Federal Deposit Insurance Corporation as Receiver for Mutual Bank

Filing 168

MEMORANDUM Opinion and Order Signed by the Honorable Virginia M. Kendall on 2/12/2013. Advised in open court notice(tsa, )

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
FEDERAL DEPOSIT INSURANCE
CORPORATION, as receiver for Mutual Bank,
Plaintiff,
v.
AMRISH MAHAJAN, ARUN VELUCHAMY,
ANU VELUCHAMY, STEVEN LAKNER,
RONALD TUCEK, PATRICK MCCARTHY,
PAUL PAPPAGEORGE, RICHARD BARTH,
THOMAS PACOCHA, JAMES REGAS, and
REGAS FREZADOS & DALLAS LLP,
Defendants.

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11 C 7590
Judge Virginia M. Kendall

MEMORANDUM OPINION AND ORDER
Plaintiff Federal Deposit Insurance Corporation(the “FDIC”) as receiver for Mutual Bank
(the “Bank”) sued the Defendants for gross negligence under the Financial Institutions Reform,
Recovery and Enforcement Act (“FIRREA”), together with various state law claims including
negligence, breach of fiduciary duty, and the wasting of corporate assets. The claims arise from
the Bank’s loss of $115 million and subsequent business failure allegedly as a result of risky
construction and commercial real estate loans and the improper expenditure of corporate assets
for personal use by the Defendants. Defendants have asserted numerous affirmative defenses,
including the defenses of failure to mitigate, comparative fault, superseding/intervening cause,
lack of proximate cause, and waiver and estoppel. FDIC moves to strike these affirmative

defenses1 and to strike Defendants’ reservation of rights to assert additional defenses. For the
reasons stated herein, FDIC’s motion is granted.
BACKGROUND2
Starting in 2005, the Illinois Department of Financial and Professional Regulations (the
“IDFPR”) began conducting examinations of the investment practices of the Bank and delivering
written reports about the results of those examinations and recommended changes to the board of
directors of the Bank. Starting in 2006, the FDIC also began examining the Bank and delivering
written reports of its findings.

After several years of examinations and the delivery of

increasingly dire reports and recommendations from both the IDFPR and the FDIC about the
Bank’s risk management practices, its record asset growth in the high-risk commercial real estate
loans for hotels, gas stations, and convenience stores, and its lack of increase in staffing to keep
pace the size of the loan portfolio, the IDFPR closed the Bank on July 31, 2009 and appointed
FDIC as receiver. As receiver, FDIC succeeded to all rights, titles, power and privileges of the
Bank. See 12 U.S.C. §§ 1821(d)(2)(A)(i). As receiver, the FDIC is charged with collecting
monies owed to the institution and distributing the funds to the Bank’s creditors. See 12 U.S.C.
§1821(d)(2)(B)(ii); 1821(d)(11). FDIC is also authorized by statute to pursue claims against
directors and officers of the Bank for alleged breaches of the applicable standard of care. See 12
U.S.C. § 1821(k).
On October 25, 2011, the FDIC initiated this suit against Defendants, each of whom was
a director, officer, board member, and/or attorney for the Bank. The Defendants filed motions to
1

FDIC has also reserved the right to move to strike the affirmative defense of a statute of limitations following
discovery on the issue.
2
The facts pleaded in the FDIC’s Amended Complaint are set forth in detail in this Court’s
Memorandum Opinion and Order dated July 26, 2012 (Docket No.118).

dismiss that this Court granted in part and denied in part by opinion dated July 26, 2012.
Defendants’ answers to the Amended Complaint include nine separate affirmative defenses.
FDIC has moved to strike six of them, three of which have been pleaded by all Defendants.
LEGAL STANDARD
Under Federal Rule of Civil Procedure 12(f) the court “may strike from a pleading an
insufficient defense or any redundant, immaterial, impertinent, or scandalous matter.” Fed. R.
Civ. P. 12(f). Motions to strike are generally disfavored but may be used to expedite a case and
“remove unnecessary clutter.” Heller Fin., Inc. v. Midwhey Powder Co., Inc., 883 F.2d 1286,
1294 (7th Cir. 1989); see also Williams v. Jader Fuel Co., Inc., 944 F.2d 1388, 1400 (7th Cir.
1991); Bank of America N.A., v. Shelbourn Dev. Group, Inc., 732 F. Supp. 2d 809, 815 (N.D. Ill.
2010) (quoting Davis v. Elite Mortgage Servs., 592 F. Supp. 2d 1052, 1058 (N.D. Ill 2009) (“It is
appropriate for the court to strike affirmative defenses that add unnecessary clutter to a case.”)
Affirmative defenses will be stricken only when it is clear that the plaintiff would “succeed
despite any state of the facts which could be proved in support of the defense.” Williams, 944
F.2d at 1400 (internal quotation omitted).
II.

Waiver and Estoppel: Pre-Receiver Conduct of the FDIC

The conduct alleged by FDIC against Defendants involves Defendants’ management and
control of the Bank, the Bank’s investments, and the Bank’s investment management procedures
during the years leading up to the closure of the Bank and the appointment of the FDIC as
receiver. See FDIC v. Veluchamy, -- F.3d. --, 2013 WL 411361 (7th Cir. Feb. 4, 2013) (“The
FDIC is most typically known as the federal agency that insures the accounts of a bank’s
despistors, but it also serves as a bank overseer and regulator.”) Using substantially similar (if
not identical) language, each of the Defendants has pleaded the affirmative defense of waiver

and estoppel based on the conduct of the FDIC during the regulatory and investigatory phase of
the FDIC’s examination of the Bank. As pleaded by Defendants, the conduct forming the basis
of the waiver and estoppel defenses is conduct that took place prior to the closure of the Bank
and appointment of the FDIC as receiver.
The conduct of the FDIC during its pre-receivership regulation of the Bank cannot be
grounds for an affirmative defense, because regulatory conduct of the FDIC falls into the
“discretionary conduct” exception to the Federal Tort Claims Act (the “FTCA”). See United
States v. Gaubert, 499 U.S. 315 (1991) (barring claims asserted against a predecessor of the
FDIC premised on that agency’s regulatory conduct). The Gaubert court reviewed the history of
the “discretionary function” exception to the FTCA as applied to the Federal Home Loan Bank
Board (FHLBB), a savings & loan regulatory agency that merged into the FDIC via FIRREA
shortly before the Gaubert ruling). See Gaubert, 499 U.S. at 318 n.1 (explaining the dissolution
of the FHLBB and grant of FHLBB’s regulatory authority to the FDIC).

See id. at 322-24

(reviewing history of the discretionary function exception). Applying the exception to the
regulatory conduct of the FHLBB, the Gaubert court concluded that “[d]ay-to-day management
of banking affairs, like the management of other businesses, regularly requires judgment as to
which of a range of permissible courses is the wisest” and that “each of the regulatory actions in
question involved the kind of policy judgment that the discretionary function exception was
designed to shield.” Id. at 325, 332. Specifically, Gaubert held as follows: “If a regulation
allows the employee discretion, the very existence of the regulation creates a strong presumption
that a discretionary act authorized by the regulation involves consideration of the same policies
which led to the promulgation of the regulations.” Id. at 324.

While Gaubert discussed claims made against the United States, the reasoning of the
opinion applies with equal force to affirmative defenses pleaded against a government agency
because of that agency’s discretionary acts. See Gallagher, 1992 WL 370248 at *5 (“Although
Gaubert involved an affirmative claim against the government while the present motion
addresses the affirmative defenses raised in response to a suit brought by the [Resolution Trust
Corporation], the jurisprudence following Gaubert clearly provides that Gaubert is applicable to
affirmative defenses.”); see also FDIC v. Wells, 1995 WL 387580 (N.D. Ill. June 27, 1995)
(striking affirmative defenses based in improper pre-closing regulatory conduct by the FDIC);
FDIC v. Cheng, 832 F. Supp. 181, 186 (N.D. Tex. 1993) (finding “affirmative defenses based on
federal regulatory conduct before or after the failure of [bank] legally insufficient”)’ FDIC v.
Stanley, 770 F. Supp. 1281, 1309 (N.D. Ind. 1991) (declining to consider regulatory conduct of
FDIC in deciding whether to reduce damages because FDIC’s actions are discretionary).
Defendants have no response to Gaubert or its direct application to the fact that the
parties do not dispute that the FDIC was acting in its regulatory capacity during the prereceivership period. Rather, Defendants argue that the continued assertion of this affirmative
defense against the FDIC will not prejudice the FDIC during discovery since the FDIC will need
to investigate the regulatory aspects of the case in any event in order to prove its case in chief.
But the fact that the area of discovery may be investigated in any event does not alter the benefit
of removing the “unnecessary clutter” of legally impermissible affirmative defenses from the
case. See Heller, 883 F.2d at 1294. Therefore, the affirmative defense of waiver and estoppel
based in pre-receivership conduct will be stricken.

FDIC alleges that the affirmative defenses of comparative fault (named contributory
negligence by some of the Defendants) and superseding and intervening cause should also be
stricken because the paragraphs of these affirmative defenses may encompass pre-receiver
conduct.

However, none of these affirmative defenses allege anything regarding pre-

receivership conduct by the FDIC. Each of these affirmative defenses specifically references the
FDIC’s conduct in liquidating the assets of the Bank – an activity that necessarily took place
after the FDIC took possession of the assets. Because these affirmative defenses do not address
pre-receivership conduct, they will be addressed in Section III below.
III.

Failure to Mitigate, Superseding/Intervening Cause, Comparative
Fault: Post-Receiver Conduct (FDIC)

FDIC urges this Court to strike the Defendants’ affirmative defenses of failure to
mitigate, comparative negligence/fault, and superseding/intervening cause of the FDIC’s postreceiver conduct, all on the grounds that such affirmative defenses are not permissible against
the FDIC. Defendants rely upon Federal Deposit Insurance Corporation v. Bierman, 2 F.3d
1424 (7th Cir. 1993), which barred the pleading of a mitigation of damages defense against the
FDIC based on the FDIC’s conduct as a receiver. Defendants, however, point to the subsequent
United States Supreme Court decision, O’Melveny & Myers v. Federal Deposit Insurance
Corporation, 512 U.S. 79 (1994), as having overruled Bierman or at least cast its holding into
serious doubt.3 In order to address the continuing viability of Bierman and its effect on the case
3

Defendants note that FDIC did not discuss, reference, or even cite O’Melveny in its opening brief. Another
court in this district recently addressed a similar motion to strike affirmative defenses filed by the FDIC, and commented
on the FDIC’s failure to acknowledge O’Melveny in the opening brief in that case as well. See FDIC v. Spangler, et al.,
2012 WL 5558941, *5 n.4 (N.D. Ill. November 15, 2012) (Dow, J.). The Court sympathizes with the Spangler court’s
frustration that the O’Melveny decision was not fronted by the FDIC. But because the FDIC has taken the position in
this case that additional grounds, separate from those raised in O’Melveny, support the continued validity of Bierman,
the FDIC has not omitted contrary and controlling authority by failing to cite O’Melveny and the omission of O’Melveny
from the opening brief does not frustrate discussion of the merits of the affirmative defenses at issue here to the same
degree that it appears to have done in Spangler.

presently before the Court, a brief summary of the history of Bierman and O’Melveny is
necessary.
In Bierman, the Seventh Circuit addressed factual circumstances quite similar to those
presently before the Court, namely, whether defendant officers and directors of a failed bank
could assert the affirmative defense that the FDIC failed to mitigate damages because it
inadequately collected on the accounts of the Bank, and/or improperly disposed of Bank assets,
during the FDIC’s receivership. See Bierman, 2 F.3d at 1438. The Seventh Circuit affirmed on
two separate grounds the lower court’s determination to strike the affirmative defense of failure
to mitigate: first, the Seventh Circuit held that actions of the FDIC, acting as a receiver, can
have no effect to mitigate the damages owed by officers and directors of the failed bank, because
the FDIC has “no duty” to the officers and directors of the bank. Id. at 1439-40. Finding such a
duty would not comport with “the congressional scheme” of the FDIC as an insurance fund,
because when the FDIC undertakes the management of assets of a failed bank, “it is the duty of
the FDIC to manage such assets in order to replenish the insurance fund that has been used to
cover the losses allegedly caused by the directors and officers.” Id. This first rationale has come
to be known as the “no duty” rule.
As a separate and alternative ground to the “no duty” rule, the Seventh Ciruict held that
the FDIC was performing a “discretionary function” when it disposed of the assets of the bank
during receivership, and as such was entitled under the discretionary function exception to the
FTCA to be free from affirmative defenses concerning those decisions. Id. at 1440-41.
Following the Seventh Circuit’s decision in Bierman, the Fifth Circuit also affirmed the
“no duty” rule and the discretionary function exception with respect to the FDIC as receiver. See

FDIC v. Mijalis, 15 F.3d 1314, 1323-24 (5th Cir. 1994). Two years after Bierman, the Supreme
Court in O’Melveny & Myers v. FDIC, 512 U.S. 79 (1994) addressed the affirmative defense of
imputation against the FDIC in its capacity as receiver for a failed savings & loan. The FDIC as
receiver sued the former counsel of the savings & loan for legal malpractice and breach of
fiduciary duty under California law. The law firm asserted the California law affirmative
defense that the FDIC stood in the shoes of the savings & loan and therefore any wrongdoing of
insiders could be imputed to the FDIC to preclude any claims against the law firm. The
Supreme Court framed the issue before it as whether, in a suit by the FDIC in its capacity as a
receiver, “it is a federal-law or state-law rule of decision that governs the tort liability of
attorneys who provide services to the bank.” O’Melveny, 512 U.S. at 80-81.
The O’Melveny court first noted that “[t]here is no federal general common law” and that
the existence of receiverships alone is not a proper basis for “adopting a special federal commonlaw rule divesting States of the authority over the entire law of imputation.” Id at 83 (quoting
Erie R. Co. v. Tompkins, 304 U.S. 64, 78 (1938)). The O’Melveny court then turned to the
specific application of law to the FDIC when commencing suits in its capacity as a receiver.
Reviewing FIRREA, the O’Melveny court held that any argument for federal common law
supplementing the terms of FIRREA was “demolished” by the presence of specific provisions in
FIRREA discussing claims by, and defenses against, the FDIC as receiver – none of which
discussed imputation. Id. at 86. In light of such specifics, held the O’Melveny court, “[t]o create
additional ‘federal common-law’ exceptions is not to ‘supplement’ [FIRREA], but to alter it.”
Id. at 87.

The O’Melveny court therefore remanded the case for further proceedings in

accordance with California state law.

Following O’Melveny, district courts have split regarding whether O’Melveny abrogates
the “no duty” rule. Compare, e.g., Resolution Trust Corp. v. Massachusetts Mut. Life Ins. Co.,
93 F.Supp.2d 300 (W.D.N.Y.2000) (no duty rule abrogated), FDIC v. Ornstein, 73 F.Supp.2d
277, 281–85 (E.D.N.Y.1999) (same), FDIC v. Gladstone, 44 F.Supp.2d 81, 86–88
(D.Mass.1999) (same), RTC v. Liebert, 871 F.Supp. 370, 371–73 (C.D.Cal.1994) (same), with
FDIC v. Healey, 991 F. Supp. 53, 59–62 (D.Conn.1998) (no duty rule survives), RTC v. Gravee,
1995 WL 599056 (N.D. Ill. 1995) (Pallmeyer, J.) (no duty rule and Bierman holding survive);
RTC v. Bright, 157 F.R.D. 397, 400 (N.D.Tex.1994) (no duty rule survives), and Resolution
Trust Corp. v. Sands, 863 F.Supp. 365, 370 (N.D.Tex.1994) (same). The only circuit opinion to
address the “no duty” rule was published four months after O’Melveny, but relied on Bierman
with no mention of O’Melveny whatsoever. See FDIC v. Oldenburg, 38 F.3d 1119, 1121 (10th
Cir. 1994).
Ordinarily, a district court “has no authority to reject a doctrine developed by a higher
one.” Olson v. Paine, Weber, Jackson & Curtis, Inc., 806 F.2d 731, 734 (7th Cir. 1986). A
district court may depart from appellate precedent only in the limited circumstance in which the
lower court is “powerfully convinced” that the higher court would overrule its previous decision
at the first available opportunity. Colby v. J.C. Penny Co., 811 F.2d 1119, 1123 (7th Cir. 1987).
“Íf … events subsequent to the last decision by the higher court approving the doctrine –
especially later decisions by that court, or statutory changes – make it almost certain that the
higher court would repudiate the doctrine if given a chance to do so, the lower court is not
required to adhere to that doctrine.” Olson, 806 F.2d at 734.

The Court agrees that the criticisms of the continued validity of a broad “no duty” rule
for the FDIC in light of O’Melveny may indeed be meritorious. It is undisputed by the parties
that the affirmative defenses of mitigation of damages and comparative negligence/fault are
valid affirmative defenses under Illinois state law. The O’Melveny court’s discussion as to why
federal common law should not be extended in the context of FIRREA strongly suggests that the
portion of Bierman’s holding grounded in general public policy concerns might not survive postO’Melveny with respect to Illinois-law based affirmative defenses.

Therefore, were the “no

duty” rule the only ground upon which the Bierman court based its holding, the Court would be
hesitant to strike Defendants’ affirmative defenses that are based in post-receivership conduct by
the FDIC.
However, the “no duty” rule was only one of two grounds for the decision to strike the
affirmative defense of failure to mitigate in Bierman.

For the second ground, Bierman relied

upon Gaubert and the discretionary function exception to the FTCA, discussed in Section II
above. Specifically, Bierman held that the affirmative defenses of mitigation of damages should
be stricken because:
[A]pplying the criteria set forth by the Supreme Court in Gaubert, we think it
clear that the FDIC was performing a discretionary function. The responsibilities
that devolve onto the FDIC when a bank has failed require quick and complex
decisionmaking. We believe that excepting the FDIC from such affirmative
defenses is consonant with the purpose of the discretionary exception to the
FTCA.
Bierman, 2 F.3d at 1440-41 (emphasis added). O’Melveny did not address Bierman’s second
ground for striking mitigation defenses, the discretionary nature of the FDIC’s authority to
determine the proper disposition of assets in the course of receivership. In fact, O’Melveny did
not discuss the FTCA, discretionary actions by agencies, or the Gaubert decision at all.

The discretionary power of the FDIC with respect to its disposition of assets has been
addressed and affirmed by the Seventh Circuit since the publication of O’Melveny.

See

Courtney v. Halleran, 483 F.3d 942 (7th Cir. 2007) (affirming the continuing viability of the
FDIC’s immunity from suit under the FTCA for its post-receiver decisions regarding the
disposition of assets).

In affirming Congress’s intention to create a broad injunction against

court interference with the FDIC’s ongoing exercise of its powers as a receiver under 12 U.S.C.
§ 1821(j), the Seventh Circuit noted that there are specific provisions of FIRREA that permit the
FDIC to act in a discretionary manner that is not subject to review. The Seventh Circuit
specifically highlighted the FDIC’s right under § 1821(d)(2)(G)(i)(II) to “transfer assets or
liability without any further approvals.” Id. at 948.
Therefore, while the portion of Bierman grounded in the “no duty” rule might be in
serious doubt in light of O’Melveny, the alternative ground of Bierman based on the Supreme
Court’s holding in Gaubert and the discretionary function exception to the FTCA remains very
much viable and reaffirmed through Courtney. With the second basis for the Bierman holding
secure, this Court remains bound by Bierman. Therefore, the affirmative defenses of mitigation
of damages, comparative fault, and intervening/superseding cause of the conduct of the FTCA
are stricken because they improperly challenge the discretionary power of FDIC to maintain and
dispose of the Bank’s assets post-receivership.
IV.
4

Causation Defenses, Reservation of Rights4

FDIC moves to strike the following miscellaneous affirmative defenses: Pacocha: Sixth Affirmative
Defense (Lack of Proximate Cause), Second Affirmative Defense (Superseding and Intervening Causes),
Eighth Affirmative Defense (Other Defenses); Mahajan: Ninth Affirmative Defense (Other Defenses), Seventh
Affirmative Defense (Lack of Proximate Cause), Third Affirmative Defense (Superseding and Intervening
Causes); Veluchamy Defendants: Third Affirmative Defense (Superseding and Intervening Causes), Seventh
Affirmative Defense (Reservation of Right to Add Affirmative Defenses); Lakner et al: Third Affirmative
Defense (Superseding and Intervening Causes); Barth: Second Affirmative Defense (Superseding and
Intervening Causes).

Various Defendants have filed affirmative defenses related to causation, such as lack of
proximate cause and intervening/superseding cause of general market conditions during the
financial downturn in the 2008 and 2009. Proximate cause is an element of the FDIC’s case in
chief and not properly pleaded as an affirmative defense. See Bauer v. J.B. Hunt Transport, Inc.,
150 F.3d 759, 763-64 (7th Cir. 1998) (“In any negligence action, the plaintiff bears the burden of
proving not only duty and breach of duty, but also that defendant proximately caused plaintiff's
injury. The element of proximate cause is an element of the plaintiff's case. The defendant is not
required to plead lack of proximate cause as an affirmative defense.”). See also, Ocean Atl. Dev.
Corp. v. Willow Tree Farms, LLC, 2002 WL 485387 *4 (N.D. Ill. March 29, 2002) (“lack of
causation” is not a proper affirmative defense and should be stricken). Striking the affirmative
defenses related to lack of proximate cause and/or the presence of an intervening cause by no
means bars the defense from asserting that the FDIC has not carried its burden with respect to
the element of causation. However, such issues are properly raised at summary judgment and
trial, not in the form of an affirmative defense. Therefore, Defendants’ affirmative defenses of
lack of proximate cause and intervening/superseding cause of general market downturn are
stricken.
Finally, the FDIC moves to strike those affirmative defenses that purport to reserve the
right to add affirmative defenses at a later date. These affirmative defenses are stricken because
they are improper reservations under the Federal Rules. The time to plead affirmative defenses
under Federal Rule of Civil Procedure 8 is at the time of answer. See Castro v. Chicago Housing
Auth., 360 F.3d 721, 735 (7th Cir. 2004) (quoting Venters v. City of Delphi, 123 F.3d 956, 969
(7th Cir. 1997) (“If Rule 8(c) is not to become a nullity, we must not countenance attempts to

invoke [affirmative] defenses at the eleventh hour, without excuse and without adequate notice
to the plaintiff.”) In the event that any Defendant determines during the course of discovery that
an additional affirmative defense should be raised, that Defendant must file a motion seeking
leave to amend the answer and affirmative defenses in accordance with the requirements of
Federal Rule of Civil Procedure 15.
CONCLUSION
For the reasons stated herein, FDIC’s Motion to Strike Affirmative Defenses is granted.

____________________________
Virginia M. Kendall
United States District Court Judge
Northern District of Illinois
Date: February 12, 2013