Federal Deposit Insurance v. Philadelphia Gear Corp.

Background

Orion Manufacturing applied for a standby letter of credit from Penn Square Bank to guarantee payment to a seller, Philadelphia Gear. Orion also signed an unsecured promissory note labeled "Back up Letter of Credit" but Orion and the bank agreed nothing was due on the note unless Philadelphia Gear presented unpaid invoices and a draft. Penn Square became insolvent on July 5, 1982. Philadelphia Gear presented drafts for over $700,000; the FDIC, as receiver, returned the drafts unpaid. Lower courts treated the letter as insured, and the Supreme Court granted review.

Reasoning

The question was whether a standby letter of credit backed only by a contingent promissory note counts as an insured "deposit" under the federal statute defining deposits. The Court deferred to the FDIC's long-standing interpretation and emphasized Congress's goal to protect "hard earnings" or assets actually entrusted to banks. Because the backup note did not surrender noncontingent assets to the bank and the bank had not treated the obligation as a deposit liability, the Court held the arrangement did not create an insured deposit. The Court noted Congress had repeatedly reenacted the deposit definition without disavowing the FDIC's practice and therefore reversed the lower courts.

Real world impact

Sellers who rely on standby letters of credit backed only by contingent notes may not be entitled to FDIC insurance after a bank failure. Banks and the FDIC may continue to treat such standby credits as contingent liabilities rather than insured deposits. The decision preserves a distinction between commercial letters of credit backed by unconditional assets (which the FDIC concedes could be insured) and standby arrangements tied to contingent obligations.

Dissents or concurrances

Justice Marshall, joined by Justices Blackmun and Rehnquist, dissented. He argued the statute plainly treats letters of credit backed by promissory notes as deposits. He said Orion's note was negotiable and an unconditional promise to pay, making it equivalent to money and thus within the statute.