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July 11, 1990


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


In this multidistrict case consolidated before this Court for pre-trial matters, investors in Gas Reclamation, Inc. ("GRI") bring suit for violations of federal securities laws, the Racketeer Influenced and Corrupt Organizations Act, common law and various state statutes. We assume familiarity with the general factual background of the claims asserted and with this Court's prior decisions. See In re Gas Reclamation, Inc. Sec. Litig., 733 F. Supp. 713 (S.D.N.Y. 1990); In re Gas Reclamation, Inc. Sec. Litig., [1987 Transfer Binder] Fed.Sec. L.Rep. (CCH) ¶ 93,731, 1988 WL 45632 (S.D.N.Y. Apr. 18, 1988); In re Gas Reclamation, Inc. Sec. Litig., 659 F. Supp. 493 (S.D.N.Y. 1987). Before the Court today are three separate groups of motions, and we address each in turn.

I. Banks' Motions for Partial Summary Judgment

The Connecticut National Bank ("CNB"), Ensign Bank FSB ("Ensign"), Morris County Savings Bank ("Morris") and Privatbanken A/S ("Privatbanken) (collectively, the "Banks") move for partial summary judgment, pursuant to Rule 56 of the Federal Rules of Civil Procedure, on their cross-claims against Northwestern National Insurance Company of Milwaukee, Wisconsin ("Northwestern") for payment on various surety bonds. We grant their motion.

The Banks hold a group of promissory notes ("Notes") made at various dates between April and October 1984 by investors in Gas Reclamation, Inc. ("GRI") to finance their purchases of gas reclamation units. Each Note requires equal quarterly payments of principal and interest over a term of approximately four and one-half years and at an interest rate set at a specified percentage over a specified prime rate. In the case of default in any payment and other specified events, each Note would, at the option of the holder, become immediately due and payable, and the interest rate would be increased to three-percent over the non-default rate. As part of the several transactions in which the Banks acquired the Notes, Northwestern, as surety for the investors, issued eleven Financial Guarantee Bonds ("Bond") which guaranty payment of principal and interest on the Notes. The Notes were originally issued to the Intercontinental Monetary Corporation ("IMC") and Privatbanken; IMC subsequently assigned the Notes it held to CNB, Ensign and Morris.

GRI collapsed almost immediately. Most of the investors never made any payments to the Banks, and almost all of the Notes are now in default. In their original consolidated complaint, the investors asserted several securities laws and other claims against the Banks, and this Court denied the Banks' motion to dismiss those claims in its Opinion of April 9, 1987, In re Gas Reclamation, Inc. Sec. Litig., 659 F. Supp. 493 (S.D.N.Y. 1987). From the first defaults in early 1985 until October 1987, Northwestern made certain payments to the Banks on each of the defaulted Notes to comply with its understanding of its option to cure the investors' defaults. On October 6, 1987, in response to this Court's denial of the motions to dismiss, Northwestern stopped making payments to the Banks on the defaulted Notes, claiming that the investors' claims against the Banks, if proven, would constitute defenses to payments under the Bonds.

After discovery was completed, most of the investors stipulated to the discontinuance of their claims against the Banks, and the Banks withdrew their claims against the investors. On August 11, 1989, each of the Banks served on Northwestern amended pleadings asserting the claims on which the Banks now seek summary judgment. The Banks argue that Northwestern has breached the Bonds and that the Banks are entitled to payment of each defaulted Note in full, including default interest from the date of investor default on each Note.

Each Bond imposes an unconditional obligation on Northwestern to pay the Banks upon the default of any investor on an underlying Note: "The Surety [Northwestern] shall pay Loss hereunder in immediately available funds no later than fifteen (15) days after the receipt of Notice of Default. . . ." Bond, ¶ 8. The parties do not dispute that the Banks hold the Notes, that the Notes are in default, that Northwestern issued the Bonds which insure payment of the Notes, and that Northwestern stopped making payments in October 1987. Northwestern advances three arguments in opposition to the Banks' motions.


First, Northwestern argues that this Court should stay its decision on the Banks' motions for partial summary judgment until after this Court decides Northwestern's motion to enforce its rights of quia timet and exoneration against the investors. Since in this Opinion, we also decide Northwestern's motion, Northwestern's request for a stay is moot.


Second, the Banks and Northwestern disagree as to the amount of Northwestern's liability under the surety Bonds. There is no dispute as to which Notes are covered by the surety Bonds and the original principal amount of those Notes. The disagreement concerns the amount of interest due and the method for calculating the credit owed to Northwestern for the payments it has already made to the Banks. The Banks argue that Northwestern must pay principal plus default interest from the original date of default for each investor, less a credit for the amounts Northwestern paid during the time it chose to cure the investors' defaults. The Banks would apply such credit first to the default interest due and then to reduce the outstanding principal balance. Since Northwestern's payments from early 1985 to October 1987 did not include default interest, such calculation would result in incomplete principal payments during that period. Northwestern argues that it is not required to pay any default interest, but instead owes principal and interest from the time it stopped curing the investors' defaults in October 1987. Alternatively, Northwestern argues that if it does owe default interest, such additional interest is not due for the period during which it cured the investors' defaults. Finally, Northwestern argues that even if it did owe default interest from the time of each investor's original default, its agreement with the Banks provides that Northwestern should nonetheless receive credit for full and timely principal payments from early 1985 to October 1987, the period it chose to cure the investors' defaults.

To resolve this dispute, this Court must look to the language of the surety Bonds and the Notes. "[S]ummary judgment is appropriate where the language of the contract is unambiguous, and reasonable persons could not differ as to its meaning." United States v. 0.35 of an Acre of Land, 706 F. Supp. 1064, 1070 (S.D.N.Y. 1988) (citations omitted). The court must decide as a legal matter whether a contract is ambiguous, and "contract ambiguity is not established simply because the parties disagree as to the meaning of a particular provision." Id. (citations omitted). On motions for summary judgment, courts must give effect to the objective intent of the parties as indicated by the unambiguous terms of their written agreements.

The parties do not dispute that all the Notes provide for acceleration in the event of default and for a three-percent increase in interest after the Notes become due, either at stated maturity or on acceleration. Paragraph eight of all of the surety Bonds requires Northwestern to pay the "Loss," which all the Bonds define in substantially the same way as:

  "Loss" as to any Note shall mean the aggregate
  amount of unpaid principal plus accrued and unpaid
  interest on the Note which is in Default, such
  interest to be calculated at the rate specified in
  such Note from the date interest began to accrue
  until the date on which the Surety pays such Loss
  hereunder in accordance

  with Section 8. Notwithstanding anything to the
  contrary herein Loss shall exclude penalties of any
  nature and expenses of collection, and shall be
  reduced by any payments of principal made by or on
  behalf of the Defaulting Principal before payment
  by the Surety. The aggregate of all Losses under
  this Bond shall not exceed the Limit of Liability.

Bond, ¶ 1(c) (emphasis supplied). The only material difference in the surety Bonds' definitions of "Loss" is that the Privatbanken Bonds omit the italicized language excluding "penalties."

Northwestern argues that the three-percent increase in interest on default is a "penalty" that is excluded from the definition of "Loss" in all but the Privatbanken Bonds. We disagree. The surety Bonds all provide for the application of New York law. Under New York law, an agreement to pay an increased interest rate on default is not a penalty, but compensation for the increased risk of non-collection. See Citibank, N.A. v. Nyland (CFS), Ltd., 878 F.2d 620, 624-25 (2d Cir. 1989) (following Ruskin v. Griffiths, 269 F.2d 827 (2d Cir. 1959), cert. denied, 361 U.S. 947, 80 S.Ct. 402, 4 L.Ed.2d 381 (1960)); Union Estates Co. v. Adlon Constr. Co., 221 N.Y. 183, 187, 116 N.E. 984 (1917) ("Likewise, an agreement to pay interest upon a loan from its date until its payment at a rate before and a differing rate after its maturity is an agreement to pay interest and not a penalty as to the latter rate."). Because New York law provides a clear definition for the term "penalty" as used in the same context, we determine that there is no ambiguity as to its meaning. This Court, therefore, cannot consider the subjective intent of Northwestern's loan officer as to whether he believed that the surety Bonds would exclude payments for default interest.

Northwestern also argues that the investors' defaults did not increase the risk of non-collection to the Banks because Northwestern remained guarantor of the payments — both before and after defaults by the investors, the Banks could and did look to Northwestern's credit to evaluate their risk. However, as the history of this multidistrict lawsuit indicates, the risk to the Banks of non-collection did increase after default despite Northwestern's guarantee of payment. Moreover, the Second Circuit rejected the same argument in Citibank when it recognized that there was an increased risk of non-collection after default on a loan secured by real estate even though the value of the collateral exceeded the amount due. Citibank, 878 F.2d at 625. We find that the unambiguous definition of "Loss" in the surety Bonds does not exclude any default interest due.

Next, we must determine the amount of default interest Northwestern is required to pay. The parties do not dispute that each Note provided that "[u]pon default in any payment hereunder (whether by acceleration or otherwise), the remaining payments shall, at the option of the holder, become immediately due and payable" and that:

    Upon the happening, with respect to any Maker,
  endorser or guarantor of this Note . . . of any of
  the following events: . . . default in payment of
  principal or interest . . . then, . . . this Note,
  if not then due, shall, at the option of the Payee
  or holder hereof, become due and payable
  immediately without demand or notice. After this
  Note becomes due, at stated maturity or on
  acceleration, any unpaid balance hereof shall
  thereafter bear interest until paid at a rate of 3
  percent more than the rate provided for above. . . .

The surety Bonds provide in paragraph five that the holder of the Note must give Northwestern written notice of any principal's default within sixty days, and in paragraph eight, Northwestern is required to pay the Banks within fifteen days of receipt of such notice. The surety bonds, however, permitted Northwestern to cure any investor default:

  Surety shall have the option to cure a Default
  under any of the Notes by paying to Obligee or
  Permitted Assignee (whoever holds the Notes) the
  amount due thereunder, within fifteen (15) days of
  its receipt of Notice of Default thereunder in
  accordance with paragraph five (5) thereof. In such
  event there shall be

  no acceleration of the subject Note or other Notes
  made by the defaulting Principal and thereafter
  due, if such Note is subject to acceleration by the
  terms thereof. In such event, the Surety shall
  thereafter make payment when due. . . .

Bond, ¶ 2 (emphasis supplied).

In early 1985, when most of the investors did not make the required interest and principal payments to the Banks, Northwestern elected to cure those defaults. According to the express terms of the surety bonds, the Banks cannot accelerate the Notes if Northwestern elects to "cure," and therefore, no default interest was then due. Northwestern continued to cure the investors' defaults until October 1987, making each quarterly payment of interest and principal to the Banks on each of the Notes in default. For the period until October 1987, Northwestern does not claim that the Banks failed to provide appropriate notice, and the Banks do not claim that Northwestern's payments were untimely or insufficient to cover the principal and non-default interest due.

In October 1987, Northwestern informed the Banks that it would no longer make quarterly payments to cure the investors' defaults. At that point, according to the express terms of the Notes, the remaining payments were, "at the option of the Payee or the holder . . . due and payable immediately without demand or notice." Northwestern concedes that two of the Banks, Morris and Privatbanken, notified Northwestern after October 1987 of their intention to accelerate the Notes they held. See Northwestern's Supplemental Brief in Opposition to the Banks' Motion for Partial Summary Judgment at 2, 5, 7-8; Affidavit of H. Adam Prussin dated June 29, 1990, Ex. 3 (Morris letter dated October 5, 1988 "demand[ing] immediate payment of the entire amount of unpaid principal on each of the Principal's Notes plus all accrued and unpaid interest thereon" at the default rate of interest), Ex. 8 (Privatbanken letter dated March 21, 1988 stating that "[w]e are not waiving or modifying our position regarding full acceleration of the defaulted notes . . ." and "hereby demanding full payment under the above Bond."); Affidavit of Jan Paulin dated June 26, 1990, Ex. D (Privatbanken letter dated February 10, 1988). Northwestern however argues that the other two Banks, CNB and Ensign, never provided unequivocable evidence of their intention to accelerate the Notes they held after Northwestern stopped curing the investors' defaults in October 1987. We disagree. The express terms of the Notes provide that no notice or demand is required to accelerate payment. CNB and Ensign clearly wrote letters to Northwestern after October 1987 stating their understanding that the Notes they held had been previously accelerated. See Affidavit of H. Adam Prussin dated June 29, 1990, Ex. 6 (Ensign notices of default and proofs of loss, dated October 27, 1987, stating: "This Notice of Default/Proof of Loss shall not be deemed a waiver of the undersigned's option to accelerate said Principal's note (the undersigned has accelerated said note by notice dated 5/31/85)."), Ex. 10 (CNB letter dated December 9, 1987 stating: "This Notice of Default/Proof of Loss shall not be deemed a waiver of the undersigned's option to accelerate the Principals notes. The undersigned has accelerated said notes by notice dated April 10, 1985."). In fact, those notices simply repeat the language contained in the prior notices sent by the Banks to Northwestern at each ...

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