Boxer and informed him that the $ 300,000 of LFCU had been used to purchase (i) the TML CD, and (ii) $ 200,000 worth of certificates of deposit in the name of TML issued by Services National Bank. This second piece of information was incorrect. Significantly, Hyde said the certificates of deposit collateralized outstanding loans to TML which could not be repaid at the time.
82. Contrary to Hyde's assertions, the TML CD in the amount of $ 100,000 was still unencumbered. As soon as Hyde knew that LFCU was seeking return of its $ 300,000, he undertook efforts to pledge the TML CD. The result was that during December 1976, Hyde obtained a loan for TML, pledging the certificate of deposit as collateral and without the knowledge of LFCU.
83. In late September 1976, Raymond Suttle ("Suttle"), an attorney for LFCU, spoke by telephone with Smith, requesting return of the $ 400,000. Smith stated that the entire $ 400,000 had already been expended by Shenandoah. In fact, at that time, about $ 375,000 had been preliminarily earmarked but could have been returned to LFCU.
84. On September 29, 1976, Smith resigned his positions as an officer and director of AMS.
85. On or about October 7, 1976, Hyde and Smith reviewed a memorandum written by the corporate counsel for AMS and Shenandoah. They learned from this memorandum that a federal credit union could not legally make loans to private corporations. Hyde and Smith did not take any action to freeze (i) the TML CD, or (ii) MMC's $ 375,000.
86. On October 18, 1976, Arthur W. Carter ("Carter"), a director and secretary of LFCU, along with Suttle, met with Hyde, Smith and Rice. Carter and Suttle again demanded return of the LFCU funds from AMS and Shenandoah. Both Hyde and Smith denied the abilities of their respective corporations to repay any of the funds at that time.
87. Since November 1976, including after this litigation was commenced in July 1977, LFCU received from Shenandoah seven interest payments of around $ 8,500, aggregating to $ 59,000. LFCU placed this money in a separate interest-bearing savings account at another financial institution where it remains today, pending the outcome of this litigation.
88. The AMS Note, due as of July 16, 1978, and the Shenandoah Note, due as of August 27, 1978, are both in default.
Conclusions of Law
The Court has jurisdiction and the venue is proper. 28 U.S.C. §§ 1332, 1391(a); 15 U.S.C. § 78aa. As previously indicated, LFCU presents several alternative theories of recovery: default on notes, mutual mistake, conversion, fraud, and violation of § 10(b) of the Securities Exchange Act of 1934, as implemented by Rule 10b-5. Both compensatory and punitive damages are sought.
Viewing the proof separately as it relates to AMS and to Shenandoah, the Court has concluded that the preponderance of the evidence establishes a clear case of conversion by each company but that there is insufficient proof to establish that either company committed either common law fraud or a violation of § 10(b).
Conversion, is, of course, a civil tort which involves the taking of property belonging to another. While it is generally said that the motive or intent of the taker as to his right to the property is irrelevant, See Morissette v. United States, 342 U.S. 246, 270, 72 S. Ct. 240, 96 L. Ed. 288 (1962); Restatement of Torts 2d §§ 222A, 223 & 244, it is clear in this instance that AMS and Shenandoah each not only took property that did not belong to it but did so knowingly. Statements by Hyde and Smith that they believed that LFCU had entered into genuine loan transactions with their respective companies for the substantial sums of money involved are not accepted. AMS and Shenandoah each knew from the outset that the "loan" received from LFCU had to have resulted from some error or misunderstanding, not from mere naivete on LFCU's part. Despite this knowledge, each company proceeded to use the funds for its own purposes. Knowledge is inferred from the totality of the facts and circumstances found above, particularly the manner in which the defendants proceeded to handle and disburse the funds after the banks refused them the opportunity to purchase certificates of deposit and the defendants' conduct once subjected to questioning by representatives of LFCU. AMS and Shenandoah were each grossly reckless in their receipt and use of LFCU's funds. Thus LFCU was not solely responsible for the loans' existence. Such conduct by the defendants amounts to conversion with knowledge of its impropriety.
While the issue is a very close one, the Court has concluded that the evidence is not sufficient to establish common law fraud or a violation of Section 10(b). LCFU's theory in this regard is that each defendant aided and abetted Rice's fraudulent conduct. Although the plaintiff is correct in stating that a finding of fraudulent aiding and abetting can sometimes be based on grossly reckless conduct, See Rolf v. Blyth, Eastman Dillon & Co., Inc., 570 F.2d 38, 44-48 (2d Cir. 1978); Jacobs v. District Unemployment Compensation Board, 382 A.2d 282, 287 (D.C.Ct.App.1978), it cites no case where the reckless conduct was other than with respect to the truth or falsity of operative misrepresentations made or known by the defendant. Here, the defendants made no false representations to LFCU upon which LFCU relied in extending the loans at issue. There is also no direct evidence that any officers of either defendant corporation actually knew of Rice's misrepresentations and thus had an opportunity to make any determination one way or the other with respect to those remarks' truth or falsity. Consequently, plaintiff's theory has to be that the defendants constructively knew the content of Rice's misrepresentations because they acted in a grossly reckless manner in not realizing that the loans they received had to have resulted from misrepresentations made by Rice. Even if this theory correctly states a cause of action an issue this Court does not decide, the proof is lacking to support it. Neither Hyde nor Smith are particularly believable witnesses, but the evidence is still insufficient to warrant an inference that their grossly reckless conduct amounted to knowledge of Rice's devious conduct. Defendants knew that they were taking something that did not belong to them but it is not shown that their awareness amounted to knowledge that this situation was created by Rice's false representations rather than by other factors.
LFCU is entitled to compensatory damages for the conversions of its funds. The question remains whether punitive damages should be assessed as to either AMS or Shenandoah. The Court in its discretion has determined that it will not order the payment of punitive damages in this instance by either corporation. Undoubtedly, many factors contributed to the ultimate conversion of the funds and the responsibility cannot be said to rest solely on the conduct of AMS and Shenandoah. There were many stages along the line where the end result could have been prevented had LFCU been more businesslike, had Harp been more astute, had the banks been less careless, etc. Under these circumstances, an exaction of punitive damages solely against AMS and Shenandoah does not seem warranted, particularly considering the generous nature of the settlement made with Rice.
LFCU is entitled to a separate judgment against AMS for $ 300,000, plus any unpaid interest which accrued on the note prior to default, plus the interest on the two aforementioned sums which has accrued since default at the legal rate of six percent, plus costs; all reduced by the amount Riggs paid and 3/7's of the amounts Rice and Harp paid the plaintiff in settlement. LFCU is entitled to a separate judgment against Shenandoah for $ 400,000, plus any unpaid interest which accrued on the note prior to default, plus the interest on the two aforementioned sums which has accrued since default at the legal rate of six percent, plus costs; all reduced by the amount Union First paid and 4/7's of the amounts Rice and Harp paid the plaintiff in settlement. The notes themselves are hereby cancelled. Counsel for plaintiff is to submit an appropriate order and form of judgment by January 15, 1979, with a brief memorandum explicating the computations made.
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