Appeals Court Deals Setback to Glenfed : Thrifts: The judges rule that the government did not break a contract with the ailing S&L.; CEO vows to appeal.

In a major setback to financially troubled Glendale Federal Bank, a U.S. appeals court Tuesday said that the federal government had not broken a contract with the thrift and was not liable for $1.4 billion in damages.

The ruling, which reversed a lower court decision, comes as Glendale Federal is struggling to meet a June 30 deadline imposed by the Office of Thrift Supervision to raise as much as $400 million in capital to meet new federal guidelines.

The financial institution, the nation’s fifth-largest savings and loan, faces a possible government takeover if it is unable to comply. After the ruling was announced, the stock of Glenfed, the thrift’s holding company, fell dramatically, closing down $1 a share to $2 in heavy trading on the New York Stock Exchange.

Stephen J. Trafton, chairman and chief executive of Glendale Federal, said the company will appeal the ruling, possibly to the U.S. Supreme Court. In the meantime, he expressed continued confidence that OTS would extend the June 30 deadline.

At issue is a claim by Glendale Federal and two other thrifts that the U.S. government broke its contract with the financial institutions when Congress enacted legislation in 1989 that bailed out the savings and loan industry.

Glendale Federal agreed to take over a debt-ridden Florida thrift 12 years ago, with the understanding that it could use “supervisory goodwill,” equal to the Florida thrift’s $735 million in bad debts, as part of its regulatory capital.

But the 1989 Financial Institutions Reform, Recovery and Enforcement Act changed permissible accounting methods and disallowed the use of supervisory goodwill as a part of capital. The change dropped Glenfed below required capital levels.

Glendale Federal contested the law in court, arguing that it would never have taken over the Florida thrift if it had known that it could not count the goodwill as capital.

Last July, the U.S. Court of Federal Claims ruled in Glendale Federal’s favor. But on Tuesday, the U.S. Court of Appeals for the Federal Circuit in Washington reversed that decision by a 2-1 vote.