Justices Question FDIC's View on Letters of Credit

By Naylor, Bartlett | American Banker, March 5, 1986 | Go to article overview

Justices Question FDIC's View on Letters of Credit


Naylor, Bartlett, American Banker


Justices Question FDIC's View on Letters of Credit

WASHINGTON -- Several Supreme Court justices sharply questioned the Federal Deposit Insurance Corp.'s contention that standby letters of credit are not deposits entitled to federal insurance coverage.

The questioning came during oral arguments Tuesday in FDIC v. the Philadelphia Gear Corp. 85-1972 on the court docket. The high court is not expected to rule for at least a month.

If the decision goes against the agency, banks could be required to pay insurance premiums on the estimated $105 billion in standby letters of credit now outstanding. Because letters of credit are not now considered deposits, they are not subject to insurance assessments by the FDIC.

If banks must pay such premiums, it also will involve fuller reporting on what are known as off-balance-sheet items, a sensitive area for bankers.

Nevertheless, a representative of the American Bankers Association, the industry's major lobby, predicted that Congress would restore the insurance exemption for standby letters if the Supreme Court rules against the banks.

A standby letter of credit serves as a guarantee. The bank that issues the letter to a company does so on behalf of another firm as a guarantee that the firm will make good on a payment to the company. Typically, there are no deposits placed with the bank backing the letter because the bank doesn't anticipate having to make good on the credit.

The Philadelphis Gear case is part of the fallout from the failure in 1982 of the Penn Square Bank of Oklahoma City. The Orion manufacturing Corp., a drill-making company, arranged for Penn Square to issue Philadelphia Gear a standby letter of credit. Philadelphia Gear was selling parts to Orion, and wanted a guarantee of payment.

When federal banking agencies closed Penn Square, Orion became unable to make good on its payment. With Penn Square under FDIC receivership, Philadelphia Gear sought payment from the federal insurance agency.

The U.S. Court of Appeals for the 10th Circuit in Denver last year upheld Philadelphia Gear's claim that its Penn Square letter of credit constituted a deposit and thus was entitled to federal deposit insurance. The FDIC appealed the lower court decision to the Supreme Court.

Arguing for the FDIC before the high court on Tuesday, solicitor Charles Rothfeld said that since no true assets were placed with the bank backing the letter, the letter could not be considered as a deposit for purposes of insurance.

But four of the nine justices contested Mr. Rothfeld's line of reasoning.

"That's just not how the statute reads," said Justice William Rehnquist. Reading the statute "cuts a lot of ground from beneath your commonsense let's-talk-it-over argument."

"The note represented an obligation," said Justice Byron White. "I just don't understand why it isn't an obligation.

The justices fired 33 questions at the FDIC's attorney, and 16 at Philadelphia Gear lawyer Gerald Slattery during the hour-long arguments. …

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