Restructuring

Also contributed by Maurice Horwitz
On March 15, 2011 the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) approved its second Notice of Proposed Rulemaking (“NPR”) with respect to the Orderly Liquidation Authority (“OLA”) created by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  Although the NPR follows the FDIC’s approval, on January 18, 2011, of an interim final rule (the “IFR”) clarifying, inter alia, how the FDIC will treat contingent claims, and what types of creditors may (or may not) benefit from the FDIC’s ability to favor certain creditors over others, the NPR represents the most significant rulemaking since Dodd-Frank was signed into law on July 21, 2010.  Together, the IFR and NPR provide a clearer view into the orderly liquidation process envisioned by the FDIC under Dodd Frank.
Dodd-Frank requires that the Board of Governors of the Federal Reserve System (the “Fed”) and the FDIC implement rules with respect to the implementation of the provisions of Dodd-Frank.  The rules will have the same weight as a statute passed by Congress.  Generally, after publishing a proposed rule, an agency must allow a “reasonable” amount of time for written comments by the public.  The final rule must be a “logical outgrowth” of the proposed rule – if it is not, then a second notice and comment period is required.
The NPR was published in the Federal Register on March 23, 2011, and will be out for comments for 60 days thereafter.
A brief summary of the contents of the NPR is set forth below.  Weil will publish a more detailed analysis of specific aspects of the OLA and NPR in the weeks to come.
Entities Subject to OLA
The OLA provisions of Dodd-Frank apply to any “financial company.”  The definition of “financial company” includes bank holding companies and any nonbank financial company supervised by the Fed.  One of the other definitions of a “financial company” is a company, organized under the laws of the United States, that is “predominantly engaged in activities that the Board of Governors has determined are financial in nature or incidental thereto for purposes of the Bank Holding Company Act.  See § 201(a)(11).  The NPR attempts to clarify what is meant by a company that is “predominantly engaged” in activities that are “financial in nature.”  According to the NPR, a company is “predominantly engaged” in financial activities if:

1. at least 85 percent of the total consolidated revenues of the company for either of its two most recent fiscal years were derived, directly or indirectly, from financial activities; or
2. based upon all the relevant facts and circumstances, the FDIC determines that the consolidated revenues of the company from financial activities constitute 85 percent or more of the total consolidated revenues of the company.

“Financial activity” is defined by the NPR as:

1. any activity, wherever conducted, described in section 225.86 of the Fed’s Regulation Y or any successor regulation – e.g., commercial and investment banking, foreign exchange services, investment services, and insurance (among others);
2. ownership or control of one or more depository institution[s]; and
3. any other activity, wherever conducted, determined by the Fed in consultation with the Secretary of the Treasury, under section 4(k)(1)(A) of the Bank Holding Company Act, to be financial in nature or incidental to a financial activity.

Recoupment of Compensation
Dodd-Frank provides that 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 (and that, in the case of fraud, no time limit applies), see § 210(s).  The NPR further clarifies the criteria that will apply in assessing whether a senior executive or director is substantially responsible for the failed condition of the covered financial company.  Specifically, the FDIC will investigate how the senior executive or director performed his or her duties and responsibilities, and the results of that performance.  Senior executives and directors who perform the responsibilities with the requisite degree of skill and care will not be required to forfeit their compensation.  Those who do not perform with the requisite degree of skill and care, however, may be required to forfeit their compensation if, as a result of their performance, the financial company suffered a loss that materially contributed to its failure.  The FDIC is currently soliciting further comments on this and other potential benchmarks that may be used to evaluate responsibility.
Under the NPR, certain persons will be presumed substantially responsible for the financial condition of the failed financial company; these include any:

• chairman;
• chief executive officer (CEO);
• president;
• chief financial officer (CFO);
• any other senior executive or director who acts in any other similar role regardless of his or her title if in this role he or she was responsible for the strategic, policymaking or company-wide operational decisions;
• a senior executive or director who has been adjudged by a court or tribunal to have breached his or her duty of loyalty to the company; and
• any senior executive or director removed from his or her position with the covered financial company pursuant to section 206(4) and (5) of Dodd-Frank.

The effect of the presumption, which is rebuttable, is to shift the burden of proof from the FDIC to the senior executive or director.
Fraudulent / Preferential Transfers
The NPR attempts to harmonize the application of the FDIC’s avoidance powers with the analogous provisions of the Bankruptcy Code.  At present, there are two areas in which the Bankruptcy Code and Dodd-Frank are potentially inconsistent in their treatment of a transferee.  First, Dodd-Frank can be read to apply the bona fide purchaser (“BFP”) standard to all fraudulent transfers and all preferential transfers.  See § 210(a)(11)(H).  In contrast, section 547(e)(1)(A) of the Bankruptcy Code only applies the BFP standard to preferential transfers of real property other than fixtures and fraudulent transfers.  The Bankruptcy Code applies the hypothetical lien creditor standard to preferential transfers of personal property or fixtures.  Section 380.9(b)(3) of the NPR clarifies that the hypothetical lien creditor standard would also apply to preferential transfers of personal property or fixtures sought to be avoided by the FDIC under the OLA.
Second, section 547(e)(2) of the Bankruptcy Code provides that security interests perfected under applicable non-bankruptcy law within 30 days of a transfer relate back to the date of transfer or the day before the commencement of the bankruptcy case.  In contrast, section 210(a)(11)(H) of Dodd-Frank does not include any express grace period.  Section 380.9(c) of the NPR clarifies that the avoidance provisions in section 210(11)(B) of Dodd-Frank would apply the 30-day grace period as provided in section 547(e)(2) of the Bankruptcy Code, subject to any exceptions or qualifications contained in the Bankruptcy Code.
Priorities
The NPR proposes two rules with respect to the priority of unsecured claims.
First, although Dodd-Frank sets forth a priority scheme for unsecured claims, see § 210(b)(1), the NPR integrates the various references to administrative expenses throughout Dodd-Frank in order to ensure consistent application of the provisions.  Pursuant to the NPR, administrative expenses include:

• obligations accruing during the FDIC receivership under rental contracts;

• obligations under contracts for services accepted by the FDIC;

• obligations under contracts which were affirmatively entered into and executed in writing by the FDIC;

• expenses incurred by the Inspector General of the FDIC in carrying out audits and investigations of receiverships every 6 months after the appointment of the receiver.

In addition, if the FDIC draws down on extended lines of credit that existed prior to receivership, as authorized by section 210(c)(13)(D) of Dodd-Frank, these creditors will hold claims that constitute “administrative expenses.”  Administrative expenses have priority over all other claims except claims for post-receivership financing obtained by the FDIC in the event that unsecured debt from commercial sources is unavailable.
Second, the NPR confirms that claims arising out of the loss of setoff rights due to the FDIC’s sale or transfer of assets will rank above general unsecured claims (but below administrative claims, claims of the United States, and certain employee wage and benefit claims).
Transfers to Bridge Financial Companies
The NPR provides that any obligation expressly purchased or assumed by a bridge financial company will be paid by the bridge financial company in accordance with the terms of such obligation.
Claims Process
The NPR provides greater detail on the procedure for filing claims against the covered financial company, how the FDIC will determine which of those claims, or portions thereof, are allowed or disallowed, and how creditors can pursue their claims in federal court in the event that the FDIC disallows their claims or portions thereof.
Secured Claims / Collateral 
The NPR provides greater clarity on how the FDIC will exercise its discretion in determining the allowed amount of secured claims, the relative priority of security interests, whether security interests are legally enforceable and perfected, and the fair market value of collateral; as well as on how the FDIC may implement expedited claims determination procedures for secured creditors who allege that they will suffer irreparable injury if they are compelled to follow the ordinary claims process.  The NPR also provides rules on how the FDIC may treat collateral, and specifically permits the FDIC to sell collateral free and clear of a creditor’s security interest, with the security interest attaching to the proceeds of the sale.
As mentioned above, in the following weeks, Weil’s financial reform working group will publish a series of articles analyzing aspects of the OLA in-depth in conjunction with the relevant provisions of the IFR and NPR, with particular attention to how creditor rights may differ under the OLA and a case under the Bankruptcy Code.