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FDIC's Expanded Role in Bank Holding Company Insolvencies

Navigating the Complexities of Banking Regulators' Participation in the Bankruptcy Process

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THURSDAY, JULY 26, 2012

Presenting a live 90-minute webinar with interactive Q&A

Todd C. Meyers, Partner, Kilpatrick Townsend & Stockton, Atlanta Ivan L. Kallick, Partner, Manatt, Phelps & Phillips, Los Angeles James D. Higgason, Partner, Diamond McCarthy, Houston

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Topic Agenda

I. Overview A. Chapter 7 v. Chapter 11 B. Key Questions to Address in BHC Bankruptcies C. FDIC’s Role in the Case D. The Nature Of BHC Debt II. Key Issues Presented in BHC Bankruptcies A. Who Owns the Tax Refund B. Directors' and Officers' Litigation: BHCs v. FDIC C. Capital Maintenance Claims D. Fraudulent Transfer and Preference Claims III. Title II of Dodd-Frank

FDIC’S EXPANDED ROLE IN BANK HOLDING COMPANY INSOLVENCIES

Navigating the Complexities of Banking Regulators’ Participation in the Bankruptcy Process

Ivan L. Kallick, Presenter ikallick@manatt.com

310.312.4152 Thursday, July 26, 2012, 1 pm EST, Noon CST, 11 am MST, 10 am PST Sponsored by the Legal Webinar Group of Strafford Publications

7

Manatt, Phelps & Phillips, LLP

The View From Above......

Chapter 7

FDIC AIR

BANK HOLDING COMPANY

Chapter 11

OPERATING BANK

BANK HOLDING COMPANY

OPERATING BANK

United States Bankruptcy Court

8

Manatt, Phelps & Phillips, LLP

• I. Understanding the issues and the questions to ask

In the context of a bank holding company bankruptcy having been filed or about to be filed, it is important to examine and understand these common issues and questions:

• Does the BHC have illiquid assets?
• Does the BHC have liquid assets?
• Does the BHC have an operating Bank subsidiary?
• Did the BHC have an operating bank subsidiary?
• Does the BHC have a non-operating Bank subsidiary?
• Did the BHC have an operating non-bank subsidiary?
• Does the BHC have a tax sharing agreement with its subsidiary?
• Did the BHC abide by the terms of the tax sharing agreement?

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Manatt, Phelps & Phillips, LLP

• I. Common Issues to Be Examined and Understood - continued
• Does the BHC have a right to such an IRS refund?
• Is there a claim to be made and realized under a D&O policy?
• Is there a claim to be made and realized under any other insurance policy?
• Who holds the BHC debt?
• Did the BHC down-stream or side-stream funds and when did they do it?
• Did the BHC and the Bank subsidiary have common directors and/or officers?
• Were there any extraordinary payments or disbursements to/benefit of insiders?
• Is anyone interested in recapitalizing the subsidiary Bank?
• Is anyone interested in the tax refund?
• Who is the Bankruptcy Judge?
• In what Circuit is the case pending?
• Other than the FDIC and the TRUPS, are there other active constituent participants?

10

Manatt, Phelps & Phillips, LLP

• II. FDIC’s Role in a Chapter 7 case

What if . . . . .

• There is no cash...
• There is no operating subsidiary...
• There is no tax refund...
• There is no D&O claim...
• There are no Directors and/or Officers to operate...
• There are no other insurance claims.

Then . . . . .

• File Chapter 7.
• Turn over the keys.
• No role for directors and/or officers.
• The Chapter 7 Trustee earns his/her $65.00.
• FDIC is a bystander.

11

Manatt, Phelps & Phillips, LLP

• III. FDIC’S Role in a Chapter 11/Section 363 sale
• BHC has presently operating bank subsidiary, but its troubled.
• BHC has reasonably marketed and there is a buyer/someone interested in re-

capitalizing the troubled bank.

• Troubled bank may or may not be its only operating subsidiary.
• FDIC is in the bank or has reserved a floor at the local hotel or motel.
• The major debt holders at the BHC level are the Trust Preferreds – TRUPs.
• Recapitalization makes sense, and FDIC may think so, too.
• Recap made impossible by TRUPs holders – their ownership is divergent and

uncertain.

• Chapter 11 - § 363 sale.
• Court order is your title policy.
• AmericanWest Bancorp, USBC, Eastern District of Washington, Case No.10-06097-

PCW11.

• What happens after the sale is approved or not approved.

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Manatt, Phelps & Phillips, LLP

• IV. FDIC’s Role in a Chapter 11 – the liquidating plan
• BHC’s only asset was an operating bank subsidiary.
• BHC has enough cash to file Chapter 11.
• BHC and operating Subsidiary had a tax sharing agreement.
• Chapter 11 formalities.
• Chapter 11 transparency.
• Chapter 11 expenses.
• Chapter 11 Disclosure Statement and Plan.
• Liquidating plan for the benefit of:

– TRUPS – FDIC

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Manatt, Phelps & Phillips, LLP

• The Tax Refund:

– BHC’s and operating bank subsidiary enter into a Tax Sharing Agreement. – Usually a matter of state corporate law. – What if both file a consolidated return. – What is historical scenario – downstream the money. – 26 USC § 1501 – BHC and bank are “affiliated companies”. – Oftentimes, TSA says who files and who actually pays. – Chapter 11 filed – who files return for refund » Option 1 – Debtor » Option 2 – FDIC » Option 3 – Both – Two Schools – Two Positions

» BHC/Bank are in a debtor/creditor relationship » IndyMac, 12-cv-02967-RGK (USDC CD CA, 5/30/2012) » NetBank, 3:11-cv-11-5-32 (USDC MD Fla, 6/25/2012) » BankUnited, 462 BR 885 (SD Fla 2011) » Coupon Clearing, 113 F 3d. 1091 (9th Cir. 1997) » M Corp, 170 BR 899 (SD Tex 1994) » BHC/Bank are in a trust relationship » Bob Richards, 473 F 2d 262 (9th Cir. 1973) » Lubin v. FDIC, 1:10-cv-00874-RWS (USDC ND GA, 2011)

• IV. FDIC’s Role in a Chapter 11 – the liquidating plan

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Manatt, Phelps & Phillips, LLP

• IV. FDIC’s Role in a Chapter 11 – the liquidating plan
• Examples – What issues have been briefed and decided and current status

–IndyMac, USBC Central District of CA, 2:08-bk-21752-BB –Imperial Capital, USBC Southern District of CA, 09-19431-LA!! –FirstFed, USBC Central District of CA, 2:10-bk-12927-ER –Corus, USBC Northern District of Illinois, 10-26881 (PSH) –NetBank, USBC Middle District of Florida, 3:07-bk-04295-JAF –First Regional, USBC Central District of CA, 2:12-bk-31372-ER –Vineyard Bancorp, USBC Central District of CA, 2:10-bk-21661-RN –Harrington West, USBC Central District of CA, 9:10-bk-14677-RR

Directors’ and Officers’ Litigation: Bank Holding Companies v. FDIC

FDIC’s Expanded Role in Bank Holding Company Insolvencies

Presented by Todd C. Meyers of Kilpatrick Townsend & Stockton LLP Partner and Chair of the Bankruptcy and Financial Restructuring Team Tmeyers@kilpatricktownsend.com 404.815.6482

Introduction

• Causes of action against former officers and directors of a bankrupt

bank holding company are one of the most valuable assets of a debtor’s estate.

• However, disputes often arise with the FDIC over ownership of such

causes of action because the bankruptcy trustee and FDIC oftentimes are suing the same persons, many of whom were officers and directors

• f both the holding company and the failed financial institution.
• The competition is intensified when insurance coverage and other

assets can satisfy only a fraction of the likely valid claims.

16

FIRREA

• The dispute over ownership of causes of action arises in the framework
• f the Financial Institutions Reform, Recovery and Enforcement Act of

1989 (“FIRREA”).

• FIRREA gives the FDIC the exclusive right to assert all derivative

claims on behalf of a bank in receivership. 12 U.S.C. §1821(d)(2)(A)(i).

• Nevertheless, a holding company may bring a cause of action against

its own officers and directors for breach of their fiduciary duties owed to the bank holding company, which is a direct claim.

17

Direct Claim Versus Derivative Claim

• So, the key question is whether a particular cause of action is a

derivative claim or a direct claim. How do you distinguish a derivative claim from a direct claim? This is a matter of state law, though the general concept is the same from state-to-state.

• A derivative action is defined by Black’s Law Dictionary as follows:

A suit by a beneficiary of a fiduciary to enforce a right belonging to the fiduciary; esp., a suit asserted by a shareholder on the corporation’s behalf against a third party (usu. a corporate officer) because of the corporation’s failure to take some action against the third party.

Black’s Law Dictionary 455 (7th ed. 1999).

18

GENERAL RUBBER

• The seminal case on the issue of whether a cause of action is direct or

derivative is General Rubber Company v. Benedict, 215 N.Y. 18, 109 N.E. 96 (N.Y. 1915), a decision authored by then Judge (and later Justice) Cardozo.

• In General Rubber, a holding company sued one of its directors for diminution in

the value of the stock in its subsidiary resulting from the diversion by the subsidiary’s manager of $185,000. The complaint alleged that the holding company’s director knew of this impropriety, acquiesced in it, and failed to report it to the holding company.

• Rejecting the argument that the only cause of action belonged to the subsidiary,

the court held that because the defendant was a director of the holding company, he owed the holding company a duty of good faith and vigilance with respect to preservation of its property. Id. at 21. Breach of that duty entitled the holding company to sue the defendant directly for the diminution in value of its stock in the subsidiary resulting from waste of the assets of the subsidiary. Id.

19

LUBIN

• The decision of the Eleventh Circuit Court of Appeals in Lubin v. Skow,

382 F.App’x 866 (11th Cir. 2010) is instructive on the issue of derivative versus direct claims in the context of a bank holding company debtor and the FDIC, as receiver for the holding company’s failed bank.

• In Lubin, the trustee for a debtor bank holding company sued officers of

the holding company and officers of the holding company’s bank subsidiary for breach of fiduciary duties allegedly resulting in the failure

• f the bank.
• In his complaint, the trustee did not segregate the claims against the

bank’s officers from the claims against the holding company’s officers.

20

LUBIN

• The Eleventh Circuit determined that the claims pled against the bank
• fficers were claims that they had breached their fiduciary duty to the

bank by impairing the bank’s working capital and wasting its assets so as to cause economic loss to the holding company and resulting in its ultimate bankruptcy. Id. at 870-71.

• As a result, the Eleventh Circuit held that the trustee’s effort as

representative of the shareholder holding company to sue bank officers for breach of fiduciary duty to the bank constituted the attempted pursuit of a classic derivative claim which is barred by FIRREA. Id. at 871 (“The Trustee therefore lacks standing to bring a derivative suit against the Bank’s officers”).

21

LUBIN

• The court in Lubin emphasized that a different analysis was required for the

trustee’s claims against the holding company’s officers for breach of their fiduciary duties to the holding company: “Under FIRREA, the FDIC succeeds to the rights of the Bank only. Therefore, where the Trustee is suing to vindicate the rights of the Holding Company against its own officers, FIRREA is not invoked.” Id. at 872.

• The court in Lubin recognized the basic principle that, when a parent corporation

(or the representative of its bankruptcy estate) sues its own officers for breach of fiduciary duty to the parent corporation, the claim is not a derivative claim, regardless of whether the claim implicates the corporation’s relationship with a subsidiary.

• If such a claim is stated, it constitutes a direct claim that belongs to the holding
• company. See also Case Fin., Inc. v. Alden, No. 1184-VCP, 2009 WL 2581873,

at *7 (Del. Ch. Aug. 21, 2009) (holding that a holding company’s breach of fiduciary duty claims against its former CEO, who was also CEO of its subsidiary, were direct claims, even though the alleged misconduct, including misappropriation of corporate opportunities, occurred at the subsidiary level).

22

LUBIN

• Nevertheless, because the trustee did not plead sufficient facts to state

a claim against the officers for breach of their fiduciary duties owed to the holding company, the Eleventh Circuit upheld the district court’s dismissal of the claims against the officers of the holding company.

• Thus, the implication from Lubin is that if the trustee sufficiently pled

that officers of the holding company breached their duties to the holding company with respect to oversight of the bank, then the claims against them would have been determined to constitute direct claims, even though they implicated the bank.

23

BANKUNITED

• Lubin involved overlapping officers and directors of the holding

company and its bank subsidiary. BankUnited, in which our firm is involved, also dealt with overlapping officers in the context of D&O

• litigation. There, the bankruptcy court took somewhat of a different

approach.

• The bankruptcy court entered an order on competing summary

judgment motions that was published at Official Comm. of Unsecured Creditors v. Fed. Deposit Ins. Corp. (In re BankUnited Fin. Corp.), 442 B.R. 49 (Bankr. S.D. Fla 2010) (“BankUnited I”).

• BankUnited I was later reversed in part and affirmed in part by the

district court in Official Comm. of Unsecured Creditors v. Fed. Deposit

• Ins. Corp., No. 11-20305-CIV (S.D. Fla. Sept. 28, 2011) (“BankUnited

II”).

24

BANKUNITED

• In BankUnited I, the bankruptcy court recognized that a claim by a bank holding company

against its own officers or directors could be a direct claim even if it related to the failure of its subsidiary bank. However, the bankruptcy court decided that when the officers or directors of the holding company were also officers or directors of the bank at the time of the alleged breaches of fiduciary duty to the holding company, a special test was needed to determine whether a claim was direct or derivative.

• Under the test employed by the bankruptcy court, when corporate fiduciaries overlap, even if

a complaint states a viable claim of breach of fiduciary duty owed to the holding company, the claim is derivative if the alleged injury occurred at the bank level as well as at the holding company level. Id. at 58-60.

• Utilizing this test, the bankruptcy court in BankUnited I concluded that Count I (seeking

recovery primarily for diminution in value of the holding company’s interest in the bank) and Count III (alleging that the holding company CEO failed to provide sufficient information to the board regarding a capital contribution from the holding company to the bank) constituted derivative claims that belonged to the FDIC (on behalf of the bank) and could not be pursued by the committee on behalf of the holding company debtor. Bank United I, 442 B.R. at 59-60.

25

BANKUNITED

• The bankruptcy court also concluded that Count II (alleging that holding

company officers failed to provide adequate information to the board about the holding company’s financial condition, resulting in loss to the holding company) constituted a direct claim of the holding company that could be pursued by the committee on behalf of the debtor. Id.

• The committee appealed the bankruptcy court’s rulings with respect to

Counts I and III and the FDIC filed a cross-appeal with respect to Count II.

26

BANKUNITED

• In BankUnited II, the district court agreed with the bankruptcy court that the Count I claim

arose from acts at the bank level and from harm that the bank suffered, and therefore, was a derivative claim. The district court determined that the damages sustained by the holding company under this count were the result of acts taken at the bank level and did not constitute a separate or unique harm to the holding company. BankUnited II at 5.

• The district court likewise agreed with the bankruptcy court and concluded that Count II was

a direct claim because it alleged damages arising from the holding company’s stock repurchase, payment of dividends and incurrence of debt at the holding company level that would not have occurred but for the alleged breaches by the holding company officers and also, of critical importance to the court, because Count II pled damages unique to the debtor holding company. BankUnited II at 7.

• However, the district court found that Count III was a direct claim of the holding company, so

it reversed the bankruptcy court on that issue. BankUnited II at 12. As the district court noted, the decision to funnel $80 million of the holding company’s funds downstream to the bank arose from actions at the holding company level. As the district court put it: “Appellant has successfully avoided the pitfalls of Lubin by drafting a proposed claim that not only targets officers of the holding company, but also that is based upon actions they took at the holding company level.” Id. at 11.

27

BANKUNITED

• BankUnited II is currently on appeal to the Eleventh Circuit Court of

Appeals, the FDIC having appealed with respect to Counts II and III, and the committee having appealed with respect to Count I.

28

BRANDT AND VIEIRA

• Similar to the holding of the bankruptcy court in BankUnited I, two other courts have taken

the view that standing is affected by whether the injury for which the holding company seeks to recover occurred solely at the holding company level or is an injury for which the subsidiary also could seek to recover against the defendants because they were also

• fficers or directors of the subsidiary.
• In Brandt v. Bassett (In re Southeast Banking Corp.), 827 F. Supp. 742, 745-46 (S.D. Fla.

1993), rev’d in part, 69 F.3d 1539 (11th Cir. 1995), the court held that a claim on behalf of a debtor holding company against its officers and directors for loss of its interest in its failed bank subsidiary was derivative when defendants were also officers and directors of the

• bank. This case is routinely cited by the FDIC in derivative versus direct standing disputes.
• Likewise, the district court in Vieira v. Anderson, 2011 WL 3794234, *5 (D.S.C. 2011)

reached the same conclusion. Unlike in some of these other cases, however, the FDIC was not involved and it was solely the defendant directors and officers who raised the standing

• argument. Based on the FDIC’s lack of involvement, the trustee argued that FIRREA was

not implicated. This was soundly rejected by the district court. Id. at *4.

29

BRANDT AND VIEIRA

• Although the trustee in Vieira argued that she drafted her complaint in light of the Eleventh

Circuit’s decision in Lubin, the district court rejected her contention: “The fatal shortcoming in her pleading, aptly described by the Eleventh Circuit, is that ‘[t]he alleged harm to the Holding Company stems from the Bank officers' management of Bank assets. This harm is inseparable from the harm done to the Bank.’ All of the directors and/or officers of Bancshares were the directors and/or officers of the Bank. ‘That the Bank officers' poor business choices reduced the value of the Holding Company's investment does not alter the fact that the harm is decidedly a derivative one.’ ” Id. at *3-4 (internal citations omitted).

• The Vieira decision is currently on appeal to the United States Court of Appeals for the

Fourth Circuit.

30

Framing the D&O Complaint in an effort to withstand attack by the FDIC

• As should be clear by now, pleading injury to the holding company is

important and requires some care and attention.

• When a parent corporation (or representative of its bankruptcy estate)

sues its own officers and directors for breach of fiduciary duty to the parent, the claim is not a derivative claim, even if the claim implicates the parent corporation’s relationship with its subsidiary.

• The appropriate inquiry is whether the complaint adequately states

facts that, if proven, will establish that the defendant officers and/or directors of the holding company breached their fiduciary duties to the holding company. If a claim is stated in that manner, then it represents a direct claim that belongs to the holding company.

31

Framing the D&O Complaint in an effort to withstand attack by the FDIC

• Examples of pleading causes of action of the bank holding company: To the extent

applicable in the particular situation, you may want to allege that the holding company

• fficers failed to:

1) provide accurate financial information to the holding company board regarding the consolidated financial condition of the holding company and its subsidiaries in order for the board to make properly informed decisions about matters affecting the holding company, 2) cause effective enterprise-wide risk assessment procedures to be implemented, 3) cause effective internal controls to be implemented, 4) provide the holding company board with all reasonably available information relevant to decisions affecting the well-being of the holding company and a reasonable opportunity to consider such decisions before they are made, and 5) exercise vigilant oversight with respect to the bank’s operations in order to protect and preserve the holding company’s interests in the bank, which is usually its most valuable asset.

32

FDIC’s Expanded Role in Bank Holding Company Insolvencies

Defending Against Assertion of a Capital Maintenance Claim Under Sections 365(o) and 507(a)(9) of the Bankruptcy Code

Presented by Todd C. Meyers of Kilpatrick Townsend & Stockton LLP Partner and Chair of the Bankruptcy and Financial Restructuring Team

The Applicable Bankruptcy Code Sections

• Two provisions of the Bankruptcy Code govern capital maintenance claims: section 365(o)

and section 507(a)(9).

• Section 365(o) of the Bankruptcy Code provides:

In a case under chapter 11 of this title, the trustee shall be deemed to have assumed (consistent with the debtor's other obligations under section 507), and shall immediately cure any deficit under, any commitment by the debtor to a Federal depository institutions regulatory agency (or predecessor to such agency) to maintain the capital of an insured depository institution, and any claim for a subsequent breach of the obligations thereunder shall be entitled to priority under section 507. This subsection shall not extend any commitment that would otherwise be terminated by any act of such an agency.

• Section 507(a)(9) of the Bankruptcy Code provides:

The following expenses and claims have priority in the following order: (9) Ninth, allowed unsecured claims based upon any commitment by the debtor to a Federal depository institutions regulatory agency (or predecessor to such agency) to maintain the capital of an insured depository institution.

34

Signed Writing Requirement

• Such a commitment must be found in a signed writing. See Wolkowitz
• v. Fed. Deposit Ins. Corp. (In re Imperial Credit Indus.), 527 F.3d 959,

964 (9th Cir. 2008).

35

Regulatory Structure

The Regulators

• Bank holding companies and banks are regulated by the following:

– The Federal Reserve System Board of Governors. Significant authority is conferred upon 12 regional Federal Reserve banks. The Board of Governors regulatory jurisdiction extends over a variety of banking institutions, including state-chartered banks and trust companies that opt to become members of the Federal Reserve System, and bank holding companies. – The FDIC is the primary federal regulator of state-chartered banks that do not elect to become members of the Federal Reserve System. – The Office of the Comptroller of the Currency regulates “national association” banks. As of July 21, 2011, it also regulates federal savings and loans and federal savings

• banks. Prior to July 21, 2011, the Office of Thrift Supervision had such responsibility,

but it has since been merged into the Office of the Comptroller of the Currency. – State-chartered banks are also subject to regulation by state banking agencies.

36

Regulatory Structure

Types of Enforcement Actions

• Board of Governors: There are essentially two types of enforcement actions

which the Board of Governors may take: (1) informal supervisory actions and (2) formal supervisory actions. A Memorandum of Understanding (discussed later) is one type of informal supervisory action. By contrast, written agreements and cease and desist orders (also discussed later) are types of formal supervisory actions.

• FDIC: Among other things, the FDIC may issue written agreements, cease and

desist orders, capital directives, and prompt corrective action directives.

• Office of the Comptroller of the Currency: Among other things, the Office of the

Comptroller of the Currency may issue formal agreements, prompt corrective action directives, and cease and desist orders.

37

How does the FDIC Assert Such a Claim?

• Ideally, the FDIC, as receiver for a failed bank, will have a guaranty

from the holding company that unequivocally provides for the holding company to guaranty the capital levels of its bank subsidiary and, when needed, to infuse capital into the bank subsidiary. In the absence of such an agreement, the FDIC typically relies on a combination of regulatory provisions and documents to assert entitlement to such a claim:

– statutory and regulatory provisions set forth in 12 U.S.C. § 1831o(e)(2)(c)(ii), 12 U.S.C. § 1464(s), and 12 C.F.R. § 225.4 – Written Agreements – Formal Agreements – Memoranda of Understanding – Capital Directives – Cease and Desist Orders – Capital Plans

38

The Statutory Scheme

Prompt Corrective Action (“PCA”), 12 U.S.C. § 1831o(e)(2)(c)(ii)

• PCA provides one avenue for bank regulators to obtain a commitment from a

bank holding company to maintain the capital of its bank subsidiary.

• This type of enforcement action is entirely separate from other formal remedies

available to the FDIC and other regulators for enforcement of regulatory requirements, such as cease and desist orders.

• The concept of PCA was ushered in with the enactment of the Federal Deposit

Insurance Corporation Improvement Act of 1991 (the “FDICIA”), Pub. L. No. 102-242, 105 Stat. 2236 (1990). FDICIA was intended to enable and encourage regulatory agencies, such as the FDIC, to act more quickly and aggressively in addressing financial problems of insured depository institutions.

• The FDICIA mandates that regulatory agencies take certain prescribed actions if

a bank fails to meet minimum capital requirements. 12 U.S.C. § 1831o.

39

The Statutory Scheme

PCA, 12 U.S.C. § 1831o(e)(2)(c)(ii)

• If an insured institution is determined, after notice and opportunity for hearing, to

be in an unsound condition or to be engaging in unsound practices, the institution may be deemed “undercapitalized.” 12 U.S.C. § 1831o(g).

• PCA powers are triggered by written notice from the regulatory agency of its

intent to issue a directive under the FDICIA (a “Supervisory Prompt Corrective Action Directive”) unless the agency determines that immediate action is required (in which case the agency may issue a Supervisory Prompt Corrective Action Directive without prior notice).

• After notification to an insured financial institution of intent to issue a Supervisory

Prompt Corrective Action Directive, the regulatory agency may issue such a directive.

40

The Statutory Scheme

PCA, 12 U.S.C. § 1831o(e)(2)(c)(ii)

• Within 45 days of being deemed “undercapitalized,” the affected institution must submit a

“capital restoration plan” for approval to the regulatory agency. Otherwise, the affected institution becomes subject to significant restrictions on its activities. 12 U.S.C. § 1831o(e)(2) & (f)(1)(B)(2).

• The appropriate regulator then has 60 days after submission of the restoration plan to

accept or reject it. 12 U.S.C. § 1831o(e)(2)(D)(ii). – Before a “capital restoration plan” will be approved, among other things, each company that controls the institution must submit a guaranty that the institution will comply with the plan until it has been “adequately capitalized” for each of four consecutive calendar

• quarters. 12 U.S.C. § 1831o(e)(2)(C); 12 C.F.R. §325.104.
• The liability of a holding company under the guaranty is statutorily limited to the lesser of (i)

the amount necessary to bring the institution into compliance with all applicable capital standards as of the date that the institution fails to comply with its “capital restoration plan”

• r (ii) five percent (5%) of the institution’s total assets. 12 U.S.C. § 1831o(e)(2)(E).

41

The Statutory Scheme

12 U.S.C. § 1464(s)

• Section 12 U.S.C. § 1464(s) authorizes the Office of the Comptroller of

Currency to establish minimum capital requirements for savings

• associations. 12 U.S.C. § 1464(s)(1).
• When savings associations fail to meet these minimum capital

requirements, the appropriate Federal banking agency may require the savings association to, among other things, “submit and adhere to a plan for increasing capital which is acceptable to the appropriate Federal banking agency.” 12 U.S.C. § 1464(s)(4)(A).

42

The Statutory Scheme

12 C.F.R. § 225.4

• A bank holding company should “serve as a source of financial and managerial

strength to its subsidiary banks and shall not conduct its operations in an unsafe

• r unsound manner.” 12 C.F.R. § 225.4(a)(1).
• A bank holding company’s failure to meet its obligations to serve as a source of

strength to its subsidiary bank, including an unwillingness to provide appropriate assistance to a troubled or failing bank, will generally be considered by the Board of Governors of the Federal Reserve System (“Board of Governors”) to be “an unsafe and unsound banking practice or a violation of Regulation Y, or both, particularly if appropriate resources are on hand or are available to the bank holding company on a reasonable basis.” Policy Statement on the Responsibility of Bank Holding Companies to Act as a Source of Strength to Their Subsidiary Bank, 52 Fed. Reg. 15707 (April 30, 1987).

43

The Statutory Scheme

12 C.F.R. § 225.4

• This policy behind 12 C.F.R. § 225.4 is further explicated in the Board of Governors’ Bank Holding

Company Manual which explains that a bank holding company should serve as source of strength when it is in a position to do so (i.e., when it has available resources): [A] bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks in a manner consistent with the provisions of the policy statement. . . Accordingly, it is the Board’s policy that a bank holding company should not withhold financial support from a subsidiary bank in a weakened or failing condition when the holding company is in a position to provide the support.

• BD. OF GOVERNORS OF FED. RESERVE SYS., BANK HOLDING COMPANY SUPERVISION MANUAL § 2010.0.1 at
• p. 2 (December 1992) (emphasis added), available at

http://www.federalreserve.gov/boarddocs/supmanual/bhc/bhc.pdf. See also Policy Statement on the Responsibility of Bank Holding Companies to Act as Sources of Strength to Their Subsidiary Bank, 52

• Fed. Reg. 15707 (April 30, 1987) (noting the “fundamental and long-standing principle underlying the

Federal Reserve’s supervision and regulation of bank holding companies” that bank holding companies should serve as a source of financial and managerial strength to their subsidiary banks).

44

The Documents

Memoranda of Understanding (“MOUs”)

• MOUs are a type of informal supervisory action, where the regulatory

agency has notified the board and management that there are problems that warrant attention. See Office of Thrift Supervision, Examination Handbook, Administration, Section 080 at 080.5 (July 2008).

• MOUs are written informal commitments that the company will correct a

violation of law, regulation, or an unsafe or unsound practice. Id. at 080.6.

• These MOUs usually contain some sort of commitment to maintain a

proscribed capital ratio, or to undertake certain actions to address weaknesses in a subsidiary.

45

The Documents

Formal Written Agreements

• Formal supervisory actions are enforceable under the Federal Deposit Insurance Act (12

U.S.C. § 1818). These include formal written agreements and cease and desist orders.

• Formal written agreements include supervisory agreements and capital directives under 12

C.F.R. § 567.

• Typically, supervisory agreements require a bank holding company to take corrective action

with respect to violations of law or regulation or continued unsafe or unsound practice. Unlike violations of other formal actions, violations of supervisory agreements are not enforceable in federal court (12 U.S.C. § 1818(i)).

• Capital Directives typically establish and enforce capital levels. A capital directive can be

based on: (a) a savings association’s noncompliance with a capital requirement established under 12 C.F.R. §§ 567.2 and 567.3; (b) a written agreement under 12 U.S.C. § 1464(s); and (c) a condition for approval of an application.

46

The Documents

Cease and Desist Orders

• Generally, the Federal Reserve may use its cease and desist authority against a

regulated entity when it finds that the entity is engaging in a violation of law, regulation, or an unsafe or unsound practice. 12 U.S.C. § 1818(b).

• A cease and desist order may require the entity subject to the order to cease

and desist from the practices and violations or take affirmative actions to correct the violations or practices. See generally BD. OF GOVERNORS OF FED. RESERVE SYS., COMMERCIAL BANK EXAMINATION MANUAL § 5040.1 at pp. 1-5.

• These orders, similar to written agreements, may require a bank holding

company to submit a capital plan, detailing how the holding company will maintain certain capital ratios.

• These orders also may reiterate the “source of strength” doctrine noted above.

47

The Case Law

Cases Holding that a Capital Maintenance Obligation was Created Resolution Trust Corp. v. FirstCorp, Inc. (In re FirstCorp, Inc.), 973 F.2d 243 (4th

• Cir. 1992):
• A bank holding company, prior to obtaining approval for its acquisition of a

savings and loan association, was required to maintain certain conditions set forth by the Federal Home Loan Bank Board, one of which was agreeing to a provision which provided that “the regulatory net worth of [the bank] shall be maintained at the greater of (1) three percent of total liabilities …, or (2) a level consistent with that required by [specific regulation] … and where necessary, to infuse sufficient additional equity capital … to effect compliance with such requirement.” Id. at 244 (emphasis added).

• The Fourth Circuit held that this constituted a capital maintenance obligation

within the meaning of section 365(o) of the Bankruptcy Code. Id. at 251.

48

The Case Law

Cases Holding that a Capital Maintenance Obligation was Created Franklin Sav. Corp. v. Office of Thrift Supervision, 303 B.R. 488 (D. Kan. 2004):

• As a condition to maintain approval of a merger and acquisition, the

holding company provided a written affidavit to agree to a condition set forth by the Federal Home Loan Bank Board that the holding company “will cause the net worth of [the bank] to be maintained at a level consistent with that required of institutions insured twenty years or longer by [specific regulation] …, infusing sufficient additional equity capital to affect [sic] compliance with such requirement whenever necessary.” Id. at 491 (emphasis added).

• The district court held that that the holding company’s written affidavit

agreeing to this condition created a capital maintenance obligation. Id. at 498.

49

The Case Law

Cases Holding that a Capital Maintenance Obligation was Created Office of Thrift Supervision v. Overland Park Fin. Corp. (In re Overland Park Fin. Corp.), 236 F.3d 1246 (10th Cir. 2001):

• In order to obtain approval of an acquisition, the holding company

stipulated in writing to the Federal Home Loan Board that “it will cause the net worth of [the bank] to be maintained at a level consistent with [specific regulation], and where necessary, that it will infuse sufficient additional equity capital to effect compliance with such requirement.”

• Id. at 1249 (emphasis added).
• The Tenth Circuit held that this stipulation created a binding obligation

to maintain capital. Id.

50

The Case Law

Cases Holding that a Capital Maintenance Obligation was Created Wolkowitz v. Fed. Deposit Ins. Corp. (In re Imperial Credit Indus.), 527 F.3d 959 (9th

• Cir. 2008):
• The FDIC instituted a Prompt Corrective Action against the holding company,

and the holding company was required to submit a capital restoration plan, along with a performance guaranty. Id. at 965.

• In the performance guaranty, the holding company committed itself to

“absolutely, unconditionally and irrevocably guarantee[] the performance of [subsidiary] under the terms of the Capital Plan and … pay the sum demanded to [subsidiary] or as directed by the [FDIC] in immediately available funds.” Id.

• The Ninth Circuit held that this guaranty created an enforceable capital

maintenance obligation. Id. at 968.

51

The Case Law

Cases Holding that a Capital Maintenance Obligation was Not Created In re Colonial BancGroup, Inc., 436 B.R. 713 (Bankr. M.D. Ala. 2010):

• The bankruptcy court first examined whether a capital maintenance commitment

within the meaning of section 365(o) of the Bankruptcy Code had been made, by analyzing (i) an agreement between the debtor bank holding company and the Federal Reserve Bank of Atlanta, (ii) a memorandum of understanding between the debtor and the Alabama Banking Department and the Federal Reserve Bank

• f Atlanta, and (iii) a cease and desist order against the debtor. Id. at 730.
• After reviewing these documents, the court found that “the Debtor and the

Federal Reserve did not intend to create a commitment in the Debtor to maintain the capital of Colonial Bank within the meaning of 11 U.S.C. § 365(o)” inasmuch as the language of such documents did not expressly provide for a capital maintenance commitment. Id. at 733.

52

The Case Law

Cases Holding that a Capital Maintenance Obligation was Not Created In re Colonial BancGroup, Inc., 436 B.R. 713 (Bankr. M.D. Ala. 2010):

• The court distinguished the language of the documents in that case from the four cases discussed above,

and opined that: The documents do not require the Debtor to comply on behalf of the Bank or impose liability on the Debtor in the event the Bank fails to reach the required capital ratios…The language is broad and general and requires only that the Debtor “assist” the Bank…Most importantly the language does not require the Debtor to make a capital infusion, in any amount, in the Bank.

• Id. at 731-33.
• The court also held that section 365(o) is inapplicable where the bank subsidiary is closed prior to the

holding company filing for bankruptcy protection: 11 U.S.C. § 356(o) does not apply to a capital maintenance commitment where the commitment cannot be assumed and cured because the underlying depository institution is no longer operating. To hold

• therwise would ignore the statutory framework of the Code. Congress intended to address claims

based on such commitments under 11 U.S.C. § 507(a)(9).

• Id. at 738.

53

The Case Law

Cases Holding that a Capital Maintenance Obligation was Not Created

• Fed. Deposit Ins. Co. v. AmFin Fin. Corp., Case No. 1:10-CV-1298, 2011 WL 2200387 (N.D. Ohio June 6,

2011):

• The FDIC, as receiver for a failed bank, argued that the holding company had made a commitment to

maintain the capital of the bank by virtue of, among other things, two cease and desist orders, a capital management policy and a three-year strategic business plan.

• The capital management policy and the three-year strategic business plan submitted by the holding

company “laid out a plan to raise capital and increase the capital ratios” Id. at *7. The court held that “[t]he [capital management policy] and the three-year strategic business plan were not, and did not contain, a commitment by [AmFin] to maintain the capital of the Bank. Rather, they contained a plan, projection, or description of a preferred course of action.” Id. at *11.

• The cease and deist orders required the holding company to achieve and maintain certain capital levels and

to submit a capital plan detailing how those capital levels would be achieved and maintained. Nevertheless, the AmFin court found: “Paragraph 4(a) of the Cease and Desist Order does not create a commitment by [AmFin] to maintain the capital of the Bank, as the only requirement in this paragraph is an obligation to ‘submit a plan.’ ” and “Paragraph 8 [of the cease and desist order] was intended to create an obligation by the Board to oversee the Bank’s attempt’s to obtain and maintain specific capital ratios, but there is no evidence that it was intended to create or impose an enforceable obligation by [AmFin] to maintain the capital of the Bank . . . . [Thus,] Paragraph 8 of the Cease and Desist Order is not a commitment to maintain the capital of the Bank.” Id.

54

Lesson from Colonial and AmFin

• Both courts refused to find a capital maintenance commitment where the

documents in question merely required the holding company to “assist” its banking subsidiary in maintaining capital levels and complying with its regulatory agreements and where the documents did not specifically require the holding company to infuse capital into the bank subsidiary.

• Both courts held that the “source of strength” doctrine, without more, does not

require a holding company to maintain the capital levels of its bank subsidiary.

– The Colonial court concluded that “the source-of-strength doctrine [found in 12 C.F.R. § 225.4] does not require a bank holding company to make capital contributions to its subsidiaries.” Colonial, 436 B.R. 730 n.15. – The AmFin court held: “There is no legal requirement, under the general banking regulations, that a holding company commit to maintain the capital of a bank; that it guarantee the performance of the bank; or, that it infuse its own capital into a failing bank, whether or not the holding company or the bank may be facing a potential bankruptcy.” AmFin, 2011 WL 2200387, at *7.

55

What if a Capital Maintenance Claim Exists?

Avoidance as a Fraudulent Transfer

• Even if a court finds that a bank holding company made a commitment

to maintain the capital of its bank subsidiary, such a commitment may be a fraudulent conveyance. See Wolkowitz, 527 F.3d at 972-73 (holding that a capital maintenance obligation can be avoided under section 548 of the Bankruptcy Code). This may be demonstrable if the alleged commitment is significant, the holding company’s financial condition was weak at the time it was given, and if the holding company received no financial consideration in return.

56

What if a Capital Maintenance Claim Exists?

Potential Section 502(d) Objections

• A capital maintenance claim may be subject to disallowance under section

502(d) of the Bankruptcy Code to the extent the bank received avoidable transfers prior to the holding company’s bankruptcy filing (such as capital infusions by the holding company to the bank with no consideration).

• To the extent such avoidable transfers exist, a trustee or debtor-in-possession

may be able to obtain disallowance of such claim under section 502(d) unless and until the avoidable transfers are repaid (even if such claim is entitled to priority under section 507(a)(9) of the Bankruptcy Code). See In re Eye Contact, Inc., 97 B.R. 990, 991-93 (Bankr. W.D. Wis. 1989) (approving of the use of section 502(d) to defeat a section 507(a)(3) priority claim); In re Plastech Engineered Prods., Inc., 394 B.R. 147, 164 (Bankr. E.D. Mich. 2008) (holding that priority claims, other than section 507(a)(2), are “undoubtedly . . . subject to the claims allowance process under section 502 and to the disallowance provisions of section 502(d)….”).

57

LITIGATION ASSETS IN BANK HOLDING COMPANY BANKRUPTCIES AFTER DODD-FRANK

James D. Higgason, Jr. Diamond McCarthy LLP Houston, Texas

jhiggason@diamondmccarthy.com 713.333.5145

59

SUMMARY

I. Definition of “Bank” and “Bank Holding Company”

• II. Litigation Assets Often in Bank Holding Company Bankruptcy Estates
• III. Fraudulent Transfer Claims

A. “Actual Intent” B. “Constructive Intent” C. Liability for fraudulent transfers

• IV. The Regulatory Landscape
• V. Anatomy of a Bank Failure
• VI. Fraudulent Transfer Claims Against the FDIC
• VII. Potential Parties
• VIII. Recent Federal Statutes Relevant to Fraudulent Transfer Claims Against the FDIC

A. Dodd-Frank § 616(d) B. Gramm-Leach-Bliley § 730 C. Dodd-Frank Title II

60

Definition of “Bank” and “Bank Holding Company”

• 12 U.S.C. § 1841(c) defines a “bank” as an insured bank as defined in

12 U.S.C. § 1813(h) or as an institution that accepts demand deposits and makes commercial loans. For our purposes, a bank includes national banks, state banks, district banks, savings banks, and thrifts.

• 12 U.S.C. § 1841(a)(1) defines a “bank holding company” as “any

company which has control over any bank or any company that is or becomes a bank by virtue of this chapter.”

• 84% of commercial banks in the U.S. are directly or indirectly owned
• r controlled by a bank holding company.
• All larger banks with more than $10 billion in assets are owned by

bank holding companies. See www.fedpartnership.gov/bank-life- cycle/grow-shareholder-value/bank-holding-companies.cfm.

61

Litigation Assets Commonly Held by Bank Holding Company Bankruptcy Estates

1. Claims against directors & officers 2. Claims against professionals that provided pre-petition services 3. Fraudulent transfer and preference claims

62

Fraudulent Transfer Claims

• Brought under Bankruptcy Code Section 548

and similar state law creditors’ rights statutes

• Section 548 authorizes a bankruptcy trustee to

avoid two types of fraudulent transactions: (1) “Actual intent” transfers under § 548(a)(1)(A) and (2) “Constructive intent” transfers under § 548 (a)(1)(B)

63

“Actual Intent” Claims

Section 548(a)(1)(A) allows a bankruptcy trustee to avoid any transfer made or obligation incurred by the debtor if the transfer was made “with actual intent to hinder, delay, or defraud” the debtor’s creditors. Actual intent claims can be established either with direct evidence or with indirect evidence reflected by “badges” of fraud. A non-exclusive list of such badges is contained in Section 4(b)

• f the Uniform Fraudulent Transfer Act.

64

Constructive Intent Claims

Section 548(a)(1)(B) provides that a bankruptcy trustee may avoid transfers the debtor made or obligations the debtor incurred if the debtor received less than reasonably equivalent value in exchange for the transfer or obligation and 1) Was insolvent on the date of the transfer or became insolvent as a result of the transfer; 2) Was engaged in a business or transaction, or was about to engage in a business or transaction, which had unreasonably small capital after the transfer; 3) Intended to incur debts that would be beyond the Debtor’s ability to pay when the debts matured; or 4) Made a transfer to or for the benefit of an insider under an employment contract and not in the ordinary course of business.

65

Liability for Avoided Transfers

Bankruptcy Code § 550(a) provides that if a transfer is avoided under Section 548, then the bankruptcy trustee may recover for the benefit of the estate the value of the transferred property from: (1) The initial transferee; (2) The entity for whose benefit the transfer was made; or (3) Any immediate or mediate transferee of the initial transferee.

66

The Regulatory Landscape

The Primary Regulator: The Office of the Comptroller of the Currency (“OCC”) has primary regulatory responsibility over national banks and thrifts. State bank regulators regulate state banks. The Federal Reserve: The Federal Reserve Board of Governors and the Federal Reserve Banks regulate bank holding companies. The Federal Deposit Insurance Corporation (“FDIC”): The FDIC administers the Deposit Insurance Fund that insures deposits at member banks. An FDIC receivership assumes the assets of a failed bank

• r conservatorship.

Regulatory Cooperation All federal bank regulators and the FDIC are required to cooperate to resolve the problems of distressed insured banks in a way that causes the least possible loss to the FDIC Deposit Insurance Fund. Since Deposit Insurance Funds are at risk, the FDIC typically is consulted early and often regarding the resolution of problems of distressed banks.

67

Anatomy of a Typical FDIC Insured Bank Failure

• An FDIC insured bank becomes distressed and under

capitalized.

• Bank regulators intervene and direct the bank to raise

capital.

• The distressed bank’s holding company is encouraged
• r required to act as a “source of strength” by

downstreaming funds to the troubled bank.

• The bank’s primary regulator declares the bank insolvent

and closes it.

• The

failed bank’s assets, including any assets transferred from the bank holding company to the bank, are placed in a receivership administered by the FDIC.

68

Fraudulent Transfer Claims Against the FDIC

• Pre-petition transfers to subsidiary banks that

subsequently were seized by the FDIC may be avoidable as fraudulent transfers.

• A bank holding company bankruptcy estate’s

largest asset is often a fraudulent transfer claim against the FDIC to recover pre-petition transfers to a failed subsidiary bank that was placed in an FDIC receivership.

69

Potential Defendants in a Fraudulent Transfer Action

If there is evidence that a bankrupt bank holding company made a fraudulent transfer to a subsidiary bank that subsequently was placed in FDIC receivership, the trustee will want to explore whether it is appropriate to seek to recover from: 1) The FDIC in its corporate capacity as the entity for whose benefit the transfer was made; 2) The FDIC in its receivership capacity as an immediate transferee from the initial transferee (the subsidiary bank); and 3) Any bank or other entity that may have acquired the transferred assets from the FDIC receivership.

70

Recent Federal Statutes Relevant in Fraudulent Transfer Actions Against the FDIC

Dodd-Frank Act Section 616 Section 616(d) of the Dodd-Frank Act codifies the Federal Reserve’s “Source of Strength” doctrine. It authorizes federal bank regulators to require a bank holding company to act as a “source of financial strength” for a distressed subsidiary bank to the extent it is able to do so. Bank regulators have used the source of strength doctrine and other means to encourage or compel bank holding companies to transfer assets to distressed subsidiary banks. Regulators control banks and bank holding companies to such an extent that it may be appropriate to impute the FDIC’s intent to the bank holding company transferor in connection with an actual intent fraudulent transfer claim. Gramm-Leach-Bliley Act Section 730 Section 730 of the Gramm-Leach-Bliley Act (12 U.S.C. § 1828(u) states,

No person may bring a claim against any Federal banking agency (including in its capacity as conservator or receiver) for the return of assets of an affiliate or controlling shareholder of the insured depository institution transferred to, or for the benefit of, an insured depository institution by such affiliate or controlling shareholder of the insured depository institution, or a claim against such Federal banking agency for monetary damages or other legal or equitable relief in connection with such transfer, if at the time of the transfer (A) the insured depository is subject to any direction issued in writing by a Federal banking agency to increase capital . . . .

Section 730 also states, however, that a “claim” barred by the provision “does not include any claim based

• n actual intent to hinder, delay or defraud” creditors pursuant to applicable federal and state fraudulent

transfer laws.

71 Dodd-Frank Title II Title II of the Dodd-Frank Act sets up a mechanism pursuant to which certain systematically important bank holding companies and other financial institutions can be placed in FDIC receivership, like failed banks, rather than going through the bankruptcy process.

72

GLBA Section 730’s Effect on Fraudulent Transfer Claims Against the FDIC

• Constructive intent claims to avoid transfers occurring after a written

directive to raise capital has issued are prohibited.

• Constructive intent claims to avoid transfers made before a directive to

raise capital is issued are not barred.

• Actual intent claims are authorized by the statute.
• The statute is designed to protect good faith efforts on behalf of regulators

and to encourage bank holding companies to recapitalize viable distressed subsidiary banks.

• Regulators are courting exposure if they cause a bank’s holding company

to downstream assets to a failing subsidiary bank, knowing the bank is likely to fail and knowing the transferred assets will likely end up in the coffers of the FDIC when the bank is placed in receivership, because GLBA § 730 specifically allows debtors to avoid actual intent fraudulent transfers.

73

Title II of the Dodd-Frank Act

• Title II of the Dodd-Frank Act establishes a mechanism pursuant to which

systematically significant bank holding companies and other financial companies can be liquidated by the FDIC through means similar to those the FDIC currently uses to resolve failed banks, rather than pursuant to the normal bankruptcy process.

• If the power is ever used to liquidate a bank holding company, Section 548 fraudulent

transfer actions likely could not be pursued. Section 210 of the Act authorizes the FDIC to bring fraudulent transfer actions as receiver of a bank holding company. However, while § 212(c) directs the FDIC to “take appropriate action” to resolve any conflicts of interest that may arise in its role as receiver of a bank holding company and its subsidiary bank, the likelihood that the FDIC as receiver of a bank holding company would take on action that would result in suing the FDIC as receiver of the subsidiary bank to avoid a fraudulent transfer is remote.

• Title II does not address the “too big to fail” problem.
• Many knowledgeable commentators have noted that systematically important financial

companies likely will never be placed in receivership precisely because they are systematically important. They believe FDIC resolution authority over such entities is a power that will not be used except in rare circumstances.

• The vast majority of failed bank holding companies will continue to be resolved via the

normal bankruptcy process.