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Construction Law Today

How Does D’Oench, Duhme Apply to Failed Credit Unions: Campbell v. Castle Stone Homes

Posted in D'Oench, Duhme, FDIC & Bank Failures

National Credit Union Administration Board LogoLike failed banks, the D’Oench, Duhme doctrine applies to claims against the National Credit Union Administration Board (“NCUAB”) acting as liquidator for a failed credit union.  And D’Oench, Duhme has a statutory companion for failed credit unions in the Federal Credit Union Act too: 12 U.S.C. §1787(p)(2).  A federal court in Utah recently used the D’Oench, Duhme doctrine and §1787(p)(2).  The decision: Campbell v. Castle Stone Homes, Inc. (PDF).

Backstory: Campbell v. Castle Stone Homes, Inc.

A Utah home builder known as Castle Stone Homes used the Internet, radio, and TV to solicit people with good credit scores to invest in a real estate investment scheme.  The investors allege that the builder used their good credit scores to obtain loans, then used the loan proceeds to construct, market, and sell homes.  Then the builder would split the home sale profits with the investors.

The builder arranged loans from HeritageWest Credit Union. The investors allege that they each submitted applications for “investment” home loans, only to discover that the final loan documents were changed to reflect “owner occupied” homes. The investors also claim the builder and the credit union began to tell them (the investors) that their construction loans were nearly exhausted, although many homes were only 50% to 75% complete.

HeritageWest Credit Union Logo and HeaderThe builder then sent a “Progress Report” to each investor saying that the builder had reached an agreement with the credit union to modify the investors’ loans without pre-modification appraisals and that the builder’s realtor “has found buyers to purchase virtually all our homes.”  So, most of the investors entered into additional loans with the credit union.

The investors alleged that even after receiving additional loan funds, the builder didn’t complete the homes on time.  And as the completion deadline expired, the builder and the credit union negotiated a the terms of a series of loan extensions for offering to the investors.  The investors claimed that throughout construction of their homes, the builder mismanaged money, completed homes late (or not at all), and provided work of poor quality, or none at all.

The Investors’ Lawsuits

So, the investors sued the builder for an array of claims, including violating federal and state securities laws (e.g., selling unregistered securities, and fraudulent marketing of securities, both violations of the Securities Act of 1933), breaching contracts, and an array intentional and unintentional torts (e.g., negligent misrepresentation, conversion).  And the investors sued the credit union too, alleging that the credit union was complicit in the builder’s offenses and its representatives had given false representations and assurances to the investors.

Then the credit union failed. The NCUAB stepped in as liquidator for the credit union, a role similar to the FDIC acting as receiver for a failed bank.

The Credit Union Liquidator’s Motion to Dismiss

The credit union’s board of directors didn’t approve any of the credit union’s alleged representations or assurances (written or oral) to, or for the benefit of, the investors.  Next, the NCUAB asked the judge hearding the case, Judge Ted Stewart, to dismiss the investors’ claims against the credit union because the NCUAB is immune under the D’Oench, Duhme doctrine and §1787(p)(2).  §1787(p)(2) is the credit union edition of the Section 13(e) of the Federal Deposit Insurance Act; they each impose 4 Requirements that must each be satisfied before a pre-failure agreement, representation, or assurance from a failed credit union or bank is enforceable against its liquidator or receiver respectively.

Judge Stewart’s D’Oench, Duhme Decision

Judge Stewart agreed with the NCAUB and dismissed the investors’ claims against the credit union. First, he noted that the D’Oench, Duhme doctrine and §1787(p)(2) apply to the investors claims against the failed credit union.  And those claims must be dismissed because they don’t satisfy each of the 4 Requirements: (a) the credit union’s board didn’t approve the alleged representations or assurances that the investors claim the credit union breached and (b) the board’s minutes didn’t reflect approval.

Judge's Hand Banging His GavelThe investors urged Judge Stewart to preserve their claims because the representations and assurances at issue were distinguishable from the agreement in the original D’Oench decision. Focusing on the particular facts involved in the D’Oench decison, the investors contended that they weren’t trying to avoid enforcement of a “secret” unwritten agreement.  Instead they suggested that they were just trying to hold the NCAUB liable for the credit union’s pre-failure violations of the securities laws, breaches of contracts, and tortious conduct (e.g., negligent loan administration, misrepresentation).

But Judge Stewart was not persuaded.  Although the D’Oench, Duhme doctrine was born in the narrow circumstances of denying enforcability to a casual, or secret, agreement, Judge Stewart observed that since 1942, federal courts have expanded the doctrine beyond the narrow facts in that decision.  The D’Oench, Duhme doctrine, and its statutory companions, deny nearly any claim, or defense, that impairs regulators’ ability to accurately appraise the assets of credit union, bank, or other institution by preventing the regulators from relying solely on the face value of assets.  The trend of legislative and judicial evolution of D’Oench jurisprudence has remained constant: its focus has shifted from the fraudulent, illegal, or secret character of a debtor’s acts to the effect those acts have on a regulatory agency’s ability to evaluate quickly and accurately an institutions’ assets.  So, Judge Stewart ruled:

Given this evolution, today the D’Oench doctrine is “applicable to virtually any claim or defense that has the effect of adversely impacting the value of assets held by a federal banking regulator as a consequence of liquidation or receivership of a failed institution.” Thus, “any claim or defense which the National Credit Union Administration Board was not placed on notice and could not have determined from the books and records of the failed institution” is barred by the D’Oench doctrine.

Conclusions and Observations

Though the result in this decision isn’t a surprise, there are three things in this decision worthy of special notice:

  • Readers of a blog about construction law should note that this controversy, like so many others involving failed financial institutions, starts with troubled construction loans
  • The D’Oench, Duhme doctrine applies to claims and defense against credit union liquidators as well as failed bank receivers.  When setting the terms of your deal with a credit union, comply with the 4 Requirements.
  • Mention of “secret” agreements in the original D’Oench, Duhme decision sometimes misleads those opposing its application.  The connotation of “secret” has fostered the errant notion that for D’Oench to apply, there must be something clandestine about the suspect agreement, representation or assurance.  There must be covert concealment, and maybe a sinister motive too.  But while those elements certainly make a more dramatic story, they aren’t necessary.  The D’Oench, Duhme doctrine and its statutory companions apply just as long as an agreement, representation, or assurance isn’t obvious to a financial regulator from the face of an asset (in this case a note or a loan agreement)