Articles – Page 8 – Law Offices of Randolf Krbechek

Fraud in the Inducement, or “I Didn’t Read the Contract But That’s OK Because the Other Guy Lied About the Terms”

In a recent and closely reasoned opinion, the 5th District Court of Appeal from Fresno held that a claim of fraud could go to trial, even if the alleged fraud was controverted by the language of the written agreement between the parties. There are points in the opinion for discussion, but let’s start with the issue presented.

Stated the court, “Plaintiffs’ complaint alleged causes of action including fraud[.] Plaintiffs alleged they signed a written agreement with defendant, but they were induced to do so by defendant’s oral misrepresentations of the terms contained in the written agreement, made at the time of execution of the agreement.”

The trial court granted summary judgment for the defendant “after ruling that plaintiffs’ evidence of misrepresentations was inadmissible pursuant to the parol evidence rule.” The court of appeal reversed.

The underlying facts are as follows. Defendant is a lender. Plaintiff owed money on an outstanding loan. “On March 26, 2007, plaintiffs and defendant entered into a written forbearance agreement . . . Plaintiffs failed to make the payments required by the March 26, 2007, agreement and defendant recorded a notice of default.”

Plaintiffs “alleged that, two weeks prior to their execution of the written forbearance agreement, defendant’s senior vice president, David Ylarregui, met with them and represented defendant would agree to forbear from collection for two years if plaintiffs would pledge two orchards as additional security.”

“On March 26, 2007, at the time of execution of the written agreement, Ylarregui told plaintiffs the agreement would be for two years and would include as security only the two orchards, and not plaintiffs’ residence or the truck yard. Plaintiffs alleged they did not read the written agreement, but relied on Ylarregui’s representations of its terms in executing the written agreement.”

The court started its review by noting that, “An integrated contract is a complete and final embodiment of the terms of an agreement . . . Whether a writing is an integration is a question of law, which we review de novo. We agree that the forbearance agreement is an integrated agreement, to which the parol evidence rule applies.”

This finding did not protect the lender. The court said there are different kinds of fraud. In the case of “promissory fraud, “ being “a false promise directly at variance with the terms of the written agreement,” parol (extrinsic) evidence is generally not admissible.

Thus, “Parol evidence of promissory fraud is only permissible in the case of a promise to do some additional act which was not covered by the terms of the contract. [When] the alleged false promise related to the identical matter covered by the written agreement and directly contradicted the plain language of the guarantee, evidence of the oral statements was properly stricken as incompetent.”

However, court found a different specie of fraud, recognizing that “a distinction between promissory fraud and misrepresentations of fact over the content of an agreement at the time of execution is a valid one.” Stated otherwise, “Where failure to read an instrument is induced by fraud of the other party, the fraud is a defense even in the absence of fiduciary or confidential relations.”

Accordingly, “parol evidence of a prior promise made without any intention of performing it that directly contradicts the provisions of the written contract must be distinguished from parol evidence of a contemporaneous factual misrepresentation of the terms contained in a written agreement submitted for signing.” This becomes “fraud in the procurement,” as distinguished from “promissory fraud.”

Added the court, “Relief based on this type of fraud would not be available in every case. It would be available only when one party made a false statement about the terms contained in the contract after the written contract was prepared, and the other party reasonably relied on that statement and was thereby induced to sign the written contract without discovering that the actual provisions were not as represented.”

To this end, the evidence does not contradict the terms of the written contract; it shows that “the written contract was not the actual, integrated agreement of the parties.”

The decision is carefully reasoned and based on long-established precedent. Yet, this author finds one gap. Fraud requires proof of reasonable reliance. Case law holds that there is no fiduciary relationship between a borrower and a lender – they occupy an arm’s length business relationship.

The court passed by this issue glancingly, recognizing “the need to prove the element of reasonable reliance” and adding that, “In light of the general principle that a party who signs a contract cannot complain of unfamiliarity with the language of the instrument, the defrauded party must show a reasonable reliance on the misrepresentation that excuses the failure to familiarize himself or herself with the contents of the document.”

That is my question. What established that the plaintiff reasonably relied on the defendant’s representation as to the contents of the contract? We have no discussion regarding the terms or format of the contract. What was the critical point buried in small print deep in the contract? Or was there some circumstance – the press of time, for example – that allowed the plaintiffs to rely on an expression regarding the terms of the contract such that plaintiffs were excused from reading the document before they signed it?

We don’t know, and thereby hangs the tail.

Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Assn. (Jan. 3, 2011) 2011 DJDAR 169

Ahcom v. Smeding – Ninth Circuit Analyzes Alter Ego Liability as Procedural, Not Substantive

In Ahcom, Ltd. v. Smeding, 2010 DJDAR 16125 (9th Cir. Oct. 21, 2010), the Ninth Circuit Court of Appeal considered when alter ego liability could be imposed on corporate shareholders. Applying California law in a bankruptcy context, the court provided contours to alter ego liability.

The issue in Ahcom was whether “a creditor of a corporation in bankruptcy has standing to assert a claim against the corporation’s sole shareholders on an alter ego theory or whether that claim belongs solely to the corporation’s bankruptcy trustee.” The district court held that the claim belonged to the trustee, who must likely was unwilling to pursue litigation against the shareholders.

On appeal, the Ninth Circuit held that the creditor could pursue the claim, because it was an injury specific to the creditor, not a generalized injury that affected all shareholders. Thus, “Ahcom’s first amended complaint asserted two substantive claims, one related to the foreign arbitration award and one related to a breach of contract.”

[According to its website, Ahcom is “one of the largest traders and distributors of tree nuts, including almonds and cashews in the world.]

“Ahcom also alleged an alter ego claim whereby they sought to pierce the corporate veil to hold the Smedings responsible for [the corporation’s] actions. Crucially, both of Ahcom’s substantive claims to recover the arbitration award and the contract-related damages, by their terms, depend on the success of Ahcom’s alter ego allegations. Without those allegations, Ahcom has no claim against the Smedings.”

Explained the court, “The issue is not so much whether, for all purposes, the corporation is the ‘alter ego’ of its stockholders or officers, or whether the very purpose of the organization of the corporation was to defraud the individual who is now in court complaining, as it is an issue of whether in the particular case presented and for the purposes of such case justice and equity can best be accomplished and fraud and unfairness defeated by a disregard of the distinct entity of the corporate form.”

Now comes a profound statement, based on prior published California case law. “In fact, there is no such thing as a substantive alter ego claim at all: A claim against a defendant, based on the alter ego theory, is not itself a claim for substantive relief, e.g., breach of contract or to set aside a fraudulent conveyance, but rather, procedural.”

This author would posit that many lawyers would view an alter ego claim as a substantive claim against the shareholders, not a mere matter of procedure.

The court continued. “This reading is unavoidable when we consider that no California court has recognized a freestanding general alter ego claim that would require a shareholder to be liable for all of a company’s debts and, in fact, the California Supreme Court stated that such a cause of action does not exist.”

As a result, the creditor could pursue its claim against the shareholders. “We conclude that California law does not recognize an alter ego claim or cause of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all the corporation’s debts. Just because [the corporation’s bankruptcy] trustee could not bring such a claim against the [shareholders] under California law, there is no reason why Ahcom’s claims against the [shareholders] cannot proceed.”

A pithy yet profound decision.

Ahcom, Ltd. v. Smeding, 2010 DJDAR 16125 (9th Cir. Oct. 21, 2010)

Debtor’s Fraudulent Transfer of Property Set Aside Years After Trust Was Formed

In a recent bankruptcy case, the Ninth Circuit held that a transfer to a trust could be set aside years after the transfer was made. In In re Schwarzkopf (9th Cir Nov. 23, 2010) ___ F.3d ___, the court held that, because the transfer was a fraud on creditors at the time it was made, the taint of fraud was not erased by the passage of time.

Accordingly, when the debtors filed a bankruptcy petition more than a decade after the trust was formed, the trustee could set aside the transfer and recover the property for benefit of other creditors.

This result is somewhat surprising, considering that California law provides a seven-year statute of limitations to challenge a fraudulent transfer. The court held that the statute of limitations did not start to run until years later, when the named trustee disputed that the trust assets were part of the bankruptcy estate.

The underlying facts were as follows. “The Debtors created both the Apartment Trust and the Grove Trust on June 15, 1992. They named their minor child, Sydnee Michaels [as] beneficiary and appointed Juan Briones [as] trustee. Simultaneously with the creation of the Apartment Trust, Michaels transferred all the stock of Kokee Woods Apartments, Inc. to the Apartment Trust.”

The trial court found that the 1992 conveyance was fraudulent. Specifically, “the bankruptcy court found that . . . the Debtors were insolvent and that [the Debtors] devised the transfer to avoid his creditors’ ability to recover the asset. Therefore, it concluded, the transfer was made for the fraudulent purpose of avoiding the Debtors’ creditors.”

Now, as it turned out, the debtors subsequently became solvent – “After the transfer, Michaels successfully appealed the verdict.” But that did not cure the taint that existed at the time of the original transfer to trust.

This action was commenced in bankruptcy court. “In October 2003, the Debtors filed bankruptcy petitions seeking to discharge approximately $5.4 million in debt. Goodrich, as trustee for the consolidated bankruptcy estates, filed an adversary complaint seeking to recover approximately $4 million in assets from the Apartment Trust and the Grove Trust.“

Held the Ninth Circuit, “We agree with the district court’s conclusion that the Apartment Trust is invalid, and we further hold that Goodrich’s claim to invalidate it is not time-barred. Because we hold that the Apartment Trust is invalid and may therefore be disregarded, we need not address whether it is Michaels’s alter ego.”

Explained the court, “It is well-settled that a trust created for the purpose of defrauding creditors or other persons is illegal and may be disregarded. Properly designating a minor child as a beneficiary does not validate a trust that was created with an improper purpose.”

“Here, the bankruptcy court found that Michaels transferred the Kokee Woods stock simultaneously with the creation of the Apartment Trust and that the transfer ‘was made for the fraudulent purpose of avoiding the Debtors’ creditors.’ Those findings are sufficient to establish that Michaels’s purpose in creating the trust was to defraud creditors. The Apartment Trust is therefore an invalid trust.”

As an invalid trust, the passage of time did not wash away any sins at the inception of the trust. “Even to the extent it alleges fraudulent transfer, Goodrich’s claim is not time-barred by the seven-year statute of limitations set forth in California Civil Code § 3439.09(c). If an express trust fails – if, for instance, it was formed for a fraudulent purpose – the trustee holds legal title to the property on a resulting trust for the trustor and his or her heirs.“

What the court is saying, implicitly, is that a fraudulent conveyance in trust is an illegal transfer, and will never become valid, notwithstanding the passage of time.

“Because the Apartment Trust is invalid, Briones is a voluntary trustee on a resulting trust for Michaels and his heirs. The statute of limitations did not begin to run until Briones repudiated the trust, that is, until he answered Goodrich’s complaint and denied that the Apartment Trust’s assets are property of the bankruptcy estate. We therefore conclude that Goodrich’s claim is not time-barred, and we affirm the district court’s judgment that the Apartment Trust is invalid.”

In re Schwarzkopf (9th Cir Nov. 23, 2010) ___ F.3d ___

Starr vs Starr – Court Upholds Finding of Undue Influence in Real Estate Matter (Part 2)

This is the second part of an analysis of Starr v Starr (Sept. 30, 2010) 189 Cal.App.4th 277. The court held that a house acquired during marriage in the name of the husband only was actually community property, even though the wife signed a quitclaim deed in favor of the husband.

Explained the court, “Evidence Code section 662 creates a presumption that title is actually held as described in a deed . . .The law, from considerations of public policy, presumes such transactions to have been induced by undue influence. When that presumption arose, it trumped the competing presumption created by Evidence Code section 662.”

The court then shifted to an analysis of undue influence, explaining that California law recognizes three forms of undue influence.

1. Undue influence is a contract defense based on the notion of coercive persuasion. Its hallmark is high pressure that works on mental, moral, or emotional weakness, and it is sometimes referred to as over persuasion.

2. Undue influence is statutorily defined as taking unfair advantage of another’s weakness of mind, or taking a grossly oppressive or unfair advantage of another’s necessity or distress.

3. There is another type of conduct that amounts to undue influence: the use of confidence or authority to obtain an unfair advantage. This is triggered by one party’s breach of a confidential relationship.

In reviewing prior case law, the court explained as follows. “Brison I and II are significant for three reasons.”

“First, they announced the overarching principle that constructive fraud due to breach of a confidential relationship amounts to undue influence, terminology that was adopted by other courts.”

That is a clean, efficient statement of the law.

“Second, they differentiated such constructive fraud from the other forms of undue influence based on acts of coercion or over persuasion.”

Also helpful.

“Third, they established a paradigm fact pattern of constructive fraud arising from one spouse’s conveyance of property to the other spouse based on an unfulfilled promise by the other spouse to reconvey. This fact pattern has been applied by our courts many times in cases involving spouses and other persons in confidential relationships.”

Similarly, “In action to quiet title and void deed from father and one son to other son based on breach of fiduciary duties, judgment affirmed; undue influence is a species of constructive fraud and depends on the facts and circumstances of each case.”

The court distinguished another similar holding. “It is easy to see why Ron relies on Mathews. The factual setting seems virtually identical to this case, with the added bonus of Martha’s testimony that she signed the quitclaim deed freely and voluntarily.”

“There is a critical – and we believe fatal – distinction, however. In Mathews, the wife said she merely assumed she would be added onto the title after escrow closed, while Martha testified that Ron told her he would do so. The importance of this distinction is tied up in both section 721 and its statutory predecessor, and the sometimes confusing use of the term undue influence’ by decisions interpreting those provisions.”

Stated the court, “As we have seen, the failure to add Martha onto the title is constructive fraud under section 721, and constructive fraud is presumed to be undue influence, which means the transaction was not free and voluntary. When the trial court found Martha did not act freely and voluntarily, it necessarily found that she quitclaimed her interest in the house as the result of undue influence.”

Now comes the interesting part of the decision. The court outlines a defense to a claim of breach of confidential relationship, aka constructive fraud, aka undue influence. This is a point well worth considering.

To overcome a claim of breach of confidential relationship, “the husband had to show that the deed was freely and voluntarily made, and with a full knowledge of all the facts, and with a complete understanding of the effect of the transfer.”

Stated otherwise, “an interspousal transaction that benefits one of the spouses creates a presumption of undue influence, requiring the husband who obtained his wife’s quitclaim deed to the family home to show that the deed was freely and voluntarily made.”

That’s a quite profound statement, as it sets up a defense to a claim of undue influence or breach of confidential relationship.

Starr v Starr (Sept. 30, 2010) 189 Cal.App.4th 277

Starr v. Starr – Sterling Analysis of Effect of Confidential Relationship (Part 1)

In Starr v Starr (Sept. 30, 2010) 189 Cal.App.4th 277, the court was confronted with division of assets at the time of divorce. In an excellently-reasoned opinion by a divorce attorney, the court found in favor of the wife, and held that she was entitled to a 50% interest in the family residence, even though title was held in the husband’s name.

Interestingly, the court also may have interposed a defense to a claim of undue influence (which defense did not help the husband).

The court reviewed the law thoroughly, and its analysis is worthy of a two–part review.

Here is the issue before the court. “Ron Starr appeals from the judgment entered after the family law court found that the house he bought in his name only while married to former wife Martha Starr was community property and ordered him to convey the property to them both as tenants in common.”

The holding, in a nutshell. “The evidence shows that Martha quitclaimed her interest in the house based on Ron’s promise to put her on title after the purchase was completed, but that Ron failed to do so. As a result, the evidence supports a finding that the house was community property based on Ron’s violation of his fiduciary duties to Martha.”

Ron’s claim was based on record title. “Ron testified that the house was bought in his name only because the $50,000 down payment came from his separate property funds, and he and Martha intended all along that the house would be his separate property. In accord with that plan, Martha quitclaimed her interest in the house before escrow closed. Property taxes and mortgage payments came from community property earnings, Ron testified.”

Not so fast, said the court. Husbands and wives owe fiduciary duties to each other. “Under Family Code section 721, Ron had the burden of proving that the quitclaim transaction satisfied his fiduciary duties to Martha. She testified that because of her poor credit history, the lender recommended she agree to the quitclaim so she and Ron could qualify for a better interest rate.”

Martha testified that, “The loan broker told Martha and Ron they could add Martha back onto the title by way of a quitclaim deed within 45 days of the close of escrow. Martha had a discussion with Ron about adding her onto the title, and he said he would do that. Martha said she and Ron jointly offered to buy the house, and that the deed to Ron was mailed to them both after it had been recorded.”

The critical fact, at least as it relates to the fiduciary relationship. “Although Ron never added Martha onto the title, she never worried about it because ‘He’s my husband. I just don’t . . . mistrust him. You know, it was our house.’ She signed the quitclaim deed freely and voluntarily.”

The trial court stretched to rule in favor of Martha. finding that “Ron did not meet his burden of proof that Martha’s quitclaim deed was signed freely and voluntarily. The reason Martha did not sign the quitclaim deed freely and voluntarily was because the intent of the lender controlled title to the house when the lender suggested that Martha’s name be left off of the mortgage for the purposes of financing, and Martha agreed to execute the quitclaim deed based on the lender’s suggestion.”

Well, that doesn’t sound like the husband overreached in his dealings with Martha. Rather, Martha took action (i.e., signed the quitclaim deed in favor of Ron) based on information she received from the lender. The court of appeal dismantled that argument.

Explained the court of appeal, “Although spouses may enter transactions with each other, such transactions are subject to the general rules governing fiduciary relationships which control the actions of persons occupying confidential relations with each other.”

Thus, transactions between spouses arise in the context of a confidential relationship. “This confidential relationship imposes a duty of the highest good faith and fair dealing on each spouse, and neither shall take any unfair advantage of the other. This confidential relationship is a fiduciary relationship subject to the same rights and duties of unmarried business partners, including the right of access to records and information concerning their transactions.”

“Because of this, our courts have long held that when an interspousal transaction advantages one spouse, public policy considerations create a presumption that the transaction was the result of undue influence. A spouse who gained an advantage from a transaction with the other spouse can overcome that presumption by a preponderance of the evidence.”

See part 2 for the conclusion of this case.

Starr v Starr (Sept. 30, 2010) 189 Cal.App.4th 277

Vuki vs. Superior Court – No Private Right to Enforce Three-Month Negotiation Period in Civil Code Section 2923.52

The California legislature has been tinkering with the foreclosure rules since the mortgage crisis started in 2007. One of the laws enacted was Civil Code section 2923.52. This section says that a lender must add three months to the normal 90-day waiting period for recoding a notice of sale (i.e., double the waiting time for a notice of sale) “if all of the following conditions exist:

“(1) The loan was recorded during the period of January 1, 2003, to January 1, 2008, and is secured by residential real property; (2) The loan at issue is the first mortgage or deed of trust; and (3) The borrower occupied the property as the borrower’s principal residence at the time the loan became delinquent.”

In the recent case of Vuki v. Superior Court (October 29, 2010) 189 Cal.App.4th 791, the borrowers alleged that the foreclosure sale of their house was invalid because the lender failed to provide them with the additional three-month “renegotiation” period. The court swept aside the argument, finding that a violation of the statute was a matter for the regulators to enforce, not an aggrieved borrower.

Here are the all-to-common facts. “Lucy and Manatu Vuki lost their Buena Park home to foreclosure. The sale took place October 7, 2009, with their erstwhile lender, HSBC Bank USA (HSBC), as the buyer at the foreclosure sale . . . On April 6, 2010, the Vukis filed this state court action against HSBC for, among other things, statutory violation of Civil Code sections 2923.52 and 2923.53.”

The court was essentially compelled to rule against the borrowers because “of the operation of section 2923.54. Subdivision (b) of that statute is clear that: ‘Failure to comply with Section 2923.52 or 2923.53 shall not invalidate any sale that would otherwise be valid under Section 2924f.’”

That’s a shame, because we have a legislative mandate to protect borrowers from over-reaching, but no effective manner of recourse. Still, the borrowers should have been able to maintain an action for wrongful foreclosure, even if they could not invalidate the sale.

As the court held, “This argument fails since any claim which the Vukis might have to invalidate the foreclosure sale based on sections 2923.52 and 2923.53 necessarily entails a private right of action which the statutes do not give them.”

Explained the court, “Civil Code section 2923.52 imposes a 90-day delay in the normal foreclosure process . . . After the enactment of section 2923.52, at least for certain loans, another 90 days must be included ‘in order to allow the parties to pursue a loan modification to prevent foreclosure.’”

The court explained that “the requirements are a matter of a general program, evaluated by regulatory commissioners . . . Everything in the exemption process, in short, is funneled through the relevant commissioner, [to wit] (1) The Commissioner of Corporations for licensed residential mortgage lenders and servicers and licensed finance lenders and brokers; (2) The Commissioner of Financial Institutions for commercial and industrial banks and savings associations and credit unions; and (3) The Real Estate Commissioner for licensed real estate brokers servicing mortgage loans.”

In the court’s analysis, the statute could not be enforced by the debtor. “Section 2923.54 first imposes a requirement that a notice of sale give information about whether the servicer has, or has not, obtained an exemption from the 90-day delay provisions of section 2923.52.”

“But then section 2923.54 makes clear that whatever else is the case as regards actual compliance or noncompliance with sections 2923.52 and 2923.53, it will not invalidate any otherwise valid foreclosure sale”

The court conclusively ruled against the debtors, stating that “The argument fails because, as shown above, any noncompliance with sections 2923.52 and 2923.53 is entirely a regulatory matter, and cannot be remedied in a private action. The statutory scheme contains no express or implied exceptions for any lender who buys property knowing that it may not have complied with sections 2923.52 and 2923.53.”

I’m not keen on all the legislative tinkering with the foreclosure process. It’s just sticking a finger in the dam – it doesn’t address the underlying problems, including the apparent wilful failure of lenders to renegotiate loans in good faith.

Yet, if there’s going to be a statutory right to an additional three-month “negotiation” period, then there has to be a private enforcement mechanism, or the law serves no useful purpose. Which point was driven home by this court.

Vuki v. Superior Court (October 29, 2010) 189 Cal.App.4th 791

Thomas Schoenbaum on the Causes of Global Financial Crisis – Part 2

Professor Thomas Schoenbaum from George Washington University has written a paper discussing the worldwide financial crisis. His paper entitled “Saving the Global Financial System: International Financial Reforms and United States Financial Reform, Will They Do the Job?”, identifies 12 factors as triggering the financial crisis.

The second six are as follows (the first six are discussed in part 1).

7. Irresponsible Behavior and Fraud by Wall Street Professionals. Investment abdicated their traditional roles as financiers for the business world, and instead decided to make money using new models, which profited from their good names.

“In creating and profiting from new types of derivatives securities, such as CDO’s and CDS’s, Wall Street professionals were taking full advantage of a permissive and inadequately policed system that encouraged sharp practices and provided large rewards for excessive greed. Of course, fraudulent activity also played a part: for example, Goldman Sachs, perhaps the most respected name on Wall Street, has accepted a civil fine of $550 million (about two weeks worth of profits) to settle a fraud case brought by the SEC accusing the firm of selling derivative investments to customers that were secretly designed to fail.”

8. Confused and Inconsistent Accounting Standards. A 2000 statue was supposed to establish the Public Company Accounting Oversight Board, whose job is to regulate the accounting industry.

Says Prof. Schoenbaum, “Regretfully, this Board has been very slow to act, prevented from getting off the mark by alleged conflicts of interest and litigation begun with the intent to destroy it all together . . . For whatever reason, the Board has not done its job and accounting miscues and inconsistences contributed to the Global Financial Crisis. For example Lehman Brothers was able to use accounting rules to remove tens of billions of dollars from its balance sheet according to an examiner’s report.”

We’ve been hearing about this for years. The investment banks were permitted to restate income and to circumvent the accounting rules with a wink and a nod from the government. You can’t have a level playing field unless the rules are uniformly enforced.

9. The U.S. Federal Reserve’s Botched Monetary Policy. “After the bursting of the high-tech bubble in 2001, the Greenspan-led Federal Reserve lowered interest rates to levels not seen in a generation. These low rates persisted too long [, ] contributing to the asset bubble that sparked the Crisis. Then, too late, the Fed rapidly raised rates. Making up for lost time to kill the asset bubble. Both polices were badly mistaken.”

In the early 200s, the Fed wanted to propel a recovery from the dot-com bust. Low interest rates encouraged the growth in mortgage-backed securities; lack of oversight allowed the mortgage-backed securities to flourish in an atmosphere free from realistic oversight. The economy overheated, and the conductor failed to apply the brakes before the train crashed.

10. U.S. Government Housing Policy. “The U.S. government is far too involved in private housing market. In a misguided effort to make every citizen a property owner, the U.S. government has skewed the housing and mortgage markets as well as the prices for homes in the United States. There is simply too much government interference in housing.”

The author cites the Community Reinvestment Act as a contributor to bad lending decisions, stating “this is not the appropriate role for government, which should enforce anti-discrimination laws but should not pressure banks to make loans to certain groups of people.”

11. Repeal of the Glass-Steagall Act. “The Glass-Steagall Act, which was enacted during the Great Depression, functioned to insulate banks from the risks inherit investment banking. This law was repealed [in 1999], which permitted consolidation of commercial banking, investment banking, and insurance companies . . . The repeal of Glass-Steagall was a reason why the Crisis infected the whole U.S. financial system, not just investment banks.”

Many warned against the repeal of Glass-Steagall, but the warnings were ignored. Hey, if we haven’t had a banking crisis in 70 years, we must have eradicated the problem, right? Wrong. Glass-Steagall served an admirable purpose, and must be reinstated.

12. Global Current Account Imbalances. A final global factor is that, “during the period leading up to the Crisis the U.S. experienced record trade in current account deficits. In 2006 the U.S. current account deficits was $811 billion; in 2007 it was $738 billion. In 2008 the deficit declined slightly to $706 billion, and because of recession a further decline was recorded in 2009 to $409 billion”

Such deficits cannot be sustained. “During the boom years before the Crisis, record U.S. trade deficits were equal to approximately 2/3rds of the trade surpluses of the rest of the world. While trade and current account deficits are not inherently bad, when they become chronic and balloon out of proportion they are a sign of structural problems that should be corrected.”

“In the case of the U.S. the current account deficits represents inadequate savings and over-consumption. In the case of China, the growing and chronic surpluses represent lack of adequate domestic demand and too much saving . . . This imbalance cannot continue without threatening the stability of the international monetary system.”

Uniform Commercial Code Law Journal, Vol. 43, No.1 (October 2010) page 479.

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Thomas Schoenbaum on the Causes of Global Financial Crisis – Part 1

The first six are as follows (the second six are discussed in part 2).

1. The diminished authority of the United States Securities Exchange Commission. This constituted a regulatory failure. States Prof. Schoenbaum, “beginning in the 1980’s, the once-feared SEC became largely toothless due to rule-revisions, exceptions, and leaders that discouraged fraud investigations and enforcement actions.”

Such failure continued for two decades, but not without warning. “One of the most egregious of SEC failure occurred on April 28, 2004, when the SEC voted to exempt investment companies from the SCC’s net capital rule . . . During this meeting, Harvey Goldschmid, one of the Commissioners, remarked, ‘If anything goes wrong, its going to be awfully big mess.’”

2. Failure to Regulate the Derivatives Market. Another regulatory failure. The derivative market is enormous, yet it operated for years without effective oversight. Again, there were warnings. The Commodities Futures Modernization Act of 2000 specify exempted derivatives and swaps from supervisory oversight by the Commodity Futures Trading Commission, “despite warning from its chairman that unregulated derivatives “could threaten our regulated markets or, indeed, our economy without any Federal agency knowing about it.”

3. Lax Regulation of Financial Institutions. Here, the author cites the Federal Reserve and the Comptroller of the Currency as failing to exercise proper oversight of the U.S. banking industry. Thus, “the persons in charge of bank regulations were totally obvious to the dangers of the extensive use of derivatives such as MBS’s. Accordingly, the use of MBS’s allowed financial institutions to profit from transactions that involved unreasonably low capital requirements.”

This point could be stated in slightly different terms. The players in the financial markets, especially in derivatives, were permitted to gamble with other people’s money. The oversight in the banking industry was absent in the derivatives market. Such easy access to such excessive leveraging encouraged Wall Street to take unreasonable and dangerous – desperately dangerous – risks.

4. Financial Institutions That Took on Too Much Leverage. The authors cites this factor as a private sector abuse, stating “a key cause of the Crisis was the fact that key financial institutions, especially the investment banks, took on far too much leverage, risking vast qualifies of borrowed capital so that they were unable to withstand a down turn in asset prices.”

What kind of leveraging was going on? “After the SCC exempted investment banks from the ‘net capital’ rule in April 2004, leverage increased dramatically to levels in excess of 40 to 1.” This meant the investment banks could make a $40 bet with only $1 in actual assets. Is this a recipe for disaster? You bet it is.

5. Mismanagement by Bond and Securities Ratings Agencies. As explained by Prof. Schoenbaum, “hearings in the Congress and the European Union have established a sloppy and misleading ratings practices that causes most of the now ‘toxic’ derivatives to be given triple A ratings. Only after the Crisis began did the ratings agencies downgrade these securities. The credit ratings agencies were among the enablers of the Crisis.“

See, the vast tradings in the investment banking world were really a shadow financial system, running parallel to the banking industry. The banks were heavily regulated and were backed by the FDIC. The investment banking world had no such official guarantees, so they invested the insurance provided by companies such as AIG. At present, “AIG has benefitted for governmental largesse amounting to a total of $182.5 billion. None of this funding has been repaid.”

That means that the U.S. taxpayers bailed out the bets that were made by Goldman Sachs and other investment banks to the tune of $182 billion that has never been repaid. It’s one thing to take risks with your own money; it’s entirely different when the government steps in to save private industry in the amount of $182 billion. Oversight and accountability must be established, otherwise the taxpayers just gave away $182 billion to the bankers.

6. Low Saving Rates and High Borrowing by American Consumers. This is a social factor. Explains the author, “as of 2007, the U.S. savings rate touched zero, which means that as a group Americans were spending every penny of income. Moreover, many Americans were deeply in debt, now only for home mortgages but on credit cards and other consumer loans. The American economy was overheated and riding for a fall.”

Part 2 follows next week.

Uniform Commercial Code Law Journal, Vol. 43, No.1 (October 2010) page 479.

Citizens Business Bank v. Carrano – A Strange Conception

In the recent decision in Citizens Business Bank v. Carrano (Nov. 05, 2010), the court sensibly applied the rules for construing a will to the interpretation of an estate planning trust. This is an appropriate result, considering that the trust was intended to serve as a substitute for will. However, the law authorizing such a result is not as clear as it should be, at least under the statute.

The facts make for an entertaining read. According to the court, “Charles and Serena Papaz created the Papaz Family Trust on August 2, 1966. Charles and Serena ha[d] one child, Christopher. Christopher fathered three children out of wedlock.”

The lawsuit concerned one of the grandchildren, Jonathan. The matter of Jonathan’s conception was unusual, to say the least. The court found that, “Christopher (the son) met Jonathan’s mother, Kathy Carrano, when he was shot in the leg in 1984.”

“Kathy was Christopher’s physical therapist while he was in the hospital and she continued to care for him during his recovery at his parents’ home. One night, Christopher gave Kathy a drug and had sex with her without her knowledge. Jonathan was conceived that night.”

Only in California, you might say. But wait, the story gets better. “Kathy was married to another man at the time. Jonathan was born in August 1985. Kathy and her husband raised Jonathan as their child. A few years after he was born, Kathy learned that Jonathan was Christopher’s son and not her husband’s. Jonathan was never formally adopted by Kathy’s husband.”

“Christopher, however, appeared to be aware that Jonathan was his son from the beginning. He bragged to his friend, Vahe Tatoian, when Kathy was pregnant that, “I know this is my kid.’”

Christopher led a troubled life. “In December 2006, Christopher became paralyzed from his neck down and could no longer speak. In January 2007, Kathy told both Jonathan and Charles [the grandfather] that Christopher was Jonathan’s biological father. Jonathan introduced himself to Charles, saying, ‘I am Jonathan, your grandson, Christopher’s son.’ Charles ‘reached over and grabbed [Jonathan’s] hand and said, ‘I know.’”

After Christopher’s death, an issue arose as to who was entitled to inherit under the trust. The trust provided for distributions to Christopher’s “then-living issue.” The matter wound up in court when “Citizens Business Bank, as trustee to the Papaz Family Trust, filed a petition for an order ascertaining beneficiaries and determining entitlement to distribution.”

Held the court, “The ultimate question in this case is whether the Papaz Family Trust’s definition of ‘issue’ includes Jonathan. Jonathan argues that the term ‘issue’ in the trust instrument is unambiguous. We agree.”

First, the court applied basic contract law, stating that “whether an ambiguity exists in a writing is an issue of law subject to independent review on appeal.” Then the court reached out and connected trust law with the law of wills, as follows:

“Our Supreme Court’s opinion in Estate of Russell (1968) 69 Cal.2d 200, 205-206, lays the foundation for our interpretation of a trust instrument: ‘The paramount rule in the construction of wills, to which all other rules must yield, is that a will is to be construed according to the intention of the testator as expressed therein, and this intention must be given effect as far as possible.’”

Now, I agree with this analysis, specifically, that estate planning trusts should be construed by rules similar to those applicable to the law of wills. The Carrano court makes an explicit link between the two bodies of law, a link that is not always followed, either in case law or in statute.

The court continued. “The rule is well established that where the meaning of the will, on its face, taking the words in the ordinary sense, is entirely clear, and where no latent ambiguity is made to appear by extrinsic evidence, there can be no evidence of extrinsic circumstances to show that the testatrix intended or desired to do something not expressed in the will.”

The court found that the word “issue” had a statutory definition which included all three of Christopher’s children, regardless of the unusual circumstances by which Jonathan was conceived. Stated the court, “typically, latent ambiguities arise where two persons or things answer the description of a bequest, or where there is a mistaken description and one or more persons match a portion of the bequest . . However, extrinsic evidence is not admissible to change a testator’s intent.”

Having found no ambiguity in the word “issue,” the court ruled in favor of Jonathan, concluding that, “Just as in Estate of Russell, we are not at liberty to rewrite the Papaz Family Trust to attach restrictions to the term ‘issue’ that Serena and Charles did not expressly include.”

The court reached the right decision for the right reasons, but I am not positive that the line connecting law of wills to the law of trusts is quite as straight as the court would have us believe.

Citizens Business Bank v. Carrano (Nov. 05, 2010) — Cal.Rptr.3d —-, 2010 WL 4371042

Lickter v. Lickter – No Standing to Sue for Elder Abuse After Distribution Made to Trust Beneficiary

The recent decision in Lickter v. Lickter (Oct. 27, 2010) — Cal.Rptr.3d —-, 2010 WL 4231300 highlights of three important points. First, a trust beneficiary does not have standing to pursue a claim on behalf of the trust after the beneficiary has received his or her distribution pursuant to the trust. This may seem like a common-sense answer, but it took a published appellate decision to affirm the point.

Second, draftspersons should be careful in how they handle pour over provisions in wills. It is common to couple an estate planning trust with a pour over will. By such standard estate planning documentation, the pour over will transfers any assets into the trust that were not already titled in the name of the trust at the time of the trustor’s death.

Yet, this can lead to an awkward circumstance if the asset consists of a claim for personal injury to the trustor, however, Costa Ivone can give you legal advice. Depending on how the pour over will was drafted, such claim may pass to the trust, to be prosecuted in the name of the trustee for benefit of the trust and its beneficiaries. Draftspersons may wish to consider modifying their pour over wills to provide that such claims for personal injury are the property of one or more named persons, rather than property of the trust, check

Third, this case emphasizes the importance of making pecuniary bequests to persons whom the trustor wants to preclude from attacking the trust. If the trustor makes a gift of $0.00 a potential beneficiary, then the beneficiary has no reason not to attack the trust. If the beneficiary loses, he still gets nothing; if he wins, then he gets something under the trust.

In this case, the beneficiaries who wanted to launch a challenge received specific bequests, which requests were distributed to them by the trustee. By such distribution, the trustee prevented an attack on the trust.

Here’s how the court addressed the matter. “The underlying facts are largely irrelevant. For our purposes, it is sufficient to say that Lois died in August 2007 at the age of 91, leaving property in a trust, of which Robert became the trustee. The terms of the trust provided that upon Lois’s death, $10,000 each would be distributed to plaintiffs and the entire residue of the trust would then be distributed to Robert. If Robert predeceased Lois, the residue was to be distributed to Maggie and Kate. If Maggie and Kate also predeceased Lois, the residue was to be distributed to their children or, if none, to Lois’s living children by right of representation.”

“Plaintiffs Joshua and Jezra Lickter sued their father (Robert Lickter), their half-sisters (Maggie and Kate Lickter), and their half-sisters’ mother (Mary McClain) for elder abuse and other related causes of action that had belonged to their grandmother (Robert’s mother), Lois Lickter, when she died. Plaintiffs claimed they had standing to commence and maintain the action under Welfare and Institutions Code section 15657.3(d).”

Explained the court, “The primary issue in this case is who is entitled to commence and/or maintain an elder abuse action after the elder who was allegedly abused has died . . . As we will explain, just because plaintiffs were beneficiaries of Lois’s trust did not make them ‘interested persons’ for purposes of pursuing this elder abuse action under subdivision (d) of Welfare and Institutions Code section 15657.3 . . . Plaintiffs were former beneficiaries of Lois’s trust, as they already had been paid the amounts they were owed under the trust. Thus, plaintiffs had no such interest in this elder abuse action.”

Bravo for a pithy and direct analysis. “Because Robert was Lois’s only surviving child, and because neither Maggie nor Kate had children, the residue of Lois’s trust would be distributed to plaintiffs under the terms of the trust if Robert, Maggie, and Kate all were deemed to have died before Lois.”

Here is the heart of the issue noted by the Best Overland Park Family Lawyer. “It has long been clear under California probate law that a person who can claim the title of ‘heir’ is not necessarily an ‘interested person’ for purposes of instituting or participating in a particular proceeding in a probate case. The question, rather, is whether the person – whether an heir, devisee, beneficiary, or other person – has an interest of some sort that may be impaired, defeated, or benefited by the proceeding at issue.”

Now shines the beauty of the specific bequests to the beneficiaries who wanted to institute the action. “Here, when the trial court granted summary judgment, plaintiffs had no right in or claim to Lois’s trust estate by virtue of their status as former beneficiaries of Lois’s trust because all of the interest they had in Lois’s trust had been satisfied when they were each paid the $10,000 Lois left each of them.”

“Thus, they were no longer beneficiaries of the trust, let alone beneficiaries with ‘a property right in or claim against the trust estate which could be affected by the’ elder abuse action. For this reason, the trial court did not err in concluding that they did not have standing as ‘interested persons’ under subdivision (d)(1)(C) of Welfare and Institutions Code section 15657.3 in their role as beneficiaries of Lois’s trust.”

To drive the point home, the court further held that, “In other words, contrary to plaintiffs’ assertions, it is not true that Robert’s payment of the $10,000 each plaintiff was owed from the trust terminated their standing to pursue this action as beneficiaries of Lois’s trust. The fact is that plaintiffs’ status as beneficiaries of Lois’s trust never gave them standing to pursue this action because the beneficial interest they had in the trust estate was not one that could have been ‘affected by’ this action.”

Hat’s off to a clear, concise, and absolutely accurate decision.

Lickter v. Lickter (Oct. 27, 2010) — Cal.Rptr.3d —-, 2010 WL 4231300