EF Hutton Mortg. Corp. v. Equitable Bank, NA

• Decision Date: 25 January 1988
• Docket Number: Civ. No. H-86-2541.
• Citation: 678 F. Supp. 567
• Parties: E.F. HUTTON MORTGAGE CORPORATION, Plaintiff, v. EQUITABLE BANK, N.A., Defendant. EQUITABLE BANK, N.A., Counter-Plaintiff, v. E.F. HUTTON MORTGAGE CORPORATION and E.F. Hutton Group, Inc., Counter-Defendants.
• Court: U.S. District Court — District of Maryland

678 F. Supp. 567

E.F. HUTTON MORTGAGE CORPORATION, Plaintiff, v. EQUITABLE BANK, N.A., Defendant.

EQUITABLE BANK, N.A., Counter-Plaintiff, v. E.F. HUTTON MORTGAGE CORPORATION and E.F. Hutton Group, Inc., Counter-Defendants.

Civ. No. H-86-2541.

United States District Court, D. Maryland.

January 25, 1988.

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Howard R. Hawkins, Jr., David R. Kittay, Robert M. Horkovitch and Cadwalader, Wickersham & Taft, New York City and Phillips P. O'Shaughnessy and Sandbower, Gabler & O'Shaughnessy, P.A., Baltimore, Md., for plaintiff and counter-defendants.

John Vanderstar, Coleman S. Hicks and Covington & Burling, Washington, D.C. and Michael D. Colglazier, John H. Culver, III and Miles & Stockbridge, Baltimore, Md., for defendant and counter-plaintiff.

ALEXANDER HARVEY, II, Chief Judge.

On December 17, 1987, Michael H. Clott was sentenced by Judge Smalkin of this Court to 12½ years imprisonment, pursuant to Clott's pleas of guilty in two separate cases to charges of fraud and racketeering. United States v. Clott, Criminal No. S-87-0190 and United States v. Clott, Criminal No. S-87-0313. Clott had been Chairman and Chief Executive Officer of First American Mortgage Company, Inc. (hereinafter "FAMCO"). Operating through FAMCO, Clott had during the years 1983-1985 defrauded both large and small corporate institutions as well as countless numbers of individuals.

In sentencing Clott, Judge Smalkin observed that

the scope of the fraud which was perpetrated is one of the largest brought to prosecution in the federal system in this District. It involved victims ranging from the biggest and most sophisticated financial institutions in this ... country to people ... who lost their total life savings.... I am hard pressed to think of a more wide-ranging fraudulent scheme.

Clott's massive frauds have spawned this suit involving two large financial institutions as well as numerous other civil actions filed in this Court.¹ FAMCO ceased business operations in November of 1985. Shortly thereafter, FAMCO and its numerous subsidiaries filed voluntary petitions under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for this District. With Clott himself devoid of funds and now in prison and with FAMCO and its subsidiaries in bankruptcy, defrauded corporations and individuals are seeking in the suits now pending in this Court to recoup the substantial losses suffered by them as a result of Clott's criminal activities.

In this particular case, E.F. Hutton Mortgage Corporation (hereinafter "Hutton") has sued Equitable Bank, N.A. (hereinafter "Equitable"), and Equitable in turn has filed a counterclaim against Hutton. Both Hutton and Equitable had business relations with FAMCO during the years before its demise. Hutton advanced funds to FAMCO for the origination of mortgage loans, purchased loans from FAMCO and sold many of them to its customers throughout the nation. Equitable was FAMCO's banker and extended credit to FAMCO for its operations. Both Hutton and Equitable have suffered substantial losses, and each is attempting in this suit to salvage from the other what it has lost.

Pretrial proceedings have been extensive. Each side has engaged in full discovery, and numerous discovery and other rulings have previously been made by the Court. Presently before the Court are two motions. Hutton and E.F. Hutton Group, Inc. (hereinafter "Hutton Group"),² have filed a motion for summary judgment as to Equitable's counterclaim. Equitable in turn has filed a motion to dismiss or for summary judgment as to all counts of the amended complaint. Memoranda and numerous exhibits and affidavits have been filed in support of and in opposition to the two pending motions. Oral argument has been heard in open Court.

For the reasons to be stated herein, both motions will be granted. Summary judgment will be entered in favor of defendant Equitable as to all claims asserted against it by plaintiff Hutton in the amended complaint. Summary judgment will be entered in favor of counter-defendants Hutton and Hutton Group as to all claims asserted against them by Equitable in its counterclaim. After an exhaustive review of the massive record in this case, this Court has concluded that the substantial losses sustained by Hutton and by Equitable were caused essentially by Clott's fraudulent conduct and not by the tortious or other wrongful acts of the opposing party.

I Background

FAMCO is a Maryland corporation with its principal place of business in Baltimore. At the time of the matters in suit, Clott, a resident of Maryland, owned 51% of the common stock of FAMCO. For its own account and through its wholly-owned subsidiaries, FAMCO was in the business of lending money and taking as security second and third mortgages on borrowers' residences. These were extremely high risk loans which were made to individuals with poor credit backgrounds. FAMCO charged very high rates of interest in addition to servicing fees. The annual interest rate on a FAMCO loan was often 18% per annum, and fees charged by FAMCO often amounted to 20% or more of the face amount of the loan.

Plaintiff Hutton is a Delaware corporation with its principal place of business in Little Rock, Arkansas. Defendant Equitable is a nationally chartered banking association with its principal place of business in Baltimore. As a part of its business operations, Hutton purchased mortgage loans and then sold them to investors in the form of participation certificates and whole loan sales.

In 1983, Arthur F. Mueller, then President of Hutton, met with executives of FAMCO to discuss a business arrangement between these two firms. An agreement was later reached between FAMCO and Hutton whereby the latter would purchase mortgages originated by FAMCO. In time, plaintiff Hutton became the largest single purchaser of loans originated by FAMCO. FAMCO used money furnished by Hutton to make additional loans.

As a part of the arrangement with Hutton, FAMCO agreed to service mortgages which it had originated and which had been sold to Hutton. A subsidiary was formed, FAM Mortgage Servicing, Inc. (hereinafter "FAM Servicing"), which had the responsibility of servicing loans purchased by Hutton. FAM Servicing was responsible for collecting monthly mortgage payments from borrowers and remitting the payments to Hutton and other investors who had purchased the loans.

Before reaching its agreement with Hutton, the necessary funds for FAMCO's loans were supplied by Equitable pursuant to a line of credit extended to its customer FAMCO. Numerous bank accounts in FAMCO's name were maintained at Equitable, and between 1983 and 1985, Equitable loaned millions of dollars to FAMCO. At various times during this period, Hutton was the principal entity which provided funds for FAMCO to lend to borrowers, and at other times Equitable was the primary source of these funds.

Commencing in early 1984, FAMCO encountered problems with its servicing operations. An agreement was then reached between Hutton and FAMCO whereby the latter would service Hutton's mortgages pursuant to a program called "Mortgage Backed Security Servicing" (hereinafter "MBS Servicing"). Under this agreement, FAMCO would forward monthly principal and interest payments due on all loans sold to Hutton, whether or not FAMCO had received monthly payments from the borrowers.

In early 1985, Hutton became concerned as to its business relationship with FAMCO and decided to drastically reduce its inventory of FAMCO loans. This decision resulted in serious cash flow problems encountered by FAMCO, which turned back to Equitable to secure funds for its operations. In mid-1985, there were even discussions between FAMCO and Equitable as to the possible acquisition by the Bank of the Clott business entities. However, investigations by Equitable of FAMCO's books and records disclosed irregularities which led to a termination of these discussions.

Meanwhile, Clott had been engaging in various types of fraudulent activities. Many mortgages were double sold. A mortgage would be sold to Hutton and included in its portfolio and thereafter FAMCO would sell the same mortgage to another institution or individual. In addition, FAMCO did not remit prepayments of mortgage loans to Hutton as required by the arrangement between the parties. When a borrower would, as permitted by the mortgage, prepay the amount due on the loan, FAMCO would often keep the amount received for operating purposes, and would continue to remit to Hutton merely monthly payments as if the mortgage were still in existence.

Various misrepresentations were made by Clott to Hutton. Hutton was told that the delinquency rate of mortgages sold to it was no more than 10 or 12%, while in fact the delinquency rate was in excess of 30%. Matters came to a head in the fall of 1985. With Hutton having restricted its purchase of mortgages from FAMCO, and with Equitable having declined to extend further credit to Clott and his various entities, FAMCO soon ran out of operating capital. On November 15, 1985, FAMCO ceased operations at mid-day. That same day, Hutton sued FAMCO, Clott and some 20 of FAMCO's subsidiary and affiliated corporations. E.F. Hutton Mortgage Corporation v. First American Mortgage Company, Inc., et al., Civil No. H-85-4671. Shortly thereafter, bankruptcy proceedings were commenced.³ This action against Equitable was filed by Hutton on August 13, 1986.

II The Claims

In its amended complaint, Hutton has asserted 15 different claims against Equitable. Four claims are based on alleged violations by Equitable of various provisions of the Racketeer Influenced and Corrupt Organizations Act (hereinafter "RICO"), 18 U.S.C. § 1961 et seq. (Counts I-IV). Four claims are based on allegations of fraud. (Counts V, VIII, XII and XIV). In four other counts, Hutton seeks a recovery based on allegations of breach of trust and fiduciary duty by...