Title II - Orderly Liquidation Authority
Sections 202 and 203 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) sets forth a three-part procedure for an “Orderly Liquidation” of certain “covered” financial companies.
Orderly Liquidation Procedure. First, the Board of Governors of the Federal Reserve System (the Board) or the Federal Deposit Insurance Corporation (the FDIC) alone, or at the request of the United States Secretary of the Treasury (the Treasury Secretary), must determine that the financial company (defined below) is in default or in danger of default (also defined below) such that the Treasury Secretary should appoint the FDIC as receiver. The recommendation must be made with not less than a two-thirds majority vote of each of the Board and the board of directors of the FDIC. If the financial company is an insurance company – or if an insurance company is the largest United States subsidiary of a financial company, the determination of default or in danger of default must be made by the Director of the Federal Office of Insurance and the Board, alone or at the request of the Treasury Secretary, and in consultation with the FDIC. If the financial company is a broker or dealer – or if the largest United States subsidiary of the financial company is a broker or dealer, the determination of default or danger of default must be made by the Board and the Securities and Exchange Commission (the SEC), alone or at the request of the Treasury Secretary, and in consultation with the FDIC. In any case, the recommendation must contain, among other findings: (1) an evaluation of whether the financial company is in default or in danger of default; (2) a description of the effect of a default on financial stability in the United States; (3) a description of the effect that the default would have on economic conditions or financial stability for low income, minority, or underserved communities; (4) a recommendation of actions to be taken; and (5) an evaluation of why a case under the Bankruptcy Code1 is not appropriate.
Second, the Treasury Secretary, after consultation with the President, must reach a number of conclusions, including that: (1) the financial company is in default or in danger of default; (2) the financial company’s failure and its resolution under otherwise applicable federal or state law would have serious adverse effects on financial stability in the United States; (3) no viable private sector alternative is available to prevent default; and (4) any action taken under the resolution authority would avoid or mitigate those adverse effects.
Third, upon such determinations by the Treasury Secretary, the Treasury Secretary is required to notify the FDIC and the financial company. If the financial company acquiesces or consents to the appointment of the FDIC as receiver, the Treasury Secretary is authorized by Section 202 to so appoint the FDIC.2 If the financial company does not acquiesce or consent to the appointment of the FDIC as receiver, the Treasury Secretary is required to file a petition under seal to the U.S. District Court for the District of Columbia (the District Court) for an order authorizing the Treasury Secretary to appoint the FDIC as receiver. After notice to the financial company and a hearing at which the financial company may oppose the petition, and a determination by the District Court that the determination of the Treasury Secretary is not arbitrary and capricious, the District Court will issue an order authorizing the Treasury Secretary to appoint the FDIC as receiver. If the District Court finds that the Treasury Secretary’s determination is arbitrary and capricious, it is required to inform the Treasury Secretary in writing of each reason supporting its decision and permit the Treasury Secretary to refile the petition. If the District Court does not make a determination within 24 hours of receipt of the original filing, then the petition is deemed granted by operation of law. The FDIC will be appointed as receiver, and the liquidation procedures will automatically begin without further notice or action. The Act provides for a limited right of appeal as to the arbitrariness and capriciousness of the decision of the Treasury Secretary to the United States Court of Appeals for the District of Columbia and ultimately to the U.S. Supreme Court on an expedited basis. The District Court is required to establish rules not later than six months from the enactment date to ensure the orderly conduct of proceedings, including rules to ensure that the 24-hour decision deadline is met.
If the covered financial company is a broker or dealer, the FDIC, pursuant to Section 205 of the Act, must appoint the Securities Investor Protection Corporation (SIPC) to act as trustee for liquidation under the Securities Investor Protection Act of 19703; however, SIPC will not have powers or duties with respect to assets and liabilities transferred by the FDIC to a bridge financial company or with respect to certain other enumerated actions that may be taken by the FDIC as receiver.
Financial Company. Section 201(11) of the Act defines a financial company as a company that is incorporated or organized under any provision of State or Federal law and is: (1) a bank holding company as defined under the Bank Holding Company Act of 1956;4 (2) a nonbank financial company supervised by the Board under Section 101(a)(4)(D) of the Act; (3) any company that is predominantly engaged in activities that the Board has determined are financial in nature or incidental thereto for purposes of Section 4(k) of the Bank Holding Company Act, which would include among other companies, insurance companies, broker or dealers, and investment advisers; and (4) any subsidiary of such named companies that is predominantly engaged in activities that the Board has determined are financial in nature or incidental thereto for purposes of Section 4(k) of the Bank Holding Company Act (other than a subsidiary that is an insurance company or an insured depository institution). An insured depository institution, a Farm Credit System institution chartered under and subject to the provisions of the Farm Credit Act of 1971, a governmental entity or a regulated entity as defined under Section 1303(20) of the Federal Housing Enterprises Financial Safety and Soundness Act of 19925 are deemed either not to be financial companies or not subject to the orderly liquidation provisions of the Act.
An insurance company is defined as an entity that is: (1) engaged in the business of insurance; (2) subject to regulation by a State insurance regulator; and (3) covered by a state law designed specifically to address liquidation, insolvency or rehabilitation of an insurance company. Under the Act, insurance companies, but not their non-insurance company affiliates or subsidiaries, are excepted from the Act’s resolution provisions and instead, rehabilitation, or liquidation of an insurance company, will be conducted under applicable State law.
Predominantly Engaged. For purposes of determining whether a company is predominantly engaged in financial activities, Section 201(b) of the Act establishes an 85% test such that no company will be deemed to be engaged in activities that the Board has determined to be financial in nature or incidental thereto unless the consolidated revenues of the company from such activities constitute 85% of the total consolidated revenues of the company, including consolidated revenues derived from the ownership or control of a depository institution. The FDIC, in consultation with the Treasury Secretary, is required to promulgate regulations to effect the calculation of consolidated revenues.
Default or in Danger of Default. The Act defines a financial company as being in default or in danger of default as: (1) a case has been or likely will be promptly commenced against the company under the Bankruptcy Code; (2) the financial company has incurred or will likely incur losses that will deplete all or substantially all of its capital, and there is no reasonable prospect of avoiding the depletion; (3) the company’s assets are or likely will be less than its obligations to creditors and others; or (4) the company is unable or will be unable to pay its obligations (other than bona fide disputes) in the normal course of its business.
Other Insolvency Laws. Section 208 of the Act provides that once the FDIC is appointed receiver (or SIPC as trustee for a broker or dealer), several mandated actions take place including dismissal of pending Bankruptcy Code (or Securities Investor Protection Act) cases or proceedings with respect to the covered financial company and re-vesting of assets in the covered financial company as a result of a proceeding commenced under the Bankruptcy Code, the Securities Investor Protection Act or any similar state liquidation statute, provided that any court order or other relief granted by a bankruptcy court prior to the appointment of the FDIC as receiver will remain valid.6
FDIC’s Broad Resolution Authority. The stated purpose of the Act, as set forth in Section 204, is to provide “necessary authority to liquidate failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.” To that end, the Act contains three additional requirements for the liquidation: first, creditors and shareholders will bear the losses; second, management responsible for the financial company’s condition will not be retained; and third, the FDIC and other appropriate agencies will take steps to recoup losses from parties, including management, who have responsibility for the condition of the financial company. Therefore, Section 206 requires that: (1) the FDIC determine that action taken under its authority is taken for purposes of the financial stability of the United States and not for the purpose of preserving the financial company; (2) shareholders will not be paid until after all other claims and the Orderly Liquidation Fund (discussed below) have been repaid in full, that unsecured creditors will bear losses in accordance with the claim priorities contained in the Act; (3) directors and management responsible for the failed condition are removed; and (4) the FDIC not take an equity interest or become a shareholder of any covered financial company or covered subsidiary. Section 210 of the Act gives the FDIC as receiver broad resolution authority, including:
- Operation of the company
- Exercising functions as stockholder, director and officer
- Removal of management responsible for the company’s condition
- Self-appointment as receiver for failing subsidiaries of the financial company (other than an insured depository institution, a covered broker or dealer, or an insurance company) that is organized under federal or state law
- Organization of “bridge” financial companies, which are similar to bridge banks under banking laws and to which chosen assets and liabilities may be transferred for later sale or other resolution
- Merger or other transfer of assets and liabilities without consents otherwise required, including broker or dealer customer consents
- Payment of valid obligations
- Termination of shareholder and creditor rights, except rights to payment and other similar claims as may be permitted by the Act
- Coordination with foreign financial authorities
- Determination and payment of claims
- Avoidance of fraudulent transfers made within the two-year period prior to receivership
- Avoidance of preferential transactions
- Repudiation of burdensome contracts, including service contracts, leases, contracts for the sale of real property, and qualified financial contracts (e.g., securities and commodities contracts, forward agreements, swap agreements and repurchase agreements)
- Pursuit of actions against directors and officers
- Recoupment of compensation from senior executive officers and directors, in which compensation will be defined to include without limitation, salary bonuses, benefits, severance, deferred compensation, and profits from the sale of securities of the covered financial company
Additionally, under Section 213, the FDIC or the Board, as applicable, has the authority to issue orders of prohibition to ban certain culpable senior executive officers and directors from participating in the affairs of any financial company.
Orderly Liquidation Fund. Section 210(n) provides that for the FDIC to carry out its receivership functions, funding will be provided through the “Orderly Liquidation Fund.” The fund is not required to be pre-funded, but when the FDIC needs funds to cover the costs of resolving any particular covered financial company, the FDIC upon appointment as receiver is permitted to issue obligations to the Treasury Secretary. The FDIC’s issuance of obligations may not exceed: (1) in the 30 days following the appointment of the FDIC as receiver, an amount equal to 10% of the total consolidated assets of the covered financial company; and (2) after the first 30 days following appointment, an amount that is equal to 90% of the fair value of the total consolidated assets of the covered financial company that are available for repayment. The FDIC and the Treasury Secretary are jointly charged (in consultation with the Financial Stability Oversight Council (the Council) with setting regulations to define the calculation of the maximum obligation limitation described above. The purchase of the obligations by the Treasury Secretary is subject to the approval of a repayment plan that demonstrates the ability to retire the obligations from the liquidated assets of the covered financial entity and assessments7 - first on “claimants” of the covered financial company, who may have received additional payments on their claims as permitted by the Act, and second, on “eligible financial companies”8 and financial companies with total consolidated assets equal to or greater than $50 billion that are not eligible financial companies.
The FDIC, in consultation with the Treasury Secretary and with recommendations from the Council, is charged with establishing regulations to determine how the assessments will be applied to eligible financial companies. These regulations must take into consideration the differences in risks posed to the financial stability of the United States by financial companies, such that entities that are assessed are treated equitably. As part of the rulemaking, however, the FDIC and the Council are required to take into account assessments paid by insured depository institutions under the Federal Deposit Insurance Act9 and insured credit unions under the Federal Credit Union Act,10 assessments under the Securities Investor Protection Act, and assessments paid by insurance companies under State law to cover (or repay) the costs of rehabilitation, liquidation or other State insolvency proceeding for insurance companies.
Since the fund does not contemplate a cap apart from the size of a covered financial company and since rolling assessments could arise out of the liquidation of more than one covered financial company, the ultimate liability of and the timing of any payment of an assessment by a financial company is not currently calculable and may not be calculable upon issuance of the required regulations.
Receivership Term. The FDIC’s appointment as receiver for a financial company is limited to three years from the date of appointment under Section 202(d) of the Act. However, the appointment may be extended for two additional one-year periods and may be further extended solely to complete ongoing litigation.
Impact on Complex Entities. The Act allocates resolution authority along financial and nonfinancial business lines. For example, in a complex entity that includes brokers or dealers, State licensed insurance companies, and banking institutions, three separate agencies in four different roles may be involved:
- Example One: The FDIC as receiver for the “financial company,” a holding company that is not also an insurance company, and its failing non-regulated subsidiaries; SIPC for a failing broker or dealer subsidiary; the FDIC as receiver of a failing insured depository institution subsidiary; and a State insurance regulator for a failing insurance company subsidiary.
- Example Two: The State insurance regulator for a failing financial company that is an insurance company; SIPC for its failing broker or dealer subsidiary; the FDIC as receiver for its failing depository institution subsidiary, and the FDIC as receiver of its failing non-regulated subsidiaries.
Complicating matters further, Section 203(e) provides that if the applicable Federal authority does not file the appropriate judicial action in a State court to place an insurance company into an orderly liquidation under the laws of the State, then the FDIC has back-up authority to file the action.
Effective Time. Although there are several rulemakings and studies required in Title II of the Act, the orderly liquidation authority provisions of Title II became effective on July 22, 2010.
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[1] Title 11, United States Code.
[2] Section 207 of the Act provides that members of the board of directors of a financial company will not be liable to shareholders or creditors of the financial company if they acquiesce or consent in good faith to the appointment of the FDIC as receiver.
[3] 15 U.S.C. 78aaa et seq.
[4] 12 U.S.C. 1841 et seq.
[5] 12 U.S.C. 4502(2).
[6] Section 202(c) of the Act provides that the provisions of the Bankruptcy Code do not apply to covered financial companies for which the FDIC is appointed receiver and that the Act’s provisions are exclusive.
[7] Section 210(o) of the Act.
[8] Section 210(o)(1)(A) of the Act defines eligible financial companies as bank holding companies with total consolidated assets equal to or greater than $50 billion and any nonbank financial company supervised by the Board.
[9] 12 U.S.C. 1811 et seq.
[10] 12 U.S.C. 1751 et seq.
If you have questions regarding anything you have read on Title II, please contact any of the attorneys listed below or your regular Sutherland contact.
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Title II - Key Provisions and Regulatory Rulemakings
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