Daily Development for
Monday, January 18, 1999

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

Thanks to Howard Lax of the Michigan firm of Mason, Steinhardt, Jacobs & Perlman for the tip on this one.

BANKING; FEDERAL RECEIVERS; D'OENCH DOCTRINE: Statutory version of D'Oench, replaces common law version, and does not prohibit suits for rescission of time share purchase agreements where original agreements would not have been shown on books of lender, even where such rescission diminishes value of assets - developer's interest in time share project - given as collateral.

Kessler v. National Enterprises, Inc. No. 98-1347, http://ls.wustl.edu/8th.cir/Opinions/990105/981347.P8 (8th Cir. 1999).

Developer attempted to create a time share condominium project in connection with an independently owned resort hotel in Hot Springs, Arkansas. A critical feature of the time share units was an license agreement from the hotel that guaranteed permanent access to the hotel facilities as well as vital utility access and parking. Developer represented to time share purchasers that the development had permanent rights to these assets. [Later in the opinion the court characterizes the developer's obligation as a contractual obligation to provide these rights.]

Developer's lender failed and its note and mortgage on the project passed to the RTC.

After selling some time share units, Developer failed, and the RTC initiated foreclosure proceedings which eventually were completed by NEI after NEI acquired the note and mortgage from the RTC.

The hotel also failed, and passed into foreclosure. NEI, attempting to protect its interest in the collateral it had foreclosed upon in the time share project, brought suit to enforce the development's license rights in the hotel. In a separate action a court held that the foreclosure of the hotel's assets had terminated the license rights.

The individual purchasers of the time share interest brought suit to rescind their purchase agreements with the developer (now NEI) because of alleged misrepresentations by the original developer concerning the priority of the license rights in the hotel property. NEI raised the defense that the statutory and common law forms of the D'Oench doctrine barred any claims against it, as successor to the RTC, that would diminish the assets of the failed bank's assets - that is the collateral in the developer's interest in the time share project. The Federal District Court held that the rescission claims were barred.

On appeal: held: Reversed.

The Eighth Circuit panel, interpreting O'Melveny & Myers v. FDIC, 114 S. Ct. 2048 (1994) held that the federal statute that embodies the D'Oench concept, 12 U.S.C. 1823(e), has preempted any reliance on the common law doctrine. The only bar to actions that might diminish the assets of a failed lender's property in the hands of a federal receiver is that authorized by the statute. The statute is quite clear that the only types of assets that it will protect from diminution in value are those that were *not* "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 committee, and . . . [have] been, continuously, from the time of [their] execution, an official record of the depository institution." The idea is that the federal receiver's interest should not be diminished by "secret" agreements that federal bank examiners could not have reviewed in evaluating their insurance risk.

The appeals court pointed out that, at the time of the failure of the developer's lender, the lender had only a security interest in certain collateral. The court never tells us what that collateral was, but presumably it consisted of the unsold time share units and various rights held by the developer to assess costs to the units already sold and possibly the right to collect upon installment notes signed by the purchasers of the sold units. The suits in question did nothing to alter the priority of that security interest in those assets.

Later, after the RTC sold the security interest to NEI, NEI foreclosed on the security interest and obtained certain assets whose value, the court conceded, would be affected by the outcome of a suit to rescind the third party purchase contracts. These contracts had not been reviewed and approved by the board of directors of the bank and were not included in the banks records. But the court concluded that such contracts were not the sort of "secret agreements" from which D'Oench and the statute insulate federal receivers and their successors in interest.

The court asserts, it was unrealistic to believe that customary banking practices would have led the original bank to review and maintain in their records every third party non-banking agreement entered into by the developer. The fact that these third party purchase contracts did not appear in the bank records was not the result of any attempt by the bank to withhold information from bank examiners, but rather a reflection of the fact that the bank's "asset" was its security interest, and not the underlying business of the developer.

The time share development was regulated by Arkansas statutes and regulatory agencies, and all of the relevant documents were matters of public record, the court concludes, were not "hidden" from the federal examiners.

In fact, the court argues that at an earlier point in time, these rescission actions would have expanded the bank's security interest. Under the terms of the security arrangement in the bank's records, the bank, in exchange for a release fee, released the time share units from the bank's lien as they were sold. The rescission of the agreements would have resulted in the units' passing back as part of the collateral. (The court fails to note that the basis of the rescission agreements was that the units had no value in and of themselves, and would have had no value as security, while other rights the rescission actions would strip from the developer would have value as collateral.)

Although the court bases its opinion strictly upon the statutory form of the D'Oench concept, it concludes that its ruling is consistent with the purposes of the common law doctrine as well.

Comment 1: Is this a case that permits all third party claims against the collateral, but not against the bank, or only those involving documentation that a bank typically would make a part of its lending records, or only those that do not involve the agreements that were "secret" and not otherwise publically available. The editor suggests that the opinion is very uncertain about the real standards applied here.

Comment 2: Although the editor, never comfortable with the impact of D'Oench on third parties who innocently dealt with the failed bank in such cases, agrees with the thrust of the decision, the editor notes that a responsible lender making a time share loan is likely to scrutinize very carefully the sale agreements that the developer intends to use and is likely to exact various assurances and warranties that these agreements will have a certain form. These agreements were not merely contributory to the value of the collateral, they basically established that collateral. Once the time share project began, its primary value was as an operating system based entirely upon the agreements between developer and time share purchasers. The court stretches the analysis when it concludes that a lender would not have made these agreements a central part of its relationship the developer borrower and would not have documented its interest in them. But, as indicated, the court goes on to talk about "secret agreements" and "third party transactions," and the opinion loses sight of the original notion that these agreements were not subject to D'Oench because of the dubious proposition that they typically would not be included in the bank's loan documentation.

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