United States District Court, N.D. California, San Jose Division
THOMAS DILLON, as Court-Appointed Receiver for Vesta Strategies, LLC and Excalibur 1031 Group, LLC, Plaintiff,
CONTINENTAL CASUALTY COMPANY, an Illinois corporation, Defendant.
ORDER GRANTING CONTINENTAL'S MOTION FOR SUMMARY JUDGMENT; DENYING DILLON'S MOTION FOR SUMMARY JUDGMENT AS MOOT
EDWARD J. DAVILA, District Judge.
Presently before the Court are Defendant Continental Casualty Company's ("Continental") and Plaintiff Thomas Dillon's, as Court-Appointed Receiver for Vesta Strategies, LLC ("Vesta") and Excalibur 1031 Group, LLC ("Excalibur") (collectively, "Dillon"), cross motions for summary judgment. Dkt. Nos. 75 ("Dillon Motion"), 80 ("Continental Motion"). The Court found this matter suitable for decision without oral argument pursuant to Civil Local Rule 7-1(b) and previously vacated the hearing. Having thoroughly reviewed the parties' submissions, the Court GRANTS the Continental Motion and DENIES the Dillon Motion.
In this action Dillon seeks to recover, under four insurance policies issued by Continental, losses suffered as a result of what was, in essence, a Ponzi scheme executed by Vesta and Excalibur's owners, John Terzakis and Robert Estupinian, with the assistance of Peter Ye, Vesta's Vice President of Operations.
A. Factual Background
1. Vesta Strategies, LLC
Vesta was founded on or about January 9, 2004 as a two-member California limited liability company. Dkt. No. 97 ("Terzakis Supp. Decl.") ¶ 1; Compl. ¶ 13. Mr. Terzakis owned 51% of Vesta through B & B Sparco Properties. Id . The remaining 49% of Vesta was owned by Mr. Estupinian through Mutual Vision, LLC. Compl. ¶ 13.
Mr. Terzakis was the manager of Vesta with "directorial capacity" over its affairs and Mr. Estupinian served as its Chief Executive Officer. Id . ¶¶ 17-18. Mr. Estupinian's wife, Ginny Estupinian, formerly Ginny Hillig, served as Vesta's President. App. Ex. 1, January 24, 2012 Deposition of Peter Ye ("Ye January Dep.") at 100:18-19. Mr. Ye served as Vesta's Vice President of Operations. Dkt. No. 77 ("Ye Decl.") ¶ 2.
Vesta promoted itself as a nationwide provider of 1031 exchange services. Compl.¶ 14. Its business model involved accepting possession of funds from its clients-client exchangers-and holding those funds so that the client could avoid paying capital gains tax when buying and selling property. Ye Decl. ¶ 2. This technique was designed to take advantage of a provision of the tax code, Internal Revenue Code § 1031, that permits a party to defer the payment of capital gains of the purchase and sale of like kind property. Id .; 26 U.S.C. § 1031. Businesses like Vesta that hold client exchanger funds are referred to as Qualified Intermediaries ("QIs").
Vesta was actually the third iteration of a QI owned by Mr. Terzakis and Mr. Estupinian. In the early 2000's, the two became partners in a company called Investment Advantage Group ("IAG"). Terzakis Dep. at 23:1-21. IAG's name was changed to IAG 1031. Id. at 29:15-18. Finally, in January 2004, IAG 1031 became Vesta. Ye Decl. ¶ 2.
2. Excalibur 1031 Group, LLC
In addition to Vesta, Mr. Terzakis and Mr. Estupinian had an interest in a company called Excalibur. Excalibur's ownership was shared by Vesta (50%), Christian Benedetto, Jr. (22.5%), Kenneth Williams (22.5%), and Michael Rapf (5%). App. Ex. 2, Deposition of Christian Benedetto, Jr. ("Benedetto Dep.") at 24:17-25.
The parties agree that, although Excalibur called itself a QI, Excalibur operated as Vesta's East Coast marketing company. Excalibur Opposition at 3, 7; Dillon Motion at 10. Excalibur would solicit new customers who would then be referred to Vesta. Id . Excalibur did not enter into any contracts with clients; rather all contracts were between the clients and Vesta. Id . Furthermore, Excalibur client funds would be deposited in Vesta's bank accounts at Merrill Lynch in New Jersey. Id.
3. Continental Policies
Vesta and Excalibur purchased insurance policies from Continental to ensure against losses relating to certain dishonest or criminal conduct. Continental issued a total of four policies to Vesta and Excalibur. Specifically, Continental issued one policy to Vesta in 2004, Compl. Ex. 4 ("Vesta Policy"), and three policies to Excalibur in 2004, 2005, and 2006, respectively, Compl. Exs. 5-7 ("Excalibur Policies"). For the purposes of the instant motion, the following aspects of the Vesta and Excalibur Policies (collectively, "Policies") are relevant:
The Policies cover losses to Vesta and Excalibur resulting from employee dishonesty. Vesta Policy, Employee Dishonesty Coverage Form at 1; Compl. Ex. 5 ("First Excalibur Policy"), Employee Dishonesty Coverage Form at 1. The Vesta Policy covers losses up to $5, 000, 000. Vesta Policy, Crime Policy Declarations at 1. The Excalibur Policies covered losses up to $2, 500, 000. First Excalibur Policy, Crime Policy Declarations at 1.
The property covered under the Policies includes not only losses to Vesta and Excalibur property, but also losses to "[c]lient [p]roperty." Vesta Policy, Endorsement No. 1; First Excalibur Policy, Endorsement No. 1. This includes property that: (1) Vesta or Excalibur "own[s] or hold[s]"; (2) is "legally liable" for; or (3) is "[h]eld in a financial institution account in a transaction involving [Vesta or Excalibur] as a qualified intermediary for a tax-deferred exchange of property intended to qualify under Internal Revenue code 1031." Id.
Notwithstanding, the Policies' coverage of losses to client property, the Policies disclaim that they are for Vesta and Excalibur's "benefit only [and] provide no rights or benefits to any other person or organization." Vesta Policy, Crime General Provisions (Discovery Form) at 3; id., Endorsement No. 1; First Excalibur Policy, Crime General Provisions (Discovery Form) at 3; id., Endorsement No. 1.
As used in the policies, "Employee Dishonesty... means... dishonest acts committed by an employee'." Vesta Policy, Employee Dishonest Coverage Form at 1; First Excalibur Policy, Employee Dishonest Coverage Form at 1. The employee must act "with the manifest intent to: (1) [c]ause [Vesta or Excalibur] to sustain loss; and also (2) [o]btain financial benefit... for... the employee." Id.
While the employee dishonesty coverage offered by Continental would not ordinarily extend to acts committed by, or in collusion with, Vesta or Vesta's partners, the Policies were subject to a special exception. Specifically, the Policies were modified to cover "losses involving the funds of client/exchangers while [Vesta or Excalibur] [was] acting as a qualified intermediary in a tax-deferred exchange of property intended to qualify under Internal Revenue Code 1031" even where such losses are caused by Vesta or Vesta's partners. Vesta Policy, Endorsement No 3; First Excalibur Policy, Endorsement No. 3.
The Policies include an internal controls requirement pursuant to which Vesta and Excalibur must maintain "[p]roceeds from the relinquished property or properties of a single exchange transaction... in a financial institution account segregated from the intermediary's operating funds." Vesta Policy, Endorsement No 1; First Excalibur Policy, Endorsement No. 1. Furthermore, "each single exchange transaction [must] be identified by a specific file number or like tracking tool so as to provide a clear paper trail for each exchange transaction or series of related exchange transactions." Id.
The Policies are discovery of loss policies. Accordingly, the Policies only cover losses that are actually discovered within or shortly after the expiration of the coverage period. Vesta Policy, Crime General Provisions (Discovery Form) at 2; First Excalibur Policy, Crime General Provisions (Discovery Form) at 2. "Discovery occurs when [Vesta] first become[s] aware of facts [that] would cause a reasonable person to assume that a loss covered by [the] insurance has been or will be incurred...." Id.
The policy period for the Vesta Policy was August 15, 2003 to August 15, 2004. Vesta Policy, Policy Transaction Invoice. Under this policy, losses were required to be discovered by October 15, 2004. Vesta Policy, Crime General Provisions (Discovery Form) at 2. The policy period for the First Excalibur Policy was April 22, 2005 to August 15, 2005. First Vesta Policy, Crime Policy Declarations at 1. Under this policy, losses were required to be discovered by October 15, 2005. First Excalibur Policy, Crime General Provisions (Discovery Form) at 2. The policy period for the second Excalibur policy was August 15, 2005 to August 15, 2006. Compl. Ex. 6, Commercial Crime Policy at 2. The policy period for the third Excalibur policy was August 15, 2006 to August 15, 2007. Compl. Ex. 7, Crime Pack Policy Declarations at 1. Under both the second and third Excalibur Policies, losses were required to be discovered by August 15, 2007. Compl. Ex. 6, Crime General Provisions (Loss Sustained Form) at 2; Compl. Ex. 7, Crime Pack Policy Declarations at 5.
4. Transfers to Mr. Terzakis from Vesta
Dillon alleges that throughout Vesta's existence, Mr. Terzakis routinely stole Vesta's clients' funds to use in his real estate ventures. Indeed, Dillon alleges that Mr. Terzakis and Mr. Estupinian formed Vesta for the express purpose of carrying out this scheme. Compl. ¶ 29 (alleging that Mr. Terzakis and Mr. Estupinian "formed Vesta and Excalibur... to ...