High Court Snags Bush S&L; Plan : Ruling Allows Creditors to Bypass Bailout Agency and Sue

In a setback for the Bush Administration’s effort to quickly resolve the savings and loan industry crisis, the Supreme Court ruled Tuesday that creditors of failed institutions may bypass the federal bailout agency and take their claims to a federal court.

The result could be a series of protracted and costly rounds of litigation, just what government officials had hoped to avoid.

The Federal Savings and Loan Insurance Corp. has sought to take over failed institutions, resolve the outstanding claims against them and then close their doors or sell them.

But in a unanimous ruling, the Supreme Court said the FSLIC does not have the legal authority to force creditors of failed S&Ls; to bring their claims directly to it for resolution.

“Congress granted FSLIC various powers in its capacity as receiver (of failed S&Ls;), but they do not include the power to adjudicate creditors’ claims,” said Justice Sandra Day O’Connor for the court.

Otherwise, O’Connor said, the government agency would be acting both as owner of the failed S&L; and as judge of claims against it. Every dollar denied a creditor would be a dollar saved by the government, O’Connor held, a conflict of interest that “raises serious constitutional difficulties.”

Could Change Rules

O’Connor suggested that the Federal Home Loan Bank Board, the parent agency of the FSLIC, could rewrite its rules to require creditors to give it a “notice of all claims” outstanding and “an initial opportunity to consider them in a centralized claims process.”

“If the bank board’s regulations only required claimants to give FSLIC notice of their claims and then to wait for a reasonable period of time before filing suit while the FSLIC decides whether to pay, settle or disallow the claim, we have no doubt that such regulations would be a reasonable exercise of the bank board’s broad rule-making power,” O’Connor wrote.

Dorothy Nichols, director of litigation for the bank board, said the court ruling “had good news and bad news for us.”

“It will be costly,” she said, because 90 insolvent S&Ls; are administered by FSLIC, and their creditors now have the right to fight for their claims in federal court.

But Nichols said O’Connor’s opinion also shows how the problem can be resolved. If the agency had notice of all claims and a chance to resolve them quickly, she said, it could head off long court battles.

Regional bank board officials had warned of the dangers of giving creditors the right to go to court. In briefs filed with the Supreme Court, officials of the Federal Home Loan Banks in San Francisco and Dallas warned that it “would significantly delay the liquidation of failed S&Ls; and add considerable expense to the cost of liquidation.”

But for Robert Goodfriend, a Dallas lawyer who represented a Texas real estate developer with a $113-million claim against an insolvent S&L;, the court ruling was strictly good news. “This is a real victory for creditors,” Goodfriend said.

Coit Independence Joint Venture, the real estate developer, took out a $50-million loan in 1983 with FirstSouth, an Arkansas S&L.; When the economy turned sour, the S&L; sought to impose higher interest on Coit and caused its development to fail, according to Coit’s complaint.

After the FSLIC took over FirstSouth, Coit’s claims fell “into a black hole,” Goodfriend said. Coit filed a suit in a federal court in Dallas, but the suit was dismissed on the grounds that only the FSLIC could handle its claims. The U.S. 5th Circuit Court of Appeals affirmed that ruling last year.

But the Supreme Court reversed that outcome (Coit vs. FSLIC, 87-996) and told the federal court to hear Coit’s claim for funds from FSLIC.