Employees of Insolvent Lender Lose Lawsuit

Three Bear Stearns companies and subsidiary EMC Mortgage Corp. were found not to be liable for payments due former employees of National Finance Corp. under the Worker Adjustment and Retraining Act because they were not the workers’ employer, a federal appeals court has ruled.

Although Bear Stearns exerted “substantial” control over National Finance Corp., and even fired NFC’s officers and chose replacements, the Wall Street firm was not the owner of the subprime mortgage lender, which was based in Clifton Park, N.Y., and closed December 23, 1999. Rather that control was “no more than was needed for a lender who had been defrauded of $5.6 million by NFC’s management and who was attempting to salvage a company bereft of cash.”

The decision, issued by a three-judge panel of the U.S. Court of Appeals of the 2nd District on August 30, upheld a U.S. District Court decision rendered on October 17, 2005. The suit, Coppola v. Bear Stearns, was filed on December 20, 2002, and was certified as a class action suit on January 15, 2004, making more than 400 former NFC employees eligible for any payments.

The suit named as defendants Bear Stearns & Co., Bear Stearns Home Equity Trust and Bear Stearns International Ltd., in addition to EMC Mortgage.

EMC had advanced funds to NFC for loans in its pipeline under forward purchase transactions, according to the decision. But, facing hard times in 1999, NFC retained money from its sales of loans that should have been paid to Bear Stearns, the judges noted. By falsifying the weekly loan schedules in violation of its master repurchase agreement with Bear Stearns, it was able to claim that those loans remained unsold.

Bear pursued a workout strategy but refused to do business with the officers who were responsible for the fraud, who were subsequently replaced, with Bear Stearns playing a role in their departures and replacements. And BankBoston, in response to the NFC’s fraud, terminated NFC’s operating credit line. With a decline in the number of loans in its pipeline, NFC, which had been founded 10 years earlier, was unable to meet its payroll and closed.

The question facing the court, according to the decision, was “whether a creditor is exercising control over the debtor beyond that necessary to recoup some or all of what it is owed, and is operating the debtor as the de facto owner of an ongoing business.” But, it found that “the evidence shows no more than that Bear exerted the control necessary for it to attempt a workout possibly resulting in the salvage of NFC” for a possible sale, “salvaging some of the debt it had extended.” Thus the court described Bear Stearns’ interest in NFC as “a short-term interest.”

WARN, which requires 60 days’ notice to workers by employers when mass layoffs or plant closures occur, would be “turned on its head” if WARN liability was imposed “based on the exercise of control by creditors during a workout,” the judges pointed out.

“We’re considering our options right now,” Cornelius D. Murray, one of three attorneys that represented the plaintiffs, told MortgageDaily.com.

“We’re disappointed,” he said, “the court chose not to impose lender liability because it was so clearly evident from the record that Bear Stearns had become the alter ego of NFC and operated it for its own benefit.” This was no different than company owners operating their businesses for their own benefit, he said.

But he said he thought the court was reluctant to impose liability upon Bear Stearns “because it could have a chilling effect in the future upon people lending money to business.”

NFC itself was never sued, he said, because “there was virtually nothing left. They even were delinquent in actual payroll.”

Last month, separate WARN suits were filed in U.S. Bankruptcy courts against HomeBanc Mortgage and American Home Mortgage on behalf of approximately 1,000 and 400 employees, respectively.