Petition for Writ of Certiorari — Downriver Community Federal Credit Union v. Penn Square Bank ex rel. Federal Deposit Insurance

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Supreme Court, U.S.

FILED

89-697 OcT 31 1989

nore JR.

IN THE

] CLERK

Supreme Court of the United States

OCTOBER TERM, 1989

DOWNRIVER COMMUNITY FEDERAL CREDIT UNION

and WooD PRODUCTS CREDIT UNION,

‘ Petitioners,

PENN SQUARE BANK, through its Receiver,

FEDERAL DEPOSIT INSURANCE CORPORATION,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

THOMAS S. DANN

Counsel of Record

DANN & THOMAS

2000 L Street, N.W., Suite 702

Washington, D.C. 20036

(202) 785-4959

MICHAEL H. GOTTESMAN

BREDHOFF & KAISER

1000 Connecticut Avenue, N.W.

Washington, D.C. 20036

ROBERT A. WIENER

WEINBERG, ZIPSER, ARBITER

& HELLER

1901 Avenue of the Stars

16th Floor

Los Angeles, California 90067

Attorneys for Petitioners

WILSON - EPES PRINTING Co.,

Inc.

- 789-0096 - WASHINGTON, D.C. 20001

QUESTIONS PRESENTED

1. Whether the ratable distribution requirement of the

National Bank Act preempts the pre-insolvency state

law right of a depositor to a constructive trust on

funds fraudulently obtained by the bank prior to in-

solvency?

2. Whether, if there is such preemption, and a federal

common law rule is to be established, the ratable dis-

tribution requirement of the National Bank Act re-

quires the beneficial owner of funds held in construc-

tive trust by a failed national bank to prove that other

creditors of the bank could not even potentially have

equal rights to the funds?

(i)

TABLE OF CONTENTS

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REASONS FOR GRANTING THE WRIT ................

II.

THE TENTH CIRCUIT’S DECISION EN-

CROACHES ON AREAS OF LAW TRADI-

TIONALLY RESERVED BY CONGRESS FOR

Ee RC ie

THE TENTH CIRCUIT’S DECISION CRE-

ATES NEW FEDERAL COMMON LAW

RULES FOR NATIONAL BANK RECEIVER-

SHIPS WHICH ARE CONTRARY TO WELL-

ESTABLISHED TRUST PRINCIPLES AND

WHICH EFFECTIVELY ABROGATE ALL

STATE LAW CONSTRUCTIVE TRUSTS

A. The Tenth Circuit Created a Federal Com-

mon Law Rule That Erects an Impossible

Evidentiary Burden Contrary to Established

eT NSE

B. The Tenth Circuit’s Federal Common Law

Rule Which Recasts the Nature of a Con-

structive Trust is Contrary to Established

Law

iv ss

TABLE OF CONTENTS—Continued

lil. THE TENTH CIRCUIT’S DECISION WILL

HAVE A GREAT ECONOMIC IMPACT ON

UNINSURED DEPOSITORS IN FAILED

De GREE EE BO cincriciceniancnnnnectiorgnnes

| _ a EL ee e ORTON RET ae LS RO

APPENDIX A—Opinion of the United States Court of

Appeals for the Tenth Circuit, dated

tg ee eee

APPENDIX B—Opinion of the United States District

Court for the Western District of

Oklahoma, dated December 15, 1986..

APPENDIX C—Journal Entry of Judgment of the

District Court, dated December 23,

APPENDIX D—Order of the District Court Denying

Respondent’s Motion for New Trial

and Petitioners’ Motion to Amend

Judgment, dated March 27, 1987........

APPENDIX E—Order of the Tenth Circuit Denying

Petitioners’ Petition for Rehearing

and Suggestion for Rehearing En

Banc, dated September 5, 1989 _...........

APPENDIX F—List of Authorities Regarding Fraud

Directed to the Public...........................

APPENDIX G—List of Authorities Regarding Fraud

Giving Rise to a Constructive Trust....

Page

22a

42a

46a

49a

5la

53a

TABLE OF AUTHORITIES

CASES Page

Blakey v. Brinson, 286 U.S. 254 (1932) -............ 13, 14, 21

Blaney v. Florida Nat’l Bank at Orlando, 357 F.2d

8 | SENET ESN eT 9

Carnegie-Illinois Steel Corp. v. Berger, 105 F.2d

485 (3rd Cir.), cert. denied, 308 U.S. 603

3 RDS cerserna tae Savy vere See oe oe 16

Coit Independence Joint Venture v. FSLIC, 489

US. , 109 S.Ct. , 103 L.Ed.2d 602

2 See a ea AM TY Sm Ned 26

Connecticut General Life Ins. Co. v. Universal Ins.

Co., 6 FO G13 (ict Civ. 1966).....-- 10, 13

D’Oench, Duhme & Co., Inc. v. FDIC, 315 US.

Pg | ERERP Race SN ROR Ee SE SRNR Sere ae 11

Downriver Community Federal Credit Union v.

Penn Square Bank, 879 F.2d 754 (10th Cir.

|, RAR acs Cee: ee 1, 6, 10, 11, 14, 15, 17, 21, 25

Erie Ry. Co. v. Tompkins, 304 U.S. 64 (1938)... 10

FDIC v. Braemoor Associates, 686 F.2d 550 (7th

NE ___: NEE eae De aD SiON LT et 9

Federal Reserve Bank v. Omaha Nat’l Bank, 45

F.2d 511 (8th Cir. 1930), cert. denied, 282 U.S.

OO cect tscacachaasaesosiectenps vceanccaadlieahtodgs ciceacaes tus 16

Fiman v. State of South Dakota, 29 F.2d 776 (8th

liens 16

Harmsen v. Smith, 542 F.2d 496 (9th Cir. 1976) .... 17

Healy v. Commissioner of Internal Revenue, 345

if 3 @ we: , TRU mions alle era 22

Hurley v. FDIC, 719 F. Supp. 27 (D. Mass. 1989) .. 17

Imperial Supply Co. v. Northern Ohio Bank, 430 -

F. Supp. 889 (N.D. Ohio 1976).............................. 17

In re Bullion Reserve of North America, 836 F.2d

1214 (9th Cir. 1988), cert. denied sub nom.

Bozek v. Danning, 108 S.Ct. 2824, 100 L.Ed.2d

Is chen has, decenicnac eeamnetieeaainaa aida 10

In re FCX, Inc., 853 F.2d 1149 (4th Cir. 1988),

cert. denied, 109 S.Ct. 1118 (1989)

TABLE OF AUTHORITIES—Continued

Page

In re General Coffee Corp., 828 F.2d 699 (11th

Cir. 1987), cert. denied, sub nom. General Coffee

Corp. v. City Nat’l Bank of Miami, 108 S.Ct.

1470, 99 L.Ed.2d 699 (1988) .........000022220022. 2. 10, 13

In re Longhorn Securities Litigation, 573 F. Supp.

ns ciserumnaneenenece 17

In re N.S. Garrott & Sons, 772 F.2d 462 (8th Cir.

cabal 2 ASE a la 8

Interfirst Bank Abilene, N.A. v. FDIC, 777 F.2d

fe ee 9

Jaffke v. Dunham, 352 U.S. 280 (1957) .......--0... 9

Kennedy v. Boston Continental Nat’l Bank, 11

F. Supp. 611 (D. Mass. 1935), rev’d on other

grounds, 84 F.2d 592 (1st Cir.), cert. denied,

I ee 7

Kershaw v. Jenkins, 71 F.2d 647 (10th Cir. 1934) .. 14

Matter of Kennedy & Cohen, Inc., 612 F.2d 963

(5th Cir.), cert. denied, 449 U.S. 833 (1980)...... 14

Morrison-Knudson Co. v. CHG International, Inc.,

Sil F.2a 1208 (Sth Cir. 1967) —........................---- 26

O’Neal v. White, 79 F.2d 835 (4th Cir. 1935), cert.

Gentes, S07 U.S. 766 (1986) ................................- 16

Peoples-Ticonic Nat’l Bank v. Stewart, 86 F.2d 359

I 8

Reno Nat’l Bank v. Seaborn, 99 F.2d 482 (9th Cir.

RG GRAS tO OE ENE Na ee 10, 11

Sanyo Electric v. Howard's Appliance Corp., Case

No. 746, slip op. (2d Cir. April 25, 1989)... 10

Schuyler v. Littlefield, 282 U.S. 707 (1914) -_....... 14

Scott v. Armstrong, 146 U.S. 499 (1892) _............. 7, 8,11

St. Louis & San Francisco R. Co. v. Johnston, 133

EIN AER Sil sea 16, 18

Standard Oil Co. v. Elliott, 80 F.2d 158 (4th Cir.

a eat Rta ee Ee a Ae 16

United States v. Fontana, 528 F. Supp. 137 (S.D.

Rt i a A Re A AL ie th a 21

United States v. Whiting Pools, Inc., 462 U.S. 198

AEE Woh BER eR a na, See 12

vii

TABLE OF AUTHORITIES—Continued

STATUTES

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Rs IU ca cercececcreeensciivenncntoneen

ais iccsicrocienencscentniiavionicenatenieconeesipetenens

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SEI EI eR ERM sets lan Pesan

re ee ance cccccesiccsvncnnnnctenance

pr eve Toh hy) YY) ese

8 i IR RRS NEN CE A

ia ccsbssepeepeiieaneennneteneieimaa

OT ailing

Or re te I aia sai cetisdascctescchccncincosenmmcmnaseipanees

Pub. L. No. 101-73, § 212(a), 103 Stat. 183 (1989),

codified at 12 U.S.C. § 1821(d) (4)-(10) -........

Pub. L. No. 101-73, §§ 212(a) and 217(4), 103

Stat. 183 (1989), codified at 12 U.S.C. §§ 1821

CS I Re incite tienen sihcigncenictinincitiimariotiananitn

HOUSE AND SENATE REPORTS

H.R. Rep. No. 222, 101st Cong., 1st Sess. 502

| AREER RE ESR eee nanan ak mtnistnaeyenne tan we nemeeran ew

H.R. Rep. No. 595, 95th Cong., Ist Sess. (1977),

reprinted in 1978 U.S. Code Cong. & Ad. News

S. Rep. No. 989, 95th Cong., 2d Sess. (1978), re-

printed in 1978 U.S. Code Cong. & Ad. News

RRP yeeros Aachen Poe TT

TREATISES

76 Am.Jur.2d Trusts § 221 (1978)............................

12B W. Fletcher, Cyclopedia of the Law of Private

Corporations § 5923.2 (1984) ..............-----------cc-0--0-

Restatement (Second) of Trusts § 1, Comment e....

5 Scott, Trusts § 462.1 (3d ed. 1967) -._....................

5 Scott, Trusts § 462.4 (3d ed. 1967) .......................

pA OH SP COO OO &

20, 25

viii

TABLE OF AUTHORITIES—Continued

SECONDARY SOURCES

“FDIC Drawing Fire on Policy of Saving Big

Banks”, The Washington Post, Apr. 2, 1989, at

I a

“FDIC Faulted for Redeeming Uninsured Depos-

its”, The American Banker, Aug. 4, 1988, at 8,

SR, RAEN eR NC AIC SO RENE RIE TSC

FDIC News Release PR-170-87 (Sept. 21, 1987) ....

Federal Deposit Insurance Corporation, 1988 An-

GREE SAREE RE GN ree SENS Iie a

Federal Deposit Insurance Corporation, Deposit

Insurance in a Changing Environment (1983)..

Federal Home Loan Bank Board, 1987 Annual

GED RN ROR AIL ASIII ED ON ee nee

“Seeds of a Crisis are Present in the Banking In-

dustry”, The American Banker, Oct. 11, 1989,

GS a, ei EE steht aa Re eo Ee

Shaw, “Who’s Insuring What for Whom: First

Republic’s Lessons”, The American Banker, Apr.

i, See Me ls Ce cicada keene scenes

Page

IN THE

Supreme Court of the United States

OCTOBER TERM, 1989

No.

DOWNRIVER COMMUNITY FEDERAL CREDIT UNION

and Woop PRODUCTS CREDIT UNION,

rm Petitioners,

PENN SQUARE BANK, through its Receiver,

FEDERAL DEPOSIT INSURANCE CORPORATION,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

To The Honorable, The Chief Justice And Associate Jus-

tices Of The Supreme Court Of The United States:

Petitioners Downriver Community Federal Credit Union

and Wood Products Credit Union respectfully pray that a

writ of certiorari issue to review the judgment and opin-

ion by the United States Court of Appeals for the Tenth

Circuit entered in the above-titled case on July 3, 1989.

OPINIONS BELOW

The July 3, 1989, opinion of the United States Court

of Appeals for the Tenth Circuit is reported at 879 F.2d

754. The opinion is reprinted as Appendix A hereto,

- infra, at la.

The Order of the United States District Court for the

Western District of Oklahoma, from which an appeal was

taken by the Respondent to the court of appeals, is not

published. The Order, dated December 15, 1986, is re-

printed as Appendix B hereto, infra, at 22a. In addi-

tion, the district court issued an order relating to the

same issue currently on appeal, denying the Respondent’s

motion for a new trial. This order, dated March 27,

1987, is reprinted as Appendix D hereto, infra, at 46a.

JURISDICTION

The judgment of the court of appeals was entered on

July 3, 1989. On September 5, 1989, the court of appeals

denied Petitioners’ petition for rehearing. The jurisdic-

tion of this Court is invoked pursuant to 28 U.S.C. § 1254

(1). On September 8, 1989, this Court granted Petitionr-

ers a thirty day extension of time until Octcber 31, 1989

to file this Petition for Writ of Certiorari (Docket No.

89-A-198). -

STATUTES INVOLVED

12 U.S.C. § 194 of the National Bank Act provides:

§ 194. Dividends on adjusted claims; distribution of

assets. From time to time, after full provision has

been first made for refunding to the United States

any deficiency in redeeming the notes of such [na-

tional banking] association, the comptroller shall

make a ratable dividend of the money so paid over to

him by such receiver on all such claims as may have

been proved to his satisfaction or adjudicated in a

court of competent jurisdiction, and, as the proceeds

of the assets of such association are paid over to him,

shall make further dividends on all claims previously

proved or adjudicated; and the remainder of the pro-

ceeds, if any, shall be paid over to the shareholders

of such association, or their legal representatives, in

proportion to the stock by them respectively held.

R.S. 5236.

12 U.S.C. § 91 of the National Bank Act provides:

$91. Transfers by bank and other acts in contem-

plation of insolvency. All transfers of the notes,

bonds, bills of exchange, or other evidences of debt

owing to any national banking association, or of de-

posits to its credit; all assignments of mortgages,

sureties on real estate, or of judgments or decrees

in its favor; all deposits of money, bullion, or other

valuable thing for its use, or for the use of any of

its shareholders or creditors; and all payments of

money to either, made after the commission of an act

of insolvency, or in contemplation thereof, made with

a view to prevent the application of its assets in the

manner prescribed by this chapter, or with a view

to the preference of one creditor to another, except

in the payment of its circulating notes, shall be ut-

terly null and void; and no attachment, injunction,

or execution, shall be issued against such association

or its property before final judgment in any suit,

action, or proceeding, in any State, county, or muni-

cipal court. R.S. 5242.

STATEMENT OF THE CASE

Petitioners Downriver Community Federal Credit

Union (“Downriver”) and Wood Products Credit Union

(“Wood Products”) placed uninsured deposits in Penn

Square Bank, N.A. in reliance on the bank’s fraudulently

misleading financial statements in early 1982. On July

5, 1982 Penn Square Bank was declared insolvent and

the Federal Deposit Insurance Corporation (“FDIC”)

was appointed receiver for the bank. The Petitioners sued

the FDIC as receiver to recover their uninsured funds

on the grounds that the bank held the funds in construc-

tive trust for the Petitioners. Petitioners argued that be-

cause the bank obtained their funds by fraud, the bank

never took financial title to the funds. The funds there-

fore were held in constructive trust for the benefit of the

Petitioners, and were not assets of the bank when it

failed. The trust funds were traced to the hands of the

receiver, and thus were not subject to ratable distribu-

tion under the National Bank Act, 12 U.S.C. § 194. Con-

sequently, the Petitioners were entitled to recover the

funds in their entirety. The United States District Court

for the Western District of Oklahoma had original juris-

diction of the Petitioners’ actions pursuant to 28 U.S.C.

§ 1331, 28 U.S.C. § 1832(a), 12 U.S.C. § 1819 (Fourth)

(now 12 U.S.C. § 1819(b) (2) (A)) and 12 U.S.C. § 21,

et seq.

Downriver requested and received Penn Square Bank’s

financial statements directly from the bank. Downriver

analyzed this data and relied on it in placing its unin-

sured deposits in Penn Square Bank. Downriver had

$3,938,240.00 in uninsured deposits at the bank when it

was declared insolvent and closed on July 5, 1982.

Wood Products obtained the financial data contained

in Penn Square Bank’s financial statements through its

money broker, Professional Asset Management, Inc. Wood

Products analyzed this data and relied on it in placing

its uninsured deposits in the bank. Wood Products had

$404,583.32 in uninsured deposits at the bank when the

bank was closed.

Although the Petitioners’ cases were consolidated, Down-

river sought and received a jury trial on the issue of

liability, and Wood Products’ case was tried to the court.

The jury returned a verdict in favor of Downriver on the

issue of fraudulent inducement. The district court inde-

pendently found in favor of Wood Products on the same

issue.

In a subsequent equitable proceeding, the district court

found by clear and convincing evidence that the Petition-

ers had satisfied the factual and legal prerequisites for

imposition of a constructive trust under Oklahoma law

because (1) the Petitioners deposited funds above the

federally insured amount in reliance on Penn Square

Bank’s fraudulent financial statements, (2) the bank’s

financial statements materially misrepresented the condi-

sie

seni

tion of the bank by, inter alia, grossly overstating capital

and ticome, (3) the Petitioners’ uninsured deposits aug- |

mented the assets of the receivership estate and (4) the

deposits could ke traced into the hands of the receiver.

The district court also found that the imposition of a

constructive trust would be equitable because there was

no evidence of other creditors’ reliance, and any other

uninsured depositors who had relied on the fraudulent

financial statements could have proven their own trust

claims by bringing suit or intervening in the case. The

~district court found that denial of recovery to Petitioners

would unjustly enrich other creditors of Penn Square

Bank who would thereby benefit from the bank’s fraud.

As for the ratable distribution requirement of the Na-

tional Bank Act, the district court held that that provi-

sion did not preclude identification and recovery of prop-

erty that does not rightfully belong to the bank. The

district court ruled that since the Petitioners’ construc-

tive trusts vested under Oklahoma law at the time of the

original deposits prior to the bank’s insolvency, the Peti-

tioners’ funds were never assets of the bank, and were

not subject to the ratable distribution requirement of the_

National Bank Act.

There was no evidence at trial that any other uninsured

depositor had also relied on the fraudulent financial state-

ments. It was undisputed that the largest creditor, the

FDIC (47 percent of the total dollar value of all receiver

certificates), did not rely on the bank’s financial state-

ments and was not similarly situated to the Petitioners;

the FDIC’s claim against the receivership estate was

based solely on the insurance payout to insured depositors,

whose deposits were unaffected by the bank’s financial

condition.

Accordingly, the district court issued an order impos-

ing constructive trusts in favor of Downriver and Wood

Products in the amounts of $1,722,208.58 and $182,062.50,

respectively. These amounts represented the uninsured

amounts on deposit ai the bank on the day it was closed,

less dividends paid by the receiver in the interim.

The FDIC as receiver appealed to the United States

Court of Appeals for the Tenth Circuit pursuant to 28

U.S.C. § 1291. The FDIC did not appeal the fraud ver-

dict or any factual finding by the trial court; the FDIC

only appealed the district court’s legal ruling that the

constructive trusts were not preempted by the National

Bank Act.

The United States Court of Appeals for the Tenth

Circuit reversed the district court’s decision. The court

of appeals acknowledged that the Petitioners would be

entitled to recover their constructive trusts under Okla-

homa law. 879 F.2d at 763 (Appendix A at 18a). How-

ever, the Tenth Circuit held that the Petitioners’ pre-

insolvency property rights under Oklahoma law were pre-

empted by the federal policies of ratable distribution and

orderly administration of the receiver’s estate embodied

in the National Bank Act. The court thereby freed itself

to devise its “own principles” governing recovery of con-

structive trusts arising from fraud. 879 F.2d at 761

Appendix A at 13a).

The Tenth Circuit next invented a new federal com-

mon law rule under which all constructive trust claims

for fraud belong to the receiver where the fraud poten-

tially harmed all creditors, regardless of whether there

is any evidence that all creditors were actually de-

frauded. The court denied recovery by the Petitioners

because the financial statements upon which their con-

structive trusts were based were publicly available. Pe-

titioners filed a petition for rehearing and suggestion for

rehearing en banc which the court of appeals denied on

September 5, 1989. See Appendix E at 49a.

REASONS FOR GRANTING THE WRIT

I. THE TENTH CIRCUIT’S DECISION ENCROACHES

ON AREAS OF LAW TRADITIONALLY RESERVED

BY CONGRESS FOR THE STATES.

This is a case of national importance. The Tenth Cir-

cuit’s decision dramatically extends the reach of federal

regulation to areas of law traditionally reserved by Con-

gress and this Court for regulation by the states. The

decision ignores a century of settled law consistently ap-

plied in federal liquidation proceedings, both under the

National Bank Act and under the Bankruptcy Act. As a

result, the Tenth Circuit’s decision foments inconsistent

application of the policy of ratable distribution among

creditors of the same class, and potentially alters the ju-

dicial treatment of hundreds of millions of dollars of un-

insured deposits held by banks and thrifts nationwide.

When Congress enacted the National Bank Act and the

Bankruptcy Act, it established a uniform federal stand-

ard for determining what constitutes the assets of the in-

solvent estate and how those assets should be distributed

among creditors of the same class.’ The assets of the in-

solvent (and hence of the receivership estate) are fixed

as of the date of the declaration of insolvency and ap-

1 Although the Bankruptcy Act is not directly applicable to na-

tional bank liquidations, federal courts have generally looked to

bankruptcy principles for guidance in the liquidation of national

banks. See, e.g., Scott v. Armstrong, 146 U.S. 499, 511 (1892);

Kennedy v. Boston Continental Nat’l Bank, 11 F. Supp. 611 (D.

Mass. 1935), rev’d on other grounds, 84 F.2d 592 (1st Cir.), cert.

denied 300 U.S. 684 (1937). As discussed herein, the policies at

issue in this case, and Congress’s intent with respect to the applica-

tion of those policies, are identical to those adopted by Congress

for federal bankruptcy proceedings. See infra at 7-9. Accordingly,

it is appropriate that the Court look for guidance to expressions of

Congressional will with respect to federal bankruptcy proceedings

as well as national bank liquidations in determining the balance

which Congress intended between federal and state interests in

this area.

ynointment of a receiver (under the National Bank Act)

or petition for bankruptcy (under the Bankruptcy Act).’

Under both statutory schemes, Congress intended that

federal courts look to state law to determine what prop-

erty rights of the debtor had vested prior to, and not in

contemplation of, insolvency. And as to trusts in partic-

ular, Congress has been explicit: the creation of trusts is

determined by state law and the beneficiaries of a con-

structive trust under state law are entitled to post-

insolvency recovery of all trust property traced to the

insolvent estate, notwithstanding the ratable distribution

requirement. For instance, Congress expressly stated its

understanding in the legislative history of the Bankruptcy

Act that constructive trusts arise at the time the duty to

make restitution arises and that such property does not

become an asset of the insolvent estate but belongs to the

beneficial owner.* Similarly, by enacting Section 92a of

2 See 12 U.S.C. § 192; Scott v. Armstrong, 146 U.S. 499 (1892)

(National Bank Act) ; Peoples-Ticonic Nat’l Bank v. Stewart, 86

F.2d 359 (ist Cir. 1936) (same); 11 U.S.C. §541 (Bankruptcy

Act); In re N.S. Garrott & Sons, 772 F.2d 462, 467 (8th Cir. 1985)

(same).

3 See H.R. Rep. No. 595, 95th Cong., Ist Sess. 368 (1977), re-

printed in 1978 U.S. Code Cong. & Ad. News 5787, 6324; S. Rep. No.

989, 95th Cong., 2d Sess. 82 (1978), reprinted in 1978 U.S. Code

Cong. & Ad. News 5868. The following language contained in H.R.

Rep. No. 595, 95th Cong., Ist Sess. 368 (1977) (emphasis added),

unambiguously states the intent of Congress respecting pre-

insolvency constructive trusts under the bankruptcy code:

Situations occasionally arise where property ostensibly belong-

ing to the debtor will actually not be property of the debtor,

but will be held in trust for another. For example, if the

debtor has incurred medical bills that were covered by insur-

ance, and the insurance company had sent payment of the bills

to the debtor before the debtor had paid the bill for which the

payment was reimbursement, the payment would actually be

held in constructive trust for the person to whom the bill was

owed.

See also cases cited infra at 10 n.5.

the National Bank Act (12 U.S.C. § 92a), Congress indi-

cated its intention that the creation of a trust relation-

ship between a national bank and its customer, and the

right of a national bank to act as trustee, turn upon the

law of the state where the bank is located.‘

Federal courts have shown remarkable consistency in

applying st»te law to determine whether a constructive

trust was created prior to insolvency. For instance, this

Court ruled in Jaffke v. Dunham, 352 U.S. 280, 281

(1957) (per curiam), that in a federal bankruptcy pro-

ceeding state law provided the rule of decision to deter-

mine whether a constructive trust was established when

the bankrupt obtained funds by fraud. Similarly, in the

context of a national bank insolvenc¥7the Seventh Cir-

cuit held that state law is presumed to apply to the ques-

tion of pre-insolvency constructive trusts. In FDIC v.

Braemoor Associates, 686 F.2d 550, 553-554 (7th Cir.

1982), Judge Posner held that, notwithstanding the fact

that the FDIC was a party, state law determined exist-

ence of a constructive trust because “the absence of any

ready-made federal common law .. . and a general re-

luctance to displace state law without explicit statutory

or constitutional direction to do so, support a presump-

tion that state law is adequate and should be adopted by

the federal court as the rule of decision”. Cf. Interfirst

Bank Abilene, N.A. v. FDIC, 777 F.2d 1092, 1094 (5th

4 See Blaney v. Florida Nat’l Bank at Orlando, 357 F.2d 27, 30

(5th Cir. 1966) (“[T]he law of trusts and estates, like the law of

domestic relations, is primarily a matter of state concern. That

Congress, too, recognized this fact seems obvious from the provi-

sions of 12 U.S.C. § 92a itself, making the right of national banks

to act as trustees, executors, administrators or in any other fidu-

ciary capacity turn upon the law of the state in which such na-

tional bank is located.” (citations omitted) ). Although Section 92a

applies to trusts generally rather than to constructive trusts in

particular, the statute taken as a whole is a strong statement of

Congressional intent with regard to the applicability of state law of

trusts.

—————

Cir. 1985) (under the National Bank Act state law pro-

vided the rule of decision to determine pre-insolvency

equitable right to setoff) .*

The Tenth Circuit actually acknowledged a direct con-

flict with the Ninth Circuit Court of Appeals on the pre-

cise question at issue here, whether federal law preempts

state law governing the pre-insolvency creation of a con-

structive trust upon deposits in a national bank. 879

F.2d at 760 n. 6 (Appendix A at lla n. 6). In Reno

Nat’l Bank v. Seaborn, 99 F.2d 482 (9th Cir. 1938), a

depositor in a failed national bank claimed a constructive

trust on its deposit based on the bank’s allegedly fraudu-

lent failure to transfer the funds to another bank. The

Ninth Circuit ruled that, in light of Erie Ry. Co. v.

Tompkins, 304 U.S. 64 (1938), state law provided the

rule of decision as to whether the conduct of the bank

gave rise to a constructive trust:

The creditor rights of a depositor of a national bank,

by virtue of his loan to the bank and the effects of

the conduct of the bank as altering such rights, are

determined by the law of the state of the deposit, in

the absence of a federal statute creating a different

- relationship. There is no underlying general federal

law determining such rights, and no federal stat-

ute denying to a cestui his right against a bank

as its trustee, where, in the course of business prior

5 Cases under the Bankruptcy Act have uniformly reached identi-

cal results. See, e.g., Sanyo Electric v. Howard’s Appliance Corp.,

Case No. 746, slip op. at 3018-19 (2d Cir. April 25, 1989) (“The

existence and nature of a debtor’s interest, and correspondingly the

estate’s interest, in property is determined by state law’); In re

FCX, Inc., 853 F.2d 1149 (4th Cir. 1988), cert. denied, 109 S.Ct.

1118 (1989) (same) ; Connecticut General Life Ins. Co. v. Universal

Ins. Co., 838 F.2d 612 (1st Cir. 1988); In re Bullion Reserve of

North America, 836 F.2d 1214 (9th Cir. 1988), cert. denied sub nom.

Bozek v. Danning, 108 S.Ct. 2824, 100 L.Ed.2d 925 (1988); In re

General Coffee Corp., 828 F.2d 699, 702-704 (11th Cir. 1987), cert.

denied, sub nom. General Coffee Corp. v. City Nat’l Bank of Miami,

108 S.Ct. 1470, 99 L.Ed.2d 699 (1988) (estate does not include

property acquired by fraud and held in constructive trust).

to the receivership, such a trust relationship has

been created by the conduct of the bank. ... The

cases holding that state laws cannot determine what

preferences should be given in the distribution of an

insolvent bank’s assets, have no applicability to the

question here of the character of the assets prior to

and at the time the bank ceases business.

99 F.2d at 483 (emphasis added) (citation omitted).’

Contrary to the Tenth Circuit, the Ninth Circuit found

no need for nationwide uniformity requiring a federal

rule governing the pre-insolvency creation of a trust re-

lationship between a national bank and a depositor. Id."

6 The Ninth Circuit’s rationale echoed the reasoning of this Court

in the landmark case of Scott v. Armstrong, 146 U.S. 499, 511

(1892), where this Court rejected a similar argument that the

ratable distribution requirement of the National Bank Act pre-

empted a depositor’s right to setoff, “We cannot believe Congress

intended .. . to destroy by implication any right vested at the time

of the suspension of a national bank.”

7A central tenet of the Tenth Circuit’s holding is its belief that

a nationwide federal rule is necessary because the Petitioners’ re-

covery of constructive trusts under Oklahoma law would be an ac-

cident of geography contrary to the federal policy favoring equal

treatment of creditors. See 879 F.2d at 761, 763 (“[It] is not a

question to be decided fortuitously because ‘a particular state hap-

pened to have the greatest connection in the conflict of laws sense.’ ”

(quoting D’Oench, Duhme & Co., Inc. v. FDIC, 315 U.S. 447, 473

(1942) (Jackson, J., concurring)). (Appendix A at 13a-14a and

17a-18a). However, there is no need for federal uniformity regard-

ing the right to a constructive trust for fraudulently obtained de-

posits because every state’s laws are already uniform. The Petition-

ers would be entitled to constructive trusts regardless of the state

where the bank was located. In every state, a fraudulent misrepre-

sentation to the public is grounds for a fraud claim by anyone who

relies on it. See Appendix F at 5la. And in virtually every state, a

constructive trust arises when property is obtained by fraud. See

Appendix G at 53a. The federal interest in ratable distrivution of

the assets of failed national banks is adequately served by the

uniform federal rule requiring augmentation of the bank’s assets

and tracing of the trust funds. See infra at 13 n.9.

\ 12

Thus, the Tenth Circuit’s wholesale rejection of state

law is in conflict with this Court and virtually every other

circuit. Contrary to the intention of Congress, the deci-

sion undermines the authority of states to regulate pre-

insolvency trusts and property interests within their

borders and threatens to upset the time-honored balance

of state and federal interests in this area. In place of

that balance, the court substitutes a resu!t-oriented ap-

proach to the choice of law which allows federal courts

to choose selectively between applying state law or formu-

lating new federal common law, depending on which will

maximize assets to be included within the receivership

estate. The intended consequence is an expansion of the

concept of an “asset” of an insolvent national bank sub-

ject to ratable distribution to the FDIC and other credi-

tors. The corollary result is the erosion of traditional

state authority over the pre-insolvency commercial rela-

tionships between national banks and the creditors with

whom they deal in the ordinary course of business.

Moreover, as shown herein, the Tenth Circuit’s rejec-

tion of state law and adoption of new federal common

law rules introduces a dangerous divergence between the

National Bank Act and the Bankruptcy Act in determin-

ing what constitutes an asset of the insolvent estate and

how those assets should be ratably distributed among

creditors of the same class.* There is no policy justifica-

tion for different treatment of pre-insolvency constructive

trusts under the two statutory schemes.

8 Although Congress established different classes of creditors

under the two statutory schemes, the policy of ratable distribution

of receivership assets among members of the same class is identical.

Moreover, under both acts property held in trust by the debtor is

considered to be completely independent of the respective priority

schemes because such property is not even a part of the estate.

See, e.g., United States v. Whiting Pools, Inc., 462 U.S. 198, 205

n.10 (1983) (“Congress plainly excluded property of others held

by the debtor in trust at the time of the filing of the petition.’’).

Il. THE TENTH CIRCUIT’S DECISION CREATES

NEW FEDERAL COMMON LAW RULES FOR NA-

TIONAL BANK RECEIVERSHIPS WHICH ARE

CONTRARY TO WELL-ESTABLISHED TRUST

PRINCIPLES AND WHICH EFFECTIVELY ABRO-

GATE ALL STATE LAW CONSTRUCTIVE TRUSTS

BASED ON FRAUD.

Having rejected the traditional application of state law

to determine whether the Petitioners are entitled to pre-

insolvency trusts, and having determined that federal

common law should be fashioned to control the issue, the

Tenth Circuit’s decision further undermines traditional

state authority in favor of an expanded federal receiver-

ship estate by the particular new federal common law

rules it creates. Those rules impose an impossible burden

of proof on those seeking to enforce state law rights to

property held in trust by a national bank and improperly

alter the fundamental nature of constructive trusts.

A. The Tenth Circuit Created a Federal Common

Law Rule That Erects an Impossible Evidentiary

Burden Contrary to Established Law.

Federal courts have traditionally placed a heavy, but

not insurmountable, burden on those in federal liquidation

proceedings seeking to recover property held by a debtor

in constructive trust. The burden may be overcome by

clear and convincing evidence that (1) the constructive

trust arose prior to and not in contemplation of insol-

vency, (2) the trust property augmented the assets of the

insolvent, and (3) the property could be traced into the

hands of the receiver.®

® See, e.g., Blakey v. Brinson, 286 U.S. 254 (1932); Connecticut

General Life, supra, 838 F.2d at 612; General Coffee, supra, 828

F.2d at 699. In trust cases, federal courts have protected the fed-

eral interest in ratable distribution primarily through application

of the tracing and augmentation requirements. The rationale is

that a trust beneficiary has an interest in particular property, not

a lien against the general assets of the debtor’s estate. Once the

In the present case, the district court found all three

elements by clear and convincing evidence, and neither

the FDIC nor the Tenth Circuit disputed those findings.

The Tenth Circuit acknowledged that the Petitioners’ de-

posits were fraudulently induced because of their indi-

vidual reliance on the bank’s financial statements, and

that the Petitioners would be entitled to constructive trusts

if Oklahoma law were applied. See 879 F.2d at 763 (Ap-

pendix A at 18a). The trusts did not arise in contem-

plation of insolvency; irrespective of whether Penn Square

Bank had failed, the constructive trusts arose under Ok-

lahoma law at the time the Petitioners’ funds were fraud-

ulently obtained. As to the other two elements, augmenta-

tion and tracing, the Respondent conceded in oral argu-

ment before the district court that the Petitioners had

proven augmentation and tracing, and the undisputed

evidence clearly supports that finding.'’° Thus, under es-

identifiable property has been dissipated, the beneficiary becomes

a general creditor because it is left with only a general, unsecured

claim against the estate. Blakey v. Brinson, supra, 286 U.S. at 254

(National Bank Act); Matter of Kennedy & Cohen, Inc., 612 F.2d

963, 965-66 (5th Cir.), cert. denied 449 U.S. 833 (1980) (Bank-

ruptey Code). In the case of commingled cash deposited in banks,

courts have applied the “lowest intermediate balance” rule to trace

the trust fund. The failed bank is presumed to have spent its own

cash first, and as long as the amount of cash held by the bank has

not fallen below the amount held in trust, the cash remaining is

presumed to be the fund held in trust. See, e.g., Schuyler v. Little-

field, 232 U.S. 707 (1914) (Bankruptcy Code) ; Kershaw v. Jenkins,

71 F.2d 647, 649 (10th Cir. 1934) (National Bank Act).

10The Respondent’s counsel acknowledged during trial that the

Petitioners had satisfied the requirements of augmentation and

tracing:

MR. RICKETTS: Your Honor, insofar as the two elements

. augmentation and the tracing to the receivership, I will

not spend time on those because, frankly, we do think that

under the evidence that was presented in Phase One there was,

number one, new money coming into the bank as a result of

the reliance on the false financial statement; and the tracing,

at least under the cases, would indicate that the amounts being

tablished law, the Petitioners are entitled to recover their

funds without any further showing.

The Tenth Circuit, however, in effect abrogated the

Petitioners’ pre-insolvency state law property rights by

raising an additional and insurmountable obstacle to re-

covery. The court’s new rule creates a presumption that

all creditors had been equally defrauded and therefore

share parity with trust beneficiaries. The court imposed

an impossible burden on the Petitioners by requiring them

to prove a negative, namely, that other unsecured credi-

tors had not been defrauded. Thus, under the federal

common law rule created by the court:

A national bank’s fraudulent conduct may give rise

to a constructive trust only when the plaintiff can

show that the bank’s fraud caused a particular harm

that is not shared by substantially all other deposi-

tors... . Any remedy for fraudulent representa-

tions that affects, or potentially affects, all creditors

belongs to the receiver, who asserts such claims for

the benefit of all creditors.

879 F.2d at 762, 764 (Appendix A at 15a, 21a). Under

this standard, in order to recover, trust beneficiaries

must not only prove their own entitlement, but also must

prove that other creditors are not even potentially en-

titled to the same relief; and other creditors (including

the FDIC as the largest creditor) are almost automati-

cally entitled to a share of the trust beneficiaries’ trust

property because they are presumed to have been equally

defrauded. No proof of actual reliance on the bank’s

claimed by Downriver and Wood Products did not dip below or

go below the amounts...

Transcript of 11/12/86 at 48. The Petitioners’ funds augmented

the assets of Penn Square Bank because the funds were new money

coming into Penn Square Bank. Penn Square Bank’s cash never

fell below $19 million between the time of the Petitioners’ deposits

and the bank’s failure, thereby satisfying the “lowest intermediate

balance” rule for tracing. See supra at 13 n.9.

-16

misrepresentations is required by the Tenth Circuit. The

receiver need only assert the slender theoretical possibility

that other depositors could have been similarly harmed,

and the Petitioners are thereafter required to affirmatively

prove otherwise.

No other court has ever adopted such a rule. The

closely related decisions of this Court and the various

circuit courts awarding constructive trusts when deposits

were received by banks which were hopelessly insolvent

are analytically identical but diametrically opposed to the

Tenth Circuit’s holding." In addition, the Tenth Circuit’s

decision is in direct conflict with a decision by the Eighth

Circuit which is exactly on point. In Fiman v. State of

South Dakota, 29 F.2d 776, 782 (8th Cir. 1928), the

receiver anticipated the Tenth Circuit’s reasoning by

claiming that other uninsured depositors who relied upon

a failed bank’s misleading financial statements should be

presumed to have been defrauded and thereby entitled to

equal priority with the constructive trust claimant. The

Eighth Circuit rejected the receiver’s arguments. It

firmly placed the burden on other depositors to establish

their own priority, not on the plaintiff to disprove their

entitlement to parity.

A presumption of reliance by all creditors is not raised

by the mere fact that the bank’s fraudulent financial

11TIn hopeless insolvency cases, federal courts have uniformly

required the defrauded depositor to show only that it had deposited

funds after the bank was known by management to be hopelessly

insolvent; no such depositor was ever required to affirmatively

show that other depositors were not defrauded because they had

deposited funds before the bank was known to be hopelessly in-

solvent. See e.g., St. Louis & San Francisco R. Co. v. Johnston,

133 U.S. 566, 575 (1890); Carnegie-Illinois Steel Corp. v. Berger,

105 F.2d 485 (3rd Cir.), cert. denied, 308 U.S. 603 (1939); Stand-

ard Oil Co. v. Elliott, 80 F.2d 158 (4th Cir. 1935); Federal Reserve

Bank v. Omana Nat'l Bank, 45 F.2d 511 (8th Cir. 1930), cert.

denied, 282 U.S. 902 (1931); O’Neal v. White, 79 F.2d 835 (4th

Cir. 1935), cert. denied, 297 U.S. 706 (1936).

statements were available to the public. The Tenth Cir-

cuit’s federal common law rule inappropriately relies

upon Jn re Longhorn Securities Litigation, 573 F. Supp.

255, 272 (W.D. Okla. 1983), to support the proposition

that claims based on fraudulent representations that

“potentially affect” all depositors belong to the receiver.

879 F.2d at 764-765 (Appendix A at 21a). With regard

to the question of fraud claims based on fraudulent pub-

lished financial statements, however, Longhorn and the

cases cited therein actually held precisely the opposite.

Longhorn held that “individual depositors .. . may sue

directly, in their own right, if they suffer a wrong that

is uniquely theirs and not common to all.” 573 F. Supp.

at 272. Two of the cases cited by Longhorn as showing

such unique harm involved fraud claims identical to the

present case because the claims were based on publicly

available financial statements. See Harmsen v. Smith,

542 F.2d 496, 499-501 (9th Cir. 1976) (shareholders who

suffered separate, individual damages by relying on false

bank financial statements may sue directly); Imperial

Supply Co. v. Northern Ohio Bank, 430 F. Supp. 339, 364-

66 (N.D. Ohio 1976) (same); see also Hurley v. FDIC,

719 F. Supp. 27 (D. Mass. 1989) (fraud claims based on

shareholder reliance on bank’s fraudulent public quarterly

and annual reports belonged to the individual sharehold-

ers, not to the bank receiver). Longhorn and the cases

cited therein thus directly contradict the Tenth Circuit’s

ruling. Only derivative injuries predicated on harm

caused to the bank itself, as distinguished from injuries

suffered directly by an individual depositor or creditor,

are claims belonging to the receiver. See generally 12B

W. Fletcher, Cyclopedia of the Law of Private Corpora-

tions § 5923.2 (1984) (where shareholders themselves

have heen defrauded, they may individually sue the

wrongdoer, even if all shareholders were victims of the

fraud). Longhorn distinguishes fraud claims arising

from individual reliance on misleading financial state-

_ ments as precisely the kind of unique harm that gives

rise to a depositor’s individual claim against the receiver.

This analysis is consistent with the treatment of public

misrepresentations in the hopeless insolvency cases cited

in the Tenth Circuit’s decision. In every hopeless in-

solvency case the bank’s false representation of solvency

is directed to the public at large. For instance, in St.

Louis & San Francisco R. Co. v. Johnston, supra, this

Court noted that the bank’s representation of solvency

was directed “to complainant and all other persons deal-

ing with [the bank]”. 133 U.S. at 577. What distin-

guishes the individual depositor is its individual reliance

on that public misrepresentation. Similarly, what dis-

tinguishes the Petitioners in this case is their individual

reliance on Penn Square Bank’s misrepresentations in its

financial statements.

The distinction is magnified by the fact that, according

to the FDIC, until the failure of Penn Square Bank few

other depositors placed any reliance on the financial state-

ments of banks like Penn Square Bank because of the de

facto 100 percent deposit insurance which they expected

to receive from the FDIC:

Since 1960 about three-fourths of failed commercial

banks and, until Penn Square Bank, all failures over

$100 million in size have been handled in purchase

and assumption transactions (P&As) ... [A]ll de-

positors and other general creditors are made whole

ina P&A....

Many believe that no large American bank will be

paid off even if it were allowed to fail, and have

acted accordingly. In addition to driving large de-

positors from smaller to larger banks, this growing

perception of almost absolute safety of funds in large

institutions is having the effect of removing the con-

sideration of bank risk from business decisions... .

As a result of [deposit insurance and loan setoffs],

few depositors are exposed to any risk and have rea-

Pe ee ee

a tale be ee Miataent ot te 100

son to be concerned about the financial condition of

their banks.

Federal Deposit Insurance Corporation, Deposit Insur-

ance in a Changing Environment at I-6 and III-1 to III-3

(1983) (emphasis added).

In sum, the Tenth Circuit’s attempt to apply the rule

governing derivative injuries to the Petitioner’s construc-

tive trusts is misguided, because the fraud perpetrated

by Penn Square Bank was personal to the Petitioners. It

is conceivable that some uninsured depositors may have

relied on the bank’s financial statements. But given the

certainty that the largest creditor, the FDIC, did not rely

on the bank’s financial statements, it is inconceivable that

all Penn Square Bank creditors relied on the financial

statements. Those who were actually defrauded should

be required to prove their entitlement to higher priority.

The Petitioners proved their individual entitlement to

recover their trust funds based on time-honored rules for

establishing the existence of the trusts and tracing the

trust res into the hands of the receiver. The Tenth Cir-

cuit’s decision to hold otherwise is wholly unsupported

and is contrary to the actual findings of the FDIC re-

garding the practices of uninsured depositors leading up

to the Penn Square Bank failure.

The result propounded by the Tenth Circuit would

upset the equilibrium established by Congress and the

courts between federal interests in national bank liquida-

tions and state interests in regulating pre-insolvency

trust relationships and property transfers.’ The decision

12 Congress itself has never seen fit to disturb this balance.

Despite the fact that for over a century federal courts have been

allowing constructive trusts for uninsured deposits fraudulently

obtained by national banks, none of the numerous amendments of

the National Bank Act and the Federal Deposit Insurance Act have

attempted to limit recovery of such constructive trusts as proposed

by the Tenth Circuit. Certainly Congress has indicated a willing-

ness to modify the legal principles applicable to bank receiverships

also breeds inconsistencies between the National Bank

Act and the Bankruptcy Act in determining whether

property obtained by fraud may be retained for the bene-

fit of a debtor’s estate. Property which every federal

court for the past century would have treated as belong-

ing to the defrauded party becomes, under the Tenth

Circuit’s new rule, property of the receivership estate

subject to ratable distribution—based solely on the theo-

retical (but unlikely) possibility that all other creditors

were similarly harmed and thus entitled to equal relief if

they chose to seek it.’* The end result is that state au-

thority is further eroded and many general creditors who

were not fraud victims receive larger distributions and

are unjustly enriched at the expense of the party whose

property was fraudulently acquired by the insolvent.

where it felt such modification was warranted. In the Financial

Institutions Reform, Recovery and Enforcement Act of 1989 Con-

gress undertook an extensive overhaul of banking receivership

laws. Congress specifically enacted provisions codifying the FDIC’s

power to preempt contract rights, defenses and counterclaims other-

wise available to borrowers under state law. See Pub. L. No. 161-

73, §§212(a) and 217(4), 103 Stat. 183 (1989), codified at 12

U.S.C. §1821(e) and 1823(e); see also H.R. Rep. No. 222, 101st

Cong., Ist Sess. 502 (1989). Nevertheless, Congress left the state

law rights of constructive trust beneficiaries untouched, thereby

maintaining the traditional equilibrium.

13 As noted above, in the present case it is not even theoretically

possible that all creditors were defrauded by Penn Square Bank.

It is undisputed that the FDIC itself is the largest creditor, holding

47 percent of the dollar value of all receiver certificates. The FDIC

was not defrauded by Penn Square Bank. It is a creditor solely by

virtue of its rights as subrogee to insured depositors, who were

never at risk and never had occasion to rely on the bank’s financial

statements. Ironically, the FDIC stands to gain the most from the

Tenth Circuit’s new rule where it is presumed to have equal parity

to constructive trust claimants. This fact suggests that the Tenth

Circuit’s rule could be better characterized as a veiled effort to

augment the FDIC insurance fund rather than ensuring equitable

distribution of funds that were fraudulently obtained by Penn

Square Bank.

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B. The Tenth Circuit’s Federal Common Law Rule

Which Recasts the Nature of a Constructive Trust

is Contrary to Established Law.

The Tenth Circuit’s decision rejects state law govern-

ing the nature and creation of property interests and

fashions its own conception of the nature of a construc-

tive trust which is at odds with the weight of authority

in almost every jurisdiction, state and federal. Rather

than a vested right arising automatically at the time

property is wrongfully acquired, the court describes the

constructive trust as merely an “equitable fiction .. . [an]

attempt to recharacterize [the debtor-creditor] relation-

ship equitably after insolvency.” 879 F.2d at 760 (Ap-

pendix A at lla). Furthermore, the court expressly

limits its recognition of constructive trusts to those where

“the parties intended to form a trust.” 879 F.2d at 758,

760 (Appendix A at 7a, lla).

The Tenth Circuit’s decision confounds the distinction

between the creation of a property interest and its en-

forcement, and is contrary to established law governing

constructive trusts. A constructive trust arises at the

time property is wrongfully acquired, not at the time the

right to recover the trust is enforced by a court. See,

e.g., 5 Seott, Trusts § 462.4 (3d ed. 1967) ; United States

v. Fontana, 528 F. Supp. 187 (S.D.N.Y. 1981). More-

over, it is not necessary that the parties intend to create

a trust relationship in order for a constructive trust to

arise. See, e.g., 76 Am.Jur.2d Trusts § 221 (1975).'

14The Tenth Circuit attempts to graft the intent requirement

for resulting trusts onto constructive trusts. The case cited by

the court as authority, Blakey v. Brinson, 286 U.S. 254, 261-62

(1932), involved an alleged resulting trust, not a constructive trust.

Resulting trusts arise where title to property is transferred under

circumstances which raise an inference that the person who makes

the transfer does not intend the transferee to take a beneficial

interest in the property. Restatement (Second) of Trusts § 1, Com-

ment e; 5 Scott, Trusts § 462.1 (3d ed. 1967). Contrary to the

The Tenth Circuit’s distortion of the nature of con-

structive trusts is a critical weakness of the court’s deci-

sion. By beginning its analysis with the premise that

constructive trusts are created only if intended by the

parties and are otherwise merely post-insolvency remedies

rather than vested pre-insolvency property rights, the

court in effect assumes its ultimate conclusion from the

outset. The rights of creditors are determined as of the

date of the declaration of insolvency. The Tenth Circuit

constructs a federal common law rule that the right to

a constructive trust has not vested as of that date, absent

the parties’ intention to create a trust at the time of de-

posit. If no trust exists as of the declaration of in-

solvency, the funds subject to the trust instead become

assets of the receivership. Thus, by definition the right

to the trust property becomes a post-insolvency remedy

that alters the distribution of the failed bank’s assets in

contravention to the National Bank Act.

This reasoning, if it were correct, would nullify every

case allowing recovery of a constructive trust from a

bank receiver. Every claim for constructive trust would

necessarily effect a post-insolvency alteration in the rights

of creditors and distribution of assets. Under the proper

analysis, however, the Petitioners’ constructive trusts

arose at the moment Penn Square Bank fraudulently ob-

tained their deposits. For that reason, the Petitioners’

beneficial interests in the trust funds had vested as of

the date of insolvency, and the receiver succeeded only to

the rights and obligations of the bank as trustee. Because

the funds were never actually assets belonging to Penn

Square Bank, returning the funds to the Petitioners is

consistent with the requirement that the failed bank’s

Tenth Circuit’s characterization, a constructive trust arises ir-

respective of the intentions of the parties, in order to prevent un-

just enrichment at the expense of the party whose property was

wrongfully obtained. See Healy v. Commissioner of Internal Reve-

nue, 345 U.S. 278, 283 (1953).

ee ee ee

assets be ratably distributed. The Petitioners’ funds are

simply not part of those assets.

Ill. THE TENTH CIRCUIT’S DECISION WILL HAVE A

GREAT ECONOMIC IMPACT ON UNINSURED DE-

POSITORS IN FAILED BANKS AND THRIFTS.

The practical economic impact of the Tenth Circuit’s

decision is real and potentially enormous. In the last five

years over 600 banks and 200 thrifts have failed and

many more are expected to fail in the future.** Many of

these have and will involve depositor payoffs similar to

Penn Square Bank where uninsured depositors are ex-

posed to losses. In absolute terms, uninsured deposits in

federally insured banks at year-end 1988 totalled over

$580 billion, the highest level in history. As a percentage

of total deposits, uninsured deposits have risen since

1984; by the end of 1988 almost one out of every four

dollars deposited in federally insured banks was unin-

sured."®

Clearly, bank failures with uninsured deposits of the

magnitude of Penn Square Bank could occur again. Al-

though after the Penn Square Bank failure in 1982 many

large depositors sought to avoid risk by depositing only

$100,000 in any single institution, many more uninsured

depositors simply moved their deposits to larger banks

based on the same questionable assumption that was re-

15 See Federal Deposit Insurance Corporation, 1988 Annual Re-

port at 72; Federal Home Loan Bank Board, 1987 Annual Report

at 11.

16 According to the Federal Deposit Insurance Corporation,

$580,509,000,000 in deposits in federally insured banks were above

the $100,000 insurance limit on December 31, 1988. This amount

comprised approximately 24.9 percent of all funds deposited in

FDIC-insured banks. With the exception of 1987, uninsured de-

posits as a percentage of total deposits in FDIC-insured banks have

risen every year since 1984. See Federal Deposit Insurance Cor-

poration, 1988 Annual Report at 74.

sponsible for attracting large amounts of uninsured de-

posits to Penn Square Bank, i.e., that the federal govern-

ment will never liquidate large banks if they fail.’ How-

ever, many predict that sooner or later another large

bank will be liquidated. If that occurs, uninsured de-

posits of a similar magnitude to Penn Square Bank will

again be subjected to loss.’®

The Tenth Circuit’s decision unfairly alters the alloca-

tion of risk among these uninsured depositors. Any large

bank failure is likely to involve some element of fraud

perpetrated against one or more uninsured depositors.’

If the effect of such fraud is to increase the amount of

cash on hand when the bank fails, other unsecured

creditors, including the FDIC as subrogee of insured

depositors who were paid off, benefit directly from the

fraud when the fraudulently procured funds are dis-

tributed among such creditors rather than returned to

the rightful owner. The Tenth Circuit’s new standard

ensures this inequitable result and potentially could result

in the redistribution of millions of dollars to the other

17 According to a report by the FDIC, prior to the failure of

Penn Square Bank in 1982, the FDIC’s practice of providing de

facto 100 percent deposit insurance for banks larger than $100

million had caused uninsured depositors to place funds in banks

like Penn Square Bank which were larger than $100 million. See

supra at 18-19. See also “FDIC Faulted for Redeeming Uninsured

Deposits”, The American Banker, Aug. 4, 1988, at 3, col. 2; “FDIC

Drawing Fire on Policy of Saving Big Banks”, The Washington

Post, Apr. 2, 1988, at F1, col. 3.

18 See, e.g., “Seeds of a Crisis are Present in the Banking In-

dustry”, The American Banker, Oct. 11, 1989, at 5, col. 1; “FDIC

Drawing Fire on Policy of Saving Big Banks”, The Washington

Post, Apr. 2, 1988, at F1, col. 3; Shaw, ‘““‘Who’s Insuring What for

Whom: First Republic’s Lessons’, The American Banker, Apr. 8,

1988, at 4, col. 1.

19In 1987 the FDIC reported that fraud or insider abuse was a

factor in one third of all bank failures. FDIC News Release PR-

170-87 (Sept. 21, 1987).

creditors. Moreover, the likelihood of such a result can

have an immediate effect on the investment behavior of

uninsured depositors, even before a major bank failure.

The Tenth Circuit attempts to justify its preemption

of state law property rights precisely because preemption

of constructive trusts would have such a wide-ranging

effect. Without citing any evidence, the court categori-

cally concluded that allowing the Petitioners to recover

would disrupt the orderly administration of the receiver’s

estate. It apparently believed that too many uninsured

depositors would claim reliance on fraudulent financial

statements, and that the FDIC would be “deluge[d] ...

with the potentially crushing weight of claims for prefer-

ences.” 879 F.2d at 764 (Appendix A at 20a). The

sheer difficulty and expense of proving fraud, augmenta-

tion, and tracing, however, is likely to discourage frivolous

lawsuits. Moreover, such claims are no less entitled to

relief than the many other claims against national bank

receivers.

Rather than address the concern for orderly adminis-

tration by wholesale elimination of state law rights for

defrauded depositors as suggested by the Tenth Circuit,

Congress has instead sought to increase the capacity of

the FDIC to expeditiously administer a larger volume of

claims through such mechanisms as alternative dispute

resolution and binding arbitration. See The Financial

Institutions Reform, Recovery and Enforcement Act of

1989, Pub. L. No. 101-73, § 212(a), 103 Stat. 183 (1989),

codified at 12 U.S.C. § 1821(d) (4)-(10); see aiso H.R.

Rep. No. 222, 101st Cong., Ist Sess. 502 (1989). The

Tenth Circuit’s attempt to judicially legislate changes in

receivership administration is clearly inappropriate given

the fact that Congress has so recently enacted compre-

hensive legislation to address the issue. The very fact

that the Tenth Circuit felt compelled to do so only under-

scores the potential impact of its decision on the many

receiverships and millions of dollars of uninsured deposits

in bank failures across the nation.

Fundamentally, the error of the court below is its fail-

ure to protect state law rights in property, contrary to

the mandate of Congress that only the assets of a failed

national bank, not trust funds in possession of the bank’s

receiver, are subject to ratable distribution. In order to

achieve the intended result, the Tenth Circuit has ignored

established choice of law principles for determining the

assets of the failed bank and created new federal com-

mon law rules which necessarily have the effect of abro-

gating the rights of constructive trust beneficiaries under

state law. The end result is that the FDIC, as the largest

creditor of Penn Square Bank, will reap the benefits of

the fraud perpetrated upon the Petitioners. This Court

in Coit Independence Joint Venture v. FSLIC, 489 U.S.

, 109 S.Ct. , 103 L.Ed.2d 602 (1989), cited with

approval the decision of the Ninth Circuit Court of Ap-

peals in Morrison-Knudson Co. v. CHG International,

Ine., 811 F.2d 1209 (9th Cir. 1987), which addressed a

similar attempt to formulate new federal common law

to protect the thrift deposit insurance fund in the context

of the thrift crisis:

We respect FSLIC’s desire to maintain its reserves

and share its concern over the currently pressing

problems in the thrift industry. Nonetheless, we must

in this case obey statutes enacted before the difficul-

ties that now confront FSLIC. We are not free to

effect a wholesale revision of an agency’s statutory

authority in response to changed national conditions.

811 F.2d at 1216. The Tenth Circuit has attempted to

address changed national conditions in the banking in-

dustry by judicially expanding the scope of assets in-

cluded in the receivership estate of a national bank. The

result is an increase in the recoveries for other creditors

(such as the FDIC) and an erosion of state law au-

thority in a manner never intended by Congress. Trust

beneficiaries’ pre-insolvency state law property rights can

only be protected if federal courts are required to uni-

formly apply state law to determine the pre-insolvency

assets of failed banks.

CONCLUSION

WHEREFORE, Downriver Community Federal Credit

Union and Wood Products Credit Union pray that a writ

of certiorari issue from this Court to review the judg-

ment of the Court of Appeals for the Tenth Circuit in

this case. In the event that the petition is granted, Peti-

tioners pray that the judgment of the court below be

reversed, and that the cause be remanded with directions

to affirm the judgment of the District Court for the

Western District of Oklahoma.

Respectfully submitted,

THOMAS 8S. DANN

Counsel of Record

DANN & THOMAS

2000 L Street, N.W., Suite 702

Washington, D.C. 20036

(202) 785-4959

MICHAEL H. GOTTESMAN

BREDHOFF & KAISER

1000 Connecticut Avenue, N.W.

Washington, D.C. 20036

ROBERT A. WIENER

WEINBERG, ZIPSER, ARBITER

& HELLER

1901 Avenue of the Stars

16th Floor

Los Angeles, California 90067

Attorneys for Petitioners

<i aia aca, Snell sti tale.

APPENDICES

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APPENDIX A

UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

Nos. 87-1648, 87-1649 and 87-1707

DOWNRIVER COMMUNITY FEDERAL CREDIT UNION,

Plaintiff-Appellant,

PENN SQUARE BANK, through its Receiver,

FEDERAL DEPOSIT INSURANCE CORPORATION,

Defendant-A ppellee,

WooD PRODUCTS CREDIT UNION,

Plaintiff-A ppellant/

Cross-A ppellee,

PENN SQUARE BANK, through its Receiver,

FEDERAL DEPOSIT INSURANCE CORPORATION,

Defendant-A ppellee/

Cross-A ppellant.

July 3, 1989

Thomas S. Dann, of Timothy D. Naegele & Associates,

Washington, D.C., and Robert A. Wiener, of Weinberg,

Zipser, Arbiter, Heller & Quinn, Los Angeles, Cal. (Timo-

thy D. Naegele, of Timothy D. Naegele & Associates,

Washington, D.C., and C. Alexander Hewes, Jr., of Hewes,

Morella, Gelband & Lamberton, Washington, D.C., with

them, on the briefs), for plaintiffs-appellants.

Ann §S. DuRoss (Donald B. McKinley, Regional Counsel,

and Jane Rossowski, of Federal Deposit Ins. Corp., Wash-

ington, D.C., and Ronald N. Ricketts, of Gable & Gotwals,

Tulsa, Okl., with her, on the briefs), Asst. Gen. Counsel,

of Federal Deposit Ins. Corp., Washington, D.C., for

defendant-appellee.

Before McKAY, and TACHA, Circuit Judges, and

O’CONNOR, District Judge.*

TACHA, Circuit Judge.

This appeal arises from a dispute between certain un-

insured depositors in the insolvent Penn Square Bank,

N.A. (PSB), and the Federal Deposit Insurance Corpora-

tion (FDIC), in its capacity as receiver, over the priority

of the depositors’ claims against the insolvent bank’s

assets. The district court found that PSB fraudulently in-

duced the plaintiffs to deposit funds through issuing finan-

cial statements that were materially misleading as to

PSB’s financial condition. In the remedy phase of the

trial, the district court imposed a constructive trust upon

PSB’s assets in favor of the plaintiff-depositors, thereby

entitling them to recover the full amount of their deposits,

rather than their pro rata share under the relevant pro-

vision of the National Bank Act, 12 U.S.C. § 194. We

hold that federal law limits these depositors’ recovery to

their pro rata share of the assets held by the receiver,

and reverse.

The plaintiffs, Downriver Community Federal Credit

Union (Downriver) and Wood Products Credit Union

(Wood Products), were among the 140 credit unions, 48

*The Honorable Earl E. O’Connor, Chief Judge, United States

District Court for the District of Kansas, sitting by designation.

savings and loans, and 47 commercial banks holding sub-

stantial uninsured deposits in PSB when the Comptroller

of the Currency ordered PSB closed on July 5, 1982. See

Penn Square Bank Failure: Hearings Before the House

Comm. on Banking, Finance and Urban Affairs, 97th

Cong., 2d Sess., pt. 2, at 271 (1983). Like many other

credit unions, Wood Products and Downriver had pur-

chased certificates of deposit in PSB relying in part upon

recommendations and financial information provided by

money brokers, “the middlemen in the CD market whose

fees were paid not by the credit unions, but by Penn

Square.” Id. at 267.

In December 1981 Downriver was solicited by First

United Fund (FUF), a money broker located in Garden

City, New York, that claimed to perform a “complete

financial analysis” of all banking institutions that it rep-

resented. Downriver purchased its first PSB certificate

of deposit on April 1, 1982, in reliance upon financial in-

formation that FUF provided over the telephone. FUF

later provided Downriver with PSB’s financial statements,

prepared by PSB’s accountants, Peat, Marwick, Mitchell

& Co. (PMM), and Downriver purchased additional certifi-

cates of deposit in reliance upon the information con-

tained therein. On the date that the Comptroller of the

Currency closed PSB, Downriver held over $4 million in

PSB certificates of deposit. The FDIC paid Downriver

deposit insurance of $100,000 and issued a receiver’s cer-

tificate for the uninsured balance of $3,938,240. As of

December 10, 1986, Downriver had received dividend pay-

ments on that receiver’s certificate totaling $2,166,031.42.

Wood Products similarly purchased a PSB certificate of

deposit in reliance upon information provided by a money

broker, Professional Asset Management, Inc. (PAM).

PAM provided a list of financial institutions in which to

invest and produced a “Capital Adequacy Report” reflect-

ing the financial condition of each of those institutions.

Financial information provided by the institutions that

PAM represented formed the basis for those reports. Af-

ter analyzing the financial information contained in the

report on PSB, Wood Products purchased a $500,000 PSB

certificate of deposit on June 14, 1982. Upon PSB’s clo-

sure, Wood Products received federal deposit insurance

of $100,000 and a receiver’s certificate covering the un-

insured balance of $404,583.32. As of December 10, 1986,

Wood Products had received dividends upon its receiver’s

certificate totaling $222,520.82.

As noted by; the district court, the “calamitous event”

of the closing of PSB generated many lawsuits against

PSB, its officers, directors, and accountants, and the money

brokers responsible for soliciting funds for the bank.

Both Downriver and Wood Products commenced suits in

the United States District Court for the Western District

of Oklahoma, claiming in part that PSB knowingly or

recklessly induced their deposits through issuing financial

statements that materially mistated the the bank’s finan-

cial condition. Those suits were consolidated with suits

filed by several other parties who eventually settled dur-

ing the trial, leaving only the claims of Downriver and

Wood Products.

The case was tried in several phases, two of which are

most relevant to this appeal. The first phase involved

primarily the factual issue of whether PSB had fraudu-

lently misrepresented its financial condition in its finan-

cial statements, and whether the plaintiffs had relied upon

those misrepresentations in purchasing certificates of

deposit in PSB. Downriver’s claim was tried to the jury,

and Wood Products’ claim was tried to the court. In both

cases, the trier of fact returned verdicts in favor of the

plaintiffs, finding that PSB’s December 31, 1981, and

March 31, 1982, financial statements contained material

misrepresentations; such misrepresentations were relied

upon by the plaintiffs; and PSB’s management and di-

rectors knew that those financial statements contained

false or misleading information, or recklessly made those

representations knowing that there was no reasonable

ground for believing they were true.

The second phase of the trial involved remedy ques-

tions: whether a constructive trust could be imposed

upon the assets held by the receiver, and, if so, whether

such a constructive trust should include the post-insolv-

ency interest that the receiver earned on the plaintiff’s

deposits.' The district court held that Oklahoma law,

rather than federal law, governed whether a constructive

trust could be imposed. Although the relevant provision

of the National Bank Act, 12 U.S.C. § 194, requires ratable

distribution among holders of receiver’s certificates, the

district court held that this provision did not “preclude

identification and recovery of property that does not

rightfully belong to the bank.”

The district court found that the plaintiffs had satisfied

the factual and legal prerequisites for imposition of a

constructive trust under Oklahoma law: PSB had obtained

the plaintiffs’ deposits by fraud; such deposits had aug-

mented PSB’s assets; and the deposits could be traced

into assets held by the receiver.

1 Downriver had also asserted a claim for a constructive trust

on the proceeds_of one of its certificates of deposit that had ma-

tured on July 2, 1982, the last banking day on which PSB was

open. Downriver’s money broker, FUF, had issued wiring instruc-

‘tions to PSB to send the funds from the matured certificate to

another bank, but the funds were not wired and remained in the

bank on July 5, 1982, the date the Comptroller of the Currency

closed PSB and appointed a receiver. The jury found that FUF

was negligent in its attempt to have the funds wired, but rejected

Downriver’s allegation that PSB was guilty of fraud in failing to

wire the funds. The court also rejected Downriver’s theories that

the proceeds constituted a segregated fund, and that PSB became

its agent and breached a fiduciary duty in failing to transfer the

funds. The district court. therefore denied Downriver’s plea for a

constructive trust on the proceeds of the wire transfer. Down-

river apparently does not appeal this aspect of the district court’s

decision.

2The district court found no Oklahoma cases discussing the

augmentation and training requirements. The court noted, how-

ever, that because other jurisdictions imposed such requirements

The court also found that the imposition of a construc-

tive trust would be equitable. First, the court noted that

recovery by the plaintiffs would have only minimal im-

pact upon the assets available to other uninsured de-

positors holding receiver’s certificates. Second, the court

noted that imposing a constructive trust in favor of the

plaintiffs was not unfair to other uninsured depositors

because other depositors could have brought similar claims

on their own or intervened in the present case.

The district court therefore imposed a constructive

trust on the assets held by the receiver to the extent of

the principal amount of the deposits and interest ac-

crued to the date of insolvency. The court denied the

plaintiffs’ claim for a constructive trust on the post-

insolvency interest that the receiver earned on the plain-

tiffs’ deposits, however, holding that federal law governed

the distribution of interest accruing on a claim after in-

solvency of a national bank and that payment of interest

on one claim while other claims remained unpaid in whole

or in part would violate the requirement of ratable dis-

tribution of assets.

Although neither party challenges the district court’s

factual findings, both the plaintiffs and the FDIC con-

tend that the court made legal errors. The plaintiffs con-

tend that the district court erred in denying their claim

for postinsolvency interest. The FDIC contends that the

court erred in imposing a constructive trust for any

amount of the plaintiffs’ deposits, arguing that an imposi-

tion of a constructive trust in this case is a preference

contrary to certain provisions of the National Bank Act,

12 U.S.C. §§ 91, 194. Because we agree with the FDIC

that a constructive trust may not be imposed in this case,

on parties seeking a constructive trust, see, e.g., Converse Rubber

Co. v. Boston-Continental Nat’l Bank, 12 F.Supp. 887, 890 (D.Mass.

1935), aff'd, 87 F.2d 8 (1st Cir. 1936), Oklahoma could be ex-

pected to impose similar requirements.

i cee!

EOL EEE ee

we do not reach the question of whether an award of post-

insolvency interest is permissible.

Il.

Although an award of equitable relief is generally re-

viewed only for an abuse of discretion, see McKinney v.

Gannett Co., 817 F.2d 659, 670 (10th Cir.1987), we re-

view de novo the district court’s judgment when, as here,

the availability of such equitable relief depends upon an

| interpretation of law, see Pratte v. NLRB, 683 F.2d 1038,

| 1040 (7th Cir.1982). In deciding the question of whether

| a constructive trust may be imposed in this case, the

| first issue to be resolved is the source of the applicable

| law.

| Prior to the insolvency of a national bank, state law

generally governs the nature of the relationship between

a national bank and its depositors. See Reno Nat’l Bank

v. Seaborn, 99 F.2d 482, 483 (9th Cir.1938).

The creditor rights of a depositor of a national bank,

by virtue of his loan to the bank and the effects of

the conduct of the bank as altering such rights, are

determined by the law of the state of the deposit, in

the absence of a federal statute creating a different

relationship. There is no underlying general federal

law determining such rights (Erie Ry. Co. v. Tomp-

kins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, 114

A.L.R. 1487), and no federal statute denying to a

cestui his right against a bank as its trustee, where,

in the course of its business prior to the receivership,

such a trust relationship has been created by the

conduct of the bank.

Id. The parties’ intention is critical in determining

whether a relationship of debtor and creditor, or trustee

and beneficiary, has been established by depositing funds

| in a national bank. See Blakey v. Brinson, 286 U.S. 254,

261-62, 52 S.Ct. 516, 517-18, 76 L.Ed. 1089 (1932).

LR hl Ee

ie ote A ar

State law governance of the preinsolvency contracts of

national banks is limited, of course, by the paramount

authority of Congress to regulate national banks.

National banks are instrumentalities of the federal

government, created for a public purpose, and as such

necessarily subject to the paramount authority of the

United States. It follows that an attempt by a state

to define their duties or control the conduct of their

affairs is absolutely void, wherever such attempted

exercise of authority expressly conflicts with the laws

of the United States, and either frustrates the pur-

pose of the national legislation or impairs the effi-

ciency of these agencies of the federal government to

discharge the duties for the performance of which

they were created. These principles are axiomatic,

and are sanctioned by the repeated adjudications of

this court.

Davis v. Elmira Sav. Bank, 161 U.S. 275, 288, 16 S. Ct.

502, 503, 40 L.Ed. 700 (1896) ; see id. at 290, 16 S. Ct.

at 506 (“general and undiscriminating state laws” govern

contracts of national banks “so long as such laws do not

conflict with the letter or the general objects and purposes

of congressional legislation’’).

Although Congress has not enacted specific legislation

to govern the preinsolvency relationship between national

banks and their depositors, Congress has enacted legisla-

tion governing the distribution of assets upon the in-

solvency of a national bank. Most relevant here are pro-

visions of the National Bank Act precluding payments by

the bank that prefer some creditors over others, 12 U.S.C.

§ 91,° and requiring a ratable distribution of assets among

3 Section 91 provides in relevant part:

All transfers of the notes, bonds, bills of exchange, or other

evidences of debt owing to any national banking association,

or of deposits to its credit; all assignments of mortgages,

sureties on rea] estate, or of judgments or decrees in its favor;

eee

all general creditors entitled to share in the receivership

estate, 12 U.S.C. § 194.4 As of the moment that a national

bank is declared insolvent and goes into the hands of a

receiver, federal law governs the distribution of the bank’s

assets. See American Surety Co. v. Bethlehem Nat’l Bank,

314 U.S. 314, 316-17, 62 S.Ct. 226, 227-28, 86 L.Ed. 241

(1941) ; First Nat’l Bank v. Selden, 120 F. 212, 215 (7th

Cir.1903). All state laws inconsistent with the “system

of equal distribution” established by the National Bank

Act are preempted. Jennings v. United States Fidelity &

Guar. Co., 294 U.S. 216, 226, 55 S.Ct. 394, 398-99, 79

L.Ed. 869 (1935). “In no other way could there be unity

of administration, and a carrying out of the federal man-

date of equality.” Selden, 120 F. at 215. As the Supreme

Court has noted:

all deposits of money, bullion, or other valuable thing for its

use, or for the use of any of its shareholders or creditors;

and all payments of money to either, made after the commis-

sion of an act of insolvency, or in contemplation thereof, made

with a view to prevent the application of its assets in the man-

ner prescribed by this chapter, or with a view to the preference

of one creditor to another, except in payment of its circulating

notes, shall be utterly null and void....

12 U.S.C. § 91.

4 Section 194 provides:

From time to time, after full provision has been first made

for refunding to the United States any deficiency in redeem-

ing the notes of such association, the comptroller shall make a

ratable dividend of the money so paid over to him by such

receiver on all such claims as may have been proved to his

satisfaction or adjudicated in a court of competent jurisdic-

tion, and, as the proceeds of the assets of such association

are paid over to him, shall make further dividends on all claims

previously proved or adjudicated; and the remainder of the

proceeds, if any, shall be paid over to the shareholders of such

association, or their legal representatives, in proportion to the

stock by them respectively held.

12 U.S.C. § 194 (emphasis added).

10a

We consider [the National Bank Act] as constituting

by itself a complete system for the establishment and

government of national banks, prescribing the man-

ner in which they may be formed . . . and the

manner . .. in which their affairs shall be wound

up, their circulating notes redeemed, and other debts

paid, or their property applied toward such payment.

Cook County Nat’l Bank v. United States, 107 U.S. 445,

_ 448, 2 §.Ct. 561, 564, 27 L.Ed. 537 (1883).

When, as here, the FDIC is involved in its capacity as

receiver, we must also read the National Bank Act in con-

junction with the Federal Deposit Insurance Act. FDIC

v. McKnight, 769 F.2d 658, 662 (10th Cir.1985), cert.

denied, 475 U.S. 1010, 106 S.Ct. 1184, 89 L.Ed.2d 300

(1986). The FDIC is empowered by statute “[t]o sue

and be sued.” 12 U.S.C. § 1819 (Fourth). The statute

further provides that “[a]ll suits of a civil nature at

common law or in equity to which the [FDIC] shall be a

pa:ty shall be deemed to arise under the laws of the

United States.” Id.;* see D’Oench, Duhme & Co. v. FDIC,

315 U.S. 447, 467-68, 62 S.Ct. 676, 683-84, 86 L.Ed. 956

(1942) (Jackson, J., concurring); FDIC v. Braemoor

Assocs., 686 F.2d 550, 553 (7th Cir.1982), cert. denied,

461 U.S. 927, 103 S.Ct. 2086, 77 L.Ed.2d 297 (1983).

Upon the insolvency of a national bank and the appoint-

ment of the FDIC as receiver, therefore, it is well settled

that all claims against the receiver’s estate are governed

by federal law. See, e.g., FDIC v. Bank of San Fran-

cisco, 817 F.2d 1395, 1398 (9th Cir. 1987); FDIC v.

Palermo, 815 F.2d 1329, 1334 (10th Cir.1987); Inter-

first Bank Abilene, N.A. v. FDIC, T77 F.2d 1092, 1094

5 Section 1819 creates an exception to this provision for “any

. suit to which [FDIC] is a party in its capacity as receiver

of a State bank and which involves only the rights or obligations

-of depositors, creditors, stockholders, and such State banks under

State law.” 12 US.C. § 1819 (Fourth) (emphasis added). That

exception is not this case.

Waa al Cte ANP OTT Rt nk Paci Sent Soca waa vee

60 sae SB a i HE

lla

(5th Cir.1985) ; McKnight, 769 F.2d at 661; Selden, 120

F. at 215.

The plaintiffs attempt to avoid the application of fed-

eral law to their claim, however, on the ground that their

equitable right to the funds arose prior to insolvency.

They contend that Oklahoma law governs the nature of

their preinsolvency relationship with PSB, and that, be-

cause of PSB’s fraud, their deposits never became part

of PSB’s assets, but were instead impressed with a trust

relating back to the date of their initial deposits. The

equitable fiction of the trusts relating back to the date

that the plaintiffs deposited funds in PSB, however, does

not change the fact that by purchasing a certificate of

deposit in PSB, the plaintiffs intended a debtor and

creditor relationship. See Atlantic Gypsum Co. v. Federal

Nat’l Bank, 76 F.2d 59, 60 (1st Cir.1935) (“Deposits

with national banks, evidenced by a certificate of deposit,

are ordinarily made on the credit of the bank, and create

only a debtor and creditor relation.”) Although the state

law of contracts governs whether the parties intended to

form a trust or a debtor/creditor ‘relationship prior to

insolvency, any attempt to recharacterize that relationship

equitably after insolvency is governed by federal law.®

6 The plaintiffs rely upon Reno Nat’l Bank v. Seaborn, 99 F.2d

482 (9th Cir. 1938), for the proposition that state law determines

whether a trust relationship arose prior to insolvency. In Seaborn,

the Ninth Circuit considered whether the conduct of a national

bank prior to insolvency converted the plaintiff’s deposit into a

trust fund. Jd. at 483. The plaintiff, the receiver of a failed

state bank, sought to establish that its deposit in a national bank

was transformed into a trust fund when the national bank promised

to transfer the receiver’s funds to another state bank, but failed to

do so prior to becoming insolvent. Jd. at 482-83. The question

before the court concerned the legal effect of an instruction to

transfer funds, and the court held that state law governed this

question. Id. at 483. “No need of federal uniformity exists re-

quiring that federal banks in each state shall conduct their ordinary

banking business exactly as in every other state.” Jd. After ex-

12a

The FDIC, as receiver, takes control of an insolvent na-

tional bank subject to the “rights and equities” existing

prior to insolvency. Palermo, 815 F.2d at 1334. The

relevant provisions of the National Bank Act admittedly

do not provide explicit guidance for the disposition of all

claims against the receiver’s estate. See D’Oench, Duhme

& Co., 315 U.S. at 470, 62 S.Ct. at 685. (Jackson, J.,

concurring) (noting “recognized futility of attempting

all-complete statutory codes”). “Congress has seen fit

not to anticipate by specific rules solution of problems

that inevitably arise in national bank liquidations.” Beth-

lehem Nat'l Bank, 314 U.S. at 316, 62 S.Ct. at 228.

“Instead, [Congress] chose achievement of a ‘just and

equal distribution’ of an insolvent bank’s assets through

the operation of familiar equitable doctrines evolved by

the courts.” Id. (quoting Elmira Sav. Bank, 161 U.S. at

284, 16 S.Ct. at 504). Federal common law governs the

application of such equitable doctrines. See FDIC v.

Mademoiselle of Cal., 379 F.2d 660, 662-63 (9th Cir.

1967).

amining the plaintiff’s instruction to transfers the funds, and the

bank’s agreement to do so, the court concluded that no trust had

been established. Jd. at 484. The plaintiff’s credit balance at the

bank was not segregated into a separate fund and was still subject

to the receiver’s check. Jd. The debtor and creditor relationship

was still intact, and no trust had been established by the plaintiff’s

order. See id. Instead of full recovery, the plaintiff merely had a

claim to a pro rata share in the distribution of the national bank’s

assets. See id. at 483.

To the extent that Seaborn is interpreted to have applied state

law to determine whether the parties intended a trust to be formed,

or whether the bank created a trust by segregating the plaintiff’s

funds, it is consistent with our analysis. To the extent that Seaborn

may be interpreted as support for the position that equitable

claims against the receiver’s estate are governed only by state law,

we disagree. As discussed more fully in part III of this opinion,

we may choose to adopt state law as the rule of decision, but we

need not do so when a conflict with the purposes of the National

Bank Act would result.

13a

III.

Having decided that federal common law governs the

plaintiffs’ claims does not necessarily preclude the appli-

cation of Oklahoma law ailowing a constructive trust

remedy. “In fashioning the federal common law in this

area we may look for guidance to the law of the state

having the closest connection to the transaction at issue

when to do so would not conflict with the need for uni-

form rules governing bank liquidations.” Palermo, 815

F.2d at 1334.

When a “federal policy or need for uniformity” would

be “frustrated” by the application of state law as the

federal rule of decision, Palermo, 815 F.2d at 1334-35,

however, we must devise from sources other than state

law our own principles that conform with that policy or

need. See id.; see also Bank of San Francisco, 817 F.2d

at 1398 (noting that federal court making “ ‘specialized

federal common law’” may “adopt the law of the state

involved” or “draw on the federal law merchant” (quot-

ing Friendly, In Praise of Erie—And of the New Federal

Common Law, 39 N.Y.U.L. Rev. 383, 406 (1964)));

Braemoor Assocs., 686 F.2d at 554 (suggesting that “in

an appropriate case a federal court could reject state

substantive law if . .. necessary to protect the FDIC’s

interest in minimizing depositor losses’). As Justice

Jackson stated:

A federal court sitting in a non-diversity case such

as this does not sit as a local tribunal. In some cases

it may see fit for special reasons to give the law of a

particular state highly persuasive or even controlling

effect, but in the last analysis its decision turns upon

the law of the United States, not that of any state.

Federal law is no juridical chameleon, changing com-

plexion to match that of each state wherein lawsuits

happen to be commenced because of the accidents of

service of process and of the application of the venue

statutes. It is found in the federal Constitution, stat-

l4a

utes, or common jaw. Federal common law imple-

ments the federal Constitution and statutes, and is

conditioned by them. Within these limits, federal

courts are free to apply the traditional common-law

technique of decision and to draw upon all the sources

of the common law....

. .. [The substantive issue here] is not ‘a question

to be answered from considerations of geography.

That a particular state happened to have the great-

est connection in the conflict of laws sense with [the

activity forming the basis of the claim] is not enough

to make us subservient to the legislative policy or the

judicial views of that state.

D’Oench, Duhme & Co., 315 U.S. at 471-73, 62 S.Ct. at

686-87 (Jackson, J., concurring) (footnote omitted) ; ef.

Silkwood v. Kerr-McGee Corp., 464 U.S. 238, 248, 104

S.Ct. 615, 621, 78 L.Ed.2d 443 (1984) (notirg preemp-

tion of state law when “the state law stands as an ob-

stacle to the accomplishment of the full purposes and ob-

jectives of Congress’).

Here, we must utilize governing principles that are in

conformity with the policies underlying the National

Bank Act. See Palermo, 815 F.2d at 1334. Most impor-

tant to this case are the policies of achieving the “equity

of equality amorg creditors,” Scott v. Armstrong, 146

U.S. 499, 511, 13 S.Ct. 148, 152, 36 L.Ed. 1059 (1892),

and of the orderly liquidation of the receiver’s estate, see

Bryant v. Linn County, Or., 27 F.Supp. 562, 565 (D.Or.

1938), that are implicit in 12 U.S.C. $§ 91, 194.

Congress chose to achieve, through the National Bank

Act, “a just and equal distribution of the assets of na-

tional banks among all unsecured creditors.” Elmira Sav.

Bank, 161 U.S. at 284, 16 S.Ct. at 504. “This public aim

in favor of all the citizens of every state of the Union

is manifested by the entire context of the national bank

act.” Id. “The FDIC, when acting as a receiver for an

- owen

15a

insolvent bank, cannot prefer some creditors over others;

rather, all creditors must share in a ratable distribution

of the insolvent bank’s assets.” Hibernia Nat’l Bank v.

FDIC, 733 F.2d 1408, 1407 (10th Cir.1984). The receiver

is charged with the duty of “securing equal justice to all

its creditors . . . under a law which sternly forbids pref-

erences.” Casey v. Cavaroc, 96 U.S. 467, 489, 24 L.Ed.

779 (1878). The National Bank Act is “distinctly un-

friendly to the recognition of special interests or pre-

ferred claims. Doubts should be resolved against them.”

Atlantic Gypsum, 76 F.2d at 61 (citations omitted).

The Act’s unfriendliness to special interests requires a

claimant seeking a preference from pro rata distribution

of assets to bear a heavy burden of proof. See Hibernia

Nat’l Bank, 733 F.2d at 1408; see also Bryant, 27 F.

Supp. at 565 (“[a]s a matter of orderly liquidation in

accordance with [the Act]” federal courts uniformly put

burden on claimant seeking preference based on trust

arising ex maleficio). A national bank’s fraudulent con-

duct may give rise to a constructive trust only when the

plaintiff can show that the bank’s fraud caused a par-

ticular harm that is not shared by substantially all other

depositors, and that granting relief to the plaintiff does

not disrupt the orderly administration of the receiver’s

estate. This general rule is exemplified in the cases in-

volving constructive trusts imposed upon the assets of a

hopelessly insolvent bank.

A bank receiving deposits after its officers know that

the bank is hopelessly insolvent is deemed to commit fraud

upon those depositors, entitling them to reclaim their

deposits.’ See, e.g., St. Louis & S.F. Ry. v. Johnston, 133

7 As in other cases involving the recovery of a trust fund, the

right to reclaim a deposit is contingent upon the plaintiff’s proof

that the deposit augmented the receiver’s estate and can be traced

into the possession of the receiver. See Queenan v. Mays, 90 F.2d

525, 531-32 (10th Cir.), cert. denied, 302 U.S. 724, 58 S.Ct. 45, 82

L.Ed. 559 (1937); Flynn v. Smith, 90 F.2d 305, 310-11 (7th Cir.

1937) ; Kershaw v. Jenkins, 71 F.2d 647, 649 (10th Cir. 1934).

16a

U.S. 566, 576-77, 10 S.Ct. 390, 392-93, 33 L.Ed. 683

(1890) ; Carnegie-Illinois Steel Corp. v. Berger, 105 F.2d

485, 487 (3d Cir.), cert. denied, 308 U.S. 603, 60 S.Ct.

140, 84 L.Ed. 504 (1939) ; Standard Oil Co. v. Elliott, 80

F.2d 158, 161 (4th Cir.1935); Federal Reserve Bank v.

Omaha Nat’l Bank, 45 F.2d 511, 519 (8th Cir.1930),

cert. denied, 282 U.S. 902, 51 S.Ct. 215, 75 L.Ed. 794

(1931). This right to reclaim is restricted to claimants

who deposited funds after the date the bank is known by

its officers to be hopelessly insolvent, and it extends only

to “the sum paid in” at such time. Berger, 105 F.2d at

487. “[M]ere embarrassed circumstances, or even simple

insolvency of a bank at the time of receiving a deposit,

without more, does not warrant the rescission, for fraud,

of the contract of deposit, if, when the deposit was ac-

cepted, there was a present genuine and reasonably

founded hope, expectation, and intention on the part of

the bank’s officers to carry on the business.” Byrd v. Ross,

58 F.2d 377, 378 (S.D.Fla.1932). If the bank’s officers

have “ground for the supposition that the bank might

continue in business,” Johnston, 1383 U.S. at 578, 10 S.Ct.

at 393, and merely omit to disclose the precarious finan-

cial condition of the bank, a constructive trust is not

available. See id.

Those who deposit funds after a bank is hopelessly

insolvent can show a specific act of fraud that affects

only them, and therefore they have a superior equitabic

position over others who deposited funds prior to hope-

less insolvency with a hope or belief in the bank’s future

ability to repay the deposit. Furthermore, a hopelessly

insolvent bank should have been closed by the Comptroller

of the Currency as of the date of such insolvency, thereby

preventing the receipt of further deposits. Equity there-

fore ‘regards that as done which should have been done,”

O’Neal v. White, 79 F.2d 835, 835 (4th Cir.1935), cert.

denied, 297 U.S. 706, 56 S.Ct. 501, 80 L.Ed. 994 (1936),

and permits the rescission of deposit contracts made after

the bank should have been closed.

17a

Even in the case of hopeless insolvency, however, full

restitution may be denied when it would sufficiently dis-

rupt the orderly administration of the receiver’s estate or

otherwise result in inequitable treatment to other simi-

larly situated depositors. See Bryant, 27 F.Supp. at 565.

In Bryant, the court refused a claim for a constructive

trust by a party which had deposited funds in a national

bank that had been insolvent “for many years.” Jd. at

563. That party, as well as many other depositors who

were not parties to the suit, had made such deposits “upon

the faith of the solvency of the Bank.” Jd. Because the

complaining party did not “assert the claim of trust ex

maleficio until almost twenty-three months after the clos-

ing of the Bank,” and because virtually all other depos-

itors could have been considered in the same situation due

to the unusual length of time that the bank was hopelessly

insolvent, the court denied a constructive trust. See id.

at 565-66; see also Berger, 105 F.2d at 487-88 (denying

constructive trust due to delay in bringing claim when

allowing claim “would work havoc in the orderly admin-

istration” of bank’s affairs); Leonard v. Gage, 94 F.2d

19, 25-26 (4th Cir.), cert. denied, 303 U.S. 653, 58 S.Ct.

752, 82 L.Ed. 1113 (1938) (allowing recovery in favor

of receivers of national banks against receivers of state

bank when relief could be awarded “without disrupting

in any way the orderly administration of the estate or

prejudicing the just rights of any of the creditors’) ;

Poole v. Elliott, 76 F.2d 772, 774-75 (4th Cir.1935)

(denying constructive trust upon assets of insolvent state

bank when claim “would affect a large part of the obliga-

tions to depositors and probably all of the cash assets

passing into the hands of the receivers” and cause “injus-

tice to other persons interested in the administration of

the estate’’).

Here, the application of these policies—preserving the

orderly administration of the receiver’s estate and achiev-

ing an equitable distribution among creditors—is not a

18a

question to be decided fortuitously because “a particular

state happened to have the greatest connection in the con-

flict of laws sense.” D’Oench, Duhme & Co., 315 U.S. at

473, 62 S.Ct. at 687 (Jackson, J., concurring). We refuse

here to adopt Oklahoma law as the federal rule of deci-

sion because to do so would permit a constructive trust

in favor of plaintiffs in contravention of the principles

implicit in the National Bank Act.

In awarding a constructive trust in favor of the plain-

tiffs, the district court relied upon an Oklahoma statute

providing that:

[o]ne who practices a deceit with intent to defraud

the public, or a particular class of persons, is deemed

to have intended to defraud every individual! in that

class, who is actually misled by the deceit.

Okla.Stat.Ann. tit. 76, §4 (West 1987). The plaintiffs,

having proved reliance upon PSB’s published financial

statements, were deemed to have been “actually misled”

by PSB at the time they purchased PSB certificates of

deposit, and accordingly the trial court ordered that they

be allowed to recover all of their deposits. Such recovery

violates both of the federal policies implicit in the Na-

tional Bank Act.

Permitting recovery to the plaintiffs because they could

prove reliance upon the financial statements, to the detri-

ment of other uninsured depositors who could not or did

not come forward to prove reliance upon PSB financial

statements, fails to accord equal treatment to PSB credi-

tors. PSB’s deceptive acts could not have reached only

the plaintiffs. A congressional committee investigatirg

the failure of PSB found that many financial institutions

similarly relied upon financial statements representing

PSB’s financial integrity.

Through the final months of Penn Square’s exist-

ence, and even up to the last day before the bank’s

doors were closed, in fact, just hours before the doors

v A 2 BT AP

19a

were closed, many small financial institutions were

placing funds in this shopping center bank, reassured

by a Peat, Marwick, Mitchell & Co. audit that some

have said gave the bank a “clean bill of health.”

So healthy did some find it that they put in sums

well above the insured amounts—in many cases run-

ning into the millions of dollars from individual in-

stitutions. All told, credit unions alone lost $111

million in uninsured funds in Penn Square—over 20

percent of the bank’s deposits when it failed.

Penn Square Bank Failure: Hearings Before the House

Comm. on Banking, Finance and Urban Affairs, 97th

Cong., 2d Sess., pt. 2, at 267 (1983) (statement of Rep.

St. Germain, committee chairman).

Whether independently analyzing PSB financial state-

ments, or relying upon money brokers who analyzed PSB’s

financial condition based upon the information contained

in those statements, financial institutions other than the

plaintiffs undoubtedly placed similar trust in PSB’s mis-

represented financial condition in assessing their risk of

future loss.* See id. at 271. The National Bank Act pre-

8 The plaintiffs argue that no other financial institutions relied

upon PSB financial statements in depositing uninsured funds in

PSB because, as noted in a report prepared by the FDIC, “[slince

1960 about three-fourths of all failed commercial banks and, until

Penn Square Bank, all failures over $100 million in size have been

handled through purchase and assumption transactions (P & As).”

FDIC, Deposit Insurance in a Changing Environment ch. I, at 6

(1983) (report submitted to Congress pursuant to §712 of the

Garn-St. Germain Depository Institution Act of 1982). “In P & As

all deposits (including uninsured deposits) and other liabilities of

general creditors are assumed by a new or existing bank. Thus,

despite a bank failure, all depositors and other general creditors

are nade whole in a P & A.” IZId.; see id. ch. III, at 4. According

to the FDIC report, the widespread use of P & A transactions, in-

stead of merely paying off uninsured depositors their pro rata share

of the bank’s assets, has altered public perceptions of the safety

of funds. Jd. ch. III, at 1. “[T]his growing perception of almost

20a

cludes these depositors from being treated differently. Cf.

Beacon Mfg. Co. v. Hood, 204 N.C. 349, 168 S.E. 523,

524 (1933) (reaching identical result under state law in

denying depositor’s claim for preference in state bank

assets). “[I]t is clear that other depositors as to deposits -

made during this period are entitled in equity to the same

relief as [the party seeking a constructive trust], and in

granting relief the court should see that their rights are

protected.” Standard Oil Co., 80 F.2d at 161. “In the

absence of a false and fraudulent representation made

specifically to the plaintiff, with respect to the financial

condition of the [bank], the plaintiff has no equity su-

perior to the rights of other depositors or creditors of

the [bank], who made deposits in said [bank] in reliance

upon the statements published by said [bank]... .”

Beacon Mfg. 168 S.E. at 524.

Although the plaintiffs contend that we might avoid

this unequal treatment by permitting all depositors situ-

ated similarly to the plaintiffs to sue as a class to estab-

lish constructive trusts, to allow such suits would poten-

tentially jeopardize the orderly administration of the

receiver’s estate that is required by the Act. We do not

think that Congress would have intended to deluge the

FDIC with the potentially crushing weight of claims for

preferences on behalf of all the uninsured depositors who

could allege that they relied upon misleading information

that was available to all depositors. Allowing such a pref-

‘absolute safety of funds in large institutions is having the effect

of removing the consideration of bank risk from business deci-

sions.” Id.

The fact that risk considerations may have been reduced at that

time due to the historical pattern of FDIC practices does not mean

that risk of failure was completely excluded from the market.

The fact that both of the plaintiffs utilized the services of money

brokers, who performed some degree of financial analysis on the

institutions they represented, and who were responsible for solicit-

ing the deposits of numerous other institutions, clearly shows that

the market was not blind to the risk of failure.

Bn bene Sas

2la

erence to be based upon a “race of diligence’? among credi-

tors would make “the equality promised to them by the

{National Bank Act] ...a mere mockery.” First Nat’l

Bank v. Colby, 88 U.S. (21 Wall.) 609, 614, 22 L.Ed. 687

(1875). Any remedy for fraudulent representations that

affects, or potentially affects, all creditors belongs to the

receiver, who asserts such claims for the benefit of all

creditors. Cf. In re Longhorn Sec. Litig., 573 F.Supp.

255, 272 (W.D.Okla.1983) (noting “general rule” that

“wrongs committed by a bank’s officers or directors that

injure all depositors and creditors alike create a liability

which is an asset of the bank itself and for which only

the bank or its receiver may recover’). When all credi-

tors have been similarly harmed, pro rata distribution of

the assets in accordance with the mandate of the National

Bank Act accomplishes the same result as if all uninsured

depositors had brought suit on their own behalf. Bryant,

27 F.Supp. at 565.

Accordingly, the order of the district court imposing a

constructive trust upon the assets of PSB in favor of the

plaintiffs is REVERSED.

22a

APPENDIX B

IN THE UNITED STATES DISTRICT COURT

FOR THE WESTERN DISTRICT OF OKLAHOMA

No. CIV-82-1357-A

Consolidated with:

No. CIV-83-69-A

No. CIV-83-1583-A

No. CIV-83-3117-A

No. CIV-84-1596-A

No. CIV-84-1612-A

No. CIV-84-1663-A

No. CIV-84-1671-A

No. CIV-84-1672-A

PROFESSIONAL ASSET MANAGEMENT, INC.,

a California corporation,

Plaintiff,

PENN SQUARE BANK, N.A., et al.,

Defendants.

ORDER

[Filed Dec. 15, 1986]

On July 5, 1982, the Office of the Comptroller of the

Currency (“OCC’’) closed Penn Square Bank (“PSB”)

and appointed the Federal Deposit Insurance Corpora-

tion (“FDIC”) as its receiver. That calamitous event

was the genesis of numerous lawsuits including the nine

cases that were consolidated for trial before this Court.

The trial of the Penn Square consolidated cases com-

AA.»

23a

menced on August 19, 1986. Several parties settled their

cases after the trial began; thus this order addresses only

the claims of the remaining plaintiffs, Downriver Com-

munity Federal Credit Union and Wood Products Fed-

eral Credit Union. Wood Products and the FDIC had

opted for a trial to the Court while Downriver sought a

jury trial. At the conclusion of Phase I of the trial, the

Court entered a verdict for Wood Products and the jury

entered a verdict for Downriver against the FDIC as

receiver for fraud committed by PSB. Wood Products!

and Downriver sought a constructive trust on their funds

that were in PSB when it was closed. The first part of

this Order contains the Court’s findings of facts and

conclusions of law on Wood Products’ fraud claim against

the FDIC; the second part addresses the constructive

trust issue.

WOOD PRODUCTS’ FRAUD CLAIM—

FINDINGS OF FACT AND

CONCLUSIONS OF LAW

After considering the evidence presented, the applicable

legal authority and the statements of counsel, the Court

enters the following findings of fact and conclusions of

law.

Findings of Fact:

1. Wood Products Credit Union (“Wood Products”)

is a non-profit, state chartered credit union in Oregon.

Its principal place of business is in Springfield, Oregon.

1 The Court notes that it denied Wood Products’ motion to amend

its Complaint to add the constructive trust theory on January 30,

i 1986. Federal Rule of Civil Procedure 54(c) provides “Except as

: to a party against whom a judgment is entered in default, every

final judgment shall grant the relief to which the party in whose

: favor it is rendered is entitled, even if the party has not demanded

( such relief in his pleadings.”” Wood Products’ requested amendment

l would have served no purpose not served by Rule 54(c) itself.

al cticieenaienaraeiaeeieel

24a

Wood Products’ approximately 35,000 members are prin-

cipally employed in the wood products industries in

Oregon.

2. Penn Square Bank, N.A. (“PSB”) was chartered

as a national banking association by the Office of the

Comptroller of the Currency (“OCC”) on November 4,

1959.

3. The Defendant, FDIC, is a party to this action as

Receiver of PSB.

4. This case arises from Wood Products’ Complaint

against the PSB/FDIC. Wood Products alleges fraud on

the part of PSB, by its officers and directors; and addi-

tionally, alleges constructive fraud? against PSB by its

officers and directors.

5. Both Wood Products’ fraud and constructive fraud

claims arise from the financial statements published and

disseminated as of December 31, 1981 and the Statement

of Condition for Penn Square Bank as of March 31, 1982.

Wood Products alleges the 12/31/81 financial statements

and 3/31/82 Statement of Condition were materially

false and misleading.

6. Professional Asset Management (“PAM?’’), a money

broker, distributed to Wood Products its Capital Adequacy

Reports that contained financial information from banks.

Wood Products could call PAM to obtain the interest rates

offered by banks listed in the Capital Adequacy Report.

The financial information included assets, net worth and

net income from which, in PAM’s opinion, the most im-

2 Wood Products’ constructive fraud claim was not actively pur-

sued in this litigation. The Court is, therefore, not sufficiently

informed to discuss constructive fraud as an alternative basis for

recovery. The Court believes that if the appellate court rules the

fraud verdict here is not sufficient to support a constructive trust

theory of recovery, then the appellate court would very likely not

consider constructive fraud as an adequate basis for recovery.

25a

portant operating ratios could be ascertained, e.g., equity

to assets.

7. Wood Products understood that PAM selected a

group of banks and savings and loans that appeared to

be sound and adequately capitalized.

8. Wood Products first purchased a certificate of de-

posit utilizing PAM’s services at the end of 1981.

9. Wood Products decided to buy a PSB certificate of

deposit based on PAM’s listing of PSB in the Capital

Adequacy Report as well as Wood Products’ own review

and analysis of the Capital Adequacy Report.

10. Wood Products purchased a PSB certificate of de-

posit in the amount of $500,000 with a ninety-one day

term on June 14, 1982.

11. On July 5, 1982 PSB was closed by the Office of

the Comptroller of the Currency (“OCC”) and the FDIC

was appointed Receiver of PSB.

12. Following the closing of PSB, Wood Products ap-

plied for and received two receiver’s certificates for the

uninsured portion of its PSB certificate of deposit.

13. Thereafter, Wood Products accepted dividend pay-

ments under the receiver’s certificate.

14. The OCC was required by federal statute to super-

vise and examine PSB.

15. The OCC had the statutory authority to, and on

September 9, 1980 did require PSB and its Board of Di-

rectors to enter into a written Administrative Agreement

with the OCC, which agreement is a “written agreement

entered into with the agency” within the meaning of

12 U.S.C. § 1818(b) (1).

16. Pursuant to 12 U.S.C. § 1818(c) (1), the OCC had

the authority to and on June 30, 1982 did issue a Tem-

porary Order to Cease and Desist against PSB, its officers,

directors, employees and agents.

26a

17. Pursuant to 12 U.S.C. § 1818(b) (1), the OCC had

the authority to and on June 30, 1982 did issue a Notice

of Charges against PSB, its officers, directors, employees

and agents, which Notice of Charges was set for hearing

in the U.S. Courthouse for the Western District of Okla-

home at 10:00 a.m. on August 30, 1982.

18. Pursuant to 12 U.S.C. § 1818(c) (1), the OCC had

the authority to and did determine that the violations or

threatened violations of law, rule and regulation, or the

unsafe or unsound practices, specified in the Notice of

Charges or the continuation thereof, were likely to cause

insolvency or substantial dissipation of the assets or earn-

ings of PSB, or were likely to seriously weaken the con-

dition of the Bank or otherwise seriously prejudice the

interests of the Bank’s depositors.

19. Under 12 U.S.C. 1818(b) (1), the OCC found that

those violations of law, rule, regulation and/or written

- conditions of the OCC, and the unsafe and unsound bank-

ing practices specified in the notice of charges which PSB

and its officers, directors, employees and agents engaged

in, were established.

20. In violation of Article IV of the Administrative

Agreement and contrary to safe and sound banking prac-

tices, PSB failed to obtain and maintain current and

satisfactory credit information on a significant volume

of its extensions of credit.

21. In violation of Article IV of the Agreement and

contrary to safe and sound banking practices, PSB

granted credit in significant amounts which were not

fully supported by all necessary collateral documentation.

22. In violation of Article V of the Agreement, PSB

extended additional credit to borrowers whose loans were

previously criticized (by the OCC) without first placing

in the credit file of the borrower and forwarding to the

Regional Administrator of National Banks for the Elev-

enth National Bank Region, Dallas, Texas (hereinafter

en saree I aint toon names:

ats Miele ee NA aha cier at el tl

27a

“Regional Administrator”) a statement, signed by the

majority of the Bank’s directors, detailing why failure to

make additional extensions of credit would be detrimental

to the interests of PSB.

23. In violation of Article IX of the Agreement and

contrary to safe and sound banking practices, the Officers

and Directors recklessly failed to maintain a loan loss

reserve at realistic and adequate levels commensurate with

the risks and losses that were inherent in PSB’s reck-

lessly mismanaged loan portfolio and thus caused or reck-

lessly permitted PSB’s income and shareholder equity to

be grossly overstated. Due in part to the significant de-

termination in the quality of PSB’s loan portfolio, as

revealed by OCC’s examination of PSB at December 31,

1979, the Administrative Agreement dated September 9,

1980 required PSB to conduct a review of its Allowance

for Possible Loan Losses on at least a quarterly basis to

ensure its maintenance at adequate levels commensurate

with the risks and potential losses inherent in PSB’s loan

portfolio. The OCC’s general supervisory examination of

PSB at December 31, 1980 revealed, however, that PSB

still lacked an internal loan review program and was un-

able to produce any meaningful list of its problem loans;

that PSB’s management had completely failed to make

any significant analysis of the various factors that were

required to be analyzed in order for PSB to maintain an

adequate and realistic loan loss reserve; and that PSB’s

loan loss reserve was based upon an arbitrary percentage

(1%) of PSB’s outstanding loans. Thus, PSB’s method

of determining the adequacy of its loan loss reserve was

criticized as being inadequate and unacceptable, and a

requirement was made that PSB’s loan loss reserve anal-

ysis be expanded to include an assessment of past-due

loans, changes in loan mix, changes in the economy, and

an in-depth review of potential weaknesses and losses in

individual loans and in PSB’s loan portfolio as a whole.

Such review and analysis was to be performed on a con-

tinuing basis, was to be well and fully documented, and

28a

was to be approved by PSB’s Board of Directors. Like-

wise, in its management letter to PSB’s Board of Direc-

tors, dated May 20, 1981, Arthur Young & Company

pointed out that PSB’s loan loss reserve was being calcu-

lated on the basis of a fixed and arbitrary percentage of

PSB’s total loans outstanding, and Arthur Young &

Company recommended that to properly monitor the loan

portfolio and related reserve for loan losses “a more

definitive policy should be implemented to provide for

review of individual loans or lines of credit.’ Despite the

requirements of the Administrative Agreement and the

subsequent criticisms of PSB’s inadequate loan loss review

analysis, PSB’s substantive loan review activities did not

begin to function until August of 1981, almost one year

after the date of the Administrative Agreement. From

that time until PSB was declared insolvent on July 5,

1982, PSB’s loan review activities were largely restricted

to a review of loans that had been previously criticized

by the OCC and to efforts to identify problem loans in

the non-oil and gas portions of PSB’s loan portfolio.

Thus, oil and gas related loans, which comprised roughly

80% of PSB’s total loan portfolio and which represented

the more complicated and higher risk loans, were never

substantially reviewed or evaluated by PSB’s loan reviev.

committee for the purpose of determining and establish-

ing an adequate loan loss reserve. As a result, PSB’s loan

loss reserve as of December 31, 1981 was grossly under-

stated, and conversely, PSB’s pre-tax income and share-

holder equity as reflected in the December 31, 1981 fi-

nancial statements and in subsequent statements of con-

dition were grossly overstated.

24. Contrary to safe and sound practices, PSB, on

loans it originated on which it had subsequently sold par-

ticipations, paid interest to participating institutions on

behalf of the borrower without advising the participating

institution PSB was advancing funds for said payments.

These habitual advances of uncollected and uncollectable

29a

principle and interest payments (called “upstreamed in-

terest”), which were made for the purpose of appeasing

the participating banks who otherwise threatened to stop

purchasing loan participations from PSB, were unsafe,

unsound and imprudent for the following reasons, among

others:

A. They caused a continual and substantial increase

in PSB’s non-earning assets and thereby substan-

tially reduced PSB’s potential earnings.

B. They amounted to unapproved and imprudent

extensions of credit to borrowers who were not credit-

worthy and who had already demonstrated their in-

ability to repay existing obligations.

C. They substantially increased the volume of PSB’s

—- loan losses beyond that which was inherent in PSB’s

otherwise risky and recklessly mismanaged loan

portfolio.

Minutes from the Asset and Liability Committee meet-

ings show that Mr. Beller, who was the president and

chief administrative officer of PSB, was aware of the

upstreaming of interest in December, 1981.

25. The officers and directors caused or recklessly

permitted PSB to repeatedly repurchase uncollectable

loans that PSB had previously participated to various up-

stream and downstream correspondent banks, despite the

fact that the participation agreements pertaining to such

loans did not obligate PSB to make such repurchases,

thereby causing PSB to incur heavy losses resulting from

such bad loans. These repurchases of bad loans were made

for the purpose of maintaining participant banks as a

ready source for sales of other loan participations, often

with the knowledge of and/or at demand of such par-

ticipant banks as the price of maintaining the merchant

banking relationship.

26. Contrary to safe and sound practices and in vio-

lation of Article VI of the Agreement, PSB failed to im-

80a

plement and adhere to procedures to limit, control and

document contingent liabilities on unfunded loan commit-

ments and letters of credit.

27. The officers and directors caused PSB to make, or

recklessly permitted PSB to make, excessive loans to the

officers and directors and their related entities without -

regard to the creditworthiness of the borrower, without

proper credit information or documentation, and often

upon preferential terms and in amounts that constituted

violations of banking laws and regulations. An example

of such loans to directors is the conglomeration of loans

to Mr. Swan and related entities; PSB’s net loans*® to

Swan and his related entities were approximately 70%

of PSB’s gross capital funds at December 31, 1981.

28. PSB and its directors filed with the OCC and pub-

lished in local newspapers, Reports of Condition and

Statement of Resources and Liabilities, respectively, for

12/31/81 which contained the following false informa-

tion:

The loan loss allowance should have been presented

in PSB’s audited financial statements, call reports and

counter statements for the year ended i981 as at least

$19,000,000 not $4,141,000.

PSB’s “provision for possible loan losses” should have

been presented as at least $21,000,000 rather than

$6,343,000 in PSB’s audited financial statements, call re-

ports and counter statements for the year ended 1981.

The “income before income taxes” is overstated by an

amount of at least $15,000,000 and should have been

presented in PSB’s audited financial statements, call re-

ports and counter statements for the year ended 1981

as a loss of at least $8,000,000 rather than as income of

$7,020,000.

3 PSB’s “net loans” means the amount on PSB’s books excluding

amounts participated out to other banks.

Pees cea

8la

Net income should have been presented in PSB’s audited

financial statements, call reports and counter statements

for the year ended 1981 as a net loss of at least $7,000,000

rather than as a net income of $4,725,000.

Equity capital should have been presented in PSB’s

audited financial statements, call reports and counter

statements for the year ended 1981 as about $19,000,000

rather than $31,597,000, which would virtually eliminate

undivided profits.

29. PSB and its Board of Directors filed with the

OCC and published in local newspapers, Reports of Condi-

tion and Statements of Resources and Liability, respec-

tively, for 3/31/82 which contain the following false in-

formation:

ea Se ee eee eee

The loan loss allowance should have been fairly reported

as approximately $44,500,000 rather than $4,500,000.

The provision for loan losses should have been fairly

reported as approximately $43,000,000 rather than

$3,019,000.

Pretax income should have been fairly reported as a loss

before income tax benefit of approximately $34,000,000

rather than income of $2,126,000.

| Net income should have been fairly reported as a net

| loss of approximately $33,500,000, rather than net income

of $1,455,000.

Equity capital should have been fairly reported as nega-

tive equity capital of approximately (‘$2,000,000”).

30. The allowance for possible loan losses and provi-

sion for loan losses, net income and equity capital were

material representations in the 12/31/81 and 3/31/82

financial statements issued by PSB.

Conclusions of Law:

1. This Court has jurisdiction over Wood Products’

Complaint pursuant to 28 U.S.C. § 1331, 28 U.S.C. § 1332

32a

(a), 12 U.S.C. $1819 (Fourth) and 12 U.S.C. § 21,

et seq.

2. PSB, through the FDIC as receiver of PSB, is liable

for the fraud of the officers and directors of PSB, who

were acting within the scope of their authority and on

behalf of PSB. Southwestern Bell Telephone Co. v. Brown,

519 P.2d 491 (Okla. 1974); Franklin Bond Corporation

v. Smith, 20 P.2d 912 (Okla. 1933).

3. PSB and its officers-and directors prepared and

published Statements of Condition and Statements of In-

come for each quarter and for year end including Decem-

ber 31, 1981 and March 31, 1982.

4. As described in the Findings of Fact, the repre-

sentations in the December 31, 1981 and March 31, 1982

financial statements were false and misleading.

5. The PSB officers and directors made the representa-

tions knowing that the December 31, 1981 and March 31,

1982 allowance for possible loan losses and provisions for

loan losses, net income and equity capital were false

or misleading and that all documents that presented such

information were false or misleading, or PSB officers

and directors recklessly made those representations as

positive statements knowing there was no reasonable

ground for believing them to be true. It is not necessary

to find that one individual in the bank had knowledge

of all of PSB’s problems and that those problems were

not accurately reflected in the financial statements. The

Court considers the collegial intent and knowledge of all

the directors and officers to be the primary factor in its

finding on the “intent” of PSB. Nevertheless, the Court

finds that senior vice-president Bill Patterson’s position

was primary and unique. He was supervised only by

Chairman Jennings both with respect to granting loans

and setting policy and effectively as to the loan review

function. The Court is satisfied by clear and convincing

evidence that Patterson recklessly transferred data know-

33a

ing it would be in the financial statements and knowing

there was no reasonable ground for belief in its truth.

6. PSB officers and directors intended to defraud Wood

Products because the PSB officers and directors intended

to defraud all potential investors, depositors and creditors

who would transact business with PSB in reliance upon

representations of its sound financial condition. 74 Okla.

Stat. § 4 (1981).

7. Wood Products relied on PSB’s financial informa-

tion received through PAM’s Capital Adequacy Report.

The reliance was evidenced by Wood Products’ empioyee’s

notes on the Capital Adequacy Report.

8. Wood Products suffered injury as a result of PSB’s

fraud.

On the basis of the foregoing findings of fact and con-

clusions of law, the Court entered a verdict for Wood

Products against the FDIC as Receiver of PSB for PSB’s

fraud.

CONSTRUCTIVE TRUST

The issue before the Court is, shall a constructive trust

be imposed against the FDIC as receiver? The Court has

been assisted by the briefs and oral arguments submitted

by counsel.

The starting place for the Court’s inquiry is the choice

of law question. Should the Court apply federal or state

law? The Court notes that nothing in the National Bank

Act (12 U.S.C. § 21 et seg.) specifically pertains to this

question even though the doctrine of ratable distribution

applies in general. Therefore, the Court turns to judge-

made law.

The creditor rights of a depositor of a national

bank, by virtue of his loan to the bank and the

effects of the conduct of the bank as altering such

34a

rights, are determined by the law of the state of the

deposit, in the absence of a federal statute creating

a different relationship. There is no underlying gen-

eral federal law determining such rights (Erie Ry.

Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed.

1188, 114 A.L.R. 1487), and no federal statute deny-

ing to a cestui his right against a bank as its trustee,

where, in the course of its business prior to the re-

ceivership, such a trust relationship has been created

by the conduct of the bank Reno Nat. Bank of Reno,

Nev. v. Seaborn, 99 F.2d 482, 483 (9th Cir. 1938).

Accordingly, Downriver’s and Wood Products’ property

rights in their funds held by PSB were established before

PSB’s failure and Oklahoma’s law will be applied to

determine those property rights. This ruling is con-

sistent with the one in FDIC v. Utica Nat’l Bank &

Trust Co., CIV-83-974-W, slip op. at 19 (W.D. Okla.

July 18, 1984), aff'd in part and rev’d in part on other

grounds, No. 84-2148, slip op. (10th Cir. Nov. 26, 1986)

18* where the District Court stated, “Thus, state laws

which create and define rights in the assets of a national

bank prior to insolvency do not conflict with the principle

of ratable distribution and are valid. In these cases at

bar, the statutory and equitable rights to set-off existed

before insolvency, even if they were exercised only after-

wards, so they are not preempted.”

The FDIC urges the Court to adopt the rule in Kershaw

v. Jenkins, 71 F.2d 647 (10th Cir. 1934) that requires a

person seeking a trust on assets of an insolvent bank to

establish a fiduciary relationship between himself and

the bank. However, from Kershaw it is impossible to

4The Tenth Circuit affirmed the district court’s ruling that bene-

ficiaries (here, banks) of standby letters of credit were entitled to

set off their claims against correspondent accounts maintained by

PSB at the banks; the court reversed with respect to Liberty’s

setoff of its claim as confirming bank and Utica’s claim for deposit

for deposit insurance.

85a

determine if the fiduciary relationship requirement was

a. determined by the court to be part of federal judge-

. made law, b. state law or c. some general principle that

the court assumed was state law. This Court chooses to

| apply state law.

The FDIC also refers the Court to Hibernia Nat’l. Bank

v. FDIC, 733 F.2d 1403 (10th Cir. 1984), wherein the

Tenth Circuit in dictum stated a party “seeking to im-

press a trust on an insolvent bank’s assets . . . must first

establish a fiduciary relationship and thereafter trace the

| trust property in its original or converted form into

identifiable property in the receiver’s possession.” Id. at

1407. The Circuit Court cites only Kershaw for that

proposition and this Court does not find support for the

fiduciary relationship requirement in the cases cited in

Kershaw. The Circuit Court does not discuss the fiduciary

relationship further. Because the quotation above from

Hibernia is dictum, this Court stands by its reasoning

to apply state law to determine plaintiffs’ rights that

were created before PSB’s insolvency.

In Oklahoma, if one person obtains title to another’s

property by fraud, equity imposes a constructive trust

upon the property in favor of the person entitled to it.

Peyton v. McCaslin, 417 P.2d 316 (Okl. 1966). See also

Marshall v. Amos, 471 P.2d 896 (Okl. 1970). Here, the

fraud committed by PSB through issuance of false finan-

cial statements has been established by clear and convinc-

ing evidence to the satisfaction of the jury, for Down-

river, and the Court, for Wood Products. Therefore,

plaintiffs are entitled to a constructive trust. Judge

West’s Order of June 15, 1984, in Downriver v. FDIC,

CIV-83-69-W is consistent with this Court’s independent

analysis herein on the constructive trust issue.

In order to obtain a constructive trust, not only must

plaintiffs prove PSB’s fraud induced them to buy certifi-

cates of deposit, they must also prove augmentation of the

receivership assets and tracing of their funds into the

ial

36a

hands of the receiver. The evidence that plaintiffs trans-

ferred funds to PSB before its failure and that PSB’s

funds never dipped below an amount sufficient to cover

plaintiffs’ funds is uncontroverted. Therefore, plaintiffs

have proven augmentation and tracing.

Is the National Bank Act preemptive so as to foreclose

the constructive trust remedy against the reeeiver of an

insolvent national bank? As noted above, the National

Bank Act requires ratable distribution among holders of

receivers certificates. 12 U.S.C. § 194. Ratable distribu-

tion does not, however, preclude identification and recov-

ery of property that does not rightfully belong to the bank.

Fiman v. State of South Dakota, 29 F.2d 776 (8th Cir.

1928). Therefore, the Court finds the National Bank Act

is not preemptive where funds were obtained by the bank

through fraud.

Having found the factual and legal prerequisites for

imposition of a constructive trust, the Court next con-

siders whether granting a constructive trust in favor of

plaintiffs would be equitable. In this regard the Court

must examine the impact on other holders of receiver’s

certificates. Wood Products provided two charts estimat-

ing the impact of the constructive trust and the parties

stipulated that Paul Heafy, chief liquidator for PSB,

would testify as follows: if the Court grants a construc-

tive trust for Downriver’s and Wood Products’ lost prin-

cipal and interest, the other receiver’s certificate holders

would receive eight tenths of one percent (.8%) less than

if the Court does not grant the constructive trust. That

5 Although the Court has found no Oklahoma cases that discuss

augmentation and tracing, authority on this issue is sparse and

other jurisdictions, e.g. Converse Rubber Co. v. Boston-Continental —

Nat'l. Bank, 12 F.Supp. 887 (D. Mass. 1935), have imposed the

augmentation and tracing requirements on parties seeking a con-

structive trust. This Court expects the Oklahoma courts would

similarly require proof of augmentation and tracing if faced with

the issue in this case.

=~ EY te

| 37a

reduction applies to all receiver’s certificate holders, in-

cluding the FDIC, which holds forty-seven percent of the

total. The Court finds that reduction, though not de

minimis, could not be regarded as such a burden as to

render inequitable the recognition of the property rights

of plaintiffs.®

Other uninsured depositors could have sued the bank

and its receiver as these plaintiffs did or they could have

intervened in this case pursuant to Federal Rules of

Civil Procedures 24(a). The vindication of their prop-

erty rights is up to those other depositors, not the FDIC.

Appellant seriously and forcibly contends that, on

the broad principle of equitable rights, to permit the

state, under the circumstances here disclosed, to ob-

tain a prior right on the funds in the insolvent bank

in such a large amount, is inequitable and unjust to

the creditors and depositors of the bank, and invokes

the rule as to the rights of innocent third persons.

He also insists that the depositors should be con-

sidered as cestui que trustent and that their rights

should be considered on an equality with those of the

plaintiff. However, it is not for the defendant

herein, but for those whose rights are thus claimed,

to raise and establish any such equality of rights.

Fiman v. State of South Dakota, 29 F.2d 776, 782

(8th Cir. 1928).

Wood Products argued that the constructive trust

should be imposed against the future dividends to be paid

Mh a nah AT hls et td

6 The issue of the effect of a constructive trust on uninsured

depositors only comes up when people have invested more than the

FDIC insurance limit in a failed bank. Representatives of money

brokers testified that after Penn Square failed, most of their

investor-clients spread funds in several banks to have FDIC insur-

ance on all monies invested in banks and stopped investing in jumbo

certificates of deposit. Therefore, the Court believes this Order will

have little precedential effect on the constructive trust issue.

88a

to the FDIC in its corporate capacity.’ If the FDIC

alone bore the reduction in dividends, uninsured deposi-

ters would incur no reduction in future dividends. Wood

Products asserts the equities weigh in favor of having

the FDIC bear the reduction in dividends because the

FDIC is an insurer and had input in the decision-making

process that resulted in the closing of PSB. The FDIC

could protect itself better than credit union investors

could. Wood Products’ argument is appealing, but be-

cause the FDIC’s right to share ratably with uninsured

depositors to recover amounts paid to insured depositors

is statutory, the Court is compelled to reject Wood Prod-

ucts’ argument on this issue.

The Court has found that plaintiffs are entitled to a

constructive trust on their lost principal and that im-

posing a constructive trust is equitable in this case. The

question remaining is whether plaintiffs should also re-

ceive a constructive trust on the lost interest on their

funds held by PSB. The dispositive issue is the choice

of law as discussed above. Plaintiffs refer the Court to

cases in which a claimant in equity of funds held by a

receiver is entitled to interest as well as principal. Bd.

of Com’rs. of Sweetwater County, Wyo. v. Bernardin,

74 F.2d 809 (10th Cir. 1934); Mothersead v. United

States Fidelity & Guaranty Co., 22 F.2d 644, 654 (8th

Cir. 1927), cert. denied, 276 U.S. 637 (1928); Amer-

ican Surety Co. v. Carbon Timber Co., 263 F. 295, 303

(8th Cir. 1919); Spring Coal Co. v. Keech, 239 F. 48,

53 (4th Cir. 1916). However, none of those cases per-

tain to the receiver of an insolvent national bank subject

to the National Bank Act. The Court is persuaded that

the controlling law on the issue of prejudgment interest

is federal law because federal law applies to any post-

insolvency rights of plaintiffs. If state law conflicts with

7™The FDIC in its corporate capacity holds receiver’s certificates

for the amount it paid to depositors for FDIC insurance. 12 U.S.C.

§ 1821(g).

oa a A FE i Oe oe ee ET

39a

federal law, the latter applies concerning the distribution

of assets of an insolvent national bank. Rushton v.

Schram, 143 F.2d 554 (6th Cir. 1944). With respect to

the receivership of an insolvent national bank, “interest

accruing on a claim after insolvency cannot be paid un-

less the assets are sufficient to pay all claims in full,

because to pay interest on one while others are unpaid

in whole or in part would violate the exaction of ratable

distribution of assets.” Fash v. First Nat. Bank of Alva,

Okla., 89 F.2d 110, 112 (10th Cir. 1937).

Downriver asserts it is entitled to a constructive trust

on its wire transfer claim. One of the four certificates

of deposit ($1 million each) Downriver had in PSB ma-

tured on July 2, 1982. First United Fund (“FUF”),

Downriver’s money broker, transmitted wiring instruc-

tions to PSB on July 2, 1982 to wire the one million dol-

lars from the maturing certificate of deposit to another

bank. The funds were not wired and remained in PSB on

July 5, 1982. The jury found that FUF was negligent

in its attempt to have the funds wired. Downriver also

sued PSB for the alleged fraud of Bert Davis, a PSB

vice-president; Downriver alleged Bert Davis told FUF

the funds were being wired and thus led FUF to believe

no further action needed to be taken. The jury found

Bert Davis did not commit fraud with respect to Down-

river’s wire transfer claim. Therefore, Downriver can-

not rely on fraud to support its constructive trust theory

on the wire transfer claim.

Downriver presented two alternative theories, besides

fraud of PSB, to support its right to recover a construc-

tive trust on the one million dollars; they are breach of

fiduciary duty and segregation of assets. Downriver

argues when PSB accepted the wiring instructions, PSB

became Downriver’s agent for purposes of transferring

the funds to the other bank and that as Downriver’s

40a

agent, PSB breached its fiduciary duty by failing to

transfer the funds and failing to disclose that PSB’s

Federal Reserve wire had been closed. For the proposi-

tion that PSB became Downriver’s agent, for the wire

transfer, Downriver relies on Bryan v. Coconut Grove

Bank & Trust Co., 182 So. 481 (Fla. 1931). In Bryan,

the bank accepted a check on which it was both the

drawee and the payee for purpose of transferring the

funds to another bank. The funds were not transferred

before the drawee became insolvent. The court imposed

a constructive trust because the bank became the drawer’s

agent by accepting the check. While the statements of

law in Bryan generally support Downriver’s argument,

the facts do not. Assuming PSB received the wiring

instructions, no new obligation of PSB was created. In

Bryan, the court found that by accepting the check, the

bank created a special fund for the drawer. Here the

Court finds no special fund was created when PSB re-

ceived the wiring instructions.

For its third theory in support of a constructive trust

on the wire transfer claim, Downriver argues its funds

were segregated because its certificate of deposit was

taken from the PSB vault to the certificate of deposit

department on July 2, 1982. The Court is not persuaded

that this set of facts supports recovery based on a segre-

gation theory because placing the certificate of deposit

in a folder in the certificate of deposit department did

not segregate the funds. The one million dollars was

still part of the general assets of the bank. Accordingly,

the Court has found no basis for a constructive trust on

Downriver’s wire transfer claim.

In accordance with the findings and conclusions stated

above, a judgment shall be entered in favor of Wood

Products for $182,062.50 and Downriver for $1,772,-

4la

208.58; * the Court finds a constructive trust shall be im-

posed against the PSB receivership assets for those

amounts.

It is ORDERED this 15th day of December, 1986.

/3/ Wayne Alley

WAYNE E. ALLEY

United States District Judge

§ Those amounts are calculated as follows.

Wood Products Downriver

Receiver’s Certificate $ 404,583.32 $ 3,938,240.00

Less Dividends Received

as of December 10, 1986 (222,520.82) (2,166,031.42)

$ 182,062.50 $1,772,208.58

42a

APPENDIX C

IN THE UNITED STATES DISTRICT COURT

FOR THE WESTERN DISTRICT OF OKLAHOMA

No. CIV-82-1357-A

Consolidated With:

No. CIV-83-69-A

No. CIV-83-1583-A

No. CIV-83-3117-A

No. CIV-84-1596-A

No. CIV-84-1612-A

No. CIV-84-1663-A

No. CIV-84-1671-A

No. CIV-84-1672-A

PROFESSIONAL ASSET MANAGEMENT, INC.,

a California corporation,

Plaintiff,

vs.

PENN SQUARE BANK, N.A., et al.,

Defendants.

JOURNAL ENTRY OF JUDGMENT

[Filed Dec. 23, 1986]

On December 15, 1986, this Court issued written find-

ing of fact and conclusions of law memorializing the

Court’s oral findings and conclusions made on September

19, 1986, ruling that the FDIC, as Receiver of Penn

Square Bank, N.A., was liable to Wood Products Credit

Union for fraud. On September 19, 1986, the jury also

43a

reached a verdict finding the FDIC, as Receiver of Penn

Square Bank, N.A., liable to Downriver Community Fed-

eral Credit Union for fraud.

On December 15, 1986, this Court further ordered that

both Wood Products Credit Union and Downriver Com-

munity Federal Credit Union were entitled to a construc-

tive trust against the Penn Square Bank receivership as-

sets for the amount of the principal lost by Wood Prod-

ucts Credit Union and Downriver Community Federal

Credit Union as a result of Penn Square Bank, N.A.’s

fraud.

The Court hereby Or¢ers in conformance with the above

findings, conclusions, Order and Verdict that:

1. Wood Products Credit Union is awarded a judg-

ment of $182,062.50 against the FDIC, as Re-

ceiver of Penn Square Bank, N.A.

2. Downriver Community Federal Credit Union is

awarded a judgment of $1,772,208.58 against the

FDIC, as Receiver of Penn Square Bank, N.A.

3. A constructive trust is hereby imposed against

the assets of the Penn Square Bank receivership

as of July 5, 1982 in the amount of $182,062.50

in favor of Wood Products Credit Union.

4. A constructive trust is hereby imposed against

the assets of the Penn Square Bank receivership

as of July 5, 1982 in the amount of $1,772,208.58

in favor of Downriver Community Federal Credit

Union.

5. The FDIC, as Receiver of Penn Square Bank,

N.A., shall pay in cash forthwith, the sum of

$182,062.50 to Wood Products Credit Union and

$1,772,208.58 to Downriver Community Federal

Credit Union in liquidation of the corpus of each

trust.

44a

6. Upon payment of the corpus of the trust prop-

erty, defendant will have no further obligation

to make payment of receiver dividend distribu-

tions on account of Downriver Community Fed-

eral Credit Union’s or Wood Products’ certificates

of deposit in Penn Square Bank, N.A. Nothing

herein shall affect the obligation of the FDIC, as

Receiver of Penn Square Bank, N.A., to pay divi-

dends to the plaintiffs prior to the time this judg-

ment is fully satisfied, provided the FDIC, as

Receiver of Penn Square Bank, N.A., shall be

entitled to a credit against the amounts awarded

herein for the amount of any dividends paid out

to Wood Products Credit Union or Downriver

Community Federal Credit Union after the date

this judgment is entered and prior to fully satis-

fying this judgment.

7. Post judgment interest at the rate of 5.77% be-

ginning December 23rd, 1986, shall accrue on the

sum of $182,062.50 as to Wood Products Credit

Union and on the sum of $1,772,208.58 as to

Downriver Community Federal Credit Union un-

til these judgments are fully satisfied.

8. The FDIC, as Receiver of Penn Square Bank,

N.A., shall pay all costs as provided by either

F.R.C.P. 54(d) or 28 U.S.C. § 1920.

DATED this 23rd day of December, 1986.

/s/ Wayne Alley

WAYNE E. ALLEY

United States District Judge

Entered this 23rd day of December, 1986.

Entered in Judgment Docket on 12-23-86.

45a

APPROVED AS TO FORM:

/s/ Robert Wiener

ROBERT A. WIENER, Esq.

CASTLEBERRY & KIVEL

302 Union Plaza

3030 Northwest Expressway

Oklahoma City, Oklahoma 73112

Attorney for Wood Products

Credit Union

/s/ Thomas S. Dann—by Raw

THOMAS §. DANN, Esq.

TIMOTHY D. NAEGELE & ASSOCIATES

Suite 1280, International Square

1850 “K” Street, N.W.

Washington, D.C. 20006

Attorney for Downriver Community

Federal Credit Union

RONALD RICKETTs, Esq.

GABLE & GOTWALS

200 Fourth National Bank Bldg.

Tulsa, Oklahoma 74119

Attorneys for Federal Deposit

Insurance Corporation, as

Receiver for Penn Square Bank, N.A.

46a

APPENDIX D

IN THE UNITED STATES DISTRICT COURT

FOR THE WESTERN DISTRICT OF OKLAHOMA

No. CIV-83-69-A

DOWNRIVER COMMUNITY FEDERAL CREDIT UNION,

Plaintiff,

Vv.

FEDERAL DEPOSIT INSURANCE CORPORATION, et al.,

Defendants.

No. CIV-84-1663-A

Woop PRODUCTS CREDIT UNION,

Plaintiff,

PENN SQUARE BANK, N.A., et al.,

Defendants.

Consolidated with:

No. CIV-82-1357-A

No. CIV-83-1583-A

No. CIV-83-3117-A

No. CIV-84-1596-A

No. CIV-84-1612-A

No. CIV-84-1671-A

No. CIV-84-1672-A

ORDER

[Filed Mar. 27, 1987]

47a

- The Court has for consideration the Federal Deposit

Insurance Corporation’s (FDIC) Motion for New Trial

and Downriver’s and Wood Products’ Motion to Amend

Judgment. The Court has broad discretion in ruling on

the motion for new trial. Thompson v. Kerr-McGee Re-

fining Corp., 660 F.2d 1380, 1888 (10th Cir. 1981).

In its motion for new trial the FDIC submits that the

constructive trust portion of the December 15, 1986 Or-

der was in error on the choice of law issue, the equitable-

ness of granting a constructive trust to these plaintiffs

and the preemption of the ratable distribution require-

ment of the National Bank Act. Those issues were briefed

at length before, during and after the trial. The Court

remains convinced that state law governs pre-insolvency

rights of the parties. While discussing the ratable dis-

tribution requirement and a bank’s right to setoff, the

Supreme Court stated,

liens, equities, or rights arising by express agree-

ment, or implied from the nature of the dealings be-

tween the parties, or by operation of law, prior to

insolvency and not in contemplation thereof, are not

invalidated. . ... The requirement as to ratable divi-

dends, is to make them from what belongs to the

bank, and that which at the time of the insolvency

belongs of right to the debtor does not belong to the

bank.

Scott v. Armstrong, 146 U.S. 499, 510 (1892). Under

Oklahoma law, the plaintiffs’ funds did not belong to

Penn Square when it failed. Equity imposes a construc-

tive trust upon property in favor of a person who has

been defrauded. Peyton v. McCaslin, 417 P.2d 316 (OkI.

1970). Therefore, plaintiffs were awarded a constructive

trust because of Penn Square’s pre-insolvency fraud.

The FDIC has presented no new theories to support

its argument that the constructive trust imposed is in-

equitable and contrary to the ratable distribution re-

48a

quirement of the National Bank Act. The Court stands

by its reasoning that the receiver must “ratably distrib-

ute” only property that belongs to the bank at the time

of insolvency and therefore, the National Bank Act is

not preemptive where funds were obtained by the bank

through fraud.

The Court now turns to the plaintiffs’ motion to amend

judgment. Plaintiffs request that the Court reconsider its

denial of post-insolvency interest on their funds held by

Penn Square. Plaintiffs rely on Ticonic Nat’l. Bank v.

Sprague, 303 U.S. 406 (1938) to support the proposition

they are entitled to post-insolvency interest. In Ticonic,

the issue was

whether or not a secured creditor of a national bank,

holding a non-interest bearing claim, is entitled to

interest for any period subsequent to the insolvency

of the bank, when the assets on which he has a lien

are sufficient to pay the principal and interest but

the total assets of the bank are not sufficient to pay

in full all creditors’ claims as of the date of insol-

vency.

Id. at. 407. The constructive trust imposed by this Court

does not rise to the level of a trust secured by bonds as

described in Ticonic, where the plaintiff had a statutory

lien. Consequently, the Court will not alter its ruling on

post-insolvency interest.

Accordingly, the FDIC’s motion for new trial is denied

and plaintiffs’ motion to amend judgment is denied.

It is so ORDERED this 27 day of March, 1987.

/s/ Wayne Alley

WAYNE E. ALLEY

United States District Judge

49a

APPENDIX E

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

Nos. 87-1645, 87-1648

DOWNRIVER COMMUNITY FEDERAL CREDIT UNION,

Plaintiff-Appellant

Vv.

FEDERAL DEPOSIT INSURANCE CORPORATION, in its

capacity as Receiver for Penn Square Bank, N.A.,

Defendant-A ppellee

Nos. 87-1649, 87-1707

Woop PRODUCTS CREDIT UNION, an Oregon Credit Union,

Plaintiff-Appellee,

FEDERAL DEPOSIT INSURANCE CORPORATION, in its

capacity as Receiver for Penn Square Bank, N.A.,

Defendant-A ppellant,

ORDER

[Filed Sept. 5, 1989]

iil

50a

Before HOLLOWAY, MCKAY, LOGAN, MOORE,

ANDERSON, TACHA, BALDOCK, BRORBY, EBEL,

Circuit Judges, and O’CONNOR, District Judge *.

This matter comes on for consideration of appellants’

petition for rehearing and suggestion for rehearing en

banc in the captioned cause.

Upon consideration whereof, the petition for rehearing

is denied by the panel that rendered the decision sought

to be reheard.

In accordance with Rule 35(b) of the Federal Rules of

Appellate Procedure, the petition for rehearing and sug-

gestion for rehearing en banc were transmitted to all

the judges of the court in regular active service. No

member of the hearing panel and no judge in regular

active service on the court having requested that the

court be polled on rehearing en banc, Rule 35, Federal

Rules of Appellate Procedure, the suggestion for rehear-

ing en banc is denied.

Judge Seymour did not participate in consideration of

the petition.

Entered for the Court

ROBERT L. HOECKER-

Clerk

/s/ Patrick Fisher

By PATRICK FISHER

Chief Deputy Clerk

* Of the United States District Court for the District of Kansas,

sitting by designation.

5la

APPENDIX F

LIST OF AUTHORITIES

A fraudulent misrepresentation directed towards the

public or a class of persons is deemed to be a fraudulent

misrepresentation as to every individual in the public

or class who relied thereon.

37 C.J.S. Fraud § 22(2) (1948)

37 Am.Jur.2d Fraud and Deceit §§ 193, 244 (1968)

Restatement (Second) of Torts § 531 (1976)

Simms v. Tigrett, 229 Ala. 486, 158 So. 326, 330 (1934)

Carville v. Jacks, 43 Ark. 454 (1884)

Wennerholm v. Stanford University School of Medicine,

20 Cal.2d 713, 128 P.2d 522 (1942); Cal. Civ. Code

§ 1711 (Deering 1971)

Gulf Oil Corp. v. Newton, 130 Conn. 37, 31 A.2d 462

(1943) ; Salmon v. Richardson, 30 Conn. 360 (1862)

Hines v. Wilson, 164 Ga. 888, 1389 S.W. 802, 804 (1927)

Wollenberger v. Hoover, 346 Ill. 511, 179 N.E. 42 (1931)

Wells v. Western U. Tel. Co., 144 Iowa 605, 123 N.W.

371, 377 (1909)

Campbell v. Gooch, 131 Kan. 456, 292 P. 752, 754 (1930)

Graham v. John R. Watts & Son, 238 Ky. 96, 36 S.W.2d

859, 861 (1931)

Holloway v. Forsyth, 226 Mass. 358, 115 N.E. 483

(1917)

Dime Savings Bank v. Fletcher, 158 Mich. 162, 122 N.W.

540 (1909)

Stevens v. Ludlum, 46 Minn 160, 48 N.W. 771 (1891)

atti

52a

Webb v. Rockefeller, 195 Mo. 57, 98 S.W. 772 (1906) ;

Chison County Bank v. Byers, 189 Mo. 627, 41 S.W. 325

(1897)

Bank of Valley v. Mattson, 215 Neb. 596, 3839 N.W.2d

923, 927 (1983)

_Rohrschneider v. Knickerbocker Life Ins. Co., 76 N.Y.

216 (1879) ; Tindle v. Birkett, 171 N.Y. 520, 64 N.E. 210

(1902)

Hart v. Hanson, 14 N.D. 570, 105 N.W. 942 (1895);

N.D. Cent. Code § 9-10-05 (1987)

Bartholomew v. Bentley, 15 Ohio 659 (1846)

Coughlin v. State Bank of Portland, 117 Or. 83, 243 P.

78, 82 (1926)

Gillespie v. Hunt, 276 Pa. 119, 119 A. 815, cert. den.

261 U.S. 622 (1923)

Whitbeck v. Sees, 10 S.D. 417, 73 N.W. 915 (1898);

S.D. Codified Laws § 20-10-3 (1987)

Martin v. Miller, 24 Wash.App. 306, 600 P.2d 698, 701

(1979)

58a

APPENDIX G

LIST OF AUTHORITIES

One who acquires property by fraud, misrepresentation,

duress or undue influence, holds the property in construc-

tive trust for the transferor.

89 C.J.S. Trusts § 146 (1985)

76 Am.Jur.2d Trusts § 221 (1975)

Restatement of Restitution § 166 and § 215, comment (e)

(1936)

Knowles v. Canant, 255 Ala. 331, 51 So.2d 355 (1951);

Bevels v. Hall, 246 Ala. 430, 21 So.2d 325 (1945)

Eckert v. Miller, 57 Ariz. 94, 111 P.2d 60 (1941)

Bainbridge v. Stoner, 16 Cal.2d 428, 106 P.2d 423 (1940)

Harper v. Adametz, 142 Conn. 218, 183 A.2d 186 (1955)

Osin v. Johnson, 100 U.S.App. D.C. 230, 243 F.2d 653

(D.C. Cir. 1957)

Bell v. Smith, 59 Fla. 817, 832 So.2d 829 (1947)

Bateman v. Patterson, 212 Ga. 284, 92 S.E.2d 8 (1956) ;

Sykes v. Reeves, 195 Ga. 587, 24 S.E.2d 688 (1943)

Peine v. Murphy, 46 Hawaii 233, 377 P.2d 708, 713

(1962)

Fresh v. Dunakin, 306 Ky. 87, 206 S.W.2d 203 (1947) ;

Moore v. Terry, 293 Ky. 727, 170 S.W.2d 29 (1943)

Strout v. Burgess, 144 Me. 268, 68 A.2d 241 (1949)

Bowie v. Ford, 269 Md. 111, 304 A.2d 803 (1973)

State Street Bank & Trust Co. v. Beale, 353 Mass. 103,

227 N.E.2d 924 (1967)

Potter v. Lindsay, 337 Mich. 404, 60 N.W.2d 183 (1953)

latter eerie

54a

Blumberg v. Taggart, 213 Minn. 39, 5 N.W.2d 388

(1942)

Pitchford v. Howard, 208 Miss. 567, 45 So.2d 142 (1950)

Wallach v. Joseph, 420 8.W.2d 289 (Mo.), cert. den. 389

U.S. 953 (1967)

Hensley v. Stevens, 156 Mont. 486, 481 P.2d 694 (1971) ;

Mont. Code Ann. § 72-20-111 (1987)

Meier v. Meyer, 153 Neb. 222, 48 N.W.2d 502 (1950)

Villalon v. Bowen, 70 Nev. 456, 273 P.2d 409 (1954)

Patey v. Peaslee, 101 N.H. 26, 181 A.2d 433 (1957)

D’ Ippolito v. Castoro, 51 N.J. 584, 242 A.2d 617 (1968)

Central National Bank of Mineola v. Robinson, 281 N.Y.

App.Div. 700, 117 N.Y.S.2d 530 (1952); Beatty v. Gug-

genheim Exploration Co., 225 N.Y. 380, 386, 122 N.E.

378 (1919)

Security National Bank of Greensboro v. Educators Mu-

tual Life Ins. Co., 265 N.C. 86, 148 S.E.2d 270 (1965)

Barker v. Barker, 75 N.D. 253, 27 N.W.2d 576 (1947)

Steener v. Fecycz, 72 Ohio App. 18, 50 N.E.2d 617 (1942)

Barnsdale State Bank v. Springer, 176 Okla. 479, 56 P.2d

390 (1936)

Legler v. Legler, 187 Or. 273, 211 P.2d 233 (1949) ; Suit-

ter v. Thompson, 225 Or. 614, 358 P.2d 267 (1960)

In re Gordon, 328 Pa. 129, 195 A. 122 (1937)

Lawrence.v. Andrews, 84 R.I. 138, 122 A.2d 182 (1956)

Greene v. Brown, 199 S.C. 218, 19 S.E.2d 654 (1946)

Johnson v. Graff, 71 S.D. 231, 23 N.W.2¢ 166 (1946)

Rutherford County v. City of Murfreesboro, 202 Tenn.

455, 304 S.W.2d 6385 (1957); McNeill v. Dobson-Bain-

bridge Realty Co., 184 Tenn. 99, 195 S.W.2d 626 (1946)

55a

Meadows v. Bierschwale, 516 S8.W.2d 125 (Tex. 1974)

Decorso v. Thomas, 89 Utah 160, 50 P.2d 951, reh. den.

57 P.2d 1406 (1935)

McGann v. Capital Sav. Bank & Trust Co., 117 Vt. 179,

89 A.2d 123 (1952)

Murdoch v. Leonard, 1 Wash.2d 37, 95 P.2d 37 (1939)

Annon v. Lucas, 155 W.Va. 368, 185 S.E.2d 348 (1971)

Glojek v. Glojek, 254 Wisc. 109, 35 N.W.2d 203 (1948)

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.