FMCC Federal Home Loan Mortgage Corporation (QB)

A federal appeals court finally issued a decision in a long-running dispute over actions taken by the U.S. government after it put Fannie Mae and Freddie Mac into conservatorship in September 2008.

It wasn't, however, the decision that many investors, housing-policy wonks and the government have been eagerly awaiting. That decision, reviewing a federal judge's dismissal of a case brought by Fannie and Freddie shareholders protesting the government's claim on profits, will come out of the U.S. Court of Appeals for the D.C. Circuit.

Thursday's decision came from the U.S. Court of Appeals for the Federal Circuit, the other group of federal courts based in the District of Columbia. It wasn't brought by shareholders protesting the government's claim on Fannie's and Freddie's profits, it was brought by the former chief financial officer of Freddie Mac.

Still, Investors Unite, a group that advocates for Fannie and Freddie shareholders, described the decision as a "positive sign" in a tweet.

That's half-right. There certainly are parts of the ruling that may benefit shareholders. But there are other parts that may hurt them.

The case decided Thursday was brought by Anthony Piszel, who was named Freddie's CFO in 2006. His contract said that if he was fired from the position without cause, he would get a severance package that would include a lump-sum payment equal to twice his annual salary and that his restricted stock units would continue to vest.

Shortly after Freddie was seized by the government, Mr. Piszel was fired at the behest of the director of the Federal Housing Finance Agency, which had become Freddie's conservator. The director also determined that Freddie shouldn't pay Mr. Piszel any severance payment.

Mr. Piszel sued in the U.S. Court of Federal Claims six years later, arguing that the cancellation of his severance payment was a taking by the government. Under the Fifth Amendment's "takings clause," the government must provide compensation when it deprives someone of property.

Last summer, a federal judge dismissed Mr. Piszel's case. Citing earlier cases in which federal courts held that shareholders of failed banks lacked property interests that could give rise to a takings claim, the judge ruled that Mr. Piszel's contract didn't create a property right for which he could demand compensation.

The judge said by signing a contract with a company as pervasively regulated as Freddie Mac, Mr. Piszel had assumed the risk that future regulation might change or eliminate benefits or compensation promised to him. That argument had been used to turn away suits by bank shareholders after the lenders were seized by the Federal Deposit Insurance Co.

Even though it ultimately agreed with the dismissal, the appeals court disagreed with the argument. It said that Mr. Piszel's contract did create a property right. The court pointed out that the law that authorized the FHFA to bar a severance payment to Mr. Piszel wasn't passed until the summer of 2008, after he had entered into the contract with Freddie. This is the part that is good news for Fannie and Freddie shareholders: Some of the lawsuits also make claims based on the takings clause. After this ruling, it is more likely that federal judges in those cases will hold that they also have property rights arising from ownership of shares.

But they shouldn't get too giddy. Keep in mind that the appeals court upheld the dismissal. It ruled that while Mr. Piszel's contract really did create a property right, nothing the government did took that right away from him.

That needs a bit more explanation. After all, the FHFA really did tell Freddie to fire Mr. Piszel and not to pay any severance. And Freddie did both those things. By Mr. Piszel's reckoning, the severance package would have been valued at $7 million. How could the government deny him that without taking anything from him?

The court ruled that the FHFA's instructions didn't take anything from Mr. Piszel because he still had the right to enforce his contract in a breach-of-contract lawsuit against Freddie Mac. Although he wouldn't have been able to force Freddie to live up to the contract, he could have sued for damages equal to the value of the promised severance. And since he still had that right to sue for breach of contract, he still had the property interest created by the contract.

This is a particularly tough line of reasoning for Mr. Piszel because the statute of limitations on breach-of-contract claims ran out years ago. So the appeals court is telling him that he brought the wrong kind of case to the wrong court at the wrong time.

It may also be bad news for shareholders, at least those hoping for a win on the takings claims.

Many of the investor lawsuits also make breach-of-contract claims. Holders of preferred shares of Fannie and Freddie argue that the government's claim to all of the profits of the companies denies them contractual rights to dividends and specified liquidation preferences. Common shareholders also claim their rights to dividends and to the residual value of the company has been violated.

Under the logic of the appeals court in Mr. Piszel's case, if shareholders have the right to sue for breach of contract, there may not have been a taking at all. Sure, all the value of the companies now accrues to the government but if shareholders can sue for breach of contract, the government arguably hasn't taken anything from them.This isn't necessarily awful news for shareholders. It doesn't foreclose all chances of a legal victory, but it may mean that their takings claims will get dismissed. That is a setback because many of the investors believe that this was their best line of legal argument.

Write to John Carney at john.carney@wsj.com

(END) Dow Jones Newswires

August 18, 2016 22:15 ET (02:15 GMT)

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