112 OTIS &CO.v. PENNSYLVANIA R. CO. et al.

AUTHOR: Tan
61 F.Supp. 905 (1945) NOTES:
TOPIC: Duty of Diligence: Business Judgment Rule This secondary, or derivative action was brought by Otis & Co., a
PONENTE: Kalodner, J. stockholder in the Pennsylvania Railroad Co., against that Company, its
officers and directors, and the Pennsylvania, Ohio and Detroit Railroad
Co., and certain of its officers and directors. The latter is a wholly-owned
subsidiary of the Pennsylvania Railroad. The matter is presently before
the Court on a motion for summary judgment for consideration on the
merits.
FACTS:
 The Pennsylvania R. R. Co. (hereinafter referred to as P. R. R.) directly or indirectly owns all of the capital stock of
the Pennsylvania, Ohio & Detroit R. R. Co. (hereinafter referred to as P. O. & D.)
 In the Spring of 1943, P. O. & D had outstanding a total of $28,483,000 "Series A" bonds, maturing April 1, 1977,
bearing interest at the rate of 4½%, payable semi- annually, and redeemable on any interest payment date subsequent
to April 1, 1932, at 102.5 upon 60 days' notice. This bond issue was guaranteed, both as to principal and interest, by P.
R. R.
 The possibility of refinancing this series of bonds had been under consideration by Mr. Clement, president of P. R. R.,
and Mr. Pabst, vice president in charge of finance of P. R. R. and president of P. O. & D., for approximately a year
prior to June, 1943.
 During the latter part of April, 1943, the bond market became so favorable to refinancing that Clement directed Pabst
to contact Kuhn, Loeb & Co. to determine whether it was possible to sell at a price not less than par, a new issue of P.
O. & D. bonds, guaranteed by P. R. R., in the same amount as the Series A bonds but bearing interest not exceeding
3¾%.
 On June 23, 1943, the directors of P. O. & D. approved a resolution authorizing the sale of the new Series D 3¾%
bonds, at the "best obtainable price," and the directors of P. R. R. approved a resolution authorizing a guarantee
agreement.
 On the same day, the bonds were sold to Kuhn, Loeb and Co. at par and accrued interest from July 1, 1943, to date of
settlement, subject to approval by the Interstate Commerce Commission.
 On June 22, 1943, before the action by the directors and before the contract of sale to Kuhn, Loeb & Co. was
executed, a Mr. Claflin, representing Halsey, Stuart & Co., Inc., visited Pabst in an effort to learn whether there might
be a refinancing of the P. O. & D. bonds, but Pabst declined to give any information and, in response to another
question, stated that he did not think it was likely Halsey Stuart & Co. would have an opportunity to bid if there were
a refunding.
 On June 23, 1943, Halsey, Stuart & Co. and Otis & Co. by telegrams to Clement and other directors of P. R. R.
requested an opportunity to submit a competitive bid for the P. O. & D. bonds.
 Clement telegraphed a reply to Otis & Co., acknowledging the joint telegram and advising that the "railroad has
transacted the business referred to in a very satisfactory way, and in what is considered the best interests of the
railroad."
 Halsey, Stuart & Co. and Otis & Co offered to guarantee a price of 101, at a competitive bidding sale, for 3¾% 35-
year bonds.
 No reply was made by Pabst or Clement so Halsey, Stuart & Co. and Otis & Co. sent a letter to Pabst offering to
guarantee a minimum bid of 102 at a competitive bidding sale for the Series D bonds, subject to adjustment of call
prices, or a minimum bid of 101 at a competitive sale for 34 or 35 year bonds.
 Application to the Interstate Commerce Commission for approval of the Series D bonds was made by P. R. R. and P.
O. & D.
 Otis & Co., a stockholder of P. R. R., was granted leave to intervene, but such leave was denied Halsey, Stuart & Co.
 A majority of the Commissioners were not convinced that the applicants received the best possible price, however,
they determined that competitive bidding was not appropriate. Because of the debt reduction provisions and because
the sale would result in a saving of approximately 9 million dollars which might not be realized if approval were
withheld, it was determined to approve the sale at a price not less than 100¼, considering the spread of 1¾ to be too
great. This price was considered just and reasonable.
 Otis & Co contends
1. That the individual defendants failed and refused to exercise ordinary care and judgment in the sale of the
Series D bonds;
2. That they kept secret the bond issue and refused to deal with any investment house other than Kuhn, Loeb &
Co. Furthermore, it is charged that as a result of failing to "shop around," a half million dollars was lost, and
another half million dollars was lost in failing to put the issue to competitive bidding; and
 3. That certain of the directors were influenced because of their position as directors of several institutions
which had made agreements with Kuhn, Loeb & Co. to purchase and/or sell part of the bond issue.
 P. R. R. and P. O. & D. contend:
1. The transaction was an honest exercise of judgment;
2. That the procedure followed was similar to that generally pursued by railroads; and
3. That it was particularly desirable here. Adverse interests on
ISSUE(S): Whether the officers and directors of Pennsylvania R. CO. are guilty of negligent mismanagement.

HELD: No. They were in the exercise of their business judgment and they were in good faith.

RATIO:
 In Pennsylvania, the relation of officers and directors to the corporation is stated in the Business Corporations Law
1933 which provides that:
"Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall
discharge the duties of their respective positions in good faith and with that diligence, care and skill which
ordinarily prudent men would exercise under similar circumstances in their personal business affairs."
 In view of the Pennsylvania statute it seems that the application of the BUSINESS JUDGMENT RULE is
warranted in the instant case. The rule was succinctly stated by Justice Shientag in Casey v. Woodruff:
"The directors are entrusted with the management of the affairs of the railroad. If in the course of
management they arrive at a decision for which there is a reasonable basis, and they acted in good faith, as
the result of their independent judgment, and uninfluenced by any consideration other than what they
honestly believe to be for the best interests of the railroad, it is not the function of the court to say that it
would have acted differently and to charge the directors for any loss or expenditures incurred."
 There can be no doubt that the officers and directors of both P. R. R. and P. O. & D. acted honestly, in good faith,
and sought to exercise their judgment for the best interests of the respective railroads. There is no contention here
that fraud was present; indeed, the allegations in the complaint contain only a faint suggestion of bad faith, calling
to the attention of the court that the officers and directors were influenced because of their position as directors or
officers of several companies which had made purchase and sale agreements with Kuhn, Loeb & Co.
 It was the duty of the officers, in the course of business, to be on the alert for an opportunity for refunding an
outstanding bond obligation in a manner which would result in a saving to their business, and there is no question
that the management of the defendant corporations did seize an opportune time for the refunding operation.
 That recourse was not had to competitive bidding does not, of itself, afford a basis of liability. It is highly
significant that the Interstate Commerce Commission refused to require competitive bidding, although plaintiff
earnestly urged it to do so. The Court accepts the opinion of the Commission as an expert department of the
government. The defendants unquestionably had the right to negotiate privately with Kuhn, Loeb & Co. In dealing
with Kuhn, Loeb & Co. the defendants were dealing with a firm in which they had the confidence of years of
satisfactory banking relations and which was well acquainted with their financial situation, structure and
requirements.
 In sum:
1. the bond issue was adequately deliberated and planned, properly negotiated and executed;
2. there was no lack of good faith, no motivation of personal gain or profit;
3. there was no lack of diligence, skill or care in selling the issue at the price approved by the Commission,
and which resulted in a saving of approximately $9,000,000 to the corporations;
4. the various directors were aware of the proposed transaction and its course of conduct;
5. copies of telegrams and letters from Halsey, Stuart & Co., and Otis & Co. were sent to them;
6. in any event they had a right to rely on the information supplied by, and the good faith judgment of, those
in whose hands the conduct of the everyday affairs of the corporation was placed.
CASE LAW/ DOCTRINE:
Requirements for Business Judgment Rule to free the directors of any liability for any loss or expenditures incurred
resulting from the decision:
1. Decision made must have a reasonable basis;
2. Directors must have acted in good faith;
a. Decision made must be the result of the directors’ independent judgment;
b. Decision made must be uninfluenced by any consideration other than what the directors honestly believed to be
for the best interests of the company.
DISSENTING/CONCURRING OPINION(S):