Overlooked by much of the commentary on the D.C. Circuit’s recent decision on the Treasury Department’s “net worth sweep” are the contract claims remanded to the district court. Perry Capital LLC et al. v. Mnuchin et al., No. 14-5243, slip op. at 58-73 (D.C. Cir. Feb. 21, 2017). These claims warrant attention because they may result in sizable damages to investors in Fannie Mae and Freddie Mac securities, despite the dismissal of plaintiffs’ statutory claims for injunctive relief.
In reaction to the financial crisis of 2008, Congress passed the Housing and Economic Recovery Act (“HERA”), which created the Federal Housing Finance Agency (“FHFA”) to oversee Fannie Mae and Freddie Mac – the “government-sponsored entities” that buy mortgages and sell mortgage-backed securities. In September 2008, FHFA put Fannie Mae and Freddie Mac into conservatorship; they, in turn, entered into Stock Purchase Agreements (“SPAs”) with the Treasury Department, which provided them with a cash lifeline in exchange for a 10% quarterly dividend payable to Treasury. As of June 2012, they had drawn $187.5 billion, but had begun returning to profitability. See Perry Capital, slip op. 5-10. In August 2012, FHFA and Treasury amended the SPAs to replace the 10% dividend with the requirement that Fannie and Freddie pay a quarterly dividend equal to their entire net worth minus a small capital reserve – the “net worth sweep” – that is never applied to their debt. Id. at 11-12. To date, Fannie and Freddie have repaid Treasury over $264 billion, but still owe it the full amount they drew under the SPAs. The net worth sweep means that they will not return profits to their investors.
In 2013, several institutional investors and a purported class of other investors in Fannie Mae and Freddie Mac securities filed a series of lawsuits against FHFA and Treasury. These suits variously claimed that the net worth sweep violated the Administrative Procedures Act, exceeded the authority provided to FHFA by HERA, constituted a Fifth Amendment Taking, violated fiduciary duties to investors, and breached the terms of a class of investors’ stock certificates for Fannie Mae and Freddie Mac securities. The suits filed in the U.S. District Court for the District of Columbia were consolidated into the Perry Capital litigation before Judge Royce Lamberth. In 2014, he dismissed plaintiffs’ complaints in their entirety for failure to state a claim. See Perry Capital LLC et al. v. Lew et al., 70 F. Supp. 3d 208 (D.D.C. 2014).
The D.C. Circuit Decision
On appeal, a split panel of the D.C. Circuit affirmed the dismissal of plaintiffs’ claims under the APA and HERA, and for violation of fiduciary duties. See Perry Capital, slip op. 17-58. The statutory claims that received most commentators’ attention sought injunctive relief and would have ended the net worth sweep, but did not seek monetary damages.The class plaintiffs’ breach of contract claims, however, did seek damages and were remanded to the district court for further consideration. Specifically, the D.C. Circuit reversed and remanded the claims involving liquidation preferences and for breach of the implied covenant of good faith and fair dealing regarding dividend rights. Id. at 64. As to liquidation preferences, the court ruled that this was effectively a claim for anticipatory breach in the event of a future liquidation, which plaintiffs claimed wiped out much of the value of their stock. Id. at 72 & n.26. As to dividend rights, the court concluded that plaintiffs’ damage claims had to be evaluated in reference to whether the net worth sweep violated “the reasonable expectations of the parties” when plaintiffs purchased their shares. Id. at 68. Some class members, for example, bought shares before HERA was enacted; some bought later. Id. at 69. The district court was instructed to consider, and potentially sub-divide, the putative class based on their dates of purchase and thus their expectations regarding the availability of funds to pay dividends. Id.
Discussion of the Contract Claims
Although the class plaintiffs have survived a grueling litigation gauntlet, their return to the district court will face further obstacles concerning the proper calculation (and existence) of cognizable damages. Valuation of the liquidation preference as of the distinct time periods when shares were purchased may prove exceedingly difficult, because the putative class of investors bought shares at very different times during the class period. Further, although it may be more straightforward to value the dividend rights abrogated by the net worth sweep, this will certainly be the subject of substantial expert discovery and disagreement. The same is true to the extent the plaintiffs seek to recover for losses in the value of their stockholdings, as share prices for Fannie Mae and Freddie Mac have fluctuated significantly since HERA was enacted in 2008, and also since the net worth sweep in 2012. Sales and re-purchases by class members will further complicate this analysis. Further, because the contracts at issue were with Fannie Mae and Freddie Mac – which are no-governmental, regulated entities – the Government did not previously, and presumably will not now, assert the “sovereign” defenses to contract claims that it unsuccessfully raised in U.S. v. Winstar Corp. et al., 518 U.S. 839 (1996). For the same reason, the favorable Winstar cases – which held that the Government acted in a fashion that breached its own contracts with private parties – should not apply to benefit plaintiffs. Although the class plaintiffs would surely contend that the Government interfered with their contracts (as in Winstar), those contracts were not actually with the Government (unlike Winstar).
In short, although the net worth sweep litigation was not a clean sweep for the Government, neither will it be an easy task for the class plaintiffs to “clean up” through their damage claims. One can expect the process to be complicated and costly. It remains to be seen whether the outcome will be worth the wait.
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Jason A. Levine is a litigation partner in the Washington, DC office of Vinson and Elkins LLP. He does not represent any parties or amici involved in the Perry Capital litigation. The views expressed herein are his own.