DOCKET: Ruling Bodes Well for Goodwill Litigants

WASHINGTON - Thrift executives with goodwill cases should be smiling.

Judge Loren A. Smith of the U.S. Court of Federal Claims, the same judge who is hearing the goodwill cases, made a legal conclusion in an unrelated matter that could pave the way for these bankers to collect billions of dollars in damages.

Judge Smith, in awarding Wells Fargo Bank $10.8 million in a breach-of- contract suit last month, adopted a damages formula that favors the goodwill litigants.

The judge ruled that a bank, if it is subject to illegal capital restrictions, can collect damages equal to what it would have made if it lent the money that regulators improperly tied up.

"The significant thing here is that Judge Smith understands (the damages theory) and accepts it," said one lawyer familiar with the case. "This is a significant precedent."

The judge's ruling comes from a case that has nothing to do with regulatory goodwill, the accounting gimmick that regulators let thrifts use to acquire failing institutions without destroying their own capital condition.

But lawyers agreed that the judge's reasoning transcends Wells Fargo, a case that began in the early 1980s when the bank agreed to finance High Plains Corp.'s construction of an ethanol plant.

The Farmers Home Administration agreed to guarantee 90% of the loan, provided the bank met several conditions.

Wells Fargo, relying on the agency's assurance, lent the construction funds. Later, however, the FmHA balked at guaranteeing the loan.

The bank was left in a precarious position. It already had lent the money, but it had no guarantee and it would have incurred substantial losses if it tried to liquidate the project.

So Wells Fargo kept the ethanol plant alive, hoping the company could become strong enough to repay its loan.

Regulators grew impatient, forcing the bank to continually write off more and more of the loan. A 1988 drought exacerbated the plant's financial problem, sending the cost of grain skyward while ethanol prices remained stagnant.

The plant finally turned the corner in 1993, raising $17.6 million in a public offering to retire part of its bank debt.

Wells Fargo, while happy it recouped some of its investment, wasn't satisfied. It sued the FmHA, arguing that regulators would not have forced it to write off $9.7 million in capital if the agency had guaranteed the loan as promised.

Instead, and this is where it gets interesting, the bank could have lent that money. Wells Fargo's expert estimated that the bank could have made $10.8 million if it put that capital to productive use.

This theory, if applied to the goodwill cases, could open the door to substantial awards.

Here's how it would work:

The affected thrifts claim the government promised them the right to carry goodwill on their books for 40 years in exchange for absorbing failing institutions.

When Congress decided to require institutions to write off goodwill over five years, the institutions suffered huge capital hits. That drastically reduced the amount they could lend.

Under the theory Judge Smith articulated, the affected thrifts could collect damages equal to the money they might have made if regulators allowed them to account for goodwill over the full 40 years.

For Glendale Federal, whose case is now pending before Judge Smith, that could mean $1.4 billion, according to a lawyer familiar with the case.

"Judge Loren Smith understands this stuff," the lawyer said after seeing the decision. "He understands how financial institutions work. He understands the technical nature of thrift accounting . . . He's the guy who's going to hear the damages case."

That's why thrift executives should be wearing huge grins.

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