Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 establishes a new specialized insolvency regime, known as orderly liquidation, for systemically significant nonbank financial companies. While well intended, Title II unfortunately raises a number of serious constitutional questions. To vest authority in an Article III judge to appoint a receiver for such companies, yet also avoid a financial panic, Dodd-Frank requires that the judicial proceedings be conducted in secret, with no notice to the public or other interested parties on pain of criminal penalties, and that the judge rule on the petition to appoint the receiver within twenty-four hours of its filing. These unprecedented procedures raise serious questions under the Due Process Clause, Article III of the Constitution, and the First Amendment. The very broad discretion given to the executive branch to decide whether a distressed financial firm should be subject to mandatory liquidation under Title II, as opposed to conventional bankruptcy, also raises questions under the uniformity requirement of the Constitution's Bankruptcy Clause. Finally, Title II raises a number of potential issues under the Takings Clause. Given the extremely abbreviated time for judicial appointment of a receiver, the prohibition on any stay pending appeal, and the absence of any post-appointment judicial review of the decision to place a firm into receivership, there are a number of vexing questions about how and when the constitutional issues raised by Title II might be presented to the courts. This Article examines these constitutional and procedural questions and argues that Congress should amend the Dodd-Frank Act to provide for plenary judicial review after rather than before a receiver is appointed. This simple change, along with amendments tightening some of the language that indicates when orderly liquidation rather than bankruptcy is appropriate, would help ensure that the new Title II authority is not undermined by a welter of constitutional claims--if and when it becomes necessary to use this authority to avert a future financial crisis.
Introduction I. Title II's Orderly Liquidation Authority (OLA) A. Bank Receiverships and Bankruptcy 1. FDIC Receivership Procedure 2. Bankruptcy Procedure B. Legislative History of Dodd-Frank's OLA C. OLA as Enacted II. Constitutional Challenges: The Who and the When A. Raising Claims by Defense B. Enjoining the Receiver C. Suit for Anticipatory Relief D. The Tucker Act Defense III. Constitutional Issues: Process Objections A. Due Process B. Article III C. Avoidance, Anyone? IV. Constitutional Issues: Substantive Objections A. Uniform Laws of Bankruptcy B. First Amendment V. Takings Issues A. Some Possible Takings Claims 1. Assessments 2. Executive Pay Clawbacks 3. Revival of Barred Actions B. Impairment of Security Interests Conclusion Introduction
The Dodd-Frank Act (1) is the federal government's most significant response to the financial crisis of 2007-2009 and the severe recession that followed. If the precipitating event of the Great Depression was the 1929 stock market crash, the September 15, 2008 filing of Lehman Brothers's bankruptcy petition was the analogous triggering event for the Great Recession. (2) Within hours of the filing, credit markets froze up, and the Dow Jones Industrial Average plunged 504 points. (3) One day later, the federal government advanced funds, eventually totaling $182 billion, to prevent the collapse of insurance giant AIG. (4) Within weeks, a reluctant Congress created a $700 billion fund, known as the Troubled Asset Relief Program (TARP), to provide emergency funds to financial firms regarded as "too big to fail." (5)
Observers drew two main lessons from these traumatic events. The first was that conventional bankruptcy tools were inadequate when dealing with insolvency of a major investment bank like Lehman Brothers. (6) A significant portion of Lehman's business consisted of making long-term loans funded by short-term borrowing. (7) Unlike a traditional bank, which makes long-term loans funded by government-insured deposits, Lehman obtained funds to support its lending activity through short-term borrowing from other financial firms secured by collateral such as mortgage-backed securities. (8) When the housing bubble started to burst in 2007-2008, the value of this collateral became uncertain. Lehman's counterparties demanded more and better collateral, and when rumors began circulating that Lehman might be insolvent, they refused to deal with Lehman at all, causing a general panic among financiers analogous to a run on a bank by depositors. (9) For a variety of reasons, including the fact that collateralized debt obligations are exempt from the Bankruptcy Code's automatic stay, (10) the bankruptcy court was utterly helpless to stop the Lehman crisis from unfolding.
The second lesson that quickly became evident was that the only alternative to bankruptcy under existing law was government bailouts of financial firms deemed too big to fail. (11) Nearly all observers recognized the problem inherent in a policy of bailing out large financial firms when they become overextended. If the government issues a standing promise to bail out the biggest financial firms, it encourages such firms to engage in excessively risky behavior, increasing the likelihood of the very type of financial crisis everyone would like to avoid. (12) Moreover, a government bailout guarantee, even if only implicit, allows the largest financial firms to obtain credit on more favorable terms than ordinary financial firms, distorting incentives and altering the competitive landscape in undesirable ways. (13)
The American public, while perhaps not appreciating the nuances of the policy arguments, unquestionably regarded the bailouts as grossly unfair. Once the immediate crisis subsided, the bailed-out firms and their well-paid officers and directors appeared to have survived quite nicely, while ordinary folks still suffered the lingering effects of the downturn.
The idea that the federal government rescued large financial firms with taxpayer dollars while ordinary citizens lost their jobs and watched their savings evaporate resulted in widespread anger. Politicians seemed to agree, at least publicly, that the general public should never again be taxed to prop up giant financial firms that the government deems too big to fail. (14)
In light of these perceived lessons from the Lehman Brothers bankruptcy and the regime of bailouts that followed, the Obama administration quickly concluded that a new insolvency regime was needed--one that would unwind "systemically significant" financial firms like Lehman Brothers while avoiding the undesirable incentives and public hostility to government bailouts. The administration therefore proposed a new type of resolution authority, modeled after the process for shutting down insolvent banks and savings and loan associations, as part of the package of proposed financial reforms that eventually became the Dodd-Frank Act. (15) Ordinary banks and savings and loan associations that accept government-insured deposits have long been subject to special resolution procedures that use a receivership or conservatorship; this authority was augmented before the enactment of Dodd-Frank to include provisions allowing the receiver or conservator to take systemic financial risk into account in certain circumstances. The Administration's Combined Draft would create a similar type of authority that applied to systemically significant financial firms, other than banks and savings and loan associations, such as bank holding companies and their subsidiaries. (17) Under this new resolution authority, government agencies would be given broad discretion to decide on a case-by-case basis when a bank holding company was in trouble and if its failure would pose a threat to the economy. (18) This decision would lead to a takeover by a government receiver or conservator, typically the FDIC, which would proceed to run the company as it resolved claims of creditors until the firm was liquidated or reorganized. (19) Positive-value assets could be transferred to a "bridge financial company" and eventually folded into another firm. (20) If, while the firm was being wound down, financing was required to meet its obligations, the administration proposed that the necessary funds would be supplied by the Treasury. (21)
Like other provisions of the financial reform, the proposed resolution authority was politically controversial. Opponents argued that the proposal would institutionalize the hated regime of bailouts. (22) Proponents insisted that the new resolution authority would put an end to bailouts. (23) The legislative back-and-forth produced amendments that added further constraints on the discretion of the executive branch in using the new authority. (24) One of these new constraints added by the Senate at the last minute--the requirement that a federal district judge make the final decision to appoint a receiver for a firm undergoing resolution--introduced the constitutional questions that are a substantial focus of this Article. (25) Other changes enhanced the punitive effects of the new resolution authority, raising further constitutional questions.
In keeping with Alexis de Tocqueville's famous adage that "[s]carcely any political question arises in the United States that is not resolved, sooner or later, into a judicial question," (26) Dodd-Frank's orderly liquidation authority is now the subject of a lawsuit. Eleven state attorneys general have sued in the United States District Court for the District of Columbia, charging that the Act's Title II violates the Due Process Clause, Article III of the Constitution, and the uniformity requirement of the Bankruptcy Clause. (27) The suit was dismissed by the district court for lack of standing and ripeness (28) and is now on appeal...