While there are several important differences between the pending proposals to revise the system to resolve failing large financial institutions, they all have at least one thing in common: the belief that chapter 11 isn’t up to the task.
The U.S. House of Representatives recently passed a bill that would amend the Bankruptcy Code to provide a new way to resolve failing systemically important financial institutions, known as SIFIs. The House’s Financial Institution Bankruptcy Act of 2014 differs from a related Senate bill — the Taxpayer Protection and Responsive Resolution Act, which was introduced in December 2013. And both bills differ from the proposal issued by the Hoover Institution in 2012 to amend the Bankruptcy Code by adopting a new chapter 14 to address SIFIs. All of these proposals came on the heels the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is considered the largest and most comprehensive financial regulatory reform since the Great Depression.
Congress adopted Dodd-Frank in 2011, in the wake of Lehman Brothers’s 2008 chapter 11 bankruptcy filing and the federal government’s bailout of Bear Sterns and AIG. Among other things, Dodd-Frank created a system to serve as an alternative to bankruptcy to resolve SIFIs. Title II of Dodd-Frank established the Orderly Liquidation Authority (OLA), which is designed to provide a process to quickly and efficiently liquidate a large, complex financial company. Under OLA, the Federal Deposit Insurance Corporation (FDIC) is appointed as a receiver to carry out the liquidation and wind up the company. The FDIC would have significant discretion in carrying out this liquidation. The U.S. Department of the Treasury would determine whether a SIFI should be placed in receivership under Title II, and the FDIC could create a “bridge financial company” that would receive the SIFI’s assets. This “single point of entry” (SPOE) would operate such that virtually all of the SIFI’s assets and liabilities (other than certain long-term unsecured liabilities) are transferred to the new bridge institution whose capital structure is sound. The bridge institution then forgives intercompany liabilities or contributes assets to recapitalize its operating subsidiaries.
But Dodd-Frank quickly met with significant criticism as encouraging bailouts, rather than preventing them. Hoover’s chapter 14 plan proposes a supplement to Title II, which provides for liquidation under the Bankruptcy Code. It would create a group of Article III district court judges in the Second or DC Circuit who would be knowledgeable about financial markets and institutions and would be responsible for handling the case, and would allow it to proceed more quickly than a case under chapter 7 or chapter 11. An involuntary case could be commenced by creditors or a government regulatory agency. Additionally, the government could propose a plan of reorganization, not just a liquidation.
The Senate bill draws on the Hoover Institution’s chapter 14 proposal, but with certain differences. The Senate bill would repeal OLA entirely, while the Hoover plan and the House bill would keep it as an alternative.
The Senate bill also explicitly prohibits federal funding, whereas the chapter 14 proposal contemplates federal funding upon a showing that no private funding is available. The House bill does not address federal funding.
Finally, the Senate bill focuses solely on an SPOE resolution. By contrast, the House bill and the Hoover proposal both accommodate an SPOE recapitalization and a conventional reorganization or liquidation of a SIFI. In an SPOE recapitalization, the holding company’s debt and equity would bear the majority of the losses as the company’s assets are transferred to the bridge institution, and cash would be pushed down to subsidiaries to prevent them from filing. A conventional reorganization would generally track a traditional bankruptcy case, with struggling subsidiaries entering bankruptcy.
These and other differences among the three proposals are significant. And given the importance that large financial institutions play in the wider U.S. economy, even practitioners who do not represent SIFIs may want to be sure to monitor developments.