By Dow Jones Business News, October 14, 2013, 03:00:00 PM EDT
By Patrick Fitzgerald
A Delaware bankruptcy judge's recent ruling that the former parent of a failed California thrift has top claim on a $
374 million tax refund is a win for investors picking over the remnants of the hundreds of failed banks left in the wake
of the financial crisis.
U.S. Bankruptcy Judge Christopher Sontchi's decision last week that the FDIC must share the tax refund with Downey
Financial Corp. bondholders is a boon for investors sparring with the regulator in related tax-refund fights, according
to the lawyers for a group of hedge funds involved in a similar dispute involving Colonial BancGroup.
Colonial BancGroup's lawyers say the recent Delaware decision strengthens the hedge funds' claim to hundreds of
millions of dollars in disputed tax refunds.
"Like all of the decisions that came before it interpreting similar contracts, Downey held the tax refunds are
property of the parent/tax-filer's estate," Colonial's lawyers said Friday with the U.S. District Court in Montgomery,
The FDIC, the federal agency that manages the receiverships of failed banking institutions, took over Colonial
BancGroup'sAlabama-based banking subsidiary, Colonial Bank, in 2009.
Colonial BancGroup, which has no revenue or business prospects, isn't seeking to reorganize. Instead, the bank-holding
company's Chapter 11 plan, which was approved last year, created a litigation trust to pursue lawsuits on behalf of
Among those creditors are several hedge funds--Jeff Altman's Owl Creek Asset Management and two others that specialize
in buying the distressed debt of troubled companies--that are funding the litigation against the FDIC by Colonial Bank's
former parent over who is entitled to the assets.
In exchange for funding the litigation, the hedge funds will get 27.5% of the winnings. If they win on an appeal they
will take one-third of the recoveries. Such a bet could pay off handsomely if a judge finds Colonial is entitled to the
disputed tax refunds and securities totaling more than $600 million.
Those assets went up for grabs when Colonial Bank was shut down four years ago and the FDIC took over as the receiver
for the defunct bank.
In two recent rulings, the U.S. 11th Circuit Court of Appeals said that so-called tax-sharing agreement between the
holding-company parents of Bank United and NetBank (NTBKQ) and the banks themselves created an agency relationship and
not a debtor-credit relationship as claimed by the holding companies' creditors.
The decisions were wins for the FDIC, the receiver for the failed banks, in its fight with creditors of bank-holding
companies over ownership of a failed bank's assets.
But Colonial's lawyers say that because its tax-sharing pact has the same features that the courts said reflected a
debtor-creditor relationship between a holding company and a bank, the core holding of those decisions supports Colonial
BancGroup's claim to the assets.
"The plain language of the Colonial [tax-sharing agreement] provides for nothing more than a debtor-creditor
relationship and that the tax refunds are property of BancGroup's estate for fair and ratable distribution to all of its
A spokesman for the FDIC said the regulator doesn't comment on pending litigation. The FDIC has previously said in
court filings that said the 11th Circuit rulings supported its claim to ownership of the Colonial tax refunds.
Ultimately, the Colonial tax-refund dispute will be decided by U.S. District Court Judge Myron H. Thompson, however,
given the history of similar disputes, further appeals are likely.
Bank-holding company creditors have been sparring with the FDIC in courtrooms across the country for several years.
Those fights have focused on tax refunds and other assets left behind in the wreckage of hundreds of failed banks closed
by regulators in recent years.
The number of bank failures surged in 2007 when the nation's housing industry went into free fall and financial
markets seized up. Those failures have cost the FDIC, the federal agency that manages the receiverships of failed
banking institutions, tens of billions of dollars.
When a faltering bank is seized, the FDIC transfers its deposits to a stronger company--to BB&T Corp. ( BBT ) in
Colonial's case---and it remains as a receiver for what is left.
Based in Alabama, Colonial was once a regional banking powerhouse. It suffered big losses as the housing market
cratered, but its fate was sealed with the collapse of mortgage lender Taylor Bean & Whitaker Mortgage Corp., which
filed for bankruptcy in August 2009.
Colonial, which had $25 billion in assets and $20 billion in deposits, was the biggest bank failure of 2009. The FDIC
estimates Colonial's collapse will cost its insurance fund $5 billion, making it one of the most expensive bank failures
in U.S. history.
(Dow Jones Daily Bankruptcy Review covers news about distressed companies and those under bankruptcy protection. Go to
Write to Patrick Fitzgerald at email@example.com
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