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REPUBLIC NATIONAL BANK v. HALES

December 14, 1999

REPUBLIC NATIONAL BANK, PLAINTIFF,
v.
JOHN LESLIE HALES, DEFENDANT.



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

    OPINION

Plaintiff Republic National Bank of New York ("Republic") has moved under Rule 56, Fed.R.Civ.P., for summary judgment for the aggregate amount of $1,930,454.13, in addition to expenses and attorneys' fees, on its claims arising out of a promissory note and equity swap transaction entered into by defendant John Leslie Hales ("Hales") in the summer of 1997. Hales has moved to amend his answer to add various defenses and counterclaims based on Republic's alleged improprieties, as well as to add claims against non-parties Coast Partners Securities, Inc. ("CPS"), Sanjay Lillaney ("Lillaney"), and Richard Milner ("Milner") (collectively the "CPS Defendants"). Hales has also moved to compel responses to his Second Request for the Production of Documents, dated March 24, 1999. Upon the findings and conclusions set forth below, Hales' motion to amend his answer is granted in part and denied in part, and summary judgment is granted in favor of Republic. Hales' motion to compel is denied.

Prior Proceedings

On December 17, 1997, Republic filed its complaint in this action, seeking payment of a July 15, 1997 promissory note, payment of indebtedness incurred by Hales pursuant to a July 15, 1997 "swap" transaction, interest, and an award of all reasonable expenses incurred as a consequence of Hales' failure to meet his financial obligations under the terms of the note and the swap. By an amended complaint dated January 7, 1998, Republic corrected a typographical error in its prayer for relief.*fn1 Hales' answer, filed on February 26, 1998, raised various "separate" defenses asserting Republic's "fiduciary duty to act in good faith and fair dealing," Republic's breach of the implied covenant of good faith and fair dealing, the doctrine of mutual mistake, and Hales' entitlement to a "set-off with respect to the monies wrongfully seized by plaintiff from defendant's bank account."

Discovery proceeded, and voluminous documents were produced. Depositions were taken, and recordings of relevant telephone conversations involving the parties were provided by Republic to Hales. After several extensions, a date certain of April 1, 1999 was set for the close of discovery.

By motion filed on March 4, 1999, Hales moved to amend his answer to raise additional defenses and counterclaims, including "counterclaims" asserted solely against non-parties CPS, Lillaney, and Milner. More specifically, in his proposed amended answer, Hales asserts the following: (1) a "separate defense" and counterclaim against both Republic and the CPS Defendants for "rescission of the transactions based on fraud"; (2) a separate defense and counterclaim against both Republic and the CPS Defendants "based on fraud"; (3) a separate defense and counterclaim against both Republic and the CPS Defendants for "conspiracy to commit fraud"; (4) a counterclaim against the CPS Defendants for breach of fiduciary duty; (5) a separate defense and counterclaim against Republic for "breach of its fiduciary duty to disclose material facts based on its superior knowledge, experience and bargaining power"; (7) a separate defense and counterclaim against both Republic and the CPS Defendants for negligent misrepresentation; (8) a separate defense and counterclaim against both Republic and the CPS Defendants for violation of Section 10(b) of the Securities and Exchange Act of 1934 (the "'34 Act"), and Rule 10b-5 promulgated thereunder; (9) a counterclaim against CPS for violation of Section 20-A of the '34 Act; (10) a separate defense and counterclaim against Republic for "breach of the implied covenant of good faith and fair dealing"; (11) a counterclaim against the CPS Defendants for breach of the implied covenant of good faith and fair dealing; (12) a separate defense and counterclaim against both Republic and the CPS Defendants for violation of Section 349 of New York's General Obligations Law; (13) a defense against Republic for a "set-off against any liability . . . equal to the amount of the monies heretofore seized by Republic from Hales' bank account in Switzerland," as well as the market value of the stock collateral retained by Republic; (14) a defense and counterclaim against Republic for failure to mitigate damages; and (15) a counterclaim against CPS based on its failure to properly supervise Lillaney and Milner. In general terms, the amended complaint claims that CPS and Republic conspired to take advantage of Hales, that the agreements to which Hales put his name were other than what they were represented by Republic to be, and that Republic engaged in behavior — such as short-selling of the stock collateralizing the promissory note — contrary to its assurances to Hales. Despite the fact that filing of an amendment at that juncture in the litigation required prior leave of court, Hales filed his amended answer on March 4.

By motion filed on April 8, 1999, Republic subsequently moved for summary judgment. A comprehensive briefing schedule for both Republic's motion and Hales' motion had been agreed upon by the parties previously, and was subsequently revised by the parties and approved by the Court. By letter application submitted on September 2, 1999, Hales moved to compel the production of various documents pursuant to his Second Request for Production of Documents. Oral argument was heard on September 8, 1999, at which time the motions were marked fully submitted.

The Parties and Relevant Non-Parties

Republic is a national banking association organized under the laws of the United States of America, and maintains its principal place of business in New York, New York.

Hales is a citizen of the United Kingdom.

CPS is a California corporation with its principal place of business in San Francisco, California.

Lillaney is a citizen of the State of California, and resides in San Francisco, California. At all times relevant to the instant action, Lillaney was employed by CPS as Director of its Risk Management Group.

Milner is a citizen of the State of California, and resides in San Francisco, California. At all times relevant to the instant action, Milner was employed by CPS as Managing Director of its Risk Management Group.

Facts

The following are facts concerning which there is no dispute, except where otherwise indicated. These facts have been culled from the parties' Rule 56.1 statement, affidavits, and exhibits.

1. The Background of the Transactions at Issue

In May of 1997, Lillaney of CPS approached Republic's Derivative Products Group, inquiring about Republic's willingness to lend several million dollars to a number of shareholders of The Exploration Company (TXCO) — a corporation publicly traded on the Nasdaq exchange. One of the individual TXCO shareholders subsequently introduced to Republic by Lillaney and CPS was Hales. By a letter agreement dated May 14, 1997 between Hales and CPS, Hales had agreed to retain CPS to provide him with consulting and financial advisory services.

Republic was interested in extending a loan to Hales, but desired a "hedge" against the risk inherent in such a transaction. Hales, however, did not want "short-selling" of the collateral by Republic, its customary hedging strategy, to depress the market price for TXCO. There were discussion in which the parties sought to accommodate their respective desires, in part, by entering into an "equity swap" transaction calling for a payment — by either Hales or Republic — dependant upon the market value of Hales' TXCO stock as of the maturity date of the loan.

On May 16, 1997, after a number of exploratory telephone conversations between Lillaney and Jay Nadelson ("Nadelson") of Republic, Lillaney arranged a three-way telephone conversation among Lillaney, Hales, and Nadelson.*fn2 During that telephone conversation, Nadelson inquired as to whether Hales was an "eligible swap participant" within the meaning of 17 C.F.R. § 35.1(b)(2), and advised Hales that Republic would be seeking a representation that (1) Hales had a net worth of at least $10,000,000, and (2) that any equity swap transaction would be entered into as part of Hales' regular business. In response, Hales stated:

  Well I mean what's the issue. I mean I'm a high net
  worth.
  To give you some idea, Peter Gruner [a fellow TXCO
  shareholder] manages $21 billion. To give you some
  idea of the

  substance of the people you're dealing with.
  I've invested on Wall Street and Tokyo since I was
  18, and I'm 45 now. . . . Options I've had $500
  million foreign exchange positions outstanding. . . .
  I've had loads of equity swaps and option
  transactions.
  I mean I would satisfy [the eligible swap
  participant] criteria easily. . . . I mean, both
  Peter [Gruner] and I have done as much as anybody
  anywhere in the world, I would imagine.

During this conversation, Nadelson also told Hales that "somewhere along the line" Republic would need "some reps and warranties" from Hales, to which Hales replied that his counsel was Shiv Grewal, Esq. ("Grewal") of Jones, Day, Reavis & Pogue ("Jones, Day"). During a later conversation with Lillaney and Nadelson, Hales represented to Nadelson that, "in terms of the derivatives business . . . Peter [Gruner] and [he] have done that for years," and that he knew that business "inside out." On June 4, 1997, Jones, Day issued an opinion letter (the "144 Opinion") concerning the unrestricted nature of the TXCO securities Hales wished to use as collateral for the loan, as well the validity of Republic's contemplated security interest in those securities.

Hales also provided Republic with a written personal profile stating that he "provides management consulting and corporate finance advice on a global basis," that the source of his wealth was "consulting fees from services to corporate clients and capital gains on investments over the last 20 years," and that he had assets of "50 ...


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