Dodd-Frank orderly liquidation authority: too big for the constitution?

• Author: Merrill, Thomas W.
• Position: III. Constitutional Issues: Process Objections through Conclusion, with footnotes, p. 204-247

3. CONSTITUTIONAL ISSUES: PROCESS OBJECTIONS

   The prospect of the appointment of the FDIC to liquidate a firm under Title II would likely spark deep anxiety in a variety of the targeted firm's stakeholders. Creditors would worry that they will not get any of their money back or that they will get only liquidation value, as opposed to the potentially greater "going concern" value available through reorganization. Officers and directors would worry that they will be out of a job or, worse, that they will be held personally liable for the failure of the firm. (211) Shareholders would be concerned by the prospect of having their investments wiped out. Each of these groups would have an incentive to bolster its position by raising constitutional objections to the OLA process. Arguments conceivably could be advanced under the Due Process Clause of the Fifth Amendment, Article III of the Constitution, the Uniformity Clause of the Bankruptcy Power, the First Amendment, and the Takings Clause of the Fifth Amendment. In this Part, we consider the various process objections that could be brought in under the Due Process Clause and Article III.

   1. Due Process

      In order to establish a due process violation, a claimant must show that he or she has a life, liberty, or property interest; that the government is threatening to deprive him or her of that interest; and that the deprivation will take place without affording him or her adequate notice or opportunity to be heard. (212)

      We assume that all relevant parties who might feel threatened by the prospect of a Title II liquidation would satisfy the threshold requirement of having a "property" interest at stake. For purposes of due process, property includes money and securities; thus, creditors of all stripes have constitutionally protected property interests in the assets of a debtor firm. (213)

      Property also includes gainful employment, at least if the employee has an unexpired employment contract that makes him or her more than an at will employee. (214) Consequently, officers and directors who will lose their positions through an exercise of the OLA have a property interest under the Due Process Clause, provided they are working under an unexpired employment contract. It is also undeniable that the actions taken by the FDIC in completing an orderly liquidation would constitute action that would deprive these parties of their respective interests.

      In assessing what process is due, the Supreme Court has tended to treat notice as a requirement distinct from other procedural elements. (215) Notice by mail or a similarly effective method is generally required for any proceeding that will adversely affect the property rights of an affected party as long as their name and address are "reasonably ascertainable." (216) The notice requirement calls into question the constitutionality of the Act's criminal penalties for providing notice to anyone other than the firm possibly facing receivership. (217) Shareholders, counterparties, creditors, and officers deemed to be responsible for the financial distress of the firm may have their interests compromised or completely wiped out by mandatory liquidation under Title II, and yet the statute makes it a criminal offense to provide them with the notice that would allow them to voice their objections before liquidation commences.

      In response, the government would undoubtedly point to bank receiverships, where traditionally no formal notice is given before a receiver is appointed and property seized. (218) In practice, however, the appointment of a receiver will typically come as no surprise to the bank and its officers and directors. As the D.C. Circuit has observed, bank regulators ordinarily raise concerns about the adequacy of the bank's reserves or other financial issues with bank officers over an extended period of time before initiating receivership procedures, giving the bank an idea of the relevant issues and an opportunity to respond, albeit informally. (219) Whether nonbank financial firms will similarly be alerted to the possibility of seizure under Title II through informal communications with regulators is unclear; certainly, the statute does not require it. Further, even if the firm has been given effective notice, notice cannot legally be given to creditors and other stakeholders.

      The government would inevitably fall back on the position that exigent circumstances, such as public health emergencies, sometimes require it to act without giving advance notice. The government would argue that advance notice to all reasonably ascertainable stakeholders cannot be given before seizing the firm pursuant to the OLA, because such notice could trigger the very financial panic or instability Dodd-Frank was designed to prevent. Such arguments have been accepted in other emergency contexts, but almost invariably with the caveat that a prompt post-deprivation hearing is made available, during which the legality of the seizure may be challenged and the property restored to its rightful owner if the seizure turns out to have been unwarranted. (220) Justice Jackson, in Fahey v. Mallonee, described bank seizure as a "drastic procedure" justified by "the delicate nature of the institution and the impossibility of preserving credit during an investigation." (221) But the procedure at issue there (222) provided for extensive hearing rights, including a full particularization of the reasons for the seizure, within a matter of days after the seizure. (223) Dodd-Frank's OLA, as amended by the Senate, eliminates the right to post-seizure judicial review routinely available (even if rarely invoked) in the banking industry. Under Dodd-Frank, creditors who dispute the FDIC's determination of the priority or the valuation of their individual claims can seek judicial review. (224) But the government could point to no provision in the statute that provides a post-seizure remedy to any other stakeholder, including creditors who believe they would obtain more for their claims in a reorganization in bankruptcy, making it much more difficult to justify the absence of notice to these affected persons or institutions.

      Beyond notice, the extremely abbreviated twenty-four-hour period required by Title II between the filing of the petition and the automatic grant of the petition also presents due process concerns. Realistically, it is hard to imagine that this is adequate time for the firm to mount an effective defense or for the court to engage in meaningful deliberation. (225) To be sure, the only issues the court may consider are whether the Secretary acted in an arbitrary and capricious fashion in determining that the firm is a "financial company," as defined by the statute, (226) and that the firm is in default or in danger of default. (227) But if these elements are contested, it is inconceivable that the firm could put together and present to the court a coherent rebuttal and that the court could digest the issues and render a well-considered decision within the extremely compressed time period. The impracticality of the deadline would be particularly apparent in any review of the FDIC's finding that the firm is in default or in danger of default, which could entail examining hundreds of disputed accounting issues, many of great complexity.

      The judicial review process is made even more problematic by the lack of guidance on the intended meaning of Dodd-Frank's "arbitrary and capricious" standard of review. (228) While the APA directs courts to set aside agency action that is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law," (229) a standard which expressly encompasses questions of law as well as fact, Dodd-Frank uses only the term "arbitrary and capricious." (230) Does Dodd-Frank's omission of the phrase "otherwise not in accordance with law" mean that the district court may not review disputed questions of law? Such a construction would very likely be unconstitutional. (231) The fundamental objective of the Due Process Clause is to assure that the government deprives persons of their property only in accordance with the law, that is, with "due process of law." (232) An attempt by Congress to cut off any ability to challenge the lawfulness of a taking of property--at both the administrative and the judicial level--would almost certainly contravene due process.

      The statute's limitation of judicial review to just two of the seven factors that the Secretary of the Treasury must consider in determining whether to petition for appointment of a receiver creates further due process problems. Dodd-Frank requires the Secretary to petition for a receivership if he makes seven enumerated determinations listed in the statute. (233) However, there is no provision for an administrative hearing to review any of the seven determinations, and only two of the seven are subject to judicial scrutiny, which must occur in the previously described twenty-four-hour hearing pursuant to the rather ambiguous "arbitrary and capricious" standard of review. (234) How can the government seize and liquidate a major financial firm based on five determinations that are never subject to any administrative or judicial review? Ordinarily, persons may not be deprived of property by administrative action that is immune from all review by the courts. (235) Why, then, can financial firms be liquidated without any opportunity to contest the legal determinations that support this action?

      Admittedly, some determinations required by Dodd-Frank involve discretionary judgments best left to an agency's expertise, such as the finding that resolution of the firm under ordinary bankruptcy law "would have serious adverse effects on financial stability in the United States." (236) But others are highly factual, such as the finding that the financial firm has been ordered "to convert all convertible debt instruments." (237) Eliminating all avenues of...