Recipe to Avoid Litigation
Published on: 11/01/2007
"For the want of a nail ... the kingdom was lost ... " - Benjamin Franklin
It's funny how the little things can trip you up. When they surface later in litigation, they become magnified and can color an entire case.
Recently, I defended a national bank in two related lawsuits. The first was a class action filed in Northern Virginia on behalf of 35 disappointed investors who had lost $20 million when an investment company ("ACME") failed and was liquidated in bankruptcy. The second was filed in Georgia by a single investor who opted out of the class action in favor of bringing a separate lawsuit in its own backyard. In both lawsuits, the bank's corporate trust department served as the escrow agent for ACME and the investors for 10 years under a written escrow agreement. ACME was a customer of the bank.
Both lawsuits had their genesis in the bankruptcy proceeding. Under the plan of liquidation, and based upon information obtained in that proceeding, the investors, who were unsecured creditors, agreed to sue the bank for the deficiency in bankruptcy. The investors crafted a complaint alleging breach of contract, breach of fiduciary duty, breach of the duties of loyalty and good faith, fraud, gross negligence and willful wrongdoing, generally blamed the bank for their lost investments, and sought millions of dollars in punitive damages and attorney's fees.
Coincidentally, a second bank served as escrow agent for another group of ACME investors. These investors filed a companion class action seeking substantially the same relief from the second bank.
The written escrow agreement contained two typical provisions. It expressly required the bank, as escrow agent, to send quarterly statements to both ACME and the investors. The agreement also stated that any amendment or modification must be in writing.
The investors learned during ACME's bankruptcy that the bank stopped sending quarterly statements to the investors at ACME's request approximately 18 months before ACME's demise. The bank, to its chagrin, did not notify the investors of this change in procedure. This transgression, though innocent at the time, loomed large in the ensuing litigation.
Discovery established that certain key facts were not in dispute. The bank had a customer relationship with ACME, not with the investors, which were rural utility cooperatives scattered across the country. ACME initiated all investments. All communications to the bank about the investments and the investors came from ACME. In fact, the bank had little contact with the investors beyond mailing the quarterly statements. The bank's trust office testified that during the 10- year escrow arrangement, a few investors had asked why they received the quarterly statements and said they were not particularly helpful.
Against this backdrop, and about 18 months before ACME's collapse, a representative of ACME told the trust officer that the investors thought the quarterly statements were confusing and unnecessary, and that they no longer wished to receive them. Sounding somewhat familiar, the bank officer complied with the request immediately but did not document the request or notify the investors. However, the ACME representative and the bank officer recalled the same conversation.
For the next 18 months, ACME continued to operate without any indication of a problem. Investors came and went as they had before. Principal and interest payments were always made on time. Prior to ACME's demise, the investors had earned, on average, hundreds of thousands of dollars in interest payments. They had voiced no complaints about ACME.
Discovery also revealed this. The investors did not read their quarterly statements. They received their interest payments "like clockwork," and their return on investment exceeded the return on a bank CD. The investors did not notice that the quarterly statements had stopped. They characterized the statements as "meaningless" and "a waste of paper." Hence, they neither complained to the bank nor ACME when the statements stopped. In fact, the investors first realized during ACME's bankruptcy proceeding that the quarterly statements had been stopped 18 months earlier. The investors' silence notwithstanding, the bank officer's handling of this matter became the lynchpin of both the class action and the Georgia suit.
The investors argued that the bank breached its express duties to provide quarterly statements to them and to document any modification of the escrow agreement. They cleverly weaved this lapse in judgment into the entire fabric of their lawsuit. The bank officer's conduct, they argued, showed that the bank was guilty of gross negligence and willful disregard for the rights of others. Because the timing of ACME's request was only 18 months before its demise, the investors argued, for example, that the bank was complicit in a cover-up of ACME's alleged "Ponzi'' scheme and bad business practices that led to bankruptcy and the investors' losses. In short, the bank's breakdown gave the investors a platform for all of their various and sundry claims, most of which were otherwise strained or weakly supported by the record.
After one and a half years of litigation and several rulings on a series of motions to dismiss the original and amended complaints, and then a motion for summary judgment, the saga reached a happy ending in the class action. The court agreed with the bank on certain fundamental points. The bank's conduct did not proximately cause the investors' losses or damages. Rather, ACME's conduct did. The bank's conduct, viewed in the light most favorable to the investors, did not amount to "gross negligence," "willful wrongdoing," or "bad faith," as required by the escrow agreement as a threshold for the bank's liability. Instead, the bank committed a simple breach of contract that was not actionable under the terms of the escrow agreement. Hence, the court granted complete summary judgment in favor of the bank. In addition, the bank recovered a substantial sum of its attorney's fees.
But the bank did not escape unscathed. The plaintiff in the Georgia lawsuit re-filed in its own backyard where it was the sole telephone and cable provider, and where the bank happened to have a branch office. After a four-day jury trial, the jury awarded the plaintiff only a small fraction of what had been sued for. The jury interviews were illuminating. The bank's liability was never debated. The bank officer's decision to stop sending quarterly statements, without written notice to or the consent of the investors, was deemed to be "gross negligence." The jury thought the breach was "blatant." ''A bank should know better," one juror said. Happily though, the jury was convinced that the plaintiff made a risky investment and was "asleep at the switch until the money ran out." Consequently, the jury was comfortable giving the plaintiff "something," but not nearly what it had asked for.
Is there a lesson here? Certainly. No matter how comfortable a bank officer may become with the parties to any banking relationship, particularly a relationship of long standing, the officer must always follow the terms of the governing instrument and must document all decisions affecting the parties. Here, the bank officer had several options. For example, he could have written each investor directly to confirm ACME's request. He could have asked ACME's representative to write the investors, or to write the bank showing copies to each investor. Had the bank officer taken any of these simple steps, in all likelihood the litigation never would have occurred, or it would have been short-lived. The bottom line is the bank would have avoided substantial expense caused by protracted litigation.
Remember: it's the little things that come back to haunt you in a banking relationship, particularly when it turns into litigation.
This was written by:
- Stephen E. Baril - (804) 783-7234