The Bank of New York v. F.D.I.C.

• Citation: 453 F.Supp.2d 82
• Decision Date: 27 September 2006
• Docket Number: Civil Action No. 03-1221(ESH).
• Parties: THE BANK OF NEW YORK, Plaintiff, v. FEDERAL DEPOSIT INSURANCE COMPANY, Defendant.
• Court: U.S. District Court — District of Columbia

Page 82

453 F.Supp.2d 82

THE BANK OF NEW YORK, Plaintiff, v. FEDERAL DEPOSIT INSURANCE COMPANY, Defendant.

Civil Action No. 03-1221(ESH).

United States District Court, District of Columbia.

September 27, 2006.

COPYRIGHT MATERIAL OMITTED

Paul F. Brinkman, Alston & Bird LLP, Washington, DC, Jack P. Smith, III, Alston & Bird LLP, Atlanta, GA, for Plaintiff.

Dennis Sanford Klein, Scott H. Christensen, Hughes Hubbard & Reed LLP, Washington, DC, George A. Davidson, Hughes Hubbard & Reed LLP, New York, NY, for Defendant.

MEMORANDUM OPINION

HUVELLE, District Judge.

The Bank of New York ("BNY"), indenture trustee for the interests of investors who purchased asset-backed securities from a trust established by the now-defunct NextBank, N.A. ("NextBank"), is suing the Federal Deposit Insurance Corporation ("FDIC") for conversion based on actions the agency took as NextBank's receiver. Five of BNY's original six counts have been dismissed. Count VI, the sole remaining claim, concerns a contract provision promising the investors ("Noteholders") recovery of their investments at an accelerated rate upon the appointment of a receiver for NextBank. BNY contends that, in declining to honor this early amortization or "ipso facto" clause, the FDIC acted without authority under the Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA), Pub.L. No. 101-73, 103 Stat. 183.

The issue before the Court is one of first impression. Essentially, BNY argues that the structure of the NextBank securitization transaction was crafted so that NextBank was not a party to the contract (the "Master Indenture") containing the ipso facto clause and that, as a result, the FDIC exceeded its powers under 12 U.S.C. § 1821(e)(12)(A)¹—and thereby converted millions of dollars belonging to the Noteholders—when it refused to honor the ipso facto clause upon NextBank's failure. The FDIC counters that BNY's securitization transaction is not immune from the FDIC's statutory powers providing that the FDIC as receiver may exercise its power to enforce an agreement notwithstanding an early amortization clause triggered by the appointment of a receiver, because NextBank "entered into" the agreement within the meaning of Section 1821(e)(12)(A). For the reasons set forth herein, the Court concludes that the early amortization clause is unenforceable against the FDIC and that, therefore, judgment will be entered for the FDIC on Count VI.²

BACKGROUND

I. NextBank and the Parties

NextBank was a national banking association established in 1999 to issue consumer credit cards, primarily through the internet. (Pl.'s Mot. for J. as to Liability ["Pl.'s Mot."] Ex. A at 4, 11.) By February 2002, NextBank had 1.2 million credit card holders and accounts totaling approximately $1.9 billion. (Christensen Decl. Ex. 3 ["Ltr. 2/12/02"] at 1187; Wigand Dep. Ex. 4 at 2.)

NextBank maintained the vast majority of its accounts—approximately $1.7 billion—in a "securitized" portfolio. (Id.) In other words, instead of financing this portfolio with money borrowed in its own name, NextBank created a trust, transferred its receivables to this trust, ordered the trust to sell notes to investors, and used the proceeds to pay merchants for charges by credit card holders. (Def.'s Statement of Material Facts ["Def.'s Stmt."] ¶ 5; see, e.g., Christensen Decl. Ex. 1 ["Offering Mem. 12/6/00"] at 390-91 (highlighting information about the trust for prospective investors).) Generally accepted accounting principles permitted NextBank to remove the securitized accounts from its balance sheets. (Pl.'s Mot. Ex. B at 6.) By doing so, NextBank was able to reduce its required capital reserves. (See id.)

The FDIC learned in September or October of 2001 that NextBank's undercapitalization and practice of extending credit to subprime borrowers had put the bank at risk for failure. (See Wigand Dep. at 20:7-8; Pl.'s Mot. Ex. A at 5-8.) In late 2001, the Office of the Comptroller of the Currency ("OCC") determined that NextBank was improperly accounting for poor credit quality on delinquent accounts. (See id.) On February 7, 2002, the OCC appointed the FDIC to become NextBank's receiver. (See id. Ex. A at 46.) As receiver, the FDIC succeeded to "all [NextBank's] rights, titles, powers, and privileges." 12 U.S.C. § 1821(d)(2)(A)(I) (2006). Further, the FDIC's appointment obligated it to "preserve and conserve [NextBank's] assets and property." Id. § 1821(d)(2)(B)(iv).

BNY is the indenture trustee for the trust NextBank established to securitize its accounts. (Christensen .Decl. Ex. 4 ["MI"] at 140, 205.) As indenture trustee, BNY represents the interests of the Noteholders, who are large, institutional investors, including Credit Suisse, Goldman Sachs, J.P. Morgan, Deutsche Bank, and Barclays Capital. (Id. Ex. 2 ["Offering Mem. 4/20/01"] at 937-38; Offering Mem. 12/6/00 at 460-61, 593; see Wigand Dep. Ex. 4 at 3.)

II. Principles and Benefits of Securitization

In order to address the parties' dispute, one must first have a basic understanding of NextBank's method of financing. "Securitization has grown from an emerging practice involving mortgage receivables more than 25 years ago to one of the most widely used fonts of commercial funding across a broad range of businesses, both in the U.S. and worldwide." (Pl.'s Mot. Ex. B at 6.) Although securitization can take various forms, most securitization arrangements involve certain basic players: a "transferor," the initial owner of the assets; a "special purpose vehicle" ("SPV"), which the transferor creates to purchase and hold the assets; and investors, who purchase securities issued by the SPV. (Id. Ex. B at 6, 9.)

A key principle underlying securitization is that quantifying the creditworthiness of pooled assets is often easier than quantifying the creditworthiness of the assets' owner. (Id.) Ease and accuracy of quantification makes it possible to bundle assetbacked securities for sale in classes, or "tranches," calibrated to varying investor preferences for income and risk. (See id. Ex. B(5) at 4 n. 2.) Both investors and transferors benefit as a consequence. Investors can insulate themselves from the difficult-to-quantify risks of a transferor's business and make investments suited to their individual preferences for income and risk. (See id. Ex. B at 9; id. Ex. B(5) at 4 n. 2.) Transferors can procure lower-cost financing and access to capital from institutional investors who might, absent securitization, be unable or unwilling to purchase the transferors' assets. (Id. Ex. B(5) at 3-4.)

A second important principle of securitization is the "legal isolation" of assets from their transferors. (Id. Ex. B(5) at 2, 4.) As defined by the Financial Accounting Standards Board ("FASB"), legal isolation means that an asset is "presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership." (Id. Ex. B(5) at 1 (quoting Fin. Accounting Standards Bd., Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities 4 (1996), available at http://www.fasb.org/pdf/fas125.pdf).) Because the FASB's generally accepted accounting principles do not permit transferors to remove assets from their balance sheets absent legal isolation, legal isolation makes possible one of securitization's notable benefits for transferors—the ability to reduce their required capital reserves. (Id. Ex. B(5) at 1-3; see Pl.'s Mem. in Supp. at 2 ("The separation between NextBank and the Trust allowed NextBank to receive favorable accounting and regulatory treatment . . . ").)

III. Securitization of NextBank's Receivables

A. The Transaction Documents

All securitizations are based on documents that define the duties and obligations that transferors, SPVs, and investors owe one another. (Pl.'s Mot. Ex. B at 9.) NextBank securitized its assets using several interrelated "transaction documents." These included a "Trust Agreement" (Christensen Decl. Ex. 6 ["Trust"] at 1-28), an "Administration Agreement" (id. Ex. 7 ["Admin."] at 43-56), a "Transfer and Servicing Agreement" (id. Ex. 10 ["T & S"] at 58-115), and the Master Indenture (MI at 138-207).³

In the Trust Agreement, dated December 1, 2000, NextBank created a trust to hold its credit card receivables and repay the Noteholders. (Trust at 1; Def.'s Stmt. ¶ 16.) The Trust Agreement designated NextBank the "owner" of the trust and, as such, accorded NextBank an "undivided beneficial interest" in the trust's assets. (Id.) Because NextBank owned the trust, the Trust Agreement provided that, "for income tax purposes, the [t]rust [would] be treated as a security device and disregarded as an entity." (Trust at 4.)

The trust depended on NextBank for its operation, because it lacked employees or infrastructure of its own. (Def.'s Stmt. ¶ 16.) The Administration Agreement, dated December 1, 2000, made NextBank responsible for carrying out the trust's duties under the other transaction documents. (Pl.'s Statement of Undisputed Facts ["Pl.'s Stmt."] ¶ 22; see Admin. at 46-47.)

In the Master Indenture, dated December 11, 2000, the trust authorized the issuance and sale of notes secured by and paid from the credit card receivables transferred to the trust. (MI at 138; Def.'s Stmt. ¶ 19.) Terms specific to particular series of notes would be set forth in seriesspecific "indenture supplements." (MI at 159.)

Notes issued by the trust would have three possible cash-flow periods. (Def.'s Stmt. ¶ 11; see Offering Mem. 12/6/00 at 391.) During an initial "revolving period," Noteholders would be paid only interest and no principal. (Id.) After the revolving period, there would be a "controlled amortization period" during which principal would be paid to Noteholders in fixed amounts at scheduled intervals. (Def.'s Stmt. ¶ 13; see Offering Mem. 12/6/00 at 391-92.) Finally, if there occurred a "redemption event"...