Costello v. Grundon

• Decision Date: 28 June 2011
• Docket Number: 10–1043,08–3990,08–3966,10–1045,08–3981,Nos. 08–3961,08–3967,10–1046,10–1059.,10–1049,10–1058,10–1056,08–3988,08–3989,s. 08–3961
• Citation: 651 F.3d 614
• Parties: John W. COSTELLO, not individually, but as Litigation Trustee Under the Comdisco Litigation Trust, Plaintiff–Appellee,v.Steven R. GRUNDON, et al., Defendants–Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

651 F.3d 614

John W. COSTELLO, not individually, but as Litigation Trustee Under the Comdisco Litigation Trust, Plaintiff–Appellee,

v.Steven R. GRUNDON, et al., Defendants–Appellants.

Nos. 08–3961

08–3966

08–3967

08–3981

08–3988

08–3989

08–3990

10–1043

10–1045

10–1046

10–1049

10–1056

10–1058

10–1059.

United States Court of Appeals, Seventh Circuit.

Argued April 6, 2010.Decided June 28, 2011.

John E. Frey, Jonathan W. Young, Attorneys, Wildman, Harrold, Allen & Dixon LLP, Chicago, IL, for Plaintiff–Appellee in Nos. 08–3961, 08–3966, 08–3981, 08–3988, 08–3989, 08–3990, 10–1045, 10–1046.Jonathan W. Young, Attorney, Wildman, Harrold, Allen & Dixon LLP, Chicago, IL, for Plaintiff–Appellee in No. 08–3967, 10–1043, 10–1049, 10–1056, 10–1058, 10–1059.Jeff D. Harris, Attorney, Figliulo & Silverman, P.C., Chicago, IL, for Defendant–Appellant.Before KANNE, ROVNER, and TINDER, Circuit Judges.TINDER, Circuit Judge.

This consolidated case comes to us on appeals from the district court's grants of summary judgment in favor of the plaintiff-appellee, John W. Costello, Litigation Trustee under the Comdisco Litigation Trust, and against defendants-appellants in an action to enforce certain promissory notes. We originally issued an opinion on October 18, 2010, affirming in part and vacating in part. Defendants-appellants filed a petition for panel rehearing, and we requested an answer, which was filed. By separate order we granted the petition and vacated the October 18, 2010 opinion and final judgment. For the reasons that follow, we vacate the grants of summary judgment in favor of the Trustee and remand for further proceedings consistent with this opinion.

I. BACKGROUND

The defendants-appellants (the “Borrowers”) are former high-level employees of Comdisco Inc., who participated in Comdisco's shared investment plan (SIP) program (“SIP Program”) offered in early 1998 by purchasing shares of Comdisco stock. One hundred percent of the stock purchase price was funded by personal loans from participating banks (“Lenders”) represented by First National Bank of Chicago (later Bank One) as their agent (the “Bank”). To secure the loans, the Borrowers executed promissory notes (“SIP Notes” or “Notes”) in their personal capacities. Comdisco chose to deal with Bank One because of the bank's experience in developing and implementing SIPs for other companies.

Comdisco guaranteed the loans as provided in a Facility and Guaranty Agreement between Comdisco and the Bank (the “Facility Agreement”). The Comdisco guaranty was “a condition to the loan arrangement” with the Bank. (SA:244.) Comdisco received the loan proceeds directly from the Lenders and held the SIP shares. It seems probable that without the guaranty, most of the loans would not have been made. SIP participants were required to purchase a minimum of 8,000 shares of Comdisco stock. At $34.50 per share, that resulted in a minimum purchase price and loan of $276,000. The loans' principal amounts ranged from $276,000 to $1,725,000. Loans were made in excess of $1,000,000 to one borrower (05–737) who reported no net worth to the Bank, to another borrower (05–745) for almost ten times his net worth, and to two other borrowers (05–735 & 05–726) for more than five times their net worths.

Comdisco introduced the SIP Program to prospective participants during a weekend meeting in Palm Springs, California. Prospective participants had to attend the meeting or listen to the presentation. The Borrowers received a binder of materials explaining the terms of the SIP Program (the “SIP Materials”). The SIP presentation and SIP Materials informed the prospective participants of various restrictions on their ability to sell the SIP shares and that they would be obligated for a specified time period to share any gains on the sale of the shares with Comdisco. More specifically, they were informed of restrictions including (a) Comdisco would hold a borrower's shares until the borrower's loan from Bank One was discharged; (b) the borrower had to deliver to Comdisco a stock power, endorsed in blank, concerning his or her shares (a blank stock power is generally required when an institution holds securities as collateral for a loan so the institution may transfer and sell the stock to satisfy the debt); (c) the borrower had to execute an irrevocable Letter of Direction with Comdisco and the Bank to ensure that all cash dividends on the shares went into the borrower's account at Bank One to pay the principal and accrued interest on the loan; (d) the proceeds from a permitted sale of the stock had to “first be used to repay the Loan,” interest and fees at Bank One; (e) the borrower paid a prepayment penalty to Bank One if the loan was paid early; and (f) the certificate representing the borrower's shares contained a legend as to the stock's restricted status. The SIP Program was structured so that, with a few exceptions, the SIP shares could not be sold during the first year of the program. An “[SIP Participant was] entitled to 100% of the gain, after payment of all amounts due on the loan, unless [the Participant] voluntarily terminate[d] [his] employment or [sold] the shares within three (3) years after purchase. In either event, the Company [was] entitled to 50% of any gain upon sale.” (SA:207.) The SIP participants were required to notify Comdisco of any intention to sell their SIP shares because Comdisco had the right to repurchase the SIP shares. The SIP Materials indicated that the promissory notes to be executed in connection with the loans had a fixed maturity date and a final balloon payment of principal and interest due at maturity. The materials also indicated that Comdisco would guarantee the SIP Notes.

The SIP Materials stated that “the Loan is not secured by the stock” (SA:226) and the “SIP shares do not serve as collateral for the loan ... [;] the loan is not a margin loan.” (SA:229.) When presenting the SIP Plan, Comdisco advised prospective participants that the “loan is not technically secured by the securities ... and this is not a margin account.” (SA:355.) During the SIP presentation, however, Comdisco was asked, “[C]an th[e] shares be used as security for other transactions or collateral for other type[s] of loans?” A Comdisco representative answered:

No, and the reason being is they are restricted from the standpoint that the company has certain rights with respect to that stock, depending upon your employment. And also there's restrictions under the terms of the bank loan that you have that there are certain things that will happen with the proceeds to the extent that you sell it before the bank loan is paid off.

So while it is not technically a secured loan, the company retains the stock physically and you cannot pledge that for other loans.

(SA:365.) In addition, the language of the Notes reflected that the stock was “Restricted Stock” and the Facility Agreement, which was incorporated into the terms of the Notes, likewise referred to the SIP shares as “Restricted Stock.”

Comdisco provided prospective SIP participants with information regarding whether (a) the proposed loans were margin loans; (b) the proposed loans were secured by the stock; (c) the stock could be pledged for another loan; (d) the proposed loans would violate or be inconsistent with Regulation G or Regulation U; and (e) Comdisco's performance of its obligations under each Loan Document (including the Facility Agreement, each Note, and each Letter of Direction), to which it was a party would violate any applicable legal requirement. The SIP Materials included Comdisco, Inc.'s 1998 Stock Option Program, which stated in a section titled, “No Illegal Transactions”:

The Program and all Stock Options granted pursuant to it are subject to all laws and regulations of any governmental authority which may be applicable thereto; and notwithstanding any provision of the Program or any Stock Options, Participants shall not be entitled to exercise Stock Options or receive the benefits thereof and the Company shall not be obligated to deliver any Common Stock or pay any benefits to a Participant if such exercise, delivery, or payment of benefits would constitute a violation by the Participant or the Company of any provision of any such law or regulation.

(SA:237–38.)

The SIP Materials described the Facility Agreement as “the agreement between Comdisco and [Bank One] establishing the loan program” and stated that “[b]y signing the Note, you ... represent that you have carefully reviewed the Facility Agreement.” (SA:225.) In the Facility Agreement, Comdisco represented and warranted that “[t]he execution and delivery of, and performance by the Company of its obligations under, each Loan Document to which it is a party will not result in a breach or violation of [or] conflict with ... any Requirement of Law,” (SA:283), which included “the Securities Act of 1933, the Securities Exchange Act of 1934, [and] Regulations G[and] U ... of the Board of Governors of the Federal Reserve System.” (SA:276.) Comdisco further represented and warranted:

No part of the proceeds of any Loan will be used in a manner which would violate, or result in a violation of, Regulation G [or] ... Regulation U.... Neither the making of any Loan hereunder nor the use of the proceeds thereof will violate or be inconsistent with the provisions of Regulation G [or] ... Regulation U....

(SA:283–84.)

In discussing Comdisco's guaranty, the Facility Agreement repeatedly referred to the “collateral securing the Guaranteed Debt.” However, the Agreement also provided:

No Collateral. Notwithstanding any reference herein to any collateral securing any of the Guaranteed Debt, it is acknowledged that, on the date hereof, neither the Company nor any Borrower has granted, or has obligation to grant, any security interest or other lien on any of its property (including, without limitation, the Restricted Stock) to the Lenders as security for the Guaranteed...