In the last bank insolvency post I introduced you to some of the extraordinary powers of the Federal Deposit Insurance Corporation (the “FDIC”) when they are appointed as receiver or conservator to resolve a failed bank. Today we’re going to focus on the FDIC’s extraordinary power to repudiate contracts that the failed bank is party to.
But first, a preliminary note. From here on out, I’m only going to refer to the FDIC as receiver for a failed bank. They’re also sometimes appointed as the conservator under the Federal Deposit Insurance Act (the “FDI Act”). But that’s not as often, and for our purposes, the difference doesn’t really matter. Plus I’ll wager that you get almost as tired of reading “receiver or conservator” as I get of writing it.
Contract Repudiation Power
Under Section 11(e) of the FDI Act, after being appointed receiver of a failed bank, the FDIC may unilaterally repudiate contracts that the bank was a party to on the Appointment Date. This is like when a debtor in a bankruptcy rejects a contract. But there’s important differences. It’s especially different if you, or someone else involved in your construction project, is the borrower under a repudiated loan agreement. Think of contract rejection in bankruptcy as getting hit by a truck. For reasons we discuss here, and will discuss in the next posts, FDIC repudiation of a contract affecting your project (think loan agreement here) is a locomotive coming along and hitting that truck.
Which Contracts May the FDIC Repudiate
- Continuing to perform under the contract will be burdensome for the FDIC, and
- Repudiation will promote the orderly administration of the failed bank’s affairs
Unlike Section 365 of the United States Bankruptcy Code, where a debtor in bankruptcy may only reject executory contracts (i.e., parties must still perform parts of the contract), a contract doesn’t need to be executory for the FDIC to repudiate it. And unlike in bankruptcy, the FDIC can partially repudiate a contract. For instance, they can repudiate future disbursements under a loan agreement, yet still require the borrower to repay principal disbursed before repudiation plus interest owed on that principal.
How Does the FDIC Repudiate
Usually they just send a repudiation letter. Really! Imagine letters like these:
- To an owner from the FDIC as receiver for the now failed construction lender: “We’re repudiating your construction loan agreement. Don’t expect any more money from us to pay the contractor’s applications for payment.” Imagine how the prime contractor and architect react when they hear. Imagine how the owner’s junior and mezzanine lenders react when they hear this
- To the owner whose principal post-completion tenant is the bank the FDIC was just appointed as receiver for: “We’re repudiating that lease the bank made with you before we took over. We won’t be moving in. We won’t be paying rent.” Imagine how the owner’s construction and permanent lenders react when they hear
- To the contractor, architect, engineer, or other design professional whose revolving line of credit lender just got resolved: “We’re repudiating your revolving line of credit. Yes, we’re not going to fund any more loan proceeds. We understand that it’s going to be tough to pay your employees, rent, and material vendors. But we’re confident you’ll find a way.” Imagine how subcontractors and suppliers react when loan proceeds aren’t available to pay them
- To the owner who posted a stand-by letter of credit to local government as security for ensuring that infrastructure improvements get completed (e.g., roads, intersections and stop lights, sewers): “We’re repudiating the letter of credit we issued to the Village of Mayberry. If you don’t finish the stoplight at the corner of Maple and Elm, we’re not paying. We’re copying the Village on this. Expect them to call asking for a substitute. Hopefully there’s another lender who will issue one. Hopefully we don’t take them over soon too”
- To the junior lender or mezzanine lender right after the FDIC resolves a senior lender: “We’re repudiating that inter-creditor agreement the senior lender signed. Some of the things we promised in there to do, we may not do any of them. And we’re also repudiating the senior loan agreement. That means we’re not funding any more construction costs. That might affect the value of your collateral.” The FDIC doesn’t usually repudiate inter-creditor agreements. But there’s really nothing to stop them if they change their minds either.
In bankruptcy, the bankruptcy court must approve rejection of a contract, either in response to a motion from the debtor, a creditor, or someone else, or as part of a Plan of Reorganization confirmed under Section 1129 of the Bankruptcy Code. When the FDIC takes over as a receiver, all they need to do is find the right address and send a form letter.
When May the FDIC Repudiate?
The FDIC must repudiate a contract within a reasonable time after their appointment as receiver. Like anything else measured by a “reasonableness” yardstick, you can’t really predict how long this will be. Some judicial decisions suggest that 90 days after appointment is safe for the FDIC while waiting longer starts to look less reasonable. Still the odds usually favor the FDIC’s notion of reasonable more than yours or some other counterparty’s.
In 1993 the FDIC issued a Statement of Policy Regarding Treatment of Security Interests After Appointment as Receiver
What Do You Get After Repudiation?
All this talk about repudiation begs the question: what does the counterparty to a repudiated contract get. Well, they get to make a claim against the estate of the failed bank. It sounds like bankruptcy because it is like bankruptcy. But it’s critically different in several ways too. Those differences are the topic for the next bank insolvency post.
Coming Up Next
In the next bank insolvency post we’ll cover:
- How to submit your claim
- Limits on how much you can claim