In re Marderosian

• Decision Date: 22 September 1995
• Docket Number: Bankruptcy No. 94-10042. Adv. No. 94-1089.
• Citation: 186 BR 341
• Parties: In re George A. MARDEROSIAN, Debtor. AMERICAN TITLE INSURANCE CO., Plaintiff, v. George A. MARDEROSIAN, Defendant.
• Court: U.S. Bankruptcy Court — District of Rhode Island

186 B.R. 341 (1995)

In re George A. MARDEROSIAN, Debtor.

AMERICAN TITLE INSURANCE CO., Plaintiff, v. George A. MARDEROSIAN, Defendant.

Bankruptcy No. 94-10042. Adv. No. 94-1089.

United States Bankruptcy Court, D. Rhode Island.

September 22, 1995.

George A. Marderosian, East Providence, RI, pro se.

Stephen P. Sheehan, Wistow & Barylick Incorporated, Providence, RI, for plaintiff.

DECISION AND ORDER DETERMINING: (1) THAT THERE IS A DEBT; and (2) THAT SAID DEBT IS NONDISCHARGEABLE

ARTHUR N. VOTOLATO, Bankruptcy Judge.

Heard on the Complaint of American Title Insurance Company ("American Title") to determine the dischargeability of a debt allegedly owed by the Debtor, George A. Marderosian, under 11 U.S.C. § 523(a)(4). American Title contends that Marderosian, as its agent, engaged in conduct that: (1) constituted defalcation by a fiduciary; and (2) resulted in the exposure of American Title to a lawsuit by a third party. Although it was ultimately judicially determined that American Title was not required to pay damages to the third party claimant, it nevertheless contends that Marderosian is liable for the cost of legal services required to defend the third party claim, and that said legal expenses should be declared nondischargeable. Marderosian admits to the defalcation, but argues, in the alternative, that: (1) he is not liable for American Title's legal expenses; or (2) if he is so obligated, any such award is dischargeable in this bankruptcy.

BACKGROUND

The parties have stipulated to the following facts: In October 1986 George E. Marderosian, then a licensed attorney in the State of Rhode Island, entered into an agreement with American Title by which Marderosian was authorized to act as a title policy writing agent. While serving in that capacity, Marderosian (and his firm) also represented the interests of several real estate developers who were converting resort-rental apartments into "Motel Condominiums," and then promoting the sale of the converted units to separate investors. The First Circuit Court of Appeals summed up the scheme as follows:

Buyers were promised a deal where no money down was required; guaranteed they could not lose money; and assured that they would receive a five percent return on the initial purchase price in five years. Many took "this deal of a lifetime" and all learned that the deal was too good to be true.

Dean Street Development Company ("Dean Street"), a real estate development operation, would purchase already existing operating motels located in Rhode Island. . . . It would then condominimize the motel, selling market title in each separate unit with shared interest in the common areas.

To procure purchasers of these units, Dean Street promised potential buyers that they did not have to make a down payment. Dean Street wired money for the down payment into the buyers\' bank accounts prior to closing. At the closing the buyer would return the down payment to Dean Street, receive a credit toward the purchase price, and execute a note in favor of East West, an originator and servicer of mortgage loans. Usually the buyer would also execute a second mortgage in favor of Dean Street which would later be forgiven without repayment. The closings were held at the law office of George Marderosian in Providence, Rhode Island. Marderosian, an authorized agent of American Title, also acted as attorney for the buyer and seller and as settlement agent. Prior to the transaction the buyers signed a document consenting to the apparent conflict of interest by Marderosian at the closing. After the transaction the buyers would lease back the unit to a subsidiary of Dean Street which would rent out the unit. From those rentals Dean Street was supposed to pay the buyers\' mortgage payments.

American Title Ins. Co. v. East West Fin. Corp., 959 F.2d 345, 346 (1st Cir.1992) ("American Title I").

From August 1987 through September 1988, Marderosian issued numerous title insurance policies covering four of the conversion projects,¹ while simultaneously acting as the settlement agent for the seller-developers. Title policies were issued to purchasers of the individual units, and to Bay Loan and Investment Bank (hereafter "Bay Loan") and East West Financial Corporation (hereafter "East West"), which provided the financing for the individual purchasers. The policies insured both the purchasers and the lender against damage or loss arising from defects in title, but none of the policies referenced the pre-existing mortgages, or declared them as exempt from coverage. Marderosian acknowledges his obligation to use the loan proceeds to pay and to discharge the prior mortgages, and that he illegally and covertly diverted the loan proceeds to the seller, Dean Street Development Co., after retaining substantial commissions for himself. Pre-existing mortgages on at least eighty parcels were not paid, and when the scheme was finally uncovered, Bay Loan filed a notice of claim for approximately $18,000,000 with its title insurance carrier, American Title.

American Title sought a declaratory judgment in the United States District Court for the District of Rhode Island to relieve it from liability, based upon the fraud of Marderosian, Dean Street Development, etc. Bay Loan and East West counterclaimed for breach of contract and bad faith refusal of coverage by American Title. See American Title I, 959 F.2d at 345. After a bench trial, the District Court entered judgment in favor of East West and Bay Loan, but dismissed their damage claim as "premature." The Court of Appeals for the First Circuit remanded the case for a new trial on the ground that the District Court erred in allocating the burden of proof. Id. On remand, the District Court again ruled against American Title on the merits, but dismissed two of the counterclaims without prejudice on the ground that the claims were "premature." See American Title Ins. Co. v. East West Fin. Corp., 16 F.3d 449 (1st Cir.1994) ("American Title II"). On appeal the second time, the Court of Appeals again affirmed the District Court's finding that American Title was liable under its contract, but this time dismissed the damage claims with prejudice, again, due to Bay Loan's failure to prove damages. Id.

American Title now seeks to recover from Marderosian, on indemnity principles, the legal expenses it incurred in the litigation with Bay Loan, arguing that, but for Marderosian's fraud and/or defalcation, said expense would not have been incurred. American Title also requests that any award against Marderosian be declared nondischargeable pursuant to 11 U.S.C. § 523(a)(4), which exempts from discharge debts for fraud or defalcation while acting in a fiduciary capacity.

DISCUSSION, FINDINGS OF FACT AND CONCLUSIONS OF LAW

A. Is Marderosian Liable to American Title for Reimbursement of its Attorneys' fees?

In this case there is no contractual right to indemnity but under Rhode Island common law, indemnification may be based on equity principles. See Fish v. Burns Bros. Donut Shop, Inc., 617 A.2d 874, 875 (R.I.1992); Wilson v. Krasnoff, 560 A.2d 335, 341 (R.I.1989). Equitable indemnification is premised on the proposition that a party should not suffer a loss incurred by exposure to liability caused by the wrongful acts of another. See Fish, 617 A.2d at 875; Muldowney v. Weatherking Products, Inc., 509 A.2d 441, 443 (R.I.1986).

Everyone is deemed responsible for the consequences of his or her own acts. This responsibility extends not only to the person directly injured but also to the one indirectly harmed by being held liable by operation of law. . . . If another person has been compelled to pay damages that should have been paid by the wrongdoer, the latter becomes liable to the former.

Id. (citations omitted).

Under Muldowney, three elements must be shown to sustain an equitable indemnification claim. "First, the party seeking indemnity must be liable to a third party. Second, the prospective indemnitor must also be liable to the third party. Third, as between the prospective indemnitee and indemnitor, the obligation ought to be discharged by the indemnitor." Id.

The facts in this proceeding fit squarely within the Muldowney test. The initial inquiry addresses whether American Title was liable to Bay Loan under its title insurance policies. This question was extensively litigated on two occasions before the United States District Court for the District of Rhode Island, and twice by the First Circuit Court of Appeals. See American Title I, 959 F.2d 349; American Title II, 16 F.3d 449. After a second trial the District Court held, and the Court of Appeals affirmed, that American Title was liable under Bay Loan's title insurance policies. American Title II, 16 F.3d at 461. Notwithstanding judgment on the merits against American Title, the District Court dismissed, without prejudice, all but one of Bay Loan's claims on the ground that they were premature. Id. at 459. On review, the Court of Appeals dismissed Bay Loan's claim for money damages, this time with prejudice, citing as cause its failure to establish damages at both trials. Id.

The denial of Bay Loan's damage claim, with prejudice, is not fatal to American Title's right to indemnity for its related legal expenses. The holding in Muldowney requires only a finding of liability, and does not require an award of damages. Twice, Bay Loan established American Title's liability under the title insurance policies, but also failed, twice, to establish damages. The fact that American Title, however fortuitously, dodged a huge (damages) bullet does not alter the legal principles applicable to this indemnity action.

The second element required to establish Marderosian's liability to American Title is easily satisfied. Marderosian represented to Bay Loan that, from the loan proceeds he would pay off the existing encumbrances, so that Bay Loan would be the senior mortgagee. From Bay Loan's point of view this...