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TESTIMONY OF
SHARON POWERS SIVERTSEN
ASSISTANT GENERAL COUNSEL
FEDERAL DEPOSIT INSURANCE CORPORATION
ON
THE FEDERAL DEPOSIT INSURANCE CORPORATION'S
USE OF THE D'OENCH DUHME DOCTRINE
BEFORE THE
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
WEDNESDAY, JUNE 14, 1995
ROOM 534, DIRKSEN SENATE OFFICE BUILDING
Mr. Chairman, and members of the Committee, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance
Corporation about our policies for application of the D 7Oench
doctrine and section 1823(e) and the impact of S. 648, the
D 7Oench Duhme Reform Act, on the FDIC.
My testimony will briefly describe the D 7Oench doctrine and
the requirements of section 1823 (e) ; the steps that the FDIC has
taken and is taking to balance the public interest in effective
banking supervision, resolution, and liquidation with the public
interest in the fair treatment of individuals; the public
policies served by D 7Oench and section 1823(e) ; and the potential
impact of the proposed D 7Oench Duhme Reform Act on those public
interests.
BACKGROUND ON THE D 7OENCH DOCTRINE AND SECTION 1823(e)
What is commonly referred to as the "D 7Oench doctrine" is
essentially an estoppel doctrine applied by the courts to bar
enforcement of secret agreements against the receiver of a failed
financial institution.
In effect, the doctrine bars reliance
upon any secret agreement or arrangement that may tend to mislead
financial institution examiners.
The D 7Oench doctrine arises
from a 1942 United States Supreme Court decision, D 7Oench Duhme &
Co. v. FDIC. 315 U.S. 447 (1942), in which a borrower signed
promissory notes to a bank with a secret side agreement that the
notes would never have to be repaid.
The Court held that the
2
debtor was estopped from asserting the oral side agreement as a
defense.
It stated that the FDIC must be able to rely on the
institution's books and records to determine the institution's
true condition and that allowing the debtor to avoid liability
based on an agreement outside the books and records would tend to
deceive the regulators.
The related statute, section 1823(e), was enacted as part of
the Federal Deposit Insurance Act (FDI Act) in 1950. It specifies
four requirements that must be met for agreements to be binding
against the FDIC if a financial institution subsequently fails.
The statute requires that any agreement be in writing, be
executed by the borrower and the institution contemporaneous with
the acquisition of the asset, be approved by the board of
directors or loan committee, and continuously be an official
record of the institution.
In essence, the D'Oench doctrine and section 1823 (e) serve
to ensure that all agreements or arrangements affecting the
depository institution's financial condition must be recorded and
available for review by regulators and receivers so that they can
accurately assess the true financial condition of the
institution.
This public policy lies at the center of the
ability of the FDIC and other regulators to supervise open
institutions and to resolve failing ones.
The ability to rely
upon the records of an institution in order to evaluate its
3
assets and liabilities supports key public policy goals and
related statutory requirements such as prompt corrective action,
the "least cost" test, and the protection of the deposit
insurance funds.
Of course, these important public policies must be balanced
with the public interest in fairness to individuals.
The FDIC
has recently taken additional significant steps to ensure that
the D 7Oench doctrine and section 1823 (e) are applied fairly and
consistently with their public purposes.
The FDIC remains
willing to work with Congress to achieve an optimal balancing of
the competing public interests in any amendments to section
1823 (e) . We are committed to finding ways to satisfy our
statutory mandates with regard to supervising open financial
institutions, resolving failing institutions, and liquidating
failed institutions while also preventing a potentially adverse
impact on individuals.
EFFORTS BY THE FDIC TO ENSURE FAIRNESS
Although the D 7Oench doctrine and section 1823 (e) promote
critical public policy goals, the FDIC recognizes that the
application of these legal principles requires a balancing of
those goals with the public interest that individuals be treated
4
fairly.
This balancing of interests has been the subject of
debate since the earliest days of the D 7Oench doctrine and
section 1823(e). Attachment A summarizes the debate surrounding
the passage of section 1823(e) in 1950.
Questions about the application of D 7Oench or section
1823(e) were raised during Chairman Heifer7s confirmation process
and during testimony by Vice Chairman Hove last year.
Chairman
Heifer and the FDIC have followed through on their commitment to
reexamine the FDIC7s use of D 7Oench and section 1823(e) and have
implemented new guidelines to govern the circumstances under
which these powers will be authorized by the FDIC.
During March 1994, an inter-divisional working group was
established at the FDIC to discuss an appropriate response to
concerns about the application of the D 7Oench doctrine and
section 1823(e) and to prepare recommendations to present to the
new Chairman.
The working group was made up of representatives
of all affected groups within the FDIC, including those parts of
the FDIC responsible for supervision of open financial
institutions, resolution of failing institutions, and disposition
of the assets and payment of claims against failed institutions.
As a result of the working group's efforts, new guidelines
were implemented during November 1994.
All FDIC staff, outside
law firms, and asset servicing contractors are now subject to the
5
guidelines in all cases involving Drench and section 1823(e).
Since adoption of the guidelines, the FDIC has conducted
intensive training in their application for its staff across the
country.
This training has been conducted nationally as well as
regionally to ensure that the guidelines are understood and
followed.
The guidelines provide a structure for the FDIC to promote
the exercise of sound discretion in the application of D 7Oench
and section 1823(e) by requiring prior Washington management
approval in seven specific categories of factual circumstances.
Critical to the guidelines is a recognition that hard and fast
rules will not permit the "case by case" review necessary to
protect against unfairness while ensuring that secret agreements
remain barred.
As a result, the guidelines require FDIC
attorneys, outside attorneys, asset servicing contractors, and
other staff to obtain approval from FDIC Headquarters in
Washington before asserting D 7Oench or Section 1823(e) in any
case within the seven categories.
The seven categories include, among other things: claims by
pre-closing vendors; claims or defenses asserted where an
authorized bank officer signed the agreement, but it was not
included in the bank records; claims or defenses based on the
bank's violation of some part of a written agreement; and claims
where there is no loan transaction involved in the dispute.
In
6
these and the other categories of cases, D 7Oench or section
1823 (e) cannot be asserted without specific prior approval from
FDIC headquarters in Washington.
Thus, the guidelines are
designed to ensure the consistent and appropriate application of
D 'Oench and section 1823(e). A copy of the guidelines is
attached to this testimony as Attachment B.
One of the few clear-cut examples where application of
D 7Oench and section 1823 (e) generally is prohibited by the
guidelines involves claims by pre-receivership sellers or
providers of goods and services to the failed financial
institution.
Under the guidelines, D 7Oench and section 1823(e)
will not be asserted to bar those claims where the goods or
services were actually received by the institution regardless of
the existence of a written agreement.
For example, as long as
there is evidence that the service was performed, section 1823(e)
cannot be used to refuse payment for services provided by a local
nursery that planted flowers around an institution's premises
prior to its failure, regardless of whether the nursery had a
written contract to perform those services.
We believe that the requirement of prior review and approval
under the guidelines is promoting a consistent approach to
application of these powers.
In
addition, the flexibility
contained in the proposed guidelines permits a careful
examination of the unique facts of all proposed cases.
7
It should be noted that the protections of D' Oench have been
interpreted by the courts as extending to parties that purchase
or receive assets from the FDIC.
Once these assets are sold or
transferred to another party, they are neither owned nor
controlled by the FDIC.
Any attempt to control the use of
D'Oench by such asset purchasers or transferees would be
difficult because the FDIC generally would not be a party to such
actions and would have no advance notice that these legal
principles would be asserted.
The guidelines, therefore, do not
apply directly to purchasers or subsequent transferees of FDIC
receivership assets.
The FDIC is continuing to examine this
issue.
In summary, the guidelines preserve the FDIC's flexibility
in addressing the specific facts of individual cases, but provide
additional safeguards against any expansive application of
D r e n c h and section 1823 (e) . At the same time, the guidelines
continue to assist the FDIC in preserving the important public
policy underlying these powers -- that regulators must be able to
rely on the records of financial institutions in evaluating open
institutions and in resolving failed ones.
PUBLIC POLICIES SERVED BY D 7OENCH AND SECTION 1823 (e)
There are three public policy goals accomplished by the
D' Oench doctrine and section 1823(e) .
First, the D' Oench
doctrine ensures that regulators can rely on a financial
8
institution's records for supervisory purposes and in order to
protect the deposit insurance funds they administer.
This goal
encompasses the supervision of open institutions, the
determination of the least cost resolution of failing
institutions, and the efficient disposition of assets and payment
of creditors of failed institutions.
Second, the D'Oench
doctrine promotes careful consideration of lending practices,
assures proper recordation of various financial activities and
protects against collusive or erroneous structuring or
restructuring of terms, especially just before the institution
fails.
Third, the D'Oench doctrine protects the innocent
depositors and creditors of a failed institution, including the
FDIC, from absorbing the losses resulting from agreements that do
not appear in the records and books of the institution and helps
to facilitate the quick return of a failed institution's assets
to the community.
While the D'Oench doctrine and section 1823(e) have always
played a role in the supervision and liquidation of financial
institutions, they have become more significant since the
enactment of FDICIA in 1991.
One of the key provisions crafted
by this Committee in FDICIA was the requirement of least cost
resolutions.
If a financial institution fails, FDICIA requires the FDIC
to determine how to "satisfy the Corporation's obligations to an
9
institution's insured depositors at the least possible cost to
the deposit insurance fund" and to document that analysis.
This
means that the FDIC must be able to rely on the institution's
records at the time of the closing to identify and establish the
value of its assets and liabilities.
If the assets are worth
less or the liabilities more extensive than evidenced in the
institution's records due to the existence of undocumented
agreements, the FDIC may not be able to determine accurately the
least cost method of resolution.
In addition, the receiver of
the failed bank may have difficulty in structuring a resolution
without providing additional rights to acquiring institutions to
return assets or obtain indemnification from any costs because
neither the receiver nor the acquirer can know what unrecorded
agreements might exist that subsequently may affect the value of
the failed institution's assets.
The failure of a financial institution can be very harmful
to a community, especially a small community that does not have
other significant financial resources.
Therefore, the efficient
resolution of a failed institution and the prompt availability of
deposits and advance dividends can be vitally important in a
community that otherwise would be devastated by the closure of
its primary financial institution.
As a result of the FDIC's
ability to rely on the financial institution's records,
depositors typically have access to their money
business day after an institution fails.
on the following
The FDIC also often
10
advances funds, known as advance dividends, to uninsured
depositors or creditors based on its historical experience
regarding the recovery it can anticipate from the liquidation of
the institution's assets.
Without the ability to rely on the
failed institution's books to value the assets, it would be
considerably more difficult for the FDIC to achieve prompt
resolutions or to pay advance dividends.
Finally, without the D'Oench doctrine and section 1823(e),
the FDIC would have difficulty enforcing many valid obligations
owed to the failed financial institution because it often cannot
rebut allegations of unwritten agreements or arrangements as
effectively as the failed institution.
After an institution
fails, the FDIC often does not have ready access to its officers
and employees.
In such circumstances, the receiver frequently is
unable effectively to counter allegations that the institution
entered into unwritten agreements or challenge the terms of such
alleged agreements.
The ability of the FDIC to enforce the
obligations due to the failed institution in reliance upon the
written records of loans and other assets prevents fraudulent
claims and unnecessary legal expenses.
As the receiver for the failed financial institution, the
FDIC has a legal obligation to the other creditors to protect the
receivership estate for the benefit of the institution's
creditors.
If the FDIC as receiver pays unsubstantiated claims,
11
other claimants and creditors of the receivership estate, such as
vendors who provided services to the institution before it
failed, will receive less.
Creditors will also receive less if
the FDIC cannot enforce valid obligations owed to the failed
institution.
There is a limited pool of assets in each
receivership of a failed institution and anything that reduces
the value of the assets or increases the number of claimants will
reduce the recoveries for creditors.
COMMENTS ON THE PROPOSED D 'OENCH DUHME REFORM ACT
On March 30, 1995, Senator Cohen introduced S. 648, the
D'Oench Duhme Reform Act, which was cosponsored by you, Mr.
Chairman, and Senators Faircloth and Bennett.
Since the
introduction of S. 648, FDIC staff have met several times with
Senator Cohen's staff and the staff of this Committee to discuss
the concerns of the FDIC regarding this legislation.
As a result
of these discussions, we have been able to resolve or narrow many
of the differences between the parties.
Last Friday, Senator Cohen provided us with a copy of the
most recent version of his legislation (the Cohen substitute).
Although the Cohen substitute does not yet reflect a total
agreement between the parties, this substitute includes a number
of changes from S. 648 that represent a thoughtful balancing of
the competing interests.
Among their important provisions, S.
12
648 and the Cohen substitute generally require that any agreement
between a financial institution and a claimant be in writing and
have been executed in the ordinary course of business by an
officer or employee of the institution with the authority to
execute such an agreement.
By requiring that the alleged
agreement be in writing, the Cohen substitute addresses the
difficult problems of proof involved with disputes regarding oral
agreements and recognizes ordinary commercial practices.
The
requirement that the agreement also be executed in the ordinary
course of business by an employee of the institution with the
authority to execute such an agreement prevents the claimant from
unilaterally creating a binding agreement simply by sending a
letter to the bank "confirming" the terms of an alleged
agreement.
The legislation also includes a number of exceptions which
significantly limit the application of the general rule requiring
a written agreement.
Some of the exceptions to the requirement
of a written agreement in the Cohen substitute are reasonable.
For example, the FDIC supports the provision which permits the
enforcement of oral agreements between the failed institution and
vendors where the goods or services are actually received by the
institution before it fails.
This is consistent with current
FDIC practice under our D'Oench guidelines.
13
The FDIC, however, is concerned that some of the exceptions
are too broad and introduce new ambiguities into the clear
requirements of the current statute that will create additional
litigation and costs.
The FDIC is particularly concerned about
the following exceptions to the general rule requiring a writing
agreement: the exception that permits unwritten liabilities; the
exception for violations of federal or state law; and the
retroactive application of the Cohen substitute.
The Cohen substitute only requires a written agreement for
"specific assets."
By repealing section 1821(d)(9)(A) which
extends the current requirements of section 1823(e) to
receivership liabilities. it would create an exception to the
general rule that an agreement must be in writing if the oral
"agreement" created a liability but never resulted in an actual
asset (loan) or if the asset no longer exists.
Examples include
claims for benefits or indemnification by institution officers
and directors, undocumented future loan commitments, and claims
arising out of a lending relationship that are asserted after
repayment of a loan.
examples.
No current asset exists in any of these
They, however, would impose liabilities on the
institution and could affect the regulators' or receivers'
evaluation of the financial condition of the institution.
For example, institution officers or directors may claim
that the institution orally promised to indemnify them for any
14
litigation or claims.
These claims can be very large and such an
indemnification agreement that is not recorded in the
institution's books and records can alter the true financial
condition of the institution as much as any asset.
For example,
there is a single indemnity claim against one of the FDIC's
receiverships for half a billion dollars based on an unwritten
agreement.
If the general goal is to permit regulators and
receivers to rely on the institution's records to determine its
financial condition, there is no logical justification to
differentiate between secret agreements that affect assets and
ones that create liabilities.
Similarly, this provision would permit individuals to bring
claims based on undocumented oral agreements if they paid off
their loan because there is no longer an asset.
If the same loan
was not paid off, the individual could not bring the claim
because the asset would still exist.
In essence, this creates an
exception for those borrowers fortunate enough to be able to pay
off their notes before bringing their claim.
Fairness would seem
to require that the general rule apply to all claimants equally
regardless of their financial resources.
The Cohen substitute also includes an exception for "alleged
intentional torts or alleged violation of State or Federal law."
While the FDIC has no desire to perpetuate or benefit from
inappropriate actions by the failed institution or its employees,
15
the exception as currently drafted could overwhelm the general
rule requiring a written agreement.
The exception requires only an allegation of an "intentional
tort" or "violation of State or Federal law."
In other words,
knowledgeable claimants could still pursue oral agreements if
they carefully framed their claim.
"Intentional torts" and
"State or Federal law" are not defined and the scope of those
terms is extremely broad.
Indeed, under the current draft there
is no requirement that a "violation of State or Federal law" be
intentional and it could be wholly regulatory.
Virtually any
creative litigant can fashion an allegation of some violation of
State or Federal law.
As a result, fraud, intentional
misrepresentation, deceptive acts/practices and similar
allegations will probably become routine elements of claims based
on oral agreements to avoid the general requirement that they be
in writing.
Since such charges are inherently fact-intensive, we
can expect many such actions to go to trial and increase the
litigation expenses of the FDIC.
Further, we can expect that the
prolonged period that it will take to resolve these factual
disputes will delay the termination of receiverships.
The Cohen substitute applies retroactively to
"administrative claims brought or pending, and any litigation
filed, in progress or on appeal on or after the date of
enactment."
By applying to all administrative claims at any
16
stage in the review process and to all litigation pending on or
after the stated date, the retroactive application of the Cohen
substitute raises issues of implementation and cost to the
deposit insurance funds.
Retroactive application of the legislation to claims and
lawsuits pending on or after the date of enactment, could impose
additional losses on the deposit insurance funds and necessitate
the recalculation of distributions from open receiverships.
Since the amendment would permit claims or defenses that were
barred by prior law, it would impose new and unanticipated
expenses and losses on receiverships.
If the expenses or losses
prove to be substantial in a receivership, the distributions in
pre-depositor preference receiverships must be recalculated with
a resulting increase in losses both to other innocent creditors
and to the deposit insurance funds.
Because the FDIC cannot
realistically take back dividends already advanced to creditors,
the full amount of any claims and additional litigation costs
most likely will be borne by the deposit insurance funds.
Using the FDIC's case tracking system, we have identified
approximately 750 cases involving D 'Oench and section 1823(e)
issues that could be affected by the retroactive application of
the Cohen substitute.
Because we received the new language of
the Cohen substitute only within the last several days, we are
still attempting to determine the extent of additional exposure
17
to the deposit insurance funds and additional litigation costs.
We will forward this information to the Committee as soon as it
is available.
These figures do not include "claims" that were never filed
or that were denied based upon the application of D'Oench or
section 1823(e) which did not result in any litigation.
It is
possible that some courts might find that the Cohen substitute
would create an opportunity for claimants to file new claims
based solely on this new provision.
It is our understanding,
however, that this is not Senator Cohen's intent.
Although the general rule in the Cohen substitute provides
important safeguards to insure fairness for individuals and to
prevent secret agreements, it is important to note that it does
not require that the agreement be recorded in the institution's
books and records and be available for review by the regulator or
receiver.
The recordation requirement of the current law
reflects clearly the difficult balancing of public policy
interests inherent in D'Oench and section 1823(e).
Some would
argue that it is not fair to hold claimants responsible for
seeing that their agreements with an institution are maintained
in the institution's records when they have no control over the
records.
On the other hand, Congress and the courts to date have
determined, on balance, that it is more important to a safe and
sound financial system to require that an agreement be reflected
18
in an institution's records for the benefit of regulators and
that the risk of loss be placed on the party in the best position
to avoid the risk -- the claimant dealing with the institution.
The Cohen substitute alters this balance.
CONCLUSION
The D fQench doctrine and section 1823 (e) serve important
public policy interests in the supervision, resolution and
liquidation of banks.
Application of these legal principles
involves a balancing of the public interest in effective banking
supervision, resolution, and liquidation with the public interest
in fairness for individuals.
The FDIC has taken significant
steps to insure that the D'Qench doctrine and section 1823(e) are
applied appropriately through the implementation of guidelines
designed to ensure consistency and careful consideration of their
use.
In addition, while we have some concerns about particular
provisions of S . 648 and the Cohen substitute, we appreciate the
constructive efforts to balance the competing public interests
embodied in the D'Qench doctrine and will continue to work with
the Congress on these important issues.
Mr. Chairman, this concludes my testimony.
I would be
pleased to respond to any questions that the Committee might
have.
Attachment A
BRIEF SUMMARY OF THE DEVELOPMENT OF THE D /OENCH DOCTRINE
In an effort to protect the federal deposit insurance funds
and the innocent depositors and creditors of insured financial
institutions, the courts fashioned a judge-made rule that bars a
party who fails to fully document or record an agreement with a
bank from relying on that agreement to assert a claim against a
failed bank, or to avoid payment of a debt owed to the bank. The
courts phrased the test in terms of the failure to fully document
or record the agreement as creating an arrangement that would
tend to mislead the banking authorities because the arrangement
would be secret.
The classic case is a borrower who signs a written loan
agreement, but later claims that he or she had an unwritten
promise from the bank that repayment could be on terms different
from those reflected in the loan file or deferred completely, or
that the bank would provide some additional services or
"sweetener" not contained in the loan documents. If enforceable,
this secret agreement could render an apparently valuable asset
worthless or create hidden liabilities that would mislead
regulators and the receiver in their efforts to accurately
determine the value of a bank's assets and liabilities.
The United States Supreme Court adopted and extended these
principles in D'Oench. Duhme & Co. v. FDIC. 315 U.S. 447 (1942).
In D'Qench, the FDIC brought an action to enforce payment of a
promissory note which it had acquired from a failed institution.
As a defense to the action, the borrower claimed that it was not
liable because the notes were given pursuant to an undocumented
agreement that the notes would not be called for payment. The
borrower raised the secret agreement and failure of consideration
as defenses to the FDIC's action. The United States Supreme
Court held that the secret agreement could not be a defense to a
suit by the FDIC because, by simply entering into that agreement,
the borrower facilitated creation of a transaction that could
mislead the banking authorities. The Court refused to require^
intent to defraud by the borrower or claimant because the public
policy purpose of requiring records in the bank's files would not
be served by limiting the doctrine only to those cases.
ENACTMENT OF SECTION 1823(e)
Congress first enacted Section 1823(e) in 1950. Section
1823 (e) currently imposes four requirements for an agreement to
be enforceable against the bank receiver:
(1)
(2)
The agreement must be in writing.
The agreement must be executed by the bank and any
person claiming under it contemporaneously with the acquisition
2
(3)
(4)
of the asset by the bank, which generally means the
closing on the loan.
The agreement must be approved by the board of
directors or loan committee and reflected in the
appropriate minutes.
The agreement must be continuously an official record
of the bank.
Effectively, this section bars any claim or defense to an
agreement with the bank that is based on facts outside the
documents contained in the institution's files. Like the D' Oench
doctrine, section 1823 (e) is designed to protect the federal
banking regulatory authorities from undocumented agreements that
impede the regulatory authorities' ability to perform their
congressionally mandated functions.
Section 1823 (e) was enacted to clarify and to provide the
public with notice of the requirements for enforceable
agreements.
In particular, while D'Oench and later court
decisions had involved debtors who had lent themselves to
questionable arrangements, there was uncertainty as to the
enforceability against the FDIC of "good faith" unrecorded side
agreements.
In fact, the final version of section 1823(e) was
enacted because Congress concluded that simply limiting the
statute to cases where the borrower or claimant committed fraud
would not serve the goal of insuring reliable bank examinations
and immediate availability of depositor funds through prompt
resolutions of failed banks.
The Congressional debates leading to the enactment of
section 1823 (e) mirror many of the concerns expressed in the
current debate.
It is clear that the statute was intended to
provide the FDIC with additional assurance that it could rely on
bank records. As recently as 1987, Justice Scalia, speaking for
a unanimous Supreme Court, stated in Lanqlev v. FDIC. 484 U.S. 86
(1987):
[0]ne purpose of § 1823(e) is to allow federal and state
bank examiners to rely on a bank's assets . . . Neither the
FDIC nor state banking authorities would be able to make
reliable evaluations if bank records contained seemingly
unqualified notes that are in fact subject to undisclosed
conditions.
A second purpose of § 1823(e) is implicit in its requirement
that the "agreement" not merely be on file in the bank's
records at the time of an examination, but also have been
executed and become a bank record "contemporaneously" with
the making of the note and have been approved by officially
recorded action of the bank's board or loan committee.
These latter requirements ensure mature consideration of
unusual loan transactions by senior bank officials, and
3
prevent fraudulent insertion of new terms, with the
collusion of bank employees, when a bank appears headed for
failure.
The issue of whether the D' Oench doctrine and section
1823(e) should be limited solely to cases of fraudulent schemes
was apparently first brought to Congress's attention by
Representative Frances E. Walter, a member of the House Judiciary
Committee in 1949. One of Rep. Walter's constituents, Mr. Alker,
had lost a case against the FDIC on the ground that D'Oench
prevented use of certain oral agreements, even though he claimed
that he had not participated in any deceptive scheme or
arrangement.
Rep. Walter introduced a bill that, in addition to amending
certain provisions of the criminal code, would have subjected the
FDIC as receiver for a failed bank to any defense that could have
been raised against the open bank, unless the borrower or
claimant committed actual fraud. The bill would have been
retroactive to 1933 and, hence, to Mr. Alker's case.
Hearings on the bill were held on August 10, 1949, and on
June 12, 1950. The FDIC opposed the bill because it "would
encourage secret agreements between a bank and its debtors, which
conceivably might be short of actual fraud, to the detriment not
only of [the FDIC], but also of general creditors and uninsured
depositors." The FDIC explained that insured banks:
are examined by governmental authorities which in turn
publish reports and statistics concerning their condition.
All of such reports are intended to be and are relied upon
by the public generally. This reliance of necessity is
based upon what records of the bank disclose and the public
invests or deposits its money accordingly. Even the most
fundamental principles of honesty, aside from any technical
rules governing distribution of property of an insolvent
bank, require that these creditors be protected against any
arrangements, understandings, or agreements which are not
disclosed in the records of the banks and, therefore, would
not be reflected in these reports.
The bill was also opposed by the Departments of Justice and
Treasury, the Federal Reserve Board and the National Association
of Supervisors of State Banks.
Other witnesses and members of the Committee repeatedly
expressed similar concerns about the bill and stressed the
importance of the FDIC's ability to rely on the written records
of the bank as well as the minimal burden a writing requirement
would have on banks and their customers. One bank president
testified:
4
[T] he bank examiner is a representative of the public, and
he has a right to rely on [the note], and I do not care
whether he is an examiner for the FDIC, whether he is an
examiner for the Comptroller's Office, or whether he is an
examiner for one of the State Departments, I do not care who
he is representing, he is still representing the American
public and he has a right to know that within the four
corners of the note that is all there is, that there is no
more.
Rep. Walter's bill never left the Judiciary Committee.
On June 20, 1950, one week after the second of the hearings
on H.R. 5811, the House Banking and Currency Committee held
hearings on S. 2822, which was to become the FDI Act. Although
S. 2822 as introduced contained no provision concerning the
protection of the FDIC against unrecorded agreement, Rep. Multer,
referring to the recent Judiciary Committee hearings, raised the
issue in a question to FDIC Director Cook:
Mr. Multer: There has been considerable litigation through
the years during the existence of the Corporation in which
contentions have been made that agreements between the banks
and debtors have not been lived up to after the banks were
closed down and that the FDIC, in collecting the assets of P
the bank, was put in a more favorable position than the bank
itself would have been and that the FDIC could ignore the
agreements with the debtors. I think some legislation has
been introduced in a hearing held before another_committee
of the House on the subject. Can you tell us briefly
whether or not there is any objection to putting into this
proposed law an amendment to require the FDIC to comply with
any such agreements that have been made in good faith and
which are properly recorded between the debtors and the
banks closed up, or taken over, or merged?
Mr. Cook: I think that statement of yours covered the
ground entirely -- where you are properly supported by such
agreements and not dependent upon oral agreements that have
no binding effect.
If the bars are once l let down on that,
there would not be a safe bank in the United States today,
because anybody could claim that so-and-so had happened and
there would be no evidence to support it. . . .
Mr. Multer:
I think the policy of your bank is to honor any
such bona fide agreement.
Mr. Cook: We never back away from a bona fide agreement and
when the record is clear we inherit that obligation and
stand by it. We cannot be bound when there is no record.
5
The bill that the Banking Committee reported to the House
contained the provision that has become Section 1823 (e) . The
provision went beyond the ideas expressed in the Judiciary
Committee hearings by opponents of Rep. Walter's bill and
required more than merely a writing to support variations from
the text of written obligations. It also required that such side
agreements be executed by the bank and the debtor simultaneously
with the execution of the note, that it have been continuously an
official record of the bank, and that official minutes show that
it was approved by the bank's board of directors or loan
committee. With one minor change in language, the Committee
provision became law.
As finally enacted, section 1823 (e) strikes a careful
balance between protection of borrowers and protection of
depositors and bank creditors nationwide. On the one hand, it
precisely delineates the means by which borrowers can protect
themselves; on the other hand, it enables the FDIC to rely on the
bank's records when assessing the true condition of FDIC-insured
banks and when collecting on obligations owing to a failed bank.
Affbci\
P i
• '* ’» 6»-.
t a
Federal Deposit Insurance Corporation
Washington, DC 20429
Division of Depositor and Asset Services
To:
Regional Directors
Regional Counsel
Associate Director « COMB
From:
John F. Bovenzi
Director
Division of Depositor and Asset Services
Thomas A* Rose
Deputy General Counsel
Subject:
Guidelines for Use of D'Qench and Section 1823(e)
1.
Purpose« To set forth guidelines for the use of the D'Qench
doctrine and 12 U.S.C. § 1823(e).
2.
Scope. This directive applies to all Service Centers and
Consolidated Offices, to all future Servicers and, to the extent
feasible, to all current Servicers.
3.
Responsibility. It is the responsibility of the Regional
Directors, Associate Director - COMB, and Regional Counsel to
ensure compliance with this Directive by all personnel in their
respective service centers.
4.
Background.
a.
D'Oench Doctrine
In an effort to protect the federal deposit insurance funds
and the innocent depositors and creditors of insured financial
institutions, the Supreme Court in the case of D'Oench. Duhme &
Co. v. FDIC. 315 U.S. 447 (1942) adopted what is commonly known
as the D /Qench doctrine. This legal doctrine provides that a
party who lends himself or herself to a scheme or arrangement
that would tend to mislead the banking authorities cannot assert
defenses and/or claims based on that scheme or arrangement.
b.
Section 1823(e)
In 1950, Congress supplemented the D*Qench doctrine with 12
U.S.C. § 1823(e) which bars any agreement which "tends to
diminish or defeat the interest of the [FDIC] in any asset"
unless the agreement satisfies all four of the following
requirements:
(1 ) it is in writing? (2 ) it was executed by the
1
depository institution and any person claiming an adverse
interest under the agreement contemporaneously with the
acquisition of the asset; (3) it was approved by the board of
directors of the institution or its loan committee as reflected
in the minutes of the board or committee; and (4) it has been
continuously an official record of the institution.
In FIRREA Congress extended the coverage of section 1823(e)
to claims against the receiver or the Corporation.
12 U.S.C. § 1821(d)(9)(A).
c.
Policy Considerations
The D /Oench doctrine and section 1823(e) embody a public
policy designed to protect diligent creditors and innocent
depositors from bearing the losses that would result if claims
and defenses based on undocumented agreements could be enforced
against a failed bank. The requirement that any arrangement or
agreement with a failed bank must be in writing allows banking
regulators to conduct effective evaluations of open banks and the
FDIC to accurately and quickly complete resolution transactions
for failed banks. This requirement also places the burden of any
losses from an undocumented or "secret" arrangement or agreement
on the parties to the transaction, who are in the best position
to prevent any loss.
Although the D /Oench doctrine and section 1823(e) generally
promote essential public policy goals, overly aggressive
application of the specific requirements of these legal doctrines
could lead to inequitable and inconsistent results in particular
cases. In order to ameliorate this possibility, the FDIC has
undertaken development of these guidelines and procedures to
promote the exercise of sound discretion in the application of
D/Oench and section 1823(e).
5.
Guidelines«
These guidelines are intended to aid in the review of
matters where the assertion of D*Oench and/or section 1823(e) is
being considered. The examples given are intended to give clear
direction as to when D #Oench and section 1823(e) issues must be
referred to Washington pursuant to the procedures discussed below
in Section 6* Zn particular, if the use of D'Oench or 1823(e) is
proposed in a DAS - Operations matter within the categories set
forth below, the matter and recommendation must be referred to
the Associate Director - operations for approval through the
procedures contained in Section ۥ
In the great majority of cases, however, it is anticipated
that no resort to Washington should be necessary, 4 It is only in
the categories of cases highlighted in the guidelines that
2
Washington approval must be obtained.
a.
Pre-closing Vendors
D /Oench and section 1823(e) shall not be used as a defense
against claims by vendors who have supplied goods and/or services
to the failed institution pre-closing when there is clear
evidence that the goods/services were received. In such cases,
D /Oench and section 1823(e) shall not be asserted whether or not
there are written records in the bank's files confirming a
contract for the goods and/or services.
This does not mean that D'Oench and section 1823(e) may
never be asserted against a vendor, but only that each claim must
be examined carefully on its facts. When there is no evidence
that goods or services were received by the failed bank or in
other appropriate circumstances, the defenses may be asserted
after approval by Washington.
Examples Requiring Washington Approval:
1.
Landscaping service filed claim for planting trees
around the institution's parking lot. There is no
contract for planting trees in the books and records of
the institution, but there are trees around the parking
lot and no record of any payment. In this example,
Washington approval must be obtained before asserting
D'Oench or section 1823(e).
2.
A contingency fee attorney is unable to produce any
contingency fee agreement, but there is evidence in the
files that this attorney has been paid for his
collection work for the past 20 years and his name
appears on the court records for collection matters for
which he has not been paid. In this example also,
Washington approval must be obtained before asserting
D'oench or section 1823(e)•
3.
Contractor had construction contract with bank to
renovate an ORE property. At the time the bank failed,
the contractor had completed 90% of the contract and
was owed about 50% of the contract price. The
Construction company filed a claim which was denied on
the ground that the contract was not enforceable
against the FDIC because it had not been approved by
the bank's board of directors or loan committee. Here
too, Washington approval must be obtained before
asserting D'Oench or section 1823(e).
3
b.
Diligent Party
D /Oench and section 1823(e) may not be asserted without
Washington approval where the borrower or claimant took all
reasonable steps to document and record the agreement or
understanding with the bank and there is no evidence that the
borrower or claimant participated in some activity that could
likely result in deception of banking regulators, examiners, or
the FDIC regarding the assets or liabilities of the bank. In
particular, Washington approval is required before D /Oench or
section 1823(e) may be asserted where the agreement is not
contained in the bank's records, but where the borrower or
claimant can establish by clear and convincing evidence that the
agreement was properly executed by the depository institution
through an officer authorized by the board of directors to
execute such agreements, as reflected in the minutes of the
board. Cases involving "insiders" of the depository institution
require particularly careful review because of the greater
opportunities of such parties to manipulate the inclusion of
"agreements" within the bank's records.
Further, where it is clear that a borrower or claimant has
been diligent in insisting on a written document in an apparently
arms-length transaction, and had no control over the section
1823(e) requirement that the transaction be reflected in the
Board of Directors' or Loan Committee minutes, assertion of a
section 1823(e) defense solely because the transaction is not
reflected in those minutes may not be appropriate. In such
cases, Washington approval must be obtained before asserting
D'Oench or section 1823(e)•
Examples Requiring Washington Approval:
1.
Plaintiff sold a large parcel of land to the borrower
of the failed bank and the property description in the
failed bank's Deed of Trust mistakenly included both
the parcel intended to be sold and a parcel of property
not included in the sale. Prior to the appointment of
the receiver, the bank agreed orally to amend the Deed
of Trust, and indeed sent a letter to the title company
asking for the amendment. However, there was nothing
in the books and records of the institution to indicate
the mistake. The bank failed and the Deed of Trust had
never been amended. The borrower defaulted and the
FDIC attempted to foreclose on both parcels. In this
example, Washington approval must be obtained before
asserting D /Qench or section 1823(e)•
2.
A limited partnership applied for refinancing. A
commitment letter was issued by the bank to fund a non
recourse permanent loan which required additional
security of $ 1 million from a non-partner. The Board
4
of Directors minutes reflect that approval was for a
nonrecourse loan, however, the final loan documents,
including the note, did not contain the nonrecourse
provisions. The bank failed, the partnership defaulted
and it was determined that the collateral plus the
additional collateral was approximately $ 3 million
less than the balance of the loan. In a suit by the
FDIC for the deficiency, Washington approval must be
obtained before asserting D'Oench or section 1823(e).
3.
A borrower completes payment on a loan, and he has
cancelled checks evidencing that his loan has been paid
off. The bank's records, however, do not document that
the final payment has been tendered. The bank fails
and the FDIC seeks to enforce the note. Washington
approval must be obtained before asserting D /Oench or
section 1823(e)•
However, if it is clear that the borrower or claimant
participated in some fraudulent or other activity which could
have resulted in deception of banking regulators or examiners,
then D'Oench and/or section 1823(e) may be asserted without prior
approval from Washington.
Examples Not Requiring Washington Approval:
1.
Borrower signed a note with several blanks including
the amount of the loan. Bank officer filled in the
amount of the loan as $ 40,000. Bank failed, loan was
in default, the FDIC sued to collect $ 40,000 and the
borrower claimed that he only borrowed $ 20,000. There
was nothing in the bank's books and records to indicate
the $ 20,000 amount, and, in fact, the bank's books and
records evidenced disbursement of $40,000. D'Oench and
section 1823(e) may be asserted.
2.
Guarantor, an officer of the borrower corporation,
signed a guaranty for the entire amount of a loan to
the corporation. At the time of the bank's failure,
the loan was in default and the corporation was in
Chapter 7 bankruptcy. FDIC filed suit against the
guarantor for the entire amount of the loan. The
guarantor claimed that he had an agreement with the
bank that he was only liable for the first $ 25,000.
There was no record in the bank's files of such an
agreement. Again, D'Oench and section 1823(e) may be
asserted.
Where the specific facts of a case raise any question as to
whether D'Oench or section 1823(e) should be asserted, Washington
approval must be obtained before asserting D'Oench or section
1823(e).
5
o
Integral pagu«wfc
If there are documents in the books and records of the
institution which indicate an agreement under the terms asserted
by the claimant or borrower, the use of D /Oench and section
1823(e) must be carefully evaluated. Particular care must be
taken before challenging a claim or defense solely because it
fails to comply with the 1823(e) requirement that the agreement
be reflected in the minutes of the Board of Directors or Loan
Committee. While any number of cases have held that the terms of
the agreement must be ascertainable on the face of the document,
in some circumstances it may be appropriate to consider all of
the failed bank's books and records in determining the agreement,
not just an individual document. Where the records of the Bank
provide satisfactory evidence of an agreement, Washington
approval must be obtained before asserting D /Oench or section
1823(e).
Examples Requiring Washington Approval:
1.
Note in failed bank's file was for one year term on its
face. However, the loan application, which was in the
loan file, was for five years renewable at one year
intervals. The borrower also produced a letter from a
bank officer confirming that the loan would be renewed
on a sixty month basis with a series of one year notes.
In this example, Washington approval must be obtained
before asserting D'Oench or section 1823(e).
2.
Debtor executed two notes with the proviso that there
would be no personal liability to the debtor beyond the
collateral pledged. When the notes became due they
were rolled over and consolidated into one note which
recited that it was a renewal and extension of the
original notes but did not contain the express
disclaimer of personal liability. All three notes were
contained together in one loan file. Here, all of the
notes should be considered as part of the bank's
records. In this example also, Washington approval
must be obtained before asserting D'Oench or section
1823(e)•
d.
No Asset/Transactions Hot Recorded in Ordinary Course
of Business
The use of D'Oench and section 1823(e) should be limited in
most circumstances to loan transactions and other similar
financial transactions, to matters involving specific current or
former assets, or to transactions designed to acquire or create
an asset. The application of D'Oench should be carefully
6
considered before it is asserted in opposition to a tort claim,
such as negligence, misrepresentation or tortious interference
with business relationships, where the claim is unrelated to a
loan or similar transaction or to a transaction creating or
designed to create an asset. Washington approval must be
obtained before asserting D'Oench or section 1823(e) in such
cases•
Examples Requiring Washington Approval:
1.
Three years before failure the bank sold one of its
subsidiaries. The bank warranted that the subsidiary
had been in "continuous and uninterrupted status of
good standing" through the date of sale. The buyer in
turn attempted to sell the subsidiary and discovered
that the subsidiary's charter had been briefly
forfeited. The prospective buyer refused to go through
with the sale and the original buyer sued the
institution for breach of warranty. FDIC is appointed
receiver. This transaction does not involve a lending
or other banking financial relationship between the
bank and the buyer. In addition, the subsidiary was
not an asset or on the books of the institution at the
time of the receivership. Zn this example, Washington*
approval must be obtained before asserting D'Oench or
section 1823(e)•
2.
In the case described above in the diligent party
section, where the property description in the failed
bank's Deed of Trust mistakenly included a parcel not
included in the sale, the parcel at issue was not an
actual asset of the failed bank and the assertion of
D'Oench would not be appropriate. Here too, Washington
approval must be obtained before asserting D'Oench or
section 1823(e)•
However, if a claim arises out of an asset which was
involved in a normal banking transaction, such as a loan, D'Oench
and section 1823(e) would be properly asserted against such a
claim despite the fact that the asset no longer exists. For
example, collection on the asset does not preclude the use of
D'Oench and section 1823(e) in response to claims by the former
debtor related to the transaction creating the asset.
Example Not Requiring Washington Approval:
1.
A borrower obtained a loan from a bank, secured by
inventory and with an agreement that allowed the bank
to audit the business. The business failed, the bank
sold the remaining inventory, and applied the proceeds
of the sale to the business's debt.
Borrower sued the
bank for breach of oral agreements, breach of fiduciary
7
duty, and negligence in performance of audits of the
business. Borrower then paid off remaining amount of
loan and continued the lawsuit. The bank subsequently
failed. Despite borrower's argument that there was no
asset involved since the debt had been paid, assertion
of D /Oench would be appropriate.
To permit the borrower to proceed with the litigation
after the loan is repaid, where that litigation would
have been barred by D /Oench prior to the payoff, would
be contrary to the public policy permitting regulators
to ignore unknown and unrecorded agreements.
e.
Bilateral Obligations
The facts must be examined closely in matters where the
agreement which the FDIC is attempting to enforce contains
obligations on both the borrower or claimant and the failed bank
and the borrower or claimant is asserting that the bank breached
the agreement. If the failed bank's obligation is clear on the
face of the agreement and there are documents supporting the
claimed breach which are outside the books and records of the
institution, Washington approval must be obtained before
asserting D'Oench or section 1823(e)•
f•
Statutory Defenses
The appropriateness of using D'Oench and section 1823(e) to
counter statutory defenses should be evaluated on a case by case
basis. Although many such defenses may be based on an agreement
that is not fully reflected in the books and records of the
institution, a careful analysis should be made before asserting
D'Oench or section 1823(e). In such cases, Washington approval
must be obtained before asserting D'Oench or section 1823(e).
The clearest examples of situations where assertion of
D'Oench or section 1823(e) may be appropriate occur where the
opposing party is relying on a statutory defense based upon some
misrepresentation or omission by the failed bank. Examples of
this type of statute are unfair trade practice statutes.
On the other hand, application of D'Oench or section 1823(e)
may not be appropriate to oppose claims based on mechanics lien
statutes or statutes granting other recorded property rights.
The fact that all elements of those liens may not be reflected in
the books and records of the institution should not control the
application of D'Oench or section 1823(e).
In analyzing the propriety of asserting the D'Oench doctrine
or section 1823(e), at least the following two general factors
8
should be considered in preparation for seeking approval from
Washington:
*
To what extent is the purpose of the statute
regulatory, rather than remedial? If the statute
simply imposes regulatory or mandatory requirements for
a transaction, such as a filing requirement or maximum
fee for services, assertion of D'Oench and/or section
1823(e) is unlikely to be successful.
*
To what extent is the application of the statute
premised upon facts that are not reflected in the books
and records of the bank? If the state statute requires
the existence and/or maintenance of certain facts, but
those facts are not recorded in the bank's records,
then D'Oench and/or section 1823(e) may be applicable.
*
To what extent do the facts involve circumstances where
the opposing party failed to take reasonable steps to
document some necessary requirement or participated in
some scheme or arrangement that would tend to mislead
the banking authorities.
Examples Requiring Washington Approval:
1.
A priority dispute arose involving a mechanic's lien
against property on which the FDIC was attempting to
foreclose. An attempt to persuade a court that the
mechanic's lien was a form of secret agreement under
D'Oench. which, if given priority over the interests of
the FDIC, would tend to diminish or defeat the value of
the asset may not be appropriate. In this example,
Washington approval must bs obtained before asserting
D /Oench or section 1823(e).
2.
State law required insurance companies doing business
in the state to deposit funds with the Commissioner of
Insurance. Further, the law provided that the deposit
could not be levied upon by creditors or claimants of
the insurance company. An insurance company purchased
a certificate of deposit from a bank and assigned it to
the Commissioner. At the same time a document was
executed entitled "Requisition to the Bank" which
stated that the bank would not release the CD funds
without authorization of the Commissioner.
Subsequently the insurance company borrowed money from
the bank. When the loan went into default, the bank
did not roll the CD over, but rather credited the
proceeds to the loan account.
The bank then failed
and the Commissioner filed a proof of claim with the
FDIC seeking payment on the CD. The FDIC may not
defend the suit by claiming that the assignment
9
documents did not meet the requirements of section
1823(e). In this example, Washington approval must be
obtained before asserting D'Oench or section 1823(e).
The FDIC is attempting to collect on a note which the
failed bank acquired from a mortgage broker. The note
is at a 15% interest rate and the mortgage broker
charged six and one half points. State law provides
that interest shall be no more than 13% and that no
more than one point may be charged. The FDIC may not
defend the borrower's counterclaim of a usurious loan
by asserting D'Oench or 1823(e). Hers too, Washington
approval must be obtained before asserting D'Oench or
section 1823(e).
Section 1823(e) Conte»pQy»«eous Requirement
This requirement of section 1823(e) may not be asserted to
invalidate a good faith workout or loan modification agreement
where the sole issue is whether the contemporaneous requirement
of section 1823(e) is met. Where there is an agreement which
otherwise satisfies the remaining requirements of the statute,
but was not executed contemporaneously with the acquisition of
the asset, in most circumstances section 1823(e) should not be
asserted. This applies only to workouts or loan modifications
done by the failed bank prior to receivership. The assertion of
the section 1823(e) contemporaneous requirement should be
considered principally where the facts demonstrate that the
workout or restructure was entered into in bad faith and in
anticipation of bank failure.
Washington approval must bo obtained before asserting D'Oench or
section 1823(e) in these cases.
6.
Procedures To Obtain Washington Approval.
DAS Operations: When facts involving the possible assertion
of D'Oench and section 1823(e) arise, Legal should be
consulted. When the assertion of D'Oench or section 1823(e)
requires Washington approval, as outlined above, prior
approval must be received from the Associate Director *
Operations in Washington in all such cases. Such approval
must be obtained by preparation of a memorandum identifying
the facts of the case forwarded through Legal Division
procedures to the Associate Director - Operations.
DAS Asset Disposition: When facts involving the possible
assertion of D'Oench and section 1823(e) arise, Legal should
be consulted. When the assertion of D 'Oench or section
10
1823(e) requires Washington approval, as outlined above,
Legal Division procedures should be followed for referral to
Washington. Washington Legal will consult with Washington
DAS where appropriate.
DAS COMB: When facts involving the possible assertion of
D 'Oench and section 1823(e) arise, Legal should be
consulted. When the assertion of D'Oench or section 1823(e)
requires Washington approval, as outlined above, Legal
Division procedures should be followed for referral to
Washington. Washington Legal will consult with the Managing
Director - COMB.
Legal: Each attorney must carefully review the facts of
each instance where the assertion of D 'Oench or section
1823(e) is being considered under revised Litigation
Procedure 3 ("LP 3W). All cases requiring consultation or
approval within these Guidelines and/or LP3 must be referred
to Washington pursuant to LP3 procedures.
These Guidelines are intended only to improve the FDIC's
review and management of utilization of D'Oench and section
1823(e). The Guidelines do not create any right or benefit,
substantive or procedural, that is enforceable at law, in
equity, or otherwise by any party against the FDIC, its
officers, employees, or agents, or any other person. The
Guidelines shall not be construed to create any right to
judicial review, settlement, or any other right involving
compliance with its terms.
11
@FedFRASER