Background
During the 2008 financial crisis, the Federal Housing Finance Agency (FHFA) placed government-sponsored enterprises Fannie Mae and Freddie Mac into conservatorship. To keep them solvent, the U.S. Treasury agreed to provide over $100 billion in capital. In exchange, the Treasury received senior preferred stock and was entitled to a quarterly dividend at a fixed 10% rate. This arrangement was formalized in Senior Preferred Stock Purchase Agreements (PSPAs).
In 2012, with the companies showing signs of returning to profitability, the FHFA and Treasury executed the “Third Amendment” to the PSPAs. This amendment replaced the 10% dividend with a “Net Worth Sweep,” which required Fannie and Freddie to pay the Treasury a quarterly dividend equal to their entire net worth, minus a small capital reserve. The sweep effectively prevented the companies from ever rebuilding capital or paying dividends to other shareholders, causing the value of their shares to plummet.
Shareholders of Fannie and Freddie filed suit, alleging that by implementing the Net Worth Sweep, the FHFA, as conservator, breached the implied covenant of good faith and fair dealing inherent in their shareholder contracts. After a decade of litigation, a jury found in favor of the shareholders, awarding them $612.4 million in damages for the lost value of their shares. The district court added prejudgment interest, entering a final judgment of $812 million. The FHFA appealed.
The Court’s Holding
The D.C. Circuit affirmed the district court’s judgment in its entirety. The court rejected the FHFA’s primary argument that the Supreme Court’s decision in Collins v. Yellen foreclosed the shareholders’ claim. The panel distinguished Collins, explaining that it addressed a statutory claim concerning the scope of the FHFA’s authority as conservator, not a contract claim for damages. While the FHFA has broad authority to act in the public interest, this power does not give it license to “arbitrarily or unreasonably” violate the reasonable expectations of parties with whom it has a contract.
The court also dismissed the FHFA’s contention that the implied covenant could not apply because the shareholder agreements gave the agency wide discretion. Citing Delaware and Virginia law, the court held that such broad grants of discretion are precisely when the implied covenant is most needed to prevent arbitrary conduct. It is meant to fill gaps in how that discretion is exercised. Finally, the court rejected the idea that the claim was merely an “unripe claim for anticipatory breach” about future dividends. Instead, it found that the adoption of the Net Worth Sweep itself was a present breach of the ongoing duty of good faith, for which the shareholders could seek damages based on the immediate drop in their shares’ value.
Key Takeaways
- Government entities acting as conservators, even with broad statutory authority to act in the public interest, remain bound by the implied covenant of good faith and fair dealing in their contractual relationships.
- A claim for breach of the implied covenant is a distinct cause of action for a present breach, not necessarily a disguised claim for future harm, even when the conduct (like the Net Worth Sweep) eliminates the possibility of future profits for other parties.
- The Supreme Court’s decision in Collins v. Yellen, which affirmed the FHFA’s statutory authority to enact the Net Worth Sweep, does not shield the agency from liability for contract-based damages resulting from that same action.
Why It Matters
This decision reaffirms a crucial principle: when the government steps into the shoes of a private actor, such as a corporate conservator, it cannot use its public-interest mandate to arbitrarily ignore its contractual obligations. The ruling clarifies that the government’s statutory authority and its contractual duties are separate considerations, and satisfying one does not excuse a breach of the other. The FHFA had the authority to implement the sweep, but it is now liable for the contractual harm it caused.
For investors in government-sponsored enterprises (GSEs) and other quasi-public entities, the ruling is a significant victory. It establishes a powerful precedent that shareholder rights are not entirely extinguished by a government conservatorship. It ensures that an avenue remains for shareholders to seek monetary damages when the government takes actions that, while legally authorized, unreasonably destroy the value of their investment and violate the fundamental bargain of their contract.