O'MELVENY & MYERS v. FEDERAL DEPOSIT INSURANCE CORPORATION, AS RECEIVER FOR AMERICAN DIVERSIFIED SAVINGS BANK

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Argument of Rex E. Lee

Chief Justice Rehnquist: We'll hear argument now in Number 93-489, O'Melveny & Myers v. Federal Deposit Insurance Corporation.

Mr. Lee.

Mr. Lee: Mr. Chief Justice and may it please the Court:

At issue in this case is whether Federal or State law determines the elements and the defenses of a negligence claim brought by the FDIC as receiver for a savings and loan against an outside attorney for that savings and loan.

The case arises out of the petitioner's assisting in the preparation of two private placement memoranda for American Diversified Savings Bank over the period from September through December of 1985.

During and prior to that time, two individuals named Sahni and Day, who owned 100 percent of ADSB, were engaged and had been for some time in fraudulent and other illegal activities which eventually resulted in Federal and State regulators placing ADSB into receivership.

None of the O'Melveny lawyers was aware of any of the illegal acts, nor are they alleged to have been, nor of ADSB's financial or regulatory problems and, indeed, the ADSB officers concealed this information from the petitioner.

The Ninth Circuit created two Federal rules of decision: first, that the knowledge of ADSB's 100 percent owners was not imputed to ADSB, and second, that the FDIC can avoid defenses to tort claims that would be good against the predecessor, ADSB.

In response to an argument by the petitioner pointing out certain provisions of State law, the Ninth Circuit stated as follows, and this is a quote:

"The flaw in O'Melveny's argument is the law O'Melveny assumes applies. "

"It is now clear beyond doubt that Federal, not State, law governs the application of defenses against the FDIC. "

and that's the issue in this case.

Unknown Speaker: Mr. Lee, you don't challenge, I take it, the Ninth Circuit's view that a law firm in this situation is under a duty of inquiry when it prepares a private prospectus like this?

Mr. Lee: We do challenge it, Mr. Chief Justice, but it's not one of the issues... we think they erred as a matter of California law in deciding that.

Unknown Speaker: But you're not asking us to--

Mr. Lee: That is correct.

That is correct.

That's not one of the questions before the Court.

What is before--

Unknown Speaker: --And you are satisfied that California law is what governs in this case?

Mr. Lee: --That's the issue.

That's the issue.

That's the issue on which--

Unknown Speaker: But if any State law governs--

Mr. Lee: --Oh, yes, that is correct.

Unknown Speaker: --it's California.

Mr. Lee: That is correct.

Unknown Speaker: It is the law of California, and do we know what the law of California is on the imputation defense?

Mr. Lee: I certainly do.

My friends here have a little doubt about it, but I certainly do.

[Laughter]

Unknown Speaker: What about the Ninth Circuit--

--Mr. Lee--

Mr. Lee: Excuse me.

Unknown Speaker: --There are very few cases on this imputation defense, and it doesn't seem all that clear to me what the California law might be in any event.

Mr. Lee: There are enough, Justice O'Connor, and I would refer you simply to four.

The leading case is McKenney v. Ellsworth.

Unknown Speaker: Mr. Lee--

Mr. Lee: Yes.

Unknown Speaker: --would you tell us preliminarily whether the Ninth Circuit made any determination of the content of California law, because if it did not, perhaps it might on remand and a conflict would be unnecessary.

There would be no conflict.

You presented a question, is it State or Federal law, but if the content of both is the same, then what difference does it make?

Mr. Lee: Well, the case certainly could be decided on the ground that under Federal common law as it existed... and we discussed this briefly in our reply brief... as it existed prior to Erie v. Tompkins, we think we would win this case, but the clearer... the ground on which certiorari was granted, and I think the clearer and the easier way to decide the case, is to decide the issue of State law.

Now, the other question that you asked, Justice Ginsburg, was whether the Ninth Circuit had decided this on the basis of State or Federal law.

It is clear to me they decided it on the basis of Federal law, for three reasons.

The first is that that's what they said they were doing.

The language that I just quoted said the flaw in O'Melveny's argument is its assumption that State law applies.

It is now clear that Federal law applies to all defenses... not just defense, but defenses... in a suit brought by the FDIC, and the second is what they did.

The opinion relies on three Federal opinions.

It does not rely on State law, and in an analogous context... Michigan v. Long... this Court said that when the opinion relies on Federal decisions, then they are applying Federal law.

Unknown Speaker: Mr. Lee, why should... assuming that they did rely on Federal law, why shouldn't we give them the job of... I mean, we have enough trouble figuring out what Federal law is.

They're closer to California law.

Why don't we... if you're correct... just send it back there and let them figure out what California law is?

Mr. Lee: That would be a possibility, Justice Scalia.

Unknown Speaker: It's what we normally would do, isn't it?

Mr. Lee: That would be a possibility, and in the usual case, that is what you normally do.

I submit this is not the usual case.

The only thing I would say in that respect, Justice Scalia, is that I would invite careful consideration of four cases that are cited in our brief, and those four cases make it very clear... it's probably best summarized by the West American case and by Mr. Witkin, who is the leading commentator on California law.

The Government points out, quite correctly, that there is an exception to the general rule of imputation in those instants where the agent is acting adversely to the principal, but in the clearest language of the which the English dictionary is capable, it then goes on to say... in the clearest words of which the English language is capable, it then goes on to say that there is an exception to the exception, and that the exception to the exception applies in those instances where the agent is in fact acting on behalf of its principal, and there is no doubt that that's what happened here.

So--

Unknown Speaker: Mr. Lee, can you give us instances in which this Court functions as a court of first view, which is essentially what you're asking us to do?

The Ninth Circuit... instead of asking the Ninth Circuit to determine the content of California law, you're asking this Court to decide a question not on review but as a mater of first view.

Mr. Lee: --There are cases that are cited in the last couple of pages of our reply brief, Justice Ginsburg, in which this Court has done that.

I realize that that is not the only option, but I would simply reiterate what I said in response to Justice Scalia.

I would invite the Court's attention to McKenney, West American, Flagg v. Seng, and Austin, and I submit that no reasonable person can read those cases without concluding what California law is.

However, we do not lose the case in the event that you do send it back for consider... I just don't think it's necessary in this instance.

Unknown Speaker: California have a certification proceeding?

Mr. Lee: They do not, unfortunately.

The first... there are three separate reasons why the judgment of the Ninth Circuit must be reversed and... and State rather than Federal law apply to this case, and the first is that there is a specific statutory provision which expressly addresses both the imputation and also the standing-in-the-shoes issues and resolves both of them.

Section 1821(d)(2)(A) of the Federal Deposit Insurance Act, which bears the title, "Successor to institution", states explicitly... and this is a quote.

It's set forth in the first page of our opening brief... that as conservator or receiver, the FDIC succeeds to

"all rights, titles, powers, and privileges of the insured depository institution. "

Now, in this instance, the insured depository institution is a California chartered corporation.

As such, its rights are determined by California law, and relevant California law, as I indicated, imputes the knowledge of an agent to his principal, and on the second issue, whether the FDIC is--

Unknown Speaker: Mr. Lee, may I--

Mr. Lee: --a receiver--

Unknown Speaker: --I'm sorry.

Mr. Lee: --I'm sorry.

Unknown Speaker: May I ask just one question?

It seems to me that the defense that is at issue here is essentially an equitable defense, and as such is essentially a personal defense, and therefore the cause of action may pass but the defense doesn't necessarily pass with it.

Is that a fair objection to the argument from California law?

Mr. Lee: Thank you for asking that question, Justice Souter, for two reasons--

Unknown Speaker: I'm flattered.

Mr. Lee: --Well, I--

[Laughter]

For two reasons, the answer is no.

The first is that the right... the word is not claims, it's rights, and you don't have a right unless you have a claim and there are no defenses to it.

The second is provided... the second reason is provided by this Court's decision in Holmes.

v. Sipek, which was authored by the Court, by you, and that makes clear... that case makes clear, as I read it, that proximate causation is an essential element of the claim itself.

And under California law, the reason that there is no proximate causation is because justifiable reliance is a required element of proximate causation, and there was no justifiable reliance where all you are saying is, should the O'Melveny lawyers have told Sahni and Day that they were... discovered that Sahni and Day were violating the law and then told them so?

On the second issue--

Unknown Speaker: Mr. Lee, while you're still on the statute... and I'm anxious for you also to get to the second point... I take it the wording of the statute in its structure would prevent us from saying that the initial liability, the initial duty, is also controlled by Federal law?

Mr. Lee: --That is correct, and that's my point... that's my point, and on the other, on the standing-in-the-shoes, it could not be more explicit, because it says, succeeds to all rights the depository institution has, and that strikes right at the heart of the major premise that underlies the Government's case, namely that the mere presence of the FDIC as receiver 2-1/2 years after the conduct at issue imposed for that reason alone upon petitioner additional liabilities which did not exist at the time the conduct occurred.

Now my second reason.

If you didn't have the specific statute, the mere existence of FIRREA, with its comprehensiveness, this 370-page statute controls the issue of whether State or Federal law governs under this Court's decision in City of Milwaukee v. Illinois.

Involved in that case was a comprehensive statute, the 1972 amendments to the Clean Water Act, and the question was, when you have that kind of statute, which supplants preexisting State rules in some instances and leaves them in place in other instances, is it then the proper function for the Federal courts to come along behind and displace State law in those instances where Congress elected to leave them in place?

The Government's only answer to that City of Milwaukee argument is that FIRREA is not in fact comprehensive, and that, with all due respect, is borderline laughable.

This is a 370-page statute.

It, with its companion statutes, regulates all aspects of banks, Federal savings and--

Unknown Speaker: Mr. Lee--

Mr. Lee: --Excuse me.

Unknown Speaker: --do you think that under your theory of FIRREA that the D'Oench, Duhme case could survive?

Mr. Lee: Yes.

Yes, it could.

D'Oench, Duhme, Justice O'Connor, is going to help the Government only if you interpret it not in light of what that case actually involved, but as establishing a per se, automatic rule that any time the FDIC enters the playing field the playing field no longer becomes level, and if you'll permit the further analogy, any players who are wearing a State law uniform not favorable to the Government immediately have to leave.

Now, that's not what D'Oench, Duhme says.

It is limited in several respects and is distinguishable from this case in several respects.

In the first place, it involved knowing conduct, which this case does not.

In the second place, it involved a note, an asset as opposed to a mere claim, and the third... as I read D'Oench, heavy reliance was placed on the fact that between the time the conduct occurred and the time the decision was reached, there was a Federal statute that was actually enacted, and that Federal statute heavily influenced the decision so that what the Court was really doing was filling in a vacuum that existed in between the time of the conduct and the time of the decision.

Unknown Speaker: Well, what's the purpose of the imputation defense?

Is it to make sure that the wrongdoers don't benefit?

Is that why there is--

Mr. Lee: Wrongdoers of a certain--

Unknown Speaker: --an imputation defense?

Mr. Lee: --Yes.

Wrongdoers of a certain quality, not those who only have been alleged, and I repeat in... what I said earlier to the Chief Justice.

We do not agree that there was a lack of exercise of due care, but that's not before the Court.

Though a difference between those who are alleged not to have exercised due care and those who have engaged in deliberate conduct--

Unknown Speaker: Well, you agree, then, that the purpose of the defense would be so that Sahni and Day wouldn't benefit from any recovery?

Mr. Lee: --That's part of it.

Unknown Speaker: Well, who would benefit from a recovery here?

Would it be the taxpayers of the United States, or who?

Mr. Lee: Difficult to say whether the taxpayers would really benefit or not, Justice O'Connor.

If I may tie that to our Kimbell Foods analysis, and that's the third reason... that's the third reason that this case must be reversed.

One of the three Kimbell Foods factors has to do with whether there is a need for a particular Federal rule in the particular instance.

The only argument that the Government even makes with respect to why a special Federal rule is needed here is the more money argument, that because otherwise it would deplete the Deposit Insurance Fund.

I cannot emphasize too strongly that this argument that the application of Federal law will result in the FDIC recovering more money is entitled to no weight at all, and I'm going to tie this back to your taxpayer's question.

Kimbell Foods itself rejected that very argument, and it did so on two grounds that are highly relevant to this case.

The first one is that in this case as in Kimbell Foods the relevant statute provides other means, other than just getting more money into the Federal Deposit Insurance Fund, for protecting the public.

These include the ability of the Federal regulators to increase both the capital and the capital-to-assets ratios, to increase the insurance premium, and in extreme cases even to remove management, and even more relevant, it is also true here, as it was in Kimbell Foods, that the principal purpose of these insurance statutes is not to raise money.

Kimbell Foods made that very explicit, and I would point out that what Kimbell Foods involved was two Federal insurance programs, one administered by the SBA and the other administered by the FHA, and Kimbell Foods pointed out that these are social welfare legislation statutes.

Unlike tax statutes, they are not money-raising statutes.

The same is true with the Federal Deposit... well, with these various acts, FIRREA and the Federal Deposit Insurance Act, whose principal purposes extend to economic incentives to encourage residential lending, the development of low and moderate income housing, and lending in depressed real estate markets.

Unknown Speaker: I don't understand your point, Mr. Lee... that Government doesn't care about losing money unless it's under the tax laws.

I mean, it seems to me if preserving the fisc is an important value, it's an important value, in whatever context.

Mr. Lee: The point is, Justice Scalia, that it is not its only purpose, and that in balancing the various different objectives, of which protecting the public fisc is of course one of them, the clear message that comes from Milwaukee and from Kimbell Foods and a lot of other cases that are cited in our brief dealing with this issue, the net balancing of those competing values is for the Congress of the United States, particularly where, as in City of Milwaukee... and here you have such a comprehensive statute where many defenses have been eliminated and others left intact, and particularly where, as here, you have other objectives, other than just the money raising.

The balancing, in short, is for Congress, and not for the courts.

I return now to the other two of the Kimbell Foods factors.

The first one is whether there's a need for a uniform Federal law.

The Government's conduct in this very case shows that there is no such need.

What the Government did in this particular instance was to ask for the application, and the court of appeals gave it to them, of what they perceived to be State law on the first issue, Mr. Chief Justice, which was the issue of whether there was a duty of due care that was owed.

Then, once they turned to the imputation and the standing-in-the-shoes issues, on which State law does not favor them, then the Government changed its direction and asked for the application of Federal common law, which the Ninth Circuit gave them.

This Court made very clear in Kimbell Foods, but even more clear in United States v. Yazell, that when the Government attempts this mix-and-match, pick-and-choose combination of Federal and State law and asks for State law to be applicable in certain instances, that that is immensely material in the language of Yazell, immensely material to the issue of whether a uniform rule really is needed.

The final of the Kimbell Foods factors concerns whether a Federal rule of decision would severely disrupt commercial relationships predicated on State law.

What we're dealing with here is two areas of State law than which there are none clearer, that are the essential and traditional centuries-long prerogative of the State courts... tort law, disciplining of lawyers, and the related one, the relationship of lawyer and client.

Each of these represents an area in which the body of government State law has been developed over decades, and in some cases even centuries, and to now place that burden in Federal courts, displacing those bodies of governmental State concern, would not only severely disrupt commercial relationships predicated on State law, but would also be extremely burdensome on the Federal courts.

Mr. Chief Justice, I would like to reserve the rest of my time for rebuttal.

Unknown Speaker: Very well, Mr. Lee.

Mr. Bender, we'll hear from you.

Argument of Paul Bender

Mr. Bender: Thank you, Mr. Chief Justice, and may it please the Court:

Petitioner in this case is a law firm that was retained by a federally insured savings institution in order to prepare what are called private placement memoranda in connection with the saving institution's offering of a land development scheme.

It is alleged, and for purposes of this appeal we have to assume it's true, that in the course of preparing that PPM... private placement memorandum... petitioner committed malpractice.

Specifically, the malpractice that they committed... were alleged to have committed was this.

The private placement memorandum says in it that the bank in this case had sufficient resources to finance the land development scheme that the bank was floating.

That was not true.

As a matter of fact, the bank was insolvent.

The negligence that is asserted against petitioner is that they negligently failed to discover that, and put in the PPM that the bank was in fact solvent, and that assets would be there to lend to the partnership for the purposes of the land development project.

If petitioner had discovered, as it should have, that the bank was insolvent, it never could have put that, and never would have put that, in the PPM, and the scheme would not have gone forward.

The allegation is that because the scheme went forward, that cost the bank a substantial amount of money.

It did that because shortly after the scheme closed, Federal regulators came in, discovered that the bank was insolvent, and once the bank was insolvent, the land development project couldn't go forward because the assets of the bank were necessary for that project to go forward.

So petitioner's negligence directly related to the viability of this project, and by negligently failing to discover that the bank was insolvent, petitioner hurt the bank.

Now, the--

Unknown Speaker: The FDIC isn't claiming the benefit of the bargain on the land.

It's just claiming its broker's fees and that sort of thing.

Mr. Bender: --The expenses of floating this scheme, and then having to withdraw it, and those expenses were considerable.

They're not in proof here, they're merely allegations, but that is exactly what the FDIC is claiming.

It's--

Unknown Speaker: To whom would they have brought this information?

To whose attention would they have brought this information?

Mr. Bender: --In the first place to the directors and officers of the bank.

Unknown Speaker: Who already knew about it.

Mr. Bender: Yes, they already knew about it, but to have the law firm bring it to their attention might have stopped them from going forward with the scheme, but more importantly, they shouldn't have signed on to the PPM.

The problem was--

Unknown Speaker: Well, that might be a... you know, a dishonorable thing to do, but I don't see how there's any causality here.

I mean, to tell the officer what he already knows--

Mr. Bender: --Because the law firm certification is necessary for shares in this partnership to be sold.

If the law firm had said, we can't prepare this PPM because the bank isn't solvent, and therefore we can't say to potential investors that the funds are there to fund the development project, then the development project wouldn't have gone forward.

That's the causality.

Unknown Speaker: --If the investors were suing, it would be a different matter, but they've already been made whole.

Mr. Bender: Right, but the bank is suing, and the bank is suing... the FDIC is suing in place of the bank, and that's the point I wanted to make.

It's very important to understand here--

Unknown Speaker: Well, Mr. Bender, before you get to the FDIC's position, isn't it true that so far as California law is concerned... leaving aside the California law that determines what defenses will be recognized, isn't it true that under California law, so far as the injury that the FDIC is trying to recover for, there's but-for causation in the law firm's failure, but there's not proximate causation, isn't that correct?

Mr. Bender: --No, I don't think that's correct.

I don't think that issue has been tried.

Unknown Speaker: Let me ask you a further question anyway.

If, under California law, the California view of proximate causation would be that under these circumstances no proximate cause, would you take the position that that rule should yield to a uniform Federal rule, too?

Mr. Bender: Yes.

Yes.

If California law provided... as I don't think it does, but if it provided, contrary to the factual causation, that there was no proximate causation, then in order to adequately protect the Federal interest, which I'll get to in a moment, that California rule would have to yield to the Federal rule, because the harm here... because the bank was insolvent, the harm here by petitioner's negligence is not harm to the stockholders.

The stockholders... once the bank is insolvent, the stockholders' stock can't be worth any less.

As the petitioner's negligence drives the bank further into insolvency, the harm occurs to the creditors of the bank.

Who are the creditors of the bank?

The creditors of the bank are principally the depositors.

Unknown Speaker: So you do say that there has to be an underlying Federal rule determining the scope of duties of the counsel to its insured institution.

Mr. Bender: No, not the scope of duties, and not the rule of negligence.

Those things are determined under California law.

The duty here was to the bank... not to the stockholders, not to the insiders, but to the bank.

Unknown Speaker: But I'm not sure what the source of law is for you to prevail if, as Justice Souter said, there's no proximate causation under the law of California.

Mr. Bender: Because under the law of California there's a duty to the bank, and under the law of California, the allegation is that the petitioner was negligent.

If the petitioner's negligence caused harm to the Federal interest, which it did here, our position is that California cannot have a rule of law that would prevent that Federal interest from being vindicated.

Unknown Speaker: Well, you're just really picking whatever favors the Government out of California law, then.

You're saying, we like the California standard of negligence, so we accept that, but we don't like what might be the California standard of causation, so we reject that.

Is there anything more principled than just whatever favors the Government in your--

Mr. Bender: It's not whatever favors the Government in some proprietary sense.

It's a question of whatever furthers the interests of the Federal legislation.

The Federal legislation, as we all know, provides that deposits in a bank like this are insured by the Federal Government, and in turn they are insured by the taxpayers who have to make sure that the fund has enough in it to pay the Federal Government.

When negligence is committed to an insolvent bank, that causes harm to the depositors.

The money to pay back their deposits, the pool of money, goes down.

Unknown Speaker: --Yes, but the Government is always presumably acting on behalf of citizens, and it seems to me that by substituting whatever furthers the interest disclosed by the statute for whatever favors the Federal Government really isn't a substitution at all.

You're saying, whatever gets us... it seems to me you're saying whatever gets us the greatest recovery, or the greatest measure of success, however it's going to be measured, is going to be the criterion for picking it.

Mr. Bender: No, it's not whatever gets us the greatest recovery, it's whatever adequately provides for compensation for the harm done to the Federal Deposit Insurance--

Unknown Speaker: Well, you never want to recover more than 100 percent, so once again, I don't see the distinction that you're making.

Mr. Bender: --It's the harm done to the fund.

The negligence of a professional in representing an insolvent bank, which causes loss of money to that bank, directly causes harm to the depositors of the bank.

If the depositors were not insured, the bank would be held in trust for them.

That's ancient common law... in trust for the creditors and the depositors.

Here, the depositors are insured, so the FDI stands in their shoes.

The harm that's done here is harm by negligence to the deposit fund, and all the FDIC is trying to recover here is the harm to the deposit fund.

Unknown Speaker: But then it seems to me that you should be proceeding under something other than 12 U.S.C. 1821.

Mr. Bender: Why is that, Justice Kennedy?

Unknown Speaker: Because your whole hypothesis is that you are succeeding to a cause of action that exists under the State law, and under Justice Souter's hypothetical question, that isn't true, and you say you prevail anyway--

Mr. Bender: No--

Unknown Speaker: --and it seems to me that what you're doing is basing a substantive right of recovery, one which formulates the duty of the professional, as a matter of Federal law.

I suppose it's a plausible enough position, but it's certainly not under 1821.

Mr. Bender: --Well, Federal law initially applies, but as this Court knows, the presumption is that in cases involving the FDIC we will use State law as long as the State law adequately protects the Federal interest.

Unknown Speaker: Mr. Bender, would you clarify, because Justice Kennedy's question raised a point that I didn't think you were contesting, that the claim initially... the claim for negligence against the law firm arises under State law, is that not so?

Mr. Bender: It's almost metaphysical.

This Court has said on most occasions that when the FDI sues the law that's applicable is Federal law, but the Federal law initially presumes that State law is applicable, and the Federal law borrows State law, except where the State law is inconsistent with the purposes of the Federal statute.

It's a through--

Unknown Speaker: Why do you allow the State to insist on negligence?

I mean, if you really want to protect the Federal fisc, why don't you impose an absolute liability on these lawyers to make sure that everything's okay?

Mr. Bender: --Because I think the presumption of the Federal scheme here is that professionals who work for a federally insured bank shouldn't be absolutely liable.

They should be liable under--

Unknown Speaker: Why make that presumption?

I can understand the answer, the presumption is that State law applies.

Mr. Bender: --Because it would be--

Unknown Speaker: The presumption is that the normal responsibilities which existed before the FDIC took over continue afterwards, and that nothing changes simply because the Government steps in.

As the statute says, it steps into the rights of the bank.

Mr. Bender: --And we don't challenge that.

The normal responsibilities continue to apply, but what this case involves, as Mr. Lee has said, is whether a particular defense should be applicable, and you've got to look at the reasons for that defense and see whether the reasons make it applicable here.

Unknown Speaker: But you borrow... even the initial claim, it's just the Federal law picking up the State law, even though this is successor liability.

This is a receiver succeeding to a claim that allegedly the bank had.

Mr. Bender: But it's the bank's claim, it's not the stockholders' claim.

It's not Sahni and Day's claim.

Unknown Speaker: But if the bank had a claim, it was under California law--

Mr. Bender: Right.

Unknown Speaker: --not under Federal law, but you say that claim that the bank had then gets transformed into a Federal claim and if the State law continues to apply it's only by grace of the Federal law.

Mr. Bender: And if State law totally eliminated the bank's claim in this situation, that might raise a federalism problem, and Federal law might have to come in and say that that's not sufficient to protect the Federal interest.

That doesn't arise in this case, because State law here clearly provides a cause of action for negligent professionals who serve banks.

What the petitioner wants to do here is raise a defense which it says it can raise because the insiders at the bank committed wrongdoing, and as an equitable matter they shouldn't be liable because the insiders committed wrongdoing.

That would be a perfectly good defense if the insiders were suing, the insiders were the 100 percent stockholders.

Then it wouldn't be fair, and State law would provide and so would Federal law.

It wouldn't be fair to let the insiders recover, but that's not this case.

Unknown Speaker: Well, what is the State law with regard to the imputation defense in these circumstances?

Mr. Bender: It's not entirely clear, Justice O'Connor.

We believe that State law would hold, as would the law of most States, as most Federal courts that have had to guess what State law was in this area have held, that State law would hold that this imputation defense is not available to petitioner in these circumstances, because the people who are suing are not the wrongdoers.

Unknown Speaker: Well then, why do we need a Federal rule?

Mr. Bender: You need a Federal rule in case State law should hold otherwise.

Unknown Speaker: Well, wouldn't you think normally the court would determine what the State law is before deciding such a question?

Mr. Bender: In this case, the Ninth Circuit divided the issue in an interesting way.

The Ninth Circuit first held that the wrongdoing of Sahni and Day would not be imputed to the bank because the bank's interest, once the bank was insolvent, was adverse to the interests of Sahni and Day.

It's not clear whether they... in doing that they were relying on State law or Federal law.

The opinion relies on some Federal cases, it rejects the leading Federal... State case that petitioners cite, but--

Unknown Speaker: Well, maybe we should just send it back.

Mr. Bender: --Well, I don't think you should, and the reason we acquiesced in certiorari here is because the defense that was raised by the petitioners in the district court and in the court of appeals is one which if it were viable would be a very important defense.

It would stop the FDIC from getting compensation to the fund for all kinds of wrongdoing.

The Ninth Circuit, we believe, correctly rejected that defense.

It's a very important point of Federal law, we think, to affirm what the Ninth Circuit did and say that this equitable defense is not available when the people who were suing are not the wrongdoers, and here--

Unknown Speaker: Mr. Bender, this goes back to a question that was raised in the course of Mr. Lee's argument, is this conflict really necessary?

If the State and Federal law are the same on the point, then why should we, at least in this case, resolve this question of what if the State law were different, then would it be displaced by Federal law?

Mr. Bender: --The reason for resolution is because that issue is raised... there are many, many of these lawsuits involving over $1 billion in asserted liability that are brought by the FDIC all around the country.

This defense, this kind of defense, imputation defense that the bank is somehow responsible for the wrongdoing of the insiders is raised by defendant professionals in those suits over and over again.

The Ninth Circuit rejected that defense.

That rejection is an important point of Federal law, and that's the reason we assume the Court granted certiorari in this case, and that's the important Federal issue that needs to be resolved.

Because if you don't... if you permit that imputation defense to be available, you do two things: 1) you really harm the Federal interest here.

You harm the Federal interest because professionals--

Unknown Speaker: Of course.

I mean, any defense does.

I'd stipulate that.

Of course you do.

You say... you get less money.

Mr. Bender: --It's worse than that.

It's worse than that.

Think about a law firm which is retained by a bank, and what the incentives are if this defense were available.

The incentives are not to discover fraud, not to discover that the bank is insolvent.

If you discover that the bank is insolvent, what's going to happen?

You'll have to say so.

You won't be able to finish the PPM.

The project won't be able to go forward.

You may never even get your fee.

Because the bank's insolvent, you're just a creditor.

The depositors come first.

On the other hand, if you don't discover it, then you get paid, the scheme goes forward, and if the defense applies, you're never going to be liable.

The incentive--

Unknown Speaker: Why is that unique to the Federal Government situation?

Isn't it the same in California?

Mr. Bender: --I think it is, and therefore we think that California would hold the same way.

Unknown Speaker: Why isn't it State law, then, rather than Federal law?

Mr. Bender: Well, it's Federal law if the State law doesn't provide that.

Unknown Speaker: I know, but that's just grabbing whatever is best for the Government.

Mr. Bender: No, it's not grabbing what's best for the Government, Chief Justice Rehnquist, it's establishing a minimum base of Federal law that's necessary.

Unknown Speaker: But it seems to me your arguments, as Justice Scalia suggest, don't show why the Federal Government here is in any different position than anyone else who might have been hurt by this sort of transaction.

Mr. Bender: I agree with that, that the Federal Government is in the--

Unknown Speaker: Why should there be a special rule for the Federal Government?

Mr. Bender: --There should be a special rule if a State, as petitioners argue here, were to depart from that rule.

If a State were to say, you do impute the defense to the bank, and stop the bank from suing, that rule--

Unknown Speaker: But your argument seems to me simply to boil down to the fact that there ought to be a Federal common law rule whenever the State common law rule isn't good enough.

Mr. Bender: --Isn't adequate to protect the Federal interest.

That's what Kimbell Foods holds.

You have a national Federal program here of insuring these institutions.

You have a program where the FDIC becomes subrogated to the claims of the depositors.

It is important for that National Federal program 1) to make sure that the depositors' claims, which the FDIC is subrogated to, are compensated, so if the fund--

Unknown Speaker: Well, what is there intrinsic in your argument that addresses the need for a common law rule as distinct from the need to amend the statute?

Mr. Bender: --The statute was written, we believe, in light of the background that this Federal common law necessary to preserve the Federal interest would be available.

We don't think you can read--

Unknown Speaker: How do we know that?

Mr. Bender: --The Federal--

Unknown Speaker: I mean, it seems to me the rabbit is coming out of the hat, but I mean, you put the rabbit in the hat.

How do we know that?

Mr. Bender: --Well, the question is... the statute I take it you're referring to is FIRREA in 1989.

Unknown Speaker: Yes.

Mr. Bender: The question is, assuming that there was... and we think it's clear that prior to that time there was this minimum base of Federal common law necessary to preserve the interests of the Federal program.

Just like in D'Oench, Duhme, the Court said there's a rule of Federal law that says that unwritten side agreements can't be applied against the FDIC.

Unknown Speaker: But nobody could identify that common law, nobody could identify that debt until we first apply the statute and find some deficiency in the statute, and then we say, aha, there must have been the bed of common law that was assumed to prevent this unfortunate result.

Mr. Bender: No, I don't think so, Justice Souter.

Unknown Speaker: You've got to be able to discover it some way other than in order to chink up whatever's wrong in your case.

Mr. Bender: I don't think so, because I don't think the statute purports to be a total package of what the Federal Government's rights are, nor does petitioner.

Petitioner admits, and we agree, that State common law of negligence would be available to the FDIC here, so it's clear that the... and that's after FIRREA was enacted in 1989.

It's clear that FIRREA didn't mean to take over exclusively all of the rights of the FDIC in suing the professional in this case.

Everybody agrees that they at least have the rights provided by State and common law.

Unknown Speaker: But I don't know why that isn't a good argument simply for concluding that the Feds take the common law as it was, including the common law defenses, and you take the bitter with the sweet.

Mr. Bender: Well, because that's not what the Court has held over the years, and I think it would be wrong to hold that.

The Feds presumptively take the common law as it is, but if there's something in the common law that would be applied by the State that insufficiently protects the Federal interest, as in D'Oench, Duhme, for example--

Unknown Speaker: Let's talk about D'Oench, Duhme.

The Federal statute, you're there.

I think you could make the argument which you're trying to make about FIRREA... the FIRREA statute, that it was legislated against a background of Federal common law.

D'Oench, Duhme was decided 3 years after Erie.

Mr. Bender: --Right.

Unknown Speaker: And the legislation at issue in that case was undoubtedly enacted on the assumption that Federal courts applied Federal law, period.

You wouldn't have to dance around Erie and Claxton and all of that stuff.

But we're in a different age now.

You can't--

Mr. Bender: Right.

Unknown Speaker: --and I don't think Congress when it passes a statute like this assumes that there's some brooding Federal law that governs all of this stuff.

Mr. Bender: Well, they assume that there's a body of common law that is going to be applicable and available to the FDIC.

Unknown Speaker: Oh, I think they assume there's a body of State common law, State by State, and that the rights of parties on financial transactions are going to be determined by State law.

Mr. Bender: Even when State law would mean that the Federal interest was not adequately protected.

Unknown Speaker: Which is why they have exceptions in there.

They have some specific rules eliminating certain defenses because they think those are important enough that they're willing to override State law.

Mr. Bender: Then the question in this case is whether you can assume that Congress, in passing FIRREA, meant to say, all defenses that the State would provide are available, except those we specifically exclude here.

Unknown Speaker: Why shouldn't we assume that?

Mr. Bender: You shouldn't assume that because I don't think that was Congress' purpose in passing it.

It would be especially ironic to assume that in this case when we know that Congress' principal purpose in passing FIRREA was to shore up the ability of the system to stop malfeasance from draining the Federal Treasury, as had happened many times during the decade before this statute.

Many banks became insolvent because of the wrongdoing of insiders of the banks, and in part because outside professionals called in by those insiders did not act carefully to protect the Federal fisc.

Unknown Speaker: But not at all costs.

I mean, this is the old argument that since an act has some purpose, anything that impedes that purpose has to be overridden.

Nobody enacts legislation that way.

Mr. Bender: But there's no... there's no significant cost here.

The only cost that would be present here is the cost of not permitting the petitioners to use a defense against people who the defense was never meant to be usable against.

As Justice O'Connor said during Mr. Lee's argument, the purpose of this defense is to stop wrongdoers from collecting for their own wrongdoing.

That would--

Unknown Speaker: Was there any attempt, Mr. Bender, in the district court to determine whether that was indeed the content of California law, so you don't need to... you don't need to displace California law?

We can't tell from the summary judgment that's included in the appendix what the district court went on.

Mr. Bender: --No.

You can... the only way I can tell is from the same thing that you have before you.

The district judge said, very summarily, that he didn't think the law firm owed any duty to anybody except the investors in the scheme, and the finding that the investors had been compensated... the investment was cancelled and they got their money back.

Finding that the investors had been compensated, he said, well, there's no duty to anybody else, and therefore I grant summary judgment.

That was patently wrong.

The duty of the professionals... maybe they do have a duty to the investors, but their primary duty is to their client, and the client here is the bank, so the district court just went off on something that was wrong.

There was a duty to the bank.

Unknown Speaker: Mr. Bender, you said a second ago that the point here is to prevent the defense from being used against someone against whom under State law it couldn't have been used.

Mr. Lee's argument was that you succeeded to rights and not to claims, and so that in fact the right is determined by reference to those against whom the defense would in fact have been assertable under State law.

What is your answer to that?

Mr. Bender: I think you have to see it in time sequence.

The bank is insolvent.

The professional commits negligence.

The negligence harms the bank, and with an insolvent bank, the negligence harms the creditors of the bank.

The negligence harms the depositors.

At that time, the depositors have a claim which is held in trust for them by the bank.

The depositors have a claim against the petitioner, against the outside professional.

The defense doesn't come in until that suit is brought.

When that suit is brought, the professional says, we have a defense.

What's the defense?

The defense is equitable estoppel, because the insiders of the bank were wrongdoers.

That just doesn't apply.

Unknown Speaker: So you're saying the claim is... the relevant claim is the depositors' claim, not the bank.

Mr. Bender: Exactly.

Exactly, and I think it's really important... there are a number of amicus briefs filed in this case which say that the thing that's wrong with the Ninth Circuit decision is it changes the rules of professional responsibility, and that that's an inappropriate thing for the Federal Government to do, and we think that by and large that is an inappropriate thing for the Federal Government to do, but that's not what the Ninth Circuit decided in this case.

Nothing the Ninth Circuit decided has anything to do with the duty of care of the professionals.

They had a duty of care when they took on this assignment.

If you had said to them the moment after they were retained by the bank, do you have a duty of care to discover things that should be in the PPM that aren't there, or do you have a duty of care to make sure the statements said in there are correct, the answer would be yes.

For them to say--

Unknown Speaker: --things that they already know.

Isn't that a new duty?

Mr. Bender: --But Justice Scalia, it's not just the directors.

The PPM isn't for the benefit of the directors.

The PPM is for the benefit of the investors, and they--

Unknown Speaker: Whatever.

Doesn't that constitute a new duty, a duty that they didn't have before?

Mr. Bender: --No, no.

It's a duty that they have because the bank is insolvent.

They have a duty to their client, and their client is the bank, and at the moment of insolvency the bank is no longer the directors, and the bank is no longer the shareholders.

At the moment of insolvency, the bank becomes the creditors of the bank, and the bank holds those creditors' claims in trust, so their duty is, at that moment, to those creditors, and it's just not plausible that they are absolved from that duty because of the wrongdoing of somebody completely different.

Unknown Speaker: The duty is the same, it's just that people who didn't used to be able to sue for the violation of that duty can now sue for the violation of that duty.

That's a pretty big change.

Mr. Bender: I wouldn't concede that they didn't used to be able to sue.

These people could always sue.

The question is whether--

Unknown Speaker: The bank?

Mr. Bender: --The bank.

The creditors.

They can't sue--

Unknown Speaker: I'm not talking about the creditors.

I'm talking about the bank or the FDIC, which is now standing in the shoes of the--

Mr. Bender: --The bank is the creditors when the bank becomes insolvent.

That's the key to understanding this case.

If this had happened while the bank was solvent, there would be a perfectly good defense, because while the bank was solvent, then the harms caused here... the $10 million, let's say, that was spent on this aborted scheme... would come out of the pockets of the shareholders.

Their stock would be worth less.

So while the bank is solvent, then this defense applies, but once the bank becomes insolvent, then the interests of the creditors are the important interests, and there was never a defense against those creditors.

They never did anything wrong.

It's utterly absurd to say that.

What the Ninth Circuit held was that if State law purported to say that absurdity, if State law purported to get in the way of a lawsuit that's 1) necessary to compensate the fund, and 2)... and I think this is important... necessary to make sure that professionals who act on behalf of insured savings institutions do so carefully, if State law got in the way of that and tried to erect a law that didn't protect those interests, then that's just where the theory of Kimbell Foods comes into play.

Then the State law is not adequately protecting the Federal interest, and under Kimbell Foods and under D'Cench, Duhme, under a long line of this Court's decisions, that State law is discarded, is not used because it's not adequate to protect the Federal interest.

It's really important to understand here what's really going on is the need to have a system of law that adequately protects insured institutions against looting by insiders.

That's not fanciful.

Looting by insiders of insured institutions cause billions of dollars to the Federal fisc.

Sometimes, in a significant number of those cases, Congress found that the negligent conduct of third party professionals was causal in permitting those insiders to do the looting.

It's important, it's vital under Kimbell Foods, it would frustrate the Federal interest under Kimbell Foods, if you had State law applying that didn't protect that interest.

Unknown Speaker: --Mr. Bender, was it in FIRREA that they specifically provided for directors' liability in certain cases where the liability might have been doubtful under State law?

Mr. Bender: Yes.

Unknown Speaker: Isn't that a pretty good reason to assume that Congress did it's picking and choosing when it decided the extent to which State common law might need to be modified to protect the Federal interest?

Mr. Bender: No, because I don't think FIRREA... FIRREA added administrative claims against directors or administrative penalties, but that's different from--

Unknown Speaker: Well, didn't it do it... I may be wrong on this, but didn't it do it at least on an arguably more... on a standard of liability that was arguably more onerous to the directors than any standard of liability at common law that would have sufficed for recovery?

Mr. Bender: --For those administrative penalties.

Unknown Speaker: Yes.

Mr. Bender: But that did not supplant the State common law, the Federal common law which will absorb the State common law, of directors' liability for negligence.

That was... that gross negligence standard was for administrative penalties.

Those penalties, by the way, do not go to the same place, and that's very important.

Those penalties do not go into the insurance fund, so that cannot be seen as an attempt to protect the insurance fund.

That's more of a penal way of controlling the directors' behavior.

I don't think petitioner urges, and we certainly don't, that that provision of FIRREA was meant to displace the State common law of negligence of directors and officers.

That's still in place, and even more clearly the law here is.

Unknown Speaker: Thank you, Mr. Bender.

Mr. Lee, you have 9 minutes remaining.

Rebuttal of Rex E. Lee

Mr. Lee: We're told that Federal common law is necessary in order to vindicate the Federal interest.

What vindicates the Federal interest is for Congress, and Congress here has spoken.

We have heard not one word in response to section 1821 as governing both of these two issues, and there is no response.

Unknown Speaker: May I ask you, Mr. Lee, on 1821, do your California cases address the question whether this defense would be available if the suit had been brought by a depositor as opposed to the bank?

Mr. Lee: I think not, but let me address that right now, because--

Unknown Speaker: Then is it not fair to say that the State law is unclear on the precise issue that we have before us?

Mr. Lee: --No, because the precise issue of the depositors is not before this Court, and I... that's one of the most important things that I need to clarify in this rebuttal.

Unknown Speaker: We wouldn't have this suit, I suppose, if the provision read that FDIC shall acquire all rights of the depositors, as opposed to saying, all rights of the bank.

Mr. Lee: Of course, and you don't even turn to State law because the Federal statute is--

Unknown Speaker: Doesn't the statute say precisely that, it succeeds to all rights, titles, powers, and so forth, of the institution, and of any stockholder, member, account-holder, depositor, and so forth?

Mr. Lee: --Yes, but on the second issue of the standing in the shoes, it deals with that expressly and on its own.

But let me just cut right through, Justice Stevens, and tell you that the real answer to this is that the claims of the creditors are not involved in this case for two separate and independently sufficient reasons.

The first is that under this Court's decision in Dietrich v. Standard Surety, in order for the FDIC to assert claims on behalf of creditors, those have to be alleged and proven.

They have been neither in this case.

Moreover, under this Court's recent decision in Holmes v. Sipek, they could not be proven.

Why?

Because in the language of that decision there is too much... the link is too remote between the O'Melveny & Myers law firm and those creditors.

This is not... the proximate cause defense is not just a... it's not just a defense, it is also an element of the claim, as Holmes v. Sipek makes very clear.

The Ninth Circuit did not rely on the claims of creditors.

The Government did not rely on the claims of creditors when it originally brought this suit, and those claims of creditors simply are not at issue in this case.

Now, coming back to the vindication of Federal interests, in addition to the specific statute, which stands unassailed, you also have this comprehensive statute, FIRREA.

Mr. Bender says... and it's absolutely essential to his case to say this... that this is not a total package of Federal law.

I assert to you, it is a total package of Federal law under City of Milwaukee, and if the Court were to determine that this is not a total package of Federal law, then City of Milwaukee has got to be overruled.

It did, Justice Souter, establish a higher duty of obligation on behalf of officers and directors.

It also, Justice Scalia, eliminated a lot of defenses, probably dozens of defenses, but some of them it left intact, and if City of Milwaukee and Kimbell Foods mean anything at all, it is that when Congress has spoken definitively and comprehensively, picking out some to be left in place and others to be displaced, it is not the job, then, of the lawyers for the Federal Government and the Federal courts to come along behind and declare what Federal policy is.

Now, with regard to causation, the only way that the Government can satisfy the causation responsibility in this case is to argue for a but-for House-That-Jack-Built type of causation.

Necessarily, the causation that we're talking about in this instance if California law applies, as it must, is proximate causation and not but-for causation.

I invite the Court's attention to Flagg v. Seng, which is very clear on this point, and is squarely consonant with Holmes v. Sipek.

That case says that unless there is justifiable reliance, which there is not if you impute the knowledge of the agent to the corporation, then there is no proximate cause, and it's not, as I say, just a defense, it is also an element of the claim.

With regard to Kimbell Foods, let me just point out I've heard nothing today, and really there is nothing effective in the brief, that disputes as to all three of those Kimbell Foods factors the following: 1) they are mixing and matching.

The argument that has been made here today that they're now asserting the claims of creditors, when they didn't even assert them in their complaint, is another classic example of mixing and matching.

With regard to the second, the--

Unknown Speaker: Mr. Lee--

Mr. Lee: --Yes.

Unknown Speaker: --I mean, there's always to some extent mixing and matching.

I don't know any Federal common law scheme that... individual property rights, for example, are still always determined by State law.

Mr. Lee: Exactly.

Unknown Speaker: There's always some mixing and matching.

Mr. Lee: Exactly, and we don't object to that.

All we object to is the Government, in those instances when it does mix and match, come in and then say that it's absolutely essential to have a uniform body of law, because as this Court said in Yazell, that is rejected by their own conduct.

Unknown Speaker: With regard to the second, we have heard nothing in response to what this Court said in Kimbell Foods that there are two other purposes that underlie these Federal insurance statutes, and these Federal insurance statutes do have other purposes.

And with regard to that, Justice O'Connor, as to how the taxpayers and the citizens will ultimately be served, let me just turn Mr. Bender's point around and ask us to put ourselves in the position of the O'Melveny partners when the next case comes up in which they're asked to represent a savings and loan and the Ninth Circuit law still remains in place.

Probably the reaction is going to be, we don't know what law is going to apply, we don't know what has happened, we have no... absolutely no indication at this time of any wrongdoing, and we certainly didn't in this instance, let's just stay out of it altogether.

Or at the very least, if we get into it, the price is going to have to go up.

Either way, ultimately, it's the public that will pay.

Now, finally, the one thing that is clear from the briefs and from this argument is that the judgment of the Ninth Circuit must be reversed.

They erred.

They erred in holding that it was Federal rather than State law that applied.

The only question is, should it be remanded, or should this Court just make final disposition of the case?

I submit that there is no doubt as to what California law is, and if the Court will permit, I will simply... well, I won't read it.

I will simply refer you to West American Financial, which states very clearly there is an exception governing the circumstance where the agent is acting on his own behalf, but there is also an exception to the exception, and that exception to the exception applies where the agent is in fact acting for his principal, and that's on page 969 of that opinion.

Mr. Lee, what's your best example of this Court reaching out to decide a question of State law contrary to what the alleged Federal common law rule would be, contrary to what is the law in many other States?

Mr. Lee: Oh, I think not contrary to what the law is many other States, but--

Unknown Speaker: In some other States.

Mr. Lee: --Yes... well, the best example is West v. AT&T, which is cited at footnote 9 of our reply brief.

Mr. Chief Justice, unless the Court has questions, I have nothing further.

Chief Justice Rehnquist: Thank you, Mr. Lee.

The case is submitted.

Print this transcript Transcript: 

Argument of Speaker

Mr. Lee: The opinion of the Court in No. 93-489, O'Melveny & Myers versus FDIC will be announced by Justice Scalia.

Argument of Justice Scalia

Mr. Scalia: This case is here on writ of certiorari to the United States Court of Appeals for the Ninth Circuit.

The petitioner, law firm, represented a California Savings and Loan Association in certain real estate syndications which turned out to be fraudulent on the part of the S&L.

The S&L later became insolvent and the respondent in this case, the Federal Deposit Insurance Corporation, became the receiver of the S&L.

The FDIC caused the S&L to make refunds to the investors in the fraudulent real estate syndications and then filed suit against the petitioner in Federal District Court alleging state causes of action for professional negligence and breach of fiduciary duty.

The petitioner moved for summary judgment alleging that the S&L officers knew of the fraudulent conduct that knowledge must be imputed under California law to the SNL and also to the FDIC which as receiver stood in the S&L's shoes, and that because of the imputed knowledge the FDIC was estooped from pursuing the tort claims.

The District Court granted summary judgment but the Court of Appeals reversed stating that a federal common law rule of decision control.

In the unanimous decision announced today, we reverse the judgment of the Ninth Circuit.

The California rule of decision rather than any federal rule governs petitioner's tort liability.

State law governs the imputation of corporate officer's knowledge to a corporation that is asserting state law causes of action.

There is no federal general common law and the remote possibility that a corporation may go into federal receivership is no basis for adapting a special federal common law rule that would divest states of authority over the entire law of imputation.

Likewise, California law governs the narrower question whether corporate officer's knowledge can be imputed to the FDIC when it sues as receiver.

This Court will not adapt a judge-made federal rule to supplement comprehensive federal regulation.

Matters that are left unaddressed in such a comprehensive scheme are presumably left to sate law.

Section 821(d)(2)(A)(i) of Title 12 places the FDIC in the insolvent S&L's shoes to pursue its claims under state law except where some provision in the extensive framework of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, more commonly known as FIRREA, specifically creates a federal rule of decision.

FIRREA created no federal rule of decision that governs in this case.

Finally, judicial creation of a special federal rule of decision would not be justified even if FIRREA is inapplicable to the instant receivership which began in 1986 three years before FIRREA was passed.

Instances where a special federal rule is warranted are few and restricted limited to situations where there is a significant conflict between some federal policy or interest and the application of state law.

The FDIC has identified no such conflict here.

The parties to the case are in agreement that if state law does govern, it is California law but they disagree to what that law provides.

We leave it to the Ninth Circuit to resolve that point.

Accordingly, the judgment of the Court of Appeals is reversed and the case is remanded for further proceedings.

Justice Stevens has filed a concurring opinion in which Justices Blackmun, O'Connor, and Souter join.