Fid. Sav. & Loan Ass'n v. Aetna Life & Cas. Corp.

• Decision Date: 31 August 1977
• Docket Number: C-45642.,No. C-51126,C-51126
• Citation: 440 F. Supp. 862
• Parties: FIDELITY SAVINGS AND LOAN ASSOCIATION, a corporation, Plaintiff, v. AETNA LIFE AND CASUALTY CORPORATION, a corporation, Fireman's Fund Insurance Company, a corporation, Republic Insurance Company, a corporation, et al., Defendants. SECURITY SAVINGS AND LOAN ASSOCIATION, a California Corporation, Plaintiff, v. FIDELITY AND DEPOSIT COMPANY OF MARYLAND, a Maryland Corporation, Defendant.
• Court: U.S. District Court — Northern District of California

440 F. Supp. 862

FIDELITY SAVINGS AND LOAN ASSOCIATION, a corporation, Plaintiff, v. AETNA LIFE AND CASUALTY CORPORATION, a corporation, Fireman's Fund Insurance Company, a corporation, Republic Insurance Company, a corporation, et al., Defendants.

SECURITY SAVINGS AND LOAN ASSOCIATION, a California Corporation, Plaintiff, v. FIDELITY AND DEPOSIT COMPANY OF MARYLAND, a Maryland Corporation, Defendant.

Nos. C-51126, C-45642.

United States District Court, N. D. California.

August 31, 1977.

COPYRIGHT MATERIAL OMITTED

John H. Finger, Hoberg, Finger & Brown, San Francisco, Cal., for plaintiff Security Sav. and Loan Ass'n.

Jon H. Kouba, Trump, Kouba & Dickson, San Francisco, Cal., for plaintiff Fidelity Sav. and Loan Ass'n.

Scott Conley, Douglas M. Moore, Jr., Sedgwick, Detert, Moran & Arnold, San Francisco, Cal., for defendants Fidelity and Deposit Co. of Maryland, Aetna Life and Cas. Co., and Fireman's Fund Ins. Co.

MEMORANDUM AND ORDER

PECKHAM, Chief Judge.

These consolidated cases arise generally from the failure of the San Francisco National Bank (hereafter "SFNB"). That bank was closed by the Comptroller of the Currency on January 22, 1965, after a period of its economic distress. On the date of closure, plaintiff Security Savings and Loan Association (hereafter "Security") had on deposit with the bank certificates of deposit totaling $600,000. The predecessors in interest to plaintiff Fidelity Savings and Loan Association (hereafter "Fidelity")¹ had on deposit $1,204,669.40, in the form of certificates of deposit and a commercial checking account. Neither plaintiff recovered its deposits in full.²

At the time of the bank's failure, both Security and Fidelity were insured by the respective defendants under a standard savings and loan association blanket bond, Form No. 22, as required by 12 C.F.R. § 563.19. Clause (E) of these bonds provided that the insured would be indemnified for, "any loss of property occurring through any other form of fraud or dishonesty by any person or persons whether employees or not." Contending that the loss of their deposits resulted from various fraudulent or dishonest acts of the SFNB, plaintiffs brought this action to recover their losses pursuant to the blanket bond.³

A brief history will help place the issues raised by the parties into context. The San Francisco National Bank began operations approximately June 1, 1962. Management of the bank was largely vested in Donald C. Silverthorne, its president and board chairman. Almost from the bank's inception, Silverthorne engaged in the practice of extending credit of the bank in exchange for the payment of "loan fees." Such fees, over and above normal interest charges, were personally pocketed by Silverthorne. In some cases they were split between Silverthorne and Mr. William S. Bennett, whose personal guarantee was frequently the basis for extension of credit. Over 60 borrowers paid loan fees kept by Silverthorne.

Most of the borrowers receiving credit in exchange for loan fees were not creditworthy. Combined with a large number of additional uncollectable loans, not involving loan fees, the assets of the bank were seriously weakened.

These conditions were discovered by the Comptroller of the Currency during the course of a routine examination of the bank conducted in May and June, 1964. The Comptroller ordered weekly visitations to the SFNB by federal bank examiners, as a means of monitoring efforts to strengthen the bank's financial position. The bank was able to meet its obligations as they fell due during the remainder of 1964 only through heavy borrowing from the Federal Reserve Bank. The SFNB did not have sufficient resources, however, to meet the demands created by a heavy concentration of certificates of deposit maturing in January, 1965. On January 22, 1965, the bank was finally closed by the Comptroller of the Currency.

In a series of pretrial rulings, this court concluded that it had jurisdiction over the subject matter of the instant controversy,⁴ that the applicable blanket bonds were sufficiently broad to encompass loss of savings and loan association funds deposited in banking institutions if such loss was caused by fraud or dishonesty,⁵ that certain claims had been waived by the parties,⁶ and, finally, that various patterns of conduct might constitute "fraud" or "dishonesty" under the terms of the bond.⁷

At trial, plaintiffs advanced three theories of recovery. The first, applicable only to the Security cause of action, is that Silverthorne fraudulently induced Security to renew a maturing certificate of deposit by making false representations as to SFNB's financial soundness. Plaintiffs' second theory, applicable to both Security and Fidelity, is that SFNB's acceptance of their respective deposits was dishonest, inasmuch as the bank was, at the time of acceptance, insolvent within the knowledge of its managing officers. Finally, both plaintiffs contend that the making of dishonest loans by the SFNB caused the bank to fail, and thus that "dishonesty" is responsible for their losses. We address these theories in turn.

(A) Security's Fraudulent Misrepresentation Claim

The facts upon which Security premises its claim of fraudulent misrepresentation may be summarized as follows. During the fall of 1964, Security had on deposit with the SFNB several certificates of deposit. One was in the amount of $250,000, with a maturity date of September 6, 1964. Another was a $700,000 certificate of deposit, maturing on October 20, 1964. The bank failed to pay the former certificate as it fell due. Concerned about that default, as well as payment of the $700,000 certificate about to mature, John J. Peters, board chairman of Security, arranged a meeting with Silverthorne to discuss these matters. Peters, accompanied by Lowell H. Duggan, a board member of Security, met with Silverthorne prior to October 20, 1964.

At that meeting, according to the uncontradicted testimony of Peters and Duggan, Silverthorne made express representations of SFNB's financial soundness. He stated that the bank's earnings were strong, that there were no particular problems with the loan portfolio, and that he expected to be able to meet withdrawal demands adequately. Silverthorne blamed the previous default on a temporary liquidity shortage induced by banking regulatory changes limiting the amount of certificates of deposit permissibly held in banks by savings and loan associations, thereby causing nonrenewal of many certificates of deposit. Peters and Duggan were aware of these regulatory changes. At no time did Silverthorne reveal that SFNB was financially unstable, that the bank was being closely monitored by the Comptroller of the Currency, that many assets of the bank were of questionable value, or that there was a possibility of financial failure.

Silverthorne promised immediate payment on the overdue certificate of deposit, but requested that payment on the $700,000 certificate be spread out over a period of months to help alleviate the liquidity crunch. Peters agreed to this arrangement. The $700,000 certificate was thereafter surrendered, and seven separate certificates in the amount of $100,000 each were issued in its stead. The first such certificate matured in November, 1964, while the others were to mature in subsequent months. As promised, the overdue $250,000 certificate was paid, as was the first maturing $100,000 certificate. No further payments were received by Security.

Security contends that the renewal of its $700,000 certificate of deposit was fraudulently induced by Silverthorne, and thus that their loss resulted from a peril insured against by the blanket bond. Both parties have looked to California law to define the elements of fraudulent misrepresentation.

A cause of action based upon fraudulent misrepresentation requires a showing of six distinct elements: (1) misrepresentation; (2) scienter; (3) intent to induce reliance; (4) actual reliance; (5) justifiable reliance; and (6) resulting damages. See Witkin, Summary of California Law, Torts § 446, at 2711. Defendant⁸ does not seriously contest the fact that Silverthorne misrepresented to Peters and Duggan the financial condition of SFNB, that Silverthorne knew these representations to be false, nor that the representations were intended to induce Security to renew its certificate of deposit. Rather, defendant's contention is that the elements of actual and justifiable reliance are absent.

Defendant's reliance argument is premised upon the contention that Silverthorne and Peters participated together in a series of questionable financial transactions between their respective institutions, and thus that Peters had knowledge of the irresponsible and unethical manner in which Silverthorne managed the SFNB. Either Peters suspected that the bank must be financially unsound and did not rely upon Silverthorne's representations, defendant contends, or Peters at the least knew enough that such reliance was unjustifiable without an independent investigation.

A brief summary of defendant's charges of unethical conduct by Peters and Silverthorne is necessary to bring the issues presented into clear focus. In substance, defendant alleges that: (1) Peters cooperated with Silverthorne to inflate the assets of SFNB by making a $5,000,000 deposit of Security funds for a short period coinciding with a date upon which SFNB (in conjunction with all other banks) had to disclose its balance sheet to the Comptroller of the Currency; (2) in an unrelated transaction, Peters arranged to inflate the assets of both Security and SFNB through a complex transaction involving the deliberate floating of two checks in such a manner as to have the same $4,000,000 appear simultaneously as assets in both institutions over the year end; and (3) Peters arranged a $250,000 deposit of Security funds in SFNB on the same day that he received a personal loan from SFNB in the amount of $300,000. The...