In a judgment delivered on 21 July 2023 (In the Matter of Silicon Valley Bank (Unreported, Grand Court, FSD 163 of 2023 (DDJ), 21 July 2023)), the Honourable Justice Doyle wound up Silicon Valley Bank as a foreign company registered under Part IX of the Companies Act. This represents a significant first step towards potentially preventing the interests of customers of the Cayman branch of the bank being relegated behind US customers in this multi-jurisdictional liquidation and looks to have set the stage for an epic battle between the Cayman liquidators and the US Federal Deposit Insurance Corporation as receiver."
When the 'black swans' glided onto the ice lake of the crypto-winter of 20221, the fate of Silicon Valley Bank (SVB), the 16th largest bank in the United States, was already sealed.
SVB had an over-concentration in the rapidly cooling technology sector, together with a high proportion of large deposits (often of VC and PE funds for tech and crypto investment) well in excess of the FDIC insured deposit level of USD250,000, making the bank particularly susceptible to a 'run'. Compounding its troubles, SVB found itself chronically out of position when relentless interest rates hikes caused large unrealised losses on Treasury bills, which then needed to be sold rapidly – realising the losses – to seek to meet the wave of customer withdrawal requests. SVB customers sought to withdraw 81% of all of the bank's deposits in a 2-day period, the run being accelerated by the rapid spread of rumours about the bank's solvency on social media.
SVB was not alone in this. SVB's failure came two days after another major US technology-focused bank, Silvergate, had announced plans to wind-down and liquidate. Two days after SVB failed, Signature Bank failed in New York, due to a run caused by customer-concerns over the bank's over-exposure to the tech/crypto sector. Shortly after, another Californian bank, First Republic, also failed, the Federal Deposit Insurance Corporation (FDIC) intervening, selling First Republic to JP Morgan.
The FDIC operates the US bank resolution regime for US insured depositary institutions, a special type of insolvency code operating outside of ordinary bankruptcy processes, having been introduced as part of the deposit insurance program in the US Banking Act 1933, following the failure of over 15,000 US banks in the Great Depression. In addition to the aims of ordinary insolvency processes – to maximize value and minimize losses for creditors, and to determine priorities and manage distributions; bank resolution aims to reduce the systemic risk of contagion, maintain public confidence in the financial system, and promote financial stability. When assessing creditor claims that have been filed, the FDIC is usually the party with the most financially at stake, being the subrogated owner of the insured depositor claims which it has paid out, which have priority over other creditor claims under the 'depositor preference rule.' The FDIC therefore has a strong incentive to deny, avoid, or set aside, conflicting creditor claims when it is evaluating submitted claims.
As outlined below, the FDIC has also become a protagonist in the ongoing drama of SVB's insolvency, being appointed as receiver over all of SVB's assets. This article examines the tension between the FDIC's actions and the expectations of depositors of SVB's Cayman Islands branch.
The Reach of the FDIC
In a Final Rule issued by the FDIC in September 2013, its stated position was that foreign branch deposits of US banks are not insured by the deposit insurance fund (DIF): "deposits in branches of U.S. banks located outside the United States are not FDIC-insured deposits."1 The DIF is paid for by levies on the US banking industry, and is supported by a line of credit from the US Treasury. The insurance limit is USD250,000 per person, per insured account, per institution; and it is seen as both protecting depositors in the event of failure, but also as acting as an important disincentive for customers to 'run' the bank. The USD250,000 limit can be disapplied where the systemic risk exception has been invoked, as it was in SVB's case, at least in respect of SVB's US depositors.2
In the September 2013 Final Rule, the FDIC also confirmed that foreign branch deposit holders would generally not qualify as deposits for the purpose of the 'depositor preference rule,' which gives priority to deposits over other unsecured creditors in the FDIC's distribution scheme on a bank resolution.3 On one view4, this could be said to be a violation of international law by effecting an extraterritorial jurisdiction in an unreasonable manner, and an interpretation to avoid that outcome would better be adopted.
The approach taken in the Cayman Islands to the equivalent issue under Cayman law, is to treat all depositors equally regardless of nationality: see e.g. Re Caledonian Bank 2015 2 CILR 8 at 107 – 110. This dichotomy of treatment has become a focal point in the liquidation of the Cayman Islands branch of SVB.
Liquidation of SVB's Cayman Island Branch
SVB was founded in 1983 and operated in 15 US states and over a dozen international jurisdictions. While SVB was incorporated under the laws of California, it was later registered as a "foreign company" in Cayman under Part IX of the Companies Act and established a branch in Grand Cayman (Cayman Branch).
On 10 March 2023, SVB was closed by the California Department of Financial Protection and Innovation and the FDIC was appointed as receiver over all of its assets and operations. Shortly thereafter, FDIC announced that all deposits and substantially all assets of SVB had been transferred to Silicon Valley Bridge Bank NA (Bridge Bank) and that depositors and borrowers will automatically become customers of the Bridge Bank. FDIC further stated that "all depositors of SVB would be made whole."5 In order to protect their position, however, the Petitioners presented a winding up petition to the Grand Court. Section 91(d) of the Companies Act empowers the Court to make a winding up order in respect of a foreign company which, inter alia, has property located in Cayman, is carrying on business in Cayman or is registered under Part IX. Relevantly, a company may be wound up by the Court if it is unable to pay its debts.6 Referring to Re Drax Holdings Ltd,7 the Court held that the three core requirements for winding up a foreign company were satisfied:8
- SVB had a clear and sufficient connection with Cayman. It had an active branch in Cayman, entered into contracts governed by Cayman law, took Cayman deposits and is regulated by the Cayman Islands Monetary Authority.
- There is a reasonable possibility of a benefit to the Petitioners if a winding up order is made. An investigation of the status of the Cayman depositors, if successful, would accrue a clear benefit to the Petitioners (i.e. the possible claw back of funds once held by the Cayman Branch from FDIC).
- The Petitioners were either Cayman entities or had submitted to the jurisdiction.
Those core requirements being satisfied, the Court went on to hold that there was also overwhelming evidence of an inability to pay debts.9 On that basis, the Court ordered the winding up of SVB, but noted that it would also have done so on a just and equitable basis.10
The Court acknowledged that it should have due regard to issues of comity between the courts of the United States and the courts of Cayman,11 but found that "the position of the Cayman depositors needs to be investigated further and where appropriate safeguarded."12 The Court going on to say that an investigation needs to take place in respect of the apparent removal of any monies and assets from the Cayman Branch out of the jurisdiction.
In July 2023, the Grand Court of the Cayman Islands appointed Joint Official Liquidators (JOLs) to SVB.13 As outlined below, given the approach taken by the FDIC, the appointment of the JOLs sets up, in the Court's own words, "a battle looming in respect of the treatment of the American and Cayman depositors" of SVB.14
Unhappily for the Petitioners and other depositors of the Cayman Branch, FDIC subsequently informed them that balances held in accounts at the Cayman Branch are not deposits under the relevant US legislation and that the Petitioners would be treated as general unsecured creditors of SVB. FDIC then appears to have caused the transfer of all funds in the Petitioners' accounts in Cayman to be transferred to the Bridge Bank, without the Petitioners' authorisation. The Petitioners inferred that all of the assets of SVB, including the funds that had been held in their accounts at the Cayman Branch, will be applied by FDIC to pay claims of creditors of SVB, including US depositors whose claims will apparently be paid in full priority to the depositors of the Cayman Branch.
Therefore, contrary to the equal treatment of Cayman and foreign depositors in Cayman liquidations, in the case of SVB (i) Cayman depositors are being discriminated against relative to similarly situated US depositors, by not being treated equally; and (ii) the preferential claims of depositors (as defined by FDIC) will likely not be fully settled by assets and recoveries.
The potential for a significant battle arises here as, rather than a winding up in Cayman in respect of a foreign company being brought by the US FDIC Receiver as the relevant foreign appointee in the place of incorporation,15 the SVB petition was brought by customers of the Cayman Branch who felt their interests were being relegated behind those customers in the US, being the jurisdiction of incorporation.
The key question is whether the Cayman liquidators (Cayman JOLs) will follow the FDIC approach or whether the Cayman JOLs, supervised by the Cayman Court, will adopt a position that is perhaps more protective of those doing business in the Cayman Islands. Indeed, Justice Doyle was persuaded that the necessary hurdle16 of there being a reasonable possibility of benefit to those applying for the winding up order was satisfied on the basis that "the liquidators can investigate the matter and can take action to establish the status of the Cayman depositors."17
Whilst in an ancillary liquidation where the ancillary common law Court considers there are sufficient protections for local creditors and they are being treated equally, the net proceeds of the ancillary liquidation will be remitted to the representatives in the place of incorporation; given the removal of assets from the jurisdiction and the positions adopted by the FDIC on both (i) whether to provide coverage for the branch deposits; and (ii) the position of the Cayman branch depositors in the distribution waterfall in the FDIC resolution process, the Cayman JOLs' and the branch creditors; and the FDIC Receiver, do seem set to be considerably antagonistic to one another. This may very well lead to the Cayman JOLs and/or the branch creditors challenging the FDIC's actions as above, as well as taking action to attempt to bring assets back to Cayman, and to run a territorially ring-fenced Cayman liquidation process for the benefit of the branch creditors. Should the Cayman JOLs decide to take such action, any such attempt will almost certainly be hotly contested given the interests of the US customers and involve complex questions of cross-border insolvency law, with the FDIC having already notified the Grand Court that it will not submit to its jurisdiction.18
Whilst the outcome in terms of an improved position for the Cayman SVB branch creditors remains to be seen, the decision by the Grand Court of the Cayman Islands to appoint liquidators over a foreign bank for the purpose of carrying out investigations aimed at protecting their interests is a significant first step towards preventing those interests continuing to be relegated in a multi-jurisdictional liquidation.
If the ultimate result of the Cayman customers bringing a petition in the Cayman Islands to wind up SVB as a foreign company is that (i) the FDIC or the US Courts decide to treat the Cayman branch depositors equally with US depositors, both on coverage and distribution priority; and/or (ii) assets are brought back to the Cayman Islands for their benefit, that would be a significant win for the customers of the Cayman Branch.
Footnotes
1. The Terra/Luna coins collapse in May 2022, Celsius Network's failure in June 2022, the Three Arrows bankruptcy in July 2022 and the failure of FTX in November 2022.
2. Summary of Rule in Federal Register 13 September 2013 – 2013-09-13_final-rule.pdf (fdic.gov)
4. Until 1993, depositors were not prioritized in the FDIC distribution scheme above general unsecured creditors.
5. Curtis, The Status of Foreign Depositors Under the Federal Depositor Preference Law (2000) U. Pa. J. Intl. Econ L 237: The Status of Foreign Deposits under the Federal Depositor-Preference Law (upenn.edu) at 256-258
6. FDIC: PR-19-2023 3/13/2023, however, state that "The purpose of the Final Rule is to protect the DIF against the liability that it would otherwise face as a potential global deposit insurer, preserve confidence in the FDIC deposit insurance system, and ensure that the FDIC can effectively carry out its critical deposit insurance functions...extension of deposit insurance to foreign branch deposits could potentially compromise the DIF, and by implication, the U.S. Government, which provides a full faith and credit backing to the deposit insurance guarantee. This threat is aggravated by the higher deposit insurance limits the FDIC provides in contrast with the deposit insurance systems of many other countries. There is no indication that Congress ever intended the DIF to have global liability."
7. Companies Act, section 92(d)
8. [2004] 1 WLR 1049.
9. At [55]-[59].
10. At [62].
11. At [63].
12. At [60].
13. At [63].
14. In the Matter of Silicon Valley Bank (Cayman Islands Branch) (Unreported, 21 July 2023, Justice Doyle).
15. At [63].
16. Which was unnecessary from its perspective given the positions adopted, and the particular need for speed of action to calm the market in circumstances of systemic risk in a bank resolution context, see note 4 above.
17. Justice Doyle followed the English law approach summarized in Re Drax Holdings Ltd [2004] 1 WLR 1049 that three 'core requirements' must be satisfied before a foreign company can be wound up: (1) there must be a sufficient connection with Cayman which may, but does not necessarily have to, consist of assets within the jurisdiction; (2) there must be a reasonable possibility, if a winding up order is made, of benefit to those applying for the winding up order; and (3) one or more persons interest in the distribution of assets of the company must be persons over whom the court can exercise jurisdiction.
18. At [57]
19. At [49].
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
