Fdic and Rtc Special Powers in Failed Bank Litigation

• Publication year: 1993
• Pages: 473

22 Colo.Law. 473 Colorado Lawyer 1993.

1993, March, Pg. 473. FDIC and RTC Special Powers In Failed Bank Litigation

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Vol. 22, No. 3, Pg. 473

FDIC and RTC Special Powers In Failed Bank Litigation

by Fred Galves

For years, financial institutions have routinely filed collection actions against their delinquent debtors. Recently, however, debtors have begun to respond to such actions by advancing various powerful "lender liability" theories.(fn1) Indeed, since the historic $18 million lender liability verdict in State National Bank v. Farah Manufacturing Co.,(fn2)lender liability cases have proliferated. In 1987, for example, five of the largest ten judgments entered in the nation were against lending institutions.(fn3)

Although lender liability theories can provide debtors with effective defenses and counterclaims,(fn4) debtors and their unsuspecting attorneys are often in for a very unpleasant surprise when the debtors' financial institutions fail. This is because once the financial institution is declared insolvent and taken over by the Federal Deposit Insurance Corporation ("FDIC") or the Resolution Trust Corporation ("RTC"), many potential defenses and counterclaims of debtors are immediately invalidated.

Such invalidation arises from a developing body of statutory and common law which enhances FDIC and RTC powers in failed bank litigation. These powers often allow the FDIC or RTC to inflict a lethal blow to the otherwise valid defenses and counterclaims of debtors, especially if the institution should fail during litigation. These special litigation powers are often referred to as "federal superpowers" due to the substantial litigation advantages obtained by the FDIC and RTC.

This article focuses on the most widely recognized federal superpowers employed by the FDIC and RTC: (1) the D'Oench, Duhme Doctrine;(fn5) (2) its statutory analogue, 12 U.S.C. § 1823(e) ["section 1823(e)"]; and (3) the federal Holder in Due Course Doctrine ("HDC Doctrine"), collectively known as "special avoidance powers."(fn6) This article also identifies additional significant FDIC and RTC litigation powers of which attorneys representing clients in failed bank litigation should be aware.

SPECIAL AVOIDANCE POWERS

Special avoidance powers typically arise after the FDIC or RTC, as receiver (or conservator(fn7)), takes over the remaining assets of a failed financial institution and seeks to recover a debt still owed to the institution.(fn8) Often the debtor will defend or counterclaim against the collection action based on: (1) alleged verbal side agreements or special arrangements previously made with the financial institution; or (2) alleged reliance on negligent or intentional verbal misrepresentations made by the institution.

These types of defenses and counterclaims are common in collection and lender liability cases because, during the repayment period, debtors and lending institutions often reach verbal "understandings" or side agreements that modify the original loan agreement. For example, the parties typically will agree on such matters as the revision of the interest rate or the time of repayment; the liquidation procedures of the collateral prior to collection; or other similar extensions, modifications or renewals of the debt obligation which may be necessary or desirable due to changing business circumstances.(fn9) Also, there may be poor communication (or even intentional deceit) between lenders and debtors, such as broken promises to extend additional or unrelated financing or the lender's inducement of the debtor to borrow more funds than originally requested. As a result, debtors frequently argue that they have been negligently or intentionally misled by their financial institutions and, therefore, are not liable for their debt obligations.

Regardless of the basis for such claims, when the FDIC or RTC takes over a failed financial institution, its avoidance powers prohibit the debtor's assertion of oral side agreements or verbal misrepresentations as defenses or counterclaims to the collection action.(fn10) This is true even though the debtor's defenses or counterclaims

[Please see hardcopy for image]

Fred Galves, Denver, is a senior litigation associate of Holland & Hart. The author acknowledges the extensive research assistance of Diana Spahr, a first-year associate with Holland & Hart.

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otherwise could be asserted against a solvent financial institution. These avoidance powers were established by the precedent set in D'Oench, Duhme & Co. v FDIC.(fn11)

The D'Oench, Duhme Doctrine And Federal Banking Policy

In D'Oench, Duhme, the U.S. Supreme Court established an estoppel doctrine in favor of the FDIC against debtors of a failed bank.(fn12) In so doing, the D'Oench, Duhme Doctrine was born and is the basis for the special avoidance powers.

In the D'Oench, Duhme case, the debtor sold the bank various bonds on which the debtor later defaulted. To avoid showing the uncollectible bonds on its books, the bank allowed the debtor to execute "sham" promissory notes to the bank with the secret oral side agreement that these notes would never have to be repaid. After the bank failed, the FDIC acquired the notes and brought an action to enforce them. Predictably, the debtor denied liability to the FDIC arguing that: (1) the oral side agreement had been the actual agreement between the debtor and the bank; and (2) the notes were unenforceable in any event because they were given without consideration.(fn13)

The Court held that the debtor was estopped from asserting these defenses. It explained that banking authorities such as the FDIC must be able to rely on all institutional books, records and loan files in assessing the true condition of a failed financial institution and its remaining assets. The Court reasoned that allowing the debtor to avoid liability would "tend to deceive" the banking authorities.(fn14) It further held that barring the debtor's defenses was necessary to protect the FDIC, and the public insurance fund which it administers, from misrepresentation.(fn15)

The D'Oench, Duhme Doctrine's strong articulation of federal banking policy has continuing significance today, especially in light of the recent banking and savings and loan ("S&L") crises. When a financial institution fails, the FDIC and RTC, as receivers, are required to determine what assets remain and what funds are available to distribute to insured depositors. The FDIC and RTC also must assess the actual market value of each of the remaining assets in the event that they can be sold to third parties in order to cover the insured deposits.(fn16) Moreover, the FDIC and RTC often are required to make these financial determinations very quickly, because a regulatory seizure of a failed financial institution must be executed as expeditiously as possible (often overnight or over a weekend).(fn17)

If debtors were allowed to assert defenses and counterclaims based on alleged oral side agreements or verbal misrepresentations made by the institution, the regulators would not be able to assess quickly and adequately the financial condition of the institution or the value of its remaining assets.(fn18) Accordingly, the FDIC and RTC can accomplish their objectives only if they "can disregard secret oral agreements that may impair the value of those assets."(fn19) In short, the policy of favoring the FDIC and RTC in the foregoing circumstances appears to outweigh virtually all other policy considerations regarding debtor's rights.

The Scope and Power of the D'Oench Duhme Doctrine

The D'Oench, Duhme Doctrine has been uniformly accepted in failed bank litigation. Moreover, it has been extended well beyond the limited facts of the D'Oench, Duhme case. For example, the Doctrine now applies to innocent borrowers who may not have engaged in any intentional wrongdoing or any attempt to mislead bank authorities.(fn20) The Doctrine is not limited to the mere enforcement of promissory notes. It controls any claim or defense, based on any alleged agreement, scheme, promise, arrangement, misunderstanding or misrepresentation. This is true for any such claim or defense that adversely impacts or has the effect of adversely impacting the value of the interest of the FDIC or RTC in a failed financial institution's remaining assets.(fn21)

Commonly Barred Debtor Defenses and Counterclaims

Attorneys who represent debtors, the FDIC or RTC, or successors or transferees of the FDIC or RTC, need to be aware of the numerous unsuccessful attempts to carve out exceptions to the ever-widening scope of the special avoidance powers. Set forth below are common debtor defenses and counterclaims that have been barred.(fn22)

--- Absence of direct dealing with the failed institution(fn23)

--- Accord and satisfaction(fn24)

--- Breach of condition precedent(fn25)

--- Breach of fiduciary duty; breach of duty of good faith and fair dealing(fn26)

--- Conspiracy(fn27)

--- Constitutional challenges: procedural due process and uncompensated taking of private property(fn28)

--- Deceptive trade practices(fn29)

--- Doctrine raised for the first time on appeal(fn30)

--- Failure of consideration(fn31)

--- Fraud, fraudulent inducement and misrepresentation(fn32)

--- Oral or written side agreements, promises or understandings(fn33)

--- Homestead exemption (simulated sale)(fn34)

--- Knowledge or imputed knowledge of side agreement by regulatory agency or examiners(fn35)

--- Laches(fn36)

--- Mitigation of damages(fn37)

--- Modification of debt instrument after borrower's execution(fn38)

--- Mutual mistake(fn39)

--- No actual reliance by FDIC or RTC(fn40)

--- Non-promissory note debt instruments(fn41)

--- Promissory or equitable estoppel and waiver(fn42)

--- Securities law violations(fn43)

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