On May 9, 2017, the U.S. Court of Appeals for the Federal Circuit (“Federal Circuit”) affirmed in part and reversed in part an earlier decision from the U.S. Court of Federal Claims, which had held that aspects of the Government’s bailout of AIG constituted an illegal exaction. This case stems from two steps the Government took as part of its bailout of AIG. First, the Government issued a loan to AIG in exchange for preferred shares that were convertible to common shares representing an 80% equity interest in AIG. Second, AIG executed a 1:20 reverse stock split that enabled AIG to have enough unissued and authorized common shares to enable the Government to convert its preferred shares, without the need for AIG shareholder to vote in favor of authorizing enough common shares to allow for the Government’s conversion. This case proceeded as an “opt-in” class action, and many institutional investors opted in to the class.
Briefly stated, AIG’s largest shareholder, Starr International Co. (“Starr”) asserted claims based on the Government’s acquisition AIG equity (the “Equity Claims”) and claims based on the reverse stock split (the “Stock Split Claims”). With respect to the Equity Claims, Starr alleged that the Government’s acquisition of AIG equity was an illegal exaction because Section 13 of the Federal Reserve Act did not authorize the Government to take equity as consideration for its bailout loan. Additionally, through the Stock Split Claims, Starr maintained that the Government engineered a reverse stock split to enable it to convert the preferred shares it obtained as consideration for the bailout loan into common shares without a shareholder vote, depriving Starr of its ability to block the resulting dilution. In sum, the Federal Circuit (a) reversed the Court of Federal Claims decision that Starr had standing to pursue its Equity Claims, holding those claims were solely derivative; and (b) affirmed the Court of Federal Claims decision that denied relief for the Stock Split Claims, holding the court did not clearly err in finding that the primary purpose of the stock split was to prevent delisting by the NYSE, not to avoid a shareholder vote.
Back in July of 2012, the Court of Federal Claims first addressed the standing issue in its ruling on the Government’s motion to dismiss. The Court of Federal Claims noted that “corporate overpayment” claims, such as Starr’s Equity Claims, are “normally regarded as exclusively derivative.” However, according to the Court of Federal Claims, the Delaware Supreme Court had recognized a “species of corporate overpayment claims that is both derivative and direct in character,” where (a) a stockholder having majority or effective control causes the corporation to issue excessive shares of its stock in exchange for assets of the controlling shareholder that have lesser value, and (b) the exchange causes a decrease to the value or voting power of the public shareholders. The Court of Federal Claims held that the first aspect was met when the Government allegedly forced AIG to overpay for the bailout loan, even though the Government was not a controlling stockholder and had no “fiduciary duty” to AIG’s shareholders at the time it made the bailout loan. Key to the Court of Federal Claims reasoning was that the Government had a “duty” under the Fifth Amendment to avoid taking property without compensation that was analogous to the fiduciary duty owed by a controlling stockholder to minority holders. The court next determined that the second aspect was met because the Government allegedly “extracted from the shareholders, and redistributed to itself, a portion of the economic value and voting power embodied in the minority interest.”
Starr ultimately scored a pyrrhic victory at trial with the Court of Federal Claims ruling in its favor on liability but holding that it had suffered no economic loss because absent the Government’s conduct, AIG would have gone bankrupt. The court did not substantively address the standing issue again in its post-trial decision, even though it had intimated in early decisions that it could revisit the standing issue once the factual record was more fully developed.
Both sides appealed. Starr argued, among other things, that the Court of Federal claims erred by applying an economic loss calculation to determine Starr’s loss – or lack thereof. Rather, Starr argued, the measure of damages on its illegal exaction claim was equal to the market value of the property exacted at the time of the exaction, which Starr claims was between $24.5 and $35.4 billion, or, at a minimum that $18.3 billion in proceeds the Government eventually made in selling its stake in AIG. The Government argued, among other things, that the Court of Federal Claims improperly held that Starr’s claims were direct rather than derivative.
On appeal, the Federal Circuit sided with the Government, holding that Starr lacked standing to bring its Equity Claims because those claims were exclusively derivative. First, the Federal Circuit rejected Starr’s argument that it should view the Government’s taking of unissued shares as the physical seizure of shares AIG shareholders. The Federal Circuit then rejected the reasoning of the Court of Federal Claims that, at the time of the bailout, the Government had a duty to protect minority shareholders akin to the fiduciary duty owed by a majority shareholder. The Federal Circuit held that, to the extent the Fifth Amended created a duty, the duty flowed to AIG, not to AIG’s shareholders individually. It further held that a breach of fiduciary duty was an essential element to bringing corporate overpayment claims outside of the general rule that such claims are always derivative. Thus, it held that the Equity Claims were derivativ and Starr lacked standing to assert them. It did not address Starr’s damages argument.
With respect to the Stock Split Claims, the Court of Federal Claims had ruled that the reverse stock split was not a vehicle designed by the Government to obtain AIG common stock. Rather, the evidence showed that the reverse stock split was necessary in order to raise the price of AIG common shares high enough to avoid delisting on the NYSE. On appeal, Starr argued that this ruling was clearly erroneous. The Federal Circuit disagreed, holding that “[e]ven if the evidence could have led a trier of fact to a different conclusion, Starr has not persuaded us that the trial court clearly erred.” In so holding, the Federal Circuit noted the evidence showed that the Government waited over a year after the reverse stock split to covert its shares, “a gap in time that makes it less likely that the reverse stock split was planned to take away shareholder interests,” as opposed to being aimed at avoiding NYSE delisting.
We expect Starr will file a motion for rehearing en banc and/or a petition for certiorari at the Supreme Court.