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Travelers Casualty and Surety Company of America v. Paderta

United States District Court, N.D. Illinois, Eastern Division

March 29, 2018

Travelers Casualty and Surety Co. of America, Plaintiff,
v.
John P. Paderta and Fifth Third Bank, Defendants.

          MEMORANDUM OPINION AND ORDER

          Honorable Thomas M. Durkin United States District Judge.

         Travelers Casualty and Surety Co. of America seeks to have Fifth Third Bank pay it funds deposited in a Fifth Third account, which Fifth Third took to satisfy a loan it made to the account holder. Travelers alleges that it has standing because, pursuant to certain surety and indemnity agreements, it is the equitable subrogee of (a) the account holder, (b) the entities that paid the funds in question to the account holder, and (c) entities that the account holder had an obligation to pay using the funds. Travelers and Fifth Third have cross moved for summary judgment on liability on Counts I (conversion) and II (constructive trust)-i.e., the issue of which of them has priority to the funds. See R. 184; R. 187. For the following reasons, Travelers's motion is granted, and Fifth Third's motion is denied.

         Legal Standard

         Summary judgment is appropriate “if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a); see also Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). The Court considers the entire evidentiary record and must view all of the evidence and draw all reasonable inferences from that evidence in the light most favorable to the nonmovant. Ball v. Kotter, 723 F.3d 813, 821 (7th Cir. 2013). To defeat summary judgment, a nonmovant must produce more than “a mere scintilla of evidence” and come forward with “specific facts showing that there is a genuine issue for trial.” Harris N.A. v. Hershey, 711 F.3d 794, 798 (7th Cir. 2013). Ultimately, summary judgment is warranted only if a reasonable jury could not return a verdict for the nonmovant. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).

         Background[1]

         I. Krahl & Travelers

         Krahl was a general contractor in the business of providing general contracting services for construction projects. R. 185 ¶ 6. The owners of some of the projects Krahl undertook required Krahl to obtain performance surety bonds to guarantee Krahl's performance, including payment of subcontractors, and required the subcontractors to submit lien waivers in order to receive payment from the project owners through Krahl as general contractor. Id. ¶ 7. Travelers issued such surety bonds for Krahl. Id. ¶¶ 8, 10. To receive surety bonds from Travelers, Krahl also had to enter into a indemnity agreement with Travelers. Id. ¶ 11. According to the indemnity agreements, Krahl was required to hold the funds it received from project owners in trust. Id. ¶ 15. But the agreement does not specifically require Krahl to segregate the funds or otherwise identify them as funds held in trust. Id. ¶ 19; see also Id. ¶¶ 20-22.

         At Krahl's request, Travelers issued surety bonds for the following seven projects in Illinois and Colorado relevant to this case: Northwestern Memorial Hospital (Bond 105150320); Rush University Medical Center (Bonds 105150332, 105200157, 105200155, 105268775); Trammell Crow Co. (Bond 105268769); City and County of Denver (Bond 105268766). Id. ¶ 23. These seven bonds covered a “combined penal sum” of about $40 million. Id. The subcontractors on these projects submitted lien waivers. Id. ¶¶ 94, 101, 108, 115, 122, 129, 135.

         II. Krahl & Fifth Third

         Krahl borrowed $6 million from Fifth Third over a period of about five years pursuant to a revolving line of credit. Id. ¶ 28. The loan documents provided Fifth Third a security interest in all of Krahl's accounts receivable and proceeds thereof, and in all of Krahl's deposit accounts. Id. ¶ 29. The loan documents also defined “Right of Setoff” as follows:

To the extent permitted under applicable law, [Fifth Third] reserves a right of setoff in all [Krahl's] accounts with [Fifth Third] (whether checking, savings, or some other account). . . . However, this does not include . . . any trust accounts for which setoff would be prohibited by law.

Id. ¶ 56.

         Krahl also opened a deposit account with Fifth Third. Id. ¶ 30. The account was not designated as a trust account, and included no other similar restriction or designation. Id. Krahl regularly made deposits into and withdrawals from this account. Id.

         III. Fifth Third's Knowledge of Krahl's Business

         Fifth Third considered its loans to Krahl to be “high quality, high performing.” Id. ¶ 31. Because of the quality of the loans made to Krahl, Krahl was only required to submit “gross numbers and balances on its various projects-the details of each project, information about accounts receivable [and payable]” were not required by Fifth Third. Id. Nevertheless, Fifth Third admits that it had documents in its possession showing that some of Krahl's projects required Krahl to obtain surety bonds, and that Travelers had issued such bonds for some of Krahl's projects. Id. ¶ 33. For example, Krahl submitted to Fifth Third a document titled, “Request for Credit Commitment, ” describing Krahl's business and noting that it sometimes was required to obtain surety bonds for its projects, and that the number of projects requiring such bonds was “growing.” Id. ¶¶ 34-35. Fifth Third's analysis also noted that all five of Krahl's largest accounts were bonded projects. Id. ¶¶ 38-39. Additionally, Fifth Third's analysis of Krahl's finances distinguished between bonded and non-bonded accounts receivable, because bonded accounts receivable had “diminished collateral value.” Id. ¶ 40; see also Id. ¶¶ 37, 40-42, 58-59. Fifth Third received monthly reports from Krahl regarding its accounts receivable and payable. These reports identified which accounts were bonded and unbonded. These reports were the basis for Krahl to demonstrate a new collateral borrowing base that would enable Krahl to continue to borrow from Fifth Third. Id. ¶¶ 78-80.

         Matthew Doucet was part of Fifth Third's relationship management team for the Krahl account. Id. ¶ 48. Prior to becoming employed by Fifth Third, Doucet worked for surety companies underwriting construction projects. Id. ¶¶ 44-46. At his deposition, he testified that he has general knowledge of the business of surety companies and that they obtain indemnity agreements from the principals on the bonds, such as Krahl. Id. ¶¶ 51-54. He also testified that he knows that the “intent” of a surety bond is that the general contractor is to “treat” bonded funds as “trust funds.” Id. ¶ 55.

         Doucet testified Fifth Third had quarterly meetings with Krahl, and at those meetings Fifth Third obtained financial statements, account receivable reports, and work in progress reports from Krahl. Id. ¶¶ 48-49. Doucet also testified that he would ask Krahl about its surety relationships, and he knew that Krahl had a surety relationship with Travelers. Id. ¶¶ 49-50. He testified further, however, that he did not know which projects Travelers had bonded. Id. ¶ 50. He testified further that “[i]n the eyes of the bank, we view bonded accounts to be the collateral of the surety company, ” and that “[i]n the case of those particular surety bonded projects, the surety company has a priority to those funds.” Id. ¶ 61.

         IV. Krahl in Default

         The FBI executed a search warrant on Krahl's offices on January 6, 2010. Id. ¶ 69. When Fifth Third inquired about the situation, Krahl informed Fifth Third that as a result of the FBI investigation it would not be pursuing collection of accounts receivable worth approximately $5 million. Id. ¶ 70. The next day, on January 7, Krahl and Fifth Third held a meeting at which Fifth Third asked Krahl to provide a business plan showing that it could maintain profitability. Id. ¶ 71. Fifth Third placed a hold on Krahl's accounts in the meantime. Id.

         Doucet was involved in the meetings with Fifth Third during this time period. He testified that Fifth Third knew that Krahl had pending payments to subcontractors. Id. ¶ 77. Krahl did not present a business plan on January 8, leaving it in default on its loans from Fifth Third. Id. ¶ 75. That day, Fifth Third took the $3, 086, 931.05 in Krahl's account. Id. ¶ 76. Doucet also testified that, at the time Fifth Third swept Krahl's accounts, he had no knowledge of what deposits in Krahl's account were bonded or not, and he does not believe anyone else at Fifth Third had such knowledge. Id. ¶ 82.

         Of $3, 086, 931.05 that was in Krahl's account, $1, 829, 250.60 were bonded funds received on November 19 and 30, 2009; December 4 and 16, 2009; and January 4 and 6, 2010, from the owners of the seven projects referenced above. Id. ΒΆΒΆ 87, 91-135. Six of these deposits were checks, and ...


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