Opinion
01 Civ. 11523 (JSR)
December 23, 2002
Frank Mosley, Esq., John M. Callagy, Esq., Steve Caley, Esq., Neil Mewkl, Esq., Jonathan Cooperman, Esq., Kevin Smith, Esq., Kelly, Drye Warren, LLP, New York, NY, Attorneys for Plaintiff.
Eva H. Posman, Esq., New York, NY, and Joseph Dworetzky, Esq., Michele Hangley, Esq., Henry Hockeimer, Jr., Esq., Hangley, Aronchick, Segal Pudlin, Philadelphia, PA, Attorneys for Defendant.
MEMORANDUM ORDER
The trial of this case commenced on December 2, 2002, with plaintiff JPMorgan Chase Bank ("Chase") seeking to recover on behalf of Mahonia Limited and Mahonia Natural Gas Limited (collectively, "Mahonia") approximately $1.1 billion on six surety bonds that the eleven defendant surety companies had issued to Mahonia. The bonds guaranteed certain termination payments that came due when the insolvency of Enron Natural Gas Marketing Corp. and Enron North America Corp. (collectively, "Enron") prevented Enron's further fulfillment of its contractual obligations to make future deliveries of oil and natural gas to Mahonia or payments in lieu thereof.
In response, defendants assert that they were defrauded by plaintiff into issuing the bonds and hence are not liable. Among other things, they claim that Chase purposely misled them into believing that the underlying contracts, known as "pre-pays," were ordinary arrangements by which Mahonia, a purported merchandiser of oil and natural gas, paid present cash to Enron in return for future deliveries of natural gas and oil, whereas in fact the contracts were simply camouflage for a disguised, "off-the-books" loan from Chase to Enron, the repayment of which the defendants were prohibited from insuring by New York law. According to defendants, they were tricked into insuring the bonds by Chase's concealing from them a series of contractual arrangements, entered into simultaneously with the pre-pay contracts between Enron and Mahonia, pursuant to which (i) Chase purchased from Mahonia the future deliveries Mahonia purchased from Enron, (ii) Chase sold the future deliveries directly back to Enron or to another Chase vehicle called Stoneville Aegean Ltd. ("Stoneville"), (iii) Stoneville sold its future deliveries back to Enron, and (iv) the various participants entered into a series of swaps and hedging arrangements that eliminated the effect of market fluctuations.
The result, according to defendants, was that Enron obtained money from Chase that Enron repaid to Chase at a prescribed rate of interest — the classic definition of a loan — with all risks except the risk of Enron's insolvency effectively eliminated.
To avoid liability, defendants must prove every element of the alleged fraud by clear and convincing evidence. This includes proving, among other things, that Chase knew that the underlying arrangements were disguised loans. As part of such proof, Chase seeks to introduce a series of internal Chase email communications from May, 1999 (after three of the bonds had issued and before the other three had issued) in which a senior Chase officer, Donald Layton, repeatedly described aspects of the bank's derivatives and prepaid commodities transactions as "disguised loans." Shortly prior to trial, plaintiff, by motion in limine, sought to exclude this proof across-the-board, arguing that "it is clear from the deposition testimony in this case that the so-called `disguised loans' referred to are the prepaid forward sale contracts themselves — the transactions which defendants knowingly bonded and concede are legitimate." Plaintiff's Memorandum of Law In Support of Its Motion In Limine To Exclude Evidence Relating To JPMorgan Chase Internal Communications Referring To "Disguised Loans," at 2. But since the references to "disguised loans" in the emails themselves are not so clearly limited, and since, in any event, it is hard to see why a prepaid commodity purchase, pure and simple, would be characterized as a "disguised loan" for any purpose, the Court, on the first day of trial, denied the motion, without prejudice to more particularized objections that might be raised before the proof was offered.
Thereafter, in appreciation of the potential impact of this proof, the Court continued to entertain further discussion of the issue, culminating in voir dire examination of Mr. Layton taken outside the hearing of the jury, as well as extensive oral argument and additional letter briefing. Having fully considered these submissions, the Court now rules finally and adheres to its prior ruling to permit introduction of this evidence over objections premised on irrelevancy, prejudice, confusion, or the like.
In his voir dire testimony, Mr. Layton disclaimed more than superficial knowledge of the particular transactions here at issue and stated that all he was trying to convey in his use of the term "disguised loans" was that equity derivatives and prepaid commodities transactions involved loan-like cash advances that were not being subjected to the same internal controls and comparisons that Chase utilized with respect to loans, a defect he sought to fix. Mr. Layton was an impressive witness, and his testimony helped focus the Court on various statements in his emails that could be read as corroborative of his interpretation. But on cross-examination, as well as in oral argument, defense counsel drew the Court to an alternative interpretation — highly relevant to the issues in this case — that a reasonable juror unpersuaded by Mr. Layton's testimony might adopt.
Specifically, on November 24, 1998, Mr. Layton received an email (JD 99) requesting approval of a pre-pay (not one of those here at issue) in which Chase would take delivery of pre-sold crude oil. In his email response later that day (also part of JD 99), Mr. Layton noted that, given the fact the oil to be purchased had already been pre-sold, "This is as much a loan as a commodity transaction." He also asked: "Is it now legal/okay for us to take physical [delivery of a commodity] in this way?"
In answer to his question, Mr. Layton received a lengthy email (JD 101), dated December 2, 1998, in which the transactions involved in the instant case were explained in some detail (except, notably, for the resale to Enron). Thus, the email explained that Chase had been doing these deals since 1993, that 80% were with Enron, that a Chase vehicle named Mahonia was used as an intermediary even though no longer legally required, that Enron's performance was previously guaranteed by letters of credit but was now guaranteed by surety bonds, and, most importantly, that even though the overall "transaction is priced as if it is a loan," nevertheless, "the prepaids are not booked as loans." Carefully read, this email supports defendants' contention that, even without reference to the resales to Enron, Chase internally understood, in ways that would not be apparent to outsiders without fuller disclosure, that these transactions functioned economically as loans and were understood by Chase as such but were nonetheless booked and recorded as if they were not loans.
So far as Mr. Layton was concerned, however, the matter apparently lay fallow until the following May, when he sent another email (JD 112) to his subordinates, in which, under the heading "Prepaid Oil Swap," he indicated that he had recently encountered another such transaction, that it was just one more example of a "hidden loan," grad that, while he understood that the credit risk "has been laid off with insurance companies," he wondered whether this kind of transaction "could not eventually make its way off balance sheet in some sort of SPV [i.e., special purpose vehicle, like Mahonia] or whatever."
This was followed, in turn, by the exchange of emails with which we are here principally concerned (all of which are included in JD 114). Mr. Layton led off, on May 12, 1999, with an email bearing the heading "Subject: Disguised Loans," in which he announced that "We are making disguised loans, usually buried in commodities or equities derivatives (and I'm sure in other areas). With a few exceptions, they are understood to be disguised loans and approved as such. But I am quesy about the process:" This was followed by a series of questions to subordinates.
In response, one of Mr. Layton's subordinates forwarded to him an email from another Chase officer, dated May 14, 1999, in which the officer, describing one category of these "products," noted that "Legal [i.e., Chase's legal staff] have requested that the Financing Component of the transaction is not represented as a loan facility internally, given the remote risk that our internal records are subpoenaed by the Court in administration." Read favorably to defendants, this seems to be an admission (albeit not directly with respect to the precise transactions here in issue) that Chase feared that a court might view internal recording of aspects of the transactions as loans as proof that they were, indeed, loans, rather than other forms of financing.
Mr. Layton, however, was unpersuaded. He responded, by email dated May 18, 1999, that "Legal says don't list it as a loan. Legal does not run the bank. They didn't want us to tape phone calls in the dealing room, either!! Their obscure risk has to be weighed against other factors as well and a wise judgment made. In this case, I am not happy with the outcome. I do not wish to have a piling up of disguised loans in trading account receivables that escape efforts at distribution, which is a central tenet of how the global bank runs." In other words, it appears that Mr. Layton (unaware of the special risk involving surety bonds and loans) believed the need for treating these kinds of transactions as loans internally, so as to better evaluate how to spread the bank's risk, outweighed the danger that an outsider might become aware of this treatment and seek to attack the manner in which these transactions had been booked externally. Nor, it is clear, did Mr. Layton limit these remarks to transactions other than those here in issue, for in the very next sentence he states: "I have asked for a thorough review of disguised loans. I know Commodities, under the heading of `prepaid . . .' has a whole bunch."
While there are several more emails of similar tenor, the above examples suffice to show that, notwithstanding Mr. Layton's testimony, a reasonable juror could find these emails highly probative of the defendants' central contention that Chase knew that the prepays here in issue, when coupled other aspects allegedly not disclosed to the defendants (but, with the exception of the fact that the resales were to Enron, disclosed to Mr. Layton) were really loans that were being disguised as such in the case of outsiders but (according to Mr. Layton) should not be so disguised in terms of Chase's own internal records. Indeed, Mr. Layton, a highly experienced banker but one only modestly familiar with the particular transactions here in issue, picked up on this right away, even though his own subordinates did not tell him the further fact that the resales went back to Enron (thus, incidentally, depriving him of the information he needed to appreciate the true magnitude of the risk of disclosure that "Legal" seemingly appreciated fully). To be sure, Mr. Layton, whom the plaintiff has indicated it will call as a witness if these emails are not excluded, may well convince the jury that a narrower and less damning interpretation of his emails is the correct one. But that is a jury question, and not one for this Court.
There remains, then, only the question of whether the putative probative value of this evidence is "substantially outweighed by the danger of unfair prejudice, confusion of the issues, or misleading the jury. . . ." Fed.R. Ev. 403 (emphases supplied). As the underscored words of the rule (as well as the official Commentary accompanying it) strongly suggest, Rule 403 is weighted in favor of admissibility. Nevertheless, the Court has found several occasions in the course of this trial to exclude evidence, offered by each side, the probative value of which, even when taken most favorably to the proffering party, was minimal, and was more than substantially outweighed by the immense amount of additional proof of otherwise extraneous issues that the Opposing party would have had to introduce in order to fairly respond. Here, however, no such danger exists, for not only is the proof highly probative if taken most favorably to defendants but also Mr. Layton's response, as shown by his short, clear, and precise testimony on voir dire, can be easily presented and assimilated. Accordingly, there is no basis to exclude this evidence on grounds of confusion or misleading.
As for prejudice, this aspect initially seemed more potentially troublesome, since defense counsel, from opening statement onward, had used the term "disguised loan" as a kind of shorthand for all their allegations of fraud, several of which are not implicated by Mr. Layton's use of the term even when read most favorably to defendants. But on further analysis the problem largely disappears. This is not a situation such as might exist, for example, in a case where a witness to a commercial dispute is forced to admit, in recounting a conversation, that he had used an ethnic slur, i.e., where the term in question is at once both irrelevant and inflammatory. Here, by contrast, if the jury accepts defendants' view of what the emails are referring to (as the jury reasonably might), the term "disguised loan" is highly relevant and precisely descriptive of what is involved. It does not constitute "unfair" prejudice any more than would, say, a confession. Conversely, if the jury accepts Mr. Layton's view of his use of the term, by that very acceptance the term becomes, in the context of his emails, innocuous.
Accordingly, for the foregoing reasons, the Court reconfirms its denial of plaintiff's motion to exclude the aforementioned evidence and overrules any objections to the evidence premised on Rules 401, 402, or 403 of the Federal Rules of Evidence.
SO ORDERED.