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From Banking and Finance Law Daily, March 12, 2014

Breach of contract by FDIC would not alter priority of claims against receivership

By Richard A. Roth, J.D.

Claims raised by a mortgage securitization trustee against the Federal Deposit Insurance Corporation, in its capacity as receiver for IndyMac Bank F.S.B., were not entitled to special priority due to the FDIC’s alleged breach of the securitization agreements, the U.S. Court of Appeals for the Ninth Circuit has determined. The trustee’s claims were to be treated as general creditor claims, the court said. Moreover, since the receivership had no assets left to pay general creditors’ claims, the trustee’s suit was moot, the court said (Deutsche Bank National Trust Company v. FDIC, March 11, 2014, Rawlinson, Circuit Judge).

Breach of trust agreements. Deutsche Bank said that it was the trustee for more than 240 mortgage securitization trusts created by IndyMac before the thrift failed in 2008. The various trust agreements imposed on IndyMac the obligation to perform services for the trusts and carry out other responsibilities in exchange for servicing fees. These contractual duties and rights were assumed by the FDIC when it was appointed IndyMac’s receiver, the bank said.

As part of winding down IndyMac, the FDIC violated the trust agreements by separating these rights and duties, Deutsche Bank complained. Principally, the bank said the FDIC sold IndyMac’s right to service the loans and charge fees, but did not transfer IndyMac’s duty to repurchase loans that did not comply with the terms of the securitizations. This left the repurchase obligation with the receivership.

The trust agreements created “unitary contracts” that could not be severed in that way, according to Deutsch Bank. By doing so, the FDIC breached the contracts, and the trusts and the bank suffered between $6 billion and $8 billion in damages, the bank claimed.

Claims payment priorities. The Federal Deposit Insurance Act establishes the order in which claims against a receivership are to be paid, dividing claims into five categories. General creditors’ claims are in the third category, after claims for the receivership’s administrative expenses and claims by depositors (12 U.S.C. 1821(d)(11)). This created a problem for Deutsche Bank because after the receivership paid the first two categories of claims, there were no assets left.

To avoid this result, the bank claimed that the FDIC’s breach of the trust agreements exempted the bank’s claims from the FDI Act priority provisions, giving the claims “superpriority.” The FDIC had the authority within the receivership to repudiate the trust agreements and pay the resulting damages, the bank argued. If the agency did not exercise that authority, it had exceeded its statutory powers and the FDI Act priorities did not apply.

The federal district court disagreed. Regardless of whether the FDIC had breached the trust agreements, the bank’s claims were in the third category, the court decided. Since there was no money left to pay third-priority claims, the court had no ability to offer any remedy. The claims were prudentially moot, the district court said, and were to be dismissed.

Effect of contract breach. The bank rested its theory mainly on a Ninth Circuit decision from 1997, Sharpe v. FDIC. This case presented an unusual set of facts. Two homeowners settled a suit against a bank for $510,000, which the bank was to pay by wire transfer when the consumers provided a note, trust deed, and other documents. The consumers provided the documents, but the bank sent cashier’s checks rather than making the required wire transfer. Before the consumers had the chance to deposit the checks, the FDIC was named the bank’s receiver. The FDIC recorded the documents provided by the consumers but refused to honor the checks.

The Ninth Circuit decided that the consumers were neither depositors nor creditors. Rather, they were parties to a contract that they had performed in full and that had not been repudiated. Both the bank and the FDIC had breached the contract, and the consumers had the right to sue for the breach.

Since the consumers were not creditors, they also were not required to submit their claim for an administrative determination before suing, the court concluded.

Considering Deutsch Bank’s suit, the court said that the Sharpe decision does not stand for the proposition that breaches of contract are excluded from the claim priority rules. Considered narrowly, the precedent says only that the consumers’ breach of contract claim was not subject to the administrative claim process because the consumers were not creditors. There was no reason to expand the precedent to apply to the claims payment priorities as well.

Even if Sharpe might apply, the trust agreements made Deutsche Bank a creditor of IndyMac and thus of IndyMac’s receiver, the court pointed out. Thus, the bank’s claims were third-priority general liabilities.

The case is No. 11-56339.

Attorneys: Thomas M. Peterson (Morgan, Lewis & Bockius LLP) for Deutsch Bank National Trust Company. J. Scott Watson for Federal deposit Insurance Corporation.

Companies: Deutsch Bank National Trust Company

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