Attorney General's Opinion
Attorney General, Richard Blumenthal
July 7, 1993
Hon. Joseph M. Suggs, Jr.
55 Elm Street
Hartford, CT 06106
Dear Mr. Suggs:
You have requested our advice regarding whether Connecticut's laws on protection of public deposits1 are adequate to fully secure such deposits in the event the depository institution in which such funds are deposited fails and is placed in receivership. The security of public deposits is an issue because federal deposit insurance for public deposits is limited to $100,000 per account, 12 U.S.C. § 1821(a)(2)(A), and public deposits often exceed that amount. Specifically, you are concerned about the security of state deposits in the event of a challenge by the Federal Deposit Insurance Corporation (FDIC) in its role as receiver of a failed depository institution, under the Federal Deposit Insurance Act, 12 U.S.C. § 1811, et seq.
In order to secure public deposits, Conn. Gen. Stat. § 36-386(a) requires depository institutions that accept public deposits to segregate eligible collateral2 from its other assets. The amount of collateral a depository institution must maintain under the statute varies depending on the risk-based capital ratio of the depository, which is a measure of the institution's financial stability, or the length of time it has been conducting business in the state.3 The depository either must transfer the collateral to its own trust department or to another financial institution as provided in section 36-386(b), and upon such transfer,
[w]ithout the requirement of any further action, the commissioner [of banking] shall have, for the benefit of public depositors, a perfected security interest in all such eligible collateral held in such segregated trust accounts, granted pursuant to and in accordance with the terms of the agreement between the public depositor and the qualified public depository. Such security interest shall have priority over all other perfected security interests and liens.
A public depositor that follows the mandates of section 36-386(b) has secured its deposits as required by state law. However, since depository institutions in Connecticut are federally insured, they are subject to the provisions of the Federal Deposit Insurance Act. The statutory provision that is the subject of your inquiry is 12 U.S.C. § 1823(e), which states:
(e) Agreements against interests of Corporation
No agreement which tends to diminish or defeat the interest of the Corporation in any asset acquired by it under this section or section 1821 of this title [conservatorship and receivership powers of the FDIC], either as security for a loan or by purchase or as receiver of any insured depository institution, shall be valid against the Corporation unless such agreement --
(1) is in writing,
(2) was executed by the depository institution and any person claiming an adverse interest thereunder, including the obligor, contemporaneously with the acquisition of the asset by the depository institution,
(3) was approved by the board of directors of the depository institution or its loan committee, which approval shall be reflected in the minutes of said board or committee, and
(4) has been, continuously, from the time of its execution, an official record of the depository institution.
The FDIC has used 12 U.S.C. § 1823(e) to avoid agreements and defeat the claims of creditors of failed institutions to assets in which they had perfected security interests under state law.4
You have asked whether section 1823(e) applies to security agreements between a public depositor, specifically the State of Connecticut, and a depository institution. It is our opinion that section 1823(e) does apply. Although some provisions of the Federal Deposit Insurance Act treat public depositors differently than other depositors,5 section 1823(e) is not such a provision. Nothing in the language of the section indicates that a depository institution's agreements with public depositors are exempt from its application, or are to be treated in any manner differently than agreements with any other depositor. Nor does the application of section 1823(e) to agreements involving public depositors achieve a result contrary to the purpose of the statute.
In Langley v. FDIC, 484 U.S. 83, 108 S.Ct. 396 (1987), the Supreme Court discussed section 1823(e):
One purpose of e 1823(e) is to allow federal and state bank examiners to rely on a bank's records in evaluating the worth of the bank's assets. Such evaluations are necessary when a bank is examined for fiscal soundness by state or federal authorities, see 12 U.S.C. §§ 1817(a)(2), 1820(b), and when the FDIC is deciding whether to liquidate a failed bank, see e 1821(d), or to provide financing for purchase of its assets (and assumption of its liabilities) by another bank, see §§ 1823(c)(2), (c)(4)(A). The last kind of evaluation, in particular, must be made "with great speed, usually overnight, in order to preserve the going concern value of the failed bank and avoid an interruption in banking services." Gunter v. Hutcheson, 674 F.2d, at 865.
Id. at 91.
Factually, Langley involved a loan agreement in which certain unwritten provisions of the agreement were avoided by the FDIC under section 1823(e). However, the Eighth Circuit Court of Appeals relied heavily upon its reasoning in a case in which the factual context is nearly identical to the context of your inquiry. North Arkansas Medical Center v. Barrett, 962 F.2d 780 (8th Cir. 1992), involved a security agreement in which the bank pledged certain assets as security for the medical center's deposits that exceeded the federal deposit insurance limit. When the bank failed, the FDIC, as receiver, challenged the medical center's claim, asserted as a secured creditor, to the collateral. Although the Court assumed that the medical center had a perfected security interest in the assets under state law, it upheld the FDIC's challenge to the security agreement, which did not meet the requirements of section 1823(e), and the collateral became part of the receivership estate for distribution to general creditors. The Court noted "[t]he FDIC's picture of a bank's net worth could be just as distorted by hidden liabilities to creditors as by secret agreements that impair the value of a loan." Id. at 789.
Accurate knowledge regarding whether an institution's assets have been pledged as collateral for public deposits would be critical for the FDIC. Although state law provisions may ensure that all pertinent information is in the institution's records, "Congress opted for the certainty of the requirements set forth in section 1823(e)." Langley, 484 U.S. at 95. Accordingly, it is our opinion that in order to fully secure state deposits in the event a depository institution is placed in receivership, security agreements between public depositors and depository institutions must meet the requirements of 12 U.S.C. § 1823(e) in addition to meeting state law requirements on perfection of security interests.
You have inquired also whether Connecticut's laws on protection of public deposits require depository institutions to meet the requirements of 12 U.S.C. § 1823(e). To paraphrase your question, you are asking if a depository institution fulfills the requirements of Connecticut law, would it be in compliance with the requirements of section 1823(e). It is our opinion that the answer to this question is no.
No provision of Connecticut's laws on protection of public deposits, nor any regulation promulgated under section 36-385(b) requires the security agreement between the public depositor and the depository institution to comply with the four requirements of 12 U.S.C. § 1823(e). In fact, there is only cursory reference to a security agreement in the last sentence of Conn. Gen. Stat. § 36-386(b). There is no state requirement that the agreement be in writing and signed by the depository institution and any party claiming an adverse interest under it.6 Further, there is no requirement of approval by the board of directors or any committee thereof, or that the agreement must be maintained as an official record of the depository institution.7 The state law on protection of public deposits and section 1823(e) have no common provisions and, therefore, compliance with state law would not obviate a challenge under section 1823(e).
Finally, you have inquired what you can do "to ensure compliance with these or other requirements?" It is our opinion that you can require, as a condition to the deposit of state funds in a depository institution, that the security agreement comply with 12 U.S.C. § 1823(e) as well as state law.
Ensuring that security agreements are in writing and executed by the depository institution will be easy to monitor since you also must sign the agreement. You should require depository institutions to demonstrate their compliance with the other requirements. An appropriate officer of the institution should certify to the State that the agreement was approved by the board of directors, and provide a copy of the minutes of the meeting where such approval was granted, and also certify that the agreement is maintained as an official record of the institution. Public depositors must assume the responsibility of vigilance regarding the depository institutions' compliance with section 1823(e) since the consequence of non-compliance, loss of public deposits, harms the public depositor, not the institution.
On its face, section 1823(e) also requires, for a security agreement to be valid against the FDIC, that it be executed "contemporaneously with the acquisition of the asset by the depository institution." However, the FDIC recently issued a policy statement stating that failure to comply with the "contemporaneous" requirement, by itself, will not result in the FDIC seeking to avoid the agreement. Statement of Policy Regarding Treatment of Security Interests After Appointment of the FDIC as Conservator or Receiver, 58 Fed. Reg. 16,833 (1993).8 The policy statement provides in part:
Specifically, the FDIC will not seek to avoid such a security interest solely because the secured obligation or collateral subject to the security interest (a) was not acquired by the Institution contemporaneously with the approval and execution of the security agreement granting the security interest and/or (b) may change, increase, or be subject to substitution from time to time during the period that the security interest is enforceable and perfected.
This exception to the requirements of section 1823(e) is important for practical reasons. When depository institutions sign security agreements, they often pledge collateral already in their possession. In addition, frequently, additions to or subtractions from collateral occur, as well as substitutions of collateral, because the amount on deposit varies, or the market value of the collateral increases or decreases. The policy statement ensures that the parties to the agreement are not unduly burdened when operating in the ordinary course of their business. The policy statement also avoids a potential conflict between 12 U.S.C. § 1823(e) and Conn. Gen. Stat. § 36-386(c), which permits the depository institution to "make substitutions of eligible collateral at any time without notice."
In the course of our research and discussions on this opinion, two additional issues came to light which must be addressed.
Conn. Gen. Stat. § 36-386(b) provides for the grant of a perfected security interest superior to all other security interests and liens in the Commissioner of Banking, on behalf of public depositors. Currently, the Commissioner does not sign the agreements between public depositors and depository institutions. It is our opinion that the security interest provided for in Conn. Gen. Stat. § 36-386(b) would be unenforceable against the FDIC, however, unless the Commissioner signs the security agreement, because 12 U.S.C. § 1823(e)(2) requires the agreement to be signed by any person claiming an adverse interest thereunder. Therefore, to take advantage of this superpriority provision, security agreements between public depositors and depository institutions also must be signed by the Commissioner of Banking.
Also, a question has been raised regarding public funds currently on deposit; specifically, whether compliance with 12 U.S.C. § 1823(e) requires a public depositor to withdraw and redeposit such funds contemporaneously with the execution of the agreement. It is our view that withdrawal and redeposit is not required where a security interest already has been perfected in accordance with state law. Under those circumstances, an agreement creating a security interest already exists. The purpose of executing the written agreement with regard to such funds is to avoid a challenge by the FDIC under section 1823(e), by ensuring that the institution's records clearly reflect the status of bank assets that have been pledged as security for a deposit.
Very truly yours,
Shelagh P. McClure
Assistant Attorney General
1 Public deposits are defined as
(A) moneys of the state or of any governmental subdivision of the state or any commission, committee, board or officer thereof, any housing authority or any court of the state deposited in any qualified public depository and (b) moneys held by the judicial department in a fiduciary capacity deposited in any qualified public depository.
Conn. Gen. Stat. e 36-382(1).
2 Eligible collateral is defined as
(A) United States treasury bills, notes and bonds, (B) United States agency securities, (C) United States agency variable-rate securities, (D) mortgage pass-through or participation certificates or similar securities, (E) performing one-to-four family residential mortgage loans that meet the following criteria: (i) The mortgage loan has a loan-to-value ratio which is less than or equal to eighty per cent for loans without private mortgage insurance, or a loan-to-value ratio which is less than or equal to ninety-five per cent for loans with private mortgage insurance; and (ii) the mortgage loan has a payment history of not more than one payment over thirty days in arrears during the past twelve consecutive months or, if the loan has a payment history of less than twelve months in duration, the loan meets the documentation requirements of the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation; provided, in the case of a subsequent default under any such mortgage loan that continues uncured for more than sixty days, such loan shall no longer qualify as eligible collateral and shall be replaced by a performing mortgage loan that meets the criteria set forth in this subdivision, and (F) state and municipal bonds.
3 Section 36-386(a) also provides that the public depositor and the depository may agree on an amount of collateral that exceeds the minimum amount required by the statute.
4 See also 12 U.S.C. e 1821(d)(9) which provides:
(9) Agreement as basis of claim
Except as provided in subparagraph (B) [regarding extensions of credit to a depository institution by a federal reserve bank or federal home loan bank], any agreement which does not meet the requirements set forth in section 1823(e) of this title shall not form the basis of, or substantially comprise, a claim against the receiver or the Corporation.
5 See, e.g., 12 U.S.C. e 1821(a). The deposit insurance limit for most depositors is $100,000 in the aggregate, but for public depositors listed in the statute it is $100,000 per account.
6 For a discussion of the requirement that the agreement be signed "contemporaneously with the acquisition of the asset by the depository institution," see p. 6-7, infra.
7 Sections 36-385-8, 36-385-10, and 36-385-12 of the Regulations all contain recordkeeping requirements in connection with public deposits. However, none of them require the institution to maintain the agreement as an official record.
8 The FDIC stated it would not seek to avoid an agreement provided the following assumptions were met:
(a) [T]he agreement was undertaken in the ordinary course of business, not in contemplation of insolvency, and with no intent to hinder, delay or defraud the Institution or its creditors; (b) the secured obligation represents a bona fide and arm's length transaction; (c) the secured party or parties are not insiders or affiliates of the Institution; (d) the grant or creation of the security interest was for adequate consideration; and (e) the security agreement evidencing the security interest is in writing, was approved by the Institution's board of directors or loan committee (which approval is reflected in the minutes of a meeting of the board of directors or committee), and has been, continuously from the time of its execution, an official record of the Institution.
Id. (footnotes omitted).