Brigham v. McCabe

20 N.Y.2d 525 | NY | 1967

Lead Opinion

Chief Judge Fuld.

The plaintiff, a teacher and member of the New York State Teachers Retirement System, brings this derivative action on his own behalf and on behalf of all other members of the System against the seven members of its governing body, known as the Retirement Board, and the National Commercial Bank and Trust Company.

The complaint alleges that there is an unlawful conflict of interest between the System and the bank arising from the fact that defendant Frank Wells McCabe is both chairman of the finance committee of the board and also the bank’s president and chief executive officer. More specifically, the plaintiff charges that, in violation of statute, the bank has had dealings and relationships with the System, as the result of which it has received various fees and other emoluments and has derived profits therefrom, all assertedly in violation of subdivision 3 of section 508 of the Education Law. The complaint sought injunctive relief and an accounting for losses suffered by the System and for profits realized by the bank as a result of these transactions.

Each of the defendants moved to dismiss the complaint, pursuant to CPLR 3211 (subd. [a]), for failure to state a cause of action, and the court at Special Term granted the motions. The Appellate Division agreed that the complaint was properly dismissed but modified the judgment by providing that such dismissal was to be without prejudice to service of an amended complaint for judgment preventing the deposit of the System’s funds with the bank as long as any officer, director or employee of the bank was a member of the board. Only the plaintiff Brigham appealed to our court from that disposition, and he asks us to “ grant [him] summary judgment ” on the ground that the statute imposes liability regardless of fraud or bad faith.

A close relationship has existed between the bank and the System since the time the System was originally set up in 1921. The then president of the bank was appointed as one of the original members of the Retirement Board by the Board of Regents (see Education Law, § 504, subd. 2) with the knowledge and understanding of the Regents that his banking connection would be utilized and, ever since then, the current executive officer of the bank has served as chairman of the finance committee. Indeed, until July, 1965, when all dealings between the board and the bank were terminated, the bank was closely and continuously involved in the financial affairs of the board.

The bank, as sole depository for the System’s funds, maintained two accounts, an active expense account in relatively small amounts, for which no charges were imposed by the bank, and a ‘ ‘ general fund account ’ ’. This latter account was a non-interest-bearing checking account which the System used both as a depository to store its incoming cash until such time as it could be invested and to cover out-going benefit checks to its members. The incoming cash was in the form of small amounts, withheld regularly from the pay of the System’s members and large, twice-a-year state-aid payments of 70 to 80 million dollars. The System wrote over 20,000 checks a month, totaling between 3 and 4 million dollars. Between 1957 and 1963, the average end-of-month balance in the account was approximately 5 million dollars, which the State Insurance Department found was substantially in excess of the percentage of funds held uninvested by similar retirement systems.¹

In addition to acting as a depository for its funds, the bank provided other services for the System, including the recommendation and administration of its investments in conventional mortgages and the placing of orders with brokers for the purchase and sale of securities. The bank received no fees for any of its services from the System. However, legal and appraisal fees were sometimes collected from the mortgagors, and the bank allegedly made money from these transactions.

As indicated above, the court at Special Term dismissed the complaint. In so doing, it found that there was no illegality in the maintenance of the account with the bank since the “Legislature did not intend in enacting section 508(3) of the Education Law to prohibit the deposit of the funds of the System in a bank of which an executive officer is a member of the Retirement Board ”.² The court found that the remaining allegations were, at best, “ conclusions of fact without any substantiation either in the complaint or in the answering affidavits ”. The Appellate Division, although it also dismissed the complaint, differed with Special Term in holding that the deposit of the System’s funds in the bank constituted a violation of the Education Law. Reasoning that the System’s bank deposit constituted a “ loan ” to the bank and that subdivision 3 of section 508 of the Education Law prohibits a member of the board from “ borrowing ”, the Appellate Division concluded that the deposits by the defendants offended against the statutory proscription.

It is true that the relationship between a bank and its depositor is one of debtor and creditor (see, e.g., His Majesty’s Treasury v. Bankers Trust Co., 304 N. Y. 282; Sundail Constr. Co. v. Liberty Bank, 277 N. Y. 137) in that there is a contractual obligation to pay money. This is, however, a far cry from saying that the depository bank is a “ borrower ’ ’ within the sense of the statute involved. Quite obviously, there may be a “ debt ” without there being a “ loan ”. To use a simple example, a “ debt ” arises where a buyer agrees to pay a seller for goods at some time after delivery but by no stretch of reason could that be deemed a ‘ ‘ loan ’ ’. The latter term, reasonably understood, means “ something lent for the borrower’s temporary use on condition that it or its equivalent be returned ”. (Webster’s Third New International Dictionary [1961].) It is something very different from a “deposit,” which Webster’s defines as “ something placed (as in a bank or in someone’s hands) for safekeeping”. In other words, a “loan” requires an intentention to place the funds at the borrower’s disposal, while a “ deposit ” is merely a convenient means of holding them for one’s own use. (See, e.g., Chapman v. Comstock, 134 N. Y. 509.)

This difference has always been recognized in the law. For instance, although subdivision 2 of section 247 of the Banking Law declares that the trustee of a savings bank may not himself, or as agent or partner of another, “ directly or indirectly borrow or use any of the [bank’s] funds ”, section 236 specifically permits the “ deposit ” of funds in a bank in which one of the trustees is a partner. Similarly, section 235 places strict restrictions on the type of loans which may be executed by a savings bank, yet it has been held that even an interest-bearing bank deposit secured by a bond is not an investment covered by that section. (See Erie County Bav. Bank v. Coit, 104 N. Y. 532, 538.)

These provisions of the Banking Law are of interest not only because of their close analogy to the situation under consideration but also because subdivision 1 of section 508 of the Education Law itself recites that the investments of the System shall be limited to those “ in which the trustees of a savings bank may invest the moneys deposited therein as provided by law.” It would be highly unreasonable to hold that, although a bank deposit is not a “ loan ” when made by a savings bank, it is one when made by the System.

While it is true, as urged, that subdivision 3 of section 508 also prohibits the ‘ ‘ use ’ ’ of the System’s funds by a corporation with which a member of the board is connected, any doubt about the propriety of maintaining the bank account is resolved by the exception which is written into that subdivision. What is overlooked is that the statute explicitly sanctions such use of the System’s funds where, to cull from the provision, it is “ to make such current and necessary payments as are authorized by the board ”. No purpose could be served by this exception other than to allow the bank to hold the funds which the System would draw upon to meet its expenditures. It follows, therefore, that the deposit of funds is not the type of “ use ” prohibited by the statute.-

In a case involving an alleged breach of a fiduciary duty, courts must, of course, look through form to substance. A balance in a checking account, grossly in excess of that reasonably necessary to handle the ordinary expenses of the System, might well constitute evidence that the account was nothing more than a device to disguise what in truth was a substantial interest-free loan to the bank. There is, though, no support whatever for such a finding. In fact, the plaintiff does not claim that the defendants were guilty of any bad faith or that a loan lurked beneath the facade of a bank account, his sole premise being that the board’s act of depositing money with the bank was absolutely prohibited by statute. As we have sought to demonstrate, the statute may not reasonably be read to support such a conclusion.

A second aspect of the bank’s relationship with the System, which the plaintiff claims violated the provisions of the Education Law, was the collection of fees from its customers for handling applications for mortgages from the System. It is the plaintiff’s contention that the bank’s receipt of such fees violated the portion of subdivision 3 of section 508 which prohibits a member or employee of the board “as such” from “ directly or indirectly receiving] any pay or emolument for his services. ” This provision was clearly designed to protect the System from having to pay, directly or indirectly, for the services rendered to it. If services are rendered to third parties, and are paid for by them, this has cost the System nothing, and the statutory provision is not offended. As to the services which were performed for the System, the papers clearly demonstrate that no fees were ever paid.

The plaintiff also complains that the bank’s participation in the purchase and sale of securities for the System violates the procedure required by the statute and that the bank was thus able to allot lucrative brokerage commissions among its friends. In this instance, reliance is placed on subdivision 1 of section 508, which provides that, once the board reaches a decision on a matter or investment policy, it shall ‘ ‘ direct the custodian to so invest the moneys or convert, or sell the securities. ” This provision, according to the plaintiff, is designed to designate the head of the State Division of the Treasury— who is ex officio the custodian of the System — as an “ independent and impartial ” authority with the sole power to select the brokers.

The selection of brokers to handle large and complex securities transactions is undoubtedly a task requiring a large amount of knowledge, experience and judgment. Certainly; it is not a matter to be left to a mechanical process or to an official whose duties are purely ministerial. We should reasonably expect that the necessary recommendations and decisions on the subject should come from an expert, such as Mr. McCabe, who fills the position on the board which had long been reserved for the “ executive officer of a bank ” (§ 504; subd. 2). On the other hand, it is difficult, if not impossible; to interpret the statute in such a way as to give discretion and authority to the State Treasurer whose duties (in the other aspects of his office) are of a clearly ministerial nature (see Tax Law, § 170). He may not disburse any of the System’s funds except “ upon warrants signed by a member of the retirement board, or an official thereof, authorized to do so ” (Education Law, § 507, subd. 3). It seems clear that the only function he is permitted to perform with respect to the System’s investments is the issuance of checks in the precise manner spelled out by the warrant and in the exercise of physical custody over the security certificates. Everything negates the idea that,he is given sole authority to determine to whom, and in what manner, checks will be drawn and transactions executed.

The order, insofar as appealed from, should be affirmed, without costs.

1 . However, procedures were adopted, in early 1963, which resulted in a steady decline — to a very small amount — in average daily balances.

2 . Subdivision 3 of section 508 of the Education Law provides, in part, as follows:

“ Except as herein provided, no member nor employee of the retirement board * * 55 directly or indirectly, for himself or as an agent or partner of others, nor a corporation of which he is an officer, stockholder or member, shall borrow any of its funds or deposits or in any manner use the same except to make such current and necessary payments as are authorized by the board ”.

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Dissenting Opinion

Van Voorhis, J.

(dissenting). The complaint states a cause of action, in our judgment, in respect of the allegations that excessive funds of the New York State Teachers Retirement System (hereafter called System) were deposited in the National Commercial Bank and Trust Company (hereafter called National) without interest. We agree with the majority that the other items of the complaint fail to state a cause of action, and, also, that deposit of the funds of System in National does not of itself constitute a loan to National in violation of subdivision 3 of section 508 of the Education Law. This section does, however, provide that no member or employee of the board of System shall have any interest, direct or indirect, in the gains or profits of any investment made by the board and that no corporation of which he is an officer, stockholder or member shall “ in any manner use ” the funds or deposits of System “ except to make such current and necessary payments as are authorized by the board”. This statute, like other statutes, should be interpreted in the light of its purposes and of the framework of the law of which it is a part. Where a fiduciary relationship is involved, as here, that signifies that “use” of the funds of System, under the circumstances here disclosed, shall be made in accordance with general equitable principles regarding interlocking directorates. Defendant McCabe is chairman of the finance committee of the board of System and is also National’s president and chief executive officer. The complaint alleges the amounts of cash balances maintained by System on deposit with National in non-interest-bearing accounts at the close of the fiscal years 1957 through 1961, ranging from $4,252,046 to $8,295,623. For the fiscal year ended June 30, 1962, it is alleged in the complaint that the average end of the month cash balances of System on deposit with National in non-interest-bearing accounts was $11,460,000 and that, during the fiscal year ending June 30, 1963, the cash balances in such accounts ranged from $4,036,000 to $17,980,000. The complaint alleges that these cash balances are excessive and unnecessary for the proper conduct of the business of System and that other retirement systems in the State, having assets even larger than those of System, deposit funds in more than one depository (unlike System) and maintain substantially lower non-interest-bearing cash balances. A list compiled by the Superintendent of Insurance reflects the comparison with three other retirement systems showing substantially larger deposits of System in proportion to total assets than in the case of the other retirement systems. Likewise, the absolute amounts of the deposits are alleged to be larger. Thus the New York City Teachers Retirement System, having larger gross assets than those of System, is alleged to have maintained an average monthly amount of $2,459,000 on deposit with four banks in non-interest-bearing accounts for the fiscal year 1963; and the New York State Employees Retirement System, having larger gross assets than those of System, is alleged to have maintained an average monthly balance of $2,220,000 on deposit with three banks in non-interest-bearing accounts for the fiscal year of 1962.

The majority opinion appears to consider that, regardless of whether these deposits of System in non-interest-bearing accounts in National were excessive, no remedy is furnished by subdivision 3 of section 508 of the Education Law. We think that this conclusion is erroneous. The proper “use” of the funds of System, required by subdivision 3 of section 508, should be determined according to the pattern of the law applicable to interlocking directorates of private corporations. Not every transaction is prohibited between such corporations, but a court of equity will ‘ ‘ require the most careful scrutiny of transactions between the corporations represented by common directors, to the end that in the absence of arm’s length bargaining the scales may not, even through mistake or inadvertance, be unfairly tipped to one side or the other. ” (Chelrob, Inc. v. Barrett, 293 N. Y. 442, 461, per Lehman, Ch. J.) In Chelrob, the court continued by quoting from Geddes v. Anaconda Min. Co. (254 U. S. 590, 599) as follows: “ The relation of directors to corporations is of such a fiduciary nature that transactions between boards having common members are regarded as jealously by the law as are personal dealings between a director and his corporation, and where the fairness of such transactions is challenged the burden is upon those who would maintain them to show their entire fairness and where a sale is involved the full adequacy of the consideration. Especially is this true where a common director is dominating in influence or in character. This court has been consistently emphatic in the application of this role, which, it has declared, is founded in soundest morality, and we now add in the soundest business policy. ”

The circumstance that there was not a majority of interlocking directors does not alter this equitable rule of fairness where, as here, the common director or trustee was in position to be influential in both organizations (Globe Woolen Co. v. Utica Gas & Elec. Co., 224 N. Y. 483).

Unquestionably the transaction of current business by System requires considerable cash to be on deposit in checking accounts in order to make the payments required to retired members. Since the complaint was dismissed as insufficient in law, the parties have not had opportunity to present evidence to establish, within reasonable limits, how large such deposits of System should be. Equitable principles governing the conduct of fiduciaries dictate, however, that unlimited scope will not be allowed in transactions of this nature where common directors or officers are involved. These principles should be deemed to have been in the contemplation of the Legislature in enacting subdivision 3 of section 508 of the Education Law. In our judgment they would control even in the absence of that statute. Certainly System, of whose finance committee defendant McCabe is chairman, cannot legally deposit funds, however large, with National, of which Mr. McCabe is president and chief executive officer, without interest and exempt from court supervision. In the absence of evidence introduced at a trial, we are not called upon at this point to decide the limits of what would be fair amounts of such deposits in the normal course of System’s business. The outcome of a trial might show that such limits have not been exceeded. Nevertheless, in our view, the complaint should not have been dismissed as insufficient in law, apparently on the theory that the courts have no power nor responsibility in the premises.

Nonpayment of interest on these deposits is sought to be justified upon the ground that National rendered services to System as its customer principally in the processing of large numbers of checks in payment of retirement benefits. Since the complaint was dismissed on its face, however, and no answer was interposed nor any issue presented with respect to how much such services were worth, nor whether they equalled or exceeded in value whatever interest System may have been entitled to be paid on these deposits, this contention is irrelevant at the present stage of the proceedings and cannot sustain the dismissal of the complaint.

The order appealed from should be reversed and the motion to dismiss the complaint should be denied, with costs to appellant in all courts.

Judges Burke, Scileppi, Bergan and Keating concur with Chief Judge Fuld ; Judge Van Voorhis dissents and votes to reverse in an opinion in which Judge Breitel concurs.

Order affirmed.