Construction Law Today : Construction Lawyer & Attorney : Joshua Glazov : Design Build Contracts, Construction Bankruptcy

A federal court in Orlando, Florida recently decided that the D'Oench, Duhme doctrine stops claims for breach of a joint venture agreement. So does D'Oench's statutory supplement, Section 13(e) of the Federal Deposit Insurance Act (also referred to as 12 USC §1823(e)). The decision: ORL, LLC v. Hancock Bank (PDF).

Backstory: ORL, LLC v. Hancock Bank

A pair of real estate development companies borrowed money from a pair of banks (Peoples First Community Bank and Colonial Bank).  They used the money to buy land and construct a condominium project called the Blue Heron Beach Resort. Some of the borrowers' principals guaranteed the loans too.

As the borrowers encountered trouble, the banks agreed to modify some terms of the loan documents. One of the banks also agreed to provide purchase money "end-loans" to the buyers purchasing completed condominium units from the borrowers.

Unfortunately, the banks ran into trouble too. Colonial failed. Then Peoples First failed too. The FDIC was appointed as receiver for each bank. The FDIC sold the Peoples First loan to Hancock Bank under a Purchase and Assumption Agreement.

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A federal court in Puerto Rico recently decided that the D'Oench, Duhme doctrine applies to deny claims for breach of informal employment contracts by former employees of failed banks.  And D'Oench's statutory supplement, Section 13(e) of the Federal Deposit Act (the "FDI Act", also referred to as 12 USC §1823(e)), applies too.  The decision: Ortiz-Hernandez v. WesternBank of Puerto Rico (PDF).

Backstory: Ortiz-Hernandez v. WesternBank of Puerto Rico

Rafael Ortiz-Hernandez worked as an employee for Westernbank of Puerto Rico.  He resigned in the spring of 2008 and, as part of his departure, entered into a severance contract with the bank. The severance contract didn't mention a Christmas bonus (the employee had traditionally received a $13,000 bonus each Christmas from the bank).  Despite the omission, the employee claimed that bank executives assured him he would still receive $13,000 as a bonus the following Christmas.  The assurances weren't written.  When Christmas arrived, the bank paid him less than $13,000 as a bonus.  So, the employee sued the bank for the remainder of his bonus.

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Like failed banks, the D'Oench, Duhme doctrine applies to claims against the National Credit Union Administration Board ("NCUAB") acting as liquidator for a failed credit union.  And D'Oench, Duhme has a statutory companion for failed credit unions in the Federal Credit Union Act too: 12 U.S.C. §1787(p)(2).  A federal court in Utah recently used the D'Oench, Duhme doctrine and §1787(p)(2).  The decision: Campbell v. Castle Stone Homes, Inc. (PDF).

Backstory: Campbell v. Castle Stone Homes, Inc.

A Utah home builder known as Castle Stone Homes used the Internet, radio, and TV to solicit people with good credit scores to invest in a real estate investment scheme.  The investors allege that the builder used their good credit scores to obtain loans, then used the loan proceeds to construct, market, and sell homes.  Then the builder would split the home sale profits with the investors.

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For the first time since the S&L crisis, the FDIC is suing a failed bank's former lawyers for professional malpractice.

The claims come against lawyers who formerly represented the now failed Neighborhood Community Bank in Newman, Georgia.  The FDIC's complaint (PDF) alleges that the lawyers deviated from the bank's instructions and colluded with a borrower to falsely represent disbursement of loan proceeds.  Important for those in the construction industry, each was an acquisition and development loan.

The complaint also alleges that the lawyers represented both the bank and the borrowers in various capacities at the same time, subverting the lawyers' loyalty to the bank and violating their fiduciary duties.

   

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The D'Oench, Duhme doctrine and Section 13(e) of the Federal Deposit Insurance Act (a/k/a 12 U.S.C. §1823(e)) were active in Sacramento late last month to deny a borrower's claim for reformation of her loan documents.  The decision: Magdaleno v. IndyMac Bancorp, Inc. (PDF).

Backstory: Magdaleno v. IndyMac Bancorp, Inc.

Catalina Magdelano borrowed money from IndyMac. Her mortgage broker assured her that the interest rate on her loan would be a 30-year fixed rate with interest at 1% per year. But the documents for the loan set an adjustable rate starting at 1% per year, with a 9.950% maximum. Then IndyMac failed and the FDIC was appointed as IndyMac's conservator. Ultimately, the FDIC transferred the borrower's loan to a new lender: OneWest Bank.

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The D'Oench, Duhme doctrine is active again, this time barring guarantors' fraud claims and defenses in Minnesota.

Outsource Services Management, LLC v. Ginsburg

Earlier this month, Judge Donovan Frank applied the D'Oench, Duhme doctrine's statutory companion, Section 13(e) of the Federal Deposit Insurance Act, a/k/a 12 U.S.C. §1823(e), to dismiss fraud claims and defenses alleged by a group of investors who guaranteed a construction loan for the construction of the Northern Winz Casino in Box Elder, Montana.  The case: Outsource Services Management, LLC v. Ginsburg (PDF).

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The FDIC (as receiver for the failed Heritage Community Bank) recently sued the bank's former Chairman and Chief Executive Officer along with ten other former bank officers and directors. 

Bank Failure Video

In a post last fall, CLT brought you a 60 Minutes video segment on how the FDIC takes over an insolvent bank.  That segment gives an intimate glimpse into the lead-up to, and closing of, the Heritage Community Bank, including footage of the bank's former Chairman and CEO as the closing unfolded.

FDIC Professional Liability Complaint

The FDIC's complaint (PDF) seeks more than $10 million in damages, alleging that the the bank's former Chairman and CEO, along with the ten other officers and directors, were negligent, grossly negligent, and breached fiduciary duties they respectively owed to the bank.  The allegations focus on:

• Mismanagement of commercial real estate and construction loans
   
• Dividend payments to shareholders, and incentives payments to senior management, even after the bank was already to serious financial trouble

 

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Wrongful Contract Repudiation

Can you sue the FDIC for wrongful repudiation of a contract?  This was a question during a presentation on contract repudiation I gave last week.  At least one set of borrowers and guarantors seem to be trying to answer that question.

Backstory of Beach DP, LLC v. United States

Christopher Frye and companies he controls borrowed money from, and guaranteed repayment to, the New Frontier Bank in Greely, Colorado.  After the bank failed and the FDIC was appointed as receiver, the FDIC repudiated those loans with hundreds of thousands of dollars in as yet undisbursed funds.  The result: no more funding. 

The borrowers and guarantors (collectively here all together, the "borrowers") sought repudiation damages through the FDIC administrative claims process.  Receiving an unsatisfactory decision, they sued the US government in the United States Court of Federal Claims by filing this complaint (PDF).

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For the first time since Madonna still had an American accent and Jerry Jones last owned a Super Bowl contender, the FDIC is suing former officers and directors of a failed bank seeking damages for pre-failure mismanagement.  Odds are this won't be the last; process servers will be busy knocking on more doors.  

The FDIC's complaint (PDF) focuses on former officers and directors in IndyMac's Homebuilder Division alleging that the President and CEO, and two successive Chief Lending Officers, breached their respective fiduciary duties of care to the bank by approving loans they shouldn't have approved. The FDIC asks for damages from four individual defendants.  Specifically, the FDIC alleges that IndyMac Homebuilder Division executives:

• Repeatedly disregarded credit policies and approved loans to borrowers who were not creditworthy and/or for projects that provided insufficient collateral
   
• Pushed for growth in loan production volume with little regard for credit quality
   
• Continued to follow a strategy for growth at the tail-end of the longest appreciating real estate market in over four decades despite awareness that a significant downturn in the market was imminent and despite warnings from IndyMac’s upper management about the likelihood of a market decline
   
• Unwisely continued operations in homebuilder lending in deteriorating markets even after becoming aware of the market decline

Hat tips to Peter Christensen at the Appraiser Law blog and Kevin LaCroix at the D&O Diary for their pieces and announcing this lawsuit and providing their analysis.

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Loss-Sharing Agreements are one of the principal features when the FDIC takes over a failed bank.  Loss-Sharing Agreements have an air of mystery about them, something almost approaching a contemporary urban legend in the public consciousness.  To dispel some of the confusion surrounding Loss-Sharing Agreements, the FDIC explains how they work in multiple media, including videos and print articles.   Scroll down for two of the most helpful examples....

Loss-Sharing Video

The FDIC produced this video about Loss-Sharing Agreements for the general public: 

 

Loss-Sharing Articles

More technical are articles like the recently published FDIC Loss-Sharing Agreement: A Primer (PDF) in the FDIC's newsletter Supervisory Insights.  Though the target audience is banking regulators and examiners, it's invaluable also for anyone interested in the nuts and bolts of how a Loss-Sharing Agreement works, including accountants, financial advisers, and consultants who advise banks on buying assets from failed bank receiverships and managing them under a Loss-Sharing Agreement.

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In our quarterly newsletter yesterday, my firm published When the FDIC Takes Over a Failed Bank: Business Pitfalls and Opportunities.  It's a brief introduction to how the FDIC taking over a bank affects:

• The failed bank's borrowers (including owners with construction loans and design professionals and contractors with revolving lines of credit)
   
• The customers of those borrowers
   
• The businesses who buy loans from the receivership estates of failed banks   

The newsletter also includes additional articles that will interest you too, among them:

• Landlords in the Lurch: Tips for Discouraging Tenant Defaults
   
• Finding Optimism in the Private Equity and Venture Capital Markets
   
• Health Care Reform: Where Do We Go from Here?
   
• The New Art of Selling (Without Selling)

 

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When the Federal Deposit Insurance Corporation (the “FDIC”) becomes the receiver for a failed bank, there’s usually a lot of lawsuits by, and against, the bank pending in state court. And there's often post-Appointment Date lawsuits filed in state court against the FDIC as receiver too.  Under Section 9(b)(2) of the Federal Deposit Insurance Act (the "FDI Act"), also known as 12 U.S.C. §1219(b)(2) (the “removal statute”), the FDIC may remove (i.e., transfer) most of those cases from state to federal court.

Most FDIC Cases are Eligible for Removal

With limited exception, under the removal statute, any case where the FDIC is a party is considered to arise under federal law.  And the FDIC may remove lawsuits arising under federal law to federal court.

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FDIC Chairwoman Sheila Bair appeared for an interview on CNBC today.  Press play below to tune-in to her remarks on: 

• Increased lending activity
   
• The financial regulatory reform bill pending in Congress
   
• The pace of bank failures and when they'll peak
   
• Resumption of scuitizations

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An anonymous commenter left this question on a past post about the FDIC extending statutes of limitations:

What if the FDIC sells the loan to another bank (not FDIC)? When the purchaser wants to sue to enforce the note, does the statute of limitations for the subsequent note-purchaser begin running on: (a) the the ordinary starting date under state law or (b) the date the FDIC is appointed as receiver for the failed bank?

According to several judicial decisions in the wake of the last financial crisis of the late 80s and early 90s, the answer is: whichever is later. And that's almost always the date the FDIC is appointed as receiver.

 

The FDIC's transfer of a loan to a private purchaser doesn't change the LP Start Date. The purchaser may defer the LP Start Date just as the FDIC can. The purchaser may also postpone expiration of the limitations period the same as the FDIC can.

 

With so many banks failing recently, and the FDIC selling so many of their loans, this has become a compelling question. Thanks to our anonymous reader for asking it!

 

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In the last bank failure post I promised a recap and wrap up on the D'Oench, Duhme doctrine and Section 13(e) of the Federal Deposit Insurance Act. Well, here it is:

• A recap of the D'Oench rule
   
• A brief explanation why federal judges and Congress created, expanded, and maintain the rule
   
• Practical observations on how to avoid trouble

Rule Recap

The best recap of the rule in D'Oench, Duhme and Section 13(e) is this paraphrase from Judge Phyllis Kravitch's decision in Baumann v. Savers Federal & Loan Association:

In a lawsuit over the enforcement of an "agreement" originally between a bank and a private party, the private party can't enforce against the bank's receiver any obligation that's isn't specifically memorialized in a written document that the bank's primary regulator would be aware of when examining the bank's records

Interested in more details of how this rule works? Just go to the TOPICS on the right sidebar of this page and click on D'Oench, Duhme.

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In the last bank insolvency post I promised to tell you about the Federal Deposit Insurance Corporation's (the "FDIC") policy restricting use of the D'Oench, Duhme doctrine and Section 13(e) of the Federal Deposit Insurance Act (the "FDI Act"). That's our topic today. The D'Oench, Duhme Policy As the last banking failure crisis progressed through the early 1990s, it became obvious that although the FDIC had the right to use D'Oench and Section 13(e), it wasn't always the right thing to do. In some cases the outcome, at the very least, looked unfair or inequitable to whomever got D'Oenched. And sometimes it really was.

The FDIC recognized this problem and responded in 1997 with a policy officially known as the: 

Statement of Policy Regarding Federal Common Law and Statutory Provisions Protecting FDIC, as Receiver or Corporate Liquidator, Against Unrecorded Agreements or Arrangements of a Depository Institution Prior to Receivership

 

But here we just call it the "Policy". Under the Policy, FDIC personnel must use extra care when deciding whether to D'Oench someone.  And even more critically, in select situations, the Policy requires FDIC personnel to get approval from headquarters in Washington, DC before D'Oenching a borrower, a guarantor, or someone else with a claim against a failed bank's receivership estate. The message: be careful with this stuff. Don't do something that might make us look like Mr. Scrooge.

The message from headquarters: Be judicious about using D'Oench, Duhme and Section 13(e).  Just because we have the right to do it, doesn't mean it will always be the right thing for us to do. 

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This afternoon I had the opportunity to present Fortifying Your Work-Out Against Future Bank Failure to Chicago's South Side Business Association (SSBA). The Grand Ballroom at 6351 South Cottage Grove Avenue in Chicago hosted the event. The SSBA is composed of many south side business owners, professionals, real estate developers, architects, engineers, contractors, and lenders. The seats were filled and the audience asked a lot of questions, most about how a bank failure could affect their business and how they could find opportunities from bank failures too.

If you'd like copies of the handouts from this presentation, just click here.

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In the last bank insolvency post, I promised to fill you in on the disagreement among federal judges about whether the D'Oench, Duhme doctrine and the federal holder in due course rule (the "FHDC Rule") are still alive after the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") became law amending Section 13(e) of the Federal Deposit Insurance Act (the "FDI Act"). The chart below will help you keep track of which judges say yes and which ones say no.

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This past spring 60 Minutes broadcast this segment on the failure of Heritage Community Bank in Chicago. Scroll down and watch CBS correspondent Scott Pelley take you through:

• FDIC officials secretly reviewing bids to buy the targeted bank through a Purchase and Assumption Transaction
• The FDIC bank closure crew preparing to go in and take over each branch on a Friday evening after the last customer leaves
• Explaining what's happening to the bank's president and employees at each branch
• Taking an inventory of the bank's assets, books, and records
• Re-opening the bank Saturday morning under the new banner of the purchaser: MB Financial
• FDIC specialists greeting depositors and reassuring them that their money is safe

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In the last bank insolvency post, we covered why it's good to be the holder in due course (an "HDC") of a promissory note. And I promised to explain why it's even better if you're the Federal Deposit Insurance Corporation (the "FDIC"), or someone who buys a promissory note from them. Why? Because they get to use the federal holder in due course rule (the "FHDC Rule"). Today we'll talk about why the FHDC Rule is better.

Relaxed Holder In Due Course Requirements for the FDIC

In the general HDC post we identified the four statutory requirements you must satisfy to qualify as an HDC under state law. But in some of their decisions, federal judges created the FHDC Rule relaxing those requirements for the FDIC. So, if the FDIC doesn't satisfy each statutory requirement, they may still be an HDC of the notes they get from a failed bank. Paraphrasing one panel of federal judges summing up the FHDC Rule:

We have also held that where state law precludes the FDIC, when acting in its corporate capacity, from attaining HDC status, application of state law frustrates the objectives of the FDIC's federal program. State law is therefore inapplicable. Therefore, even if, as is argued by the borrower, Ohio laws stops the FDIC from attaining HDC status, the FDIC may still take the note as an HDC. When the FDIC, in its corporate capacity, as part of a Purchase and Assumption Transaction, acquires a note in good faith, and without actual knowledge of any personal defense against the note, the FDIC takes the note free of all defenses that would not prevail against an HDC

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If you're looking for a great way to roll into Thanksgiving this year, forget preparing turkey and stuffing a day early! Instead, drop by the Chicago Bar Association where I'll be speaking about the FDIC's D'Oench, Duhme powers at lunchtime.

• Topic: D'Oench, Dhume, Section 13(e) of the Federal Deposit Insurance Act, and How They Affect Real Estate Workouts
• Where: Chicago Bar Association, 321 South Plymouth Court, Chicago, Illinois
• When: Wednesday, November 25, 2009, 12:15 PM to 1:30 PM Central Time
• Food and Beverage: Lunch will be served
• CLE credit: Yes!
• Cost: CBA members: $9.50. Non-members and guests: $12

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According to Credit Unions Online, The FDIC closed 3 banks yesterday (November 13, 2009):

• Pacific Coast National Bank in San Clemente, California
• Orion Bank in Naples, Florida
• Century Bank, FSB in Sarasota, Florida

Want news of FDIC bank closures sooner? Click here and follow me on Twitter.

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To paraphrase Mel Brooks: "It's good to be a holder in due course!"

In the last bank insolvency post, we talked about how the buyers and assignees of loans from the Federal Deposit Insurance Corporation (the "FDIC") use the D'Oench, Duhme doctrine, and Section 13(e) of the Federal Deposit Insurance Act ("FDI Act"), a/k/a 12 U.S.C. §1823, to neutralize many of the defenses that borrowers and guarantors raise against repaying loans after a bank fails. Add one more: the federal holder in due course rule (the "FHDC Rule").

The Federal Holder In Due Course Rule

The FHDC Rule is the second, and last, of D'Oench, Duhme's companions. Like the D'Oench, Duhme doctrine and Section 13(e), the FHDC Rule neutralizes many defenses that borrowers and guarantors raise in their post-bank failure attempts to avoid re-paying loans. But the FHDC Rule is separate from, and operates independent of, D'Oench, Duhme and Section 13(e). Critically, D'Oench and Section 13(e) apply only where an "agreement" hurts the FDIC. But the FHDC Rule foils borrowers' and guarantors' defenses even when there is no agreement. For example, when the amount of interest on a loan is usurious.

Holder In Due Course Basics

First, we must start with the basics of holder in due course law before we get into how the FDIC (and buyers of loans from their failed bank receiverships) use the FHDC Rule against borrowers and guarantors. So, basic holder in due course law is our topic for this post. I promise to keep it short. In the next bank insolvency post, we'll talk about special federal rules that make it easier for the FDIC, and loan buyers, to qualify as holders in due course.

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Becky Yerak at the Chicago Tribune reports that the FDIC just seized 9 banks operated by FBOP Corporation, including Park National Bank in Oak Park, Illinois.

Park National's construction related initiatives include:

• Lending to redevelop 200 acres in the Pullman neighborhood
• Development and construction lending for the Christ the King Jesuit College Prep school and the Chicago Jesuit Academy

According to the FDIC's press release, U.S. Bank, NA from Minneapolis has entered into a Purchase and Assumption Agreement with the FDIC to buy the deposits of FBOP banks and ensure continued banking services for their depositors.

It's not clear yet whether U.S. Bank will assume and continue funding construction loans, lines of credit and other un-disbursed loan obligations of the FBOP banks. Borrowers are standing-by to see whether that happens or whether the FDIC will stop funding and repudiate their loans.

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National Mortgage Professional Magazine just reported that the Federal Deposit Insurance Corporation, in conjunction with other federal financial regulators, just released this Policy Statement on Prudent Commercial Real Estate Loan Workouts.

According to this Policy Statement (Policy Statement No. FIL-61-2009), financial regulators recognize that prudent commercial real estate ("CRE") loan workouts often serve the best interest of banks and creditworthy CRE borrowers.

This Policy Statement focuses on the essential elements of a prudent workout. And it provides illustrations of the analytical review process to ensure the credit risk in a loan workout is accurately identified and the arrangements receive appropriate regulatory reporting and accounting treatment.

Highlights from this Policy Statement:

• Banks and borrowers confront reduced operating cash flows, lower collateral values, and prolonged sale and rental absorption periods. Financial regulators recognize that prudent CRE loan workouts often serve the best interests of both the affected banks and the affected borrowers
• Banking regulators won't "adversely classify" performing loans, including those renewed or restructured on reasonably modified terms, just because the value of the underlying collateral has declined below the loan balance
• Banking regulators won't criticize banks' efforts to prudently workout CRE loans after the bank comprehensively reviews the borrower's financial condition, even if the restructured loans have weaknesses that result in "adverse classification"
• Banking examiners will take a balanced approach when assessing the adequacy of a bank's risk management practices for loan workout activity
• This Policy Statement identifies Model CRE loan workout structures, but they're for illustrative purposes only
• This Policy Statement replaces the Interagency Policy Statement on the Review and Classification of Commercial Real Estate Loans (November 1991)

To see more on how the FDIC affects construction and real estate lenders and borrowers, go here and scroll down.

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In the last bank insolvency post we talked about what kinds of things are considered "agreements" that the Federal Deposit Insurance Corporation (the "FDIC") can ignore under the D'Oench, Duhme doctrine and Section 13(e) of the Federal Deposit Insurance Act ("FDI Act"), a/k/a 12 U.S.C. §1823. I also promised to tell you about who else, besides the FDIC, may use D'Oench, Duhme and its companions against borrowers and guarantors.

The answer: the FDIC's assignees - the people who buy loans from the FDIC out of a failed bank's receivership estate.

Assets The FDIC Transfers

After getting appointed as receiver for a failed bank, the FDIC usually transfers the bank's assets. The primary assets are:

• Promissory notes and other loan documents the bank holds, along with
• The accompanying borrower obligations to repay the principal, plus interest and fees (wrapped-up together, "loans")

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In the last bank insolvency post I mentioned that what qualifies as an "agreement" vulnerable to the D'Oench, Duhme doctrine and its companions includes a lot more than what you probably think. If I say "agreement," you probably see a stack of 8.5" x 11" paper with "Agreement" or "Contract" at the top of the first page. When it comes to deciding whether D'Oench and its companions apply, "agreement" means a lot more. After the Federal Deposit Insurance Corporation (the "FDIC") gets appointed receiver for a failed bank, they can use D'Oench and its companions to classify all sorts of other defenses, claims, and counterclaims that borrowers and guarantors raise when trying to avoid paying a loan as "agreements." And "agreements" that don't satisfy each of the 4 Requirements - as identified in Section 13(e) of the Federal Deposit Insurance Act ("FDI Act"), a/k/a 12 U.S.C. §1823 - won't help borrowers or guarantors avoid paying on a loan the FDIC inherits from a failed bank.

Enough of the lead-in. You probably want to know what are these other things that get treated as agreements and then get D'Oenched? Below are some prime examples:

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In the last bank insolvency post we talked about the genesis of the D'Oench, Duhme doctrine. That's the rule allowing the Federal Deposit Insurance Corporation (the "FDIC") to disregard select agreements between borrowers and guarantors on one side and their banks on the other. Those are agreements struck before the bank fails and goes into FDIC receivership. Today I'm going to introduce you to the first of D'Oench, Duhme's companions - Section 13(e) of the Federal Deposit Insurance Act ("FDI Act"), a/k/a 12 U.S.C. §1823. The U.S. Supreme Court justices created the D'Oench, Duhme doctrine in one of their decisions. Section 13(e) essentially puts it into a federal statute.

What Kinds of Agreements Are They Talking About?

Before we get started, you've probably noticed a lot of the talk about how the D'Oench, Duhme doctrine and its companions focus on "agreements." You may ask yourself: "what kind of agreements are they talking about?" Well, it's usually the kinds of agreements you often see in "work-outs" - loan modifications and other other debt restructuring transactions. Now those aren't the only "agreements" affected by the D'Oench, Duhme doctrine and its companions. But more on that later.

D'Oench, Duhme's Statutory Companion

After the D'Oench, Duhme decision, Congress amended the FDI Act to add Section 13(e) imposing mandatory requirements. And the FDIC is free to disregard nearly all pre-Appointment Date agreements modifying a loan or guaranty that don't comply with Section 13(e)'s requirements.

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In the last bank insolvency post we talked about how the Federal Deposit Insurance Corporation (the "FDIC") can revive limitations periods even after they expire. Today we'll talk about another of the FDIC's extraordinary powers - the D'Oench, Duhme doctrine and it's companions.

D'Oench, Duhme gets its name from the 1942 U.S. Supreme Court decision in D'Oench, Duhme & Co., Inc. v. FDIC.  After the FDIC takes over as receiver of a failed bank, that decision, along with many that follow it, spells doom for many a borrower.  

In a nutshell, after the FDIC gets appointed as receiver for a failed bank, the D'Oench, Duhme doctrine and its companions allow the FDIC to ignore select pre-Appointment Date agreements and deals between bank representatives on one side and their borrowers and guarantors on the other.  Agreements that commonly fall victim are debt work-outs and restructurings that often include features like:

• Extending a promissory note's maturity date
   
• Reducing an interest rate
   
• Suspending, deferring, or reducing principal payments, and even interest payments
   
• Waiving fees and other payments (e.g., prepayment premiums)
   
• Waiving non-money defaults
   
• Waiving or reducing so-called "default interest" at higher than original rate
   
• Releasing guaranties

The FDIC refusing to honor these kinds of agreements can doom borrowers, guarantors, and the projects they're working on.  It doesn't matter if they're an owner under a construction loan or a contractor subcontractor, material supplier, or design professional under a working capital loan or line of credit.

As you learn about what D'Oench, Duhme can do, you'll recognize that it's a boon for whomever buys the affected loans from the FDIC.  It's meant to work that way.  More on that in future posts.

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In the last bank insolvency post I mentioned that not only can the Federal Deposit Insurance Corporation (the "FDIC") extend statutes of limitation, they can even revive some claims after the limitations period has already expired.  "You've got to be kidding me!!" you say.  I kid you not.

Under Section 11(d)(14)(C) of the Federal Deposit Insurance Act (the "FDI Act"), once the FDIC is appointed as receiver for the failed bank, the FDIC can revive the claims by the bank even if the statute of limitations on those claims already expired before the Appointment Date.  In L-3 Communications v. Clevenger, one judge suggests that Section 11(d)(14)(C), represents Congress's unambiguous intent to preempt state statutes of limitation and allow the FDIC to revive certain claims even after the limitations period has already expired.   

But Congress qualified and limited the FDIC's ability to revive claims too. It's not open season on statutes of limitation.

First Limitation: Limited Kinds of Claims

The FDIC can only revive claims arising from:

• Fraud
  
• Intentional misconduct resulting in unjust enrichment
• Intentional misconduct resulting in substantial loss to the bank
  

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In the last bank insolvency post I gave you the first of two examples of how the Federal Deposit Insurance Corporation's (the "FDIC") can use Section 11(d)(14) of the Federal Deposit Insurance Act (the "FDI Act") to extend the limitations period on claims against a prime contractor for defects in a building's curtain wall.  Today I'll give you the second example.  This time it's the FDIC extending the limitations period on claims against a surety under a performance bond.

Example #2 - FDIC vs Surety

First, assume all of the facts from yesterday's example.  Now add that the prime contractor provides a performance bond to the original owner.  Under the bond the surety guarantees the prime contractor's performance under the prime contract.  The bank is a co-obligee under the bond (meaning that the bank can enforce the bond too). The bond is on the American Institute of Architects Form A312 - 1984 Performance Bond.

After taking over as receiver for the failed bank (nearly 3 years after the prime contractor last provided any work on the project), the FDIC also sues the surety because the curtain wall gaps breach an express warranty in the prime contract.

Like the prime contractor, the surety asks the judge to dismiss the FDIC's lawsuit because the FDIC filed it too late.  The surety says that Section 9 of the bond shortens the the time to submit claims under the bond to 2 years after the earlier of: 

• Prime contractor default under the prime contract, and 
  
• When the prime contractor stopped work on the project

The FDIC filed their lawsuit more than 2 years after the prime contractor last worked on the project.  So the surety urges the judge to dismiss the FDIC's lawsuit because the FDIC filed it after that deadline expired.
 
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In the last bank insolvency post I promised to give you some hypothetical examples of how the Federal Deposit Insurance Corporation's (the "FDIC") power to extend statutes of limitation works.  Here's the first.  The second comes tomorrow.

Example #1 - FDIC vs. Prime Contractor

Imagine a prime contractor working on an office building project in my hometown - Chicago.  They have a prime construction contract with the owner (from here on in I call this owner the "original owner" because there's going to later owners that come along later). 

The original owner gets a loan from a bank to pay for part of the construction.  As security for repayment of the loan, the bank takes (1) a mortgage against the building, (2) a collateral assignment of the tenants' rents, and, most importantly for us, (3) a collateral assignment of the original owner's rights under the prime construction contract, including the warranties.

During construction some of the curtain wall subcontractor's workers don't comply with all of the manufacturer's instructions for installing parts of the curtain wall panels.  This creates gaps in the joints between some of the curtain wall panels allowing water and air to seep into the interior of the building. 

A couple of months after the prime contractor substantially completes the project, some tenants complain to the original owner about water and drafts coming into their premises.  Based on the tenant's complaints and the reports of consultants that the original owner hired, the original owner discovers that the gaps in the curtain wall joints are the likely source of the problem.  The day the original owner discovers that is the original LP Start Date.
 
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In the last bank failure post we focused on the basics of statutes of limitation - what they do and how they work. Today we're going to talk about how, after they get appointed as receiver for a failed bank, the Federal Deposit Insurance Corporation (the "FDIC") can extend the statute of limitations on claims they inherit from the failed bank.

The FDIC gets the power to extend statutes of limitation under Section 11(d)(14) of the Federal Deposit Insurance Act (the "FDI Act").

Here's what the FDIC can do.....

1. Defer the Start of Limitations Period

Recall from the last bank insolvency post that the first critical element affecting the statute of limitations is identifying when the "limitations period" begins to run (i.e., the first time the thumb presses down on the stopwatch's start/stop button to start the dial going round). Well, Section 11(d)(14) re-sets when the dial on the stopwatch starts. Ordinarily, the day the limitations period starts to run ("LP Start Date") is:

• For a breach of contract claim, the day when someone breaches the applicable contract.
• For most tort claims, the day when the victim first knows, or reasonably should have known, that someone's tortious conduct injured them.

But under Section 11(d)(14), the limitations period begins to run on the later of the following:

• The day the FDIC gets appointed as receiver for the failed bank "Appointment Date")
• The day when the claim "accrues" under state law. That's often the LP Start Date.

Often the limitations period on claims that the FDIC inherits from a failed bank won't start running until Appointment Date. If the limitations period stopwatch already started running on the claim before Appointment Date, once the bank fails and the FDIC is appointed as receiver, the dial on the stopwatch is re-set to zero.  It then begins running again, but it starts counting from Appointment Date.

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In the last bank insolvency post we talked about how after being appointed as receiver for a failed bank, the Federal Deposit Insurance Corporation (the "FDIC") may unilaterally insist on a stay of proceedings involving the bank (e.g., lawsuits).  Now we're going to focus on how the FDIC can extend statutes of limitation on the claims against people like you, and, in some cases, even revive claims after the statute of limitations has expired.

The "Limitations Period"

Before you really appreciate how extraordinary the FDIC's power to extend statutes of limitation really is, first you must understand what a statute of limitations is and how it works.  A statute of limitations sets a deadline for you to sue someone, or for someone to sue you.  Lawyers often call this the "limitations period".  If you don't sue someone before the limitations period expires, the person you sue can stop your lawsuit.  Or, if you're on the receiving end and get sued after the limitations period expires, the statute of limitations may be a defense against the lawsuit.  You may even be able to use the statute of limitations to get the lawsuit against you summarily dismissed at an early stage, instead of enduring discovery, trial, appeals, and the distraction and legal fees that go with them.

There are three critical elements affecting the limitations period:

• When does the limitations period begin to run?  Think of this as a thumb pressing the start/stop button on a stopwatch that starts dial sweeping around the face

• How long does the limitations period last (i.e., when does it expire)?  Think of this as the number of times the sweeping dial must go around the face of the stopwatch before the thumb presses the start/stop button again, stops the sweeping dial, and announces "all finished"!

• What can suspend the running of the limitations period? Think of this as intermediate events that sometimes make the thumb press the start/stop button and temporarily stop the dial from rotating around the face before it rotates enough times to be "all finished"
  

When A Claim "Accrues"

For most claims, the thumb doesn't start the limitations period until the claim "accrues".  Usually a claim accrues when you recognize, or reasonably should have recognized, that something someone else did has injured you (i.e., you suffer damages). 

But different types of claims accrue, and the limitations periods on those claims start, at different times.  For instance, the case of Hermitage Corporation v. Contractors Adjustment Company recognizes that most tort claims (e.g., negligence) accrue, and the limitations period starts to run, when the victim of the negligence knows, or reasonably should have known, that they suffered injury because of someone else's negligence.  But a claim for breach of contract accrues, and the limitations period on that claims starts running, when the contract is breached, regardless of whether the victim of the breach knows of the breach or has any way of knowing that the breach will injure them.   

Upcoming Posts 

In the next bank insolvency post we'll talk about:

• How the Federal Deposit Insurance Act postpones when a claim accrues
• How that postponement allows the FDIC to extend the limitations period on the claims of failed banks that the FDIC takes over as the failed bank's receiver 

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In the last post on bank insolvency we talked about how the Federal Deposit Insurance Corporation (the "FDIC") sets the priorities for paying out claims against failed banks how the bank's creditors can set their allowed claims off against the FDIC's pursuit of loan repayment. 

Today we're going to take a break from how the FDIC repudiates contracts and claims for repudiation damages.  We're going to focus on another one of the FDIC's extraordinary powers - imposing a stay on proceedings (i.e., court cases) the failed bank is involved in.  The FDIC gets this power under Section 11(d)(12) of the Federal Deposit Insurance Act.

Mandatory Stay of Proceedings

After the FDIC is appointed as receiver or conservator of a failed bank, they may request a stay in any judicial action, or proceeding, that the bank is a party to, or becomes a party to.  The stay may last 90 days if the FDIC is appointed as receiver, and 45 days if they're appointed as conservator.

According to at least one judicial decision, Praxis Properties, Inc. v. Colonial Savings Bank S.L.A, the judge hearing the case must grant the stay.  It's mandatory.  They don't have any basis or discretion to deny the stay, regardless of how compelling the reasons for making an exception.  And the stay applies to all parties in the proceeding, not just the bank and the parties adverse to the bank.

Duration of the Stay

But according to the Praxis case, the stay doesn't last for that long.  The 90 (or 45) days begins on the day the FDIC gets appointed as receiver (or conservator) for the failed bank, not when the FDIC asks the judge to stay the case or when the judge grants that request.  So if the FDIC waits until the Appointment Date plus 80 days to ask for a stay, the stay only lasts for ten more days.

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In the last bank insolvency post we talked about limits on claims against the estate of a failed bank after the Federal Deposit Insurance Corporation (the "FDIC") takes over as the bank's receiver.  Today we're going to talk about:

• The priority of which claims the FDIC pays in what order from the assets of the failed bank's estate
   
• What's likely to be left in the estate when the FDIC gets around to paying your repudiation damage claims
   
• What claims you can set-off against the FDIC when they come after you, as a former borrower with a principal and interest balance still outstanding on your loan

Claim Allowance and Payment

We've already talked some about how the FDIC denies claims in the last post.  Once they allow a claim, the FDIC issues the claim holder a Certificate of Award, sometimes called a Receiver's Certificate, in the amount of their allowed claim.  Payment on a claim, or part of a claim, is called a Dividend.  Sometimes the FDIC will pay an advance Dividend if they expect a good recovery of money into the receivership estate.  But, generally, because of the priorities we'll talk about below, the FDIC doesn't pay much in the way of Dividends. 

 

Claim Priority

Assume for the moment that despite the strict limits on your claims for damages after the FDIC repudiates your loan - regardless of whether it's a construction loan, a revolving line of credit, or some other type of loan - the FDIC ultimately allows a pretty substantial claim against the failed bank's receivership estate.  You're not out of the woods or into the money quite yet.  You're probably a long way from there.  You see even though the FDIC has allowed your repudiation damages claim, whether you see any cash depends on:

• The priority of your claim (i.e., of all the people the failed bank owes money to, how far back are you in the queue of those asking for payment), and

• Whether there is any money left when you get to the head of the queue?

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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. 

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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.

Receiver Only

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

The FDIC may repudiate any contract they want, as long as the FDIC, in their own discretion, decides that both:

• 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.

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In FDIC Takeover: How It Affects Your Construction Project we started talking about the Federal Deposit Insurance Corporation (the "FDIC") and how they take over a failed bank.  Today we're going to talk about the history and background of the FDIC.  And that will lead us into talking about the FDIC's extraordinary powers.

The Great Depression and Creation of the FDIC

In the wake of the 1929 stock market crash the Great Depression was so bad that by March 1933 more than 9,000 U.S. banks failed.  The entire U.S. financial system was on the verge of melting down.  President Hoover and other government officials even feared that general anarchy could soon follow. 

 

Confidence in banks was at an all time low.  Panicked depositors withdrew money so fast that on the day after he was inaugurated, President Franklin Roosevelt declared a banking holiday - all U.S. banks shut down for the next 4 days while federal officials examined their financial condition. 

 The holiday stabilized the banking system and the crisis subsided.   After the holiday most banks re-opened and there were no more crises like 1933 again.  Part of the reason was new laws passed in the wake of the crisis that included setting-up the FDIC to insure bank deposits.

Bank deposit insurance programs in the U.S. go back as early as a New York state program that started in 1829.  Between 1866 and 1933, Congressmen has introduced 150 bills for bank deposit insurance in one form or another.  But it took the panic of 1933 to finally get deposit insurance enacted into law as part of the Banking Act of 1933, also known as the Glass-Steagall Act after its co-sponsors, Virginia Senator Carter Glass and Alabama Representative Henry Steagall.

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You can't help but notice recent high profile bank failures like IndyMac and Washington Mutual.  In each case the Federal Deposit Insurance Corporation (the "FDIC") came in and took over those banks as they have many others.  According to a list composed by recession.org, 21 banks already failed in 2009 and 23 banks failed in 2008.  In Guessing How Many Banks Will Fail Time magazine reported that research firm RBC Capital Markets revised its estimate for U.S. bank failures in the next 3 years up from 200-300 to over 1,000.

With the looming prospect of more bank failures and FDIC takeovers, you can't help but wonder how they'll affect your construction project.  What will happen if the FDIC takes over: (1) the owner's construction lender or (2) the revolving line of credit lender for: (a) the prime contractor, (b) a critical subcontractor, or (c) an architect, engineer, or other designer?

With those kinds of questions in mind, in this post and the series that follows, we'll talk about how the FDIC take over process works, the FDIC's extraordinary powers, and how a takeover can affect your project (1) regardless of your role in the project (owner, designer, contractor, material supplier) and (2) regardless of whether it's your bank that the FDIC takes over.

Banking Insolvency

The first thing you must understand is that banks, thrifts, savings and loans, credit unions, and other "depository institutions" (collectively all together, "banks") don't go into bankruptcy.  Because they're so critical to the workings of the U.S. commercial system and stability of society in general, bank insolvencies are treated differently, under different laws, than regular business insolvencies.  So the United States Bankruptcy Code specifically excludes banks from becoming debtors under the Bankruptcy Code.

Instead, banking regulators and the FDIC "resolve" insolvent banks.  A state banking regulator will start resolution of an insolvent state chartered bank. Either the United States Treasury Department's Office of the Comptroller of the Currency or Office of Thrift Supervision will start resolution of an insolvent federally chartered bank.  They do this by putting an insolvent bank that's under their regulatory jurisdiction into a receivership or conservatorship.  Then they call in the FDIC to act as receiver or conservator for the insolvent bank.  That's when resolution of the bank hits the news media and you see a spot on how the FDIC just took over this or that bank today.

In The Next Bank Failure Post

In the next bank failure post, we'll talk about the FDIC, its history and some of its extraordinary powers that can make real big problems on construction projects.

 

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