Part I - What’s In A Name? – The Impact of Titles on Cash Management Accounts.

Shakespeare may have thought that a rose by any other name was still a rose…but would an FDIC regulator see things the same way? Don’t bet on it.

This past weekend while the FDIC was taking over Signature Bank, many lenders (and their lawyers) were busy trying to understand the impact of the shutdown on the multitude of reserve accounts, cash management accounts and lockbox accounts set up at Signature Bank relating to hundreds of commercial real estate loans. It turns out – names matter.

Before the FDIC announced late on Sunday, March 12, 2023, that all depositors at Signature Bank would be made whole, many lenders were grappling with the FDIC regulations regarding deposit insurance coverage. As many recent articles have already described in great detail, the FDIC insures the balance of a depositor’s account up to $250,000. However coverage amounts depend on how accounts are owned, including the application of certain distinct ownership categories recognized by the FDIC (e.g., individual accounts, joint accounts, trust accounts, retirement accounts, etc.). It came as a surprise, even to some highly sophisticated parties, that the maximum $250,000 of insurance is aggregated across all accounts in each ownership category at a failed bank that are owned by the same party.

It is common practice for commercial real estate loan documents to require deposits of property revenues directly into a lockbox account, which then sweeps on a daily basis into a cash management account. In addition, reserve accounts (for taxes, insurance, FF&E, etc…) are a customary feature. These accounts -- lockbox, cash management and reserve -- are usually required to be “lender controlled” accounts, or accounts “in the name of a lender” or “for the benefit of the lender”. While that nomenclature may have been designed to describe a lender’s security interest in and control over the accounts, that wording could have unintended consequences when dealing with a bank receivership. The FDIC rules focus on the owner of the deposits and regulators start with the presumption that ownership is determined by the deposit account records of the failed bank (12 C.F.R. § 330.5). If an account is entitled in the name of the lender or f/b/o the lender, and the FDIC were to consider such lender to be the owner of the account, then the deposit insurance would be payable to that lender. So, what’s the problem with that outcome? Well, it turns out that lenders were often using Signature Bank for accounts on multiple loans at the same time. Under the aggregation rules, the FDIC would only allow a single $250,000 insurance claim across all of a lender’s accounts at Signature Bank, notwithstanding that the accounts related to completely different loans and unrelated borrowers.

So, what’s a lender to do? Most complex commercial real estate loan documents require lender-controlled accounts, and some even contain boilerplate language stating that such lender-controlled accounts are not the property of borrower and should be excluded from the estate of any borrower who files for bankruptcy. But then, many loan agreements may also contain statements requiring borrower to report any interest earned on an account as borrower income, suggesting that the accounts are owned by borrower. It’s clear that for purposes of the FDIC insurance regulations, both lender and borrower benefit from making sure that borrower is considered the owner of the accounts and related deposits and gets the benefit of the FDIC insurance in the event of a bank failure. With that in mind, it would be prudent for commercial real estate lenders to:

(i) include in the loan agreement an express statement regarding the ownership of any required accounts, including specifically for purposes of 12 C.F.R. § 330.5 (Recognition of deposit ownership and fiduciary relationships);

(ii) require that borrower’s name also appear in the title of every account established in connection with a loan that is lender-controlled or f/b/o lender;

(iii) require that any accounts maintained by a servicer (or custodian) clearly indicate that such account is being held in a servicing or custodial capacity only (See 12 C.F.R. § 330.7 – Accounts held by an agent, nominee, guardian, custodian or conservator);

(iv) use the borrower’s tax ID number when establishing each required account; and

(v) ensure that the account records at the bank consistently reflect that the account is owned by borrower.

The FDIC’s late night decision on March 12th to provide insurance above the $250,000 cap saved lenders with cash management accounts at Signature Bank from having to wade through the details of how their accounts were named and owned (and avoided the need to explain these complex arrangements to regulators). However, a future bank takeover might turn out differently. So, lenders take heed and remember that a rose smells sweetest when you simply call it a rose.

Stay tuned for further analysis of issues raised for commercial real estate lenders by the Signature Bank closure.