United States v. Winstar

Facts

The Savings and Loan Crisis was in full swing. To mitigate damages deregulation of the industry was immediately implemented. While the regulators tried to mitigate the squeeze on the thrift industry generally through deregulation, the multitude of already-failed savings and loans confronted FSLIC with deposit insurance liabilities that threatened to exhaust its insurance fund. By 1988, the year of the last transaction involved in this case, FSLIC was itself insolvent by over $50 billion and by early 1989, the GAO estimated that $85 billion would be needed to cover FSLIC's responsibilities and put it back on the road to fiscal health. It was estimated that the total cost was $140 billion. The Bank Board chose to avoid the insurance liability by encouraging healthy thrifts and outside investors to take over ailing institutions in a series of 'supervisory mergers.' The principal inducement for these supervisory mergers was an understanding that the acquisitions would be subject to a particular accounting treatment that would help the acquiring institutions meet their reserve capital requirements imposed by federal regulations. The purchase method of accounting under GAAP permits the acquiring entity to designate the excess of the purchase price over the fair value of all identifiable assets acquired as an intangible asset called 'goodwill.' Recognition of goodwill under the purchase method was essential to supervisory merger transactions of the type at issue in this case. Supervisory goodwill was attractive to healthy thrifts for at least two reasons. First, thrift regulators let the acquiring institutions count supervisory goodwill toward their reserve requirements under 12 CFR Section(s) 563.13 (1981). This treatment was, of course, critical to make the transaction possible in the first place, because in most cases the institution resulting from the transaction would immediately have been insolvent under federal standards if goodwill had not counted toward regulatory net worth. From the acquiring thrift's perspective, however, the treatment of supervisory goodwill as regulatory capital was attractive because it inflated the institution's reserves, thereby allowing the thrift to leverage more loans (and, it hoped, make more profits). A second and more complicated incentive arose from the decision by regulators to let acquiring institutions amortize the goodwill asset over long periods, up to the forty-year maximum permitted by GAAP. At the same time that it amortizes its goodwill asset, however, an acquiring thrift must also account for changes in the value of its loans, which are its principal assets. The loans acquired as assets of the failed thrift in a supervisory merger were generally worth less than their face value, typically because they were issued at interest rates below the market rate at the time of the acquisition. This differential or 'discount,' appears on the balance sheet as a 'contra-asset' account, or a deduction from the loan's face value to reflect market valuation of the asset. Because loans are ultimately repaid at face value, the magnitude of the discount declines over time as redemption approaches; this process, technically called 'accretion of discount,' is reflected on a thrift's income statement as a series of capital gains. The advantage in all this to an acquiring thrift depends upon the fact that accretion of discount is the mirror image of amortization of goodwill. Thrift regulators typically agreed to supervisory merger terms that allowed acquiring thrifts to accrete the discount over the average life of the loans (approximately seven years), while permitting amortization of the goodwill asset over a much longer period. Given that goodwill and discount were substantially equal in overall values, the more rapid accrual of capital gain from accretion resulted in a net paper profit over the initial years following the acquisition. The difference between amortization and accretion schedules thus allowed acquiring thrifts to seem more profitable than they were. Congress then enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The statute required thrifts to 'maintain core capital in an amount not less than 3 percent of the savings association's total assets,' 12 U. S. C. Section(s) 1464(t)(2)(A), and defined 'core capital' to exclude 'unidentifiable intangible assets,' 12 U. S. C. Section(s) 1464(t)(9)(A), such as goodwill. The impact of FIRREA's new capital requirements upon institutions that had acquired failed thrifts in exchange for supervisory goodwill was swift and severe. After the passage of FIRREA, federal regulators seized and liquidated the Winstar and Statesman thrifts for failure to meet the new capital requirements. Although the Glendale thrift also fell out of regulatory capital compliance as a result of the new rules, it managed to avoid seizure through a massive private recapitalization. Believing that the Bank Board and FSLIC had promised them that the supervisory goodwill created in their merger transactions could be counted toward regulatory capital requirements, respondents each filed suit against the United States in the Court of Federal Claims, seeking monetary damages on both contractual and constitutional theories. That court granted respondents' motions for partial summary judgment on contract liability, finding in each case that the Government had breached contractual obligations to permit respondents to count supervisory goodwill and capital credits toward their regulatory capital requirements. This was eventually affirmed on appeal. The Supreme Court granted certiorari. 

Issues

Rule of Law

Holding and Decision

Legal Analysis

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