## Facts

- Minority shareholders of Guaranty Trust Company of New York brought a derivative action against directors and officers of Guaranty Trust, its wholly owned subsidiary (Guaranty Company of New York), and persons connected to J.P. Morgan & Co.
- Alleghany Corporation needed cash to satisfy a large payment obligation and planned to sell Missouri Pacific Railroad debentures, which were unsecured and subordinated.
- A structured transaction was approved in November 1930: J.P. Morgan bought $10 million of the debentures at par and gave Alleghany a six-month option to repurchase at par.
- Guaranty Trust committed to participate in the purchase with J.P. Morgan.
- Guaranty Company agreed that if Alleghany did not exercise its option, Guaranty Company would take the bonds from Guaranty Trust at par.
- The structure allocated upside to Alleghany (it could repurchase at par if prices rose) while leaving Guaranty and its subsidiary exposed to downside (Alleghany could walk away if prices fell).
- Bond prices declined during the six-month option period; Alleghany did not repurchase, and Guaranty Company took the bonds at par and later sustained substantial losses on disposition.
- Plaintiffs alleged the directors violated the duty of care and prudent banking standards by authorizing a highly risky and unnecessary arrangement.

## Issues

1. Whether the directors breached the duty of care by approving and implementing the Missouri Pacific bond transaction in light of its risk structure.
2. If there was a breach, whether damages should include the entire eventual loss or only the loss proximately caused by the negligent decision during the option period.
3. Whether liability attached to all directors or only those who participated in and voted for the approvals.

## Decision

- The court held that the directors breached the duty of care by approving a transaction deemed extraordinarily imprudent for a bank.
- The court limited recoverable damages to losses proximately caused during the six-month option period, rather than the full later decline while the bonds were held.
- The court imposed liability only on directors who were present and voted for the transaction at the relevant board meetings; nonparticipating directors were not held liable on that theory.
- The central fiduciary-duty analysis focused on the bank’s directors and officers rather than imposing the same liability theory on J.P. Morgan’s partners.

## Legal Principles

- Directors are not insurers of business outcomes, but they must act with honesty, diligence, and prudence; extreme departures from prudent judgment can constitute actionable negligence even absent self-dealing.
- The business judgment rule does not protect decisions that fall outside reasonable bounds of prudent banking practice, including arrangements that impose uncompensated downside risk while surrendering potential upside.
- It is contrary to prudent banking practice for a bank to purchase securities while granting the seller a right to repurchase at the same price, when the effect is to shift the entire risk of loss to the bank without a corresponding chance of gain.
- Director liability for damages is limited by proximate cause; recovery is confined to losses causally connected to the negligent act or omission, not all subsequent losses associated with later, distinct management decisions.
- Director liability is individualized; participation and affirmative approval at the relevant meeting is a key basis for imposing responsibility.

## Conclusion

The court found that the bank directors negligently approved an unusually one-sided securities transaction inconsistent with prudent banking practice, but confined damages to losses proximately caused during the six-month option period and limited liability to directors who participated and voted for the approvals.


Litwin v. Allen, 25 N.Y.S.2d 667 (N.Y. Sup. Ct. 1940)