- When the FDIC Takes Over a Failed Bank: Business Pitfalls and Opportunities
- June 7, 2010 | Author: Joshua M. Glazov
- Law Firm: Much Shelist Denenberg Ament & Rubenstein, P.C. - Chicago Office
The FDIC has taken over more than 205 failed banks since the start of 2008. This affects nearly every U.S. business, and many outside the country. Analysts forecast even more bank failures in 2010. A bank failure will probably affect your business in the next two years, regardless of whether you are a depositor, borrower, guarantor, letter of credit beneficiary, contractor or another bank.
But you can prepare by becoming familiar with how the FDIC (sometimes called the corporation) takes over a failed bank and disposes of its assets, as well as the FDIC's extraordinary powers. That knowledge may even yield new opportunities for your business.
For starters, banks and other depository institutions don't actually go bankrupt. The Bankruptcy Code doesn't allow it. Instead, when a bank becomes insolvent, its state or federal chartering authority orders the bank into receivership and usually appoints the FDIC as the receiver. In that role, the FDIC assumes control over the bank's receivership estate, which includes the bank's assets (e.g., loans with payments due, investment securities) and liabilities (e.g., deposits, undisbursed loan funds, leases, qualified financial contracts).
Since 1933, Congress and the federal courts have granted the FDIC extraordinary powers that help the corporation manage a failed bank's receivership estate and enhance the value of the estate's assets. These powers allow the FDIC to maximize the amount of money paid in exchange for the estate's assets. And that reduces payments from the Deposit Insurance Fund to insured depositors and successors who acquire those assets with assurances or subsidies from the FDIC. Below are some of the most remarkable of the FDIC's powers:
- Disregarding a failed bank's so-called agreements, including loan modifications
- Repudiating a failed bank's contracts, including leases, service contracts, and obligations to fund future loan disbursements and letter of credit draws
- Temporarily suspending litigation involving a failed bank
- Extending statutes of limitations on claims by a failed bank, and even reviving some statutes of limitations that have already expired
Extraordinary Powers: Disregarding Agreements
Under federal statutes and U.S. Supreme Court decisions, if an agreement between a failed bank and various parties (including borrowers, guarantors and other creditors) does not comply with certain requirements, that agreement is not enforceable against the FDIC. In fact, the FDIC may disregard these agreements. Common among these unenforceable agreements are loan modifications.
To avoid this fate, what requirements must an agreement comply with?
- The agreement must be written.
- The agreement must be signed by both the bank and the other affected parties (e.g., the borrower, guarantors, junior/senior lenders) when the bank acquires the asset (usually a promissory note).
- Either the bank's loan committee or its board of directors must approve the agreement and document that approval in its official minutes.
- The agreement must be continuously maintained in the bank's official records (i.e., in a place where bank regulators will see the agreement during regulatory examinations and audits).
In this context, "agreement" includes much more than the traditional notion of an agreement. It is defined broadly to include any assurance or concession from bank personnel, regardless of whether it is (1) oral or written, (2) a bilateral or multilateral exchange of promises, (3) an informal statement, representation or assurance, or (4) honest, or even fraudulent.
Prime examples of actions that qualify as an agreement include:
- Overlooking a missed payment
- Reducing interest
- Waiving/reducing fees or default interest
- Postponing a maturity date
- Releasing a guaranty
- Promising to forbear from declaring a default, accelerating a note or foreclosing against collateral
- Agreeing to accept less than the full amount of a debt
The FDIC may disregard any of these actions if they do not satisfy each of the four enforceability requirements mentioned above—an extraordinary power that often renders the FDIC immune to most lender liability claims.
And it is not just the FDIC that enjoys this extraordinary power; so do its successors, including:
- Healthy banks that purchase loans from failed bank receiverships under an FDIC purchase and assumption transaction
- Joint ventures composed of the FDIC and private investors that manage and collect loans formerly held by failed banks
- Trustees and servicers that collect on loans securitized out of a failed bank's receivership estate
- Private investors that buy loans formerly held by failed banks
For those who buy or invest in loans from failed bank receiverships, this extension of the FDIC's powers offers opportunity. For example, they may disregard informal agreements and enjoy immunity against legacy lender liability claims and defenses against payment. The result could be summary due diligence that is less intense and less costly, as well as the ability to underwrite higher, more competitive prices
for loans from failed bank receiverships.
Those entering into, or relying on, anything that qualifies as an agreement from a bank (especially a loan modification) are wise to focus special attention on complying with the four enforceability requirements mentioned above. Those who do not may find their agreements dishonored and undone.
Extraordinary Powers: Contract Repudiation
As receiver, the FDIC may repudiate contracts inherited from a failed bank if the corporation considers them burdensome to the administration of the receivership estate. Post-repudiation, the FDIC is no longer obliged to perform under the repudiated contract. Examples of repudiated contracts and their consequences include:
- Loan agreements: No disbursement of undisbursed loan proceeds (i.e., no more draw payments under a repudiated construction loan agreement and no more disbursements under repudiated revolving line of credit loans)
- Letters of credit: No payment to beneficiaries under a repudiated letter of credit
- Leases: No rent payments under repudiated leases
The FDIC must repudiate a contract within a reasonable amount of time after its appointment as receiver. Although the definition of "reasonable" depends on the individual circumstances of the failed bank and the contract in question, a reasonable time is usually no fewer than 90 days after appointment.
Unlike in bankruptcy, where a judge must first approve the rejection of a contract, the FDIC may repudiate unilaterally just by sending a letter announcing the repudiation and explaining what the recipient may do in response. Typically, the recipient may file a claim against the failed bank's receivership estate for the damages suffered as a result of the repudiation. But the recipient must act fast. The deadline for filing claims is usually only 90 days after the date of the repudiation letter.
The FDIC also decides how much to allow as repudiation damages. These damages are limited by federal law to actual, direct and compensatory damages and specifically exclude damages for pain and suffering, lost profits and lost opportunities that the recipient suffers. Once the FDIC decides the amount of the claim allowed, the recipient is entitled to a pro rata share of the money in the receivership estate available to general unsecured creditors. Because failed bank receiverships rarely have money left to pay general unsecured creditors, those who hold repudiation damage claims rarely receive even partial payment on their claims.
If you have an undisbursed loan, letter of credit, lease or some other contract with a failed bank, watch your mailbox for a repudiation letter. If one arrives, act quickly to submit your claim before the deadline. But keep your expectations modest. The odds for payment are usually remote.
Extraordinary Powers: Stay of Litigation
Once a bank goes into FDIC receivership, the FDIC may suspend any pending litigation or administrative proceeding involving the failed bank for up to 90 days. This gives the corporation's receivership staff and consultants time to familiarize themselves with pending litigation and proceedings. Those involved in a case where a failed bank is also a party may find the case frozen for up to 90 days while the FDIC takes stock of the case and decides how to approach it.
Extraordinary Powers: Extending the Statute of Limitations
Once the FDIC is appointed as a failed bank's receiver, the Federal Deposit Insurance Act preempts the statutes of limitations under state and other federal law, allowing the corporation to:
- Postpone when those statutes of limitations expire
- Even revive an expired statute of limitations in select cases, including claims involving alleged fraud or intentional misconduct, often alleged against the failed bank's former officers and directors
The result? The statute of limitations on claims the FDIC brings as receiver runs for a longer period of time. Consequently, the receiver (and those parties that succeed to those claims from the receiver) have more time to pursue claims against borrowers, guarantors, vendors, rival creditors and the failed bank's former management.
The Upshot for Your Business
With the FDIC holding such extraordinary powers, each bank failure has dramatic, and often unanticipated and unintended, consequences. You can prepare yourself with advance knowledge of how the FDIC becomes the receiver for a failed bank, the extraordinary powers the corporation wields, and who else may also use those powers. And it may even present an opportunity for you and your business to work with the FDIC in the process of resolving failed banks and returning their assets to private ownership and operation.