Insurance Co. of North America v. Morris

• Decision Date: 14 July 1998
• Docket Number: No. 96-1039,96-1039
• Citation: 981 S.W.2d 667
• Parties: 41 Tex. Sup. Ct. J. 1227 INSURANCE COMPANY OF NORTH AMERICA and Waite Hill Services, Inc., Petitioners, v. John W. MORRIS, et al., Respondents.
• Court: Texas Supreme Court

Page 667

981 S.W.2d 667

41 Tex. Sup. Ct. J. 1227

INSURANCE COMPANY OF NORTH AMERICA and Waite Hill Services Inc., Petitioners, v. John W. MORRIS, et al., Respondents.

No. 96-1039.

Supreme Court of Texas.

Argued Jan. 6, 1998.

Decided July 14, 1998.

David C. Mattka, Mark M. Donheiser, Dallas, for petitioners.

Andrew R. Harvin, James E. Doyle, Stephen H. Lee, Houston, for respondents.

GONZALEZ, Justice delivered the opinion of the Court, in which PHILLIPS, Chief Justice, ENOCH, SPECTOR, BAKER, ABBOTT and HANKINSON, Justices, joined.

This surety bond case involves issues of agency, fraud, conspiracy, state securities act violations, DTPA, and duty of good faith and fair dealing. An insurance company issued bonds to guarantee some investors' loan commitments made in connection with leveraged purchases of limited partnership interests in oil and gas partnership programs. The investors defaulted, and the insurance company honored its bonds by making payment on the notes and then demanded reimbursement from the investors pursuant to indemnification agreements. The investors counterclaimed alleging various theories of liability. At trial, the jury answers were favorable to the investors. The jury found that the investors were not liable on the promissory notes or indemnity agreements they had executed, and the trial court declared the notes, bonds, and indemnification agreements to be unenforceable. The trial court rendered a money judgment for the investors under the DTPA and for attorneys fees. The court of appeals affirmed. 928 S.W.2d 133. The principal issue is whether the surety is liable to the investors for misrepresentations the general partner's broker-dealers made to induce

their investment. We conclude that there is no evidence that the broker-dealers had actual or apparent authority to charge the surety with their misrepresentations concerning the risks and profitability potential of the oil and gas partnerships. For this reason and those explained in this opinion, we affirm in part and reverse in part the judgment of the court of appeals, and render judgment that all parties take nothing.

BACKGROUND

In the early 1980s, Commonwealth Enterprises, Inc., a Tennessee corporation, engaged in the business of structuring and syndicating interests in limited partnerships formed for the exploration, drilling, development, and production of oil and gas. Structuring these partnership interests as leveraged investments made them appealing to some investors. For an initial down payment, an investor could expect substantial federal tax deductions available for oil and gas development costs. Moreover, if the partnerships were profitable, the investors were hopeful that the oil and gas production revenues would be sufficient to pay the investor's promissory note installments as they came due.

This case concerns two of these limited partnerships, Overlord III and Overlord IV. Each limited partnership unit cost $20,000, comprising a $5,000 down payment and a $15,000 promissory note. Commonwealth assigned the limited partners' promissory notes to lenders in exchange for production loans. To make the promissory notes attractive to the lenders from which it sought the production loans, Commonwealth obtained Insurance Company of North America's ("INA") commitment to issue surety bonds guaranteeing the limited partners' promissory notes. While negotiating such credit-enhancement services, Commonwealth gave agents of INA drafts of Overlord III and IV documents, including the investor disclosure statements known as private placement memoranda ("PPMs").

INA's agents and their counsel reviewed the PPMs and other documents, evaluated the success of past Commonwealth syndications, and hired a firm to report on the geologic and economic viability of the programs. INA ultimately approved the programs, but only after Commonwealth consented to changes in the PPMs and in the fee and financing arrangement of the Overlord III and IV programs.

In the fall of 1984, Joseph Ace and Stephen Gunnels solicited the Overlord III and IV limited partnership units to John W. Morris, Rebecca S. Red, John T. and Bernice Person, Graham and Sherrie Glass, and Earl and Audrey Lowe ("the Investors"). Ace, the Administrative General Partner and Managing Broker-Dealer of Overlord III and IV, was the broker for all of the Investors except Red. Gunnels was Red's personal broker. Ace and Gunnels exaggerated the prospects and potential rewards of the Overlord programs while minimizing the risks and misrepresenting the returns on past Commonwealth programs. Ace and Gunnels touted the fact that INA had thoroughly reviewed the Overlord programs, suggesting that INA's approval and underwriting of the programs meant that they were trustworthy, solid investments expected to generate two- and three-fold returns with a minimum of risk.

Ace and Gunnels provided the Investors with the PPMs for Overlord III and IV, consisting of over 200 pages, but the Investors did not read them fully. They instead relied on the summary at the beginning of the PPMs and Ace's and Gunnels's representations concerning the programs. Both the Overlord III and IV PPMs contained the following conspicuous notice near the front of the PPMs:

NO DEALER, SALESMAN, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS ON BEHALF OF THE PARTNERSHIP OR THE GENERAL PARTNERS RELATED TO THIS OFFERING OTHER THAN AS SET FORTH IN THE OFFERING MEMORANDUM.

The Glasses, Lowes, and Persons each purchased one $20,000 unit of Overlord III. Red purchased one unit of Overlord III and two units of Overlord IV. Morris purchased two units of each program. Each of the Investors In 1985, revenues generated by the Overlord programs covered the first installment payments on the promissory notes, but the revenues ceased in 1986. The Investors defaulted on their promissory notes. ¹ The lenders demanded payment from INA on its bonds, which INA honored. INA then demanded reimbursement from the Investors pursuant to their promissory notes, which the lenders assigned to INA, and the indemnification agreements.

signed several agreements included in the back of the PPMs, including the subscription agreement, a promissory note for $15,000 per unit, a surety bond application form, and an indemnification agreement whereby the Investors (the principal on the surety bond) promised to indemnify INA in the event INA was required to honor the bond.

The Investors did not reimburse INA, and INA sued them. The Investors counterclaimed for violations of the Texas Deceptive Trade Practices Act ("DTPA"), the Texas Securities Act ("TSA"), fraud, conspiracy, and breach of the duty of good faith and fair dealing. The Investors alleged that they were fraudulently induced to purchase the Overlord investments by being misled to believe the investments were safe and low-risk. They claimed that INA was jointly responsible for the fraud for several reasons, including: (1) the surety bond and indemnification agreements were packaged with the subscription agreements in the Overlord PPMs and were simultaneously marketed to and executed by the Investors; (2) Ace and Gunnels, the investment advisers who solicited the Investors' purchases of the limited partnership interests, acted not only as sales agents for Commonwealth, but also as soliciting agents for INA's surety and indemnity agreements; (3) Ace and Gunnels promoted INA's underwriting of the Overlord programs as proof of the soundness of the Overlord programs; (4) INA reviewed the Overlord PPMs and refused to underwrite the programs until Commonwealth agreed to make structural changes to the Overlord programs; (5) INA required leveraged purchases of at least eighty percent of the partnership units in order to maximize the bond premiums it received; (6) INA knew that John Meatte, Commonwealth's president, had been enjoined by the SEC from selling unregistered securities, but failed to disclose this material information to the Investors; and (7) INA entered into a joint collection agreement with Commonwealth to pursue reimbursement from the Investors and continued its collection efforts even after discovering that Commonwealth had defrauded the Investors.

The jury found that the indemnification agreements and promissory notes did not bind the Investors to INA. The jury found, favorable to the Investors' counterclaims, that INA materially aided securities violations committed by Commonwealth, Ace, and Gunnels in the sale of the Overlord securities; that INA was liable for fraud, conspiracy to commit a fraud, and unconscionable acts in violation of the DTPA; and that INA willfully breached its duty of good faith and fair dealing toward Red. However, the jury also found that INA did not misrepresent the surety bond or INA's sponsorship, approval, affiliation, or connection with Commonwealth or the Overlord programs. The trial court rendered judgment for the Investors based upon the jury findings of unconscionable conduct under the DTPA. The court of appeals affirmed, holding that Ace and Gunnels, who furnished the Investors with the surety bond and indemnity agreements, were dual agents for INA and Commonwealth. 928 S.W.2d at 157.

We conclude that Ace's and Gunnels's actual and apparent agency authority on behalf of INA extended only to representations concerning the insurance product and not also the investment product. Consequently, there is no evidence to support the jury's verdict of fraud, conspiracy to commit fraud, or DTPA violations. We also hold that INA owed no duty of disclosure under the Texas Securities Act. However, because INA violated the Insurance Code by allowing Ace and

Gunnels to act as soliciting agents on behalf of INA even though they were not registered, we hold that the Investors' obligations under their indemnity agreements are void. Accordingly, we affirm in part and reverse in part the court of appeals' judgment, and...