Article

Note: To assure prompt payment of a portion of outstandings for the wholesale purchase of tires, Hubbard Enterprises, Inc., provided a financial standby for US$350,000 issued by First Tennessee Bank in favor of an Italian tire distributor and wholesaler, Pneus Acqui S.P.A. which was acting for Swiss tire manufacturers, Rimade Ltd. and Giait Ltd. After a year, Applicant was permitted to reduce the LC amount to $150,000.

Although Applicant had paid more than $4.3 million and, at one point, had reduced the outstanding balance to zero, its request to cancel the LC was refused. After having reduced the outstanding balance to zero, it began to run up debts on the tires which were allowed on the promise that a portion of the profits on new tire sales would be devoted to reducing the debts. During this period, Beneficiary/Seller requested that the amount of the LC be increased to $400,000 since debts amounted to $1,000,000. Applicant indicated that it could not do so. Subsequently, Seller required payment on delivery.

What Applicant failed to tell Seller was that prior to this request, Beneficiary's bank, SG Ruegg Bank SA, informed Issuer that the LC "was no longer required". As a result, Issuer cancelled the LC and so informed Applicant the day before the request to increase the amount of the LC.

When Beneficiary/Seller discovered that the LC had been cancelled, it stopped selling tires to Applicant and attempted to work out payments. When these attempts ceased, Applicant still owed $359,052 out of sales of $6 million.

Beneficiary/Seller and Tire Manufacturers then brought this action against Applicant and against its principal, Robert M. Hubbard, Applicant's president, sole shareholder and director, alleging breach of contract and fraud with respect to the LC and that the corporate veil should be disregarded because of transfers of funds and assets to corporations owned by family members. The U.S. District Court for the Northern District of Texas, McBryde, J., entered partial summary judgment against the corporation for $359,052 but, after a bench trial, found for Applicant's Principal on the issue of whether he had personally used the corporation to defraud the Tire Manufacturers. On appeal, the U.S. Court of Appeals for the 5th Circuit in an opinion by Jolly, J., affirmed with a dissent by Wiener, J.

Beneficiary/Seller and Tire Manufacturers argued that the evidence established as a matter of law that Applicant's Principal defrauded them by misrepresenting the status of the LC and by fraudulent transfer of assets. The appellate court considered whether Applicant's Principal used the corporation to perpetrate a fraud, examining the trial court's fact findings for clear error.

The appellate court noted that under Texas law, a failure to disclose a material fact is only fraudulent where there is a duty of disclosure arising by operation of law, by agreement, or from some special relationship. In addition, the court noted that there is a duty to correct any false or misleading statement. It observed that where there is a partial disclosure, even if not required, a person assumes a duty to tell the entire truth. In particular, by operation of law, a person who discloses some but not all material facts must disclose all material facts to prevent the partial disclosure from creating a false impression.

It was argued that:

"Specifically, even though [Applicant's Principal] knew that the [Beneficiary/Seller] required a Letter to sell tires on credit, and received invoices stating that they were covered by the thennonexistent Letter, he never disclosed that the Letter had been canceled. When [Applicant's Principal] emailed [Employee of Beneficiary/ Seller] to say that he could not increase the Letter, and when he made continued promises to pay outstanding balances, he never corrected the [Beneficiary/Seller's] impression that the Letter remained effective. And [Applicant's Principal's] misrepresentation was material because it induced the [Beneficiary/Seller] to continue to sell to [Applicant] on credit, sales for which they were never paid."

It was also argued that actions of Applicant's Principal were indistinguishable from those of his corporation. The appellate court, however, concluded that Applicant's Principal had "no duty to notify the [Beneficiary/Seller] that their own bank had caused the Letter's cancellation."

The court deferred to the trial court's evaluation of the evidence and noted testimony of Applicant's Principal that at the time he responded to Beneficiary/ Seller, he knew that the LC had been cancelled but did not mention the fact. The appellate court also noted that the corporation paid down more than four times the amount of the LC while attempting to work out the debt. In addition, the court noted that no damages were shown since Beneficiary/Seller testified that had they stopped doing business at the time of cancellation, they would have lost more than they ultimately lost after attempted workouts.

The appellate court observed:

"While [Applicant's Principal] did nothing to correct the [Beneficiary/Seller's] mistaken impression about the Letter, he also made no partial disclosures to cause or perpetuate that misunderstanding. His simple refusal to increase the amount of the Letter did not disclose a fact that would impose a legal duty to disclose his knowledge of the Letter's cancellation. It was, after all, the [Applicant's Principal's] own bank that had canceled the Letter and had failed to communicate that fact to the [Beneficiary/ Seller]."

[JEB/tas]

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