CITIGROUP, INC. v. USA

Filing 206

REPORTED Order The Clerk is directed to enter judgment. Signed by Senior Judge Eric G. Bruggink. (jpk1) Service on parties made.

In the United States Court of Federal Claims
No. 15-953T
(Filed: November 29, 2023)
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CITIGROUP, INC.,
Plaintiff,
v.
THE UNITED STATES,
Defendant.
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Jean A. Pawlow, Washington, DC, for plaintiff.
Benjamin C. King, Jr., Attorney of Record, United States Department
of Justice, Tax Division, Washington DC, with whom were David A.
Hubbert, Deputy Assistant Attorney General, David I. Pincus, Section Chief,
G. Robson Stewart, Assistant Chief, for defendant.
ORDER
BRUGGINK, Judge.
After resolving the remaining fact and legal issues in this case at trial,
we are left with a disagreement as to the amount of the tax refund owed to
plaintiff. The issue stems from a mismatch between the law of contracts, tax,
and perhaps also accounting norms, a disconnect that is only made worse
when the breaching party is the federal government—the regulator and the
taxing authority. Although both areas of law aim to achieve ends that roughly
comport with economic realities, here, the tether is stretched very thin.
Glendale, Citigroup’s predecessor, was induced by federal regulators
to absorb a failing Savings & Loan bank (Broward) in large part due to
promises of favorable regulatory and accounting treatment. Broward had

liabilities exceeding assets of nearly $800 million in 1981. As we held at
trial, the accounting rules of the day permitted Glendale to record these
excess liabilities as an asset (“supervisory goodwill”) and to amortize the
asset over the maximum allowable period, 40 years. The government
promised Glendale that this would be permitted and further guaranteed that
Glendale could use this asset for regulatory capital compliance purposes.
This set of promises is known as the “RAP right.”
When Congress became aware of this and similar arrangements
approved by regulators to prop up the failing S&L industry, it changed the
accounting and regulatory treatment of supervisory goodwill by ending the
use of supervisory goodwill as capital for reserve requirements and by
requiring that it be amortized off the banks’ books within five years,
effectively repudiating the deal with Glendale. Suddenly bereft of the “asset”
it had on its books and no longer able to reap the rewards from the long
amortization period, Glendale was forced to recapitalize through various
measures and to pay higher premiums to borrow money until it could
sufficiently reorganize and regain its capital reserve compliance status. It
therefore brought suit, along with other similarly situated banks, against the
federal government in its contracting role for breach of contract. The
government asserted a number of defenses unique to it as a sovereign
regulator.
The issues ultimately required resolution by the Supreme Court. The
Court was faced with the difficulty of balancing the government’s interests
in regulating through legislation, which were often inconsistent with the
public’s interest in relying on the government as a contracting party. In this
circumstance, the interests were inconsistent and the Court concluded that it
was the government which should make the banks whole. In doing so, it also
had to explain how the promises of federal regulators could be squared with
the legislature’s abrogation of those rights. In our constitutional republic of
enumerated and separated powers, the only answer left to it was to hold that
the promises from the Federal Savings and Loan Insurance Corporation
(“FSLIC”), the regulator here, were enforceable as financial guarantees but
did not preclude changes in regulation. United States v. Winstar Corp., 518
U.S. 839, 869-70 (1996).
That construction of the contract and balancing of the government’s
dual roles solved the riddle for contract law purposes. The banks then were
left to collect damages, to the extent proven, for the government’s breach. 1
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In the contract law context, it made little difference whether the promise
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Glendale did so and was awarded nearly $381 million in reliance damages.
Not included in those damages was any recompense for the loss of the
supervisory goodwill. Judge Smith originally awarded over $908 million in
damages, which included restitution for the amount of net liabilities that
Glendale absorbed, less the value of benefits to Glendale, which would be an
approximation of the value of the supervisory goodwill. Glendale Fed. Bank
FSB. v. United States, 43 Fed. Cl. 390 (1999). The Federal Circuit reversed
the latter restitution award, holding that Glendale did not in fact suffer any
loss by absorbing Broward’s liabilities because interest rates subsequently
rose. The market value of the assets acquired from Broward thereby
increased, lowering, if not eliminating, the delta between assets and
liabilities. 239 F.3d 1374, 1382-83 (Fed. Cir. 2001).
This left open the question, for tax purposes, of what became of the
supervisory goodwill “asset” on the books of Glendale. Glendale removed
the supervisory goodwill from its books, as directed by FIRREA, and
recapitalized to meet capital reserve requirements. 2 It then sought a
deduction from income for the now-missing asset. The IRS first rejected the
deduction on the grounds that Glendale had no basis in the supervisory
goodwill. We do not know whether that was due to a similar view as that of
the Federal Circuit that the rise in interest rates had in some way reduced the
basis. The question of the calculation of basis was thus taken to the courts.
The issue first came to a head in court in the Western District of
Washington when Washington Mutual attempted to take a similar deduction
stemming from mergers that its predecessor-in-interest, Home Savings Bank,
had undertaken in coordination with FSLIC. The district court agreed with
the government, holding that the plaintiff there had no basis in the package
of rights granted by the government because the bank was insured by FSLIC.
In essence, the liability was shared between both parties but would ultimately
be borne by the government should the merged entity fail. Wash. Mut., Inc.
v. United States, No. C06-1550, 2008 WL 8422136, at *6-7 (W.D. Wash.,
Aug. 12, 2008). That conclusion was reversed by the Ninth Circuit, which
held that the bank’s basis in the package of promises from the government—
was for specific regulatory treatment or just a guarantee against loss if that
treatment ended. When Congress changed the law, it did not compensate the
banks. Thus, they could enforce that promise, however cabined, through a
breach suit, which they did.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989,
Pub L. 101-73, 103 Stat. 183.

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the RAP right and branching rights—was equal to its cost of acquiring the
failing thrift. 636 F.3d 1207, 1219 (9th Cir. 2011). The court does not appear
to have been presented the issue of how the subsequent rise of interest rates
affected the bank’s basis in the RAP right (the value of the underwater assets
that presumably regained much of their value). Washington Mutual
ultimately did not recover on its refund claim because it failed on remand to
prove the value of those rights in order to allocate them proportionately
within the purchase price to arrive at a proper figure for basis. 856 F.3d 711
(2017). Importantly, however, had Washington Mutual been able to prove
Home Saving’s basis in those two rights—per the Ninth Circuit’s holding
that it would have some basis in those rights reflected in the purchase price
that Home Saving’s paid to acquire the failing thrifts—it would have been
owed a deduction for their loss after FIRREA.
That same view of these transactions was adopted by this court and
the Federal Circuit in litigation stemming from another of Washington
Mutual’s predecessor’s thrift acquisitions. See Wash. Mut., Inc. v. United
States, 130 Fed. Cl. 653 (2017), aff’d sub. nom. WMI Holdings Corp. v.
United States, 891 F.3d 1016 (Fed. Cir. 2018). Washington Mutual again
pursued a similar tax deduction for the loss of the RAP rights and branching
rights garnered in several other mergers in other states, this time in the Court
of Federal Claims. It appears that again the government did not argue against
the acquiring thrift’s basis in the RAP right on the grounds that the rise in
interest rates after the merger increased the value of the mortgages, thereby
reducing or eliminating the purchase price. Washington Mutual faired no
better here because it again failed to satisfactorily prove its basis in those
rights. 3 WMI Holdings Corp., 891 F.3d at 1030 (affirming this court’s
finding that plaintiff had failed to meet its burden of proving its value in the
RAP and branching rights). In affirming that conclusion, the Federal Circuit
reiterated that Washington Mutual would have been entitled to a deduction
if it could have proven its basis in each of the rights individually. Id. at 1021,
1030.
Citigroup, however, fared better in its quest. We applied the rubric
set out by the Ninth and Federal Circuits: the purchase price was the
assumption of net liabilities. Because the evidence did not show a loss of all
of the value of the rights plaintiff acquired, especially the branching rights
As we noted in our trial opinion, one of plaintiff’s experts here, Dr. Mann,
testified for the government and was instrumental in disproving Washington
Mutual’s income-based approach in its district court suit. See Wash. Mut.,
Inc. v. United States, 996 F. Supp. 2d. 1095, 1116-17 (W.D. Wash. 2014).
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unaffected by FIRREA, trial was necessary to show a loss and to value what
was lost. Citigroup, Inc. v. United States, 140 Fed. Cl. 283, 290 (2018).
At trial, defendant’s overarching defense was that plaintiff did not
suffer a loss of the RAP right because, as only a financial guarantee, plaintiff
did not lose that right by the passage of FIRREA. And that, in fact, Judge
Smith’s earlier damages award was evidence that the value of that promise
was retained post-FIRREA. We found that plaintiff proved the value of the
RAP right. In response to the government’s argument against loss, we
attempted to explain how, even if viewed as enforcing the RAP right,
Glendale’s award of reliance damages could only be attributed to part of the
RAP right. 166 Fed. Cl. 748, 759 n.17 (2023). We then asked the parties to
compute the applicable tax deduction based on our finding of value for the
RAP right.
The government, however, seizing on footnote 17, urges that we
found only a partial loss of the RAP right and suggests that, although no
evidence was adduced at trial for the isolation of the amortization portion of
the RAP right, we could figure its value by subtracting Judge Smith’s
reliance damages award from the value we found for the RAP right, which
would ultimately leave plaintiff with a tax deduction value reduced by over
$100 million. Plaintiff opposes any such reduction on the basis that we have
already held that the RAP right was rendered worthless, that Judge Smith’s
reliance damages award was not a valuation of the RAP right lost, and that,
in any event, defendant’s theory is unsupported by any evidence heard at
trial. We held a status conference to discuss defendant’s theory on November
8, 2023.
Although we can see how our footnote invited the government’s
argument, the reduction in the value of plaintiff’s tax claim sought by
defendant now is unmerited. The case went to trial on the assumption that
the RAP right was rendered worthless by FIRREA. See 140 Fed. Cl. at 28990 (stating that the Federal Circuit had already held that banks had some basis
in the RAP right and that a deduction was owed if the value of the basis was
proven). It is settled law that the contract right was breached. The thrifts
were denied the benefits of those promises. Judge Smith’s reliance damages
award only compensated plaintiff for the increase in costs suffered on
account of that broken promise, but not the loss of the asset for tax purposes.
The treatment of these broken promises by tax and contract law do not
intersect or overlap.
At heart, defendant has never been comfortable in this case with the
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notion that a contractual promise gave rise not only to the right to sue for
damages but also for a tax deduction for the loss of an asset, albeit one that
seems more the product of accounting practices than economic reality. As
Dr. Mann explained at trial, goodwill is recorded on an acquiring company’s
balance sheet to account for any amount of the purchase price that is beyond
the market value of the assets of the acquired business. 166 Fed. Cl. at 752.
In this case, there was some debate at trial whether it was appropriate to
record goodwill from the merger with Broward given that it was a failing
thrift. In fact, that goodwill was given a special characterization:
“supervisory goodwill.” There is no dispute, however, that the accounting
rules and the federal regulators permitted the creation of such an asset on
Glendale’s books. The creation of that asset and subsequent regulatory
treatment were central to the deal.
As we explained during summary judgment, the amount recorded as
supervisory goodwill accounted for the RAP right and any other intangible
assets not separately recorded on Glendale’s books from the merger. 140
Fed. Cl. at 289-90. The Federal Circuit was unequivocal in stating that RAP
rights represent a valuable intangible asset that was lost and could be
deducted if the basis were proven. WMI Holdings Corp., 891 F.3d at 1021.
Citigroup did so at trial. It is thus entitled to a deduction for that full value.
Our trial opinion should not be read otherwise.
Plaintiff is entitled to a tax deduction for its adjusted basis in the RAP
right of $498,597,000 plus an exclusion from income for the recapitalization
costs portion of the reliance damages that it did not previously deduct in the
amount of $24,234,000. The parties agree that, if those inputs are correct,
Citigroup is owed a tax refund for the 2005 tax year of $182,991,000. See
Def.’s Status Rep. of Sept. 11, 2023 at 1 (ECF No. 199). Accordingly, the
Clerk of Court is directed to enter judgment for plaintiff for a tax refund of
$182,991,000 for the tax year ended December 31, 2005, plus statutory
interest.

s/Eric G. Bruggink
Eric G. Bruggink
Senior Judge

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