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

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

STERLING SAVINGS ASSOCIATION, a state-chartered savings association, STERLING FINANCIAL CORPORATION, a Washington Corporation, Plaintiffs, vs.

Court No. 95-829-C (Judge Wheeler)

UNITED STATES OF AMERICA, Defendant.

STERLING'S POST-TRIAL MEMORANDUM OF CONTENTIONS OF FACT AND LAW

WITHERSPOON, KELLEY, DAVENPORT & TOOLE, P.S. 1100 US BANK BUILDING 422 W. RIVERSIDE SPOKANE, WA 99201 Tele: (509) 624-5265 WILLIAM D. SYMMES LESLIE R. WEATHERHEAD WILLIAM M. SYMMES September 21, 2007

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TABLE OF CONTENTS

I. INTRODUCTION AND SUMMARY OF ARGUMENT ........................................................................1 II. ISSUES PRESENTED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 III. PROPOSED FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 A. STERLING HAS ALWAYS EMPLOYED A GROWTH STRATEGY AND IN IMPLEMENTING THAT STRATEGY HAS GROWN FROM A TWO MILLION DOLLAR INSTITUTION TO AN INSTITUTION WITH ASSETS IN EXCESS OF TEN BILLION DOLLARS AS OF 2007 . . . . . 5 1. 2. Sterling Constantly Increases Assets, Profits And Capital . . . . . . . . . . . . . . . . . 5 Sterling's Corporate Management And Geographic Location Have Contributed To Its Continued And Near Constant Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Sterling's Pre-FIRREA Relationship With Government Regulators Was Uniformly Positive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

3.

B.

Consistent With Its Plans, And In Exchange For Significant Promises, Sterling Accepted The Government's Invitation To Contract To Acquire Three Failed Thrifts . . . . . . . 11 1. Sterling Acquired Lewis Federal Savings & Loan In 1985 . . . . . . . . . . . . . . . 11 a. The Government Approached Sterling And Asked It To Investigate An Acquisition Of Lewis Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreement To The Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . 12

b.

2.

Sterling Acquired Tri-Cities Savings & Loan In 1988 . . . . . . . . . . . . . . . . . . . 13 a. Following The Acquisition Of Lewis Federal, The Government Approached Sterling Regarding Tri-Cities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 The Tri-Cities Acquisition Was Directly Linked To Sterling's Acquisition Of Central Evergreen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreeing To The Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

b.

c.

d.

Following The Acquisition Of Tri-Cities, Sterling Had Sufficient Capital To

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Acquire Central Evergreen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 C. FIRREA Was Implemented And The Government Enforced Its Regulations On Sterling In Breach Of The Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 1. 2. The Enactment of FIRREA And Adoption Of Regulations Led To Breach . . 16 Sterling Tried in Vain To Obtain Relief From The Government's New Restrictions Under FIRREA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 In Accordance With Its Business Plan, Sterling Attempted To Raise Capital In 1989 That Would Have Brought It Into Compliance With FIRREA's Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Sterling Attempted To Mitigate The Harm Caused By Its FIRREA Non-Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 a. b. Sterling Shrank Its Assets To Meet Required Capital Ratios . . . . . . . . . 22 Sterling Obtained A TRO And An Injunction . . . . . . . . . . . . . . . . . . . . . 23 i. Despite The Injunction, The Government Continued To Regulate Sterling As A Capital-Deficient Thrift . . . . . . . . . . . . . . . . . . . . . . 25 The Court Issued A Preliminary Injunction Continuing The Terms Of The TRO, But The Government Persisted In Unlawful Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

3.

4.

ii.

c. D.

Sterling Ultimately Raised Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

STERLING SUFFERED HARM AS A RESULT OF THE GOVERNMENT'S ACTIONS . . . . . 29 1. Sterling Lost Valuable Assets And Was Precluded From Seeking Others . . . . 29 a. b. c. Sterling Lost Valuable Business Customers . . . . . . . . . . . . . . . . . . . . . . 29 Experienced Employees Left Sterling Following The Breach . . . . . . . . 31 The Government's Regulations Precluded Sterling From Pursuing Business Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

2.

Two Profitable Subsidiaries Faced Severely Restricted Business Activities . . 32 a. b. Intervest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Action Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

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3.

Following The Lifting Of The Restrictions And Sterling's Return To Capital Compliance, Sterling Began To Grow Again But Was Never Able To Attain The Growth It Would Have Had If It Not Been Restricted After FIRREA . . . . . . . 34 a. Sterling Is A Smaller Bank Than It Would Have Been But-For The Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Sterling Could Have Used The Additional Capital It Lost As A Result Of The Breach To Support Additional Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Sterling's Profits Continued To Grow Even As It Acquired More Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

b.

c.

E.

STERLING SUFFERED DAMAGES AS A RESULT OF THE GOVERNMENT'S BREACH OF CONTRACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1. 2. Lost Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 QSGW And Contractual Goodwill Are Different Things . . . . . . . . . . . . . . . . 57

F.

Wounded Bank Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 1. 2. 3. 4. 5. Sterling Incurred Additional Litigation And Accounting Costs . . . . . . . . . . . . 60 Sterling Incurred Losses On The CJ-4 Loan Losses . . . . . . . . . . . . . . . . . . . . . 61 Sterling Incurred Additional Regulatory And Supervisory Costs Incurred . . . 61 Sterling Incurred Costs From The Withdrawn 1989 Offering . . . . . . . . . . . . . 62 Sterling Incurred Damages As A Result of The Increased Purchase Price Of Great American Bank Branches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Sterling Incurred Damages As A Result Of Not Being Able To Bid On Resolution Trust Corporation Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

6.

G.

COST OF CAPITAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 1. 2. 3. Dr. Christopher James Is A Qualified Expert In Thrift Economics And Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Supervisory Capital Was Valuable Prior To FIRREA . . . . . . . . . . . . . . . . . . . 65 Similarities And Differences Between Supervisory Capital And Tangible Equity Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

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4. 5. 6. H.

Capital Raised By Sterling In The Assumed Mitigation Was Costly . . . . . . . . 66 Components Of Damages Arising From Assumed Replacement . . . . . . . . . . . 67 Sterling Incurred Costs Related To Mitigation . . . . . . . . . . . . . . . . . . . . . . . . . 68

Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

IV. ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 A. STERLING IS A "LOST VOLUME SELLER" . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 1. 2. 3. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Legal Standards For A Lost Volume Seller . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Sterling Has Demonstrated That It Would Have Done The Business It Did And More . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

B.

A LOST PROFITS MEASURE IS THE APPROPRIATE MEASURE TO CALCULATE THE DAMAGES OWED STERLING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 1. Sterling Has Established Causation Of Lost Profits Damages . . . . . . . . . . . . . 76 a. b. c. Standard To Establish Causation Of Lost Profits . . . . . . . . . . . . . . . . . . 76 Sterling's Lost Profits Were Caused By The Breach . . . . . . . . . . . . . . . . 76 The Damages Incurred By Sterling Caused By The Government's Breach Were Foreseeable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

2.

The Measure Of Sterling's Damages Is Reasonably Certain . . . . . . . . . . . . . . 78 a. b. Standard To Establish Reasonable Certainty . . . . . . . . . . . . . . . . . . . . . . 78 Sterling's Lost Profits Calculation Is Reasonably Certain . . . . . . . . . . . . 79

C. D.

THE ACTUAL PERFORMANCE OF STERLING IS THE BEST EVIDENCE OF ITS DAMAGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 STERLING MITIGATED, BUT DID NOT CURE, THE HARM CAUSED BY THE BREACH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Professor Horvitz's Opinion That Sterling Would Be Permitted To Count Both The QSGW From Central Evergreen And The Contractual Goodwill From Lewis Federal And Tri-Cities Is Correct As A Matter Of Law And Undisputed Fact . . . . . . . . . . . 84

E.

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1.

Sterling's Right To Count The Supervisory Goodwill From Central Evergreen Is Also Contractual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 Messrs. Bankhead's And Hargett's Opinions Improperly Categorize QSGW And Contractual Goodwill As Being Identical . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 a. Contractual Goodwill May Be Treated As Tangible Capital Under FIRREA; Non-contractual Goodwill May Not . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 Other Important Distinctions Invalidate Messrs. Bankhead's And Hargett's Opinions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

2.

b.

F.

Sterling Suffered Wounded Bank Damages As A Result Of The Government's Breach Of Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 If The Court Agrees That Sterling Replaced The Lost Capital, Damages Should Be Awarded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

G.

V. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

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TABLE OF AUTHORITIES FEDERAL CASES Advent Systems, Limited v. Unisys Corporation, 925 F.2d 670 (3d Cir. 1991) . . . . . . . . . . . . . 83 American Federal Bank, F.S.B. v. United States, 68 Fed. Cl. 346 (2005) . . . . . . . . . . . . . . . . . 75 Anchor Sav. Bank, F.S.B. v. United States, 59 Fed. Cl. 126 (2003) . . . . . . . . . . . . . . . . . . . . . . 77 Bank United of Texas, FSB v. United States, 50 Fed. Cl. 645 n. 11 (2001), aff'd in part, rev'd in part, 80 Fed. Appx. 663 (2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74, 83 Bluebonnet Sav. Bank, F.S.B. v. U.S., 266 F.3d 1348 (Fed. Cir. 2001) . . . . . . . . . . . . . . . . . . . . 79 California Federal Bank v. United States, 395 F.3d 1263 (Fed. Cir. 2005) . . . . . . . . . . 75, 76, 79 California Federal Bank, F.S.B. v. United States, 245 F.3d 1342 (Fed. Cir. 2001) . . . . . . . 75, 90 Citizens Fed. Bank v. United States, 474 F.3d 1314 (Fed. Cir. 2007) . . . . . . . . . . . . . . . . . . . . 76 Columbia First Bank, FSB v. United States, 60 Fed. Cl. 97 (2004) . . . . . . . . . . . . . . . . . . . 82, 83 Commercial Federal Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004) . . . . . . . . . . . . . . . 75 Dura Pharmaceuticals, Inc. v. Broudo, U.S., 161 L. Ed. 2d 577, 125 S.Ct. 1627 (2005) . . . . . . 95 Elec. & Missile Facilities, Inc. v. United States, 189 Ct. Cl. 237, 416 F.2d 1345 (Ct. Cl.1969) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002) . . . . . . . . . . . . . . . . . . 76 Fifth Third Bank v. United States, 71 Fed. Cl. 56 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 First Federal Savings and Loan Association of Rochester v. United States, No. 95-517C, __ Fed. Cl. __, 2007 WL 1160294, slip op. at 9 (April 13, 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . 76-78 Glendale Federal Bank, FSB v. United States, 239 F.2d 1374 (Fed. Cir. 2001) . . . . . . . 3, 79, 90 Globe Savings Bank, F.S.B. v. U.S., 65 Fed. Cl. 330 (Ct. Fed. Cl. 2005) . . . . . . . . . . . . . . 93, 95 Home Savings Bank of America v. United States, 399 F.3d 1341 (Fed. Cir 2005) . . . . . . . . 93, 95 LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363 (Fed. Cir. 2003) . . . . . . . 75, 93, 95

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LaSalle Talman Bank, F.S.B. v. United States, 45 Fed. Cl. 64 (1999), aff'd in part, vacated in part and remanded, 317 F.3d 1363 (Fed. Cir. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79, 95 Long Island Savings Bank, FSB v. United States, 60 Fed. Cl. 80 (2004) . . . . . . . . . . . . . . . 83, 96 Precision Pine & Timber, Inc. v. United States, 72 Fed. Cl. 460, 490 (2006) . . . . . . . . . . . 71, 72 R.E. Davis Chemical Corp. v. Diasonics, Inc., 924 F.2d 709 (7th Cir. 1991) . . . . . . . . . . . . . . 74 Ragen Corp. v. Kearney & Trecker Corp., 912 F.2d 619 (3d Cir. 1990) . . . . . . . . . . . . . . . . . . 74 Robert Burton Associates, Inc. v. Preston Trucking Co., 149 F.3d 218 (3d Cir. 1998) . . . . . . . 74 Southern California Federal Sav. & Loan Ass'n v. U.S., 422 F.3d 1319 (Fed. Cir. 2005) . . . . 90 Specialty Assembling & Packing Co. v. United States, 174 Ct. Cl. 153, 355 F.2d 554 (1966) . . 79 Sterling Savings Assoc. v. USA, 53 Fed. Cl. 599 (2002), amended on other grounds, 72 Fed. Cl. 404 (2003), vacated in part on rehearing by 72 Fed. Cl. 404 (2006) . . . . . . . . . 12, 14, 15, 58, 85 Sterling Savings Assoc., v. United States, 72 Fed. Cl. 404 (2006) . . . . . . . . . . . . . . . . . . . . 58, 85 Winstar, 518 U.S. 839, 116 S. Ct. 2432 (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 FEDERAL STATUTES Financial Institutions Reform, Recovery and Enforcement Act of 1989 . . . . . . . . . . . ad passim OTHER AUTHORITIES FUNDAMENTALS OF FINANCIAL MANAGEMENT 387 (10th ed. 1998) . . . . . . . . . . . . . . . . . . . . . 95 Office of Thrift Supervision, Capital Adequacy: Guidance on the Status of Capital Accounting Forbearances and Capital Instruments Held by a Deposit Insurance Fund, Thrift Bulletin No. 38-2, 1990 WL 309397 (Jan. 9, 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 RESTATEMENT (SECOND) OF CONTRACTS § 347 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72, 73 THE LAW OF CONTRACTS, § 14.16 (4th ed. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 UNIFORM COMMERCIAL CODE § 7-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 WILLISTON ON CONTRACTS § 64:2 (4th ed. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

STERLING SAVINGS ASSOCIATION, a state-chartered savings association, STERLING FINANCIAL CORPORATION, a Washington Corporation, Plaintiffs, vs. UNITED STATES OF AMERICA, Defendant.

Court No. 95-829-C (Judge Wheeler)

STERLING'S POST-TRIAL MEMORANDUM OF CONTENTIONS OF FACT AND LAW

I. INTRODUCTION AND SUMMARY OF ARGUMENT Via the enactment, implementation and enforcement of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the United States breached two contracts with Sterling Savings Association ("Sterling") that were made at the Government's request to help the Government remedy a nationwide thrift crisis. The issue before the Court is the appropriate damages due to Sterling resulting from that breach. The evidence and expert testimony presented at trial demonstrate that the lost profits measure of damages most appropriately compensates Sterling for the losses it suffered because of the breach, and Sterling, therefore, requests entry of an award of $63.327 million representing lost profits and wounded bank damages. Sterling has always been a profitable business, run by well-respected and experienced bankers. It has grown from $2.1 million in assets in 1983 to over $10 billion today. Throughout 2

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its existence, it has been managed by the same team of executive officers. When the savings and loan crisis threatened the thrift industry, the Government sought out healthy thrifts like Sterling and induced them to acquire failing thrifts. Sterling, a highly-rated institution with strong management, was approached several times by the Government, and eventually acquired three failing thrifts. In exchange for taking the failing thrifts off of the Government's hands, Sterling was given cash assistance, credits to its regulatory net worth and forbearances from adverse action by the Government for specified terms. The consideration paid to Sterling was a mere fraction of what it would have otherwise cost the Government to liquidate these three thrifts. Months after the last transaction closed, however, the newly-enacted FIRREA legislation and regulations issued under the Act rendered the contracts, in the Government's eyes, void. The Government turned on the very thrifts it had looked to in a crisis for help, including Sterling, and decided those thrifts were the problem. The Government foreclosed nearly all avenues of profitability for Sterling, regulating it almost out of existence and, finally, planned to shut it down because of a perceived negative capital ratio that resulted from Sterling's acquisitions of the failing thrifts and from the Government's refusal to recognize the contractual capital credits in favor of Sterling. A temporary restraining order kept Sterling open, but the Government persevered in threatening Sterling with more sanctions should it venture outside of the limited activity allowed by the Government and attempt to regain the progressive growth that it had enjoyed prior to the breach. Ultimately, Sterling raised capital and got a reprieve from the regulatory death sentence against it and has since remained a profitable institution, despite the breach. But it has never cured the damage done by the Government's broken promises.

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During the three-week trial, the Government proffered two theories: (1) that Sterling fully mitigated the breach two years after it occurred and should only be compensated for its transaction costs; and, alternatively (2) that if Sterling did not fully mitigate, it is at fault for failing to do so and should recover nothing. Stated differently, the Government wants this Court to permit it to use the fact that Sterling has prospered in spite of the Government's breach to elide, via accounting, the harm its breach wrought. This should be rejected for two reasons. The United States Government's promise had value which would have been cumulative to the success Sterling enjoyed and black letter contract law requires a party who breaches a contract to pay the costs occasioned by his or her breach: Much of law and legal liability turns on fault, on the notion of wrong-doing, and of providing retribution for and discouraging such conduct. Contract law, and the consequences of breach of contract, do not. When parties enter into a contract, and promise each other that they will perform in accordance with the terms of their agreement, they retain a choice: when the time comes they can perform, and accept whatever benefits and losses the contract gives them, or they can refuse to perform and pay the consequences. Glendale Federal Bank, FSB v. United States, 239 F.2d 1374, 1379-80 (Fed. Cir. 2001) (emphasis added). The Government is not excepted from this rule. Whether FIRREA was justified as sound legislation is immaterial. The Government's breach may well have been an "efficient breach", but the Government must pay damages for the efficiency it gained. The Government breached a valid and binding contract and it is obliged to substitute its performance with money damages.

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II. ISSUES PRESENTED 1. 2. What is the amount of damages to which Sterling is entitled for breach of contract? Whether the lost profits measure of damages reflect the actual harm done to Sterling

by the Government's breach? 3. In the event the Court determines that the lost profits analysis should not be applied,

what amount for the cost of replacement capital is the appropriate award of damages?

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III. PROPOSED FINDINGS OF FACT A. STERLING HAS ALWAYS EMPLOYED A GROWTH STRATEGY AND IN IMPLEMENTING THAT STRATEGY HAS GROWN FROM A TWO MILLION DOLLAR INSTITUTION TO AN INSTITUTION WITH ASSETS IN EXCESS OF TEN BILLION DOLLARS AS OF 2007. 1. 1. Sterling Constantly Increases Assets, Profits And Capital. Sterling opened its doors on April 4, 1983, with $2.1 million in capital. (Gilkey, Tr.

68, lines 19-25; Gilkey, Tr. 70, lines 13-16; see also Joint Stipulation of Facts ("JSF") #1) 2. For every year of its operations, Sterling has been profitable. (Gilkey, Tr. 153, lines

3-19; Horvitz, Tr. 2036, lines 7-18, 2528, line 20 through 2529, line 5). In its entire history, Sterling has only shown a loss in one single quarter; this occurred in 1996, because of an extraordinary SAIF premium being imposed upon Sterling by the Government. (Byrne, Tr. 684, line 7 through 687, line 2) 3. From the very beginning, Sterling intended to grow quickly and has been successful

in this strategy. (Gilkey, Tr. 78, line 18 through 79 line 9; Gilkey, Tr. 82, line 3 through 83, line 13) 4. Sterling's strategy has been to grow the company by internal or organic growth at an

equal proportion to the growth by acquisition and to use leverage risk for the company's benefit. (Gilkey, Tr. 83, lines 3-19). 5. Sterling's growth plan recognizes that rural farm communities lack loan opportunities,

and accordingly Sterling took deposits from rural communities and used those funds to make loans in metropolitan market areas through its mortgage company operations, specifically, in Spokane, Boise, Portland, and Seattle. (Gilkey, Tr. 76 line 15 through 77 line 14) 6. Sterling has always sought ways to add capital through acquisitions or public

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offerings. (Gilkey, Tr. 147, lines 16-20) 7. Sterling has always grown through acquisitions, and has, over time, acquired

approximately 20 banks or thrifts. (Gilkey, Tr. 83, lines 11-13; P-503; Gilkey, Tr. 398, line 25 through 399, line 11) 8. Sterling's business strategy for growth had always consistently included calculated

leverage risk. (Gilkey, Tr. 77, line 15 through 78 line 7). 9. Sterling's planned operation as a highly-leveraged company has historically placed it

in the lowest 10 percent for capital ratio among its peers. (Gilkey, Tr. 148, lines 5-15; Hamm, Tr. 3975, lines 20-22; Hamm, Tr. 3976, lines 5-6) 10. As a consequence of Sterling's capital ratios, its regulators have consistently taken the

position that Sterling needs additional capital. (Gilkey, Tr. 147, line 3 through 148, line 15; DX263 (SG0053028)) 11. During Sterling's history, it never encountered difficulty adding assets except for

immediately after the implementation of FIRREA. (Gilkey, Tr. 156, lines 7-12). 12. After the Lewis & Clark acquisition, Sterling had roughly $4 million in capital;

within a year, after leveraging that $4 million, Sterling grew to approximately $100 million. (Gilkey, Tr. 82, line 14 through 83, line 2) 13. Even facing competitive markets, Sterling grew from an initial capital input of

approximately $2 million to an asset size of over $10 billion with 3,000 employees spread over nine states as of 2007. (Barnett, Tr. 1180, lines 7-17) 14. As of 2007, Sterling is well over $10 billion in size, and has branches in Washington,

Idaho, Montana, Oregon, California, Nevada, Colorado, Utah and Arizona. (Gilkey, Tr. 153,

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line 20 through 154, line 4; P-501) 15. Sterling currently intends to continue to make more acquisitions, and requires more

capital to do so. (Gilkey, Tr. 442, lines 1-12) 16. But for the breach, Sterling would have been between a $25 billion and $50 billion

institution. (Gilkey, Tr. 405, lines 1-21) 17. Sterling still intends to grow, and eventually become an institution with a value in

excess of $50 billion. (Gilkey, Tr. 440, line 20 through 441, line 14) 18. Since 1991, Sterling has raised capital every year but two. (Gilkey, Tr. 290, lines 1-7

and 13-19; P-501; P-505; Gilkey, Tr. 418, line 24 through 419, line 2) 2. Sterling's Corporate Management And Geographic Location Have Contributed To Its Continued And Near Constant Growth. Sterling was formed by managers with commercial banking backgrounds, which

19.

gave the Government great confidence in its ability to succeed. (Faulstich, Tr. 344, line 7 through 345, line 25; Horvitz, Tr. 2042, line 10 through 2043, line 8). 20. Since opening Sterling Savings Bank, its management has formed a number of

related companies contributing to Sterling's market success: (1) In 1992 a holding company called Sterling Financial Corporation ("SFC") was formed. (Gilkey, Tr. 73, line 24 through 74, line 4; (Gilkey, Tr. 74, lines 5-11); (2) Action Mortgage Company, a Sterling subsidiary of Sterling in the business of residential mortgage construction, headquartered in Spokane, opened in 1988. (Gilkey, Tr. 72, lines 11-25; Gilkey, Tr. 123, line 24 through 124 line 5); (3) Intervest Mortgage Investment, another Sterling subsidiary in the business of commercial mortgages and concentrating both in construction and permanent loans for income-producing property, headquartered in Lake Oswego, Oregon (a suburb of Portland), opened in 1987. (Gilkey, Tr. 72, 8

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lines 13-22; Gilkey, Tr. 124, lines 5-7) 21. In the thrift industry, $5 of equity or capital will translate to approximately $100 of

assets using leverage. (Gilkey, Tr. 78 lines 10-17; Horvitz, Tr. 2022, lines 17-21) 22. The economy in the Pacific Northwest during the early 1990s was positive, with growth in the population, personal income, employment, and agricultural economy. (Gilkey, Tr. 284 lines 3-12; Faulstich, Tr. 343, line 20 through 344 line 6; Conerly, Tr. 885, lines 5-10; P268, p. 9) 23. In addition to its corporate form and organization, Sterling's growth was aided by the

fact that from 1985 through 2000, the Washington, Oregon and Idaho economies were consistently growing, in contrast to other parts of the country and the overall U.S. economy. (Conerly, Tr. 888, line 2 through 891, line 4; Conerly, Tr. 894, line 21 through 899, line 18; Conerly, Tr. 917, line 11 through 919, line 13; Conerly, Tr. 922, line 18 through 926, line 6; Conerly, Tr. 931, line 20 through 934, line 6; Conerly, Tr. 942, line 17 through 944, line 9; Conerly 946, line 19 through 948, line 1; Conerly, Tr. 957, line 24 through 959, line 2; P-514; P-515; P-516; P-517; P-518; P-519A; P-521; P-268, p. 9) 24. A company operating in the Northwest would be in a favorable environment

compared to a comparable company operating in another part of the country. (Conerly, Tr. 959, line 23 through 960, line 13) 25. Sterling's market area enjoyed stronger growth than most states. (Conerly, Tr. 963,

lines 21-25) 26. It is more likely that a financial institution will grow in a growing economy.

(Conerly, Tr. 984, lines 20-23; Conerly, Tr. 986, line 20-987, line 9)

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3.

Sterling's Pre-FIRREA Relationship With Government Regulators Was Uniformly Positive. The Government knew from the very beginning of Sterling's existence that it intended

27.

to grow, and the President of the FHLB of Seattle had confidence in management's ability to grow. (Faulstich, Tr. 340, lines 5-23) 28. From 1983 to 1988 Sterling's examination and supervisory ratings, which provide a snapshot of an institution's safety and soundness regulatory condition, were "exceptionally positive" and reflected good management. (Faulstich, Tr. 352, line 2 through 353, line 15; Horvitz, Tr. 2049, lines 21-23, 2051, lines 12-14; P-45, pp. 6-7; P-541) 29. Prior to the enactment of FIRREA, Sterling's relationship with its regulators was one

of mutual respect. (Gilkey, Tr. 141, lines 1-8.) 30. 1) 31. The President of the FHLB of Seattle never considered Sterling to be a troubled thrift In 1988, the FHLB of Seattle noted that Sterling's management was strong. (P-40, p.

and, indeed, thought of it as an ally because of its good management and willingness to acquire troubled thrifts which aided the FHLBB. (Faulstich, Tr. 320, line 21 through 321, line 15) 32. Mr. James Faulstich never believed Sterling was being mismanaged or run in an

unsafe or unsound manner prior to the enactment of FIRREA. (Faulstich, Tr. 354, line 20 through 355, line 1; see also Faulstich, Tr. 363, lines 5-12) 33. Prior to the enactment of FIRREA and its corresponding regulations, Sterling was in

full capital compliance. (Gilkey, Tr. 183, lines 3-8) 34. Before FIRREA, the Federal Home Loan Bank of Seattle never considered Sterling to

be a troubled thrift. (Faulstich, Tr. 230, lines 21-24) 10

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35.

Before FIRREA, the Federal Home Loan Bank of Seattle considered Sterling to be an

ally in resolving troubled thrift issues. (Faulstich, Tr. 231, lines 3-15) 36. At the time of the Tri-Cities acquisition the Federal Home Loan Bank of Seattle had

"no supervisory concerns with" Sterling. (P-24; p. 8). 37. The Federal Home Loan Bank of Seattle viewed Sterling's business plan after the

Tri-Cities acquisition as "an ambitious one," but consistent with Sterling's prior growth trends. (Faulstich, Tr. 336, lines 13-20; P-24, p. 9). 38. Mr. Faulstich, the principal supervisory agent for the Federal Home Loan Bank of Seattle, had high regard for Sterling's management. This opinion was validated by Mr. Gilkey's high degree of competence and by Sterling's success. (Faulstich, Tr. 344, lines 4-19) 39. As of November 7, 1988 the Federal Home Loan Bank of Seattle considered Sterling

to have "a proven success record in demonstrating it can successfully integrate acquired institutions and/or offices into its operations while maintaining profitability and meeting minimum regulatory capital requirements." (P-45, p. 6) 40. As of November 7, 1988 the Federal Home Loan Bank of Seattle believed that "[p]art

of the reason for continued favorable examination ratings, despite its rapid growth, is due to its careful strategic planning. Sterling has indicated that it also prepares for growth by hiring capable personnel prior to consummation of the mergers to avoid potential operational problems." (P-45, p. 7) 41. As of November 7, 1988 the Federal Home Loan Bank of Seattle wrote of Sterling,

"[s]ince its opening in 1983, Sterling has experienced four examinations and received satisfactory ratings in all areas. The institution continues to be well-managed with positive earnings, good

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asset quality, and acceptable capital level." (P-45, p. 46) 4. 42. Early In Sterling's Existence, Government Regulators Looked To It For Assistance. Before Sterling even opened for business, it was approached by state regulators and

asked to enter negotiations to acquire Lewis & Clark Savings ("Lewis & Clark") located in Clarkston, Washington. (Gilkey, Tr. 75, lines 4-16; Gilkey, Tr. 87, lines 4-13) 43. Sterling agreed and acquired Lewis & Clark on or about June 30, 1983. (Gilkey, Tr.

87 lines 4-22) 44. Sterling's acquisition of Lewis & Clark was consistent with its business plan of taking deposits in rural communities in order to make loans in metropolitan areas. (Gilkey, Tr. 76, lines 12-18) 45. After the Lewis & Clark acquisition, regulators from the state and the Federal Home

Loan Bank asked Sterling's management team to consider other acquisitions and to given them opinions as to the specific problems facing the failing thrifts. (Gilkey, Tr. 88, line 21 through 89, line 15). B. CONSISTENT WITH ITS PLANS, AND IN EXCHANGE FOR SIGNIFICANT PROMISES, STERLING ACCEPTED THE GOVERNMENT'S INVITATION TO CONTRACT TO ACQUIRE THREE FAILED THRIFTS. 1. Sterling Acquired Lewis Federal Savings & Loan In 1985. a. The Government Approached Sterling And Asked It To Investigate An Acquisition Of Lewis Federal.

46.

In early 1984, Ed Hedlund, the branch supervisor for the Federal Home Loan Bank of

Seattle ("FHLB of Seattle"), asked Sterling to look into acquiring the Lewis Federal Savings and Loan Association ("Lewis Federal"), a failing Washington State thrift. (Gilkey, Tr. 90, line 15 through 91, line 17) 12

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47.

Unless Lewis Federal was acquired, the Government would have been obliged to pay

an expected $6.049 million to liquidate the thrift. (P-1, p. 1) 48. By the time Sterling was contacted, the FHLB of Seattle had placed Lewis Federal

into conservatorship and asked for bids. (Gilkey, Tr. 93, line 23 through 24, line 2) 49. Sterling bid on Lewis Federal and was selected to acquire the thrift; this transaction

closed in early 1985. (Gilkey, Tr. 93, line 23 through 94, line 2; P-18; P-19) 50 In November 1985, Sterling acquired Lewis Federal Savings and Loan Association

("Lewis Federal"), a thrift with negative regulatory net worth. 51. When Sterling acquired Lewis Federal, Lewis Federal's liabilities were greater than

the assets and it had a negative net worth. (Gilkey, Tr. 101, line 16 through 102, line 1) b. Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreement To The Acquisition.

52.

In negotiating the acquisition of Lewis Federal, Sterling requested that the

Government grant it certain regulatory forbearances, in order to allow Sterling appropriate time to evaluate and reform problem assets and deal with unanticipated problems. (Gilkey, Tr. 94, 16-23; P-3) 53. The FHLB agreed to grant Sterling a forbearance from adverse action, arising from its

failure to meet net worth requirements, which resulted from Sterling's acquisition of Lewis Federal. (Sterling Savings Assoc. v. USA, 53 Fed. Cl. 599, 610-11 (2002), amended on other grounds, 72 Fed. Cl. 404 (2003), vacated in part on rehearing by 72 Fed. Cl. 404 (2006); Horvitz, Tr. 2024, line 20 through 2026, line 25; P-20, p. 2) 54. This forbearance meant that Sterling could subtract Lewis Federal from its total assets

in determining Sterling's net worth for regulatory purposes or, alternatively, could subtract Lewis 13

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Federal's deficiency capital. (Gilkey, Tr. 99, lines 3-18; Horvitz, Tr. 2099, line 9 through 2101, line 24; P-549) 55. This forbearance was designed to protect Sterling from any damaging consequences

as a result of its acquisition of Lewis Federal, for a period of five years. (Gilkey, Tr. 99, lines 8-18) 56. In addition to the forbearance discussed above, Sterling received $1.75 million in cash

assistance from Federal Savings and Loan Insurance Corporation ("FSLIC"), which the Assistance Agreement stated would be credited to Sterling's net worth account. (Gilkey, Tr. 108, lines 13-23; P-19, p. 6; JSF #3) 57. The acquisition of Lewis Federal provided Sterling with additional capital to leverage,

and fit within Sterling's business plan of gathering rural deposits for metropolitan lending. (Gilkey, Tr. 114, line 19 through 116 line 6) 2. Sterling Acquired Tri-Cities Savings & Loan In 1988. a. Following The Acquisition Of Lewis Federal, The Government Approached Sterling Regarding Tri-Cities.

58.

After Sterling's successful acquisition of Lewis Federal, the managing officer of

Tri-Cities Savings and Loan Association ("Tri-Cities") contacted Sterling and asked if it would be interested in acquiring Tri-Cities. (Gilkey, Tr. 125, lines 16-25) 59. Sterling and Tri-Cities entered into a letter of intent, permitting Sterling to conduct

due diligence and evaluate a proposed private acquisition. (Gilkey, Tr. 125, lines 16-25) 60. After only three hours of conducting due diligence, Sterling opted not to acquire Tri-

Cities where problems were significant; Sterling's decision was confirmed by Federal Regulators who expressed surprise that Sterling would even consider acquiring such a troubled thrift. 14

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(Gilkey, Tr. 126, lines 1-15) b. The Tri-Cities Acquisition Was Directly Linked To Sterling's Acquisition Of Central Evergreen.

61.

Hilton Hewitt, Federal Home Loan Bank of Seattle supervisory agent to Central

Evergreen Savings and Loan Association ("Central Evergreen") called Mr. Gilkey and asked if he wanted to be the "King of Chehalis" by acquiring Central Evergreen. (Gilkey, Tr. 126, line 16 through 127, line 8) 62. Mr. Gilkey declined, on behalf of Sterling, stating that Central Evergreen was too big,

too problematic, and did not have capital. (Gilkey, Tr. 127, lines 1-8) 63. Two days after Sterling declined to acquire Central Evergreen, Mr. Hewitt again

called and informed Sterling that if it acquired Tri-Cities, Sterling would have sufficient capital to acquire Central Evergreen. (Gilkey, Tr. 127, lines 9-17) 64. Sterling conducted due diligence on both Central Evergreen and Tri-Cities and bid on

an assisted acquisition of Tri-Cities, however Sterling was not the original low bidder on TriCities. (Gilkey, Tr. 127, lines 18-22; Gilkey, Tr. 158, line 22 through 159, line 6) 65. Upon learning that it was not the successful bidder on Tri-Cities, Sterling contacted

Mr. Hewitt who told Sterling not to worry about the other bidder and that Sterling would win the bid. (Gilkey, Tr., 127, line 4 to 128, line 1; Gilkey, Tr. 159, lines 12-22) 66. Shortly after Mr. Gilkey's conversation with Mr. Hewitt, Sterling "magically" became

the low bidder on Tri-Cities, and started the process for that acquisition and for acquisition of Central Evergreen. (Gilkey, Tr. 160, lines 3-16) 67. Sterling acquired Tri-Cities on April 8, 1988; and in doing so was able to obtain the capital to acquire Central Evergreen. (P-37; Gilkey, Tr. 733, line 12 through 734, line 8; Barnett, 15

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Tr. 1207, lines 19-22; Horvitz, Tr. 2049, lines 3-23; see also P-391; JSF #4) 68. Shortly after the Tri-Cities acquisition, Sterling's MACRO ratings were at "2", the

highest level typically awarded in practice. (Gilkey, Tr. 143, lines 10-18; Faulstich, Tr. 352, line 8 through 353, line 10; Horvitz, Tr. 2050, lines 8-20; P-40; P-268, p. 6) c. Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreeing To The Acquisition.

69.

As with Lewis Federal, Sterling contracted for forbearances in connection with the

Tri-Cities acquisition. (Sterling Savings, 53 Fed. Cl. at 610-11.; Gilkey, Tr. 129, lines 2-6; Horvitz, Tr. 2099, linen 9 through 2101, line 24; P-549) 70. Sterling's need for a forbearance in the Tri-Cities acquisition was even stronger than in

the Lewis Federal transaction because Tri-Cities faced significant problems, including defalcation by the executive officer and the directorship and numerous problem assets which would take time for Sterling to resolve. (Gilkey, Tr. 132, line 22 through 133, line 15) 71. As part of the Tri-Cities acquisition, the Federal Home Loan Bank Board ("FHLBB")

agreed that the initial cash contribution made pursuant to the Assistance Agreement would be a credit to Sterling's regulatory capital. (Sterling Savings, 53 Fed. Cl. at 610-11; P-28, ¶ 4) 72. The FHLBB also agreed to forbear from regulatory action for any failure by Sterling

to meet capital requirements, for a five year period following the acquisition. (Sterling Savings, 53 Fed. Cl. at 610-11; P-28, ¶ 1) 73. Sterling received $11,730,128 in cash assistance from FSLIC. (Sterling Savings, 53

Fed. Cl. at 610-11; P-38, p. 17; JSF #5) 74. Sterling viewed the Tri-Cities acquisition as beneficial because of the capital it

brought to Sterling. (Gilkey, Tr. 140, lines 6-12) 16

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d.

Following The Acquisition Of Tri-Cities, Sterling Had Sufficient Capital To Acquire Central Evergreen.

75.

The Office of Thrift Supervision ("OTS") and Sterling understood that Sterling lacked

sufficient capital to acquire Central Evergreen without the Government's cash assistance from the Tri-Cities transaction. (Friend, Tr. 2285, line 13 through 2286, line 12) 76. Recognizing the realities regarding Sterling's capital, Ed Hedlund, the OTS regulator

for Central Evergreen, stated that Sterling's acquisition of Central Evergreen transaction was "subject to Sterling getting Tri-Cities." (P-375) 77. On July 1, 1988, Mr. Gilkey met with a representative of the OTS, and George

Godding, president of Central Evergreen, to discuss Sterling's potential acquisition of Central Evergreen. (P-391) 78. The FHLBB obtained internal confirmation that Sterling could leverage FSLIC

assistance, and at that meeting Sterling was told that the capital would be counted in such a way as to permit Sterling to acquire Central Evergreen. (Gilkey, Tr. 733, line 12 through 735, line 11; Gilkey, Tr. 739, line 15 through 740, line 4; P-390, P-391, P-392, P-393, P-399) C. FIRREA WAS IMPLEMENTED AND THE GOVERNMENT ENFORCED ITS REGULATIONS ON STERLING IN BREACH OF THE CONTRACTS. 1. 79. #9) 80. FIRREA changed the computation of the capital ratio required to support assets. The Enactment of FIRREA And Adoption Of Regulations Led To Breach. FIRREA was enacted in August 1989, and became effective in November 1989. (JSF

(Byrne, Tr. 1340, line 7 through 1342, line 10) 81. After FIRREA, an institution was required to meet a three-tier measurement: (1)

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tangible capital at 1½ percent of tangible assets; (2) core capital divided by adjusted tangible assets at 3%; and (3) risk-based capital at 6.4% (which graduated over time to 8%). (Byrne, Tr. 1341, line 18 through 1342, line 10; Byrne, Tr. 1346, lines 7-12) 82. Before FIRREA, Sterling had total assets of $731 million and deposits of $519

million. (JSF #8) 83. However, even before FIRREA became effective, in July 1989, Sterling's "composite

rating" was reduced to a "3" because of its anticipated capital deficiencies under the pending FIRREA legislation: The unassisted acquisition of Central Evergreen...at year-end 1988 has resulted in an increase in Sterling's overall level of risk. The primary concern is a currently low level of capital adequacy and increasing future capital requirements due to proposed legislative action increasing capital requirements and precluding, over a period of time, the inclusion of goodwill as capital. (Horvitz, Tr. 2050, lines 15-20; Horvitz, Tr. 2053, line 9 through 2054, line 7; P-407, p. 1) 84. The OTS recognized that Sterling's perceived capital deficiency was a direct result of

FIRREA, and was not a result of poor management or operations: "[t]he lack of capital compliance is due to the implementation of FIRREA versus unsafe and unsound operating procedures." (P-268, p. 8) 85. After the adoption of regulations following the enactment of FIRREA, Sterling's

regulators (now OTS) formally instructed Sterling that, contrary to its contracts, it would not permit Sterling to treat the Government's cash assistance and supervisory goodwill as regulatory capital; as a direct result, the Government began to treat Sterling as an undercapitalized, troubled thrift, in Thrift Bulletin 38-2: The Office of Thrift Supervision is applying the new capital standards to all savings associations, including those associations that have been operating under 18

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previously granted capital and accounting forbearances. Section 5(t) of HOLA as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) eliminates these forbearances. All savings associations presently operating with these forbearances, therefore, should eliminate them in determining whether or not they comply with the new minimum regulatory capital standards. (Any FSLIC capital contribution that resulted in the creation of goodwill will be subject to the requirements for goodwill established to the capital regulation). Office of Thrift Supervision, Capital Adequacy: Guidance on the Status of Capital Accounting Forbearances and Capital Instruments Held by a Deposit Insurance Fund, Thrift Bulletin No. 38-2, 1990 WL 309397 (Jan. 9, 1990). 2. Sterling Tried in Vain To Obtain Relief From The Government's New Restrictions Under FIRREA. After FIRREA's enactment, the Government informed Sterling that the Government

86.

was no longer obliged to comply with the terms of its contracts with Sterling, however the Government also informed Sterling that Sterling was obliged to comply with the same contracts. (Byrne, Tr. 1451, lines 6-11) 87. Holding Sterling to the contracts it had just disclaimed, the OTS maintained that Sterling "had a legal obligation" to raise capital under the Central Evergreen agreement. (Friend, Tr. 2309, line 24 through 2310, line 8; Friend, Tr. 2311, lines 8-14; Friend, Tr. 2019, line 18-23) 88. The OTS maintained that the Government's contracts with Sterling had no relevance to

Sterling's demand for capital under the regulations; the Government also maintained that despite the fact that Sterling's capital-deficiency was a direct result of the Government's breach, FIRREA's regulations needed to be enforced and Sterling must enter a conservatorship. (Friend, Tr. 2335, line 1 through 2338, line 18) 89. With the enactment of FIRREA the Government ceased viewing Sterling as an ally

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and began to see it as a problem: We were perceived, up until the time of FIRREA, as a savior for the savings and loan industry because of how we were approached by the Government to take over these failing thrifts. We saw it as a business opportunity. The Government saw it as a way to handle some issues that they really didn't want to handle. But when FIRREA came along, the interpretation of FIRREA, I believe, by the OTS and those contracts, how they interpreted the contracts, which negated the net worth and put us in an undercapitalized position in the eyes or the law of FIRREA, that's what happened. Now, because we were deemed to be an undercapitalized thrift that was in trouble at that time based on the fact that the capital that we had was taken away from us and based upon the law of FIRREA which basically said you have to have X capital, we didn't have it because it was taken away, the OTS applied restrictions to us . . . (Barnett, Tr. 1198, line 16 through 1199, line 11) 90. Viewing Sterling as an undercapitalized troubled thrift, on November 9, 1989, OTS

ordered Sterling to cease to grow its assets beyond growth incidental to interest credited to existing deposit accounts. (P-247) 91. The Government also hamstrung Sterling's ability to grow through acquisitions; for

example, the Government refused to permit Sterling to purchase two branches of Great American Bank ("Great American") until Sterling was in compliance with FIRREA's new capital requirements. (Gilkey, Tr. 212, lines 15-24; Friend, Tr. 2307, line 19 through 2308, line 15; P-413; DX-388) 92. The Government also discouraged Sterling from accepting or renewing uninsured

deposits, or deposits that exceeded the $100,000 insured by the FDIC. (Gilkey, Tr. 231, line 16 through 232, line 21; P-256) 93. Additionally, the Government imposed a $500,000 lending limitation, which forced

Sterling to discontinue its commercial real estate lending. (Gilkey, Tr. 237, line 3 through 239, line 6; P-258) 20

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94.

The Government also denied Sterling the right to accept, renew or rollover brokered

deposits, again based upon Sterling's capital position. (P-285; P-288) 95. As a result of this Government action, Sterling was severely limited in the amount of

loans it could make; this in turn curtailed its profitability. (Gilkey, Tr. 232, lines 9-21; Gilkey, Tr. 233, line 6 through 236 line 10) 96. Sterling was unable to grow between November 1989 and November 1991 due to

FIRREA's impact on its capital levels and the OTS' resulting operating restrictions. (Byrne, Tr. 1965, line 14 through 1966, line 6) 3. In Accordance With Its Business Plan, Sterling Attempted To Raise Capital In 1989 That Would Have Brought It Into Compliance With FIRREA's Regulations. In July 1989, the Government knew that Sterling intended to raise capital of up to $20

97.

million through a public stock offering. (Gilkey, Tr. 178, lines 1-17; P-407, p. 2; P-246A, p. 2) 98. Mr. Potthast, an OTS field manager, stated the obvious, but fundamental: "You have

to have capital to grow." (Potthast, Tr. 3250, lines 20-22; see also P-268, p. 6) 99. In or about August 1989, the Government told Sterling it was still obligated to

complete the offering under its contracts, even though the Government was in breach after FIRREA. (Gilkey, Tr. 186, line 25 through 187, line 10) 100. Sterling entered into an agreement with its investment bankers, Dain Bosworth, to proceed with a public offering of $18 million. (P-408, p. 1) 101. In October 1989, the offering amount was reduced to $10 million. The reduction was necessary in order to preserve a net operating loss tax benefit that benefitted both to Sterling and the Government. (Gilkey, Tr. 190, line 8 through 192, line 16; Friend, Tr. 2220, line 20 through 2221, line 6; P-306; P-411) 21

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102. Because Sterling did not then meet FIRREA's capital ratios (without the benefit of its contracts), on advice of its investment bankers, Sterling sought: . . .assurance with respect to Sterling's ability to continue to pay dividends, notwithstanding temporary noncompliance with the capital requirements under FIRREA. Specifically, we ask that you indicate that the Office of Thrift Supervision - Twelfth District would not object to Sterling's payment of dividend on the Preferred Stock in the future assuming that Sterling continued its operations in a safe and sound manner and that funds for the payment of such dividends were legally available, notwithstanding noncompliance with the capital requirements under FIRREA. (Gilkey, Tr. 196, lines 4-16; Welch, Tr. 1575, line 4 through 1578, line 6; see also P-268, p. 6; P342) 103. Sterling had strong investor support for the 1989 offering, which was oversubscribed. (Byrne, Tr. 1433, lines 4-20; Gilkey, Tr. 195, line 4 through 196, line 3) 104. The OTS knew that the offering could not succeed without its non-objection to Sterling paying future dividends on the stated conditions. (Friend, Tr. 2316, line 16 through 2317, line 14; Friend, Tr. 2323, line 14 through 2324, line 10) 105. The OTS indicated that it was in the Government's and Sterling's best interests for Sterling to raise capital, and that it therefore would be illogical to deny Sterling's request. (Byrne, Tr. 1962, line 21 through 1963, line 24; P-345; see also DX-373) 106. This statement encouraged Sterling to proceed with the road shows and other preludes to the offering. (Byrne, Tr. 1962, line 21 through 1963, line 24) 107. On December 12, 1989, Mr. Gilkey and Mr. Byrne met with Donald Dochow, the second in command of the OTS in Washington, D.C., to discuss the need for the acceleration of the process for review of the dividend issue. (Gilkey, Tr. 198, line 7 through 199, line 18; P-253) 108. After hearing of Sterling's plans to regain capital compliance, Mr. Dochow indicated 22

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that if any institution was worthy of an exemption from FIRREA's capital requirements, Sterling appeared to qualify. (Gilkey, Tr. 203, lines 1-12; P-253) 109. Sterling was not granted an exemption. Instead the OTS denied the request for nonobjection to future payment pay dividends because Sterling was not in compliance with the capital ratios of FIRREA; the OTS never granted FIRREA requirements. (Friend, Tr. 2413, lines 5-21; Friend, Tr. 2309, lines 1-23; P-254) 110. The planned stock offering was cancelled because OTS refused to state its nonobjection. (Byrne, Tr. 1445, lines 15-23; Horvitz, Tr. 2094, lines 12-19; James, Tr. 2891, line 16 through 2892, line 6; P-268, p. 6; see also JSF #10) 111. Sterling incurred costs paid to Dain Bosworth and for printing costs and road shows as a result of the Government's refusal to allow dividends and resulting cancellation of the offering. (Gilkey, Tr. 208, line 10 through 209, line 5) 112. The Government knew its position "would be death to a new offering." (Gilkey, Tr. 211, line 25 through 212, line 7) 113. On November 9, 1989, while Sterling was in the process of promoting the offering described above, the Government notified Sterling that it believed that Sterling would fail to meet FIRREA's capital requirements and that Sterling was therefore obliged to submit a capital restoration plan; this required Sterling to limit its expected growth by seventy-five percent (75%). (Byrne, Tr. 1430, line 6 through 1431, line14; P-247, p. 1; Gilkey, Tr. 227, line 1 through 228, line 6; P-247, p. 2) 4. Sterling Attempted To Mitigate The Harm Caused By Its FIRREA Non-Compliance. a. Sterling Shrank Its Assets To Meet Required Capital Ratios.

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114. Having been denied the benefit of its contracts with the Government, Sterling's regulatory capital fell short of FIRREA's requirements; due to the OTS' restriction of Sterling as a capital-noncompliant thrift, Sterling was wholly unable to grow from January 26, 1990 to November 1991. (Byrne, Tr. 1538, lines 12-20; Page, Tr. 1125, lines 15-24) 115. Sterling could not raise capital because of the regulators' refusal to state that they would not object to endorse dividends so long as Sterling was in compliance. (Gilkey, Tr. 211, line 25 through 212, line 7) 116. Due to the Government order that it cease growing and in light of the Government's refusal to honor its contractual capital promises and forbearances, Sterling attempted to shrink its assets to reduce the regulatory threat. (See P-280, 281) Sterling was forced to stop making most types of construction loans, one of Sterling's most profitable markets; Sterling was also unable to renew active loans, thereby further reducing its profitability. (Byrne, Tr. 1462, line 19 through 1463, line 12; P-280, P-281) 117. Between 1989 and 1991, Sterling reduced its assets from approximately $730 million to approximately $590 million. (Gilkey, Tr. 278, line 8 through 279, line 2; see JSF#11) 118. Sterling had not planned to shrink in 1990 or 1991. (Page, Tr. 1144, lines 7-9) b. Sterling Obtained A TRO And An Injunction.

119. By April 11, 1990, the Government began the process of closing Sterling by sending its Board of Directors a letter for consent to an appointment of a conservator; Sterling's Board refused to consent to a conservatorship, pointing out that any capital deficiency was caused by the Government's breach of the contracts. (P-269; P-270) 120. OTS regulators invited themselves to a Sterling board meeting to impress upon the

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directors that the directors were obligated to agree to a conservatorship. (Friend, Tr. 2335, line 1 through 2338, line 18) 121. Sterling met with the OTS in Seattle to convey its concerns about the proposed conservatorship; the OTS stated, regardless of the contracts, "the FIRREA legislation has made these contracts null and void." (P-274) 122. The day after this meeting, the Government sent correspondence insisting that Sterling sign the agreement. (P-271) 123. Contemporaneously, the head of the Seattle office of the OTS and Ed Hedlund, Sterling's regulator, stated that despite the OTS's intent to shut Sterling down, there were no problems with Sterling's management. (P-274, p. 7) 124. Sterling appealed to the Director of the OTS, again asking that its contracts be honored. (P-272) 125. The Government imposed more restrictions through a letter sent to the Board of Directors at their homes; these regulations effectively shut down any profitable business. (Gilkey, Tr. 247, lines 3-15; P-273) 126. These letters were implied threats that if the board did not acquiesce to the OTS's desires the directors would be individually and personally liable. (Barnett, Tr. 1186, lines 5-21) 127. OTS personnel appeared at board meetings and made similar threats to both the individual members and the company; again the Government threatened Sterling's directors with personal liability if they did not surrender the company. (Barnett, Tr. 1187, lines 13-20) 128. The Government ordered Sterling to execute a Capital Directive, which would end Sterling's remaining business opportunities and waive Sterling's right to judicial review.

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(P-275A) 129. Sterling again met with the OTS in an attempt to find a solution to the capital deficiency caused by the Government's breach, however the OTS refused to provide Sterling time to raise the necessary capital. (P-276, pp. 2-7) 130. Sterling offered several capital plans with alternatives to gain the necessary capital, including shrinking the company, selling branches, returning Tri-Cities and Central Evergreen to the Government and reviving the offering that failed in November 1990. (Byrne, Tr. 1474, line 16 through 1476, line 3) 131. Despite Sterling's efforts, the Government maintained that the only option was to sell Sterling Savings Bank. (Byrne, Tr. 1476, lines 7-11) 132. At this point Sterling faced Government Regulators intent on closing it down and had no choice but to, on May 29, 1990, petition the Court for a temporary restraining order ("TRO"), which it obtained. (Gilkey, Tr. 249, lines 21-23; JSF #13) i. Despite The Injunction, The Government Continued To Regulate Sterling As A Capital-Deficient Thrift.

133. Six days after Sterling obtained the TRO, the OTS imposed a new restriction, this time requiring Sterling to provide weekly reports of any actions not in compliance with the previous restrictions. (P-277) 134. Sterling objected, noting that in its view this new restriction violated the terms of the temporary restraining order. The OTS stated, via reply letter, that the TRO in no way impacted the concerns it had regarding Sterling, and rephrased the basis for its concern in terms of "safety and soundness":

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We fully recognize that, until the Temporary Restraining Order is dissolved or the court orders otherwise, we may not enforce the restrictions set forth in our letters of January 26th, March 9th and May 11th. We intend to strictly obey the court's order. However, as our earlier letters indicated, we have significant Supervisory concerns about the condition of Sterling and the soundness of some aspects of its operations. (P-278; P-279) 135. Sterling understood the OTS' letter to indicate that, despite the TRO, the Government would not be dissuaded from shutting Sterling down under the aegis of "safety and soundness" "concerns": They use the words safety and soundness to open the doors to regulatory activity. To me, it meant big trouble. (Gilkey, Tr. 252, lines 9-22) 136. The Government's expressions of "concerns" about "safety and soundness" were driven by Sterling's perceived capital deficiency. (P-268; P-284, P-464) 137. Despite the Government's expression of concern about Sterling's "safety and

soundness", it internally recognized that there were, in fact, no safety and soundness grounds to sanction Sterling and that its problem was solely capital deficiency after FIRREA: The lack of capital compliance is due to the implementation of FIRREA versus unsafe and unsound operating practices. Lending restrictions imposed by RB 3a are in place. With the acceptance or rejection of this capital plan, a formal enforcement document will be executed. (P-268, p. 9) 138. Sterling did believe and was told numerous times that the restrictions were still operative, despite the TRO. (Byrne, Tr. 1822, lines 2-12; Byrne, Tr. 1501, lines 17-24; ; P-281 DX-441) 139. Despite the TRO, the OTS continued to indicate that Sterling was subject to such 27

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restrictions. (Friend, Tr. 2352, line 18 through 2356, line 10; P-281) 140. Given the OTS' continued restrictions in spite of the TRO, Sterling decided to comply with the reporting restriction to avoid further regulatory punishment. (Gilkey, Tr. 254, line 12 through 256, line 18; P-280) 141. On June 20, 1990, while the TRO was in full effect, the Government re-confirmed that Sterling was permitted no growth; Sterling continued to report variances from restrictions imposed upon Sterling. (P-282; Gilkey, Tr. 257, lines 12-22; P-281) 142. On June 25, 1990, the Government explained that the restrictions were justified independently of any problems resulting from the Government's breach; Sterling concluded that the only protection the TRO afforded was that the Government could not close Sterling unless it established a violation of one of the restrictions that the Government claimed was unaffected by the TRO. ( Gilkey, Tr. 258, line 19 through 259, line 7; P-283; Gilkey, Tr. 258, line 25 through 259, line 7) 143. Notwithstanding that Sterling's capital deficiency was due to the Government's breach, and the Court's Order restraining the it from taking action inconsistent with the terms of the contracts, the Government conducted an examination focused on Sterling's capital position and assigned a "5" rating ­ the lowest possible. (P-284; P-287) ii. The Court Issued A Preliminary Injunction Continuing The Terms Of The TRO, But The Government Persisted In Unlawful Enforcement.

144. On August 8, 1990, the Court issued a