In the
United States Court of Appeals
For the Seventh Circuit
Nos. 08-4030 & 08-4248
H OOSIER E NERGY R URAL E LECTRIC C OOPERATIVE, INC.,
Plaintiff-Appellee,
v.
JOHN H ANCOCK L IFE INSURANCE C OMPANY;
OP M EROM G ENERATION I, LLC; and
M EROM G ENERATION I, LLC,
Defendants-Appellants,
A MBAC A SSURANCE C ORPORATION;
C OBANK, ACB; AE G LOBAL INVESTMENTS, LLC; and
A MBAC C REDIT P RODUCTS, LLC,
Defendants-Appellees.
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.
A RGUED JANUARY 5, 2009—D ECIDED S EPTEMBER 17, 2009
Before E ASTERBROOK , Chief Judge, and K ANNE and
W OOD , Circuit Judges.
2 Nos. 08-4030 & 08-4248
E ASTERBROOK, Chief Judge. Hoosier Energy, a co-op,
had depreciation deductions that it could not use. John
Hancock Life Insurance Co. had income exceeding its
available deductions. 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 million 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 Hancock 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
Nos. 08-4030 & 08-4248 3
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 con-
tractual 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 deadline
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
4 Nos. 08-4030 & 08-4248
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 injunction 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 con-
cluded that an injunction would have net benefits,
because John Hancock 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.
Nos. 08-4030 & 08-4248 5
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 transac-
tion 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 trans-
action probably should be unwound. The second is that,
under New York law (which the parties agree supplies
the rule of decision), “temporary commercial impractic-
ability” 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 per-
form. 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 insuf-
ficient 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 deci-
sion. 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
6 Nos. 08-4030 & 08-4248
of nominally independent contracts spanning more than
3,000 pages. But it would press legal fiction beyond
the breaking point to say that the independent enforce-
ability 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 finan-
cial 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 em-
ployed to transfer tax benefits from Hoosier Energy to
Nos. 08-4030 & 08-4248 7
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 lever-
aged 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 improved 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 struc-
8 Nos. 08-4030 & 08-4248
turing 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
contract 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 out to be no, Hoosier
Energy still owes John Hancock the promised rental
payments (and is entitled to keep the $21 million pre-
mium), while Ambac still provides security for those
payments.
New York law is skeptical of contentions that irregular
dealings between one contracting party and the govern-
ment excuse the other contracting party’s performance.
For example, John E. Rosasco Creameries, Inc. v. Cohen,
11 N.E.2d 908, 909 (N.Y. 1937), held that the dairy’s
customer must pay for goods received, even though the
dairy lacked a license and thus should not have been
in business. In New York, “[a]s a general rule also, for-
feitures by operation of law are disfavored, particularly
where a defaulting party seeks to raise illegality as ‘a
sword for personal gain rather than as a shield for the
public good.’ ” Lloyd Capital Corp. v. Pat Henchar, Inc., 603
N.E.2d 246, 248 (N.Y. 1992), quoting from Charlebois v. J. M.
Weller Associates, Inc., 531 N.E.2d 1288, 1292 (N.Y. 1988).
These cases illustrate Justice Holmes’s quip that there
is a strong “policy of preventing people from getting
other people’s property for nothing when they purport
Nos. 08-4030 & 08-4248 9
to be buying it.” Continental Wall Paper Co. v. Louis Voight
& Sons Co., 212 U.S. 227, 271 (1909) (Holmes, J., dissenting).
John Hancock’s taxes are a matter for it to resolve with
the IRS; that John Hancock may have set out to take
larger deductions than the law allows does not affect
Hoosier Energy’s contractual duties.
This leaves the doctrine of “temporary commercial
impracticability.” John Hancock’s principal argument on
this front is that New York law does not recognize any
such doctrine. Like other states, New York recognizes
the doctrine of impossibility—but even then only the
kind of impossibility that the parties could not have
anticipated. As John Hancock describes things, the
parties anticipated the possibility that Hoosier Energy,
Ambac, or both might get into financial distress and
provided what was to happen: if Hoosier Energy did not
come up with better security in 60 days, John Hancock
could draw on the credit-default swap to protect it-
self. When the economy turned sour, and the risk mate-
rialized, John Hancock tried to take advantage of this
extra security. Yet the district court deemed the risk’s
coming to pass as a reason why John Hancock could not
draw on the security. John Hancock sees this as perverse,
an order that defeats the parties’ bargained-for alloca-
tion of risks. The district court may have thought
that economy-wide conditions justified this reallocation,
but it is hard to see how an economic downturn can
be alleviated by making contracts less reliable. En-
forceable contracts are vital to economic productivity.
See Simeon Djankov, Oliver Hart, Caralee McLiesh &
Andrei Shleifer, Debt Enforcement around the World, 116 J.
10 Nos. 08-4030 & 08-4248
Pol. Econ. 1105 (2008); Thomas Cooley, Ramon Marimon &
Vincenzo Quadrini, Aggregate Consequences of Limited
Contract Enforceability, 112 J. Pol. Econ. 817 (2004).
Whether Hoosier Energy’s performance was “impossi-
ble” in the strong sense that contract law requires
depends on what its obligations were. John Hancock
urges on us the perspective that, when Ambac’s credit
rating slipped, Hoosier Energy had an option: find a
new surety in 60 days, or pay Ambac the sums to
which Ambac would become entitled once it paid John
Hancock. The holder of an option may not be able to
take advantage, but that differs from impossibility. Sup-
pose that Hoosier Energy had an in-the-money option
to purchase the Indianapolis Colts by the end of
December 2008, and that as a result of the reduced avail-
ability of credit it was unable to find a lender to finance
the transaction. That would not make performance
“impossible” and extend the option’s expiration, effec-
tively giving Hoosier Energy a new option (for 2009) for
free. Likewise if Hoosier Energy had borrowed
$100 million and was obliged to pay the money back on
October 1, 2008. That Hoosier Energy found itself unable
to borrow money to roll over the loan would not excuse
repayment; the “impossibility” doctrine never justifies
failure to make a payment, because financial distress
differs from impossibility. See Restatement (Second) of
Contracts §261 & comment d.
The uranium case illustrates these propositions. Westing-
house sold uranium on long-term requirements con-
tracts at fixed prices, thus assuming the risk that market
Nos. 08-4030 & 08-4248 11
prices would rise (and it would lose money). Westinghouse
anticipated that market prices would fall; its customers
thought they would rise, or at least wanted protection
against higher prices. And rise they did, partly as a
result of a cartel. Westinghouse had neglected to protect
its position in futures markets or through long-term
forward contracts. Faced with large losses if it had to
buy uranium on the spot market and resell to customers
at lower prices, Westinghouse contended that the unan-
ticipated spike in uranium prices made its performance
impossible. The argument failed; the court observed
that Westinghouse and its customers had negotiated
over the risk of higher prices for uranium, and that the
occurrence of the risk did not excuse one side’s perfor-
mance. Even if the losses drove Westinghouse into bank-
ruptcy, that would not make performance “impossible”;
it would just assure that all of Westinghouse’s creditors
received equal treatment. See In re Westinghouse Electric
Corp. Uranium Contracts Litigation, 563 F.2d 992 (10th Cir.
1977); Richard A. Posner & Andrew M. Rosenfield,
Impossibility and Related Doctrines of Contract Law: An
Economic Analysis, 6 J. Legal Studies 83 (1977).
Much the same can be said about Hoosier Energy. If
keeping its promise to Ambac drives it into bankruptcy,
this ensures equal treatment of its creditors. It is hard to
see why Hoosier Energy should be able to stiff John
Hancock or Ambac, while paying 100¢ on the dollar to all
of its other trading partners, just because the very risk
specified in the contracts between Hoosier Energy and
John Hancock has occurred. Hoosier Energy did not
expect an economic downturn, but Westinghouse did not
12 Nos. 08-4030 & 08-4248
expect an international uranium cartel. Downturns and
cartels are types of things that happen, and against which
contracts can be designed. When they do happen,
the contractual risk allocation must be enforced rather
than set aside. The district court called the credit crunch
of 2008 a “once-in-a-century” event. That’s an overstate-
ment (the Great Depression occurred within the last
100 years, and the 20th Century also saw financial
crunches in 1973 and 1987), and also irrelevant. An
insurer that sells hurricane or flood insurance against a
“once in a century” catastrophe, or earthquake insur-
ance in a city that rarely experiences tremblors, can’t
refuse to pay on the ground that, when a natural event
devastates a city, its very improbability makes the
contract unenforceable.
We postponed discussing New York law until the
general points of contract doctrine had been set out. New
York law is consistent with what we have said; indeed,
New York takes a very dim view of “impossibility”
defenses and has never suggested that, when an impossi-
bility defense is unavailable, a “temporary commercial
impracticability” defense might serve instead. New York
courts refuse to excuse performance where difficulty
“is occasioned only by financial difficulty or economic
hardship, even to the extent of insolvency or bank-
ruptcy.” 407 East 61st Garage, Inc. v. Savoy Fifth Avenue
Corp., 244 N.E.2d 37, 41 (N.Y. 1968). This applies to finan-
cial instruments—and, although impossibility might
allow a party to suspend its obligations under a finan-
cial swap contract, this means more than a short-term
inability to pay money. General Electric Co. v. Metals
Nos. 08-4030 & 08-4248 13
Resources Group Ltd., 741 N.Y.S.2d 218 (App. Div. 2002). For
its part, Hoosier Energy all but ignores New York law;
its brief cites only a single decision, by a trial court; ap-
pellate decisions go unmentioned. And the trial-court
decision that Hoosier Energy cites speaks of temporary
impossibility, not “temporary commercial impractic-
ability.”
All of this assumes, however, that John Hancock is
right to characterize Hoosier Energy as having an option
to find a better surety. As Hoosier Energy understands
the contract, however, it had a duty to find a better
surety, and failure to perform this duty was the default
allowing John Hancock to draw on the swap. Then it
might be possible to make out a real impossibility
defense, meaning that (a) all parties to the transaction
assumed, when they negotiated the terms, that it
would be possible to find some other intermediary with
adequate credit standing, and (b) as a result of a finan-
cial crisis, no such intermediary existed in late 2008, no
matter how much Hoosier Energy offered to post in
liquid assets to secure its obligations.
Even this would be a difficult defense to make out
under New York law. The leading New York case on
impossibility, Kel Kim Corp. v. Central Markets, Inc., 519
N.E.2d 295 (N.Y. 1987), says that the defense works only
if some unexpected event upsets all parties’ expectations;
it is not enough that the unexpected event puts one side
in a bind. The lessee of a roller skating rink was
required by contract to obtain liability insurance, which
it got and maintained six years before the insurer
14 Nos. 08-4030 & 08-4248
declined to renew. When the policy expired, the lessor
asserted default, and the lessee sought a declaration that
performance was excused by impossibility, because no
insurer would underwrite a liability policy for a roller
rink at any price. Rejecting the lessee’s argument, the
Court of Appeals stated that impossibility can excuse
performance only if the new event “could not have
been foreseen or guarded against” in the contract.
Financial distress could be and was foreseen; that’s
what the credit-default swap is all about. But if no one
could have foreseen the extent of the credit crunch in
2008—and if it really made performance impossible, a
subject on which the parties profoundly disagree—then
the sort of argument that Hoosier Energy makes could
satisfy the requirements of Kel Kim.
We have said enough to show that there is uncertainty
about how this suit comes out under New York law. It is
uncertain whether Hoosier Energy had a duty to replace
Ambac, or just an option; the impossibility defense is
unavailable if the option characterization is correct. (We
have avoided quoting the documents; some portions
of these lengthy contracts support each side’s charac-
terization of them.) It is uncertain whether the extent of
the 2008 credit crunch, which extended into 2009, was
foreseeable. It is uncertain whether Hoosier Energy
could have replaced Ambac by offering more, or better,
security to another intermediary. Hoosier Energy under-
mined its own position in the litigation by telling
John Hancock that it was negotiating with Berkshire
Hathaway and could strike a deal with just a little
more time, which implies that replacing Ambac was not
Nos. 08-4030 & 08-4248 15
impossible, but John Hancock returned the favor by
suggesting that this deal was just pie in the sky and that
Hoosier Energy would not or could not ever replace
Ambac—and, if “could not” is the right understanding,
perhaps performance was impossible after all.
All of these uncertainties collectively support the
district court’s conclusion that Hoosier Energy has some
prospect of prevailing on the merits. Because appellate
review is deferential, the district court’s understanding
must prevail at the interlocutory stage.
But what was impossible in fall 2008 may well be possi-
ble in fall 2009. What is more, the longer this impasse
continues, the more the balance of equities tilts in favor
of John Hancock. Recall that the reason for the credit-
default swap was concern that the Merom station would
eventually become non-economic because of changes in
the market for electricity, the regulation of emissions
from coal-fired stations, or the advancing age of the
plant. The more time passes, the more serious this
risk—and the greater the risk that one or another
problem may afflict Hoosier Energy as a firm. If, as
Hoosier Energy asserts, meeting Ambac’s demands
under the swap contract will drive it into bankruptcy,
then Hoosier Energy must be skating close to the edge,
and the longer it skates there the greater the cumulative
risk that it will fall over. Similarly Ambac may become
less desirable as a swap partner; while this appeal has
been under advisement, Ambac’s credit rating has been
reduced twice.
John Hancock is entitled to the security it negotiated
against these possible outcomes. The injunction bonds,
16 Nos. 08-4030 & 08-4248
at only $22 million in liquid security, do not cover
John Hancock’s exposure. The change in Ambac’s credit
rating, in particular, requires the district court to take a
new look at the adequacy of the Rule 65(c) security
promptly after receiving this court’s mandate (which
will be issued together with this opinion). So although
we affirm the district court’s preliminary injunction, we
conclude that, if Hoosier Energy has not produced a
replacement for Ambac by the end of 2009, the time
will have arrived when the court must let John Hancock
realize on its security. The district court itself stressed the
word “temporary” in “temporary commercial imprac-
ticability”; we are confident that the court will not allow
“temporary” to drag out in the direction of permanence.
A FFIRMED
9-25-09