Articles The Effect of an FDIC Bank Takeover on Outstanding Standby Letters of Credit By Frederic M. Umane & James Medwick | March 21, 2023 Landlords frequently rely on standby letters of credit issued by banks as security deposits for the lease payments of their commercial tenants. Lenders to landlords also frequently benefit indirectly from the existence of such standby letters of credit. But what happens to such instruments when the issuing bank is placed into FDIC receivership, as has recently happened to both Silicon Valley Bank and Signature Bank? The following is an exploration of this issue and sets out some practical steps that landlords and their lenders should consider taking if the bank that issued a standby security deposit letter of credit is in receivership. On March 10, Silicon Valley Bank (“SVB”) entered receivership with the Federal Deposit Insurance Corporation (“FDIC”) and was followed shortly by Signature Bank on March 12. While a joint release of the Board of Governors of the Federal Reserve System, the FDIC, and the Department of the Treasury announced that all depositors of both banks will be made whole, receivership will have consequences for creditors of the two banks. The FDIC is authorized to repudiate certain contracts of banks in receivership, including if, among other requirements, the FDIC determines that the contract would hinder the orderly administration of the receivership. This open-ended authorization leaves much discretion to the FDIC, which must make a determination within a “reasonable time” from its appointment as receiver. Unless the FDIC finds a buyer for the letter of credit obligations of SVB and Signature, the FDIC is likely to repudiate the letter of credit obligations of these banks. If the FDIC repudiates a contract, the counterparty to some (but not all) types of contracts is entitled to receive compensatory damages. Even if compensatory damages are available, they are limited to actual compensatory damages, and only as of the date of the appointment of the FDIC as receiver. Lost profits and punitive damages are expressly excluded. In the case of standby letters of credit, the FDIC has long taken the approach that they are contingent obligations and thus not provable claims in bank receivership (no damages available). This position was publicly adopted in a statement of policy dated May 18, 1995, and the FDIC has stuck to this position since then. That being said, it should be noted both that the FDIC first adopted this policy even though it contradicted the uniform decisions of U.S. Courts of Appeals predating it and that the FDIC has clung to its position in the face of recent court decisions to the contrary. The courts that have rejected the FDIC’s position that all contingent obligations are not provable claims have generally chosen instead to distinguish contingent claims that are “provable” from those that are “unprovable”. A “contingent provable” claim is one whose “worth or amount can be determined by recognized methods of computation at a time consistent with the expeditious settlement of estates,” while a “contingent unprovable” claim is one who is “so uncertain that [its] worth cannot be ascertained.” (First Empire Bank-New York v. FDIC, 572 F.2d 1361, 1369 (9th Cir. 1978) (quoting from Pennsylvania Steel Co. v. New York City R. Co. 198 F. 721, 739-40 [2nd Cir. 1912])). Nevertheless, the FDIC continues to cleave to its position that all standby letters of credit are unprovable claims. The result is a considerable degree of uncertainty resulting from the conflicting authorities, and a beneficiary may find pursuing a claim in the courts to be an expensive and time-consuming proposition. Practical steps: In the event one is a beneficiary of a letter of credit issued by a bank in receivership or a lender to such a beneficiary, it may be desirable to require the tenant to provide a replacement letter of credit from another bank or financial institution and to do so now instead of waiting for the FDIC to make a determination whether to repudiate one’s letter of credit. Agreements should be reviewed to determine whether the issuing bank’s entry into receivership triggers an obligation for the tenant and/or the beneficiary to obtain a replacement letter of credit or constitutes an event of default. Other practical steps, remedies, and protective measures may be available. Please don’t hesitate to reach out if you have any questions or concerns. Frederic M. Umane is a partner at ZEK and heads the firm’s transactional banking, corporate and real estate group. In this multi-disciplinary capacity, Fred is involved in new lending and acquisition transactions as well as remedial workouts. James Medwick is a senior associate at Zeichner Ellman & Krause LLP. James’ practice focuses on mergers and acquisitions, private funds, securities matters, business formations, as well as corporate, partnership and LLC laws more generally. In addition, having founded his own wine business which operates in a heavily regulated industry, James brings both legal and regulatory savvy and an entrepreneurial viewpoint to advise clients on matters relating to e-commerce, online and social media marketing, and IP protection. For questions regarding this article, please contact James at email@example.com.