In the last post on bank insolvency we talked about how after becoming the receiver for a failed bank, the Federal Deposit Insurance Corporation (the “FDIC”) can repudiate any of the bank’s contracts, including construction loan agreements and revolving line of credit loan agreements. So if you’re on the receiving end of contract repudiation, what do you get? Not much. That’s our topic today.
Dual Role of the FDIC
First we need to go off topic to clarify something important about the FDIC. You see the FDIC acts in several capacities; they wear two hats so to speak.
- The FDIC’s corporate capacity. The FDIC acts in their corporate capacity when they oversee operating banks, collect deposit insurance premiums, and pay deposit insurance claims to depositors after their bank fails. When you see those Suze Orman ads and posters, she’s talking about the FDIC acting in their corporate capacity. (But does she have to turn her collar up like that to do it?) And when the FDIC acts in their corporate capacity, they’re acting with the full faith and credit of the FDIC
- The FDIC in their receivership capacity. The FDIC acts in their receivership capacity when they “resolve” a failed bank as the bank’s receiver. You see this most often when they take over and close a bank down. When the FDIC acts in their receivership capacity, their liability to creditors of the bank they’ve taken over is limited to the assets of the bank they’re receiver for. Keep this limit in mind. It’s very important later.
Repudiation Claims Process
Under Section 11(e) of the Federal Deposit Insurance Act (the “FDI Act”), you can make a claim against the receivership estate for the damages you suffer because the FDIC repudiates your contract. The “receivership estate” is law talk for the assets of the failed bank that the FDIC is able to marshal and turn into cash.
Repudiation of a contract is considered a breach of the contract. But it’s a special kind of breach. There’s an unusual claims process for getting damages and the damages you can get are limited.
So after you get the FDIC’s repudiation letter telling you they just repudiated your contract, the next step is to file a claim for repudiation damages. You do this by submitting a Proof of Claim to the FDIC. Here’s a sample Proof of Claim form. They usually look something like that, but can vary depending on the situation. You might even get a form with instructions along with your repudiation notice.
You usually have 90 days days after the date of the repudiation letter to properly file your Proof of Claim, unless the FDIC sets a different claims “bar date” that’s later. Double check each repudiation letter you get.
After you file your Proof of Claim, the FDIC has 180 days to allow or deny your claim. They usually deny. After the FDIC initially denies your claim, you can appeal within 60 days after the earlier of:
- The end of the 180 day initial review period
- The date the FDIC denies your claim
And who decides your appeal? Yes, it’s the FDIC. And I bet you can guess how they decide too. So then after the FDIC denies your appeal, you can sue the them in United States District Court, either: (1) in the district where the failed bank had its principal place of business or (2) in Washington, DC.
- Statutory limits on repudiation damages
- Low priority of repudiation damage claims
- Modest receivership assets left over to pay repudiation damage claims
Statutory Limits on Repudiation Damages
Section 11(e)(3) of the FDI Act limits damage claims in two ways: (1) by the type of damages you can get and (2) by the timing of when the damages occur (i.e., when you suffer the damages).
- Limitation by type- To be allowed, your damages must be all three:
- Direct (i.e., not consequential damages)
- CompensatoryFor short, we’ll call these “ADC damages”. And under Section 11(e)(3)(B), ADC damages specifically exclude:
- Damages for lost profits and lost opportunities
- Punitive and exemplary damages
- Damages for pain and sufferingWe’re going to be most concerned with the the first exclusion for lost profits lost opportunities. Most of us have been around the commercial litigation block enough times that we don’t expect to get punitive damages or pain and suffering damages for a breach of contract.
- Limitation by timing – you’re only entitled to repudiation damages that you suffer as of the day the FDIC gets appointed as receiver for the failed bank
Example of Repudiation Damages Limits
These limitations are easier to follow once you’ve seen an example. Imagine that you’re an owner. Your project is partially complete when the bank with your construction loan fails. The FDIC takes over and repudiates your loan agreement half way through construction.
What kinds of damages will you have? Here’s some:
- Higher fees and interest you pay to a substitute lender, if you can get one
- Re-mobilization costs you must pay to your prime contractor if they suspend work because without a construction lender, you can pay their monthly interim payments
- Delay damages you must pay your prime contractor because suspending the work extends the project’s completion date, depending on the terms of your prime construction contract. These kinds of damages will probably include at least extra jobsite overhead costs, and maybe even profits the contractor lost, and opportunities on other projects they had to forego because they we working longer on your project
- Interest on late payments to your prime contractor
- Damages that your prime contractor has to pay their subcontractors – if you can’t pay your prime contractor, they may still be obligated to pay their subcontractors, but be unable to pay on time, or at all
- Termination damages. Your failure to pay on time will probably put you in default under your prime contract. And the prime contractor may respond by terminating your prime contract
- Higher fees and costs you must pay to a substitute prime contractor after your original prime contractor terminates
- The cost to remove or bond-off mechanics liens.
- Depending on the type of project, lost sales prices from sales buyers you can’t close, rent from tenants you can’t move in, and revenue lost because facilities aren’t operating to produce goods you can sell.
Repudiation Damage Type Problems
Which of those damages qualify as ADC damages? Many are traditionally considered consequential damages, especially the big ones (e.g., lost sales, lost rent, lost profits from delayed operations). Others may lean towards what are traditionally considered direct damages (e.g., out of pocket costs like a prime contractor’s extended jobsite overhead costs). It’s hard to tell whether higher substitute loan costs will be treated as direct or consequential. The others, who knows? As we’ve discussed in earlier posts on consequential damages, predicting which of your damages will be treated as direct (and allowed) and which treated as consequential (and denied) is like picking the combined ages of the bronze medalists in four-man bobsledding at the 2014 Winter Olympics.
At least one judicial decision, FDIC v. Parkway Executive Office Center, recognizes some of the damages you suffer as ADC damages. In that case the FDIC took over a bank and repudiated a construction loan on a partially completed office building. The owner claimed repudiation damages.
The owner said the damages the FDIC should allow under their claim was difference between (1) the higher market value of the partially completed building with the construction loan in place (i.e., with the expectation that more loan proceeds would be available to complete the building and (2) the lower market value of the partially completed building without the construction loan in place.
The FDIC said those weren’t ADC damages because they’re not direct. The FDIC argued that those damages are excluded lost profits and opportunities. But the judge disagreed with the FDIC. He held that the owner’s damages were direct, qualified as ADC damages, and allowed the owner’s claim.
But it wasn’t all good news for the owner. How much was that difference in value? How did the owner prove that difference? I suspect that with a partially completed office building and no rent paying tenants, they had little spare cash to pay an appraiser for expert testimony on the difference in value that was at best speculative.
Repudiation Damage Timing Problems
You don’t suffer damages on the day the FDIC gets appointed as the receiver; they usually can’t take over a bank and send out repudiation letters that fast. So your damages start after appointment – when the FDIC repudiates your construction loan agreement and stops paying in response to monthly “draw” requests. For years the FDIC has jumped on this to deny claims. They say that on the day they’re appointed, any damages you suffer from repudiation of your construction loan agreement are contingent (i.e., they’re not “fixed and certain”). And if your damages are fixed and certain in the day the FDIC gets appointed, they can deny your claim for those damages.
Well of course you’re damages can’t be fixed and certain on the day the FDIC gets appointed as receiver. That’s before the they decide to repudiate your construction loan!
Even though the literal language of the FDI Act says your damages are measured as of the day of appointment, and the FDIC continues to urge the point, most judges disagree. In cases like McMillian v. FDIC, judges have allowed claims for repudiation damages even when the damages don’t occur until after the FDIC repudiates the contract in question.
That’s exactly what played out in the Parkway Executive Office Center case. The FDIC argued that the owner’s claim should be denied because they weren’t “fixed and certain” on the day of appointment. But again the judge disagreed with the FDIC. Citing the McMillian case, he said:
Although superficially such reasoning appears consistent with Section 11(e), this argument conflicts with the statutory intent of the FDI Act to allow claims for contracts in force prior to insolvency. The FDIC’s reasoning could be extended to deny any contractual claim arising from repudiation. Such claims are always contingent on the date of insolvency because a receiver cannot repudiate a contract until after it is appointed. In this case, the contract right that gave rise to the owner’s claim was created before the FDIC was appointed receiver. So long as this right existed on the date of appointment, the damages that result from the repudiation of the obligation are sufficiently fixed and certain. The damages are simply calculated “as of” the appointment date. Any contrary interpretation would permit recovery only when a contract had been breached before receivership-a result clearly contrary to the plain language of the statute, Congress’ intent, and the common law.
If you’re a contractors, architect, engineer, or other design professional, you’ll encounter similar problems if the bank with one of your revolving lines of credit fails and the FDIC takes over as the bank’s receiver.
You’ll face the the same uncertainty about which of the damages you suffer as a result qualify as ADC damages. At least one judicial decision, DJP Company Limited Partnership v. FDIC, recognizes ADC damages from the repudiation of a revolving line of credit. You’ll also face the problem of damages occurring after the the FDIC gets appointed. But, based on our discussion of this issue above, that’s not as pressing a concern.
In the Next Bank Failure Post
Assume that you have the best of luck with your claims. The FDIC decides to allow everything that you put in your proof of claim. You’re still not in the money. You’re still a long way away. You see, when the FDIC acting as receiver liquidates the failed bank, the last people to get paid are creditors like you. In the next bank failure post we’re going to talk about:
- Priority of who the FDIC pays in what order from the assets of the failed bank’s receivership estate
- What’s likely to be left in the estate when the FDIC gets around to paying your repudiation damages
- Whether the FDIC, or someone else may come looking for money from you, and what you can set-off against them