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The existing theory in the mechanics of corporate trusteeships is entirely different. The theory and practice has been that the trustee is primarily an agent of the bondholders, taking his instructions from them, and he rarely has any active duties prior to default; and subsequent to default the trustee, although in most present-day indentures it is given the right to take action on its own initiative, with proper exoneration clauses, acts primarily as an agent in carrying out the instructions of the security holders. The trust indentures generally provide that the trustee shall be under no duty to act unless a certain percentage of the security holders request it to do so, and that if it does act on such request with reasonable diligence it shall not be responsible for the consequences of such action; and, further, that it shall be exonerated for nonaction in the absence of any request on the part of the security holders.

Under existing practice the first thing a responsible trustee does when a default has occurred is to acquaint itself with the facts, contact bondholders, and seek instructions as to their wishes. The theory of the bill is to largely take away from the security holder the control of his own destinies and put that duty on the trustee. In view of the fact that a single corporate indenture frequently has an amount of securities issued thereunder in excess of the total capital assets of the trustee, it is readily apparent that a mistake or error in judgment or a course of action which might appear negligent to a jury after the event in a period of depression could bankrupt the trustee.

It has been my experience that it is very easy to put a corporation into the hands of a receiver or into bankruptcy, and it is generally a very difficult thing to get it out. Generally, and in normal times particularly, trustees, security holders, bank creditors, and the management work to avoid a receivership and bankruptcy because it involves loss to all of them. If a trustee is confronted with a possible liability for an action taken or omitted in good faith in the belief that it was to the best interests of the security

holders and has to consider that not a group of businessmen but an ordinary jury might surcharge him with being negligent, he will avoid a responsibility which may well break him, by following the easy and safe course of projecting the company into bankruptcy and putting the responsibility of action or nonaction up to the court.

On numerous occasions in my life as an officer of a trustee which was acting for security holders I have taken part in many conferences, extending days and nights, for weeks, seeking to determine what was the proper course of action and how receivership could be avoided. The proper course to pursue was always a matter of debate, and it rarely was clear. Some authority in the trustee, even with bondholder representation and advice, did eventually have to decide on a course of action or, in some cases, on a course of inaction. In most cases the problem was worked out without court proceedings and with the saving of the value of a going concern, to the great advantage of the indenture security holders. In some cases, viewed in retrospect, the course of action proved to be a failure. Negligence is a question of fact, and fact is a question for a jury under our system of law. A jury may be instructed by a judge to disregard subsequent events in determining negligence; but juries, being human, have a habit of being influenced by the subsequent course of events. Hindsight is allknowing. It is for these reasons that the trustee ought to have exoneration beyond the scope contemplated in this bill.

It is for these two reasons—first, the danger to the banks and banking structure of the country of the imposition of liabilities contemplated by this bill, and secondly, the danger that trustees, under fear of liability, will force concerns that could otherwise be saved, into bankruptcy or 77B—that I think the provisions of the bill in respect to the liabilities assumed by the trustee should be qualified, and exoneration of the trustee should be greatly liberalized and definitively stated in the bill.

In conclusion, I would be lacking in candor if I did not express my personal conviction that the subject matter of this legislation, in its relation to a delicate economic, financial, and banking structure, is of such public interest that it deserves a more complete exploration and study before it is incorporated into statutory law. If we are to have legislation at this time, my suggestion is that it might well be confined to the conflict features of the bill. Further, if we are to have legislation including the "active" trustee features of the bill, I urge that the bill be amended so as to afford definitively in the bill proper exonerating provisions for the trustee's protection. Finally, if the bill is to be passed substantially in its present form, I would urge that the Federal Reserve Board be required to concur in rules and regulations of the Securities and Exchange Commission having to do with the active responsibilities of the trustee and the exoneration afforded the trustee.

I have not come here with any prepared amendments to cover the points I have raised, because I believe the drafting and editing of the language of the bill should remain in the hands of people who know its structure through past contact with it, and I am quite ready to accept the draftmanship of the Securities and Exchange Commission and the committee of the American Bankers Association, who together have been editing the bill.

I might add that at lunch I did, with Mr. Amberg, prepare an amendment to the exoneration section, which I can submit and leave with the committee, if it so desires.

As a judge, Mr. Chairman, you know that the difference between negligence and gross negligence is very wide. I do not think any trustee desires to be exempt from clear negligence; but I also do not think that any responsible trustee wants to have a common jury, after the event, and in the light of the unfortunate circumstances, pass on whether a certain standard of conduct has been negligence.

Gross negligence is a term which is well understood. It is probably too broad for the purposes of this bill.

Senator TOWNSEND. Would you care, Mr. Brown, to work out a series of amendments which would carry your ideas into the bill, or can you submit such an outline to the committee?

Mr. BROWN. I could. The CHAIRMAN. I think that would be the better plan. Mr. BROWN. I can submit an amendment on the mandatory clause. If the committee cares to ask me any questions about any sections of the bill, I would be glad to discuss them.

The point that I want to make, particularly in view of the liabilities of the trustee, is that while the trustee might be willing to submit to judgment on its conduct as to whether or not it was negligent, to a group of men who were familiar with reorganization procedurewith what had to be done under such circumstances—it does not want to be placed at the mercy of a jury on the question of fact, where the judgment of a jury is conclusive as to whether or not the trustee was negligent.

It was my thought that some word should be chosen which would be an affirmative standard, and which would provide that if the trustee does certain things, he shall be exonerated.

Gross negligence is probably too strong a term to use, but there may be some intermediate term, such as “clear negligence", that could be used.

The CHAIRMAN. I think that so far we have "reasonable care” and "gross negligence.” What is there in between? Mr. Brown. You have got a proviso, as I understand it

The CHAIRMAN (interposing). I am speaking now of the different degrees of negligence that are ordinarily used. In some cases only the care that a reasonably prudent person would use is required; in other cases one is required to use extreme care, the care that an extremely prudent person would use. There is that distinction in negligence.

Mr. Brown. I fully concur in Mr. Posner's remarks. If you go beyond the degree of care which a prudent man occupying any fiduciary position should exercise, you get into a new realm of conjecture, which the courts have not yet passed upon. I think there is a difference between negligence, clear negligence, and gross negligence.

The CHAIRMAN. I do not know the distinction between negligence and clear negligence. I do not know what you have in mind there.

Senator TOWNSEND. Mr. Brown says gross and clear.

The CHAIRMAN. Gross and reasonable are the two. We have reasonable care and gross negligence.

Mr. Brown. I think language could be found to provide an intermediate ground, which would protect the trustees against the vagaries of juries, particularly when there has been a group of bondholders which has suffered a great loss, on the one side, and a large bank or corporation on the other side. Juries are bound to be prejudiced and are bound to look at the action of a trustee in the light of subsequent events and not in the light of events as they existed at a prior time.

The CHAIRMAN. Of course, when we say reasonable care, we always measure it by what a reasonably prudent person would do under like circumstances, and I suppose that one acting in a fiduciary capacity, using that definition, would be subject to a higher degree of care than one who was just sweeping a sidewalk or doing something of that kind.

Mr. BROWN. I grant that.

Senator TOWNSEND. Mr. Brown, you and Mr. Posner are agreed on many of your objections to the bill, are you not?

Mr. Brown. We are agreed on some of them; I do not think we are at all agreed on others.

Senator TOWNSEND. I think that if we could get the amendments which would revise the bill in accordance with your views, they would, at least, help the committee to understand your contentions.

The CHAIRMAN. I think you have enough help. You ought to be able to prepare the amendments to carry out your objections.

Mr. BROWN. All right. I know, however, from experience in drafting legislation, that it is a very difficult and dangerous matter to attempt to amend one section of the bill without throwing a lot of the other sections and provisions of the bill out of kilter.

The CHAIRMAN. The committee will have to assume that responsibility eventually.

Mr. Brown. Thank you, gentlemen.
The CHAIRMAN. Mr. Canright, would you care to be heard?
Mr. CANRIGHT. Yes, Mr. Chairman.

(The following is a letter from Mr. Brown presenting certain amendments in accordance with the committee's suggestion:)

FIRST NATIONAL BANK,

Chicago, June 25, 1937. Hon. ROBERT F. WAGNER, Chairman of the Committee on Banking and Currency,

United States Senate, Washington, D. C. DEAR SENATOR WAGNER: Complying with your request at Tuesday's hearing on the Barkley bill before your committee, I am submitting amendments which, I am definitely convinced, represent the minimum required to protect the securityholders' interest and to safeguard trustees to the end that responsible and experienced trustees may be available and participate in the essential function of corporate financing under conditions that will not place the banking structure of the country in serious jeopardy. I will note in connection with each proposed amendment the reason underlying its suggestion. My references will be to committee print no. 2.

As to the security holders:

1. To meet the requirements of local financing of local industry in other than the biggest cities and to lessen to that extent at least the tendency of the bill to force corporate financing and corporate trusteeships into the biggest financial centers (where local conditions and what is good for the local obligor and the security holders is not as intimately known) and further to protect the security holders_ by keeping open the obligor's lines of current short-term commercial credit, I urge that the prohibition against loans by a trustee should be eliminated, and that the apportionment penalty provision of subsection (c) be applied to all “penalized" loans, eliminating the question of proof. The potentiality of a detrimental conflict of interest does not justify the prohibition against loans, particularly when in most cases the conflict never materializes. I suggest, therefore, to accomplish this purpose, that subparagraph (6) beginning at line 12 and ending at line 18 of page 24 be stricken. The reference to this section in paragraph (d) on page 31 would thereupon become superfluous so the language at line 10, page 31 "from the operation of paragraph (6) of subsection (b) of this section and” should be deleted. This amendment also involves a deletion of lines 12 to 25 on page 29 and lines 1 to 8 through the word “payment' on page 30. Finally, there should also be eliminated the last four words of line 9, all of lines 10 and 11, and the first seven words of line 12 on page 30.

2. To preserve the time-honored so-called “rescue” loan by a trustee bank to a corporate borrower to carry it over emergencies, which experience clearly demonstrates is for the interest of all concerned, I suggest changes as follows:

Page 29, line 6: Insert after the word "period” the words or to the extent of such claim only, any security for a claim received simultaneously with the creation of such claim whether prior to or after the beginning of such four months' period,”.

Page 29, lines 9 and 10: Strike out the words "prior to such date” and insert the words "and simultaneously released.”

3. After default of a corporate issue, the waiver of the interest or principal payments on the indenture securities by the bondholders, is frequently an absolute essential of any businesslike work-out of the obligor's difficulties. Clearly this should be left to the determination of the security holders in cooperation with the trustee under the circumstances of the particular case and should not be circumscribed by a fixed prohibition in the indenture. This change is solely for the benefit of the security holders and affects the trustee nly in that it restricts its field of action for security holder's protection. To this end I suggest that the language of subsection (1) ön page 36 beginning with the word “except” on line 12 of page 36 and ending at line 18 should be stricken.

As to the trustee:

Reiterating my testimony of last Tuesday, I fear the potential danger to the banking structure contained in the proposal to impose affirmative active duties on the trustee and denying protection to the trustee except on the narrow test of simple "negligence.' The existing test commonly used of "gross negligence" may be too broad but by the same token the proposed test of “negligence” is

clearly too narrow; I suggest, therefore, there be added at the end of subsection (j) on page 38 the following language: "but may contain provisions protecting the trustee from liability for any error of judgment; for any action taken or inaction deliberately suffered (a) at the request of the holders of not less than a majority in principal amount of the indenture securities at the time outstanding or (b) independently of the security holders, in good faith and without negligence; and for any omission in the execution of the trust not the result of bad faith or negligence. Such indenture may also provide that as to claims against the indenture trustee predicated on negligence reasonable doubt in respect thereof shall be resolved in favor of the indenture trustee.”

If this or similar language is added, then subsection (3) on page 36 beginning at line 23 and ending at line 2 on page 37 should be stricken.

Incidentally, the indenture trustees do not now, and probably will not in the future, receive fees commensurate with the assumption of any greater degree of liability than suggested in the above provision.

My final suggestion is that if the Securities and Exchange Commission is to have the contemplated unlimited authority to insist on the inclusion of additional provisions in the trust indenture affecting the rights of the borrower, the lender, and the trustee, then, inasmuch as the Securities and Exchange Commission is by law charged with protecting the interests of security holders and would be remiss in its duties if it did not resolve all doubt in favor of the security holders, it seems to me that some governmental agency charged with the protection of our banking structure should sit around the table when provisions affecting the trustees are to be adopted. Without specifying any particular language, I believe, as I testified on Tuesday, that the rules and regulations of the Securities and Exchange Commission, promulgated under this bill should, so far as they affect the trustees' responsibilities and liabilities, be subject to the approval of the Federal Reserve Board, which is now by law charged with a general control of trust operations of member banks of the Reserve System, which encompasses practically all banks doing a trust business in this country.

In conclusion, I repeat, as I testified on Tuesday, that the subject matter of this bill merits much more complete exploration before it is fixed in our statutory law, and that the suggestions in this letter represent a minimum of amendments to make the bill useful and desirable in a workaday world, if we are to have legislation at this time. Anything less would be risking too great a tearing of our economic, industrial, and financial fabric, and therefore clearly is not in the public interest.

I am sending under separate cover a number of mimeographed copies of this letter, so that they will be available for such distribution to your fellow members of the Committee as you may deem desirable.

Thanking you again for your courtesy in continuing the hearings so that I might testify, and further for the courtesy extended to me by you and your fellow members at the hearing, I am Sincerely yours,

E. E. BROWN.

STATEMENT OF G. S. CANRIGHT, COUNSEL FOR THE CORPORATE

TRUST DIVISION, CONTINENTAL ILLINOIS NATIONAL BANK & TRUST CO. OF CHICAGO, ILL,

Mr. CANRIGHT. Mr. Chairman and Senators, our approach to this bill is somewhat different from that of any of the others who have testified here, and our conclusions are different. We do not believe that a trustee has only routine duties or is only a mechanical agency.

The CHAIRMAN. When you say “we,” whom do you mean?

Mr. CANRIGHT. I am representing the Continental Illinois National Bank & Trust Co. of Chicago, and I am speaking only for it.

The CHAIRMAN. I see.

Mr. CANRIGHT. We have always regarded or assumed that a trustee was appointed because there should be someone to see that a contract made by a corporation for the protection of its bondholders was carried out. To that extent we agree with the Securities and Exchange Commission that a trustee should be an active trustee, although we might differ to some extent as to what that action should be.

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