Banking Law

It's not often that the so-called "Superpowers" of the FDIC as receiver of a failed bank are curbed. However, Kevin LaCroix discussed a recent decision of the federal Second Circuit Court of Appeals that clipped the FDIC's wings in his The D&O Diary blog.

The suit arose out of a claim by the FDIC against a failed bank's fidelity bond, based on a fraudulent loan scheme allegedly concocted by officers of Connecticut Commerce Bank (CBC), which failed in 2002. The issuer of the bond denied coverage on the basis that CBC had made false statements and omissions on its application for the bond. The FDIC sued the issuer, alleging that such defenses are barred by the dreaded provisions of 12 USC 1823(e), which provides:

No agreement which tends to diminish or defeat the interest of the Corporation in any asset acquired by it under this section or section 11, either as security for a loan or by purchase or as receiver of any insured depository institution, shall be valid against the Corporation unless such agreement--

(A)  is in writing,

(B)  was executed by the depository institution and any person claiming an adverse interest thereunder, including the obligor, contemporaneously with the acquisition of the asset by the depository institution,

(C)  was approved by the board of directors of the depository institution or its loan committee, which approval shall be reflected in the minutes of said board or committee, and

(D)  has been, continuously, from the time of its execution, an official record of the depository institution.

The section lists some exceptions to this general rule, none of which were applicable to this case.

The district court granted summary judgment in favor of the bond issuer and the Second Circuit upheld the district court's decision. While holding (contrary to an earlier Sixth Circuit opinion) that the fidelity bond is an "asset" of the failed bank, the court ruled that 1823(e) bars "secret defenses," but not bar defenses raised by the bond itself.

The Second Circuit found that "as the grounds for rescission were plainly stated on the face of the bond, there is nothing secret about [the fidelity bond insurer?s] misrepresentation defense." To recognize the FDIC?s position, the Second Circuit said, would be to "strike the rescission clause from the bond."

Kevin asserts that the decision has a couple of implications. First, it affirms that notwithstanding the "Superpowers" of the FDIC and the FDIC's willingness to push the envelope on the limits of those "Superpowers," "the FDIC?s ability to enforce the failed bank?s insurance coverage is subject to the defenses the insurer may have that appear in the relevant policies." Second, "the opinion starkly demonstrates the critical importance of the policy application process and the extent of the insurer?s rights, under certain circumstances, to seek rescission."

The Second Circuit?s view of the applicant?s obligation to provide responsive information is broad and encompassing...The breadth of the ruling rescission ruling could well prove helpful to insurers in other rescission cases, even those lacking the distinctive characteristics of this case."

The nature and extent of the FDIC-receiver's powers under 12 USC 1823(e) were critically important during the last bank crisis of the late 1980s and early 1990s. With the failure of nearly 250 banks in the last year and one-half, and with many more failures coming before the current crisis has run its course, banks and those who have relationships with them (including their borrowers, correspondent banks, loan participants, landlords, and service providers) are rediscovering, often to their extreme dismay, the extent and breadth of these "Superpowers."

Those interested in learning more might consider listening to Tuesday's webinar, "Revisiting the FDIC's "Super Powers": Contract Repudiation and D'Oench Duhme," given by Haynes and Boone lawyers John Podvin and Erin Burrows.