• Dodd-Frank Wall Street Reform and Consumer Protection Act -- Proposed FDIC Rule Regarding Orderly Liquidation Authority
  • November 5, 2010 | Authors: Hollace Topol Cohen; Jacob "Jake" A. Lutz
  • Law Firms: Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Richmond Office
  • The Dodd-Frank Act Orderly Liquidation Authority (“OLA”) provides an alternate insolvency regime for systemically important non-bank financial companies determined to pose a significant risk to the nation's financial stability. OLA provides that the Federal Deposit Insurance Corporation (the "FDIC") may be appointed as receiver of a "financial company" as defined in the Act if the Secretary of the Treasury, in consultation with the President, makes certain determinations following the recommendation of the Board of Governors of the Federal Reserve System and the FDIC (in the case of a "financial company"), the Securities and Exchange Commission (in the case of a broker or dealer) or the Director of the Federal Insurance Office (in the case of an insurance company). The Act also authorizes the FDIC to draft implementing regulations in consultation with the Financial Stability Oversight Council.

    On October 6, 2010, the FDIC proposed 12 C.F.R. section 380 (the "Proposed Rule") which addresses four different provisions of the OLA: (1) treatment of claims of similarly situated creditors; (2) continuation of certain personal services agreements; (3) provability of certain contingent claims; and (4) liquidation of insurance companies and their subsidiaries.  On October 19, 2010, the FDIC published notice of the Proposed Rule containing the text of the Proposed Rule and supplementary information (Supplementary Information”) and seeking public comment (“Request for Comment”) concerning the Proposed Rule and OLA generally for purposes of future rulemaking.  The comment period on the Proposed Rule ends on November 18, 2010 while the comment period on the more general questions posed by the FDIC ends on January 17, 2011.

    Treatment of Similarly Situated Creditors' Claims

    Section 210(b)(4) of the Act permits the FDIC to pay certain creditors of a receivership more than other similarly situated creditors if necessary to (1) maximize the value of the assets; (2) initiate and continue operations essential to implementation of the receivership and any bridge financial company to which assets may be transferred for future sale or disposition by the receiver; (3) maximize the present value of return from the sale or other disposition of the assets, or (4) minimize the amount of any loss on sale or other disposition.  Section 380.2 of the Proposed Rule would define certain categories of creditors who never satisfy these requirements.  These include (1) holders of "long-term senior debt"; (2) holders of subordinated debt; (3) shareholders and other equity holders; and (4) other holders of general or senior unsecured claims (unless the Board of Directors of the FDIC specifically determines that additional payment or credits are necessary and meet the requirements of the Act).  The Proposed Rule defines "long-term senior debt" as "senior debt issued by a covered financial company to bondholders or other creditors that has a term of more than 360 days." The term excludes partially funded, revolving or other open lines of credit that are necessary to continuing operations essential to the receivership or any bridge financial company and contracts to extend credit enforced by the receiver under the Act.
    The Supplementary Information states that extraordinary payments made under such authority are subject to clawback by the FDIC in the event the proceeds from the sale of the assets of the covered financial company are insufficient to repay any monies drawn by the FDIC from the United States Treasury during the liquidation, thereby assuring creditors of the covered financial company will be assessed before the financial industry as a whole will be under provisions of the Act.  Importantly, the Supplementary Information also provides that such payments must be considered in light of the Act’s required report to Congress, not later than 60 days after appointment of the FDIC as receiver for a covered financial company specifying the identity of any claimant treated in a manner different from other similarly situated claimants, the amount of any payments and the reason for such action.  It suggests that this information will allow other creditors to file a claim asserting challenges to such payment.

    Personal Service Agreements

    Section 380.3 defines "personal service agreement" as a written agreement between an employee and a covered financial company, covered subsidiary or a bridge financial company setting forth the terms of employment, including a collective bargaining agreement.  Before repudiation of such an agreement, the FDIC as receiver may utilize the services of employees who have a personal service agreement and any payments would be treated as an administrative expense of the receiver.  Any party that acquires a covered financial company or any operational unit, subsidiary or assets thereof from the FDIC as receiver or from any bridge financial company will not be bound by a personal service agreement unless the acquiring party expressly assumes the personal service agreement. The provision for payment of employees would not apply to senior management participating in major policy making functions of the covered financial company. The Proposed Rule defines the term "senior executive" as a person who has authority to participate (other than in the capacity as a director) in major policymaking functions including certain high ranking officers enumerated therein unless the person is excluded by resolution of the board of directors, bylaws, operating agreement or partnership agreement of the company from participation (other than as a director) in major policy making functions of such company.  The acceptance of services subject to a personal service agreement by the FDIC or any bridge financial company would not limit or impair the ability of the receiver to later disaffirm such agreement nor to recover compensation from any senior executive or director of a failed financial company.

    Contingent Claims

    The Act has provisions concerning allowance of contingent claims.  For clarification, section 380.4 of the Proposed Rule provides that claims based on contingent obligations of the covered financial company consisting of a guarantee, letter of credit, loan commitment, or similar credit obligation, may be provable against the FDIC if such contingent obligation becomes due and payable upon the occurrence of a specified future event (other than the mere passage of time) which event (1) is not under the control of either the covered financial company or the party to whom the obligation is owed and (2) has not occurred as of the date of the appointment of the FDIC as receiver.  If the receiver repudiates a guarantee, letter of credit, loan commitment, or similar credit obligation that is contingent as of the date of the receiver's appointment, the actual direct compensatory damages for repudiation would be no less than the estimated value of the claim as of the date that the FDIC was appointed receiver of the covered financial company based upon the likelihood that such contingent claim would become fixed and the probable magnitude of such claim. There is no standard set for determining the likelihood that a contingent claim will become fixed or the probable magnitude of the claim.

    Liquidation of Covered Financial Companies that are Insurance Company Subsidiaries; Lien Limitation

    Proposed Rule section 380.5 provides that the FDIC shall distribute the value realized from the liquidation, transfer, sale or other disposition of the direct or indirect subsidiaries of an insurance company, that are not themselves insurance companies, solely in accordance with the order of priority in section 210(b)(1) of the Act.  Although the Proposed Rule does not so state, it appears to be predicated on the assumption that not only is the subsidiary not an insurance company but also that the subsidiary is a covered financial company subject to section 210(b)(1).  The Supplementary Information indicates that the purpose of section 380.5 of the Proposed Rule is to clarify that such value will be available to the policyholders of the parent insurance company to the extent required by the applicable State laws and regulations.  However, under Section 210(b)(1) obligations to shareholders have the lowest priority.  Therefore, the language of section 380.5 of the Proposed Rule appears to be inconsistent with the purpose stated in the Supplementary Information.

    Section 380.6 limits liens by the FDIC on assets of covered financial companies that are insurance companies or covered subsidiaries of insurance companies.