Appendix — Northwest Racquet Swim & Health Clubs, Inc. v. Resolution Trust Corp.

In the

Supreme QDourt of the United States

October Term, 1990

STEPHEN ADAMS,

Petitioner,

v.

RESOLUTION TRUST CORPORATION, as receiver for

MIDWEST FEDERAL SAVINGS AND LOAN 24

ASSOCIATION,

HAROLD W. GREENWOOD, JR.; DONALD SNEDE; and JOHN

DOES 1-10,

Respondents,

and

STEPHEN ADAMS,

Petitioner,

¥.

FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC)

as manager of the FSLIC RESOLUTION FUND,

Respondent.

APPENDIX

TO PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

TIMOTHY D. KELLY

JOHN E. GRZYBEK

3720 IDS Center

Minneapolis, Minnesota 55402

. (612) 349-6171

Attomeys for Petitioner

May 29, 1991

1991 — Bachman Lega! Printing, 835 Second Ave. So., Mpls., MN 55402 — (612) 339-9518

@ FAX 612-337-8053

[4s

APPENDICES

Page

Appendix A

The Court of Appeals Decision,

A R lution Tr

Corp., et al., dated February 28,

cc Sp en erie aaa la

Appendix B

The Court of Appeals Judgment,

Adams v. Resolution Trust

Corp., et al., dated February 28,

CS eas os 5 es 6-6 086 wos 6:6 6b eee '29a

Appendix C

The Court of Appeals Decision,

Northwest Racquet Swim &

Health Clubs, Inc., v.

Resolution Trust Corp.,

et al., dated February 28,

WE a as Gk os oO Oe eee ee 31a

Appendix D

The District Court Decision,

Adams v. Resolution Trust

Corporation, dated February 9,

1990, as amended March 2,

Appendix E

The District Court ee

- ms v. Federal De it

ns. Corp., dated ola rx

oes et ee a ar a ae ee 98a

|

Appendix F

Statutes Relied Upon

eee. @ 6S .........

co. 96 ee, © 1444a ......

Ste. 02 0.8.€. § 1729 .......

Regulations Relied Upon

a 12 C.F.R. § 563.8-1

a sau bo 6 64 0 000 e

Iz. 12 €.9.8. § 563.13

PTC SESE kisses ce

III. 12 C.F.R. § 567.2(a)

i Oe

Appendix G

Transcript of Motion

Proceedings Before The

Honorable James M.

Rosenbaum, United States

District Court, dated

August 24, 1989 .............

ii

‘APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

No. 90-5123

Stephen Adams,

Appellant,

Vv.

Resolution Trust Corporation as

Receiver for Midwest Federal

Savings and Loan Association;

Harold W. Greenwood, Jr.;

Donald Snede; and John

Does 1-10,

Appellees.

No. 90-5124

Stephen Adams,

Appellant,

Vv.

Federal Deposit Insurance

Corporation (FDIC) as manager

of the FSLIC Resolution Fund,

Appellee.

la

+ + + HF H HH HF HH HH HF HK

+ + * H HF HF HK F

Appeals from the United States

District Court for the

District of Minnesota.

Submitted: September 12, 1990

Filed: February 28, 1991

Before McMILLIAN, Circuit Judge, BRIGHT,

Senior Circuit Judge, and BOWMAN, Circuit

Judge.

BRIGHT, Senior Circuit Judge.

Stephen Adams (Adams) appeals’ the

district court's’ grant of summary

judgment? te the Resolution Trust

Corporation (RTC) in this action for

rescission of a subordinated debt

securities agreement which Adams executed

in conjunction with his purchase of $2.5

‘The Honorable James M. Rosenbaum,

United States District Judge for the

District of Minnesota.

*The district court's decision is

reported as Adams v,. Resolution Trust

Corp., 731 F. Supp. 352 (D. Minn. 1990).

2a

million in subordinated debt securities

from now insolvent Midwest Federal

Savings and Loan Association (MWF). On

appeal, Adams contends that MWF's

insolvency does not affect his right to

rescind the agreement by which MWF

fraudulently induced him to purchase the

securities. According to Adams, a post-

insolvency rescission would elevate the

subordinated debt to general creditor

status, entitling him to set off the debt

against a promissory note he executed in

favor of MWF. Adams also contends that

the district court should not have

dismissed as moot his common law fraud

claim against the RTC, in its capacity as

receiver for MWF, merely because MWF

possessed insufficient funds to satisfy

a successful damages judgment. Finally,

he contends that the district court erred

in dismissing his related claim against

the Federal Deposit Insurance Corporation

(FDIC) for violating ratable distribution

principles in disposing of MWF's assets.

We affirm.

I. BACKGROUND

This case arises out of the failure of

the Minneapolis based Midwest Federal

Savings and Loan Association (MWF) which

we visited in Northwest Racquet Swim

Health Clubs Inc. v. Resolution Trust

Corp., Nos. 89-5526, 89-5585, slip op.

(8th Cir. Feb. __, 1991) -- a companion

case which we discuss below. Stephen

Adams, a Florida businessman with

interests in banking, broadcasting and

publishing, purchased $2.5 million in

subordinated debenture securities

(Securities) from MWF on March 31, 1988.

Adams financed the purchase with funds he

borrowed on an apparently unsecured

promissory note he executed in favor of

4a

MWF at the time he _ purchased the

Securities. On the same day, Adams

executed a subordinated debt securities

agreement (Securities Agreement) setting

out the terms and conditions of the

purchase.

The Securities Agreement expressly

subordinated Adams's claims in the event

of MWF's liquidation, "to all claims

against [MWF] having the same priority

as savings account holders or any higher

priority."

Joint Appendix (J.A.) 66.

It also specified the remedies to apply

in the event of default. The Securities

‘The priority scheme governing

claims against an insolvent’ thrift

institution placed savings account

holders in the sixth priority position

after various administrative costs,

expenses and debts associated with the

operation of the receivership, various

wage and benefits claims of the employees

of the failed thrift, and certain

government tax claims. 14: C.F. FS

569c.11 (1989).

———eOOoO7OT

Agreement defined default as including

failure to make timely payment of the

principal or interest due, declaration of

insolvency, or the appointment of a

conservator, receiver or liquidating

agent. A default would also arise in the

event that “any representations or

warranty made in writing by or on behalf

of [MWF] herein or in connection with the

transactions . . . shall prove to have

been false or incorrect in any material

respect on the date as of which made."

J.A. 69.

In the event of a default, the remedies

section provided that Adams could protect

and enforce his rights by an action in

law, suit in equity, or other appropriate

proceeding. However, the Securities

Agreement placed three significant

limitations upon Adams' rights, powers

and remedies. First, he could accelerate

payment in the event of default only to

the extent that such payment did not

leave MWF with insufficient capital to

meet regulatory capital requirements set

out in 12 C.F.R. §. 563.13 (1968).

Second, in the ‘event that the Federal

Savings and Loan Insurance Corporation

(FSLIC) was appointed receiver of MWF,

FSLIC would have no obligation to arrange

for _the assumption of the Securities.

Finally, the Securities Agreement bound

Adams to abide by the priority scheme set

out in the Federal Home Loan Bank Board’

(Bank Board) regulations governing the

distribution of assets in liquidation

“The Federal Home Loan Bank Board

acted as the principal regulator of the

federal savings and loan industry until

August 9, 1989, when Title IV of the

Financial Institutions Reform, Recovery

and Enforcement Act of 1989, Pub. L. No.

101-73, 103 Stat. 354, abolished the Bank

Board and replaced it with the Office of

Thrift Supervision.

proceedings.”

The sale of the Securities was

contingent upon Bank Board approval

pursuant to 12 C.F.R. § 563.8-1 (1988),

governing the issuance of subordinated

debt securities by federal savings and

loan associations. By letter dated March

31, 1988, Donald Snede, MWF's’ chief

financial officer, stated that the Bank

Board had approved the issuance of the

note. The Bank Board apparently had

given prior approval, on December 21,

1987, to the sale and issuance of up to

$25 million in MWF subordinated debt

securities.

| *under the regulatory priority

scheme, see note 4, the claims of

subordinated debt holders like Adams held

a ninth rank priority, behind the claims

of all general creditors, and ahead only

of equity interest holders. 12C.F.R. §

569c.11 (1989).

MWF immediately applied the Securities

to its regulatory capital.° From March

31, 1988 through November 1988, the Bank

Board recognized the Securities as part

of MWF'’s regulatory capital. In January

1989, however, the Bank Board issued a

°Regulatory capital is the sum of,

inter alia, reserve accounts, retained

earnings, permanent common stock,

securities which constitute permanent

equity capital, appraised equity capital

and any other nonwithdrawable accounts

which constitute the institutions

reserves available for satisfying the

claims of depositors and other account

holders. See 12 C.F.R. § 561.13 (1988).

Pursuant to statutory authority, 12

U.S.C. § 1464(s) (1988), the Bank Board,

and its successor, the Office of Thrift

Supervision (OTS), sets the minimum

capital requirements for the industry.

Since 1973, the Bank Board or OTS has

permitted thrift institutions to include

long-term subordinated debt securities as

part of their regulatory capital because

such securities possess many of the

characteristics of permanent capital. 54

Fed. Reg. 34,148 (1989) (commentary

accompanying Final Rule amendments to

regulations governing the issuance and

use of subordinated debt (codified at 12

C.9.R.s @& $63.73 (1969))); 12 C.FR. §

561.13 (1988).

directive ordering MWF to prospectively

remove the Securities from regulatory

capital because Adams had purchased them

with funds he had borrowed from MWF on an

unsecured basis.

On February 13, 1989, the Bank Board

declared MWF insolvent after finding that

its obligations to its creditors

(including savings account holders)

exceeded its assets. Accordingly, the

Bank Board exercised its’ statutory

authority under 12 U.S.C. § 1464(d)

(6)(A)(i) (1988), and named FSLIC as

conservator of MWF. FSLIC attempted to

operate MWF as a going concern.

On March 21, 1989, Adams filed the

initial complaint against MWF and its

ottiows which gave rise to this action.

Adams brought claims for violations of

federal and state securities laws,

alleging that MWF had _ fraudulently

10a

induced him to purchase the Securities by

making material misrepresentations

regarding its financial condition at the

time of the transaction.’ Adams asked

the court to declare the Securities

Agreement subordinating the investment

rescinded and to set off the unpaid

balance of the Securities obligation

against a $7,485,000 promissory note

7Adams alleged that MWF and its

officers did not disclose that one of its

assets, which was carried on its books at

over $100 million, was the subject of a

legal dispute which brought its actual

value into question. The dispute over

the asset, currently the subject of

litigation in federal court, brought into

question at least $100 million of MWF's

$140 million regulatory capital base,

according to Adams. He asserted that

MWF's nondisclosure and the resulting

misrepresentations regarding its

financial condition violated § 10b of the

Securities Exchange Act of 1934, 15

U.S.C. § 783(b), Rule 10b-5 of the

Securities Exchange Commission, 17 C.F.R.

§ 240.10b-5 (1988), § 12(2) of the

Securities Act of 1933, 15 U.S.C. § 771,

and Minn. Stat. § 80A.01 (1986), and also

constituted common law fraud and breach

of contract.

lla

which he owed to MWF.®° He also sought

damages for common law fraud.

Soon after, on April 7, 1989, MWF

informed Adams that it would default on

the 1989 first quarter interest payment

due on the Securities. On May 4, 1989,

the Bank Board, noting that MWF's

liabilities continued to exceed its

assets, concluded that MWF could not be

operated as a going concern. The Bank

Board, acting _ pursuant to statutory

authority, 12 U.S.C. § 1464(d)(6)(A)

(1988); 12 C.F.R. § 547 (1988), appointed

FSLIC as receiver for the purpose of

liquidating MWF. FSLIC, by operation of

law, thus took possession of MWF and

succeeded to all of MWF's rights, titles,

powers and privileges. See 12 U.S.C. §§

1464(d), 1729 (1988). In addition, the

Bank Board determined that the total

®See note 3.

12 a

liquidation of MWF would not generate

sufficient funds to satisfy the claims of

MWF's general creditors. Therefore, it

formally declared all subordinated debt

and equity interests in MWF to be

mithises.’

The Bank Board also contemporaneously

created a new savings and loan

association, Midwest Savings Association

(Midwest Savings), to facilitate the

liquidation of MWF and the reorganization

of its assets. The Bank Board

*The settlement of claims in the

event of liquidation proceeded under an

absolute priority scheme, meaning that

ninth and tenth priority subordinated

debt and equity holders could receive

treatment of their claims only after all

claims of the first eight ranks had been

fully settled. See 12 C.F.R. §

569c.11(d) (1989). Thus, the Bank

Board's determination that MWF's assets

were insufficient to satisfy the claims

of seventh priority general creditors

meant that no money remained for the

claims of ninth priority subordinated

debt holders like Adams.

13a

immediately placed Midwest Savings under

FSLIC conservatorship. It further

directed FSLIC to enter into a purchase

and assumption agreement with Midwest

Savings, transferring most of MWF's

assets to Midwest Savings in

consideration for Midwest Savings,

assumption of certain MWF liabilities.

Under the purchase and assumption

agreement, Midwest Savings did not assume

any MWF subordinated debt or equity

liabilities or obligations, including the

securities at issue here. As a result of

this transaction, the obligations arising

from the Securities remained with FSLIC,

as receiver for MWF, while Midwest

Savings assumed possession of the

promissory notes against which Northwest

sought to exercise its claimed right of

setoff.

14a

Adams responded to these regulatory

actions by discontinuing payment on the

promissory note now held by Midwest

Savings. He also filed a_é second

complaint, on June 28, 1989, against

FSLIC in its corporate capacity, in which

he contended that the purchase _ and

assumption agreement violated ratable

distribution principles implicit in the

statutory provision governing the

liquidation of failed thrifts, 12 U.S.C.

§ 1729 (1988). Adams contended that

FSLIC should not have transferred Adams'

$7,485,000 note to Midwest Savings

because it knew that Adams sought to set

it off against the Securities which FSLIC

also knew MWF had fraudulently induced

Adams to purchase. Adams contended that

his rescission entitled him to share in

the pro rata distribution of MWF's assets

to the general creditors. Adams

consequently asked the court to declare

the purchase and assumption agreement

invalid and permit him to set off the

Securities obligations against his MWF

loan obligations now held by assignee

Midwest Savings.

In February 1990, the district court

granted FSLIC's motion for summary

judgment in the first action. Adams v.

Resolution Trust Corp., 731 F. Supp. 352

(D. Minn. 1990)."° The district court

adopted the analysis of the Second

Circuit in In re Weis Sec., Inc., 605

"in August 1989, as part of the

overhaul of the thrift industry embodied

in the Financial Institutions Reform,

Recovery and Enforcement Act, Congress

abolished Federal Savings and_ Loan

Insurance Corporation (FSLIC) and

replaced it with the Resolution Trust

Corporation (RTC). Pub. L. No. 101-73,

Title IV, 103 Stat. 354 (1989). During

the pendency of the proceedings before

the district court, the parties

accordingly stipulated to the

substitution of RTC, for FSLIC, as

receiver of MWF.

16a

F.2d 590 (2d Cir. 1978), cert. denied,

439 U.S. 1128 (1979), and held, as a

matter of iaw, that because MWF had

applied the funds from the sale of the

Securities to regulatory capital, Adams

was precluded from rescinding the

Securities Agreement after the Bank Board

had declared MWF insolvent. The

Securities, therefore, remained

subordinated, and thus lacked the

requisite mutuality of obligation

necessary to set them off against the

promissory note.

The district court also dismissed as

moot Adams' claim for common law fraud.

The Bank Board's determination that

Adams' subordinated debentures were

worthless because MWF's assets’ were

insufficient to satisfy general creditor

liabilities meant, according to the

district court, that FSLIC, as receiver,

17 4

simply had no assets with which to

satisfy a judgment if Adams were to

succeed on his common law fraud damages

claim. Thus, the court dismissed the

damages action on prudential grounds.

In a separate proceeding, the district

court also dismissed Adams' second action

against FSLIC seeking to invalidate the

purchase and assumption agreement with

, The district court

Midwest Savings. '

again held that because Adams could not

rescind the Securities Agreement, he

remained a subordinated interest who had

no right to participate in the pro rata

distribution of assets to the general

“puring the pendency of this action,

Congress abolished FSLIC, in its

corporate capacity, and replaced it with

the Federal Deposit Insurance Corporation

(FDIC). Financial Institutions Reform,

Recovery and Enforcement Act of 1989,

Pub. L. No. 101-73, Title IV, 103 Stat.

354. FDIC, accordingly, now stands in

FSLIC's place as defendant and appellee

in Adams, second filed action regarding

the purchase and assumption agreement.

18a

a aaa Nati bates OS TRE Op RRR A TY

creditors."

Adams filed this consolidated appeal.

II. DISCUSSION

All but one of Adams' contentions on

appeal hinge upon the validity of the

district court's determination that the

application of his investment to MWF's

regulatory capital precluded him from

rescinding the Securities Agreement after

the date of MWF's’ insolvency. We

addressed this very issue in Northwest

Racquet Swim & Health Clubs. Inc. v.

Resolution Trust Corp., Nos. 89-5526, 89-

5585, slip op. (8th Cir. Feb. __, 1991),

For the same reasons, the district

court also denied Adams, motion to

preliminarily enjoin FSLIC from further

transferring the assets of MWF and from

enforcing the promissory note which Adams

had ceased paying. Because Adams was not

entitled to rescind the Securities

Agreement, the Securities obligation

remained subordinated to the higher

priority promissory note of general

creditor rank. Thus, Adams had no legal

interest in the note which might justify

enjoining its further transfer.

19a

TD

which was argued before this court on the

same day we heard the present appeal. In

Northw Racquet, we held that where

investors in a federally regulated

institution subordinate their claims in

such a manner as to make the investments

eligible for use as regulatory capital,

and where the issuing institution applies

such investments to regulatory capital,

the investments must be regarded as fully

encumbered by the regulatory obligation

to remain subordinate to the claims of

depositors and general creditors in the

event of insolvency.

The Securities and Securities Agreement

at issue in this case are nearly

identical to those discussed in Northwest

Racquet. As in Northwest Racquet, there

is no dispute that the investment, in

fact, was included in MWF's regulatory

capital from March through November 1988.

20a

Further, the underlying allegations of

fraud in the inducement presented in each

case also are nearly identical. We

therefore refer the reader to our

discussion in Northwest Racquet, and hold

that MWF's insolvency precludes Adams

from rescinding the Securities

Agreement. '° Adams' claim therefore

remains subordinate to the claims of

general creditors. The continuing

subordinated status of the Securities

means that they lack the requisite

‘Swe also note that Adams, unlike the

plaintiff in Northwest Racquet, did not

initiate any remedial action against MWF

prior to the declaration of MWF's

insolvency. Northwest Racquet attempted

to exercise its contractual right to

accelerate payment prior to the

declaration of insolvency. Adams, by

comparison, did not take any remedial

action until he filed his’ initial

complaint on March 21, 1989, five weeks

after the declaration of insolvency.

Thus, the facts of this case provide an

even stronger basis for holding that the

subordinated debt holder is precluded

from rescinding than those presented in

Northwest Racquet.

21a

mutuality of obligation required to set

them off against the promissory note

which holds a superior general creditor

rank.'* The continuing subordination also

means that Adams is not entitled to share

in any pro rata distribution of assets

with MWF's general creditors. Because

Adams has no right to participate in any

pro rata distribution of assets’ to

general creditors, we also hold that the

“Generally, the right to setoff

exists only as to mutual debts. See,

e.g., Sioux Line R.R. v. Escabana & Lake

Superior R.R., 840 F.2d 546, 551 (7th

Cir. 1988). To exhibit the requisite

mutuality, the debts must be in the same

right. See 5A Michie, Banks & Banking

ch. 9, § 115c (1983). Subordinated

debentures, however, do not exist in the

same r.ght as promissory notes, thus they

may not be set off against each other.

See FDIC v. Texarkana Nat'l Bank, 874

F.2d 264, 268-69 (5th Cir. 1989)

(subordinated debentures in insolvent

bank do not, as a matter of both law and

equity, meet mutuality of obligation

test); see also FDIC v. de Jesus Velez,

678 F.2d 371 (1st Cir. 1982)

(subordinated debentures in insolvent

bank not mutually extinguishable with

promissory notes).

22a

district court properly dismissed his

Claim attacking the validity of the

purchase and assumption agreement between

FSLIC and Midwest Savings.

One final issue merits individual

attention. Adams contends that the

district court should not have dismissed

as moot his common law fraud claim for

damages against FSLIC in its capacity as

receiver for MWF. We agree with the

district court's decision declaring the

claim moot on prudential grounds because

the Bank Board's determination that MWF's

assets were insufficient to meet the

Claims of general creditors meant that

the court could not grant subordinate

debt holder Adams any effectual relief.

731 F. Supp. at 357-58.

Although it is true, as Adams contends,

that in some instances a claim for

damages is not mooted merely because of

23a

the insolvency of the defendant, see

Ratn ioux N —_. Tre

F.2d 512 (Sth Cir. 1985), “the

feasibility or futility of effective

relief should a litigant prevail" remains

a crucial consideration in this court's

determination of whether to adjudicate a

claim on its merits. In re AOV Indus.

Inc., 792 F.2d 1140, 1147-48 (D.C. Cir.

1986). To satisfy the case or

controversy requirement of Article III of

the Constitution, Adams' claimed injury

must be redressable by a favorable

judicial decision. Iron Arrow Honor

Society v. Heckler, 464 U.S. 67, 70

(1983) (per curiam).

The Bank Board formally determined that

the claims of subordinated debt holders

like Adams are worthless. We are bound

by the Bank Board's worthlessness

24a

determination in this proceeding.” See

1 Vv nbel v., F.S.B., 902 F.2d

348, 351 (5th Cir. 1990), cert. denied,

ge. ls SRY Bs Ge. «6G Ree

Villa h int Venture v. Federal

Deposit Ins. Corp., 733 F. Supp. 50 (N.D.

Tex. 1990); Federal Sav. & Loan Ins.

‘Sa Bank Board determination of

worthlessness is a "final agency action,

which is reviewable under the provisions

of the Administrative Procedure Act [, 5

U.S.C. §§ 701-706,] in an action against

the Bank Board, but not subject to

collateral attack through discovery or

other means in individual lawsuits

against the receiver.'"' Federal Sav. &

Loan In r v. Locke, 718 F. Supp.

573, 586 (W.D. Tex. 1989). Adams has not

directly challenged the Bank Board's

worthlessness determination. Rather, he

has attacked the determination only

collaterally, in the context of this

action, which does not name the Bank

Board as a party to the litigation, but

is stated simply against the RTC, as

receiver for MWF. Such a collateral

attack is not sufficient to create a

justiciable issue in the context of the

present case. In the absence of a prior

adjudication that the Bank Board's

worthlessness determination was arbitrary

and capricious, Adams has failed to

sufficiently state a claim upon which

relief could be granted.

25 a

Corp. v. Locke, 718 F. Supp. 573, 586

(W.D. Tex. 1989). The import of this

determination is that FSLIC, as receiver

for MWF, will never have any assets with

which to satisfy a common law fraud

judgment. Under these circumstances, we

follow the axiomatic principle that when

"it [is] impossible for [a] court, if it

should decide the case in favor of the

plaintiff, to grant him any effectual

relief whatever, the court will not

proceed to a formal judgment."'® Mills v.

In Ratner v. Sioux Natural Gas

Corp., 770 F.2d 512 (5th Cir. 1985),

which Adams cites in support of his

arguments, the court, in addressing a

mootness defense by an insolvent

corporation, stated that the "mere

possibility that a judgment debtor lacks

the means to satisfy its monetary

liability" does not necessarily mean that

the case is moot. 770 F.2d at 516 (5th

Cir. 1985). Here we are dealing not with

the "mere possibility," but rather an

absolute certainty that defendant RTC, as

receiver for MWF, lacks the means to

satisfy a judgment on the common law

fraud claim. See Federal Sav. & Loan

In r v. Locke, 718 F. Supp. 573,

587 n.4 (W.D. Tex. 1989). Adams contends

26a

0 lille

Green, 159 U.S. 651, 653 (1895).

Adams contends that adjudication of his

claim on the merits is warranted,

nonetheless, because resolution of the

fraud claim on the merits would aid him

in pursuing his pending claims against

the former officers of MWF individually.

Prudential concerns of judicial economy

and preservation of scarce judicial

resources counsel that Adams pursue any

overlapping issues of fraud within the

context of those proceedings.

that pending litigation over disputed MWF

assets raises the possibility that some

money may be available, at some future

date, to satisfy a common law fraud

judgment. This argument, however,

overlooks the fact that the assets now

belong to Midwest Savings as a result of

the purchase and assumption agreement,

not to the RTC, as receiver for MWF. RTC

no longer holds any MWF assets, let alone

assets which might be used to satisfy a

judgment in favor of Adams.

27 a

III. CONCLUSION

For the reasons expressed above, we

affirm the judgment of the district

court.

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH

CIRCUIT.

28a

=

APPENDIX B

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

No. 90-5123MN

Stephen Adams,

Appellant,

vs.

Resolution Trust Corporation as

Receiver for Midwest Federal

Savings and Loan Association;

Harold W. Greenwood, Jr.j;

Donald Snede; and John Does 1-10,

Appellees.

No. 90-5124MN

Stephen Adams,

Appellant,

vs.

Federal Deposit Insurance

Corporation (FDIC) as manager

of the FSLIC Resolution Fund,

Appellee.

Appeals from the United States

District Court for the

District of Minnesota

29a

JUDGMENT

This appeal from the United States

District Court was submitted on the

record of the district court, briefs of

the parties and was argued by counsel.

After consideration, it is ordered and

adjudged that ‘the judgment of fhe

district court in this cause is affirmed

in accordance with the opinion of this

Court.

February 28, 1991

A true copy.

ATTEST: /s/ Robert D. St. Vrain

CLERK, U.S. COURT OF APPEALS,

EIGHTH CIRCUIT

MANDATE ISSUED: 4/2/91

30a

NS

APPENDIX C

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

Nos. 89-5526 and 89-5585

Northwest Racquet Swim

& Health Clubs, Inc.,

| a Minnesota corporation,

Appellant,

Vv.

Resolution Trust Corporation,

as receiver for Midwest Federal

Savings and Loan Association

and Midwest Savings Association, F.A.,

Appellees.

Submitted: September 12, 1990

Filed: February 28, 1991

Appeals from the United States District

Court for the District of Minnesota.

Before MCMILLIAN, Circuit Judge, BRIGHT,

Senior Circuit Judge, and BOWMAN, Circuit

Judge.

BRIGHT, Senior Circuit Judge.

3la

Northwest Racquet Swim & Health

Clubs, Inc. (Northwest) appeals the

district court's’ grant of summary

judgment? in favor of the Resolution

Trust Corporation (RTC) in this action

for rescission of subordinated debt

securities purchased from now

insolvent Midwest Federal Savings and

Loan Association (MWF). On appeal,

Northwest contends that MWF's insolvency

does not affect its right to rescind the

securities which MWF fraudulently induced

it to purchase. Northwest further

asserts that its post-insolvency act of

rescission of the securities elevated the

‘The Honorable Harry H. MacLaughlin,

United States District Judge for the

District of Minnesota.

‘The district court's decision is

reported as Northwest Racquet Swim §&

H n Vv 1 Vv Loan

Ins. Corp., 721 F. Supp. 211 (D. Minn.

1989).

32a

subordinated debt to general creditor

status, entitling it to set off the debt

against its promissory note obligations

to MWF. We affirm the judgment of the

district court and substantially agree

with its well-reasoned opinion.

I. BACKGROUND

On December 29, 1987, Northwest, a

developer and operator of health clubs,

purchased $15 million in subordinated

debt securities (Securities) in a private

offering by MWF, a Minneapolis based,

federally insured savings and loan

association. Northwest financed its

investment with funds from two promissory

notes totaling $59 million which it had

previously executed with MWF also in

December 1987.° The Securities contained

“Northwest executed the promissory

notes for $10 million and $49 million on

December 1 and December 10, 1987,

respectively.

33a

language expressly subordinating

Northwest's claim, in the event of

liquidation, "to all claims against [MWF]

having the same priority as_ savings

account holders or any higher priority."

Joint Appendix (J.A.) 33. The parties

also entered into a subordinated debt

securities agreement (Agreement) which

Similarly subordinated Northwest's claim

in the event of the liquidation of MWF.°

“The priority scheme governing

claims against an insolvent’ thrift

institution placed savings account

holders in the sixth priority position

after various administrative costs,

expenses and debts associated with the

appointment and operation of the

receivership, various wage and benefits

claims of the employees of the failed

thrift and certain government tax claims.

12 C.F.R. § 569c.11 (1989).

"In addition, Northwest executed an

Offeree Statement representing that it

had "sufficient knowledge and experience

in financial and business matters to be

capable of evaluating the merits and

risks of [the] proposed investment," that

it was "able to bear the economic risk of

the proposed investment," and that it had

"considered that it might have to hold

34a

The Agreement specified Northwest's

remedies in the event of default. Events

of default included failure to make

timely payment of the principal or

interest due, declaration of insolvency,

or the appointment of a conservator,

receiver or liquidating agent. A default

would also arise in the event that "any

representations or warranty made in

writing by or on behalf of [MWF] herein

or in connection with the transactions

contemplated hereby shall prove to have

been false or incorrect in any material

respect on the date as of which made."

J.A. 36.

In the event of a default, the remedies

the proposed investment for an indefinite

period of time and might have to bear a

complete economic loss." J.A. hs mF

Northwest similarly executed a

Subscription Agreement in which it again

stated it had "considered and understands

the high degree of risk of the securities

offered." J.A. 178.

35 a

section provided that Northwest could act

to protect and enforce its rights by

instituting an action in law, suit in

equity, or other appropriate proceeding.

However, the Agreement placed three

significant limitations upon Northwest's

rights, powers and remedies. First,

Northwest could accelerate payment in the

event of default only to the extent that

such payment did not leave MWF with

insufficient capital to meet regulatory

capital requirements set out in 12 C.F.R.

§ 563.13 (1988). Second, in the event

the Federal Savings and Loan Insurance

Corporation (FSLIC) was appointed

receiver for MWF, FSLIC would have no

obligation to arrange for the assumption

of the Securities. Finally, the

Agreement bound Northwest to abide by the

priority scheme set out in Federal Home

36 a

SO then sok Cts eaten ae tee rll

PA MANS RE tlt RM LS NO OF ae ingle a OT 208 Bm

nna ret? sath wee ©

On

Loan Bank Board® (Bank Board) regulations

governing the distribution of assets in

liquidation proceedings.’

The sale of the Securities was

contingent upon Bank Board approval

pursuant to 12 C.F.R. § 563.8-1 (1988),

governing the issuance of subordinated

debt securities by federal savings and

loan associations. The Bank Board, on

December 21, 1987, approved the sale and

issuance of up to $25 million in MWF

°The Federal Home Loan Bank Board

acted as the principal regulator of the

federal savings and loan industry until

August 9, 1989, when Title IV of the

Financial Institutions Reform, Recovery

and Enforcement Act of 1989, Pub. L. No.

101-73, 103. Stat. 354, became _ law,

abolishing the Bank Board and replacing

it with the Office of Thrift Supervision.

7under the regulatory priority

scheme, see note 4, the claims of

subordinated debt holders like Northwest

held a ninth rank priority, behind the

claims of all general creditors, and

ahead only of equity interest holders.

12 C.F.R. § 569c.11 (1989).

37 a

subordinated debt securities.

On December 31, 1987, MWF applied the

Securities to its regulatory capital,

where it constituted more than ten

percent of MWF's total regulatory capital

through November 1988.° In January 1989,

however, the Bank Board issued a

SRegulatory capital is the sum of,

inter alia, reserve accounts, retained

earnings, permanent common stock,

securities which constitute permanent

equity capital, appraised equity capital

and any other nonwithdrawable accounts

which constitute the institutional

reserves available for satisfying the

claims of depositors and other account

holders. See 12 C.F.R. § 561.13 (1988).

Pursuant to statutory authority, 12

U.S.C. § 1464(s), the Bank Board, and its

successor, the Office of Thrift

Supervision (OTS), sets the minimum

capital requirements for the industry.

Since 1973, the Bank Board or OTS has

permitted thrift institutions to include

long-term subordinated debt securities in

their regulatory capital because such

securities possess many of the

characteristics of permanent capital. 54

Fed. Reg. 34,148 (1989) (commentary

accompanying Final Rule amendments to

regulations governing the issuance and

use of subordinated debt (codified at 12

C.F.R. § 563.13 (1989))).

38 a

directive ordering MWF to prospectively

remove the Securities from regulatory

capital because Northwest had purchased

them with funds it had borroweac from MWF

on an unsecured basis. MWF, accordingly,

did not report the Securities as

regulatory capital in its 1988 fourth

quarter report to the Bank Board.

Publicity concerning MWF's’ troubled

financial condition prompted Northwest,

by letter dated January 25, 1989, to

notify MWF that it considered the

subordinated debt security to be in

default. The letter stated that the

events of default "include[d] but are not

limited to breach of representations and

warranties" made in the Agreement

regarding the financial condition of MWF.

J.A. 197. Northwest accordingly deciared

that it was exercising its remedies as

set forth in the Agreement.

39 a

Specifically, Northwest declared an

acceleration of payment of the balance of

the principal and demanded immediate

payment "in the manner and with the

effect provided in the Debenture

Agreement." J.A. 198. Northwest also

declared an immediate setoff of any

remaining amount against its promissory

note obligations to MWF.

On February 13, 1989, the Bank Board

declared MWF insolvent after finding that

its obligations to its creditors

(including savings account _ holders)

exceeded its assets. Accordingly, the

Bank Board, acting pursuant to its

statutory authority under 12 U.S.C. §

1464(d)(6)(A)(i) (1988), named FSLIC as

conservator of MWF. FSLIC attempted to

operate MWF as a going concern. On March

10, 1989, Northwest again informed MWF by

letter that it had concluded that the

40 2

sa ena tome Ob ie

sale of the Securities had "involved the

misrepresentation of material facts and

willful failure to disclose material

facts . . . pertaining to the financial

condition of [MWF]." J.A. 201. This

time, however, rather than assert its

contractual remedies as it did in the

January 25 letter, Northwest tendered the

Securities in rescission and declared an

immediate setoff of the amount’ due

against the balance of the two promissory

notes held by MWF.

Northwest formalized its allegations

of fraud by filing the complaint giving

rise to this action in April 1989. The

complaint, as later amended, alleged that

MWF's material misrepresentations and

nondisclosures at the time of the

transaction violated state and federal

41a

Northwest asked the

securities laws.

court to declare the Securities and the

Agreement rescinded. It further sought

a declaration that the rescission

elevated the Securities obligation to

general creditor status. According to

Northwest, the elevation of the

Securities to general creditor status

meant that the debt possessed a mutuality

*The financial statements appended

to and incorporated into the Agreement

stated that an MWF asset identified as a

"Pinance and Excess Service Fee Income

Receivable" had a value of approximately

$207 million. Northwest alleged that, at

the time of the’ transaction, MWF

officials knew and failed to disclose to

Northwest that the asset, which is

presently the subject of separate

litigation, was likely worth far less

than $207 million represented in the

financial statements upon which Northwest

based its decision to invest. Northwest

asserted in its complaint that this

material misrepresentation violated §

10(b) of the Securities Exchange Act of

1934, 15 U.S.C. § 783(b), Rule 10b-5 of

the Securities Exchange Commission, 17

C.F.R. § 240.10b-5 (1988), and Minn.

Stat. § 80A.01 (1986).

42 a

of obligation with the two promissory

notes, entitling it to set off the

Securities against the notes.

On May 4, 1989, the Bank Board, noting

that MWF's liabilities continued _ to

exceed its assets, concluded that MWF

could not be operated as a going concern.

Acting under statutory authority, 12

U.S.C. § 1464(d)(6)(A) (1988); 12 C.F.R.

§ 547 (1988), the Bank Board appointed

FSLIC as receiver for the purpose of

liquidating MWF. Accordingly, FSLIC, by

operation of law, took possession of MWF

and succeeded to all of MWF's rights,

titles, powers, and privileges. See 12

U.S.C. §§ 1464(d), 1729 (1988). In

addition, the Bank Board determined that

the total liquidation of MWF would not

generate sufficient funds to satisfy the

claims of MWF's general creditors, thus,

it formally declared all subordinated

43a

debt and equity interests in MWF to be

worthless.

The Bank Board also contemporaneously

created a new savings and loan

association, Midwest Savings Association

(Midwest Savings), to facilitate the

liquidation of MWF and the reorganization |

of its assets. The Bank’ Board |

immediately placed Midwest Savings under

FSLIC conservatorship. It further

directed FSLIC to enter into a purchase

and assumption agreement with Midwest

Savings, transferring most of MWF's

The settlement of claims in the

event of liquidation proceeded under any

absolute priority scheme, meaning that

ninth and tenth priority subordinated

debt and equity holders could receive

treatment of their claims only after all

claims of the first eight ranks had been

fully satisfied. 12 C.F.R. § 569c.11(d)

(1989). Thus, the Bank’ Board's

determination that MWF's assets. were

insufficient to satisfy the claims of

seventh priority general creditors meant

that no money remained for the claims of

ninth priority subordinated debt holder

like Northwest.

44a

tetra

assets to Midwest Savings in

consideration for Midwest Savings'

assumption of certain MWF liabilities.

Under the purchase and assumption

agreement, Midwest Savings did not assume

any MWF equity liabilities or

obligations, including the subordinated

debt securities at issue here. As a

result of this transaction, the

obligations arising from the Securities

remained with FSLIC, as receiver for MWF,

while Midwest Savings assumed possession

of the promissory notes against which

Northwest sought to exercise its claimed

right of setoff. Northwest accordingly

amended its complaint to include Midwest

Savings as a defendant and requested that

the court preliminarily enjoin Midwest

Savings from further selling or

transferring the notes which Northwest

sought to set off.

45a

FSLIC filed a Fed. R. Civ. P. 12(b)(6)

motion to dismiss for failure to state a

claim. The district court, finding that

the disposition of the motion turned on

matters outside the pleadings, treated it

as a motion for summary judgment and

ruled in favor of FSLIC. The district

court adopted the analysis of the Second

Circuit in In re Weis Sec., Inc., 605

F.2d 590 (2d Cir. 1978), cert. denied,

439 U.S. 1128 (1979), and held, as a

matter of law, that because MWF had

applied the funds from the sale of the

Securities to its regulatory capital

accounts, Northwest was precluded from

rescinding the Securities after the Bank

Board had declared MWF insolvent. The

Securities, therefore, remained

subordinated, and thus lacked the

requisite mutuality of obligation

necessary to set them off against the two

46a

promissory notes.'' Northwest filed this

appeal in which it renews the arguments

it presented before the district court. °

Ez. DISCUSSION

We review a grant of summary judgment

under the same standard applied by the

district court. McCuen v. Polk Count

Iowa, 893 F.2d 172, 173 (8th Cir. 1989).

“The district court also denied

Northwest's motion to enjoin Midwest

Savings from further selling or

transferring the promissory notes because

the motion was predicated upon

Northwest's claimed right to set off the

Securities against the notes.

‘“2puring the pendency of this action,

Congress created the Resolution Trust

Corporation (RTC) as part of its 1989

restructuring of the federal savings and

loan regulatory system. See Financial

Institutions Reform, Recovery and

Enforcement Act of 1989, Pub. L. No. 101-

73, 103 Stat. 183. Under the regulatory

reorganization, the RTC assumed most of

the receivership, conservatorship and

liquidation functions of the _ FSLIC.

Consequently, RTC replaced FSLIC as

receiver for MWF and conservator of

Midwest Savings, and now stands in

FSLIC's place as defendant and appellee

in this action.

47 a

Thus, we review the facts de novo, Didier

v. J.C. Penney Co., 868 F.2d 276 (8th

Cir. 1989), and affirm the district court

only if we agree that "there is no

genuine issue of material fact, viewing

the facts in the light most favorable to

the non-moving party, and that the moving

party is entitled to judgment as a matter

of law."" McCuen, 893 F.2d at 173 (citing

Kegel v. Runnels, 793 F.2d 924, 926 (8th

Cir. 1986)); see Anderson v. Liberty

Lobby, Inc., 477 U.S. 242, 247, 48

(1986).

Viewing the facts in the light most

favorable to Northwest, we must assume

that MWF did indeed fraudulently induce

Northwest to purchase the Securities by

making material misrepresentations

regarding its financial condition at the

time of the transaction. Neither party

disputes that MWF immediately applied the

48a

investment to regulatory capital. In

addition, neither party disputes that, as

of February 13, 1989, MWF was insolvent.

On the basis of these facts, the district

court held that Northwest, as a matter of

law, was precluded, as of the date of

MWF's insolvency, from rescinding the

sale of the Securities. Northwest did

not attempt to rescind until March 10,

1989, nearly one month after the Bank

Board's declaration of MWF's insolvency,

thus it was barred from rescinding the

Securities.

In reaching its decision, the district

court concluded that In re Weis Sec.,

Inc., 605 F.2d 590 (2d Cir. 1978),

resolved the outcome of this case. We

therefore focus our attention on Weis.

In Weis, lenders to a securities broker-

dealer subordinated their loans to the

claims of all other creditors in exchange

49a

for a higher rate of return. The

subordination, which in effect rendered

the loans unencumbered for regulatory

purposes, enabled Weis to comply with

industry regulatory capital requirements

necessary to continue operations.

Following Weis' insolvency, the lenders,

claiming fraud in the inducement, sought

to rescind the subordination agreements.

The Second Circuit rejected the

Subordinated lenders' claims, holding

that because the lenders had subordinated

their loans specifically to enable Weis

to comply with regulatory capital

requirements, they were estopped from

rescinding their subordination agreements

following Weis' declaration of

insolvency, regardless of whether general

creditors actually relied upon’ the

subordination in extending credit to the

company. The Weis court analogized the

50 a

—t

Ee ee SS eee ee “Cm ee

position of the lenders to shareholders

in a series of cases arising under the

old National Banking Act, in which those

purchasing shares of a national bank were

conclusively presumed to have known that

they had increased the bank's capital and

facilitated its conduct of business. 605

F.2d at 595 (construing Scott v. Deweese,

181 U.S. 202 (1901)). Having assumed

such a position, the shareholders were

not permitted to escape their statutory

liability to the banks creditors at the

time of insolvency.'*

In Scott v. Deweese, for example, a

shareholder claiming that he was

fraudulently induced to invest in a

national bank sought to rescind after the

bank had declared its insolvency. In

prior to 1959, shareholders of

national banks were statutorily liable

for the banks' obligations to the extent

of the par value of their shares. 12

U.S.C. § 63 (1958) (repealed 1959).

51a

rejecting the shareholder's claim, the

Court stated:

The present suit is primarily

in the interest of creditors of the

bank. It is based upon a statute

designed not only for their

protection but to give confidence to

all dealing with national banks in

respect of their contracts, debts

and engagements, as well as to

stockholders generally. If the

subscriber became a shareholder in

consequence of frauds practiced upon

him by others, whether they be

officers of the bank or officers of

the Government, he must look to them

for such redress as the law

authorizes, and is estopped, as

against creditors, to deny that he

is a shareholder .. . if at the

time the rights of creditors accrued

he occupied and was accorded to

rights appertaining to that

position.

181 U.S. at 213. By analogy, the court

in Weis held that, having assumed a

subordinate position in order to enable

to company to meet federally mandated

regulatory capital requirements necessary

to continue operations, the lenders were

Similarly estopped from rescinding their

subordination after the date of

52 a

insolvency.”

The district court deemed Weis

analogous to the present action because

Northwest's investment, like those of the

lenders in Weis, was applied to the

regulatory capital of the issuing

institution. We agree. The district

court stated the Weis "is premised on the

fact that the capital regulations

reflected ‘a strong desire to assure

investors of the stability and integrity

of the securities markets and of the

broker-dealers responsible for channeling

investments into them.'" Northwest

Racquet Swim & Health Clubs, Inc. vv.

“the declaration of insolvency is

the critical moment in determining the

relationship between various competing

interests because "[i]t is well settled

that the rights and liabilities of a bank

and the bank's debtors and creditors are

fixed at the declaration of the bank's

insolvency." American Nat'l Bank v.

Foic, 710 F.2d 1526, 1540 (11th Cir.

1983) (citations omitted).

53a

Federal Sav. & Loan Ins. Corp., 721 F.

Supp. 211, 216 (D.Minn. 1989) (quoting

Weis, 605 F.2d at 596). We believe,

contrary to Northwest's assertion, that

the regulatory capital requirements of

the thrift industry serve similar

regulatory interests and purposes as

those in the securities industry.

In both industries, regulatory capital

acts as a cushion helping the institution

to absorb losses in lean times, thus |

ensuring customers, investors in the

5

securities context and depositors’ in the

the purposes of regulatory capital

requirements are typically framed in

terms of the risk of loss borne by FSLIC

(and now the Federal Deposit Insurance

Corporation (FDIC) ) rather than

depositors per se. However, Congress

created thrift deposit insurance to

promote thrift and protect savings by

ensuring that the "saver will get his

money back." H.R. Rep. No. 1922, 73d

Cong., 2d Sess. 3 (1934) (accompanying

Title IV of the National Housing Act,

codified as amended as 12 U.S.C. §§ 1724-

2D Lath a ee MOOR ey Ole aI Vis NAS Ee MAO A Ain BR Sie

1730i (1988), xrepealed by Financial

Institutions Reform, Recovery and

Enforcement Act of 1989, Pub. L. No. 101-

ny |

544

savings and loan context, of the

stability and integrity of the

institution in which they have placed

their money. See 53 Fed. Reg. 51,800

(proposed Dec. 23, 1988) (commentary on

"Purpose of Regulatory Capital"

accompanying proposed amendments to

regulatory capital requirements codified

748 ©.9:8: 66 861, 3$63).™ The

protection provided by regulatory capital

requirements, thus, is most critical

73, Tatle IV, § 407, 103 Stat. 363)

(emphasis added). It is therefore

appropriate to view the interests of

FSLIC as synonymous with the interests of

depositors.

Regulatory capital requirements

also "reduce the ‘moral hazard'

engendered when the insurer bears most of

the cost of a thrift's failure .. . [by

ensuring that] initial losses are borne

not by the insurer, but by the

institution's equity and subordinated

h r wh hr h their ntrol

of the institution's management, control

the actions most likely to lead _ to

insurance losses." 53 Fed. Reg. 51,800

(1988) (emphasis added).

55a

during an economic downturn, and

particularly in the event of insolvency.

This protection would be severely

undermined if, at the time when the

protection was most sorely needed, claims

of general creditors or depositors were

made contingent upon the lower priority

claims of subordinated debt and equity

interests.’

"We disagree with Northwest that

Oppenheimer _v. Harriman Nat'l Bank &

Trust Co., 301 U.S. 206 (1937), sanctions

just such a contingency of depositor and

general creditor claims. in Oppenheimer,

the Court did permit a shareholder in a

national bank to rescind his investment

on the basis of the bank's fraud after

the bank had declared its insolvency.

However, the Court deemed the right to

rescission contingent upon prior

satisfaction of Oppenheimer's statutory

liability to the bank's creditors. The

Court allowed Oppenheimer's rescission

only because he had previously satisfied

his statutory obligation:

Plaintiff appeared by the bank's

records to be a stockholder and, as

against creditors for whose benefit

the statutory liability was created,

was estopped from denying that

status. Recognizing that the bank's

fraud and his rescission availed

56a

10“ a Nh anal Oh AC i AIBN | atl NN

An action for rescission by a

subordinated debt holder after the date

of insolvency must be viewed, in effect,

as one between the investor and general

creditors, including innocent depositors,

Scott v. Deweese, 181 U.S. at 212,

because the claim of the rescinding

investor "Can be satisfied only out of

assets which otherwise would be allocated

to making innocent parties whole." Slain

& Kripke, The Interface Between

ecuriti R lation and Bankruptcy--

Allocating the Risk of Illegal Securities

Issuance Between Securityholders and the

Issuer's Creditors, 48 N.Y.U. L.Rev. 261,

286 (1973); see also Scott v. Abbott, 160

F. 573, 581 (8th Cir.), cert. denied, 212

U.S. 571 (1908); In re Stirling Homex

nothing against the comptroller's

assessment, plaintiff paid the

amounts laid against him.

301 U.S. at 214.

57a

Corp., 579 F.2d 206, 213 (2d Cir. 1978),

cert. denied, 439 U.S. 1074 (1979). It

is fair to suggest, in a case such as the

one now before us, that all of the

parties are victims of the institution's

fraud. The question thus becomes which

party should receive priority in the

settlement of their claims: the

investor, who is in the best position to

judge the condition of the thrift and

influence its management, or the innocent

depositors and general creditors.

Northwest asks that the subordinated

debt holder be given an equal bite at the

apple. This argument is a familiar one |

which brings to mind the observation of

this court many years ago that in the

event of an insolvency, "the temptation

to lay aside the garb of a stockholder,

on one pretense or another, and to assume

the role of a creditor, is very strong.”

58 a

itera

OO ———oOorrwrrS —— ao

Newton Nat'l Bank v, Newbegin, 74 F. 135,

140 (8th Cir. 1896), quoted in In re

irling Homex co., Sree F.24 et 213.

Northwest's request overlooks the fact

that the depositors and general creditors

"did nothing to create the rescinder's

problems and in the overwhelming majority

of cases .. . relifed] on the existence

of the equity or junior debt cushion

which the rescinder purported to

provide." Slain & Kripke, 48 N.Y.U. L.

Rev. at 286. In such situations,

fairness and equity dictate that

investors, having undertaken the greater

risk, give way to the depositors and

general creditors by honoring the

regulatory obligations they have assumed.

It is the regulatory interest of

protecting the innocent depositors and

general creditors which drove the Second

Circuit's analysis in Weis which we now

59a

adopt.

Northwest asserts, however, that under

Weis, it cannot be said to have

undertaken such a regulatory obligation

without a showing that it subordinated

its claims with the specific intent of

enabling MWF to meet its regulatory

capital requirements. As noted above,

the lenders in Weis did execute the

subordination agreements with the

specific intention of enabling Weis to

meet its regulatory capital requirements.

By comparison, Northwest asserts that it

did not know the MWF needed, or would

use, the proceeds of the sale of the

Securities for regulatory capital

purposes. Northwest thus asserts that

Weis does not apply under the facts of

this case.

We agree that the specific intention

of the lenders in Weis was a factor in

60a

ir a a EI OI

the Second Circuit's decision. However,

we believe that Northwest reads the

implications of Weis too narrowly in

light of the regulatory interests at

stake. While the facts of Weis appear to

limit its application to subordinations

with the specific intent of enabling a

federally regulated institution to meet

mandatory capital requirements, we

believe its rationale extends to

situations in which parties subordinate

their claims in such a manner as to make

the investments eligible for use as

regulatory capital. Once a federally

regulated institution applies such

investments to its regulatory capital

base, the investors must be conclusively

presumed to know that they have increased

the institution's capital and facilitated

the conduct of its business. See Scott

v. Deweese, 181 U.S. at 212. Any other

614

result would undermine the regulatory

protections and priorities accorded

innocent third parties who rely upon

stated capital reserves.

Under the standard we now enunciate,

it is clear that under the facts as

presently constituted, Northwest, as a

matter of law, is not entitled to any

relief. First, both the Securities and

the Agreement were structured to render

the investment available for use as

regulatory capital. The Agreement

expressly required that the sale be

approved by the Bank Board pursuant to 12

C.F.R. § 563.8-1 (1988), which sets forth

numerous terms and conditions for the

issuance of subordinated debt securities.

Subordinated debt securities meeting the

terms and conditions of § 563.8-1 were

eligible for use as regulatory capital.

12 C.F.R. § 561.13(c)(1) (1988) ("The

62a

ee eee ee ee ee

Pieris seein.

term ‘regulatory capital' also includes

subordinated debt securities issued

pursuant to § 563.8-1").

Section 563.8-1 expressly employs the

term "regulatory capital" in conjunction

with subordinated debt securities. See

12 C.F.R. § 563.8-1(b)(2)(i) (1988).

This provision suggests to us that a

subordinated investor such as Northwest

should recognize the link between

subordinated debentures and regulatory

capital, and, more to the point, that

this sort of investment might be applied

to regulatory capital. We also consider

telling the language in the Agreement, as

required by the regulations, 12 C.F.R. §

563.8-1(d)(1)(iv) (1988), clearly stating

ye also note that the regulatory

capital requirements set out at 12 C.F.R.

§ 563.13 were expressly referred to in

both the regulation governing the

approval of the sale of the Securities,

and the Agreement itself.

63a

that no payment of principal shall be

accelerated without approval of the Bank

Board if such payment would leave MWF

with insufficient regulatory capital. In

agreeing to this provision, Northwest,

again, expressly limited its rights and

remedies to those available to

contributors to regulatory capital.

Finally, Northwest agreed to subordinate

its claims to those claims having the

Same priority as savings account holders

or higher, again a condition of

investments to be devoted to regulatory

capital. Sean 12 C.F7R. § 563.8-

1(d)(1)(ii) (1988). Having agreed to

terms and conditions that made its

investment eligible for use as regulatory

capital, Northwest should not now be

heard to complain that it was in fact

64a

used in this manner.’?

Having determined that Northwest

Clearly subordinated its investment ina

manner that made it eligible for use as

regulatory capital, we next look to the

record to determine whether the funds, in

fact, were used for that purpose. On

‘this issue, there is not dispute. MWF

included the investment in regulatory

capital beginning in the fourth quarter

of 1987 and continuing at least through

the third quarter of 1988. We should

note that the Bank Board's January 1989

directive instructing MWF to remove the

"ST Northwest had alleged that, at

the time of the transaction, MWF

specifically indicated that the money

would not be used for regulatory capital

purposes, then we might view this case

differently. However, that is not the

case we have before us. Northwest has

merely asserted that MWF did not

expressly state that the investment would

be used as regulatory capital. This

allegation simply does not create a

genuine issue of material fact in light

of the terms of the Agreement.

65a

Securities from its reported regulatory

capital does not affect our analysis.

The Bank Board directed MWF to remove the

Securities from regulatory capital only

prospectively. The purely prospective

nature of the action means that, for

regulatory purposes, the Securities must

be regarded as regulatory capital from

December 1987 until November 1988. Thus, |

in the final analysis, Northwest's

investment must be regarded as fully

encumbered by the regulatory obligation

to remain subordinate to the claims of

depositors and general creditors in the

event of insolvency.”

Had the Bank Board ordered the

removal of the Securities from MWF's

regulatory capital account

retrospectively as well as prospectively,

this case might have more closely

resembled FDI i

Bank, 685 F.2d 270 (9th Cir. 1982), upon

which Northwest relies. In United States

Nat'l Bank, the court permitted a

subordinated debt holder to rescind its

fraudulently induced investment in a hank

despite the fact that the debt holder did

66a

a ee

In holding that Northwest may not

rescind, we emphasize that we do not hold

that a subordinated investor who had

agreed to terms and conditions that make

his investment eligible for inclusion in

regulatory capital never had recourse for

fraud. We hold only that such investors

may not rescind after’ the issuing

not rescind until after the bank had been

declared insolvent. The FDIC, as

receiver for the insolvent bank, argued

that Weis should apply and that no

rescission should be permitted post-

insolvency. However, National Banking

Act regulations governing the

subordinated loan at issue in United

States Nat'l Bank prohibited the use of

subordinated debt as regulatory interests

at stake in United States Nat'l Bank.

Thus, the court ruled that Weis, in which

the subordinated loans could be, and

were, used as regulatory capital, was

distinguishable and did not apply. For

the very reason that the court in United

States Nat'l Bank concluded that “‘eis did

not apply, we conclude that United States

Nat'l Bank must be distinguished on its

facts and does not apply in the present

case.

67a

institution has been declared insolvent.°'

The continuing subordinated status of the

Securities meas that they lack the

requisite mutuality of obligation

required to set them off with the

promissory note which possesses a

superior general creditor rank.

“IRTC has asserted that Northwest

bound itself to an exclusive set of

remedies to apply even in the event of

fraud in the inducement, thus suggesting

that Northwest cold not have rescinded

even prior to the date of insolvency.

Our holding does not require us to pass

judgment on this issue.

Generally, the right to setoff

exists only as to mutual debts. See,

e.q., Sioux Line R.R. v. Escabana & Lake

Superior R.R., 840 F.2d 546, 551 (7th

Cif. tHe6). To exhibit the requisite

mutuality, the debts must be in the same

right. See 5A Michie, Banks & Banking

ch. 9, § 1718e (1963). Subordinated

debentures do not exist in the same right

as promissory notes, thus they may not be

set off against each other. See FDIC v.

Texarkana Nat'l Bank, 874 F.2d 264, 268-

69 {Sth Cir. 1989) (subordinated

debentures in insolvent bank do not, as

a matter of both law and equity, meet

mutuality of obligation test); see also

FDIC v. de Jesus Velez, 678 F.2d 371 (1st

Cir. 1982) (subordinated debentures in

insolvent bank not mutually

68 a

ait. CONCLUSION

For the reason expressed above, we

affirm the judgment of the district

court.

A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH

CIRCUIT.

extinguishable with promissory notes).

69a

APPENDIX D

UNITED STATES DISTRICT COURT

DISTRICT OF MINNESOTA

FOURTH DIVISION

Civil No. 4-89-330

Stephen ADAMS

Vv.

RESOLUTION TRUST

CORPORATION, as

Receiver for

Midwest Federal

Savings and Loan,

et al.

February 9, 1990.

As Amended

March 2, 1990.

Timothy D. Kelly, Diane M. Helland,

KELLY & # BERENS, 80 South Eighth

Street, #3720, Minneapolis, Minnesota

55402, for plaintiff.

John Paul Martin, John E. /Yanish,

Jeffrey G. Stephensen, PETERSON, TEWS

& SQUIRES, 80 South Eighth Street,

#4800, Minneapolis, Minnesota 55402,

for defendant RTC.

ORDER

ROSENBAUM, District Judge

Defendant FSLIC (the Federal Savings

and Loan Insurance Corporation), now the

70a

RTC (Resolution Trust Corporation), in

its role as receiver for Midwest Federal

Savings and Loan Association (Midwest

Federal), seeks judgment on the

pleadings, pursuant to Rule 12, Federal

Rules of Civil Procedure,

(Fed.R.Civ.P.).* Based upon the files,

records, proceedings, and oral arguments

herein, and for the reasons set forth

‘On August 9, 1989, the Financial

Institutions Reform, Recovery, and

Enforcement Act (FIRREA) became law.

Pub.L.No. 101-73, 103 Stat. 183. Section

401(f£) (2) abolishes the FSLIC_ and

substitutes the Resolution Trust

Corporation (RTC) as its successor. Id.

at 356. A stipulation and order to

substitute RTC, as receiver, for FSLIC,

as receiver, was signed by the parties

and the magistrate and was filed November

7, 1989. For purposes of this motion the

Court will continue to refer to the

defendant as the FSLIC.

‘while the FSLIC has styled its

pleading as a motion to dismiss pursuant

to Rule 12(b)(6), Fed.R.Civ.P., the Court

has considered affidavits and documents

outside the pleadings. Thus, this motion

is treated as one for summary judgment.

Rule 12(b) and (c) and Rule 56,

Fed.R.Civ.P.

Tia

below, defendant's motion, considered as

if for summary judgment, is granted.

Facts

Plaintiff is a Florida businessman who

purchased $2.5 million in subordinated

debentures issued by Midwest Federal on

March 31, 1988. Defendant FSLIC was a

congressionally created agency of the

United States charged with protecting the

financial integrity of the savings and

loan industry. The RTC, FSLIC's

statutory successor, is currently the

receiver for Midwest Federal, a failed

financial institution.

On February 13, 1989, some ten months

after plaintiff's purchase of the

subordinated debentures, the Federal Home

Loan Bank Board (FHLBB) determined that

Midwest Federal was insolvent and

appointed the FSLIC as conservator of

Midwest Federal. FHLBB Resolution 89-

72a

Dares 1 ar i

7B, OC Be

On March 21, 1989, plaintiff brought

this action against Midwest Federal and

several former officers of Midwest

Federal.’ Plaintiff seeks to rescind the

subordination agreement claiming he was

fraudulently induced to make the $2.5

million loan. Plaintiff also seeks to

set off the entire unpaid balance of the

subordinated debentures against a

$7,845,000 promissory note, dated June

30, 1988, which plaintiff owes to Midwest

Federal.

On May 4, 1989, having determined

Midwest Federal's assets to be less than

3The action was originally filed in

Hennepin County as a Minnesota state

court proceeding against Midwest Federal

and others as_ defendants. It was

subsequently removed to this Court on the

petition of the FSLIC, as conservator.

The parties stipulated on July 6, 1989,

to the substitution of the FSLIC, as

receiver, as party defendant for Midwest

Federal.

73a

its obligations, the FHLBB replaced the

FSLIC as conservator with the FSLIC as

receiver. FHLBB Resolution 89-1388 at 1-

2. On the same date, the FHLBB created

a new savings and loan association,

Midwest Savings Association. The FHLBB

then directed the FSLIC as receiver to

transfer substantially all of Midwest

Federal's assets, and certain of its

liabilities, to Midwest Savings via a

purchase and assumption transaction.

FHLBB Resolution 89-1389 at 2-5.

The result of these proceedings is

that the FSLIC (now RTC), as receiver,

holds Midwest Federal's obligation on the

subordinated debentures and Midwest

Savings, with FSLIC (now RTC) as its

conservator, holds plaintiff's obligation

on the promissory note.

At the time this case was removed,

jurisdiction was conferred upon this

74a

Costes

Court by 12 U.S.C. §1730(k)(1).‘

Plaintiff's Contentions

Plaintiff's 1988 debenture purchase

was memorialized in a written agreement.

A review of that document shows it to be

replete with language making clear the

subordinate nature of the debt. The

document is entitled ''SUBORDINATED DEBT

SECURITIES AGREEMENT." Amended

Complaint, Ex. C, title page. The

introductory paragraph of the agreement

states "the Lender agrees to purchase,

subordinated debt securities.'"' Id. at 1.

Paragraph 1 of the agreement sets forth

Midwest Federal's authority to issue

subordinated debt securities. Id.

“Section 407 of FIRREA repeals 12

U.S.C. §1730 (k)(1). Pub.L. No. 101-73,

§407, 103 Stat. 183, 363 (1989). Section

209 of FIRREA amends 12 U.S.C. §1819,

which is now the relevant jurisdictional

provision. aa... @@ 206. This Court

presently has jurisdiction, pursuant to

12 U.S.C. §1819, as amended.

rey |

Paragraph 3 states the notes are not

secured by the assets of Midwest Federal

and cannot be held by an FSLIC-insured

institution. i, et 3: Paragraph 11

states:

Payment of the principal of and

interest on the Notes is hereby

expressly subordinated on

liquidation to all claims (including

post default interest) against

[Midwest Federal] having the same

priority as savings account holder

or any higher priority. Further,

for any and all purposes whatsoever,

the Notes shall be subordinate to

the 8-1/4% $8 million subordinated

debentures of [Midwest Federal] due

in 1993.

Id. at 14. Paragraph 20 also contains an

explicit subordination in the event of

the failure of Midwest Federal:

If the FSLIC shall be appointed

receiver for [Midwest Federal] and

shall arrange for. the

assumption of less than all of the

liabilities of [Midwest Federal] by

one or more other insured

institutions, the FSLIC shall have

no obligation . . . to contract for

or otherwise arrange for the

assumption of the obligation

represented by the Note in whole or

in part

76a

2 tame rah hot anne

wee ee ee!

ia, at 26.

It is plaintiff's contention that he

did not know his investment in these

debentures would be used to enable

Midwest Federal to meet its regulatory

capital requirements. In the absence of

contrary evidence, at this point in the

proceedings, the Court assumes this to be

true. But whatever the state of

plaintiff's knowledge, Midwest Federal

did include the $2.5 million in its

regulatory capital. Affidavit of Steven

L. Opsal, 497-9; Affidavit of Lynne

Blixt, 4974-6. In January, 1989, the

FSLIC directed that Midwest Federal cease

the inclusion of the subordinated

debentures in its regulatory ~ capital

base. Opsal Affidavit at 410. The

directive was issued because it appeared

the subordinated debentures had been

purchased with funds loaned by Midwest

T7a

Federal.”

Plaintiff, by this action, first seeks

to rescind the subordinated debenture

agreement and, then, seeks to set off the

amount he claims is due against his

promissory note, now held by Midwest

Savings. Plaintiff argues he is entitled

to rescission because Midwest Federal

made material misrepresentations which

induced him to enter into the

subordinated debt securities agreement.

It is his position that upon rescis»' >n

he would be entitled to rank in parity

with general creditors. He then argues

that this elevation in status creates a

mutuality of obligation which permits the

debentures to be set off against his

“This arrangement was acknowledged.

by counsel for plaintiff at oral

argument. Tr. of motion proceedings, at

19-20 (Aug. 24, 1989). Plaintiff

borrowed from Midwest Federal to secure

the funds he used to purchase these

debentures.

78a

promissory note. Plaintiff contends the

right to set-off was effective upon

Midwest Federal's insolvency, so that

Midwest Savings took the promissory note

subject to the set-off.

Analysis

Summary judgment is appropriate if

there is not genuine issue as to any

material fact and the moving party is

entitled to judgment as a matter of law.

Rule 56(c), Fed.R.Civ.P. "Summary

judgment procedure is properly regarded

not as a disfavored procedural shortcut,

but rather as an integral part of the

Federal Rules as a whole . Celotex

Corp. v. Catrett, 477 U.S. 317, 327

(1986). Prior to the Feceral Rules of

Civil Procedure and notice pleading,

motions to dismiss a complaint or strike

a defense were the primary tools to

prevent factually insufficient claims

719 a

from proceeding to trial. Id. Under

notice pleading, summary judgment assumes

this integral function. Id.

Summary judgment may be- granted

against a party who fails to make a

showing sufficient to establish the

existence of an element essential to its

case and on which that party will bear

the burden of proof at trial. Id. at

322-23. The party opposing summary

judgment must produce concrete facts

demonstrating there is a genuine issue of

fact for trial. Buford v. Termayne, 747

F.2d 445, 447 (8th Cir.1984).

Plaintiff asserts he is entitled to

set off these debentures against his loan

from Midwest Federal. The right to set-

off exists only as to mutual debts. Soo

Line R. Co. v. Escanaba & Lake Superior

R. Co., 840 F.2d 546, 551 (7th Cir.1988);

Qlsen-Frankman Livestock Mktg. Serv.,

80 a

VW econ aes aad attend as

Inc. v. Citizens Nat'l Bank, 605 F.2d

1082, 1087 (8th Cir.1979). Here,

plaintiff purchased debentures which,by

their terms, were expressly subordinated

to all claims having the same or higher

priority as savings account holders.

In Northw Rack wim Health

Clubs, Inc. v. Federal Sav. & Loan, Ins.

Corp., 721 F.Supp. 211 (D.Minn.1989),

Judge MacLaughlin, of this court,

considered claims virtually identical to

these. \His analysis in Northwest Racket

is fully applicable here.

The words of the subordinated debt

agreement are precisely to the contrary

of plaintiff's position. The agreement,

by its terms, provides for the purchase

of subordinated debt. To overcome this

contractual bar, plaintiff attempts to

establish mutuality based upon the rule

set forth in Oppenheimer v. Harriman

81a

Nat' nk = , 301 U.S. 206

(1937). Claiming Midwest Federal's fraud

and misrepresentation, he asserts himself

to be a defrauded purchaser. Citing

Oppenheimer, plaintiff concludes a

defrauded purchaser is entitled to rank

on a parity with general creditors. It

is, then, to Oppenheimer, its

progenitors, and its progeny which the

Court must turn.

It is noted, first, that Oppenheimer

did not involve subordinated debt. In

Oppenheimer the Supreme Court held that

defrauded purchasers of a bank's capital

stock could rescind their purchase and

rank with the bank's unsecured creditors.

301 U.S. at 214-15. The Court, however,

found rescission to be contingent upon

payment of a statutorily defined

82a

liability to the bank's creditors.®° "by

payment of the comptroller's assessment

they fully discharged their liabilit, as

stockholders. And as claimants’ they

stand on the same footing as other

creditors.” 301 U.S. at 215. See also

In WwW riti Inc., 605 F.2d

590, 596 n.12 (2d Cir.1978), cert.

denied, 439 U.S. 1128 (1979).

This issue was then considered by the

Second Circuit in Weis Securities, which

did involve subordinated debt. The

Second Circuit refused to allow defrauded

lenders to rescind their subordination

agreements. That court held that when a

lender subordinates a loan to enable a

®Prior to 1959, shareholders of a

national bank were statutorily liable for

all obligations of the bank to the extent

of the par value of their shares. 12

U.S.C. §64 #=[repealed]; In re Weis

Securities, Inc., 605 F.2d at 590, 595

(2d Cir. 1978), cert. denied, 439 U.S.

1128 (1979).

83 2

securities broker to comply with

regulatory capital requirements, the

lender will be estopped from rescinding

the subordination agreement. 605 F.2d at

596. Weis Securities is consistent with

Oppenheimer and reflects the fact that

the subordination agreements allowed the

broker-dealer to comply with regulatory

capital requirements. Id.

In Weis Securities, the Court found

that whether customers and creditors of

the broker-dealer relied on the

subordination agreements was irrelevant.

Id. This finding was premised on Scott

v. Deveese, 181 U.S. 202 (1901). In

Scott, the plaintiff sought to rescind

his purchase of bank stock, claiming the

purchase was fraudulently induced. The

Court denied rescission, finding a

purchaser of bank shares’ must be

conclusively presumed to have known he

84a

i

he SE rhea al

Soa cA tS Sli A nl, sr le

Pinter ti atin» Wie rae ae

had increased the bank's capital and

facilitated the conduct of its business.

Id. at 212.

It is true that in Federal Deposit

Ins. Corp. v. United States Nat'l Bank

685 F.2d 270 (9th Cir.1982), the Ninth

Circuit allowed a defrauded purchaser to

rescind its subordinated note agreement

and thereby rank with the bank's other

creditors. But, in that case, the court

found the loan could not be used for

regulatory capital under the National

Banking Act. Id. at 274-75. Thus, since

the subordinated loan in United States

Nat'l Bank was not used to enable the

bank to comply with regulatory capital

requirements, the Ninth Circuit found

Weis Securities was not analogous and the

Oppenheimer rule was applicable. Id.

Plaintiff argues that, in the absence

of his actual knowledge that his loan to

85a

Midwest Federal would be used to meet

Midwest Federal's regulatory capital

requirements, he fits within the

Oppenheimer rule and Weis Securities does

not apply. But, like the plaintiff in

Wei rities, the present plaintiff

purchased subordinated debt which allowed

Midwest Federal to meet’ regulatory

capital requirements. Opsal Affidavit,

197-9; Blixt Affidavit q14-6.

Plaintiff's contention, that subjective

knowledge is the critical concern,

misreads the law.

Close analysis reveals that

vindication of regulatory interests in

the predicate to rescission. In

Oppenheimer, the plaintiff's right to

parity with other unsecured creditors

accrued only upon his payment of a

statutory liability to those creditors.

The bank's fraud did not discharge that

86 a

2st shea cling

nn

liability. 301 U.S. at 214-15. In Weis

Securities, the court's holding was based

on the purposes underlying regulatory

capital requirements. Weis Securities,

605 F.2d at 596. In United States Nat'l

Bank, the plaintiff's right to parity

with unsecured creditors existed only

because the subordinated loans did not,

in fact, enable the bank to meet

regulatory requirements. 685 F.2d at

274-75. In other words, the regulatory

interests in Oppenheimer and Weis

Securities were satisfied and there was

no regulatory interest implicated in

United States Nat'l Bank.

The regulatory capital requirements

clearly are designed to bolster public

confidence in the stability and integrity

of financial institutions, thereby

encouraging orderly financial

transactions and supporting the national

87 a

economy. See Weis Securities, 605 F.2d

at 596. "To assure creditors that they

could rely on the stated capital

resources of a bank, the legislature

compelled those who had _ contributed

capital to stand by their commitments."

Id. When a subordinated loan is used to

enable a financial institution to comply

with capital regulations, the

subordinated lender properly is estopped

from rescinding its agreement. See Weis

Securities, 605 F.2d at 596.

In this case, plaintiff expressly

purchased subordinated debentures.

Amended Complaint Ex. C, title page,

introductory paragraph, 41, 3, 11, 20.

Midwest Federal reported these

subordinated debentures as part of its

regulatory capital. Opsal Affidavit,

117-9; Blixt Affidavit, 114-6.

Plaintiff's own documents’ repeatedly

88a

:

a

|

|

}

3

:

:

+

j

¢

refer to regulatory capital, federal

regulations governing subordinated debt

and regulatory capital, and Midwest

Federal's treatment of other subordinated

debt as part of regulatory capital.

The Court finds that, as in Scott v.

Dew , Plaintiff must be presumed to

know that his loan increased Midwest

Federal's capital and facilitated the

conduct of its business.’ See Scott,

181 U.S. 202, 212 (1901). Accordingly,

plaintiff's present claim of lack of

subjective knowledge that Midwest Federal

would report the subordinated debentures

as regulatory capital is irrelevant.

7Indeed, at ora’. argument

plaintiff's counsel acknowledged that

plaintiff knew he had purchased equity of

the bank. Tr. of motion proceedings, at

18 (Aug. 24, 1989).

89a

Plaintiff is a sophisticated

businessman.®

In this transaction, he

purchased subordinated debt -- and that

is precisely what he received. That debt

was made part of Midwest Federal's

regulatory capital. As a result,

plaintiff is estopped from rescinding the

purchase of the debentures and escaping

his subordinated status.

As a second line of attack, plaintiff

seeks rescission of the transaction under

the Minnesota Blue Sky law, Minnesota

Statutes, §§ 80A.01 and 80A.23.

Equitable principles apply in a

purchaser's action. for rescission under

§ 80A.23. Minnesota Statutes, §

80A.23(1); Logan v. Panuska, 293 N.W.2d

359, 363 (Minn.1980); McCauley _v.

8In Weis Securities, the Second

Circuit rejected an argument that a lack

of sophistication converts a subordinated

debenture holder into a general creditor.

Weis Securities, 605 F.2d at 597.

90a

Michael. 256 N.W.2d 491, 500 (Minn.1977).

Rescission under § 80A.23 serves a

dual function: it protects innocent

purchasers and compels sellers to comply

with securities regulations by depriving

9

them of ill-gotten gains. Note, The

Minnesota Supreme Court: 1980, 65 Minn.

L. Rev. 1063, 1069 (1981). Here, neither

policy of § 80A.23 will be furthered by

allowing rescission.

This transaction, even at this early

stage of the proceeding, cannot be

regarded as one conducted in the regular

course of business dealings. As

acknowledged at oral argument, plaintiff

took a loan from Midwest Federal and

immediately loaned the selfsame funds

back to the institution from which he had

But plaintiffs cannot use the Blue

Sky law to save themselves from errors in

business judgment; equity will not allow

blind protection of purchasers. Logan,

293 N.W.2d at 363.

9la

just secured the loan. Tr. of motion

proceedings, at 19-20 (Aug. 24, 1989).

These are the funds which purchased the

subordinated debt. Id. See Bond v.

Charlson, 374 N.W.2d 423, 430 (Minn.1985)

(a defrauded purchaser is estopped from

rescinding if performed with knowledge of

the facts which constituted the fraud).

Plaintiff also asserts a claim for

money damages on the basis of common law

fraud. In response, the FSLIC seeks to

have this claim dismissed as moot since

plaintiff can never obtain satisfaction

of a money judgment. The Court

recognizes that the general rule is

"[c]Jlaims for damages or other monetary

relief automatically avoid mcotness, so

long as the claim remains viable." 14A C.

Wright & A. Miller, Federal Practice and

Procedure, § 3533.3 (1984).

92a

As demonstrated above, plaintiff is a

subordinated creditor. The FHLBB has

already determined the subordinated

debentures are worthless because Midwest

Federal's assets were insufficient to

satisfy general creditor liabilities.

FHLBB Resolution 89-1388 at 3. Thus, the

FSLIC argues, even if plaintiff were to

succeed on his subordinate debt claims,

his victory would be unavailing; his

claim is not viable.

At least three courts have ruled that

if the receiver would never have any

assets with which to satisfy a judgment,

a damages action is properly dismissed on

prudential grounds. MTriland Holdin &

Co. v. Sunbelt Serv. Corp., 884 F.2d 205,

208 (5th Cir.1989); Federal Sav. and Loan

Ins. Corp. v. Locke, 718 F.Supp. 573, 587

(W.D.Tex.1989); Stevenson v. Federal Sav.

and Loan Ins. Corp.. 716 F.Supp. 981, 982

93a

(S.D.Tex.1989). This Court adopts this

rule.

Accordingly, in order to conserve the

limited resources of the judiciary, this

Court declines to adjudicate plaintiff's

futile damages claim.

Plaintiff, citing Rule 56(f),

Fed.R.Civ.P., also asserts defendant's

summary judgment motion to be premature,

claiming a need to conduct’ further

discovery. The request for additional

discovery is wholly general and offers no

specifics as to what discovery is

sought. '° A court may grant a continuance

‘under the rule, one who claims a

need for additional discovery must file

an affidavit stating the reasons they

cannot sufficiently establish the

existence of a material factual dispute.

Beckers ¥. International Snowmobile

Indus. Ass'n, 581 F.2d 1308, 1311 (8th

Cir.1978), (citing C. Wright & A. Miller,

Federal Practice and Procedure §2740),

cert. denied, 440 U.S. 986 (1979). See

also Burlington Coat Factory v. Esprit De

Corp., 769 F.2d 919, 926 (2d Cir.1985)

(affidavit under Rule 56(f) must explain

what facts are sought, how they are to be

94a

aN AIEEE es vinta

in accordance with Rule 56(f£),

Fed.R.Civ.P. United States v. Light, 766

F.2d 394, 398 (8th Cir.1985). That rule,

however, does not require a court to

order further discovery prior to summary

judgment. Id. at 397.

The Court finds no reason for further

-discovery or for delay here. At oral

argument, plaintiff's counsel indicated

the proposed discovery pertained to

plaintiff's subjective knowledge

concerning whether his investment would

be used to enable Midwest Federal to

comply with regulatory capital

obtained, how those facts are expected to

create an issue of material fact, what

efforts the affiant has made to obtain

the facts, an why the efforts have been

unsuccessful; failure to file such an

affidavit is enough to reject a claim of

inadequate discovery), aff'd in part,

rev'd inpart, 769 F2d 919 (2d Cir.1985).

95a

requirements. '' Tr. of motion pro-

ceedings, at 28-29 (Aug. 24, 1989). The

Weis Securities discussion of subjective

knowledge, above, makes clear that the

proposed discovery would be superfluous.

Plaintiff's final contention is that

the purchase and assumption transaction

was flawed. This entire argument is

premised upon a finding that plaintiff is

able to rescind’ the subordination

agreement and occupy the same posture as

Midwest Federal's general creditors. The

Court has found that plaintiff is not

entitled to rescind his agreement and

remains a _ subordinated creditor of

Midwest Federal. Thus, since plaintiff

is not to be treated as a _ general

creditor, he is not entitled to

"The Court finds it difficult to

understand why one would need to conduct

discovery to discern his own subjective

state of mind.

96a

participate ratably in the distribution

of Midwest Federal's assets pursuant to

12 U.S.C. § 1729.

Accordingly, IT IS ORDERED that:

1. The motion of defendant FSLIC as

receiver for Midwest Federal to dismiss

Counts III, IV, V, VI, and VII of the

third amended complaint is granted.

2. In light of this Court's dismissal

of all claims against the FSLIC (now

RTC), the remaining parties are directed

to submit letters to this Court within

ten days of this order addressing whether

to remand this action to the state court

from whence it came.

97a

APPENDIX E

UNITED STATES DISTRICT COURT

DISTRICT OF MINNESOTA

FOURTH DIVISION

Civil No. 4-89-558

Stephen Adams

Federal Deposit

Ins. Corp.

)

)

Vv. ) ORDER

)

)

)

This matter is before the Court on

defendant's motion to dismiss’ or,

alternatively, for summary judgment.

Defendant's motion is granted. Oral

arguments were heard January 12, 1990.

This action arises out of plaintiff's

purchase of $2.5 million in subordinated

debentures from Midwest Federal. The

relevant facts concerning this event are

set forth in this Court's February 9,

1990, order in the related case of Adams

v. R lution Tru rp., et al., Civil

No. 4-89-330 (D.Minn). In that order,

this Court dismissed plaintiff's claims

98 a

against the Resolution Trust Corp. In

particular, the Court found plaintiff is

not entitled to rescission of the

subordinated debenture purchase = and

therefore retains his subordinated

status.

The gravamen of plaintiff's complaint

in this case is that the purchase and

assumption transaction was flawed and he,

as a general creditor, is entitled to

ratable distribution. As was

acknowledged at oral argument,

plaintiff's entire case is premised on a

finding that he is entitled to ratable

distribution. Tr. of motion proceedings

at 20 (Jan. 12, 1990). Because this

Court, in Adam v. Resolution Trust

Corp., determined plaintiff is not a

general creditor entitled to ratable

distribution, this action must be

dismissed. Accordingly, based on the

99a

files, records, and proceedings herein,

IT IS ORDERED that:

Defendant's eekion to dismiss is

granted and this matter is dismissed with

prejudice.

Dated: February 23rd, 1990

ls/ James M. Rosenbaum

JAMES M. ROSENBAUM

United States District Judge

100 a

Iit.

Itt.

APPENDIX F

STATUES RELIED UPON

TERS oe.

12 Uv8.C. 6 1444a ........

ve. ee Freee

REGULATIONS RELIED UPON

12 C.F.R. § 563.8-1

| eae

12 C.F.R. § 563.13

CE Glos CUM Ob ew ks iG das

BAe rere Crest eT Tee

101a

APPENDIX F

I. 12 U.S.C. § 63

The shareholders of every national

banking association shall be held

individually responsible, equally and

ratably, and not one for another, for all

contracts, debts, and engagements of such

association, to the extent of the amount

of their stock therein, at the par value

thereof, in addition to the amount

invested in such shares.

Repealed Pub.L. 86-230, § 7, Sept. 8,

1959, 73 Stat. 457.

102 a

tz. 2 U.S.C. 1441a

Financial Institutions Reform,

Recovery and Enforcement Act of 1989

* * *

(b) Resolution Trust Corporation

established. (1) Establishment. (A) In

general. There is hereby established a

Corporation to be known as the Resolution

Trust Corporation which shall be an

instrumentality of the United States.

* *~ *

(3) Duties. The duties of the Corporation

shall be to carry out a program, under

the general oversight of the Oversight

Board and through the federal Deposit

Insurance Corporation (or any replacement

authorized pursuant to subsection (m)),

including:

(A) To Manage and resolve all cases

involving depository institutions-

(i) the accounts of which were insured

by the Federal Savings and _ Loan

Insurance Corporation before the

enactment of the Financial Institutions

Reform, Recovery, and Enforcement Act

of 1989 [enacted Aug. 9, 1989]; and

(ii) for which a conservator or

receiver--

(I) had been appointed at any

time during the period beginning

on January 1, 1989, and ending on

the date of the enactment of such

Act (including any institution

described in paragraph (6)); or

(II) is appointed within the 3-

year period beginning on the date

of the enactment of such Act.

103a

(B) To manage the Federal Asset

Disposition Association, subject to

the provisions of subsection (f)-

(C) To conduct the operations of the

Corporation in a manner which--

(i) maximizes the net present value

return from the sale or other

disposition of institutions described

in subparagraph (A) or the assets of

such institutions;

(ii) minimizes the impact of such

transactions on local real estate and

financial markets;

(iii) makes efficient use of funds

obtained from the Funding Corporation

or from the Treasury;

(iv) minimizes the amount of any loss

realized in the resolution of cases;

and

(v) maximizes the preservation of the

availability and affordability of

residential real property for low- and

moderate-income individuals.

* * *

(6) Successor to FSLIC as conservator or

receiver. As of the date of enactment of

the Financial Institutions Reform,

Recovery, and Enforcement Act of 1989

[enacted Aug. 9, 1989], the Corporation

shall succeed the Federal Savings and

Loan Insurance Corporation as conservator

or receiver with respect to any

institution for which the Federal Savings

and Loan Insurance Corporation was

appointed conservator or receiver during

the period beginning on January 1, 1989

and ending on such date of enactment.

104 a

III. Federal Savings and Loan Insurance

Corporation Act, 12 U.S.C. § 1729,

et seq. (excerpt)

A. 12 U.S.C. § 1729'

* * *

(b) Powers of corporation on default of

Federal Savings and Loan Association. In

the event that a Federal savings and loan

association is in default, the

Corporation shall be appointed as

conservator or receiver and is authorized

as such (1) to take over the assets of

and operate such association, (2) to take

such action as may be necessary to put it

in a sound and solvent condition, (3) to

merge it with another insured

institution, (4) to organize a new

Federal savings and loan association to

take over its assets, or (5) to proceed

to liquidate its assets in an orderly

manner, whichever shall appear to be to

the best interests of the insured members

of the association in default; and in any

event the Corporation shall pay the

insurance as provided in section 405 [§

1728 of this title] and all valid credit

obligations of such association. The

surrender and transfer to the Corporation

of an insured account in any such

association which is in default shall

subrogate the Corporation with respect to

such insured account, but shall not

affect any right which the insured member

may have in the uninsured portion of his

account or any right which he may have to

"Repealed by Act August 9, 1989,

P.L. 101-73, Title Iv, § 407, 103 Stat.

105 a

participate in the distribution of the

net proceeds remaining from the

disposition of the assets of such

association.

106 a

REGULATIONS RELIED UPON

I. 12 C.F.R. § 563.8-1 (1989)

I n rdinat

debt securities

(a) General. No insured institution

shall issue subordinated debt securities

pursuant to this section or amend the

terms of such securities unless it has

obtained written approval of the

Corporation. Approval of the issue under

this section, in order to meet the

requirements of § 561.13, may be obtained

either before or after the securities and

the form and manner of filing of the

application are in accordance with the

provisions of this section.

II. 12 C.F.R. § 563.13 (1989).

R 1 r ital R irement.

* * *

(b) Minimum required amount. Except as

otherwise provided in this section, the

minimum regulatory capital requirement

for any calendar quarter (commencing with

the quarter ending March 31, 1987) shall

be an amount equal to the sum of an

institution's liability component and

contingency component minus its maturity

matching credit. An institution shall

not use the maturity matching credit to

reduce its required amount of regulatory

capital below 3 percent of _ total

liabilities for the period from December

31, 1986, until December 31, 1989, or to

reduce its required capital below 4

107 a

1

percent of total liabilities on or after

January 1, 1990.

III. 12 C.F.R. § 567.2 (1991)

Minim r iremen

(a) To meet its regulatory capital

requirement a savings association must

satisfy each of the following capital

standards;

(1) Risk-based capital requirement.

(i) A savings association's minimum

risk-based capital requirement shall be

an amount equal to 6% of its risk-

weighted assets as measured pursuant to

§ 567.6 of this part plus 2% of its risk-

weighted assets as measured pursuant to

that section.

(ii) A savings association may not use

supplementary capital to satisfy this

requirement in an amount greater than

100% of its core capital as defined in §

567.5 of this part.

108 a

APPENDIX G

TRANSCRIPT OF MOTION PROCEEDINGS

HAD BEFORE THE HONORABLE

JAMES M. ROSENBAUM

August 24, 1989

United States District Court

District of Minnesota

Page 19, Lines 18-25

Page 20, Lines 1-8

THE COURT: Well, let me go a

little further here. Are you familiar

with the source of the two and a half

million dollars:

MR. KELLY: Yes.

THE COURT: Where is that from?

MR. KELLY: It was a bridge loan

from Midwest Federal.

THE COURT: So let me get clear

in my mind. Midwest Federal loaned two

and a half million dollars, and that two

and a half million dollars was

immediately lent back for subordinated

debentures.

109 2

MR. KELLY: Yes, Your Honor.

THE COURT: And less than a

quarter later, there was a seven and some

large change million dollar loan that was

made to Mr. Adams, correct?

MR. KELLY: Correct.

110a