Back to the Future: Dealing with the FDIC as Your New Loan Participant, Lender or Seller
Law360May 25, 2010
For practitioners old enough to remember, the Federal Deposit Insurance Corporation, and its cousin the Resolution Trust Corporation, were regular players in the 1990's during the last severe bank crisis in the United States. Just like in a popular movie sequel, we too can now scream, "They're baaaaack!" Recent reports confirm the rising number of bank failures. The FDIC is opening new offices and announces more bank takeovers weekly.
As a result, borrowers' lawyers now find that the opposing party is not the lending bank, but the FDIC. Bankers and bank lawyers now find their loan participants include the FDIC. A quick review of recent cases suggests litigation involving the FDIC is returning to court dockets. Clearly, FDIC involvement is not yet near the volume it attained twenty years ago, but it is increasing. In response, this article is a refresher for those who lived through the last go around, and a primer for those without that experience.
Most people know the FDIC as the agency that insures bank deposits. It is that, but more importantly, from the perspective of an attorney involved in lending, in the event of a bank failure, the FDIC is a receiver with responsibility for liquidating the insolvent bank's assets. Probably the most famous or infamous example is the 1982 failure of Oklahoma City's Penn Square Bank. Other names that will bring back memories include The Bank of New England and Columbia Savings and Loan. These failures had very real implications for lawyers and their clients that worked through these issues.
The FDIC is a creature of statute. Accordingly, a brief summary of 12 U.S.C. § 1821 is necessary. Under this section, the FDIC as receiver succeeds to all rights and powers of the insolvent bank . It takes title to the books, records, and assets. It may conduct the insolvent bank's business, collect money due, and take any "necessary" actions to rehabilitate or liquidate the insolvent bank. It may organize a new or a bridge depository institution. Some readers likely remember the "New" Bank of New England from the early 1990's. The FDIC may also merge the insolvent bank with another bank or sell the insolvent bank to another bank. As a practical matter, however, experience has shown that despite an FDIC takeover, the same bank loan officer may remain in charge of the credit.
The D'Oench Duhme Doctrine
As a preliminary matter, anyone dealing with the FDIC needs to be familiar with the case of D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942). This case gave rise to the D'Oench Duhme Doctrine (appropriately pronounced Dench Doom). It is now codified at 12 U.S.C. § 1823(e). Simply stated, an agreement with an insolvent bank is enforceable against the FDIC as receiver only when the agreement was in writing, executed by the insolvent bank and the counterparty, approved by the insolvent bank's board of directors or its loan committee and kept in the insolvent bank's official records. There are no enforceable "secret" agreements.
The D'Oench Duhme Doctrine has two important practical implications. First, a lawsuit against the FDIC based on a course of dealing by the insolvent bank will fail, unless documented to an uncommon degree. Second, as discussed below, D'Oench Duhme has also been held to protect purchasers of loans from the FDIC.
Selected Participant Issues
In representing a participant in a multi-lender credit facility with the FDIC now acting as receiver for another participant, there are several new considerations, particularly if the insolvent bank was the lead lender. While the document may be a self-declared participation, is it really a sale of an individual participation interest in a loan made by the lead bank, or is it multiple separate loans made by lending group members to the borrower with the FDIC now acting as the lending group agent, or can it be characterized as a loan to the lead bank? The difference is extremely important. If the participants have taken a security interest in the borrower's collateral pledge to the now insolvent lead bank (uncommon), the participants should have rights against the borrower and the borrower's collateral. Lending group loans made to the borrower on a several basis should be in a similar position. If, however, the participation is characterized as a loan to the lead bank, the participant could find itself in the unenviable position of simply being an unsecured creditor of an insolvent bank.
Because of the D'Oench Duhme Doctrine and courts' general reluctance to find a fiduciary relationship in participation agreements, any legal actions against the FDIC using these underlying theories face an uphill battle. Still, lawyers representing participants should consider strategies such as whether the participation can be classified as a "qualified financial contract" pursuant to 12 U.S.C. § 1821(e)(8)(D) making it enforceable rather than a mere unsecured creditor claim.
Selected Borrower Issues
A borrower with the FDIC as its new lender faces substantial uncertainty and anxiety. The FDIC, like a bankruptcy trustee, does not have to honor the insolvent bank's financial commitments. Unlike in bankruptcy, the power is not limited to executory contracts and the decision to "repudiate," as it is called, does not require any court approval. Moreover, also unlike bankruptcy rejection, which must be a rejection of the entire contract, the FDIC can pick and choose which provisions it repudiates. For example, the FDIC can refuse funding commitments going forward, but can simultaneously sue for repayment of existing advances. The borrower will have a claim for damages, which is simply an unsecured non-priority claim against an insolvent bank; it likely has about the same chance of payment as a Russian Czarist Bear Bond from the Romanov regime.
Another issue for a borrower relates to deposits with the insolvent bank. A borrower with deposits in excess of FDIC insured amounts should seriously consider setting off the deposit against the obligation it owes the bank. If the borrower does not take this action, it will be an unsecured creditor of the insolvent bank for the amounts above the FDIC insured amount while still owing the entire loan amount. Longstanding U.S. Supreme Court precedent in Scott v. Armstrong, 146 U.S. 499 (1892) supports this strategy.
Selected Creditor Issues
While not often considered by the general public, practitioners and bankers know that banks borrow money as well as lend it. Before considering this perspective, it is important to note the difference between regulated banks and the parent bank holding companies. It is not accurate to say that bank holding companies are unregulated -- because they are. The Federal Reserve and other agencies monitor and regulate the holding companies. There is, however, a major difference in their treatment in case of financial distress.
While regulated banks can not file bankruptcy, and therefore fall under FDIC receivership, that is not true for their, many times, publicly traded parent holding companies. The holding companies are eligible for bankruptcy protection. More often, holding company bankruptcies are ultimately Chapter 7 bankruptcies, although there has been at least one successful bank holding company reorganization in Chapter 11. The first step, therefore, is to determine whether the obligation is owed by the holding company or the regulated bank subsidiary.
Repudiation, as discussed above, is a significant concern. This would be true, in particular, if the creditor is the beneficiary of a letter of credit from the insolvent regulated bank. This most likely becomes a general unsecured claim and of little to no value. The best possible characterization is for the obligation to be a deposit with the insolvent bank so that there is at least some level of FDIC deposit insurance coverage.
With respect to claims, an FDIC claim process exists which is similar to bankruptcy. The FDIC has an expedited 180 day process to determine whether a claim is allowed. 12 U.S.C. § 1821(d)(5)(A). The FDIC website contains detailed information in that regard.
Litigating With the FDIC
The FDIC as receiver may request a stay of judicial action in any court and the court is required to grant the stay for 90 days. It can also remove any state court case to U.S. District Court as it is attempting with a bank holding company's Florida Assignment for Benefit of Creditors. Some parties have opposed this seemingly unrestricted removal right by opposing substitution of the FDIC for the existing party or arguing the FDIC is not a party.
While generally subject to federal law, litigating with the FDIC is not exclusively about federal issues. As long as a state law does not conflict with the federal law, courts may utilize state law concepts. Also, in those cases when the FDIC takes over a state chartered bank as receiver, the law of the chartering state is applied as required by 12 U.S.C. § 1821(g)(4).
It has been observed that the rule regarding litigating with the FDIC is simple: the other party loses. This is a gross simplification of an extremely complex body of case law. Most relevant cases are not recent; rather, they derive primarily from the 1990's. Moreover, in at least one recent and ongoing case, the court denied the FDIC summary judgment dismissal of an unjust enrichment claim against the FDIC. MVB Mortgage Corp. v. FDIC, in its capacity as receiver for Miami Valley Bank, No. 08-771, 2009 U.S. Dist. LEXIS 93121(S.D. Ohio, Oct. 6 2009); Motion denied at 2010 U.S. Dist. LEXIS 15385 (S.D. Ohio, Feb. 19 2010).
Before litigating with the FDIC, a survey of the leading cases will provide guidance for the cautious lawyer and creative opportunities for the more aggressive advocate.
Buying From the FDIC
While recent experience is limited, reference to the 1990's provides some insight into the asset sale process as it may be implemented in 2010. Many of those sales were made by the now extinct Resolution Trust Corporation whose functions were subsequently rolled into the FDIC. At that time, the volume of distressed properties and loans for sale was significant. Also, the agencies were overwhelmed and understaffed. While generally represented by regional law firms in these sales, those lawyers found their clients challenging. For instance, getting an agency response was difficult and rarely prompt. Accordingly, while the lawyers representing the agency might have an outstanding reputation for prompt responses, their client did not necessarily enhance the lawyers' reputation.
Additionally, much of the documentation was provided in a standard form on a "take it or leave it" basis. Typically the documentation was, as in most distress situations, without warranties or representations. Clearly, the ability to negotiate language depended on whether one was representing an existing bank buying a troubled bank on short notice from the FDIC so it could reopen in 24 hours, versus a loan, loan portfolio, or specific asset. Still, the purchase process many times went very deliberately even when conducted in some type of auction format. Whether this will still be the common experience will be determined as these situations unfold.
As mentioned briefly above, a significant buyer benefit is that an asset purchaser from an insolvent bank is not liable for the insolvent bank's or the FDIC's conduct unless it is assumed in the purchase agreement. First Indiana Fed. Savings Bank v. FDIC, 964 F.2d 503, 508 (5th Cir. 1992).
In The Tempest, William Shakespeare tells us "What's past is prologue." This should not be understood as "history repeats itself." Rather, the better interpretation is that the past influences the present. In dealing with the FDIC as receiver, there has been relatively little new precedent over the past 20 years. Whether that law and associated practices will repeat themselves is uncertain. What is certain, however, is that anyone advising a client in 2010 is well advised to familiarize themselves, or as the case may be for some practitioners, re-familiarize themselves, with those statutes, precedents, and practices since many of the same issues and questions will recur.