In our prior posts on this topic, we focused on what your loan agreements might say about how to deal with a defaulting lender.  In this post,  we’ll talk about what happens when a member of your bank group goes into default because it is taken over by the FDIC.  Special rules apply in that case.

Automatic Stay.  The Federal Deposit Insurance Act  provides for an “automatic stay” whenever a lender is taken over by the FDIC.  In part, the statute says that no one may “exercise any right or power to terminate, accelerate, or declare a default under any contract” that the failed institution is a party to, for a period of 90 days after appointment of the FDIC as receiver (45 days, if it is a conservatorship).

My colleagues Colleen McDonald and Nikki Kolhoff have explained (pdf) that this means you can’t do anything that would affect the contractual rights of the defaulting lender, if such action is based solely on the insolvency or FDIC takeover.  So, for example, you can still amend your loan documents, but you have to invite the defaulting lender to vote, and the amendment can’t affect the rights of the defaulting lender without that lender’s consent.  According to McDonald, the bottom line here is “if you are going to amend your loan agreement, make sure you do it correctly.”  She points out that both the “D’Oench Duhme doctrine” (D’Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942)) and 12 U.S.C. Section 1823(e) impose specific requirements on modifications of loans involving financial institutions taken over by the FDIC.  Contracts that don’t meet the requirements can be avoided altogether by the FDIC – so it’s worth taking the time to make sure those requirements are met.

In addition, even if the loan agreement would otherwise permit you to stop sharing payments with a defaulting lender, if the lender is taken over by the FDIC, you’ll still have to share all principal and interest payments with it — at least, to the extent of the obligations it has previously funded.  (As discussed in our prior post, the loan documents should ordinarily prohibit the defaulting lender from sharing in principal and interest payments relating to advances it did not fund.)

As a practical matter, the automatic stay can create significant problems for a bank group, particularly if the defaulting lender is the administrative agent for the credit facility.  Since the agent manages the funding and payment processes, and often holds the borrower’s bank accounts and controls other collateral for the loan, an FDIC takeover could bring everything to a halt – at least temporarily.

McDonald recommends that to help protect against these problems, the loan agreement should include the right to declare the lender in default early — before FDIC takeover.  This would allow the bank group to take action before the automatic stay kicks in.  For example, if the agent in a syndicated loan goes into default (pre-FDIC takeover), its rights as agent could be terminated and assigned to a successor, and all the collateral could be transferred to the new agent — thus permitting the credit facility to function pretty much as usual through the FDIC takeover.  McDonald suggests including a definition of  “Impaired Agent” in the loan agreement that would include an agent that fails to make payments or fund loans required under the loan documents, or that rescinds or repudiates a loan document.

Exceptions.  There are other sections of the Federal Deposit Insurance Act that provide exceptions to the automatic stay, including an exception for when the FDIC as conservator/receiver fails to comply with otherwise enforceable provisions in the loan agreement.  Sometimes these exceptions can provide relief for the bank group, though their full effect is as yet untested.   I have a feeling we’ll get the chance to test some of these provisions over the next few months.