Appeals from the United States District Court for the Southern District of Indiana, Indianapolis Division. No. 1:08-cv-1560-DFH-DML - David F. Hamilton, Chief Judge.
The opinion of the court was delivered by: Easterbrook, Chief Judge.
Before EASTERBROOK, Chief Judge, and KANNE and WOOD, Circuit Judges.
This opinion is being released in typescript, and the mandate will issue today, so that the district court may hold a prompt hearing to re-examine the size of the injunction bond. A printed copy will follow.
Hoosier Energy, a co-op, had depreciation deductions that it could not use. John Hancock Life Insurance Co. had income exceeding its available deduc- tions. The two engaged in a transaction designed to move Hoosier Energy's deductions to John Hancock. They entered into a leveraged lease: John Hancock paid Hoosier Energy $300 mil-lion for a 63-year lease of an undivided 2/3 interest in Hoosier Energy's Merom generation plant. Hoosier Energy agreed to lease the plant back from John Hancock for 30 years, making periodic payments with a present value of $279 million. The $21 million difference, Hoosier Energy's profit, represents some of the value to John Hancock of the deductions that John Han-cock could take as the long-term lessee of the power plant. The transaction exposed John Hancock to several risks. The power station might become uneconomic before the parties' estimate of its remaining useful life (roughly 30 years). Or Hoosier Energy might encounter financial difficulties in its business as a whole. As a debtor in bankruptcy, Hoosier Energy would be entitled to repudiate the lease, leaving John Hancock with a power station that it had no interest in operating. Hoosier Energy's obligation as a repudiating debtor would be considerably less than the present value of the rentals. See 11 U.S.C. §502(b)(6). So Hoosier Energy agreed to provide John Hancock with additional security, in the form of both a credit-default swap and a surety bond. Ambac Assurance Corporation and three affiliates agreed to pay John Hancock approximately $120 million if certain events occurred. (For its part, Hoosier Energy posted substantial liquid assets to Ambac's credit, in order to protect Ambac should it be required to pay John Hancock; this was part of the transaction's swap feature.) A credit-default swap, like a letter of credit, is a means to assure payment when contingencies come to pass, without proof of loss (as a surety bond would require). One of the contingencies in this transaction is a reduction in Ambac's own credit rating. If that rating falls below a prescribed threshold, Hoosier Energy has 60 days to find a replacement that satisfies the contractual standards.
During 2008 Ambac's credit rating slipped below the threshold. John Hancock then demanded that Hoosier Energy find a replacement, and it extended the deadline from 60 days to more than 120 days when Hoosier Energy reported trouble. Whether replacing Ambac was "impossible" at the time, as Hoosier Energy maintains, or just would have cost Hoosier Energy more than it was willing to pay, as John Hancock believes, is a subject that remains in dispute. When the extended dead-line arrived, Hoosier Energy told John Hancock that it was in negotiations with Berkshire Hathaway to replace Ambac. John Hancock concluded that "in negotiations" was not good enough (perhaps it suspected Hoosier Energy of stalling) and called on Ambac to perform. Ambac is ready, willing, and able to meet its obligations. But before Ambac could pay, Hoosier Energy filed this suit under the diversity jurisdiction, and the district court issued a temporary restraining order. The justification for that order, since replaced by a preliminary injunction, is that if Ambac pays, it will demand that Hoosier Energy cover the outlay, and that this will drive Hoosier Energy into bankruptcy-a step that the district court called an irreparable injury.
Irreparable injury is not enough to support equitable relief. There also must be a plausible claim on the merits, and the in-junction must do more good than harm (which is to say that the "balance of equities" favors the plaintiff). See Winter v. Natural Resources Defense Council, Inc., 129 S.Ct. 365 (2008); Illinois Bell Telephone Co. v. WorldCom Technologies, Inc., 157 F.3d 500 (7th Cir. 1998). How strong a claim on the merits is enough depends on the balance of harms: the more net harm an injunction can prevent, the weaker the plaintiff's claim on the merits can be while still supporting some preliminary relief. See Cavel International, Inc. v. Madigan, 500 F.3d 544 (7th Cir. 2007); Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the United States of America, Inc., 549 F.3d 1079 (7th Cir. 2008). The district court concluded that an injunction would have net benefits, because John Han-cock would remain well secured in its absence (it remains the lessee of a power station that is essential to Hoosier Energy's business, so Hoosier Energy will not abandon the lease), and that Hoosier Energy's position on the merits is strong enough to support relief while litigation continues. 588 F. Supp. 2d 919 (S.D. Ind. 2008). The district court also directed Hoosier Energy to post $2 million in cash, a $20 million injunction bond with sureties, and an unsecured bond of $130 million, to ensure that John Hancock would be made whole should it prevail in the litigation.
As for the merits: The district court thought that Hoosier Energy has two arguments with enough punch to justify interlocutory relief. The first is that the transaction is an abusive tax shelter. The district court observed that the Internal Revenue Service has declined to allow similar transactions to transfer deductions from one corporation to another and concluded that this transaction probably should be unwound. The second is that, under New York law (which the parties agree supplies the rule of decision), "temporary commercial impracticability" permits Hoosier Energy to defer coming up with another swap partner until the economy has improved.
John Hancock disputes both of these conclusions, but its appellate brief opens with the contention that Hoosier Energy lacks standing to complain. After all, John Hancock observes, Ambac is willing and able to perform. What interest does Hoosier Energy have in whether Ambac performs under a contract that, the parties agreed, would be deemed independent of Hoosier Energy's promises? The answer is that, if Ambac pays John Hancock, then Hoosier Energy must pay Ambac. (The funds already on deposit with Ambac are insufficient to cover all of Hoosier Energy's obligations.) A payout would be injury, caused by John Hancock's acts, and remediable by a favorable judicial decision. That's enough for standing under the Supreme Court's precedents. See, e.g., Steel Co. v. Citizens for a Better Environment, 523 U.S. 83, 102--05 (1998).
This is a three-corner transaction (four-corner, if one counts the IRS). It was accomplished through a series of nominally in-dependent contracts spanning more than 3,000 pages. But it would press legal fiction beyond the breaking point to say that the independent enforceability of each party's promises to the others meant that any of the three parties lacked standing to complain about acts of the others that will produce an immediate, concrete injury. It may be that Hoosier Energy has waived its right to complain (that, too, is a subject on which litigation lies ahead), but a waiver is a defense on the merits, which differs from the absence of an Article III case or controversy.
On the subject of irreparable injury, appellate review is deferential at the preliminary injunction stage, and we lack an adequate basis on which to disagree with the district court's assessment. That leaves the question whether Hoosier Energy has a plausible theory on the merits-not necessarily a winning one, but a claim strong enough to justify exposing John Hancock to financial risks until the district court can decide the merits. We do not agree with all of the district judge's reasoning, but we do not think that the court erred in thinking Hoosier Energy's claim sufficient for this limited purpose, given Ambac's continuing ability to perform and the injunction bonds posted under Fed. R. Civ. P. 65(c).
Let us start with the question whether the transaction is an illegal tax shelter that must be unwound rather than enforced. The district court's approach has two steps: First, the court concluded that the transaction lacks economic substance and therefore cannot be employed to transfer tax benefits from Hoosier Energy to John Hancock. Second, the court believed that a tax shelter that the Internal Revenue Code does not allow is "illegal" as a matter of contract law. The first of these steps may or may not be right; the tax treatment of leveraged leases, and related transactions such as the sale and leaseback, can be difficult. See, e.g., Frank Lyon Co. v. United States, 435 U.S. 561 (1978). The second is wrong. A leveraged lease is a perfectly enforceable contract. Whether or not the contract lawfully transfers tax benefits, there is nothing wrong with, or illegal about, the contract itself; only the claim of tax benefits from the contract would be problematic.
All questions about tax benefits to one side, a leveraged lease is simply a loan secured by a lease rather than a mortgage. John Hancock needs to make investments in order to have money available to pay the death benefits on its life insurance policies. Often it invests in real estate. The transaction with Hoosier Energy is one in which John Hancock invested $300 million in exchange for a promised stream of repayments that would last 30 years; it also obtained a security interest in the assets that Hoosier Energy would use to produce the funds for repayment. Neither New York nor Indiana would call such a transaction illegal, and the fact that a credit-default swap im-proved the lender's security does not create any additional problem.
Hoosier Energy has not cited, and we have not found, any decision holding a leveraged lease or sale-and-leaseback unenforceable as a matter of contract law, just because the main (or even the sole) reason for structuring the transaction that way, rather than as a loan, was tax benefits. "Economic purpose" is not a requirement for the enforceability of contracts. If the Green Bay Packers cut a player one day and then re-sign him the next, a court would not dream of canceling the new con-tract on the ground that a release-and-resign sequence lacks economic purpose. The Commissioner of Internal Revenue will address the question whether the leveraged-lease transaction provides John Hancock with the tax benefits it seeks. If the answer turns ...