National Union Fire Ins. v. Alexander

• Citation: 728 F. Supp. 192
• Decision Date: 21 December 1989
• Docket Number: No. 86 Civ. 9636 (LLS).,86 Civ. 9636 (LLS).
• Parties: NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA., Plaintiff, v. Jerry D. ALEXANDER and Margaret F. Alexander, John D. Alstadt, Arlene E. Barton, Constance L. Biddle and James E. Biddle, Theodore C. Burgdorf and Lois M. Burgdorf, Ravinder N. Chopra and Mohini Chopra, Larry J. Flynn, G. Michael Fratto, Henry R. Frost and Annette G. Frost, David H. Garfield, Lawrence L. Gore, Howard A. Johnson, Lenny A. Kark, William Pope, David J. Robert, Carl Scheer, Edward E. Singleton, John R. Smith, Donald R. Sumner, Sandra M. Wadsworth, Stephen P. Walker, III and Michael Willet, Defendants.
• Court: U.S. District Court — Southern District of New York

728 F. Supp. 192

NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA., Plaintiff, v. Jerry D. ALEXANDER and Margaret F. Alexander, John D. Alstadt, Arlene E. Barton, Constance L. Biddle and James E. Biddle, Theodore C. Burgdorf and Lois M. Burgdorf, Ravinder N. Chopra and Mohini Chopra, Larry J. Flynn, G. Michael Fratto, Henry R. Frost and Annette G. Frost, David H. Garfield, Lawrence L. Gore, Howard A. Johnson, Lenny A. Kark, William Pope, David J. Robert, Carl Scheer, Edward E. Singleton, John R. Smith, Donald R. Sumner, Sandra M. Wadsworth, Stephen P. Walker, III and Michael Willet, Defendants.

No. 86 Civ. 9636 (LLS).

United States District Court, S.D. New York.

December 21, 1989.

COPYRIGHT MATERIAL OMITTED

Lewis E. Love, Jr., D'Amato & Lynch, New York City, for plaintiff.

Leslie D. Corwin and Jeffrey M. Duban, Morrison Cohen Singer & Weinstein, New York City, for defendants.

OPINION AND ORDER

STANTON, District Judge.

National Union Fire Insurance Company of Pittsburgh ("National Union"), an issuer of financial guarantee bonds, sues to enforce indemnity agreements between itself and limited partners in a tax shelter limited partnership, and to enforce its rights as subrogee on the limited partners' promissory notes which it honored on their behalf. National Union issued bonds which guaranteed, to the partnership and to the bank that financed the partnership, that the limited partners would make all of the capital contributions represented by their promissory notes to the partnership. The defendant limited partners stopped making their required contributions, and National Union made them on their behalf. Now it sues them for reimbursement, under the indemnity agreements they gave National Union at the time it guaranteed their payments, and as subrogee on the notes on which they defaulted.

National Union moves for leave to amend the complaint, for summary judgment on its claim for reimbursement, and to strike defendants' affirmative defenses. The defendants move for summary judgment dismissing the complaint. National Union's motion for leave to amend the complaint is granted, its motion for summary judgment is denied in part and granted in part, and its motion to strike defendants' affirmative defenses is denied. The defendants' motion for summary judgment is denied.

BACKGROUND

In 1983 the defendants purchased limited partnership interests in Sunward Diversified Properties, Ltd. ("Sunward"), a Missouri limited partnership. Sunward's purpose was to raise capital by selling limited partnership interests in order to invest in other limited partnerships which owned and operated apartment complexes in Texas and Oklahoma. Investors would make a cash down payment, and sign a promissory note (the "note") for the balance of the purchase price of their limited partnership interests. The anticipated return to the limited partners included tax deductions as well as profits from the sale of the apartment complexes.

Defendants Arlene Barton, David H. Garfield, William Pope, Edward E. Singleton, and John R. Smith (collectively the "Group One defendants") signed notes that provide:

For value received, I promise to pay to the order of Sunward ... at its offices in ... Texas ... or at such other place as the Holder may designate by written notice, ____¹ and No/100 Dollars (), plus interest on or before March 15, 1984, ____ and No/100 Dollars (), plus interest on or before March 15, 1985, ____ and No/100 Dollars (), plus interest on or before March 15, 1986, ____ and No/100 Dollars (), plus interest on or before March 15, 1987, and ____ and No/100 Dollars (), plus interest on or before March 15, 1988.

Interest shall accrue from the date written above to the date of payment at the lesser of the maximum rate allowed by law or two percent (2%) above the "prime rate" then being charged (adjusted on a daily basis) by the Cullen/Frost Bank of Dallas, N.A.

* * * * * *

This Note shall be construed in accordance with the laws of the State of Texas.

The remaining defendants (collectively "the Group Two defendants") signed notes that differed from the Group One defendants' notes. Their notes did not tie the interest rate before maturity to the prime rate, but rather only provided for "interest". The notes state:

For value received, I promise to pay to the order of Sunward ... at its offices in ... Texas ... or at such other place as the Holder may designate by written notice, ____ and No/100 Dollars (), plus interest on or before March 15, 1984, ____ and No/Dollars (), plus interest on or before March 15, 1985, ____ and No/Dollars (), plus interest on or before March 15, 1986, ____ and No/Dollars (), plus interest on or before March 15, 1987, and ____ and No/Dollars (), plus interest on or before March 15, 1988.

However, the interest rate after default was tied to the prime rate:

Interest shall accrue at the lesser of the maximum rate allowed by law or two percent (2%) above the "prime rate" then being charged (adjusted on a monthly basis) by the Cullen/Frost Bank of Dallas, N.A., in the event said sums are not paid within ten (10) days from the date due the Limited Partnership.

The Sunward private placement memorandum ("PPM") stated that Sunward would assign the notes to Union Planters National Bank of Memphis (the "Bank"), in return for a loan of working capital. The PPM also provided that National Union would supply a surety bond which would guarantee payment by the limited partners of their notes to the Bank.

National Union requested the limited partners to complete applications for the bond which stated:

The Undersigned acknowledges that this Application does not bind National Union to guarantee the Undersigned's credit, but the Undersigned hereby agrees that this Application shall be the basis of the contract should National Union guarantee the Undersigned's credit and issue its surety bond, and the Undersigned, by his signature hereto, shall be bound with National Union individually and severally as a Principal under such surety bond.

A copy of the proposed bond was not provided to the defendants.

The limited partners were required to execute indemnity agreements whereby they agreed to reimburse National Union for any payments it made on the notes to the Bank on their behalf. In addition, the limited partners were required to pledge their partnership interests as security for their obligations to the surety under the indemnity agreements.

The indemnity agreements provide:

The Undersigned will protect, indemnify, and save harmless National Union from and against any and all liability, loss, costs, damages, fees of attorneys, and other expenses which National Union may sustain or incur under or in connection with the policy or bond issued to the Partnership, or in connection with this Indemnification and Pledge Agreement, for:

(a) sums paid to the Partnership or its assigns to cure the Undersigned's Default under, or to purchase the Undersigned's Note.

When the defendants failed to make payments on their notes in 1985 and 1986, National Union paid the Bank on their behalf. On December 16, 1986 National Union commenced this diversity suit. It claims that it is entitled to reimbursement, both under the indemnity agreements and as subrogee of the Bank on the promissory notes, for the funds it has paid on the defendants' behalf. National Union asserts that any personal defenses the defendants may have against the partnership are cut off because the Bank took the note as a holder in due course, and that as subrogee to the extent that it has made payments under the notes, National Union has the same rights as the Bank.

The defendants claim that National Union cannot recover under the indemnity agreements because the PPM and indemnification agreements led them to believe that National Union would issue a "typical" surety bond, which would require National Union to raise their defenses to payment on the notes. However, the bond National Union issued provided:

Defenses available to the Surety or any Principal against the Obligee or Permitted Assignee to deny payment of the Notes or of a claim under this Bond due to acts or omissions of the Obligee or Permitted Assignee, or other entity or person shall not be valid against the Permitted Assignee. Such defenses include but shall not be limited to:

a) the invalidity of any Note;

b) the illegality of any Note;

c) the unenforceability of any Note;

d) the bankruptcy of the Obligee or any Principal;

e) any defense that the Principal is under no obligation to discharge all or any part of its obligations to the Obligee, Permitted Assignee, or any other person under the Note, including any defense relating to the assignment of the Notes or any Principal(s) interest in the Obligee to the Permitted Assignee; and

f) any defense based upon the failure of any Principal to execute this Bond or the failure of the Obligee to perform its obligations under this Bond....

Defendants assert that by issuing a bond that waived their defenses to payment National Union breached its contract with them. They also claim that by failing to disclose that the bond would waive their defenses to payment, National Union committed fraud in the inducement and fraud in the factum.

Defendants argue that National Union is not subrogated to the rights of a holder in due course of the notes because the notes are nonnegotiable. Accordingly, they claim that National Union is subject to their defenses of (1) failure of consideration, (2) non-performance of a condition precedent, and (3) illegality of the transaction. Those defenses arise from Sunward's failure timely to file an amended partnership certificate, as required by Missouri law², and as called for in the Partnership Agreement³, and the PPM⁴, which would have admitted the defendants into the partnership. The certificate was filed only after Sunward filed for bankruptcy.

The defendants assert that even if the notes are negotiable, the Bank took...