FORECLOSURE ordered over claim of unclean hands by bank… loan modification misrepresentation claims under CPA rejected… Lynch/Molloy.

Magistrate Lynch’s findings & recommendation:

National City Mortgage loaned $186,800 to Michael Wilson & Karen Sell in 3/09 for property in Gallatin Co. NCM merged with PNC Bank in 11/09 and became successor under the note and deed of trust. Wilson & Sell made payments through 3/11 and then stopped. Sell conveyed her interest to Wilson in 2012. PNC requests that foreclosure and sale of the property be ordered. Wilson counterclaimed alleging that PNC engaged in unlawful conduct when he attempted to obtain a modification. He alleges that he began experiencing financial difficulties in 2009 and inquired about a modification, and that it directed him to provide numerous documents which he provided. PNC rejected his request in 1/10 but requested that he resubmit the same documents and information to again apply for possible modification options. According to Wilson, he requested a modification and PNC rejected it at least 7 times, leading him to believe that he might qualify, but later informed him that it did not have authority to modify the loan. He emphasizes that much of the time he was requesting a modification he was not in default. But his allegations confirm that due to multiple factors including his financial difficulties he was “unable to uphold his obligations under the financing arrangements.” PNC commenced its foreclosure in state court. In 7/13 the parties attempted to settle. PNC’s counsel represented that he could again submit a request for modification. Wilson collected the documents and information and submitted his request, but on the day of his submission, counsel for PNC informed him that PNC had rejected his request. Wilson complains that even during those discussions, PNC did not have authority to modify the loan. He now contends that at some point in his discussions with PNC it suggested that he would need to be in default before it would consider a modification. He alleges that he has incurred additional interest & penalties as a result of his default, his credit rating has been damaged, he has suffered emotional distress including lost sleep, lost appetite, lost weight, stress, depression, anxiety, and anger problems, his family relationships have suffered due to the stigma, and he has sold personal property to generate funds to pay for necessities. He advances counterclaims under Montana law for fraud, constructive fraud, and violations of the CPA. Emphasizing that foreclosure is an equitable remedy, Blaine Bank (Mont. 1993), and in equity one may not take advantage of one’s own wrong, MCA 1-3-208, Wilson argues that PNC is barred from foreclosure under the doctrine of unclean hands based on its violations of the CPA, Cowan(Mont. 2004) (discussing unclean hands). The Court previously dismissed his fraud claims. PNC requests summary judgment on its foreclosure complaint and dismissal of Wilson’s counterclaim under the CPA, arguing that Wilson never submitted a complete modification application, it did have authority to modify, it did not instruct him to default, and he suffered no damages as a result of its conduct.

PNC identifies through affidavit testimony of mortgage officer Dorothy Thomas deficiencies in the documents or information that Wilson provided. Wilson responds with PNC’s notes from 3/17/10 which he believes establish that it did find at least 3 of his applications complete: “INFORMATION RECEIVED”; “INCOME VERIFICATION FOR ALL SOURCES LISTED”; “INITIAL REVIEW COMPLETED. BORROWER SHOWING SURPLUS INCOME. PROCEEDING WITH QUALIFICATION PROCES.” His interpretation of the notes is nothing more than speculation, while it is undisputed from Thomas’s affidavit that he did not verify his unemployment income. Therefore his application in 3/10 was not complete and there is no triable issue to the contrary. He next asserts that documents he submitted 7/9/10 completed his partial application, citing PNC’s notes: “RECEIVED FAX FROM BWWR, WITH DOCS REQUESTED. COMPLETE FILE WILL SUBMIT TO NEGOTIATOR FOR REVIEW.” His interpretation again constitutes speculation, nor does he respond to Thomas’s testimony establishing that his 7/9/10 documents did not verify information. He finally asserts that PNC’s records from 8/22/11 indicate that it had completed a review of his modification package: “INITIAL REVIEW COMPLETED. BORROWER SHOWING SURPLUS INCOME. PROCEEDING WITH QUALIFICATION PROCESS.” He again speculatively interprets these notes to mean that documents PNC received actually completed his application, while they clearly state that only the “initial review” was complete, and Thomas states that further review was required to assess whether the application was complete. He cannot demonstrate that PNC falsely represented that it would consider his application.

Wilson asserts that PNC had invited him to apply for a HAMP modification but then on 1/10/11 it informed him that it could not provide assistance under HAMP because “we service your loan on behalf of an investor or group of investors that has not given us the contractual authority to modify your loan under [HAMP]. Also, its 3/12/12 letter informed him that his loan did not qualify under HAMP because it originated after 1/1/09. However, the record does not reflect that it actually invited him to apply for a HAMP modification. Absent an actual representation telling him to apply for a HAMP modification, he cannot sustain his claim that PNC’s representation violated the CPA.

Wilson’s claim that PNC advised him to default is based on the fiduciary relationship holding of Morrow (Mont. 2014). PNC asserts that it never advised him to default. Wilson relies on his deposition testimony including that “it’s suggested the way they talk to you that you go into default.” However, his testimony describing its communications is, at best, nothing more than an explanation of the circumstances or conditions precedent to consideration of any borrower’s application for a modification, which cannot give rise to liability under Morrow absent express advice instructing the borrower as to the conduct of his affairs. He also cites PNC’s notes of 7/13/10: “LOAN IS CURRENT AND HAS NOT WENT 30+. WILL HAVE OFFER THE BORROWER THE OPTION OF GOING DEL ON FB.” He contends, on “information and belief,” that the notes demonstrate that it did or planned to advise him to “go delinquent on forbearance.” But he identifies to evidence to support this speculation as to exactly what is meant.

PNC alternatively argues that Wilson cannot identify any damages as a result of its conduct. Wilson responds that “actual damages are not required for the recovery of statutory damages under the” CPA. The Court disagrees. It authorizes a consumer to bring a civil action when he “suffers any ascertainable loss of money or property, real or personal, as a result of” an unfair or deceptive act or practice prohibited by MCA 30-14-103. §30-14-133(1). Even the possibility of recovering the statutory $500 under 133(1) is triggered only after first identifying an “ascertainable loss.”

Recommended, PNC is entitled to foreclosure and sale of the property, and Wilson’s CPA claims be dismissed.

Judge Molloy adopted Lynch’s findings & recommendation in full.

PNC Bank v. Wilson, 43 MFR 283, 4/28/16, 5/26/16.

Jean Faure & Katie Ranta (Faure Holden), Great Falls, for PNC; Jessie Lundberg (Montana Consumer Law Center), Missoula, for Wilson.

INSURANCE: No Businessowners’ Liability coverage for dispute between marketing/advertising entities… no obligation to provide independent counsel to individual Defendant… Christensen.

Lee Enterprises, owner of The Missoulian, alleged in State Court that Windfall Inc., Mettle LLC (dba Marketing Solutions), Jim McGowan, Brooke Redpath, Tara Halls, Tia Metzger, and Megan Richter wrongfully used Lee’s confidential & proprietary information to compete with Montana Marketing Group, which operates on behalf of The Missoulian. Mid-Century insures Windfall, which employs or employed McGowan, Richter, and Metzger. It accepted their defense under reservation. Metzger has also secured independent counsel. All of the individuals worked for The Missoulian and had some connection to its advertising department. Each resigned in the spring of 2015. In 2001, McGowan, formerly The Missoulian’s Sales Director, formed Windfall, an advertising & marketing agency, and worked there while employed by The Missoulian. McGowan, Halls, and Redpath own Mettle, a business based in Missoula that develops marketing strategies. Lee alleges violation of Montana’s Uniform Trade Secrets Act, breach of the implied covenant of good faith & fair dealing, tortious interference with business relations, civil conspiracy, breach of duty of loyalty, unfair competition and misappropriation, conversion, deceit, and constructive fraud. It seeks injunctive relief and money damages including punitives. On 7/30/15 Judge Townsend denied a preliminary injunction. The case remains pending before her. In this case, Mid-Century requests summary judgment on coverage and on Metzger’s counterclaims. Metzger requests summary judgment on her counterclaims against Mid-Century. Windfall, Mettle, Marketing Solutions, McGowan, Redpath, Halls, and Richter request summary judgment on coverage. Mid-Century claims that Mettle, Halls, and Redpath are not insureds. Respondents have justifiably not addressed this. Windfall is the named insured. Its Businessowners’ Liability policy listed Windfall and its “executive officers and directors…, but only with respect to their duties as [Windfall’s] officers ior directors;” Windfall’s stockholders, “but only with respect to their liability as stockholders;” and Windfall’s employees and managers, “but only for acts within the scope of their employment … or while performing duties related to the conduct of [Windfall’s] business.” Mettle is a separate business entity from Windfall; it is not a partner, member, or shareholder. Halls and Redpath are principals and owners of Mettle and have no established connection to Windfall. Mid-Century owes no duty to defend these 3 Respondents.

Mid-Century argues that there was no initial grant of coverage because Lee did not allege “bodily injury” or “property damage.” The Court agrees. There can be no serious argument in favor of bodily injury, and Lee has alleged damage only to intellectual and not tangible property. Even had there been “property damage,” there is no “occurrence” when the insured acts intentionally and “the consequences of those acts are objectively intended or expected from the standpoint of the insured.”EMCC (Mont. 2016). Lee has not claimed that Respondents accidentally took and used confidential and propriety information or that they took its intellectual property, but merely accidentally or negligently solicited its customers. The complaint gives rise to only one possibility — that Respondents intended both their actions and the ensuing consequences. Metzger argues that a factual dispute remains on this issue because Lee did not put Respondents on sufficient notice of the nature of confidential information or its misuse. While there may be a factual dispute as to the wrongfulness of Respondents’ conduct, there can be no dispute that the same conduct was intentional. This Court does not have the authority to determine whether Respondents have a valid defense in the underlying litigation, and it is irrelevant to this proceeding. Regardless of the merits of their defense in State Court, there are no facts suggesting that their conduct constituted an “occurrence” such that Mid-Century’s duty to defend was triggered.

Mid-Century argues that there was no initial grant of coverage because Lee did not allege “personal and advertising injury.” Respondents argue that it construes the complaint too narrowly. The Court disagrees. The complaint does not allege “personal and advertising injury” as defined by Windfall’s policy. The parties dispute whether Lee alleged that its injuries arose from “oral or written publication of material that violates a person’s right of privacy” and “the use of another’s advertising idea in your `advertisements.”’ While the complaint sufficiently alleges publication, Lee did not allege “violat[ion of] a person’s right of privacy.” Respondents assert that Lee is a “person” under the policy and that Lee alleged a violation of its right to privacy when it claimed that Respondents stole its confidential information. But even if Lee were a “person” under the policy, it would have no “right of privacy.” The Montana Supreme Court has not specifically considered whether a right to privacy is violated by a private actor’s use of a corporation’s confidential information such that insurance coverage is triggered, but the plain text of the Montana Constitution and the Court’s decisions in other areas foreclose that possibility. Art. II §10 states:

The right of individual privacy is essential to the well-being of a free society and shall not be infringed without the showing of a compelling state interest.

This does not apply to corporations. Tribune (Mont. 2003). Additionally, it applies only to state and not private action. Long (Mont. 1985). There is no statutory or standalone federal constitutional right to privacy. Thus if Lee had a “right of privacy,” it would have to exist under the common law. Penzer (Fla 2010) (“The plain meaning of `right of privacy’ is the legal claim one may make for privacy, which is to be gleaned from federal or [state] law, rather than defined by a dictionary.”). Under Montana law, a common law cause for invasion of privacy exists when there is a “wrongful intrusion into one’s private activities in such a manner as to outrage or cause mental suffering, shame or humiliation to a person of ordinary sensibilities.” Deserly(Mont. 2000). The common law right of privacy is limited to natural persons. “Except for the appropriation of one’s name or likeness, an action for invasion of privacy can be maintained only by a living individual whose privacy is invaded.” Restatement of Torts §6521. Ohio has cited this with approval in construing its right of privacy, which is identical to and the source of Montana’s common-law right. The USSC has cited the same section and suggested that the common law right to privacy has never applied to corporations. FCC (US 2011). Lee has not alleged a violation of its right of privacy because it has no violable right of privacy. As a corporation, it cannot bring a claim limited to natural persons. It is incapable of “mental suffering, shame or humiliation.”Deserly. Even if it could bring a right of privacy claim, another’s use of its confidential information would not give rise to the mental and emotional distress associated with infringement of privacy. Nor is there coverage under the theory of use of Lee’s advertising idea in Respondents’ advertisements. Respondents patch together pieces of the complaint, removing them from their contexts. They argue that Lee pled facts sufficient for coverage when it alleged “dissemination” and “use” of confidential and proprietary information “created by Lee Enterprises,” including “strategic online plans” and “advertising materials” for the “purposes of promoting Windfall.” However, Lee alleged neither that Respondents used its “advertising idea” nor that they created an “advertisement.” Both parties cite ASA (8th Cir. 2002) for a definition of “advertising idea” as “encompass[ing] an idea for calling public attention to a product or business, especially by proclaiming desirable qualities so as to increase sales or patronage.” However, Lee did not allege that Respondents used its “advertising idea,” but that it used proprietary information regarding historical customers in order to solicit its customers.” There is no advertising idea because the allegedly misappropriated information did not include any “idea calling public attention” to Lee’s products or business. Even had there been an advertising idea, Respondents would not have used it in an “advertisement.” The policy defines an “advertisement” as “a notice that is broadcast or published to the general public or specific market segment about your goods, products or services for the purpose of attracting customers or supporters.” Respondents call for a broad interpretation of “broadcast or published,” arguing that Lee pled sufficient facts when it claimed that Respondents “disseminated” and “misappropriated” its confidential and proprietary information. Even if they could support such a broad interpretation, it would be unambiguously limited by the language immediately following policy terms: “to the general public or specified market segment.” Lee has claimed that Respondents solicited its customers, not that it co-opted its marketing strategy. There was neither an “advertising idea” nor an “advertisement.”

Metzger argues that Mid-Century acted in bad faith and breached its contractual obligations by failing to provide additional counsel of her choosing. She argues that regardless of the duty to defend at this stage, it had a duty to provide independent counsel because of the possibility of a conflict of interest. An insurer has a duty to provide independent counsel due to “inconsistent and yes, antagonistic positions that have developed.” Thompson (Mont. 1967). The Montana Supreme Court has not specifically addressed when a potential conflict is sufficiently antagonistic to trigger a duty to provide independent counsel. There are no “inconsistent” or “antagonistic” positions between Respondents such that Mid-Century had a duty to provide independent counsel. In fact, when she requested independent counsel, she stated that “there isn’t currently a conflict known.” Mid-Century had no duty to comply with her request when she herself was unaware of an actual conflict. Even if there had been a conflict, she waived it. She remains represented by Respondents’ counsel. She also signed a waiver affirming that she gave informed consent to concurrent representation despite the potential for a future conflict among the insureds. Mid-Century owed no duty to provide independent counsel to her and is entitled to judgment as a matter of law on her counterclaim for coverage.

Metzger argues that a dispute of fact remains on her claims under the UTPA. She claims that Mid-Century had an obligation to affirmatively contact her to discuss Lee’s allegations against her. There is no statutory authority for this argument, and the Montana Supreme Court has “expressly declined to require that insurers seek out facts beyond the complaint.” Landa (Mont. 2013). Given that there is no duty to defend or provide independent counsel to Metzger, the Court need not consider her remaining UTPA claims. Ribi (Mont. 2005).

Mid-Century Ins. v. Windfall Inc. et al, 43 MFR 263 , 5/23/16.

Nicholas Pagnotta & Alexander Tsomaya (Williams Law Firm), Missoula, for Mid-Century; Robert Terrazas (Terrazas Law Office), Missoula, for Respondents; Liesel Shoquist (Milodragovich Dale Steinbrenner), Missoula, for Metzger.

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REMOVAL: Remand of bad faith suit against insurer and adjuster on the basis of asserted defects in removal notice denied under 1988 amendments to Title 28, but granted on basis that Complaint alleged sufficient facts to state claim of unfair settlement practices by adjuster, Defendants’ failure to show that joinder should be deemed fraudulent… Morris.

W. William Leaphart filed a complaint in the 8th Judicial District Court in Cascade Co. as GAL for Jeremy Vangsnes, alleging that National Union Fire Ins. and Mike McNabb engaged in bad faith when they failed to promptly address and settle claims where liability had become reasonably clear. Defendants removed to this Court based on diversity. Leaphart moved to remand, claiming that Defendants violated the forum defendant rule. Defendants allege that Leaphart fraudulently joined McNabb to defeat diversity. McNabb also moves to dismiss Leaphart’s claim for failure to plead sufficient facts.

The forum defendant rule provides that a defendant may remove based on diversity only when no properly joined and served defendant represents a citizen of the state where the action has been brought.Spencer (9th Cir. 2004). Defendants admit that McNabb is “a resident and citizen of the State of Montana.” His presence invoked the forum defendant rule. An exception to the rule exists where a plaintiff fraudulently joins a local defendant. Hunter(9th Cir. 2009).

Leaphart argues that Defendants must allege facts in their removal notice to prove fraudulent joinder. Smith (9th Cir. 1951) declined to address fraudulent joinder when the removal petition alleged only “mere conclusions” of fraudulent joinder and failed to allege any factual allegations. Defendants’ removal notice similarly contains no factual allegations of fraudulent joinder. They merely conclude that Leaphart joined McNabb “as a party to improperly defeat diversity jurisdiction.”

Defendants argue that Smith fails to reflect the effect of the 1988 amendments to Title 28, which simplified removal notice requirements. FP&P §3733. They argue that federal courts have since employed a less exacting standard to removal notices. Removal procedure previously required “a short and plain statement of the facts.” Id. §1446(a) now requires only “a short and plain statement of the grounds for removal.” Defendants contend that the Court should consider the entire record rather than limit its view to the removal petition.

Courts have allowed defendants to allege fraudulent joinder in a removal notice and subsequently provide factual support. The plaintiffs in Mendrop (N.D. Miss. 2006) argued that the case should be dismissed based on pleading deficiencies. They claimed that the removal notice contained a “conclusory assertion of fraudulent joinder.” The court looked outside the removal notice and considered statements in a responsive pleading to a motion to remand, reasoning that “looking to the record as whole” appeared to be the “most sagacious course.”

Defendants alleged fraudulent joinder when they filed their removal notice. They have supported their claim with a response brief which provides factual allegations. It seems a “better rule … that detailed grounds for removal need not be set forth in the notice.” FP&P §3733. The Court declines to remand on the basis of asserted defects in the removal notice.

The Court should find fraudulent joinder where the plaintiff has failed to “state a cause of action against a resident defendant.” Hunter. The failure must be obvious according to the “settled rules of the state.” Id.The Court must look at the complaint in a light most favorable to the plaintiff. Otani (9th Cir. 1997). Defendants argue that Leaphart has failed to state a cause against McNabb, the resident defendant. The Complaint states that he committed fraud by violating MCA 33-18-201(13) which prohibits one from failing to “promptly settle claims” when liability has become “reasonably clear” under the policy. Montana courts have recognized that claims under 33-18-201 can be brought against adjusters, not just insurers. O’Fallon (Mont. 1993);Soanes(D.Mont. 2011). However, claims against individuals require that the defendant commit the unfair trade practice “with such frequency as to indicate a general business practice.” MCA 33-18-201; Strizic(D.Mont. 2015). Plaintiffs can establish that violations indicate a general business practice by showing that multiple violations occurred in one claim or violations occurred by the same company in different cases.Cook (D.Mont. 1990). Defendants allege that Leaphart has failed to allege facts that show that McNabb’s conduct represented a general business practice. The Complaint alleges that McNabb engaged in common law bad faith while acting as an agent for Continental Casualty Co. and National Union Fire Ins. and that he “acted in this manner as a general business practice.” It factually describes at least one instance where he allegedly failed to settle a claim despite reasonably clear liability. Leaphart alleges that McNabb “refused to pay CCC’s $1,000,000 policy limit unless the Plaintiff accepted a small portion of National Union’s $25,000,000 policy limit in full settlement of the claim.”

Judge Lovell determined in Strizic that a defendant had been fraudulently joined when the complaint contained “no allegation that [the defendant’s] acts were of such frequency as to indicate a general business practice.” He noted that the plaintiff had failed to allege that the defendant acted as a claims adjuster. Leaphart, in contrast, has alleged that McNabb acted as a claims adjuster. He also has alleged that McNabb’s conduct occurred as a general business practice.

Leaphart may obtain proof of violations that show a general business practice from other attorneys, claimants, or people having knowledge of the company’s general business practice. Klaudt (Mont. 1983). He could obtain proof of other violations after the pleadings stage, through discovery.

Looking at the Complaint in a light most favorable to the plaintiff, Leaphart has alleged sufficient facts to state a claim that McNabb engaged in unfair claim settlement practices. Settled Montana law does not clearly prohibit a cause against him. Leaphart has not failed obviously to state a cause against McNabb. Defendants have failed to show by clear & convincing evidence that joinder of McNabb should be deemed fraudulent. The forum defendant rule bars removal.

Leaphart’s request for attorney fees & costs is denied. Defendants had an objectively reasonable basis to seek removal. Martin (US 2005).

Leaphart (GAL for Vangsnes) v. National Union Fire Ins., Continental Casualty, and McNabb, 43 MFR 204, 1/7/15.

Zander Blewett & Anders Blewett (Hoyt & Blewett), Great Falls, for Vangsnes; Randy Cox & Ross Tillman (Boone Karlberg), Missoula, for National Union; Gary Zadick & Jordan Crosby (Ugrin, Alexander, Zadick & Higgins), Great Falls for Continental; Robert Phillips (Garlington, Lohn & Robinson), Missoula, for McNabb.

INDIANS: Tribal Housing Authority and other entities and individuals shielded by Tribal sovereign immunity from $20 million explosion suit… Morris.

Glenn & Celesia Eagleman and their niece Theresa Small sued Chippewa-Cree Housing Authority and other Tribal entities and individuals in Chippewa-Cree Tribal Court of the Rocky Boys Reservation in 2009 to recover damages from an explosion in 4/07. Eaglemans are members of the Chippewa-Cree Tribe and Small is a Fort Belknap Reservation member. They lived on trust property on the Chippewa-Cree Reservation at the time of the explosion. Tribal Court dismissed their claims based on a 1-year statute and tribal sovereign immunity. Tribal Appeals Court affirmed the dismissal except as to Mike Rosette in 10/11. Plaintiffs filed a complaint in this Court 10/7/14 — 3 years after Tribal Appeals Court issued its order. Defendants move to dismiss based on the 1-year statute, laches, lack of subject jurisdiction, and tribal sovereign immunity.

Defendants argue that CCHA acts as an arm of Tribal Government and enjoys immunity. Plaintiffs argue that it should be characterized as an entity incorporated under federal law by the Tribe for business purposes and thus enjoying no tribal immunity. Similar to Gold Country Casino (9th Cir. 2006), CCHA is chartered through a tribal ordinance and provides benefits other than revenue production to the Tribe, such as affordable housing and employment opportunities. Karuk Tribe Housing Authority (9th Cir. 2001 recognized that a similar housing authority served as an arm of tribal government. The Tribe’s sovereign immunity extends to CCHA.

Plaintiffs have named CCHA Director Donna Hay and employee Thela Billy in their official and individual capacities. They allege that Billy “improperly authorized Mike Morsette … to dispose of the condemned house materials” and that Hay misled Plaintiffs as to insurance proceeds. It appears that Plaintiffs brought this suit against Billy and Hay because of their official capacities. Maxwell (9th Cir. 2008). More importantly, they seek to recover $20 million. A judgment against Billy and Hay and the other Defendants would operate against the Tribe. The Court should not let Plaintiffs “circumvent tribal sovereign immunity” merely by naming Billy and Hay in their individual capacities. Cook (9th Cir. 2008). The Tribe represents “the real and substantial party in interest” under these circumstances. Maxwell.

Plaintiffs allege that Defendants may have waived sovereign immunity in the lease agreement between Glenn Eagleman and CCHA, but at the hearing they presented the lease agreement which contained no waiver, and conceded that it contained no waiver. They next contend that Defendants waived sovereign immunity through the tribal ordinance’s “sue and be sued” provision. However, similar to Dillon (8th Cir. 1998) and Hagen (8th Cir. 2000), the plain language of the clause provides CCHA the ability to waive sovereign immunity by contract. The clause alone should not act as a general waiver.

Defendants’ motion to dismiss is granted.

Eagleman v. Rocky Boys Chippewa-Cree Tribal Business Committee et al, 43 MFR 193, 12/2/15.

Mark Mackin, Helena, for Plaintiffs; Evan Thompson (Browning, Kaleczyc, Berry & Hoven), Helena, for CCHA; Daniel Belcourt Chippewa-Cree Tribe), Box Elder, for other Defendants.

ARBITRATION: Award rejecting claims against bank stemming from its role in $5 million 1031 ranch exchange investment losses confirmed… Lovell.

Kenneth & Lesley Schilling disposed of part of their ranch in 2005 in a $5 million “like-kind” §1031 exchange

through Bobby Parks, a representative of Fintegra and dual employee of Sterling Bank. Under an Investment Services Agreement between Fintegra and Sterling, and a Dual Account Executive Agreement between Sterling, Fintegra, and Parks, Fintegra was responsible for securities activities and Sterling was responsible for banking activities. There was no express contract between Sterling and Schillings. After the collapse of 2008, their investment in the exchanged property lost a significant percentage. They filed a FINRA arbitration action against Fintegra and Parks and sued Sterling in Montana state court claiming fraud under the Montana Securities Act, breach of fiduciary duty, negligent supervision, negligence, misrepresentation & constructive fraud, breach of contract, and breach of the covenant of good faith & fair dealing. Sterling asserted statute of limitations and that there was no fiduciary or other special relationship with Schillings. Although it was not a FINRA broker-dealer or member, it agreed to be joined in the arbitration action in 2012. Schillings’ state action was dismissed. They dismissed Parks in 2013 after he filed bankruptcy. The FINRA arbitration hearing with Fintegra and Sterling was set for 1/14. Schillings settled with Fintegra a few days before the hearing. Following 11 days of hearing, the panel denied Sterling’s motion to dismiss on statute of limitations grounds. In a written decision it denied Schillings’ claims against Sterling, citing the 1994 Interagency Statement on Retail Sales of Nondeposit Investment Products by federal bank regulators, the 2014 FDIC Compliance Manual, the Investment Services Agreement between Fintegra and Sterling, the Dual Account Agreement with Parks, and the Gramm-Leech-Bliley Act. Schillings request vacatur of the award.

It can hardly be said that the arbitrators committed misconduct or any other misbehavior in letting Schillings’ expert opine as a rebuttal witness as to application to Sterling of the GLBA networking exception — that when a bank fulfills the criteria, it “shall not be considered to be a broker” when it enters into 3rd-party arrangements to offer brokerage services on or off bank premises. While a district court has jurisdiction to admit or exclude such testimony under the FRCivP, an arbitrator is not bound by the FRCivP and receives evidence quite liberally. FINRA-ARB2014, Rule 12604(a). Schillings opened the door by eliciting legal opinions from their own expert, Paul Meyer, who testified that Sterling stood in the shoes of Fintegra and owed Schillings duties similar to those of a FINRA broker-dealer.

Schillings assert that the award reflected undue means by Sterling’s alleged failure to assert the networking exception as an affirmative defense. However, even if this arbitration were governed by the FRCivP, this is not a traditional defense that would be required in civil litigation. Further, while an arbitration panel may bar a defense if it was known but withheld at the time of the filing of the answer, there is no evidence that Sterling knew of the networking exception when it filed its answer. Further, it reserved the right to assert any defense that became apparent during discovery, and it apparently did come to light through discovery, and in fact 1 week before the hearing Schillings’ counsel provided Sterling’s counsel a part of the FDIC Compliance Manual that explained the exception. The panel also offered to take further briefing, but Schillings’ counsel declined, preferring to proceed to the panel’s decision. (On the 11th day, Schillings’ counsel informed the panel that if it wanted to take into account this federal law, the arbitration should go back to discovery followed by another hearing. Clearly, the panel decided that counsel could not forbid it from considering relevant federal law, and the arbitrators heard counsel state that he did not want to brief the issue.) Schillings’ argument that they could not be expected to guess that a statutory defense would be advanced fails in the face of the multiple documents governing the transaction that cited the GLBA exception. A month before the hearing, Schillings’ counsel received Sterling’s brief which stated that “Mr. Bley will testify that, contrary to Mr. Meyer’s testimony, a commercial or community bank like Sterling that enters into a third-party agreement with a FINRA broker-dealer to enable the sale of non-deposit investment products to its customers does not take on the obligations of a FINRA broker-dealer.” The GLBA exception was also cited in discovery, so its existence was certainly discoverable by Schillings’ counsel with due diligence. Their studious avoidance of a perfectly obvious defense, followed by the claim of surprise when it was so predictably presented, does not persuade the Court that they did not receive fair notice of the argument. Counsel’s reply brief lifts this controversy into the realm of hyperbole:

Furthermore, nowhere can it be found in any document ever created in the history of the world, as far as the Schillings are aware, that meeting the “networking exception” under the GLBA does anything but exempt the bank from having to register as a broker-dealer.

Besides this narrow reading of the exception being plainly incorrect, Schillings fail abjectly in their duty to present a prima facie claim that established from whence Sterling’s contractual and common law duties arose, if not from its only relationship to the transaction in question (which relationship is exempted from liability by the networking exception). Schillings’ real conundrum is not that they did not have notice of the exception that exempts Sterling from liability for Fintegra’s errors, but that they cannot define its contractual and common law duties without resort to a derivative broker-liability theory. They had ability to discover the exception — an obvious impediment to their case — and with exercise of due diligence could have challenged its application.

As to the allegedly false testimony by Bley, the Court finds that he did not give false testimony:

Q. Are you aware of any legal authorities — law journal articles, broker-dealer publications, bank publications that are scholarly in nature that have come out and said that if a bank enters into a networking arrangement with a third-party broker-dealer, then they can’t be held liable in a situation that we have here today?

A. Melanie Fein Bank Securities’ Activities.

Q. And did you bring a copy of that with you?

A. No. It’s a book about that size. It’s a reference manual. Incidentally, that reference manual didn’t reference any case law either. But it did reference, specifically, the networking exception.

What is clear in hindsight that the question was ambiguous and open to interpretation as to its scope. Bley’s answer was correct as it related to the topic being discussed, which was the impact of the networking exception on Sterling’s liability under the SEA of 1934. Only if it was meant to encompass all of Schillings’ common law and contract claims could the answer have been incorrect. Any misunderstanding results from the ambiguity inherent in counsel’s question and the subsequent attempt to stretch the true meaning of the answer into a falsehood. It is reasonably apparent that the panel could have and probably did understand and interpret Bley’s testimony such that it was true and correct. Thus there can be no fraud — certainly not by clear & convincing evidence. The Court further finds that the result would not have been different had that question not been asked and answered. The federal law would have had to be applied by the panel whether or not any expert testified.

Schillings fail to show that the award should be vacated. There is no gross error on the face of the award or any evidence of intent to disregard the law. Their complaints as to the process do not rise to the level of clear & convincing evidence of fraud, arbitrator misbehavior, of the kind of immoral conduct that procures an invalid decision by undue means.

Schilling v. Sterling Bank, 43 MFR 177, 12/1/15.

Jeffrey Feldman (Feldman Law Offices), San Francisco, and Linda Deola (Morrison, Sherwood, Wilson & Deola), Helena, for Schillings; Bruce Campbell (Miller Nash), Portland, and Danielle Coffman (Crowley Fleck), Kalispell, for Sterling.