Post Date: 2/29/2012

Eckley & Associates Video Article D'Oench Duhme Rule:

Real Estate and Construction Attorney
January 1, 2012

Current Circulation: 75,004 per Month


After months of the heavy investment of your wits, work and patience as his agent, your developer client just concluded last week a very reasonable and “workable” resolution with his creditor Bank on a $90 million major shopping center loan. The monthly payments have been reduced, the loan was written down, the balloon was pushed off for a few more years, the whole project is now both profitable and marketable and all of it was signed off in writing handled by you and the bank’s attorneys. In the Bank deal made your client also settled a lender liability claim he felt he had against the Bank for an overstated appraisal which the Bank used to fund the original loan and on which your client relied to buy the property, pay the price and sign the loan. Everyone walked away happy. Your client promptly paid your six-figure fee, told you that you were a “God-sent” miracle-worker, quickly signed off on your new management and sale listing agreement for the property and has been touting you to all of his rich and powerful friends, all of whom have been since calling you to offer you an agency domain over their entire and considerable portfolios. Your colleagues show you new respect, your brokerage is talking senior partnership and, looking in the mirror, you even seem to have more hair, straighter teeth and fewer wrinkles than you remember having before this deal. Your life has been made!


That is, “made” until you took the shopping center client’s lawyer’s call on line 2, today! The lawyer told you as follows: First, that the FDIC just took over the Bank yesterday; second, that under the D'Oench Duhme Rule and its codified avoidance rule of 12 U.S.C. 1823(e), et. seq., you failed to follow the statutory procedures required to make the workout agreement valid in the event of a later bank seizure or closure by the Feds and, consequently, that the entire settlement was just declared void by FDIC as is its right when those procedures are ignored; third, that since under the same rules you also did not take the proper steps to preserve your client’s rightful lender liability claim which could have defended him against most of the loan even if FDIC voided the settlement, he has lost that as a defense as the FDIC sues your client for the entire original loan amount, and, fourth, that the client is now defenseless and ruined, is furious with you, calling all of his friends to defame you and has every intention of suing you for millions of dollars in negligence and fraud and is filing a complaint with the Real Estate Commission to have your license revoked. Your response (after a lot of gasps and amid striking heart palpitations)? “WHAT THE HECK IS THE ‘D’OENCH DUHME’ RULE and HOW WAS I SUPPOSED TO KNOW THIS KIND OF STUFF?” Good question. Bad time to be asking it.


With every Bank in the system right now having one foot into the “watch list” of their Regulator and the other on a banana peel, the better question might have been: “Why didn’t I require my client to get a lawyer involved at the negotiation stage who is versed in the rules for modifying and settling loans and claims with banks and making them stick with the Regulators in the likely event of an FDIC seizure or closure at some point after the deal is made?”

The fact is that what that lawyer said about the power of the FDIC is true: No loan workout or settlement deal you cut with the Bank or other federally-regulated or insured lender survives it being taken over by the Regulators unless precise highly-technical steps are followed by the borrower (the Bank cannot and usually will not help and after it is taken over, it is pretty much a dead body and suing it is about the same as stabbing a cadaver). All such procedurally non-conforming workouts and settlements of mutual claims while the Bank was alive are VOID. The original loan and liability gets reinstated, FIDC can and does sue on it, and any clams or defenses your client had to the loans cannot be raised as a defense against FDIC, as the law deems it a super holder in due course, taking free of all claims and defenses that were not properly preserved. Accordingly, it is at least actionable negligence and a violation of your agency duties per se if you did not advise your client of these rules in writing, did not get him to a lawyer to follow the formalities that would have made the deal valid even if the Bank was taken over and the workout is later voided and elected instead to handle all of this hi-tech legalese yourself. As my first broker/lawyer mentor used to say: “The agent who acts as a lawyer for his client and himself has a fool for a client.”


The D'Oench Rule is not new. It started originally in 1942 as a federal common law rule of estoppel which precludes loan defendants from asserting defenses or claims against the FDIC based on unwritten agreements between the defendants and a borrower under D'Oench, Duhme & Co. v. Federal Deposit Ins. Corp.,315 U.S. 447 at 459-60, 86 L. Ed. 956, 62 S. Ct. 676 (1942). The purpose of the doctrine was to enable the FDIC to enforce agreements between failed banks and their borrowers in strict accordance with the terms on the face of the original loan documents without having to sift through thousands of later Bank files or “handshake” or “off-record” paperwork or deals between borrowers and Banks to find “the real status” on these loans. Id. at 459-62. The general rule derived from D'Oench, Duhme and its like cases provides: In a suit over the enforcement of an agreement originally executed between an insured depository institution and a private party, a private party may not enforce against a federal deposit insurer any claim, offset or obligation not contained in the official record. Under the Rule, that deal is void which is not specifically memorialized in a written document particularly made part of the Bank’s executive-level, regulatory documents such that the Regulatory agency would be aware of the obligation when conducting an examination of the institution's records. Resolution Trust Corp. v. Foust, 177 Ariz. 507, 517, 869 P.2d 183, 193 (App. 1993) (citations omitted). Written documents that are merely executed between the borrower and a loan officer or manager and claims which are not officially made before regulation and which are not elevated to or filed at this executive, regulatory record level are void and lost in a regulatory take-over.


From 1942, the D'Oench Duhme Rule remained federal common law doctrine until Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA") in 1989 and officially codified the D'Oench Duhme Rule in 12 U.S.C. § 1823(e) and expanded its reach beyond just “written side agreement” and unwritten oral agreements. Obviously bad national economic times brings out the Feds to change the rules of the Bank Collapse Card Game to “the Fed’s house takes all” when tough times come about or are anticipated. In 1942, the economy was just emerging from the Great Depression. In 1989, the market was just coming off one of the worst declines since the Great Depression. It is no surprise that these rules are dusted off by the Feds once again in what most of us are coming to realize is the “Second Great Depression of 2012,” i.e. today. Obviously, the Feds expect further collapse and they want to go after all of those borrowers behind all of that paper the Feds expect to inherit and the shortest way to assuring the success of that anticipated mass borrower attack (and the ability to get past all of the rotten Bank practices and complicities that could give the borrowers a defense) is to line up regulation that says “no matter how doctored the coin or the toss and whether done so by borrower or lender, its heads, the borrower loses, tails the Feds win in a Bank takeover!” These are not just the little state bank, credit union and savings outfits the Feds are taking about. It’s also the Fortress Five. The Fed is waiting for them to collapse in whole or part, too, and recent economic legislation was to empower the Feds to topple them in digestible pieces as needed. And for the borrowers (and their agents) who did not follow the protective rules to exempt them from the application of the D’Oench Duhme Rule in their loans and modifications, trouble lies ahead.


The FIRREA version of D'Oench Duhme allows the FDIC, as the receiver of an insolvent financial institution, to ignore any agreement, written or unwritten, which "tends to diminish or defeat" any asset of the insolvent institution, as determined by the FDIC in its sole discretion, unless such agreement:

• is in writing;

• was executed by the depository institution and any person claiming an adverse interest thereunder, including the obligor, contemporaneous with the acquisition of the asset by the depository institution;

• 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;

• has been, continuously, from the time of its execution, an official record of the depository institution.

Claims against the Bank do not have to follow the above process to be preserved. They can be made by a filing level or medium that causes them to become of official, executive and regulatory record so that the FDIC cannot claim to be “surprised” by them. But they have to be filed in that manner BEFORE the regulation ensues. Not after. Thus, this would be “standard operating procedure” even where a loan settlement is otherwise reached and there is not an apparent regulatory cloud on the Bank’s horizon. The loan may be reinstated by regulatory take-over, but in that event at least the lender liability claim would not die and could be still be used for defense, offset, counterclaim or settlement purposes against the loan when in FDIC hands.

Since most loan modification agreements or claims settlements obviously are not executed at the time the loan is made and there are no disputes in the air and are obviously something that comes about later in the life of the loan when voiding issues come up, 12 USCS § 1821(e)(8)(D) softens the “contemporaneous” requirement by providing that resolutions shall not be deemed invalid pursuant to that provision above “solely” because the settlement or workout agreement was not executed contemporaneously with the acquisition of the collateral or because of pledges, delivery, or substitution of the collateral made in accordance with such agreement.


The reach of the D'Oench Duhme Rule was expanded by FIRREA and Federal Courts have continued to broaden its reach over the years. Even after meeting all of the other criterion, above, and even after admitting how seemingly “unfair” it is that a private borrower—even one with a sensible workout and legitimate lender liability claims and defenses--should be defeated in this way, the Courts have tended to work hard to find reasons to defeat the settlement. This is why making the deal and lender liability claims in a way that can be preserved even in seizure or closure is critical as a method of “insuring” that there will be some remaining “legal hammers” to deal with FDIC if it voids the pre-closure loan settlement. In some extreme cases, this rule might even make it a wiser legal step, if these agreements and claims have not been concluded or preserved, to file a lender liability lawsuit or an “artful” bankruptcy or Chapter 11 prior to the date of a known or suspected FDIC takeover if one has that insight (and there are sources to get wind of those closures before they happen). Bankruptcy or a Chapter 11 may be the only solution after the FDIC has already taken over. In bankruptcy, the debtor at least has some powers and rights that can “in practical effect” trump the Rule and deal better with FDIC than the trial courts.

The central risk (and thus concern) for a borrower (any kind of borrower, any kind of loan from a federally-regulated or insured lender) is that an agreement, such as a forbearance agreement or modification agreement, executed some time after the original loan documents, could be ignored and the original loan terms restored if the lender goes into an FDIC receivership even years later. This could certainly also damage a guarantor who may renegotiate a reduction of the guarantee obligations, only to have the original obligations restored under the Rule. If this happens, the borrower and guarantor can be essentially powerless against the FDIC to stop it. Especially if none of the practices and procedures above were followed.


More to the point, the agent (or financial advisor, consultant, CPA, unskilled lawyer, etc.) , that leads his client to this usually-avoidable or “mitigatable” slaughter without the input of a lawyer schooled in banking and regulatory rules and procedures is going to be paying (and paying, and paying, and paying!) for his clients’ resultant losses. And be might be doing it shorn of his license, as well


So what’s the game plan on assisting clients with loan workouts—especially on large loans—with regulated lenders? This is the best advice:

• know the risks, above, and disclose them to your client in writing right up front—this is particularly so in commercial or business settings where loans trend to be capable of full recourse against the borrower and guarantors;

• early on, get someone knowledgeable to examine the financial health and stability of the lender who holds the loan and, above all, to determine if the originating institution has already gone bust and the loan has already been “washed through” FDIC and has been sold to the present holder (new deals with the second holder might stick when deals with the old one would not and certainly lender liability defenses with the old one would not stick if no official claim was made before the closure or sale)—this is critical “due diligence” work;

• put your client in the position to get competent professional assurance that any deal consummated with the bank will follow the above “survival rules”, that is to say, for example, be sure your client gets someone who can capably assure that your deal is going to be at the right officer level of the Bank and assure that there will be an approval process to make it part of the regulatory record as set forth to try to bypass later voiding, above;

• collect and examine all the loan files of the client (all, whether you think them relevant or not) and as you interview your client or collect the records, be on the lookout for any “compromises” that may already have been made (which may not survive Bank closure if it happened tomorrow) and any lender liability claims that may need to be analyzed or raised and bring them to the attention of the client and his legal representatives;

• collect and examine documents regarding your client’s LLCs and other entities to make sure that your client’s financial “firewalls” are to date, intact and viable…or erected if there are none..and bring them to the attention fo the client and his legal representatives.

And, above all...


Another old rule my broker/lawyer mentor used to pound into my head: “Be the ‘source of the source’ and not the source” of this kind of legal analyses and planning. Don’t try to be 100% of the solution; all it means is that you will certainly be targeted for 100% of the blame if the best-intentioned plans and intentions don’t work. The likelihood is that you will be well-used somewhere in the “solution loop” by this advisory team you will form for your client and your client will certainly feel that you have well-earned your commissions or other fees associated with extricating him from the financial mess and these terrible post-deal risks! After all, YOU advised them of the risks and of the path to solutions and you assembled the team to make the trek!

Old Adage in Real Estate and Business: “It’s better to have lawyers on your team than on your tail.”


In debt or workout settings where there are larger financial numbers involved on fully-recoursable debt with a solvent (and sometimes even “balance-sheet insolvent”) client, you, the lawyer your found the client, your client and his CPA are best advised to form an “A-Team” well ahead of the marketing, the workout or even making first contact with the Bank to analyze the risks and processes, the contact points and to set and coordinate The Game Plan to deal with the Bank. In many cases, well before going to the Bank, it is necessary to “tidy up” other entities and financial exposures that could be affected by a fallout on an entirely unrelated loan with the Bank. Without that critical upfront pow-wow, it is unlikely the client is going to emerge from his financial jungle intact or even with any certainty that he gets to keep any game he may have bagged. And who wants their professional malpractice policy and personal net worth to become the “personal guarantor” for every down-and-out (or soon to be) Bank that folds up when the FDIC comes to take back all the client gained from every workout, short sale or modification you did for them for over the last decade?

‘Nuff said!