BOWCUTT v. DELTA NORTH STAR CORP., 19785-9-III (Wash.App. 2-28-2002)

No. 19785-9-III.The Court of Appeals of Washington, Division Three. Panel Two.
Filed: February 28, 2002. DO NOT CITE. SEE RAP 10.4(h). UNPUBLISHED OPINION.

Appeal from Superior Court of Spokane County, No. 97-2-02584-7, Hon. Richard J. Schroeder, November 17, 2000, Judgment or order under review.

Counsel for Appellant(s), David P. Boswell, 505 W Riverside Ste 500, Spokane, WA 99201.

Counsel for Defendant(s), James B. King, Keefe King Bowman, 1102 Wa Mutual Financ Ctr, W. 601 Main, Spokane, WA 99201.

Counsel for Respondent(s), John F. Bury, Murphy Bantz Bury, 818 W Riverside Ave # 631, Spokane, WA 99201-0910.

KENNETH H. KATO, J.

Jack Bowcutt, Leo Murphy, Ingve Turnquist, and Elmer Turnquist (property owners) sued Paul Railton Cabbell, Headhunters, and Headhunters Pension Plan (Cabbell), claiming civil conspiracy, enterprise activity under the Criminal Profiteering Act, violation of the Equity Skimming Act, violation of the Consumer Protection Act, negligence, violation of public policy, unconscionability, and illegality. The court found in favor of Cabbell on all claims. We affirm.

Jack Bowcutt listed his property, 1819 West Boone Avenue in Spokane, for sale on April 7, 1995. Mark Pitts was the president, sole shareholder, and officer of Delta North Star Corporation. Delta North Star offered to purchase Mr. Bowcutt’s property on April 24, 1995, on terms dictated by Mr. Pitts. The Real Estate Sale and Purchase Agreement (RESPA) stated that a portion of the purchase price in the amount of $37,000 was to be paid by a promissory note secured by a second deed of trust.

Delta North Star submitted a loan application to Far West Mortgage. Jessica Chiono, a loan officer for Far West, solicited private individuals to invest in loans. Cabbell owned and operated a personnel placement agency under the tradename Headhunters. He had previously financed loans through Ms. Chiono and agreed to finance the Delta North Star loan so long as he received a deed of trust in first priority position.

The sales price for the Bowcutt property was $55,000. Cabbell loaned Delta North Star $28,000 and Mr. Bowcutt carried a $37,000 second deed of trust. The property was thus encumbered in excess of the sales price. Delta North Star received $5,442 cash back at closing because of the way the transaction was structured.

Delta North Star defaulted on its payments to Cabbell and Mr. Bowcutt in September 1995. After a trustee’s sale, the Bowcutt property was sold for $28,800. The net proceeds are being held in the court registry.

Leo Murphy listed his property, 3630 East 31st Avenue in Spokane, for sale on June 28, 1995. On July 16, 1995, Delta North Star offered to purchase the property on terms dictated by Mr. Pitts. The RESPA required the seller to carry a second deed of trust.

Delta North Star again applied for a loan with Far West Mortgage. Cabbell agreed to finance part of the loan, which was secured by a first deed of trust. Mr. Murphy received a promissory note secured by a second priority deed of trust.

The Murphy property sold for $78,250. Cabbell loaned Delta North Star $46,000 and Mr. Murphy carried $46,250 on the second deed of trust. As a result, the Murphy property was encumbered in excess of the sales price. Delta North Star received $8,385.84 cash back at closing because of the way the transaction was structured.

Delta North Star defaulted on its payments to Cabbell and Mr. Murphy in September 1996. After a trustee’s sale, the property was sold for $72,000. The net proceeds are being held in the court registry.

Ingve Turnquist, executor of the Anna V. Turnquist Estate, listed property at 619 South Ralph in Spokane for sale on December 1, 1994. Delta North Star offered to buy the property and again required the seller to carry a second deed of trust.

Delta North Star obtained a loan through Far West Mortgage, with Cabbell financing the first deed of trust. The purchase price was $53,000. Cabbell’s loan was for $37,000 and the Estate carried $28,000 on the second deed of trust. The Turnquist property was thus encumbered in excess of the sales price. Delta North Star received $5,938.43 cash back at closing because of the way the transaction was structured.

In September 1996, Delta North Star defaulted on both loans. The property was sold at a trustee’s sale. The net proceeds are being held in the court registry.

The property owners brought suit against Cabbell for civil conspiracy, enterprise activity under the Criminal Profiteering Act, violation of the Equity Skimming Act, violation of the Consumer Protection Act, negligence, violation of public policy, unconscionability, and illegality. The court concluded there was no clear and convincing evidence that Cabbell conspired with Mr. Pitts or Delta North Star. It also held Cabbell was not negligent and did not violate the Consumer Protection Act. The court further found the property owners had not shown any evidence of an enterprise, which was required to substantiate a claim of criminal profiteering. The court accordingly entered judgment in favor of Cabbell. This appeal follows.

The property owners contend the court erred by holding there was no negligence because Cabbell owed them no duty. Negligence encompasses four basic elements: duty, breach, proximate cause, and injury. Howard v. Horn, 61 Wn. App. 520, 523, 810 P.2d 1387, review denied, 117 Wn.2d 1011 (1991).

A duty may arise from common law or from a statute. Whether a duty exists is a question of law. In deciding questions of duty, courts must evaluate public policy considerations. Id.

The property owners argue that Cabbell, the lender, had a duty to investigate and contact the sellers about the true nature of the transaction. They rely on California law imposing such a duty and argue Washington should adopt this rule.

In Radunich v. Basso, 235 Cal.App.2d 826, 835, 45 Cal.Rptr. 824
(1965), the seller’s lien, originally second in line, became superior to the lender’s when the lender knew the loan proceeds were not being used as set forth in the subordination clause. The court held the lender’s knowledge put him on notice of a violation of the agreement and required that he investigate with the seller. The court determined the failure to investigate was negligent. Id.

Two later cases also dealt with the relationship and rights between a lender and a subordinating seller. In Miller v. Citizens Sav. Loan Ass’n, 248 Cal.App.2d 655, 664, 56 Cal.Rptr. 844 (1967), the court held that when a lender is aware of limitations in the subordination agreement, it cannot claim priority for any monies advanced for purposes not specifically permitted in the agreement. In Middlebrook-Anderson Co. v. Southwest Sav. Loan Ass’n, 18 Cal.App.3d 1023, 96 Cal.Rptr. 338
(1971), the court held that if a subordination agreement exists and the lender fails to protect the seller’s security interest, the seller has a cause of action against the lender. Id. at 1037-38.

In Gluskin v. Atlantic Sav. Loan Ass’n, 32 Cal.App.3d 307, 108 Cal.Rptr. 318 (1973), the court held that `public policy . . . requires [the] protection of subordinating sellers and that a lender and a borrower may not . . . make . . . material modification in the loan to which the seller has subordinated, without the knowledge and consent of the seller . . ., if the modification materially affects the seller’s rights.’ Id. at 314. The court stated that the risk the buyer will default and the lender will foreclose is the hazard to which a subordinating seller exposes himself by agreeing to subordinate his lien. In the abstract, there is no obligation on a lender to protect a seller from this risk. Id. at 315. If the lender and borrower act in a manner that modifies the terms of the first loan so that the risk of default is increased, the lender may subject itself to liability. Id.

The Ninth Circuit expanded the holdings of these cases in Plastino v. Eureka Fed. Sav. Loan Ass’n, 944 F.2d 1503 (9th Cir. 1991). It held that California law requires the lender to consult public records and discover the conditions upon which the seller has subordinated his lien, as well as to contact the seller. Id. at 1512. The court stated that the `priority of the lender’s lien is contingent upon the fulfillment of any conditions stated in the seller’s lien, whether or not the lender has actual knowledge of those conditions at the time the deeds are recorded.’ Id. at 1513.

The property owners ask this court to follow these California cases and adopt the rule that a lender has a duty to investigate the conditions of a subordinating lien with the seller. But these are readily distinguishable. Each involved a subordination agreement.

Subordination agreements frequently arise from a mutual enterprise wherein the property owner provides the building site, the purchaser the expertise in developing the site, and the bank provides the capital. The bank’s priority rights under a subordination agreement are strictly limited to the express terms and conditions of the agreement. The rationale behind the rule is that the owner is a quasi-surety who has pledged his property to the bank in order to finance a construction loan. This is done anticipating that the loan proceeds will enhance the value of the property to a position where both the bank and the owner are protected. Should the bank fail to follow the terms of the subordination agreement, the owner’s security could be jeopardized, leaving him at the mercy of the developers. Campanella v. Rainier Nat’l Bank, 26 Wn. App. 418, 420, 612 P.2d 460, review denied, 94 Wn.2d 1017
(1980). At the heart of the rationale behind the California cases was the duties imposed by the specific requirements of a subordination agreement.

Unlike the California cases, there was no subordination agreement here in any of the transactions. There is no evidence that the property owners agreed to take second deeds of trust based upon any assurances from Cabbell. There is also no evidence that Cabbell’s loan proceeds were for the sole purpose of enhancing the value of the property. Moreover, there was no relationship between Cabbell and the property owners. As the Gluskin court stated, there is no obligation in the abstract on a lender to protect a subordinating seller. Gluskin, 32 Cal.App.3d at 315. Accordingly, even California law would not impose a duty on Cabbell in the particular circumstances here.

The property owners also contend that existing Washington law would nonetheless impose such a duty on Cabbell. Washington does indeed impose a duty on a lender who should have foreseen problems and included them in a subordination agreement. Campanella, 26 Wn. App. at 420-21. But it is the subordination agreement that imposes the duty, not the status as a lender itself.

The property owners claim Kim v. Lee, 102 Wn. App. 586, 9 P.3d 245
(2000), rev’d, 145 Wn.2d 79, 31 P.3d 665 (2001), supports their position. Kim involved a refinancing situation in which the Court of Appeals, adopting the doctrine of equitable subrogation for mortgage refinancing, held that the title insurer could avoid liability under this doctrine. Id. at 594-95. The Supreme Court reversed because the title insurer had actual knowledge of a prior judgment lien, but failed to disclose the existence of that lien to its insured. Kim v. Lee, 145 Wn.2d 79, 92-92, 31 P.3d 665 (2001).

Kim deals with refinance situations and the priority problems specific to them. It is not persuasive in this case. The property owners contend Kim establishes that Washington would recognize that a lender could engage in negligent conduct. But simply because a lender can be negligent does not impose a duty on Cabbell when none exists.

The property owners contend Washington also protects junior lien holders against prejudicial acts by senior lien holders. See MGIC Fin. Corp. v. H. A. Briggs Co., 24 Wn. App. 1, 4-5, 600 P.2d 573, review denied, 92 Wn.2d 1038 (1979). While Washington does abide by this rule, there is no evidence of any prejudicial act on the part of Cabbell.

The property owners rely on Enterprise Timber, Inc. v. Wash. Title Ins. Co., 76 Wn.2d 479, 457 P.2d 600 (1969), which involves recovery under a title insurance policy. The court held that the plaintiff had notice of fraud in the transaction. Because the plaintiff had constructive notice of the fraud, he was not a bona fide encumbrancer. Id. at 483. This case required the plaintiff to protect himself. Here, the property owners ask this court to require Cabbell to protect them. There is no support for that position in Enterprise Timber.

In these transactions, Cabbell made a loan to a purchaser. None of these loans exceeded the purchase price of the property. The sellers also agreed to finance the transaction by second deeds of trust. Although Cabbell knew there were subordinating sellers, he had no duty to protect their interests.[1] The court did not err by so holding.

The property owners next claim the court erred by concluding Cabbell violated the Consumer Protection Act (CPA). Washington’s CPA provides that “[u]nfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce” are unlawful. Guijosa v. Wal-Mart Stores, Inc., 144 Wn.2d 907, 917, 32 P.3d 250 (2001) (quoting RCW 19.86.020) (alteration in original). To establish a violation of the CPA, a plaintiff must establish (1) an unfair or deceptive act or practice, (2) occurring in the conduct of trade or commerce, (3) impacting the public interest, and (4) proximately causing injury to the plaintiff in his or her business or property. Id.

The property owners argue Cabbell’s acquiring first priority loans in each situation was an unfair or deceptive act or practice. Whether conduct constitutes an unfair or deceptive practice is an issue of law that we review de novo. Robinson v. Avis Rent A Car Sys., Inc., 106 Wn. App. 104, 114, 22 P.3d 818, review denied, 145 Wn.2d 1004
(2001).

A practice is unfair or deceptive if it has the capacity to deceive a substantial portion of the public. Dwyer v. J.I. Kislak Mortgage Corp., 103 Wn. App. 542, 547, 13 P.3d 240 (2000), review denied, 143 Wn.2d 1024 (2001). The purpose of this test is to deter deceptive conduct before injury occurs. Id. Neither intent to deceive nor actual deception is required. Id.

Cabbell did not engage in an unfair or deceptive practice. He offered loans to Delta North Star. The terms of the loans were fully disclosed. His loans were for less than the full purchase price of the property involved. The sellers also agreed to finance the transactions for Delta North Star. The closing documents in each instance clearly indicated that the seller was taking a second priority deed of trust. There was no deception.

The public interest element was also not met. Whether the public has an interest in any given action is to be determined by the trier of fact from several factors, depending upon the context in which the alleged acts were committed. Hangman Ridge Training Stables, Inc. v. Safeco Title Ins. Co., 105 Wn.2d 778, 789-90, 719 P.2d 531 (1986). It is the likelihood that additional plaintiffs have been or will be injured in exactly the same fashion that changes a factual pattern from a private dispute to one that affects the public interest. Id. at 790. When the transaction is essentially a private dispute and not a consumer transaction, it is more difficult to show public interest in the subject matter. Id.

Here, three homeowners suffered the same injury, that is, the loss of the equity in their homes. But it is not clear that others would be injured in the same fashion. Other homeowners could conduct a greater investigation of the first priority loan than the sellers did here. Others might refuse to take a second position loan. The public interest element has not been met.

The property owners further had to establish that Cabbell’s actions caused an injury to their property. The loss of equity in their homes is indeed such an injury. But their injury was caused by Delta North Star’s default, not Cabbell’s loan or his actions.

The property owners had the burden of establishing all the required elements of a CPA violation. They failed to do so. Therefore, the court did not err by concluding Cabbell had not violated the CPA.

The property owners next argue Cabbell was liable for his actions under chapter 9A.82 RCW, Washington’s Criminal Profiteering Act. The act is patterned after the federal Racketeer Influenced and Corrupt Organizations Act (RICO). See Winchester v. Stein, 135 Wn.2d 835, 848, 959 P.2d 1077
(1998). Our Supreme Court has characterized this act as a `little RICO’ statute. Id. (citing Rice v. Janovich, 109 Wn.2d 48, 55, 742 P.2d 1230
(1987)). Therefore, in interpreting Washington’s act, it is helpful to look to federal RICO cases. Winchester, 135 Wn.2d at 848.

Both federal and state law provides a private right of action for damages. Bowcutt v. Delta North Star Corp., 95 Wn. App. 311, 317, 976 P.2d 643 (1999) (citing 18 U.S.C. § 1964(c); RCW 9A.82.100(1)(a)). In an effort to combat organized crime, Washington passed its version of RICO in 1985. Winchester, 135 Wn.2d at 849-50. The act created new crimes and provided for civil penalties and remedies. Id. at 850. The act requires a showing of a pattern of criminal profiteering activity.

`Pattern of criminal profiteering activity’ means engaging in at least three acts of criminal profiteering, one of which occurred after July 1, 1985, and the last of which occurred within five years, excluding any period of imprisonment, after the commission of the earliest act of criminal profiteering. In order to constitute a pattern, the three acts must have the same or similar intent, results, accomplices, principals, victims, or methods of commission, or be otherwise interrelated by distinguishing characteristics including a nexus to the same enterprise, and must not be isolated events. RCW 9A.82.010(12) (emphasis added).

In order to show a pattern of criminal profiteering activity, one must show the existence of an enterprise. RCW 9A.82.010(12).

`Enterprise’ includes any individual, sole proprietorship, partnership, corporation, business trust, or other profit or nonprofit legal entity, and includes any union, association, or group of individuals associated in fact although not a legal entity, and both illicit and licit enterprises and governmental and nongovernmental entities. RCW 9A.82.010(8). At issue here is whether the property owners established that Cabbell and Delta North Star were an enterprise for purposes of this act.

No Washington case has provided a test to determine whether an enterprise exists. However, the Supreme Court has indicated what is required to show an enterprise under the federal RICO statute. An enterprise is an entity or a group of people `associated together for a common purpose of engaging in a course of conduct.’ United States v. Turkette, 452 U.S. 576, 583, 101 S.Ct. 2524, 69 L.Ed.2d 246 (1981). The existence of an enterprise is proved by `evidence of an ongoing organization, formal or informal, and by evidence that the various associates function as a continuing unit.’ Id.

Several United States Courts of Appeal have interpreted Turkette and expanded on what must be shown to prove an enterprise. There are three sub-elements referred to by Turkette that are required to establish an enterprise. United States v. Pelullo, 964 F.2d 193, 211 (3d Cir. 1992). Those elements are `(1) . . . the enterprise is an ongoing organization with some sort of framework for making or carrying out decisions; (2) . . . the various associates function as a continuing unit; and (3) . . . the enterprise [is] separate and apart from the pattern of activity in which it engages.’ Id. Several other circuits have adhered to this view. See generally Hartz v. Friedman, 919 F.2d 469, 471 (7th Cir. 1990); Montesano v. SeaFirst Commercial Corp., 818 F.2d 423, 426-27 (5th Cir. 1987); United States v. Lemm, 680 F.2d 1193, 1198 (8th Cir. 1982), cert. denied, 459 U.S. 1110 (1983); United States v. Bagnariol, 665 F.2d 877, 891 (9th Cir. 1981), cert. denied, 456 U.S. 962 (1982).

However, the property owners correctly point out that not all circuit courts have so interpreted Turkette. Some circuits do not require a finding that the enterprise must be an entity separate and apart from the pattern of activity in which it engages. See United States v. Mazzei, 700 F.2d 85, 88-89 (2nd Cir.), cert. denied, 461 U.S. 945 (1983); United States v. Cagnina, 697 F.2d 915, 920-21 (11th Cir.), cert. denied, 464 U.S. 856 (1983). These circuits still require the existence of an association, however informal, that has a common purpose that unites individuals. Cagnina, 697 F.2d at 920-21.

We are persuaded that the Third Circuit’s test most closely follows the holding in Turkette where the Supreme Court stated:

While the proof used to establish these separate elements may in particular cases coalesce, proof of one does not necessarily establish the other. The `enterprise’ is not the `pattern of racketeering activity’; it is an entity separate and apart from the pattern of activity in which it engages. The existence of an enterprise at all time remains a separate element which must be proved by the Government.

Turkette, 452 U.S. at 583 (emphasis added). We accordingly adopt the Third Circuit’s test to determine if an enterprise exists.

Under this test, the property owners must first establish the existence of an ongoing organization between Cabbell and Delta North Star.

They must show the existence of some sort of decision making structure within the group, whether it be hierarchical or consensual. United States v. Riccobene, 709 F.2d 214, 221 (3rd Cir.), cert. denied, 464 U.S. 849
(1983). There must be some method for controlling and directing the affairs of the group on an ongoing basis. Id.

Cabbell and Delta North Star had no dealings with one another before the first loan transaction. Cabbell had loaned money to Mr. Pitts on a prior occasion. Each loan to Delta North Star was brokered by Far West Mortgage. It was Far West who brought Cabbell and Delta North Star together. There was no evidence of an ongoing organization and there was no evidence of any decision-making structure between the two.

Next, the property owners must prove that the various associates function as a unit. To satisfy this requirement, they must show that each person performs a role in the group consistent with the organizational structure established by the first element. Riccobene, 709 F.2d at 223. This role must also further the activities of the organization. Id.

Here, there was no evidence of any organization in the first instance.

Therefore, there could be no showing that in this unit Cabbell fulfilled one role, while Delta North Star fulfilled another.

The evidence must further show that the enterprise is an entity separate and apart from the pattern of activity in which it engages. Riccobene, 709 F.2d at 223. This does not require a showing that the enterprise has some function wholly unrelated to the racketeering activity. Id. at 223-24. Rather, it must be shown that the enterprise has an existence beyond that which is necessary merely to commit each of the acts charged as racketeering offenses. Id. at 224.

The purpose of the association between Cabbell and Delta North Star was the loan of money for the purchase of property. The property owners based their claim of illegal activity on these loans. Even if there were an organization, its function thus would not be unrelated to the alleged racketeering activity.

Here, the property owners allege Cabbell’s and Delta North Star’s common purpose was a conspiracy to steal the equity in their property. However, there is no evidence to support this claim of conspiracy. The evidence shows Cabbell and Delta North Star were first brought together by Far West Mortgage and had minimal contact with each other. Cabbell loaned the money to earn interest. Delta North Star borrowed money to buy property. No enterprise existed and the trial court did not err by so finding.

The property owners next contend the court erred by determining Cabbell was not liable for equity skimming. A violation of the Equity Skimming Act, chapter 61.34 RCW, is an act of criminal profiteering under RCW 9A.82.010(4)(bb). Because there was no enterprise, however, there can be no criminal profiteering.

But the property owners contend a violation of RCW 61.34.020 only requires proof of an association. An association is a group of individuals with a common interest who choose to work together. See Save A Valuable Environment v. City of Bothell, 89 Wn.2d 862, 866, 576 P.2d 401
(1978).

Even if only a showing of an association were required, there is no evidence that Cabbell and Delta North Star worked together for a common goal. Therefore, there was no enterprise and no association. The lack of either element is fatal to their claim.

The property owners contend the court erred by failing to enter findings of fact and conclusions of law on their claims of illegality, unconscionability, and violation of public policy. They argue that the underlying contracts or agreements between Cabbell and Delta North Star were illegal, unconscionable, and violated public policy. Because these contracts were made for the purpose of equity skimming, which is illegal, unconscionable, and against public policy, they claim that the underlying contracts must be as well. However, the trial court determined there was no evidence of equity skimming, so there was no basis to find the contracts were illegal, unconscionable, or in violation of public policy. The failure to enter such a conclusion was harmless in these circumstances.

Affirmed.

A majority of the panel has determined this opinion will not be printed in the Washington Appellate Reports, but it will be filed for public record pursuant to RCW 2.06.040.

WE CONCUR: BROWN, A.C.J., SCHULTHEIS, J.