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Lake Ridge New Tech Schools v. Bank of New York Mellon, Trust Company, N.A.

United States District Court, N.D. Indiana

November 13, 2018




         This matter is before the Court on the Defendant's, Bank of New York Mellon Trust Company, N.A. (“Bank” or “Trustee”), Motion to Dismiss Plaintiffs' Complaint pursuant to Federal Rule Civil Procedure 12(b)(6) [ECF No. 38]. The Plaintiffs, Lake Ridge New Tech Schools and Lake Ridge Multipurpose School Building Corporation (collectively, “Plaintiffs”), filed their Response on September 24, 2018. [ECF No. 44.] On October 11, 2018, the Bank filed its Reply [ECF No. 47.] For the reasons stated in this Opinion and Order, the Court GRANTS the Defendant's Motion.


         This case concerns whether the Bank, as an indenture trustee, can be held liable for processing a fraudulent pay affidavit, purportedly sent by Lake Ridge Multipurpose School Building Corporation, under contract and tort theories. Accordingly, the Court begins with a review of the relevant contract and underlying facts.

         A. September 1, 2015 Trust Indenture Agreement

         The Bank and Lake Ridge Multi School Building Corporation (“Building Corporation”) entered into a Trust Indenture Agreement on or about September 1, 2015 [ECF No. 1, Ex. A] (“Indenture Agreement”), which governed the issuance and redemption of municipal bonds to fund the renovation of Calumet High School (“Project”) through a trust (“Trust”).[1] (Compl. ¶¶ 7-11, ECF No. 5.) Under the Indenture Agreement, the Bank was to act as the indenture trustee and was authorized to employ agents, attorneys, and counsel to administer and execute the Trust. (Compl. ¶ 12.) Construction funds for the Project were deposited and held in the trust account, and the Bank, as indenture trustee, made payments to contractors and vendors on the Project from the trust account upon the submission of a pay affidavit. (Compl. ¶ 15-16.)

         The Indenture Agreement contained several provisions governing the Building Corporation's and the Bank's submission and processing of pay affidavits. Under Section 3.01 of the Indenture Agreement, all pay affidavits were to be submitted by an authorized representative of the Building Corporation. Section 3.01 stated: “All payments from the Construction Account shall be made by the Trustee upon presentation of an affidavit executed by an officer of the [Building] Corporation or the Lessor Representative, stating the character of the expenditure, the amount thereof, and to whom due, together with the statement of the creditor as to the amount owing.”

         Section 10.09 of the Indenture Agreement governed the obligations and rights of the Bank once it had received a pay affidavit. Section 10.09 provided that “the Trustee shall have the right to accept and act upon the instructions, including funds transfer instructions (“Instructions”) given pursuant to this Indenture and delivered using Electronic Means . . . .” The Agreement defined “Electronic Means” to include e-mail. (Indenture Agreement § 1.01(g).) Further, with respect to pay affidavits submitted through Electronic Means, Section 10.09 stated: “If the [Building] Corporation elects to give the Trustee Instructions using Electronic Means and the Trustee in its discretion elects to act upon such Instructions, the Trustee's understanding of such Instructions shall be deemed controlling.”

         In connection with the authenticity of pay affidavits submitted through Electronic Means, the Indenture Agreement added: “[The Building] Corporation understands and agrees that the Trustee cannot determine the identity of the actual sender of such Instructions and that the Trustee shall conclusively presume that directions that purport to have been sent by an Authorized Officer listed on the incumbency certificate provided to the Trustee have been sent by such Authorized Officer.” (Indenture Agreement § 10.09.) Moreover, the Agreement contained the following language regarding the possibility of unauthorized pay affidavit submissions and liability thereof:

“The [Building] Corporation shall be responsible for ensuring that only Authorized Officers transmit such [pay affidavit] Instructions to the Trustee and that the Corporation and all Authorized Officers are solely responsible to safeguard the use and confidentiality of applicable user and authorization codes, passwords and/or authentication keys upon receipt by the Corporation. The Trustee shall not be liable for any losses, costs or expenses arising directly or indirectly from the Trustee's reliance upon and compliance with such Instructions notwithstanding such directions conflict or are inconsistent with a subsequent written instruction. The Corporation agrees: (i) to assume all risks arising out of the use of Electronic Means to submit Instructions to the Trustee, including without limitation the risk of the Trustee acting on unauthorized Instructions, and the risk of interception and misuse by third parties; (ii) that it is fully informed of the protections and risks associated with the various methods of transmitting Instructions to the Trustee and that there may be more secure methods of transmitting Instructions than the method(s) selected by the Corporation; (iii) that the security procedures (if any) to be followed in connection with its transmission of Instructions provide to it a commercially reasonable degree of protection in light of its particular needs and circumstances; and (iv) to notify the Trustee immediately upon learning of any compromise or unauthorized use of the security procedures.

(Indenture Agreement § 10.09.)

         The Agreement also contains provisions defining and limiting the Bank's duties to the Building Corporation with respect to the administration of the Trust. Of specific importance in this case, the Agreement stated: “The Trustee shall not be responsible in any manner for: . . . [T]he default or misconduct of any agent or employee appointed by it, if such agent or employee shall have been selected with reasonable care, or for anything done by it in connection with this trust, except for its willful misconduct or gross negligence.” (Agreement § 10.01(f)(4).)

         B. Fraudulent October 12, 2016, Pay Affidavit

         The Building Corporation appointed Laura Hubinger as the authorized representative designated to submit pay affidavits to the Bank. (Compl. ¶ 16.) Between March 30, 2016, and October 3, 2016, Hubinger prepared pay affidavits and sent them to the Bank through e-mail. (Compl. ¶¶18-19.)

         On October 9, 2016, Bradley Moss, a Bank employee, emailed Hubinger about a lease document. (Compl. ¶ 21.) Moss received an automatic “out-of-office” email from Hubinger informing Moss that Hubinger would be on vacation until October 18 or 19. (Id.) On October 12, 2016, a fraudulently submitted pay affidavit (“October 12 Pay Affidavit”) was sent to the Bank from Hubinger's e-mail account, which an unknown third-party had hacked. (Id. ¶ 22.) The Bank's agents and employees processed and paid $120, 882.83 from the Trust pursuant to the October 12 Pay Affidavit. After the parties discovered the October 12 Pay Affidavit was fraudulent, Plaintiffs demanded that the Bank credit $120, 882.83 to the Trust but the Bank refused.

         C. The Plaintiffs' Complaint

         On August 2, 2017, the Plaintiffs filed their Complaint against the Bank and Bradley Moss, in Lake County, Indiana. In finding that the Bank properly removed the case to federal court, this Court dismissed Bradley Moss from the action. (Op. & Order, ECF No. 31.) The Plaintiffs seek damages against the Bank under two theories. In Count I, the Plaintiffs argue that the Bank breached the September 1, 2015, Indenture Agreement by (1) failing to select its agents and employees with reasonable care and, (2) failing to prevent its employees from acting in a grossly negligent manner in processing the October 12 Pay Affidavit and disbursing $120, 882.83 in fraudulent vendor payments. (Compl. ¶¶ 34-38.) In Count II, the Plaintiffs allege that the Bank is vicariously liable in tort for the grossly negligent acts of its agents and employees in processing the October 12 Pay Affidavit and disbursing $120, 882.83 in fraudulent vendor payments. (Compl. ¶¶ 39-48.)


         A. Legal Standard

         The Defendant seeks dismissal of this case pursuant to Federal Rule of Civil Procedure 12(b)(6). “A motion to dismiss pursuant to [Rule] 12(b)(6) challenges the viability of a complaint by arguing that it fails to state a claim upon which relief may be granted.” Camasta v. Jos. A. Bank Clothiers, Inc., 761 F.3d 732, 736 (7th Cir. 2014). The Court presumes that all well-pleaded allegations are true, views these well-pleaded allegations in the light most favorable to the Plaintiff, and accepts as true all reasonable inferences that may be drawn from the allegations. See Whirlpool Fin. Corp. v. GN Holdings, Inc., 67 F.3d 605, 608 (7th Cir. 1995). The Complaint need not contain detailed facts, but surviving a Rule 12(b)(6) motion “requires more than labels and conclusions . . . . Factual allegations must be enough to raise a right to relief above the speculative level.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). “A claim has facial plausibility when the pleaded factual content allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (citing Twombly, 550 U.S. at 556).

         In deciding a motion to dismiss, a court is to evaluate the sufficiency of the pleadings, not to examine evidence outside the pleadings. Rule 10(c) of the Federal Rules of Civil Procedure, however, provides that a “copy of a written instrument that is an exhibit to a pleading is part of the pleading for all purposes.” Therefore, this Court may examine the Pay Affidavit and Indenture Agreement as the Plaintiffs attached these documents as exhibits in their Complaint and as these documents will assist the Court in determining whether dismissal is proper. See Travelers Casualty & Adecco USA, Inc., Civ. No. 2:12-cv-416, 2013 WL 4776771, at *2 (N.D. Ind. Sept. 5, 2013) (Documents attached to a complaint may be examined at the motion to dismiss stage as “such documents may permit the Court to determine that the plaintiff is not entitled to judgment.” (quoting Reger Dev., LLC v. Nat'l City Bank, 592 F.3d 759, 764 (7th Cir. 2002)).

         B. Breach of Contract Claim

         The Plaintiffs' breach of contract claim is premised on the argument that the Bank violated section 10.01(f)(4) of the Indenture Agreement. (See Pls.' Resp., ECF No. 44, pp. 7-11.)

         Section 10.01(f)(4) provides that the Bank may be held liable for the default or misconduct of an agent and employee when the Bank failed to select the agent or employee in question with reasonable care. Section 10.01(f)(4) also states that the Bank may be held liable for its willful misconduct or gross negligence. Therefore, the Plaintiffs' Complaint must allege facts that would plausibly suggest that an agent's or employee's default was due to the Bank's failure to select the agent or employee with reasonable care, or that an agent or employee acted with willful misconduct or gross negligence in connection with October 12 Pay Affidavit..

         At the outset, the Complaint contains only conclusory allegations that the Bank failed to select its agents or employees with reasonable care. (Compl. ¶ 36.) The Complaint is devoid of any facts suggesting how the Bank selected its agents and employees, much less facts pertaining to the selection of the employees and agents involved in processing the October 12 Pay Affidavit.

         Consequently, for their breach of contract claim to survive, Plaintiffs are left with pleading facts that demonstrate the Bank engaged in willful misconduct or gross negligence in violation of the Indenture Agreement. As discussed more fully below, the Plaintiffs have failed to plead such a violation of the Indenture Agreement.

         1. Contract Modification

         The Plaintiffs argue that Bank and its employees engaged in misconduct or gross negligence by failing to follow “the established Protocol” for processing pay affidavits. (See Pls.' Resp., at p. 8.) The so-called Protocol reflects the procedure the Building Corporation and Bank came to follow after signing the Indenture Agreement for processing pay affidavits. (Compl. ¶¶18-19.) Although the Protocol procedures are absent from the Indenture Agreement, the Plaintiffs contend that the Protocol procedure the parties followed modified their obligations under the Indenture Agreement such that the Protocol procedures became enforceable. (See Pls.' Resp., at p. 8.) In support, the Plaintiffs cite to established Indiana law[2] holding that “modification of a contract can be implied from the conduct of the parties.” (See Pls.' Resp. at p. 9 quoting Skweres v. Diamond Craft Co., 512 N.E.2d 217, 221 (Ind.Ct.App. 1987)). The Plaintiffs add that “[q]uestions regarding the modification of a contract are one of fact, and are to be determined by the trier thereof upon the evidence of each case.” (Id.)

         Although the Bank failed to respond to the Plaintiffs' argument in reply, this Court nevertheless finds the analysis underlying Plaintiffs' contract modification claim incomplete. First, “questions regarding the modification of a contract are ones of fact, and are to be determined by the jury upon the evidence in each case.” Gilliana v. Paniaguas, 708 N.E.2d 895, 897 (Ind.Ct.App.1999). “However, the same can be said of many issues that arise in trials” and federal courts in this circuit applying Indiana law have ruled on the issue of contract modification before trial. See Mark Line Indus., Inc. v. Murillo Modular Grp., Ltd., Civ. No. 3:10-cv-189, 2013 WL 393289, at *2-3 (N.D. Ind. Jan. 20, 2013) (deciding on the issue of contract modification on summary judgment) (quoting Anderson v. Ne. Otalaryngology, P.C., Civ. No. 106-cv-37, 2006 WL 3487333, at ...

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