Lead Opinion
The careful and extended opinion in the district court is reported in
The defendant seeks to distinguish York v. Guaranty Trust Co., 2 Cir.,
Hazzard v. Chase National Bank,
Thus we come to the consideration of how far, if at all, the collection of the loan in the spring of 1932 conflicted with the bank’s duty to the plaintiff’s bondholders. If it did conflict, the power to collect should have yielded to the duty of loyalty, for all powers are to be interpreted as conditional upon observance of that duty. Although the judge found that the bank knew the financial condition of “Ageco” to be “bad,” neither in his findings nor in his opinion did he define what that adj ective meant, except in so far as that may be inferred by his saying that it did not know that “Ageco’s” “condition was ‘bad’ enough * * * to be insolvent or in imminent danger of insolvency.” He did indeed hold that it “had notice of facts which would lead a man of ordinary prudence — a bank at least — to make inquiry,” but he also found that it had done so, for it “was not obligated to make more than a reasonably diligent inquiry,” and a thorough-going inquiry would have been more laborious and expensive than could be “reasonably” demanded. So we shall assume. On the other hand, the record is full of evidence that in the spring of 1932 the bank’s officials were most uncertain whether the “System” would be able to refund its long term debts and loans which were very soon to become due. Its lawyers had advised it that the first proposed expedient — an issue of a new “Age-co” series, guaranteed by “Agecorp” — was unlawful and about the second proposal— the “Agecorp 8s” — the lawyers were in some doubt; and it must be owned that, so far as concerned “Ageco’s” covenants and in view of its absolute control of “Age-corp,” it is very hard to understand why it was in substance any better than the first. After the bank had repeatedly examined the financial condition of the “System” at length, it was by no means certain that it would survive the crisis which in 1932 was so ominous. It is true that it thought it more likely than not that the “System” would survive but the future was most insecure.
This insecurity was certainly what the judge meant when he found that the bank knew that “Ageco’s” condition was “bad”;
We cannot agree that with such knowledge and such a forecast of “Age-co’s” immediate future the bank was justified in collecting the loan. We say “collected” advisedly, not forgetting that over one fourth of it was paid before i-t became due. Nobody questions that “Ageco” would have welcomed an extension and asked for one; nobody doubts that it needed every dollar of credit that it could squeeze out. A creditor who accepts payment of part of a loan before it is due, from a debtor known to be “fighting for its, life,” and who insists upon security for the balance when it is due, has not merely sat by, receptive to the debtor’s voluntary advances; he has compelled payment; and to compel payment when the debtor’s survival was as doubtful, as the bank’s own declarations
It is hornbook law that the beneficiary’s remedies for a breach of trust are the recovery of any damages which may result, or of any profit which -the trustee may have gained. Restatement of Trusts §§ 205, 206. In the case at bar the amount of the damages and of the profits is the same, unless we hold, as the plaintiff wishes us to hold, that the damages include the whole sum collected, $4,000,000. That would result in the plaintiff’s bondholders’ receiving, not alone the assets which the bank took away from them, but in addition an added payment of whatever should turn out to be the value of the bank’s rights in the reorganization, for -the bank was entitled to that amount anyway. Adopting a phrase in our opinion on the former appeal, the plaintiff calls this the bank’s “right of subrogation”; and asks us to forfeit it because of the bank’s misconduct. It is true that courts have denied any compensation for a trustee’s services, if he has been guilty of a breach of trust; and have even refused to allow him his expenses, except in so far as they have benefited the estate. Restatement of Trusts §§ 243, 245. But we know of no case in which a court has forfeited his preexisting rights because of a breach of duty, that would be penalty, pure and simple. The nearest analogy is that of a creditor who receives a preference, voidable in bankruptcy, and after a good deal of confusion (owing, however, only to the terms of the statute) it was finally settled that such a creditor did not forfeit his claim. Keppel v. Tiffin Savings Bank,
However, we have hitherto assumed that the plaintiff may recover the entire profit which the bank made, and that is not a necessary consequence of the breach. Two
There remains the second claim: i. e. that the bank should be held liable for its profit, if any, upon the exchange of securities on August 28, 1934; or in the alternative that it should be compelled to rescind the exchange. We shall assume arguendo that at the time of the exchange the financial condition of the “System” as a whole had grown worse than in 1932 — that of “Ageco” along with the others- — ; and, if so, the risk had correspondingly increased that the plaintiff’s bondholders would not be paid. The “Recap Plan” did in the end stave off insolvency for about five years; but it was uncertain in August, 1934, how many of the “Ageco” bondholders would accept any of the proposed options, and -therefore whether the “Plan” would be successful. -That does not, however, answer the question whether any profit made by the bank upon the exchange was a breach of loyalty to its beneficiaries, until we have determined what was the probability that any such profit would reduce -the dividend of the plaintiff’s bondholders in the event of “Ageco’s” insolvency. Owing to the labyrinth of intercorporate relations which Hopson had contrived, the answer is not easy. Except for $52,000 of securities which we shall disregard, the only securities tha-t the bank received on the exchange, and out of which it could make any profit, consisted of bonds of the “Associated Electric Company,” a holding company, whose assets were for the most part the stocks, notes and bonds of two holding and two operating companies, whose assets gave to the bonds substantially all their value. A report of one, Robinson, to the bank at the time of the exchange gave these bonds a favorable rating so far as concerned the obligor’s income; but the plaintiff’s witness, Hartt, valued them at 82 and their price in the market was only 35%, which Love appears to have accepted. Even at 82 the bonds were on a more than six per cent basis, -and at 35% their basis was probably over 15 per cent; they were therefore at best uncertain, and the market obviously -thought them to the last degree speculative. The parties from which the bank received the bonds on the exchange were four corporations, three of which were holding companies, and the fourth an “investment” company, whatever that
Thus no profit made by the bank on the exchange could come out of the plaintiff’s bondholders unless all the following circumstances coexisted. (1) The corporations, whose securities made up the assets of the “Associated Electric Company,” did not themselves become insolvent, or at least that their assets did not pass a ‘substantial dividend to the “Associated Electric Company.” (2) The four corporations which owned the bonds and delivered them to the bank did not become insolvent, so that “Agecorp,” their shareholder, would receive something upon their shares which it held. (3) “Agecorp” itself remained solvent, so that “Ageco” its shareholder would receive something on “Agecorp’s” shares. (4) “Ageco” itself became insolvent. It was indeed a possibility that this particular chain of events would take place, though in fact it never did; moreover the bank was intimately acquainted with all the details of the “System.” However, it is not every possibility, however remote, of a conflict of interest between a trustee and his beneficiary which'will forbid his entering into a transaction with a third person. Although, as we have seen, the disabilities of a trustee, vis-á-vis his beneficiary, are to the last degree exacting, especially in New York, there must come a point at which he is not bound to take against himself a future chain of events, each link of which carries a substantial coefficient of improbability. Pushed with relentless logic, a possible conflict of interest can be conjured up out of all sorts of situations in which persons of normal scruple would feel no hesitation to go ahead. The law ought not make trusteeship so hazardous that responsible individuals and corporations will shy away from it. As we said in York v. Guaranty Trust Co., 2 Cir.,
It follows from what we have said that the judgment on the “Fourth Cause of Action” must be affirmed; but that the judgment upon the “Second Cause of Action” must be reversed, subject to final disposition after the supplementary briefs have been filed. The plaintiff will file his brief within thirty days after this opinion is filed; the defendant will file its answering brief within twenty days thereafter.
Judgment affirmed on the “Fourth Cause of Action.”
Notes
. Sidney Blumenthal & Co., Inc., v. Atlantic Coast Line, It. Co., 2 Cir.,
. Ten Eyck v. Craig,
. Scott on Trusts, § 170.
. Scott v. Ray, 18 Pick., Mass., 360, 366; First Trust Co. of Lincoln v. Ricketts, 8 Cir.,
. See for example, Anderson v. Bean,
Concurrence Opinion
(concurring in part and dissenting in part).
I am in complete accord with so much of the opinion as affirms the judgment on the “Fourth Cause of Action.” I am unable to agree with that portion of the opinion which holds -the defendant liable for accepting payment of its loa,n. The trust indenture expressly permitted the trustee to make loans to “Ageco.” A six months’ loan without security was made October 16, 1931. Partial payments were made in March 1932, before maturity, and the balance was paid May 11, 1932. I agree that a trustee, even though the trust instrument permits him to lend money to the settlor of the trust, is under a fiduciary duty not to collect the loan if he has reason to believe that collecting the debt will impair the likelihood of his cestuis receiving payment of debts owed by the settlor to them, but I cannot view this as such a case. The trial judge found that the proof did not establish that the Bank had reasonable cause to believe that Ageco was insolvent or in imminent danger of insolvency in March or May 1932. Judge Hand’s opinion recites facts which show that the Bank’s officials were uncertain whether the Ageco “System” would survive -the 1932 crisis and be able to refund its long term debts and loans which were soon to become due, and “thought it more likely than not that the ‘System’ would survive, but the future was most insecure.”. My brothers hold that this is enough to require the Bank to account for “profits.” I agree that if there was a breach of .fiduciary duty in collecting the debt the Bank’s “profits” should be determined as suggested in Judge Hand’s opinion. But I am not convinced -that there was a breach of fiduciary duty. The debtor did not go into bankruptcy until 1940. In 1932 there was no reason for the Bank to suppose that accepting payment of its debt would accelerate by a single day a bankruptcy which the debtor was able to avert for eight years or that, if the debt were not paid, the debtor would have one cent more of assets for distribution in a reorganization not then imminent. To this situation I would apply the same principle which leads us to -affirm the judgment on the fourth cause of action, namely, that “merely vague or remote selfish advantages to a trustee are not sufficient to prove such an adverse interest as to bring his conduct into question.”
(concurring in part and dissenting in part).
I concur in the opinion holding defendant liable for the repayment of the loan to itself and leaving the amount to be settled after the filing of briefs by the parties developing the issues. But I do not agree with the holding absolving defendant of any liability with respect to the second transaction complained of.
This latter transaction was an exchange of securities — under an agreement effected' by the Ageco management — between defendant Chase and four subholding companies of the system. Acting as an individual trader and not in its capacity as trustee, Chase delivered some $4,249,000 face amount Ageco debentures and other utility notes; in turn it received securities of certain lower constituents of the hierarchy. The district court did not get to the point of setting values to the securities involved and probably we should not attempt to do so here. But for purposes of our discussion of defendant’s legal liability we may assume the plaintiff’s claims- — based on the testimony of the expert Hartt, which was generally -accepted by. the court —that defendant received securities worth some two million more than it gave up. The opinion holds that defendant need not replace the securities or otherwise give up this advantage on the ground that possibility of loss to Ageco’s bondholders was too remote; since the securities received by defendant came from subholding companies some tiers down from Ageco, the resulting insulation mitigated possible effects on Ageco’s security holders to such an extent that they could not complain. But this, it seems to me, is based on an er
The basic principle of holding-company finance is that of leverage through pyramiding.
I cannot escape the conclusion from this that the security holders of the top holding company suffer first whenever assets — either operating properties or securities— are reduced within the system. And the further down an unfavorable exchange occurs, the more highly magnified its effect is on the upper tier of security holders. So the occurrence of the four circumstances which the opinion assumes necessary before the Ageco debentures would be injured by this unfavorable exchange — the insolvency of Ageco and the solvency of -the various undercompanies — does not appear unlikely or highly speculative. Ageco would almost inevitably be the first one unable to meet its interest and dividend requirements.
I take it to be clear that had Chase made the exchange directly with Ageco, its resulting gain is one that it would have to give up in view of its fiduciary obligations to the bondholders of Ageco and the latter’s insolvency. But here the situation is not different save -that the loss may be potentially greater as it ripples up through the tiers of companies.
I would therefore remand this part of the proceedings to the district court for findings as to the relative value of the exchanged securities. Such remand should probably await decision on the other branch of the case settling the appropriate rule-of damages if benefit is found.
. Bonbright & Means, The Holding Company, 1932; Comment, Section 11(b) of the Holding Company Act: Fifteen Years in Retrospect, 59 Yale L.J. 1088-1092.
. An excellent short description of this pyramiding effect is to be found in Trachsel, Public Utility Regulation 385-393, 1947.
. Barring the use of such dubious and more or less temporary devices as high-priced servicing contracts, asset write-ups, or inadequate depreciation reserves to pump income into the top levels when operating profits are inadequate. See Federal Trade Commission, Utility Corporations, Sen. Doc. No. 92, Part 72-A, 70th Cong., 1st Sess. 352-355, 440-448, 496, 847.