Federal Leasing, Inc. v. Underwriters at Lloyd's, No. 80-1363

• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)
• Writing for the Court: Before BRYAN, Senior Circuit Judge, and PHILLIPS and ERVIN; ALBERT V. BRYAN
• Citation: 650 F.2d 495
• Parties: FEDERAL 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.
• Docket Number: No. 80-1363
• Decision Date: 02 June 1981

Page 495

650 F.2d 495 FEDERAL 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. No. 80-1363. United States Court of Appeals,
Fourth Circuit. Argued Feb. 5, 1980.
Decided June 2, 1981.

Page 496

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

Page 497

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.

Page 498

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;...