success almost entirely depended. Doubtless Pyle, the cashier, was encouraged in his reckless handling of the bank’s funds in making bad loans and allowing worthless overdrafts by knowledge of the fact that the directors were giving practically no attention to the matter of loans, as was demonstrated in his own case, for he, although confessedly insolvent, was permitted to borrow $2,800 from the bank without question and without security.
But we need not pursue the subject further. The above are the most important facts which show that the officers of the bank were grossly negligent in making worthless loans and allowing worthless overdrafts, and which conduct the directors, in the exercise of ordinary care in the management of the business and affairs of the bank, knew, or could have known, and should have corrected. This applies to the directors jointly and severally as members of the board. Some of the directors individually stand on a different footing from the others as to certain stockholders, but it does not affect the question of their liability generally.
The decree in favor of I. N. Johnson against J. F. Mayes individually and separately for the sum of $250, with interest, the amount of the 50 per cent, assessment, was grounded on the false and fraudulent representations made directly by Mayes to Johnson. This decree is not against the clear preponderance of the evidence and is affirmed.
The record shows that A. N. Cole and J. H. Frost, against whom judgments were entered for the amount of their notes for stock, prayed and were granted an appeal, but no brief has been filed by them, and therefore we presume that they have abandoned their appeal, and the judgment against them must be affirmed for failure to comply with Rule 8 of this court.
As to the cross-appeal of appellees Lora Goolsby, Z. L. Reagan, Mary B. Reagan and L. V. Parker, it appears that February 9, 1914, the stockholders had become aware of the fact that there had been a considerable depreciation in the value of the notes and other assets of the bank, and being desirous of making such depreciation good and restoring the full value of all the stock, and to give the bank a full paid-up capital based upon assets of unquestioned' value, a long list of the stockholders signed an agreement to levy an assessment of 50 per cent, on their stock.
On July 1, 1914, there was a call meeting of the stockholders of the bank at which an assessment of 50 per cent, was voted and levied by the stockholders for the continuance of the bank. Judge Hon, who represented Mrs. Goolsby, attended the meeting of the stockholders and suggested that they make the assessment 25 per cent, instead of 50 per cent., and his testimony shows that the directors talked about the cashier “having put the bank in the hole,” and that he favored the assessment rather than to lose what he had put in it for Mrs. Goolsby. He testified that the Bank Commissioner had ordered an assessment of 50 per cent. He asked Mayes, the president of the bank, as to whether the others were going to pay the assessment and Mayes replied that “he thought they were pretty generally.” Judge Hon then paid the assessment with the understanding that the others had paid it, and advised Mrs. Goolsby that others were paying it, “and if they paid the bank was going to go.” The others paid their assessment under practically the same circumstances.
The court found that these assessments were paid on representations made by the officers of the bank to the effect that in their opinion the payment of such assessment would place the bank in a position to carry on the business successfully and give it operating capital until outstanding debts could be collected; and, upon the representations that other stockholders were paying these assesments, Mrs. Goolsby and the other cross-appellants paid the amounts assessed against them.
The court held, upon these findings, that the payment of the assessments and the giving of the notes for unpaid assessments was voluntary, and entered a decree refusing a judgment for the amount of these assessments, except as to Johnson, whose judgment against Mayes for the assessment was "based upon false representations, which we have already disposed of. The court dismissed the complaints of Mrs. Lora Goolsby and the other interveners mentioned, except Johnson, for these assessments, and also entered a decree canceling the outstanding notes that were given for such assessments as being without consideration, past due, and nonnegotiable.
None of the delinquent stockholders against whom the court rendered judgments for the unpaid balance of their stock subscriptions in favor of the bank have appealed.
The decree in favor of J. H. Frost, E. B. Russum, A. N. Cole, R. O. Herbert, Alta Blaylock, J. O. Gunter, C. L. Pyle, W. H. Cole, R. T. Powell, Lawrence Wright, R. P. Reynolds, E. D. Vann and J. O. Johnson against the directors were upon the contingency or condition that each of these parties should pay the decrees rendered against them respectively in favor of the bank. These decrees were not only anomalous, but they were without authority of law and void.
That a judgment in presentí can not be rendered and grounded upon a future condition or contingency, see Battell & Collins v. Lowery et al., 46 Iowa 49" date_filed="1877-04-20" court="Iowa" case_name="Battell v. Lowery">46 Iowa 49. In the course of the opinion in that case the court said: “If there was a present judgment, it was at most a judgment that there should be a judgment. But we can not sanction such an anomalous proceeding.” See, also, Simmons v. Jones, 24 S.E. 114" date_filed="1896-02-05" court="N.C." case_name="Stewart v. . State">24 S. E. 114, 118 N.C. 472" date_filed="1896-02-05" court="N.C." case_name="Simmons v. . Jones">118 N. C. 472; Early v. Moore, 4 Munford, 262. Moreover, these decrees were beyond the scope of the issues raised by the pleadings. The delinquents who were sued on notes for stock and for borrowed money were not asking for judgments over in their favor against the directors.
This record, which is embodied in nearly nine hundred pages of transcript, shows that the chancery court gave the case, which involved numerous parties, with varied interests, and in which there was a great volume of evidence presenting complicated issues of fact as well as law, a most painstaking and thorough consideration, and that it has reached, for the most part, the correct conclusion. The decrees in favor of the delinquent stockholders above named are reversed, set aside and held for naught. In all other respects the decree is affirmed.