Free Post Trial Brief - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS __________________________________________ ) ) ) Plaintiff, ) ) v. ) ) UNITED STATES OF AMERICA, ) ) Defendant. ) ) __________________________________________) NORTHEAST SAVINGS, F.A.

Civil Action No. 92-550C Judge Williams

PLAINTIFF'S POST-TRIAL BRIEF

Charles J. Cooper COOPER & KIRK, PLLC 555 Eleventh Street, N.W., Suite 750 Washington, D.C. 20004 (202) 220-9600 (202) 220-9601 (fax) Counsel of Record Of Counsel: Michael W. Kirk Vincent J. Colatriano David H. Thompson David Lehn COOPER & KIRK, PLLC 555 Eleventh Street, N.W., Suite 750 Washington, D.C. 20004 (202) 220-9600 (202) 220-9601 (fax)

January 22, 2007

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TABLE OF AUTHORITIES .......................................................................................................... 5 INTRODUCTION .......................................................................................................................... 7 STATEMENT OF ISSUES OF FACT AND LAW ..................................................................... 15 ARGUMENT................................................................................................................................ 16 I. II. Legal standards for evaluating Northeast's damages claims. ........................................... 16 Northeast is entitled to lost profits as a result of the breach. ........................................ 18 A. But for the breach, Northeast would not have shed billions of dollars in interest-earning assets and consequently lost substantial profits. ................................................................... 19 1. Northeast's pre-breach business plans and strategies. .............................................. 19 2. The government's breach caused Northeast to fall out of capital compliance. ........ 21 3. In 1989 and 1990, Northeast shrank to mitigate the loss of its supervisory goodwill......................................................................................................... 22 4. There is no evidence that Northeast would have shrunk further than $6.7 billion in tangible assets absent the breach....................................................................................... 24 5. In 1991, Northeast had to shrink again to mitigate the breach. ................................ 27 6. In 1994, Northeast shrank for reasons unrelated to the breach................................. 27 7. The breach-induced shrinkage in 1989­90 and in 1991 reduced significantly Northeast's earnings.......................................................................................................... 28 B. It was foreseeable and actually foreseen that the inability to count supervisory goodwill would reduce Northeast's profits. ......................................................................................... 29 C. Northeast has proven its lost profits damages with reasonable certainty. .................... 31 1. Lost profits from the divested assets......................................................................... 34 2. Lost profits from the replacement assets. ................................................................. 36 3. Dr. Baxter has fully accounted for credit risk........................................................... 39 a) The divested assets' credit risk. ............................................................................ 39 b) The replacement assets' credit risk. ...................................................................... 39 4. The interest rate risk profile of the but-for bank is appropriate................................ 41 D. Northeast's shrink was a reasonable response to the breach. ....................................... 44 E. Glendale and CalFed do not stand in the way of awarding lost profits to Northeast... 46 1. Glendale.................................................................................................................... 46 2. CalFed....................................................................................................................... 48 Northeast is entitled to the cost of raising capital through the DEPCO transaction. .... 49 But for the breach, Northeast would not have raised capital through the DEPCO deal. 49 B. It was foreseeable and actually foreseen that Northeast would need to raise capital as a result of the breach................................................................................................................ 50 C. Northeast has proven the cost of raising capital through the DEPCO transaction with reasonable certainty. ............................................................................................................. 50 1. Northeast actually bore the economic cost of the preferred stock and warrants. ..... 53 2. The PIK feature......................................................................................................... 54

III. A.

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D. IV. A. B. V. A. B. C. VI. A. B. VII.

The tax gross-up............................................................................................................ 55 Northeast is entitled to reimbursement for out-of-pocket expenses. ............................ 57 Advisory services fees. ................................................................................................. 57 SAIF deposit premiums. ............................................................................................... 58 Northeast did not benefit from the breach. ....................................................................... 59 G&A cuts. ..................................................................................................................... 60 Credit risk...................................................................................................................... 61 Dividends. ..................................................................................................................... 61 Northeast would not have written off its supervisory goodwill absent the breach....... 62 The supervisory goodwill writeoffs were caused by the breach................................... 63 GAAP does not control Northeast's treatment of its supervisory goodwill. ................ 70 The Court has the power to enter a "jury-verdict" damages award.............................. 73

PROPOSED FINDINGS OF FACT ............................................................................................. 74 I. A. B. C. D. II. III. A. B. C. How thrifts make money................................................................................................... 74 Components of thrift income. ....................................................................................... 74 Generating net interest income. .................................................................................... 75 Capital and leverage...................................................................................................... 79 Wholesale vs. retail....................................................................................................... 81 FIRREA. ....................................................................................................................... 83 Northeast before FIRREA............................................................................................. 85 Rapid wholesale growth from 1982 to 1988................................................................. 85 Challenges on the horizon............................................................................................. 90 Northeast heads in a new direction in 1988. ................................................................. 91 1. New management: Rutland and Walters................................................................... 93 2. Northeast studies its options. .................................................................................... 94 3. The December 1988 Business Plan........................................................................... 95 a) Balance sheet composition: shift in emphasis from wholesale to low-credit risk retail banking. ............................................................................................................... 97 b) Balance sheet size: holding constant................................................................... 100 c) Timeframe: gradual, over several years.............................................................. 102 d) Interest rate risk: maintain gap within existing range but reduce gap if possible through variable-asset assets....................................................................................... 103 e) G&A: greater efficiency by holding G&A constant despite shift to retail. ........ 106 D. The regulators recognize the new strategy: the June 1989 FHLBB Report of Examination. ....................................................................................................................... 107

IV. Regulatory Purgatory: the changing regulatory environment disrupts Northeast's new plans. 109

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A. The February 1989 Board meeting. ............................................................................ 111 B. The March 1989 Board meeting. ................................................................................ 112 C. The April 1989 Board meeting. .................................................................................. 112 D. The May 1989 draft revised business plan. ................................................................ 113 E. The May 1989 Board meeting. ................................................................................... 117 F. Rutland's May 1989 letter to shareholders and Q&A. ............................................... 118 G. The June 1989 Board meeting. ............................................................................... 120 H. Northeast's July 1989 Response to the June 1989 FHLBB Report of Examination........................................................................................................ 121 I. The July 1989 Revised Business Plan. ....................................................................... 124 1. Substantial reduction in size of balance sheet because of loss of supervisory goodwill. ......................................................................................................................... 125 2. Abandonment of commercial and consumer lending activities because of risk-based capital requirement.......................................................................................................... 126 3. Reduction in absolute level of G&A....................................................................... 127 J. Summary. .................................................................................................................... 127 V. Northeast's response to FIRREA.................................................................................... 128 A. FIRREA's restrictions on supervisory goodwill and cumulative preferred stock caused Northeast to fall out of compliance..................................................................................... 128 B. Northeast's response to FIRREA................................................................................ 131 1. Converting preferred to common............................................................................ 132 2. Reducing assets....................................................................................................... 133 3. Securitizing residential loans. ................................................................................. 135 4. Northeast could not raise more capital.................................................................... 136 5. Coming into capital compliance under FIRREA. ................................................... 137 C. No rest for the weary: FIRREA's phase-out and FDICIA's heightened requirements. .................................................................................................... 138 D. DEPCO: Northeast raises capital in connection with the Rhode Island acquisitions. 142 E. Advisory service fees.................................................................................................. 146 F. SAIF insurance premiums........................................................................................... 147 G. Coda: Shawmut acquires Northeast. ....................................................................... 149 Measuring the impact of the breach: calculation of damages..................................... 150 Tangible asset balance but for the government's breach. ........................................... 151 Lost profits on the foregone assets.............................................................................. 154 1. The 1989­90 Shrink and the 1991 Shrink reduced Northeast's earnings............... 154 2. Framework for measuring lost profits..................................................................... 158 3. Lost profits on the divested assets. ......................................................................... 160 a) Volume and composition of the divested assets. ................................................ 160 b) Net interest spread on the divested assets. .......................................................... 164 c) Offsets to divested asset damages....................................................................... 165 (i) G&A................................................................................................................ 165 (ii) Gains on sales of divested assets. ............................................................... 167 d) Total lost profits on divested assets .................................................................... 167 4. Lost profits on the replacement assets. ................................................................... 168

VI. A. B.

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a) Much of the replacement assets would have been wholesale. ............................ 169 b) Using wholesale assets and liabilities understates the lost profits on the replacement assets....................................................................................................... 170 c) Reinvestment risk................................................................................................ 174 5. Dr. Baxter's damages calculation accounts fully for credit risk............................. 175 b) Divested asset credit risk. ................................................................................... 175 c) Replacement asset credit risk.............................................................................. 177 (i) Commercial loans. .......................................................................................... 179 (ii) Consumer loans........................................................................................... 182 (iii) Single-family residential mortgages. .......................................................... 183 6. The interest rate risk of Dr. Baxter's But-For Bank is consistent with what it would have been but for the breach. .......................................................................................... 186 7. Core earnings. ......................................................................................................... 197 C. Cost of raising capital through the DEPCO transaction. ............................................ 198 D. Tax gross-up on the cost of raising capital through the DEPCO transaction. ............ 200 E. Advisory services fees. ............................................................................................... 203 F. SAIF insurance premiums........................................................................................... 204 G. Alleged benefits of the breach. ............................................................................... 205 1. The breach did not benefit Northeast by causing cuts in G&A. ............................. 205 2. The breach did not cause Northeast to reduce its credit risk. ................................. 206 3. The breach did not cause Northeast to cease paying dividends.............................. 208 H. Northeast would not have written off its supervisory goodwill for regulatory purposes absent the breach.................................................................................................. 209 1. The 1990 writeoff. .................................................................................................. 209 2. The 1992 writeoff. .................................................................................................. 212 VII. O'Keefe's and Brenner's deposition testimony does not undermine the evidence regarding Northeast's business strategies absent the breach. ................................................. 215 A. Kevin O'Keefe. ........................................................................................................... 215 B. Albert Brenner. ........................................................................................................... 216 VIII. A. B. C. D. The government's experts are not credible............................................................. 218 Professor Fischel......................................................................................................... 218 Professor Thakor......................................................................................................... 220 Mr. Bankhead.............................................................................................................. 222 Mr. Clowery................................................................................................................ 222 1. Mr. Clowery's opinion as to taxability is not relevant............................................ 222 2. Mr. Clowery's opinion as to taxability contradicts one of the most fundamental provisions of the Internal Revenue Code........................................................................ 223 3. Mr. Clowery's opinion as to Bank of America's tax planning opportunities is not credible because it defies common sense........................................................................ 224

CONCLUSION........................................................................................................................... 225

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TABLE OF AUTHORITIES Cases Page(s)

Am. Cap. Corp. v. United States, 66 Fed. Cl. 315 (2005), aff'd in relevant part and rev'd in part, Nos. 05-5150, 05-5152, 05-5159, 2006 U.S. App. LEXIS 26987 (Fed. Cir. Oct. 30, 2006)...................................................................................59 American Fed. Bank, FSB v. United States, 72 Fed. Cl. 586 (2006) ..................................... passim Anchor Sav. Bank, F.S.B. v. United States, 59 Fed. Cl. 126 (2003) ..............................................51 Bank of Am., FSB v. United States, 70 Fed. Cl. 246 (2006) ..........................................................17 Bank of Am., FSB v. United States, 67 Fed. Cl. 577 (2005) ..........................................................52 Bluebonnet Sav. Bank, F.S.B. v. United States, 67 Fed. Cl. 231 (2005)..................................51, 59 Bluebonnet Sav. Bank, F.S.B. v. United States, 339 F.3d 1341 (Fed. Cir. 2003) ....................13, 73 Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348 (Fed. Cir. 2001) .................. passim California Fed. Bank v. United States, 395 F.3d 1263 (Fed. Cir. 2005) ...........................17, 18, 29 California Fed. Bank, FSB v. United States, 54 Fed. Cl. 704 (2002)............................................48 California Fed. Bank, FSB v. United States, 245 F.3d 1342 (Fed. Cir. 2001) ..............................22 Caroline Hunt Trust Estate v. United States, 470 F.3d 1044, 2006 U.S. App. LEXIS 28464 (Fed. Cir. Nov. 16, 2006).........................................................................................................59 Coast Fed. Bank, FSB v. United States, 48 Fed. Cl. 402 (2000), aff'd on other grounds, 323 F.3d 1035 (Fed. Cir. 2003)....................................................................................30, 72, 73 Commercial Federal Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004), aff'd, Nos. 04-5075 & 04-5076, 2005 U.S. App. LEXIS 6802 (Fed. Cir. Apr. 8, 2005).................................................................................................... passim Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002).................................17, 30 Fifth Third Bank v. United States, 71 Fed. Cl. 56 (2006) ........................................................55, 56 First Heights Bank v. United States, 422 F.3d 1311 (Fed. Cir. 2005)...........................................44 Franconia Assocs. v. United States, 61 Fed. Cl. 718 (2004) .........................................................44 Glendale Fed. Bank v. United States, 378 F.3d 1308 (Fed. Cir. 2004) ................................. passim Glendale Fed. Bank, F.S.B. v. United States, 239 F.3d 1374 (Fed. Cir. 2001) .................29, 31, 57 Glendale Fed. Bank, FSB v. United States, 43 Fed. Cl. 390 (1999) ........................................46, 47, 48 Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005), aff'd in part and vacated in part, No. 06-5001, 2006 U.S. App. LEXIS 18417 (Fed. Cir. July 20, 2006) .................................................................................................. passim Granite Mgmt. Corp. v. United States, 416 F.3d 1373 (Fed. Cir. 2005) .......................................54

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Home Sav. of Am., F.S.B. v. United States, 50 Fed. Cl. 427 (2001), aff'd in part and vacated in part, 399 F.3d 1341 (Fed. Cir. 2005).......................................................................... passim La Van v. United States, 382 F.3d 1340 (Fed. Cir. 2004)..............................................................17 Lasalle Talman Bank, F.S.B. v. United States, 64 Fed. Cl. 90 (2005), aff'd in part and vacated in part on other grounds, 462 F.3d 1331 (Fed. Cir. 2006).......................... passim LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363 (Fed. Cir. 2003).........32, 33, 49, 52 LaSalle Talman Bank, F.S.B. v. United States, 45 Fed. Cl. 64 (1999) ..........................................28, 58 Long Island Sav. Bank, FSB v. United States, 67 Fed. Cl. 616 (2005).................................. passim National Australia Bank v. United States, 452 F.3d 1321 (Fed. Cir. June 22, 2006)..............38, 39 Northeast Sav. v. United States, 63 Fed. Cl. 507 (2005) .................................................................7 See Northeast Sav. v. United States, 72 Fed. Cl. 173 (2006)...........................................................9 Old Stone Corp. v. United States, 450 F.3d 1360 (Fed. Cir. 2006) ...................................22, 45, 49 Sinclair Ref. Co. v. Jenkins Petroleum Process Co., 289 U.S. 689 (1933) ...................................51 United States v. Winstar Corp., 518 U.S. 839 (1996)........................................................16, 19, 29 Westfed Holdings, Inc. v. United States, 407 F.3d 1352 (Fed. Cir. 2005)...................12, 54, 59, 60 Westfed Holdings, Inc. v. United States, 55 Fed. Cl. 544 (2003) ..................................................60 Other RESTATEMENT (SECOND) CONTRACTS § 347 .................................................................................58 24 SAMUEL WILLISTON & RICHARD A. LORD, A TREATISE ON THE LAW OF CONTRACTS § 64:2 (4th ed. 2002)..........................................................................................................57, 58

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INTRODUCTION This Court has found that the government breached its contractual promises to recognize, for regulatory capital purposes, nearly $300 million of "supervisory goodwill" booked by Northeast in connection with the acquisitions of three failing thrifts. Northeast Sav. v. United States, 63 Fed. Cl. 507, 519 (2005). Over the course of the three-week damages trial held by the Court, Northeast proved that the government's breach caused it no less than--and in fact, in all likelihood much more than--$129.286 million in damages. Northeast's damages were foreseeable, they were clearly caused by the breach, and they were calculated with reasonable certainty. In the pages that follow, we present in considerable detail the facts established at trial that prove Northeast's damages and defeat the government's attempt to avoid paying these damages. Given the scope and magnitude of the government's breach, and the fact that the effects of that breach were felt by Northeast over a period of many years, it is not surprising that our discussion of the relevant facts is quite lengthy. But the Court should not be fooled by the heft of this brief or by the sheer number of our proposed findings of fact into thinking that the case for Northeast's entitlement to damages is complex or difficult to explain. Quite the opposite is true: Northeast's damages claim both is quite straightforward and rests on a mountain of contemporaneous supporting evidence--much of which comes from the thrift regulators' own documents. At its essence, that claim is premised on the simple and indisputable propositions that (1) a thrift's level of regulatory capital is a fundamental determinant of the amount of interest-earning assets and interest-bearing liabilities it may hold; and (2) because the government's breach of its promise to recognize over $200 million of regulatory capital forced Northeast to jettison billions of dollars of assets and liabilities on which it was earning a positive spread, the breach deprived Northeast of tens of millions of dollars in income. Ultimately, the length of our factual recitation is attributable not to the complexity of our claim but instead to both the overwhelming amount of

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evidence supporting that claim and our effort to address the numerous arguments that the government has raised in its attempt to distract the Court from that evidence. While the determination of breach-of-contract damages, and particularly expectation damages (including lost profits), is rarely a routine matter, there can be no doubt, given the facts relating to Northeast's pre-breach financial profile and business plans, that the government's breach had a devastating impact on Northeast's financial condition. These same facts establish that the breach not only deprived Northeast of over one hundred million dollars of earnings it otherwise would have made, but it also forced Northeast to incur millions of dollars of expenses, relating to such things as capital-raising efforts and deposit insurance premiums, that it would not otherwise have incurred. The breach, in other words, hit Northeast with a double whammy-- it deprived Northeast of income and increased its expenses. While Northeast, through the hard work of its experienced, talented, and dedicated management, ultimately survived the government's breach, it did not survive unscathed. The basic facts underlying Northeast's damages claim are straightforward. While economic conditions and other factors made the 1980s a very challenging decade for the thrift industry, and while Northeast was not immune to those challenges, by the middle part of the decade it had actually established a track record of fairly consistent profitability and substantial yet managed growth (thus exceeding the hopes and expectations of the contracting parties). This record is particularly remarkable when one considers that the government's own regulators, at the time of the 1982 transactions, projected that it would take Northeast five years after its absorption of the failing thrifts before it would become profitable. Moreover, the experienced and highlyregarded management team that took over at Northeast in 1988, which was uniformly praised as excellent by thrift regulators, was poised to implement business plans that sought to consolidate

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and build upon the institution's previous success and further improve earnings. In particular, those business plans aimed to maintain Northeast's size at about $8 billion in assets while at the same time gradually transitioning Northeast from a business strategy that relied heavily upon holding "wholesale" (that is, purchased) assets and liabilities that generated positive, if modest, net interest income to a strategy that relied more heavily upon the higher spreads generated by "retail" assets and liabilities (that is, loans and deposits generated by Northeast's branch and loan origination networks). The government's breach, however, changed everything. As the regulators themselves candidly put it, the breach pulled "the proverbial rug" out from under Northeast and disrupted virtually every facet of its business plans. Literally overnight, Northeast was deprived of over $200 million of its regulatory capital, causing it to plunge into non-compliance with its regulatory capital requirements. With the capital markets effectively closed to it, Northeast prudently, and foreseeably, took the only course of action it could: it improved its capital ratios through massive shrinkage of its assets and liabilities. In the space of only a few years, Northeast cut itself in half--going from more than $8 billion in assets to less than $4 billion. See Northeast Sav. v. United States, 72 Fed. Cl. 173, 175 (2006). Of course, and just as foreseeably, such massive shrinkage had a massive impact on Northeast's bottom line. As Northeast shed billions of dollars of wholesale assets and liabilities on which it was earning a positive spread, Northeast was deprived of approximately $73.2 million of net income from the divested assets alone. Moreover, because the government's breach prevented Northeast from maintaining its planned size by reinvesting in replacement assets as existing assets ran off, Northeast was deprived of approximately $39.1 million in additional income.

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That was not all. In connection with its acquisition of deposit franchises in 1992, Northeast was required to raise, at a cost of about $15.3 million, approximately $35 million in additional capital. Absent the government's breach, Northeast would not have needed to raise this capital in order to support these acquisitions. And finally, because of the precarious position in which it found itself as a result of the breach, Northeast was required to pay approximately $1.3 million more in premiums for deposit insurance than it otherwise would have paid, and approximately $0.3 million in expenses related to other efforts to raise capital that it needed as a direct result of the government's breach. In sum, Northeast's damages expert, Dr. Nevins Baxter, has conservatively estimated that the breach damaged Northeast to the tune of at least $129.286 million. Of course, this amount would not come close to actually making Northeast whole, since Dr. Baxter's calculations are premised upon very conservative assumptions about how Northeast would have performed had the government honored its contract, and since the government is not liable for prejudgment interest on the damages that Northeast suffered more than a decade ago. Given the magnitude of the government's breach and the straightforward facts underlying Northeast's damages claim, one who was not familiar with the government's litigation strategies in the Winstar cases might have legitimately expected that while the government may dispute certain aspects of Dr. Baxter's damage calculations, it would never dispute the basic proposition that its breach had a crushing impact on Northeast. However reasonable such an expectation would be, it would be wrong. Once again, as it has done in numerous Winstar cases, the government did its damages "numbers, and, surprise, came up with zero." Glendale Fed. Bank, FSB v. United States, 378 F.3d 1308, 1311 (Fed. Cir. 2004). The government is asking this Court to believe that a contract breach eliminating more than one fifth of a billion dollars of Northeast's

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bargained-for regulatory capital visited not a single penny of damages on the institution. Indeed, at the same time the government's experts, apparently bound less by principles of logical consistency than by the notion that if they throw enough assertions against the wall, something might stick, contend that it is impossible to determine how Northeast would have fared absent the breach, they also claim that the breach actually saved Northeast money--that, in effect, the government did Northeast a huge favor by breaching the contract. As we demonstrated at trial, the government's arguments are not only unsupported by the record, they are without any merit. While we will of course recount in this brief, in considerable detail, the facts that fatally undermine the government's contentions, we are compelled at this point to briefly address why the basic themes of the government's case are utterly devoid of support. The government contends that Northeast's massive asset shrinkage between 1989 and 1991 was undertaken for nonbreach reasons and therefore would have occurred even absent the breach. While this argument suffers from multiple problems, at its essence, it simply fails to reckon with the basic facts that (1) all of the contemporaneous evidence, from both Northeast documents and regulatory documents, makes clear that Northeast's asset shrinkage was driven by Northeast's regulatory capital profile; and (2) absent the breach, Northeast would have had hundreds of millions of dollars in additional regulatory capital. Once these basic facts are understood, there can be no question that the government's causation arguments border on the frivolous. Another theme of the government's case is that Dr. Baxter's damages analysis, which measures damages by reference to the spread Northeast earned on its wholesale asset/liability portfolio, is a "hindsight driven" model that improperly shields the but-for Northeast from credit risk and that improperly exposes the but-for Northeast to excessive levels of interest rate risk. Once again, these arguments ignore the indisputable facts regarding what Northeast actually did

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in response to the breach. The evidence establishes that Northeast accomplished its breachinduced shrinkage by divesting billions of dollars of wholesale assets and liabilities, which by their very nature carry virtually no credit risk. In calculating damages based on the assets that Northeast actually sold as a result of the breach, therefore, Dr. Baxter is not "cherry picking" or engaging in a hindsight-driven analysis, but is instead grounding his determination of Northeast's divested asset damages in the real-world facts. For this reason, the government's credit risk and interest rate risk arguments simply do not apply to Northeast's claim for such damages. Moreover, with respect to Dr. Baxter's calculation of Northeast's damages pertaining to replacement assets--that is, the assets Northeast would have put on its books as its divested assets repaid and ran off of its books--Northeast has established that assuming that Northeast would have gradually replaced some or all of its wholesale assets and liabilities with retail assets and liabilities as market opportunities allowed, those replacement assets and liabilities, fully accounting for such items as credit risk, would have generated more net income than the replacement assets used in Dr. Baxter's analysis. Northeast's analysis, in other words, if anything understates its damages. Significantly, none of the government's experts have presented their own damages analysis. Rather, they were content to sit back and take pot-shots at Northeast's analysis. For the reasons summarized above and discussed in more detail below, none of the government's experts presented credible critiques that in any way undermine Northeast's analysis. See, e.g., Westfed Holdings, Inc. v. United States, 407 F.3d 1352, 1364 (Fed. Cir. 2005) (noting that trial court did not give credit to testimony of Government's experts (who included one of the government's experts here, Barefoot Bankhead) because none of those witnesses developed a model of the "butfor" world).

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The common thread running through the Federal Circuit's Winstar damages jurisprudence is its repeated "reject[ion of] the government's argument that it should pay no damages at all." Bluebonnet Sav. Bank, F.S.B. v. United States, 339 F.3d 1341, 1346 (Fed. Cir. 2003). The fact of the matter is that, notwithstanding dicta in some decisions noting the difficulty of proving lost profits in Winstar cases, Northeast's claims constitute a straightforward, and indeed conservative, case for expectation damages. The damages that Northeast proved at trial are in fact quite consistent with awards in other cases that have been affirmed by the Court of Appeals. See, e.g., Commercial Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004), aff'd, 2005 U.S. App. LEXIS 6802 (Fed. Cir. Apr. 8, 2005); Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005), aff'd in part and vacated in part, 2006 U.S. App. LEXIS 18417 (Fed. Cir. July 20, 2006) (unpublished). Indeed, the damages analysis that Judge Lettow found persuasive in Globe is very similar to, and, in fact, in certain important respects discussed herein is more aggressive than, Dr. Baxter's analysis in this case. As in this case, the damages experts in Globe (1) determined how big the thrift would have been absent the breach; (2) estimated, on the basis of runoff data, how long the assets Globe divested as a result of the breach would have remained on its books; (3) identified the appropriate spread to use to calculate Globe's lost net interest income on those divested assets; and (4) calculated the income lost from the replacement assets that Globe would have put on its books as the divested assets ran off. Globe, 65 Fed. Cl. at 352­57. In short, if it is possible for a financial institution to establish its entitlement to recovery of expectation damages in the Winstar context--and the Federal Circuit's affirmance of the awards in Globe and Commercial Federal confirms that it is--Northeast has done so here. **** This brief is divided into two separate sections. The argument section addresses the rele-

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vant legal authority and summarizes the key evidence establishing the elements of our claims. The findings of fact provide a more detailed analysis of the relevant factual material in the record.

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STATEMENT OF ISSUES OF FACT AND LAW 1. Whether Northeast's damages were caused by the government's breach of the

parties' goodwill contracts? 2. 3. Whether Northeast's damages were reasonably foreseeable to the government? Whether the fact of Northeast's damages is established, and whether the amount

of damages claimed by Northeast is a fair and reasonable approximation of those damages?

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ARGUMENT I. Legal standards for evaluating Northeast's damages claims. The impact of the government's breach of contract on Northeast's strategy and financial position was, as the Supreme Court has put it, "swift and severe." United States v. Winstar Corp., 518 U.S. 839, 857 (1996). Without its supervisory goodwill, Northeast could not comply with FIRREA's capital requirements and would have been subject to seizure if it had not mitigated the effects of the government's breach. Northeast mitigated or attempted to mitigate the government's breach through several actions. First, Northeast shrank its asset base substantially. Second, Northeast raised capital through the DEPCO transaction. Third, Northeast pursued a rights offering through which it would have raised capital. " `One way the law makes the non-breaching party whole is to give him the benefits he expected to receive had the breach not occurred.' " Bluebonnet Sav. Bank, F.S.B. v. United States, 266 F.3d 1348, 1355 (Fed. Cir. 2001) (quoting Glendale Fed. Bank, FSB v. United States, 239 F.3d 1374, 1380 (Fed. Cir. 2001)); see also, e.g., Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330, 345 (2005) ("Expectancy damages ordinarily serve as the basis for an award of contractual damages."), aff'd in part and vacated in part, No. 06-5001, 2006 U.S. App. LEXIS 18417, at *1­2 (Fed. Cir. July 20, 2006). "A party's expectation interest is the interest in having the benefit of his bargain by being put in as good a position as he would have been in had the contract been performed." Bluebonnet, 266 F.3d at 1355 (quotation marks omitted). Northeast seeks expectancy damages for $112.352 million in lost profits resulting from the shrink, $15.287 million for the cost of raising capital through the DEPCO deal, $313,000 in advisory services fees, and $1.334 million in excess SAIF deposit premiums on the ground that it would not have incurred these costs had the government honored its contractual obligations with respect to

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supervisory goodwill. The standards for proving any kind of expectancy damages, of which mitigation damages are a subset, are well established. A plaintiff is entitled to expectancy damages upon demonstrating by a preponderance of the evidence that: (1) the loss was caused by the breach; (2) the loss was a foreseeable consequence of the breach or an actually foreseen consequence of the breach; and (3) the measure of damages is reasonably certain. California Fed. Bank v. United States ("CalFed"), 395 F.3d 1263, 1267 (Fed. Cir. 2005); La Van v. United States, 382 F.3d 1340, 1351 (Fed. Cir. 2004); Energy Capital Corp. v. United States, 302 F.3d 1314, 1325 (Fed. Cir. 2002); Bluebonnet, 266 F.3d at 1355; Globe, 65 Fed. Cl. at 345. As long as these three elements are satisfied, the plaintiff is entitled to expectancy damages, even if other factors besides the breach may have been present. The Federal Circuit in CalFed made this clear: "That is not to say that the breach must be the sole factor or sole cause in the loss of profits. The existence of other factors operating in confluence with the breach will not necessarily preclude recovery based on the breach." CalFed, 395 F.3d at 1268. Thus, for example, Judge Lettow, adhering to CalFed's teaching, held in American Federal Bank v. United States ("AmFed") that "despite the existence of secondary business reasons for American Federal's execution of the 1993 offering and exchange, the court concludes that the bank has satisfied its burden to prove that the government's breach directly caused the 1993 offering and exchange to occur." 72 Fed. Cl. 586, 601 (2006); see also Bank of Am., FSB v. United States ("BofA"), 70 Fed. Cl. 246, 251 (2006). The facts proved at trial establish that Northeast is entitled to recover these expectancy damages from the government.

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II.

Northeast is entitled to lost profits as a result of the breach. As Judge Lettow has pointed out, "[d]amages measured as lost profits are the ordinary

starting point for evaluating available remedies for breach of contract." Globe, 65 Fed. Cl. at 351. On two occasions, the Federal Circuit has remarked in dicta that lost profits are difficult to prove in the Winstar context. Glendale Fed. Bank v. United States, 378 F.3d 1308, 1313 (Fed. Cir. 2004); CalFed, 395 F.3d at 1270­71. But the Federal Circuit has "not ... barred as a matter of law the use of expectancy/lost profits theory." Glendale, 378 F.3d at 1313. In fact, the Federal Circuit has recently affirmed two awards of lost profits resulting from a breach-induced shrink in the Winstar context, one by Judge Lettow in Globe, 65 Fed. Cl. 330, aff'd in part and vacated in part, No. 06-5001, 2006 U.S. App. LEXIS 18417, at *1­2 (agreeing with Judge Lettow's "well-reasoned opinion" "in all respects but one," namely, whether an offset needed to be taken for a branch sale), and one by Judge Futey in Commercial Federal Bank, F.S.B. v. United States ("CommFed"), 59 Fed. Cl. 338 (2004), aff'd, Nos. 04-5075 & 04-5076, 2005 U.S. App. LEXIS 6802 (Fed. Cir. Apr. 8, 2005) (affirming without opinion). In addition, Judge Bruggink awarded lost profits damages resulting from a breach-induced shrink in Lasalle Talman Bank, F.S.B. v. United States; the government did not appeal that portion of the decision. 64 Fed. Cl. 90, 106 (2005), aff'd in part and vacated in part on other grounds, 462 F.3d 1331, 1335 n.2 (Fed. Cir. 2006). It is hardly surprising that the Federal Circuit has consistently affirmed lost profits awards since the relevant law is well-settled and thus the resolution of such claims turns on factual findings. Here, as a foreseeable result of the government's breach, Northeast lost $112.352 million in profits.

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A.

But for the breach, Northeast would not have shed billions of dollars in interest-earning assets and consequently lost substantial profits.

But for the loss of its supervisory goodwill as a result of the government's breach, Northeast would not have shrunk its asset base nearly as far as it did and consequently would not have lost $112.352 million in profits. Plaintiff's Finding of Fact ("FF") ¶¶ 295, 331. 1. Northeast's pre-breach business plans and strategies. In 1982, at the invitation of federal banking regulators, Northeast acquired three failing thrifts. FF ¶ 40. The acquired thrifts were in such poor financial condition that the acquisitions would have caused Northeast's liabilities to exceed its assets, that is, the acquisitions would have rendered Northeast insolvent. FF ¶ 41. To help Northeast overcome the deficit that otherwise would have resulted from those acquisitions, the government contractually promised that Northeast could count $290 million in supervisory goodwill toward capital requirements. FF ¶ 42. This would allow Northeast to leverage the supervisory goodwill into interest-earning assets and, in turn, into profits. FF ¶¶ 43, 46. Winstar, 518 U.S. at 851 ("[T]he treatment of supervisory goodwill as regulatory capital was attractive because it inflated the institution's reserves, thereby allowing the thrift to leverage more loans (and, it hoped, make more profits)."). Northeast made the most of its supervisory goodwill by growing its balance sheet rapidly, mainly by taking on wholesale assets with little credit risk, such as MBSs and purchased residential mortgages. FF ¶¶ 47, 48. Through this growth strategy, Northeast achieved profitability much faster than the regulators had expected. FF ¶¶ 47, 49, 50. In fact, the regulators had not expected Northeast to become profitable for at least five years after the acquisitions. FF ¶ 45. In July 1988, Northeast brought in George Rutland as CEO and Chairman. FF ¶ 63. In April 1989, Mr. Rutland brought in Kirk Walters to be his right-hand man. FF ¶ 64. After serving as Executive Vice President, Controller, and Principal Accounting Officer, Mr. Walters 19

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became CFO in September 1989, President in 1991, and CEO and Chairman in 1993. FF ¶ 64. The regulators uniformly held Mr. Rutland and Mr. Walters in very high regard, calling them "honest," "talented," and "a good thrift manager." FF ¶ 65. In consultation with the Board, Mr. Rutland and Mr. Walters set the strategic direction of the company. FF ¶ 66. After exploring several courses of action with the assistance of Kaplan, Smith & Associates ("Kaplan"), and after conferring with the Board and the regulators, Mr. Rutland decided upon a new business strategy. FF ¶¶ 67-73. Northeast set out its new strategy in its December 1988 Business Plan. FF ¶¶ 74­75. The core idea of the December 1988 Business Plan was that over a period of about five years, Northeast would shift its focus from wholesale banking to retail banking. FF ¶¶ 71­73, 77, 80­81, 98­102, 120, 122. Further, the loans that Northeast would originate would be predominantly low-risk adjustable-rate residential mortgages. FF ¶¶ 71, 82, 109, 120, 159­160. Rutland believed (correctly) that such retail activities would generate greater and more stable net interest income than the wholesale activities that Northeast had been engaged in. FF ¶¶ 76, 78­79, 127. And because Northeast already had a substantial but underused retail infrastructure in place, shifting Northeast's focus to retail would make the bank more efficient overall. FF ¶ 113­116. A key feature of the new strategy was that, consistent with meeting applicable capital requirements (and maintaining a capital cushion of about 50 basis points), Northeast would hold the size of its balance sheet constant. FF ¶¶ 90­97, 120, 125­126. As shown by the December 1988 Business Plan, Northeast determined that it would maintain a total asset balance of just over $8 billion through 1989. FF ¶¶ 95, 120. In addition, although Northeast wanted to move away from wholesale banking, Northeast was not going to discard its wholesale assets unless, until, and only to the extent that it could

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capture more profitable opportunities in retail. FF ¶¶ 89, 101­102, 159. Thus, as the wholesale assets ran off, Northeast would seek to replace them with retail assets, but to the extent that more attractive retail assets were not available, Northeast would reinvest the proceeds from the wholesale assets in new wholesale assets, thereby maintaining the overall asset balance. FF ¶¶ 92­93, 99, 101­102, 121. 2. The government's breach caused Northeast to fall out of capital compliance. In breach of Northeast's supervisory contracts with the government, FIRREA, which was enacted in August 1989, severely limited Northeast's ability to count its $200 million in unamortized supervisory goodwill toward the capital requirements. FF ¶¶ 194, 197, 35­39, 200, 202. With respect to the tangible capital requirement, the breach eliminated all of Northeast's supervisory goodwill immediately, putting Northeast into non-compliance overnight. FF ¶¶ 203, 206­207. Losing the ability to count supervisory goodwill toward FIRREA's capital requirements was, to say the least, "a very negative development" for Northeast. Walters, Trial Tr. 276; FF ¶ 208. Without the ability to count its supervisory goodwill or FSLIC preferred stock, Northeast went instantly from squarely in capital compliance to having a negative tangible capital ratio. FF ¶¶ 200, 203, 206­207. Under such circumstances, Northeast "could not have remained in business." Walters, Trial Tr. 276; FF ¶ 208. As one regulator put it, "Northeast ... had the proverbial rug pulled out from under them by FIRREA in that the cumulative preferred stock was ruled negligible and so was the Goodwill they had contracted for with FHLB Bank Board." PX 1196 (Mem. from F. Peckham to R. Gridley, Nov. 27, 1989) at WOT144 0010; FF ¶ 198.

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3. In 1989 and 1990, Northeast shrank to mitigate the loss of its supervisory goodwill. As the Federal Circuit, judges of this Court, the regulators, and the government's expert Professor Fischel have recognized repeatedly, "there are two obvious alternatives for any institution seeking to raise its capital ratios. First, it can raise additional capital so that the ratio of capital to assets is likewise raised. In the alternative, an institution can maintain its existing capital base while disposing of assets, which raises the capital ratio by `shrinking' the firm's asset base." CommFed, 59 Fed. Cl. at 343; FF ¶ 46; California Fed. Bank, FSB v. United States ("CalFed"), 245 F.3d 1342, 1350 (Fed. Cir. 2001); Old Stone Corp. v. United States, 450 F.3d 1360, 1365 & n.2 (Fed. Cir. 2006). Here, as discussed in greater detail below, the evidence establishes conclusively that Northeast's experienced and capable management team attempted to raise capital to mitigate the effects of the government's breach. But such capital was not available because of the uncertainty resulting from the regulatory environment. Thus, Northeast's management turned to the only other alternative available to them: they dramatically shrank Northeast's asset base to meet the regulatory capital requirements. Under the circumstances, this strategy was eminently reasonable since inaction would have resulted in the seizure of the thrift. Northeast shrank its asset base almost exclusively by selling wholesale assets and using the proceeds to pay down wholesale liabilities.1 FF ¶¶ 217­221, 297, 332­333. The contemporaneous documents and testimony uniformly establish that the only reason that

The government also breached the supervisory contracts by excluding Northeast's $60 million in cumulative FSLIC preferred stock for regulatory capital purposes. Northeast fully mitigated this aspect of the government's breach by converting the FSLIC preferred to common stock. Northeast does not seek damages for the loss of the FSLIC preferred. FF ¶¶ 197, 200, 209­210, 212­217. 22

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Northeast reduced its assets was to stay in capital compliance. FF ¶¶ 134­136, 138, 149­151, 155, 161, 164­166, 170­176, 180­185, 191­192, 297. In fact, Northeast anticipated the consequences of FIRREA from the moment it was proposed by President Bush. FF ¶¶ 128­135, 137­140, 146, 150­151, 161, 163­166, 180, 192. As Mr. Walters explained to the regulators, "[f]ollowing the introduction of FIRREA by the administration and during the ensuing debate and amendment in Congress, Northeast made a continual analysis of its financial condition as the legislation approached final form. Northeast determined even as the legislation was still pending, that in addition to its traditional thrift retail strategy discussed above, it would have to shrink its wholesale assets and liabilities to assist it in meeting the evolving capital requirements." PX 1209 (Letter from Walters to Weichman, Jan. 23, 1990) at FNE011 2928. FF ¶ 192. Thus, as of June 30, 1989, shortly before FIRREA was enacted, Northeast had already shrunk to $7.5 billion in total assets; by September 30, 1989, it had shrunk to $6.3 billion in total assets. FF ¶¶ 183, 218. The shrinkage continued until Northeast's asset base reached about $4.9 billion in total assets at the end of March 1990, at which time Northeast finally returned to capital compliance. FF ¶¶ 233­234, 297. Consistent with the strategy adopted in December 1988 to hold the size of its asset base constant provided it complied with applicable capital requirements (while maintaining a capital cushion of about 50 basis points), Northeast would not have shrunk further than to $6.9 billion in total assets and $6.7 billion in tangible assets had it been able to count all of its supervisory goodwill toward FIRREA's capital requirements.2 FF ¶¶ 298­307; PX 2017 (Actual and But-For

Northeast's total asset balance equals its tangible assets plus its intangible assets, namely, about $200 million in unamortized supervisory goodwill at the time of the breach. Absent the breach, Northeast's total asset balance would have declined slightly over time as the supervisory goodwill was amortized, but the tangible asset balance would have remained constant at $6.7 billion. PX 2017 (Actual and But-For Bank Tangible Assets) at 2­3. Because lost profits 23

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Bank Tangible Assets) at 2­3. At $6.7 billion in tangible assets, Northeast would not only have continuously complied with FIRREA's capital requirements, but it also would have continuously had a robust capital cushion. FF ¶¶ 300­302, 306. 4. There is no evidence that Northeast would have shrunk further than $6.7 billion in tangible assets absent the breach. There is simply no evidence that Northeast would have shrunk further than $6.7 billion in tangible assets absent the breach. First, shrinking below $6.7 billion in tangible assets would have made no economic sense. Because the assets that Northeast divested as a result of the breach were earning and would have continued to earn consistently positive net interest spreads while requiring minimal G&A, shrinking further than necessary to remain in capital compliance would have been tantamount to throwing money down the drain. FF ¶¶ 49, 307, 345­346. As long as Northeast would stay in capital compliance, it wanted to leverage its capital as much as possible to maximize the return on its assets. FF ¶¶ 68­69, 101­102. In fact, at $6.7 billion in tangible assets, Northeast would have consistently had a larger capital cushion than Northeast actually had--that is, $6.7 billion in tangible assets is a conservative estimate of the balance that Northeast would have maintained but for the breach because it would leave Northeast underleveraged as compared to how leveraged Northeast actually was after the breach. FF ¶ 306. Second, the government has pointed to several documents from 1989--specifically, the May 1989 draft revised business plan, Northeast's July 1989 response to the June 1989 FHLBB Report of Examination, and the July Revised Business Plan--in an attempt to show that Northeast would have shrunk beyond $6.7 billion in tangible assets even absent the breach. But none of those documents supports the government's contention. All of those documents were are calculated on foregone tangible assets, for convenience we focus on the balance of tangible assets that Northeast would have had but for the breach rather than on the balance of total assets. 24

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prepared at a time when FIRREA, and especially the loss of supervisory goodwill, were at the forefront of Northeast's mind. See, e.g., FF ¶¶ 146, 148, 163­166, 170, 179­180. Moreover, the calculations reflected in those documents reveal that any shrinkage contemplated therein was driven by the loss of supervisory goodwill and potential alternative capital requirements that would not have applied even absent the breach because FIRREA's capital requirements superseded them. The May 1989 draft revised business plan is simply not an authoritative, reliable statement of Northeast's policy. FF ¶¶ 141­145. In any event, the projections presented in this draft plan confirm that the loss of supervisory goodwill would demand that Northeast shrink its balance sheet. The May 1989 draft revised business plan presents analyses of Northeast's capital position in light of the versions of FIRREA then pending before Congress. Except for the "total capital" ratio, all of the modeled FIRREA capital ratios presented in the draft plan excluded some or all of the supervisory goodwill, cumulative preferred stock, or both; as a result, all of these capital ratios were sufficiently low that the reduction in assets was necessary to comply with FIRREA's capital requirements. Therefore, the May 1989 draft revised business plan shows that the cause of the contemplated shrinkage was the loss of supervisory goodwill and FSLIC preferred under FIRREA, that is, the breach. FF ¶¶ 149­151. The May 1989 draft revised business plan also includes projected capital calculations according to a proposed FHLBB risk-based requirement and the OCC's risk-based requirement. These hypothetical risk-based calculations are not indicative of what Northeast would have done absent the breach. FIRREA's risk-based capital requirement would have superseded these alternative risk-based requirements even absent the breach. Moreover, both of these alternative requirements contained provisions that were quite different from FIRREA's risk-based capital

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requirement, which was ultimately enacted. Once it became clear that FIRREA would be enacted, Northeast had no reason to take action to comply with these alternative proposals. And a balance of $6.7 billion in tangible assets fully accounts for any shrinkage that Northeast might even arguably have undertaken to comply with these proposals before it was clear that FIRREA would supersede them. Significantly, none of the government's experts challenged Dr. Baxter's calculation establishing that Northeast would, in the no-breach world, easily have satisfied FIRREA's capital requirements, including the risk-based capital requirement, at $6.7 billion in tangible assets. FF ¶¶ 39, 152­154, 300­303, 307. The shrinkage contemplated in the July 1989 exam response is driven by exclusion of supervisory goodwill from the tangible capital ratio and the proposed FHLBB risk-based capital requirement. The exclusion of supervisory goodwill from capital is, of course, the very breach at issue here, and so, to that extent, the contemplated shrinkage is breach-induced. And the proposed FHLBB risk-based capital requirement, although not a breach, does not afford a useful basis for understanding what Northeast would have done absent the breach for the same reasons it did not in the May 1989 draft revised business plan. FF ¶¶ 171­177. Finally, the shrinkage contemplated in the July 1989 Revised Business Plan is almost identical to the shrinkage contemplated in the July 1989 exam response and it is driven by the same thing: the exclusion of supervisory goodwill from the tangible capital ratio, which, again, constitutes a breach. FF ¶¶ 181­185. In the final analysis, the government's argument that factors other than the breach caused Northeast's massive shrinkage simply cannot withstand an examination of the contemporaneous documents and evidence, including but not limited to Northeast's securities filings, its business and capital plans, and regulatory documents, all of which confirm what common sense dictates:

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the loss of about $200 million in regulatory capital forced Northeast to drastically reduce its size. See, e.g., PX 173 (Capitol Plan, Jan. 8, 1990) at 1-6; PX (Northeast 10-Q, Sept. 30, 1989) 46 at 7; PX 9 (Northeast 1990 Annual Report) at 3; PX 20 (Northeast 1990 10-K) at 38. 5. In 1991, Northeast had to shrink again to mitigate the breach. In anticipation of the next phase-out of supervisory goodwill and the heightened capital requirements under FDICIA, Northeast shrank its asset base again over calendar year 1991. As with the shrinkage in 1989 and early 1990, the documents and testimony uniformly establish that the shrinkage in 1991 was undertaken solely because of Northeast's capital problems. See, e.g., PX 10 (Northeast 1991 Annual Report) at 6­7; PX 195 (OTS Interim Report of Examination, Oct. 2, 1991) at 14; FF ¶¶ 236­253. Furthermore, if Northeast had been able to maintain a balance of $6.7 billion in tangible assets, Northeast would not have had to shrink at all to comply with the heightened capital requirements and have a healthy capital cushion, even in the face of the continuing phase-out of supervisory goodwill. FF ¶¶ 299­303. Therefore, but for the breach, Northeast would have continued to maintain a balance of $6.7 billion in tangible assets through December 1991. 6. In 1994, Northeast shrank for reasons unrelated to the breach. Northeast shrank its asset base one final time when it sold off $600 million in California loans in 1994. FF ¶¶ 287­288. Northeast would have sold these loans even absent the breach. Consequently, but for the breach, Northeast would have maintained a balance of $6.7 billion in tangible assets from when FIRREA was enacted until the sale of the California assets (which was not driven by the breach), and then Northeast would have reduced its balance by the same amount that the actual bank's tangible assets decreased as a result of the California sale. FF ¶ 299. No other reductions would have been necessary absent the breach to comply with FIRREA's and 27

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FDIC