Hartford Acc. and Indem. Co. v. Sullivan

• Decision Date: 06 July 1988
• Docket Number: Nos. 87-1784,87-1843,s. 87-1784
• Parties: HARTFORD ACCIDENT AND INDEMNITY COMPANY, Plaintiff-Appellant, v. Michael SULLIVAN, Defendant-Third-Party-Plaintiff-Appellee, v. FORD CITY BANK, Third-Party-Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 377

846 F.2d 377

10 Fed.R.Serv.3d 1331

HARTFORD ACCIDENT AND INDEMNITY COMPANY, Plaintiff-Appellant, v. Michael SULLIVAN, Defendant-Third-Party-Plaintiff-Appellee, v. FORD CITY BANK, Third-Party-Defendant-Appellant.

Nos. 87-1784, 87-1843.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 8, 1988.

Decided April 28, 1988.

Rehearing and Rehearing En Banc Denied July 6, 1988.

Kenneth R. Gaines, Altheimer & Gray, Chicago, Ill., for appellant.

Stephen B. Diamond, Beeler, Schad & Diamond, P.C., Chicago, Ill., for appellee.

Before POSNER, COFFEY, and EASTERBROOK, Circuit Judges.

POSNER, Circuit Judge.

This diversity case presents questions of federal jurisdiction and Illinois tort law in an unseemly setting of bank fraud and attorney misconduct. In the early 1970s Michael Sullivan, a successful real estate lawyer and broker and a stockholder of the Ford City Bank, would refer clients to William Quinn, an officer of the bank, for loans and other bank services. In exchange Quinn would refer legal business to Sullivan. (Sullivan may have violated the Illinois Code of Professional Responsibility, which in Canon 2 provides that "a lawyer shall not promise or give another person anything of value to initiate a contact with a prospective client on behalf of the lawyer." Ill.Rev.Stat. ch. 110A, foll. p774, Rule 2-103(d).) One of Quinn's customers was Richard Orlak. He was a tile contractor with ambitions to be something grander, and a client of Sullivan. In February 1970 he wanted to borrow $6,000, but he could not obtain a loan in that amount from any bank because of his poor credit history, which included a bankruptcy. He turned to Sullivan for help, and Sullivan, although he knew about the bankruptcy, recommended Orlak to Quinn, who approved Orlak's application for the loan. Orlak did not disclose his bankruptcy on the application, although the application form required him to list all bankruptcy proceedings in which he had been involved.

The $6,000 loan inaugurated a substantial relationship between Orlak and the Ford City Bank. By the summer of 1972 Orlak, through a series of loans approved by Quinn and by another bank officer, Bruce Beede, owed the bank some $500,000. Sullivan did not participate in the negotiations for these loans, but, as Orlak's lawyer, was aware of them.

That summer Orlak got wind of an unimproved 17-acre parcel of land, later dubbed Neuport Estates, that was for sale for $190,000. Beede, Quinn, Orlak--and Sullivan--hatched a fraudulent plan to obtain financing for the purchase and development of the parcel. This plan included the formation of a partnership, in which Orlak and Sullivan would be disclosed partners and Quinn and Beede undisclosed ones, to buy the land; the concealment from the bank's executive committee not only of the undisclosed (and unlawful) partnership interests of the bank officers but also of Orlak's bankruptcy and of the purchase price; and the submission of an appraisal of the property as worth $540,000 developed, without revealing that it was as yet undeveloped. By means of these representations the partnership obtained a loan from the bank for $250,000, later raised to $270,000. The loan was secured by the land, which was placed in a land trust ("Land Trust No. 300"). An Illinois land trust is like a mortgage, so the bank corresponded to a mortgagee and the partnership to a mortgagor. Sullivan signed a personal guarantee of the trust's debts. The guarantee figured in the trial, but as our disposition renders the guarantee issues moot we shall omit them to simplify the opinion.

For the next two years Orlak continued to borrow money fraudulently from the bank, using the good offices of Quinn and Beede. None of the loans was intended for the Neuport Estates project, and Sullivan, although he continued to represent Orlak, was not involved in negotiating any of them. However, Orlak used some of the proceeds of the loans to pay interest on the Neuport Estates loan--and Sullivan knew this, as he admitted in his deposition, and he also knew that Orlak was in financial trouble. Also during this period Sullivan received covert, plainly irregular cash payments from Beede. The source of these funds was the other loans, but Sullivan testified that he thought the source was the Neuport Estates loan, and the judge believed him.

Orlak's house of cards collapsed in June 1974, when Quinn, realizing that Orlak was insolvent and hoping to save his own hide, 'fessed up to the president of the Ford City Bank. Orlak shortly defaulted, owing the bank more than $2.5 million. The bank demanded that Sullivan sign over his interest in Neuport Estates, and he complied. Although the bank ended up some $1.5 million in the hole after foreclosing on Orlak's loans, Neuport Estates turned out to be one of his happier projects; the bank was able to complete and sell the project for more than the unpaid balance of the $270,000 loan and the costs of completion. It applied the proceeds of the sale to Orlak's other loans.

Hartford Accident and Indemnity Company had insured Ford City Bank against defalcations by its officers. Hartford settled Ford City's indemnity claim against it for $1.25 million plus an assignment of Ford City's legal rights. Hartford is not a citizen of Illinois, so it was able to sue the bank officers, Orlak, and Sullivan--all of whom are citizens of Illinois, as is Ford City Bank--in federal district court. The suit charged a civil conspiracy. Only Sullivan fought the suit; the others, who unlike Sullivan had been prosecuted criminally, either settled or defaulted. Sullivan filed a third-party complaint against Ford City, seeking to recover the amount that Ford City had realized from the sale of Neuport Estates over and above the amount owed the bank under Land Trust No. 300. Sullivan's principal ground was that the bank had breached a fiduciary duty to him by applying the proceeds to Orlak's other loans. He also made this ground the basis of a counterclaim (really a set off) against Hartford.

Hartford's claim against Sullivan, and Sullivan's counterclaim against Hartford and third-party complaint against Ford City, were tried together, resulting in a decision by Judge Leighton that Sullivan was not liable to Hartford--because his participation in the conspiracy had been limited to the Neuport Estates loan, on which Ford City had lost no money--but that Ford City was liable to Sullivan to the tune of $280,000. The judge dismissed Sullivan's counterclaim against Hartford. Hartford and Ford City appeal from the judgments against them. Sullivan has not cross-appealed from the dismissal of the counterclaim.

It is convenient to take up the question of federal jurisdiction over the third-party complaint first, because that question raises in turn a question about jurisdiction over the main complaint. Since Sullivan and Ford City are citizens of the same state and their claims present no federal questions, the suit between them can be maintained in federal court, if at all, only under the doctrine of ancillary jurisdiction. Had Ford City agreed to indemnify Sullivan for any judgment that Hartford might obtain against him, Sullivan could cite much authority for deeming his third-party complaint within the federal courts' ancillary jurisdiction by reason of the great economy of trying such closely related claims in the same court. See, e.g., Revere Copper & Brass Inc. v. Aetna Casualty & Surety Co., 426 F.2d 709 (5th Cir.1970); Pennsylvania R.R. v. Erie Avenue Warehouse Co., 302 F.2d 843, 844-45 (3d Cir.1962). But, even more clearly, if Hartford had had claims against both Sullivan and Ford City arising out of Orlak's fraudulent course of borrowing, it could not have used the doctrine of ancillary jurisdiction to get around the requirement of complete diversity by first suing Sullivan and then impleading Ford City. See Owen Equipment & Erection Co. v. Kroger, 437 U.S. 365, 374, 98 S.Ct. 2396, 2402, 57 L.Ed.2d 274 (1978); American National Bank & Trust Co. v. Bailey, 750 F.2d 577, 583 (7th Cir.1984); cf. Acton Co. v. Bachman Foods, Inc., 668 F.2d 76, 79-80 (1st Cir.1982). This case is somewhere in between these examples of proper and improper invocation of ancillary jurisdiction, but we think it closer to the improper pole and therefore order the dismissal of the third-party action for lack of federal jurisdiction.

Since Hartford was suing Sullivan by virtue of an assignment of Ford City's rights, Sullivan could set up by way of defense to the suit any defenses he would have had if Ford City had sued him. And he did; he pleaded his claim to the return of his interest in Neuport Estates as a set off to Hartford's claim for the damages that he had caused the bank by his participation in a conspiracy to defraud it. However, he had no right to an affirmative judgment against Hartford, which had taken an assignment of Ford City's rights but not an open-ended assignment of Ford City's liabilities. His only method of obtaining an affirmative judgment was to sue Ford City Bank. But he could have done this (had Hartford not sued him first in federal court) only in state court, and if Hartford had later sued him in federal court he could not have consolidated his state court action with his federal court defense. It is only because Hartford sued him before he got around to suing Ford City in state court that he can argue that since he was hauled into federal court he ought to be able to try his entire "defense" there, one part of which is an offense against Ford City Bank (but as the saying goes, a good offense is the best defense).

The issues in the two suits are closely related, but they are not identical, nor logically entwined in the sense that the decision in one suit would necessarily decide the other by operation of collateral estoppel or otherwise. None of the parties argues that if Hartford wins, Ford City must win, or that if Hartford loses, Ford City must...