Silicon Valley Bank collapsed in spectacular fashion earlier this month, with the Federal Deposit Insurance Corporation putting the bank into a federal receivership. This is the largest collapse of an FDIC-insured bank since the 2008 financial crisis and the second largest in history, with more than $200 billion in assets involved. FDIC receiverships for two other large banks, Silvergate Bank and Signature Bank, quickly followed. The holding companies for all three banks are expected to enter bankruptcy soon.
What is an FDIC receivership?
Unlike most other businesses, an operating bank cannot seek relief in bankruptcy. (A bank holding company may reorganize in bankruptcy, though.) Rather, an operating bank is subject to its own insolvency regime, namely the FDIC receivership.
When regulators deem a bank critically undercapitalized, the FDIC is appointed as a receiver of its operating bank to “liquidate or wind up” operations. As receiver, the FDIC has broad equitable powers to manage and dispose of bank assets, including the power to operate the bank, transfer assets and liabilities, and terminate contracts.
Although litigation in receivership and bankruptcy differ significantly—and the differences must be clearly understood before engaging in litigation—the major issues for stakeholders are similar. In both FDIC receiverships and bankruptcy, creditors and counterparties can be sued to retroactively avoid (or “claw back”) prior transactions that have the effect of preferring one creditor over another.
Stakeholders may also be sued to claw back “fraudulent transfers,” which include not only transactions done with the intent to defraud, but also “constructively fraudulent” transfers, which require no evidence of intent. In addition, certain contracts and leases can be rejected or assumed and assigned, and assets may be sold, over the objections of stakeholders. This is not to mention related nonbankruptcy claims, such as fraud and negligence claims that are sure to arise, especially in light of the suddenness of the banks’ collapse.
Thus, bondholders, lienholders, creditors, officers, directors, major shareholders, management, employees, insurers and acquiring banks will likely wind up in litigation with the receiver and other parties, whether to enforce their own claims or to defend clawback actions, to challenge the rejection of contracts, to object to sales of assets in which they hold interests, or to object to unfavorable distribution schemes.
What should counsel for impacted parties be thinking about now?
In-house counsel and litigators should closely examine their clients’ relationships with the failed banks to determine potential claims by and against their clients. Even though the FDIC has announced that all deposits will be insured, many entities will still have claims. But sorting out what those claims are, who can bring them, and where to bring them will not be straightforward.
Some of this confusion results from tension between the goals of an FDIC receivership and the bankruptcy regime. The FDIC’s mandate is to minimize losses to its insurance fund, not necessarily to maximize recoveries for creditors, as is the goal in bankruptcy. In an FDIC receivership, the claims of depositors generally take priority over the claims of other creditors; this is not the case in bankruptcy, or here, where depositors’ claims will be greatly limited. Also, clawback statutes in bankruptcy are generally more favorable to creditors and defendants than in FDIC receiverships. In either context, it will be important to anticipate problems and start formulating litigation strategies.
There will also be pitched battles over where the litigation takes place. Bankruptcy and FDIC receiverships are federal matters, but many issues are required to be litigated in other forums for constitutional and jurisdictional reasons. Receivers and debtors usually prefer to litigate as many claims as possible in one forum, e.g., bankruptcy court. In contrast, creditors and other stakeholders often prefer state court or district court, whether for strategic advantages or belief that such forums will devote greater attention to, or focus more on, nonbankruptcy issues.
Notably, the holding companies’ eventual bankruptcies will trigger an “automatic stay” that takes effect immediately on filing, barring all lawsuits and virtually every other effort to enforce contracts or claims. Although there is no automatic stay in receivership, counterparties are statutorily barred from enforcing contracts for 90 days after the start of a receivership. Counsel should be closely attuned, because violating these stays, even inadvertently, can result in huge liability.
Plan for a long slog
Bank failures are rare and, given the size of these failures and the government’s unusual response, these in particular will likely raise novel issues. In-house counsel and litigators should be sure to take the long view from the start. It will be critical to preserve issues for appeal and avoid inadvertently waiving them, even issues that may seem unlikely to get traction immediately. After all, you can’t raise on appeal what you didn’t preserve below, and it’s a fair bet that a good deal of this litigation will end up on appeal. If your client has enough at stake, you might want to add an appellate expert to consult with your team early on.
Reno Fernandez is one of the only lawyers in California to specialize purely in bankruptcy law appeals and litigation consulting. He practices with the Complex Appellate Litigation Group, an award-winning boutique of 20 attorneys who are experts in all manner of federal and state appeals, appellate writs, and appellate petitions, and frequently consult on litigation in its earlier stages. The firm has offices in San Francisco, Los Angeles, San Diego and Newport Beach. You can learn more at www.calg.com. Fernandez’s background is at www.calg.com/reno, and you can email him at firstname.lastname@example.org.
This article originally appeared in The Recorder on March 15, 2023.