Four years after the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act, financial institutions continue to feel the backlash of the excessive practices of some bank and thrift owners.

In particular, federal legislation adopted over the past several years has given banking regulators increasing authority to take significant actions against financial institutions.

This is not limited to formal and informal agreements with an impact on the operations of the institution; it also includes the authority to revoke deposit insurance and close banks despite the apparent financial condition of the institution.

Another obvious and related area in which regulators have taken an increasingly active role is in the compensation of directors, officers and employees of financial institutions.

Unfortunate Timing

This emphasis comes at a time when more institutions are forced to restructure and regroup, and to rely more heavily on the dedication of every level of personnel. Banks that are restructuring also must attract and retain quality employees.

As the banking and thrift industries consolidate, every employee can be essential to the ultimate success of a bank or thrift.

This is particularly important for institutions that are carrying out restructuring programs, are subject to formal agreements or cease and desist orders, or are under other regulatory scrutiny.

Delay Entails Dangers

Recent regulatory proposals and cases brought by the Resolution Trust Corp. and the Federal Deposit Insurance Corp. make it essential to establish appropriate compensation plans before an institution becomes severely troubled.

There is probably no financial institution executive, accountant or lawyer that does not face, on a daily basis, some repercussions of the Federal Deposit Insurance Corporation Improvement Act of 1991.

While some provisions had immediate impact, others depend on enabling legislation or regulation and are only now challenging the banking industry.

|Golden Parachutes'

One provision gaining widespread recognition is section 18(k), which allows the FDIC to prohibit or limit any "golden parachute" payment or indemnification payment.

The act defines a golden parachute payment as:

"Any payment, or agreement to make any payment, in the nature of compensation" contingent on the termination of affiliation and received "on or after the date on which the institution is insolvent, a conservator or receiver is appointed for the institution, or the institution's appropriate federal agency determines that the depository institution is in troubled condition," has been assigned a rating of 4 or 5 under the Uniform Financial Institutions Rating System, or is subject to a proceeding initiated by the FDIC to terminate or suspend deposit insurance.

Other Considerations

The law also requires the FDIC to prescribe factors to consider in taking action to prohibit such payments. These factors include whether there is a reasonable likelihood that the payment is part of any abuse by an insider or whether there has been a violation of law.

On Sept. 24, 1991, the FDIC proposed regulations to implement section 18(k).

That regulation severely limits the ability of an institution to provide for compensation payments.

Permitted Cases

In essence, it limits them to the following conditions:

* Where an individual is hired for the specific purpose of "saving" the institution;

* Where it is Part of a plan of downsizing; or

* Where the institution has adopted this as part of a nondiscriminatory ERISA-based defined benefits plan.

While each of these situations is understandable, none face the need of many institutions to attract and retain employees during troubled times.

For example, if an institution has already slimmed down its personnel significantly and believes that its senior management is able to carry out a plan of restructuring, it would be unable to provide those individuals the security that they could receive even modest severance compensation.

This, in turn, can lead to a high turnover of personnel just at the time that the institution needs it.

In the author's experience with the FDIC, the agency takes an extremely strict view of section 18(k) and the proposed regulation.

Court Frees FDIC

On Feb. 17 the United States Court of Appeals for the First Circuit held in Howell v. Federal Deposit Insurance Corp. that the FDIC was not required to honor the terms of employment agreements which provided for severance payments to two executives.

In that case, Eliot Savings Bank made agreements in 1988 with its executive vice president and other officers promising them severance pay in case of their termination by the institution, and reaffirmed that agreement in a letter agreement in 1989.

While the agreements did not alter the "at will" nature of the employment relationship, they specifically provided severance payments in consideration of the officers' "willingness to remain" in the bank's employ.

Eliot Savings Bank failed and was closed on June 29, 1990, with the FDIC appointed as receiver. Within two months, the officers were terminated, and then made administrative claims for their severance benefits, which the FDIC disallowed.

The district court and the court of appeals determined that, notwithstanding the plain intent of the contracts entered into by the executives, the 1989 reform act prevents an employee from collecting severance benefits since they do not constitute direct compensatory damages.

Parallel Ruling

In a strikingly similar decision, the United States District Court for the District of Columbia held in Office and Professional Employees International Union, Local 2 v. FDIC that employees fired by the FDIC after receivership of a bank were not entitled to severance pay under a collective bargaining agreement, even though the FDIC had not exercised its statutory power to repudiate the collective bargaining agreement.

The court relied, in large part, on the theory that the 1989 law requires damages to be measured when the receiver is pointed, and not when the agreement is repudiated.

The court held that the employees' severance claims were contingent at the time of insolvency, since they could mature only on an action by the bank or the receiver of the bank.

This case is particularly significant because, on its face, it appears to be the sort of agreement that the FDIC Improvement Act validates -- a nondiscriminatory, broad-based benefits agreement.

Since the individuals who were to benefit from these provisions -- tellers, receptionists and other line personnel -- are essential to the operation of a bank, the FDIC's determination can have a chilling effect on the ability of a bank to attract and retain people to serve in these positions.

Stemming the Tide

The trend established by the Howell and Office Professionals cases may have been stemmed by the recent decision of the United District Court for the District of New Jersey in Malcom Marsa v. Metrobank for Savings and Metrobank Financial Group.

In the Marsa case, the district court faced a claim by a former officer of Metrobank under a settlement agreement and release which terminated Mr. Marsa's employment with Metrobank and provided for yearly payments through 1994.

Thirteen months after entering into the settlement agreement, the Office of Thrift Supervision appointed the Resolution Trust Corp. as receiver for Metrobank and, shortly after that, disaffirmed the settlement agreement.

Mr. Marsa sought to recover the remaining payments owed him under the settlement agreement, and his fees and costs in the case.

The district court made several important findings in deciding that the RTC was liable for damages equal to Mr. Marsa's accrued benefits under the agreement.

Rights Were Vested

First, the court found that "Marsa's rights to payment under the settlement agreement were vested at the time the RTC was appointed receiver and therefore could not be impaired by any purported disaffirmance."

The court held that the rights under the agreement were vested because they were not subject to a condition precedent,

Even more strikingly, the court rejected the RTC's argument that it was entitled to disaffirm the contract under the receiver's avoidance powers under the 1989 law or, more importantly, the disaffirmance did not prevent Mr. Marsa from obtaining damages.

Citing the Howell case, the court said that repudiation would be treated as a breach of contract giving rise to an ordinary contract claim. Since Mr. Marsa's claims were not contingent. he could recover payments owed to him.

As can be seen from the cases outlined above, federal laws and regulations affect not only the overreaching plans which characterized abuses in the 1980s, but also bona fide attempts to compensate employees and management officials on a modest but meaningful basis.

These limitations can ultimately hurt the institution's ability to attract and retain its most important asset -- the individuals who protect shareholder and depositor values.

The first thing a bank can do is to consider its employment, compensation and severance plans as early as possible. Because of the potential problems facing nearly all financial institutions, no bank or thrift is immune from the possibility of regulatory action.

Early Action Advisable

An undercapitalized or troubled bank will have significantly greater difficulty setting up appropriate compensation programs than an adequately capitalized bank or thrift. As a result, taking action now may be the only proper step.

Boards of directors must consider who at the institution is essential for the continued growth and success of the institution.

The board should then develop appropriate compensation plans that contemplate the actions that regulators may take involving an institution's internal activities.

Under current economic conditions, employment security and severance compensation may be appropriate incentives to attract and retain personnel, and adopting programs before a deterioration in financial condition may be key in ensuring the enforceability of the plan.

All these may make it possible to adopt effective programs.

To enhance the type of plan adopted, a board should consider placing the initial decisionmaking in the hands of an independent board committee with the authority to call upon their own experts and counsel to avoid even the appearance of self-dealing.

These experts will provide valuable advice in crafting plans that are effective from the point of view of employees and professional management, and meet the rigors of regulatory scrutiny.

Finally, management and boards of director must give more thought to the type of plan adopted.

As is clear from the Office and Professional Employees case, an essential factor may ultimately be the extent to which benefits under employment plans vest before any receivership or conservatorship action.

While initially more expensive, creating a fully funded, ERISA-qualifying plan may provide a more attractive and more effective employment incentive. The approach of creating fully vested benefits, as seen in the Marsa case, should also be considered to ensure that benefits are provided.

Each of these steps will send a clear message to management and regulators that the institution is prepared to approach today's challenges with all of the tools available to them.

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