SVB Parent’s Fight for Seized Deposits Will Test FDIC Authority

The Federal Deposit Insurance Corp. is poised to put up an aggressive fight in a showdown over $2 billion that Silicon Valley Bank’s former parent company and its bondholders say belongs to them.

The $2 billion bank deposit represents a significant amount of potential cash recovery to the bankrupt SVB Financial Group and its bondholders, who are owed $3.3 billion, and other creditors. But the FDIC has laid claim to the money. It aims to offset potential claims related to Silicon Valley Bank, which cost the FDIC’s deposit insurance fund an estimated $20 billion.

The emerging battle over the $2 billion may test the FDIC’s power to put bankrupt banking parent companies on the hook for the costs of their failed banks.

The FDIC will likely be emboldened in the battle through a number of factors, including its powers from Congress, the potential use of its own internal claims process, and a section of bankruptcy law that favors federal banking agencies.

In the coming months, a New York bankruptcy judge will likely have to address whether the FDIC has a valid claim against the bankrupt company, whether the FDIC should be first in line to be paid back, and whether the agency can use the money to offset its own potential claims. The FDIC hasn’t filed a claim against SVB Financial yet, according to court records.

“The ensuing litigation may conclusively resolve issues that have been extant since the Great Recession concerning the limit of the FDIC’s authority over Banking Holding Companies and the responsibility that Banking Holding Companies have for the failure of their subsidiaries,” Andrew T. Lolli, a Armstrong Teasdale LLP partner representing SVB Financial creditor Capital Markets Company LLC, said in an email.

‘Driver’s Seat’

David Skeel, a law professor at the University of Pennsylvania, said it’s hard to challenge FDIC decision-making. While SVB Financial may get some of the cash back, it’s likely to be on the FDIC’s timetable, he said.

“I think the FDIC is in the driver’s seat on this one,” Skeel said in an email. “Not only is possession (in this case of the cash) nine-tenths of the law, as we used to say, but banking law gives the FDIC extraordinarily broad powers in the resolution context.”

The FDIC, via a receiver, froze the bank accounts holding the roughly $2 billion in March. SVB Financial kept the money in accounts with the Santa Clara, California-based Silicon Valley Bank before it was taken over by regulators.

Silicon Valley Bank was the biggest bank to collapse in more than a decade and the second largest bank to fall under the agency’s receivership, behind only Washington Mutual Inc., which imploded in 2008.

Congress has empowered the FDIC as a receiver to withhold depositor funds in accounts to offset claims it may have against the bankrupt company, the FDIC said in court papers.

Clifford J. White, a former director of the US Trustee’s office, said a bankruptcy court will have to wade through both legal and factual issues.

“I would not bet against the primacy of the FDIC’s mandate to protect the deposit insurance system,” White said.

Skeel noted that there’s historically been friction between bank regulators and bankrupt bank holding companies because of their conflicting interests, dating back to the savings and loan crisis in the 1980s.

“In the earlier cases, holding companies were reluctant to funnel money to troubled banks,” Skeel said. “Bank regulators subsequently persuaded Congress to amend the bankruptcy laws to force holding companies to honor agreements to support a bank—this is something that may be becoming an issue in the SVB situation.”

Bondholders have disputed the FDIC’s claims to the $2 billion. In addition to the $3.3 billion bond debt, SVB Financial has about $3.7 billion of preferred equity outstanding.

“We don’t believe that it’s the case that the FDIC has the right to recover a shortfall,” Marshall Huebner of Davis Polk & Wardwell LLP, who represents a large group of senior noteholders, said at SVB’s bankruptcy court hearing last month.

Venue Issues

The FDIC has suggested that courts don’t have jurisdiction over the dispute until a claimant has exhausted the FDIC’s own exclusive administrative claims process, citing the Financial Institutions Reform, Recovery and Enforcement Act of 1989.

SVB Financial hasn’t exhausted that process, the FDIC has said.

FDIC receiver attorney Kurt F. Gwynne of Reed Smith LLP said during a March bankruptcy court hearing for SVB Financial that it’s “premature” to say whether the agency will submit a claim in the Chapter 11 case.

Tom Lauria, a lawyer representing a SVB Financial bondholder and shareholder Appaloosa Management, said at a court hearing last month that resolving the issue via the FDIC’s claims process could take years.

“This case doesn’t have years to get to resolution,” Lauria said.

‘Source of Strength’

Silicon Valley Bank wasn’t large enough to have a “living will” on file with the Federal Reserve, which would have promised financial support to a subsidiary bank under certain circumstances.

It’s not clear yet whether there are liquidity agreements or other guarantees between the bank and its parent company that could support the FDIC’s case. However, the public portion of the bank’s 2022 resolution plan said SVB Financial “serves as a source of strength” for the bank, which included supporting its growth opportunities.

The FDIC has lost such battles before. In 2010, an Alabama bankruptcy judge blocked an FDIC push to retrieve nearly $905 million against the bankrupt holding company of Colonial BancGroup Inc., rejecting FDIC claims that the company promised to maintain capital at its failed bank subsidiary.

The FDIC could cite part of the bankruptcy code that says debtors must immediately cure any deficit under “any commitment by the debtor” to a federal banking agency, including the FDIC, John Popeo, a former FDIC lawyer and now a partner at Gallatin Group, which advises banks and other firms on regulatory issues, said in an email.

But it’s unclear whether an enforceable “commitment” exists under the meaning of the code, and courts have looked to written agreements for guidance, Popeo said.

The FDIC could argue SVB Financial has a commitment because it’s required to provide financial support under 2010’s Dodd-Frank Act, Popeo said. The doctrine requires that a bank holding company serve as a source of financial strength to a subsidiary depository institution in financial distress, he said.

“This issue will be a test for the source of strength doctrine following its codification in the Dodd-Frank Act,” Popeo said.

In the Chapter 11 of Washington Mutual Bank’s holding company, the FDIC, the bank’s receiver, and buyer JPMorgan Chase & Co. reached a global resolution on creditor priorities. But the odds favored the debtor in that case, said Joseph Cioffi, a partner at Davis+Gilbert, said in an email.

Usually, there’s a presumption that amounts on deposit in the debtor’s name are the bankruptcy estate’s property, Cioffi said. But the FDIC moved to seize the SVB Financial funds on deposit before the bankruptcy case.

“The FDIC appears to be taking a more aggressive and less deferential stance than it has in the past, for example in the bankruptcy of WaMu’s corporate parent, by transferring funds to itself pre-petition,” Cioffi said.