Bum Deal

IDLE PROMISES

CASE IN FOCUS: Although business partners started out as friends, their arrangement ended in acrimonious litigation after one party cut off the interests of the remaining participants.

BY DIANE TAYLOR

SIDEBAR

Type: Breach of oral contract, fraud, negligent misrepresentation, breach of fiduciary duty and constructive trust.

Verdict: $32,400,000

Disbursement: Plaintiff Dennis J. Fitzpatrick-$ 10,299,440 (compensatory damages); $1,500,000 (punitive damages). Plaintiff Maurice J. DeWald-$14,035,307 (compensatory damages); $6,500,000 (punitive damages).

Case/Number: Maurice J. DeWald: Dennis M. Fitzpatrick v. Wayne L. Knyal / SC 044949

Court/Date: Los Angeles Superior, Pasadena /April 9

Judge: Judson Morris, Dept. 0

Attorneys: Plaintiff Dennis M. Fitzpatrick-Walter J. Lack, Steven C. Shuman (Engstrom, Lipscomb & Lack, Los Angeles). Plaintiff Maurice J. DeWald-Robert C. Baker, Daniel P. Leonard (Baker, Silberberg & Keener, Los Angeles). Defendant Wayne L. Knyal-Joseph Davis (Davis & Thomas, Los Angeles).

Technical Experts: Defendant-James Smith, Esq., securities, mergers and acquisitions.

In 1992, plaintiffs Dennis M. Fitzpatrick and Maurice J. DeWald were involved in a mortgage lending business with defendant Wayne L Knyal. DeWald was an investor and limited partner in Franchise Mortgage Acceptance Co., a limited partnership formed by Knyal. Franchise Mortgage Acceptance Corp., wholly owned by Knyal, was the corporate general partner. The entire enterprise was known as FMAC. Fitzpatrick who had a long business and personal history with Knyal, was retained as the senior advisor of FMAC. According to Fitzpatrick in order to induce him to join FMAC, Knyal promised him a one-third portion of Knyal's equity interest in the business. When the business needed more capital, Greenwich Capital of Connecticut offered to buy its assets. However, Greenwich insisted that all of the limited partners unanimously approve the deal and that they sign a release of any claims that had accrued against FMAC.

DeWald maintained that in order to persuade him to sign the release, Knyal orally agreed to set aside a quarter of his own interest in the resulting entity for the benefit of all of the limited partners. Due to Fitzpatrick's prior affiliation with a failed savings and loan company, which was also the subject of a federal investigation, Greenwich's parent company refused to proceed with Fitzpatrick involved. Knyal thereby excluded Fitzpatrick from the transaction, promising his inclusion in a different business venture to replace the equity interest he would be losing.

After securing the consent and signed release of all of FMAC's limited partners, Greenwich Capital acquired FMAC in 1993. Two years later, Imperial Credit Industries purchased the FMAC division from Greenwich for $4 million. In the next two years, the business became very successful, eventually going public in an initial pubic offering valuing the company at $400 million. However, Knyal never conveyed the interests he purportedly promised to DeWald and Fitzpatrick, despite the fact that his interest in FMAC was worth approximately $131 million on the day that it went public. DeWald and Fitzpatrick thereafter sued Knyal for breach of oral contract, fraud and breach of fiduciary duty. The jury ultimately found Knyal liable for fraud and breach of fiduciary duty, awarding the plaintiffs a total of $32,400,000, including $8 million in punitive damages.

In 1972, Dennis Fitzpatrick, a businessman and entrepreneur, was the president and chief executive officer of Beverly Hills Savings & Loan. In the late 1970s, Fitzpatrick met Wayne Knyal and they formed a friendship. In 1984, Fitzpatrick left the savings and loan to form Fitzpatrick & Associates, a firm which arranged real estate financing for commercial properties and transactions, and which later became CBI Financial. In 1986, Fitzpatrick and Knyal established CBI Mortgage, a residential mortgage banking firm. At that time, they originated the idea of lending money to fast food franchisees by using the assets and value of the franchise as security. The funding for the loans would arise from the sale of the security instruments or bonds, backed by the mortgages on the business assets.

In 1989, Fitzpatrick, Knyal and another participant at CBI Financial secured an exclusivity agreement with Taco Bell, wherein Taco Bell would not promote another mortgage-backed security program for five years. By the time Fitzpatrick left the CBI entities in 1989 to pursue a real estate development project, he had invested over $125,000 of his personal funds into the firm. After Fitzpatrick's departure, the CBI companies continued to utilize his real estate license. Between 1989 and 1992, in addition to his own business ventures, Fitzpatrick provided occasional consulting advice to Knyal regarding structuring deals, dealing with investment bankers and preparing business plans.

In early 1991, Knyal formed Franchise Mortgage Acceptance Corp. as a vehicle to arrange low cost financing for fast food franchisees. Additionally, he organized Franchise Mortgage Acceptance Co. to obtain financing for the enterprise. The corporation, wholly owned by Knyal and his family, was the sole general partner of the limited partnership. The venture became collectively known as FMAC.

Maurice J. DeWald was one of the initial investors in FMAC, contributing $167,000 for a 16.67 percent interest in the limited partnership. Of the five limited partners, only DeWald and two other partners invested any money. Knyal, one of the limited partners who failed to invest, received a 50 percent limited partnership interest as compensation for the time and labor he had already allocated to the business. Knyal functioned as the chief operating officer of the corporation, while DeWald provided consulting services and helped assemble meetings and open doors to potential funding sources.

In July 1991, the limited partnership agreement was amended to add another limited partner, but DeWald contributed additional money to retain his proportionate interest in the partnership. The investors contributed a total of $500,000 to the limited partnership to assist in financing certain Taco Bell franchisees. FMAC soon procured funding from Prudential Insurance Co. and thereafter made approximately $65 million in loans to franchisees. The principal source of repayment to the limited partnership was from the "interest spread" between the price of the money borrowed from Prudential and that which the franchisees repaid. The differential, although small in percentage, generated sufficient income to repay the limited partners a four-fold return on their initial investment.

In June 1992, after Knyal's repeated entreaties, Fitzpatrick left his position with a real estate development firm to join FMAC as a senior advisor. At his prior job, Fitzpatrick was purportedly earning a yearly salary of $120,000, plus an equity interest. Fitzpatrick's new position at FMAC gave him responsibility over all internal operations and entailed working with bankers and financial institutions to seek new funding sources. As a result Knyal could spend his time marketing loans to the franchise operations.

According to Fitzpatrick, in addition to an annual salary of $60,000, Knyal orally offered him one-third of his own equity interest in the franchise lending enterprise as incentive to come on board. At the time Fitzpatrick was retained, it was common knowledge that FMAC would be looking for new funding and would potentially need to recapitalize with a new equity partner. Fitzpatrick alleged that he did not insist that Knyal put his purported promise in writing because of his long-held trust in Knyal and the impending recapitalization. Throughout 1992, while Fitzpatrick was searching for a funding source, Knyal allegedly reassured him that whatever deal was ultimately reached, Fitzpatrick would be retained and would receive one-third of Knyal's resulting equity interest.

Despite the success of the initial Taco Bell financing, FMAC was unable to procure any other lenders to loan to franchisees unless FMAC was able to increase its equity investment in future loans. Many lenders purportedly indicated that they would only be willing to make franchise loans if FMAC invested up to $10 million of its own money, which was well beyond FMAC's capabilities.

After approaching a number of potential institutional investors, only Greenwich Capital expressed interest in committing. Greenwich, a Connecticut company engaged in a variety of financial businesses, agreed to purchase FMAC's assets, including its loans in progress, but not its completed loans. Additionally, Greenwich would assume nearly $800,000 of FMAC's accumulated debts and would take over FMAC's ongoing monthly operating expenses of $50,000. According to the defendant this deal inured to the benefit of all of the limited partners, including DeWald.

As part of the purchase transaction, Greenwich purportedly required that each of the limited partners sign releases to relinquish any past or present claims that they had against Greenwich, FMAC or Knyal. Greenwich also insisted that all of the limited partners unanimously approve the acquisition. After the deal was consummated, Knyal and certain other staff members would be retained as employees, but Knyal would also receive a one-third equity interest in the continued enterprise.

For DeWald, the Greenwich buy-out seemed like a very good deal, providing that his partnership interest was carried forward. The completed loans retained by the partnership would entitle DeWald to distributions of approximately $400,000, which translated to a 140 percent return over the distribution period of the loans. Further, that calculation did not take into account the debt that Greenwich was taking over.

To ensure that DeWald and the other limited partners signed the release, Knyal purportedly promised DeWald that he would set aside one quarter of the one-third equity interest he would be receiving for the benefit of all of the limited partners. DeWald claimed that a number of documents reflect Knyal's intent to convey this carried equity interest to the limited partners. First, Greenwich's initial written proposal indicated that Knyal wished to include the partners in the new FMAC, and that Greenwich was receptive to that. Secondly, the penultimate paragraph of the proposal states that Knyal intended to grant a portion of his share to old FMAC employees. Thirdly, Knyal's handwritten notes on the proposal indicate that DeWald should be considered as a possible advisory board member for the new entity. Finally, Knyal's own notes concerning the proposal allegedly raise the subject of the respective interest holdings of the limited partners after the acquisition and whether all of the interests would come from Knyal's own interest.

On March 19,1993, DeWald signed the release, which was purportedly limited to claims that arise, accrue or otherwise come into existence on or before that date. According to DeWald, since the date of the release preceded the closing of the Greenwich transaction, he was still entitled to a carried equity interest. Additionally, the release purportedly provided that the carried equity interest which would come into existence in the future was not encompassed by the release.

On March 25,1993, Greenwich issued a letter of intent to Knyal, which he accepted and signed. The letter allegedly indicated that Knyal could assign part of his interest to his present investors, which included DeWald. Further, a draft of Knyal's contract with Greenwich states that Knyal could assign his interest in his equity payments to anyone currently owning a limited partnership interest in FMAC.

As for Fitzpatrick, it quickly became apparent that he would be entirely excluded from the Greenwich deal. Due to his previous affiliation with the Beverly Hills Savings& Loan, Greenwich was unwilling to proceed with the acquisition if Fitzpatrick was included in the new venture. A year after Fitzpatrick's departure from the savings and loan, it was taken over by the RTC and became the subject of an intensive investigation by federal litigators. Because of Fitzpatrick's former position as chief executive officer of the savings and loan, Greenwich's parent company allegedly considered it "too onerous" to have Fitzpatrick involved in their transaction. Knyal, who purportedly had no other alternatives to salvage his company, thereby informed Fitzpatrick that he could no longer be part of the management team that moved to Greenwich, Conn.

However, according to Fitzpatrick, Knyal also promised that he would include Fitzpatrick in a different business venture to replace the equity interest he would be losing by his exclusion from FMAC. Fitzpatrick thereafter left FMAC and moved to Whistler Mountain, British Columbia, where he obtained a job in land development.

Following Greenwich's acquisition, FMAC was relocated to Greenwich and Knyal began to commute on a weekly basis. However, the fit between FMAC and Greenwich allegedly never occurred, as the FMAC division lost approximately $4 million over the next two years. In June1995, Imperial Credit Industries, Inc. purchased the FMAC division from Greenwich for approximately $7 million, and Knyal continued his one-third equity interest in the new business. Imperial poured a great deal of capital into FMAC and also extended it substantial lines of credit. As a result, the company became very profitable and went public in November 1997.

The initial public offering valued the company at $400 million, while Knyal's interest in the company was allegedly worth $131 million. Despite FMAC's ultimate success, Knyal never conveyed the interests he purportedly promised to DeWald or Fitzpatrick. In the two years following Greenwich's acquisition, Knyal allegedly told DeWald that he was extremely busy trying to operate the business, which was fairing poorly. Further, Knyal purportedly never stated that DeWald wasn't entitled to any carried interest, but only that he hadn't had the opportunity to convey it. When DeWald telephoned him to inquire about the interest, Knyal allegedly failed to return the calls.

In August 1995, during a chance conversation with the chief executive officer of Imperial, DeWald learned that Imperial had purchased FMAC and that the deal would likely prove very profitable. At that time, DeWald first realized that Knyal did not intend to convey the owed interest. Likewise, Fitzpatrick waited for several years in the hope that Knyal would eventually perform on his purported promise. In the meantime, he received occasional reports from DeWald regarding how busy Knyal was and how poorly FMAC was doing. When DeWald informed him of Imperial's acquisition, Fitzpatrick also realized that Knyal had been misleading him.

In November 1996, DeWald and Fitzpatrick together sued Knyal, alleging breach of contract, declaratory relief, fraud, breach of fiduciary duty and various other claims for relief. After several motions for summary adjudication were granted in defendant's favor, DeWald commenced trial on the breach of oral contract, declaratory relief and accounting causes of action, while Fitzpatrick alleged fraud, negligent misrepresentation, breach of fiduciary duty, constructive trust and accounting claims.

At trial, DeWald dropped his breach of oral agreement cause of action and after prevailing on a motion to amend the complaint, claimed that defendant breached his fiduciary duty stemming from the limited partnership agreement. Knyal maintained that the trial judge had no authority to reinstate DeWald's breach of fiduciary duty claim, as the issue had already been summarily adjudicated in December 1997.

Contentions: Plaintiff DeWald initially contended that Knyal breached his oral contract by failing to allocate a share of his own interest in FMAC after its acquisition by Greenwich. According to DeWald, he agreed to approve the Greenwich transaction and to sign the release in consideration for Knyal's promise to set aside one-third of his interest in the future recapitalized entity for the benefit of the limited partners. DeWald performed by entering the release and approving the transaction, while Knyal purportedly breached the agreement by failing to convey the carried interest without any justification or excuse. At trial, after Knyal's testimony regarding converting the assets of the partnership and not fully completing the Greenwich transaction, DeWald contended that Knyal breached his fiduciary duty based on the terms of the April 1991 written partnership agreement. DeWald claimed that Knyal's transfer of some of the limited partnership's assets to Imperial violated the terms of the limited partnership agreement, as he never provided notice of the transaction to any of the limited partners. DeWald further contended that the notice provided to Greenwich was insufficient because the Greenwich transaction was never completed and the notice did not disclose anything about the transfer to Imperial. DeWald maintained that Knyal took advantage of his limited partners by converting an asset of the partnership to his own use, parlaying it into a big profit, while falsely promising to give DeWald a carried interest in his share of the business. DeWald thus contended that Knyal's actions, including his cavalier use of partnership benefits for his benefit only, constituted a breach of his fiduciary duty. Plaintiff Fitzpatrick claimed that Knyal promised him a one-third share of his own interest in order to induce Fitzpatrick to return to the franchise lending business. Fitzpatrick relied on the promise by accepting the position and foregoing an opportunity on another venture. Fitzpatrick alleged that Knyal had no intent to perform on his promise, as demonstrated by. his exclusion of Fitzpatrick from the recapitalization transaction with Greenwich. Additionally, Knyal made a further false promise to Fitzpatrick by telling him that he would compensate him for this exclusion by including him in a future venture, which he failed to do. Defendant Knyal alleged that there are no documents or writings corroborating Fitzpatrick's claim that Knyal promised him one-third of his equity interest in FMAC. Knyal claimed that no such oral promise was ever made and that there were no witnesses to support it. Knyal further claimed that Fitzpatrick's claims were barred by the statute of limitations. As to DeWald, Knyal contended that the signed release barred all of his claims against FMAC, and waived his rights under Civil Code 1542. Additionally, there were no witnesses or documents which corroborated Knyal's alleged oral promise to DeWald.

Jury trial: Length, four weeks; Deliberation, one day, Poll, 12-0 (fraud as to Fitzpatrick), 11-1 (breach of fiduciary duty as to DeWald). With regard to Fitzpatrick, even though the jury found in its special verdict that no promise was made to him, and that there was no breach of the fiduciary duty, it determined in its general verdict that Knyal committed fraud against him. Knyal argued that these finding were inconsistent, yet the judge still entered the verdict.

Settlement discussions: Plaintiffs demanded a total of $5 million. Prior to trial, defendant extended an offer of $200,000, which was rejected.

Post-trial motions: Defendant filed a motion for new trial, motion for judgment notwithstanding the verdict and motion to tax costs, which are currently scheduled for hearing on July 9.