Verdict Makes Bankers Tremble

Two state court jury verdicts against two banks–one in California and one in Texas–are sending national tremors through the merchants of debt.

In El Paso, Texas, a jury awarded the Farah Manufacturing Co., a large clothing firm, $19 million to be paid by the State National Bank and other lenders. The trial, which took eight weeks, heard Farah’s lawyers claim that the El Paso bank, the Continental Illinois National Bank & Trust Co., RepublicBank Dallas and the Prudential Insurance Company conspired to influence the composition of Farah’s top management and pushed the company to the brink of bankruptcy.

Farah was an economically troubled company in 1977 and 1978. Its labor problems had incurred a widespread boycott of its products by unions and their supporters. The company alleged that its corporate creditors left the firm in a “shambles” because of fraudulent and unlawful interference in company affairs.

Farah’s lawyer, Tom Thomas, described the court’s decision as one that “at least here, will require banks to re-evaluate a number of their practices for handling troubled debtors. They won’t be able to substitute their business judgment.”

All over the country, however, banks are doing just that–substituting their business judgment in ways that are not always rehabilitating to the business debtor. When jurors from a conservative area of the country can sock it to a local bank, as just happened in El Paso, some bankers can be excused if they are getting worried. For there are more and more troubled companies in the hands of banks.

The California case, in Pomona Superior Court against the Security Pacific Bank, concerned the mishandling of probate trust funds. This is an area that historically has generated many complaints from next of kin–complaints not only toward banks but also against probate lawyers.

The widow and two children of Claremont, Calif., philanthropist Clifford Pitzer were the beneficiaries of a trust fund that had a value of about $600,000. After two years under the bank’s management, the value was $400,000. The decline in value did not in itself reflect adversely on the bank. What did was a bank memorandum stating that a 20-acre parcel of property owned by the trust in Claremont should be sold at “wholesale” prices. After the sale, the bank provided a loan to the developer to purchase and develop the property as a housing tract.

The judge ruled that as a matter of law the bank engaged in a breach of trust by making the loan while handling the family’s funds. He allowed the jury to consider the bank’s intent and to assess punitive damages.

By a 10-2 vote the jury awarded the family $27,500 in compensatory damages and $3 million in punitive damages. Punitive damages are awardable when the jury believes the behavior of the defendant was outrageously reckless or fraudulent and wants to deter the defendant from future repeat performances.

William Shernoff, the family’s lawyer in this case, asserted that “this verdict will certainly be a warning to all banks that they can no longer willy-nilly conduct themselves as they please in probate matters.”

He added, “I think it is really going to have an impact on the banking industry as a whole, which will have a beneficial impact on the public. People have realized for a long time there is a lot of hanky-panky by banks in probate cases.”

Security Pacific Bank said that a probate matter is no place for punitive damages and plans an appeal. But there are thousands of mishandled or carelessly treated probate trust funds whose beneficiaries are without appeal. They do not know what the bank is doing and, if they did, few lawyers would take the cases. So it is encouraging to learn that, at last, some juries are being given an opportunity to evaluate the quality of bank management.

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