While some of us may have had turkey on the mind over the last few days following the Thanksgiving holiday, members of the U.S. House of Representatives clearly had more important things than turkey to ponder. Just yesterday, December 1, 2014, the House passed H.R. 5421, the Financial Institution Bankruptcy Act of 2014. The legislation was passed with bipartisan support and was first introduced in the House on September 9, 2014 by Representative Spencer Bachus, a Republican from Alabama, House Judiciary Committee Chairman Bob Goodlatte, a Republican from Virginia, and Ranking Member John Conyers, a Democrat from Michigan. According to the bill’s co-sponsors, the Financial Institution Bankruptcy Act was crafted not only with the cooperation between Republicans and Democrats, but also with the collection of input from regulators, including the Federal ReserveFederal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). As described below, the proposed legislation would amend the Bankruptcy Code to facilitate the resolution of an insolvent financial institution in bankruptcy. Before any such amendments are made and the bill becomes law, the Financial Institution Bankruptcy Act of 2014 must be approved by the U.S. Senate and then by the President. The text of the bill can be found here.

Under current law, the government may place certain large financial institutions, upon failure, into receivership. Specifically, Title II of the Dodd-Frank Act provides a process to quickly and efficiently liquidate a large, complex financial company that is close to failing pursuant to a receivership under the direction of the FDIC. For a discussion of Title II of the Dodd-Frank Act, click here. The Financial Institution Bankruptcy Act of 2014 would establish an alternative to the use of Title II of the Dodd-Frank Act, in allowing for a failure of bank holding companies and certain large financial institutions to be handled through the Bankruptcy Code rather than by the FDIC.

The Financial Institution Bankruptcy Act of 2014 would amend chapter 11 of the Bankruptcy Code by adding Subchapter V, targeting large financial institutions. Subchapter V reflects the principles of the single point of entry approach. Under this approach, a holding company would enter chapter 11 and its operating subsidiaries would stay out of the process through recapitalization and continue as subsidiaries of a new bridge company. Using the single point of entry approach as a framework, the Financial Institution Bankruptcy Act of 2014 (i) provides the Bankruptcy Court with the authority to transfer certain property, contracts, and leases of the covered financial corporation (i.e., bank holding companies or large financial institutions having consolidated assets of at least $50 billion) to a bridge company, if necessary to prevent serious adverse effects on financial stability in the United States, (ii) allows for a temporary stay of certain contractual rights tied to the financial condition of the failed institution (e.g., collection of collateral, acceleration of debt, or close-out netting of derivatives), and (iii) prevents counterparties from modifying or terminating debt, contracts, leases, licenses, permits or registrations upon failure of the financial institution, and instead allows for their transfer to a bridge company.

The proposed legislation provides that the equity securities in the bridge company must be transferred to a qualified and independent special trustee, who will hold the equity securities in trust for the sole benefit of the estate. The trust must be a newly formed trust, governed by a trust agreement approved by the Bankruptcy Court, which exists for the sole purpose of holding and administering the equity securities of the bridge company. The assets held in trust would be distributed by the special trustee in accordance with a plan confirmed by the Bankruptcy Court.

Subchapter V provides for both voluntary and involuntary filings by covered financial corporations. Involuntary filings could be initiated by the Federal Reserve by demonstrating that the filing is necessary to prevent serious adverse effects on financial stability in the United States. In addition, the prospective statute empowers judges to consider the effects of their decisions on the financial stability of the United States and allows the Federal Reserve, the Securities and Exchange Commission, the Office of the Comptroller of the Currency, and the FDIC to be heard on any issue in the case or any proceeding in a case. Finally, the bill would create a special category of bankruptcy judges who would handle these cases.

The Financial Institution Bankruptcy Act of 2014 goes to the Senate next for consideration. If the bill ultimately becomes law, the landscape for resolving financial institutions could take a whole new shape. Stay tuned as we continue to monitor the status of the proposed legislation.