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Allen
1940
Shientag, J.
Digest by Clark Uytico
Topic: Duties of Directors and Controlling Stockholders
Summary:
The directors of a Trust Company bought securities issued by Missouri Pacific Rail from Alleghany with
an option to repurchase granted to the seller, Alleghany, at the same price it was bought by the Trust
Company. Hence if the market price of the securities should rise, the holder of the repurchase option
would exercise it in order to recover his securities from the bank at the lower price at which he sold
them to the bank. If the market price should fall, the seller holding the option will not exercise it and
the bank will sustain the loss. Thus, any benefits of a sharp rise in the price of the securities is assured
the seller and any risk of heavy loss is in evitable assumed by the bank. The court here held that the
act was not only ultra vires, but also inimical to the banking system, hence the directors are liable.
FACTS
Derivative stockholders action brought on behalf of persons owning 36 shares of the stocks of
Guaranty Trust Company (BANK for brevity). The defendants are the directors of the Guaranty Trust
Company of New York. There are 4 transactions involved, but the most significant one is the Missouri
Pacific Bond transaction.
This transaction involves the purchase by the bank (Trust Company or Guaranty Company or both) of
Missouri Pacific Convertible debentures, to the extent of 3 million dollars, on October 15, 1930, through
the J.P. Morgan and Co. firm, at par, from Alleghany Corporation, with the option of repurchase by the
seller, Alleghany, within a period of six months.
Alleghany needed money for its purchase of certain terminal properties in Kansas City and St. Joseph,
Missouri. Because of the borrowing limit in Alleghanys charter, which limitation it had already
exceeded, Alleghany was unable to borrow money. To overcome this borrowing dilemma, and solely to
enable Alleghany to consummate the purchase of the terminal properties, it sold some of the securities
it held among which is a large block of about $23,500,000 Missouri Pacific convertible 5-1/2%
debentures. These were unsecured and subordinate to other Missouri Pacific bond issues, but however,
they were convertible into common stock at the rate of ten shares for each $1000 bond. The only
purpose of this option was to make the transaction conform as closely as possible to a loan without the
usual incidents of a loan transaction.
Before the Trust Company made its written commitment to J.P. Morgan to participate in the bond
purchase, Guaranty Company (subsidiary of the Trust Company), committed itself to the Trust
Company to take up the bonds from the Trust Company at the end of the six-month period, for the
same price that the Trust Company paid.
During that time (1930), it must be remembered that the US has just suffered from the Great
Depression of 1929 (aka the October 1929 Wall Street Crash). The financial conditions of the US were
unstable and so, the prices of the bonds fluctuated. The decline continued and Alleghany was unable
to purchase back the bonds, prompting the Guaranty Company to purchase the same from the Trust
Company (the price had dropped to 98-5/8 of the original price).
Because of this, the stockholders involved commenced this suit against the directions, claiming a loss
of approximately $2,250,000 in this transaction alone.
ISSUE
1. WON the transaction was a loan.
2. WON the directors are liable for committing an act (repurchase option) contrary to banking policy,
and hence, ultra vires.
HELD
1. NO. It was NOT a loan.
2. YES. They are liable.