American Bank of St. Paul v. Carolina First Bank
Filing
109
MEMORANDUM OPINION AND ORDER granting in part and denying in part 84 Defendant's Motion for Summary Judgment (Written Opinion). Signed by Judge Ann D. Montgomery on 05/09/2011. (TLU)
UNITED STATES DISTRICT COURT
DISTRICT OF MINNESOTA
American Bank of St. Paul,
Plaintiff,
v.
MEMORANDUM OPINION
AND ORDER
Civil No. 09-2240 ADM/TNL
TD Bank, N.A.,
Defendant.
______________________________________________________________________________
Eric J. Nystrom, Esq., Anthony N. Kirwin, Esq., Daniel N. Sacco, Esq., John C. Ekman, Esq.,
and William P. Wassweiler, Esq., Lindquist & Vennum PLLP, Minneapolis, MN, on behalf of
Plaintiff.
Alan L. Kildow, Esq., David M. Doyle, Esq., Jeffrey E. Mitchell, Esq., Robert J. Pratte, Esq.,
and Sonya R. Braunschweig, Esq., DLA Piper LLP, Minneapolis, MN and San Francisco, CA,
and Eric S. Golden, Esq., Howard S. Marks, Esq., Jennifer B. Kimble, Esq., and Joe A. Joseph,
Esq., Burr & Forman LLP, Orlando and Winter Park, FL and Birmingham, AL, on behalf of
Defendant.
______________________________________________________________________________
I. INTRODUCTION
On February 25, 2011, the undersigned United States District Judge heard oral argument
on Defendant TD Bank, N.A.’s Motion for Summary Judgment [Docket No. 84]. Plaintiff
American Bank of St. Paul (“American Bank”) opposes the motion. For the reasons set forth
below, the motion is granted in part and denied in part.
II. BACKGROUND1
Defendant TD Bank, N.A. (“Mercantile”) does business as Mercantile Bank throughout
Florida. First Am. Compl. [Docket No. 44] ¶¶ 2-3. Plaintiff American Bank is a Minnesota
1
On a motion for summary judgment, the Court views the evidence in the light most
favorable to the nonmoving party. Ludwig v. Anderson, 54 F.3d 465, 470 (8th Cir. 1995).
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bank headquartered in St. Paul, Minnesota. Id. ¶ 1. This case concerns a $28.5 million MultipleAdvance Term Loan Agreement (the “Loan Agreement”) between American Bank as lender and
Louis Pearlman (“Pearlman”), Trans Continental Records, Inc., and TOTP, LLC as borrowers.
Id. ¶ 139.
Pearlman was well-known in Southern Florida as a successful businessman, having
promoted prominent “boy bands” such as ‘N Sync and the Backstreet Boys. See Kildow Aff.
[Docket No. 87] Louis Pearlman Deposition (“Pearlman Dep.”) at 13-14. Pearlman had a
banking relationship with Mercantile dating back to 2001. First Am. Compl. ¶ 9. At one time,
Pearlman had several depository accounts with Mercantile with balances of more than $4
million. Id. ¶ 12. Mercantile also extended loans to Pearlman exceeding $17 million, including
a $6 million revolving line of credit extended in February 2004. Appendix to Mem. in Opp. to
Mot. for Summ. J. (“App’x to Opp. Mem.”) [Docket Nos. 90-102] Ex. 99. The $6 million line of
credit was secured by collateral, including shares of Trans Continental Airlines (“TCA”) stock.
Id.
In February 2005, the $6 million line of credit came due, and Pearlman proposed
consolidating all his loans with Mercantile, including the line of credit obligation, into a single
note. App’x to Opp. Mem. Ex. 119. Mercantile then identified information it needed to consider
the request, and extended, and would later re-extend, the due date of the line of credit obligation
to give the parties time to negotiate a new agreement. Id.; App’x to Opp. Mem. Ex. 277. By
August 2005, Pearlman had not responded to many of Mercantile’s information requests. See
App’x to Opp. Mem. Ex. I, Barbara Bytell Deposition (“Bytell Dep.”) at 147-150.
After Pearlman failed to provide the information sought by Mercantile, Mercantile began
its own investigation. Id. at 151. From public records, Mercantile soon discovered that Cohen &
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Siegel, the accounting firm that purportedly prepared TCA’s financial statements, was not
licensed in Florida as represented. App’x to Opp. Mem. Ex. 46. Mercantile then retained NFC
Global (“NFC”) to investigate further. Bytell Dep. at 161. NFC’s investigation found no
professional licensing or registration for Cohen & Siegel in Florida or New York, where it
purportedly had offices, and no listing in Germany, where the firm purportedly was
headquartered. App’x to Opp. Mem. Ex. 10. NFC then prepared a due diligence report for
Mercantile. See generally Kildow Aff. Ex. 11. The NFC report included the discovery that no
aircraft were directly registered to TCA, but some were registered to subsidiaries or affiliates,
and NFC was unable to find any licensing or registration for Cohen & Siegel, or its principals
Arthur Siegel and Stanley Kaplan, in the United States or Germany. Kildow Aff. Ex. 11 at
NFC000115-16, NFC000126. Mercantile then prepared an internal memorandum detailing the
financial information provided by Pearlman that it could not verify, including $145 million in
cash and equivalents held by TCA, the memorandum also reflected that Pearlman’s financial
statement omitted some $35.5 million in liabilities that it had confirmed. See App’x to Opp.
Mem. Ex. 205.
On August 29, 2005, after this investigation, Mercantile declared Pearlman in default on
the line of credit. App’x to Opp. Mem. Ex. 246. Mercantile then met with Pearlman privately
on September 7, 2005. See id. Mercantile met with Pearlman again in late September, where he
represented that he could not immediately repay his Mercantile loans without it getting “very
messy” and opening “a can of worms.” Pearlman Dep. at 116-17, 157-59. However, Pearlman
claimed that with more time and debt restructuring, he would be able to repay the Mercantile
loans. Id. at 97-99. Mercantile then agreed to enter into a forbearance agreement (the
“Forbearance Agreement”) with Pearlman. See App’x to Opp. Mem. Ex. 242. The documents
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requesting approval from Mercantile executives for the Forbearance Agreement used the suspect
financial information supplied by Pearlman. App’x to Opp. Mem. Ex. 50.
North American Capital Markets (“NACM”) then began working on behalf of Pearlman
to obtain a new loan that would satisfy Pearlman’s debts to Mercantile and secure rights to a
popular British music television program. See Pearlman Dep. at 135. NACM circulated an
Offering Memorandum to several banks, including Mercantile. See App’x to Mem. Opp. Ex.
259. The Offering Memorandum included representations that Mercantile had previously been
unable to verify, including (1) TCA held cash and equivalents of $145 million and (2) TCA
owned eight aircraft. App’x to Opp. Mem. Ex. 259 at MERC.AB001800-01. The Offering
Memorandum also included statements from Cohen & Siegel and Stanley Kaplan, and omitted
mention of the $35.5 million in liabilities of which Mercantile had knowledge. Id. at
MERC.AB001809-10, MERC.AB001827-28, MERC.AB001876-1907. Additionally, the
Offering Memorandum expressly stated that its purpose was to “refinance existing debt and to
purchase rights to . . . ‘The Top Of The Pops.’” Id. at MERC.AB001790.
In response to the Offering Memorandum, a loan syndicate was formed with American
Bank to act as the servicing bank. See Kildow Aff. Ex. 12. Several banks agreed to purchase
shares, but as Pearlman’s forbearance period with Mercantile expired, NACM had insufficient
commitments to close the deal. See App’x to Opp. Mem. Ex. 57. During this time of soliciting
financing, Mercantile made no disclosure of its knowledge regarding the lack of registration and
licensing of Cohen & Siegel, Stanley Kaplan, or TCA’s aircraft. Throughout the process,
NACM solicited Mercantile’s participation, but received no commitment. App’x to Opp. Mem.
Ex. M, Andrew Cheney Deposition (“Cheney Dep.”) at 150. With the transaction still lacking
the necessary funds, Mercantile agreed to purchase a share as a participating bank to close the
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deal. See Kildow Aff. Ex. 12 at Ex. A. Mercantile’s participation, in light of its knowledge of
the problems with the Offering Memorandum, violated its own underwriting standards. App’x to
Opp. Mem. Ex. U, James McRae Deposition (“McRae Dep.”) at 188. The deal closed on March
28, 2006, when Pearlman and American Bank executed the Loan Agreement and a promissory
note (the “Note”), and the participating banks signed a participation agreement (the
“Participation Agreement”). Pursuant to the Loan Agreement, Pearlman pledged stock in TCA
as collateral, which had previously been pledged to Mercantile and required Mercantile to
release its security interests in that stock. See App’x to Opp. Mem. Ex. 194. As part of the
Participation Agreement, Mercantile’s interest would be reduced to $0 as participation funds
were advanced to Pearlman. See Kildow Aff. Ex. 12 at 1.
By April 2006, the loan was distributed and Mercantile was paid. First Am. Compl. ¶¶
170-73. In December 2006, Pearlman and the other debtors defaulted on the loan. Id. ¶ 176.
Pearlman was then discovered to have misled other lenders and investors and defaulted on over
$300 million in obligations. He eventually pled guilty to fraud and other crimes and is currently
serving a 25-year prison sentence. On August 26, 2009, American Bank commenced this action,
and Mercantile now moves for summary judgment on all claims.
III. DISCUSSION
A.
Summary Judgment Standard
Federal Rule of Civil Procedure 56(c) provides that summary judgment shall issue “if the
pleadings, depositions, answers to interrogatories, and admissions on file, together with the
affidavits, if any, show that there is no genuine issue as to any material fact and that the moving
party is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(c); see Matsushita Elec.
Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986); Anderson v. Liberty Lobby, Inc.,
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477 U.S. 242, 252 (1986); Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). On a motion for
summary judgment, the Court views the evidence in the light most favorable to the nonmoving
party. Ludwig, 54 F.3d at 470. The nonmoving party may not “rest on mere allegations or
denials, but must demonstrate on the record the existence of specific facts which create a genuine
issue for trial.” Krenik v. County of Le Sueur, 47 F.3d 953, 957 (8th Cir. 1995).
B.
Fraud by Omission
American Bank asserts a claim for fraud by omission against Mercantile, arguing that
Mercantile had a duty to disclose its knowledge about Pearlman to American Bank. Under
Minnesota law, which the parties agree governs this dispute, a party to a commercial transaction
has a duty to disclose information only in the following limited circumstances: (1) one who
speaks must say enough to prevent his words from misleading the other party; (2) one who has
special knowledge of material facts to which the other party does not have access may have a
duty to disclose these facts to the other party, (3) one who stands in a confidential or fiduciary
relation to the other party must disclose material facts. Klein v. First Edina Nat’l Bank, 196
N.W.2d 619, 622 (Minn. 1972).
It is undisputed that the first and third circumstances requiring disclosure do not apply
here; the parties only dispute whether Mercantile’s knowledge amounted to “special knowledge
of material facts to which the other party does not have access.” The parties’ dispute focuses on
the proper standard for what constitutes “special knowledge of material facts.” Mercantile
argues that in the context of banking, it has a duty to disclose only actual knowledge of
“irretrievable insolvency.” See Richfield Bank & Trust Co. v. Sjogren, 244 N.W.2d 648, (Minn.
1976) (“If . . . a party is so insolvent that he has no reasonable expectation of fulfilling his
contract obligations, then it is fraud for that party to fail to disclose his insolvency before
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entering the contract.”); Boubelik v. Liberty State Bank, 553 N.W.2d 393, 401 (Minn. 1996)
(“[W]hen a bank has knowledge of a customer's irretrievable insolvency, that is, knowledge of a
customer's inability to meet obligations, there is a bright line standard of the duty to disclose
information regarding the customer's financial condition . . . .”). In opposition, American Bank
contends that a bank has a duty to disclose whenever it has actual knowledge of “fraudulent
activities.” Richfield Bank, 244 N.W.2d at 652 (“[W]e hold that under the unique and narrow
‘special circumstances' of this case, in which the bank had Actual [sic] knowledge of the
fraudulent activities of one of its depositors, it had an affirmative duty to disclose those facts . . .
.”).
Indeed, the directive from Minnesota courts is unclear. On one hand, Boubelik disclaims
that it holds that “only knowledge of irretrievable insolvency must be disclosed.” Boubelik, 553
N.W.2d at 399 (quotations in original). On the other hand, Boubelik states that “a clear standard
with regard to a bank’s duty to disclose the financial condition of its customer is necessary” and
that clear standard is “knowledge of irretrievable insolvency.” Id. at 400. Given these
seemingly inconsistent holdings, the parties robustly argue each position.
The uncertainty of how Boubelik applies to this case, however, is not surprising. This
case does not present the situation confronted in Boubelik, Richfield Bank, and other related
cases, where a bank is privy to “special knowledge” due to its relationship with its customer.
Rather, this case has a fact pattern where a bank possesses “special knowledge” due to its own
investigative efforts. Therefore, this case turns not on what type of knowledge a bank must
disclose, the issue discussed at length in Boubelik and Richfield Bank, but instead turns on
whether Mercantile’s knowledge was from such sources as to make it “readily ascertainable” for
American Bank. See id. at 400 (noting that bank had no duty to disclose information that was
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“readily ascertainable”).
Under Minnesota law, “special knowledge” must be disclosed only when it is knowledge
“to which the other party does not have access.” Klein, 196 N.W.2d at 622. This means that the
knowledge must not be “readily ascertainable,” but must be peculiarly within the defendant’s
knowledge. Boubelik, 553 N.W.2d at 400. In this context, “readily ascertainable” means
available through “ordinary channels.” Ohio Cas. Grp. v. Salo, No. C3-97-776, 1997 WL
739331, *3 (Minn. Ct. App. Dec. 2, 1997).
Mercantile had no duty to disclose its knowledge, whether special knowledge or not,
because the knowledge it possessed was readily ascertainable through ordinary channels. The
evidence of record is that Mercantile became suspicious of Cohen & Siegel because it could not
find professional licensing for that entity or its principals. That information is publicly available
and was accessed by Mercantile through routine searches of public records. App’x to Opp.
Mem. Ex. 46. Mercantile then retained FCA, which used typical investigatory means to search
public information for professional credentials for Cohen & Siegel and for aircraft registration
for TCA. Kildow Aff. Galen R. Clements Deposition (“Clements Dep.”) at 19, 26-27, 31-33, 3538. There is nothing extraordinary about Mercantile retaining a private investigation firm or the
methods the firm used to conduct its investigation.
American Bank argues that whether or not the information was “readily ascertainable,”
Mercantile Bank had a duty to disclose actual knowledge of fraudulent activities, again citing
Richfield Bank. This is not the law; knowledge must be disclosed only where it is “peculiarly”
in the possession of a party. Richfield Bank, 244 N.W.2d at 650 (citing Thomas v. Murphy, 91
N.W. 1097, 1098 (1902)). In Richfield Bank and Boubelik, the actual knowledge of fraud was
peculiarly in the possession of the depository bank because the depository bank had access to the
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depositor’s account information that showed irretrievable insolvency. Here, the depository bank,
Mercantile, gained its knowledge not through access to confidential account information but
rather through conducting an investigation to obtain further information. This information was
not “peculiarly” in its knowledge; had any other bank conducted a similar investigation, it would
have uncovered the same information.
Next, American Bank argues that Mercantile was peculiarly in possession of some
knowledge that was not “readily ascertainable”–namely the existence of the Forbearance
Agreement and the earlier declaration of default on the $6 million line of credit. However, the
Offering Memorandum made no misrepresentations regarding this knowledge. The Offering
Memorandum stated that Pearlman’s loans were “paid as agreed.” The Forbearance Agreement
was a modification of the prior contract between Mercantile and Pearlman, and because it was
not in default, that statement was not false. See Blake v. J. Neils Lumber Co., 127 N.W. 450,
515 (Minn. 1910) (noting that after modification, all rights and liabilities of parties to contract
are controlled by the new agreement). Therefore, under any standard of disclosure, Mercantile
did not have a duty to disclose information regarding the forbearance agreement or the default on
the $6 million line of credit.
Finally, American Bank argues that the information obtained by NFC was not “readily
ascertainable” because an NFC investigator acknowledged that it was not “generally available”
and that many of the databases used were accessible only by subscription. See App’x to Opp.
Mem. Ex. N, Clements Dep. at 49. “Readily ascertainable” does not mean that available free of
charge. “Readily ascertainable” means that information is available through “ordinary
channels.” American Bank has adduced no evidence that NFC was privy to information that
could not be obtained through “ordinary channels.” See Ohio Cas. Grp., 1997 WL 739331 at *29
3 (holding that employment status information was “readily ascertainable” through “ordinary
channels” because insurance company could have asked employer about insured’s employment).
Any knowledge of Pearlman’s fraud obtained by Mercantile was “readily ascertainable” to the
other participating banks, and Mercantile had no duty to disclose it. Mercantile’s decision to go
beyond normal due diligence, and hire a private firm as the most cost-effective way of doing so,
does not negate that the evidence is Mercantile used ordinary channels in its investigation.
Mercantile is entitled to summary judgment in its favor on American Bank’s fraud by omission
claim.
C.
Fraudulent Misrepresentation
To prevail on a claim for fraud, a plaintiff must show: (1) a false representation of a past
or present material fact which was susceptible of knowledge, (2) the defendant knew the
representation was false or made it without knowing whether it was true or false, (3) an intention
to induce plaintiff to act in reliance on the misrepresentation, (4) and resulting damages.
Karlstad State Bank v. Fritsche, 392 N.W.2d 615, 618 (Minn. 1986). Representations may be
implied from conduct. Brainerd Dispatch Newspaper Co. v. Crow Wing Cnty., 264 N.W. 779,
780 (Minn. 1936).
American Bank’s fraud claim fails because Mercantile made no affirmative
representations. American Bank identifies only two affirmative acts that it claims form the basis
of an actionable fraud claim. First, American Bank argues that by participating in the transaction
Mercantile made the implied representation that the information in the Offering Memorandum
was true. This position is unavailing. The Offering Memorandum was a representation made by
Pearlman, not Mercantile. Mere participation in the loan is not sufficient conduct to represent
that information in the Offering Memorandum was true. Otherwise, each participating bank
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would have a cause of action against all others predicated solely on their participation, an
untenable position. Each party to an agreement enters the transaction at its own peril, with an
independent duty of diligence. See Kildow Aff. Ex. 12 § 10; Leonard v. Dorsey & Whitney,
LLP, 553 F.3d 609, 626 (8th Cir. 2009) (noting that banks are sophisticated entities with the duty
to make their own evaluations of participation loans).
No courts have held that the act of contracting is a representation endorsing the
representations of another regarding the contract, especially as here where the seller, American
Bank, urges the Court to imply a representation concerning the product sold by the buyer,
Mercantile. The only cases cited by American Bank allowing representations to be implied from
the mere act of contracting are cases holding that contracts for the issuing of securities implicitly
represent that the issued securities are valid. See Stern v. Nat’l City Co., 25 F. Supp. 948, 957
(D. Minn. 1981); Hutchings v. Tipsword, 363 S.W.2d 40, 45 (Mo. Ct. App. 1963). It is
reasonable to imply that the performance promised by a contracting party for issuance of
securities will indeed be what it purports to be. However, in the sales context of the instant case,
it is unreasonable to imply assurances by a buyer to a seller, regarding the product sold, from the
mere act of contracting, as urged by American Bank here.
Second, American Bank argues that the Mercantile’s release of its security interest in
TCA stock so that it could be used as collateral for the participating banks was an implied
representation that the stock had positive value. Again, this position is untenable. First,
assuming arguendo that the TCA stock was worthless, no evidence of record indicates that
Mercantile knew it to be worthless. Mercantile suspected that TCA did not have proper
licensing or own any aircraft. However, that knowledge might lead it to suspect that TCA stock
had less than its stated value, not zero value, as TCA could have held other assets. Second,
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Mercantile’s act of releasing its security interest in the stock to allow Pearlman to pledge it to the
participating banks is not a representation that the stock has any value; Mercantile was not
issuing the stock, it merely released its interest in that stock. The implication that can be taken
from that conduct is that the stock was less valuable as collateral for the $6 million line of credit
than Mercantile initially believed.
D.
Breach of Contract
American Bank claims that Mercantile breached two provisions of the Participation
Agreement by making two false warranties. The representations that American Bank argues
were breached are § 10(c) and § 10(f). In § 10(c) Mercantile “warrant[ed], represent[ed],
acknowledge[d], and certif[ed]” that “it has received such financial and other information with
respect to [Pearlman, etc.] and the loan transaction contemplated hereby as in its opinion is
necessary or desirable to permit it to make an informed credit decision with respect to the
purchase of its respective participating ownership interest.” Kildow Aff. Ex. 12 § 10(c). Section
10(f) is a representation that Mercantile “is relying on its own due diligence, credit investigation
and credit analysis, and not on any representations, warranties or statements of [American Bank]
. . . .” Id. § 10(f). As a matter of law, Mercantile breached neither provision.
First, American Bank has adduced no evidence that the representation in § 10(c) was
false. To be sure, American Bank argues and has presented evidence that Mercantile did not
follow its internal policies. However, deviating from its internal policies does not mean that
Mercantile did not hold the opinion that it had information sufficient to make an informed
decision. To the contrary, the evidence of record indicates that Mercantile’s decision was highly
informed–it secured additional information that led to its decision to reduce its lending exposure
to Pearlman. There is no genuine issue of material fact regarding whether Mercantile held the
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opinion that it was making an informed decision.
Further, American Bank has adduced no evidence that Mercantile did not base its
decision to participate in the Loan based on “due diligence, credit investigation and credit
analysis.” Nothing about that representation is false. Again, all evidence of record supports that
Mercantile conducted its own diligence and investigation of Pearlman, and based on that
information decided to reduce its loan exposure with him. Based on that investigation and
analysis, Mercantile concluded that Pearlman would be able to repay his obligations only with
debt restructuring and additional time. As such, Mercantile agreed to a forbearance and then to
participation in the Participation Agreement. No genuine issue of material fact exists as to
whether Mercantile conducted its own investigation and analysis; it did. Mercantile breached no
representations and is entitled to summary judgment on the breach of contract claims.
E.
Aiding and Abetting
American Bank also asserts a claim against Mercantile for civil aiding and abetting. A
plaintiff can prevail on such a claim if it shows: (1) a tort by another that causes injury to the
plaintiff, (2) actual knowledge of the defendant that the tortfeasor’s conduct constituted a breach
of duty, and (3) substantial assistance by the defendant. Witzman v. Lehrman, Lehrman & Flom,
601 N.W.2d 179, 187 (Minn. 1999). The second and third elements are analyzed in tandem; for
example, a minimal showing of substantial assistance requires a greater showing of knowledge.
Id. at 188.
Pearlman has pled guilty to criminal fraud and admitted to making misrepresentations
about his financial health to banks. Kildow Aff. Ex. 1 at 18. Based on those admissions, if
American Bank reasonably relied on those misrepresentations and suffered damages, fraud was
committed against American Bank by Pearlman. See Karlstad, 392 N.W.2d at 618 (listing
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elements of fraud). Therefore, a genuine issue of material fact exists with respect to the first
element of this claim.
With respect to the actual knowledge element, actual knowledge was discussed above as
it related to American Bank’s fraud by omission claim. That discussion, however, did not rule
whether a genuine issue of material facts exists regarding Mercantile’s actual knowledge of
Pearlman’s fraud because whatever knowledge Mercantile had was derived from sources readily
available to American Bank and therefore did not trigger a duty of disclosure. See Richfield
Bank, 244 N.W.2d at 650 (noting that material facts must be disclosed only when “peculiarly”
within a parties knowledge). The issue of actual knowledge of fraud, however, is now squarely
before the Court.
Actual knowledge is usually a question of fact, as it must be inferred from circumstantial
evidence. Krout v. Goemmer, 583 F.3d 557, 567 (8th Cir. 2009) (citing Farmer v. Brennan, 511
U.S. 825, 842 (1994)). Here, American Bank has produced evidence that the Offering
Memorandum contained false statements regarding Pearlman’s financial health. Further,
American Bank has produced evidence that Mercantile conducted an investigation that failed to
corroborate some of Pearlman’s financial representations. See App’x to Opp. Mem. Ex. 205.
That same investigation produced information of some $35.5 million in liabilities not mentioned
in the Offering Memorandum. Id. Further, when payment was sought from Pearlman, he
warned that he would need more time or things would “get messy.” Pearlman Dep. at 116.
When questioned about whether TCA could pay his debt, he responded that demanding payment
from TCA would “open a can of worms.” Id. at 157. Those statements, combined with the
results of Mercantile’s investigation, could lead a reasonable person to infer that Mercantile had
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actual knowledge that Pearlman was committing fraud by circulating the Offering Memorandum.
Therefore, a genuine issue of material fact exists regarding the second element of the claim.
With respect to the third element, substantial assistance is assistance that is a “substantial
factor” in bringing about the ultimate tort. K&S P’ship v. Continental Bank, N.A., 952 F.2d 971,
979 (8th Cir. 1991). Whether an act was a “substantial factor” is analyzed under the rubric of
proximate cause. Id. Here, Mercantile engaged in two overt acts of assistance: it released its
interests in TCA stock and it purchased a $2 million share in the Loan Agreement. American
Bank has produced evidence that without Mercantile’s participation in the Loan, the loan would
not have closed and Pearlman would not have obtained the funds. See McRae Dep. at 211.
Further, given that Mercantile had seen the Offering Memorandum, it may have been foreseeable
that Pearlman’s fraud would be successful if Mercantile in fact participated in the loan.
Finally, Mercantile violated many of its own internal policies with respect to Pearlman.
Conducting business in an atypical way is evidence of knowledge. Metz v. Unizan Bank, No.
5:05 CV 1510, 2008 WL 2017574, *18 (N.D. Ohio May 7, 2008) (holding that atypical banking
procedures, such as disregarding requirements for corporate authorization statements and valid
signature cards, was sufficient to infer knowledge by bank of depositor’s fraud). With a high
level of knowledge that Pearlman was engaging in fraud, a showing of a lower level of
substantial assistance is sufficient for aiding and abetting liability. Witzman, 601 N.W.2d at
188. Therefore, a genuine issue of material fact exists regarding whether Mercantile provided
substantial assistance to Pearlman. As genuine issues of material fact exist with respect to each
element of American Bank’s civil aiding and abetting claim, summary judgment for this claim is
denied.
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F.
Covenant of Good Faith and Fair Dealing
American Bank asserts a claim alleging breach of the implied covenant of good faith and
fair dealing. The implied covenant of good faith and fair dealing requires that one party not
unjustifiably hinder the other party’s performance of the contract. In re Hennepin Cnty. 1986
Recycling Bond Litig., 540 N.W.2d 494, 502 (Minn. 1995). The covenant is breached when a
party has an ulterior motive for its refusal to perform a contractual duty. Minnwest Bank Central
v. Flagship Props. LLC, 689 N.W.2d 295, 303 (Minn. Ct. App. 2004).
Here, Mercantile did not refuse to perform its contractual duties; it fully paid its share
and released security interest in the collateral pursuant to the Participation Agreement. In its
relationship with American Bank, Mercantile did nothing to inhibit performance of the
Participation Agreement. The implied covenant of good faith and fair dealing cannot create
additional duties of disclosure as urged by American Bank. See LaFleche v. Clark Prods., Inc.,
Civil No. 05-2549, 2007 WL 2023564, *10 (D. Minn. July 9, 2007) (“[Plaintiff] cannot use the
covenant of good faith and fair dealing to create new, specific contract terms that he simply
wished had been included in the [original contract].”). Therefore, Mercantile is entitled to
summary judgment on this claim.
G.
Conspiracy
The final claim of American Bank is civil conspiracy. “A conspiracy is a combination of
persons to accomplish an unlawful purpose or a lawful purpose by unlawful means.” Harding v.
Ohio Cas. Ins. Co., 41 N.W.2d 818, 824 (Minn. 1950). The elements of a civil conspiracy are:
“(1) two or more persons, (2) an object to be accomplished, (3) a meeting of the minds on the
object or course of action to be taken, (4) the commission of one or more unlawful overt acts,
and (5) damages as the proximate result of the conspiracy.” In re Temporomandibular Joint
16
(TMJ) Implants Prods. Liab. Litig., 113 F.3d 1484, 1498 (8th Cir. 1997). “No express or certain
agreement is necessary. A common understanding to commit the wrong is enough, even though
the purpose and assignment of parts to the several actors be tacit.” Scheele v. Union Loan &
Fin. Co., 274 N.W. 673, 679 (Minn. 1937).
A genuine issue of material fact exists as to whether Mercantile and Pearlman reached a
“meeting of the minds” regarding Pearlman’s alleged fraudulent activities. Pearlman testified
that, based on Mercantile’s changed posture regarding their banking relationship, he knew
Mercantile had become aware of at least some of his fraudulent dealings. Pearlman Dep. at 118.
Pearlman had a private meeting with Mercantile employees Bruce May and Walt Ramsey to
discuss Pearlman’s debts to Mercantile. Id. at 96. At that meeting, Pearlman stated that he
would need more time and debt restructuring in order to satisfy his obligations to Mercantile. Id.
at 97-99. Mercantile then entered into the Forbearance Agreement, using the documents it
suspected to be false to obtain corporate approval. App’x to Opp. Mem. Ex. 50. Pearlman then
hired NACM to solicit banks for the Participation Agreement using the Offering Memorandum,
which included the suspect documents. While the Offering Memorandum was circulating,
Mercantile and NACM continued to discuss the extent of Mercantile’s participation. Cheney
Dep. at 150-51. Finally, when the loan was unable to close, Mercantile agreed to enter as a
participating bank but on terms that allowed it to receive full payment almost immediately.
Mercantile argues that no meeting of the minds existed because a Forbearance
Agreement is a routine transaction that does not evince an unlawful plan. This position misses
the point. The Forbearance Agreement itself does not raise a genuine issue of material fact, but
the circumstances surrounding it do. Pearlman testified that he suspected Mercantile knew of his
fraud. Pearlman Dep. at 118. Pearlman also testified that he told Mercantile that if it demanded
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immediate payment things would “get messy” and it would “open a can of worms.” Id. at 11617, 157-59. In response, Mercantile used the documents it suspected to be false to obtain
authorization for the Forbearance Agreements, in violation of its internal policies, and then
agreed to enter the Participation Agreement, on terms allowing it to be paid almost immediately,
knowing that those same suspect documents had been used to solicit the participating banks.
From those specific facts a reasonable mind could infer that Mercantile and Pearlman had an
tacit agreement that Pearlman would continue to use suspect documents to obtain loans to pay
off Mercantile, and that Mercantile would assist by foregoing action against Pearlman and
participating in the loan if necessary. Genuine issues of material fact preclude summary
judgment on American Bank’s conspiracy claim.
H.
Damages
The parties vigorously dispute whether American Bank may recover the entire amount of
the Loan, $28.5 million, or the amount it purchased, $5 million. The only surviving claims here
are civil aiding and abetting and civil conspiracy. Under these theories of recovery, the
underlying tortfeasor is jointly liable with his accomplice or co-conspirator. Witzman, 601
N.W.2d at 185 (aider and abettor jointly liable with primary tortfeasor); 15A C.J.S. Conspiracy §
21 (“Parties to a civil conspiracy are joint tortfeasors; their liability is joint and several . . . .”).
The cause of action underlying both claims is fraud. Damages for fraud are generally the “outof-pocket” losses sustained by a plaintiff. LeSueur Creamery, Inc. v. Haskon, Inc., 660 F.2d
342, 346 (8th Cir. 1981). In this case, each participating bank suffered out-of-pocket losses
equal to its purchase of a participation share. Further, each bank was given the Offering
Memorandum that included Pearlman’s misrepresentations. Therefore, each participant bank has
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the same claims as American Bank for aiding and abetting and conspiracy against Mercantile
unless it has assigned its claims to American Bank.
Under Minnesota law, assignment occurs where the owner of a claim manifests an intent
to transfer that claim without retaining control or power of revocation. Minn. Mut. Life Ins. Co.
v. Anderson, 504 N.W.2d 284, 286 (Minn. Ct. App. 1993). The sole manifestation of an intent
to transfer claims to American Bank identified by American Bank is the Participation
Agreement. American Bank argues that under the Participation Agreement the participating
banks agreed to purchase “the risks, liabilities and expenses . . . arising or incurred under or in
connection with the Note, the Loan Agreement or the other documents executed therewith,
including the risks of non-payment, late performance or non-performance by the Borrower
thereunder and of disputes or litigation relating thereto.” American Bank argues this language is
the manifestation of an intent to have American Bank assert claims on behalf of the participating
banks in this litigation.
While the Participation Agreement allows American Bank to assert the participating
banks’ claims arising from the Note or Loan Agreement on their behalf, it does not authorize
American Bank to assert their claims for aiding and abetting or civil conspiracy against
Mercantile. The language does not manifest an intent for American Bank to assert all tort claims
against any party on behalf of the participating banks. The language does not speak of claims,
sounding in tort or otherwise, but rather identifies the loan documents and the risks associated
with default. See Kildow Aff. Ex. 12 § 1(d). The contract language, therefore, is limited to
recovery from Pearlman, or the other borrowers, based on default on the Loan and Note. This
reading is bolstered by § 4 of the contract, that discusses the manner in which American Bank
can bring claims. While American Bank is correct that the section does not itself assign claims,
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contracts must be construed as a single instrument, and that section clarifies the scope of the
assignment found in section 1. See Halla Nursery, Inc. v. City of Chanhassen, 781 N.W.2d 880,
884 (Minn. 2010) (“[T]he terms of a contract are not read in isolation.”).
Further, in discerning contracting parties’ intent, courts look to their subsequent conduct.
Fredrich v. Independent School Dist. No. 720, 465 N.W.2d 692, 695 (Minn. 1991). Here, the
participating banks have acted as if they did not assign their claims; executives at those banks
have testified that the claims were not assigned. Further, American Bank has not acted as if the
claims were assigned to it. The language American Bank identifies as an assignment, also
authorizes American Bank to collect attorney’s fees from the participating banks; yet, American
Bank did not apprise many participating banks of the lawsuit and has not sought attorney’s fees
under § 1(d).
The conduct of the parties is also relevant in determining what preclusive effect will be
given to this litigation. In determining whether a party is the real party in interest, courts
generally follow the rule that if the litigation will be given res judicata effect in subsequent
cases, the party asserting the claims is the real party in interest. See Anderson v. Conn. Fire Ins.
Co., 43 N.W.2d 807, 814 (Minn. 1950). Res judicata operates only against a party to the
litigation and its “privies.” Rucker v. Schmidt, 794 N.W.2d 114, 117 (Minn. 2011). “Privity
expresses the idea that as to certain matters and in certain circumstances persons who are not
parties to an action but who are connected with it in their interests are affected by the judgment
with reference to interests involved in the action, as if they were parties.” Id. at 118 (quotations
omitted). A person may be in privity with a party in at least three ways: (1) he can control the
action even though not a party to it; (2) his interests can be represented by a party; or (3) he can
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be a successor in interest, deriving his claim through a party to the prior action. Id. (citing
Margo-Kraft Distributors, Inc. v. Minneapolis Gas Co., 200 N.W.2d 45, 47-48 (Minn. 1972)).
Here, if American Bank were able to assert its claim for the entire $28.5 million, it would
likely not be given res judicata effect because the participating banks are not privies of American
Bank. The participating banks have no control over this action, have no attorney-client
relationship with American Bank’s counsel, and have no ability otherwise to influence American
Bank’s litigation strategy. The participating banks did not authorize American Bank to represent
their interests, and no evidence suggests that American Bank is doing anything other than
litigating entirely in pursuit of its own interests. Finally, American Bank is not a successor in
interest to the participating banks’ interests.
American Bank’s argument that as a matter of law the lead bank in a participation loan is
the real party in interest is unavailing. The rights of the banks are dictated by the Participation
Agreement. Leonard, 553 F.3d at 626. In support of its position, American Bank cites Midland
Nat’l Bank v. Cousins Props., Inc., 68 F.R.D. 427 (N.D. Ga. 1975), where the court held that the
participating banks were not indispensible parties under Rule 19 of the Federal Rules of Civil
Procedure because the lead bank was the only real party in interest for asserting its fraud claims.
Id. at 430-31. The Midland court noted that the participating banks did have an interest in the
promissory note and may have been able to assert any claims arising out of that instrument. Id.
at 430. Evidently, then, Midland involved an entirely different scenario than here. There, the
participating banks could assert claims on the note, but the fraud was committed only against the
lead bank. Here, the participating banks have assigned any claims for default on the Note
against Pearlman and the other borrowers, but the tort claims against Mercantile based on the
Offering Memorandum remain with each bank as discussed above.
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In summary, American Bank may only recover its share of the participation agreement at
this juncture. However, Rule 17 of the Federal Rules of Civil Procedure governs when a party
may assert claims to which it is not the real party in interest. That rule allows a “reasonable time
after objection” for substitution, ratification, or joinder. Fed. R. Civ. P. 17(a)(3). As such,
American Bank urges that it be given an opportunity to seek ratification from the participating
banks. Mercantile argues that ratification at this stage will cause it undue prejudice. However,
no discernable showing of undue prejudice has been made. The mandate of Rule 17 is clear, a
“reasonable time” for ratification must be given after objection. Id. Therefore, American Bank
will have until June 9, 2011 to obtain ratification from participating banks.
IV. CONCLUSION
Based upon the foregoing, and all the files, records, and proceedings herein, IT IS
HEREBY ORDERED that:
1. Mercantile’s Motion for Summary Judgment [Docket No. 84] is GRANTED IN
PART AND DENIED IN PART;
2. Counts I, II, V, and VI are DISMISSED WITH PREJUDICE; and
3. American Bank has until June 9, 2011 to obtain Rule 17 ratification from
participating banks.
BY THE COURT:
s/Ann D. Montgomery
ANN D. MONTGOMERY
U.S. DISTRICT JUDGE
Dated: May 9, 2011.
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