Banking and Finance Law Daily Debt release failed to meet requirements to assert defense against FDIC
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Wednesday, June 19, 2019

Debt release failed to meet requirements to assert defense against FDIC

By Nicole D. Prysby, J.D.

A debtor failed to show that an alleged release of his personal guarantees on business loans met the requirements of 42 U.S.C. §1823(e), where the evidence consisted of (at best) a collection of documents that could reflect a release agreement.

A debtor’s argument that a bank released him from his personal guarantees on loans before the bank failed was barred by the D’Oench doctrine and 42 U.S.C. §1823(e), held the Tenth Circuit Court of Appeals. The debtor had made personal guarantees on loans to businesses he owned with his wife, and when the couple divorced, the wife was assigned the debts of the business. The bank failed, and the debtor’s promissory notes were sold by the Federal Deposit Insurance Corporation. The new holder of the guarantees attempted to collect on them and the debtor argued that the release defense applies. The Tenth Circuit rejected that argument, because the alleged release did not meet the requirements of Section 1823(e): that the agreement be in writing, be executed by both parties, and have been an official record of the bank continuously since its execution. The court also held that the no asset exception to Section 1823(e) does not apply. That exception is construed narrowly and is limited to defenses asserting an asset is void, or that an asset is invalid due to a breach of bilateral obligations contained in the asset itself (neither of which was asserted by the debtor). The Tenth Circuit also criticized the lower court’s reliance on oral testimony in applying an exception to Section 1823(e) (Cadlerock III, LLC v. Wheeler, June 18, 2019, Briscoe, M.).

Background. The defendant (Dustin Wheeler) and his former wife (Shana Wheeler) owned a mobile home rental and sales business (Wheeler Rental). Wheeler Rental borrowed millions of dollars from the bank of Union and on behalf of Wheeler Rental, Dustin and Shana executed multiple promissory notes in connection with these loans. Dustin also signed two personal guarantees of Wheeler Rental’s indebtedness to the bank (guarantees). Dustin and Shana divorced and their divorce decree allocated Wheeler Rental and its associated debts to Shana. After their divorce, all promissory notes on behalf of Wheeler Rental were executed only by Shana. Shana also signed new guarantees of the Wheeler Rental loans; Dustin did not. When the bank failed in 2014, the FDIC was appointed as receiver. At that time, Dustin’s guarantees of the Wheeler Rental debt remained in the bank’s records (although it also had records of later documents, such as memos summarizing Wheeler Rental’s debt that listed Shana as the sole guarantor). The FDIC sold the Wheeler Rental promissory notes to Cadlerock’s affiliate, who assigned those assets to Cadlerock, which attempted to enforce Wheeler’s guarantees of the Wheeler Rental debt.

Wheeler argued that the bank had released him from his guarantees of the Wheeler Rental debt before the bank failed, and the district court held in favor of Wheeler on that defense. In doing so, the court held that the so-called "no asset" exception to 12 U.S.C. §1823(e) applied. Alternatively, the court held that the release agreement asserted by Wheeler in defense of Cadlerock’s claim satisfied the requirements of D’Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942) (in which the United States Supreme Court held that debtors obligated to a failed bank could not assert a side agreement with the bank as a defense against the FDIC’s efforts to collect on the debtors’ notes). D’Oench’s holding was codified in Section 1823(e), and protection of the doctrine extends to third-party transferees from the FDIC.

D’Oench and Section 1823(e) bar the release defense. The Tenth Circuit held that the D’Oench doctrine and Section 1823(e) apply to Wheeler’s release defense and bar him from asserting it against Cadlerock, as the FDIC’s transferee. His defense against Cadlerock’s claim is based on an agreement by the bank to release his guarantees; such an agreement must satisfy the requirements of Section 1823(e). Section 1823(e) requires that the agreement be in writing, be executed by both the bank and Wheeler, and have been an official record of the bank continuously since its execution. But when the FDIC acquired the bank’s assets, the bank’s records did not contain an explicit written release of Wheeler’s guarantees. The district court pointed to certain documents that the FDIC received when the bank failed (such as the Wheelers’ divorce decree incorporating their settlement agreement). The district court acknowledged there was no single document in the bank’s records reflecting the bank’s agreement to release Wheeler from his guarantees of the Wheeler Rental debt but held that a collection of documents could reflect such an agreement. The Tenth Circuit held that, while it is questionable whether a collection of documents could meet the standard, the specific collection of documents in this case fails to establish the existence of a release agreement. At best, the district court pointed to suggestive evidence in the bank’s records that would have required the FDIC to infer the existence of an agreement. Consequently, because Wheeler’s asserted release agreement fails to satisfy Section 1823(e), the statute bars him from raising that agreement in defense of Cadlerock’s claim to enforce his guarantees (unless an exception to Section 1823(e) applies).

The court then held that the no asset exception to Section 1823(e) does not apply. Cadlerock argued for a narrow construction of the no asset exception—limiting it to defenses (1) asserting an asset is void, or (2) asserting an asset is invalid due to a breach of bilateral obligations contained in the asset itself. The court agreed with that interpretation, which it found also in keeping with the text and the purposes of Section 1823(e). In the first category of the exception, Section 1823(e) does not apply because the FDIC never took title to an "asset." And the second category preserves the FDIC’s ability to rely on the bank’s records in evaluating the worth of its assets because the "asset," and the "agreement" that "tends to diminish" it, are one and the same. The no asset exception does not apply to Wheeler’s release defense because he does not assert that his guarantees are void, nor does he claim that they are invalid due to a breach of bilateral obligations in the guarantees themselves.

The court also emphasized that the extent to which the district court relied on oral testimony in applying an exception to Section 1823(e) in this case is entirely at odds with the purposes of the statute. Any inference of a release agreement that might have been drawn from the bank’s records required the extensive background, explanation, and context supplied by the testimony at trial. Reliance on such evidence plainly runs counter to the purpose of Section 1823(e) to enable the FDIC to quickly and accurately assess the value of a failed bank’s assets.

The case number is No. 18-6171.

Attorneys: Gary A. Bryant (Crowe & Dunlevy) for Cadlerock III, LLC. Laura McConnell-Corbyn (Hartzog Conger Cason) for Dustin Wheeler.

Companies: Cadlerock III, LLC

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