UK: Bankruptcy Court Rejects FDIC’s Claim for Capital Shortfall

Last Updated: 28 September 2010
Article by Thomas P. Vartanian, Robert H. Ledig, Gordon Miller and Glenn Siegel

The next few years will see the "redevelopment" of the law in two critical areas involving bank failures where the Federal Deposit Insurance Corpora-tion ("FDIC") is appointed receiver: (i) the relative rights and claims of creditors of a bank or savings and loan holding company, including the FDIC; and (ii) D&O and professional liability. Significant decisions are be-ginning to be issued with regard to the former.

The bankruptcy court overseeing the reorganiza-tion of Colonial BancGroup, Inc. ("BancGroup"), the former bank holding company for the failed Colonial Bank of Montgomery, Alabama ("Bank"), on August 31, 2010, rejected a $900 million claim of the FDIC, as receiver for the Bank, against BancGroup with respect to an alleged capital maintenance commitment BancGroup had and failed to honor.

Whether a bank or thrift holding company is obli-gated to cure a capital shortfall existing at a de-pository institution prior to the institution's failure, and the manner in which such an obligation can be enforced once the parent is in bankruptcy, have reemerged as contentious issues in connection with the current round of bank failures. Indeed, this and a handful of other core issues, such as competing claims over tax refunds and other tax benefits, may be critical to the value of both the holding company in bankruptcy and the depository institution's receivership.

The Colonial court distinguished this case from several others in which depository institution regulatory agencies successfully argued that a holding company had entered into a capital main-tenance commitment. Under Section 365(o) of the Bankruptcy Code, a holding company that is in Chapter 11 must immediately cure its default un-der a capital maintenance commitment or convert its case to Chapter 7. The court held that none of BancGroup's enforcement-related agreements with the Federal Reserve Bank of Atlanta constituted a commitment to maintain the capital of Colonial under Section 365(o), since BancGroup never spe-cifically agreed to make a capital infusion or to guarantee the Bank's capital obligations and never intended to do so.

The court went on to make two other significant rulings, which are likely to spur additional debate:

  • To be enforceable, any capital maintenance commitment by a holding company must have been made with its subsidiary bank's federal regulator, rather than with the hold-ing company's own regulator; and
  • Even if there had been a binding capital main-tenance commitment by the holding com-pany, it would have been unenforceable under Section 365(o) because the Bank was closed before the bankruptcy petition was filed, which made performance under a capital maintenance commitment impossible.

The court's ruling suggests that federal bank regu-lators may have to reevaluate their approach to creating an enforceable holding company capital maintenance commitment for purposes of Section 365(o).

An even more far-reaching implication of the court's decision involves the practical enforceability of a capital maintenance commitment. In most situations, a bank holding company enters bankruptcy after its depository institution subsidiary is placed in receivership. Under the court's reasoning, such a sequence would prevent the application of Section 365(o), since there would be no operating depository institution whose capital is to be maintained. On the other hand, there has been at least one recent instance where a holding company in bankruptcy infused capital in accordance with a capital maintenance commitment into an operating depository institution in a Section 365(o)-type situation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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