U.S. BANK FAILURES: Through June 25, 2010

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1 A DISCUSSION OF SECTION 597 & FDIC ASSISTED TRANSACTIONS Michael Kliegman Ty Patel PricewaterhouseCoopers LLP 1 I. INTRODUCTION In recent times, deteriorating economic conditions and declining loan asset values have caused a number of banks to be exposed to an increased risk of failure. That is to say, banks may not have a sufficient amount of assets to cover their deposit and other liabilities. Forty-one Federal Deposit Insurance Corp ( FDIC ) insured institutions failed during the first calendar quarter in 2010, while 37 institutions were merged into other charters. Only three new bank charters were added during the quarter, and all three were charters formed to acquire failed banks. The number of insured commercial banks and savings institutions on the FDIC s problem list increased from 702 to 775 during the quarter, and total assets of problem institutions increased from $403 billion to $431 billion. 2 In 2009, 140 banks failed. Based on the current pace of failures, 2010 will see more than 160 bank failures. U.S. BANK FAILURES: Through June 25, 2010 Number Bank Failures in the U.S. (By Year) Year Source: After a bank has failed (or been declared insolvent), the FDIC has a number of options: PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Michael Kliegman is a principal, and Ty Patel is a director, in the Mergers & Acquisitions Tax Group of PricewaterhouseCoopers LLP, in New York City. The authors acknowledge the valuable assistance provided by Benjamin Willis, a senior associate in our Washington National Tax office. 2 FDIC.gov, U.S. Bank Failures , available at (last visited June 29, 2010). 1

2 The FDIC can arrange for another bank to purchase all or part of the failed bank and to assume its liabilities (a purchase and assumption transaction). The FDIC can pay off insured depositors and then sell the bank s assets. The FDIC can establish a bridge bank, which is eventually sold. In recent times where a bank has failed, the FDIC has most commonly taken action by seizing control of the failed bank and selling the bank assets and liabilities to a bidder that offers the least-cost solution for the FDIC i.e., a so-called purchase and assumption transaction. There is currently an abundance of supply of distressed banks and this has allowed opportunistic banks (and non-banks such as private equity buyers) to acquire failed bank institutions under highly attractive terms that commonly include federal financial assistance ( FFA ), as defined below, and loan portfolio loss protection provided by the FDIC. It is common for the FDIC to encourage buyers to take as much of the failed bank s asset base as possible by entering into loss sharing agreements with the buyer whereby the FDIC agrees to bear much of the further credit loss associated with the failed bank s loan assets. In these instances, the buyers continue to bear only a portion of the loss. These transactions provide investors and acquirers with benefits such as: Expanding customer base and geographic footprint; Significant cost reduction opportunities and synergies; FDIC provided loss sharing agreements which provides significant protection to investors and acquirers; and Attractive acquisition pricing. However, assessing the tax implications of these transactions can prove to be a challenge. The tax rules governing FDIC assisted transactions is found in Section and the Treasury Regulations thereunder. This report provides an overview of Section 597, the Treasury Regulations thereunder and their application to certain aspects of FDIC assisted transactions. This report is divided into three parts. The first part summarizes the evolution of Section 597 and the relevant Treasury Regulations. The second part discusses certain aspects of FDIC assisted transactions and the application of the relevant tax rules. Finally, the conclusion will provide some final observations regarding upcoming guidance in the area. II. EVOLUTION OF SECTION 597 AND THE REGULATIONS THEREUNDER This part is divided into five sections. The first section provides an overview of the Section 597 rules originally contained in the Economic Recovery Tax Act of The second section provides an overview of the Technical and Miscellaneous Revenue Act of 1988 and its impact on the then existing Section 597 rules. The third section will discuss the elimination of the old Section 597 rules pursuant to the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and its mandate to issue new Section 597 rules. The fourth section provides an overview of the interim Section 597 guidance under Notice Finally, the fifth section provides an overview of the Section 597 regulations proposed in 1992 and final regulations promulgated in The Economic Recovery Tax Act of Section or I.R.C. references are to the Internal Revenue Code ( Code ) of 1986 (or 1954, as the case may be), as amended, and to the Treasury Regulations issued thereunder unless otherwise stated. 2

3 Section 597 was enacted in the Economic Recovery Tax Act ("ERTA") of 1981, which generally permitted the relevant federal supervisory authority to arrange acquisitions of financially troubled institutions by healthy institutions at a tax-subsidized cost. 4 ERTA added the following three tax rules to the Code: a. Sections 597(a) and 597(b), which generally provided that payments from the Federal Savings and Loan Insurance Corporation ("FSLIC") to a troubled financial institution was excluded from gross income and did not reduce the adjusted basis of the institution's assets. 5 b. Certain FSLIC- or FDIC-assisted acquisitions involving a troubled financial institution could qualify as tax-free reorganizations, without regard to the requirement that the shareholders of an acquired corporation must maintain a meaningful ownership interest in the acquiring corporation pursuant to the continuity of interest requirement that generally applies to tax-free reorganizations under Section c. The general Section 382 loss limitation on the ability of an acquiring corporation to utilize the net operating losses ( NOLs ), built-in losses ( BILs ), and excess credits was not applicable to a nontaxable acquisition of a troubled financial institution where depositors acquired deposits in the acquiring institution with a fair value equal to at least 50 percent of the aggregate fair value of the total deposits and the outstanding stock of the acquiring institution. 7 Collectively, these rules were advantageous to troubled financial institutions and their acquirers due to the favorable results whereby the acquired institution was generally permitted to retain its NOLs and/or BILs while simultaneously being exempt from the income taxation of FFA (i.e., a so-called double dip benefit). 2. The Technical and Miscellaneous Revenue Act of The Technical and Miscellaneous Revenue Act of 1988 ("TAMRA"), enacted on November 10, 1988, made several changes to Section 597. Subsection (c) was added to Section and was generally effective for acquisitions occurring after December 31, Prior to TAMRA, there was no cost for a troubled bank that was able to exclude FFA from its taxable income. Section 597(c)(1), added in TAMRA, provided that 50 percent of any FFA amount that is excludable from the troubled institution s taxable income in any taxable year shall be applied to reduce the tax attributes (e.g., NOLs, interest 4 I.R.C. 597 added by ERTA of 1981, Pub. L. No , 95 Stat Specifically, I.R.C. 597(a), as added by ERTA, provided that: "gross income of a domestic building and loan association does not include any amount of money or other property received from the Federal Savings and Loan Insurance Corporation pursuant to I.R.C. 406(f) of the National Housing Act (12 U.S.C. sec. 1729(f)), regardless of whether any note or other instrument is issued in exchange therefor." I.R.C. 597(b) provided that: "[n]o reduction in the basis of assets of a domestic building and loan association shall be made on account of money or other property received under the circumstances referred to in subsection (a). 6 See I.R.C. 368(a)(3)(D) as in existence prior to the repeal of these rules (prior to the enactment of FIRREA). See generally Kliegman, Troubled Thrift Reorganizations The Short Happy Life of Section 368(a)(3)(D), 64 Taxes 281 (1986). 7 See I.R.C. 382 (l)(5)(f) as in existence prior to the repeal of these rules (prior to the enactment of FIRREA). In general, I.R.C. 382 limits the amount of NOLs and BILs that can be deducted following a change in ownership in the loss corporation. The purpose of I.R.C. 382, was to deter trafficking in loss corporations, i.e., new owners were to be denied access to losses generated by others. Prior to ERTA, even where reorganization was permissible, Section 382(b) limited the use of the acquired institution s pre-reorganization NOLs if its depositors did not become shareholders in the transferee corporation. 8 Pub. L. No , 102 Stat Id. at 4012(c)(1). Prior to TAMRA, the favorable treatment was limited to savings and loan institutions and was set to expire on December 31, TAMRA extended the favorable treatment of FFA exclusion to banks in connection with acquisitions occurring after December 31, 1988 and extended the expiration date to December 31, TAMRA, Pub. L. No , 102 Stat (c)(3). 3

4 expense and BILs) of the taxpayer. 11 Section 597(c)(2), added in TAMRA, provided that the attribute reduction shall occur in the following order: (1) pre-assistance NOLs 12 determined, with some exceptions, in the same manner as a pre-change loss in Section 382(d), 13 (2) allowable interest deductions for the taxable year, 14 (3) built-in portfolio losses 15 determined, with some exceptions, in the same manner as built-in losses in Section 382(h). 16 Therefore, beginning in 1988, the cost for FFA exclusion under Section 597 became a reduction in the NOLs, interest expenses and/or BILs of the troubled institution in the amount of 50 percent of the amount excluded. 17 As a result, troubled institutions were nonetheless generally able to retain 50 percent of the tax benefits that were subsidized by FFA. 3. Enactment of FIRREA Section 597 was substantially amended by section 1401 of FIRREA, 18 which delegated to the Secretary of the Treasury ( Treasury ) authority to prescribe regulations concerning any transaction in which FFA is provided. The legislative history clearly reflects that FIRREA was enacted to shut down the advantages discussed above by removing the exemption from taxation of FFA and the rules permitting the transfer of NOLs and/or BILs without the imposition of the Section 382 limitation rules. 19 In conjunction with the elimination of these tax benefits, Congress, in the legislative history of FIRREA, also directed the Treasury Department to issue regulations, as soon as possible, to address the federal income tax treatment of transactions involving financially troubled financial institutions. 20 In this regard, in order to provide immediate and temporary guidance regarding the taxation of FFA in certain transactions, the legislative history of FIRREA specifies that FFA will generally be taxable to the acquired financially troubled institution immediately before the acquisition even where the FFA is paid to the acquirer and, consequently, the taxation of FFA is imposed on the acquired financially troubled institution at the time its assets are sold or transferred. 21 In addition, Congress indicates that FFA payments generally will be taxable to the acquiring institution only to the extent the FFA payments exceed the tax basis allocable to such payments. Congress expressly indicates its intent to impose taxation to the acquiring institution on any FFA received by the acquiring institution only to the extent there is true economic gain on such asset. In addition, Congress expresses in the legislative history that the expectation of the rule imposing taxation on FFA is that no net tax liability will result from the receipt (or deemed receipt) of FFA on the basis that the FFA will generally be offset with NOLs or BILs of the acquired financially troubled institution. 22 However, Congress specifically recognizes that this may not always be the result. For example, such a result may occur where the acquired financially troubled institution is a member of a federal consolidated 11 See TAMRA, Pub..L. No , 102 Stat In explaining the provision, the Joint Committee on Taxation provided that: "[u]nder [TAMRA], taxpayers were required to reduce certain tax attributes by one-half of the amount of financial assistance received from the FSLIC or the FDIC pursuant to acquisitions of certain financially troubled depository institutions occurring after December 31, 1988 and prior to the enactment of FIRREA." Staff of the Joint Committee on Taxation, Tax Aspects of Government-Assisted Acquisition of Savings and Loan Associations (H.R. 1135, H.R. 1326, H.R. 1338, H.R. 561) Scheduled Before The House Ways and Means, JCX-2-92 (1992), reprinted in 1992 WL I.R.C. 597(c)(2)(A) (as in existence prior to FIRREA). 13 I.R.C. 597(c)(3)(A) (as in existence prior to FIRREA). 14 I.R.C. 597(c)(2)(B) (as in existence prior to FIRREA). 15 I.R.C. 597(c)(2)(C) (as in existence prior to FIRREA). 16 I.R.C. 597(c)(4) (as in existence prior to FIRREA). 17 See generally I.R.C. 597(c) (as in existence prior to FIRREA). 18 FIRREA of 1989 is effective for transactions occurring on or after May 10, Pub. L. No , 103 Stat. 183 (1989). 19 See H.R. Rep. No , Pt. 2, at 27 (1989). 20 See Id at 358 (1989) (hereinafter referred to as House Report ). 21 In the legislative history of FIRREA, Congress specifies the types of transactions involving FFA generally include transactions where all the assets and liabilities of the troubled institution are acquired or where transactions are structured as an assumption of deposit liabilities in exchange for FFA. 22 See House Report, supra, note 19, 4

5 group and the historic NOLs generated by the acquired financially troubled institution were used to offset taxable income generated by other members of such federal consolidated group. 23 On August 9, 1989, FIRREA was signed into law. 4. Notice In Notice , 25 the IRS published interim guidance on the tax treatment of common transactions involving FFA that taxpayers were able to rely upon until the issuance of regulations. 26 Consistent with the mandate set forth in the legislative history of FIRREA, Notice generally provided that, in connection with its acquisition, FFA received by the troubled financial institution in the form of cash or notes paid is required to be included in the taxable income of the acquired institution before the acquisition, even if the assistance is paid to the acquiring corporation. 27 Generally, this rule permitted the NOLs of the acquired institution to offset the income arising from FFA. Notice also provided that no transferee liability would be assessed on the acquiring corporation for any unpaid federal taxes of the target institution where FFA is provided to target institution in a taxable asset transaction. 28 In addition, Notice provided that, where the troubled institution is not includible in a consolidated group, any federal tax liabilities (including taxation of FFA) resulting from the troubled institution s transfer of a substantial amount of its assets in a taxable asset transaction will not be assessed or collected if such tax liability would be borne by the federal agency providing the FFA Proposed and Final Regulations Proposed regulations issued by the Treasury Department on April 23, superseded Notice and final regulations (the "Final Regulations") were promulgated on December 21, 1995, which generally maintained the approach of the proposed regulations. The Final Regulations have remained substantially unchanged since their promulgation. 32 The proposed regulations and Final Regulations generally reflect the following four principles, which were derived from the legislative history of FIRREA: a. FFA is treated as ordinary income of the failed institution that is being compensated for its loss through the provision of the assistance. b. The timing of the inclusion of FFA should, where feasible, match the recognition of the Institution's losses. c. Where possible, the income tax consequences of an assisted acquisition should not depend on its form. d. The Service generally will not collect tax on FFA if the Service determines a Federal insurer would bear the burden of the tax Id at 358, n C.B Id. 26 Id. 27 Id. 28 Id. 29 Id. 30 Preamble to Prop. Treas. Reg , 57 Fed. Reg , C.B (Apr. 23, 1992) C.B T.D Id. 5

6 III. Overview of Key Aspects of the Final Regulations Among other things, the Final Regulations provide (i) rules regarding the taxability of FFA, including special rules where the troubled institution is a member of a consolidated group; (ii) special rules regarding taxable asset (and deemed asset) transactions; and (iii) the applicability of transferee income tax liability in connection with assisted transactions. These aspects will be main focus of the remaining discussion in this report. The discussion below will refer to fact patterns and, as a general proposition, the base case fact pattern involves a corporate parent ( P ) of a troubled bank corporate subsidiary ( T ). T is taken into receivership by the FDIC in the same year as the taxable asset transaction. In each fact pattern P and T file consolidated federal income tax returns on a calendar year basis. While T is in receivership, an acquiring corporate institution ( A ) acquires all of the assets of T and assumes all of T s liabilities (e.g., deposits) in a transaction where FFA is provided by the FDIC in the form of cash. The FFA is intended to restore T s solvency at the time of the transaction (e.g. Net Worth Assistance). 34 P T Assets & Liabilities A FFA FDIC a. Taxation of FFA FFA is broadly defined as any money or property provided, under certain provisions of the National Housing Act, the Federal Home Loan Bank Act, the Federal Deposit Insurance Act, or under similar provision of law, by Agency to an Institution or to a direct or indirect owner of stock in an Institution. 35 The Final Regulations define Agency as the Resolution Trust Corporation, FDIC, or any similar instrumentality of the U.S. government, and any predecessor or successor of the foregoing (including the FSLIC). 36 The term "Institution" is defined as an entity that is, or immediately before being placed under Agency Control was, a bank or domestic building and loan association within the meaning of Section 597 (including a Bridge Bank ). 37 The term also includes (i) an acquiring corporation in certain taxable transfers of a failed institution's assets or liabilities and (ii) the new corporation that is treated as acquiring all of the assets of the failed institution in a taxable deemed asset sale. 34 Treas. Reg Net Worth Assistance generally means money or property that Agency (e.g., FDIC) provided as an integral part of a Taxable Transfer. A Taxable Transfer will be discussed later in this report. The base case fact pattern described above is a Taxable Transfer. Id. 35 I.R.C. 597(c); Treas. Reg (b). 36 Treas. Reg (b). 37 Treas. Reg (b). An Institution or entity is under Agency Control if Agency is conservator or receiver of the Institution or entity, or if Agency has the right to appoint any of the Institution s or entity s directors. Id. A Bridge Bank generally means an Institution that is organized by Agency to hold assets and liabilities of another Institution and that continues the operation of the other Institution s business pending its acquisition or liquidation. Id. 6

7 Therefore, in the base case fact pattern, FDIC is Agency, T is Institution since it was a bank before it was placed into receivership, A is an Institution since it acquired the assets and liabilities of T in an actual asset transfer and the money provided by FDIC to A constitutes FFA. FFA is Taxable as Ordinary Income As stated above, FIRREA repealed the ERTA provision that allowed troubled institutions to receive FFA tax free. Treasury Regulation (a) provides the general tax rules that apply to FFA and specifically provides that FFA is includible as ordinary income to the recipient institution in accordance with the recipient s method of accounting. There are two exceptions to this general rule. The first is the loss guarantee exception. Certain amounts received pursuant to a loss guarantee are included in the amount realized with respect to the covered asset rather than directly in gross income. 38 This exception will be analyzed in more detail below in the discussion of the treatment of loss guarantees in taxable asset transfers and the rule requiring a step-up in tax basis of the acquired loan portfolio that is covered by the loss guarantee to no less than the guaranteed amount. The second exception, which pertains to one of the expressly stated principles of the Final Regulations, affects the timing of FFA inclusion and is aimed at matching the imposition of FFA taxation to the institution with its losses. In certain circumstances, a portion of the FFA is not included in the institution s taxable income until the institution recognizes losses. 39 If an institution defers its inclusion of FFA into taxable income, it is required to establish a deferred FFA account 40, which generally must be recaptured into taxable income as the institution generates losses. 41 These deferral provisions generally do not apply to acquirers as such entities are generally not subject to taxation on FFA received in conjunction with the acquisition of a troubled financial institution Treas. Reg (d)(2). 39 Treas. Reg (c). Two formulae are provided to determine the timing of FFA taxation: one that is applicable to institutions without continuing equity and the other is applicable to institutions with continuing equity. An institution without Continuing Equity includes an institution that is in Agency receivership, a Bridge Bank and a bank treated as a New Entity due to a deemed purchase of assets of an Old Entity. A New Entity means the new corporation that is treated as purchasing all of the assets of an Old Entity in a Taxable Transfer (a deemed asset purchase) within the meaning of Treas. Reg (b). An Old Entity generally means the Institution or its subsidiary that is treated as selling all of its assets in a taxable transfer (a deemed asset purchase) within the meaning of Treas. Reg (b). Id. For institutions without Continuing Equity, the amount of FFA for a tax year that must be included in income currently is limited to the sum of: (1) the excess at the beginning of the taxable year of the institution s liabilities over the adjusted tax basis of its assets; and (2) the amount by which the excess of the institution s deductions (other than NOLs and capital loss carryforwards) over its gross income (determined without regard to FFA) for the taxable year is greater than the excess at the beginning of the taxable year of the adjusted tax basis of the institution s assets over its liabilities. This formula is generally designed to allow the institution the benefit of any earlier losses of its owners equity, but offset any losses of creditors capital by the inclusion of FFA. See Treas. Reg (c)(2); Preamble to T.D. 8641, C.B. 103 (Dec. 21, 1995). Thus, in order to prevent the mismatching of income and deductions, the amount of income currently includible in taxable income is limited to the amount of deductions allowed to the financial institution in prior years and the current year. A deferred FFA account is established for the remaining unreported income and is required to be recaptured when the institution has a net loss, before loss carryovers, after taking account any additional FFA received in the current year. A different formula applies to Institutions with Continuing Equity. An institution with Continuing Equity is one that is not (i) in Agency receivership, (ii) a Bridge Bank, or (iii) a bank that treated as a New Entity. 40 Treas. Reg (c)(4)(i). 41 Treas. Reg (c)(4)(ii)-(iii). In any tax year in which an institution has a balance in its deferred FFA account, it is required to include in income any amount equal to the lesser of (1) that balance or (2) the annual recapture amount, and reduce its deferred FFA account by a corresponding amount. The annual recapture amount is generally the excess of (1) the institution s deductions (other than net operating and capital loss carryovers) over its gross income (other than deferred FFA) over (2) its remaining equity as of the beginning of the tax year. For an institution with continuing equity, the deferred FFA income is generally recaptured over six years. Treas. Reg (c)(4). 42 Treas. Reg (c)(1). 7

8 These deferral rules are intended to carry out one of the stated principals of the Final Regulations. That is, as described in the preamble of the Final Regulations, the underlying concept of the deferral mechanism is that income will be recognized based on a formula designed to approximate the amount of tax benefits the institution (or its consolidated group) either currently has available or previously used. Notwithstanding the aforementioned rules, it should be noted the IRS has stated that unless and until further guidance is issued to the contrary, no amount furnished by the Treasury Department to a financial institution pursuant to the Troubled Asset Relief Program established under the 2008 Emergency Economic Stabilization Act will be treated as the provision of FFA under Section FFA and Consolidated Groups Generally, if an institution is seized by the FDIC, the institution is still subject to its normal tax filing requirements even though the FDIC (Agency) owns stock of the institution. The same is true for a Bridge Bank where it acquires the assets of an institution. In these situations, the FDIC s ownership of an institution (Agency Control), where it is a member of a consolidated group, does not terminate the institution s membership in the group. As indicated in the legislative history of FIRREA (and again in the preamble to the Final Regulations), Congress intended FFA to be included in the taxable income of the institution or consolidated group, at least to the extent that the consolidated group benefitted from its use of the institution s losses. 44 Thus, since this may result in taxable FFA income to the consolidated group in the year of a taxable transfer, there may be a mismatching of FFA income and loss carryover or BILs because the losses may have been applied against the income of other members in prior consolidated return years. If an institution within a larger consolidated group owns subsidiaries, they are generally treated as a single entity with respect to income and expenses, assets and liabilities, and tax attributes, with appropriate adjustments made to avoid duplication. 45 Under the regulations, a consolidated group that has a subsidiary institution in receivership may irrevocably elect to exclude the institution from the consolidated group. 46 The effect of such an election could be the exclusion of FFA into the taxable income of the institution and, therefore, the consolidated group. However, making an election to disaffiliate an institution can have adverse tax consequences to a consolidated group. A toll charge will be imposed by requiring the consolidated group to include in its taxable income an amount equal to the institution s excess liabilities over the adjusted tax basis of its assets (less bad-debt reserves under Sections 585 or 593, other than supplemental reserves under Section 593) immediately before the institution is placed in receivership. 47 The toll charge is intended to reflect the amount the consolidated group would include in income if the FDIC (Agency) were to provide the FFA required to restore the solvency (e.g., Net Worth Assistance) of an institution at the time of the 43 See Notice , I.R.B See House Report, supra note 19, at 27 (1989). 45 Treas. Reg (c)(6)(ii). Thus, in determining the amount of FFA income that is currently includable in income under Treas. Reg (c), the limitation is based on the combined excess liabilities and net loss for the year of the Institution and its consolidated subsidiaries. Note that in determining the limitation with respect to an institution with continuing equity (continuing 5 percent shareholders), the consolidated NOL for the year and consolidated loss carryover are to be used if the amount is greater than the institution's net loss plus the group's consolidated NOL carryover. Treas. Reg (c)(3). 46 Treas. Reg (g). An affirmative election is made by the consolidated group by sending a written statement to the affected institution within 120 days of the later of its placement in Agency receivership. Treas. Reg (g)(5). Treas. Reg (g)(2) sets forth the consequences of electing to disaffiliate. The IRS has granted at least one parent company an extension of time to disaffiliate. See I.R.S. P.L.R (May 31, 1996), as amended by I.R.S. P.L.R.s (Sept. 4, 1996) and (Jan. 3, 1997). 47 Treas. Reg (g)(3). 8

9 deconsolidation. 48 In addition to triggering a toll charge, a deconsolidation election also requires the institution (and any of its subsidiaries) to do the following: (i) accelerate all Section 481 adjustments; (ii) restore all deferred intercompany gains and ELAs; (iii) close their taxable year and (iv) if the institution s liabilities exceed the aggregate fair market value of its assets, the members of the group must treat their stock in the institution as worthless. 49 If the consolidated group makes an election to disaffiliate an institution placed under receivership, the institution is generally treated as a new corporation that obtains a carryover basis in its assets but does not inherit any loss carryovers of the troubled institution. 50 Taxable Asset Transfers Actual or Deemed The acquisition of an institution in a Taxable Transfer is treated as a taxable asset acquisition. This applies whether the acquisition is an actual asset purchase, or a stock purchase that is treated as an asset purchase. 51 A Taxable Transfer is a transaction in which an entity transfers, to a transferee other than a Bridge Bank (a) any deposit liability (whether or not the institution also transfers assets) if FFA is provided in connection with the transaction, or (b) any asset for which the Agency has any financial obligation, e.g., under a loss guarantee or Agency obligation. 52 Certain transfers of stock of an institution (or its subsidiary) are also treated as a sale of assets and, therefore, treated as a Taxable Transfer, if (a) FFA is provided in connection with the transfer or (b) the transfer occurs while (i) the institution is a Bridge Bank or has a balance in its deferred FFA account or (ii) with respect to an institution s subsidiary while the institution is under Agency Control. 53 For a deemed sale of assets to occur, the amount of shares that must be transferred must be sufficient to cause the institution (or its subsidiary) to leave or join a consolidated group or to experience a 50 percent or more ownership shift. The base case fact pattern above reflects a Taxable Transfer since the transaction involves a transfer of deposit liabilities (among other things) to A where the FDIC is providing FFA. 54 If the base case fact pattern is altered slightly such that all the shares of T are transferred to A, a deemed asset sale would still result since the FDIC is providing FFA in the transaction. In the Taxable Transfer, T is treated as having directly received, immediately before the transfer, the Net Worth Assistance that the FDIC provided to A in the transaction. The Net Worth Assistance is treated as T s asset that is sold to A in the transaction An Institution must include the assets and liabilities of its consolidated subsidiaries in computing the toll charge. The regulations impose a deemed election (subject to the toll charge) if consolidated group members deconsolidate a subsidiary institution in contemplation of agency control or receipt of federal financial assistance. Treas. Reg (g)(3). 49 Treas. Reg (g)(2). 50 Treas. Reg (g)(4)(i). The new corporation is treated as if it receives all of its assets and liabilities in a Section 351 transaction in which no gain or loss is recognized. Each new corporation retains the taxpayer identification number of the corresponding disaffiliated corporation. 51 Treas. Reg (a)(2). 52 The phrase in connection with is not explained in the Final Regulations. In the Preamble, T.D. 8641, C.B. 103 (Dec. 21, 1995), the phrase in connection with is intended to be interpreted broadly. 53 Treas. Reg (b)(1). The institution (the Old Entity) is treated as selling all of its assets in a single transaction and is treated as a New Entity that buys all of the Old Entity's assets at the close of the day immediately before the transfer. The New Entity succeeds to the taxpayer identification number of the transferor in the deemed sale. Id. Taxable Transfers are not limited to transactions where the institution is under Agency Control. It is possible for an Agency to resolve an institution under its control without providing assistance, or to provide assistance without placing an institution under its control. 54 Note a Taxable Transfer would result even if none of T s assets were transferred to A. 55 Treas. Reg (c)(1). This outcome applies whether the acquirer or the New Entity receives the Net Worth Assistance directly or indirectly. 9

10 P Assets & Deposit Liabilities FFA FDIC T A As a result of a Taxable Transfer, the acquiring entity does not inherit any of the old institution s historic tax attributes (e.g., NOLs or BILs). 56 The stated purpose of the rules that govern the treatment of actual or deemed asset sales (Taxable Transfers) is to treat acquisitions of institutions under FDIC receivership (Agency Control) as taxable asset acquisitions whether the acquisition is in the form of an asset purchase, a stock purchase or a carryover basis transaction. 57 In addition to conforming the federal income tax consequences of various forms of acquisitions, the deemed transfer rule is designed to foster the matching of FFA income with an institution s losses by triggering its BILs. These rules are also aimed at implementing Congress intent to prevent taxpayers from purchasing the tax attributes of an institution. Treatment of Taxable Asset Transfers Gain or loss recognized on an actual transfer of assets is based on the consideration paid for the assets. 58 In a deemed sale of assets, however, the amount realized is the total of the grossed-up basis of the stock acquired in the Taxable Transfer (excluding stock acquired from the Old Entity or New Entity) plus the assumed liabilities (plus other relevant items). 59 The amount realized in a Taxable Transfer, whether an actual or deemed asset transfer, is allocated among the acquired assets in a manner similar to Section 338, but the Final Regulations provide some special modifications that are described below. 60 For this purpose, we will analyze certain of the key modifications provided in the Final Regulations that can have dramatically different results from the standard Section 338 approach. 56 The deemed asset transfer rule tiers down through any consolidated subsidiaries of the acquired institution thereby resulting in deemed asset transfers with respect to such subsidiaries as well. 57 Treatment of Acquisition of Certain Financial Institutions; Certain Tax Consequences of Federal Financial Assistance to Financial Institutions, Prop. Treas. Reg , 57 Fed. Reg (Apr. 23, 1992). The Preamble to Treas. Reg mentions the prototypical Taxable Transfer is a transaction in which an acquirer assumes all of a failed Institution s deposit liabilities in exchange for FFA and the failed Institution s assets. 58 Treas. Reg (c)(2); I.R.C. 1001(b). 59 Treas. Reg (c)(2). The grossed-up basis of the acquired stock is determined by dividing the acquirer s basis in the acquired stock by the percentage of value of the Old Entity s stock attributable to the acquired stock. Thus, for example, if owners of A acquired 85% of T stock for $850,000, the grossed-up basis of the acquired stock would be $1 million ($850,000/85%). 60 Pursuant to Treas. Reg (b), (c)(1) and (2), the adjusted grossed-up basis ( AGUB ) of the new target is generally allocated to the target's assets under a residual method based on their relative fair market value. Under that method, AGUB is first reduced by cash and cash equivalents (Class I assets). The balance is then allocated, in order, among Class II assets (certain actively traded personal property, certificates of deposit, and foreign currency), among Class III assets (accounts receivable, mortgages, and credit card receivables which arise in the ordinary course of business), among Class IV assets (stock in trade or other property includable in inventory, or property held primarily for sale in the ordinary course of business), among Class V assets (all assets not in Class I, II, III, VI, or VII), Class VI assets (I.R.C. 197 intangibles, except those in the nature of goodwill or going concern value) in proportion to, and not in excess of, the fair market values of the assets within the class (and subject to other limits). The balance is, subject to other limits, allocated to Class VII assets (good will and going concern value). See also Treas. Reg (c)(3)(ii). Under this provision, stock of a subsidiary is treated as a Class II asset to the extent the fair market value of the subsidiary s Class I and Class II assets exceeds its liabilities. Also, the fair market value of a debt obligation issued by an Agency (e.g., FDIC) to the Institution is deemed to equal its adjusted issue price immediately before the taxable asset acquisition. A detailed discussion of these modifications is beyond the scope of this report. 10

11 1. Special Purchase Price Modifications Loss Share Guarantees Another unique aspect of FDIC-assisted acquisitions, and indeed a key aspect of bank acquirers evaluation of these transactions, is the loss share arrangement with the FDIC. Under the Final Regulations, a Loss Guarantee generally means an agreement pursuant to which Agency (or an entity controlled by Agency) guarantees or agrees to pay an institution a specified amount upon the disposition or charge-off (in whole or in part) of specific assets, an agreement pursuant to which an institution has a right to put assets to Agency (or an entity controlled by Agency) at a specified price, or a similar arrangement. 61 The FDIC generally structures a sale of a troubled financial institution to include a loss share agreement ( LSA ) whereby, in connection with a purchase and assumption of a troubled financial institution s assets and liabilities, the FDIC agrees to assume a portion of any economic loss incurred on a specified pool of acquired loan portfolio assets. The FDIC believes the use of a LSA reduces the immediate cash needs of the FDIC, is operationally simpler and more seamless to failed bank customers and moves assets quickly into the private sector. 62 The more common LSA involves the FDIC providing for reimbursement of 80% of any economic losses incurred by the institution up to a specified amount and 95% of any losses in excess of the threshold amount. 63 Thus, for example, assume the base case fact pattern is altered such that the loan assets of T, with a book value of $1,500 are purchased by A for a purchase price of $1,000 and the FDIC agrees to reimburse A (pursuant to a LSA) for (i) 80% of the losses relating to the acquired loan portfolio to the extent those losses do not exceed $900 and (ii) 95% of the losses above such amount. If A sells the acquired assets to a third party for $1,300, the FDIC reimburses A for $160 ([$1,500 less 1,300] x 80%). If instead the $900 threshold was already met and reimbursements occurred with respect to such losses and a subsequent disposal of loans occurred whereby A sells certain loans for $100, the FDIC reimburses A for $95 ([$100 x 95%]). Although generally the rules of Section 338 govern the basis and classification of the acquired assets, the Final Regulations specify that assets covered by a LSA are treated as Class II assets for purposes of the Section 338 allocation, the fair market value of which is deemed not to be less than the loan assets guaranteed value. 64 Pursuant to the Final Regulations, the guaranteed value is not less than the greater of the asset s highest guaranteed value or the highest price at which the asset can be put. 65 Example: Institution A acquires assets and assumes liabilities of T in a Taxable Transfer. Among the assets transferred are three parcels of real estate which, in the hands of T, had book values of $100,000 each. In connection with the Taxable Transfer, the FDIC agrees to reimburse A for 80% of any loss (based on the original book value) realized on the disposition or charge-off of the three properties. This arrangement is a Loss Guarantee. Thus, in allocating basis, A treats the three parcels as Class II assets. A is assured the parcels will not be worth less to it than $80,000 each, because even if the properties are 61 Treas. Reg FDIC, Loss-Share Questions and Answers, available at (last visited June 29, 2010). 63 FDIC, supra note Treas. Reg (c)(3)(ii), (d)(2)(ii). For purposes of I.R.C. 338, Class II assets only include actively traded personal property (within the meaning of I.R.C. 1092(d)(1)), certificates of deposit and foreign currency. Treas. Reg (b)(2)(ii). This definition would presumably exclude the loans not actively traded and other assets (e.g., real estate) that tend to be covered by a typical FDIC LSG. Unlike under Generally Accepted Accounting Principles, no basis is allocable to the FDIC s agreement to provide LSG. 65 Treas. Reg (c)(3)(ii). If, immediately after a Taxable Transfer, an asset is not covered by a Loss Guarantee but the New Entity or Acquiring has the right to designate specific assets that will be covered by a Loss Guarantee, the New Entity or Acquiring must treat any asset so designated as having been subject to the Loss Guarantee at the time of the Taxable Transfer. 11

12 worthless, the FDIC will reimburse 80% of the loss. Thus, A is not guaranteed that it will realize more than $80,000. Accordingly, $80,000 is the highest guaranteed value of the three parcels. N will allocate basis to the Class II assets up to their fair market value which, for this purpose, is not less than $80,000 each. 66 Based on time value of money principles, one can reason the fair market value of the amount constituting the highest guaranteed value or highest price at which the asset can be put as of the acquisition date should not be the minimum future amount to be received but instead is be more appropriate to be a discounted amount of such future proceeds. However, absent any guidance to the contrary it appears the allocation must be based on the highest guaranteed value or price the loans can be put to the FDIC. 2. Phantom Income if Mandatory Allocation to Class I and II Assets Exceeds Purchase Price If the fair market value of the Class I and Class II assets acquired by the financial institution is greater than the purchase price for the acquired assets, the basis of the Class I and Class II assets equals their fair market value. 67 In allocating the total amount realized among the classes of assets as in a Section 338 transaction, if the fair market value of the Class I and Class II assets exceeded their allocated basis (i.e., the purchase price), the basis of the assets is still increased to their fair market value and the excess amount is included ratably in income of the acquiring institution (New Entity or Acquiring Corporation) over a six-year period beginning in the year of transfer. 68 Thus, if the only asset received is cash of $5 million and the total basis is $2 million, the acquiring institution would be required to include $500,000 in taxable income in each year over a six-year period (an aggregate of $3 million) beginning in the year of the asset acquisition. 69 Depending on the anticipated life of the loan portfolio that is covered under a LSA, the six-year inclusion rule may create a timing benefit (life of loan portfolio is less than 6 years) or detriment (life of loan portfolio is greater than 6 years) to the acquired institution. Example: Assume the base case fact pattern is altered such that the loan assets of T, with a book value of $1,500 are purchased by A for a purchase price of $1,000 and the FDIC agrees to reimburse A (pursuant to a LSA) for (i) 80% of the losses relating to the acquired loan portfolio to the extent those losses do not exceed $900 and (ii) 95% of the losses above such amount. Under the rule requiring the allocated tax basis of the covered loans to be no less than the highest guaranteed value or highest price at which the asset can be put, the allocation to those assets is $1,290 ([$900 x 80%] + [$600 x 95%]). Since the amount allocated to the Class I and II assets exceeds the $1,000 purchase price by $290, A is required to include $48 in taxable income in each year over a six-year period (an aggregate of $290) beginning in the year of the asset acquisition. 70 If A sells all the acquired loans before the end of the six-year period and receives reimbursement payments from the FDIC, A is able to defer a portion of its income (that corresponds with the $290 of extra tax basis) until after receiving all payments on the loans (including payments on LSG). Therefore, A benefits from this rule based on the facts of this example. However, should A not receive any payments on the loans until after the six-year period (including LSG payments), A is disadvantaged by having to accelerate the recognition of taxable income over the six-year period. 66 Treas. Reg (f), Example Treas. Reg (d)(2)(iii). 68 Id. 69 Id. 70 Id. 12

13 Thus, the Final Regulations potentially produce a mismatch in timing of income recognition due to the combination of the forced step-up in tax basis of the Class I and II assets and the accrual into taxable income, of any excess basis over the purchase price, over a six-year period beginning in the year of the asset acquisition. 71 Due Diligence of Troubled Institutions and Transferee Liability The growing number of failed bank institutions has created significant opportunity for healthier banks and non-traditional investors to look aggressively at acquiring institutions in transactions assisted by the FDIC. Failed bank transactions usually occur very quickly with limited time for due diligence and little or no elapsed time between deal announcement date and closing. Acquirers of financially troubled institutions often analyze the prospective implications of the rules described above in conjunction with their evaluation of the target. However, prudent acquirers also evaluate the potential income and indirect (e.g., property taxes, payroll taxes, use taxes, etc.) tax risks of the target institution that may be inherited by the acquirer. The Preamble to the Final Regulations indicates that good-faith purchasers of assets for value generally do not have transferee liability in an actual purchase of assets. With respect to a deemed purchase of assets where stock of the institution is acquired (for example, where all of the troubled institution s stock is acquired from its previous owners in a transaction where the FDIC provides FFA), it appears the purchase is made free of any pre-existing federal income tax liability, including joint and several liability for a consolidated group under Treasury Regulation Section , unless there are continuing owners in the institution before and after the acquisition. 72 Thus, given this position of the IRS and the Treasury Department, a diligence of federal income taxation may be less important. However, State income taxation may still be warranted based on transferee liability provisions and especially due to various states not having adopted principles similar to Section 597. If any tax due is ultimately payable by the FDIC, it will not be collected. 73 This, for example, could occur where an institution is in receivership and receives FFA. Conclusion In the current environment involving failed bank acquisitions, the acquisitions are predominantly structured as FDIC assisted transactions whereby the FDIC provides FFA and/or loss protection to buyers. Due to the recent increase in FDIC assisted transactions, the tax rules applicable in this area are getting more attention from prospective buyers, sellers (e.g., consolidated groups) and tax practitioners. The Final Regulations were drafted in light of the S&L crisis and, in the words of Ms. Emily McMahon, Treasury deputy assistant secretary for tax policy, the [Section 597] provision itself and the regulations 71 Note this mismatch may be exacerbated in transactions involving debt financing from the FDIC as such debt is not treated as outstanding for any purposes of the Code. See Treas. Reg (b). A discussion of the rules governing the treatment of debt issued to the FDIC is beyond the scope of this report. 72 See Preamble to Final Section 597 Regulations, T.D. 8641, C.B. 103 (Dec. 21, 1995) and Proposed Section 597 Regulations, Prop. Treas. Reg , 57 Fed. Reg , C.B (Apr. 23, 1992). The Final Regulations focus on whether any of the Institution s previous equity interests retain any of their value in the acquisition. This approach departs from that originally provided in the Proposed Regulations that looked to whether there are persons who owned at least a 5- percent before and after the deemed asset transaction. 73 Treas. Reg (d)(2)(iii). For this purpose, any indemnity, tax-sharing, or similar obligation of the Agency or institution is disregarded. 13

14 that go with it are quite old and nobody's really paid very much attention to them in the last 15 years or so." 74 Acknowledging it will be a difficult project, in November 2009, Ms. McMahon announced that Treasury will endeavor to issue new Section 597 guidance soon. We anticipate the guidance to be more focused on the particular types of FDIC assisted transactions that have been taking place recently and are hopeful the guidance will provide clarity regarding the taxation of FFA. 74 Amy S. Elliot, Guidance Coming on Information Reporting, Debt Obligation Rules, Treasury Official Says, TAX NOTES TODAY, Nov. 2, Id 14

15 RECEIVERSHIP, CONSERVATORSHIP AND THE RESOLUTION OF INSOLVENT BANKS Sara A. Kelsey Wilmer Cutler Pickering Hale and Dorr LLP Former General Counsel Federal Deposit Insurance Corporation American Bar Association Business Law Section Summer 2010

16 Who Determines that a Receiver should be appointed? 12 U.S.C Chartering Authority OCC for National Banks OTS for Federal Thrifts State Banking Authorities for State Chartered Banks and Thrifts FDIC, as Receiver, has Self-Appointment Authority, 12 U.S.C. 1821(c)(10) 2

17 FDIC has Self-Appointment Authority 12 U.S.C. 1821(c)(10) If the appointment is necessary to reduce loss or the risk of loss to the deposit insurance fund, AND The FDIC Board determines that there are grounds for the appointment under the same standards as apply for determinations by the Appropriate Federal Bank Regulator, 12 U.S.C. 1821(c)(5), AND The FDIC does so after consultation with the Appropriate Federal banking agency and the Appropriate p State supervisor (if any). The scope of review for any challenge to the appointment of a Receiver is arbitrary or capricious 3

18 What are the grounds for appointment? 12 U.S.C. 1821(c)(5) Assets insufficient to meet obligations Substantial dissipation of assets due to any violation of any statute or regulation, or any unsafe or unsound practice Unsafe or unsound condition Willful violation of a cease-and-desist order Concealment of books or records or refusal to submit to examination 4

19 Grounds for Appointment Inability to pay obligations or meet depositors demands Losses incurred or likely to be incurred that will deplete all or substantially all bank capital Violation of law or unsafe or unsound practice or condition likely to cause insolvency or substantial dissipation of assets or earnings; weaken the bank s condition; or otherwise seriously prejudice the interests of the depositors or the deposit insurance fund Consent to appointment 5

20 Grounds for Appointment Cessation of insured status t Money Laundering offense under 1956 or 1957 of Title 18 or 5322 or 5324 of Title 31 Undercapitalized (as defined by Prompt Corrective Action) and has no reasonable prospect of becoming Adequately Capitalized or fails to become so or to submit or implement a capital restoration plan Critically Undercapitalized (as defined by Prompt Corrective Action) 6

21 Prompt Corrective Action 12 U.S.C Purpose: to resolve the problems of insured depository institutions at the least possible long-term loss to the deposit insurance fund Appropriate Federal banking agency and the FDIC (acting in the FDIC s corporate capacity as the insurer of depository institutions) shall carry out the purpose of this section by taking prompt corrective action to resolve the problems of insured depository institutions Capital requirements are prescribed by each appropriate Federal banking agency by regulation and must include a leverage limit and a risk-based capital requirement 7

22 Prompt Corrective Action Regulatory Capital Categories Capital Measure Capital Category* Leverage Ratio Tier 1 RBC Total RBCR Well Capitalized 5% and 6% and 10% Adequately Capitalized 4% and 6% and 8% Undercapitalized d < 4% and/or < 4% and/or < 8% Significantly Undercapitalized < 3% and/or < 3% and/or < 6% Critically Undercapitalized < 2% tangible equity capital divided by total assets Leverage Ratio refers to tier 1 capital divided by total assets. Tier 1 RBCR refers to the tier 1 risk-based capital ratio: tier 1 capital divided by total risk-weighted assets. Total RBCR refers to the total risk-based capital ratio: the sum of tier 1 and tier 2 capital, divided by total risk-weighted assets. *These definitions may be superceded by higher requirements imposed by enforcement order or regulation. 8

23 Undercapitalized Banks: Appropriate Federal banking agency must closely monitor undercapitalized banks Capital restoration plan required from undercapitalized bank within 45 days Federal banking agency to act on plan within 60 days of submission i and must provide copy of any approved plan to the FDIC Undercapitalized banks are restricted as to asset growth and require prior approval for acquisitions, branching or new activities 9

24 Significantly Undercapitalized Banks and undercapitalized Banks that fail to submit or implement capital restoration plans Recapitalization required Affiliate transactions restricted Restrictions on interest rates, asset growth and activities Removal/replacement of Board and senior management Prohibition on the acceptance of deposits from correspondent banks Prior approval required for any capital distributions made by parent bank holding company Divestitures of bank subsidiaries, affiliates or the bank itself required Any other action to carry out the purposes of prompt corrective action Compensation of senior executive officers restricted 10

25 Critically Undercapitalized Banks In addition to the above restrictions applicable to Undercapitalized and Significantly Undercapitalized banks, the Appropriate Bank Regulatory Agency must restrict the activities of the bank, prohibiting it from: entering into any material transactions; ti extending credit for highly leveraged transactions; amending the bank s charter or bylaws; making any material change to its accounting methods; engaging in any covered transactions with affiliates; paying excessive compensation or bonuses; and paying interest rates higher than the prevailing rates of interest on insured deposits in the bank s normal market areas. A Receiver must be appointed within 90 days Up to two 90-day extensions may be allowed Critically Undercapitalized bank MUST be closed not later than 270 days 11

26 Resolution Preparation Valuation Marketing Soliciting and accepting bids Distribution of bid packages, exchange of information, performance of due diligence now done on the web Bids are submitted shortly before closing FDIC quickly chooses among competing bids More than one transaction structure may be offered to get more and better bids 12

27 FDIC Bank Sales - Structures How does the FDIC sell a bank? Purchase and assumption Whole bank purchase and assumption Modified purchase and assumption, including loan purchase P&A; P&A with put option; P&A with asset pools; clean P&A Bridge/conservatorship Loss-sharing arrangements Deposit Payoff/Liquidation Deposit Insurance National Bank 13

28 Open Bank Assistance: That was then The FDIC may provide assistance to an open bank to prevent an insured depository from closing. Due to changes in the law making it much more difficult for the FDIC to be able to enter into such transactions, ti such as the least cost test t and the prohibition on FDIC assistance providing a benefit to shareholders, this option fell into disuse until recently. Under an open Bank conservatorship, the FDIC would become conservator, without a receiver being appointed. The institution would be under the FDIC s control without displacing the shareholders as normally occurs in a purchase and assumption transaction 14

29 Open Bank Assistance: This is now Although h in general this option is rarely utilized, in a situation ti where a systemic risk is determined to exist, such a determination will trump the other requirements that make this option difficult to use. Recently systemic risk determinations cleared the way for open bank assistance to be extended by the FDIC to Citibank and to Bank of America, in the form of loss sharing agreements, in order to assist those institutions in managing the risks in their portfolios. It is interesting to note that Treasury s TARP program has, through its capital injection programs, provided open bank assistance that the FDIC would not have been able to provide absent a systemic risk determination. 15

30 Additional Resolution Alternatives Income maintenance agreements Capital forbearance Merger assistance Capital loss coverage Negative net worth payments Indemnifications 16

31 Systemic Risk Determination 12U.S.C. 1823(c)(4)(G) A systemic risk determination must only be made by the Secretary of the Treasury, in consultation with the President, upon the written recommendation of the Boards of Directors (with not less than a 2/3 vote) of the FDIC and the Federal Reserve. Any action or assistance under this subparagraph would avoid or mitigate such adverse effects. If such a determination ti is made, the FDIC may take other action or provide assistance under this section as necessary to avoid or mitigate such effects. Modified by Dodd-Frank legislation. 17

32 Least Cost Test The determination must find that the FDIC s compliance with the least cost test and the prohibition against the FDIC increasing losses to the FDIC fund by protecting uninsured depositors or creditors other than depositors would have serious adverse effects on economic conditions or financial stability; and any action or assistance under this subparagraph would avoid or mitigate such adverse effects. 18

33 FDIC May Act and Assess If such a determination is made, the FDIC may take other action or provide assistance under this section as necessary to avoid or mitigate such effects. The FDIC shall recover the loss to the Fund arising from any action taken or assistance provided with respect to an insured depository institution expeditiously from one or more emergency special assessments on the members of the Fund. 19

34 FDIC as Receiver or Conservator 12 U.S.C. 1821(d) Powers of the FDIC as Receiver are similar il to those of a Bankruptcy Trustee. Like a Trustee, the Receiver steps into the shoes of the insolvent party. The Receiver may liquidate the insolvent bank or transfer some or all of its assets to an acquiring bank. Congress has given the FDIC superpowers beyond those of a Bankruptcy Trustee, which allow the FDIC to expedite the liquidation process in order to maintain confidence in the banking system, and maximize the cost-effectiveness of the receivership process to preserve a strong deposit insurance fund. 20

35 Comparison of FDIC Resolution/ Receivership/Conservatorship To Bankruptcy Insolvency Regime FDIC Resolution/ Receivership/Conservatorship Bankruptcy Entities covered Objectives Banks (including insured banks not within 3 of BHC Act) and thrifts Limit impact of failure on overall economy and financial markets; least cost resolution unless Systemic Risk Determination Everything except banks, thrifts, insurance companies, Fannie, Freddie and FHLBs Through liquidation or reorganization: Maximize returns to creditors Give debtor chance for fresh start Be fair to all creditors Source of Funding Liquidated assets/proceeds of P&A transaction Liquidated or reorganized assets FDIC Deposit Insurance Fund; supported by assessments paid by banks and thrifts Backed by full faith and credit of the U.S. Govenrment Initiator Control Oversight Chartering authority: OCC, OTS, State Regulator FDIC back-up authority Ex parte seizure Bank or thrift charter dissolved Administrative Judicial review extremely limited Company s management ( voluntary ); or Creditors (upon default) ( involuntary ) In Chapter 11, company generally remains in control of business In Chapter 7 (and some Chapter 11 cases), a trustee is appointed Corporate charter survives Judicial oversight, review and appeal 21

36 Insolvency Regime FDIC Resolution/ Receivership/Conservatorship Bankruptcy Management, Creditor and Shareholder Rights Removal of management Elimination of shareholder rights and powers Creditors have no say In Chapter 11, management generally retains control over major decisions Most often, shareholders are limited and former creditors become equity holders Powers Administrative: Superpowers to provide for seamless continuation of access to deposits and continuation of banking functions, include: Contract repudiation/disaffirmation o Allow/disallow claims Reorganize/merge/divest entities Sell assets May invoke limited stay of 90/45 days Judicial: Automatic stay Contract repudiation/disaffirmation Allow/disallow claims Reorganize/merge/divest e/ e ge/d entitieses Sell assets Fraudulent and preferential transfers avoidable QFCs One business-day window to: Immediate unwind assume transfer permit unwind Speed Early intervention Immediate resolution Robust and fair judicial process may take years, decades 22

37 Receivership Powers Claims process Contract repudiation Stay of litigation Avoidance powers Special defenses Ipso facto clauses unenforceable Cross guarantee liability Directors and officers liable for gross negligence 23

38 More Receivership Powers Side agreements invalid unless Courts may not enjoin the Receiver QFCs 24

39 Creditor Claims/Depositor Preference Administrative expenses of Receiver Deposit liabilities General Creditors Foreign deposits are treated as general creditors Subordinated debt of bank Shareholders 25

40 Creditor Claims Process Notice to claimants by publication Claim must be filed within 90 days of notice Determination ti by receiver within 180 days Late-discovered claims barred, but Receiver may allow Disappointed claimant has 60 days to seek judicial review in Federal District Court 26