**CLAIMS AND RECOVERIES**

**Abstract**

The capacity to manage the assets and liabilities of a failed bank is an
essential part of all effective safety-net systems. In the broadest
sense, it involves disposing of the bank's assets and resolving the
bank's liabilities for the benefit of creditors with *bona fide* claims
against the bank. This paper considers the major objectives,
organisational and resource requirements, and strategies of the
claims-and-recoveries function that arise after a failure-resolution
strategy has been adopted.

The optimal strategy for effectively and efficiently managing the
claims-and-recoveries function is situational, and reflects different
economies, safety-net structures, insolvency regimes, and financial,
legal and political systems. However, the claims-and-recoveries function
is subject to common management processes. These include a feedback loop
of analysis, planning, and execution. In addition, effectiveness and
efficiency likely are best achieved through decisive control and
commercial practice rather than reliance upon legal rights or
bureaucratic procedures.

**CLAIMS AND RECOVERIES**

In the broadest sense, it involves disposing of the bank's assets and
resolving the bank's liabilities for the benefit of creditors with *bona
fide* claims against the bank. This paper, which was prepared by the
Subgroup on Claims and Recoveries, considers the major objectives,
organisational and resource requirements, and strategies of the
claims-and-recoveries function that arise after a failure-resolution
strategy has been adopted.[^1]

In bank failures, claims take several forms. [^2] In the context of
insolvency proceedings, for example, creditors file claims. Claims also
may encompass matters such as legal actions by or against the insolvent
bank, or costs and outlays from financial assistance provided to the
bank by the deposit insurer or another safety-net participant.
Recoveries on these claims are typically derived from the disposition of
the bank's assets, payments by borrowers, and proceeds from legal
actions, including claims against directors, officers, auditors and
other third parties.

The organisation(s) that actually performs the claims-and-recoveries
function varies across jurisdictions, and reflects country-specific
developments beyond the scope of this paper. In most cases, the deposit
insurer will have, at a minimum, a mandate to advance its claims to
recover on deposit insurance payments and possibly other costs. Thus,
irrespective of whether a deposit insurer is responsible for resolving
claims or disposing of the failed bank's assets, it is likely to have an
interest in understanding and possibly influencing the
claims-and-recoveries process in order to achieve its goals.[^3]

The optimal strategy for effectively and efficiently managing the
claims-and-recoveries function is situational, and reflects different
economies, safety-net structures, insolvency regimes, and financial,
legal and political systems. However, the claims-and-recoveries function
is subject to common management processes. These include a feedback loop
of analysis, planning, and execution. In addition, effectiveness and
efficiency likely are achieved best through decisive control and
commercial practice rather than reliance upon legal rights or
bureaucratic procedures.

**Objectives of the** **Claims-and-Recoveries** **Function**

In most countries, claims and recoveries typically involve at least some
of the following objectives: (i) maximisation of recoveries from the
assets of the failed bank; (ii) minimisation of the costs associated
with the failed bank's liabilities and those arising from the failure
resolution; (iii) determination of the most cost-effective strategies;
(iv) contribution to financial-system stability; (v) timely and
equitable payment to creditors; and (vi) contribution to system
discipline by such measures as instituting legal action against errant
officers, directors, auditors, and other parties.

Some objectives may conflict with other objectives. For example, a
mandate to return assets to market promptly may be conditional upon
minimising adverse economic effects. Similarly, pursuing
professional-liability actions for system discipline may be subject to
considerations regarding the financial benefits of reaching early
compromise. Ideally, such trade-offs are considered and agreed upon in
the development of the claims-and-recoveries function in order to
facilitate consensus and coordination on, and commitment to, the
necessary action steps and priorities involved in dealing with a failed
bank.

### 

### Conditions Precedent

###### A number of factors affect the performance of the claims-and-recoveries function. As with any bankruptcy process, bank-insolvency resolution requires clear and enforceable priority-of-claim rules. These establish seniority of various classes of claimants, including depositors' claims. Also important are bank-liquidation and asset-disposition procedures, open-marketing and effective conveyance processes, and an effective and transparent judiciary with expertise in the liquidation of banks.

The powers provided to the organisations responsible for performing the
claims-and-recoveries function also have considerable effect on overall
performance. These powers include control over the assets, contract
rights, and privileges of the failed bank. The ability to allow or
disallow claims, stay litigation, enforce or repudiate certain
contractual obligations, and challenge fraudulent transfers, affect the
performance of the claims-and-recoveries function. Finally, fiduciary
responsibilities may limit the ability of those performing the
claims-and-recoveries function to fulfil other responsibilities and
goals.

**Strategies for Management of the Failed Institution's Assets and
Liabilities**

Although the precise nature of the claims-and-recoveries strategies vary
from country to country, in each case the strategies should be
consistent with (i) the objectives of the safety net, (ii) the economic
and legal environment in which claims-and-recoveries activities are
conducted, and (iii) the organisational form and resources available. In
the absence of a country-wide political consensus on the steps to be
undertaken, claims-and-recoveries activities may be lengthy, inefficient
and ineffective.

The benefits of explicit rules and procedures for handling various
aspects of the claims-and-recoveries function may be particularly
significant in enhancing credibility, increasing market discipline,
prompting action, and thereby minimising costs arising from delay. For
example, regularly updated memoranda of understanding among participants
in the financial safety net help protect the claims-and-recoveries
function from political interference.[^4] In the event of a failure,
explicit policy statements that authorities will not protect creditors
and shareholders beyond pre-specified commitments, also may help manage
expectations.

By contrast, discretion may be beneficial in certain circumstances in
order to achieve public-policy objectives, such as financial-system
stability. Discretion also may be useful in providing a degree of
flexibility that otherwise may be lost when too many aspects of the
claims-and-recoveries function are made explicit.

**Organisation and Resources for the** **Claims-and-Recoveries**
**Functions**

The determination of whether the claims-and-recoveries function should
be performed by public, private, or hybrid organisation(s) is
country-specific. However, it may be guided by an evaluation of which
form is expected to be more efficient and effective in handling claims
and recoveries, and by rigorous application of commercial criteria with
incentives for efficiency. Likewise, the choice of outsourcing or
developing the internal capacity to fulfil the functions of the
claims-and-recoveries function may be facilitated by a consideration of
the frequency, scale, and cyclical nature of projected failures, and the
mandates and objectives of the deposit insurer and other safety-net
participants.[^5]

The identification and development of the capabilities and skills
involved in claims-and-recoveries activities are ongoing processes. In
most countries, professionals are drawn from the insolvency, accounting,
banking, real-estate, information-technology and legal professions.
Although projecting staffing requirements for future failures is
problematic, it is important that those responsible for the
claims-and-recoveries function have both the funding to remunerate and
access---internally or through standby arrangements with external
suppliers---to professionals capable of dealing with projected failures.
Inadequate funding will lead to delay and increased costs.

## 

#### Planning Claims-and-Recoveries Activities

## 

Business plans are a key element of the claims-and-recoveries process.
They provide a strategic framework within which financial and
non-financial performance information is developed and evaluated. Plans
articulate the strategy for maximising the recovery of assets (including
litigation) on a net present-value basis; for employing effective
resources in the liquidation; and for establishing benchmarks for
assessing performance. The goal is efficiency and consistency, with
reliable estimates based on timely, verifiable information and
assumptions.

Ideally, business plans should be updated regularly and cover all major
areas of the claims-and-recoveries function, including claims
processing, asset management and disposition, and forensic-litigation
management. To address large failures and/or multiple failures, it also
is essential to develop contingency plans that mobilise the resources of
internal staff and contractors, as well as coordinate activities of the
safety-net participants.[^6]

#### Maximising Recoveries from Asset Management and Disposition

Asset management and disposition is typically the most visible and the
most expensive activity of the claims-and-recoveries function, and
usually has the greatest effect on recoveries. To ensure that
appropriate strategies are adopted, it is important to evaluate the
assets, in much the same manner as the medical procedures of a hospital
emergency ward, where victims are first classified for treatment on a
priority basis.

On this basis, healthy or performing ("good-bank") assets may be
separated from nonperforming ("bad-bank") assets. The good bank may be
retained as part of a "going-concern" solution, or otherwise marketed as
soon as possible, as they have no "upside" potential. The disposition of
the bad bank may be more problematic in the event of a large overhang of
similar assets, such as unsold real estate, held by other banks and
market participants. In such circumstances, the bad bank may be "worked
out" under professional management with a mandate to maximise
recoveries, after operational and financial costs, precisely because
there is an "upside."

Efficient and effective asset-management strategies reflect the type and
quality of assets being realised, and include tools to validate
valuation assumptions employed in the asset valuation/appraisal process
and business plans. Risks relating to interest rates, market
fluctuations, particular asset-disposition strategies, and
asset-specific and legal issues need to be identified, evaluated,
quantified, managed or hedged. Use of discounted cash-flow analysis or
another appropriate valuation technique is required to ensure that
approaches to claims and recoveries recognise the time value of money,
as well as the risks associated with hold *versus* sell decisions.
Consideration also might be given to the estimated value of the assets
to potential purchasers, each of whom values the assets differently
because of different plans and different financing costs.

Once the assets have been examined and categorised, the timing and
method of disposition may be considered in light of the nature of the
assets being disposed of and the condition of the markets into which
they are being sold, with a view to such objectives as maximisation of
recoveries on a net present-value basis. Other considerations may have
to be balanced against such objectives, including environmental
implications or legislatively mandated policy requirements.

Selling assets at resolution or immediately thereafter has the advantage
of returning assets to the market quickly, as well as replenishing the
deposit insurance fund and minimising government involvement with the
assets. These advantages should be considered against the risk of lower
recoveries and potential resistance from creditors who stand to benefit
from a more lengthy realisation process.

It is vital to maintain the value of those assets that cannot be sold
immediately, or that have been selected for longer-term workout, through
clear asset-management procedures. Even performing loans tend to lose
value unless managed actively. Clearly, the risks of holding for later
sale and the availability of skilled asset-management practitioners need
to be factored into any application of this approach. As well, internal
information and operations systems and procedures will be required to
catalogue and track the assets.

Transparency and access to information are key factors in asset
management and disposition, since marketing the assets to qualified and
interested potential purchasers is likely to stimulate competition and
thereby increase recoveries. The quality of information available to
potential purchasers has an important bearing on prices, so effort is
needed to arrange information in as orderly and complete as possible a
manner to generate greater buyer interest and thereby maximise value.

**Marketing methods**

There is a wide range of methods for marketing the assets of failed
banks, including (i) asset-by-asset sales on a commercial basis; (ii)
auctions; (iii) portfolio sales; (iv) securitisation; (v) workout/
restructuring; and (vi) equity partnerships:

i.  On the premise that retail prices are higher than wholesale, it may
    be better to sell certain assets individually, particularly
    nonperforming assets where the security interest has been realised.
    This permits their sale as appropriate with a marketing program
    tailored to the asset in question. The purchaser may be the end user
    who is often more willing to pay a higher price than the "middleman"
    in a bulk sale. One potential downside to an asset-by-asset sale is
    higher transaction costs.

ii. Auctions by outcry or sealed written bids---including tender bids
    and expressions of interest---have been utilised to facilitate bulk
    or individual-asset sales, sometimes with enhancements such as
    seller financing, representations and warranties. The advantages of
    auctions, which can significantly accelerate the speed of
    recoveries, should be considered against the risks of few bidders
    and low bids.

iii. Marketing assets that have been combined into pools may facilitate
     quick sale, generate market-value returns, and significantly reduce
     both the assets under administration and the resources required to
     manage the assets. As is the case with auctions, consideration
     should be given to the risks of few bidders and low bids.

iv. Securitisation involves packaging similar assets and selling
    portions with rights to cash flows identified by contract, in some
    cases with credit enhancements. As is the case with portfolio sales,
    securitisation may be advantageous in enhancing asset recovery
    values and expediting asset sales. To date, the application of
    securitisation has been most effective in well-developed markets
    with existing markets for asset-backed securities.

v.  Asset-management companies can serve as rapid asset-disposition
    vehicles for bundling and securitising or portfolio sales, and as
    longer-term restructuring or workout agencies to deal with
    nonperforming assets. They also enable a consolidation of skills,
    resources, and uniform workout practices within one agency, thereby
    providing efficiencies in recovering maximum possible value.

vi. Equity partnerships have been an effective method of disposing of
    portfolios of underperforming, nonperforming, and owned real estate.
    In these joint ventures, the agency responsible for recoveries
    provides the assets and financing, and the partners/investors
    contribute equity and assume responsibility for management and
    disposition of the partnership's assets.

In some instances, the method of marketing may be enhanced with vendor
take-back (seller) financing and limited guarantees. Seller financing
may be particularly advantageous in dealing with hard-to-sell assets,
but should be part of a well-thought-out exit strategy. Guarantees
against loss---as well as related put agreements by which a buyer has
the option of returning assets for a refund within a specified period of
time---may be of assistance in completing a transaction. Although
guarantees have the disadvantage of creating contingent liabilities,
such disadvantages can be mitigated by limiting their duration and total
value.

Factors affecting asset management and disposition performance include
general economic conditions, the quality of the assets of the failed
bank, depth of secondary markets, assets subject to competing creditor
claims, and litigation or other proceedings that complicate
realisations. Similarly, the ability to market assets promptly may be
problematic where a failure is sudden, such as failure caused by a rapid
lack of liquidity, where failure occurs across multiple jurisdictions,
or where an asset-valuation review and pricing of assets cannot be
accomplished in advance of failure.

The absence of specialised human resources for the handling of
insolvency issues, including distressed assets, is a challenge for many
countries. Contracting out tasks relating to claims and recoveries
raises the "principal-agent" risk that the agent will not act in the
principal's interest, resulting in below-expectation returns. Where
practical, this risk may be addressed explicitly with measures to align
the interests of the agents with those of the deposit insurer or other
relevant safety-net participant.

Measures designed to align interests include negotiating incentive plans
with receivers or other entities to increase the probability that net
realisations will be in the upper range of projections, measured on a
net present-value basis. Other measures may specify that the liquidation
of assets will be completed by a specific date, that the liquidation
management will focus on the need to minimise costs, and that existing
management expertise will be retained to completion of the plan.

**Maximising Recoveries from Claims and Litigation**

Claims and litigation advanced against other parties by the failed bank
or relevant safety-net participants represent a potentially important
asset on which recoveries may be realised. In some cases, these
activities also are an important tool in fostering greater discipline in
the financial-services sector. For these reasons, potential claims
should be identified and investigated carefully to determine the
appropriateness and potential for recovery (cost/benefit) before being
pursued . Consideration of whether to pursue an action might include an
analysis of the possible defenses, counterclaims, or claims-over that
may be made by the defendants. Once commenced, activities may be refined
or curtailed at appropriate times.

Among the more important claims pursued are professional-liability
claims. These arise in circumstances where the deposit insurer, failed
bank, or another safety-net participant has suffered damages, and there
is information that raises a reasonable case of negligent or wilful
misconduct or wrongdoing by directors, officers, or auditors, or by
other relevant parties. In cases of fraudulent or otherwise patently
egregious behaviour, the results of an investigation also may raise the
possibility of potential criminal proceedings---typically pursued by the
state as opposed to a deposit insurer or other safety-net participants.

### Minimisation of Liabilities

In addition to depositor claims, failed banks typically have a number of
liabilities, such as environmental problems associated with real estate
or businesses owned by the bank, indemnifications or other guarantees,
off-balance-sheet liabilities, and claims against the failed bank.

The claims-and-recoveries function likely will require that claims
against the failed bank are resolved in a fair and cost-effective
manner. This will involve notifying potential claimants of the claims
process, reviewing and resolving asserted claims, distributing dividends
to proven claimants, and transferring unclaimed dividends to the
appropriate state authority.

The resolution of claims against a failed bank can add significantly to
the cost and duration of a liquidation. Such claims may involve a
creditor taking security before failure of a bank; higher ranking or
priority claims;[^7] multi-jurisdictional insolvency issues;
complications arising from a parent/affiliate pursuing significant
claims; and reviewable transactions entered into before failure
resolution.

A particularly important source of cost and delay arises from litigation
instituted by creditors, shareholders, or other claimants and plaintiffs
against the failed bank or the agency that performs the
claims-and-recoveries function. This is the negative side of the
possibility of realising recoveries from litigation, and a crucial
aspect of liability management for those charged with handling claims
and recoveries. For this reason, it is advisable to conduct regular
evaluation of the claims in order to quantify appropriate reserves,
estimate the potential liability exposure, and consider alternative
means for resolution.

**Measuring Performance and Managing Knowledge**

One of the key strategies to be applied to the claims-and-recoveries
function is the creation of a framework to measure and credibly
demonstrate performance, as well as promote continuous learning.
Performance measurement is likely to focus on such criteria as the
least-cost criteria of resolution, as well as on the quality of
management processes, including performance against management's plans,
and performance against quantitative and qualitative industry
standards.[^8]

To be meaningful, performance measures reflect the country-specific
claims and recoveries' objectives, the institutional framework, and
characteristics of the bank failures. Moreover, precisely because the
claims-and-recoveries function is country-specific, it is important to
ensure that the knowledge and experience gained be both captured and
disseminated. In particular, an analysis of each bank failure may be
beneficial in providing guidance for future liquidations and thereby
potentially reducing costs to both the safety net and other creditors.

**Conclusions**

The effectiveness of the claims-and-recoveries function depends on
understanding the problems, matching appropriate strategies with goals
and country-specific conditions, and the level of commitment to achieve
such goals. Above all, careful planning and analysis need to be
complemented by decisive action and the discipline of commercial
practice.

-   The claims-and-recoveries function benefits from clear and
    enforceable priority-of-claim rules, and well-developed bank
    liquidation and asset-disposition procedures supported by the legal
    system. Uncertainty or inequality of treatment of creditor groups
    may jeopardise confidence in the financial system, with attendant
    costs.

###### Coordination among safety-net participants plays an important role in contributing to the efficiency and effectiveness of the claims-and-recoveries function. Where those functions are not consolidated in the hands of the deposit insurer, memoranda of understanding among financial safety-net participants becomes even more critical in facilitating coordination.

-   Once a bank has failed, liquidation of its assets should be pursued
    on the basis of the economic merits. Other considerations---such as
    concern for system-wide stability, or a determination to pursue
    professional-liability actions to enhance business standards of
    conduct---may introduce conflicting objectives and pose trade-offs
    that will need to be addressed.

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-   Success depends upon sufficient organisational, funding, and human
    resources to conduct efficient and effective claims-and-recoveries
    activities. These resources should be consistent with the structure
    of the financial-services sector, and with the frequency and
    cyclical nature of failures. Inadequate funding can lead to delay in
    completing asset dispositions or claims-resolution activities, and
    to a significant extent increases in costs.

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-   Plans are a key element of the claims-and-recoveries process. Plans
    articulate the strategy for maximising the net present-value
    recovery of assets; ensure the employment of effective resources in
    the liquidation; and establish benchmarks for assessing progress and
    performance.

Regular review and reporting to stakeholders on the efficiency and
effectiveness of claims-and-recoveries activities provide a feedback
loop for identifying steps to strengthen supervision and standards of
bank management, and, to validate or revise practices relating to claims
and recoveries as well as failure-resolution methodologies.

[^1]: The capacity to manage the assets and liabilities of a failed bank
    is an essential part of all effective safety-net systems.[^9] See
    the paper on failure resolution, which describes the main issues
    relating to the resolution of troubled banks.

[^2]: Definitions of bank failure tend to be country-specific. In this
    paper, bank failure may be considered to have occurred when one or
    more of the following circumstances obtain: the institution's
    liabilities exceed its assets, it has been placed in administration
    or liquidation, or it has voluntarily sought to wind-up its affairs.

[^3]: ^4^ There is considerable variation in the claims-and-recoveries
    role played by deposit insurers and other safety-net participants.
    Where deposit insurance payments are made upon the liquidation of a
    bank, the deposit insurer usually is subrogated to the rights of the
    insured depositors, and is likely to file and actively manage the
    claim arising from the deposit insurance payment. In some instances,
    deposit insurers have broader roles in risk-minimisation or recovery
    processes, for example as lender, creditor, or possibly as receiver.
    In other cases, these functions are the responsibility of other
    entities, including central banks.

[^4]: Coordination between safety-net participants is the subject of a
    paper on interrelationships.

[^5]: A more comprehensive review of this subject, as it pertains to
    deposit insurance systems, may be found in the paper on structure
    and organisation.

[^6]: For an elaboration on this point, see the paper on
    interrelationships.

[^7]: Creditor ranking is discussed more fully in the paper on depositor
    priority.

[^8]: Qualitative benchmarks might include performance in closure of the
    bank, management of cash, claims processing, and litigation.
    Quantitative benchmarks likely would focus on such issues as speed
    of asset disposition, yield on asset realisations, overhead costs,
    and the net present value of recoveries/losses.