As we discussed in our previous post, in the wake of the financial crisis that began with large financial institutions failing in 2008, practitioners and politicians alike have been calling for Bankruptcy Code reform. Both the U.S. House and Senate have proposed solutions, yet with the recent midterm election results, the future of these two proposals is murkier than ever.
Part 1:
The House Plan: Subchapter 5
The House of Representatives has proposed a revision of Chapter 11 that would add a fifth subchapter to the Bankruptcy Code dealing specifically with the promotion of recapitalization of distressed financial institutions and protecting global financial markets from panic. The proposal, entitled the “Financial Institutions Bankruptcy Act” (FIBA), was passed by the House Judiciary Committee in a bipartisan vote in September and now sits before the full chamber.
Schedule II of the Dodd-Frank Act set up an Orderly Liquidation Authority, which granted unprecedented power to the FDIC to take control of a failed firm in the role of a receiver. Critics say Section II gives politically-sensitive regulators exceptionally broad discretion to liquidate a large financial institution without adequate considerations of creditor’s rights. Title II also authorizes the FDIC to hold taxpayers responsible for the most worthless assets on a company’s books.
As proposed, FIBA would eliminate Schedule II and strip the FDIC of significant power. Nevertheless, FIBA remains committed to a “single point of entry” strategy that the FDIC developed under the Dodd-Frank Act. This single point of entry strategy would place the holding company of a financial institution in Chapter 11, while allowing its operating subsidiaries to continue their ordinary course of business.
Instead of the FDIC’s broad authority as a receiver, FIBA authorizes the U.S. Treasury to put the holding company involuntarily into Chapter 11 with a specially-appointed judge deciding within an hour whether the Chapter 11 process is appropriate. The debtor’s newly formed “bridge” company (the operating subsidiaries of the debtor-institution) would gather the financial institution’s healthy assets within a very narrow time frame, and would in turn leave its loss-bearing debt in Chapter 11 with the holding company. The new bridge company would be managed by a Chapter 11 trustee that would hold the equity interests in the institution’s non-loss bearing assets for the benefit of the institution’s creditors – and subject to bankruptcy court oversight. As a result, the holding company’s losses would be absorbed by the shareholders and unsecured creditors. The goal of FIBA is to prevent fire-sale liquidation of the bank’s healthy assets by allowing the bank to preserve its operating units’ earning ability.