Chapter 16 Dodd-Frank's Liquidation Scheme: Basics for Bankruptcy Practitioners

• Jurisdiction: United States

16. Dodd-Frank's Liquidation Scheme: Basics for Bankruptcy Practitioners

Written by:

Douglas E. Deutsch

Chadbourne & Parke LLP; New York

Eric Daucher

Chadbourne & Parke LLP; New York

In what is likely the most important change to U.S. insolvency law in recent times, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010. Although Dodd-Frank covers a wide range of topics, perhaps no aspect of the law has drawn as much attention as its proponents' claim that it will end the era of "too big to fail." Title II of Dodd-Frank creates the framework to address such company failures.

Pursuant to Title II, titled "Orderly Liquidation Authority" (OLA), large financial institutions are to be wound down and administered prior to a free-fall bankruptcy like that experienced by Lehman Brothers in 2008. The centerpiece of OLA is the creation of a new federal receivership procedure, pursuant to which the Secretary of the Treasury, subject to limited procedural safeguards, may appoint the Federal Deposit Insurance Corp. (FDIC) as receiver for a troubled "covered financial company."¹

The next time a financial institution on the scale of Lehman Brothers fails,² the law that administers the clean-up will likely not be the longstanding and well-tested Bankruptcy Code. Instead, bankruptcy practitioners and others will have to turn to OLA. Accordingly, practitioners would be well-advised to familiarize themselves with the basics of OLA.

A. What Institutions Are Covered by OLA?

Financial entities placed in receivership through OLA are exempted from the provisions of the Bankruptcy Code, subject to certain limited exceptions. Therefore, it is crucial for bankruptcy practitioners to appreciate what entities may be subject to OLA so that they may advise their clients —potential debtors and creditors alike—accordingly.

Dodd-Frank delineates four types of "financial companies" that are eligible for FDIC receivership pursuant to OLA: (1) bank holding companies; (2) non-bank financial companies supervised by the Federal Reserve's Board of Governors (the "Governors"); (3) any company predominately engaged in activities that the Governors deem "financial in nature" or "incidental thereto"; and (4) any subsidiary of any company that falls within the above categories that is predominantly engaged in activities that are financial in nature.³ Even at first glance, the range of entities potentially subject to OLA is exceptionally broad.

As part of its larger scheme to promote financial stability, Dodd-Frank created the "Financial Stability and Oversight Council." The council has discretion to identify entities as "systemically important." Any institution deemed "systemically important" becomes subject to supervision by the Governors and could fall under category two of the "financial companies" definition noted above. Categories three and four are similarly broad: A company may be deemed to be predominately engaged in financial activities if at least 85 percent of its total revenue stems from "financial activities," which can include anything from selling insurance to trading derivatives.⁴

Investment banks on the scale of Lehman Brothers are obviously intended to be covered by OLA. Equally obvious is that smaller institutions, such as retail store chains, are not intended to be covered by OLA, but what about organizations that fall somewhere in between? Would Enron, with its enormous energy trading and derivatives operations, have been covered? In short, at least at this point in time, it is unclear which institutions are eligible for OLA proceedings. This uncertainty is a point of serious concern because application of OLA may deprive a company's creditors of some of the protections that are taken for granted under the Bankruptcy Code.⁵

B. OLA Receivership Criteria

Before a company can be put into receivership under OLA, the Secretary of the Treasury must make a determination that the company is a "financial company" that is either in—or is in danger of —default and that a default would have "serious adverse effects on financial stability in the United States." Additionally, the Secretary must determine that (1) no viable...