In re First American Mortg. Co., Inc., Bankruptcy No. 85-B-1987-JS

• Decision Date: 23 June 1992
• Docket Number: Adv. No. 87-0185B.,Bankruptcy No. 85-B-1987-JS
• Parties: In re FIRST AMERICAN MORTGAGE CO., INC., Debtor. Gordon ROSENBERGER, et al., Plaintiffs, v. FINANCIAL SERVICES GROUP, INC., et al., Defendants.
• Court: U.S. Bankruptcy Court — District of Maryland

143 B.R. 665 (1992)

In re FIRST AMERICAN MORTGAGE CO., INC., Debtor Gordon ROSENBERGER, et al., Plaintiffs, v. FINANCIAL SERVICES GROUP, INC., et al., Defendants.

Bankruptcy No. 85-B-1987-JS, Adv. No. 87-0185B.

United States Bankruptcy Court, D. Maryland.

June 23, 1992.

H. Alan Young, Young & Goldman, Alexandria, Va., for plaintiffs.

Michael McGettigan, Murphy, McGettigan & West, P.C., Alexandria, Va., for defendant Financial Services Group, Inc.

Michael D. Colglazier, David P. King, Hogan & Hartson, Baltimore, Md., for defendant MD. Nat. Bank (Successor to Equitable Bank, N.A.).

Richard W. Bryan, Jackson & Campbell, P.C., Washington, D.C., for defendant Francis X. Lambert.

MEMORANDUM OPINION GRANTING DEFENDANT MARYLAND NATIONAL BANK'S MOTION FOR SUMMARY JUDGMENT

JAMES F. SCHNEIDER, Bankruptcy Judge.

FINDINGS OF FACT

1. First American Mortgage Company, Inc. "FAMCO" filed a voluntary Chapter 11 bankruptcy petition in this Court on November 15, 1985 which was subsequently converted to Chapter 7.

2. The instant complaint was originally filed on April 9, 1987 in the Circuit Court of Fairfax County, Virginia by Gordon and Mary Rosenberger against the defendants, Financial Service Group, Inc., Francis X. Lambert, Joel Stillman and Equitable Bank, N.A. Maryland National Bank is the successor to Equitable Bank, N.A. Financial Services Group, Inc. F.S.G. is a Virginia corporation engaged in providing financial advice and the management of the financial affairs of its clients. Messrs. Lambert and Stillman were agents or employees of F.S.G. None of the parties is a debtor in this Court.

3. The complaint was removed to the U.S. Bankruptcy Court for the Eastern District of Virginia, Alexandria Division by an application filed by F.S.G. on May 5, 1987. F.S.G. then moved to transfer venue to the District of Maryland which was granted by consent order P. 9 dated June 16, 1987, because of the pendency of the FAMCO bankruptcy in this Court.

4. The plaintiffs are investors who lost their investment of $80,000 in the purchase of two deed of trust notes from FAMCO. The investment was recommended by F.S.G. and the named individuals who were employees of F.S.G. The complaint alleges that the plaintiffs purchased the notes in April, 1984. F.S.G. allegedly promised to tender insured second deed of trust notes, copies of truth-in-lending statements, an amortization schedule and a certificate of insurance to the plaintiffs, in consideration for the payment of $80,000. Upon execution of the alleged contract, the Rosenbergers claim to have been entitled to an insured 16% of their investment per annum, in addition to the eventual return of their principal investment. They tendered $80,000 to F.S.G. but never received the notes, copies of the truth-in-lending statements, or an amortization schedule. Notwithstanding these breaches by F.S.G., the Rosenbergers did receive monthly interest payments of $1,174.99 from May, 1984 through November, 1985, and one additional payment on March 7, 1986. When the payments ceased, the Rosenbergers made demand for the notes from both F.S.G. and FAMCO, without success. The complaint states that "some or all of the notes originally purchased for Complainants" were assigned by FAMCO to Equitable Bank without the plaintiffs' knowledge or consent, and that Equitable Bank knew or should have known that the notes so assigned had been previously assigned to the plaintiffs.

5. The Bank acknowledged in its memorandum P. 35 that it had been assigned the notes in question "as part of the collateral for working capital loans FAMCO received from Equitable in October and November, 1985." Id. However, the Bank, through the affidavit of its Vice President, James Henry, denied any knowledge that the notes had previously been assigned to the Rosenbergers. Mr. Henry further stated that before FAMCO's collapse, he was unaware "of the pervasive fraud being carried out by Michael Clott against Equitable and others." Exhibit A to Memorandum P. 35.

6. The "pervasive fraud" mentioned above has been well documented in a number of reported decisions concerning FAMCO after it filed for bankruptcy. All of these opinions were written by then-Chief Judge Alexander Harvey II of the U.S. District Court for the District of Maryland¹. In Stratton v. Equitable Bank, N.A., 104 B.R. 713 (D.Md.1989), a case brought by the debtor's bankruptcy trustee, Judge Harvey summarized the history of FAMCO's fraudulent dealings:

FAMCO I, FAMCO II and their subsidiaries and affiliates were in the business of lending money and taking as security second and third mortgages on borrowers\' residences. These were extremely high risk loans made to individuals with poor credit backgrounds. The debtors charged extremely high rates of interest in addition to substantial servicing fees. Equitable was banker for both FAMCO I and FAMCO II. Numerous bank accounts were maintained at Equitable by FAMCO I and FAMCO II and by subsidiaries and affiliates. Between 1983 and 1985, Equitable extended credit or otherwise loaned millions of dollars to FAMCO II for its operations. At various times during the debtor\'s existence, E.F. Hutton Mortgage Corporation (hereinafter "Hutton") was the principal entity which provided funds to the debtor to be lent to borrowers. At other times, Equitable was the primary source of these funds.

As the record here shows, there were at different times two corporations known as First American Mortgage Company, Inc. In 1979, Clott formed the first such corporate entity (referred to herein as "FAMCO I"), and he alone owned all of the outstanding stock of this corporation. In October of 1982, FAMCO I was renamed MH Mortgage Company, Inc. (hereinafter "MH Mortgage"). A new corporation bearing the same name, First American Mortgage Company, Inc. (referred to herein as "FAMCO II"), was then formed. Additional stockholders joined Clott in the formation of FAMCO II. At the outset, Clott owned 49% of the outstanding stock of FAMCO II while five other individuals owned the other shares. In March of 1984, Clott became the owner of 51% of the outstanding stock of FAMCO II, with four other stockholders owning 12¼% each.

Throughout the corporate life of FAMCO II, Clott controlled the corporation, its subsidiaries and its affiliates. He was the dominant figure in operating and managing the business of the various debtors, and all major decisions were made by him. At Clott\'s direction, corporate funds were from time to time transferred from FAMCO II to MH Mortgage (which remained wholly owned by him) and to other entities. Other directors had little to do with the business operations of FAMCO II and were not aware of the magnitude and extent of the fraudulent activity which was at the very core of the debtor\'s corporate existence.

As Chairman and Chief Executive Officer of these various corporate entities, Clott, operating through FAMCO II, defrauded both large and small corporate institutions during the years 1983 to 1985, as well as countless numbers of individual investors. Both Hutton and Equitable suffered substantial losses as a result of Clott\'s fraudulent and criminal activities. Shortly after the bankruptcy of FAMCO II, each accused the other of participating in Clott\'s frauds. In the Hutton case, this Court concluded that there was no credible evidence of actionable wrongdoing by either Equitable or Hutton. 678 F.Supp. at 572. Although Equitable had learned of various irregularities in the debtor\'s operations and although some of its employees may have suspected that Clott was engaged in fraudulent activity, Equitable had no knowledge of actual fraud on the debtor\'s part. As the Court noted in the Hutton case, it would have made little sense for Equitable with knowledge that it was being defrauded to have continued to lend large sums of money to Clott and the corporations he controlled until shortly before bankruptcy proceedings were instituted. 678 F.Supp. at 580.

It was during the summer of 1985 that FAMCO II began to experience serious financial difficulties. Hutton had restricted its purchases of mortgages, and Equitable had been hesitating to extend further credit to Clott and his corporate entities. Negotiations between Equitable and Clott concerning a possible merger, acquisition or other joint enterprise failed. In July 1985, Equitable and FAMCO II entered into the so-called Mortgage Sale Service and Repurchase Agreement (hereinafter "the MSSR"). Through the MSSR, Equitable agreed to lend funds to FAMCO II for the purpose of originating mortgage loans; FAMCO II would then use the funds provided to originate new loans, and FAMCO II would then sell the loans to Equitable to be held as collateral for sums borrowed by the debtor. FAMCO II agreed to provide servicing for these mortgage loans, by collecting payments of principal and interest (including prepayments) and making monthly remittances or advances to Equitable. Under the agreement, FAMCO II was to attempt to locate ultimate purchasers of these loans.

Between July of 1985 and FAMCO II\'s cessation of operations on November 15, 1985, Equitable advanced more than $15 million to the debtor, either under the MSSR or as so-called Working Capital Loans (hereinafter the "WCL"). The WCL consisted of two loans made by Equitable to FAMCO II in October and November of 1985. On or about October 9, 1985, Equitable made a $1.5 million loan to FAMCO II, and on November 4, 1985, Equitable advanced an additional $400,000. The WCL was secured by mortgages held by Equitable in its FAMCO II portfolio and by a confessed judgment note executed by Clott and his wife individually. Sums loaned under both the MSSR and the WCL were advanced so that FAMCO II might continue its business operations. When evidence of irregularities and possible fraud came to the attention of Equitable, it declined to extend further credit to Clott and his various entities, and bankruptcy proceedings were commenced

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