Editor's Note: The House Judiciary Committee passed H.R.5421 - Financial Institution Bankruptcy Act of 2014 - on December 1, 2014.
On Sept. 10, 2014, the House Judiciary Committee approved H.R. 5421, the Financial Institution Bankruptcy Act of 2014, by a voice vote.[1] The Act is the product of the Judiciary Committee’s long-standing oversight of the U.S.’s bankruptcy laws, as well as its recent examination into improving such laws for the resolution of bankruptcies of financial institutions.[2] The Act incorporates the recommendations of hearing witnesses, experts and regulators at three Judiciary Committee hearings held over the past year.[3] The Act adds a new subchapter V to chapter 11 of the Bankruptcy Code to address the resolution of financial institutions, including large multi-national financial firms.[4] Because the text of the Act is 34 pages,[5] this article will only discuss its more salient provisions.
Section 2(a) of the Act amends Code § 101 by inserting a new defined term into said section after paragraph 9 in paragraph 9(A). The new term is “covered financial corporation,” which means any corporation incorporated or organized under any federal or state law, other than a stockbroker, a commodity broker, or an entity of the kind specified in § 109(b)(2) and (3) that is:
(A) a bank holding company, as defined in section 2(a) of the Bank Holding Company Act of 1956; or
(B) a corporation that exists for the primary purpose of owning, controlling and financing its subsidiaries, that has total consolidated assets of $50,000,000,000 or greater, and for which, in its most recent completed fiscal year—
(i) annual gross revenues derived by the corporation and all of its subsidiaries from activities that are financial in nature (as defined in section 4(k) of the Bank Holding Company Act of 1956) and, if applicable, from the ownership or control of one or more insured depository institutions, represents 85 percent or more of the consolidated annual gross revenues of the corporation; or
(ii) the consolidated assets of the corporation and all of its subsidiaries related to activities that are financial in nature (as defined in section 4(k) of the Bank Holding Company Act of 1956) and, if applicable, related to the ownership or control of one or more insured depository institutions, represents 85 percent or more of the consolidated assets of the corporation.[6]
Section 2(b) of the Action amends Code § 103 (“Applicability of chapters”) by adding a new section (l), which makes new Subchapter V of chapter 11 applicable only in a chapter 11 case concerning a covered financial corporation.[7] The Act also amends Code § 109 (“Who may be a debtor”), adding a new section that provides that a covered financial corporation may be a debtor under the Code, and amending § 109(d) of the Code to include a covered financial corporation as an entity who may be a debtor under chapter 11 of the Code.[8] Section 2(d) of the Act creates Code § 1112(g), which provides that a court may convert a case under new subchapter V of chapter 11 to a case under chapter 7 of the Code only if (1) a transfer approved under new Code § 1185 has been consummated; (2) the court has ordered the appointment of a so-called “special trustee” under new Code § 1186; and (3) the court finds, after notice and a hearing, that conversion is in the best interest of the creditors and estate.[9]
If enacted, the Act will alter the distribution of property of the estate under § 726 of the Code, elevating to first position “payment of any unpaid fees, costs, and expenses” of a special trustee appointed under new Code § 1186.[10] It will also make payment of such fees, costs and expenses by no later than the effective date of the plan a requirement under new Code § 1129(a)(17).[11] Another new confirmation requirement will be new Code § 1129(a)(18), which requires the plan proponent to demonstrate that “confirmation of the plan is not likely to cause serious adverse effects on financial stability in the United States.”[12]
New Code § 1181 will make §§ 303 (involuntary cases) and 321(c) (making the U.S. Trustee for a judicial district in which the case is pending eligible to serve as trustee for the case) inapplicable to cases under new subchapter V concerning a covered financial corporation.[13] New Code § 1182 adds five new definitions, including: “Board” (the Board of the Governors of the Federal Reserve System); “bridge company” (defined as “a newly formed corporation to which property of the estate may be transferred under new Code § 1185(a) and the equity securities of which may be transferred to a special trustee under Code § 1186(a)); “capital structure debt” (all unsecured debt of the debtor for borrowed money, other than a qualified financial contract, for which the debtor is the primary obligor other than debt secured by a lien on property of the estate that is to be transferred to a bride company under an order of the court under Code § 1185(a)); and “special trustee” (the trustee of a trust formed under Code § 1186(a)(1).[14]
Only the debtor and Board are empowered to commence a subchapter V case by filing a petition with the court; both are required to state to the best of their knowledge under penalty of perjury that the debtor is a covered financial corporation.[15] Additionally, the Board must state to the best of its knowledge under penalty of perjury that the debtor—
(i) has incurred losses that will deplete all or substantially all of the capital of the covered financial corporation, and there is no reasonable prospect for the covered financial corporation to avoid such depletion;
(ii) is insolvent;
(iii) is not paying, or is unable to pay, the debts of the covered financial corporation (other than debts subject to a bona fide dispute as to liability or amount) as they become due; or
iv) is likely to be in a financial condition specified in clause (i), (ii), or (iii) sufficiently soon such that the immediate commencement of a case under this subchapter is necessary to prevent serious adverse effects on financial stability in the United States; and
(B) the commencement of a case under this title and effecting a transfer under section 1185 is necessary to prevent serious adverse effects on financial stability in the United States.[16]
Once a case under subchapter V is commenced, it will move at lightning speed. Unless the debtor consents to an order for relief, the court must hold a hearing on the Board’s petition under Code § 1183(a)(2) “as soon as practicable but not later than 16 hours after the Board files such a petition,” with notice only to the covered financial corporation, the FDIC, the office of the Comptroller of the Currency of the Department of the Treasury, and the Secretary of the Treasury.[17] Participation in the hearing is limited to the Board, the covered financial corporation, the FDIC, the Comptroller and Secretary (the “Interested Parties”).[18] The Board or the trustee may request that all documents filed in the case and transcripts of all hearings held in the case be sealed if their disclosure “could create financial instability in the United States.”[19] If such documents and transcripts are sealed, they shall be available only to the court, the appellate panel, and the Interested Parties, and if the case is dismissed, all documents and transcripts shall be permanently sealed.[20]
The debtor’s filing of a voluntary petition under § 1183(a)(1) constitutes an order for relief under subchapter V.[21] If the case is commenced by the Board under Code § 1183(a)(2), the court must hold a hearing not later than 18 hours after the filing of the Board’s petition, with notice only to the Interested Parties, and the court must enter: (1) an order for relief if the Board carries its burden as to the requirements under § 1183(a)(2) by a preponderance of the evidence, or the debtor consents to the Board’s petition, or (2) an order dismissing the case.[22] Any order entered under § 1183(c)(2) must be appealed “not later than 1 hour after the court enters such order,” with notice only to the Board and Interested Parties, and the order shall be stayed pending such appeal.[23] The appellate panel must hear the appeal within 12 hours of the filing of the notice of appeal, with the standard of review being abuse of discretion.[24] The appellate panel must enter an order determining the matter not later than 14 hours after the notice of appeal is filed.[25] A more rapid appellate process is unimaginable. The court may not authorize a special transfer of property of the estate under § 1185 before the determination of the appeal.[26] Because a case under subchapter V can move very rapidly, counsel to the debtor or Board must provide, to the greatest extent possible, sufficient confidential notice to the Office of Court Services of the Administrative Office of the U.S. Courts regarding the potential commencement of a subchapter V case, without disclosing the identity of the potential debtor, to ensure the ready availability of a bankruptcy judge to preside over the case.[27]
Only the Board, the Securities and Exchange Commission (SEC), the Comptroller, the Department of the Treasury and the FDIC have the right to “raise” and “appear and be heard” on any issue in any case or proceeding under subchapter V.[28]
The meat of the Act is § 1185 (“Special transfer of property of the estate”). On the request of the trustee (the debtor) or the Board, and after notice and a hearing that shall occur not less than 24 hours after the order for relief, the court may order a transfer under § 1185 of property of the estate, and the assignment of executory contracts, unexpired leases and qualified financial contracts of the debtor, to a bridge company.[29] Upon entry of an order approving a transfer under § 1185(a), any property transferred and/or assigned under such an order shall no longer be property of the estate.[30] Except as provided in § 1185(a), the provisions of Code §§ 363 and 365 shall apply to a transfer and assignment under § 1185(a).[31] Unless the court orders otherwise, notice of a request for an order under § 1185(a) shall consist of electronic or telephonic notice of not less than 24 hours to numerous parties, including the debtor; the holders of the 20 largest secured and unsecured claims against the debtor, counterparties to any debt, executory contract, unexpired lease, and qualified financial contract requested to be transferred, the Board, the Interested Parties, the SEC and U.S. Trustee.[32] In order to order a transfer under § 1185, the court must determine, based on a preponderance of the evidence, that, among other things:
(1) the transfer under this section is necessary to prevent serious adverse effects on financial stability in the United States;
(2) the transfer does not provide for the assumption of any capital structure debt by the bridge company;
(3) the transfer does not provide for the transfer to the bridge company of any property of the estate that is subject to a lien securing a debt, executory contract, unexpired lease or agreement of the debtor unless—
(A)(i) the bridge company assumes such debt, executory contract, unexpired lease or agreement, including any claims arising in respect thereof that would not be allowed secured claims under section 506(a)(1) and after giving effect to such transfer, such property remains subject to the lien securing such debt, executory contract, unexpired lease or agreement; and
(ii) the court has determined that assumption of such debt, executory contract, unexpired lease or agreement by the bridge company is in the best interests of the estate; or
(B) such property is being transferred to the bridge company in accordance with the provisions of section 363;
(4) the transfer does not provide for the assumption by the bridge company of any debt, executory contract, unexpired lease or agreement of the debtor secured by a lien on property in which the estate has an interest unless the transfer provides for such property to be transferred to the bridge company in accordance with paragraph (3)(A) of this subsection;
(5) the transfer does not provide for the transfer of the equity of the debtor;
(6) the party requesting the transfer under this subsection has demonstrated that the bridge company is not likely to fail to meet the obligations of any debt, executory contract, qualified financial contract, or unexpired lease assumed and assigned to the bridge company;
(7) the transfer provides for the transfer to a special trustee all of the equity securities in the bridge company and appointment of a special trustee in accordance with section 1186;
(8) after giving effect to the transfer, adequate provision has been made for the fees, costs, and expenses of the estate and special trustee; and
(9) the bridge company will have governing documents, and initial directors and senior officers, that are in the best interest of creditors and the estate.[33]
Immediately before any transfer under § 1185, the bridge company recipient must not have any property and have equity securities that are property of the estate, which may be sold or distributed in accordance with subchapter V.[34]
An order approving a transfer under § 1185 shall require the trustee to transfer to a “qualified and independent special trustee” all of the equity securities in the bridge company that is the recipient of a transfer under § 1185 to hold in trust for the sole benefit of the estate, subject to satisfaction of the special trustee’s fees, costs and expenses.[35] The court must approve the trust agreement of the newly-formed trust of which the special trustee is the trustee as being in the best interests of the estate, and the trust shall exist for the sole purpose of holding and administering, and shall be permitted to dispose of, the equity securities of the bridge company in accordance with the trust agreement.[36] Prior to a hearing to approve a special transfer under § 1185, the trustee must confirm to the court that the Board has been consulted concerning the identity of the proposed special trustee and advise the court of the results of the consultation.[37]
The trustee agreement governing the trust must provide, among other things: (1) for the payment of the fees, costs, expenses and indemnities of the special trustee from the assets of the debtor’s estate; (2) that the special trustee provide quarterly reporting to the estate, which must be filed with the court; (3) information about the bridge company reasonably requested by a party in interest to prepare a disclosure statement for a plan providing for the distribution of any securities of the bridge company if such information is necessary to prepare such a disclosure statement; (4) that any sale of any equity securities of the bridge company shall not be consummated until the special trustee consults with the FDIC and the Board regarding such a proposed sale and discloses the results of the consultation to the court; (5) that the proceeds of the sale of any equity securities of the bridge company be held in trust by the special trustee for the benefit of or transferred to the estate; and (6) that the property held in trust by the special trustee is subject to distribution under Code § 1186(c).[38]
The special trustee must distribute the assets held in trust in accordance with a confirmed plan on the effective date, or as ordered by the court if the case is converted to a case under chapter 7 of the Code.[39] As soon as practicable after final distribution of the trust’s assets under Code § 1186(c)(1), the office of the special trust shall terminate, except as may be necessary to wind up the business and financial affairs of the trust.[40] After a transfer to the special trustee under § 1186, the special trustee shall be “subject only to applicable non-bankruptcy law,” and the special trustee shall no longer be subject to the approval by the court in the subchapter V case.[41]
A petition filed under § 1183 operates as a stay, applicable to all entities, of the termination, acceleration or modification of any debt, contract, lease or agreement of the debtor or an affiliate of the debtor, other than a capital structure debt or qualified financial contract.[42] Such a petition also stays any right or obligation under any such debt, contract, lease or agreement, solely because of a default by the debtor under any such debt, contract, lease or agreement, and proposed § 1187 also contains an ipso facto provision strikingly similar to § 365(e)(1).[43] The stay under § 1187(a)(1) terminates for the benefit of the debtor upon the earliest of 48 hours after the commencement of the case, assumption of the debt, contract, lease or agreement by the bridge company under an order authorizing a special transfer under § 1185, or a final order of the court denying a request to approve a transfer under § 1185.[44] The stay under Code § 1187(a)(1) terminates for the benefit of an affiliate of the debtor, upon the earliest of the entry of an order authorizing a special transfer under § 1185 in which the director or indirect interests in the affiliate that are property of the estate are not transferred under § 1185, a final order by the court denying a request for a special transfer under § 1185, or 48 hours after the commencement of the case if the court has not ordered a transfer under § 1185.[45] Code § 362(d)-(g) are applicable to a stay under § 1187(a)(1).[46]
Anti-assignment provisions of a debt, executory contract (other than a qualified financial contract) or unexpired lease of the debtor, or an agreement under which the debtor has issued or is obligated for any debt, are inapplicable and may be assumed by a bridge company in a special transfer under Code § 1185, and ipso facto provisions cannot be enforced against such a bridge company.[47] If there is a default by the debtor under a debt (other than a capital structure debt), contract, lease or agreement (other than a qualified financial contract), the bridge company may assume such debt, contract, lease or agreement only if the bridge company: cures the default; compensates, or provides adequate assurance that it will promptly compensate, a party other than the debtor to the debt, contract, lease or agreement, for any actual pecuniary loss to the party resulting from the default; and provides adequate assurance of future performance under the debt, contract, lease or agreement.[48]
Notwithstanding any other provisions of the Code, a petition filed under Code § 1183 operates as a stay, during the period specified in Code § 1187(a)(3)(A), applicable to all entities of the exercise of a contractual right: (1) to cause the modification, liquidation, termination, or acceleration of a qualified financial contract of the debtor or an affiliate; (2) to offset or net out any termination value, payment amount, or other transfer obligation arising under or in connection with a qualified financial contract of the debtor or an affiliate; or (3) under any security agreement or arrangement or other credit enhancement forming a part of or related to a qualified financial contract of the debtor or an affiliate.[49] During the period specified in § 1187(a)(3)(A), the trustee or affiliate must perform all payment and delivery obligations under qualified financial contracts of the debtor or the affiliate, as the case may be, that become due after commencement of the case, and the stay under § 1188(a) terminates as to a qualified financial contract immediately upon the failure of the debtor or affiliate to perform any such obligation.[50] Any post-petition failure of a nondebtor counterparty to any qualified financial contract of the debtor or any affiliate to perform any payment or delivery obligation thereunder constitutes a breach of such contract by the counterparty.[51]
A qualified financial contract between an entity and the debtor may not be assigned to or assumed by the bridge company in a transfer under § 1185 unless—
(1) all qualified financial contracts between the entity and the debtor are assigned to and assumed by the bridge company in the transfer under section 1185;
(2) all claims of the entity against the debtor under any qualified financial contract between the entity and the debtor (other than any claim that, under the terms of the qualified financial contract, is subordinated to the claims of general unsecured creditors) are assigned to and assumed by the bridge company;
(3) all claims of the debtor against the entity under any qualified financial contract between the entity and the debtor are assigned to and assumed by the bridge company; and
(4) all property securing or any other credit enhancement furnished by the debtor for any qualified financial contract described in paragraph (1) or any claim described in paragraph (2) or (3) under any qualified financial contract between the entity and the debtor is assigned to and assumed by the bridge company.[52]
A qualified financial contract of the debtor that is assumed or assigned in a special transfer under § 1185, and any right or obligation thereunder, may not be accelerated, terminated or modified after the entry of the order approving such a transfer solely because of a condition specified in § 1187(c)(1).[53] Additionally, any agreement of an affiliate of the debtor, and any right or obligation thereunder, may not be terminated or modified solely because of a condition specified in § 1187(c)(1).[54]
If a request is made under § 1185 for a transfer of property of the estate, any federal, state or local license, permit or registration that the debtor or an affiliate had immediately before the commencement of the case and that is proposed to be transferred under § 1185 may not be terminated or modified at any time after the request solely on account of: (1) the insolvency or financial condition of the debtor at any time before the closing of the case; (2) the commencement of a chapter 11 case concerning the debtor; (3) the appointment of or taking possession by a trustee in a case under chapter 11 concerning the debtor or by a custodian before the commencement of such a case; and (4) a special transfer under Code § 1185.[55] Any federal, state or local license, permit or registration of the debtor that was valid and in existence immediately before the commencement of the case and that is included in a special transfer under § 1185 shall be valid and all rights and obligations thereunder shall vest in the bridge company.[56]
For purposes of Code § 1145, a security of the bridge company shall be deemed to be a security of a successor to the debtor under a plan if the court approves a disclosure statement for the plan.[57]
A transfer made or an obligation incurred by the debtor to an affiliate prior to or after the commencement of the case, including any obligation released by the debtor or the estate to or for the benefit of an affiliate, in contemplation of or in connection with a special transfer Code § 1185, is not avoidable under Code §§ 544, 547, 548(a)(1)(B) or 549, or under any similar nonbankruptcy law.[58]
If enacted, § 4 of the Act will amend 28 U.S.C. § 298 (Organization of the U.S. Courts) and require the Chief Judge of the United States to designate (1) not fewer than three judges of the courts of appeals in not fewer than four circuits to serve on an appellate panel to be available to hear an appeal under Code § 1183, and (2) not fewer than 10 bankruptcy judges to be available to hear a case under subchapter V.[59] The chief judge of the court of appeals for the circuit embracing the district in which a case under subchapter V of chapter 11 is pending shall assign a bankruptcy judge to hear such case.[60] The court of appeals shall have jurisdiction of appeals from all orders for relief and orders of dismissal under § 1183.[61]
Parting Thoughts
Cases in bankruptcy court move rather rapidly compared to nonbankruptcy cases or proceedings in state or federal court. Cases under subchapter V will move at the speed of light. A hearing on a petition filed by the Board that is not consented to by the debtor must take place within 16 hours of the filing, and, not less than 18 hours after the filing of a Board petition, the court must enter an order for relief or an order dismissing the case. Appeals of an order for relief or dismissal must be filed within one hour of entry, and the appeal must be heard within 12 hours and decided within 14 hours after the notice of appeal is filed. Talk about swift justice! Fortunately (or perhaps not), most bankruptcy practitioners will never be involved in a subchapter V case given the criteria for being an eligible covered financial corporation.
[1] U.S. House of Representatives Judiciary Committee, Judiciary Committee Approves Bipartisan Bankruptcy Legislation (Sept. 10, 2014), available at http://judiciary.house.gov/index.cfm/press-releases?id=71A94DCE-AAA3-4B….
[2] Id.
[3] Id.
[4] Id.
[5] The text of the Act is available at http://www.gpo.gov/fdsys/pkg/BILLS-113hr5421ih/pdf/BILLS-113hr5421ih.pdf.
[6] Act at § 2(a) (proposed Code § 109(A)).
[7] Act at § 2(b) (proposed Code § 103(l)).
[8] Act at § 2(c)(1) and (2) (proposed Code §§ 109(b)(4) and 109(d)).
[9] Act at § 2(d) (proposed Code § 1112(g)).
[10] Act at § 2(e)(1) (proposed amendment to Code § 726(a)(1)).
[11] Act at § 2(e)(2) (proposed Code § 1129(a)(17)).
[12] Act at § 2(e)(2) (proposed Code § 1129(a)(18)).
[13] Act at § 3 (proposed Code § 1181)).
[14] Act at § 3 (proposed Code § 1182)).
[15] Act at § 3 (proposed Code § 1183(a)(1) and (2)).
[16] Act at § 3 (proposed Code §§ 1183(a)(2)(A)(i)-(iv) and 1183(a)(2)(B)).
[17] Act at § 3 (proposed Code § 1183(b)(1)).
[18] Act at § 3 (proposed Code § 1183(b)(2)).
[19] Id.
[20] Act at § 3 (proposed Code § 1183(b)(3)).
[21] Act at § 3 (proposed Code § 1183(c)(1)).
[22] Act at § 3 (proposed Code § 1183(c)(2)).
[23] Act at § 3 (proposed Code § 1183(d)(1)).
[24] Act at § 3 (proposed Code § 1183(d)(2)).
[25] Id.
[26] Act at § 3 (proposed Code § 1183(d)(3)).
[27] Act at § 3 (proposed Code § 1183(f)).
[28] Act at § 3 (proposed Code § 1184)).
[29] Act at § 3 (proposed Code § 1185(a)).
[30] Id.
[31] Id.
[32] Act at § 3 (proposed Code § 1185(b)).
[33] Act at § 3 (proposed Code § 1185(c)).
[34] Act at § 3 (proposed Code § 1185(d)).
[35] Act at § 3 (proposed Code § 1186(a)(1)).
[36] Id.
[37] Act at § 3 (proposed Code § 1186(a)(2)).
[38] Act at § 3 (proposed Code § 1186(b)).
[39] Act at § 3 (proposed Code § 1186(c)(1)).
[40] Act at § 3 (proposed Code § 1186(c)(2)).
[41] Act at § 3 (proposed Code § 1186(d)).
[42] Act at § 3 (proposed Code § 1187(a)(1) and (2)).
[43] Act at § 3 (proposed Code § 1187(a)(1)(B)). The ipso facto provisions of § 1187(a)(1)(B) are broader than those found in Code § 365(e)(1) in that they extend to any credit rating agency rating, or absence or withdrawal of such a rating of the debtor, an affiliate of the debtor, or the bridge company. See § 1187(a)(1)(B)(iv).
[44] Act at § 3 (proposed Code § 1187(a)(3)(A)).
[45] Act at § 3 (proposed Code § 1187(a)(3)(B)).
[46] Act at § 3 (proposed Code § 1187(a)(4)).
[47] Act at § 3 (proposed Code § 1187(b) and (c)(1)).
[48] Act at § 3 (proposed Code § 1187(c)(2)). Section 1187(c)(2) is very similar to Code § 365(b)(1).
[49] Act at § 3 (proposed Code § 1188(a)).
[50] Act at § 3 (proposed Code § 1188(b)(1)).
[51] Act at § 3 (proposed Code § 1188(b)(2)).
[52] Act at § 3 (proposed Code § 1188(c)).
[53] Act at § 3 (proposed Code § 1188(d)).
[54] Act at § 3 (proposed Code § 1188(e)).
[55] Act at § 3 (proposed Code § 1189(a)).
[56] Act at § 3 (proposed Code § 1189(b)).
[57] Act at § 3 (proposed Code § 1190).
[58] Act at § 3 (proposed Code § 1191).
[59] Act at § 4 (proposed amendment to Chapter 13 of title 28, adding 28 U.S.C. § 298(a) and (b)(1)).
[60] Act at § 4 (proposed amendment to Chapter 13 of title 28, adding 28 U.S.C. § 298(b)(2)).
[61] Act at § 4 (proposed amendment to Chapter 13 of title 28, adding 28 U.S.C. § 298(c)(1)).