Case Highlights Importance of ‘Robust Creditor Protections,’ Upholds Key Banking Law Principles

A recent Supreme Court of Virginia decision in favor of FVCbank provides valuable lessons for bankers and could have an impact on banking law outside the state, representatives of the bank and its legal team said.

Michael Nassy, EVP and Chief Credit Officer at FVCbank, said the methodical and thorough way the bank approached legal filings and security agreements throughout its relationship with a borrower was key to the positive outcome for the bank. Moving forward, the bank’s legal representatives said, the high court’s strongly worded opinion in the bank’s favor makes a bank’s rights in an equitable subrogation case clear.   

This article provides an account of the case, plus analysis and useful takeaways.  

The Facts of the Case

In Arch Insurance Company vs. FVCbank, Arch, an issuer of surety bonds, appealed a Fairfax County Circuit Court decision in FVCbank’s favor to the high court. After considering the facts in the case—in which Arch argued that FVCbank engaged in unjust enrichment by freezing the accounts of a borrower whose work was insured by Arch—the high court upheld the ruling in favor of Fairfax, Virginia-based FVCbank. In its opinion the high court said FVCbank’s acquisition of several security and legal protections was key to its decision.

According to the Supreme Court of Virginia’s opinion, FVCbank granted an $8 million revolving line of credit to Dominion Mechanical Contractors, Inc., a subcontractor and contractor for mechanical and plumbing work for various construction projects. FVCbank first obtained a security interest, a security agreement, and a collateral assignment and security agreement in 2017 as part of the credit line agreement. The security agreement granted FVCbank a first priority security interest in all of Dominion’s “presently existing or hereafter acquired or created accounts,” the high court noted. Additionally, FVCbank filed a UCC-1 financing statement reflecting the bank’s security interest.

The credit line agreement defined collateral as “all property of [Dominion] subject from time to time to the liens of this agreement” and any of the loan documents, the opinion said, so it included Dominion’s “deposit accounts with any financial institution.” The credit line agreement also said Dominion would trigger a default if it failed to comply with certain covenants, entitling FVCbank to remedies including declaring outstanding loan obligations due.

In 2018, Arch issued surety, or “payment and performance,” bonds for some Dominion projects. Surety bonds, paid for by the contractor, compensate a contractor’s customers and counterparties if the contractor does not fulfill its obligations. Another element of the relationship between Arch and Dominion, and one that Arch leaned on heavily in the case, was that Dominion assigned all its rights under bonded contracts to Arch in the event of Dominion’s default.

In July 2019, Arch requested that all revenue through Dominion’s bonded work be deposited in a separate trust account so that it would not have a contest with FVCbank over those funds. A separate trust account was not opened at that time.

By August 2019, after FVCbank spent months working with the borrower, Dominion was in default under the terms of its credit facilities. In accordance with the loan documents, FVCbank accelerated on Dominion’s deposit accounts, sweeping approximately $2.5 million of Dominion’s accounts to pay down a portion of the term loan and the line of credit. Arch and Dominion then sued the bank, claiming conversion and unjust enrichment. Arch argued that all funds related to Dominion’s work that was bonded by Arch should have been kept in a separate trust account and remitted to Arch, citing Dominion’s subrogation agreement to grant all its rights under bonded contracts to Arch in the event of Dominion’s default.

FVCbank argued that since Dominion was in default, the bank’s security interest took priority over any claim by Arch.

In the circuit court case, Arch sought to call an expert witness to testify about the tracing of bonded funds from Dominion’s accounts. The bank objected, saying testimony regarding tracing was irrelevant, because as a matter of law all the funds, bonded or not, were commingled and the bank had a priority interest in the accounts. The circuit court granted the objection and the Supreme Court of Virginia agreed. In its opinion, the high court noted that in a previous case—Williams v. Dickenson County Bank, Inc., 175 Va. 359, 363-64 (1940)—the court held that “[i]n the absence of a clear agreement to the contrary, expressed or implied, a deposit is presumed to be a general deposit.”

As for Arch’s subrogation rights, the high court found that they were not relevant, either. The high court noted that subrogation refers to “[t]he substitution of one person in the place of another with reference to a lawful claim, demand, or right.” The court said, “Arch only obtained Dominion’s right to the deposit accounts—a right Dominion had already signed away.”

Further, the court said, Arch’s security interest in the deposit accounts was not perfected. Likewise, Arch did not have a perfected interest in the proceeds from the bonded contracts because Arch did not file a UCC financing statement covering the original bonded contract funds.

Outcome

In issuing its decision, the Supreme Court of Virginia said, “The circuit court correctly concluded that FVCbank’s interest in Dominion’s deposit accounts took priority over Arch’s interest as a matter of law.”

The court also said there was “no dispute on appeal that Dominion was in default when FVCbank offset the deposit accounts against Dominion’s outstanding debt. FVCbank had a superior interest in Dominion’s deposit accounts under both the UCC and the doctrine of equitable subrogation.”

“In sum,” the opinion noted, “because FVCbank had a superior claim to Dominion’s deposit accounts over Arch, the circuit court did not err in granting the bank’s motion to strike as to conversion and unjust enrichment.”

In affirming the judgment of the circuit court, the high court dismissed the case against FVCbank with prejudice.

In addition, said Edward “Sunny” Cameron, a partner in the Virginia-based Cameron/McEvoy PLLC, who represented FVCbank, the bank was successful in a counterclaim against Arch. Cameron said Arch had interfered in the bank’s efforts to collect outstanding accounts receivables that were owed to Dominion, including for projects that were not bonded by Arch, by telling Dominion’s debtors that the money the bank was seeking to collect was owed to Arch. The bank was awarded about $100,000, Cameron said.

Analysis

DeMarion Johnston, counsel for the Virginia Bankers Association, said FVCbank put itself in a strong legal position by including “robust creditor protections” in a loan agreement that “clearly defined the terms of their relationship.”

Noteworthy as well, she said, was that “the bank also filed a UCC financing statement in favor of FVCbank that covered all of Dominion’s bank accounts and accounts receivable. The bank and the borrower also entered into a commercial promissory note, a security agreement, and a collateral assignment and security agreement.”

“This case reinforced the legal principle under Virginia law that when a person obtains a right through subrogation, that person is placed in the shoes of its subrogor and can have no greater rights than those of the subrogor,” she said. The case also had implications for other banking law, Johnston said, prompting the Virginia Bankers Association to file an amicus curiae brief.

Importantly, she said, the high court upheld that:

• The relationship between a bank and a depositor is that of debtor and creditor, and not a fiduciary relationship.
• In the absence of a clear agreement to the contrary, expressed or implied, a deposit is presumed to be a general deposit.
• A bank has the right to offset funds in a general deposit account, including commingled deposits, against an outstanding debt.

“The bank dotted its i’s and crossed its t’s going back to 2017,” Cameron said. “Arch came in a full year later knowing the bank had a prior security interest.”

Another attorney for FVCbank, Monica Monday, said it put “excellent planning and thought into the relationship and understood Dominion’s business.” She said that in its opinion, the high court was effectively saying that FVCbank “did everything right and there is no reason Arch should be able to come in and to recast an established contractual relationship.” Monday, head of the appellate practice at Virginia-based Gentry Locke, also said the case could “become persuasive authority for banks to be used outside Virginia in similar situations where there is a battle over who owns the funds on deposit.”

Takeaways

Johnston said the case is a reminder to “invest in well-drafted agreements, collateralize loans, and perfect the bank’s security interests in pledged collateral.”

Monday said the case also points up that the “construction industry has volatility that other industries don’t. Banks need to be vigilant about what’s happening with the financial situation of their construction-industry customers and appreciate that there probably is a surety issuing some kind of bond.” Banks need to know “what the rights of the surety are if it becomes a three-party relationship—the bank, the borrower, and the surety,” she said.  

Nassy said, “Bankers should ensure they are monitoring their borrowing base certificates continuously. And despite the fact that there are exclusions,” he said, “your blanket UCC and loan documents are what ultimately protect you if a clear, express trust has not been established.”