Commercial Law Part 9

LIABILITY OF OFFICERS AND DIRECTORS TO THE CORPORATION.--Whether a corporation becomes liable by virtue of action taken by its officers or directors depends upon principles of agency applied to the law of corporations. These principles have already been stated. Whether the directors or officers are themselves personally liable is another matter. Conceivably they may be liable either to their employer (the corporation) or to creditors of the corporation. They are not directly liable to the shareholders as such. Any injury or wrong they may indirectly do to shareholders is directly done to the corporation, the shareholders being injured only because the corporation in which he is interested is injured. Shareholders may, however, inst.i.tute proceedings against directors or officers if, as not infrequently happens, the corporation itself, being controlled by the wrongdoers, fails to take proceedings. The shareholders in such a case, however, demand redress for the corporation, not for themselves; and whatever may be recovered, is recovered for the benefit of the corporation. The duty of the directors and officers of the corporation is a.n.a.logous to the duty of any agent to his princ.i.p.al. That is, each officer or director must exercise reasonable diligence in the performance of his work and must observe fidelity to his princ.i.p.al. The application of these principles to particular fact is not always easy, but the principles themselves are plain. Especially the degree of care which directors are bound to use presents a troublesome question of fact. In a small business it may be the duty of a director to take active control of the policy of the company and supervise with some minuteness each business operation. Such direction is impossible where a great railroad or industrial corporation is concerned. In such a case directors necessarily derive their information from subordinate agents and cannot investigate facts for themselves. Directors are not liable for mistakes of judgment if they use reasonable care; if, however, they wilfully do an act which they know is not authorized by the charter or by-laws of the corporation, they will be liable for the consequences. Directors who are cognizant of wrongs committed by their co-directors and fail to take available measures to prevent the wrongs, become liable themselves. Directors may terminate their liability for future acts by resigning, but resignation will not destroy liability for acts already done even though the resulting damage does not happen until after resignation. The corporation requires that a director or other officer shall not act on behalf of the corporation in a matter in which he has a personal interest at variance with that of the corporation. Should matters of this sort arise, as they often do, the interested officer or director should not take part in the decision of the question, and may render himself liable if he does so.

LIABILITY OF OFFICERS TO CREDITORS.--So long as a corporation is solvent, creditors of the corporation have no reason or right to seek redress from any one but the corporation itself. Creditors of an insolvent corporation, however, may enjoin action by the company's officers which is unauthorized or likely to prove detrimental to the a.s.sets of the corporation. If the officers knowingly misapply the a.s.sets of an insolvent corporation they are personally liable to the creditors for the injury caused thereby. They are liable sometimes by statute, but also even apart from statute, for false statements of the condition of the corporation in reliance upon which credit is given the corporation.

Like other agents, the officers of a corporation impliedly warrant to persons with whom they deal their authority to do the acts which they undertake; and if authority is lacking, they are liable personally. The only qualification of this principle is that if the facts from which authority, or lack of it, may be determined, are known to the person dealing with them, they are not liable; that is, they do not warrant the correctness of an inference of authority from known facts.

LIABILITY OF BANK OFFICERS.--The principles governing the liability of bank directors and other officers of a bank are the same as those which govern similar questions regarding other corporations. The bank laws, however, impose certain duties and penalties which affect the application of general principles. It may be worth while to enumerate briefly some of the duties of different bank officers, a violation of which renders them personally liable. As to directors it has been said that "It is not necessary to show directly that the directors actually had their attention called to the mismanagement of the affairs of the bank, or to the misconduct of subordinate officers. It is sufficient to show that the evidence of the management or misconduct were such that it must have been brought to their knowledge unless they were grossly negligent or wilfully careless in the discharge of their duties." They are liable for the consequences not only of their own fraud but of their ultra vires acts. They are liable for approving the discount of notes known to be worthless or of so doubtful value as to be obviously unsafe.

If guilty of negligence in failing to discover that such paper was worthless they may also be liable. They are guilty of negligence and may thereby render themselves liable if they wholly neglect to ascertain the condition of the bank from its books, though a thorough examination of the books of a bank, especially of one transacting a large business, cannot be expected of every director; and the law would require no more than would be demanded by the standard of reasonableness.

THE PRESIDENT.--The duties of the president, and consequently his liabilities, must be determined by general law, the charter of the particular inst.i.tution, its by-laws, and by general business usage.

Thus, if the usage exists for the president to draw and sign checks in the absence of the cashier, the president will have authority so to act.

He has authority to conduct the litigation of the bank; he may employ counsel. He may generally indorse negotiable paper of the bank. On the other hand, he will be personally liable if he permits improper loans or over-drafts; if he fails to give proper instructions to inferior officers; if it is his duty to require a bond from an inferior officer, and he fails to do so; and, generally, if he commits a breach of duty to the corporation which causes damage. He has no power to execute deeds of real estate without authority of the directors and, generally, an instrument which must be executed under the seal of the bank must be authorized by the board. The discount of negotiable paper also is a duty of the directors.

THE CASHIER.--The Supreme Court of Maine has thus expressed the functions of the cashier of a bank: "A cashier, it is well known, is allowed to present himself to the public as habitually accustomed to make payment for its bills or notes payable to other persons; to make payment for bills and notes discounted by the directors; to receive payment for bills of exchange, notes, and other debts due to the bank; to receive money on deposit and to pay the same to the order of the depositors. He is presented as having the custody of its books, bills of exchange, notes, and other evidences of debt due to it, and, indeed, of all its movable property; as making entry in its books and as keeping its accounts and a record of its proceedings. In many banks these duties are performed in part by tellers, clerks, or a.s.sistants, but generally, it is believed, under his superintendence, and he might at any time a.s.sume the performance of them and perform them, if able to do so, without such a.s.sistance. His true position appears to be that of a general agent for the performance of his official and accustomed duties.

While acting within the scope of this authority he would bind the bank, although he might violate his private instructions." He must exercise proper oversight over subordinate officers; he must use reasonable care and skill. He may become liable personally for failure to observe instructions as to a special deposit; for the improper sale of stock held as security for a loan; for improperly making loans, for failure to give essential information to the directors; for failing to exercise proper oversight over inferior officers or agents, as well as in the more obvious case where he has taken advantage of his position to commit intentional fraud upon the bank.

BLUE SKY LAWS.--The term "blue sky" has become very familiar to the corporation lawyer in the last few years. The so-called "blue sky"

legislation is a well meaning, if partly futile, attempt to meet an existing evil in connection with the sale of corporate securities. We shall find later that five elements are necessary to const.i.tute the action of fraud or deceit: (1) a false representation of a material fact; (2) made with knowledge of its falsity; (3) with intent that it be acted upon; (4) that it be acted upon; (5) damage follows. The courts have almost universally held that a mere statement of opinion does not give rise to a cause of action for fraud, whereas a mistatement of fact does. Hence if I state to you when selling you 100 shares of the Bonanza Gold Mining Corporation that the company has never paid less than 20% in dividends during the last five years and you purchase the stock relying on this misrepresentation of fact (the situation actually being the company has never paid a dividend) you would have a cause of action in deceit against me. If, however, I had simply said in selling you the stock that the outlook for the company was the brightest in its history, that the president had told me that dividends of 30% a year were a.s.sured indefinitely and that this stock was by far the best bargain which had been on the market in over a year, although I know when I made such statements that there was little or nothing to substantiate them, nevertheless, I would not be liable in deceit. My statements were merely matters of opinion or what we call "seller's talk" or "puffing one's wares."

THE FINANCIAL PROSPECTUS.--If you will examine the average financial prospectus of a new stock being offered for sale to the public, you will find that when most of the high sounding terms and flattering statements are a.n.a.lyzed carefully that they will fall in this second cla.s.s of non-actionable statements. There are few statements of fact but many glowing statements in the nature of "seller's talk." We all know, however, that enormous quant.i.ties of worthless stock are sold each year by this method. When business conditions are good it sometimes seems as if the wilder the scheme the easier it is to find a gullible public ready to purchase such securities. To prevent the perpetration of such frauds on the public is the object of the so-called "blue sky"

legislation.

THE LAW a.n.a.lYZED.--The first "blue sky" law was pa.s.sed in Kansas in 1911. The evil sought to be remedied was so prevalent that the idea spread rapidly and now similar legislation, of one type or another, has been enacted in a majority of the States. Some of the acts are crude, some have been held unconst.i.tutional, and many are difficult of enforcement. Recently, however, more care has been taken in drafting such legislation, and many of the earlier laws will undoubtedly be amended to conform with this later legislation. We may take the Illinois statute of 1919 as a good sample of a drastic yet fairly workable Act.

The law may be briefly considered from three standpoints: (1) the persons affected; (2) the securities affected; (3) the penalties provided for violation of its provisions.

AS TO THE PERSONS AFFECTED.--Generally any person offering any securities, and any seller's agent or broker, the issuer, or any agent or director of the issuer, or any owner or dealer, is covered by the Act. Illinois fiscal corporations such as banks, trust companies, insurance companies, building and loan a.s.sociations and the like are practically exempt from the provisions of the Illinois securities law.

THE ILLINOIS ACT.--The Illinois act covers the following securities:

Section 3. For the purposes of this Act securities are divided into four cla.s.ses as follows:

(1) Securities, the inherent qualities of which a.s.sure their sale and disposition without the perpetration of fraud, which shall be known as securities in Cla.s.s "A";

(2) Securities, the inherent qualities of which, or in the nature of one or both parties to the sale thereof, a.s.sure their sale and disposition without the perpetration of fraud, which shall be known as securities in Cla.s.s "B";

(3) Securities based on established income, which shall be known as securities in Cla.s.s "C";

(4) Securities based on prospective income, which shall be known as securities in Cla.s.s "D";

Section 4. Securities in Cla.s.s "A" shall comprise securities:

(1) Issued by a government or governmental agency, or by anybody having power of taxation of a.s.sessment;

(2) Issued by any National or State bank or trust company, building and loan a.s.sociation of this State, or insurance company organized or under the supervision of the Department of Trade and Commerce of this State;

(3) Issued by any corporation operating any public utility in any State wherein there is or was at the time of issuance thereof in effect any law regulating such utilities and the issue of securities by such corporation;

(4) Appearing in any list of securities dealt in on the New York, Chicago, Boston, Baltimore, Philadelphia, Pittsburgh, Cleveland or Detroit Stock Exchange, respectively, pursuant to official authorization by such exchanges, respectively, and securities senior to any securities so appearing;

(5) Whereof current prices shall have been quoted from time to time for not less than one year next preceding the offering for sale thereof, in tabulated market reports published as news items, and not as advertising, in a daily newspaper of general circulation, published in this or in an adjoining State, including the State of Michigan, not including any trade paper or any paper circulating chiefly among the members of any trade or profession;

(6) Issued by any corporation organized not for pecuniary profit or organized exclusively for educational, benevolent, fraternal, charitable or reformatory purposes;

(7) Being notes or bonds secured by mortgage lien upon real estate or leasehold in any State or territory of the United States or in the Dominion of Canada, when the mortgage is a first mortgage on real estate, and when in case it is not a first mortgage lien or is on a leasehold, the mortgage and notes or bonds secured thereby (not including interest notes or coupons) shall each bear a legend in red characters not less than one-half inch in height, indicating (1) that the mortgage is on a leasehold, if that be the case, and (2) that the mortgage is a junior mortgage, if that be the case;

(8) Being a note secured by first mortgage upon tangible or physical property, when such mortgage is a.s.signed with such securities to the purchaser;

(9) Evidencing indebtedness due under any contract made in pursuance to the provisions of any statute of any State of the United States providing for the acquisition of personal property under conditional sale contract;

(10) Being negotiable promissory notes given for full value and for the sole purpose of evidencing or extending the time of payment of the price of goods, wares or merchandise purchased by the issuer of such notes in the ordinary course of business, and commercial paper or other evidence of indebtedness running not more than twelve months from the date of issue;

(11) Being subscriptions for the capital stock under any license issued to commissioners to incorporate a company under the laws of this State where no commission or other remuneration paid for the sale or disposition of such securities;

Securities in Cla.s.s "A" and the sales thereof shall not be subject to the provisions of this Act.

Section 5. Securities in Cla.s.s "B" shall comprise securities:

(1) Sold by the owner for the owner's account exclusively when not made in the course of continued and repeated transactions of a similar nature;

(2) Increased capital stock of a corporation sold or distributed by it among its stockholders without the payment of any commission or expense to solicitors, agents or brokers in connection with the distribution thereof;

(3) Sold by or to any bank, trust company, or insurance company or a.s.sociation organized under any law of this State or of the United States, or doing business in this State under the supervision of the Department of Trade and Commerce; or of the auditor of Public Accounts; or by or to any building and loan a.s.sociation organized and doing business under the laws of this State, or any public sinking fund trustees; or to any corporation or dealer or broker in securities;

(4) Sold or offered for sale at any judicial, executor's or administrator's sale, or at any sale by a receiver or trustee in insolvency or bankruptcy, or at a public sale or auction held at an advertised time and place;

Securities in Cla.s.s "B," when disposed of by the persons and in the manner provided by this section, shall not be subject to the provisions of this Act.

Section 6. Securities in Cla.s.s "C" shall comprise the following:

Those issued by a person, corporation, firm, trust, partnership or a.s.sociation owning a property, business or industry, which has been in continuous operation not less than two years and which has shown net profits, exclusive of all prior charges, as follows:

(1) In the case of interest-bearing securities not less than one and one-half times the annual interest charge upon all outstanding interest-bearing obligations;

(2) In the case of preferred stock not less than one and one-half times the annual dividend on such preferred stock;

(3) In the case of common stock not less than 3% per annum upon such common stock.

Section 7. Securities in Cla.s.s "C" may be disposed of, sold or offered for sale upon compliance with the following conditions, and not otherwise:

A statement shall be filed in the office of the Secretary of State:

(1) Describing the evidence of indebtedness, preferred stock or common stock intended to be offered or sold;

(2) Stating the law under which and the time when the issuer was organized;

(3) Giving a detailed statement of the a.s.sets and liabilities of such issuer and income of profit and loss statement, and giving an a.n.a.lysis of surplus account;

(4) Giving the names and addresses of its princ.i.p.al officers and of its directors or trustees;

(5) Giving pertinent facts, data and information establishing that the securities to be offered are securities in Cla.s.s "C."