F.D.I.C. v. United Pacific Ins. Co., 92-4195

• Decision Date: 29 March 1994
• Docket Number: No. 92-4195,92-4195
• Citation: 20 F.3d 1070
• Parties: FEDERAL DEPOSIT INSURANCE CORPORATION, receiver for and on behalf of Heritage Bank and Trust, Plaintiff-Appellee, v. UNITED PACIFIC INSURANCE COMPANY, a corporation; Reliance Insurance Company, a corporation, Defendants-Appellants.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1070

20 F.3d 1070

FEDERAL DEPOSIT INSURANCE CORPORATION, receiver for and on behalf of Heritage Bank and Trust, Plaintiff-Appellee, v. UNITED PACIFIC INSURANCE COMPANY, a corporation; Reliance Insurance Company, a corporation, Defendants-Appellants.

No. 92-4195.

United States Court of Appeals Tenth Circuit.

March 29, 1994.

Phillip L. Bruner of Faegre & Benson, Minneapolis, MN (Raymond M. Berry, Robert H. Henderson of Snow, Christensen & Martineau, Salt Lake City, UT with him on the brief), for defendants-appellants.

Claire L. McGuire, Sr. Counsel, F.D.I.C., Washington, DC (Mark E. Friedman of Garvey, Schubert & Barer, Portland, OR, Ann S. DuRoss, Asst. General Counsel, Colleen B. Bombardier, Counsel, F.D.I.C., Washington, DC with her on the brief), for plaintiff-appellee.

Before BALDOCK, BRORBY, and EBEL, Circuit Judges.

BALDOCK, Circuit Judge.

The Federal Deposit Insurance Corporation ("FDIC"), as receiver for Heritage Bank and Trust ("Heritage"), filed this action against Defendant United Pacific Insurance Company seeking recovery under two fidelity bonds covering dishonest acts by employees. ¹ The aggregate liability under the bonds totaled $1,450,000. A jury trial was commenced on June 10, 1992, and after five days of testimony, the jury returned a unanimous special verdict in favor of the FDIC. The jury found that John R. Starley, while an officer of Heritage, committed a dishonest act, with manifest intent to cause Heritage to sustain a loss and obtain financial benefit for himself or another person, and that the loss resulting from Starley's dishonest act was $3,333,044.

The evidence at trial established the following course of events. On November 7, 1977, Heritage, a state chartered banking institution and a member of the Federal Reserve System, opened for business in Salt Lake City, Utah. The major stockholders of Heritage were Starley and Dr. Jay McEntire, Starley's brother-in-law. Starley served as President of Heritage and was also a member of the Board of Directors.

In June 1983, Starley negotiated an arrangement whereby Heritage would enter into a large loan transaction with Andover Funding, Ltd. ("Andover"), a South Dakota corporation. Andover purportedly created a tax shelter investment involving twenty-three separate oil and gas drilling limited partnerships (known as the Transpac Partnerships), in which 873 individuals had each invested $15,000 cash and individually signed twenty-year promissory notes in the amount of $60,000 each. Andover proposed to transfer to Heritage the promissory notes, with a face value of $40 million, in exchange for a $4 million loan. The Transpac Partnerships would then purchase certificates of deposit from Heritage in the amount of $4 million, pledging the certificates to Heritage to secure the discounted notes from Andover. Andover would also pay Heritage a fee of $100,000 for entering into the loan.

At the same time that Heritage was proposing to enter into the Andover loan, McEntire entered into a proposed stock purchase agreement with John Landon, Thomas Williams, Stuart Felton, and Phillip Rennert--who were all involved in the Andover loan--to sell his controlling block of Heritage stock. Starley negotiated both the Andover loan and the stock purchase agreement for his brother-in-law McEntire, with the stock purchase being dependant upon the consummation of the Andover loan. Also at this time, at the invitation of Starley and McEntire, Landon became a member of Heritage's Board of Directors. Additionally, Starley entered into a ten-year option agreement with Williams and Landon, pursuant to which if the McEntire stock purchase agreement went into effect, Starley could require the new stockholders to purchase his Heritage stock for 1.75 times book value on demand.

Starley submitted the proposed Andover loan transaction for regulatory approval. In June 1983, the Commissioner of Financial Institutions for the State of Utah refused to grant approval and instead issued a temporary Cease and Desist Order to stop the loan transaction, deeming the Andover loan an unsafe and unsound banking practice. The Commissioner and Heritage agreed to have the loan reviewed by a Salt Lake City law firm, which issued a draft opinion on June 27, 1983. The draft opinion noted the following three concerns with the Andover loan: (1) given Andover's involvement in the creation of the promissory notes, the loan by Heritage could be deemed to be a loan not to 873 individuals but rather to one borrower, Andover, and thus could violate the limits on extension of credit to one borrower; (2) the promissory notes could be deemed to be without recourse thereby affecting the ability of the investment to operate as tax shelters for the 873 investors, and also affecting the ability of Heritage to collect on the notes at maturity; and (3) the transfer of Heritage stock ownership by McEntire to some of the limited partners in the Transpac group could result in violations by Heritage of the restrictions on loans to insiders or affiliated persons.

In July 1983, Starley informed the Commissioner that the Andover loan would not be consummated. In November 1983, Landon, Williams, Felton, and Rennert signed a written document cancelling their June 1983 agreement to purchase McEntire's Heritage stock.

In December 1983, Noram Secured Income Trust, N.V. ("Noram"), a Netherlands Antilles company, loaned Starley $515,822.42 to purchase McEntire's Heritage stock. The loan was secured only by the shares of stock that Starley intended to purchase. In exchange, Starley signed a without recourse promissory note. Starley admitted that the loan he received from Noram was high risk and that, as a banker, he wouldn't have made it, nor did he know of any banker who would.

In January 1984, Heritage issued 94,340 new shares of stock, which were purchased by John Geanoulis, Landon, and Felton. These new shares represented a control block of stock. At the time of purchase, each of the three subscribers provided an affidavit that he was acquiring the shares for his own use, and that they were not acting in concert.

Prior to the stock purchase by Geanoulis, Landon, and Felton, Starley began negotiating a loan transaction with Hartwell International, N.V. ("Hartwell"), a wholly-owned subsidiary of Noram. In February 1984, Starley arranged an agreement with Andover Finance, Ltd. ("Andover Finance") ² and Hartwell whereby Heritage would loan Hartwell $4,586,257 to be repaid on April 30, 2007. As security for the loan, Hartwell agreed to pledge 1,522 promissory notes, each payable to Andover Finance and assigned to Hartwell. The makers on the notes were individuals throughout the United States, each of whom was an investor in a Transpac partnership. Hartwell, like Andover Funding, Ltd., purportedly created a tax shelter investment. The investor notes were secured by individual certificates of deposit purchased from Heritage, totaling $5,771,611, which also had maturity dates of April 30, 2007. Heritage received a fee of $91,798. Although this loan arrangement was in substance identical to the proposed Andover loan, Starley did not notify the regulators of the loan transaction. The Hartwell loan transaction caused Heritage to be in violation of a 1982 agreement it made with the Federal Reserve to maintain a capital to asset ratio of nine percent.

During a routine visit to Heritage in March 1984, the Federal Reserve discovered the Hartwell loan transaction. The Federal Reserve determined that, on its face, the Hartwell loan transaction presented no unusual credit risk. However, the regulators expressed serious concern over the following: (1) the three new shareholders--Geanoulis, Landon, and Felton--appeared connected to companies or persons associated with the Hartwell loan transaction, (2) the three appeared to have acted in concert in the acquisition of Hartwell stock, ³ and (3) the three appeared to have financed Starley's purchase of McEntire's stock. ⁴

The Federal Reserve conducted a further investigation of the entire matter and concluded that, in apparent violation of federal and state law pertaining to a change in bank control, individuals connected to the "large and unusual" Hartwell loan transaction acquired control of Heritage prior to consummation of the loan. The report also concluded that the "curious characteristics" of the Hartwell loan transaction suggested that fraud and/or violations of federal law may be at issue. Finally, the investigation revealed that Starley acted with "negligence and a disregard for the safety and soundness" of Heritage by handling the loan transaction with a lack of knowledge about the principals involved, the purpose of the transaction, and the validity of the promissory notes. The report indicated that Starley acknowledged he knew very little about the loan transaction and "did not want to know very much because if something was wrong he did not want to be implicated."

In April 1987, one of the Andover Finance principals, Thomas Williams, pleaded guilty to securities fraud, tax fraud, and bank fraud in connection with the marketing of the Transpac oil and drilling ventures. Shortly thereafter, the Transpac investors filed class action suits, alleging securities fraud and naming Heritage as a defendant. The investors sought rescission of their investments and promissory notes, and a return of their certificates of deposit. As a result of Williams' guilty plea, on April 17, 1987, the state took control of Heritage, demanded and received Starley's resignation, and appointed an interim president. The interim president sent notice of a potential bond claim to Defendant on April 23. On April 29, Heritage was declared insolvent by the Utah State Department of Financial Institutions, and the FDIC was appointed as receiver. At this time, the FDIC discovered that Hartwell had not been in existence since 1986. First Interstate Bank acquired Heritage's assets and...