Opinion ID: 196528
Heading Depth: 2
Heading Rank: 2

Heading: Rescissionary Damages Award

Text: Rescissionary damages against the FDIC and the other defendants, jointly and severally, were awarded to all plaintiffs except Lopes and the Rileys. The district court also novated the remaining debt of all plaintiffs (except Lopes and the Rileys) on the first and second mortgages held by the FDIC and HHI. The plaintiffs quarrel with this aspect of the district court's award in two respects: that the district court used an incorrect method of calculating 9. The only fraudulent behavior the plaintiffs attribute to the Bank stems from the Bank's opposition to the plaintiffs' Motion for Order Segregating Assets filed a few weeks before the Bank was declared insolvent. In opposing the motion, the Bank represented to the court that any harm the plaintiffs feared from an FDIC takeover was mere speculation. The Bank failed to inform the court that it was in negotiations with the FDIC and a takeover by the FDIC was imminent. Without condoning this regrettable lapse by the Bank, it does not help the plaintiffs. The plaintiffs have not demonstrated that they would have been entitled to a segregation of assets had the Bank properly informed the court of its financial condition as it should have. -20- 20 damages, and that the district court improperly excluded Lopes and the Rileys from the rescissionary damages award that ran against the FDIC.
The district court ordered an award of rescission, excluding interest, of $654,949. The district court started with the total amount of money at issue -- the principal, interest and other expenses paid by the plaintiffs minus income received and the unpaid debt on the first and second mortgages held by the FDIC, for a total of $2,072,205. The court then subtracted the unpaid mortgage debt owed to the FDIC and HHI, a total of $1,271,100, and the principal and interest payments made by Lopes and the Rileys, a total of $146,156, to reach $654,949. The court then ordered a novation of the notes owed by the plaintiffs to defendants, HHI and the FDIC, although the court apparently intended an outright cancellation of the notes. Plaintiffs argue that the district court should have awarded them the entire amount of consideration paid for the units, including the unpaid portions of the loans, subject to a setoff by the FDIC and HHI for the unpaid portions of the loans. They also argue that the district court should also have allowed the plaintiffs to keep the units as a setoff for any damages owed to the plaintiffs from -21- 21 the FDIC that would be left unpaid because of the insolvency of the Bank. As a practical matter, there is little difference between what the district court ordered (return of principal, interest, fees and expenses minus income and novation of the loans) and what the plaintiffs are requesting (entire cost of loans plus amount paid on the units minus income, leaving plaintiffs' debt to the FDIC and HHI intact). As the plaintiffs recognize, the district court's award with a solvent defendant, would fully fund rescission and return to Plaintiffs their full damages in exchange for title to their units. The plaintiffs argue, however, that their method of calculation makes a difference because the Bank is insolvent and will not be able to pay the damages judgment in full. Plaintiffs say their method allows them to keep the units as a setoff and thus make up any shortfall between the damages owed and the pro rata share of the Bank's assets they will receive. We disagree. A setoff is often justified where a plaintiff owes a debt to an insolvent party and will be forced to pay off that debt without being allowed to recover a debt the insolvent party may owe to the plaintiff. See In re Saugus General Hosp., Inc., 698 F.2d 42, 45 (1st Cir. 1983). It is typically employed where a depositor, who also owes money to a bank, seeks to offset the amount owed by the amount -22- 22 deposited. It is employed where the parties have reciprocal or mutual obligations to one another. The plaintiffs have tried to characterize the obligations between the parties as being mutual and appropriate for a setoff of the units. Under the plaintiffs' argument, the offsetting obligations would exist were the court (1) to create a damages award in the plaintiffs' favor for the entire amount of the loans and the amount plaintiffs have paid on the units (minus income) and (2) then award the FDIC and HHI the amounts the plaintiffs owe on the promissory notes. With such offsetting obligations, the plaintiffs argue, they should be entitled to set off the units, i.e., keep them, in the face of the Bank's insolvency. See FDIC v. Mademoiselle of California, 379 F.2d 660, 664 (9th Cir. 1967) (It is well settled that the insolvency of a party against whom a set-off is claimed constitutes a sufficient ground for the allowance of a set-off not otherwise available.) (internal quotations omitted)). This argument, however, is incongruous with the plaintiffs' theory of recovery in this case. Plaintiffs here sought rescission, a form of restitution. Under this theory, the restitution by the defendant of the ill-gotten gains cannot be enforced unless the plaintiff[s] return[] in some way what [they] ha[ve] received as a part performance by the defendant. Arthur L. Corbin, Corbin on Contracts 1114, at -23- 23 608 (1964); see also Restatement of Restitution 65 (1937) (the general rule is that the right of a person to restitution for a benefit conferred upon another in a transaction is dependent upon his return of, or offer to return, anything the person received as a part of the transaction). Thus, under the applicable statute, rescission is allowed upon tender of the security by the plaintiff. See Mass. Gen. L. ch. 110A, 410(a); see also 15 U.S.C. 77l. Since tender of the unit is a condition for triggering the obligation of the Bank to repay the amount paid for the units, the plaintiffs cannot also use the units as setoffs. The Bank owes the plaintiffs nothing until the plaintiffs relinquish their rights to the units. And once the plaintiffs no longer have rights to the units, the plaintiffs have no basis to use the units as setoffs.10 10. Even assuming that the plaintiffs might, in theory, be entitled to set off of the units, that does not automatically entitle them to do so. A setoff may be denied in order to do equity, prevent injustice, and achieve the goals of procedural fairness. In re Lakeside Hospital, Inc., 151 B.R. 887, 893 (N.D. Ill. 1993). In equitable terms it could be viewed that plaintiffs have received windfalls from the remedial order. First, a portion of the consideration paid for the security awarded to the plaintiffs was the interest component of the mortgage payments. Assuming that the interest on the Bank's loans to the plaintiffs was at market rate, the effect of the award is to give the plaintiffs a market rate of interest on the price of the units as well as the statutory interest award of 6%. This issue was not presented by the parties and we do not reach the issue of whether 410(a) allows for the calculation of consideration in such a way. Second, the plaintiffs were -24- 24 Although the general method employed by the district court in reaching the rescissionary damages award was appropriate, one aspect of the order needs to be modified. The district court ordered a novation of the amounts the plaintiffs owed on the first and second mortgage notes to the FDIC and HHI. A novation is typically a substituted contract that includes as a party one who was neither the obligor nor the obligee of the original duty. Restatement (Second) of Contracts 280 (1979). The court's order, however, does not provide for a substitution of parties and, given the cases cited by the district court in its order, Limoli v. Accettullo, 265 N.E.2d 92 (Mass. 1970) and Levy v. Bendetson, 379 N.E.2d 1121 (Mass. App. Ct. 1978), in which the courts cancelled the notes, it does not appear that a substitution was intended. Because an outright cancellation of the notes may render unclear the relative rights of the parties in the unit, we vacate the portion of the order which novates the notes along with granting rescissionary damages and remand with directions that the district court order a novation whereby the judgment defendants (FDIC, Keezer, Chaban, and HHI) are substituted as obligors on the notes secured by the mortgages and the given the option of keeping the units free and clear. Because this allows the plaintiffs to keep what they bought and effectively have a return of a significant portion of the consideration paid for the unit, it might be viewed as a potential over-recovery. -25- 25 plaintiffs are discharged of any liability on the notes. Any units eventually tendered to the judgment defendants would be subject to the mortgages.11
Lopes and the Rileys were denied any relief against the FDIC because they had given mortgages and promissory notes to disinterested third party banks and the court believed that it could not novate those debts. Although the district court correctly concluded that it should not interfere with the debts owed to the third party banks, it improperly denied Lopes and the Rileys rescissionary damages against the FDIC. The only difference between Lopes and the Rileys and the other plaintiffs is that Lopes and the Rileys paid substantially more cash to the defendants when purchasing the units. It was not the entire price because both Lopes and the Rileys appear to have given second mortgages to HHI. Lopes and the Rileys were still purchasers of unregistered securities. They should therefore be able to recover from the FDIC and 11. This approach keeps the respective rights in the units following the award relatively clear. After the transfer, the judgment defendants would own as tenants in common the units subject to the first and second mortgages on the properties. If the defendants were to default on the notes to the Bank, then the FDIC could foreclose on the first mortgage and use the proceeds of any sale to satisfy that debt. Anything left over would be used to satisfy HHI's second mortgage debt. Anything remaining after that would be distributed to the defendants, and presumably could be sorted out in an action among the defendants. -26- 26 the other defendants the consideration paid for the units. See Mass. Gen. L. ch. 110A, 410(a). Unfortunately, the record does not clearly reveal the consideration Lopes and the Rileys paid for the units. On remand the district court should hold a hearing to determine the consideration Lopes and the Rileys paid for the units. As with the other plaintiffs, Lopes' and the Rileys' entire claims will be subject to the ratable distribution rule. Lopes' and the Rileys' claims do raise additional wrinkles for consideration on remand. The novation given to the plaintiffs who borrowed from the Bank was an implicit setoff of the amount of the mortgage debt. Lopes and the Rileys are not entitled to such an implicit setoff because, with respect to the loans to the third-party banks, there would be no mutuality of obligation. Absent mutual obligations, a setoff, or its equivalent, is inappropriate. Cf. In re Lakeside Community Hospital, 151 B.R. at 891 (setoff in bankruptcy). Unlike the other plaintiffs, Lopes and the Rileys must bear the full cost of the Bank's insolvency. If Lopes and the Rileys convey their units to the defendants, they will remain liable on their promissory notes. It may be the case, however, that the third party banks will refuse to allow Lopes and the Rileys to reconvey their units to the defendants. If that occurs, the district -27- 27 court may want to make clear that their remedy is subject to any terms provided in their loan agreements with the third party banks. The district court may also consider treating such a situation like that in which a purchaser cannot tender the security because she no longer owns it. In that case, damages are awarded. See Mass. Gen. L. ch. 110A, 410(a).