Contributed by Andrea Saavedra
During the 2008 financial crisis and its aftermath, it became commonplace for a distressed bank to be taken over(night) by the Federal Deposit Insurance Corporation (FDIC) and then sold, that same day, to another bank (or bank holding company) that agreed to take on the depository liability associated with the failed bank in exchange for its assets (and customer base). Some banks, however, survived the tidal wave of takeovers. A recent decision by the United States Bankruptcy Court for the Middle District of Georgia in the involuntary chapter 7 case of In re FMB Bancshares, Inc. tells a new chapter in the life cycle of these nearly-failed banks—the possibility of their sale in chapter 11, something that is occurring with greater frequency in the past few years.
The FMB Bancshares debtor—a Georgia bank holding company—owns a bank with approximately half a billion in total assets. Both the debtor and its bank are subject to regulation by the Federal Reserve and the Georgia Department of Banking and Finance, although the bank is also subject to the regulatory supervision of the FDIC, and each are also required to maintain certain minimum levels of “Tier 1” capital as mandated by and overseen by the Federal Reserve and the FDIC. One way for banks and their holding companies to satisfy this capital requirement is via the issuance of “TruPS.” TruPS—short for Trust Preferred Securities—were created for bank holding companies to “access Tier 1 capital at attractive rates by issuing very long-term, deferrable, interest-only securities with equity like features.” To achieve favorable tax treatment, a bank holding company does not issue TruPS directly, but rather forms a wholly-owned trust subsidiary that issues TruPS to investors. Concurrent with the issuance of TruPS, the trust also purchases junior subordinated notes issued by the bank holding company. The notes constitute the “sole asset” of the trust, and the terms of the notes mirror those of the TruPS. One important feature of both is the absolute right of the obligor to elect to defer all payments on the notes for up to five consecutive years. As the court explained, this “payment deferral period is designed to allow the holding company and subsidiary bank to withstand any economic recessions or misfortune they may face during the long life” of the notes.
The debtor’s trust—the FMB Trust—was formed in 2006 and issued TruPS to investors in the amount of $12 million and, in return for receiving the sale proceeds, the debtor issued unsecured junior subordinated notes in the same amount with a maturity date set in 2036. In 2009, the bank experienced a net loss of approximately $14 million. As a result, it was pushed to the “brink of collapse” and forced to participate in a federally mandated rehabilitation program known as “Prompt Corrective Action.” In October 2012, the FDIC required the bank to submit a capital restoration plan, which required, among other things, that the debtor provide a capital maintenance commitment and guaranty, which would be enforceable by either the bank or the FDIC. Because the bank is currently in default of its capital restoration plan, the debtor is obligated to pay approximately $30 million to the bank (again, enforceable by the FDIC).
Beginning in March 2009, and continuing for each consecutive quarter, the debtor elected to defer payments under the notes to FMB Trust. In January 2014, after expiration of the contractual deferral period, the debtor requested that the trustee permit it to begin a new five-year deferral period, citing its lack of funds as reason for non-payment. The trustee did not respond to the request, resulting in a March default. Shortly thereafter, a creditor (an entity that purchased all the outstanding TruPS) provided the debtor with notice of its intent to accelerate the notes and make all principal and interest immediately due and payable. The creditor subsequently also filed an involuntary petition against the debtor.
In opposing the involuntary petition and requesting dismissal of the chapter 11 case, the debtor asserted that a default had not occurred because it was legally barred by its regulators from making the payments due to the FMB Trust. It also argued that the creditor’s right of collection against it, rather than the FMB Trust, was very limited under the terms of the notes and their governing indenture. Further, the debtor argued that the creditor’s claim was “contingent” because it was prohibited from paying the interest amounts due as a result of its participation in the “Prompt Corrective Action” program. Lastly, it asserted that, even if the involuntary chapter 11 case were in the best interests of its estate and creditors (meaning that dismissal was not warranted), abstention was appropriate where a liquidation of the bank could potentially result in a conflict with the debtor’s obligations to its federal banking regulators.
The court found in favor of the creditor on all counts. First, because the default stemmed from non-payment of interest due after expiration of the deferral period, the court held that the trust agreement clearly gave the creditor the right to bring any “suit” for enforcement in such circumstances, and that the word “suit” was broad enough to include the filing of an involuntary bankruptcy petition. Second, the court found that the creditor was actually a creditor of the debtor, rather than the trust and, given the nature of the TruPS structure, its claim was presently due and payable. Indeed, the court found that the debtor’s argument concerned its “ability to pay, rather than its legal duty” to do so. Because the debtor had a present obligation to pay the creditor under the notes and all triggering events under the TruPS had occurred, there was no contingency that prevented the creditor from asserting its position as a bona fide creditor of the debtor with the right to file the involuntary petition. Lastly, the court found that abstention was not necessary, particularly where the FDIC did not oppose the bankruptcy, even in light of the likely sale of the bank as part of the creditor’s efforts to liquidate its claims. Accordingly, the court denied the debtor’s request for dismissal.
Interestingly, the relevance of section 365(o) of the Bankruptcy Code—which provides for automatic assumption by the debtor of any capital commitment obligation owing to the FDIC—was not discussed in the opinion. Ostensibly, any purchaser of the bank in the chapter 11 may have to satisfy—or assume—the $30 million dollar liability that the debtor currently owes the bank (which, again, is enforceable by the FDIC). In any event, the case demonstrates yet another creative way in which bankruptcy can be used to facilitate the resolution of distressed banks.