CASE Otis and Co. V.

Pennsylvania AUTHOR: REYES

Co. et al. NOTES:
[G.R. No. DATE]
TOPIC:
PONENTE: District Judge Kalodner
FACTS:
 The case involved is a derivative action brought by Otis and Co. against
Pennsylvania Railroad co. (PRR) and its wholly-owned subsidiary, Pennsylvania
ohio and Detroit Railroad (POD) co.
 Otis being a stock holder in PRR is concerned with the alleged losses PRR
suffered from its issuance and sale of over P28,000,000.00 in bonds which was
Guaranteed by POD.
 PRR directly or indirectly owned all the capital stock of POD. In 1943 POD had
an outstanding total of P28,483,000 “series A” bonds maturing on April 1 1977,
bearing interest at 4-1/4% payable, semi-annually and redeemable on any interest
payment date subsequent to April 1, 1932. The bonds were guaranteed both as to
principal and interest by PRR.
 Mr. Clement, president of PRR and Mr. Pabst, Vice-president of PRR and
president of POD were contemplating on how to refinance the series A bonds.
 When the bond market became lucrative during April of 1943, Clement and was
enticed so much so that he directed Pabst to seek out the financing house of
Kuhn, Loeb and co. to explore the idea of selling at a price not less than par a
new issue of POD bonds guaranteed by PRR in the same amount as the series a
bonds but bearing an interest not exceeding 3-3/4%.
 After lengthy negotiations, the directors of POD authorized a board resolution
authorizing the sale of the new series D 3-3/4% bonds “at the best obtainable
price” they were sold on the same day to Kuhn, Loeb and co. at par and accrued
interest. This transaction took place on June 22, 1943.
 The series D bonds contained a sinking provision ( the sinking provision allowed
for the bonds to be redeemed at an earlier date than the date of maturity and for a
premium), the sinking provision did not exist in the series A bonds.
 JUNE 22 1943 A DAY BEFORE THE SALE TO KUHN ET AL. A certain Mr.
Claflin who represented Halsey, Stuart, and co. visited Pabst and inquired if he
could their house could refinance the POD series A bonds. Pabts was
unresponsive and implied that should there be s refinancing, Halsey would not be
able to bid.
 The Halsey house along with Otis and co. sent telegrams to Clements and other
directors and officers of POD and PRR. They offered to bid competitively. The
 defendants would later on say that they recived such telegram on June 24th, after
their transaction had already been completed.
 On june 28, the Halsey House and Otis and co. sent another telegram, criticizing
the technical aspects of the deal with Kuhn and they should be given the chance
to present their proposal. They also scheduled a conference to discuss changes in
terms and conditions and that the Intestate commerce commission was invited to
weigh in
 The findings of the ICC showed that they felt that the applicants for the bonds
approval (PRR and POD) did not receive the best price and that the negotiations
were not done properly but merely at an “arm’s length.”
 An action was brought against PRR and POD accusing them of negligence and
failing to shop around for the best offer which resulted in a half a million dollar
loss.
 Defendants moved for a summary judgment arguing that it was done with an
honest exercise of judgment and that they followed a procedure normally done
by other railroad companies.
ISSUE
Whether or not the individual defendants ( Clement and Pabst and the officers and
directors of PRR) are liable for the losses suffered by POD.

HELD: No, defendants motion for summary judgment is granted.

RATIO:
 Because PRR is incorporated in Pennsylvania, the statute of Pennsylvania
regarding the relations of officers and directors to the corporation is deemed as
the operative law.
 According to Penn Statute: the 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.
 Applying the Business Judgment rule and reconciling it with the rule on
negligence, courts do not intervene in the decisions of directors because it
presumed that reasonable judgment is always being exercised. Negligence to
be a basis for court intervention must be proven clearly. Mistakes or errors in
the exercise of honest business judgment do not subject the officers and
directors to liability for negligence in the discharge of their appointed duties.
 It is not the function of the courts to say “had the directors decided in this
manner, they would have averted mistake” because they are entrusted with the
 management of the affairs of the corporation and are thus given wide latitude.
 Fraud could not be proven to have existed, no conflict of interest was shown
when the defendants dealt with Kuhn et al. Kuhn did not even reveal their
agents or underwriters to PRR and POD nor did they even discuss matters
regarding railroad interests.
 The court finally said that upon examination of the facts, the transactions were
not attended by bad faith or negligence. But rather were carefully planned out.
CASE LAW/ DOCTRINE:
DISSENTING/CONCURRING OPINION(S):