IX Provisional Administration Under the Banking Law
- T. Asser
- Published Date:
- April 2001
1. General Issues
Provisional administration, or conservatorship as it is sometimes called, is a bank administration procedure for managing and operating a bank in distress back to compliance with prudential requirements, or for preserving the value of the bank while it is being prepared for the transfer to another institution by sale or merger, or for liquidation. Although its objective is largely corrective in nature, it should be distinguished from other corrective action in that it requires taking control of a bank. It should also be distinguished from receivership whose main goals are to minimize the systemic effects of a bank failure and to preserve the value of a bank for its creditors.
Provisional administration is usually carried out under regulatory administration through one or more provisional administrators who are appointed and supervised by the bank regulator and take over part or all of the management of the bank. Provisional administration may, however, be instituted and supervised by the courts,253 especially if it is used in conjunction with a judicial moratorium on payment of bank debt.254
Objectives of Provisional Administration
The principal functional objectives of provisional administration of a bank in distress are to save all or a substantial part of the bank by managing and operating it back to regulatory compliance, or to preserve the value of the bank while it is being prepared for transfer to another institution, in a sale or merger, or for liquidation.
The purposes of provisional administration may be specified in the law, either explicitly or implicitly. An example of the former is found in the provision of United States law granting the FDIC, as conservator, the power to take such action as may be
(i) necessary to put the insured depository institution in a sound and solvent condition; and
(ii) appropriate to carry on the business of the institution and to preserve and conserve the assets and property of the institution.255
Instances of an implicit recognition of these objectives can be found in banking law provisions that require termination of provisional administration and liquidation if the bank cannot be rescued or preserved.256
A bank under provisional administration continues to operate as a going concern. This means that, to be successful, the provisional administrator must behave like an entrepreneur, entering into new transactions, taking and managing risks, in short, engaging in banking activities. As a rule, where the law provides for provisional administration, provisional administrators must carry out their tasks from within the corporate structure of the bank to which they are appointed.
There is general agreement that provisional administration should not be misused to postpone an inevitable failure of a bank. Therefore, the law may require as a condition for its institution a judgment that there is a real prospect that the provisional administration would achieve its purpose, such as the survival of the bank as a going concern.257 In conjunction with a moratorium, the law may require that the bank to be placed under provisional administration is not overindebted.258 Conversely, the law may require that a provisional administration be terminated if either (a) the bank’s deposit liabilities have been repaid or suitable provision has been made for their repayment so that provisional administration is no longer necessary; or (b) the bank is insolvent or is unlikely to be returned to solvency within a reasonable time.259
There is much to be said for requiring as conditions precedent to provisional administration that the goals to be pursued with such administration are defined and that a judgment is made that there is a real prospect that such goals will be achieved. For instance, if the goal of a provisional administration is to return a bank to compliance with prudential standards, realization of that goal should be judged likely before a provisional administrator is appointed for the bank. In serving transparency, this judgment should be recorded and explained in the decision and notification of appointment of the administrator. Requiring the authorities to articulate the purpose of a provisional administration and to assess the likelihood of realizing that purpose before it begins adds discipline to the process. It also helps avoid situations where an administrator would be appointed without consideration of the risk of further deterioration of the bank’s condition at the expense of its creditors or, worse yet, situations where the principal objective of the appointment would be to put off an inevitable bank closure.
If the objective of the provisional administration of a bank is to manage the bank back to compliance with prudential requirements, that objective can be realized only if the regime of corrective measures to be carried out under provisional administration is fully integrated into, and carried out as an integral part of, the bank’s policies and procedures. Corrective measures are intended and designed to be executed by the bank concerned as part of its operations.
Reasons Supporting Provisional Administration
The principal rationale for provisional administration is to have corrective or conservatory measures carried out by a provisional administrator, because the bank’s own management is judged unwilling or unable to execute the corrective measures ordered by the bank regulator, or cannot be trusted to take the conservatory measures that are required to stabilize the bank’s financial condition pending its sale, merger, or liquidation.260
Reasons Against Provisional Administration
In several countries the law does not provide for regulatory provisional administration.261 One practical reason may be that the bank regulator simply lacks the staff resources to manage a bank or to supervise the management of a bank by an administrator. This argument is more serious than it may seem at first glance. Bank regulators are not in the business of managing and operating banks but of exercising prudential banking supervision. Prudential banking supervision is not the same as bank management, and bank regulators do not necessarily have the qualifications, experience, or even the temperament required of a successful bank manager.
Provisional administration lends itself to abuse. Provisional administration has been used to postpone the inevitable closure of banks, for instance, owing to political pressure or because the deposit insurance system lacked the funds to pay off bank depositors. Obviously, the use of provisional administration to mask forbearance is likely to worsen the condition of the banks concerned and to increase the costs associated with their resolution to be borne by the state and by their creditors.
Finally, yet not less important, in most countries with provisional administration for banks, bank owners largely retain their rights. As a result, they could frustrate a provisional administration. Therefore, the appointment of a receiver whose powers exceed those of the provisional administrator and typically include those of the bank’s owners is often preferred.
The provisional administration procedures used in the United States during the savings and loan crisis of the 1980s are illustrative of how some of the disadvantages of provisional administration can be overcome. Because the staff and other resources of the U.S. bank regulator were inadequate to resolve the relatively large number of failing savings and loan institutions, the Resolution Trust Company (RTC) was established by the U.S. Congress and charged with the merger or liquidation of savings associations previously insured by the Federal Savings and Loan Insurance Corporation that would be declared insolvent between the beginning of 1989 and mid-1995. The Federal Deposit Insurance Corporation (FDIC) became the manager of the RTC. Of the 747 bank failures resolved by the RTC, 706 were administered under a conservatorship.262
As described in a report issued by the FDIC,263 the procedures generally worked as follows:
The conservatorship process began when the bank regulator closed an insolvent savings and loan institution and appointed the RTC as receiver. The bank regulator executed a pass-through receivership in which all deposits, substantially all assets, and certain non-deposit liabilities of the original institution instantly “passed through the receiver” to a newly chartered federal mutual association, subsequently known as “the conservatorship.” The regulator then appointed the RTC as conservator of the new institution, which placed the RTC in control of the institution. To achieve its goals and objectives, the RTC assigned a managing agent and one or more asset specialists, who were also RTC employees, to the institution in conservatorship. The RTC retained the majority of the former institution’s employees, who continued to perform the same functions they had before conservatorship; however, the day-to-day management and ultimate authority was given to the RTC-appointed managing agent. The managing agent’s role was to ensure that management of the institution adhered to the RTC’s policies and procedures, while the asset specialist would assist the managing agent with asset management and disposition.
The objectives of the conservatorship were to (1) establish control and oversight while promoting depositor confidence; (2) evaluate the condition of the institution and determine the most cost-effective method of resolution; and (3) operate the institution in a safe and sound manner pending resolution by minimizing operating losses, limiting growth, eliminating any speculative activities, and terminating any waste, fraud, and insider abuse. Shrinking an institution by curtailing new lending activity and selling assets was also a high priority.
At the time the conservatorship was resolved, either through a sale or deposit payoff, the institution again was placed into a receivership (the second receivership). Both receiverships, the initial pass-through receivership and the second receivership, paid unsecured creditors and other claimants on a pro rata basis according to the recoveries within each receivership.
One of the key features of this procedure is that it avoids the continued influence of bank owners by transferring most of the bank’s assets and liabilities to a new entity established for the purpose. Here, provisional administration governs not a failing bank but a failing bank’s assets and liabilities.
2. Appointment of a Provisional Administrator
In several countries, the regulator is authorized to appoint a provisional administrator to a bank264 or to take direct control of a bank.265 In others, the provisional administrator is appointed by the courts.266
The grounds on which the appointment of a provisional administrator may be made vary. In some countries, the law provides for one or more general grounds of appointment of a provisional administrator. The law may authorize the appointment, for instance, when the operation of the bank on a normal basis can no longer be assured;267 when there are serious management irregularities or violations of the law or when serious losses are predicted;268 where the liquidity or solvency of a bank is threatened;269 or when the bank is overindebted or insolvent.270 The law may mandate the appointment of a provisional administrator when the bank is granted a debt-service moratorium.271 In other countries, a provisional administrator may be appointed at the request of the management of the bank concerned.272
Alternatively, the law may list several distinct grounds for the appointment of a provisional administrator. For instance, the banking law of Canada specifies the following grounds:
a) the bank has failed to pay its liabilities or, in the opinion of the Superintendent, will not be able to pay its liabilities as they become due and payable;
b) in the opinion of the Superintendent, a practice or state of affairs exists in respect of the bank that may be materially prejudicial to the interests of the bank’s depositors or creditors, or the owners of any assets under the bank’s administration;
c) the assets of the bank are not, in the opinion of the Superintendent, sufficient to give adequate protection to the bank’s depositors and creditors;
d) any asset appearing on the books or records of the bank or held under its administration is not, in the opinion of the Superintendent, satisfactorily accounted for;
e) the regulatory capital of the bank has, in the opinion of the Superintendent, reached a level or is eroding in a manner that may detrimentally affect its depositors or creditors;
f) the bank has failed to comply with an order of the Superintendent ....; or
g) the bank’s deposit insurance has been terminated by the Canada Deposit Insurance Corporation.273
As the appointment of a provisional administrator is a serious and invasive measure, the law may follow a two-step procedure and require that prior notice had been given to the bank and that the bank had been ordered unsuccessfully to correct the situation within a certain time period, before a provisional administrator may be appointed;274 the law may restrict the authority to appoint a provisional administrator to exceptionally grave conditions;275 or the law may provide that the appointment must be made by the bankruptcy court.276
In any event, where the goal of provisional administration is to manage a bank back to compliance with prudential requirements, the administrative law principle of proportionality would appear to require that, as a rule, the provisional administrator be appointed only when less intrusive corrective action has failed or cannot reasonably be expected to restore the bank to health within a reasonable time frame. A central condition for the institution of provisional administration seems to be that the bank’s management is judged unable or unwilling to take the necessary corrective or conservatory measures.
3. Legal Effects of the Appointment of a Provisional Administrator
In many countries, the appointment of a provisional administrator for a bank must be given the necessary legal effects by notifying the bank of the appointment and by announcing the appointment to the public through newspapers, the Official Gazette, or entry into the register of companies.
Powers of the Administrator
Where the provisional administrator takes control of the bank, he effectively takes over the management of the bank. This can be authorized by the law in several ways.
In most countries with provisional administration, the powers of the administrator are explicitly and formally provided for in the law. In some countries, the law attaches to the appointment of a provisional administrator the dissolution of management and grants the provisional administrator the powers and functions of the members of the board of directors of the bank (collectively and individually), including the board’s powers of delegation.277 Or the law may state that the powers of the bank’s management are transferred to the provisional administrator,278 or that the provisional administrator succeeds to all rights, titles, powers, and privileges of the bank’s management and may operate the bank with all the powers of its management.279 Alternatively, the law may order the provisional administrator to manage and operate the bank, and may provide that the powers of the bank’s managers are ipso facto suspended,280 or that they may be suspended by the regulator.281 There are cases where the law grants the provisional administrator only implicit managerial authority, for instance, when the law leaves bank management in place and provides that management may exercise its authority only after approval of the administrator and in compliance with the instructions of the administrator.282
In most countries where the law authorizes the appointment of a provisional administrator, it follows from the law that the provisional administrator must work within the existing corporate structure of the bank. In most of the countries reviewed, the provisional administrator has powers limited to those of bank management, and lacks the super powers that the law may grant to receivers of an insolvent bank.283 Submitting the provisional administrator to the restrictions imposed on the powers of bank managers by company law and banking law has the legal advantage of forcing the provisional administrator to operate within the normal and therefore familiar framework of corporate governance. Bringing provisional administrators under the bank’s corporate structure ensures creditors of the bank that there is a continuity of legal regime.
Yet, the very fact that existing corporate structures remain intact harbors the risk that remaining bank managers, who caused or contributed to the problems leading to provisional administration, would sabotage the work of the administrator. Therefore, removing bank management and replacing it with a provisional administrator must be preferred over alternatives that permit bank management to remain in office. Alternatively, the law may provide that if the manager of a bank under provisional administration purports to act in relation to the bank’s business while a provisional administrator is in office, those acts are invalid and of no effect.284
Competing Rights of Bank Owners
In most of the countries reviewed whose banking law provides for provisional administration, owners of a bank under provisional administration retain their rights, even though the law may authorize that restrictions be imposed on the exercise of such rights. These include the authority of the provisional administrator to veto decisions of shareholders,285 and the authority of the bank regulator to submit decisions of the general meeting of shareholders to the prior approval of the provisional administrator.286
There are exceptions, however. In the United States, the law provides that the FDIC as provisional administrator (conservator) of a bank succeeds to all rights, titles, powers, and privileges of any stockholder or member of the bank.287 In Italy, the order by which the provisional administrator is appointed has the effect of suspending the functions of the meetings of shareholders, except when the meeting is convened by the administrator.288 In France, when a bank is under provisional administration, the law authorizes the court, at the request of the bank regulator made in the interest of the bank’s depositors, to order some of the owners of the bank who exercise legal or factual control over the bank to dispose of their shares at a price set by the court, or to decide that for a period fixed by the court their shareholder voting rights will be exercised by a trustee appointed by the court, or to order the disposal of all shares of the bank.289 It should be noted that the banking law may grant authority to suspend the voting rights of shareholders as a general matter, irrespective of provisional administration.290
Where provisional administrators must carry out their function within the corporate structure of the bank to which they are appointed and they are not vested with the powers of bank owners, shareholder consent must be obtained for all actions where this is normally required by company law. Consequently, in many countries, an ailing bank may not be recapitalized at the initiative of the provisional administrator without the express consent of the general meeting of shareholders.291 This consent requirement gives bank owners a veto over corrective measures that are not in their interest. This must be regarded as the Achilles’ heel of provisional administration. Innovative approaches will be needed to obtain the consent of recalcitrant bank owners while denying them free ridership. One of these is the before-mentioned authority of the courts in France to decide that for a certain time period shareholder voting rights are to be exercised by a trustee appointed by the court.292 If such solutions are not available, the bank may have to be moved into receivership.
On balance, the conclusion is justified that owners should be removed as impediments to corrective measures, either by suspending their powers by court order or by vesting those powers in the provisional administrator by operation of law. Saving a bank is normally dictated by systemic considerations and the regulator, or the judiciary upon application of the regulator, should have the statutory powers to do all it takes to achieve that objective. However, it cannot be denied that, apparently, in several of the countries providing for provisional administration, society (acting through its legislature) attaches so much weight to ownership rights that it is prepared to sacrifice some efficiency and to incur some additional systemic risk in order to afford bank owners one last chance to help save their bank before their rights are formally extinguished or otherwise made illusory in a receivership.
In some countries, the effects of provisional administration include a debt-service moratorium.294 As a bank when it is placed under provisional administration is often still solvent, the stay imposed by the law may be made subject to certain exceptions intended to accommodate creditors. For instance, in Australia, the law provides that a person cannot begin or continue a proceeding (including a cross-claim or third-party claim) in a court against a bank while a provisional administrator is in control of the bank’s business, unless either the court grants leave on the ground that the person would be caused hardship if leave were not granted, or the bank regulator consents to the proceedings beginning or continuing.295 In Austria, the law declares a stay with respect to prior claims from the beginning of the day following publication of the court order imposing provisional administration on a bank, and permits the court to order that, depending on the bank’s financial condition, prior claims be exempt from the stay for a specified percentage or that the administrator pay off selected prior claims.296 Conversely, in other countries, notably Switzerland, the appointment of a provisional administrator is not a ground for, but rather a consequence of, the institution of a debt-service moratorium for the benefit of banks.297 The difference between provisional administration accompanied by a moratorium and a moratorium accompanied by provisional administration appears to be more one of procedure than one of substance, as the grounds for both are more or less the same and as the order depends on whether the procedure begins with the appointment of a provisional administrator or with the granting of a moratorium.
The timing of the effectiveness of a moratorium is important for payment system operators. This issue is discussed more fully below.298
Provisional administration would normally terminate either when its goals have been achieved and the operation of the bank can be returned to the management appointed by its owners, or when it is decided that it is unlikely that the bank will return to compliance with prudential standards or that the bank should be merged with another institution or be liquidated,299 or that the conditions instrumental for its institution no longer exist.300 The law may provide for the termination of provisional administration when bankruptcy proceedings are instituted against the bank.301
When, in a country where the law provides for regulatory provisional administration as well as regulatory receivership for banks (France, Italy, United States), the provisional administration for a bank fails, the regulator may replace it with a receivership to liquidate the bank.
The foregoing should not imply that provisional administration should last as long as it takes to achieve its goals without time limit. Therefore, it is appropriate for the law to specify deadlines for provisional administration, subject to extension.302 Time limits impose discipline on the process, by prompting the regulator to review the prospects of provisional administration periodically and to act accordingly.
An elegant alternative is found in the banking law of Canada. If, 30 days after the bank regulator has taken control of the bank or its assets, the regulator receives from the bank’s board of directors a notice in writing requesting the regulator to relinquish control, the regulator must, not later than 12 days after receipt of the notice, comply with the request or request the Attorney General of Canada to apply for a winding-up order in respect of the bank.303