Summary
holding that Marwil lacked standing to assert fraudulent conveyance claims directly on behalf of noteholders but could assert those claims on behalf of CEG
Summary of this case from CENTRAL COMMUNITY CHURCH OF GOD v. ENT IMLER CPA GROUPOpinion
CASE NO. 1:03-cv-0482-DFH
December 11, 2003
ENTRY ON MOTION FOR PARTIAL JUDGMENT ON THE PLEADINGS
The court appointed plaintiff Marwil conservator and receiver for Church Extension of the Church of God, Inc. ("CEG") and United Management Services, Inc. ("UMS"). Acting in this capacity, Marwil has sued defendant Barry Farah and two of his businesses on claims arising from Farah's sale of business assets to CEG. In Counts I and II, Marwil alleges that the sale of the business amounted to a fraudulent conveyance under Indiana Code §§ 32-18-2-14 and -15, respectively. In Count III, Marwil seeks "equitable disgorgement" of the proceeds of the sale, and in Count IV he alleges negligent misrepresentation.
Defendants Farah, AMT Services, Inc. and The Personnel Department, Inc. have moved for judgment on the pleadings on Counts III and IV. With regard to Count III seeking equitable disgorgement, defendants argue that Marwil lacks standing and that the doctrine of in pari delicto bars Marwil from asserting the claim on behalf of CEG investors even if standing were proper. With regard to Count IV for negligent misrepresentation, defendants' primary argument is that Indiana law does not recognize the tort of negligent misrepresentation by a seller of a business.
For the reasons explained below, the court denies defendants' motion for judgment on the pleadings on the equitable disgorgement count. Marwil does not have standing to assert claims directly on behalf of note holders, but he has sufficiently pled a claim on behalf of CEG that also is not necessarily barred by the doctrine of in pari delicto. The court grants the defendants' motion on the negligent misrepresentation count.
The Applicable Standard
Defendants' challenge to Marwil's standing is a challenge to the court's subject matter jurisdiction under Rule 12(b)(1) of the Federal Rules of Civil Procedure, and the motion is based only on the pleadings, without additional evidentiary material. In considering a motion to dismiss for lack of standing addressed only to the pleadings, a district court must accept as true all material allegations of the complaint, drawing all reasonable inferences in the plaintiff's favor. Lee v. City of Chicago, 330 F.3d at 468 (7th Cir. 2003), citing Retired Chicago Police Assoc. v. City of Chicago, 76 F.3d 856, 862 (7th Cir. 1996). The plaintiff, as the party invoking federal jurisdiction, bears the burden of establishing the required elements of standing. Lee, 330 F.3d at 468, citing Lujan v. Defenders of Wildlife, 504 U.S. 555, 561 (1992). "If standing is challenged as a factual matter, the plaintiff must come forward with 'competent proof — that is a showing by a preponderance of the evidence — that standing exists." Lee, 330 F.3d at 468, quoting Retired Chicago Police Assoc., 76 F.3d at 862.
On the defense of in pari delicto and whether Marwil has stated a claim for negligent misrepresentation, defendants have moved for judgment on the pleadings under Rule 12(c). The standard for granting a motion for judgment on the pleadings is the same as for a motion to dismiss for failure to state a claim under Rule 12(b)(6). See Gustafson v. Jones, 117 F.3d 1015, 1017 (7th Cir. 1997). In deciding a motion for judgment on the pleadings, a court must accept as true the complaint's well-pleaded factual allegations and must draw all reasonable inferences in plaintiff's favor. Forseth v. Village of Sussex, 199 F.3d 363, 368 (7th Cir. 2000). Under the liberal notice pleading standard in federal civil actions, moreover, the plaintiff is entitled to the benefit not only of his allegations but of any other facts he might assert that are not inconsistent with his allegations. Thus, in responding to a motion for judgment on the pleadings, a plaintiff may posit facts in his brief and, so long as they are not inconsistent with his complaint, the court must assume they are true for purposes of deciding the motion. See, e.g., Trevino v. Union Pacific Railroad Co., 916 F.2d 1230, 1239 (7th Cir. 1990) (reversing dismissal).
The defendants are entitled to dismissal of a claim only if it appears beyond doubt that plaintiff would not be entitled to relief under any set of facts that might be proven within the scope of the complaint's allegations. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Chaney v. Suburban Bus Div. of Regional Transp. Auth., 52 F.3d 623, 626-27 (7th Cir. 1995). Nevertheless, a plaintiff may still plead himself out of court if the complaint includes allegations that show he cannot possibly be entitled to the relief he seeks. See, e.g., Jefferson v. Ambroz, 90 F.3d 1291, 1296-97 (7th Cir. 1996); Warzon v. Drew, 60 F.3d 1234, 1240 (7th Cir. 1995).
Defendants have objected to Marwil's submission of several affidavits and other documents to support his factual arguments. The objection is overruled. A party moving for judgment on the pleadings must limit the basis of the motion to the pleadings and to documents attached to or referred to in the pleadings and certain matters of public record. E.g., Menominee Indian Tribe of Wisconsin v. Thompson, 161 F.3d 449, 456 (7th Cir. 1998) (affirming dismissal based on treaties that were central to and were referenced in complaint); General Electric Capital Corp. v. Lease Resolution Corp., 128 F.3d 1074, 1080 (7th Cir. 1997) (reversing dismissal based in part on disputed external document). A party opposing such a motion, however, is free to oppose the motion by suggesting in a brief the existence of facts that are not inconsistent with the party's allegations in the pleadings. E.g., Chavezv. Illinois State Police, 251 F.3d 612, 650 (7th Cir. 2001) ("we will consider new factual allegations raised for the first time on appeal provided they are consistent with the complaint"), quoting Veazey v. Communications Cable of Chicago, Inc., 194 F.3d 850, 854 (7th Cir. 1999), quoting in turn Highsmith v. Chrysler Credit Corp., 18 F.3d 434, 439 (7th Cir. 1994). There is no reason why the opposing party cannot add rhetorical support for such suggestions with some supporting documents — indicating that there is a substantial basis for the assertions — though the opponent risks possible conversion of the motion into a summary judgment motion. In this case, the court has not converted the Rule 12(c) motion into a Rule 56 motion.
The Complaint's Allegations
For the purpose of considering this motion, the court accepts the following allegations as true. CEG is an Indiana not-for-profit corporation that was founded to raise funds for the Church of God, a church that has more than 2, 000 affiliated congregations and over 230, 000 members nationwide. From 1996 to April 2002, CEG sold over $85 million worth of investment notes, mostly to church members. CEG represented that the funds from these notes would be used primarily for interest-bearing loans to local churches.
Instead, Marwil alleges, the majority of the note proceeds were used to make payments to prior CEG investors and to fund "bargain sale" transactions. Marwil alleges that bargain sale transactions allow charitable organizations to recognize non-cash contributions. Typically, the charitable organization will acquire a property at less than full value, and the difference between the purchase price and actual value can be characterized as income to the charity.
CEG's transaction with Farah was a "bargain sale" transaction. Farah's corporation, The Personnel Department, was in the business of leasing temporary workers to third-party clients. The Personnel Department additionally provided payroll and other human resource services. On February 28, 2000, Peter Grubbs, acting in his capacity as President of CEG, signed a purchase agreement for Farah's employee leasing business. Cplt. Ex. A, Asset Purchase and Sale Agreement. CEG purchased The Personnel Department, along with its client list and contractual agreements (collectively, the "Indiana Assets") for $2 million. Farah represented that the fair market value of the Indiana Assets was $3.7 million, which allowed CEG to realize "income" of $1.7 million from the transaction. As alleged in the complaint, however, this $3.7 million valuation was actually inflated by at least $1 million. This transaction was negotiated and authorized by Grubbs and Louis Jackson, President of UMS, a CEG-controlled corporation responsible for managing CEG's subsidiary corporations and real estate holdings.
A subsequent investigation by the Securities Exchange Commission revealed that CEG had been using these bargain sale transactions to cover up its financial difficulties. Investments (through the sale of notes) were solicited via circulars, which represented that the funds would be used for church loans. The proceeds were then misappropriated and used to pay prior investors and to fund bargain sale transactions, like the one with Farah. By conspiring with the sellers to substantially overvalue the assets it was acquiring, CEG was able to report sizable "phantom" income from these transactions, which in turn made the operation look more solvent to potential note investors. In reality, CEG was experiencing substantial losses, and most of its reported income was artificial.
Between February and August 2000, CEG paid Farah the first $1 million under the purchase agreement. CEG was unable to make further payments on its obligation. In the fall of 2001, Farah sued and CEG consented to a judgment for the balance. CEG continued to make payments until 2002, when it defaulted and Farah obtained a judgment in the amount of $725,737.13. Cplt. ¶ 19.
In July 2002, the SEC filed a securities action against CEG, UMS, Grubbs and Jackson. On July 31, 2002, this court appointed Marwil to serve as conservator of CEG and UMS. Marwil was ordered to try to "ensure that the Investors are made whole with respect to the funds they invested with Defendant Church Extension." Cplt. Ex. B, Final Judgment and Order of Preliminary Injunction and Other Equitable Relief, at 4. In its order of January 31, 2003, the court approved the note holder repayment plan and pursuant to 28 U.S.C. § 754, 959, and 1651, Federal Rule of Civil Procedure 66, Local Rule 66.1, and the court's inherent powers, conferred upon Marwil powers of receivership. See Pl. Ex. A, Order (A) Approving Plan For Noteholder Repayment by CEG and UMS, and (B) Granting Related Relief ("Plan Order").
On April 3, 2003, Marwil, acting as Conservator and Receiver for CEG, brought the present action. He alleges that CEG's payments for the Indiana Assets from Farah amounted to a fraudulent conveyance to Farah. Marwil seeks to rescind the transaction and to recover the money already paid by CEG to Farah under the purchase agreement. He also alleges that Farah negligently misrepresented the value of the Indiana Assets.
Discussion
I. Count III — Equitable DisgorgementDefendants raise two objections to Marwil's equitable disgorgement claim. First, defendants argue that the claim belongs to the investors and creditors of CEG exclusively, and that Marwil, as conservator and receiver for CEG, does not have standing to bring suit on behalf of the CEG's note holders or other creditors. Second, defendants argue that even if Marwil does have standing, the doctrine of in pan delicto bars the equitable disgorgement claim.
A. Standing
Marwil's threshold response to the standing argument is that defendants are barred by the doctrine of collateral estoppel from contesting standing. In Marwil's view, defendants had ample notice of his intent to bring actions on the note holders' behalf and had a full opportunity to litigate the standing issue before the court entered its order appointing Marwil receiver in the SEC case. As a result, Marwil contends, defendants should be estopped from contesting his standing to bring suit on behalf of the note holders.
This argument is without merit for several reasons. First, standing is an element of the court's subject matter jurisdiction, so "principles of estoppel do not apply." Insurance Corp. of Ireland v. Compagnie desBauxites de Guinee, 456 U.S. 694, 702 (1982), citing American Fire Casualty Co. v. Finn, 341 U.S. 6, 17-18 (1951) (reversing judgment despite losing party's consent to jurisdiction). A party never waives the right to contest subject matter jurisdiction. National Labor Relations Board v. Somerville Constr. Co., 206 F.3d 752, 755 (7th Cir. 2000). "Standing represents a jurisdictional requirement which remains open to review at all stages of the litigation." Gagan v. American Cablevision, Inc., 77 F.3d 951, 958 (7th Cir. 1996), quoting National Organization for Women, Inc. v. Scheidler, 510 U.S. 249, 255 (1994).
Second, collateral estoppel would not apply on these facts. Federal law applies to collateral estoppel issues when, as here, the judgment to be given preclusive effect was a federal judgment. Havoco of America, Ltd. v. Freeman, Atkins Coleman, Ltd., 58 F.3d 303, 307 n. 7 (7th Cir. 1995). For issue preclusion to apply: (1) the issue must be the same as the one involved in the prior action; (2) the issue must actually have been litigated in the prior action; (3) the determination of the issue must have been essential to the prior final judgment; and (4) the party against whom issue preclusion is asserted must have been fully represented in the prior action. Id. at 307.
These requirements have not been met in this case. The question of Marwil's standing to represent note holders or other CEG creditors directly was not raised or litigated in the SEC's lawsuit against CEG. Counsel for Farah did appear in that proceeding, but only as a creditor of CEG seeking full payment for the Indiana Assets pursuant to a state court judgment. See Marwil Aff. ¶¶ 3-4. Marwil has not pointed to any discussion of the standing question in the record of that prior proceeding. Marwil argues that defendants had notice of his intent to sue from their "numerous discussions." More than a courthouse hallway conversation, however, is required to show that Farah had a full and fair opportunity to litigate the issue. The note holder's alleged claims have now been asserted by Marwil. The standing issue is now squarely before the court for the first time.
On the substantive question of Marwil's standing to represent the note holders, Marwil argues first that this court "vested" him with standing in its order approving the plan for note holder repayment. In that order, the court conferred the powers of receivership on Marwil to enable him, among other things, "to assert Causes of Action on behalf of Noteholders." See P1. Ex. A, Plan Order, ¶ 4.
Marwil's argument misunderstands both the court's intention and the scope of its power. The general rule is that a receiver may pursue only the rights and claims that belong to the receivership entity. See Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416, 429-34 (1972) (affirming dismissal of bankruptcy trustee's action; trustee lacked standing to sue on behalf of bond holders of debtor); Troelstrup v. Index Futures Group, Inc., 130 F.3d 1274, 1277 (7th Cir. 1997) (vacating judgment in case brought by receiver on behalf of creditors of the receivership entity); Scholes v. Lehmann, 56 F.3d 750, 753-54 (7th Cir. 1995). Notwithstanding the phrase included in an agreed court order negotiated among counsel in the SEC action, the court simply does not have the power to transfer property (including causes of action) from non-parties (the note holders) to the conservator/receiver.
The role of a receiver is to "promote orderly and efficient management of . . . property involved in a dispute for the benefit of creditors." 13 Moore's Federal Practice § 66.03 (3d ed. 1997). The benefit to creditors contemplated by receivership law, however, is a derivative one. As in bankruptcy, creditors like the note holders stand to benefit from the efficient management, administration, and disposition of the receivership property, including successful pursuit of claims that belong to the receivership estate. The court and the parties to the SEC action expected that Marwil, by pursuing CEG's claims, would render a benefit to the note holders by protecting and adding to the company's assets. However, Marwil's role in providing this benefit was solely as "Receiver of CE[G] and UMS. Pl. Ex. A ¶ 4.
Courts facing similarly expansive language in court orders also have declined to extend their jurisdiction beyond the confines of Article III. A good example is the Caplin case, in which the district court had expressly authorized the bankruptcy trustee to bring an independent action on behalf of the creditors of the debtor. When the issue of standing was raised explicitly, though, the district court dismissed for lack of standing. 406 U.S. at 420. The Supreme Court affirmed, though its opinion acknowledged that the issue had divided some of the nation's most distinguished judges. See id. at 421-22, discussing Clarke v. Chase Nat'1 Bank, 137 F.2d 797 (2d Cir. 1943) (A. Hand, J., holding that trustee lacked standing to sue on behalf of debtor's bond holders; L. Hand, J., dissenting); accord, e.g., B.E.L.T., Inc. v. Lacrad lnt'l Corp., 2002 WL 1905389, *2 n. 3 (N.D. I11. 2002) (receiver for entity did not have standing to bring claims belonging to entity's creditors despite statement in court order that receiver was appointed "on behalf of the creditors"); Scholes v. Tomlinson, 1991 WL 152062, *2 (N.D. I11. 1991) (declining to give effect to language in court order "purport[ing] to confer upon the Receiver the authority to bring actions belonging to the 'investors or clients' of the receivership entities"); Scholes v. Schroeder, 744 F. Supp. 1419, 1421 (N.D. I11. 1990) (same); Canut v. Lyons, 450 F. Supp. 26, 29 (C.D. Cal. 1977) ("Plaintiff asserts that the language in the order which charges him with 'protect(ing) the interests of investors' gives him power to sue in their behalf. The plaintiff is confusing the duty of the conservator with his power to act.") (internal citation omitted).
Nothing in this decision prevents the note holders themselves from asserting claims against defendants on their own, perhaps as a class action. Issues of timeliness and tolling can be addressed if and when they arise. Because the court's decision in this and another similar case today conclude that the language of the January 31, 2003 order appointing Marwil as receiver was overly broad, the court is issuing an order to show cause in the SEC action why that order should not be modified to reflect more accurately the proper scope of the receiver's power.
Marwil argues in the alternative that he has standing to bring the equitable disgorgement claim as the representative of CEG, the receivership entity itself. Construed liberally, at least, the complaint will support this reading (though it is not yet clear to the court what Count III adds to Counts I and II alleging fraudulent transfers if Count III survives only on behalf of CEG). A necessary corollary to this argument is that CEG must allege and show that it has suffered an "injury in fact" as a result of Farah's alleged conduct. See Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-61 (1992); Books v. City of Elkhart, 235 F.3d 292, 299 (7th Cir. 2000); Perry v. Village of Arlington Heights, 186 F.3d 826, 829 (7th Cir. 1999).
The fact that Marwil is precluded from bringing the equitable disgorgement claim directly on behalf of the note holders does not prevent him from being able to assert the claim in CEG's name.
Fraud on investors that damages those investors is for those investors to pursue — not the receiver. By contrast, fraud on the receivership entity that operates to its damage is for the receiver to pursue (and to the extent that investors as the holders of equity interests in the entity may ultimately benefit from such pursuit, that does not alter the proposition that the receiver is the proper party to enforce the claim).Scholes v. Schroeder, 744 F. Supp. at 1422 (emphasis in original).
Marwil alleges that CEG, under the control of Peter Grubbs and Louis Jackson, promised to pay Farah $2 million in return for the Indiana Assets. Marwil claims that because the Indiana Assets were worth far less than the $2 million CEG paid and CEG was essentially insolvent at the time of the transaction, the sale was a fraudulent conveyance and CEG is entitled to equitable disgorgement of the money Farah received under the deal.
Defendants correctly point out that the Complaint does not mention Grubbs or Jackson, but plaintiff is free to describe their role in his briefs. Also, the court may consider documents incorporated by reference into the pleadings. The SEC's complaint against CEG, Grubbs and Jackson, which is attached to Marwil's Complaint as Exhibit E, includes detailed allegations regarding Grubbs's and Jackson's allegedly unlawful activity with respect to the Indiana Assets transaction. See Cplt. Ex. E, SEC Complaint ¶ 35.
Taking Marwil's allegations as true, CEG itself has suffered an injury. See Knauer v. Jonathon Roberts Financial Group, Inc., 348 F.3d 230, 234 (7th Cir. 2003) (finding that the diversion of funds from the receivership entity constituted an injury for the purposes of standing); Scholes v. Lehmann, 56 F.3d at 754 (same); Scholes v. African Enterprises, Inc., 838 F. Supp. 349, 353 (N.D. I11. 1993) (same).
Nor is this a case of an ostensible "injury" that actually resulted in the "fattening of the compan[y's] coffers." See Knauer, 348 F.3d at 234. Whatever accounting benefit CEG might have derived from the acquisition of the Indiana Assets was illusory and fleeting. See Schacht v. Brown, 711 F.2d 1343, 1347-48 (7th Cir. 1983) (holding that conduct that exacerbates a corporation's insolvency and artificially prolongs its life does not benefit that corporation). No actual income was produced as a result of this transaction. Cf. Knauer, 348 F.3d at 234 n. 4 (agreeing with the district court's determination that the "sales stage" of the Ponzi scheme — where the Ponzi entity solicits and collects funds from investors — did not injure the entity sufficient to support standing to sue other participants).
The reality of CEG's injury is not diminished by the fact that the allegedly fraudulent transaction took place under the company's auspices. Judge Cudahy's opinion in Knauer explains that the key consideration is whether the receivership entity is "legally distinct from the person who diverted funds from the entity." Id. at 235; accord, Scholes v. Lehmann, 56 F.3d at 754 (finding that the receivership corporations were harmed by the employee-perpetrator's fraudulent conveyances). Cf. Troelstrup, 130 F.3d 1274, 1277 (finding no cognizable injury to the receivership entity when a person diverts funds from his own personal account rather than an account in the name of a legally distinct entity). The Complaint here alleges that CEG was harmed by a fraudulent conveyance allegedly orchestrated by Grubbs and Jackson. The fact that they were CEG's lawful representatives at the time of the transaction does not extinguish the injury to CEG. See Scholes v. Lehmann, 56 F.3d at 754 (finding a justiciable injury despite the fact that the perpetrator of the fraud "could lawfully have ratified the diversion of corporate assets to noncorporate purposes."). Marwil has standing to bring the equitable disgorgement claim on CEG's behalf, though not on behalf of the note holders. B. In Pari Delicto
"The doctrine known by the latin phrase in pari delicto literally means 'of equal fault.'" Theye v. Bates, 337 N.E.2d 837, 844 (Ind.App. 1975), quoting Perma Life Mufflers, Inc. v. Intern. Parts Corp., 392 U.S. 134, 135 (1968). "The expression 'in pari delicto' is a portion of the longer Latin sentence, 'In pari delicto potior est conditio defendentis,' which means that where the wrong of both parties is equal, the position of the defendant is the stronger." Theye, 337 N.E.2d at 844, quoting W.M. Moldoff, Annotation, Purchaser's Right To Set Up Invalidity of Contract Because of Violation of State Securities Regulation as Affected by Doctrines of Estoppel or Pari Delicto, 84 A.L.R.2d 479, 491. As legal entities, corporations are subject to the in pari delicto defense, although the doctrine "loses its sting when the person who is in pari delicto is eliminated." Scholes v. Lehmann, 56 F.3d at 754-55, citing McCandless v. Furlaud, 296 U.S. 140, 160 (1935).
Defendants contend that the pleadings demonstrate that CEG "actively participated" in the alleged fraud that forms the basis for the equitable disgorgement claim. Specifically, defendants point to the allegation made in the Complaint that CEG colluded with Farah to "vastly inflate" the value of the acquired Indiana Assets, which in turn artificially inflated the value of CEG's holdings. See Cplt. ¶¶ 21, 23. Accordingly, defendants argue that Marwil, as receiver of CEG, should be barred by the in pari delicto defense from pursuing the equitable disgorgement count.
Two recent Seventh Circuit decisions have addressed the application of the in pari delicto defense to actions brought by receivers. In Scholes v. Lehmann, the Seventh Circuit was faced with a Ponzi scheme in which the perpetrator of the fraud, a Michael Douglas, had carried out the scheme through the use of three wholly owned corporations that he had created specifically for that purpose. The corporations solicited funds from "investors", which were used to pay dividends to previous investors and to maintain the pyramid scheme. Douglas also caused the corporations to pay funds to himself, his ex-wife, and his favorite charities. Douglas's scheme was eventually exposed, and he pled guilty to federal fraud charges. In the wake of the criminal proceedings, the court appointed Scholes as a receiver for Douglas and the corporations.
Scholes filed a fraudulent conveyance action under Illinois law against the entities that had received pay-outs from the Ponzi corporations. The Seventh Circuit was asked to considered whether the in pari delicto defense barred Scholes from pursuing the Illinois fraudulent conveyance action. The court held that it did not. The court found that the rationale behind in pari delicto — "that the wrongdoer must not be allowed to profit from his wrong" — did not apply to the receiver's action since "Douglas himself did not stand to benefit from the receiver's suit." Scholes v. Lehmann, 56 F.3d at 754. The wrong invoked to support the defense of in pari delicto was chargeable to the Ponzi perpetrator. After the receivership entities were "freed from his spell[,] they became entitled to the return of the moneys . . . that Douglas had made the corporations divert to unauthorized purposes." Id.
The Seventh Circuit revisited this issue in Knauer. 348 F.3d 230. Like Scholes v. Lehmann, Knauer arose out of a classic Ponzi scheme. Kenneth Payne and several other individuals, operating under the auspices of Heartland Financial Services and JMS Investment Group, defrauded nearly a thousand investors of millions of dollars. Knauer differed from Scholes v. Lehmann, however, in that the receiver in Knauer was not seeking to void a fraudulent conveyance but rather was pursuing tort damages against several securities broker-dealers for failing to adequately supervise Payne, who was a registered representative of the broker-dealers. Id. at *3.
At the district court level, Judge Tinder held that the receiver's claims were barred by in pari delicto, distinguishing Scholes v. Lehmann as involving a fraudulent conveyance. Knauer, 2002 WL 31431484 at *10 (S.D. Ind. 2002). On appeal, the Seventh Circuit framed the question as whether to apply the general Indiana rule that the receiver is subject to all the defenses — including in pari delicto — that would have been available against the receivership entity, see Iglehart v. Todd, 178 N.E. 685, 690 (Ind. 1931); Marion Trust Co. v. Blish, 84 N.E. 814, 816-17 (Ind. 1908), or the exception to that rule, which states that areceiver may nonetheless sue to set aside fraudulent conveyances, see Blish, 84 N.E. at 816; Hammond v. Cline, 84 N.E. 827, 828 (Ind. 1908); Franklin Nat'1 Bank v. Whitehead, 49 N.E. 592 (Ind. 1908); State ex rel. Shepard v. Sullivan, 21 N.E. 1093, 1093 (Ind. 1889).
The Seventh Circuit ultimately chose to apply the general rule, holding in Knauer that in pari delicto barred the receiver's tort claims. However, as Judge Tinder expressed and the Seventh Circuit confirmed, the equitable context in which the in pari delicto defense is asserted is crucial: "If the case before us involved the voiding of a fraudulent conveyance, as in Scholes [v. Lehmann] or the Indiana cases just cited, we would likely apply Scholes and the Indiana law favoring exceptional treatment of receivers in those circumstances." Knauer, 348 F.3d at 236. In the Seventh Circuit's view, the key distinction between was that in Scholes v. Lehmann the receiver had been seeking to recover "diverted funds from the beneficiaries of the diversions," while the defendants in Knauer, the broker-dealers, "had derived no benefit from the embezzlements." Id. In pari delicto was appropriate in Knauer because the equitable balancing favored the defendants, who had not seen a cent of the diverted funds and whose "involvement in the Ponzi scheme as a whole was quite minor." Id. at 237. On the other side of the equation, the Ponzi entities, as a result of the machinations of Payne, "were very much at the forefront of the Ponzi scheme." Id.
Applying the reasoning of Scholes v. Lehmann and Knauer, the court cannot hold as a matter of law, based on the pleadings alone, that in pari delicto applies here. The "equitable alignment" alleged here appears to resemble Scholes v. Lehmann more closely than Knauer. Marwil alleges that Grubbs and Jackson, acting through CEG, unlawfully conveyed assets from CEG to the defendants. As in Scholes v. Lehmann, the principal defendant in this case is also a principal beneficiary of the alleged fraud. Assuming for the purposes of this motion that Marwil's allegations are true, the benefit derived by Farah as a result of the fraudulent conveyance could put this case within Indiana's equitable exception to the rule that a receiver is subject to all the defenses that would be available against the receivership entity. See Blish, 84 N.E. at 816 (the general rule is "subject to the exception that the receiver so far represents the general creditors that he may avoid transactions in fraud of their rights"); Hammond, 84 N.E. at 828 ("[the receiver] takes over nothing but what belongs to the corporation, except, in certain cases, where the corporation is estopped by its fraud, he takes the right to prosecute an action for an avoidance of the transaction for the use of the general creditors.").
This result does not ignore the important question of CEG's comparative culpability in the transaction. Grubbs and Jackson have been removed from CEG management. See Cplt. Ex. E ¶¶ 11-12. While the removal of the fraud perpetrators from the receivership entity may lessen the "sting" of in pari delicto, see Scholes v. Lehmann, 56 F.3d at 754, it does not totally exculpate the entity. The degree to which the perpetrators' actions can be imputed to CEG depends on the facts and should not be decided on the basis of the pleadings alone. As the Seventh Circuit in Knauer recognized, "in pari delicto is an affirmative defense and generally dependent on the facts, and so often not an appropriate basis for dismissal." Knauer, 348 F.3d at 237 n. 6 (affirming dismissal, though, based on the facts "thoroughly alleged" in the complaint"). Based solely on a review of the pleadings, the court is unable to say as a matter of law that CEG's alleged fault in the transaction exceeded that of defendants. Accordingly, the court denies defendants' motion for judgment on the pleadings on Count III.
II. Count IV — Negligent Misrepresentation
Defendants offer several reasons for judgment on the pleadings on the negligent misrepresentation claim. Defendants argue correctly that Indiana does not recognize the tort of negligent misrepresentation outside the context of an employment relationship. Because the court agrees with this view of Indiana law, the remainder of defendants' arguments objections need not be considered.
Count IV of the Complaint alleges that defendants negligently exaggerated the fair market value of the Indiana assets. Specifically, Marwil contends that defendants told CEG and UMS that the value of the Indiana Assets was $3.7 million, which he alleges was at least $1 million above the actual fair market value of the Indiana Assets. Cplt. ¶ 44.
In considering questions of state law that arise in diversity cases, the court must determine the issues as it believes the Indiana Supreme Court would. E.g., Trytko v. Hubbell, Inc., 28 F.3d 715, 719 (7th Cir. 1994); Dameron v. City of Scottsburg, 36 F. Supp.2d 821, 831 (S.D. Ind. 1998). On this question, several Seventh Circuit opinions have uniformly acknowledged that, apart from contract-based claims for poor quality professional work, "Indiana appellate courts have declined to recognize the tort of negligent misrepresentation outside the context of an employment relationship." Trytko v. Hubbell, Inc., 28 F.3d at 720; see also Szabo v. Bridgeport Machines, Inc., 249 F.3d 672, 674 (7th Cir. 2001); Industrial Dredging Engineering Corp. v. Southern Indiana Gas Electric Co., 840 F.2d 523, 526 (7th Cir. 1988). This interpretation is plainly supported by the decisions of Indiana courts. See Darst v. Illinois Farmers Ins. Co., 716 N.E.2d 579, 584 (Ind.App. 1999); Short v. Haywood Printing Co., 667 N.E.2d 209, 213 (Ind.App. 1996); Pugh's IGA, Inc. v. Super Food Services, Inc., 531 N.E.2d 1194, 1197 (Ind.App. 1988).
Marwil contends that the Seventh Circuit has misinterpreted these Indiana decisions. Specifically, Marwil argues that the Seventh Circuit has overlooked and/or mischaracterized the Indiana appellate courts' decisions in Eby v. York-Division, Borg-Warner, 455 N.E.2d 623 (Ind.App. 1983), Wilson v. Palmer, 452 N.E.2d 426 (Ind.App. 1983), and Essex v. Ryan, 446 N.E.2d 368 (Ind.App. 1983). Unless and until the Indiana courts clearly signal a different view of Indiana law, however, this court is bound by Seventh Circuit precedent.
Moreover, the cases that Marwil cites do not support his argument. In Essex, for example, the court expressly declined to recognize the tort of negligent misrepresentation. 446 N.E.2d at 370. In Eby, the misrepresentation at issue occurred in the employment context, and the same appellate division that decided Eby limited it to that context in a later opinion. See Pugh's IGA, 531 N.E.2d at 1199 n. 1 ("Eby is limited to its own facts and is not applicable in this instance. Indiana does not recognize the tort of negligent misrepresentation."). "Since Eby, Indiana courts have declined to extend its rationale beyond the employment context." Trytko, 28 F.3d at 721.
Marwil suggests that Indiana law should be different, and that it makes no sense to limit the doctrine to the employment context. Whether that argument is right or wrong, it is reasonable, but those policy questions must be addressed to the Indiana courts. At this point, the precedents of both the Seventh Circuit and the courts of Indiana are clear. Indiana law does not recognize the tort of negligent misrepresentation outside the context of an employment relationship. Since the alleged misrepresentation at issue here did not occur within this context, Count IV must dismissed.
Conclusion
Defendants' motion for judgment on the pleadings is denied as to Count III and granted as to Count IV.