Neese v. Brown

• Decision Date: 04 June 1964
• Citation: Neese v. Brown, 218 Tenn. 686, 405 S.W.2d 577, 22 McCanless 686 (Tenn. 1964)
• Parties: , 218 Tenn. 686, 25 A.L.R.3d 932 G. Royal NEESE, Trustee, v. Scott N. BROWN et al.
• Court: Tennessee Supreme Court

Page 577

405 S.W.2d 577

22 McCanless 686, 218 Tenn. 686, 25

A.L.R.3d 932

G. Royal NEESE, Trustee, v. Scott N. BROWN et al.

Supreme Court of Tennessee.

June 4, 1964.

John T. Fort, John A. Chambliss, Chattanooga, for appellants, John P. Gaither, Leonard R. Tanner, Jr., Taber, Chambliss & Stophel, John T. Fort, Dietzen, Graham & Dietzen, Spears, Moore, Rebman & Williams, Coffey, Durand, Coffey, Chambliss, Chambliss & Hodge, Harry J. Schaeffer, Chattanooga, of counsel.

W. A. Wilkerson, Chattanooga, for appellee.

OPINION

BURNETT, Chief Justice.

The bill, as amended and supplemented, was filed by G. Royal Neese as Trustee in Bankruptcy of the First Trust Company, Bankrupt, against the defendants who were directors of said company, for losses sustained by that company as the result of the failure of the defendants to use due care and diligence in the discharge of their duties as such directors.

The defendant directors filed demurrers and pleas in bar. The Chancellor overruled the demurrers, and overruled the pleas in bar and allowed a discretionary appeal. The questions presented have been ably briefed and argued. After spending several days studying this matter, the authorities cited in the briefs, and making an independent investigation, we now have the matter for disposition.

The bill charges the defendants with numerous acts and failures to act which, it is said, constituted negligence and likewise charges these defendants with the failure to use reasonable care and diligence in the discharge of their duties as directors of this trust company, which, it is said, caused substantial losses to the company.

Briefly the acts of negligence charged are: (a) failure to give as much time and attention to the affairs of the corporation as the care of its business interests required; (b) virtual abdication of their control of the corporation by turning the entire management of the corporation over to its president, Scott N. Brown; (c) failure to inform themselves of the affairs, condition and management of the corporation; (d) ignored their duties as directors and paid no attention to the company's affairs; (e) took no action to direct or control the company, its officers and agents; (f) permitted large, open unsecured loans to be made by the company to affiliated companies which were dominated, controlled and owned by the said Scott N. Brown, and said companies were not financially sound; (g) failed to examine the financial reports on the company prepared by a firm of public accountants, which financial reports the defendants knew existed, and which an examination by them would have disclosed the continuing unsound and disastrous financial practices of the company; (h) reliance on selected portions of said reports read to them by the said Brown, and failed to insist on being furnished with said reports, and failure to examine the same, which reports and an examination thereof would have disclosed the illegal diversions of the company's funds and waste of its assets; (i) failure to exercise proper oversight and supervision of the officers and directors of the company.

The bill likewise averred that the negligence, malfeasance, misfeasance and non-feasance on the part of these directors was the direct and proximate cause of large losses suffered by the company.

The bill also alleges that the affiliated companies to whom the loans were made are insolvent, that two of them are in bankruptcy, that the Trustee has obtained judgments against two of them but the judgments are uncollectable, and that the loans cannot be collected.

The demurrers, as amended and supplemented, consist of many grounds. These grounds though may be consolidated in that (1) they allege that the averments of the bill are insufficient to state a cause of action against the defendants; (2) that the suit is premature; and (3) that complainant as Trustee in Bankruptcy cannot maintain an action for negligence against the directors of the bankrupt corporation.

After these demurrers were overruled the pleas in bar were filed averring that the complainant was barred from recovery and estopped to bring this suit because the stockholders had ratified and approved the acts of the directors and officers, and that the Trustee in Bankruptcy having obtained judgments on two of the claims on which this suit is predicated he could not pursue the matter further.

It is generally held that the liability of the directors and other officers of a corporation is not limited to wilful breaches of trust or excessive power but also extends to negligence. What constitutes such negligence? In Fletcher's Private Corporations, Vol. 3, 1947 Rev.Ed., § 1029, page 541, the author after discussing the question at some length says this:

'The fact remains, however, that, except as already stated, the courts are practically unanimous in their general statements that directors and other corporate officers must be diligent and careful in performing their duties; that the directors must be something more than mere figureheads, etc. And in recent years, courts have in general held directors of corporations to a higher standard of duty than was formerly the rule. A stricter rule has become necessary by a growing inclination on the part of officers and directors of large corporations to consider their personal interests and profits to the exclusion of the rights and interests of a large and uninformed body of stockholders. Whether or not a court will act must be determined by the facts developed on the trial, with the complaining stockholders carrying the burden of proof. Accordingly, it is held that liability may result from mere inaction on their part, where such inaction is the proximate cause of a loss. Likewise, a director is chargeable with knowledge actually possessed or which he might have possessed had he diligently discharged his functions. Ignoreance of performance of illegal acts which is the result of inattention does not exculpate.'

This standard or requirement of directors of any private corporation is well set forth by this Court in Wallace v. Lincoln Savings Bank, 89 Tenn. 630, at page 653, 15 S.W. 448; and in Shea v. Mabry, 69 Tenn. 319, beginning on page 342 and extending over to 343. It is true that these duties devolving upon directors of a company like this, or any other corporation, is not the direct problem in these cases, but these duties as set forth in these two Tennessee opinions referred to are particularly applicable in a suit against the directors of any corporation.

In reference to whether or not the allegations in this bill come within the alleged acts of negligence wherein these directors are charged with such acts, the averments of the bill fit the statements made by this Court in the two cases last above cited as to what the duties of the directors of a corporation are. The opinion in the Wallace case was prepared for this Court by Judge Lurton, who afterwards so wonderfully graced the Supreme Couret bench of the United States. It might not be amiss to again quote what he said there, because what is so well said by him is equally applicable today, even though the opinion was written some seventy odd years ago. He said:

'Directors, by assuming office, agree to give as much of their time and attention to the duties assumed as the proper care of the interests intrusted to them may require. If they are inattentive to their duties, if they neglect to attend meetings of the board, if they turn over the management of the business of the company to the exclusive control of other agents, thus abdicating their control, then they are guilty of gross neglect with respect to their ministerial duties, and, if loss results to the corporation by breaches of trust or acts of negligence committed by those left in control, which by due care and attention on their part could have been avoided, they will be responsible to the corporation. The diligence required from them has been defined as that exercised by prudent men about their own affairs, being that degree of of diligence characterized as ordinary. If a less degree of diligence is exercised, the negligence is gross, and for losses consequent he is liable. 'What constitutes a proper performance of the duties of a director,' says Mr. Morawetz, 'is a question of fact, which must be determined in each case in view of all the circumstances,--the character of the company, the condition of its business, the usual method of managing such companies, and all other relevant facts must be taken into consideration.' Mor.Priv.Corp. § 552.'

After very carefully reading and re-reading this bill we think that it does state a cause of action against the directors for nonfeasance and mismanagement of the corporate affairs, including the standard of care and duties imposed upon the directors as hereinabove set forth. The assignments of error which embody the first thirteen grounds of the demurrers to the effect that the allegations of the bill are insufficient to state a cause of action against these defendants are consequently overruled.

Most courts hold that a director, or other officer, of a corporation, although not responsible for errors of judgment is a fiduciary charged with the duty of caring for property of the corporation and managing its affairs honestly and in good faith. Manning v. Campbell, 264 Mass. 386, 162 N.E. 770. From our very thorough study of the matter we have concluded that there is no appreciable conflict of opinion among the courts as to the liability of directors as hereinabove set forth.

'In most jurisdictions ordinary or reasonable care and diligence is the test, * * *' Fletcher, supra, § 1035, page...