UNITED STATES DISTRICT COURT DISTRICT OF COLUMBIA BEAL BANK

Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 1 of 14 UNITED STATES DISTRICT COURT DISTRICT OF COLUMBIA BEAL BANK, S.S.B., Plaintiff, v. No. 1:02CV02146 RJL FEDERAL DEPOSIT INSURANCE CORPORATION AS RECEIVER FOR SUPERIOR BANK, F.S.B., AND IN ITS COPORATE CAPACITY, Defendants. _____________________________________/ REPLY OF THE FEDERAL DEPOSIT INSURANCE CORPORATION IN ITS CORPORATE CAPACITY IN SUPPORT OF ITS MOTION TO DISMISS OR FOR STAY In its Motion to Dismiss (Document #73 at 7-10), FDIC-C demonstrated that Beal’s request for Declaratory Judgment concerning the meaning of the Guaranties issued by FDIC-C was inappropriate because FDIC-Receiver (FDIC-R) had the funds to cover any likely obligation with regard to the subprime loans at issue, and therefore, the lack of any urgency precluded this Court from exercising jurisdiction. FDIC-C alternatively argued (Doc. #73 at 10-13) that the Guaranties were collection rather than payment guarantees, and, under New York law, could not be invoked prior to the termination of the judicial proceedings against FDIC-R. Finally, the FDIC-C contended (Doc. #73 at 13-14) that at the very least a stay of the case against FDIC-C was appropriate until such time as the Court and the parties were able to ascertain with some reasonable certainty that the liabilities of FDIC-R will be sufficiently high that the Guaranties will likely come into operation. Beal has filed a Memorandum in Opposition (“Opp.”) (Document #76) disputing FDIC-C’s contentions. Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 2 of 14 A. Beal’s Estimate of the Receiver’s Potential Liabilities is Too High and Unrealistic. In order for the Guaranties to come into operation, two conditions must be satisfied. First, FDIC-R must be found to be liable to Beal. Second, FDIC-R must fail to pay that liability. As FDIC-C has shown, it is highly unlikely that the second condition will ever be satisfied in light of the $247.5 million in the receivership on which Beal has a priority claim.1 Beal offers (Opp. at 3-4, 6-7) an inflated, speculative set of figures to show the likelihood that FDIC-R will fail to pay a liability. These figures totally lack credibility. As FDIC-C demonstrates, that attempt relies on a misreading of the record and an incorrect reading of the law. Deflating these figures is not difficult. Beal incorrectly states (Opp. at 6 and n.5) that “[t]he FDIC has provided no assurance regarding the existence and scope of other administrative claims that may currently be pending against the receivership or may be filed in the future, . . . .” To the contrary, the financial statement appended to the Declaration of Robert Ferrer (Doc. #73-3) provides a complete tally of the currently pending claims that compete with Beal’s under the heading “Administrative Liabilities.” The $247.5 million to which Beal has first claim results from subtracting the total of those competing claims ($13.9 million) from the total assets of the receivership ($261.4 million). Moreover, the latest Superior receivership dates from 2002. There are time limits for making receivership claims, and those have run. In addition, we would expect that other dissatisfied purchasers of loans, if any, would have filed claims long ago. Finally, Beal has failed to specify any scenario which is likely to change “what assets may exist in the future” in the receivership. Thus, the only competition Beal will have for the $247.5 million is relatively trivial claims from trade creditors currently furnishing services to the receivership, e.g., companies providing IT services. Thus, the speculative nature of Beal’s contention undercuts any implication that it somehow needs an answer to its question now. FDIC-C notes that the total receivership assets available to pay Beal’s claim will be subject to some fluctuation from time to time as the receivership pays dividends on other claims already proven to its satisfaction. Clearly, should the payment of the dividends result in the available assets dropping to a level at which operation of the Guaranties becomes a realistic possibility, it will be appropriate at that time, but not before, to adjudicate the issues relating to them. 2 1 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 3 of 14 Beal claims (Opp. at 6-7) that there are “far more than 1778 defective loans [the number Beal submitted] among the 5315 that the FDIC sold to Beal.” However, as FDIC-R has pointed out in its Motion for Partial Summary Judgment (Doc. # 75 -- Partial SJ Motion), of 5315 loans, only about 1500 potentially meet the two necessary conditions for liability -- (i) breach of a representation or warranty that (ii) caused a material loss. Of the remaining loans, 247 have been repurchased already; an estimated 2600 have been paid off by the borrowers; and approximately 600 are performing.2 Although the parties cannot determine the exact numbers in each of these categories of loans until all of the loan files and servicing files have been reviewed, it appears that, at most, a third are likely to give rise to liability. Thus FDIC-R’s repurchase of all of these loans, even at face value, would come nowhere near depleting the $247.5 million.3 Beal also alleges (Opp. at 7) that the FDIC’s consultants concluded in a study done in 2004 that 56% of the loans were "defective." Aside from the fact just adverted to that these loans may contain breaches of representations or warranties without creating liability for damages, Beal’s reliance on the document attached to its Memorandum in Opposition (Doc. # 76-4 at 3) is misplaced. A close examination of that document reveals that it is dated May 14, 2004 and appears to be a draft. The final version of the report, dated June 30, 2004 (excerpts attached as Exhibit A hereto) contains none of the pages relied on by Beal. Moreover, as the Executive Summary (Ex. A at 4, final 2 The fact that Beal submitted a loan to FDIC-R does not mean that there is FDIC-R liability since it could fit into one of the categories listed above which would not create liability. Thus, the 1778 figure is, itself, misleading. 3 The fact that a large number of loans have been paid off means that, under any damages theory, Beal’s recovery would be substantially decreased by the setoff from the paid-off loans and end up well within the $247.5 million. 3 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 4 of 14 paragraph) makes clear, the consultants’ best estimate of the FDIC’s total liability was $21 million: Based on our analysis detailed herein, we estimated appropriate reserve allocation or potential loss amount to the FDIC for remaining potential claims loans to be within the range of $12 MM to $30 MM. Our most likely estimate of $21 MM is reliant on the principal determination from our sampling and loan review process suggesting that 21% of the remaining loans . . . had material claims associated with them. As such, the most that the Bank should be entitled to is $21 MM. The consultants also attempted to calculate the total potential repurchase liability assuming that FDIC-R had to repurchase all of the loans with material breaches (Ex. A at 25). That figure is $63 million. Thus, the consultants’ final report paints a quite different picture; FDIC-R’s potential liability is much lower than what appears from the material Beal has excerpted from a draft of the report. Beal also erroneously relies (Opp. at 4, emphasis in original) on a draft internal FDIC memorandum from 2004 (Doc. # 76-5 at 4) that Beal now knows was prepared by a mid-level staff member, and was never even seen by Mitchell Glassman, Director of the Division of Resolutions and Receiverships, much less submitted to the FDIC's Board of Directors. To the extent the document has any relevance at all, as indicated by the paragraph following the one Beal quotes, this FDIC analyst believed that the outer limit of any recovery by Beal would be $70 million. At his deposition, this same analyst stated his personal opinion that the FDIC's liability was in the $8 to $12 million range.4 Beal alleges that two other components of potential liability are likely to ratchet up significantly the ultimate figure: interest and attorneys' fees. Beal’s analysis is wrong with respect to both. Beal alleges (Opp. at 7) that it will be entitled to interest at the New 4 Exhibits B and C, attached hereto, contain the relevant excerpts from the depositions of Mitchell Glassman and Victor Robert, the staff member who prepared the memorandum. 4 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 5 of 14 York statutory rate of 9% from the date of the purchase of the loans to the entry of judgment. However, the case Beal cites in support, Wechsler v. Hunt Health Sys., 330 F.Supp.2d 383, 434-35 (S.D.N.Y. 2004), holds only that state law determines the interest rate. While the state law cited by Beal, N.Y.C.P.L.R. § 5004, imposes a 9% interest rate, it does not apply in cases in which the contract has a specific provision governing interest. E.g., Citibank, NA v. Liebowitz, 110 A.D.2d 615, 487 N.Y.S.2d 368, 369 (App. Div. 2d Dept. 1985). In this case, as FDIC-R’s Motion points out (Partial SJ Motion at 22), the Mortgage Loan Purchase Agreements each have specific provisions governing interest on loans FDIC-R repurchases. Interest accrues at the Mortgage Loan rate in each case, and depending on the agreement, accrues either up to but not including the date of repurchase (November 2001 Agreement) or for a period not to exceed 60 days (March and April 2002 Agreements). Thus, whatever the number of loans that FDIC-R finally is liable to repurchase, the interest it will be required to pay will be substantially less than 9% on each of these loans from the date Beal acquired them. Beal also points to attorneys' fees as an element potentially contributing significantly to FDIC-R’s ultimate liability (Opp. at 4). However, as FDIC-R’s Motion makes clear (Partial SJ Motion at 21-22), the attorneys' fees to which Beal will be entitled are only those incurred in connection with dealing with specific loans (e.g., workouts, foreclosures and the like), not the fees incurred in prosecuting this suit. Accordingly, these fees will not likely add significantly to FDIC-R’s ultimate liability. In sum, there appears to be no plausible scenario in which FDIC-R’s ultimate liability would come close to the $247.5 million in assets to which Beal has first claim. 5 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 6 of 14 B. Even If the Guaranties are Payment Guaranties, the Court Lacks Jurisdiction to Grant Declaratory Relief. Beal’s argument (Opp. at 5-7) on why this Court should exercise its jurisdiction to grant declaratory relief is straightforward. In its view, its complaint states a claim for relief under Fed. R. Civ. P. 12(b)(6), and that is all that is necessary (Id. at 5). Additionally, it contends (Id. at 5-7) that the size of the potential FDIC-R liability, which it deems “irrelevant for purposes of a motion to dismiss” (Id. at 5), nonetheless is likely enough to cause the Guaranties to operate so that the Court should not dismiss the case. As FDIC-C has just shown, the second point, as a factual matter, is based on a misreading of the record and law. However, Beal is also in error with respect to the first point. The inquiry into this Court’s authority to issue a declaratory judgment does not end even if this Court concludes that Beal’s complaint states the elements of breach of contract. Declaratory relief is a form of relief rather than a substantive claim and is subject to certain limitations. As set forth in FDIC-C’s Motion to Dismiss (at 6-7, 8-9), the test in this Circuit for whether the Court has jurisdiction to grant declaratory relief is whether the dispute has the “immediacy” necessary to warrant declaratory relief, Penthouse International, Ltd. v. Meese, 939 F.2d 1011, 1018 (D.C. Cir. 1991) (citations omitted), and whether it will put an end to “uncertainty and insecurity,” see Tierney v. Schweiker, 718 F.2d 449, 456 (D.C. Cir. 1983). Yet, nothing in Beal’s submission explains why there is any necessity or even a point to this Court’s adjudicating the meaning of the Guaranties now rather than later, other than Beal’s desire, for some unspecified reason, to have a decision. Beal gives no hint of any “immediacy” or “insecurity” which might drive its request. 6 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 7 of 14 As FDIC-C has previously demonstrated (Motion at 7-8), the uncertainty existing at this time appears academic. FDIC-R will almost certainly have adequate assets to fund any judgment Beal receives. Even if under different facts there were some doubt about the receivership’s ability to fund a judgment, there would still be no urgency in this Court deciding the issue at this time, since there will be time enough at the end of the judicial proceedings against FDIC-R for Beal to join FDIC-C and ask the Court to adjudicate a claim that would finally have some immediacy. Beal’s Opposition is silent concerning any reason why having a decision now will provide any concrete benefit to either party. There is no case or controversy under Article III between the parties because Beal is asking the Court to provide an advisory opinion on a hypothetical question. We can encapsulate the substance of Beal’s complaint concerning the Guaranties in the following question: if this Court ultimately concludes that the liability of FDIC-R will be of an amount that exceeds the assets in the receivership estate, what would be the extent of liability of FDIC-C under the Guaranties? To state the issue this way makes clear that the question is hypothetical and outside the jurisdiction of this Court. Under Article III, courts “do not render advisory opinions.” See, e.g., DKT Memorial Fund v. AID, 887 F.2d 275, 296 (D.C. Cir. 1989) (citations omitted); Louisiana Environmental Action Network v. USEPA, 172 F.3d 65, 72 (D.C. Cir. 1999) (Sentelle, J., concurring) (where the terms describing the “current injury” are a would/if sentence, the current injury is speculative and decision thereon would violate the prohibition on advisory opinions); Gavett v. Alexander, 477 F. Supp. 1035, 1040 (D.D.C. 1979) (“[courts] may not decide hypothetical questions or provide advisory opinions to parties who would not be injured 7 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 8 of 14 if they did not prevail.”). See also Unified School District No. 259, Sedgwick County, Kansas v. Disability Rights Center of Kansas, 491 F.3d 1143, 1147 (10th Cir. 2007) (advisory opinion not appropriate in a declaratory judgment action). Ultimately, by asking the Court to decide this claim now, Beal is inviting the Court to do one of two things. In the most likely scenario -- that the Guaranties never come into play -- Beal is asking the Court to issue an advisory opinion, which it lacks jurisdiction to do. If, contrary to expectation, the Guaranties become operational, Beal is asking the Court to decide the case against FDIC-C in a piecemeal, inefficient fashion instead of once at the end of the proceedings against FDIC-R. This Court should decline Beal’s invitation. C. The Context of the Guaranties’ Issuance Militates In Favor of Their Construction as Collection Guarantees. Although the Guaranties do not use the term “collection,” the circumstances strongly suggest that the parties understood that the Guaranties were for collection rather than payment. Indeed, interpreting them as payment guaranties avails Beal nothing, a state of affairs that the parties to the Guaranties would have understood at the time they executed the Guaranties. As a practical matter, Beal ultimately must present its claims to FDIC-R for determination and litigate any adverse determinations. It cannot bypass this process. Thus, the Guaranties, in effect, are collection guarantees, and interpreting them to be anything else makes no sense. In interpreting the Guaranties, it is important for the Court to bear in mind that context is important. As the New York courts have recognized, a court should interpret the contract before it to give fair meaning to “all of the language employed” and with a view to realizing the parties “reasonable expectations.” See, e.g., Patrick v. Guarniere, 8 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 9 of 14 204 A.D.2d 702, 704 (App. Div. 1994) (emphasis in original, citations and internal quotation marks omitted); IBM Credit Financing Corp. v. Mazda Motor Mfg. Corp., 170 Misc.2d 15, 647 N.Y.S.2d 322, 327 (Sup. Ct. 1996) (interpretation in light of “reasonable expectation” of parties); Restatement (Second) of Contracts § 203 (interpretation in light of trade practice and custom).5 One crucial aspect of the context is the Agreements themselves to which the Guaranties relate. Most of the cases in which courts have attempted to determine the type of guarantee at issue have involved loan repayments where determination of default presented little problem. E.g., Evergreen Bank v. Sullivan, 980 F. Supp. 747 (D. Vt. 1997) (payments on a line of credit); Marine Midland Bank v. Elshazly, 753 F. Supp. 20 (D. Conn. 1991) (installment note); General Phoenix Corp. v. Cabot, 89 N.E.2d 238 (N.Y. Ct. App. 1949) (payment of note at maturity). In contrast, in this case, the Guaranties require Beal to have complied with the Agreements. Paragraph 2 and Section 5 of each of the Agreements provides for a procedure by which Beal must request that the FDIC-R examine individual loans, and show that there are “material” violations of one or more of the 27 representations and warranties which “adversely affect” their value. FDIC-R then considers Beal’s proffer and decides whether: (1) a breach has occurred; and (2) to cure the breach or repurchase the loan. The price for the cure or repurchase is In interpreting contracts involving the federal government, the United States Court of Appeals for the Federal Circuit has also emphasized the importance of “context” or, put another way, the “meaning that would be derived from the contract by a reasonably intelligent person acquainted with the contemporaneous circumstances.” Metric Constructors, Inc. v. NASA, 169 F.3d 747, 752 (Fed. Cir. 1999) (citations omitted). See also Fifth Third Bank v. U.S., 402 F.3d 1221, 1233 (Fed. Cir. 2005) (motivations and purposes of the parties as well as broader circumstances surrounding the transactions at issue). 5 9 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 10 of 14 determined pursuant to a formula set forth in the Agreements. Thus, not only must Beal pursue the issues of the nature and extent of the alleged default with FDIC-R initially by filing a claim with significant supporting evidence, but that claim may be subject to significant debate between Beal and FDIC-R. Indeed, as the Hall Declaration filed with FDIC-C’s Motion makes clear, FDIC-R has approved some of Beal’s claims and denied others. In addition, Beal has contracted with a government agency having the assets to address the problem rather than with private parties who may present some risk. Whatever the meaning of the Guaranties, Beal can have confidence that, at the end of the process, it will receive whatever sums are due. Indeed, to date, FDIC-R has tried to pay all of the Beal approved claims -- totaling in excess of $10 million according to the Hall Declaration -- within two weeks of approval, and there do not currently appear to be any approved but unpaid claims. These two contextual facts – the involved procedures for determining whether and to what extent the receivership was obligated to pay Beal, and that the government agency ultimately can pay whatever is due and owing – argue strongly that the parties did not contemplate that the Guaranties would operate prior to termination of proceedings against FDIC-R. They render untenable Beal’s suggestion (Opp. at 8) that the mere filing of a claim with the Receiver and FDIC-R’s failure to pay supports a claim that these are amounts FDIC-R is “obligated to pay” but has failed to pay under the Guaranties and that, therefore, FDIC-C is liable. Moreover, the language of the Guaranties supports the same interpretation. The crucial language resides in the first two sentences of ¶1 of the Guaranties: 10 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 11 of 14 The FDIC in its corporate capacity (“FDIC-Corporate”) hereby guarantees performance of the Conservator’s obligations to pay monetary amounts to Beal Bank, S.S.B., as those obligations are set forth in Sections 5 and 19 of the Purchase Agreement (“Conservator’s Obligations”). FDIC-Corporate shall be liable hereunder only for such amounts, if any, as the Conservator or a receiver for the Conservator is obligated to pay under the terms of the Conservator’s Obligations but which the Conservator or the receiver for the Conservator fails to pay. Beal argues (Opp. at 9) that the language of the first sentence creates a payment guarantee. While courts have interpreted language similar to that in the first sentence to create a payment guarantee, Beal’s analysis fails to recognize that its interpretation effectively renders the second sentence superfluous. See, e.g., Int’l Multifoods Corp. v. Commercial Union Ins. Co., 309 F.3d 76, 86 (2nd Cir. 2002); Restatement (Second) of Contracts § 203(a) (preference given to “an interpretation which gives a reasonable and effective meaning to all terms . . . .”). Cf. Patrick, 612 N.Y.S.2d at 632 (interpretation must give fair meaning to “all language”). Thus, under Beal’s analysis, the first sentence, in effect, would suffice to create a payment guarantee. However, the language of the second sentence must have some function. Thus, when the first sentence is read along with the second sentence, the only reasonable reading of the provision as a whole is that the Guaranties only come into play after all proceedings against FDIC-R are exhausted, effectively creating a collection guarantee. This is particularly true in light of the interrelationship between the procedures set forth in the Agreements which must be pursued prior to submission of a claim to FDIC-C. Moreover, this analysis makes sense as a practical matter. The Guaranties limit FDIC-C’s liability to those sums that the FDIC-R is obligated to pay but fails to pay. Thus, FDIC-C retains the defense that FDIC-R is not obligated to pay certain amounts. It 11 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 12 of 14 can litigate this issue even if Beal chooses only to make a demand upon and litigate against FDIC-C as Beal alleges it is entitled to do because in its view it has a payment guarantee (Opp. at 9-10). However, because of the complex procedure for determining liability and remedy under the Agreement and the Guaranties’ requirement to comply with the Agreements, as a realistic matter Beal must present its claims to FDIC-R and will not be able to obtain a judgment against FDIC-C without litigating exactly the same issues it is currently litigating against FDIC-R. D. If the Court Does Not Dismiss the Case as To FDIC-C, a Stay is Appropriate. Beal asserts (Opp. at 10-11) that a stay is unwarranted. For the reasons set forth above, FDIC-C submits that a stay is more than justified. At this point, there seems almost no likelihood that the Guaranties will come into operation. At a later date, after further litigation between Beal and FDIC-R, this Court and the parties should have a much more precise idea of the range of possible damages. At that point, the Court will be in a better position to decide whether or not the case against FDIC-C should proceed. It makes sense as a matter of judicial economy and to conserve the resources of the parties for the Court to wait until that point to determine how to deal with the case against FDIC-C, should the Court determine that dismissal is inappropriate.6 6 In support of its argument that a stay is inappropriate, Beal cites National Bank of Detroit v. United States, 1 Ct. Cl. 712, 715 (Ct. Cl. 1983). That case involved a somewhat different question from this case – whether the federal court should stay its proceedings pending the outcome of state court proceedings – with a number of jurisdictional and other considerations not present here. See id. at 714 and n.3, 715-16. However, that court’s conclusion that requests for a stay are addressed to this Court’s discretion and the promotion of efficient litigation would certainly bear on this Court’s consideration of FDIC-C’s request. See id. 12 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 13 of 14 CONCLUSION For the reasons set forth above and in FDIC-C’s Motion to Dismiss, FDIC-C respectfully requests that the Court dismiss the First Amended Complaint as to FDIC-C. In the alternative, the Court may wish to defer decision on this issue until the nature and extent of the claims that will survive against FDIC-R are clearer and permit the Court and parties to determine how to proceed. Dated: June 11, 2008 Respectfully submitted, Charles L. Cope (D.C. Bar #70672) Senior Counsel s/Thomas L. Holzman Thomas L. Holzman (D.C. Bar #950162) Martha W. McClellan (VA Bar # 17255) Counsel Federal Deposit Insurance Corporation 3501 Fairfax Drive Arlington, VA 22226 Phone: 703-562-2369 Fax: 703-562-2477 Email: thholzman@fdic.gov 13 Case 1:02-cv-02146-RJL Document 77 Filed 06/11/2008 Page 14 of 14 CERTIFICATE OF SERVICE I hereby certify that on June 11, 2008, I electronically filed the foregoing document with the Clerk of the Court using the ECF system which will send notification of such filing to the following: Andrew Sandler, Anand Raman, and Thomas Reeves, and I hereby certify that I have mailed by United States Postal Service the paper document to the following non-ECF participants: N/A. . s/Thomas L. Holzman THOMAS L. 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