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. 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.
 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.