WASHINGTON - A recent federal court ruling has jeopardized state regulators' ability to seize the assets of domestic branches of failed foreign banks, but so far appeals by New York and other states have fallen on deaf ears.
Led by the New York State Banking Department, a host of state regulators urged Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York to reconsider a decision he made in June that the regulators said would cripple their ability to help creditors in the event of a foreign bank collapse. They said that Judge Rakoff had not considered the ramifications for state regulatory agencies.
But the judge turned them down in a bluntly worded order last week.
"Regretfully for the superintendent, the court did not overlook these issues: it simply found them so lacking in merit as not to warrant discussion," he wrote.
Judge Rakoff also rejected the regulators' petition for him to certify his decision so that it could be appealed quickly. Instead he sent the case back to bankruptcy court.
New York State Banking Department officials said Tuesday that they planned to appeal. Officials say that if the decision is not changed, their ability to pay off domestic creditors in a foreign bank failure will be hampered.
"It's a grave problem for us if this holds," said Sara Kelsey, deputy superintendent and counsel for the New York State Banking Department, in an interview. "If something happens" to a bank, such as a failure, "we don't have the funds to look for."
"If the funds can be pulled back by the home country, it makes it much harder to protect creditors throughout the world," she said.
The case has a complex history, but could have implications for all state regulatory officials. It stems from the failure of two Yugoslavian banks - Jugobanka A.D., Beograd, and Beogradska Banka A.D., Beograd - that declared bankruptcy in 2002. Because the banks had state-licensed branches in New York, the state banking department immediately moved to seize the $100 million of assets at the branches so that they could be sold and used to pay off creditors.
This is a process sometimes called "ring fencing," in which regulators isolate the assets of a bank branch to protect them from being sold and the proceeds sent elsewhere.
Yugoslavia renamed itself Serbia and Montenegro in February of last year. The country's equivalent of the Federal Deposit Insurance Corp. - the Agency for Deposit Insurance, Rehabilitation, Bankruptcy, and Liquidation of Banks in Belgrade - sued the New York State Banking Department that same year, charging that it seized the assets unlawfully. (The FDIC is not involved in this case because it does not insure, with certain exceptions, foreign bank branches.)
The Belgrade agency argued that under Section 304 of the U.S. Bankruptcy Code, all of the banks' assets should be sent back to Belgrade, and that any U.S. creditors would have to stand in line to receive restitution.
But Judge Cornelius Blackshear of the U.S. Bankruptcy Court for the Southern District of New York rejected the Belgrade agency's claim, saying it did not have standing under Section 304. Judge Rakoff overturned that decision June 14, saying that the "plain language of" Section 304 recognizes the agency's standing.
The New York State Banking Department - which is supported by the Conference of State Bank Supervisors, and several other regulators including the Federal Reserve Bank of New York, and state banking departments in Connecticut, Georgia, Texas, California, Florida, and Illinois - argued that the ruling was wrong. They claimed that if it is left unchanged, it would reverse years of precedent and congressional intent that banks should be left out of the normal bankruptcy process. Regulators also fear that foreign banks could use the ruling to evade state regulators, repatriating all of the banks' U.S. assets in the event of a failure or other serious crisis.
"Without the liquidation power banking regulators have been given by our banking laws, we would effectively lose the ability to supervise a troubled foreign agency or branch operating in our state, close it if it becomes insolvent, and pay off its creditors as our state statute requires," wrote several state regulators in support of New York. "This is not simply a parochial state interest. Ring-fencing bank assets for the benefit of its creditors is how bank liquidations have always worked - including at the federal level and in many foreign countries."
In a letter to the judge, Neil Milner, the president and chief executive of the supervisors group, wrote, "The court's interpretation of Section 304, as applied in this context, is unprecedented and brings the bankruptcy code - which ordinarily would not apply to these institutions - into irreconcilable conflict with state bank insolvency laws."
But Judge Rakoff said federal bankruptcy law was clear and could not be interpreted to suit the regulators.
"Whether or not Congress' unwillingness to so limit 304 reflects Congress' realization that to do so would undercut the purpose of 304 to achieve fairness among creditors on an international scale, or whether … the absence of such a limitation in 304 simply reflects an oversight on Congress' part, it is not for this court to rewrite what Congress has written," Judge Rakoff said in the Friday decision.
Ms. Kelsey of the New York State Banking Department said the state will keep fighting to defend its right to seize assets of foreign bank branches.
"It's far from over," she said. "If people doing business realize that if things don't go well that New York or other states will not have funds at hand and make creditors whole, it is going to undercut the confidence people have in the banking industry, with unfortunate results."
