Free Response to Motion - District Court of Federal Claims - federal


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Case 1:92-cv-00550-MCW

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS __________________________________________ ) NORTHEAST SAVINGS, F.A., ) ) Plaintiff, ) ) Civil Action No. 92-550C v. ) Judge Williams ) UNITED STATES OF AMERICA, ) ) Defendant. ) _________________________________________ )

PLAINTIFF'S RESPONSE TO DEFENDANT'S MOTION FOR LEAVE TO NOTIFY THE COURT OF SUPPLEMENTAL AUTHORITY

James C. Martin REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 15219 412.288.3131 (phone) 412.288.3063 (fax) (Counsel of Record for Northeast Savings, F.A.)* Of Counsel:* Donna M. Doblick REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 152319 412.288.3131 (phone) 412.288.3063 (fax)

*A Consent Motion to Substitute Counsel was filed March 25, 2008.

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Northeast agrees with the government on one thing: In Sterling Savings Association v. United States, 80 Fed. Cl. 497, 512-18 (2008), this Court denied lost profits to a thrift. Thereafter, Northeast parts company. Where the recovery of lost profits is concerned, the facts make the case, and the facts of Sterling are readily distinguishable from the facts of this case in several critical ways. The methodologies used by Sterling's expert also differ from the methodologies used by Northeast's expert in equally significant ways. Sterling accordingly has no applicability here. The government portrays Sterling as precluding lost profits in this case (if not in all Winstar cases), largely by taking a portion of a quote from the case out of its proper context. As a preliminary matter, the government's position notwithstanding, lost profits are recoverable in Winstar cases. See, e.g., Anchor Savings Bank, F.S.B. v. United States, 2008 WL 725518, *176 (Mar. 14, 2008) (awarding nearly $180 million in lost profits); Astoria Fed. Sav. & Loan Assoc. v. United States, 80 Fed. Cl. 65, 90-92 (2008) (awarding over $14 million in lost profits); Globe Savings Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005), aff'd in part and vacated in part, 189 Fed. Appx. 964 (Fed Cir. July 20, 2006) (unpublished) (affirming in part the award of lost profits, but remanding to determine the offset value of the sale of a branch). Sterling is thus better understood as standing for the narrower, and far less remarkable proposition that a thrift's entitlement to lost profits will depend on the facts of the given case and on the soundness of the methodology the thrift's expert uses to estimate those lost profits. Because the facts and expert methodology in this case are different in critical respects, the result must be different also. The First Fundamental Distinction: Sterling Went On An Aggressive Capital Campaign In Response To FIRREA, And Had Significant Capital At Its Disposal. Sterling's and Northeast's reactions to the government's breaches of their contracts could not

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have been more different. After initially enjoining the government from enforcing FIRREA's new capital requirements, Sterling relented and went on an aggressive (and successful) campaign to raise capital.1 As discussed below, it was precisely because that capital campaign was successful (indeed, it generated more capital than Sterling was able to use) that the Court could not conclude that the government's breach of Sterling's contracts caused Sterling to suffer lost profits. Sterling contended that the government's elimination of $15.557 million in supervisory goodwill caused it to forego profits in the years following the breach.2 However, Sterling was able to raise over $500 million in capital in the years following the passage of FIRREA in 1989. Sterling, 80 Fed. Cl. at 515. Specifically, Sterling had benefited from an arrangement whereby it received capital distributions from a corporation ("SFC") set up, in large part, to raise capital for it. Id. at 508, 516. Under this arrangement, SFC raised millions of dollars each year, all of which was available to Sterling. Id. at 508. Although Sterling had access to all of the raised capital, it accepted millions of dollars less than the full amount each year following the government's breach. Id. In fact, Sterling had over $140 million in available capital at its disposal between 1992 and 2006 that it did not use. Id. at 508, 516.

Indeed, this Court found it significant that Sterling had in fact been able to "soften[ ] FIRREA's blow," by obtaining a court-ordered injunction that prohibited the government from holding Sterling to FIRREA's capital standards. 80 Fed. Cl. at 515. That injunction, which remained in effect for nearly two years (until after Sterling had replaced the lost supervisory goodwill in the capital markets) mitigated Sterling's claimed damages. Id. at 505-06. This Court faulted Sterling's expert for failing even to consider the ameliorative effect of that injunction. Id. at 515. Here, however, Northeast did not benefit from any such court-ordered temporary relief from FIRREA's requirements. 2 As a preliminary matter, the sheer amount of supervisory goodwill at issue here in excess of $200 million dwarfs the amount at issue in Sterling. The evidence established that Northeast, unlike Sterling, simply was in no position to replace hundreds of millions of dollars of lost supervisory goodwill in the capital markets.

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This Court concluded that the availability of that substantial unused capital nullified Sterling's argument that, had it not been for the government's breach, Sterling would have used the supervisory goodwill to generate additional profits in those same years. Id. at 516, 518. Sterling's failure to use that available capital thus was central to this Court's rejection of Sterling's lost profits claim. See, e.g., 80 Fed. Cl. at 516 (criticizing Sterling's lost profits model for failing to account for its mitigation efforts, and noting that Sterling had "sufficient capital that could have been used" to make up for any lost volume sales); id. (criticizing Sterling's expert's model for lack of evidence showing Sterling's lost opportunities and reasoning that Sterling's claim of lost profits was undermined because thrift had access to additional capital that it did not use); id. at 518 (criticizing Sterling's damages model for failing to account for the law of diminishing returns, and explaining that Sterling's failure to use its available capital demonstrated that it lacked profitable opportunities in which to invest). The facts here could not be more different. Northeast lost hundreds of millions of dollars in supervisory goodwill that it was not able to replace in the capital markets. Northeast (unlike Sterling) was in serious need of capital in each of the relevant years following the government's breach (to satisfy FIRREA's breaching capital requirements), but it lacked ready access to the capital markets until well into the 1990s. See, e.g., Plaintiff's Post-Trial Brief (1/22/07), Proposed Findings of Fact ("FF"), 226-231. In short, the impact of the government's breach on Northeast was both direct and substantial. While Sterling was able to raise capital to satisfy FIRREA's capital requirements, Northeast was forced to shrink substantially (and repeatedly) over a period of years in order to meet (and remain compliant with) FIRREA. The Second Fundamental Distinction: Sterling Did Not Lose Opportunities. Prior to the government's breach, Sterling and Northeast had fundamentally different business models

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and business plans. Sterling historically grew largely by acquiring other thrifts. Indeed, Sterling had acquired approximately 20 other thrifts since 1983. Sterling, 80 Fed. Cl. at 501. However, Sterling failed to identify even "a single potential acquisition that it was unable to consummate because of a lack of capital." Id. at 516. Moreover, as the Court similarly appreciated, the fact that Sterling did not use all of the capital that was readily available to it (from SFC) supported the finding that Sterling simply "did not have additional profitable opportunities" those years. Id. (emphasis added). Northeast, on the other hand, had a fundamentally different business plan and strategy, and the government's breach thus affected it differently. Northeast had been primarily engaged in wholesale banking. As set forth in its December 1988 Business Plan (and but for FIRREA), Northeast planned to shift its focus (over a period of about five years) from wholesale banking to retail banking. FF 71-73, 77, 80-81, 98-102, 120, 122. Even with the shift, Northeast planned to remain roughly a $8 billion institution. FF 95, 120. As a result of FIRREA's capital requirements, though, Northeast was forced to jettison billions of dollars of assets and liabilities on which it was earning a positive spread, and which carried very little credit risk. The government's breach also cost Northeast the ability to maintain its planned size by profitably reinvesting in replacement assets as existing assets ran off as it historically had done. In short, the profit-making opportunities Northeast lost as the result of the government's breach were real, not speculative. The Third Fundamental Distinction: Sterling's Lost Profits Claim Was Fundamentally Different. The government reads Sterling as standing for the proposition that the hypothetical rate of return on a thrift's incremental assets cannot, as a matter of law, exceed the actual returns the thrift enjoyed on its assets. Sterling does not stand for any such

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proposition, as the Court made no categorical pronouncements of this sort. In any event, Sterling certainly is not, as the government erroneously contends, "fatal" to Northeast's lost profits claim, especially since Sterling's lost profits claim was very different from the lost profits claim Northeast makes here. Sterling's expert's lost profits model started with the assumption that, but for the government's breach, Sterling would have replicated its existing portfolio on a larger scale (e.g., making the same proportion of relatively higher-yielding loans as it currently had). However, the evidence showed that Sterling had supplemented its loans with investments in mortgagebacked securities ("MBS") and Federal Home Loan Bank advances assets that "typically yield[ed] less return than most of its loans." Id. Sterling's investments in MBS's and FHLB advances were attributable in large part to the presence of "formidable competition from larger banks" that hampered Sterling's ability to generate loans. Id. The government claims that the Sterling Court held (as a matter of law or as a matter of economics) that: "`Sterling could not have added incremental assets at the same rate of return as Sterling's actual assets.'" Govt. Motion at p. 1 (quoting Sterling, 80 Fed. Cl. at 518). But what the Sterling Court actually wrote was: "Other evidence confirms that Sterling could not have added incremental assets at the same rate of return as Sterling's actual assets." Sterling, 80 Fed. Cl. at 518 (emphasis added). The "other evidence" was the presence of the relatively low-yield investments on Sterling's balance sheet. The Court saw this as proof that Sterling historically had been unable to "fill its portfolio with higher yielding assets and lower cost liabilities." Id. It was in that specific factual context that the Court concluded that "Sterling could not have added incremental assets at the same rate of return as Sterling's other assets," and that the expert's

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failure to account for the "formidable competition" for loans was a fatal flaw in his methodology. Id. The facts here are markedly different, so different, in fact, that the government's statement (for which it relies on Sterling for support) that "companies make their most profitable investments first, and then make the less profitable ones subsequently" is nonsensical when applied here, for several reasons. First, the very premise of the government's position in its Motion that "Northeast is asking the Court to assume that [its] incremental assets and liabilities would have achieved far higher, indeed, infinitely higher returns than its actual assets" is false. That position is a reformulation of the government's myopic fixation on the returns on Northeast's so-called "core earnings." However, as Northeast explained in its briefs, it would be error for the Court to focus on this highly artificial measure. The bank as a whole was profitable during most of the period which Northeast claims damages, and Dr. Baxter's assumptions about the returns on incremental assets and liabilities are both conservative and instep with the bank's actual experience. Second, unlike the hypothetical loans the expert in Sterling assumed the thrift would had made but for the government's breach, the MBS's and collateralized mortgage obligations ("CMOs') that Northeast jettisoned in an effort to meet FIRREA's capital requirements were not hypothetical or speculative in the least: they were profitable assets Northeast already held but was pressured to divest. Moreover, those assets remained profitable after divestiture. In his analysis, Dr. Baxter simply restored them to the bank's incremental portfolio, and then calculated the profits they would have generated for the bank (based on actual results) but for the government's breach.

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In short, while the facts of Sterling led this Court to conclude that lost profits could not be recovered as a result of the government's breach, the markedly different facts of this case compel a contrary result. Respectfully submitted, DATED: April 1, 2008 /s/ James C. Martin James C. Martin REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 15219 412.288.3131 (phone) 412.288.3063 (fax) (Counsel of Record for Northeast Savings, F.A.) Of Counsel: Donna M. Doblick REED SMITH LLP 435 Sixth Avenue Pittsburgh, PA 15219 412.288.3131 (phone) 412.288.3063 (fax)

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