The Supreme Court agreed yesterday to decide whether banking laws require the Federal Deposit Insurance Corp. to insure a "letter of credit" just as it insures any deposit.
A letter of credit from a bank guarantees payment to a third party who sells goods to the bank's customer.
Acting in a case involving the failed Penn Square Bank of Oklahoma City, the 10th U.S. Circuit Court of Appeals said last December that the FDIC must pay claims involving such letters because they are equivalent to deposits.
The FDIC appealed, saying the ruling would require the FDIC for the first time to insure "almost $120 billion worth of outstanding standby bank letters of credit, while making banks liable for more than $100 million in additional annual insurance assessments."
The FDIC, joined by the Council on International Banking, said the ruling would also "play havoc with the multibillion-dollar market in industrial revenue bonds, which may lose their tax-exempt status if backed by an FDIC-insured letter of credit."
The case involves a standby letter of credit issued by Penn Square on behalf of Orion Manufacturing Corp. to Philadelphia Gear Corp. Philadelphia Gear supplied Orion with parts for its drilling-equipment production. Philadelphia Gear, citing defaults by Orion, attempted to collect from Penn Square.
After Penn Square was declared insolvent in 1982, Philadelphia Gear tried to collect from the FDIC, maintaining that it was in effect a depositor and entitled to the maximum $100,000 insurance.
A district court agreed, finding that the letter was backed by a promissory note and therefore was insured by the FDIC.
The appeals court upheld that ruling, saying that Congress intended to include standby letters of credit, which are not backed by deposits, in the deposit insurance program.
The FDIC argues that it never has treated such letters as deposits and never has insured them, and that Congress never has challenged its interpretation of the 1935 law.
"The court of appeals' decision is based on several fundamental misconceptions," and it "disregards both economic reality and the purposes of the Federal Deposit Insurance Act," the FDIC said.
Attorneys for Philadelphia Gear said that the "case presents a simple question" of the 1935 law, that the district and appeals courts agreed, that the law clearly intended to have the FDIC back such letters and that Penn Square was directly liable for payment.
"The importance of the decision by the 10th Circuit has been greatly exaggerated by the FDIC," Philadelphia Gear argued, saying "there are no statistics available to determine the outstanding amount of such standby letters of credit."
A decision in the case, Federal Deposit Insurance Corp. v. Philadelphia Gear Corp., is expected this spring.