Opinion
Case No. 95-14438-SSM, Adversary Proceeding No. 96-1167-SSM
October 20, 1996
Ira C. Wolpert, Esquire, Bethesda, MD, Of Counsel for the plaintiff
James R. Schroll, Esquire, Bean, Kinney Korman, P.C., Arlington, VA, Of Counsel for the defendant
MEMORANDUM OPINION
This matter is before the court on the defendant's motion to dismiss, and the plaintiff's motion to amend, the complaint in this adversary proceeding. The plaintiff, DEP, Inc. ("DEP" or "the debtor"), is the debtor in possession in the underlying chapter 11 case. The defendant, Atlantic Funding Corporation ("Atlantic") is the holder of a $1,000,000 promissory note that the debtor asserts a prior holder of the note had agreed to sell to the debtor's principal for $250,000. Accordingly, the debtor argues that the note cannot now be enforced in an amount greater than $250,000. The question before the court is whether a triable issue has been presented.
Facts
As noted below, the issues raised by the complaint have already been the subject of a two-and-a-half day evidentiary hearing in this court in connection with a motion for relief from the automatic stay. This statement of facts is largely based on the evidence adduced at that hearing.
The debtor, DEP, Inc., filed a voluntary petition in this court under chapter 11 of the Bankruptcy Code on October 10, 1995. It owns three parcels of real estate, all located in Prince William County, Virginia. One of these is an undeveloped tract of land of approximately 61 acres sometimes referred to as the "Pick-A-Pair" tract. The second is a mobile home park and three adjacent lots (currently undeveloped, but with potential for commercial zoning) known as Elm Farm Mobile Home Park. And the third is a 22-unit office condominium complex known as the Dominion Professional Center. Only the latter is directly implicated in the present adversary proceeding.
All three parcels are subject to a first-lien deed of trust in favor of C.F. Trust, Inc. ("C.F. Trust"), securing two promissory notes. The claimed balance due is approximately $6.1 million, although the debtor asserts that the actual amount owed is only $4.2 million. The $1,000,000 promissory note held by Atlantic is dated November 7, 1986, and is secured by a second-lien deed of trust against the Dominion Professional Center only. The makers of the note are Barrie M. Peterson, individually, and Barrie Peterson, Trustee. Mr. Peterson is currently the president and sole shareholder of DEP. At the time the note was signed, however, DEP did not exist, and title to the Dominion Professional Center was held by Mr. Peterson as trustee. The original lender was Dominion Federal Savings Loan Association ("Dominion"). Dominion was subsequently taken over by Trustbank Savings Bank, F.S.B. ("Trustbank"), which in turn was taken over by the Resolution Trust Corporation ("RTC").
The debtor's assertion is based on an alleged settlement agreement with Central Fidelity Bank, the prior holder of the notes, to release the collateral upon the payment of $4.2 million. With respect to the Dominion Professional Center, testimony presented at the relief from stay hearing suggested that C.F. Trust is in a first-lien position only to the extent of $1.2 million. Lien priority was not an issue in the relief from stay hearing, however, and in any event the evidence before the court was insufficient to make any ruling as to priority.
After the RTC acquired the note — which was then in default — it obtained a judgment against Mr. Peterson on November 15, 1991, in the amount of $1,217.202. Mr. Peterson then negotiated to purchase the note and the judgment at a discount. At that time, a first deed of trust note against the Dominion Professional Center held by Signet Bank was in default, and Signet Bank threatened foreclosure. Mr. Peterson sought to borrow from Central Fidelity Bank — DEP's existing lender on the other two parcels — sufficient funds to purchase the property at the foreclosure sale. Ultimately, foreclosure was averted when Central Fidelity Bank purchased the note directly from Signet Bank. The obligation under the Signet Bank note was then "merged" into a new note secured by all three parcels on or about September 21, 1992. While all this was occurring, Mr. Peterson was negotiating an agreement with Gemini Asset Managers, Inc. — which was acting as the RTC's asset manager — to purchase the RTC note and judgment for $250,000. The terms of the sale were $50,000 up front followed by ten monthly payments of $20,000 each. A formal written agreement was prepared by Gemini's attorney and signed by Mr. Peterson on June 7, 1993. It was forwarded to the RTC for signature but for whatever reason was never signed. Instead, the note was sold as part of a portfolio of nonperforming loans to Superior Financial Services, Inc., on November, 10, 1994. Superior in turn sold it two months later to Atlantic Funding Corporation for $100,000. After Atlantic purchased the note and judgment, it notified Mr. Peterson that it now held the note. Mr. Peterson insisted to Atlantic that he had had an agreement with the RTC to purchase the note for $250,000. Atlantic then offered to sell the note and judgment to Mr. Peterson on terms identical to those in the agreement that the RTC had never signed. Atlantic hired Morse to prepare the agreement, which was then mailed to Peterson on February 16, 1995. Pltf. Exh. 5. Peterson, however, neither accepted nor signed the agreement. By this time, the obligation to Central Fidelity had been split into two notes, each dated November 1, 1993. One was in the principal amount of $4,414,903.57, and the other was in the principal amount of $1,650,000.00. When Peterson did not respond to the settlement proposal, William Cooley, Atlantic's president, arranged for C.F. Trust to purchase the Central Fidelity notes.
The note — actually, an industrial revenue bond — was in the original principal amount of $1.6 million. The testimony at the relief from stay hearing reflected that the approximate amount owed at the time the note was purchased by Central Fidelity Bank was $1.2 million.
William Cooley is the sole shareholder, officer and director of Atlantic Funding. He is a 10% shareholder, but not an officer or director, of Superior. He testified at the relief from stay hearing that he did the "due diligence" investigation for Superior in connection with the purchase from the RTC.
The cover letter stated that the settlement offer was open until February 24, 1995. Mr. Peterson testified at the relief from stay hearing that he did not accept the offer because he did not believe Atlantic had the "right" to purchase the notes and was concerned the taxpayers may have been defrauded by the sale of the note for only $100,000, when he had offered to pay $250,000. Having heard his explanation, and having had an opportunity to observe his demeanor on the witness stand, the court does not find his testimony credible.
Cooley is indirectly (through his sole ownership of Mid-Pacific Funding) a 25% owner of C.F. Trust. Cooley testified at the relief from stay hearing that the reason he had C.F. Trust purchase the Central Fidelity notes was because they were senior to the note Atlantic had purchased, and he was concerned that Mr. Peterson was attempting to acquire the Central Fidelity notes himself in order to eliminate Atlantic's interest.
DEP filed its chapter 11 petition in response to a state court receivership action brought by C.F. Trust. C.F. Trust subsequently filed a motion for relief from the automatic stay in order to foreclose under its deed of trust. An evidentiary hearing was held on July 2, 3, and 10, 1996, at which extensive testimony was taken concerning the value of the real estate and the debtor's defenses to the Atlantic and C.F. Trust notes. The court found that the total amount due on the notes held by C.F. Trust and Atlantic was $7,830,788, and that the total fair market value of all the real estate was $6,335,000. The court did not, however, terminate the automatic stay but conditioned it on the making of monthly interest payments on the C.F. Trust notes and on the debtor's obtaining confirmation of a plan of reorganization not later than October 25, 1996.
The fair market value of the Dominion Professional Center by itself was found to be $2,100,000.
The present adversary proceeding was commenced on May 29, 1996. The complaint sought a determination — based essentially on a theory of accord and satisfaction — that Atlantic's claim was limited to $250,000 (Count I). In the alternative, the complaint sought an order equitably subordinating any portion of Atlantic's allowed claim in excess of $250,000 (Count II). Atlantic responded by filing a motion under F.R.Bankr.P. 7012 to dismiss the complaint for failure to state a claim for relief. Shortly before that motion was filed, the United States District Court for the Eastern District of Virginia had dismissed with prejudice a similar complaint that Mr. Peterson had brought against Atlantic, ruling that, based on the allegations in the complaint, no cause of action existed based on accord and satisfaction. In a subsequent order dated September 6, 1996, the District Court clarified its earlier order to reflect that the pleadings did not raise, and the court did not rule upon, any cause of action grounded in breach of contract. The effect of that order was to postpone any determination of whether Mr. Peterson could maintain such an action until a complaint was actually filed alleging such a cause of action. Approximately a week prior to the hearing in this court on Atlantic's motion to dismiss, the debtor filed a motion under F.R.Bankr.P. 7015 to amend its complaint. Both motions were argued on September 24, 1996, after which the court took them under advisement.
The court also took under advisement Atlantic's objection to the debtor's motion for authority to conduct examinations under F.R.Bankr.P. 2004 of G. J. Manderfield and Margaret L. Lawrence of Gemini Asset Managers, Inc., Lewis F. Morse, and Muldoon, Murphy Faucette.
Conclusions of Law and Discussion
This court has subject-matter jurisdiction under 28 U.S.C. § 1334 and 157(a) and the general order of reference entered by the United States District Court for the Eastern District of Virginia on August 15, 1984. This is a core proceeding under 28 U.S.C. § 157(b)(2)(B) and (K). Venue is proper in this District under 28 U.S.C. § 1409(a).
Under Fed.R.Civ.P. 12(b)(6), made applicable to this adversary proceeding by F.R.Bankr.P. 7012, a complaint may be dismissed at the pleading stage if it fails to state a claim upon which relief may be granted. On a Rule 12(b)(6) motion to dismiss, the well-pleaded facts in the plaintiff's complaint must be taken as true and must be construed in the light most favorable to the plaintiff. Ultimately, the complaint should not be dismissed unless no set of facts consistent with the complaint would entitle the plaintiff to relief. Conley v. Gibson, 355 U.S. 41, 45-6, 78 S.Ct. 99, 102, 2 L.Ed.d 80 (1957). In an appropriate case, however, the court may look to matters outside the four corners of the pleading, in which event the motion to dismiss becomes in effect a motion for summary judgment. Under Fed.R.Civ.P. 56(c), made applicable to adversary proceedings by F.R.Bankr.P. 7056, a party is entitled to summary judgment "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Going outside the four corners of the pleading is particularly appropriate in the present case, where the court has already made extensive findings of fact after a two-and-a-half day contested evidentiary hearing during which many of the issues raised by the present complaint were extensively litigated. Accordingly, in ruling on the present motion, the court will consider the affidavit of William P. Gerald (attached by DEP to its motion to amend) as well as the sworn testimony taken and exhibits admitted at the relief from stay hearing.
"If, on a motion asserting the defense numbered (6) to dismiss for failure of the pleading to state a claim upon which relief can be granted, matters outside the pleading are presented to and not excluded by the court, the motion shall be treated as one for summary judgment and disposed of as provided in Rule 56, and all parties shall be given reasonable opportunity to present all material made pertinent to such a motion by Rule 56." Fed.R.Civ.P. 12(b).
A transcript of the court's findings of fact and conclusions of law made orally on the record on July 10, 1996, has been filed by Atlantic and will be referred to as "Tr."
The proposed amended complaint is pleaded in four counts: equitable estoppel (Count I), equitable subordination (Count II), promissory estoppel (Count III), and unjust enrichment (Count IV). By moving to amend its original complaint (after Mr. Peterson's complaint was dismissed by the District Court), the debtor has in effect conceded that Count I of the original complaint could not survive a motion to dismiss. The question, then, is whether the proposed amended complaint adequately states claims for relief that could survive a motion for summary judgment. Although under F.R.Bankr.P. 7015 and Fed.R.Civ.P. 15(a), leave to amend a pleading "shall be freely given when justice so requires," clearly no purpose would be served by permitting an amendment that fails to set forth a claim for relief or where it is otherwise apparent that the party seeking to amend its pleading cannot prevail because the available evidence simply does not support the theories pleaded.
A. Does collateral estoppel bar the debtor's claims?
As a threshold matter, the court must address Atlantic's argument that all of the debtor's causes of action are barred by res judicata or collateral estoppel, based either on this court's findings of fact and conclusions of law made at the relief from stay hearing, or based on the order of the United States District Court for the Eastern District of Virginia that dismissed with prejudice the parallel action filed by Mr. Peterson in that court. As to the latter, this court concurs that DEP would be unable — in light of the dismissal of Mr. Peterson's complaint by the District Court — to maintain a cause of action in this court sounding in accord and satisfaction. As subsequently clarified, however, the District Court ruling did not necessarily preclude a cause of action based on breach of contract, nor did the ruling address equitable subordination. Although the amended complaint alleges essentially the same facts as those in the parallel complaint, the causes of action differ. Counts I, III, and IV sound essentially in contract or quasi-contract, while Count II is uniquely a bankruptcy cause of action. Therefore, this court concludes that, while the District Court's dismissal with prejudice of Mr. Peterson's parallel action mandates the dismissal of Count I of the original complaint in this case, it does not resolve the question of whether DEP may maintain the causes of action set forth in Count II of both the original and amended complaints and Counts I, III, and IV of the amended complaint.
Res judicata, or claim preclusion, prevents litigation of all grounds for, or defenses to, recovery that were previously available to the parties regardless of whether they were asserted or determined in the prior proceedings. Collateral estoppel, or issue preclusion, bars relitigation of facts actually litigated in a prior lawsuit between the same parties in a subsequent lawsuit which involves a different cause of action, but some or all of the same facts. Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979).
The question of whether collateral estoppel or res judicata applies to this court's findings of fact and conclusions of law reached in connection with the relief from stay motion filed by C.F. Trust is somewhat closer. The primary issue at that hearing was whether the debtor had equity in the property that C.F. Trust was seeking to foreclose upon. § 362(d)(2), Bankruptcy Code. To answer this question, the court was necessarily required to determine (1) the fair market value of the real estate and (2) the amount of the liens against the property. Extensive evidence was presented on these issues, and the court made a finding of fact that the amount due on the note and judgment held by Atlantic was $1,719,923. Tr. 14.
"On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay . . . (2) with respect to a stay of an act against property . . . if — (a) the debtor does not have an equity in such property, and (b) such property is not necessary to an effective reorganization" (emphasis added).
The debtor, in an effort to show that there was equity in the property, presented testimony and exhibits in support of its assertion that there was an enforceable agreement with the RTC to accept $250,000 for the note and judgment, and the debtor vigorously argued that Atlantic's lien could not exceed that amount. This court, having reviewed and weighed the evidence, stated, "I do not find that there was an enforceable agreement between the RTC and Mr. Peterson to sell him the note for $250,000." Tr. 11.
It is certainly tempting to hold that the debtor, having chosen to litigate the issue in the context of the relief from stay, is bound by the court's findings. The general rule, however, is that a hearing on relief from the automatic stay is not an appropriate vehicle for litigating the debtor's affirmative defenses or counterclaims. 2 Lawrence P. King, Collier on Bankruptcy, ¶ 362.08[3], p. 362-82 et seq (15th ed. 1996); Little Creek Development Co. v. Commonwealth Mortgage Corp. (In re Little Creek Development Corp.), 779 F.2d 108 (5th Cir. 1986) (affirming bankruptcy court ruling striking extrinsic state law defenses from debtor's response to relief from stay motion); Grella v. Salem Five Cent Savings Bank, 42 F.3d 26 (1st Cir. 1994) (order granting relief from the automatic stay did not have preclusive effect on trustee's counterclaim to avoid a preference). Congress specifically put relief from stay hearings on a fast track. By contrast, an adversary proceeding or an objection to a claim may (depending on the issues) proceed at a more deliberate pace, including the opportunity to conduct more extensive discovery than would be practical in the compressed time frame in which a relief from stay motion must be resolved. Collier, supra, at ¶ 362.08[1], p. 362-79; Grella, supra, 42 F.3d at 31-32. It was for that reason that this court, on a motion brought by DEP to alter or amend the relief from stay order of July 11, 1996, or to grant a new trial, denied the specific relief requested but did enter an order stating,
The court is required to hold at least a preliminary hearing within 30 days of the filing of a request for relief from the automatic stay. § 362(e), Bankruptcy Code. The automatic stay automatically terminates at the end of the 30 day period unless the court, at a preliminary hearing held within that period, orders the stay continued in effect pending a final hearing. Id. That final hearing itself must be concluded within 30 days of the conclusion of the preliminary hearing. Id. Such 30 day period may be extended only with the consent of the parties or based on the court's finding of "compelling circumstances." Id.
"[T]he hearing on a motion for relief from stay is meant to be a summary proceeding, and the statute requires the bankruptcy court's action to be quick. . . . The limited grounds [for relief from stay], read in the context of the overall scheme of § 362, and combined with the preliminary, summary nature of the relief from stay proceeding, have led most courts to find that such hearings do not involve a final adjudication on the merits of claims, defenses, or counterclaims, but simply a determination as to whether a creditor has a colorable claim to property of the estate." (emphasis added).
[T]he court's findings and conclusions as to the existence and enforceability of legally binding agreements to purchase or compromise the notes held by the Resolution Trust Corporation and Central Fidelity Bank were not intended as a final adjudication on the merits as to those issues, but were made solely to determine, in the context of the motion for relief from the automatic stay, whether there was a reasonable likelihood the debtor would succeed on its claim that such agreements existed.
C. F. Trust, Inc. v. DEP, Inc. (In reDEP, Inc), No. 95-14438-SSM (Bankr. E.D. Va. Sep. 12, 1996), p. 2.
This is not to say, however, that findings made as a result of relief from stay litigation can never have preclusive effect. In The Estate Constr. Co. v. Miller Smith Holding Co., Inc., 14 F.3d 213 (4th Cir. 1994), for example, the Fourth Circuit affirmed the dismissal of a fraudulent conveyance claim brought by a property owner against the savings and loan association that had foreclosed on the property. After the lender had accelerated the debt, the property owners filed for bankruptcy. The lender then brought a motion for relief from the automatic stay. The bankruptcy court, in granting relief from the stay in order to foreclose, made findings as to the fair market value of the property and the amount of the debt and concluded that the debtor had no equity in the property. The district court relied on that finding as a basis for dismissing the fraudulent conveyance action. Although the Court of Appeals acknowledged that "estimates of value made during bankruptcy proceedings are `binding only for the purposes of the specific hearing and . . .[d]o not have a res judicata effect in subsequent hearings," id. at 219, it noted that the bankruptcy court in that case had considered and weighed all the available evidence on value. The court therefore relied on the bankruptcy court's finding of lack of equity to conclude that the plaintiffs "had no legally protectable interest" under the Virginia fraudulent conveyance statute. Id. at 220.
In the present case, it would be stretching the point to characterize the relief from stay hearing as "summary," Grella, supra. Presentation of the evidence took two and a half days. Nine witnesses testified at length and were subject to extensive cross-examination concerning the valuation of the property, the amount due on the notes, Mr. Peterson's negotiations with Central Fidelity and the RTC over their respective notes, and the acquisition of those notes by C. F. Trust and Atlantic, respectively. Dozens of exhibits were offered by each side and received in evidence. The court placed no formal restrictions on the debtor's ability to present evidence in support of its defenses. The only restriction, if there was one, lay in the limited opportunity to conduct discovery as a result of the prompt hearing mandated by § 362(e), Bankruptcy Code. Accordingly, while I fully concur with Grella that a ruling granting relief from the automatic stay is not res judicata as to the debtor's defenses or counterclaims, even if those are "considered" by the Bankruptcy Court in balancing the equities, nevertheless specific findings of fact relevant to those defenses or counterclaims can have collateral estoppel effect in subsequent litigation where the parties had a full and fair opportunity to present evidence and the findings were necessary to the court's ruling. Estate Constr. Co., supra. In short, the debtor cannot use the present adversary proceeding simply to present the same evidence a second time and ask the court to reach a different conclusion. At the same time, the debtor should not be categorically precluded from the opportunity to procure and present evidence that might not have reasonably have been available at the relief from stay hearing. The question, in each instance, will be whether the debtor can demonstrate a genuine issue as to any material fact.
I note, however, that the debtor's case had been pending in this court for over eight months at the time the relief from stay hearing was held. From the outset of the case the debtor had disputed the claims of Atlantic and C. F. Trust. Under F.R.Bankr.P. 2004, the debtor was entitled to, and did, conduct an examination of William Cooley early in the case and could by the same process have obtained other testimony and documents relevant to its claimed defenses. Accordingly, the time limits imposed by § 362(e), Bankruptcy Code, did not have the same restrictive effect on the debtor's ability to mount its defenses as might, for example, have been the situation had C. F. Trust filed its motion for relief from stay earlier.
"This is not to say that bankruptcy courts can never consider counterclaims and defenses . . . during a relief from stay hearing. . . . Certainly, a court may take into account any matter that bears directly on the debtor's equity, or that clearly refutes a creditor's claim to the property." Grella, supra, 42 F.3d at 34 (emphasis in original).
B. Count I — Equitable Estoppel
Count I of the proposed amended complaint seeks, on a theory of equitable estoppel, to limit Atlantic's claim to the $250,000 amount that the debtor asserts the RTC had agreed to accept for the note. The complaint alleges that after the RTC obtained its judgment against Mr. Peterson, Gemini, as the RTC's agent, began negotiations with Mr. Peterson. ¶ 11. In those negotiations, Mr. Peterson sought to acquire "through a designee," all of the RTC's interest in the note and judgment. ¶ 11. Peterson intended that DEP would be a third party beneficiary of the agreement. ¶ 12. Specifically, Peterson "intended to have an entity designated by him" acquire the note, thereby conferring on DEP "the benefit resulting from the acquisition of these assets at a price well below the amount outstanding" under the note. ¶ 12. At that time, Signet Bank had begun foreclosure proceedings with respect to the first deed of trust. Exh. A; ¶ 18(a). William P. Gerald, a senior vice president of Gemini, agreed "that Mr. Peterson was to arrange to take out the Signet loan" to prevent the RTC's deed of trust "from being wiped out," and that Mr. Peterson was to pay $250,000 for the note. Exh. A. Mr. Peterson "preserved the RTC position by not allowing the foreclosure when he had Central Fidelity Bank" purchase Signet's note. Exh. A. Additionally, as a result of the new financing, DEP incurred an additional new liability "at a monthly interest and carrying cost far in excess of . . . the previous monthly carry." ¶ 18(b). DEP would not have incurred this cost but for its reliance on the RTC's offer to settle. ¶ 18(b). On June 10, 1993, an agreement was reached to sell the note to Mr. Peterson. ¶ 13. He signed the agreement and delivered it to Gemini's attorney, Lewis Morse ("Morse"). ¶ 13. At no time between then and January 17, 1995, did the RTC advise him that the settlement offer had been revoked. ¶ 16. The RTC, although it was aware that DEP had altered its position by refinancing the Signet loan, offered to sell its own note to Superior. ¶¶ 19, 20. Superior, as part of its due diligence, had Cooley inspect the RTC loan files and was aware that Mr. Peterson had signed and submitted the settlement agreement. ¶ 21. The loan and the judgment were sold to Superior for $100,000 on November 10, 1994. ¶¶ 22, 23. On January 5, 1995, Superior assigned the note to Atlantic. ¶ 24. Cooley has an ownership interest in both Superior and Atlantic. ¶ 25. In acquiring the note, Atlantic was represented by Morse. ¶ 26. The RTC, by its repeated assurances after June 10, 1993, that RTC execution of the settlement agreement "was forthcoming," reasonably led Mr. Peterson to expect that he could acquire "for the benefit of DEP" a $1.4 million obligation for only $250,000. ¶ 29.
The doctrine of equitable estoppel is well-recognized by Virginia law. As explained in a prior opinion of this court,
The general rule of equitable estoppel, or, as it is frequently called, estoppel in pais, is that when a person, by his statements, conduct, action, behavior, concealment, or even silence, has induced another, who has a right to rely upon those statements, etc., and who does rely upon them in good faith, to believe in the existence of the state of facts with which they are compatible, and act upon that belief, the former will not be allowed to assert, as against the latter, the existence of a different state of facts from that indicated by his statements or conduct, if the latter has so far changed his position that he would be injured thereby.
In re Royal Meadows Stables, Inc., 187 B.R. 516, 518 (Bankr. E.D. Va. 1995), quoting Thomasson, Adm'r v. Walker, 168 Va. 247, 256, 190 S.E. 309, 312-313 (1937). Equitable estoppel "flows from the principle `that when one of two innocent persons, each of whom is guiltless of an intentional moral wrong, must suffer a loss, it should be borne by that one of him who by his conduct has rendered the injury possible.'" Id., 187 B.R. at 518.
In the present case, there is the added circumstance that the party sought to be estopped is an assignee of the Resolution Trust Corporation, an instrumentality of the United States. Atlantic cites Gibson v. Resolution Trust Corp., 750 F. Supp. 1565 (S.D. Fla. 1990) for the proposition that estoppel does not lie against the RTC in its role as receiver or conservator. However, Gibson does not go quite that far. What it holds, following Eleventh Circuit precedent, is that estoppel does not apply when the RTC acts in its sovereign capacity rather than its propriety capacity, and that "the RTC's duties in disposing of failed institutions' assets are duties to the public." 750 F. Supp. at 1573. Gibson acknowledges, however, that the majority of the circuits have followed Office of Personnel Management v. Richmond, 496 U.S. 414, 110 S.Ct. 2465, 110 L.Ed.2d 387 (1990) in recognizing that equitable estoppel may apply against the Government but requiring "affirmative misconduct" before the Government may be estopped. 750 F. Supp. at 1572, n. 6. There do not appear to be any Fourth Circuit decisions on point. However, this court is persuaded that the Fourth Circuit would likely apply the test articulated by the Ninth Circuit in Watkins v. U.S. Army, 875 F.2d 699, 706-707 (9th Cir. 1989), cert. denied, 498 U.S. 957, 111 S.Ct. 384, 112 L.Ed.2d 395 (1990):
The Supreme Court has expressly left open the issue whether estoppel may run against the government, refusing to hold "that there are no cases in which the public interest in ensuring that the Government can enforce the law free from estoppel might be outweighed by the countervailing interest of citizens in some minimum standard of decency, honor, and reliability in their dealings with their Government." It is well settled, however, that the government may not be estopped on the same terms as a private litigant . . . Before the government will be estopped . . . two additional elements must be satisfied beyond those required for traditional estoppel. First, "[a] party seeking to raise estoppel against the government must establish `affirmative misconduct going beyond mere negligence'; even then `estoppel will only apply here the government's wrongful act will cause a serious injustice, and the public's interest will not suffer undue damage by imposition of the liability.'"
(internal citations and footnote omitted.)
Applying these principles to Count I of the proposed amended complaint, it is clear that DEP cannot satisfy the essential requirement that it had "so far changed [its] position that [it] would be injured" if the RTC and its assignees were allowed to deny the existence of a legally enforceable agreement to sell the note. The RTC not only had a lien against the Dominion Professional Center owned by DEP, it also had a personal judgment against Mr. Peterson that could potentially be enforced against other property that Mr. Peterson owned or later acquired. The first deed of trust note held by Signet Bank was in default, and foreclosure proceedings were underway that would have resulted in DEP losing the property. Obviously, some action had to be taken with respect to the Signet note if DEP were to retain the property. While Central Fidelity Bank's purchase of the Signet note clearly inured to the RTC's benefit, it is specious to suggest that it was undertaken solely or even largely as an accommodation to the RTC. Certainly, it is plausible that the RTC would not have agreed, even tentatively, to accept $250,000 — less than one-fifth of what was owed under the note and judgment — unless it retained a lien against the Dominion Professional Center to secure the payments that were to be made over time. But the RTC acquired no legal benefit by agreeing to accept less than the amount it was owed on the note and judgment. Mr. Peterson was personally liable for the full amount and obviously pursued the negotiations with the primary aim of reducing his own exposure. That DEP would also have benefitted was incidental. In any event, unless DEP or Mr. Peterson somehow arranged to take out or satisfy the Signet note, DEP would have lost the property. Accordingly, the fact that DEP became liable on the Signet note, even at an increased interest carry, in order to keep the property, does not constitute an injurious change of position.
For the purpose of deciding the present motion, I assume the truth of the averments in the complaint that Mr. Peterson intended to acquire the note through DEP. However, as Atlantic correctly notes in its brief, nothing in the evidence compels this conclusion. The proposed settlement agreement allowed the note and judgment to be purchased by any "third party designated by Peterson." The signature block that the RTC's attorney had provided for DEP to sign the agreement was crossed-out by Mr. Peterson, and only he signed the proposed agreement. In a January 28, 1993, letter forwarding to Gemini's attorney an earlier version of the proposed agreement, Peterson cagily refers to the $50,000 initial payment being made "by the party who will buy the note." Debtor Exh. A. It would have been entirely consistent with the agreement for Mr. Peterson to have transferred the note and judgment to some entity he controlled other than DEP, thus keeping the deed of trust "alive" of record as a device to thwart subsequent judgment lien creditors.
Furthermore, even if DEP — although not a formal party to the proposed settlement agreement between Peterson and the RTC — could get over the hurdle of showing detrimental reliance on Gemini's assurance that the agreement was a "done deal," it cannot satisfy the additional elements that must be established in order to estop the Government. That is, even if the proof were to show conclusively that Gemini had, as Gerald's affidavit asserts, actual authority to settle claims of the dollar amount involved here, but that the RTC then reneged and decided to deal with someone else instead, such conduct would not constitute "affirmative misconduct" resulting in "a serious injustice" correctable without "undue damage" to the "public's interest." Watkins, supra. Basically, the facts alleged show no more than the RTC decided to sell the note for $100,000 cash rather than $50,000 cash and a promise of another $200,000 over time. As the agency responsible for disposing of the assets of failed thrift and banking institutions, the RTC unquestionably enjoyed broad discretion in determining the price and terms at which it would sell such assets. For this court to second guess such decisions by the RTC would hardly be consistent with the public interest. Peterson had no inherent right, legal or moral, to pay less than was owed on the note and judgment. He had defaulted, pure and simple. That the RTC's agent might have agreed, for pragmatic reasons, to accept a fraction of the amount owed does not transform a subsequent sale of the note and judgment to someone else into "a serious injustice." Watkins, supra.
For the purpose of this motion, the court assumes, without deciding, that DEP could prove that it was a third-party beneficiary of the agreement.
In fact, however, Peterson never tendered the $50,000 and simply promised that he would pay it when the agreement was signed.
C. Count II — equitable subordination.
Count II of both the original and the amended complaint invokes the court's power of equitable subordination. Under § 510(c), Bankruptcy Code, a bankruptcy court may, after notice and a hearing,
(1) under the principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest; or
(2) order that any lien securing such a subordinated claim be transferred to the estate.
Although the statute authorizes a bankruptcy court to utilize the "principles of equitable subordination," it does not provide any guidelines for doing so. In fact, Congress, in drafting this section specifically left this doctrine to be developed by the judiciary. See 124 CONG.REC. 32350, 32398 (1978). The Supreme Court recently had the opportunity to examine the doctrine of equitable subordination. United States v. Noland, — U.S. —, 116 S.Ct. 1524, 134 L.Ed.2d (1996). While the issue arose in a very different context, the Court's discussion provides helpful guidance in construing the statute. Specifically, the Noland case held that a bankruptcy court could not categorically use equitable subordination to subordinate the IRS's claim for tax penalties (which would typically have an administrative priority) to the claims of unsecured creditors in derogation of Congress' scheme of enacted priorities. Id. at 1525. The Court examined the development of the doctrine and determined that equitable subordination of a claim is generally prompted by the occurrence of three factors: (1) "the creditor has engaged in `some type of inequitable conduct'"; (2) "the misconduct `resulted in injury to the creditors of the [estate]'"; and (3) "that the subordination is `not inconsistent with the provisions of the Bankruptcy [Code].'" Id. at 1526 (quoting In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977); see also EEE Commercial Corp. v. Holmes (In re ASI Reactivation, Inc.), 934 F.2d 1315, 1321 (4th Cir. 1991) (citing the same three considerations for equitable subordination of a claim); C-4 Media Cable South, L.P. v. Reds T.V. and Cable, Inc., 150 B.R. 374, 377 n. 2 (Bankr. E.D. Va. 1992) (Tice, J.) (dicta) (stating that in order to invoke equitable subordination, some form of inequitable conduct must be proven and the doctrine should not be invoked lightly).
The doctrine of equitable subordination, however, had been around for some time when the present Bankrutpcy Code was enacted and was hardly a novel concept. At least as early as Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281 (1939), it had been held that bankruptcy courts possessed, as part of their broad range of equitable powers, the authority to disallow or subordinate the claims of any creditor who attempts to take unfair advantage of the debtor or other creditors: "[T]he bankruptcy court has the power to sift the circumstances surrounding any claim to see that injustice or unfairness is not done in administration of the bankrupt estate." 308 U.S. at 307-8, 60 S.Ct. at 246.
A claim is generally subordinated under the concept of equitable subordination only when the holder of the claim has committed some fraudulent conduct. 3 COLLIER ON BANKRUPTCY ¶ 510.05 (1996). Typical situations in which creditors have had their claims subordinated involve gross undercapitalization of the debtor by its shareholders, fraud on the part of the subordinated party, and insider transactions where the corporate debtor is in essence the alter-ego or the mere instrumentality of the insider. Id. For example, in Costello v. Fazio, 256 F.2d 903 (9th Cir. 1958), the court was confronted with a situation where a partnership had been incorporated and the partners transformed their at risk partnership capital to promissory notes, thereby leaving the newly formed corporation grossly undercapitalized. The court subordinated the claims of these insiders holding promissory notes to general unsecured creditors reasoning that these persons, who owed a fiduciary duty to the corporation, actually withdrew capital contributions at a time when the corporation was at high financial risk simply for personal gain to improve their priority in a liquidation. Id. at 910-11; see also In re N D Properties, 799 F.2d 726, 732 (11th Cir. 1986) (holding that the claim of an insider who liquidated her stock collateral in favor of an assignment of a security interest in the debtor's inventory should be equitably subordinated to the creditors she injured because of the clear breach of her fiduciary duty to the corporation by continuing the operation of the debtor while it faced severe financial problems).
However, mere insider status alone does not mandate equitable subordination. See, EEE Commercial Corp. v. Holmes (In re ASI Reactivation, Inc.), 934 F.2d 1315 (4th Cir. 1991). In that case, the debtor's majority owner was another corporation, which in turn was controlled by one Ram Narayanan. The debtor was confronted by threats of foreclosure by its secured creditor, and to stave off foreclosure, the secured creditor assigned the note, worth $196,000, and its security interest in the debtor's equipment and fixtures to Narayanan for $120,000. The court held that Narayanan's interest as a secured creditor should not be subordinated to the unsecured creditors under Code section 510(c). Id. at 1321. The court reasoned that there was no evidence of fraud and that there is no provision in the Code prohibiting an equity holder from also possessing an interest as a lien creditor. Id. Finally, the court noted in dicta that the $76,000 discount that Narayanan purchased the note for would also not constitute insider conduct that would warrant equitable subordination. Id. at 1320 n. 1.
Similarly, in In re Clark Pipe and Supply Co., Inc., 893 F.2d 693 (5th Cir. 1990), the court was faced with a situation where the creditor was allegedly treating the debtor as its mere instrumentality. In the case, the creditor would make revolving loans secured by an assignment of accounts receivable and an inventory security interest. Id. at 695. The loan agreement provided that the creditor would lend as determined by set formula, that is a percentage of the accounts receivable and inventory, and that the creditor could "reduce the percentage advance rates at any time at its discretion." Id. When the debtor's business hit a downturn, the creditor reduced the percentage advance rates to a point where the debtor had just enough cash to keep its doors open, sell inventory, and pay off past advances from the creditor. Id. The court held that while the creditor was exercising control over the debtor, the control did not rise to a level warranting equitable subordination in that every creditor exercises some control over their borrower. Id. at 701. Further, the court noted, the creditor was given the right in the loan agreement to reduce the percentage rates at any time in its discretion; thus, the creditor was merely exercising its contractual rights and not exceeding them. Id. at 699-700.
In the present case, Count II essentially proceeds on the theory that because the RTC unjustifiably breached an oral agreement to sell the note and judgment to Mr. Peterson for $250,000, despite knowing that Peterson had arranged for Central Fidelity Bank to take over Signet Bank's position, it would be inequitable to allow Atlantic, as the RTC's assignee, to exploit that breach by enforcing the note for a greater amount, to the detriment of DEP's creditors and shareholder.
At the hearing on the motion for relief from stay, I ruled, on the authority of Albright v. Burke Herbert Bank Tr. Co., 249 Va. 463, 457 S.E.2d 776 (1995), that the alleged oral contract to accept $250,000 for the note was unsupported by consideration. In Albright, the Supreme Court of Virginia held that a bank's oral promise to refinance an existing note when it became due was not supported by consideration, even though the debtor continued to make, and the Bank accepted, interest payments after the loan became due, since "[A] debtor's promise to pay sums already due is not sufficient consideration to support a creditor's promise to refinance the loan." 249 Va. at 466, 457 S.E.2d at 778. Clearly, if a promise to pay sums already due does not constitute consideration, a promise to pay only one-fifth, approximately, of what was owed does not constitute consideration. Of course, as discussed below in connection with Count III, promissory estoppel may in appropriate circumstances permit the enforcement of an agreement that is not supported by consideration in the traditional sense. In the absence of promissory estoppel, however, it seems clear that under Virginia law the unperformed promise of the RTC — even if fully established by the evidence — to accept less than the amount owed on the note and judgment, would not constitute an enforceable contract.
This conclusion, however, does not end the inquiry, since the available evidence does suggest that Mr. Peterson had a reasonable expectation that he could purchase the note and judgment for $250,000.00. Virginia law recognizes — in the tort of intentional interference with contractual relations — a right to be protected from third party interference not only in one's enforceable contracts but also in one's business expectancies. Specifically, under Virginia law, the elements of a prima facie case for the tort of interference with contractual relations are: "(1) the existence of a valid contractual relationship or business expectancy; (2) knowledge of the relationship or expectancy on the part of the interferer; (3) intentional interference inducing or causing a breach or termination of the relationship or expectancy; and (4) resultant damage to the party whose relationship or expectancy has been disrupted." Chaves v. Johnson, 230 Va. 112, 120, 335 S.E.2d 97, 102 (1985). Moreover, the interferer's awareness of the contract and "his intent to disturb it are requisite elements" Id. at 120-21, 335 S.E.2d at 102 (emphasis added). Because of the uncertain nature of a potential contract, the tort of interference with a prospective contract sets an even higher hurdle to establish a prima facie case. To sustain such a cause of action, a party must prove "an intentional, improper interference with another's contractual relations, and this interference must (1) induce or otherwise cause a third party not to enter into a prospective contract with the plaintiff, or (2) prevent the plaintiff from entering into a contract." Alien Realty Corp. v. Holbert, 227 Va. 441, 449, 318 S.E.2d 592, 597 (1984).
In the present case, there are no allegations, and absolutely no evidence, that Atlantic, or its predecessor in interest, Superior, wrongfully and intentionally interfered with Mr. Peterson's settlement negotiations with the RTC in order to obtain the note and judgment for itself. Whatever the RTC's reasons for not signing the proposed settlement agreement, it is clear that Superior became involved only after the RTC decided not to sign the agreement with Peterson and made a public offer to sell the note as part of a package of nonperforming loans. Even if Superior — as a result of Cooley's examination of the RTC file — learned of the negotiations that had occurred 17 months before between Mr. Peterson and the RTC and knew the terms of the proposed settlement, such knowledge would not constitute interference with a business expectancy. Superior would have been entitled to rely on the RTC's assurance that it had the right to sell the note and could properly assume that any prior offer — particularly one more than a year old — to sell the note to another party had, for whatever reason, expired or terminated.
In short, the allegations in the amended complaint simply do not support a cause of action for equitable subordination. No fraud on Atlantic's part is alleged, nor is this an insider transaction or an "alter-ego" situation. What the plaintiff has alleged is simply that it would be "inequitable" for Atlantic to be able to enforce the note at its face value. However, what Atlantic has done is bought a non-performing note at a significant discount. The plaintiff asserts that it is inequitable for the defendant to enforce a note worth $2 million for which it paid only $100,000. However, Atlantic is entitled to enforce its note according to its terms. See, Clark Pipe, 893 F.2d at 699-700. Even if Atlantic knew that there had been agreement a year and a half earlier to permit Mr. Peterson to purchase the note from the RTC for $250,000 over time, such knowledge would not have made Atlantic's acquisition of the note unfair. This is especially true in light of Atlantic's extension of precisely the same offer to Mr. Peterson after it acquired the note. Peterson having declined to accept the offer, the debtor (whose standing is certainly no higher than that of Peterson) is hardly in a equitable posture to complain that Atlantic now wishes to enforce the note according to its terms. Simply put, there is no unfair or overreaching conduct of the type that would justify equitable subordination of Atlantic's claim.
D. Count III — promissory estoppel.
Count III of the proposed amended complaint asserts the existence of an enforceable contract between Mr. Peterson and the RTC based on a theory of promissory estoppel. Promissory estoppel is equitable estoppel applied in the specific context of a promise that is unenforceable under traditional contract law, most commonly because of a lack of mutuality or consideration. The doctrine of promissory estoppel has been defined as follows:
A promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promissee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.
MBA, Inc. v. VNU Amvest, Inc. (In re MBA, Inc.), 51 B.R. 966, 971 (Bankr. E.D. Va. 1985), quoting Restatement (First) of Contracts § 90 (1932). To establish promissory estoppel, the following elements must be proven:
(1) a promise, (2) reasonable and foreseeable reliance on the promise, (3) resulting detrimental action or forbearance by the promissee, (4) injustice avoidable only by enforcement of the promise.
Id. The promise may be enforced even in the absence of formal consideration, since "[t]he promissee's detrimental reliance, as demonstrated by its action or forbearance, satisfies this requirement." Id. at 972. See, Georgeton v. Reynolds, 161 Va. 164, 173-4, 170 S.E. 741, 744 (1933) (release not supported by consideration may be sufficient when one has thereby been induced to alter his position to his prejudice).
As noted above, this court ruled at the relief from stay hearing that the alleged agreement between the RTC and Mr. Peterson to sell the RTC note and judgment for $250,000 was not supported by consideration. Albright v. Burke Herbert Bank Tr. Co., supra. Clearly, the debtor hopes in Count III to get around the lack of formal consideration by invoking promissory estoppel as a substitute. The allegations and available evidence, however, no more support a triable issue of promissory estoppel than they do of equitable estoppel. What is lacking for promissory estoppel, just as for equitable estoppel, is a detrimental change of position in reliance on the promise. For the same reasons the debtor cannot prevail under a theory of equitable estoppel, it cannot prevail on a theory of promissory estoppel, and Count III is no more viable than Count I.
In Albright, the borrower asserted that he had relied on the bank's oral promise to refinance the loan when it became due by making no effort to secure financing from other sources. The Court ruled that such reliance did not supply the necessary consideration to make the agreement enforceable. 249 Va. at 466, 457 S.E.2d at 778.
E. Count IV — "unjust enrichment"
Finally, in Count IV the debtor broadly asserts — as a kind of equitable smorgasbord — that the loan and judgment "were not fairly or properly acquired by . . . Atlantic;" that "equity should treat as done, what ought to have been done;" and that Atlantic "should be prevented from 99 unjustly benefitting from the breach of contract." In effect, it is simply the equitable subordination argument repeated. However, all Atlantic did was to acquire from Superior a note that Superior purchased when the RTC offered it for sale. The RTC represented that it had the right to sell the note, and even if Superior and Atlantic were aware of agreements made more than a year earlier to sell the note to someone else, they would have been justified in relying on the RTC's authority to sell and in assuming that the agreement had expired or was no longer enforceable.
The term "unjust enrichment" is normally applied to a cause of action in which recovery is sought under a theory of implied contract or quantum meruit. The general rule, as recognized in Virginia, is that where an agreement is not enforceable as an express contract — for example, because of the statute of frauds — but money is paid or services are rendered under it by one party, there can be a recovery upon an implied contract for the money paid or the value of the services rendered. Hendrickson v. Meredith, 161 Va. 193, 170 S.E. 602 (1933). Count IV of the proposed amended complaint clearly does not state a cause of action in implied contract, since it does not assert that any money was paid, or services provided, by Peterson to the RTC under the alleged agreement.
Particularly in view of Atlantic's willingness — once Peterson asserted that he had a binding agreement with the RTC — to extend precisely the same offer, there is no basis whatsoever for characterizing Atlantic's actions as an attempt to take unfair advantage of the debtor. When Peterson, instead of showing his good faith by accepting the offer, refused to respond, Atlantic was justified in withdrawing the offer and thereafter seeking full payment. Had Peterson genuinely been willing and prepared to perform under the agreement he thought he had with the RTC, he would have accepted Atlantic's offer. The fact that he did not — and, as noted above, I expressly find his explanation for not accepting unworthy of belief — leads inescapably to the conclusion that he was either unwilling or unable to perform.
Even in its original form, the agreement was not open ended: it required immediate payment of the $50,000 followed by ten monthly payments of $20,000 each as a condition of the sale. Since the agreement Peterson thought he had with the RTC was entirely conditioned on timely payment, and since those payments were not made even when Atlantic offered to accept them, neither he nor DEP now has an equitable leg to stand on. If Peterson lost the opportunity to acquire the note and judgment for DEP's benefit at a very favorable price, he has only himself to blame. Certainly, no blame attaches to Atlantic simply because it purchased the note, assumed the risks and expense of collection, and now — after its settlement offer was spurned — wishes to enforce the note.
Ruling
For the foregoing reasons, the court concludes that Count I of the original complaint fails to state a claim upon which relief may be granted. The court also concludes that, in light of the available evidence, the debtor cannot prevail on Counts II of either the original or proposed amended complaint or on Counts I, III, and IV of the proposed amended complaint. Accordingly, a separate order will be entered dismissing the original complaint and denying leave to file the proposed amended complaint.