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E*Trade Financial Corporation v. Duetsche Bank AG

March 7, 2006

E*TRADE FINANCIAL CORPORATION AND E*TRADE BANK, PLAINTIFFS,
v.
DEUTSCHE BANK AG, DEFENDANT.



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

OPINION

Defendant Deutsche Bank AG ("Defendant" or "Deutsche Bank") has moved pursuant to Rule 12(c), Fed. R. Civ. P., for judgment on the pleadings to dismiss the complaint filed by plaintiffs E*Trade Financial Corporation ("E*Trade Financial") and E*Trade Bank ("E*Trade Bank") (collectively, "Plaintiffs"). The Plaintiffs have moved pursuant to Rule 15(a), Fed. R. Civ. P., for leave to file its first amended complaint ("FAC"). For the reasons set forth below, the motion of Deutsche Bank is denied, and the motion of Plaintiffs is granted.

These sophisticated, well-advised parties have developed a dispute over transactions which occurred in 2002 and 2003 by which E*Trade Bank acquired from Deutsche Bank the common stock of Ganis Credit Corporation ("Ganis") and Deutsche Recreational Asset Funding Corporation ("DRAFCO"), a subsidiary of Ganis. The Plaintiffs claim damages of over $25.3 million, and Deutsche Bank seeks dismissal on the pleadings. An early resolution of the dispute would be welcome, but a more cautious approach is warranted.

The Parties

E*Trade Financial is a Delaware corporation with its principal place of business in New York, New York. (Compl. ¶ 1.)

E*Trade Bank is a federally-chartered savings bank with its principal place of business in Arlington, Virginia. (Id. ¶ 2.) E*Trade Bank is "a second tier, wholly-owned subsidiary of E*Trade Financial." (Id.)

Deutsche Bank is a German corporation with its principal place of business in Frankfurt/Main, Germany. (Id. ¶ 3.)

Prior Proceedings

On January 26, 2005, Plaintiffs filed the complaint asserting claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and unjust enrichment, in which they alleged that Deutsche Bank breached its obligations and representations under a stock purchase agreement ("SPA") between the parties by overstating the value of the deferred tax asset on the closing balance sheet, resulting in an overpayment in the purchase price paid by E*Trade Bank.

Deutsche Bank answered the complaint on April 18, 2005, and then moved for judgment on the pleadings on June 20, 2005. On August 15, 2005, the Plaintiffs moved for leave to file their FAC.

Deutsche Bank requested that the two motions, its motion to dismiss and the Plaintiffs' motion to amend, be heard together, and on September 6, 2005 that request was granted. On November 23, 2005, both motions were heard and marked fully submitted.

Appropriately in this procedural setting, the parties have focused on the FAC, Deutsche Bank renewing its positions urged against the initial complaint and contending that, for those reasons and others, the amendments would be futile.

The FAC

The FAC describes the parties (FAC ¶¶ 1-3), the diversity jurisdiction of the Court (FAC ¶¶ 4-7), the background of the transactions between the parties (FAC ¶¶ 8-12), including a transaction involving the sale of the common stock of Ganis under the SPA (FAC ¶¶ 13-17),*fn1 the sale of DRAFCO, a Nevada corporation (FAC ¶¶ 18-65), the events following the DRAFCO transaction (FAC ¶¶ 66-91), and the damage to E*Trade of over $10 million (FAC ¶¶ 92-94).

The FAC then alleges eleven causes of action arising out of these events. Count I, Fraud (FAC ¶¶ 95-104), Count II, Fraud in the Inducement (FAC ¶¶ 105-113), Count III, Fraudulent Inducement (FAC ¶¶ 114-124), Count IV, Constructive Fraud (FAC ¶¶ 125-135), Count V, Negligent Misrepresentation (FAC ¶¶ 136-145), Count VI, Unjust Enrichment as to the Deferred Tax Asset (FAC ¶¶ 146-150), Count VII, Unjust Enrichment as to the $10 Million Tax Credit (FAC ¶¶ 151-156), Count VIII, Violation of California Unfair Competition Law (FAC ¶¶ 157-164), Count IX, Breach of Contract (FAC ¶¶ 165-170), Count X, Breach of Implied Covenant of Good Faith and Fair Dealing (FAC ¶¶ 171-175) and Count XI, Quantum Meruit (FAC ¶¶ 176-181). These allegations are described in greater detail in the FAC.

E*Trade provides a range of online consumer financial services from securities trading to banking services, mortgages and loans. In 2002, E*trade, to broaden its range of consumer services, sought to acquire Ganis, a wholly-owned subsidiary of Deutsche Bank. Deutsche Bank was auctioning off Ganis, which provided online consumer loans used to purchase recreational vehicles ("RVs") and marine vehicles. (FAC ¶¶ 8-10.)

Ganis consisted of the parent entity, Ganis, and some related affiliates. One of the affiliates was DRAFCO, a wholly-owned subsidiary. DRAFCO holds receivables and securitized interests for consumer loans for RVs, boats and musical equipment. (FAC ¶ 11.)

On November 25, 2002, E*Trade and Deutsche Bank consummated the sale of Ganis to E*Trade through a contract called the SPA. That sale, however, did not transfer Ganis's subsidiary DRAFCO to E*Trade. (FAC ¶¶ 13-14.) Instead, E*Trade and Deutsche Bank agreed that E*Trade could acquire DRAFCO at a later time, if certain conditions precedent were met. One important condition was that the three major ratings agencies (Moody's, Standard & Poor's, and Fitch) would not reduce their ratings of Ganis's notes if E*Trade acquired DRAFCO. Accordingly, the SPA provided that Deutsche Bank would transfer Ganis to E*Trade and DRAFCO to a holding company awaiting satisfaction of the conditions precedent. The sale of Ganis (not including DRAFCO) to E*Trade closed on December 23, 2002. (FAC ¶¶ 17-20.)

While E*Trade conducted its "due diligence" of Ganis's value and assets in January 2003, Deutsche Bank personnel prohibited E*Trade from reviewing materials specific to DRAFCO, on the grounds that the parties did not have an agreement to transfer DRAFCO. On March 18, 2003, before finalizing the purchase price of Ganis, and as required by SPA § 2.06, Deutsche Bank provided E*Trade with a "Closing Balance Sheet" for Ganis (the "Ganis Closing Balance Sheet"). The Ganis Closing Balance Sheet showed Ganis's assets, but did not mention DRAFCO or include any of DRAFCO's assets. (FAC ¶¶ 14-16.)

The last of the approvals of the three ratings agencies came on July 18, 2003.

On July 18, 2003, Deutsche Bank provided E*Trade with a new, different closing balance sheet listing just DRAFCO's value and assets (the "DRAFCO Balance Sheet"). The DRAFCO Balance Sheet showed a total value for DRAFCO of $65.2 million. One of the assets Deutsche Bank listed on the balance sheet was a "Deferred Tax Asset" valued at $15.3 million. (FAC ¶¶ 23-23.)

The Deferred Tax Asset is alleged to be the present value of future tax credits that DRAFCO could obtain as a result of its "booked" revenues being slightly higher from its revenues reported on past tax returns. This occurs when, for example, DRAFCO has revenue losses that it does not report to the IRS in order to carry them forward into future tax periods. Future tax returns for DRAFCO (to be filed by E*Trade) would report these losses, and thus show less taxable revenue than what E*Trade actually would book in those future years, resulting in a net decrease in taxes owed in those future periods. (FAC ¶ 24.)

E*Trade requested information from Deutsche Bank to support the figures contained in the DRAFCO Balance Sheet, including the Deferred Tax Asset. (FAC ¶ 26.) Deutsche Bank provided an audit report from the independent audit firm KPMG, dated July 2, 2003, which concluded that the Deferred Tax Asset was worth $15.3 million. (FAC ¶ 32.)

On August 21, 2003, Dr. Ulrich Gaertner, Deutsche Bank's director, sent E*Trade a computer file breaking down the elements of the Deferred Tax Assets, which comprised the $15.3 million total. (FAC ¶ 33.)

On September 2, 2003, E*Trade personnel discussed the Deferred Tax Asset in a phone call with Deutsche Bank personnel, including Harry Montgomery ("Montgomery"), who managed Deutsche Bank's tax department. Montgomery affirmed the accuracy of the $15.3 million value of the Deferred Tax Asset. (FAC ¶ 35.)

On September 11, 2003, Anthony Ferino ("Ferino"), who worked in Deutsche Bank's tax department, sent E*trade a one-page spreadsheet that also showed various constituent elements of the Deferred Tax Asset, with the net effect of these elements totaling $15.3 million. (FAC ¶ 37.)

Deutsche Bank also agreed that E*Trade could review work papers of Deutsche Bank's outside auditor, KPMG, that supported its audit of the Deferred Tax Asset. Deutsche Bank required an E*Trade representative to travel to KPMG offices in New York where E*Trade could review them but could not copy them or leave with them. On September 15, 2003, E*Trade sent as its representative to KPMG an experienced accountant from the outside audit firm Ernst & Young. KPMG provided this auditor with about two to three inches of paper, which purportedly represented the audit work papers supporting the $15.3 million value for the DRAFCO Deferred Tax Asset. Relying on what he was shown, E*Trade's representative found nothing in these work papers that raised questions about any aspect of the $15.3 million value of DRAFCO's Deferred Tax Asset. (FAC ¶¶ 50-54.)

Based on numerous representations that the Deferred Tax Asset was worth $15.3 million, and having no contrary information to question this figure, E*Trade accepted Deutsche Bank's valuation of the Deferred Tax Asset. E*Trade's due diligence did turn up three other adjustments to the values of other DRAFCO assets. One change affected DRAFCO's booked revenues, and thus this change affected the net value of the Deferred Tax Asset, increasing it by $2.7 million. However, E*Trade had no information to adjust the initial $15.3 million value of the Deferred Tax Asset. (FAC ¶¶ 55-57.)

E*Trade and Deutsche Bank closed the DRAFCO transactions on October 20, 2003. On that date, the parties signed a two-page letter agreement (the "Letter Agreement"), drafted by Deutsche Bank, stating that the E*Trade purchase is made pursuant to Section 2.07 of the SPA. (FAC ¶¶ 58-59.) The Letter Agreement incorporated by reference the meaning of the capitalized terms assigned to those terms in the SPA. The Letter Agreement also listed the "final" sales price of DRAFCO as $59.7 million, which consisted of the value of DRAFCO assets on the DRAFCO Balance Sheet (including the $15.3 million Deferred Tax Asset) plus E*Trade's specific adjustments (including the $2.7 million adjustment to the Deferred Tax Asset). The Letter Agreement attached the specific list of adjustments, stating that the parties "mutually agreed to resolve their differences with respect [to] the [DRAFCO Balance Sheet] by agreeing to make the adjustments set forth on Schedule A hereof . . . for the purposes of adjusting the Purchase Price [of DRAFCO]." (FAC ¶¶ 61-63.)

Nothing in the Letter Agreement addressed or resolved claims unknown to E*Trade at that time. Confirming this fact, upon receiving Deutsche Bank's draft of the Letter Agreement, E*Trade's in-house counsel, Kristopher Simpson ("Simpson"), commented to Peter Rooney ("Rooney"), Deutsche Bank's outside counsel, that the letter did not waive any claims other than those specifically identified. Rooney did not disagree, and at no point did Deutsche Bank ever disagree with Simpson's interpretation of the Letter Agreement. (FAC ¶ 60.)

In November 2003, E*Trade's outside auditor Deloitte & Touche ("Deloitte") began preparing year-end tax papers which, for the first time, included DRAFCO. Deloitte began looking into DRAFCO's tax status and as part of that inquiry Deloitte sought to independently verify the $15.3 million value of the Deferred Tax Asset. (FAC ¶¶ 66-67.)

While the documents about the Deferred Tax Asset that Deutsche Bank had provided to E*Trade before the DRAFCO closing all seemed to separately confirm the $15.3 million value of the Deferred Tax Asset, none of them provided a detailed "build-up" of that value. At Deloitte's request, E*Trade contacted Deutsche Bank again, asking for more backup materials to support the valuation of DRAFCO's Deferred Tax Asset. (FAC ¶¶ 68-69.)

On November 24 and December 8, 2003, E*Trade asked Montgomery and Ferino (who had been involved in the DRAFCO transaction) to provide additional documents. Initially, they merely re-sent the one-page spreadsheet they had previously provided and claimed that this was the only information Deutsche Bank had about the Deferred Tax Agreement. E*Trade escalated the issue to higher levels of Deutsche Bank management, ultimately asking Deutsche Bank's national management to direct their tax department to cooperate. (FAC ¶¶ 69-71.)

On December 12, 2003, Deutsche Bank provided documents E*Trade had never seen before. These documents appeared to be an auditor's work papers analyzing the Deferred Tax Asset. E*Trade found a gross irregularity in the work papers: the $15.3 million contained at least $3.7 million of "cushion," meaning an admittedly unsupported figure not based on any actual revenues or tax documents. This irregularity was not contained in ...


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