Unpublished Disposition, 875 F.2d 318 (9th Cir. 1986)

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U.S. Court of Appeals for the Ninth Circuit - 875 F.2d 318 (9th Cir. 1986)

INSURANCE COMPANY OF NORTH AMERICA, Plaintiff-Appellant,v.David B. HARRIMAN; Paul, Hastings Janofsky & Walker,Defendants-Appellees.

No. 88-6312.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 1, 1989.Decided May 12, 1989.

Before SNEED, REINHARDT and BRUNETTI, Circuit Judges.


Insurance Company of North America (INA) appeals the district court's granting of summary judgment in favor of defendants David B. Harriman and Paul, Hastings, Janofsky and Walker (collectively Harriman). Harriman and the Bank of California (Bank) were co-trustees of the Huntington Beard Crouse Witherill Trust (Trust). INA brought this diversity subrogation action asking for declaratory relief in contribution and indemnity from Harriman for money it paid to the Bank to cover losses sustained by the Trust when a Bank employee, Gary Stone (Stone), embezzled trust funds. We affirm.


The court reviews the granting of summary judgment de novo. Valandingham v. Bojorquez, 866 F.2d 1135, 1137 (9th Cir. 1989). We will affirm the district court's granting of summary judgment if, viewing the evidence and the inferences in the light most favorable to the nonmoving party, we determine that no genuine issues of material fact exist and the moving party is entitled to judgment as a matter of law. Oltarzewski v. Ruggiero, 830 F.2d 136, 138 (9th Cir. 1987).


The Trust was established in 1971, with Harriman and the Bank as co-trustees until February 1984. Harriman, a partner in co-defendant law firm Paul, Hastings, Janofsky and Walker, alleges he selected the Bank to handle the day to day financial affairs of the trust because the Bank claimed special expertise in trust management. The Bank assigned the account to Stone, one of the "best and brightest" of their investment trust officers, to manage and administer the trust. The Trust consisted of millions of dollars in stocks, bonds and other assets, with its principal asset a thinly traded stock. Each time the co-trustees invested, they had to find a ready buyer at a reasonable price for the stock, causing delays or sometimes lost investment opportunities and the sale generated capital gains tax.

To create better liquidity and lessen the trust's tax burden, the co-trustees and the Bank established a $3 million line of credit, secured by the stock, in January 1980. The line of credit agreement (the "Letter Loan Agreement") required signatures from Harriman, Stone and two Bank vice presidents and senior trust officers, Donald R. Dooling (Dooling) and Douglas F. Nosworthy (Nosworthy), or their "nominee, pursuant to your written authorization acceptable to us" to withdraw money from the in-house line of credit.

This arrangement, found to be cumbersome, was modified by a letter addressed and given to Allistair C. Russell, an assistant vice president of commercial loans. The letter, dated February 7, 1980 stated:

In accordance with paragraph No. 1 of the Letter Loan Agreement dated January 25, 1980, any one of the following individuals may authorize advances under the Loan Agreement between the bank and the Huntington B.C. Witherill Trust:


Vice-President and Senior Trust officer

Vice-President and Trust Officer

Vice-President and Investment Officer

All requested advances will be with one day's notice and in increments of $200,000 or multiples thereof.

The letter was signed by trustee Harriman, and two officers of the co-trustee Bank, Gary Stone, vice president and investment officer of the Bank, and Bryant Manley, investment officer. When Harriman returned the required papers to Stone on February 12, 1980, for the line of credit complete with signatures, his cover letter stated

In the course of getting that stuff together I observed one document that I have some question about. A copy of that document is enclosed for your convenience. It would appear to me that it might be better for us to have two individuals required to authorize advances under the Loan Agreement rather than one, as indicated in the enclosed letter.

We are talking about an awful lot of money and surely we could dig up two out of the four people on pretty short notice, if necessary....

The Bank never responded to this letter.

Between February 7, 1980 and November, 1983, Stone embezzled over $8 million from the trust. At the time, Stone was acting as both a Trust officer and Administrative Officer in violation of the Bank's own internal policy against Trust Officers serving in dual capacities. Stone went on disability leave in November, 1983, at which point the Bank began discovering Stone's defalcations. Stone died the next April.

The Bank reimbursed the Trust for its losses. The Bank was reimbursed by its insurer, INA, through a fidelity bond, which covered losses directly resulting from dishonest or fraudulent acts of an employee. On April 29, 1986, INA as subrogee of the Bank, filed its complaint against Harriman claiming it was entitled to contribution or indemnity. The district court, treating a motion for judgment on the pleadings as a summary judgment motion, rendered judgment for the defendants-appellees here and INA appealed.


A. Equitable Subrogation.

As this is a diversity case, we turn to California law to determine the rights between the parties. Los Angeles Nut House v. Holiday Hardware Corp., 825 F.2d 1351, 1353 (9th Cir. 1987); KL Group v. Case, Kay & Lynch, 829 F.2d 909, 915 (9th Cir. 1987). We review state law questions de novo. Los Angeles Nut House, 825 F.2d at 1353.

INA, as the surety and subrogee of the co-trustee Bank, seeks subrogation against co-trustee Harriman. INA contends that Harriman is more at fault than the Bank and should help make good the Trust's loss through either indemnity or contribution. In subrogation litigation, California follows the doctrine of superior equities. Rokeby-Johnson v. Aquatronics Intern. Inc., 159 Cal. App. 3d 1076, 1084, 206 Cal. Rptr. 232, 237 (1984); Meyers v. Bank of America Nat. Trust & Savings Ass'n, 11 Cal. 2d 92, 98, 77 P.2d 1084 (1938) (Subrogation is the way which equity "employs to require the payment of the debt by him who in good conscience ought to pay it."). It may only be invoked when "justice demands its application" and the party seeking subrogation must have a "greater equity" than those who oppose the subrogation. Meyers, 11 Cal. 2d at 98; Continental Ins. Co. v. Morgan, Olmstead, Kennedy & Gardner, Inc., 83 Cal. App. 3d 593, 148 Cal. Rptr. 57, 62 (1978) ("the surety's normal right of recovery through subrogation against the third person is limited to situations in which the surety's equity is superior to that of the third person"). It will never be enforced when equities are equal or rights unclear. Meyers, 11 Cal. 2d at 98. The surety does not have the same rights as the principal to recover from a third person, but must prove a superior equity. Continental, 148 Cal. Rptr. at 62; Meyers, 11 Cal. 2d at 103. The surety may obtain subrogation against a third party, here a co-trustee, if 1) Harriman was more at fault than the Bank for the loss and 2) Harriman was in a better position to prevent the harm. Fireman's Fund Ins. v. Morse Sig. Dev., 151 Cal. App. 3d 681, 687-88, 198 Cal. Rptr. 756, 759-60 (1984); Continental, 148 Cal. Rptr. at 63.

INA alleges it has superior equities over Harriman because 1) Harriman was a co-trustee and as such is jointly and severally liable; 2) that Stone was Harriman's agent and thus Harriman is vicariously liable; 3) that Harriman illegally delegated his trustee powers to Stone making him liable; 4) that Harriman was in a better position to prevent the harm because he signed the February 7, 1980 letter and failed to notify the Bank of it.

The cases cited by INA which discuss liability between co-trustees when sued by a beneficiary are inapposite. See, e.g., Gaver v. Early, 191 Cal. 123 (1923) (action by beneficiary against former guardian who relinquished control over all guardianship matters to attorney who misappropriated a large part of beneficiary's funds); Gbur v. Cohen, 93 Cal. App. 3d 296, 155 Cal. Rptr. 507 (1979) (Trustee found liable to trust for misappropriation stated cause of action for contribution against co-trustees who consented and approved of distribution of funds to him). Here, INA as the surety is suing as a subrogee and under the doctrine of superior equities, to recover must show more culpability on the part of Harriman than if the trust beneficiary sued Harriman directly. Estate of Whitney, 124 Cal. App. 109, 118-19 (1932).

Even if we consider INA to be a co-trustee and apply the test stated in Gbur to determine liability between co-trustees for misappropriation of trust funds, INA does not prevail. Each trustee ordinarily is entitled to contribution from the other trustees for a breach of trust except where their respective degrees of fault substantially differ. Gbur, 155 Cal. Rptr. at 510. Factors to be considered are 1) whether the first trustee fraudulently induced others to join the breach; 2) whether the first trustee's breach was intentional and the other trustees were merely negligent; 3) whether because of greater expertise the breaching trustee controlled the conduct of the others; 4) whether the breaching trustee alone committed the breach and the other trustees are liable only because they improperly delegated or failed to exercise reasonable care to prevent the breach. Gbur, 155 Cal.Rptr. at 510-11; see also former Cal.Civ.Code Sec. 2239 [now Cal.Prob.Code Sec. 16402 (1986) ] which limits the liability of co-trustees to where they either consented to the breach of trust or by their negligence permitted it to occur. Stone forged Harriman's name on documents, thereby fraudulently involving Harriman in the breach. Stone's acts were intentional, Harriman's were at most negligent, and the Bank and Stone were purported to be experts in their field. INA contends, however, that Harriman improperly delegated his trust duties and failed to exercise reasonable care to prevent the defalcations of Stone, which fits Gbur's fourth factor.

Furthermore, there can be no contribution between co-trustees if the breaching trustee fraudulently participates in misappropriating trust funds. Scott, The Law of Trusts III, Sec. 258.1 (3d ed. 1967). Considering all these facts under standards set for subrogation actions, we conclude the district court did not err in finding that Harriman is not primarily responsible for the loss and under a co-trustee theory, the Bank, and hence INA as subrogee, is not entitled to contribution. Commercial Union Assur. v. Safeway Stores, 26 Cal. 3d 912, 917-18, 164 Cal. Rptr. 709, 712, 610 P.2d 1038 (1980) (subrogee insurer stands in the shoes of the insured); Weaver v. Bishop,--Cal.App.3d--, 254 Cal. Rptr. 425, 425 (1988) (same).

INA contends that because Harriman signed the February 7, 1980 letter, giving Stone the power to withdraw from the $3,000,000 line of credit on his signature alone, he either delegated his authority or by power of attorney gave his authority to Stone, thus giving Stone the ability to embezzle the Trust's funds. INA cites various inapplicable cases on power of attorney and agency law to support these contentions of liability. Not only did Bryant Manley, another officer of the Bank sign the agreement, but also the letter was given to Allstair Russell, a commercial loan officer of the Bank, giving at least two employees of the co-trustee Bank besides Stone knowledge of the letter and the terms. Stone, as the district court found, was acting on behalf of the Bank, and was therefore a trustee and not an agent of Harriman's.

[T]he administration of a trust by a bank or trust company necessarily implies that all the powers of the trustee will be exercised through one or more of its officers or employees.... The use of officers and employees is not delegation but rather action of the trustee itself.

Bogert, Trusts and Trustees, Sec. 555 (2d ed. 1982). Stone committed the intentional act of embezzlement whereas Harriman is only alleged to have been negligent by allowing Stone to be the sole signator on the line of credit. Thus, under California's doctrine of superior equities, Stone was the primary cause of the loss. Fireman's Fund, 198 Cal. Rptr. at 759; Meyers, 11 Cal. 2d at 102. The district court's finding that Stone was acting on behalf of the Bank was not erroneous. Therefore, INA, as subrogee of the Bank, was more at fault than Harriman and cannot recover through subrogation. Continental, 148 Cal. Rptr. at 62. Even if Harriman delegated powers to Stone, that would make Stone an agent of both the Bank (by virtue of his employment) and Harriman, making the equities equal. Under the doctrine of superior equities, INA as subrogee of the Bank and Stone, could not recover. Meyers, 11 Cal. 2d at 98.

Harriman was not in a better position to prevent the harm as INA contends. INA states that because Harriman expressed concern about the February 7th letter allowing one signature on the line of credit in his February 12th letter to Stone, Harriman acknowledged that something was amiss and should have acted. However, the Bank, through Manley and Russell, also knew of the February 7th letter. Stone embezzled funds from the Trust through forgery and means other than the line of credit authorization. Harriman had no control over these acts of Stone but the Bank had direct control over Stone as its employee. The Bank was also aware that Stone had made unauthorized investments other than those of the Trust here. Stone also had a dual capacity, of Trust Officer and Administrative Officer, in contravention of Bank rules. Thus, the Bank, and its subrogee INA, was in a better position to prevent the harm. Fireman's Fund, 198 Cal. Rptr. at 760.

B. Material Issues of Fact.

INA contends that material issues of fact exists as to Harriman's "negligence" in signing the February 7th letter enabling Stone to misuse the trust funds. This reiterates INA's argument above and also has no merit. Harriman's actions, as alleged by INA, are merely negligent while the Bank's are intentional. Even if Harriman's actions were a cause of the loss, under California subrogation doctrine and under co-trustee liability theory, as a matter of law, INA may not claim indemnity or contribution from Harriman. Fireman's Fund, 198 Cal. Rptr. at 759. INA points out factual errors made by the district court but they are immaterial to the court's findings.



This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by Circuit Rule 36-3