In a recent opinion, the Ninth Circuit Court of Appeals held that the FDIC may be liable in damages to a counter party for breach of a bank’s pre-receivership contract.  Bank of Manhattan v. Federal Deposit Insurance Corporation, 2015 WL 898232 (9th Circ. 2015).  The facts in Bank of Manhattan involved a participation agreement between two banks.  Bank of Manhattan’s predecessor in interest – Professional Business Bank (“PBB”) – sold a participation interest in a loan to First Heritage Bank (“Heritage”).  The participation agreement contained two key provisions relevant to the case:  (1) Heritage could not transfer its interest in the loan without PBB’s prior written consent and (2) PBB was granted a right of first refusal entitling it to repurchase Heritage’s interest in the loan on the latter’s receipt of a bona fide third party offer. 

About one year after the participation agreement was executed, the FDIC was appointed by the Comptroller of the Currency as receiver of Heritage’s assets.  By operation of law (18 U.S.C. § 1821(d)(2)(A)) the FDIC became the successor in interest to Heritage as to all of its assets and liabilities.  Several months after its appointment as receiver for Heritage, the FDIC – without first seeking PBB’s consent or providing it an opportunity to exercise its right of first refusal – sold the participation interest to Commerce First Financial (“CFF”).  When the borrower on the loan defaulted, PBB sued to collect the debt.  CFF brought an action to enforce its rights as the successor to Heritage’s participation interest, and PBB filed a third party complaint against the FDIC for breach of the participation agreement.  The FDIC filed a motion to dismiss the third party complaint, asserting the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) preempted PBB’s claims.  The District Court’s denial of the motion was appealed to the Ninth Circuit Court of Appeals, which affirmed the decision in a split opinion.

On appeal, the FDIC contended that FIRREA frees it from complying with any pre-receivership contractual obligations.  However, the District Court had held that 12 U.S.C. § 1821(d)(2)(G)(i)(II), which states that the FDIC as receiver may “transfer any asset or liability of the institution in default . . . without any approval, assignment, or consent with respect” thereto did not immunize the agency from damage claims if it elects to breach pre-receivership contractual arrangements.  In commencing its review, the Ninth Circuit noted that the case did not “arise in a precedential vacuum.”  First, the court distinguished its prior opinion in Sahni v. American Diversigied Partners, 83 F.3d 1054 (9th Cir. 1996).  In Sahni, the Ninth Circuit held that § 1821(d) preempted a California statute that required the consent of all general partners prior to a transfer of the bulk of a partnership’s assets.  The court held thatSahni, which involved a statutory rather than a contractual restriction on transfer, was not applicable. 

Instead, the court found that its prior decision in Sharpe v. FDIC, 126 F.3d 1147 (9th Cir. 1997) to be more relevant.  InSharpe the court held that the FDIC can escape liability under pre-receivership contracts only through its right under 12 U.S.C. § 1281(e), which authorizes it to disaffirm or repudiate any contract it deems burdensome and pay only compensatory damages.  The court also relied on the opinion of the D.C. Circuit in Waterview Management Co. v. FDIC, 105 F.3d 696 (D.C. Cir. 1997), which held that § 1821(d) does not preempt pre-receivership purchase-option contracts and that such contracts are appropriately governed by § 1821(e)’s provisions on repudiation and compensatory damages.  Specifically, the court held that “section 1821(d) merely permits the transfer of a failed bank’s assets without prior approval, while section 1821(e) governs the mechanisms by which such transfers are executed if the disputed assets are burdened by pre-existing contractual obligations.” 

The court considered the distinction between state statutory transfer restrictions and contractual restrictions to be key.  The court held that § 1821(d)’s preemption works to preemptstatutory transfer restrictions but does not extend to contractual restrictions:  “To rule otherwise would permit the FDIC to succeed to powers greater than those held by the insolvent bank, as implausible result when FIRREA provides that the FDIC, as receiver, ‘shall . . . succeed to all rights, titles, powers, and privileges of the insured depository institution.’”  12 U.S.C. § 1821(d)(2)(A).

As a result, because the FDIC sold Heritage’s participation interest without first obtaining PBB’s consent or offering it a right of first refusal as required by the participation agreement, the FDIC was subject to PBB’s claims for damages arising from that breach.