A judge has ruled that the involuntary bankruptcy of FMB Bancshares in Lakeland, Ga., may proceed, a decision that could embolden more trust-preferred creditors to pursue a similar strategy.
The ruling, issued Friday by Judge John Laney of the bankruptcy court for the Middle District of Georgia, is the first to address the question of whether a trust-preferred creditor has the right to force an unwilling holding company into bankruptcy. FMB is the second lender whose creditors have sought involuntary bankruptcy, and the first to try to fight the process.
Trapeza Capital Management filed a petition in June to force FMB into involuntary bankruptcy over $13.6 million in defaulted trust-preferred debt and unpaid interest. The $566 million-asset FMB opposed the move, arguing that Trapeza lacks the legal standing to force it into bankruptcy.
In addition, FMB is operating under a regulatory order from the Federal Reserve Board that bars it from making trust-preferred payments without Fed approval. FMB argued that the order supersedes its obligation to pay its creditors.
Laney disagreed, denying FMB’s request to dismiss the involuntary bankruptcy and ruling that Trapeza had standing to force the issue. The judge determined that the regulatory order does not negate FMB’s obligation to pay its debt.
FMB’s “argument concerns its ability to pay, rather than its legal duty to pay,” Laney wrote in his decision.
Considering the problem posed by the FMB’s regulatory order, Laney wrote that the court “will not choose one contract over another when FMB Holdco is legally obligated under both. FMB Holdco’s inability to satisfy its obligations to Trapeza does not affect its duty to do so.”
Involuntary bankruptcy has emerged in recent months as a tactic for trust-preferred holders seeking repayment. Laney’s ruling could encourage other creditors to consider the strategy, and it may strengthen the bargaining position of creditors that are negotiating repayment with indebted holding companies.
What it means for FMB, however, is not yet clear.
Laney’s decision may open a window for FMB to negotiate repayment with Trapeza, said Richard Cheatham, a lawyer at Troutman Sanders who represents FMB. By treating the Fed order as an agreement with a “private party,” the ruling “means that we can convert the case to a Chapter 11 and propose a plan whereby FMB raises enough capital at the holding company to bring the” trust-preferreds current, he wrote in an email.
“That is exactly what FMB wanted to do before it defaulted but didn’t think was possible,” Cheatham added. “Since the bankruptcy court has ruled that it can override the Written Agreement, we have much more flexibility in resolving this matter.”
Trapeza did not respond to a phone call seeking comment.
Trust-preferred issuers can defer interest payment for up to five years, after which point the creditor can demand full payment. Many banks that began deferring payments during the financial crisis are now reaching the end of the line. So far, 238 banks have defaulted and 197 are still deferring payment, said Alina Pak, an analyst at Fitch Ratings.
Since the financial crisis, a handful of debt-burdened holding companies have voluntarily filed for bankruptcy to restructure their debt. In these cases, the bank has been sold at auction and the money used to repay the holding company’s debts.
Recently, creditors have begun trying to force holding companies into bankruptcy in order to receive repayment of trust-preferred debt. In May, American Bancorp. in Minnesota became the first holding company forced into liquidation over trust-preferred debt. Unlike FMB, American acquiesced to the process.
FMB is not yet in bankruptcy, and there are several issues that must be resolved before bankruptcy can proceed. The next step involves a status conference among all the parties in the suit, which is set for Monday.
