Shearson Lehman Hutton, Inc. v. Wagoner

• Decision Date: 18 September 1991
• Docket Number: D,No. 1602,1602
• Citation: 944 F.2d 114
• Parties: , Bankr. L. Rep. P 74,290 SHEARSON LEHMAN HUTTON, INC., Plaintiff-Appellee, v. Walter WAGONER, Jr., Trustee, Defendant-Appellant. ocket 91-7105.
• Court: U.S. Court of Appeals — Second Circuit

Page 114

944 F.2d 114

60 USLW 2283, Bankr. L. Rep. P 74,290

SHEARSON LEHMAN HUTTON, INC., Plaintiff-Appellee, v. Walter WAGONER, Jr., Trustee, Defendant-Appellant.

No. 1602, Docket 91-7105.

United States Court of Appeals,

Second Circuit.

Argued May 28, 1991.

Decided Sept. 18, 1991.

William M. Laviano, Ridgefield, Conn., for defendant-appellant.

Kevin McCann, Hartford, Conn. (William S. Rogers, Joseph A. Aceto, Tyler Cooper & Alcorn, of counsel), for plaintiff-appellee.

Before CARDAMONE and WALKER, Circuit Judges, and McKENNA, District Judge. ^*

CARDAMONE, Circuit Judge:

After opening an account with a leading brokerage firm, the principal, by his actions, proved the truth of the old adage--that the cost of keeping one's friends does not lie in what one does for them, but in what one refrains from doing to them. Here the principal sold worthless notes and loan agreements to fellow church members, and used the proceeds to make stock trades in the name of his wholly-owned corporation, which subsequently went bankrupt.

Among the issues we must decide is whether the trustee in bankruptcy, standing in the corporation's shoes, is attempting to assert the noteholders' claims in an arbitration forum against the brokerage house.

FACTS

In July 1982 Herbert M. Kirschner, a member of Jehovah's Witnesses, formed HMK Management Corporation and, as its sole stockholder, director, and president, he managed, directed, and controlled its trading and business activities. In August, 1982 HMK opened an account with plaintiff Shearson/American Express (Shearson Lehman Hutton's predecessor) (Shearson or appellee) in Greenwich, Connecticut. A second account was opened with the same office in November, 1982 and a third in March, 1983. HMK used these accounts to execute trades on which Shearson took commissions. Because they were not discretionary accounts Shearson had no authority to execute trades on behalf of HMK, absent Kirschner's express order. When HMK opened these accounts it signed Customer Agreements with Shearson that contained arbitration clauses.

HMK's trading was quite active, and since Kirschner was a trusted customer Shearson agreed to his use of a spare desk and a video monitor on the fourth floor of its offices. Shearson's main office was on the ground floor of the same building. The rules of the New York Stock Exchange permit such use of a broker's equipment by its experienced and trusted customers. While trading as HMK, Kirschner was issuing HMK Notes and HMK Loan Agreements to fellow Jehovah's Witnesses and using the proceeds of the loans to make trades in the HMK accounts. Neither Kirschner nor HMK was licensed or registered as a broker or investment advisor, so the trades made with these funds violated Connecticut law. See Conn.Gen.Stat. § 36-474 (broker-dealer registration). The Notes and Loan Agreements were not sold or listed on any stock exchange, nor were they sold in or through any Shearson account or recommended or sold by any Shearson salesperson. All of the funds used to trade in the HMK accounts were derived from HMK checks drawn on an HMK bank account in the Connecticut Bank and Trust Company in Ridgefield, Connecticut.

In February and March, 1983 HMK experienced losses, and Shearson attempted to give Kirschner advice in order to minimize them. During these conversations, a Shearson manager asked Kirschner if he had any partners in HMK or was trading with the money of others. Kirschner represented orally, and later affirmed in writing, that he was the sole owner of HMK and was trading only with his own funds. In July, 1984 the manager of the Greenwich office became aware that Kirschner might be using loan proceeds derived from others to trade in the HMK accounts. After In 1985, HMK noteholders brought suits in federal court against Shearson. In June, 1988 the Trustee in Bankruptcy for the Estate of HMK, Walter Wagoner, Jr., filed a demand for arbitration with the arbitration division of the New York Stock Exchange. The demand stated that it was asserting contractual claims stemming from the Customer Agreements on behalf of HMK, as well as claims that Shearson had breached its fiduciary duty to HMK. Detailing the alleged breach of fiduciary duty, the demand charged that Shearson "engaged in conduct intended to strip HMK of its assets and to make unsuitable investments and to improperly invest trust funds of clients of HMK and of HMK." In particular, it alleged that Shearson knew the trading in the HMK accounts was not suitable for HMK, that Shearson manipulated Kirschner into excessively speculative trading (thereby making Kirschner its implied agent) by disregarding account opening rules and verification requirements and by providing Kirschner the use of the office and equipment, and that Shearson controlled Kirschner by "allowing him, through the use of Shearson facilities to trade with highly leveraged funds," thereby gaining for itself "extraordinarily high" commissions. Finally, it accused Shearson of churning the HMK accounts.

                meeting with Kirschner on August 6, the manager closed the HMK accounts, and terminated Kirschner's use of Shearson's fourth floor office and equipment.   Later in 1984 HMK filed for bankruptcy
                

Shearson asked the New York Stock Exchange to decline to accept the arbitration, but the Exchange refused. Shearson then moved for a temporary restraining order and a preliminary injunction in the United States District Court for the District of Connecticut (Eginton, J.). These motions were referred to a magistrate, who on December 27, 1988 issued a proposed ruling denying the motion for a preliminary injunction, holding that though it was difficult to discern precisely what the trustee was alleging, it appeared to be a "breach of contract claim" properly brought within New York's six-year statutory period. The proposed ruling also noted that the claims bordered on being frivolous, but stated that this determination should be left to the arbitrators. The magistrate also found that the trustee had standing to raise the claims at issue and that he had not waived his right to arbitration by accepting and using pretrial discovery obtained from the earlier instituted noteholders' federal actions.

On reconsideration, the magistrate reversed himself, and ruled that HMK's claims in fact sounded in tort and did not adequately allege a breach of contract. Applying the Connecticut three-year statute of limitations on tort claims, the magistrate recommended that the district court grant Shearson's motion for an injunction because the statute of limitations had expired. On February 24, 1989 the district court granted the preliminary injunction on that basis and on January 8, 1991 it granted a permanent injunction barring the trustee from instituting or pursuing arbitration of its claims against Shearson. The trustee appeals.

DISCUSSION

I Trustee's Standing

Although the district court based its decision solely on the ground that HMK's claims sound in tort and that the applicable three year statute of limitations has run as to those claims, it is necessary first to address the question of the trustee's standing to assert these causes of action. Because standing is jurisdictional under Article III of the United States Constitution, see Valley Forge Christian College v. Americans United for Separation of Church and State, Inc., 454 U.S. 464, 471-76, 102 S.Ct. 752, 757-61, 70 L.Ed.2d 700 (1982), it is a threshold issue in all cases since putative plaintiffs lacking standing are not entitled to have their claims litigated in federal court.

Shearson asserts that the trustee lacks standing because the claims he alleges on behalf of HMK's estate are really those of the noteholders, and because any action HMK itself might assert regarding Shearson's alleged participation in looting the Under the Bankruptcy Code the trustee stands in the shoes of the bankrupt corporation and has standing to bring any suit that the bankrupt corporation could have instituted had it not petitioned for bankruptcy. See 11 U.S.C. §§ 541, 542 (1988); Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 429, 92 S.Ct. 1678, 1685, 32 L.Ed.2d 195 (1972); Cissell v. American Home Assur. Co., 521 F.2d 790, 792 (6th Cir.1975), cert. denied, 423 U.S. 1074, 96 S.Ct. 857, 47 L.Ed.2d 83 (1976). The trustee insists he is not asserting the claims of the noteholders, so it is unnecessary for us to delve deeply into when, if ever, a trustee may sue a third party on behalf of the bankrupt's creditors. See Lank v. New York Stock Exchange, 548 F.2d 61, 67 (2d Cir.1977).

                corporation is barred by virtue of the fact that HMK's sole shareholder and officer was the principal that engaged in the looting.   As a rule, unless the party whose standing is at issue has a " 'personal stake in the outcome of the controversy,' " the suit does not meet the case or controversy requirement of the Constitution.  Warth v. Seldin, 422 U.S. 490, 498-99, 95 S.Ct. 2197, 2205, 45 L.Ed.2d 343 (1975) (quoting Baker v. Carr, 369 U.S. 186, 204, 82 S.Ct. 691, 703, 7 L.Ed.2d 663 (1962)).   A party must "assert his own legal rights and interests, and cannot rest his claim to relief on the legal rights or interests of third parties."  Id. 422 U.S. at 499, 95 S.Ct. at 2205.   In our analysis of the question presented, the "case or controversy" requirement coincides with the scope of the powers the Bankruptcy Code gives a trustee, that is, if a trustee has no power to assert a claim because it is not one belonging to the bankrupt estate, then he also fails to meet the prudential limitation that the legal rights asserted must be his own
                

Nevertheless, we do need briefly to explore when it is that a trustee may assert claims on behalf of the corporation's creditors--as opposed to those of the corporation itself--in order to clarify what types of claims belong to a corporation and what types of claims belong to its bondholders and other creditors. We then...