BC624542 Hoffman v. City National Bank, N.A.

March 13, 2017 Tentative

City National Bank Demurrer: Sustained without leave to amend

Joinder by Fitzwilliam Defendants to Demurrer: Sustain without leave to amend
Defendants to prepare appropriate order consistent herewith and to answer or otherwise
respond to the 7th cause of action by April 12, 2017.

Defendant City National Banks Requests for Judicial Notice: Grant in full
These are unopposed.

Merits of Demurrer:
Defendant bank demurs as to all of the causes of action except the claim for fraudulent transfer
(7th C/A) based on the equitable defense of in pari delicto. Based on controlling state appellate
cases and notwithstanding plaintiffs invocation of non-controlling federal court decisions, the
Court finds that there is no factual issue and that a ruling on this purely legal question at this
early point in the life of this case is legally correct. The defense works with equal potency for
both the bank and the Fitzwilliam defendants.

The extent of fault of a plaintiff (or here a plaintiffs predecessor) may present a factual issue
when the in pari delicto affirmative defense is raised requiring resolution of this issue by motion
for summary judgment or even by court trial, but the undisputed allegations of the plaintiff
herein, the court-appointed Receiver of National Automated Systems, Inc. (NAS), via the
Complaint herein and other documents authored or approved by the plaintiff of which judicial
notice can be properly taken, remove any factual question from the issue now presented.
Plaintiffs own allegations in this case and in related litigation sufficiently demonstrate the
thorough-going bad-faith misconduct of NAS under its original principals during the relevant
period. It was run as a Ponzi scheme, pure and simple. Defendant bank is not relying on some
disputed allegations regarding this fraudulent conduct by NAS. Rather it is relying on plaintiffs
own words and the events to which plaintiff refers (e.g. the guilty pleas by NAS principals
regarding their misuse of NAS to the harm of NAS investors). For this reason, nothing will
change if this plaintiff were granted leave to amend since he is estopped to deny hereafter the
fact allegations made in his initial Complaint.

The federal cases on which plaintiff relies, e.g. FDIC v. OMelveny & Myers (9th Cir. 1995) 61
F.3d 17 do appear at times to be inconsistent with the state appellate decisions binding on this
Court under Auto Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d 450. Some of them
express a broad view that the in pari delicto defense has no relevance after a fraudulent
investment entity has been purged of its original schemers (e.g. the evil zombie theory). The
banks briefs adequately set forth at length why those cases are wrongly decided and/or factually
distinguishable. It is enough to say that the current question is state-law legal question such that
federal court precedents from courts inferior to the U.S. Supreme Court are not controlling on
this Court.

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Receiver Hoffmans complaint herein is not a direct suit for investor recovery. Investor claims,
as such, can be advanced by individual plaintiffs and/or via a class action device. While the
Receivers good efforts under the general direction of the federal District Court will hopefully
recover funds properly due the estate from culpable parties, the Receiver does, in general
principle stand in the shoes of Messrs. Joel Gillis and Edward Wishner, odious as those shoes
may be.

What is key to this ruling are the prior state appellate cases. In Camerer v. California Savings &
Commercial Bank (1935) 4 Cal.2d 159, the relevant plaintiff was an injured safe deposit box
customer whose bearer bonds had been misused by a bank CEO to perpetuate a fraud. The bank
had failed during the Great Depression, and the Superintendent of Banks (one Edward Rainey)
had assumed control of the bank and its remaining assets and possessions (including plaintiff
Camerers bearer bonds). The question was not whether the Receiver, i.e. Rainey in his
capacity as Superintendent of Banks could get something more out of Camerer. The question
was whether Camerer could get his bonds back, and he did. The trial court had rendered
judgment for plaintiff to get his bonds back, but the District Court of Appeal had reversed on the
theory that imputed co-equal blame on plaintiff Camerer for loaning his bearer bonds to the bank
(i.e. its crooked CEO I.I. Irwin). The Supreme Court rejected the District Court of Appeals
holding that the Superintendent enjoyed some sheep-dip washing away the taint of Irwin:

The District Court of Appeal expressly recognized in the portion of the opinion above
quoted that the bank did not occupy the status of a holder in good faith of the bonds. But
the appellate court was of the view that the defendant Superintendent of Banks,
representing the creditors and depositors, could assert rights and defenses not
available to the bank, and that in his capacity of receiver he was entitled to retain
the bonds as assets for distribution to depositors and creditors. It was to examine this
conclusion that we granted plaintiff Camerer's petition for transfer to this court.
***
Had Camerer delivered or permitted his bonds to be delivered to the bank to be used to
deceive the bank examiner, upon the authority of the above cases, defendant as receiver
would be entitled to retain them. But the trial court's findings exonerate Camerer from
connivance and collusion in the fraud and from negligence. In cases involving negotiable
promissory notes it has been held that the receiver of a bank cannot recover on the note
where the maker was not a party to the deceit practiced on the bank examiner and was not
aware that the note was to be used for an unlawful purpose.
***
In the Verder case it is stated that the rule permitting a liquidating receiver to
claim certain rights and defenses not available to the insolvent corporation is applied to
cases where the dealings of the insolvent are in fraud of the creditors' rights, or where the
dealings are had directly between the third party claimant and the insolvent corporation.
But such generalizations mean little except as applied to particular facts. In certain
proper cases where the receiver has been permitted to assert defenses not available
to the insolvent, it will be found that dealings were directly with the insolvent, or in
fraud of the creditors' rights, but it does not follow that in all cases where either of
these circumstances is present the receiver may assert rights not available to the
insolvent in disregard of rules of law and equitable principles.

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 The judgment [against the Superintendent of Banks] is affirmed.

4 Cal.2d at 168, 171-72, 176. Simply put, the facts did not support the Superintendents view
that plaintiff Camerer shared in pari delicto status on HIS claim, and the Court further held that
the Superintendent had no better legal or equitable rights in defending the claim than fraudster
Irwin. This does not logically lead a conclusion that Hoffmans tort claims against City National
Bank escape in pari delicto analysis.

A generation later, the California appellate courts reaffirmed the general principle that [a]
receiver occupies no better position than that which was occupied by the party for whom he
acts. . Downey v. Humphreys (1951) 102 Cal.App.2d 323, 336. There a nonsuit after a trial
against the Insurance Commissioner in his capacity as Liquidator of an insolvent insurance
company in a claim against a general agent for payment of unearned premiums was affirmed
because the defendant had a legally valid claim for a complete setoff as against the plaintiffs
predecessor. While in pari delicto was not at issue, the larger standing in the shoes principle
was being applied to limit a receivers right to special or better justice.

A decade later, a receivers attempt to avoid the general rule was again rejected (via sustaining of
a demurrer without leave to amend) in Allen v. Ramsay (1960) 179 Cal.App.2d 843. Here the
question was whether or not inquiry notice of a claim by the insolvent entity was chargeable to
the court-appointed receiver when a statute of limitations defense was raised. The answer was
yes:

In the complaint in this case the plaintiff alleged that he first had knowledge that
the "repayment by check" to defendant was made solely from trust funds on or
about February 27, 1957, from an audit of Cole's books by an auditor employed by the
trustee in bankruptcy. But the time when the receiver made the discovery himself is not
particularly important in this case. The time when the party or parties for whose benefit
he brought the action first made the discovery is the important date and it is the only date
which is proper in the establishment or nonestablishment of a cause of action. There is
nothing in the complaint as to why the plaintiff's principals failed to discover the claimed
fraud. As heretofore set forth, the receiver takes his cause of action subject to all of the
defenses that can be raised against his assignor with the exceptions heretofore noted.

A receiver occupies no better position than that which was occupied by the person
or party for whom he acts and the receiver takes the property and the rights of one for
whom he was appointed in the same condition and subject to the same equities as existed
before his appointment and any defense good against the original party is good against
the receiver. (Downey v. Humphreys, 102 Cal.App.2d 323; Estate of Smith, 123
Cal.App.2d 844.)

179 Cal.App.2d at 853-54.

The more recent case of Casey v. U.S. Bank Natl Assn (2005) 127 Cal.App.4th 1138, involved a
situation where a bankruptcy trustee sued various banks after a corporate entity had been abused
by certain officers. There, unlike this case, the in pari delicto defense (applied by the trial court)

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was held on appeal NOT to apply on demurrer because domination of the insolvent corporation
by the fraudulent actors was NOT alleged:

We further note that the second amended complaint contains no allegation the
DFJ Fiduciaries acted as the alter egos of DFJ, or otherwise so dominated and
controlled DFJ that their wrongdoing should be imputed to the corporation.
(O'Halloran v. First Union Nat. Bank of Florida (11th Cir. 2003) 350 F.3d 1197, 1204
[absent alter ego allegation, wrongs of individual acting adversely to corporation are not
imputed to corporation]; In re Bennett Funding Group, Inc. (2nd Cir. 2003) 336 F.3d 94,
100 [alter ego allegation necessary for imputing agent's wrongdoing to
corporation]; Lafferty, supra, 267 F.3d at p. 360 [Wagoner rule and in pari delicto
defense apply only if fraudulent actors controlled and dominated corporation].) While
in a different procedural context (e.g., summary judgment), the banks may be able to
establish a factual basis for imputing the DFJ Fiduciaries' wrongdoing to DFJ, the
complaint itself does not support that result. Consequently, we conclude the court erred in
sustaining the demurrer on the grounds of in pari delicto and the Wagoner rule.

127 Cal.App.4th at 1143-44.

The general concept of applying in pari delicto when a corporation is so dominated (as alleged
here by plaintiff in various pleadings) was approved in Peregrine Funding, Inc. v. Sheppard
Mullin Richter & Hampton LLC (2005) 133 Cal.App.4th 658. That case arose out of a Ponzi
scheme, like the instant case, and a law firm was sued for alleged facilitation of the Ponzi
scheme. Judgment on an Anti-SLAPP motion under C.C.P. 425.16 was ordered because the
plaintiff corporation, acting through its bankruptcy trustee, was stuck for in pari delicto (i.e.
unclean hands) purposes with the fraudulent conduct of its former officers.

A bankruptcy trustee succeeds to claims held by the debtor as of the commencement of

bankruptcy. (11 U.S.C. 541(a)(1).) Section 541 of the Bankruptcy Code thus requires
that courts analyze defenses to claims asserted by a trustee as they existed at the
commencement of bankruptcy, and later events (such as the ouster of a wrongdoer) may
not be taken into account. (Lafferty, supra, 267 F.3d at pp. 356357; In re Hedged-
Investments Associates, Inc., supra, 84 F.3d at p. 1285; see also Bank of Marin v.
England (1966) 385 U.S. 99, 101 [17 L. Ed. 2d 197, 87 S. Ct. 274] [The trustee
succeeds only to such rights as the bankrupt possessed; and the trustee is subject to all
claims and defenses which might have been asserted against the bankrupt but for the
filing of the petition].) In the context of an unclean hands defense, this means a
bankruptcy trustee stands in the shoes of the debtor and may not use his status as an
innocent successor to insulate the debtor from the consequences of its wrongdoing.
***
We agree with Sheppard that Peregrine's claims present a classic case for the unclean
hands defense. Although plaintiffs are correct that application of this defense generally
rests on questions of fact (see Kendall-Jackson Winery, Ltd. v. Superior Court, supra, 76
Cal.App.4th at p. 978), this does not mean the defense can never prevail at the pleading
stage or on a motion to strike. Where, as here, a plaintiff's own pleadings contain
admissions that establish the basis of an unclean hands defense, the defense may be
applied without a further evidentiary hearing.

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133 Cal.App.4th at 681. It bears noting that a bankruptcy trustee acting under federal law, as in
Peregrine, may have certain rights which are not conferred on ordinary receivers and the rights
of a bankruptcy are defined as a matter of federal, bankruptcy. Plaintiff herein, William J.
Hoffman, is a court-appointed receiver, not a bankruptcy trustee. Insofar as bankruptcy trustees
find themselves stuck with their predecessors bad deeds (as they often do in the cases cited
herein), there is no reason to think that state-law receivers have a better coat of Teflon.

The in pari delicto defense was successfully used on demurrer against a bankruptcy trustee in the
recent case of Uecker v. Zentil (2016) 244 Cal.App.4th 789:

I. In Pari Delicto and Bankruptcy Trustees

The Trustee first argues that, assuming in pari delicto would bar the claims if
asserted by the Company, the doctrine does not bar them when asserted by the
bankruptcy trustee suing on behalf of the Company's bankruptcy estate. We disagree.

Peregrine Funding rejected a similar argument. The court explained: A

bankruptcy trustee succeeds to claims held by the debtor as of the commencement of
bankruptcy. (11 U.S.C. 541(a)(1).) Section 541 of the Bankruptcy Code thus requires
that courts analyze defenses to claims asserted by a trustee as they existed at the
commencement of bankruptcy, and later events (such as the ouster of a wrongdoer) may
not be taken into account. [Citations.] In the context of an unclean hands defense, this
means a bankruptcy trustee stands in the shoes of the debtor and may not use his status as
an innocent successor to insulate the debtor from the consequences of its wrongdoing.
[Citations.] [The debtor's] unclean conducti.e., its participation in the scheme that
defrauded investors of millionsmust therefore be considered without regard to the
trustee's succession. (Peregrine Funding, supra, 133 Cal.App.4th at p. 680.)

244 Cal.App.4th at 794. Plaintiffs cites no California state appellate case factually on point
which leads to a different conclusion.

This Court is aware that Circuit Judge Richard Posner and Circuit Judge Alex Kozinski (via the
Per Curiam opinion in FDIC v. OMelveny & Myers) would apply an alternative evil zombie
purge rule, but their jurisprudence is not controlling on this Court. The Second Circuit applied
in pari delicto to dismiss of claims of a Trustee appointed under the Securities Industry
Protection Act on behalf of victims of the infamous Bernie Madoff Ponzi scheme brought against
various JP Morgan Chase & Co., UBS AG, HSBC Bank plc and UniCredit Bank Austria AG for
their alleged facilitation of the Madoff Ponzi scheme over a period of months and years (claims
very similar to those presented here by Receiver Hoffman). The trial court had granted a motion
to dismiss, the federal court equivalent of a demurrer on the basis of in pari delicto. This ruling
was affirmed on appeal in Picard v. JP Morgan Chase Bank & Co. (In re Bernard L. Madoff
Investment Securities LLC) (2nd Cir. 2013) 721 F.3d 54. While New York law was being applied
instead of California substantive law, the reasoning is the same, and Chief Judge Jacobs reasons
for rejecteing the Trustees arguments in that case speak with equal force to Receiver Hoffmans
scattershot responses in this case:

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 Under New York law, one wrongdoer may not recover against
another. See Kirschner v. KPMG LLP, 15 N.Y.3d 446, 938 N.E.2d 941, 950, 912
N.Y.S.2d 512 (N.Y. 2010). The principle that a wrongdoer should not profit from his own
misconduct "is . . . strong in New York." Id. at 964. The New York Appellate Division,
First Department, has long applied the doctrine of in pari delicto to bar a debtor
from suing third parties for a fraud in which he participated. See Barnes v. Hirsch,
215 A.D. 10, 212 N.Y.S. 536, 539 (App. Div. 1st Dep't 1925) ("The bankrupts could not
recover against these defendants for bucketing orders because they were responsible for
the illegal transaction and parties to the fraud."), aff'd, 242 N.Y. 555, 152 N.E. 424 (N.Y.
1926).

A "claim against a third party for defrauding a corporation with the

cooperation of management accrues to creditors, not to the guilty
corporation." Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir.
1991) (citing Barnes, 212 N.Y.S. at 537). The debtor's misconduct is imputed to the
trustee because, innocent as he may be, he acts as the debtor's representative. See Wight v.
BankAmerica Corp., 219 F.3d 79, 87 (2d Cir. 2000) ("[B]ecause a trustee stands in the
shoes of the corporation, the Wagoner rule bars a trustee from suing to recover for a
wrong that he himself essentially took part in."); accord Breeden v. Kirkpatrick &
Lockhart LLP (In re Bennett Funding Grp., Inc.), 336 F.3d 94, 99-100 (2d Cir.
2003) (applying Wagoner rule in the context of "the greatest Ponzi scheme [then] on
record" and holding that "the defrauded investors and not the bankruptcy trustee" were
entitled to pursue malpractice claims against attorneys and accountants arising from the
fraud).

Picard alleges that the Defendants were complicit in Madoff's fraud and facilitated
his Ponzi scheme by providing (well-paid) financial services while ignoring obvious
warning signs. These claims fall squarely within the rule of Wagoner and the ensuing
cases: Picard stands in the shoes of BLMIS and may not assert claims against third
parties for participating in a fraud that BLMIS orchestrated.

Picard's scattershot responses are resourceful, but they all miss the mark. He
contends that a SIPA trustee is exempt from the Wagoner rule, but adduces no
authority. He argues that the rationale of the in pari delicto doctrine is not served
here because he himself is not a wrongdoer; but neither were the trustees in the
cases cited above. He contends that in pari delicto should not impede the enforcement
of securities laws, citing Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299,
105 S. Ct. 2622, 86 L. Ed. 2d 215 (1985); but Bateman Eichler is inapposite. See id. at
315-16 (holding that in pari delicto would not prevent defrauded tippee from bringing
suit against defrauding tipper, at least absent further inquiry into "relative culpabilities"
of tippee and tipper). He invokes the "adverse interest" exception, which directs a court
not to impute to a corporation the bad acts of its agent when the fraud was committed for
personal benefit. See The Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d
822, 827 (2d Cir. 1997). However, "this most narrow of exceptions" is reserved for cases
of "outright theft or looting or embezzlement . . . where the fraud is committed against a
corporation rather than on its behalf." Kirschner v. KPMG LLP, 15 N.Y.3d 446, 938

6
 N.E.2d 941, 952, 912 N.Y.S.2d 512 (N.Y. 2010). It is not possible thus to
separate BLMIS from Madoff himself and his scheme. Finally, Picard argues that the
district courts should not have applied the in pari delicto doctrine at the pleadings stage;
but the New York Court of Appeals has held otherwise. See id. at 947 n.3; see
also Wagoner, 944 F.2d at 120. Early resolution is appropriate where (as here) the
outcome is plain on the face of the pleadings.

Picard v. JP Morgan Chase Bank & Co., supra, 721 F.3d at 63-64 (emphasis added).

In sum, a fair reading of the state appellate cases show that the in pari delicto defense remains
alive and well, that it has been repeatedly applied to leave morally innocent receivers and
bankruptcy trustees without effective redress, and that, consistent therewith, the asserted
exceptions to this broad equitable principle have not yet swallowed the rule. There is no reason
to grant leave to amend. Accordingly, the demurrer to causes of action one through six and eight
and nine is sustained without leave to amend. Defendants to prepare appropriate order consistent
herewith and to answer or otherwise respond to the 7th cause of action by April 12, 2017.