United States District Court, Southern District of New York
October 19, 1990
RUSSELL THORNOCK, ET AL., PLAINTIFFS,
KINDERHILL CORPORATION, ET AL., DEFENDANTS. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. DONALD J. RATKOWSKI, DEFENDANT. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. ANDRE DAWSON AND VANESSA DAWSON, DEFENDANTS. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. SCOTT D. SANDERSON AND CATHLEEN C. SANDERSON A/K/A CATHY SANDERSON, DEFENDANTS. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. RICHARD M. MOSS AND CAROL E. FREIS, DEFENDANTS. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. RIK AALBERT BLYLEVEN AND PATRICIA ANN BLYLEVEN, DEFENDANTS. FIRST CITY NATIONAL BANK AND TRUST COMPANY, PLAINTIFF, V. DWP INVESTMENT LIMITED PARTNERSHIP AND DAVID W. PALMER, DEFENDANTS.
The opinion of the court was delivered by: Sweet, District Judge.
First City National Bank and Trust Company ("FCNB" or "the
Bank"), a defendant in Thornock v. Kinderhill Corp., 87 Civ.
7737 ("Thornock") and a plaintiff in the six cases, First City
National Bank and Trust Co. v. Ratkowski, 88 Civ. 6154, First
City National Bank and Trust Co. v. Dawson, 88 Civ. 6155, First
City National Bank and Trust Co. v. Sanderson, 88 Civ.
6156, First City National Bank and Trust Co. v. Moss, 88 Civ.
6978, First City National Bank and Trust Co. v. Blyleven, 88
Civ. 7020, and First City National Bank and Trust Co. v. DWP
Investment Limited Partnership, 88 Civ. 7547 (collectively,
"the FCNB actions"), has moved to dismiss the Second Amended
Complaint in Thornock. The defendants in the FCNB actions have
moved to vacate the default summary judgments entered in favor
of FCNB in each of those cases. For the reasons stated below,
the motion to dismiss in Thornock is granted, and the motions
to vacate the summary judgments are denied.
The plaintiffs in Thornock are individual investors in
various limited partnerships which were involved in the
business of buying, breeding and selling thoroughbred
racehorses. In both this case and Bruce v. Martin, 87 Civ.
7737, the investors have sued those who organized, promoted,
and managed the partnerships, alleging securities fraud and
other misdeeds. The numerous parties and their claims are
described in further detail in earlier opinions in both cases.
See, e.g., Bruce v. Martin, 712 F. Supp. 442 (S.D.N.Y. 1989);
Thornock v. Kinderhill Corp., 712 F. Supp. 1123 (S.D.N.Y. 1989).
FCNB provided financing to some of the Thornock plaintiffs
for the Kinderhill investments, in exchange for the borrowers'
promissory notes ("the Notes"). The claims against FCNB in
Thornock are based on allegations that the Bank was an aider
and abettor in the primary securities violations. In the FCNB
actions, the borrowers seek to defend against enforcement of
the Notes based on FCNB's alleged fraudulent inducement of the
A complete description of the events and activities which led
up to this litigation is set forth in the May 22, 1989 Opinion,
712 F. Supp. 1123 (S.D.N.Y. 1989). In the original
Thornock complaint, filed on June 8, 1988, FCNB was not named
as a defendant. On July 9, 1988, the Bank sued seven individual
borrowers, six of whom were already plaintiffs in Thornock, in
New York state court to enforce the Notes. Six of these seven
actions were subsequently removed to federal court and
consolidated.*fn2 In October, 1988, the investors filed an
amended complaint in Thornock in which FCNB was added as a
The Bank moved to dismiss the amended complaint, and the
motion was granted with the investors given leave to refile.
Following the filing of the Second Amended Complaint in May,
1989, FCNB again moved to dismiss, and also for summary
judgment in the FCNB actions. On June 9, 1989, the investors'
law firm sought to withdraw from all representation in both
Thornock and the FCNB actions because of a conflict of
interest. Because of the delay and confusion caused by the
change of counsel, the investors and borrowers failed to
respond to any of FCNB's pending motions, and default judgments
were entered in the Bank's favor on the summary judgment
motions on July 10 and on the motion to dismiss on July 17,
One month later, the investors moved to vacate the default
judgments on the grounds of excusable neglect. In January,
1990, the motion to set aside the judgment of dismissal in
Thornock was granted, but the motions to vacate the default
summary judgments in the FCNB actions were denied, because "no
sufficient showing of merit ha[d] yet been made in opposition
to the summary judgment motions" in those cases. Thornock v.
Kinderhill Corp., 88 Civ. 3978, slip op. at 7, 1990 WL 3924
(S.D.N.Y. January 12, 1990). The borrowers were, however,
granted leave to submit
further papers on their motions in the FCNB actions. Following
another round of briefing, the (reopened) motion to dismiss and
the motions to vacate the default summary judgments were argued
on June 22, 1990. Subsequent to this argument, both sides
submitted further material relating to the New York state court
activity in the single collection action which had not been
I. The Motion To Dismiss
A. The Standard
A court should dismiss a complaint for failure to state a
claim under Rule 12(b)(6), Fed.R.Civ.P., only if it appears
beyond doubt that the plaintiff can prove no set of facts in
support of its claim that would entitle it to relief.
Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229,
2232, 81 L.Ed.2d 59 (1984); Thornock, 712 F. Supp. at 1127
(S.D.N.Y. 1989). The complaint's allegations must be construed
in the light most favorable to the plaintiff and accepted as
true. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683,
1686, 40 L.Ed.2d 90 (1974); Dacey v. New York County Lawyers'
Assoc., 423 F.2d 188, 191 (2d Cir. 1969), cert. denied,
398 U.S. 929, 90 S.Ct. 1819, 26 L.Ed.2d 92 (1970).
As explained more fully in the April, 1989 opinion granting
FCNB's first motion to dismiss, the test in this circuit for a
claim of aiding and abetting a securities violation is that
described in IIT v. Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980)
(Friendly, J.). This test requires that the plaintiff show: (1)
a securities violation by the primary offender; (2) knowledge
by the alleged aider and abettor of the underlying violation;
and (3) substantial assistance by the aider and abettor in
achieving the underlying violation. IIT, 619 F.2d at 922.
In the April 1989 opinion, the investors' (first) amended
complaint was found to satisfy the first two prongs of the
IIT test for aider and abettor liability, but was dismissed
because it did not adequately allege "substantial assistance"
by FCNB in the underlying securities violation. Thornock v.
Kinderhill Corp., 88 Civ. 3978 slip op at 5-6, 1989 WL 40079
(S.D.N.Y. April 13, 1989). In their Second Amended Complaint,
the investors have responded to this criticism by adding one
32. First City National Bank rendered
substantial assistance to the fraudulent conduct
by the Kinderhill Defendants by providing funds to
the Broodmare Limited Partnership in return for
which the Bank received, as direct payee,
promissory notes from each of the limited partners
in the Broodmare limited partnership.
Unfortunately for the investors, the mere recitation of the
words "substantial assistance" does not suffice to elevate
FCNB's activities to the level necessary to uphold the claim.
In the simplest case, "substantial assistance" exists where
the alleged aider and abettor has played an active role in
furthering the securities violation. However, FCNB's alleged
behavior does not qualify as active assistance. Although the
Bank's provision of financing may have been a but-for cause of
the investors' losses — without financing they would never
have invested in the Kinderhill partnerships — it was not the
proximate cause. Faced with a similar allegation of substantial
assistance, the Second Circuit remarked
We question whether [defendant's] acts "caused"
the loss of [plaintiff] in a proximate sense,
since that loss was "caused" not by [defendant's]
short selling but by the failure of [defendant] to
inform [plaintiff] that it was selling short for
its own account.
Edwards & Hanly v. Wells Fargo Securities Clearance Corp.,
602 F.2d 478, 484 (2d Cir. 1979), cert. denied, 444 U.S. 1045, 100
S.Ct. 734, 62 L.Ed.2d 731 (1980). Likewise, the investors'
losses here were caused not by FCNB's provision of financing,
but rather by the Kinderhill defendants' alleged mismanagement
of the investments.
Because the Bank cannot be said to have actively assisted the
alleged fraud, the investors must, in order to state a claim,
succeed in showing substantial assistance
by inaction, namely the Bank's nondisclosure of information
concerning the risks of the investments and the
misrepresentations made to the investors. Such assistance was
alleged in National Union Fire Insurance Co. v. Turtur,
892 F.2d 199 (2d Cir. 1989), where the court explained that there
are only two situations in which a refusal to act can rise to
the level of substantial assistance required by IIT. The first
is when the alleged aider and abettor has a pre-existing duty
to act, such as where a fiduciary relationship exists, while
the second is where the third party has a "conscious and
specific motivation for not acting." Turtur, 892 F.2d at 207
(citing IIT, 619 F.2d at 927). With regard to the latter
situation, the court cautioned that something more than an
ordinary business purpose was required:
If we were to extend that exception to
[defendant], whose sole apparent motive was to
collect the premium for its Guarantee, the
exception would swallow the rule, since almost any
entity playing a role in a securities transaction
will have some economic motivation for doing so.
Rather, as we stated more recently in Armstrong v.
McAlpin, 699 F.2d 79, 91 (2d Cir. 1983), inaction
can provide a basis for liability, in the absence
of a duty to act, only when "designed intentionally
to aid the primary fraud."
892 F.2d at 207 (emphasis added).
In the present case, the investors have not alleged that they
had any relationship with FCNB which would have created a duty
for the Bank to disclose information concerning the Kinderhill
investments.*fn3 The investors therefore must establish that
FCNB's inaction was due not to its ordinary economic interest
in providing financing, but rather was the result of "a
conscious and specific motivation" and was "designed
intentionally to aid the primary fraud." This the complaint
fails to do.
Paragraph 32 alleges no more than that the Bank provided
funds in exchange for the investors' notes, an entirely routine
transaction. The investors, however, argue that FCNB's
participation was anything but routine, asserting that
FCNB has a special stake in the investment,
because it is alleged to have provided package
financing to all of the limited partners in
Kinderhill Farm Broodmare Leasing Program I, L.P.
. . . It knowingly financed a limited partnership
which was engaging in ponzi transactions.
Movants' Reply Brief at 8. Unfortunately, even this allegation
does not constitute a special motive for the Bank's behavior:
there is still no claim that FCNB stood to gain anything on the
transactions other than the normal profit which it would make
on the loans. Grouping all of the individual loans together and
arguing that FCNB provided them as part of a scheme to fund the
entire program cannot transform this ordinary economic
motivation into the "specific motivation." "designed
intentionally to aid the primary fraud" which Turtur
In summary, the investors have not alleged facts necessary to
support a claim that FCNB aided and abetted the alleged
underlying securities fraud here, and therefore
the claims against FCNB in the Second Amended Complaint will be
II. The Motions to Vacate the Default Summary Judgments
A. Standard for a Motion to Vacate
The standards for a motion under Rules 55(c) and 60(b),
Fed.R.Civ.P., to set aside a default judgment are set forth in
the January opinion, Thornock v. Kinderhill, 88 Civ. 3978, slip
op. at 5-7 (S.D.N.Y. Jan. 12, 1990). As explained more fully in
that decision, the borrowers have established "excusable
neglect" sufficient to justify setting aside the default
judgments in the FCNB actions, and have adequately shown that
such disposition would not substantially prejudice any of the
parties. Id. at 5-6. The primary reason for denying the earlier
motion was that
no sufficient showing of merit has yet been made
in opposition to the summary judgment motions made
in the [FCNB] actions. Movants' mere assertion,
unsupported by affidavit of merit or other
evidence, that there exist issues of fact as to
whether FCNB had knowledge of fraud and therefore
is not a holder in due course of the movants'
notes, does not establish a meritorious defense.
Id. at 7 (citation omitted). Although the investors have now
remedied the evidentiary deficiency, the new evidence presented
does not support the existence of a defense to the enforcement
of the notes.
In their supplemental papers in support of the motion to
vacate, the investors have presented the affidavit of Gerald
Henderson ("Henderson"), an accountant and financial consultant
who advised some of the investors, and of Marilyn Neiman
("Neiman"), an attorney for the investors. Henderson asserts
that FCNB was a knowing participant in the "fraudulent
inducement of investments in Broodmare and related
[investments]," and that the fraudulent inducement was
accomplished by means of misrepresentations and material
omissions in the various offering memoranda. The investors
assert that, because FCNB had knowledge of the fraud it can
never be a holder in due course of the Notes, and that
therefore the defense of fraudulent inducement can defeat the
Bank's attempt to enforce the Notes. See N.Y.U.C.C. §§ 3-302,
However, the borrowers have not alleged, nor have they
presented any evidence, that the loans themselves were
fraudulently induced. Rather, they contend that they were
fraudulently induced to invest the proceeds of the loans in the
Kinderhill partnerships. As a matter of law, this contention is
insufficient to establish a defense to enforcement of the
Notes, regardless of whether FCNB had knowledge of the
circumstances surrounding the investment.
1. Fraudulent Inducement
Under New York law, fraudulent inducement is a valid defense
to an action by the holder of a negotiable instrument to
enforce the instrument. Pan Atlantic Group, Inc. v. Isacsen,
114 A.D.2d 1022, 495 N.Y.S.2d 458 (2d Dep't 1985); Magi
Communications, Inc. v. Jac-Lu Associates, 65 A.D.2d 727, 410
N YS.2d 297 (1st Dep't 1978). If the holder is not a holder in
due course, the defense may be valid even if the fraud was
committed by a third party. However, those New York cases which
hold that fraud by a third party is a defense are limited to
situations where the third party was at some time the holder or
owner of the instrument. Id. In addition, in order for
fraudulent inducement to prevent enforcement of a promissory
note, it generally must be based on misrepresentations
concerning the terms or conditions of the loan itself. See,
e.g., Hunt v. Bankers Trust Co., 689 F. Supp. 666, 673-74
(N.D.Tex. 1987) (applying New York law, fraudulent inducement
was adequately alleged by affidavits that lender promised to
revise repayment schedules if necessary); Millerton Agway
Coop., Inc. v. Briarcliff Farms, Inc., 17 N.Y.2d 57,
268 N.Y.S.2d 18, 215 N.E.2d 341 (1966) (fraudulent inducement
adequately alleged by affidavits that lender promised to extend
further credit and not to press for payment).
Here, the borrowers have not set forth any evidence which
would indicate that they were in any way misled about the FCNB
loans themselves. Whether or not they were given a truthful
picture of the soundness of their investments in the Kinderhill
partnerships, they have not alleged any lack of awareness that
the Notes would have to be repaid according to their terms. In
light of this deficiency, the borrowers' assertions that FCNB
knew of the Kinderhill promoters' misrepresentations and that
its relationship with the promoters was closer than "a
traditional individual lender/borrower relationship"
(Borrowers' Statement Pursuant to Rule 3(g) ¶ 3) are simply
insufficient to establish a triable issue on the defense of
fraudulent inducement of the Notes.
The Bank also argues that even if the borrowers had presented
evidence to support their fraud defense, all claims against the
Bank have been explicitly waived. In New York, a waiver will
overcome a defense to enforcement of a promissory note provided
that the waiver explicitly addresses the defense in question
and that it was knowingly entered into by the promisor.
Citibank, N.A. v. Plapinger, 66 N.Y.2d 90, 94-95, 495 N.Y.S.2d
309, 311, 485 N.E.2d 974, 976 (1985); First City National Bank
and Trust Co. v. Tobias, 156 A.D.2d 267, 548 N.Y.S.2d 655 (1st
Dep't 1989); Seaman-Andwall Corp. v. Wright Mach. Corp.,
31 A.D.2d 136, 295 N.Y.S.2d 752 (1st Dep't 1968), aff'd, 29 N.Y.2d
617, 324 N.Y.S.2d 410, 273 N.E.2d 138 (1971).
In the instant case, each borrower requested the loan from
the Bank by signing a two-page "Borrower's Letter," consisting
of six paragraphs. The lengthiest paragraph, occupying most of
the second page, read:
I acknowledge and fully understand that the Bank
is acting solely as a lender and not as an
investment advisor. The Bank has made no attempt
to analyze or evaluate my intended investment in
the Partnership. The Bank has made no
representations to me, express or implied, to
induce me to request this loan. The bank has given
no opinion or advice as to whether it is wise or
prudent for me to invest funds in the Partnership.
The Bank has made no representations concerning the
Partnership, its General Partner(s) or their
financial strength, prospects, or integrity. I have
made my investment decision based on such
independent investigation as I have deemed
necessary. I understand that the Bank has not
participated in the preparation of a Private
Placement or Offering memorandum or similar
document for the Partnership and therefore is not
responsible for any statement contained in or the
completeness of such document. I assume all
responsibility for keeping myself informed of the
financial condition and operation of the
Partnership and agree that the Bank shall have no
duty to advise me of any such information. I agree
to hold the Bank harmless and do hereby release the
Bank from any and all claims that I may have
relating to or arising out of my investment.
(emphasis added). It seems clear that the highlighted sentences
constitute an explicit waiver of any claim that the loans were
fraudulently induced. Furthermore, the borrowers do not allege
either that they did not read this paragraph or that they did
not understand its implications when they signed the letters.
Therefore, under New York state law, the waiver is valid and
the borrowers claims of fraudulent inducement must fail.*fn6
3. The Need for Further Discovery
Finally, the borrowers — in a tacit admission of the
weakness of the evidence supporting
their allegations — rely on Neiman's affidavit to justify
setting aside the default judgments here because of their
inability to obtain discovery from FCNB. However, as explained
in the preceding sections, the problems the borrowers face are
not due to any failure to support their allegations adequately.
The allegations themselves — supported or not — are simply
not sufficient to constitute a defense to enforcement of the
Notes. More precisely, the borrowers have not alleged any
misrepresentations concerning the terms or conditions of the
loans, nor have they suggested how the alleged fraud of the
Kinderhill defendants caused them to sign the Notes, as opposed
to causing them to invest the proceeds of the Notes in the
Kinderhill partnerships. Furthermore, the borrowers have not
set forth any facts which would negate the explicit waiver of
their defense against the Bank. Because much of the evidence
which would support these allegations — such as that relating
to the borrowers' understanding of the waivers — is not solely
within the control or possession of FCNB, vacating the default
judgments here to allow the borrowers more opportunity for
discovery is not appropriate.
Because the Second Amended Complaint in Thornock does not
state a claim against FCNB for aiding and abetting a securities
violation, the complaint will be dismissed as to the Bank. In
the FCNB actions, the borrowers have failed to demonstrate the
existence of a meritorious defense to the Bank's motion for
summary judgment, and therefore the default judgments entered
in FCNB's favor on July 10, 1989 will not be set aside.
It is so ordered.