A federal court has rejected an attempt by former First Republic Bank employees to recover assets held in a rabbi trust that funded deferred compensation benefits. In Harrington v. Federal Deposit Insurance Corporation, the court found that the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) established an absolute bar to any action that restrains or affects the ability of the FDIC to fulfill its receivership duties, including the plaintiffs’ attempt to recover their benefits.

In Harrington, a group of former First Republic Bank employees participated in nonqualified deferred compensation plan (“NQDCP”) that was funded by assets, including bank-owned life insurance, which were held in a so-called “rabbi” trust. The trust assets also included amounts attributable to the employees’ elective deferral of their current compensation. Under the tax structure applicable to a nonqualified plan, plan participants must be treated as unsecured creditors in the event of the employer’s insolvency. However, many plans, including the First Republic plan, set aside assets in a special trust, known colloquially as a rabbi trust, to fund the employer’s obligation under the plan. While the assets of a rabbi trust are available to the employer’s creditors in the event of insolvency, the terms of the trust generally prevent the employer from diverting the trust assets to fund the employer’s day-to-day expenses.

The plaintiffs brought a series of claims under California law and common law (quiet title, conversion, and constructive trust), arguing that the FDIC, as receiver for First Republic, was barred from using the trust assets to settle claims arising out of the bank’s failure. The plaintiffs also sought a declaratory judgment that only the plaintiffs could recover directly from the trust assets. Further, the plaintiffs argued that they were entitled to a determination as to whether the trust assets were outside of the receivership estate, presumably on the theory that the court would find that the plaintiffs, and not the FDIC, were the owners of the trust assets.

However, the court accepted the FDIC’s argument that it lacked jurisdiction to consider the plaintiffs’ claims. Under 12 U.S.C. §1821(j), which was added by FIRREA, courts are barred from taking any action that restrains the powers or functions of the FDIC as the receiver of a failed financial institution so long as the FDIC is acting within the scope of its permitted functions or powers. In Harrington, the court invoked Section 1821() as an absolute jurisdictional bar to the court’s review of the plaintiffs’ claims. Granting the relief sought by the plaintiffs would, the Court found, directly impinge on the agency’s broad receivership powers in direct conflict with Section 1821(j). Further, the court found that the FDIC’s mere possession of the disputed assets was sufficient to foreclose any inquiry into the ownership of the assets, pointing to the agency’s broad authority under 12 U.S.C. §§1821(d)(13)(C) and 1825(b)(2) to wind up the affairs of a failed institution without judicial interference.

Harrington illustrates the danger of the NQDCP structure when the plan sponsor becomes insolvent. To benefit from the favorable tax consequence associated with NQDCPs, including elective deferral plans and supplemental retirement plans, the plan participants must always be unsecured creditors in the event of insolvency, and any assets set aside to informally fund the plan sponsor’s obligations under the NQDCP must be available to creditors. While the rabbi trust structure may provide a sense of security for plan participants, particularly in a change in control context, the plan sponsor’s insolvency effectively exposes the trust assets to the plan sponsor’s creditors, and plan participants are forced to join the line of unsecured creditors. It is noteworthy, however, that the court in Harrington analyzed the claim solely by reference to the scope of the FDIC’s receivership powers without recognizing that the basic structure of NQDCPs was, standing alone, an effective bar to the plaintiffs’ claim.