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FDIC v. GRAVEE

January 15, 1997

FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff,
v.
JOHN R. GRAVEE, JEROME A. MAHER, DONALD J. PORTH, EDWARD J. WILLIAMS, ROBERT B. MERRIFIELD, I. ROBERT BALLIN, THOMAS O'BOYLE, RICHARD A. SAMUELS, and PATRICE D. WHITE, as independent executor of the ESTATE OF WILLIAM T. WHITE, JR., Defendants.



The opinion of the court was delivered by: SHADUR

 This action has spawned several pending motions that are ripe for decision. Federal Deposit Insurance Corporation ("FDIC") has moved to dismiss defendants' Counterclaim against it. *fn1" All defendants have brought motions for summary judgment on FDIC's gross negligence claim against them. In addition, certain defendants seek to strike certain exhibits submitted by FDIC in opposition to the summary judgment motions. For the reasons stated in this memorandum opinion and order, FDIC's motion to dismiss the Counter-claim is granted, the motions to strike are denied and the motions for summary judgment are denied.

 Facts2

 FDIC's Claim

 Horizon Federal Savings Bank ("Horizon") was a federally chartered and federally insured mutual savings and loan association headquartered in Wilmette, Illinois. It had branches throughout the Chicago metropolitan area. John Gravee ("Gravee") was Horizon's President, Chief Executive Officer and Chairman of the Board of Directors ("Board"); Jerome Maher ("Maher") was Horizon's Chief Operating Officer and Vice Chairman of its Board; and Donald Porth ("Porth"), Robert Merrifield ("Merrifield"), I. Robert Ballin ("Ballin"), Thomas O'Boyle ("O'Boyle") and William White, Jr. ("White") (collectively "Outside Directors") were the remaining members of Horizon's Board together with two other outside directors, Richard Samuels ("Samuels") and Edward Williams ("Williams"). All defendants except Gravee and Maher were members of Board's loan committee from 1983 to 1990, except that Samuels resigned from Horizon's Board at the end of 1985.

 In early 1982 Horizon (then known as First Federal Savings and Loan Association of Wilmette *fn3" ) was approached by officials of Federal Home Loan Bank Board ("FHLBB") and Federal Savings and Loan Insurance Corporation ("FSLIC") with the proposal that Horizon merge with Glenview Guaranty Savings & Loan Association ("Glenview"), Evergreen Savings & Loan Association ("Evergreen") and Lincoln Square Federal Savings & Loan Association ("Lincoln Square"). Glenview, Evergreen and Lincoln Square were all experiencing serious financial difficulties and would cease to operate without a merger with a solvent institution. On the basis of certain agreements with and forbearances by FHLBB and FSLIC, Horizon's Board approved the mergers, although absent the forbearances the resulting institution would have been insolvent from the moment of its creation.

 Before 1984 Horizon had long-standing relationships with two mortgage brokerage firms, Markham Sellers & Mony ("Markham") in Phoenix and Tucson, Arizona, and McKay, McManamon & Maguire ("McKay") in Sarasota, Florida. For some years those business relationships had been limited to residential mortgages and condominium conversions, which had been profitable for both Horizon and the brokers. Beginning in 1984 defendants, as Horizon's loan committee, approved a number of "acquisition, development and construction" loans ("ADC loans") submitted by Markham and McKay for commercial real estate projects in Arizona and Florida, types of loans that carried with them both greater risk and the possibility of greater return than residential mortgages. Among others, those projects included Tidy Island, a residential condominium project on an island off the coast of Sarasota that, although initially approved in 1984, had additional commitments of more than $ 3 million approved in 1985; Agua Dulce in Tucson, a raw land development project that, although originally approved in 1984, had additional commitments of more than $ 7.5 million during 1986 and 1987; La Buena Vida in Glendale, Arizona (a suburb of Phoenix), a project to convert undeveloped land into improved lots for which commitments of more than $ 15 million were approved in 1987 and 1988; Power Road Medical Center in Mesa, Arizona, a medical building project approved in 1985 for an initial commitment of more than $ 5 million; and a working capital line of credit to Markham, $ 2 million of which was approved in 1985. All of those loans are at issue in this case.

 FHLBB performed annual examinations of Horizon's operations. Its 1984 examination report, which Horizon received in February 1985, contained serious criticisms of Horizon's practices in connection with the ADC loans, including Horizon's reliance on Markham and McKay, its lack of underwriting and monitoring procedures and its lack of written policies regarding underwriting and monitoring. Specifically, the examiners concluded that Horizon had approved ADC loans even when it had failed to verify information submitted by the brokers with the loan applications, including information regarding the borrower's financial status, and had failed to obtain such basic information as appraisals on the property in question. Among other things, the 1984 examination report (D. Ex. 30 at 2.6 - 2.7) *fn4" said,

 
Since the previous examination report of December 14, 1983, the savings bank has funded 31 brokered loans totaling approximately $ 57,000,000. The loans in question are primarily development and construction loans which by their very nature carry a higher-than-average degree of risk.
 
The association is not employing prudent loan under- writing procedures in regards to lending policies, credit analysis, loan approval, appraisals, and disbursements. . . . While policies and standards are available for residential and apartment loans, there are none in place for the types of loans being originated through the two brokers.
 
* * *
 
Vice President Thomas Wallace *fn5" said that there was no need to verify the personal financial statements because the mortgage loan brokers handle that.

 In addition the letter from the supervisory agent that accompanied the examination report stated (D. Ex. 29 at 2):

 
This office is disturbed by the volume of these types of loans already in the portfolio and the serious nature of the documentation deficiencies noted by the examination staff.
 
* * *
 
It appears that the savings bank is relying to a large extent on loan brokers to perform basic loan underwriting and recordkeeping functions.

 That letter also addressed specific problems with Horizon's practices (id. at 3), recommending among other things that written underwriting policies for ADC loans be adopted (id.). It noted that failure to obtain appropriate documentation such as applications, credit reports and title policies before approving loans was "an unsafe and unsound business practice" (id.). It asked that defendants ensure that properly completed appraisals were obtained and reviewed in a timely manner and stated that in FHLBB's opinion an appraisal done at the request of a prospective borrower was not acceptable for underwriting purposes (id.).

 To return to the 1984 examination report, the examiners there also criticized several aspects of the Tidy Island project, including the lack of documentation of personal and corporate financial statements (D. Ex. 30 at 2.12), the inadequacy of the appraisal (id.) and the lack of timeliness of the appraisal (id.). As to the Agua Dulce project, the examiners found among other things that Horizon had funded 100% of the purchase price (id. at 2.15), that interest reserves would be exhausted half-way through the life of the loan (id.), that the borrowers had no personal liability (id.), that there were several serious problems with the appraisal (id. at 2.16) and that there was no record of the loan approval (id. at 2.18).

 As a result of those perceived deficiencies, in October 1984 (even before Horizon was given the examination report) FHLBB requested that Horizon temporarily cease approving out-of-state broker-originated ADC loans, a constraint to which Horizon agreed. FHLBB did not authorize Horizon to resume such lending until May 1985, and that authorization was conditioned on certain limitations in both the amount of assets Horizon could commit to such loans and the amount of the loans themselves.

 In a written response to the 1984 report (D. Ex. 32), Horizon's Board (now defendants) took strong exception to many of the most serious criticisms leveled at Horizon's underwriting and monitoring practices. In part the response said:

 
We do not agree with the current examiners' evaluation of the safety and soundness of said loans, nor do we agree that there is any lack of documentation. We ask that another examination of these loans be made as soon as possible to resolve the conflicting reports.
 
* * *
 
The Bank's [lending] policies are set out in the minutes as part of the standard resolutions which are approved and revised on a yearly basis. . . . We do not agree that there has been a problem regarding our lending policies.
 
* * *
 
The pertinent issue is whether adequate documentation was available both from the mortgage banking firm that originated the loans and from the lending officers of Horizon for the Board of Directors to make a judgment regarding the soundness of the investment. We do not agree that adequate documentation was not available.
 
* * *
 
We consider the allegation made by the examiner that the documentation is not adequate to be a serious misstatement of fact.
 
* * *
 
The examiner's criticism of certain of the appraisals in the Bank's loan files is unwarranted.
 
* * *
 
We believe the loans originated by the two mortgage banking firms in Phoenix and Sarasota contributed to the significant progress [in profitability] that has been made in the past two years.
 
* * *
 
We strenuously object to the criticism reflected in the examination. The opinions expressed by the examiners are not warranted. The facts, as set out by the examiners, are not correct.

 Next FHLBB conducted a special examination in July 1985 to review only the ADC loans approved between May and July of that year. David Kalina ("Kalina") was assigned as the supervisory agent for Horizon, a position in which he remained until 1989. Kalina's report concluded that the underwriting procedures Horizon had utilized in connection with those loans were satisfactory. Similarly, an annual examination report dated December 1985 did not repeat the criticisms that had been made in 1984.

 FHLBB's next annual examination took place in 1987. Once again the report (D. Ex. 47) found serious deficiencies in Horizon's ADC loan underwriting and monitoring practices. Kalina's letter accompanying the report (D. Ex. 46) stated:

 
The examination report indicated that the association had outstanding commitments of $ 55.4 million on construction loans purchased from [Markham] and aggregate outstanding loan balances on these loans was $ 30.5 million as of February 28, 1987. In addition, the institution had outstanding commitments of $ 7.2 million with aggregate outstanding balances of $ 6.1 million on construction loans purchased from [McKay] as of the same date. These loan concentrations are of supervisory concern since not only has the association failed to maintain adequate monitoring procedures for construction loans purchased from brokers, but [Markham] are the brokers for four of the construction loans which have been classified as substandard assets and the fifth loan classified as substandard is a working line of credit with [McKay]. We request that the board cease granting any further commitments to [Markham] and [McKay] until it can verify that an improvement in the association's documentation, underwriting, and monitoring procedures with regards to construction loans purchased from brokers.

 As for the report itself, it found problems with inadequate monitoring, lack of documentation and excessive reliance on loan brokers (D. Ex. 47 at 2); with Gravee's plan to alter the paper status of the Agua Dulce loan to improve Horizon's books (id. at 3); with the outdated appraisal, the lack of borrower equity and the "good potential for loss" on Agua Dulce (id. at A-12.5); and with the slow sales and lack of a current appraisal on Tidy Island (id. at A-13.1).

 Once again defendants rejected the criticisms in responding to the examination report. Their letter to Kalina said, among other things (D. Ex. 53 at 2, 5):

 
The Board does not agree with the opinions expressed in your letter with regard to the management of construction lending, broker relations, the quality of the Bank's assets, or lending in the Florida and Arizona areas. The documentation required by Section 563.17-1(c)(1) has been complied with on all construction loan files.
 
* * *
 
Management does not agree with the Supervisory Agent that there is any undue concentration of loans in either Florida or Arizona.

 FHLBB conducted two more annual examinations in 1988 and 1989. Each year's report echoed the criticisms of the 1984 and 1987 examinations.

 In 1988 the examination report (D. Ex. 60) found a lack of appraisal policies (id. at 2); an out-of-date appraisal on Tidy Island (id.); problems with the appraisals of Agua Dulce (id. at A-13.2); "material concerns" about the Power Road Medical Center project (id. at A-13.5 to A-13.6); difficulty with the fact that nearly half of the entire amount outstanding on ADC properties in Arizona consisted of "criticized assets" (id. at A-14.1 to A-15.4); and regulatory violations regarding appraisals (id. at A-26.1). Although defendants responded to the examination report, their response (D. Ex. 63) did not contest the examiner's conclusions as earlier responses had.

 FHLBB's 1989 examination report (P. Ex. 38) criticized Horizon's relationship with Markham (id. at 1-a-3); noted the lack of support for the La Buena Vida loans (id. at 2-a to 2-a-1); criticized the Power Road Medical Center loan and appraisal (id. at 2-a-6); said "it [was] unclear why bank management chose to proceed with [Agua Dulce]" (id. at 2-a-13 to 2-a-14); and criticized Tidy Island (id. at 2-a-16 to 2-a-17). Because the appointment of RTC as receiver (referred to later) intervened, Horizon had no opportunity to respond to that report.

 In addition to conducting the annual examinations, FHLBB engaged in an annual review of Horizon's business plans. From the time of the merger until Horizon was placed in receivership, FHLBB always approved those business plans.

 In 1989 Congress enacted FIRREA, which altered the existing regulatory structure and, most importantly to this case, did away with the recognition of supervisory goodwill to meet capital requirements. Without its supervisory goodwill, Horizon immediately fell below the capital requirements. Hence, on January 11, 1990 the Office of Thrift Supervision ("OTS") declared Horizon insolvent and appointed RTC as receiver. At that time 69.5% of Horizon's substandard or classified assets were the result of loans brokered by Markham, and 93% of Horizon's substandard or classified assets were in Arizona or Florida.

 RTC filed this action on July 27, 1994, asserting that between 1985 and 1988 defendants were grossly negligent in carrying out their duties as Horizon's directors and officers. In relevant part the Complaint alleges that for each of the doubtful loans defendants relied almost exclusively on Markham and McKay to perform the underwriting, failed to verify the information submitted by the brokers and failed to monitor the loans. Horizon ...


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