4000 - Advisory Opinions
Handling of Loan Participations Where Receiver is Appointed for Lead Bank
October 23, 1984
Lawrence F. Bates, Counsel
This is in reference to your questions regarding the handling of loan participations in cases where a receiver is appointed for the lead bank. It is my understanding that a loan participant will receive its pro rata share of any payment made by a debtor which augments the receivership estate. In the event a debtor defaults and the receiver forecloses on collateral securing the loan, these proceeds will also be paid to the loan participant in accordance with its proportional interest in the loan.
The loan participant may suffer a loss as a result of a bank's failure if the debtor has a right of offset against the bank. As the exercise of this offset does not augment the receivership estate, there are no "proceeds" to be passed on to the loan participant. Therefore, the loan participant is left with a general unsecured claim against the receivership estate for the amount it has lost as a result of the setoff.
These principles are illustrated by the following example. Assume that Mr. Debtor owes Bank A $200,000, and 50 percent of this loan has been participated out to Bank B. Assume further that this debt is secured by a $200,000 house, and that Mr. Debtor has $150,000 on deposit at Bank A. When Bank A fails, Mr. Debtor offsets his deposit against his debt, leaving a balance of $50,000. Bank B is left with a $75,000 general claim against the receiver of Bank A. When the receiver receives a loan payment on the $50,000 balance from Mr. Debtor, it will forward 50 percent of that payment (less expenses, etc.) to Bank B. If Mr. Debtor defaults, the receiver may foreclose on the house for the $50,000 it is owed, and will forward 50 percent of this amount to Bank B.
The possibility exists that a debtor will prefer to receive deposit insurance proceeds instead of setting off his entire deposit against his debt. Assume that in the above example Mr. Debtor desires to receive $100,000 in deposit insurance from the FDIC and that the FDIC determines that it does not want to exercise an offset in this case. Under these circumstances, Mr. Debtor would offset only $50,000 against his debt. Bank B would have a $25,000 general claim against the Receiver, and would receive $75,000 of the $150,000 that is subsequently recovered by the Receiver.
There has been some discussion as to the enforceability of a written waiver of offset executed by both a debtor and a lead bank in the event of the lead bank's insolvency. The Federal Deposit Insurance Act defines insured deposit as:
"the net amount due to any depositor . . . for deposits in an insured bank (after deducting offsets) less any part thereof which is in excess of $100,000." 12 U.S.C. § 1813(m)(1).
It is my opinion that, at least insofar as the insured portion of a deposit is concerned, the FDIC's statutory right of offset cannot be impaired by a waiver executed by the lead bank. See also 12 U.S.C. § 1822(d).
As you know, there are three relatively recent cases which deal with this subject: FDIC v. Mademoiselle of California, 379 F.2d 660 (9th Cir. 1967); Chase Manhattan Bank, N.A. v. FDIC, 554 F. Supp. 251 (W.D. Okla. 1983); Hibernia National Bank v. FDIC, 733 F.2d 1403 (10th Cir. 1984).
In reference to your question regarding the protection of loan participants from the consequences of such offsets, you may be interested in reviewing the following articles:
Essay, Aftermath of Penn Square Bank: Protecting Loan Participants from Setoff, 18 Tulsa L.J. 261 (1982)
Armstrong, The Developing Law of Participation Agreements, 23 Bus. Law 689 (1968)
Comments, Bank Insolvency and Depositor Setoff, 51 U. Chi. L. Rev. 188 (1984)
I hope that this is responsive to your inquiry.