12 F.3d 1485 (9th Cir. 1993), 91-15511, Murphy v. F.D.I.C.

Docket Nº:91-15511, 91-15640 and 91-15642.
Citation:12 F.3d 1485
Party Name:Patrick J. MURPHY, et al., Plaintiffs-Appellees, v. FEDERAL DEPOSIT INSURANCE CORPORATION, et al., Defendants-Appellants. Patrick J. MURPHY, an Individual; Murphy's Markets, Inc., a California Corporation; Ramsey Marketing and Management Co. (
Case Date:December 10, 1993
Court:United States Courts of Appeals, Court of Appeals for the Ninth Circuit
 
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Page 1485

12 F.3d 1485 (9th Cir. 1993)

Patrick J. MURPHY, et al., Plaintiffs-Appellees,

v.

FEDERAL DEPOSIT INSURANCE CORPORATION, et al.,

Defendants-Appellants.

Patrick J. MURPHY, an Individual; Murphy's Markets, Inc., a

California Corporation; Ramsey Marketing and Management Co.

("Ramco"); aka Ramsay Marketing and Management Co., a

California Corporation, Plaintiffs-Appellants,

v.

FEDERAL DEPOSIT INSURANCE CORPORATION, et al., Defendants-Appellees.

FEDERAL DEPOSIT INSURANCE CORPORATION; First National Bank,

Plaintiffs-Appellees,

v.

Patrick J. MURPHY, Defendant-Appellant.

Nos. 91-15511, 91-15640 and 91-15642.

United States Court of Appeals, Ninth Circuit

December 10, 1993

Argued and Submitted Sept. 14, 1992.

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William A. Norris, Circuit Judge, dissented and filed opinion.

E. Whitney Drake, F.D.I.C., Washington, DC, Patrick J. Hogan and John D. O'Connor, Tarkington, O'Connor & O'Neill, San Francisco, CA, for F.D.I.C.

John F. Wells, Stark, Wells, Rahl, Field & Schwartz, Oakland, CA, and William C. Rust, Jr., San Francisco, CA, for Murphy.

Appeal from the United States District Court for the Northern District of California.

Before: SCHROEDER, NORRIS, and BRUNETTI, Circuit Judges.

SCHROEDER, Circuit Judge:

This is a dispute between the Federal Deposit Insurance Corporation and Patrick J. Murphy, the holder of two letters of credit issued by a failed bank, The First National Bank, Chico. Mr. Murphy was an investor in the parent company of the bank, Pacific National Bancshares ("PNB"), and had also served as one of PNB's directors. The Bank

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issued the letters of credit as security for the obligations of PNB to Murphy.

In this litigation, Murphy sought to enforce the letters of credit against the FDIC in its corporate capacity as assignee of the assets and liabilities of the bank. The FDIC defended on the ground that it was not responsible for obligations of the Bank that were not properly carried on its books and records, relying upon the doctrine of D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 62 S.Ct. 676, 86 L.Ed. 956 (1942), and its partial codification in 12 U.S.C. Sec. 1823(e). The FDIC also contended that it was not responsible for the Bank's obligations that violated federal statutes prohibiting inadequately secured credit transactions between the Bank and affiliate entities. See 12 U.S.C. Secs. 371c(c), 375b. The district court, relying upon our decision in First Empire Bank v. FDIC, 572 F.2d 1361 (9th Cir.), cert. denied, 439 U.S. 919, 99 S.Ct. 293, 58 L.Ed.2d 265 (1978), ruled that the FDIC had to honor its obligations to Murphy on the letters of credit. The district court denied the FDIC's motion for summary judgment, tried the issues of breach of contract and fraud to the jury, and entered judgment on the jury's verdict in favor of Murphy. The court's judgment required the FDIC to honor the letters of credit and to pay Murphy a ratable share of the Bank's assets pursuant to 12 U.S.C. Secs. 91, 194 and First Empire. The FDIC appeals.

The district court denied Murphy's post-trial motion challenging the award of only a ratable share and contending that he was entitled to a dollar for dollar setoff against his obligation to the FDIC on a separate loan transaction. Murphy cross-appeals.

In First Empire, supra, creditors of a failed bank sued to enforce their claims against the FDIC as Receiver of the failed bank. This court ruled in favor of the creditors against the FDIC, holding that the creditors were entitled to a ratable dividend under the National Banking Act, 12 U.S.C. Secs. 91, 194. The test employed by the court was whether or not the Bank's liability on the claim had accrued and was unconditionally fixed at the date of insolvency. This court found that the letters of credit were in existence before insolvency and were not dependent on any new contractual obligations arising after insolvency, and so ruled for the creditors.

In contrast to the facts of this case, however, the First Empire letters of credit involved no irregularities in the manner in which the obligations were carried on the books and records of the bank, nor were they issued in connection with any transactions that violated federal banking statutes. In this case, both parties stipulated that "[t]he letters were not carried on the books of accounts, accounting records or ledgers of FNB as liabilities of the bank, contingent or otherwise, as of March of 1986. The letters are referred to in the financial statements of the year ended December 31, 1985." These letters of credit were issued as a result of the Bank's extending credit to its parent company without the security required by federal banking statutes. The issues in this case concerning the enforceability of a letter of credit in these circumstances are issues of first impression in this circuit.

We hold that these letters of credit are not enforceable against the FDIC because they were not reflected in the Bank's books and records and lacked the collateral legally required under the banking statutes. We therefore do not reach the remaining issues in the FDIC's appeal or Murphy's cross-appeal.

BACKGROUND

The story begins in 1982 when Frederick L. Hilger, Sr. organized Pacific National Bancshares as a holding company in order to acquire, for $3,000,000, First National Bank, Chico. Patrick Murphy was one of the initial group that Hilger persuaded to invest in the holding company, PNB. Investors contributed $750,000; PNB borrowed the remaining $2,250,000 from Security Pacific National Bank. Murphy contributed $83,000 to the investment, agreed to be a guarantor of the Security Pacific loan, and became a director of both the Bank and PNB.

About eighteen months later, in July of 1984, Murphy resigned from the directorships and sold his stock in PNB back to the

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company for the ostensible price of $400,000. The transaction, effected on PNB's behalf by Hilger, consisted of the payment to Murphy of $5,000 in cash and PNB's promissory note for the remaining $395,000. The note, in turn, was secured by a letter of credit issued by the Bank, referred to in these proceedings as the 1984 letter. Because the letter of credit was issued to secure the obligations of the Bank's holding company, federal law required that there be collateral for any letter of credit issued by the Bank on behalf of any affiliate. 12 U.S.C. Sec. 371c(c)(1). 1 PNB provided no collateral for the letter of credit. The FDIC also relies on 12 U.S.C. Sec. 375b, which prohibits loans or extensions of credit to directors and controlling shareholders. The parties disagree about whether Murphy was still a director when he received the letter of credit. We do not reach this question, however, because the violations of 12 U.S.C. Sec. 371c(c) are sufficient to prevent Murphy from collecting from the FDIC.

In March of 1985 an audit criticized the bank for unlawful extensions of credit to directors and officers. In June of 1985 the Office of the Comptroller of the Currency issued a Cease and Desist Order based on a determination that violations of law and sound banking practices threatened the bank's financial soundness. The order included a prohibition against extending credit to affiliates without OCC review.

In October, 1985, Murphy loaned $190,000 to PNB so that PNB could pay the next installment of its loan to Security Pacific. Murphy remained as a guarantor of the Security Pacific loan. The transaction was similar to the 1984 letter of credit transaction in that PNB gave Murphy promissory notes for $190,000 and the Bank issued a letter of credit on behalf of PNB to Murphy for $190,000. PNB provided the Bank with no collateral for this letter of credit.

In addition, the letters of credit, and, of course, the lack of collateral for their issuance, were not approved by the Board of Directors of the Bank, nor were they carried on the regular books and records of the Bank. This is significant to this case because under a line of authority beginning with the Supreme Court's decision in D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 62 S.Ct. 676, 86 L.Ed. 956 (1942), and partially codified in 12 U.S.C. Sec. 1823, the FDIC is afforded certain protections from liability on obligations that are not properly documented in a bank's records.

A year later, in October, 1986, PNB defaulted on its payments to Security Pacific, and by November 20, 1986, FDIC had been appointed as Receiver. Hilger was later convicted of fraud violations in connection with his handling of PNB and the Bank. After PNB defaulted on the note payments to Murphy in January, 1986, his demands to PNB and the Bank on the letters of credit were not honored. He then filed claims with the FDIC; these were denied.

Murphy's suit in the United States District Court for the Northern District of California in April, 1988, resulted in the judgment entered in his favor after a jury trial, from which the FDIC now appeals.

DISCUSSION

Murphy's position at all times in this litigation is that he is the bona fide holder of

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letters of credit that the FDIC must honor. He maintains that so long as proper presentment was made, 2 the FDIC as Receiver can avoid the obligation of the bank only if Murphy was in pari delicto with Hilger in a scheme to defraud. Because the jury exonerated Murphy of fraud, he contends that he correctly prevailed in the district court.

Murphy's position persuaded the district court, for it embodies two unassailable principles well grounded in our law.

The first is that letters of credit, by their very nature, represent an obligation of the issuing bank independent of the relationship between the bank's customer, who asked...

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