Opinion
Case No. 2:00CV0495B
March 5, 2003
MEMORANDUM OPINION AND ORDER
This Opinion and Order addresses Defendant E*Trade Bank's Motion for Summary Judgment Relating to Lost Profits Damages, and Defendant E*TRADE Bank's Motion for Directed Verdict in Favor of E*TRADE Bank on the Basis of LifeWise's Failure to Satisfy Conditions Precedent (Liens).
I. BACKGROUND
This case has a long and tortured history. Plaintiffs, LifeWise Master Funding, LLC, a Delaware limited liability company, and LifeWise Family Financial Security, Inc., a Utah Corporation (hereinafter the two entities will be collectively referred to as "LifeWise" or "plaintiffs", unless otherwise indicated) are in the business of lending money to terminally ill patients. The patients' life insurance policies serve as collateral for the loans. The interest rate charged varies from state to state, depending on usury laws and other considerations, but is typically in the neighborhood of 18%, compounded annually. There are also additional fees and charges. Interest accrues throughout the life of the loan, which is coincidental with the life of the patient. When the patient dies, the insurance policy proceeds are first used to pay off the loan, and the remainder, if any, is distributed to the patient's heirs. To qualify for the loan, the patient must be medically certified to have a life expectancy of less than five years and to possess a paid-up policy with an "A" rated or similarly secure life insurance company. At the loan closing, the policy is placed in trust for the benefit of the lender, and the lender makes all premium payments on the policy. This arrangement is generally known as an asset-backed securitization. LifeWise commenced business operations in late 1995. The company's founder and president is Mr. Mark Livingston who had earlier worked in the viatical industry. Initially, under Mr. Livingston's direction, LifeWise made loans to AIDS patients as well as cancer patients, but over time the business dealt exclusively with terminally ill cancer victims.
According to LifeWise's audited financial statements, the company began business in 1995 as The Viaticum Fund, DC., a Utah liability company. The company was initially funded by issuing approximately $1,200,000 of debentures that bore interest between 8 and 8.5%. During that year the company engaged primarily in the purchase of life insurance policies held by AIDS patients. The company performed about 50 of these transactions. Total losses for 1995 were $390,859.
In 1996, the company was organized as LifeWise and secured two credit arrangements with Bank One. Effective July 3, 1996 LifeWise and Bank One entered into a senior subordinated loan agreement for $4,500,000. Effective December 31, 1996 LifeWise and Bank One entered into a line of credit loan agreement for $5,000,000. These arrangements enabled LifeWise to expand its operations and extend more loans to terminally ill cancer patients. Loan originations for 1996 totaled approximately $700,000. Total losses for 1996 were $1,157,732.
In 1997, LifeWise continued much as it did in 1996, however, the company's business plan was capital intensive and it was looking for a major equity partner to grow operations. Late in the year LifeWise was introduced to two New York based investors — Henry and Michael Salzhauer. Michael, Henry's son, hired a due diligence team to investigate a possible $10,000,000 equity investment in the company by the Salzhauer family and a small group of their associates. After certain negotiations that resulted in Michael Salzhauer's becoming chairman of the company, the Salzhauer-led group of investors contributed nearly $10,000,000 in the late-1997, early-1998 time period. Loan originations in 1997 totaled nearly $750,000. Total losses for 1997 were $1,639,633.
As it became clear that a major capital investment from the Salzhauer group was imminent, LifeWise engaged major national advertising companies to give presentations for a nationwide advertising campaign designed to rapidly grow the business. In November 1998, LifeWise hired a prominent Madison Avenue advertising firm to create what became known as the "Madison Avenue campaign." It projected that the business would be "jump started" and produce 500 loans in process by June 1999. This campaign was a multi-million dollar effort that LifeWise admits was a dismal failure. In fact, as will be noted below, with the campaign in place total loan volume dropped from nearly $7,000,000 in 1998 to approximately $2,600,000 in 1999. LifeWise terminated the Madison Avenue campaign in July 1999. At that time LifeWise claimed to have found a new and more effective message. The focus of the message was to shift the LifeWise product from being marketed as a loan to something referred to as "financial assistance." The theory was terminally ill patients may have been avoiding a loan product because many are too ill to work and with no income would not qualify for a traditional loan.
In 1998, LifeWise, after securing the Salzhauer investment and implementing the Madison Avenue campaign, was actively looking for a large infusion of capital by a lender that could provide funds that did not need to be repaid until a terminally ill cancer patient had died. Typically this period of time was between eighteen months and five years. In this regard LifeWise was introduced to Telebank.
As will be discussed in more detail below, Telebank was later acquired by E*TRADE, an "online" brokerage firm, and E*TRADE Bank was then formed.
Telebank was organized as a commercial bank that operated exclusively over the telephone and later the internet, when it purchased Metropolitan Savings Bank in 1989. Its headquarters are in Arlington, Virginia. At the time it began discussing a business relationship with LifeWise, Mr. Mitchell Caplan was Telebank's Chief Executive Officer, and Mr. Steven Dervenis was its executive vice president, and its principal contact with LifeWise. In connection with the LifeWise proposal, the bank relied heavily on the services of Telebank board member Ms. Marcia Myerberg, an experienced New York City-based financial consultant and investment banker. It largely fell to Ms. Myerberg to perform due diligence on the project on behalf of the bank, and to generally advise Telebank regarding the potential business relationship.
After numerous discussions and negotiations in the latter half of 1998, the parties agreed to the general terms of a potential contract. The basic deal anticipated Telebank making available to LifeWise up to $200,000,000 in long-term funding. Also, Ms. Myerberg was to be the main contact to LifeWise once the lending relationship began. LifeWise desired that its lawyers draft the written contract documents.
During contract discussions, Telebank wanted to include a satisfaction clause in the contract, seeking the ability to be released from the contract if, in the bank's sole discretion, it was not fully satisfied with the way LifeWise's business was being operated. LifeWise refused to grant such unfettered discretion to Telebank. Eventually, the parties compromised on this point, agreeing to Section 4.10 of the contract which gave Telebank the right to determine whether LifeWise's general business operations were unsatisfactory to it, and if it was ever so determined, the reasons for the dissatisfaction were to be provided to LifeWise in writing in "reasonable detail." The clause reads as follows:
4.10 Underwriting and Business Operations of LifeWise. The Initial Investor shall have determined that the underwriting policies and procedures of LifeWise and the general business operations of LifeWise are satisfactory to it. If not so satisfactory, the Initial Investor shall disclose to the Company in writing, in reasonable detail, the reasons for such determination.
The final contract, known as the Funding Agreement, committed Telebank to make available to LifeWise up to $200 million in financing for a period of seven years, ending December 31, 2005 at LIBOR plus 3.25%. This financial arrangement was generally referred to as the "facility." The basic terms and structure of this facility contemplated that Telebank would serve as a long-term "takeout lender." This meant that once the Telebank facility was in place, LifeWise would draw on its Bank One credit lines to make loans to terminally ill cancer patients secured by their life insurance policies to develop a "pool" of loans totaling no less than $1,750,000. Once such a "pool" of loans was created, LifeWise would make a funding request to Telebank, through Ms. Myerberg. Telebank would then fund 99% of the "pool" amount and Bank One would be repaid. The life insurance policy collateral would then transfer to Telebank through a trust arrangement. Later, when a borrower in one of the "pools" died, Telebank would first be paid in full from the proceeds of the life insurance policy, and then LifeWise would receive its interest and fees. The practical effect of this structure was that Bank One became the short-term 60-90 day lender and Telebank became the long-term lender that funded LifeWise's intensive capital needs. The idea was that this process would repeat itself enough times in a seven year time period that the entire $200 million committed by Telebank may be used by LifeWise.
For most of the relationship this averaged 9%. The British Bankers Association's ("BBA") LIBOR is the most widely used benchmark or reference rate for short term interest rates. It is compiled by the BBA and released to the market each morning. LIBOR stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from other banks, in marketable size, in the London interbank market.
Pursuant to § 4, the Funding Agreement essentially designated all of the various covenants and obligations of the parties as conditions that must be met before any funding was required to be provided. In this respect, the Funding Agreement reads as follows:
The Company and LifeWise shall each have performed all of their respective obligations to be performed hereunder and in the other Program Documents prior to or on such Funding Date.
Among the obligations set forth in the Funding Agreement was § 9.8(b) which prohibited LifeWise from allowing any liens to be placed on the life insurance policies after they were placed in trust as collateral for the benefit of Telebank. Section 9.8(b) reads as follows:
In the lending relationship, the parties retained Bankers Trust Corporation to establish and manage a trust account to hold the life insurance policies as collateral. Once these life insurance policies were transferred to the Bankers Trust account as collateral, they became Trust Property as referred to in § 9.8(b) of the Funding Agreement.
Except for the conveyances under the Indentures, LifeWise will not sell, pledge, assign or transfer to any other Person, or grant, create, incur, assume or suffer to exist any Lien on the Trust Property or any interest therein (other than Permitted Liens), and LifeWise shall defend the right, title, and interest of the Company and the Trustee in, to and under the Trust Assets against all claims of third parties claiming through or under LifeWise; provided however, that LifeWise's obligations under this Section 9.8 shall terminate upon the repayment in full of the Notes and the expiration of any applicable preference period.
The final contract documents were signed on January 15, 1999 with an effective date of December 31, 1998. In 1998, LifeWise originated nearly $7,000,000 in loans, with losses for 1998 totaling $3,705,018.
During 1999, the first year that the Telebank funding facility was in place, LifeWise only originated 48 loans for a total loan origination amount of $2,693,000. LifeWise was still feeling the effects of its ill-advised Madison Avenue advertising campaign, which was terminated in July, 1999. Total losses for the year were $3,509,377. The company had a negative working capital of $694,401 at the end of 1999.
In 2000, Telebank merged with E*TRADE Bank. Most of its staff remained in place. In approximately February or March of 2000 there began to be discussions within E*TRADE Bank about LifeWise in which concerns were raised about the business operations of LifeWise. The bank was concerned with the steep decline in loan originations from 1998 to 1999 and the company's apparently negative working capital. Also, LifeWise had made several requests for changes to the agreement regarding life expectancy, use of brokers and payment of broker's fees, and medical underwriting, which caused the bank concern. Moreover, LifeWise had never in its history made a profit, nor had it met, or even come close to, any of its projections. A meeting was arranged for March 15, 2000 in Arlington, Virginia at E*TRADE Bank's offices for a general discussion of the business. At the recent liability trial in this case, LifeWise's witnesses generally contended they attended this meeting with virtually no advance knowledge that E*TRADE Bank had serious concerns about LifeWise.
At this meeting, E*TRADE Bank's personnel, primarily Steve Dervenis and Matt Audette, expressed some of their concerns about LifeWise to Mr. Livingston and Mr. Syver Norderhaug, LifeWise's CEO. In turn, the LifeWise officials expressed some of their concerns regarding a main contact at E*TRADE Bank, and whether E*TRADE Bank personnel understood the LifeWise relationship because Ms. Myerberg was no longer at the bank. The meeting ended with no clear indication of what would follow.
E*TRADE Bank's controller and contact to LifeWise after the merger.
Thereafter, Mr. Dervenis asked Ms. Myerberg to schedule a lunch in New York City with the Salzhuaers. Mr. Dervenis, Mr. Audette, Mr. Willard, and Ms. Myerberg attended. At this meeting, Mr. Dervenis gave the Salzhauers a memo referred to as a "summary of issues" outlining some of the same concerns he discussed at the March 15, 2000 meeting with Mr. Livingston and Mr. Norderhaug. Also, the adequacy of Mr. Livingston's management skills and the firmness of the Salzhauer's commitment to provide additional capital were discussed. Additionally, Mr. Dervenis requested that LifeWise submit a revised business plan as soon as possible.
E*TRADE Bank's in-house counsel.
Thereafter, on April 28, 2000 E*TRADE Bank sent a letter to LifeWise invoking its right under § 4.10 of the Funding Agreement to delay funding to LifeWise until it became satisfied with the general business operations of LifeWise. The letter listed areas of dissatisfaction, including insufficient capital, continuous failure to meet business goals, and inadequate management.
Thereafter, on May 3, 2000 Mr. Livingston sent a letter in response asserting there was no problem with the business of LifeWise and that he would cooperate to clear up any misunderstandings if he was given more detail of E*TRADE Bank's dissatisfaction.
On May 25, 2000 Mr. Livingston sent a follow-up letter to the May 3, 2000 letter clarifying reasons why he asserted that LifeWise's business operations were satisfactory. On May 30, 2000 he made a funding request.
On June 2, 2000 Mr. Dervenis sent a letter via Federal Express to Mr. Livingston acknowledging his receipt and consideration of the May 3 and May 25 letters and the May 30 funding request. He reiterated his position that LifeWise's business operations were not satisfactory to the bank for the same reasons stated in the April 28, 2000 letter and that LifeWise had not taken any steps to address the concerns listed in that letter.
On June 5, 2000 LifeWise made some projections for the business that were apparently communicated to E*TRADE Bank, but no business plan was included. On June 6, 2000 Mr. Livingston and Mr. Norderhaug wrote a letter to Mr. Audette. In the letter they projected that LifeWise was on track to perform monthly loan originations of $2,000,000 by the end of 2000.
On June 13, 2000 Michael Salzhauer sent a letter to Chris Willard projecting an imminent origination of nearly $5,000,000 in loans that would require funding by E*TRADE Bank. On June 15, 2000 LifeWise made a funding request. On June 19, 2000 LifeWise made a request that E*TRADE Bank fund a non-conforming loan, meaning it did not meet the underwriting criteria agreed upon in the Funding Agreement.
Thereafter, Mr. Livingston wrote E*TRADE Bank a letter dated June 21, 2000 in which he demanded that E*TRADE Bank fund the June 15, 2000 request. He stated that E*TRADE Bank's refusal to fund was damaging LifeWise's business.
Thirteen days later, on June 28, 2000, LifeWise filed this lawsuit against E*TRADE Bank.
Once litigation commenced, the relationship between the parties was significantly affected by the pending case. LifeWise continued to attempt to obtain funding from E*TRADE Bank and two more fundings were requested by LifeWise in September and October of 2000. Both were funded on December 15, 2000, and both were predicated on litigation-related issues. E*TRADE Bank continued to assert its position that LifeWise's general business operations were unsatisfactory to the bank, and, therefore, E*TRADE Bank was under no obligation to provide funding. LifeWise continued to maintain that its business operations were satisfactory and that E*TRADE Bank was in breach of the contract for its refusal to fund.
LifeWise continued to operate until April of 2001, primarily with its own money and short-term funding from Bank One. However, E*TRADE Bank funded at least three requests in 2001 totaling over $7,000,000 under a reservation of rights. Bank One's funding was eventually eliminated, and LifeWise essentially ceased business operations as of April 1, 2001. LifeWise's business showed some improvement in late 2000 and the first quarter of 2001, with 117 loans in 2000, totaling $9,138,000; and 31 loans in the first quarter of 2001 totaling $4,584,398. Total losses for 2000 were $1,888,309; and total losses for 2001 were $1,412,698. From 1995 through 2000, LifeWise's total losses exceeded $12,000,000.
II. PROCEDURAL HISTORY
Trial in this case was originally set pursuant to the magistrate judge's scheduling order for November 26, 2001. On August 10, 2001 E*TRADE Bank filed two motions — a motion for summary judgment on liability and a motion for summary judgment dismissing plaintiffs' contract claims for lack of damages. Briefing on these motions was completed on October 9, 2001. The motions were scheduled for oral argument on November 14, 2001. On October 9, 2001 E*TRADE Bank moved to continue the trial date citing a conflict with a criminal trial the Court had scheduled which had preference over civil matters. Also, the Court would have only seven working days to consider and rule upon two complex summary judgment motions prior to the scheduled trial. Accordingly, the Court continued the trial date to May 13, 2002. The two motions for summary judgment were then rescheduled for oral argument on December 13, 2001.
At the December 13 hearing, E*TRADE Bank argued there were no genuine issues of material fact on the key question of whether LifeWise's general business operations and underwriting policies and procedures were in fact unsatisfactory to E*TRADE Bank. In order to rule on the motion, the Court was necessarily required to interpret § 4.10 of the Funding Agreement, the so-called satisfaction clause. E*TRADE Bank contended the provision was subjective in nature, requiring only that E*TRADE Bank was genuinely dissatisfied when it so declared in its communications with LifeWise in the Spring of 2000, leading up to its letter of April 28, 2000 wherein LifeWise was informed of several areas of E*TRADE Bank's dissatisfaction and the fact that funding would be delayed until those areas were addressed to its satisfaction. The plaintiffs argued an objective standard was the appropriate test, citing the undisputed fact that Telebank's original proposed language seeking unfettered discretion in this regard was not included in the final contract. The Court agreed with plaintiffs, finding that controlling New York law, both case law and that based on the Restatement (Second) of Contracts, as adopted by New York's courts, required an objective standard. E*TRADE Bank was accordingly required to exercise its right of dissatisfaction on objectively reasonable business reasons. Under such a standard, the Court saw a clear issue of material fact, and the summary judgment motion was denied. The question to be put to the fact finder was whether an objectively reasonable person, in the position of E*TRADE Bank, would have been dissatisfied with the general business operations of LifeWise. The oral argument on this motion was so extensive that the Court had to set over the motion for summary judgment on damages to be heard the following week on December 19, 2001.
The Funding Agreement contains a choice of law provision that states that it is to be governed by the laws of the State of New York. (Funding Agreement, § 12.3.) A federal court exercising diversity jurisdiction must apply the choice of law rules of the forum state. Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 497 (1941). Utah courts generally honor the intent of contacting parties and enforce contractual choice of law provisions. Prows v. Pinpoint Retail Systems, Inc., 868 P.2d 809 (Utah 1993). Accordingly, the Court will apply New York law to the Funding Agreement.
On December 19, after considerable briefing and argument, the Court granted E*TRADE Bank's motion for summary judgment on damages in part and denied it in part. The Court granted the motion to the extent it sought lost profits beyond December 31, 2005. Any damages evidence after that date would be purely speculative and violate New York law's requirement of reasonable certainty. As to damages evidence prior to December 31, 2005, the Court denied E*TRADE Bank's motion, finding a question of fact for the jury, assuming that LifeWise would proffer a damages case that met the requirements of Rule 702 of the Federal Rules of Evidence, and the reasonable certainty requirement of New York law.
LifeWise initially designated Mr. Merrill Norman, a Salt Lake City based economist, as its damages expert. On January 22, 2002 E*TRADE Bank filed a motion in limine that challenged the admissibility of Mr. Norman's expert testimony and damages model, claiming it was unduly speculative under New York law, and that it was based on improper science under Rule 702. The Court referred this Daubert — type motion to Magistrate Judge Ronald Boyce, along with several other pending motions in limine filed by both sides. While this motion was pending and near the May 13, 2002 trial date, one of E*TRADE Bank's lead attorneys had a heart attack and E*TRADE Bank requested a trial continuance to allow him to recover. The Court granted the continuance and the trial was rescheduled to July 29, 2002. Meanwhile, Magistrate Judge Boyce conducted an extensive hearing on the motion regarding Mr. Norman's expert report and damages model. At the conclusion of the hearing, the magistrate judge prepared a thorough fourteen page Report and Recommendation on July 23, 2002, which found Mr. Norman's proposed evidence to be inadmissible. The magistrate judge recommended that the evidence be disallowed in its entirety. The Court held a status hearing on July 25, 2002 and heard objections to the magistrate judge's Report. Under these circumstances the July 29, 2002 trial date was continued, and trial was set for September 18, 2002.
After consideration of the parties' briefs in objection to the magistrate judge's Report, the district court agreed with the magistrate judge. The Report and Recommendation was adopted in its entirety.
On July 26, 2002, while the objections to the magistrate judge's Report were pending and in light of the possible rejection of plaintiffs' damages evidence if the magistrate judge's Report was adopted by the Court, LifeWise submitted an alternative statement of damages. This, too, was immediately met with a motion in limine by E*TRADE Bank, contending that this new model suffered from essentially the same defects as the earlier version. The Court found this July 26, 2002 damages model also to be inadmissible. It was not in compliance with Rule 702's requirements of reliability and fit and also suffered from the lack of a qualified expert.
Once again, however, rather than granting summary judgment and dismissing the lost profits damages case with prejudice, the Court permitted the plaintiffs to try again. The Court felt that an acceptable damages model could be developed. The Court again attempted to communicate to plaintiffs the type of damages evidence that would satisfy both New York law and Federal Rules of Evidence 701- 704. In its written Order of August 16, 2002 the Court invited LifeWise to submit one last damages model and reiterated what it had tried to express in open court numerous times regarding the criteria of an admissible model.
LifeWise's president, Mr. Livingston, had also been designated (in addition to Mr. Norman) by plaintiffs during discovery as a damages expert, although he had never submitted a report. Over defendant's objection that a new damages model would now be untimely, the Court nevertheless allowed Mr. Livingston to prepare a damages report. The plaintiffs remained desirous of going to trial on September 18, 2002 but the question whether they would have an admissible damages case to present was an obvious impediment. In an effort to hold the trial date as LifeWise desired, the Court ordered any new damages model to be submitted by August 9, 2002 and ordered all briefing for any possible motions completed by September 5, 2002.
Thereafter, the plaintiffs submitted a new damages model, dated August 9, 2002. E*TRADE Bank challenged this model in a motion for summary judgment filed on August 22, 2002. The Court heard argument on the matter on September 5, 2002. E*TRADE Bank contended the model was nothing more than another modification of Merrill Norman's excluded damages model, and worse yet, was even more removed from the company's actual operating history as it employed a regression type model that only incorporated the most positive periods of the company's operating history.
The Court agreed with defendant's assertion that LifeWise essentially only used loan volume from July 1999 to April 2001, and used only twelve months of expenses from 2000 to reach its conclusions. Also of concern to the Court was that LifeWise preferred Syver Norderhaug and Mark Livingston — who were clearly not qualified and in Mr. Norderhaug's case, was not properly designated as an expert — to present this complex economic model utilizing regression analysis.
However, despite the shortcomings and inadmissibility of yet another damages statement, the Court again allowed plaintiffs to attempt to develop an acceptable damages report based on the actual operating history of the company. Once again, over defendant's objections on timeliness grounds, the Court allowed LifeWise one last chance to offer an admissible damages statement through Mr. Livingston. A deadline was set for September 13, 2002. Trial at this point was set for September 18, 2002. After consultation with the parties in chambers, the trial was continued to December 2, 2002.
On September 13, 2002, the plaintiffs filed another damages model, which is the subject of today's Opinion and Order. This latest model is offered through the testimony of Mr. Livingston. It purports to be based on the actual operating history of the company, with reasonable, even conservative, predictions for the future that do not run afoul of New York's prohibition against speculative damages and that comply with Rule 702 of the Federal Rules of Evidence. This model seeks damages of $7 to $10 million.
After this new damages statement was filed, defendants challenged its admissibility. First, defendants challenged Mr. Livingston's competence to offer much of the evidence contained in the statement by filing a motion in limine on November 12, 2002. Second, defendants filed the instant motion for summary judgment relating to lost profits damages. Defendant's initial memorandum in support of the motion was filed on November 12, 2002, plaintiffs' opposition memorandum was filed on November 20, 2002, and defendants' reply memorandum followed on November 25, 2002. A hearing was scheduled for Wednesday, November 27, 2002 leaving only one working day (the Thanksgiving holiday fell on Thursday, November 28, 2002) before the trial date of December 2, 2002. The hearing went well into the evening hours. This left little time for consideration of the motions. At the end of this hearing a trial continuance was discussed, which plaintiffs' counsel vigorously opposed.
This would have been at least the fourth trial continuance, and plaintiffs had complained about, and vigorously resisted, each previous continuance, even though, in fairness, it should be pointed out that most of the continuances were caused by plaintiffs, in particular because of their inability to present an admissible damages case. Under the circumstances, it was apparent to the Court that the pending motion required further study, and that if a thoughtful ruling on the motion were to be made, it would take some time, and necessitate moving the trial. However, because of the history of the case, the Court thought it best to give plaintiffs' counsel the option of proceeding to trial the following Monday, as scheduled. Because the admissibility of the proposed damages evidence was undecided, however, there was no logical way a damages case could be allowed to go forward. Accordingly, if trial were to commence on December 2, 2002, it would be limited to a determination of liability. The Court pointed out that the pending motion, if granted, could result in a dismissal of much, or all, of the plaintiffs' case and if that were to occur the anticipated three week trial may have been unnecessary. Plaintiffs' counsel stated that plaintiffs were desirous of going to trial on the liability question on December 2, 2002 with a full understanding that a ruling in defendant's favor on the pending motions could possibly moot the trial verdict if the verdict was in plaintiffs' favor.
Accordingly, trial commenced on December 2, 2002 and proceeded for three weeks, until December 20, 2002.
At trial, the central issue revolved around E*TRADE Bank's exercise of its right under § 4.10 of the Funding Agreement when it determined in the Spring of 2000 that LifeWise's general business operations and underwriting policies and procedures were unsatisfactory to E*TRADE Bank. On this critical issue the jury was instructed pursuant to the objective standard discussed above consistent with New York law and the Restatement (Second) of Contracts. One of the key jury instructions on this point was Instruction Number 19, as follows:
Section 4.10 of the Funding Agreement contains a specific provision relative to E*TRADE Bank's obligation to fund each funding request submitted by LifeWise. Under Section 4.10, E*TRADE Bank does not have an obligation to fund if E*TRADE Bank has determined that the general business conditions and underwriting policies and procedures of LifeWise are unsatisfactory to E*TRADE Bank, and the reasons for such dissatisfaction are disclosed to LifeWise in writing, in reasonable detail.
Section 4.10 gives E*TRADE the ability to determine if this provision is satisfied. However, E*TRADE must make any such determination consistent with principles of good faith and fair dealing.
In determining whether E*TRADE acted in good faith, you should consider whether E*TRADE acted honestly and genuinely.
In determining whether E*TRADE Bank acted consistent with principles of fair dealing, you should consider whether the reasons offered by E*TRADE Bank are objectively reasonable, that is, do they make commercial sense and are they the kinds of factors that a business such as E*TRADE Bank would consider appropriate and relevant to this type of transaction when assessing the business operations and underwriting policies and procedures of LifeWise.
If you find that E*TRADE Bank made its determination of dissatisfaction consistent with the above statement, and that such dissatisfaction was disclosed in writing to LifeWise in reasonable detail, then E*TRADE Bank's refusal to fund was not a breach of the Funding Agreement.
At the close of plaintiffs' case, defendants moved for summary judgment as a matter of law on the ground that the evidence was undisputed that plaintiffs had violated a condition precedent by improperly causing the "Trust Property" (i.e., the borrower's life insurance policies) to be encumbered by liens. Plaintiffs' sole testimony on the subject came from plaintiffs' former legal counsel, Mr. Glen Arden. He testified that the lien in question did not violate the contract because the lien was terminated according to its own terms. Defendant filed a memorandum in support of its motion. The Court took the matter under advisement and allowed plaintiff an opportunity to submit a written response. The Court found the issue to be solely one of law, there being no factual dispute. Neither party had asserted that the contract language in question was ambiguous, leaving only a matter of contract interpretation which is purely a question of law for the Court. Accordingly, the jury was not asked to deliberate on this issue. This Opinion and Order will later address this lien issue and E*TRADE Bank's associated motion for summary judgment in more detail.
The Special Verdict form required the jury to answer four questions, as follows:
1. LifeWise claims E*TRADE Bank's decision not to provide funding to LifeWise in 2000, was in breach of the Funding Agreement. E*TRADE Bank claims it declined to provide funds because it was not satisfied with LifeWise's general business operations and underwriting policies and procedures. LifeWise claims this decision was not consistent with the principles of good faith and fair dealing as explained in Instruction No. 19. E*TRADE Bank claims that its decision was consistent with the principles of good faith and fair dealing. With respect to this issues, check one of the following:
[ ] LifeWise has proved that E*TRADE Bank breached the agreement? [ ] LifeWise has not proved that E*TRADE Bank breached the agreement?
2. Did LifeWise prove that E*TRADE Bank materially breached the Funding Agreement by failing to disclose in writing, in reasonable detail, the reasons for its dissatisfaction?
ANSWER: Yes ____ No ____
3. Did E*TRADE Bank prove that LifeWise and/or its related entities materially breached the contract by entering into prohibited intercompany transfers that resulted in intercompany debt and/or intercompany loans?
ANSWER: Yes ____ No ____
4. Did E*TRADE Bank prove that LifeWise materially breached the Funding Agreement by failing to disclose to E*TRADE Bank the prohibited LifeWise-related intercompany transfers?
ANSWER: Yes ____ No ____
The jury deliberated approximately seven hours on Thursday, December 19, 2002. At 11:00 p.m. that evening the jury informed the Court through a note that despite its best efforts, the jurors were not in agreement and were unable to reach a unanimous verdict. After consulting with counsel the Court determined that rather than declaring a mistrial on the basis of a hung jury, the Court would ask the jurors to reassemble in the courtroom where the Court would encourage them to resume their deliberations and try again. After ascertaining that the jurors were tired from a long day, and after asking the jury to try again to do their best to reach a unanimous verdict, and with the jury's agreement to make such an effort, the Court excused the jury for the evening. The jury reconvened deliberations the next morning commencing at 9:00 a.m. Approximately one hour later the jury foreperson announced that the jury had reached a verdict.
As to LifeWise's claims, the jury answered the first question in favor of E*TRADE Bank finding that E*TRADE Bank had a good faith basis for denying funding because it was not satisfied with the general business operations of LifeWise, and the second question in favor of LifeWise finding E*TRADE Bank did not adequately disclose, in writing, the reasons for its dissatisfaction with LifeWise's business operations. As to E*TRADE Bank's claims in questions 3 and 4, both were answered in favor of LifeWise finding LifeWise had not entered into and then failed to report prohibited intercompany transfers.
III. DEFENDANT'S MOTION FOR SUMMARY JUDGMENT REGARDING DAMAGES
As described above, the subject of plaintiffs' alleged lost-profits damages is not new to this case. Extraordinary time, effort, and expense have been devoted to this subject.
A. PLAINTIFFS' INITIAL DAMAGES CASE
Initially, plaintiffs contended they should be awarded damages in the neighborhood of $50 million, based on losses associated with the remaining five years on the funding facility (through December 31, 2005) and the seven year period immediately following. New York law prohibits speculative damages. See Schonfeld v. Hilliard, 62 F. Supp.2d 1062 (S.D.N.Y. 1998). The Court ruled that any damages beyond 2005 were not legally allowable and granted E*TRADE Bank's motion for summary judgment dismissing plaintiffs' contract claims for lack of damages "to the extent that LifeWise seeks to recover lost profits for the period after December 31, 2005." There was no definite business operation period contracted for beyond 2005, only an option for renewal, at defendant's sole discretion. Furthermore, of concern to the Court was the relatively limited operating history of LifeWise, and the undeniable fact that LifeWise had yet to make any profit. Defendants argued that under these circumstances, any damages beyond 2005 would be speculative and not permitted under New York law. As to the earlier period, through the end of 2005, the Court saw damages as an appropriate factual issue. The Court was satisfied that LifeWise's business history, though relatively short, and its loan history, though relatively limited, provided a sufficient basis from which an admissible damages argument could be made to a jury. The Court saw the case then, as it sees it now, as a relatively straightforward business case, which should allow some person or persons knowledgeable about the business to opine as to how much money LifeWise lost because of the loss of the benefit of its bargain assuming, of course, that a breach is found.
B. PLAINTIFFS' FIRST EXPERT REPORT
During discovery, the plaintiffs designated Mr. Merrill Norman and Mr. Mark Livingston as damages experts. Mr. Norman is an economist and a CPA who frequently testifies as an expert witness in business litigation. He submitted a written report, which calculated LifeWise's damages to be approximately $9.6 million in present dollars. After receiving Mr. Norman's report, E*TRADE Bank challenged Mr. Norman's qualifications as an expert, and also the report in its entirety as inadmissibly speculative under New York law, and inadmissible under Rule 702 of the Federal Rules of Evidence. As described in the foregoing procedural history, the Court referred this matter to Magistrate Judge Ronald Boyce. The magistrate judge after careful consideration of the written briefs, hearing argument, and reviewing numerous exhibits, issued a fourteen page Report and Recommendation. The testimony was found to be "completely extrapolated speculation", "disparate from the historical business data and reality", and "doubtful at best." He concluded as follows:
Based on the above discussion and the considerations evaluated as to Mr. Norman's report and methodology, and making a proper gatekeeper analysis under Rule 104(a) F.R.E., it is concluded Mr. Norman's opinion and the damage model on which it is based, should be excluded. E*TRADE's motion in limine should be Granted.
The Court concurred in the conclusion reached by the magistrate judge, and adopted his recommendation. All objections to the report were overruled. The Court also emphasized and expanded upon one aspect of the Report and Recommendation by finding that Mr. Norman was not deemed by the Court to be helpful to the jury in any event. In other words, even if Mr. Norman's economic model, with its graphs, calculations, and theories, were deemed admissible as non-speculative acceptable science, and even if that science was deemed relevant to the instant case, it was still not viewed by the Court as being of assistance to the jury. The Court saw no need for the services of Mr. Norman to assist the jury under the circumstances. He was not trained in the area of plaintiffs' business, or anything remotely close to it. He had no special insight into the world of terminally-ill cancer patients, and their financial needs. The Court saw him as an economist paid to give an opinion in a area where he had very little to offer. His testimony not only failed to comport with the Daubert/Kumho line of cases and F.R.E. 702, it also ran afoul of Rule 403 of the Federal Rules of Evidence. Mr. Norman's testimony possessed the danger of misleading or confusing the jury. Pared down to its essential ingredients, the damages model by Mr. Norman revealed a remarkable transformation of a debt-ridden company that had never made a profit in its five year history (in fact, it had lost in excess of $12 million through this time period) into a tremendously profitable enterprise which would see impressive net profits of close to $20 million dollars by 2005, all through the use of an unreasonably complicated economic model that had neither the virtue of prior use nor the necessary attachment to reality.
Daubert v. Merrell Dow Pharm., 509 U.S. 579 (1993); Kumho Tire Co., v. Carmichael, 526 U.S. 137 (1999).
C. PLAINTIFFS' SECOND DAMAGES MODEL, DATED JULY 26, 2002
After rejection of Mr. Norman's testimony, the Court informed the plaintiffs that if they wanted to present another damages opinion through a different witness, the Court would be willing to entertain it. The only expert left was Mr. Livingston, but as the person most familiar with LifeWise from its beginning, it was expected that he could produce an admissible opinion. The plaintiffs then submitted their next damages model, dated July 26, 2002. This too immediately met with a challenge from E*TRADE Bank, and the Court concluded that this additional submission was also inadmissible.
The July 26, 2002 model had several serious deficiencies related to Rule 702, Daubert/Kumho, and New York law's reasonable certainty standard. See Schonfeld v. Hilliard, 62 F. Supp.2d 1062, 1071 (S.D.N.Y. 1998). Also, it contained information and assumptions and damages scenarios extending beyond 2005 that the Court had specifically ruled were speculative and not admissible. For damage scenarios prior to 2005, the model suffered from the same deficiencies found in Magistrate Judge Boyce's Report and Recommendation — namely the use of projections not tied to history coupled with a discounted accrued earnings methodology, that was not only unreliable and previously ruled inadmissible, but that Mr. Livingston, the only remaining designated expert, was clearly not qualified to present.
The model was flawed in many other key respects related to reasonable certainty: it appeared to use only 15 months of actual operating history; it did not support assumptions of actual life expectancy of patients; it did not support assumptions regarding future expenses and cost of capital; and it did not appropriately account for risks associated with the business.
The model also failed to explain with reasonable certainty a causal nexus between E*TRADE Bank's actions and loss to LifeWise. The model provided no clear picture of which actions led to loss or when they occurred.
For these reasons, the Court, as noted above, found the July 26, 2002 model inadmissible. In so doing, the Court issued an Order on August 16, 2002. The Court's Order reads, in part, as follows:
The Court finds that LifeWise's alternative damages opinion dated July 26, 2002, does not meet the reasonable certainty standard under New York law and therefore cannot be presented to the fact finder. LifeWise's alternative damages numbers are based in large part on LifeWise's projections coupled with Mr. Norman's discounted earnings methodology, both of which Magistrate Judge Boyce and this Court have found to be unreliable. Two of its damage scenarios extend damages beyond December 2005 in contravention of this Court's previous order. Damages based on an assumption that LifeWise will use the entire $200 million facility utilizing growth rates in loan volume based on data for the years 2000 and 2001 are in stark contradiction to what LifeWise has done previously and are speculative. This Court finds under the circumstance, with such a modest and short track record, this kind of extrapolation is unduly speculative. All testimony and evidence regarding damages based on LifeWise's Statement of Damages dated July 26, 2002, are therefore excluded from presentation to the jury.
However, the Court, still feeling plaintiffs could, through Mr. Livingston, present a simple and straightforward statement of damages based on his expertise in operating and managing the company, over defendant's objections allowed plaintiffs to submit another damages statement. The Court instructed plaintiffs not to utilize complex economic analysis and modeling such as Mr. Norman's, but to focus on submitting a damages case supported by the expertise of a businessman with experience in the pertinent industry. In this regard, the Court's Order of August 16, 2002 states:
LifeWise is invited at its option to submit one last alternative damages model for the Court's consideration.
LifeWise's damages should comply with New York's reasonable certainty standard. See Schonfeld v. Hilliard, 62 F. Supp.2d 1062, 1071 (S.D.N.Y. 1998). LifeWise may not resurrect a damages model based on the assumptions that Magistrate Judge Boyce found, and this Court affirmed, to be speculative or unreliable. For example, LifeWise's damages opinion cannot base growth rates solely on LifeWise's June 5, 2000 projections or on the assumptions that underlie those projections. LifeWise cannot discount accrued earnings, but must instead base its damages on lost profits consisting of the additional actual cash it would have kept absent the alleged conduct by E*TRADE, discounted to the present.
LifeWise's damages should be reasonably tied to the actual history of the company, and not only the most recent 15 months prior to the cessation of business. LifeWise's damages should be reasonably based on the actual history of how long borrowers are going to live, and the company's actual history of expenses. LifeWise should show how any claimed lost profits arising from operations would have been realistically financed (i.e., the specific source of the cash required for operations) and incorporate the realistic costs of such financing. The fact finder needs to be able to have a clear understanding of how LifeWise would obtain the money it would need to fund its operations in order to determine ultimately how much real money eventually will end up in LifeWise's pocket, anticipating all of the risks associated with its business.
LifeWise should explain with reasonable certainty which of E*TRADE's actions caused its loss, when such actions occurred, when LifeWise experienced damages, and the causal nexus between E*TRADE's acts and LifeWise's damages.
LifeWise's damage model shall not be based on any new information not already in the record. For example, no comparable companies can now be introduced. The model shall not incorporate any excluded documents, and Mark Livingston shall be the only witness for LifeWise allowed to present opinion evidence on damages.
Damages can only consist of rescission or lost profits (i.e. profits lost as a result of alleged conduct by E*TRADE). Any offset must be explicit. However, this Court has not had the opportunity to evaluate whether there is a legitimate basis for rescission damages and its conclusion that such damages may be available is contingent on LifeWise showing there is a legitimate legal and factual basis for them. The valuation of LifeWise as a company in this case is in the realm of speculation and is not appropriate for submission to a jury.
At plaintiffs' request, in an effort to hold a September 18, 2002 trial date — the July 29, 2002 date had been continued due to plaintiffs' failure to submit an admissible damages case — the Court ordered the new damages statement submitted by August 9, 2002 and all associated motions briefed by September 5, 2002.
D. PLAINTIFFS' THIRD MODEL, DATED AUGUST 9, 2002
On August 9, 2002 plaintiffs submitted another damages model. This model purported to be based on a regression analysis and yielded damages of some $9 million. An examination of its contents revealed numerous defects, including not in the least the fact that Mr. Livingston was not qualified to discuss the model in many of its sections. He had no training in regression analysis, for example, and it was apparent this new damages model was in many respects a reconstruction and reformulation of the approaches and premises of the rejected Merrill Norman model. In some respects, this model was more problematic than its predecessors. It was even further removed from the reality of LifeWise's operational history than the earlier reports. The regression approach was ill-suited to the situation, and raised concern on the Court's part that not only would this not help the jury, it would actually more likely confuse and mislead them. And in the end, like its forerunners, this proposal achieved remarkably profitable business operations for LifeWise ($9 million plus in present dollars) without a solid explanation as to how it was appropriately based on the company's actual history.
In rejecting this new model, the Court again allowed plaintiffs to submit another damages proposal. The Court attempted again to explain in general terms what would comply with New York law and the Federal Rules of Evidence that would allow the question of damages to go to the jury.
E. EVIDENTIARY STANDARD. NEW YORK LAW REGARDING SPECULATIVE DAMAGES AND THE FEDERAL RULES OF EVIDENCE.
The Court's rejection of the plaintiffs' proposed damages evidence up to this point in time was based, as has been mentioned above, on New York's law against speculative damages, and on the Federal Rules of Evidence. New York law requires that in order to recover for lost profits a party must show first, that "such damages have been caused by the breach" and second, that "the alleged loss . . . [is] capable of proof with reasonable certainty." Schonfeld v. Hilliard, 62 F. Supp.2d 1062, 1071 (S.D.N.Y. 1998). Expanding on the second prong, New York courts have explained that the damages may not be "merely speculative, possible or imaginary, but must be reasonably certain." Id. at 1071; Kenford Co., v. County of Erie, 537 N.E.2d 176 (N.Y. 1989). In contrast to long-standing, well-established companies, New York law also establishes a higher standard for new businesses such as LifeWise. Because new businesses do not have a "reasonable basis of experience — i.e. historic profits — upon which to estimate lost profits with the requisite degree of reasonable certainty" any evidence of lost profits must be "receive[d] with greater scrutiny." Id. at 1071-72.
In Schonfeld, the defendants entered into an "Interim Agreement" with the British Broadcasting Corporation ("BBC") in which the BBC would provide provisional programming to defendants' cable channels for 3.35 million pounds sterling. Despite defendants repeated assurances that the agreement would be upheld, the defendants never tendered payment for the programming, and defendants' business partner sued the defendants for — among other things — breach of contract.
Similarly to the case before this Court, the plaintiffs lost profits damages claim in Schonfeld was predicated on a number of future assumptions. The operating entity in question had no performance records, thus, the plaintiff based his damage assessment on the business plans and revenue projections of the company. The court, however, found that these types of projections failed to meet the legal standard of reasonable certainty. The court stated:
[P]laintiff's damages assessment presumes at least, that: (1) an operating entity would have been formed and operated for 20 years; (ii) an estimated $44 million in pre-launch financing would have been raised; (iii) the hypothetical subscriber levels would have been reached; (iv) carriage agreements would have been entered; (v) advertisers would have been found at the assumed rates; (vi) all projected expenses would have proved correct; (vii) marketing costs would have remained constant and expenditures would have been sufficient to attract and maintain subscriber interest; and (viii) the type and amount of equity interest held by each investor . . . would have been determined in the manner plaintiff alleges.Id. at 1073. The court found that "each of these presumptions is based on nothing but speculation and conjecture." Id. Therefore, the court held that plaintiffs motion for recovery based on lost profits was unwarranted; to hold otherwise would be to "put plaintiff in a better position that he might reasonably have expected to be in after full performance." Id. at 1074.
The Court in Kenford Co., v. County of Erie, 537 N.E.2d 176 (N.Y. 1989), was also presented with similar circumstances to both this case and to Schonfeld. In that case, Erie County had entered into a contract with Kenford and its affiliate, Dome Stadium, in which Kenford agreed to convey land to Erie County for construction of a domed stadium. The county agreed to construct the stadium and to lease it to Dome Stadium for 40 years or, if the parties could not agree upon the terms of the lease, to enter into a 20-year contract under which Dome Stadium would manage the facility. The stadium was never constructed and Dome Stadium sued the county for breach. The jury returned a verdict for $25.6 million based on lost profits flowing from the management contract. The court, however, set aside the jury verdict.
In upholding the lower court's decision to set aside the verdict, the court found no fault with the statistical procedures or data used to calculate the damages; in fact the court stated that it was "difficult to conclude what additional proof could have been submitted." Kenford at 261-62. Despite these findings, however, the court found the economic assessment of damages to be legally insufficient. The court explained:
[w]e of course recognize that any projection cannot be absolute, nor is there any such requirement, but it is axiomatic that the degree of certainty is dependent upon known or unknown factors which form the basis of the ultimate conclusion . . . Quite simply, the multitude of assumptions required to establish projections of profitability over the life of this contract require speculation and conjecture, making it beyond the capability of even the most sophisticated procedures to satisfy the legal requirement of proof with reasonable certainty.Id. at 262. Ten years later, the Schonfeld court extrapolated on the Kenford court's reasoning:
Kenford . . . does not absolutely bar the award of lost profits for failed ventures with no profit history but the Kenford . . . Court refused to enter into the speculative counter-factual required to determine hypothetical revenues over a period of 20 years from performances at a stadium that was never built, by entertainers who were never booked, before an audience that was never developed. The relevant issues, the Court made clear, is one of evidence; hopes and plans are not enough, and the burden is upon the plaintiff to prove lost profits with reasonable certainty.Schonfeld at 1072; see also Ashland Mgmt. Inc., v. Janien, 624 N.E.2d 1007 (N.Y. 1993) (stating that the damages model in Kenford failed because it "rested on a host of speculative assumptions and few known factors").
Not only must plaintiffs' damages model conform to New York law, as set out by the first requirement of Federal Rule of Evidence 702 and the Daubert/Kumho Tire standard, but plaintiffs' model must also meet the second requirement of Federal Rule of Evidence 702 which requires that a damages model be the product of a sufficiently reliable methodology. While the Daubert Court dealt only with scientific knowledge, it is clear that this standard has been extended to all forms of technical or other "specialized knowledge." See Kumho, 526 U.S. 137, 140 (1999); FED. R. EVID. 702 advisory committee's note. Thus, the Court must determine if plaintiffs' damages model meets Rule 702's requirements. Specifically, the Court must find that "(1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case." FED. R. EVID. 702.
In determining whether proffered testimony is reliable, the court's focus should be fixed firmly on "principles and methodology, not on the conclusions they generate." Daubert, 509 U.S. at 595. There is admittedly, however, some overlap between a conclusion and the methodology used to reach that conclusion. See General Elec. Co., v. Joiner, 522 U.S. 136, 146 (1997). Thus, a "trial judge must have considerable leeway in deciding in a particular case how to go about determining whether particular expert testimony is reliable." Kumho, 526 U.S. 137, 152 (1999). Notwithstanding this leeway, however, it is clear that a damages model that creates "too great an analytic gap between the data and the opinion proffered" is not reliable and should be excluded. General Elec. Co., 522 at 146.
F. PLAINTIFFS' FINAL ATTEMPT: THE SEPTEMBER 13, 2002 DAMAGES REPORT
Against this legal standard, and the foregoing litigation history, plaintiffs' final damages statement was submitted to the Court on September 13, 2002 and as noted is one of the subjects of today's Opinion and Order. Due to the Court's continued willingness to extend every benefit of the doubt to plaintiffs' ability to submit an admissible damages case, this is at least the fourth written damages statement presented by plaintiffs. The sole witness to present this statement is Mr. Livingston. It estimates from $7 to $10 million in damages, discounted to present value. It purports to be directly tied to LifeWise's actual operating history, and to be a conservative estimate of future profits. It produces its results through the use of "three-month rolling averages," and "compounded monthly growth rates." It describes itself as a simple model that will allow the jury to see how LifeWise's newly discovered message — delivery system was about to produce significant profits for the years 2001 through 2005.
E*TRADE Bank claims in its motion for summary judgment that this newest damages model is the most deceptive yet. It claims the three-month rolling averages and compounded monthly growth rates are not only based on improper science but are internally inconsistent. It claims the model is yet another attempt to reach the same $7 to $10 million dollar result as in the earlier models through another incarnation of complicated yet faulty economics and misleading calculations.
Unfortunately for plaintiffs, the Court agrees with defendant's position. The Court uses the word "unfortunately" advisedly, because the Court has long felt an admissible damages case could be produced. But this latest version fails to clear the admissibility hurdles required by Federal Rules of Evidence 104, 403, and 702. By any means of analysis, the Court cannot find the September 13, 2002 submission qualified to go to a jury.
Perhaps the biggest problem with plaintiffs' present model is its lack of connection with the past. This model turns a company that, according to audited financial statements, lost at least $12 million from 1995 through April of 2001, for an average yearly loss of over $1.7 million, into a successful company with over $14 million in net profits from April 1, 2001 to December 31, 2005, for an average yearly net profit of approximately $2.8 million (calculation based on a full calendar year for 2001). Remarkably, it purports to do this based solely on conservative projections of future growth based on its own past.
For a closer analysis, it is helpful to understand precisely what LifeWise did month-to-month from its beginning in 1995 to the day it ceased business operations in April of 2001. The September 13, 2002 statement of damages supplies data on actual monthly loan originations for 62 months — from early 1996 through April of 2001. The number of loan originations fluctuated each month. Loan originations declined from the previous month 28 times, and increased from the previous month 33 times. The average monthly change was an increase of $18,288. Total loan production for these 62 months was $24,343,722. In rough numbers the company averaged nearly $5,000,000 annually in loan originations for five years. However, in this same period the company incurred over $13,000,000 in operating losses as follows:
1996 — $1,157,732
1997 — $1,639,633
1998 — $3,705,018
1999 — $3,509,377
2000 — $1,888,309
2001 — $1,412,698 ___________ Total losses $13,312,767 _____________________________________________________________________ Month Net Income Month Net Income Month Net Income _____________________________________________________________________ Feb-96 -77,696 Mar-98 -178,182 May-00 -112,051
Mar-96 -243,051 Apr-98 -175,147 Jun-00 -127,008
Apr-96 -144,728 May-98 -168,452 Jul-00 -144,785
May-96 -77,965 Jun-98 -236,168 Aug-00 -180,507
Jun-96 -12,692 Jul-98 -105,211 Sep-00 -200,374
Jul-96 -199,690 Aug-98 -239,143 Oct-00 -207,654
Aug-96 -79,402 Sep-98 -231,766 Nov-00 -179,634
Sep-96 -158,318 Oct-98 -390,342 Dec-00 -40,955
Oct-96 -48,767 Nov-98 -508,568 Jan-01 -217,866
Nov-96 -79,837 Dec-98 -1,225,146 Feb-01 -223,559
Dec-96 -35,587 Jan-99 -227,032 Mar-01 -289,072
Jan-97 -66,678 Feb-99 -314,365 Apr-01 -241,676
Feb-97 -79,808 Mar-99 -344,596 May-01 -250,485
Mar-97 -108,749 Apr-99 -515,873 Jun-01 -163,855
Apr-97 -173,181 May-99 -245,250 Jul-01 -79,340
May-97 -123,406 Jun-99 -423,811 Aug-01 -28,470
Jun-97 -144,593 Jul-99 -347,428 Sep-01 -142,129
Jul-97 -161,539 Aug-99 -132,594 Oct-01 -75,732
Aug-97 -147,634 Sep-99 -234,360 Nov-01 -45,875
Sep-97 -180,715 Oct-99 -196,913 Dec-01 -87,217
Oct-97 -158,194 Nov-99 -140,325 Jan-02 -56,548
Nov-97 -137,399 Dec-99 -378,007 Feb-02 -61,519
Dec-97 -157,736 Jan-00 -166,742 Mar-02 -133,735
Jan-98 -122,928 Feb-00 -202,900 Apr-02 -179,790
Feb-98 -123,963 Mar-00 -198,830 May-02 -112,997
Apr-00 -126,887
This pattern is illustrated on a month to month basis as follows:
In graph format, LifeWise's loan origination history is depicted as follows:
The Tubis-Hendricks draws refer to a single borrower with a credit line of $5 million, pursuant to which the borrower actually borrowed $3,150,000. The Keller draws refer to a single borrower with a credit line of $5 million, pursuant to which the borrower actually borrowed $3,358,000.
Plaintiffs' September 13, 2002 damages model claims to be based on its own operating history. Because it is so grounded, plaintiffs argue the model is not speculative and is in compliance with New York law. Plaintiffs assert that Mr. Livingston's projections of future growth, and the corresponding profits, are conservative estimates based on Mr. Livingston's experience in running the company and his educated opinion about what the company would have accomplished in the future. What one finds upon closer examination, however, is a model that distinguishes itself more as a separation from the past, than an attachment to it.
The September 13, 2002 model is inadmissible under Rule 702 because it is based on a deficient scientific formula. It claims to be based on the use of three-month rolling averages, step-down methodologies, compounded monthly growth rates, S-curves, and the use of a 13% percent discount rate, all of which are adjusted and manipulated until the final result is achieved. This formula, or device, or process, or whatever it might be labeled, is unique to this case and is not based on any recognized standard. It is not claimed to be in regular usage as a methodology for predicting future profits. It is not peer reviewed. It has no uniform usage in any known industry. And it is capable of manipulation to achieve virtually any desired result.
The September 13, 2002 damages statement is a 35-page document, with numerous exhibits. Although somewhat lengthy and disjointed, its basic component parts can be fairly succinctly summarized.
First, the statement declares itself to be based "on actual, historical loan volume numbers and monthly internal growth rates from the inception of LifeWise's loan program in 1996 through the end of March 2001."
Second, the statement "conservatively estimates" that LifeWise will originate loans totaling $167,045,094 from April 1, 2001 through the end of 2005. Based on that estimate, it predicts gross revenue of $44,410,253 and total costs of $30,288,573. When the costs are subtracted from the gross revenue the resulting lost profits equal $14,121,680. This figure increases to $19 million if a longer average loan life is used.
Third, applying a discount rate of 13%, the resulting damages are from $6.7 to $9.3 million in present dollars (April 1, 2001 dollars), depending again on the average loan life and other variables. To this figure would also be added 9% prejudgment interest.
Fourth, obviously the most important number in this process is the $167 million in projected loans. This number is arrived at through a convoluted method that is based on high sounding economic terminology and calculations, but in the end appears to be an arbitrary guess. It works like this. First, we are introduced to the use of "three-month rolling averages" that are supposedly utilized to "smooth out the significant month to month changes." Once these are calculated, their primary, perhaps only, use is to serve as the basis for the assertion that "from its inception in 1996 until it ceased loan operations, LifeWise experienced monthly growth rates greater than 4.5 percent." Apparently, as defendants point out in their brief (and which is not refuted by plaintiffs), this percentage was arrived at by taking the second, third and fourth months at the beginning of the company's history in 1996, adding together the loan amounts for those months and calculating the average. Why the first month ($20,000 in loans) was not used is anyone's guess. Month 2 had $142,325 in loan originations, month 3 $10,000 and month 4 $156,014, for a three-month rolling average of $102,780. Then the final three months of the company, January, February and March of 2001, were used to arrive at another three month rolling average. January 2001 had $1,519,637 in loan originations, February, 2001, $1,476,021 and March, 2001 $1,136,322, for an average of $1,377,327. A comparison of $102,780 to $1,377,327 yields the so-called compounded growth of 4.5763%. Hence the statement "from its inception in 1996, LifeWise experienced month growth rates greater than 4.5%."
Fifth, once am at the compounded monthly growth rate of 4.58%, that figure is dropped, and a second compounded monthly growth rate of 3.6% is calculated using different three-month rolling averages, this time substituting the first three months of 1999, rather than 1996, for the early numbers while still using the same final three months for the later average.
If the statement had employed the 4.58% figure as a basis for projecting future loans, it would have quickly led to astronomical results. For example, in LifeWise's actual 5-6 year history, loan originations were $24,343,722. Under a 4.5% compounded growth rate the total for the next five years through 2005 would be $373,225,312, for an average yearly origination amount of $77 million. Therefore, under such a scenario, in one year alone, 2002, LifeWise would triple, in terms of loan originations, what it had produced in its five year history. Apparently, LifeWise recognized that such a number would be viewed as unduly speculative on its face; hence, a smaller growth rate was used.
Sixth, having established the 3.6% number by using the above method, the statement elects to use that growth rate (although not precisely, because it is without explanation reduced to 3.5%) for the remainder of 2001. Thereafter, for reasons never fully explained, the monthly growth rate drops to 3% for 2002, 2% for the first six months of 2003, 1.0% for the next 18 months, and finally, .05% for the final year, 2005. This yields yearly estimates of loan originations as follows ( in millions):
Year Projected Loan Originations ______________________________________________
2001 $14,780
2002 $27,573
2003 $36,665
2004 $41,997
2005 $46,029 ______________________________________________ TOTAL $167,044
Seventh, the statement spends considerable time explaining why these numbers are attainable based on the number of cancer patients, the number of these patients with life insurance policies, and similar statistics. An excerpt at page 10 of the statement reads:
One way to compute market potential for LifeWise loans is to start with the death benefits paid out where the cause of death is cancer, $9.33 billion' dollars. Assume that only one-half of these families are feeling financial pressure and may therefore consider a LifeWise loan to be an appropriate financial solution. The collateral available for LifeWise's lending activities is therefore equivalent to more than $4.6 billion' annually . . . 2,500,000 Americans might medically qualify for a LifeWise loan at any one time. There are nearly 500,000 new terminal diagnoses each year and 500,000 cancer deaths yearly. If only 20% of this 500,000 had life insurance and suffered financial distress as a result of their illness, there would be 100,000 new potential borrowers annually. In the present Statement, LifeWise assumes a maximum of 411 new loans annually, less than one-half of 1% of the potential market.
However, LifeWise fails to explain how it will manage to originate 411 loans in one year after barely originating a total of 400 loans in its 62 month history.
Eighth, the statement spends considerable time explaining why LifeWise's earlier years were unprofitable and relatively meager. With the benefit of hindsight, it declares that by the end of 2000 LifeWise had learned from its past, had changed its "message" (now emphasizing "financial assistance" as opposed to "loans") and had, as indicated by the last quarter of 2000, and the first quarter of 2001, begun to do much better.
Ninth, a 13% discount rate is discussed in a terse one-page explanation that somehow attempts to justify the 13% figure as being consistent with the interest rates charged by E*TRADE Bank and because the lost profits calculation is based on the receipt of cash rather than accrued earnings. This latter explanation is made to distinguish the 13% discount rate used in this model from the 21% discount rate used in Mr. Norman's earlier damages model. Using the lower discount rate allows damages to reach an amount that is virtually the same as the earlier number in Mr. Norman's discredited and disallowed report — approximately $7-$10 million. If Mr. Norman's 21% discount rate were used the amount of damages would be approximately half that amount.
The September 13, 2002 statement is inadmissible as unduly speculative. Although the statement professes to be fairly based on the company's past, it is only based on those aspects of its past that allows it to predict significant future profits.
Even if its speculative nature did not render the statement inadmissible, its methodology is nevertheless inadmissible under the standard set forth in Daubert v. Merrill Dow Pharm., 509 U.S. 579 (1993), and later case law, and pursuant to Federal Rule of Evidence 702 which reflects the reasoning of those cases. This is true for four reasons. First, Mr. Livingston is not qualified as an expert on most of the methodology employed in the statement. Second, the methodology is not reliable. In some respects it is misleading, in most respects it is unsupported by use in any other comparable setting, and in many other respects it is confusing. It is a collection of terminology and calculations developed solely for this litigation. Third, even if Mr. Livingston were qualified — which he is not — to opine on the intricacies of three month rolling averages, compound monthly growth rates, S-curves, and the like, and even if the methodology were deemed reliable, it doesn't fit the present case. This is not a case for the use of such devices in any event. Three month rolling averages may have legitimate and reliable application in areas such as stock market analysis to discern trends in data that exhibit high volatility, but not for the purpose of making predictions beyond one period. Similarly, S-curves may have some application with regard to explaining a slow down in growth rate of a non-unique business in an industry faced with a saturated market or a rash of competition, but such application is not appropriate to a young company such as LifeWise that claims to be unique and to have a vast untapped market in need of its unique loan product. Fourth, the Court finds the statement not helpful to a jury. Rather, the statement would more likely confuse and mislead the jury. If allowed, it would lead to exhaustive cross examination and exploration of many economic issues that are not pertinent to this relatively straightforward business contract dispute. In this sense, in addition to being inadmissible under Rule 702, the statement is inadmissible under Rule 403 of the Federal Rules of Evidence. Any probative value is outweighed by the danger of being misleading, confusing and unnecessarily time-consuming.
In finding the September 13, 2000 statement of damages inadmissible, the Court also finds that Mr. Livingston is not qualified as an expert to present it. He is not a trained economist and cannot legitimately educate a jury on many of the complex economic aspects of this model such as "S-curves." Therefore, the Court grants defendant E*TRADE Bank's motion in limine to exclude certain damages testimony of Mark Livingston, dated November 12, 2002.
The most compelling reason why the Court views this statement as violating New York's requirement of reasonably certain damages, is the striking contrast between LifeWise's documented past, and its predicted future. Although it is no doubt true that there are a variety of reasons why the company was so unprofitable, it nevertheless remains a fact that LifeWise sustained losses in every year of its five plus years of existence, and frequently experienced capitalization problems. And it is also plain that in 62 months, LifeWise placed 400 loans for a total for all years of $24,343,722. It is true that the amounts increased in late 2000, and early 2001, but it is also clear that the predominant reason for these relatively significant increases was a single borrower, Keller, whose draws totaled $3,358,000. Similarly, the major reason for the limited success the company had in 1998 was attributable to another single borrower, Tubis-Hendricks, whose draws were $3,150,000. Subtracting these two loans from the total leaves a 62-month total of only $17,835,721.
Far from anything remotely close to a steady 4.58% monthly compounded growth rate, or even 3.6%, the overall monthly average increase during the actual life of the company was only $18,233. Indeed, in LifeWise's actual history, 28 months show a decline in originations and 33 months show an increase.
Through the use of this September 13 methodology, Mr. Livingston predicts future growth that anticipates not a single future set back, only uninterrupted future growth that experiences no future mistakes such as the Madison Avenue campaign, a lack of sufficient capital, or any other impediments to healthy growth. It takes a small number of months at the end of the company's operations and uses them as a springboard to significant success ever after. In doing so, rather than fairly tying its estimates for the future to its past results, it picks only a small amount of good indicators, and uses them to predict unprecedented future accomplishments. This it cannot do under New York law. See Schonfeld v. Hilliard, 62 F. Supp.2d 1062, 1071 (S.D.N.Y. 1998); Kenford County v. County of Erie, 537 N.E.2d 176 (N.Y. 1989). It is also flatly contrary to the Court's Order of August 16, 2002.
Turning to Rule 702 of the Federal Rules of Evidence, the Daubert line of cases, and the unreliability of the September 13th statement, it is significant to the Court that not even the statement itself, or the witness through whom it is offered, professes to employ a proven or accepted method for predicting future profits of a relatively new company. Mr. Livingston is not limiting himself to his expertise as a business person. Rather, he enters into the realm of rolling averages, S-curves, and compound growth rates that appear to be an amalgam of logic, hope, and economic jargon. And if that was the extent of it, perhaps it wouldn't be so objectionable. But it pretends to be expertise, delivered by an expert. And in the final analysis, the methodology is not even internally consistent. The rolling averages, the monthly compounded growth rates, the S-curves, all in the end give way to what amounts to guesswork, starting with a growth rate of 3.5% in year 2001, an arbitrary drop to 3.0% the next year, and so on, to .05% in the final year. All of these manipulations are necessary because such arbitrary reductions still yield a final year (2005) with an astronomical $46 million in loans, a number twice as high in one year as the company actually accomplished in its five-plus years of existence. The entire process is remarkably result-oriented, producing $7 to $10 million dollars in present-day dollar damages. This result-oriented approach is especially apparent in its unjustified use of a 13% discount rate, a full 8% less than the rate employed by Mr. Norman in his earlier model. Plaintiffs' attempt to justify the difference because of the distinction between cash and accrued earnings is not only not supported by credible evidence, or logic, but such a distinction would eviscerate this Court's and the magistrate judge's earlier rulings regarding Mr. Norman's model, rulings which found accrued earnings as an unacceptable basis for estimating damages in this case. If all that was needed to achieve the same result as the earlier discredited model, a model that was inappropriately based on accrued earnings, was to change the discount rate when the new model is based on the actual receipt of cash, then the Court's earlier ruling is a nullity. Defendant's position regarding the proper discount rate is well taken. ( See E*TRADE Bank's memorandum in support of defendant's motion for summary judgment relating to lost damages, at 24-26.)
Rule 702, consistent with Daubert and Kumbo Tire, suggests a number of factors to consider when evaluating the analysis of expert testimony. These factors include (1) whether an expert's technique or theory can be (and has been) tested, (2) whether it has been subjected to peer review and publication, (3) whether, in respect to a particular technique, there is a high "known or potential rate of error," (4) whether there are "standards controlling the technique's operation," and whether the theory or technique enjoys "general acceptance" within a "relevant scientific community." Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 at 592-594. Virtually none of these are met here.
The Court in Kumho held that these factors might also be applicable in assessing the reliability of non-scientific expert testimony, depending on the particular circumstances of the particular case at issue." Kumbo Tire Co. v. Carmichael, 526 U.S. 137, 150 (1999). Moreover, courts both before and after Daubert have found other factors relevant in determining whether expert testimony is sufficiently reliable to be considered by the trier of fact. These factors include whether the expert has unjustifiably extrapolated from an accepted premise to an unfounded conclusion, see General Elec. Co. v. Joiner, 522 U.S. 136, 146 (1997) and whether the expert has adequately accounted for obvious alternative explanations. See Ambrosini v. Labarrague, 101 F.3d 129, 139-40 (D.C. Cir. 1996).
Finally, as stated previously, it is the Court's view that the September 13 statement, as with its predecessors submitted by plaintiffs, would not be helpful to the jury. Experts are designed to assist juries. This evidence obfuscates rather than illuminates. The operating history of LifeWise, the nature of its business, its contract with E*TRADE Bank, and the general financial considerations necessary to an understanding of, and the ability to reasonably assess, damages in this case are not especially complicated. A jury can see what went on m the past, assess the reasons for success, the reasons for failure, and the relative market acceptance of the product. From these factors a reasonable effort could have been undertaken to predict future business and the likely profits or losses. It may have been helpful for an expert to point to some accepted method of predicting future profits in a situation like this, if such a method exists. Apparently, it does not.
The Court would be more inclined to allow Mr. Livingston's testimony — stating even an obviously exaggerated estimate of LifeWise's future loan originations — if it was delivered as a straightforward opinion of a businessman unadorned with the trappings, complications and internal inconsistencies of the September 13 statement. But no such approach was taken. In the past several months the Court, through comments of both the magistrate judge and the district judge, has suggested possible approaches that could pass the necessary evidentiary hurdles. At the Daubert hearing on Mr. Norman's first report, Magistrate Judge Boyce stated:
Suppose the Judge were to say, all right, I will accept the expert opinion of at least a consistent projection, that is, that it is constant, a constant return at that level for the projected 2001 and approximately 16,000 [$16,527,920] for each of the rest of the four years.
At a hearing as recently as October 2002, this Court stated:
I can do the math in my own head. In looking simply at the amount of loan originations that occurred in the year 2000 or even the first three months of 2001, and give the plaintiffs the benefit of even the annualized number that they set forth for 2001, and give them that amount with a slight increase through 2002 through 2005 and I don't get to $167 million. I don't without some fairly significant annual increases, which I am not sure can be justified in light of this company's previous history.
These comments and suggestions and others were noted in defendant's reply memorandum. The following chart indicates the various outcomes from different possible approaches.
Projected Originations ___________________________________________________________________
A. LifeWise's September 13, 2002 $167,045,094 Damages Model
B. Assuming LifeWise achieves its $ 22,380,519 past average originations (2/96-3/01) through 2005
C. Magistrate Judge Boyce's suggestion $ 78,507,620
D. Assuming LifeWise's origination $ 95,000,418 grows $18,288 per month through 2005 _______________________________________________________________________
Apparently, however, such simple methods, which are grounded in a less-speculative connection to LifeWise's past, were unacceptable to plaintiffs. For one thing they would yield far less than the $7 to $10 million in damages LifeWise has consistently sought, regardless of the model it employs.
Although it is difficult to state with specificity what these different projected loan origination numbers would mean in final damages numbers, it is possible to make rough approximations. Using a 13% discount rate, the approach labeled B would result in a loss of approximately $4,500,000. Similarly, approach C would generate a loss of approximately $40,000, and approach D would produce lost profits damages of approximately $1,900,000. If a 21% discount rate were used, the final damages numbers would be even less. Applying a 21% discount rate to A would yield approximately $4,500,000, approximately half of the amount declared in plaintiffs' September 13, 2002 Model.
Because of the extensive history of this issue before the Court, the consistent refusal of the plaintiffs to be more realistic, responsible, and straightforward in their damages presentation, and the clear inadmissibility of the September 13, 2002 statement, the Court has no choice but to grant E*TRADE Bank's Motion for Summary Judgment Relating to Lost Profits Damages.
IV. DEFENDANT'S MOTION FOR JUDGMENT AS A MATTER OF LAW REGARDING LIENS
Also before the Court is E*TRADE Bank's motion for judgment as a matter of law on the basis that LifeWise violated § 9.8(b) of the Funding Agreement by allowing a lien to be placed upon Trust Property. Section 9.8(b) of the Funding Agreement states:
To be precise, E*TRADE Bank's motion is a "motion for a directed verdict." However, the 1991 Amendment to Federal Rule of Civil Procedure 50 abandoned the term "directed verdict." Pursuant to the rule, therefore, the Court will treat the motion as a motion for judgment as a matter of law. FED. R. CIV. P. 50(a), 1991 advisory committee's note.
Except for the conveyances under the Indenture, LifeWise will not sell, pledge, assign or transfer to any other Person, or grant, create, incur, assume or suffer to exist any Lien on the Trust Property or any interest therein (other than Permitted Liens), and LifeWise shall defend the right, title, and interest of the Company and the Trustee in, to and under the Trust Assets against all claims of third parties claiming through or under LifeWise; provided however, that LifeWise's obligations under this Section 9.8 shall terminate upon the repayment in full of the Notes and the expiration of any applicable preference period.
It is undisputed that LifeWise's obligation to comply with § 9.8(b) was a condition precedent to E*TRADE Bank's obligation to advance funds to LifeWise. Therefore, E*TRADE Bank argues that LifeWise's noncompliance with § 9.8(b) violated a condition precedent of the Funding Agreement and as a result E*TRADE Bank's obligation to fund never arose. For the reasons stated below the Court agrees.
A. BACKGROUND
On April 1, 1999, LifeWise Family executed a Security Agreement in favor of Benjamin Partners Incorporated. The Security Agreement is governed by Utah law. In that Agreement, LifeWise Family pledged notes and the life insurance policies held by Bankers Trust to Benjamin Partners in exchange for a $5 million line of credit. Section 2 of the Security Agreement granted Benjamin Partners a security interest in:
On or about December 31, 2000, LifeWise Family executed a Correction to the Senior Subordinated Note Purchase Agreement. That document stated that it was always the intent that Combined Partnership act as the secured party in the Security Agreement. In essence, Combined Partnership replaced Benjamin Partners as the secured party in the security agreement. Because, however, the agreement was originally made with Benjamin Partners, and to avoid confusion, both entities are collectively referred to herein as Benjamin Partners.
The Security Agreement and the Loan Sale Agreement contain choice of law provisions for Utah and New York, respectively. Accordingly, the Court will apply Utah law to the interpretation of the Security Agreement and New York law to the interpretation of the Loan Sale Agreement.
[A]ll assets of the Debtor (the "Collateral"), whether now owned or existing or hereafter acquired, owned, existing or arising (whether acquired by contract or operation of law) and wherever located . . . including, without limitation . . .
(a) All of Debtor's right, title and interest in any and all Life Insurance Policies . . .
The Security Agreement expressly delineates two ways in which Benjamin Partners' lien on the policies may be released. First, both § 2 and § 7 of the Security Agreement specify that Benjamin Partners' lien is eliminated on "all assets" of LifeWise Family if "the Secured Obligations have been paid in full." Second, § 11 of the Security Agreement — which is entitled "Release" — explains that the lien is terminated if the "Secured Parties . . . release and/or surrender all or any of the Collateral." It is undisputed that none of these conditions were met prior to the time the life insurance policies were transferred to the Bankers Trust account where they became Trust Property. Therefore, if Benjamin Partners' liens were released, they must have been released in some other way.
LifeWise, therefore, argues that — notwithstanding §§ 2, 7 and 11's express language — Benjamin Partners' lien was released pursuant to § 5.6 of the Security Agreement. Section 5.6 of the Security Agreement states:
Debtor will not sell, assign, transfer or otherwise dispose of any material portion of the Account or Contracts, which constitute a part of the Collateral, or attempt, offer or contract to do so except, so long as no Event of Default has occurred and is continuing, for the disposition of such Accounts and Contracts in the ordinary course of business to third party purchasers without recourse to the Debtor.
The Security Agreement defines "Contracts" to include "specifically, the Life Insurance Policies." Security Agreement, § 1.5.
Subsequent to the formation of the Security Agreement with Benjamin Partners, the life insurance policies were transferred to LifeWise Master and thereafter placed in the trust account of Bankers Trust as Trust Property pursuant to the Funding Agreement with E*TRADE Bank. The transfer of the life insurance policies from LifeWise Family to LifeWise Master was governed by the Loan Sale Agreement. Section 2(i) of that Agreement provides:
LifeWise Master was formed as a "special-purpose" entity to act as a bankruptcy remote subsidiary. See Loan Sale Agreement, at 1. If the subsidiary is set up in a way that prevents a court from consolidating it with the parent, the bankruptcy of the parent does not affect the subsidiary. See generally Standard and Poor's Corporation, Structured Finance Criteria at 23, 69-70, and 112-14 (1988).
Except as specifically provided for herein, the sale and the purchase of the Loans under this Agreement is without recourse to any Seller; provided that the Seller shall be liable to the Purchaser for all representations, warranties, covenants and indemnities made by it under this Agreement.
The Loan Sale Agreement then lists seventeen circumstances that, if breached, would allow LifeWise Master to seek relief from LifeWise Family. Moreover, § 5(h) of the Loan Sale Agreement reiterates the continuing nature of the representations and warranties. It states,
It is understood and agreed that the representations and warranties set forth in this Section 5 shall survive the sale or contribution of a Sold Loan to the Purchaser and any assignment of such Sold Loan by the Purchaser to any subsequent assignee and shall continue so long as any such Sold Loan shall remain outstanding.
E*TRADE Bank did not discover the alleged improper liens on the life insurance policies until March 7, 2001. The discovery was made in a post-litigation deposition of Syver Noderhaug, LifeWise's CFO. Three weeks later, on April 1, 2002, LifeWise and Combined Partners executed a document entitled "Acknowledgment and Confirmation." ("Confirmation Document"). The Confirmation Document acknowledged that "LifeWise granted Combined Partnership a security interest in LifeWise's right under certain Life Insurance Policies." The document stated further that "Combined Partnership wishes to disclaim any and all right, title or interest in the Life Insurance Security Interest, if any such interest ever existed. . . ." Because this document was not executed and therefore did not become effective until April 1, 2001, it did not affect E*TRADE Bank's obligation to fund LifeWise in the spring of 2000, or at any time prior to LifeWise's suit.
At trial, LifeWise's attorney, Glenn Arden, testified about the Security Agreement and its implications to the life insurance policies. Mr. Arden, the partner in charge of the securitization practice at the law firm of Jones, Day, Reavis Pogue, testified that § 5.6 of the Security Agreement released Benjamin Partners' lien.
After LifeWise rested its case at trial, E*TRADE Bank moved for judgment as a matter of law arguing that it was undisputed that LifeWise had violated a condition precedent of the Funding Agreement. E*TRADE Bank argues that the Benjamin Partners' Security Agreement authorized LifeWise Family to sell its life insurance policies in a certain manner. Because the required manner was not followed, E*TRADE Bank argues that the sale was completed without authorization of Benjamin Partners and, therefore, that the lien was never released from the life insurance policies. Thus, they argue that once the policies were transferred to the Bankers Trust account as Trust Property, those policies were encumbered with a lien in violation of § 9.8(b) of the Funding Agreement. Because 9.8(b) is a condition precedent to E*TRADE Bank's obligation to fund, E*TRADE Bank asserts that its obligation to fund never arose.
Rule 50 of the Federal Rules of Civil Procedure authorizes a court to "perform its duty to enter judgment as a matter of law at any time during the trial, as soon as it is apparent that either party is unable to carry a burden of proof that is essential to that party's case." FED. R. CIV. P. 50, 1991 advisory committee's note.
LifeWise admits that it granted a lien (i.e. a security interest) in the life insurance policies. However, LifeWise argues that § 5.6 released Benjamin Partners' lien and, therefore, that the life insurance policies were never placed into the Bankers Trust account with any encumbering lien attached. Therefore, they argue E*TRADE Bank's obligation to fund never ceased.
"Lien" is defined in the Funding Agreement to include, "any interest in the property securing an obligation owed to . . . any Person other than the owner of the property . . . whether or not such interest shall be recorded or perfected and whether or not such interest shall be contingent upon the occurrence of some future event or events . . . and including the lien, privilege, security interest or other encumbrance . . ." Funding Agreement, § 12.
This Court must decide as a matter of law whether § 5.6 released the Benjamin Partners' security interest in the policies before they were transferred to Bankers Trust as Trust Property. If Benjamin Partners' security interest was not released, the Court must determine if the violation of that condition precedent terminated E*TRADE Bank's obligation to advance funds pursuant to the Funding Agreement.
B. DISCUSSION 1. Judgment as a Matter of Law
Federal Rule of Civil Procedure 50 governs motions for judgment as a matter of law in jury trials. Such a motion may be granted if "a party has been fully heard on an issue and there is no legally sufficient evidentiary basis for a reasonable jury to find for that party on that issue." FED. R. CIV. P. 50(a)(1). Thus, Rule 50 allows the trial court to remove issues from the jury's consideration "when the facts are sufficiently clear that the law requires a particular result." Weisgram v. Marley Co., 528 U.S. 440, 447 (2000) (quoting 9A C. WRIGHT A. MILLER, FEDERAL PRACTICE AND PROCEDURE § 2521, at 240 (2d ed. 1995)). Before this Court can decide E*TRADE Bank's motion, however, the Court must find that the issues within the motion are issues of law and not issues of fact to be decided by a jury.
It is undisputed that LifeWise granted a lien to Benjamin Partners in exchange for a $5 million line of credit. It is further undisputed that these life insurance policies were placed into the trust account of Bankers Trust as Trust Property. The Court must determine if § 5.6 of the Security Agreement did indeed release Benjamin Partners' security interest before the policies were transferred to the trust as collateral for E*TRADE Bank. Such a determination can only be made as a matter of law.
In Utah, "interpretation of a written contract is ordinarily a question of law." Jones v. Hinkle, 611 P.2d 733, 735 (Utah 1980). Although ambiguous contracts provide an exception to this rule, the Court finds that the applicable contract provisions in this case are not ambiguous. See Peterson v. The Sunrider Corporation, 48 P.3d 918, 924 (Utah 2002) (quoting Interwest Constr. v. Palmer, 923 P.2d 1350, 1358 (Utah 1996)) (holding that a determination as to whether a contract is ambiguous is also question of law). Neither party has argued that the contract provisions applicable to this issue are ambiguous. Instead, the parties dispute only the legal implication of those provisions. The Court also finds the applicable contract provisions to be unequivocal and clear. As a result, the issues presented within this motion are questions of law for the Court.
LifeWise's brief in opposition to this motion attempts to argue that the issues within this motion may well be for a jury. However, such arguments are directly opposed to statements it made earlier to this Court. In response to the Court's inquiry, counsel for LifeWise responded that the interpretation of § 5.6 is "largely legal" with the exception of LifeWise's waiver and other defenses. T.Tr. at 2184:17-2185:3. The following day LifeWise's counsel again agreed that this issue is a question of law: "[I]f this jury instruction is inconsequential in the sense that you are going to be deciding this issue as a matter of law, and I think I concur with you that it probably is a question of legal construction, then there's no reason to give this to the jury." Jury Instruction Conference Transcript at 46:3-9.
This conclusion is further supported by the fact the neither party presented any factual evidence relating to this issue at trial. LifeWise's evidence before the jury was limited to Mr. Arden's opinion of the legal effects of § 5.6 of the Security Agreement; LifeWise's evidence was limited to evidence of pure legal construction. Furthermore, there was no effort by LifeWise to develop any fact from any witness that could conceivably put this issue in the realm of a jury question. Therefore, the Court finds that this issue is a question of law.
2. Did § 5.6 of the Security Agreement Release Benjamin Partners' Lien on the Life Insurance Policies?
E*TRADE Bank argues that LifeWise Family allowed its life insurance policies to be transferred to LifeWise Master and thereafter into the Bankers Trust account with an attached lien. LifeWise argues that, while a lien was created on LifeWise Family's property, that lien was terminated pursuant to § 5.6 of the Security Agreement before it reached LifeWise Master. Section 5.6 of the Agreement states:
Debtor will not sell, assign, transfer or otherwise dispose of any material portion of the Account or Contracts, which constitute a part of the Collateral, or attempt, offer or contract to do so except, so long as no Event of Default has occurred and is continuing, for the disposition of such Accounts and Contracts in the ordinary course of business to third party purchasers without recourse to the Debtor.
Pursuant to the plain language of this provision, it is clear that § 5.6 prohibits LifeWise Family from transferring the life insurance policies to any party — including LifeWise Master — unless that transfer is completed (1) "in the ordinary course of business," (2) "to third party purchasers" and (3) "without recourse to [LifeWise Family]." Standing alone, this language — while authorizing the disposition of the life insurance policies — does not contain any language that would release the Benjamin Partners' lien. However, when read in conjunction then with § 9-306(2) of the 1999 Utah Uniform Commercial Code it becomes apparent why LifeWise argues that § 5.6 does indeed eliminate the lien. Section 9-306(2) of that code states:
[A] security interest continues in collateral notwithstanding sale, exchange, or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identifiable proceeds including collections by the debtor.
UTAH CODE ANN. § 70A-9-306(2) (1999).
Reading the two sections together then leads to the following conclusion: if LifeWise Family sold the disputed life insurance policies to LifeWise Master in accordance with § 5.6 then Benjamin Partners' lien was released at the time of the transfer of the life insurance policies from LifeWise Family to LifeWise Master because the transfer was "authorized by the secured party in the security agreement." UTAH CODE ANN. § 70A-9-306(2). However, the opposite conclusion also applies: if LifeWise Family failed to transfer the life insurance policies pursuant to § 5.6, the transfer to LifeWise Master was not authorized and no release occurred.
It appears that the first two requirements of § 5.6 are met. The Loan Sale Agreement explains that LifeWise Master "has been formed . . . for the sole purpose of acquiring certain fixed-rate, non-amortizing loans secured by related life insurance policies." (Loan Sale Agreement, at 1.) Furthermore, it states that LifeWise Family "intend[s] to sell or contribute loans" to LifeWise Master. Id. Therefore, LifeWise Family arguably sold its loans "in the ordinary course of business" and to a "third party purchaser." However, the Court finds that the third requirement — the requirement that LifeWise Master not have recourse against LifeWise Family — was not met.
Section 2(i) of the Loan Sale Agreement states that the sale of the life insurance policies from LifeWise Family to LifeWise Master was not effectuated without recourse but instead explains clearly and unambiguously that LifeWise Master retained recourse against LifeWise Family. Section 2(i) states:
Except as specifically provided for herein, the sale and the purchase of the Loans under this Agreement is without recourse to any Seller; provided that the Seller shall be liable to the Purchaser for all representations, warranties, covenants and indemnities made by it under this Agreement.
(emphasis added). Following § 2(i) are a list of seventeen circumstances in which LifeWise Master had recourse against LifeWise Family.
The plain language of § 2(i) clearly and unambiguously explains that the purchase of the loans by the "Purchaser" — LifeWise Master — is without recourse "except as specifically provided for herein." Later, the provision lists four categories of claims by which the "Seller" — LifeWise Family — "shall be liable to the Purchaser." Thus, the Court finds that the transfer of the life insurance policies was not effected without recourse. Were that the case, the provision would have stated simply that "the sale and the purchase of the Loans under this Agreement is without recourse to any Seller." Instead, the provision includes two clauses — one before that language and one after — that qualify the general statement that the transfer is effectuated without recourse. The only way in which the Court could find that the transfer was completed without recourse would be to ignore the first and last clauses of the provision. This it cannot do; instead the Court must give full effect to the section as it is written.
LifeWise attempts to subvert this relatively clear conclusion by arguing that representations and warranties do not provide a party with "recourse" because representations and warranties do not "create a continuing guarantee of the value of the sold loans." (Defendant's Brief at 3.) If claims for relief pursuant to representations and warranties, covenants and indemnities constitute "recourse," then, LifeWise argues, any claim on any contract would also fall under the expanded definition of "recourse."
Black's Law Dictionary 1280 (7th ed. 1999) defines "recourse" as, "the right to repayment of a loan from the borrower's personal assets, not just from the collateral that secured the loan." Similarly, a "recourse loan" is "a loan that allows the lender if the borrower defaults, not only to attach the collateral but also to seek judgment against the borrower's (or guarantor's) personal assets." Id. at 948; see Saviano v. C.I.R., 765 F.2d 643, 645 (7th Cir. 1985) (contract providing that money was lent to appellant on a nonrecourse basis means that appellee was not personally liable for its repayment). In contrast, nonrecourse "simply means that the lienor may look only to the property subject to his lien to satisfy his debt and cannot look to the debtor personally for payment." In Re Dan Hixson Chevrolet Co., 20 B.R. 108, 111 (Bankr. N.D. Tex. 1982).
It appears that representations and warranties generally provide recourse to the nonbreaching party. This is true because representations and warranties allow the nonbreaching party to seek repayment not just from any existing collateral but also from the borrower's personal assets.
The Court readily acknowledges, however, that there are an "infinite number of points which are situated along the line which runs from 'full recourse' to 'no recourse.'" 1 GRANT GILMORE, SECURITY INTERESTS IN PERSONAL PROPERTY § 44.4 (1965). Therefore, there may not be majority rule on this issue. As the Court notes, below, however, this case is one which lies closer to the "full recourse" side of the spectrum.
Regardless of the general rule, however, it is abundantly clear in this case that the Loan Sale Agreement provides LifeWise Master with recourse against LifeWise Family. Section 2(i) unambiguously gives LifeWise Master the ability to seek relief from LifeWise Family personally for any failure to meet one the of the seventeen representations, warranties, and covenants specified in that contract. Section 5(h) of the Loan Sale Agreement reiterates the parties' understanding that the "representations and warranties . . . shall survive the sale or contribution of a Sold Loan to the Purchaser and any assignment of such Sold Loan."
Directly on point is the warranty made by LifeWise Family to LifeWise Master in § 5(i) of the Loan Sale Agreement. That provision requires that a breach of a representation or warranty "which materially and adversely affects the value of a Sold Loan" could obligate LifeWise Family to "immediately repurchase . . . [a] Sold Loan." (Loan Sale Agreement, § 5(i).) This type of obligation has been referred to as "credit recourse." See Thomas E. Plank, The True Sale of Loans and the Role of Recourse, 14 GEO. MASON L. REV. 287, 289 (1992) (defining credit recourse as a situation in which "the seller agrees to repurchase any of the underlying loans that go into default or otherwise agrees to compensate the buyer for losses on defaulting loans"). More importantly, the provision goes on to state that:
If, at the time of the discovery of such breach or failure to deliver, a loss has occurred with respect to such Sold Loan, then the Seller shall pay to the Purchaser or any subsequent assignee an amount equal to the amount, if any, by which the Repurchase Price exceeds the net proceeds from such Sold Loan.
Therefore, the Loan Sale Agreement specifically states that in case of a breach of a representation that materially affects the value of the "Sold Loan" — the collateral — LifeWise Master has the right to seek "repayment of a loan from the borrower's personal assets," by requiring LifeWise Family to pay the difference between the "Repurchase Price" and the "proceeds" from sale of the "Loan." This one representation alone indisputably shows that LifeWise Master had recourse against LifeWise Family. LifeWise Master not only had the right to the value of the collateral but it also had the right to seek repayment against LifeWise Family's personal assets.
Furthermore, if this Court were to adopt LifeWise's argument, both the "except for" and the "provided for" clauses within § 2(i) would be rendered superfluous and unnecessary. This is true because a party may always seek relief against a breaching party's assets pursuant to a violation of representation or a warranty. Thus, were the Court to interpret the "except for" and the "provided for" clauses as not providing "recourse" in this case, they would convey no new rights to LifeWise Master than it was already entitled to as a matter of contract law. However, New York law disfavors contract interpretations that render provisions of a contract superfluous. Int'l Multifoods Corp. v. Commercial Union Ins. Co., 309 F.3d 76, 86 (2d Cir. 2002); See Scholastic, Inc. v. Harris, 259 F.3d 73, 83 (2d Cir. 2001) (quoting Sayers v. Rochester Tel. Corp. Supplemental Mgmt. Pension Plan, 7 F.3d 1091, 1094-95 (2d Cir. 1993)) ("In determining whether a contract is ambiguous, a court must look at "the entire integrated agreement," to "safeguard against adopting an interpretation that would render any individual provision superfluous."); Galli v. Metz, 973 F.2d 145, 149 (2d Cir. 1992) (quoting Garza v. Marine Transport Lines, Inc., 861 F.2d 23, 27 (2d Cir. 1988)) ("Under New York law an interpretation of a contract that has 'the effect of rendering at least one clause superfluous or meaningless . . . is not preferred and will be avoided if possible.'"); Lawyers' Fund for Client Protection of State of N.Y v. Bank Leumi Trust Co., 727 N.E.2d 563, 566-67 (N.Y. 2000) ("Bank Leumi's interpretation would render the second paragraph superfluous, a view unsupportable under standard principles of contract interpretation."). The Court must assume, therefore, that this language was not inserted to act as an exposition of general corporate law but rather to augment LifeWise Master's power to seek relief in case of a breach of the Loan Sale Agreement. In summary, it is clear that the language provides for the transfer of the life insurance policies to be without recourse except for those statements contained in the representations, warranties, covenants and indemnities.
The fact that both the Loan Sale Agreement and the Security Agreement were both drafted by LifeWise legal counsel at Jones, Day makes LifeWise's argument even more curious. Surely, Jones, Day was well aware — as the drafter of both the Loan Sale Agreement and the Security Agreement — that the Security Agreement required a disposition of the policies to be without recourse in order for it to qualify as an authorized sale per the Uniform Commercial Code and Utah law. Even assuming they were not aware of the language — a large assumption indeed — the fact that the Security Agreement was written with the language "without recourse" clearly shows that Jones, Day was capable of drafting the Loan Sale Agreement to be without recourse as well. Therefore, the Court must assume that Jones, Day intended for the sale of the policies from LifeWise Family to LifeWise Master to be an unauthorized sale.
It is also worthy of note that LifeWise had previously and unambiguously obtained a release from Bank One on its security interest in the life insurance policies. In a letter from LifeWise Family to Bank One, dated January 7, 1999 — over two years before E*TRADE Bank learned about the improper liens — LifeWise stated:
Pursuant to Section 2.7 of the Agreement, the Borrower hereby requests the release of that portion of the Collateral identified on Schedule 1 hereto (the "Released Collateral"), effective as of January 12, 1999, or such later date as notified to you. The Borrower requests such release in connection with the Asset Securitization to be effected by LifeWise Family Financial Security, Inc.
Therefore, it is clear that LifeWise could have executed the necessary documents to clearly and unambiguously release the Benjamin Partners' lien, just as it had done with regard to Bank One's security interest, before the life insurance policies were sold to LifeWise Master.
Based on all the facts and the applicable law, the Court finds that there is no legally sufficient evidentiary basis to find that LifeWise transferred the life insurance policies without recourse. Therefore, the Court finds as a matter of law that Benjamin Partners' lien was not released by § 5.6 of the Security Agreement. The lien, therefore, remained on the life insurance policies when they were transferred to the Bankers Trust account as Trust Property.
Even if the Loan Sale Agreement is characterized as a "true sale" there is nothing implicit within that form of transfer that would release the lien upon transfer. Furthermore, the fact that LifeWise did not sell the life insurance policies without recourse means that § 5.6 was still not met and the lien was not released.
3. Excuse of LifeWise's Failure to Comply With An Express Condition Precedent
Based on the foregoing analysis, it is clear that LifeWise's action violated § 9.8(b) of the Funding Agreement. A condition precedent is "an act or event other than a lapse of time, which unless the condition is excused, must occur before a duty to perform a promise in the agreement arises. Oppenheimer Co. v. Oppenheim, Appel, Dixon Co., 86 N.Y.2d 685, 690 (N.Y. 1995). Conditions precedent can be expressed or implied. Express conditions are conditions that are "agreed to and imposed by the parties themselves." Id. Implied conditions are those that are imposed by the law "to do justice." Id. Furthermore, express conditions precedent must be literally performed. Id. Indeed, "no contract arises unless and until the condition occurs." Id.
In Oppenheimer, the parties entered into an agreement to sublease office space. As part of that agreement, plaintiff was required to obtain and deliver to defendant, "the Prime Landlord's written notice of confirmation," on or before a certain date. Id. at 688. However, if defendant had not received the landlord's written consent by the agreed date, the lease was deemed to be "null and void." Id. Plaintiff never delivered the landlord's written consent; instead plaintiffs attorney telephoned defendant's attorney and informed him that the landlord's consent had been secured. Defendant therefore declared the lease invalid and plaintiff sued for breach of contract arguing that they had substantially complied with the condition precedent.
A jury found for plaintiff and awarded $1.2 million. The trial court, the Supreme Court of New York, however, granted a motion for judgment notwithstanding the verdict ruling that "the doctrine of substantial performance" had no application to the dispute because the agreement was free from ambiguity and that the plaintiff had simply failed to honor that agreement. The Appellate Division reversed and reinstated the jury verdict, reasoning that the question of substantial compliance was properly submitted to the jury.
The Court of Appeals of New York, however, reversed the Appellate Division explaining that the doctrine of substantial compliance does not apply to a violation of an express condition precedent. Because the language in the agreement explicitly set forth plaintiffs obligation to present the landlord's consent in writing the plaintiffs failure to comply was a breach as a matter of law and a contractual relationship never arose. The court also held that the nonoccurrence of a condition could be excused by waiver, breach or forfeiture. However, the court found that none of those principles applied to the case before it.
Similarly to Oppenheimer, it is undisputed in this case that LifeWise's failure to comply with § 9.8(b) was a violation of an express condition precedent. Section 4 of the Funding Agreement explains that E*TRADE Bank's obligation to make advances is "subject to the satisfaction, prior to or concurrently with the making of such Advances, of the following conditions:"
Section 4.1 [LifeWise Master] and LifeWise [Family] shall each have performed all of their respective obligations to be performed hereunder and in the other Program Documents prior to or on such Funding Date.
Funding Agreement, § § 4, 4.1.
This language unambiguously shows the parties intent to make each of LifeWise's obligations under the contract conditions precedent to E*TRADE Bank's obligation to fund. See Jacob Youngs v. Kent, 230 N.Y. 239, 243 (N.Y. 1921) (explaining that "parties are free by apt and certain words to effectuate a purpose that performance of every term shall be a condition of recovery"). It is undisputed that § 9.8(b) was one of those obligations. The Court finds, therefore, as a matter of law that LifeWise violated a condition precedent of the Funding Agreement. As a result, E*TRADE Bank had no obligation to advance funds to LifeWise while LifeWise was in violation of § 9.8(b).
This is not to say, however, that an express condition precedent can never be excused. As explained in Oppenheimer, New York law may provide relief to a party who has failed to comply with a condition precedent in cases of "waiver, breach or forfeiture." Id. at 691. Seizing on this language, LifeWise argues that their breach should be excused, first because to dissolve E*TRADE Bank's obligation to fund in this case would constitute "a disproportionate forfeiture" and second, because E*TRADE Bank waived its right to strictly enforce § 9.8(b). The Court will now address each of these issues in turn.
A. Disproportionate Forfeiture
LifeWise argues that its breach should be excused because to eliminate E*TRADE Bank's obligation to fund would cause "disproportionate forfeiture." In support of its proposition, LifeWise cites § 229 of the Restatement, Second, of Contracts. It states:
To the extent that the non-occurrence of a condition would cause disproportionate forfeiture, a court may excuse the non-occurrence of that condition unless its occurrence was a material part of the agreed exchange.
Consistent with LifeWise's argument, New York courts have adopted the reasoning of § 229 under the label of "forfeiture." Under this doctrine, the "nonperformance of a nonmaterial condition precedent by one party does not excuse performance of a material contractual obligation by another party if it would result in 'disproportionate forfeiture.'" Freedom Chemical v. BC Sugar Refinery, Ltd., 1998 WL 289736, *3 (S.D.N.Y 1998); RESTATEMENT (SECOND) OF CONTRACTS § 237, cmt. d. Therefore, this Court must decide whether E*TRADE Bank's obligation to fund should be excused as a result of LifeWise's failure to comply with § 9.8 or if such a result would be so inequitable as to compel this Court to "intervene to excuse the nonoccurrence of [the] condition precedent." Oppenheimer Co. v. Oppenheim, Appel, Dixon Co., 86 N.Y.2d 685, 692 (1995).
Conspicuously placed in each of the above formulations of the doctrine of "forfeiture" is the requirement that the unfulfilled condition not be a material part of the parties' agreement. If the non-occurrence of the condition at issue is material to the parties' contract, "forfeiture" may not be used to excuse the nonperformance of that condition. If that were not the case, contracts would lose their efficaciousness and parties would be relieved of the consequences of their bargain. See Restatement (Second) of Contracts § 227, cmt. b (explaining that where the language is clear, "[t]he policy favoring freedom of contract requires that, within broad limits, the agreement of the parties should be honored even though forfeiture results").
Applying these principles to this case, it is clear that New York law does not permit this Court to find that LifeWise's breach is one that should be excused as a "disproportionate forfeiture." This is true because LifeWise's covenant to keep the life insurance policies free from any lien or any other interest was without question a "material part of the agreed exchange." See Royal Bank of Canada v. Beneficial Finance Leasing, 1992 WL 167339, *8 (S.D.N.Y 1992).
By its very nature, an asset-backed securitization is centered around the lender's ability to access the value of the collateral in case of a default. In this case, the life insurance policies constituted E*TRADE Bank's primary, if not sole, method of repayment in case LifeWise Master defaulted on its payments to E*TRADE Bank. Thus, the violation of § 9.8(b) — by allowing a third party to take an interest in the life insurance policies — went to the very heart of the parties' financing arrangement.
To hold that the violation of § 9.8(b) was not material to the parties' agreement would "materially change the parties' express written allocation of risks." Freedom Chemical Co. v. BC Sugar Refinery, Ltd., 1998 WL 289736, *4 (S.D.N.Y. 1998). E*TRADE Bank and LifeWise — both sophisticated parties with sophisticated counsel — settled on the terms and details of the Funding Agreement after substantial negotiations. Those negotiations resulted in a contract that distributed the risk between both parties. As is common in virtually all lending arrangements, LifeWise, the borrower, receives money and agrees to repay it at some future date. In return, the borrower transfers to the lender the property or an interest in property with two conditions: (1) if the borrower does not repay the money as agreed, the lender may sell the property and use the proceeds of the sale to satisfy the borrower's repayment obligation and (2) if the borrower does repay the money borrowed, then the borrower gets her property back and the lender must relinquish all interest in it.
LifeWise assumed the risk that it would be financially feasible to repay E*TRADE Bank at the agreed upon interest rate or they would lose their collateral — the life insurance policies. On the other hand, E*TRADE Bank was willing to assume the risk that LifeWise could not repay the money lent to it by E*TRADE Bank, but only on the condition that it, and only it, had a security interest in the life insurance policies. Accordingly, using an asset-backed financing structure, the parties agreed that the life insurance policies would be placed in a trust. This arrangement reduced E*TRADE Bank's risk by ensuring that it would receive at least a portion of its money back through the value of that collateral in case of default by LifeWise. However, if this Court were to now find that the preservation of the value of the life insurance policies in Trust Property is not a material part of the parties' agreement, the Court would jeopardize and possibly nullify E*TRADE Bank's ability to seek repayment for its loans and thereby shift a substantial amount of the risk back to E*TRADE Bank. In that case, the Court would rewrite the contract despite the parties' unambiguous and clearly defined intentions as set out in the Funding Agreement. See W.W.W. Assocs., Inc. v. Giancontieri, 566 N.E.2d 639, 643 (N.Y. 1990) ("By ignoring the plain language of the contract, plaintiff effectively rewrites the bargain that was struck.").
Furthermore, LifeWise's failure to prevent a lien from being placed on Trust Property is a "material part of the agreed exchange," because it is intertwined with E*TRADE Bank's objectively reasonable reasons for terminating funding of LifeWise's business. In its April 28, 2000 letter, E*TRADE Bank invoked its right to delay funding advances until it became satisfied with the general business operations of LifeWise. The letter listed areas of dissatisfaction including insufficient capital, failure to meet projections and inadequate management of the business. The jury found that these reasons were "consistent with the principles of good faith and fair dealing." (Question 1, Special Verdict Form.) Therefore, E*TRADE Bank had legitimate and justifiable reasons to be concerned about the nature of LifeWise's business operations, the very essence of which centered on the value of its collateral. The fact that E*TRADE Bank did not know the details of the improper lien on Trust Property at that time does not eliminate the fact that each of the specific matters that it did know about were also directed to LifeWise's ability to repay its obligations to E*TRADE Bank and LifeWise's ability to protect the collateral in the Trust Property by paying the premiums on the life insurance policies in a timely manner. In other words, E*TRADE Bank's concerns regarding LifeWise's general business practices were motivated by the fact that such practices jeopardized E*TRADE Bank's collateral and put E*TRADE Bank at the risk of not receiving the benefit of its bargain.
Despite the almost overwhelming support for this conclusion in New York law and the facts of this case, LifeWise argues that § 229 of the Restatement requires a finding of a forfeiture in this case. In support of its argument LifeWise cites Burger King Corp. v. Family Dining, Inc., 426 F. Supp. 485 (D.C. Pa. 1977), aff'd mem., 566 F.2d 1168 (3d Cir. 1977). The comments to § 229 of the Restatement cite this case as "an excellent discussion of the principle on which this Section is based." The Court agrees that this case provides valuable instruction to properly decide a case involving § 229 of the Restatement. The Court also believes, however, that this case provides absolutely no support for LifeWise's argument but instead reinforces the Court's finding that LifeWise's breach is not a case in which the doctrine of "disproportionate forfeiture" should be applied.
In Burger King, the parties signed an agreement which obligated the franchisee to open a new Burger King restaurant each year for the next ten years. If the franchisee complied with this obligation, the franchisor covenanted not to permit any other Burger King restaurants to be built within a certain geographic area for a period of ninety years. Thus, the franchisee would be granted an "exclusive territory" in which it would be immune from competition from other Burger King restaurants in return for its obligation to develop a restaurant in that area within a certain time frame. If the franchisee failed to open a new restaurant in any of the successive years, however, the "exclusive territory" agreement would terminate and would be of no further force or effect.
By the fourth year, the franchisee had fallen behind and had failed to open its fourth restaurant. It was also apparent that a fifth restaurant would not be opened by the scheduled date. However, these delays did not prompt the franchisor to revoke the territorial agreement. Instead the parties entered into a "Modification of the Territorial Agreement." This agreement extended the time for the franchisee to open future restaurants and therefore prevented it from defaulting on its obligations. Subsequently, the franchisee missed deadlines in its eighth and ninth years. This time, however, the franchisor sought to enforce the schedule and filed suit seeking to enjoin the franchisee from using its trademarks in its ninth restaurant.
Holding that the franchisor could not properly enjoin the franchisee, the district court found that the franchisor had never communicated its new position regarding the franchisees failure to meet the development rate deadlines. More importantly, the court found that neither party considered the development rate to be critical. "If it did become critical it was not until very late in the first ten years and in such a way that, in conscience, it cannot be used to the detriment of the [franchisee]." Id. at 494. The Court ultimately held that the franchisee's breach was excused pursuant to the doctrine of forfeiture.
While LifeWise argues that "the analogy to the instant case is palpable" the Court finds that the court's reasoning in Burger King directly supports E*TRADE Bank's position, and the Court's finding, in the instant case. Most importantly, Burger King is not a case in which a material provision of the contract was excused. Instead, the court in Burger King specifically held that the restaurant timetable was "not critical" to the agreement. The court reasoned that the timetable, although explicitly mentioned in the contract, was not material because the franchisor agreed to rescind the franchisee's obligation to comply with the terms of that condition precedent by drafting a modified schedule. The franchisor's actions, therefore, clearly indicated that the franchisor did not actually intend for the timetable to be a material part of the contract.
However, as explained above, § 9.8(b) was clearly material to the parties' agreement. The language of § 4.1 along with § 9.8(b) of the Funding Agreement clearly convey the material nature of LifeWise's obligation to keep the life insurance policies free from other security interests. Furthermore, there is no evidence that E*TRADE Bank's view towards § 9.8(b) ever changed from the time the parties negotiated these provisions. E*TRADE Bank never explicitly or implicitly agreed to grant LifeWise a reprieve from its obligation to keep the Trust Property free from liens. Nor did E*TRADE Bank ever renegotiate the terms of § 9.8(b). Therefore, the Court finds that LifeWise's failure to comply with the express terms of the parties' agreement regarding the treatment of the Trust Property was material to the very structure of the parties' financing arrangement, to the parties' allocation of risk and to the Funding Agreement negotiated in good faith by both parties. Therefore, by its very definition, the recognition of § 9.8(b) as a material part of the Funding Agreement is warranted and the finding that its breach by LifeWise suspended E*TRADE Bank's obligation to provide funding for as long as the improper lien was in place does not cause a "disproportionate forfeiture."
Finally, the Court finds that even if § 9.8(b) was not material to the parties' agreement, the nonoccurrence of § 9.8(b) would not be sufficient grounds for the Court to invoke the disproportionate forfeiture doctrine in this case. This is true because the violation of § 9.8(b) by LifeWise did not permit E*TRADE Bank to nullify the Funding Agreement in its entirety; it did not allow E*TRADE Bank to stop funding forever. Instead, the Funding Agreement specifically stated that a failure by LifeWise to comply with a condition precedent was relevant only to the question whether E*TRADE Bank had the "obligation to make Advances." (Funding Agreement, § 4.) Thus, E*TRADE Bank's obligation to fund resumed the moment that LifeWise became compliant with the conditions precedent set out in the Funding Agreement. If this were not the case, if E*TRADE Bank had the ability to remove itself from the Funding Agreement based entirely on LifeWise's noncompliance with § 9.8(b), the case for application of disproportionate forfeiture would be more persuasive. However, such is not the case here.
B. Waiver
LifeWise also argues that E*TRADE Bank waived its right to object to the nonoccurrence of § 9.8(b) by failing to raise these objections after April 1999 — the month in which the liens were first granted. LifeWise premises this argument on the fact that, pursuant to the Funding Agreement, E*TRADE Bank had a right to investigate the records and activities of LifeWise Family and LifeWise Master and therefore should have become aware of the improper lien to Benjamin Partners. "A waiver is the voluntary abandonment or relinquishment of a known right." Jefpaul Garage Corp., v. Presbyterian Hosp. in City of New York, 462 N.E.2d 1176, 1177 (N.Y. 1984).
E*TRADE Bank had the right to request evidence "to establish that there are no financing statements filed against the Collateral other than with respect to Permitted Liens." (Funding Agreement, § 4.5.) LifeWise also covenanted to allow E*TRADE Bank to (1) examine and make copies of the books of LifeWise, (2) to discuss the affairs of LifeWise with LifeWise's officers and its certified public accountants, and (3) to visit and inspect the properties of LifeWise.
Plaintiffs proposed Jury Instruction No. 9 acknowledged this legal standard. It defined waiver as, "an intentional abandonment or relinquishment of a known right or advantage."
Neither party asserts that E*TRADE Bank knew about LifeWise's lien prior to this suit. Therefore, as a matter of law, E*TRADE Bank did not voluntarily relinquish its right to require LifeWise to keep the Trust Property free of liens. The fact that E*TRADE Bank had the right to inspect LifeWise's documents does not change this conclusion. The doctrine of waiver is not satisfied by a party's constructive knowledge; instead waiver requires actual knowledge. Therefore, the fact that a party could hypothetically have become aware of a particular fact is irrelevant to this legal analysis. Furthermore, the parties' agreement contains no provision that allows a matter to be deemed waived in the event that a party failed to discover the violation due to a lack of investigation. Therefore, as a matter of law, E*TRADE Bank did not waive its right to assert the existence of the liens as the non-occurrence of a condition precedent.
4. Implied Covenant of Good Faith and Fair Dealing
Finally, LifeWise attempts to argue that E*TRADE Bank is not entitled to judgment as a matter of law because E*TRADE Bank violated its duty of good faith and fair dealing. "Under New York law, every contract contains an implied duty of good faith and fair dealing." Filner v. Shapiro, 633 F.2d 139, 143 (2d Cir. 1980). Clearly, however, this argument has no merit.
Question number one of the Special Verdict form read in part, "LifeWise claims this decision was not consistent with the principles of good faith and fair dealing as explained in Instruction No. 19. E*TRADE Bank claims that its decision was consistent with the principles of good faith and fair dealing." The jury then marked the box that read "LifeWise has not proved that E*TRADE Bank breached the agreement." Because the jury reached a decision on this precise issue, both parties are bound by the jury's decision. LifeWise's argument is therefore moot.
The Court, therefore, finds as a matter of law that LifeWise violated a condition precedent of the parties' Funding Agreement. Accordingly, E*TRADE Bank's obligation to fund never arose and E*TRADE Bank is entitled to judgment as a matter of law that they were not obligated to advance funds to LifeWise.
V. OTHER PENDING MOTIONS
In addition to the foregoing, there are presently pending two other motions. The first is Defendant's Motion for Reconsideration and to Vacate Finding of Liability in which the defendants contend that the jury's verdict was inconsistent and should be set aside. The second relates to defendant's motion for summary judgment on plaintiffs' claim for reliance damages. In light of today's Opinion and Order, the Court will not issue a ruling on these motions. If, for any reason, these issues become relevant in the future they will be addressed at that time.
VI. CONCLUSION
In summary, the Court GRANTS defendant's Motion for Summary Judgment Regarding Lost Profit Damages and also GRANTS defendant's Motion for Judgment as a Matter of Law on the Basis of LifeWise's Failure to Satisfy Conditions Precedent Relating to Liens. IT IS SO ORDERED.