Fannie and Freddie: The NWS and the Implied Covenant of Good Faith and Fair Dealing

Is the NWS (i) an action of a type permitted by express contractual provisions, or (ii) an unreasonable act of government discretion taken in bad faith?

Perhaps you have been like me, focusing all of your GSE litigation attention this year on the fortunes of Collins before SCOTUS, and haven’t paid much attention to the merits of the Fairholme plaintiffs’ action for breach of implied covenant of good faith and fair dealing (implied covenant) in front of Judge Lamberth at the federal DC district court.

While the full Collins story has yet to be told, as what remains of the Collins case is on remand to the 5th Circuit court of appeals en banc (which will be the subject of a future post), it is now time to turn attention to Judge Lamberth’s court.

The Lede


  • (i) the Net Worth Sweep (NWS) a contractual amendment of a type that was expressly permitted by, and does not frustrate, the terms of the plaintiffs’ junior preferred stock certificates (Certificates), such that the junior preferred holders could reasonably foresee it, at the time of their investment and taking into account subsequent developments such as the GSEs’ conservatorship and Treasury’s Senior Preferred Stock Purchase Agreement (SPSPA)? or

  • (ii) if the NWS was not reasonably anticipated by the contractual provisions of the Certificates but left to the discretion of FHFA and Treasury, did Treasury and FHFA exercise this discretion under the SPSPA and conservatorship, respectively, in bad faith so that the NWS frustrated the reasonable expectations of junior preferred holders?

Put more generally under Delaware law, if specific contractual provisions can be fairly said to address a potential future situation, even though these provisions permit a party to be opportunistic and engage in sharp dealing, then the implied covenant will not prohibit such opportunistic behavior.

But if specific contractual provisions can be fairly said to not address the situation, and instead one party exercises the discretion available to it under the contract in bad faith, then the covenant of good faith and fair dealing can be invoked by the party adversely affected.

“[T]he law presumes that parties never accept the risk that their counterparties will exercise their contractual discretion in bad faith.”1

One can pose a sequence of questions regarding the NWS and junior preferred stockholders’ expectations:

  • i) do the Certificates permit the GSEs to issue senior preferred stock?…clearly yes;

  • ii) do the Certificates permit the GSEs to amend the terms of the senior preferred stock so as to contain the terms of the NWS?…since there are no limitations upon amendment of the senior preferred contained in the Certificates, yes; and

  • iii) do the Certificates permit the GSEs to amend the senior preferred stock to contain the terms of the NWS when the GSEs obtained no funding or any other value in connection therewith, and Treasury could only do better with the NWS, and not worse, than was the case with the original terms?…this is the question posed by plaintiffs’ implied covenant claim.

So in my view, as discussed below, the crux of the analysis will focus on whether the NWS amendment conferred any value, or could only produce a detriment, to the GSEs.

This is a question of fact, and the math (as I illustrate below) is on the plaintiffs side. If Judge Lamberth finds that in connection with the NWS, Treasury incurred no risk, gave up nothing and could only benefit from the NWS, and the GSEs gained no value in connection with the NWS, then in my view Judge Lamberth should conclude that the NWS breached the implied covenant owed to junior preferred stockholders.

By engaging in the analysis, you will have gone most of the way to determine the merits of plaintiffs’ claim that the NWS breached the implied covenant. But it should be apparent that this analysis remains something of a subjective exercise to be conducted by the judge (and because of this, Delaware law prescribes that the implied covenant should be applied sparingly).

The wild card in this analysis is Judge Lamberth, who is known to be something of a stickler, and who takes offense to attorney misconduct, especially when the misconduct comes from the government.

On the other hand, Judge Lamberth has shown no previous willingness to credit plaintiffs’ implied covenant claim in the original stage of the case, having originally dismissed plaintiffs’ claim of breach of implied covenant, only to be reversed by the DC Circuit Court of Appeals.

But remember in that prior stage of the case, Judge Lamberth received a government affidavit (Ugoletti Affidavit) averring that the NWS was enacted to stop the “death spiral” circular draws on Treasury’s line of credit to pay senior preferred stock dividends, and that at the time of the NWS:

  • “Conservator and the Enterprises had not yet begun to discuss whether or when the Enterprises would be able to recognize any value to their deferred tax assets. Thus, neither the Conservator nor Treasury envisioned at the time of the Third Amendment that Fannie Mae's valuation allowance on its deferred tax assets would be reversed in early 2013, resulting in a sudden and substantial increase in Fannie Mae's net worth, which was paid to Treasury in mid-2013 by virtue of the net worth dividend.” (paragraph 20, Ugoletti Affidavit).

Plaintiffs have alleged in their amended complaint, and will present evidence at trial, that the Ugoletti Affidavit is false, and plaintiffs will argue that the Ugoletti Affidavit was presented to Judge Lamberth with an intent to deceive the court as to the government’s motivations concerning the NWS, in order to bolster the reasonableness of the NWS.

What will Judge Lamberth conclude as to the government’s good/bad faith with respect to the enactment of the NWS if Judge Lamberth believes plaintiffs’ testimony that the government knew at the time of NWS enactment that the GSEs were about to enter a “golden age of profitability” that would return value to the GSEs’ deferred tax assets, creating a windfall for Treasury?


This analysis of plaintiffs’ breach of implied covenant will focus on two opinions: i) Judge Lamberth’s denial of the government’s motion to dismiss (MTD) the implied covenant claim in 2018, and ii) the subsequent leading Delaware Supreme Court decision on the implied covenant, Oxbow v Crestview, in 2019.2

An important part of the analysis, in my view, should focus on the nature and extent of bad faith present in the government defendants’ actions, both at the time of the NWS and when the Department of Justice defended the NWS on the basis of an administrative record that contained only the Ugoletti Affidavit.

Importantly in Oxbow (the leading Delaware case with respect to the implied covenant, discussed below), the plaintiffs did not allege bad faith on the part of the defendants, whereas in the case before Judge Lamberth, the plaintiffs will have every opportunity to allege bad faith on the part of the defendants FHFA and Treasury, both at the time of enactment of the NWS (implementing the NWS at the exact moment the government learned from Fannie’s CFO that the GSEs were entering their “golden age of profitability”, giving rise to the opportunity to reinstate the GSEs’ large deferred tax assets and make windfall distributions to Treasury), and subsequently in defending the NWS at the initial stage of the case (by producing the false Ugoletti Affidavit).

Indeed, every third and fourth word out of the mouth of Plaintiffs’ counsel should be bad faith.

Judge Lamberth’s Denial of Government Motion to Dismiss (MTD)

The government has defended the NWS on the basis that i) the Certificates by their express terms permit the issuance of senior preferred securities, ii) the senior preferred securities issued to Treasury by their express terms were able to be amended to alter the original terms, and iii) the Treasury took on additional risk in amending the senior preferred dividend terms and gave up value, forgoing the commitment fee under its line of credit, in connection with the NWS amendment.

Therefore, according to this line of argument, because the Certificates contemplated the potential issuance of senior preferred securities (which did not proscribe the NWS terms), the GSEs’ gained value (commitment fee eliminated) and Treasury incurred risk by agreeing to the NWS terms, the plaintiff junior preferred shareholders must live by the terms of their own Certificates.

Plaintiffs have countered that although the Certificates contemplated the issuance of senior preferred stock, such issuances of senior preferred stock (and by implication, the NWS amendment of such securities) could only be done in connection with the receipt of valuable consideration by the GSEs. This is implicit in the terms of the Certificates.

At the time of the NWS amendment, plaintiffs will argue that

  • i) it was a mathematical certainty that, given the terms of the NWS, Treasury gave up absolutely no valuable consideration in exchange for cancelling the commitment fee, and

  • ii) Treasury incurred no risk of receiving less payments under the NWS terms as compared to the original terms, but obtained the opportunity to receive huge windfall payments in perpetuity in excess of the payments under the original terms (and Treasury fully expected to reap this windfall given that it learned that the GSEs were entering into their golden age of profitability).

Given the reasonable presumption in the Certificates that senior securities could only be issued, or amended, in a transaction in which the issuer GSEs received valuable consideration (for it would be provocative to have contracted for this protection…see footnote 2), this is not a simple case of Treasury exercising rights made available to it by the express provisions of the Certificates to issue or amend senior securities. If this were a conventional issuance or amendment of senior securities, permitted under the Certificates, the implied covenant would have no application.

The NWS amendment falls into the “gap” in the terms of the Certificates where the GSEs and Treasury are not exercising their rights to amend the senior preferred stock in good faith…because good faith is lacking where, as a mathematical certainty, Treasury could only benefit, and the GSEs gained no value and could only suffer detriment, from and after the NWS amendment.

Before we proceed to Judge Lamberth’s MTD opinion, let’s first review the mathematical errors concerning the government’s defense of the NWS. Because the government’s arguments are wrong as a matter of math, plaintiffs will be able to press their claim that the NWS was not foreseeable by junior preferred stockholders, but was a governmental exercise of discretion in bad faith.

  • Treasury gave up valuable consideration in exchange for the NWS amendment, by foregoing the line of credit commitment fee.

    • This is nonsense. While Treasury never charged any commitment fee prior to the NWS amendment, indicating that it never considered a commitment fee to be an important part of its investment return3, the claim is just wrong as a matter of math.

      • The government has fatuously argued that the amount of the commitment fee (CF) was incalculably great, impossible to calculate. This is absurd. Plaintiffs expert witnesses will testify that a fair market CF for Fannie would be about $400 million per annum.

        • But given the terms of the NWS, it is mathematically impossible for Treasury to have “given up” this CF. The NWS called for the distribution of all of a GSE’s net worth each quarter (initially in excess of a buffer amount, but declining to zero)…let’s call this amount available to distribute under the NWS as X. If the CF were still in effect, the CF would have been $400 million and the NWS distribution would have been X - $400 million. Without the CF, the NWS distribution would be X…which of course is equal to the CF amount plus the remaining amount distributable under the NWS [(X - $400 million) + $400 million]. Either way, with or without the CF, under the terms of the NWS, Treasury would receive X. Treasury gave up nothing by “giving up” the CF in exchange for the NWS dividend terms.

  • Treasury incurred risk in connection with the NWS amendment.

    • Again, this is wrong as a matter of math. Treasury could only receive more and could never receive less under the NWS, by being able to receive all GSE available net worth, rather than under the original 10% dividend terms. If a GSE lacked an amount of distributable funds (Y) sufficient to pay the entire 10% dividend, Treasury would extend Y amount of funds to the GSE to receive the 10% dividend. Netting out its outlay, Treasury received the 10% dividend less Y…which is exactly the amount of funds Treasury receives under the NWS.

      • If the GSE had distributable funds well in excess of the 10% dividend amount, under the original terms Treasury would received the 10% dividend, while under the NWS Treasury receives all of the distributable funds equal to, plus in excess of the, 10% amount. Treasury can only do better under the NWS. Treasury incurred no risk in connection with the NWS.

  • By enacting the NWS amendment, the GSEs benefitted by preserving the availability of the full amount of the Treasury line of credit, which would decrease in availability if Treasury continued to extend funds to a GSE in order for the full 10% dividend to be paid.

    • This is wrong, and it is an embarrassingly stupid argument on the part of the government. The SPSA contained a contractual provision permitting a GSE to make in-kind distributions of additional senior preferred stock instead of distributing cash dividends. These in-kind distributions would not have reduced availability under the line of credit. Treasury never had to extend further funds to a GSE under the line of credit, but rather could simply exercise the contractual provision in the SPSA that specifically addressed this situation…and if Treasury resorted to the contractual payment in-kind provision, there would never be any specter of a decline in line of credit availability.

Judge Lamberth denied the government’s MTD the implied covenant precisely because plaintiffs in their amended complaint alleged these facts relating to the government’s bad faith…and on a MTD, the judge is obliged to treat these allegations as true to determine whether plaintiffs state a valid implied covenant claim.

Now at trial, plaintiffs will have to prove these factual allegations. The government will have its opportunity to present witnesses supporting the “death spiral” narrative, and cross examine plaintiffs witnesses. Also importantly, each side will present expert testimony on various issues, such as the CF amount, the accounting standard for restoring the deferred tax assets to the GSEs balance sheets, and whether satisfaction of this standard could be foreseen by the government as being satisfied at the time of the NWS.

But it is important to note that Judge Lamberth did not accept the government’s argument that there can be no implied covenant claim when the Certificates contemplate the future issuance of senior preferred stock, and (as Judge Lamberth has found, incorrectly in my view) the NWS otherwise complies with the dividend provisions of the Delaware General Corporation Law.

In the MTD opinion, Judge Lamberth correctly states the Delaware law to the effect that

  • ‘[t]he implied covenant generally applies only if the contract [in this case, the Certificates] is silent as to the subject at issue. If the contract directly addresses the matter at hand, existing contract terms control...such that implied good faith cannot be used to circumvent the parties' bargain…But if the contract is silent on the issue, the Court must consider whether implied contractual terms fill the gap...To do this, the implied covenant asks what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting;” and

  • "good faith" in this context simply entails "faithfulness to the scope, purpose, and terms of the parties' contract.”

What is the “subject at issue”? Whether it was reasonable for the junior preferred stockholders to anticipate that Treasury would bargain for senior preferred stock having the provisions of the NWS. Did the NWS exhibit "faithfulness to the scope, purpose, and terms of the parties' contract” if the GSEs did not obtain any benefit and Treasury incurred no risk in connection with the NWS?

When is the “time of contracting”? Plaintiffs argued for the times that the various series of junior preferred stock were issued, all before conservatorship. But Judge Lamberth noted, correctly I believe, that holders of junior preferred stock may have acquired their shares at various times up until the enactment of the NWS in 2012, and their investment expectations should not be measured by what the original holders may have expected. Moreover, corporate securities holders can reasonably expect that issuers will undergo various events and changes of circumstance after issuance which will affect their investment expectations.

Therefore, for purposes of the implied covenant, Judge Lamberth found that all events and circumstances relating to the GSEs through the time leading up to the NWS, including for example conservatorship, should be taken into account when considering what a junior preferred stockholder could reasonably expect during this period.

This elongated time period of contracting to measure the junior preferred holders reasonable expectations was a favorable determination for the government, but nonetheless plaintiffs retain their trump card:

  • can it ever be reasonable for a junior preferred holder to expect, even during conservatorship, that the GSEs would agree to deplete its assets by diverting all of their net worth to Treasury, when the GSEs obtained no benefit in return, and Treasury incurred no risk in the transaction and could only do better, not worse, in the NWS transaction….especially at a time when Treasury was informed that the GSEs were about to enter their golden age of profitability?

  • Isn’t this factual scenario (which plaintiffs have to prove by a preponderance of the evidence) precisely the type of bad faith that the implied covenant is intended to prevent?

As Judge Lamberth put it, “[t]he pleaded facts not only show that the GSEs would not need to draw on Treasury's funds to pay dividends, but also that the GSEs could repay Treasury for its investment under the pre-Third Amendment (NWS) dividend structure. Such facts could support a finding that Defendants exercised their discretion arbitrarily or unreasonably….And at the nascent of a sustained period of profitability, Plaintiffs would have reasonably expected the GSEs to be moving out of conservatorship, not doubling down by executing the Net Worth Sweep.” (emphasis added)

Since the time of Judge Lamberth’s MTD opinion, the Delaware Supreme Court (DSC) decided the Oxbow case. While the DSC reversed a Chancery Court holding, by determining that the implied covenant was not breached under the facts of the Oxbow case, it is important to understand the Oxbow facts, which contrast significantly with the facts relating to the NWS. In my view, nothing in Oxbow should persuade Judge Lamberth to refrain from invoking the implied covenant in connection with the NWS.


Oxbow involved a joint venture investment in 2006 by a private equity firm, Crestview, in a private company (Oxbow) in which the other shareholder was William Koch and affiliates, who controlled the company. Koch contributed $483 million for some 60% of the venture’s equity, and Crestview contributed $190 million for 23% of the equity, and another private equity firm acquired the balance.

As is typical in joint venture agreements, Crestview negotiated for an “exit” right, the right of Crestview under certain circumstance and after seven years, to force Koch to i) buy out Crestview (put right), or in the event that Koch failed to agree to buy Crestview’s shares, ii) sell Oxbow in its entirety.

Since Koch would have to finance the buyout of this Crestview exit right or sell Oxbow at a time not of his choosing, Koch negotiated a condition to the right of Crestview to exercise its put, so that all shareholders must receive 1.5x their original investment, including interim distributions and the proceeds of the exit sale, in order for the exit right to be validly exercisable.

The joint venture agreement provided that all common equity holders would receive distributions pro rata in accordance with their percentage equity holdings…there was no waterfall provision directing that distributions and payment should go first to any joint venture partner to achieve the 1.5x target, before distributions and payments would go to the other joint venture partners (who had achieved their 1.5x hurdle).

In 2010, Oxbow bought another business and allowed the executives of the acquired business, together with additional Koch family members, to make small equity investments in Oxbow (the Small Shareholders). As it turns out, these small equity issuances were not conducted in accordance with the provisions of the joint venture agreement. They were voidable. Crestview had two directors on the Oxbow board of directors, but they did not object to the terms of issuance to the Small Shareholders.

At this time, the Oxbow unit value would have satisfied Crestview’s 1.5x return hurdle, but Crestview’s exit right had not matured in duration into being exercisable. Of course, even if Crestview could exercise its exit right, it would not have been able to compel Koch to buy out Crestview’s shares at that time, since all shareholders would have needed to have hit their 1.5x hurdle and the Small Shareholders, having just purchased equity in Oxbow, would not have satisfied this return hurdle. Whether Crestview’s directors simply believed that Oxbow’s prospects were such that all shareholders would satisfy the investment hurdle by the time Crestview’s exit right matured (2013), or they were simply asleep at the switch, was not clear. But it is apparent, without the DSC saying so explicitly, that Crestview had the opportunity under the joint venture agreement to protect itself, had it desired to do so.

When Crestview eventually exercised its exit right during 2014-2016, at which point the Koch and Crestview relationship had deteriorated, the value of Oxbow’s shares had dropped and the Small Shareholders would not satisfy their investment hurdle for their equity at the price of an Oxbow sale. Crestview exercised its put right, and Koch refused to honor it, noting that the put right would not satisfy the 1.5x hurdle for the Small Shareholders. Koch also filed a declaratory action seeking to have its interpretation of the joint venture agreement, that the 1.5x clause needed to be satisfied for all holders, found to be correct.

Observe how this factual pattern differs from the NWS case.

In Oxbow, Crestview never alleged that Koch had engaged in bad faith. As the DSC said, “although the vesting of a Board with discretion does not relieve the Board of its obligation to use that discretion consistently with the implied covenant of good faith [Crestview does] not argue that the Board exercised its contractual discretion in bad faith in admitting the Small Shareholders”. Crestview could have negotiated the joint venture agreement to include a waterfall provision in order to ensure that no holder acquiring equity after Crestview could hold its exit right hostage to the 1.5x investment return hurdle. Moreover, Crestview’s directors could have objected to the sale of equity to the Small Shareholders for failure to comply with the joint venture agreement at the time of the sale, but these Crestview directors did not protect Crestview’s interests.

The DSC held that the express terms of the joint venture agreement applied, there was no application of the implied covenant, and the Small Shareholders could enforce the agreement to block Crestview’s exit sale. Crestview could reasonably foresee the application of the 1.5x clause to apply to the Small Shareholders in a manner adverse to its interests. Indeed, Crestview watched and slept while the Small Shareholders took up their position to do exactly that.

It would not have been obvious or provocative for Crestview to negotiate anti-hostage provisions relating to the exercise of its exit right. The waterfall provision does this precisely, it is a common joint venture agreement provision, and this was a provision that Koch refused to adopt at the time of Crestview’s investment in 2006. Crestview had to live with the terms it negotiated for its exit right, and live with its acquiescence of the sale of equity to the Small Shareholders when it should have realized that the Small Shareholders might be able to hold Crestview’s exit hostage.

These facts are a far cry from the NWS, where plaintiffs are alleging bad faith insofar as the GSEs derived no benefit from the NWS, and Treasury incurred no risk but could only benefit, especially given its knowledge that the GSEs were entering their golden age of profitability.

Timing and Damages

Trial is set for July 2022. Prior thereto during the fall of 2021, both plaintiffs and the government will file summary judgment (SJ) motions and briefing. I expect Judge Lamberth to deny these motions for SJ, since the facts are important to decide this case. In the case of a SJ motion by the government, it would have to assume for purposes of the motion that the plaintiffs’ version of the facts is correct. I dont see the government doing this. Judge Lamberth will want to see live witnesses and testimony.

In a breach of implied covenant, like a breach of contract, plaintiffs can receive expectancy damages. This would award plaintiffs the benefit of their bargain, which would void the distributions made to Treasury under NWS in excess of those it would have received under the original senior preferred stock terms.


Amirsaleh v. Bd. of Trade of N.Y.C., Inc., 2008 WL 4182998, at *1 (Del. Ch. Sept. 11, 2008) (Chandler, C.)


See generally, Court of Chancery Denies Motion to Dismiss Implied Covenant of Good Faith and Fair Dealing Claim, in the Delaware Corporate & Commercial Litigation Blog, by Francis G. X. Pileggi.

The author concludes that “…claims predicated on the implied covenant may survive dismissal where well-pled factual allegations support a reasonable inference that a contracting party has, in exercising otherwise-legitimate contractual rights, taken actions to undermine express contractual rights of the other party. This is especially so where the offending actions were such that explicitly proscribing them in the contract would have been too obvious or provocative.”

With respect to the GSEs and the NWS, it would have been “too obvious and provocative” for the Certificates to state that the GSEs could only issue senior preferred stock, or amend its terms, in exchange for valuable consideration received. Why would an issuer do otherwise?


My speculation is that because HERA mandated that any commitment fee received by Treasury be applied solely to deficit reduction (Section 1304(d) of Public Law 111-203, amending HERA in 2010), but dividends could be applied without limit, the Obama administration preferred to receive only dividends which it could apply without restriction.

This further supports the conclusion that the commitment fee “give up” was without substance.