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Washington Mutual, Inc. v. United States

United States Court of Appeals, Ninth Circuit

May 12, 2017

Washington Mutual, Inc., as successor in interest to H.F. Ahmanson & Co. and Subsidiaries, Plaintiff-Appellant,
v.
United States of America, Defendant-Appellee.

          Argued and Submitted December 9, 2016 Seattle, Washington

         Appeal from the United States District Court for the Western District of Washington Barbara Jacobs Rothstein, District Judge, Presiding D.C. No. 2:06-cv-01550-BJR

          Thomas D. Johnston (argued) and Richard J. Gagnon, Shearman & Sterling LLP, Washington, D.C.; Maria O'Toole Jones, Alan I. Horowitz, and Steven R. Dixon, Miller & Chevalier Chartered, Washington, D.C.; for Plaintiff-Appellant.

          Arthur Thomas Catterall (argued) and Teresa E. McLaughlin, Attorneys, Tax Division/Appellate Section, United States Department of Justice, Washington, D.C.; Annette L. Hayes, United States Attorney; United States Attorney's Office, Seattle, Washington; for Defendant-Appellee.

          Before: Richard C. Tallman and Morgan Christen, Circuit Judges, and Morrison C. England, Jr., [*] District Judge.

         SUMMARY [**]

         Tax

         The panel affirmed the district court's judgment, in a tax refund action, finding that taxpayer had failed to establish a reliable cost basis in certain rights for which it sought tax deductions and losses, in connection with taxpayer's acquisition of certain failed savings and loan associations during the 1970s and 1980s.

         In 1981, Home Savings of America, FSB (Home Savings), agreed to acquire three failing savings and loan associations (thrifts) in exchange for a package of incentives from the Federal Savings and Loan Insurance Corporation. The incentives included the right to maintain branches in other states (branching rights) and the right to use the purchase method of accounting, which focused on Regulatory Accounting Principles (RAP rights). Washington Mutual Inc., as successor in interest to Home Savings, initially appealed the district court's judgment that Home Savings had no cost basis in its RAP right to amortization deductions, and its abandonment loss deduction for branching rights in Missouri. In a previously published opinion, this court held that Home Savings had a cost basis in both sets of rights equal to some part of the excess of the acquired thrifts' liabilities over the value of their assets, and remanded for determination of that cost basis. On remand, the district court determined that Washington Mutual had not met its burden of proving Home Savings's cost basis in the rights at issue.

         In this subsequent appeal, the panel held that the district court permissibly concluded that taxpayer did not meet its burden of establishing a cost basis for its intangible assets. The panel first held that the district court applied the proper legal standards, did not clearly err in determining that the evidence was insufficient to reliably value the Missouri branching right, and was not required to sua sponte assign a value to that right. The panel also held that taxpayer had failed to establish that Home Savings had permanently abandoned its right to operate in Missouri for purposes of an abandonment loss deduction.

          OPINION

          ENGLAND, District Judge:

         Plaintiff-Appellant Washington Mutual, Inc. ("Appellant"), as successor in interest to H.F. Ahmanson & Co., and Ahmanson's wholly owned subsidiary Home Savings of America ("Home"), appeals from a judgment entered in favor of Defendant-Appellee United States of America ("Government") after a bench trial in this tax refund action. Appellant argued in the district court that it was entitled to refunds attributable to losses and deductions it should have been afforded for certain intangible assets acquired during the savings and loan crisis of the 1970s and 1980s. The district court, however, determined that the valuation model relied upon by Appellant's expert was fundamentally flawed. As such, the district court held that Appellant failed to meet its burden to establish the value for the intangible assets, as well as its burden to establish a cost basis in those assets-a necessary requisite to allowing amortization deductions for those assets. Further, the district court determined that Appellant failed to show that it abandoned the Missouri Branching Right when it closed its Missouri deposit-taking branches and, therefore, that it was not entitled to an abandonment loss deduction. As a result, the district court dismissed the case. We have jurisdiction under 28 U.S.C. § 1291, and we affirm.

         I

         A

         The parties' dispute evolved out of transactions originating from the savings and loan crisis. During the 1970s and 1980s, savings and loan associations, or "thrifts, " saw their profitability dissipate when the Federal Reserve chose to remedy rising inflation by allowing interest rates to skyrocket. See United States v. Winstar Corp., 518 U.S. 839, 844-45 (1996). Thrifts were consequently forced to pay depositors higher interest rates, while the thrifts' income streams, which derived from long-term mortgage loans with low, fixed rates, remained stagnant. Id. at 845. The high interest rates also decimated the housing market, further drying up the thrifts' revenue streams and forcing the entire industry towards insolvency. See H.R. Rep. No. 101-54(I), at 296 (1989).

         In the event that a thrift's liabilities exceeded its assets, the Federal Savings and Loan Insurance Corporation ("FSLIC"), as thrift regulator and insurer of thrift deposits, was required to initiate a takeover and liquidate the thrift. See Winstar, 518 U.S. at 844-47. FSLIC lacked the funds necessary to liquidate all of the thrifts that were failing at the time, however, and the Federal Home Loan Bank Board ("Bank Board") instead chose to encourage healthy thrifts to agree to such takeovers through what were referred to as "supervisory mergers." Id. at 847. In order to make these supervisory mergers attractive to healthy thrifts, the FSLIC had to offer non-cash incentives, two of which-both exempting limitations otherwise imposed on the operations of savings and loan associations-are especially relevant here. Id. at 848; see also Wash. Mut. Inc. v. United States, 636 F.3d 1207, 1209 (9th Cir. 2011) ("WAMU I").

         First, thrifts were historically prohibited from opening branches outside of their home states. WAMU I, 636 F.3d at 1213. Accordingly, the FSLIC offered an incentive to healthy associations hoping to expand nationally by allowing those thrifts an opportunity to operate in a new state if the first branch in that state was acquired through a supervisory merger. Id. This incentive is referred to by the parties as the "Branching Right." Id. at 1209, 1213.

         Second, thrifts were limited by minimum regulatory capital requirements, which mandated that each thrift maintain minimum capital of at least three percent of its liabilities. See Winstar, 518 U.S. at 845-46. This presented an obstacle to taking over a failing thrift since, by definition, the failing thrift's liabilities already exceeded its assets. See id. at 850. To counter this, regulators permitted healthy thrifts agreeing to a supervisory merger to apply the "purchase method" of accounting. Id. at 848. Under this method, an acquiring thrift was permitted to designate those excess liabilities as "supervisory goodwill, " which, in turn, could be counted toward the supervisory thrift's minimum regulatory capital requirement. Id. at 848-49. Thrifts were also permitted to amortize that supervisory goodwill over a period of 40 years. Id. at 851. These incentives, which focused on Regulatory Accounting Principles, are referred to as the "RAP Right." WAMU I, 636 F.3d at 1209, 1213.

         Home was a "healthy" thrift and, in 1981, agreed to a supervisory merger by which it would take over three failing thrifts, two in Missouri and one in Florida. Id. at 1211-12. Through a series of transactions Home assumed the liabilities of the failing thrifts in exchange for a "generous incentive package." Id. at 1219. Under this package, Home received, among other things, cash and indemnities as to covered assets, and was allowed to structure the transaction as a tax free "G" reorganization, giving it significant tax benefits. Id. Home also received Branching Rights for Missouri and Florida, permitting it to open branches in those states, as well as the RAP Right and its associated benefits. Id. at 1213, 1219.

         B

         The current litigation arose after Home sold its Missouri branch offices in 1992 and 1993 and was later acquired by Appellant in 1998. Id. at 1209, 1214. Appellant filed amended tax returns on behalf of Home in 2005, requesting refunds for tax years 1990, 1992, and 1993. Id. at 1214. According to Appellant, the Internal Revenue Service ("IRS") had not credited Home for its RAP Right amortization deductions during those years, nor had it allowed an abandonment loss deduction in 1993 for the Missouri Branching Right. Id. Based on these denials, Appellant filed suit on Home's behalf. Id.

         In its first review of this case, the district court ruled in favor of the Government at summary judgment, deciding that Home did not have a cost basis in either the RAP Right or the Branching Rights. Id. at 1216. As such, the district court held that Appellant was not entitled to amortization and loss deduction-related refunds. Id.

         Appellant appealed, and we reversed, holding that "Home Savings had a cost basis in the RAP rights and the branching rights equal to some part of the excess of the three acquired thrifts' liabilities over the value of their assets." Id. at 1209. The panel remanded with instructions to the district court "to determine the cost basis and conduct further proceedings in accordance to [that] opinion." Id. at 1221.

         C

         On remand, the district court heard evidence over the course of an eight-day bench trial and ultimately held that Appellant had failed to carry its burden of establishing a reliable cost basis for the Missouri Branching Right. Accordingly, the court ruled that Appellant had not established its right to a tax refund. Appellant similarly failed to convince the district court that Home had permanently abandoned its right to operate in Missouri. As a consequence, the court ruled that it was not entitled to take an abandonment loss for the 1993 tax year. The court dismissed Appellant's tax refund claims with prejudice and entered judgment for the Government.

         In reaching its decision, the district court initially reasoned that, based on our prior remand, Appellant was required to do two things to establish the cost basis for each right. First, it needed to establish the "Purchase Price" for the failed thrifts, which could be determined by subtracting the value of the three failed thrifts' assets from their liabilities. See WAMU I, 636 F.3d at 1219. Second, Appellant was required to show what portion of the Purchase Price should be allocated among the various rights. Importantly, however, because the Purchase Price was less than the total fair market value of Home's incentive package, it was not enough for Appellant to determine the fair market value of a single asset and assign to it a proportionate amount of the Purchase Price. Instead, Appellant had to establish the fair market value of each individual asset to reach a total fair market value for the entire incentive package. Appellant could then use this total fair market value to determine each asset's proportionate value, and apply that value pro rata to the Purchase Price to establish the cost basis of each asset. The district court explained Appellant's burden with a helpful illustration:

Assume that a thrift paid $300 for an incentive package it received in a supervisory merger. Assume, as well, that the incentive package is comprised of three assets: A, B, and C. Now assume that the fair market value of A is $175, the fair market value of B is $125, and the fair market value of C is $100. Therefore, the total fair market value of the combined assets constituting the incentive package is $400. This information is not sufficient to allow for the correct allocation of the purchase price among A, B, and C. For instance, one cannot simply allot $175 of the purchase price to A because that would result in too much of the purchase price being allotted to A. In other words, A would be allotted one-hundred percent of its fair market value, while B and C would be left with some percentage less than one-hundred percent because only $125 of the purchase price would remain to allocate to B and C, whose fair market value is $125 and $100, respectively, for a total of $225.

Wash. Mut., Inc. v. United States, 996 F.Supp.2d 1095, 1105 (W.D. Wash. 2014) ("WAMU II"). Thus, if Appellant failed to establish the fair market value for any of the individual assets, it would be impossible to determine the total fair market value of the incentive package and, thereby, the pro-rata share of the Purchase Price-and the cost basis-for each individual asset. Id.

         Considering the evidence adduced at trial, the district court concluded that Appellant "failed to establish, to a reasonable certainty, the fair market value for the Missouri Branching Right" and, therefore, could not establish a cost basis in that Right or in the RAP Right.[1] Id. at 1106. The district court found that Appellant failed to meet its evidentiary burden in large part due to shortcomings in the testimony of Appellant's valuation expert, Roger Grabowski. The district court explained the "Grabowski Model" as follows:

Mr. Grabowski used an income approach to determine the fair market value of the Missouri Branching Right to a hypothetical buyer. More specifically, Mr. Grabowski used a discounted cash flow model known as the "excess earnings" approach. Excess earnings represent the cash flows that the hypothetical buyer would have expected the Branching Right to generate beginning in December 1981, net of charges for the use of contributory assets, and discounted to present value. In order to determine the excess earnings (i.e. the cash flow) attributable to the Missouri Branching Right under the excess earnings approach, Mr. Grabowski employed a five-step analysis. First, he projected the net operating income generated by the Branching Right based on: (a) the projected rate of overall statewide thrift deposit market growth in Missouri; (b) the projected market share that the hypothetical buyer could be expected to capture in Missouri; (c) the projected spread on loans funded by the new deposits; and (d) the projected operating expenses for the hypothetical buyer. Second, he deducted income taxes from the net operating income to arrive at the projected net income. Third, Mr. Grabowski projected charges for the use of contributory assets (commonly referred to as "capital charges") and deducted those charges from the net income to arrive at the projected cash flow attributable to the Missouri Branching Right. Fourth, Mr. Grabowski used a 22% discount rate to determine the present value of the projected cash flow. Lastly, Mr. Grabowski deducted estimated transition costs and assemblage value from the present value of the cash flow. This resulted in Mr. Grabowski finding a fair market value of $28.8 million for the Missouri Branching Right.

Id. at 1107 (citations omitted).

         The Government responded to the Grabowski Model, not by offering its own valuation, but by convincing the trial judge that the Model was fundamentally flawed and unreliable as a basis for determining the value of the Missouri Branching Right. For example, the district court determined that Mr. Grabowski's assumptions regarding Missouri deposit market growth were unreliable because his projections regarding statewide deposit growth failed to account for the effects of disintermediation[2] and improperly included "interest credited" balances as a source of "new" deposit growth, thereby inflating his calculations. Id. at 1111.

         The court also discredited Mr. Grabowski's assumption that Home's ability to capture market share in Missouri could be adequately predicted by looking to its prior expansion into Northern California. The court explained that Home's intrastate expansion was not a reliable predictor of a hypothetical interstate expansion into the Missouri deposit market because: (1) Home's prior expansion occurred in the 1970s when the economic landscape for thrifts was entirely different; (2) Home's Northern California expansion was facilitated primarily by acquiring existing thrifts, while the Grabowski Model assumed Missouri growth ...


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