The FMB Bancshares Decision: Clarifying or Not Clarifying TruPS Holders’ Exercise of Remedial Rights

Case Summary

This case presents a common scenario and dynamic that a party involved with a distressed bank holding company may have seen in the last several years.

In 2006, FMB Bancshares, Inc. (FMB) — as did many other bank holding companies before it — entered into a trust preferred transaction, which is a two-tiered debt structure whereby — in the first instance — the holding company issued debentures (Debentures) that were to be sold to a newly created statutory trust (the Trust). The Trust, a separate legal entity from FMB the holding company, issued its own preferred (or capital) securities (the TruPS), which were sold to investors, and common securities, which were sold to FMB. The proceeds from the sale of the TruPS were used by the Trust to purchase the Debentures, which are the sole asset of the Trust and are usually held in the name of the trustee appointed under the applicable indenture and trust agreement. The Debentures are governed by an indenture and the TruPS are governed by a trust agreement and, typically, there are — as there are in the FMB documents — cross-related provisions.

Under this trust structure, all payments of principal and interest owing under the Debentures are paid to the Trust, which then passes such amounts through to the TruPS Holders. As further inducement for investors to purchase the TruPS, FMB — as did other bank holding companies — guaranteed the payment of principal and interest under certain circumstances to the TruPS holders pursuant to a guaranty agreement.

As with many issuances of this type of debt instrument, FMB, as the issuer, could — and did — defer interest payments for 20 consecutive quarters. As that deferral period was coming to an end, FMB sent the Indenture Trustee and Institutional Trustee a request to waive the expiration of the deferral period, citing certain regulatory restrictions and its lack of funds as the reasons why it could not make any payments to the trust. That request was not granted. Thereafter, on March 30, 2014, FMB went into default on the Debentures for failure to pay interest when due and also defaulted on its obligations under the TruPS. On April 7, 2014, Trapeza CDO XII, LTD (Trapeza) provided FMB and the Trustee with written notice that — in accordance with the terms of the applicable indenture — it was accelerating all amounts due under the Debentures and that all principal and interest thereunder was due immediately.

After FMB failed to pay the accelerated amount, Trapeza, as holder of the TruPS, filed an involuntary Chapter 7 petition against FMB. FMB filed a motion to dismiss the involuntary petition, asserting that the involuntary petition failed to state a claim upon which relief can be granted because FMB was legally barred from making the payments due on the Debentures and the TruPS as a result of the regulatory restrictions. FMB also argued that Trapeza had limited contractual rights to seek payment directly from FMB, which rights did not include filing an involuntary petition against FMB and, therefore, Trapeza did not hold a “claim” as required by Section 303(b) of the Bankruptcy Code. In response, Trapeza asserted that the involuntary petition was valid because Trapeza held 100 percent of the TruPS and, as a result, FMB was directly liable to it for all amounts due and payable by FMB to the Trust under the terms of the TruPS.

The United States Bankruptcy Court for the Middle District of Georgia (the Court) denied FMB’s motion to dismiss. In its opinion, it considered and analyzed three central issues:
 

1. Do Trapeza’s contractual rights against FMB include the right to institute an involuntary case?
    

The Court found that an involuntary bankruptcy is a permitted means of enforcement under the applicable indenture and trust agreement. The question that the Court considered was whether the filing of an involuntary bankruptcy petition is a “suit … for enforcement of payment” under the indenture and trust agreement. The Court, looking to precedent from other circuits, held that an involuntary bankruptcy petition does constitute a “suit … for enforcement of payment” as contemplated by the indenture and trust agreement. The Court was not persuaded by FMB’s argument that, because another section of the indenture vested the Trustee with broader enforcement rights than those granted to the TruPS holders, this places an additional limit on the enforcement remedies available to Trapeza. Instead, the Court stated that the granting of broad powers to the Trustee is not a limit on the enforcement rights specifically granted to a TruPS holder. Further, the Court found that the TruPS holders may enforce their rights against FMB directly under the applicable documents in certain circumstances. Those circumstances were satisfied here because an event of default had occurred due to FMB’s failure to pay interest when due, FMB was notified of that default, and Trapeza properly notified FMB that it was exercising its right under the applicable documents to accelerate the debt owed by FMB. Therefore, Trapeza had standing under the indenture and trust agreement to file an involuntary bankruptcy petition.
 

2. Is Trapeza a proper creditor under Section 303(b) of the Bankruptcy Code?
    

Given that Trapeza had standing to file the involuntary petition, the next question was whether Trapeza, as the holder of the TruPS — which are interests in a trust whose sole property is a debt instrument issued by an affiliate of FMB — holds a claim against FMB that is not “contingent” or “subject to a bona fide dispute as to liability or amount” as required by Section 303(b)(2) of the Bankruptcy Code. FMB did not challenge the bona fide nature of the claim asserted by Trapeza, but rather asserted that the claim was contingent due to the regulatory restrictions placed upon FMB, which prohibited any payment of amounts due under the indenture and trust agreement.

The Court disagreed with FMB’s argument. The Court stated FMB’s argument concerned only its ability — as opposed to legal obligation — to pay amounts owed to the TruPS holder, and that FMB had a present legal obligation to pay Trapeza because all “triggering” events had occurred once the interest deferral period expired and FMB went into default. Accordingly, the Court found that Trapeza is a creditor entitled to file an involuntary petition under Section 303 of the Bankruptcy Code.
 

3. Is abstention under Section 305 of the Bankruptcy Code proper?
    

Finally, FMB moved the Court to abstain from exercising jurisdiction over this matter because (1) allowing the bankruptcy case to proceed would cause excessive interference and entanglement with FMB and the bank’s regulators; (2) bankruptcy was not in the best interest of FMB or Trapeza; and (3) the case is essentially a two-party dispute that would be more appropriately resolved in a court of general jurisdiction. The Court dismissed each of these arguments.

First, the Court found that the bankruptcy case would not cause excessive entanglement with the bank’s regulators, as any potential purchaser of the bank would be subject to the same regulations and requirements for regulatory approval.

Second, the Court opined that abstention only is appropriate when dismissal is in the best interests of both the debtor and its creditors. Here, the sole non-insider creditor of FMB and a sophisticated party, Trapeza, chose to file the bankruptcy and the Court said it would not second guess Trapeza’s business judgment.

Finally, the Court dismissed FMB’s argument that bankruptcy was not the proper forum for a two-party dispute. In making this ruling, and in contrast to the precedent relied on by FMB, the Court stated that there was not any state or federal court litigation pending between the parties outside of the bankruptcy action, and it did not appear that Trapeza was attempting to accomplish through bankruptcy what it could not accomplish through litigation in another court. Further, the Court found that Section 305 of the Bankruptcy Code specifically contemplates a two-party dispute by allowing a single creditor to file an involuntary petition in certain circumstances. Therefore, even if FMB is correct that the Court was not the best forum, Trapeza chose the forum, which properly had jurisdiction. As a result, the Court declined to exercise its “extraordinary power of abstention” because it was not clear that the debtor and creditors would be better served by the Court relinquishing jurisdiction, nor was it clear that Trapeza could obtain adequate relief in another forum.

Thoughts and Solutions

The FMB decision is another in a series of emerging cases whereby TruPS holders attempt to directly assert their rights to collect amounts owed to them under the applicable documents, notwithstanding the two-tier structure of TruPS. In many situations, the company or other parties take the position that the holders of the TruPS do not have standing to assert claims or take actions, and have, previously been successful with that position. Indeed, the FMB Decision is in stark contrast to the In re Franklin Bank Corporation decision (the Franklin Bank Decision) issued by the United States Bankruptcy Court for the District of Delaware (the Delaware Bankruptcy Court) on September 5, 2013. In the Franklin Bank Decision, the Delaware Bankruptcy Court — in the context of a claim objection — found that the holders of the TruPS issued by Franklin Bank Corporation were not creditors of the bank holding company but only had claims against the trust that actually issued the TruPS. The Delaware Bankruptcy Court stated that the “real” creditor in relation to the claims arising from the TruPS transaction, and therefore the party that had standing to assert the related claims, was the indenture trustee, as the contractual holder of rights by virtue of the trust, as it was trust (not the bank holding company) that held title to the actual debt securities issued by the bank holding company.

Now, the decision by the United States Bankruptcy Court for the Middle District of Georgia in FMB Bancshares moves away from this prior holding and further opens the door for TruPS holders to assert rights, such as the filing of involuntary petitions against the issuers TruPS, and to take other action to collect amounts owed without indenture trustees, who are fiduciaries in a default scenario and have standing, having to decide whether to take action or incur liability or expense. Given this decision, bank holding companies and, to a certain extent, indenture trustees under TruPS documents, should be aware that TruPS holders may have some support for a further or direct power in their efforts to realize a return on their investment. As a result, indenture trustees involved with TruPS issued by distressed bank holding companies should be aware of the various decisions concerning direct standing of holders of TruPS. In the end, open lines of communications with holders likely will result in cost-effective solutions that can satisfy the TruPS holders’ actions, while reducing disputes.

If you have any questions about this case, please contact the attorneys listed with this alert, or the Arent Fox professional who handles your matters.