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Germinaro v. Fidelity National Title Insurance Co.

United States District Court, W.D. Pennsylvania

February 21, 2017

JOSEPH J. GERMINARO, an individual, and GABRIELLA P. GERMINARO, an individual, Plaintiffs,


          Nora Barry Fischer United States District Judge


         In this civil action, Joseph and Gabriella Germinaro (“Plaintiffs”) have sued Defendants Fidelity National Title Insurance Company (“FNTIC”), as successor to Lawyers Title Insurance Corporation (“LTIC”), [1] and Commonwealth Land Title Insurance Company (“CLTIC”) for alleged violations of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §1961, et seq. (“RICO”). The suit arises out of Plaintiffs' unsuccessful attempt to effectuate a tax-deferred land exchange (“§1031 exchange”) pursuant to Section 1031 of the Internal Revenue Code, 26 U.S.C. §1031.

         In November 2008, as part of the §1031 exchange, Plaintiffs entrusted approximately $831, 187 to LandAmerica 1031 Exchange Services, Inc. (“LES”), a “qualified intermediary” under the Internal Revenue Code. Approximately one week later, LES -- then a sister-corporation to LTIC and CLTIC -- filed for bankruptcy. As a result, Plaintiffs were unable to complete their §1031 exchange and sustained financial loss.

         In this lawsuit, Plaintiffs allege that LTIC, CLTIC, and LES - together with their parent company, LandAmerica Financial Group, Inc. (“LFG”) and various corporate officers - operated a Ponzi scheme as part of a RICO “enterprise.” Plaintiffs aver that, as part of this scheme, LTIC and CLTIC induced the Plaintiffs to entrust their money to LES while making misrepresentations about and/or fraudulently concealing the fact that: (a) LES was on the brink of insolvency; (b) Plaintiffs' funds were being commingled with those of other LES customers; (c) Plaintiffs' funds were being used to complete the exchanges of LES' pre-existing customers; and (d) Plaintiffs were at substantial risk of losing their funds by placing them with LES. Plaintiffs further maintain that LTIC and CLTIC injected cash into LES for the purpose of allowing LES to make “lulling payments” and thereby perpetuated the Ponzi scheme.

         Presently pending before the Court is the Defendants' Motion for Summary Judgment (Doc. No. 124) and the Plaintiffs' Motion for Partial Summary Judgment on the issue of liability (Doc. No. 119). For the reasons that follow, Defendants' motion will be granted and Plaintiffs' motion will be denied.


         A. IRC 1031's Allowance of Deferred Capital Gains

         Section 1031(a) of the Internal Revenue Code provides that “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” 26 U.S.C. §1031(a)(1). Under this provision, the seller of an investment property (i.e., a “relinquished property”) may defer his or her capital gains on the taxable proceeds of the sale (“exchange funds”) if those funds are used to purchase a like-kind property (a “replacement property”). To qualify for this tax-deferred treatment, the property owner must identify the like-kind replacement property within 45 days of the sale of the relinquished property and must close on the purchase of the replacement property within 180 days from the sale of the relinquished property. Id. at §1031(a)(3).

         In order to obtain the tax deferral benefit provided by Section 1031, the property owner must not actually or constructively receive the proceeds of the sale of the relinquished property. See 26 C.F.R. §1.1031(k)-1(f). The Internal Revenue Service has defined four “safe harbors” which will ensure a determination of non-receipt, to wit: a “qualified escrow account, ” a “qualified trust, ” a “qualified intermediary, ” or certain security or guarantee arrangements. See Id. §1.1031(k)-1(g). Under the U.S. Treasury's regulations, a “qualified intermediary” (“QI”) is defined, in relevant part, as someone who: “[e]nters into a written agreement with the taxpayer (the “exchange agreement”) and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer.” 26 C.F.R. §1.1031(k)-1(g)(4)(iii)(B).

         B. The Alleged “Enterprise” Participants

         At times relevant to this lawsuit, LFG was a holding company that, along with certain of its subsidiaries, provided insurance and real estate services nationwide. (P1.)[3] LES was a subsidiary of LFG that provided services, including acting as a QI, for customers who desired to effectuate §1031 exchanges. (P2.) LTIC and CLTIC were Nebraska-regulated title insurers and subsidiaries of LFG that provided title insurance and related real estate services in numerous states. (P3, P4.)

         During times relevant to this lawsuit, LFG and its various subsidiaries had a number of interlocking officers and directors. Prior to November 26, 2008, when LFG and LES filed for bankruptcy (P1, P2), Theodore Lindy Chandler, Jr. (“Chandler”) served as Chief Executive Officer and Chairman of the Board of Directors for LFG, LTIC, and CLTIC. (P6, P8, P9.) G. William Evans (“Evans”) served as the Chief Financial Officer for LFG, director for LES, and Senior Executive Vice President for LTIC and CLTIC. (P6-P9.) Michelle Gluck (“Gluck”) was the General Counsel of LFG as well as Executive Vice President for LTIC and CLTIC. (P6, P8, P9.) Ronald B. Ramos (“Ramos”) was the Senior Vice President and Treasurer for LFG and provided financial oversight for LES. (P7; Ramos Dep. at 14:12-25, Doc. No. 129-13.) Pamela Saylors (“Saylors”) was an Executive Vice President for LTIC and CLTIC. (P8, P9.) Peter A. Kolbe (“Kolbe”) was the Senior Vice President and Government Affairs Counsel for LFG, LTIC and CLTIC. (P6, P8, P9.) Stephen Connor (“Connor”) was the Chief Operations Officer and a director of LES. (P7.)

         C. LES's Exchange Agreements

         Prior to filing for bankruptcy in 2008, LES functioned as a QI that performed §1031 exchanges for customers across the country. (P2.) Defendants LTIC and CLTIC had a physical presence in larger cities across the country and would offer LES's marketing materials to its customers in those locations. (P70.)

         In the years preceding its bankruptcy, LES entered into thousands of exchange agreements with its customers (referred to at times as “exchangers”), a sample of which is included within Plaintiffs' appendix of exhibits. (See Pls.' Ex. 58, Doc. Nos. 122-26 and 122-27, referred to hereafter as the “form exchange agreement” or “form agreement.”)[4] Under the terms of the form exchange agreement, LES agreed to acquire the relinquished property from the customer and convey the replacement property to the customer. (Pls.' Ex. 58, Form Exchange Agreement ¶1(a).) LES agreed to “hold” the exchange funds from the customer's sale of the relinquished property and “make payments from the [e]xchange [f]unds to acquire the [r]eplacement [p]roperty” on behalf of the customer. (Form Exchange Agreement ¶2(a) and (b).) In the interim, LES would have “sole and exclusive possession, dominion, control and use of all [e]xchange [f]unds, ” including any interest earned thereon. (Id.¶2(c).) The customer would have “no right, title, or interest in or to the [e]xchange [f]unds or any earnings thereon” and “no right, power, or option to demand ... or otherwise obtain” same, during the pendency of the exchange period. (Id.)

         Upon its receipt of the exchange funds, LES agreed to “deposit” the funds “in an account maintained at SunTrust Bank in Richmond, Virginia.” (Form Exchange Agmt. ¶3(a).) LES guaranteed the customer a certain specified rate of interest on the funds deposited which, if not applied toward the purchase of the replacement property, would be paid to the customer at the end of the exchange period. (Id.) Pursuant to Paragraph 3(a) of the form agreement, the customer “acknowledge[d] and agree[d] that the amount of the [e]xchange [f]unds may be in excess of the maximum amount of deposit insurance carried by the depository institution indicated . . .;” but regardless of this, “LES unconditionally guarantee[d] the return and availability of the [e]xchange [f]unds and the guaranteed interest rate stated” in the exchange agreement. (Id.)

         Paragraphs 4(a)-(b) of the exchange agreement set forth the procedures by which LES's customers would identify their replacement properties. (Form Exchange Agmt. ¶4.) Paragraphs 5(a)-(b) set forth the terms under which LES would acquire the replacement property and transfer it to the customer. (Id. ¶5.)

         LES's contractual duties were set forth in Paragraph 6 of the form agreement. Subparagraph 6(a) stated that “LES has entered into this [e]xchange [a]greement with the intention of being a ‘qualified intermediary' within the meaning of [Treasury Regulation] Section 1.1031(k)-1(g)(4)(iii) . . . and shall use its best efforts to retain that status until all of the [e]xchange [f]unds have been disbursed in accordance with this [e]xchange [a]greement.” (Form Exchange Agreement ¶6(a).) Subparagraph 6(b) reiterated that “LES is entering into this [e]xchange [a]greement solely for the purpose of facilitating [the customer's] exchange of the [r]elinquished [p]roperty for the [r]eplacement [p]roperty.” (Id. ¶6(b).) It acknowledged that the customer was executing the exchange agreement based on the advice of his or her legal and tax advisers. (Id.) Subparagraph 6(c) limited LES's duties and obligations under the agreement by providing:

LES shall only be obligated to act as an intermediary in accordance with the terms and conditions of this [e]xchange [a]greement and shall not be bound by any other contract or agreement, whether or not LES has knowledge of any such contract or agreement or of its terms or conditions. LES has undertaken to perform only such duties as are expressly set forth herein, and no additional duties or obligations shall be implied hereunder or by operation of law or otherwise.

         Paragraph 11 of the form exchange agreement set forth various miscellaneous provisions, including an integration clause acknowledging that “[t]his [e]xchange [a]greement contains the entire understanding between the parties hereto.” (Form Exchange Agmt. ¶11.) It also made clear that the agreement could be “modified, altered, or amended only by the written agreement of all the parties.” (Id.)

         Based on the language of the form agreement, Plaintiffs contend that: (i) LES promised to deposit and “hold” the customer's exchange funds in its bank account at SunTrust Bank in Richmond until the funds were needed to purchase the customer's replacement property, and (ii) LES “unconditionally guaranteed” that, when needed, the exchange funds would be immediately available for purposes of acquiring the said replacement property.

         D. LES's Investment in Auction Rate Securities

         As a qualified intermediary, LES received the proceeds from the sales of its customers' relinquished properties. As a general practice, LES held these proceeds - or “exchange funds” --in a commingled account at Sun Trust Bank in Richmond, Virginia (referred to hereafter as the “commingled account” or “Account #3318”).[5] (Devon M. Jones Affid. ¶3, Doc. No. 136-14.) Although exchangers could specifically request that LES place their funds into a segregated account, LES's default procedure was to deposit exchange funds into its commingled account. (P39, P40.) Account #3318 was the principal account maintained by LES for its daily operations. (Jones Affid. ¶ 4.) LES utilized the account to pay its operating expenses, pay dividends to LFG, obtain replacement properties, or return exchange funds to customers whose §1031 exchanges could not be completed. (Id. ¶6.)

         At all times relevant to this lawsuit, LFG's treasury department performed the treasury functions of LES. (Jones Affid. ¶2.) Based on LES's liquidity needs, LFG's treasury department determined, on a daily basis, whether to transfer funds out of Account #3318 and place them into investment accounts or whether to redeem outstanding investments and deposit investment proceeds into Account #3318. (Jones Affid. ¶7.) Any funds that were not transferred from Account #3318 were automatically swept at the end of each business day to a money market account which LES held at SunTrust Bank, because Account #3318 was a non-interest bearing account. (Id. ¶¶ 9-10.) LFG's treasury department routinely invested the funds from Account #3318 in a number of investment vehicles in accordance with LFG's corporate investment policy, including commercial paper, treasuries, and agency and corporate bonds. (Id. ¶8.)

         Beginning in or around 2002, LES, through LFG, began investing a portion of the commingled exchange funds in Auction Rate Securities (“ARSs”), which were sold to LES by Citigroup Global Markets, Inc. and SunTrust Robinson Humphrey, Inc. (“STRH”), a separate entity-affiliate of SunTrust Bank.[6] (P47, P76; Pls.' Ex. 42, Doc. No. 122-20 at 6.) The ARSs that LES purchased consisted entirely of debt instruments backed by student loans, substantially all of which were guaranteed by the U.S. government. (See Pls.' Ex. 21, Doc. No. 122-5 at 6.) The ARS investments were not FDIC-insured. (P48.)

         LES purchased the ARSs by transferring funds out of Account #3318 and into brokerage accounts outside of SunTrust Bank. Plaintiffs posit that the ARS purchases were financially motivated in that LES earned income from the spread between its returns on the ARS investments and the contractual rate of interest it paid to customers pursuant to the exchange agreements. (See P95; Pls.' Ex. 21, Doc. No. 122-5 at 6.)

         E. The ARS Freeze and LES's Ensuing Liquidity Deficit

         In February 2008, the ARS market froze and the ARSs in which LES had invested became illiquid. An internal LandAmerica memorandum explained the situation as follows:

as a result of liquidity issues in the global credit and capital markets, beginning in February 2008, the auctions for ARS started to “fail, ” meaning that there was not enough demand to sell all of the securities that holders desired to sell . . . [LES] will not be able to liquidate its ARS until the issuer calls the security, a successful action occurs, a buyer is found outside of the auction process, or the security matures. [LES] has liquidity exposure to these securities to the extent that it would be required to utilize these securities to satisfy the purchase of properties.

         (Pls.' Ex. 21, Doc. No. 122-5 at 7.) Gerard McHale, Jr., who would eventually serve as LES's Liquidation Trustee in bankruptcy, described the situation as a liquidity “crisis”:

In February of 2008, the student loan auction rate security market collapsed. LES had been investing all of the escrow funds of the 1031 exchangers in student loan auction rate securities, [ARSs]. When the market froze, there was [a] liquidity crisis within LES. Because of the nature of the 1031 exchange, LES would need funds within 180 days to close any pending 1031 transactions. Having no ability to sell off the auction rate securities in which it invested, it operated from small amounts of funds that were on hand and also the funds that it was bringing in on a regular ... basis.

         (P237 (citing McHale Dep. at 32:23-33:12).) McHale confirmed that, following the freezing of the ARS market, LES had to use new, incoming exchange deposits to fund its older exchange obligations. (P237 (citing McHale Dep. at 33:20-34:21).)

         The financial figures bear out LES's liquidity problems. As of March 31, 2008, LES held approximately $1.8 billion, some $290.5 million of which was invested in the now frozen ARSs. (P54, P55.) Throughout the remainder of 2008, the volume of new real estate transactions declined sharply, and fewer exchanges occurred. As a result, the outflow of LES's exchange fund payments outpaced the inflow of new deposits, and the funds tied up in frozen ARSs became an ever larger percentage of LES's commingled exchange fund portfolio. By April 29, 2008, LES's total exchange fund portfolio was down to $612 million, $290 million of which was still tied up in the frozen ARSs. (P65.) According to the minutes from LFG's Board of Directors meeting, the company did not view the illiquid ARSs as a “concern because the 1031 portfolio always has a base amount of money it is holding.” (P65.) By September 2008, however, the total commingled fund portfolio was down to $318 million, $290.5 million of which consisted of the frozen ARSs. (P96, P97.) That same month, outflows from the commingled account exceeded inflows by approximately $83 million, leaving LES only $7.2 million in net assets. (P98, P99, P102, P103.)

         F. LFG's Efforts to Resolve the Liquidity Deficit

         Following the February 2008 ARS freeze, LFG's officers and directors explored a number of avenues for obtaining additional funds in an effort to remediate LES's liquidity deficit. To that end, LFG pursued cost-reduction measures and attempted to sell one of its subsidiary banks. (P89; D146.)[7] Between September 25 and October 17, 2008, LFG transferred a total of $65 million to LES to assist LES in meeting its obligations. (P91; D146.) LFG also requested a $35 million draw on an existing line of credit and attempted to obtain new lines of credit equal to the par value of the frozen ARSs. (D146.) In addition, LFG attempted to sell ARSs to third parties and also tried, unsuccessfully, to persuade the financial institutions that had sold LES the ARSs to buy back the securities or loan against them. (P106, D146; Pls.' Ex. 47, Doc. No. 122-20 at 6.) When those efforts failed, LFG explored the possibility of filing a legal action against those institutions for securities fraud. (D146; Kirpalani Dep. at 43:10-12, Doc. No. 145-56.) Beginning in October 2008, LFG coordinated a transfer of ARSs to LTIC and CLTIC in exchange for approximately $70 million in liquid assets. (Pls.' Ex. 43, Doc. No. 122-18 at 26, Doc. No. 122-19 at 2-3; see also P106, P112, P217, D146.) LFG also executed a merger agreement with Fidelity National Financial (“FNF”), which ultimately fell through when FNF withdrew from the merger on November 20, 2008. (D146, D147.) LFG sought assistance, unsuccessfully, from the Federal Reserve Bank in Richmond. (D146.) Finally, LFG's Chairman and CEO Chandler wrote to Treasury Secretary Henry M. Paulson, Jr. on October 20, 2008, to request that the U.S. Treasury Department provide TARP funds by either directly purchase the ARSs or lend against them; however, the request was denied. (P162-P165; D146.)

         Throughout this period of time, LES continued to execute exchange agreements with new customers whose exchange funds were then utilized to satisfy LES's other outstanding obligations, including the funding of prior exchange agreements. (P222.) Plaintiffs contend that, in effect, LES -- with the assistance of LFG, the Defendants, and their overlapping officers and executives -- was operating a fraudulent “Ponzi scheme.” Plaintiffs insist that the exchange agreements were deceptive insofar as they failed to disclose that: exchange funds would not be “held” at a bank for the customer's benefit; LES could not “guarantee” the availability of the exchange funds for purposes of completing the customer's intended §1031 transactions; and LES was in fact on the verge of a financial collapse.

         Defendants contend that LFG's management acted in good faith at all times in an attempt to steer LES through an unprecedented global financial crisis and satisfy all of LES's §1031 exchange obligations. Defendants deny that the post-ARS freeze transactions were fraudulent in any respect or that they were part of a “Ponzi scheme.” Defendants maintain that, up until November 20, 2008 when FNF withdrew from the announced merger agreement, LFG's management felt confident that LES could continue to meet its customer obligations as they became due.

         In either case, it is undisputed that LFG's efforts to resolve LES's liquidity deficit were unsuccessful and, by late November 2008, LES could no longer continue its activities as a QI. On November 24, 2008, LES ceased operations. (D2.) Two days later, LES and LFG filed voluntary Chapter 11 petitions. (P1, P2.)

         G. Plaintiffs' Attempt to Effectuate a §1031 Exchange

         Meanwhile, in October 2008, Plaintiffs were interested in effectuating a §1031 exchange in connection with their anticipated sale of an investment property located in Pittsburgh. Plaintiffs had previously transacted a §1031 exchange in 2002-2003, utilizing the services of LTIC and LES's predecessor company. (See Decl. of Joseph Germinaro at ¶1, Doc. No. 143, and Exhibits 1(a)-(e) thereto.) Plaintiffs chose LES to serve as the QI for their 2008 transaction based, in part, on LES's solid reputation and based partly on Plaintiffs' prior dealings with LES's predecessor company and with Alfred Watterson, an attorney employed by LTIC. (P480.)[8]

         On October 22, 2008, Plaintiffs executed an exchange agreement with LES. (Pls.' Ex. 113, Doc. No. 122-37 at 11-20.) In virtually all respects, the provisions of Plaintiffs' exchange agreement mirrored those of the form exchange agreement discussed above. One exception pertains to Paragraph 3(a) of Plaintiffs' exchange agreement, which stated:

Taxpayer will receive interest on the Exchange Funds at an annualized rate equal to 100% of the intended Federal Funds Rate as announced by the Federal Open Market Committee less seventy five basis points (-75 bps), compounded daily, adjusting as the Federal Funds Rate does, one day following the same, during the Exchange Period (the “Growth Factor”) from the first business day following LES' receipt of funds via wire transfer to the LES account in Richmond, Virginia that it maintains at SunTrust Bank for the purpose of collecting taxpayers' exchange funds ... to the day of withdrawal. LES and Taxpayer agree that the Growth Factor, if not applied to the acquisition of the Replacement Property identified by Taxpayer ..., shall be ...

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