Dell'Oca v. Bank of New York Trust Co.

• Decision Date: 29 January 2008
• Docket Number: No. A111267.,No. A112153.,A111267.,A112153.
• Citation: 71 Cal.Rptr.3d 737,159 Cal.App.4th 531
• Court: California Court of Appeals Court of Appeals
• Parties: Conrad J. DELL'OCA et al., Plaintiffs and Appellants, v. The BANK OF NEW YORK TRUST COMPANY, N.A., Defendant and Appellant.

71 Cal.Rptr.3d 737

159 Cal.App.4th 531

Conrad J. DELL'OCA et al., Plaintiffs and Appellants, v. The BANK OF NEW YORK TRUST COMPANY, N.A., Defendant and Appellant.

No. A111267.

No. A112153.

Court of Appeal, First District, Division 1.

January 29, 2008.

As Modified on Denial of Rehearing February 22, 2008.

Howard Rice Nemerovski Canady Falk & Rabkin, Ethan P. Schulman, Eric S. Pettit, Law Offices of George Donaldson, George Donaldson, San Francisco, for Plaintiffs and Appellants.

Morgan, Lewis & Bockius, Vincent P. Finigan, Jr., Brett M. Schuman, Robert A. Bailey, Umung Varma, San Francisco, for Defendant and Appellant.

STEIN, J.

Plaintiffs Conrad J. Dell'Oca et al. brought suit against a number of defendants including the Bank of New York Trust Company (BNY), seeking damages for investment losses. A jury returned a verdict in favor of plaintiffs against BNY on some, but not all, of their claims. The trial court granted a new trial unless plaintiffs consented to a substantial reduction in damages. Plaintiffs appeal from that order. Plaintiffs also appeal from an order denying their motion for partial judgment notwithstanding the verdict (JNOV), directed at the claims rejected by the jury. BNY appeals from an order denying its own motion for JNOV and also from an order awarding costs to plaintiffs. BNY also has filed a protective cross-appeal, raising issues that become relevant only if the order granting a new trial is reversed. We affirm the order granting a new trial and both orders denying the parties' respective motions for partial JNOV and JNOV. We reverse the order awarding costs.

BACKGROUND

The DFS Defendants and the Business Plan

Robert E. Vener was the president, director and controlling shareholder of DynaCorp Financial Strategies, Inc. (DynaCorp), and the president, chief executive officer, chief financial officer and director of DFS Credit Corporation (DFSCC), a wholly owned subsidiary of DynaCorp. Beginning in 1994, these entities operated under a business plan designed to profit, from buying and collecting on health care receivables. The business plan, described in private placement memoranda (PPM's), called for the creation of corporate trusts. DFSCC was the grantor and trustee of the trusts, and also their administrator.¹ DynaCorp was the beneficiary of the trusts. (In keeping with the practice of the parties, from time to time, Vener, DynaCorp., DFSCC and Trusts I, II and IV will be referred to collectively as the "DFS defendants.")

The trusts were funded by money obtained from investors (sometimes referred to as the noteholders), who received promissory notes on their investments and who were promised a stated return of interest. The PPM's recited the administrator would use trust money to purchase selected "eligible" healthcare receivables at a discounted price, paying a portion of the purchase price when the trust took possession of a receivable and the remainder when the receivable was collected. One attribute generally required of an "eligible" receivable was that it be relatively young in that no more than 90 days had elapsed from its billing date. The sums collected above and beyond the purchase price of the receivables were to be used to cover expenses, pay the promised interest to the noteholders and compensate the administrator. The PPM's cautioned potential investors that the notes involved a high degree of risk and should be regarded as a speculative investment.

Ultimately, four trusts were created: Trust I, Trust II, Trust III and Trust IV. Trust III later was dissolved and is not directly involved in this appeal.² The trusts continued to operate, and to pay interest to the investors, until June 2000, when it was announced they would be unable to make the scheduled payments. At that time, the trusts, collectively, owed over $50 million to the noteholders. In the end, trust receivables were auctioned off for approximately $4.4 million, which, after expenses were deducted, left $1.5 million.

The Plaintiffs and Their Claims Against the DFS Defendants

Plaintiff Conrad J. Dell'Oca, trustee of the Dell'Oca Family Trust, had purchased notes from Trusts I and IV. Plaintiffs James P. and Karen Brainerd, trustees of the James P. Brainerd and Karen M. Brainerd Revocable Trust, had purchased notes from Trust II. Plaintiffs, on behalf of themselves and other persons who had purchased or otherwise acquired and held notes from the trusts, brought suit against the DFS defendants, and others, to recover damages resulting from the collapse of the trusts and related relief. According to plaintiffs, the DFS defendants had engaged in what was in essence a "Ponzi" scheme, where later-invested funds—particularly funds invested in Trust IV—were used to make the interest payments on earlier-invested funds.

Plaintiffs claimed the DFS defendants devised various schemes that allowed them to conceal that investor funds were being used for an improper purpose. As relevant here, plaintiffs claimed the DFS defendants used over $4 million from Trust IV to purchase healthcare receivables from Trusts I and II, violating the requirement that receivables be purchased directly from healthcare providers. Plaintiffs claimed the receivables Trust IV purchased from Trusts I and II were old and uncollectible, effectively ensuring that noteholders investing in Trust IV would recover little, if anything, on their investments. Plaintiffs also claimed the DFS defendants improperly shifted funds between trusts by asserting the transfers of funds were "deposit error corrections" or "repayments of fees." As a result of these actions, the trusts improperly commingled funds, generated fees for the administrator based on unauthorized and improper purchases, and concealed from investors that the trusts were not generating income.

BNY: The Indenture Trustee

BNY's role in all of this was to be the indenture trustee to Trusts I, II and IV, under separate indenture agreements for each trust. (Another entity, Rivkin Radler, had been indenture trustee to Trust III, but as noted earlier, Trust III was dissolved.) An indenture trustee is created to handle debt securities, for the purposes of providing limited protection to investors. (See 15 U.S.C. § 77bbb.) In their book, Corporate Trust Administration and Management (5th ed.1998), Robert I. Landau and John E. Krueger explain the basic form: "The trust indenture is a device by which a corporation ... borrows money from the general public or large institutional investors to issue securities.... The indenture provides the terms and conditions on which credit is extended; restricts the activities of the issuing corporation ... as long as the indenture securities are outstanding; sets forth remedies available to the security holders if there is a default in payment on the debt securities or in the terms of the indenture contract; and otherwise defines the rights, duties, and obligations of the obligor company ..., the security holders, and the trustee or trustees named in the instrument. If the indenture obligations are to be secured, the indenture creates or pledges the security and explains the terms and conditions for dealing with the security." (Id. at p. 22.) As plaintiffs' witness explained, the indenture trustee monitors the provisions of the loan agreements. It authenticates documents, and holds collateral. If there is a default, the indenture trustee takes charge of the assets and takes such steps as are required or allowed by the indenture agreement.

It will be recalled each trust had its own trustee, DFSCC, and each also had an administrator whose obligation was to manage the trust assets in accordance with the trust documents. BNY's responsibilities obligations and legal liability as indenture trustee are not to be confused with those of the trustee or the administrator. It generally is acknowledged that the indenture does not create a trust relationship in the customary sense. (Landau & Krueger, Corporate Trust Administration and Management, supra, at p. 23.) "An indenture trustee is not subject to the ordinary trustee's duty of undivided loyalty. Unlike the ordinary trustee, who has historic common-law duties imposed beyond those in the trust agreement, an indenture trustee is more like a stakeholder whose duties and obligations are exclusively defined by the terms of the indenture agreement." (Meckel v. Continental Resources Co. (1985) 758 F.2d 811, 816.)³

The indenture agreements involved here are lengthy, detailed and complicated. The agreement for Trust I, for example, is comprised of 13 articles set forth over 84 single-spaced typed pages, plus a 19-page "First Supplemental Indenture." The agreement for Trust IV is comprised of 13 articles set forth over 79 single-spaced typed pages. In brief, under the terms of the agreements, BNY held a security interest in the trust assets that enabled it to take possession of those assets in the event of a default. In addition, as plaintiffs put it, BNY held the "purse strings," meaning it had control over the funds. The indenture agreements specified how and when BNY could release funds. BNY also had the obligations of authenticating the notes issued to the investors, processing instructions for transfers of money, and serving as a repository for documents. Article 6 sets forth the bulk of BNY's obligations as Indenture Trustee, and also includes a number of provisions designed to limit or eliminate BNY's liability for investment decisions or for the ill-advised or wrongful conduct of the administrator. Among other provisions, Article 6 recites that the Indenture Trustee "undertakes to perform such duties and only such duties as are expressly set forth in this Indenture." (Art. 6, § 6.1(a)(1).) It allows BNY to "conclusively rely on the instructions provided by the Administrator ... as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to...