Court Opinion

ID: 6929300
Source: CourtListenerOpinion
Date Created: 2022-07-23 23:48:58.71404+00
Date Added: 2024-06-11T16:07:04.770701
License: Public Domain

WILLIAM A. NORRIS, Circuit Judge,
dissenting:
The majority holds that the FDIC is not required to honor two letters of credit issued by the First National-Bank, Chico, before the FDIC took it over. Although the majority rejects the FDIC’s efforts to rely upon the D’Oench, Duhme doctrine, § 1823(e), and § 371c(c)(l) as justification for refusing to *1493honor the letters of credit, it nonetheless rules in favor of the FDIC on the basis of a novel legal doctrine it forges from disparate elements of § 1823(e) and § 371e(c)(l). In applying the new law it makes to the facts of this case, the majority eviscerates the principle that the validity of a letter of credit is not affected by irregularities in the underlying transactions.
I
The standby letters of credit in dispute were issued by the Bank to appellee Patrick J. Murphy to secure promissory notes issued to Murphy by the Bank’s holding company. The holding company ultimately defaulted on the notes, and when Murphy attempted to draw upon his letters of credit, the Bank refused to honor them.1 When the FDIC was appointed the Bank’s receiver, it too refused to honor the letters of credit.
Murphy brought this action to enforce payment of his letters of credit. By way of defense, the FDIC argued to the jury that it was not obligated to honor the letters of credit for essentially three reasons. First, the FDIC argued that the letters of credit transactions were not negotiated at arms length and that Murphy, whom the FDIC contended was a director of both the Bank and the holding company at the time the first letter of credit was issued, engaged in improper self-dealing. Reporter’s Transcript (“RT”) at' 1207-11. Second, the FDIC argued that as a sophisticated businessman and director or former director, Murphy knew or should have known that the letters of credit were issued in violation of federal banking laws that require, among other things, a bank affiliate to provide adequate collateral for letters of credit the bank issues for its benefit. RT at 1211-13. Third, the FDIC contended that Murphy had failed to make proper presentment of the letters of credit. RT 1214-18. The jury rejected these arguments and returned a verdict in favor of Murphy. The district court entered judgment for Murphy in the amount of the letters of credit plus interest.
II
On appeal, the FDIC challenges neither the jury findings nor the jury instructions. Rather, it argues that, as a matter of law, it is not required to* honor Murphy’s two letters of credit, relying seriatim on D’Oench, Duhme, § 1823(e), and § 371e(c)(l). I agree with the majority that the FDIC’s reliance upon these protective doctrines is misplaced. I discuss each of them in turn for the purpose of laying the groundwork for a critique of the far-reaching doctrine the' majority has invented for the. FDIC to use in defeating creditor’s claims against failed banks.
§ 371c(c)(l). First the FDIC relies upon 12 U.S.C. § 371c(c)(l), which prohibits a bank from extending credit to an affiliate without adequate collateral. Because in this case the Bank’s holding company failed to provide collateral sufficient to protect the Bank against loss on the letters of credit, the FDIC argues that the Bank violated § 371c(c)(l). And so it did. But the real question is why the Bank’s own violation of § 371c(c)(l) in failing to get adequate collateral from its holding company should have any bearing on Murphy’s right to payment on the letters of credit.2 The traditional principle that a letter of credit remains enforceable despite any irregularities in the underlying transaction has “prompted courts to uphold the financial device despite claims of underlying illegality.” Security Finance Group, Inc. v. Northern Kentucky Bank and Trust Inc., 858 F.2d 304, 307 (6th Cir.1988). The FDIC offers no reason for disregarding that principle here.
D’Oench, Duhme. The FDIC’s invocation of D’Oench, Duhme in this case is as much of *1494a stretch as its reliance’ on § 371c(c)(l). D’Oench, Duhme is an equitable, unclean hands estoppel rule that protects the FDIC against defenses or claims based upon secret or unrecorded side agreements which, if enforced, would diminish the value of particular assets as reflected in the books and records of a bank. It embodies a federal policy, derived from the' statutory scheme that created the FDIC, to protect the FDIC “and the public funds which it administers against misrepresentations as to the securities or other assets in the portfolios of the banks which [the FDIC] insures or to which it makes loans.” FSLIC v. Gemini Management Co., 921 F.2d 241, 244 (9th Cir.1990) (quoting D’Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 457, 62 S.Ct. 676, 679, 86 L.Ed. 956 (1942)). As we have stated:
D’Oench, Duhme precludes obligors from asserting side deals or secret agreements which may mislead bank examiners against the FDIC to diminish the value of written loan obligations. Section 1823(e) bars the use of extrinsic agreements to diminish or defeat the FDIC’s interest in an asset, unless the documents meet specific requirements. Together, the effect of D’Oench, Duhme and section 1823(e) is to allow federal and state bank examiners to rely exclusively on a bank’s records in evaluating the worth of a bank’s assets.
Notrica v. FDIC, 2 F.3d 961, 964-65 (9th Cir.1993) (emphasis added, internal quotations and citations omitted).
There are three obvious reasons why D’Oench, Duhme does not apply in this case. First, Murphy was not a party to any side agreement with the Bank, or with the Bank’s holding company for that matter. Second, a standby letter of credit issued by the Bank is not a Bank asset, but a liability. Third, Murphy is an obligee, not an obligor. In the absence of a side agreement and an asset whose value would be diminished if a side agreement were enforced, the debtor-creditor relationship between the Bank and Murphy falls far outside the ambit of D’Oench, Duhme. See Agri Export Co-Op. v. Universal Sav. Ass’n, 767 F.Supp. 824, 832 (S.D.Tex.1991) (finding D’Oench, Duhme inapplicable to unrecorded letter of credit because of absence of secret agreement and fact that letter of credit is not a bank asset).
The central purpose of D’Oench, Duhme is clear: “The D’Oench, Duhme doctrine ... favors the interests of depositors and creditors of a failed bank, who cannot protect themselves from secret agreements, over the interests of borrowers, who can.” Timberland Design, Inc. v. First Serv. Bank For Sav., 932 F.2d 46, 48 (1st Cir.1991) (quoting Bell & Murphy & Assoc. v. Interfirst Bank Gateway, N.A., 894 F.2d 750, 754 (5th Cir.), cert. denied, 498 U.S. 895, 111 S.Ct. 244, 112 L.Ed.2d 203 (1990)) (emphasis added). D’Oench, Duhme was never intended to be used as a shield against a holder of a letter of credit. Murphy, after all, is suing as a creditor of the Bank, not as a borrower.
§ 1828(e). The FDIC fares no better with D’Oench, Duhme’s statutory cousin, § 1823(e), even though the Bank failed to record the letters of credit on its own books as liabilities on a continuous basis. Section 1823(e) protects the FDIC from an “agreement which tends to diminish or defeat the interest of the [FDIC] in any asset” it acquires, if the agreement is not in writing, executed contemporaneously with the acquisition of the asset, approved by the bank’s board of directors, and recorded on its books. It thus has two threshold requirements. First, the FDIC must have acquired a particular asset from a bank. See, e.g., Agri Export, 767 F.Supp. at 833 (requiring “particular, identifiable asset” as trigger for applicability of § 1823(e)). Second, there must be an unrecorded and unapproved agreement that would lessen the FDIC’s claim in that asset.' See, e.g., Commerce Federal Sav. Bank v. FDIC, 872 F.2d 1240, 1244 (6th Cir.1989) (noting that § 1823(e) applies only to “an action or defense which is anchored in an agreement separate and collateral from the instrument which the FDIC is seeking to protect”). For the same reasons that D’Oench, Duhme is inapplicable to this letter of credit case, § 1823 is also inapplicable: there was no side agreement and the letters of credit were liabilities, not assets, of the Bank. See Notrica, 2 F.3d at 964-65. Indeed, what we said in Notrica is worth repeating: “Section 1823(e) bars the use of *1495extrinsic agreements to diminish or defeat the FDIC’s interest in an asset, unless the documents meet specific requirements.” 2 F.3d at 964-5 (emphasis added).3
Ill
Even though my colleagues agree with me that the FDIC cannot rely upon § 371e(c)(1), D’Oench, Duhme, or § 1823(e) as a defense to Murphy’s action to enforce his letters of credit, they nonetheless rule in favor of the FDIC on the basis of a novel doctrine forged from disparate elements of § 1823(e) and § 371c(c)(l). They excuse the FDIC’s failure to honor the letters of credit because (1) the Bank’s own failure to carry the letters of credit on its books as liabilities constitutes an' “irregularit[y] in the Bank’s books,” within the meaning of § 1823(e), and (2) the failure of the Bank to obtain adequate collateral for the letters of credit from its holding company constitutes an “illegality] in the banking transaction,” within the meaning of § 371c. Opinion at 13887. The majority’s freshly-minted doctrine is as unsupported in logic as it is in law.
At the core of the majority’s reasoning is an analogy it tries to draw between the letter of credit transactions at issue here and a hypothetical banking transaction to which § 1823(e) would clearly apply. “If PNB [the holding company] had given collateral to the Bank as security for the issuance of the letters of credit and had made a secret agreement that the Bank would never foreclose upon that security,” the majority writes, “we would have little doubt that § 1823(e) would be violated.” Opinion at 13887. It then declares, summarily, that “[t]his transaction is functionally the same. The FDIC is entitled to at least as much protection here as it would be in those circumstances.” Id.
In fact, the real and the hypothetical transactions are neither analogous nor “functionally the same.” The majority’s hypothetical is nothing more than a paradigmatic § 1823(e) or D’Oench, Duhme case: a bank’s interest in an asset — the collateral posted by a holding company as security for the issuance of letters of credit — may not be diminished or defeated by an unrecorded side with a bank obligor, which, in the majority’s hypothetical, is the holding company.
But what does a bank’s failure to obtain adequate collateral from its holding company have to do with the bank’s obligation to honor letters of credit issued to third parties? Absolutely nothing. The only issue the hypothetical raises is the FDIC’s right to foreclose upon the collateral notwithstanding a secret agreement with the holding company not to foreclose. I am left bewildered as to how the majority’s hypothetical sheds any light whatsoever on its holding that Murphy loses his rights under the letters of credit bécause of the Bank’s failure to obtain adequate collateral from its holding company and the Bank’s failure to record the letters of credit as liabilities on its own books.
In the real case before us, neither of § 1823(e)’s two triggers have been tripped: the letters of credit were not assets of the Bank,' and Murphy has not raised a claim or defense against the FDIC based upon a side agreement with the Bank. As a result, until words lose their meaning entirely, Murphy’s two letters of credit simply cannot qualify as .“agreements] which tend[] to diminish or defeat the interest of’ the FDIC in an asset it acquired from the Bank. The holding company’s failure to provide collateral, which is so important in the majority’s analysis, is an extraneous fact that cannot substitute for § 1823(e)’s express threshold requirements.4
The majority, in drawing upon its hypothetical secret transaction between the Bank and its holding company, conflates two related, but distinct transactions: the issuance of credit to the holding company and the is*1496suance of letters of credit to Murphy. In doing so, the majority ignores settled law that the debtor-creditor relationship created between the Bank and Murphy must be viewed separately from the creditor-debtor relationship created between the Bank and its holding company. In a letter of credit transaction, the credit arrangement between the issuing bank and the beneficiary of the letter of credit “is distinct from and independent of all the related” contractual arrangements. J. Dolan, The Law of Letters, of Credit: Commercial and Standby § 2.09 at 2-31 (2d ed. 1984). See also FDIC v. Bank of San Francisco, 817 F.2d 1395, 1398 (9th Cir.1987) (noting that a letter of credit “becomes an engagement of the issuer to the beneficiary who accepts it”). Accordingly, the FDIC’s obligation to honor Murphy’s letters of credit exists “distinct from and independent of’ whatever arrangement was made between the Bank and the holding company to give the Bank security for the issuance of the standby letters of credit.5
And that’s not all. The majority’s decision establishes as the law of the Ninth Circuit that the FDIC may repudiate — rather than enforce, as in the hypothetical and every past § 1823(e) case of which I am aware — the facial terms of written contractual obligations, in this case letters of credit. See, e.g., Langley v. FDIC, 484 U.S. 86, 108 S.Ct. 396, 98 L.Ed.2d 340 (1987) (enforcing facial terms of note and personal guarantees, under section 1823(e), despite oral condition); FDIC v. Zook Bros. Const. Co., 973 F.2d 1448, 1451 (9th Cir.1992) (enforcing written guarantee held by FDIC despite defendant’s claim that a side agreement released this obligation); FDIC v. Hatmaker, 756, F.2d 34, 37 (6th Cir.1985) (noting that “[t]he purpose [of § 1823(e) ] is to protect the FDIC from hidden agreements that would defeat its interest in what is otherwise a facially valid note”).
IV
The majority is able to apply § 1823(e) to Murphy’s letters of credit only by rewriting the statute. At one point in its opinion, the majority states that “[w]hat matters [in determining whether § 1823(e) applies] is whether the agreement diminished the FDIC’s interest in an asset acquired when it took over the bank....” Opinion at 13888 (emphasis added). This is á precise and accurate reading of § 1823(e), which requires an agreement that would diminish the FDIC’s interest in a particular, identifiable asset. See Notrica v. FDIC, 2 F.3d at 964-65; Agri Export, 767 F.Supp. at 833; see also supra at 1494.
Just two sentences later, however, the majority radically amends the statute by asserting that honoring the letters of credit in the absence of adequate collateral would have a “palpable adverse impact on the assets of the bank as required for invocation of § 1823(e)’s protection.” Id. (emphasis added).' The majority’s unacknowledged change in the statutory language — its substitution of the plural word “assets,” which Congress chose not to use, for the singular word “asset” — is as critical to its holding as it is unwarranted.
Paying Murphy would not defeat or diminish the FDIC’s interest in any particular asset it acquired from- the Bank. This- is because, quite simply, a letter of credit is a liability, not an asset. To be sure, paying Murphy would diminish the Bank’s total assets, specifically its cash account, since Murphy would presumably be paid in cash. But so would paying the electricity bill.
Indeed, under the majority’s amended version of § 1823(e), every obligation a bank owed to its creditors, without limit, would fall into § 1823(e)’s domain, for every obligation it honors has a “palpable adverse impact” on *1497the bank’s assets generally. Cf. Thigpen v. Sparks, 983 F.2d 644, 649 (5th Cir.1993) (overly expansive reading of § 1823(e) and related statute would transform the FDIC’s protective doctrine, designed to safeguard “the failed bank’s loan portfolio ' from D’Oenchr-]ike secret agreements!!,] into a meat-axe for avoiding debts incurred in the ordinary course of business”). It has long been the law of the circuit, however, that the FDIC may not dishonor an obligation merely because doing so would diminish the capital of a bank it takes over: “[I]t could not have been the congressional intent, upon balance, to have the fiscal integrity of the deposit insurance fund (which can be adequately protected by other more equitable means) outweigh the policy of equitable and ratable payment of creditors.... ” First Empire Bank v. FDIC, 572 F.2d 1361, 1371 (9th Cir.1978), cert. denied, 439 U.S. 919, 99 S.Ct. 293, 58 L.Ed.2d 265 (1978).
Although the majority claims to reject the FDIC’s “broadest contention” that every obligation must meet § 1823(e)’s recordation and approval requirements, the breadth of its reading of § 1823(e) belies such a limitation. Opinion at 13886. Only if “asset” means “total assets” does § -1823(e) work to render Murphy’s letters of credit unenforceable.
Not only is the majority’s decision to apply § 1823(e) to Murphy’s letters of credit inconsistent with the statute’s language, but it is contradicted by § 1823(e)’s structure. If the threshold requirements of § 1823(e) were as all-inclusive as the majority believes, § 1823(e)(2) would make no sense. Section 1823(e)(1) requires that agreements falling within the parameters of the statute be reduced to writing. Section 1823(e)(2) requires such writings to be executed “contemporaneously with the acquisition of the asset by the depository institution.” Here “asset” simply cannot mean a bank’s assets generally. It can only refer to a specific item of value that the bank “acquires” at a particular time. As Judge Jones, writing for the Fifth Circuit, has observed, “These • modifiers [the terms “asset and “acquisition” in subsection 1823(e)(2) ] bind § 1823(e) to its origins in the D’Oench doctrine as a device to protect the federal regulators from side agreements that would haye impeded the collection of obligations owed to the bank. Such obligations are the bank’s ‘assets’ acquired in the course of its banking activities.” Thigpen v. Sparks, 983 F.2d at 649 (emphasis added).
When a bank issues a letter of credit, it does not acquire an asset. It undertakes an obligation for the benefit of a third party. To be sure, the collateral it may receive from its customer constitutes, an asset. But it is perverse to think that if the collateral is not provided, the letter of credit the bank issues — its liability — somehow becomes its asset. Yet this is exactly what the majority does in holding that the Bank’s violation of § 371c(c)(l) creates “an ‘asset’ within the purview of § 1823(e).” Opinion at 1491.6
It is a serious error to try to fit this ease under the rubric of § 1823(e) — an error compounded by the fact that the commercial reliability of letters of credit is at issue. The majority’s fabrication of a new doctrine out of , bits and pieces of § 1823(e) and § 371c(c)(l) threatens settled commercial law governing letters of credit by creating an intolerable risk that they will not be honored if the issuing bank is taken over by government regulators. Cf. FDIC v. Bank of San Francisco, 817 F.2d at 1399 (noting that allowing defenses to actions for payment of letters of credit other than “fraud in the presentment of the required documents” would destabilize commercial transactions). Indeed, the majority’s new rule of law “will undermine the certainty and reliability of *1498commercial transactions which depend upon letters of credit.” Chuidian v. Philippine National Bank, 976 F.2d 561, 567 (1992) (Fernandez, J., dissenting).7
The whole purpose of both D’Oench, Dutime and § 1823(e) is to allow government regulators to assume the facial validity of loans and other assets in the Bank’s portfolio. What my colleagues do, in forging elements of disparate statutes into a novel doctrine, is present government regulators with a new weapon that permits them to go behind letters of credit — which, on their face, memorialize bank obligations, not assets — in order to defeat the claims of bank creditors. The majority’s holding represents an unprecedented and untenable extension of the doctrines that protect the deposit insurance fund. It converts § 1823(e) into a “transac-tionally infinite[,] ... limitless, per se guarantee of victory by federal banking agen-cies_” Alexandria Association Ltd. v. Mitchell Co., 2 F.3d 598, 602 (5th Cir.1993) (holding to the contrary). I dissent.

. Section 371c constitutes part of a regulatory scheme that requires banks to carry out their business according to a set of statutory guidelines. If a bank violates § 371c by issuing credit to an affiliate without adequate collateral, it — not the parties to whom it issues letters of credit— may be subject to administrative sanctions. See, e.g., 12 U.S.C. § 504 (subjecting banks that violate, inter alia, § 371c to civil penalties). § 371c regulates banks; it does not create defenses to bank obligations to third party creditors.

. Section 1823(e) was amended to its present form in 1989. Other circuits have held that before the 1989 amendment, § 1823(e) did not apply to the FDIC in its capacity as receiver. See, e.g., Beighley v. FDIC, 868 F.2d 776, 783 (5th Cir.1989). The majority relies on the text of § 1823(e) as amended in 1989, assuming without discussion that the amendment applies retroactively to the transactions at issue in this case, which took place in 1986.

. I discuss in greater detail the majority’s attempt to categorize Murphy’s letters of credit as “assets” in part IV, infra.

. Contrary to the majority’s characterization of my position, I fully agree with the majority that no irregularity in the transaction between Murphy and the holding company is at issue in this case. See Opinion at 1492. Nor do I dispute the majority’s conclusion that the Bank violated federal banking law by failing to obtain collateral from its holding company. I part company with the majority because I fail to understand how such internal irregularities can possibly justify a refusal to honor the letters of credit. That Murphy was an "intended beneficiary of an unlawful extension of credit,” Opinion at 1491, is true, but irrelevant to whether the FDIC should be excused from honoring the letters of credit. All that is relevant is that the Bank engaged its own credit in issuing the letters of credit to Murphy.

. The majority cites OPS Shopping Center, Inc. v. FDIC, 992 F.2d 306, 309 (11th Cir.1993), to support its assertion that “[t]here is an 'asset’ within the purview of § 1823(e).” Opinion at 1491. But OPS, which the majority quotes out of context, .lends it no support. OPS was decided under D'Oench, Duhme, not § 1823(e), and the court specifically noted "[t]he FDIC does not contend in this case that there was an asset held by the FDIC to which the letter of credit was related." Id. at 309 n. 4. In fact, the parties to the instant case stipulated, as the majority notes, that the letters of credit at issue are bank liabilities, not assets: "[B]oth parties stipulated that '[t]he letters were not carried on the books of accounts, accounting records or ledgers of FNB as liabilities of the bank, contingent or otherwise, as of March of 1986.' " Opinion at 1487 (emphasis added).

. Despite its disclaimer, the majority concludes that "[t]hese particular letters of credit should not be the responsibility of the FDIC," Opinion at 1492, partly on the basis of its sense that Murphy’s hands are unclean. Without a word of elaboration, the majority accuses Murphy of receiving "an undoubtedly inflated purchase price” for his stock in the holding company and of delaying his responsibility to guarantee the holding company's debt. Id.
But this is pure speculation. How do we know that the price Murphy received for his stock was "inflated”? The majority doesn’t tell us. And why does the fact that Murphy may have made money on his stock defeat his right to enforce the letters of credit? Again the majority doesn't tell us. Nor does it mention that, in response to an argument by Murphy’s trial counsel that the price Murphy received for his holding company stock was reasonable, the FDIC’s trial counsel called the entire issue of the stock's value a "red herring” that has "nothing to do with the transaction with the Bank." RT at 1208. Yet now, on appeal, the majority makes much of that very red herring.
The majority also makes a finding of fact that the second letter of credit issued to Murphy is unenforceable because the loan Murphy made to the holding company was used to reduce indebtedness that Murphy guaranteed. What the majority seems to be saying is that the transactions were somehow tainted because Murphy was an insider who engaged in self-dealing. The trouble with this bit of appellate factfinding is that the jury exonerated Murphy of any wrongdoing as an insider. At trial the FDIC argued to the jury that the Bank was "an innocent intended victim in this case” (RT at 1206), that Murphy was an insider who engaged in self-dealing ("Well, if that’s not self-dealing, I don’t know what is.” RT at 1209), that Murphy’s dealings were not "arms-length” (RT at 1207), and that Murphy had failed to carry his burden that his dealings with the Bank were "just and reasonable” (RT at 1207, 1209). The jury found for Murphy on all these issues.
What the majority has done by considering the equities of the. transactions is exactly what the Supreme Court has said courts may not do: it has taken § 1823(e)'s precise statutory requirements and ”graft[ed] equitable exceptions” onto them. Langley v. FDIC, 484 U.S. 86, 91, 108 S.Ct. 396, 401, 98 L.Ed.2d 340 (1987).