Federal Deposit Insurance Corporation v The Coleman Law Firm et al

Filing 26

MEMORANDUM Opinion and Order Signed by the Honorable Milton I. Shadur on 5/22/2012:Mailed notice(srn, )

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
FEDERAL DEPOSIT INSURANCE
CORPORATION, etc.,
Plaintiff,
v.
THE COLEMAN LAW FIRM, et al.,
Defendants.

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No.

11 C 8823

MEMORANDUM OPINION AND ORDER
In its role as receiver for the George Washington Savings
Bank (the “Bank”), Federal Deposit Insurance Corporation (“FDIC”)
has brought suit against the Coleman Law Firm (“Coleman”) and
Kevin Flynn & Associates (“Flynn”), seeking recovery of funds
paid to them by the Bank in alleged violation of 12 U.S.C.
§1828(k)(3).1

Defendants filed a motion to dismiss the action

under Fed. R. Civ. P. (“Rule”) 12(b)(6), and the litigants have
briefed the matter.

For the reasons stated here, Count I is

dismissed as moot, while the motion is denied as to Counts II and
III.
But before this opinion turns to its substantive discussion,
something should be said about the very fact that there are three
“counts” over which the parties have crossed their litigation
swords.

1

In truth FDIC has a single “claim for relief,” the

That and other provisions of Title 12 are hereafter cited
“Section --,” omitting the prefatory “12 U.S.C.”

operative concept in federal practice (see the lucid discussion
in NAACP v. Am. Family Mut. Ins. Co., 978 F.2d 287, 291-92 (7th
Cir. 1992))--and yet FDIC’s counsel, infected by the same virus
that tends to inflict itself on virtually all Illinois lawyers,
have carved up that single claim into so-called “counts”2 to
separate out different theories of liability.

Such separation is

of course the hallmark of a “cause of action,” a state law
concept that should play no role in federal pleading.
Despite the passage of two decades since the teaching
essayed in the NAACP case, this Court finds itself part of a
small minority that follows its lead.

It may or may not be too

late to hope for a restoration to first principles (remember that
Cato the Elder was ultimately successful in his ubiquitous
efforts that had concluded every speech on the floor of the Roman
Senate, whatever the subject matter, with “Delenda est
Carthago”--“Carthage must be destroyed.”

But in this instance

the parties’ usage has compelled this Court to follow their lead
by dividing up the discussion in terms of the Complaint’s three
“counts.”
Rule 12(b)(6) Standards
Under Rule 12(b)(6) a party may move for dismissal of a
complaint on the ground of “failure to state a claim upon which

2

It does not seem to trouble counsel that Rule 10(b)
speaks of separate counts only in terms of “each claim founded on
a separate transaction or occurrence.”
2

relief can be granted.”

By now it is stale news that nearly five

years ago Bell Atl. Corp. v. Twombly, 550 U.S. 544, 562-63 (2007)
repudiated, as overly broad, the then half-century-old
formulation in Conley v. Gibson, 355 U.S. 41, 45-46 (1957) “that
a complaint should not be dismissed for failure to state a claim
unless it appears beyond doubt that the plaintiff can prove no
set of facts in support of his claim which would entitle him to
relief.”

Twombly held that to survive a Rule 12(b)(6) motion a

complaint must provide “only enough facts to state a claim to
relief that is plausible on its face” (550 U.S. at 570).

Or put

otherwise, “[f]actual allegations must be enough to raise a right
of relief above the speculative level” (id. at 555).

Since then

Erickson v. Pardus, 551 U.S. 89 (2007) (per curiam) and Ashcroft
v. Iqbal, 556 U.S. 662 (2009) have provided further Supreme Court
enlightenment on the issue.
Familiar Rule 12(b)(6) principles--still operative under the
new pleading regime--require this Court to accept as true all of
FDIC’s well-pleaded factual allegations, with all reasonable
inferences drawn in its favor (Christensen v. County of Boone,
483 F.3d 454, 457 (7th Cir. 2007) (per curiam)).

What follows in

this opinion adheres to those principles, with allegations in the
Complaint cited “¶ --” and its exhibits cited “Ex. --.”

3

Background
In or around June 20093 FDIC noted a significant decline in
the Bank’s overall financial condition and alerted the Bank to
its concerns in a September 9 letter and a September 24 meeting
with the Bank’s Board of Directors (the “Board”) (¶29).

During

that meeting FDIC advised the Bank that its tentative off-site
rating under the Uniform Financial Institutions Rating System had
fallen and notified the Board that an early comprehensive
examination was being scheduled (¶31).

One of the Bank’s inside

directors, Mark J. Weigel (“Mark”), pointed out at a September
meeting of the Bank’s senior management that the Bank was
burdened by the high cost of funds and that its liquidity
remained critical (¶32).

Throughout October and November the

Bank repeatedly sought legal advice from its regulatory counsel
about its precarious financial position (¶33).

In late October

or early November one of the Bank’s outside directors, John
Kovatch (“Kovatch”), repeatedly observed that the Bank was going
to be closed, and in a November 10 meeting of the Bank’s senior
management Mark noted the likelihood that FDIC would place the
Bank under some kind of disciplinary constraint (¶¶34-35).
On November 19 Mark and another inside director of the bank,
George E. Weigel (“George”), executed an Advance Payment Retainer

3

All other dates referred to here are also from 2009
unless otherwise specified.
4

Agreement with Coleman (the “Coleman Agreement”) under which
Coleman would represent Mark and George “in any action, suit or
proceeding...in which [Mark or George] are made, or are
threatened to be made, a party to, or a witness in, such action,
suit or proceeding by reason of the fact that he is or was an
officer, director or employee of [the Bank]” (Ex. 1).

On

November 20 the Bank paid Coleman $150,000 pursuant to the
Coleman Agreement in prepayment for future legal services to be
rendered to Mark or George relating to their positions at the
Bank (¶24).
FDIC notified the Bank of the early comprehensive
examination’s findings in a November 24 letter (¶36).

It

concluded among other things that (a) the Bank’s asset quality
was of significant concern, (b) the Bank had an excessive amount
of adversely classified loans, including approximately $154
million substandard, $2 million doubtful and $33 million in loss
status and (c) the Bank should make an immediate adjustment to
its Allowances for Loans and Lease Losses account--which provides
an estimate of uncollectible debts used to reduce the book value
of a bank’s loans and leases--to lower its Tier 1 leverage
capital (id.).

Such an adjustment would cause the Bank to become

critically undercapitalized (id.).
By an agreement dated November 30 (the “Flynn Agreement”)
the Bank retained Flynn to “advise, counsel and defend” various

5

outside directors, including Kovatch, in any proceeding in which
an outside director was made or threatened to be made a party or
witness by virtue of his or her role as an officer, director or
employee of the Bank (¶25, Ex. 2).

On December 2 the Bank paid

Flynn $100,000 pursuant to the Flynn Agreement in prepayment for
future legal services to be rendered to outside directors
relating to their positions at the Bank (¶27).
Both the Coleman and Flynn Agreements (Exs. 1 and 2) contain
this provision:
[U]nder the unique and special circumstances present at
this time, the Law Firm,4 Clients and [the Bank]
believe the use of an Advance Payment Retainer is
advantageous to the Clients because of the present and
likely risk that [the Bank] will be seized or otherwise
taken over by [FDIC] before the services provided
herein are fully provided. As a consequence, the
Clients may be left with inadequate resources to pay
the law firm for the legal services it is providing to
the Clients pursuant to this Agreement.
As the ensuing substantive discussion reflects, those provisions
play a key role in the analysis.
On December 4 the banking division of the Illinois
Department of Financial and Professional Regulation (the
“Department”) issued an Order to Cease and Desist (the “Order,”
Ex. 3) to the Bank pursuant to Sections 5007, 9015 and 11001 of
the Illinois Savings Bank Act (¶37).

That Order found that the

Bank’s capital was “less than the minimum permitted” and that the

4

[Footnote by this Court] That term is defined in the two
agreements as referring to Coleman or Flynn, as the case may be.
6

Bank was “operating in an unsafe and unsound condition.”
Relatedly the Order determined that the Bank was “likely to
experience a substantial dissipation of assets or earnings that
will weaken the condition of [the Bank] and will prejudice the
interests of its depositors contrary to the Savings Bank Act.”
On February 19, 2010 the Department closed the Bank,
reiterating the deficiencies referred to in the Order (¶38).

On

April 27, 2010 FDIC asked Coleman and Flynn to return their
respective retainers of $150,000 and $100,000 (¶42).

Coleman and

Flynn sent identical responses refusing to return the retainers
and stating that the retainers had been used in anticipation of
FDIC’s takeover of the Bank (Exs. 6 & 7).
Count I:

Declaratory Judgment

Section 1828(k)(3) forbids prepayment of legal expenses on
behalf of institution-affiliated parties, such as a financial
institution’s officers and directors, if (a) such payments are
made either in contemplation of the institution’s insolvency or
after an act of insolvency and (b) the payments have the purpose
or effect of preventing the proper application of the assets of
the institution to its creditors or prefer one creditor over
another.

FDIC alleges that the payments made pursuant to the

Coleman and Flynn Agreements fit those criteria (¶¶41, 46, 47).
Complaint Count I seeks a declaratory judgment against Coleman
and Flynn under 28 U.S.C. §2201 to establish that the Coleman and

7

Flynn Agreements are void ab initio under Section 1828(k)(3) and
require repayment of the funds paid under those Agreements.
Coleman and Flynn argue that the purpose of a declaratory
judgment is “to avoid accrual of avoidable damages to one not
certain of his rights” and that remedy is therefore inappropriate
where the alleged damage has already occurred (Cunningham Bros.,
Inc. v. Bail, 407 F.2d 1165, 1167-68 (7th Cir. 1969) (internal
quotations omitted)).

For its part, FDIC seeks to call upon

Bontkowski v. Smith, 305 F.3d 757, 761 (7th Cir. 2002) as the
springboard for a response.
In candor, the need for that debate, and indeed for this
Court’s involvement, are a total waste of resources.

So-called

Count I simply exemplifies the point made in the second paragraph
of this opinion, for it would just add another theory en route to
the recovery sought in the other two “counts.”

Hence Count I is

dismissed as moot.
Counts II and III:

Repayment of the Retainer Fees

Defendants advance a number of reasons why Counts II and
III, which seek repayment of the retainer fees by Coleman and
Flynn respectively, should be dismissed.

None of those arguments

is at all persuasive.
First, D. Mem. 4-5 contends that FDIC cannot recover a
payment made in violation of Section 1828(k)(3) because the
statute merely prohibits financial institutions from making

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payments under certain circumstances and does not expressly
authorize any right of recovery in the event of a violation.

But

FDIC is not attempting to advance a federally implied private
action--instead it invokes Illinois law as to the consequences of
the violation of the federal statute.
Illinois courts have routinely held that a contract in
violation of a valid statute is void without exception because
the law cannot enforce a contract that it prohibits (Kim v.
Citigroup, Inc., 368 Ill. App. 3d 298, 307, 856 N.E.2d 639, 647
(1st Dist. 2006)).

Although courts generally leave parties to a

void contract where they find them, an exception arises where the
parties are not in pari delicto and where the law violated by the
contract is intended to protect the person who paid for the
services (Gamboa v. Alvarado, 407 Ill. App. 3d 70, 75-76, 341
N.E.2d 1012, 1017 (1st Dist. 2011)).
Here FDIC stepped into the Bank’s shoes at the time of its
appointment as receiver (FDIC v. Berman, 2 F.3d 1424, 1438 (7th
Cir. 1993)) and is clearly not in pari delicto with Coleman and
Flynn.

Recall the obvious purpose of Section 1828(k)(3):

to

ensure a properly ratable distribution of an insolvent bank’s
assets by preventing precisely this situation--that of bank
insiders diverting funds to their own legal defense, thereby
carving out a piece of the corporate pie before it can be shared

9

(as it should be) among the Bank’s creditors.5
Defendants argue that the Gamboa exception does not apply
because they had less knowledge of the Bank’s financial condition
than the Bank did at the time they entered into the Coleman and
Flynn Agreements (D. R. Mem. 13-14).

But the express language of

the Agreements makes it clear that both Coleman and Flynn
understood that it was FDIC’s anticipated imminent takeover of
the Bank that necessitated the prepayment of their legal services
in the first place, for after the takeover the Bank’s officers
and directors would no longer be able to divert Bank assets to
their legal defense.
That Illinois courts may generally sanction the use of
retainer agreements does not change the facts that the specific
agreements here are void and that the defendants--sophisticated
law firms--know that they were trying to steal a march on the
Bank’s existing creditors.

It really does not matter whether

defendants knew about Section 1828(h)(3) or knew that the
Agreements violated that statute.
Second, defendants claim that Counts II and III must be
dismissed because the Complaint exhibits supposedly establish
that FDIC took over the Bank as a result of its

5

Because it is the Bank insiders for whose benefit the
Agreements were reached and because those insiders, not the Bank
itself, are at equal fault with Coleman and Flynn, the exception
to application of the in pari delicto doctrine would still hold
if the Bank rather than FDIC were the comparator.
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undercapitalization rather than insolvency, so that the retainer
payments assertedly did not violate Section 1828(k)(3) (D. Mem.
5-12).

That too does not survive analysis.

Although defendants dedicate much of their memoranda to the
contention that undercapitalization is not the same as
insolvency, that is really irrelevant because current insolvency
is not the standard for violation of Section 1828(k)(3).

D. Mem.

6 perplexingly describes insolvency as a “requisite element” of
FDIC’s claims, but Section 1828(k)(3) makes clear that FDIC need
show only that the payments were made in contemplation of
insolvency or, in other words, at a time when the Bank was not
yet actually insolvent.

Even if FDIC had predicated its Bank

takeover solely as a result of undercapitalization, the payments
to Coleman and Flynn would still have been made in contemplation
of insolvency, hence in violation of Section 1828(k)(3).

Indeed,

defendants’ own caselaw states that undercapitalization, though
not necessarily equivalent to insolvency, “increases the risk of
insolvency” (Baldi v. Samuelson & Co., Ltd., 548 F.3d 579, 584
(7th Cir. 2008)).6
In any event, the D. Mem. 6 suggestion that
undercapitalization was the sole ground for FDIC’s takeover of

6

See also the later discussion of the Fifth Circuit’s
Goldberg case and the n.8 explanation of the meaning of “in
contemplation of insolvency” rather than “insolvency”
simpliciter.
11

the Bank and that the Complaint and its exhibits “conclusively
demonstrate that [the Bank] was not insolvent” is disingenuous at
best.

Instead Ex. 5 identified a number of grounds in addition

to undercapitalization, including:
(2) That there is a likelihood that the savings
bank will not be able to meet the demands of its
depositors or pay its obligations in the normal course
of business.
(3) That losses have occurred or are likely to occur
that have or will deplete all or substantially all of the
savings bank’s capital and that there is no reasonable
prospect for replenishment of the savings bank’s capital
without federal assistance.
(4) That the savings bank is in an unsafe or unsound
condition likely to cause insolvency or a substantial
dissipation of assets or earnings that will weaken the
condition of the savings bank and will prejudice the
interests of its depositors.
(5) That the deposit accounts of the savings bank are
impaired to the extent that the realizable value of its
assets is insufficient to pay in full its creditors and
holders of its deposit accounts or meet its obligations in
the normal course of business; or that its capital stock is
impaired.
(6) That the savings bank is unable to continue
operation.
FDIC’s allegations as to the time when the Bank had
knowledge of its critical financial position date back to
September 9, months before the November 20 and December 2
retainer payments.

Those allegations assert that before the

payments occurred (1) FDIC had advised the Bank that its Uniform
Financial Institutions Rating System rating had fallen and that
an early examination of the Bank’s finances was being scheduled,
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(2) Mark had advised the Bank’s senior management that the Bank
was burdened by the high cost of funds and its liquidity remained
critical, (3) the Bank repeatedly sought legal advice concerning
its precarious financial position, (4) Kovatch observed on more
than one occasion that the Bank was going to be closed and (5)
Mark noted that FDIC would probably place the Bank under
disciplinary constraint (¶¶29, 31-35).
Indeed, both the Coleman and Flynn Agreements themselves
explicitly recognize that prepayment would be necessary because
of the “present and likely risk” that FDIC would seize the Bank,
leaving the Bank insiders without access to Bank funds.

As an

additional (though not vital) fillip, the Bank received the
dismal results of FDIC’s examination on November 24 (which,
although after the Coleman payment, preceded the payment to
Flynn)(¶36).7

Any suggestion that this Court should find as a

matter of law that the retainers were not paid in contemplation
of insolvency is frankly preposterous--so it is wholly
unnecessary to pursue the alternative question whether the
payments were made after an act of insolvency.
Third, D. Mem. 12-15 argues that the retainer payments did

7

Bizarrely, D. Mem. 7 characterizes the November 24 results
of the FDIC examination as “[t]he earliest allegation concerning
[the Bank’s] financial condition.” Perhaps defense counsel
neglected to read (or more likely read but conveniently ignored)
Complaint ¶¶ 29 and 31-35, which must be accepted as true for
purposes of this motion (Christensen, 483 F.3d at 457).
13

not prevent the proper application of the Bank’s assets or prefer
defendants over the Bank’s creditors because Illinois state law
generally permits the prepayment of legal fees, so that the funds
became defendants’ property upon receipt.

But it has already

been said that retainer agreements are not universally beyond
reproach simply because they are typically permitted by Illinois
law (Kim, 368 Ill. App. 3d at 307, 856 N.E.2d at 647).

Failed

banks’ assets are distributed according to the priority scheme
set forth in Section 1821(d)(11)(A), which provides that
administrative expenses of the receiver are paid first, followed
by deposit liabilities and then general liability claims such as
the unsecured indemnity claims that the Bank’s officers and
directors would have had if they had not taken $250,000 off the
top to prepay their legal expenses.

By siphoning funds to

defendants after FDIC alleges that insolvency concerns had
arisen, those Bank insiders improperly jumped the gun on FDIC,
the Bank’s depositors and its unsecured creditors, reducing the
post-seizure assets available for distribution by $250,000 and
thus preferring themselves over all those entitled to priority
over them or to privity treatment with them.
FDIC v. Goldberg, 906 F. 2d 1087 (5th Cir. 1990) confronted
a conceptually identical situation in which FDIC sought to
recover on a $100,000 promissory note executed by bank insider
Goldberg, who argued he was not liable because the bank had

14

issued him a credit extinguishing his liability on the note (id.
at 1088).

FDIC claimed the credit was granted in contemplation

of the bank’s insolvency and was therefore void pursuant to
Section 91, a provision of the National Bank Act that
substantively parallels Section 1828(k)(3).

Goldberg, id. at

1091 (internal quotation omitted) reconfirmed that “[a] bank is
in contemplation of insolvency when the fact becomes reasonably
apparent to its officers that the concern will presently be
unable to meet its obligations, and will be obliged to suspend
its ordinary operations.”8

It went on to hold that the credit

was issued after Goldberg and members of the bank’s board knew
that closure was imminent, with the credit thus being improper
because “[i]f Goldberg is allowed to take $100,000 ‘off the
top’...then every other unsecured creditor will receive
proportionately less for his or her claim because the asset pool
will have been reduced by that amount” (id. at 1093).

8

Whether a

This Court has regularly articulated to counsel during
earlier proceedings the universally known dual usage employed
when lawyers and judges speak of “insolvency”--sometimes in the
often sterile (and often misleading in real-world terms) balance
sheet sense and sometimes in the sense employed in the justquoted holding. Where as here the operative concept is “in
contemplation of insolvency,” the latter usage is obviously the
more plausible--it would plainly be rare (and most likely wholly
artificial) to pose a situation in which a bank is focusing on
its balance sheet to consider whether some action would convert a
positive shareholders’ equity to a negative one. By sharp
contrast, defense counsel point only to the Bank’s balance sheet
positive numbers in the face of imminent disaster, much the
equivalent of the ship’s musicians playing “Nearer My God to
Thee” as the Titanic sank to the bottom of the ocean.
15

bank intends to prefer a certain creditor is irrelevant--only the
preferential effect of the transfer matters (id.).
That Goldberg language could well have been written for this
case.

Here the Coleman and Flynn Agreements expressly

acknowledge “the present and likely risk that [the Bank] will be
seized or otherwise taken over by [FDIC]” (Exs. 1 and 2).
Despite that knowledge of likely impending closure, the Bank
issued $250,000 in prepayment of legal fees for specified Bank
insiders, reducing the pool of assets available to all other
creditors.
Conclusion
FDIC has met its burden of pleading its right to the relief
sought in Counts II and III far beyond the speculative level,
with Count I consequently rendered (and dismissed as) moot.
Coleman and Flynn are ordered to answer the surviving counts on
or before May 29, 2012, and a status hearing is set for 9 a.m.
May 31, 2012 to discuss further proceedings in the case.

In that

respect it appears quite likely that no factual disputes stand in
the way of a judgment in FDIC’s favor as a matter of law, and
defense counsel should come prepared to speak to that subject.

________________________________________
Milton I. Shadur
Senior United States District Judge
Date:

May 22, 2012

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