People ex rel. Sepulveda v. Highland Fed. Savings & Loan, B058411

CourtCalifornia Court of Appeals
Citation19 Cal.Rptr.2d 555,14 Cal.App.4th 1692
Docket NumberNo. B058411,B058411
PartiesThe PEOPLE EX REL Josefina SEPULVEDA et al., Plaintiffs and Appellants, v. HIGHLAND FEDERAL SAVINGS AND LOAN, etc., et al., Defendants and Respondents.
Decision Date26 January 1993

[14 Cal.App.4th 1697] James K. Hahn, City Atty., Stephanie Sautner and Ronald Low, Deputy City Attys., Litt, Marquez & Fajardo, Barrett S. Litt and Ben Margolis, Los Angeles, for plaintiffs and appellants.

McKenna & Fitting, Michael D. Berk, Aaron M. Peck, Theresa A. Kristovich and Carl W. Sonne, Los Angeles, for defendants and respondents.

CROSKEY, Associate Justice.

Plaintiffs appeal from the judgment of dismissal following the sustaining without leave to amend demurrers to the second amended complaint of defendants Highland Federal Bank (Highland), Ben Karmelich (Karmelich), Selina Elizabeth Pratt (Pratt), and H.F.S. Corporation (HFS; collectively, the Highland defendants). The court found the complaint failed to state a cause of action for Racketeer Influenced and Corrupt Organizations Act (RICO) (18 U.S.C. § 1961 et seq.) violations, fraud or fraudulent concealment. The court [14 Cal.App.4th 1698] further found the entire complaint, except the RICO cause of action, was barred by federal preemption.

Because the trial court erred in finding no cause of action was stated and the doctrine of federal preemption barred the state claims, we reverse the judgment.

1. The Parties

Plaintiffs consist of the People of the State of California (People) and numerous individuals, in their individual capacity and as guardians ad litem and on behalf of a class who resided in one or more of the subject slum Los Angeles City buildings (tenant plaintiffs). 1

The defendants who are parties to this appeal are Highland, Karmelich (its president), Pratt (its loan coordinator and vice-president), and HFS (its wholly owned subsidiary).

[14 Cal.App.4th 1699] Highland, a federally chartered savings and loan institution, specializes in making loans to owners of residential properties, including slum buildings in the greater Los Angeles area. Eight of the eleven slum properties listed in this complaint were financed by defendant Highland. Karmelich is both its president and chief executive officer. Karmelich also served as secretary of the board of directors of defendant Northeast. Pratt is a vice-president and loan coordinator for defendant Highland. Pratt helped Highland facilitate the rapid transfer of record ownership of slum buildings. She was also actively engaged in soliciting and arranging for uncreditworthy borrowers to assume Highland loans on those slum buildings without regard to the borrowers' ability to maintain and repair the buildings. HFS is a California corporation and a wholly owned subsidiary of defendant Highland. Among its activities is the servicing of loans made by defendant Highland. 2

2. Nature of Charging Allegations

In this action plaintiffs seek to hold the Highland defendants responsible for the continuing slum conditions of certain buildings. In addition to monetary damages and penalties the complaint seeks injunctive relief. 3

[14 Cal.App.4th 1700] The thrust of the complaint charges Highland with engaging in unfair business practices and fraud for the purpose of maximizing its profits. Such goal was achieved by creating a situation where rents, which were collectable only if the units complied with the habitability laws, were generated without the expenditure of sums necessary to ensure such compliance. Thus, the slum nature of the buildings was perpetuated and the tenant plaintiffs were defrauded of their right to a habitable dwelling.

Essentially, Highland allegedly committed such illegal activities through fraudulent loan transactions in order to avoid criminal and civil liability. Highland hid and exercised its control over the subject buildings by setting up record owners who had only token or no investment in the buildings, i.e., either such owners had insufficient assets or lacked bona fide business qualifications to obtain the loans. In general, title to the buildings was worthless since the amount of the loans exceeded the fair market value of the security. The record owners therefore were "strawmen" who were basically managers of the buildings for Highland's benefit.

It is further alleged that Highland in effect was the true beneficial owner of the buildings because it determined who would be the record owner and when the owner failed to perform, Highland replaced him or her with another whom it could control. Such transfers of record ownership also [14 Cal.App.4th 1701] served to complicate and frustrate civil and criminal prosecution for violation of the habitability law.

It was also alleged that Highland routinely facilitated the title transfer of the

buildings without the exercise of the due-on-sale clauses of the loan agreements, without requiring loan assumption by creditworthy individuals, and without scrutiny to ensure necessary repairs were made. Highland charged loan points and interest at a rate higher than those for bona fide loan transactions and utilized the entire or almost entire loan amount from the new record owner to pay off the principal, interest, penalties and arrearages owed by the former record holder. Such loans were often arranged by lender-related defendants controlled by and/or associated with Highland. Highland then allowed or caused the fraudulent documents to be recorded in order to hide their control

Finally, it was alleged the above pattern of activity by Highland was outside of and inconsistent with the normal and standard practice of lenders.


This action was filed on March 28, 1989. On June 7, 1990, a second amended complaint asserting numerous causes of action was filed, including those for RICO violations, fraud and fraudulent concealment. 4

[14 Cal.App.4th 1702] On August 6, 1990, Highland defendants filed demurrers to that complaint. They also filed a companion motion to strike. On or about October 19, 1990, plaintiffs filed joint opposition. On or about November 13, 1990, Highland defendants filed their reply.

On January 25, 1991, the court sustained certain demurrers without leave to amend. The court sustained demurrers without leave to amend as to all causes of action, except the second for RICO violations, on the ground of failure to state a cause of action (Code Civ.Proc., § 430.10, subd. (e)) because of federal preemption. As authority it relied on section 545.2 of title 12 of the Code of Federal Regulations; Fidelity Federal Savings and Loan v. De La Cuesta (1982) 458 U.S. 141, 162, 102 S.Ct. 3014, 3027, 73 L.Ed.2d 664; Wisconsin League of Financial Institutions v. Galecki (W.D.Wis.1989) 707 F.Supp. 401, 405.)

The court further sustained demurrers without leave to amend on the ground of failure to state a cause of action (Code Civ.Proc., § 430.10, subd. (e)) specifically as to the second cause of action (RICO), the 11th cause of action for fraud, and the 12th cause of action for fraudulent concealment. The court also sustained uncertainty demurrers to the entirety of the complaint with leave to amend. (Code Civ.Proc., § 430.10, subd. (f).) The motion to strike was placed off calendar.

On March 15, 1991, the court entered the order (judgment) of dismissal based on the

sustaining of the demurrers of the Highland defendants without leave to amend.

This appeal presents three basic issues: (1) Are the state claims against Highland, a federal savings and loan association, preempted by federal law? (2) If so, does federal preemption also bar the action against Karmelich, Highland's president, Pratt, its loan coordinator and a vice-president, and HFS, its wholly-owned subsidiary? (3) Does the complaint state a cause of [14 Cal.App.4th 1703] action against the Highland defendants for RICO violations, fraud, or fraudulent concealment?

1. Action Against Highland Not Barred by Federal Preemption; Federal Preemption under HOLA 5
a. Principles Applicable to Determination of Preemption

"Preemption issues are resolved through the process of statutory interpretation. [Citation.] We look to the language of the statute and to the intent of Congress." (Siegel v. American Savings & Loan Assn. (1989) 210 Cal.App.3d 953, 959, 258 Cal.Rptr. 746.)

" 'In determining whether a state statute [or a state cause of action] is pre-empted by federal law and therefore invalid under the Supremacy Clause of the Constitution, our sole task is to ascertain the intent of Congress.... First, when acting within constitutional limits, Congress is empowered to pre-empt state law by so stating in express terms. Second, congressional intent to pre-empt state law in a particular area may be inferred where the scheme of federal regulation is sufficiently comprehensive to make reasonable the inference that Congress "left no room" for supplementary state regulation.... [p] As a third alternative, in those areas where Congress has [14 Cal.App.4th 1704] not completely displaced state regulation, federal law may nonetheless preempt state law to the extent it actually conflicts with federal law. Such a conflict occurs either because "compliance with both federal and state regulations is a physical impossibility," or because the state law stands "as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." Nevertheless, pre-emption is not to be lightly presumed.' (California Federal S. & L. Assn. v. Guerra (1987) 479 U.S. 272, 280-281, 107 S.Ct. 683, 689, 93 L.Ed.2d 613, 623, citations omitted.) In R.J. Reynolds Tobacco Co. v. Durham County (1986) 479 U.S. 130, 149, 107 S.Ct. 499, 511, 93 L.Ed.2d 449, 467, the court stated: 'Although the regulations are not themselves controlling on the pre-emption issue, where, as in...

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