MBIA Ins Corp v. Royal Indemnity Co ( 2006 )

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
3-30-2006
MBIA Ins Corp v. Royal Indemnity Co
Precedential or Non-Precedential: Precedential
Docket No. 03-4382
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PRECEDENTIAL
AMENDED
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 03-4382
No. 04-2207
No. 04-3487
MBIA INSURANCE CORPORATION; WELLS FARGO
BANK
MINNESOTA, N.A., as Trustee of SFC Grantor Trust, Series
2000-1,
SFC Grantor Trust, Series 2000-2, SFC Grantor Trust,
Series 2000-3, SFC Grantor Trust, Series 2000-4,
SFC Grantor Trust, Series 2001-1, SFC Grantor Trust
2001-2, SFC Owner Trust 2001-I and SFC Grantor Trust,
Series 2001-3
v.
ROYAL INDEMNITY COMPANY,
Appellant, No. 03-4382
v.
ROYAL INDEMNITY COMPANY,
Third-Party Plaintiff
v.
PNC BANK, N.A.; STUDENT LOAN SERVICING LLC;
ANDREW N. YAO; SFC ACCEPTANCE II LLC;
SFC ACCEPTANCE III LLC; SFC ACCEPTANCE IV LLC;
SFC ACCEPTANCE V LLC; SFC ACCEPTANCE VIII LLC;
SFC ACCEPTANCE IX LLC; SFC FINANCIAL I LLC;
SFC FINANCIAL II LLC; SFC ACCEPTANCE VI LLC;
SFC ACCEPTANCE VII LLC,
Third-Party Defendants
WILMINGTON TRUST OF PENNSYLVANIA
v.
ROYAL INDEMNITY COMPANY,
Appellant, No. 04-2207 and 04-3487
v.
ROYAL INDEMNITY COMPANY,
Third-Party Plaintiff
v.
SFC FINANCIAL I, LLC,
Third-Party Defendant
ON APPEAL FROM THE UNITED STATES DISTRICT
COURT
FOR THE DISTRICT OF DELAWARE
District Court Nos. 02-cv-01294 and 02-cv-01361
District Court Judge: The Honorable Joseph J. Farnan, Jr.
Argued January 19, 2005
Before: ALITO, McKEE, and SMITH, Circuit Judges
(Filed: October 3, 2005)
2
LAWRENCE C. ASHBY
PHILIP TRAINER, JR.
Ashby & Geddes
222 Delaware Avenue
Wilmington, Delaware 19899
MICHAEL H. BARR (Argued)
KENNETH J. PFAEHLER
Sonnenschein Nath & Rosenthal LLP
1221 Avenue of the Americas
New York, New York 10020-1089
Counsel for Appellant
RONALD S. RAUCHBERG (Argued)
STEVEN E. OBUS
ANDRE G. CASTAYBERT
FRANK SCIBILIA
Proskauer Rose LLP
1585 Broadway
New York, New York 10036
DAVID C. McBRIDE
JOHN W. SHAW
Young Conaway Stargatt & Taylor, LLP
The Brandywine Building
1000 West Street
P.O. Box 391
Wilmington, Delaware 19899
Counsel for Appellees MBIA Insurance Corporation
and Wells Fargo Bank Minnesota, N.A.
KEVIN R. SHANNON
Potter Anderson & Corroon LLP
Hercules Plaza
P.O. Box 951
Wilmington, Delaware 19899
DAVID H. PITTINSKY (Argued)
LAWRENCE D. BERGER
3
Ballard Spahr Andrews & Ingersoll, LLP
1735 Market Street, 51st Floor
Philadelphia, Pennsylvania 19103
Counsel for Appellee PNC Bank, N.A.
JOSEPH H. HUSTON, JR. (Argued)
THOMAS G. WHALEN, JR.
Stevens & Lee, P.C.
1105 North Market Street, 7th Floor
Wilmington, Delaware 19801
Counsel for Appellee Wilmington Trust
of Pennsylvania
OPINION OF THE COURT
ALITO, Circuit Judge:
In these consolidated appeals, we are called upon to
construe a series of contracts. Appellant Royal Indemnity
Company (“Royal”) agreed in these contracts to insure the
repayment of principal and interest on several hundred million
dollars of student loans. The named beneficiaries of the policies,
Wells Fargo Bank Minnesota, N.A. (“Wells Fargo”) and
Wilmington Trust of Pennsylvania (“Wilmington Trust”),1 sued
after the loans went into default and Royal failed to pay the claims
they submitted. Royal defended on the ground that the lender on
the underlying obligations fraudulently induced it to issue the
policies and that this fraud entitled it to rescission.
The District Court entered summary judgment for the
1
A third appellee-beneficiary, PNC Bank, N.A., reached a
settlement with Royal prior to our decision. This opinion does not
discuss its policy with Royal or its claims thereon.
4
beneficiaries, and this appeal followed. We agree with the District
Court that Royal’s policies unambiguously and effectively waive
defenses to its obligations based on fraud, but we conclude that
Royal has raised a triable issue as to whether all of the losses
claimed by the beneficiaries were covered under its policies. We
thus affirm in part and reverse in part.
I.
Student Finance Corporation (“SFC”) was founded in 1992
to cater to the vocational segment of the student loan market.
Some of the loans it originated itself; others it acquired from the
original lenders. Many of the loans were apparently made to
students at truck-driving schools. At all relevant times, SFC was
owned and controlled by its founder and chief executive officer,
Andrew N. Yao.
The capital for SFC’s business came from financial
institutions like Wilmington Trust and Wells Fargo. In 1999,
Wilmington Trust issued SFC a $75 million loan, taking a pool of
student loans as security. Wells Fargo, by contrast, helped finance
SFC by securitizing the older loans in its portfolio. In each
securitization, student loans were packaged and sold to a trust
settled for the specific purpose of holding title to the loans. Wells
Fargo, as trustee, funded the purchase by selling certificated shares
in the trust to institutional investors. The record reflects that Wells
Fargo raised approximately $450 million for SFC in eight
securitizations from 1999 to 2002.
To encourage Wilmington Trust and the investors in Wells
Fargo’s trusts to part with their capital, SFC contracted with Royal
to insure the repayment of interest and principal on the student
loans. At issue in this case are ten “Credit Risk Insurance Policies”
issued by Royal. Eight of them insured the loans held by the Wells
Fargo trusts (one per trust), and two of them insured the loans
pledged as collateral to Wilmington Trust. Each policy named
either Wells Fargo or Wilmington Trust as beneficiary. The
following table summarizes their terms:
Table 1. Summary of Policy Terms
5
Policy Beneficiary Inception Liability Limit
Number
RST 293334 Wells Fargo 1/22/99 $50,000,000.00
RST 293309 Wells Fargo 12/3/99 $53,053,642.08
RST 147522 Wells Fargo 4/30/00 $48,459,255.76
RST 147524 Wells Fargo 8/30/00 $29,999,999.94
RST 147525 Wells Fargo 11/27/00 $55,616,550.00
RST 147526 Wells Fargo 1/31/01 $48,286,713.44
RST 147538 Wells Fargo 10/19/01 $120,000,000.0
0
RST 147536 Wells Fargo 11/15/01 $80,000,000.00
RST 321276 Wilmington 1/22/99 $75,000,000.00
Trust
RST 147533 Wilmington 8/17/01 $5,518,459.00
Trust
Royal alleges, and the beneficiaries do not dispute, that SFC
procured this insurance through a spectacular fraud. According to
Royal, SFC misrepresented the creditworthiness and employment
history of its student borrowers and conspired with schools to
generate as many loans as possible by altering or forging loan
documents. As loans went into default, SFC allegedly paid some
of them down by surreptitiously diverting the proceeds of later
loans. By thus masking the default rates of the older loans, SFC
allegedly induced Royal to insure still more loans, whose proceeds
then had to be applied in Ponziesque fashion to pay down the
earlier ones. According to Royal, some of the proceeds were also
diverted to Yao’s personal accounts.
SFC’s business proved unsustainable. In a March 2002
telephone call to Royal, Yao allegedly confessed that SFC had
been paying down defaulted loans and explained that this practice
could no longer be continued. An investigation launched by Royal
revealed that SFC’s loans had been defaulting at rates – over 80%
6
in the case of one pool – well in excess of reported figures. Within
three months of Yao’s call, SFC was in Chapter 7 bankruptcy,
where it apparently remains to this day. With SFC no longer
paying down student loans, the defaults fell on the shoulders of
Wilmington Trust and Wells Fargo, who turned to Royal to make
good on its policies. Claims on those policies, which totaled only
$38.6 million between 1999 and the spring of 2002, had piled up
to $380 million by the end of 2002.
A flurry of lawsuits followed. Royal filed suit in Texas state
court to rescind the policies, but this case was dismissed after
limited discovery for lack of personal jurisdiction. In July 2002,
Wells Fargo and MBIA Insurance Corporation (“MBIA”)2 sued
Royal in the US District Court for the District of Delaware. Their
complaint, which invoked the Court’s diversity jurisdiction, alleged
that Royal had wrongfully repudiated the trusts’ eight policies by
filing the Texas action and sought relief in the form of specific
performance, a declaratory judgment that the policies were in
effect, and damages. Wilmington Trust filed its own suit in
Delaware federal court, alleging essentially the same claims.
Royal defended on the ground that SFC’s fraudulent
inducement entitled it to rescission. The beneficiaries countered
that the policies unambiguously waived this defense. In separate
opinions, the District Court entered summary judgment for the
beneficiaries. See MBIA Ins. Corp. v. Royal Indem. Co., 312 F.
Supp. 2d 583 (D. Del. 2004); MBIA Ins. Corp. v. Royal Indem.
Co., 286 F. Supp. 2d 347 (D. Del. 2003). It found that the ten
policies unambiguously waived fraud in the inducement as a
defense to payment, and it predicted that Delaware’s highest court
2
MBIA issued a “Certificate Guaranty Insurance Policy”
guarantying the student loans held by the Wells Fargo trusts.
Royal and MBIA disagree about the function of this guaranty.
MBIA characterizes it as backstop insurance for a risk primarily
insured by Royal, while Royal characterizes it as supplemental
coverage protecting the trusts from risks not covered under the
Royal policies. Royal no longer disputes, however, that MBIA has
contractual standing to sue, so we assume that it is a proper
plaintiff-appellee.
7
would enforce them. The Court acknowledged that Delaware law
was reluctant to enforce boilerplate waivers against unsophisticated
parties, but it believed a clear waiver negotiated by sophisticated
parties could be enforced. See 312 F. Supp. 2d at 586; 286 F.
Supp. 2d at 355.
Since the Court concluded that Royal’s waivers were
enforceable, and that they clearly covered the defense Royal sought
to present, it found further discovery on that defense unnecessary.
It awarded summary judgment to the beneficiaries, ordering Royal
to pay $269,851,527 plus interest to Wells Fargo and
$12,908,966.43 plus interest to Wilmington Trust, and it further
ordered Royal to pay subsequent claims as they came due. Royal
timely appealed to this Court.
II.
We review an award of summary judgment de novo,
applying the same test on review that the District Court should
have applied. In re Ikon Office Solutions, Inc., 277 F.3d 658, 665
(3d Cir. 2002). Summary judgment should be awarded when “the
pleadings, depositions, answers to interrogatories, and admissions
on file, together with the affidavits, if any, show that there is no
genuine issue as to any material fact and that the moving party is
entitled to a judgment as a matter of law.” Fed. R. Civ. P. 56(c).
All reasonable inferences from the record must be drawn in favor
of the nonmoving party. Brewer v. Quaker State Oil Refining
Corp., 72 F.3d 326, 333 (3d Cir. 1995). The Court may not weigh
the evidence or assess credibility. Boyle v. County of Allegheny
Pa., 139 F.3d 386, 393 (3d Cir. 1998).
Royal attacks the District Court’s award of summary
judgment on several grounds. It first argues that the Court erred in
finding that the text of its policies unambiguously waived its
defense to payment based on SFC’s fraud. It further argues that
waivers of the breadth and generality found in its policies are
unenforceable under Delaware law. Finally, it argues that triable
issues remain as to whether the policies covered all of the losses
claimed by the beneficiaries. Since it is undisputed that Delaware
provides the substantive law for this dispute, we turn to that state’s
law of contract to determine whether summary judgment was
8
properly awarded.
III.
A.
Delaware follows the objective theory of contract. See Haft
v. Haft, 671 A.2d 413, 417 (Del. Ch. 1995); Progressive Int’l Corp.
v. E.I. Du Pont de Nemours & Co., No. C.A. 19209, 2002 WL
1558382, at *7 (Del. Ch. 2002) (unpublished opinion). Although
the law of contract generally strives to enforce agreements in
accord with their makers’ intent, the objective theory considers
“objective acts (words, acts and context)” the best evidence of that
intent. Haft, 671 A.2d at 417. Unambiguous written agreements
should be enforced according to their terms, without using extrinsic
evidence “to interpret the intent of the parties, to vary the terms of
the contract or to create an ambiguity.” Eagle Indus., Inc. v.
DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997); see
also City Investing Co. Liquidating Trust v. Cont’l Cas. Co., 624
A.2d 1191, 1198 (Del. 1993).
A contract is not ambiguous merely because the parties
disagree about its proper interpretation. Whether a contract is
ambiguous is determined according to an objective, reasonable-
person standard and is a question of law. See Eagle Indus., 702
A.2d at 1233 n.8 (“The true test is what a reasonable person in the
position of the parties would have thought it meant.”). Words are
to be given their ordinary meaning and should not be “torture[d]”
to impart ambiguity where none exists. Rhone-Poulenc Basic
Chems. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1196 (Del.
1992).
The language of Royal’s waivers varies from policy to
policy, but we agree with the District Court that each policy
satisfies these standards of clarity. We consider the contracts in
reverse chronological order, beginning with the last two policies
Royal issued and considering the remaining eight in subsection 2
below.
1.
9
Policies RST 147536 and RST 147538 are the clearest.
Policy RST 147536 states in bold capital letters:
THE RIGHT OF THE BENEFICIARY TO
RECEIVE PAYMENT FOR LOSSES UNDER
THIS POLICY SHALL BE ABSOLUTE,
CONTINUING, IRREVOCABLE AND
UNCONDITIONAL IRRESPECTIVE OF (A)
ANY FRAUD WITH RESPECT TO THE
STUDENT LOANS, (B) THE GENUINENESS,
VALIDITY OR ENFORCEABILITY OF
ANY . . . STUDENT LOAN OR THE BREACH
OF ANY SUCH CONTRACT OR ANY
COVENANT OR REPRESENTATION OR
WARRANTY MADE THEREIN, OR (C) ANY
OTHER RIGHTS OR DEFENSES THAT MAY
BE AVAILABLE TO THE INSURER TO
AVOID PAYMENT OF ITS OBLIGATION
UNDER THIS POLICY (ALL OF WHICH
RIGHTS AND DEFENSES ARE HEREBY
EXPRESSLY WAIVED BY THE
INSURER) . . . .
App. at 2221. The language of Policy RST 147538 is virtually
identical. See App. at 2253-54.3 The policies plainly strip Royal
of a defense to payment based on fraud, first by declaring that its
liability will be unaffected by “fraud with respect to the student
loans” and then by “expressly waiv[ing]” any other right or defense
it could marshal to avoid payment.
In the face of this clarion language, Royal contends that the
phrase “with respect to the student loans” contemplates only the
microfraud of individual schools or students, not the macrofraud of
3
In Policy RST 147538, clause (C) appears as clause (D)
and follows a new clause (C), which leaves Royal liable
irrespective of “ANY FAILURE ON THE PART OF THE
INSURED, THE SERVICER OR THE BENEFICIARY TO
OBSERVE OR PERFORM ANY COVENANT OR
CONDITION.” App. at 2254.
10
SFC. The waivers were designed, argues Royal, only to protect
Wells Fargo from obstreperous litigation over the validity of
individual loan documents. In support of this position, Royal
points to clause (B), which homes in on “the genuineness, validity
or enforceability of any . . . student loan.” Invoking the expressio
unius and ejusdem generis canons, it argues that clause (B) waives
only a defense based on the “validity or enforceability” of a student
loan and that clause (A) should be given a commensurately narrow
meaning.
Aside from completely ignoring the blanket language of
clause (C) (clause (D) in Policy RST 147538), Royal’s argument
renders clause (A) surplusage. If clause (A) were limited to
individual cases of fraud by schools or students, it would sweep no
further than clause (B). The fraudulent inducement of a loan
agreement by a student or school would render the defrauded
party’s obligations under that agreement voidable. See
Restatement (Second) of Contracts § 164(1) (1981). In such a case,
the “genuineness, validity or enforceability” of the loan would be
affected. While the validity of the loans would not be affected by
SFC’s (or the schools’) fraud on Royal, this is precisely the type of
fraud that Royal now claims is not covered by clause (A), despite
the fact that it clearly occurs “with respect to” the student loans
within the ordinary meaning of those words. See Webster’s Third
New International Dictionary 1934 (Philip Babcock Gove ed. in
chief, unabr. ed. 1971). Since Royal’s interpretation makes clause
(A) surplusage and reads out clause (C) (clause (D) in Policy RST
147538), it must be rejected.
Royal argues that the definition of “Student Loans” creates
a triable issue as to whether the defense of fraudulent inducement
was intended to be waived in a case such as this. The definition of
“Student Loans” is restricted by each policy to the loans covered
therein and does not include any earlier loans SFC may have
issued. Since the definition is so restricted, clause (A) could not be
read, Royal argues, as waiving defenses based on
misrepresentations about the earlier loans on which Royal relied.
Even if this policy wrinkle created a triable issue as to the
scope of clause (A), it would not follow that summary judgment
was unwarranted. To establish fraudulent inducement, Royal must
11
show reasonable and detrimental reliance on a misrepresentation
intentionally or recklessly made to induce action or inaction. See
Kronenberg v. Katz, 872 A.2d 568, 585 n.25 (Del. Ch. 2004);
Gloucester Holding Corp. v. U.S. Tape & Sticky Prods., LLC, 832
A.2d 116, 124 (Del. Ch. 2003). Even if clause (A) did not waive
a defense based on misrepresentations with respect to earlier loans,
Royal could not establish reliance on those representations in light
of the clear “anti-reliance” language of clause (C) (clause (D) in
Policy RST 147538). See Kronenberg, 872 A.2d at 593. It is
unfathomable that an insurer that intended to rely on
extracontractual representations would agree that its obligations are
“absolute, continuing, irrevocable and unconditional irrespective
of . . . any other rights or defenses that may be available to the
insurer . . . (all of which rights and defenses are hereby expressly
waived by the insurer).” App. at 2221, 2254 (emphasis omitted).
Royal cannot possibly claim that its reliance on those
representations was reasonable when it waived all defenses based
on reasonable reliance. Since Royal’s reliance was unreasonable
however “Student Loans” is defined, the definition of that term
does not create an ambiguity in the policies, and the District Court
did not err in finding Royal’s waiver unambiguous.
2.
Each of the remaining eight policies contains some variant
of the following language:
NOTWITHSTANDING ANY OTHER
PROVISION OF THIS POLICY TO THE
CONTRARY, THE RIGHT OF THE
BENEFICIARY TO RECEIVE PAYMENT FOR
LOSS UNDER THIS POLICY AFTER
PAYMENT OF THE INITIAL PREMIUM BY
THE INSURED SHALL BE ABSOLUTE AND
UNCONDITIONAL, AND NO FAILURE ON
THE PART OF THE INSURED OR THE
BENEFICIARY TO OBSERVE OR PERFORM
ANY COVENANT OR CONDITION
CONTAINED IN THIS POLICY (INCLUDING
WITHOUT LIMITATION THOSE
CONTAINED IN ARTICLE III, ARTICLE IV
12
AND ARTICLE V) SHALL ENTITLE THE
INSURER TO ANY RIGHT OF SET-OFF,
COUNTERCLAIM OR DEFENSE AGAINST
THE BENEFICIARY OR ANY OTHER
PARTIES OR OTHERWISE RELIEVE THE
INSURER OF ANY LIABILITY TO MAKE
ANY SUCH PAYMENT FOR LOSS TO THE
BENEFICIARY UNDER THIS POLICY,
SUBJECT ONLY TO THE LIMIT OF
LIABILITY.
E.g., App. at 5485 (original emphasis). In addition, seven of the
policies contain some variant of the following language:
The Insurer’s obligation to pay any Claim made
under this Policy is absolute, unconditional and
irrevocable and shall not in anyway be affected,
mitigated or eliminated by (y) a breach of any
representation or warranty made by the Insured, the
Servicer, Student Finance Corporation or the
Beneficiary, or (z) the failure of the Insured or
Student Finance Corporation to comply with the
Underwriting Policies.
E.g., App. at 2021. The eighth policy, RST 321276, refers only to
“the Insured,” omitting mention of “the Servicer,” “Student
Finance Corporation,” and “the Beneficiary.” App. at 5499-500.
Though none of the eight policies uses the word “fraud,” no
reasonable interpretation can be teased from this language that
would preserve Royal’s defense. The policies all declare that, after
payment of the premium, Royal’s liability will become “absolute”
and “unconditional” and “subject only to the limit of liability.”
Though such language might not contemplate a fraud that induced
the policies in the first place, the policies also provide that Royal’s
liability will be unaffected by “a breach of any representation.”
Since a misrepresentation is an essential element of a fraud, it
follows that fraud cannot affect Royal’s liability. Finally, the
policies provide that Royal’s liability is unaffected by a
“failure . . . to comply with the Underwriting Policies.” This is a
significant recital because the alleged fraud had its genesis in
13
misrepresentations that SFC’s lending complied with certain
underwriting policies. Royal cannot claim that it was entitled to
rely on SFC’s representations about its lending when it agreed to
liability regardless of whether the lending conformed to those
representations.
Royal argues that a “breach of . . . representation” is not the
same thing as a “misrepresentation” but refers instead to the failure
of a condition set forth “in the contract or perhaps in specific
accompanying contracts.” Royal’s Br., No. 03-4382, at 41.
Although the policies do not list any “representations and
warranties” on which the parties may rely, Royal observes that the
term sheet for each policy declares that “the statements in this
Policy . . . are the agreements and representations of the Insured”
and that “this Policy embodies all agreements existing between the
Insured and the Insurer or any of its representatives.” E.g., App. at
5525. According to Royal, the phrase “breach of any
representation” must refer to representations in the policies, since
those are the only “agreements and representations of the Insured.”
It is ironic that Royal should look to an integration clause
for evidence that it was entitled to rely on SFC’s extracontractual
representations. Such an interpretation stands that clause on its
head. Even under Royal’s contorted reading, however, the clause
makes no mention of SFC’s representations. SFC and the Servicer
were not even parties to the policies, so their representations would
have to be found outside the four corners of the agreements. In
short, the phrase “breach of any representation . . . [by] Student
Finance Corporation” must refer to extracontractual
representations. Under the only reasonable interpretation of the
policies, Royal has agreed that its liability will be unaffected by
reliance on SFC’s extracontractual representations.
Royal argues that even if the analysis above is correct it has
not waived its defense of fraudulent inducement in Policy RST
321276 because that policy refers only to a breach of representation
by “the Insured.” The Insured on that policy was “SFC Financial
I, LLC,” a special purpose entity affiliated with SFC. App. at
5477. Royal argues that since it relied on the misrepresentations of
SFC rather than that special purpose entity, its common law
defense of fraud in the inducement is unaffected by the policy.
14
As we noted earlier, an agreement may foreclose a fraud
defense not only by waiving “fraud” but also by setting forth terms
clearly inconsistent with reasonable reliance on extracontractual
representations. Royal here has effectively disclaimed reliance on
SFC’s representations no less than those of SFC Financial I, LLC,
even though the former is not mentioned in the agreement. Royal
admits that both entities were under the ownership and control of
Andrew Yao. See, e.g., Royal’s Memorandum in Support of Its
Motion for an Order Appointing a Chapter 11 Trustee at 5, App. at
4395 (“Yao . . . owned and controlled [SFC] and all of its affiliates
at all times pertinent to this case.”). Since SFC Financial I, LLC,
was an alter ego of SFC separated only by corporate formalities,
Royal’s disclaimer of reliance on the former’s representations
made it unreasonable as a matter of law for it to rely on the
representations of the latter.
Finally, Royal argues that even if the policies waive
defenses based on fraud, they do not waive a defense based on the
invalidity of the policies themselves. This argument does not
identify a reasonable alternative construction of the policies so
much as an alternative characterization of Royal’s defense. Royal
supposes that the policies are invalid because it was fraudulently
induced to issue them. However recharacterized, this remains a
defense based on fraud and is waived no less than a defense that
invoked SFC’s “fraud with respect to the student loans” or “a
breach of [its] representation.”
3.
Because we conclude that the agreements on their face
waive Royal’s fraud defense in unambiguous terms, we need not
consider the extrinsic evidence submitted by the parties.4 We also
4
Royal asserts, citing several Third Circuit cases, that this
Court always considers extrinsic evidence in determining whether
an agreement is unambiguous. These cases, however, were not
decided under Delaware law. See, e.g., In re New Valley Corp., 89
15
need not discuss the doctrine of contra proferentem, which operates
against the insurer only when policy terms are ambiguous. See
Twin City Fire Ins. Co. v. Del. Racing Ass’n, 840 A.2d 624, 630
(Del. 2003). Finally, we need not decide whether the parties’
agreements are properly characterized as insurance policies or
guaranties, since the interpretive principles discussed above apply
to both and would yield the same result in either case. See
Westfield Ins. Group v. J.P.’s Wharf, Ltd., 859 A.2d 74, 76 (Del.
2004); Universal Studios Inc. v. Viacom Inc., 705 A.2d 579, 589
(Del. Ch. 1997); see also Restatement (Third) of the Law of
Suretyship and Guaranty §§ 1-2 (1996) (explaining that a finding
of suretyship status depends on the rights and obligations set forth
in the agreement, not the other way around). However
characterized, the policies on their face waive Royal’s defense to
payment of its obligations based on fraud, and the District Court
did not err in so finding.
B.
F.3d 143, 149 (3d Cir. 1996) (“[a]pplying the federal common law
of contract”); Mellon Bank, N.A. v. Aetna Bus. Credit, Inc., 619
F.2d 1001, 1005 (3d Cir. 1980) (Pennsylvania law). Although no
text can be read in a vacuum, the Delaware Supreme Court has held
that in determining whether an ambiguity exists a court may
consider only “undisputed background facts to place the
contractual provision in its historical setting.” Eagle Indus., Inc. v.
DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 n.7 (Del. 1997).
“[U]ndisputed background facts” do not include the self-serving
parol evidence submitted by the parties, whose recollections as to
the intended meaning of the agreements predictably differ.
Even if we considered the sworn affidavit of Royal’s
employee, William Hibberd, it would not lend ambiguity to the
plain language of the Royal policies. Hibberd could state only that
it was his “understanding” that the policy language was not
intended to leave Royal liable in the case of a “widespread fraud
like the one that occurred here.” E.g., App. at 5345. Hibberd’s
subjective impression of what the parties meant, recollected years
after the events in question, is at very best a “scintilla” of evidence
in support of the objective reasonableness of Royal’s alternative
construction of the policies.
16
We next consider whether these waivers are enforceable.
The Delaware Supreme Court has not addressed the standards for
effective waiver of a defense based on fraud in the inducement, so
we must predict how it would decide this question. See Koppers
Co. v. Aetna Cas. & Sur. Co., 98 F.3d 1440, 1445 (3d Cir. 1996).
The District Court recognized that some authority had looked
askance at broad waivers in adhesive form agreements but
predicted that the Delaware Supreme Court would enforce an
unambiguous waiver negotiated by sophisticated parties. We
agree.
The Delaware Supreme Court’s closest precedent on this
question is its decision in Norton v. Poplos, 443 A.2d 1 (Del.
1982). In that case, the plaintiff sought to rescind a real estate
transaction by alleging that the seller had negligently
misrepresented the land’s zoning. The Court declined to find the
claim barred by a standard integration clause in the purchase
agreement reciting that the purchaser had not relied on
extracontractual representations. Id. at 3. The Court noted that
Delaware case law generally did not consider an integration clause
a reliable indicium of intent to waive a fraudulent inducement
defense. See id. at 6. It concluded, after a survey of cases from
other jurisdictions, that the better authorities extended this rule to
negligent misrepresentations, allowing the claim to proceed despite
the integration clause. See id.The boilerplate nature of the parties’ agreement weighed
heavily in the Norton Court’s calculus. See id. at 7 (“We see no
reason why a court of equity should enforce a standard ‘boiler
plate’ provision that would permit one who makes a material
misrepresentation to retain the benefit resulting from that
misrepresentation at the expense of an innocent party.”). Since the
scope of Royal’s obligations turns not on a boilerplate merger
clause but on waivers sculpted by parties of exquisite legal and
financial sophistication, we do not believe Norton provides a
reliable guidepost for our decision. See Great Lakes Chem. Corp.
v. Pharmacia Corp., 788 A.2d 544, 555 (Del. Ch. 2001)
(distinguishing the agreements in Norton and its progeny as
“simple real estate contracts having boilerplate, unnegotiated
disclaimer language”).
17
More reliable guidance may be found in the Chancery
Court’s recent decision in Kronenberg v. Katz, 872 A.2d 568 (Del.
Ch. 2004). In a thoughtful opinion by Vice Chancellor Strine, the
Court reasoned that an enforceable waiver of fraud should have
“language that, when read together, can be said to add up to a clear
anti-reliance clause by which the plaintiff has contractually
promised that it did not rely upon statements outside the contract’s
four corners in deciding to sign the contract.” Kronenberg, 872
A.2d at 593. The Court acknowledged that an integration clause
could be read as a promise of nonreliance, since the clause recited
that the contract was the “entire agreement” and superseded all
prior “understandings” and “inducements.” See id. at 591. But it
found the integration clause also susceptible to a “more traditional
interpretation,” according to which the clause “simply operates to
police the variance of the agreement by parol evidence.” Id. at
591-92. Since these competing interpretations of the clause left the
parties’ intent in doubt, the Court declined to enforce it to bar a
fraud claim.
Royal protests that the sine qua non of enforceability is not
clarity but specificity. A waiver, argues Royal, is nothing but the
voluntary relinquishment of a known right. See Kallop v.
McAllister, 678 A.2d 526, 532 (Del. 1996). Since a waiver must
be voluntary, clear evidence of the party’s intent to waive is
required for enforcement. See Realty Growth Investors v. Council
of Unit Owners, 453 A.2d 450, 456 (Del. 1982); George v. Frank
A. Robino, Inc., 334 A.2d 223, 224 (Del. 1975). A requirement of
specificity serves this end by ensuring that parties do not, by
promising the moon, unintentionally waive rights they had not
really contemplated. Accordingly, Royal concludes, Delaware
courts will refuse to enforce even a clear waiver of fraud unless it
sets forth the particular representations on which the induced party
agreed not to rely.
Though this argument has some force, its conclusion finds
virtually no support in Delaware law. Cases have focused on the
function of the terms at issue, see DRR, L.L.C. v. Sears, Roebuck
& Co., 949 F. Supp. 1132, 1137 (D. Del. 1996) (holding that an “as
is” clause does not “insulate a seller from suit for its fraudulent
misrepresentations”); Traylor Eng’g & Mfg. Co. v. Nat’l Container
Corp., 70 A.2d 9, 13 (Del. 1949) (holding that a warranty cannot
18
serve to disclaim reliance on extracontractual representations for
purposes of a fraud claim); DCV Holdings, Inc. v. Conagra, Inc.,
No. 02-550, 2003 WL 2008199, at *3 (Del. Apr. 29, 2003)
(unpublished table decision) (finding an all-inclusive warranty
ambiguous with respect to waiver of fraud claims); Kronenberg,
872 A.2d at 592 (“[M]any learned authorities state that typical
integration clauses do not operate to bar fraud claims.”), or the
circumstances of their negotiation. See Norton, 443 A.2d at 7(discounting “‘boiler plate’ found in the merger clause”); Great
Lakes, 788 A.2d at 555 (observing the “carefully negotiated
disclaimer language” crafted by “highly sophisticated parties,
assisted by industry consultants and experienced legal counsel”).
Although specificity and clarity often go hand in hand, we are
unaware of any Delaware case that has made specificity a
prerequisite to effective waiver.
In fact, a recent unpublished opinion of the Chancery Court
appears to have rejected the specificity requirement. See
Progressive Int’l Corp. v. E.I. Du Pont de Nemours & Co., No.
C.A. 19209, 2002 WL 1558382 (Del. Ch. July 9, 2002). The Court
there held that an integration clause reciting that neither party
would rely on extracontractual promises or representations
foreclosed rescission based on fraud. The allegedly defrauded
party protested that the clause did not identify the unreliable
representations or promises, but the Court found this omission
insignificant:
If adopted as law, Progressive’s argument would
impede commerce. It is not efficient for negotiators
to identify all the material issues that are not part of
the foundation of their relationship, and to list them
in a contractual schedule. Indeed, that exercise
would be wasteful and silly, as the integration clause
in the License Agreement shows. By simple and
unambiguous means, the parties to that Agreement
identified all the representations and statements that
could not have induced the execution of the
Agreement: all representations and statements not
included in the text of the Agreement itself.
Id. at *10; see also Debakey Corp. v. Raytheon Serv. Co., No.
19
14947, 2000 WL 1273317, at *27 (Del. Ch. Aug. 25, 2000)
(rejecting a fraud counterclaim because the aggrieved party could
have included the assurances on which it relied as representations
and warranties in the agreement). Although the Progressive
decision was not published, we believe its persuasive reasoning
provides a good model for the Delaware Supreme Court’s own
decision in this area.
The putative requirement of specificity seems rooted not in
Delaware case law but in a line of New York cases, and even there
it has been applied inconsistently. Although the Second Circuit in
Manufacturers Hanover Trust Co. v. Yanakas, 7 F.3d 310, 316 (2d
Cir. 1993), declared specificity the “touchstone” of enforceability,
other authority has focused on the clarity of the waiver rather than
its detail. See Valley Nat’l Bank v. Greenwich Ins. Co., 254 F.
Supp. 2d 448 (S.D.N.Y. 2003); Citibank, N.A. v. Plapinger, 485
N.E.2d 974 (N.Y. 1985). The Plapinger Court found the omission
of detail unimportant, deeming it “unrealistic in such circumstances
to expect an express stipulation that defendants were not relying on
a separate oral agreement.” 485 N.E.2d at 977. The Court in
Valley National Bank reached a similar conclusion, distinguishing
Yanakas as “less applicable . . . where the drafter and more
sophisticated party in the transaction now claims that the disclaimer
is too broad.” 254 F. Supp. 2d at 458.
Royal relies heavily on JPMorgan Chase Bank v. Liberty
Mutual Insurance Co., 189 F. Supp. 2d 24 (S.D.N.Y. 2002), a case
brought over a natural gas forward contract between Enron and one
of its affiliates. The affiliate borrowed money from plaintiff bank
to purchase the gas. Defendant surety guarantied that Enron would
deliver it. Unbeknownst to the surety, the bank had agreed with
Enron that the affiliate would subsequently repurchase the gas at a
higher price. This secret side agreement transformed the forward
contract into a simple loan. See id. at 26. The Southern District of
New York concluded that the surety could avoid payment on the
bond, rejecting the argument that “a general sweeping disclaimer
can serve to disclaim any and all extrinsic fraud between
sophisticated parties.” Id. at 27. It read Plapinger and Yanakas to
require “a clear indication that the disclaiming party has knowingly
disclaimed reliance on the specific representations that form the
basis of the fraud claim.” Id.20
Were JPMorgan Chase a case of garden-variety fraud, its
analysis would be in tension with both Yanakas and Plapinger.
See, e.g., Yanakas, 7 F.3d at 317 (finding the disclaimer
insufficient in part because it contained “no blanket disclaimer of
the type found in Plapinger as to ‘any other circumstance which
might otherwise constitute a defense’ to the Guarantee”). We agree
with the District Court, however, that JPMorgan Chase is “an
unusual and extreme case [that] . . . provides little guidance.” 312
F. Supp. 2d at 589; 286 F. Supp. 2d at 358.
Though characterized as a fraudulent inducement, the
transaction in JPMorgan Chase bordered on a fraud in the factum
– “the sort of fraud that procures a party’s signature to an
instrument without knowledge of its true nature or contents.”
Langley v. Fed. Deposit Ins. Corp., 484 U.S. 86, 93 (1987) (citing
U.C.C. § 3-305(2)(c) cmt. 7 (1977)); see also Restatement (Second)
of Contracts § 163 (1981) (referring to a fraud with respect to the
“character or essential terms of a proposed contract”). The surety
was asked to insure the delivery of a commodity, when in fact it
was guarantying a loan. See JPMorgan Chase, 189 F. Supp. 2d at
28. In such a case, where the party does not even know the “true
nature” of what it is signing, it is unsurprising that the standards for
effective waiver would be stricter, if waiver is possible at all. Cf.
Restatement §§ 163-164 (explaining that a contract fraudulently
induced is voidable, whereas a “contract” procured through fraud
in the factum is no contract at all).
Unlike Liberty Mutual, Royal does not seriously question
the nature of the transactions covered by its policies. It
characterizes SFC’s business as a sham, but it does not deny that
SFC was issuing student loans and that the repayment of the
interest and principal on those loans was insured by Royal’s
policies. A fairly obvious risk of this insurance decision was that
SFC would misrepresent the quality of the loans. For the reasons
given above, the policies clearly assign this risk of fraud to Royal
when they declare that its liability will be unaffected by a “breach
of any representation” or “fraud with respect to the student loans.”
Because the risk of fraud was so obvious, it is unimaginable that a
party with Royal’s experience and knowledge would not have
realized it was assuming that risk when it agreed to that language.
21
Many of the remaining cases cited by Royal involved
alleged violations of the federal securities laws. See, e.g., Caiola
v. Citibank, N.A., 295 F.3d 312 (2d Cir. 2002); CP Kelco U.S., Inc.
v. Pharmacia Corp., No. CIV.A.01-240, 2002 WL 31230816 (D.
Del. Oct. 2, 2002). It is well known that the federal securities laws
provide broader fraud protection than the common law, having
been enacted in response to the common law’s perceived failure at
stamping out fraud in the securities markets. See, e.g., Herman &
MacLean v. Huddleston, 459 U.S. 375, 388-89 (1983); In re Data
Sys. Sec. Litig., 843 F.2d 1537, 1544 (3d Cir. 1988). Since the
analysis of cases like CP Kelco appears to have been colored by
federal securities law, we do not believe those cases provide
reliable guidance on this question of Delaware’s common law of
contract.
The lack of specificity in Royal’s waivers does not make
them any less clear. As the Progressive Court put it, a “method of
identification does not become unclear simply because it is terse.”
2002 WL 1558382, at *10. This is all the more true when the
method of identification is hammered out by sophisticated parties
aided by consummate legal professionals, who can be expected to
anticipate the subjects it will identify. Accordingly, we predict that
when sophisticated parties have inserted clear anti-reliance
language in their negotiated agreement, and when that language,
though broad, unambiguously covers the fraud that actually occurs,
Delaware’s highest court will enforce it to bar a subsequent fraud
claim.
Royal asserts that this prediction risks giving protected
parties a “license to commit fraud,” CP Kelco, 2002 WL 31230816,
at *5, but the alternative poses its own danger. The danger is that
a contracting party may accept additional compensation for a risk
that it has no intention of actually bearing. This prevarication may
amount to a fraud all its own. See Progressive Int’l, 2002 WL
1558382, at *10 (“In essence, Progressive is saying to the court,
‘Believe us now when we tell you we made a false promise to
DuPont then.’”); Danann Realty Corp. v. Harris, 157 N.E.2d 597,
600 (N.Y. 1959) (“[T]he plaintiff made a representation in the
contract that it was not relying on specific representations not
embodied in the contract, while, it now asserts, it was in fact
relying on such oral representations. Plaintiff admits then that it is
22
guilty of deliberately misrepresenting to the seller its true
intention.”).
Given the potential for misrepresentation from each side of
the agreement, the safer route is to leave parties that can protect
themselves to their own devices, enforcing the agreement they
actually fashion. This rule will make for less prolix disclaimers
and reduce the likelihood that an intended allocation of the risk of
fraud will be frustrated by an unintentional omission from a long
and tedious list of representations. Such concerns have figured
prominently in recent Delaware case law. See Kronenberg, 872
A.2d at 593 (accommodating “contractual freedom and efficiency
concerns” as well as a “public policy . . . intolerant of fraud”);
Progressive Int’l, 2002 WL 1558382, at *10. When sophisticated
parties include a broad but unambiguous anti-reliance clause in
their agreement, the Delaware Supreme Court will likely indulge
the assumption that they said what they meant and meant what they
said.
It follows from the foregoing discussion that the Royal
waivers are in full force and effect. For the reasons given in
Section A of this opinion, those waivers unambiguously strip Royal
of the defense of fraud in the inducement. The District Court thus
did not err in awarding the beneficiaries summary judgment on
them, and it also did not err in denying Royal further discovery into
the beneficiaries’ knowledge of the fraud. The agreements
unambiguously waive Royal’s fraud defense whether or not the
beneficiaries had an inkling of the fraud before Royal, leaving
Royal with no remaining defense to payment that discoverable
evidence could support. To the extent set forth above, the
judgment of the District Court is accordingly affirmed.
C.
We turn now to consider the scope of Royal’s obligations
under the policies. The District Court ordered it to pay all claims
submitted by Wells Fargo and Wilmington Trust, including claims
that had been filed since the commencement of the lawsuit. Royal
argues that the Court overlooked triable issues regarding whether
all of the claimed losses were covered under the policies and
whether the beneficiaries’ claims had been properly documented.
23
The beneficiaries counter that they are entitled to immediate
payment under the policies and that Royal’s defense based on
SFC’s alleged misappropriation is waived along with its other fraud
defenses.
The scope of coverage is set forth in the first section of each
policy. The language differs from policy to policy, but the
substance is the same: Royal agrees to reimburse the insured or
beneficiary under the policy for a “Loss” that occurs during the
policy period. E.g., App. at 2247, 5479. Critically, “Loss” is
defined as “for any Student Loan as to which a Claim is made in
accordance herewith the Value as of the Default Date with respect
to such Student Loan.” E.g., App. at 2017, 5527. The “Value” of
a Student Loan is simply the “principal balance outstanding . . . as
of the Default Date plus accrued interest thereon.” E.g., App. at
2018, 5528. The “Default Date” is the first date of a “Default,”
e.g., App. at 2016, 5526, which in turn is defined as:
(i) a Student Loan becoming ninety (90) days or
more delinquent (treating payments made by a
Student but paid over to a bankruptcy court having
jurisdiction over the Student as a preference item as
not having been paid by the Student), with payments
made after a delinquency applied to the earliest
delinquency, or (ii) any impairment or avoidance of
the rights of the Beneficiary or the Insured in a
Student Loan arising out of the bankruptcy or similar
event or proceedings with respect to Student Finance
Corporation or the Insured, including without
limitation pursuant to Section 362 of the United
States Bankruptcy Code.
E.g., App. at 2032-33; see also, e.g., App. at 2016, 5479.
These provisions give rise to a reasonable inference, if not
an irresistible conclusion, that the “Loss” for which Royal agreed
to reimburse the beneficiaries was the nonpayment of interest and
principal on the student loans. If a loss may be traced to something
other than a “Default” – that is, “a Student Loan becoming ninety
(90) days or more delinquent” – it is not covered under the
24
policies.5 Under this highly reasonable interpretation, Royal need
not reimburse the beneficiaries for nonreceipt of loan proceeds
misappropriated by SFC.
Wells Fargo argues that SFC’s misappropriation is just
another form of fraud that Royal waived as a defense to payment.
This argument misses the point. Royal’s defense is not based on
SFC’s fraud per se but on the extent of coverage afforded by the
policies. The waivers themselves make this distinction clear. In
the first eight policies, Royal agreed that its “obligation to pay any
Claim” would be unaffected by a “breach of any representation.”
In the last two policies, it agreed to waive any defense that would
allow it “to avoid payment of its obligation under this policy.”
Wells Fargo’s argument begs the question of whether a loss due to
SFC’s conversion is one of Royal’s “obligation[s].”
We also reject Wilmington Trust’s argument that its policies
“require Royal to pay every Claim submitted to it upon the
submission of a conforming ‘Notice,’ without more.” Wilmington
Trust’s Br. at 40 (emphasis omitted). Although section III(A) of
the Wilmington Trust policies provides that “[a]ny Claim . . . shall
be paid by the Insurer within sixty (60) days,” App. at 5481, 5528,
other language appears to contemplate that Royal may challenge
claims prior to payment. Section III(C)(1) requires the insured or
beneficiary to deliver with notice of its claims a “written proof of
loss form . . . identifying the applicable Student Loans” and the
unpaid balance on them. App. at 5481, 5528. The policies also
require the insured to provide, upon Royal’s request, “evidence
reasonably available with respect to circumstances surrounding a
Loss.” Id. Requiring such evidence prior to payment would serve
no purpose if Royal were obligated to pay any claim upon receipt.
Arguably, section III(A) simply lays out a time frame for payment
of a claim that the parties have already agreed is valid.
5
We recognize that by their terms the policies also extend
coverage to losses resulting from the impairment of the
beneficiaries’ rights in bankruptcy. SFC entered bankruptcy in
June 2002, but the parties have not discussed how this event affects
their rights and obligations under the policies. We leave this
interesting question to the District Court.
25
To what extent SFC’s misappropriation contributed to the
beneficiaries’ losses remains unclear. Royal points to evidence that
Andrew Yao was receiving distributions from SFC at the rate of
approximately $1 million per month while serving as its director,
treasurer, and chief executive officer. See App. at 4405-07.
According to Royal, SFC’s tottering financial position at the time
makes it likely that some of this money was diverted from the
income streams due the beneficiaries. The beneficiaries have not
disputed this evidence on appeal, relying instead on the interpretive
arguments rejected above. Having found the ten policies
reasonably susceptible to an interpretation under which Royal
would not be liable for losses due to SFC’s misappropriation, we
conclude that further development of the record is necessary to
determine the extent of this misappropriation before Royal may be
ordered to pay the beneficiaries’ claims.
On remand, the District Court must first decide whether or
not the policies cover losses attributable to SFC’s alleged
conversion. If not, it must then determine the extent to which
SFC’s misappropriation contributed to those losses. Further
discovery may be necessary, but we caution that this remand is not
an opportunity for Royal to revive its rejected fraudulent
inducement defense. The proceedings should be limited to
deciding which of the losses claimed by the beneficiaries are
covered under the policies.
IV.
After careful consideration of the parties’ arguments and
submissions, we conclude that each of the ten Royal policies
unambiguously and effectively waived its defense to payment of its
obligations based on SFC’s fraud. The District Court correctly
denied Royal rescission, correctly declared the policies in full force
and effect, and correctly ordered Royal to perform its obligations
under them. That part of the District Court’s decision is affirmed.
The remainder of the decision is vacated. Triable issues
regarding the scope of the policies’ coverage and the nature of the
beneficiaries’ losses preclude summary judgment. On remand, the
District Court must determine whether the policies cover all of the
losses claimed by the beneficiaries before ordering Royal to pay
26
them.
27