Foremost Guar. Corp. v. Meritor Sav. Bank
| Decision Date | 04 September 1990 |
| Docket Number | Nos. 88-3163,s. 88-3163 |
| Citation | 910 F.2d 118 |
| Parties | , Fed. Sec. L. Rep. P 95,410 FOREMOST GUARANTY CORPORATION, Plaintiff-Appellee, v. MERITOR SAVINGS BANK, formerly known as The Philadelphia Saving Fund Society, Defendant-Appellant, Securities & Exchange Commission, Amicus Curiae, and Epic Mortgage Inc., Delaware Corp.; Community Savings & Loan, Inc.; Dominion Federal Savings & Loan Association, federal S & L Assn.; First National Bank of Maryland; Silverado Banking Savings and Loan Association, Colo. Corp.; Unity Loan and Building Company, Ohio, Defendants. FOREMOST GUARANTY CORPORATION, Plaintiff-Appellee, v. FIRST NATIONAL BANK OF MARYLAND, Defendant-Appellant, Securities & Exchange Commission, Amicus Curiae, and Epic Mortgage Inc., Delaware Corp.; Community Savings & Loan, Inc.; Dominion Federal Savings & Loan Association, federal S & L Assn.; Meritor Savings Bank, formerly known as The Philadelphia Saving Fund Society; Silverado Banking Savings and Loan Association, Colo. Corp.; Unity Loan and Building Company, Ohio, Defendants. FOREMOST GUARANTY CORPORATION; United Guaranty Residential Insurance of Iowa, an Iowa Corp., Plaintiffs-Appellees, v. DOMINION FEDERAL SAVINGS & LOAN ASSOCIATION, federal S & L Assn., Defendant-Appellant, Securities & Exchange Commission, Amicus Curiae, and Epic Mortgage Inc., Delaware Corp.; Community Savings & Loan, Inc.; First National Bank of Maryland; Meritor Savings Bank, formerly known as The Philadelphia Saving Fund Society; Continental Federal Savings Bank, a federal savings bank; American Savings & Loan Association, an Indiana Savings and Loan Assoc., individually & on behalf of others similarly situated, Defendants. UNITED GUARANTY RESIDENTIAL INSURANCE OF IOWA; Foremost Guaranty Corporation, Plaintiffs-Appellees, v. EPIC MORTGAGE INC., Delaware Corp.; Community Savings & Loan, Inc., Defendants-Appellants, Securities & Exchange Commission, Amicus Curiae, and Dominion Federal Savings & Loan Association, federal S & L Assn.; First National Bank of Maryland; Meritor Savings Bank |
| Court | U.S. Court of Appeals — Fourth Circuit |
William A. Slaughter, argued (Warren L. Dennis, Christopher Wolf, Michael I. Endler, on brief), Ballard, Spahr, Andrews & Ingersoll, Washington, D.C., William L. Stauffer, Jr., argued (Robert I. Chaskes, on brief), Frank, Bernstein, Conaway & Goldman, Tysons Corner, Va., for defendant-appellant.
Eva Marie Carney, S.E.C., Washington, D.C., argued (Daniel L. Goelzer, Gen. Counsel, Jacob H. Stillman, Associate Gen. Counsel, Rosalind C. Cohen, Asst. Gen. Counsel, S.E.C., Arthur W. Leibold Jr., Frank J. Eisenhart, Jr., Robert M. Clark, Dechert, Price & Rhoads, Washington, D.C., Thomas A. Pfeiler, Gen. Counsel, U.S. League of Sav. Institutions, Chicago, Ill., on brief), for amicus curiae.
Edward Cyrus Winslow, III (James T. Williams, Jr., Mack Sperling, on brief), Brooks, Pierce, McLendon, Humphrey & Leonard, Greensboro, N.C., Irving P. Margulies, argued (Randal D. Shields, on brief), Weiner, McCaffrey, Brodsky & Kaplan, P.C., Washington, D.C., for plaintiff-appellee.
Before WIDENER and WILKINSON, Circuit Judges, and HAYNSWORTH, * Senior Circuit Judge.
This case involves two insurance companies, United Guaranty Residential Insurance Company (United Guaranty) and Foremost Guaranty Corporation (Foremost), who seek to rescind mortgage insurance coverage because they claim the insurance was procured by fraud. It is reported in the district court as In re Epic Mortgage Ins. Litigation, 701 F.Supp. 1192 (E.D.Va.1988). The insurance covers loans originated by EPIC Mortgage Inc. (EMI) and sold to third parties 1 either as whole loans or mortgage pass-through certificates. 2 The insurance companies based their initial underwriting decision upon representations of EMI and its parent corporation, Equity Programs Investment Corporation (EPIC). These representations pertained to the workings of the EPIC organization, the particular aspect of which now being considered is the segregation of the funds available for the payment of the underlying loans, as well as the investment of such funds. The district court found that the insurers were justified in relying upon oral representations and allowed them to rescind because facts had been misrepresented. Because papers in the insurers' possession, however, indicated either that the oral representations in question were not true, or were at the least in conflict with the written statements, we hold that the insurers were not justified in relying on the oral representations. These same contradictions should have alerted the insurers that the facts now relied upon were not as represented and called for a duty on the part of the insurers to investigate. They did not. Accordingly, we reverse the decision of the district court permitting rescission.
The history of this case is lengthy and complex. It is set out in detail in the district court's extensive findings of fact. Briefly, EPIC served as a general partner in each of a series of a great number of limited partnerships set up to buy houses from builders. To purchase a property, a limited partnership would acquire a loan from EMI and secure it with a mortgage on the property. Investors bought into the limited partnerships through periodic capital contributions.
The partnerships bought houses and held them as rental properties until they were sold, ideally after a period of four to five years. The proceeds of the sale were to be used in the following order to pay (1) the expenses of the sale; (2) the mortgage loans; (3) any advances from EPIC; (4) limited partners' capital contributions; and, finally, (5) profits, if any, to EPIC and the limited partners according to an agreed-upon formula.
EMI represented that each seller of property provided a rebate called a rental deficit contribution to the limited partnership which had purchased the property to insure that the debt service of the mortgaged properties was paid each month. The amount of the rebate was calculated according to the guidelines of a worksheet designed for that purpose. 3
Representatives of EMI met with those of the insurers on several occasions and made oral representations concerning the EPIC program. EMI represented that each partnership was formed and designed to be maintained separately. Each was to acquire a relatively small number of homes and maintain assets in the area of $4 to $5 million. Any loss incurred by one of the partnerships was to be independent from the other partnerships. The capital contributions of the limited partners were to be held solely for the benefit of that partnership. A builder rebate was also to be held exclusively for the particular partnership which generated it. Similarly, the monthly rental income from each partnership's properties was to be used only for the benefit of that partnership.
As partnerships reached their fifth year, however, they could not sell properties at a price high enough to cover the contributions of the limited partners. 4 The trouble began in early 1985, and EPIC had to camouflage the problems in order to attract new investors. Instead of taking a loss, EPIC would resyndicate the older partnerships. 5 This, however, contributed to the problem.
Because EPIC had to sell the property at a value high enough to cover the limited partnership contributions, and thus create the appearance that the concept was working, EPIC frequently asked appraisers to increase their original evaluations. In fact, EPIC routinely asked for more than one appraisal to this end. In addition, a resyndicated partnership lacked a builder to give a rebate required to fund the rental deficit contribution. As a result, the new partnership had the same property as the old and the difficulty in selling the home was merely displaced until a future time.
In addition to the resyndications, older partnerships were propped up with advances from EPIC which came from taking new partnership money and lending it to old partnerships. In spite of its oral representations concerning the independence of the individual partnerships, EPIC routinely withdrew all of the funds out of the partnerships as soon as they were received. The funds were not kept in separate accounts but rather were commingled in one large account and used to revive artificially the older, failing partnerships while immediately impairing the new partnerships from which the funds were taken.
The insurers' claim on which rescission is based is that EMI misrepresented the actual facts of the EPIC program and thus induced them to insure the loans. The insurers now claim that EPIC represented that the partnerships were separate and independent, and that funds were held in escrow, at a time when in fact the funds of all the partnerships were commingled and EPIC was using everyone's money to prop up the old partnerships; that properties of older partnerships were being sold without problems at a time when in fact EPIC's internal studies showed that the properties available to be sold could not be sold at a price sufficient to return the investors' capital; that investors were continuing to buy limited partnership interests at a time when in fact EPIC was unable to attract new investors and had stopped forming new partnerships; and that the EPIC group was in sound financial condition at a time when it was not in sound financial condition, and provided United Guaranty with false and misleading financial statements. 6
The district court found that before the insurers began insuring EPIC loans they ...
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