When a bank holding company files a chapter 11 case, a key factor to the success of the case will be whether the debtor previously made any commitment to a federal depository institution regulatory agency, such as the FDIC, to maintain the capital of the debtor’s bank subsidiary.  This is because section 365(o) of the Bankruptcy Code provides that the debtor is deemed to have assumed such obligations, and any claim for subsequent breach of these obligations is entitled to priority under section 507(a)(9) of the Bankruptcy Code.  The FDIC often demands that the debtor honor these commitments, and the viability of the chapter 11 case may depend on the debtor’s ability to either meet its obligations or pay the priority claim.  Otherwise, the debtor needs to successfully challenge the FDIC’s claim for breach.  In evaluating these challenges, courts often focus on whether the debtor is found to have made a “commitment” at all, but a recent decision by the United States Bankruptcy Court for the District of New Mexico highlights yet another potential challenge: whether the commitment was breached.  Although the case, In re First State Bancorporation, is a chapter 7 case, the chapter 7 trustee’s ability to raise this challenge could easily be applied in the chapter 11 cases of other bank holding companies.

Background

In First State, the FDIC, as the receiver for First Community Bank, Taos, New Mexico, filed a priority claim in the chapter 7 case of the bank’s parent, First State Bancorporation, asserting an unsecured priority claim under section 507(a)(9) of the Bankruptcy Code in the amount of $63,821,000 based on an alleged commitment to maintain the capital of the bank.  The chapter 7 trustee commenced an adversary proceeding against the FDIC seeking, in part, to expunge the claim on the grounds that, among other things, none of the documents that the FDIC relied upon in support of its claim obligated the debtor to infuse its own capital to restore the capital of the bank.  Instead, the debtor had committed to assist the bank by agreeing to take affirmative steps to try and retire $100 million in debt and raise in excess of $200 million in third party capital.

In opposing the FDIC’s motion to dismiss, the trustee cited several cases in support of her argument, including In re Colonial BancGroup, Inc., about which we have previously written, in which the Bankruptcy Court for the Middle District of Alabama found no commitment “to maintain the net worth of the Bank or to infuse additional capital as necessary . . . .”  The court in First State noted, however, that “nothing in 11 U.S.C. § 365(o) or 11 U.S.C. § 507(a)(9) requires ‘a commitment to ‘infuse equity capital’ in order to constitute a commitment to maintain the capital of an FDIC-insured bank.”  Instead, the court said, “section 507(a)(9) gives priority status to ‘any commitment’ to maintain an insured depository institution’s capital.”  The court concluded that based on the documents relied upon by the FDIC, the debtor had made a commitment to maintain the capital of the bank, even if it had not specifically promised to make an equity infusion, because the debtor had agreed to take affirmative steps to raise third party capital.

Concluding that the debtor made “a commitment” did not end the court’s inquiry, because “to sustain a claim based on a commitment to maintain the capital, [the debtor] must have breached that commitment.”  As the trustee stated in her complaint, the debtor had “struggled to close a deal with third party investors to adequately capitalize the bank,” and “engaging an investment banking firm, which brought in 13 investor groups for a potential whole bank purchase, each of which declined to go forward, as well as 8 private equity firms that performed diligence on a private placement transaction.”  Ultimately, one investor came forward with a qualifying proposal, but the FDIC “preferred a whole bank purchase by another bidder with whom it had been negotiating a purchase and assumption agreement.”  In light of these facts, the court found that the trustee’s allegations sufficiently stated a claim that the debtor did not, in fact, breach its commitment to maintain the capital of the bank.

Conclusion

Among other things, First State adds another item to the pre-bankruptcy diligence checklist for a financially distressed bank holding company.  As a preliminary matter, any commitment to maintain the capital of a bank subsidiary should be carefully considered, even if it is not a commitment to contribute capital.  Whatever that commitment is, consideration should be given to whether that commitment has been breached, and if it has not been breached, whether the time and means exist to satisfy those commitments.  The debtor in First Street may not have had the resources to save its own bank subsidiary, but the court found it, nevertheless, took adequate measures prior to the bankruptcy to satisfy its pre-bankruptcy commitments and, potentially, defend against a claim for breach from the FDIC.