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Federal Deposit Insurance Corp. v. Bank of New York

January 29, 2007


The opinion of the court was delivered by: Ellen Segal Huvelle United States District Judge


The Bank of New York ("BNY") is the indenture trustee for investors ("Noteholders") who purchased asset-backed securities from the NextCard Credit Card Master Note Trust ("Trust"), which the now-defunct NextBank, N.A. ("NextBank") established in December 2000 to finance its internet-based consumer credit card business. After NextBank failed in February 2002 and the Federal Deposit Insurance Corporation ("FDIC") was appointed receiver, the Noteholders commenced what has now become a four-year challenge to the FDIC's rights to the NextBank credit card receivables.

The Noteholders' dispute with the FDIC first came to this Court in 2003 when, acting on behalf of the Noteholders, BNY sued the FDIC for six counts of conversion. Over the course of more than three years of litigation, this Court dismissed Count II; the parties settled Counts I, III, IV, and V; and the Court entered judgment for the FDIC on Count VI. See Bank of N.Y. v. FDIC ("NextBank I"), 453 F. Supp. 2d 82, 91, 101 (D.D.C. 2006). BNY appealed the ruling on Count VI, which appeal is still pending.

In November 2006, BNY abruptly discontinued regular disbursements of NextBank collections, which it had been consistently paying to the FDIC as "Transferor Interest" for the prior thirteen months, and initiated an interpleader action in New York state court seeking a determination as to whether NextBank's remaining receivables belonged to the Noteholders or the FDIC. In response, the FDIC initiated this action, arguing that BNY's conduct violated this Court's prior judgments and orders, breached a settlement agreement that the parties had reached in NextBank I, andconverted FDIC assets.

For the reasons set forth herein, the Court concludes that BNY's conduct violated the holding of NextBank I that, under the Financial Institutions Reform Recovery and Enforcement Act of 1989 ("FIRREA"), Pub. L. No. 101-73, 103 Stat. 183, early amortization of the NextBank notes based solely upon the FDIC's appointment as receiver is unenforceable. BNY's violation of this Court's September 2006 judgment and order entitles the FDIC to judgment on Count I of its complaint and related remedies.*fn1

I. Background

A. Facts Underlying the Dispute*fn2

"NextBank was a national banking association established in 1999 to issue consumer credit cards, primarily through the internet." Id. at 85. NextBank financed its business by securitizing the monthly payments due from its credit card holders, selling several series of notes to investors, and using the proceeds from the sale of notes to fund payments to merchants for charges made by the credit card holders. (Pl.'s Stmt. of Undisputed Facts ["Pl.'s Stmt."] ¶ 2.) To obtain certain accounting and regulatory benefits, NextBank established the Trust to serve as a middleman in the sale of notes and collection of receivables. See NextBank I, 453 F. Supp. 2d at 85.

The securitization of NextBank's credit card receivables was accomplished through a series of four interrelated "transaction documents" and related supplements. See id. at 86--88. The most important of these documents, for purposes of the present dispute, is the "Master Indenture." The Master Indenture provided that "[n]otes issued by the [T]rust would have three possible cash-flow periods." Id. at 87. During an initial "revolving period," Noteholders would receive payments of interest but no principal. Id. Later, during a "controlled amortization period," principal would be repaid "in fixed amounts at scheduled intervals." Id. Finally, upon the occurrence of a "redemption event" - - including the appointment of a receiver for NextBank - - an "early amortization period" would commence, during which "Noteholders would receive payments of principal and interest on an accelerated schedule defined in their indenture supplements." Id.

In the event that Noteholders failed to receive full repayment of their principal, the Master Indenture provided that they would have "recourse only to the Collateral." (See Christensen Decl. of Dec. 15, 2006 ["Christensen Decl."] Ex. 3 at 141.) The "Collateral" was the Trust's interest in the NextBank credit card receivables, which the Trust granted to the Indenture Trustee. (See id. Ex. 3 at 140--41.) The Collateral excluded the "Transferor Interest," a portion of the receivables as to which NextBank retained ownership and from which NextBank was paid a monthly percentage. (See id. Ex. 3 at 152; id. Ex. 11 ["NextBank I Cmpl."] ¶ 13.)

On February 7, 2002, the FDIC was appointed receiver for NextBank. See NextBank I, 453 F. Supp. at 89. By the terms of the Master Indenture, the appointment of a receiver constituted a redemption event triggering the commencement of an early amortization period and obligating the Trust to repay the Noteholders' principal and interest at an accelerated rate. See id. at 87. If the Trust were to make such accelerated payments, however, the funds invested by the Noteholders would no longer be available to finance the continuing operation of NextBank's consumer credit card business.See id. at 90. In order to keep NextBank's business running, the FDIC decided not to honor the provision of the Master Indenture (§ 5.01) providing that the appointment of a receiver would automatically trigger the commencement of an early amortization period (the "ipso facto" clause). See id. at 89--90. Notwithstanding the ipso facto clause, the FDIC enforced the Master Indenture's regular repayment schedule. See id. at 90--91. Upon adopting this course of action, the FDIC explained to BNY that the ipso facto clause was "unenforceable under 12 U.S.C. § 1821(e)(12)(A)"*fn3 because early amortization under the clause was triggered "solely by reason of . . . the appointment of a receiver," which was "in direct contravention of FIRREA." Id. at 90 (quoting the FDIC's letter to BNY of February 14, 2002).

Although the FDIC succeeded in keeping NextBank's business running for several months, in July 2002 "the FDIC notified BNY that NextBank's securitized credit card portfolio had failed to meet a financial performance threshold, which triggered early amortization under the Master Indenture independently of the ipso facto clause." Id. at 91. Consequently, "the FDIC closed NextBank's credit card accounts by prohibiting credit card holders from making new charges." Id. At the same time, the FDIC informed BNY that it was repudiating some of the transaction documents and related supplements, including the Master Indenture. (See Christensen Decl. Ex. 8 at 3.) Thereafter, all Noteholders of the notes now at issue (the Series 2000-1 and 2001-1 notes) continued to receive monthly interest payments. See NextBank I, 453 F. Supp. 2d at 91. The owners of the highest-priority, lowest-risk notes (Classes A and B) also received full repayment of their principal. See id.

However, the owners of the lowest-priority, highest-risk notes (Classes C and D) did not fully recover their principal. See id. "[T]he Class C Noteholders were repaid only half their principal and the Class D Noteholders were not repaid any principal." Id. It was on behalf of these Noteholders that BNY sued the FDIC in NextBank I, and it is on their behalf that BNY appears in the present action. (Hr'g Tr. at 5--6, Jan. 11, 2007; see id. at 9--10.)

B. Procedural History

The proceedings before this Court in NextBank I began in June 2003. BNY alleged six counts of conversion against the FDIC, two of which are now relevant. In Count II, BNY alleged that the FDIC's retention of over $13 million "in connection with the Transferor Interest" amounted to conversion because, by repudiating the Master Indenture in July 2002, the FDIC had thereafter forfeited any rights to the Transferor Interest. (NextBank I Cmpl. ¶ 53; see id. ¶¶ 49--53.) In Count VI, BNY alleged that, by ignoring the Master Indenture's ipso facto clause and continuing to enforce the regular repayment schedule, the FDIC had converted "assets of the Trust" that should have been repaid to the Noteholders. (Id. ¶ 75; see id. ¶¶ 67--75.) More specifically, BNY argued that, by preventing the commencement of early amortization in February 2002, the FDIC had acted unlawfully under FIRREA and had "interfere[d] with the property and the economic and contractual rights of third parties," namely the Trust and the Noteholders. (Id. ¶ 74; see Christensen Decl. Ex. 12 ["NextBank I Hr'g Tr."] at 19--20, 26--27, 45--46, 48 (raising this argument during the November 2004 hearing).)

The FDIC moved to dismiss Counts II and VI. See NextBank I, 453 F. Supp. 2d at 91.This Court granted the motion as to Count II, but denied it as to Count VI. (See NextBank I Hr'g Tr. at 53.) The basis for dismissing Count II was that, under the Master Indenture, the Transferor Interest belonged to NextBank (into whose shoes the FDIC had stepped). (See id.) Only the Collateral belonged to the Noteholders and, as all parties agreed, the Collateral excluded the Transferor Interest. (See id.) The FDIC's repudiation of the Master Indenture in July 2002 in no way altered this arrangement or gave the Noteholders new rights to the NextBank credit card receivables. (See id.)

Following the Court's rulings on Counts II and VI, counsel for BNY, the FDIC, and representative Noteholders participated in extensive mediation sessions. (See Pl.'s Stmt. ¶ 39.) Mediation resulted in an agreement settling all remaining claims and counterclaims except for Count VI. See id. ¶¶ 38. The settlement agreement was signed by counsel for BNY, the FDIC, and two major Noteholders - - CS First Boston LLC and Millennium Partners LLP. (See Christensen Decl. Ex. 13 at 1.) CS First Boston LLC and Millennium Partners LLP agreed "to strongly and promptly recommend [the] settlement" to the Noteholders as a whole. (Id.) On August 2, 2005, BNY informed the mediator that it had "all the approvals needed for settlement." (Pl.'s P. & A. at 8; see Christensen Decl. Ex 14 at 1.) Accordingly, on September 7, 2005, this Court entered a consent order dismissing with prejudice all claims but Count VI. NextBank I, Minute Order (D.D.C. Sept. 7, 2005). Shortly thereafter, on September 15, 2005, BNY commenced making monthly payments of Transferor Interest to the FDIC and continued to do so through October 2006. (Pl.'s Stmt. ¶ 41.)

The parties continued to litigate Count VI. See NextBank I, 453 F. Supp. 2d at 91. After discovery, cross-motions for judgment were filed. See id. In an opinion issued on September 27, 2006, this Court held that NextBank had "entered into" the Master Indenture within the meaning of 12 U.S.C. § 1821(e)(12)(A) and that, consequently, "FIRREA sanctioned the FDIC's decision not to honor the Master Indenture's ipso facto clause." Id. at 101. BNY's appeal of this Court's September 2006 decision is now pending before the D.C. Circuit. Bank of N.Y. v. FDIC, 453 F. Supp. 2d 82 (D.D.C. 2006), appeal docketed, No. 06-5358 (D.C. Cir. Nov. 3, 2006).

While pursuing the D.C. Circuit appeal, Noteholders First Millennium, Inc., Millennium Partners, L.P., and RMK Advantage Fund - - who now control a majority of the relevant notes - -also initiated additional actions to recoup their lost principal, which they claim amounts to over $112 million. (E.g., Christensen Decl. Ex. 21 at 2.) On November 9, 2006, they sent BNY an "instruction letter" directing BNY to (1) execute a "Notice of Event Default and Acceleration under the Master Indenture;" (2) exercise control over the "Collateral;" (3) prevent further distribution of Trust assets other than as authorized in the instruction letter; (4) "cause all moneys and proceeds received from the [Trust] or from the Collateral" to be disbursed as if an early amortization had occurred in February 2002, until there is "full repayment" of the notes; (5) "on or prior to November 17, 2006, commence an action in the Supreme Court of the State of New York sitting in New York County" seeking (i) to obtain a judgment against the [Trust] for the full unpaid principal and interest due on the accelerated Notes, (ii) . . . to obtain a declaratory judgment authorizing the payment of all amounts due to the Series C and Series D Noteholders . . . [,] and (iii) to obtain any other injunctive relief . . . for the continuation of the existence of [the Trust] and the Collateral and the continuation of the distributions . . . until all unpaid principal and interest have been paid in full; and (6) "pursue the [D.C. Circuit] appeal." (Christensen Decl. Ex. 17 at 1--4.) The instruction letter indemnified BNY for following the Noteholders' directions and allowed BNY to use any funds recovered both to satisfy the substantial overruns in fees and costs from NextBank I and to pay reasonable fees and expenses for pursuing the D.C. Circuit appeal and the proposed New York litigation. (Id. Ex. 17 at 2, 4--5.)

Although initially BNY informed the Noteholders that it "decline[d] to accept the Instruction Letter" because the Noteholders' directions conflicted with this Court's September 2006 decision in NextBank I, BNY subsequently reversed its position. (Id. Ex. 16 at 1 (quoting BNY's letter to the Noteholders); see, e.g., Def.'s Reply at 3 ("On the basis of the analysis in [a] letter from [counsel for the Noteholders], BNY concluded in good faith that the actions demanded [in the instruction letter] were not prohibited by any language in the [September 2006] decision.").) Accordingly, on November 14, 2006, BNY sent the Trust, its "Servicer," and the FDIC a "Notice of Default under Master Indenture and Notice of Acceleration for Both Series 2000-1 Notes and Series 2001-1 Notes." (See Christensen Decl. Ex. 19 at 1--5.) On November 16, 2006, the Noteholders issued a substantially similar "Notice of Default." (See id. Ex. 21 at 1--4.)

On November 15, 2006, after receiving BNY's notice of default but before receiving the Noteholders' notice, the FDIC informed BNY that BNY's notice "ha[d] no effect for the reasons explained" by this Court in its September 2006 Memorandum Opinion. (See Christensen Decl. Ex. 20 at 1.) The FDIC warned BNY that "if [BNY] or the Noteholders attempt[ed] to take further action on the Notice of Default or otherwise [took] funds not due to them, the FDIC Receiver [would] seek judicial intervention, as well as attorneys' fees and costs for having to take such action." (Id.) Nevertheless, that same day, BNY discontinued its monthly payments of Transferor Interest to the FDIC, and it has since failed to make the payments scheduled for December 15, 2006, and January 15, 2006. (See, e.g., Hr'g Tr. at 29 (agreeing with the Court that the payments stopped in November 2006); see generally Christensen Decl. of Dec. 28, 2006 ["Christensen Supp. Decl."] Ex. 1 (showing payments of $3,178,731.15 due on December 15, 2006); Christensen Decl. Ex. 28 (showing payments of $3,626,534.39 due on November 15, 2006).)

The following day, counsel for the Noteholders sent BNY an email reiterating that BNY should obey the directives set forth in the instruction letter and stating: "If you are truly concerned regarding [the FDIC's] contempt threat, then the Noteholders would understand that you may wish to bring an interpleader action in New York - - and only in New York." (Def.'s Ex. 1 at 2.) Hours later, at approximately 10:30 p.m. on November 16, 2006, BNY filed an interpleader complaint in New York state court naming the Noteholders and the FDIC as interpleader defendants. (See Christensen Decl. Ex. 23 at 1; Pl.'s P. & A. at 14.)

One day after BNY filed the New York interpleader action, the FDIC filed this case. The FDIC's complaint sets forth three claims: Count I requests an injunction to protect the FDIC's statutory power to disregard the Master Indenture's ipso facto clause; Count II asserts that, by discontinuing the FDIC's monthly payments of Transferor Interest, BNY breached the NextBank I settlement agreement; and Count III alleges that BNY's retention of the disputed funds constitutes conversion of the FDIC's Transferor Interest. (See Cmpl. ¶¶ 44--50 (Count I); id. ¶¶ 51--56 (Count II); id. ¶¶ 57--62 (Count III).)

In addition to its complaint, the FDIC filed a motion for a temporary restraining order ("TRO") and preliminary and permanent injunctions barring BNY from distributing Trust assets to the Noteholders in violation of this Court's September 2006 decision. (See Pl.'s P. & A. in Supp. of the FDIC Receiver's Mot. for a TRO and a Preliminary and Permanent Injunction at 8.) To eliminate the need for a TRO hearing, BNY stipulated that the disputed funds "[would] not be transferred or distributed in any way . . . pending an order from this Court regarding the distribution or transfer of such funds." (Christensen Decl. Ex. 22 at 1.) On the basis of BNY's stipulation, this Court issued an order denying as moot the FDIC's TRO motion. FDIC v. Bank of N.Y., No. 06-1975, Minute Order (D.D.C. Nov. 28, 2006). At the same time, pursuant to Federal Rule of Civil Procedure 65, the Court issued a notice consolidating its merits determination with its determination of the FDIC's request for a preliminary injunction. See id.

Meanwhile, on November 20, 2006, the Millennium Noteholders moved for summary judgment in the New York interpleader. (See Christensen Decl. Ex. 24 ["Noteholders' Mem. in Supp. of S.J."] at 12.) Because the Millennium Noteholders served the FDIC at its New York office, without serving either the FDIC's District of Columbia headquarters or its outside counsel's office, the FDIC was unaware of the motion for summary judgment when it removed the interpleader to the U.S. District Court for the Southern District of New York on November 21, 2006. (See Pl.'s Emergency Mot. to Stay Related Cases ["Pl.'s Mot. to Stay"] at 1, 3.)

When the FDIC became aware of the Millennium Noteholders' motion for summary judgment, it filed an "Emergency Motion to Stay Related Cases," asking this Court to stay the New York interpleader pursuant to the All Writs Act, 28 U.S.C. § 1651. (See Pl.'s Mot. to Stay at 1.) In support of its motion, the FDIC argued that, absent a stay, its "rights [would] be prejudiced by being forced to relitigate in New York the complicated issues already litigated before and decided by this Court." (Id. at 7.) BNY opposed this motion on the ground that neither the New York action nor its briefing schedule, which the FDIC could seek to extend, was an emergency warranting an All Writs Act stay. (See Def.'s Reply at 7--8.)

On December 4, 2006, after the Noteholders and BNY refused to consent to a voluntary stay of the interpleader, the FDIC sought a stay from the New York district court. (See Def.'s Ex. 2 at 12.) On December 21, 2006, the Honorable Charles S. Haight considered the FDIC's motion after hearing arguments from counsel for the FDIC, BNY, and the Millennium Noteholders. (See Pl.'s Ex. A ["S.D.N.Y. Hr'g Tr."] at 1.) In a decision issued from the bench, Judge Haight opined that BNY could adequately represent the Noteholders in the present action, and he rejected the argument that the "first-filed" rule should be followed so as to give precedence to the New York action. (See id. at 70--76.) Relying on the Supreme Court's decision in Landis v. North American Co., 299 U.S. 248 (1936) - - in particular, the emphasis that Landis places on "the complexity of the case, and the importance of the public issues involved, and the necessity within the context of proper and efficient and prompt administration of justice to stay one proceeding in deference to the other" - - Judge Haight stayed the New York proceedings pending this Court's ruling. (Id. at 78--79.)

On January 11, 2007, with the New York interpleader stayed, this Court heard argument on BNY's motion to dismiss, the FDIC's motion for judgment, and the FDIC's motion for an All Writs Act stay. ...

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