- 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
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.
Why Have This Rule?
Because federal judges, and then Congress too, decided that primary bank regulators should be able to rely on the face of a bank’s official written records during financial and solvency examinations. When reviewing a bank’s financial health, regulators shouldn’t have to ferret out every document in the bank’s possession and interview every bank executive and loan officer. The same goes for the FDIC, especially after they’re appointed as receiver on the Appointment Date. Justice Antonin Scalia put it best speaking about Section 13(e) in Langley v. FDIC:
One purpose is to allow federal and state bank examiners to rely on a bank’s records in evaluating the worth of the bank’s assets. Such evaluations are necessary when a bank is examined for fiscal soundness by state or federal authorities, and when the FDIC is deciding whether to liquidate a failed bank, or to provide financing for purchase of its assets (and assumption of its liabilities) by another bank. The last kind of evaluation, in particular, must be made with great speed, usually overnight, in order to preserve the going concern value of the failed bank and avoid an interruption in banking services. Neither the FDIC nor state banking authorities would be able to make reliable evaluations if bank records contained seemingly unqualified notes that are in fact subject to undisclosed conditions
The FDIC and buyers of loans from a failed bank have time for only summary due diligence. Loan buyers are purchasing a proverbial pig in a poke. In normal circumstances, not knowing the problems, defenses, and counterclaims they might inherit, they’d be inclined to dramatically discount their price or insist on higher subsidies from the FDIC. But the immunity from defenses and counterclaims that buyers get from D’Oench and Section 13(e) removes uncertainty and allows buyers to reduce discounts and live with lower subsidies. And reduced discounts and lower subsidies mean that the FDIC can keep more money in the Bank Insurance Fund, one of the principal goals of their very existence.
You’re right. D’Oench and Section 13(e) are unfair. Your banker gives you terms and assurances that keep your deal alive. You’re relieved, and you rely on those terms and assurances as you put your plans into action. Then the FDIC shows up and won’t honor your banker’s terms and assurances. Doesn’t sound fair! Judge Kravitch responded to that in the Baumann decision:
Although this seems unfair to the guarantor, he had the opportunity to include the entire agreement in writing. By not doing so, he lent himself to a scheme or arrangement whereby the banking authority was, or was likely to be, misled. That the guarantor may have had no intention of misleading regulators is of no moment. As between private parties and the FDIC, both Congress and the Supreme Court have placed the burden on private parties to document fully the contours of their obligations from the inception of the transaction
The lesson here: if you’re dealing with a bank, ensure you comply with D’Oench’s and Section 13(e)’s 4 Requirements. If you don’t, and your bank fails, don’t expect the FDIC, or any loan buyer, to live up to non-compliant terms or assurances your bankers gave you before their bank failed.
But I Had Only the Best of Intentions
It doesn’t matter. The FDIC and loan buyers can D’Oench you whether or not you intended to mislead or deceive banking regulators or anyone else. Tell them D’Oench or Section 13(e) shouldn’t apply because your intentions were good and your heart pure. Their reply will probably sound something like this….
There is no requirement of malfeasance, negligence, or intent to deceive on the part of the borrower. Consequently, the [D’Oench] doctrine operates even when the only fault of the borrower was in not reducing the entire agreement to writing
The lack of a malfeasance requirement makes D’Oench, Duhme a sharp sword and sturdy shield indeed. What is the purpose of such imposing armaments? Fundamentally, D’Oench attempts to ensure that FDIC examiners can accurately assess the condition of a bank based on its books. The doctrine means that the government has no duty to compile oral histories of the bank’s customers and loan officers. Nor must the FDIC retain linguists and cryptologists to tease out the meaning of facially unencumbered notes. Spreadsheet experts need not be joined by historians, soothsayers, and spiritualists in a Lewis Carroll-like search for a bank’s unrecorded liabilities. Perhaps mindful of the fate that befell the Baker, whose search for the Snark ended with his own disappearance, D’Oench, Duhme seeks to ensure that a bank’s assets do not “softly and suddenly vanish away.”
The dangers of a contrary policy should be obvious. Today, stable financial institutions sometimes seem as elusive as the Snark. Unrecorded agreements – those rooted in the loose soil of casual transactions as much as those that spring from the malodorous loam of outright fraud – are a threat to the ecology of the banking system that we can ill-afford. To check the growth of these hardy perennials, D’Oench forces borrowers to bear the risk that their unorthodox plants will bear no fruit. Those who till these soils may not shift the cost of their peculiar agronomy to the FDIC, the bank’s depositors and unsecured creditors, and the taxpayers and depositors who fund the FDIC.
Balancing the Harm
It’s a tough job to decide who should bear the cost of an informal agreement after a bank fails. Different people have very different views on this and I think which side they’re on usually depends on whose ox is getting gored. But the borrower, guarantor, etc. usually loses. Judge Garnett Thomas Eisele explained why in FSLIC v. Smith:
The issue raised by the borrower’s defenses is whether a borrower should be allowed to raise personal defenses against FSLIC collection efforts. D’Oench, Duhme and Section 13(e) do not directly answer that question, but in this Court’s judgment they identify the policy decisions necessary for the answers. As the Supreme Court said in Langley, it is a question of which equities are to prevail: those in favor of an otherwise innocent borrower who has signed a note with unwritten conditions upon its repayment, or those of FDIC and the depositors and creditors who look to the facially unconditional note for assets against which to assert their claims. And, again as explained in Langley, the equities the borrower invokes are not the equities the law regards as predominant
Staying Out of Trouble
If you’re a borrower, guarantor, or even someone putting new senior money into a deal, the first critical step to avoiding trouble if the bank fails: ensure you’ve complied with D’Onech’s and Section 13(e)’s 4 Requirements.
I understand you can’t ensure those things 100%. You can’t control whether your bank does a good job managing their files so examiners will see all the terms of your loan.
Ask your banker for certified minutes of the board’s or loan committee’s approval of your deal, yes, they probably will look at you like you have a third eye in the middle of your forehead.
But you have to take these things into account. And now, at least, you know that failing to satisfy each of the 4 Requirements puts you at risk and how big that risk could be.