Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 1 of 76
DRAFT 11/19/07 @ 5:00 pm 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 RESPONSE TO DEFENDANT'S POST-TRIAL PROPOSED FINDINGS 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 November 19, 2007
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 2 of 76
TABLE OF CONTENTS
I. INTRODUCTION AND SUMMARY OF ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 A. B. II. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 SUMMARY OF ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
STERLING'S RESPONSES TO THE GOVERNMENT'S REPEATED OBJECTIONS . . 2 A. STERLING WOULD HAVE BEEN COMPLIANT WITH FIRREA'S CAPITAL RATIO REQUIREMENTS HAD THE GOVERNMENT HONORED ITS OBLIGATIONS . . . . . . . . . . . . 2 1. The Court Has Already Ruled That Sterling Has A Contractual Right To Include All The Supervisory Goodwill From The Lewis Federal And Tri-Cities Transactions As Capital Without Limitation . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Pursuant To The Court's Prior Ruling, The Central Evergreen Contract, And FIRREA's Mandate, Sterling Is Entitled To Include The Qualifying Supervisory Goodwill From The Central Evergreen Transaction Toward Its Regulatory Capital Ratio Requirement To The Extent Permitted By Law . . . . . . . . . . . . . . . . . . . 4 In Evaluating The But-For Sterling's Post FIRREA Capital Compliance, The Court Should Include The $10.5 Million, Which But For The Breach Would Have Been Realized By The Failed 1989 Stock Offering . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.
3.
B.
THE GOVERNMENT'S ARGUMENTS REGARDING EXCESS CAPITAL AT STERLING'S HOLDING COMPANY LEVEL ARE WRONG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 1. 2. Sterling's Actual History And Performance Belie The Government's Position 16 To The Extent That Sterling Financial Corporation Held Any Capital That It Did Not Downstream, It Was Obliged To Do So . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 The Government's Argument That Sterling Should Have Operated Below The "Well-Capitalized" Standard Should Be Rejected . . . . . . . . . . . . . . . . . . . . . . 10
3.
III. STERLING'S DAMAGES MODELS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 A. B. STERLING IS ENTITLED TO LOST PROFITS AS A LOST VOLUME SELLER . . . . . . . . . . 29 DR. HORVITZ'S MODEL ESTABLISHES DAMAGES WHICH ARE FORESEEABLE, CAUSED BY ii
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 3 of 76
THE BREACH, AND PROVEN WITH A DEGREE OF REASONABLE CERTAINTY WELL OVER THE MODEST THRESHOLD REQUIRED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 1. That Sterling Would Be Forced To Forego Assets And Profits In The Event Of A Breach Was Foreseeable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Sterling's Foregone Assets And Lost Profits Were Caused By The Breaches . 35 a. 3. The Government's Breach Caused Sterling To Forgo Profitable Assets . 39
2.
Sterling Has Proven With Reasonable Certainty That The Government's Breach Resulted In Approximately $63 Million In Lost Profits . . . . . . . . . . . . . . . . . . 44 a. b. Sterling Established Forgone Assets With Reasonable Certainty . . . . . . 45 Dr. Horvitz's Use Of 4% As The Government's "Alternate But-For World" Sterling's Capital Ratio Is Proper And Does Not Impair The Certainty Of His Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
2.
Sterling Established The Profitability Of The Forgone Assets With Reasonable Certainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Sterling's Lost Profits Model Is Based In Facts Not present In Other Winstar Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Sterling's Occasional Failure To Meet Budgeted Growth Does Not Render Dr. Horvitz's Model Speculative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.
4.
C.
IF THE COURT DOES NOT ACCEPT STERLING'S LOST PROFITS MODEL, IT SHOULD AWARD COSTS OF REPLACEMENT DAMAGES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Dr. James' Model Is Not A Hypothetical Model And His Use Of The Preferred Stock's Coupon Rate As A Proxy For The Costs Of Raising Common Stock Is Reasonable And Results In A Reliable And Proper Award Of Replacement Cost Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assuming Sterling Replaced All The Capital Lost To FIRREA, It Could Not Have Done So Until After The 1993 Offering Was Completed . . . . . . . . . . . . . . . . . . . The Government's Notion That Raising Capital Has No Costs Beyond Transaction Costs Has Been Rejected By The Courts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Court Should Award A Tax Gross Up Unless The United States Is Willing To State On The Record That Any Award Will Not Be Taxable . . . . . . . . . . . . . . . . iii
2.
3.
4.
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 4 of 76
D.
THE COURT SHOULD AWARD WOUNDED BANK DAMAGES . . . . . . . . . . . . . . . . . . . .
IV. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
iv
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 5 of 76
TABLE OF AUTHORITIES
FEDERAL CASES Alexander v. Gardner-Denver Co., 415 U.S. 36, 94 S. Ct. 1011 (1974) . . . . . . . . . . . . . . . . . . . . . American Federal Bank, F.S.B. v. United States, 68 Fed. Cl. 346 (2005) . . . . . . . . . . . . . . . . . . . Anchor Sav. Bank, F.S.B. v. United States, 59 Fed. Cl. 126 (2003) . . . . . . . . . . . . . . . . . . . . . . . . Bluebonnet Sav. Bank, F.S.B. v. U.S., 266 F.3d 1348 (Fed. Cir. 2001) . . . . . . . . . . . . . . . . . . . . . . Bull v. U.S., 65 Fed. Cl. 407 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . California Federal Bank v. United States, 395 F.3d 1263 (Fed. Cir. 2005) . . . . . . . . . . . . . . . . . . California Federal Bank, F.S.B. v. United States, 245 F.3d 1342 (Fed. Cir. 2001) . . . . . . . . . . . . Castle v. United States, 48 Fed. Cl. 187 (2000), aff'd, 301 F.3d 1328 (Fed. Cir. 2002) . . . . . . . . . Citizens Financial Service, F.S.B. v. United States, 64 Fed. Cl. 498 (2005) . . . . . . . . . . . . . . . . . . Citizens Fed. Bank v. United States, 474 F.3d 1314 (Fed. Cir. 2007) . . . . . . . . . . . . . . . . . . . . . . Columbia First Bank, FSB v. United States, 60 Fed. Cl. 97 (2004) . . . . . . . . . . . . . . . . . . . . . . . . Commercial Federal Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004) . . . . . . . . . . . . . . . . . Elec. & Missile Facilities, Inc. v. United States, 416 F.2d 1345 (Ct. Cl.1969) . . . . . . . . . . . . . . . Fifth Third Bank of Western Ohio v. United States, 55 Fed. Cl. 223 (2003) . . . . . . . . . . . . . . . . . . Fifth Third Bank v. United States, 71 Fed. Cl. 56 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . First Federal Savings and Loan Association of Rochester v. United States, 76 Fed. Cl. 99 (2007) Foley Co. v. United States, 11 F.3d 1032 (Fed. Cir 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . George A. Fuller Co. v. United States, 108 Ct. Cl. 70, 69 F. Supp. 409 (1947) . . . . . . . . . . . . . . . Gianetti v. Norwalk Hospital, 833 A.2d 891 (Conn. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 6 of 76
Glendale Fed. Bank. F.S.B. v. United States, 378 F.3d 1308 (Fed. Cir. 2004) . . . . . . . . . . . . . . . . Globe Savings Bank, FSB v. United States, 59 Fed. Cl. 86 (2003) . . . . . . . . . . . . . . . . . . . . . . . . . Granite Management Corp. v. United States, 58 Fed. Cl. 766 (2003) . . . . . . . . . . . . . . . . . . . . . . Guaranty National Insurance Co. v. Gates, 916 F.2d 508 (9th Cir. 1990) . . . . . . . . . . . . . . . . . . . Hol-Gar Mfg. Corp. v. United States, 169 Ct. Cl. 384, 351 F.2d 972 (1965) . . . . . . . . . . . . . . . . . Home Sav. of. America v. United States, 57 Fed. Cl. 694 (2003) . . . . . . . . . . . . . . . . . . . . . . . . . . Landmark Land Company, Inc. v. FDIC, 256 F.3d 1365 (Fed. Cir. 2001) . . . . . . . . . . . . . . . . . . . LaSalle Talman Bank, F.S.B. v. United States, 317 F.3d 1363 (Fed. Cir. 2003) . . . . . . . . . . . . . . . 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) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . LaSalle Talman Bank v. United States, 64 Fed. Cl. 90 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Locke v. United States, 151 Ct. Cl. 262 (1960) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lone Star Ford, Inc. v. McCormick, 838 S.W.2d 734 (Ct. App. Texas 1992) . . . . . . . . . . . . . . . . McAbee Constr., Inc. v. United States, 97 F.3d 1431 (Fed. Cir.1996) . . . . . . . . . . . . . . . . . . . . . . Northrop Grumman Information Technology, Inc. v. United States, 78 Fed. Cl. 45 (2007) . . . . . . Praecomm, Inc. v. U.S., 78 Fed. Cl. 5 (2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Precision Pine & Timber, Inc. v. United States, 72 Fed. Cl. 460 (2006) . . . . . . . . . . . . . . . . . . . . S. Nuclear Operating Co. v. United States, 77 Fed. Cl. 396 (2007) . . . . . . . . . . . . . . . . . . . . . . . . Southern California Federal Savings & Loan Association v. United Sates, 57 Fed. Cl. 598 (2003) .............................................................................. Southern California Federal Sav. & Loan Ass'n v. U.S., 422 F.3d 1319 (Fed. Cir. 2005) . . . . . . Southern National Corporation v. United States, 57 Fed. Cl. 294 (2003) . . . . . . . . . . . . . . . . . . . SSA Marine, Inc. v. United States, 77 Fed. Cl. 662 (Fed. Cl. 2007) . . . . . . . . . . . . . . . . . . . . . . . .
vi
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 7 of 76
Standard Federal Bank v. United States, 62 Fed. Cl. 265 (2004) . . . . . . . . . . . . . . . . . . . . . . . . . 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) . . . . . . . . . . . . . . . . . . . . . . . . . . Sterling Savings Assoc., v. United States, 72 Fed. Cl. 404 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . Stockton East Water Dist. v. United States, 75 Fed. Cl. 321 (2007) . . . . . . . . . . . . . . . . . . . . . . . . Story Parchment Co. V. Paterson Parchment Paper Co., 282 U.S. 555, 51 S. Ct. 248 (1931) . . . United States v. Johnson Controls, Inc., 713 F.2d 1541 (Fed. Cir.1983) . . . . . . . . . . . . . . . . . . . . Winstar Corp. v. United States, 518 U.S. 839, 116 S. Ct. 839 (1996) . . . . . . . . . . . . . . . . . . . . . . Wright v. Universal Maritime Service Corp., 525 U.S. 70, 119 S. Ct. 391 (1998) . . . . . . . . . . . . . FEDERAL STATUTES U.S. Const. Art. I., Sec. 10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 U.S.C. § 1464(t)(3)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 U.S.C. § 1831e(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financial Institutions Reform, Recovery and Enforcement Act of 1989 . . . . . . . . . . . ad passim OTHER AUTHORITIES RESTATEMENT (SECOND) OF CONTRACTS § 205 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RESTATEMENT (SECOND), § 347, comment (f) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
vii
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 8 of 76
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 RESPONSE TO DEFENDANT'S POST-TRIAL PROPOSED FINDINGS OF FACT AND LAW
I. INTRODUCTION AND SUMMARY OF ARGUMENT The Government's arguments are premised on a purely theoretical world. A world with perfect information. A world with no transaction costs. A world with no market or human friction to deploying capital. A world where infrastructure materializes instantly to facilitate immediate expansion. A world where "capital flows like water." Sterling Savings Association ("Sterling") does business in the real world. A world where growth is accretive. A world where infrastructure must gradually be developed to serve the requirements of deliberate business growth. A world where acquisitions take time to digest. A world where people must be trained. A world with actual imperfect capital markets rather than instantaneous omniscient markets of laissez faire perfection. Sterling's growth and profitability from
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 9 of 76
a $2.1 million dollar institution in 1983 to a more than $10 billion dollar institution today provides more than sufficient evidence and support for the application of the volume seller rule to enable the Court to arrive at "reasonable approximation of the damages" owed to Sterling in the form of lost profits. See Bluebonnet Sav. Bank, FSB v. United States, 266 F.3d 1348 (Fed. Cir. 2001). II. STERLING'S RESPONSES TO THE GOVERNMENT'S REPEATED OBJECTIONS The Government raises two objections in most every section of its brief. These two arguments are: (1) that Sterling would have been non-compliant with the FIRREA's capital ratio requirements in the "but-for" world and (2) that Sterling, and SFC, maintained excess capital. Rather than responding to these arguments each time the Government raises them, Sterling opts to respond to each of them at the outset and once. A. STERLING WOULD HAVE BEEN COMPLIANT WITH FIRREA'S CAPITAL RATIO REQUIREMENTS HAD THE GOVERNMENT HONORED ITS OBLIGATIONS. Much of the United States' argument involves various assertions that even if the Lewis Federal and Tri-Cities contracts had been honored, Sterling still would have been capital non-compliant after the enactment of FIRREA. The numbers and the accounting are not disputed; this is not a question of accounting or for expert opinion. It is merely a question of law. Sterling had a right under its contracts to count the following items toward its regulatory capital requirements: (1) its actual capital calculated under GAAP; (2) the contractual goodwill from the Lewis Federal transaction (subject to amortization); (3) the contractual goodwill from the TriCities transaction (subject to amortization); and (4) the contractual goodwill from the Central Evergreen transaction, in an amount equal to that permitted under FIRREA and subject to FIRREA's phase out provisions. Additionally, as a direct and foreseeable consequence of the Government's breach, Sterling was unable to complete its intended 1989 unit stock offering, the proceeds of which -2-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 10 of 76
together with the supervisory goodwill, would have been sufficient to render Sterling compliant with FIRREA's capital ratios. Though it has been determined that Sterling had no contractual right to the unit offering, the refusal to approve the dividend payment was a direct and foreseeable consequence of the Government's breach based upon the conclusion that Sterling would not thereafter be capital compliant under FIRREA, a conclusion that was the direct contravention of Sterling's contractual right to treat goodwill as regulatory capital. The Government, missing the point, erroneously asserts: (1) that the Central Evergreen contract was not breached and therefore Sterling cannot include any contractual goodwill from that transaction in its calculations; and (2) that Sterling had no contractual right to declare dividends during the 1989 offering. From these false premises, the Government concludes that Sterling would have been post-FIRREA capital deficient in the but-for world. From this conclusion the
Government argues that Sterling's damages models are speculative, not foreseeable and not reasonably certain. 1. The Court Has Already Ruled That Sterling Has A Contractual Right To Include All The Supervisory Goodwill From The Lewis Federal and Tri-Cities Transactions As Capital Without Limitation.
Before FIRREA, thrifts had a single capital ratio requirement; there was no distinction between core, tangible and risk-based capital. These distinctions were first introduced with the enactment of FIRREA. The Government and Sterling entered into the Lewis Federal and Tri-Cities agreements under the pre-FIRREA regime. In 2002, the Court decided cross motions for summary judgment as to liability. Sterling Savings v. United States, 53 Fed. Cl. 599 (2002) (Sterling I). The Court held: . . . with respect to the Lewis and Tri-Cities transactions, the Court finds that Defendant breached the contractual rights of Plaintiff to the use of supervisory goodwill and FSLIC cash contributions for regulatory capital -3-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 11 of 76
purposes and to amortize the goodwill over 40 and 15 years, respectively. Defendant also breached its contractual obligation with respect to the Lewis and Tri-Cities transactions to forbear from exercising its regulatory authority against Plaintiff for failing to meet its regulatory ratio requirements when it imposed restrictions on Plaintiff's operations. Sterling I, 53 Fed. Cl. at 615. Thus, it has already been established that Sterling had a right to count the entirety of the Lewis Federal and Tri-Cities supervisory goodwill toward its capital requirement ratios. There has been no dispute regarding the fact that Sterling was entitled to count "every penny of the goodwill and capital credits" from the Lewis Federal and Tri-Cities transactions toward its capital ratio requirements subject to the amortization schedules set forth in the contracts. (See Schott, Tr. 2490, line 22 through 2491, line 6). When Sterling contracted with the Government it contracted for regulatory capital without restriction that could be leveraged in the same manner as cash. The Government cannot reclassify that capital as "qualifying supervisory goodwill" a concept which did not exist at the time of contracting. 2. Pursuant To The Court's Prior Ruling, The Central Evergreen Contract, And FIRREA's Mandate, Sterling Is Entitled To Include The Qualifying Supervisory Goodwill From The Central Evergreen Transaction Toward Its Regulatory Capital Ratio Requirement To The Extent Permitted By Law.
Though the parties are in complete agreement regarding the Lewis Federal and Tri-Cities transactions there is significant disagreement regarding how the Court should regard the supervisory goodwill stemming from the Central Evergreen transaction. The Government's position is that the Court's 2006 order on reconsideration (Sterling Savings Association v. United States, 72 Fed. Cl. 404 (2006) (Sterling V) stripped Sterling of any contractual right to the Central Evergreen supervisory goodwill. Sterling submits that the Court's ruling did no such thing. In fact, during the
-4-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 12 of 76
Government's cross examination of Allan Schott, the Court indicated that the Government's expressed view goes too far: If I understand your question, it does seem to be an improper hypothetical. It does not reflect the court's holding about the Central Evergreen transaction . . . Just to elaborate on that, the court held, regarding the Central Evergreen transaction, that the Plaintiff Sterling assumed the risk of any change in regulations that might occur after the date of the transaction. But I don't think it goes so far as to say that the supervisory goodwill should be ignored thereby. It still is an item that ought to be treated to the extent it might be allowed thereafter on a phase-out basis by FIRREA. (Schott, Tr. 2485, line 21 through 2486, line 10). As demonstrated in Sterling's opening brief, and as indicated above, the Court's ruling in no way strips Sterling of any rights under the Central Evergreen contract. Instead the Court's ruling was that the contract requires Sterling to accept the risk of regulatory change, that is, accept that its rights and obligations under the contract could be modified by a subsequent regulatory change. Such a regulatory change occurred with the enactment of FIRREA. Before FIRREA, the Central Evergreen contract permitted Sterling to count the supervisory goodwill credited in the Central Evergreen transaction as capital without limitation. After FIRREA, the Central Evergreen contract permitted Sterling to count the supervisory goodwill therefrom toward its core and risk-based capital requirements in an initial amount equal to or less than 1.5% of the bank's total assets. Counsel for the Government conceded that " . . . the Tri-Cities and Lewis Federal contracts do not tell us anything about what we can or cannot do with Central Evergreen's goodwill . . ." (Schott, Tr. 2489, lines 9-12). That concession is correct, in so far as it goes, but the facts demonstrate that a major objective of the Tri-Cities contract was to facilitate the Central Evergreen merger. The Court should reject a constricted reading of the Tri-Cities contract that would render the Central Evergreen merger unsupportable.
-5-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 13 of 76
In addition to having a contractual right to so count the supervisory goodwill from Central Evergreen, Sterling had a statutory right to include that goodwill in its regulatory capital calculations. This Court has recognized that rights and obligations arising ex contractu are separate and distinct from those arising from statute or common law. See Bull v. U.S., 65 Fed. Cl. 407, 413 -14 (2005) (citing Wright v. Universal Maritime Service Corp., 525 U.S. 70, 78-9, 119 S. Ct. 391 (1998); Alexander v. Gardner-Denver Co., 415 U.S. 36, 49-50, 94 S. Ct. 1011 (1974)). At the time of the breach, pursuant to FIRREA [specifically 12 U.S.C. § 1464(t)(3)(A)] an eligible savings association had a right to "include qualifying supervisory goodwill in calculating core capital." The amount of supervisory goodwill that FIRREA permitted to be included in a thrift's capital calculations began at 1.5% of total assets and phased out to 0% at the year's end of 1994. 12 U.S.C. § 1464(t)(3)(A). This right inured to Sterling without regard to its contracts with the Government; the contract rights are additive to the rights Sterling otherwise has under statute. The Court heard expert testimony that "contractual capital" and "qualifying supervisory goodwill" are separate and distinct; pointedly the Court heard expert testimony that "[c]ontractual assistance exists and is based upon the contract that created it and it exists in accordance with the terms and conditions of that contract[, while] [q]ualifying supervisory goodwill is a grant of authority by FIRREA . . ." (Schott, 2454, lines 2-5; 2455, lines 8-14). The Government's experts were fully in agreement. (Plaintiff's Findings Nos. 284-293). The Government and Sterling understood and recognized that the acquisitions of Tri-Cities and Central Evergreen were inextricably connected. Sterling evaluated the possibility of acquiring TriCities without government assistance. (Plaintiff's Findings Nos. 58 & 59). However, after mere hours of investigation, Sterling chose not to acquire Tri-Cities. (Plaintiff's Findings No. 60). Subsequent to Sterling's refusal to acquire Tri-Cities, it was contacted by the Government and asked -6-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 14 of 76
if it would be interested in acquiring Central Evergreen; Sterling declined due to Central Evergreen's size, problems, and Sterling's lack of capital. (Plaintiff's Findings Nos. 61 & 62). After Sterling had declined to acquire these two failing thrifts it was again contacted by the Government, this time with a proposal under which the regulatory capital from acquiring Tri-Cities would enable Sterling to acquire Central Evergreen. (Plaintiff's Findings Nos. 63 & 64). The governmental regulators wanted Sterling to acquire Central Evergreen, and noted that it was necessarily "subject to Sterling getting Tri-Cities." (Plaintiff's Findings No. 76). Despite: (1) Sterling V,; (2) FIRREA's clear mandate; and (3) the undisputed factual evidence that the parties mutually understood that the Tri-Cities and Central Evergreen acquisitions were dependent upon one another, the Government persists in arguing that Sterling was not permitted to count the qualifying supervisory goodwill from the Central Evergreen transaction (up to 1.5% of total assets) toward its core capital calculations if it also counts the regulatory capital vouched safe by the Lewis Federal and Tri-Cities contracts. That is simply a breach in new creative guise. The Government has presented argument from Messrs. Bankhead and Hargett suggesting that a hypothetical regulator would not permit Sterling to include the qualifying supervisory goodwill from the Central Evergreen transaction in its core capital calculations. (See Defendant's Findings at pp. 55 through 58). The Court should reject this argument for two reasons. First, whether the Central Evergreen contract and/or FIRREA permit Sterling to include the true Central Evergreen supervisory goodwill in its core capital calculations are matters of contract and statutory interpretation. These are matters of law exclusively within the Court's domain, as to which the post-hoc speculation of the Government's experts are not really opinion so much as legal argument. See Fed. R. Evid. 701, cmt. ("If . . . attempts are made to introduce meaningless assertions which amount to little more than choosing up sides, exclusion for lack of helpfulness is -7-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 15 of 76
called for . . ."). In the real world, the OTS never recognized any supervisory goodwill, (see Hargett, Tr. 3453, line 4 through 3454, line 18; Bankhead, Tr. 3356, line 17 through 3359, line 13), so there is no factual basis on which to know how OTS might have calculated capital had it decided not to breach its contracts (or to breach them in a different way). The FDIC, another federal agency with regulatory authority, did decide to honor Sterling's contracts. Its conclusion, contrary to the speculations of the Government's witnesses, was that Sterling was fully compliant with capital requirements. (P-88 (". . . including these off-balance sheet items. The institution meets its applicable minimum capital levels . . .")). Further, the calculation suggested by Mr. Bankhead is not only argumentative and speculative, it actually constitutes another breach by the Government. E.g., Fifth Third Bank v. United States, 71 Fed. Cl. 56, 70 (2006). The second reason to reject the Government's argument is more subtle. Throughout this case, the Court has been presented evidence and argument regarding what happened in the "but-for" world and what happened in the actual world. The "but-for" world is a world where the Government honored its contracts with Sterling; it is a world where FIRREA does not breach contracts. The actual world is self-explanatory. However, the Government's argument occurs in an alternate but-for world a world where FIRREA exists, and where the Lewis Federal and Tri-Cities agreements can still be breached by applying the mechanics of FIRREA to render the regulatory capital unusable and valueless.. The Government argues that in this alternate but-for world the Government would not permit Sterling to include the supervisory goodwill from Central Evergreen toward its core capital calculations even to the limited extent that Sterling was in fact permitted by FIRREA in the real world to use it as Qualifying Supervisory Goodwill. The Government's argument must fail because this alternate but-for world scenario would result in the frustration of the Tri-Cities contract (which was intended to facilitate the Central Evergreen merger) and a breach of the Lewis Federal, -8-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 16 of 76
Tri-Cities and Central Evergreen contracts1. In addition, the Government's alternate but-for world scenario would revoke the goodwill which the real-world Sterling is entitled to use as capital, under law and by agreement. Furthermore, even using the accounting criteria forwarded by Messrs. Bankhead and Hargett, the but-for Sterling would be entitled to include the Central Evergreen supervisory goodwill toward its core and risk-based capital requirements under FIRREA. Both Mr. Bankhead and Mr. Hargett recognize that the regulatory capital from the Lewis Federal and Tri-Cities acquisitions may be counted towards all of FIRREA's capital standards, whereas qualifying supervisory goodwill from Central Evergreen cannot be used to satisfy the tangible capital requirement. (Hargett, Tr. 3364, lines 2-8; Bankhead, Tr. 3463, lines 10-16). Since FIRREA contains quantitative and temporal limitations on the use of supervisory goodwill as capital and it is stipulated that the regulatory capital created in the Lewis Federal and Tri-Cities contracts is subject to no such limitations, it is obvious that the two are different, and while FIRREA limits the use of Central Evergreen goodwill, it cannot (without breaching) put limits on the use of the regulatory capital from the previous two contracts. As was demonstrated in Sterling's opening post-trial brief, in the but-for world [and conceded by the Government and its experts (Plaintiff's Findings Nos. 284-293)], Sterling could have used the entirety of the Lewis Federal and Tri-Cities supervisory goodwill toward its tangible capital requirement, thereby leaving its core and risk-based capital requirement (or bucket) open to allow for the inclusion of the Central Evergreen supervisory goodwill. (Plaintiff's Findings at pp. 90-91).
1
It is important to reiterate that Sterling V did not hold that there was no contract, or that the contract was abrogated in full by FIRREA. The holding was that the risk of regulatory change was assumed by Sterling. The regulatory change that occurred was a mere limitation on the amount of supervisory goodwill that could be included, not a wholesale prohibition on including supervisory goodwill. -9-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 17 of 76
Because the Lewis Federal and Tri-Cities contracts entitle Sterling to count capital without limitation (tangible or otherwise) toward its regulatory requirement, and because FIRREA permits Sterling to include the Central Evergreen qualifying supervisory goodwill as core and/or risk based capital2, any regulatory action in contravention of Sterling's right to treat its contractual goodwill as such would constitute a different sort of breach. See Fifth Third Bank v. United States, 71 Fed. Cl. 56, 70 (2006). 3. In Evaluating The But-For Sterling's Post FIRREA Capital Compliance, The Court Should Include The $10.5 Million, Which But For The Breach Would Have Been Realized By The Failed 1989 Stock Offering.
As part of the Central Evergreen transaction Sterling was contractually required to raise capital. (Plaintiff's Findings No. 87). That having been a specific and express part of the Central Evergreen contract, the Government cannot credibly maintain either that it was not foreseen, or that the breach caused no harm to Sterling. In order to raise the required capital, Sterling had planned a stock offering in 1989. (Plaintiff's Findings Nos. 98 & 99). After FIRREA, Sterling's regulators took the position that despite the Government's breach, Sterling was still contractually obliged to raise the required capital. (Plaintiff's Findings Nos. 87, 98 & 99). Certain facts regarding this stock offering were accepted into evidence without contradiction or dispute. One, the offering would have been successful indeed, it was oversubscribed. (Plaintiff's Findings No. 103). Two, because of FIRREA and the Government's breach, at the time of the offering the Government did not consider Sterling to meet regulatory capital requirements. (Plaintiff's Findings No. 102). Three, the Government recognized that it was in both the Government's and Sterling's best interest for the offering to succeed and a key regulatory official
2
Subject, of course to FIRREA's temporal phase out requirements. -10-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 18 of 76
recommended that the OTS use its discretion to approve it. (Plaintiff's Findings No. 105). Four, the Government knew that the offering would fail without the Government's non-objection to Sterling paying future dividends on certain conditions. (Plaintiff's Findings No. 104). Five, the Government refused to issue a non-objection statement, for the sole reason that Sterling would not, after the offering, be capital compliant a conclusion the Government could not have reached but-for the breach. (Plaintiff's Findings Nos. 109 & 110). Six, as a result, the offering failed and Sterling suffered monetary losses. (Plaintiff's Findings No. 110). Sterling would have been fully compliant with FIRREA's capital requirements had the Government honored its contracts with Sterling and if the 1989 offering was completed. The Government overstates Sterling's request for a non-objection. Sterling sought a very modest statement from the Government; all Sterling asked was that the Government . . . 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. (Plaintiff's Findings No. 102) In practical effect (though not in so many words), Sterling asked the Government to honor the forbearances which were part of its contracts with Sterling. The Government refused, despite its knowledge that its refusal "would be death to [the] new offering." (Plaintiff's Findings Nos. 104, 109, 110 & 112). It is immaterial whether the Government' refusal was policy-driven or not. Either way, it was a breach of contract: the Government insisted Sterling's contract bound it to raise capital. To interfere with that effort was absurd and a breach of the Government's contract duty of good faith.
-11-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 19 of 76
The Government argues: "[t]his Court . . . has previously ruled that Sterling did not obtain a contractual right to pay dividends . . . when it entered into an agreement in connection with its acquisition of Central Evergreen." (Defendant's Findings at pg. 114). However, that is not what the Court held; the Court actually ruled that the Central Evergreen contract did not impose a duty on the Government to permit Sterling to pay dividends. Sterling I, 53 Fed. Cl. at 614-5. And, as Sterling observed at the time, that ruling did not alter the fact that cancellation of the offering was, if itself not a direct breach, a foreseeable consequence of the Government's prior breach. Sterling's Reply Regarding Motion to Clarify, filed 10/31/2002, at pg. 3 (". . . [T]he Court should clarify that its ruling does not foreclose Sterling from proving, in the damages phase of the case, that but for the Government's breach, the November 1989 capital issue would have proceeded."). The Government also argues that Sterling sought some form of pre-approval and that "long-standing" OTS policy prohibited pre-approval. (Defendant's Findings at pp. 115-116). First, of course, the stock offering at issue was in 1989 the very year OTS was formed and OTS could not have had a "longstanding" policy on anything at the time. Second, and far more importantly, Sterling did not seek pre-approval of anything; all Sterling sought was a statement by the Government indicating that it would, in effect, comply with the contracts it sought and entered. It is a long-standing and firmly established principle of contract law that "[t]here is 'an implied provision of every contract, whether it be one between individuals or between an individual and the [g]overnment, that neither party to the contract will do anything to prevent performance thereof by the other party or that will hinder or delay him in its performance.' " Praecomm, Inc. v. U.S., 78 Fed. Cl. 5, 13 (2007) (quoting George A. Fuller Co. v. United States, 108 Ct. Cl. 70, 69 F. Supp. 409, 411 (1947)), see also Restatement (Second) of Contracts § 205, at 99 (1981). The Government breached its contract with Sterling, despite the fact that it had no affirmative obligation to permit Sterling to -12-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 20 of 76
declare dividends, by improperly preventing Sterling from raising the very capital it was saying Sterling was contractually bound to raise. The Government has taken the position that Sterling was obliged to raise capital; the Government knew that the 1989 offering was intended to satisfy that contractual obligation; and the Government knew that its refusal to issue a non-objection was the death knell to that offering3. As such, the Government breached the implied provision prohibiting it from interfering with Sterling's performance. Additionally, and independent of whether the Government breached any contractual implied provision, the failure of the 1989 stock offering was a foreseeable consequence of the breaches, which were established as a matter of law by Sterling I and Sterling V. Breach of contract damages are foreseeable where "they follow from the breach of contract in the ordinary course of events." LaSalle Talman Bank v. United States, 64 Fed. Cl. 90, 98 (2005) (internal quotations omitted) (quoting Home Sav. of. America v. United States, 57 Fed. Cl. 694, 726 (2003). As demonstrated above, the Government's refusal to honor its contracts with Sterling resulted in the failure of the 1989 offering. The Government cannot be heard to argue that this was unforeseeable where the only evidence before the Court shows that: (1) the offering was an express part of the Central Evergreen contract, performance of which the Government demanded, (2) the offering would have been
3
The Defendant argues that one reason for cancelling the offering was a recommendation by the FDIC that certain assets be classified. Defendant's Proposed Finding 34. That is not true. Mr. Gilkey testified that he objected forcefully to the FDIC's recommendation, and that the FDIC withdrew the recommendation, acceding to Mr. Gilkey's assertion that it lacked jurisdiction to require that the disputed assets be downgraded. (Gilkey, Tr. 641, line 11 through 642, line 12). The 1989 offering was withdrawn due to the OTS's unwillingness to provide its non-objection to the payment of dividends. (Byrne, Tr. 1445, lines 15-23). In fact, an OTS Memorandum drafted by William Durbin, OTS's District Director, dated March 30, 1990, states, in relevant part: "Due to the inability to pay dividends, Sterling decided not to go ahead with the offering." (P-268, Bates WON942 1320). Mr. Durbin had earlier told Sterling that its request was denied because Sterling would not be in capital compliance upon completion of the offering. (P-254). -13-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 21 of 76
successful, indeed, oversubscribed; (3) the Government recognized that the stock offering was in all parties' best interest; (4) the Government knew that its refusal to issue a non-objection would kill the offering; and (5) had the Government had honored its contracts and not prevented the 1989 offering, Sterling would have been fully compliant with FIRREA's capital ratio requirements. The Government candidly accepted, at the time, that its own action (or inaction) caused the offering to fail. In a March 1990 memorandum, the OTS described the events as follows: In keeping with the agreement executed in conjunction with the Central Evergreen acquisition, management planned to issue additional preferred stock in late 1989. The projected offering, however, would not have brought the institution into capital compliance. Because of this, prior approval would not be issued for the payment of dividends on the "to be issued" preferred stock. Investment advisors for the institution indicated that nondividend bearing stock would not be received well in the market place, and advised management accordingly. Due to the inability to pay dividends, Sterling decided not to go ahead with the offering. (P-268, Bates WOT942 1320) (Emphasis added). Had the Government honored Sterling's contractual and statutory rights to include supervisory goodwill as capital, the 1989 stock offering would have rendered Sterling fully capital compliant. Additionally, as Carol Friend's demonstration (DX-1080) graphically illustrated on cross examination, had Sterling been allowed to go forward with the planned 1989 capital raising, it would have had positive tangible capital by December 31, 1989. (DX-1080; Friend, Tr. 2399, line 7 through 2402, line 1). DX-1080 is meant to demonstrate Sterling's capital deficiency even after adding in the FSLIC assistance and qualifying supervisory goodwill from the Lewis Federal and TriCities acquisitions. Ms. Friend's demonstrative shows a deficit of $8.3 million. However, if the 1989 offering had taken place, and Sterling was allowed to raise the contemplated $10.5 million, it is beyond dispute that the institution would have been in compliance with its tangible capital requirement. (Adding $10.5 million to DX-1080's "bottom line" of negative $8.3 million creates a -14-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 22 of 76
positive $2.3 million.) The Government asks the Court to evaluate this case on the false presumption that Sterling would have fallen short of FIRREA's capital ratio requirements even if the Government honored its contracts. However, based upon the proper legal standards and the facts presented, the Court should evaluate this case from the only premises supported by the evidence: (1) the Government breached its contracts with Sterling; and (2) but for those breaches, Sterling would have been fully capital compliant based upon: (a) the supervisory goodwill stemming from Lewis Federal and Tri-Cities; (b) the qualifying supervisory goodwill from the Central Evergreen transaction, pursuant to and in accord with FIRREA; and (c) the capital that would have been obtained via the 1989 stock offering, which failed as a direct and foreseeable result of the Government's breaches. B. THE GOVERNMENT'S ARGUMENTS REGARDING EXCESS CAPITAL AT STERLING'S HOLDING COMPANY LEVEL ARE WRONG. The Government has located, among over fifteen years of Sterling's records, a handful of records that show that at a few moments in Sterling's history it had not met the aggressive targets it set for itself. Relying on this handful of snap shots, and completely ignoring the larger picture of Sterling's explosive growth, the Government argues that Sterling could not, at any point over the past 17 years, have found and profited from more assets than it actually had. It also notes that Sterling maintained a capital cushion, and concludes that this proves that Sterling did not have profitable opportunities available to it. However, neither fact nor law supports the Government's position. This Court has previously rejected that exact same argument asserted by the exact same litigant, and held that "a thrift is 'entitled to manage its capital conservatively, maintaining a cushion . . . adequate to protect against the vagaries of the market." Commercial Federal Bank v. United States, 59 Fed. Cl. 338, 347 (2004) (quoting Home Sav., 57 Fed. Cl. at 721). The Government's
-15-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 23 of 76
argument is also contrary to the evidence in this case. The Government argues that the profits Sterling actually earned after 1992 must be credited to the damages it caused as "mitigation." This is correct only if Sterling fails to prove that it could have earned both its actual profits and the profits lost because of the breach. Sterling did prove exactly that: all of Sterling's senior executives testified, all without doubt, that Sterling would have carried more profitable assets, and made greater profits but for the breach. (Harlow, Tr. 824, lines 4-11; 825, lines 12-23; Page, Tr. 1145, line 12 through 1147, line 1; Barnett, Tr. 1191, lines 17-23; Stanley, Tr. 1282, lines 4-13; Zuppe, Tr. 3094, lines 3-9; Gilkey, Tr. 395, lines 8-15; 405, lines 2-14). But the Government argues that Sterling had "excess" or unused capital, which the Government insists constitutes proof that Sterling would not, or could not, have carried more profitable assets than it actually did. The Government is wrong. 1. Sterling's Actual History And Performance Belie The Government's Position.
The Government has cherry-picked a few select points in Sterling's history in a vain attempt to argue that Sterling Financial held capital in reserve which went unused, and that this proves there were no business opportunities from which Sterling might generate profits. However, the record before the Court establishes (a) that Sterling was constantly growing and continuously in need of capital, and (2) that anytime Sterling (or SFC) had accumulated capital on hand it was holding it for a specific project or promptly used it for other growth initiatives always accumulating and then profitably deploying capital. The Government has specifically pointed to 1994, 1997, and SFC's Key Bank line of credit in order to defeat Sterling's lost profit model; each of those arguments is addressed in turn below. The undisputed evidence was that Sterling was constantly seeking additional capital. Mr. Welch, Sterling's investment banker, testified that Sterling's primary strategy has been to grow and that it needed capital to do so. (Welch, Tr. 1642, line 12 through 1643, line 6). Mr. Gilkey testified -16-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 24 of 76
that from the beginning, Sterling sought to add capital via acquisitions and to pursue an aggressive growth strategy. (Plaintiff's Findings Nos. 3-6). The Government asserts that SFC held excess
capital which it failed to downstream in the 1994. (Defendant's Findings 74). That is simply untrue. In the year ending on June 30, 1994 SFC had a preferred stock offering which increased shareholder's equity from $48.272 million to $76.539 million. (P-88, Bates 0802786; Byrne, Tr. 4327, lines 2-19). All of the capital which was raised by this preferred stock offering was invested in Sterling Savings Bank. (P-88, Bates 0802786; Byrne, Tr. 4328, lines 2-18). Sterling used that capital to acquire (1) three branches from Far West Bank; (2) five branches from Great American Bank; and (3) American Liberty Savings Bank. (P-505; P-503). Sterling also adjusted its balance sheet by decreasing loans and increasing its mortgage-backed securities during the fiscal year ending on June 30, 1994. (P-88, Bates 0802753) As Mr. Byrne explained, these were the same assets, but converting them to mortgage-backed securities was a low-cost way of raising Sterling's risk-based capital ratio. Finally, SFC only maintained $1.8 million in cash in fiscal year 1994; this was a significant decrease from the $4.1 held at the end of fiscal year 1993. Sterling also grew from $1.039 billion in 1993, to $1.541 billion in 1995. (P-86, Bates 0063151; P-89, Bates 0048640). Despite the Government's position, the facts show that neither Sterling nor SFC maintained excess capital; Sterling used the capital it had to support its actual growth. Sterling could have used the contract capital to be bigger to begin with, or for greater asset value. The Government also points to SFC's having capital on hand at the close of 1997. However, once that snapshot is placed in context, it becomes clear that this capital reserve provides no support for the Government's position. At year end 1997, SFC had approximately $21.3 million in reserve. (P-95, Bates 702953; Byrne, Tr. 4315, line 18 through 4316, line 6). However, as Mr. Byrne explained, during 1997 this money was being held in reserve in anticipation of Sterling's purchase -17-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 25 of 76
of a number of Key Bank branches, which was completed in June 1998. (Byrne, Tr. 4316, lines 720; 4320, lines 18-21). Once Sterling's acquisition of these branches was complete, SFC's capital was drawn down to "bare minimum levels." (Byrne, Tr. 4320, line 22 through 4321, line 6). Not only did Sterling use the entirety of the $21.3 million in reserve to purchase the Key Bank branches, Sterling also had to borrow an additional $25 million to complete the acquisition. (P-95, Bates 702953). Again, the facts do not support the Government's position that Sterling held excess capital and lacked profitable opportunities. These facts betray the basic flaw in the Government's position: in the real world, it takes time to accumulate capital and negotiate the acquisition of profitable opportunities. Only in the theoretical world of the Government's imagination is there an instantaneous matching of capital and opportunity. In that world, one might argue that a short-term capital reserve proves the absence of profitable opportunity; but that is not the real world, the world established by the evidence in this case. In addition to regulatory and contractual requirements that SFC maintain some capital reserve, a brief historical analysis of Sterling's plans, capital assets, and borrowings, establishes that Sterling always maintained a capital cushion, and would have done so absent any breach. In 1998, Sterling intended to pursue an aggressive growth strategy; had approximately $2.3 billion in total assets; and had approximately $97.24 million in "other borrowings," which are the type of borrowings the Government asserts should have been used more liberally. (P-95, Bates 702862, 702916 &702938). The next year, Sterling again intended to pursue an aggressive growth strategy; had increased assets to $2.55 billion; and had increased those borrowings to $110 million. (P-96, Bates 703144, 703198 & 703220). In 2000, Sterling again pursued an aggressive growth strategy; again increased assets to $2.66 billion; and had borrowings of $110 million. (P-97, Bates 706358, 706411 & 706434). -18-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 26 of 76
The Government claims that SFC did not use a $15 million combined line of credit with Key Bank in 2000. (Byrne, Tr. 4330-4336). It claims, therefore, that this proves Sterling could not have been larger. However, taking the Government's snapshot and placing it in context, it is clear that Sterling grew aggressively in 2000 and 2001. In 2000 assets went from $2.55 billion to $2.66 billion, then in 2001, Sterling increased its total assets to $3.039 billion. (P-98, Bates 900005-6; 900061). In 2001, SFC increased borrowings by $17.5 million, to $127.5 million. (Id. at 900088). The Government relies on a sleight of hand made possible by deliberately ignoring the realities about the timing of investment and growth in the in the real world. The undisputed evidence is that Sterling grew in size every year. The Government's argument should be rejected because Sterling has demonstrated a pattern of pursuing and using as much capital as it could to fund its operation and has increased its borrowings when necessary to do so; Sterling continues this pattern up to today. Additionally, as demonstrated below, Sterling has used capital and borrowings to grow its business both organically and via acquisition. In light of Sterling's long and uninterrupted history of growth and profitability the Court should reject the Government's argument as flatly incredible in view of the growth Sterling actually achieved. Indeed, the Government has not answered the question that it must answer before its position can be credited: if Sterling had no opportunities, how did it grow the way it did? A brief examination of Sterling's acquisitions, new branch openings and capital events establishes that Sterling had a practice and pattern of raising capital, putting it to profitable use, raising more capital and again putting it to profitable use. Based upon this pattern, Sterling may superficially appear to have excess capital at a handful of moments in time. However, the facts when viewed as a whole show that Sterling consistently used this capital to fund internal growth or acquisitions. For example, in 1993 Sterling raised approximately $12.9 million via an issuance of -19-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 27 of 76
subordinated notes. (P-86, Bates 0063142). That same year Sterling used that capital to purchase six branch sites from Key Bank. (P-503; P-505; Gilkey, Tr. 434, line 16 through 435, line 1). In 1994 Sterling raised approximately $21.2 million in convertible preferred stock and $4 million by acquiring American Liberty. (Gilkey, Tr. 414, lines 5-12; 481, lines 9-13). That same year Sterling used that capital to acquire the following: (1) three branches from Far West Bank; (2) five branches from Great American Bank; and (3) American Liberty Savings Bank. (P-503; P-505; Gilkey, Tr. 414, lines 5-9; 435, lines 16-18; P-88, Bates 0802753). These acquisitions brought significant accounts and cash to the bank. Also in 1994 Sterling opened a new branch in Spokane Valley. (P-504; P-88, Bates 0802753). In 1995 Sterling raised $5 million from SFC's previous financing, and used the funds for internal growth. (P-505; Gilkey, Tr. 414, lines 1320). In 1996 Sterling borrowed $8 million from Key Bank, again to fund internal growth. (P-505; Byrne, Tr. 1763, line 16 through 1764, line 6). In 1997 Sterling began the process of purchasing the Key Bank branches discussed above, however in the same year Sterling raised $3 million for internal growth and issued $12 million in trust preferred securities. (P-505; P-488; Gilkey, Tr. 416, line 13 through 417, line 3; Welch, Tr. 1621, line 17 through 1622, line 5). In 1998 Sterling acquired Big Sky Bancorp, this brought $7.7 million in capital; however, that same year Sterling opened a new branch in Coeur d'Alene, Idaho. (P504; P-505; Gilkey, Tr. 417, line 16 through 418, line 17; 428, line 14 through 429, line 2). In 1999, Sterling received $6.5 million in capital from floating rate notes, and in 2001 raised approximately $38 million, through combined capital events. (P-505; Gilkey, Tr. 418, line 18 through 420, line 2). In 2001 Sterling also acquired Source Capital Corp. for $9.1 million (P-98, Bates 0900064 & 0900107) and opened a new Corporate Banking Center in Portland, Oregon, which also required an outlay of capital. (P-503; P-504; P-98, Bates 0900037). Furthermore, in 2002 Sterling opened a new Corporate Banking Center in Seattle, Washington, and -20-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 28 of 76
a Business Banking Center in Portland, Oregon. (P-504; Gilkey, Tr. 428, line 14 through 429, line 11). Sterling's practice of raising capital and shortly thereafter putting it to use for organic and acquisition growth illustrates four important points: (1) Sterling has always been in a growth mode; (2) Sterling was capable of putting capital to profitable use; (3) Sterling in fact put capital to profitable uses; and (4) the Government's arguments from selected moments in time provides no support for its position that Sterling could not have profitably employed the capital lost due to the breach. The evidence before the Court is that Sterling consistently intended to grow and that it consistently grew in deposits, assets and capital. Without consistently pursuing capital, Sterling could not have grown to become a more than $10-billion-dollar institution. Sterling's constant increases to its capital to support its steady growth defeat the Government's argument that Sterling held excess capital and lacked profitable opportunities. The undisputed evidence before the Court also establishes that Sterling was consistently in need of additional capital. Though it is true that Sterling had access to the markets, as it told its investors, and raised lots of capital, it was never able, at any moment in time, to get as much as its management believed it could use. (Welch, Tr. 1509, lines 8-15, 25; 1590, line 3; 1592, lines 7-11). Accretion to capital and assets are gradual, in the real world. Sterling has proven that it would have added all the capital and assets it actually did add even if the Government hadn't forced it to shrink as part of its breach. There is no evidence to suggest that Sterling could have added capital any faster than it actually did, but chose not to because it didn't think it would be profitable to do so. (Welch, Tr. 1589, lines 8-15; 1589, line 25 through 1590, line 30). Absent such evidence, the Government is not entitled to claim Sterling's actual profits as a credit to the lost profits caused by its breach. 2. To The Extent That Sterling Financial Corporation Held Any Capital That It Did Not -21-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 29 of 76
Downstream, It Was Obliged To Do So. Through its history, SFC was obliged to maintain increasing levels of capital and liquidity. SFC was regulatorily required to maintain capital. SFC had contractual commitments with its commercial lenders, which required it to maintain capital. Finally, SFC was in practical terms required by its rating company to maintain capital. SFC was required to maintain increasing capital to satisfy OTS examinations. (Byrne, Tr. 4322, lines 8-24). Specifically, SFC was required to show its regulators that it had sufficient capital to meet is operating expenses and to pay interest on its debt, in order to maintain its status as a source of strength for Sterling. (Id.). This obligation and SFC's need to remain a source of strength for the bank required it to maintain a certain level of liquidity at the holding company level and belies the Government's argument that SFC's capital position should prevent an award of lost profits. Sterling showed that SFC issued subordinated notes the proceeds of which were downstreamed to Sterling Savings Bank. But these notes, and the regulatory environment in which they exist, forbade SFC to downstream all the proceeds. Sterling showed that the notes were attended by (1) restrictions on incurring additional indebtedness; (2) covenants which restricted SFC's operations; and (3) requirements that SFC maintain certain liquidity. (James, Tr. 2887, line 20 through 2888, line 6). Mr. Byrne testified that SFC's lenders required Sterling to agree to covenants as a condition of borrowing funds, and that these covenants limited Sterling's ability to incur additional debt. (See Byrne, Tr. 4325, line 11 through 4326, line 6). Mr. Byrne also explained that the holding company, SFC, was required to maintain increasing levels of capital to satisfy its rating company's requirements. (Byrne, Tr. 4323, line 11 through 4324, line 19). SFC was rated by a service which provides information to the general market regarding the company's strength. (Id.). In order to maintain an investment grade rating, SFC was -22-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 30 of 76
required to maintain a certain level of liquidity; without an investment grade rating SFC would have been less able to raise capital at all, and it would have ceased to be able to provide an inexpensive source of capital to Sterling Savings Bank. Finally, the Court heard testimony that Sterling was always in need of additional capital to continue its growth. (Byrne, Tr. 1786, lines 23-25). In fact, David Welch testified that there never came a time when Sterling indicated it did not have growth plans and need for additional capital. (Welch, Tr. 1595, lines 7-11). It is simply untrue that SFC's business operations, specifically its maintenance of liquidity and observance of limits on its borrowing capacity illustrate that Sterling could not profitably have employed the capital taken from it by the breach. Finally, it is not Sterling's burden to prove that there were not isolated moments when its loan volume was not as targeted, or where its capital was momentarily higher than optimal. In the theoretical world of "efficient markets" assumed by the Government and its experts, capital "flows like water" immediately to opportunities. (See Bajaj, Tr. 4003, lines 16-19). But the evidence before the Court is that this is not how the real world works. Capital formation and asset growth, external and internal, are gradual accretive processes. Mr. Gilkey explained that profitably deploying capital via commercial mortgages or construction loans can take 2 to 3 years from the time of agreement to completion. (Gilkey, Tr. 931, line 22 through 392, line 15). Mr. Page illustrated for the Court that building a loan portfolio requires more than simply hiring a gross of loan officers4. (Page, Tr. 1100, line 9 through 1101, line 6). Mr. Page explained that new employees must be educated in the bank's lending culture and capital must be allocated to support their loan portfolios. (Page, Tr. 1101, lines 7-25). Mr. Byrne testified that it takes time to grow
4
As discussed below, the Government's breach impaired Sterling's ability to hire and retain loan officers. -23-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 31 of 76
internally because it takes time to hire loan officers, to train the loan officers to where they can generate portfolios of loans; Mr. Byrne testified that it may take a year and a half for a loan officer to develop a quality loan portfolio. Mr. Byrne also testified that approximately half of Sterling's growth occurred internally. (Byrne, Tr. 1317, line 20 through 1315, line 13). Mr. Page also addressed the ultimate issue well; he was asked if there has ever been a time where Sterling was not in pursuit of additional capital to leverage, and he responded: "[o]nly maybe brief, brief periods. But we are always, always after capital." (Page, Tr. 1103, lines 2-6). Mr. Welch worked as Sterling's investment banker from 1991 to 2002. (Welch, Tr. 1568, lines 11-14; 1598, lines 8-10). Mr. Welch testified that there is not "an unlimited willingness among investors to provide capital to anyone who wants it . . ." (Welch, Tr. 1570, line 23 through 1571, line 1). Before capital can be raised via issuance of public securities, an investment banker must conduct due diligence, which involves hours of meeting with the issuer's top executives and full day meetings with the issuer's Chief Financial Officer and Chief Executive Officer in order for the banker to understand the issuer's business model. The due diligence process also involves the banker conducting research or investigation into the issuer's accounting and regulatory relationships. this process of due diligence can take four to six months. (Welch, Tr. 1570, lines 13-17; 1571, line 2 through 1573, line 3). Based upon his analysis and study of Sterling, Mr. Welch testified that had the Government permitted Sterling to use the regulatory capital lost due the breach in November of 1991, Sterling would have employed that capital. Specifically, Mr. Welch testified that "Sterling was a growing institution. And it was going to employ capital." (Welch, Tr. 1589, lines 8-15; 1589, line 25 through 1590, line 3). At no time did Sterling tell Mr. Welch that it was done growing and did not need additional capital for the foreseeable future. (Welch, Tr. 1592, lines 7-11). Not only does growth take time, the capital markets will not respond to rapid growth. Mr. -24-
Case 1:95-cv-00829-TCW
Document 287
Filed 11/19/2007
Page 32 of 76
Welch explained that he was not always in a position to get the capi