US Court Rules on the AIG Rescue

During the global financial crisis that was triggered by subprime
mortgages, the US Government engaged in rescuing several banks and financial
companies. Through nationalization, the Government even acquired ownership and
control over several of them.[1] One such
was AIG. In that case however, a large shareholder of AIG mounted a legal
challenge to the terms of the Government bail out package together with its
acquisition of ownership in AIG, and sought compensation for loss suffered by
AIG’s shareholders at the time. Last week, in Starr International Company, Inc. v. The United States, a US Court of Federal
Claims found that the exercise of power by the Government was invalid, but it
refused to award damages on the ground that shareholders had not suffered any
loss.
The plaintiff, Starr International Company, Inc. was one of the largest
shareholders of AIG. Starr’s controlling shareholder is Maurice Greenberg, a
former CEO of AIG. It challenged an $85 billion loan facility that the Federal
Reserve Board provided to AIG, which ultimately saved AIG from bankruptcy. More
specifically, Starr challenged the terms of the loan facility such as the rate
of interest, and most importantly the fact that the Government obtained 79.9%
ownership stake in AIG. This, it argued, was not only done without the approval
of AIG’s shareholders but that it also caused them to suffer losses.
As its primary ruling, the Court found on a matter of technicality under
US law, that the Federal Reserve Board did not have the power to acquire shares
in a borrower as part of a loan it granted. Moreover, the Court also placed
emphasis on the relative fairness of the terms of the loan. It appears markedly
perturbed that the terms of the loan granted to AIG were much more onerous than
terms offered to other banks and financial institutions in the wake of the
financial crisis when all of them had to be bailed out. The implications of
this finding are that they allow courts to sit in judgment over actions of the
Government, and more so with the benefit of hindsight. That AIG was in fact
bailed out due to the swift actions of the Government did not cut much ice with
the Court. As Professor John Coffee writes in his incisive analysis, this approach of the
Court also raises questions of moral hazard, wherein managers of crisis-hit
companies could demand bail out assistance from the Government, and that too on
terms favourable to them. From a broader perspective, the Court’s incursion
into the Government’s decision-making process leaves the canvass wide open in
terms of how the Government ought to act in a future financial crisis. It
confounds rather than to clarify the position.
As an incidental matter, since the action of the Government was found to
be unauthorized, the Court refused to grant the plaintiff’s claim under the Fifth Amendment of the US Constitution
for “taking” (expropriation). The Court noted that “a claim cannot be both an
illegal exaction (based upon unauthorized action), and a taking (based upon authorized
action).”
Finally, on the question of compensation, the Court clarified that the
plaintiff’s claim is based on a loss suffered as shareholders and not for the
gain that the Government made by becoming an AIG shareholder. Such a loss is to
be determined based on a scenario where the Government had not intervened.
Comparing this scenario with the actual facts, the Court made it clear that but
for the Government’s intervention AIG would have gone into bankruptcy and lost
all its value. In the present case, they have only been diluted by 80% because
of the Government acquiring that stake. The Court seems persuaded by the
statement of one of the witnesses, who stated that for the shareholder “twenty
percent of something [is] better than 100 percent of nothing.”
Starr had also challenged a reverse stock-split (essentially a
consolidation of share capital) carried out by AIG to ensure that the stock
price remained above the minimum limit required for continued listing of the
company on the NYSE. Since the motivation of such a reverse stock split was to
ensure continued listing, the plaintiff’s claim was denied on this count.
In all, the Court’s decision muddies the waters regarding the
Government’s role in rescuing firms in crisis. But, this may not be the end of
the matter since both sides are likely to appeal – the Government to the extent
that its actions have been treated invalid, and Starr to the extent it has been
denied compensation.

[1] For a discussion, see
Marcel Kahan & Edward Rock, “When the Government is the Controlling
Shareholder” (2011) 89 Texas Law Review 1293; Mariana Pargendler, “State
Ownership and Corporate Governance” (2012) 80 Fordham Law Review 2917.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • In the context herein, attention may be usefully drawn to the current domestic scenario on more or less similar arena HERE

    Why should the banks take over bank defaulters?
    Why should a secured creditor who is suffering default on his payment, be converted into the owner of the same third rate entity?
    moneylife.in

    Readers’ comments thereat may be viewed to know the tentative reactions.

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