# Petition for Writ of Certiorari — Downriver Community Federal Credit Union v. Penn Square Bank ex rel. Federal Deposit Insurance > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385020_1220%3A1 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition for Writ of Certiorari - **Published:** January 1, 1990 - **Citation:** 493 U.S. 1070 ## Text 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 ot Dg 4 {| po ine 8 ig yh > Se IIE iinterneectncenercecscouress eats I OO es esecmosecercoeecoees pe oe gt ay Et ' | eee REASONS FOR GRANTING THE WRIT ................ I. 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 EE 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 13 13 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 23 27 la 22a 42a 46a 49a 5la 53a v 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) vi 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 I Foca asccicrconstceccnssaiecosnumndernenctiaanaion Rs IU ca cercececcreeensciivenncntoneen ais iccsicrocienencscentniiavionicenatenieconeesipetenens pg | | ERO ee ee Sree ral Man At 4g ) Gb See pi hucienacateeeenadine 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) ....................... rg R © i) pA OH SP COO OO & i) or i) 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 24 24 24 23 19 23 24 24 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. 2 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. 3 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 4 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 5 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 ao 6 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. 7 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. 8 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. 9 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. ————— 10 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). 11 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.’’). 13 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 14 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 15 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). 17 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- 18 _ 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 19 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 20 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. AN LEE AAS,» i) Net oh a AR A st Hd LO ad, PMO Bai rit: eee lens ihe "eat 4S sk gee Oe LAE eal ed on Pacino ale may Se" ee Pea ate 21 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 eT 22 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 23 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. 24 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). 25 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. 26 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 27 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