Kilpatrick v. Riddle

Decision Date25 July 1990
Docket NumberNo. 89-2963,89-2963
Citation907 F.2d 1523
PartiesWade A. KILPATRICK, et al., Plaintiffs, Stan E. Golub, et al., Plaintiffs-Appellants, v. John C. RIDDLE, et al., Defendants, The Federal Deposit Insurance Corp., as Receiver for First RepublicBank Houston, N.A., et al., Defendants-Appellees.
CourtU.S. Court of Appeals — Fifth Circuit

J. Eugene Clements, Evelyn V. Keyes, Porter & Clements, Houston, Tex., for plaintiffs-appellants.

Robert D. Daniel, Houston, Tex., for defendants-appellees.

Appeal from the United States District Court for the Southern District of Texas.

Before BROWN, JOLLY and DAVIS, Circuit Judges.

E. GRADY JOLLY, Circuit Judge:

This case presents the following question: Does the D'Oench, Duhme doctrine, 1 which protects the Federal Deposit Insurance Corporation from the effect of unrecorded agreements between an insured bank and its customers, preclude borrowers who were defrauded by failed banks, from bringing an action under federal securities laws against the FDIC as receiver? Although several circuits have touched on this question, none have squarely considered it. Supreme Court precedent, however, now makes clear that debtors may not raise bank fraud as a defense to the FDIC's collection efforts. The D'Oench, Duhme doctrine would be effectively nullified if borrowers could characterize their fraud-based defenses as independent causes of action and maintain them against the federal receiver. Thus, although the plaintiffs may, of course, pursue actions for securities fraud against the individuals involved, we conclude that they may not recast their barred defenses as causes of action under the federal securities laws.

I

This case arises from a summary judgment granted defendants, the FDIC, and NCNB, the bridge bank used to rescue the failed institutions in this case. The plaintiffs are investors who executed promissory notes in favor of First RepublicBank ("FRB"), the failed bank. When FRB failed, these notes were acquired by the FDIC in its capacity as receiver. The FDIC then assigned the plaintiffs' notes to the bridge bank. The plaintiffs originally sued FRB for alleged fraud in the promotion and sale of certain bank stock, which FRB underwrote by inducing the plaintiffs to execute the promissory notes at issue. The plaintiffs then added the defendants FDIC and NCNB, as successors-in-interest.

This litigation has a complex procedural history that is not relevant to the issue on appeal. As this case appears before us, the plaintiffs seek rescission of these notes on the ground that they are invalid because they were originally obtained through fraud. They allege that FRB assisted two men, who were heavily in debt to it, in a scheme to defraud investors. The two alleged swindlers promoted a plan to open several branches of the Texas National Bank (TNB). FRB financed the plan by loaning the investors money for the purchase of new TNB stock. The investors executed promissory notes and FRB thus acquired new collateral for the debts owed it by the alleged swindlers.

The plaintiffs allege fraud in that FRB never told them that the TNB stock was subject to a voting trust, which gave control over the stock to the two alleged swindlers. Furthermore, the plaintiffs allege that the stock was overvalued, and that the new banks were doomed to fail from the outset, and that this was all known by FRB. In the end, however, the net result of the stock-for-promissory note transactions was to give FRB fresh obligations from creditworthy investors by simply loaning money for a very short time in paper transactions that were essentially riskless to FRB. Although it was FRB that is alleged to have committed the fraud, the plaintiffs contend that the FDIC had acquired knowledge of FRB's fraud by the time it became receiver, because it had previously participated in litigation involving the failed TNB branches. Since the FDIC knew of FRB's fraud, and informed NCNB of it, neither the FDIC nor NCNB can escape FRB's liability as "innocent purchasers" of the notes.

The plaintiffs seek recovery from the FDIC and NCNB on eight bases, all of which involve alleged misrepresentation or fraud on the part of the alleged swindlers and FRB. Among these causes of action are claims under federal and state securities laws. 2 They assert that the FDIC was liable for FRB's fraudulent actions, and thus cannot collect on the notes, because it acquired them with actual knowledge of the fraud gained from its participation in the TNB litigation. NCNB, as assignee of FDIC, can have no greater right to collect on them than did the FDIC. NCNB counterclaimed to enforce the notes.

The defendants rely on the D'Oench, Duhme doctrine in two ways: they argue that it is a complete defense to the investors' fraud claims and that it bars their defenses against enforcement of the notes. The district court granted summary judgment to the defendants. It concluded that the federal common law D'Oench, Duhme doctrine, which precludes defenses to recovery against a closed bank that are premised on undisclosed agreements between the borrower and the bank, both barred the plaintiffs' claims and allowed the defendants' counterclaims. Plaintiffs filed a timely notice of appeal.

II

The plaintiffs raise three arguments. First, although they concede that the D'Oench, Duhme doctrine precludes many of their claims, they contend that it cannot bar their actions under the federal securities laws. Second, they argue that the FDIC and NCNB cannot escape liability for securities violations as "innocent purchasers" under section 29 of the Securities Exchange Act, because they took the notes with actual knowledge of the plaintiffs' claims and defenses. Finally, they argue that summary judgment was inappropriate because genuine issues of material fact remain concerning misrepresentations made by FRB in the issuance of the securities. Our resolution of the first issue is dispositive of the entire appeal.

III

The essence of the plaintiffs' argument is that the D'Oench, Duhme doctrine cannot bar their federal securities law claims, because this result would empower the FDIC to enforce agreements that are illegal under federal securities laws. They contend that the Supreme Court has held insolvent national banks liable for misrepresentations made in the sale of their own stock, 3 and that this court has not held that the D'Oench, Duhme doctrine trumps federal securities law. They further argue that, as a policy matter, protecting investors by holding the FDIC liable for securities fraud on the part of failed banks need not undercut the system of national bank regulation. They assert that the FDIC's liability may appropriately be limited to cases in which it assumes a failed bank's liabilities with actual knowledge of the bank's fraudulent securities dealings. Given the FDIC's participation in the TNB litigation, the plaintiffs argue that the FDIC had knowledge of the fraud behind this transaction before it acquired FRB and consequently was not an "innocent purchaser" of the notes in question.

Although the plaintiffs are correct that only one court has explicitly held that federal securities claims may be barred by the D'Oench, Duhme doctrine, recent Supreme Court precedent makes clear that claims that are in essence indistinguishable from those the plaintiffs seek to maintain are barred by the doctrine. Moreover, several courts have held that the doctrine bars state securities fraud claims, which often provide causes of action that overlap the federal securities laws. Finally, and most importantly, permitting borrowers to maintain federal securities claims would enable them to simply recast as affirmative causes of action the very defenses that the Supreme Court has long held are precluded by the doctrine.

A

The D'Oench, Duhme doctrine, as originally stated, holds that when a federally insured bank fails, borrowers from the bank may not later defend against collection efforts of a federal receiver by arguing that they had an unrecorded agreement with the bank. D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 459-60, 62 S.Ct. 676, 680, 86 L.Ed. 956 (1942). In D'Oench, the borrower had executed obligations to an insured institution but claimed, after the bank failed, that the bank had orally agreed that these obligations would not be enforced. This oral side arrangement became the paradigmatic "secret agreement" barred by the doctrine. Congress has embodied this common law doctrine in statute. 4 As codified, the doctrine precludes borrowers from avoiding obligations to failed banks unless they have an arrangement in writing, that was executed by the bank and the borrower, approved by the bank's board and listed in the bank's records. 5 As the Supreme Court has recently explained, the doctrine has two purposes.

One purpose ... is to allow federal and state bank examiners to rely on a bank's records in evaluating the worth of the bank's assets.... A second purpose ... [is to] ensure mature consideration of unusual loan transactions by senior bank officials, and prevent fraudulent insertion of new terms, with the collusion of bank employees, when a bank appears headed for failure.

Langley v. FDIC, 484 U.S. 86, 91-92, 108 S.Ct. 396, 401, 98 L.Ed.2d 340 (1987). Since the initial statement of the doctrine in D'Oench, Duhme, the Court has expanded its preclusive effect well beyond the context of an oral "secret agreement" between the bank and the borrower. Most recently, in Langley the Supreme Court extended the doctrine to preclude the same defense that the plaintiffs seek to advance here: that the obligation to the failed bank was procured through fraud in the inducement.

In Langley, the Langleys borrowed money from a bank in order to buy land, and executed a mortgage as security for the loan. After the bank failed the Langleys sued it, claiming that the bank had deceived them concerning the land's value. They alleged that the bank had...

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