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NORTHWESTERN NAT. INS. v. ALBERTS

July 11, 1991

NORTHWESTERN NATIONAL INSURANCE COMPANY OF MILWAUKEE, WISCONSIN, PLAINTIFF,
v.
MICHAEL J. ALBERTS, JAMES R. ALBERTS, CASSANDRA M. SHEEHAN, RAYMOND COSGROVE, PENELOPE A. BOYLE, JOHN C. MAUCERE, JERRY SILVA, MICHAEL L. METHENY, H.U.A. RESOURCES, INC., ALTON JONES, ARTHUR LAWSON, JOHN J. MULLER, MICHAEL J. O'CONNELL, RANDOLPH K. PACE, SOUTHERN COMPANIES, INC., MICHAEL J. MCCANN, WILLIAM CURRAN, JAMES M. MCCABE, HAROLD A. THAU, PATRICK J. ROONEY, VAN ALLEN CAPITAL CORP., AND ROBERT T. NORTON, DEFENDANTS. RAYMOND COSGROVE, WILLIAM CURRAN, JAMES M. MCCABE, JOHN J. MULLER, ROBERT T. NORTON AND HAROLD A. THAU, COUNTERCLAIM PLAINTIFFS, V. NORTHWESTERN NATIONAL INSURANCE COMPANY OF MILWAUKEE, WISCONSIN, AND ALLAN ESRINE (A/K/A IVAN EZRINE), COUNTERCLAIM DEFENDANTS.



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

    OPINION

Plaintiff and counterclaim defendant Northwestern National Insurance Company ("Northwestern") has moved pursuant to Rule 56, Fed.R.Civ.P. for summary judgment dismissing the First Amended Counterclaim (the "counterclaim") of defendants and counterclaim plaintiffs Raymond Cosgrove ("Cosgrove"), William Curran ("Curran"), James M. McCabe ("McCabe"), John J. Muller ("Muller"), and Robert T. Norton ("Norton"), (collectively the "Cosgrove Defendants"), as well as for summary judgment of its claims against the Cosgrove Defendants. Additionally, counterclaim defendant Allan Esrine ("Esrine") moved pursuant to Rules 9(b), and 12(b)(6) to dismiss the counterclaim against him; in the alternative, pursuant to Rule 56(a), Fed.R.Civ.P., for summary judgment dismissing the counterclaim against him; and also joined in Northwestern's summary judgment motion. For the reasons set forth below, Northwestern's and Esrine's summary judgment motion is granted in part and denied in part.

The Parties

Esrine is a resident of the State of New York.

Northwestern is a corporation organized under the laws of the State of Wisconsin with its principal place of business in the State of Wisconsin.

Norton is a lawyer, Cosgrove is president of a holding company, Curran is president of a mortgage company, McCabe is an industry analyst, and Muller is an executive for Wang Laboratories. All are New Jersey residents. Along with seventeen others, the Cosgrove Defendants were limited partners (the "Limited Partners") in Southern Pipelines Partners ("the Partnership"), an Oklahoma limited partnership formed for the purpose of constructing, owning and operating a pipeline for the transportation of natural gas in southern Oklahoma (the "Pipeline").

Among the general partners in the Partnership was Southern Pipeline Development, Inc. ("Development"), a subsidiary of Southern Reserve, Inc. ("Reserve").

Prior Proceedings

On May 18, 1988 Northwestern filed this diversity action as surety to recover sums of money paid by it on behalf of its principals, the former Limited Partners, including the Cosgrove Defendants.

The Limited Partners filed an answer to the complaint in August, 1988. In an opinion of the court of July 7, 1989 ("July 7, 1989 Opinion"), the Cosgrove Defendants were granted in part leave to amend their initial response to the complaint by filing a counterclaim alleging fraud, breach of duty to disclose, breach of duty of good faith and fair dealing amounting to constructive fraud, and failure to liquidate collateral and/or apply the proceeds thereof on a prorata basis to offset the alleged debts.

On March 9, 1990, the court heard oral argument on three motions: a letter of the Cosgrove defendants seeking to resolve certain discovery disputes that was treated as a motion; Northwestern's motion for leave to amend to add a new count asserting its surety rights of exoneration and quia timet and for a preliminary injunction; and the Cosgrove defendant's motion to amend the counterclaim, filed on February 6, 1990.

The counterclaim added Esrine as a counterclaim defendant and asserted a fraud claim in Count I; a breach of fiduciary duty in Count II; breach of duty to disclose in Count III; a breach of duty of fair dealing in Count IV; intentional interference with contractual relations in Count V; aiding and abetting the breach of fiduciary duty in Count VI; state and federal statutory causes of action for securities fraud in Counts VII, VIII, and IX; a violation of RICO in Count X; and failure to liquidate collateral and/or apply the proceeds thereof in Count XI.

In an opinion of June 25, 1990 (the "June 25, 1990 Opinion"), the court granted the motion to compel discovery, Northwestern's motion to amend and for preliminary injunction, and granted in part the motion to amend the counterclaim. An order of July 9, 1990, entered pursuant to the June 25 Opinion, required the Cosgrove Defendants to plead loss causation with respect to Counts I, III, IV, VI, VIII, and X of the Counterclaim.

The Cosgrove Defendants then moved for vacatur of the July 9 Order, and for reconsideration of the June 25 Opinion. In a memorandum opinion of August 29, 1990, the court ruled that the Cosgrove Defendants must plead loss causation with respect to Counts I and III, the common law fraud counts, and also with respect to Counts IV, V, and VI, the common law tort counts. With respect to Counts VII and IX, the memorandum opinion modified the July 9 Order to provide leave to amend to the extent such counts are based upon "control person" liability. The memorandum opinion granted leave to amend with respect to "seller liability" on the condition that the Cosgrove Defendants plead that Northwestern directly solicited the sales for each defendant.

The Cosgrove Defendants, joined by the other defendants in this action, appealed the Court's decision in the quia timet count. Northwestern subsequently filed a motion to dismiss the appeal. In an opinion of June 28, 1991, 937 F.2d 77, the Court of Appeals vacated the injunction based on quia timet as to the Cosgrove Defendants, and dismissed the appeal as to the remaining defendants-appellants.

On December 10, 1990, Esrine filed his motion to dismiss and for summary judgment. Upon agreement of the parties, Esrine's motions were taken on submission on March 4, 1991. On March 19, 1991 Northwestern filed its motion for summary judgment. Oral argument on the Northwestern motion was heard on May 23, 1991.

The Facts

The Partnership

The promoters and organizers of the Partnership were its general partners, Development, Van Allen Capital Corp. ("Van Allen"), and Michael Alberts ("Alberts"), Development's president and principal shareholder. Alberts was the president and principal shareholder of Reserve, which owned 50% of the stock in Development. Development had been formed in August of 1984 chiefly for the purpose of serving as a general partner in the Partnership.

The Partnership solicited potential investors in limited partnership interests by means of a Private Offering Memorandum dated October 11, 1984 (the "POM"). The POM described an offering of 37 limited partnership units at a purchase price of $200,000 per unit, and represented that the unit purchases would ultimately be financed by revenues that the operation of the Pipeline was expected to generate.

As part of their purchase price of the limited partnership units, the Limited Partners, including the Cosgrove Defendants, each executed and delivered promissory notes to the Partnership (the "1985 Notes") in the amount of $185,000 per unit. The Partnership then endorsed, assigned and negotiated these promissory notes to Equilease Corporation ("Equilease") in return for a $6,845,000 loan (the aggregate principal amount of the promissory notes) from Equilease to the Partnership.

In order for it to consent to purchase the 1985 Notes, Equilease required the limited partners to deliver a surety bond (the "1985 Bond") guaranteeing that the limited partners would make timely payments of principal and interest under the 1985 Notes. In order for Northwestern, as their surety, to issue such a bond on behalf of the Limited Partners as principals, each of the Limited Partners executed and delivered to Northwestern an application for surety bond which contained an agreement to indemnify the surety and an estoppel letter. The POM included among the exhibits sample Northwestern bond applications and indemnity agreements.

The offering described in the POM closed on January 25, 1985 (the "1985 Closing"). Esrine attended the Closing, at which time he delivered the 1985 Bond to the Partnership and collected in exchange Northwestern's bond premium.

The Partnership made interest and principal payments on the Equilease loan through the spring of 1986, reducing the principal balance on the loan, and thereby reducing the balance due on each of the Limited Partners' notes. The Partnership was unable to meet payments due in June 1986 and thereafter.

On or about September 30, 1986, and on or about December 16, 1986, Equilease advised Northwestern that the Limited Partners had defaulted on their obligation under their promissory notes, and demanded payment from Northwestern pursuant to the 1985 Bond. Northwestern, as surety, made total payments of $2,095,688.66 to Equilease on behalf of the Limited Partners.

The 1987 Restructuring

In late December of 1986, Development and Reserve advised Northwestern and Equilease of a proposed restructuring of the Limited Partners' promissory notes negotiated to Equilease and bonded by Northwestern (the "Restructuring"). In general the Restructuring consisted of (1) the transfer of the Partnership's assets (including the Pipeline) to Reserve; (2) Reserve's borrowing of $6,845,000 from a new financial institution (the "1987 Loan"); (3) the assumption by the former Limited Partners of the $6,845,000 borrowing by execution of assumption agreements (the "Assumption Agreements") and their receipt of common stock in Reserve, as well as a promissory note payable to each limited partner in the amount of $50,000; (4) Northwestern's issue of a financial guarantee bond in favor of the new financial institution guaranteeing the payments due under the Assumption Agreements (the "1987 Bond"); (5) Reserve and Development indemnifying Northwestern against all loss, cost and expense it would incur by issuing a new financial guarantee bond, and, as collateral security for their promise to indemnify, granting to Northwestern a first security interest/mortgage in the Pipeline; and (6) Reserve's undertaking to use the $6,845,000 loan proceeds to pay Equilease the remaining monies due on the Limited Partners Promissory Notes (less a discount), reimburse Northwestern for the payment it had made to Equilease on behalf of the Limited Partners, and establishment of a fund of $700,000 to make improvements to the Pipeline.

The December 23 Letter

On December 23, 1986 Northwestern distributed to the Limited Partners a letter explaining the terms and conditions of the restructuring (the "Letter"). Counsel for Northwestern reviewed and commented on drafts of the Letter, which Alberts signed.

The Letter contained the following statements: (1) that the purpose of the Restructuring was to obtain an additional $700,000 with which to complete and improve the Pipeline, thereby enabling the Pipeline to generate sufficient funds to amortize the 1987 Loan; (2) that, upon a vote in favor of the Restructuring by a majority of the Limited Partners, all of the Limited Partners would be required to participate in the Restructuring on essentially the same terms, in proportion to their initial percentage investment in the Partnership; (3) that the Limited Partners would receive 10,000 shares of Reserve stock, and a note from Reserve for $50,000 payable pari passu with reductions in the $6,845,000 indebtedness from the 1987 Loan, with such payment anticipated to occur during 1987; (4) that Equilease would discount the Equilease Loan at a maximum of $500,000; (5) that the expenses and costs of the Restructuring would not exceed $225,000; (6) that the Pipeline and other assets transferred to Reserve pursuant to the Restructuring would stand as the primary security for the Cosgrove Defendants' obligations under the Assumption Agreements, and that the liability of the Cosgrove Defendants would stand as a reserve fund in case of the insufficiency of the assets to indemnify fully Northwestern in the event that it would have to make payment pursuant to the 1987 Bond.

In its description of the Restructuring, the Letter allegedly omitted the following information: (1) that Reserve and Development would execute an indemnity agreement in favor of Northwestern; (2) that Reserve and Development would grant Northwestern a mortgage interest in the Pipeline; (3) that Reserve would incur additional debts over the $6,845,000 borrowing in connection with the Restructuring; (4) that approximately one-third of the Limited Partners would be forgiven their obligations in connection with the 1984 Loan and Bond; and that (5) counsel for Northwestern was simultaneously representing the Partnership.

On February 6, 1987, Reserve issued a comfort letter to the Cosgrove Defendants and other Limited Partners enclosing a copy of its investment banker's letter to Northwestern, which stated that the Equilease discount was $300,000.

The 1987 Closing

At the February 12, 1987 closing (the "1987 Closing"), Reserve executed and delivered to the Merchants Bank its promissory note (the "Reserve Note") in the principal amount of $6,845,000 plus interest, and a Pledge and Security Agreement both in favor of the Bank. Esrine procured Merchants Bank as a lender in the Restructuring. Pursuant to the terms of the Reserve Note, the $6,845,000 principal was to be repaid as follows: $2,280,000 on December 31, 1987; $2,280,000 on December 31, 1988; $2,285,000 on December 31, 1989. In addition, quarterly interest payments were to be due on the first day of March, June, September, and December in each of those years. The Reserve Note was secured by the Assumption Agreements executed by the Limited Partners, which were in turn secured by Northwestern's Bond delivered to the Merchant Bank.

To induce Northwestern to issue the Bond on their behalf, each of the Limited Partners executed an "Agreement with Surety" in favor of Northwestern. Pursuant to the "Agreement with Surety" among other things, the Limited Partners/principals requested Northwestern to issue a new bond on their behalf, and agreed to indemnify Northwestern in the event Northwestern suffered a loss by reason of its issuance of such a bond.

As a further inducement to Northwestern to issue the bond, Reserve and Development each executed an indemnity agreement dated February 12, 1987 (the "Indemnity Agreement") in favor of Northwestern pursuant to which, in effect, they both agreed to indemnify and hold harmless from all loss, cost and expense that Northwestern may incur as a result of issuing its bond on behalf of the makers of the Assumption Agreements. As security to Northwestern for their obligation under the indemnity agreement, Reserve and development also executed a "Mortgage, Assignment, Security Agreement and Financing Statement" (the "mortgage") pursuant to which Reserve and Development granted to Northwestern a first mortgage/security interest in the Pipeline.

On February 11, 1987, $247,000.84 was transferred from the E.F. Hutton account of Southern Completion Fund ("Completion"), a limited partnership of which Development is a general partner, Account No. A-12-13425-1, to the E.F. Hutton account of Southern Pipeline, Inc. On February 13, 1987, Reserve opened a new bank account at United Jersey Bank, Account No. 1800-142-4, with an opening balance of $698,603.88.

The $698,603.88 represented the sum of the following three checks: (1) a Merchants Bank check for $403,603.88 payable to Reserve; (2) a Chemical Bank check for $250,000 payable to Esrine and endorsed to Reserve; and (3) a $45,000 check from Idiico, a corporation controlled by ...


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