First Pacific Bank v. Gilleran

• Decision Date: 21 November 1994
• Docket Number: Nos. 91-55890,91-56081,s. 91-55890
• Citation: 40 F.3d 1023
• Parties: FIRST PACIFIC BANK; First Pacific Bancorp, Inc., Plaintiffs-Appellants, v. James E. GILLERAN; California State Banking Department; Federal Deposit Insurance Corporation, as Receiver for First Pacific Bank, Defendants-Appellees. FIRST PACIFIC BANK; First Pacific Bancorp, Inc., Plaintiffs-Appellees, v. James E. GILLERAN; California State Banking Department, Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1023

40 F.3d 1023

FIRST PACIFIC BANK; First Pacific Bancorp, Inc., Plaintiffs-Appellants, v. James E. GILLERAN; California State Banking Department;

Federal Deposit Insurance Corporation, as Receiver

for First Pacific Bank, Defendants-Appellees.

FIRST PACIFIC BANK; First Pacific Bancorp, Inc., Plaintiffs-Appellees, v. James E. GILLERAN; California State Banking Department,

Defendants-Appellants.

Nos. 91-55890, 91-56081.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted July 15, 1994.

Decided Nov. 21, 1994.

Brant M. Laue, Rouse, Hendricks, German, May & Shank, Kansas City, MO, for plaintiffs-appellants-cross-appellees.

Joseph M. O'Heron, Deputy Atty. Gen., Los Angeles, CA, for defendants-appellees-cross-appellants.

Appeals from the United States District Court for the Central District of California.

Before: WALLACE, Chief Judge, REINHARDT, Circuit Judge, and TANNER, ^* District Judge.

WALLACE, Chief Judge:

On August 10, 1990, the State of California (State) seized control of First Pacific Bank (Bank) pursuant to California Financial Code (Financial Code) Sec. 3100 because, among other things, it concluded that the Bank's contributed capital was impaired. The State appointed the Federal Deposit Insurance Corporation (FDIC) as receiver for the Bank. In accordance with Financial Code Sec. 3101, the Bank and its owners brought suit in state court to reverse the seizure. The FDIC removed the case to federal district court pursuant to 12 U.S.C. Sec. 1819(b)(2)(B). The district court entered summary judgment confirming the seizure.

The Bank now appeals from the district court's summary judgment, and its conclusion that its contributed capital was impaired. The State cross-appeals from an earlier ruling that a capital note should be included in the Bank's contributed capital. We have jurisdiction over these timely appeals pursuant to 28 U.S.C. Sec. 1291. We affirm, but for reasons different than those stated by the district court.

I

The Bank argues that summary judgment was improper because there was a genuine issue of material fact as to whether its contributed capital was impaired. We review a summary judgment de novo. Jones v. Union Pac. R.R., 968 F.2d 937, 940 (9th Cir.1992). Our tasks on appeal are to determine (1) whether there is a genuine issue of material fact when the evidence is viewed in the light most favorable to the nonmoving party, and (2) whether the district court correctly applied the law. Tzung v. State Farm Fire & Cas. Co., 873 F.2d 1338, 1339-40 (9th Cir.1989). On appeal, we may affirm on any ground supported by the record. United States v. Washington, 969 F.2d 752, 755 (9th Cir.1992), cert. denied, --- U.S. ----, 113 S.Ct. 1945, 123 L.Ed.2d 651 (1993).

The starting place for our analysis is Financial Code Sec. 134, which provides the statutory definition of contributed capital and the formula for determining whether a bank's contributed capital is impaired. According to section 134(a), contributed capital consists of "all of [the Bank's] shareholders' equity other than retained earnings." Section 134(b) provides that the Bank's contributed capital "shall be deemed to be impaired whenever such bank has deficit retained earnings in an amount exceeding 40 percent of such contributed capital."

The Financial Code requires that the impairment analysis be performed using figures for contributed capital and retained earnings that would be presented on a balance sheet prepared in accordance with generally accepted accounting principles (GAAP):

All references ... to financial statements, balance sheets ... and all references to assets, liabilities, earnings, retained earnings, shareholders' equity, and similar accounting items of a bank mean such financial statements or such items prepared or determined in conformity with generally accepted accounting principles then applicable, fairly presenting in conformity with generally accepted accounting principles the matters which they purport to present....

Cal.Fin.Code Sec. 118 (1978).

The State argues that the Bank's own financial statements demonstrate that its contributed capital is impaired, even before they are adjusted to compensate for the overvaluation of the Bank's assets. The record contains at least three sets of calculations that differ in minor amounts because they use figures from three different dates. Each calculation, however, shows that the Bank's contributed capital is impaired. For the sake of simplicity, we will use the figures for August 10, 1990, as found in the Bank's brief on appeal.

The Bank's figures show $4,945,880 in contributed capital, consisting of $1,922,865 in common stock and $3,023,015 in additional paid in capital. Forty percent of contributed capital is $1,978,352. The Bank's figures also show $2,700,007 in deficit retained earnings, which exceeds forty percent of contributed capital by $721,655. Thus, according to these figures the Bank's contributed capital was impaired.

The Bank argues that these figures are from "interim, unadjusted" statements prepared for internal use that must be adjusted to conform with GAAP. The Bank proposes that: (A) loan loss reserves totaling $1,507,137 and deferred loan fee income totaling $481,587 should be deducted from deficit retained earnings; (B) a capital note worth $844,000 should be included in contributed capital; and (C) deficit retained earnings should be reduced by $390,553 to reflect adjustments necessary to bring the financial statements in line with GAAP.

If each of the Bank's proposed adjustments is accepted, its contributed capital of $4,945,880 would be increased by $844,000 to equal $5,789,880. Forty percent of contributed capital would be $2,315,952. Deficit retained earnings of $2,700,007 would be reduced by amounts of $1,507,137, $481,587, and $390,553 to equal $320,730. According to these adjusted figures the Bank's deficit retained earnings would be $1,995,222 below the impairment mark. We address each of the Bank's arguments in turn.

A.

Loan loss reserves are credit accounts on the asset side of the balance sheet, created by accounting entries that have the effect of increasing deficit retained earnings. They are estimates, required by GAAP, to reduce the recorded value of a loan portfolio to account for loans that will become uncollectible in the future. Deferred loan fees are also credit accounts on the asset side of the balance sheet. They represent fees which the Bank has already received, but for which the earnings process is not yet complete. Because the recognition of these fees is deferred, they have the effect of increasing deficit retained earnings.

The Bank argues that for purposes of the impairment analysis, its deficit retained earnings should be reduced by $1,507,137 in loan loss reserves and $481,587 in deferred loan fees. However, because the impairment calculation must be performed using contributed capital and deficit retained earnings figures as they would be presented on a balance sheet prepared in accordance with GAAP, these adjustments cannot be made. Cal.Fin.Code Sec. 118 (1978).

The Bank contends that the declarations of three certified public accountants, demonstrate that the adjustments can be made consistent with GAAP. Nowhere in these declarations, however, is there a statement that including loan loss reserves and deferred fees in deficit retained earnings is consistent with GAAP.

The Bank also argues that the administrative record shows that a state bank examiner had previously included loan loss reserves in deficit retained earnings when calculating the impairment of the Bank's contributed capital. But the Bank has taken this calculation out of context. The bank examiner's calculation was based on adjusted financial statements. Because the adjustments increased deficit retained earnings by over $6 million after writing off uncollectible loans, it was also necessary to reverse the $1.5 million estimated allowance for those same losses. But these adjusted calculations are irrelevant because the State chose to proceed on summary judgment using unadjusted figures.

The Bank also argues that loan loss reserves are part of the Bank's capital. This may be true, but it is also irrelevant because capital is not the same as deficit retained earnings.

Our conclusion that deficit retained earnings may not be reduced by loan loss reserves is also supported by an understanding of the function of such reserves. Loan loss reserves are established in order to reflect the reality that a loan portfolio is not worth the total outstanding balance of such loans. By establishing a loan loss reserve, a bank effectively reduces the statement of loan values to an estimate of their net realizable value. If a bank's deficit retained earnings are reduced by the amount of its loan loss reserves, the actual financial condition of the bank may be overstated. Therefore, it makes sense not to allow deficit retained earnings to be reduced by the amount of a bank's loan loss reserves.

B.

A capital note is a liability that can be converted into common stock. Therefore it has characteristics of both debt and equity. The Bank successfully argued before the district court that its $844,000 capital note should be considered contributed capital. The State cross-appeals from the district court's ruling in the Bank's favor.

The language and structure of the Financial Code indicate that the district court reached an incorrect result. The Financial Code defines contributed capital as "all of shareholders' equity other than retained earnings." Cal.Fin.Code Sec. 134(a) (1978). Thus, in order for a capital note to be contributed capital it must first be an element of shareholders' equity. However, article 4 of the Financial Code, entitled "Shareholders' Equity," considers a...