Credit Card Debt v. Home Federal Bank ( 2004 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
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No. 03-1920
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Credit Card Debt Solutions, Inc. , *
*
Appellant, *
* Appeal from the United States
v. * District Court for the
* District of South Dakota.
Home Federal Bank, formerly known *
as Home Federal Savings Bank, *
*
Appellee. *
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Submitted: December 18, 2003
Filed: April 13, 2004
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Before RILEY, LAY, and HEANEY, Circuit Judges.
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HEANEY, Circuit Judge.
This case involves a contractual dispute between Credit Card Debt Solutions,
Inc. (CCDS) and Home Federal Bank (Home Federal). After the parties submitted
cross-motions for summary judgment, the district court1 granted summary judgment
in favor of Home Federal. CCDS appeals this determination, and we affirm.
1
The Honorable Andrew W. Bogue, United States District Judge for the District
of South Dakota.
I. Background
Home Federal entered the credit card business, offering credit to high risk
applicants. Once Home Federal approved the credit applications, it did not service
the accounts; rather, it outsourced this function to First Data Resources (FDR). After
being approached by an intermediary, CCDS agreed to purchase Home Federal’s
“charged-off” accounts – accounts that were 180 days or more in arrears. The
purchase agreement (Agreement) set a closing date of February 23, 1999. CCDS paid
six cents on the dollar for the right to collect on these accounts, which included
accounts that were charged-off prior to January 1, 1999. The outstanding balances
totaled $7,534,819.33.
On March 4, 1999, Home Federal fired the head of its credit card department,
Hugh Fullerton, because he increased his personal credit line in violation of company
policy. A subsequent investigation of the department revealed that Fullerton had
been receiving kickbacks from a marketing firm in connection with the credit card
operation. Fullerton, apparently motivated by these kickbacks, had been expanding
the sub-prime credit card operation despite evidence that this was not a profitable
strategy. Home Federal ultimately settled with its bonding company for $700,000 –
the amount reflecting the loss Home Federal incurred as a result of Fullerton’s
mismanagement of the credit card department.
Subsequent to the closing of the sale, and while CCDS was attempting to
collect on the outstanding accounts, CCDS discovered that the package of accounts
it purchased from Home Federal included secured credit card accounts. Secured
accounts differed from unsecured accounts in the following manner: In order to open
a secured account, applicants were required to pay $225 as a deposit that would be
applied to the account balance in the event of nonpayment. No customers paid the
$225 up front; instead, Home Federal charged the $225 to the newly opened credit
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card, treating it like a cash advance.2 In its internal accounting records, Home Federal
debited its loan account, showing a $225 loan to the credit card purchaser, and
credited its demand deposit account by the same amount. According to Home
Federal, this transaction was reversed when each account was charged-off. FDR’s
system, however, did not reflect this reversal at the time CCDS purchased the
accounts.
After CCDS brought the existence of the secured accounts to Home Federal’s
attention, the parties began negotiations to compensate CCDS for its overpayment for
the secured accounts. In the Agreement, the parties included a clause to deal with
unenforceable accounts. Home Federal determined the $225 advances were
2
The Security Agreement between Home Federal and the cardholder states:
SECURITY AGREEMENT. This is a secured credit card account. You
agree that, to secure the repayment of your obligations under this
Account, we will charge $225.00 to your Account to establish a non-
interest bearing security deposit. This charge is posted to your Account
as a Cash Advance and is subject to a periodic Finance Charge from the
date of posting until it is paid. However, Cash Advance fees, as
described below, do not apply to this charge. You hereby grant a
security interest in this deposit to us as collateral to secure all of your
obligations to us on this Account. You agree that, without notice to you,
we may exercise our rights as a secured creditor to apply this security
deposit to the amounts you owe to us if you are delinquent, in default or
your Account is closed for any reason. You agree that we may assign
this collateral to any party that acquires our rights in your Account.
YOU AGREE THAT YOU DO NOT HAVE ACCESS TO ANY
FUNDS IN YOUR SECURITY ACCOUNT UNTIL NINETY (90)
DAYS AFTER YOUR ACCOUNT HAS BEEN CLOSED AND ALL
OUTSTANDING AMOUNTS DUE ON YOUR ACCOUNT HAVE
BEEN PAID IN FULL.
(Appellant’s App. at 35.)
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unenforceable,3 credited $225 to each of the secured accounts, and gave CCDS a
check for $23,902.98. Home Federal arrived at this amount by totaling all of the
security deposits, $398,382.96, and multiplying the total by .06. By Home Federal’s
calculation, the $23,902.98 represented CCDS’s overpayment. CCDS cashed this
check.
CCDS, unsatisfied with this resolution, filed a complaint seeking the full
amount of the security deposits and, in the alternative, rescission of the entire
Agreement. CCDS later amended its complaint to include fraud and deceit claims,
alleging that Home Federal had an obligation to inform CCDS of Fullerton’s
mismanagement of the credit card operation. After considering the parties’ cross-
motions for summary judgment, the district court granted Home Federal’s motion for
summary judgment. In regard to the secured accounts, the district court found that
the $23,902.98 payment fairly compensated CCDS. Any higher amount, the court
reasoned, would result in a windfall to CCDS. As to CCDS’s deceit claim, the district
court found that Home Federal did not have a duty to disclose information it may
have had about Fullerton because that information did not include facts basic to the
transaction.
II. Analysis
This court reviews de novo the district court’s grant of summary judgment.
Computer Aided Design Sys., Inc. v. Safeco Life Ins. Co., 358 F.3d 1011, 1012 (8th
Cir. 2004). In doing so, we must examine the record in the light most favorable to the
nonmoving party. State Auto. Ins. Co. v. Lawrence, 358 F.3d 982, 985 (8th Cir.
2004). Summary judgment should be awarded when there is “no genuine issue as to
3
This particular scenario was not listed as an example of an unenforceable
account in the Agreement.
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any material fact” and the movant is entitled to a judgment as a matter of law. Fed.
R. Civ. P. 56(c).
A. Secured Accounts
1. Breach of Contract
Under South Dakota law,4 a breach of contract occurs when an enforceable
promise is made, the promise is breached, and damages follow as a result of that
breach. McKie v. Huntley, 620 N.W.2d 599, 603 (S.D. 2000). On appeal, CCDS
argues that the district court erred in finding that CCDS did not have a claim to the
secured accounts’ security deposits and hence incurred no damages. CCDS renews
its argument that Home Federal’s $225 credit to each of the secured accounts
constituted a “payment, credit, or other consideration” to which it was entitled under
the terms of the Agreement.5
As a preliminary matter, we must resolve which account balances control our
analysis. Home Federal outsourced the collection of the credit card accounts to FDR.
FDR’s records did not accurately reflect the reversal of the $225 deposit Home
4
Per Section 12.1 of the Agreement, the parties agree South Dakota law
controls our analysis of the substantive issues in this matter.
5
Section 3.4 of the Agreement provides:
If any payments, credits, or other consideration distributed or paid by or
on behalf of Obligor on or after the Closing Date, Seller or Sellers’
agent will be entitled to accept such payments. Except as provided in
2.31. If Seller or Sellers’ agent receives such payments, credits, or other
consideration after the Closing Date, Seller or Sellers’ agent shall
deliver such payments to Buyer within 45 days.
(Appellant’s App. at 19.)
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Federal effectuated prior to a secured account being charged-off. When CCDS was
considering the purchase of the delinquent accounts, it was informed by FDR’s
account balances. Because of this, CCDS maintains that FDR’s balances are the
relevant balances. Home Federal, on the other hand, urges us to consider its internal
records of the credit card accounts, which reflect the $225 credits being applied to the
secured accounts prior to the sale of the accounts to CCDS. We agree with the
district court that “[t]he important account information, as far as the cardholders,
CCDS, and the Agreement were concerned, are the external balances found on the
FDR system.” (Dist. Ct. Op. at 8.) We next consider whether Home Federal’s
application of the security deposits to the secured accounts after their sale resulted in
a breach of contract.
If Home Federal had collected security deposits at the time the secured
accounts were opened, we would be inclined to agree with CCDS that it would be
entitled to the full amount of those security deposits. In such a situation, Home
Federal would be in a position to reimburse CCDS this amount because it would have
already collected it from the cardholder. This situation would be much like a landlord
returning a tenant’s security deposit. This is not, however, the situation we are faced
with here. As the district court aptly explained, Home Federal’s advance of the $225
to the cardholder allowed the cardholder to purchase the $225 security interest over
time. The $225 was charged to the credit card. When CCDS purchased the charged-
off accounts, it purchased the right to collect the outstanding balances, including the
$225 security deposits. The parties agreed, per the Agreement, that the value of the
opportunity to collect the security deposits was $23,902.98. Because Home Federal
credited $398,382.96 to the secured accounts, CCDS has been deprived of the value
it paid for the right to collect. Home Federal has already compensated CCDS this
amount, however. We agree with the district court that CCDS is not entitled to any
damages. Therefore, its breach of contract claim must fail.
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2. Conversion
For similar reasons, CCDS’s conversion claim is also unsuccessful. South
Dakota law defines conversion as the “unauthorized exercise of control or dominion
over personal property in a way that repudiate’s an owner’s right in the property or
in a manner inconsistent with such right.” Chem-Age Indus., Inc. v. Glover, 652
N.W.2d 756, 766 (S.D. 2002). When Home Federal adjusted the account balances
after the Agreement was signed, it did affect CCDS’s ability to collect on the security
deposits. Since it interfered with this ability, Home Federal is liable to CCDS for the
fair market value of the property at the time of conversion. See Denke v. Mamola,
437 N.W.2d 205, 207 (S.D. 1989). We agree with the district court’s determination
that six cents on the dollar accurately reflects the fair market value of the accounts.
Since CCDS has already received this amount ($23,902.98), it has already been
compensated for its diminished ability to collect on the secured accounts’ outstanding
balances.
B. Deceit and Mutual Mistake
1. Deceit
CCDS maintains that Home Federal was obligated to disclose Fullerton’s
fraudulent conduct while he was head of the credit card operation. Home Federal
argues that it was not aware of any relevant misconduct at the time the Agreement
became effective. According to the Restatement (Second) of Torts Section
551(2)(e),6 in a business transaction, a party must disclose “facts basic to the
transaction” when the party thinks the other transacting party is mistaken as to the
facts, and a special relationship exists between the parties such that disclosure of the
6
South Dakota applied the Restatement in Ducheneaux v. Miller, 488 N.W.2d
902, 913 (S.D. 1992).
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facts would be reasonably expected. The district court held that Home Federal did
not have a duty to disclose what it knew of Fullerton’s actions because this
information was not basic to the transaction.
We agree with the district court’s conclusion. At issue is what information
Home Federal was privy to prior to the transaction with CCDS, and then whether it
was under an obligation to disclose this information to CCDS. Home Federal fired
Fullerton on March 4th – shortly after the Agreement was signed by both parties. At
that time, Home Federal was aware that Fullerton had increased his own credit line
in violation of company policy. This fact is not essential to the charged-off debt
CCDS purchased, as it does not relate to the credit card accounts.
CCDS maintains that at the time of the Agreement’s consummation,7 Home
Federal was also aware that Fullerton had mismanaged the credit card operation and
had been receiving kickbacks from marketing firms. CCDS, relying on Home
Federal’s claim to its bonding company, points out that Fullerton’s mismanagement
of the credit card operation began in mid-1998. This fact, taken in the light most
favorable to CCDS, ultimately proves fatal to CCDS’s deceit claim. CCDS purchased
accounts charged-off prior to January 1, 1999. Home Federal did not charge-off an
account until it was in arrears for 180 days, or six months. At best, this means the
earliest possible origination date on an account sold to CCDS was June 1, 1998.
CCDS has not shown that any of the accounts in CCDS’s package were affected by
Fullerton’s mismanagement and it is unlikely that it could do so. See Chem-Age
Indus., Inc., 652 N.W.2d at 765-66 (noting that fraud allegations require a higher
7
The parties disagree as to when the Agreement became operative. The
Agreement itself sets a closing date of February 23, 2004. CCDS signed the
Agreement on March 2nd. CCDS did not obtain detailed account information from
Home Federal until May 26, 1999. This latest date, May 26th, represents the
consummation date according to CCDS. Our analysis , however, is not dependent on
the consummation date and we therefore need not decide this issue.
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level of specificity and granting summary judgment to defendant because plaintiff
failed to produce specific evidence of fraud); Bruske v. Hill, 567 N.W.2d 872, 876
(S.D. 1997) (requiring specific facts to be proven in a deceit claim in order to survive
a summary judgment motion).
CCDS argues that because it had the option to purchase future charged-off
accounts, the “forward flow,” under an amendment to the Agreement, Home Federal
had an ongoing duty to disclose relevant information. CCDS did not purchase any
forward flow and therefore cannot recover in a deceit action because it did not rely
on Home Federal’s potential misrepresentations. See Himrich v. Carpenter, 569
N.W.2d 568, 576 (S.D. 1997) (“An action for deceit requires proof that the
misrepresentations were material to the formation of the contract and that the party
relied on the misrepresentations to his detriment.”).
Further, even if Fullerton had encouraged the expansion of the credit card
operation beyond profitability, it is important to note that the accounts subject to the
Agreement were – by definition – delinquent. The fact that Home Federal made
unprofitable extensions of credit, at Fullerton’s behest or not, was obvious due the
nature of the transaction between CCDS and Home Federal. CCDS has not adduced
any evidence indicating that Home Federal deceitfully withheld information basic to
the transaction.
2. Mutual Mistake
CCDS argues that, as an alternative remedy, the entire Agreement should be
rescinded on a mutual mistake theory. CCDS maintains the existence of the secured
accounts fundamentally altered the nature of the deal between it and Home Federal.
In order to allow a rescission of the Agreement because of a mutual mistake, we must
be convinced that but for the inclusion of the secured accounts, CCDS would not
have entered the arrangement. See Knudsen v. Jensen, 521 N.W.2d 415, 418 (S.D.
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1994). The security deposits accounted for only 5% of the total amount of the debt
purchased by CCDS. We agree with the district court that “[a]lthough CCDS may
have refused to purchase that portion of the package that contained the secured
accounts, there is no indication that CCDS would have refused to purchase the
remaining charged-off debt from Home Federal.” (Dist. Ct. Op. at 17.) Accordingly,
we deny CCDS’s request to rescind the entire Agreement based on a mutual mistake.
III. Conclusion
Finding no genuine issue of material fact remaining for resolution at trial, we
affirm the district court’s grant of summary judgment in favor of Home Federal.
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