114 Litwin Vs Allen (Valera)

Litwin vs.
Allen AUTHOR: Valera

25 N.Y.S 2d 667 (1940) NOTE:
Duty Of Dilligence
Shientag, J:
FACTS:
 This is a derivative suit by the shareholders of Guarantee Trust Company of NY (Bank/Trust Company) and its
subsidiary now in liquidation, The Guarantee Company of NY (Guarantee Company) and together with the banking
firm of JP Morgan & Co.
 The derivative suit arises from 4 transactions:
1.) The purchase of the Directors from JP Morgan, of common stock owned by Alleghany Corporation
2.) Participation of the Trust Company or the Guarantee Company to the extent of 3 million in a purchase of
Missouri Pacific convertible debenture at 5.5 % bonds at par and interest with a repurchase option in favor of the
seller, Alleghany Corporation within 6 months. The plaintiffs claim that they realized a loss of 2.25 million
because of the transaction
3.) Participation of the Trust Company to the extent of 11 million in a 39 million loan to Veness Company and
Cleveland Terminals Building Company
4.) Sale of Collaterals under loan.
- THE COURT ALREADY RULED IN FAVOR OF THE DEFENDANT IN TRANSACTIONS 1,3 AND 4.
 The plaintiffs have conceded that that in all but the 4 stated transactions the defendants exercised an unusual degree of
care in the management of the company.
 The only transaction in question is the transaction involving the Missouri Pacific convertible debenture
 The debenture was originally owned by the Allegany Corporation which was then transferred to JP Morgan and then
eventually to the Trust corporation
 The Trust corporation in its agreement with JP Morgan chase stipulates that they shall purchase the debentures at the
amount of 10.5 thousand for 3 million. However they agreed on a buy back option in favor of the seller which was the
Alleghany Corporation for 6 months and then if they don’t exercise such option the Guarantee company would under
take such bonds.
 The Alleghany Corporation did such scheme in order to make it appear that such sale was not a loan n order to not go
over their borrowing limitation. for financing the purchase of terminal properties in Kansas.
 There was a continuous decline in the market at the time the Trust company’s Executive committee approved the
transaction the bonds were at 103-7/8 then on when the BoD of the Trust company approved it it was on 102-7/8
when the guarantee company approved its undertaking in the event that Alleghany does not exercise its buy back
option the price dropped to 95-7/8 at the end of the option period the bonds sold at high 86 and at low 81 and then the
Guaranty Company took over them at par and accrued interest and carried them on its books as an investment. There
was o evidence to indicate that the defendants acted in bad faith or profited or attempted to profit or gain personally
by reason of any phase in the transaction
 At the course of the transaction the Trust and Guarantee company’s stock holders claim that they realized a loss of
2.25 million from that transaction on which they fault the very disadvantageous buy back option hence the derivative
suit.
ISSUE(S):
 WON the buy-back option agreed by the trust company’s BoD is an Ultra Vires Act thus they are liable.
HELD:
1.) Yes.
RATIO:
1.) The court viewed in confusion on whether the transaction as that it was a purchase by the Trust Company with an
agreement by the Guaranty Company to repurchase if Alleghany fails to exercise its buy back option within 6
months or it was a purchase by the guarantee company wth a buy back option to Alleghany, financed for the frst 6
months by the Trust Corporation.
2.) The court held that its is against public policy where the bank purchases securities and gives the seller a buy back
option at the same price, thereby incurring the entire risk of loss wth no possibility of gain other than the interest
derived from the securities during the period that the bank holds them.
3.) In such case, if the market price falls the seller hoding the option will not exercise ts buy back option and the bank
would sustain the loss. And in any benefit of a shar rise in the price the seller is assured that any risk of heavy loss
is assumed by the bank. It is considered a short sale.
4.) In this case the Trust company on the outset relieved itself form liability to the bond when it had the guaranty
Company assume the bonds. The court held that the buyback option is ultravires.
5.) What sound reason is there for a bank desiring to make an investment to buy securities under an arrangement
whereby any appreciation will insure to the benefir of the seller and any loss will be borne by the bank. The BoD
failed to bestow the care which the situation demanded.
6.) Whichever way we look at the transaction, is it was so improvident, so dangerous, so unusal and so contrary to
ordinary bankng practice as to subject the irectors who approved it to liability in a derivative suit.
CASE LAW/ DOCTRINE:
DISSENTING/CONCURRING OPINION(S):

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