FEDERAL DEPOSIT INSURANCE CORPORATION, PETITIONER V. PHILADELPHIA GEAR CORPORATION No. 84-1972 In the Supreme Court of the United States October Term, 1985 On Writ of Certiorari to the United States Court of Appeals for the Tenth Circuit Reply Brief for the Petitioner Although respondent insists that the Penn Square letter of credit at issue in this case was an insured deposit, it has failed to take issue with most of the legal propositions established in our opening brief. Respondent thus does not deny that the federal deposit insurance system was intended only to protect things of value that are entrusted to banks. It nowhere suggests that the Orion note backing the Penn Square letter of credit had any present value, or otherwise was the equivalent of money. And respondent does not establish that the Federal Deposit Insurance Corporation (FDIC) ever has assessed an insurance premium on such an unfunded letter of credit, or otherwise has departed from its position -- concededly articulated by the Corporation at the time of the promulgation of Regulation I in 1935 -- that such letters are uninsured. In these circumstances, respondent and its supporting amici have offered no reason to believe that Congress would have wanted such letters to receive the benefits of federal deposit insurance. 1. At the outset, the Allen amici take issue with our statement of the aim of the federal deposit insurance program, insisting that the Banking Act of 1933, ch. 89, 48 Stat. 162 et seq., had purposes in addition to the protection of funds entrusted to banks (Br. 7-9, 12). This undoubtedly is true; Congress plainly intended the Act to restore public confidence in the banking system generally, and in transactions turning on bank credit (See Gov't Br. 12-14). But this hardly means that Congress intended to insure all extensions of bank credit. To the contrary, as amici themselves recognize (Br. 8), Congress found as the root of the Depression-era banking crisis the fact that "(t)he public is afraid to deposit their money in the banks, and the banks are afraid to employ their deposits in the extension of bank credit for the support of trade and commerce." H.R. Rep. 150, 73d Cong., 1st Sess. 6 (1933). Thus, as one of the Act's sponsors explained: We cannot have a normal use of bank credit in the United States until people are willing to put their deposits in banks. Deposits constitute the basis for bank credit, and bankers can never be free to extend credit accommodations for the support of trade and commerce until they are permitted to retire at night without fear of mobs at their doors the next morning demanding cash for their deposits. 77 Cong. Rec. 3839 (1933) (remarks of Rep. Steagall). It is for this reason, of course, that Congress chose to address the public's lack of confidence in the banking system through the creation of a system of deposit, rather than of credit, insurance. And it is for this reason that Congress basically defined the term "deposit" to include "money or its equivalent received or held by a bank." 12 U.S.C. 1813(l)(1); see 12 U.S.C. 1813(l)(2)-(5). Despite the skepticism of amici, it hardly seems necessary to belabor the point: if the bank's customer has not entrusted the bank with something of value, the customer has not made a deposit that is protected by deposit insurance coverage if the bank fails. /1/ 2. a. For its part, respondent evidently does not take issue with the proposition established above, acknowledging (see Br. 11) that the crucial question for deposit insurance purposes is whether the bank received money or its equivalent from its customer. But respondent entirely fails to answer that question here. Instead, it devotes much of its brief to misstating the nature of our submission, reading our opening brief to contend that a letter of credit may be insured only if it is supported by funds directly credited by the bank to the customer's (or to a special) account. Such an approach, respondent continues, would read the promissory note proviso out of Section 1813(l)(1), because it effectively would permit a letter of credit to represent a deposit only if the letter is issued in exchange for cash. Resp. Br. 12-14 & n.8. In fact, we fully agree with respondent that the determinative question does not concern the disposition of the money or its equivalent received by a bank in exchange for a letter of credit. The focus of the deposit insurance program, instead, is on what the bank receives from its customer. It is only when the bank is entrusted with money or its equivalent that a "customer who delivers his own funds to the bank risks their total or partial loss if the bank should suspend operations" (FDIC v. Irving Trust Co., 137 F. Supp. 145, 162 (S.D.N.Y. 1955)), and it accordingly is only in those circumstances that a deposit is created. Thus, as one commentator recently has observed, "from the standpoint of deposit insurance law," the hallmark of a note that is the equivalent of money "is nothing short of its convertibility to currency by the depository bank prior to the bank's payment of the standby (letter of credit)." 2 Gov't Information Servs., Letter of Credit Update 23-24 (Jan. 1986) (remarks of Prof. Kozolchyk). /2/ The central flaw in respondent's argument is its failure to establish that Orion's contingent back-up note was in fact the equivalent of money. Respondent (Br. 17-18) and the Allen amici (Br. 12-16) argue at considerable length that a contingent note of the sort at issue here serves as a useful mechanism to guarantee that a bank will be reimbursed for the funds that it pays out on a standby letter of credit. This may well be true -- although, depending upon its terms, such a note may be no more useful in serving this purpose than would be a simple reimbursement agreement that concededly does not give rise to an insured deposit when received by a bank in exchange for a letter of credit. /3/ But whatever its validity, respondent's proposition is beside the point. As we explained in our opening brief (at 16-17), a contingent note such as Orion's creates no present indebtedness; Penn Square could not have obtained value for Orion's note, could not have offset it against any obligation that it had to Orion, and could not have sued on Orion's obligation. Respondent nowhere disputes this. And this implicit concession is fatal to respondent's argument, for such a note is in no sense the equivalent of money. b. At bottom, respondent accordingly hinges its argument on the assertion that the Court may not consider the actual value of the instrument that Orion entrusted to the bank because that instrument purported to be a promissory note. Respondent contends (Br. 17-18, 19) that this approach is supported by a literal reading of Section 1813(l)(1), asserting that the question here is settled by the statutory proviso that a letter of credit "must be regarded as evidencing the receipt of the equivalent of money" when issued in exchange for a "promissory note." But Congress enacted Section 1813(l)(1) to protect deposits, not to permit clever draftsmen to insure their business transactions by using the proper form of words in drafting their reimbursement agreements. The instruments listed in the proviso to Section 1813(l)(1) as representing the equivalent of money -- including promissory notes -- are thus illustrative, serving to establish that the protections of deposit insurance extend to all things of value (rather than only cash) that have been entrusted to banks. /4/ And a contingent back-up note, whether or not it has the term "promissory note" printed across the top, is in no meaningful sense the equivalent of money. Moreover, as we explained in our opening brief (at 18-19), the administrative drafters of the promissory note proviso would have recognized that, for a variety of purposes, federal law at the time of the promulgation of Regulation I did not recognize a contingent instrument to be a "promissory note." Here as well, the statutory reference to promissory notes plainly was intended to encompass uncontingent instruments that are in fact the equivalent of money. Neither respondent nor the Allen amici have offered any reason to believe that Congress intended to depart from this sensible approach. /5/ 3. Respondent's second argument (Br. 20-32) -- that the FDIC's distinction between funded and unfunded letters of credit is newly developed or has been applied inconsistently, and thus is not due deference -- also is flawed. Although respondent contends that the 1935 transcript cited in our opening brief (at 24) is entitled to little weight (Resp. Br. 15-16 n.9), it cannot deny that the transcript represents a contemporaneous construction by the drafters of Regulation I declining to treat unfunded letters of credit as deposits. And while respondent (Br. 28-32; see Allen Am. Br. 16-17) insists that the FDIC failed to recognize the distinction between funded and unfunded letters of credit prior to this litigation, it does not suggest that the FDIC ever has assessed insurance premiums on such letters, or paid out on claims relating to such letters. This obviously involved more than administrative "inattention" (Allen Am. Br. 20); given the more than $100 billion worth of standby letters of credit outstanding, /6/ the FDIC's failure to assess premiums on these instruments plainly manifests a consistent, considered judgment that standby letters of credit are uninsured. Respondent's further attempt to demonstrate inconsistency in the FDIC's regulatory approach (Br. 31-32) turns on the quotation of out-of-context snippets of the regulatory history. The 1955 amendment to Regulation I, which respondent cites (Br. 31) for the proposition that all letters of credit were to be insured, simply reversed the order of the words "traveler's checks and letters of credit." 12 C.F.R. 326.1(c) (1957). The obvious purpose of this amendment was to make it clear that the word "traveler's" did not modify the term "letter of credit," a reading that would have limited insurance coverage to traveler's letters of credit. Cf. 12 C.F.R. 327.210 (1959). The FDIC thus explained that this "change in the wording" of the regulation was "a clarification of the consistent interpretation by the Corporation of the term 'letters of credit' to include all letters of credit issued under the circumstances stated in this paragraph." 12 C.F.R. 326.1(c) n.2 (1959) (emphasis added). These "circumstances," of course, involved letters issued for money or its equivalent, or for a charge against a deposit account. 12 C.F.R. 326.1(c)(1) and (2) (1959). /7/ Respondent also points (Br. 31-32) to an assessment decision issued by the FDIC in 1956. But that decision, later incorporated into a regulation, in fact articulated the distinction between funded and unfunded letters of credit. Part (a) of the regulation (12 C.F.R. 327.209(a) (1959)) provided that letters of credit "issued in exchange for checks or drafts or for a promissory note" would be treated as insured. Part (b) (12 C.F.R. 327.209(b) (1959)) provided that unfunded letters backed only by "an agreement to reimburse the bank for payments to be made by the bank under the letter of credit" would be uninsured unless the reimbursement agreement "constitute(d) a promissory note." And as explained above, a back-up note plainly does not constitute a promissory note for purposes of the deposit insurance program. /8/ 4. Respondent finally takes issue with our reading of the Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, 98 Stat. 494 et seq. (see Gov't Br. 26 n. 21, 29-30), which we suggested points up Congress's current understanding that standby letters of credit are not insured. DEFRA provides that a state or local obligation will lose its tax exempt status if it is federally-guaranteed (Section 622, 98 Stat. 919 (to be codified at 26 U.S.C. 103(h)(1) and (2)), while adding the proviso that "an obligation * * * shall not be treated as federally guaranteed merely by reason of the fact that * * * there is a guarantee by a financial institution." Section 622 (to be codified at 26 U.S.C. 103(h)(3)(D)). As respondent (Br. 35) and the Allen amici (Br. 24) acknowledge, the report of the Joint Committee on Taxation regarding this provision indicates the congressional view that obligations backed by standby letters of credit fall within this proviso (and thus are not federally-guaranteed) because standby letters of credit are not covered by federal deposit insurance. See Joint Comm. on Taxation, 98th Cong., 2d Sess., General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 941 (Comm. Print 1984). /9/ Respondent contends, however, that the Joint Committee misunderstood the legislation. Instead, respondent looks for guidance (Br. 35; see Allen Am. Br. 23) to the report of the House Ways and Means Committee, which commented as to the House bill's version of Section 622 that "obligation(s) shall not be treated as Federally guaranteed solely because * * * a financial institution guarantees repayment of the loans (e.g., issues a letter of credit)." H.R. Rep. 98-432, 98th Cong., 2d Sess. Pt. 2, at 1690 (1984). Respondent reads this to signal Congress's recognition that letters of credit are insured, as well as a congressional intent nevertheless to preserve the tax exempt status of bonds backed by insured letters of credit. This analysis plainly is far-fetched. The focus of Congress's concern during the debate on Section 622 was the use of federal deposit insurance to protect tax free bonds. Against this background, the House report cited by respondent can most naturally be read -- as the Joint Committee report specifically states -- as recognizing that standby letters of credit are not federally-insured. This reading also avoids the anomalous conclusion that the Joint Committee failed to understand the intent of the legislation that it set out to explain. /10/ And if this was the view of Congress, it plainly has probative value in ascertaining the meaning of Section 1813(l)(1). See, e.g., Bell v. New Jersey, 461 U.S. 773, 784-785 (1983); Seatrain Shipbuilding Corp. v. Shell Oil Co., 444 U.S. 572, 596 (1980). For the foregoing reasons and the reasons stated in our opening brief, the judgment of the court of appeals should be reversed. Respectfully submitted. CHARLES FRIED Solicitor General FEBRUARY 1986 /1/ Congress's inclusion of cashier's checks, money orders, and the like within the definition of deposit (12 U.S.C. 1813(l)(4)) is hardly inconsistent with this principle, as respondent (Br. 15) and the Allen amici (Br. 10) assert. In the normal course of business, a bank insists on receiving payment before issuing such an instrument, because it assumes an immediate obligation to make payments on the instrument; for that reason, such instruments are included in the definition of deposit for reserve purposes. 12 C.F.R. 204.2(a)(i)-(iii). It thus can be safely assumed that a bank issuing an instrument of that type has received money or its equivalent in exchange. /2/ To become a balance in favor of the depositor, the note, regardless of its negotiability, must mature and be collectible from an outside source or from an account with the issuing bank, prior to the maturity of the letter of credit." Gov't Information Servs., supra, at 24 (remarks of Prof. Kozolchyk). /3/ This is the case, for example, of notes in the form of the one at issue in the Allen litigation. Allen v. FDIC, 599 F. Supp. 104, 105 (E.D. Tenn. 1984), appeal pending, No. 85-5003 (6th Cir.) (citation omitted) (note providing that bank's customer would pay "'such amount(s) as the Bank may be required to disburse on behalf of (the customer) on account of (the) Letters of Credit'"). Indeed, in many cases the value of a back-up note securing a standby letter of credit will be wholly illusory, because the customer by definition already has defaulted on its obligation to the beneficiary of the letter before the note is called upon (see Gov't Br. 3 n.1); in such circumstances, the bank's ability to collect on the note is likely to be considerably less than certain. See Regulation of Standby Letters of Credit: Hearing on S. 2347 Before the Senate Comm. on Banking, Housing and Urban Affairs, 94th Cong., 2d Sess. 256 (1976) (hereinafter cited as Senate Hearing) (statement of Federal Reserve Board staff) ("(i)n many cases, the financial condition of the customer is apt to be unsatisfactory at the time when a standby letter is used, as evidenced by its default on the underlying business transaction"); cf. id. at 174 (statement of Independent Bankers Association of America) (payments made under a standby letter on behalf of a bank's customer are "of questionable value (to the bank) since they are made only when the holder of the letter has already defaulted to a third party"). /4/ The history of the proviso makes it plain that the various instruments listed there have significance only because Congress believed them to be the equivalent of money. As originally promulgated in 1935, the FDIC's Regulation I, the predecessor to Section 1813(l)(1), did not define the term "money or its equivalent." See 1935 FDIC Ann. Rep. 90-91. On October 1, 1935, the FDIC's Board of Directors issued an "Interpretation of the Words 'its equivalent' in Section 2 of Regulation I." Ibid. This interpretation set out the language of the current proviso, which was incorproated into the regulation (see 12 C.F.R. 326(d) (1959)) and ultimately into Section 1813(l)(1). /5/ The Allen amici suggest (Br. 11-12 n.6) that the Orion back-up note would be viewed as a promissory note as a matter of state commercial law. Whether the Orion note is a "promissory note" within the meaning of Section 1813(l)(1), however, plainly involves a question of federal law (see generally D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 456-462 (1942); First National Bank v. Dickinson, 396 U.S. 122, 133-134 (1969)), which must be answered in a manner consistent with the statutory purpose. See id. at 134. /6/ Respondent is incorrect in stating (Br. 29-30 n.15; see Allen Am. Br. 16-17) that the FDIC's estimate of the number of outstanding unfunded standby letters of credit -- or its position in this litigation -- has been inconsistent. Virtually all standby letters of credit are unfunded. See Senate Hearing 6 (letter from First Deputy Comptroller Robert Bloom to Sen. Proxmire) ("(i)n the context of a standby letter of credit, there is no deposit made by beneficiary of the letter of credit"); id. at 17 (letter from Federal Reserve Board to Sen. Proxmire) ("a bank issuing a() (standby letter of credit) (does) not receive funds in the amount of the (standby letter of credit)"). Our opening brief (at 27) (in contrast to our petition for certiorari and our brief before the court of appeals) accordingly referred to "unfunded" standby letters of credit simply for reasons of clarity. Indeed, the Federal Reserve Board and FDIC record "standby letters of credit" in the category of off-balance sheet liabilities, rather than in the category of deposit liabilities for which banks have received funds. As of December 31, 1983, the published records of these agencies disclosed that there were just under $100 billion worth of standby letters of credit outstanding (Board of Governors of the Federal Reserve System, Annual Statistical Digest 71 (1983); FDIC, 1983 Statistics on Banking 62); as we explained in our opening brief (at 28 n.22), the $120 billion figure cited in that brief and in our petition for certiorari had been updated by reference to call reports submitted to the FDIC by banking institutions. The $450-500 billion figure mentioned in our brief before the court of appeals referred not to the number of standby letters of credit currently outstanding, but to the number of standby letters of credit issued over the past five years. /7/ That the FDIC did not intend to insure standby letters of credit is confirmed by the history of the standby device. Standby letters were used relatively infrequently prior to the 1960's. Cf. Harfield, The Increasing Domestic Use of the Letter of Credit, 4 U.C.C. L.J. 251, 258 (1972); Comment, The Independence Rule in Standby Letters of Credit, 52 U. Chi. L. Rev. 218, 219 & n.14 (1985). As their use became more common, the FDIC took the position in 1968 that the issuance of such letters by banks should be proscribed as an unsound banking practice unless the bank "had a segregated deposit sufficient in amount to cover its potential liability under the standby letter of credit." See Senate Hearing (letter from FDIC Chairman Frank Wille to Sen. Proxmire). While the FDIC abandoned this position several years later (see id. at 20-21) it is hardly likely that the Corporation intended to insure an instrument that it had once hoped to proscribe altogether. /8/ Indeed, the distinction between funded and unfunded letters is so fundamental that it has been recognized by the Federal Reserve Board and the Comptroller of the Currency, as well as the FDIC, in regulations treating funding letters as deposits and unfunded letters as so-called off-balance sheet contingent liabilities (see Gov't Br. 16 n.11, 20-21 n.14). Some 10 years ago, the agencies emphasized the distinction between the two types of instruments in testimony opposing a bill that would, among other things, have aggregated standby letters of credit with bank deposits for reserve purposes. S. 2347, 94th Cong., 2d Sess. (1976). See Senate Hearing 7 (letter from First Deputy Comptroller Robert Bloom to Sen. Proxmire); id. at 9-10 (letter from Reserve Board Chairman Arthur Burns to Sen. Proxmire). The bill was not enacted. /9/ The Joint Committee stated (at 941) that "obligations are not treated as federally guaranteed * * * solely because a financial institution guarantees repayment of the loans other than by means of Federal deposit insurance (e.g., by a letter of credit)." /10/ Indeed, Congress evidently believed in 1976 that standby letters of credit are not deposits for reserve purposes under existing law; Congress otherwise would have felt no need to entertain legislation (see note 8, supra) -- which was not, in any event, enacted -- that would have aggregated standby letters with deposits for that purpose.