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Costello v. Grundon

October 18, 2010


Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. Nos. 1:05-cv-763, -727, -767, -740, -746, -764, -736. Robert W. Gettleman, Judge.

The opinion of the court was delivered by: Tinder, Circuit Judge


Before KANNE, ROVNER, and TINDER, Circuit Judges.

This consolidated case comes to us on appeals from the district court's grant of summary judgments in favor of the plaintiff-appellee, John W. Costello, Litigation Trustee under the Comdisco Litiga- tion Trust, and against defendants-appellants in an action to enforce certain promissory notes. For the reasons that follow, we affirm in part and vacate in part the grants of summary judgment in favor of the Trustee and remand for further proceedings not inconsistent with this opinion.


The defendants-appellants (the "Borrowers") are former high-level employees of Comdisco Inc., who participated in Comdisco's shared investment plan ("SIP") program ("SIP Program") offered in early 1998 by purchasing shares of Comdisco stock. One hundred percent of the stock purchase price was funded by personal loans from participating banks ("Lenders") represented by First National Bank of Chicago (later Bank One) as their agent. To secure the loans, the Borrowers executed promissory notes ("SIP Notes" or "Notes") in their personal capacities. Bank One had developed and implemented SIPs for other companies and promoted the SIP concept to Comdisco. Comdisco chose to deal with Bank One because of the bank's experience with SIPs for other companies.

Comdisco guaranteed the loans as provided in a Facility and Guaranty Agreement between Comdisco and the Lenders. The Comdisco guaranty was "a condition to the loan arrangement" Comdisco had made with the First National Bank of Chicago. (SA:244.) Comdisco received the loan proceeds directly from the Lenders and held the SIP Shares. It seems probable that without the guaranty, most of the loans would not have been made. SIP Participants were required to purchase a minimum of 8,000 shares of Comdisco stock. At $34.50 per share, that resulted in a minimum purchase price and loan of $276,000. The loans' principal amounts ranged from $276,000 to $1,725,000. Loans were made in excess of $1,000,000 to one borrower (05-737) who reported no net worth to the Bank, to another (05-745) for almost ten times his net worth, and to two others (05-735 & 05-726) for more than five times their net worth.

Comdisco introduced the SIP Program to prospective participants during a weekend meeting in Palm Springs, California. Prospective participants had to attend the meeting or listen to the presentation. The Borrowers received a binder of materials (approximately 240 pages) explaining the terms of the SIP Program (the "SIP Materials"). The SIP Materials included the SIP Plan Summary; Questions and Answers; Comdisco, Inc. Shared Investment Plan; the Facility and Guaranty Agreement between Comdisco and Bank One, individually and as agent (the "Facility Agreement"); a form of Master Promissory Note; and an Appendix that included a package of Bank One's documents. The Bank's package consisted of a form of Note; the Facility Agreement; a Letter of Direction; a Loan Application; an Account Application; and a letter from Bank One, stating that the Bank had to receive a completed personal financial statement to complete the loan application.

The SIP Presentation and SIP Materials informed the prospective participants of various restrictions on their ability to sell their SIP Shares and that SIP Participants were obligated for a specified time period to share any gains on the sale of the shares with Comdisco. More specifically, the shares were restricted in that: (a) Comdisco would hold a borrower's purchased shares until that borrower's loan to Bank One was discharged; (b) the borrower had to deliver a stock power, endorsed in blank, concerning his or her shares to Comdisco (a blank stock power is generally required when an institution holds securities as collateral for a loan so the institution may transfer and sell the stock to satisfy the debt); (c) the borrower had to execute an irrevocable Letter of Direction with Comdisco and the Bank to ensure that all cash dividends on the shares went into the borrower's account at Bank One to pay the accrued interest on the loan; (d) the proceeds from a permitted sale of the stock had to "first be used to repay the Loan," interest and fees at Bank One; (e) the borrower paid a prepayment penalty to Bank One if the loan was paid early; and (f) the certificate representing the borrower's shares contained a legend as to the stock's restricted status. (The language of the Notes reflected that the stock being purchased was "Restricted Stock" and the Facility Agreement, which was incorporated into the terms of the Notes, referred to the SIP Shares as "Restricted Stock.") The SIP Program was structured so that the SIP Shares could not be sold during the first year of the program, with a few exceptions. An "[SIP Participant was] entitled to 100% of the gain, after payment of all amounts due on the loan, unless [the Participant] voluntarily terminate[d] [his/her] employment or [sold] the shares within three (3) years after purchase. In either such event, the Company [was] entitled to 50% of any gain upon sale." (SA:207)

The SIP Participants were required to notify Comdisco of any intention to sell their SIP Shares because Comdisco had the right to repurchase the SIP Shares. The SIP Materials indicated that the promissory notes to be executed in connection with the loans had a fixed maturity date, that at maturity a final balloon payment of principal and interest would be due, and that Comdisco would guarantee the SIP Notes.

The SIP Materials stated that "the Loan is not secured by the stock" (SA:226) and that the "SIP shares do not serve as collateral for the loan . . . the loan is not a margin loan." (SA:229.) When presenting the SIP Plan, Comdisco advised prospective participants that the "loan is not technically secured by the securities . . . and this is not a margin account." (SA:355.) During the SIP Presentation, an unidentified person asked, "[C]an th[e] shares be used as security for other transactions or collateral for other type[s] of loans?" A Comdisco representative answered:

No, and the reason being is they are restricted from the standpoint that the company has certain rights with respect to that stock, depending upon your employment. And also there's restrictions under the terms of the bank loan that you have that there are certain things that will happen with the proceeds to the extent that you sell it before the bank loan is paid off.

So while it is not technically a secured loan, the company retains the stock physically and you cannot pledge that for other loans.


Comdisco also provided prospective SIP Participants with information regarding whether: (a) the proposed loans were margin loans; (b) the proposed loans were secured by the stock; (c) the stock could be pledged for another loan; (d) the proposed loans would violate or be inconsistent with Regulation G or Regulation U; and (e) Comdisco's performance of its obligations under each Loan Document to which it was a party would violate any applicable legal requirement. The SIP Materials included Comdisco, Inc.'s 1998 Stock Option Program, which provided in Section 6.11:

No Illegal Transactions. The Program and all Stock Options granted pursuant to it are subject to all laws and regulations of any governmental authority which may be applicable thereto; and notwithstanding any provision of the Program or any Stock Options, Participants shall not be entitled to exercise Stock Options or receive the benefits thereof and the Company shall not be obligated to deliver any Common Stock or pay any benefits to a Participant if such exercise, delivery, or payment of benefits would constitute a violation by the Participant or the Company of any provision of any such law or regulation.


The SIP Materials described the Facility Agreement as "the agreement between Comdisco and [Bank One] establishing the loan program" and stated that "[b]y signing the Note, you will represent that you have carefully reviewed the Facility Agreement." (SA:225.) In the Facility Agreement, Comdisco represented and warranted that:

The execution and delivery of, and performance by the Company of its obligations under, each Loan Document to which it is a party will not result in a breach or violation of, conflict with, or constitute a default under the certificate of incorporation or bylaws of the Company, any Requirement of Law . . . . " (SA:283.) The Facility Agreement was included within the meaning of "Loan Document"; "Requirement of Law" included "the Securities Act of 1933, the Securities Exchange Act of 1934, [and] Regulations G [and] U . . . of the Board of Governors of the Federal Reserve System." Comdisco further represented and warranted that:

No part of the proceeds of any Loan will be used in a manner which would violate, or result in a violation of, Regulation G [or] . . . Regulation U . . . . Neither the making of any Loan hereunder nor the use of the proceeds thereof will violate or be inconsistent with the provisions of Regulation G [or] . . . Regulation U . . . .


In discussing Comdisco's Guaranty, the Facility Agreement repeatedly referred to the "collateral securing the Guaranteed Debt." However, section 7.06 of the Facility Agreement provides:

No Collateral. Notwithstanding any reference herein to any collateral securing any of the Guar- anteed Debt, it is acknowledged that, on the date hereof, neither the Company nor any Borrower has granted, or has obligation to grant, any security interest or other lien on any of its property (including, without limitation, the Restricted Stock) to the Lenders as security for the Guaranteed Debt.

(SA:290.) "Guaranteed Debt" is defined as the principal and interest on the loans to the borrowers, plus any other fees of borrowers owing pursuant to the Notes. (SA:288.)

The Borrowers elected to participate in the SIP Program, executing a SIP option exercise form and a Letter of Direction, authorizing the Bank to pay the proceeds of the loan to Comdisco. Each of them also executed an SIP Promissory Note. The proceeds of the SIP Loans were remitted to Comdisco as consideration for the purchase of the SIP Shares. Comdisco caused the appropriate number of shares to be allocated and transferred to its Registrar and Transfer Agent, Mellon Investor Services, LLC, for the benefit of the Borrowers. The Borrowers opened accounts at the First National Bank of Chicago in order to receive distributions of stock dividends that were used to offset payments due under the SIP Notes.

Within six months, Comdisco's stock split, doubling the number of shares each SIP Participant had obtained. And in just over two years, Comdisco's stock was trading at $53 per share. Several participants decided to sell their shares and did so at a price that not only satisfied their loan obligations but also earned them a profit, even after sharing with Comdisco the required 50% of the balance of the gain realized on the sale after payment of principal, interest, and fees due on the loan. However, the tide turned and in July 2001, Comdisco filed for bankruptcy. This was an event of default under the Notes and caused Bank One to accelerate all amounts outstanding on the Notes. The bankruptcy also triggered an event of default under the Facility Agreement. The Lenders filed a proof of claim in Comdisco's bankruptcy for approximately $133 million. Comdisco settled its guarantor obligation to the Lenders for a payment of over $126 million in exchange for the Lenders' assignment of all rights under the Notes against the Borrowers to the Comdisco Litigation Trustee. The bankruptcy court approved the settlement, and the district court held that the Trustee is the holder of the Notes with all rights of enforcement.

In 2005, the Trustee filed separate actions against each Borrower, seeking to enforce the SIP Notes. The Borrowers raised many affirmative defenses, including fraud and duress. The Trustee moved for summary judgment against two of the defendants, James Duncan and Lyssa K. Paul. Duncan and Paul filed a cross-motion for summary judgment, arguing that the Notes were unenforceable based on violations of federal margin regulations. In December 2007, the district court denied their cross-motion and granted the Trustee's motion. The court ruled that the Trustee had proved his prima facie case on the SIP Notes and rejected the defendants' "primary defense that the SIP Program was fraudulent" (SA:177), concluding that Comdisco's alleged misrepresentations were expressions of legal opinion, which could not support a fraud claim. (SA:178). The court found that the defendants had not shown reliance on the alleged misrepresentations. (Id.). The district court also rejected the defendants' argument that the loans were unenforceable because they violated Regulation U, after concluding that the defendants could not assert the alleged illegality of the loans as an affirmative defense. (SA:180.) As for the negligent misrepresentation defense, the court found based on the record that the defense was not available as against Comdisco or the banks. The district court rejected all other affirmative defenses.

The Trustee subsequently moved for summary judgment against the remaining defendants, incorporating its memorandum in support of its summary judgment motions against Duncan and Paul. The defendants amended their affirmative defenses, asserting that Comdisco committed securities fraud and violated securi-ties laws and that the violations constituted breaches of contract which excused the Borrowers' nonperformance. The Trustee supplemented his memorandum to address the new defenses. The district court granted summary judgment to the Trustee, concluding that the SIP Plan did not violate the margin regulations and, even if it had, the defendants had no evidence of scienter and thus could not establish the Rule 10b-5 claim in their fifth affirmative defense. The court also decided that even if there was a technical violation of any regulation, such a violation did not render the Notes unenforceable because the defendants were not within the "zone of interests" protected by the regulations. The district court entered judgments, and the Borrowers appealed.

Within one year of the entry of the judgments, the Trustee filed a Motion for Correction, or in the Alternative, Modification of Judgment Pursuant to Federal Rule of Civil Procedure 60. The motion states that "due to an inadvertent oversight, the judgments understated the amounts of interest owing under the promissory notes on which judgment was entered." (60SA:147.) The Borrowers opposed the motion on procedural grounds, arguing that any relief, if available, was available only under Rule 60(b)(1). The district court indicated that it was inclined to grant the Trustee's Rule 60(a) motion, and we granted the district court leave to rule on the Rule 60(a) motion. The district judge entered Rule 60(a) Amended Final Judgment Orders, nunc pro tunc to the dates of the prior judgments (October 2008), increasing the judgment amounts entered against the Borrowers who are the appellants in the cases before us by over $1 million. Amended Judgments were entered and the Borrowers timely appealed. The appeals were consolidated for disposition. Additional facts are discussed later in this opinion as appropriate.


The Borrowers argue that the district ...

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