Some might think that it's hard to believe that supervisory goodwill cases arising out of bank failures that occurred in the 1980s are still working their way through the federal court system, but those faithless readers of this blog know that what Arnold & Porter partner Edward Sisson called "dancing with the bear" takes a very long time. In fact, it takes as long as is necessary for the bear to get tired enough to finally stop dancing, and this bear's "got legs."
FinCri Advisor (free registration required) profiled a shareholder derivative action that has been huffing and puffing since 1993. It arose out of the FDIC's seizure of Meritor Savings Bank, which had been given favorable accounting treatment of "supervisory goodwill" when it bailed out the former FSLIC to the tune of $696 million by buying the broke Western Savings Fund Society.
A key part of the deal, however, was a Memorandum of Understanding that the FDIC gave Meritor allowing it to treat "the differences between the liabilities assumed and the total of the market value of the Western assets, less reserves" as goodwill and amortized on a straight-line basis for up to 15 years.
Without that understanding, the merged bank would not have had enough capital to meet regulatory requirements.
To make a long story short, the regulators broke their word, refused to recognize the "supervisory goodwill" as capital, ordered Meritor to raise its capital levels, and seized it when it couldn't do so. A principal shareholder sued the government and won, to the tune of $276 million. The government appealed and argued that the FDIC was a "non-appropriated funds instrumentality (NAFI)," and, as such, should have been sued in federal district court, rather than the Federal Claims Court. A majority of a three-judge panel of the U.S. Court of Appeals for the Federal Circuit disagreed, and said that the FDIC is backed by the full faith and credit of the United States and, therefore, is not a NAFI, and that a lawsuit in the Federal Claims Court was proper.
Much of the discussion in the FinCri Advisor article focused on how the Department of Justice was shooting the FDIC behind the left ear. Rather than be paid out of the larger pot of funds appropriated by the federal government, if the argument presented by the Justice Department had prevailed, all of the judgment would have to be paid from the Deposit Insurance Fund, meaning that FDIC-insured banks might very well be stuck with the tab (through the assessments they pay to fund the DIF). More important, prejudgment interest, available in federal district court suits but not in the Federal Claims Court, might have elevated that $276 million award to $ 1 billion.
The FDIC is "operating in a manner that is against their own interests," says Thomas Buchanan, the partner in charge of litigation at Winston & Strawn in Washington, D.C., who represented the plaintiffs. "I don't think they thought it through."
Ya' think?
One of the most interesting lessons of all this is one discussed by Arnold & Porter attorney Michael Johnson, toward the end of the article.
But he cautions private parties now contracting with the government to be careful. When the crisis ends, he says, politics can come into play and "hindsight can make the deals look a little different. Government is uniquely situated to alter the terms of the deals everyone thought were good at the time. Hopefully the lesson learned here is that the government does need to keep its promises. If it chooses not to, there are consequences," he says. "Another lesson for the private parties is the wheels of justice can turn a little slowly."
That's a point I've been hammering home to banks who thought about taking TARP money (and some community banks who are still toying with that idea). Some ignored the warnings, took the TARP, and many are now having second thoughts. No small part of those second thoughts have been caused by the manner in which Congress enacted legislation after the deals were consummated that changed some of the deal terms. Those banks can't say they weren't warned, but some of the bank executives still shake their heads and ask whether the government is deliberately trying to screw up or if this is just pure incompetence. It's the latter, mixed up with cold political demagogy, in my view.
It's also a point that those who enter into "loss-sharing" and other types of agreements with the FDIC as part of the resolution of failed banks would be wise to ponder. Those agreements can be breached overnight by folks with (as a former client once put it to me) the ethical principles of an Iranian rug merchant. If a breach occurs, you may have a right to sue the government for that breach, but you may be "dancing with the bear" for 16 years or more before you see a nickel.
The government will next likely ask for a full hearing before the appeals court.
And on and on it goes...
