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The Novel Procedural Complexities in Perry Capital v. Lew

6/30/2016

Richard Epstein

On April 15, 2015, the Court of Appeals for the District of Columbia Circuit heard oral argument in Perry Capital LLC v. Lew, in which Perry Capital challenged the Net Worth Sweep (NWS) put into place by the Third Amendment to the Senior Preferred Stock Purchase Agreements (SPSPA) of August 17, 2012. Those agreements were made between the Federal Housing Financial Agency (FHFA) and the Department of the Treasury. On September 30, 2014, District Court Judge Royce Lamberth roiled the market when, unexpectedly, he granted FHFA and Treasury’s motion for summary judgment on the merits. In anticipation that the Circuit Court would soon decide the case, I published on June 15, 2016, an analysis of the oral argument, intended to explain why the Net Worth Sweep (NWS) gave the government a huge windfall that under every conceivable future scenario sucked dry all the value in the junior preferred and common stock held by the private shareholders in two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.

The D.C. Circuit’s Questions

During the oral argument before Judge Lamberth, the lawyers for both sides addressed only the substantive issues in the case. Then, without warning, on June 21, 2016, the Circuit Court on its own motion issued an order addressing key issues of subject-matter jurisdiction and sovereign immunity that had previously been glossed over in the case. The order reads as follows:

The D.C. Circuit seeks supplemental briefing on the following questions:

(i)  Regarding the ‘class plaintiffs’ claim against Treasury for breach of fiduciary duty, is there a grant of subject matter jurisdiction and a waiver of sovereign immunity that is not the Federal Tort Claims Act?

(ii)  Regarding all the class plaintiffs’ other claims:

  1. Is each defendant subject to suit absent a waiver of sovereign immunity and, if not, is there such a waiver? The answer to this question should include a discussion of whether the FHFA’s challenged actions were taken solely in the agency’s capacity as conservator for Fannie Mae and Freddie Mac, or whether they were taken in whole or in part in a regulatory capacity
  2. What is the source of subject matter jurisdiction over the claims?

Before turning to these specific queries, we should ask, why this order at this time? Clearly, Judges Millett and Brown and Senior Judge Ginsburg had ample time to moot the underlying substantive questions. If they thought that Judge Lamberth was correct, they could have issued an opinion that tracked his reasoning without further briefing. The surprise request from the panel suggests, at the very least, that the judges do not think that the substantive issues are cut and dry in favor of the government. So what should the answers be to their queries?

As usual, I answer these questions in my role as an advisor to several institutional investors. The simplest way to deal with this question is to start with the jurisdictional issues; thereafter I shall turn to the sovereign immunity questions, which pose greater difficulties, and finally to the question of whether any judicial deference is owed FHFA and Treasury in this contractual dispute. The basic inquiry must take into account that FHFA is an independent agency, while the Department of the Treasury is part of the United States to which different rules apply. The matter is still more complex because the correct answers depend in part on the underlying nature of the claim: what relief is sought, and for what reason.

Subject matter jurisdiction

Subject matter jurisdiction is governed in part by 28 U.S.C. § 1331, which provides simply that:

The district courts shall have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States.

It is hard to think of any reason why the action for breach of duty against FHFA does not fall under this provision. In each case, the plaintiffs rely on the substantive provisions of the Housing and Economic Recovery Act of 2008 (HERA) to advance claims that FHFA entered into agreements in violation of its duties as conservators of the Enterprises, which required it to uphold its fiduciary responsibilities to preserve and conserve assets, to allow the GSEs to return in sound and solvent condition into the private marketplace. 12 U.S.C. § 4617(b)(2)(D). Any cause of action that pursues this claim arises under the laws of the United States. The plaintiffs further allege that FHFA was in violation of its duties as trustee when it entered into the Third Amendment after December 31, 2009, when it had no power to give away the assets of the private GSE shareholders under 12 U.S.C. §§ 1455 (l)(1(A), 1719(g)(1)(B). Section 6.4 of each SPSPA contains an explicit reference to federal law as the primary source of authority: “This Agreement and the Warrant shall be governed by, and construed in accordance with, the federal law of the United States of America if and to the extent such federal law is applicable, and otherwise in accordance with the laws of the State of New York.” Similarly, the stock certificates for the senior preferred stock provide, in the case of Fannie Mae, that “the respective rights and obligations of the Company and the holders of the Senior Preferred Stock with respect to such Senior Preferred Stock shall be construed in accordance with and government by the laws of the United States, provide that the law of the State of Delaware shall serve as the federal rule of decision in all instances except where such law is inconsistent with the Company’s enabling legislation, its public purposes and any provision of this Certificate.” The analogous provisions for Freddie Mac specify the laws of Virginia instead of Delaware. In both cases, the content of state law is adopted as part of federal law, which again shows how this dispute necessarily arises under the laws of the United States.

As noted in my June 15, 2016 column—but not addressed by the Circuit Court in its question—the duties imposed by HERA on FHFA are distinct from those that are imposed on Treasury. The fiduciary duties against FHFA rest securely upon the duties that HERA imposes on it. The situation with respect to Treasury is distinguishable, however, because at no time has it explicitly taken on the role of manager of the Fannie and Freddie obligations. More specifically, the Certificates for both Fannie and Freddie contain the following provision: “Except as set forth in this Certificate or otherwise required by law, the shares of the Senior Preferred Stock shall not have any voting powers, either general or special.” There are no voting rights that would allow the holders of the senior preferred stock to vote on the terms of the Third Amendment as contracted between Treasury as the purchaser of the senior preferred stock, and FHFA and the GSEs as sellers of the senior preferred stock. Nor has Treasury exercised its warrants to acquire voting common shares. Nonetheless, the trustee relationship could be established in two other ways. The first is that the Treasury assumed the role of a de facto trustee by acting in concert with FHFA in making all of these decisions. All the evidence suggests that neither FHFA nor Treasury respected any of the differences between them, but acted as if a single entity.

In addition, the standard principles of equitable jurisdiction are sufficient to impose trust obligations on Treasury as a constructive trustee when it received the funds from the two GSEs. This remedy is well known and its basic outline is the same in virtually all jurisdictions. “A constructive trust is not an actual trust by the traditional definition. It is a legal fiction that is used as a remedy for unjust enrichment. Hence, there is no trustee, but the constructive trust orders the person who would otherwise be unjustly enriched to transfer the property to the intended party.” The principle dates back to Roman times: “He also who received something that was not due from a person who paid him through mistake, is liable under a contract of this description. . . This species of obligation does not, however, appear to arise from a contract, for a party who gives with the intention of paying a debt, rather desires to discharge an obligation than to incur one.” Gaius Institutes Book III.91. Similarly, under the Restatement of Restitution, “Legal rules that give the property to the wrongdoer cannot simply be ignored, but they can be accommodate to the doctrine prohibiting unjust enrichment by a simple, equitable device: a decree that the wrongdoer holds the property as constructive trustee for someone else.” Restatement (Third) of Restitution and Unjust Enrichment, Chapter 5, Topic 2, Introductory Note (2011). The constructive trust does not create a full-blown trust under which the trustee has the usual duties of management and loyalty. The trust is imposed solely to make sure that the trustee, so called, carries out his or her legal duty to convey the property to its proper owner. The limited nature of the duty makes it easy to enforce by equitable decree.  All that is asked in Perry is to impose a constructive trust on Treasury to return the money to which it had no right to receive in the first place.

The remedy is the same whether the plaintiffs win because the basic transaction was corrupt under a breach of trust theory or because it was entered into after the December 31, 2009 date for bailout transactions.  In each case, the correct form of equitable relief is to impose a constructive trust on Treasury to return the money, which it had no right to receive in the first place.  Under this theory, there is subject-matter jurisdiction over Treasury in the federal district courts under 28 U.S.C. § 1346(b) given that the United States (including the Department of the Treasury) is a party to the suit. The action for breach of fiduciary duty under any of the above theories is therefore rightly brought in federal court.

Sovereign Immunity                                

The question of immunity from suit based on the sovereign status of the United States is much more difficult to answer. The principle of sovereign immunity applies both to the federal government and to the states. In Block v. North Dakota, the Supreme Court wrote that “[t]he basic rule of federal sovereign immunity is that the United States cannot be sued at all without the consent of Congress.” 461 U.S. 273 (1983).  In Lane v. Pena, the Court added that “waiver of the Federal Government’s sovereign immunity must be unequivocally expressed in statutory text.” 518 U.S. 187 (1996). As stated, the rule applies to all forms of legal relief, including money damages, and all forms of equitable relief, including the issuance of an injunction.

Stated in this form, sovereign immunity has always been the source of deep intellectual discomfort because of the enormous leeway it gives to the federal government to disregard its contracts and to seize private property with impunity unless it explicitly consents to be sued. Indeed, this principle is in sharp tension with the common public understanding that the Constitution is intended to protect individuals from the very forms of abusive government conduct that the principle of sovereign immunity shields. In response to these insistent and justifiable demands, Congress has passed legislation under which it explicitly supplies consent in general form to much litigation against the United States. At this point the grounds for subject matter jurisdiction differ from FHFA and Treasury. As the first question indicates, the waiver of sovereign immunity in this instance cannot rest on the Federal Torts Claims Act (FTCA), which in 28 U.S.C. § 2674 provides a general waiver “relating to tort claims to the same extent as a private individual under like circumstances.” This waiver is subject to a long list of exceptions found in § 2680, including suits that arise out of the performance of, or any failure to perform, any “discretionary function.” That exception has been read so broadly in earlier cases that Perry Capital cannot be successfully maintained under the waiver contained in the FTCA, which is why the Circuit Court explicitly puts it aside as a possible source of jurisdiction.

Nonetheless, sovereign immunity is clearly waived with respect to FHFA under 12 U.S.C. § 1723(a), which authorizes the GSE “to sue and to be sued, and to complain and to defend, in any court of competent jurisdiction, State or Federal.” The Supreme Court has held that “a congressional charter’s ‘sue and be sued’ provision may be read to confer federal court jurisdiction if, but only if, it specifically mentions the federal courts.” American National Red Cross v. S.G., 505 U.S. 247 (1992). The provision in 12 U.S.C. § 1723(a) surely satisfies this test, because there is no ambiguity in this waiver of jurisdiction. That waiver applies, moreover, to any and all theory of relief, be it legal or equitable. Hence a money damage action against FHFA, including a suit for restitution based on a theory of unjust enrichment, is permissible. So too is any action for injunctive relief that seeks to prohibit any further payments to Treasury under the NWS, and so too is any request for specific performance of other obligations that FHFA might have incurred under HERA.

It should also be evident that FHFA does not have the resources to pay any judgment lodged against it for breach of the fiduciary duty for the NWS, given that all the free cash has already been paid over to Treasury. The question then is whether it is possible to force FHFA to recover the money from Treasury on behalf of the private shareholders of the GSEs, or, in the alternative, to treat these excess sums paid over as a de facto redemption of the senior preferred stock. The last point is critical because each reduction in the amount of outstanding senior preferred stock reduces the interest burden on the remaining outstanding stock, which means that the cash position of the GSEs improves with each overpayment.

Bringing these theories against FHFA, however, would amount to an end run around sovereign immunity if the GSEs could not sue Treasury directly.  Suit against Treasury, however, is not authorized under the “sue and be sued” clause, which is applicable only to the GSEs. But it is possible to establish subject-matter jurisdiction over Treasury under 5 U.S.C. § 702, part of the Administrative Procedure Act, which contains a waiver of sovereign immunity as to actions “seeking relief other than money damages . . . Provided, That any mandatory or injunctive decree shall specify the Federal officer or officers (by name or by title), and their successors in office, personally responsible for compliance.”

As is evident from this section, a court can order specific officers not to do specific acts by issuing an injunction. A court can also order specific officers to do something by way of a mandatory decree. The term “decree” in this passage refers to judgments issued by a court sitting in its equitable capacity. Therefore, it is evident that nothing in Section 702(a) prohibits an order that the government not receive further money from FHFA, and it is arguable—this is a controversial point developed below—that under a constructive trust theory a court can mandate that the government return the money that it has illegally received as well. The proposition here covers cases of payment of money, but extends beyond that to the transfer of any other form of property to the plaintiff. In all cases, the defendant is only asked to disgorge what he has improperly received. There is no claim for the payment of independent funds held by Treasury.

In this case, given the illegal NWS, the plaintiffs only request a return of the money that has been paid over—ideally with interest, in order to neutralize the risk that the defendant will stonewall the plaintiff, trying to secure what is tantamount to an interest-free loan. The constructive trust theory is fully applicable under standard equitable principles for two reasons. First, Treasury, which organized this transaction, knows that FHFA paid them over in breach of its fiduciary duties to the private GSE shareholders. Indeed, Treasury here is not even a bad-faith purchaser, since it gave no consideration of any kind (not even the release of some antecedent debt) in exchange for the money that it received. In essence, it was a bad-faith donee. Second, it is clear that these new transactions took place after the December 31, 2009 cutoff date.

Thus, the overall situation looks like this. If FHFA had turned over all the shares of junior preferred and common stock to Treasury, then the duty of restitution would require that those shares be returned. If the money that had been paid over in gold bullion, then Treasury would have had to return it as well. If the money paid over was segregated into a separate account, then those dollars would have to returned too. In all of these cases, the restitution remedy permits a general raid on the Treasury because the relief only undoes ill-gotten gains. It does not impose a fresh liability on the Treasury.

Accordingly, this case falls clearly on the equitable side of the line. As an initial premise, the Supreme Court, citing Joseph Story, held in Teamsters v. Terry that actions against a trustee for breach of fiduciary duty “were within the exclusive jurisdiction of the courts of equity,” which meant in that context that the beneficiaries under a trust were not entitled to a jury trial because they were not “suits at common law,” for which the right to a jury trial is preserved under the Seventh Amendment to the Constitution. 494 U.S. 558 (1990).  As the Supreme Court noted in Bowen v. Massachusetts,

The term ‘money damages,’ 5 U. S. C. § 702, we think, normally refers to a sum of money used as compensatory relief. Damages are given to the plaintiff to substitute for a suffered loss, whereas specific remedies `are not substitute remedies at all, but attempt to give the plaintiff the very thing to which he was entitled.’ D. Dobbs, Handbook on the Law of Remedies 135 (1973). Thus, while in many instances an award of money is an award of damages, ‘[o]ccasionally a money award is also a specie remedy.’ Id. Courts frequently describe equitable actions for monetary relief under a contract in exactly those terms. 487 U.S. 879, 895 (1988).

Bowen’s test would be too broad if it allowed every action for contract or tort damages to be recharacterized as a claim for specific relief that falls outside the scope of Section 702. Thus, in Hubbard v. Administrator, E.P.A., the D.C. Circuit held that the United States had not “waived sovereign immunity for a back pay award to an individual denied federal employment in violation of his constitutional rights.” 982 F.2d 531 (D.C. Cir. 1992) (en banc). That claim could not be for restitution, correctly understood, because there were no goods or services delivered to the defendant that had to be restored. The claim was really for payment of full wages for services never rendered, best understood as a disguised claim for expectation damages, not restitution. In contrast, the plaintiffs in Perry Capital have no contract action of any to recover what was illegally taken from them by Treasury.

Similarly in Kalodner v. Abraham, the plaintiff lawyers had helped consumer groups secure refunds of excess payments under the Emergency Petroleum Allocation Act, for which they claimed compensation under the common fund doctrine—yet another variation on the principle of unjust enrichment—to recover fees from money that the United States held in escrow for distribution to the individual consumers. 310 F.3d 767 (D.C. Cir. 2002). Yet their restitution claims were not against the United States but against the consumers.  They were brought, moreover, after the plaintiffs had previously received a direct payment from the underlying defendant, Occidental Petroleum, as part of the overall settlement of the case. The government received no unjust enrichment from operating an escrow account. Accordingly, the court treated the plaintiffs as if they were asking the government to pass judgment on who should get the disputed funds. By applying sovereign immunity, the court kept the government from being caught in the cross-fire between two parties where it claimed no beneficial interest. The plaintiffs in Kalodner were trying for an end run around the usual rules of restitution. The D.C. Circuit also noted that once the funds were distributed, sovereign immunity did not prevent the plaintiffs from bringing their common fund claim against the consumers. Again, there was no demand for restitution from the government of the sort made in Perry Capital, where the plaintiffs have no other way to get their money back. So long as money is fungible, it is ludicrous to insist that full recovery is possible by tethering the claim to specific dollars but not otherwise.

The restitution remedy has also been allowed notwithstanding Section 702(a) where it is “restitutionary or if it was incidental to or intertwined with injunctive relief.” Teamsters, 494 U.S. at 571. In this case, it is beyond dispute that the plaintiffs are entitled to obtain an injunction that prevents the defendant from receiving any further payments from FHFA. It is not defensible to argue that it can undercut the effectiveness of that injunction by adopting delaying tactics in litigation so that it can keep all money it illegally received from FHFA until it finally runs out of excuses and appeals. The restitution remedy completes the task of relief that the injunction begins. It is the type of mandatory decree that is contemplated in Section 702(a), and is thus incidental to and intertwined with equitable relief, which could also include treating excess payments made as an implicit redemption of senior preferred shares. It is inconceivable that the availability of sovereign immunity should turn on the line between restoration and set-off of the exact same dollars. All equitable remedies, including restitution, are allowable against FHFA and Treasury.

Administrative Deference

The final question posed by the D.C. Circuit is whether “the FHFA’s challenged actions were taken solely in the agency’s capacity as conservator for Fannie Mae and Freddie Mac, or whether they were taken in whole or in part in a regulatory capacity.” That is a question that receives a definitive answer: no part of the government’s actions was done in its regulatory capacity, either by FHFA or Treasury. The explicit terms of the 2008 bailout says it all: the transaction was called the Senior Preferred Stock Purchase Agreement. Over and over again, the parties were described as sellers and purchasers. The separate statutory authorizations under HERA for both FHFA and Treasury were solely for entering these agreements. The Third Amendment to the SPSPA was also an agreement signed by Timothy Geithner for Treasury and Edward DeMarco for FHFA, without any rulemaking activity of any kind, tailored precisely to this case. FHFA and Treasury need to keep their interactions contractual in order to deal promptly with this unique emergency situation, without the fuss and bother of administrative rulemaking in any of its endless variations. This unique agreement was indispensable for the bailout process to work.

Understanding the contractual base of this transaction means that the government is not entitled to any sort of deference in enforcing this deal. In United States v. Winstar, Justice Souter noted that in “evaluating the relevant documents and circumstances, we have, course, followed the Federal Circuit in applying ordinary principles of contract construction and breach that would be applicable to any contract action between private parties.” 518 U.S. 839, 871 (1996). Accordingly, the Supreme Court’s 1984 decision in Chevron v. NRDC, with all its countless variations, has no application. 467 U.S. 837.

In conclusion, none of the three issues raised by the D.C. Circuit prevents this case from being decided on its merits. There is full subject-matter jurisdiction over both parties. The doctrine of sovereign immunity has been effectively waived, and the rule of administrative deference does not apply to contract disputes to which the government is a party.

Original Article from Forbes

More Resources Below:

New unsealed court documents from Fannie & Freddie Secrets

GSE Links

Investors Unite

Howard on Mortgage Finance

GlenBradford.com

New filing in the Robinson case, click here to view.

New filing in the Saxton case, click here to view.

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