### In the 

# United States Court of Appeals For the Seventh Circuit

____________________ No s . 08

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- 4248 H OOSIER E NERGY R URAL E LECTRIC C OOPERATIVE , I NC ., Plaintiff

- Appellee ,

v. J OHN H ANCOCK L IFE I NSURANCE C OMPANY ; OP M EROM G ENERATION I, LLC; and M EROM G EN ER ATION I, LLC, Defendants

- Appellants

. A MBAC A SSURANCE C ORPORATION ; C OBANK , ACB; AE G LOBAL I NVESTMENTS , LLC; and A MBAC C REDIT P RODUCTS , LLC, Defendants

- Appellees

.

____________________ Appeals from the United States District Court for the

Southern District of Indiana, Indianapolis Division. No. 1:08

- cv- 1560

- DFH

- DML

— David F. Hamilton , Chief Judge

.

____________________ A RGUED J ANUARY 5, 2009 — D ECIDED S EPTEMBER 17 , 2009 †

____________________ Before E ASTERBROOK , Chief Judge , and KANNE and W OOD , Circuit Judges

. E ASTERBROOK , Chief Judge . Hoosier Energy, a co

- op, had depreciation deductions that it could not use. John Hancock Life Insurance Co. had income exceeding its available dedu c -

† This opinion is being released in typescript, and the mandate will issue today, so that the district court may hold a prompt h earing to reexamine the size of the injunction bond. A printed copy will follow.No s . 08

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tions. The two engaged in a transaction designed to move Ho o sier Energy’s deduct ions to John Hancock. They entered into a leveraged lease: John Hancock paid Hoosier Energy $ 300 mi l

lion for a 63

-year lease of an undivided 2/3 interest in Hoosier Energy’s Merom ge n eration plant. Hoosier Energy agreed to lease the plant back from John Ha ncock for 30 years, making periodic payments with a present value of $ 279 million. The $ 21 million difference, Hoosier Energy’s profit, repr e sents some of the value to John Hancock of the deductions that John Ha n cock could take as the long

- term lessee of t he power plant. The transaction exposed John Hancock to several risks. The power station might b e come uneconomic before the parties’ estimate of its remaining useful life ( roughly 30 years ) . Or Ho o sier Energy might encounter financial difficulties in its b usiness as a whole. As a debtor in bankruptcy, Hoosier Energy would be entitled to repudiate the lease, leaving John Hancock with a power station that it had no interest in operating. Hoosier E n ergy’s oblig a tion as a repudiating debtor would be considerabl y less than the present value of the rentals. See 11 U.S.C. §502 ( b )( 6 ) . So Hoosier Energy agreed to provide John Hancock with add i tional security, in the form of both a credit

- default swap and a surety bond. Ambac Assu r ance Corporation and three affiliates agreed to pay John Hancock approximately $ 120 million if certain events occurred. ( For its part, Ho o sier Energy posted substantial liquid assets to Ambac’s credit, in order to protect A m bac should it be required to pay John Hancock; this was part of the t ransaction’s swap fe a ture. ) A credit

- default swap, like a letter of credit, is a means to assure payment when contingencies come to pass, without proof of loss ( as a surety bond would require ) . One of the contingencies in this transa c tion is a reduction in A m bac’s own credit rating. If that rating falls below a prescribed threshold, Hoosier Energy has 60 days to find a r e placement that satisfies the contractual standards. During 2008 Ambac’s credit rating slipped below the threshold. John Ha n cock then deman ded that Hoosier Energy find a replacement, and it extended the deadline from 60 days to more than 120 days when Hoosier E n ergy reported trouble. Whether replacing Ambac was “imposs i ble” at the time, as Hoosier Energy maintains, or just would have cost Hoo sier E n ergy more than it was willing to pay, as John Hancock b e lieves, is a subject that remains in dispute. When the extended dea d

line arrived, Hoosier Energy told John Hancock that it was inNo s . 08

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negotiations with Berkshire Hathaway to replace Ambac. John Ha n cock concluded that “in negotiations” was not good enough ( perhaps it suspected Ho o sier Energy of stalling ) and called on Ambac to perform. Ambac is ready, wil l ing, and able to meet its obligations. But before Ambac could pay, Hoosier Energy filed this sui t under the diversity jurisdiction, and the district court i s sued a temporary restraining order. The justification for that order, since replaced by a preliminary injunction, is that if A m bac pays, it will demand that Hoosier Energy cover the outlay, and t hat this will drive Hoosier Energy into ban k ruptcy
— a step that the district court called an irreparable injury. Irreparable injury is not enough to support equitable relief. There also must be a plausible claim on the merits, and the i n junction must do mor e good than harm ( which is to say that the “balance of equities” favors the plaintiff ) . See Winter v. Natural Resources Defense Council, Inc ., 129 S. Ct. 365 ( 2008 ) ; Illinois Bell Telephone Co. v. Worl d

Com Technologies, Inc. , 157 F.3d 500 ( 7th Cir. 1998 )

. How strong a claim on the merits is enough depends on the balance of harms: the more net harm an injunction can pr e vent, the weaker the plaintiff’s claim on the mer its can be while still supporting some preliminary relief. See Cavel Intern a tional, Inc. v. Madigan , 500 F.3d 544 ( 7th Cir. 2007 ) ; Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the United States of America, Inc ., 549 F.3d 1079 ( 7th Cir. 2008 ) . The district court concluded that an injunction would have net benefits, because John Ha n cock w ould remain well secured in its absence ( it remains the lessee of a power station that is essential to Hoosier Energy’s bus i ness, so Hoosier Energy will not abandon the lease ) , and that Hoosier Energy’s position on the merits is strong enough to support re lief while litigation continues. 588 F. Supp. 2d 919 ( S.D. Ind. 2008 ) . The district court also directed Hoosier E n ergy to post $ 2 million in cash, a $ 20 million injunction bond with sureties, and an unsecured bond of $ 130 mi l lion, to ensure that John Hanco ck would be made whole should it prevail in the litig a tion. As for the merits: The district court thought that Hoosier Energy has two arguments with enough punch to justify inte r locutory relief. The first is that the transaction is an ab u sive tax shelter. The district court observed that the Internal Revenue Service has declined to allow similar transactions to transfer deductions from one corporation to another and concluded that this transaction probably should be unwound. The se c ondNo s . 08

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is that, under New Yo rk law ( which the parties agree supplies the rule of decision ) , “temporary comme r cial impracticability” permits Hoosier Energy to defer coming up with another swap partner until the economy has improved. John Hancock disputes both of these conclusions, but its appellate brief opens with the contention that Hoosier Energy lacks standing to complain. After all, John Hancock o b serves, Ambac is willing and able to perform. What interest does Ho o sier Energy have in whether Ambac performs under a contract that, t he parties agreed, would be deemed independent of Ho o sier Energy’s promises? The answer is that, if Ambac pays John Hancock, then Hoosier Energy must pay Ambac. ( The funds already on deposit with Ambac are insu f ficient to cover all of Hoosier Energy’s obligations. ) A payout would be injury, caused by John Hancock’s acts, and remediable by a favorable judicial d e cision. That’s enough for standing under the Supreme Court’s precedents. See, e.g., Steel Co. v. Citizens for a Better En vironment , 523 U.S. 83, 102

– 05 ( 1998 )

. This is a three

- corner transaction ( four

- corner, if one counts the IRS ) . It was accomplished through a series of nominally i n dependent co n tracts spanning more than 3,000 pages. But it would press legal fi c tion beyond the breaking point to say t hat the independent enforceability of each party’s promises to the others meant that any of the three parties lacked stan d ing to complain about acts of the others that will produce an immed i

ate, concrete i n jury. It may be that Hoosier Energy has waived its right to complain ( that, too, is a subject on which litigation lies ahead ) , but a waiver is a defense on the merits, which di f fers from the absence of an Article III case or contr o versy. On the subject of irreparable injury, appellate review is de f

erentia l at the preliminary injunction stage, and we lack an ad e - quate basis on which to disagree with the district court’s a s sessment. That leaves the question whether Hoosier Energy has a plaus i ble theory on the merits

— not necessarily a winning one, but a claim strong enough to justify exposing John Hancock to financial risks until the district court can decide the merits. We do not agree with all of the district judge’s reasoning, but we do not think that the court erred in thin k ing Hoosier Energy’s claim suffic ient for this limited purpose, given Ambac’s co n tinuing ability to perform and the injunction bonds posted u n der Fed. R. Civ. P. 65 ( c )

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Let us start with the question whether the transaction is an illegal tax shelter that must be unwound rather than enforc ed. The district court’s approach has two steps: First, the court concluded that the transaction lacks economic substance and therefore cannot be employed to transfer tax benefits from Hoosier Energy to John Hancock. Second, the court believed that a tax s helter that the Internal Revenue Code does not a l

low is “illegal” as a matter of contract law. The first of these steps may or may not be right; the tax treatment of leveraged leases, and related transactions such as the sale and leaseback, can be difficul t. See, e.g., Frank Lyon Co. v. United States , 435 U.S. 561 ( 1978 ) . The second is wrong. A leveraged lease is a perfectly enforceable contract. Whether or not the contract lawfully transfers tax benefits, there is nothing wrong with, or illegal about, the contract itself; only the claim of tax benefits from the contract would be problematic. All questions about tax benefits to one side, a leveraged lease is simply a loan s e cured by a lease rather than a mortgage. John Hancock needs to make investments in or der to have money available to pay the death benefits on its life insurance policies. Often it invests in real estate. The transaction with Ho o sier Energy is one in which John Hancock invested $ 300 million in exchange for a promised stream of r e payments th at would last 30 years; it also obtained a security inte r est in the assets that Hoosier Energy would use to produce the funds for repayment. Neither New York nor Ind i ana would call such a transaction illegal, and the fact that a credit

- default swap i m prove d the lender’s security does not cr e ate any additional problem. Hoosier Energy has not cited, and we have not found, any decision holding a leveraged lease or sale

- and

- leaseback une n - forceable as a ma t ter of contract law, just because the main ( or even the sole ) reason for structuring the tran s action that way, rather than as a loan, was tax benefits. “Economic pu rpose” is not a requirement for the enforceability of co n tracts. If the Green Bay Packers cut a player one day and then re

- sign him the next, a cour t would not dream of canceling the new co n tract on the ground that a release

- and

- resign sequence lacks economic purpose. The Commissioner of Internal Rev e nue will address the question whether the leveraged

- lease tran s action provides John Hancock with the t ax benefits it seeks. If the answer turns out to be no, Hoosier Energy still owes John Ha n -No s . 08

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cock the promised rental payments ( and is entitled to keep the $ 21 mi l lion premium ) , while Ambac still provides security for those pa y

ments. New York law is skeptical of contentions that irregular dealings between one contrac t ing party and the g overnment excuse the other contracting party’s performance. For exa m ple, John E. Rosasco Creameries, Inc. v. Cohen , 11 N.E.2d 908, 909 ( N.Y. 1937 ) , held that the dairy’s custome r must pay for goods received, even though the dairy lacked a license and thus should not have been in business. In New York, “ [ a ] s a general rule also, forfeitures by operation of law are disfavored, partic u larly where a d e faulting party seeks to raise il legality as ‘a sword for personal gain rather than as a shield for the public good.’” Lloyd Capital Corp. v. Pat Henchar, Inc ., 603 N.E.2d 246, 248 ( N.Y. 1992 ) , quoting from Charlebois v. J. M. Weller Associates, Inc ., 531 N.E.2d 1288, 1292 ( N.Y. 1988 ) . Th ese cases illu s trate Justice Holmes’s quip that there is a strong “ policy of preventing pe o ple from getting other pe o ple’s property for nothing when they purport to be buying it.” Continental Wall P a per Co. v. Louis Voight & Sons Co ., 212 U.S. 227, 271 ( 19 09 ) ( Holmes, J., dissen t
ing ) . John Ha n cock’s taxes are a matter for it to resolve with the IRS; that John Hancock may have set out to take larger d e du c tions than the law allows does not affect Hoosier Energy’s contractual d u ties. This leaves the doctrine o f “temporary commercial impra c ticability.” John Ha n cock’s principal argument on this front is that New York law does not recognize any such do c trine. Like other states, New York recognizes the doctrine of impossibi l

ity

— but even then only the kind of imposs ibility that the pa r ties could not have anticipated. As John Hancock describes things, the parties anticipated the possibility that Hoosier E n - ergy, Ambac, or both might get into financial distress and pr o vided what was to ha p pen: if Hoosier Energy did not come up with better security in 60 days, John H ancock could draw on the credit

- d e fault swap to protect itself. When the economy turned sour, and the risk materialized, John Hancock tried to take advantage of this extra security. Yet the district court deem ed the risk’s coming to pass as a reason why John Ha n cock could not draw on the security. John Hancock sees this as perverse, an order that defeats the parties ’ bargained

- for alloc a tion of risks. The district court may have thought that eco n omy - wide condit ions justified this rea l location, but it is hard toNo s . 08

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see how an economic downturn can be alleviated by making contracts less reliable. Enforceable contracts are vital to ec o nomic pr o ductivity. See Simeon Djankov, Oliver Hart, Caralee McLiesh & A n drei Shleif er, Debt Enforcement around the World , 116 J. Pol. Econ. 1105 ( 2008 ) ; Thomas Cooley, Ramon Marimon & Vi n cenzo Quadrini, Aggregate Consequences of Limited Contract Enforceabi l ity , 112 J. Pol. Econ. 817 ( 2004 )

. Whether Hoosier Energy’s performance was “impos sible” in the strong sense that co n tract law requires depends on what its obligations were. John Hancock urges on us the pe r spective that, when Ambac’s credit rating slipped, Hoosier Energy had an option: find a new surety in 60 days, or pay Ambac the sums to which Ambac would become entitled once it paid John Ha n cock. The holder of an option may not be able to take adva n tage, but that differs from impossibility. Suppose that Hoosier Energy had an in

- the

- money option to purchase the Indianap o lis Colts by th e end of December 2008, and that as a result of the reduced availabi l ity of credit it was unable to find a lender to finance the transa c tion. That would not make performance “impossible” and extend the option’s expiration, effectively gi v

ing Hoosier E n ergy a new option ( for 2009 ) for free. Likewise if Hoosier Energy had borrowed $ 100 mi l lion and was obliged to pay the money back on O c tober 1, 2008. That Hoosier Energy found itself unable to borrow money to roll over the loan would not excuse repayment; the “impossibility” doctrine never just i

fies failure to make a payment, because financial distress differs from impossibility. See Restatement ( Second ) of Contracts§261 & comment d. The uranium case illustrates these propositions. Westin g house sold uranium on long

- term requirements contracts at fixed prices, thus assuming the risk that market prices would rise ( and it would lose money ) . Westinghouse anticipated that market prices would fall; its customers thought they would rise, or at least wanted protection against higher prices. And rise they did, partly as a result of a cartel. Westinghouse had n e glected to pr o tect its position in futures markets or through long

- term forward co n tracts. Faced with large losses if it had to buy uranium on the spot market and resell to customers at lower prices, Westinghouse contended that the unanticipated spike in ur a nium prices made its performance impossible. The argument failed; the court observed that Westinghouse and its customers had negotiated over the risk of higher p rices for ur a -No s . 08

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nium, and that the occu r rence of the risk did not excuse one side’s performance. Even if the losses drove Westin g house into bankruptcy, that would not make perfor m ance “impossible”; it would just assure that all of Westinghouse’s creditors rec eived equal treatment. See In re Westinghouse Electric Corp. Uranium Contracts Litigation , 563 F.2d 992 ( 10th Cir. 1977 ) ; Richard A. Posner & Andrew M. Rosenfield, Impossibility and Related Do c trines of Contract Law: An Economic Analysis , 6 J. Legal Studie s 83 ( 1977 )

. Much the sa me can be said about Hoosier Energy. If kee p ing its promise to A m bac drives it into bankruptcy, this ensures equal trea t ment of its creditors. It is hard to see why Hoosier Energy should be able to stiff John Hancock or Ambac, while paying 100¢ on the dollar to all of its other trading partners, just b e cause the very risk specified in the contracts between Hoosier Energy and John Hancock has occurred. Hoosier E n ergy did not expect an economic downturn, but Westinghouse did not expect an intern a tional uranium cartel. Downturns and cartels are types of things that happen, and against which co n tracts can be designed. When they do happen, the contra c tual risk allocation must be enforced rather than set aside. The di s trict court called the credit crunch of 2008 a “once

- in

- a century” event. That’s an overstatement ( the Great Depre s sion occurred within the last 100 years, and the 20th Century also saw financial crunches in 1973 and 1987 ) , and also irrel e vant. An insurer that sells hurricane o r flood insurance against a “once in a century” catastrophe, or earthquake insurance in a city that rarely experiences tre m blors, can’t refuse to pay on the ground that, when a natural event devastates a city, its very improbabi l

ity makes the contract une n forceable. We postponed discussing New York law until the general points of contract do c trine had been set out. New York law is consistent with what we have said; indeed, New York takes a very dim view of “impossibility” defenses and has never sug gested th at, when an i m possibility defense is unavailable, a “temporary commercial i m practicability” defense might serve instead. New York courts refuse to excuse performance where difficulty “is occ a sioned only by financial difficulty or economic hardship, even to the extent of insolvency or ban k ruptcy.” 407 East 61st Garage, Inc. v. Savoy Fifth Avenue Corp ., 244 N.E.2d 37, 41 ( N.Y. 1968 ) . This applies to financial instruments

— and, a l

though impossibility might allow a party to suspend its oblig a -No s . 08

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tions under a financ ial swap co n tract, this means more than a short

- term inability to pay money. General Ele c tric Co. v. Metals Resources Group Ltd ., 741 N.Y.S.2d 218 ( App. Div. 2002 ) . For its part, Hoosier E n ergy all but ignores New York law; its brief cites only a single de cision, by a trial court; appellate decisions go unmentioned. And the trial

- court decision that Hoosier E n ergy cites speaks of temporary impossibility, not “te m porary commercial impracticability.” All of this assumes, however, that John Hancock is right to characterize Hoosier Energy as having an option to find a be t
ter surety. As Hoosier Energy understands the contract, ho wever, it had a duty to find a better surety, and failure to perform this duty was the default allowing John Hancock to draw on the swap . Then it might be possible to make out a real impossibility defense, meaning that ( a ) all parties to the transaction assumed, when they n e gotiated the terms, that it would be possible to find some other intermediary with ad e quate credit standing, and ( b ) as a result of a financial crisis, no such inte r mediary existed in late 2008, no matter how much Hoosier Energy offered to post in liquid assets to secure its oblig a tions. Even this would be a difficult defense to make out under New York law. The lea d ing N ew York case on impossibility, Kel Kim Corp. v. Central Markets, Inc ., 519 N.E.2d 295 ( N.Y. 1987 ) , says that the defense works only if some unexpected event upsets all parties’ expect a tions; it is not enough that the unexpected event puts one side in a bin d. The lessee of a roller skating rink was required by contract to obtain liability insu r ance, which it got and maintained six years before the insurer declined to renew. When the policy expired, the le s sor asserted default, and the lessee sought a declara tion that pe r formance was excused by impossibility, because no insurer would unde r - write a liability policy for a roller rink at any price. Rejecting the lessee's argument, the Court of Appeals stated that impo s sibility can excuse performance only if the ne w event “could not have been foreseen or guarded against” in the contract. Fina n cial distress could be and was foreseen; that’s what the credit

default swap is all about. But if no one could have foreseen the extent of the credit crunch in 2008

— and if it r eally made pe r formance impossible, a subject on which the parties pr o foundly disagree

— then the sort of argument that Hoosier Energy makes could satisfy the requirements of Kel Kim

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We have said enough to show that there is uncertainty about how this suit c omes out under New York law. It is u n certain whether Hoosier Energy had a duty to replace Ambac, or just an option; the impossibility defense is unavailable if the option chara c terization is correct. ( We have avoided quoting the documents; some portions of these lengthy contracts su p port each side’s characterization of them. ) It is uncertain whether the extent of the 2008 credit crunch, which extended into 2009, was foreseeable. It is uncertain whether Hoosier E n ergy could have replaced Ambac by offering mo re, or better, security to another interm e diary. Hoosier Energy undermined its own position in the litigation by telling John Ha n cock that it was negotiating with Berkshire Hathaway and could strike a deal with just a li t tle more time, which implies that r eplacing Ambac was not impossible, but John Hancock returned the f a vor by suggesting that this deal was just pie in the sky and that Hoosier E n ergy would not or could not ever replace Ambac

— and, if “could not” is the right understanding, perhaps perfor m anc e was i m possible after all. All of these uncertainties collectively support the district court’s conclusion that Ho o sier Energy has some prospect of prevailing on the merits. Because appellate review is defe r ential, the district court’s understanding must prevail at the interloc u tory stage. But what was impossible in fall 2008 may well be possible in fall 2009. What is more, the longer this impasse continues, the more the balance of equities tilts in favor of John Hancock. R e call that the reason for the cre dit

- default swap was concern that the Merom station would eventually become non

- economic b e cause of changes in the market for ele c tricity, the regulation of emissions from coal

- fired stations, or the a d vancing age of the plant. The more time passes, the mo re serious this risk

— and the greater the risk that one or another problem may afflict Hoosier Energy as a firm. If, as Hoosier Energy asserts, mee t ing Ambac’s demands under the swap contract will drive it into bankruptcy, then Hoosier Energy must be skatin g close to the edge, and the longer it skates there the greater the c u mulative risk that it will fall over. Similarly Ambac may become less d e sirable as a swap partner; while this appeal has been under a d

visement, Ambac’s credit rating has been r e duced twi ce. John Hancock is entitled to the security it negotiated against these possible ou t comes. The injunction bonds, at onlyNo s . 08

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$ 22 million in liquid security, do not cover John Hancock’s e x posure. The change in Ambac’s credit rating, in particular, r e quires the district court to take a new look at the adequacy of the Rule 65 ( c ) security promptly after receiving this court’s mandate ( which will be issued together with this opinion ) . So although we a f firm the district court’s preliminary injunction, we conclude th at, if Hoosier Energy has not produced a r e placement for Ambac by the end of 2009, the time will have arrived when the court must let John Hancock realize on its security. The di s trict court itself stressed the word “temporary” in “temporary commercial imp ract i cability”; we are confident that the court will not allow “temporary” to drag out in the d i

rection of pe r manence. A FFIRMED