River East Plaza, LLC v. Variable Annuity Life Insurance Co. Seventh Circuit of Appeals Appeal # Transcript of Oral Argument April 11, 2007

Transcription

1 River East Plaza, LLC v. Variable Annuity Life Insurance Co. Seventh Circuit of Appeals Appeal # 0- Transcript of Oral Argument April, 00 Arch Street, rd Floor Boston MA 00 Tel --00 Fax --

2 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- JUDGE KANNE: We now move to the third case for this morning, which is River East v. Variable Annuity. 0 Good morning Your Honor. Eric Brunstad on behalf of Appellate, VALIC. In this case, the District Court made two key errors. The first of which is the District Court should not have applied a liquidated damages analysis at all, and the second is the District Court applied it improperly. The District Court misapplied the burden, failed to evaluate the prepayment yield maintenance clause at the time of contracting and simply substituted MCL's ex-post proposal for what the contract actually contains. Now let me explain why this is important and why this has generated a huge windfall for MCL. MCL acquired this property for $. million. Three years into the loan decided that it wanted to sell the property to Costco for about $ million. Went back and renegotiated a higher purchase price to cover the prepayment premium and then sought to, once it got the money from Costco, sought to invalidate the prepayment premium that it had, in fact, got from Costco. But Mr. Brunstad, I want to point out a couple of things. First of all, they at least, if we want to

3 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 have a discussion that engages the argument fully, say that from the very beginning, from the day you signed that contract, the flat rate treasury formula that you were using systemically was going to overcompensate your clients. And so it's not so much an ex-post problem as a problem that this was a clause that, from the very start, was going to be an oppressive clause. Now I recognize this assumes we're using liquidated damages analysis. A lot of courts do use that kind of analysis so I think that's... that's one thing. And secondly, if you want to get into the Costco transaction, the amount of money that they factored in was on the order of $ million, way less, it was less than 0% of what your client... the many calculations... I wasn t really sure why your client seemed to have so much problem with the math here... That's right, Judge (laughter) Well anyway, it was about half. Sure Judge Wood, and that's because they miscalculated the make-whole premium themselves. But on your first point, I think it's important to explain why their argument just simply cannot be true. This is a $ trillion market, the mortgage

4 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 backed, the debt market, of which insurers have about $00 billion invested. This yield maintenance provision is a standard provision and here is why... With no basis points added though? Correct... Flat? Treasury flat and that's exactly correct and here is why. Insurers hold these loans. They don t sell them on the secondary market. AT the time of the loan, we do not know in the future if the insurers are going to be able to reinvest in anything other than treasuries and this is important to keep in mind, because they are regulated. Their portfolios are regulated. They have regulatory pressures. They have to keep balanced portfolios. They must match their assets to their liabilities including the riskiness of their assets. We do not know, five, ten,,, years in the future, if there is... if they're going to be able to invest in commercial real estate mortgage loans at all. So this provision protects the down side...

5 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 To... I mean, it seems like such an expansive thing to say. Surely there must be a price at which they could choose to reinvest in commercial real estate mortgage loans, right? No, Your Honor, no. I guess your... They may not be available. They may not be acceptable in their portfolio for regulatory reasons. They may not be able, they may not be able to competitively get them. Because remember, there's a link between the interest rate that insurers charge and the yield maintenance clause. Sure, sure. They... here MCL got the benefit of the lowest interest rate in the market in exchange for this term. Now they want to say, "Oh, we don t want to be stuck with the term." Again, insurers need predictable income source because they have to match this asset to what they pay out. If you take away this clause, treasury flat, which is the industry standard, you will do two things. One, make it impossible for them to offer the interest rate they offer which is very, very competitive, and two, perhaps prevent them from making these

6 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 kinds of loans at all. And again, this is a $00 billion market. What was the evidence in the record that treasury flat is the industry standard? Because the District Court, of course, does not accept that. The District Court looks at this basis point spread that existed at the time of this loan, and he sort of seems to use that... I don t know whether he's using it as an example or whether that's always the way it should be. Judge, he made that up. That was a simply made up. The point... the testimony... there's no testimony that point spread is standard in the market at all. The only... Is there... what's the testimony that treasury flat is, in fact, the industry standard and anybody who gets basis points put in is just getting gravy? Grenadier, Owen, and the case law. If you look to Hidden Lake, you will see an extensive analysis in that case about how treasury flat is the industry standard. Sometimes, but rarely, as the Hidden Lake court pointed out, is it negotiated where you might add basis points or 0 basis points but never anymore. And that's also the testimony in

7 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- this case. The -point spread was simply made up. There's no basis in the market for it. There's no basis, really, in the record for it. It's just simply what the District Court felt was fair and that can't be the test. Here, the correct test, even assuming you apply a liquidated damages analysis, is whether the clause, the amount, greatly exceeds the upper range of estimated damages. Now they cannot satisfy that burden here. This was, this was a pretty high yield, right? Didn t they come up with the number %? Well that was if you took into account the mathematical error. It's more like the high 0%. But if you look across the cases, those similar percentages have been upheld across the board. Why? Because there's a quid pro quo, lower interest rate, higher prepayment yield. Remember, this is a business transaction where... 0 JUDGE KANNE: And it was negotiated. There was... and signed, and no objection to that at all was there? Correct Judge Kanne. They simply said, "strike the clause," the insurer refused and then there was no further discussion. They dropped the point.

8 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- Nobody ever comes back and says, "how about 0 basis points, how about, you know," that discussion never happens? 0 They didn t do it. OK. They did not do it. Now back to the point of why this is... it was completely inappropriate to apply liquidated damages analysis at all. Yeah, I... there's a question I wanted to ask you about that as you introduced this subject, which is that reading the briefs it looks like we're being given a binary choice here. Either you're going to use the liquidated damages model or you're going to use, what I'm calling your approach is, the freedom of contract model. You know, sophisticated business parties can arrange these things for themselves and you just have to ask kind of basic contract questions. Are those the only two options? Is there any third approach any court has taken? Or is it really just liquidated damage versus freedom of contract. Those are the two, those are the two paradigms Your Honor. But remember, liquidated damages applies not in voluntary prepayment context, which this is.

9 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 Where you don t have damages, you don t have a liquidated damages analysis. Here's... OK, but just to... just to follow up then, you don t know of any other approach other than two that might take? We just have to pick which... Not one that's been accepted by any court.... we think is... OK. These are the two paradigms. Liquidated damage analysis does not apply because, again, we have a voluntary prepayment and we cite the Equitable Life case for this. It's an Illinois Appellate Court decision that clearly says that these kinds... these kinds of prepayment yield maintenance provisions are enforceable. Such provisions have been routinely upheld and enforced where the mortgagors election to call the loan to maturity was voluntary. Why? Because it's simply an alternative form of performance. You basically have an option to not pay for the entire loan but you can prepay it all now and this is the price and that's what they purchased when they took out the loan and the insurer's entitled to rely on that. Because there is no damages, there is no liquidated damages analysis, and that's important because the

10 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 reason why we have this liquidated damages analysis is to protect borrowers, perhaps, in instances where they breach, perhaps for something that's trivial. But you... And we want to put a cap on the damages. That doesn't apply here and the Illinois Courts recognize that that doesn t apply here, and I think we're bound by that. But... Here's maybe the problem with that. I mean, I certainly understand the point that, you know, if, hypothetically, you know, you didn t even have the right to prepay, you would have more or less the same economic effect as a prepayment fee that brings the yield back up to where you want it to be. But, putting that to one side, if you're locking somebody in to a 0 year, a 0 year, a very long term arrangement, there might be some public policy reason, liquidity in markets or the like, to say that we don t want the price of choosing to pay sooner to be, you know, double, triple, quadruple, some huge number, some punitive level. But that's not really my point Your Honor.

11 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 I think that's why the courts are... that's what the courts... why they sometime do apply liquidated damages analysis to this. Your Honor, if you look at, for example, the Slevin case which is the Illinois Supreme Court's discussion on liquidated damages, that was an involuntary... Sure, no, I understand.... and the court said, "it's an election of remedies." You can say I want my money now, in which case you waive the interest, or you can say, pay me over time and pay me the interest. But the reason that I'm, I'm trying to look at this is because even though it's voluntary in a sense, if you have something sufficiently punitive, it's not a real choice. It's as though it's not even there at all, right? Yes, but here... this can't be considered to be sufficiently punitive, even under liquidated damages analysis, because when we do the loan, we have to look at this when the loan is made out, it is perfectly conceivable that years from now, if we're in a depression for example, the only thing the insurers can invest in is treasuries. That is

12 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 the only thing. So by using treasuries as the benchmark, it cannot be grossly disproportionate to the upper range of damages. It simply cannot be. Because years from now that may be the only thing they can invest in. They cannot satisfy the liquidated damages test. But again, the liquidated damages test doesn t apply because the public policy reason for it doesn t apply here. There's no reason to protect borrowers from their own bargain they willingly enter into here. The public policy behind protecting borrowers with a damage cap in the liquidated damages is because, perhaps, they might breach for some inconsequential reason, you know, something beyond their control. If that happens, then you could see where public policy would come in and say, well, we're not going to hold them liable for, you know, 0% of the loan balance, something that is grossly disproportionate. But whereas here, the standard reason why, in this context you have voluntary prepayment is, they want to sell the property for a profit, or, they simply want to refinance for a lower interest rate. Both of those are simply where they want to make more money. That is not a

13 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- reason to excuse them from the burden of the contract which they freely entered into. If there are no further questions at this point, I'd like reserve my time... balance of my time for rebuttal. JUDGE KANNE: That's it. Thank you. JUDGE KANNE: Mr. Holtzman? 0 May it please the Court, Arthur Holtzman appearing on behalf of Appellee River East, LL... River East Plaza, LLC. The trial court found the yield maintenance clause of the prepayment provision in the loan agreement between Appellant VALIC and River East to be an unenforceable penalty. That decision should be affirmed for many reasons. First, it's punitive. Why is it punitive when it's tied to a rate which itself, as we've certainly seen, fluctuates up and down and, you know, there will be sometimes that the spread is a little larger, sometimes it's a little smaller but I don t really see how a court is supposed to decide that treasury flat is unreasonable and treasury plus basis points might still be unreasonable but treasury plus is looking OK. I mean, you know, this is not a court

14 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 kind of decision. These are sophisticated commercial parties. Both sides experts, case law, and commentators say, "the use of treasuries flat without any basis points will overcompensate the lender." But you know, in some ways I would say, overcompensate means something a little different to you than it might mean in the... in the law. Treasury flat, if you assume that there's a market for commercial loans, which we can also assume because there's going to be some degree of greater risk in those loans than the risk of the United States failing, or I certainly hope so. (laughter) I think things haven t gotten that bad yet. But anyway, so yes, I mean if you get the treasury flat rate, maybe the dollars will come in but on the other hand, as I recall in this record, people don t re-loan money instantaneously. Something like, I think it said, one in five, one in six, some number like that of possible investments are accepted. They're are transaction costs and your opponent has argued very firmly this morning that there could be market environments in which only treasury bills would be reasonable.

15 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 None of that's in the record. The portfolio of VALIC is about $ billion, I think, with % of it in either bonds or Ginny Maes or Freddie Macs. Only about % in commercial real estate mortgages. Your Honor if we use the clause that VALIC has us use and, just hypothetically, what if the loan is repaid the same day it's taken out. That the treasuries and the CREM, commercial real estate mortgage rates, hadn t changed. That formula still results in a $. million penalty to be paid to the lender... I don t see what and that's with no movement at all. But your argument assumes two other things that I'm not sure make any sense in, again, in a commercial context. As you say, there's a dollar figure you could associate with immediate repayment but there's also an interest rate figure that you could associate with that dollar figure and I don t think you'd be here arguing that there was a penalty if you... instead of.0% interest, I'm not going to do the math right, but suppose it was.% interest. Or some other interest rate that would, over the life of the loan, do... cause you to pay

16 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- that extra amount of money. So that's one thing, and certainly, even though the market has become accustomed to prepayment clauses, there's nothing against the law that I'm aware of in writing a loan that doesn t have a prepayment clause. So if you didn t have that at all, you would be in the same situation. Your Honor, we're not here attacking prepayment clauses, we're attacking... No, I'm just saying economically speaking, your complaining that you had to pay a premium to get out of the loan and I'm not sure that there is some reason to relieve you of your bargain. No, Your Honor, we're not complaining we had to pay a premium. We're complaining that we had to pay an unreasonable and punitive premium. 0 JUDGE KANNE: Well you indicated earlier that the treatises and case law indicates that the flat, treasury flat, was not used. But you entered into the agreement with that provision in there. We entered into it and counsel for River East Plaza, Schiff Harden, indicated that it might turn out to be a penalty, might be unenforceable and

17 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 carved out in their opinion letter, the enforceability of that provision. But that doesn t mean you didn t sign the contract. It could have been carved out in opinion letters and as soon as you sign the contract, you sign the contract. People sometimes sign contracts and there's later litigation and there are attorney's fees and shifting provisions in this contract, I wouldn t say that that is any sign that this was not an agreement that both sides signed. And indeed, there's a course of performance after the agreement so if you wanted to get into that, you also have that. No, but, but, when you go to the Restatement d of Contracts which the Jameson case takes us to, which a number of other cases takes us to in Illinois, we look at whether or not this clause is reasonable in light of actual or anticipated damages. Well, all I'm saying is the Restatement of Contracts nowhere says, "if you're lawyer gives you an opinion letter that questions a particular clause, then that part is erased from the contract." I mean 0 doesn t say that, nothing, I mean obviously in the sale of good context.

18 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 No, but Your Honor, Jameson says that the parties had intended to agree in advance and our position is that the Defendant can't meet that test of what is a proper liquidated damage clause in Illinois because by the borrower, ab initio, during negotiations saying, "listen I just want to put you on notice, this clause may be unenforceable the way it's written." That would have... that would require us to ignore the integration clause I think. Well, Your Honor, the clause itself, because it results in unreasonable overcompensation to the lender, is unenforceable. They could have drafted and negotiated a more reasonable clause that would be enforceable. Well, but that has nothing to do with the opinion letter. It has nothing to do with anything. If you're... I mean, one can adjudicate and you are asking us to do that, whether a particular clause in a contract can be enforced as against public policy, you know, or should be refused as against public policy, that's the fundamental theory in these liquidated damages cases. But it really has nothing to do with the opinion letter or anything

19 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 else and if you get down to the liquidated damages, I would ask again, I don t know how in a situation where the penalty is tied, or the fee if you will, you didn t call it a penalty, the fee is tied to a rate which itself fluctuates with the same market factors that would cause a borrower to want to prepay. And it's two commercial parties entering into a commercial loan, I don t know where a court is supposed to draw the line when it becomes unreasonable. First of all, the sophistication of the parties this court made clear in Checkers Eight is irrelevant to the analysis of whether the liquidated damage clause is a penalty or not. Otherwise, as I think Judge Flaum said, we would be validating every clause. So whether or not the parties are commercially savvy or not is irrelevant in the analysis. But you know, I'm kind of uncomfortable... I mean it seems to me, it is important that this is a commercial loan. This is not a consumer loan. It's not somebody buying their house, you know, there are other rules that apply in the consumer context.

20 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- This is a situation where because we know going in it will overcompensate the lender, by definition, we submit it can't be reasonable. But by how much over compensation? $0, $ million, $ million? 0 Well, again we know, to use the example of the same day, it's a $. million and that's not reasonable. We know that compared to the amount that that was being prepaid, it's %. Your Honor, there is no reported case that we found where any court has enforced a prepayment penalty of % of what's being paid. And as Your Honor pointed out, it originally was %. So if we go back... Well that was all this math craziness. I don t know why... But Your Honor no one could figure out what the amount was. (laughter)... that goes back to intended to agree. We submit that when VALIC's own servicing agent, GEMSA, can't correctly calculate the amount then it's hard to say that everybody agreed on what this thing meant and how to apply it. It wasn t just two numbers Your Honor. In fact, we were litigating the case

21 River East v Variable Annuity Page 0 Seventh Circuit of Appeals, 0-0 when VALIC, excuse me, when River East's expert, Chip Morrow, discovered an $,000 error. We had to amend the Complaint to convince VALIC to pay it back and finally they agreed. They did, yes. The wrong date was used and that's years after the lawsuit is filed. So we submit that's further evidence of what we're dealing here is not an unreasonable... not a reasonable, enforceable provision. I don t think that's evidence of unreasonableness. It may be evidence that the formula reflected in the loan agreement was ambiguous or something but I don t see anyone developing an argument on that basis. Your Honor, Mr. Brunstad talked about the impact on the industry. I submit the record shows there was no testimony to that effect and I submit that these clauses have been attacked as far back as probably in the Skyler Ridge case, maybe before that. There's an ABA Law Review, or an ABA article we cited, "Prepayment Clauses Under Attack," so it should be no surprise to the industry that the borrowers have been challenging them for years.

22 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 With respect to the State of Illinois, we have the Jameson case. We also have Judge Shadur's opinion in Automotive Finance interpreting that these prepayment... that these clauses would use the liquidated damage analysis and I think critically important in this case when the trial court denied cross-motions for Summary Judgment in September of 00, the trial court said, "I'm denying the Motions and the trial will proceed under a liquidated damage analysis." No one challenged in from September 00 the trial court's order when he said, "this will proceed under a liquidated damage analysis." Is it liquidated damages or a penalty. We submit it's clear waiver. This is what the trial was about in 00. This is how the parties briefed it and presented the evidence. Your Honor, the Illinois Supreme Court going back, I believe, to in the Goodyear Shoe case, talked about a prepayment. Now there's a question, are they talking about an early payment or a later payment, but they certainly used... at least the Court of... the Appellate Court, which is affirmed by the Supreme Court said, "liquidated damages."

23 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 Well that's... (a) that's a rather old case and I guess the thing that's most important to me is sort of, in a sense, what difference does it make? Because not all liquidated damages clauses are illegal, you know, it's possible to have them if it's reasonable. There's a fair margin of reasonableness there because court's don t want to be in the business of drafting peoples contracts for them. And so I think we get down to, even if you're right and it's liquidated damages and there was waiver or forfeiture, whatever you want to say, we come down to the question, "why is this one so far out of line that a court should intervene." We have the testimony, under oath in another proceeding, of the loan officer, it's very, very punitive. Well what... That's the testimony of VALIC. We have the expert opinion of Plaintiff's expert and Defendant's that this clause will deter non-performance. But why... That is will deter people from prepaying. And why do we care about that actually? Suppose it is, in fact, so expensive that a rational borrower

24 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 is going to say, you know what, I'm not going to prepay. I'll figure some other way to arrange my financial affairs so I'll just keep this Note and avoid the prepayment? Because this court... What's wrong with that?... and the Courts of Illinois have said that a clause that punishes non-performance or deters it... It's not non-performance though.... is (inaudible) Your choosing an alternative method of performance. It's more economically attractive. Well as Judge Shadur said, it's non-conforming. Well I like Judge Shadur a lot but he's not on this court and he's not in Illinois Courts. (laughter) No, but I'm saying it's the Auto Finance case that the trial court also cited and used the examples and other courts and other commentators have said, "the reason why in a prepayment case, while it's not a default or a breach, it's not exactly what the lender expected." The lender is getting back it's money much earlier than it expected. And so that in this...

25 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 In a falling interest rate environment, of course, because no buyer is going to refinance if interest rates have made it more expensive. But there could be a sale. In this case, it's not a refinancing. River East, for economic reasons, needed to sell the property to Costco. And, in fact, there's no evidence that any windfall or that any huge profit, as Your Honor pointed out, Mr. McLain thought it was $ million when he made the deal with Costco... Right.... and the evidence shows he had a choice, either be sued by Costco for specific performance because he tried to get out of that deal to sell the property, or sue VALIC to invalidate or challenge the reasonableness of the clause. This was not a case where... and, in fact, the appraisal that, I think, VALIC has shows he lost money. So that's just an irrelevant issue that wasn t even presented to the trial court at the hearing. Your Honor, this is a case where because it will overcompensate, because there were more reasonable ways to calculate or create the formula, because some amount of basis points...

26 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- JUDGE KANNE: Well why weren t those negotiated? Because VALIC told River East, this clause stays in. The testimony from Felice Bressler Rose was the clause stays in. Nothing else was being offered to River East. JUDGE KANNE: Find another lender. At that time, this was the situation they wanted. They had an opinion letter from counsel carving out the enforceability and River East decided to go forward. JUDGE KANNE: But as Judge Wood pointed out, that's not part of the contract. I mean the fact that you had that opinion letter... I don t know where that goes. 0 They agreed to it but their agreement doesn t make it enforceable. When you apply the liquidated damage analysis, you're still in the situation where because it will overcompensate the lender because it is not reasonable, because it deters performance... you have testimony from VALIC's own expert saying, "a clause like this is not economically justifiable to the lender. It serves to deter non-performance and it overcompensates the lender." For all those reasons we would ask that

27 River East v Variable Annuity Page Seventh Circuit of Appeals, 0- the District Court opinion be affirmed. Thank you very much. JUDGE KANNE: Thank you Mr. Holtzman. How much time? CLERK: JUDGE: You have four minutes Mr. Brunstad. Thank you. In this case, first of all, the Financial Center case that we cite in our papers, had a premium of.% on treasury flat which is pretty much identical to the correct calculation of the premium here. So it's not true that this is unprecedented. It's consistent with how these things are calculated. The reason why it's so high... You see, this is still a bit higher. This is more like 0. or something like that? 0 Well I think it's in the 0s, I think it's like. But in this case, I think Your Honor, it's important to understand Judge Wood that here, the reason why it's so high is because they decided to cash out of this property within three years into a 0 year loan. Therefore, telling VALIC you're not going to get the interest that you bargained for these additional years. You got to look somewhere else for it. And it's important to understand, they acquired this property for $.

28 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 million. Three years later, they decide to sell it to Costco for $ million. Then they renegotiate the price for over $0 million to cover what they thought the prepayment premium was going to be. The reason why it was miscalculated, Judge Wood, is because GEMSA used the wrong model. Internally when they calculate these things, they didn t use the formula in the Note. They use an internal model that they have. They just made a mistake. VALIC recognized when the mistake was presented to it, oops. Yes, they made a mistake. Now GEMSA is a company that's a joint venture of GE and Melody. Melody was their broker that they used to acquire the loan. It's not a VALIC entity. So there was a mistake made in the calculation but it was corrected and I think it's irrelevant. I think Judge Wood, as you also point out, the opinion letter is basically meaningless. You can't have your counsel say, "oh, I don t know about the enforceability of this, therefore, we're not bound by the contract that we signed." Paragraph of the Note does contain a complete integration clause. They signed the contract. They knew what they were getting into. Again, they chose this

29 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 JUDGE: JUDGE: JUDGE: JUDGE: loan because it was the lowest interest rate in the market. The reason why it was the lowest interest was because there was this yield maintenance provision. They want all the benefit of getting the lowest interest rate and then if they decide to make a lot of money, millions of dollars, to sell the property several years into the loan, they want to cash out, they can renegotiate the purchase price to get that money and then declare it to be unenforceable as a penalty? Could I ask you... It simply isn t. Let me ask you whether there was any evidence in the record introduced by either side of the amount by which VALIC was "overcompensated" in this particular case? This money has been sitting around in escrow or paid under protest or what have you, is that right? It's sitting there. Yes. It hasn t been paid to MCL yet. We have basically a stay pending appeal supersedea situation. OK, but did anyone introduce any evidence of what the so-called windfall was to VALIC?

30 River East v Variable Annuity Page Seventh Circuit of Appeals, 0-0 JUDGE: JUDGE: It's about $. million. I mean that's what the amount is but it's not a windfall Your Honor... No, but what about the, you know, reinvestment... I guess because you don t have the money yet, you haven t reinvested it then. It's not traceable Judge Wood because when they get the money back when it's prepaid, it simply goes into the general fund. OK. But again, the point is that it's not overcompensation. What they're simply saying is that they used the word overcompensate, that's not right. And besides it is their burden to prove that this structure that they bargained for was unreasonable at the time they bargained for it and they signed the Note. What Judge... what the District Court did was it inverted that and said, "no," on page of the District Court's opinion, "it's your burden VALIC to show that this was reasonable." And here, I have MCL saying well you could have done it this way, you could have done it that way. That inverted the burden and that was completely improper as this Court ruled in XCO, when you do that, that's reversible error. It was

31 River East v Variable Annuity Page 0 Seventh Circuit of Appeals, 0- their burden to show it's unreasonable and I submit the proper, the proper doctrine to superintend a voluntary prepayment is simply the doctrine of unconscionability which is an extraordinary high bar. Either that they were duped into signing it, which they obviously weren't, or that it is so shocking that nobody would ever enter into this kind of contractual provision. But we know this is industry standard. The testimony was that it was industry standard. They don t even allege it was unconscionable. They can't get out of the burden that they themselves took on to have this yield maintenance provision and they got all the benefit of and now three years after the fact, for profit, renegotiate it and we respectfully ask that the court be... the District Court decision be reversed. Thank you very much. JUDGE KELLY: Thanks to both counsel. The case... [End of River East v Variable Annuity Audio]

32 CERTIFICATE I, Patrick Emond, do hereby certify that the following pages, numbered through, embody a true and accurate transcript of a Seventh Circuit Court of Appeals hearing in the matter of River East v. Variable Annuity. Prepared under my direction in the Tape Transcription Center of Boston to the best of our abilities, it contains the contents of an audio file provided to me by Legalink/Merrill Corporation. Date Patrick Emond, Production Supervisor Tape Transcription Center