WASHINGTON, D.C. – In a case that begins at the dawn of the 1980s S&L crisis, the U.S. Court of Federal Claims has found “fair and reasonable” the opinion of an expert witness for S&L owners that the Government’s breach of their assistance agreements caused by the enactment of FIRREA cost them $18.6 million in economic value. Claims for future lost profits did not survive, however.
Publisher’s Note: You can comment on this story and see the complete case summary where the Court addresses a number of valuation methods and the defense expert’s testimony elsewhere on this blog.
Plaintiffs Holland and Ross purchased all of the shares in Rock Falls Savings & Loan Association in 1986, about the time that S&Ls were collapsing across the country. The FSLIC, which insured the thrift deposits, tried to get healthy thrifts to acquire insolvent ones. The plaintiffs entered into an assistance agreement with the FSLIC to purchase some S&Ls. The agreement included language that cash contribution from the FSLIC, the subordinated debenture and preferred stock purchased by the FSLIC could all be counted as regulatory capital on River Valley’s books – a provision that was wiped out with the enactment of FIRREA in1989. To purchase another thrift called San Antonio Federal Savings Bank, the pair had to find other investors and form a new entity. They acquired the bank. Its assets were sold at a significantly gain for the investors. First Bank acquired River Valley in 1995.
Holland, Ross and First Bank sued the Government for breach of contract. The court ruled in an earlier decision that the Government’s enactment of FIRREA did breach the contracts.
Losing on Future Lost Profits
In calculating damages, the Court reviewed the plaintiffs’ theories, starting with the claim that they suffered lost opportunity to purchase SAFSB; therefore losing potential profits or dividends. Rejecting this claim, the Court said that when seeking damages from future income generating property, the market value of the asset at the time of the breach must be considered, not lost actual profits that could have been produced in the future had a different set of circumstances occurred. Lost potential future income and dividends are not recoverable for the loss of the acquisition opportunity, the Court determined.
The plaintiffs argued that had the Government not breached the assistance agreements, River Valley would have been able to purchase SAFSB and would have received the huge profits from the sale of SAFSB’s assets. The Court explained that in order to recover for breach of contract, both the type and amount of damages must be foreseeable at the time of the contract. The Court found it was not reasonably foreseeable at the time the Government entered into the assistance agreements with River Valley that a breach in the agreement would lead to a loss of capital that would have prevented River Valley from purchasing a thrift at such a low price and then selling its assets for a windfall profit. The amount of profit was simply not foreseeable, the Court concluded.
Nor would the Court award damages under plaintiffs’ claim that they were entitled to damages equal to the value of the retained earnings that they had to use to replace the capital lost because of the Government’s breach (i.e. enacting FIRREA), and thus were not there for other uses by River Valley (for example as dividends to shareholders). Holland testified that the damages sustained by River Valley under this theory should be measured by the cost River Valley would have paid to raise sufficient capital on the open market to have covered the breached capital, had it not used its retained earnings. The Court rejected this argument reiterating the Federal Circuit’s refusal to award damages based on hypothetical transactions to raise capital.
Expert Testimony on Economic Value Damages
Finally, plaintiffs offered the alternative that River Valley’s economic value (referred to as “market value” or “going concern value”) was diminished as a result of the Government’s breach. The Court agreed with the application of the economic value approach and with the plaintiffs’ calculation of the amount of damages. It held that First Bank, as successor in interest to River Valley, should be awarded $18,623,000 in damages.
Plaintiffs relied on the expert testimony of Dr. Neil B. Murphy who concluded that River Valley’s economic value declined over the period of April 1988 to March 1991. Defendants tried to refute Dr. Murphy’s testimony, by using a mark-to-market valuation method. River Valley’s mark-to-market value increased during the referenced time period and thus defendant claims there was no damage to River Valley by the breach. Economic value is the appropriate valuation method to look to in this case because it is the value of an institution operating as a going concern and includes a valuation of assets, liabilities, the value of capital compared to liabilities (and thus the risk of seizure) and an estimate of cash flows that occur in the future. The mark-to-market valuation method strictly looks at a snapshot on a given day of assets and liabilities. This method is often associated with a liquidation value. The Court recognized the value of mark–to-market valuation, especially when evaluating things like the management of institutions’ portfolios. It concluded, however, that economic value is more appropriate here to evaluate this business as a going concern.
The Court concluded that because there is evidence that the economic value of River Valley did decline over the relevant time period, and since defendants could not refute that the decline was the result of the breach, the plaintiffs did prove diminished value. The Court added that even if River Valley overcame the breach and was able to increase economic value during this period, it is not precluded from recovering damages, because without the breach, it might have had even great economic value gains.
Valuation Expert’s Qualifications
Even though the Government did not object to Dr. Murphy’s qualifications at trial, they did so in argument to the Court. The defendant tried to attack his credibility and his approach to the valuation of a thrift/financial institution as flawed. The Government argued that Dr. Murphy is only an academic and lacks real world experience in valuing financial institutions and instruments. The Court felt it “disingenuous” to raise this argument on appeal, when failing to do so at trial. Moreover, the Court went on to discuss the merits of Dr. Murphy’s qualifications; Dr. Murphy testified that he did have experience as an expert witness in valuing damages to financial institutions (the fact that Dr. Murphy had never been hired by a bank or thrift to perform a valuation was not relevant in light of this experience); Dr. Murphy has a PhD in economics; he has published approximately sixty articles in journal; is a professor of finance at Virginia Commonwealth; and, has received several prestigious awards. Therefore, the Court concluded that he does not lack the experience to give a reasonable estimate of damages suffered by plaintiffs . . . .
The plaintiffs were represented by Arnold & Porter LLP of Washington, DC. The Government was represented by several trial attorneys, litigation counsel and a deputy assistant attorney general with the Justice Department