Download FDIC`s Expanded Role in Bank Holding Company Insolvencies

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FDIC's Expanded Role in Bank
Holding Company Insolvencies
Navigating the Complexities of Banking Regulators' Participation in the Bankruptcy Process
THURSDAY, JULY 26, 2012
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Today’s faculty features:
Todd C. Meyers, Partner, Kilpatrick Townsend & Stockton, Atlanta
Ivan L. Kallick, Partner, Manatt, Phelps & Phillips, Los Angeles
James D. Higgason, Partner, Diamond McCarthy, Houston
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The
Banking
Law Journal
Established 1889
An A.S. Pratt & Sons PublicationJanuary 2010
Headnote: The Winds of Change
Steven A. Meyerowitz
k Fraudulent Transfer Remedies Available To Bank Holding
Company Bankruptcy Trustees After Gramm-Leach-Bliley
James D. Higgason, Jr.
Are We Halfway There Yet? House Passes Major Financial Services Bill With Senate Expected to Act Early This Year
Gail C. Bernstein, Matthew A. Chambers, Sara A. Kelsey, and Martin E. Lybecker
FDIC Issues Advance Notice of Proposed Rulemaking for Safe
Harbor Protection for Securitizations
Howard S. Altarescu and Scott A. Stengel
Federal Reserve Proposes Incentive Pay Restrictions For
Banks
Barbara-Ann Gustaferro and David B. Miller
Transboundary Environmental Effects in World Bank Project Planning: Recommendations, Structure, and Policy
Jedidiah D. Vander Klok
2009 Index of Cases
2009 Index of Authors
2009 Index of Articles
Fraudulent Transfer Remedies Available
to Bank Holding Company Bankruptcy
Trustees After Gramm-Leach-Bliley
James D. Higgason, Jr.
The author examines the scope of the limitations imposed by a provision in the
Gramm-Leach-Bliley Act that shields the FDIC from certain preference and
fraudulent transfer actions and discusses claims and arguments that still can be
used in the post-GLBA environment.
I
n the late 1980s and early 1990s the collapse of the real estate and energy
markets caused scores of banks across the United States to fail, and the
federal fund used to insure bank deposits was nearly exhausted. In 1989,
in the midst of this turmoil, bank regulators1 conducted onsite examinations
of one of the largest banks in New England, the Bank of New England, N.A.
(“BNENA”), and discovered catastrophic asset quality and control problems
that caused its allowance for loan and lease losses to be dramatically understated and severely limited the bank’s ability to identify and manage risk going forward. Although BNENA’s prognosis for survival was bleak at best, the
regulators nevertheless encouraged its parent company, Bank of New England Corporation (“BNEC”), to raise additional capital in a $250 million
debt offering and downstream the bulk of the proceeds to BNENA. The
regulators also instructed BNEC to downstream other valuable assets, like,
for example, its information services subsidiaries and a mortgage servicing
James Higgason is a partner in the Houston office of Andrews Kurth LLP and
represented the Chapter 7 bankruptcy trustee of the Bank of New England Corporation, Dr. Ben S. Branch, in litigation against the Federal Deposit Insurance
Corporation. Mr. Higgason can be reached at [email protected].
2
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Fraudulent Transfer Remedies Available
company, into BNENA. After most of BNEC’s non-bank assets were transferred to BNENA, BNENA and other banks owned by BNEC (collectively
the “BNEC Banks”), were declared insolvent and their assets, including the
downstreamed assets, were placed into FDIC receiverships. The next business day, with hundreds of millions of dollars in debt and most of its assets in
the coffers of the FDIC, BNEC filed for Chapter 7 bankruptcy protection.
The events that unfolded in connection with the failure of the BNEC
system demonstrate the tension that invariably exists between a bank holding
company and bank regulators when the holding company and its subsidiary
bank(s) are in danger of failing. Bank regulators have an interest in shifting
the risk of loss away from the bank insurance fund and on to the holding
company and often will cause the holding company to transfer assets to the
troubled bank even if it is in no position to act as a source of strength.2 Directors and officers of a bank holding company in or near insolvency, on the
other hand, have an obligation to protect the interests of creditors, and in
most instances those interests would be better served by preserving assets for
distribution in the event of bankruptcy, rather than funneling them to an
entity destined for seizure by the FDIC.
In the BNEC bankruptcy, the Chapter 7 bankruptcy trustee (the “Trustee”) brought “actual intent” and “constructive intent” fraudulent transfer
claims against the FDIC and against the banks that acquired the transferred
assets from the FDIC (the “FDIC Litigation”).3 The actual intent claim
sought to avoid transfers pursuant to Bankruptcy Code Section 548(a)(1)(A)
on the grounds that they were made with “actual intent to hinder, delay, or
defraud” BNEC creditors. The constructive intent claim alleged that transfers should be avoided pursuant to Bankruptcy Code Section 548(a)(1)(B)
because BNEC was insolvent at the time the transfers were made and because
BNEC did not receive reasonably equivalent value in exchange for the transfers. The Trustee ultimately recovered $140 million from the FDIC.
The financial industry is now experiencing the type of major down cycle
it has not seen for almost two decades, and the problems are accelerating.
After several years with no significant bank failures, the failure rate increased
dramatically in 2008, when 25 banks with $371.9 billion in assets failed.4 In
2009, 140 banks failed.5 There were 552 banks on the FDIC’s troubled bank
watch list at the end of the third quarter of 2009, up from 416 the previous
3
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quarter, scores of additional banks are predicted to fail, and the bank insurance fund has been reported to have a negative balance.6 Bank regulators will
thus have an incentive to shift the risk of loss for bank failures away from
the bank insurance fund by encouraging bank holding companies to downstream assets to failing banks. Bankruptcy trustees and debtors-in-possession
of bankrupt holding companies will want to explore if such transfers occurred
prior to bankruptcy and whether there are grounds to avoid them.
The regulatory landscape has, however, shifted since the BNEC Trustee
brought the FDIC Litigation. Soon after the FDIC Litigation concluded,
a provision was inserted in the Gramm-Leach-Bliley Act (“GLBA” or the
“Act”) that shields the FDIC from certain preference and fraudulent transfer
actions.7 This article examines the scope of the limitations imposed by the
Act and discusses claims and arguments which were effective for the BNEC
Trustee in the FDIC Litigation that still can be used in the post-GLBA environment.
The Scope of GLBA Section 730
Section 730 of the Act is designed to “in certain instances, protect[] the
federal banking agencies and the deposit insurance funds from claims brought
by the bankruptcy trustee of a depository institution holding company…for
the return of capital infusions.”8 Specifically, GLBA Section 730 states:
No person may bring a claim against any Federal banking agency (including in its capacity as conservator or receiver) for the return of assets
of an affiliate or controlling shareholder of the insured depository institution transferred to, or for the benefit of, an insured depository institution by such affiliate or controlling shareholder of the insured depository
institution, or a claim against such Federal banking agency for monetary
damages or other legal or equitable relief in connection with such transfer, if at the time of the transfer (A) the insured depository is subject to
any direction issued in writing by a Federal banking agency to increase its
capital….9
4
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Fraudulent Transfer Remedies Available
Trustees Can Still Sue the FDIC to Recover Transfers Made With the Intent to Benefit the FDIC at the
Expense of a Bank Holding Company’s Creditors
Section 730 does not protect the FDIC from all fraudulent transfer actions. Indeed, the definition section of Section 730 states that a “claim”
barred by the provision “does not include any claim based on actual intent to
hinder, delay, or defraud pursuant to such a fraudulent transfer or conveyance
law.”10
Although no case has yet considered the issue, the plain language of the
statute and its legislative history indicate that the provision was designed to
protect and encourage good faith efforts on behalf of regulators and bank
holding companies to recapitalize distressed banks. Section 730 clearly does
not give the regulators carte blanche to use their substantial leverage to intentionally loot a holding company for the benefit of the FDIC. On the
contrary, if regulators realize that a bank holding company is likely to fail,
they are courting risk by causing it to downstream assets to a failing subsidiary bank, and ultimately the FDIC, because GLBA Section 730 specifically
authorizes actual intent fraudulent transfer claims against the FDIC.
Regulator Control May Give Rise to Actual Intent
Fraudulent Transfer Claims
As a general rule, to prevail on an actual intent fraudulent transfer claim
a plaintiff must prove fraudulent intent on the part of the debtor/transferor.11
There is, however, an exception to this rule when the transferor is dominated
or controlled by the transferee or the entity for whose benefit the transfer is
made.12 In such circumstances the transferee’s intent can be imputed to the
transferor if the plaintiff can show: (1) the controlling transferee had the intent
to hinder, delay, or defraud the transferor’s creditors; (2) the transferee was in
a position to dominate or control; and (3) the domination and control was
exercised in connection with the disposition of the property in question.13
Bank regulators have a number of means available to exert control over
distressed banks and bank holding companies, pursuant to which they can
cause the downstreaming of holding company assets and shift the risk of loss
5
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of a bank failure to the holding company. The most commonly employed
methods are (1) the Federal Reserve’s so-called “Source-of-Strength Doctrine,” which provides that a bank holding company is obliged to “use available resources to provide adequate capital funds to its subsidiary during periods of financial stress;”14 (2) “Prompt Corrective Action” provisions, which
authorize and limit certain steps to be taken to recapitalize undercapitalized
banks;15 and (3) formal and informal OCC agreements and orders, including
Memoranda of Understanding, Formal Agreements, Consent Orders, and
Cease and Desist Orders. 16 Such provisions give the regulators extraordinary power over troubled banks and bank holding companies to compel asset
transfers and other actions, and the level of control increases as their financial
condition deteriorates.17
In the FDIC Litigation, the Trustee alleged that the FDIC, the OCC,
and the Federal Reserve were all aware of the desperate financial condition of
BNEC and BNENA, that they controlled all significant activities of BNEC
and the BNEC Banks from 1989 until they failed in January 1991, and that as
a result of that control they caused BNEC to transfer assets to BNENA with
knowledge that such transfers would benefit the FDIC. To the extent such a
scenario is repeated in the current environment the FDIC may once again be
subjecting itself to exposure to an actual intent fraudulent conveyance claim.
GLBA Section 730 Does Not Apply Until the Bank Is
Subject to a Written Direction to Raise Capital
GLBA Section 730 provides that constructive intent fraudulent transfer
and preference claims are barred only if the transferee bank is “subject to
any direction issued by a Federal bank agency to increase capital.”18 The
circumstances surrounding the issuance (or non-issuance) of such a directive
are critical. If a regulator never issues a directive or issues it after the transfers in question, then Section 730’s protections are never triggered and there
are no limitations on bringing any avoidance action against the FDIC.19 If,
however, it is issued at a time when the bank holding company is in or near
insolvency and the bank is doomed for FDIC receivership, then what the directive gives with one hand it may take away with the other. In other words,
while it may shield the FDIC from a constructive intent fraudulent transfer
6
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Fraudulent Transfer Remedies Available
action, the directive also may support an actual intent claim, which is specifically authorized by Section 730, by providing strong evidence of domination
and control necessary to impute the FDIC’s intent to the transferor.20
Claims Against Subsequent Transferees
The FDIC is not in the business of operating banks, so in most instances
an FDIC receivership sells a failed bank’s assets as soon as possible. It is
unclear whether the protection afforded the FDIC by the Act will extend to
private parties that purchase fraudulently transferred property from an FDIC
receivership. Section 730 only prohibits suits against “any federal banking
agency” and contains no reference to or explicit prohibition of avoidance
suits against such an agency’s subsequent transferee(s).21 Plaintiffs may argue
that if such protection were meant to extend to non-governmental entities
the statute would have said as much and claim that avoidance actions against
them are justified based on cases which provide that a bankruptcy trustee may
recover from subsequent transferees of avoidable transfers pursuant to Bankruptcy Code Section 550(a)(2) without first suing the initial and/or intermediate transferees. 22 The purchasers of assets from the FDIC receivership may
counter that the protection given the FDIC from avoidance actions should
extend to the FDIC’s transferees.23
Conclusion
In the current economic down cycle bank regulators will have an interest in shifting the risk of loss of bank failures away from the FDIC bank
insurance fund by using their substantial leverage to cause bank holding
companies to transfer assets to subsidiary banks in danger of failing and
being placed in FDIC receivership. If the bank holding company of a failed
bank files for bankruptcy protection, the debtor-in-possession or bankruptcy trustee will want to explore whether there are any grounds to avoid any
such transfers. The GLBA placed limitations on claims to recover such
transfers from the FDIC. The protection afforded is, however, limited, and
parties contemplating bringing actions to recover avoidable transfers should
consider the following:
7
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• The GLBA does not protect the FDIC from claims to avoid transfers
made with actual intent to hinder, delay, or defraud creditors.
• If a transferee or the party for whose benefit a transfer is made controls
the transferor, then it may be appropriate to impute the transferee’s intent to the transferor.
• To the extent bank regulators cause a bank holding company to transfer
assets to a troubled subsidiary bank in order to benefit the FDIC at the
expense of the holding company’s creditors, then it may be appropriate
to impute the FDIC’s intent to the transferor.
• The protections afforded the FDIC by the Act are not triggered unless
and until the transferee bank receives a written directive from a bank
regulator to raise capital. Such directives may be a double-edged sword
for the FDIC. While they protect the FDIC from constructive intent
fraudulent transfer claims, they may also provide evidence of regulator
control that supports an actual intent claim.
• It is unclear whether GLBA Section 730 will be construed to prohibit
claims against subsequent transferees who purchase fraudulently conveyed assets from an FDIC receivership.
News reports issued almost daily over the past several months provide
that congressional committees and regulators are considering a wide range
of options that could dramatically change the financial industry. Some of
the proposed reforms could substantially change the rights of creditors and
shareholders of banks and bank holding companies. Bank holding company
bankruptcy trustees, investors, and others with a stake in such issues should
monitor developments closely because the legal landscape, including the
rights and remedies discussed above, soon may be altered materially.
Notes
The regulators primarily involved when national banks become troubled are the
Office of the Comptroller of the Currency (“OCC”), which regulates national banks;
the Federal Reserve, which regulates bank holding companies; and the Federal Deposit
Insurance Corporation (“FDIC”), which oversees the fund that insures bank deposits
and acts as receiver of the assets of failed banks. Because FDIC insurance funds are at
1
8
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Fraudulent Transfer Remedies Available
risk, the FDIC is consulted early and often when a bank becomes troubled, and great
deference is often given to the wishes of the FDIC with respect to the treatment of
such banks and their holding companies.
2
The Comptroller of the Currency discussed the downstreaming of BNEC’s assets
in congressional testimony, stating, “The loss to the FDIC did not increase, and may
well have been reduced, due to the efforts of the new [BNEC] management team
[put in place by the regulators]. These efforts included the sale of [BNEC] assets and
the downstreaming of the proceeds of the sale to [BNENA]. Had [BNENA] been
closed earlier, these assets would have been left behind in the holding company and
would not have been available to reduce the FDIC’s ultimate cost.” The Failure of
the Bank of New England: Hearings Before the Senate Comm. on Banking, Hous., and
Urban Affairs, 102d Cong. 11 (1991)(statement of Robert L. Clarke, Comptroller).
3
The Trustee brought claims against the FDIC in its corporate and receivership
capacities and against Fleet Bank of Massachusetts, N.A., and Fleet Bank, N.A., and
Fleet Bank of Maine, who acquired transferred assets from the FDIC. In addition
to the fraudulent transfer claims brought pursuant to §548(a)(1)(A) and (B), the
Trustee’s Complaint also included claims for avoidance of fraudulent conveyances
pursuant to Bankruptcy Code § 544(b) via the Massachusetts fraudulent conveyance
laws (109 Mass. Gen. Laws Ann. §§4-7); avoidance of preferential payments
pursuant to Bankruptcy Code §§ 542 and 543, restitution of estate property in
certain accounts and Rabbi Trusts, violation of § 91 of the National Bank Act, and
constructive trust and equitable lien.
4
See 2008 FDIC Annual Report.
5
See www.fdic.gov/bank/ individual/failed/banklist.html.
6
Matthew Jaffe, FDIC Bank Insurance Fund Plunges Into Red, ABCNEWS.
GO.COM (Nov. 24, 2009); See Stephen Bernard, Calif. Bank Becomes 99th in U.S.
to Be Shut in 2009, APNEWS.MYWAY.COM (Oct. 17, 2009); David Ellis, FDIC
Fund in Red Until 2012, CNN.MONEY.COM (Oct. 19, 2009).
7
12 U.S.C. § 1828(u).
8
1999 U.S.C.C.A.N. 276 (House Position).
9
12 U.S.C. § 1828(u)(1).
10
12 U.S.C. § 1828(u)(2)(B)(emphasis added).
11
See, e.g., S.E.C. v. Res. Dev. Int’l, LLC, 487 F.3d 295, 301 (5th Cir. 2007); Asarco
LLC v. Americas Mining Corp., 396 B.R. 278, 369 (S.D. Tex. 2008); In re Bayou
Group, LLC, 362 B.R. 624, 631 (Bankr. S.D.N.Y. 2007).
12
See Asarco, 396 B.R. at 369; In re FBN Food Servs., Inc., 175 B.R. 671, 686
(Bankr. N.D. Ill. 1994); In re Sackman Mortgage Corp., 158 B.R. 926, 938 (Bankr.
S.D.N.Y. 1993); In re Parker Steel Co., 149 B.R. 834, 855 (Bankr. N.D. Ohio 1992);
In re Formaggio MFG., Inc. 23 B.R. 688, 691 (Bankr. D. R. I. 1982); Collier on
9
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Bankruptcy ¶ 548.24 (15th ed. rev.).
13
Asarco, 396 B.R. at 369; In re Adler, Coleman Clearing Corp., 263 B.R. 406, 443
(S.D.N.Y. 2001).
14
52 Fed. Reg. 15,707 (1987). See Christine Bradley & Kenneth Jones, Loss Sharing
Rules for Bank Holding Companies: An Assessment of the Federal Reserve’s Source-ofStrength Policy and the FDIC’s Cross-Guarantee Authority, Munich Personal Repee
Archive (March 16, 2009) (discussion by FDIC staff members of history and
application of Source of Strength Doctrine).
15
12 U.S.C. § 1831o.
16
See 12 U.S.C. § 1831p-1 and 12 C.F.R. 30.
17
See An Examiner’s Guide to Problem Bank Identification, Rehabilitation, and
Resolution (January 2001), pp. 27-55 (providing a comprehensive discussion of the
bank regulators’ powers and how they work together to manage troubled banks).
18
12 U.S.C. 1828(u)(1)(A).
19
The debtors-in-possession of the holding companies of Washington Mutual
Bank (“WMB”), which was placed in FDIC receivership on September 25, 2008,
have brought constructive and actual intent fraudulent conveyance and preference
claims against the FDIC to recover certain amounts transferred to WMB before
its failure. See Complaint, ¶¶ 25-44, Washington Mutual, Inc, v. FDIC, Case No.
1:09-cv-00533(RMC)(March 20,2009). The FDIC has not raised Section 730 as a
defense, presumably because WMB was never issued a directive to raise capital. See
Memorandum of Law in Support of the Partial Motion to Dismiss of Defendant
FDIC, as Receiver for Washington Mutual Bank, pp. 23-27 (moving to dismiss
fraudulent transfer claims on other grounds).
20
See Asarco, 396 B.R. at 369; In re Alder, 263 B.R. at 443; In re Formaggio Mfg., 23
B.R. at 691.
21
12 U.S.C. § 1828(u).
22
See, e.g., IBT Int’l, Inc. v. Northern, 408 F.3d 689, 706 (11th Cir. 2005) (“[O]
nce a trustee proves that a transfer is avoidable he may seek to recover against any
transferee, initial or immediate, or an entity for whose benefit the transfer is made”);
Woods & Erickson v. Leonard, 389 B.R. 721, 724 (9th Cir. 2008) (“[A] trustee is
not required to avoid the initial transfer before seeking recovery from subsequent
transferees under § 550(a)(2).”); Kendall v. Sorani, 195 B.R. 455, 463 (Bankr. N.D.
Cal. 1996) (same).
23
See, e.g., UMLIC-Nine Corp. v. Lipon Springs Dev. Corp,. 168 F.3d 1173 n.3
(10 Cir. 1999)(extending special six-year statute of limitations afforded FDIC to
purchasers of loans from FDIC receivership); United States v. Thornburg, 82 F.3d 886,
890-92 (9th Cir. 1996)(same). Bankruptcy Code Section 550(b) also may protect
subsequent transferees if they can demonstrate that they were purchasers who took
for value, in good faith, and without knowledge of the voidability of the transfer.
10
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Breaking the
Trust Preferred Logjam
N
ot long ago, many banks viewed trust
preferred securities (“TPS”) as inexpensive capital, and TPS are on the balance sheets of many bank holding companies
today. Now, many of these same companies
must raise capital and are finding their TPS an
insurmountable impediment.
The reason for this is that TPS, which are
considered debt, have priority over common
stock upon liquidation. Investors will not invest new equity knowing that it eventually will
be used to repay the TPS. This is particularly
galling to sophisticated investors, the likely
sources of new capital, who have no interest in
“bailing out” debt holders. So prospective investors who might otherwise step up are sitting
on the sidelines.
For particularly troubled bank holding companies, the failure to raise capital could lead to
the failure of the bank subsidiary, leaving little
or no value for TPS holders. Faced with this
situation, most debt holders would be motivated to negotiate a discounted payoff. Unfortunately, TPS are different, and negotiations
often have proved impossible. To understand
why, one must understand how TPS were sold.
To take advantage of a securities registration
exemption, many TPS were sold to special purpose entities (“SPEs”) that own pools of assets,
usually debt or preferred stocks that provide
cash flows. These SPEs, in turn, issued bonds
secured by their pools of assets. So, many TPS
are owned by SPEs, which in turn have senior
and junior bond holders.
Some SPEs have asset managers, who make
investment decisions with respect to the SPEs
assets. But many SPEs are unmanaged “static
pools,” where investment decisions may be
made only by the holders of the SPEs bonds.
Each SPE has its own set of rules as to when
and how decisions may be made. Often, in cases where a security is not in default, decisions
must be reached unanimously by senior bond
holders or by all bond holders, which is a practical impossibility. Indeed, many SPEs were
structured with the intent of prohibiting negotiated settlements; those SPEs have no mechanism for reapportioning the cash flows of their
bonds following an asset restructure.
As a result, many distressed bank holding
companies seeking to negotiate with TPS holders have found there simply is no one to negoti-
For particularly troubled bank holding
companies, the failure to raise capital
could lead to the failure of the bank
subsidiary, leaving little or no value
for TPS holders.
ate with, even in situations where negotiations
are so clearly in the best interests of the TPS
holders. Tender offers receive no response.
Avoiding bank failure is imperative. Thus,
boards of directors who are unable to negotiate with TPS holders have sought ways to raise
capital by forcing a reduced payout for TPS
holders without their consent.
One approach, completed successfully in
Washington in 2010, was the sale by a holding
company of its ownership interest in its bank
Summer 2012
Carolina Banker
47
Joel Rappoport
is a partner in the
Washington, DC
office of Kilpatrick
Townsend & Stockton
LLP, where he advises
banks on corporate
and securities
transactions.
through a bankruptcy process. To do this, the
holding company files for bankruptcy and at
the same time enters into an agreement with
a “stalking horse bidder” to sell the bank. The
holding company then auctions the bank under
procedures approved by the bankruptcy court.
The bank ultimately is sold to the highest bidder, which likely is the stalking horse bidder.
Upon closing, the proceeds from the sale of the
bank go to the TPS holders, and the winning
bidder recapitalizes the bank.
This type of transaction carries the risk of a
run on the bank, as customers may think the
holding company bankruptcy means the bank
too has failed. For this reason, a well thought
out public relations campaign is essential. The
holding company should seek court approval
for as short an auction process as possible.
A second way to recapitalize a bank without
negotiating with TPS holders would be to raise
capital at the bank level by selling bank equity
to investors. Such a transaction also poses risks,
in that if a sufficient ownership interest in the
bank is sold it could amount to a breach of the
TPS covenant against a sale of all or substantially all of the holding company’s assets unless
the buyer assumes the TPS obligations. A careful reading of the exact wording of the TPS covenants would be required.
Relief may be on the horizon. Some SPE
bond holders recently have begun to organize,
and there are investors who have acquired TPS
who are willing to negotiate, so it may now be
possible to negotiate with at least some TPS
holders. This raises the intriguing possibility of a mutually negotiated settlement among
the holding company, investors and some TPS
holders. The negotiated settlement could be enforced against all TPS holders through a prepackaged bankruptcy. The settlement might
even give the TPS holders an equity stake in the
recapitalized bank, which would be an opportunity to recover in the future some of their lost
value.
One thing is certain – TPS will continue to
be an impediment to bank holding companies
who need to recapitalize their bank subsidiaries, and so long as TPS holders are unwilling
or unable to negotiate, companies will continue
to seek creative solutions to break the logjam,
even if it means deliberately breaching TPS
covenants. CB
VOLUME 29
NUMBER 1 JANUARY 2010
FEATURES
Establishing Bank Holding Company
Insolvency: Lessons Learned From The Bank
Of New England Corporation Bankruptcy . . . . . 1
By Ben S. Branch and James D. Higgason, Jr.
Naked Life Settlements . . . . . . . . . . . . . . . . . . . 9
By Franklin L. Best, Jr.
THE MONITOR
Bank Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Securities/Section 20/Broker-Dealer . . . . . . . . . . . . . . 20
Court Developments . . . . . . . . . . . . . . . . . . . . . . . . . .22
Law & Business
Establishing Bank Holding Company Insolvency:
Lessons Learned From The Bank Of New
England Corporation Bankruptcy
By Ben S. Branch and James D. Higgason, Jr.
W
hen a national bank is in financial distress
government regulators1 typically encourage
or require the bank’s holding company to act as a
source of strength by making loans, equity infusions,
and/or other asset transfers to the troubled institution.2 If such measures heal the ailing bank, it is good
for the banking system and the holding company’s
creditors and shareholders also likely will benefit, at
least in the long term. If the bank nevertheless fails
despite the holding company’s transfers, the bank’s
assets are placed in a receivership administered by
the Federal Deposit Insurance Corporation (FDIC)
and the transfers end up enriching the FDIC at the
expense of the holding company and its creditors.
The latter scenario unfolded in connection with
the failure of the Bank of New England Corporation
(BNEC), a Boston-based bank holding company, and
the seizure of its subsidiary banks (the “BNEC Banks”).3
In 1989 bank regulators discovered fundamental asset
quality and control problems at BNEC’s largest bank,
Bank of New England, N.A. (BNENA), that were so
severe that it soon became apparent that its prospects for
survival were bleak. Despite BNENA’s terminal condition, the regulators nevertheless encouraged BNEC to
downstream cash and merge non-bank subsidiaries into
BNENA. As a result, when BNENA failed and its assets
were placed in FDIC receivership, property that would
have been available for BNEC’s creditors but for the
downstreaming went into the coffers of the FDIC.
The BNEC Chapter 7 bankruptcy trustee (the
“Trustee”) brought both “actual intent” and “constructive
intent” fraudulent transfer claims against the FDIC and
Dr. Branch is the Chapter 7 Bankruptcy Trustee of the Bank
of New England Corporation and is a professor of finance at
the University of Massachusetts, Amherst. James Higgason is a
partner in the litigation section of the Houston office of Andrews
Kurth LLP and represented Dr. Branch in litigation brought in the
BNEC bankruptcy.
Volume 29 • Number 1 • January 2010
against the banks to whom the FDIC subsequently transferred the property in question (the “FDIC Litigation”).
The actual intent claim sought to avoid the transfers
pursuant to Bankruptcy Code Section 548(a)(1)(A) on
the grounds that they were made with “actual intent to
hinder, delay, or defraud” BNEC’s creditors. The constructive intent claim, based on Section 548(a)(1)(B),
sought the return of such assets on the basis that BNEC
was insolvent at the time the transfers were made and
that BNEC did not receive reasonably equivalent value
in exchange for the transfers.4
The Trustee’s insolvency model was a cornerstone
of his success on the actual and constructive intent
fraudulent transfer claims.5 Such models will be particularly important in the current environment6 to
trustees or debtors-in-possession of failed bank holding
companies who have cause to pursue similar fraudulent transfer claims.7 This article discusses certain legal
and factual concepts relevant to establishing insolvency
and explains how the BNEC insolvency model was
constructed.
The Anatomy of a Bank Failure
The BNEC system followed a typical path to failure.
During the mid-to-late 1980s BNEC grew exponentially, primarily through acquisitions and the dramatic
and uncontrolled growth of the real estate loan portfolios of the BNEC Banks. Adequate controls were not
put in place to monitor its changing risk profile, and
when the real estate market in New England began
to crumble, BNEC careened into a death spiral from
which it never would recover.
The BNEC Banks’ primary regulator, the Office
of the Comptroller of the Currency (OCC), and the
FDIC discovered BNENA’s desperate financial condition during 1989 bank examinations. The regulators
nonetheless encouraged BNEC to issue $250 million
in additional subordinated debt and downstream the
proceeds to BNENA, which the Trustee alleged was
Banking & Financial Services Policy Report • 1
not only insolvent, but doomed to fail and be placed
in FDIC receivership. BNEC also was instructed
to merge certain valuable non-bank assets, like, for
example, its information services subsidiaries, into
BNENA so they would be able to service the BNEC
Banks directly in the event they were placed into
FDIC receivership.8
The Insolvency Standard
Bankruptcy Code Section 101(32) defines “insolvent” as a “financial condition such that the sum of such
entity’s debt is greater than all of such entity’s property,
at fair valuation. . . .” In virtually all instances “fair value”
under the Bankruptcy Code is synonymous with fair
market value.13
In January 1991 the OCC declared BNENA insolvent and the FDIC became receiver of its assets,
including the transferred BNEC property. Pursuant
to the “Cross-Guarantee Provision” of the recently
enacted Financial Institutions Reform, Recovery, and
Enforcement Act (FIRREA), the FDIC immediately
served Notices of Assessment on the other BNEC
Banks (BNENA’s “Sister Banks”) for the amount of the
loss the FDIC anticipated incurring in connection with
the failure of BNENA. The Sister Banks were unable
to pay the assessed amounts, so they were declared
insolvent and placed in FDIC receivership as well. The
following business day, with hundreds of millions of
dollars in debt and most of its assets in the coffers of the
FDIC, BNEC filed for bankruptcy protection.
The insolvency valuation methodology required by
the Bankruptcy Code often is referred to as a “balance
sheet test” because the assets in question typically are
identified on the debtor’s balance sheet. This does not
mean, however, that the book value appearing on the
balance sheet necessarily reflects an asset’s fair market
value. Financial statements of going concerns prepared
in accordance with Generally Accepted Accounting
Principles do not record assets at fair market
value.14
Insolvency and Reasonably
Equivalent Value
When a parent company makes a transfer to a
solvent subsidiary there typically is a presumption of
an exchange for reasonably equivalent value because
the parent company’s investment in its subsidiary is
increased by the amount transferred.9 If, however, the
subsidiary is insolvent, then there is no such presumption because there is no corresponding increase in
equity; i.e., the value of its investment in its subsidiary
is “zero” both before and after the transfer.10 In such
circumstances, when a transfer to or for the benefit of
an insolvent subsidiary has the net effect of diminishing
the value of the parent company, it is deemed to be for
less than reasonably equivalent value.11
The Trustee’s insolvency model was designed to
address whether both the transferor (BNEC) and the
transferees (BNENA and its Sister Banks) were insolvent,
thus providing proof for both the insolvency and reasonably equivalent value elements of his constructive intent
claim. Since insolvency and lack of reasonably equivalent
value also are “badges” of fraud from which a conclusion
of actual intent to hinder, delay, or defraud can be drawn,
the model also supported his actual intent claim.12
2 • Banking & Financial Services Policy Report
Instead of relying on book values, asset values are
measured by the amount of cash that would be generated if sold into the market that existed at the time of
the transfer. If a debtor is on its deathbed and near-term
failure is highly likely, then a so-called “liquidation
value” approach is used, whereby one determines the
amount for which the assets would sell over a short
period in a forced or distressed sale.15 If failure was not
imminent at the time of the transfer, a “going concern”
valuation approach is required, and fair value is the
price that would be obtained for the debtor’s assets if
they were sold in a prudent manner within a reasonable
period of time to pay the debtor’s debts.16 A reasonable period of time for a “going concern” valuation is
“an estimate of the time that a typical creditor would
find optimal: not so short a period that the value of the
goods is substantially impaired via a forced sale, but not
so long a time that a typical creditor would receive less
satisfaction of its claim, as a result of the time value of
money and typical business needs, by waiting for the
possibility of a higher price.”17
Courts have rejected “operational” valuation methodologies in which the focus is not on how much cash
assets would generate if they were sold to pay creditors,
but on their value to the debtor if they are held indefinitely. In a seminal decision rendered in the Trans World
Airlines bankruptcy, the Delaware bankruptcy court
criticized the argument that a going concern valuation
does not require consideration of what the assets could
Volume 29 • Number 1 • January 2010
produce to pay creditors, but a derivation of the “in
place” value to the debtor assuming the debtor would
continue as a going concern for an indeterminate time
and with no time constraints to pay off its creditors.18
The court said, “I find nothing . . . to support [the]
position that in making a ‘fair valuation’ determination,
the so called ‘going concern’ approach does not involve
a consideration of realizing value from the assets which
value (cash) can be paid to creditors within a reasonable
time period. . . . [F]air market valuation entails a hypothetical sale, not a hypothetical company.”19
Depending on the circumstances, courts generally
consider a variety of methodologies to determine fair
market value, including, but not limited to, actual sale
price, discounted cash flow, market multiples, comparable transactions, and market capitalization.20 Whether
a particular methodology or methodologies are appropriate in an individual case depends on whether they
reasonably and reliably calculate the amount of cash
that would be generated if the asset were sold within a
reasonable period of time.21
In some instances an analysis of a hypothetical sale
of a debtor as a whole, operating concern may generate a premium over and above the sum of the values of
the entity’s constituent parts. Other times, there may be
no buyers for the entire enterprise and the fair market
value of its individual assets may be far less than their
recorded book value.
The BNEC Model
Although there was convincing evidence to the contrary, to be conservative the Trustee’s model presumed
that at all relevant times BNEC and the BNEC Banks
were not in immediate danger of failure and liquidation.
This ruled out a “liquidation” valuation methodology
based on what would be generated in a short-term,
forced sale. Instead, a “going concern” approach was
used to determine the fair market value of BNEC’s
assets if converted to cash in a prudent manner over a
12 to 18 month period. The Trustee’s experts first considered whether BNEC was an entity for which a buyer
in an arm’s-length transaction who had the opportunity
to perform adequate due diligence would pay a premium over and above the value of the sum of its parts.
They concluded that it was not, based on factors like,
for example, BNEC’s inability to find a merger partner
or sell itself for any price after concerted efforts to do
Volume 29 • Number 1 • January 2010
so and contemporaneous opinions by informed expert
observers that BNEC was not salable as a whole and
had a high likelihood of near-term failure.
After it was determined that BNEC could not be
sold for a premium, a fair market value analysis was
performed on the individual assets on BNEC’s balance sheet. BNEC’s assets included: cash, interest
bearing deposits, investment securities, investments in
and advances to bank subsidiaries, investments in and
advances to non-bank subsidiaries, other assets, and
intangible assets.
Valuing BNEC’s Subsidiary Banks
Approximately 90 percent of BNEC’s book value
was contained in its investments in and advances to
its subsidiary banks, so the lion’s share of the valuation
work focused on the banks.22 Each bank was evaluated independently. Numerous data points reflecting on
market value were considered, including any offers (or
lack thereof) to buy all or parts of the banks, contemporaneous reports on asset quality and value generated
by OCC and FDIC examiners and analysts,23 contemporaneous analyses performed by experts retained
by BNEC and regulators, and numerous other factors,
depending on the unique circumstances presented by
each bank.
BNEC’s largest bank on a book value basis was
BNENA. Extensive efforts had been made to sell
BNENA during the relevant period. Potential buyers
performed varying levels of due diligence, but for a
variety of reasons relating to asset quality and control
problems no offers were forthcoming for any price.24
Furthermore, numerous knowledgeable observers determined at the time that BNENA’s loan portfolio was in
catastrophic condition and that BNENA was insolvent
and doomed to fail. Under these circumstances, assigning a premium value to BNENA was not appropriate,
so BNENA’s assets were valued individually.
As with most banks, BNENA’s most valuable asset
was its loan portfolio. Bank loan portfolios are monitored, reserved, and valued by using risk rating systems
that categorize loans from the highest quality (secured
by cash on deposit) to the lowest quality (write-off).
While such a system can be an effective tool in assessing loan portfolio value, BNENA’s nine-point rating
system was completely unreliable and substantially
Banking & Financial Services Policy Report • 3
understated the risk in the loan portfolio. Furthermore,
many of the loan files were missing the most basic
information, including appraisals, loan officer updates,
rent rolls, financial information on guarantors, etc.
Because the risk rating system and other value
indicators were unhelpful or unreliable, a bottom-up
approach had to be implemented. Pursuant to this
approach 56 percent of the loan portfolio, including virtually all the troubled real estate loans and all
commercial loans above a certain dollar amount, was
reviewed. Using information that was available at the
time (but which perhaps had been missing from the
loan files), the loans were re-rated and re-reserved.
Discounts were then applied to the re-rated portfolio
to reflect collection costs, the cost of funds, and an
expected return on investment to determine the fair
value amount that a buyer would actually pay for the
loan portfolio considering the market conditions that
existed at the time. When BNENA’s liabilities were
subtracted from the fair value of BNENA’s assets it was
determined that BNENA was insolvent by in excess of
$1.5 billion.25
BNENA’s smaller Sister Banks also were valued. It
was determined that three of those banks, BNE-West,
Old Colony, and Maine National Bank, had positive fair
market values on a stand alone basis.
The Effect of the
Cross-Guarantee Provision
What is commonly referred to as the FIRREA
“Cross-Guarantee Provision” states that any FDIC
insured bank is liable to the FDIC for losses the FDIC
reasonably anticipates incurring in connection with a
default of a “commonly controlled insured depository
institution” (i.e., a sister bank owned by the same bank
holding company).26 This meant that in the event the
FDIC reasonably anticipated a default by BNENA the
FDIC could turn to BNENA’s Sister Banks for payment of the amount of the anticipated loss.27
The Trustee’s experts concluded that the FDIC’s reasonably anticipated loss for BNENA during the relevant
period was at least $1.5 billion, the amount by which
BNENA was insolvent. Applying just 20 percent of
the cross-guarantee liability to BNENA’s solvent Sister
Banks wiped out all of their positive value, leaving
BNEC’s investments in its bank subsidiaries at $0.28
4 • Banking & Financial Services Policy Report
BNEC’s Non-Bank Assets
After investments in bank subsidiaries, the largest
category of BNEC assets on a book value basis was
investments in and advances to non-bank subsidiaries. These companies were engaged in various lines of
business, including data services, commercial finance,
investment banking, investment management, and lease
management services. A fair market valuation was performed for each entity using methodologies ranging
from cash generated from actual sales, to discounted
cash flow analyses, to an examination of comparable
sales data. The fair market value of these assets was
determined to be approximately $310 million, well in
excess of the $138 million book value assigned to them.
The combined value of BNEC’s other non-bank assets,
including cash, interest bearing deposits, investment
securities, other assets, and intangible assets, was just less
than $100 million, bringing the total of BNEC nonbank assets to approximately $409 million.
BNEC Was Insolvent and Did Not
Receive Reasonably Equivalent Value in
Exchange for Its Transfers to BNENA
BNEC had debt, consisting of commercial paper,
other short-term borrowings, notes and debentures, and
other liabilities, totaling approximately $837 million.
Because the fair value of its assets was approximately
$409 million, the Trustee’s model showed that BNEC
was insolvent by approximately $428 million. In addition, because the model demonstrated that BNENA was
deeply insolvent, it provided strong evidence BNEC
did not receive reasonably equivalent value in exchange
for its transfers to BNENA and its Sister Banks.29
Campbell Soup and Market
Capitalization Analysis
In VFB LLC v. Campbell Soup Co., the Third Circuit
held that it was not clearly erroneous for the trial court
to rely primarily on a market capitalization data to determine whether reasonably equivalent value was exchanged
in connection with a leveraged spinoff transaction.30
Although some have claimed that Campbell Soup indicates
that the Third Circuit has abandoned a flexible, fact and
circumstance valuation approach in favor of a rigid market capitalization methodology, that argument has been
specifically rejected by the Delaware district court.31
While a detailed discussion of Campbell Soup is
beyond the scope of this article, it bears noting that
Volume 29 • Number 1 • January 2010
market capitalization data would not have been a
reliable indicator of the market value of the assets of
BNEC or BNENA for at least two reasons. First, the
public market in which BNEC’s securities traded during the relevant period did not have access to complete
or reliable information. For example, testimony from
BNEC’s underwriter and its Chief Financial Officer
revealed that they (and the public) were unaware of
material control deficiencies that understated the risk
inherent in the loan portfolios of BNENA and the
other BNEC Banks and the amount that was necessary to adequately reserve for losses in those portfolios.
The Trustee’s experts, on the other hand, had access
to extensive amounts of internal BNEC and BNENA
documents, materials generated by BNENA’s bank regulators, and other reliable non-public information that
supported the conclusion that BNEC and the BNEC
Banks were deeply insolvent.
Second, the market capitalization value of BNEC’s
publicly traded stock was dramatically different from
contemporaneous market valuation assessments performed by unbiased experts based on information that
was vastly superior to what was available to the public
market. These potential purchasers, bank regulators, and
other experts reached conclusions regarding the value
of BNEC and BNENA that were starkly inconsistent
with a market capitalization valuation.
Although there may be instances in which a market
capitalization valuation may provide a useful data point
for a insolvency analysis of a bank holding company
and its subsidiary bank(s), it likely is not be the best
indicator of the fair market value of their assets. The
public market does not have access to material information like, for example, bank regulators’ assessments
of financial condition and viability, materials relating to
efforts to sell the holding company or its subsidiaries,
valuation and solvency analyses performed by regulators
and/or their outside experts, and loan files and other
information that may be essential to valuing loan portfolios. This type of non-public information is in most
instances going to be a far superior indicator of value
than the public share price, which is calculated without
the benefit of such data.
Conclusion
When a bank becomes troubled, the interests of
the bank’s regulators and those of the bank’s holding
Volume 29 • Number 1 • January 2010
company and its creditors, which typically are for the
most part aligned, can dramatically diverge. Regulators,
concerned about protecting the FDIC bank insurance
fund and the stability of the banking system, often
require bank holding companies to act as a source of
strength and downstream funds and other property to
their distressed banks. If a troubled bank fails and is
placed into FDIC receivership after receiving holding
company assets, such transfers end up benefitting the
FDIC at the expense of the holding company’s creditors. In the BNEC bankruptcy, the Trustee sued the
FDIC and subsequent transferees to avoid fraudulent
transfers to BNEC subsidiary banks that were seized by
the FDIC. The Trustee’s insolvency model supported
both “actual” and “constructive” fraudulent intent
claims and was a fundamental driver of the Trustee’s
$140 million recovery from the FDIC.
Major factual and legal considerations and components of the BNEC insolvency analysis were:
• To pass Daubert muster an insolvency model must
contain a reliable estimate of the amount of cash
that would be generated if the debtor’s assets were
converted to cash over a reasonable period of time
to pay creditors.
• There is no one-size-fits-all valuation methodology
that is applicable to all insolvency analyses. What is
appropriate depends on the nature of the asset, the
market conditions that existed during the relevant
period, and any other circumstances that may be relevant to calculating the amount of cash that would
be generated in a hypothetical sale.
• Despite concerted efforts to sell BNEC and BNENA,
no offers were made for the entities as whole,
operating businesses. The lack of offers not only
showed that a premium over and above the value of
their individual assets was not justified, it provided
direct evidence of the insolvency of BNEC and
BNENA.
• The value of BNEC’s non-bank assets was small
in relation to the book value of its investments in
its banks and in proportion to BNEC’s outstanding debt. This meant that if the BNEC Banks were
insolvent or their fair value was substantially less than
their book value, then BNEC was insolvent.
• FIRREA’s Cross-Guarantee Provision provides that
if a bank is placed in FDIC receivership, the FDIC
can turn to the failed bank’s sister bank(s) for
Banking & Financial Services Policy Report • 5
payment in full of the amount the FDIC expects to
incur in connection with the failure.
• Because BNENA was so deeply insolvent, the
contingent liabilities that arose as a result of the
Cross-Guarantee Provision rendered all of BNENA’s
smaller Sister Banks insolvent and, in turn, made the
value of BNEC’s investment in its subsidiary banks
“zero.”
• The insolvency of the BNEC Banks was strong evidence that transfers to those banks were for less than
reasonably equivalent value.
• The conclusions that BNEC was insolvent and received
less than reasonably equivalent value in exchange for
the transfers in question supported both the Trustee’s
actual and constructive intent fraudulent transfer
claims.
Banks and bank holding companies typically follow
similar paths through decline and failure. The same
palliative efforts, including the transfer of holding company property to banks doomed to FDIC receivership,
have been employed time and time again. The issues
discussed above, therefore, likely will be relevant in connection with the current cycle of bank failures.
Notes
1. The regulators primarily involved when national banks become
deeply troubled are the Office of the Comptroller of Currency
(OCC), which regulates national banks, the Federal Reserve,
which regulates bank holding companies, and the Federal
Deposit Insurance Corporation (FDIC), which oversees the Bank
Insurance Fund (BIF) that insures deposits. Because BIF funds
are at risk, the FDIC is consulted early and often by the Federal
Reserve and the OCC when a bank becomes troubled, and great
deference is often given to the FDIC’s wishes with respect to the
treatment of such banks and their holding companies.
2. A 1987 Federal Reserve policy statement on the so-called
“Source of Strength Doctrine” provides that a bank holding
company has an obligation to “use available resources to provide adequate capital funds to its subsidiary during periods of
financial stress or adversity….” 52 Fed. Reg. 15,707 (1987). See
Christine Bradley & Kenneth Jones, Loss Sharing Rules for Bank
Holding Companies: An Assessment of the Federal Reserve’s Source-ofStrength Policy and the FDIC’s Cross-Guarantee Authority, Munich
Personal RePEc Archive (March 16, 2009) (discussion by FDIC
staff members of history and application of Source of Strength
Doctrine). Not all banks have holding companies. The Source
of Strength Doctrine applies only to those that do.
3. The failure of the BNEC system was one of the largest in history
and was the largest since the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act (“FIRREA”)
until the failure of IndyMac Bank, F.S.B. in July 2008.
6 • Banking & Financial Services Policy Report
4. In addition to fraudulent transfer claims brought pursuant
to §548(a)(1)(A) and (B), the Trustee’s Complaint included
claims for avoidance of fraudulent conveyances pursuant to
Bankruptcy Code § 544(b) and the Massachusetts fraudulent
conveyance laws (109 Mass. Gen. Laws Ann. §§4-7), avoidance
of preferential payments pursuant to Bankruptcy Code §§ 542
and 543, restitution of estate property in certain accounts and
Rabbi Trusts, violation of § 91 of the National Bank Act, and
constructive trust and equitable lien.
5. The Trustee recovered $140 million from the FDIC. The
Trustee also used his insolvency model to support fraudulent
transfer and “deepening insolvency” claims he brought in an
action against BNEC’s former auditors, for which he recovered
$84 million.
6. After several years with no significant bank failures, the failure rate
increased dramatically in 2008, when 25 banks with $371.9 billion in assets failed. See 2009 FDIC Annual Report. In 2009, 140
banks failed. See www.fdic.gov/bank/individual/banklist.html. There
were 552 banks on the FDIC’s troubled bank list at the end of
the third quarter of 2009, up from 416 the previous, and scores of
additional banks are predicted to fail. Matthew Jaffe, FDIC Bank
Insurance Fund Plunges Into Red, abc.go.com/business (Nov. 24, 2009);
Ari Levy, Toxic Loans Topping 5% May Push 150 Banks Past Point
of No Return, Bloomberg.com., Aug. 14, 2009.
7. After the FDIC Litigation concluded, Congress passed the
Gramm-Leach-Bliley Act. Section 730 of the Act prohibits any
person from bringing preference or constructive intent fraudulent transfer claims against the FDIC to avoid transfers to subsidiary banks that occur after a bank receives a written direction
from a bank regulator to raise capital. 12 U.S.C. § 1828(u)(1).
There is, however, no restriction on bringing actual intent
claims against the FDIC. Id. § 1828(u)(2)(B). In addition, Section
730 only limits claims against the FDIC and other bank regulators, and makes no reference to suits pursuant to Bankruptcy
Code Section 550 to recover avoidable transfers from banks or
other subsequent transferees that obtain them from an FDIC
receivership. See In re Int’l Admin. Servs., Inc., 408. F.3d 689,
704-08 (11th Cir. 2005) (trustee may sue subsequent transferee
under Bankruptcy Code § 550 without first suing initial and
intermediate transferees); Woods & Erickson v. Leonard, 389 B.R.
721, 734-35 (9th Cir. 2008) (same); In re Richmond Produce, 195
B.R.455, 463 (Bankr. N.D. Cal. 1996) (same).
While only time will tell the extent to which GLBA Section 730
will effect constructive intent fraudulent transfer and preference
claims against the FDIC, in at least one instance it has not acted
as a barrier. For example, it does not appear that Section 730 was
triggered before the failure of Washington Mutual Bank (WMB),
a federal savings bank placed in FDIC receivership on September
25, 2008, because it does not appear that a bank regulator ever
issued a written direction to WMB to raise capital. As a result,
Washington Mutual, Inc. and WMI Investment Corp., holding
companies of WMB, have brought preference and fraudulent
transfer claims against the FDIC to recover certain amounts
transferred to WMB before its failure. See Complaint, ¶¶25-44,
Washington Mutual, Inc. v. FDIC, Case No. 1:09-cv-00533
(RMC)(March 20,2009)(preference and constructive intent
fraudulent transfer claims); Memorandum of Law in Support
Volume 29 • Number 1 • January 2010
of Motion toi Dismiss of Defendant FDIC, as Receiver for
Washington Mutual Bank, pp. 23-37(moving to dismiss fraudulent transfer claims on grounds other than GLBA § 730).
8. After the FDIC seized banks in the First RepublicBank
Corporation system in 1988, the FDIC discovered that the
information services for the banks were provided by nonbank subsidiaries owned by the holding company. The FDIC
had to pay what it viewed as “hostage money” for the systems
needed to run the banks. Having learned its lesson with the First
Republic resolution, one of the first things it did after assessing BNENA’s dire situation was to compel the merger of the
BNEC information services subsidiaries into BNENA.
9. See, e.g., Branch v. FDIC, 825 F. Supp. 384, 399-400 (D. Mass.
1993) (“Transfers to a solvent subsidiary are considered to be
for reasonably equivalent value because, since the parent is
the sole stockholder of the subsidiary corporation, any benefit
received by the subsidiary is also a benefit to the parent.”);
In re Metro Communications, Inc., 95 B.R. 921, 933 (Bankr. W.D.
Pa. 1989), rev’d on other grounds, 945 F.2d 635 (3rd Cir. 1991);
In re W.T. Grant Co., 699 F.2d 599, 608-09 (2d Cir. 1983); In re
First City Bancorporation of Tex., Inc., 1995 Bank. Lexis 1683, at *34
n.9 (Bankr. N.D. Tex. May 15, 1995).
10. In re First City, 1995 Lexis 1683 at n.9; Branch, 825 F. Supp. at
399-400.
11. See, e.g., In re First City, 1995 Lexis 1683 at n.9; Branch, 825
F. Supp. at 399-400; In re Duque Rodriguez, 77 B.R. 937, 939
(Bankr. S.D. Fla. 1987) (finding no reasonably equivalent value
because net worth of debtor diminished and its creditors
harmed by payment made on behalf of insolvent subsidiary),
aff’d; 895 F.2d 725 (11th Cir. 1990); Commerce Bank of Kansas
City v. Achtenberg, 1993 WL 476510, at *2-4 (W.D. Mo. 1993)
(debtor did not receive reasonably equivalent value in exchange
for guarantee of wholly-owned insolvent subsidiary’s debt
because debtor’s net worth was diminished by the obligation).
12. See, e.g., Land O’Lakes, Inc. v. Schaeffer, No. 99-7147, Slip Op. at
5 (10th Cir. Jan. 19, 2001); United States v. Fernon, 640 F.2d 609,
613 (5th Cir. 1981); Asareo LLC v. Am. Mining Corp., 396 B.R.
278, 370-74 (S.D. Tex. 2008).
13. See, e.g., In re Trans World Airlines, Inc., 134 F.3d 188, 194 (3d Cir.
1998) (“Overwhelming body of authority” provides that appropriate methodology is a market valuation); BFP v. Resolution
Trust Corp., 511 U.S. 531, 548-49 (1994) (“Fair market value”
is “normal tool for determining what property is worth” under
the Bankruptcy Code).
14. See In re Trans World Airlines, Inc., 180 B.R. 389, 405 n.22 (Bankr.
D. Del. 1994), aff’d in part, rev’d in part on other grounds, 203 B.R.
890 (D. Del. 1996), aff’d in part, rev’d in part on other grounds, 134
F.3d 188 (3d Cir. 1998); Briden v. Foley, 776 F.2d 379, 382 (1st
Cir. 1985); Nickless v. Golub, 152 B.R. 394, 403 (Bankr. D. Mass.
1993) (book value does not reflect “fair valuation” under the
Bankruptcy Code.) Book value was specifically rejected as an
appropriate measure of the fair value of the assets of a bank and
bank holding company in Corbin v. Franklin Nat’l Bank, 2 B.R.
68, 7127 (E.D.N.Y. 1979), aff’d, 633 F.2d 203 (2d Cir. 1980)
(“In this particular case it is fruitless to argue . . . that book
value has any meaning.”)
Volume 29 • Number 1 • January 2010
15. See, e.g., Diamond v. Osborne, 102 F. App’x 544, 548 (9th Cir.
2004); In re Taxman Clothing Co., 905 F.2d 166, 170 (7th Cir.
1990); Langham, Langston & Burnett v. Blanchard, 246 F.2d 529,
532-33 (5th Cir. 1957); In re DAK Indus., Inc., 195 B.R. 117, 125
(Bankr. D. Ca. 1996).
16. See, e.g., Lawson v. Ford Motor Co., 78 F.3d 30, 35 (2d Cir. 1996);
Constructora Maza, Inc. v. Banco de Ponce, 616 F.2d 573, 577 (1st
Cir. 1980); In re Irridium, 373 B.R. 283, 344 (Bankr. S.D.N.Y.
2007); Sleepy Valley, Inc. v. Leisure Valley, Inc., 93 B.R. 925, 927
(Bankr. W.D. Tex. 1988).
17. In re Trans World Airlines, 134 F.3d at 195. In the TWA case 12 to
18 months was deemed reasonable. Id.
18. In re Trans World Airlines, 150 B.R. 389, 411 (Bankr. D. Del. 1994)
aff’d in part and rev’d in part on other grounds, 203 B.R. 890, 893
(D. Del. 1996) aff’d in part and rev’d in part, 134 F.3d 188 (3d Cir.
1998).
19. Id. at 410 (citations omitted). See also Lawson, 78 F.3d at 35 (“Fair
value, in the context of a going concern, is determined by the
fair market price of the debtor’s assets that could be obtainable
in the market if sold in a prudent manner over a reasonable
period of time”); Briden v. Foley, 776 F.2d 379, 382 (1st Cir. 1985);
Constructora Maza, 616 F.2d at 577; Sleepy Valley, 93 B.R. at 927.
In considering Daubert motions relating to expert testimony on
asset valuation, the court held in the FDIC Litigation that the
Trustee’s arguments regarding the necessity of a market-based
valuation methodology were persuasive and prohibited the FDIC
from proffering an inconsistent methodology at trial. See Branch v.
FDIC, C.A. No. 91-10976 (RGS), slip op. at 1 (May 15, 1998).
20. See, e.g., In re Irridium, 373 B.R. 283, 344 (Bankr. S.D.N.Y. 2007)
(listing various methodologies); VFB LLC v. Campbell Soup
Co., 482 F.2d 624, 631 (3rd Cir. 2007) (market capitalization);
In re Coated Sales, Inc., 144 B.R. 663, 670 (Bankr. S.D.N.Y. 1992)
(actual sale); MFS/Sun Life Trust-High Yield Sec. v. Van Dusen
Airport Servs. Co., 910 F. Supp. 913, 939-43 (S.D.N.Y. 1995)
(asset purchase price, discounted cash flow and comparables);
In re Lids Corp., 281 B.R. 535, 541 (Bankr. D. Del 2002) (market
multiple and comparables); In re Zenith Elec. Corp., 241 B.R. 92,
104 (Bankr. D. Del. 1999) (discounted cash flow).
21. See, e.g., In re TWA, 134 F.3d at 194; Lawson, 78 F.3d at 35-36;
LaSalle Nat’l Bank Ass’n v. Paloian, 406 B.R. 299, 350-52 (N.D.
Ill. 2009).
22. The value of BNEC’s non-bank assets was dwarfed by the
amount of its public debt. As a result, without the substantial
book value assigned to its investments in its subsidiary banks,
BNEC was deeply and hopelessly insolvent.
23. Bank regulators generate an extraordinary amount of nonpublic reports, analyses, and other material designed to quantify
and predict risk and value in the institutions over which
they have supervisory responsibility. See An Examiners Guide
to Problem Bank Identification, Rehabilitation, and Resolution, pp.
18-26 (Describing systems and reports designed to monitor,
document, and communicate risks and concerns in banks). The
OCC, for example, has a “Canary” web-based early warning
system that provides benchmarks, credit risk analysis, market
barometers, and predictive models. See id. at 19. Some of its
models include, for example, a Bank Performance Projection
Banking & Financial Services Policy Report • 7
Model (predicts future performance when a bank’s ultimate
solvency is in question), a Risk Based Capital Model (provides
a uniform and consistent estimate of risk-based capital ratios
and enables evaluation of expected changes to capital, assets, and
off-balance sheet items), and a Credit Assessment Tool (uses Call
Report information to classify banks according to credit quality
condition and potential to develop problems). See id. at 19-20.
Other OCC and FDIC materials relate to virtually every aspect
of the supervision of troubled banks. See id. at 18-26.
The Trustee was able to overcome the regulators’ assertions of the
deliberative process privilege and obtain unfettered access to their
files relating to the supervision of the BNEC system. Although
this was an arduous process involving motion practice in multiple
courts, it provided a treasure trove of documents for the Trustee
and his experts. These contemporaneous materials generated by
experts with the best knowledge available regarding the condition of BNEC and the BNEC Banks were primary support for
the Trustee’s valuation model.They also provided strong evidence
in support of the Trustee’s actual intent claim Protective orders
issued in connection with the production of the documents prevent the Trustee from disclosing their contents.
24. The fact that BNEC and BNENA were unable to find any
buyers despite concerted efforts to do so is, in and of itself,
strong evidence of insolvency. In Corbin v. Franklin Nat’l Bank,
2 B.R. 687 (E.D.N.Y. 1979), aff’d, 683 F.2d 203 (2d Cir. 1980),
the court, considering the solvency of Franklin National
Bank (“FNB”) and its holding company, Franklin New York
Corporation (“FNYC”), held:
The facts here are that FNYC tried to sell stock of FNB to
Manufacturers Hanover Trust Company in early May, 1974 and
were on May 11th that that bank was not interested because
‘there was nothing left on Franklin’s bottom line.’ Thereafter
the Secretary of the Treasury, the Federal Reserve Bank of New
York, the Comptroller, the FDIC, FNYC and FNB all attempted
during May and June 1974 to find a purchaser for FNB but
were utterly unsuccessful. In this particular case it is fruitless to
argue, as FDIC does, that book value has any meaning. If there
were no purchasers or bidders for FNB in May and June 1974,
its stock, realistically speaking, had no value and that meant that
FNYC was insolvent . . . .
Id. at 711-12. See also Briden, 776 F.2d at 382 (requiring reductions for assets not readily susceptible to liquidation and payment of debts); Constructora Maza, 616 F.2d at 577 (same).
25. The credibility of this number was bolstered by similar conclusions reached in analyses performed by informed, expert observers at or around the time of the transfers.
26. 12 U.S.C. § 1815(e).
27. BNEC acknowledged the contingent liability the cross-guarantee
provision imposed on its subsidiary banks in its 1989 Form 10K, stating, “In the event that the FDIC experiences losses or reasonably anticipates losses in connection with the appointment
8 • Banking & Financial Services Policy Report
of a conservator or a receiver for a national bank subsidiary of
[BNEC] or in connection with assistance provided by the FDIC
in anticipation of a danger of default by a subsidiary bank, the
FDIC may make an assessment against other [BNEC] subsidiary
banks in the amount of the loss or reasonably anticipated loss,
which assessment could result in those other subsidiary banks
being declared in default and placed in receivership.”
After BNENA was declared insolvent and placed in an
FDIC receivership, the FDIC served Notices of Assessment
on BNENA’s Sister Banks for the full amount of the anticipated loss. The Sister Banks were unable to pay the demanded
amounts, so they too were declared insolvent and placed in
FDIC receiverships.
28. Numerous cases have held that contingent liabilities are to be
considered when evaluating the insolvency of a company. See,
e.g., In re Trans World Airlines, 134 F.3d at 197; Mellon Bank, N.A.
v. Official Comm. of Unsecured Creditors, 92 F.3d 139, 156 (3d Cir.
1996); In re Xonica Photochemical, Inc., 841 F.2d 198, 200 (7th Cir.
1988). In the FDIC Litigation, the FDIC moved to dismiss the
Trustee’s § 548(a)(1)(B) claims to avoid transfers to two of the
Sister Banks on the grounds that those banks were solvent on a
stand-alone basis at the time of the transfers and that BNEC thus
received reasonably equivalent value in exchange for the transfers. Branch¸ 825 F. Supp. at 399-40. The court noted that while
there is a presumption of reasonably equivalent value when a
company transfers assets to a solvent subsidiary, the Trustee had
alleged that BNENA was deeply insolvent at the time of the
transfer and that a contingent liability that arose from a possible
cross-guarantee assessment rendered the Sister Banks insolvent.
Id. The FDIC’s motion was denied on the basis that transfers to
Sister Banks rendered insolvent by cross-guarantee liability may
not have been for reasonably equivalent value. Id.
29. See In re First City, 1995 Lexis 1683 at n. 9; Branch, 825 F. Supp.
at 399-400; In re Commerce Bank, 1993 WL 476510, at *2-4;
In re Duque, 77 B.R. at 939.
30. 482 F.3d 624, 627-34 (3d Cir. 2007). The trial court also relied
on other contemporaneous indicators of value in addition to
market capitalization, like valuations performed internally by the
transferor and the transferee both before and after the spinoff.
Id. at 629. The 3rd Circuit noted that the trial court’s valuation
was “largely immune from attack” and could not be overturned
unless it was “completely devoid of credible evidentiary basis” or
bore “no rational relationship to the supporting data.” Id. at 683.
31. In re American Classic Voyages Co., 384 B.R. 62, 65 (D. Del. 2008)
(noting that Campbell Soup does not require a market capitalization approach in all instances). See LaSalle Nat’l Bank Ass’n v.
Paloian, 406 B.R. 299, 351 (N.D. Ill. 2009) (discussing Campbell
Soup and holding that even where contemporaneous market
data is available a court may assign greater weight to expert testimony, particularly if the contemporaneous methodology was
faulty or biased).
Volume 29 • Number 1 • January 2010