The opinion of the court was delivered by: ROBERT J. WARD
On April 23, 1993, this Court issued an opinion granting in part and denying in part defendant Maryland National Bank's ("MNB") motion for summary judgment against plaintiff Banque Arabe et Internationale d'Investissement ("Banque Arabe"). 819 F. Supp. 1282 (S.D.N.Y. 1993) ("Banque Arabe I"). As a result of that decision, only claims for breach of contract and fraudulent inducement remained for trial.
Following discovery, however, plaintiff abandoned the breach of contract claim and sought only damages for rescission under the fraud claim.
Plaintiff alleges that defendant fraudulently induced BAII Banking Corp. ("BAII"), a former subsidiary of Banque Arabe, into purchasing a participation interest in a real estate loan by failing to disclose material information and by making material misrepresentations prior to execution of a participation agreement. MNB denies the allegations of fraud and counters that plaintiff is procedurally barred from bringing a fraud claim. In particular, MNB argues that Banque Arabe is not the real party in interest and, therefore, lacks standing. It also asserts that plaintiff ratified the participation agreement by failing to assert the fraud claim in a timely fashion and by accepting benefits under the agreement after being put on notice of facts sufficient to inquire about the fraud.
The Court conducted a bench trial on November 3-10, 1993. Upon a review of the evidence and testimony offered at trial, the parties' pre and post-trial submissions and the applicable law, the Court issues this opinion, which constitutes its findings of fact and conclusions of law, pursuant to Rule 52, Fed. R. Civ. P. For the following reasons, the Court finds that Banque Arabe lacks standing to assert a fraud claim in this action but that it raised its rescission claim in a timely fashion and it did not ratify the participation agreement. The Court also finds that Banque Arabe has failed to prove intent to defraud on the part of MNB by clear and convincing evidence.
The factual background of this case has already been recited in Banque Arabe I, with which familiarity is presumed. However, Banque Arabe I was based on stipulated facts submitted exclusively for the purposes of the summary judgment motion. Subsequent to discovery, the parties revised the stipulated facts and submitted the newer version together with their pre-trial order. Therefore, the Court deems it necessary to restate those facts pertinent to the issues raised at trial.
A. The Marceca Loans and the Participation Agreement
The loan at issue was a mortgage loan arranged by MNB's merchant banking affiliate, MNC International Bank ("MNCIB"), in June 1988 for real estate developer Robert K. Marceca ("Marceca") and partnerships owned or controlled by him (the "Marceca borrowers"). Referred to as the Marceca II loan, it was divided into two portions with the first having an original principal amount of $ 35 million and the second an original principal amount of $ 12.5 million. The loan's purpose was to provide the Marceca borrowers with the funds necessary to refinance, renovate and convert to condominium or cooperative use eight rent-controlled or rent-stabilized apartment buildings in Manhattan. Marceca personally guaranteed payment of principal and interest on the first mortgage component but only payment of interest on the second mortgage component. Before the Marceca II loan was made, the gross retail sellout value of the properties collateralizing the loan after conversion to cooperative ownership was estimated at $ 59,345,000 (the "appraisal"). The appraisal was based upon various factual assumptions, including that one hundred percent of the units would be sold at "outsider" prices.
Toward the end of May 1988, MNCIB officials had contacted prospective participants, including BAII, and requested commitments by mid-June.
Almost immediately, BAII engaged in arm's length negotiations with MNCIB and BAII vice president Maurice Nhan ("Nhan") drafted a credit analysis of the Marceca II loan, based on documents supplied to it by MNCIB officials. Included in these documents were schedules of projected principal prepayments which had been prepared by the Marceca II borrowers in June 1988 (the "June projections" or the "paydown schedules"). The Marceca borrowers advised MNB that they expected to make the projected prepayments from the conversion proceeds. The June projections were based on a number of assumptions, including, inter alia, that (a) the first projected repayment allocable to each building would be made at the time of the closing of the building to cooperative ownership, and (b) the closing of the conversion of each building would occur ninety days after an offering plan for the conversion of the building was accepted for filing by the New York State Department of Law (the "AG" or the "Department of Law"). In June 1988, BAII recognized that the paydown schedules were projected prepayments of the Marceca II loan, but they also understood the projections to be realistic.
In addition, to its documentary analysis of the Marceca II loan, BAII conducted a due diligence investigation. Nhan, in particular, met with Marceca at the developer's office and inquired about the eight properties collateralizing the Marceca II loan. Although an MNCIB official was present for the first ten to fifteen minutes, the balance of the hour-long meeting was a "broad conversation" between Nhan and Marceca. Nhan Dep. at 76-77. While they discussed the real estate market in New York, the Marceca properties and Marceca's experience, Nhan did not make specific inquiry regarding renovations at any of the buildings nor did he review with Marceca any of the documents he had received from MNB. Nhan also spoke with others in the real estate business in order to familiarize himself with the cooperative and condominium conversion process in general.
Based upon its credit analysis and due diligence investigation, BAII decided to purchase a $ 10 million participation interest in the Marceca II loan. BAII indicated in a letter dated July 13, 1988 that it was committed to participating in the loan (the "Commitment Letter"). As a condition to its purchase of the participation interest, BAII required that the Marceca II loan be "cross collateralized," such that a portion of the proceeds from sales of units in each of the Marceca II properties be applied to pay down portions of the loan allocable to the other properties. It took approximately six weeks for MNB to obtain the Marceca borrowers' agreement to this condition. On September 29, 1988, BAII executed a participation agreement with MNB, which became effective on October 3, 1988, when the participant paid $ 10 million to the lead bank and, in return, received a fee of $ 200,000 (the "Participation Agreement"). In the Participation Agreement, BAII warranted that its participation was based on independent investigation and not as the result of documents and information supplied by the lead bank.
B. The Co-Sponsorship Issue
Conversion of the Marceca properties, in fact, was delayed, because the Department of Law raised questions concerning the sponsorship of the Marceca loans as disclosed in some of the offering documents (the "co-sponsorship issue"). In particular, MNB had not been identified as a co-sponsor, even though it had a right under the Marceca mortgages to approve the terms of the offering plans.
The co-sponsorship issue was raised prior to the execution of the Participation Agreement but subsequent to the issuance of the Commitment Letter. On August 9, 1988, the Department of Law notified Marceca of sponsorship problems in the offering plans for some of the properties and indicated that it was referring the matter to the Enforcement Division. Marceca informed MNCIB officials of the co-sponsorship issue in mid-August 1988. On August 18, R.B. Diffenderfer ("Diffenderfer"), one of the MNCIB officials administering the Marceca loans, signed a letter for submission to the Department of Law explaining that MNB was a lender and not actively involved with the conversion of the Marceca properties (the "to whom it may concern letter"). Subsequently, Diffenderfer followed the status of the co-sponsorship issue through correspondence both in writing and on the telephone with Marceca's attorney, Myron Beldock ("Beldock"). In mid-September 1988, Beldock informed Diffenderfer during a telephone call that the AG would be considering the co-sponsorship issue at a hearing scheduled for September 22 but that he expected imminent resolution. Diffenderfer memorialized this conversation in a memorandum he drafted for the Marceca file ("the September 12 memo"). In the memo, Diffenderfer related that Beldock had minimized the significance of the co-sponsorship issue.
Between July 13 and October 3, 1988, BAII did not request information regarding the status of the proposed conversions from Marceca and the Marceca borrowers because it viewed such a request as inappropriate banking practice. BAII also refrained from seeking information from the Department of Law. While it could not have discovered the existence of the co-sponsorship issue from the Department of Law, BAII could have learned about the status of the offering plans for the Marceca I and Marceca II properties. Had BAII asked the Department of Law about the status of the offering plans, the Department of Law (a) would have advised BAII whether red herrings had been submitted and for which buildings; (b) advised BAII whether red herrings submitted to the Department of Law had been accepted or rejected; and (c) made available for review and copying by BAII the red herrings submitted by the Marceca borrowers, any revised versions thereof, any supporting documentation submitted by the Marceca borrowers to the Department of Law, and any deficiency letters and other correspondence between the borrowers or their counsel and the Department of Law concerning any plans that had been rejected.
Prior to funding its participation interest, BAII had not been advised of the co-sponsorship issue by MNB. On November 10, 1988, Cynthia Buescher [Allner] ("Allner"), another MNCIB official assigned to the Marceca loans, sent a revised repayment schedule to Nhan. She indicated that payments would not begin until March 1989 instead of November 1988 because the Department of Law had failed to complete its review of one of the red herrings within the statutorily required period of six months. On January 19, 1989, Allner wrote Nhan again, disclosed the existence of the co-sponsorship issue, and explained that the co-sponsorship problem had been resolved by a modification made to the mortgage documents (the "January 19 letter"). The modification removed Section 2.17, which had granted MNB the right to approve the terms of the offering plans submitted by the Marceca borrowers. Between January and November 1989, BAII received monthly status reports from MNB. None of these, however, revealed that MNB had knowledge of the co-sponsorship issue prior to execution of the Participation Agreement.
By the end of 1989, as a consequence of the delay caused by the co-sponsorship issue, none of the Marceca properties were converted to cooperative ownership, and the Marceca borrowers were in default on their obligations under the loan documents. The interest reserves had been exhausted and BAII received its last interest payment on December 1, 1989. During December 1989 and January 1990, MNB apprised the participants of Marceca's deteriorating financial status and began considering ways to work out the loan. Simultaneously, BAII vice president, William Waller ("Waller"), conducted a review of the Marceca transaction and requested permission to visit MNB's offices. Waller and an attorney visited BAII's offices at the end of February 1990, where they reviewed the Marceca file and discovered Diffenderfer's September 12 memo.
On March 26, 1990, MNB and Marceca executed a settlement agreement (the "Consensual Foreclosure Agreement"). It provided, among other things, that while the Marceca properties would be surrendered to MNB, the bank would make payments to the Marceca borrowers and would release Marceca from liability on his personal guarantee. MNB eventually made payments to the Marceca borrowers and charged BAII for its pro rata share of these payments. In April 1990, MNB brought an action to foreclose the mortgages securing the Marceca II loan. A Judgment of Foreclosure and Sale was entered in favor of MNB and against the Marceca II borrowers directing that the mortgaged properties be sold to satisfy the mortgage indebtedness plus interest, costs, and disbursements.
In May 1991, the Marceca II properties were sold at a public auction at which MNB was the successful bidder. MNB then entered into an agreement with a real estate investor who purchased the Marceca II properties at the closing of the foreclosure sale in June 1991. The proceeds of this sale totalled $ 11,337,500 in the aggregate, before payment of tax and other liens entitled to priority, and costs. In July 1991, Banque Arabe received $ 1,843,140 from MNB as its share of the net foreclosure sale proceeds. Banque Arabe also received $ 176,697 from MNB as its pro rata share of the net rental income collected from the Marceca II properties during the pendency of the foreclosure action. Marceca filed a petition under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court, Southern District of New York, in August 1990. On May 29, 1991, Banque Arabe filed a claim in Marceca's Chapter 7 case for $ 10,000,000.
In the early part of 1990, Banque Arabe, BAII's French parent company, decided to sell the American subsidiary and dissolve it as an entity.
At that time, Waller conferred with the bank's attorneys and explained that BAII sought to dispose of the vast majority of its assets by transferring them to Banque Arabe. In a memorandum dated April 27, 1990 (the "April 27 memo"), Waller identified the Marceca transaction as one of three real estate loans he would transfer first as part of his overall task of "transferring all loans and letters of credit off the books in New York and onto the books of Banque Arabe in Paris." Defendant's Ex. AA. Waller conferred with BAII's attorneys and directed them to draft an assignment for the purpose of carrying out the instructions referenced in the memorandum. On May 31, 1990, BAII executed an assignment in which it "assigned, transferred, and conveyed . . . all . . . rights, title and interest" in the Participation Agreement and BAII's participation in the Marceca II loan (the "Assignment"). Plaintiff's Ex. 81.
In the middle of 1990, Waller engaged in settlement discussions with MNB. Although the other participants accepted MNB's offer to be bought out at thirty cents on the dollar, Banque Arabe determined that this offer and other settlement offers were unacceptable. On October 4, 1990, in an effort to try and recover its loss on the Marceca II loan, Banque Arabe instituted this action against MNB.
Before addressing the substantive fraud allegations, the Court must first consider whether Banque Arabe is a real party in interest and has standing to assert its claims against MNB. Banque Arabe I noted that, while the Assignment unquestionably transferred contract claims from BAII to Banque Arabe, it was unclear whether tort claims were transferred as well. Because the parties offered differing readings of the Assignment, the Court reserved judgment on the standing question until it received extrinsic evidence at trial concerning whether BAII intended to transfer the fraud claims to Banque Arabe.
MNB has the burden to prove Banque Arabe's lack of standing by a preponderance of the evidence. Brignoli v. Balch, Hardy & Scheinman, Inc., 178 A.D.2d 290, 577 N.Y.S.2d 375 (App. Div. 1991); Hansen v. Cauldwell-Wingate Co., 25 Misc. 2d 857, 201 N.Y.S.2d 827, 831 (Sup. Ct. 1960).
A. New York Law Concerning the Assignment of Fraud Claims
Banque Arabe I explained that in New York, "an assignment of the right to assert contract claims does not automatically carry with it an assignment of the right to assert tort claims relating to the transaction which established the contract. The assignor must also transfer the cause of action for tort claims to the assignee." Banque Arabe I, 819 F. Supp. at 1289 (citing Nearpark Realty Corp. v. City Investing Co., 112 N.Y.S.2d 816 (Sup. Ct. 1952)). The Court qualified, however, that "it is not necessary for an assignment to contain specific 'boilerplate' language in order to transfer a cause of action. 'Any act or words are sufficient which "show an intention of transferring the chose in action to the assignee . . . . "'" Id. (quoting Miller v. Wells Fargo Bank Int'l Corp., 540 F.2d 548 (2d Cir. 1976) (quoting Advance Trading Corp. v. Nydegger & Co., 127 N.Y.S.2d 800, 801 (Sup. Ct. 1953))).
At trial, MNB characterized the explicit assignment of fraud claims as a well-established principle of New York law that dates back to Fox v. Hirschfeld, 157 A.D. 364, 142 N.Y.S. 261 (App. Div. 1913). In Fox, an assignment transferring "all my right, title, and interest in and to the within contract" was held not to cover a claim for fraudulent misrepresentation because "the language employed in the assignment of the contract was not appropriate to assign a cause of action arising, not under the contract, but for the fraudulent representations of the defendant." Id. at 263. As analyzed by later New York case law, Fox stands for the principle that when an assignment of a contract does not explicitly assign a cause of action based upon fraud, "only the plaintiff's assignor may rescind or sue for damages for fraud and deceit; the representations were made to it and it alone had the right to rely upon them." Nearpark Realty Corp. v. City Investing Co., 112 N.Y.S.2d at 117. When the Court questioned defendant's counsel at trial whether there was any more recent precedent for this principle, he cited Fund of Funds v. King, No. 74 Civ. 1981, Fed. Sec. L. Rep. (CCH) P95,640 (S.D.N.Y. June 29, 1976) in which an assignment of "any and all interests" was held not to have transferred a fraud claim on account of lack of specificity.
In response, plaintiff's counsel questioned whether this principle is still good law. He asserted that it appeared to have been overruled by N.Y. Gen. Oblig. Law § 13-107, which reads in pertinent part:
Unless expressly reserved in writing, a transfer of any bond shall vest in the transferee all claims or demands of the transferrer [sic], whether or not such claims or demands are known to exist, (a) for damages or rescission against the obligor on such bond . . . .
Id. (emphasis added). Claiming that the statute literally covered the Participation Agreement, plaintiff argued that, the Court would have to find that the Assignment included tort claims and dismiss defendant's affirmative defense of lack of standing.
During the defense's summation, however, defendant's counsel correctly pointed out that the Participation Agreement is not covered by § 13-107 for two reasons. First, because the participation Agreement is not a "bond" as defined by the statute. Section 13-107(2) reads: "As used in this section, 'bond' shall mean and include any and all shares and interests in an issue of bonds, notes, debentures and other evidences of indebtedness . . . ." Second, because under the provision, rescission claims must exist against the obligor, and on the Marceca loan that would be the Marceca borrowers and not MNB.
B. Judge Sofaer's Approach: Freely Assignable Fraud Claims
In a post-trial submission, plaintiff reasserted its statutory argument by referring to Judge Sofaer's decision in ACLI Intern. Commodity Servs., Inc. v. Banque Populaire Suisse, 609 F. Supp. 434 (S.D.N.Y. 1984). According to Judge Sofaer, because "the law has moved away from the limitations on free assignability . . . New York law now permits the assignment of most types of claims, including claims of fraud, and . . . the assignee of a claim should be deemed to have received the right to enforce any claim assigned." Id. at 441-42. As a result, ACLI held that even where § 13-107 could not be relied on as actual authority that any claim can be assigned, it could be used as guiding authority inasmuch as "the statute reflects the legislature's willingness to presume the assignment of all claims in order to enhance felt commercial needs." Id. at 444. On the facts in ACLI, Judge Sofaer reasoned that even though "accounts receivable" were not bonds and even though the defendant bank was not an obligor, the fraud claim could be assignable under § 13-107 because "the statute should be seen to teach by example, rather than to exclude by implication." Id. at 443.
ACLI acknowledged that, while it was reading § 13-107 broadly, the statute was enacted in order to overrule New York case law involving the assignment of bonds and other forms of commercial paper. Judge Sofaer wrote:
Id. (emphasis added) (citations omitted). Indeed, the Historical Note following § 13-107 states clearly that the statute reverses the holdings in Smith v. Continental Bank & Trust Co., 292 N.Y. 275, 54 N.E.2d 823 (1944) (absent express assignment, transferor of corporate bonds retains accrued causes of action for damages against trustee) and Elias v. Clarke, 143 F.2d 640, 644 (2d Cir.) ("under the governing New York law a claim for fraud or misrepresentation in connection with an obligation evidencing a debt, whether for damages or for rescission, does not pass merely with the transfer of the obligation itself, where there are lacking special words of assignment of the claim."), cart. denied, 323 U.S. 778 (1944). See, N.Y. Gen. Oblig. Law § 13-107 Historical Note.
Judge Sofaer rejects the view, however, that § 13-107 is a narrow exception to the general rule that a fraud claim must be explicitly assigned. ACLI maintains that this perceived "long-standing rule" never really existed. Judge Sofaer acknowledges that there are New York cases which cite Fox for the principle "that in the absence of an assignment of a cause of action based upon the fraud, as distinguished from an assignment of the contract . . . the cause of action belongs to the assignor." Nearpark Realty Corp. v. City Investing Co., 112 N.Y.S.2d at 817 (citing Fox v. Hirschfeld, 142 N.Y.S. at 262). Nevertheless, Judge Sofaer declares: "the 'long-standing rule' that ACLI claims was implicitly affirmed by the 'statutory exception' is in fact represented by a mere handful of cases, which fail to establish any such rule." ACLI Intern. Commodity Servs., Inc. v. Banque Populaire Suisse, 609 F. Supp. at 443. According to ACLI, Fox cannot be considered a landmark case because it "was a 3-2 decision based on very special circumstances." Id. Under ALCI's interpretation of Fox, the assignor retained the fraud claim because the assignee was the assignor's wife and she paid nothing to her husband for the house, which was the subject of the contract. Therefore, Judge Sofaer inferred from Fox that:
Had the assignee paid for the contract in an arms-length transaction before discovery of the fraud, the same court would likely have found that the cause of action passed to the assignee, absent evidence of an intention that it be retained by the assignor. In such circumstances the accrued action for fraud would be "essential to a complete and adequate enforcement of the contract, [and therefore] it passes with an assignment of the contract as an incident thereof."
Id. (quoting 6A C.J.S. Assignments, § 77, at 721 (1975)).
Absent a rule requiring explicit assignment of fraud claims, Judge Sofaer suggests that courts rely exclusively on modern contract principles in determining the scope of an assignment. Id. at 442. "The parties to an assignment are now free to agree by contract to virtually any form of assignment, subject to such general limitations as the principle that an assignee can receive no greater rights than the assignor possessed." Id. Freely assignable claims means that a fraud claim is presumptively assignable and is restricted only by "a manifestation of a different intention." Id. at 444.
C. ACLI's Approach Criticized
Based upon principles of comity and federalism, this Court cannot adopt ACLI's refusal to adhere to a principle of New York law. Under the Erie doctrine, federal courts considering an issue of state law are bound to respect a state court judgment concerning that issue. See, Erie Railroad Co. v. Tompkins, 304 U.S. 64, 78-80, 82 L. Ed. 1188, 58 S. Ct. 817 (1938).
Hanna v. Plumer, 380 U.S. 460, 474-75, 14 L. Ed. 2d 8, 85 S. Ct. 1136 (1965) (Harlan, J., concurring) (footnote omitted). Indeed, in a diversity action, a federal district court acts in the role of a state court and is required to uphold the law of the state. "Since a federal court adjudicating a State-created right solely because of the diversity of citizenship of the parties is for that purpose, in effect, only another court of the State, it cannot afford recovery if the right to recover is made unavailable by the State nor can it substantially affect the enforcement of the right as given by the State." Guaranty Trust Co. v. York, 326 U.S. 99, 108-09, 89 L. Ed. ...