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I have made a careful study of the Barkley bill in the form in which it was introduced and in its form of June 10, 1937, and of the report (hereinafter termed "report”) of the Securities and Exchange Commission (hereinafter termed "Commission”) dated June 18, 1936, entitled “Trustees Under Indentures”, this being the report from which the Barkley bill originated.


In order not to encumber this memorandum with details which may or may not interest the subcommittee (hereinafter termed "committee”), I annex hereto a copy of my article which appeared in the Columbia Law Review of December 1936 under the title “The Securities and Exchange Commission and Corporate Trustees.” This article discusses the above-mentioned report of the Commission. There are certain parts of this report, particularly those which may be read as suggesting general maladministration by corporate trustees, which are not urged by anyone; and in this respect the article is not presently in point.

However, it is annexed for two reasons:

First, because it states accurately the extensive duties now commonly performed by corporate trustees; and the committee may wish to study the existing situation in order to determine the extent to which legislative changes are desirable;

Second, because the recommendations contained in the report are substantially embodied in the Barkley bill, and therefore the comments made in the article upon these recommendations are entirely pertinent.

The appended article does not discuss the portion of the report which deals with conflicts of interest. However, the most important alleged conflict of interest is discussed herein.


There is no basis whatever for any argument that present administration of corporate trusts, in any substantial percenjage of cases, is incompetent, selfseeking, or dishonest. The quality of administration naturally varies with the experience and competency of the trustees; but inasmuch as the vast majority in amount of these trusts are administered by banking institutions of long experience, good character, and full competency, the general standard of administration is very high. Responsible trustees are jealous of their reputations. They are anxious to avoid any basis for proper criticism. During recent years, and before as well as after the criticisms contained in the above-mentioned report, they have assumed increasingly active functions. The extensive duties which they presently perform, before and after default, are stated quite fully in the annexed article. There are not a large number of banking institutions which have the experience, personnel and resources to serve as competent and responsible corporate trustees. Therefore, legislation which would tend to force fully qualified trustees out of the administration of these intricate trusts and transfer such administration to inexperienced or irresponsible trustees would be a major catastrophe.. The harm which would thus be done would be out of all proportion to any defects which presently exist.

Nevertheless, most informed and fair-minded persons would admit that there are defects in the present system. The most important of these are, in my opinion, the following:

There have been some instances wherein, immediately preceding default under an indenture, banks have obtained the repayment of a larger part of their unsecured loans than unsecured debenture holders have realized. This practice is improper, and now is commonly so regarded. Undoubtedly the practice existed to a substantial extent in the past; but it should be realized that there was a fairly general acquiescence therein by other creditors because of the view that bank loans, although not legally entitled to preference, should be preferred in order to continue credit for the new company.

The provisions of many indentures have been weak in that they did not adequately safeguard the interest of the security holders in respect, for example, of substitution of collateral or release of property.

The trustees have been under no obligation to keep the security holders informed as to matters substantially affecting the trust estate, such as substitution of collateral, release of important property, or major defaults in payments to the trustee (for example, for sinking fund, or for interest in cases where the trustee acted also as paying agent). No machinery has existed for the supplying to the trustee of a list of the names and addresses, so far as known, of security holders and for the supplying by the trustee to the security holders, in proper cases, of


such lists. On the other hand, there have existed no such provisions as are properly contained in section 7, subsection (1) of the Barkley bill, permitting the court in its discretion to assess costs and attorneys' fess against a losing party in strike suits.

The trustees have been relieved in practically all cases from liability for ordinary negligence as distinguished from gross negligence. This was entirely proper when trustees were not paid for assuming the risks of ordinary negligence; but there is much to be said in favor of the view that trustees should assume and should be paid for assuming, the risks of ordinary negligence, but only if proved beyond a reasonable doubt.

These existing defects can be eliminated in a practical way by the bill if changed as hereinafter suggested.


1. It would prevent loans for less than 1 year by a bank to a corporation for whose

debenture issue the bank was acting as trustee This provision, in my opinion, is one of the most harmful, and one of the least justified, of the important provisions in the bill.

The provision is contained in section 7, subsection (b), paragraph (6) of the bill (p. 24, lines 12–18) the exception which would prevent disqualification in certain cases being found in section 7, subsection (d), paragraph (1), (p. 31, lines 9-17).

The principal effect of this provision is, of course, apparent. If the bank was acting as trustee for the corporation's debentures when the loan was applied for, it would have to refuse the loan or resign as trustee. If it had an outstanding loan when requested to act as trustee, it would have to refuse so to act.

Debentures outstanding under corporate indentures aggregate many millions of dollars, and the trusteeships thereunder are extremely important. Many corporations require seasonal loans but do not wish to borrow for a year. Conditions are often such that banks would be justified in making short-term loans but not loans for a year. The great disruptions in financing which this provision of the bill would cause are plain.

The most serious effects would probably occur when conditions were not good. The source to which the corporation would have to look in such times would be its usual bank. A bank having no prior relations with the corporation could not be expected to extend credit under such conditions. If the corporation had debentures outstanding, the same bank would usually be the trustee. Under the provisions of the bill, the bank, in order to make the loan, would have to resign and the trusteeship would be transferred to some other bank which, if not less qualified and less responsible, would at least be entirely unfamiliar with the affairs of the corporation. If the bank should keep the trusteeship, the corporation would have great difficulty in obtaining the loan. Wholesale resignations or wholesale failures or both might well be the result of this provision of the bill. The making of the loan in bad times might be of great benefit to the debenture holders themselves.

Assume, on the other hand, good times. What possible reason can there be in such times for preventing a bank from making short-term loans to a corporation for whose debentures it is acting as trustee? This is a normal and beneficial relationship.

The great fault in this provision of the bill is that it supposes a conflict long in advance of actualities, and is purely theoretical. There is no reasonable justification whatever for the provision, provided that the bank is prevented, as should be the case, from gaining an advantage over the debenture holders. The fundamental error is that a conflict is presumed to exist as of a date when there is in fact no conflict, whereas the bill should be limited in application to a date when the possibilities of conflict are real. The bill presently contains provisions designed to prevent the betterment of the position of the lending bank as against the debenture holders. These provisions are contained in section 7, subsection (c), (p. 27, line 22, to p. 31, line 8), although this language would require some revision.

Also it is not apparent why the trustee's rights in funds collected by the bank should be entitled to priority over the bank loan, as is presently provided in section 7, subsection (c), paragraph (2) (p. 30, lines 3–8). If, as is unquestionably true, there is no vice merely in the fact that the same bank is both the lender and the trustee, obviously there is no reason why the bank should be penalized by deferment of its loan any more than there is a reason why the bank should obtain prior payment of its loan.

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2. Inasmuch as the Commission is given power to determine the new duties of trustees,

such duties may be unlimited (except, of course, that they would have to have some connection with the trust)

The bill provides certain specific duties but permits the Commission, without limitation, to impose other duties. These provisions are found in section 7, subsection (g), (p. 33, line 24 to p. 34, line 6); section 7, subsection (m), (p. 40, line 7 to p. 41, line 19). The bill, therefore, would give to a commission, whose future personnel, experience, and character is presently unknown, the power to impose duties which no trustee having regard to the interests of its depositors could undertake. It is no answer to say that such trustees as are unwilling to risk their depositors' funds would not have to accept such trusts. I do not believe that this committee is willing to recommend a bill which would prevent the acceptance of trusts by banks which take seriously their duty to safeguard depositors; and, therefore, unless these provisions can be adequately amended, the only alternative, assuming the adoption of such provisions, is to give reasonable and proper protection to the trustees by the methods hereinafter suggested under specific comments 4 and 5.

I do not see how those provisions could be fully amended in a practical way. As to duties after default the bill would be much better if it did not give to the Commission power to prescribe duties—which in any event would be most difficult for the Commission—but were limited to providing, as it now provides, that after default the trustees shall be required “to use the same degree of care and skill in their exercise as a prudent man would exercise under the circumstances if he were a fiduciary

The language just quoted comes from section 7, subsection (h), (p. 35, lines 22–24).

As to duties before default, it would be practically impossible to specify in the bill the duties to be performed under future indentures. On the other hand, as is recognized above, there are additional duties which before default trustees might properly undertake, assuming reasonable protection as hereinafter suggested. Therefore and upon the assumption that trustees will be reasonably protected, I see no helpful suggestions which can be made regarding the provisions now under consideration, except that as to duties before default the Commission's powers should be limited by the use of the word "reasonable” or similar language, and except that as to duties after default there should be the same limitation unless, which I think is preferable, there should be no power in the Commission to specify duties after default. It would be entirely adequate to prescribe "prudent man” duties as presently prescribed by the language from subsection (h) just quoted above.

The bill in section 7, subsection (k), (p. 38, line 11, to p. 39, line 5) contains language relating to the duty of trustees to give notice of defaults.

I believe that these provisions would be better and more workable if they required the trustees to give notice of specified major defaults; that is, defaults in payment of interest, sinking fund or principal, and left discretionary with the trustees the giving of notice of other defaults. Clearly, the trustee should have the duty to give notice of such defaults. It should not have to exercise discretion (as possibly it might have to do under the bill as drawn) with possible consequent charges of mismanagement in the event that it should give notice of such defaults. On the other hand, in the instance of other defaults, the trustees should exercise their discretion, as provided in this subsection of the bill. It seems to me to be entirely unnecessary to impose upon the Commission the additional function of determining the defaults in respect of which the trustee shall or shall not exercise its discretion.

3. All indentures (with some minor exceptions) must be approved, or may even be

"prescribedby the Commission These provisions—which are contained principally in section 8 subsection (a), (p. 42, line to p. 43, line also section 6, paragraph (4), (p. lines 13-15)— and the other provisions just mentioned confer upon a commission of unknown future membership vast powers and duties which they cannot properly perform except by means of a very comprehensive, expensive, capable, and judicially minded organization. Without such an organization it can readily be seen how greatly they might disrupt the financing of the country's business by delay, incompetence, favoritism, prejudice, or otherwise.

Consideration might well be given (and I understand that some consideration has already been given) by corporate trustees to the forming of an organization for the specific purpose of framing standard important compulsory indenture provisions for the proper protection of security holders; and I believe that such procedure, taken in consultation with the Commission, would be far preferableuntil demonstrated to be unworkable—to conferring upon a future commission the power to prescribe the indenture provisions.

If, on the other hand, this committee shall be of the opinion that such powers should be given to a commission at this time, then, at the least, these powers should be limited to the right to require "reasonable” provisions and the trustees should be properly protected as hereinafter suggested. 4. The liability of trustees would be vastly increased by changing the test of liability

from gross negligence to ordinary negligence; suggested protection to trustees These provisions are contained in section 7, subsection (j) (p. 38, lines 6-9), and elsewhere.

If any of the members of the committee are not attorneys, they may not realize the vast difference in possible liability between the standard of gross negligence and that of ordinary negligence. A striking illustration may be found in the Hazzard case (159 Misc. 57), decided by New York Supreme Court, special term, in 1936. In that case, the indenture contained provisions exempting the trustee from liability except for "gross negligence or bad faith.”. The indenture provided that the collateral originally pledged should be released upon the delivery to the trustee of the substituted collateral and of specified documents. Upon receipt of such collateral and documents, the trustee released the original collateral. Subsequently the substituted collateral proved to be less valuable than the original. The security holders brought suit against the trustee, claiming as damages several millions of dollars. The court said that, while the trustee would have been liable under a standard of ordinary negligence (because some of its officers, in departments other than the corporate trust department, should have known that the substituted collateral was of less value than the original collateral) it was not guilty of gross negligence, and the complaint was dismissed. In that case, wherein the trustee was held to have followed exactly the provisions of the indenture, the difference between the standard of gross negligence and that of ordinary negligence made a difference to the trustee of several millions of dollars in respect of one trust.

There is much which may properly be said on both sides of the question whether trustees should be willing to accept liability for ordinary negligence, provided that they are adequately compensated. Of course, present rates of compensation are not based upon any such liability, and one of the great difficulties in the present situation arises from the fact that it is almost impossible to calculate, in the absence of actual experience with the new obligations, the extent of the liability which trustees would be undertaking, and the compensation which they should receive, if they should accept trusts under which they would be liable for whatever a court or a jury might hold to be negligent.

Because there is so much difference of opinion among competent persons as to whether trustees, in view of their duties to depositors, could accept a standard of ordinary negligence, I am not expressing an opinion with regard thereto. I do urge, however, that this change in the standard of liability should not be made without adequate understanding of the enormous increase in liability which may follow therefrom.

If the committee believes that this new standard should be adopted, then, for plainest reasons of justice, the trustees should be given reasonable and proper protection.

It was suggested at the hearing on June 22 that the standard of ordinary negligence should not be imposed without qualification, and that use might be made of a term such as "clear" negligence. This term could not be used because presently it has no accepted meaning. However, if ordinary negligence is to be adopted as the test, the bill should provide that trustees shall not be liable unless the negligence shall be proved beyond a reasonable doubt. This would give a fuller right of court supervision, upon appeal or otherwise, and would properly tend to prevent the taking away from bank depositors of millions of dollars which might be lost to them in a very close case.

For the same reason; viz, that if the possible liabilities of the trustees are to be enormously increased they should have all reasonable protection, there should be a change in the provisions of the bill which are contained in section 7, subsection (h), paragraph (3) (p. 36, line 23 to p. 37, line 2), which states, with reference to duties of the trustee in case of default, as follows:

“(3) protecting the trustee from liability for any error of judgment or for any loss arising out of any act or omission in the execution of the trust so long as it acts in good faith and without negligence.

This provision should be equally applicable to the duties of the trustee prior to default and therefore-after the changes next suggested-it should be transferred in substance so as to form a part of section 7, subsection (j) (p. 38, lines 6-9).






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The language of paragraph (3), just quoted, should be changed by inserting & semicolon after the word "judgment” (p. 36, line 24); and the remaining language of said paragraph, in conjunction with the language of section 7, subsection (1), should be changed so as to embody the above essential suggestion that trustees should not be liable for negligence unless proved beyond a reasonable doubt. 5. Trustees are not reasonably and properly protected against large and unjustified

liabilities; further suggested protection to trustees Section 7, subsection (i) (p. 37, line 13 to p. 38, line 4), begins by permitting the trustee "conclusively to rely

upon opinions or certificates of attorneys, accountants, or other experts (subject to such requirements as to independence and qualifications and the exercise by the trustee of reasonable care in their selection

as the Commission may deem necessary or appropriate in the public interest or for the protection of investors).” However, it then goes on to qualify this right of reliance by stating that it shall be “subject to such other terms and conditions, as the Commission may deem necessary or appropriate in the public interest or for the protection of investors”, and further qualifies the right of reliance by the words "if the Commission deems that such provisions do not materially conflict with the required standard of care and are not detrimental to the public interest or the interest of investors."

In substance, the right of reliance, which clearly should be absolute, is so qualified that the Commission could destroy it. This right of reliance is, in my opinion the most important provision in the entire bill for the proper protection of trustees. Certainly, if the Commission is to have vast powers in prescribing trustee duties and indenture provisions, and if they are to have such duties as are specified in section 7, subsection (g), paragraphs 1, 2, and 3 (p. 33, line 24, to p. 37, line 24), the trustees could not possibly accept the trusts unless they have the absolute right to rely upon certificates, opinions, etc., subject as the bill presently provides and as is above quoted, “to such requirements as to independence and qualifications and the exercise by the trustee of reasonable care in their selection as the Commission may deem necessary or appropriate in the public interest or for the protection of investors." I do not see how any reasonable person having proper regard to the interests of banks and of their depositors could possibly disagree with the proposition that, since a trustee must perform many of its duties by the aid of experts, it must have the right to rely upon the opinions or certificates of experts properly selected. Otherwise, the funds of the bank would be subject to enormous liabilities if the experts should make mistakes. There is a prohibition against waiver of certain defaults, which prohibition would

make it impossible, even by agreement of a large percentage of the security holders, to extend certain maturing obligations, even though in many cases such extension might be far preferable to receivership or bankruptcy This provision is found in section 7, subsection (h), paragraph 1, subparagraph (B) (p. 36, lines 12–18). While this is stated as a qualification upon the right of the holders of a majority in principal amount of the securities, and it may be a proper qualification upon the rights of such majority, I believe that the bill would be greatly to the public advantage if it contained a provision permitting the holders of two-thirds in principal amount of the securities to waive default in the payment of principal and to waive a default in interest for a total period exceeding 1 year. While a majority may be too small an amount to have such power, it seems to me that two-thirds in amount should have the power. There will be many cases wherein this power might prevent a corporation from receivership or bankruptcy, whereas under the present bill the corporation would have to go into receivership or bankruptcy. The disadvantage of forcing corporations into receivership or bankruptcy, when by extension or readjustment they might avoid it, is far greater than any improper disadvantage to a minority when so large a percentage as two-thirds should agree to the extension. All security holders would know of the provision, if included in their indenture; and they would not buy the security if they objected to the provision. 7. The bill properly permits the courts in their discretion to impose penalties in strike

suits There have been some suggestions that one of the valuable provisions of the bill be eliminated, that is, the provision contained in section 7, subsection (1) (p. 39, line 13, to p. 40, line 5). This states that the indenture may contain provisions to the effect that the court may “in its discretion” require the filing of an undertaking to pay the costs of a suit for the enforcement of the indenture or against the trustee, and may “in its discretion” assess reasonable costs including reason


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