Adams v. FDIC
Case Date: 01/23/1996
Court: United States Court of Appeals
Docket No: 94-2161
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United States Court of Appeals For the First Circuit ____________________ No. 94-2161 LEVI C. ADAMS, ET AL., Plaintiffs, Appellees, v. ZIMMERMAN, ET AL., Defendants, Appellees. ____________________ FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant, Appellant. ____________________ No. 94-2162 LEVI C. ADAMS, ET AL., Plaintiffs, Appellants, v. ZIMMERMAN, ET AL., Defendants, Appellees. ____________________ FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant, Appellee. ____________________ No. 94-2246 LEVI C. ADAMS, ET AL., Plaintiffs, Appellees, v. ZIMMERMAN, ET AL., Defendants, Appellees. ____________________ FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant, Appellant. ____________________ No. 94-2247 LEVI C. ADAMS, ET AL., Plaintiffs, Appellants, v. ZIMMERMAN, ET AL., Defendants, Appellees. ____________________ APPEALS FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS [Hon. Nathaniel M. Gorton, U.S. District Judge] ___________________ ____________________ Before Torruella, Chief Judge, ___________ Lynch, Circuit Judge, _____________ and Stearns,* District Judge. ______________ ____________________ Vincent M. Amoroso, with whom Harry A. Pierce and Parker, __________________ ________________ _______ ____________________ *Of the District of Massachusetts, sitting by designation. 2 Coulter, Daley & White were on brief, for plaintiffs. ______________________ J. Scott Watson, Federal Deposit Insurance Corporation, with _______________ whom David S. Mortensen, Glenn D. Woods, and Tedeschi, Grasso and __________________ ______________ ____________________ Mortensen were on brief, for defendant Federal Deposit Insurance _________ Corporation. ____________________ January 19, 1996 ____________________ 3 LYNCH, Circuit Judge. A troubled condominium LYNCH, Circuit Judge. ______________ development led to these appeals, which raise issues of federal banking law: whether 12 U.S.C. 1823(e) and D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942), shield the ____________________ ____ FDIC, as receiver for a failed bank, from liability for the bank's sale of unregistered securities. We hold that the FDIC has no such shield and is liable, but remand for adjustment of the remedies fashioned by the district court. These consolidated cross appeals arise out of the development of the Hyannis Harborview Hotel. The units in the Hotel were marketed and sold by the University Bank and Trust Company and the other defendants as "pooled income" condominium units. Although these units were securities, they were never registered, and, when the development of the Hotel faltered, the plaintiffs, purchasers of individual units in the Hotel, sued the Bank for, inter alia, the sale _____ ____ of unregistered securities in violation of the Massachusetts Uniform Securities Act, Mass. Gen. L. ch. 110A, 410(a)(1). The Bank was later declared insolvent and the FDIC, as receiver, was substituted for the Bank as a defendant. After rejecting the FDIC's argument that 1823(e) and D'Oench _______ barred the plaintiffs' registration claims, the district court held the FDIC liable under section 410(a)(1) and awarded the plaintiffs rescissionary damages, attorneys' fees and interest. -4- 4 I. Background And Procedural History In 1985, Gary Zimmerman, president of Hyannis Harborview Hotel, Inc. (HHI), approached Robert Keezer for financial and marketing advice about converting the Hotel into condominiums. Keezer, who was then the Bank's second largest stockholder, Vice Chairman of its Board of Directors, and a member of the Bank's Loan Committee, agreed to do so for an interest in the project. Keezer brought Norman Chaban, an expert in condominium marketing, into the project to manage the marketing and sales of the condominiums and arranged to have a $6.8 million condominium conversion loan placed through the Bank. To make the Hotel units more attractive, Keezer, Chaban and Zimmerman marketed and sold the units on a "pooled income" basis. That is, the purchasers were told they would receive income based upon their pro rata interest in the entire condominium project rather than on the income generated by their individual units. The Hotel's Declaration of Trust and By-Laws (these and the Master Deed constitute the "Master Documents") provided that each unit owner: [1] shall be liable for Common Expenses attributable to the operation of the Condominium in the same proportion as his Beneficial Interest in this Trust bears to the aggregate Beneficial Interest of all Unit Owners . . . ;[and] -5- 5 [2] shall be entitled to common profits, if any, attributable to the operations of the motel- type Units of the Condominium in the same proportion as his Beneficial Interest in this Trust bears to the aggregate Beneficial Interest of all [unit] owners. When several of the plaintiffs were unable to get financing to purchase their units, the Bank's Loan Committee voted to approve $3,000,000 in "end loan" financing to them. After the plaintiffs executed their purchase and sale agreements, which incorporated by reference the Master Documents, the Loan Committee (with Keezer voting) approved end loans to several of the plaintiffs to finance the purchases. This was the first time that the Bank's lending arm, University Financial Services Corporation, had considered and approved such end loans, a type of financing arrangement not considered standard procedure in the banking business at the time. The plaintiffs then purchased the units. Three of the plaintiffs, Marietta Lopes ("Lopes") and Michael and Barbara Riley (the "Rileys"), were able to secure financing from other lending institutions. The units were never registered as securities. About six months after the plaintiffs purchased the units, they were told by HHI that, upon advice of counsel, it would no longer pay unit income based on a rental pool. The unhappy plaintiffs in 1989 filed their six-count amended complaint against HHI, Zimmerman, Chaban, Keezer and the -6- 6 Bank, inter alia.1 On May 31, 1991, the Comptroller of the _____ ____ Currency declared the Bank insolvent and appointed the FDIC as receiver. The FDIC was substituted for the Bank as a defendant. The district court granted summary judgment for the FDIC based on its special defenses under D'Oench and _______ 1823(e), except on the state securities registration count (Count V). After a bench trial, the district court issued a Memorandum of Decision, Adams v. Hyannis Harborview, Inc., _____ _________________________ 838 F. Supp. 676 (D. Mass. 1993), holding, among other things, that the plaintiffs were entitled to judgment against the FDIC on Count V. The court held that the provisions in the Master Documents made the Hotel units "investment contracts" and thus securities within the meaning of the securities laws. Id. at 686. It also held that, in light of the financing ___ arrangements made for the purchasers, Keezer was acting as the Bank's agent in the sale of the units and so his actions ____________________ 1. In addition to their claims under Mass. Gen. L. ch. 110A, 410(a)(1), the complaint also alleged (1) violations of 12(2) of the Securities Act of 1933 (the "1933 Act"), 15 U.S.C. 77l(2) (Count I), (2) violations of the anti-fraud provisions of 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. 240.10b-5 (Count II), (3) common law fraud and deceit (Count III), (4) negligent misrepresentation (Count IV), and (5) violations of the anti- fraud provisions of Mass. Gen. L. ch. 110A, 410(a)(2) (Count VI). Zimmerman was eventually dismissed as a defendant. -7- 7 would be imputed to the Bank. Id. at 692. It reaffirmed its ___ rulings that D'Oench and 1823(e) provided the FIDC with no _______ special defenses to Count V, id. at 691 n.14, and rejected ___ the FDIC's argument that the loans to the plaintiffs made by the Bank were "bona fide" loan transactions under Mass. Gen. L. ch. 110A, 401(i)(6) and thus exempt from registration requirements. Id. at 694 n.16. ___ The court later ordered a rescissionary damages award pursuant to Mass. Gen. L. ch. 110A, 410(a). That statute provides for recovery of "the consideration paid for the security, together with interest at six per cent per year from the date of payment, costs, and reasonable attorneys' fees, less the amount of any income received on the security, upon tender of the security, or for damages if [the plaintiff] no longer owns the security." Id. ___ Specifically, the court awarded to all plaintiffs except Lopes and the Rileys $855,434, plus interest of 6% per annum from February 11, 1994 to the date of the damages order. The court said it "novated" the amounts the plaintiffs owed on the first and second mortgage notes held by the FDIC and HHI respectively. The "novation" apparently cancelled the plaintiffs' debt on the mortgages. The court denied Lopes and the Rileys a rescissionary damages award under section 410(a)(1) because it believed it could not novate the loans that Lopes and the Rileys owed to third- -8- 8 party banks. It did, however, give Lopes and the Rileys damages of $256,564 (the principal and interest payments they had made on their mortgage loans plus the amount they still owed on those loans) from Keezer, Chaban and HHI on the other securities law claims successfully asserted. The court gave each plaintiff the option of either accepting the rescission award (and the novation) in exchange for title to the unit or, in lieu of the rescission award, retaining the unit free and clear. It awarded attorneys' fees of $351,213 against Keezer, Chaban, HHI and the FDIC. Finally, it ordered that the plaintiffs' recovery would be subject to the FDIC's "obligation to distribute the assets of [the Bank] on a pro rata basis." The FDIC appeals the rulings on 1823(e) and D'Oench with respect to Count V, the finding that the bank _______ loans were not "bona fide" loan transactions, the award of attorneys' fees and post-insolvency interest, and the order that any reconveyance be made to all defendants rather than just to the FDIC. The FDIC does not challenge either the district court's conclusion that the Hotel units were securities or its conclusion that Keezer's actions were imputable to the Bank. The plaintiffs' cross-appeals challenge the district court's method of calculating the rescissionary damages award, its decision to limit the award -9- 9 in accordance with the rule of ratable distribution, and its failure to grant fee enhancements. II. Section 1823(e) And D'Oench _______ The FDIC argues that 1823(e) and D'Oench bar the _______ claims under state securities law because the plaintiffs cannot point to a written agreement regarding the "registrability of securities." Section 1823(e) bars anyone from asserting against the FDIC any "agreement" that is not in writing and is not properly recorded in the records of the bank. 12 U.S.C. 1823(e). D'Oench generally prevents _______ plaintiffs from asserting as either a claim or defense against the FDIC oral agreements or "arrangements." Timberland Design, Inc. v. First Service Bank for Savings, ________________________ _______________________________ 932 F.2d 46, 48-50 (1st Cir. 1991). We do not believe that either 1823(e) or D'Oench shields the FDIC here.2 _______ ____________________ 2. As modified by the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), 1823(e) provides: No agreement which tends to diminish or defeat the interest of the [FDIC] in any asset acquired by it . . . shall be valid against the [FDIC] unless such agreement [is in writing and satisfies a number of other requirements]. 12 U.S.C. 1823(e). A circuit split appears to have developed over the question of whether 1823(e) has preempted D'Oench. Compare FDIC v. McClanahan, 795 F.2d 512, _______ _______ ____ __________ 514 n.1 (5th Cir. 1986) ("there is no reason to suppose that Congress intended [by the passage of 1823(e)] to forbid the rule of estoppel from being applied when the FDIC sues as receiver of a failed bank") with Murphy v. FDIC, 61 F.3d 34, ____ ______ ____ 39 (D.C. Cir. 1995) (relying on O'Melveny & Myers v. FDIC, __________________ ____ -10- 10 While expansive in scope, 1823 and D'Oench only _______ protect the FDIC from claims or defenses based upon an "agreement" or "arrangement." See 12 U.S.C. 1823(e); In re ___ _____ NBW Commercial Paper Litigation, 826 F. Supp. 1448, 1461, _________________________________ 1466 (D.D.C. 1992). Although the concept of "agreement" has been broadly defined to include not only promises to perform, but also misrepresentations or material omissions, see ___ Langley v. FDIC, 484 U.S. 86, 92-93 (1987), plaintiffs' _______ ____ claims against the FDIC are not based upon an agreement or arrangement.3 Liability for failure to register a security under Mass. Gen. L. ch. 110A, 410(a)(1) is strict. The right to a remedy under section 410(a)(1) is independent of anything that was said or agreed to between the Bank and the plaintiffs. The act of selling the securities is what created the liability and, as the district court found, the Bank, through Keezer, sold the plaintiffs unregistered securities. See NBW, 826 F. Supp. at 1468 (sale of ___ ___ ____________________ 114 S. Ct. 2048 (1994) for the proposition that the FIRREA preempts D'Oench); see also DiVall Insured Income Fund Ltd. _______ ___ ____ ________________________________ Partnership v. Boatmen's First Nat'l Bank of Kansas City, 69 ___________ _________________________________________ F.3d 1398, 1402 (8th Cir. 1995) (D'Oench and holder in due _______ course doctrines preempted by FIRREA); Timberland Design, 932 _________________ F.2d at 51 (not reaching the preemption question because it had been raised for the first time on appeal). We need not, and do not, reach the question of whether D'Oench has been _______ preempted by 1823(e). 3. Indeed, after Langley, the terms "agreement" and _______ "arrangement" appear to be virtually synonymous. See id. ___ ___ ("agreement" is "scheme or arrangement"). -11- 11 unregistered securities in violation of 12(1) of the 1933 Act does not rest on an agreement or arrangement).4 The FDIC's attempt to shoehorn this case into the Supreme Court's Langley decision is unfitting. Starting with _______ the observation in Langley that the term "agreement" includes _______ an implicit condition such as the "truthfulness of a warranted fact," see Langley, 484 U.S. at 93, the FDIC argues ___ _______ that the plaintiffs' claims depend on the Bank's "implied warranty" that the securities it was selling were legal. But to the extent that such a warranty can even be characterized as an agreement or arrangement, the plaintiffs' claims do not depend upon it. The claims come from an independent legal obligation arising from the act itself -- the sale of unregistered securities -- and not from any warranty that the action was legal. See NBW, 826 F. Supp. at 1468. ___ ___ The FDIC says that D'Oench and 1823(e) are _______ designed to shield the FDIC from hidden liabilities and that the FDIC could not have known from the Bank's records that the Bank had sold securities to the plaintiffs. But that does not appear to be the case. Although the Bank's ____________________ 4. This case is not like typical securities fraud cases in which plaintiffs claim that they were induced to purchase a security based upon some material misrepresentation or omission. In such cases, a plaintiff's claim depends upon something the bank said or did that misled the plaintiff. See, e.g., Dendinger v. First Nat'l Corp., 16 F.3d 99 (5th ___ ____ _________ __________________ Cir. 1994); Kilpatrick v. Riddle, 907 F.2d 1523 (5th Cir. __________ ______ 1990), cert. denied, 498 U.S. 1083 (1991). _____ ______ -12- 12 documents did not specifically use the term "security," the pooled income arrangement is disclosed in the documents. The HHI Declaration of Trust and By-Laws specifically provide that the Hotel would be operated on a pooled income basis. The mortgages were reflected in the Bank's records. The Loan Proposal for the conversion loan states that the condominium would be operated on a pooled income basis. The plaintiffs' purchase and sale agreements incorporate by reference the Declaration of Trust and By-laws; and the Loan Extension documents for the plaintiffs referenced the condominium units as collateral. A review of the documents pertinent to the plaintiffs' promissory notes would have revealed the facts showing that the Hotel units were pooled income units. Perhaps recognizing this problem with its general policy argument, the FDIC presses a slightly refined variant. It argues that 1823(e) and D'Oench apply because no _______ specific writing appears on the Bank's records signed by both a plaintiff and the Bank that "memorializes any obligation of the Bank with respect to a securities transaction." This argument, which is premised on the notion that there must be a written agreement that specifically states in terms that the condominium units are securities, rests on the incorrect assumption that the bank examiners must be able to determine the legal import of the facts reflected in the bank's records. This assumption ignores that "[t]he real issue -13- 13 . . . is not whether the bank examiners could tell whether the bank's actions were illegal (or indeed whether the examiners knew what the law was), but rather, whether the factual predicate for the application of the law is established on the bank's books." NBW, 825 F. Supp. at 1469 ___ n.28.5 That the plaintiffs' claims rest on collateral documents referenced in the books of the Bank does not transform their section 410(a)(1) claims into ones based upon an agreement or arrangement. Id.6 ___ ____________________ 5. This case is quite similar to NBW, in which the court ___ held that the FDIC could be liable for a bank's sale of unregistered securities. The FDIC's attempts to distinguish NBW on its facts are unpersuasive. First, the FDIC argues ___ that the bank in NBW was only a seller of securities and the ___ ____ Bank here was both a seller and a lender. But all that ____ really means is that the NBW plaintiffs paid for the security ___ with cash while the plaintiffs here paid for the security with a promissory note and mortgage. Second, the FDIC argues that in NBW there was a written agreement which in terms ___ provided for a securities purchase. But that is not necessary, and the Bank's records reflect the sale of the pooled income units. Third, the FDIC claims that unlike in NBW where the bank was self-dealing, the Bank here was simply ___ acting as a third party lender in this transaction. That claim is just not supported by the record. Moreover, none of these distinctions bears on the central insight of NBW that ___ the plaintiffs' claims against a bank for the sale of unregistered securities do not arise from an agreement or arrangement. 6. It is fair for the FDIC to make the very general point that the plaintiffs' claims depend upon an agreement because they depend upon a "sale" of a security and a sale is an agreement. However, it is undisputed that the sale of these units to the plaintiffs is clearly reflected in the Bank's records sufficient to satisfy both 1823(e) and D'Oench. _______ The FDIC suggests however that there is an absence of a writing, sufficient to satisfy 1823(e) and D'Oench, _______ specifically mentioning in terms that the Bank was a "seller" of the units. As with the FDIC's argument that the documents -14- 14 The only policy consideration underlying D'Oench _______ that the FDIC argues is relevant here is the concern that the FDIC be able to value the assets of a bank by reviewing a bank's records either for purposes of liquidation or for purposes of a purchase and assumption transaction. See ___ Langley, 484 U.S. at 91-92. Such a valuation must be done _______ "'with great speed, usually overnight, in order to preserve the going concern value of the failed bank and avoid an interruption in banking services.'" Langley, 484 U.S. at 91 _______ (quoting Gunter v. Hutcheson, 674 F.2d 862, 865 (6th Cir.), ______ _________ cert. denied, 459 U.S. 1059 (1982)). Where the Bank records _____ ______ reflect adequately the sale of the Hotel units as pooled income units, these concerns appear to be satisfied.7 ____________________ must have stated in terms that the units were securities, this argument assumes that the legal significance of the documents must be apparent to the bank examiners in order to overcome 1823(e) and D'Oench. Just as the pooled income _______ language in the Master Documents made the units securities by operation of securities law, the loan documents reflected in the record, as the district court concluded and the FDIC concedes, made Keezer's sale of the units imputable to the Bank by operation of principles of agency incorporated into securities law. That the legal significance of these loan transactions was not explicitly spelled out does not bar the plaintiffs' claims. See NBW, 826 F. Supp. at 1469 n.29. ___ ___ 7. Plaintiffs have also argued that notwithstanding whether their claim depends upon an agreement, their claims will affect no "asset" for purposes of 1823(e). They point out that where notes are invalidated by acts or omissions independent of an alleged secret agreement, the notes are not an asset protected by 1823(e). See FDIC v. Bracero & ___ ____ _________ Rivera, Inc., 895 F.2d 824, 830 (1st Cir. 1990). They argue ____________ that because the sales of the condominium units were void, see Kneeland v. Emerton, 183 N.E. 155, 159 (Mass. 1932) ___ ________ _______ (under predecessor to Massachusetts Uniform Securities Act, -15- 15 III. Sales Of Securities Or Bona Fide Loans? The FDIC also says that there were no sales of securities, arguing that these were bona fide loan transactions instead. We disagree. The pertinent state securities statute provides that the terms "sale," "sell," "offer," or "offer to sell" do not include any "bona fide pledge or loan." Mass. Gen. L. ch. 110A, 401(i)(6). The record amply supports the district court's conclusion that the loans were not made in the ordinary course of business and were not bona fide. The Bank and Keezer operated together in the marketing and financing of these condominium units to the plaintiffs. When it became apparent that the project might fail because the purchasers were having trouble getting financing, the Bank departed from standard banking practice and offered end loans to the plaintiffs (except Lopes and the Rileys). When it came to granting the end loans to the plaintiffs, the Bank's agent, ____________________ sale of stock was a void transaction where notice of intention to sell shares had not been filed with the Department of Public Utilities), the promissory notes based upon the units were also void, and that, accordingly, no asset passed to the FDIC when it took over the Bank. The FDIC counters that notwithstanding Kneeland's use of the term ________ "void," the case actually employed the concept of "voidability," see id. (stating that the transaction was void ___ ___ at the buyer's instance), and that an asset does pass to the FDIC if the transaction is voidable. See Kilpatrick v. ___ __________ Riddle, 907 F.2d 1523, 1528 (5th Cir. 1990). Because we hold ______ that the plaintiffs' claims in this case do not depend upon an agreement or arrangement, we need not resolve this question. -16- 16 Keezer, knew or should have known that the sales were not registered and therefore could not be completed in compliance with the securities laws. He nevertheless participated in the vote to approve the end loans. That the substitution of the plaintiffs' good debt for HHI's bad debt may have been in the interest of the Bank and its shareholders does not establish that the Bank was involved in bona fide loan transactions. The substitution was based on the transfer of an unregistered security to the plaintiffs. Where the loans were entered into in the course of the Bank's effort to finance and market, through its agent, securities that the Bank knew or should have known could not be sold without registration, the loans were not bona fide. IV. Remedy Each side complains about the district court's remedial order. Plaintiffs argue that the district court erroneously ordered that any recovery against the FDIC be subject to the FDIC's responsibility to distribute the assets of the failed bank in a ratable manner. They also argue that the district court's method of setting the rescissionary damages was infirm, that the award improperly excluded Lopes and the Rileys, and that the court should have awarded an attorneys' fee enhancement. For its part, the FDIC claims that the district court erred in awarding post-insolvency -17- 17 interest and attorneys' fees and in requiring the plaintiffs accepting the rescissionary damages to reconvey their units to all of the defendants rather than only to the FDIC. The district court's award is reviewed for an abuse of discretion unless it rests on an erroneous legal determination. See ___ Downriver Community Federal Credit Union v. Penn Square Bank _________________________________________ ________________ through FDIC, 879 F.2d 754, 758 (10th Cir. 1989), cert. _____________ _____ denied, 493 U.S. 1070 (1990). ______ A. Ratable Distribution ____________________ The FDIC, as receiver, is authorized to distribute the assets of a failed bank to all creditors on a pro rata basis pursuant to the National Bank Act at 12 U.S.C. 91 and 194, and the FIRREA at 12 U.S.C. 1821(i)(2).8 See ___ also United States ex rel. White v. Knox, 111 U.S. 784, 786 ____ ____________________________ ____ ____________________ 8. Section 91 prohibits a bank facing insolvency from making payments that prefer some creditors over others. 12 U.S.C. 91. Section 194 requires a ratable distribution of assets among all general creditors entitled to a share in the receivership estate. 12 U.S.C. 194 (providing that the FDIC "shall make a ratable dividend . . . on all such claims as may have been proved to [its] satisfaction or adjudicated in a court of competent jurisdiction"). Section 1821(i)(2) limits the FDIC's liability as receiver to the amount a claimant would have received in a straight liquidation of the failed bank. 12 U.S.C. 1821(i)(2) ("The maximum liability of the [FDIC] . . . to any person having a claim . . . shall equal the amount such claimant would have received if the [FDIC] had liquidated the assets and liabilities of such institution . . . ."). Section 1821(i)(2) does not, by itself, resolve the issue of whether a plaintiff is entitled to a preference because the statute does not "alter[] or define[] the priorities [that] define liquidation value." Branch v. FDIC, 825 F. Supp. 384, 417 & n.35 (D. Mass. 1993) ______ ____ (internal quotation omitted). -18- 18 (1884) ("Dividends are to be paid to all creditors ratably; that is to say, proportionally. To be proportionate they must be made by some uniform rule. . . . All creditors are to be treated alike."). While the ratable distribution rule is not absolute, the statutory framework is "distinctly unfriendly to the recognition of special interests or preferred claims." Downriver, 879 F.2d at 762 (internal _________ quotation omitted). A plaintiff seeking an exception from the pro rata rule bears a heavy burden of proof to show that a preference is warranted. Id.; see also Branch 825 F. Supp. at 416. A ___ ___ ____ ______ preference might be warranted where a plaintiff is a secured creditor and is seeking to enforce a lien against the security, see Ticonic Nat'l Bank v. Sprague, 303 U.S. 406, ___ __________________ _______ 413 (1938), or where the plaintiff, although a general unsecured creditor, can show an entitlement to a constructive trust. See Downriver, 879 F.2d at 762. Because the ___ _________ plaintiffs can show neither, their awards are subject to pro rata distribution. None of the plaintiffs has a secured claim, and they argue to no avail that they have claims entitling them to a constructive trust. The plaintiffs must have shown, and did not, that the Bank's fraudulent conduct caused a particular harm that is not shared by substantially all other creditors, and that granting the relief would not disrupt the -19- 19 orderly administration of the estate. Id. The district ___ court found, however, that the defendants committed no fraud in this case, and fraud (or violation of a fiduciary duty) is generally a prerequisite to the formation of a constructive trust.9 Moreover, the plaintiffs have not shown that a preference would not interfere with the orderly administration of the estate. The district court properly held that the plaintiffs' awards were subject to the pro rata distribution rule. B. Rescissionary Damages Award ___________________________ Rescissionary damages against the FDIC and the other defendants, jointly and severally, were awarded to all plaintiffs except Lopes and the Rileys. The district court also "novated" the remaining debt of all plaintiffs (except Lopes and the Rileys) on the first and second mortgages held by the FDIC and HHI. The plaintiffs quarrel with this aspect of the district court's award in two respects: that the district court used an incorrect method of calculating ____________________ 9. The only fraudulent behavior the plaintiffs attribute to the Bank stems from the Bank's opposition to the plaintiffs' Motion for Order Segregating Assets filed a few weeks before the Bank was declared insolvent. In opposing the motion, the Bank represented to the court that any harm the plaintiffs feared from an FDIC takeover was mere speculation. The Bank failed to inform the court that it was in negotiations with the FDIC and a takeover by the FDIC was imminent. Without condoning this regrettable lapse by the Bank, it does not help the plaintiffs. The plaintiffs have not demonstrated that they would have been entitled to a segregation of assets had the Bank properly informed the court of its financial condition as it should have. -20- 20 damages, and that the district court improperly excluded Lopes and the Rileys from the rescissionary damages award that ran against the FDIC. 1. Method of calculation. _____________________ The district court ordered an award of rescission, excluding interest, of $654,949. The district court started with the total amount of money at issue -- the principal, interest and other expenses paid by the plaintiffs minus income received and the unpaid debt on the first and second mortgages held by the FDIC, for a total of $2,072,205. The court then subtracted the unpaid mortgage debt owed to the FDIC and HHI, a total of $1,271,100, and the principal and interest payments made by Lopes and the Rileys, a total of $146,156, to reach $654,949. The court then ordered a "novation of the notes owed by the plaintiffs to defendants, HHI and the FDIC," although the court apparently intended an outright cancellation of the notes. Plaintiffs argue that the district court should have awarded them the entire amount of consideration paid for the units, including the unpaid portions of the loans, subject to a setoff by the FDIC and HHI for the unpaid portions of the loans. They also argue that the district court should also have allowed the plaintiffs to keep the units as a setoff for any damages owed to the plaintiffs from -21- 21 the FDIC that would be left unpaid because of the insolvency of the Bank. As a practical matter, there is little difference between what the district court ordered (return of principal, interest, fees and expenses minus income and "novation" of the loans) and what the plaintiffs are requesting (entire cost of loans plus amount paid on the units minus income, leaving plaintiffs' debt to the FDIC and HHI intact). As the plaintiffs recognize, the district court's award "with a solvent defendant, would fully fund rescission and return to Plaintiffs their full damages in exchange for title to their units." The plaintiffs argue, however, that their method of calculation makes a difference because the Bank is insolvent and will not be able to pay the damages judgment in full. Plaintiffs say their method allows them to keep the units as a setoff and thus make up any shortfall between the damages owed and the pro rata share of the Bank's assets they will receive. We disagree. A setoff is often justified where a plaintiff owes a debt to an insolvent party and will be forced to pay off that debt without being allowed to recover a debt the insolvent party may owe to the plaintiff. See In re Saugus ___ ____________ General Hosp., Inc., 698 F.2d 42, 45 (1st Cir. 1983). It is ____________________ typically employed where a depositor, who also owes money to a bank, seeks to offset the amount owed by the amount -22- 22 deposited. It is employed where the parties have reciprocal or mutual obligations to one another. The plaintiffs have tried to characterize the obligations between the parties as being mutual and appropriate for a setoff of the units. Under the plaintiffs' argument, the offsetting obligations would exist were the court (1) to create a damages award in the plaintiffs' favor for the entire amount of the loans and the amount plaintiffs have paid on the units (minus income) and (2) then award the FDIC and HHI the amounts the plaintiffs owe on the promissory notes. With such offsetting obligations, the plaintiffs argue, they should be entitled to set off the units, i.e., keep them, in the face of the Bank's insolvency. See FDIC v. ___ ____ Mademoiselle of California, 379 F.2d 660, 664 (9th Cir. 1967) __________________________ ("It is well settled that the insolvency of a party against whom a set-off is claimed constitutes a sufficient ground for the allowance of a set-off not otherwise available.") (internal quotations omitted)). This argument, however, is incongruous with the plaintiffs' theory of recovery in this case. Plaintiffs here sought rescission, a form of restitution. Under this theory, the restitution by the defendant of the ill-gotten gains cannot be enforced unless the "plaintiff[s] return[] in some way what [they] ha[ve] received as a part performance by the defendant." Arthur L. Corbin, Corbin on Contracts 1114, at ___________________ -23- 23 608 (1964); see also Restatement of Restitution 65 (1937) ___ ____ (the general rule is that the right of a person to restitution for a benefit conferred upon another in a transaction is dependent upon his return of, or offer to return, anything the person received as a part of the transaction). Thus, under the applicable statute, rescission is allowed upon "tender of the security" by the plaintiff. See Mass. Gen. L. ch. 110A, 410(a); see also 15 U.S.C. ___ ___ ____ 77l. Since tender of the unit is a condition for triggering the obligation of the Bank to repay the amount paid for the units, the plaintiffs cannot also use the units as setoffs. The Bank owes the plaintiffs nothing until the plaintiffs relinquish their rights to the units. And once the plaintiffs no longer have rights to the units, the plaintiffs have no basis to use the units as setoffs.10 ____________________ 10. Even assuming that the plaintiffs might, in theory, be entitled to set off of the units, that does not automatically entitle them to do so. A setoff may be denied in order to do "equity, prevent injustice, and achieve the goals of procedural fairness." In re Lakeside Hospital, Inc., 151 _______________________________ B.R. 887, 893 (N.D. Ill. 1993). In equitable terms it could be viewed that plaintiffs have received windfalls from the remedial order. First, a portion of the consideration paid for the security awarded to the plaintiffs was the interest component of the mortgage payments. Assuming that the interest on the Bank's loans to the plaintiffs was at market rate, the effect of the award is to give the plaintiffs a market rate of interest on the price of the units as well as the statutory interest award of 6%. This issue was not presented by the parties and we do not reach the issue of whether 410(a) allows for the calculation of "consideration" in such a way. Second, the plaintiffs were -24- 24 Although the general method employed by the district court in reaching the rescissionary damages award was appropriate, one aspect of the order needs to be modified. The district court ordered a "novation" of the amounts the plaintiffs owed on the first and second mortgage notes to the FDIC and HHI. A "novation" is typically a "substituted contract that includes as a party one who was neither the obligor nor the obligee of the original duty." Restatement (Second) of Contracts 280 (1979). The court's order, however, does not provide for a substitution of parties and, given the cases cited by the district court in its order, Limoli v. Accettullo, 265 N.E.2d 92 (Mass. 1970) ______ __________ and Levy v. Bendetson, 379 N.E.2d 1121 (Mass. App. Ct. 1978), ____ _________ in which the courts cancelled the notes, it does not appear that a substitution was intended. Because an outright cancellation of the notes may render unclear the relative rights of the parties in the unit, we vacate the portion of the order which "novates" the notes along with granting rescissionary damages and remand with directions that the district court order a novation whereby the "judgment" defendants (FDIC, Keezer, Chaban, and HHI) are substituted as obligors on the notes secured by the mortgages and the ____________________ given the option of keeping the units free and clear. Because this allows the plaintiffs to keep what they bought and effectively have a return of a significant portion of the ___ consideration paid for the unit, it might be viewed as a potential over-recovery. -25- 25 plaintiffs are discharged of any liability on the notes. Any units eventually tendered to the judgment defendants would be subject to the mortgages.11 2. Lopes and the Rileys. ____________________ Lopes and the Rileys were denied any relief against the FDIC because they had given mortgages and promissory notes to disinterested third party banks and the court believed that it could not "novate" those debts. Although the district court correctly concluded that it should not interfere with the debts owed to the third party banks, it improperly denied Lopes and the Rileys rescissionary damages against the FDIC. The only difference between Lopes and the Rileys and the other plaintiffs is that Lopes and the Rileys paid substantially more cash to the defendants when purchasing the units. It was not the entire price because both Lopes and the Rileys appear to have given second mortgages to HHI. Lopes and the Rileys were still purchasers of unregistered securities. They should therefore be able to recover from the FDIC and ____________________ 11. This approach keeps the respective rights in the units following the award relatively clear. After the transfer, the judgment defendants would |