April 13, 2014
Authored by: Jerry Blanchard
One of the very powerful rights that the FDIC possesses in any receivership is a provision added by FIRREA which states that the FDIC may enforce any contract entered into by the depository institution notwithstanding any provision of the contract providing for termination, default, acceleration, or exercise of rights upon, or solely by reason of, insolvency or the appointment of or the exercise of rights or powers by a conservator or receiver (i.e., “ipso-facto” clauses). Many typical vendor contracts will oftentimes contain just such a clause providing that one party to the contract can terminate the contract at will if the other party files for relief under the Bankruptcy Code or is taken over by the government. The logic is pretty compelling, a party wants to be able to decide if it is comfortable dealing with an entity that is insolvent or attempting to reorganize.
A recent Georgia Court of Appeals decision raises interesting issues about how this specific FDIC power can be used in the context of a loan participation. In CRE Venture 2011-1, LLC v. First Citizens Bank of Georgia, First Citizens found itself the surviving bank of a group of four banks that had been involved in a loan participation. The lead bank and two others had been placed into receivership and the FDIC had sold the lead position to CRE Venture 2011-1, LLC. As is oftentimes the case in such situations, the local bank objected to the manner in which the lead was handling the credit, specifically, the proposed foreclosure of the real property securing the participated loan. First Citizens sought equitable relief based on its argument that if the foreclosure went forward, First Citizens would lose most of its interest in the loan and would be forced to account for the sale in a manner that would do it serious and irreparable harm to its finances and business prospects. First Citizens pointed out that unlike the two other loss-share banks that had succeeded to the other failed banks shares in the loan, it had not entered into a loss-sharing agreement with the federal government. Moreover, First Citizens argued that CRE Venture purchased the Loan at a significant discount and would not suffer the same loss, and might even profit from a quick sale of the property.
The biggest issue for First Citizens was its assertion that it was entitled to enforce the ipso facto clause in its loan participation agreement which provided that the participant could assume the administration of the loan if the lead bank were taken over or otherwise closed by a governmental regulatory agency. The participation agreement further stated that in the event of multiple participants the participant with the largest share would have the first option to assume the administration of the loan with the option passing on down the line if one or more of the participants did not wish to exercise their option. At the hearing on First Citizens’ motion for a temporary restraining order, counsel for First Citizens argued that, since the original administrator of the loan and the other two original participants had all been closed by regulators, First Citizens, as the only original participant remaining, was entitled to administer the loan pursuant to the participation agreement.
The trial court entered the injunctive relief First Citizens sought and prohibited CRE Venture from foreclosing on the real property pending the resolution of First Citizens’ claims for declaratory judgment. CRE Venture argued on appeal that the trial court had erred because First Citizens would not be able to prevail of the merits of its claim. The Georgia Court of Appeals first looked to the language of the underlying participation agreement and found that the language was clear as to First Citizens’ right to supplant the existing lead and administer the loan. CRE Venture countered that the language was overridden by the statue prohibiting the enforcement of ipso facto clauses against the FDIC. [12 USC § 1821(e)(13(A)] The court rejected this argument finding that the section only applies when the FDIC seeks to prevent termination of a contract, not when it is actually seeking to enforce it.
The factual background of this case makes it somewhat unusual. The status of the holder of the loan participation interest was significant because under FIRREA the FDIC is immune from injunctive actions. Thus the outcome could have been very different if the FDIC still held the asset directly. What is so very ironic is that the FDIC is actually an investor in CRE Venture! The FDIC has entered into a number of public/private partnerships where it allows another party to manage the assets acquired from failed institutions while the FDIC retains an interest in future cash flows generated from the workout of the loans over a period of years.
The implications of the case are hard to predict. Many form loan participation agreements published by major forms providers contain language similar to what was used here. While some loan participants may want to supplant the lead lender they may not have the personnel or the expertise to step in and administer the loan. The case will undoubtedly provide participants with more practical leverage over how loans are administered than what is actually provided for in the loan participation agreement since many agreements give very wide discretion to the lead lender to administer the loan when the borrower is in default.