N.H.'s Law A Trailblazer For Rescues
New Hampshire is the first state in the nation to enact legislation that applies federal bank-rescue techniques to state-chartered institutions.
The New Hampshire statute took effect on June 10. It applies to any state-chartered bank that has been reorganized in an open-bank assistance transaction.
Under the new law, a bank of this type may defeat any agreement, claim, or defense any agreement, involved in prior to reorganization - if the FDIC could have defeated these actions for a bank that was closed rather than reorganized.
The new law comes at a critical time for New Hampshire. A number of its banks are in trouble - including five of its largest independent banks.
On June 17, the Federal Deposit Insurance Corp. announced its plan for bailing out those five banks. The plan calls for closing the banks and merging them into two institutions: The FDIC will remove the problem loans, infuse cash, and seek additional capital from private investors.
Previously, the FDIC indicated its willingness to consider a pilot project involving openbank assistance in New Hampshire. While that possibility may now be unlikely for those five banks, in view of the FDIC's plan, it continues to be a viable alternative in the appropriate case.
The new law substantially increases the attractiveness of open-bank assistance in New Hampshire, and it may become a model for other states as well. In one step, New Hampshire has incorporated into its statutory law the full range of protections afforded the FDIC, under federal law, in resolving troubled-bank situations.
The FDIC is charged with responsibility to act in the most cost-effective manner. The FDIC has several options in its arsenal:
* It may close an insolvent bank and either liquidate its assets and pay off creditors. Or it may enter into a purchase-and-assumption transaction with another healthy bank, to transfer some or all of its assets and liabilities.
* It may also provide financial assistance to keep the bank open by investing capital, making loans, purchasing bad assets, assuming liabilities, making indemnities against loss, or taking other similar actions - provided that outside funds are invested, as well.
A Relief to Taxpayers
Open-bank assistance is often the most cost-effective choice. Private-sector capital and asset management result in savings to taxpayers.
The open bank continues its relationship with depositors and borrowers and maintains its value as a going concern. The closure of a bank substantially diminishes its economic value. However, certain impediments have discouraged its use.
In instances where the FDIC has decided to close a bank, it has been able to rely on federal statute and common law to preserve the value of the banking assets against attacks by borrowers, creditors, and other claimants.
Since 1942, the decision of the U.S. Supreme Court in D'Oench, Duhme and Co. v. FDIC has served to block claims or defenses based on agreements that tend to deceive banking authorities.
FDIC's Interests Protected
In 1950, the Congress enacted 12 U.S.C. 1823(e). In its current form, this law bars any agreement tending to diminish or defeat the FDIC's interest in any asset it has acquired - as a receiver or otherwise - from an insolvent bank, unless the agreement meets certain requirements.
The agreement must be in writing, executed contemporaneously with the bank's acquisition of the asset, approved by the bank's board of directors or investment committee, as properly reflected in its minutes, and continuously part of its official records since execution.
The D'Oench Duhme case and Section 1823(e) have been broadly used by the federal courts. Together, they have enabled the FDIC to defeat a wide variety of agreements, claims, or defenses that would otherwise reduce the value of assets it has acquired. Claims of fraud or misconduct, lender-liability claims, defenses based on unwritten agreements, and the like - involving the bank prior to closure - have fallen by the wayside.
The courts have recognized that the integrity of the banking system and, in particular, the conservation of FDIC deposit insurance reserves and investments, depend on access to the records and financial statements of troubled banks. Regulatory officials must rely on these records to value a troubled bank's assets and to assess the most cost-effective method of resolving its problems.
In balancing public and private interests, the courts have come down on the side of the regulators - and, ultimately, the taxpayers.
The courts have permitted private purchasers of assets from the FDIC to stand in the shoes of the FDIC and avail themselves of the protections of D'Oench Duhme and Section 1823(e). The extension of these protections to the private sector fosters the public interest in the disposition of assets by removing uncertainty as to their value.
Early Stage of Development
While D'Oench Duhme and Section 1823(e) have had a significant impact in closed-bank transactions, they have yet to have a similar effect in open-bank assistance transactions. For closed banks, the federal bar on claims and defenses, and the stiff requirements for enforceable agreements, are triggered when the FDIC acquires the assets of the troubled bank.
While the FDIC may acquire some of the bank's assets as part of an assistance package, the remaining assets stay with the open bank. The applicability of the federal protections to open banks is not clear in that situation. While there is some indication that courts may be willing to extend these protections to open banks, the law is in an early stage of development.
There are strong policy reasons underlying the extension of D'Oench Duhme and Section 1823(e) to open-bank assistance. Both Congress and the FDIC have emphasized the importance of private-sector resources to enhance, through leverage, the expenditure of federal funds to resolve the banking crisis.
Justifications for Risk
As noted above, open-bank assistance is the cheapest alternative in many situations. However, so long as there is a cloud on the value of the bank's assets, private investors submit unacceptably low bids - or are simply afraid to take the risk. The result is that only a small number of open-bank assistance transactions have been consummated.
Rather than wait for federal law to evolve in this direction, New Hampshire has assimilated into state law all of the federal statutory and common law applicable to closed-bank transactions. It is now available to any state-chartered bank reorganized in an open-bank assistance transaction.
By this action, the state has made this alternative more attractive to the FDIC and the private sector. It removes the bias in the system that favors closing banks and elevates open-bank assistance to equal status.
Laws of this nature inevitably provoke claims that they are unconstitutional. But the same could have been said about D'Oench Duhme and Section 1823(e). They have withstood constitutional attack, and the public policy reasons underlying them are the same for open-bank assistance.
Where the FDIC opts for open-bank assistance, it has determined that it is less costly than closing the bank. In addition, it frequently has an economic stake in the reorganized bank.
If the FDIC had it chosen to close the bank, the federal prohibition on improper agreements, claims, and defenses would be in force. It doesn't make sense to penalize open-bank assistance solely on the basis of its form. Thus, while the new law will likely be challenged by some aggrieved party, it should be upheld as a proper exercise of legislative power.
Old Law, New Context
The practical effect of the New Hampshire law will be to strengthen the position of private investors in open-bank assistance transactions. They will have statutorily recognized authority to invalidate agreements, claims and defenses that would fail if otherwise asserted against the FDIC in a closed-bank transaction. The courts will not have to develop new law; rather, they must apply old law in a new context.
While those agreements, claims, or defenses will not disappear overnight, they will no longer be a significant factor. If not dismissed, they will likely be settled at minimal expenses. The new management will be able to focus its energies on rebuilding the institution, rather than fighting old battles.
The New Hampshire law underscores the vitality of the dual banking system. The creative interplay between federal and state law provides opportunities for individual states to contribute to a broad solution to the banking crisis.
Mr. Funk is an attorney with the law firm of Gallagher, Callahan & Gartrell in Concord, N.H.