Re National Bank of Wales, Limited
[1899] 2 CH 629(Judgment by: Wright J, Lindley MR, Sir FH Jeune, Romer LJ)
Re National Bank of Wales, Limited
Court:
Judges:
Lindley MR
Sir FH Jeune
Romer LJ
Wright J
Case References:
Turquand v Marshall - (1869) LR4ChApp 376
Judgment date: 27 February 1899
Judgment by:
Wright J
Lindley MR
Sir FH Jeune
Romer LJ
I will deal first with the charge that dividends were paid out of capital. Under this head the case made by the liquidator is shortly this. By clause 108 of the articles of association the directors are to recommend dividends "out of the profits." In the annual balance-sheets debts due to the bank, which were in fact bad debts, are treated and valued as good assets; and it is suggested that at the end of each year the total of the bad debts so treated in the balance-sheet as good, or at any rate so much of them as had been "made" in that year (by which I understand advances made in the year which have turned out bad) ought to have been deducted from the amount of the profit shewn on the profit and loss account; that if this had been done it would have appeared that there was little or no profit left for dividend; and that consequently the dividends must be taken to have been paid out of capital. The whole matter is treated as a mere process of simple subtraction, no systematic distinction being made between debts which at the time were, or ought to have been, known to be bad and debts which, by reason of subsequent events, have become bad, or by reason of ubsequent information have become known to have been bad. On this, as on other points in the case, I am embarrassed by the want of expert evidence; but I am not satisfied that this view is consistent with Lee v. Neuchatel Asphalte Co. 1, or that there is any such direct relation between a balance-sheet and a profit and loss account, or between the profit and loss account of one year and the balance-sheets of other years, as this reasoning appears to assume. The one is not founded on the other. A surplus on the valuation of assets at the end of a year is not necessarily profit of the year, or profit at all. A deficiency on the balance-sheet is not necessarily loss of the year, or loss on profit and loss account, nor is the basis of valuation necessarily the same for the purposes of the two accounts. On this, as on other parts of the case, I asked in vain for expert evidence. Had it been the practice of bankers or auditors to treat the two accounts as related in the manner which is suggested, it would have been easy to prove the practice; but nothing of the kind was attempted.
But, even if the charge cannot be maintained on the particular ground on which it was principally based, there are other grounds which appear to me sufficient to establish the claim, to some extent at least. It does not require expert evidence to shew that it must be an essential part of sound banking to make in some way an adequate provision for bad or doubtful debts. If such a provision is not made, capital mast be lost, and dividends paid must be regarded as paid out of capital, because there is no other fund except borrowed money from which they can be paid: Verner v. General and Commercial Investment Trust. 2
The real question seems to me to be whether in this case it is proved that the provision made in each year for debts which either were known to be bad, or were likely to turn out to be bad, was so inadequate that it can be said that moneys were applied for dividend which ought to have been retained for the purpose of replacing advances of capital made to customers who were unable to repay them. I think that this does appear. [After referring to the evidence, the learned judge continued:-]
It seems plain that, assuming the facts to have been known to the directors, they ought, in view of the large amount and the great and continual progressive increase of the bad and doubtful debts, to have made a provision for them out of the profits to an amount in each year representing the increase of them in that year, or preferably, as I think, representing the average or normal rate of increase, and that in paying dividends without having made such adequate provision they were pro tanto dividing money which was required for replacing capital lent to customers who could not repay it. I do not forget that in any particular year the bad debts of the trading of that year were not all then bad, or then known to be bad. Indeed, the increase of bad debts in a given year may not be wholly or even at all attributable to the trading of that year. It may be the result of insolvency overtaking persons who have received advances, or who have become sureties, in previous years. But, on the other hand, the debts supposed to be good when they were made in former years, but which would become, or become known to be, bad in that year, would require to be treated as bad in that year, although not strictly bad debts of the trading of that year, and these must, I think, be treated as bad debts of the year in which they become or were known to be bad, as otherwise they never would be treated as bad debts at all. Nor do I forget that sums amounting to 25,000l. were in the four years from 1887 to 1890 carried from profit to the reserve fund, in addition to large amounts derived from the issue of shares at a premium; but, on the figures as I find them, there were not any real profits out of which the 25,000l. could be taken, and the so-called reserve was in truth merely a partial provision for bad debts and a pro tanto absolution from the consequences of further improper payment of capital for dividend, whereas, as the auditors pointed out in their letters to the board, a real reserve fund is a fund set apart to meet contingencies after due provision made for all bad and doubtful debts, and cannot be regarded as a substitute for such a provision. Moreover, the reserve was habitually pledged for the current needs of the bank.
If these views and figures are correct, there were not in ither of the three years, 1887 to 1889, any substantial profits properly applicable for dividend, nor in 1890 more than about 4000l., even if that 4000l. ought not to be treated as wiped out by the great increase of insufficiently secured advances to directors in that year. No other fund is suggested, and the dividends must be regarded as having been in fact, except as to the 4000l., paid out of capital.
It is next to be considered how far a knowledge of the facts which, if known to the directors, would have imposed on them a duty to make further provision such as I have mentioned for bad debts, ought to be imputed to them, and in particular to the respondent. His defence is that he knew nothing of what was going on, but trusted to the general manager and the chairman, who was his brother. How far this could be held to be a defence consistently with Leeds Estate, Building and Investment Co. v. Shepherd 3, and the authorities there cited, I need not stop to inquire; or whether such a total abnegation of the use of his faculties as he alleges would not of itself be a ground of liability. He was a paid director from November, 1883, until, at any rate, December, 1890. He was a man of business, of great local influence and position, a director of other important local companies, and his name was a mainstay of the bank's credit. He attended board meetings with considerable regularity, every fortnight in the first year, and about once a month afterwards. He held himself out as taking an active part in the management. On January 19, 1888, he wrote to the chairman, requesting him on the respondent's behalf "to congratulate the shareholders on the flourishing condition of the bank .... and say, with a little more push for new business by the shareholders, and the continued attention of the directors to every detail of the working of the bank, I see no reason why the National Bank of Wales should not become one of the most important banking concerns in Wales." He was a large shareholder and depositor. The customers of the bank were persons "with whom he had grown up," and many of the largest accounts were those of his relations or colleagues, or of firms in which he or they were interested. He had the general knowledge, o which I have already adverted, of the bank's affairs and customers. He must have known the necessity of providing for bad debts in such a business, and especially at a time when trade was in a critical state, and many of the bank's customers were in difficulties. He had before him at every board meeting accounts of such a kind that the most cursory glance at them would inform him of much of what is alleged by the complainant.
Representations to the shareholders to the effect that due provision had been made for all bad and doubtful debts appear in the directors' report for each year of the respondent's directorate after 1886; and it seems to me that, even if the entire neglect of his duties to which he confesses was not enough to make him responsible for an ultra vires payment of dividend out of capital, these representations do so to the extent, at any rate, to which the exercise of the care which he represented that he had exercised would have discovered the true state of the facts. The representations are put forward, not as a statement of the manager, but as a statement of the directors as to matters which the shareholders were by clause 107 of the articles of association precluded from investigating for themselves, and they implied that the directors had personally taken reasonable steps to ascertain that the statement was true. They made it intending it to be acted on, although they knew that they had taken no such steps, and although at the best they were ignorant whether the statement was true or false. That, as it seems to me, is fraud, or at any rate it involves the same consequences as fraud.
The case would, of course, be greatly aggravated if it were proved that, at the time of assenting to these reports, the respondent had been aware that the auditors, at the very time when they were certifying that the accounts were "properly drawn up, so as to exhibit a true and correct view of the state of the company's affairs, as shewn by the books of the company," were privately writing to the board in the strongest terms of warning and remonstrance as to the necessity of making special provision for bad debts, and bringing the matter to the notice of the shareholders. It is not, however, shewn hat any of these letters came to the knowledge of the respondent, and I think it would be too much to impute to him an actual knowledge of them from the fact that on two occasions he was present at meetings when minutes of former meetings were read and confirmed which mentioned the receipt of letters from the auditors. I think that Ashhurst v. Mason 4 is the only case in which that has been held to be enough, and that decision can hardly be reconciled with In re Lands Allotment Co. 5
In my opinion the respondent cannot claim the benefit of the Statute of Limitations in respect of the years as to which fraud such as I have mentioned is shewn. As to the last half of 1889 and as to 1890 no question arises with regard to the Statute of Limitations, this summons having been issued on June 14, 1895; but a different question arises as to the end of the year 1890. It is said by the respondent that he resigned his directorship in November, 1890, that his resignation was duly accepted by the board in the following month, and that he was no party to the report and accounts for 1890, or to the recommendation of a dividend for that year.
The facts, as I find them, are that he did send in a letter of resignation, and that it was accepted at a meeting of the directors on December 18, 1890. No doubt the resignation and the acceptance of it were fraudulently concealed until after the shareholders' meeting in January, and false minutes were made for some purpose not altogether intelligible, and, in my opinion, the respondent was a party to the concealment, though not to the making or use of the false minutes. But, except in one respect, this fraud and concealment do not affect the result. Even if the respondent had never resigned, or his resignation had not been accepted validly, or at all, the mere fact of the continuance of his directorate would not have been enough to make him responsible for what was done by the other directors without his concurrence after he had ceased to attend meetings, or otherwise act as a director, unless there were evidence of subsequent adoption by him. That consideration lears him of liability for everything done after November, 1890, except the presentation of the report and accounts, and the recommendation of dividend in January, 1891, for 1890. To those acts it must be taken that he was a party. His name appears as a director in that report, and I am unable to believe that he did not know that it so appeared, and he took no steps to disabuse the minds of the shareholders. The fact of the retirement of other directors is mentioned in the report, but no intimation of his retirement was given there, or at the shareholders' meeting, or at any time until July, 1891. He cannot have been ignorant that no successor to him was appointed, as would have been naturally the case upon his retirement. His adhesion to the fraudulent representation seems to me to make it a representation by him as an ostensible director for which he is liable in the same way as in respect of the previous dividends. Although he had ceased to be a director, he is liable on the ground that he allowed himself to be held out as a director. On this part of the case I have only to add that, immediately after receiving the dividend for 1890, the respondent sold nearly all his shares, retaining by a curious coincidence apparently the exact amount required for a director's qualification.
The result is that, in my judgment, the respondent must be held liable to repay the amount of dividends paid for the years 1887 to 1889, amounting to about 25,000l., and 12,000l. out of the amount paid for 1890, or 37,000l. in all, besides interest, as in cases of fraud, at 5 per cent. from the dates when the dividends were paid, which I suppose will make the total sum about 50,000l. I have said nothing as to the year 1884, because I am not satisfied that a sufficient case has been made out on the figures with respect to that year; and in the case of the years 1885 and 1886, as to which no express representation was made in the directors' report that due provision had been made for bad and doubtful debts, I think he would be protected by the Statute of Limitations, as applied by the Trustee Act, 1888, except perhaps to the unimportant extent of the dividends which he personally received. Some similar representation is said to have been made at the shareholders' eetings in those two years, but it is not shewn that the respondent was a party to the making of it.
There remains one other point for consideration on this part of the case. The creditors have been paid, and it is contended for the respondent, on the authority of Turquand v. Marshall 6 and Flitcroft's Case 7, that a claim in the interest of the shareholders for repayment to them of capital, which they have themselves received in the form of dividends, cannot be maintained. In Turquand v. Marshall 8, however, a bill was filed on behalf of some of the shareholders in a going company, and the expression attributed to Cotton L.J. in Flitcroft's Case 9, if intended to be an absolute statement of law, which I think it was not, seems opposed to the opinion of Jessel M.R. in the same case, and to the doctrine established by many cases since, that in a liquidation the liquidator has a new and independent right to recover what belonged to the company. And, even in the case of a company not in liquidation, it is difficult to see how a payment to the shareholders can be a payment to the company in a case in which the payment to the shareholders is itself a fraud on the company.
But, however this may be, the facts of the present case are such that the question does not really arise. All the assets of the bank (except the uncalled capital) have been assigned to another company, which has, out of its own funds, satisfied creditors to the amount of 41,000l., and which is now the real claimant, not in the interest of the bank's shareholders (except in so far as the result may be to prevent the necessity of a further call upon them), but to recoup itself the 41,000l. That other company seems to me to be now subrogated to the rights of the creditors, or of the liquidator in respect of their rights. As Sir Robert Reid put it, the case is in effect the same as if the liquidator, instead of selling the assets and liabilities of the bank, had borrowed money to pay off its creditors. In such a case it could not be doubted that he could maintain these proceedings in order to recover the amount which he has had to borrow for that purpose, and the Metropolitan Bank is in the same position.
The judgment against the respondent must, indeed, in accordance with the precedents, be expressed to be without prejudice to any right which he may have to recover from the shareholders individually the amount of capital improperly paid to them, but in the present case this expression seems to be a mere formality. In an action against a shareholder the respondent would be met (amongst other defences) by his own representation, which entitled the shareholder to receive and spend the money as income derived from profits.
The next claim to be considered is the claim for repayment of money alleged to have been improperly advanced to customers of the bank. It is contended that the respondent ought to be held responsible for the losses on several large accounts which were certainly known by him and his co-directors to be bad or doubtful, and which have turned out to be almost wholly bad, but which were continued from year to year, and even allowed to be increased without proper security. The total amount claimed to the end of 1890 in this respect is over 43,000l., which, however, includes about 3000l. advanced for the most part before the respondent was a director. All these accounts were repeatedly the subject of special reports and discussions at the board, and it cannot be said, on the one hand, that the directors, including the respondent, were not fully aware of their character, or, on the other hand, that there was any neglect to consider them. There is no specific suggestion of interest or fraud or bad motive in the respondent in relation to that. I think it would be impossible for me on these materials to hold the directors responsible. They may have acted with folly and imprudence, but they seem to have used their judgment, such as it was, and so far as I can see, honestly in this respect until the end of 1890, and I think that the observations of Jessel M.R. in In re Forest of Dean Coal Mining Co. 10 have great weight in a matter of this kind. He there said 11:
"The customers of a trading partnership are very often allowed time, because the partners may think that, if they do not allow them time, they will drive the customers into bankruptcy and so suffer a greater loss than by iving them time; indeed they not only very often give them time, but they lend them money or sell them goods in the hope that better times may come and enable them to pay their debts. Again, it may very often be most injurious to the trading concern to sue some of their debtors after the first few losses, because driving some of their debtors into bankruptcy might be very injurious to the trade, more so, in fact, than the chance of suffering a loss by letting them go on without taking action against them."
A different conclusion might in the present case have been proper if the respondent had been a party to the advances of money in 1891, and, even in respect of those made in the previous years, the case would have been of a different kind if all the statements made in the complainant's affidavits had been founded on evidence; but in this, as in other cases, it is necessary to distinguish the matters which are really proved from the mere inferences of fact which are drawn by the deponents, or statements which are put forward as statements of facts, but of facts not within the deponent's knowledge, and not established by the books and accounts of the bank or other admissible evidence. Lastly, this second claim is really a partial alternative to the claim for recovery of capital paid away in dividends, and the subject of it has already been allowed for under that head as part of the bad debts. The respondent ought not to be made to pay twice in respect of the same matter.
There remains the third claim in respect of advances made to directors without security. [His Lordship read clause 98 of the articles.] There is no doubt that very large advances were made to directors on insufficient security, and many of them were made on no security except the bank's lien under clause 15 of the articles on shares held by the directors. Here, again, there would have been a very strong case if the respondent had been a party to the advances made in 1891. But down to the end of 1890 I think there was no reason to doubt the solvency of F. R. Crawshay, to whom the largest sums were advanced, or that his shares were then practically a sufficient security. The liquidator assumes that as a matter of law the ien cannot be "security" within the meaning of clause 98. I cannot take that view as a matter of law. It seems to me that "security" in that clause must include whatever a banker would ordinarily accept as security, and I have no evidence to shew that such a lien would not be so accepted, subject, of course, to considerations of amount and margin. Down to the end of 1890 F. R. Crawshay held shares of a market value considerably exceeding the total of the advances made either to him or to the firms in which he was interested, and he had deposited some other security which no doubt has turned out to be worthless, but which may at the time have appeared to be of value. Further difficulties are that the evidence does not enable me to determine how far advances made to firms or works in which F. R. Crawshay was interested can properly be treated as advances made to him personally, or what portions of the advances made to him personally in 1889 were made after June 14, 1889, so as to be excepted from the defence of the Statute of Limitations. I see no evidence of fraud in relation to him such as would exclude the operation of the statute, unless, indeed, on the true construction of clause 98 the lien could not in point of law be a security. In that view it might have been argued that a deliberate disregard of the express provision of the trust amounted to fraud, or must be treated as equivalent to fraud; but in the view which I take of that clause this question does not arise. Similar difficulties arise with regard to advances made to other directors.
1899. Feb. 27. Differences of opinion having arisen in settling the minutes of the judgment, especially with reference to the question whether, from the amount payable by the respondent, there should be deducted income tax on the interest mentioned in the judgment, the matters in difference were brought before Wright J. in court.
Ingpen, for the liquidator. If income tax can be deducted, it must be under s. 40 of the Income Tax Act, 1853 (16 & 17 Vict. c. 34), which provides for the deduction of the tax by every person who shall be liable to the payment of any rent, or any yearly interest of money, or any annuity or other annual payment, either as a charge on any property or as a personal debt or obligation by virtue of any contract." The interest which has been ordered to be paid by the respondent does not come within either of those alternatives, and the deduction ought not to be allowed.
[WRIGHT J. I shall not allow the deduction unless there is some authority which binds me to do so. I consider this interest is in the nature of damages for a fraudulent breach of trust.]
G. F. Hart, for the respondent. The interest is rightly deducted, and the deduction was made on the authority of two orders, one in In re Patent Cocoa Fibre Co., Bacon V.-C. 1878, B., 645, and the other in In re J. W. Hobbs & Co., 00119 of 1892, Wright J., December 13, 1893. The orders are set out in Palmer's Company Precedents, 7th ed. pt. ii., Forms 631 and 635A, and in each case the order is to pay interest "less income tax."
An analogy can be obtained from the case of a purchaser in an action for specific performance. Where he is ordered to pay the vendor his purchase-money with interest, the tax is allowed to be deducted from the interest. This is yearly interest on money due "as a personal debt or obligation by virtue of a contract" within the meaning of s. 40. The respondent was held liable on the ground that he was under a contractual obligation to the company. He became a debtor to the company as from the moment at which each dividend was paid, and the debt, being by virtue of a trust, arose out of a contract. Having from that time the money in his hands, and not paying interest for it, the income on which he has paid the tax has been larger than if he had paid at once, and now, when he is ordered to pay interest, he ought to be allowed to deduct the amount of the surplus tax which he has been paying.
WRIGHT J. In In re J. W. Hobbs & Co. the question whether income tax could be deducted never came before me. I do not see my way to allowing Mr. Cory to deduct the mount of income tax from the penal interest of 5 per cent. It is not a question of contract at all, so far as I can see. The matter must be regarded for this purpose as if the respondent had fraudulently given away 37,000l. of the capital of the company. I ordered him, rightly or wrongly, to repay that sum, and I make an order the effect of which is to find that the company has by its capital being withheld all these years suffered damages equal to 5 per cent. per annum. If the company has suffered those damages, I can see no reason why it should not get the whole of the damages back. It is called "interest," but it is really damages for withholding its capital from the company. I have tried to find some authorities on the question, but I am unable to find any.
(F. E.)
Cory appealed against the order that he should pay 37,000l. with interest, and the liquidator gave a cross-notice of appeal as to those claims made by the summons which were dismissed.
There was no appeal on the question of deduction of income tax.
The appeals came on for hearing on June 21, 1899.
Sir E. Clarke, Q.C., Swinfen Eady, Q.C., G. F. Hart, and Nepean, for the appellant. The creditors of the National Bank have all been paid, and the liquidator now represents only the contributories. This summons was issued in their interest in order that they might escape having to pay further calls to make good to the Metropolitan Bank the deficiency in the assets of the National Bank. On behalf of the contributories the claim of the liquidator cannot be maintained, for it is they who have received the dividends which are said to have been paid out of capital. They cannot compel the directors to pay over again the money which they have themselves received, whether it was or was not wrongly paid to them: Turquand v. Marshall 12, which exactly applies to the present case. Moreover, another difficulty would be that the present shareholders may not be the same persons as those who received the dividends in question.
[ROMER L.J. Is the liquidator bound to make a call before he sues Cory?]
The uncalled capital is an asset of which he must avail himself before he can bring an action on behalf of the shareholders. The Metropolitan Bank do not stand in the shoes of the creditors; the agreement between them and the National Bank provides what is to be done in case the assets of the latter are not sufficient to discharge their liabilities-a call is to be made on the shareholders to meet the deficiency. But the shareholders cannot recover capital which has already been paid to them, even though it has been improperly paid.
[LINDLEY M.R. In Turquand v. Marshall 13 the company was not incorporated. The same reasoning will not technically apply to a corporation. Is it any answer to the claim of the company to say the money was paid to the shareholders?]
That is a mere technicality when there are no creditors. Whatever the liquidator recovers from the directors he will have to distribute among the shareholders, so that in substance they will be paid twice over. Flitcroft's Case 14 will probably be relied upon for the liquidator. But in that case Cotton L.J. said 15: "If the corporation were suing for the purpose of paying over again to the shareholders what the shareholders had already received, the Court would not allow it. But that is not the case here, the company is insolvent, and there is no objection to allowing it to get back its funds for the purpose of paying debts." The director, if compelled to pay, would be entitled to recover back what he paid from the shareholders: Moxham v. Grant 16; In re National Funds Assurance Co. 17
[LINDLEY M.R. But here the National Bank are not suing for the benefit of the shareholders; they are suing for the benefit of the assignees of their assets.]
In substance they are asking that Mr. Cory should pay instead of the shareholders, who must otherwise pay. The right to make calls was not an asset which was sold to the Metropolitan Bank, nor was such a claim as this against a irector part of the assets which were sold to the Metropolitan Bank.
Upon the evidence it is by no means clear that dividends have in fact been paid out of capital, and at any rate an inquiry should be directed on this point. It is not enough to shew that a debt due to the bank has become a bad debt; the question is whether the directors were guilty of a misfeasance in not recognising in a particular year that a debt then due was bad. They may have made at that time a reasonable provision for bad debts, and this provision may have turned out afterwards to have been insufficient.
It has been decided that dividends may properly be paid to the shareholders of a company, notwithstanding that there has been a loss of capital. There is no obligation under the Companies Acts to make good out of the profits of one year a loss of capital occurring in previous years: Lee v. Neuchatel Asphalte Co. 18; Wilmer v. McNamara & Co. 19; Verner v. General and Commercial Investment Trust. 20
[ROMER L.J. Debts due to a bank from their customers must in some way or another be brought into the profit and loss account.]
There has been no misfeasance on the part of the appellant, and, if he is liable at all, he is not properly liable for so large a sum as Wright J. has ordered him to pay. By virtue of s. 8 of the Trustee Act, 1888 (51 & 52 Vict. c. 59), the appellant is entitled to the benefit of the Statute of Limitations. This will cover all the payments of dividend made before June 14, 1889. This section applies to directors of a company, they being trustees as to moneys of the company which have come to their hands or are under their control: In re Lands Allotment Co. 21; In re Kingston Cotton Mill Co. (No. 2).22 The claim is not alleged to be founded upon any fraud or fraudulent breach of trust to which the appellant was party or privy. It was said on behalf of the liquidator that there was concealment in the statement of the directors that they ad made provision for bad and doubtful debts, and that this involved the same consequences as an actual fraud. But by clause 84 of the articles of association the directors are not liable unless they have been guilty of wilful default.
The payment of dividends out of capital is not per se a fraud. It may be a breach of trust, but it is not necessarily fraudulent. To constitute wilful default there must be something more than negligence-there must be an intentional omission. In order that there may be wilful default the man must be a free agent-must know what he is doing and intend to do it: In re Young and Harston's Contract 23, per Bowen L.J.(2)
The appellant cannot properly be made responsible for any dividend which was declared after his resignation of the office of director in November, 1890, and he ought to be credited with the profits made in 1890.
[ROMER L.J. If a man allows it to be represented to the shareholders that he is a director, can he escape liability as such? If he allows it to go forth to the shareholders that he as director has stated that the company has earned a profit, can he stand in any better position than if he had actually made that statement: Pickard v. Sears? 24]
The responsibility of a director arises from his having improperly dealt with the funds of the company, not from any statement which he has made. It would be a novel doctrine to say that there can be a liability for fraud by estoppel. If the director was not present when the wrongful act was done, that is a sufficient answer on his part. Can a director be held liable merely because he said or allowed it to be said that he took part in a wrongful act, when in fact he did not? It must be shewn that he was a director, and that while he held that office he concurred in the declaration and payment of a dividend which had not been earned. It is essential that he should have actually taken part in the wrongful act: In re Denham & Co. 25 The effect of the decision of Wright J. is to make the appellant responsible, though he was not a director, for that for which he would not have been responsible if he ad been a director, because he was not present at the meeting in January, 1891.
Upon the evidence the learned judge was wrong in finding that there was any breach of duty by the appellant, or that dividends were in fact paid out of capital. The accounts having been audited by competent officers the directors were entitled to rely upon them, and are not liable, even if it afterwards turned out that dividends had been paid out of capital: Rance's Case 26; In re Denham & Co. 27 And, inasmuch as the dividends were paid with the assent of the shareholders, the directors cannot be personally liable for the payments, even if they were wrongfully made.
It was not wrong to bring the premiums received on the issue of new shares into the profit and loss account as profit. There is no obligation to make good lost capital before dividing the profit earned in a year.
[ROMER L.J. I agree that when a company has made a profit in one year they may be entitled to divide it as profit, without regard to capital lost in a previous year. There is no hard and fast rule that you cannot divide profits until capital lost in a previous year has been made good. But premiums on the issue of shares are not ordinary trading profits; they are rather of the nature of an increase of capital.]
It is submitted that, even if the whole of the nominal capital had been lost, premiums received upon the issue of new shares could be divided as profits: Verner v. General and Commercial Investment Trust. 28 There is no obligation to keep up the value of a company's capital to its nominal amount, and there is no middle course.
[LINDLEY M.R. referred to Stringer's Case. 29]
No doubt it is settled by Trevor v. Whitworth 30 that no part of the fund which has been subscribed as capital can be returned to the shareholders. But that does not prevent the payment of a dividend out of the profits of a particular year: Dent v. London Tramways Co. 31
[ROMER L.J. referred to Lubbock v. British Bank of South America. 32 It is not easy to distinguish between the issue of new shares and the sale of a part of the capital assets.]
A depreciation of goodwill during a year need not be brought into account in ascertaining profit for the year: Wilmer v. McNamara & Co. 33 But in truth the 25,000l. received for premiums was not divided as profit: it was carried to the reserve fund. On a true view of the accounts no dividend was paid out of capital. The complaint against the directors resolves itself into this-that they did not make sufficient provision for bad and doubtful debts. But they made an honest estimate. They may have been mistaken, but they were not guilty of any misfeasance or breach of trust.
At any rate the appellant ought not to be charged with interest on the sum which he has been ordered to pay, except as to the dividends paid to himself, for with that exception he did not retain the money to his own use; it was paid away to other persons. But in principle there is no difference between dividends received by a director himself and dividends paid to other shareholders: In re Denham & Co. 34 Moreover, the claim against the appellant is in substance made by the Metropolitan Bank, and they can only be entitled to interest (if at all) from the date at which it was ascertained that the assets of the National Bank were insufficient to meet their liabilities.
Warmington, Q.C., Buckley, Q.C., Ingpen, and S. T. Evans, for the liquidator. On the materials before him the learned judge has ordered the appellant to pay to the liquidator the minimum amount which according to the evidence was due from him. The appellant was a man of great business experience and reputation and was a director of the bank. A course of procedure had been laid down by the directors for their own guidance, and if that course had been followed the bank would never have been brought into this disastrous position. From the documents placed before the board, without searching into the books of the bank, the appellant might have known that many of the items which were included in the balance-sheets as assets had ot at the time any real existence. He had only to look at the "weekly states" from the branches to see that there were many suspicious items, and it was his especial duty to inquire into those items. The rules laid down by various minutes of the board were not carried out in practice. Debts due to the bank from debtors who had become bankrupt were retained in the books as of their full nominal amount, and this was done even after the directors had been informed of and had recognised the bankruptcies, and had resolved to accept a composition in respect of the debts. Debts undoubtedly bad were carried forward as good assets, without any reserve being made against them. How can a director be heard to say that he did not know what was being done? The same observations apply to the "dormant accounts" and to the "improper advances." Advances were made at a time when there was no chance of the bank's being repaid. Even statute-barred debts were included among the assets. And yet the reports made to the shareholders stated that sufficient provision had been made for all bad and doubtful debts. In the case of a bank, a loss made, say in 1888, ought to have been brought into account against a profit made in 1889. Till that had been done the profits of 1889 could not properly be divided among the shareholders.
It is not an answer to the liquidator's claim to say that the money when recovered will go in relief of the shareholders because it will increase the assets of the bank. Such a defence goes too far. The shareholders may not be the same persons now as when the improper payments were made. In such cases the Court has always given relief without prejudice to any right of indemnity which the directors may have against any of the shareholders. But, even if the body of shareholders who received the money was composed of identically the same persons as those for whose relief it would be repaid, still the company being incorporated is a distinct legal entity-the creature of the Companies Act-and has rights independent of those of the shareholders who compose it: Salomon v. Salomon & Co. 35; Welton v. Saffery.36 This distinguishes the present case from Turquand v. Marshall. 37 There cannot be a waiver f a right without knowledge of the facts. It is the duty of the liquidator to get in all the assets of the company, and money of the company which has been improperly paid away as dividend still remains part of the company's assets. It is a different question how the liquidator is to apply the money when he has got it.
The Court is not dealing with a company formed for working a tramway, or a patent or a colliery, but with a company operating with a circulating capital. In Verner v. General and Commercial Investment Trust 38, Lindley L.J., in stating39 that "there is no law which compels limited companies in all cases to recoup losses shewn by the capital account out of the receipts shewn in the profit and loss account," adds this important qualification: "although care must be taken not to treat capital as if it were profit. This is in accordance with Bolton v. Natal Land and Colonization Co." 40 That qualification applies here, for the facts have not been truly stated in the profit and loss accounts. A bank should carry forward a debt just as a credit is carried forward: it could not exist on the principle contended for on behalf of the appellant.
[LINDLEY M.R. Is it illegal? Suppose capital is lost in 1880: it is lost, and there is an end of it.]
It is illegal on these articles. You cannot pay dividends except out of profits: if there is no profit there can be no dividend. There is a wide distinction between fixed capital and circulating capital. Payment of dividends out of capital is ultra vires in the strict sense of the words. It is contrary to the constitution of the company. But if the directors, without negligence, honestly exercising their judgment, think there was a profit and pay a dividend, they are not liable for so doing if it turns out there was no profit: Stringer's Case. 41 The onus is on them to shew that there was a profit, or that they formed an honest opinion. Making improper advances is not ultra vires at all-it is negligence. A director is to apply commercial prudence; he may take a proper risk and make a profit by taking that risk; but negligence exists when the irector has failed to bring to his conduct of the company's affairs proper care and diligence, and has thus broken his contract with the company. Advances to directors may be partly ultra vires and partly negligent. For (a) if the board, in face of the articles, make advances to a director without security, it is ultra vires; they are acting contrary to their instruction; (b) the advances may be made by negligence, as in the case of other improper advances. The right of a company or its liquidator to take proceedings for the recovery of its assets which have been lost or improperly applied is clear, and it is immaterial that the defendant will be entitled to share in the distribution of the assets when recovered: New Sombrero Phosphate Co. v. Erlanger 42; Phosphate Sewage Co. v. Hartmont.43 In Moxham v. Grant 44 the only question was whether directors were entitled to an indemnity over against the shareholders. It is no authority for the appellant; neither is Flitcroft's Case 45 when properly understood. There Cotton L.J. points out 46 that directors may be sued for money improperly paid to the shareholders. It is said that if the company makes a loss one year and a profit the next, the profit may be divided irrespective of the loss of the previous year; but in commercial transactions you cannot make a profit unless you have provided for your losses: that is true from month to month; and, if so, why not from year to year? Accounts are rendered yearly to shew the financial position of the concern. A trader cannot say at the end of any year, "I will disregard the loss of capital, and will only regard my future profits." There is no ground for taking different periods for ascertaining profits and losses. Take the analogy of preference capital carrying a fixed dividend: there the deficiency of dividend paid out of profits in one year may be made good out of the profits of any subsequent year: Henry v. Great Northern Ry. Co. 47; Webb v. Earle.48 Thus you carry your debit on the profit and loss for one year forward to the ext year. In a banking company of this kind the capital must be kept up to its nominal amount, and any application of it to the contrary is ultra vires; but in a trading company when capital is sunk once for all in the purchase of wasting property, such as stocks and shares or mills and machinery, a depreciation in the capital caused by trading with it need not be made up: Lee v. Neuchatel Asphalte Co. 49; Verner v. General and Commercial Investment Trust 50; Wilmer v. McNamara & Co. 51; In re Kingston Cotton Mill Co. (No. 2).52 Now, the business of a bank is dealing in money, to attract custom, and to create debts. A customer is allowed to create a debt by having an overdraft, not for ever, but in order to pay interest. Circulating capital of this kind must be made good before dividends are paid: In re National Funds Assurance Co. 53 The two cases, Dent v. London Tramways Co. 54 and Davison v. Gillies 55, in one of which it was held that profits could not be ascertained without reinstating capital, and in the other that profits could be ascertained without doing so, are no doubt difficult to reconcile, except on the ground that in the case of preference shareholders there was to be a sinking fund, but in the case of ordinary shareholders there was not. If a line can be drawn at any year, what is the object of applying to the Court to sanction the writing off a loss of capital under the Companies Act, 1877, which was passed to rectify the previous want of jurisdiction, as is shewn in In re Ebbw Vale Steel, Iron and Coal Co.? 56 The distinction between fixed capital, on which a dividend can be paid notwithstanding a loss of capital, and floating or circulating capital, on which a dividend cannot be paid so long as there is a deficit in the capital, is shewn in Verner v. General and Commercial Investment Trust. 57 Lubbock v. British Bank of South America 58, a case of a banking company, is the converse of the present case, for there the assets had appreciated; the company wished to divide the urplus assets as profit; and it was held that their obligation was to keep up the amount of the paid-up nominal capital, not more. That case also explains the principles on which the accounts of a trading company should be kept. On principle, then, fixed capital need not be kept up, but floating or circulating capital, such as the capital of a banking company, must, and what has been lost in any year must be made good before you can arrive at a profit in a subsequent year available for dividend.
What, then, is the obligation of directors in declaring what in fact the profits are? If it is shewn that they took no proper care to ascertain whether there were profits, the onus is on them to shew that in paying a dividend they paid it out of profits, and for that purpose prepared a proper profit and loss account: Rance's Case. 59 Here we shew that the balance-sheets are utterly wrong, and that the amount paid is dividends ought never to have been so paid. The auditors, whose duty it was to form an opinion and report upon the financial position of the company, had not, as regards the branches, sufficient information laid before them, and the directors cannot, therefore, rely upon the auditors' certificates as protecting them. It was the duty of the directors to inform the auditors of the state of the debts due to the bank, which they themselves knew from the weekly statements, and this duty was not performed. It was the duty of the directors to put the auditors in a position to report upon the assets of the bank in compliance with clause 117 of the articles of association, and this was not done. Upon the materials which the directors had before them they ought to have formed an honest judgment whether the debts were or were not worthless, and they did not. If a man does a dishonest act with knowledge of all the facts, he cannot defend himself by saying, "I did not intend to act dishonestly": In re National Funds Assurance Co. 60; In re Oxford Benefit Building and Investment Society 61; Leeds Estate, Building and Investment Co. v. Shepherd 62; In re Sharpe.63 If a irector allows debts due from bankrupt debtors to be put down as worth 20s. in the pound, he cannot be heard to say he did not know this was wrong. Ratification by all the shareholders is not as against the company a valid defence for a director who has done an act which is ultra vires the company: Flitcroft's Case. 64 The negligence for which a director is liable is that which would render him liable in an action: Marzetti's Case. 65 A director when he accepts the office contracts that he will act honestly, and that he will bring to the discharge of his duties a reasonable amount of care, diligence, and knowledge. Here the directors, knowing the state of the "dormant accounts," should have required further information from the branch managers. They should not have treated those debts as worth their full nominal value. They should have made a proper estimate of their value. In fact, they made no inquiry at all. Sect. 8 of the Trustee Act, 1888, does not apply to an act which is ultra vires the company. In In re Lands Allotment Co. 66 the acts complained of were ultra vires the directors. The doing by an agent of an act which the principal himself could not do is not a breach of trust. If the principal could not do the act, the agent when he did it must have done it on his own behalf, not on behalf of the principal.
[ROMER L.J. The director must be treated either as an agent or a stranger. If he was a stranger, the ordinary Statutes of Limitations apply to him.]
If, however, there was a breach of trust, it was fraudulent. An untrue statement as to the truth or falsity of which the man who makes it has no belief is fraudulent: Smith v. Chadwick 67; Derry v. Peek. 68 The appellant had no honest belief that due provision had been made for bad and doubtful debts, and yet he took upon himself to assert that it had. The payment of the dividend was a result of the fraudulent statement on which the board recommended the payment of a dividend. The dividend would not have been declared and paid unless the directors had said that due provision had been ade for bad and doubtful debts. This amounts to a fraudulent breach of trust.
As regards the cross-appeal, the evidence shews that "improper advances" were made to customers-namely, advances were made without any reasonable care. There was gross negligence on the part of the directors.
Again, advances were made to directors without any security beyond the lien which the company had under clause 15 of the articles upon their shares, though art. 98e clearly requires a "security," in the case of an advance to a director-that is, a definite security-something different from the "lien" under art. 15. Giving credit to a director by an overdraft is prohibited: if he wants an advance, he may have it on his giving "security." The articles thus make a clear distinction between a debt due from an ordinary shareholder, for which a "lien" is given on his shares, and an advance to a director for which he is to give "security."
An advance to a firm of which a director was a member would stand in the same position as an advance to a director.
The appellant has not discharged the onus of shewing that his letter of resignation relieved him from responsibility.
Sir E. Clarke, Q.C., in reply.
[LINDLEY M.R. We are satisfied that s. 8 of the Trustee Act, 1888, applies, though not, of course, to dividends which the appellant himself received. We are satisfied, also, that the appellant retired from the office of director, and that he is not responsible for the balance-sheet which was published after his retirement. That reduces his liability to the period between June 14, 1889, and the date of the acceptance of his resignation.]
The lien given by clause 15 upon a director's shares is a "security" for an advance to him within the meaning of clause 98e: Everitt v. Automatic Weighing Machine Co. 69 It is not disputed that down to 1890 the shares of the bank were of their par value, and under those circumstances the shares were as much a "security" as the shares of any other company which were at par would have been.
The onus is on the liquidator to shew that dividends were aid out of capital, and he has not done so. In Rance's Case 70 the directors had paid dividends without taking the least pains to ascertain whether any profits had been made. That was not so in the present case.
There is no evidence of any such negligence on the part of the appellant as will render him liable for a misfeasance.
The appeal and the cross-appeal require the Court to examine into Mr. John Cory's conduct as a director of the company from the time when he became a director in 1884 until he ceased to be so in December, 1890, or even later, if the liquidator is correct.
The order under review was made on a summons issued under s. 10 of the Companies (Winding-up) Act, 1890, on June 14, 1895, a date which is material, having regard to the Statute of Limitations, on which Mr. Cory relies as a defence to the greater part of the demands made against him.
It will be convenient to consider his appeal first. This raises the question whether the funds of the company have been misapplied in payment of dividends, and, if they have, whether Mr. John Cory is liable for the misapplication. Before examining the controverted facts and discussing the legal questions which arise, it is desirable to state shortly the history of the company, and how the present controversy has arisen. [His Lordship then stated the objects of the company, its capital, and the provisions of the articles of association as above mentioned, and the general course of the business of the company, and continued:-]
The minutes of the directors' meetings shew that, speaking generally, they attended with reasonable regularity and transacted a large amount of business. No director, unless it was the chairman, attended to any details not brought before the oard either by the chairman or by the general manager. Mr. John Cory has stated in his affidavit the general course of business at board meetings, and his cross-examination does not substantially differ from the account he there gives.
Wright J. has regarded this evidence as an admission by Mr. John Cory of a total abnegation of the use of his faculties, and of an entire neglect of his duties. We cannot go so far as this. His evidence does, however, shew that he only attended, when present, to whatever his attention was called to; and that, having no suspicion that anything was wrong, he made no special inquiries in order to ascertain that all was right.
After Mr. John Cory had ceased to be a director, the company made large advances on insufficient security, and took over an insolvent business which greatly embarrassed it. The company, however, was not unable to pay its debts, for its large uncalled capital was amply sufficient for that purpose, and, so far as its outside liabilities are concerned, it always has been and is quite able to discharge them in full.
Being, however, in difficulties, the National Bank of Wales determined to amalgamate with another company and to wind up. An agreement was entered into between the National Bank and the Metropolitan Bank of England and Wales for the transfer to the Metropolitan Bank of all the assets of the National Bank (except the uncalled capital), and for the payment by the Metropolitan Bank of all the debts and liabilities of the National Bank, subject, however, to this stipulation, namely, that if the assets transferred exceeded the liabilities the excess should be returned to the National Bank, whilst if the assets transferred should prove insufficient to discharge those liabilities the deficiency should be made good by the National Bank.
There is a deficiency of about 41,000l. which the National Bank has to make good. The sum can be raised easily enough by a call on the shareholders; but they naturally object to this if money can be got in from other quarters, which will relieve them from the necessity of paying a call.
The investigation into the affairs of the National Bank which has been made in order to carry out the amalgamation ith the Metropolitan Bank has revealed a very unsatisfactory state of things. The whole of the paid-up capital has been lost, and some 41,000l. has to be raised to clear the bank from debt. The cause of loss is to a great extent attributable to the fact that a large number of debts due to the bank by its customers have turned out to be bad; and large sums advanced to directors and owing by them are irrecoverable. Moreover, large dividends have been paid for a number of years as if the bank was flourishing, whilst in truth, if its affairs had been properly conducted, the large dividends declared and paid ought never to have been recommended by the directors.
There can be no doubt that the shareholders were grievously deceived by the reports and balance-sheets laid before them, and no one can be surprised at their anger with their directors, and especially with the chairman and general manager, both of whom have been criminally prosecuted and convicted for their fraudulent conduct. Mr. John Cory's answer, however, to the attempt to make him liable for the losses sustained, and dividends paid, whilst he was a director, is that he was himself as much deceived as the shareholders by the chairman and manager, and that he was not guilty of any breach of his duty in not making special investigation when he had no reason to suppose that anything was wrong.
Wright J. has come to the conclusion that Mr. John Cory was not only negligent but fraudulent; or, at all events, guilty of misconduct equivalent to fraud as regards its legal consequences. The learned judge has arrived at this conclusion from the fact that in their reports the directors unjustifiably stated that they had made provision for bad and doubtful debts, whereas they had not. That the chairman and Collins, the manager, knew this is very likely true, but whether Mr. John Cory knew it is quite another matter. The table of bad debts shews that sums were constantly written off for bad debts, and there is nothing to justify the inference that Mr. John Cory knew that those sums were insufficient or that he did not honestly believe them to be sufficient. It may be that he ought to have been more vigilant than he was, and that he should not have trusted his brother and Collins as much as e did. But negligence is one thing; fraud is another; and we are quite unable to adopt the view of Wright J.-that Mr. John Cory acted fraudulently in making reports to the shareholders and laying the balance-sheets before them.
At the close of the argument for the liquidator we intimated that, in our opinion, the charge of fraud against Mr. John Cory failed, and further study of the evidence has strengthened this conviction. This is not only a very important matter to him as regards character, but to a great extent it relieves him from responsibility for anything done or omitted before June 14, 1889.
Another part of the case on which we are unable to agree with Wright J. relates to the date of Mr. John Cory's retirement from the board. There can be no doubt that he sent in a letter of resignation (although it was not produced) and that his resignation was accepted at a meeting of the directors, held in London on December 18, 1890, and that he was informed of its acceptance on December 22, 1890. There can also be no doubt that his resignation was concealed from the shareholders until after their meeting on January 21, 1891, and that in the report then laid before the shareholders the name of Mr. John Cory appeared as a director. The evidence is conflicting upon the question whether his resignation was or was not mentioned at the meeting. On the other hand, he was not present at the meeting; and he swears he did not know that his name still appeared as a director. The learned judge says he is unable to believe that he did not know that his name so appeared, and in the view of the Court below he improperly allowed his retirement to be concealed, and allowed himself to be held out as a continuing director, and as concurring in the report of January, 1891, which the learned judge holds to be as fraudulent on Mr. John Cory's part as those reports which preceded it. We cannot adopt the learned judge's view of this part of the case. We are satisfied that Mr. John Cory's resignation was bonâ fide-a fact, and not a sham. He was not in fact a director after his resignation was accepted. He took no part in drawing up the report, nor in recommending the dividend declared in January, 1891. ven if he received the report before the meeting, and saw his name in it as a director, and did not insist that his name should be struck out, or that his resignation should be mentioned to the meeting (and the case against him cannot be put more strongly than this), even then we fail to see how such knowledge and omission can, without more, make him liable for misapplying the funds of the company, when in truth he took no part in their misapplication.
With these preliminary observations we pass to consider Mr. John Cory's liability in respect of the dividends declared in July, 1889, December, 1889, and July, 1890. The liquidator has taken the view that the dividends declared and paid by the company, when Mr. John Cory was a director, were all paid out of the capital of the company; and the evidence adduced is directed to prove that such was the case. But when this evidence is examined, it seems quite plain that the dividends were not in fact paid out of any part of the money forming the paid-up nominal capital of the company, but were paid notwithstanding the loss of such capital, and without making it good. What was done was this: the accounts were made up annually. Such losses incurred during the year as the directors recognised as losses were written off or provided for by carrying sums of money over to a reserve fund, and the balance of the receipts in each year over the outgoings in the same year, after making some allowance for bad debts and deductions for sums carried over to the reserve fund, were treated as the profits of that year, and were distributed as dividends. Losses written off in one year were not brought forward the next year, so as to diminish the profits of that year, but were simply ignored, a fresh start being made every year, and dividends being paid out of the excess of the annual receipts over the annual expenses. The effect of this was to throw all bad debts, written off and not provided for by an increase of the reserve fund, on to the capital; to diminish the paid-up capital year by year, and nevertheless to keep paying dividends out of the excess of the annual receipts over the current expenses. It is obvious that this method of procedure, if long continued, would ultimately exhaust the paid-up capital f the company, and the first disastrous year in which the current outgoings exceeded the current incomings would produce great embarrassment. Such a mode of dealing with the company's assets, however reprehensible, must nevertheless not be confounded with paying dividends out of the paid-up capital of the company. The paid-up capital of a limited company cannot be lawfully returned to the shareholders under the guise of dividends or otherwise. Even an article of association authorizing the payment of interest to shareholders on the amounts paid upon their shares cannot authorize a payment of such interest out of capital: see In re Sharpe 71; but paid-up capital which is lost can no more be applied in paying dividends than in paying debts. Its loss renders any subsequent application of it impossible. There was no such dealing with the paid-up capital of the company in this case as to amount to an illegal application of it. Further, it is not possible for the Court to say that the law prohibits a limited company, even a limited banking company, from paying dividends unless its paid-up capital is intact. Suppose a heavy unexpected loss is sustained, which must be met if there are assets with which to meet it. The capital, even uncalled capital, must, if necessary, be applied to meet it. Such an application of capital is a perfectly legitimate use of it. There is no law which in the case supposed prevents the payment of all future dividends until all the capital so expended is made good. Many honest and prudent men of business would replace a large loss of capital by degrees, and would reduce the dividends, but not stop them entirely, until the whole loss was made good. No law compels them to pay none at all. There are cases in which no honest competent man of business would think of charging particular debts or expenses to capital.
We are certainly not prepared to sanction the notion that all debts incurred in carrying on a business can be properly permanently charged to capital, and that the excess of receipts over other outgoings can be afterwards properly divided as profit as if there had been no previous loss. No honest competent man engaged in trade or commerce would carry on usiness on such a principle. But, excluding cases in which every one can see that a particular debt or outlay cannot be reasonably charged to capital, it may be safely said that what losses can be properly charged to capital, and what to income, is a matter for business men to determine, and it is often a matter on which the opinions of honest and competent men will differ: see Gregory v. Patchett. 72 There is no hard and fast legal rule on the subject.
There can, however, be no doubt that, if expenses or payments are obviously improperly charged to capital, and are so charged simply to swell the apparent profits, and to make it appear that dividends may properly be declared, dividends declared and paid under such circumstances cannot be treated as legitimately paid out of profits, and can no more be justified than if they were paid out of capital. This was determined in Bloxam v. Metropolitan Ry. Co. 73, and has been acted upon in many other cases, e.g., Rance's Case 74; In re Oxford Benefit Building and Investment Society 75; Leeds Estate, Building and Investment Co. v. Shepherd 76; In re London and General Bank (No. 2). 77
It would seem that Jessel M.R. inclined to the opinion that a limited company could not pay dividends unless its paid-up capital was kept up: see In re Ebbw Vale Steel, Iron and Coal Co. 78 But no decision has yet gone this length, and it has since been decided that dividends may be paid, even by a limited company, although its nominal capital is not kept up: see Verner v. General and Commercial Investment Trust 79 and Lee v. Neuchatel Asphalte Co. 80 What was lost there was fixed capital, and it is obvious that circulating capital, or any other money employed in earning returns, must be deducted from them in order to ascertain how much of them can be regarded as profit. If the returns do not exceed the money spent in procuring them (whether such money be called circulating capital or by any other name) there can be no profits; and o ingenious process of book-keeping can alter the fact. It is not denied that in this case the annual receipts did exceed the annual outgoings, and, the dividends having been paid out of the excess, the allegation that they were paid out of capital is not accurate. But, as already pointed out, it does not at all follow that the course adopted by the directors in declaring dividends year after year as they did was legally justifiable. It cannot be denied that the balance-sheets and profit and loss accounts concealed the truth, as now known, from the shareholders, and were, as it now turns out, grievously misleading. The shareholders were never told that the paid-up capital was being constantly diminished by bad debts, as now appears to have been the case. The shareholders were told every year that proper provision was made for such debts, and now that the case has been thoroughly investigated it is really reduced to the question whether Mr. John Cory was justified in making the statements he did, and in dealing as he did with debts which have now been ascertained to be bad. It is easy to be wise after the event, and there is danger in treating a director as knowing years ago what now appears to be the fact. But it is the duty of the Court to examine the state of things as they appeared to him when the dividends were declared, and to determine whether he was justified in what he did by what he knew or ought to have known. What he ought to have known is as important as what he knew.
It was stated in the judgment of this Court in Lagunas Nitrate Co. v. Lagunas Syndicate 81 that, if directors act within their powers-if they act with such care as is reasonably to be expected from them, having regard to their knowledge and experience-and if they act honestly for the benefit of the company they represent, they discharge their equitable as well as their legal duty to the company. We believe this statement of the law to be correct, and we adopt it as our guide. It has been shewn that in this case the dividends did not in fact come out of the paid-up capital of the company. Fraud is not established against Mr. John Cory, nor is there any proof that he was acting in the interest of his own friends or of himself, and ot bonâ fide with a view to the interest of the National Bank. The inquiry, therefore, so far as he is concerned, is reduced to the representations which he made as to the position of the company, and his alleged want of care and attention to the affairs of the bank, and more particularly to his omission to find out that the manager was misleading the directors. In the Lagunas Case 82 it was said, and we repeat it, that the amount of care to be taken is difficult to define; but it is plain that directors are not liable for all the mistakes they may make, although, if they had taken more care, they might have avoided them: see Overend, Gurney & Co. v. Gibb. 83 Their negligence must be, not the omission to take all possible care; it must be much more blameable than that: it must be in a business sense culpable or gross. We do not know how better to describe it. Some useful observations justifying the expression "gross negligence" will be found in Lord Chelmsford's judgment in Giblin v. McMullen. 84
It is not, however, necessary to enlarge on this subject.
The care which in any case can be reasonably expected to be taken is, speaking generally, the measure of the care which the law requires to be taken when there is no contract affecting the question. What we have to determine is whether Mr. John Cory was justified in making the statements which he made, and whether he could be reasonably expected to find out more than he in fact knew.
Bad and doubtful debts were constantly considered and provided for-some by being written off, some by setting aside reserve capital. Over 12,000l. were written off before 1890, and 13,600l., or thereabouts, were written off in that year, and 70,000l. was set aside for reserve capital.
Such matters were considered by the directors. The accusation is that they did not do enough in this way. But here again, even if some debts known to the manager to be bad were treated as good, it is not proved that Mr. John Cory knew this, or had reason to suspect that what was done was inadequate.
His evidence is clear that he neither knew nor suspected that such was the case, and that he really believed that the provision was ample.
The same question arises: Was it his duty to test the accuracy or completeness of what he was told by the general manager and the managing director? This is a question on which opinions may differ, but we are not prepared to say that he failed in his legal duty. Business cannot be carried on upon principles of distrust. Men in responsible positions must be trusted by those above them, as well as by those below them, until there is reason to distrust them. We agree that care and prudence do not involve distrust; but for a director acting honestly himself to be held legally liable for negligence, in trusting the officers under him not to conceal from him what they ought to report to him, appears to us to be laying too heavy a burden on honest business men. But this is the whole of Mr. John Cory's shortcoming as proved by the evidence. Even his letter of January 19, 1888, on which Wright J. placed so much stress, ceases to turn the case against him if he honestly believed it to be true and if he was justified as a reasonably careful man in so believing; and we cannot say that he was not. Cases such as these are always cases of degree. In Leeds Estate, Building and Investment Co. v. Shepherd 85 the directors trusted their manager and were held liable. They did not take the trouble to see that what he did was even apparently what he ought to have done. They delegated their functions to him.
In re Denham & Co. 86 is more like the present case, and there the director was held not liable.
It must be now conceded that, if Mr. John Cory had himself studied the weekly states and quarterly returns, and had compared those for one period with those for another, and more especially if he had seen the letters addressed by the auditors to the directors, he would have been put upon inquiry and would have found out, if he had not neglected his duty, that the affairs of the bank were not in the flourishing condition in which he believed them to be.
The existence of the letters written by the auditors and accompanying their certificates was very much relied on against Mr. John Cory. Those letters are not produced; they were never found by the liquidator. His knowledge of them is derived from copies furnished by the auditors. The letters warned the directors annually in and after 1884, and especially in January, 1890, that there were matters which required investigation, and if Mr. John Cory had known or suspected that there were such letters, and he had omitted to make inquiries into the matters to which attention was drawn, he would plainly have neglected his duty as a director, and have been guilty of negligence to the degree justifying the epithet gross. But he had no reason to suppose there were any such letters, and apart from them the auditors' reports justified him in supposing that all was right. The letter from the auditors of January 13, 1890, to the secretary of the bank was answered by the secretary on February 13, 1890, saying it had been laid before the board, and it was true that this had been done on the 10th. But Mr. John Cory was not there. He was apparently present at a subsequent meeting at which the minutes of the meeting of the 10th were confirmed, but the matter did not attract his attention, and, considering the terms of the minute, this was very natural. We are satisfied that these letters from the auditors were fraudulently concealed from Mr. John Cory, and that he never knew of or suspected their existence. His ignorance of them was not attributable to negligence on his part.
His omission to examine the weekly states and quarterly returns is also, we think, excusable, although not on the same grounds, for they were known by him to exist, and were in the board-room for inspection. We have had the advantage of an exhaustive examination of them and of a comparison of long series of them, and we know the result and their full significance. But, without a comparison of those for one period with those of an earlier period, a director would derive little information which was really useful. No suspicion being aroused, Mr. John Cory's reasons for not examining them are natural, and his omission to examine them does not shew ant of reasonable care and attention on his part to the affairs of the bank. He had no reason to suppose that there were unsatisfactory debts beyond those written off and provided for.
The evidence when carefully sifted unquestionably shews that Mr. John Cory might have found out that he was being deceived by the general manager, and that the dividends declared were not in a business sense warranted by the profits made. On the other hand, the evidence shews that, although he was deceived, he neither knew nor suspected it.
We are not prepared to say that he was guilty of any breach of duty in not discovering that those whom he trusted were misleading him; nor that in point of law he was guilty of any breach of duty in recommending the payment of dividends as and when he did. A director does not warrant the truth of his statements; he is not an insurer. But if he makes mis-statements to his shareholders he is liable for the consequences, unless he can shew that he made them honestly, believing them to be true, and took such care to ascertain the truth as was reasonable at the time. This we think Mr. John Cory did.
It follows that Mr. John Cory is not only not liable to make good the dividends declared, but also that he is not liable to refund those which he himself received as a shareholder, whether before or after June 14, 1889, for there was no breach of trust in this matter by him. His conduct before that date was not more remiss than it was afterwards.
As regards the advances made to directors without security between June 14, 1889, and December 18, 1890:-
The lien given by art. 15 came into existence automatically, and gave the company an equitable charge on the shares, with a power of sale, which is very important. It certainly constituted a security: In re General Exchange Bank. 87 Art. 98 enumerates what the board may do, and presupposes consideration and attention by them; and we are of opinion that no credit was to be given, and no advance was to be made, to a director without deliberation by the board nor without security, and if so made it would be difficult to justify the advance by falling back on the lien conferred by art. 15. But we cannot o the length of saying that shares in the bank might not be accepted as security on reasonable deliberation, if of adequate value. We do not overlook the fact that their value depends on the value of the assets of the company lending its money on them. This renders care and deliberation all the more necessary, whether the borrower was a shareholder or a director. But in either case we are of opinion that shares in the bank might be accepted as security, if the board considered them sufficient as regards value. Suppose the board considered a proposed advance, and, being satisfied that the shares would sell for considerably more than the sum advanced, authorized an advance upon them, and obtained a deposit of the share certificates of the borrower as security. We do not think they would have failed in their duty, even if the borrower were a director. This being so, we cannot hold the board liable in point of law for omitting to obtain the certificates; for their lien and power of sale under art. 15 would not be defeated by the absence of the certificates, and we do not understand that any loss has been sustained by the bank by reason of the absence of certificates. In substance, therefore, we agree with the view of Wright J. on this point.
Now let us see what was done by Mr. John Cory. Large advances were made to some directors in 1889 and 1890. We leave out of account the advances made in 1891, as Mr. John Cory was not then a director. It is proved that in 1889 and 1890 Mr. Crawshay, one of the directors, was constantly allowed to overdraw. The branch manager at Bridgend perpetually drew attention to this and wrote for instructions, but apparently got none. Crawshay was a large shareholder in the company, and the market value of his shares exceeded his advances and overdrafts. Other deeds and documents were apparently also held by the bank as a security. Other similar cases are given by the liquidator. These advances and overdrafts have resulted in large losses.
The directors clearly regarded the lien as a security, and a "stop share" book was accordingly ordered to be kept in 1884, in which all shareholders' overdrafts were to be entered. There is no proof that, if the shares could, in point of law, be taken s security, they were insufficient at the time they were taken. The securities were never reported to the board as insufficient; nor did Mr. John Cory know or suspect they were so. His cross-examination on these matters shews that many very material facts were concealed from him, e.g., the fact that a director was a partner in a borrowing firm; the amounts to which some of the directors obtained advances, or were indebted to the bank; the insufficiency of the securities. Moreover, several of the advances which have resulted in loss were not sanctioned by him, and were made without his knowledge.
The question of course again arises whether Mr. John Cory ought not to have been more vigilant. The observations already made on this head need not be repeated. Nor is it necessary to examine in detail his liability for other improper advances. Here, again, his answer is the same, and his liability depends on his omission to find out the facts. His liability for that omission has been already considered and negatived.
Having arrived at the above conclusions, it is unnecessary to decide whether Mr. John Cory's counsel were right in their contention that, assuming him to be liable to make good the dividends declared whilst he was a director, the liquidator, as representing the shareholders in the bank, could not have recovered those dividends from him. The argument was that all moneys recovered by the liquidator would have to be distributed amongst the shareholders, who had already had the benefit of the dividends improperly declared, so that they would in effect be paid twice over. In the course of the argument it was pointed out that the money sought to be recovered was, if recoverable, an asset of the company, and that the liquidator was the person to get it in; and that Turquand v. Marshall 88 has no application to claims by incorporated companies. We pointed out that the money which had been divided in years gone by had been paid and received as profits, and not as capital, and that Mr. J. Cory ould not treat the shareholders whom, on the present assumption, he would have misled, as having received the dividends as capital. We said that we agreed with the observations of Cotton L.J. in Flitcroft's Case 89 as we understood them, namely, that the Court could and would prevent the liquidator from taking any proceedings which were useless and vexatious, but that this proceeding in the case supposed would be neither the one nor the other. On this part of the case we agree with Wright J.
Lastly, we think it only due to the liquidator to add that, although Mr. John Cory has succeeded in his appeal, his conduct justified the closest scrutiny. But the order appealed from ought to be reversed, and, having regard to the serious charges made against him, the liquidator must pay Mr. John Cory his costs both of the summons and of his appeal.
Representation
Solicitors: Michael Abrahams, Sons & Co.; Riddell, Vaizey & Smith, for Thos. Williams, Neath; Burton, Yeates & Hart.