The Bank Of N.Y. v. First Millennium Inc

• Decision Date: 01 June 2010
• Docket Number: Docket No. 09-1628-cv.
• Citation: 607 F.3d 905
• Parties: The BANK OF NEW YORK, in its capacity as Indenture Trustee for the NextCard Credit Card Master Note Trust, Interpleader Plaintiff-Counter Claimant Defendant-Appellee,v.FIRST MILLENNIUM, INC., Millennium Partners, L.P., RMK Advantage Income Fund, Interpleader Defendants-Appellees,andFederal Deposit Insurance Corporation, in its capacity as Receiver for NextBank, N.A., Interpleader Defendant-Counter Claimant-Appellant.
• Court: U.S. Court of Appeals — Second Circuit

607 F.3d 905

The BANK OF NEW YORK, in its capacity as Indenture Trustee for the NextCard Credit Card Master Note Trust, Interpleader Plaintiff-Counter Claimant Defendant-Appellee,v. FIRST MILLENNIUM, INC., Millennium Partners, L.P., RMK Advantage Income Fund, Interpleader Defendants-Appellees,andFederal Deposit Insurance Corporation, in its capacity as Receiver for NextBank, N.A., Interpleader Defendant-Counter Claimant-Appellant.^*

Docket No. 09-1628-cv.

United States Court of Appeals, Second Circuit.

Argued: March 4, 2010.

Decided: June 1, 2010.

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Scott H. Christensen, Hughes Hubbard & Reed LLP, Washington, D.C. (George A. Davidson, Hughes Hubbard & Reed LLP, New York, N.Y. and Colleen J. Boles, Lawrence H. Richmond, and Jaclyn C. Taner, Federal Deposit Insurance Corporation, Arlington, VA, on the brief) for Interpleader Defendant-Counter Claimant-Appellant, Federal Deposit Insurance Corporation, in its capacity as Receiver for NextBank, N.A.

Michael E. Johnson (Judith A. Amorosa, on the brief), Alston & Bird LLP, New York, NY, for Interpleader Plaintiff-Counter Claimant Defendant-Appellee, The Bank of New York, in its capacity as Trustee for the NextCard Credit Card Master Note Trust.

Michael J. Edelman (Michael G. Davies, on the brief), Vedder Price P.C., New York, NY, for Interpleader Defendants-Appellees, First Millennium, Inc. and Millennium Partners, L.P. Ronald S. Herzog (Michael Wexelbaum, Evangelos Michailidis, on the brief), Snow Becker Krauss P.C., New York, NY, for Interpleader Defendant-Appellee, RMK Advantage Income Fund.

Before: LYNCH and CHIN, Circuit Judges.^**

GERARD E. LYNCH, Circuit Judge:

In this interpleader action, the parties assert competing claims to the dregs of a failed securitization of credit card debt. Appellant, the Federal Deposit Insurance Corporation (the “FDIC”), as well as appellees, First Millennium, Inc., Millennium Partners, L.P. (together, “Millennium”) and RMK Advantage Income Fund (“RMK”), seek distribution of the funds held by the interpleader plaintiff, the Bank of New York (“BNY”), as trustee for the NextCard Credit Card Master Note Trust (“the trust”). The FDIC argues that it is entitled to the funds as the receiver for NextBank, N.A., (“NextBank”) a now-defunct internet-only bank, which established the trust in order to generate money to lend to credit card holders. Millennium and RMK claim that they are entitled to the funds as owners of notes issued by the trust.

BNY initiated this interpleader action in New York state court. The FDIC removed it to the United States District Court for the Southern District of New York (Haight J.). In a series of rulings, the district court denied the FDIC's motion to transfer the action to the United States District Court for the District of Columbia, enjoined BNY from making distributions from the interpleader funds, dismissed the FDIC's counterclaims against BNY, and, lastly, denied the FDIC's motion for summary judgment and granted summary judgment to Millennium and RMK. The district court then ordered BNY to begin distributing the trust corpus, giving preference to satisfying the claims of Millennium and RMK. The FDIC now appeals the decisions of the district court. We affirm.

BACKGROUND

I. The Securitization Transaction

In 1999, NextBank, an internet-only bank, began to issue consumer credit cards to sub-prime borrowers who applied over the internet. The business grew, and by February 2002, NextBank had 1.2 million cardholders. Rather than borrow money directly to lend to consumers, NextBank entered into a securitization transaction to generate funds. It established a trust at BNY and sold its credit card receivables-the rights to be paid interest and principal for purchases on the cards-to the trust, using the proceeds to finance cardholders' purchases. BNY then issued notes backed by the cash flows generated from the receivables to investors. This transaction generated approximately $1.7 billion and provided funding for most of the credit cards issued by NextBank.

The trust issued two series of notes, the 2000-1 Series and the 2001-1 Series, which came due, respectively, in December 2006 and April 2007. These notes were issued in four classes (A, B, C and D), which paid different rates of interest and carried differing levels of risk. The class A notes were the least risky, since they carried the right to first repayment from the trust corpus. Accordingly, the class A notes paid the lowest rate of interest. The class B notes both carried more risk-since their holders had rights to repayment subordinate to the class A noteholders'-and paid a slightly higher rate of interest. The classes C and D notes were successively both riskier and higher paying. However, as protection for the holders of these riskier C and D notes, certain money from their initial purchase of the notes was set aside in a “spread account” to be used to fund interest and principal payments on the notes should the money generated by the receivables prove insufficient. Over the life of the trust, the amount of money in the spread account was adjusted on a regular basis according to a formula.

The securitization was executed through a set of documents that included a master indenture and various indenture supplements. As is customary, some terms of the noteholders' investments were also laid out on the notes themselves. Additionally, all potential purchasers of the notes received copies of offering memoranda that described the terms of the notes and the risks associated with investing in them.

Under the transaction documents, the trust owned the credit card receivables. Cardholders' payments of fees and interest (or, as they are described in the deal documents, “finance charges”) were used to make interest payments on the notes. Money not used to make interest payments was divided into two pots, labeled “collateral” and the “transferor interest.” The collateral was intended for the eventual repayment of the principal of the notes (although during an initial “revolving period” it was used to fund new loans to credit card holders.) The transferor interest, on the other hand, was intended to fund regular payments to NextBank as the creator of the trust. The trust documents provided that at the termination of the trust, any money left over after all the trust's obligations had been satisfied in full was to be distributed to NextBank.

In the event that cardholders defaulted on their card payments, the defaulted amount was charged off against the assets in the trust labeled the “invested amount,” which was defined as the sum of the collateral and the spread account. In effect, if cardholders failed to repay their loans, the reduction was accounted for in the trust by reducing the funds labeled collateral rather than those labeled transferor interest. This accounting provision proved significant when large numbers of the sub-prime borrowers with whom NextBank did business eventually defaulted.

II. NextBank's Receivership

In 2001, the FDIC determined that NextBank's undercapitalization and practice of extending credit to subprime borrowers had endangered its ability to continue operating. In 2002, after the Comptroller of the Currency discovered that NextBank's accounting was improper, it appointed the FDIC as the bank's receiver. As receiver, the FDIC succeeded to “all [NextBank's] rights, titles, powers, and privileges,” 12 U.S.C. § 1821(d)(2)(A)(I), while continuing to operate the bank. The FDIC allowed the credit card accounts to remain open while it sought a buyer for NextBank's assets. Eventually, however, when no buyer materialized, the FDIC closed the credit card accounts. The cardholders were then unable to make new charges on their cards, but remained responsible for paying off their balances.

Funds from the trust were distributed to the classes A and B noteholders, who were fully repaid the principal and interest due on their notes. Class C noteholders received partial repayment of the principal and interest owed to them. Class D noteholders received some interest payments, but their investment principal was not repaid. The FDIC continued to receive payments of transferor interest from the trust until such payments were stopped in connection with this interpleader action.

As things stand now, cardholders have defaulted on their loans in large number and charge-offs have reduced the collateral in the trust to zero. Furthermore, the funds in the spread account have now been distributed to the class C noteholders, by an order of the district court not challenged in this appeal, with the result that the entire trust corpus consists of funds labeled “transferor interest.” The present dispute concerns who is entitled to these funds as between the remaining unpaid noteholders and the FDIC, which as receiver for the trust's creator NextBank possesses both rights to regular payments of transferor interest and a residuary interest in any assets of the trust that remain after all the trust's other obligations have been satisfied.

III. The District of Columbia Litigation

In June 2003, BNY filed suit against the FDIC in the United States District Court for the District of Columbia on behalf of the C and D noteholders, bringing six claims for conversion. One of BNY's claims was dismissed by the court early in the litigation see Bank of New York v. FDIC, 453 F.Supp.2d 82, 91 (D.D.C.2006) (“ NextBank I ”) aff'd, 508 F.3d 1 (D.C.Cir.2007), and four other claims were dismissed pursuant to a settlement agreement that provided for the distribution of some trust assets to the FDIC.

The D.C. district court granted summary judgment to the FDIC on BNY's final claim, that the FDIC had unlawfully converted funds to which the noteholders were entitled by refusing to honor the so-called ipso facto clause of the master indenture. That term provided for accelerated repayment of principal to the noteholders in the event that...