Federal Leasing, Inc. v. Underwriters at Lloyd's

Decision Date02 June 1981
Docket NumberNo. 80-1363,80-1363
PartiesFEDERAL LEASING, INC. et al., Appellees, and The Bank of California, N.A. et al., Plaintiffs, v. UNDERWRITERS AT LLOYD'S et al., Appellants, v. SUBURBAN TRUST COMPANY, a Maryland Corporation, Appellee, and Federal Leasing, Inc. et al., Counterdefendants.
CourtU.S. Court of Appeals — Fourth Circuit

Eugene F. Bannigan, New York City (John D. Gordan, III, Lord, Day & Lord, New York City, John E. Sandbower, III, Robert J. Carson, Phillips P. O'Shaughnessy, Smith, Somerville & Case, Baltimore, Md., on brief), for appellants.

John Doar, New York City, Benjamin Rosenberg, Baltimore, Md. (G. Stewart Webb, Jr., Venable, Baetjer & Howard, Baltimore, Md., on brief), for appellee Federal Leasing, Inc.

Michael Sandler, Washington, D. C. (John E. Nolan, Jr., Steptoe & Johnson, Washington, D. C., on brief), for appellee Suburban Trust Co.

Before BRYAN, Senior Circuit Judge, and PHILLIPS and ERVIN, Circuit Judges.

ALBERT V. BRYAN, Senior Circuit Judge:

Federal Leasing, Inc. (Federal), a Maryland corporation engaged in the lease and sale of computer equipment, brought this action to recover damages, compensatory and punitive, of certain underwriters at Lloyd's, London (Underwriters), and a number of British insurance companies for their alleged breach of various "computer equipment lease indemnity policies." 1 These policies insure Federal against losses arising from obligations incurred by it in the financing of its transactions. The District Court entered a preliminary injunction requiring Underwriters to process claims pursuant to an agreement hereinafter treated of and previously negotiated with Federal; it is from this injunction, under which they have provisionally paid claims totalling over thirty million dollars, that Underwriters appeal.

After a hearing upon affidavits and counter-affidavits, 2 the District Judge, in accord with Fed.R.Civ.P. 52(a) and 65, upon findings of fact not proven clearly erroneous and upon sound conclusions of law, passed the decree of injunction in suit. Federal Leasing, Inc. v. Underwriters at Lloyd's, 487 F.Supp. 1248 (D.Md.1980). Adopting these findings and approving the legal conclusions, we affirm.

I.

Federal purchases computers from the manufacturer and then markets them, through leases or conditional sales agreements, to commercial and government users. It borrows initial purchase money from banks, insurance companies, and other institutions (investors). In the lease transactions involved here, the purchase-money loan would be evidenced by Federal's note to the investor; to amortize the loan, Federal would assign to the investor all or part of the lease payments. In conditional sales contracts, Federal would assign the agreement with its future stream of principal and interest payments to the investor at a present-value discount. 3

Although both types of contract typically extended over several years, each permitted the user on a specified notice to terminate without penalty after a shorter "firm" period. When a user exercised this privilege, Federal became obligated to the investor for the amount still owed under the original contract. The mechanics differed in the two types of transaction, but in each case Federal would attempt to make good its loss by placing terminated equipment with a new user, and we will refer to this operation generally as "remarketing."

Prior to March 1977, early terminations were not thought to present meaningful risks. Changes in the computer equipment market had been "evolutionary" rather than "revolutionary": improved capacity came only at significantly greater cost, and older computers retained value because of inflation, because they did not deteriorate, and because their capacity could be enhanced through "add-on" equipment. Thus, a user contemplating termination would be deterred by the higher cost of replacement equipment; moreover, in conditional sales transactions the user would be deterred by the sacrifice of equity built up in the course of payment. In these circumstances Federal generally could expect to remarket terminated equipment at a rate that would satisfy its obligations.

Nevertheless, a risk was there of an upheaval in market conditions. Federal and its potential investors realized that Federal's financial structure was not equal to the demands that such a reversal, coupled with numerous terminations, would precipitate. Seeking a device which would afford investors additional security, Federal asked a Baltimore intermediary to ascertain whether Lloyd's of London would insure against the hazard that early terminations would occasion losses not recoverable through remarketing. Thus it learned that such a policy had already been devised for another computer leasing concern. One Peter Nottage, manager of a Lloyd's wholesale brokerage firm, had negotiated and drafted this prototype policy in conjunction with representatives of an underwriting syndicate at Lloyd's; Nottage now acted as broker for other potential assureds seeking the same coverage. Through Nottage, Federal first obtained coverage for a single transaction, and then a "master policy" under which individual transactions could be submitted for coverage. The master policy had a one year term commencing September 1, 1974, and was renewed for additional one-year periods in 1975 and 1976. Between 1974 and 1978 Underwriters insured Federal's transactions of approximately $130 million. Prior to March 1977, only thirteen early terminations occurred, and only seven of these led to claims against Underwriters, which paid them as they were presented.

On March 25, 1977, however, International Business Machines (IBM) introduced a new generation of computer far superior to, and far less costly than, earlier models, while simultaneously discounting its existing equipment. Federal's users thus were induced to terminate in unprecedented numbers, and the reduced market for older units effectively precluded remarketing at prices that would recoup Federal's losses. As the District Judge observed, these circumstances exampled "the very risks covered by the indemnity insurance policies," 487 F.Supp. at 1257, and in the last half of 1977 Federal presented thirty-seven claims amounting to several million dollars.

Notwithstanding its prior practice of paying claims as they were filed, Underwriters declined to honor these demands when presented. They now asserted that their master policy obligations matured only upon expiration of the entire term of each lease or conditional sales agreement, arguing that Federal's net loss was not ascertainable earlier.

This surprising interpretation placed Federal Leasing in a precarious financial position. Federal Leasing was obligated to pay investors for the losses sustained while being denied recovery from the insurers for the very risk insured against As Federal Leasing correctly asserted, the basic purpose of this indemnity insurance was to provide for the immediate payment of proper claims asserted by the investors because of terminations.

487 F.Supp. at 1257.

After Federal threatened suit, Nottage met in London with Federal's officials in February 1978. He subsequently advised Underwriters to seek accommodation with Federal; buttressing his view was the opinion of Underwriters' American counsel that the policies could not be construed to support Underwriters' position. In March 1978 Nottage, Federal officials and counsel, and counsel for Underwriters met and negotiated a compromise agreement, executed March 13 (the March 13 Agreement). Its terms, as summarized by the District Judge, were as follows:

Underwriters agreed that after a claim had been filed and Underwriters had determined that the claim appeared to be valid and that Federal Leasing was complying with the due diligence clause, Underwriters would promptly advance to the investor sufficient funds to satisfy Federal Leasing's obligations. In return, Federal Leasing agreed to pay Underwriters all proceeds it collected as a result of the remarketing of the computer equipment involved in a cancellation but not more than the amount of the loss paid by Underwriters. In addition, Underwriters agreed that seventeen outstanding claims were in fact valid, and Underwriters agreed to pay those claims.

487 F.Supp. at 1258.

This accord, effective April 1, 1978, was approved by all the underwriting syndicates which had taken portions of the risks covered by the policies. Underwriters on April 6, 1978 paid $1,581,774.16 owing on the seventeen claims and, from March 1978 to January 1979, the sum of $7,095,143.83 on eighteen more claims.

In February 1979 Underwriters ceased payments under the March 13 Agreement. Their reason, found the District Judge, was not "the discovery of any previously unknown facts which would amount to a proper defense to the claims," but merely the large number of claims then being filed. Id. The next month Underwriters appointed First National Bank of Boston as claims adjuster and declared a moratorium on further payments; they did pay three claims in March and April, however, totalling $866,149.31.

Then came the crisis for Federal:

Caught between the investors' pressing demands for payment of their legitimate claims and Underwriters' refusal to pay for these losses under the insurance policies and the March 13 Agreement, Federal Leasing filed this pending action on June 12, 1979. Since this action was filed, a few claims have been paid by Underwriters. In June 1979, a claim in the amount of.$1,789,412.19 was paid. On December 10, 1979, this Court approved the settlement of the claims of Barnett Leasing Company in the amount of approximately $1,765,000. No other claims by Federal Leasing have been paid or settled.

Federal Leasing's predicament has become more acute as a result of litigation in other courts against it. Several investors have sued Federal Leasing in other state or ...

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