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THERMAL IMAGING, INC. v. SANDGRAIN SECURITIES

August 15, 2001

THERMAL IMAGING, INC. AND PAUL D. HOLT D/B/A P.D.H. LTD., PLAINTIFFS,
V.
SANDGRAIN SECURITIES, INC. AND ELLIOT MARCHANT, DEFENDANTS.



The opinion of the court was delivered by: Chin, D.J.

OPINION

In 1995, plaintiff Thermal Imaging, Inc. ("Thermal") decided to seek financing for an affiliated company, Computerized Thermal Imaging, Inc. ("CTI"). After a series of negotiations, Thermal entered into a loan agreement with Keystone Financial, Inc. ("Keystone"), a commercial lender specializing in loans secured by shares of stock. Under the terms of the agreement, Keystone agreed to loan Thermal $1,400,000 and Thermal "pledged" a certain amount of CTI stock as collateral. Thermal obtained the stock from plaintiff Paul Holt, a stock certificate was issued in Keystone's name, and the CTI shares (the "Pledged Shares") were deposited into Keystone's account at defendant Sandgrain Securities ("Sandgrain").

Keystone did not, however, fund the loan as required by the loan agreement. When pressed by Thermal representatives, Keystone made several small disbursements, but did not provide the full amount. Thermal became increasingly suspicious that Keystone was wrongfully selling the Pledged Shares, and eventually discovered that Keystone had sold more than 600,000 of the Pledged Shares that had been deposited in Keystone's account at Sandgrain.

Plaintiffs sued Keystone. Although they were successful in the lawsuit, they were unable to recover the Pledged Shares because Keystone apparently became insolvent. Plaintiffs thereafter brought the instant diversity action against Sandgrain and Eliot Marchant, the individual broker on the account, alleging breach of fiduciary duty, "assumed agency," fraud, and breach of implied contract. Defendants move for summary judgment dismissing all claims, arguing, inter alia, that they owed no duty to plaintiffs with respect to the Pledged Shares.

Upon review of the evidence presented by the parties, I conclude that no reasonable jury could find defendants Sandgrain and Marchant liable for the improper sales of the Pledged Shares. If plaintiffs' allegations are true, then they were indeed harmed — but not by Sandgrain. Sandgrain had no duty, contractual or otherwise, to Thermal. It was not legally obligated to inform Thermal that sales of the Pledged Shares were taking place. In fact, it had an obligation to follow Keystone's instructions and complete whatever sales Keystone instructed it to make. plaintiffs' recourse is against Keystone — not Sandgrain. The fact that Keystone is now apparently insolvent, while unfortunate, does not shift liability to Sandgrain.

For the reasons that follow, defendants' motion for summary judgment is granted and the complaint is dismissed.

BACKGROUND

A. Keystone and its Predecessor

Keystone was incorporated in 1992, and became active in March 1995, when it acquired certain assets of First Financial, a company that specialized in funding stock-secured loans. (Deposition of Edwin D. Wood, II ("Wood Dep.") at 12, 64-65, 202; Deposition of Jacqueline Johnson ("Johnson Dep.") at 97-98). At the time, Keystone was owned by Edwin Wood, an individual serving time in federal prison for securities fraud who had served as "advisor" to First Financial. (Wood Dep. at 10, 13-15, 20-23, 27-28). Jacqueline Johnson, a sometime attorney for First Financial, became the company's president. (Wood Dep. at 22-23, 79; Johnson Dep. at 14). Like First Financial, Keystone made loans to individuals and businesses that were to be secured by shares of stock pledged as collateral. (Wood Dep. at 81-83; Johnson Dep. at 15). Despite his incarceration, Wood maintained regular contact with Johnson, who was supposed to receive instruction from him with respect to each loan. (Wood Dep. at 81).

In March 1995, Keystone opened an account at Sandgrain (the "Keystone Account"), into which First Financial transferred certain securities.*fn1 (Deposition of Paul Chinchar ("Chinchar Dep.") at 20-21, 25; Affidavit of Paul Chinchar ("Chinchar Aff.") ¶ 15). Johnson, Wood, and Janetta Hatfield, a Keystone employee who serviced the individual loans, retained authority over the Keystone Account.*fn2 (Chinchar Dep. at 24; Deposition of Eliot Marchant ("Marchant Dep.") at 47). The account was "non-discretionary," which meant that trades could only be made at Keystone's direction: in other words, Marchant, the broker on the account, could not sell stock without Keystone's authorization or refuse to comply with Keystone's order to sell. (Marchant Dep. at 103-04; Chinchar Aff. ¶ 15). Pursuant to Sandgrain policy, Marchant was also prohibited from sharing information about a client's account with anyone other than the client.*fn3 (Id. ¶ 19).

Despite his involvement with First Financial's and Keystone's accounts, Marchant claims that he never inquired as to the specifics of Keystone's business and thus did not realize the precise nature of Keystone's business (other than the fact that it "ma[de] loans"). Marchant further claims that he did not know that Keystone typically secured its loans with shares of stock. (Marchant Dep. at 44). Chinchar, on the other hand, understood, based on Marchant's representations, that Keystone, like First Financial, loaned money in exchange for securities. (Chinchar Dep. at 33-34). He was not told, however, until Thermal's complaints that the securities were pledged as collateral or restricted in any way. (Id. at 34-37).

B. The Thermal/Keystone Loan

Thermal, an Oregon corporation, develops and sells medical diagnostic devices used to detect cancer and other physiological disorders. (Affidavit of David B. Johnston ("Johnston Dep.") at 14-15). In 1988, Thermal transferred its diagnostic technology to CTI, a publicly traded company; Thermal eventually became CTI's largest shareholder. (Id. at 18-20, 25-26).

Thermal, through its president, David Johnston, decided to seek financing for CTI in early 1995.*fn4 To do so, it enlisted the services of Jim Forbes, a consultant to CTI who in turn sought help from another broker named Mike Heitz. (Johnston Dep. at 31-33, 38; Deposition of James R. Forbes ("Forbes Dep.") at 35-36, 39; Deposition of Michael E. Heitz ("Heitz Dep.") at 24). Through the efforts of Heitz, Thermal was put in contact with Keystone. (Forbes Dep. at 35-36; Heitz Dep. at 25).

Heitz first learned of Keystone through an ad in Barron's magazine and thereafter contacted the company about its stock loan program. (Id. at 26). In response to Heitz's inquiry, Jacqueline Johnson, the President of Keystone, proposed a loan transaction secured by shares of stock. (Id. at 26). Under the plan described by Johnson, Keystone would make a loan based on a percentage of a certain stock's market value, Thermal would pledge free-trading shares of that stock as collateral, and the shares — which were not to be sold unless Thermal defaulted on the loan — would be deposited in a brokerage account for safekeeping. (Id. at 36, 178-79; Johnston-Dep. at 46).

Thermal expressed interest, and in May 1995, began negotiating with Keystone for a $1,400,000 loan to be secured with free trading shares of CTI stock. (Heitz Dep. at 37-39; Johnston Dep. at 44-46). On July 19, 1995, representatives from Thermal and CTI met with Johnson to finalize the details. (Johnston Dep. at 41-43, 103). At the meeting, Johnston indicated his concern that the shares be held in a reputable brokerage, and eventually agreed to deposit the shares with A.G. Edwards, a brokerage he recognized as credible. (Heitz Dep. at 66-67; Johnston Dep. at 139-140). The parties then executed a series of documents, including a security and pledge agreement and a promissory note, setting forth the terms of the loan. (Declaration of Robert A. Giacovas ("Giacovas Decl."), Exs. D-E; Johnston Dep. at 41-43). By the terms of these documents, Thermal acknowledged receipt of $1,400,000 from Keystone and granted Keystone a security interest in 2,000,000 unrestricted shares of CTI.*fn5 (Giacovas Decl., Ex. D at 1, Ex. E at 1). At the time the documents were signed, Johnson specifically assured Johnston that the Pledged Shares would only be used as collateral and would not be sold. (Johnston Dep. at 107).

Because Thermal's own shares in CTI were restricted, Johnston arranged for Thermal to borrow 2,000,000 shares of unrestricted stock from plaintiff Paul Holt, a former consultant to Thermal.*fn6 (Johnston Dep. at 47, 58-59, 64-65; Deposition of Paul D. Holt ("Holt Dep.") at 14-16, 33-35). As Keystone had required, a stock certificate for the 2,000,000 shares was issued in Keystone's name. (Giacovas Decl., Ex. K; Johnston Dep. at 83; Johnson Dep. at 33-35). The certificate did not indicate ...


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