United States Court of Appeals,

Fifth Circuit.

No. 94-50043.

HELLER FINANCIAL, INC., Plaintiff-Appellee,

v.

GRAMMCO COMPUTER SALES, INC. and Donald B. Grammer, d/b/a DBG Leasing,

Defendants-Appellants.

Jan. 4, 1996.

Appeal from the United States District Court for the Western District of Texas.

Before POLITZ, Chief Judge, and REAVLEY and BARKSDALE, Circuit Judges.

POLITZ, Chief Judge:

Donald Grammer and Grammco Computer Sales, Inc. appeal a judgment in favor of Heller

Financial, Inc. on its civil RICO, fraud, and contract claims. We affirm in part and reverse in part.

BACKGROUND

In 1979 Grammer left his position as a computer sales representative with IBM, Inc. to start

Grammco Computer Sales, Inc., a company specializing in the marketing and leasing of computer

equipment. Shortly after organizing Grammco, Grammer solicited the business of the Santa Rosa

Medica l Cent er in San Antonio, Texas which, through its director of information systems, Joseph

Dixon, began leasing co mputer equipment exclusively from Grammco. No competitive bids were

solicited. This exclusive relationship continued for the next eight years and, by 1986, resulted in a

total of 54 Grammco leases at a monthly cost of $124,000.

In 1987 Santa Rosa reexamined its lease obligations with a view to reducing costs. Grammer

proposed consolidating the existing leases into a single 36-month lease with a monthly payment of

$84,841, thereby reducing Santa Rosa's monthly payments by approximately $40,000. This proposal

included an opti on which allowed Santa Rosa to purchase the equipment at the end of the lease term

for a nominal sum. Santa Rosa accepted the proposal and, on May 20, consolidated its leases into

a single lease denominated L3177. Grammer, d/b/a DBG Leasing, then purchased this lease and all

rights Grammco held in the leased equipment for 1.2 million dollars.1 Santa Rosa decided to terminate Dixon, but Dixon resigned before Santa Rosa officially

terminated him. Grammer obtai ned financing for this transaction through Heller Financial, Inc., a company

with which Grammco had financed lease transactions in the past. Prior to the formation of the new

co nso lidated lease, Heller informed Grammer that it could not extend a loan secured by a lease

containing a purchase opti on in its terms without substantial m o dification of the loan documents.

Grammer represented that the new lease would not contain a purchase opti on and that modification

of the documents would not be necessary. With this understanding, Heller agreed to extend Grammer

a 2.65 million dollar loan on a non-recourse basis, taking a security interest in Grammer's rights to

the leased equipment and the lease income stream. Grammco agreed to guarantee t he loan to

Grammer.

As part of the loan closing process, Gra mmer pro vided Heller with an "original" of lease

L3177; this "original," however, did not include the purchase option that had been included in the

lease signed by Grammco and Santa Rosa. Grammer also entered a Master Security Agreement

pledging the leased equipment and lease income stream as security for the loan. In this agreement,

Grammer warranted that he: (1) had good title to the leased equipment; (2) had provided Heller with

all documents related to L3177; (3) had granted Heller a first, prior, and perfected security interest

in all collateral; and (4) would not modify the terms of the lease without the express approval of

Heller. After reviewing the lease provided by Grammer and the Master Security Agreement, Heller

formally approved the loan, closing the loan on June 15 and releasing the funds to Grammer on June

26. Heller received the income from the lease as payment on the loan for the next four months.

In the s ummer of 1987 a change in management at Santa Rosa prompted a review of

co mput er equipment expenditures. The review revealed that Santa Rosa was paying well-abo ve

market rates on its computer lease with Grammco. Because the lease contained a purchase option,

Santa Rosa viewed L3177 as an inst allment sales cont ract rather than a true l ease; m oreover, i t

concluded that the high rates on the lease were usurious and violated Texas usury laws. Santa Rosa

stopped making payments on the lease to Heller, arranged to dismiss Joseph Dixon, 1 and filed suit2 Referred to herein as the "Santa Rosa litigation."

against Gramm

er d/b/a DBG Leasing, Grammco, and Heller alleging that L3177 was a usurious

installment sales contract.

During the ensuing litigation in Texas state court, 2 Heller and Santa Rosa uncovered monthly

payments from Grammer to Dixon starting in Sep t ember of 1983 and continuing until Dixon's

departure from S ant a Ro sa in October of 1987. Grammer maintained that these payments

compensated Dixon for computer programming services he performed for Grammco. Those services,

however, were later valued at approximately $15,000 while the payments total ed $171,804. Heller

and Santa Rosa also uncovered Dixon's participation in a series of lease transactions with Grammer

that provided significant tax benefits to Dixon at no cost and Dixon's receipt of $14,900 in royalties

from Grammer for sales of computer shelving equipment that Dixon had designed. On the basis of

this information, Santa Rosa amended its complaint to include a claim of commercial bribery against

Grammer, Grammco, and Dixon.

Heller also discovered that lease L3177 contained a purchase opti on and that ICS Cybernetics,

another computer vendor, owned the central processing un it of the computer equipment leased to

Santa Rosa. Thus, Heller realized that despite Grammer's warranties to the contrary, Grammer did

not have title to the leased equipment. Heller, codefendant with Grammer and Grammco on the usury

claim, filed a cross-claim against Grammer and Grammco for breach of contract and a counter-claim

against Santa Rosa for recovery of sums due under the lease.

To avoid actions that could be construed as illegal "charging" of usur i ous interest, Heller

nonsuited its counter-claim against Santa Rosa; Heller then received summary judgment on Santa

Rosa's usury claim against it. As the remaining claims headed to trial, Heller nonsuited its cross-claim

agains t Grammer and Grammco. Subsequently, Santa Rosa, Grammer, Grammco, and Dixon reached

a settlement whereby Santa Rosa received title to all of the lease equipment, 1.7 millio n dollars from

Grammco, $7500 from Dixon, and entry of a judgment stating that Santa Rosa had satisfied the terms

of the lease and that the lease was terminated.

After final judgment in the Santa Rosa litigation, Heller filed the instant action in federal court3 28 U.S.C. § 636(c).

4 Because final judgment in the Santa Rosa litigation was rendered in a Texas state court, Texas

law governs the application of res judicata based on that earlier judgment. See Marrese v.

American Academy of Orthopaedic Surgeons, 470 U.S. 373, 105 S.Ct. 1327, 84 L.Ed.2d 274 against Grammer and Grammco alleging breaches of the warranties found in the Master Securit y

Agreement, breach of contract on the loan guarantee, fraud in inducing Heller to make the loan, and

violations of the Racketeering Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §

1962(a) and (c). By consent of the parties, the district court referred the case to a magistrate judge

for a jury trial. 3

Prior to trial the court issued an order prohibiting Grammer and Grammco from introducing

evidence at trial regarding Heller's failure to mitigate damages, impairment of collateral, and waiver

of claims. At the close of the defendants' case, the court instructed a verdict in Heller's favor on one

of the breach of warranty claims. The jury returned a series of special verdicts for Heller on the fraud,

contract, and civil RICO claims. The co urt rendered judgment for Heller against Grammer d/b/a

DBG Leasing in the amount of $14,665,866.63 plus costs and attorneys' fees for violating RICO §

1962(a). The judgment outlined three alternative awards against Grammer: 1) $1,950,446.01 plus

costs and attorneys' fees for violating RICO § 1962(c); 2) $1,650,148.67 with prejudgment interest

on that amount from September 13, 1987 at the rate of 10% per annum and $2,000,000 in punitive

damages plus costs f

or fraud; and 3) $4,888,622.21 plus costs and attorney's fees for breach of

warranty. The court rendered judgment against Grammco for $4,888,622.21 plus costs and attorneys'

fees for breach of the guarantee of Grammer's loan.

Grammer and Grammco timely appealed.

Analysis

I. Res Judicata

Grammer and Grammco first seek to dispose of all of Heller's claims on the ground that

Heller could have asserted these claims in the earlier Santa Rosa litigation and that principles of res

judicata therefore now bar Heller's assertion of these claims. We disagree. Under Texas r es judicata

principles, 4 a prior judgment precludes a claim only if the parties are identical, the prior judgment was(1985); Rollins v. Dw yer, 666 F.2d 141 (5th Cir.1982).

5 Barr v. Resolution Trust Corp., 837 S.W.2d 627 (Tex.1992); Hollow ay v. Starnes, 840

S.W.2d 14 (Tex.Ct.App.1992), cert. denied, --- U.S. ----, 114 S.Ct. 93, 126 L.Ed.2d 60 (1993).

6 Getty Oil v. Ins. Co. of N. America, 845 S.W.2d 794, 800 (Tex.1992) ("[R]es judicata applies

only to adverse parties."), cert. denied, --- U.S. ----, 114 S.Ct. 76, 126 L.Ed.2d 45 (1993).

7 Id. ("[W]here a defendant does assert a cross-claim against a co-party, they become adverse,

and the principles of res judicata apply.").

8 Alvarado v. Hyundai Motor Co., 885 S.W.2d 167, 174 (Tex.Ct.App.1994) (citing Crofts v.

Court of Civil Appeals, 362 S.W.2d 101 (Tex.1962)), rev'd on other grounds, 892 S.W.2d 853

(Tex.1995).

9 Robertson v. Bell Helicopter Textron, Inc., 32 F.3d 948 (5th Cir.1994). rendered by a court of competent jurisdiction and was a final judgment on the merits, and the

challenged claim arises out of the same subject matter litigated in the first suit. 5

Grammer and Gram

mco maint ain that all prerequisites for r es judicata have been met

although they acknowledge that codefendants in an action , as were Heller and Grammer and

Grammco in the Santa Ros a litigation, are not considered adverse parties for purposes of r es

judicata. 6 Grammer and Grammco would avoid this bar by contending that once Heller asserted its

cross-claim it became an adverse party. We agree that the filing of the cross-claim made Heller an

adverse party, 7 but Heller's subsequent nonsuit o f t he cross-claim returned the parties to the same

position as if the claim had never been filed. 8 Therefore, Heller was not adverse t o Grammer and

Grammco when the agreed judgment was entered and res judicata does not operate to bar Heller's

claims in this action.

II. RICO Claims

Grammer next contends that Heller failed to establ ish t hat Grammer's alleged acts of

commercial bribery and mail and wire fraud amount to a "pattern of racketeering activity" as required

to support a verdict for violations of § 1962(a) or (c). Because Grammer appeals from a denial of

his po st -verdict motion for judgment as a matter of law, we review this appeal using the same

standard as the district court; factual issues are reviewed only for the presence of substantial evidence

supporting the verdict while legal issues are reviewed de novo. 910 United States v. Carlock, 806 F.2d 535, 542 (5th Cir.1986), cert. denied, 480 U.S. 949, 950,

107 S.Ct. 1611, 1613, 94 L.Ed.2d 796, 798 (1987).

11 492 U.S. 229, 109 S.Ct. 2893, 106 L.Ed.2d 195 (1989).

12 Id. at 239, 109 S.Ct. at 2900.

13 Id.

14 Id.

15 Normally, the existence of a sufficient relationship between the predicate acts is either

obvious or assumed and our review focuses on the continuity requirement. See e.g., Calcasieu

Marine Nat'l Bank v. Grant, 943 F.2d 1453 (5th Cir.1991). We reverse that approach here in

light of Heller's complete reliance on the evidence of Grammer's bribery of Santa Rosa employee

Joseph Dixon to support a finding of continuity. Even if we assume that this bribery activity

independently provides sufficient continuity for a RICO "pattern," such a pattern can not support

Heller's claim unless Heller demonstrates that the predicate acts causing its injury, the mail and

wire fraud, are sufficiently related to the predicate acts of bribery to be part of the same

racketeering pattern. See Vild v. Visconsi, 956 F.2d 560 (6th Cir.), cert. denied, --- U.S. ----, 113

S.Ct. 99, 121 L.Ed.2d 59 (1992).

16 United States v. Eufrasio, 935 F.2d 553, 564-65 (3d Cir.1991), cert. denied, 502 U.S. 925,

112 S.Ct. 340, 116 L.Ed.2d 280 (1991). To prove a "pattern of racketeering activity" under § 1962(a) and (c), Heller had to prove

"at least two acts of racketeering activity,

... the last of which occurred within ten years ... after the

commission of a prior act of racketeering activity." 10 In H .J. Inc. v. Northwestern Bell Telephone

Co., 11 the Supreme Court clarified and narrowed this statutory definition, holding that "to prove a

pattern of a racketeering activity a plaint iff

... must show that the racketeering predicates are related

and that they amount to or pose a threat of continued crim inal activity." 1 2 "It is this factor of

continuity plus relationship which combines to produce a pattern." 13 Although proof of continuity

and relationship may often overlap, the two inquiries analyt ically are distinct prongs of the pattern

element requiring separate analysis. 14

Grammer asserts that Heller failed to demonstrate that the allegations of commercial bribery

and mail and wire fraud satisfied either prong of the pattern requirement. We, however, need only

address Heller's satisfaction of the relationship prong of the pattern requirement. 15 The relatedness

inquiry "foc uses on the interrelationship of charged RICO predicates," 1 6 thereby ensuring that a

person is not "subjected to sanction s fo r co mmitting two widely separated and isolated criminal17 Id. at 565 (citing H.J. Inc., 492 U.S. at 239, 109 S.Ct. at 2900-01 (quoting from legislative

history) (citations omitted)).

18 Calcasieu, 943 F.2d at 1463 (quoting H.J. Inc., 492 U.S. at 240, 109 S.Ct. at 2901).

19 Heller's witnesses testified that the loan to Grammer could have been made with the purchase

option but that Heller would have required significant modifications in the terms of the loan and

security agreement. offenses." 17 A plaintiff can satisfy the relationship requirement by demonstrating that the alleged

predicate acts "have the same or similar purposes, results, part i cipants, victims, or methods of

commission or otherwise are interrelated by distinguishing characteristics and are not isolated

events." 18

Examining the predicate acts alleged by Heller within this framework, we conclude that they

are no t sufficiently interrelated to constitute a pattern of racketeering activity. Heller essentially

complains of two types of criminal activity: Grammer's alleged commercial bribery of Santa Rosa

employee Joseph Dixon and his use of the mail and wires to fraudulently induce Heller into extending

him credit. Acco rding to Heller's pleadings, the purpose of the bribery scheme was to maintain

Grammco's exclusive business relationship with S anta Rosa free of competition that might have

caused Santa Rosa to take its computer business elsewhere. The alleged mail and wire fraud, on the

other hand, sought to induce Heller into making a loan on terms that would have not otherwise been

available. 19 The purposes of the alleged predicate acts were distinct and dissimilar.

The predicate acts also had dissimilar results. The bribery resulted in Santa Rosa's payment

of excessive prices on its leases of computer equipment while the mail and wire fraud resulted in the

extension of a loan on terms offering less protection to Heller than Heller normally required. This

conclusion is reinforced by an examination of the injuries o f the "victims" of the alleged criminal

activity. By paying the higher lease rates Santa Rosa lost those sums paid in excess of the market

rate; Heller suffered a default on a loan and the loss of payments not yet made.

The difference in the "methods of commissi on" further supports our concl usi on that the

alleged predicate acts were not related. The bribery of Santa Rosa employee Joseph Dixon eliminated

competitive pressures by causing Dixon to betray his fiduciary relat io nship with Santa Rosa.20 See Vild (holding fraud against marketer of real estate development to be "unrelated" to

fraud against the targeted consumers of the development); McLaughlin v. Anderson, 962 F.2d

187 (2d Cir.1992). Grammer defrauded Heller by refusing to disclose material aspects of the lease serving as security for

the loan. It is manifest that the alleged activities involved not only substantively different crimes but

also functionally different methods of commission.

We also note that the participants in the two types of criminal activity alleged by Heller were

different. The bribery activity included Santa Rosa employee Dixon, a principal player in the scheme

without who m the bribery could not have taken place. Only Grammer participated in the alleged

fraud on Heller; neither Dixon nor a substitute intermediary participated in or was necessary to the

fraud.

Finally, we note that the two types of conduct which Heller seeks to connect into a pattern

were directed at different victims. Grammer's bribery of Dixon directly affected o nly Santa Rosa

while his fraudulent acts injured only Heller. We do not consider Heller and Santa Rosa to be

similarly situated victims; Santa Rosa occupied the position of a consumer of Grammer's services

while Heller served as Grammer's creditor.

In an effort to make out some relationship between the acts, Heller maintains that Grammer's

bribery allowed the extraction of supra-competitive profits from its Santa Rosa leases, one of which

leases Grammer then used as collateral for the fraudulently induced loan. Hel ler contends that by

using the lease as collateral for the loan, Grammer immediately reaped the profits of his fraud on

Santa Rosa rather than doing so over time and thereby insulated himself from the consequences of

Santa Rosa's discovery of the bribery. We are not persuaded.

Although we recognize that a plaint iff can satisfy the relationship requirem ent by

demonstrating that the alleged predicate acts "are interrelated by distinguishing characteristics" other

than those outlined above, we interpret the relationship prong of the pattern requirement to require

more than an articulable factual nexus. 20 We take the clear import of the Supreme Court's admonition

in H.J. Inc. to consider whether the predicate acts "hav e t he same o r similar purposes, results,

participants, victims, or me t ho ds o f co mmission" to require that a RICO plaintiff must prove a21 H.J. Inc., 492 U.S. at 238, 109 S.Ct. at 2900.

22 In so holding, we attempt to give some meaning to the relationship prong of the pattern

requirement. The "test" stated by the Supreme Court for the relationship prong is "admittedly

difficult to apply," Banks v. Wolk, 918 F.2d 418, 424 (3d Cir.1990), but that difficulty does not

allow us to ignore its effect. To allow a finding of relationship on the facts of this case would

effectively eliminate any meaningful relationship requirement. We interpret the Supreme Court's

teaching in H.J. Inc. that the relationship prong is "analytically distinct" to make that an untenable

result. See Vild. We leave to future panels the task of further defining the limits of this test.

23 Because Heller fails to make out a pattern of racketeering as required to support any RICO

claims, we need not consider Grammer's other assignments of error on the RICO claims.

24 The trial court held that this modification contemporaneously breached Grammer's warranty

that the obligation of Santa Rosa to make payments on the lease would remain absolute and

unconditional and not subject to any claims or rights against Grammer. relationship between the criminal aspects of the predicate c riminal acts, thereby supporting the

conclusion that the criminal acts are " "ordered' or "arranged.' " 21

Heller would paint with too broad a stroke. The "reaping the profits" theory describes every

lease financing loan, whether that loan involved mail or wire fraud. Through such financing, a lessor

finances his own acquisition of the leased or sold goods and realizes his profit while the debt service

on the financing is satisfied by the payments from the account debtor (consumer), all of which is a

purely legitim at e business pursuit. Nothing in this scenario or in the evidence suggests that

Grammer's fraudulent acts were related to his bribery of Dixon. 22

Finding the fraud and the bribery to be unrelated, we must conclude that Heller has failed to

d emonstrate that Grammer's acts against it were part of a pattern of racketeering activity. The

verdicts on Heller's RICO claims must therefore be reversed. 23

III. Breach of Warranty

Grammer next challenges the verdicts on Heller's claims that Grammer breached warranties

made in the security agreement executed contemporaneousl y wit h his loan from Heller. He first

asserts that the district court erred in instructing the jury that Grammer breached his warranty not to

modify the lease when he entered the settlement agreement releasing Santa Rosa from all of its

obligations under the lease, including its obligation to make payments. 24 Grammer contends that any

such modification could not affect Heller's rights against Santa Rosa and that Heller therefore suffered25 Ill.Rev.Stat. ch. 26 para. 1-105. Because the transaction, whether characterized as a

conditional sale or a lease, created a security interest, the transaction is governed by Article 9 of

the Uniform Commercial Code as adopted in Illinois. See Ill.Rev.Stat. ch. 26 para. 9-102.

26 Ill.Rev.Stat. ch. 26, para. 1-201(3).

27 Bysom Enterprises, Ltd. v. Peter Carlton Enterprises, Ltd., 267 Ill.App.3d 1, 204 Ill.Dec.

408, 414, 641 N.E.2d 838, 844 (1994) ("The parties' intent as to the scope of a contract is

irrelevant where the language of the contract is clear and unambiguous."), appeal denied, 159

Ill.2d 564, 207 Ill.Dec. 514, 647 N.E.2d 1007 (1995).

28 Grammer contends that any modification he made was not binding on Heller because

Grammer had already assigned the lease to Heller and that Heller therefore should have sought

recovery from Santa Rosa. The evidence, however, supports only the conclusion that Grammer

assigned his right of payment to Heller. The only agreements between Heller and Grammer of

which there is evidence are Grammer's promissory note and the related security agreement.

Grammer's notification of assignment to Santa Rosa can not support a finding of an assignment of

the lease; it provides no evidence of an agreement on the part of Heller. no damages as a result of the modification.

We first note that the security agreement containing the subject warranties includes a choice

of law provision designating the law of Illinois as controlling the interpretation of the agreement. 25

Under Illino is law, a security agreement is a co nt ract interpreted by reference to Article 9 of the

Commercial Code, if applicable, otherwise, by reference to the law of contracts. 26

The starting point for our analysis of the security agreement is, of course, its plain language. 27

Paragraph 3(n) of the agreement states that the "Debtor (Grammer) will not make any modifications

to any Lease without the prior written consent of Secured Party (Heller)." In the event that this or

other warranties are breached by Grammer, the agreement provides that Grammer is then considered

in default and fully liable for "any loss or damage incurred or suffered by Secured Party (Heller),

arising out of or in connection with the breach." Although these provisions clearly allow Heller to

bring a claim against Grammer for a breach of warranty, 28 Grammer contends that the modification

of the lease is not the proximate cause of the damages which Heller seeks to recover, namely the

balance due and owing on the underlying note to Grammer.

"A perso n breaching a contract can be held liable for such damages as may fairly and

reasonably be considered as naturally arising from the breach thereof in light of the facts known or

which should have been known or such as may reasonably be supposed to have b een within the29 Case Prestressing Corp. v. Chicago College of Osteopathic Medicine, 118 Ill.App.3d 782,

74 Ill.Dec. 382, 387, 455 N.E.2d 811, 816 (1983).

30 See Bysom Enterprises, Ltd. (rejecting argument similar to Grammer's in context of breach of

an express warranty).

31 Ill.Rev.Stat. ch. 26 para. 9-318. See Bank One, Texas, N.A. v. Communication Specialists,

Inc., 813 S.W.2d 755 (Tex.Ct.App.1991) (commenting on same provision under Texas

Commercial Code). Cf. Southern Rock, Inc. v. B & B Auto Supply, 711 F.2d 683 (5th Cir.1983)

(interpreting security agreement to create security interest in accounts rather than a complete

assignment of title to those accounts). contemplation of the parties as a probable result of a breach thereof." 29 Common sense dictates that

if the lessor releases the lessee from making payments on the note, the lessee's failure to make those

payments naturally arises from and i s connected to the lessor's release. 3 0 Further, a review of the

agreement and the underlying promissory note lead us to conclude that the damages were precisely

those contemplated by the parties in the event of a breach of the warranty a gainst modification.

Paragraph 3(n), which sets forth the warranty against modification, specifically discusses the amount

o f t he reduction in payments to Heller from the lessee as the proper measure of damages after a

modification. In Grammer's pro missory note, the parties agree that in the case of a breach of

warranty, Grammer would be liable for the payment of the principal.

We also reject Grammer's argument that Heller should have sought recovery of the balance

due on the note from Santa Rosa. Whether Heller could have pursued an action against Santa Rosa

for the payments on the note is irrelevant to our inquiry into the existence of a cause of action against

Grammer. The Illinois Commercial Code section governing modifications after assignments of rights

to payment specifically provides that the parties can agree to make a modification of the underlying

contract (the lease) a breach by the assignor of the right. 31 The parties here manifested such an

intention in the securit y agreement. Accordingly, we conclude that the damages sought by Heller

were proximately caused by the breach of the warranty against modification and that the trial court's

directed verdict on this issue was not erroneous.

IV. Adjustment of Damage Aw ard

Grammer next argues that even if the breach o f warranty judgment stands, the trial court

erred in increasing the damage award on this claim from the jury's award of 1 million dollars to 4.732

Neiman-Marcus Group, Inc. v. Dw orkin, 919 F.2d 368 (5th Cir.1990).

33 See Shaffer v. Great American Indemnity Co., 147 F.2d 981 (5th Cir.1945) (allowing

substitution when only one damage amount is possible if liability attaches); United States v.

Kennesaw

Mountain Battlefield Ass'n, 99 F.2d 830 (5th Cir.1938), cert. denied, 306 U.S. 646, 59

S.Ct. 587, 83 L.Ed. 1045 (1939); Texas Compensation Ins. Co. v. Heard, 93 F.2d 548 (5th

Cir.1937).

34 Even if we assume that the evidence to which Grammer points justifies a lower damage

award, that evidence is relevant only to the warranties of title, prior perfected interest, and

provisions of all relevant documents. See Security Agreement ¶ 3(a), 3(c), and 3(g).

35 Schindler v. Austw ell Farmers Co-op., 829 S.W.2d 283, 289 (Tex.Ct.App.—Corpus Christi

1992), aff'd as modified, 841 S.W.2d 853 (Tex.1992); Jim Walter Homes, Inc. v. Reed, 711

S.W.2d 617 (Tex.1986). The parties agree that Texas law governs Heller's fraud claim. millio n dollars, the balance due on the underlying debt. We accord a jury great discretion in awarding

damages within the range shown by the evidence. 32 In the infrequent circumstance where there is no

rational basis for the jury's verdict, however, a trial court may impose the only damages award that

reasonably can be drawn from the evidence. 33

The only evidence of damages at trial was testimony by Heller witness John Payne who placed

the damages at the balance due on the underlying debt. Although Grammer co ntends that he

presented extensive evidence showing that he cured most of the breaches of which Heller complains,

he points to no evidence supporting the conclusion that the breach of the wa rranty against

modification caused damages less than the balance due on the debt. 34 We perceive no error in the trial

court's amendment of the judgment; the record is devoid of any evidence allowing a lesser verdict

on the breach of warranty claim.

V. Fraud

Grammer asserts that Heller can not recover for fraud when that claim arises from the same

transaction supporting the successful breach of contract claim. Contending that Heller simply recast

one of its breach of

warranty claims into a fraud claim, Grammer maintains that the jury's fraud

verdict and its associated award of punitive damages can not stand.

As a general rule, "the failure to perform the terms of a contract is a breach of contract, not

a tort." 35 This statement, however, belies the difficulty the Texas courts and this court have had in36 See Southw estern Bell Tel. Co. v. DeLanney, 809 S.W.2d 493, 495 (Tex.1991) ("We have

muddled the law of "contorts' and an all encompassing bright line demarcation of what constitutes

a tort distinct from breach of contract has proven to be elusive.") (Gonzalez, J. concurring). The

matter is further complicated in this instance by the non-recourse nature of the underlying

promissory note. Thus, the co-existing breach of contract claim is based on the security

agreement which incorporates the promissory note.

37 809 S.W.2d 493 (Tex.1991).

38 Jim Walter Homes, 711 S.W.2d at 618.

39 See Trenholm v. Ratcliff, 646 S.W.2d 927 (Tex.1983) (tracing damages to losses on resale

after misrepresentation induced contract for sale).

40 American Nat'l Petroleum Co. v. Transcontinental Gas Pipe Line Corp., 798 S.W.2d 274

(Tex.1990). determining when a party may assert a tort action in addition to a contract action. 36 In S outhw estern

Bell Tel. Co. v. DeLanney, 37 the Texas Supreme Court cleared up some of the confusion by endorsing

a two step inquiry for such determinations. First, a court should examine the faulted conduct to

determine if it violates duties imposed by law, independent of those duties imposed by the contract.

Next, it should examine the nature of the alleged injury, recognizing that "[w]hen the injury is only

the economic loss to the subject of a contract itself the action sounds in contract alone." 38

The first inquiry militates in favor of allowing Heller's fraud claim. Heller essentially claimed

and proved at trial that Grammer induced Heller to extend him a loan by misrepresenting materi al

facts regarding the presence of a dollar purchase opti on in lease L3177 and Grammer's ownership of

the leased equipment. Texas courts have held that when one party misrepresents a material fact to

induce another to enter an otherwise normal contract, the induced party may assert an action for fraud

based on duties imposed separate and apart from the contract. 39

The second inquiry is more troublesome. Heller's asserted injury, both in its pleadings and

as reflected by evidence adduced at trial, was the balance due on the defaulted note; indeed, Heller

notes in brief that the default amount was the only evidence of damages even presented to the jury.

The posited injury, then, is that payments Heller was promised were never received—precisely the

subject of the contract. Although fraud damages may be measured in "benefit of the bargain" terms, 4 0

the Texas courts are split on the issue whether these damages must be independent from damages for41 National Union Fire Ins. Co. v. Care Flight Ambulance, 18 F.3d 323, 327 n. 1 (5th

Cir.1994) (noting split and collecting cases). Compare Hebisen v. Nassau Dev. Co., 754 S.W.2d

345 (Tex.Ct.App.—Houston [14th Dist.] 1988) (no claim of fraud when only damages are to the

subject of the contract) and Schindler (no requirement that separate injuries be shown to support

fraud claim).

42 Heller cites Schindler v. Austw ell Farmers Co-op., for the proposition that damages directly

attributable to the fraud need not be shown. That case, however, dealt with the fraudulent

inducement of a contract where the inducing party never intended to perform. In that instance,

we agree that the law of Texas is that the action will support a fraud claim as well as a contract

claim. See Spoljaric v. Percival Tours, Inc., 708 S.W.2d 432 (Tex.1986). The instant suit deals

with a material misrepresentation inducing a contract the parties intend to perform. On those

facts, the majority rule appears to be that separate damages must be proven.

We recognize that this holding gives a narrow reading to our decision in National

Union Fire Ins. Co. where we held that a party could assert a conversion claim in addition

to a contract claim. That decision relied on the fact that no Texas cases had ever required

separate damages for the conversion claim. 18 F.3d at 327-28. In the case of fraud

claims, however, the majority of the precedent requires separate damages.

43 See Texas Nat'l Bank v. Karnes, 717 S.W.2d 901 (Tex.1986) (contract claim alone cannot

support punitive damages). Because we conclude that the fraud verdict can not stand, we need

not address Grammer's challenge to the award of prejudgment interest on the fraud damages.

44 Ill.Rev.Stat. para. 3-606 & 9-207. the breach of the contract affected by the fraud. 41 The majority of the Texas cases appear, however,

to require proof of some damages beyond the economic losses to the subject matter of the contract.

Bound as we are by Texas law on this issue, and finding no damages attributable to the fraud rather

than the contract, we perforce must conclude that Hell e r is not entitled to a verdict on its fraud

claim. 42 Because Heller's fraud claim is necessary to support a finding of punitive damages, the award

of punitive damages must also be vacated. 43

VI. Exclusion of Evidence

Grammer finally contends that the district court erred in excluding his evidence that Heller

failed to mitigate its damages, impaired the collateral for the loan, that collateral being the right to

lease payments, and waived its claims against him. Citing sections 3-606 and 9-207 of the Illinois

Commercial Code, Grammer maintains that Heller, as a secured party in possession of collateral, had

to act in a commercially reasonable manner to preserve the value of collateral. 44 Grammer contends

that Heller failed to so act when it nonsuited its claims against Santa Rosa and that Gram mer was

therefore entitled to a special issu e regarding possible impairment of the collateral and failure to45 Fed.R.Evid. 103; E.E.O.C. v. Manville Sales Corp., 27 F.3d 1089, 1093 (5th Cir.1994) ("In

order to vacate a judgment based on an error in an evidentiary ruling, "this court must find that

the substantial rights of the parties were affected.' ") (citing Carter v. Massey-Ferguson, Inc.,

716 F.2d 344, 349 (5th Cir.1983)), cert. denied, --- U.S. ----, 115 S.Ct. 1252, 131 L.Ed.2d 133

(1995).

46 Ill.Rev.Stat. ch. 26, para. 9-501.

47 See North Bank v. Circle Investment Co., 104 Ill.App.3d 363, 60 Ill.Dec. 105, 432 N.E.2d

1004 (1982).

48 See Ramsey v. First Nat. Bank and Trust Co. of Corbin, 683 S.W.2d 947 (Ky.Ct.App.1984)

(discussing purpose of impairment of collateral defense). We also note that Grammer's claims of

failure to mitigate and impairment of collateral depend upon Heller's possession of the lease

income stream. The evidence introduced at trial also supports the conclusion that Heller never

received all the documents making up L3177 and therefore was arguably never in possession of

the lease income stream as contended by Grammer. mitigate damages. Grammer further contends that under section 3-606, Heller's nonsuit of its claims

against Santa Rosa discharged pro tanto Grammco's liabilit y on its guaranty of Grammer's note and

that this point further warranted the admission of evidence on the mitigation issue.

At the outset w e no te that we will reverse a trial court's evidentiary rulings only if they

prejudiced a substantial right of the complaining party. 45 Grammer's arguments rely on the

assumption that Heller was obligated to pursue the collateral for the lease then held by Santa Rosa

after Santa Rosa ceased making payments. The Illinois Commercial Code clearly provides, however,

that a secured party has the choice of pursuing a judgment against the debtor (Grammer) on default

rather than the collateral, in addition to the collateral, or in combination therewith. 46 We therefore

agree with the trial court that evidence of Heller's decision to nonsuit its claims against Santa Rosa

was irrelevant to the claims litigated at trial.

To the extent that Grammer argues Heller's nonsuit of Santa Rosa injured him by impairing

his rights in the lease income stream, we are not persuaded. Sections 3-606 and 9-207 are designed

t o prot ect the rights of sureties to act on the collateral after satisfy ing a debt owed to the secured

party. 47 Grammer and Grammco, however, gave up any rights in L3177 when they ent ered t he

settlement agreement with Santa Rosa. Thus, there was nothing for Heller to impair through its

acts. 48

Finally, we reject Grammer's argument that the trial court erred in exclud ing Grammer's49 See First Interstate Bank v. Interfund Corp., 924 F.2d 588 (5th Cir.1991) (noting that

waiver requires proof of an unequivocal intention to no longer assert the right in question). evidence regarding Heller's alleged waiver of its claims aga inst Grammer by failing to object or

participate in Grammer's settlement discussions with Santa Rosa. Assuming, a rguendo, that the trial

court erred in granting a motion in limine on evidence relat ed t o t his alleged waiver, the record

reflects that the parties did in fact introduce evidence regarding the settlement and that such evidence

overwhelmingly supports the conclusion that no waiver occurred. 49 We perceive no prejudice to a

substantial right.

We REVERSE the judgment in favor of Heller on the RICO claims and the fraud claims. We

AFFIRM the judgment on the breach of warranty claims.

REAVLEY, Circuit Judge, concurring:

I concur in the result reached by the majority, but I differ in the RICO analysis.

In H.J. Inc. v. Northwestern Bell Telephone Co., 492 U.S. 229, 109 S.Ct. 2893, 106 L.Ed.2d

195 (1989), the Court held that a "pattern of racketeering activity" embraced both a "relationship"

requirement and a "continuity" requirement. As to the relationship requirement it concluded t hat

"criminal conduct forms a pattern if it embraces criminal acts that have the same or similar purposes,

results, participants, victims, or methods of commission

, o r otherwise are interrelated by

distinguishing characteristics and are not isolated events." Id. at 240, 109 S.Ct. at 2901 (emphasis

added). Particularly when read in context, I believe that the Court intended this relationship

requirement to be a minimal one. The Court recognized concerns that RICO has too broad a sweep

and was being used to pursue "legitimate" businesses as well as organized criminals, but concluded

that this result is compelled by the expansive language of the statute, and the failure of Congress to

scale it back. I

d. at 235-37, 109 S.Ct. at 2899. It concluded that "the legislative history shows that

Congress knew what it was doing when it adopted commodious language capable of extending

beyond organized crime." I d. at 246, 109 S.Ct. at 2904. The Court rejected an Eighth Circuit

requirement that a "pattern of racketeering activity" requires multiple illegal schemes, as opposed to

a single fraudulent effort or scheme. I d. at 233-34, 109 S.Ct. at 2898-99. It concluded instead that"Congress indeed had a fairly flexible concept of a pattern in mind." Id. at 239, 109 S.Ct. at 2900.

I would hold that Grammer's conduct met this relationship requirement. The predicate acts

included (1) repeated bribes to Dixon, (2) misrepresenting to Heller that th ere was no purchase

option, and (3) misrepresenting to Heller that Grammer owned the equipment. These acts are not

isolated events; they are related because they were all part of an ongoing scheme by Grammer to

obtain the benefits of an above-market lease by deceiving the hospital and his l ender. The l oan

facilitated this scheme by allowing Grammer to receive cash up front, thereby insulating him from a

loss should the bribery later be discovered.

However, Grammer argues as a separate ground for rejecting the § 1962(a) RICO judgment,

no t reached by the majority opinion, that Heller did not prove an "investment injury." I agree.

Section 1962(a) makes it "unlawful for any person who has received any income derived ... from a

pattern or racketeering activity

... to use or invest

... any part of such income, or the proceeds of such

income, in acquisition of any interest in, or the establishment or operation of, any enterprise...." 18

U.S.C. § 1962(a). We have held that a civil recovery under § 1964(c) premised on a violation of §

1962(a) requires the plaint iff to prove that his injury was caused by the defendant's use or investment

of racketeering income. "[A]ny injury under section 1962(a) must flow from the use of investment

of racketeering income." P arker & Parsley Petroleum Co. v. Dresser Indus., 972 F.2d 580, 584 (5th

Cir.1992). A ccord, Crowe v. Henry, 43 F.3d 198, 205 (5th Cir.1995) ("For subsection (a), this means

that the injury must flow from the investment of racketeering income into the enterprise."). I agree

with the majority that Heller's only evidence of damages was the unpaid amounts due on the note.

Heller's injury did not flow from the manner in which Grammer invested or used the loan proceeds

once he had obtained them by false pretenses. Heller did not tie its injury to Grammer's use or

investment of the loan, but instead claimed injury only on the basis of the init ial act of making the loan

to Grammer. Likewise, Heller did not establish that the bribes to Dixon caused Grammer to receive

income and then invest or use that income in a manner that caused injury to Heller. Heller did link

Grammer's use of the income from the leases, about which there was little if any evidence presented1 As the majority points out, Heller also won a judgment based on § 1962(c) of RICO. Unlike

§ 1962(a), this subsection does not require a defendant's use or investment of racketeering

income, but instead makes it "unlawful for any person employed by or associated with any

enterprise ... to conduct or participate ... in the conduct of such enterprise's affairs through a

pattern of racketeering activity...." I need not consider whether the § 1962(c) judgment should

stand even if the majority agreed with me that the relationship requirement (which applies to both

§§ 1962(a) and (c)) was met here. First, the district court clearly awarded this judgment in the

alternative to the larger breach of warranty judgment. Heller makes no argument that the district

court erred in awarding these judgments in the alternative rather than stacking them, and makes

no argument that the jury (which awarded only $500,000 under § 1962(c)) or the court erred in

calculating damages under § 1962(c). Even after trebling by the court the § 1962(c) judgment

was still smaller than the breach of warranty judgment, and Heller should be deemed to have

elected the larger judgment. Second, as explained above, Heller's only proof of damages was the

unpaid balance on the note. Since the breach of warranty judgment awards the full amount due

on the note, adding the § 1962(c) judgment to the breach of warranty judgment would amount to

a double recovery. See Alcorn County v. U.S. Interstate Supplies, Inc., 731 F.2d 1160, 1171 (5th

Cir.1984) (noting that "duplicative damages [under RICO and state common law] should not be

allowed."). at trial, to Heller's decision to make its loan to Grammer. 1

Furthermore, I reluctantly concur in the holding on punitive damages. We must follow Texas

law, no matter what we think of it. I understand why the breach of a duty arising out of the terms

o f a contract, where the damages are measured precisely by the contract, may be treated as t he

predicate for an action on the contract rather than as a n independent tort. However, proof of the

elements of a cause of action for fraud should certainly establish an independent tort, whether or not

the amount of actual damages would be the same if the claim were for breach of contract. But if the

Texas courts dislike punitive damages so much as to decree that law, I am Erie bound to it.