Winstar-related case; cross-motions for summary judgment on damages; expectancy damages; cost of replacement capital; lost profits; reliance damages; incidental losses; tax gross-up
Howard N. Cayne, Arnold & Porter, LLP, Washington, D.C., argued for plaintiff. With him on the briefs were David B. Bergman, Michael A. Johnson, Michael A. Sackey, and Joshua P. Wilson, Arnold & Porter LLP, Washington, D.C.
John N. Kane, Trial Attorney, and Sameer Yerawadekar, Trial Attorney, Commercial Litigation Branch, Civil Division, United States Department of Justice, Washington, D.C., argued for defendant. With them on the briefs were Stuart E. Schiffer, Deputy Assistant Attorney General, David M. Cohen, Director, Commercial Litigation Branch, Jeanne E. Davidson, Deputy Director, and Timothy Abraham, Mark Pittman, and Edward E. Sullivan, Trial Attorneys, Commercial Litigation Branch, Civil Division, United States Department of Justice, Washington, D.C.
OPINION AND ORDER
Charles F. Lettow Judge
This Winstar-related case is before the court on cross-motions for summary judgment on damages. The government's liability for breach of contract has been established following a trial. American Fed. Bank, FSB v. United States, 62 Fed. Cl. 185 (2004). For the reasons that follow, the court finds that summary judgment on damages in plaintiff's favor is not appropriate. Genuine issues of material fact exist regarding the cost of replacement capital, certain incidental losses, and a tax "gross-up." The government's motion as to those claims correspondingly is also denied and those claims are remitted to trial. The government is, however, granted summary judgment respecting plaintiff's claims for damages based upon a lost-profits expectancy theory and upon a reliance theory, and for incidental losses based upon an alleged increased cost of funds.
American Federal Bank, FSB ("American Federal") was a federally chartered savings and loan association based in Greenville, South Carolina. American Federal, 62 Fed. Cl. at 186. Over a thirty-seven day period in 1982, American Federal received approval from the Federal Home Loan Bank Board ("FHLBB" or "Bank Board") to acquire four troubled thrifts: United Federal Savings and Loan Association, Home Savings and Loan Association, Family Federal Savings and Loan Association, and Bell Federal Savings and Loan Association, each of which was located in South Carolina. Id. at 186-87. At the time, American Federal had a net regulatory book value of $15.488 million that was 4.4% of its assets. Id. at 189.
As part of the agreed arrangements with the Bank Board for the mergers, American Federal was able to use the purchase method of accounting, count as regulatory capital the intangible goodwill that was produced as a result of the mergers, and amortize that goodwill over a forty-year period. American Federal, 62 Fed. Cl. at 187. In total, American Federal recorded $61,158,716 of amortizing goodwill from these four acquisitions. See Appendix in Support of Plaintiff's Response to Defendant's Motion for Summary Judgment Upon Damages and Cross-Motion for Partial Summary Judgment on Damages ("Pl.'s App.") tab 3 (Consolidated Financial Statements (1983 & 1982)), at 6-7. After a trial on liability issues, this court found that plaintiff entered into implied-in-fact contracts with the Bank Board concerning all four mergers. American Federal, 62 Fed. Cl. at 205. From the Bank Board's approval of the mergers until October 1988, American Federal amortized its goodwill in accordance with the agreed forty-year schedule and recorded it as part of the bank's regulatory capital. Stipulations ¶¶ 118-19; American Federal, 62 Fed. Cl. at 199 (finding that American Federal implemented its four contracts with the government regarding the amortization of goodwill through and to the time the bank's application for a modified stock conversion was approved).
On September 6, 1988, American Federal applied to the Bank Board for approval for a modified stock conversion. Appendix to Defendant's Motion for Summary Judgment on Damages and Defendant's Proposed Findings of Uncontroverted Fact ("Def.'s App.") at A-603 to A-606 (Letter from John F. Breyer, Jr., Housley Goldberg & Kantarian, to J. Lawrence Fleck, FHLBB (Sept. 6, 1988)); see 12 C.F.R. §§ 563b.39, 563b.41 (1988). In reviewing the conversion application, the "most significant issue" for the Bank Board was the continued use of the purchase method of accounting and forty-year amortization period for the goodwill attributable to the mergers that occurred in 1982. American Federal, 62 Fed. Cl. at 193 (quoting trial transcript). Ultimately, the parties negotiated new terms whereby the goodwill would be amortized over a remaining period of 23.25 years to begin October 1, 1988, i.e., 29.5 years dating from the time of the approval of the four mergers. Pl.'s App. tab 6 (1989 Annual Report), at 28. With this agreement, the Bank Board conditionally approved American Federal's application on November 10, 1988, Def.'s App. at A-618 to A-619 (Letter from Fleck to Breyer (Nov. 10, 1988)), resulting in the formation of a substituted contract for goodwill that discharged the four prior merger contracts ("Substituted Goodwill Contract"). American Federal, 62 Fed. Cl. at 199-203.
American Federal also filed, in conjunction with the conversion application, a request to include as part of its regulatory capital $100,000 of Series A subordinated debentures and approximately $13.5 million of Series B subordinated debentures, both of which were to be issued and sold as part of the modified conversion. Def.'s App. at A-761 (Memorandum from Kim R. Scheurenbrand, Supervisory Agent, Federal Home Loan Bank of Atlanta ("FHLB-Atlanta"), to Robert E. Showfety, Principal Supervisory Agent, FHLB-Atlanta (Dec. 20, 1988)). Following a positive recommendation made by FHLB-Atlanta on the ground that the bank's proposal would allow it to meet its minimum capital requirement, the Bank Board approved this further application by American Federal on December 23, 1988. American Federal, 62 Fed. Cl. at 193-94. The Bank Board's action created an additional contract between American Federal and the government ("Subordinated Debt Contract"). Id. at 203-205.
On January 26, 1989, American Federal completed its modified stock conversion, generating $10.0 million in gross proceeds through the sale of 2 million shares. Def.'s App. at A-771 (Form 10-K (1988)). From those proceeds, "$2.0 million was allocated to common stock and $6.3 million, which is net of [c]onversion costs of $1.7 million, was allocated to additional paid-in capital." Id. In addition, American Federal "sold $100,000 aggregate principal amount of noninterest-bearing Series A convertible subordinated debentures due 2004, with nondetachable mandatory purchase contracts for an aggregate purchase price of $12.5 million, which include[d] a $12.4 million conversion premium." Id. at A-772 (Form 10-K (1988)). Finally, the bank also sold $15 million aggregate principal amount of Series B subordinated debentures, with detachable warrants to purchase 600,000 shares of common stock at $5.00 per share, at an interest rate of 11.25% and due in 1999. Id. In total, American Federal increased its regulatory capital by $35.557 million, Def.'s App. at A-790 (Office of Thrift Supervision ("OTS") Report of Examination (Sept. 12, 1989)), reporting a total of $59.1 million in regulatory capital subsequent to the conversion, $27.1 million over its capital requirement. Def.'s App. at A-772 (Form 10-K (1988)).
On August 9, 1989, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA"), Pub. L. No. 101-73, 103 Stat. 183 (codified in scattered sections of Title 12 of the U.S. Code, including 12 U.S.C. § 1464) that eliminated the use of goodwill as a component of regulatory capital and restricted the use of subordinated debt as part of core capital. OTS, the Bank Board's successor under FIRREA, announced the regulations implementing FIRREA's new capital requirements on October 27, 1989, to be effective on December 7, 1989. 54 Fed. Reg. 46,845 (Nov. 8, 1989) (codified at 12 C.F.R. pts. 561, 563 and 567). The passage of FIRREA breached the government's two existing contracts with American Federal as of the effective date of FIRREA's implementing regulations: namely, (1) its substituted contract concerning the treatment of goodwill, and (2) its contract permitting newly issued subordinated debt to be counted as regulatory capital. American Federal, 62 Fed. Cl. at 205.
At the time of FIRREA's implementation, and thus when the government breached its contracts with American Federal, the bank had $48.702 million of unamortized goodwill and $13.6 million of subordinated debentures, recorded as regulatory capital. Pl.'s App. tab 6 (1989 Annual Report), at 35, 37. Following OTS's implementation of FIRREA's new capital requirements, the bank needed $15.987 million of tangible capital, $31.974 million of core capital, and $49.788 million of risk-based capital. Id. at 37. American Federal immediately failed the tangible- and core-capital requirements with deficiencies of $28.836 million for each, and it failed the risk-based capital requirement by $43.512 million. Id.; see also American Federal, 62 Fed. Cl. at 194.
FIRREA required that institutions such as American Federal that did not meet the new capital requirements had to file a capital plan with OTS detailing how they planned to become fully compliant with all capital requirements by December 31, 1994. Pl.'s App. tab 8 (Thrift Bulletin 36), at 1-2; see 12 U.S.C. § 1464(t)(6); see also Pl.'s App. tab 9 (Letter from John E. Ryan, District Director, OTS, to Board of Directors (Nov. 15, 1989)). On January 8, 1990, American Federal filed a capital plan with OTS describing how the bank would meet its capital requirements by the prescribed deadline. Def.'s App. at A-833 to A-867 (Capital Plan), A-1463 (Letter from J. Laurence Sykes, Supervisory Agent, OTS, to William L. Abercrombie, Jr., President, American Federal (Jan. 10, 1990)) (acknowledging receipt of the capital plan and commencement of OTS's review). Following the submission of two amendments to the capital plan by American Federal, Pl.'s App. tab 20 (Capital Plan 1st Amendment (Mar. 8, 1990)); Pl.'s App. tab 22 (Capital Plan 2nd Amendment (May 18, 1990)), OTS approved the plan subject to stated conditions. Pl.'s App. tab 24 (Letter from Ryan to Board of Directors (May 31, 1990)).
"The principal components of the capital plan include[d] retention of future earnings, reduction of non-qualifying assets and securitization of mortgage loans into mortgage-backed securities." Pl.'s App. tab 12 (1990 Annual Report), at 21. On April 17, 1990, as part of the capital plan, American Federal undertook and completed the conversion of the Series B subordinated debentures into $15.0 million of non-cumulative preferred stock ("Series I preferred stock"). Id. at 38. The detachable warrants associated with the Series B debentures were not affected by this conversion. Id. The conversion added $13.7 million in equity capital for American Federal. Def.'s App. at A-1668 (Press Release (Mar. 20, 1990)). Although the bank was still unable to comply with the minimum capital requirements for 1990, having a risk-based capital deficiency of $25.202 million, it did surpass its capital plan's risk-based capital target of $26.845 million or 3.50% by $3.680 million or 0.44%. Pl.'s App. tab 12 (1990 Annual Report), at 21-22.
Pursuant to its capital plan and to reduce further the bank's "risk-based capital requirements and provide a source of liquidity," American Federal converted many of its residential mortgage loans into mortgage-backed securities. Pl.'s App. tab 48 (Offering Circular (Mar. 12, 1993), at 34-35. During the years 1990, 1991, and 1992 the bank securitized loans of $47.918 million, $55.634 million, and $48.891 million, respectively. Id. at 35. It sold some of the resulting mortgage-backed securities in 1991 and 1992, realizing net proceeds of $3.6 million over those two years. Pl.'s App. tab 46 (1993 Annual Report), at 29.
The steps American Federal took under its conditionally approved capital plan produced a steady improvement in its capital structure. By September 30, 1992, for the first time since the passage of FIRREA, American Federal had satisfied all of its then-applicable minimum capital requirements. Def.'s App. at A-1965 (Form 10-Q (Sept. 30, 1992)), A-2010 (Form 10-K (1992)). During the period from December 31, 1989 to December 31, 1992, American Federal increased its tangible equity by $46.9 million, of which $32.7 million was attributable to retained earnings and approximately $13.6 million stemmed from the conversion of Series B subordinate debentures into common stock. Def.'s App. at A-2010 (Form 10-K (1992)). Thus, during this three-year period, American Federal increased its regulatory tangible-capital position from a deficiency of $12.8 million to a positive $34.0 million. Id. Nevertheless, the bank explicitly stated that due to the expected future increases in the then-minimum capital requirements, it could provide "no assurance" that it would satisfy the projected higher requirements in the future. Def.'s App. at A-1965 (Form 10-Q (Sept. 30, 1992)).
On March 18, 1993, holders of the Series A subordinated debentures converted their securities into 2,173,912 shares of common stock without the payment of added considerationand purchased an additional 2,195,650 shares of common stock for $12.625 million through the execution of their related mandatory purchase contracts. Pl.'s App. tab 46 (1993 Annual Report), at 40. Concurrently, holders of the Series I preferred stock that had been issued in April 1990 exchanged all of their shares for 2,340,768 shares of common stock without any payment of additional consideration. Id. In addition, the bank sold 2,083,955 shares, and the former Series A and Series I holders sold 4,126,045 shares, of common stock in a public offering, for a total of 6,210,000 shares at $8.75 a share. Id. American Federal realized net proceeds of $16.6 million from the sale, of which $2.1 million was allocated to the newly-issued common stock and the remaining proceeds were recorded as paid-in capital. Id. Thus, in March 1993, a total of approximately $29.4 million in additional capital was raised by American Federal through the issuance and sale of common stock, the exchange of subordinated debentures and preferred stock for common stock, and the execution of mandatory purchase contracts. Id. at 17.
At the end of March 1993, the bank was released from all provisions of its capital plan. Pl.'s App. tab 80 (Letter from Ryan to Abercrombie (Mar. 31, 1993)).
By April 1993, American Federal was classified as "well capitalized" and exceeded all of its capital requirements. Pl.'s App. tab 46 (1993 Annual Report), at 17-18. In particular, on December 31, 1993, American Federal reported $89.612 million in risk-based capital, accounting for 14.17% of total assets, which was 6.17% above the minimum capital requirement and 4.17% above the requirement for a well-capitalized institution. Id. The bank also adopted, retroactive to January 1, 1993, the preferred accounting guidelines for goodwill as described in the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 72 ("SFAS 72"). Id. at 18. The adoption of SFAS 72 caused the bank to write off the remaining $36.2 million of unamortized goodwill as of January 1, 1993, and to announce that it no longer anticipated incurring any additional goodwill expenses relating back to the mergers from 1982. Id.
American Federal declared its first quarterly dividend payable on August 16, 1993 at $0.05 per share. Def.'s App. at A-2061 (Press Release (July 15, 1993)). During 1994, quarterly dividends were increased to $0.06 per share with an annual dividend rate that year of $0.22 per share. See Pl.'s App. tab 51 (1994 Annual Report), at 1. Quarterly dividends rates increased in 1995 to $0.07 per share, and again in 1996 to $0.10 per share. Appendix to Defendant's . . . Opposition to Plaintiff's Cross-Motion for Partial Summary Judgment on Damages at SA0081 (Press Release (July 20, 1995)); Def.'s App. at A-2113 (Minutes of Board of Directors Meeting (Mar. 21, 1996)); Plaintiff's Motion for Leave . . . to Respond to the Court's Inquiry Regarding Dividend Payments ("Pl.'s Resp. on Dividends") Ex. B (1996 Annual Report). Finally, in 1997, American Federal established a dividend policy of quarterly payments of $0.12 per share. Pl.'s Resp. on Dividends Ex. D (Letter from Jean Rankin, Applications Manager, OTS, to Deborah A. Brady, Corporate Secretary, American Federal (Jan. 8, 1997)). The bank altered the dates of payments that year, issuing three separate dividend payments of $0.12 per share payable on February 10, May 12, and July 1, 1997, to adjust its dividend schedule in anticipation of the closing of the bank's merger to CCB Financial Corporation and ensure that American Federal's shareholders would receive four dividend payments that year. Id. Ex. C (Minutes of Board of Directors Meeting (May 15, 1997)). Cumulatively, from 1993 through March 1997, American Federal paid a total of $11.873 million in dividends to shareholders of its common stock. Pl.'s Resp. to Def.'s Facts at 55-56; Pl.'s App. tab 56 (Dr. Kormendi's First Supplemental Expert Report), Ex. D.
In early 1996, the bank instituted a stock repurchase program whereby American Federal would buy up to 5% of the outstanding common shares over the succeeding 12 months. Def.'s App. at A-2112 to A-2113 (Minutes of Board of Directors Meeting (Mar. 21, 1996)), at A-2122 (Press Release (Mar. 21, 1996)). At the time, the bank had approximately 10.9 million shares outstanding, and thus the repurchase program involved up to approximately 550,000 shares. Id. On April 24, 1996, American Federal repurchased 7,000 shares of common stock. Def.'s App. at A-2128 (Minutes of Board of Directors Meeting (Apr. 24, 1996)). In addition, by July 9, 1996, 600,000 outstanding warrants, constituting all of the warrants associated with the 1989 sale of Series B subordinated debentures, were exercised or redeemed at an average net price of $10.45 per warrant. See Def.'s App. at A-2134 (Press Release (July 18, 1996)), A-2129 (Minutes of the Board of Directors Meeting (July 18, 1996)). One holder sought ...