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Varga v. U.S. Bank N.A.

United States District Court, D. Minnesota

July 2, 2013

Geoffrey Varga, Plaintiff,
U.S. Bank National Association, Defendant

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Stephen D. Susman, Susman Godfrey LLP, New York, New York, Edgar G. Sargent, Susman Godfrey LLP, Seattle, Washington, Ashley McMillian, Susman Godfrey LLP, Houston, Texas, Steven M. Pincus, Joseph W. Anthony, Steven C. Kerbaugh, Anthony Ostlund Baer & Louwagie, P.A., Minneapolis, Minnesota, for Plaintiff.

Richard G. Wilson, Wayne S. Moskowitz, Sarah A. Horstmann, Maslon Edelman Borman & Brand, LLP, Minneapolis, Minnesota, for Defendant.


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RICHARD H. KYLE, United States District Judge.



When Tom Petters's Ponzi scheme collapsed in 2008, hundreds of investors - from retirees to hedge funds - lost nearly everything. Two such " losers" were the Cayman Islands-based hedge funds Palm Beach Offshore, Ltd. and Palm Beach Offshore II, Ltd. (together, the " Palm Beach Funds" or the " Funds" ), which lost over $700 million. Plaintiff Geoffrey Varga is the Funds' court-appointed liquidator. He commenced this action in December 2012 against U.S. Bank National Association (" U.S. Bank" ), asserting claims of negligence and aiding and abetting breach of fiduciary duty for the bank's role in certain transactions with the company at the heart of the scheme, Petters Company, Inc. (" PCI" ). Varga later filed an Amended Complaint, which U.S. Bank now moves to dismiss. For the reasons that follow, its Motion will be granted.


I. Petters, PCI, distressed goods, and the fraud

Petters held himself out as a savvy businessman with extensive contacts in the " distressed-goods" industry. He claimed he could obtain large quantities of consumer items - overruns, closeouts, and the like, typically electronics such as flat-screen televisions - at a steep discount, which he would then sell to big-box retailers such as Sam's Club at a hefty profit. To finance these purchases, he borrowed money through PCI, with the " investments" maturing when the retailer paid for the goods a short time later. Over more than a decade, Petters, through PCI, claimed to have purchased and sold more than $30 billion in distressed goods, all " financed" with investor funds.

A typical PCI " deal" was structured as follows. PCI would learn that distressed goods were " available" for purchase and it would " pre-sell" them at a profit to a big-box retailer. PCI would then obtain investor funds, in return for which it issued a high-interest-rate, short-term promissory note secured by the goods themselves, and use the funds to buy the goods. The funds would be wired to the seller, and the seller, in turn, would be directed to deliver the goods to the big-box retailer. The retailer would then pay for the goods, typically within 60 to 90 days, the investor's promissory

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note would be paid with interest, and PCI would keep the remainder.

This was all good in theory, but in reality the PCI deals were fake - Petters and his associates forged the purchase and sale documents, and the " sellers" of the distressed goods were actually Petters's co-conspirators, who would wire investor funds to PCI shortly after receiving them. No payments came from retailers because no goods were actually bought and sold. Instead, PCI paid old promissory notes with the proceeds from new promissory notes, siphoning off a portion of the funds in the process. The scheme collapsed in September 2008 when a Petters insider went to authorities; the losses were staggering, with investors left holding the bag for more than $3 billion. Petters was later indicted and convicted of 20 counts of fraud, money laundering, and similar crimes and, in 2010, sentenced to 50 years' imprisonment.

II. The Palm Beach parties

The Palm Beach Funds were established in the mid-2000s and were investors in PCI deals, albeit indirectly. They sent their investors' money to another, related finance fund called Palm Beach Finance Partners (" Palm Beach Finance" )[1] which, in turn, invested that money in PCI notes. Palm Beach Finance was founded and controlled by David Harrold and Bruce Prevost, who were also the controlling directors of the Palm Beach Funds. In addition, Harrold and Prevost owned and controlled Palm Beach Capital Management, LLC (" Palm Beach Capital Management" ), which managed the investments of both the Palm Beach Funds and Palm Beach Finance.

III. The Direct Payment System and the Collateral Account

U.S. Bank's involvement in this case arises out of the flow of money to and from the Palm Beach Funds in the PCI deals, which Varga labels the " Direct Payment System." The Funds' money passed " through what was supposed to be a system of direct payments to and from" a bank account at U.S. Bank known as the " Collateral Account." (Am. Compl. ¶ ¶ 6, 29.) The Collateral Account was under the " sole dominion and control" of an entity called Palm Beach Capital Corp., which was controlled by Harrold and Prevost.

The Direct Payment System was structured so that the Palm Beach Funds' investment money was first transferred to the Collateral Account, and from there sent directly to the seller of the goods. (Id. ¶ 29.) After the goods were delivered, the big-box retailers were to make their payments directly to the Collateral Account. (Id.) According to Varga, this was intended to (1) prevent a third-party from having access to the funds at any point during the transaction and (2) ensure that all of the deals were legitimate. (Id. ¶ 30; accord, e.g., id. ¶ 29 (" This was a crucial structural safeguard: observable, direct payments from wholesale retailers to U.S. Bank were supposed to validate the transactions financed by the [notes] and ensure that the [merchandise] sales proceeds did not pass through [PCI]." ); id. ¶ 38 (" [T]he Direct Payment System and, in particular, its Incoming Payment component, were intended to ensure that there was an observable direct payment from a [] Retailer to the Collateral Account for each transaction, demonstrating that a Merchandise Transaction funded by a Petters [] Note was bona fide. " ).) The Direct

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Payment System was referenced in the Palm Beach Funds' offering memoranda to investors, as well as the Funds' marketing materials. (Id. ¶ ¶ 32-33.) And it was memorialized in the " Collateral Agreement" establishing the Collateral Account, which was entered into by and between U.S. Bank, Palm Beach Finance, and a Petters entity known as Petters Capital, Inc.[2]

Of course, it was impossible for money to flow to the Collateral Account from retailers, because there were no actual sales or any real merchandise being purchased. Instead, for many years " payments" to the Collateral Account came from PCI, which (as discovered later) was simply using newly stolen money to pay off old notes.

According to Varga, however, the Palm Beach Funds' managers and fiduciaries - Harrold and Prevost, and (derivatively) Palm Beach Capital Management - knew the Direct Payment System was not being followed and " conceal[ed] this from the Palm Beach [] Funds while continuing to invest in Petters [] Notes," thereby breaching their fiduciary duties. (Id. ¶ ¶ 47, 52-53.)[3] Varga also alleges that U.S. Bank, too, knew that payments to the Collateral Account came from PCI rather than retailers, noting that fact on bank statements it prepared for the Collateral Account. (Id. ΒΆ 43.) And, he alleges that U.S. Bank was aware, via the terms of the Collateral Agreement and the Palm Beach ...

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