Hartford Accident and Indemnity Company v. Michael Sullivan, Defendant-Third-Party-Plaintiff-Appellee v. Ford City Bank, Third-Party-Defendant-Appellant
Docket: 87-1784
Court: Court of Appeals for the Third Circuit; July 6, 1988; Federal Appellate Court
The case involves Hartford Accident and Indemnity Company as the plaintiff-appellant against Michael Sullivan, the defendant-third-party-plaintiff-appellee, with Ford City Bank as the third-party-defendant-appellant, before the Seventh Circuit Court of Appeals. The issues at hand relate to federal jurisdiction and Illinois tort law amidst allegations of bank fraud and attorney misconduct.
In the early 1970s, Michael Sullivan, a real estate lawyer and stockholder at Ford City Bank, referred clients to bank officer William Quinn for loans, while Quinn directed legal business to Sullivan. Sullivan may have breached the Illinois Code of Professional Responsibility by improperly facilitating these referrals. One client, Richard Orlak, a tile contractor with a poor credit history, sought Sullivan's assistance for a $6,000 loan. Despite knowing about Orlak's bankruptcy, Sullivan recommended him to Quinn, who approved the loan without Orlak disclosing his bankruptcy on the application.
By 1972, Orlak had accumulated approximately $500,000 in loans from the bank, with Sullivan aware of these dealings. Subsequently, Orlak and Sullivan devised a fraudulent scheme to secure financing for purchasing a 17-acre parcel of land called Neuport Estates. This involved creating a partnership where Sullivan and Orlak were disclosed partners, while Quinn and another bank officer, Bruce Beede, held undisclosed interests. They concealed crucial information from the bank's executive committee, including the partnership structure, Orlak's bankruptcy, and the land's purchase price, ultimately securing a $250,000 loan, which was later increased to $270,000, secured by the land placed in a land trust. Sullivan also signed a personal guarantee for the trust's debts, though the resolution of the case rendered the guarantee issues moot.
Orlak engaged in fraudulent borrowing from the bank for two years, using Quinn and Beede, without any loans intended for the Neuport Estates project. Sullivan, although representing Orlak, was not involved in negotiating these loans but was aware that Orlak used some loan proceeds to pay interest on the Neuport Estates loan and knew of Orlak's financial difficulties. During this time, Sullivan received irregular cash payments from Beede, mistakenly believing them to be from the Neuport Estates loan, a belief the judge accepted.
Orlak's financial situation deteriorated in June 1974, leading Quinn to confess Orlak's insolvency to the bank. Orlak defaulted on over $2.5 million in loans, prompting the bank to require Sullivan to sign over his interest in Neuport Estates. After foreclosure, the bank suffered a loss of about $1.5 million, but the sale of Neuport Estates ultimately generated sufficient funds to cover the original loan and completion costs, allowing the bank to apply the proceeds to Orlak's other debts.
Hartford Accident and Indemnity Company, which insured the bank against officer defalcations, settled a claim of $1.25 million with Ford City Bank and obtained its legal rights to pursue claims against Orlak and Sullivan in federal court, alleging civil conspiracy. Sullivan was the only defendant to contest the suit, while the others settled or defaulted. He filed a third-party complaint against Ford City, claiming they breached a fiduciary duty by misapplying proceeds from the Neuport Estates sale, also making this claim in a counterclaim against Hartford.
The case was tried together, resulting in Judge Leighton ruling that Sullivan was not liable to Hartford due to his limited involvement in the conspiracy, while Ford City was ordered to pay Sullivan $280,000. Sullivan's counterclaim against Hartford was dismissed, and both Hartford and Ford City are appealing their judgments, while Sullivan did not cross-appeal the dismissal of his counterclaim.
Federal jurisdiction over the third-party complaint is contingent upon the jurisdiction over the main complaint. Since Sullivan and Ford City are citizens of the same state without federal questions, the suit can only be maintained in federal court under ancillary jurisdiction if Ford City had indemnified Sullivan for any judgment Hartford might obtain against him. While authority exists supporting the inclusion of closely related claims in one court (e.g., Revere Copper & Brass Inc. v. Aetna Casualty), Hartford could not use ancillary jurisdiction to circumvent the complete diversity requirement by suing Sullivan and then impleading Ford City if Hartford had claims against both parties. This situation leans toward improper invocation of ancillary jurisdiction, leading to the dismissal of the third-party action for lack of federal jurisdiction.
Sullivan, sued by Hartford through an assignment of Ford City's rights, could assert defenses against Hartford that he would have against Ford City. He claimed a set-off for his interest in Neuport Estates against Hartford's damages claim. However, he could not seek an affirmative judgment against Hartford, which only held an assignment of rights, not liabilities. To obtain an affirmative judgment, Sullivan would need to sue Ford City Bank, but he could only do so in state court. Hartford's prior federal lawsuit against him precluded the consolidation of his state court action with his federal court defense. Thus, Sullivan argues for the ability to address his entire "defense" in federal court due to Hartford's prior action, framing his counterclaim as a defense strategy.
The two lawsuits are related but not identical, meaning a decision in one does not determine the outcome of the other through collateral estoppel. No party contends that a victory for Hartford would guarantee a win for Ford City, or vice versa. For instance, Hartford could prevail based solely on Sullivan's personal guarantee, while Ford City may still face loss on Sullivan's claim against it. Ancillary jurisdiction should be applied narrowly, respecting the states' rights to manage state law issues within their own courts. It should not be used simply to consolidate state and federal cases for judicial efficiency but rather in situations where federal jurisdiction is essential for justice. This case does not meet that criterion, as being required to pursue parallel lawsuits does not constitute an injustice. Furthermore, courts often draw parallels between ancillary jurisdiction and the distinction between compulsory and permissive counterclaims. Compulsory counterclaims, which arise from the same transaction or occurrence as the main claim, fall under ancillary jurisdiction, while permissive counterclaims do not. This case exemplifies the analogy as the relationship between Ford City and Hartford is akin to assignor and assignee; should they be treated as one entity, Sullivan's third-party claim would function as a counterclaim.
Rule 14(a) allows a defendant, such as Sullivan, to implead a third party, like Ford City Bank, if that third party may be liable for all or part of the plaintiff's claim against the original defendant. This rule blurs the line between compulsory and permissive counterclaims, as the third party's liability typically must be derivative of the original dispute. This concept is illustrated by the case of Revere Copper v. Aetna Casualty, where Aetna, the defendant, impleaded Fuller after Revere sued Aetna on a suretyship agreement following Fuller’s breach of a performance bond. In this scenario, the issues in the third-party claim paralleled those in the main claim, allowing for ancillary jurisdiction.
However, the relationship between counterclaims and impleader is not entirely analogous. A defendant who fails to plead a compulsory counterclaim may be barred from pursuing a related state lawsuit, creating potential injustice if the court refuses jurisdiction over the counterclaim. Despite this, it is unlikely that a state court would impose such a severe penalty. The principles underpinning the forfeiture of a compulsory counterclaim resemble res judicata, suggesting that if a claimant had no real opportunity to raise the counterclaim due to jurisdictional issues, forfeiture should not apply. The text suggests a reluctance to categorize a claim as a counterclaim if it cannot be brought due to jurisdictional constraints.
Impleader is a voluntary process, allowing Aetna to seek indemnity from Fuller even without impleading him, which serves merely as a convenience. The appropriateness of federal court jurisdiction over state law issues between citizens of the same state remains questionable, as noted by Judge Lumbard in dissent in Dery v. Wyer. The case at hand compares Sullivan's claim against Ford City Bank to a permissive counterclaim rather than a compulsory one. Hartford's claim against Sullivan is rooted in a fraudulent scheme to defraud the bank, while Sullivan's claim arises from the bank's foreclosure efforts after discovering fraud. Despite some factual overlap, the claims originate from different events and times, failing the "same transaction or occurrence" test necessary for ancillary jurisdiction under Rule 14(a).
If Sullivan's case were deemed closely related enough for federal ancillary jurisdiction, it could raise questions about the validity of Ford City's assignment to Hartford in terms of diversity jurisdiction, as collusive assignments are considered ineffective under 28 U.S.C. § 1359. However, there is no evidence suggesting that the assignment was collusive or improper, as it appears to have been a standard part of the insurance contract. Thus, the assignee's citizenship is relevant for determining diversity jurisdiction.
The merits of Hartford's claim suggest that Sullivan was significantly involved in a broader conspiracy with Orlak, Quinn, and Beede to defraud Ford City Bank, rather than merely participating in a smaller scheme related to a specific loan for the Neuport Estates project.
Illinois courts have established that civil conspiracy is treated similarly to criminal conspiracy, allowing for the use of criminal conspiracy precedents in civil cases. A conspiracy involves an agreement, which may be implicit, and determining its scope can be challenging. Key principles include that a conspirator need not know all other parties involved but must be aware of and accept the common purposes of the conspiracy. The specific issue at hand is whether there were two separate conspiracies related to loans or one overarching conspiracy to defraud the bank. For Sullivan to be held liable for losses related to loans to Orlak, it must be shown that he knowingly subscribed to a common purpose throughout the dealings with Orlak, despite not being continuously involved. The court found that the characterization of a single conspiracy is not only permissible but necessary, as Sullivan played a central role in the fraud, including introducing Orlak to the bank and facilitating a loan despite Orlak's prior bankruptcy, for which Sullivan had knowledge. Sullivan's involvement in two fraudulent loans is acknowledged as a fact.
Participation in a conspiracy does not automatically impose liability for the actions of co-conspirators. There is no evidence that Sullivan's agreement to secure a loan for Neuport Estates was part of a broader scheme to misappropriate bank funds for Orlak. Although a conspiracy to commit fraud exists, the critical inquiry is whether Sullivan joined this conspiracy. Evidence strongly suggests that he did, as he was aware of Orlak's ongoing fraudulent loan activities and that funds from this scheme were being used to service the Neuport Estates loan. Sullivan not only initiated a continuing fraud against the bank but also benefited from its persistence, as it increased demand for his legal services. While providing legal services does not equate to collusion in a client's wrongdoing, legal professionals are not exempt from liability for actions outside their professional bounds. The facts presented meet the clear and convincing evidence standard for civil conspiracy under Illinois law. The factual determination of Sullivan's involvement in the broader conspiracy remains to be resolved, despite his incorrect concession regarding the legal standards applicable to mixed questions of law and fact.
Abraham L. Day's case illustrates that indifference to the intentions of a conspiracy can lead one to become a party to it, as seen in Santee v. Day. Sullivan's actions contributed to a broader conspiracy involving fraudulent loans, particularly with the Neuport Estates loan, which he helped initiate. He failed to report the wrongdoing despite his role as an officer of the court and a stockholder in the defrauded bank, thereby complicating his legal standing. Sullivan's passive observation of money being misappropriated for his benefit indicates intentional participation rather than mere knowledge or acquiescence. Under Illinois law, individuals who aid or benefit from fraudulent acts are liable as if they had committed the acts themselves. The analogy of a drug distribution conspiracy emphasizes that knowing participation in an expanded illegal enterprise results in liability for the broader conspiracy. Thus, Sullivan's active involvement in the initial conspiracy and his awareness of its expansion establishes his status as a participant in both the original and broader conspiracies, increasing his liability accordingly.
Sullivan's set off against Hartford's claim cannot be considered, as Judge Leighton dismissed Sullivan's counterclaim, and Sullivan failed to file a conditional cross-appeal to preserve the set off after his suit against Ford City Bank failed. An appellee seeking to modify a district court judgment must file a cross-appeal, as established in Ayers v. United States. The jurisdictional nature of this rule is debated, and its applicability in cases reliant on other pending decisions remains unclear. However, Sullivan's lack of mention of the set off in his brief indicates a waiver of any objection to its dismissal, as he requested affirmation of the district court's decision in full. Additionally, it was revealed that Sullivan, despite committing serious fraud acknowledged during the trial, has not faced any disciplinary proceedings and remains in good standing with the Illinois bar. The court is notifying the Illinois Attorney Registration and Disciplinary Commission regarding potential action against him. The judgment against Ford City Bank is vacated due to lack of federal jurisdiction, while the judgment against Hartford Accident and Indemnity Company is reversed, directing a judgment in Hartford's favor and further proceedings to determine damages. Sullivan's liability as a conspirator renders Hartford's claim based on his personal guarantee moot. The overall judgment is reversed with specific directions.
