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Oneida Savings Bank v. Uni-Ter Underwriting Management Corporation

United States District Court, N.D. New York

September 18, 2014


HISCOCK & BARCLAY, LLP DAVID G. BURCH, JR., ESQ., GABRIEL M. NUGENT, ESQ., KAREN S. SOUTHWICK, ESQ., Syracuse, New York, Attorneys for Plaintiffs.

CARLTON FIELDS, P.A. BRIAN ROSNER, ESQ., NATALIE A. NAPIERALA, ESQ., JUSTAN CALEAF BOUNDS, ESQ., WALTER HOLLOWAY BUSH, ESQ., New York, New York, Attorneys for Defendants Uni-Ter Underwriting Management Corporation, Uni-Ter Claims Services Corporation, U.S. RE Companies, Inc., Jonna Miller, and Richard Davies.

MORRISON & FOERSTER, LLP JAMIE A. LEVITT, ESQ., JAMES J. BEHA, II, ESQ., New York, New York, Attorneys for Defendants Sanford Elsass and Donna Dalton.


MAE A. D'AGOSTINO, District Judge.


On June 25, 2013, Plaintiffs commenced this action alleging claims under the federal securities laws and state common law arising out of Defendants' alleged false representations, which Plaintiffs claim induced them to make additional investments in a now-defunct insurance company. See Dkt. No. 1 ("Complaint"). Presently before the Court are Defendants separate but similar motions to dismiss the Complaint, see Dkt. Nos. 33, 35, and Plaintiffs' cross-motion to amend the Complaint, see Dkt. No. 44. For the reasons stated below, the motions to dismiss are granted in part and denied in part, and the cross-motion to amend is granted.


A. Plaintiffs' Allegations[1]

Plaintiffs Oneida Savings Bank ("Oneida"), Marquis Companies I, Inc. ("Marquis"), Pinnacle Healthcare, Inc. ("Pinnacle"), Rohm Services Corporation ("Rohm"), Heathwood Healthcare Center, Inc. ("Heathwood"), and Eagle Healthcare, Inc. ("Eagle") (collectively, "Plaintiffs"), allege that Defendant Uni-Ter Underwriting Management Corporation ("Uni-Ter"), at the direction of its co-Defendant and parent company U.S. Re Companies, Inc. ("U.S. Re"), fraudulently and unlawfully induced Plaintiffs to invest $2, 200, 000 in convertible debentures in Lewis & Clark LTC Risk Retention Group, Inc. ("Lewis & Clark"). Dkt. No. 44-1, Exh. A ("Proposed Amended Complaint") ¶¶ 1-3.

During the time period at issue here, Defendants Sanford Elsass and Donna Dalton were the President and Chief Executive Officer, and Chief Operating Officer and Chief Financial Officer, respectively, of Uni-Ter. Id. ¶¶ 16-17. Defendant Jonna Miller was the Vice President of Claims at Uni-Ter, and Defendant Richard Davies was the Chief Financial Officer of U.S. Re. Id. ¶¶ 18-19.

Lewis & Clark is an insurance company that provides professional liability insurance to nursing homes, assisted living facilities, and other long-term care ("LTC") facilities through a risk retention group structure. Risk retention group entities are similar to captive insurance companies, except for the following differences: risk retention groups include multiple policyholders, rather than a single policyholder; policyholders must be equity owners in risk retention groups; risk retention groups are limited to providing only liability coverage; and risk retention groups retain liability for small claims risk and reinsure against large losses. Under a risk retention group model, a "shell" insurance company is created, which in turn contracts with third-party organizations to provide management services, underwriting services, claims management services, risk management services, and reinsurance. Id. ¶¶ 24-27.

In 2004, following a series of discussions between an affiliate of Plaintiff Oneida, Bailey & Haskell Associates, Inc., and Defendant Elsass, Oneida agreed to provide capital for the creation of a LTC risk retention group. Thereafter, Uni-Ter formed an entity known as Henry Hudson Risk Retention Group, Inc., whose market for the sale of general and professional liability insurance to LTC facilities was New York State north of Westchester County. At the beginning of 2004, Uni-Ter also formed Lewis & Clark to sell the same products in the states of Washington, Oregon, and Idaho. In early 2005, Henry Hudson and Lewis & Clark merged their operations under Lewis & Clark. At that time, Oneida provided capital to Lewis & Clark in the amount of $1.75 million in the form of a subordinated debenture ("Onieda Debenture"). Each of the Plaintiffs appointed an individual to represent them on Lewis & Clark's Board of Directors. Id. ¶¶ 36-45.

Lewis & Clark, which has no employees of its own, engaged Uni-Ter pursuant to a management agreement to provide all of the insurance company services necessary to run it, including the placement of reinsurance with third parties. Pursuant to the terms of the management agreement, Uni-Ter was to act as a fiduciary of Lewis & Clark and manage its business. In addition, Uni-Ter and its co-Defendant Uni-Ter Claims Services Corporation ("UCSC") were to receive management fees in the form of commissions, claims handling fees, and a profit sharing bonus. In 2010 and 2011, Uni-Ter earned at least $1.5 million and $1.0 million, respectively, in management fees. The management agreement also obligated Uni-Ter and UCSC to provide complete and accurate information regarding the operations of Lewis & Clark to Plaintiffs. Id. ¶¶ 28-32, 46.

Lewis & Clark operated successfully and profitably in each of the four calendar years from 2007-2010. In July 2009, Lewis & Clark, at Uni-Ter's direction, accepted two California-based, multi-site LTC operators as policyholders. This decision was a divergence from the established business model of Lewis & Clark in several respects: it was the first time Lewis & Clark chose to insure a large multi-facility operator; these LTC operators had historical loss records outside Lewis & Clark's typical underwriting range; and one of the contracts contained an unprecedented provision that limited the claims exposure of Lewis & Clark on an aggregate level rather than on a claim-specific level. Id. ¶¶ 48-51.

In the first three quarters of calendar year 2011 ending September 30, 2011, Lewis & Clark experienced a net loss of $3.1 million. The principal reason for this loss, along with increases in claims reserves for other insureds, was that the two new California-based insureds had passed on significant losses to Lewis & Clark in the two policy years from July 2009 to July 2011. Lewis & Clark did not renew coverage for the two new California-based insureds in July 2011. Id. ¶¶ 52, 54.

On or about September 1, 2011, Defendants Elsass and Dalton sent a memorandum to the Lewis & Clark Board of Directors to outline the recent events causing financial difficulties and "Uni-ter's proposed action plan." Included in that action plan memorandum was a representation that Uni-Ter would hire "[a] consultant... to do a complete analysis of the claims process of [UCSC]" and that "[w]e should have his [sic] report to share with the board at the September 21st meeting.["] Prior to the September 21, 2011 Board of Directors meeting, Defendant Dalton transmitted a package of materials to each member of the Board of Directors, which included a report from the consultant retained by Uni-Ter, Praxis Claims Consulting ("Praxis"), dated September 15, 2011. Id. ¶¶ 59, 63.

On or about September 21, 2011, the Lewis & Clark Board of Directors held a meeting in Las Vegas, Nevada. At that meeting, which was attended in person or by phone by each of the Directors representing Plaintiffs, as well as Defendants Elsass, Dalton, Miller, and Davies, Uni-Ter presented the amount of the expected claims and the amount of the significantly increased claims reserves to the Board. Defendant Elsass informed the Board that the revised claims reserves were adequate to cover existing and anticipated claims. At that time, Defendants Elsass and Dalton both represented to the Plaintiffs that the one-time operating loss would not result in a financial disruption of Lewis & Clark and that it retained sufficient capital to support its operations and payment of the Oneida Debenture. A representative of Praxis also presented its September 15, 2011 report and raised no concerns with Lewis & Clark's claims reserves. The Praxis report reviewed the reserve methodology in a sample of nine claim files, and did not find fault with any of those claims or recommend any addition to the loss reserve for any of those claims.

Also during the September 21, 2011 meeting, Defendant Dalton presented the "GAAP Proforma Financial Statement for Period Ending December 31, 2011" that Uni-Ter had prepared for Lewis & Clark. This financial statement did not raise any question as to Lewis & Clark's ability to continue as a going concern and reflected a healthy capital structure, including only the existing claims reserves. During the September 21, 2011 meeting, the Directors (Plaintiffs' representatives) asked Uni-Ter's representatives, Defendants Elsass and Miller, whether there were any claims developments not previously reported. Ms. Miller replied that there were none, and Mr. Elsass agreed - stating that there were none. Mr. Davies of U.S. Re said nothing. Ms. Dalton also remained silent. Ultimately, Defendant Elsass requested that Plaintiffs make additional investments in Lewis & Clark in order to, inter alia, preserve Lewis & Clark's good standing with the Nevada Department of Insurance and an acceptable premium-to-equity ratio. Id. ¶¶ 55-58, 60-66.

Subsequently, on November 7, 2011, the Board of Directors held a telephonic meeting to discuss the requested additional investment, and Defendants Elsass and Dalton again reassured the Plaintiffs, with Mr. Davies and U.S. Re's acquiescence, that this capital infusion would satisfy Lewis & Clark's capital needs and that the claims reserves were adequate. With the assurances from Uni-Ter and U.S. Re at the Board of Directors meetings on September 21, 2011, and November 7, 2011, Plaintiffs committed to invest an aggregate of $2, 200, 000 in Lewis & Clark through additional debentures ("November 2011 Debentures"). Id. ¶¶ 67-68.

Despite Defendants Elsass' and Dalton's earlier representation on September 1, 2011 that Praxis had been retained to do a complete claims analysis, the Lewis & Clark Board of Directors later learned that Uni-Ter and U.S. Re limited the scope of Praxis' initial engagement (which resulted in the September 15, 2011 report) to a review of claims-related processes and of a small sample size of nine specific claims reserves. In late November 2011, Uni-Ter, at U.S. Re's direction, conducted a full-scale internal review of all claims reserves and subsequently engaged Praxis to also conduct a full-scale review. The internal review was initiated based on Uni-Ter's and U.S. Re's concerns raised in the September 15, 2011 Praxis report about the adequacy of claims reserves. Before the September 21, 2011 meeting, U.S. Re, Uni-Ter, Mr. Elsass, Ms. Dalton, Ms. Miller, and Mr. Davies knew that Praxis was going to be evaluating the amount of Lewis & Clark's loss reserves because it was likely that the reserves needed to be materially larger. They intentionally misrepresented this material claims development information to Plaintiffs' representatives at the September 21, 2011 meeting. Id. ¶¶ 75, 77-78

U.S. Re required Uni-Ter to retain Praxis in December 2011 to complete its full claims review, because U.S. Re had doubts about the adequacy of Lewis & Clark's reserves based on the significantly adverse findings of the internal review. Neither Uni-Ter nor U.S. Re disclosed these doubts to the Plaintiffs despite U.S. Re's knowledge at the time that Uni-Ter's internal review was very negative. The December 2011 review found that Uni-Ter had understated the sampled claims in the September 15 report by a net $1, 200, 000. At some point following the December review performed by Praxis, Uni-Ter and U.S. Re informed the Lewis & Clark Board of Directors on a conference call that, in fact, an increase of $5 million to the claims reserves was necessary based on the Praxis full-scale review. This significantly increased the net loss of Lewis & Clark on a full 2011 year basis and further decreased Lewis & Clark's capital to an unacceptable level for operational, regulatory, and rating purposes. Id. ¶¶ 64, 79-81

At the time of their additional investments on November 7, 2011, Plaintiffs were not aware of the significant reserve concerns raised to Uni-Ter and U.S. Re by Praxis in September 2011, but not expressed to the Lewis & Clark Board of Directors. Further, Plaintiffs were led to believe by Uni-Ter that the September Praxis report represented a complete review of the claims process (not just the sample size review reported upon by Praxis), giving them comfort in Uni-Ter's and U.S. Re's representations at the September 21 Board Meeting that claims reserves were adequate. Id. ¶ 82.

Uni-Ter's and U.S. Re's motive for making these misrepresentations and omitting these material facts was to delay Lewis & Clark's insolvency and increase its capital available to pay claims before Lewis & Clark's reinsurance policy was triggered. U.S. Re, as a broker of reinsurance, had brokered Lewis & Clark's reinsurance through policy issuer BeazelyRe. Increasing Lewis & Clark's capital by $2, 200, 000 lowered the exposure of the reinsurance policy U.S. Re had brokered by a similar amount, mitigated any claims of self-dealing BeazelyRe may have against U.S. Re for self-dealing in a policy U.S. Re knew would be triggered, and protected U.S. Re's reputation in the reinsurance business. The delay of insolvency also allowed Uni-Ter to continue receiving management fees for its services to Lewis & Clark and to expand its market share to new policyholders. Id. ¶¶ 85-87.

Immediately after Plaintiffs executed the November 2011 Debentures, Uni-Ter prepared and issued an Offering Memorandum seeking additional equity investments in Lewis & Clark ("November 2011 Offering"). Uni-Ter issued the Offering Memorandum to LTC facilities, home health care business, and others in an attempt to sell securities to additional insured parties. At the time Uni-Ter prepared and issued the Offering Memorandum, it knew that the Offering Memorandum failed to disclose material adverse information, such as the existence of the review by Praxis. The Offering Memorandum concealed the true financial position of Lewis & Clark. For example, it stated:

The Company has experienced signification [sic] underwriting losses in 2011 and has increased its capital by $2, 220, 000 as a result of surplus note contributions and, as a result, had a capital and surplus of approximately $3.7 million as of September 30, 2011 (See "Additional Financing")[.] A summary of the Company's most recent financial statement is attached hereto as Exhibit E.
It is expected that the net proceeds generated from this Offering of the Company's Shares will provide additional funds for the Company to continue operations and to comply with all applicable capitalization requirements under the laws of Nevada.

Uni-Ter had told the Plaintiffs that once the Plaintiffs paid for the November 2011 Debentures, the capital of Lewis & Clark would be sufficient to continue operations. Id. ¶¶ 89-93.

Uni-Ter, as a manager of other risk retention groups servicing the same market as Lewis & Clark, was in a position to capture additional business for its other risk retention groups from the new insured parties obtained through the November 2011 Offering, which was made possible only by the November 2011 Debentures. The November 2011 Debentures also delayed the inevitable dissolution of Lewis & Clark long enough for Uni-Ter to expand its market share and gain additional insured parties that it could simply service through the other risk retention groups Uni-Ter controlled after Lewis & Clark dissolved. Id. ¶ 95

During a December 20, 2011 telephonic Board of Directors meeting, Uni-Ter and U.S. Re informed Plaintiffs of Praxis' full claims review, its findings, and the adverse financial developments of Lewis & Clark. Citing to the Praxis audit findings, Uni-Ter and U.S. Re informed the Lewis & Clark Board of Directors that Lewis & Clark's reserves were inadequate and that urgent action was required to preserve Lewis & Clark's capital structure. Id. ¶¶ 99-100.

None of Uni-Ter's or U.S. Re's subsequent efforts to preserve Lewis & Clark's capital structure succeeded, and it ultimately entered a dissolution proceeding under Nevada law on or about November 11, 2012. All of Plaintiffs' investments in Lewis & Clark, including November 2011 Debentures, have been lost. Id. ¶¶ 103-104.

Based on the foregoing allegations, Plaintiffs have made the following claims for relief: (1) a violation of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") against Defendants Uni-Ter, Elsass, Dalton, Miller, and Davies; (2) a violation of Section 20(a) of the Exchange Act against Defendant U.S. Re; (3) common law fraud against all Defendants; (4) constructive fraud against all Defendants; (5) negligent misrepresentation against all Defendants; (6) fraudulent inducement against all Defendants; and (7) constructive trust against Defendants Uni-Ter and UCSC. Plaintiffs also claim that they are entitled to punitive damages by virtue of Defendants' willful, fraudulent, malicious, and oppressive conduct. Id. ¶¶ 106-159.

B. Defendants' Motions to Dismiss

Defendants Uni-Ter, UCSC, U.S. RE, Miller, and Davies (collectively, the "Uni-Ter Defendants") move to dismiss pursuant the Complaint to Fed.R.Civ.P. 12(b)(6) for failure to state a claim. Dkt. No. 35-1. Defendant Miller individually moves to dismiss the Complaint pursuant to Fed.R.Civ.P. 12(b)(2) for lack of personal jurisdiction. Id. The Uni-Ter Defendants first argue that Plaintiffs fail to state a claim under Section 10(b) of the Exchange Act. Id. at 11-20. Specifically, they contend that the Complaint does not adequately allege a misstatement or omission made by each of the defendants. They also contend that the Complaint does not plead facts supporting a strong inference of scienter for each relevant defendant. The Uni-Ter Defendants further contend that the Complaint does not allege reasonable reliance on any alleged misrepresentation or omission, and does not adequately plead facts alleging loss causation.

Second, the Uni-Ter Defendants argue that Plaintiffs' "control person" claim pursuant to Section 20(a) of the Exchange Act should be dismissed because that claim is dependent on a Section 10(b) claim, which Plaintiffs have failed to adequately allege. Id. at 20-23. The Uni-Ter Defendants further assert that the Section 20(a) claim is subject to dismissal for Plaintiffs' failure to plead facts supporting a reasonable inference of control by U.S. Re of Uni-Ter. Moreover, the Uni-Ter Defendants contend that the Complaint fails to plead with particularity that U.S. Re knew or should have known that the primary violators ( i.e., the Defendants against whom the first claim for relief is interposed) were engaged in fraudulent conduct.

Third, the Uni-Ter Defendants argue that all of Plaintiffs' remaining state law claims should be dismissed. Id. at 23-30. They assert that, assuming the federal claims are dismissed, the Court should decline to exercise supplemental jurisdiction over the state law claims. Even if the Court does not dismiss the federal claims or decides to exercise supplemental jurisdiction, the Uni-Ter Defendants contend that the state law claims should be dismissed because of Plaintiffs' failure to allege a material misrepresentation or reasonable reliance thereon. The Uni-Ter Defendants also contend that Plaintiffs' common law fraud and fraudulent inducement claims fail for lack of adequate pleading of scienter, and that the constructive trust claim fails because there is a valid and enforceable agreement between the parties and for lack of any allegation that Defendants were unjustly enriched at Plaintiffs' expense.

Fourth, the Uni-Ter Defendants argue that Plaintiffs' claim for punitive damages must be dismissed because Plaintiffs have not alleged an "egregious tort directed at the public at large." Id. at 30-31 (citation omitted).

Finally, Defendant Miller asserts that all of Plaintiffs' claims against her should be dismissed for lack of personal jurisdiction. Id. at 31-37.

Defendants Elsass and Dalton also seek dismissal of each of Plaintiffs' claims against them, raising many of the same issues as the Uni-Ter Defendants. First, Elsass and Dalton argue that Plaintiffs' fraud and negligent misrepresentation claims, which are both governed by Fed.R.Civ.P. 9(b)'s particularity requirements, fail to adequately allege the "who, what, where, when" of any alleged misstatements. Dkt. No. 33-1 at 14-18. Specifically, Elsass and Dalton contend that the Complaint does not allege who made any of the alleged misstatements, and instead refers to alleged misstatements made by "Uni-Ter" or the "defendants" generally. Elsass and Dalton also contend that the Complaint does not allege precisely what was actually said, nor does it allege that they knew Miller's statement that there were no claims developments not previously reported was false and that they had a duty to correct that statement. Next, Elsass and Dalton contend that the Complaint fails to allege why and how any of the alleged misstatements were false and misleading.

Second, Elsass and Dalton argue that Plaintiffs' fraud claims fail to allege facts supporting a strong inference of scienter by way of either (a) motive and opportunity or (b) conscious misbehavior or recklessness. Id. at 18-24. In particular, Elsass and Dalton assert that the Complaint does not identify any concrete benefits realized by Elsass or Dalton as a result of any false statements or wrongful nondisclosures, nor does the Complaint allege any individualized motive to do so. With respect to recklessness, Elsass and Dalton assert that the Complaint does not sufficiently allege that they had specific contradictory information at the time they made the allegedly false statements. Elsass and Dalton further assert that Uni-Ter's own investment in Lewis & Clark at the time of the allegedly fraudulent misstatements negates any inference of scienter. Elsass and Dalton also assert ...

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