FDIC Can Be Held Liable for Loan-Contract Breach

(CN) - The FDIC can be held liable for violating the terms of a contract that a bank entered into before it failed and went into receivership, the 9th Circuit ruled.

In 2007, Professional Business Bank (PBB) sold a fifty percent interest in a commercial loan made to Al's Garden Art to First Heritage Bank.

But within a year, Heritage Bank closed and the Federal Deposit Insurance Corporation (FDIC) became the successor in interest to the bank's assets and liabilities. In the interim, PPB was purchased by a third party, Manhattan Bank.

The FDIC sold Heritage's interest in the Al's Garden Art loan six months later to Commerce First Financial, but without first giving PBB/ Manhattan Bank, an opportunity to repurchase the interest in the loan as stipulated in the sale agreement.

When Al's Garden Art defaulted on the loan, the banks sued each other in court over the rights to collect on the loan, and PBB filed a third party complaint against the FDIC.

The FDIC conceded that it breached the contract, but claimed it was immune from liablity under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989.

The 9th Circuit disagreed, and ruled that the agency is not immune from PBB's breach of pre-receivership contract claims.

Resting on the circuit's own precedent in Sharpe v. FDIC, Judge Diarmuid O'Scannlain noted "that the 'statute clearly contemplates that the FDIC can escape the obligations of contracts' only through the prescribed mechanism of 12 U.S.C. § 1821(e), which 'allows the FDIC to disaffirm or repudiate any contract it deems burdensome and pay only compensatory damages.' In so concluding, we stated that 'FIRREA does not authorize the breach of contracts' or 'preempt state law so as to abrogate state law contract rights.'"

This precedent convinced two of the three members of the panel to rule in favor of the bank.

U.S. Circuit Judge Johnnie Rawlinson dissented. She said that Congress enacted the FIRREA accelerate the process of liquidating a failed bank's assets and give depositors access to their funds.

"I cannot agree that the FDIC should be liable to Manhattan Bank for damages when FIRREA expressly provides that the FDIC may transfer assets without consent as part of its liquidation of a failed financial institution," Rawlinson said.

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