Franklin Sav. V. Office of Thrift Supervision, 95-2039-JWL.

• Decision Date: 12 January 2004
• Docket Number: No. 95-2039-JWL.,95-2039-JWL.
• Parties: FRANKLIN SAVINGS CORPORATION, Plaintiff, v. OFFICE OF THRIFT SUPERVISION, Defendant.<SMALL><SUP>1</SUP></SMALL>
• Court: U.S. District Court — District of Kansas

303 B.R. 488

FRANKLIN SAVINGS CORPORATION, Plaintiff, v. OFFICE OF THRIFT SUPERVISION, Defendant.¹

No. 95-2039-JWL.

United States District Court, D. Kansas.

January 12, 2004.

Jonathan A. Margolies, R. Pete Smith, McDowell, Rice, Smith & Gaar, Kansas City, MO, for Plaintiff.

Anne L. Weismann, Arthur R. Goldberg, John T. Stemplewicz, James J. Faughnan, Jeffrey Axelrad, U.S. Department of Justice J. Amanda Machen, Martin Jefferson Davis, Office of Thrift Supervision, Washington, DC, Christopher Allman, Office of United States Attorney, Kansas City, KS, for Defendants.

Richard D. Ralls, Farchmin Ralls Wagoner, P.C., Kansas City, MO, for Movant.

MEMORANDUM AND ORDER

LUNGSTRUM, Chief Judge.

This adversary proceeding was withdrawn from the Chapter 11 bankruptcy of plaintiff Franklin Savings Corporation ("FSC"). Defendant Office of Thrift Supervision (the "OTS") filed a proof of claim in the bankruptcy proceeding and FSC objected to that proof of claim. The matter is before the court on the parties' cross-motions for summary judgment (Docs. 136 & 137). For the reasons explained below, the court will grant FSC's motion and deny the OTS's motion because FSC's capital maintenance commitment ceased when the OTS appointed a conservator for Franklin Savings Association ("FSA"), because the OTS has failed to raise a genuine issue of material fact regarding whether FSA was capitally deficient on that date, and because even if OTS did have a valid capital deficiency claim against FSA, that claim would not be entitled to priority over the administrative fee and expense claims of FSC's counsel.

STATEMENT OF MATERIAL FACTS

This case arises from the failure of a state-chartered savings and loan association, FSA. FSC² at all relevant times owned more than ninety percent of FSA's stock. FSC, FSA, OTS, the Resolution Trust Corporation ("RTC"), the Federal Deposit Insurance Corporation ("FDIC"), and the federal government have a history of extensive, protracted, and contentious litigation during the past fourteen years. Suffice it to say that the court is familiar with their history.³ For purposes of the parties' cross-motions for summary judgment in this case, the court need not recount that extensive history here, but instead will endeavor to focus on the issues currently before the court.

In 1980, FSC acquired General Savings Association ("GSA") and merged GSA into FSA, FSC's thrift subsidiary. FSC could not lawfully complete the acquisition and merger without obtaining approval from the Federal Savings and Loan Insurance Corporation ("FSLIC"). Therefore, FSC applied to FSLIC to obtain the required approval. At that time, the Federal Home Loan Bank Board ("FHLBB") was the operating head of FSLIC. FHLBB approved FSC's application, but its approval was conditioned on the following:

[FSC] shall stipulate to [FSLIC] that so long as [FSC] controls [FSA], [FSC] will cause the net worth of [FSA] to be maintained at a level consistent with that required of institutions insured twenty years or longer by Section 563.13(b) of the Rules and Regulations for Insurance of Accounts, as now or hereafter in effect, infusing sufficient additional equity capital to effect compliance with such requirement whenever necessary.

In order to satisfy this condition, on December 15, 1980, FSC's president provided a written affidavit to FSLIC that contained the following:

[S]o long as [FSC] controls FSA[,][FSC] will cause the net worth of FSA to be maintained at a level consistent with that required of institutions insured twenty years or longer by Section 563.13(b) of the Rules and Regulations for Insurance of Accounts, as now or hereafter in effect, infusing sufficient additional equity capital to affect [sic] compliance with such requirement whenever necessary.

OTS is the successor to FHLBB and FSLIC.

In late 1984, FSA issued $2.9 billion in bonds for approximately $68 million in cash. The bonds provided that they would be in default if FSA failed to meet its regulatory capital requirements. In the event of a default, FSA would be required to purchase certain United States treasury or agency obligations in an amount that would pay off the bonds at maturity. Quite simply, if such a default were to occur, FSA would suffer millions of dollars of loss by virtue of these purchasing obligations.

In 1985, the regulatory capital rules changed. Under the new rules, federally insured thrift institutions such as FSA were required to have three percent capital in place. An institution with inadequate capital was required to make up the shortage over a five-year period. FSA's management developed a plan to provide FSA with an additional capital cushion to prevent a default under the bond indenture. FSA filed consolidated federal income tax returns with FSC. FSC and FSA planned to enter into certain tax reimbursement and forgiveness agreements. The essence of those agreements would be that FSA would transfer deferred income tax liability to FSC, then FSC would "forgive"⁴ FSA for this tax liability, thus creating a capital contribution to FSA.

Deferred income taxes is an accounting concept involving temporary differences between the financial reporting basis and the actual tax basis of a company's assets and liabilities. FSA had deferred income taxes because its books reflected a liability to FSC for income taxes it would have owed under generally accepted accounting principles ("GAAP"), but the actual amount it paid to FSC for its share of the consolidated tax obligation was the amount it owed under tax laws. Because the amount of the obligation to FSC under GAAP exceeded the amount FSA owed to the IRS under tax laws, FSA's books reflected a liability to FSC for the difference, which represented the GAAP computation of deferred income taxes.

FSA's board of directors approved the proposed tax forgiveness transaction. FSA submitted the plan to the FHLBB for approval. The FHLBB advised FSA's president to determine whether FSA's independent auditors would approve the plan and, if so, to submit the request in writing to the FHLBB. FSA's president did so, and FSA's independent auditor, Deloitte Haskins & Sells, opined that the plan would in fact increase FSA's capital under GAAP. On December 11, 1985, FSA's president submitted the auditor's opinion and a request for approval of the contemplated tax transactions to the FHLBB. The FHLBB never responded to the request for approval.

In 1987 and 1988, FSC and FSA entered into the tax reimbursement and forgiveness agreements. As a result, approximately $120 million of FSA's deferred taxes were transferred to FSC's books, resulting in a $120 million increase in FSA's paid-in capital account. Ultimately, these tax forgiveness transactions provided FSA with a capital cushion that was sufficiently adequate to keep the bonds from going into default.

In 1989 and early 1990, the propriety of the tax forgiveness transactions came under scrutiny by government regulators. These regulators contended the transactions were improper because FSA still remained jointly and severally liable for those deferred taxes if and when they came due. In April of 1989, David Martens, Chief Accountant of the Federal Home Loan Bank System's Office of Regulatory Activities, wrote to FSC's auditor and stated: "In our opinion this transaction is an inappropriate way to increase capital of a thrift." This letter was not based on an official policy or regulation, and the letter did not assert that the transaction was contrary to GAAP principles. In a letter dated January 9, 1990, Louis V. Roy of the OTS stated in a letter to FSA's board of directors that FSA's reported capital was overstated by $110.4 million because of the tax forgiveness transaction. OTS directed FSA to essentially reverse the tax forgiveness transactions and re-establish the deferred taxes as a liability.

On January 10, FSA advised the OTS that doing so would cause a capital failure under FSA's 1984 bond issue and would cost FSA $185 to defeasance the bond debt. On January 11, the OTS informed FSA that it would reconsider its January 9 directive requiring FSA to re-establish the deferred tax liability on its books. On January 15, FSA responded to an earlier request from the OTS for more specific information regarding the tax forgiveness transactions. On January 23, Mr. Roy again wrote to FSA, this time directing FSA to hold the January 9 supervisory directive in abeyance until the OTS fully reviewed the additional information FSA submitted regarding the tax forgiveness transactions.

FSA took the position that the tax forgiveness transactions were in accordance with GAAP because the deferred taxes would in all likelihood never become due. For the years 1985 through 1988, FSA reported the tax forgiveness transactions to the FHLBB without objection from the FHLBB. It also disclosed the additional capital generated by the tax forgiveness transactions in its audited financial statements for 1985 and 1986. The audited financial statements that FSA filed with the FHLBB for fiscal years ended June 30, 1987, June 30, 1988, and June 30, 1989, reflected the additional capital generated by the tax forgiveness transactions. The FHLBB and the OTS examined FSA for years, including examining all transactions with FSC, and including an examination of the tax forgiveness transactions.

On February 15, 1990, the OTS appointed the RTC as conservator for FSA based on safety and soundness allegations "other than a failure to meet capital standards," and "not for the purpose of liquidation." On February 16, 1990, in a securities Form 8-K, the RTC reported a "change in control of the registrant" on behalf of FSA. This Form 8-K stated:

By operation of law the RTC, as conservator for the registrant, succeeded to all rights, titles, powers, and privileges of the registrant and of any stockholder, accountholder, depositor, officer, or director of the registrant with respect to the registrant...