Financial institutions seeking to challenge discovery relating to Loss-Share Agreements and payments from the FDIC should be able to do so on the grounds of relevance, as we previously discussed. A second argument against such discovery is based on the public policy underlying Loss-Share Agreements.

Reducing a creditor’s claim based on the amount that it paid to acquire the loan would greatly prejudice the ability of the FDIC to attract purchasers of the assets of failed banks. Loss-Share Agreements were introduced in the early 1990’s in a period in which the FDIC had a record amount of assets in liquidation that it was unable to market. By agreeing to bear a portion of the credit loss associated with the failed bank’s assets, Loss-Share Agreements promoted transactions where buyers were otherwise not willing to risk their own capital and balance sheets by acquiring failed banks with a potentially large amount of “toxic assets.” Loss sharing encourages bidding based on an accurate valuation of assets, and thus allows FDIC to maximize the bank’s value while at the same time disposing its assets efficiently.

When purchasing substantially all assets of a failed bank, the acquiring institution relies on the long-standing legal precedent that the purchase price or the loss reimbursement worked out with the FDIC will not affect the value or status of its newly acquired assets. If, on the other hand, the price or reimbursement affected the value or status of the acquired loans, the rationale for purchasing assets from the FDIC and for the Loss-Share Agreements that facilitate those purchases would be eviscerated. Just as the secondary market for notes and mortgages would be destroyed if the law permitted the reduction of a creditor’s claim based on the amount that it paid to acquire the loan, the FDIC would be effectively unable to attract purchasers to buy substantially all of the assets of some failed banks without the option of using Loss-Share Agreements.  Such was a concern addressed by Florida’s Second District Court of Appeal in Branch Banking and Trust v. Kraz, LLC. Thus, the public policy underlying Loss-Share Agreements provides further support for the prohibition of any discovery related to payments an acquiring institution receives from the FDIC pursuant to such agreements.