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Banksters Successful Defenses for Assets Acquired Under FDIC Purchase and Assumption Transactions

May 2010 Successful Defenses for Assets Acquired Under FDIC Purchase and Assumption Transactions

Paul T. Musser and David J. Jurkiewicz, Bose, McKinney & Evans LLP

As of March, 41 financial institutions have failed this year. This number puts 2010 on pace to surpass 2009s total of 140 failed institutions. While considerable attention has gone to preventing further collapses, little has been paid to the rights of the Federal Deposit Insurance Corp. and banks acquiring the assets of these failed institutions. How can acquirers protect themselves from the legal baggage that often accompanies these assets to their new owners? One answer is federal law. Case law and legislation provide banks acquiring assets through FDIC purchase and assumption agreements with powerful protections from many allegations that develop from the underlying interactions between failed banks and their borrowers. Through federal statute and common law, assuming banks have been able to collect upon acquired assets and quickly invalidate various borrower counterclaims and defenses. In 1942 the Supreme Court initiated a line of defenses for FDIC-acquired assets with its holding in DOench, Duhme & Co. Inc. v. FDIC. This case examined the sale of bonds by a securities broker to a bank, where the bond issuers subsequently defaulted on payment. To allow the bank to avoid showing the bonds as non-performing assets, the bank and broker signed a promissory note, with the bank giving the broker a receipt that agreed not to call on the note for payment. When the FDIC assumed the bank after its failure, it demanded payment on the note from the broker. The DOench, Duhme court rejected the brokers defense and allowed the FDIC to collect on the note, recognizing a Congressional policy to protect the FDIC from secret agreements that could undermine the value of an acquired banks assets. Shortly afterward, Congress essentially codified this holding in Section 13(e) of the Federal Deposit Insurance Act (12 U.S.C. 1823(e)), which required, among other things, that agreements modifying a loan or guaranty made prior to the FDICs appointment must be in

writing. Over time, courts have used both DOench, Duhme and section 1823(e) to invalidate an increasing number of defenses and counterclaims as secret agreements. In 1987 the Supreme Courts unanimous ruling in Langley v. FDIC rejected an attempt by borrowers to use a banks oral misrepresentations concerning loan terms as a defense against the FDICs efforts to collect on the loan, after the bank failed and went into FDIC receivership. Relying on DOench, Duhme, the Langley Court held that such oral misrepresentations constitute a secret agreement, regardless of whether they were fraudulent or if FDIC had knowledge of the defense through a lawsuit filed prior to the FDICs acquisition of the note. The Langley court noted an important public policy interest in allowing the FDIC to exclusively rely on a failed banks written documents, especially given the speed and economic considerations involved in preserving the going concern value of failed banks. Other courts have extended this protection to invalidate counterclaims and defenses based on duties or obligations not specifically articulated in the underlying loan records, such as purported breaches of fiduciary duties, implied covenants of good faith, negligence and third-party agreements. Most importantly for financial institutions, courts have extended the DOench, Duhme Doctrine and section 1823(e)s protections to institutions purchasing assets from failed institutions through FDIC purchase and assumption agreements. Thus, assuming banks are afforded the same protections as the FDIC against claims and defenses classified as secret agreements. As the Fifth Circuit noted in 1991s Porras v. Petroplex Savings Association, to hold otherwise would undermine the public policy preference articulated by DOench, Duhme in favor of the FDIC, as it would defeat any FDIC gains by discouraging the acquisition of these failed assets. Both the Seventh Circuit and Indiana courts have adopted and utilized DOench, Duhme and section 1823(e) to invalidate counterclaims and defenses based upon secret agreements. In 1981s Howell v. Continental Credit Corporation, however, the Seventh Circuit limited their application, by allowing a debtor to bring defenses against the collection on a lease when the debtors defenses were based upon an alleged breach of the leases terms. The Howell court held that, even though the court had to go outside of the lease to examine the debtors defenses, the fact that the basis of their defense rested in a disclosed document fulfilled the requirements of section 1823(e) and precluded the application of DOench, Duhme. The Indiana Court of Appeals adopted the Howell courts interpretation in 1999s Diversified Financial Systems, Inc. v. Minerdecision. In Miner, the court precluded the use of an oral agreement between a bank and its borrower as the basis of a counterclaim when the FDIC took the failed bank into receivership and transferred the loans to an assuming bank. The Minercourt clearly articulated Indianas favorable position on this issue: *B+oth case law and federal statute protect the F.D.I.C. when it seeks to recover on an asset acquired from a failed bank. Specifically, the F.D.I.C. is protected from assertions by obligors that the latter had an oral agreement with the failed bank. Moreover, this protection extends to third parties to whom the F.D.I.C. may transfer a note.

With the increasing number of bank failures during 2009 and 2010, there is a renewed possibility that DOench Duhmecould be reviewed by the state and federal courts of Indiana. If so, there is a strong policy argument in favor of keeping the doctrine, given the need to quickly and efficiently transfer the assets of failed banks to and through the FDIC. The same could also be said for a broad interpretation of section 1823(e). As a result, financial institutions can seriously consider acquiring assets from their failed counterparts under FDIC purchase and assumption agreement, even though these assets might seem unduly burdened by undesirable legal claims. A careful examination of these claims through the lens of DOench Duhme and section 1823(e) might show these assets to be more valuable than initially thought. In an upcoming Hoosier Banker article, we will discuss the development of the federal holder in due course doctrine, which is a more powerful tool for acquirers of assets from the FDIC.

Hoosier Banker articles are published by the Indiana Bankers Association. With the exception of official announcements, the Indiana Bankers Association disclaims responsibility for opinions expressed and statements made in the articles published in Hoosier Banker and/or appearing on the IBA website. Unless requested otherwise by the author in writing, all material published in Hoosier Banker and/or on the IBA website is the property of the Indiana Bankers Association.

Email this page to a friend Successful Defenses for Assets Acquired Under FDIC Purchase and Assumption Transactions Part 2

June 2010 Successful Defenses for Assets Acquired Under FDIC Purchase and Assumption Transactions: Part 2 Paul T. Musser and David J. Jurkiewicz, Bose, McKinney & Evans LLP In our previous article in the May Hoosier Banker, we began to explore the use of federal statutory and common law as a means of protecting assets acquired from failed financial institutions through Federal Deposit Insurance Corp. purchase and assumption agreements. Through the Supreme Courts ruling in DOench, Duhme & Co. Inc. v. FDIC and 12 U.S.C. 1823(e), the Seventh Circuit and Indiana courts have provided assuming banks with useful case law in protecting these assets from counterclaims and defenses grounded in secret agreements between the failed institutions and their borrowers. The present article examines another, even more robustthough controversialtool at an assuming banks disposal: the Federal Holder in Due Course Doctrine.

Typically defined under state law, a partys status as a holder in due course (HDC) is a powerful means of protecting negotiated instruments from attacks rooted in their underlying events. To qualify as an HDC, a party must be a holder, for value, given in good faith, without any notice of problems regarding the instrument. The HDC will take an instrument subject only to its real defenses, which are limited to infancy, duress, lack of capacity, illegality, fraud on the instrument and discharge through insolvency. Therefore the HDC will not be subject to any personal defenses including, but not limited to, counterclaims and defenses sounding in breach of contract, fraudulent inducement or negligence. Furthermore the HDC can pass on this protection against personal defenses when it transfers the instrument to other parties that might not themselves be HDCs under the shelter rule. Thus being an HDC or being able to locate an HDC within an instruments chain of title is extraordinarily valuable when attempting to protect it against subsequent defenses and claims rooted in its formation. Under state law, however, the FDIC and financial institutions acquiring assets from the FDIC only occasionally qualify as HDCs. Often the FDIC and assuming banks fail to qualify as HDCs due to their failure to satisfy the notice element, either imputed by an instruments abnormally low purchase price or through actual knowledge that the note is overdue or subject to a pre-existing lawsuit. In contrast, the Federal Holder in Due Course Doctrine relaxes these requirements, allowing the FDIC and its transferees to become HDCs. The Seventh Circuit has recognized the Federal Holder in Due Course Doctrine as to the FDIC when acting in its corporate capacity in 1980s FDIC v. Rosenthal. In Rosenthal, the FDIC was appointed as receiver over a failed bank and sold a note, subject to a claimed defense of fraudulent inducement. The Rosenthal court held that while the FDIC, in its corporate capacity, was not an HDC based upon state law, through 11 U.S.C. 1823(e), Congress intended to grant it Federal Holder in Due Course status so as to promote soundness in banking and to aid and protect the FDIC in the conduct of its duties. While the Seventh Circuit has not ruled on whether the FDIC, in its capacity as receiver or subsequent transferees of FDIC assets, is covered by the Federal Holder in Due Course Doctrine, the Fifth Circuit came to this conclusion in 1990s Campbell Leasing, Inc. v. FDIC. The Campbell Leasing court found a bank that purchased a note from the FDIC, subject to a lawsuit alleging tortuous interference by the failed lender was a Federal Holder in Due Course, such that it was immune from personal defenses raised by the borrower. The Fifth Circuit further cemented its position in 1993s FDIC v. Gilbert, which held that both the DOench Duhme and Federal Holder in Due Course Doctrines apply to any subsequent purchasers and assignees of notes from the FDIC. However the Fifth Circuits position has proven far from universal. In fact several federal circuit courts have rejected or limited the use of federal common law in litigation concerning failed banks in light of the Supreme Courts 1994 decision in OMelveny & Meyers v. FDIC. The OMelveny court rejected a request by the FDIC to create new federal common law so as to avoid a state-law based defense for the officers of a failed savings and loan, holding that absent a significant conflict between some federal policy or interest and the use of state law, the Court would not create federal common law to supplement a detailed federal statute. The Third, Eighth, Ninth and D.C. Circuits have taken this holding to mean that the DOench, Duhme and federal holder in due course doctrines are no longer applicable in light of Congress passage of the

Financial Institutions Reform, Recovery and Enforcement Action of 1989 (FIRREA). However the Fourth and Eleventh circuits have upheld these doctrines, finding that OMelveny concerned only the creation of new federal common law and did not affect these longstanding federal common law doctrines. While there is an increased chance that the use of federal common law in litigation concerning failed banks could be subject to review, potentially even by the Supreme Court given the recent spike in financial institution failures and the existing circuit split, Indiana still represents a favorable venue for banks assuming failed assets through FDIC purchase and assumption agreements. Indiana courts look likely to continue protecting these assets, especially considering the strong policy arguments in favor of encouraging the FDICs viability, with existing state and federal case law already supporting the continued implementation of these doctrines. In addition financial institutions can always rely on 12 U.S.C. 1823(e) to protect these failed assets from many of the common counterclaims and defenses that arise from the underlying interactions between borrowers and the failed institution. Part 1 of this article appeared in the May 2010 Hoosier Banker. Hoosier Banker articles are published by the Indiana Bankers Association. With the exception of official announcements, the Indiana Bankers Association disclaims responsibility for opinions expressed and statements made in the articles published in Hoosier Banker and/or appearing on the IBA website. Unless requested otherwise by the author in writing, all material published in Hoosier Banker and/or on the IBA website is the property of the Indiana Bankers Association.

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