Contributed by Jennifer Wine
As we previously reported here, in Colonial Bancgroup, the United States Bankruptcy Court for the Middle District of Alabama held that the chapter 11 debtor, a bank holding company whose bank subsidiary was put into receivership by the FDIC and sold by it to BB&T Corp., did not have a capital maintenance obligation to the FDIC within the meaning of Bankruptcy Code section 365(o).  As a result, the FDIC was entitled only to receive on a pro rata distribution with other general unsecured creditors.  While we continue to wait for a decision from the District Court for the Middle District of Alabama on the Colonial Bancgroup appeal, this post discusses a recent Sixth Circuit decision, In re AmTrust Financial Corp., Case No. 11-3677 (6th Cir. Sept. 14, 2012), upholding a district court’s finding that the debtor, also a bank holding company, did not have an enforceable capital-maintenance requirement to its failed bank subsidiary under section 365(o).
Section 365(o) of the Bankruptcy Code requires a chapter 11 debtor to assume and immediately cure any deficit under a commitment to a federal depository institution regulatory agency (such as the FDIC) to maintain the capital of a bank.  Thus, when a bank holding company files for chapter 11, the FDIC often demands that the debtor immediately honor any outstanding capital commitment obligations to its bank subsidiary, which can threaten the administrative solvency of the debtor’s chapter 11 case.  Such was the case in AmTrust Financial, where the FDIC moved the bankruptcy court for an order under section 365(o) requiring debtor AmTrust Financial Corp., to immediately cure its subsidiary bank’s capital deficit.  The FDIC successfully moved to withdraw the reference so the matter was hearing in the first instance by the United States District Court for the Northern District of Ohio (the “District Court”).
Prior to the bankruptcy, AFC and its subsidiary, AmTrust Bank, operated under the regulation of the Office of Thrift Supervision.  The AmTrust Financial Corp. decision is based on a complicated fact pattern surrounding the bank’s deterioration and related OTS regulatory action spanning nearly a year and a half from June 2008 until AFC’s chapter 11 filing on November 30, 2009 and the OTS’s closure of the bank and appointment of the FDIC as receiver four days later.  The decision reviews the underlying facts in detail, but the key facts for the Sixth Circuit’s section 365(o) decision involve two cease-and-desist orders issued by the OTS to AFC and the bank, respectively, on November 18, 2008.
In September 2008, the OTS downgraded the bank to a “4” rating on the OTS’s 1-5 scale based on the continuing deterioration of the bank’s loan portfolio.  This rating placed the bank in “Troubled Condition” pursuant to 12 C.F.R. § 563.555 and placed various restrictions on the bank’s management practices.  In order to “formalize” the bank’s “Troubled Condition” and further restrict the operations of AFC and the bank, on November 19, 2008, OTS presented both AFC and the bank with proposed C&D orders.  The C&D order issued to the bank required that:

[The bank] have and maintain . . . by no later than December 31, 2008, and at all times thereafter . . . (I) a Tier 1 (Core) Capital Ratio of at least seven percent (7%) and (ii) a Total-Risk Based Capital Ratio of at least twelve percent (12%).

The C&D order issued to the holding company required AFC to submit for approval “a detailed capital plan” and required that “[t]he Board shall ensure that the [bank] complies with all of the terms of its Order to Cease and Desist issued by OTS on November 19, 2008.”  Both AFC and AmTrust bank stipulated to the issuance of the C&D orders rather than fighting the orders in administrative hearings.
The FDIC’s section 365(o) argument focused on the “ensure” language in AFC’s C&D order: “The Board shall ensure that the [bank] complies with all of the terms of [its own C&D order].”  The FDIC argued that this language bound AFC’s board to take whatever steps necessary to satisfy the terms of the bank’s C&D order, including the required capital ratios.  Based on the “shall ensure that the [bank] complies” language in AFC’s C&D order, the FDIC argued that AFC was obligated to buttress the bank’s capital with its own funds if the bank failed to maintain the prescribed capital requirements.
The District Court denied the parties competing summary judgment motions, finding that the C&D order, requiring AFC to “ensure” that the bank complied with the terms of its own C&D order (included the specified capital ratios), was ambiguous and the provision was “susceptible of more than one reasonable interpretation,” rendering its meaning a question of fact, not law.
After a four-day trial, an advisory jury found that AFC had not made an enforceable commitment to maintain the bank’s capital under section 365(o) and the District Court agreed holding that:

Paragraph 8 was intended to create an obligation by the Board to oversee the Bank’s attempt[s] to obtain and maintain specific capital [ratios], but there is no evidence that it was intended to create or impose an enforceable obligation by AFC to maintain the capital of the Bank.

The FDIC appealed both the District Court’s finding of ambiguity and its ultimate interpretation of the C&D order to the Sixth Circuit.
The Sixth Circuit first conducted a de novo review of the District Court’s finding that AFC’s C&D order was ambiguous.  The Court found that although the FDIC’s interpretation was reasonable based on text alone, it was not the only reasonable interpretation of the C&D order.  While the FDIC argued that the words “shall ensure” can reasonably be read to create obligations, the Court noted that “[e]nsuring that another party does something is different from doing that thing directly, and it [is] not clear from this phrasing that paragraph 8 was intended to obligate AFC to maintain the Bank’s capital ratios itself if the Bank did not do so.”  The Court then examined textual evidence in the C&D order and found that there was sufficient textual evidence to support either interpretation and, therefore, upheld the District Court’s finding that the C&D order was ambiguous.
The Court next considered the FDIC’s argument that even if the C&D order was ambiguous, OTS had already settled its meaning by interpreting the order as imposing a capital-maintenance requirement on AFC and, therefore, this reasonable interpretation of OTS’s own order should be controlling under Auer v. Robbins, 519 U.S. 452 (1997).  Specifically, the FDIC pointed to a February 2009 OTS examination report which found that “the holding company and the bank were not in compliance with the minimum capital requirements of paragraph 4.a. of [AFC’s C&D order] at December 31, 2008.”  Citing more recent Supreme Court precedent, the Sixth Circuit noted that “Auer deference is not absolute . . . [c]ourts need not defer to an agency’s interpretation that ‘is plainly erroneous or inconsistent with the regulation[s]’ or where there is any other ‘reason to suspect that the interpretation does not reflect the agency’s fair and considered judgment . . . .’”  The Court noted that paragraph 4(a) of AFC’s C&D order created no minimum capital requirement at all, let alone one that applied to both AFC and the bank, and found that the statement was “plainly inconsistent with the [C&D order] itself and thus not a reflection of fair and considered judgment” and was not entitled to Auer deference.
Finally, the Sixth Circuit reviewed the District Court’s ultimate interpretation of the C&D order, including its use of extrinsic evidence.  The Court rejected the FDIC’s arguments that the lower court used extrinsic evidence improperly and failed to recognize pertinent evidence supporting the FDIC’s interpretation.  The Sixth Circuit found that “the bulk of the extrinsic evidence” supports an interpretation of the C&D order as establishing an oversight role for AFC rather than a capital maintenance commitment and, therefore, the District Court’s finding was not clearly erroneous.
Notably, the Sixth Circuit declined to rule on the scope of section 365(o).  The District Court held that section 365(o) “does not require a commitment to ‘infuse equity capital,’ or an ‘absolute guarantee of performance,’ although such promises are clearly included in the realm of ‘commitments to maintain capital.’”  The Sixth Circuit noted the District Court’s “broad interpretation of section 365(o)” but refused to “pass judgment on [this issue]” in its decision, perhaps foreshadowing a potential issue for future section 365(o) decisions.
Together with the Colonial Bancgroup decision, the AmTrust Financial Corp. decision demonstrates that in order for section 365(o) to apply, agreements or orders between bank holding companies and banking regulators must explicitly create a capital maintenance commitment— words such as “assist” or “ensure” are not synonymous with “maintain.”