Federal Deposit
Insurance Corporation

• Professional Liability and Criminal Recoveries
  
• Statutes of Limitation Defenses
  
• Directors' and Officers' Liability
  
• Goodwill Litigation
  
• Tax Penalties
  
• Bank Holding Company Litigation
• Insurance Assessments
  
• D'Oench Duhme
  
• FIRREA's Anti-Injunction Provision

Professional Liability and Criminal Recoveries

The Legal Division and the Division of Resolutions and Receiverships recovered $186.5 million during 1998 from professional liability settlements or judgments. At year-end, the FDIC’s professional liability caseload included investigations, lawsuits and settlement collections involving 141 institutions, a decrease of 39 institutions from the prior year.

The FDIC also collected more than $11.4 million from criminal restitution payments and $5.6 million in asset forfeitures ordered by the Courts as part of the judgments against defendants in criminal cases brought by the U.S. Department of Justice.

Statutes of Limitation Defenses

In professional liability matters, the applicable "statutes of limitation" (the state laws that determine the period during which an action against directors, officers or others who contributed to the failure of federally insured depository institutions may be brought) continued to be a hotly contested issue in 1998. The FDIC argues that when wrongdoers dominated the board of a failed institution, the agency should get additional time to file suit against them because these controlling board members would not have sued themselves, and no one else could sue them while they were in power. For many years the FDIC successfully asserted this doctrine of "adverse domination" as a matter of federal common law, until the U.S. Supreme Court’s decision in O’Melveny & Myers v. FDIC in 1994. As a result of the O’Melveny decision, these issues are now determined by state laws, which vary widely.

For example, in Texas, the 1993 decision in Dawson v. FDIC by the U.S. Court of Appeals for the Fifth Circuit in New Orleans, and subsequent decisions interpreting it, limit the FDIC’s use of the doctrine of adverse domination to cases where the defendants engaged in intentional misconduct or fraud, as opposed to gross negligence. In 1998, in a variation on this issue, the Fifth Circuit rejected the FDIC’s argument in a Louisiana case, FDIC v. Abraham, that 15 former directors of a failed savings institution should be held accountable under a 10-year statute of limitation for claims of breach of fiduciary duty instead of a one-year statute of limitation for claims of gross negligence. The Fifth Circuit concluded that a claim for breach of fiduciary duty, and thus application of the 10-year statute of limitation, requires a showing of fraud, self-dealing, bad faith, breach of trust, or other "ill acts." It rejected the FDIC’s position, and a recent Louisiana appellate court decision, that grossly negligent conduct is sufficient for a claim of breach of fiduciary duty. The Abraham ruling caused the FDIC to lose approximately $54 million in dismissed claims in four Louisiana suits.

The statute of limitation precedents are not uniform in all circuits. For example, in 1998 the U.S. Court of Appeals for the Ninth Circuit in San Francisco held in FDIC v. Jackson that an Arizona statute of limitation is tolled (that is, extended) during the time that grossly negligent directors adversely dominate an institution. Thus, in Arizona (unlike Texas), fraudulent or intentional concealment of facts is not necessary in order to toll the statute of limitation. As a result of the significant differences in state laws regarding statutes of limitation, as well as differing interpretations of such statutes by the courts, this area will likely continue to be hotly contested for years to come.

Directors' and Officers' Liability

The case of FDIC v. Jackson mentioned previously dates back to 1992, when the FDIC brought a professional liability lawsuit against the former directors of Century Bank, a failed Arizona bank. The suit involved claims that the former directors negligently approved improper loans that later went into default. In October 1992, the U. S. District Court for the District of Arizona ruled against the FDIC on claims for negligence, gross negligence and breach of fiduciary duty brought against the former directors. The FDIC appealed the case, and on January 5, 1998, the U.S. Court of Appeals for the Ninth Circuit issued a mostly favorable decision in FDIC v. Jackson.

The Ninth Circuit determined that the district court had improperly dismissed all of the FDIC’s claims for simple negligence without regard to whether they fell within the Arizona law on "business judgment" (i.e., a rule that corporate officers and directors acting in good faith are not liable for errors in judgment unless they engage in unauthorized or illegal acts). The appellate court found that under Arizona law, bank directors should be held to a gross negligence standard of liability when the business judgment rule applies, but a simple negligence standard when the alleged wrongful acts fall outside the scope of the business judgment rule. The Ninth Circuit also concluded that a long-time bank director’s greater knowledge and historical perspective regarding regulatory problems may be considered in determining whether a director had acted negligently in approving a loan.

In its decision, the Court also addressed when the statute of limitation started to run on the FDIC’s claims. It determined that under Arizona law, the earliest that the claims could have been brought against the former directors was when the improper loans were made or approved, not, as the FDIC had argued, at the later time when the loans actually went into default. This ruling by the Court did not bar the FDIC’s claims, however, because the Court also found that the doctrine of adverse domination (described previously in this chapter) applied to the FDIC’s claims.

The Ninth Circuit’s analysis of these significant issues—the standard of care for bank directors, the business judgment rule and adverse domination—provides favorable precedent for the FDIC’s future professional liability cases.

Goodwill Litigation

As a result of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), the Office of Thrift Supervision (OTS) in 1990 changed the regulations governing the capital requirements for thrift institutions to make them conform to those for commercial banks. Consequently, certain forms of intangible capital, such as supervisory goodwill, were no longer allowed to be counted as part of a thrift’s capital. Acquirers of thrift institutions sued the government, alleging that they had purchased failed or failing thrifts prior to the passage of FIRREA based on a promise from the Federal Savings and Loan Insurance Corporation (FSLIC) that they could count such intangibles toward their capital requirements. Plaintiffs allege that FIRREA’s changes resulted in a breach of contract or a taking of their property without just compensation.

In July 1996, in Winstar Corporation v. United States (Winstar), the U.S. Supreme Court ruled in three consolidated goodwill cases (Winstar, Statesman and Glendale) that the United States is liable for a breach of contract based on FIRREA’s change in capital standards and remanded those cases for a trial on damages. More than 120 goodwill cases were pending in the U.S. Court of Federal Claims as of year-end 1998. The major issues include breach of contract liability in many cases and the appropriate legal standards for the recovery of damages (the recovery of future lost profits being the most controversial issue). Four cases were settled, in whole or in part, during 1998 (Statesman, Union, Winstar and Dollar). Twelve "priority" cases are scheduled to go to trial in 1999. Upon completion of the priority cases, the remaining cases are expected to go to trial at a rate of 12 or 15 per year. In addition, five cases, known as the Guarini cases, involve challenges to legislation passed after FIRREA that changed the method for computing certain tax benefits given to acquirers of failed or failing thrifts.

The FDIC, as successor to the rights of failed institutions with potential goodwill claims against the United States, is a co-plaintiff or plaintiff in more than 40 goodwill cases. The FDIC, as successor to the FSLIC, is providing support to the Department of Justice in its defense of the United States. Appropriate "fire walls" have been established within the FDIC to keep the two groups of employees supporting these different roles separate and apart in order to preserve confidentiality and avoid conflicts of interest.

In October 1998, Congress passed legislation appropriating necessary sums to pay judgments and settlements arising out of goodwill litigation. Pursuant to a Memorandum of Understanding between the FDIC and the Department of Justice, the litigation expenses incurred by the United States are to be funded separately by the FDIC from other resources. That portion of the FSLIC Resolution Fund that contains the assets and liabilities of the former FSLIC shall be the funding source for goodwill litigation expenses.

On April 10, 1999, the United States Court of Federal Claims ruled that the federal government must pay Glendale Federal Bank $908.9 million for breaching a contract that allowed the thrift to count goodwill toward regulatory capital. Both the plaintiffs and the Department of Justice are expected to appeal the decision. Additionally, on April 16, 1999, in a similar case, another judge of the U.S. Court of Federal Claims, using a different analysis than the one used by the judge in the Glendale case, awarded California Federal Bank $23 million. California Federal Bank was seeking more than $1.5 billion in damages and is expected to appeal the decision. The analyses of the damage issues in the two cases appear to be irreconcilable. Due to the anticipated appeals and the conflicting analyses in the two cases, the ultimate outcome is uncertain.

Tax Penalties

FIRREA precludes state and local governments from imposing any taxes, fees or penalties on real property owned by the FDIC except for real property taxes based on value. The statute was in part a codification of the well-settled doctrine announced by the Supreme Court in 1819 in McCulloch v. Maryland that the national government is generally immune from taxes by state and local governments. To enforce this statute and the related FDIC policy, the FDIC as receiver of various failed financial institutions and as manager of the FRF filed suit in 1998 against 28 California counties to recover in excess of $5 million in overpaid property tax penalties paid in violation of FIRREA. These cases are significant both because they concern a challenge to the FDIC’s express statutory immunity from state and local taxes and because they raise the issue of whether the Tax Injunction Act of 1948 or the 11th Amendment to the Constitution preclude federal courts from enforcing that immunity.

Bank Holding Company Litigation

In the case of Branch v. FDIC, the bankruptcy trustee for a bank holding company in 1992 alleged that it was due $2.1 billion as a result of money and assets the company "downstreamed" to its subsidiary banks (including the Bank of New England) when the parent company was insolvent. The plaintiff cited the Bankruptcy Code, which allows a trustee to avoid transfers of a debtor’s property made when the debtor was insolvent, without regard to the motives of the parties involved, if the debtor did not receive reasonably equivalent value in exchange. The case highlighted an inherent conflict between the bank regulatory and statutory systems (which require holding companies to provide financial support to their subsidiary banks) and the Bankruptcy Code (which focuses exclusively on recovering the debtor’s property regardless of the legitimacy of the reasons transfers were made). The FDIC argued that it could not be held liable for transfers under the Bankruptcy Code’s fraudulent transfer section (or a corresponding state law) when the transfer was made pursuant to a valid regulatory directive. The district court in 1993 rejected this argument, made in a motion to dismiss in 1993, and allowed the plaintiff to proceed to trial on the merits.

In 1998 the FDIC prevailed on its motion to dismiss plaintiff’s largest claim for more than $1.6 billion in federal funds from two of the subsidiary banks. These efforts reduced the claims to be tried to about $400 million. After engaging in mediation, the FDIC in 1998 settled the remaining claims by paying $140 million.

Insurance Assessments

In 1996, the FDIC revised the assessment schedule for the Savings Association Insurance Fund (SAIF) for the fourth quarter of 1996 because a special assessment authorized by Congress had recapitalized the insurance fund. The revised assessment schedule resulted in a refund of most of the SAIF assessments previously collected for the fourth quarter but not the money collected at the same time to service bonds of the Financing Corporation (FICO). America’s Community Bankers (ACB), an industry trade association, sued the FDIC to have the FICO assessment refunded. ACB argued that since the SAIF had been recapitalized in the fourth quarter, the FDIC was precluded from collecting the FICO assessment that quarter.

In November 1998, the District Court for the District of Columbia rejected the ACB’s challenge. It found that the FDIC’s interpretation of the statute was entitled to deference and was reasonable in light of the statute’s conflicting goals and the broad discretion afforded the FDIC in setting assessments. The court also concluded that because the FICO assessment had already been transferred to the FICO prior to enactment of the SAIF special assessment, the FICO funds did not belong to the FDIC and therefore an award of money damages was precluded by the Administrative Procedure Act. In early 1999, ACB announced its intention to appeal the court’s decision.

D’Oench Duhme

The D’Oench doctrine, which is traced to a 1942 Supreme Court ruling, protects the FDIC against any arrangements, including oral or secret agreements, that are likely to mislead bank examiners in the review of a bank’s records. On May 8, 1996, the U.S. Court of Appeals for the Eleventh Circuit in Atlanta, sitting en banc (with all active judges participating), held in Motorcity of Jacksonville v. Southeast Bank that the D’Oench doctrine survives the passage of FIRREA and remains a viable protection for the FDIC. However, that decision disagreed with a 1995 opinion by the U.S. Court of Appeals for the District of Columbia. On February 28, 1997, the FDIC issued its operative Statement of Policy on D’Oench to deal with the concerns raised in the courts as to the D’Oench doctrine’s continuing viability after FIRREA. The FDIC determined in the policy statement that agreements made pre-FIRREA will be governed by D’Oench; FIRREA will not be applied retroactively to agreements entered into before the enactment of FIRREA on August 9, 1989. In addition, the FDIC determined that agreements made after the enactment of FIRREA will be governed by sections of FIRREA barring claims against the FDIC that do not meet specific recording requirements set forth in the statute.

The plaintiff in Motorcity also had appealed to the U.S. Supreme Court, arguing that the "split" between the two circuits needed to be resolved. In January 1997, the U.S. Supreme Court instructed the Eleventh Circuit to reconsider its decision and determine whether a previous U.S. Supreme Court case involving federal common law (Atherton v.FDIC) affected the outcome. In August 1997, the Eleventh Circuit held that nothing in Atherton altered the outcome of its earlier decision and, consequently, it was not necessary to address the FDIC’s policy statement. The Motorcity plaintiff filed its second appeal to the U.S. Supreme Court on December 18,1997. On April 27, 1998, the Supreme Court denied the plaintiff’s petition, bringing an end to this litigation. Although the Eleventh Circuit’s favorable decision stands, the FDIC will continue to apply the provisions of the 1997 policy statement in determining whether to apply the D’Oench doctrine.

FIRREA’s Anti-Injunction Provision

When Congress enacted FIRREA in 1989, it gave the FDIC broad powers to resolve failed financial institutions efficiently and expeditiously. One of these powers was an anti-injunction statute that enables the FDIC, in its capacity as receiver or conservator for a failed bank, to operate quickly and without interference. In particular, the statute prohibits judicial action that would "restrain or affect the exercise of powers or functions" of the FDIC.

In 1994, five former shareholders of Meritor Savings Bank sued the FDIC and the Pennsylvania Secretary of Banking, challenging the 1992 closure of the bank and the appointment of the FDIC as receiver. In this case (Hindes v. FDIC), the plaintiffs argued that the FDIC had wrongfully issued advance "notification" of its intent to terminate Meritor’s deposit insurance in order to provide the Pennsylvania banking supervisor with a pretext for seizing the institution. On February 19, 1998, the U.S. Court of Appeals for the Third Circuit in Philadelphia, upheld a district court ruling dismissing the shareholders’ action because a review of the FDIC’s "notification" was barred by the anti-injunction statute. In addition, the Court stated that even if the anti-injunction provision did not apply, the agency’s issuance of the notification was not subject to judicial review because it was not a final action that could be reviewed by the Court.

This case is significant because the Third Circuit determined that the shareholders’ failure to timely challenge the FDIC’s appointment as receiver under state procedures precluded them from later seeking to remove the FDIC. In addition, it is the first court of appeals decision to hold that shareholders could not assert a claim under FIRREA against the FDIC challenging the appropriateness of the receivership accounting.