F.D.I.C. v. Ernst & Young

• Decision Date: 03 August 1992
• Docket Number: No. 91-7193,91-7193
• Citation: 967 F.2d 166
• Parties: FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Appellant, v. ERNST & YOUNG, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 166

967 F.2d 166

61 USLW 2097

FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Appellant, v. ERNST & YOUNG, et al., Defendants-Appellees.

No. 91-7193.

United States Court of Appeals Fifth Circuit.

Aug. 3, 1992.

Dorothy Nichols, Assoc. Gen. Counsel, FDIC, Colleen B. Bombardier, Counsel, Jerome A. Madden, Counsel, Floyd I. Robinson, Sr. Counsel, Melissa Satterwhite, Washington, D.C., John P. Greenan, Vincent J. Hudock, Jr., Vera L. Poe, Hopkins & Sutter, Dallas, Tex., John L. Conlon, Hopkins & Sutter, Chicago, Ill., for F.D.I.C Kathryn A. Oberly, Ernst & Young, Washington, D.C., Carl D. Liggio, Ernst & Young, New York City, Wendy A. Ackerman, Mayer, Brown & Platt, Washington, D.C., Morton L. Susman, Weil, Gotshal & Manges, Houston, Tex., for defendants-appellees.

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

Before POLITZ, Chief Judge, and WILLIAMS and DUHE, Circuit Judges.

JERRE S. WILLIAMS, Circuit Judge:

The Federal Deposit Insurance Corporation brought suit against Ernst & Young. The suit asserts that Arthur Young & Company and its successor Ernst & Young both negligently audited Western Savings Association and breached their contracts to audit Western Savings. The district court dismissed the breach of contract action for failure to state a claim. The court also granted Ernst & Young's motion for summary judgment on the negligence claim. The Federal Deposit Insurance Corporation appeals the two rulings.

I. FACTS

On August 30, 1982, Jarrett E. Woods, Jr. purchased 100% of Gatesville Savings and Loan Association's stock. He subsequently transferred the stock to Western Capital Corporation and changed the name of Gatesville Savings to Western Savings Association ("Western"). Woods also owned all of Western Capital Corporation. Woods, therefore, was Western's sole owner.

Woods effectively dominated and controlled Western. Upon acquiring Western, he expanded the board of directors and appointed himself as chairman and chief operating officer. He was also Western's chief executive officer, and he served on its executive, loan, audit, compliance, and credit policy committees. He further held various offices in Western's wholly-owned subsidiaries, including Westwood Mortgage Company and WS Service Corporation.

Pursuant to his domination and control of Western, Woods dramatically changed its policies and practices. Western aggressively began to pursue complex commercial ventures that often were based upon unsafe and unsound underwriting practices. Western's commercial real estate transactions generated paper profits, making Western appear solvent. The FDIC further alleges that Woods made false entries in Western's books with intent to deceive Western's board and government regulators, and he conspired to misapply Western's funds. The FDIC claims these policies were part of a scheme by Woods to defraud Western's depositors and creditors.

By 1984, Western's financial condition had seriously deteriorated. On June 22, 1984, as a result of numerous violations of Bank Board regulations, the Federal Home Loan Bank Board issued a Temporary Order to Cease and Desist Western's improper commercial lending practices. In accordance with the Cease and Desist Order, Western engaged Arthur Young to review Western's financing transactions and conduct independent audits for the years ending December 31, 1984 and December 31, 1985. Arthur Young's engagement letters specified its duties.

Arthur Young completed its audits and certified that it conducted the audits in accordance with generally accepted accounting principles. Arthur Young indicated that Western had a net worth at the end of 1984 of over $41 million. In reality, Western was insolvent by more than $100 million. Similarly, Arthur Young's 1985 report certified that Western had a net worth of over $49 million when it was actually insolvent by over $200 million.

On September 12, 1986, the Federal Savings and Loan Insurance Corporation ("FSLIC") was appointed as Western's Receiver. Under the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA"), 12 U.S.C. § 1821a, all FSLIC assets, including this claim, were transferred to the FSLIC Resolution Fund, which the Federal Deposit Insurance Corporation ("FDIC") now manages.

On March 1, 1990, the FDIC filed a two-count complaint against Ernst & Young ("EY") alleging negligence and breach of contract. ¹ EY is a general partnership organized in 1989 as successor to Ernst & Whinney and Arthur Young. The FDIC alleges that Western suffered $560 million in damages resulting from Arthur Young's audits because if the audits had been accurate, Western's board of directors or government regulators would have prevented further losses. Critically important to the ultimate resolution of the case is the FDIC's decision to bring this suit only as assignee of a claim by Western against the auditors. The FDIC had authority to sue EY in its own behalf or on behalf of Western's creditors, but it chose not to do so.

II. STANDARD OF REVIEW

The FDIC appeals the district court's summary judgment and also its dismissal for failure to state a claim. In reviewing a summary judgment, we apply the same standard of review as the district court, and we review questions of law de novo. Christopherson v. Allied-Signal Corp., 939 F.2d 1106, 1109 (5th Cir.1991) (en banc), cert. denied, --- U.S. ----, 112 S.Ct. 1280, 117 L.Ed.2d 506 (1992). A summary judgment is proper if "after adequate time for discovery and upon motion, ... [the non-movant] ... fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial." Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986). We review the record in the light most favorable to the non-movant. Ayo v. Johns-Manville Sales Corp., 771 F.2d 902, 904 (5th Cir.1985). We also apply a de novo standard of review to a district court's ruling on a Rule 12(b)(6) motion for failure to state a claim. Barrientos v. Reliance Standard Life Ins. Co., 911 F.2d 1115, 1116 (5th Cir.1990), cert. denied, --- U.S. ----, 111 S.Ct. 795, 112 L.Ed.2d 857 (1991).

III. FDIC AS ASSIGNEE

The most significant factor in the present case's outcome is the FDIC's decision to sue only as Western's assignee. The FDIC did not sue on its own behalf or on Western's creditors' behalf. Essentially, therefore, this is a client case in which a client is suing its auditor. Consequently, the effect of the auditor's alleged negligence on third parties is legally irrelevant to the determination of the present case. "An assignee obtains only the right, title, and interest of his assignor at the time of his assignment, and no more. Accordingly, an assignee may recover only those damages potentially available to his assignor." State Fidelity Mortgage Co. v. Varner, 740 S.W.2d 477, 480 (Tex.App.--Houston [1st Dist.] 1987, writ denied) (citations omitted).

The FDIC correctly argues that certain situations require the courts to treat the FDIC differently from other assignees. The D'Oench Duhme doctrine, for example, precludes a borrower from asserting defenses against the FDIC based upon secret unrecorded side agreements the borrower entered into with the failed institution. Campbell Leasing, Inc. v. F.D.I.C., 901 F.2d 1244, 1248 (5th Cir.1990). Moreover, strong federal policy dictates that the FDIC as corporate insurer takes greater rights than the failed bank. In re Jeter, 48 B.R. 404, 410 (Bankr.N.D.Tex.1985).

Relying upon F.D.I.C. v. Cherry, Bekaert & Holland, 742 F.Supp. 612 (M.D.Fla.1990), the district court declined to treat the FDIC differently from other assignees under the facts of this case. Cherry is similar to the present case because the FDIC was suing a partnership of certified public accountants for their negligent audit of a bank. The Cherry court held the FDIC as assignee was subject to the same defenses as could be asserted against other assignees because "the FDIC does not cite any statutory authority affording it special protection ... [T]he special protections afforded the FDIC by D'Oench and its progeny are limited in scope.... [T]his Court sees no reason that the FDIC in this case should be treated differently than any other assignee." Id. at 614-15. Other cases stating the same controlling law are F.D.I.C. v. Harrison, 735 F.2d 408, 412 (11th Cir.1984) ("[W]hen FDIC acts in its corporate capacity as receiver, its liability must be determined in the same fashion as that of a private party.... It has been held that when FDIC acts as a receiver and liquidating agent for a failed bank, as it did here, it merely 'stands in the shoes of the insolvent bank.' ... We see no reason not to apply the traditional rules of equitable estoppel to the conduct of FDIC in this case") (citations omitted); F.D.I.C. v. Jenkins, 888 F.2d 1537, 1545-46 (11th Cir.1989) ("The FDIC urges this Court ... to fashion a federal common law rule of priority.... Any such priority over third-party lawsuits will have to come from Congress, not this Court").

We affirm the district court's holding that the FDIC is not entitled to special protection when it brings a tort claim against a third party on behalf of a defunct financial entity. No statutory justification or public policy exists to treat the FDIC differently from other assignees when the FDIC as a matter of choice in this case has limited its claim to that of an assignee.

IV. NEGLIGENCE

The FDIC sued EY claiming Arthur Young negligently conducted the audit, causing $560 million in losses. The district court granted EY's motion for summary judgment because neither Woods nor Western relied upon the audit. The FDIC contends that the district court erred because reliance is not an element of a negligence claim.

Under Texas law, a cause of action based upon negligence requires proof of three essential elements: the...