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LUND v. CHEMICAL BANK

June 23, 1992

RUSSELL T. LUND, JR., LUND'S INC. and WARDWELL M. MONTGOMERY, Plaintiffs,
v.
CHEMICAL BANK, Defendant. CHEMICAL BANK, Third-Party Plaintiff, v. LAIDLAW ADAMS & PECK, INC., Third-Party Defendant.


Sweet


The opinion of the court was delivered by: ROBERT W. SWEET

Sweet, D.J.

 Plaintiffs Russell T. Lund, Jr. ("Lund") and Wardwell M. Montgomery ("Montgomery") seek in this diversity action to recover from defendant Chemical Bank ("Chemical") for the amounts of two checks dated March 9, 1981, drawn on Chemical (the "Checks"). The Checks, one in the amount of $ 716,946 and the other for $ 46,056, were fraudulently negotiated by William T. Rubin ("Rubin"). As set forth in the following findings of fact and conclusions of law, because Lund and Montgomery failed to mitigated their damages and because they are equitably estopped, their complaints will be dismissed, and judgment entered in favor of Chemical.

 Prior Proceedings

 Lund, Lunds Inc., and Montgomery initiated this action in 1984 against Chemical. Chemical in turn brought a third-party action against Laidlaw Adams & Peck ("Laidlaw"), a securities firm which had deposited the fraudulently endorsed checks and which was later dissolved.

 This action has achieved an impressive procedural history since then. In an opinion dated June 16, 1987, this Court held that, among other things, the absence of actual delivery of the Checks would not bar the Plaintiffs from recovery. See Lund v. Chemical Bank, 665 F. Supp. 218, 226 (S.D.N.Y. 1987) ["Lund I "], on recons., 675 F. Supp. 815 (S.D.N.Y. 1987) ["Lund II "]. On March 16, 1989, the Second Circuit affirmed this part of Lund I while reversing and remanding to determine whether Rubin's acts were authorized, the facts relating to Chemical's defense under N.Y. U.C.C. Law § 3-406, and the applicability of N.Y. U.C.C. Law § 3-419(2) to co-endorsee. See Lund's Inc. v. Chemical Bank, 870 F.2d 840, 851-53 (2d Cir. 1989) ["Lund III "].

 After remand from the Second Circuit, summary judgment was granted to Chemical against Lund's Inc. on the basis of the then-recent New York State court decision in State v. Barclays Bank of New York, N.A., 151 A.D.2d 19, 546 N.Y.S.2d 479 (App. Div. 1989) ("Barclays I "). See Lund v. Chemical Bank, 1990 U.S. Dist. LEXIS 1679 (1990) ["Lund IV "]. Barclays I was the first fully reported decision of an intermediate New York appellate court on the delivery issue. In it, the Third Department took note of Lund III and expressed its disagreement with the Second Circuit's analysis. See 546 N.Y.S.2d at 481.

 Lund's Inc. moved to reconsider Lund IV in light of the New York Court of Appeals having granted review of Barclays I. This motion was granted by endorsement on May 4, 1990, "pending the determination of the Barclays Bank case in the Court of Appeals". That court affirmed Barclays I on October 18, 1990, See State v. Barclays Bank of New York, N.A., 76 N.Y.2d 533, 561 N.Y.S.2d 697, 563 N.E.2d 11 (1990) ["Barclays II "], and Chemical moved for entry of judgment. Chemical's motion was granted in an opinion dated March 27, 1991, which found that the check in question had not been constructively delivered to Lund's Inc. See Lund v. Chemical Bank, 760 F. Supp. 51, 55 (S.D.N.Y. 1991) [" Lund V "]. Judgment was entered dismissing the complaint of Lund's Inc. on April 5, 1991.

 Discovery meanwhile proceeded on the remaining claims, and a bench trial was held from March 2-4, 1992. Final submissions were completed on April 13, 1992.

 Findings of Fact

 The Background of FTC and the Relationship of the Parties

 Lund, Montgomery, and four former military pilots found Flight Training Center ("FTC") in 1968 as a flight school and aircraft rental business. Lund had no day-to-day management role, but did invest money in the corporation and flew its aircraft. Montgomery served as FTC's president but was never particularly active in the company's affairs. By 1975, all of the original owners had left except Lund and Montgomery.

 FTC hired Janet Karki ("Karki") as a bookkeeper in 1976. She told the others in the company that many of FTC's financial problems stemmed from an unfavorable airplane lease with William Rubin ("Rubin"). When FTC tried to renegotiate this lease,Rubin offered instead to participate in an effort to make the company profitable.

 Rubin told Lund and Montgomery that he had made other troubled companies profitable, and that he had a background in aviation and was already operating an air taxi service. Rubin was hired as a consultant in 1977. He soon controlled expenses, advertised, and increased FTC's customer base. As a result, FTC started making money on the formerly unprofitable lease from Rubin. At Rubin's suggestion, FTC also leased a Learjet to offer training to pilots who had GI Bill benefits. The Learjet became a major profit center for FTC.

 In 1978 Montgomery resigned as an officer of FTC. Rubin became president, a director, and chairman of the board.

 When the lease for the first Learjet was about to expire, Rubin proposed that, rather than renewing the lease, Lund should buy a Learjet and lease it to FTC. After locating a Learjet 25, Rubin and Lund decided both would buy it in a 50/50 joint venture. They rejected a partnership arrangement for tax purposes. *fn1" Lund arranged for the financing, and both Lund and Rubin signed the note. A checking account was established in which to make deposits and write checks to pay for expenses. Rubin's P.O. Box was listed as the address on the account.

 The plane crashed, and two new planes were purchased -- a Learjet 25D and a Learjet 28 -- as well as a used Learjet 24. Separate Joint Venture Agreements were executed by Lund and Rubin for each of these planes. Lund does not remember the documents, including having signed them or any of the surrounding circumstances relating to them.

 The Joint Venture Agreements specified that ownership of the aircraft was vested equally between Lund and Rubin, see P2, and that each was to pay his proper share of the venture's expenses:

 
5. Expenses. Each Joint Venturer shall pay his proper share of the expenses of the joint venture, including legal, accounting, insurance premiums, finance charges, and other expenses directly relating to the aircraft and its operation, to the extent that revenues from the operation of the aircraft are insufficient to pay expenses in full as the same come due.

 Each Joint Venture Agreement also contained the following provisions:

 
3. Purpose of Joint Venture. It is expressly declared to be the purpose of this joint venture to acquire the aircraft at the purchase price and under the terms and conditions set forth in the purchase order hereinabove described, and to lease said aircraft after delivery or resell said aircraft at a profit.
 
. . .
 
8. Control of Venture. It is expressly recognized and agreed that in all of its dealings with third parties in respect to this enterprise, any one of the Joint Venturers may bind the other Joint Venturer individually and the joint venture collectively, as is the case in a general partnership. Accordingly, although it is contemplated that the manager will generally be the Joint Venturer who shall conduct such affairs, the signature of any one of the Joint Venturers shall be sufficient for all business purposes in regard to the enterprise, including but not limited to the signing of checks, the transfer of title to the aircraft, the mortgaging or encumbering the aircraft or any similar matter.

 Montgomery and Karki, who by then was FTC's Executive Vice President and Secretary and a director, also jointly purchased a Cessna P210 in 1979 under a Joint Venture Agreement containing similar provisions.

 Joint bank accounts -- sometimes called the jet accounts -- were used for the airplane transactions. Rubin did not maintain the funds separately for the different airplanes owned by the Lund Joint Ventures. Rubin never paid Lund money from outside the jet accounts, and Lund never received any payments from third parties relating to the aircraft. Specifically, FTC never paid any funds related to the airplanes directly to Lund. Lund had no financial dealings with FTC related to the aircraft other than through the joint accounts.

 Rubin did not make any substantial contributions to the expense account and, as of March 9, 1982, had withdrawn $ 1,093,225 more than he deposited. Lund had contributed $ 1,610,840 more than had been withdrawn from his account.

 The Transactions Giving Rise to the Checks

 To raise capital needed for growth and a new hangar, Rubin proposed in 1979 that FTC issue stock to the public. To achieve this, Rubin hired James McGovern ("McGovern") of McGovern, Opperman & Paquin as FTC's counsel, and made arrangements with an accounting firm and a securities underwriter. Lund and Montgomery, as board members of FTC, approved the subsequent offering despite their lack of prior relevant experience. The closing took place in 1979, and neither one attended. The proceeds of the offering were used by FTC for various purposes.

 Shortly after the initial offering was completed, FTC began to plan a second offering. McGovern again represented FTC, and Laidlaw became the lead underwriter.

 Lund and Rubin determined that they should sell the Learjet 25D and the Learjet 28 to FTC to reduce the Minnesota tax on the planes. On January 11, 1981, they undertook by signed inducement letters to sell the Learjet 25D to FTC for $ 2.4 million and the Learjet 28 for $ 2.5 million upon the completion of the second public stock offering. Montgomery and Karki proposed the sale of their Cessna to FTC for $ 180,000 and executed similar letters.

 A prospectus for 1.0 million shares of FTC was prepared on March 2, 1981, which referred to the proposed sales as well as to Lund's status as an officer, director and shareholder of 341,000 shares (20.12% of FTC stock) and Montgomery's similar status as director and shareholder of 315,000 shares (18.59% of FTC stock). Rubin owned 448,240 shares (26.45% of FTC stock) as of February 27, 1981. The prospectus also stated at page 27 that FTC would purchase the Learjet 25D and the Learjet 28 "from Messrs. Rubin and Lund," and the Cessna P210 from"Mr. Montgomery and Ms. Karki".

 The Closing and Negotiation of the Checks

 At the closing, Laidlaw presented the Checks, which it had prepared and which were drawn on Chemical and were payable to the order of FTC. Karki, as corporate secretary of FTC, endorsed the Checks, making the $ 716,946 check payable to the order of "William Rubin and Russell T. Lund, Jr."; and the $ 46,056 check payable to "Wardwell Montgomery and Janet Karki". Karki's endorsement represented payment for the aircraft sold to FTC.

 McGovern had prepared power of attorney forms purporting to authorize Rubin to endorse the Checks for Lund and Montgomery. The documents were, however, forgeries. On Lund's purported power of attorney form, for example, his forged signature appears twice, once on the proper line and once in the space for the notary's signature. There is no indication of a stamp or seal having been affixed in the place on the form reserved for a "NOTARY STAMP OR SEAL," nor anywhere else on the form.

 McGovern presented the power of attorney forms at the closing and discussed the transfer of the Checks with a representative of Laidlaw. The Checks were then endorsed payable to the order of Laidlaw. Rubin endorsed the $ 716,946 check in his own name and as purported attorney-in-fact for Lund. The $ 46,026 check was endorsed by Karki and by Rubin as purported attorney-in-fact for Montgomery.

 The Checks were given back to Laidlaw. Laidlaw endorsed the Checks and deposited them in its account at Chemical Bank on which the Checks were drawn.

 Chemical's Role

 Chemical's Branch 66, the Wall Street Branch, handled accounts of customers which were brokers, dealers and underwriters, including Laidlaw. The account on which the Checks were drawn and into which they were deposited was maintained at Branch 66. Internal auditors for Branch 66 in audit memoranda done both before and after the date the Checks were deposited stated, "This department adheres to the Metropolitan Bank operational procedures, where applicable." The metropolitan operational procedures manual was a six or seven volume manual (the "Manual") to which the head of the department had access. No other manual existed at that time for Branch 66. The memoranda also stated that, "among the various functions performed by this department are: maintenance of paid check files and a teller's window for deposits made by Wall Street firms".

 In its retail branches, Chemical had a specific policy with respect to double-endorsed checks payable to a corporation that were presented for deposit. A teller referred any such check over $ 500 to a supervisor. The supervisor would then determine whether the check would be accepted for deposit. See Manual § II, P5.4.6.a.(4), (5).

 This policy illustrated Chemical's recognition of the risks of double endorsed checks initially payable to corporations. Such checks often provide an opportunity to circumvent corporate controls that create auditable paper trails, thus facilitating the misdirection of corporate funds.

 Chemical's Tellers Training Manual also iterated that, for business accounts, double endorsed checks cannot be accepted without supervisor approval which would, if necessary, result in an inquiry to the officer responsible for the account. However, Branch 66 tellers were not trained under this manual and received no particularized formal training.

 Chemical did not apply the Manual's procedures on double-endorsed checks to Branch 66 or to the Checks in part because of its relationship with its customers, the size of the transactions, and its reliance upon its knowledge of the customers' accounts. In the event of a forgery, Chemical looked to its depositor customer for indemnity. This was a common practice for other large banks in New York serving underwriter customers.

 The Manual also included specific restrictions on the use of powers-of-attorney. Section I.1.4.1 provided:

 
A power of attorney is a legal document authorizing one to act in certain situations as the attorney or agent of the grantor. The Bank's power of attorney form should be used. If the principal wishes to use a form other than the Bank's, the form must be submitted to the Legal Division for approval. . .

 However, Branch 66 would accept endorsements by a purported power of attorney in general, or on the Checks, again ...


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