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TABLE OF CONTENTS
Page TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 CONTENTIONS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 I. II. STERLING'S ACQUISITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 STERLING'S POST-FIRREA INJUNCTION AND CAPITAL RAISING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 STERLING'S LITIGATION IN THE COURT OF FEDERAL CLAIMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
III.
CONTENTIONS OF LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 I. II. THE APPLICABLE LEGAL STANDARDS . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 THE COURT SHOULD REJECT STERLING'S LOST PROFITS MODEL BECAUSE IT IS SPECULATIVE AND HAS NO BASIS IN FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 A. B. Dr. Horvitz's Flawed Lost Profits Model . . . . . . . . . . . . . . . . . . . . . . . . 18 The Lost Profits Damages In Dr. Horvitz's Model Are Invalid As A Matter Of Law Because His Calculations Ignore Sterling's Mitigation Of Damages Through Recapitalization in 1991 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 The Allegedly Forgone Profits In Dr. Horvitz's Model Were Not Foreseeable When Sterling Acquired Lewis Federal and Tri-Cities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Sterling Cannot Prove That The Breach Caused The Lost Profits Alleged In Dr. Horvitz's Model . . . . . . . . . . . . . . . . . . . . . . . . . . 26 1. Dr. Horvitz's Lost Profits Calculation Is Invalid As A Matter Of Law Because He Incorrectly Assumes That The Breach Caused Sterling's Failure To Meet FIRREA's Minimum Capital Requirements . . . . . . . . . . . . . . . . 28 a. Sterling Would Have Failed FIRREA's Tangible Capital Requirement Absent The Breach . . . . . . . . . . . . . 28
C.
D.
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Dr. Horvitz Incorrectly Assumes That Sterling Would Meet The Minimum Core Capital Requirement Absent The Breach . . . . . . . . . . . . . . . . . . . 30
2.
Dr. Horvitz's Model Erroneously Assumes That The The Breach Caused Sterling To Cease The Pursuit Of Profitable Opportunities During A Period When The Government Was Enjoined From Enforcing FIRREA's Breaching Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 The Breach Did Not Cause Sterling To Forgo Profitable Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.
E.
Dr. Horvitz's Damages Estimates Are Speculative . . . . . . . . . . . . . . . . . 37 1. Dr. Horvitz's Model Is Invalid Because He Fails To Identify The Assets And Liabilities That Would Have Been Obtained Absent The Breach . . . . . . . . . . . . . . . . . . . . . . . 37 a. Fifth Third, Southern National And Standard Federal Are Indistinguishable From This Case . . . . . . . . . . . . . . . 40 Dr. Horvitz's Lost Profits Model In This Case Suffers From The Same Flaws As The Models Proffered In Citizens Financial And SoCal . . . . . . . . . . . 42 First Federal of Rochester Is Inapposite . . . . . . . . . . . . . . 44
b.
c. 2.
Dr. Horvitz's Growth Rate Is At Odds With Sterling's Underusage Of Its Leverage Capacity In The Actual World . . . . 44 Dr. Horvitz Incorrectly Assumes That Growth Equates With Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 The Assumed Capital Ratios In Dr. Horvitz's Model Are Speculative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
3.
4.
III.
THE COURT SHOULD REJECT PLAINTIFFS' "MITIGATION" DAMAGES AS A MATTER OF LAW BECAUSE PROFESSOR JAMES'S MODEL REFLECTS HYPOTHETICAL, RATHER THAN ACTUAL, COST TO RAISE REPLACEMENT CAPITAL . . . . . . . . . . 46 A. Professor James's Mitigation Theory, Which Is Based Upon The Payment Of Preferred Stock Dividends, Should Be Rejected Because The Only Costs Associated With Raising Capital Are Transactions Cost . . . . . . . . . . . . . . . . . . . . . . 49
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The Court Should Reject Professor James's Mitigation Damages Theory Because It Is Based Upon A Hypothetical Regulatory Capital Replacement Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Even Were The Court To Award Sterling Its Claimed Cost-Of-Replacement Damages, It Is Not Entitled To A Tax "Gross-Up" . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
C.
IV.
PLAINTIFFS' ALLEGED WOUNDED BANK CLAIMS FAIL AS A MATTER OF LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 A. The Breach Did Not Cause Sterling To Incur Increased Costs In Acquiring A Branch Of Great American Savings Bank . . . . . . . . . . . 57 Losses Incurred In Connection With The CJ-4 Loan Are Not Attributable To The Breach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Excess Supervision Costs Are Not Attributable To The Breach . . . . . . . 61 Sterling's Inability To Guarantee The Payment Of Preferred Stock Dividends In Connection With The 1989 Units Offering Is Not Breach-Related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Increased Legal Fees To Litigate The Alleged Breach Of Contract Are Barred As A Matter Of Law, And Sterling Has Not Established That Other Legal And Accounting Fees Are Attributable To A Breach . 63
B.
C. D.
E.
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
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TABLE OF AUTHORITIES CASES Admiral Fin'l Corp. v. United States, 378 F.3d 1336 (Fed. Cir. 2004) ....................................... 14 Advanced Medical, Inc. v. Arden Medical Sys., 955 F.2d 188 (3rd Cir. 1992) ......................... 24 American Federal Bank, FSB v. United States, 68 Fed. Cl. 346 (2005) ............................... 22, 40 Bank of America, FSB v. United States, 67 Fed. Cl. 577 (2005) appeals argued, Nos. 2006-5008, -5089, -5090 (Fed. Cir. Apr. 4, 2007) ............................ passim Bank of America, FSB v. United States, 70 Fed. Cl. 246 (2006) .............................................. 55 Bank United v. United States, 50 Fed. Cl. 645 (2001), aff'd, 80 Fed. Appx. 663 (Fed. Cir. Sept. 22, 2003) .................................................................................................... passim Bluebonnet Sav. Bank v. United States, 266 F.3d 1348 (Fed. Cir. 2001) .................................. 15 California Fed. Bank, FSB v. United States, 395 F.3d 1263 (Fed. Cir. 2005), cert. denied, 126 S. Ct. 344 (2005) ...................................................................................... passim California Federal Bank v. United States ("CalFed"), 43 Fed. Cl. 445 (1999), aff'd in part, 245 F.3d 1342 (Fed. Cir. 2001) ...................................................................... passim Castle v. United States, 48 Fed.Cl. 187 (2000), aff'd, 301 F.3d 1328 (Fed. Cir. 2002) ........................................................................................................................... 37 Centex Corp. v. United States, 55 Fed. Cl. 381 (2003), aff'd, 395 F.3d 1283 (Fed. Cir. 2005) .......................................................................................... 55 Chain Belt Co. v. United States, 115 F. Supp. 701 (Ct. Cl. 1953) .............................................. 21 Citizens Fed. Bank v. United States, 59 Fed. Cl. 507 ........................................................... 54, 55 Citizens Federal Bank v. United States, No. 05-5173, 2007 WL 162820 (Fed. Cir. Jan. 24, 2007) ............................................................................................................. 27 Citizens Fin'l, Services, 57 Fed. Cl. 64 (Fed. Cl, 2003) .............................................................. 51 Citizens Fin'l Services, FSB v. United States, 64 Fed. Cl. 498 (2005), aff'd, 170 Fed. Appx. 129 (Fed. Cir. 2006) ......................................................................... passim
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Coast Fed. Bank, FSB v. United States, 48 Fed. Cl. 402 (2000), aff'd, 323 F.3d F.3d 1035 (Fed. Cir. 2003) ............................................................................. 4, 55 Columbia First Bank, FSB v. United States, 54 Fed. Cl. 693 (2002) .................................... 3, 52 Columbia First Bank, FSB v. United States, 60 Fed. Cl. 97 (2004) ........................................... 39 Commercial Fed. Bank, F.S.B. v. United States, 59 Fed. Cl. 338 (2004) ................................. 55 Dolphin Tours, Inc. v. Pacifico Creative Service Inc., 773 F.2d 1506 (9th Cir. 1985) .............. 18 Estate of Berg v. United States, 231 Ct. Cl. 466, 687 F.2d 377 (1982) ................................ 16, 65 Everett Plywood Corp. v. United States, 206 Ct. Cl. 244, 512 F.2d 1082 (1975) ...................... 17 Far West Federal Bank v. OTS, 951 F.2d 1093 (9th Cir. 1991) ................................................. 13 Fawick Corp. v. United States, 149 Ct. Cl. 623 (1960) .............................................................. 22 Fifth Third Bank v. United States, 402 F.3d 1221 (Fed. Cir. 2005) ................................... passim First Fed. Sav. and Loan Ass'n of Rochester v. United States, 76 Fed. Cl. 106 (Fed. Cir. 2007) ................................................................................................. 40 First Heights Bank, F.S.B. v. United States, 57 Fed. Cl. 162 (2003) ......................................... 55 Franklin Fed. Savings Bank v. United States, 55 Fed. Cl. 108 (2003) ............................... passim General Elec. Co. v. Joiner, 522 U.S. 136 (1997) ....................................................................... 38 Glendale Fed. Bank, FSB v. United States, 43 Fed. Cl. 390 (1999), aff'd in part, vacated in part, 239 F.3d 1374 (Fed. Cir. 2001) .................................................... 49 Glendale Fed. Bank, FSB v. United States, 239 F.3d 1371 (Fed. Cir. 2001) ............................... 1 Glendale Fed. Bank, F.S.B., v. United States, 378 F.3d 1308 (Fed. Cir. 2004) ......................... 16 Granite, 416 F.3d 1373 (Fed. Cir. 2005) ................................................................................. 4, 53 Granite Management Corp. v. United States, 58 Fed. Cl. 766 aff'd in part and remanded on other grounds, 416 F.3d 1373 (Fed. Cir. 2005) .............................................. passim Hughes Communications Galaxy, Inc. v. United States, 271 F.3d 1060 (Fed. Cir. 2001) ..................................................................................................................... 27, 28 v
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Krauss v. Greenbarg, 137 F.2d 569 (3d Cir. 1943) ..................................................................... 27 Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999) ................................................................ 38 LaSalle Talman Bank, F.S.B. v. United States, 45 Fed. Cl. 64 (1999), aff'd in part, vacated in part, 317 F.3d 1363 (Fed. Cir. 2003) .............................................. 56, 64 LaSalle Talman Bank, FSB v. United States, 317 F.3d 1363 (Fed. Cir. 2003) .................. passim Landmark Land Co. v. United States, 256 F.3d 1365 (Fed. Cir. 2001) ................................ 24, 25 Local Okla. Bank, N.A. v. United States, 59 Fed. Cl. 713 (2004), aff'd, 452 F.3d 1371 (Fed. Cir. 2006) (same) .............................................................................. 55 Midwest Indus. Painting v. United States, 4 Cl. Ct. 124 (1983) ........................................... 17, 21 Northern Helex Co. v. United States, 207 Ct. Cl. 862, 524 F.2d 707 (1975) ....................... 21, 57 Old Stone Corp. v. United States, 450 F.3d 1360 (Fed. Cir. 2006) ............................................ 16 Piggly Wiggly Corp. v. United States, 112 Ct. Cl. 391, 81 F. Supp. 819 (1949) ........................ 64 Prudential Ins. Co. of America v. The United States, 801 F.2d 1295 (Fed. Cir. 1986) ............. 57 Quiman v. United States, 39 Fed. Cl. 171 (1997), aff'd, 178 F.3d 1313 (Fed. Cir. 1999) ..................................................................................................................... 16, 17 R.S.E., Inc. v. Pennsy Supply, Inc., 523 F.Supp. 954 (M.D. Pa. 1981) ...................................... 18 Ramsey v. United States, 121 Ct. Cl. 426, 101 F. Supp. 353 (1951) .................................... 27, 55 Robinson v. United States, 305 F.3d 1330 (Fed. Cir. 2002) ................................................. 21, 24 Shyface v. Secretary of Health & Human Servs., 165 F.3d 1344 (Fed. Cir. 1999) .................... 27 Southern Calif. Fed. Sav. & Loan Ass'n v. United States, 422 F.3d 1319 (Fed. Cir. 2005) ............................................................................................. 15, 39 Southern California Fed. Sav. & Loan v. United States, 57 Fed. Cl. 598 (2003), aff'd in part, rev'd in part, and remanded on other grounds, 422 F.3d 1319 (Fed. Cir. 2005) ................................................................................................................... passim Southern National Corp. v. United States, 57 Fed. Cl. 294 (2003) ................................ 39, 40, 41 Standard Fed. Bank v. United States, 62 Fed. Cl. 265 (Fed. Cl. 2004) ................................. 39, 42 vi
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Sterling Sav. Assn. v. Ryan, 751 F. Supp. 871 (E.D. Wash. 1990), rev'd, 959 F.2d 241 (9th Cir. 1992) ..................................................................................... passim Sterling Sav. Assn. v. United States, 57 Fed. Cl. 234 (2003) ..................................................... 15 Sterling Sav. Assn. v. United States, 57 Fed. Cl. 445 (2003) ............................................... 14, 19 Sterling Sav. Assn. v. United States, 72 Fed. Cl. 404 (2006) ............................................. passim Sterling Savings Assoc. v. Ryan, 959 F.2d 241 (9th Cir. 1992) .......................................... 13, 32 Sterling Savings, et al. v. United States, No. 95-829C, slip op., pp. 3-4 (Nov. 15, 2002) ..................................................................................................................... 62, 63 Sterling Savings v. United States, 53 Fed. Cl. 599 (2002) ................................................. passim Sun Cal, Inc. v. United States, 25 Cl. Ct. 426 (1992) ................................................................ 17 Suess v. United States, 74 Fed. Cl. 510 (2006) ........................................................................... 55 Toledo P. & W. Ry. v. Metro Waste Sys., 59 F.3d 637 (7th Cir. 1995) .................................... 21 United States v. Burton Coal Co., 273 U.S. 337 (1927) ............................................................. 16 Wells Fargo Bank v. United States, 88 F.3d 1012 (Fed. Cir. 1996) ........................................... 55 WestFed Holdings, Inc. v. United States, 52 Fed. Cl. 135 (2002) .............................................. 27 STATUTES 12 C.F.R. §563.13 ......................................................................................................................... 7 12 C.F.R. §§ 567.1 567.2, 567.5 (1990) ....................................................................................... 7 12 C.F.R. § 567.8 (1989) ...................................................................................................... 30, 31 12 C.F.R. § 567.9(a) (1989) ........................................................................................................ 29 12 C.F.R. § 567.10(a)(4) ............................................................................................................... 9 12 U.S.C. §1464(t) (1989) ............................................................................................................ 7 12 U.S.C. §1464(t) ........................................................................................................................ 7 12 U.S.C.A. § 1464(s)(4) .............................................................................................................. 9 vii
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103 Stat. 183, 303 ......................................................................................................................... 9 Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat. 183 ("FIRREA") .................................................................. passim MISCELLANEOUS 5 A. Corbin, Corbin On Contracts §1039 (1964) ........................................................................ 18 E. Allen Farnsworth, Farnsworth On Contracts §12.11 at 217 (1990) ....................................... 18 Restatement of Contracts § 335 .................................................................................................. 21 Restatement (Second) of Contracts §§ 347, 351, 352 (1981) ..................................................... 15 Restatement (Second) of Contracts §347cmt. e .......................................................................... 20 Restatement (Second) of Contracts § 350 ................................................................................... 18 Restatement (Second) of Contracts § 350 cmt a. ...................................................................... 22 Restatement (Second) of Contracts § 350 cmt b. ................................................................ 21, 24 Restatement (Second) of Contracts § 350(1) (1981) ......................................................... passim Restatement (Second) of Contracts §351 (1) .............................................................................. 25 Restatement (Second) of Contracts §351 (2) .............................................................................. 25 Restatement (Second) of Contracts § 351 cmt a. (1981) ........................................................... 25 Restatement (Second) of Contracts § 351 cmt e. ....................................................................... 26
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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, v. UNITED STATES OF AMERICA, Defendant. ) ) ) ) ) ) ) ) ) ) ) )
No. 95-829C (Judge Wheeler)
DEFENDANT'S MEMORANDUM OF CONTENTIONS OF FACT AND LAW Pursuant to Paragraph 11, Appendix A of the Rules of the United States Court of Federal Claims, and this Court's Pretrial Order dated January 3, 2007, defendant, the United States, submits the following Memorandum of Contentions of Fact and Law. INTRODUCTION Plaintiff Sterling Savings Association ("Sterling") asserts lost profits,"mitigation," and wounded bank damages1 that were purportedly incurred as a result of the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat. 183 ("FIRREA"). The Court should reject Sterling's lost profits model because it is speculative and has no basis in fact. As a preliminary matter, Sterling's lost profits model is premised upon the thrift's Prior to December 2006, Sterling also maintained claims for restitution, reliance, and hypothetical replacement costs of capital damages. Sterling acknowledged, however, at the status conference held on December 15, 2006, that these theories are barred by precedent of the United States Court of Appeals for the Federal Circuit, and, therefore, will not be presented at trial. See, e.g., Fifth Third Bank v. United States, 402 F.3d 1221, 1237 (Fed. Cir. 2005); Glendale Fed. Bank, FSB v. United States, 239 F.3d 1371, 1381 (Fed. Cir. 2001).
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invalid assumption that, between 1989 and 2006, it never replaced a single dollar of the $15.557 in contractual goodwill eliminated by FIRREA, notwithstanding a legal duty to mitigate and actual mitigation. In 1991, Sterling raised $23 million in capital, achieving full compliance with FIRREA's regulatory capital requirements and fully replacing all of the contractual goodwill attributable to its acquisitions of Lewis Federal Savings and Loan Association ("Lewis Federal") and Tri-Cities Savings and Loan Association ("Tri-Cities"). Thus, Sterling's lost profits model projects damages through 2006 on the plainly incorrect assumption that Sterling never replaced the regulatory capital eliminated by FIRREA. Further, Sterling cannot demonstrate that its alleged lost profits were caused by the breach because the thrift would have been out of compliance with FIRREA's minimum capital requirements in 1989, even if the goodwill attributable to the Lewis Federal and Tri-Cities acquisitions had been permitted to count as regulatory capital. The lost profits model suffers from other fatal flaws that render it invalid. First, the model incorrectly assumes that FIRREA prevented Sterling from pursuing its investment strategy. It is undisputed that, in 1990, Sterling obtained an injunction prohibiting the Office of Thrift Supervision ("OTS") from enforcing any restrictions imposed due to Sterling's noncompliance with FIRREA's regulatory capital requirements. Moreover, the injunction applied to noncontractual goodwill associated with Sterling's acquisition of Central Evergreen Savings & Loan Association ("Central Evergreen") as well as the contractual goodwill associated with Sterling's acquisitions of Lewis Federal and Tri-Cities, thus rendering Sterling better off than it would have been absent the breach. Therefore, Sterling's lost profits model is
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counterfactual to the extent that it assumes that FIRREA prevented Sterling from achieving the thrift's growth projections. The model also fails to identify the assets and liabilities that Sterling would have acquired absent a breach, thus rendering its claimed lost profits speculative. In addition, the model fails to account for, or even acknowledge, that there would have been competition in the market for the assets Sterling assumes it would acquire. Similarly, the model's assumption that Sterling would have achieved additional growth absent the breach is inconsistent with the thrift's track record. Specifically, Sterling had faced difficulty in acquiring assets due to competition and lack of supply. Moreover, Sterling's assumptions that growth equates with profits and that incremental assets earn the same return as actual assets is at odds with its actual experience and fundamental principles of finance and economics. For these reasons, the court should reject the model. Sterling also advances a "mitigation" damages theory that purports to calculate the actual costs of replacing regulatory capital eliminated by FIRREA, although Sterling steadfastly maintains that it never replaced the goodwill. Indeed, Sterling devotes only one factual contention and one footnote to the theory in its contentions of fact and law. Sterling's Contentions at 11, 38. With the exception of the estimated transaction costs incurred in replacing the Lewis Federal and Tri-Cities goodwill, the Court should reject Sterling's mitigation theory because its hypothetical premise has been repeatedly rejected by the Federal Circuit and this Court. Fifth Third, 402 F.3d at 1237; LaSalle Talman Bank, FSB v. United States, 317 F.3d 1363, 1375 (Fed. Cir. 2003); California Federal Bank v. United States ("CalFed"), 43 Fed. Cl. 445, 460-61 (1999), aff'd in part, 245 F.3d 1342, 1350 (Fed. Cir. 2001); Franklin Fed. Savings Bank v. United States, 55 Fed. Cl. 108, 134-39 (2003); Columbia First Bank, FSB v. United 3
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States, 54 Fed. Cl. 693, 697-98 (2002);; Bank United v. United States, 50 Fed. Cl. 645, 655-56 (2001), aff'd, 80 Fed. Appx. 663 (Fed. Cir. Sept. 22, 2003). In 1991, Sterling replaced all of the goodwill attributable to its acquisition of Lewis Federal and Tri-Cities through a common stock offering and a conversion of preferred stock to common stock. Through this offering, Sterling achieved compliance with FIRREA's new capital standards. Sterling's expert, however, does not attempt to quantify the actual costs of issuing those securities in 1991. Instead, he assumes that, in 1991, Sterling sold preferred stock, and uses the dividend rate for that hypothetical preferred stock offering to calculate damages. This hypothetical model is contrary to the Federal Circuit ruling in LaSalle, 317 F.3d 1363 at 1375, and this Court in Granite Management Corp. v. United States, 58 Fed. Cl. 766, 778-79, aff'd in part and remanded in part on other grounds, 416 F.3d 1373 (Fed. Cir. 2005). The only true measure of Sterling's cost to replace its capital is its transaction costs. CalFed, 43 Fed. Cl. at 460-61 ("[o]n the day stock is issued, the amount you receive for the stock is equivalent to its worth and the only costs are transaction, or flotation costs."). Sterling also offers an assortment of so-called "wounded bank" damage claims, pursuant to which it seeks: 1) increased costs allegedly incurred to acquire a branch of another thrift known as Great American Savings and Loan; 2) losses on a loan, known as the CJ-4 Loan, claimed to result from FIRREA's requirements; 3) excess supervision costs purportedly based upon its status as a "troubled thrift," 4) transaction costs attributable to an unsuccessful 1989 public offering; and 5) legal, accounting, and insurance costs allegedly incurred in defending against regulatory interference. Plaintiffs offer no proof that the alleged breach caused these increased costs, or that the damages were foreseeable. In Coast Fed. Bank, FSB v. United States, 4
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48 Fed. Cl. 402, 434-41 (2000), aff'd, 323 F.3d F.3d 1035 (Fed. Cir. 2003), the trial court rejected a wounded bank claim upon summary judgment where plaintiff failed to demonstrate a causal link between the alleged damage and FIRREA. Further, Sterling's wounded bank claims suffer from other infirmities. For example, Sterling claims that the increased costs allegedly incurred in connection with the 1989 public offering resulted from its inability to pay preferred stock dividends. This claim is foreclosed because the Court has previously ruled that Sterling was not contractually entitled to pay dividends. Sterling Savings v. United States, 53 Fed. Cl. 599, 614-15 (2002). In addition, Sterling's claim for legal fees encompasses fees incurred in litigation that are foreclosed by statute. For these reasons, the Court should award a judgment to Sterling equal only to the transaction costs incurred in replacing the goodwill attributable to its acquisition of Lewis Federal and Tri-Cities. CONTENTIONS OF FACT I. STERLING'S ACQUISITIONS Sterling is a state-chartered, federally-insured stock savings association headquartered in Spokane, Washington. Compl. ¶ 1.1. Sterling commenced operations in 1983. Id. Sterling's damages claim arises out of the thrift's acquisition of two failing savings and loan institutions in the 1980s: Lewis Federal and Tri-Cities. While Sterling acquired another thrift in 1988, Central Evergreen Savings & Loan Association ("Central Evergreen"), the Court has held that the Government did not commit a breach of contract in connection with the acquisition. Sterling Sav. Assn. v. United States, 72 Fed. Cl. 404, 411 (2006).
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In November 1985, Sterling successfully bid for and acquired Lewis Federal, an insolvent institution with assets of approximately $52.5 million, pursuant to an acquisition agreement with the Federal Savings and Loan Insurance Corporation ("FSLIC"). P-18. Sterling did not invest any money in the acquisition. Instead, FSLIC, in its corporate capacity, executed an Assistance Agreement with Sterling in which FSLIC contributed $1.75 million to the acquisition, as well as other financial consideration. P-19. In addition, the Federal Home Loan Bank Board issued a forbearance letter. P-20. The Lewis Federal acquisition resulted in the creation of $3,606,389 in goodwill. P-72, p. SG1005264.2 In April 1988, Sterling acquired Tri-Cities. On April 7, 1988, the Federal Home Loan Bank Board ("FHLBB"), pursuant to Resolution No. 88-250, approved the acquisition, authorized an Assistance Agreement, and authorized and directed that a forbearance letter be sent to Sterling. P-30. The Assistance Agreement required a FSLIC cash contribution of $11,730,128.00. Again, Sterling did not invest any money in the acquisition. P-38. The TriCities acquisition resulted in the creation of approximately $14 million in goodwill. P-76, p. 0062989-0062990. In December 1988, Sterling acquired Central Evergreen. Although the Bank Board issued a resolution, No. 88-1273, approving the acquisition, and entered into an agreement with Sterling governing the maintenance of regulatory capital by Sterling, the Bank Board did not issue a forbearance letter or enter into an assistance agreement, and FSLIC did not provide cash
For purposes of this memorandum, the goodwill associated with the Lewis Federal and Tri-Cities acquisitions will be referred to as the "contractual goodwill," while the goodwill associated with the Central Evergreen acquisition will be referred to as the "noncontractual goodwill." 6
2
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assistance. P-47; DX 338. The Central Evergreen acquisition resulted in the creation of $22,803,000 million in noncontractual goodwill. P-78, p. PSG0270425. Sterling considered each of its acquisitions to be a success. In an OTS filing submitted in 1989, subsequent to the enactment of FIRREA, Sterling detailed the advantages of its acquisitions: These acquisitions have enabled [Sterling] to expand its deposit and mortgage delivery systems considerably in a relatively short period and have added significant assets, a more geographically diversified loan portfolio, and potential future tax benefits. . . . Through consolidation, the Association has reduced the cost of performing administrative functions and increased the operating efficiencies of these acquired institutions. Management of the Association believes that continued disciplined supervision of the assets acquired from Lewis Federal, Tri-Cities, and Central Evergreen will result in increased profitability to [Sterling.] DX 908. Prior to the enactment of FIRREA, Sterling considered shrinking its asset base to $650 million in an attempt to improve the negative tangible capital position that resulted from its acquisition of Central Evergreen. DX 342. On August 9, 1989, Congress enacted FIRREA. Among other things, FIRREA established new capital requirements. In particular, FIRREA, and the regulations promulgated to implement it, required thrifts to comply with three separate regulatory capital standards: a leverage (or "core capital") standard, a tangible capital standard, and a risk-based capital standard. 12 U.S.C. §1464(t) (1989); 12 C.F.R. §§ 567.1, 567.2, 567.5 (1990). "Qualifying supervisory goodwill" was to be phased-out gradually between 1990 and 1995. 12 U.S.C. §1464(t); 12 C.F.R. §563.13. In the intervening years, eligible savings associations were
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permitted to include qualifying supervisory goodwill to satisfy core and risk-based capital standards. Id. In November 1989, prior to the effective date of FIRREA's implementing regulations, OTS approved Sterling's application to acquire two branches of Great American Savings Bank. DX 376. Further, one of Sterling's assets, known as the "CJ-4" Loan, was placed into foreclosure by Sterling in November 1989. In connection with this loan, thrift examiners were aware that Sterling was considering the advance of additional funds to the borrower, and did not object. P181. Pursuant to a business plan adopted in connection with its acquisition of Central Evergreen, Sterling was required to raise $5 million in capital between 1989 and 1990. DX 1041. In December 1989, OTS declined to provide preapproval of Sterling's payment of dividends in connection with its pending plan to raise $12.5 million in capital through a preferred stock "units offering." P-415. This Court has held that Sterling did not have a contractual right to the payment of dividends. Sterling, 53 Fed. Cl. at 615. II. STERLING'S POST-FIRREA INJUNCTION AND CAPITAL RAISING As of December 31, 1989, Sterling failed to meet FIRREA's minimum capital requirements. By its own calculations, Sterling failed its tangible, core, and risk-based capital requirements by $22.8 million, $23.0 million, and $32.3 million, respectively. DX 422. At the time, Sterling retained only $15.557 in contractual goodwill attributable to the Lewis Federal and Tri-Cities acquisitions. DX 1046, Exh. 6, Table 4a. Pursuant to FIRREA's directive that all capital deficient thrifts "submit and adhere to" a plan setting forth the institution's strategy for 8
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increasing capital, Sterling filed an amended "Capital Restoration Plan" on February 28, 1990. 12 U.S.C.A. § 1464(s)(4), 103 Stat. 183, 303. DX 422. In that plan, Sterling acknowledged that, as of December 31, 1989, it failed to meet each of FIRREA's new capital standards. Id. To resolve its capital deficiency, Sterling proposed that it be acquired by another financial institution by May 31, 1990. Id. In April 1990, OTS approved Sterling's capital restoration plan on the condition that Sterling's board execute an operating agreement which, among other things, consented to the appointment of a receiver or conservator in the event that Sterling did not execute a definitive merger agreement. P-269. On May 10, 1990, Sterling declined to execute the operating agreement. P-270. On May 22, 1990, because Sterling had failed to meet FIRREA's capital standards, refused to consent to the operating agreement, and did not propose an acceptable remedy for its capital deficiency, OTS denied the capital plan and imposed certain operating restrictions on the thrift in an effort to ensure its safe and sound operation, pursuant to 12 C.F.R. § 567.10(a)(4). P420. In May 1990, Sterling filed suit in the United States District Court for the Eastern District of Washington and sought a temporary restraining order. The court issued a temporary restraining order ("TRO") in May 1990 and a preliminary injunction in August 1990. In its opinion granting the preliminary injunction, the court severely restricted OTS's and the Federal Deposit Insurance Corporations's ("FDIC") authority to regulate Sterling pursuant to FIRREA because the court determined that FIRREA did not preclude the agencies from honoring what it
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determined to be contracts with Sterling. Sterling Sav. Assn. v. Ryan, 751 F. Supp. 871, 881-82 (E.D. Wash. 1990), rev'd, 959 F.2d 241 (9th Cir. 1992). As a result of the injunction, the Government was "enjoined and restrained from:" a. imposing or enforcing any regulatory restriction or taking other regulatory action against Sterling that is inconsistent with the provisions of the November 1985, April 1988, and December 1988 supervisory acquisition agreements between Sterling and FHLBB and the FSLIC; enforcing or attempting to enforce the operating restrictions imposed by the January 26, 1990, March 9, 1990, and the May 11, 1990, letter from the Office of Thrift Supervision to Sterling that treat Sterling as a troubled thrift; placing Sterling in receivership or conservatorship; and interfering with Sterling's proposed public offering contemplated in the 1988 Central Evergreen acquisition agreement.
b.
c. d.
Id. OTS and FDIC filed a motion for reconsideration, which the court granted in part and denied in part in November 1990. Sterling, 751 F. Supp. at 882-83. The court determined that the prohibition against placing Sterling into conservatorship or receivership was overly broad, and narrowed that portion of the injunction to clarify that the "Government need only be enjoined from appointing a receiver or conservator to the extent that such action would not be appropriate when the contracts are honored and given effect." Id. at 884. OTS complied with the injunction's terms. In June, 1990, OTS notified Sterling that the agency intended to "strictly obey" the district court's order prohibiting it from enforcing any restrictions contrary to the agreements Sterling entered into in connection with its acquisitions of Lewis Federal, Tri-Cities, and Central Evergreen. P-279, P-285, P-288. Nonetheless, the agency
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did require Sterling to report any activity inconsistent with pre-injunction restrictions. P-279. This reporting requirement, however, did not affect Sterling's ability to realize any growth plans in place prior to the issuance of the injunction. Further, while the injunction was in place, the OTS permitted Sterling to operate as if its Central Evergreen goodwill was contractual regulatory capital notwithstanding this Court's ultimate determination that it was not. Sterling, 72 Fed. Cl. at 411. During the pendency of the injunction, which ultimately was dissolved in 1992, Sterling never needed to initiate an action to compel enforcement of the injunction or complain of Government noncompliance with the injunction. Indeed, Sterling's internal audit department referred to restrictions imposed prior to the issuance of the injunction as "OTS operational concerns stayed by preliminary injunction." DX 534. Moreover, in exam reports issued during the pendency of the injunction, examiners expressly acknowledged that OTS was enjoined from enforcing FIRREA's capital requirements. P-182, DX 252. While the injunction was in place, Sterling shrank its asset base. That shrink improved the thrift's profitability. DX 1051. Prior to the enactment of FIRREA, as Sterling's total assets increased from $433.953 million as of June 30, 1988, to $730.933 million as of June 30, 1989, Sterling's net income decreased from $1.2 million to $981,000, respectively. DX 1046, Exh. 3. Similarly, Sterling's profitability decreased from the fiscal year ended June 30,1986, through fiscal year end June 30, 1989, as demonstrated by its return on average assets, which declined as follows: 1.02 percent for 1985, .93 percent for 1986, .91 percent for 1987, .73 percent for 1988 and .65 percent for 1989. Id.
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In November 1991, Sterling raised approximately $23 million through a public offering of common stock and the conversion of $2.1 million in preferred stock to common stock. P-84, pp. 18, 28, 39; P-310, p. 14. At the time, Sterling held only $13.346 million in contractual goodwill. DX 1047, Exh. G. The public offering brought Sterling into compliance with all of FIRREA's minimum capital ratios. Id. The prospectus for the offering set forth the purpose for raising the capital: The primary purpose of the offering is to increase Sterling's regulatory capital levels. The net proceeds from this offering will be used to support the growth of Sterling's business, including the origination of loans. DX 913, p. 4. In addition, Sterling's 1992 Annual Report indicated that completion of the equity offering brought Sterling into compliance with FIRREA's capital standards: Fiscal 1992 was an outstanding year for Sterling Savings. Your company, profitable every year since its inception, reported record earnings this fiscal year. We also completed a $21 million equity offering, making Sterling one of the only thrifts in the nation to have met all applicable capital requirements after having been deemed to be in non-compliance with such requirements. Our primary regulator, OTS, had taken the position that FIRREA eliminated most of the capital regulatory provisions of acquisition agreements entered into during the late 80's. Our compliance with capital standards is a victory for us all our shareholders, customers, employees, and the communities we serve across the Pacific Northwest. P-84, p. 2 (emphasis added). The same 1992 annual report advised Sterling shareholders that, due to the capital raising, the Government' appeal of the issuance of the injunction was "not expected to have a material adverse effect on Sterling regardless of the ultimate outcome of the case." Id. at 31.
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According to Harold Gilkey, Sterling's Chief Executive Officer, the 1991 capital raising would not have occurred if Sterling had already been in capital compliance at the time, because Sterling would have had substantial excess capital. Deposition of Harold Gilkey, June 8, 2000, pp. 464-66. On more than one occasion, Sterling has acknowledged that the 1991 offering permitted it to recapitalize after FIRREA. DX 923, p. 3; DX 1002, p. 3. On April 14, 1992, the United States Court of Appeals for the Ninth Circuit reversed the district court decision imposing the injunction. Sterling Savings Assoc. v. Ryan, 959 F.2d 241. Relying upon Far West Federal Bank v. OTS, 951 F.2d 1093 (9th Cir. 1991), the Ninth Circuit concluded that "the stricter capital requirements in FIRREA apply to thrift institutions notwithstanding prior agreements by the government such as the agreements alleged by Sterling." Sterling, 959 F.2d at 241. On that basis, the Ninth Circuit vacated the district court's judgment and remanded the case to the district court. Id. By the time the Ninth Circuit issued its decision, however, Sterling had already completed its public offering and achieved compliance with FIRREA's capital requirements. In 1993, Sterling's holding company, Sterling Financial Corporation ("SFC"), raised approximately $17 million through a preferred stock offering, and downstreamed approximately $12 million to Sterling. In the prospectus, SFC noted increased capital requirements would be phased-in as of December 31, 1994. P-316, p. 7. As of September 30, 1992 (prior to the offering), however, Sterling "exceeded all regulatory capital requirements, including requirements . . . scheduled to be phased in through December 31, 1994." Id. at 10. Further, it was anticipated that Sterling would continue to meet all regulatory requirements in the future, although "there can be no assurance in this regard." Id. at 7. 13
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III.
STERLING'S LITIGATION IN THE COURT OF FEDERAL CLAIMS In 1995, Sterling filed its complaint in this Court. In 2002, the Court determined that the
Government breached contracts permitting goodwill to count as regulatory capital in connection with Sterling's acquisitions of Lewis Federal, Tri-Cities and Central Evergreen. Sterling, 53 Fed. Cl. at 615. As stated above, in 2006, the Court, upon reconsideration requested in light of the decision of the United States Court of Appeals for the Federal Circuit in Admiral Fin'l Corp. v. United States, 378 F.3d 1336, 1341 (Fed. Cir. 2004), determined that a breach had not occurred with respect to the Central Evergreen acquisition. Sterling, 72 Fed. Cl. at 411. The Court has issued several other rulings applicable to this proceeding. First, the Court has dismissed all contract claims asserted by plaintiff SFC because it did not exist at the time of Sterling's acquisitions, and is not in privity of contract with the Government. Sterling, 53 Fed. Cl. at 602 n.1.3 Therefore, SFC is barred from recovering upon the contract claims asserted by Sterling. Further, the Court, as indicated above, has determined that the Government did not undertake a contractual obligation to permit Sterling to pay preferred stock dividends after raising capital. Sterling, 53 Fed. Cl. at 614-15. Similarly, Sterling, in connection with its acquisition of Central Evergreen, did not obtain a contractual right to maintain regulatory capital at levels at variance with regulations. Id. at 615. In 2003, the Court determined that Sterling's Lewis Federal and Tri-Cities contracts required it to amortize any goodwill associated with FSLIC cash assistance it obtained at the time of the acquisition. Sterling Sav. Assn. v. United States, 57 Fed. Cl. 445, 455 (2003). In a
3
Only one noncontractual claim remains at issue in that both Sterling and SFC allege a taking of property contrary to law. The Court has deferred a ruling upon the taking claim until all contract claims are resolved. Sterling, 53 Fed. at 616 n.4. 14
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separate opinion, the Court determined that, while the District Court's issuance of the injunction in 1990 did not deprive Sterling of standing to sue, it may be relevant to damages. Sterling Sav. Assn. v. United States, 57 Fed. Cl. 234, 240 (2003). Sterling, at a status conference held on December 15, 2006, indicated its intent to abandon claims for restitution as a remedy, reliance, and hypothetical cost of replacement damages that had been asserted in the complaint. In addition, the Court has dismissed plaintiffs' claims for restitution as an affirmative claim, specific performance, and due process. Sterling, 53 Fed. Cl. at 616, n.4. CONTENTIONS OF LAW I. THE APPLICABLE LEGAL STANDARDS Sterling seeks expectation damages in this case. To recover expectation damages, Sterling must demonstrate that the damages it seeks "are actually foreseen or reasonably foreseeable, are caused by the breach of the promisor, and are proved with reasonable certainty." Bluebonnet Sav. Bank v. United States, 266 F.3d 1348, 1355 (Fed. Cir. 2001); see also Southern Calif. Fed. Sav. & Loan Ass'n v. United States, 422 F.3d 1319, 1334 (Fed. Cir. 2005); Bank of America, FSB v. United States, 67 Fed. Cl. 577, 584-85, (2005), appeals argued, Nos. 20065008, -5089, -5090 (Fed. Cir. Apr. 4, 2007); Restatement (Second) of Contracts §§ 347, 351, 352 (1981). The issues of causation, certainty, and foreseeability are questions of fact and, as we will demonstrate at trial, under the facts of this case, Sterling cannot prove entitlement to damages beyond the transaction costs associated with its 1991 capital raising. Sterling's statement of the legal standard applicable to expectation damages assumes that lost profits are the sole source of expectation damages, and must be awarded in each case. Sterling Contentions at 24. That assumption is contrary to precedent. The Court of Appeals for 15
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the Federal Circuit has reviewed many Winstar-related cases and has assessed the ability of plaintiffs to prove claims such as those presented by Sterling. In four opinions, the appellate court has explained the legal requirements applicable to lost profits claims and the factual circumstances in which these claims arise in Winstar -related cases, and observed that, "given the speculative nature of such a damages claim, . . . experience suggests that it is largely waste of time and effort to attempt to prove such damages" in a Winstar-related case. Glendale Fed. Bank, F.S.B., v. United States, 378 F.3d 1308, 1313 (Fed. Cir. 2004); accord Old Stone Corp. v. United States, 450 F.3d 1360, 1377 (Fed. Cir. 2006); CalFed, 395 F.3d at 1270-71; Fifth Third, 402 F.3d at 1237. This Court, like all courts, applies the least speculative, cost-minimizing methodology for calculating damages in a given case. See, e.g., Quiman v. United States, 39 Fed. Cl. 171, 185 (1997), aff'd, 178 F.3d 1313 (Fed. Cir. 1999). Courts do not seek to "penalize" parties that breach contracts. CalFed, 43 Fed. Cl. at 461 (punitive damages are "not the purpose of contract remedies"). Instead, the purpose of expectation damages is to put the non-breaching party in the financial position it would have been in had the breach not occurred, subject to the limitations upon these damages. Accordingly, the usual remedy for a breach of contract is "cover," or the difference between the cost of the item under the breached contract and the market price of the item at the time of the breach. See, e.g., United States v. Burton Coal Co., 273 U.S. 337 (1927); Estate of Berg v. United States, 231 Ct. Cl. 466, 469-74, 687 F.2d 377 (1982) (damages for the Government's breach of its obligation to redeem bonds at par value is the difference between the par value of the bonds and their market value at the time of breach).
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Sterling's assumption that lost profits are the only appropriate measure of its damages also ignores the thrift's4 duty to mitigate. Here, Sterling raised over $500 million in capital between 1991 and 2006, yet it claims that it never replaced, and could not replace, the $15.557 million in Lewis Federal and Tri-Cities goodwill remaining when FIRREA became effective. Sterling Contentions at 38. The duty to mitigate potential damages by raising replacement capital applies to claims for lost profits in the Winstar-related cases. Bank United, 50 Fed. Cl. at 662. Black-letter law requires a non-breaching party to attempt to mitigate its damages following another party's breach of contract. See, e.g., Sun Cal, Inc. v. United States, 25 Cl. Ct. 426, 432 n.10 (1992); Midwest Indus. Painting v. United States, 4 Cl. Ct. 124, 133 (1983). Accordingly, Sterling "may not recover those damages which could have been avoided by reasonable precautionary action on its part." Midwest Indus., 4 Cl. Ct. at 133. Because Sterling cannot recover expectancy damages if it "failed to take action to mitigate such damages," Quiman, 39 Fed. Cl. at 185-86, this Court precludes plaintiffs, like Sterling, from recovering expectancy damages when they did not make sufficient efforts to mitigate their damages. Everett Plywood Corp. v. United States, 206 Ct. Cl. 244, 512 F.2d 1082, 1092 (1975) (denying lost profits damages to a buyer of timber because there was no attempt to mitigate its losses by a cover transaction, such as procuring other timber as a substitute; nor evidence that such a substitute transaction would cost the plaintiff more than the withheld timber
While Sterling converted to a commercial bank in 2005, we will, for the sake of convenience, refer to it as a "thrift" herein. 17
4
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would have cost it); Restatement (Second) on Contracts § 350; 5 A. Corbin, Corbin On Contracts §1039 (1964); E. Allen Farnsworth, Farnsworth On Contracts §12.11 at 217 (1990). These decisions show that the Court should not award "lost profits" related to an investment strategy unless the plaintiff can prove it attempted to acquire capital in order to pursue that opportunity. II. THE COURT SHOULD REJECT STERLING'S LOST PROFITS MODEL BECAUSE IT IS SPECULATIVE AND HAS NO BASIS IN FACT A. Dr. Horvitz's Flawed Lost Profits Model
Sterling's lost profits claim is presented by Dr. Paul Horvitz. Dr. Horvitz estimates damages by creating a hypothetical "but for" bank in which supervisory goodwill counts as capital post-FIRREA.5 The hypothetical "but for" bank is based in its entirety upon a series of unrealistic assumptions. For instance, Dr. Horvitz simply assumes that, but for the alleged breach, Sterling would have had a much larger balance sheet and would have earned profits on the balance sheet at the same rate as the actual Sterling. DX 1036, p. 14. Dr. Horvitz also assumes that Sterling suffered damage during the pendency of the temporary injunction, notwithstanding the fact that the issuance of the injunction prohibited the Government from enforcing any breach-related growth restrictions. See generally DX 1036. In addition, he
The model assumes Sterling would be free from FIRREA's breaching provisions while other institutions with alleged goodwill contracts would be subject to the same provisions. Under the case law, however, all similarly situated institutions must be treated the same way in a "but for" world. See, e.g. Dolphin Tours, Inc. v. Pacifico Creative Service Inc., 773 F.2d 1506, 1510-12 (9th Cir. 1985) (a valid damage model must account for the fact that if one market participant becomes free of anti-competitive behavior, other similarly situated market participants become free as well); R.S.E., Inc. v. Pennsy Supply, Inc., 523 F.Supp. 954, 966 (M.D. Pa. 1981) (same). Putting aside other flaws in Dr. Horvitz's model, the incorrect assumption concerning other market participants, in and of itself, renders the model invalid. 18
5
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assumes that the "but for" Sterling would have raised $10.5 million in new capital in December 1989. DX 1046, Exh. 6, Table 3a. Absent that capital, his model yields zero damages. DX 1049. Moreover, Dr. Horvitz ignores the fact that, according to Sterling's own witness, Sterling replaced its goodwill in 1991. Gilkey Deposition, June 8, 2000, pp. 464-66. Using this invalid methodology, Dr. Horvitz incorrectly opines that Sterling incurred $58.164 million in lost profits damages between 1990 and September 30, 2006. DX 1046, Exh. 8. According to Dr. Horvitz's latest model,6 the addition of $15.557 in contractual goodwill to regulatory capital would have enabled the "but for" bank to acquire up to $427 million more in assets than those of the actual bank between 1989 and 2006. DX 1046, Exh. 6, Tables 1, 4a. According to the model, these incremental assets would have earned the same average return as Sterling's actual assets. DX 1036, p. 14. Dr. Horvitz calculates that the earnings on these "foregone assets" would have been approximately $58.164 million as of September 30, 2006. DX 1046. He also claims that the value of the goodwill remaining at that date would have been approximately $641,000, based upon Professor James's replacement model. DX 1046, p. 4.
In an initial expert report, dated September 6, 2001, Dr. Horvitz calculated lost profits through 2000 of $75.777 million, plus future damages of $21.264 million. DX 1036, p. 16. Dr. Horvitz based this calculation on his belief that goodwill associated with FSLIC assistance should not be amortized. In a supplemental report issued in February 2004, Dr. Horvitz adjusted his damages calculation to acknowledge that goodwill associated with FSLIC assistance provided in connection with the Lewis Federal and Tri-Cities acquisitions was required to be amortized. Sterling Savings v, United States, 57 Fed. Cl. 445, 455 (2003). DX 1044, pp. 1-2. The 2004 adjustment, however, resulted in greater lost profits, in the amount of $77.405 million, because Dr. Horvitz extended the lost profits calculation through 2003. Id. at 3. The damages alleged in Dr. Horvitz's current report, dated December 11, 2006, allegedly reflect this Court's recent ruling that the Government did not breach a contract in connection with Sterling's acquisition of Central Evergreen. Sterling, 72 Fed. Cl. at 411. 19
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At trial, we will demonstrate that Dr. Horvitz's lost profits model is invalid because he assumes that Sterling made no attempt to mitigate by replacing the $15.557 in contractual goodwill remaining as of December 31, 1989, notwithstanding Sterling's raising of nearly $500 million in new capital since that date and its acknowledgment that a 1991 capital raising resulted in recapitalization. Further, Dr. Horvitz's alleged lost profits were neither foreseeable at the time of contracting nor caused by the breach, and fail to meet the reasonable certainty test, as explained in greater detail below. B. The Lost Profits Damages In Dr. Horvitz's Model Are Invalid As A Matter Of Law Because His Calculations Ignore Sterling's Mitigation Of Damages Through Recapitalization In 1991
Dr. Horvitz's lost profits model is premised upon his assumption that, between 1989 and 2006, Sterling never replaced a single dollar of the $15.557 in contractual goodwill eliminated by FIRREA. This assumption, which ignores Sterling's duty to mitigate as well as its actual mitigation in 1991 by raising $23 million in new capital, renders the entire model invalid.7 The Court of Appeals for the Federal Circuit requires the Court to account for any mitigation a plaintiff undertakes as a result of a breach. LaSalle, 317 F.3d at 1371-72 (citing Restatement (Second) of Contracts §347(c) cmt. e). In LaSalle, the Federal Circuit held that recapitalization of the thrift that resulted in replacement of the lost goodwill constituted a substitute transaction that mitigated damages. Id. Here, Sterling's 1991 recapitalization, which it admits was for purposes of reaching capital compliance and would not have occurred but for the breach, is also a form of mitigation. Indeed, Sterling possessed a duty to mitigate. Bank United,
Professor James's estimate of lost profits is consistent with Dr. Horvitz's model and invalid for the same reasons. 20
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50 Fed. Cl. at 662. A plaintiff must mitigate "at the least cost to the defendant," Northern Helex Co. v. United States, 207 Ct. Cl. 862, 524 F.2d 707, 713 (1975), and is "under an obligation to avoid by a reasonable effort any damages which it should have foreseen," Chain Belt Co. v. United States, 115 F. Supp. 701, 714 (Ct. Cl. 1953) (citing Restatement of Contracts § 335), and "cannot recover damages for loss that he could have avoided by reasonable efforts." Robinson v. United States, 305 F.3d 1330, 1333 (Fed. Cir. 2002) (emphasis in original) (quoting Restatement (Second) of Contracts § 350, cmt. b). If a nonbreaching party fails to make any attempt to mitigate its damages, but instead merely attempts to impose all loss, even if it could have been avoided, upon the breaching party, the nonbreaching party will be precluded from recovering the amount of loss that could have been avoided. See, e.g., Midwest Indus., 4 Cl. Ct. at 133 ("nonbreaching or injured party may not recover those damages which could have been avoided by reasonable precautionary action on its part"); Toledo P. & W. Ry. v. Metro Waste Sys., 59 F.3d 637, 640 (7th Cir. 1995) ("[i]n the event [the injured party] fails to take reasonable steps to avoid additional harm, [the injured party] bears the risk of any increased damages which could have been avoided"); Restatement (Second) of Contracts § 350(1), at 126 (1981). The rationale of this rule is to provide an incentive to the nonbreaching party to reduce any damages resulting from the breach: Rationale. The rules stated in this Section reflect the policy of encouraging the injured party to attempt to avoid loss. The rule stated in Subsection (1) encourages him to make such efforts as he can to avoid loss by barring him from recovery for loss that he could have avoided if he had done so. The exception stated in
21
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Subsection (2) protects him if he has made actual efforts by allowing him to recover, regardless of the rule stated in Subsection (1), if his efforts prove unsuccessful. Restatement (Second) of Contracts § 350 cmt. a, at 127 (1981) (citation omitted). This Court's predecessor, the Court of Claims, has held that, if a contractor's damage is a direct result of the Government's breach of contract, and the contractor could have reduced its loss by expending money and subsequently seeking recovery of that money from the Government (in lieu of the entire claimed amount of the loss absent mitigation), the contractor's failure to do so precludes recovery. Fawick Corp. v. United States, 149 Ct. Cl. 623, 637 (1960). This principle applies in the Winstar-related cases as well. In American Federal Bank, FSB v. United States, 68 Fed. Cl. 346, 358-59 (2005), the Court rejected the plaintiff's lost profits claim in part because the model failed to recognize that the plaintiff had mitigated by raising replacement capital. In this case, in 1991, Sterling raised approximately $23 million in regulatory capital for purposes of achieving compliance with FIRREA's capital requirements. P-84, pp. 3, 27, 31. Sterling's Chief Executive Officer, Harold Gilkey, acknowledged at deposition that, absent the breach, Sterling would not have raised capital in 1991. Gilkey Deposition, June 8, 2000, pp. 364-66. Further, Sterling's 1992 Annual Report to shareholders expressly states: Fiscal 1992 was an outstanding year for Sterling Savings. Your company, profitable every year since its inception, reported record earnings this fiscal year. We also completed a $21 million equity offering, making Sterling one of the only thrifts in the nation to have met all applicable capital requirements after having been deemed to be in non-compliance with such requirements. Our primary regulator, OTS, had taken the position that FIRREA eliminated most of the capital regulatory provisions of acquisition agreements entered into during the late 80's. Our compliance with 22
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capital standards is a victory for us all our shareholders, customers, employees, and the communities we serve across the Pacific Northwest. P-84, p. 2 (emphasis added). The same 1992 annual report advised Sterling shareholders that, due to the capital raising, this litigation was "not expected to have a material adverse effect on Sterling regardless of the ultimate outcome of the case." Id. at 31. Consequently, Sterling mitigated its damages.8 Nonetheless, in his model, Dr. Horvitz assumes that, between 1989 and 2006, Sterling never replaced a penny of the goodwill associated with the Lewis Federal and TriCities acquisitions. Based on this assumption, he calculates damages through September 30, 2006. Dr. Horvitz's assumption that Sterling has never mitigated its damages invalidates his model as a matter of law.9 Further, Dr. Horvitz's failure to acknowledge Sterling's 1991 capital raising, as well as nearly $470 million in additional capital raising since 1991, DX 1046, Table 2a, reinforces another fatal flaw in his model. Specifically, the model posits that it is reasonably certain that replacement of the $15 million in contractual goodwill would have resulted in over $58 million in additional profits for Sterling. Id. at Exh. 6, Table 1. If, in fact, replacement of the $15 million in goodwill would have foreseeably resulted in $58 million in additional profits for the company, then Sterling, which acknowledges that it has raised nearly $500 million in capital since the enactment of FIRREA, should have experienced no difficulty in raising an additional $15 million in order to realize these profits. Thus, Sterling's, and Dr. Horvitz's,
Thus, at most, Sterling would be entitled to the transaction costs incurred in connection with the recapitalization. As we explain below, the lost profits that allegedly arose before the 1991 recapitalization are not recoverable for other reasons. 23
9
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insistence that Sterling never mitigated renders Dr. Horvitz's model inherently speculative, and precludes an award of lost profits because, as demonstrated above, it possessed a duty to mitigate, and it "cannot recover damages for loss that [ ] could have [been] avoided by reasonable efforts." Robinson v. United States, 305 F.3d at 1333 (emphasis in original)(quoting Restatement (Second) of Contracts, § 350, cmt. b). Sterling attempts to avoid its duty to mitigate by claiming that its status as a "lost volume seller" rendered it impossible to replace the goodwill eliminated by FIRREA. Sterling Contentions at 38-39. As a preliminary matter, Sterling is not a "lost volume seller." A "lost volume seller" is one who, upon a breach of contract, resells an article, e.g., a piece of equipment, to a second purchaser who would have