The Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver (“Receiver”) for two failed banks within the last week. The Receiver subsequently transferred all deposits (both insured and uninsured) and “substantially all” assets of the failed banks to two newly established bridge banks, which are nationally chartered banks that remain administered by the FDIC, although not in its capacity as Receiver. A bridge bank is designed to “bridge” the gap between the failure of a bank and the time when the FDIC can stabilize the bank’s business and implement an orderly resolution.
In light of these recent developments, we are receiving a number of questions concerning the receivership and the effect of the transfer of assets, including contracts, to the bridge banks. Counterparties to these contracts may include syndicated and other lenders, as well as borrowers and creditors of the failed banks. This client alert addresses general questions with respect to counterparties’ contractual rights and obligations. For more information and answers to other frequently asked questions that depositors, borrowers, and creditors of either of these failed banks may have, please refer to our recent client alert.
Effect of Receivership on Contracts of a Failed Bank
- Anti-acceleration and Anti-default Provisions: Under the Federal Deposit Insurance Act (“FDIA”), the Receiver has extensive rights to prevent acceleration and termination of contracts with a failed bank, as distinct from a bridge bank. As a general matter, the Receiver succeeds to all of the failed bank’s “rights, titles, powers, and privileges” and, therefore, may enforce the contracts of the failed bank in full.
In addition, without the Receiver’s consent, no person may terminate, accelerate, or declare a default under any contract with the failed bank during the 90-day period beginning when the FDIC is appointed as receiver, even if the failed bank was in default when it was closed (the “90-day stay”). During the 90-day stay, contractual counterparties may not, without the Receiver’s consent, obtain possession of, or exercise control over, any property of the failed bank or, more broadly, “affect any contractual rights” of the failed bank.
Clauses in contracts that provide for termination or acceleration due to the failed bank’s bankruptcy, insolvency, or financial condition (i.e., ipso facto clauses) also are broadly unenforceable. The Receiver also has the general right to transfer the failed bank’s assets and liabilities, including to a bridge bank, “without any approval, assignment, or consent with respect to such transfer.”
- Limitation on New Borrowings: Alongside its power over contracts generally, the Receiver also may refuse funding borrower requests under undrawn or partially undrawn credit facilities. According to the FDIC, the “role of receiver generally precludes continuing the lending operations of a failed bank.” In limited circumstances, the Receiver will consider emergency funding needs required to ensure the short-term viability of a borrower, to protect or enhance collateral value, or to maintain public safety. This limitation, however, applies only while the failed bank is in receivership.
- Repudiation Authority: The Receiver has the express power, within a “reasonable period” following its appointment as receiver, to repudiate any contract of the failed bank that the Receiver determines would be burdensome if doing so would promote the failed bank’s “orderly administration.” The Receiver’s repudiation right does not appear to be limited to “executory contracts,” although the FDIC has excluded repudiations and recovery of financial assets in connection with qualifying securitization and participation transactions under its Securitization Safe Harbor Rule. In the event of repudiation, a counterparty’s damages generally are limited to direct compensatory damages.
- Additional Considerations: The Receiver’s repudiation authority does not extend to “permitting the avoidance of any legally enforceable or perfected security interest in any of the assets of any depository institution,” other than interests taken in anticipation of the failed bank’s insolvency or with the intent to hinder, delay, or defraud the bank or its creditors. Nonetheless, any claim by a creditor, or any claim of security, preference, or other priority, must be proven to the satisfaction of the Receiver. Certain restrictions also may apply to the FDIC’s repudiation or transfer of “qualified financial contracts,” which include securities contracts, commodities contracts, forward contracts, repurchase agreements, swap agreements, or similar agreements as determined by the FDIC.
Contracts Transferred to Bridge Banks
Importantly for current circumstances, however, a bridge bank is not the same as a failed bank, and the FDIA does not grant the FDIC, in its distinct capacity as administrator of a bridge bank, the same rights the FDIA grants the FDIC in its capacity as Receiver of a failed bank. For instance, the agreement by which the Receiver of the failed bank transfers the deposits and other assets of the failed bank requires the bridge bank to pay, perform, and otherwise discharge all transferred liabilities. Consequently, the bridge bank may not invoke any 90-day stay, prevent a party from exercising its contractual rights, or repudiate any agreements in the manner afforded the Receiver. At the same time, the bridge bank assumes the transferred assets and claims of the failed bank, which means that it may enforce the contractual remedies of the failed bank transferred to it, as well.
In structuring the rights and obligations of the bridge banks in this manner, the FDIA expresses the intent of Congress to “prevent unnecessary hardship or losses” to the customers of the failed bank. Accordingly, the FDIC, as administrator of a bridge bank, should “continue to honor commitments” of the failed bank to “creditworthy customers,” and not “terminate adequately secured loans” in repayment. The bridge bank, in other words, should represent a return to normal operating conditions while the FDIC determines how to sell the business of the bank.