Cumis Insurance Society, Inc. v. CU Pacific Audit Solutions, LLC

Filing 59

ORDER GRANTING THIRD-PARTY DEFENDANT OTS EMPLOYEES FEDERAL CREDIT UNION MOTION TO DISMISS re 39 Motion to Dismiss for Failure to State a Claim. Signed by JUDGE LESLIE E. KOBAYASHI on 11/30/2014. OTS's Motio n to Dismiss Amended Third-Party Complaint, filed July 31, 2014, is HEREBY GRANTED. Third-Party Counts I and III are HEREBY DISMISSED WITH PREJUDICE, and Third-Party Count II is HEREBY DISMISSED WITHOUT PREJUDICE. CU Pacific shall file its second ame nded third-party complaint by January 12, 2015.This Court CAUTIONS CU Pacific that, if it fails to file its second amended third-party complaint by January 12, 2015 or if it fails to cure the defects in the remaining claim that are identified in this Order, this Court may dismiss the remaining claim with prejudice. This Court emphasizes that CU Pacific does not have leave to add any new parties, claims, or theories of liability. If CU Pacific wishes to do so, it must file a motion to amend a ccording the deadline set forth in the Rule 16 Scheduling Order, filed August 6, 2014. [Dkt. no. 42 .] (eps)CERTIFICATE OF SERVICEParticipants registered to receive electronic notifications received this document electronically at the e-mail address listed on the Notice of Electronic Filing (NEF). Participants not registered to receive electronic notifications were served by first class mail on the date of this docket entry

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF HAWAII
CUMIS INSURANCE SOCIETY,
INC.,

)
)
)
Plaintiff,
)
)
vs.
)
)
CU PACIFIC AUDIT SOLUTIONS,
)
LLC,
)
)
Defendant/Third)
Party Plaintiff,
)
)
vs.
)
)
DONNA TAKUSHI, JENNY NISHIDA, )
NICOLE CHEUNG and OTS
)
EMPLOYEES FEDERAL CREDIT
)
UNION,
)
)
Third-Party
)
Defendants.
)
_____________________________ )

CIVIL NO. 14-00140 LEK-BMK

ORDER GRANTING THIRD-PARTY DEFENDANT
OTS EMPLOYEES FEDERAL CREDIT UNION MOTION TO DISMISS
Before the Court is Third-Party Defendant OTS Employees
Federal Credit Union’s (“OTS”) Motion to Dismiss Amended ThirdParty Complaint (“Motion”), filed on July 31, 2014.
no. 39.]

[Dkt.

Defendant/Third-Party Plaintiff CU Pacific Audit

Solutions (“CU Pacific”) filed its memorandum in opposition on
August 25, 2014, and OTS filed its reply on August 29, 2014.
[Dkt. nos. 43, 48.]

Third-Party Defendant Dona Takushi

(“Takushi”) filed a statement of no position on August 25, 2014.
[Dkt. no. 46.]

This matter came on for hearing on September 15,

2014.

OTS filed a supplemental memorandum on October 17, 2014,

and CU Pacific filed its supplemental memorandum on October 24,
2014.1

[Dkt. nos. 57, 58.]
After careful consideration of the Motion, supporting

and opposing memoranda, and the arguments of counsel, OTS’s
Motion is HEREBY GRANTED.

Counts I and III of the Amended Third-

Party Complaint are HEREBY DISMISSED WITH PREJUDICE, and Count II
of the Amended Third-Party Complaint is HEREBY DISMISSED WITHOUT
PREJUDICE for the reasons set forth below.
BACKGROUND
Plaintiff CUMIS Insurance Society, Inc. (“CUMIS”) filed
its Complaint against CU Pacific on March 20, 2014, based on
diversity jurisdiction.

[Dkt. no. 1.]

According to the

Complaint, CUMIS is an Iowa corporation with its principal place
of business in Madison, Wisconsin, and CU Pacific is a Hawai`i
corporation with its principal place of business in Honolulu,
Hawai`i.

[Id. at ¶¶ 1, 5.]

CUMIS asserts four claims:

1) breach of the Audit Services Agreement (“Count I”);
2) negligent misrepresentation (“Count II”); 3) professional
negligence (“Count III”); and 4) deceptive trade practices in
violation of Haw. Rev. Stat. Chapter 481A (“Count IV”).

1

On October 29, CU Pacific filed redacted versions of the
exhibits it attached to its supplemental memorandum.
[Dkt. no.
58.]
2

According to the Complaint, CUMIS is a fidelity insurer
of credit unions, and it insured OTS “under the conditions of a
fidelity bond which provided coverage to OTS for losses caused
by, inter alia, employee dishonesty.”

[Id. at ¶¶ 2-3.]

The

Complaint alleges that CU Pacific “holds itself out as a
certified public accounting firm[,] . . . registered with the
Hawai`i Board of Accountancy,” and specializing in credit union
audits, compliance, and accounting services.

[Id. at ¶¶ 6-7.]

CU Pacific served as OTS’s independent external auditor for the
years ending December 31, 2006, through December 31, 2012.

[Id.

at ¶ 8.]
According to the Complaint, during various periods
between October 2003 and February 2013, Third-Party Defendants
Takushi, Jenny Nishida (“Nishida”), and Nicole Cheung (“Cheung”,
collectively “the Former Employees”) allegedly embezzled and
misappropriated funds while employed at OTS.

[Id. at ¶¶ 13-32.]

After discovering the embezzlements on or about December 6, 2013,
OTS: terminated their employment; reported the embezzlement to
law enforcement; and filed an employee dishonesty bond claim with
CUMIS.

CUMIS found that the claim was meritorious and made a

claim payment of $993,125.58 to compensate OTS for its loss.
CUMIS alleges that, by virtue of this payment, it became
subrogated to OTS’s rights to seek recovery from the alleged
wrongdoers.

[Id. at ¶¶ 33-36.]

3

The Complaint alleges that OTS is required by law to
have an independent, annual business audit, performed by a
certified public accountant in compliance with National Credit
Union Association regulations.

According to the Complaint,

CU Pacific made several representations to OTS about what
CU Pacific would do:

produce audit reports in compliance with

all relevant regulatory requirements and attestation standards;
examine the internal controls of OTS to make recommendations for
improvements; review employee accounts, official accounts, and
credit card creation; review and reconcile general ledger
accounts; and reconcile OTS’s credit card loans to the supporting
information provided by OTS’s credit card processor.

[Id. at

¶¶ 38-41.]
On May 20, 2014, CU Pacific filed its “Answer to
Complaint (ECF No. 1),” with a Third Party Complaint against OTS
and the Former Employees.

[Dkt. no. 14.]

Third Party Complaint on May 22, 2014.

OTS filed its Amended

[Dkt. no. 18.]

The

Amended Third Party Complaint alleges three claims:
1) CU Pacific is entitled to recover from OTS based upon
indemnity, contribution, reimbursement and/or equitable
subrogation (“Third-Party Count I”); 2) OTS breached the
Management Representation Letters that it executed for each of
the audits by CU Pacific (collectively “the Management
Representation Letters”), and OTS’s breach is the legal cause of

4

both CU Pacific becoming involved in litigation with CUMIS and
CU Pacific suffering other injuries and damages (“Third-Party
Count II”); and 3) OTS’s negligent failure to follow CU Pacific’s
recommendations in the audit reports is the legal cause of
injuries and/or damages to OTS and/or CUMIS (“Third-Party
Count III”).
In the instant Motion, brought pursuant to Fed. R. Civ.
P. 12(b)(6), OTS argues that the Amended Third Party Complaint
fails to state a claim upon which relief can be granted because
“there is no cognizable theory under which CU Pacific can assert
claims against OTS as a third-party defendant independent from
defenses asserted against Plaintiff CUMIS . . . , as subrogee of
OTS,” and because CU Pacific failed to properly implead OTS as
required by Fed. R. Civ. P. 14.
DISCUSSION
I.

Jurisdiction
CU Pacific first argues that this Court should dismiss

the entire case because it does not have diversity jurisdiction
over the claims alleged in CUMIS’s Complaint.

CU Pacific argues

that CUMIS is merely suing on behalf of OTS, which is the real
party in interest in this case.

CU Pacific argues that this

Court should re-align OTS as a plaintiff in this case, which
would destroy diversity because both OTS and CU Pacific are
Hawai`i citizens.

[Mem. in Opp. at 2-3.]

5

A.

Conversion of the Motion
As a general rule, when a district court considers a

motion to dismiss, its review is limited to the allegations in
the complaint.

Daniels-Hall v. Nat’l Educ. Ass’n, 629 F.3d 992,

998 (9th Cir. 2010).

“[A] court may consider evidence on which

the complaint necessarily relies if: (1) the complaint refers to
the document; (2) the document is central to the plaintiff’s
claim; and (3) no party questions the authenticity of the copy
attached to the 12(b)(6) motion.”
quotation marks omitted).

Id. (citations and internal

If the district court considers

exhibits that do not meet these requirements, it must convert the
motion to dismiss into a motion for summary judgment.

Yamalov v.

Bank of Am. Corp., CV. No. 10–00590 DAE–BMK, 2011 WL 1875901, at
*7 n.7 (D. Hawai`i May 16, 2011) (citing Parrino v. FHP, Inc.,
146 F.3d 699, 706 n.4 (9th Cir. 1998)).2
In the instant case, this Court finds that it is
necessary to consider the declaration and exhibits submitted with
the parties’ supplemental memoranda in ruling on the
jurisdictional argument.
described in Daniels-Hall.

These are beyond the type of exhibits
This Court therefore CONCLUDES that

the instant Motion must be converted into a motion for summary
judgment for purposes of the jurisdictional argument only.

2

Parrino was superseded by statute on other grounds, as
stated in Abrego Abrego v. The Dow Chemical Co., 443 F.3d 676,
681-82 (9th Cir. 2006) (per curiam).
6

B.

Real Party in Interest
Fed. R. Civ. P. 17(a) requires that an action “be

prosecuted in the name of the real party in interest.”

The

Complaint alleges that “[b]y virtue of its $993,125.58 payment to
OTS, CUMIS became subrogated to the rights of OTS to seek
recovery for its loss.”

[Complaint at ¶ 36.]

The Complaint

alleges that CU Pacific is responsible for the loss because of
CU Pacific’s breach of contract, misrepresentations, negligence,
and deceptive trade practices.
The Hawai`i Supreme Court has explained subrogation as
follows:
“[T]wo different kinds of subrogation exist.
‘Equitable subrogation’ (sometimes called,
curiously enough, ‘legal subrogation’) is a
principle of equity; it is effected by operation
of law and arises out of a relationship that need
not be contractually based. ‘Conventional
subrogation’ arises out of the contractual
relationship of the parties . . . .” [Robert H.
Jerry, II,] Understanding Insurance Law, . . .
§§ 96[a] and 96[b], at 602–04 [(2d ed. 1996)]
(footnotes and brackets added). Accordingly,
“[a]n insurer which pays a claim against an
insured for damages caused by the default or
wrongdoing of a third party is entitled to be
subrogated to the insured’s rights against such
third party, irrespective of the nature of the
contract . . . even though the policy contains no
stipulations to that effect.” 8B John A. Appleman
and Jean Appleman, Insurance Law and Practice
§ 4941, at 31–38 (1981) (Appleman on Insurance)
(emphases added); see also Taylor [v. Gov’t Emps.
Ins. Co.], [90 Hawai`i 302,] 310, 978 P.2d [740,]
748 [(1999)].
State Farm Fire & Cas. Co. v. Pac. Rent-All, Inc., 90 Hawai`i

7

315, 328-29, 978 P.2d 753, 766-67 (1999) (some alterations and
emphasis in State Farm) (footnotes and some citations omitted).
It also explained the requirements for equitable
subrogation:
[a]n insurer’s right to legal or equitable
subrogation arises only when certain
requirements are met. First, the insurer
must have paid the loss. The right extends
to the extent of the amount actually paid and
the amount paid must have been paid to the
insured.
In addition, the amount paid by the
insurer must result in the insured’s being
made “whole.” The general rule is that the
subrogated insurer is entitled to no
subrogation, or to reduced subrogation, if
the result of full subrogation would be to
cause the insured to be less than fully
compensated for the loss, although some cases
hold to the contrary. . . .
Courts have taken three approaches to
the issue of whether or not subrogation will
be allowed when the insured has not been
fully compensated. One approach is to find
that the insurer is entitled to the full
amount of its subrogation, whether or not its
insured is made whole. Another is to find
that the insurer is entitled to no
subrogation until the insured recovers his
entire loss, between the insurance payment
and the recovery from the tortfeasor. The
third approach is to hold that the court
should make an equitable distribution of any
recovery from the tortfeasor, in light of all
of the circumstances.
. . . .
The second requirement for the existence
of the right to legal subrogation is that the
insurer must not have merely volunteered to
pay the loss, but must have been required to
8

pay based upon[, for example, operation of
law or a] . . . contract of insurance. . . .
Finally, since legal subrogation is
equitable in nature, the right will not be
enforced unless the rights of the party
seeking it are greater than the rights of
others.
Id. at 328 n.8, 978 P.2d at 766 n.8 (alterations in State Farm)
(citation omitted).

In contrast,

The right to conventional subrogation, as opposed
to legal subrogation, does not depend upon
principles of equity. When subrogation claimed by
an insurer is based on contract, the subrogation
provisions of the policy constitute the sole
measure of its rights. In such a case, the
insurer’s rights would be subject to any
limitations contained in the contract of
insurance.
Id. at 328 n.9, 978 P.2d at 766 n.9.
In the instant case, OTS submitted a declaration by its
Chairman of the Board stating that the Former Employees
“collectively embezzled or stole $993,125.33 from OTS,” but OTS
“was made whole for the embezzlement loss under OTS’s bond claim
caused by its Former Employees by virtue of CUMIS’s $993,125.33
claim payment.”

[OTS’s Suppl. Mem., Decl. of Guy Moriwaki

(“Moriwaki Decl.”) at ¶¶ 1, 3, 6.]

Further, “OTS does not intend

to pursue a separate civil action against” CU Pacific or the
Former Employees.

[Id. at ¶ 7.]

CU Pacific, however, argues that, “[e]ven if OTS does
not currently intend to file its own lawsuit against CU Pacific,
the possibility that it could do so” renders OTS the real party
9

in interest at least as to OTS’s “uninsured, excess losses.”
[CU Pacific’s Suppl. Mem. at 2 (emphases in original).]
CU Pacific argues that, based on the Proof of Loss forms that OTS
submitted to CUMIS, OTS’s actual losses were $1,017,952.56.

[Id.

(citing CU Pacific’s Suppl. Mem., Decl. of Keith K. Hiraoka
(“Hiraoka Decl.”), Exhs. B-F).]

Further, CUMIS’s Large

Loss/Trial Report states that OTS incurred audit expenses of
$73,000, but the policy limit for that expense was $25,000.
[Hiraoka Decl., Exh. G at 2.]

The Release and Settlement

Agreement between OTS and CUMIS reflects a settlement amount of
$993,125.58.

[Id., Exh. A (email dated 11/4/13 to Kevin Rainbolt

from Pam Sumimoto, CEO/Manager of OTS, transmitting Release and
Settlement Agreement) at CUMIS002873.]

CU Pacific argues that,

based on the portion of the loss and the portion of the audit
expenses that were not covered, “OTS is the real party in
interest and could still sue CU Pacific for . . . $72,826.98 more
than CUMIS is claiming in this lawsuit.”

[CU Pacific’s Suppl.

Mem. at 3 (emphasis in original).]
The Release and Settlement Agreement, however, states:
4.
OTS hereby acknowledges that through
this RELEASE AND SETTLEMENT AGREEMENT, it releases
any and all claims, known or unknown at this time,
against the RELEASEE, with respect to any
additional loss(es) OTS may incur as a result of
the alleged dishonest conduct of Dona Takushi,
Nicole Cheung and Jenny Nishida, acting
individually and/or in collusion with one another.
5.

By making payment to OTS, the RELEASEE
10

will become subrogated to the rights of OTS to
pursue recovery against any party who may be
legally responsible for causing the abovedescribed losses to the credit union. . . .
[Release and Settlement Agreement at CUMIS002874 (emphasis in
original).]

This Court finds that, pursuant to paragraphs 4 and

5 of the Release and Settlement Agreement, CUMIS has conventional
subrogation rights as to the amount of the loss payment, and OTS
has released its claims as to all other losses and expenses
beyond the payment amount which OTS incurred - or may incur - as
a result of the Former Employees’ alleged conduct.
C.

CUMIS’s Rights as Subrogee
This Court has recognized that, under Hawai`i law, a

subrogee-insurer stands “in the shoes” of the subrogor-insured,
with the same rights and the same defenses assertable against it
as the insured.

Cf. Seabright Ins. Co. v. Matson Terminals,

Inc., 828 F. Supp. 2d 1177, 1188 (D. Hawai`i 2011) (“[subrogation
only allows an insurer to step into the shoes of the insured as
they exist, meaning that it can exercise no greater rights than
the insured had.”).
In considering subrogation in the insurance context,
the Hawai`i Supreme Court further stated that, because
subrogation involves “stepping into” the
shoes of another, when an insurer brings an
action against a tortfeasor based upon its
subrogation rights, the insurer’s rights flow
from the insured’s rights. The subrogated
insurer, known as the “subrogee,” can be
subrogated to and enforce only such rights as
11

the insured, known as the “subrogor,” has
against the party whose wrong caused the
loss. In a subrogation suit, a tortfeasor
may assert against the insurer any defense
which the tortfeasor could have asserted
against the insured.
Pac. Rent-All, 90 Hawai`i at 329, 978 P.2d at 767 (citation
omitted).

Thus, under Hawai`i law, CUMIS stands in OTS’s shoes

as its subrogee.
This Court CONCLUDES that: CUMIS now has the same
rights that OTS had; CUMIS is the real party in interest in this
case; and it is not necessary to realign OTS as a co-plaintiff
with CUMIS.

This Court therefore rejects CU Pacific’s argument

that this Court lacks diversity jurisdiction.
This Court now turns to the merits of OTS’s Motion.
II.

Third-Party Count I
In light of this Court’s conclusion that CUMIS is OTS’s

subrogee, Third-Party Count I fails because “a third-party
complaint seeking contribution and indemnity must fail when the
third-party defendant stands in the same position as the original
plaintiff.”

See House v. Mine Safety Appliances Co., 573 F.2d

609, 622 (9th Cir. 1978), overruled on other grounds by Warren v.
United States Dep’t of Interior Bureau of Land Mgmt., 724 F.2d
776 (9th Cir. 1984).

This Court therefore DISMISSES Third-Party

Court I WITH PREJUDICE because it fails to state a plausible
claim for relief and amendment would be futile.

See Ashcroft v.

Iqbal, 556 U.S. 662, 678 (2009); Sonoma Cnty. Ass’n of Retired
12

Emps. v. Sonoma Cnty., 708 F.3d 1109, 1117 (9th Cir. 2013)
(describing when a court may deny leave to amend after the
dismissal of a complaint).
III. Third-Party Counts that are Merely Defenses
As previously noted, the defenses a defendant may use
against a subrogee in a subrogation action are identical to those
that may be used against the subrogor.
Supp. 2d at 1188.

Seabright Ins., 828 F.

Thus, any defenses CU Pacific could have

asserted against OTS can be asserted against CUMIS as OTS’s
subrogee.

Third-Party Count III’s allegation that OTS’s

negligence is the legal cause of any injuries that OTS sustained
is not an affirmative claim for relief, but merely a defense to
CUMIS’s claims against CU Pacific.

This Court therefore

DISMISSES Third-Party Count III WITH PREJUDICE because it fails
to state a plausible claim for relief and amendment of the claim
would be futile.
It is unclear whether Third-Party Count II merely
alleges what should be a breach of contract defense to CUMIS’s
claim or states an affirmative claim for relief.

CU Pacific

asserted in its memorandum in opposition that Third-Party
Count II states a claim for misrepresentation.

This Court will

therefore DISMISS Third-Party Count II WITHOUT PREJUDICE to allow
CU Pacific to clarify the claim.

See Harris v. Amgen, Inc., 573

F.3d 728, 737 (9th Cir. 2009) (“Dismissal without leave to amend

13

is improper unless it is clear that the complaint could not be
saved by any amended.” (citation and quotation marks omitted)).
Although the parties have raised several arguments regarding the
merits of the purported misrepresentation claim, including, inter
alia, the effect of the collateral source rule, this Court finds
that it premature to address those arguments before CU Pacific
has clarified Third-Party Count II to expressly allege a
misrepresentation claim.
CONCLUSION
On the basis of the foregoing, OTS’s Motion to Dismiss
Amended Third-Party Complaint, filed July 31, 2014, is HEREBY
GRANTED.

Third-Party Counts I and III are HEREBY DISMISSED WITH

PREJUDICE, and Third-Party Count II is HEREBY DISMISSED WITHOUT
PREJUDICE.

CU Pacific shall file its second amended third-party

complaint by January 12, 2015.
This Court CAUTIONS CU Pacific that, if it fails to
file its second amended third-party complaint by January 12, 2015
or if it fails to cure the defects in the remaining claim that
are identified in this Order, this Court may dismiss the
remaining claim with prejudice.

This Court emphasizes that CU

Pacific does not have leave to add any new parties, claims, or
theories of liability.

If CU Pacific wishes to do so, it must

file a motion to amend according the deadline set forth in the
Rule 16 Scheduling Order, filed August 6, 2014.
14

[Dkt. no. 42.]

IT IS SO ORDERED.
DATED AT HONOLULU, HAWAII, December 1, 2014.

/s/ Leslie E. Kobayashi
Leslie E. Kobayashi
United States District Judge

CUMIS INSURANCE SOCIETY, INC. VS. CU PACIFIC AUDIT SOLUTIONS,
LLC; CV 14-00140 LEK-BMK; ORDER GRANTING THIRD-PART DEFENDANT OTS
EMPLOYEES FEDERAL CREDIT UNION MOTION TO DISMISS

15