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June 18, 1990


The opinion of the court was delivered by: Mukasey, District Judge.


This motion for summary judgment relates to 37 unconsolidated cases*fn1 brought by Fidelity Bank, against each defaulting investor in a limited partnership, to collect sums due under promissory notes executed in connection with the partnership. Defendants contend that these notes were procured by fraud, and that plaintiff's notice of this fraud bars plaintiff from asserting the rights of a holder in due course. Defendants have raised a genuine issue of material fact as to whether fraud underlay the partnership transaction, as well as an issue as to Fidelity's status as either a holder in due course or a transferee of such a holder's rights. Therefore, plaintiff's motion is denied as to all defendants except those specified in Section V of this opinion, who as alleged participants in the fraud may not themselves assert the defense of fraud absent evidence that they were victims rather than perpetrators of the fraud.


This case arises out of a complex series of financial transactions whose details and rationale are far from clear from the evidence presented on this motion. Defendants here purchased units in the Deep Creek Timber Associates I Limited Partnership, a partnership established under Oregon law to acquire parcels of property and timber in Oregon and Washington. Two general partners managed the partnership: the individual general partner, Richard Birkins, and the managing general partner, Timber Management, Inc., which was controlled by James J. Spolyar. In 1983, Deep Creek made an unsuccessful attempt to sell limited partnership units. Thereafter, Deep Creek attempted another offering of units, as evidenced by a Private Placement Memorandum (PPM) dated January 10, 1984. (PX C)*fn2 The offering was for 50 units at $159,000 per unit, for a total of $7,950,000, with a minimum investment of one-quarter unit per limited partner.

To purchase units in the partnership, investors paid an initial installment of $15,000 per unit, and then executed 5-year promissory notes, payable in five installments, for the remainder of the purchase price. According to the PPM, investors also filled out financial and other forms, allegedly to enable the partnership to obtain an investor bond guaranteeing these notes, and to buy credit life insurance insuring each investor's life in an amount equal to the outstanding balance of his or her promissory note. (PX C at 2)

During the initial offering in 1983, Spolyar asked Peter Riebling, president of Surety Intermediaries, Inc., to help find a surety to guarantee payment of the investor notes in connection with the partnership. (Riebling Aff. at ¶ 4) Riebling referred Deep Creek's PPM to the Mutual Fire Marine and Inland Insurance Company, whose holding company was also part owner of Surety Intermediaries. According to Riebling, Mutual Fire's counsel helped draft Deep Creek's PPM, and eventually Mutual Fire issued a letter in March 1984 committing to issue the surety bond. (Riebling Aff. at ¶ 5; DX H) The PPM, issued in January, recited that Mutual Fire had committed not only to issue the surety bond, but also to provide the initial loan of $5.3 million to buy the property; the commitment letter issued by Mutual Fire in March recited that Mutual Fire would finance the whole transaction if Deep Creek could not find another lender. (DX C)

Meanwhile, Spolyar and broker-dealers sold units in the partnership to various investors, who executed promissory notes payable to Deep Creek in five installments; apparently, investors were led to believe that these notes were meant only as collateral that would enable the partnership to borrow funds. If this project was set up as most such projects are, it presumably would generate enough revenue so that the investors would not have to use their own funds to pay the installments on the notes. The surety bond issued by Mutual Fire guaranteed these notes.

On June 27, 1984, IVB and Deep Creek entered into a term loan agreement under which Deep Creek executed a note payable to IVB in five installments and assigned the investor notes to IVB as partial security for the loan. (PX D, E) As part of the term loan agreement, Deep Creek warranted that the "collateral documents," which included the investor notes, "when delivered will be valid, binding and enforceable in accordance with their respective terms." (PX D § 5.01(D))

In 1985, Mutual Fire became insolvent, and has been in a rehabilitation proceeding under Pennsylvania's insurance insolvency laws since December 8, 1986. The parties to the case at bar characterize the timing of the Deep Creek and investor defaults differently, but it is clear that Deep Creek defaulted on its note to IVB, that all defendants except two failed to make payments on the investor notes to Deep Creek, assigned to IVB and due on January 15, 1987, and that all defendants failed to make payments due January 15, 1988. (Styer Aff. at ¶ 15) Some defendants also failed to make the payments due under their notes on January 15, 1985 and January 15, 1986; IVB made demand on Mutual Fire, and received payment for these amounts under the surety bond. Plaintiff does not seek to recover these amounts.

On June 13, 1986, Fidelity Bank acquired IVB's interests in certain commercial paper, including the investor notes here at issue, as part of an asset transfer accompanying a merger of the two banks. (DX I) On the very same day, Mutual Fire, now insolvent, came under a supervision order by the Commonwealth of Pennsylvania. On June 20, 1986, IVB and Fidelity Bank executed an Agreement to Merge, and on September 15, 1986, the merger became effective. (DX J, K) Fidelity Bank now asserts its rights as a transferee of the notes from IVB to collect the payments due on the investor promissory notes in the amounts listed in plaintiff's Exhibit G.


A federal court deciding a diversity case applies the same choice of law rules as the state courts of the state in which it sits. Klaxon v. Stentor Elec. Mfg. Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941). This is a diversity case, so New York choice of law rules dictate which law governs.

The notes at issue here provide that they "shall be construed in accordance with the law of the State of Oregon." Although Oregon, like New York, has adopted the Uniform Commercial Code, and although the parties here refer to only one Oregon case and otherwise cite New York law, it is necessary under New York choice of law rules to follow the intention of the parties as to choice of law, as reflected in the signed instrument. Under New York choice of law principles, the "contractual selection of governing law is generally determinative so long as the chosen state has sufficient contacts with the transaction, absent fraud or violation of public policy." Capital National Bank of New York v. McDonald's Corp., 625 F. Supp. 874 (S.D.N. Y. 1986). See Hawes Office Systems, Inc. v. Wang Labs, Inc., 537 F. Supp. 939 (E.D. N.Y. 1982). Further, U.C.C. § 1-105 provides that "when a transaction bears a reasonable relation to this state and also to another state or nation the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties." Here, although Oregon arguably has few contacts with the transaction at issue, it was the site of the property and timber that the limited partnership was created to exploit. Further, because Oregon, New York and Pennsylvania all have adopted the Uniform Commercial Code, it is unlikely that either New York or Pennsylvania would have a policy that would override the choice of law provision.

Although both New York and Oregon have adopted the U.C.C., "states may provide varying interpretations of uniform statutes." Lund's Inc. v. Chemical Bank, 870 F.2d 840, 845 (2d Cir. 1989). Therefore, when possible, this opinion must be based upon interpretations of Article 3 of the U.C.C. as explicated by Oregon courts. See ORS ch. 73. Inasmuch as Oregon has been the site for few reported disputes over the interpretation of the U.C.C.'s holder in due course provisions, I have found it necessary to refer to New York courts' interpretations of the U.C.C. to fill several gaps.


Under Fed.R.Civ.P. 56(c), a trial judge must grant summary judgment if the evidence demonstrates that "there is no genuine issue as to any material fact and [that] the moving party is entitled to a judgment as a matter of law." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986). In determining whether a genuine issue of material fact has been raised, a court must resolve all ambiguities and draw all reasonable inferences against the moving party. United States v. Diebold, Inc., 369 U.S. 654, 655, 82 S.Ct. 993, 994, 8 L.Ed.2d 176 (1962) (per curiam), cited in Donahue v. Windsor Locks Bd. of Fire Comm'rs., 834 F.2d 54, 57 (2d Cir. 1987). Nonetheless, in order to defeat a motion for summary judgment, the non-movant "must do more than simply show that there is some metaphysical doubt as to the material facts. . . . Where the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no 'genuine issue for trial.'" Matsushita Elec. Ind. Co. v. Zenith Radio, 475 U.S. 574, 586-87, 106 S.Ct. 1348, 1356, 89 L.Ed.2d 538 (1986).

Defendants here concede that they signed the promissory notes and that they defaulted on payments due under the notes. Thus Fidelity, as a holder of the signed instruments, is entitled to recover on them unless defendants establish a defense. U.C.C. § 3-307(2) (ORS 73.3070(2)) Defendants assert as their defense fraud in the limited partnership transaction. As discussed below, some of these defendants present evidence of fraudulent inducement sufficient to create a genuine issue as to this defense, and thus to defeat this summary judgment motion insofar as Fidelity asserts only the rights of a holder.

If a party establishes defenses, the burden then shifts to the holder to prove that it is not merely a holder but a holder in due course. U.C.C. § 3-307(3) (ORS § 73.3070(3)). See Community Bank v. Ell, 278 Or. 417, 564 P.2d 685, 688 (1977). If Fidelity is a holder in due course, it may collect on the notes regardless of defendants' fraud defense; under the U.C.C., a holder in due course acquires a negotiable instrument free of all claims by any person, and all defenses of any party to the instrument with whom the holder has not dealt, except for five statutory exceptions not implicated in this case.*fn3 U.C.C. § 3-305 (ORS § 73.3020-73.3050). See Hobgood v. Sylvester, 242 Or. 162, 408 P.2d 925, 927 (1965).

As set forth below, defendants have presented evidence from which a rational trier of fact could conclude that there was fraud in the inducement; thus, Fidelity must show that it is a holder in due course not subject to this defense in order to prevail on its summary judgment motion as to defendants allowed to use this defense. Because there is a material issue as to Fidelity's holder-in-due-course status, however, this action must go to trial as to those defendants who may assert the fraud defense.


Defendants allege that the limited partnership units for which the investor-defendants executed the promissory notes at issue were sold and proposed through "a variety of fraudulent means." (Def.Mem. at 22) As discussed below, the PPM said that all financing for the transaction had been obtained, while in fact the financing was not finally assured until months after the PPM was issued.

Defendants assert also that the surety company's mortgage on all the Deep Creek properties was not disclosed in the PPM. Further, defendants assert that Spolyar could not get the minimum number of investors he needed to preserve the offering, and therefore arranged for nearly half the units to be purchased by insiders, including two well-respected brokers whose units he personally guaranteed and whose names he then used to endorse the deal without disclosing the risk-free nature of their investment.

Still further, the partnership offering supposedly was exempt from the requirements of the Securities Act of 1933 under § 4(2), which exempts "non-public" offerings, and pursuant to Regulation D, which provides certain criteria for exempt offerings.*fn4 Defendants contend that some of the investors who participated in this offering were not "accredited investors" under Regulation D, thus rendering the entire transaction voidable. Defendants are vague, however, about the basis for the last of these claims, as Rule 506 under Regulation D does not require that all investors be accredited, but rather permits up to 35 non-accredited investors to participate. On pages 15 and 16 of the PPM, potential investors are advised that they must meet the requirements of Regulation D, either by showing that they are accredited investors or that they have the requisite "knowledge and experience." (PX C) Assumably, defendants are alleging that more than 35 investors were unaccredited, or that the issuer knew that the unaccredited investors were not sophisticated. Defendants, however, present no evidence to support this defense.

In order to establish fraudulent inducement, defendants must show: (1) a representation of a material fact; (2) falsity; (3) intent to deceive or knowledge by the party making the representation that it is false, or reckless disregard as to whether the representation is true or false; (4) justifiable reliance by the person to whom the representation is made; and (5) damages. See Riley Hill Gen. Contr. v. Tandy Corp., 303 Or. 390, 737 P.2d 595, 604-5 (1987). See also Mallis v. Bankers Trust Co., 615 F.2d 68, 80 (2d Cir. 1980), cert. denied, 449 U.S. 1123, 101 S.Ct. 938, 67 L.Ed.2d 109 (1981). Under Liberty Lobby, 477 U.S. at 254, 106 S.Ct. at 2513, the court must consider the evidence on a summary judgment motion "through the prism of the substantive evidentiary burden," which on a fraud claim is proof by clear and convincing evidence.*fn5 Riley Hill Gen. Contr., 737 P.2d at 604. See also Rudman v. Cowles, 30 N.Y.2d 1, 9, 330 N.Y.S.2d 33, 39, 280 N.E.2d 867, 871 (1972).

Three of the defendants have submitted affidavits describing circumstances of the limited partnership offering which, when read in the light most favorable to nonmovants, strongly suggest that the Deep Creek partnership offering was permeated by fraud. George Parry, a broker/dealer at Rooney Pace, Inc., explained in his affidavit that Spolyar told him that two well-respected brokers — Norman Pessin and Carl Doerge — had purchased units of the partnership, but did not inform him either that Spolyar himself had guaranteed these interests or that most of the units of the partnership were bought by "insiders."

  "I was not aware at the time, that so many people
  affiliated or related to the Private Placement
  Memorandum had in fact purchased same, and had I
  been aware, I certainly would have been much more
  reticent [sic] to enter into this transaction. I
  also would not have touted same to my clients and
  customers, nor would I have represented to them
  that some very sophisticated and knowledgeable Wall
  Street people had purchased same in their own
  right. I was misled by Mr. Spolyar and deceived by
  him into believing that these limited partners who
  were already 'on board' purchased same out of a
  sense of enthusiasm, rather than out of a sense of
  no risk or pecuniary gain on their part."

(Parry Aff. at ¶ 3) Parry listed in his affidavit 13 investors, now defendants, to whom he personally sold partnership interests as a result of his misconceptions about the offering.

Norman Pessin, a partner of the investment firm Neuberger & Berman, and Carl Doerge, an executive at Smith Barney, confirmed in their affidavits that in a desperate attempt to prevent the contingent offering from falling through, Spolyar, "in an impassioned plea, urging me to make such an investment, offered to me his personal guarantee that under no circumstances would I ever be called upon to pay any of the notes and in the event that there was a call made on any of the notes, he would personally pay them in my behalf." (Pessin Aff. at ¶ 4; Doerge Aff. at ¶ 4) These guarantees are attached to the affidavits. A list of defendant-investors in this case confirms that many of the people who bought units in the partnership were "insiders": Spolyar, his brother, his lawyers, Riebling — the President of Surety Intermediaries, which found a surety for Deep Creek — broker/dealers and the two people whose interests Spolyar personally guaranteed. Although the "insider" status of these investors does not necessarily reflect improprieties in the deal, Spolyar's representations that many of the units already had been sold, like his representation that Pessin and Doerge had purchased units, created the misperception in potential purchasers that many savvy Wall Street people were in effect endorsing the deal. The guarantees and the relationships among many of the investors were allegedly material facts that the issuer of partnership interests did not disclose to the other investors. There is thus a genuine issue as to defendants' fraud defense.*fn6

Defendants, however, have adduced evidence of a genuine issue of material fact as to only one of the two alleged misrepresentations in the PPM. Although the timing and order of financing commitments remains murky, there is a genuine issue as to whether the PPM's statement that the partnership had obtained financing was a material misrepresentation. On the other hand, as set forth below, defendants' allegation in the affidavits of Parry, Pessin and Doerge,*fn7 that the PPM materially omitted to mention that Mutual Fire was granted a mortgage on the partnership's ...

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