514 F.3d 1008 (9th Cir. 2008), 05-56653, Bank of New York v. Fremont General Corp.

Docket Nº:05-56653.
Citation:514 F.3d 1008
Party Name:BANK OF NEW YORK, a banking corporation organized under law of New York, Plaintiff-Appellant, v. FREMONT GENERAL CORPORATION, a California corporation, Defendant-Appellee.
Case Date:February 01, 2008
Court:United States Courts of Appeals, Court of Appeals for the Ninth Circuit
 
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514 F.3d 1008 (9th Cir. 2008)

BANK OF NEW YORK, a banking corporation organized under law of New York, Plaintiff-Appellant,

v.

FREMONT GENERAL CORPORATION, a California corporation, Defendant-Appellee.

No. 05-56653.

United States Court of Appeals, Ninth Circuit.

February 1, 2008

Argued July 9, 2007.

Submitted Aug. 16, 2007.

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[Copyrighted Material Omitted]

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COUNSEL

Robert L. Wallan (argued), Kimberly L. Buffington, Mariah L. Brandt, Pillsbury Winthrop Shaw Pittman LLP, Los Angeles, CA, for appellant Bank of New York.

Michael C. Lieb (argued), Leemore Kushner, Willenken, Wilson, Loh & Lieb, CA; Iain Nasatir, Pachulski Stang Ziehl Young Jones & Weintraub LLP, Los Angeles, CA, for appellee Fremont General Corporation.

John F. Finston, Katherine J. Eddy, Sonnenschein Nath & Rosenthal LLP, San Francisco, CA, for amicus curiae Superintendent of the State of New York as Ancillary Receiver of Fremont Indemnity Company and the New York Liquidation Bureau.

Appeal from the United States District Court for the Central District of California; Christina A. Snyder, District Judge, Presiding. D.C. No. CV-03-09238-CAS.

Before: ALEX KOZINSKI, Chief Judge, ANDREW J. KLEINFELD and RICHARD C. TALLMAN, Circuit Judges.

TALLMAN, Circuit Judge.

This case arises from a commercial bank deposit contract involving an account in which funds were held to secure the payment of claims in the highly regulated world of workers' compensation insurance. The Bank of New York ("BONY") appeals the district court's entry of partial summary judgment against it and ultimately judgment against it following a bench trial. BONY brought suit against Fremont General Corporation ("Fremont General"), the ultimate corporate parent of Fremont Indemnity Company ("Fremont Indemnity") and Industrial Indemnity Company ("Industrial Indemnity")--two California insurance companies that provided workers' compensation policies to employers in several states, including California and New York.1 BONY asserted claims for damages

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allegedly incurred as a result of Fremont General's withdrawal of $14 million from custodial accounts that Fremont Indemnity maintained at BONY. Fremont General's withdrawals violated New York Insurance law and the "custodian agreement" that Fremont Indemnity signed with BONY. According to BONY, Fremont General intentionally interfered with the custodian agreement between Fremont Indemnity and BONY, and converted the funds in the custodial accounts. We review the district court's judgment against BONY on Claim One for Interference with Contract and Claim Two for Conversion. We have jurisdiction under 28 U.S.C. § 1291, and we affirm in part, reverse in part, and remand.

I

A

Fremont Indemnity provided workers' compensation insurance services to New York residents. New York insurance law required Fremont Indemnity to maintain custodial accounts at a New York bank in trust for the benefit of Fremont Indemnity's policyholders as a condition to Fremont Indemnity writing workers' compensation insurance in New York. See N.Y. Ins. Law § 1314. By requiring insurance carriers to maintain such custodial accounts, the New York Insurance Department ensures that the carriers have adequate funds to pay claims in the event that they become insolvent. New York state law required Fremont Indemnity to enter into a Workers' Compensation Insurance Retaliatory Custodian Agreement ("custodian agreement") with BONY.2 Fremont General managed Fremont Indemnity's investments pursuant to a written Services and Management Agreement.

The custodian agreement named BONY as the custodian and barred BONY from releasing funds without a written request from Fremont Indemnity and written approval from the Superintendent of Insurance of the State of New York ("Superintendent"). The agreement provided in relevant part:

Securities placed in the custodian account shall be held by the Custodian, its successors or assigns, in custody exclusively for the Superintendent of Insurance of the State of New York, as trustee, in trust for the security of the workers' compensation insurance policyholders and claimants of the Company resident of New York State and free of any lien or other claim of the Custodian . . .

Except as hereinafter provided, no securities in this account or any of the principal cash account held pursuant to this Agreement shall be released by the Custodian except upon receipt of a written request of the Company and written approval by or in the name of the Superintendent of Insurance . . .

Custodian shall be accountable to the Superintendent of Insurance for the safekeeping of the securities and cash reserves held by it under this Agreement.

New York Insurance Law sections 1314 and 1318 permit insurance carriers to withdraw from custodial accounts interest

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earned on the deposited principal, but not the principal itself. Insurance carriers typically sweep the custodial accounts to withdraw the interest as it is earned. Fremont General, acting as Fremont Indemnity's investment manager, initially deposited in the custodial accounts interest-bearing securities--California State Veterans bonds in the amount of $10 million--that made no periodic partial principal repayments. Fremont General, however, then sought and obtained approval from the New York Insurance Department to substitute Government National Mortgage Association ("GNMA") securities in place of the interest-bearing securities.3

Because GNMA securities make periodic payments of principal along with payments of interest, the New York Insurance Department initially found them unacceptable trust deposit securities for Fremont Indemnity's custodial account. Fremont General proposed alternatives to alleviate the regulatory concerns about Fremont Indemnity potentially receiving principal payments as the GNMA securities paid principal into the custodial account. The New York Insurance Department ultimately approved substitution of GNMA securities contingent on a commitment by Fremont Indemnity's Board of Directors, who agreed by unanimous written consent to "replace any GNMA or GNMA CMO security on deposit before any return of principal is made." Here lies the genesis of the lawsuit.

In October 2000, Fremont General replaced the existing bonds in the custodial accounts with GNMA securities with a principal value of approximately $14 million. Before May 2002, all returns on investment in the custodial accounts were of interest only. The first periodic credit including partial repayment of principal occurred in May 2002. In September 2000, Fremont General gave BONY a standing order to transfer all cash in the custodial account to Fremont Indemnity's non-custodial account at J.P. Morgan Chase. Acting pursuant to that order, BONY transferred the May 2002 principal payment out of the custodial account --and continued to do so through September. Beginning in October 2002, BONY required Fremont General to send monthly letters specifying how much cash BONY should transfer. Following Fremont General's instructions, between May 2002 and April 2003, BONY transferred approximately $14 million from the custodial accounts to the J.P. Morgan Chase Account.4 New York's Superintendent of Insurance never authorized BONY to release principal held in the custodial accounts. Evidence at trial showed that some BONY employees knew about the requirement for regulatory approval of reductions in principal contained in the custodian agreement,

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but BONY nonetheless honored the requests and transferred the money.

Meanwhile, Fremont Indemnity ran into financial difficulties which ultimately resulted in the company being placed in conservatorship. In November 2000, the California Department of Insurance, Fremont Indemnity, Fremont General, and FCIG entered into a Letter Agreement of Regulatory Oversight in which the Department appointed a Special Deputy Examiner to supervise FCIG and Fremont Indemnity. This agreement prohibited Fremont Indemnity from making payment to, engaging in any transaction, or entering into any agreement directly or indirectly with Fremont General, absent the approval of the California Department of Insurance. Nor could Fremont Indemnity make any dividend payment or other distribution to Fremont General without the prior approval of the California Department of Insurance.

When FCIG's financial health further deteriorated, Fremont General, FCIG, Fremont Indemnity, and the California Department of Insurance entered into a second letter agreement in July 2002 called "Letter Agreement of Run-Off and Regulatory Oversight of the Fremont Compensation Insurance Group, Inc. Workers' Compensation Insurance Companies." Fremont Indemnity was now completely prohibited from engaging in transactions with its parent or affiliate. The district court found as a matter of fact that Fremont General never "engage[d] in any transactions that violated the [November letter agreement]," and that it "substantially complied" with the July letter agreement.

The situation worsened. On June 4, 2003, the California Department of Insurance obtained an order conserving Fremont Indemnity; shortly thereafter, the Superior Court of the State of California for the County of Los Angeles converted the conservatorship into a liquidation proceeding. After the California...

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