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FIRST NATIONWIDE BANK v. GELT FUNDING

April 9, 1993

FIRST NATIONWIDE BANK, A FEDERAL SAVINGS BANK, a federal stock association, Plaintiff,
v.
GELT FUNDING, CORP., et al., Defendants.



The opinion of the court was delivered by: MICHAEL B. MUKASEY

 MICHAEL B. MUKASEY, U.S.D.J.

 Plaintiff First Nationwide Bank sues defendants Gelt Funding, Corp., et al., under RICO, 18 U.S.C. § 1962, and state law. Plaintiff alleges that defendants fraudulently misrepresented the value of commercial properties and induced it to make non-recourse loans secured by those properties. In a previous opinion, familiarity with which is assumed, this Court granted defendants' motion to dismiss plaintiff's complaint for failure to state a claim upon which relief can be granted, pursuant to Fed. R. Civ. P. 12(b)(6), subject to plaintiff's opportunity to replead. That opinion set forth the requirements for pleading RICO injury and proximate causation.

 On December 23, 1992 plaintiff submitted a 174-page amended complaint with appendices (the "Amended Complaint"), alleging injury from "loans in amounts substantially greater than it would have made had it known the true value of the properties securing the loans and/or the borrowers' ability to service the loan debt," (Am. Compl. P 10a) and from the adverse effects of loss reserves plaintiff took against those loans. (Am. Compl. P 10b). Now defendants move to dismiss the Amended Complaint as well.

 I.

 Plaintiff's original claims are set forth fully in First Nationwide Bank v. Gelt Funding, Inc., No. 92 Civ. 0790, 1992 U.S. Dist. LEXIS 18278 (S.D.N.Y. Nov. 30, 1992) (the "Opinion and Order"). That opinion held that plaintiff could not state RICO-claims simply by alleging that defendants had induced plaintiff to lend money by falsely representing rental incomes and by concealing so-called "flip" transactions with other parties. Opinion and Order at 2, 4. More specifically, this Court held that plaintiff failed to plead adequately (1) "injury to business or property," and (2) proximate or loss causation. Opinion and Order at 4; see 18 U.S.C. § 1964(c); Holmes v. Sec. Investor Protection Corp., 117 L. Ed. 2d 532, 112 S. Ct. 1311, 1317 (1992); Hecht v. Commerce Clearing House, Inc., 897 F.2d 21, 23-24 (2d Cir. 1990).

 Plaintiff's Amended Complaint alleges two RICO violations (Am. Compl. PP 112-162) and state common law claims of fraud, conspiracy to defraud, negligent misrepresentation, conversion, conspiracy to convert, unjust enrichment, and breach of fiduciary duty. (Am. Compl. PP 163-172) Plaintiff's first RICO claim is against only defendants Gelt Funding Corp., Allen I. Gross, and Ralph Herzka. (the "Gelt Defendants") Defendant Gelt Funding was the mortgage broker for the loans in the Amended Complaint. (Am. Compl. P 21) Defendant Gross was president of Gelt Funding and its principal shareholder. ( Id. P 22) Defendant Herzka was an officer and employee of Gelt Funding. (Id.) Plaintiff's second RICO claim is against all defendants including the Gelt Defendants and several defendant borrowers. (Am. Compl. PP 24-59)

 In the Amended Complaint, plaintiff seeks to fill the gaps in its RICO claims by pleading two additional kinds of injury. First, plaintiff claims that it

 
made loans in amounts substantially greater than it would have made if it had known the true value of the properties securing the loans and/or the borrowers' ability to service the loan debt, resulting in losses [which] were not the proximate result of any general decline in the New York real estate market.

 (Am. Compl. P 10a) For each of the 30 loans described in the Amended Complaint, plaintiff estimates the actual value of the loan property in order to determine, based on certain lending criteria, what it would have loaned against that property value and what it would have lost had it made such a loan. (Am. Compl. P 70(1)-(3)) Then plaintiff compares that hypothetical loss with its actual losses to determine what portion of its injury is attributable to defendants' fraud. (Am. Compl. P 70(4)) Plaintiff alleges that defendants overstated the gross income of properties on average by 31%, and that consequently plaintiff loaned at least 64% more than it would have loaned had it known the truth. (Am. Compl. P 69) Thus, plaintiff alleges injury from these additional amounts of loans to defendants.

 Second, plaintiff claims that its

 
ability to lend money to others has been adversely affected by the fact that [it] has been required to place in reserve amounts roughly equal to the outstanding principal balance of the defaulted Gelt loans less the estimated current value of the properties securing those loans . . . .

 (Am. Compl. P 10b) To support this claim, plaintiff estimates the reserves against loan losses it would have taken had it made loans based on truthful information, and compares the annual loss it would have incurred as a result of divesting assets and liabilities to take those reserves, with the actual loss it incurred from reserves it took against loans that were based on allegedly false information. (Am. Compl. 70(5)-(8)) Thus, plaintiff alleges injury from the consequences of the additional sums loaned to defendants.

 It appears from the papers that the illustrative example in the previous opinion, see Opinion and Order at 11-12, helped the parties to focus on certain issues. Therefore, as a preliminary matter, it may be useful to extend that example based on the additional allegations in the Amended Complaint, as follows: Suppose that Bank lends $ 100 to Borrower based on Borrower's misrepresentations. The loan is secured by a mortgage on Borrower's property. Following a local real estate market collapse, Borrower's property declines in value. Borrower defaults on the loan, and Bank sues, alleging RICO violations. Bank demonstrates that had it known the truth about the matters Borrower misrepresented, Bank would have loaned only $ 50. Because Bank would have loaned $ 50 to Borrower even if it had known the truth, Bank's claim as to the first $ 50 would be dismissed -- for the same reasons plaintiff's claims were dismissed in the previous opinion. However, Bank claims that its injury arises also from (1) the additional $ 50 which it loaned, and (2) the lost profits from taking additional required reserves. These additional claims relate only to injury from additional amounts loaned, not from the decision to lend in the first place. The holding in this opinion, in terms of this hypothetical example, ...


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