Restructuring

Also contributed by Maurice Horwitz
As previously reported  by Weil’s Financial Regulatory Reform Center, the FDIC’s Board of Directors met on July 6, 2011 to discuss a number of different topics and rulemakings.  Notably, at this meeting, the FDIC approved a final rule, codified as 12 C.F.R. §§ 380.1 – 380.53, with respect to the Orderly Liquidation Authority (“OLA”) created by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The approval of the final rule follows up on two other rulemakings with respect to the OLA, each previously discussed in this blog.  First, on January 18, 2011, the FDIC approved an interim final rule (the “IFR”) which clarified, among other things, how the FDIC will treat contingent claims, as well as what types of creditors may (or may not) benefit from the FDIC’s ability to favor certain creditors over others.  A second Notice of Proposed Rulemaking (“NPR”) was subsequently proposed by the FDIC on March 15, 2011, addressing issues such as the criteria for determining whether a company is predominantly engaged in activities that are financial in nature or incidental thereto; the recoupment of compensation from senior executives and directors; the power to avoid fraudulent or preferential transfers; the priorities of expenses and unsecured claims; and the administrative process for initial determination of claims.
The final rule codifies the text of both the IFR and the NPR, but also incorporates certain changes to the IFR and NPR in response to comments submitted to the FDIC during the comment periods that followed their publication.  Set forth below are certain of the most significant changes that have been made to the provisions of the IFR and the NPR as finally codified in the final rule.
Recoupment of Compensation
The final rule significantly changes the criteria applied by the FDIC in determining whether to “claw back” the compensation of current or former directors or officers of a covered financial company.  Pursuant to section 210(s) of Dodd-Frank, the FDIC may recover from any current or former senior executive or director “substantially responsible” for the company’s failure any compensation received during the two-year period preceding the date of the FDIC’s appointment as receiver under the OLA.  (In the case of fraud, no time limit applies).  In assessing whether a senior executive or director is substantially responsible for the failed condition of the covered financial company, the NPR had applied a “gross negligence” standard:  The final rule lowers the standard to a mere “negligence” standard, exposing senior executives and directors to greater risk of being deemed “substantially responsible.”
Provisions Affecting Secured Creditors
To the extent that the FDIC determines that a claim is undersecured, Title II of Dodd-Frank gives the FDIC the authority to bifurcate claims and treat the undersecured portion as an unsecured claim.  See Dodd-Frank § 210(a)(3)(D)(ii).  This ability to bifurcate secured claims is similar to the treatment of secured claims in section 506(a) of the Bankruptcy Code.
Unlike the Bankruptcy Code, however, section 380.2(c) of the IFR provided that for the purpose of determining the extent to which a creditor is secured, the collateral securing the debt of the covered financial company would be valued as of the date of the appointment of the receiver.  Section 506(a) of the Bankruptcy Code, in contrast, provides that the extent of a creditor’s secured status shall be determined “in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.”
In practice, this provision of the Bankruptcy Code (along with section 1129(b)(2)(A) in chapter 11 cases) operates such that in a bankruptcy case, a creditor’s secured status is determined either when the collateral securing the claim is sold or when a chapter 11 plan is confirmed.  To make the determination of secured status under the OLA more consistent with the Bankruptcy Code, section 380.50(b) of the final rule states that, for the purpose of determining a creditor’s secured status, “the fair market value of any property of a covered financial company that secures a claim shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property and at the time of such proposed disposition or use.”  The final rule is therefore more consistent with the Bankruptcy Code than the IFR was.
This does not mean, however, that the FDIC’s application of the rule will achieve parity with the Bankruptcy Code.  Presumably, if the FDIC is unable to find a third-party to purchase the property securing a creditor’s claim, the FDIC may transfer such property to a bridge financial company organized by the FDIC pursuant to section 210(h)(1)(A) of Dodd-Frank.  Section 210(h)(1) of Dodd-Frank authorizes such bridge financial companies to “purchase” the assets of the covered financial company – but for what consideration?  In a bankruptcy case, the use or sale of a debtor’s property outside of the ordinary course of business may only take place after a duly noticed hearing, the ultimate purpose of which is to ensure that the debtor “obtain[s] the highest price for the property sold.”  The Bankruptcy Code also limits a debtor’s ability to sell collateral free of liens. But the OLA contains no such limitations, and with the FDIC on both sides of the transaction, and no court or creditor oversight, it will be the FDIC alone that ultimately decides the value of the property securing a creditor’s claim.  The ability of the FDIC to make this subjective value determination leaves many open questions as to how secured creditors can expect to be treated if a company is liquidated under the OLA.
Entities Subject to the OLA
As explained in prior blog entries, the OLA provisions of Dodd-Frank apply to any “financial company,” which includes a company, organized under the laws of the United States, that is “predominantly engaged in activities that the Board of Governors of the Federal Reserve System has determined are financial in nature or incidental thereto for purposes of the Bank Holding Company Act.  There are, in fact, two separate provisions in Dodd-Frank setting forth the criteria for determining whether a company is “predominantly engaged in financial activities” – one in Title I of Dodd-Frank, and another in Title II – each implemented by separate rules promulgated by the Federal Reserve Board and the FDIC, respectively.  In light of these similarities, FDIC staff are in the process of coordinating with staff at the Federal Reserve Board to the extent practicable on the proposed criteria in the FDIC’s final rule.  The FDIC intends to finalize the criteria for determining whether a company is predominantly engaged in activities that are financial in nature or incidental thereto through a separate notice within the Federal Register. Consequently, section 380.8 is reserved in the final rule.
Setoff Rights
The NPR and the final rule both provide that the FDIC as receiver may sell assets of the covered financial company to a bridge financial company or a third party free and clear of a creditor’s setoff rights.  In such circumstances, consistent with the NPR, the final rule provides that “such party shall have a claim against the receiver in the amount of the value of such setoff established as of the date of the sale or transfer of such assets.”  In response to the concerns of many commentators, however, the final rule now clarifies that these provisions do not affect netting rights with respect to qualified financial contracts.
Other Claims Provisions
The final rule contains a number of other changes to the provisions of the IFR and NPR that govern claims against the covered financial company.  For example:

• The final rule makes clear that the claims process does not apply to claims against a bridge financial company or involving its assets or liabilities, or any extension of credit from a Federal Reserve Bank or the FDIC to a covered financial company.
• Under the final rule, the definition of “amounts owed to the United States” has been revised to clarify that the obligations entitled to the priority include only amounts advanced to the covered financial company to promote the orderly resolution of the covered financial company or to avoid or mitigate adverse effects on the financial stability of the United States in the resolution of the covered financial company.

• When the IFR was published in the Federal Register, the FDIC solicited comments regarding whether the receiver of a covered financial company should designate a specific time during the receivership when the allowed amount of contingent claims would be estimated.  Under the final rule, new provisions have been added to provide that the receiver will estimate the value of a contingent claim no later than 180 days after the claim is filed or any extended period agreed to by the claimant.

With the publication of the final rule in the Federal Register, the final rule will now have the same weight as a statute passed by Congress.  We will continue to monitor any additional rulemaking with respect to the OLA.