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New YorkOliver J. Armas
Scott S. Balber
Thomas J. Hall
Thomas J. McCormack
Alan I. Raylesberg
Robert A. Schwinger
Donald I Strauber
Jeffrey I. Wasserman
Phoebe A. Wilkinson
Marc D. Ashley
Jonathan C. Cross
Thomas N. Pieper
Los AngelesRobin D. Ball
Jay R. Henneberry
Richard J. Ney
Washington, DCAbbe D. Lowell
Pamela J. Marple
William K. Perry
Michael Socarras
C. Ignacio Suarez Anzorena
Christopher D. Man
Keith M. Rosen
BeijingChris Flood
DubaiDaniel J. Greenwald, III
IstanbulAyşe Yüksel
KyivJaroslawa Z. Johnson
FOR MORE INFORMATION, CONTACT
London Michelle George
Melanie Willems
Mexico CityLuis Enrique Graham
MoscowJulia Romanova
Mikhail A. Rozenberg
São PauloCharles Johnson
WarsawSylwester Pieckowski
Marcin Boruc
JUNE 2012
FINANCIALSERVICESLITIGATIONNEWSWIRE
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 1
Judge Jed S. Rakoff of the United States District Court for the Southern District of New York recently granted
a motion to dismiss civil Racketeering Influenced Corrupt Practices Act (“RICO”) claims and related common
law claims brought against UniCredit S.p.A., its CEO, and two of its subsidiaries (together, “UniCredit”) by
Irving Picard, the Trustee for the estate of Bernard L. Madoff Investment Securities LLC (“Madoff Securities”).
Picard v. Kohn, Case No. 11-CV-1181, 2012 U.S. Dist. LEXIS 22083 (S.D.N.Y. 2012). The district court dismissed the
challenged claims concluding that, among other deficiencies, the Trustee’s complaint failed to demonstrate
that the Trustee, standing in the shoes of the estate of Madoff Securities, had standing to bring either civil
RICO or common law claims against UniCredit.
MADOFF TRUSTEE’S RACKETEERING CLAIMS AGAINST UNICREDIT ARE DISMISSEDBy Thomas J. Hall ([email protected]) and Robert Kirby ([email protected])
BackgroundAfter it was revealed in December 2008 that Madoff Secu-rities was in fact a ponzi scheme, the company went into bankruptcy. The Trustee was appointed soon thereafter to manage the consolidated liquidation of Madoff Securities. The instant action was one of many lawsuits commenced by the Trustee to recover assets for the benefit of creditors of the estate.
In this action, the Trustee brought suit against dozens of defendants, including UniCredit S.p.A., its CEO Alessandro Profumo, and its subsidiaries Pioneer Global Asset Manage-ment S.p.A. (“Pioneer”) and UniCredit Bank Austria AG (“Bank Austria”) for civil RICO and assorted common law claims, in-cluding claims for unjust enrichment, conversion and money had and received. The complaint alleged the existence of “an extensive criminal enterprise centered around Sonja Kohn,” an Austrian banker with a relationship with Madoff, and that Kohn “used the purported enterprise to feed $9.1 billion of investments into Madoff Securities . . . in return for kickbacks that Madoff and Kohn fraudulently disguised as payments for research.” The UniCredit defendants and others named in the complaint allegedly conducted and conspired to conduct this “criminal enterprise” in violation of RICO “through a pat-tern of racketeering activity consisting of money laundering, money transactions involving property known to be derived from unlawful activity, wire fraud, financial institution fraud,
mail fraud, transportation of funds taken by fraud, transpor-tation of persons to defraud, [and] receiving funds taken by fraud.” The Trustee sought to recover from the defendants the entire $19.6 billion alleged to have been lost by investors in Madoff Securities because, without Kohn’s “criminal enter-prise,” Madoff’s ponzi scheme allegedly could not otherwise have continued for as long as it did. If proven, these civil RICO claims could have entitled the Trustee to recover treble dam-ages (i.e., approximately $59 billion) from the defendants.
As to the four UniCredit defendants, the Trustee alleged that their participation in Sonja Kohn’s “criminal enterprise” primarily “consisted of attracting investors to supposedly diversified investment funds that, in reality, did nothing more than feed money into Madoff Securities” and engaging in “deception” to conceal the true natures of those so-called feeder funds. Specifically, Pioneer and Bank Austria allegedly conspired with Kohn and others to market certain Madoff feeder funds to investors. According to the complaint, UniCredit S.p.A acquired Pioneer in May 2000 and Bank Austria in 2005. After the latter acquisition, UniCredit alleg-edly “identified concerns and defects — e.g., the absence of written contracts between Primeo Fund [one of Bank Austria’s investment funds] and Madoff Securities — associ-ated with those of their new funds that invested exclusively with Madoff.” The complaint further alleged that UniCredit “attempted to disguise the fact” that Primeo Fund “invested
2 CHADBOURNE & PARKE LLP
exclusively with Madoff.” This alleged cover up purportedly included the firing of a UniCredit analyst “who identified de-fects in UniCredit’s relationship with a Madoff feeder fund.”
The four UniCredit defendants moved to dismiss the complaint’s civil RICO and common law claims as against each of them. For the reasons explained below, the district court granted that motion in its entirety. Thereafter, the Trustee appealed Judge Rakoff’s decision to the United States Court of Appeals for the Second Circuit. By agreement of the parties, that appeal was subsequently withdrawn with the stipulation that the Trustee be permitted to reinstate the appeal, if he should so choose, at any time on or before April 6, 2013.
Trustee Lacks Standing to Bring Civil RICO ClaimsTo state a civil claim under the federal RICO statute, the Trustee was required to allege adequately, among other things, UniCredit’s “(1) conduct (2) of an enterprise (3) through a pattern (4) of racketeering activity.” The district court concluded, however, that the complaint foundered even before reaching those essential elements because it failed to demonstrate that the Trustee, suing on behalf of the estate of Madoff Securities, had standing to pursue such a claim against UniCredit. As the district court explained, for the Trustee to have standing to bring a civil RICO claim against UniCredit, the complaint would need to establish that the defendants’ “criminal enterprise” was “the proxi-mate cause” of the injury to Madoff Securities. In other words, the complaint must demonstrate “the directness of the relationship between the [criminal] enterprise’s alleged criminal acts and [Madoff Securities’] injuries.” It would not suffice to allege “[a]cts that merely furthered, facilitated, permitted or concealed an injury which happened or could have happened independently of the act.”
According to Judge Rakoff, the complaint failed to satisfy this standard. The complaint’s allegations that Kohn’s “criminal enterprise,” with respect to which UniCredit was an alleged conspirator, had “fed, perpetuated, and profited from Madoff Securities’ Ponzi scheme” were “too indirect to sat-isfy the proximate cause requirement.” The Trustee further conceded “that Madoff Securities operated independently of defendants’ conduct, instead alleging only that defendants extended Madoff Securities’ duration by providing it with a ‘flood of cash.’” Such allegations, according to the district court, did not suffice to allow the Trustee to proceed with its civil RICO claims against UniCredit.
The district court’s opinion stated another, independent reason for its dismissal of the complaint’s civil RICO claims, namely that the so-called RICO amendment in the Private Securities Litigation Reform Act (the “PSLRA”) prohibited the Trustee from relying on nearly all of the complaint’s specific factual allegations concerning UniCredit to state a civil RICO claim. According to the district court, the RICO amendment of the PSLRA “bars civil RICO claims, including claims for wire and mail fraud, alleging predicate acts of securities fraud, even where a plaintiff cannot itself pursue a securities fraud action against the defendant.” Judge Rakoff concluded that the Trustee’s complaint ran afoul of this rule because it principally alleged that UniCredit engaged in “deception” to attract investors to Madoff feeder funds and “conspired to conceal” the fact that those funds only invested with Madoff Securities.
The district court further held that the comparatively few allegations in the complaint that did not concern a purported securities fraud “utterly fail to state a claim” under the RICO statute. Other than “suggesting that Kohn plagiarized some of Bank Austria’s research,” the complaint provided “almost no indication that UniCredit, Pioneer, Bank Austria, and Profumo meaningfully participated” in those aspects of the “criminal enterprise” that allegedly involved the receipt of fraudulent payments for “research” as “kickbacks” from Madoff Securities.
The Doctrine of In Pari Delicto Likewise Defeats the Common Law Claims The district court made short work of the Trustee’s related common law claims against UniCredit for unjust enrichment, conversion and money had and received. Judge Rakoff noted
Judge Rakoff’s recent decision in Picard v. Kohn dismissing the civil RICO and common law claims against UniCredit demonstrates the many complexities and challenges with respect to the Trustee’s efforts to recover funds for the creditors of Madoff Securities.
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 3
that, in a separate action commenced by the Trustee against several financial institutions, “this Court has already held as a matter of law that the Trustee lacks standing to bring common law claims such as those advanced in these three counts.”
In that prior decision, Picard v. HSBC Bank PLC, 454 B.R. 25 (S.D.N.Y. 2011), the district court dismissed claims for unjust enrichment, aiding and abetting fraud and aiding and abetting breach of fiduciary duty, explaining that “the trustee stands in the shoes of the debtor, not the creditors” and the Trustee is “barred from bringing claims on behalf of the debtor’s estate because of the common law doctrine of in pari delicto, which generally precludes a wrongdoer like Madoff Securities from recovering from another wrongdoer.” In that case, the Trustee’s own complaint conceded Madoff’s role as the “mastermind” of the ponzi scheme. Accordingly, the so called in pari delicto doctrine barred the Trustee, suing
on behalf of the estate of Madoff Securities, from pursuing common law claims against financial institutions alleged to have participated in or facilitated Madoff’s ponzi scheme. That reasoning led the district court to the same result here, the dismissal of each of the Trustee’s common law claims against UniCredit.
ConclusionJudge Rakoff’s recent decision in Picard v. Kohn dismissing the civil RICO and common law claims against UniCredit demon-strates the many complexities and challenges with respect to the Trustee’s efforts to recover funds for the creditors of Madoff Securities. This decision also serves as yet another re-minder of the wide range of third party financial institutions that either have already or may yet face litigation exposure arising from the collapse of Madoff’s ponzi scheme.
Joseph F. Skowron, III was a Morgan Stanley Managing Director. On August 15, 2011, Skowron pleaded guilty to a one-count information charging him with conspir-acy to commit securities fraud by engaging in insider trading and with obstructing an SEC investigation.
In connection with Skowron’s sentencing, Morgan Stanley sought an order requiring Skowron to make restitution to Morgan Stanley under the Mandatory Victims Restitution Act, 18 U.S.C. § 366A, which pro-vides for mandatory restitution to victims in sentenc-ing proceedings for convictions for, inter alia, offenses against property under Title 18. The United States District Court for the Southern District of New York granted that request in part, awarding Morgan Stanley restitution of over $10.2 million in total.
First, Morgan Stanley sought restitution for a $33 million fine it paid to the SEC to resolve claims the SEC brought again Skowron and related defendants. In denying this request, the court found that this
amount was for the losses that Morgan Stanley avoided as a result of Skowron’s insider trading, and was not money that it was legally entitled to retain.
Second, Morgan Stanley sought restitution for $3.8 million that it spent in legal fees and related expenses in connection with the SEC investigation of Skowron. In awarding this amount, the court found that these expenses were directly and proximately incurred as a result of Skowron’s scheme.
Lastly, the court awarded Morgan Stanley $6,420,801 as reinbursement of 20% of the compensa-tion it paid Skowron during the time of the wrongdo-ing, between 2007 and 2008. The court found 20% to represent the difference in the value of the services that Skowron rendered and the value of those services had they been rendered an honest employee. United States v. Joseph F. Skowron, III, 11 Cr. 699 (DLC) (S.D.N.Y. 2012).
MORGAN STANLEY AWARDED $10.2 MILLION IN RESTITUTION FROM DISHONEST EMPLOYEE
4 CHADBOURNE & PARKE LLP
In Kelly, Grossman & Flanagan LLP v. Quick Cash, Inc., No, 04283-2011, 2012 WL 1087341 (Suffolk Co. 2012),
the plaintiff law firms and their partners sought a declaration that their agreements with the defendant
Quick Cash entities were void as violative of New York Penal Law Section 190.40 for being criminally usurious.
After defendants advanced the law firms money with expected legal fees from the plaintiffs’ contingency fee
lawsuits pledged as collateral, the plaintiffs brought suit asserting that, in addition to being required to repay
the principal amount of the advances, their contracts called for over 40% in annualized interest payments,
which exceeds the criminally usurious rate of 25%. After converting the defendants’ motion to dismiss the
complaint to a motion for summary judgment, the court found that the relevant financial transactions were
not loans, and thus New York’s prohibition against usury was not triggered.
BackgroundFrom May 2005 through August 2009, the plaintiff law firms and their partners entered into various agreements with the Quick Cash entities through which the firms were provided with financing secured by the expected legal fee recoveries in specific lawsuits. Plaintiffs were required to pay interest on the funds provided, and frequently individual partners personally guaranteed repayment in the event that, in any of the lawsuits serving as collateral, a judgment was entered in plaintiff’s favor but the judgment debtor was unable to pay.
Kenneth Bradt, President and CEO of certain defendant entities, asserted that, in addition to earlier agreements, in December 2007 the law firms entered into three contracts with Quick Cash entities for cash advances, paid a process-ing fee, and agreed that the financing was in the form of non-recourse advances with an obligation that would increase at a rate of 40% per annum compounded quarterly. These advances were secured by the law firms’ expected fee recoveries in certain lawsuits, and the firm’s partners were required to provide status updates regarding those cases. In addition, the law firm partners personally guaranteed the firms’ performance of these contracts.
In May 2009, a newly formed partnership consisting of the previous law firms engaged in transactions with Quick Cash to fund advertising. Defendants advanced funds for
advertising in exchange for an agreement that the law firm continue to prosecute the cases previously handled by the two former firms that were used as collateral under prior agreements. To memorialize the terms of this agreement, in August 2009 the partners executed an Addendum and the fees from sixteen pending lawsuits were added as collateral. Additionally, a liquidated damages clause was added for double the payment obligation in the event of a breach.
The Law Firms Argue Criminal UsuryThe plaintiffs asserted that the defendants extended numer-ous loans to them for which defendants charged an interest rate in excess of 40%, on which the firms had already paid over $1 million. In asserting that the financial transactions at
The court found that defendants had demonstrated that the agreements were non-recourse advances, not loans, and that there was no material issue of fact to be tried in that regard.
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 5
issue were in fact loans, the plaintiffs pointed to the agree-ments themselves which name them as “Borrower” and defendants as “Lender.” They alleged that it was not until August 2009, when various agreements were consolidated into the Addendum, that one defendant began to use the term “advance” instead of “loan.” Plaintiffs also alleged that, despite non-recourse language in the agreements, the transactions were in fact recourse because defendants were never truly at risk, thereby making them loans. To support this argument, the plaintiffs pointed to the contractual re-quirement that, if they were discharged as counsel on a case pledged as security, plaintiffs were obligated to find a new case to serve as collateral or to pay liquidated damages.
Defendants Argue They Provided Advances, Not LoansThe defendants explained that their business was to provide financing to attorneys, or plaintiffs involved in litigation, as either recourse loans or as non-recourse advances. In a re-course loan, the attorney grants a lien to Quick Cash against the attorney’s expected contingency fee for the recovery in a case, and attorney makes monthly payments, pays when each case settles, or pays at the end of the loan term. In a non-recourse advance, on the other hand, the attorney as-signs to Quick Cash a portion of the expected fee from a case and pays only if and when each case settles or there is an alternative recovery; if there is no recovery in the case, then no payment is made to Quick Cash on that case. Defendants asserted that the transactions at issue here fell into the latter category of non-recourse advances.
The Court’s AnalysisThe court made a threshold finding that, to be subject to the criminal usury prohibition in Penal Law Section 190.40, a transaction must be a loan. The court further stated that “[w]here a transaction involves interest to be paid based upon a contingency which is in the control of the debtor, usury will not apply.” To determine if a financial transaction is a loan subject to criminal usury laws, courts will look to the character of the transaction rather than its title.
Here, several of the contracts at issue specifically stated: “Attorney represents and warrants that Attorney fully under-stands that the Advance made hereunder is not a recourse loan, but a non-recourse financial transaction pursuant to which Investor’s funds are at full risk.” Additionally, the Au-gust 2009 Addendum provided that “Recourse Agreement(s) shall be deemed null and void and the amounts due pursu-ant to those recourse agreement(s) are now incorporated in full herein as non-recourse.”
The court found that defendants had demonstrated that the agreements were non-recourse advances, not loans, and that there was no material issue of fact to be tried in that re-gard. The court gave little weight to plaintiffs’ argument that the transactions were loans because at times the relevant contracts referred to the parties as “borrower” and “lender.” Additionally, the court found persuasive that the defendants were always at risk of the collateral cases going to trial and resulting in defense verdicts. Given this possibly, the court found that the transaction could not be considered a loan. Finally, the court found that the language of the contracts was unambiguous in stating that the transactions were non-recourse advances.
The court relied on the case of Matter of Strategies, LLC v. Ferreira, 28 Misc. 3d 1204[A], 2010 N.Y. Slip Op. 51159 [U] (N.Y. Co. 2010), which dealt with an arbitration to enforce payment of a non-recourse advance with a pending legal matter as collateral. The court in Strategies, LLC wrote: “The instant transaction, by contrast [to a loan], is an ownership in proceeds for a claim, contingent on the actual existence of any proceeds. Had respondents been unsuccessful in negotiating a settlement or winning a judgment, petitioner would have no contractual right to payment.” The court in Strategies, LLC found that, based on this reasoning, the usury laws did not apply. Likewise, in the instant case, the court found that the transactions created ownership interests in proceeds of claims, contingent on there being a recovery, and that the New York usury law simply did not apply to such transactions.
6 CHADBOURNE & PARKE LLP
On April, 12, 2012, Goldman Sachs & Co. (“Goldman”) agreed to pay $22 million to the Securities and Exchange
Commission (“SEC”) and the Financial Industry Regulatory Authority and consented to a censure, a cease-and-
desist order, and other undertakings to quell SEC charges that Goldman lacked adequate policies and procedures
to protect against disclosure of nonpublic information to key Goldman clients bubbling out of sector-specific
analyst meetings known as “huddles.” See April 12, 2012 SEC Administrative Order, Release 66791, File No. 3-14845.
(available at http://www.sec.state.ma.us/sct/sctgoldmansachs/goldman_sachs_consent_order.pdf).
GOLDMAN AGREES TO PAY $22 MILLION FOR LACKING ADEQUATE PROCEDURES FOR RESEARCH “HUDDLES” By Pamela J. Marple ([email protected]) and Lisa Schapira ([email protected])
Goldman was alleged to have willfully violated Section 15(g) of the Securities and Exchange Act of 1934 (“Exchange Act”) which requires broker-dealers to impose policies and proce-dures designed to prevent the misuse of nonpublic informa-tion by a broker or dealer or any person associated with such a broker or dealer. The SEC’s April 12, 2012 Administrative Order found that Goldman should have established new policies and procedures to address concerns arising from the newly adopted huddle program and that it failed to ensure compliance with existing policies regarding the misuse of nonpublic information. While Goldman agreed to the terms of the Administrative Order, it did so without admitting or denying the facts presented by the SEC.
The SEC’s ClaimsAccording to the SEC, from 2006 to 2011, research analysts responsible for covering equity securities in the United States, Canada and Latin America provided published reports to Goldman clients with investment recommendations. In these reports, the analysts provided investment ratings and expectations for specific stocks, as well as an outlook for all stocks within an industry sector. Goldman also published a “Conviction List” which was a focused list of the firm’s “best ideas” for the industry sector. Changes to this list required formal approval from Goldman’s Americas Investment Review Committee.
Starting in 2006, Goldman began holding weekly “hud-dle” meetings in each of its seven equity research sectors. These huddles were internal meetings in which Goldman’s analysts and traders, and sometimes sales persons, allegedly engaged in a focused dialogue on developments, market color and short-term trade ideas. In January 2007, Goldman allegedly began sharing information from these huddles with top clients through a program known as the Asym-metric Service Initiative (“ASI”). The ASI client list consisted of approximately 180 hedge fund and investment manage-ment clients. Goldman’s research analysts would call this select group of priority clients to share information and trad-ing ideas from their weekly huddles. Although the analysts would use a script as a guideline when speaking with ASI clients, they allegedly were instructed to “lead with trading color . . . and the most interesting and actionable ideas.”
According to the SEC, these huddles were created by Goldman with the goals of improving the performance of the firm’s traders and increasing commissions obtained from ASI clients. Goldman began following the performance a subset of ideas originating from the huddles and tracked how those ideas impacted trading. Indeed, revenues received by Goldman’s Securities Division from certain ASI clients sig-nificantly increased after Goldman began ASI. During the life of the program, research analysts were acutely aware of the importance of the huddles and ASI to Goldman, and to their own performance evaluations and compensation.
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 7
The SEC determined that the huddles and ASI created a “serious and substantial risk” that analysts would share material, nonpublic information concerning their industry sectors with key clients. It faulted Goldman for failing to establish new risk management policies tailored to the pro-gram and for insufficiently enforcing existing policies. While Goldman had policies that prohibited research analysts from discussing unpublished research with Goldman’s clients or anyone outside of Goldman’s Global Research Investment Division or Compliance Department, no specific policies were established regarding the huddles.
At the start of the huddle program, Goldman had a broad dissemination policy that required any new, material state-ments by an analyst be disseminated broadly to all clients of the firm. In November 2006, Goldman’s dissemination policy allegedly was revised to include the disclosure of “key quan-tum data” when such information would call the analyst’s prior rating into question. All other statements, however, “including internal messages commenting on short-term trading issues or market color” still did not require broad dissemination unless they would call into question published price targets or recommendations. At a training presentation regarding the changed policy, analysts allegedly were told that they were free to share their short-term trading ideas even if those ideas were “not necessarily in the same direc-tion as the investment rating.” That is, under the November 2006 revision, it was permissible to share a short-term idea to sell a stock when that stock had a published “buy” rating.
Management first issued a memorandum regarding the huddles in January 2008. In that internal communication, Goldman reportedly stated that the huddles were subject to existing policies and cautioned that “analysts must not engage in selective disclosure of unpublished research or indicate pending changes in ratings, conviction list desig-nations, price targets or earnings estimates, or in any way disavow their published views.” The SEC criticized Goldman for not providing adequate guidance on what constituted a short-term and near-term trading idea that could be shared with the ASI clients and what constituted a material mis-statement requiring broad dissemination. There were also no guidelines informing analysts that they should not propose trade ideas for a specific stock when the group had already sought formal approval to change that stock’s rating.
In addition to providing insufficient guidance to its analysts, Goldman allegedly did not put in place adequate monitoring and testing surrounding the huddles and ASI to
ensure compliance with existing procedures. Attendance at the huddles by representatives from the Global Compli-ance Division varied over time, and the SEC concluded that hundreds of huddles were not monitored. The SEC claimed that there were hundreds of instances where a rating change occurred within five days of the stock being discussed in a huddle. With few exceptions, there were no records of in-vestigations into what was communicated to the ASI clients following the huddle, and there were no regular reviews or comprehensive audits.
Goldman also allegedly failed to keep complete records of compliance questions arising from huddles. The firm’s policies only required that records be kept when a procedure was in fact violated, and not where there was an inquiry into a potential violation. The SEC stated that although there was no regulatory requirement to keep track of such issues, Gold-man’s failure to do so had undermined its ability to monitor the huddles for a misuse of information or other regulatory concerns.
ConclusionAccording to the SEC, the red flags surrounding Goldman’s huddle and ASI program were apparent, and Goldman should have proactively revised its monitoring and compli-ance policies. Its failure to do so was a $22 million dollar mistake. In addition to paying $11 million to each of the SEC and the Financial Industry Regulatory Authority, Goldman has consented to conduct a comprehensive review of its poli-cies, and to enact new polices and procedures in light of the Administrative Order.
The SEC’s April 12, 2012 Administrative Order found that Goldman should have established new policies and procedures to address concerns arising from the newly adopted huddle program and that it failed to ensure compliance with existing policies regarding the misuse of nonpublic information.
8 CHADBOURNE & PARKE LLP
A New York federal district court recently granted the motions to dismiss of Clariden Leu Bank, n/k/a, Clariden Leu
(“Clariden Leu”) and Credit Suisse Group, Inc. (“Credit Suisse”) for actions Clariden Leu allegedly took in Singapore.
Desyatnikov v. Credit Suisse Group, Inc., No. 10-cv-1870, 2012 WL 1019990 (E.D.N.Y. 2012). With respect to Clariden
Leu, the court determined that it lacked personal jurisdiction over it. With respect to Credit Suisse, the court
determined that plaintiff had failed to state a claim because the only allegation against Credit Suisse was that it
is the parent company of Clariden Leu. In addition, the court determined that dismissal was appropriate based
upon a forum selection clause and the doctrine of forum non conveniens. The court also determined that all of
the federal and state claims should be dismissed for failure to state a claim.
NEW YORK LAWSUIT OVER BANK’S ACTIONS IN SINGAPORE IS DISMISSEDBy Robert A. Schwinger ([email protected]) and Caroline Pignatelli ([email protected])
BackgroundIn 2006, plaintiff Igor Desyatnikov, a dual citizen of the United States and Russia, opened an investment account with Clariden Leu’s Singapore branch office. Credit Suisse is the parent company of Clariden Leu. Both Credit Suisse and Clariden Leu are incorporated in Switzerland. Plaintiff alleged that his agent at Clariden Leu, without his prior knowledge or consent, purchased a foreign security that he had specifi-cally prohibited the agent from purchasing. Subsequently, the plaintiff brought suit in New York against Clariden Leu and Credit Suisse asserting violations of federal securities laws and claims under New York state law arising out of the purchase. Both defendants filed motions to dismiss.
Clariden Leu’s Motion to DismissClariden Leu moved to dismiss the complaint on the grounds that the court did not have personal jurisdiction over it. The court explained that, because the court was relying on the pleadings and affidavits and not conducting an evidentiary hearing, “the plaintiff need only make a prima facie showing that the court possesses personal jurisdiction over the defen-dant.” (quoting DiStefano v. Carozzi N. Am., Inc., 286 F.3d 81, 84 (2d Cir. 2001)). The court also explained that, “[a]lthough a plaintiff’s allegations are ordinarily accepted as true at the pleadings stage, on a motion to dismiss for lack of jurisdic-tion, where [a] ‘defendant rebuts [a] plaintiff[‘s] unsupported
allegations with direct, highly specific, testimonial evidence regarding a fact essential to jurisdiction-and plaintiff[ ] do[es] not counter that evidence-the allegation may be deemed refuted.’” (quoting Merck & Co., Inc. v. Mediplan Health Con-sulting, Inc., 425 F.Supp. 2d 402, 420 (S.D.N.Y.2006) (quoting Schenker v. Assicurazioni Genereali S.p.A ., Consol., 2002 WL 1560788, at *3 (S.D.N.Y. July 15, 2002)).
The court determined that plaintiff failed to make a prima facie showing of personal jurisdiction over Clariden Leu. Specifically, the court noted that plaintiff asserted in his complaint jurisdiction over Clariden Leu “upon information or belief.” In Clariden Leu’s motion to dismiss, however, it submitted a detailed declaration from its in-house counsel explaining why it would be improper for the court to exercise personal jurisdiction over it. Specifically, the court explained that the declaration stated that Clariden Leu is incorpo-rated in Switzerland and headquartered in Zurich; it does not have an office, place of business, address or telephone listing in the United States; and it does not manufacture or distribute products in the United States, is not registered to do business in the United States and has no employees in the United States. The declaration also stated that plaintiff certified at that time he opened his account at the Singapore branch office that he was not a United States resident and was not liable for taxation in the Untied States. The declara-tion further stated that plaintiff was domiciled in Russia and
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 9
provided a Russian passport and electric bill for a residence in Moscow and communicated with his agent at Clariden Leu using Russian telephone and fax numbers.
In opposition, the plaintiff submitted what was titled the “Affidavit of Igor Desyatnikov,” the plaintiff in the action. The court concluded, however, that the “purported affidavit is insufficient as a matter of law” because it was signed by the plaintiff’s agent and not the plaintiff and “only an affiant himself can attest to the veracity of facts based on personal knowledge.” Thus, the court concluded that “Clariden Leu has presented sufficient credible evidence to support the Court’s finding that the exercise of jurisdiction over Clariden Leu would be improper” and dismissed, with prejudice, the complaint against Clariden Leu.
Credit Suisse’s Motion to Dismiss With respect to Credit Suisse’s motion to dismiss, the court explained that “[i]t is well settled that where the complaint names a defendant in the caption but contains no allega-tions in the complaint indicating how the defendant violated the law or injured the plaintiff, a motion to dismiss the complaint in regard to that defendant should be granted.” (quoting Jackson v. Cnty. of Nassau, 2009 WL 393640, at *3 (E.D.N.Y. Feb. 13, 2009)). In addition, the court explained that generally “a parent corporation is not liable for the acts of its subsidiary.”
The court determined that the complaint failed to include any allegations of wrongdoing attributed to Credit Suisse. The court also determined that the “only link” in the com-plaint to Credit Suisse was the assertion that Credit Suisse is Clariden Leu’s parent, “which is insufficient to hold Credit Suisse liable.” Thus, the court concluded that the allegations in the complaint against Credit Suisse are “insufficient as a matter of law” and granted Credit Suisse’s motion to dismiss with prejudice. The court also rejected plaintiff’s argument that dismissal would be premature, concluding that, “[p]ermitting plaintiff discovery on the relationship between Credit Suisse and Clariden Leu would be permitting a ‘fishing expedition,’ which this Court declines to allow.”
Forum Selection Clause and Forum Non Conveniens In addition, the court addressed the defendants’ arguments that the New York forum was improper because a forum se-lection clause in the parties’ asset management agreement required the litigation to be in Singapore and that dismissal was appropriate under the doctrine of forum non conveniens.
With respect to the forum selection clause, the court concluded that the forum selection clause in the asset man-agement agreement “was plainly written, provides for man-datory and exclusive jurisdiction in Singapore, and the claims asserted arise out of the asset management agreement.” The court explained that plaintiff, who the court noted was a “sophisticated international entrepreneur,” did not provide evidence of fraud or overreaching on the part of Clariden Leu. Thus, the court concluded that plaintiff should have brought the case in Singapore and the forum selection clause “to which plaintiff willingly assented, prevents litigation of this action in this Court.”
The court also determined that dismissal was appropriate under the doctrine of forum non conveniens, which “allows a district court to dismiss a case where the preferred venue is a foreign tribunal.” (quoting Overseas Media, Inc. v. Skvortsov, 441 F. Supp. 2d 610, 615 (S.D.N.Y. 2006)). In support of this determination, the court pointed to the facts that the defen-dants are foreign entities, the acts complained of occurred outside of the United States, plaintiff agreed to jurisdiction in Singapore by agreeing to the forum selection clause in the asset management agreement, and plaintiff represented to Clariden Leu that he had no contact with or interest in the United States.
Failure to State Claims Finally, the court addressed the defendants’ arguments that the complaint failed to state a claim.
First, the court concluded that plaintiff’s first cause of action, asserted under Section 5 of the Securities Act of 1933, 15 U.S.C. § 77e, was time-barred and, thus, dismissed the cause of action with prejudice. As an initial point, the court explained that there is no private right of action under Section 5. Even if the claim was construed to be assert-
The court also determined that dismissal was appropriate under the doctrine of forum non conveniens, which “allows a district court to dismiss a case where the preferred venue is a foreign tribunal.”
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ing a claim under Section 12(a)(1) of the Securities Act, the court determined it was time-barred as it would be subject to a one-year statute of limitations and the complaint was filed nearly two years after plaintiff allegedly purchased the foreign security.
Plaintiff’s second cause of action alleged securities fraud under Section 10(b) of the Securities and Exchange Act, 15 U.S.C. § 78j(b), which makes it illegal “[t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance . . .[,]” and Rule 10b-5, which makes it unlawful for “any person, directly or indirectly . . . [t]o make any untrue statement of a mate-rial fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” (quoting 17 C.F.R. § 240.10b-5). The court found that to state a claim un-der Section 10(b) and Rule 10b-5, a plaintiff “must plead six elements: (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation.” With respect to sci-enter, the court explained, among other things, that scienter is “a mental state embracing intent to deceive, manipulate, or defraud.”
The court further explained that the claim was subject to two heightened pleading requirements. First, the complaint must “state with particularity the circumstances constitut-ing the fraud” as required by Federal Rule of Civil Procedure 9(b) and, second, the complaint must satisfy the pleading requirements of the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b), which “insists that securities fraud complaints ‘specify’ each misleading statement; that they set forth the facts ‘on which [a] belief’ that a state-
ment is misleading was ‘formed’; and that they ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.’”
The court determined that plaintiff failed to satisfy the heighted pleading requirements of Section 10(b) and Rule 10b-5. Specifically, with respect to Credit Suisse, the court determined that the only allegation against Credit Suisse in the complaint was that it is the parent company of Clariden Leu. The court noted that there were no allegations in the complaint of fraudulent statements or material omissions made by Credit Suisse or that Credit Suisse was aware of any fraudulent statements or material omissions. With respect to scienter, the court determined that plaintiff failed to sat-isfy the pleading requirements by “lumping” the allegations of scienter against the “defendants.” Finally, with respect to Clariden Leu, the court determined that the “conclusory allegations” against Clariden Leu including that Clariden Leu “knowingly and recklessly traded in Mr. Desyatnikov’s account,” did not meet the heighted pleading requirements. Thus, the court dismissed the second cause of action with prejudice.
Next, with respect to plaintiff’s third cause of action as-serted under Section 17(a) of the Securities Act of 1993, 15 U.S.C. § 77q(a)(1), the court dismissed the claim, with preju-dice, as there is no private right of action under Section 17(a).
Finally, with respect to the New York state law claims, because the court dismissed all of the federal securities claims, with prejudice, it declined to exercise supplemental jurisdiction over the state law claims. Accordingly, the court dismissed the state law claims.
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 11
The United States District Court for the Northern District of California recently denied the motion of Wells
Fargo & Company (“Wells Fargo”) to dismiss claims that its directors and officers breached their fiduciary
duties to shareholders during the mortgage crisis. Judge Susan Illston ruled that the plaintiffs, Wells Fargo
shareholders suing derivatively on behalf of Wells Fargo, had pled particularized facts alleging that defendants
breached their duty of loyalty by allegedly omitting material facts about the company’s practices in the proxy
statement to shareholders. Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust v. Stumpf, No. C 11-2369 SI
(N.D. Cal. 2012).
SHAREHOLDER DERIVATIVE ACTION AGAINST WELLS FARGO’S DIRECTORS SURVIVES MOTION TO DISMISSBy Thomas J. McCormack ([email protected]) and Jill Kahn ([email protected])
Background In May 2011, shareholders of Wells Fargo instituted a deriva-tive action against the company’s board of directors, alleging claims for breach of fiduciary duty, abuse of control, gross mismanagement and corporate waste, arising from the company’s policy of mass processing or “robo-signing” the declarations or affidavits to be submitted in Wells Fargo’s foreclosure proceedings. The plaintiffs alleged that the prac-tice recklessly avoided the actual work and costs associated with obtaining facts or documents representing ownership, standing and the right to foreclose on properties. They also alleged that the policy concealed the possibility that title and standing might not be perfected, and therefore required Wells Fargo employees to file false affidavits on behalf of the company.
Plaintiffs’ allegations were supported by testimony from two Wells Fargo employees in which they admitted to signing unverified affidavits, as well as news articles that documented the bank’s robo-signing practice. Additionally, in October 2010, defendant Howard Atkins, Wells Fargo’s former Chief Financial Officer and Executive Vice President, had stated that the robo-signing policy was designed by Wells Fargo and the policy was sound and accurate. One week later, Wells Fargo issued a press release admitting that its foreclosure processes did not adhere to the company’s
formal policy, and that it was reviewing more than 55,000 foreclosure affidavits.
The complaint also alleged that Wells Fargo’s board of directors urged its shareholders to reject a proposal calling for the Audit Committee to conduct an independent review of the company’s internal controls related to foreclosures, claiming in its proxy statement that it had already under-taken comprehensive self assessments and reviews of its mortgage servicing processes, and was cooperating with reviews undertaken by federal banking regulators. According to the allegations, Wells Fargo in fact had been filing motions to quash discovery and appeals in order to stall government investigations, and had continued robo-signing, even after stating that the practice had been stopped more than six months earlier.
Government SettlementIn addition to the shareholder derivative action, Wells Fargo faced allegations of misconduct from federal and state gov-ernment regulators, arising from the same practices. In Feb-ruary 2012, the company entered a settlement agreement with state and federal governments, releasing it from claims regarding its handling of foreclosures and requests for loan modifications, including the use of robo-signed affidavits in foreclosure proceedings. In exchange, Wells Fargo agreed to
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pay more than $5 billion to borrowers who lost their homes to foreclosure as part of $25 billion government settlement between federal and state governments and Wells Fargo, Bank of America Corp., JP Morgan Chase & Co., Citigroup Inc. and Ally Financial Inc. Though the settlement was based on related allegations, it had no direct impact on the shareholder derivative action against the bank.
Wells Fargo’s Motion to DismissWells Fargo moved to dismiss the shareholders’ complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). The court noted that, for a shareholder derivative action to survive a motion to dismiss, plaintiffs must adequately allege: (1) that they contemporaneously owned Wells Fargo stock at the time of the wrongful acts and continue to own stock through the suit, (2) that they made a demand to the board of directors for corrective action or that the demand was futile, and (3) adequate and particularized facts to support their claims.
The court found the plaintiffs had satisfied the contem-poraneous ownership and demand futility requirements. It held that a demand for action from Wells Fargo’s directors would have been futile because, based on the allegations
against the board, there was a substantial likelihood the directors could be personally liable for the alleged wrongful acts, and there was a reasonable doubt that at least half the directors could have properly exercised their independent and disinterested business judgment in responding to the demand.
The court also found that particularized facts alleging breach of fiduciary duty had been pled. Judge Illston ex-plained that, if the complaint’s allegations were true, and defendants had in fact claimed in the company’s proxy state-ment they were cooperating with government investigations when, in fact, they were not, it would amount to a material omission and a breach of the duty of loyalty to the company. The court therefore denied defendants’ motion to dismiss the claim for breach of fiduciary duty.
The court also granted defendants’ motion to dismiss the shareholders’ claims for abuse of control, gross mismanage-ment and corporate waste. The court held that Delaware law, which governed these claims because Wells Fargo is a Delaware corporation, does not recognize an independent cause of action against corporate directors and officers for abuse of control or gross mismanagement; such claims are treated as claims for breach of fiduciary duty. It also held that the shareholders had not adequately met their burden to plead corporate waste, because they had not alleged the payment of bonuses to Wells Fargo’s director and former Chief Financial Officer and Executive Vice President after they made false statements to the public served no corpo-rate purpose, and thus no consideration was received.
ConclusionJudge Illston’s denial of the motion to dismiss the sharehold-ers’ claim for breach of fiduciary duty demonstrates that banks are vulnerable to such suits based upon their conduct during the mortgage crisis, even following the large financial settlement with the government. Similar shareholder actions have also been filed against JP Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.
Judge Illston’s denial of the motion to dismiss the shareholders’ claim for breach of fiduciary duty demonstrates that banks are vulnerable to such suits based upon their conduct during the mortgage crisis, even following the large financial settlement with the government.
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 13
In dismissing the claim, the court found that UBS had acted as a seller, not an advisor, to HSH, and had specifically dis-claimed any fiduciary role. As a result, HSH, a sophisticated investor, had a duty to conduct an independent appraisal of the risks inherent in the deal. The true risks were known to the market and HSH could have ascertained them by the exercise of ordinary diligence. HSH had no right to rely on UBS for guidance, and UBS had no obligation to reveal its internal views of the inherent risks. With this ruling, the court declared its continued support for the principles that sophisticated corporate entities can deal with one another at arms length and that sellers can protect themselves from fraud claims by specific contractual disclaimers.
The TransactionIn 2002, UBS launched a collateralized debt obligation (“CDO”) investment based upon a “reference pool” of U.S. real estate assets. UBS designed the CDO specifically for HSH, a regional German bank which professed to have little expertise in U.S. real estate structured finance, and which allegedly was seeking a safe investment. UBS allegedly as-sured HSH that it was designing the CDO to provide a low return with a high degree of safety, that it was designed to function similar to other CDOs that were performing well, and that UBS intended to align its interest in the transaction with HSH’s interest so that HSH could be assured they would benefit mutually.
A New York State appellate panel has concluded that the fraud claim of HSH Nordbank (“HSH”) against
UBS Securities LLC (“UBS”), for allegedly misrepresenting the risk profile of a complex transaction, must be
dismissed. HSH Nordbank AG v. UBS AG, 941 N.Y.S.2d 59 (1st Dep’t 2012). HSH had sued UBS for allegedly
inducing HSH to purchase $500 million worth of notes in a collateralized debt obligation by allegedly
misrepresenting the risks concerning UBS’s role and UBS’s intention to manage the underlying asset
pool conservatively. When the U.S. real estate market tumbled in 2008, HSH suffered a near total loss
of its investment.
SOPHISTICATED INVESTOR’S DUTY TO INVESTIGATE BARS FRAUD CLAIM OVER CREDIT DEFAULT SWAP LOSSESBy Thomas J. Hall ([email protected]) and Michael Samalin ([email protected])
HSH’s intended role in the CDO was to provide credit default protection for the reference pool through a special purpose entity established by UBS, North Street Referenced Linked Notes 2002-4 Limited (“NS-4”). UBS entered into a credit default swap with NS-4 under which UBS was to make regular payments, similar to insurance premiums, to NS-4. In the event of certain “credit events,” such as a default or rat-ing downgrade, with regard to each security in the portfolio, NS-4 was to required to make payment to UBS to compen-sate for lost value to the asset pool. To raise the capital to pay its potential obligations, NS-4 issued notes, with the “insur-ance premium” payments from UBS to flow through NS-4 to the noteholders to pay the interest on the notes. In the event of a “credit event,” NS-4 was required to compensate UBS for its losses, and reduce the principal balance due to notehold-ers. The notes were issued pursuant to an offering circular, and were divided into tranches. Any reductions in principle would affect the various tranches in order of seniority. HSH was the intended holder of the majority of the notes.
At the closing in 2002, UBS purchased $74 million of NS-4 notes in the subordinate class, and HSH purchased $500 million of notes in the highest class. With this structure, UBS would absorb the first $74 million of any losses. Because the CDO leveraged $574 million to backstop $3 billion worth of assets, it would take a decline of only 19% in the value of the reference pool to eliminate the value of all of the NS-4 notes.
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UBS allegedly assured HSH that, by purchasing this lowest tranche, UBS had “aligned its interests” in the CDO with HSH. UBS allegedly explained that both parties would benefit from the same conservative approach, UBS would take the first losses, and the $74 million would be sufficient to protect HSH entirely.
The governing contracts allowed UBS to populate and maintain the reference pool according to certain specifica-tions, particularly with regard to each asset’s credit rating. By 2004, UBS was to populate the asset pool with 70% asset-backed securities, commercial mortgage backed securities, and real estate investment trust assets. All assets were to have a minimum rating of BBB, with the average for the entire pool to exceed BBB+. Pursuant to a side agreement with HSH, UBS agreed to establish a “Commitments Com-mittee” that was to oversee substitutions of collateral in the reference asset pool to ensure long term credit quality. UBS allegedly assured HSH that it could rely on these credit ratings, and on the Commitments Committee, to ensure that the reference pool remained a safe investment.
The offering circular for the NS-4 notes contained disclo-sures detailing the risk of a conflict created by UBS’s multiple roles, and the risk of enhanced losses caused by the high le-verage, and disclaimed any fiduciary or advisory role with the noteholders. The indenture for the notes likewise contained numerous disclaimers, with HSH representing therein that it had engaged in its own review, had its own advisors, was not relying on UBS’s investment advice and had reached its own judgment as to the wisdom of investing in the NS-4 notes.
The NS-4 notes proceeded without a credit event until 2008, when the dramatic decline in the U.S. real estate mar-ket led to significant credit events in the asset pool, and a near total loss for the NS-4 notes and HSH’s investment.
The LawsuitHSH filed suit against UBS in 2008, alleging breach of con-tract, fraud and negligent misrepresentation, among other claims. While not denying that UBS had complied with the contract’s specifications in selecting the assets in the refer-ence pool, HSH alleged that UBS had engaged in a sophisti-cated, and undisclosed, ratings arbitrage scheme. According to HSH, UBS had purchased assets that had the required credit rating, but that were trading at low values because the market had recognized their declining circumstances before the ratings agencies did. This allegedly allowed UBS to ben-efit from bargains when stocking the reference pool, while increasing the risk of a credit event at HSH’s expense.
Motion to Dismiss, Round OneUpon UBS’s motion, the trial judge dismissed HSH’s fraud claim. The court looked to the New York rule that a breach of contract claim cannot be expanded into a fraud claim simply by adding the allegation that one party never intended to perform the contract. To survive a motion to dismiss, a fraud in the inducement claim must allege a misrepresentation of a material fact collateral to the contract that induced the plaintiff to enter the contract. The trial judge concluded that HSH’s allegations missed this mark as they merely alleged that UBS never intended to perform the contract, thereby simply restating HSH’s contract claim.
Motion to Dismiss, Round TwoHSH re-pled, adding numerous allegations of alleged mis-representations of facts by UBS. According to HSH, UBS had misrepresented its intentions by stating that it was creating a low risk, steady income stream for HSH when in fact UBS intended to engage in ratings arbitrage at HSH’s expense. HSH alleged that UBS represented credit ratings as reliable, when it knew that they were an inaccurate reflection of the true risk. UBS allegedly misrepresented the value of the assets in the reference pool, causing HSH a loss at the mo-ment of execution. UBS moved again to dismiss on the same grounds on which it had previously prevailed. But upon the second motion, the trial judge upheld HSH’s revised fraud claim, concluding that the new allegations “leaped, if ever so narrowly, the barrier between a claim for breach of contract and one for fraud.” The significant difference was that the amended complaint showed that UBS had an “undisclosed economic motivation” at the time of closing. UBS had rep-resented that the NS-4 transaction would realize a steady long-term gain, and was tailored to HSH’s needs. In fact, the amended complaint alleged that UBS intended to use HSH as a source of low cost credit default protection while engaging in ratings arbitrage. The amended complaint further alleged that UBS knew that the credit ratings of the assets were an inaccurate reflection of their value but assured HSH to the contrary. The amended complaint alleged that UBS knew the NS-4 notes were worth only $360 million on the closing date, but told HSH they were worth $500 million. HSH alleged that these representations of facts were collateral to the contract and induced HSH to enter the contract.
The Decision on AppealUBS appealed the denial of its motion to dismiss the fraud claim, and the appellate panel reversed. The appellate court’s
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 15
dispositive conclusion was that the amended complaint had failed to allege any misrepresentation of material fact upon which HSH reasonably relied. All of the alleged misrepresen-tations, the court explained, “ultimately relate to the level of risk attached to the securities in the reference pool.” The risk level of those assets was not a fact uniquely within UBS’s knowledge. Rather, any sophisticated party could have con-ducted the same market research that UBS had conducted, and could have reached the same risk assessment. Absent a request from HSH, UBS was not obliged to disclose that it considered the contract’s asset selection standards to be riskier than HSH wanted.
The appellate court reviewed the amended complaint’s allegations that UBS harbored an undisclosed intention, at the time of entering the contract, to engage in risk arbitrage — buying securities that the market had decided were riskier than their credit rating suggested — while encouraging HSH to rely on credit ratings that UBS knew were unreliable. Inherent in these allegations, the court concluded, was an admission that the truth was available in the marketplace for anyone to learn by application of due diligence. HSH had complained that, as a small regional German bank, it had to rely on UBS’s expertise in managing the asset pool. The court disagreed. HSH’s relative lack of expertise did not give it any right to claim reliance on UBS. HSH was a sophisticated party, with assets in excess of €140 billion (US $180 billion), with sufficient resources to conduct its own research, or hire an ad-visor. It had no right to rely on UBS for advice concerning the suitability of the deal for HSH. “As a matter of law,” the court declared, “a sophisticated plaintiff cannot establish that it entered into an arm’s length transaction in justifiable reliance
on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it.” This is particularly true, the court continued, where the “nature of the risk being assumed could have been ascertained from reviewing market data or other publically available informa-tion.” Here, the alleged misrepresentations regarded the market’s perception of the value of the assets, facts that any sophisticated party could investigate on its own.
The court next turned to the contractual disclaimers, finding they provided more reason to dismiss the fraud claim. HSH alleged that UBS had orally pledged to align its interests with HSH and to seek a long-term, low risk investment, while UBS actually intended to act in conflict with HSH by using risky trading strategies. The court reviewed the offering ma-terials’ extensive risk disclosures, including statements that UBS had no fiduciary duty to any noteholder, that each buyer must rely on its own evaluation of risks, that the notes were highly leveraged, that the leverage increased the risk of a total loss, that there was no secondary market for the notes, and that the safety of the notes depended on the credit-worthiness of the assets in the reference pool. The offering materials also disclosed UBS’s dual role in the CDO, and the potential for conflicts with the noteholders.
Likewise, HSH had disclaimed in the relevant contracts any reliance on UBS’s investment advice and represented that it had conducted its own investigation and was relying on its own counsel. In one contract, UBS had disclosed its potential conflicts with the noteholders, described the risks of the notes, and denied that any noteholder could rely on UBS’s advice. While HSH had alleged that UBS’s oral representations were entirely different from these contrac-tual representations, the court found that the contractual disclaimers went directly to the matter of which HSH com-plained and therefore destroyed HSH’s allegations of oral representations to the contrary. These were not general boilerplate disclaimers, the court noted, but specifi-cally covered the subject matter of the alleged misrepresen-tation. If these disclaimers were not sufficient to stop HSH from making a fraudulent inducement claim, the court said, then no disclaimers could be.
The court took its conclusions even further, declaring that to permit HSH’s claim would in effect condone HSH’s deliberately misrepresenting its true intentions to UBS when it disclaimed reliance on UBS’s advice. It would in effect allow HSH to defraud UBS by signing contracts with representa-tions with which HSH had no intention to comply.
Finally, the court echoed the trial court’s decision on the original motion to dismiss, concluding that the allegations of “insincere promises” to align interests with HSH, to follow a conservative trading strategy, and to share a common motive and economic interest, could not support a fraud claim.
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Finally, the court echoed the trial court’s decision on the original motion to dismiss, concluding that the allegations of “insincere promises” to align interests with HSH, to follow a conservative trading strategy, and to share a common mo-tive and economic interest, could not support a fraud claim. These were not promises collateral to the contract, but were inherent in its performance, and were thus duplicative of HSH’s contract claim.
ConclusionThe appellate court noted that, if UBS did indeed make the oral misrepresentations that HSH alleged, the court did not condone such “sharp dealing.” But the court concluded that any result other than dismissal would cast doubt on whether sophisticated parties can engage in arm’s length transac-tions without taking on fiduciary duties to one another and whether any set of disclaimers, no matter how detailed and specific, could provide protection from a fraud claim. The court chose to send a clear message that sophisticated par-ties must engage in their own investigation, keep their own counsel, and accept the consequences of the contracts that they sign.
In 2007, John Lucido borrowed $494,000 secured by a mortgage on his house. He later defaulted, with a $493,219 principal balance owing. The mortgagee, Bank of America, bought a foreclosure action in New York state court in Suffolk County.
New York’s Uniform Rules for Trial Courts, 22 NYCRR § 202.12-a, obligates lenders and homeowners in fore-closure actions to attend settlement conferences at which they are to negotiate in good faith. In this case, 18 settlement conferences reportedly were scheduled at which the homeowner suggested a reduction in the principal amount. The bank purportedly informed the court that it could not agree to reduce the principal amount because the Pooling and Servicing Agreement covering this mortgage barred such.
But when the court ordered the bank’s counsel to provide a copy of the Pooling and Services Agreement,
problems began. First, despite the Court’s clear Order, the bank’s counsel proposed to provide only “salient parts” of that Agreement. Ultimately, Bank of America retained new counsel to represent it. Through its new counsel, the bank informed the court that it could find no legal bar to the bank agreeing to reduce the principal amount of the loan.
Judge Jeffrey Spinner was not too happy with these events. He found that Bank of America “deliberately acted in bad faith” when prosecuting this action over 34 months. As such, he assessed $200,000 in dam-ages against the bank, thereby reducing the home-owner’s total principal indebtedness from $493,219 to $293,219. Bank of America v. Lucido, 03769-2009 (Sup. Ct. Suffolk Co. 2012).
FORECLOSING LENDER LIABLE FOR $200,000 IN DAMAGES
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BackgroundIn November 2007, DAB, a company that does business in the “construction and property industry,” and Brooklyn executed a promissory note in connection with Brooklyn’s $5.5 mil-lion project loan to DAB. A Loan Modification Agreement dated August 21, 2009 extended the loan’s maturity date to September 1, 2009, and, at the bank’s option, allowed for three additional extensions to March 1, 2011. In August 2008, the same parties executed a second promissory note in connection with a $19.05 million building loan (“Building Loan”), maturing on September 1, 2009, with three extension terms at the option of the bank to March 1, 2011. Both notes were secured by a mortgage on DAB’s real property located on Orchard Street in New York City. Although its name did not appear on any of the loan documents, State Bank agreed to participate in the funding of both the Project Loan and the Building Loan through a participation agreement with Brooklyn.
At some point after the execution of the loan agree-ments and before the loan maturity dates, DAB, Brooklyn and State Bank executed an estoppel certificate, providing for “confirmation, renewal, and extension of certain rights.” In that agreement, DAB acknowledged that Brooklyn, its
In an action arising out of two loan agreements, a New York trial court recently dismissed counterclaims
brought by a commercial development company, D.A.B. Group (“DAB”), alleging that two banks, Brooklyn
Federal Savings Bank (“Brooklyn”) and State Bank of Texas (“State Bank”), and their assignee, Orchard Hotel,
LLC (“Orchard”), fraudulently misrepresented their intention to extend the maturity date of the loans, breached
the loan agreement by delaying to fund loan advances, and exaggerated the amount due on the loan. Orchard
Hotel, LLC v. D.A.B. Group, LLC, 35 Misc. 3d 1206(A), 2012 N.Y. Slip Op. 50576(U) (Sup. Ct. N.Y. County 2012). The
court held that DAB had failed to plead its claims with the requisite particularity, and found that (1) DAB had
not sufficiently alleged the reliance requirement for a claim of fraudulent representation, (2) Brooklyn and
State Bank were not obligated to fund advances, and (3) DAB failed to articulate a cognizable legal theory.
ESTOPPEL CERTIFICATE DOOMS BORROWER’S CLAIMS FOR FRAUD AND BREACH OF CONTRACTBy Pooja Asnani ([email protected])
successors and assigns had no obligation to provide any advances other than as provided in the Building Loan Agree-ment, and further that DAB was estopped from raising any claims to the contrary.
The lenders agreed to extend both maturity dates to March 1, 2011. On the date the loans matured, DAB had not made payment on them. By a letter dated March 23, 2011, Brooklyn informed DAP that both of the notes secured by the mortgages were in default and therefore were immediately payable. On June 17, 2011, Brooklyn assigned the Notes and Mortgages to Orchard. Orchard subsequently filed suit on July 1, 2011, seeking to foreclose upon the mortgages.
Counterclaims In response to Orchard’s foreclosure action, DAB asserted three counterclaims against Brooklyn, Orchard as assignee, and State Bank by virtue of its agreement to participate in the funding of the loans. DAB alleged that Brooklyn and State Bank fraudulently misrepresented their intention to extend the maturity of the loans beyond March 1, 2011. DAB also asserted that Brooklyn breached its contract with DAB by improperly delaying additional fundings, which prevented DAB from paying its contractors and subcontractors.
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Finally, DAB alleged that both Brooklyn and Orchard miscal-culated interest and late charges, thereby exaggerating the amount owed by DAB, and further rendering DAB unable to satisfy or refinance the loans.
Brooklyn, Orchard and State Bank moved to dismiss the counterclaims on the basis that they failed to state a claim and that they were contradicted by the documentary evidence. With regard to the counterclaim for fraudulent misrepresentation, the lenders asserted that DAB’s pleadings were vague and conclusory, and did not satisfy the particu-larity required by an action for fraud under New York law. The lenders further argued that the allegations of breach of contract failed to articulate which contractual provision was allegedly breached, and that DAB failed to plead that it had fully complied with the terms of the Building Loan Agreement.
Fraudulent MisrepresentationAs part of DAB’s claim of fraudulent misrepresentation, DAB alleged that, prior to March 1, 2011 — the maturity date of the loans under the loan extensions — it had negotiated with Brooklyn and State Bank for a further extension of the maturity dates on the two loans. To support this claim, DAB alleged that, in connection with these purported negotia-tions, Brooklyn and State Bank approved a contract between DAB and a co-defendant construction company, Flintlock Construction Services, LLC, that provided for a construction completion date past March 1, 2011. DAB additionally as-serted that “in furtherance of their express approval” of the contract, Brooklyn and State Bank drafted and required DAB to execute an estoppel certificate, wherein both parties con-firmed, renewed and extended certain rights. According to DAB, Brooklyn and State Bank both “repeatedly represented to DAB that the maturity date would be extended beyond March 1, 2011.”
DAB claimed that these and other representations were false and known to be false by Brooklyn and State Bank when they were made, and that they were made to induce DAB’s reliance on them. DAB further alleged that its reliance was justified in light of Brooklyn’s approval of the Flintlock contract, and the “confirm, renew and extend” language contained in the Estoppel Certificate. Relying on the oral representations that the maturity dates had been extended, DAB asserted that it “delayed in seeking a refinance of the loan or sale of the business project,” and was thus damaged in an amount in excess of $50 million.
Even crediting all of DAB’s factual assertions in the plead-ings and supporting affidavits as true, the court declined to find that DAB’s alleged reliance was justified. As an essential element of a claim of fraudulent misrepresenta-tion, reliance must be pled with particularity pursuant to a standard that is more stringent than for other types of complaints. The court found that DAB’s alleged reliance on oral representations made by Brooklyn and State Bank were in contravention to express provisions in the loan docu-ments “prohibit[ing] oral amendment or termination,” in the absence of a further agreement that is “in writing signed by Holder.” Another such provision in the loan documents stated that “[n]o course of dealing between Maker, the endorser(s) or guarantor(s) hereof, or any of them, shall be effective to change or modify in whole or in part, this Note.” Given these “bargained-for, and agreed-upon contractual provisions” barring any amendment or termination of the loan agreement without a written, signed agreement by the parties, the court rejected DAB’s assertion of justified reliance. Accordingly, the court dismissed DAB’s counterclaim of fraud.
Breach of ContractDAB’s second counterclaim for breach of contract alleged that Brooklyn had failed and refused to make appropriate loan advances during the term of the building loan in a man-ner that was wrongful and without cause. In a supporting affidavit, DAB’s majority and managing member averred, inter alia, that Brooklyn had failed to fund the project for seven months, that it subsequently withheld funding for four months, that it refused to fund requisitions totaling $1.5 million dollars, and that it failed to honor an agreement to re-serve $960,000 for the payment of a mechanic’s lien filed by
In this case, the court declined to find that the borrower had reasonably relied on alleged oral misrepresentations where the loan agreement expressly prohibited changes to the loan agreements in the absence of a written agreement signed by the holder.
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a subcontractor. According to DAB, these refusals and delays prevented DAB from paying subcontractors, which resulted in judgments against DAB. Thus, DAB charged, the actions of Brooklyn, State Bank and Orchard constitute a breach of the loan agreements.
As with its finding on the claim of fraudulent misrepre-sentation, the court stated that it was granting DAB the ben-efit of every favorable inference on this issue, but concluded nevertheless that DAB had failed to state a claim for breach of contract. The court based its decision in part on provi-sions in the Estoppel Certificate that provided that Brooklyn and its successors “shall have no obligation to provide any Advances . . . except as provided for in the Building Loan Agreements . . .”, and further that DAB is “hereby estopped from raising any claims or making any defenses contrary to the foregoing.” Accordingly, the court concluded that DAB’s allegation relating to denial of funding was “flatly contradict-ed by documentary evidence and need not be considered.”
The court similarly addressed and dismissed DAB’s remaining allegations for breach of contract. Regarding DAB’s claim that Brooklyn and State Bank failed to set aside $960,000 for payment to a subcontractor, the court noted that DAB did not point to any written agreement relating to the $960,000 payment to subcontractor, and further that the Estoppel Certificate contained no agreement providing for such a payment. As to the DAB’s claim that Brooklyn and State Bank failed to fund two other funding requisitions, the court found that Brooklyn had no obligation to fund these requisitions in light of (1) the fact that DAB defaulted on its loans prior to their submission, and (2) the “plain language in the Building Loan Mortgage Agreement stating that Brooklyn
had “no obligation to fund Advances if an Event of Default . . . shall have occurred or will be continuing.” Thus, finding no contractual obligations underlying DAB’s alleged breaches, the court dismissed both claims.
Claim of Exaggeration of the Amounts DueDAB’s third counterclaim alleged that Brooklyn and Orchard “exaggerated the amounts due and owing on the Loans, leaving DAB unable to satisfy, or refinance them.” Even assuming the truth of these allegations, the court found that it could not “discern any cognizable legal theory into which they might fit.” Accordingly, the court dismissed this counterclaim.
ConclusionThe holding in Orchard Hotel, LLC v. D.A.B. Group demon-strates the challenges that borrowers in foreclosure actions may face when attempting to countersue lenders where language in the loan agreement effectively insulates lenders from the claims. In this case, the court declined to find that the borrower had reasonably relied on alleged oral misrepre-sentations where the loan agreement expressly prohibited changes to the loan agreements in the absence of a written agreement signed by the holder. Similarly, claims alleging breach of contract were dismissed as DAB acknowledged in the Estoppel Certificate that Brooklyn shall have no obliga-tion to provide any advances “except as provided for in the Building Loan Agreement and based upon the Advances to date . . . [and] is hereby estopped from raising any claims or making any defenses contrary to the foregoing.”
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BackgroundPlaintiffs in this action, a group of investment entities called Walnut Place, are holders of certificates of mortgage-backed securities issued by two securitization trusts, “Trust 1” and “Trust 2,” and brought suit derivatively on behalf of those trusts against defendants Countrywide Home Loans, Inc. (“Countrywide”), Park Granada LLC, Park Monaco Inc., Park Sienna LLC (collectively, the “Countrywide Defendants”), and Bank of America Corporation. The complaint alleged that the defendants breached Pooling and Servicing Agreements (the “PSAs”) that governed the administration of residential mortgage loans sold by Countrywide to the trusts. Specifi-cally, the plaintiffs alleged that Countrywide made false representations and warranties in the PSAs “about the char-acteristics and credit quality of those loans, materially and adversely affecting the interests of plaintiffs.”
Section 2.03(c) of the PSAs provided that each of the Countrywide Defendants “covenants that within 90 days of the earlier of its discovery or its receipt of written notice from any party of a breach of any representation or warranty with respect to a Mortgage Loan sold . . . that materially and adversely affects the interests of the Certificateholders in that Mortgage Loan, it shall cure such breach in all material respects, and if such breach is not so cured, shall . . . repur-chase the affected Mortgage Loan or Mortgage Loans from
A New York State trial court recently held that a derivative lawsuit brought by Walnut Place on behalf of various
bondholders against Bank of America’s Countrywide Financial unit was premature, as the trustees for the
bondholders, Bank of New York Mellon (“BNY”), had determined days before the filing of the complaint that it
required more time to evaluate the demand to sue Countrywide. Walnut Place LLC, et al. v. Countrywide Home
Loans, Inc., et al., No. 1650497/11 (N.Y. Co. 2012) (the “Walnut Litigation”). This ruling will certainly delay, and
perhaps eventually end, breach of contract suits brought by mortgage-backed securities investors against
Countrywide, looking to force Countrywide to buy back mortgages.
TRUSTEE ENTITLED TO MORE TIME TO REVIEW CLAIMS BEFORE CERTIFICATEHOLDERS CAN BRING SUITBy Andrea Voelker ([email protected])
the Trustee at the Purchase Price . . . .” Pursuant to these terms, on August 3, 2010, the plaintiffs allegedly informed BNY by letter about certain misrepresentations and demand-ed that BNY require Countrywide to buy back any noncom-pliant loans. The plaintiffs alleged further that, on August 31, 2010, BNY sent the defendants written notice of the breach of warranties and representations.
When the Countrywide Defendants failed to repurchase the loans within the 90-day period, the plaintiffs sent a letter to BNY on December 21, 2010 asserting breaches relating to Trust 1, and a letter on January 28, 2011 asserting breaches relating to Trust 2, and requesting that BNY file suit against the Countrywide Defendants within 60 days of receipt of the letters. In those letters, the plaintiffs agreed to indemnify BNY for any costs, expenses and liabilities resulting from bringing the litigation. On February 18, 2011, BNY allegedly sent a letter to the plaintiffs stating that “it needed addi-tional time to evaluate” whether a lawsuit should be brought against the Countrywide Defendants for alleged breaches related to Trust 1 and, on April 5, 2011, BNY allegedly sent a letter to the plaintiffs stating that it needed even more time to evaluate the matter because the demand letter “raise[d] . . . legal, contractual and practical issues . . . that BNY Mellon, in its capacity as trustee, must in good faith consider.”
On February 23, 2011, plaintiffs brought suit against the defendants alleging breach of the Trust 1 PSA and, on
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April 12, 2011, the plaintiffs amended the complaint to add allegations relating to breach of the Trust 2 PSA.
Unrelated LitigationIn a matter unrelated to the claims that plaintiffs asserted in their lawsuit, on June 29, 2011, BNY filed a petition with a New York trial court, In the Matter of the Application of Bank of New York Mellon, Index No. 651786/2011, seeking approv-al of a proposed settlement that would cover claims arising out of several trusts, including Trust 1 and 2. If a settlement is approved in that litigation, which does not encompass the claims alleged in the Walnut Litigation, the settlement would require the defendants to pay $8.5 billion into these trusts to settle claims of breach of representations and warranties in the PSAs that govern each of the trusts. That petition is pending.
The Parties’ Contentions In response to plaintiffs’ complaint for breaches of Trust 1 and 2, the defendants moved to dismiss. The defendants rea-soned that the PSAs expressly gave BNY, and not the plain-tiffs, the right to require the repurchase of the loans after the creation of the trusts, that the plaintiffs failed to allege that an event of default had occurred pursuant to Section 10.08 of the PSAs, and that plaintiffs failed to satisfy the pleading requirements for bringing a derivative action.
Section 10.08 of the PSAs provides in relevant part that “[n]o Certificateholder shall have any right by virtue or by availing itself of any provisions of this Agreement to institute any suit, action or proceeding in equity or at law upon or under or with respect to this Agreement, unless such Holder previously shall have given to the Trustee a written notice of
an Event of Default and of the continuance thereof . . .” An Event of Default is defined in the PSAs as a “specified failure of the Master Servicer to perform its servicing duties.” The defendants argued that the representations and warranties alleged in the complaint were not the result of any failure by the Master Servicer, as they were made by Countrywide to the Depositer, the Master Servicer, and to BNY before any servicing obligations arose under the PSAs.
The defendants reasoned that barring certificateholders from bringing suit before an event of default had occurred is consistent with the purpose of similar clauses “which is to prevent . . . individual bondholders from pursuing an individual course of action and thus harassing their common debtor and jeopardizing the fund provided for the common benefit, . . . deter individual debenture holders from bringing independent law suits which are more effectively brought by the indenture trustee,” . . . and to “protect against the risk of strike suits.” Citing Sterling Federal Bank, F.S.B. v. DLJ Mortgage Capital, Inc., 2010 WL 3324705 at *4 (N.D. Ill. Aug 20, 2010), a case in which the court applied New York law to interpret a substantially similar clause, the defendants argued that the plaintiffs must satisfy Section 10.08 or else any claims would be barred as the clause “could not be read to apply only to claims . . . seeking damages caused by Events of Default.”
The defendants further argued that the plaintiffs failed to satisfy the pleading requirements for derivative actions, citing Velez v. Feinstein, 87 A.D.2d 309, 315, 451 N.Y.S.2d 110 (1st Dep’t 1982), which held that “[i]n an action brought by a beneficiary on behalf of a trust, the beneficiary must show why he has the right to exercise the power . . . [which] will normally require either a showing of a demand on the trust-ees to bring the suit, and of a refusal so unjustifiable as to constitute an abuse of the trustee’s discretion, or a showing that suit should be brought and that because of the trustees’ conflict of interest, or some other reason, it is futile to make such a demand.” The defendants argued that plaintiffs failed to allege that BNY’s refusal was unjustifiable so as to consti-tute an abuse of discretion, as required by Velez.
The plaintiffs conceded that, because their claims were against Countrywide and not the Master Servicer, they did not fall under “Events of Default” as described in the PSAs. They nevertheless argued that suit was appropriate under Section 10.08 because “giving notice of an Event of Default is not a necessary condition for suing to enforce the PSAs, and therefore should be read out of Section 10.08 when an action is not based on a default by the Master Servicer,”
Specifically, where a contract conveys to a third party the discretion of whether litigation is appropriate, the parties usually should defer to that discretion, and wait to initiate suit until that party has had a reasonable opportunity to investigate the allegations and make a determination.
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and that plaintiffs “should be excused from complying with conditions in a no-action clause that are impossible to satis-fy.” Plaintiffs contended that, even if Section 10.08 did apply, they were able to sue derivatively because BNY’s refusal to sue was unreasonable in light of the investigation made by plaintiffs concerning the allegations. Lastly, plaintiffs argued that a demand on BNY would have been futile, and thus unnecessary, as BNY had a conflict of interest because its fee would be reduced if the Countrywide Defendants were to in fact repurchase the loans.
The Court’s Ruling The court found that plaintiffs failed to comply with Section 10.08. Specifically, the court held that the cases plaintiffs cit-ed in support of their argument that they should be excused from satisfying “impossible” conditions were inapposite. The court stated that plaintiffs’ cases “address the objective fac-tual impossibility if meeting certain requirements, and not, as here, the failure to assert a claim conceptually based on an Event of Default, as required by the PSAs.”
The court also held that plaintiffs’ argument that compli-ance with Section 10.08 is not required where the action is suing under an event of default, was similarly misguided. The court again reasoned that plaintiffs’ cases in support of this proposition, including Metropolitan West Asset Manage-ment, LLC v. Mangus Funding Ltd., 2004 WL 1444868 at *4 —5 (S.D.N.Y. 2004), were inapposite, as allegations of trustee
wrongdoing were central issues in those cases, and no such allegations were pled by plaintiffs regarding BNY.
The court also rejected plaintiffs’ arguments that BNY acted unreasonably in not bringing suit, or that BNY had a conflict of interest. The court pointed out that, as pled in the complaint, BNY did not refuse to bring suit, but rather required additional time to investigate the allegations. The court also noted that BNY does, in fact, take action when it deems it appropriate, “as demonstrated by the settlement agreement reached with the defendants and submitted to this Court” in the unrelated litigation. Accordingly, the court held that plaintiffs’ filing of the lawsuit was premature under the circumstances, and should be dismissed.
Conclusion Courts are generally unwilling to impose their judgment where a contract has expressly set obligations and limita-tions on the contractual parties. Accordingly, where a con-tract restricts the ability of a party to commence litigation in relation to the contract, the parties should be prepared to abide by those limitations, or risk dismissal. Specifically, where a contract conveys to a third party the discretion of whether litigation is appropriate, the parties usually should defer to that discretion, and wait to initiate suit until that party has had a reasonable opportunity to investigate the allegations and make a determination.
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The Exempt Income Protection ActArticle 52 of the CPLR governs the enforcement and collec-tion of money judgments in New York state courts. In 2008, Article 52 was amended by the EIPA to provide significant additional protections to judgment debtors by establishing a procedure for the execution of money judgments that ensures that debtors will retain access to certain exempt funds — including certain social security benefits, disability benefits and public assistance — deposited in their bank ac-counts. See CPLR §§ 5205, 5222, 5222-a, 5230, 5231 and 5232. Pursuant to these new procedures, the EIPA requires notifica-tion to debtors of available exemptions and information re-garding how to claim them. The EIPA further prohibits banks from charging fees to judgment debtors whose accounts are exempt from restraint or restrained in violation of the EIPA.
Under the EIPA, a judgment creditor must serve two cop-ies of the restraining notice, an exemption notice, and two exemption claim forms upon the bank to impose a restraint on the debtor’s account. If the creditor fails to serve these notices and forms upon the bank, any restraint on the debt-or’s account is void and the bank cannot restrain the account
Addressing an issue of first impression, a New York federal district court dismissed a putative class action
brought by holders of savings and checking accounts who sought injunctive relief and monetary damages
from their bank for freezing their accounts on behalf of their third-party creditors and for charging them
administrative fees related to the frozen accounts, in alleged violation of Article 52 of the New York Civil
Practice Law and Rules (“CPLR”), as amended by the Exempt Income Protection Act (the “EIPA”), and New York
common law. Cruz v. TD Bank, N.A., No. 10-8026 (PKC) (S.D.N.Y. 2012). The court held that the EIPA did not
create a private right of action for money damages by judgment debtors against banks that fail to comply
with the EIPA, including those provisions requiring banks to provide judgment debtors with the applicable
restraining notices received from third-party creditors, as well as disclosures concerning any income in the
judgment debtors’ accounts that may be exempt from third-party creditors. The court further held that the
account holders had failed to allege sufficient facts to sustain their New York common law claims.
NO PRIVATE RIGHT OF ACTION FOR DAMAGES AGAINST BANKS UNDER NEW YORK’S EXEMPT INCOME PROTECTION ACTBy Benjamin D. Bleiberg ([email protected])
until it receives the notices and forms from the creditor. The EIPA further requires the bank to mail copies of the notice and forms to the debtor once it receives them.
The Plaintiffs’ ActionGary Cruz and Claude Pain, the plaintiffs in this action and residents of New York, each allegedly held checking or savings accounts at a New York branch of TD Bank, N.A., a national bank that maintains branches in several states. In August 2009, TD Bank notified Cruz that his account would be frozen due to the service of a restraint notice on the bank by Cruz’s third-party creditors. TD Bank similarly froze Pain’s account in December 2010 after having been served with a restraint notice by Pain’s third-party creditors. TD Bank alleg-edly subsequently charged the plaintiffs with administrative fees associated with the bank’s restraints on the plain-tiffs’ accounts, as well as overdraft fees due to checks that bounced after their respective accounts were frozen.
Although TD Bank froze the plaintiffs’ accounts, it alleg-edly did not provide the plaintiffs with copies of the restrain-ing notices that the third-party creditors served upon
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TD Bank as required under the EIPA. Further, having alleg-edly failed to receive or request them from the third-party creditors, TD Bank also allegedly did not provide the plaintiffs with any disclosures regarding whether the income in the plaintiffs’ accounts might be exempt under the EIPA, or pro-vide the plaintiffs with copies of exemption notices or forms that explained the rights of debtor-account holders and that would permit the plaintiffs to challenge the bank’s restraints and claim exemptions.
On October 21, 2010, Cruz filed a putative class action against TD Bank, pursuant to the EIPA and New York com-mon law, seeking compensatory damages and injunctive relief. Cruz alleged, in part, that TD Bank intentionally or reck-lessly failed to send him the statutorily required disclosures, notices and exemption forms; unlawfully restrained his ac-counts; and charged unlawful fees. On March 14, 2011, Cruz filed an amended complaint that added Pain as a plaintiff, further alleged that TD Bank employed a general practice of not complying with the statutory requirements of the EIPA, and asserted common law claims for conversion, breach of fiduciary duty, fraud, unjust enrichment and negligence.
TD Bank moved to dismiss the complaint on several grounds, that the EIPA does not include either an express or implied private right of action against banks, the plaintiffs lacked standing, the complaint was barred by New York’s abstention doctrine, the EIPA allegations were preempted by federal law, and the common law claims failed as a matter of law.
The Court’s DecisionAfter finding that the plaintiffs had standing to bring the action and that the court was not required to abstain from excising federal jurisdiction over the case, the court granted TD Bank’s motion to dismiss the plaintiffs’ EIPA claim, hold-ing that the EIPA did not create either an express or implied private of action by judgment debtors against their banks for damages.
Although the plaintiffs admitted that no provision of the EIPA specifically identifies an express right for judgment debtors to sue their banks, the plaintiffs argued that the language of the EIPA nevertheless creates an express private right by application of the statutory construction rules of expressio unius est exclusion alterius — whereby “the men-tion of one thing implies the exclusion of the other” — and negative inference. The plaintiffs claimed that because the EIPA only states that an “inadvertent failure by a depository institution to provide the notice required by this subdivision
shall not give rise to liability on the part of the depository institution,” the EIPA should not bar private actions against banks for an intentional, willful or negligent failure to provide the required notices — as the plaintiffs allege TD Bank had done here. The plaintiffs also argued that a private right of action against banks is expressly created by the EIPA’s language that states: “Nothing in [the EIPA] shall in any way restrict the rights and remedies otherwise available to judg-ment debtor . . . .”
The court held that these provisions did not create a new liability for banks, regardless of the purported intentional nature of the banks’ actions, and did not enlarge the rights of a judgment debtor in any way. Instead, the quoted language merely forecloses any additional restrictions on the newly available rights to judgment debtors under the EIPA. The court further rejected the plaintiffs’ attempt to apply broadly the principle of expressio unius, holding that application of this rule of statutory interpretation is limited to preventing the expansion of an enumerated list of items or exceptions, and that the principle does not create new substantive rights by negative inference.
The plaintiffs additionally argued that the EIPA created a private right of action by implication under the standard set forth by New York’s highest court in Sheehy v. Big Flats Com-munity Day, Inc., 73 N.Y.2d 629 (1989). The Sheehy standard requires a court to consider three factors when determining if an implied right exists: “(1) whether the plaintiff is one of the class for whose particular benefit the statute was enacted; (2) whether recognition of a private right of action would promote the legislative purpose; and (3) whether cre-ation of such a right would be consistent with the legislative scheme.” The plaintiffs argued that a private right of action
The court additionally found persuasive that the EIPA was modeled after a Connecticut statute addressing the enforcement of money judgments which, unlike New York’s version, expressly provides for a private right of action by a judgment debtor against a bank.
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here would be consistent with the EIPA’s legislative scheme — which includes extensive mechanisms to protect judg-ment debtors from the improper restraint of their exempt funds — because, if the lawsuit were not allowed, bank cus-tomers would be unable to ensure their banks’ compliance with the statute and have no means of receiving compensa-tion for damages caused by unlawful restraints.
Addressing only the third Sheehy factor as the “most criti-cal,” the court rejected the plaintiffs’ argument finding that a judgment debtor’s suit against a bank would be inconsistent with the EIPA’s legislative scheme. The court reasoned that the EIPA’s new provisions do not create a process for suing a bank but, rather, only permit debtors and creditors to bring claims against one another. The court noted that Article 52 enumerates numerous available enforcement mechanisms that may be brought via special proceedings, but none of these mechanisms implies a post-restraint action by a debtor against a garnishee bank. The court concluded that where the legislature specifically considered and provided for enforcement mechanisms in the statute, recognition of a private right of action is inconsistent with its legislative scheme. Similarly, the court held that the specific remedies available under Article 52 are inconsistent with a private ac-tion seeking money damages or injunctive relief against a bank.
The court additionally found persuasive that the EIPA was modeled after a Connecticut statute addressing the enforce-ment of money judgments which, unlike New York’s version,
expressly provides for a private right of action by a judg-ment debtor against a bank. The court reasoned that this “conscious variance” with the Connecticut statute suggested that the legislature did not wish to include a similar remedy in the EIPA. The court’s review of the EIPA’s general legislative history further supported its conclusion that the EIPA did not imply a private right of action.
Finally, the court dismissed all of the plaintiffs’ com-mon law claims against TD Bank for failure to state a claim. The court held that the plaintiffs’ conversion claim failed because funds deposited in a general bank account do not remain the depositor’s property, and the plaintiffs failed to demonstrate that the funds at issue were deposited upon special terms and conditions that distinguished them from a general deposit. The court rejected the plaintiffs’ breach of fiduciary duty and negligence claims, holding that banks and customers typically have a creditor and debtor relationship, and the plaintiffs failed to allege any unique circumstances that demonstrated TD Bank owed them any fiduciary duties. The plaintiffs’ fraud claims failed because they did not assert any statements or omissions with particularity pursuant to Rule 9(b) of the Federal Rules of Civil Procedure, and failed to identify facts indicating a strong inference of TD Bank’s fraudulent intent. Finally, the court dismissed the plaintiffs’ unjust enrichment claim because the parties had a valid and enforceable written contract regarding the subject matter of the disputes at issue in the lawsuit.
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BackgroundOn October 29, 2009, Randy Long (“plaintiff”) allegedly purchased an item at a Hilfiger store using his credit card. Plaintiff received an electronically-printed receipt from Hilfiger that displayed the month, but not the year, of the credit card’s expiration date so that the relevant portion of the receipt looked similar to the following: EXPIRY: 04/##. On December 29, 2009, plaintiff filed an action against Hilfiger alleging that the printing of “EXPIRY: 04/##” on the receipt willfully violated FACTA’s prohibition against printing an expiration date. On February 11, 2011, the district court granted Hilfiger’s motion to dismiss finding that the printing of the month of expiration did not violate FACTA and such a violation would not have been “willful.”
FACTAWhen Congress amended the Fair Credit Reporting Act in 2003 by enacting FACTA, 15 U.S.C. § 1681c(g)(1) was added as part of an effort to prevent identity theft and states as follows:
Except as otherwise provided in this subsec-tion, no person that accepts credit cards or debit cards for the transaction of business shall print more than the last 5 digits of the card number or the expiration date upon any receipt provided to the cardholder at the point of the sale or transaction. (Emphasis added).
The Third Circuit Court of Appeals has dismissed a putative nationwide class action alleging that the retailer
Tommy Hilfiger U.S.A., Inc. (“Hilfiger”) violated the Fair and Accurate Credit Transactions Act (“FACTA”) when
it printed the expiration month of consumers’ credit cards on receipts. Long v. Tommy Hilfiger U.S.A., Inc.,
671 F.3d 371 (3d Cir. 2012). The court found that, although the plaintiff properly alleged a violation of FACTA,
Hilfiger’s actions in printing the expiration month, but not the year, of credit cards on receipts did not amount
to a “willful” violation as required to recover under the statute.
THIRD CIRCUIT DISMISSES FACTA CLASS ACTIONBy Stacey Trimmer ([email protected])
Notably, under FACTA the scope of a civil remedy for a violation depends on whether the violation was willful. If the violation is merely negligent, then a plaintiff may only recover actual damages, if any. If the violation is willful, a plaintiff may recover actual or statutory damages between $100 and $1,000, as well as punitive damages. In addition, as a result of hundreds of lawsuits alleging that merchants failed to remove the expiration date, Congress clarified that, even if a credit card number had been sufficiently truncated, the expiration date also must be removed, and thus amend-ed FACTA in 2008 to include a safe harbor for merchants who printed an expiration date between December 4, 2004 and June 3, 2008. This case did not fall within that safe harbor.
Printing Expiration Month Violates FACTAThe court first considered whether the plaintiff stated a claim under FACTA by reviewing the principles of statu-tory interpretation. In determining the meaning of FACTA’s requirement that no person shall print “the expiration date,” the court stated that its role was to give effect to Congress’s intent and to consider “the overall object and policy of the statute.” The phrase “expiration date” is not defined in the statute. Hilfiger argued that printing just the month did not constitute printing the “expiration date” because it refers to “an ascertainable date on which the credit or debit card ceases to be valid, and requires simultaneous coexistence of both the month and the year.” The court rejected this interpretation and explained that the natural reading of the statute and the remedial nature of the legislation indicated
FINANCIAL SERVICES LITIGATION NEWSWIRE JUNE 2012 27
that Congress intended that merchants be prohibited from printing any part of the expiration date.
Even though the statute is silent as to the effect of partial printing of a date, the court found that Congress could have reflected such intent with specific language similar to that used for the truncated credit card number. Furthermore, the statute’s objective of preventing identity theft would not be furthered by adopting Hilfiger’s interpretation because then merchants could print different portions of the expiration date, “making it possible to ascertain the entire expiration date from multiple receipts.” Accordingly, the court con-cluded that “the most natural reading of the phrase ‘expira-tion date’ is that it refers to the information or data (usually a string of numbers) contained in the expiration date ‘field’ on the face of the credit or debit card.” Thus, plaintiff properly stated a claim pursuant to FACTA.
Violation Was Not Willful Next, the court reviewed whether FACTA allowed the plaintiff to recover for Hilfiger’s violation of the statute. Because the plaintiff admitted that he did not suffer actual damages, a willful violation was necessary to recover statutory damages.
The court discussed the United States Supreme Court decision in Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47 (2007),
which addressed the willfulness requirement in a different context. In Safeco, the Supreme Court held that willfulness requires that the violation show that “the company ran a risk of violating the law substantially greater than the risk associated with a reading that was merely careless.” Thus, the “violation does not cross the willfulness threshold just because a defendant’s interpretation is erroneous; it must in-stead be ‘objectively unreasonable.’” The “objectively unrea-sonable” standard was not met in Safeco because the statute was silent on the point of issue, the defendant’s proposed interpretation had a foundation in the statutory text which the district court found sufficiently persuasive to adopt it, and neither a court of appeals nor the FTC had previously addressed the issue.
Based on the principles elucidated by the Supreme Court, the Third Circuit similarly concluded that Hilfiger’s interpreta-tion of the statute was not “objectively unreasonable.” First, the phrase “expiration date” is not defined in the statute. Second, Hilfiger’s interpretation of the statute was at least persuasive enough to convince the District Court to adopt it. Finally, no court of appeal had provided guidance on the issue. In addition, the court found that evidence of subjective bad faith or intent is irrelevant when an objectively reason-able interpretation exists. Accordingly, the court rejected plaintiff’s arguments that Hilfiger disregarded the statute altogether and that plaintiff required discovery to determine Hilfiger’s subjective knowledge. Therefore, the court affirmed the dismissal of the action because the plaintiff failed to state a claim for willful violation.
ConclusionWhile consumers may establish that retailers have violated FACTA’s prohibition against printing a credit card expiration date with relative ease, to demonstrate that a defendant has willfully violated the statute is a substantial hurdle that will likely prevent many FACTA actions from moving forward if the Third Circuit’s decision is followed elsewhere. So long as retailers present a plausible interpretation of the statute that supports their actions, similar lawsuits will likely be defeated at the outset.
While consumers may establish that retailers have violated FACTA’s prohibition against printing a credit card expiration date with relative ease, to demonstrate that a defendant has willfully violated the statute is a substantial hurdle that will likely prevent many FACTA actions from moving forward if the Third Circuit’s decision is followed elsewhere.
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Background Plaintiff alleged that the five banks were redlining com-munities, a practice involving the denial of credit to specific geographic areas based on the income, race or ethnicity of its residents. As a result, the plaintiff and other similarly situated persons were allegedly denied FHA mortgages based on race, religion and/or national origin. In addition, the complaint alleges that the U.S. Department of Housing Urban and Development (“HUD”) failed to oversee these banks’ lending practices, enabling arbitrary, capricious and
Judge Allyne R. Ross of the United States District Court for the Eastern District of New York recently
dismissed claims brought by pro se plaintiff, Ezekial Frederick, in Frederick v. Wells Fargo Bank NA, 12-CV-
00553 (E.D.N.Y. 2012), alleging that the denial of a Federal Housing Administration loan by five banks was
discriminatory. The complaint brought claims pursuant to 42 U.S.C. §§ 1981, 1982, 1985, 1986, 1988 and
2000d, claims under Bivens v. Six Unknown Named Agents of the Federal Bureau of Narcotics, 403 U.S. 388
(1971) (“Bivens”), Racketeer Influenced and Corrupt Organizations Act (“RICO”) claims, state law claims, and
Fair Housing Act (“FHA”) claims. Ultimately, Judge Ross found that the plaintiff failed to plead adequately
any of the claims, though leave was granted to file an amended complaint with regard to the FHA claim.
CLAIMS ALLEGING BIAS IN DENIAL OF FHA LOANS DISMISSED FOR FAILURE TO STATE A CLAIMBy Erin M. Shinneman ([email protected])
discriminatory application of the FHA lending program and resulting in injury to the plaintiff. The plaintiff sought monetary damages as well as injunctive and declaratory relief. Evaluating the claims with the appropriate flexibility allowed a pro se plaintiff, Judge Ross dismissed all claims for the following reasons.
Bivens ClaimA plaintiff who brings a claim under Bivens must demon-strate that “the defendants acted under color of federal law to deprive plaintiff of a constitutional right.” Bivens, 403 U.S. at 389. Bivens actions must be directed against individual federal officers, acting in their individual capacities. In Freder-ick, Judge Ross dismissed the plaintiff’s Bivens claim because the plaintiff failed to name any specific federal officer as a defendant. Instead, the plaintiff named HUD, a federal agency that Judge Ross explained is immune from suit under the doctrine of sovereign immunity. Because a suit against a federal agency is essentially a suit against the United States, Judge Ross reasoned, the claim could not go forward unless sovereign immunity was waived. As the plaintiff failed to demonstrate that HUD waived its immunity, the court thus declined to address the substance of this claim.
To bring a claim under the FHA, a plaintiff must show either that he was treated differently because of his status as a minority (disparate treatment) or that the defendant’s practices have a disproportionately negative impact on minorities.
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RICO ClaimA private claim for damages under RICO requires that a plaintiff show “(1) the defendant’s violation of 18 U.S.C. § 1962, (2) an injury to the plaintiff’s business or property, and (3) causation of the injury by the defendant’s violation.” Frederick, 12-CV-00553 at 4 (citing Commercial Cleaning Servs. v. Colin Servs. Sys., Inc., 271 F.3d 374, 380 (2d Cir. 2001)). The first prong of this test is satisfied by showing that the defendant violated the criminal provisions of the RICO statute. More specifically, the plaintiff must allege that the defendant’s actions constituted a pattern of racketeering activity, which resulted in directly or indirectly investing in, maintaining an interest in, or participating in an enterprise that has activities affecting interstate or foreign commerce. Further, the second prong requires that the plaintiff was injured in his business or property because of a violation of Section 1962.
Judge Ross held that the plaintiff here had failed plau-sibly to allege any predicate racketeering activity on the part of the defendants or the existence of any racketeering enterprise. Citing with approval another case out of the Eastern District of New York, Judge Ross concluded that “unsubstantiated and conclusory allegations that certain named and unnamed defendants participated in certain enterprises and took actions at unspecified times and places are insufficient to state a RICO claim.” Frederick, 12-CV-00553 at 5 (internal citations and quotations omitted). Thus, the plaintiff’s RICO claim was also dismissed with prejudice for failure to state a claim.
Civil Rights ClaimsJudge Ross held that the plaintiff’s civil rights allegations pursuant to 42 U.S.C. §§ 1981, 1982, 1985, 1986 and 1988, as well as the Title VI, 42 U.S.C. § 2000d, were similarly conclu-sory and not adequately pled. Specifically, Judge Ross found the allegation that the plaintiff suffered unconstitutional discrimination and that a conspiracy deprived him of his constitutional rights were vague and unsubstantiated. The plaintiff failed to allege any facts demonstrating or raising a plausible inference of discriminatory intent on the part of defendants or of a conspiracy as required under Sections 1981, 1982, 1985, 1986 and 1988. Similarly, the plaintiff failed to plead adequately that defendants were motivated by a discriminatory animus. As such, all of the plaintiff’s civil rights claims were dismissed for failure to state a claim upon which relief may be granted.
State Law ClaimsPlaintiff’s state law claim for common law fraud was also dismissed, summarily, because the claim was “vague and devoid of factual content.”
Fair Housing ActThe FHA prohibits discrimination in connection with the sale or rental of a dwelling or any related provision of service. More specifically, Section 3605(a) prohibits anyone “whose business includes engaging in residential real estate-related transactions to discriminate against any person in making available such a transaction, or in the terms or conditions of such a transaction, because of race, color, religion, sex, hand-icap, familial status, or national origin.” 42 U.S.C. § 3605(a). The statute covers the provision of loans or other financial assistance offered in connection with the purchasing of a house. To bring a claim under the FHA, a plaintiff must show either that he was treated differently because of his status as a minority (disparate treatment) or that the defendant’s practices have a disproportionately negative impact on minorities.
Again, Judge Ross found that plaintiff’s allegations were lacking in plausible factual support. Though the correct legal and technical buzzwords were incorporated in the complaint, this was insufficient to raise the plaintiff’s claims above the speculative level. Judge Ross exercised caution, however, in light of the plaintiff’s pro se status and granted the plaintiff an opportunity to amend his complaint as to the FHA claim. The judge even directed the plaintiff to connect each of the named defendants to the specific acts or omissions giving rise to the FHA claim as well as provide factual support of a non-conclusory nature.
ConclusionThis decision makes clear that even a pro se plaintiff may fail to state a claim absent plausible factual allegations and non-conclusory statements.
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The LoansIn 2008, defendant Word Aflame Community Church Inc. (“Word Aflame”) borrowed $975,000 from CFSB to purchase a parcel of real property, pursuant to a note secured by a mortgage on that property. In 2009, CFSB issued a Commit-ment Letter for a loan to Word Aflame of another $2.5 mil-lion for the construction of a church sanctuary on the prop-erty. The Commitment Letter contained numerous terms and conditions, including a requirement that Word Aflame secure a substantial equity contribution for construction prior to receiving additional funds from CFSB. Word Aflame accepted the terms of the Commitment Letter, but allegedly neither anticipated nor noticed the inclusion of the equity contribution terms. Word Aflame then obtained additional financing from a group of other individuals and entities (the “Reznick defendants”), secured by a junior mortgage on the real estate, to supplement the construction funds it antici-pated from CFSB.
Word Aflame, however, did not secure an equity contri-bution as required under the Commitment Letter. Thus, CFSB refused to release funds authorized under the construction loan. In March 2010, Word Aflame responded by ceasing to pay interest as it came due under the 2008 note, making only one further insufficient payment of $5,600.
The LawsuitIn March 2010, CFSB commenced an action to foreclose upon the mortgage securing the 2008 note, based upon Word
In a recent decision by a New York trial court, Justice David Schmidt granted summary judgment in favor
of a lender, Carver Federal Savings Bank (“CFSB”), in its action to foreclose after the borrower defaulted
on a loan. In so ruling, the court rejected counterclaims by the borrower and a junior lender for breach
of contract, finding the counterclaim allegations to be inconsistent with the terms of the parties’ loan
agreement. Carver Fed. Sav. Bank v. Word Aflame Cmnty. Church Inc., No. 21344/10, 2012 N.Y. Misc. LEXIS
1137 (Sup. Ct. Kings Co. 2012). This opinion emphasizes the importance of carefully reviewing a contract’s
language prior to execution to ensure that it addresses each party’s expectations.
BORROWER OUT OF LUCK AFTER FAILING TO REVIEW LOAN TERMSBy Nicolas A. Stebinger ([email protected])
Aflame’s failure to make payments as they came due. Word Aflame responded with counterclaims alleging that CFSB had breached the terms of the Commitment Letter by failing to finance construction of its church sanctuary. The Reznick defendants, who were joined in the action as a result of their status as junior mortgagees, similarly asserted breach of contract counterclaims against CFSB. All parties moved for summary judgment, setting the stage for Justice Schmidt’s opinion.
Merits of the Foreclosure ActionIn addressing the merits of the action for foreclosure, the court noted that a plaintiff in such an action can establish its prima facie right to judgment “by producing the mortgage, the unpaid note, and undisputed evidence of default.” In addition to supplying the court with the mortgage and note relating to the 2008 loan, CFSB also produced an affidavit of its Assistant Vice President. The affidavit stated, based upon CFSB’s records, that Word Aflame had failed to timely pay each of its interest payments since March 1, 2010, and had subsequently made only one payment that was insufficient to extinguish its indebtedness. Word Aflame did not dispute these failures of payment. As a result, the court found Word Aflame in default of its obligations under the note, which also constituted a cross default under the terms of the subsequent Commitment Letter, thereby entitling CFSB to a grant of summary judgment on its claims.
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The Counterclaims for Breach of ContractWord Aflame’s counterclaim against CFSB was for breach of the 2009 Commitment Letter based upon CFSB’s failure to advance funds for construction of the church sanctuary. As noted, the terms of the Commitment Letter required Word Aflame to obtain an equity infusion before receiving funds for the construction. Word Aflame argued that the enforcement of the equity infusion requirement was unfair, because it did not anticipate that an equity infusion would be a prerequisite to obtaining a construction loan when it obtained financing under the initial 2008 note for purchase of the real property. Therefore, Word Aflame argued, it had been “deceived by [CFSB] form the very beginning.” The court rejected Word Aflame’s argument that it had been deceived. Justice Schmidt noted the total absence of any evidence that CFSB misrepresented the terms of future construction loans when issuing the 2008 note and of any evidence that Word Aflame complained about the equity infusion requirement during negotiations over the 2009 Commitment Letter.
The court similarly rejected Word Aflame’s argument that CFSB had breached the implied covenant of good faith and fair dealing in refusing to modify the equity infusion require-ment of the Commitment Letter. Justice Schmidt noted that the “covenant of good faith and fair dealing ‘is breached when a party to a contract acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other party of the right to receive the benefits under their agreement.’” It does not, however, require a party to modify agreed-upon terms. Because CFSB’s refusal to waive the equity infusion requirement would not deprive Word Aflame of any rights due to Word Aflame under the agreements’ negotiated terms, the court held that CFSB had not breached the covenant of good faith and fair dealing, and thus Word Aflame’s breach of contract claims must fail.
Finally, the court dismissed the breach of contract claims brought against CFSB by the Reznick defendants, because the
Reznick defendants were not party to any of the contracts at issue. Further, the Reznick defendants could not claim rights as third-party beneficiaries because all of the alleg-edly breached agreements were executed before the Reznick defendants acquired an interest in the real property by way of their mortgage. As a result, “there could not have been an intent by [CFSB] to benefit the Reznick defendants” such as would confer rights upon them under the agreements between CFSB and Word Aflame.
ConclusionIn sum, Carver Fed. Sav. Bank v. Word Aflame Cmnty. Church Inc. demonstrates that a party to a contract must clearly and carefully ensure that its expectations are expressed in the plain language of its contracts if the party hopes to later vindicate those expectations in court. While Word Aflame’s alleged failure to notice the equity contribution terms of the Commitment Letter resulted in its signature of contracts that allegedly did not give it the deal it wanted, the plain language of a contract trumps the unexpressed expectations of a party.
Justice Schmidt noted the total absence of any evidence that CFSB misrepresented the terms of future construction loans when issuing the 2008 note and of any evidence that Word Aflame complained about the equity infusion requirement during negotiations over the 2009 Commitment Letter.
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