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Murphy v. Federal Deposit Insurance Corp.

filed: October 26, 1994.

PATRICK J. MURPHY, ET AL., PLAINTIFFS-APPELLEES,
v.
FEDERAL DEPOSIT INSURANCE CORPORATION, ET AL., DEFENDANTS-APPELLANTS. PATRICK J. MURPHY, AN INDIVIDUAL; MURPHY'S MARKETS, INC., A CALIFORNIA CORPORATION; RAMSEY MARKETING AND MANAGEMENT CO. ("RAMCO"), AKA: RAMSAY MARKETING AND MANAGEMENT CO., A CALIFORNIA CORPORATION, PLAINTIFFS-APPELLANTS, V. FEDERAL DEPOSIT INSURANCE CORPORATION, ET AL., DEFENDANTS-APPELLEES. FEDERAL DEPOSIT INSURANCE CORPORATION; FIRST NATIONAL BANK, PLAINTIFFS-APPELLEES, V. PATRICK J. MURPHY, DEFENDANT-APPELLANT.



Appeals from the United States District Court for the Northern District of California. D.C. No. CV-88-01396-RHS. D.C. No. CV-88-01396-RHS. D.C. No. CV-90-00849-RHS. Robert H. Schnacke, District Judge, Presiding.

Before: James R. Browning, Procter Hug, Jr., Cecil F. Poole, Dorothy W. Nelson, William A. Norris, Stephen Reinhardt, Robert R. Beezer, Cynthia Holcomb Hall, Charles Wiggins, David R. Thompson and Andrew J. Kleinfeld, Circuit Judges. Opinion by Judge Kleinfeld.

Author: Kleinfeld

KLEINFELD, Circuit Judge:

The beneficiary of a letter of credit sought to recover against the FDIC, after the issuing bank failed. The FDIC argues that recovery is barred by the D'Oench, Duhme doctrine and 12 U.S.C. § 1823(e). We reject these arguments. The traditional commercial law principle, that a letter of credit stands independent of irregularities in its procurement, survives bank failure. Our earlier decision, at 12 F.3d 1485 (9th Cir. 1993), is vacated.

I. Facts.

Mr. Murphy won his suit against the FDIC in a jury trial. The FDIC does not challenge any of the jury instructions. Its appeal arises out of denial of its motions for directed verdict and judgment notwithstanding the verdict. Many of the facts were established by stipulation. For those which were not, Murphy is entitled to have the evidence viewed in a light most favorable to him, resolving conflicts in his favor and giving him the benefit of reasonable inferences, to determine whether substantial evidence supported the verdict. Vaughan v. Ricketts, 950 F.2d 1464, 1468 (9th Cir. 1991). We are required to sustain a judgment based on a jury verdict if it was supported by substantial evidence, that is, such relevant evidence as "reasonable minds might accept as adequate to support a Conclusion." Davis v. Mason County, 927 F.2d 1473, 1486 (9th Cir.), cert. denied, 116 L. Ed. 2d 227, 112 S. Ct. 275 (1991). For that reason, the facts as recounted below are based largely on Murphy's testimony, the exhibits, and the stipulated facts. The central issue at trial was whether Murphy was a perpetrator or a victim of the mismanagement of a bank. The jury decided he was a victim.

In 1982, Frederick L. Hilger, Sr. organized a holding company, Pacific National Bancshares, in order to buy a bank, First National Bank, Chico. Eleven investors put up $83,000 each, and each obtained a one-eleventh share of the holding company. Murphy, a grocer, was one of the investors. The holding company borrowed $2.25 million from Security Pacific National Bank to pay for the bank it was buying. Each of the eleven investors had to guarantee the $2.25 million note. Murphy became one of the directors of both entities, the holding company and the Bank. Hilger was chairman of the board and chief executive officer of both entities.

In June of 1984, Murphy decided to withdraw from the Bank. At a board of directors meeting in June, he announced his resignation, said good-bye to his fellow board members, and left. Within a day or two Hilger came to him on behalf of the remaining shareholders and offered to have the holding company buy his shares for $400,000. When other board members had resigned shortly before, the remaining investors had agreed to pay up to $400,000 for each of their shares, and had succeeded in acquiring them for $200,000. Murphy agreed on the $400,000 price, and agreed to take a promissory note for $395,000 of it. He wanted the note to be secure, and to be something which his grocery and equipment supplier, United Grocers, would accept as collateral when he needed credit. Hilger suggested the Bank give him a letter of credit. After Murphy called United Grocers and ascertained that it would accept the note secured by the letter of credit as collateral for Murphy's own obligations, Murphy agreed. Murphy remained liable to Security Pacific on his personal guarantee of the holding company's $2.25 million note, subject to his cross-indemnification agreements for one eleventh each with the other ten investors.

The FDIC presented as evidence minutes of board of directors meetings which said that Murphy resigned in July. The date matters because, according to Murphy's evidence, he was no longer a director when he sold his stock and accepted the note secured by the letter of credit. According to the FDIC's evidence, he was still on the board. Murphy testified that the minutes which suggested that he did not resign until July were false. To the extent that it supports the verdict, Murphy is entitled to have his appeal proceed on the basis that his account was the truth.

To secure its $395,000 note, the holding company gave Murphy a standby letter of credit from the Bank addressed to Murphy's supplier, United Grocers. The letter of credit promised United Grocers that the Bank would pay the holding company's note if the holding company defaulted:

This will act as your letter of credit wherein should there be a default in the payment of the note according to its terms to Murphy or his assignee, then First National Bank will buy from you or the then holder of the note, the note at its then unpaid balance. Our only requirement relative to this letter of credit is that any failure of payment according to the terms be brought to the notice and attention of First National Bank within thirty (30) days after the same shall have occurred.

Murphy's supplier could, with the note and this standby letter of credit, rely on the Bank's financial soundness, not just the holding company's and Murphy's, when it extended credit to Murphy. Its $395,000 would be as safe as the Bank's credit.

The contingent form of the "standby" letter of credit distinguished it from a traditional letter of credit. In its traditional form, a letter of credit to a supplier might be a bank's promise to pay the supplier upon presentation of the seller's draft and shipping documents such as a bill of lading. See Robert Braucher & Robert A. Riegert, Introduction to Commercial Transactions 358-76 (1977). Formal requirements for letters of credit are so flexible that they have evolved to embrace, in some "standby" applications, something resembling a guarantee. See id. at 375; U.C.C. §§ 5-103, 5-104.

The principal difference between the traditional letter of credit and these newer standby letters is that "whereas in the classical setting, the letter of credit contemplates payment upon performance, 'the standby credit,' . . . 'contemplates payment upon failure to perform.'"

First Empire Bank-New York v. FDIC, 572 F.2d 1361, 1367 (9th Cir.) (quoting Katskee, The Standby Letter of Credit Debate - the Case for Congressional Resolution, 92 Banking L.J. 697, 699 (1975)), cert. denied, 439 U.S. 919 (1978). Standby letters of credit are expressly provided for by federal banking regulations. See 12 C.F.R. §§ 208.8(d), 215.3(a)(3), 337.2. The FDIC has not contested the categorization of the instrument in the case at bar as a letter of credit.

In November of 1983, Murphy borrowed $100,000 from the Bank to invest in some municipal bonds. His note came due in November of 1984, but the Bank extended it. Murphy testified that Hilger, on behalf of the Bank, assured him orally that he would not have to pay the note until he had been paid the $395,000. But the jury returned a verdict that there was no "agreement between Patrick Murphy and First National Bank that he would not be required to pay his note to the bank until the obligations of Pacific National Bank were paid to him." On Murphy's cross-appeal, the FDIC is entitled to have this part of the verdict treated with as much deference as Murphy's verdict.

In October, 1985, about sixteen months after Murphy sold out, the holding company was in desperate need of money to pay Security Pacific on its note. Hilger and William G. Edmondson, another board member, asked Murphy to loan $190,000 to the holding company, which would be repaid in January. They told him they would back the loan with "a letter of credit, like the other one, guaranteed by some fifty-five million plus in deposits." After checking with United Grocers to make sure it had received the new letter of credit, Murphy gave Edmondson the $190,000.

In the course of the Discussions, Murphy asked Edmondson "how is it going at the Bank?" and Edmondson replied that "we've got growing pains." The Office of the Comptroller of the Currency had, in June 1985, issued an order to the Bank to cease and desist transactions such as this one. The Bank should not have issued the letter of credit. Edmondson and Hilger could not properly use the Bank's credit for the holding company's note as they did. But Murphy did not know any of this. The government ordinarily keeps such orders secret. Edmondson and Hilger did not tell him that the "growing pains" included a cease and desist order. The jury decided that as to this letter of credit, Murphy was defrauded.

In January, when the holding company did not pay him, Murphy mentioned it to his attorney during a consultation on another matter. The attorney said "let's go get your money," they walked the five blocks to Edmondson's office, and demanded payment. Edmondson said there was nothing to worry about, and payment was on its way. After some unsuccessful correspondence to try to collect, Murphy arranged for United Grocers to make formal demand from the Bank on the letters of credit, which it did in March of 1986. Then United Grocers assigned the notes and letters of credit back to Murphy.

There was evidence from which the jury could infer that these letters of credit were in the Bank's files, though not reflected in its books of account and ledgers. Murphy testified that Hilger's son, the Bank's cashier and then president in 1984 and 1985, called Murphy and asked him for a copy of the 1984 letter of credit because the Bank had misplaced it. Hilger later told Murphy not to bother, because he knew where it was kept. Kenneth Willbanks, a vice president of the Bank testified that he had put the 1985 letter of credit in the Bank's Murphy loan file. The letters are referred to in a footnote to the financial statements of the year ended December 31, 1985, which says that "management intends not to honor the letters of credit based on the questioned authenticity of such letters of credit." This footnote shows that the letters of credit were not secret from the Bank when the statements were prepared. Hilger testified that they were approved and ratified by the Bank's board of directors. Murphy's evidence entitled the jury to conclude that the Bank did not reflect the letters of credit as liabilities before demand was made, because they were contingent, and after the contingency became certain, because it took the position that they were not properly authorized.

Eight months after its refusal to pay on the letters of credit, the Bank failed. On November 20, 1986, the Comptroller of the Currency closed the Bank and appointed the FDIC as receiver. The United States successfully prosecuted Hilger criminally for defrauding Murphy in connection with the $190,000 loan in 1985, and for concealing the 1984 letter of credit from bank regulators. Hilger was convicted of both sets of charges and went to prison. The FDIC refused to pay the letters of credit when it paid the Bank's other obligations. Murphy then sued the FDIC. He joined First Interstate Central Bank, which had assumed the failed Bank's liabilities. The FDIC sued Murphy, in the case consolidated with this one, for payment of his $100,000 note to the failed bank. Murphy won his lawsuit against the FDIC but lost against First Interstate, and the FDIC won its suit against Murphy. Each party appeals to the extent that it lost.

The jury specifically found that Murphy had been misled but not defrauded with respect to the 1984 letter of credit. It found that he had been defrauded as well as misled with respect to the 1985 letter of credit. The jury found that the FDIC was liable to Murphy on both letters of credit, on contract and negligent misrepresentation theories, and on the 1985 letter of credit on his fraud theory as well.

The district court decided that the $100,000 note was not subject to setoff by the Bank's obligation to Murphy, so he was required to pay interest and attorneys' fees for collection despite the existence of the larger obligation of the Bank to him. The District Court rejected Murphy's claim against First Interstate Central Bank as a matter of law, because it specifically did not assume standby letters of credit when it assumed all the Bank's deposits and took over its assets at the FDIC's request.

II. Analysis.

The primary issue in the case is whether the FDIC could properly dishonor letters of credit because of irregularities in their issuance, if Murphy was not responsible for the irregularities. Secondary issues relate to setoff and assumption by the successor bank.

A. D'Oench, Duhme.

The FDIC argues that as a matter of law, Murphy could not recover on the letters of credit because he was barred by the D'Oench, Duhme doctrine. In D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 62 S. Ct. 676, 86 L. Ed. 956 (1942), a bond dealer had given a bank a promissory note for $5,000 on demand to cover some slow paying bonds. The Bank had promised him not to call the note, just to take what the bonds eventually paid. The note was given to the bank to conceal irregularities from the bank examiners. Neither the language of the note nor anything else in the Bank's records disclosed the agreement not to call the note. So far as anyone could tell from examining the Bank's files, it had a $5,000 asset. The Supreme Court held that the bond dealer was estopped to deny his ...


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