In the

United States Court of Appeals

For the Seventh Circuit ____________

No. 03-2619

FEDERAL DEPOSIT INSURANCE CORPORATION,

Plaintiff-Appellant,

v.

ERNST & YOUNG LLP,

Defendant-Appellee.

____________

Appeal from the United States District Court for

the Northern District of Illinois, Eastern Division.

No. 02 C 7914—Robert W. Gettleman, Judge.

____________

ARGUED NOVEMBER 4, 2003—DECIDED JULY 8, 2004

____________

Before EASTERBROOK, ROVNER, and EVANS, Circuit

Judges.

EASTERBROOK, Circuit Judge. For almost a decade

Superior Bank FSB participated in the sub-prime lending

market, making loans to home and auto buyers with poor

credit records. It then sold to public investors interests in

pools of these loans; the process is known as securitization.

Investors were promised a fixed rate of interest lower than

the one the borrowers had agreed to pay Superior. Securitization creates diversification; a pool of loans is safer than
2 No. 03-2619

any one loan (and fractional interests in many pools are

safer than one pool), unless defaults are perfectly (and

positively) correlated. Superior held a residual interest

in these pools to the extent that the total return exceeded

the fixed rate promised to the investors. Two things could

drain value from this retained interest: an unexpectedly

high default rate, or an unexpectedly high prepayment rate

(for if the borrowers prepaid, then Superior would not

receive the high contractual interest rate). At one point

Superior reported that its retained interest in securitized

loans was worth about $1 billion. When interest rates fell

during the late 1990s, however, borrowers began to prepay

and refinance their loans more frequently. In January 2001

Ernst & Young, Superior’s auditors, concluded that Superior’s accounts must be restated to reduce the value of the

retained interests by $270 million; a write-down of a further

$150 million soon followed.

Disappearance of $420 million that had been booked as

investors’ equity left Superior insolvent, and the Federal

Deposit Insurance Corporation assumed control in July

2001. The FDIC appointed a conservator to wind down

Superior’s business; as manager of the Savings Association

Insurance Fund, the FDIC supplied credit to facilitate this

process and assure that all insured depositors would be

paid in full. The FDIC says that the net loss to the insurance fund exceeds $500 million. Superior’s equity owners

have promised to pay $460 million over time. Believing that

the accountants also bear responsibility for the bank’s

failure—that generally accepted accounting principles required the residual interests to be discounted in light of the

possibility of prepayments and other events that could

intervene before the outside investors had been paid off—

the FDIC has sued Ernst & Young for hefty compensatory

and punitive damages. Illinois law, which the FDIC agrees

controls, permits third parties such as investors to sue accountants for fraud (which the FDIC alleges). 225 ILCS
No. 03-2619 3

450/30.1(1). It allows third parties to recover for ordinary

negligence (which the FDIC also alleges) if the accountant

knew that “a primary intent of the client was for the

professional services to benefit . . . the particular person

bringing the action”. 225 ILCS 450/30.1(2). If the FDIC

prevails, 25% will go to the equity investors (effectively reducing the net proceeds of that settlement) and the rest will

be applied to the benefit of Superior’s other creditors,

principally the insurance fund.

By referring to “the FDIC” as the plaintiff, we have simplified unduly—for that agency acts in multiple capacities,

and the difference affects this litigation. For many purposes

it is helpful to treat the FDIC as two entities: FDIC-Receiver and FDIC-Corporate. (The FDIC has a third capacity

as bank overseer and regulator.) FDIC-Receiver acquires

the assets and legal interests of the failed bank and proceeds much as a trustee in bankruptcy; FDIC-Corporate

acts as guardian of the public fisc, disburses proceeds from

the insurance fund, and having paid insurance claims is

subrogated to rights of the bank’s depositors against the

failed institution. See 12 U.S.C. §1821(g). FDIC-Corporate

also holds the right to prosecute claims against the failed

bank’s officers and owners. 12 U.S.C. §1821(k). As we have

recounted, FDIC-Corporate has secured a substantial

settlement from Superior Bank’s managers and equity

investors. Other claims held by the failed bank (as opposed

to its depositors) come within the control of FDIC-Receiver.

Accounting misconduct, like legal malpractice, may entitle

the client (and FDIC-Receiver as its proxy) to recover

damages. But FDIC-Receiver has neither sued Ernst &

Young nor assigned that right to FDIC-Corporate. See 12

U.S.C. §1823(d) (permitting FDIC-Receiver to sell or assign

choses in action to FDIC-Corporate). Instead FDIC-Corporate has sued without benefit of an assignment. The FDIC

believes that this maneuver allows it to avoid two terms of

the contract by which Superior Bank engaged Ernst &
4 No. 03-2619

Young. Superior Bank promised to arbitrate any disputes

with the accounting firm, and it also waived any claim to

punitive damages. FDIC-Receiver steps into the shoes of the

failed bank and is bound by the rules that the bank itself

would encounter in litigation. See O’Melveny & Myers v.

FDIC, 512 U.S. 79 (1994). But FDIC-Corporate did not

assume Superior Bank’s contracts and can litigate free of

Superior’s promises. See EEOC v. Waffle House, Inc., 534

U.S. 279 (2002) (federal agency not bound by arbitration

clause when it litigates in its own name, even though

persons who agreed to arbitrate would be the principal

beneficiaries of a favorable judgment).

Ernst & Young argued that the FDIC sued in the wrong

capacity—and that if the agency’s capacity were changed to

reflect that FDIC-Receiver is the proper adversary, then the

suit must be dismissed in favor of arbitration. The district

court did not directly resolve these contentions. Instead it

dismissed the suit for lack of standing. 256 F. Supp. 2d 798,

reconsideration denied, 216 F.R.D. 422 (2003). As the judge

saw matters, suit by FDIC-Corporate would frustrate the

operation of 12 U.S.C. §1821(d)(11)(A), which establishes

preferences among creditors in the failed bank. FDICReceiver must apply any recoveries first to secured creditors, then to pay off any uninsured depositors, next to

general creditors, and finally to subordinated claims

(including those of the shareholders). But FDIC-Corporate

could satisfy its own claims as insurer first before turning

over any excess to FDIC-Receiver for distribution under the

statutory priority.

What this has to do with “standing” is unfathomable. A

person whose injury can be redressed by a favorable judgment has standing to litigate. See Lujan v. Defenders of

Wildlife, 504 U.S. 555, 559-62 (1992). FDIC-Corporate

suffered an injury when it disbursed money from the insurance fund; it asserts that Ernst & Young caused (part of)

this loss; and the loss can be redressed (and the fund
No. 03-2619 5

replenished) by a judgment for money damages against

Ernst & Young. Nothing more is required for standing.

At all events, FDIC-Corporate has promised to distribute

proceeds of the litigation just as if they had come to FDICReceiver. The district court was skeptical about this promise but did not explain why the FDIC should be thought

untrustworthy (one branch of government should not

assume that another is deceitful), let alone why such an

undertaking could not be enforced if the FDIC reneged.

Promises by the Executive Branch to pay money other than

as statutes require do not estop the United States, because

the Constitution gives Congress the power to control

distributions from the Treasury. See Office of Personnel

Management v. Richmond, 496 U.S. 414 (1990). But a

promise to abide by a federal statute poses no such difficulties. Section 1821(d)(11)(A) does not block this litigation.

But why should FDIC-Corporate be allowed to pursue a

claim that §1821 seemingly allocates to FDIC-Receiver? The

FDIC’s principal response is: “What’s to prevent it?” No

statute says that FDIC-Corporate is forbidden to sue third

parties such as lawyers and accountants. As FDIC-Corporate sees things, §1821(g) authorizes it to sue the failed

institution as subrogee of the depositors, and §1821(k)

authorizes it to sue the managers and investors; everything

else is optional. If state law would allow an insurer (say) to

sue the firm’s accountant, then off we go. That no decision

of any federal appellate court—or for that matter any

Illinois court—vindicates its claim just means (FDICCorporate insists) that this is the first suit; it does not

mean that FDIC-Corporate should lose. O’Melveny & Myers

holds that state law governs litigation in the wake of bank

failures; and as Illinois permits third parties to recover

from accountants on account of injuries caused by fraud,

whether or not the accountant knew that its client intended

to benefit this third party, FDIC-Corporate believes that it

is entitled to proceed. (The claim of fraud makes it unneces-
6 No. 03-2619

sary to determine what 225 ILCS 450/30.1(2) means in

conditioning negligence actions against accountants on

proof that “a primary intent of the client was for the

professional services to benefit . . . the particular person

bringing the action”. 225 ILCS 450/30.1(2). See Freeman,

Freeman & Salzman, P.C. v. Lipper, 2004 Ill. App. LEXIS

743 (1st Dist. June 23, 2004). On the extent to which

Illinois is an Ultramares jurisdiction, see Builders Bank v.

Barry Finkel & Associates, 339 Ill. App. 3d 1, 7-8, 790 N.E.

2d 30 (1st Dist. 2003), discussing Ultramares Corp. v.

Touche, 255 N.Y. 170, 174 N.E. 441 (1931) (Cardozo, J.).)

FDIC-Corporate points out that FDIC v. Ernst & Young,

967 F.2d 166, 171-72 (5th Cir. 1992), says in dictum that

FDIC-Corporate “might be able to make this claim”. It

wants us to turn “might be able” into “is entitled”.

O’Melveny & Myers held that claims by FDIC-Receiver

depend on state law unless a federal statute provides otherwise. In O’Melveny & Myers FDIC-Receiver contended

that it should be allowed to proceed under federal common

law—if only the kind that incorporates most state law, see

United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979)—

because nothing in §1821 forbids that approach, and because bending some state-law rules would increase recoveries for the benefit of the insurance fund. That’s the same

line of argument that FDIC-Corporate makes to us: “let

us proceed because nothing in §1821 explicitly forbids that

step, and because if we win the insurance fund will be better off.” But the reason FDIC-Corporate proposes this is to

escape rules of state contract law that bind FDIC-Receiver.

In other words, FDIC-Corporate in this suit (just like FDICReceiver in O’Melveny & Myers) wants to take advantage of

state law’s beneficial aspects while avoiding those it does

not like—particularly rules enforcing waivers of punitive

damages and agreements to arbitrate (which under the

Federal Arbitration Act, 9 U.S.C. §2, must be enforced to

the same extent as any other contractual promise).
No. 03-2619 7

O’Melveny & Myers observed that §1821 does override some

state-law doctrines, but that efforts to evade additional ones

through clever litigation tactics thus are not simply unprovided-for situations; permitting the maneuver would

contradict the statutory resolution that federal law governs

a few matters and state law the rest. 512 U.S. at 86-87. The

Court added that even if §1821 were removed from the

picture, it would be inappropriate to allow the FDIC to

evade state law; “there is no federal policy that the [insurance] fund should always win.” Id. at 88. Much of O’Melveny

& Myers, including this passage, is addressed as pointedly

to FDIC-Corporate as to FDIC-Receiver. Only by insisting

that FDIC-Receiver pursue the failed bank’s claims against

third parties such as accountants and law firms can we

ensure that all aspects of state law govern.

Still, we must consider the possibility that §1821(g)(1)

authorizes this litigation indirectly. Following payment to

a depositor from the insurance fund, FDIC-Corporate “shall

be subrogated to all rights of the depositor against such

institution or branch to the extent of such payment

or assumption.” Ernst & Young is not the “institution or

branch” of which this statute speaks. Perhaps, however, an

action against the failed bank could do service for an action

against third parties. People who cannot sue directly often

may sue derivatively: for example, a corporate shareholder

unable to sue the firm’s lawyers or accountants may be able

to sue on behalf of the firm itself, if the board of directors

unreasonably refuses or is financially aligned with the

potential defendant. See Kamen v. Kemper Financial

Services, Inc., 500 U.S. 90 (1991); Mid-State Fertilizer Co.

v. Exchange National Bank, 877 F.2d 1333 (7th Cir. 1989);

American Law Institute, Principles of Corporate

Governance: Analysis and Recommendations Part 7 Ch. 1

(1994). As the collective representative of depositors (who

after insolvency are equivalent to equity owners), FDICCorporate could demand that the failed bank pursue a
8 No. 03-2619

claim against responsible third parties and take over if a

conflict of interest prevented the bank from acting to protect its investors. See Adato v. Kagan, 599 F.2d 1111, 1117

(2d Cir. 1979); Brandenburg v. Seidel, 859 F.2d 1179, 1191

(4th Cir. 1988). But here the analogy to derivative litigation

breaks down, because the manager of the failed bank’s

estate is FDIC-Receiver, which has no conflict. Illinois

would not let FDIC-Corporate bypass “the management” (=

FDIC-Receiver) just to avoid the terms of the bank’s engagement letter with Ernst & Young. So the statutory

subrogation route offers no prospect to FDIC-Corporate

even when used as the fulcrum of a derivative claim.

Everything points to FDIC-Receiver as the right entity to

pursue any claim against Superior Bank’s accountants.

Footnotes to the parties’ briefs debate whether FDICReceiver can escape the arbitration clause and waiver of

punitive damages by repudiating these provisions on the

authority of 12 U.S.C. §1821(e). The district judge thought

not, concluding that this subsection allows the repudiation

of contracts as a whole but not unwelcome clauses in contracts. Otherwise FDIC-Receiver could walk away from the

obligation to pay for goods and services that the bank had

received before its failure. Or maybe the FDIC could claim

a right to repudiate words (such as “not”) or to repudiate

the decimal point out of a figure (turning a borrower’s

promise to pay “10.9% interest” into “109% interest”). Cf.

Risser v. Thompson, 930 F.2d 549 (7th Cir. 1991) (discussing the power of Wisconsin’s governor to veto words out of

sentences and letters out of words—subject to override,

which the FDIC does not propose to afford Ernst & Young).

Cherry picking is not allowed by the rejection power in

bankruptcy, see In re Crippin, 877 F.2d 594 (7th Cir. 1989);

why should it be permitted under §1821(e)? When denying

reconsideration the judge recognized that, because FDICReceiver is not a party, the statement is dictum and that

the subject remains open should FDIC-Receiver launch a
No. 03-2619 9

suit of its own. Likewise we avoid definitive resolution,

though it is hard to escape the logic of the district judge’s

position. If the FDIC really thought that FDIC-Receiver

could ignore these promises, then why did FDIC-Corporate

pursue this litigation? It makes sense only if FDIC-Receiver

is bound (because per O’Melveny & Myers it steps into the

failed bank’s shoes). The FDIC has not identified any

appellate decision holding that §1821(e) may be used to

excise words, sentences, or paragraphs from contracts. Still,

until FDIC-Receiver has sued, and the subject has been

fully briefed, it would be premature to resolve this question.

We can say, however, that the district court has ample

authority to award attorneys’ fees against parties that

make unjustified efforts to escape commitments to arbitrate, and that the validity of the waiver of punitive

damages would be a subject for the arbitrator rather than

the court. See, e.g., PacifiCare Health Systems, Inc. v. Book,

538 U.S. 401 (2003).

The judgment is modified to reflect a decision against

FDIC-Corporate on the merits (rather than for lack of

standing), and as so modified is affirmed.

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—7-8-04