FDIC Resolution and Receivership of Failed Banks: Pitfalls for Landlords

Financial industry news predicts a growing number of bank failures and that failures will occur more rapidly. For instance, on January 23, 2009, The Wall Street Journal reported that federal regulators are bracing for more than 20 bank failures in the first quarter of 2009 and that the existing system of regulatory oversight designed to monitor, catch and correct weak banks before they fail is inadequate in the face of the ongoing liquidity crises. As further evidence of the problem, on the same day The Wall Street Journal reported that regional banks are setting aside unexpectedly large loan loss reserves.

Failed banks usually become subject to a Federal Deposit Insurance Corporation ("FDIC") resolution and receivership process. Increasing numbers of landlords of failed financial institutions will find it helpful to understand the FDIC resolution and receivership process, specifically - the key differences between FDIC receivership and bankruptcy.

The FDIC Resolution and Receivership Process

The FDIC Resolution and receivership process is used to value and market a failed financial institution, close the failed financial institution and to then pay insured depositors (or arrange for a healthy bank assumption). Typically, the FDIC arranges for an assumption by a healthy bank, liquidates any assets which remain after the purchase and assumption transaction and distributes the proceeds to the costs of the receivership, to the FDIC as subrogee of the insured depositors and, to the extent any proceeds remain, then to creditors with approved claims. The FDIC is required by statute to use the type of resolution that is the least costly to the deposit insurance fund. This in turn requires the highest recovery from the assets of the failed financial institution considering all factors affecting the cost, timing and risk of recovery. When acting as receiver, the FDIC has broad statutory authority and expansive powers to ensure the efficiency of the receivership process, expedite the liquidation and maximize the cost-effectiveness of the receivership.

The most common approach to resolution relies on a purchase and assumption transaction prior to closure of the failing financial institution. Historically, the FDIC has found that some form of purchase and assumption transaction usually provides the least costly alternative. A purchase and assumption agreement is a closed bank transaction whereby a buyer (the assuming entity and usually a healthy bank) purchases some or all of the assets and assumes some or all of the bank's liabilities which include, at a minimum, the insured deposits of the failing financial institution. Given the emphasis on the least costly resolution (which is more likely to be obtained when the number of bidders is maximized), complex purchase and assumptions transaction have evolved to include options and puts on certain assets, asset pools and loss sharing.

In situations where the circumstances do not allow the resolution process to take place prior to closure, such as in the case of sudden or severe liquidity problems, the FDIC has several methods to address the immediate concern of the institution's deposits and later address the sale of the assets and liabilities of the failed institution. One method is to form a bridge bank (discussed below) as was done in the recent failure of IndyMac Bank.

The entire resolution process, from determination that the financial institution is in imminent danger of failing to bank closure and appointment of FDIC as receiver, is generally carried out in 90 to 100 days. The duration of the receivership process varies depending on individual circumstances. Excluding the administration of loss sharing agreements, it is usually completed in 6 to 12 months after closure of the failed financial institution.

Avoiding Pitfalls - What Landlords Should Know About the FDIC as Receiver of a Failed Bank

A. The Basic Rules

While many of the concepts and procedures are similar, the Federal Deposit Insurance Act (the "Act") grants the FDIC receivership powers that are substantially broader and stronger than those of a bankruptcy trustee – think "Super Receiver." Some of the critical differences are:

1. Nature of Proceeding. Unlike bankruptcy, an FDIC receivership is not a proceeding filed in a court. The FDIC steps in as receiver for a failed bank under its congressionally-granted powers, as opposed to being appointed in a court proceeding. The FDIC administers and disposes of the failed bank's assets as described above without advance notice to creditors or a public hearing. Review of the FDIC's actions as receiver by a court is only available in very limited circumstances.
2. Stay of Litigation. Unlike bankruptcy, the stay of judicial actions and proceedings against the failed financial institution is not automatic. The FDIC must request a stay and the court handling the legal proceeding must grant it for 90 days. Unlike the automatic stay in bankruptcy, the stay available in a FDIC receivership is not limited to the failed institution, but applies to all parties to the proceeding. Non-judicial actions by creditors against the failed bank are not stayed. The Act does not expressly authorize extensions of the stay.
3. Repudiation of Leases and Contracts; Lease Termination Damages. A bankruptcy trustee may only reject executory contracts within the relevant time period provided under the Bankruptcy Code. For commercial leases, the time period is 120 days, unless extended for 90 days by the bankruptcy court. In contrast, the FDIC as receiver may repudiate any contract within a "reasonable" period of time so long as the receiver deems the contract burdensome and repudiation would promote the orderly administration of the receivership estate. "Reasonableness" will vary with the circumstance but several published decisions regard 90 to 180 days to be acceptable. Although the receiver will be liable for damages, except for certain types of financial contracts, those damages will be limited to direct damages. There are no accelerated, consequential or loss of profit damages. In the case of a repudiated lease, the landlord may only claim rent which was due as of the receiver's appointment and rent accruing thereafter until repudiation. In contrast to bankruptcy rules which generally allow a claim for up to one year of future rent, no claim for rent accruing after repudiation is allowed. Because of the priority given to depositors, in most cases the receivership will not generate sufficient funds to pay general unsecured claims, including those for unpaid rent accruing prior to repudiation. Furthermore, as discussed below, there may be a question regarding whether a claim for rent accruing after the appointment of FDIC as receiver is entitled to administrative priority. Note, however, that only leases not included in the sale of the failed financial institution (i.e., included with the purchase and assumption agreement for the failed financial institution) would be candidates for repudiation.
4. Administrative Priority. In a bankruptcy, the debtor's obligations under a lease that arise post-petition, such as rent, must be paid current by the bankruptcy trustee, and therefore have priority over other unsecured claims. Although expenses which the FDIC considers to be administrative are also given payment priority, the rental owed after the filing of receivership and before repudiation of the lease is not necessarily an administrative expense of an FDIC receivership. "Administrative expenses of the receiver" only include expenses incurred by the receiver "that the receiver determines are necessary and appropriate to facilitate the smooth and orderly liquidation or other resolution of the institution." Presumably, keeping rent current on leases which are part of a valuable retail bank branch network or which have "bonus" value due to below market rents would qualify. To the extent a claim for rent is not an administrative expense, it is a general unsecured claim. Because the Act gives priority to depositors over other general unsecured creditors, and most liabilities of a failed institution are deposit liabilities, the practical effect of the depositor priority is to eliminate recovery for other general unsecured creditors in most situations.
5. The Claims Process. In a bankruptcy, the interests of the bankruptcy estate, debtor and creditors are separately represented and the bankruptcy judge applies congressionally-passed bankruptcy statutes and rules to the interests of all parties, who receive advance notice and the opportunity to express their concerns. In contrast, in many regards, the FDIC as receiver functions as lawmaker, judge, trustee and debtor. The FDIC as receiver both makes and implements the rules which govern its review of claims, is not subject to judicial supervision and, with limited exceptions, its decisions are not reviewable by any court. Claimants have limited ability to object and most objections must be pursued by separate court action or dispute resolution. In many cases, a separate court action to contest the FDIC's determination is cost prohibitive. The claims process consists of notice of the receivership, a period for filing claims and a period for review by the FDIC. Specifically, the requirement for notice is limited to a local publication for three consecutive months of a notice of the receivership. There are no specific requirements regarding the circulation of the publication used or the size or placement of the notice. A specific mail notice is required only if the creditor's address appears in the books of the failed institution or if such information is discovered by the receiver. The FDIC has no duty to confirm delivery. If the claim is not proven to the satisfaction of the FDIC, it is disallowed. Claims filed after the cut-off which is set by the FDIC (which must be at least 90 days after the initial publication) are disallowed. Even if the FDIC failed to provide specific notice to the creditor's address in the failed institution's books, a late claim may be disallowed if distributions have already been made. The FDIC is required to provide to claimants notice of whether the claim has been allowed or disallowed. The only recourse with respect to a disallowed claim is for the creditor, within 60 days after disallowance, to seek administrative review (which requires the FDIC's consent), alternative dispute resolution per procedures established by the FDIC or to file a suit on such claim in U.S. District Court.
6. Assignment and Assumption. The FDIC as receiver has the power to transfer any asset of the failed institution without any approval or consent. Thus, unlike the assumption and assignment of an unexpired lease in bankruptcy, the receiver is not constrained by requirements for adequate assurance, the terms of transfer are generally not disclosed, and the landlord has no notice or opportunity to object. Further, there are no cure requirements for assumption. The FDIC may assign a lease in default to an acquiring bank and the landlord is left to pursuing its remedies under the lease against the new tenant. In the shopping center context, it is unclear whether the FDIC's powers allow it to disregard use, radius, tenant mix and exclusivity limitations in the lease. In bankruptcy, leases may not be assumed and assigned in violation of such limitations.
7. Other Critical Differences.
8. 1. Fraudulent Conveyances/Set Aside. The FDIC may set aside any transfer by the failed institution, an affiliated party or a debtor of the failed institution made within five years prior to the receivership if such transaction was made with the intent to hinder, delay or defraud the financial institution or any financial regulatory authority. In contrast, the reach-back period for fraudulent conveyances in bankruptcy is generally two years from the petition date.
   2. Statute of Limitations. If longer than the subject state's limitation on bringing an action, the FDIC has six years after accrual of a cause of action to bring a contract claim and three years after the cause of action accrues to bring a tort claim. In addition, the FDIC may revive certain tort claims (such as a fraud claim) so long as such claim expired no more than five years prior to when the receivership was established.
   3. Special Defenses. Improperly documented and undocumented agreements are not binding on the FDIC as receiver. In addition, no court may enjoin or restrain the FDIC from exercising its powers or functions.

B . Tips for Landlords with Financial Institution Leases

In recognition that many of the creditor protections that exist in a bankruptcy proceeding do not exist in a FDIC receivership, landlords of financial institutions weakened by the current economic conditions should be vigilant in monitoring the tenant and diligent in addressing any claims against the tenant in the event the tenant becomes subject to an FDIC receivership. Specifically, such Landlord should:

1. Monitor the tenant's status via news sources and periodically check the FDIC website that lists failed banks. Don't rely on receiving notice from the FDIC or tenant.
2. Monitor payment of rent. Upon the appointment of a receiver for the financial institution, landlords should immediately seek to clarify with the FDIC whether the post-receivership rent is entitled to an administrative priority.
3. Determine the importance of the subject real estate to the bank and possible acquirers.
4. If applicable, accelerate the resolution of outstanding claims and disputes.
5. If the subject lease is repudiated, file a claim as soon as possible to start the 180-day review period.