Banking and Finance Law Daily As receiver, FDIC validly repudiated letters of credit
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Tuesday, August 3, 2021

As receiver, FDIC validly repudiated letters of credit

By Ursula Furi-Perry, J.D.

In a case of first impression, the FDIC did not violate FIRREA because the letters of credit were repudiable contracts for purposes of the law.

In a case brought by a surety bond company against the Federal Deposit insurance Corporation, the U.S. Court of Appeals for the Fifth Circuit has decided an issue of first impression, holding that letters of credit were repudiable contracts for purposes of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). The surety bond company sued the FDIC in its receiver capacity (FDIC-R) after the failure of a Louisiana bank, alleging that the agency did not repudiate its letters of credit within a reasonable time. The Fifth Circuit disagreed, holding that the FDIC-R did not act in bad faith. (Lexon Insurance Company, Inc. v. FDIC, Aug. 2, 2021, Elrod, J.W.).

Background. FIRREA was passed in 1989, in the wake of a national banking crisis, and was "intended to promote stability, economic recovery, and increased public confidence." Under FIRREA, the FDIC has the power to serve as a receiver for failed financial institutions, including its power to repudiate contracts.

In 2016, the surety bond company executed performance bonds totaling approximately $11 million to the Bureau of Ocean Energy Management on behalf and as certified surety of an oil company. To acquire the collateral, the oil company applied to a then-functioning Louisiana bank, which issued two letters of credit amounting to $9,985,500, with the surety bond as the beneficiary. In 2017, Louisiana regulators closed the bank and appointed the FDIC-R as receiver. Over the next few months, the FDIC-R indicated to the surety bond company on at least two occasions that the letters of credit might be repudiated. It subsequently sold the oil company’s loan portfolio to a third party, repudiated the letters of credit, and mailed the surety bond company notices of repudiation.

The bond company sued the FDIC in the federal district court in the Eastern District of Louisiana. The court granted summary judgment in favor of the FDIC, and the surety bond company appealed.

Fifth Circuit’s analysis. Summary judgment issue. The appellate court first held that the district court could convert the FDIC-R’s motion to dismiss into a motion for summary judgment, sua sponte. While the court erred in not giving the parties sufficient notice, that error was harmless, and there was no genuine issue of material fact.Claims under FIRREA. The surety bond company argued that the letter of credit was not a "contract or lease" that can be repudiated under FIRREA. Moreover, it argued that the FDIC-R did not repudiate within a reasonable time and that the surety bond company was entitled to actual, direct compensatory damages.

The Fifth Circuit disagreed with the surety bond company. Deciding an issue of first impression, the court held that a letter of credit was a repudiable contract under the law. Letters of credit, the court explained, create an obligation between the issuer and the beneficiary—in this case, the surety bond company and the failed bank.

The FDIC-R repudiated the letters of credit 153 days after its appointment as receiver for the bank, which the court held was a reasonable time period for repudiation. During that time, the FDIC-R was engaged in extensive negotiations with the oil company about its problematic loan portfolio, making for a costly and labored process. The FDIC-R did not act in bad faith, the court held; in fact, the surety bond company was on notice throughout the entire delay that the letters of credit might be repudiated. Lastly on this issue, the court rejected the surety bond company’s argument that its damages consisted of its collateral, holding that it did not provide evidence of actual, direct compensatory damages. Federal Tort Claims Act claim. The surety bond company also brought a claim alleging that the FDIC, in its corporate capacity, negligently controlled the bank by allowing the letters of credit to renew in early 2017. The appellate court found two issues with the claim: first, the surety bond company alleged only financial harm, not physical harm as required by the statute; second, the FDIC-C did not have a duty to the surety bond company as a third party, much less a duty to prevent the letters of credit from renewing.

Final disposition. The appellate court affirmed the lower court’s grant of summary judgment.

The case is No. 20-30173.

Attorneys: Jason Marechal Cerise (Locke Lord, L.L.P.) for Lexon Insurance Company, Inc. Joseph Brooks for the Federal Deposit Insurance Corporation. Peter M. Mansfield, U.S. Attorney's Office, for the United States.

Companies: Lexon Insurance Company, Inc.

MainStory: TopStory BankingOperations Loans LouisianaNews MississippiNews Receiverships SecuredTransactions StateBankingLaws TexasNews

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