United States Court of Appeals,
Fifth Circuit.
No. 94-50043.
HELLER FINANCIAL, INC., Plaintiff-Appellee,
v.
GRAMMCO COMPUTER SALES, INC. and Donald B. Grammer, d/b/a DBG Leasing,
Defendants-Appellants.
Jan. 4, 1996.
Appeal from the United States District Court for the Western District of Texas.
Before POLITZ, Chief Judge, and REAVLEY and BARKSDALE, Circuit Judges.
POLITZ, Chief Judge:
Donald Grammer and Grammco Computer Sales, Inc. appeal a judgment in favor of Heller
Financial, Inc. on its civil RICO, fraud, and contract claims. We affirm in part and reverse in part.
BACKGROUND
In 1979 Grammer left his position as a computer sales representative with IBM, Inc. to start
Grammco Computer Sales, Inc., a company specializing in the marketing and leasing of computer
equipment. Shortly after organizing Grammco, Grammer solicited the business of the Santa Rosa
Medical Center in San Antonio, Texas which, through its director of information systems, Joseph
Dixon, began leasing computer equipment exclusively from Grammco. No competitive bids were
solicited. This exclusive relationship continued for the next eight years and, by 1986, resulted in a
total of 54 Grammco leases at a monthly cost of $124,000.
In 1987 Santa Rosa reexamined its lease obligations with a view to reducing costs. Grammer
proposed consolidating the existing leases into a single 36-month lease with a monthly payment of
$84,841, thereby reducing Santa Rosa's monthly payments by approximately $40,000. This proposal
included an option which allowed Santa Rosa to purchase the equipment at the end of the lease term
for a nominal sum. Santa Rosa accepted the proposal and, on May 20, consolidated its leases into
a single lease denominated L3177. Grammer, d/b/a DBG Leasing, then purchased this lease and all
rights Grammco held in the leased equipment for 1.2 million dollars.
Grammer obtained financing for this transaction through Heller Financial, Inc., a company
with which Grammco had financed lease transactions in the past. Prior to the formation of the new
consolidated lease, Heller informed Grammer that it could not extend a loan secured by a lease
containing a purchase option in its terms without substantial modification of the loan documents.
Grammer represented that the new lease would not contain a purchase option and that modification
of the documents would not be necessary. With this understanding, Heller agreed to extend Grammer
a 2.65 million dollar loan on a non-recourse basis, taking a security interest in Grammer's rights to
the leased equipment and the lease income stream. Grammco agreed to guarantee the loan to
Grammer.
As part of the loan closing process, Grammer pro vided Heller with an "original" of lease
L3177; this "original," however, did not include the purchase option that had been included in the
lease signed by Grammco and Santa Rosa. Grammer also entered a Master Security Agreement
pledging the leased equipment and lease income stream as security for the loan. In this agreement,
Grammer warranted that he: (1) had good title to the leased equipment; (2) had provided Heller with
all documents related to L3177; (3) had granted Heller a first, prior, and perfected security interest
in all collateral; and (4) would not modify the terms of the lease without the express approval of
Heller. After reviewing the lease provided by Grammer and the Master Security Agreement, Heller
formally approved the loan, closing the loan on June 15 and releasing the funds to Grammer on June
26. Heller received the income from the lease as payment on the loan for the next four months.
In the summer of 1987 a change in management at Santa Rosa prompted a review of
computer equipment expenditures. The review revealed that Santa Rosa was paying well-above
market rates on its computer lease with Grammco. Because the lease contained a purchase option,
Santa Rosa viewed L3177 as an installment sales contract rather than a true l ease; moreover, it
concluded that the high rates on the lease were usurious and violated Texas usury laws. Santa Rosa
stopped making payments on the lease to Heller, arranged to dismiss Joseph Dixon,1 and filed suit
1
Santa Rosa decided to terminate Dixon, but Dixon resigned before Santa Rosa officially
terminated him.
against Grammer d/b/a DBG Leasing, Grammco, and Heller alleging that L3177 was a usurious
installment sales contract.
During the ensuing litigation in Texas state court,2 Heller and Santa Rosa uncovered monthly
payments from Grammer to Dixon starting in September of 1983 and continuing until Dixon's
departure from Santa Rosa in October of 1987. Grammer maintained that these payments
compensated Dixon for computer programming services he performed for Grammco. Those services,
however, were later valued at approximately $15,000 while the payments totaled $171,804. Heller
and Santa Rosa also uncovered Dixon's participation in a series of lease transactions with Grammer
that provided significant tax benefits to Dixon at no cost and Dixon's receipt of $14,900 in royalties
from Grammer for sales of computer shelving equipment that Dixon had designed. On the basis of
this information, Santa Rosa amended its complaint to include a claim of commercial bribery against
Grammer, Grammco, and Dixon.
Heller also discovered that lease L3177 contained a purchase option and that ICS Cybernetics,
another computer vendor, owned the central processing unit of the computer equipment leased to
Santa Rosa. Thus, Heller realized that despite Grammer's warranties to the contrary, Grammer did
not have title to the leased equipment. Heller, codefendant with Grammer and Grammco on the usury
claim, filed a cross-claim against Grammer and Grammco for breach of contract and a counter-claim
against Santa Rosa for recovery of sums due under the lease.
To avoid actions that could be construed as illegal "charging" of usurious interest, Heller
nonsuited its counter-claim against Santa Rosa; Heller then received summary judgment on Santa
Rosa's usury claim against it. As the remaining claims headed to trial, Heller nonsuited its cross-claim
against Grammer and Grammco. Subsequently, Santa Rosa, Grammer, Grammco, and Dixon reached
a settlement whereby Santa Rosa received title to all of the lease equipment, 1.7 million dollars from
Grammco, $7500 from Dixon, and entry of a judgment stating that Santa Rosa had satisfied the terms
of the lease and that the lease was terminated.
After final judgment in the Santa Rosa litigation, Heller filed the instant action in federal court
2
Referred to herein as the "Santa Rosa litigation."
against Grammer and Grammco alleging breaches of the warranties found in the Master Security
Agreement, breach of contract on the loan guarantee, fraud in inducing Heller to make the loan, and
violations of the Racketeering Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §
1962(a) and (c). By consent of the parties, the district court referred the case to a magistrate judge
for a jury trial.3
Prior to trial the court issued an order prohibiting Grammer and Grammco from introducing
evidence at trial regarding Heller's failure to mitigate damages, impairment of collateral, and waiver
of claims. At the close of the defendants' case, the court instructed a verdict in Heller's favor on one
of the breach of warranty claims. The jury returned a series of special verdicts for Heller on the fraud,
contract, and civil RICO claims. The co urt rendered judgment for Heller against Grammer d/b/a
DBG Leasing in the amount of $14,665,866.63 plus costs and attorneys' fees for violating RICO §
1962(a). The judgment outlined three alternative awards against Grammer: 1) $1,950,446.01 plus
costs and attorneys' fees for violating RICO § 1962(c); 2) $1,650,148.67 with prejudgment interest
on that amount from September 13, 1987 at the rate of 10% per annum and $2,000,000 in punitive
damages plus costs for fraud; and 3) $4,888,622.21 plus costs and attorney's fees for breach of
warranty. The court rendered judgment against Grammco for $4,888,622.21 plus costs and attorneys'
fees for breach of the guarantee of Grammer's loan.
Grammer and Grammco timely appealed.
Analysis
I. Res Judicata
Grammer and Grammco first seek to dispose of all of Heller's claims on the ground that
Heller could have asserted these claims in the earlier Santa Rosa litigation and that principles of res
judicata therefore now bar Heller's assertion of these claims. We disagree. Under Texas res judicata
principles,4 a prior judgment precludes a claim only if the parties are identical, the prior judgment was
3
28 U.S.C. § 636(c).
4
Because final judgment in the Santa Rosa litigation was rendered in a Texas state court, Texas
law governs the application of res judicata based on that earlier judgment. See Marrese v.
American Academy of Orthopaedic Surgeons, 470 U.S. 373, 105 S.Ct. 1327, 84 L.Ed.2d 274
rendered by a court of competent jurisdiction and was a final judgment on the merits, and the
challenged claim arises out of the same subject matter litigated in the first suit.5
Grammer and Grammco maintain that all prerequisites for res judicata have been met
although they acknowledge that codefendants in an action, as were Heller and Grammer and
Grammco in the Santa Rosa litigation, are not considered adverse parties for purposes of res
judicata.6 Grammer and Grammco would avoid this bar by contending that once Heller asserted its
cross-claim it became an adverse party. We agree that the filing of the cross-claim made Heller an
adverse party,7 but Heller's subsequent nonsuit of the cross-claim returned the parties to the same
position as if the claim had never been filed.8 Therefore, Heller was not adverse to Grammer and
Grammco when the agreed judgment was entered and res judicata does not operate to bar Heller's
claims in this action.
II. RICO Claims
Grammer next contends that Heller failed to establish that Grammer's alleged acts of
commercial bribery and mail and wire fraud amount to a "pattern of racketeering activity" as required
to support a verdict for violations of § 1962(a) or (c). Because Grammer appeals from a denial of
his post-verdict motion for judgment as a matter of law, we review this appeal using the same
standard as the district court; factual issues are reviewed only for the presence of substantial evidence
supporting the verdict while legal issues are reviewed de novo.9
(1985); Rollins v. Dwyer, 666 F.2d 141 (5th Cir.1982).
5
Barr v. Resolution Trust Corp., 837 S.W.2d 627 (Tex.1992); Holloway v. Starnes, 840
S.W.2d 14 (Tex.Ct.App.1992), cert. denied, --- U.S. ----, 114 S.Ct. 93, 126 L.Ed.2d 60 (1993).
6
Getty Oil v. Ins. Co. of N. America, 845 S.W.2d 794, 800 (Tex.1992) ("[R]es judicata applies
only to adverse parties."), cert. denied, --- U.S. ----, 114 S.Ct. 76, 126 L.Ed.2d 45 (1993).
7
Id. ("[W]here a defendant does assert a cross-claim against a co-party, they become adverse,
and the principles of res judicata apply.").
8
Alvarado v. Hyundai Motor Co., 885 S.W.2d 167, 174 (Tex.Ct.App.1994) (citing Crofts v.
Court of Civil Appeals, 362 S.W.2d 101 (Tex.1962)), rev'd on other grounds, 892 S.W.2d 853
(Tex.1995).
9
Robertson v. Bell Helicopter Textron, Inc., 32 F.3d 948 (5th Cir.1994).
To prove a "pattern of racketeering activity" under § 1962(a) and (c), Heller had to prove
"at least two acts of racketeering activity, ... the last of which occurred within ten years ... after the
commission of a prior act of racketeering activity."10 In H.J. Inc. v. Northwestern Bell Telephone
Co.,11 the Supreme Court clarified and narrowed this statutory definition, holding that "to prove a
pattern of a racketeering activity a plaintiff ... must show that the racketeering predicates are related
and that they amount to or pose a threat of continued criminal activity."12 "It is this factor of
continuity plus relationship which combines to produce a pattern."13 Although proof of continuity
and relationship may often overlap, the two inquiries analytically are distinct prongs of the pattern
element requiring separate analysis.14
Grammer asserts that Heller failed to demonstrate that the allegations of commercial bribery
and mail and wire fraud satisfied either prong of the pattern requirement. We, however, need only
address Heller's satisfaction of the relationship prong of the pattern requirement.15 The relatedness
inquiry "focuses on the interrelationship of charged RICO predicates,"16 thereby ensuring that a
person is not "subjected to sanctions for co mmitting two widely separated and isolated criminal
10
United States v. Carlock, 806 F.2d 535, 542 (5th Cir.1986), cert. denied, 480 U.S. 949, 950,
107 S.Ct. 1611, 1613, 94 L.Ed.2d 796, 798 (1987).
11
492 U.S. 229, 109 S.Ct. 2893, 106 L.Ed.2d 195 (1989).
12
Id. at 239, 109 S.Ct. at 2900.
13
Id.
14
Id.
15
Normally, the existence of a sufficient relationship between the predicate acts is either
obvious or assumed and our review focuses on the continuity requirement. See e.g., Calcasieu
Marine Nat'l Bank v. Grant, 943 F.2d 1453 (5th Cir.1991). We reverse that approach here in
light of Heller's complete reliance on the evidence of Grammer's bribery of Santa Rosa employee
Joseph Dixon to support a finding of continuity. Even if we assume that this bribery activity
independently provides sufficient continuity for a RICO "pattern," such a pattern can not support
Heller's claim unless Heller demonstrates that the predicate acts causing its injury, the mail and
wire fraud, are sufficiently related to the predicate acts of bribery to be part of the same
racketeering pattern. See Vild v. Visconsi, 956 F.2d 560 (6th Cir.), cert. denied, --- U.S. ----, 113
S.Ct. 99, 121 L.Ed.2d 59 (1992).
16
United States v. Eufrasio, 935 F.2d 553, 564-65 (3d Cir.1991), cert. denied, 502 U.S. 925,
112 S.Ct. 340, 116 L.Ed.2d 280 (1991).
offenses."17 A plaintiff can satisfy the relationship requirement by demonstrating that the alleged
predicate acts "have the same or similar purposes, results, participants, victims, or methods of
commission or otherwise are interrelated by distinguishing characteristics and are not isolated
events."18
Examining the predicate acts alleged by Heller within this framework, we conclude that they
are not sufficiently interrelated to constitute a pattern of racketeering activity. Heller essentially
complains of two types of criminal activity: Grammer's alleged commercial bribery of Santa Rosa
employee Joseph Dixon and his use of the mail and wires to fraudulently induce Heller into extending
him credit. Acco rding to Heller's pleadings, the purpose of the bribery scheme was to maintain
Grammco's exclusive business relationship with Santa Rosa free of competition that might have
caused Santa Rosa to take its computer business elsewhere. The alleged mail and wire fraud, on the
other hand, sought to induce Heller into making a loan on terms that would have not otherwise been
available.19 The purposes of the alleged predicate acts were distinct and dissimilar.
The predicate acts also had dissimilar results. The bribery resulted in Santa Rosa's payment
of excessive prices on its leases of computer equipment while the mail and wire fraud resulted in the
extension of a loan on terms offering less protection to Heller than Heller normally required. This
conclusion is reinforced by an examination of the injuries of the "victims" of the alleged criminal
activity. By paying the higher lease rates Santa Rosa lost those sums paid in excess of the market
rate; Heller suffered a default on a loan and the loss of payments not yet made.
The difference in the "methods of commission" further supports our conclusion that the
alleged predicate acts were not related. The bribery of Santa Rosa employee Joseph Dixon eliminated
competitive pressures by causing Dixon to betray his fiduciary relationship with Santa Rosa.
17
Id. at 565 (citing H.J. Inc., 492 U.S. at 239, 109 S.Ct. at 2900-01 (quoting from legislative
history) (citations omitted)).
18
Calcasieu, 943 F.2d at 1463 (quoting H.J. Inc., 492 U.S. at 240, 109 S.Ct. at 2901).
19
Heller's witnesses testified that the loan to Grammer could have been made with the purchase
option but that Heller would have required significant modifications in the terms of the loan and
security agreement.
Grammer defrauded Heller by refusing to disclose material aspects of the lease serving as security for
the loan. It is manifest that the alleged activities involved not only substantively different crimes but
also functionally different methods of commission.
We also note that the participants in the two types of criminal activity alleged by Heller were
different. The bribery activity included Santa Rosa employee Dixon, a principal player in the scheme
without whom the bribery could not have taken place. Only Grammer participated in the alleged
fraud on Heller; neither Dixon nor a substitute intermediary participated in or was necessary to the
fraud.
Finally, we note that the two types of conduct which Heller seeks to connect into a pattern
were directed at different victims. Grammer's bribery of Dixon directly affected only Santa Rosa
while his fraudulent acts injured only Heller. We do not consider Heller and Santa Rosa to be
similarly situated victims; Santa Rosa occupied the position of a consumer of Grammer's services
while Heller served as Grammer's creditor.
In an effort to make out some relationship between the acts, Heller maintains that Grammer's
bribery allowed the extraction of supra-competitive profits from its Santa Rosa leases, one of which
leases Grammer then used as collateral for the fraudulently induced loan. Heller contends that by
using the lease as collateral for the loan, Grammer immediately reaped the profits of his fraud on
Santa Rosa rather than doing so over time and thereby insulated himself from the consequences of
Santa Rosa's discovery of the bribery. We are not persuaded.
Although we recognize that a plaintiff can satisfy the relationship requirement by
demonstrating that the alleged predicate acts "are interrelated by distinguishing characteristics" other
than those outlined above, we interpret the relationship prong of the pattern requirement to require
more than an articulable factual nexus.20 We take the clear import of the Supreme Court's admonition
in H.J. Inc. to consider whether the predicate acts "have the same or similar purposes, results,
participants, victims, or methods of commission" to require that a RICO plaintiff must prove a
20
See Vild (holding fraud against marketer of real estate development to be "unrelated" to
fraud against the targeted consumers of the development); McLaughlin v. Anderson, 962 F.2d
187 (2d Cir.1992).
relationship between the criminal aspects of the predicate criminal acts, thereby supporting the
conclusion that the criminal acts are " "ordered' or "arranged.' "21
Heller would paint with too broad a stroke. The "reaping the profits" theory describes every
lease financing loan, whether that loan involved mail or wire fraud. Through such financing, a lessor
finances his own acquisition of the leased or sold goods and realizes his profit while the debt service
on the financing is satisfied by the payments from the account debtor (consumer), all of which is a
purely legitimate business pursuit. Nothing in this scenario or in the evidence suggests that
Grammer's fraudulent acts were related to his bribery of Dixon.22
Finding the fraud and the bribery to be unrelated, we must conclude that Heller has failed to
demonstrate that Grammer's acts against it were part of a pattern of racketeering activity. The
verdicts on Heller's RICO claims must therefore be reversed.23
III. Breach of Warranty
Grammer next challenges the verdicts on Heller's claims that Grammer breached warranties
made in the security agreement executed contemporaneously with his loan from Heller. He first
asserts that the district court erred in instructing the jury that Grammer breached his warranty not to
modify the lease when he entered the settlement agreement releasing Santa Rosa from all of its
obligations under the lease, including its obligation to make payments.24 Grammer contends that any
such modification could not affect Heller's rights against Santa Rosa and that Heller therefore suffered
21
H.J. Inc., 492 U.S. at 238, 109 S.Ct. at 2900.
22
In so holding, we attempt to give some meaning to the relationship prong of the pattern
requirement. The "test" stated by the Supreme Court for the relationship prong is "admittedly
difficult to apply," Banks v. Wolk, 918 F.2d 418, 424 (3d Cir.1990), but that difficulty does not
allow us to ignore its effect. To allow a finding of relationship on the facts of this case would
effectively eliminate any meaningful relationship requirement. We interpret the Supreme Court's
teaching in H.J. Inc. that the relationship prong is "analytically distinct" to make that an untenable
result. See Vild. We leave to future panels the task of further defining the limits of this test.
23
Because Heller fails to make out a pattern of racketeering as required to support any RICO
claims, we need not consider Grammer's other assignments of error on the RICO claims.
24
The trial court held that this modification contemporaneously breached Grammer's warranty
that the obligation of Santa Rosa to make payments on the lease would remain absolute and
unconditional and not subject to any claims or rights against Grammer.
no damages as a result of the modification.
We first note that the security agreement containing the subject warranties includes a choice
of law provision designating the law of Illinois as controlling the interpretation of the agreement.25
Under Illinois law, a security agreement is a contract interpreted by reference to Article 9 of the
Commercial Code, if applicable, otherwise, by reference to the law of contracts.26
The starting point for our analysis of the security agreement is, of course, its plain language.27
Paragraph 3(n) of the agreement states that the "Debtor (Grammer) will not make any modifications
to any Lease without the prior written consent of Secured Party (Heller)." In the event that this or
other warranties are breached by Grammer, the agreement provides that Grammer is then considered
in default and fully liable for "any loss or damage incurred or suffered by Secured Party (Heller),
arising out of or in connection with the breach." Although these provisions clearly allow Heller to
bring a claim against Grammer for a breach of warranty,28 Grammer contends that the modification
of the lease is not the proximate cause of the damages which Heller seeks to recover, namely the
balance due and owing on the underlying note to Grammer.
"A perso n breaching a contract can be held liable for such damages as may fairly and
reasonably be considered as naturally arising from the breach thereof in light of the facts known or
which should have been known or such as may reasonably be supposed to have been within the
25
Ill.Rev.Stat. ch. 26 para. 1-105. Because the transaction, whether characterized as a
conditional sale or a lease, created a security interest, the transaction is governed by Article 9 of
the Uniform Commercial Code as adopted in Illinois. See Ill.Rev.Stat. ch. 26 para. 9-102.
26
Ill.Rev.Stat. ch. 26, para. 1-201(3).
27
Bysom Enterprises, Ltd. v. Peter Carlton Enterprises, Ltd., 267 Ill.App.3d 1, 204 Ill.Dec.
408, 414, 641 N.E.2d 838, 844 (1994) ("The parties' intent as to the scope of a contract is
irrelevant where the language of the contract is clear and unambiguous."), appeal denied, 159
Ill.2d 564, 207 Ill.Dec. 514, 647 N.E.2d 1007 (1995).
28
Grammer contends that any modification he made was not binding on Heller because
Grammer had already assigned the lease to Heller and that Heller therefore should have sought
recovery from Santa Rosa. The evidence, however, supports only the conclusion that Grammer
assigned his right of payment to Heller. The only agreements between Heller and Grammer of
which there is evidence are Grammer's promissory note and the related security agreement.
Grammer's notification of assignment to Santa Rosa can not support a finding of an assignment of
the lease; it provides no evidence of an agreement on the part of Heller.
contemplation of the parties as a probable result of a breach thereof."29 Common sense dictates that
if the lessor releases the lessee from making payments on the note, the lessee's failure to make those
payments naturally arises from and is connected to the lessor's release.30 Further, a review of the
agreement and the underlying promissory note lead us to conclude that the damages were precisely
those contemplated by the parties in the event of a breach of the warranty against modification.
Paragraph 3(n), which sets forth the warranty against modification, specifically discusses the amount
of the reduction in payments to Heller from the lessee as the proper measure of damages after a
modification. In Grammer's pro missory note, the parties agree that in the case of a breach of
warranty, Grammer would be liable for the payment of the principal.
We also reject Grammer's argument that Heller should have sought recovery of the balance
due on the note from Santa Rosa. Whether Heller could have pursued an action against Santa Rosa
for the payments on the note is irrelevant to our inquiry into the existence of a cause of action against
Grammer. The Illinois Commercial Code section governing modifications after assignments of rights
to payment specifically provides that the parties can agree to make a modification of the underlying
contract (the lease) a breach by the assignor of the right.31 The parties here manifested such an
intention in the security agreement. Accordingly, we conclude that the damages sought by Heller
were proximately caused by the breach of the warranty against modification and that the trial court's
directed verdict on this issue was not erroneous.
IV. Adjustment of Damage Award
Grammer next argues that even if the breach of warranty judgment stands, the trial court
erred in increasing the damage award on this claim from the jury's award of 1 million dollars to 4.7
29
Case Prestressing Corp. v. Chicago College of Osteopathic Medicine, 118 Ill.App.3d 782,
74 Ill.Dec. 382, 387, 455 N.E.2d 811, 816 (1983).
30
See Bysom Enterprises, Ltd. (rejecting argument similar to Grammer's in context of breach of
an express warranty).
31
Ill.Rev.Stat. ch. 26 para. 9-318. See Bank One, Texas, N.A. v. Communication Specialists,
Inc., 813 S.W.2d 755 (Tex.Ct.App.1991) (commenting on same provision under Texas
Commercial Code). Cf. Southern Rock, Inc. v. B & B Auto Supply, 711 F.2d 683 (5th Cir.1983)
(interpreting security agreement to create security interest in accounts rather than a complete
assignment of title to those accounts).
million dollars, the balance due on the underlying debt. We accord a jury great discretion in awarding
damages within the range shown by the evidence.32 In the infrequent circumstance where there is no
rational basis for the jury's verdict, however, a trial court may impose the only damages award that
reasonably can be drawn from the evidence.33
The only evidence of damages at trial was testimony by Heller witness John Payne who placed
the damages at the balance due on the underlying debt. Although Grammer contends that he
presented extensive evidence showing that he cured most of the breaches of which Heller complains,
he points to no evidence supporting the conclusion that the breach of the warranty against
modification caused damages less than the balance due on the debt.34 We perceive no error in the trial
court's amendment of the judgment; the record is devoid of any evidence allowing a lesser verdict
on the breach of warranty claim.
V. Fraud
Grammer asserts that Heller can not recover for fraud when that claim arises from the same
transaction supporting the successful breach of contract claim. Contending that Heller simply recast
one of its breach of warranty claims into a fraud claim, Grammer maintains that the jury's fraud
verdict and its associated award of punitive damages can not stand.
As a general rule, "the failure to perform the terms of a contract is a breach of contract, not
a tort."35 This statement, however, belies the difficulty the Texas courts and this court have had in
32
Neiman-Marcus Group, Inc. v. Dworkin, 919 F.2d 368 (5th Cir.1990).
33
See Shaffer v. Great American Indemnity Co., 147 F.2d 981 (5th Cir.1945) (allowing
substitution when only one damage amount is possible if liability attaches); United States v.
Kennesaw Mountain Battlefield Ass'n, 99 F.2d 830 (5th Cir.1938), cert. denied, 306 U.S. 646, 59
S.Ct. 587, 83 L.Ed. 1045 (1939); Texas Compensation Ins. Co. v. Heard, 93 F.2d 548 (5th
Cir.1937).
34
Even if we assume that the evidence to which Grammer points justifies a lower damage
award, that evidence is relevant only to the warranties of title, prior perfected interest, and
provisions of all relevant documents. See Security Agreement ¶ 3(a), 3(c), and 3(g).
35
Schindler v. Austwell Farmers Co-op., 829 S.W.2d 283, 289 (Tex.Ct.App.—Corpus Christi
1992), aff'd as modified, 841 S.W.2d 853 (Tex.1992); Jim Walter Homes, Inc. v. Reed, 711
S.W.2d 617 (Tex.1986). The parties agree that Texas law governs Heller's fraud claim.
determining when a party may assert a tort action in addition to a contract action.36 In Southwestern
Bell Tel. Co. v. DeLanney,37 the Texas Supreme Court cleared up some of the confusion by endorsing
a two step inquiry for such determinations. First, a court should examine the faulted conduct to
determine if it violates duties imposed by law, independent of those duties imposed by the contract.
Next, it should examine the nature of the alleged injury, recognizing that "[w]hen the injury is only
the economic loss to the subject of a contract itself the action sounds in contract alone."38
The first inquiry militates in favor of allowing Heller's fraud claim. Heller essentially claimed
and proved at trial that Grammer induced Heller to extend him a loan by misrepresenting material
facts regarding the presence of a dollar purchase option in lease L3177 and Grammer's ownership of
the leased equipment. Texas courts have held that when one party misrepresents a material fact to
induce another to enter an otherwise normal contract, the induced party may assert an action for fraud
based on duties imposed separate and apart from the contract.39
The second inquiry is more troublesome. Heller's asserted injury, both in its pleadings and
as reflected by evidence adduced at trial, was the balance due on the defaulted note; indeed, Heller
notes in brief that the default amount was the only evidence of damages even presented to the jury.
The posited injury, then, is that payments Heller was promised were never received—precisely the
subject of the contract. Although fraud damages may be measured in "benefit of the bargain" terms,40
the Texas courts are split on the issue whether these damages must be independent from damages for
36
See Southwestern Bell Tel. Co. v. DeLanney, 809 S.W.2d 493, 495 (Tex.1991) ("We have
muddled the law of "contorts' and an all encompassing bright line demarcation of what constitutes
a tort distinct from breach of contract has proven to be elusive.") (Gonzalez, J. concurring). The
matter is further complicated in this instance by the non-recourse nature of the underlying
promissory note. Thus, the co-existing breach of contract claim is based on the security
agreement which incorporates the promissory note.
37
809 S.W.2d 493 (Tex.1991).
38
Jim Walter Homes, 711 S.W.2d at 618.
39
See Trenholm v. Ratcliff, 646 S.W.2d 927 (Tex.1983) (tracing damages to losses on resale
after misrepresentation induced contract for sale).
40
American Nat'l Petroleum Co. v. Transcontinental Gas Pipe Line Corp., 798 S.W.2d 274
(Tex.1990).
the breach of the contract affected by the fraud.41 The majority of the Texas cases appear, however,
to require proof of some damages beyond the economic losses to the subject matter of the contract.
Bound as we are by Texas law on this issue, and finding no damages attributable to the fraud rather
than the contract, we perforce must conclude that Heller is not entitled to a verdict on its fraud
claim.42 Because Heller's fraud claim is necessary to support a finding of punitive damages, the award
of punitive damages must also be vacated.43
VI. Exclusion of Evidence
Grammer finally contends that the district court erred in excluding his evidence that Heller
failed to mitigate its damages, impaired the collateral for the loan, that collateral being the right to
lease payments, and waived its claims against him. Citing sections 3-606 and 9-207 of the Illinois
Commercial Code, Grammer maintains that Heller, as a secured party in possession of collateral, had
to act in a commercially reasonable manner to preserve the value of collateral.44 Grammer contends
that Heller failed to so act when it nonsuited its claims against Santa Rosa and that Grammer was
therefore entitled to a special issue regarding possible impairment of the collateral and failure to
41
National Union Fire Ins. Co. v. Care Flight Ambulance, 18 F.3d 323, 327 n. 1 (5th
Cir.1994) (noting split and collecting cases). Compare Hebisen v. Nassau Dev. Co., 754 S.W.2d
345 (Tex.Ct.App.—Houston [14th Dist.] 1988) (no claim of fraud when only damages are to the
subject of the contract) and Schindler (no requirement that separate injuries be shown to support
fraud claim).
42
Heller cites Schindler v. Austwell Farmers Co-op., for the proposition that damages directly
attributable to the fraud need not be shown. That case, however, dealt with the fraudulent
inducement of a contract where the inducing party never intended to perform. In that instance,
we agree that the law of Texas is that the action will support a fraud claim as well as a contract
claim. See Spoljaric v. Percival Tours, Inc., 708 S.W.2d 432 (Tex.1986). The instant suit deals
with a material misrepresentation inducing a contract the parties intend to perform. On those
facts, the majority rule appears to be that separate damages must be proven.
We recognize that this holding gives a narrow reading to our decision in National
Union Fire Ins. Co. where we held that a party could assert a conversion claim in addition
to a contract claim. That decision relied on the fact that no Texas cases had ever required
separate damages for the conversion claim. 18 F.3d at 327-28. In the case of fraud
claims, however, the majority of the precedent requires separate damages.
43
See Texas Nat'l Bank v. Karnes, 717 S.W.2d 901 (Tex.1986) (contract claim alone cannot
support punitive damages). Because we conclude that the fraud verdict can not stand, we need
not address Grammer's challenge to the award of prejudgment interest on the fraud damages.
44
Ill.Rev.Stat. para. 3-606 & 9-207.
mitigate damages. Grammer further contends that under section 3-606, Heller's nonsuit of its claims
against Santa Rosa discharged pro tanto Grammco's liability on its guaranty of Grammer's note and
that this point further warranted the admission of evidence on the mitigation issue.
At the outset we note that we will reverse a trial court's evidentiary rulings only if they
prejudiced a substantial right of the complaining party.45 Grammer's arguments rely on the
assumption that Heller was obligated to pursue the collateral for the lease then held by Santa Rosa
after Santa Rosa ceased making payments. The Illinois Commercial Code clearly provides, however,
that a secured party has the choice of pursuing a judgment against the debtor (Grammer) on default
rather than the collateral, in addition to the collateral, or in combination therewith.46 We therefore
agree with the trial court that evidence of Heller's decision to nonsuit its claims against Santa Rosa
was irrelevant to the claims litigated at trial.
To the extent that Grammer argues Heller's nonsuit of Santa Rosa injured him by impairing
his rights in the lease income stream, we are not persuaded. Sections 3-606 and 9-207 are designed
to prot ect the rights of sureties to act on the collateral after satisfy a debt owed to the secured
ing
party.47 Grammer and Grammco, however, gave up any rights in L3177 when they entered t he
settlement agreement with Santa Rosa. Thus, there was nothing for Heller to impair through its
acts.48
Finally, we reject Grammer's argument that the trial court erred in excluding Grammer's
45
Fed.R.Evid. 103; E.E.O.C. v. Manville Sales Corp., 27 F.3d 1089, 1093 (5th Cir.1994) ("In
order to vacate a judgment based on an error in an evidentiary ruling, "this court must find that
the substantial rights of the parties were affected.' ") (citing Carter v. Massey-Ferguson, Inc.,
716 F.2d 344, 349 (5th Cir.1983)), cert. denied, --- U.S. ----, 115 S.Ct. 1252, 131 L.Ed.2d 133
(1995).
46
Ill.Rev.Stat. ch. 26, para. 9-501.
47
See North Bank v. Circle Investment Co., 104 Ill.App.3d 363, 60 Ill.Dec. 105, 432 N.E.2d
1004 (1982).
48
See Ramsey v. First Nat. Bank and Trust Co. of Corbin, 683 S.W.2d 947 (Ky.Ct.App.1984)
(discussing purpose of impairment of collateral defense). We also note that Grammer's claims of
failure to mitigate and impairment of collateral depend upon Heller's possession of the lease
income stream. The evidence introduced at trial also supports the conclusion that Heller never
received all the documents making up L3177 and therefore was arguably never in possession of
the lease income stream as contended by Grammer.
evidence regarding Heller's alleged waiver of its claims against Grammer by failing to object or
participate in Grammer's settlement discussions with Santa Rosa. Assuming, arguendo, that the trial
court erred in granting a motion in limine on evidence related to this alleged waiver, the record
reflects that the parties did in fact introduce evidence regarding the settlement and that such evidence
overwhelmingly supports the conclusion that no waiver occurred.49 We perceive no prejudice to a
substantial right.
We REVERSE the judgment in favor of Heller on the RICO claims and the fraud claims. We
AFFIRM the judgment on the breach of warranty claims.
REAVLEY, Circuit Judge, concurring:
I concur in the result reached by the majority, but I differ in the RICO analysis.
In H.J. Inc. v. Northwestern Bell Telephone Co., 492 U.S. 229, 109 S.Ct. 2893, 106 L.Ed.2d
195 (1989), the Court held that a "pattern of racketeering activity" embraced both a "relationship"
requirement and a "continuity" requirement. As to the relationship requirement it concluded that
"criminal conduct forms a pattern if it embraces criminal acts that have the same or similar purposes,
results, participants, victims, or methods of commission, or otherwise are interrelated by
distinguishing characteristics and are not isolated events." Id. at 240, 109 S.Ct. at 2901 (emphasis
added). Particularly when read in context, I believe that the Court intended this relationship
requirement to be a minimal one. The Court recognized concerns that RICO has too broad a sweep
and was being used to pursue "legitimate" businesses as well as organized criminals, but concluded
that this result is compelled by the expansive language of the statute, and the failure of Congress to
scale it back. Id. at 235-37, 109 S.Ct. at 2899. It concluded that "the legislative history shows that
Congress knew what it was doing when it adopted commodious language capable of extending
beyond organized crime." Id. at 246, 109 S.Ct. at 2904. The Court rejected an Eighth Circuit
requirement that a "pattern of racketeering activity" requires multiple illegal schemes, as opposed to
a single fraudulent effort or scheme. Id. at 233-34, 109 S.Ct. at 2898-99. It concluded instead that
49
See First Interstate Bank v. Interfund Corp., 924 F.2d 588 (5th Cir.1991) (noting that
waiver requires proof of an unequivocal intention to no longer assert the right in question).
"Congress indeed had a fairly flexible concept of a pattern in mind." Id. at 239, 109 S.Ct. at 2900.
I would hold that Grammer's conduct met this relationship requirement. The predicate acts
included (1) repeated bribes to Dixon, (2) misrepresenting to Heller that there was no purchase
option, and (3) misrepresenting to Heller that Grammer owned the equipment. These acts are not
isolated events; they are related because they were all part of an ongoing scheme by Grammer to
obtain the benefits of an above-market lease by deceiving the hospital and his lender. The loan
facilitated this scheme by allowing Grammer to receive cash up front, thereby insulating him from a
loss should the bribery later be discovered.
However, Grammer argues as a separate ground for rejecting the § 1962(a) RICO judgment,
not reached by the majority opinion, that Heller did not prove an "investment injury." I agree.
Section 1962(a) makes it "unlawful for any person who has received any income derived ... from a
pattern or racketeering activity ... to use or invest ... any part of such income, or the proceeds of such
income, in acquisition of any interest in, or the establishment or operation of, any enterprise...." 18
U.S.C. § 1962(a). We have held that a civil recovery under § 1964(c) premised on a violation of §
1962(a) requires the plaintiff to prove that his injury was caused by the defendant's use or investment
of racketeering income. "[A]ny injury under section 1962(a) must flow from the use of investment
of racketeering income." Parker & Parsley Petroleum Co. v. Dresser Indus., 972 F.2d 580, 584 (5th
Cir.1992). Accord, Crowe v. Henry, 43 F.3d 198, 205 (5th Cir.1995) ("For subsection (a), this means
that the injury must flow from the investment of racketeering income into the enterprise."). I agree
with the majority that Heller's only evidence of damages was the unpaid amounts due on the note.
Heller's injury did not flow from the manner in which Grammer invested or used the loan proceeds
once he had obtained them by false pretenses. Heller did not tie its injury to Grammer's use or
investment of the loan, but instead claimed injury only on the basis of the initial act of making the loan
to Grammer. Likewise, Heller did not establish that the bribes to Dixon caused Grammer to receive
income and then invest or use that income in a manner that caused injury to Heller. Heller did link
Grammer's use of the income from the leases, about which there was little if any evidence presented
at trial, to Heller's decision to make its loan to Grammer.1
Furthermore, I reluctantly concur in the holding on punitive damages. We must follow Texas
law, no matter what we think of it. I understand why the breach of a duty arising out of the terms
of a contract, where the damages are measured precisely by the contract, may be treated as the
predicate for an action on the contract rather than as an independent tort. However, proof of the
elements of a cause of action for fraud should certainly establish an independent tort, whether or not
the amount of actual damages would be the same if the claim were for breach of contract. But if the
Texas courts dislike punitive damages so much as to decree that law, I am Erie bound to it.
1
As the majority points out, Heller also won a judgment based on § 1962(c) of RICO. Unlike
§ 1962(a), this subsection does not require a defendant's use or investment of racketeering
income, but instead makes it "unlawful for any person employed by or associated with any
enterprise ... to conduct or participate ... in the conduct of such enterprise's affairs through a
pattern of racketeering activity...." I need not consider whether the § 1962(c) judgment should
stand even if the majority agreed with me that the relationship requirement (which applies to both
§§ 1962(a) and (c)) was met here. First, the district court clearly awarded this judgment in the
alternative to the larger breach of warranty judgment. Heller makes no argument that the district
court erred in awarding these judgments in the alternative rather than stacking them, and makes
no argument that the jury (which awarded only $500,000 under § 1962(c)) or the court erred in
calculating damages under § 1962(c). Even after trebling by the court the § 1962(c) judgment
was still smaller than the breach of warranty judgment, and Heller should be deemed to have
elected the larger judgment. Second, as explained above, Heller's only proof of damages was the
unpaid balance on the note. Since the breach of warranty judgment awards the full amount due
on the note, adding the § 1962(c) judgment to the breach of warranty judgment would amount to
a double recovery. See Alcorn County v. U.S. Interstate Supplies, Inc., 731 F.2d 1160, 1171 (5th
Cir.1984) (noting that "duplicative damages [under RICO and state common law] should not be
allowed.").