Levin v. Miller, No. 12-3474 (7th Cir. 2014)

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Justia Opinion Summary

Irwin, a holding company, entered bankruptcy when its two subsidiary banks failed. The FDIC closed both in 2009. Their asset portfolios were dominated by mortgage loans, whose value plunged in 2007-2008. Irwin’s trustee in bankruptcy sued its directors and officers (Managers). The FDIC intervened because whatever Irwin collects will be unavailable to satisfy FDIC claims. Under 12 U.S.C. 821(d)(2)(A)(i), when taking over a bank, the FDIC acquires “all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder, member, accountholder, depositor, officer, or director of such institution with respect to the institution and the assets of the institution.” The claims assert that the Managers violated fiduciary duties to Irwin by not implementing additional financial controls; allowing the banks to specialize in kinds of mortgages that were especially hard-hit; allowing Irwin to pay dividends (or repurchase stock) so that it was short of capital; “capitulating” to the FDIC and so that Irwin contributed millions of dollars in new capital to the banks. The district judge concluded that all claims belong to the FDIC and dismissed. The Seventh Circuit affirmed in part, but vacated with respect to claims that concern only what the Managers did at Irwin: supporting the financial distributions, informing Irwin about the banks’ loan portfolios, and causing Irwin to invest more money in the banks after they had failed.

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In the United States Court of Appeals For the Seventh Circuit ____________________   No.  12-­ 3474   ELLIOTT   D.   LEVIN,  as  Trustee  in  bankruptcy  for  Irwin  Finan-­ cial  Corporation,   Plaintiff-­ Appellant,   v.   WILLIAM   I.   MILLER,   GREGORY   F.   EHLINGER,   and   THOMAS   D.   WASHBURN,   Defendants-­ Appellees,   and   FEDERAL  DEPOSIT  INSURANCE  CORPORATION,   Intervenor-­ Appellee.   ____________________   Appeal  from  the  United  States  District  Court  for  the   Southern  District  of  Indiana,  Indianapolis  Division.   No.  1:11-­ cv-­ 1264-­ SEB-­ TAB    Sarah  Evans  Barker,  Judge.   ____________________   ARGUED  SEPTEMBER  10,  2013    DECIDED  AUGUST  14,  2014   ____________________   Before   WOOD,   Chief   Judge,   and   EASTERBROOK   and   HAMILTON,  Circuit  Judges.   EASTERBROOK,  Circuit  Judge.  Irwin  Financial  Corporation,   a  holding  company,  entered  bankruptcy  when  its  subsidiar-­ 2   No.  12-­ 3474   ies  failed.  Both  subsidiaries  were  banks  (Irwin  Union  Bank  &   Trust  and  Irwin  Union  Bank,  FSB),  which  the  Federal  Depos-­ it  Insurance  Corp.  closed  and  took  over  in  2009.  The  banks   asset   portfolios   had   been   dominated   by   mortgage   loans,   whose   value   plunged   in   2007   and   2008.   The   FDIC   is   in   the   process   of   collecting   the   banks   assets   and   paying   their   debts.   Further   details   are   not   material   to   the   disposition   of   this  appeal.   Elliott   Levin,   Irwin   Financial s   trustee   in   bankruptcy,   filed   this   suit   against   three   of   its   directors   and   officers.   For   simplicity,  we  refer  to  Irwin  Financial  and  the  trustee  collec-­ tively  as   Irwin,  to  Irwin s  two  subsidiaries  as   the  Banks,   and   to   the   defendants   as   the   Managers.   The   FDIC   inter-­ vened   to   defend   its   own   interests,   because   whatever   Irwin   collects  from  the  Managers  will  be  unavailable  to  satisfy  any   claims   that   the   FDIC   has   against   them.   Both   the   FDIC   and   the  Managers  contend  that  most  of  Irwin s  claims  belong  to   the   FDIC   under   12   U.S.C.   §1821(d)(2)(A)(i),   which   says   that   when  taking  over  a  bank  the  FDIC  acquires   all  rights,  titles,   powers,  and  privileges  of  the  insured  depository  institution,   and   of   any   stockholder,   member,   accountholder,   depositor,   officer,  or  director  of  such  institution  with  respect  to  the  in-­ stitution   and   the   assets   of   the   institution .   Irwin,   the   FDIC,   and  the  Managers  all  understand  this  language  to  allocate  to   the   FDIC   not   only   the   closed   banks   rights   but   also   any   claims   that   investors   might   assert   derivatively   on   behalf   of   the  closed  banks.  Courts  of  appeals  (including  this  one)  rou-­ tinely  describe  §1821(d)(2)(A)(i)  the  same  way.  See,  e.g.,  Ada-­ to   v.   Kagan,   599   F.2d   1111,   1117   (2d   Cir.   1979);   Courtney   v.   Halleran,  485  F.3d  942,  950  (7th  Cir.  2007);  Pareto  v.  FDIC,  139   F.3d  696,  700  (9th  Cir.  1998).   No.  12-­ 3474   3   Irwin  presented  four  types  of  claims  against  the  Manag-­ ers.   The   first   (counts   1,   2,   4,   and   5   of   the   complaint)   asserts   that  the  Managers  violated  their  fiduciary  duties  to  Irwin  by   not   implementing   additional   financial   controls   that   would   have  protected  Irwin  from  the  Managers  errors  in  their  roles   as   directors   and   managers   of   the   Banks.   The   Managers   (as   officers   of   the   Banks)   allowed   the   Banks   to   specialize   in   kinds  of  mortgages  that  were  especially  hard-­ hit  in  2007  and   2008.   Irwin   contends   that   they   should   have   diversified   the   Banks   portfolios,   hedged   the   risk   using   other   instruments,   or  both,  and  are  liable  to  Irwin  for  failing  to  implement  hold-­ ing-­ company-­ level  rules  that  would  have  compelled  them  to   curtail  bank-­ level  risks.   Count   3   alleges   that   the   Managers   allowed   Irwin   to   pay   dividends   (or,   equivalently,   repurchase   stock)   in   amounts   that  left  it  short  of  capital  when  the  financial  crunch  arrived.   Irwin  maintains  that  it  would  not  have  distributed  money  to   investors   had   the   Managers   furnished   better   information   about  the  Banks  portfolios,  for  then  Irwin  would  have  real-­ ized  the  benefit  of  being  better  capitalized.   Count   6   alleges   that   one   of   the   Managers   breached   his   duty  of  care  by  hiring  unnecessary  (or  unnecessarily  expen-­ sive)   consultants,   squandering   Irwin s   money.   Irwin s   reply   brief  abandons  this  claim;  we  do  not  mention  it  again.   Count  7  alleges  that  two  of  the  Managers  breached  their   duties  of  care  and  loyalty  when  in  the  first  half  of  2009  they   capitulated   to   the   FDIC   and   caused   Irwin   to   contribute   millions   of   dollars   in   new   capital   to   the   Banks.   The   com-­ plaint   asserts   that   the   Managers   knew,   or   should   have   known,  that  this  was  equivalent  to  throwing  money  away that  it  might  benefit  the  FDIC  (and  could  conceivably  benefit   4   No.  12-­ 3474   the   Managers   in   their   roles   at   the   Banks)   but   held   no   pro-­ spect  of  benefit  for  Irwin.   The  district  court  asked  Magistrate  Judge  Baker  for  anal-­ ysis.  He  recommended  that  the  first  cluster  of  counts  (1,  2,  4,   and   5)   be   dismissed   because   under   §1821(d)(2)(A)(i)   the   FDIC   rather   than   Irwin   owns   any   legal   claim   that   depends   on  acts  the  Managers  took  in  their  roles  at  the  Banks.  He  rec-­ ommended   that   counts   3   and   7   continue   to   summary   judg-­ ment  or  trial.  The  district  judge,  however,  concluded  that  all   claims   belong   to   the   FDIC,   and   she   dismissed   the   entire   complaint.   Irwin   has   appealed.   The   Managers   defend   the   district   court s   decision;   the   FDIC   does   not   and   concedes   that   counts   3   and   7   belong   to   Irwin.   (The   FDIC   nonetheless   asks   us   to   affirm   across   the   board,   contending   that   Irwin s   position  on  these  counts  is  substantively  implausible.)   All  of  the  litigants  agree  that  the  distinction  between  di-­ rect  and  derivative  claims  depends  on  Indiana  law,  for  Irwin   was  incorporated  there.  Indiana  treats  a  stockholder s  claim   as  derivative  if  the  corporation  itself  is  the  loser  and  the  in-­ vestor  is  worse  off  because  the  value  of  the  firm s  stock  de-­ clines.  See  Barth  v.  Barth,  659  N.E.2d  559  (Ind.  1995);  Massey   v.  Merrill  Lynch  &  Co.,  464  F.3d  642,  645  (7th  Cir.  2006)  (Indi-­ ana   law).   That s   a   good   description   of   the   theory   behind   counts  1,  2,  4,  and  5:  The  Banks  suffered  a  loss  when  the  val-­ ue   of   their   portfolios   cratered,   and   Irwin   suffered   a   deriva-­ tive  loss  when  the  value  of  its  stock  in  the  Banks  plummeted.   At   oral   argument   counsel   for   Irwin   conceded   that   it   would   not   have   suffered   any   injury   unless   the   Banks   had   done   so   first.   The   theory   behind   these   counts that   the   Managers   owed  a  duty  to  Irwin  to  protect  it  from  their  own  behavior  at   the  Banks is  a  veneer  over  a  derivative  claim  based  on  the   No.  12-­ 3474   5   harm  the  Managers  choices  caused  to  the  Banks  and  trans-­ mitted  to  Irwin  through  a  decline  in  the  value  of  the  shares  it   held.  The  FDIC,  not  Irwin,  therefore  owns  any  claim  against   the  Managers  that  depends  on  the  choices  they  made  as  di-­ rectors   or   employees   of   the   Banks.   Any   recovery   by   Irwin   would  be  double  counting.  See  Mid-­ State  Fertilizer  Co.  v.  Ex-­ change   National   Bank,   877   F.2d   1333,   1335 36   (7th   Cir.   1989);   Kagan  v.  Edison  Bros.  Stores,  Inc.,  907  F.2d  690  (7th  Cir.  1990).   Count   3,   by   contrast,   concerns   only   what   the   Managers   did   at   Irwin both   with   respect   to   supporting   the   financial   distributions   and   with   respect   to   the   information   they   gave   Irwin   about   the   Banks   loan   portfolios.   If   count   3   is   dis-­ missed,   the   FDIC   cannot   gain;   it   owns   the   Banks   and   all   of   their  assets,  but  the  Banks  cannot  collect  from  the  Managers   for   any   shortcomings   in   the   services   that   they   rendered   to   Irwin.  Section  1821(d)(2)(A)(i)  is  designed  to  allocate  claims   between   the   FDIC   and   other   injured   parties;   it   is   not   de-­ signed   to   vaporize   claims   that   otherwise   exist   after   a   busi-­ ness  failure.  Yet  if  count  3  is  dismissed,  the  claim  will  disap-­ pear;  no  one  will  be  able  to  pursue  it.  It  would  not  be  sensi-­ ble  to  read  §1821(d)(2)(A)(i)  that  way.   The  potential  problem  with  count  3  is  not  ownership  but   whether   Indiana   law   permits   recovery   on   a   theory   that   a   holding  company  distributed   too  much  to  its  investors.  As   a   first   approximation,   dividends   and   repurchases   are   a   wash;   stockholders   gain   exactly   what   the   corporation   loses.   These   transactions   leave   the   firm   with   less   capital,   but   this   may  be  beneficial  if  it  induces  managers  to  work  harder  and   smarter.   And   if   the   firm   later   lands   in   financial   trouble,   stockholders   see   payouts   as   a   blessing for   the   distribution   means  that  the  money  was  not  lost  with  the  firm s  financial   6   No.  12-­ 3474   distress.  But  the  district  court  did  not  dismiss  count  3  on  the   merits,   which   have   not   been   fully   briefed   on   appeal.   Nor   have  the  parties  explored  how  Indiana s  version  of  the  Busi-­ ness  Judgment  Rule  applies  to  the  Managers  activities  with   respect   to   information   and   distributions.   It   was   accordingly   premature  to  dismiss  this  part  of  the  complaint.   The  district  court  thought  that  count  3  does  not  narrate  a   plausible   claim,   as   the   Supreme   Court   used   that   word   in   Ashcroft  v.  Iqbal,  556  U.S.  662  (2009),  and  Bell  Atlantic  Corp.  v.   Twombly,  550  U.S.  544  (2007).  Yet  those  decisions  concern  the   adequacy  of  the  notice  given  by  the  pleading,  not  the  claim s   legal  substance.  The  Court  held  that  Fed.  R.  Civ.  P.  8  is  not   satisfied  by  a  skeletal  complaint  that  contains  conclusion  or   surmise   and   requires   a   court   to   decide   whether   events   not   pleaded   could   be   imagined   in   a   plaintiff s   favor.   The   Court   wrote   that   judges   may   bypass   implausible   allegations   and   insist   that   complaints   contain   enough   detail   to   allow   courts   to   separate   fantasy   from   claims   worth   litigating.   Iqbal   and   Twombly   do   not   change   the   standards   for   judgment   on   the   pleadings   (Rule   12(c))   or   summary   judgment   (Rule   56),   nor   do   they   require   complaints   to   address   potential   defenses   such   as   the   Business   Judgment   Rule.   The   Court   held   in   Gomez  v.  Toledo,  446  U.S.  635  (1980),  that  complaints  need  not   anticipate   affirmative   defenses;   neither   Iqbal   nor   Twombly   suggests  otherwise.  See  Richards  v.  Mitcheff,  696  F.3d  635  (7th   Cir.  2012).  So  although  count  3  may  not  have  much  prospect,   it  could  not  be  dismissed  at  the  suit s  outset.   Count   7   maintains   that   two   of   the   Managers   injured   Ir-­ win   by   causing   it   to   invest   more   money   in   the   Banks   even   after   they   had   failed.   Fundamentally   it   alleges   that   they   threw   good   money   after   bad.   Again   this   is   based   on   injury   No.  12-­ 3474   7   that   Irwin   sustained   in   its   own   right,   a   claim   that   the   FDIC   could   not   pursue   as   the   Banks   successor.   (Counsel   for   the   FDIC  agreed  with  this  proposition  at  oral  argument.)  Irwin s   loss  does  not  depend  on  injury  to  the  Banks;  to  the  contrary,   Irwin s   investment   would   have   made   the   Banks   better   off.   But  since  they  were  under  water  (so  the  complaint  alleges)  at   the  time  of  the  investment,  Irwin  suffered  an  immediate  and   irreparable   loss.   This   is   the   strongest   of   Irwin s   claims   be-­ cause  it  potentially  entails  a  violation  of  the  duty  of  loyalty;   Irwin   contends   that   the   two   Managers   sought   to   promote   their  own  interests  (as  officers  of  the  Banks)  at  the  expense  of   Irwin s   interests.   Count   7   cannot   be   dismissed   under   §1821(d)(2)(A)(i)  or  Rule  8.   At   oral   argument   the   court   asked   counsel   whether   §1821(d)(2)(A)(i)   should   be   understood   not   simply   to   allo-­ cate  claims  between  the  FDIC  and  other  entities,  but  to  trans-­ fer  to  the  FDIC  all  claims  held  by  any  stockholder  of  a  failed   bank even  claims  that  like  counts  3  and  7  do  not  depend  on   an   injury   to   the   failed   bank.   No   federal   court   has   read   the   statute  that  way,  however,  and  counsel  for  all  of  the  litigants   declined   to   adopt   that   understanding.   Section   1821(d)(2)(A)(i)   transfers   to   the   FDIC   only   stockholders   claims   with   respect   to   ¦   the   assets   of   the   institution in   other   words,   those   that   investors   (but   for   §1821(d)(2)(A)(i))   would  pursue  derivatively  on  behalf  of  the  failed  bank.  This   is   why   we   have   read   §1821(d)(2)(A)(i)   as   allocating   claims   between  the  FDIC  and  the  failed  bank s  shareholders  rather   than  transferring  to  the  FDIC  every  investor s  claims  of  eve-­ ry  description.  Any  other  reading  of  §1821(d)(2)(A)(i)  would   pose   the   question   whether   Irwin   and   similarly   situated   stockholders  would  be  entitled  to  compensation  for  a  taking;   8   No.  12-­ 3474   our   reading   of   the   statute   (which   is   also   the   FDIC s)   avoids   the  need  to  tackle  that  question.   The   judgment   of   the   district   court   is   affirmed   with   re-­ spect   to   counts   1,   2,   4,   and   5.   It   is   vacated   with   respect   to   counts  3  and  7.  The  case  is  remanded  for  further  proceedings   consistent  with  this  opinion.   No. 12-3474 9 HAMILTON, Circuit Judge. I join Judge Easterbrook s opinion for the court. His opinion accurately applies the difference between a shareholder s direct and derivative claims, which all parties agree is the decisive legal question. Counts three and seven are correctly categorized as direct claims and must be remanded, even though they do not have promising futures because of the Business Judgment Rule. I have come to that conclusion reluctantly, however. Stepping back from the parties arguments, I believe this case raises some broader policy questions that deserve consideration by the FDIC and Congress, including why the direct/derivative distinction should still matter, either under the current version of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, see 12 U.S.C. § 1821(d)(2)(A), or perhaps other statutory amendments that Congress may want to consider. The most interesting facts about this case are buried in two footnotes in the briefs. They concern money that might be available to pay the plaintiff in this case, the trustee of Irwin Financial Corporation, which is the holding company that presided over this expensive debacle. The money could come from Irwin Financial s director and officer liability insurance policy. That insurance policy covered directors and officers of Irwin Financial and all of its subsidiaries, including the defunct banks that were taken over by the FDIC. It is apparently a wasting policy, meaning that the legal costs of defense are charged against the policy limits and thus reduce the amount available to compensate the FDIC for its expenditures in excess of $500 million to clean up the mess. See FDIC Br. at 16 n.10; IFC Reply Br. at 19 n.17. And that mess, 10 No. 12-3474 we need to remember, was left behind by the entire Irwin Financial empire and its directors and officers. To the extent those insurance proceeds might be used to pay Irwin Financial, the result is troubling. It is even more troubling because two of the three directors and officers whose actions are targeted in this case and who are covered by the insurance policy held positions with both the holding company (Irwin Financial) and its defunct banks. Under those circumstances, allowing Irwin Financial any prospect of recovery ahead of or on par with the FDIC turns the equities upside down. Yet that result follows from the parties and our adoption of the direct/derivative dichotomy in interpreting 12 U.S.C. § 1821(d)(2)(A), which gives the FDIC extensive rights with respect to failed banks. 1 One possible solution to the problem I see would be a broader reading of § 1821(d)(2)(A) than the parties have embraced. Section 1821(d)(2)(A) provides that when the FDIC steps in as the conservator or receiver of a failed bank, it shall succeed by operation of law to all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder, member, accountholder, depositor, officer, or director of such institution with respect to the institution and the assets of the institution. 1 I recognize that, as a practical matter, the trustee at this point represents the interests of Irwin Financial s creditors rather than its shareholders. I doubt that those creditors participated in Irwin Financial s profits or the financial debacle that required the FDIC to step in. Nothing about the trustee s claims, however, depends on Irwin Financial itself having gone into bankruptcy. If Irwin Financial had managed to remain solvent itself, it would be able to assert counts three and seven as direct claims for the benefit of its own shareholders. No. 12-3474 11 The parties, including the FDIC itself, and Judge Easterbrook s opinion interpret this language about the rights of a stockholder to be limited to derivative claims a stockholder might have. It is not obvious to me that the language must be interpreted so narrowly, nor did the cases cited at page 2 of the opinion confront this issue or require that result. The FDIC can already pursue what would be a derivative claim because the claim really belongs to the failed depository institution itself. So what does the language referring to the rights ¦ of any stockholder add to the meaning and effect of the statute? The doctrine that statutes should not be construed to render language mere surplusage is not absolute, but it weighs in favor of a broader reach that could include direct claims. See, e.g., Dunn v. Commodity Futures Trading Comm n, 519 U.S. 465, 472 (1997). If rights ¦ of any stockholder was meant to refer only to derivative claims, it s a broad and roundabout way of expressing that narrower idea. The statutory language is not precise and could be interpreted, for sound policy reasons, more broadly to include a stockholder s direct claims that are based on harms resulting from dealings with the assets of the failed institution, or at least claims against other persons and entities who were part of the holding company structure. Under that broader reading, it would be possible for the FDIC to go after all the insurance proceeds and other available assets in a case like this one, at least until the FDIC has been fully reimbursed for the losses it incurred to protect depositors from the folly of the banks and their parent company, plaintiff Irwin Financial. At the core of the financial crisis of 2008 were policies that allowed bankers and other financiers to privatize prof- 12 No. 12-3474 its but socialize losses. See, e.g., Joseph E. Stiglitz, Freefall: America, Free Markets, and the Sinking of the World Economy (2010). There are of course powerful reasons for the FDIC and its counterparts for credit unions and other financial institutions to play their vital roles in socializing losses to protect depositors and stabilize the economy. Any student of the Great Depression who remembers the runs on banks can appreciate those roles. But this case at its core presents a troubling effort. The holding company structure and the direct/derivative dichotomy are being used in ways that could allow those who ran the banks into the ground to take for themselves some of the modest sums available to reimburse the FDIC for a portion of the socialized losses they inflicted. If that result is not contrary to federal law, it should be. I do not know whether the stakes on a national level are large enough to motivate policymakers to act, but there are several ways to accomplish that more just result. First, the FDIC could choose to modify its interpretation of the ambiguous § 1821(d)(2)(A). That course would depend on having courts accept that new interpretation. Even better, Congress could amend the statute to clarify that it does not want to let those responsible for these financial debacles push ahead of the FDIC in collecting available assets. A statutory rule giving the FDIC priority over such direct claims by stockholders of failed banks against others within the holding company structure would surely withstand any challenge by parties like Irwin Financial under the Takings Clause of the Fifth Amendment. And no doubt there are other ways that experts in this field could devise to protect the public interest. Counsel for Irwin Financial s trustee pointed out in oral argument that the FDIC is supported by insurance premi- No. 12-3474 13 ums collected by covered banks rather than by direct appropriations by Congress. The FDIC asserts, however, that its insurance is backed by the full faith and credit of the United States government, meaning all taxpayers. In light of that public interest and the banks ability to socialize the losses they cause, I hope the FDIC and/or the Congress will consider this issue.