United States District Court, Southern District of New York
March 25, 1991
NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA., PLAINTIFF,
JOSEPH FREMONT AND BEVERLY FREMONT, WILLIAM J. KNOWLTON, DONAL W. LOOSELY, CARL H. MCBAIN, SIMEON MORIN AND JOHN R. WOILLARD, JR., DEFENDANTS.
The opinion of the court was delivered by: Stanton, District Judge.
OPINION AND ORDER
National Union Fire Insurance Company of Pittsburgh
("National Union"), an issuer of financial guarantee bonds,
sues to enforce an indemnity agreement between itself and
limited partners in a tax shelter limited partnership, and to
enforce its rights as subrogee on the limited partners'
promissory notes which it honored on their behalf. National
Union issued a bond which guaranteed to the partnership, and to
the bank that financed the partnership, that the limited
partners would make all of the capital contributions
represented by the promissory notes they gave to the
partnership. The defendant limited partners stopped making
their required contributions, and National Union made them on
their behalf. Now it sues them for reimbursement under
indemnity agreements they gave National Union at the time it
guaranteed their payments, and as subrogee of the notes on
which they defaulted.
National Union moves for summary judgment against defendant
Simeon Morin. The motion is granted.
In December, 1982 defendant, Simeon Morin purchased a limited
partnership interest in E.A. Associates ("E.A.A."), a New York
Limited Partnership. Defendant paid for this interest partly
with cash and partly with a series of five promissory notes
(the "notes") in the total principal amount of $71,300. Pl.
Statement Pursuant to Rule 3(g) ¶ 2.
Defendant and National Union entered into an indemnity
agreement regarding the notes (the "indemnity agreement"), and
National Union issued a bond guaranteeing the notes (the
"bond"). The indemnity agreement required defendant to
reimburse plaintiff for any payments it made under the bond,
and for interest and expenses incurred in obtaining
reimbursement. The bond guaranteed the payment of defendant's
notes and required National Union, as surety, to make payment
on the notes in the event of defendant's default. Pl. 3(g)
Statement ¶¶ 3-4. The bond further provided that if National
Union made payments on the notes to cure an investor's default,
it would be subrogated to the note holder's rights against the
investor. Exhibit C to Complaint ¶ 7.
Defendant failed to make payment on his final note, which
became due on March 15, 1987. Pursuant to the terms of the
bond, plaintiff made payment for him. Plaintiff sues to recover
this payment and interest, attorneys' fees, and expenses
pursuant to the indemnity agreement. It now moves for summary
1. Summary Judgment
Summary judgment shall be granted "if the pleadings,
depositions, answers to interrogatories, and admissions on
file, together with the affidavits, if any, show 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." Fed.R.
Civ.P. 56(c). "Summary judgment is appropriate when, after
drawing all reasonable inferences in favor of the party against
whom summary judgment is sought, no reasonable trier of fact
could find in favor of the nonmoving party." Lund's, Inc. v.
Chemical Bank, 870 F.2d 840, 844 (2d Cir. 1989). If a summary
judgment motion is properly supported, "the adverse party 'must
set forth specific facts showing that there is a genuine issue
for trial.'" Anderson v. Liberty Lobby, Inc., 477 U.S. 242,
250, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986) (quoting
2. National Union's Rights Under the Promissory Note
National Union seeks recovery under the notes pursuant to the
bond, and as the transferee of LaSalle National Bank (the
"bank"). It argues that the bank was a holder in due course of
the note, and that it enjoys all the bank's rights and is
entitled to payment on the note as the bank's transferee.
It is undisputed that the bank was a holder in due course of
defendant's note. A holder of a promissory note establishes a
prima facie case for recovery by proving execution of the note
and a default in payment pursuant to its terms. Hogan & Co. v.
Saturn Management, Inc., 78 A.D.2d 837, 433 N.Y.S.2d 168, 169
(1st Dep't. 1980); Shields v. Stevens, 55 A.D.2d 1017, 391
N YS.2d 766, 767 (4th Dep't. 1977). Once a holder establishes
a prima facie case, the maker has the burden of coming forward
with proof of evidentiary facts — not merely conclusory
allegations — demonstrating the existence of a genuine and
substantial issue rebutting the holder's entitlement to
payment. Shields, 391 N.Y. So.2d at 767.
National Union, as transferee of the promissory note, assumes
the right of the transferor bank unless the "transferee . . .
has himself been a party to any fraud or illegality affecting
the instrument or . . . as a prior holder had notice of a
defense or claim against it. . . ." U.C.C. § 3-201(1).*fn1
Defendant relies on National Union Fire Ins. Co. v. Turtur,
892 F.2d 199 (2d Cir. 1989). In Turtur the district court
found, and the Second Circuit affirmed, that defendants had
barely raised a factual issue as to whether
National Union was aware of the misstatements in
the PPM before it issued the bond, (assuming that
such knowledge would make National Union such a
"party to [a] fraud or illegality affecting the
[notes]" as to disable it from improving its
position by suing as the Bank's subrogee . . .)
Id. at 206. This finding was based on Turtur's specific factual
allegations of incidents and information which might have put
National Union on notice of the alleged fraud before National
Union issued the bond.
Defendant argues that prior to issuing the bond, National
Union was aware or should have been aware of misrepresentations
and fraud in the E.A.A. Private Placement Memorandum (the
"PPM") on which defendant relied when he purchased his interest
in E.A.A. He alleges that National Union, as part of its normal
practice, reviewed the E.A.A. PPM and investigated the E.A.A.
transaction with due diligence. He argues that from a review of
the PPM alone, National Union knew or should have known that,
contrary to the assertions in the PPM, (1) E.A.A. did not have
a "profit motive"; (2) the E.A.A. transaction was not
"substantially dissimilar" to other Rothschild sponsored
partnerships which had been found in tax audits to lack
economic substance; and (3) investors in E.A.A. would not
receive anticipated tax benefits. Morin Aff. ¶¶ 14-15; Def.
Mem. of Law 7-8.*fn2
To establish fraud, defendant must show "the traditional five
elements of fraud: misrepresentation of a material fact,
falsity of that representation, scienter, reliance and
damages". Mallis v. Bankers Trust Co., 615 F.2d 68, 80 (2d Cir.
1980) (italics in original) (citations omitted), cert. denied,
449 U.S. 1123, 101 S.Ct. 938, 67 L.Ed.2d 109 (1981).
Assuming that there is a genuine issue regarding fraudulent
misstatements in the PPM, defendant has not raised a genuine
issue of whether National Union was a party to the fraud. He
contends that the income projections in the PPM project a net
loss to the partnership, and therefore it was obvious to
National Union from a mere reading of the PPM that E.A.A. did
not have a profit motive and that the transactions lacked
economic substance. Def. Mem. of Law 7-8. This contention is
based on a misreading of the PPM which in fact projects, for
the thirteen years ending December 31, 1994 a net income of
$656,759 (projected rental losses of $2,262,241, plus projected
residual income of the equipment of $628,500, plus projected
return from lessee's anticipated net residual income of
$2,290,500). See Paykin Reply Aff. ¶ 2; Morin Aff. ¶ 14.
Other than his mistaken contention as to projected income,
defendant has not alleged any facts or circumstances from which
National Union's participation in the alleged fraud could be
inferred. Accordingly, he has not raised a genuine issue of
whether National Union was a party to any fraud or illegality
affecting the instrument. See National Union Fire Ins. Co. v.
Woodhead, 917 F.2d 752, 757-58 (2d Cir. 1990).
Nor should the assumption in which this court indulged in
Turtur (that knowledge of misstatements might render National
Union a "party" to a fraud) be extended here. Under U.C.C. §
3-201(1) mere "notice of a defense" (such as fraud or
illegality) does not disable the transferee unless the
transferee had the knowledge as "a prior holder" — which
indisputably National Union was not. Furthermore National
Union, which owed defendant no fiduciary duty, was under no
obligation to disclose to him deficiencies in the PPM of which
it became aware in the course of making its own investigations
for its own purposes. See Woodhead, 917 F.2d at 758.
Defendant had no defenses to payment against the bank as a
holder in due course. National Union, as transferee, took the
note with all the rights of the transferor bank. See Woodhead,
917 F.2d at 756-58; National Union Fire Ins. Co. v. Connally,
87 Civ. 3815, 1990 WL 20156, 1990 U.S. Dist. Lexis 2039
(S.D.N.Y. March 1, 1990). Plaintiff is entitled to summary
judgment on the note as the bank's transferee.
3. National Union's Rights Under the Indemnity
In Turtur, 892 F.2d at 203-05, the Second Circuit held that
if an indemnity agreement is part of a package of
interdependent contracts, one of which was induced by a fraud
to which the plaintiff was a party, all of the contracts in
that package may be unenforceable by that plaintiff. The court
held that the interdependency of contracts "boils down to the
intent of the parties", and that "[q]uestions of intent . . .
are usually inappropriate for disposition on summary judgment."
Id. at 205.
Here, even assuming that defendant raises a genuine issue of
interdependence of the contracts and fraud by third parties, he
does not raise a genuine issue of whether National Union was a
party to the fraud in the PPM, because he has not alleged any
facts or circumstances from which plaintiff's knowing
participation in fraudulent activity can be inferred.
Therefore, under Turtur, defendant has not raised a genuine
issue of fact regarding National Union's right to enforce the
Defendant further states that based on the subscription
agreement and the indemnity agreement, he believed that
National Union would issue a conditional
bond.*fn3 He argues that National Union breached the indemnity
agreement and issued an unconditional bond which waived any
defenses National Union had to payment due to acts of omissions
of Obligee (E.A.A.) as against a permitted assignee, such as
National Union argues that defendant made a unilateral
mistake as to the parties' intention, and that given that
nature of this transaction, the defendant should have known
that National Union was required to issue an unconditional
surety bond. Because the indemnity agreement does not specify
which type of suretyship applies, it is ambiguous as to the
type of suretyship the parties intended. This factual issue
cannot be decided on a motion for summary judgment.
National Union Fire Ins. Co. v. Alexander, 728 F. Supp. 192, 199
(S.D.N. Y. 1989).
However, this factual issue, though genuine, is immaterial.
Assuming the parties did not intend National Union to waive
defendant's defenses, the ultimate result would be that "the
waiver would be ineffective as to [Mr. Morin] and [he] could
still assert [his] defenses against the Bank and National
Union." Id. at 199. Here defendant has not alleged any defenses
against the bank, which was a holder in due course. Therefore,
even if National Union had issued a conditional surety bond
which did not waive Morin's defenses, it would have been
obliged to make good on defendant's default, and defendant
would still be liable under the indemnity agreement.
Accordingly, plaintiff is entitled to summary judgment on the
National Union's motion for summary judgment is granted.