Here is what we have been up to NEWSLETTER
Here is what we have been up to NEWSLETTER
The ultimate deal gone bad ending up as a defendant in Federal Court. On September 23, 2011, the Judges of the Federal District Court for the Eastern District of Pennsylvania appointed Scott Sigman to the Criminal Justice Act Panel for the District. The CJA Panel is a select group of private attorneys appointed by the Court to defend people accussd of federal crimes.
The general legal principal, which even non-lawyers understand, is that individual members, shareholders, and partners are not liable for actions of a corporate entity to which they belong. However, that general principal does not seem to stop aggressive plaintiff’s attorneys from seeking to hold individuals liable for corporate wrongdoing. Moreover, despite procedural requirements that mandate fraud claims be plead with “particularity” – in other words the who, what, when and where, of the fraud - the reluctance of many Judges to dismiss claims at an early stage in the litigation has proliferated claims against individuals for wrongful corporate acts.
The undercapitalization of many entities, especially single purpose entities often used in real estate transactions, and the accompanying difficulty of collecting on any judgment that may be obtained against an undercapitalized entity obviously makes claims against individuals associated with an entity attractive. As I always tell clients, there is a big difference between liability and collectability.
The website www.vegasinc.com has a post about how one such claim against individual members of a corporate entity is playing out in a fight over the failed Foutainebleau Las Vegas resort and casino. Vegasinc reports that hedge funds, who are investors in the Fontainebleau debt, have claimed the individuals affiliated with the development entities of the resort
defrauded the lenders by failing to disclose the true cost off the project, hiding cost overruns and producing false architectural drawings to deceive the lenders, among other things.
The defendants in that case have raised a complaint common among such defendants and their counsel, namely the complaint apparently fails to state who said what to whom about the status of the failed development. Because fraud requires a plaintiff to prove, among other things, a material false statement made with knowledge of its falsity, a plaintiff should not pass go without first at least stating what the specific misrepresentation is. Even more difficult for a plaintiff to prove in a fraud claim is that a defendant knew the statement was false when he made it.
The Judge in the Fontainebleau matter has not ruled on the defendants’ motion to dismiss which seeks to have the complaint dismissed based on the lack of specificity of the fraud claim. However, assuming the complaint survives the motion, as they often do, the plaintiffs will be in a powerful position to demand a settlement with the defendants, even if the ability to ultimately prove their fraud claims is doubtful. In other words, if the plaintiffs can survive the motion to dismiss, they can extort a settlement out of the individual member defendants. We will continue to monitor this litigation and we are keeping our fingers cross that if the plaintiffs complaint does indeed fail to plead the fraud claim as procedure requires that it is dismissed.
Last week the Federal Housing Finance Agency case against Bank of American (BAC) and J.P. Morgan Chase (JPM) made headlines and moved markets. The Agency is bringing claims against BAC and JPM based upon the alleged breaches of the “representation and warranties” provisions contained in the standard Fannie Mae purchase agreement. Pursuant to Fannie Mae’s purchase agreement, if the Fannie Mae finds that any of the loans sold to it deviated from the Fannie Mae’s strict underwritting standard Fannie can demand that a bank repurchase the rotten loan or reimburse Fannie for the loss resulting for the loan.
Fannie’s demands come as old news to many small and regional lenders and mortgage originators. Over the past year, as the Fannie has felt increased pressure to recoup loses, it has stepped upon demands of smaller lenders to repurchase loans sold to it during the real estate boom. However, the FHFA’s case dwarfs Fannie previous demands against smaller lenders.
The bar on Fannie to prove a violation of a representation and warranty is set surpisingly low. Lenders who sell loans to Fannie represent and warranty “that all mortgage loan delivery data is true, correct, and complete, even for such data elements that are not required to qualify a borrower or underwrite a loan. A complete list of warranties and representations can be found in Fannie Mae’s selling guide. Fannie Mae Selling Guide
Thus, because of this broad based warranrty, even the slightest deviation from Fannie’s underwritting guidelines, such as, a borrower’s undisclosed debt, faulty appraisals based upon inappropriate comprable properties, qualify as violations of the representations and warranties provisions in the purchase agreement. Unlike BAC and JPM, smaller lenders do not have the resources to fight a protracted legal battle against Fannie. Therefore, they typically cede to Fannie’s demands and repurchase the loan at a loss.
In turn smaller lenders will often look to the mortgage insurer to make them whole for the lose or to the appraiser’s errors and ommissions carrier, if Fannie’s demand was based upon a faulty appraisal. If BAC and JPM were to join the insurers of the mortgages that the FHFA is demand reimbursment for or the E&O carriers of the appraisers, the loses to these carriers could be catastrophic. In fact, the impact may be so severe that it is conceiveable mortgage insurers such as PMI Group (PMI), MGIC Investment (MTG), and Radian (RDN) may end up being the biggest loaser in this whole mortgage mess.
I am surprised how many successful private companies can manage to avoid litigation considering the number of transactions in which they are involved. I suppose it is a testament to their business skills because a company that revels in litigating disputes usually will not last that long. Alas, like death and taxes, litigation is an inevitable reality for any company.
The litigation experience is usually an eye opener for the first time litigant. Here is part 1 in a 5 part series on what to expect your first time in litigation.
Lesson 1. Litigation Does Not Cause Money to Rain From the Sky.
When a first time plaintiff comes to me, he is at his wits end. He has tried to negotiate a settlement with his adversary. He has made reasonable concessions in an effort to try to settle. He has held off on involving lawyers. Yet, he is unable to convince the defendant to come to his senses. Moreover, first time private company plaintiffs are frustrated at the prospects of litigation because they are accustomed to – and are typically good at – bridging differences in order to come to a deal. Now, he wants justice and not only does he want what is due, but he wants the defendant’s first born as well. Or, as one first time plaintiff client recently told me “he wants to burry” the defendant.
I have bad news for you, no lawyer, as good as he or she says they are, will make the defendant cower in the corner when they are served with your complaint. Usually, just the opposite happens, they hire their own hired gun and a long complex dance beings. Unfortunately, you will not likily get your chance to bury your adversary. Even if you do, you should be prepared to wait at least two years.
So what is the lesson? Litigation is a option of last resort. It will not result in getting you paid any faster. In fact, your adversary’s attorney is likely to take his or her time with the matter in order to earn his or her fee (I know some
unscrupulous attorneys who make it a practice of telling their defendant clients the potential outcome is worst for them than it really is in order to justify their attorneys fees). I know I am spiting myself here and there is nothing I like more than litigating cases, but its true.
Need another reason to try to settle a case before resorting to litigation? Most litigation ends in settlement rather than and no one is usually burried. In fact, studies have shown that only about 1% of all civil cases filed in federal court actual go to trial.
Therefore, you should try every means possible to settle a matter before turning it over to your attorney to litigate. Those options can still include the advice of counsel, such as mediation, without resorting to full blown nuclear war. Therefore, before telling your attorney to push the button for litigation, discuss with him or her the alternative avenues towards resolution.