Alert September 14, 2010

Bankruptcy Court Blocks FDIC’s Attempt To Assert $905 Million Priority Claim

On September 1, 2010, an Alabama bankruptcy judge issued opinion refusing to allow the FDIC to demand $905 million as a priority claim (the “Demand”) in the Chapter 11 bankruptcy case of a failed bank holding company The Colonial Bancgroup, Inc. (“Colonial”).  In re The Colonial Bancgroup Inc., Case No. 09-32303 (Bankr. M.D. Ala., September 1, 2010).  As part of a broad, aggressive effort by the FDIC to minimize the costs of bank failures, the FDIC filed the Demand because Colonial had signed several agreements with the FDIC, including a memorandum of understanding, a stipulation and consent to the issuance of a cease and desist order and a separate agreement under Section 4(m)(2) of the Bank Holding Company Act (the “Agreements”), pursuant to which Colonial pledged to use “good faith efforts” to “assist” its bank subsidiary and, specifically, to try to ensure that such subsidiary had adequate capital reserves.  After the failure of the subsidiary bank, the FDIC filed the Demand in Colonial’s bankruptcy reorganization to cover the losses to the Federal Deposit Insurance Fund.

The Court held that the specific language of the Agreements between Colonial and the FDIC did not create enforceable promises by Colonial to infuse additional capital into the subsidiary bank and that none of the Agreements amounted to a formal, enforceable capital maintenance agreement.  However, the Court did not preclude the possibility that agreements with stronger language could be enforceable in bankruptcy courts.  Nonetheless, the Court noted that even if Colonial had made an enforceable commitment to maintain the capital of its subsidiary bank, such commitment would not be entitled to a priority claim under Section 365(o) the Bankruptcy Code because the failed subsidiary bank was not operating on the date Colonial filed for bankruptcy protection.