DocketNumber： 91-1976
Citation Numbers： 968 F.2d 1332
Filed Date： 7/1/1992
Status： Precedential
Modified Date： 1/13/2023
July 1, 1992 UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________
No. 91-1976
IN RE: 604 COLUMBUS AVENUE REALTY TRUST,
Debtor,
_________
CAPITOL BANK & TRUST COMPANY,
Appellee,
v.
604 COLUMBUS AVENUE REALTY TRUST,
Appellant.
__________
No. 91-1977
IN RE: 604 COLUMBUS AVENUE REALTY TRUST,
Debtor,
_________
FEDERAL DEPOSIT INSURANCE CORPORATION,
AS RECEIVER/LIQUIDATING AGENT OF
CAPITOL BANK & TRUST COMPANY,
Appellant,
v.
604 COLUMBUS AVENUE REALTY TRUST, ET AL.,
Appellees.
____________
ERRATA SHEET
The opinion of this court issued on June 19, 1992, is
amended as follows:
On page 10, line 11 after block quote - add "and" after the
word "taxes."
On page 43, line 6 after block quote - "Court" should be
lower case.June 19, 1992
____________________
No. 91-1976
IN RE: 604 COLUMBUS AVENUE REALTY TRUST,
Debtor,
__________
CAPITOL BANK & TRUST COMPANY,
Appellee,
v.
604 COLUMBUS AVENUE REALTY TRUST,
Appellant.
__________
No. 91-1977
IN RE: 604 COLUMBUS AVENUE REALTY TRUST,
Debtor,
__________
FEDERAL DEPOSIT INSURANCE CORPORATION,
AS RECEIVER/LIQUIDATING AGENT OF
CAPITOL BANK & TRUST COMPANY,
Appellant,
v.
604 COLUMBUS AVENUE REALTY TRUST, ET AL.
Appellees.
____________________
APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. A. David Mazzone, U.S. District Judge]
___________________
____________________
Before
Torruella, Circuit Judge,
_____________
Weis* and Bownes, Senior Circuit Judges,
_____________________
____________________
Robert Owen Resnick with whom John F. Cullen, George J. Nader,
____________________ _______________ _______________
and Cullen & Resnick were on brief for 604 Columbus Avenue.
________________
Michael H. Krimminger with whom Richard J. Osterman, Jr., Ann S.
_____________________ _________________________ _______
Duross, and Richard N. Gottlieb were on brief for Federal Deposit
______ ____________________
Insurance Corporation.
____________________
____________________
_____________________
*Of the Third Circuit, sitting by designation.
BOWNES, Senior Circuit Judge. This is a case involving
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a failed loan transaction that well illustrates Polonius'
advice, "[n]either a borrower, nor a lender be."1 These
appeals require us to determine, inter alia, the
_____ ____
applicability of certain federal defenses available to the
Federal Deposit Insurance Corporation (FDIC) in its capacity
as receiver when it seeks to enforce against a bankrupt
borrower an obligation formerly held by a failed financial
institution.
PROCEDURAL PATH
PROCEDURAL PATH
This case arises from the default by the 604 Columbus
Avenue Realty Trust ("the Trust") on payment of a loan from
the Capitol Bank and Trust Company ("the Bank"). Following
the Trust's default, the Bank commenced mortgage foreclosure
proceedings on the properties securing its loan, among which
were the property owned by the Trust itself and properties of
the Trust's principal beneficiary, Millicent C. Young
("Young").2
To forestall the foreclosures by the Bank, both the
Trust and Young filed for protection under Chapter 11 of the
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1. W. Shakespeare, Hamlet, act I, sc. iii at 75.
2. The Bank also had a mortgage on a property owned by the
Young Family Trust, of which Millicent Young was sole
beneficiary. The Young Family Trust was a named plaintiff in
the adversary proceeding in the bankruptcy and district
courts below. For purposes of convenience, we refer to Young
and the Young Family Trust collectively as "Young."
-6-
Bankruptcy Code in the United States Bankruptcy Court for the
District of Massachusetts. In May 1988, the Trust, with
Young as co-plaintiff, initiated an adversary proceeding
against the Bank, its principal secured creditor. In
September 1990, the bankruptcy court awarded the plaintiffs
approximately $140,000 in damages on claims of fraud and
deceit, conversion, and breach of contract, plus interest and
attorney's fees. The bankruptcy court found that the Bank
improperly applied loan proceeds to payment of "soft costs"
incurred by the Trust financing fees, interest, taxes and
similar expenses. It also found that an officer of the Bank
extracted kickback payments from the loan proceeds in return
for his assistance in securing approval of the loan. Under
its power of equitable subordination pursuant to 11 U.S.C.
510(c), the bankruptcy court subordinated the Bank's secured
claim on the Trust's bankruptcy estate to the claims of the
Trust's other creditors by an amount equal to the damages,
plus interest and attorney's fees. It ordered the transfer
from the Bank to the Trust of a security interest in the
Trust's estate equivalent to the total of the damages,
interest and attorney's fees.
During the pendency of an appeal of this judgment to the
district court, the Bank was declared unsound by
Massachusetts banking officials. The FDIC was appointed
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receiver, and in February 1991 was substituted as defendant-
appellant in the district court.
In August 1991, the district court affirmed in
substantial part the bankruptcy court's rulings on the merits
of the Trust's claims and equitable subordination of part of
the Bank's secured claim. It ruled, however, that the FDIC
was entitled to raise the defenses available to it under the
doctrine of estoppel established in D'Oench, Duhme & Co. v.
________________________
FDIC, 315 U.S. 447 (1942), and 12 U.S.C. 1823(e). Invoking
____
the D'Oench doctrine, the district court vacated that part of
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the bankruptcy court's judgment that was premised on the
secret agreement by one of the Trust's principals to provide
kickbacks to a Bank officer.
Both the Trust and the FDIC appeal various aspects of
the judgments of both the bankruptcy and district courts. We
affirm the judgment of the bankruptcy court, as modified by
the district court.
BACKGROUND AND FACTS
BACKGROUND AND FACTS
Before stating the facts, we think it useful to review
the dual role of the FDIC in bank failures. Our recent
decision in Timberland Design, Inc. v. First Service Bank For
_________________________________________________
Savings, 932 F.2d 46, 48 (1st Cir. 1991), provides an
_______
excellent summary of the FDIC's different functions:
As receiver, the FDIC manages the assets of the
failed bank on behalf of the bank's creditors and
shareholders. In its corporate capacity, the FDIC
is responsible for insuring the failed bank's
-8-
deposits. Although there are many options
available to the FDIC when a bank fails, these
options generally fall within two categories of
approaches, either liquidation or purchase and
assumption. The liquidation option is the easiest
method, but carries with it two major
disadvantages. First, the closing of the bank
weakens confidence in the banking system. Second,
there is often substantial delay in returning funds
to depositors.
The preferred option when a bank fails, therefore,
is the purchase and assumption option. Under this
arrangement, the FDIC, in its capacity as receiver,
sells the bank's healthy assets to the purchasing
bank in exchange for the purchasing bank's promise
to pay the failed bank's depositors. In addition,
as receiver, the FDIC sells the "bad" assets to
itself acting in its corporate capacity. With the
money it receives, the FDIC-receiver then pays the
purchasing bank enough money to make up the
difference between what it must pay out to the
failed bank's depositors, and what the purchasing
bank was willing to pay for the good assets that it
purchased. The FDIC acting in its corporate
capacity then tries to collect on the bad assets to
minimize the loss to the insurance fund.
Generally, the purchase and assumption must be
executed in great haste, often overnight.
Id. at 48 (citations omitted).
___
Turning to the case at hand, we first summarize the
extensive findings of fact of the bankruptcy court. See In
___ __
re 604 Columbus Avenue Realty Trust, 119 B.R. 350 (Bankr. D.
____________________________________
Mass. 1990) ("Bankruptcy Court Opinion"). The loan
transaction at issue in these appeals originated in the
efforts of Young and several business associates to purchase
two buildings located at 604-610 Columbus Avenue in Boston,
Massachusetts ("the Columbus Avenue properties"), and a
restaurant operated on the premises known as "Bob the Chef."
-9-
Young was the owner of a contracting and construction
company. Among her business partners was Carl Benjamin
("Benjamin"), who served as her financial adviser.
In October 1985, Young and Benjamin learned of the
availability for purchase of the Columbus Avenue properties.
Young and Benjamin, along with two other partners, agreed to
enter into a business relationship through which they would
purchase the Columbus Avenue properties, renovate and resell
the properties as condominiums, resell the restaurant, and
share the profits from the condominium sales and sale of the
restaurant. In November 1985, Young and Benjamin offered the
owner of the Columbus Avenue properties $1.2 million for the
buildings and the restaurant.
Young's attorney, Steven Kunian ("Kunian"), suggested
that she and her partners seek financing for the purchase and
renovation of the Columbus Avenue properties from the Bank.
Kunian had represented the Bank from time to time on loan
transactions. In December 1985, Benjamin negotiated the
terms of a loan from the Bank on behalf of Young and the
other partners. The Bank was represented in these
negotiations by a loan officer, Arthur Gauthier, and a member
of the Bank's Board of Directors, Sidney Weiner ("Weiner").
Weiner also served on the Bank's Executive Committee, which
was responsible for the approval of loans. Although not a
salaried employee of the Bank, Weiner was paid director's and
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consultant's fees, and was regarded by Gauthier and other
bank employees as having primary authority for negotiation of
the loan to Young and her partners.
Loans larger than $25,000 required the approval of the
Bank's Executive Committee. Gauthier presented the proposal
for the loan for the Columbus Avenue properties three times
before the Executive Committee approved it on January 15,
1986. Final approval by the Executive Committee was achieved
when Young agreed to pledge her residence as additional
collateral for the loan. Weiner was one of the Executive
Committee members who voted to approve the loan.
Some time before the Executive Committee voted to
approve the loan, Weiner told Benjamin that the loan would
only be approved on the condition that Benjamin agree to pay
Weiner personally for his assistance in securing the Bank's
approval of the loan. In exchange for this kickback, Weiner
helped the loan proposal reach the Executive Committee, voted
to approve the loan, and influenced other Committee members
to vote in favor of the loan. There was no evidence that
other members of the Executive Committee were aware of
Weiner's kickback arrangement with Benjamin when they voted
to approve the loan. The bankruptcy court found that $26,300
was paid to Weiner.
Attorney Kunian represented both the Bank and the
borrowers at the closing on the loan on February 27, 1986.
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Kunian suggested that Young and her associates hold the
Columbus Avenue properties through a realty trust. At the
closing the 604 Columbus Avenue Realty Trust was created,
with Young as its trustee. Young was given 62.5% of the
beneficial interest in the trust, while each of her three
partners, including Benjamin, was made a 12.5% beneficiary.
To secure the loan from the Bank, Young executed on behalf of
the Trust a "Commercial Real Estate Promissory Note," a "Loan
and Security Agreement" ("L&SA"), an "Addendum to Loan &
Security Agreement ("L&SA Addendum"), and a "Construction
Loan Agreement" (referred to collectively as the "First Loan
Agreement"). The Bank, in turn, agreed to lend the Trust
$1,500,000.
The Bank used a standard-form L&SA, which contained the
following provisions:
SECTION 6. BANK'S RIGHT TO SET-OFF
6.01 The Borrower agrees that any deposits or
other sums at any time credited by or due from the
Bank to the Borrower, or any obligor or guarantor
of any liabilities of the Borrower in possession of
the Bank, may at all times be held and treated as
collateral for any liabilities of the Borrower or
any such obligor or guarantor to the Bank. The
Bank may apply or set-off such deposits or other
sums against said liabilities at any time.
. . . .
SECTION 8. EXPENSES:
8.01 The Borrower shall pay or reimburse the Bank
on demand for all out-of-pocket expenses of every
nature which the Bank may incur in connection with
this Agreement and the preparation thereof, the
-12-
making of any loan provided for therein, or the
collection of the Borrower's indebtedness under
this Agreement . . . . [T]he Bank, if it chooses,
may debit such expenses to the Borrower's Loan
Account or charge any of the Borrower's funds on
deposit with the Bank.
The parties also executed an Addendum to this L&SA,
which established the following schedule for the Bank's
advancement of the proceeds of the loan to the Trust:
$1,200,000 at the closing to pay for the Trust's acquisition
of the Columbus Avenue properties and the restaurant; a
further $200,000 for construction-related expenditures at the
Columbus Avenue properties, but only upon itemized
requisitions approved by the Trust, its architect, and the
bank; and $100,000 for the "soft costs" incurred with respect
to the loan. "Soft costs" covered the various non-
construction costs of the renovation effort, and included
closing fees, interest, taxes, and insurance. To secure its
promissory note, the Trust gave the Bank, inter alia, a
_____ ____
mortgage on the Columbus Avenue properties and a conditional
assignment of rents from the properties in favor of the bank.
Young, in her individual capacity, also gave the Bank
mortgages on her residence and two other properties owned or
held on her behalf.
At the closing, the Bank disbursed approximately
$1,250,000, of which nearly $1,200,000 was paid to the owners
of the Columbus Avenue properties, and the remaining amount
was paid to the Bank itself for the costs of the loan. The
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Bank also created a checking account through which it was to
disburse the remaining amounts of the loan. A signature card
was created for the account bearing the names of Young,
Benjamin, and another partner of the Trust. Those listed on
the signature card had access to loan proceeds upon their
disbursement by the Bank. Young was apparently not aware
that Benjamin's signature was on the card.
The bankruptcy court found that the Trust's ability to
repay the loan on the Columbus Avenue properties hinged on
several assumptions that Young and her partners understood or
reasonably should have understood at the closing. One of
these assumptions was that $100,000 for soft costs
anticipated in First Loan Agreement would not cover those
costs completely and would have to be supplemented by funds
of Young and her partners. Another assumption was that the
Trust could generate the funds necessary to complete the
condominium project by selling the restaurant.
The Bank advanced the remainder of the proceeds of the
loan approximately $250,000 within forty-seven days of
the closing, in three large payment. Weiner personally
directed Gauthier to pay these advances into the Trust's
account, but did so without the approval of Young and in
violation of the procedures specified in the First Loan
agreement. The bankruptcy court found that the Bank paid
itself a total of $102,305.54 out of loan proceeds to cover
-14-
soft costs, thereby exceeding by $2,305.54 the amount of soft
costs contemplated in the First Loan Agreement. The sum of
$26,300 was withdrawn by Benjamin from the loan account
without Young's knowledge or authorization, which was then
used to make kickback payments to Weiner. Sometime
thereafter, Young learned of Benjamin's conduct, and
attempted unsuccessfully to expel him from the Trust and to
get him to give up his beneficial interest in it.
When the six-month term of the First Loan Agreement
expired in August 1986, the Trust could not repay the loan.
It therefore negotiated a second six-month loan to refinance
the first (the "Second Loan Agreement"). On September 12,
1986, the Trust signed a promissory note to the Bank for
$1,750,000, which was secured by the same mortgages and
guarantees as the First Loan Agreement. Young, on behalf of
the Trust, executed a new L&SA that contained provisions
identical to those in the L&SA accompanying the previous
loan. In addition, the Addendum to the L&SA in the Second
Loan Agreement provided, inter alia, the following scheme for
_____ ____
disbursement:
The Bank shall advance the loan proceeds
approximately as follows: a. $1,500,000.00 at
closing for acquisition of real estate and personal
property[;] b. $190,000.00 for construction costs
. . . [;] c. $60,000.00 for soft costs incurred
with respect to the loan.
At the closing of the Second Loan Agreement, $1,580,151.11 in
loan proceeds were disbursed to pay the $1,524,516.11 balance
-15-
remaining on the First Loan agreement and $55,635 in
origination and attorney's fees for the new loan.
Four months later, in January 1987, the Trust sold the
property at 610 Columbus Avenue for $692,400 and paid the
Bank this amount in order to reduce the outstanding principal
balance of the Second Loan Agreement. In March 1987,
however, when the Second Loan Agreement came due, the Trust
was unable to repay it. The Bank therefore entered into an
"Agreement to Extend Mortgage and Note" with the Trust, in
exchange for an extension fee.
The bankruptcy court found that during the term of the
Second Loan Agreement and its extension, the Bank withdrew
from the loan proceeds $169,406.12 for various soft costs,
including closing fees, interest, charges for the loan
extension, taxes, and attorney's fees. This amount exceeded
the "approximately" $60,000 in soft costs originally provided
for in the second L&SA Addendum by $109,406.12.
The Second Loan Agreement, as extended, came due on June
10, 1987. The Trust was unable to make payment. In
September 1987, the Bank began foreclosure of the various
mortgages it held as security for the loan. The bankruptcy
court found that the reasons for the Trust's default
included, inter alia: the inability of the Trust to sell the
_____ ____
restaurant, and the attendant loss of cash needed to finance
the condominium renovations originally planned; the further
-16-
deprivation of cash needed for the project as a result of the
kickback payments; and the Bank's overapplication of
$109,406.12 in proceeds from the second loan to payment of
soft costs. The bankruptcy court also concluded that it was
the Trust's failure to sell the restaurant, rather than the
Bank's overapplication of loan proceeds for soft costs and
the kickback payments, that was by far the single most
important reason for the failure of the project.
DECISIONS OF THE BANKRUPTCY AND DISTRICT COURTS
DECISIONS OF THE BANKRUPTCY AND DISTRICT COURTS
In bankruptcy court, the Trust and Young alleged that
the Bank entered into and administered the loans for the
improper purpose of extracting a kickback from loan proceeds.
They also alleged that the Bank improperly applied proceeds
from the two loans to the payment of soft costs. The
plaintiffs alleged fraud and deceit, conversion, and breach
of contract by the Bank. They also argued that the Bank's
inequitable conduct warranted the subordination of the Bank's
secured claim in the Trust's bankruptcy estate to those of
all of the Trust's other creditors. In addition, the Trust
and Young requested an order invalidating entirely the Bank's
mortgages on their properties.
The bankruptcy court conducted a seven-day trial. It
awarded the Trust $138,011.66 in damages. Of this amount,
$26,300 was assessed as damages for the kickback payments
made to Weiner by Benjamin. The kickback damages were based
-17-
on claims of conversion, breach of contract and fraud under
Massachusetts law. The remaining $111,711.66 in damages
represented the total amount of soft costs that the
bankruptcy court found to have been improperly removed from
the loan proceeds by the Bank in violation of the limits set
by the two loan agreements i.e., $2,305.54 on the First
Loan Agreement and $109,406.12 on the Second Loan Agreement.
This award was premised on claims of conversion and breach of
contract. The bankruptcy court also ordered that the
$138,011.66 damages award be supplemented by an award of
reasonable attorney's fees, which it found were warranted as
an element of the conversion damages under Massachusetts law,
and also of post-judgment interest at the contract rate
specified in the loan agreements.
Invoking its powers of equitable subordination pursuant
to 11 U.S.C. 510(c), the court entered an order
subordinating the Bank's secured claim to the claims of
priority and general unsecured claimants in an amount equal
to the full amount of the damages, interest and attorney's
fees. It further directed that the Bank transfer to the
Trust's estate a portion of its security interest in an
amount equal to the total damages. The bankruptcy court
refused, however, to issue an order entirely invalidating the
mortgages held by the Bank.
-18-
While the Bank's appeal of the bankruptcy court's
judgment was pending, the FDIC was appointed receiver and
liquidating agent of the Bank, and substituted for the Bank
as defendant-appellant. The FDIC continued the Bank's appeal
of the bankruptcy court's judgment as to the conversion,
breach of contract, and fraud claims, as well as its
challenge to the bankruptcy court's equitable subordination
of its secured interest in an amount equal to the total
damages. In addition, the FDIC raised two special federal
defenses as to each aspect of the damages claims. The FDIC
argued that the D'Oench doctrine or its statutory
_______
counterpart, 12 U.S.C. 1823(e) precluded the bankruptcy
court's award of damages on the kickback arrangement, insofar
as this claim was based on a secret agreement between Weiner
and Benjamin. The FDIC also argued that the special holder
in due course status accorded it under federal common law
entirely barred the Trust's claims for damages and equitable
subordination against it in its receivership capacity.
The Trust and Young, on the other hand, challenged the
applicability of the federal defenses urged by the FDIC, as
well as the FDIC's right to raise these defenses for the
first time on appeal. They also contested the bankruptcy
court's refusal to grant them an order invalidating entirely
the Bank's mortgages on their properties.
-19-
In August 1991, the district court affirmed the
bankruptcy court's rulings on the merits of the plaintiffs'
conversion and breach of contract claims with respect to the
Bank's improper application of loan proceeds for payment of
soft costs. Although the district court found that the FDIC
was entitled to raise its federal defenses for the first time
on appeal, it rejected the FDIC's argument that the federal
common law holder in due course doctrine barred the Trust's
claims against it in its capacity as the Bank's receiver.
The district court also affirmed the equitable subordination
of the FDIC's secured claim on the Trust's estate in an
amount equal to the damages on the soft costs claims, i.e.,
$111,711.66, plus post-judgment interest. It reversed,
however, the bankruptcy court's inclusion of attorney's fees
as part of the overall amount of the FDIC's claim subject to
equitable subordination.
The district court vacated the bankruptcy court's award
of $26,300 of damages based on the kickback arrangement
between Benjamin and Weiner. Finding that the FDIC was
entitled to raise the D'Oench doctrine for the first time on
_______
appeal, the court held that the kickback arrangement was a
secret agreement squarely within the coverage of the
doctrine. It therefore reduced the equitable subordination
against the FDIC by an amount equal to the kickback damages.
Because it found that the fraud claims based on the kickback
-20-
arrangement could not stand against the FDIC, the court
rejected the Trust and Young's arguments that it declare the
loan agreements and the mortgages on the plaintiffs'
properties void as illegal contracts in contravention of
public policy.
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THE ISSUES ON APPEAL AND STANDARD OF REVIEW
THE ISSUES ON APPEAL AND STANDARD OF REVIEW
In their appeals to this court,3 both the FDIC and the
Trust press substantially the same arguments made in their
appeals of the bankruptcy court's judgment to the district
court.4 The FDIC argues that because it was the receiver of
an insolvent bank, federal common law barred the plaintiffs'
claims of conversion, breach of contract, and fraud, as well
as the equitable subordination of the FDIC's secured interest
in the Trust's estate. The FDIC maintains that any damages
against it in its receivership capacity based on the soft
costs claims were barred by the federal common law holder in
due course doctrine, and that the equitable subordination
against it in an amount equal to those damages is contrary to
federal common law. The FDIC also attacks the rulings of the
bankruptcy court, affirmed by the district court, that the
Bank misappropriated soft costs monies, as well as the
equitable subordination of its secured claim to reflect the
damages caused by the Bank's misappropriation. It further
challenges the district court's affirmance of an award of
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3. Following the district court's judgment, both the FDIC
and the Trust docketed separate appeals with this court. The
FDIC's appeal is No. 91-1977; the Trust's is No. 91-1976.
4. Young is not a party to the Trust's appeal. Neither the
Trust nor Young has challenged the district court's
affirmance of the bankruptcy court's refusal to void the
mortgages on their properties.
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post-judgment interest on the $111,711.66 in damages on the
soft costs claims.
The Trust, on the other hand, argues that the district
court erred by applying the D'Oench doctrine for the first
_______
time on appeal. The Trust insists that the D'Oench doctrine
_______
does not bar its recovery on its claims relating to the
kickback scheme. The Trust also maintains that the district
court erred when it held that the bankruptcy court
incorrectly included attorney's fees as part of the overall
amount of the FDIC's security interest subject to equitable
subordination in favor of the Trust and other creditors.
In an appeal from a district court's review of a
bankruptcy court's decision, we "independently review[] the
bankruptcy court's decision, applying the clearly erroneous
standard to findings of fact and de novo review to
conclusions of law." In re G.S.F. Corp., 938 F.2d 1467, 1474
__________________
(1st Cir. 1991). See also In re Navigation Technology Corp.,
________ _________________________________
880 F.2d 1491, 1493 (1st Cir. 1989) (bankruptcy court's
determinations of law subject to de novo review); Briden v.
_________
Foley, 776 F.2d 379, 381 (1st Cir. 1985) (clearly erroneous
_____
standard of review applied to bankruptcy court's factual
findings).
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DISCUSSION
DISCUSSION
I. DISTRICT COURT REVIEW OF THE FDIC'S FEDERAL DEFENSES FOR
THE FIRST TIME ON APPEAL
Before considering the Trust's state law claims
underlying its damages award against the Bank, we first
address the FDIC's arguments that two special defenses
established under federal law the federal common law holder
in due course and D'Oench doctrines barred all of the
_______
plaintiffs' claims and resulting equitable subordination
against it as the Bank's receiver. In order to address the
merits of these federal defenses, we must, as a threshold
matter, determine whether the FDIC was entitled to raise them
for the first time in the district court in its appeal of the
bankruptcy court's judgment.
The district court based its decision to permit the FDIC
to assert its federal defenses exclusively on the Financial
Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"), Pub. L. No. 101-73, 103 Stat. 183 (1989)
(codified at 12 U.S.C. 1811-1833e), which provides in
pertinent part:
(13) Additional rights and duties
(A) Prior final adjudication
The Corporation shall abide by any final
unappealable judgment of any court of
competent jurisdiction which was rendered
before the appointment of the Corporation as
conservator or receiver.
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(B) Rights and Remedies of conservator or
receiver
In the event of any appealable judgment,
the Corporation as conservator or receiver
shall
(i) have all the rights and remedies
available to the insured depository
institution (before the appointment of
such conservator or receiver) and the
Corporation in its corporate capacity,
including removal to Federal court and
all appellate rights; and
(ii) not be required to post any bond in
order to pursue such remedies.
12 U.S.C.A. 1821(d)(13)(A)-(B). The district court found
that the bankruptcy court's judgment in favor of the Trust
was "appealable" within the meaning of 1821(d)(13)(B). It
reasoned that the federal defenses against the Trust's claim
asserted by the FDIC in its receivership capacity were among
"the rights and remedies available to . . . the [FDIC] in its
corporate capacity." The district court concluded that the
"rights and remedies" granted the FDIC in its receivership
capacity included the right to raise its federal defenses for
the first time on appeal. The district court based this
analysis on its reading of FIRREA's text and legislative
history.5
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5. As evidence of Congress' special solicitude for the
preservation of the rights of the FDIC in its receivership
capacity, the district court emphasized FIRREA's provision of
an automatic stay in any litigation to which the FDIC becomes
a party. See 12 U.S.C. 1821(d)(12). It also highlighted
___
language in FIRREA's legislative history explaining the need
for the automatic stay: "The appointment of a conservator or
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The district court acknowledged that this interpretation
of 1821(d)(13)(B) conflicted with that of the Fifth and
Eleventh Circuits, both of which have rejected this
interpretation of FIRREA. In Olney Savings & Loan
________________________
Association v. Trinity Banc Savings Association, 885 F.2d 266
_______________________________________________
(5th Cir. 1989), the Fifth Circuit ruled that
1821(d)(13)(B) did not in any way modify the substantive
rights of the FSLIC in its receivership capacity, but merely
assured the FSLIC standing to pursue all appeals previously
available to it only in its corporate capacity. Accordingly,
it held that FIRREA did not entitle the FSLIC to raise the
D'Oench doctrine for the first time on appeal. Id. at 275.
_______ ___
In Baumann v. Savers Federal Savings & Loan Assoc., 934 F.2d
_______________________________________________
1506 (11th Cir. 1991), cert. denied, ___ U.S. ___, 1992 U.S.
____________
LEXIS 2709, 60 U.S.L.W. 3780 (1992), the Eleventh Circuit
followed Olney, and rejected the argument of the Resolution
_____
Trust Corporation ("RTC") that 1821(d)(13)(B) entitled it
to raise the D'Oench doctrine. Id. at 1511. In Baumann, the
_______ ___ _______
Eleventh Circuit expressly rejected the interpretation of
____________________
receiver can often change the character of the litigation;
the stay gives the FDIC a chance to analyze pending matters
and decide how best to proceed." H.R. Rep. No. 54(I), 101st
Cong., 1st Sess. 331 (1989), reprinted in 1989 U.S.C.C.A.N.
_____________
86, 127. The district court further relied on two decisions
of the Texas Court of Appeals holding that 1821(d)(13)(B)
permits the FDIC to raise the D'Oench doctrine for the first
_______
time on appeal. See FDIC/Manager Fund v. Larsen, 793 S.W.2d
___ ___________________________
37 (Tex. Ct. App.), writ granted, 34 Tex. Sup. Ct. J. 91
____________
(1990); FSLIC v. T.F. Stone-Liberty Land Assocs., 787 S.W.2d
_________________________________________
475 (Tex. Ct. App. 1990).
-26-
1821(d)(13)(B) advanced by the district court in this case.
The Baumann court concluded that to read the statute
_______
otherwise would be to grant a federal receiver new
substantive rights, because neither FIRREA nor previously
existing statutes granted the RTC in its corporate capacity
the power to raise arguments for the first time on appeal.
Id.
___
We think that the Olney and Baumann courts'
_____ _______
interpretation of 1821(d)(13)(B) is the proper one, and
hold that the district court erred when it read FIRREA as
allowing the FDIC in its receivership capacity to raise its
federal defenses for the first time on appeal. We agree with
the distinction drawn by Baumann: "the right at issue in this
_______
case is not the right of the [federal receiver] to argue [a
federal defense], which is unquestioned, but rather the right
of the [federal receiver] to raise an argument for the first
time on appeal." Id. at 1512. Section 1821(d)(13)(B) merely
___
accords the FDIC in its receivership capacity standing to
raise the same defenses available to the FDIC in its
corporate capacity. It does not establish that the FDIC as
receiver is entitled to raise its federal defenses for the
first time on appeal.
Although FIRREA does not grant the FDIC as receiver the
right to raise its special federal defenses to the Trust's
claims for the first time on appeal, we must also consider
-27-
whether there is any alternative basis on which the district
court could have permitted the FDIC to raise its federal
defenses. The FDIC argues that even if 1821(d)(13)(B) does
not grant it the right to raise its federal defenses, the
district court nonetheless had the discretion, in its
capacity as an appellate court, to address these defenses for
the first time on appeal.
The FDIC relies principally on Baumann for this
_______
argument. There, the Eleventh Circuit held that its
discretion as an appellate court permitted it to address the
federal receiver's D'Oench doctrine argument for the first
_______
time on appeal. Id. at 1513. The court stressed the fact
___
that the RTC had not had the opportunity to present its
argument in the trial court because it had not become a party
to the suit until after the entry of final judgment. Id. In
___
order to prevent the RTC from being "penalized for not
raising a defense it had no opportunity to present," the
Baumann court concluded that it would be appropriate to
_______
exercise its discretion to exempt the RTC in its receivership
capacity from its general rule precluding argument of issues
for the first time of appeal. Id. The Fifth Circuit has
___
also adopted Baumann's approach in similar circumstances in
_______
which the federal conservator or receiver becomes a party to
an appeal after the final judgment of the trial court. See
___
Resolution Trust Corp. v. McCrory, 951 F.2d 68, 71 (5th Cir.
__________________________________
-28-
1992) (citing Baumann and Union Fed. Bank v. Minyard, 919
_______ ____________________________
F.2d 335, 336 (5th Cir. 1990)).
It is the general rule in this circuit that arguments
not raised in the trial court cannot be raised for the first
time on appeal. See, e.g., Boston Celtics Ltd. Partnership
___ ____ ________________________________
v. Shaw, 908 F.2d 1041, 1045 (1st Cir. 1990); Brown v.
________ _________
Trustees of Boston Univ., 891 F.2d 337, 359 (1st Cir. 1989),
_________________________
cert. denied, ___ U.S. ___, 110 S. Ct. 3217 (1990). Like
____________
other circuit courts of appeals, however, we have recognized
that an appellate court has the discretion, in exceptional
circumstances, to reach issues not raised below. See United
___ ______
States v. La Guardia, 902 F.2d 1010, 1013 (1st Cir. 1990).
_____________________
In United States v. Krynicki, 689 F.2d 289, 291-92 (1st Cir.
_________________________
1982), we outlined the criteria for determining the
appropriate exercise of our discretion to hear new issues.
These criteria include, inter alia, whether the new issue is
_____ ____
purely legal, such that the record pertinent to the issue can
be developed no further; whether the party's claim appears
meritorious; whether reaching the issue would promote
judicial economy because the same issue is likely to be
presented in other cases; and whether declining to reach the
argument would result in a miscarriage of justice. Id.
___
The circumstances of this case were sufficiently
exceptional to have permitted the district court to consider
for the first time on appeal the merits of the federal
-29-
defenses raised by the FDIC in its receivership capacity.
The question of whether various federal defenses barred the
Trust's claims was purely legal and required no further
development of the factual record; the FDIC's federal
defenses were colorable, judged by the district court's
acceptance of the FDIC's D'Oench argument to bar damages on
_______
the kickback claims; judicial economy would have been
promoted by a ruling on the merits of the applicability of
the FDIC's federal defenses, given the increasing volume of
litigation involving federal receivers and/or conservators in
this circuit; and finally, it would have been unfair to
prevent the FDIC from raising its federal defenses when it
had no such opportunity to assert them before the bankruptcy
court. As Baumann and McCrory make clear, it is not uncommon
_______ _______
for a federal receiver or conservator to become a party to a
litigation after the final judgment of the trial court. To
prevent the FDIC from raising its federal defenses in such
circumstances would vitiate much of the purpose of allowing
these defenses in the first place.
II. THE D'OENCH DOCTRINE AS A BAR TO THE TRUST'S RECOVERY ON
_______
THE KICKBACK CLAIMS
We next review the question of whether the D'Oench
_______
doctrine, or its statutory counterpart, 12 U.S.C.
-30-
1823(e),6 bars the Trust's claims based on the kickback
scheme and any equitable subordination against the FDIC as
receiver.
In D'Oench, the Supreme Court held that in a suit
_______
brought by the FDIC to collect on a borrower's promissory
note, in which the FDIC was the successor in interest to the
original lender, the borrower was not entitled to rely on
agreements outside the documents contained in the lender
bank's records to defeat the FDIC's claim. 315 U.S. at 460-
61. The Supreme Court announced a federal common law
doctrine of equitable estoppel preventing the borrower from
using a "secret agreement" with the original lender as a
____________________
6. As amended by FIRREA, 1823(e) provides:
No agreement which tends to diminish or defeat the
interest of the Corporation in any asset acquired
by it under this section . . . , either as security
for a loan or by purchase or as receiver of any
insured depository institution, shall be valid
against the Corporation unless such agreement
(1) is in writing,
(2) was executed by the depository institution
and any person claiming an adverse interest
thereunder, including the obligor,
contemporaneously with the acquisition of the
asset by the depository institution,
(3) was approved by the board of directors of
the depository institution or its loan
committee, which approval shall be reflected
in the minutes of said board committee, and
(4) has been, continuously, from the time of
its execution, an official record of the
depository institution.
We treat 1823(e) as the statutory codification of the
D'Oench doctrine. See Capizzi v. FDIC, 937 F.2d 8, 9 (1st
_______ ___ ________________
Cir. 1991); FDIC v. P.L.M. Int'l, Inc., 834 F.2d 248, 253
____________________________
(1st Cir. 1987).
-31-
defense to the FDIC's demand for payment. Id. D'Oench did
___ _______
not require that the borrower have the intent to defraud:
"The test is whether the note was designed to deceive
creditors or the public authority, or would tend to have that
effect. It would be sufficient in this type of case that the
maker lent himself to a scheme or arrangement whereby the
banking authority . . . was or was likely to be misled." Id.
___
at 460.
The contours of the D'Oench doctrine, which have
_______
expanded since the Court's original decision, are well-
established in this circuit. See Timberland Design, 932 F.2d
___ _________________
at 48-49; FDIC v. Caporale, 931 F.2d 1, 2 (1st Cir. 1991);
________________
FDIC v. P.L.M. Int'l, Inc., 834 F.2d 248, 252-53 (1st Cir.
___________________________
1987). Although the D'Oench decision involved the FDIC in
_______
its corporate capacity, "courts have consistently applied the
doctrine to those situations where the FDIC was acting in its
capacity as receiver." Timberland Design, 932 F.2d at 49
_________________
(citing cases). We have also adopted the position of the
great majority of the circuits that D'Oench "operates to bar
_______
affirmative claims as well as defenses which are premised
upon secret agreements." Id. In addition, D'Oench applies
___ _______
to claims involving secret agreements that sound either in
tort or in contract. Id. at 50 (citing Langley v. FDIC, 484
___ _______________
U.S. 86 (1987)). And finally, the fact that the FDIC may
have actual knowledge of the secret agreement is irrelevant:
-32-
"The proper focus under D'Oench is whether the agreement, at
_______
the time it was entered into, would tend to mislead the
public authority." Id.
___
Applying the principles enunciated in Timberland, the
__________
district court held that D'Oench estopped the Trust from
_______
raising against the FDIC its affirmative claims based on the
kickback scheme. It found that the record established that
the Trust, through its agent Benjamin, had "lent itself" to a
kickback scheme with the Bank. The district court concluded
that the unwritten agreement and subsequent kickback payments
between Weiner and Benjamin were a "secret agreement"
squarely within the coverage of D'Oench.
_______
The Trust contends that D'Oench should not have been
_______
applied for the district court for several reasons. It
argues that its tort claims of conversion and fraud stand on
a factual basis independent of the kickback arrangement, and
that these claims therefore cannot be barred by D'Oench. For
_______
similar reasons the Trust argues that its breach of contract
claim must also be upheld because the removal of $26,300 from
the loan proceeds was a breach of the express terms of the
written loan agreement, and not a breach of the unwritten
kickback arrangement. In the alternative, the Trust invokes
certain recognized exceptions to the D'Oench doctrine: it
_______
claims (1) that it is a non-negligent victim of "fraud in the
factum," and (2), that the district court should have found
-33-
that it was innocent of any intentional or negligent
deception because Benjamin was not acting as the Trust's
agent at the time he removed loan proceeds for the kickback
payments.
A. The Scope of the Kickback Agreement
___________________________________
We find little merit in the Trust's first argument,
which counsel appears in part to have abandoned during oral
argument.7 As we understand it, the Trust's contention is
that because its fraud and conversion claims are "not
premised upon" the kickback arrangement, D'Oench cannot
_______
apply. According to the Trust, "the kickback arrangement
merely explains why Capitol Bank chose to misappropriate the
[Trust's] assets, whereas the misappropriations themselves
are the basis of the [Trust's claims]." Brief for Appellant
604 Columbus Avenue Realty Trust at 27. The problem with the
Trust's position is that the bankruptcy court's findings in
respect to these claims, as well as its equitable
____________________
7. When pressed to explain why the D'Oench doctrine did not
_______
apply to all the Trust's claims relating to the secret
agreement between Benjamin and Weiner, counsel for the Trust
placed exclusive reliance on the argument that the Trust was
an innocent party that had not knowingly made itself a party
to the kickback arrangement with Weiner. Counsel stated that
"if the Trust had in fact entered into an oral agreement,
then you would be right; D'Oench would clearly apply. But
_______
the bankruptcy court did not find that fact. The bankruptcy
court found that Benjamin was liable to the Trust for the
twenty-six thousand dollars as well as the Bank. . . . [I]t
seems to me to be a very, very broad application of D'Oench
_______
where a borrower has not lent themselves [sic] in any fashion
to this agreement."
-34-
subordination of $26,300 in lieu of damages, were in fact
explicitly premised on the kickback arrangement. See
___
Bankruptcy Court Opinion, 119 B.R. at 371 (conversion); id.
___
at 374 (fraud); id. at 377 (equitable subordination). Nor
___
does the Trust elaborate as to how other facts, independent
of those relating to the kickback arrangement, provide an
alternative basis for the bankruptcy court's findings in its
favor.8 The Trust's tort claims fall squarely under
D'Oench: "D'Oench bars . . . affirmative claims . . . as long
_______ _______
as those claims arise out of an alleged secret arrangement."
___________________________________________
Timberland, 932 F.2d at 50 (emphasis added).
__________
The Trust next argues that D'Oench does not bar its
_______
breach of contract claim against the Bank for the $26,300
misappropriated from the Trust's account because this breach
was a violation of the written terms of the loan agreement.
It relies on Howell v. Continental Credit Corp., 655 F.2d 743
__________________________________
(7th Cir. 1981), which held that the FDIC cannot invoke
D'Oench "where the document the FDIC seeks to enforce is one
_______
. . . which facially manifests bilateral obligations and
serves as the basis of the [promisor's] defense." Id. at 746
___
(emphasis omitted). Seizing on the language of Howell, the
______
____________________
8. The Trust's attempts to distinguish Weiner's conduct from
the tortious conduct of the Bank are completely without
merit. The Trust prevailed on its tort claims against the
Bank in bankruptcy court on a respondeat superior theory, and
cannot now evade the precepts of D'Oench by intimating that
_______
these tort claims against the Bank had nothing to do with the
kickback arrangement masterminded by Weiner.
-35-
Trust advances much the same argument with respect to the
breach of contract claim as asserted in its challenge to
D'Oench's application to its tort claims, i.e., that the
_______
"bilateral obligations" of the loan agreement, and not the
secret kickback agreement, are the basis for its breach of
contract claim. Once again, the Trust's argument ignores the
opinion of the bankruptcy court, which expressly stated that
the $26,300 judgment for the Trust on the breach of contract
claim was founded on the kickback arrangement. See
___
Bankruptcy Court Opinion, 119 B.R. at 375.
The Trust's reliance on Howell is also misplaced. The
______
Trust's breach of contract claim required proof of the
existence of a secret kickback arrangement. Howell, on the
______
other hand, involved the FDIC's attempted enforcement of a
lease that expressly imposed bilateral obligations on both
the lessor and lessee. See Howell, 655 F.2d at 747. The
___ ______
Seventh Circuit ruled that the FDIC, as successor to the
lessor, could not assert D'Oench to bar the lessee's contract
_______
defenses. Id. In Howell, the lessee's contract defenses
___ ______
were not premised on any secret agreement, but were based on
the failure of the original lessor to fulfill the express
conditions of the lease. Id. The limited exception to the
___
-36-
D'Oench doctrine crafted by Howell does not apply to the
_______ ______
Trust's breach of contract claim.9
B. Fraud In The Factum
___________________
The Trust further claims that two other recognized
exceptions to the D'Oench doctrine apply to this case. The
_______
first exception is fraud in the factum. The Supreme Court's
decision in Langley v. FDIC, 484 U.S. 86 (1987), while
_________________
addressed to the issue of the FDIC's right to invoke
D'Oench's statutory counterpart, 12 U.S.C. 1823(e), is also
_______
applicable to analysis of fraud in the factum as a bar to the
application of D'Oench. In Langley, the Court distinguished
_______ _______
between the real defense of fraud in the factum, which
renders a loan agreement entirely void and takes the
agreement out of 1823(e), and a defense of fraud in the
inducement, which renders the loan agreement voidable but
does not preclude the FDIC's assertion of 1823(e).
Langley, 484 U.S. at 93-94. After reviewing the claim by the
_______
note makers that their participation in a land transaction
had been procured by misrepresentations as to the size and
character of the property involved, the Court concluded that
____________________
9. Since Howell, the Seventh Circuit has cautioned note
______
makers from the over-hasty invocation against the FDIC of the
exception to D'Oench contemplated by that decision: "Lesson
_______
Number One in the study of law is that general language in an
opinion must not be ripped from its context to make a rule
far broader than the factual circumstances which called forth
the language." FDIC v. O'Neil, 809 F.2d 350, 354 (7th Cir.
_______________
1987).
-37-
the note makers' argument was a claim of fraud in the
inducement. Accordingly, the Court found that the FDIC could
properly invoke 1823(e) to bar the assertion by the note
makers of their fraud defense. Id. at 94.
___
We think that the Langley Court's distinction for
_______
purposes of 1823(e) between fraud in the inducement and
fraud in the factum applies with equal force in the context
of D'Oench. We have characterized fraud in the factum as a
_______
real defense that may be asserted when the original lender
fraudulently procures the borrower's signature to an
instrument without that borrower's knowledge of its true
nature or contents. See FDIC v. Caporale, 931 F.2d 1, 2 n.1
___ _________________
(1st Cir. 1991) (noting that in the case of fraud in the
factum, "the instruments would be void rather than voidable,
leaving no title capable of transfer to the FDIC."). See
___
also E. Allan Farnsworth, Contracts 4.10 (1982) (describing
____ _________
fraud in the factum as arising in the rare situation in which
the defrauded party "neither knows nor has reason to know of
the character of the proposed agreement . . . .").
The Trust analogizes its situation to that of the
defendant in FDIC v. Turner, 869 F.2d 270 (6th Cir. 1989).
______________
There, the defendant signed a blank guaranty form to which
the name of the debtor and the amount of the guaranty were
later added. In addition, the name of the lending bank on
the original guaranty was subsequently obliterated with
-38-
correction fluid and substituted with that of another bank.
Id. at 272. When the FDIC sued to enforce this altered
___
version of the loan guaranty, the defendant raised the
defense of fraud in the factum. The Sixth Circuit agreed
that the defendant was defrauded as to the guaranty's
essential terms, and held that the FDIC was therefore
precluded from interposing D'Oench to bar the defense. Id.
_______ ___
at 275-76.
Review of these cases convinces us that the Trust's
claim was one of fraud in the inducement, and not of fraud in
the factum. The bankruptcy court found that the Bank, acting
under Weiner's supervision, falsely represented to the Trust
that the consideration for the first loan was limited to the
consideration itemized in the original agreement.10 The
Bank's misrepresentation did not go to the very character of
the proposed loan agreement, but only to its underlying
terms. Unlike the note maker in Turner, the Trust cannot
______
claim that when it executed the promissory note to the Bank,
it was "unaware of the nature of the documents [it] signed."
Caporale, 931 F.2d at 2, n.1. The Bank, through Weiner,
________
____________________
10. The bankruptcy court also found that the damages against
the Bank for both the Trust's tort and contract claims were
limited to the $26,300 in additional "consideration"
extracted from the proceeds of the First Loan Agreement. It
declined to declare the First Loan Agreement unenforceable
because of the illegal consideration, reasoning that to do so
would "penaliz[e] the Bank in the full amount of the loan, an
amount . . . grossly disproportionate to the amount
converted."
-39-
induced the Trust to execute the loan agreement by
misrepresenting the consideration involved. There was,
however, no fraud in the factum precluding application of
D'Oench because there is no evidence to suggest that the
_______
Trust did not fully understand the basic nature of the
obligation it assumed by entering the loan agreement. The
Bank's extraction of additional $26,300 in consideration from
the Trust did not fundamentally alter the nature of the
instruments themselves.
C. Innocence As A Defense to D'Oench
_________________________________
The second exception to D'Oench claimed by the Trust is
_______
that it was completely innocent of any intentional or
negligent deception. The Trust contends that it could not
have "lent [itself] to a scheme or arrangement" which misled
the FDIC because Benjamin negotiated and transferred the
kickback payments to Weiner without the knowledge of the
other beneficiaries of the Trust. The Trust maintains that
the district court improperly concluded that the record
established that the Trust involved itself in the kickback
scheme. Emphasizing that the bankruptcy court found that
both Benjamin and the Bank were liable on the conversion
____
count, the Trust claims that Benjamin could not have been
acting as its agent or for its benefit when he removed
$26,300 in loan proceeds from the Trust's accounts to make
kickback payments.
-40-
As authority for its claim of innocence as an exception
to D'Oench, the Trust cites a footnote to Vernon v.
_______ __________
Resolution Trust Corp., 907 F.2d 1101, 1106 n.4 (11th Cir.
_______________________
1990), which in turn relies on an earlier decision of the
Ninth Circuit, FDIC v. Meo, 505 F.2d 790 (9th Cir. 1974).
____________
Yet in Baumann, the Eleventh Circuit expressly rejected
_______
Vernon's suggestion of the continued viability of a "complete
______
innocence" exception: "it is clear that this exception is no
longer tenable because lack of bad faith, recklessness, or
even negligence is not a defense in D'Oench cases." 934 F.2d
_______
at 1516. See also FSLIC v. Gordy, 928 F.2d 1558, 1567 n.14
___ ____ ______________
(11th Cir. 1991) (observing that innocence doctrine of Meo,
___
in light of Supreme Court decision in Langley, "is based on
_______
an outdated understanding" of D'Oench). Baumann emphasized
_______ _______
that such an exception would be contrary to the broad purpose
of D'Oench to prevent a private party from enforcing against
_______
the federal authority "any obligation not specifically
memorialized in a written document such that the agency would
be aware of the obligation when conducting an examination of
the institution's records." Baumann, 934 F.2d at 1515.
_______
In Timberland, this court also stressed the basic
__________
purpose of D'Oench to protect a federal receiver even "where
_______
the only element of fault on the part of the borrower was his
or her failure to reduce the agreement to writing." 932 F.2d
at 49 (citation omitted). We agree with the Baumann court
_______
-41-
that the borrower's state of mind is irrelevant, because the
"proper focus under D'Oench is whether the agreement, at the
_______
time it was entered into, would tend to mislead the public
authority."
Id. at 50. Our earlier cases have never recognized the
___
"complete innocence" exception to D'Oench alluded to by the
_______
Trust, and we reject the invitation to adopt it now as the
law of this circuit.
Our conclusion that there is no "complete innocence"
exception to D'Oench is not entirely dispositive of the
_______
Trust's argument. As we understand it, the "innocence"
professed by the Trust is not the kind of paradigmatic
"complete innocence" formerly recognized as an exception to
D'Oench i.e., a borrower entering into an unrecorded side
_______
agreement innocent of any intentional or negligent deception.
Rather, the Trust's claim of "innocence" is really an
argument that the actions of Benjamin should not be
attributed to the Trust and that the Trust did not actually
lend itself to the kickback arrangement.
The factual record belies the assertion that Benjamin
did not act on behalf of the Trust. The bankruptcy court
found that it was Benjamin alone who negotiated the terms of
the First Loan Agreement on behalf of Young and her
associates. It was Benjamin who at the same time agreed to
the kickback arrangement that secured Weiner's assistance in
-42-
obtaining approval of the loan by the Executive Committee.
At the closing of the First Loan Agreement at which time
the Trust was formally created a signature card was
executed authorizing Benjamin to withdraw funds from the
Trust's loan proceeds account. The bankruptcy court further
found that Benjamin was also given authority to access the
Trust's funds in other accounts at the Bank, including one
for the restaurant and another for rental income from the
Columbus Avenue properties.
It seems clear that Benjamin acted with the ostensible
authority of the Trust and its principals throughout the
negotiation and execution of the First Loan Agreement. The
Trust, therefore, cannot disclaim all of Benjamin's actions
with respect to the kickback agreement. Indeed, the Trust is
willing to concede that "one could argue that Benjamin was
acting as an agent of the [Trust] when he entered into the
kickback scheme with Weiner." Brief for Appellant 604
Columbus Avenue Realty Trust at 32. In these circumstances,
the Trust "lent [itself] to a scheme or arrangement whereby
the banking authority . . . was or was likely to be misled."
D'Oench, 315 U.S. at 460.11
_______
____________________
11. Our ruling is consistent with the decision in FDIC v.
________
Kasal, 913 F.2d 487 (8th Cir. 1990), cert. denied, ___ U.S.
_____ _____ ______
___, 111 S. Ct. 1072 (1991). In its reply brief, the Trust
draws on language from a dissenting opinion in Kasal for the
_____
general proposition that "it is a perversion of justice to
hold the borrowers responsible for funds misappropriated by a
bank officer." Id. at 496 (Heaney, J., dissenting). In
___
-43-
Because we find that the district court correctly
applied the D'Oench doctrine to bar the Trust's claims and
_______
equitable subordination against the Bank based on the
kickback agreement, we do not reach the FDIC's arguments
under 1823(e).
III. THE FEDERAL HOLDER IN DUE COURSE DOCTRINE AS A BAR TO
THE TRUST'S CLAIMS AND EQUITABLE SUBORDINATION AGAINST THE
FDIC IN ITS RECEIVERSHIP CAPACITY
We turn next to the FDIC's principal argument on appeal:
that the district court erred when it held that the federal
common law holder in due course doctrine did not bar the
Trust's claims against the FDIC in its receivership capacity
and the equitable subordination of the FDIC's secured
interest in the Trust's bankruptcy estate. The FDIC
addresses this argument to the bankruptcy court's judgment
against the Bank for $111,711.66 on the Trust's conversion
and breach of contract claims for misapplication of loan
proceeds for payment of interest, taxes and other soft
costs.12 The FDIC has conceded in this case that D'Oench
_______
does not bar the Trust's claims based on breach of the soft
____________________
Kasal, the borrower was totally unaware of a misappropriation
_____
from his accounts by a bank officer. In this case, Benjamin,
a representative of the Trust, both negotiated and carried
out the misappropriations from the Trust's account.
12. The FDIC also argues that the federal holder in due
course doctrine bars the Trust's fraud claim arising from the
kickback agreement. Because we have already held that the
Trust's claims based on the kickback agreement were barred by
the D'Oench doctrine, we need not address this aspect of the
_______
FDIC's holder in due course argument.
-44-
costs provisions of the two loan agreements. Instead, the
FDIC insists that policy concerns similar to those underlying
the D'Oench doctrine militate in favor of expanding the
_______
federal holder in due course doctrine to the FDIC in its
receivership capacity when, as here, there has been no
purchase and assumption transaction by the FDIC in its
corporate capacity.
A. Origins of the Federal Holder in Due Course Doctrine
____________________________________________________
In order to evaluate the strength of the policy concerns
that the FDIC asserts as the basis for extending the federal
holder in due course doctrine to the FDIC in the
circumstances of this case, we first examine this doctrine as
it has emerged in cases involving purchase and assumption
transactions by the FDIC in its corporate capacity.
The germinative opinion in the development of the
federal holder in due course doctrine was Gunter v.
__________
Hutcheson, 674 F.2d 862 (11th Cir.), cert. denied, 459 U.S.
_________ ____________
826 (1982). In Gunter, the FDIC in its corporate capacity
______
acquired a promissory note after a purchase and assumption
transaction involving a failed Tennessee bank. The note
makers brought suit for rescission of the note held by the
FDIC on the basis of, inter alia, fraudulent
_____ ____
misrepresentation by the directors of the failed bank. Id.
___
at 866. The FDIC counterclaimed for payment of the note in
the district court, asserting that 1823(e) barred the note
-45-
makers' claims, and arguing in the alternative that federal
common law gave it a defense against claims of fraud of which
it lacked knowledge. Id. at 866-67.
___
Although the Gunter court rejected the application of
______
1823(e) to bar the note maker's fraud claims,13 it accepted
the FDIC's argument that a federal common law rule of non-
liability against these claims was necessary in order for the
FDIC to accomplish its statutory objectives. In reaching
this conclusion, the Gunter court applied the Supreme Court's
______
test for determining whether the implementation of a federal
program would be frustrated without the adoption of a uniform
federal rule. See United States v. Kimbell Foods, Inc., 440
___ ____________________________________
U.S. 715 (1979). Applying Kimbell Foods, the Gunter court
______________ ______
stressed the FDIC's duty to promote "the stability of and
confidence in the nation's banking system," id. at 870, and
___
the preferred status of the purchase and assumption
transaction as a means of accomplishing this duty because "it
avoids the specter of closed banks and the interruption of
daily banking services." Id.
___
____________________
13. The Gunter court found it necessary to reach the merits
______
of the FDIC's federal common law argument because it found
that the note maker's fraud defenses were not precluded by
1823(e). Gunter, 674 F.2d at 867. This analysis of
______
1823(e) as not barring a claim of fraud in the inducement was
subsequently disapproved by the Supreme Court in Langley.
_______
See Langley, 484 U.S. at 93-94.
___ _______
-46-
The court noted that speed was of the essence in a
purchase and assumption transaction because of the need to
preserve the going concern value of the bank:
[T]he FDIC must have some method to evaluate its
potential liability in a purchase and assumption
versus its potential liability from a liquidation.
Because of the time constraints involved, the only
method of evaluating potential loss open to the
FDIC is relying on the books and records of the
failed bank to estimate what assets would be
returned by a purchasing bank and to estimate which
of those assets ultimately would be collectible.
Id. After considering the impact of the federal rule on
___
settled commercial expectations ordinarily governed by state
law, the court concluded that protection of the FDIC from
unknown fraud claims "far outweighed" any potential damage to
these expectations. Id. at 872.
___
The court therefore announced a federal common law
holder in due course rule applicable to the FDIC in its
corporate capacity:
[A]s a matter of federal common law, the FDIC has a
complete defense to state and common law fraud
claims on a note acquired by the FDIC in the
execution of a purchase and assumption transaction,
for value, in good faith, and without actual
knowledge of the fraud at the time the FDIC entered
into the purchase and assumption agreement.
Id. at 873. Gunter thus expanded federal common law to bar
___ ______
fraud claims by the note makers that would not otherwise have
been barred by the D'Oench doctrine or 1823(e). See id. at
_______ ___ ___
872 & n.14 (noting that D'Oench doctrine and 1823(e) embody
_______
a "more limited" policy of protecting the FDIC).
-47-
This court has adopted the rule of Gunter. See Southern
______ ___ ________
Indus. Realty, Inc. v. Noe, 814 F.2d 1 (1st Cir. 1987) (per
__________________________
curiam). See also FDIC v. Bracero & Rivera, Inc., 895 F.2d
_________ _______________________________
824, 828-29 (1st Cir. 1990) (dicta acknowledging holder in
due course doctrine's availability to the FDIC in its
corporate capacity). Other circuit courts have expanded the
federal common law holder in due course doctrine to bar all
personal defenses against the FDIC, and have looked to state
law principles in order to distinguish between real and
personal defenses. See Campbell Leasing Inc. v. FDIC, 901
___ ______________________________
F.2d 1244, 1249 (5th Cir. 1990); FDIC v. Wood, 758 F.2d 156,
____________
161 (6th Cir.) (the FDIC "takes the note free of all defenses
that would not prevail against a holder in due course."),
cert. denied, 474 U.S. 944 (1985). See also FDIC v. Bank of
____________ ________ _______________
Boulder, 911 F.2d 1466, 1474-75 (10th Cir. 1990) (en banc)
_______
(adopting federal rule of transferability of letters of
credit protecting FDIC in its corporate capacity during
purchase and assumption), cert. denied, ___ U.S. ___, 111 S.
____________
Ct. 1103 (1991). In all of these cases, the underlying
rationale for a federal holder in due course rule has been
consistent with that articulated by Gunter: to promote
______
purchase and assumption transactions. See Wood, 758 F.2d at
___ ____
160-61 (federal holder in due course rule necessary because
"the essence of a purchase and assumption transaction is
speed"); Campbell Leasing, 901 F.2d at 1248-1249 (same
_________________
-48-
analysis); Bank of Boulder, 911 F.2d at 1474-75 (uniform rule
_______________
of transferability necessary because of time constraints of
purchase and assumption).
B. Application Of The Federal Holder in Due Course
___________________________________________________
Doctrine To The FDIC As Receiver
________________________________
The FDIC argues that the federal holder in due course
rule should be available to it in its capacity as the Bank's
receiver. The FDIC insists that in order for it to decide
whether a purchase and assumption or a liquidation is the
least costly approach to disposing of the assets of a failed
bank, it must be able to make that decision based on absolute
reliance on the bank's records, unimpeded by personal
defenses. The FDIC also asserts that if the federal holder
in due course doctrine is limited exclusively to purchase and
assumption transactions, it will be unable to employ a
variety of newly-developed "hybrid" transactions for the
resolution of bank failures that include elements drawn from
both a liquidation and a purchase and assumption.
Accordingly, the FDIC urges that we hold that the federal
holder in due course doctrine applies to the FDIC in its
receivership capacity, regardless of whether a purchase and
assumption transaction is consummated.
To support its argument, the FDIC relies on several
cases in which the FDIC in its receivership capacity was
allowed to invoke the federal holder in due course doctrine
to bar the makers of promissory notes from asserting their
-49-
personal defenses. But these cases involved notes acquired
by the FDIC as receiver after a purchase and assumption
_____
transaction.14 For example, in Campbell Leasing, the FDIC
________________
was appointed receiver of a failed Texas bank and arranged
for a purchase and assumption transaction with a federally-
established bridge bank, NCNB. 901 F.2d at 1247. During the
purchase and assumption, NCNB acquired a promissory note that
had previously been the subject of a lawsuit by the note
maker against the failed bank. As receiver of the failed
bank, the FDIC, along with NCNB, moved for summary judgment
on the note maker's claims and on a counterclaim for
enforcement of the note, arguing that the D'Oench and federal
_______
holder in due course doctrines barred all the note maker's
____________________
14. The cases cited by the FDIC either involved the
application of the federal holder in due course doctrine to
assets acquired by the FDIC as receiver following a purchase
and assumption transaction, or were not directly decided
under the holder in due course rule. See FDIC v. McCullough,
___ __________________
911 F.2d 593 (11th Cir. 1990), cert. denied, ___ U.S. ___,
____________
111 S. Ct. 2235 (1991); In re CTS Truss, Inc. v. FDIC, 868
_______________________________
F.2d 146 (5th Cir. 1989); Firstsouth, F.A. v. Aqua Constr.
__________________________________
Inc., 858 F.2d 441 (8th Cir. 1988). In McCullough, the court
____ __________
observed that both the FDIC and FSLIC as receiver are
"clothed under federal common law with the same defenses that
would be accorded a holder in due course under state law."
911 F.2d at 603. Yet in McCullough, the note on which the
__________
federal receiver was seeking to recover had earlier been
acquired by the failed savings institution in a purchase and
assumption transaction. Id. at 596. CTS Truss involved the
___ _________
enforcement by the FDIC as receiver of an asset acquired by
it in its corporate capacity, 868 F.2d at 147, and was
decided under 1823(e) rather than the federal holder in due
course doctrine. Id. at 150. As for Firstsouth, the federal
___ __________
common law rule at issue was the D'Oench doctrine, and not
_______
the more expansive holder in due course doctrine recognized
by Gunter. Firstsouth, 858 F.2d at 443.
______ __________
-50-
claims and affirmative defenses. Id. The district court
___
granted summary judgment for the FDIC and NCNB, and the Fifth
Circuit affirmed the judgment on appeal. The court observed
that it could find
no logical reason to limit federal holder in due
course protection to the FDIC in its corporate
capacity, to the exclusion of its receivership
function. In its corporate capacity, the FDIC is
obligated to protect the depositors of a failed
bank, while the FDIC as receiver must also protect
the bank's creditors and shareholders. In both
cases, the holder in due course doctrine enables
the FDIC to efficiently fulfill its role, thus
minimizing the harm to depositors, creditors, and
shareholders. . . . We conclude that the FDIC
enjoys holder in due course status as a matter of
federal common law whether it is acting in its
corporate or receivership capacity.
Id. at 1249 (citations omitted).
___
The FDIC argues that because the protections of the
federal holder in due course doctrine have been available to
it in its receivership capacity in cases like Campbell
________
Leasing, the logical next step is to apply the doctrine to
_______
the FDIC in its receivership capacity regardless of whether a
purchase and assumption transaction has occurred. According
to the FDIC, this extension of the federal holder in due
course rule is necessary to enable it to decide properly
whether a liquidation or purchase and assumption is the least
costly means of dealing with the failed bank.
In its briefs in this appeal, however, the FDIC has
neglected to mention the one decision that has directly
addressed this argument. In FDIC v. Laguarta, 939 F.2d 1231
________________
-51-
(5th Cir. 1991), the FDIC argued that it was entitled to
invoke the federal holder in due course doctrine to bar any
defenses against enforcement of a promissory note acquired by
it directly in its capacity as receiver. Id. at 1233-35.
___
After observing that the FDIC's federal holder in due course
argument had been raised in a "belated supplemental brief,"
the Fifth Circuit dismissed it peremptorily in a footnote:
Here the FDIC sues only in its capacity as receiver
for the institution which made the loan and is
payee in the note sued on, and the FDIC does not
assert, nor does the record establish, that the
loan or note has ever been transferred or was ever
part of a purchase and assumption transaction. To
the extent that it precludes defenses beyond those
precluded by D'Oench, Duhme, the federal holder in
______________
due course doctrine is inapplicable to such a
situation. Gunter . . . . See Campbell Leasing .
______ ___ ________________
. . . Indeed, a major policy goal underlying the
federal common-law holder in due course doctrine is
to facilitate purchase and assumption transactions
of failed financial institutions in lieu of
liquidations. Campbell Leasing; Gunter.
________________ ______
Id. at 1239 n.19 (citations partly omitted).
___
We likewise reject the FDIC's attempt to expand the
federal holder in due course doctrine far beyond its original
purpose of promoting purchase and assumption transactions
that preserve the going concern value of the bank. None of
the policy considerations that originally prompted the
adoption of a federal holder in due course rule are present
when, as in this case, the FDIC as receiver is seeking only
to enforce an obligation in a liquidation. A liquidation
does not further the federal policy of "bringing to
-52-
depositors sound, effective, and uninterrupted operation of
the [nation's] banking system with resulting safety and
liquidity of bank deposits." Campbell, 901 F.2d at 1248
________
(quoting S. Rep. No. 1269, 81st Cong., 2d Sess., reprinted in
____________
1950 U.S.C.C.A.N. 3765, 3765-66). Likewise, there is no need
for speedy evaluation of the assets of a failed institution,
and therefore little justification for adoption of a broad
federal rule that would displace settled commercial
expectations controlled by state law. Cf. Gunter, 674 F.2d
___ ______
at 872 (applying the Kimbell Foods test for adoption of
______________
federal common law rule). Furthermore, the FDIC does not
rely as heavily on the books and records of the failed bank
to estimate its total loss in a liquidation as it must in a
purchase and assumption.15
____________________
15. This distinction between the cost estimate of a
liquidation versus that in a purchase and assumption
transaction was noted in Gunter:
______
The maximum liability of the FDIC in a liquidation
is fixed by the $100,000-per-depositor insurance
limitation. In a purchase and assumption
transaction, however, the FDIC agrees to repurchase
any unacceptable assets from the purchasing bank
and cannot rely on the statutory limitation of its
liability. Hence to make the [cost test currently
codified at 18 U.S.C. 1823(c)(4)(A)], the FDIC
must have some method of estimating its potential
liability under a purchase and assumption to
compare it to the maximum liability in a
liquidation.
Gunter, 674 F.2d at 870 n.10. This analysis belies the
______
FDIC's assertion that if the federal holder in due course
doctrine were limited solely to assets sold through a
purchase and assumption, the federal receiver could not
reliably estimate the cost of a liquidation as compared to
that of a purchase and assumption.
-53-
However desirable it may be for the FDIC in its
receivership capacity to be able to bar counterclaims or
affirmative defenses by the maker of a promissory note not
already eliminated by D'Oench and 1823(e), such a broad
_______
principle of federal common law cannot find its justification
in the federal holder in due course doctrine currently
applied by the courts. The district court's well-reasoned
analysis of the FDIC's federal holder in due course argument
aptly summarizes some of its deficiencies:
The holder in due course doctrine normally allows
innocent purchasers of negotiable instruments to
rely on such instruments when they are acquired for
value. The FDIC is granted this status so it can
quickly scan a bank's balance sheet to negotiate
its sale. Thus, the FDIC is not held up to an
obligation to scrutinize the assets of a failed
bank before it agrees to execute a purchase and
assumption. . . .
The exigencies of a purchase and assumption
transaction also differentiate the holder in due
course doctrine from D'Oench. D'Oench is concerned
_______ _______
with the integrity of a bank's records the FDIC
can only be charged for claims apparent from a
search of the bank's files. The holder in due
course doctrine, on the other hand, relieves the
FDIC even from claims apparent on the face of the
Bank's records. . . . The reach of the federal
holder in due course doctrine being much wider than
even the extraordinary remedy of D'Oench, the
_______
circumstances in which it is applied should be
correspondingly limited.
The FDIC nonetheless insists that the unavailability of
the federal holder in due course rule in the absence of a
purchase and assumption would "immeasurably delay and
complicate the resolution of receiverships" and create
-54-
"delays and difficulties [that] could greatly impair the
FDIC's ability to complete its statutory mission." In the
same breath, however, the FDIC complains that the existing
federal rule is problematic because it "substantively alters
the receiver's evaluation of the alternative transactions in
favor" of purchase and assumptions. The FDIC cannot have it
both ways. The federal holder in due course doctrine was
fashioned precisely for the purpose of expediting the
purchase and assumption transaction. See Gunter, 674 F.2d at
___ ______
869-71. It was never intended as a panacea intended to
relieve the FDIC of all the "difficulties" arising from state
law defenses and counterclaims during the liquidation of
assets. We decline to address the FDIC's argument that a
decision not to extend the federal holder in due course rule
will impair its ability to conduct certain new "hybrid"
transactions i.e., transactions that involve elements of
both a liquidation and a purchase and assumption because
this case does not involve such a "hybrid."
We therefore hold that the FDIC was not entitled to
invoke the federal common law holder in due course doctrine
to bar the Trust's claims of breach of contract and
conversion as to the soft costs damages.16
____________________
16. Because the FDIC is not entitled to holder in due course
status under the federal common law rule, we need not decide
whether the Trust's soft costs claims would be barred by
Massachusetts holder in due course law.
-55-
IV. FEDERAL COMMON LAW AS A BAR TO EQUITABLE SUBORDINATION
OF THE FDIC'S SECURED CLAIM AGAINST THE TRUST
The FDIC next argues that to allow equitable
subordination of part of its secured claim would be contrary
to federal common law. The FDIC asserts that the
availability of the equitable subordination remedy against it
would frustrate federal policies intended to assist it in
fulfilling its statutory duty to recover the maximum amount
from bankrupt borrowers during the liquidation of assets of
failed banks. The FDIC also insists that to allow equitable
subordination against it would be inappropriate where the
misconduct leading to the equitable subordination was that of
the Bank and its officers, and not of the innocent federal
receiver.
Section 510(c) of the Bankruptcy Code specifically
authorizes a bankruptcy court to apply "principles of
equitable subordination."17 The judicially-developed case
law of equitable subordination is of long standing. See 3 L.
___
King, Collier on Bankruptcy 510.01 (15th ed. 1992)
_______________________
____________________
17. 11 U.S.C. 510(c) provides:
Notwithstanding subsections (a) and (b) of this section,
after notice and a hearing, the court may
(1) under principles of equitable
subordination, subordinate for purposes of
distribution all or part of an allowed claim
to all or part of another allowed claim or all
or part of an allowed interest to all or part
of another allowed interest; or
(2) order that any lien securing such a
subordinated claim be transferred to the
estate.
-56-
("Collier"). The doctrine permits a bankruptcy court to
rearrange the priorities of creditors' interests, and to
place all or part of the wrongdoer's claim in an inferior
status. The generally-recognized test for equitable
subordination, adopted by this court, is set forth in In re
_____
Mobile Steel Co., 563 F.2d 692, 703 (5th Cir. 1977):
________________
(i) The claimant must have engaged in some type of
inequitable conduct.
(ii) The misconduct must have resulted in injury
to the creditors of the bankrupt or conferred an
unfair advantage on the claimant.
(iii) Equitable subordination of the claim must
not be inconsistent with the provisions of the
Bankruptcy Act.
Id. at 699-700 (citations omitted). See also In re Giorgio,
___ ___ ____ _____________
862 F.2d 933, 938-39 (1st Cir. 1988) (applying Mobile Steel
_____________
test); 3 Collier at 510.05[2]. Before reaching the issue
of whether this test was properly applied by the bankruptcy
court, we first determine whether equitable subordination
against a federal receiver should be prohibited as a matter
of federal common law.
Only one decision in the federal courts of appeals has
directly addressed the issue of equitable subordination
against the FDIC. See In re CTS Truss, Inc., 868 F.2d 146
___ ______________________
(1989), withdraw'g, 859 F.2d 357 (5th Cir. 1988). In CTS
__________ ___
Truss, the FDIC in its corporate capacity filed a proof of
_____
claim in bankruptcy court on certain notes and security
documents made by the debtor. The debtor objected to the
-57-
proof of claim, arguing that the FDIC's claim should be
equitably subordinated to the claims of all the other
creditors because the failed bank had engaged in wrongful
conduct against the debtor prior to the FDIC's intervention
as receiver. Id. at 147. The bankruptcy and district courts
___
held that the FDIC's claims could not be subordinated because
the "FDIC was a transferee innocent of any misconduct against
CTS." Id.
___
The Fifth Circuit affirmed the bankruptcy court's
decision, but on different grounds, holding that equitable
subordination against the FDIC would have been improper for
two distinct reasons. First, the court found that "[e]ven if
the Bank's actions could be imputed to the FDIC, we do not
believe that the unusual remedy of equitable subordination is
appropriate to the facts alleged by the [debtor]." Id. at
___
148. Applying the Mobile Steel test, the court held that the
____________
debtor had failed to allege facts that demonstrated that the
bank's conduct towards it would have justified the equitable
subordination of a claim on the debtor's assets subsequently
acquired by the FDIC. Id. at 148-49. The court disregarded
___
the issue of the FDIC's "innocence" in assuming the assets of
the failed bank, focussing instead on whether the failed
bank's actions fit "within any of the classic patterns of
-58-
conduct that have led the courts to fashion the extraordinary
remedy of equitable subordination." Id. at 148.18
___
The other ground for the Fifth Circuit's holding in CTS
___
Truss was the availability to the FDIC of 1823(e) and,
_____
implicitly, the D'Oench doctrine to bar the debtor's
_______
claims. Id. at 149-50 & n.8. The court thought it "likely"
___
that the debtor had deliberately decided against raising its
defenses to its indebtedness premised on the bank's conduct
because it realized that the FDIC would be shielded from
these claims. Id. at 149. It found that 1823(e)
___
"squarely" covered the debtor's claims against the Bank, and
that the debtor would therefore have been unable to raise
these claims against the FDIC. Id. at 150. The court
___
concluded that "[e]ven if principles of equitable
subordination otherwise permitted the imputation of wrongful
conduct to a transferee such as the FDIC, we would be
constrained to hold that [ 1823(e)] forbids that result."
Id.
___
The Fifth Circuit's decision in CTS Truss establishes
_________
several principles that are useful to consideration of the
____________________
18. The court also noted that to the extent the debtor's
claims of fraud and breach of an oral promise were
"allegations [that] would justify disallowance or an offset
against the Bank's secured claim, they would prevent the
assertion of a claim of equitable subordination." Id. at 149
___
(citing Mobile Steel for the proposition that "claims should
____________
be subordinated only to the extent necessary to offset the
harm done by the inequitable conduct").
-59-
FDIC's argument in this case. CTS Truss stands for the
__________
proposition that equitable subordination against the FDIC is
barred when the claims on which the request for subordination
is premised cannot be asserted against the FDIC because of
federal law. On the other hand, CTS Truss does not entirely
_________
preclude the possibility of equitable subordination of an
interest acquired by the FDIC because of the conduct of the
failed bank. The Fifth Circuit declined to adopt the
reasoning of the bankruptcy court below that the FDIC could
not be equitably subordinated because it was "a transferee
innocent of any misconduct" against the debtor. Id. at 147.
___
Instead, the court focussed on the issue of whether the
conduct of the FDIC's predecessor in interest fit the
"classic pattern[]" necessary for equitable subordination
under the test in Mobile Steel. Because it found that the
____________
bank's conduct in relation to the debtor in CTS Truss did not
_________
fit that pattern, the Fifth Circuit never directly reached
the issue of whether it would be appropriate to impute the
actions of the bank to the FDIC for purposes of equitable
subordination.
In this case, the FDIC asks that we adopt a rule of
federal common law preventing the equitable subordination of
the secured claim of a federal receiver as a result of
misconduct by a failed bank. We reject this approach because
we think that the analysis of the Fifth Circuit in CTS Truss
_________
-60-
demonstrates that such a broad rule of federal common law is
unnecessary to protect a federal receiver.
As evidence of a federal policy to protect the value of
assets acquired by the FDIC in its receivership capacity, the
FDIC cites the developing federal common law embodied in the
D'Oench and federal holder in due course doctrines. As an
_______
additional example of Congressional intent to protect it, the
FDIC also points to the recent amendments in FIRREA extending
the coverage of 1823(e) to the FDIC as receiver.19
Drawing on these examples, the FDIC urges that the adoption
of a federal rule barring equitable subordination is a
logical extension of this policy to protect it in its
receivership capacity. Otherwise, the FDIC warns, the
"absence of a federal rule barring equitable subordination of
the receiver's claims against bankrupt borrowers will
materially and adversely restrict the receiver's ability to
resolve bank receiverships at the lowest cost to the public."
Brief for Appellant FDIC As Receiver for Capitol Bank and
Trust Company at 32.
____________________
19. FIRREA amended 1823(e) by extending its coverage to "any
asset . . . acquired by [the FDIC] . . . either as security
for a loan or by purchase or as receiver of any insured
________________________________
depository institution . . . ." (Emphasis added). Before
______________________
FIRREA, 1823(e) applied only to the FDIC in its corporate
capacity, and it was only through decisions applying the
D'Oench doctrine that the FDIC as receiver was protected from
_______
unrecorded agreements. See Timberland, 932 F.2d at 49.
___ __________
-61-
The problem with this argument, as CTS Truss
__________
demonstrates, is that the adoption of a federal common law
rule precluding equitable subordination would be superfluous
in those cases in which the debtor's claims against the
receiver were already barred under D'Oench, 1823(e), or, if
_______
the asset was acquired by the receiver after a purchase and
assumption, the federal holder in due course doctrine. Only
if the debtor's request for equitable subordination were
based on claims not already barred by the FDIC's federal
defenses would a federal common law rule preventing equitable
subordination be necessary to protect the value of assets
acquired by the FDIC in its receivership capacity. The
FDIC's suggestion that the absence of such a common law rule
would "undercut the policy underlying the well-established
federal common law D'Oench Duhme and federal holder in due
_____________
course doctrines" is plainly hyperbole. A rule precluding
equitable subordination against the FDIC would in fact work a
significant expansion of the protections already afforded it
in its receivership capacity under D'Oench and 1823(e).
_______
Claims or defenses that a borrower might otherwise properly
assert against the federal receiver would be rendered
meaningless if the borrower entered bankruptcy because
equitable subordination would be unavailable even if the
borrower prevailed on these claims or defenses.
-62-
The FDIC maintains that such a result would be
consistent with the policy of enhancing the federal
receiver's ability to resolve bank failures at the lowest
cost to the public. Yet if the maximization of the FDIC's
recovery on the assets of a failed bank was the sole
objective of federal statutory and common law in this area,
then all claims or defenses against the FDIC's recovery on
___
assets would by now have been barred by federal statutes or
common law. As our discussion of D'Oench, 1823(e) and the
_______
federal holder in due course doctrine makes clear, while it
is certainly true that federal law affords the FDIC broad
protection against the claims and defenses of borrowers, that
protection has never amounted to total immunity. Cf. FDIC v.
___ _______
Jenkins, 888 F.2d 1537, 1546 (11th Cir. 1989) ("Of course, it
_______
would be convenient to the FDIC to have an arsenal of
priorities, presumptions and defenses to maximize recovery to
the insurance fund, but this does not require that courts
must grant all of these tools to the FDIC in its effort to
maximize deposit insurance fund recovery."). Nor are we
convinced that the absence of a federal rule preventing
equitable subordination would impair the operation of the
FDIC as receiver to the same extent that, for example, the
absence of a federal holder in due course doctrine would
impair the FDIC's ability to conduct purchase and assumption
transactions. Cf. Gunter, 674 F.2d at 870 (principal
___ ______
-63-
justification for federal common law rule was that its
absence would "make the FDIC's task of executing its
statutory mandate . . . nearly impossible"). Maximization of
the FDIC's recovery alone has never been an adequate
justification for the adoption of a rule of federal common
law.
The FDIC also argues that equitable subordination would
never be appropriate when it was only the wrongful conduct of
the failed bank and its officers, and not of the innocent
federal receiver, that provided the bankruptcy court with the
basis for subordination.20 This argument raises the issue
left undecided by CTS Truss: whether it would be appropriate
_________
to impute the misconduct of officials of a failed bank to the
federal receiver for purposes of equitable subordination.
While the question is a close one, we think that any
inequity that would result from imputing bank officials'
misconduct to the federal receiver would be outweighed by
adoption of a federal common law rule that would entirely
prevent the debtor/borrower or its creditors from benefitting
from the remedy of equitable subordination. The FDIC would
____________________
20. The FDIC relies for this argument, inter alia, on the
___________
reasoning of the lower courts' decisions in CTS Truss that
_________
there would be "no basis for equitably adjusting the
distribution of the bankrupt's assets because the claimant
________
never engaged in misconduct." Brief for Appellant FDIC at 34
(citing district court decision in CTS Truss). As we have
_________
noted, the Fifth Circuit expressly declined to ground its
decision on this rationale.
-64-
not necessarily be the only "innocent" creditor affected by
the adoption of such a rule. Many of the debtor/borrower's
other "innocent" creditors would be deprived of any
possibility of recovery from the estate in bankruptcy if
equitable subordination was barred against the federal
receiver. The FDIC should also be subjected to the
constraints of equity.
CTS Truss prevents equitable subordination against a
_________
federal receiver based on claims or defenses of the
debtor/borrower that are barred by the FDIC's established
federal statutory and common law protections. The FDIC has
not identified any additional policy considerations, beyond
those already supporting its preexisting federal protections
against borrowers' claims, that would favor the adoption of a
new federal common law rule giving the federal receiver even
greater protection in the event of the borrower's
bankruptcy.21 Accordingly, we find that there is no basis
____________________
21. The FDIC maintains that in this case the statutory
limitation on its liability as a receiver justifies the
denial of equitable subordination. See 12 U.S.C.
___
1821(i)(2). This fact-specific argument is not pertinent to
our consideration of whether it is necessary to adopt a rule
of federal common law barring equitable subordination against
the federal receiver. We also note that we doubt that the
diminution of the secured claim of the federal receiver
resulting from equitable subordination would be a "liability"
against the FDIC within the meaning of this provision. Texas
_____
American Bancshares, Inc. v. Clarke, 954 F.2d 329 (5th Cir.
____________________________________
1992), a case involving the priority of payments by the FDIC
to creditors of a failed bank after a purchase and
assumption, is not material to the issue before us.
-65-
for totally exempting the FDIC in its receivership capacity
from the remedy of equitable subordination permitted under
the Bankruptcy Code.
We hold that equitable subordination may be sought
against a federal receiver as long as this claim survives the
test imposed by CTS Truss. The claim of equitable
__________
subordination is valid only if, (1) the claims or defenses on
which the borrower's claim for subordination is premised are
not already barred by the FDIC's recognized protections under
federal law, and, (2) if the misconduct alleged in these
claims or defenses against the receiver's predecessor in
interest falls within "any of the classic patterns of conduct
that have led courts to fashion the extraordinary remedy of
equitable subordination." CTS Truss, 868 F.2d at 148.
_________
V. THE BANKRUPTCY COURT'S JUDGMENT ON THE MERITS OF THE
TRUST'S SOFT COSTS CLAIMS
The district court correctly determined that the federal
holder in due course doctrine did not bar the Trust's
conversion and breach of contract claims stemming from the
misapplication of loan proceeds to soft costs payments.
Having decided that equitable subordination is not barred as
a matter of federal common law against a federal receiver, we
must now consider the FDIC's challenge on the merits to the
bankruptcy court's rulings in favor of the Trust on the
-66-
breach of contract, conversion and equitable subordination
claims relating to the soft costs overages.22
A. Breach of Contract and Conversion
_________________________________
The FDIC challenges the district court's affirmance of
the ruling of the bankruptcy court that the Bank breached the
loan agreements by removing from the loan proceeds amounts
that exceeded the agreed-upon limits for soft costs by
$111,711.66. It contends that the provisions of the
standard-form L&SA used for each loan agreement required the
Trust to pay all expenses incurred by the Bank, and
authorized the Bank to withdraw from any of the Trust's
account any monies necessary to repay those expenditures.
The FDIC places particular emphasis on sections 6.01 and 8.01
of the L&SA, which provide, inter alia, that "the Borrower
_____ ____
agrees that any deposits or other sums . . . may at all times
be held and treated as collateral for any liabilities of the
Borrower . . . ."; that "the Borrower shall pay or reimburse
the Bank on demand for all out-of-pocket expenses of every
nature . . . ."; and that "the Bank, if it chooses, may debit
____________________
22. The merits of the Trust's claims arising from the
kickback arrangement are not at issue because the district
court properly applied D'Oench to vacate that part of the
_______
bankruptcy's court's judgment and equitable subordination
award in favor of the Trust that was premised on the kickback
claims.
-67-
such expenses to the Borrower's Loan Account or charge any of
the Borrower's funds on deposit with the Bank."23
The FDIC argues that both the district and bankruptcy
court concluded erroneously that the allocations of soft
costs provided in the addendum to the L&SA in each loan
agreement prohibited the Bank from removing from the Trust's
loan account additional amounts necessary to cover soft costs
expenses once the original estimates were exceeded. It
contends that both the Bank and the Trust knew that the soft
costs allowances in both loan agreements $100,000 in the
First Loan Agreement and "approximately" $60,000 in the
Second Loan Agreement would be inadequate to pay all the
soft costs expenses. According to the FDIC, by withdrawing
payments for soft costs in excess of these amounts, the Bank
was within its rights under the express terms of both L&SAs.
More importantly, the FDIC argues, the Bank never intended to
relinquish its rights under the L&SAs to complete recovery of
unpaid expenses by limiting itself to the soft costs
allowances included in the addenda to the L&SAs.
Following the lead of the parties and both courts below,
we treat Massachusetts law as controlling in this case. This
circuit has recognized that when interpreting contracts under
Massachusetts law, "[i]n the search for plain meaning, a
____________________
23. The FDIC also relies on several similar provisions of
the construction loan agreements.
-68-
court should consider 'every phrase and clause . . . [in
light of] all the other phraseology contained in the
instrument, which must be considered as a workable and
harmonious means for carrying out and effectuating the intent
of the parties.'" Boston Edison Co. v. FERC, 856 F.2d 361
__________________________
(1st Cir. 1988) (quoting J.A. Sullivan Corp. v. Commonwealth,
___________________________________
494 N.E.2d 374, 378 (Mass. 1986)). The principles of
interpretation applied by the Massachusetts courts conform to
those of the leading commentators. Specific terms are given
greater weight than general language. See Lembo v. Waters,
___ ________________
294 N.E.2d 566, 569 (Mass. App. Ct. 1973) ("'If the apparent
inconsistency is between a clause that is general and broadly
inclusive in character and one that is more limited and
specific in its coverage, the latter should generally be held
to operate as a modification and pro tanto nullification of
the former.'") (quoting 3 A. Corbin, Contracts 547, at 176
_________
(1960)). Separately negotiated or added terms are given
greater weight than standardized terms or other terms not
specifically negotiated. See Carrigg v. Cordeiro, 530 N.E.2d
___ ___________________
809, 813 (Mass. App. Ct. 1988) ("If . . . there is conflict
and inconsistency between a printed provision and one that
was inserted by the parties especially for the contract that
they are then making, the latter should prevail over the
former.") (citations omitted).
-69-
Applying these principles to the Bank's conduct in this
case, we conclude that the courts below were correct in
holding that the Bank breached both loan agreements by
withdrawing from the Trust's accounts payments for soft costs
that exceeded the agreed-upon allocations. Although the
provisions of the standard form L&SA used in both loan
agreements gave the Bank broad authority to recover its out-
of-pocket expenses, each L&SA was supplemented by an addendum
prepared by the parties that specifically limited the amount
of loan proceeds recoverable by the Bank as soft costs. The
L&SA Addendum to the First Loan Agreement provided that only
$100,000 of the loan proceeds were to be applied to soft
costs and the remaining $200,000 in proceeds would be used
for construction funding. The Bank's withdrawals of soft
costs exceeded that $100,000 allocation by $2,305.54. The
L&SA Addendum to the Second Loan Agreement provided that the
Bank would "advance the loan proceeds approximately as
follows: . . . $60,000 for soft costs incurred with respect
to the loan." The Bank's withdrawals of soft costs exceeded
this "approximate" allocation by $109,406.12.
We reject the FDIC's arguments that the soft cost limits
were merely estimates. The loan agreements clearly
contemplated that while a portion of the loan proceeds would
be used for the soft costs, the balance of the proceeds were
to be applied by the Trust to the costs of the construction
-70-
project that was the objective of the entire transaction. A
finding that the Bank breached these provisions does not, as
the FDIC maintains, necessarily conflict with the bankruptcy
court's determination that both parties understood that the
$100,000 soft costs allocation in the First Loan Agreement
would have to be supplemented by payments from the Trust's
funds.
The FDIC correctly points out that when the Trust failed
to cover the entirety of soft costs expenses incurred by the
Bank, the Bank had the authority to recover these expenses
from any of the Trust's accounts under the general provisions
of the L&SAs used in each loan. Yet the means by which the
Bank chose to exercise that authority that is, by
immediately recovering all its excess expenses directly from
the loan proceeds otherwise earmarked for construction
costs countermanded the specifically-agreed upon allocation
of loan proceeds between soft costs and construction costs.
As the district court correctly noted, while the general
provisions of the L&SAs and the construction loan agreements
gave the Bank discretion to apply the Trust's payments on the
________
loan as it saw fit, these provisions did not "give the Bank
the untrammelled right to advance and apply loan proceeds
willy-nilly." We therefore affirm the bankruptcy court's
judgment for an amount equivalent to the total of the excess
withdrawals made by the Bank towards soft costs payments for
-71-
both loans i.e., $2,305.54 for the First Loan Agreement and
$109,406.12 for the Second, for a total of $111,711.66.
The FDIC also challenges the finding of the courts below
that the Bank was also liable for conversion of the extra
$111,711.66 removed from the loan proceeds for soft costs.
Conversion consists of the wrongful exercise of dominion or
control over the personal property of another. See 14A D.
___
Simpson & H. Alperin, Massachusetts Practice: Summary of the
______________________________________
Law 1771 (1974). In order to recover for conversion,
___
plaintiffs must show that at the time of the alleged
conversion they had either actual possession or the right to
immediate possession or control of the property in question.
Id. See also Mechanics Nat'l Bank of Worcester v. Killeen,
___ ___ ____ _____________________________________________
384 N.E.2d 1231, 1240 (Mass. 1979).
The FDIC argues that the Bank's withdrawal of excess
soft costs payments did not constitute conversion because the
Trust never had an immediate right to possession or control
over the loan proceeds. It contends that the Trust failed to
satisfy the conditions of the loan agreement that required
the Trust, inter alia, to provide itemized requisitions of
_____ ____
its construction expenses prior to the Bank's disbursement of
any proceeds. Because of its failure to satisfy these
conditions precedent, the FDIC reasons, the Trust never
acquired a right to control or possession of any loan
proceeds disbursed for construction purposes. Thus, the FDIC
-72-
concludes, when the Bank disbursed loan proceeds for payment
of construction costs and then applied these payments to soft
costs payments, the Bank could not have converted those
funds.
The problem with the FDIC's reasoning is that it
misstates the factual circumstances of this case that explain
why the Bank chose to disburse loan proceeds for
___
construction. The FDIC ignores the finding by the bankruptcy
court that Bank officers, under Weiner's orders, deliberately
violated the conditions precedent of the First Loan Agreement
in order to expedite the advancement of loan proceeds. See
___
Bankruptcy Court Opinion, 119 B.R. at 360-61. The bankruptcy
court also found that portions of those proceeds were then
removed by Benjamin to make kickback payments to Weiner. As
for the Second Loan Agreement, the bankruptcy court found
that the conditions precedent for construction fund
disbursement were in fact complied with by the Trust. Id. at
___
367. The record demonstrates that the Bank advanced monies
to the Trust's loan account after the completion of
construction work, only to apply these loan proceeds to the
payments of soft costs.
We reject the FDIC's argument that the Trust had no
right to possess and control the proceeds of both loan
agreements once they were deposited to the Trust's account.
There is no basis in the record for the claim that violations
-73-
by the Trust of the conditions precedent entitled the Bank to
disburse funds for construction costs, begin to charge the
Trust interest, and at the same time withdraw portions of
these proceeds for soft costs payments. Both courts below
correctly concluded that the Bank, by withdrawing amounts for
soft costs beyond the agreed-upon limits of both loan
agreements, thereby converted funds belonging to the Trust.
B. Equitable Subordination
_______________________
Because we have determined that the district court
correctly found that the Trust's soft costs claims were not
barred against the FDIC by federal law, we focus on the
second element of the CTS Truss analysis: whether the
__________
misconduct of the Bank fit "within any of the classic
patterns of conduct that have led the courts to fashion the
extraordinary remedy of equitable subordination." CTS Truss,
_________
868 F.2d at 148.24
The FDIC argues that even if the district court properly
upheld the Trust's breach of contract and conversion claims,
equitable subordination was nonetheless erroneous because the
Trust failed to establish two of the elements of the Mobile
______
Steel test: that the Bank's overapplication of loan proceeds
_____
to soft costs was misconduct sufficient to support an award
of equitable subordination, or that this misconduct resulted
____________________
24. We disregard the FDIC's arguments that it is an
"innocent" receiver, having rejected this line of reasoning
in Part IV, supra.
_____
-74-
in injury to the Trust's other creditors. See Giorgio, 862
___ _______
F.2d at 938-39; Mobile Steel, 563 F.2d at 692. It also
____________
claims that to permit equitable subordination of its secured
claim would result in a double recovery by the Trust.
Although the remedy of equitable subordination has been
applied relatively infrequently, it is usually directed
towards misconduct arising in three situations: when a
fiduciary of the debtor misuses his position to the
disadvantage of other creditors; when a third party dominates
or controls the debtor to the disadvantage of others; or when
a third party defrauds the other creditors. Id. at 148-49
___
(citing 3 Collier at 510.05). See also A. DeNatale and P.
___ ____
Abram, The Doctrine of Equitable Subordination as Applied to
______________________________________________________
Nonmanagement Creditors, 40 Bus. Law. 417, 430-45 (1985)
________________________
("DeNatale & Abram"). This court has summarized briefly the
purpose of the remedy:
The case law does not suggest that the doctrine of
equitable subordination gives the bankruptcy court
a general license to weigh the moral quality of
_______
each debt or to compare creditors in terms of moral
worth; rather it indicates that the bankruptcy
court may equitably subordinate those debts, the
creation of which was inequitable vis-a-vis other
_______________
creditors. It permits a bankruptcy court to take
_________
account of misconduct of one creditor towards
another, just as that court often can take account
of a creditor's misconduct towards the debtor when
______
considering whether to allow, or to disallow, a
claim.
Thus, most cases involving "equitable
subordination" also involve corporate insiders or
fiduciaries who have obtained unfair advantages
over other creditors through, for example, fraud.
-75-
Where a bankruptcy court has subordinated the debt
of a creditor who was not an insider, it has done
so on the ground that that conduct was egregious
and severely unfair in relation to other creditors.
Giorgio, 862 F.2d at 939 (citations omitted and emphasis in
_______
original).
Whether the creditor is an insider or fiduciary of the
debtor is fundamentally important to the level of scrutiny
that courts apply to allegations of misconduct against a
creditor. See In re Fabricators, Inc., 926 F.2d 1458, 1465
___ ________________________
(5th Cir. 1991). See also DeNatale & Abram at 424 ("The
___ ____
creditor's duty of fair dealing is increased in the precise
degree that the creditor has power and control over the
debtor's affairs."). Claims arising from dealings between a
debtor and an insider are rigorously scrutinized by the
courts. Fabricators, 926 F.2d at 1465. On the other hand,
___________
if the claimant is not an insider, "then evidence of more
egregious misconduct such as fraud, spoliation or
overreaching is necessary." Id. (citing In re N&D
___ ____________
Properties, Inc., 799 F.2d 726 (11th Cir. 1986)). See also
________________ ___ ____
In re Friedman, 126 B.R. 63, 71-72 (Bankr. 9th Cir. 1991)
______________
(same principle).
Rather than decide the question of whether the Bank was
a fiduciary or insider of the Trust, the bankruptcy court
based its decision to award equitable subordination on its
finding that the Bank's conduct was "illegal, egregious and
severely unfair to other creditors" within the meaning of
-76-
Giorgio. Bankruptcy Court Opinion, 119 B.R. at 377. The
_______
bankruptcy court's equitable subordination of the Bank was
grounded on the Trust's claims of fraud, breach of contract
and conversion claims relating to the kickback scheme and its
___
claims of breach of contract and conversion premised on the
soft costs overages. The court specifically cited the Bank's
"fraud and illegality," which the bankruptcy court found
"together constitute one of the three general categories of
misconduct recognized by the courts as warranting equitable
subordination." Id.
___
The district court upheld the equitable subordination
against the FDIC's challenge on appeal, but at the same time
vacated that portion of the original judgment that was based
on the kickback claims, which it properly determined were
barred by D'Oench. Accordingly, the district court removed
_______
from the judgment of equitable subordination the $26,300 in
damages attributable to the kickback scheme. The district
court otherwise affirmed in its entirety the bankruptcy
court's determination that the Bank's misconduct justified
equitable subordination with respect to the soft costs
claims.
The FDIC argues that the Bank's misconduct in relation
to the breach of contract and conversion claims was
insufficient to support equitable subordination. This
argument raises an issue that was not fully addressed by the
-77-
district court when it reviewed the Trust's equitable
subordination claim against the FDIC as the successor to the
Bank: whether the bar under D'Oench to the Trust's kickback
_______
claims, and in particular its fraud claim, affected the
validity of the bankruptcy court's original judgment of
equitable subordination.
The bankruptcy court specifically premised the equitable
subordination on the Bank's "fraud and illegality," and the
Trust has never argued in this case that the Bank was an
insider or fiduciary of the Trust. Nor has the Trust ever
asserted that the Bank dominated or controlled its
affairs.25 Accordingly, the issue is whether equitable
subordination can be based solely on the Bank's misconduct in
relation to the excess withdrawals of soft costs.
Courts have struggled to define precisely the misconduct
necessary to support equitable subordination against a
creditor who is not an insider. Fraud or misrepresentation
____________________
25. We add that such allegations, if made in this case,
would not have been sufficient to satisfy the rigorous
standard necessary to prove control or domination of the
Trust's affairs by the Bank. See, e.g., In re Burner, 109
___ ____ _____________
B.R. 216, 228 (Bankr. W.D. Texas 1989) ("A non-insider
creditor will be held to a fiduciary standard only where his
ability to control the debtor is so overwhelming that there
has been a merger of identities."); In re Beverages Int'l
______________________
Ltd., 50 B.R. 273, 282 (Bankr. D. Mass. 1985) ("[m]ore than
____
mere pressure or influence on a debtor must be shown"). We
also note that "[a]s a general rule lenders are not
fiduciaries when it comes to collection on their claims." In
__
re Kelton Motors, Inc., 121 B.R. 166, 191 (Bankr. D. Vt.
________________________
1990) (citing In re W.T. Grant Co., 699 F.2d 599, 609 (2d
_____________________
Cir.), cert. denied, 464 U.S. 822 (1983)).
____________
-78-
are the most frequent justifications for equitable
subordination of the non-insider.26 They are not, however,
required:
Something less than actual fraud . . . will
suffice. The fixing of the lower limit is the
elusive boundary which cannot be clearly defined.
Although the courts have used general terms such as
injustice or unfairness to fix this lower limit,
the minimum level of offending conduct appears to
be conduct that shocks the conscience of the court.
. . .
DeNatale & Abram at 423-24. Types of misconduct sufficient
to warrant equitable subordination against non-insiders have
included instances of "[v]ery substantial misconduct
involving moral turpitude or some breach or some
misrepresentation where other creditors were deceived to
their damage . . . or gross misconduct amounting to
overreaching . . . ." In re Mayo, 112 B.R. 607, 650 (Bankr.
__________
D. Vt. 1990) (citations omitted). For the most part, courts
____________________
26. See, e.g., In re Bowman Hardware & Elec. Co., 67 F.2d
___ ____ ___________________________________
792, 795 (7th Cir. 1933) (where creditor participated with
debtor in scheme to misrepresent debtor's financial state,
creditor's claim subordinated to that of other creditor
injured by that misrepresentation); In re Osborne, 42 B.R.
_____________
988, 1000 (W.D. Wis. 1984) (equitable subordination
appropriate against lender based on its misrepresentations to
another creditor about that creditor's prospects for
payment); In re Slefco, 107 B.R. 628, 644 (Bankr. D. Minn.
____________
1989) (equitable subordination of bank's claim predicated on
bank's misrepresentation of amounts it intended to loan
debtor).
-79-
have been reluctant to find the requisite level of misconduct
in arms-length dealings between borrowers and lenders.27
In Kham & Nate's Shoes No. 2, Inc. v. First Bank of
_____________________________________________________
Whiting, 908 F.2d 1351 (7th Cir. 1990), the Seventh Circuit
_______
reversed the equitable subordination of a bank's priority
claim to a borrower's estate. Id. at 1356-1359. The
___
bankruptcy court had justified the equitable subordination on
the basis of, inter alia, the hardship caused to the
_____ ____
borrower/debtor by the bank's suspension of a new line of
credit.28 Finding that the bank was not an insider or
fiduciary of the borrower, and that the suspension of the
borrower's line of credit was permitted under the loan
contract, the Seventh Circuit rejected the reasoning of the
bankruptcy court. Id. at 1356-58. During the course of its
___
opinion, the court stated:
____________________
27. See In re Pacific Express, Inc., 69 B.R. 112, 117-18
___ _____________________________
(Bankr. 9th Cir. 1986) (creditors' loan agreement with
debtor, which effectively shifted risk of loss to other
creditors, was not "the type of overreaching, fraud or other
conduct which would justify subordination of a non-insider's
claim"); In re Dry Wall Supply, Inc., 111 B.R. 933, 937-39
____________________________
(D. Colo. 1990) (rejecting equitable subordination based on
allegations that creditor knew that loan transaction would
render borrower insolvent); In re Pinetree Partners, Ltd., 87
_____________________________
B.R. 481, 490 (Bankr. N.D. Ohio 1988) (lender's refusal to
provide additional credit and threatened foreclosure of
debtor's mortgage not sufficiently egregious to warrant
equitable subordination).
28. The other basis for the district court's equitable
subordination was its finding that the bank had induced the
borrower's suppliers to draw on letters of credit issued
prior to the bank's provision of the new line of credit. Id.
___
at 1354.
-80-
[W]e are not willing to embrace a rule that
requires participants in commercial transactions
not only to keep their contracts but also do
"more" just how much more resting in the
discretion of a bankruptcy judge assessing the
situation years later. . . . Unless pacts are
enforced according to their terms, the institution
of contract, with all the advantages private
negotiation and agreement brings, is jeopardized.
"Inequitable conduct" in commercial life means
breach plus some advantage-taking, such as the star
____
who agrees to act in a motion picture and then,
after $20 million has been spent, sulks in his
dressing room until the contract has been
renegotiated. Firms that have negotiated contracts
are entitled to enforce them to the letter, even to
the great discomfort of their trading partners,
without being mulcted for lack of "good faith."
Id. at 1356-57 (citations omitted). The Seventh Circuit also
___
rebutted the debtor's arguments that equitable subordination
could be based on a breach of contract arising from the
bank's failure to provide it telephonic as well as written
notice of the suspension of the line of credit, noting that
"[e]quitable subordination . . . is not a device to magnify
the damages available for inconsequential breaches of
contract." Id. at 1359.
___
Applying the somewhat amorphous case law standards for
equitable subordination to the facts of this case, we find
that the Bank's excess withdrawals of soft costs was conduct
sufficiently egregious to justify equitable subordination.
The Bank's actions could fairly be characterized as "gross
misconduct amounting to overreaching." Mayo, 112 B.R. at
____
650. Unlike the insubstantial breach of contract alleged in
-81-
Kham & Nate's Shoes, the Bank's withdrawal of over $100,000
___________________
in excess of the agreed-upon soft costs limits was a
substantial breach of the loan agreements. Moreover, the
fact that the Bank advanced and withdrew loan proceeds
arbitrarily, and at the same time caused interest to run on
misappropriated proceeds, in our view rises to the level of
"advantage-taking" within the meaning of Kham & Nate's Shoes.
___________________
As the bankruptcy court also found, the conversion of
the soft costs monies handicapped the renovation effort and
resulted in the Bank's recovering for its own benefit funds
that the Trust had bargained with the Bank to set aside for
construction creditors. Bankruptcy Court Opinion, 119 B.R.
at 377. While the Bank was entitled to enforce the loan
agreements without regard to the hardship imposed on the
Trust, Kham & Nate's Shoes, 908 F.2d at 1357, those loan
____________________
agreements did not authorize the Bank to seek reimbursement
for unpaid soft costs from the Trust's construction funds.
In this case, the hardship imposed on the Trust and its
construction creditors flowed from the Bank's improper and
unauthorized administration of the loans, and could therefore
properly have been considered an element of the equitable
subordination inquiry. We conclude that the Bank's
misconduct in relation to the soft costs claims was
sufficient evidence of misconduct on which to predicate the
equitable subordination of the FDIC's secured claim.
-82-
The FDIC nonetheless argues that equitable subordination
would be not appropriate under the second prong of Mobile
______
Steel because the Bank's misconduct did not result in injury
_____
to the Trust's other creditors. The FDIC bases this argument
on the bankruptcy court's determination that the
misappropriation of loan proceeds by the Bank was not the
principal cause of the failure of the Trust's construction
project and failure to repay the loan. The FDIC maintains
that the bankruptcy would have resulted even if the
misapplication of loan proceeds had not occurred, and that
any harm to the Trust's other creditors thus cannot be
attributed to the Bank's conduct.
The FDIC's argument boils down to the assertion that
equitable subordination is inappropriate unless the
misconduct at issue is a major cause of the debtor's
bankruptcy. This argument is without support in the case
law. The second prong of Mobile Steel establishes only that
____________
equitable subordination is appropriate when the misconduct
results in actual harm to the debtor or the other creditors,
"or conferred an unfair advantage on the claimant":
In examining the effect of the conduct on
creditors, the court should consider the effect on
the then-known creditors, as well as future
creditors. In this analysis, the question to be
answered is whether or not the offending conduct
had an impact on the bankruptcy results, that is,
the bottom line, in the proceeding before the
court. . . . This would encompass all the effects
of fraud and inequitable conduct that would have an
-83-
impact upon [other creditors' legal or equitable
rights in the bankruptcy results]. . . .
In demonstrating the harm, the objecting party
usually need not identify specifically each
particular creditor who was harmed and quantify the
injury suffered by each. If the misconduct results
in harm to the entire creditor body, the objecting
party need demonstrate only that the misconduct
harmed the creditor body in some general, albeit
concrete, manner.
DeNatale & Abram at 426 (footnotes omitted). The bankruptcy
court found, inter alia, that the Bank's misconduct damaged
_____ ____
other creditors by depleting the Trust's assets and,
consequently, its bankruptcy estate, and by substantially
handicapping the renovation effort, on which many creditors
ultimately had to rely for compensation. Bankruptcy Court
Opinion, 119 B.R. at 377. We find that this depletion of the
funds available for construction, and its attendant impact on
the success of the Trust's renovation efforts, was a
sufficiently concrete harm to the Trust's other creditors to
warrant equitable subordination of the Bank. Cf. In re
___ ______
Beverages Int'l Ltd., 50 B.R. 273, 283 (Bankr. D. Mass. 1985)
____________________
("the misconduct may result in harm to the entire creditor
body, [or] a particular class of creditors") (citing DeNatale
& Abram).
There is no merit to the FDIC's argument that the Bank's
conduct did not reduce the money present in the bankruptcy
estate available to the other creditors. The FDIC points out
that the Bank's overages of soft costs payments merely
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reduced the overall amounts due the Bank (and FDIC) as the
Trust's principal secured creditor. It reasons that there
could be no harm to the Trust's other creditors because the
FDIC's secured claim exceeds the value of the Trust's assets.
Such an argument ignores the very nature of the equitable
subordination remedy, whose precise purpose is to permit
recovery by other creditors with lower priority claims
because of misconduct of a particular creditor whose claim
would otherwise enjoy priority.
We also reject the FDIC's assertion that equitable
subordination of its secured claim would grant the Trust a
windfall double recovery. It is clear that it is the Trust's
unsecured creditors who will benefit from the partial
subordination of the FDIC's claim, not the Trust. The FDIC's
contention that damages are an adequate remedy at law is
equally spurious. The FDIC asserts that its secured claim
far exceeds the value of the Trust's estate or its
properties. Payment of damages by the FDIC on the soft costs
claim, rather than equitable subordination of an equivalent
amount, would simply increase the value of the estate that
the FDIC would recover. Without equitable subordination, the
FDIC would recoup from the Trust's estate any damages
attributable to the Bank's misconduct. Equitable
subordination is necessary in order to permit recovery by the
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Trust's other creditors to reflect the injury caused by the
Bank's misappropriation of loan proceeds for soft costs.
Accordingly, we affirm the equitable subordination of
the FDIC's secured claim, as reduced by the district court to
an amount equivalent to the damages attributable to the
excess soft costs monies withdrawn by the Bank.
VI. INTEREST
The FDIC next attacks the inclusion of interest on the
soft costs overages as part of the total amount of its
secured claim subject to equitable subordination. It
contends that the district court's affirmance of the
bankruptcy's court award of post-judgment interest "at the
contract rate from the dates on which they were
misappropriated" was contrary to law. The FDIC argues that:
(1) federal law forbids a post-judgment award of interest to
the extent that it provides for interest after appointment of
a receiver; and (2) the district court erred by setting post-
judgment interest at the rate found in the Loan Agreements.
Because the FDIC did not raise its first argument in the
district court below, we will not consider it. The district
court's opinion makes no mention of the federal law bar to
post-judgment interest claimed by the FDIC. The Trust
asserts in its brief that the issue was never raised in the
district court, and the FDIC has not refuted this contention
in its reply brief. There is also nothing in the record
-86-
before us that indicates that the issue was raised below.
We, therefore, deem the argument waived. See Boston Celtics,
___ ______________
908 F.2d at 1045.
The FDIC relies for its second argument on section 6C of
chapter 231 of the General Laws of Massachusetts, which
provides in pertinent part:
In all actions based on contractual obligations,
upon a verdict, finding or order for judgment for
pecuniary damages, interest shall be added by the
clerk of the court to the amount of damages, at the
contract rate, if established, or at the rate of
twelve per cent per annum from the date of the
breach or demand.
Mass. Gen. Laws Ann. ch. 231, 6C. The FDIC argues that
this statute requires a twelve percent rate of interest on a
judgment on a contract unless the contract obligated the
judgment debtor in this case the Bank to pay interest at
a different rate. The FDIC contends that because the Loan
Agreements imposed no obligation on the Bank to pay any
interest to the Trust, Massachusetts' default judgment
interest rate of twelve percent must be applied.
To our knowledge, the Massachusetts Supreme Judicial
Court has never addressed the issue of whether rates of
interest in a promissory note should be treated as the
"contract rate" for purpose of post-judgment interest against
the lender. See Mechanics Nat'l Bank, 384 N.E.2d at 1240
___ _____________________
n.14 (declining to address issue). After review of the
bankruptcy court's interpretation of section 6C, we are
-87-
persuaded that the court correctly decided to apply interest
at the contract rate specified in the loan agreements:
The contract rate is appropriate here . . . because
the Bank charged interest at the contract rate for
the misappropriated proceeds. Some of the interest
charged has been paid, and the remainder is part of
the Bank's secured claim[]. . . .
Bankruptcy Court Opinion, 119 B.R at 371 n.17. Application
of the contract rate of interest was necessary in order to
assure that the equitable subordination award fully reflected
the damages to the Trust resulting from the Bank's excess
withdrawal of soft costs. We affirm the district court's
rejection of the FDIC's challenge on this issue.
VII. ATTORNEY'S FEES
The district court affirmed equitable subordination
against the FDIC's secured claim in an amount equivalent to
the damages incurred by the Trust from the soft costs
overages plus interest. It reversed, however, the bankruptcy
court's determination that Massachusetts law permitted
attorney's fees as an element of the damages for conversion.
The district court held:
The Bankruptcy Code permits equitable subordination
of "all or part of an allowed claim to all or part
of another allowed claim." 11 U.S.C. 510(c)(1).
As I have previously held that it was improper to
award attorney's fees as an element of conversion
damages, the attorney's fees can no longer be
considered part of appellees' allowed claim against
the estate. Thus, the plain language of the
statute precludes the subordination of the Bank's
claim to the fee award.
-88-
While the district court rejected subordination of attorney's
fees on the grounds identified by the bankruptcy court, it
also observed in a footnote that "[a]ttorney's fees [could] .
. . still be allowed, of course, as an administrative
expense, see 11 U.S.C. 503(b)(3), accorded the priority
___
specified in the Bankruptcy Code."
The Trust challenges the district court's reversal of
the bankruptcy court's inclusion of attorney's fees in the
equitable subordination. The Trust does not, however,
contest the district court's interpretation of Massachusetts
conversion law. Rather, the Trust or more precisely, the
Trust's attorneys argue that attorney's fees are a valid
administrative expense claim against the bankruptcy estate
within the meaning of 11 U.S.C. 330(a)(1) and
503(b)(2).29 The Trust's attorneys contend that because
____________________
29. Section 503(b) of the Bankruptcy Code governs the
allowance of administrative expenses. Among the
administrative expenses permitted, after notice and a
hearing, are claims for "compensation and reimbursement
awarded under section 330(a) of this title." 11 U.S.C.
503(b)(2). Section 330(a) provides in pertinent part:
(a) After notice to any parties in interest and to
the United States trustee and a hearing . . . the
court may award to a trustee, to an examiner, to a
professional person employed under section 327 or
1103 of this title, or to the debtor's attorney
(1) reasonable compensation for actual,
necessary services rendered by such trustee,
examiner, professional person, or attorney,
. . . based on the nature, the extent, and the
value of such services, the time spent on such
services, and the cost of comparable services
other than in a case under this title . . . .
-89-
their fees are in fact a valid "claim" under these
provisions, the bankruptcy court's decision to include
attorney's fees in the equitable subordination against the
Bank was proper. See 11 U.S.C. 510(c)(1) (bankruptcy court
___
may, "under principles of equitable subordination,
subordinate for purposes of distribution all or part of an
allowed claim to all or part of another allowed claim . . .
.").
This argument puts the cart before the horse. Although
both the bankruptcy and district courts acknowledged, in
dicta, that a request by the Trust for attorney's fees might
_____
be an allowable administrative expense under the Bankruptcy
Code, neither court expressly made such a determination. In
fact, the Trust's attorneys acknowledge in their reply brief
that they have not, as yet, asked the bankruptcy court to
award them attorney's fees as an administrative expense
claim. See Reply Brief for Appellant 604 Columbus Avenue
___
Realty Trust at 2-3. Any such award of attorney's fees as an
administrative expense under sections 330(a)(1) and 503(b)(2)
would require notice and a hearing. See 11 U.S.C. 330(a)
___
and 503(b).
____________________
11 U.S.C. 330(a). Administrative expenses allowable under
503(b), which include expenses under 330(a), are given
first priority of payment under the Bankruptcy Code. See 11
___
U.S.C. 507(a)(1).
-90-
In these circumstances, we need not address the argument
that the bankruptcy court should properly have subordinated
the Bank's secured claim to an administrative expense claim
of the Trust's attorneys. Such a claim had neither been made
nor allowed by the bankruptcy court at the time of its
equitable subordination of the Bank. We, therefore, affirm
the district court's reversal of the bankruptcy court's
inclusion of attorney's fees in the equitable subordination
against the Bank, insofar as that decision reversed the award
of attorney's fees as an element of the conversion
damages.30
CONCLUSION
CONCLUSION
To summarize, we find that:
(1) the FDIC was entitled to raise its defenses under
federal law for the first time on appeal in the district
court;
(2) the D'Oench doctrine barred the Trust's claims for
_______
fraud, conversion, and breach of contract arising from
the kickback scheme;
(3) the federal holder in due course doctrine did not
apply to the FDIC in its receivership capacity in the
absence of a purchase and assumption transaction, and
____________________
30. We express no opinion on the merits of the Trust's claim
that its attorney's fees are administrative expenses within
the meaning of sections 330(a)(1) and 503(b)(2).
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therefore did not bar the Trust's claims for conversion
and breach of contract based on the soft costs overages;
(4) federal common law did not preclude equitable
subordination against the FDIC in its receivership
capacity;
(5) the bankruptcy and district courts properly found
for the Trust on its breach of contract and conversion
claims based on the soft costs overages;
(6) equitable subordination of the FDIC's secured claim
in an amount equivalent to the soft costs damages was
proper;
(7) the bankruptcy court properly included as part of
the overall amount of the FDIC's claim subject to
equitable subordination an award of post-judgment
interest on the soft costs damages at the contract rate;
and
(8) attorney's fees were not an element of conversion
damages, and could not properly have been included in
the amount equitably subordinated.
AFFIRMED.
________
-92-
Slefco v. First National Bank of Stuttgart (In Re Slefco) , 107 B.R. 628 ( 1989 )
Unsecured Creditors' Committees of Pacific Express, Inc. v. ... , 69 B.R. 112 ( 1986 )
Michael J. Capizzi v. Federal Deposit Insurance Corporation,... , 937 F.2d 8 ( 1991 )
In Re G.S.F. CORPORATION, Debtor, Chase Commercial ... , 938 F.2d 1467 ( 1991 )
In Re Friedman , 126 B.R. 63 ( 1991 )
Federal Deposit Insurance Corporation, Etc. v. Leonard ... , 931 F.2d 1 ( 1991 )
In Re Frank Giorgio and Pauline Giorgio, Debtors. John ... , 862 F.2d 933 ( 1988 )
Richard J. BRIDEN, Appellant, v. Anne FOLEY, Trustee in ... , 776 F.2d 379 ( 1985 )
Timberland Design, Inc. And William C. Barnsley v. First ... , 932 F.2d 46 ( 1991 )
Federal Deposit Insurance Corporation v. P.L.M. ... , 834 F.2d 248 ( 1987 )
United States v. Judith Ann Krynicki , 689 F.2d 289 ( 1982 )
In Re Navigation Technology Corporation, Debtor. Victor W. ... , 880 F.2d 1491 ( 1989 )
United States v. Julio La Guardia, United States of America ... , 902 F.2d 1010 ( 1990 )
Boston Celtics Limited Partnership v. Brian Shaw , 908 F.2d 1041 ( 1990 )
in-re-n-d-properties-inc-debtor-julia-schou-estes-v-n-d , 799 F.2d 726 ( 1986 )
Federal Deposit Insurance Corporation, a United States ... , 911 F.2d 1466 ( 1990 )
the-federal-savings-loan-insurance-corp-as-receiver-for-vernon-savings , 928 F.2d 1558 ( 1991 )
Federal Deposit Insurance Corporation, as Receiver of Twin ... , 911 F.2d 593 ( 1990 )
Boston Edison Company v. Federal Energy Regulatory ... , 856 F.2d 361 ( 1988 )
Federal Deposit Insurance Corporation, in Its Corporate ... , 888 F.2d 1537 ( 1989 )