What happens to my business loans, leases, and contracts if my bank fails?

Bank failures happen more often than you think. And if you have a loan with a bank, a bank is your landlord, or you rent to a bank, you could get caught up in the process too. You can get hit by a bank’s failure even if you don’t have any deposits!

Nobody - seriously, nobody - can predict a bank failure. Mismanagement, risky loans and the forces of the economy can all contribute to a bank failure. More often than not, the FDIC steps in to manage the aftermath. Be familiar with the steps in that process so you’ll know what to expect in advance. Preparing for the process ahead of time can save you a lot of hassles afterward.

After an Insured Bank Fails

The typical process after an insured bank fails is that the FDIC takes that failed bank into what’s called “receivership” - sort of a holding period that the FDIC uses to try to either sell the bank to another bank, or shut it down entirely.

In the FDIC’s recent Silicon Valley Bank example, it created a temporary “bridge” bank in order to continue operations.

You know about the FDIC and the $250,000 worth of protection it gives you, but here’s the fine print. In the Silicon Valley Bank case, it covered everything, but don’t count on that next time. Over that amount, you hold a “claim,” in any assets of the failed bank ahead of other creditors.

Anything held in escrow, like property taxes or insurance payments, is set aside and held for the intended purpose. It will be returned to you.

When a New Bank Takes Over

Subtle but serious loss: you’ll lose any longstanding relationships at old branches. People you’ve worked with in the past can probably move you through the process faster than a brand new person who is going by the book on someone who they’ve never dealt with. It’s a small thing to lose but it’s an important one. Little favors go out the window. Want to make a quick call to extend your payment term by a couple of weeks? Your old banker probably would, but the new guy is going to stick to the book.

Just because you have history with a bank doesn’t mean they’re going to give you what you need overnight. The same will hold true with a bank who acquires your own - they’re not as incentivized to help you either. Your account is not the only one that’s part of the acquisition, and the company behind the deal probably isn’t spending a lot of time considering what to do with a puny account like yours. Even though you’ve been with your bank for years, this customer profile may be one that the acquirer doesn’t want. A bank acquirer may decide to quit lending to your industry. Reporters have already asked if the collapse of Silicon Valley Bank means the affordable housing industry is cut off from a key funding source. Normally you’d have time to find another way, but… Because it’s an immediate failure, it’s harder to game plan the exit.

Say you’ve just had a crummy quarter and don’t have the money to satisfy the covenants on your commercial loan. Your current bank might be willing to cut you slack: waiving covenants that break when you miss payments, plus overdraft protection, until next quarter comes around. With a new bank, the rules are different, which might mean they will refuse to cut you slack and pull the rug out. New bank may say no, and tell you last minute.

Before any new bank steps in, the FDIC, acting as receiver, can reject a lease because of a bank failure at any time within a ”reasonable period,” generally read as 180 days. The FDIC has all the same powers (and then some) to terminate your contract, even a lease, as a debtor in possession does. Unlike in bankruptcy, the FDIC doesn’t need court approval and there’s no judge over its shoulder watching.

If your lease is repudiated you won’t get damages based on how much rent you lost out on as a result of the bank failing. You get money from the prior, unpaid rent they failed to pay. And if the bank had agreed to issue a letter of credit for your deal, that promise may be pulled as well and you might have to plan around it. But in the end, any payments come from the FDIC which might be limited if all the money goes to covering deposits. The good news is the new bank may choose to keep all of your terms in place, but you have to ask.

When you take out a commercial loan, you can hold a lender to the standards that apply in business: for example, say your lender made advances on your loan that were a discretionary (read: not contractual) part of the loan, and then suddenly stopped. The elements of a defense can all depend on the particular facts of your situation: usury, laches, waiver, estoppel, fraud, among others. But having a defense doesn’t mean you’ll win.

When the FDIC takes on receivership, most defenses to a lender’s claims are wiped out. The Supreme Court settled the matter in 1942, then Congress solidified it, by stating that the only way a defense survived was on a written agreement signed by both parties, approved by the bank’s board or loan committee and kept in bank records the whole time.

In some cases, the person in charge of calling your loan (the lender or “loan officer”) has agreed to waive covenants or hold off on calling your loan due for several months. Over time, maybe you don’t even remember all the specifics, just that it was agreed. But without all of the paperwork on file at the bank, that agreement will disappear in an FDIC receivership. That email from your old bank’s loan officer telling you the loan won’t be called just because of a few missed payments goes right out the window when a new bank takes over. Anything that isn’t in writing and approved by the board or loan committee is a worthless promise. Pay the money back.

If you have a loan from a bank that just failed, your loan agreement might have a provision letting you walk away if the bank went insolvent. When the bank goes insolvent, any contractual clause that says you can walk is probably unenforceable, so you’re out of luck.

Limit the Damage

Once a bank fails, things go quickly. When you’re facing a change, limit the damage by being ready for what’s next.

First, keep paying what you owe. The FDIC can repudiate a loan contract, but that doesn’t mean you don’t have to pay the loan anymore.

Customers trying to pay into an account with a failed bank? The FDIC is under no obligation to accept new deposits. Try to get a new or bridge bank to take them instead. Money sent into a failed bank overnight might not reach you without a workaround to collect deposits.

Since your bank collapsed, the automatic payments from your bank to your creditors might have stopped. Call the replacement bank to confirm they’ll continue to make those payments.

Keep some cash ready in case the FDIC repudiates your line or letters of credit. Some experts say 1 week at another bank, 6 weeks total.

Know where you can cut back in the short term and long term, and perhaps line up another source of funding ahead of time in the event that new lenders give you the cold shoulder.

If a bank who’s a customer or a tenant fails, anything they owed to you becomes a claim. File a proof of claim by the deadline - for example, the FDIC set a July 23, 2023 deadline for Silicon Valley Bank’s claimants to file - to have a chance at getting paid. You can file your claim online in the Silicon Valley Bank collapse. Creditors will rarely be paid in full.

Ask the new bank or FDIC regularly whether your contract was assigned to it. If it was, FDIC has probably lost its right to repudiate.

The cost of a single bank failure is high for an economy, for a community, and for an individual. This is why regulators seek to prevent them by conducting supervisory and regulatory services.

The Supreme Court case is D’Oench, Duhme & Co. v. Federal Deposit Ins. Corporation, 315 U.S. 447 (1942). Congress reaffirmed the holding by enacting 12 U.S.C. §1823(e) in 1989, through FIRREA.