311 F.Supp.2d 179 (2004) | Cited 2 times | D. Massachusetts | March 30, 2004


On October 7, 2002, Dr. Ben Branch, in his capacity as the Chapter 7Bankruptcy Trustee of the failed Bank of New England Corporation (BNEC),sought a ruling by way of partial summary judgment that the correctmethod for determining whether BNEC and its largest subsidiary, Bank ofNew England, N.A. (BNENA),1 were insolvent on September 29,1989,2 is the "fair market value" (or "balance sheet") test mandatedby the Bankruptcy Code, 11 U.S.C. § 101(32)(A) ("[I]nsolvent means. . . that the sum of [an] entity's debtsPage 2is greater than all of [the] entity's property, at a fairvaluation. . . .").3 Under this test, an entity is valued not by itsability to meet its current obligations, but by the extent to which its"fairly valued" assets exceed its liabilities. Farmers Bank ofClinton. Mo. v. Julian. 383 F.2d 314, 326 (8th Cir. 1967). "Fairvalue" is the negotiated price that a willing and sophisticated buyerwould pay for an asset in an arm's-length transaction in which neitherthe buyer nor the seller is acting under temporal or financial duress.In re Ouellette. 98 F. Supp. 941, 942-943(0. Me. 1951). If thecourt agrees with the market value approach, Dr. Branch asks the courtto find that his experts have correctly determined that BNENA was $2billion in debt in September of 1989 when the errant bonds were offered.

On October 7, 2002, Ernst & Young filed a cross-motion arguing thatthe bankruptcy test has no relevance to the valuation of a national bank,and that the appropriate focus is on the viability of BNENA as a "goingconcern."4 Because Ernst & Young's experts are of the opinionthat BNENA was a viable entity as of the end of 1989,5 they are alsoof the opinion that a hypothetical sale of the bank on the open market inSeptember of 1989Page 3(when conditions were better) would have earned a premium (orfranchise value) on the theory that the whole is worth more than the sumof its parts, thereby demonstrating the bank's solvency.

On March 20, 2003, the court heard oral argument. Each of the partiestook the predictable position that the other's experts had applied thewrong measure of valuation, thus erring on the issue of the bank'ssolvency on September 29, 1989.6 After the hearing, the court alloweddiscovery to be taken in a related case, Branch v. Hawke,03-CV-10192-RGS, for use in this litigation. On December 8, 2003, Ernst& Young filed a supplemental brief arguing that the discovery hadrevealed additional support for its position on the insolvency issue.According to Ernst & Young, one of Dr. Branch's expert witnesses,Dean Marriott, a former official of the Office of the Comptroller of theCurrency (OCC), testified that OCC examiners had deemed BNENA solvent asof September 30, 1989.7 Ernst & Young argues that Dr. Branch isnow precluded from contradicting the OCC's "conclusive" finding. SeeMortgage Market. Inc. v. FDIC for Bankers Trust. 780 F. Supp.406, 407 (E.D. La. 1991) ("Congress has appointed the OCC as the watchdogof national banks and hasPage 4delegated to that agency the exclusive power to declare nationalbanks insolvent and assign receivers.").

Dr. Branch, while conceding that the OCC has the paramount regulatoryauthority to determine whether a bank is operationally insolvent, argues(correctly, I believe) that the OCC's evaluation has no relevance to thiscase for three reasons. First, the OCC's determination whether toliquidate a bank is made using a book value approach, which calculates abank's assets (principally its loan portfolio) as the sum of historicalpurchase prices less depreciation.8 In a deepening insolvency case,by contrast, the law requires that the fair market valuation method beused. Official Comm. of Unsecured Creditors v. R.F. Lafferty &Co. 267 F.3d 340, 349 (3rd Cir. 2001). See Corbin v. FranklinNat'l Bank (In re Franklin Nat'l Bank Sec. Litigation). 2 B.R. 687,712 (E.D.N.Y. 1979), aff'd. 633 F.2d 203 (2d Cir. 1980) ("Inthis particular case it is fruitless to argue, as FDIC does, that bookvalue has any meaning. If there were no purchasers or bidders for [thebank] in May and June 1974, its stock, realistically speaking, had novalue and that meant that FNYC was insolvent . . .").9 Second, theOCC's decision to close or not close a bank is influenced,Page 5as it was in the case of BNENA, by factors independent of thebank's financial health as measured by its market value. Regulators takeinto account the impact of a bank failure on the national economy and thebanking system as a whole, as well as the ability of the FDIC to managethe liquidation of the bank's assets. This is a different task than thedetermination of a bank's value for purposes of a sale. Third, while theOCC has the exclusive power to declare a federally chartered bankinsolvent for liquidation purposes, the deference accorded to the OCC'sbook value determination applies only in that context. See, e.g.James Madison Ltd, v. Ludwig. 868 F. Supp. 3, 7 (D.D.C. 1994).

The dispute thus comes full circle to the parties' original argumentsover the proper methodology for valuing BNENA. While much ink has beenshed on the issue, Dr. Branch does not disagree that a going concernanalysis is part of any fairly conducted application of the fair markettest.

If, in the real world, selling the entity as a whole would generate the higher price, then that value is appropriate; if, in the real world, sale of the individual assets would raise more cash, then that amount controls. The choice between the two is unrelated to whether the entity is a "going concern" in the sense that it is currently operating; the determining factor is the reality of the market place, i.e., how much, if anything, would a buyer pay to acquire the entity as a whole? That question can only be answered by a careful study of the particular market's appetite for the specific assets in question. . . .Page 6

Plaintiff's Sur-Reply, at2-3.10 Hence, the critical assumptionof Dr. Branch's experts-that there was no willing buyer for the bank inSeptember of 198911 — and their conclusion that the fair markettest, correctly applied, demonstrates that the bank was insolvent.12Ernst & Young's experts, on the other hand, assume the contrary— that the bank could have been sold as a going concern at apremium that would have exceeded its accumulated debt. At bottom, this isnot a dispute of law over differing valuation tests (despite the parties'refusal to recognize that they are singing contrapuntally from the samepage), but a factual dispute over which side has picked the rightassumption. Because Dr. Branch is correct that the proper valuationmethod in this case is the fair market test, so much of his motion asseeks the court's endorsement of this approach will be allowed, and thecross-motion of Ernst & Young, to the extent that it can be read tocontend otherwise, willPage 7be denied. Because the facts are not as unambiguous as each sidewould have it, the court declines to make a ruling as to whether the bankwas or was not insolvent on September 29, 1989, but will leave that issueto the jury (or for disposition by way of a directed verdict depending onthe evidence, or lack of evidence, offered at trial).

Ernst & Young's motion for summary judgment on the issue ofreliance will also be denied. While I agree with Ernst & Young thatreliance is a necessary element of Dr. Branch's negligence andmalpractice counts, I do not agree with the contention that Dr. Branch isobliged to produce testimony from a more senior member of BNEC's controlgroup than Barry Barkley, the BNEC Controller responsible for financialreporting. Barkley, as I understand it, will testify that if Ernst &Young had not issued an unqualified opinion and comfort letter, the bondoffering would not have gone forward. While this may be a delicate reedon which to rest the issue of reliance, it is sufficient to prick thebubble of summary judgment.13


For the foregoing reasons, Ernst & Young's motion for summaryjudgment on the insolvency issue is DENIED. Dr. Branch's motionfor summary judgment on the insolvency issue is ALLOWED inpart, as explained in the above memorandum. Ernst & Young's motionfor summary judgment on the issue of reliance is DENIED inpart, as explained in the above memorandum. Ernst & Young's motion tostrike is DENIED. Ernst & Young's motion to file a responseto Dr. Branch's sur-reply is ALLOWED. In anticipation of trial,Page 8the parties will within twenty-one (21) days of the date of thisOrder submit a joint estimate of the number of jury days they anticipatea trial will require, together with proposed trial dates mutuallyconvenient to the parties and witnesses. The court reserves the option ofsetting time limits on the trial of the case, if it deems that suchlimits are appropriate.


1. The court will refer to BNEC and BNENA collectively as the"bank."

2. Dr. Branch alleges that but for Ernst & Young's negligence inissuing an unqualified opinion and comfort letter attesting to the bank'sfinancial health, the estate would not have been saddled with a $250million debt incurred as the result of a September 1989 public bondoffering, some $180 million of the proceeds of which were sucked intoBNEC's failing subsidiary banks.

3. Dr. Branch filed a sur-reply two months after the briefing wascomplete, causing Ernst & Young to file a motion to strike the briefor in the alternative to be granted leave to file a response. The motionto strike is DENIED. The motion to file a response isALLOWED.

4. Dr. Branch interprets this assertion to mean that Ernst &Young's experts have calculated the bank's book value in such a way as toshow an excess of assets over liabilities. This appears to be a generallyaccurate characterization, although Ernst & Young at times uses theterm "going concern" more loosely to describe the prospective ability ofthe bank to generate a flow of cash from whatever source (includingregulatory capital) sufficient to meet current obligations.

5. Ernst & Young's principal expert, Craig Elson, concluded thatthe market value of BNENA's assets exceeded its liabilities by $281million at the end of 1989, while the fair value of the assets of BNEC'sother subsidiary banks exceeded liabilities by $583 million.

6. Ernst & Young also seeks to preclude the testimony of Dr.Branch's principal expert witness, Richard Stover, under the"gatekeeping" rule of Daubert v. Merrell Dow Pharmaceuticals,Inc., 509 U.S. 579 (1993). Ernst & Young argues that Stoverfailed to adequately investigate BNENA's loan portfolio before hediscounted the value of individual loans and did not fully understand the"Forecast Summary" that he used to conduct his valuation. The motion isDENIED. While I understand Ernst & Young's criticism of theway in which Stover rated and marked down individual loans, I see nothingfaulty in his choice of methodology. In any event, "[v]igorouscross-examination, presentation of contrary evidence, and carefulinstruction on the burden of proof are the traditional and appropriatemeans of attacking shaky, but admissible evidence." Daubert,509 U.S. at 596.

7. BNEC, as a holding company, was not regulated by the OCC.

8. Book value is "not ordinarily an accurate reflection of themarket value of an asset." Lawson v. Ford Motor Co. (In re RoblinIndus. Inc.). 78 F.3d 30, 36 (2d Cir. 1996). This is not because ofany accounting perversion. Rather, the book value method as used to valueassets for purposes of preparing the financial statement of anoperationally sound company serves a legitimate, but different purposethan does a market analysis in a liquidation context.

9. Similarly misplaced is Ernst & Young's inventive argumentthat the fair market valuation test set out in section 101(32) of theBankruptcy Code cannot be used to value a national bank because bankscannot be debtors under the Bankruptcy Code. As Dr. Branch points out,the definition of insolvency applies to both debtors and non-debtors andthat bankruptcy courts routinely apply the section 101 (32) insolvencytest to non-debtors in order to determine whether a fraudulent transferhas occurred or to determine the solvency of a third party who owes debtsto the estate.

10. Compare what Ernst & Young has to say on the subject. "It isbecause going concerns have greater value than the sum of their partsthat bankruptcy valuation law requires an initial determination as to theviability of an entity and a valuation according to that status. It isnot in the interests of the creditors generally for the assets to be soldat less than the full value that could be obtained in a prudent sale in areasonable amount of time." Defendants' Opposition, at 9.

11. Dr. Branch summarizes his evidence on this point as follows. "Inthe fall of 1989, BNEC retained two preeminent investment banking firms— Goldman Sachs and Lazard Freres — who, contrary to [Ernst& Young's] colossal misstatement that only a `few' potential buyerswere solicited . . ., literally left no stone unturned in seeking anacquirer for all or some of the banks. . . . The record contains theexhaustive list of over 255 potential purchasers contactedby these two investment firms. . . . No one, however, would payanything." Plaintiff's Sur-Reply, at 3-4 (emphasis in original).

12. Dr. Branch insists that his experts did take "going concern"into account. "Going concern valuation only relates to the period of time(a `reasonable' period) over which the hypothetical liquidation takesplace. . . . Because they allowed a reasonable period for thehypothetical sale, the Trustee's experts valued BNEC and BNENA as agoing concern." Plaintiff's Response, at 9 n.12.

13. The court will schedule a pretrial hearing on the issue ofcausation as an aid in the preparation of appropriate jury instructionson the subject. The cross-motions for summary judgment on the issue ofcausation will in the interim be DENIED withoutprejudice.Page 1

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