By Richard A. Roth, J.D.
A provision of federal law that permits the Federal Deposit Insurance Corporation, acting as a failed bank’s receiver, to transfer the bank’s assets without any prior consent does not immunize the FDIC from damages if it breaches a contract the bank entered into before the failure, the U.S. Court of Appeals for the Ninth Circuit has decided. As a result, the FDIC is liable for damages that resulted from its breach of prior consent and right of first refusal provisions in a loan participation agreement the bank signed (Bank of Manhattan, N.A., v. FDIC).
The uncontroverted facts were that First Heritage Bank bought a 50-percent participation interest in a loan that had been made by Professional Business Bank. The purchase was subject to two conditions: Heritage could not resell the participation without PBB’s consent, and PBB had a right of first refusal if Heritage received any purchase offers.
Heritage failed less than a year later, and the FDIC took over as receiver. The FDIC sold the loan participation without honoring the conditions, in a transaction the agency conceded breached the contract. Subsequently, the loan borrower defaulted; PBB sued the borrower; the FDIC’s buyer sued PBB; and PBB both counterclaimed against the buyer and sued the FDIC for breach of contract.
The FDIC asserted that the Financial Institutions Reform, Recovery, and Enforcement Act provisions on how it could dispose of a failed bank’s assets preempted PBB’s breach of contract claims. Specifically, the authority to “transfer any asset or liability of the institution in default . . . without any approval, assignment, or consent” (12 U.S.C. §1821(d)(2)) immunized it from any claims for doing so, the agency asserted.
State law v. contract law. In analyzing whether FIRREA preempts the contract law claims, the appellate court first examined the effect of an earlier Ninth Circuit decision, Sahni v. American Diversified Partners, 83 F.3d 1054 (1996). The court summarized that opinion as deciding that FIRREA preempted a California statute requiring the prior consent of all general partners before a sale of all of the partnership’s assets. However, since Sahni dealt with statutory limits rather than contractual limits, the precedent was inapposite, the court said.
Prereceivership contracts. The court preferred, instead, to rely on a different precedent, Sharpe v. FDIC, 126 F.3d 1147 (1997). The Ninth Circuit panel in that case decided that 12 U.S.C. §1821(d) governed the FDIC’s authority to transfer assets, but 12 U.S.C. §1821(e) governed the results of those transfers. The latter subsection allows the FDIC to repudiate prereceivership contracts and pay only compensatory damages. According to Sharpe, if the FDIC does not properly repudiate a contract, it is liable for breach of contract damages, the appellate court said.
In other words, when dealing with a receivership asset that is affected by prereceivership contract limits, the FDIC has two options. It can repudiate the contract, transfer the asset, and pay only compensatory damages, or it can breach the contract and become liable for breach of contract damages.
If the FDIC could breach the contract and be immune from damages for the breach, it would have powers greater than the failed bank had, the court said. That was contrary to FIRREA’s receivership provisions, under which the agency succeeded only to the failed bank’s powers. An opinion by the U.S. Court of Appeals for the District of Columbia Circuit, Waterview Management Co. v. FDIC, 105 F.3d 696 (1997), reached the same conclusion, the court added.
Dissenting opinion. A dissent by Circuit Judge Rawlinson argued that there is no difference in principle between preempting a cause of action based on state statutes and one based on state common law. This meant the majority opinion was incorrect in saying that Sahni was inapposite.
In other words, when dealing with a receivership asset that is affected by prereceivership contract limits, the FDIC has two options. It can repudiate the contract, transfer the asset, and pay only compensatory damages, or it can breach the contract and become liable for breach of contract damages.
If the FDIC could breach the contract and be immune from damages for the breach, it would have powers greater than the failed bank had, the court said. That was contrary to FIRREA’s receivership provisions, under which the agency succeeded only to the failed bank’s powers. An opinion by the U.S. Court of Appeals for the District of Columbia Circuit, Waterview Management Co. v. FDIC, 105 F.3d 696 (1997), reached the same conclusion, the court added.
Dissenting opinion. A dissent by Circuit Judge Rawlinson argued that there is no difference in principle between preempting a cause of action based on state statutes and one based on state common law. This meant the majority opinion was incorrect in saying that Sahni was inapposite.
Sharpe, on the other hand, was not applicable, the dissenter argued. Sharpe involved persons who had fully performed a contract with a bank that was declared to be insolvent on the same day the bank attempted, and failed, to pay what it owed under the prereceivership contract. That completed performance made a difference, he said.
Effect of decision. As Judge Rawlinson’s dissent points out, the majority opinion has the potential to interfere with the efficient resolution of failed banks by allowing more suits against the FDIC. However, this danger could be avoided if the agency repudiates contracts before taking actions that are inconsistent with those contracts.
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Effect of decision. As Judge Rawlinson’s dissent points out, the majority opinion has the potential to interfere with the efficient resolution of failed banks by allowing more suits against the FDIC. However, this danger could be avoided if the agency repudiates contracts before taking actions that are inconsistent with those contracts.
For more information about receivership powers, subscribe to the Banking and Finance Law Daily.
