Definition of 'financial company' subject to resolution under the OLA
Recoupment of compensation from former and current senior executives and directors
On July 6 2011 the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved a final rule addressing certain provisions of the Orderly Liquidation Authority (OLA) contained in Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act(1).
Under the OLA, upon the recommendation of designated regulatory agencies and certain determinations by the secretary of the treasury in consultation with the president, failing financial companies can be taken out of the bankruptcy regime that would normally apply to them and be resolved instead under the OLA, with the FDIC acting as receiver.
The final rule adopts, with certain changes, the proposed rule set forth in the FDIC's March 15 2011 notice of proposed rulemaking and January 18 2011 interim final rule regarding the OLA.(2) A summary of the substantive changes is set out below.
At the board meeting, FDIC staff also provided the board with a progress report on rules requiring resolution plans (so-called 'living wills') and credit exposure reporting by systemically important non-bank financial companies and bank holding companies that are called for by Section 165(d) of the Dodd-Frank Act, and on rules proposed by the FDIC in May 2010 requiring special reporting and resolution plans by certain large FDIC-insured depositary institutions. FDIC staff indicated that it is working to harmonise both rules and to address industry concerns regarding the confidentiality of information that it will be receiving under them. FDIC hopes to finalise the rules in the future.
Definition of 'financial company' subject to resolution under the OLA
Under the Dodd-Frank Act, 'financial companies' that are potentially subject to the OLA are limited to companies incorporated or organised under federal or state law (ie, only US domestic companies) that are any of the following:
- a bank holding company under the Bank Holding Company Act of 1956, as amended;
- a non-bank financial company supervised by the Federal Reserve Board under Title I of the Dodd-Frank Act;
- a company that is predominantly engaged in activities that are financial in nature or incidental for the purposes of Section 4(k) of the Bank Holding Company Act; or
- any subsidiary of the foregoing that is predominantly engaged in such activities, other than a subsidiary that is an FDIC-insured depositary institution or an insurance company.
In the notice of proposed rulemaking, the FDIC had proposed criteria for determining whether a company is predominantly engaged in activities that are financial in nature for purposes of the above tests. In the preamble to the final rule, the FDIC notes that the Federal Reserve Board has proposed criteria for determining whether a company is predominantly engaged in such activities for purposes of determining whether the company is a non-bank financial company which may be supervised by the Federal Reserve Board under Title I of the Dodd-Frank Act, and that there are substantial similarities between the 'predominantly engaged' tests in Title I and Title II of the Dodd-Frank Act. In view of such similarities, the FDIC indicates that the FDIC staff is continuing to coordinate with the staff of the Federal Reserve Board regarding the predominantly engaged criteria and intends to finalise such criteria in future rulemaking.
Recoupment of compensation from former and current senior executives and directors
Section 210(s) of the Dodd-Frank Act authorises the FDIC to recover, from any current or former executive officer or director substantially responsible for the failed condition of a financial company, any compensation received during the two-year period preceding the date on which the FDIC was appointed receiver (with no time limit in the case of fraud). The notice of proposed rulemaking provided that a senior executive or director would be deemed to be substantially responsible if he or she failed to conduct his or her responsibilities with the requisite degree of skill or care required by that position.
The final rule clarifies that the requisite degree of care is that which "an ordinarily prudent person in a like position would exercise under similar circumstances". In other words, the standard of care that will trigger possible recovery is a negligence standard, rather than a higher standard such as gross negligence.
Despite objections from commenters, the final rule retains the controversial notice of proposed rulemaking provision that a senior executive or a director of a financial company will be presumed to be substantially responsible merely because he or she served in the role of chairman of the board, chief executive officer, president, chief financial officer or in a similar role prior to the date on which the financial company was placed into an OLA receivership.
The final rule also retains the presumption of substantial responsibility in cases where:
- a senior executive officer or director was adjudged liable by a court or tribunal for having breached his or her duty of loyalty to the financial company; or
- a senior executive was removed from management or a director was removed from the board of directors under the removal provisions of the Dodd-Frank Act.
Under the final rule, an individual who is presumed to be substantially responsible based on his or her role in the financial company can rebut such presumption by proving that he or she performed his duties with the degree of skill and care that a prudent person in a like position would have exercised. In other cases an individual can rebut the presumption by proving that he or she did not cause a loss to the financial company that materially contributed to the failure of the financial company under the facts and circumstances.
The above presumptions do not apply to:
- a senior executive officer hired by the financial company in the two years prior to the FDIC's appointment as receiver to assist in preventing further deterioration of the financial condition of the financial company; or
- a director who joined the board of directors of the financial company in the two years prior to the FDIC's appointment as receiver under an agreement or resolution to assist in preventing further deterioration of the financial condition of the financial company.
The preamble to the final rule clarifies that the FDIC anticipates that it will seek recoupment of compensation through the court system using a procedure similar to that which it currently uses when it seeks recovery from individuals whose negligent actions have caused losses to failed FDIC-insured depositary institutions.
Like the Dodd-Frank Act and the notice of proposed rulemaking, the final rule lists 11 priority classes for unsecured claims, the effect of which is to give several classes, including 'amounts owed to the United States', priority over general unsecured creditor claims (eg, claims of holders of senior unsecured debt securities of the financial company).
Amounts owed to the United States
Consistent with the Dodd-Frank Act and the notice of proposed rulemaking, the final rule accords amounts owed to the United States the second highest priority (after administrative expenses of the receiver) in the list of priorities. The notice of proposed rulemaking contained a definition of 'amounts owed to the United States' that included all amounts of any kind owed to a department, agency or instrumentality of the United States. The final rule narrows the definition to encompass only unsecured amounts that are related to:
- funds provided for the orderly liquidation of the financial company;
- funds provided to avoid or mitigate adverse effects on the financial stability of the United States; or
- unpaid unsecured federal income tax obligations of the financial company.
In response to requests from commenters, the final rule contains a non-exclusive list of advances that fall within the definition of 'amounts owed to the United States', which clarifies that such amounts include the following:
- unsecured amounts owed to the FDIC for any extension of credit by the FDIC;
- unsecured amounts owed to the Department of the Treasury on account of unsecured tax liabilities of the financial company;
- unsecured amounts paid or payable by the FDIC pursuant to its guarantee of any debt issued by the financial company under the FDIC's Temporary Liquidity Guarantee Programme, any widely available debt guarantee programme authorised under specified provisions of the Dodd-Frank Act or any other debt or obligation that is guaranteed by the FDIC;
- the unsecured amount of any debt owed to a Federal Reserve bank; and
- any unsecured amount expressly designated in writing in a form acceptable to the FDIC by the appropriate US department, agency or instrumentality that specifies that the particular amount is to be included.
The final rule also specifically excludes from 'amounts owed to the United States':
- unsecured amounts owed to government sponsored entities, including Freddie Mac and Fannie Mae;
- unsecured amounts owed to federal home loan banks; and
- unsecured amounts owed in satisfaction of filing, registration or permit fees due to any government department, agency or instrumentality.
In addition, the final rule provides that, subject to certain conditions, the United States may consent to subordinate the repayment of any amount owed to the United States to any other obligation.
The final rule makes clear that contractual subordination agreements will be respected. This provision is consistent with Section 510(a) of the Federal Bankruptcy Code, which provides that subordination agreements that are enforceable under applicable non-bankruptcy law will be respected by a trustee in bankruptcy.
The Dodd-Frank Act specifically empowers the FDIC as receiver to transfer assets of a financial company "free and clear of the set-off rights of any third party", but grants a preferred recovery right to the claim of a creditor based on the loss of an otherwise valid right of set-off due to such transfer. The final rule, like the notice of proposed rulemaking, provides that such a claim is to be paid at a level of priority immediately prior to all other general unsecured creditors, but below administrative expenses of the receiver, amounts owed to the United States and certain employee-related claims. However, in a change from the notice of proposed rulemaking, the final rule makes clear that the priority given to creditors that have lost set-off rights as a result of the exercise by the FDIC of its right to transfer assets does not affect the provisions of the Dodd-Frank Act relating to qualified financial contracts.
The final rule provides that the FDIC as receiver will estimate the value of a contingent claim no later than 180 days after the claim is filed or any extended period agreed to by the claimant. If the claim becomes fixed before it has been estimated, it may be allowed in the final fixed amount.
The Dodd-Frank Act provides for the resolution of claims against a financial company through an administrative claims process conducted by the FDIC as receiver.
The final rule makes clear that the OLA administrative claims process does not apply to claims against a bridge financial company or involving its assets or liabilities, or to extensions of credit from a Federal Reserve bank or the FDIC to a financial company. By exempting such contracts from the requirement to seek consent of the receiver before exercising contractual rights against property of the financial company, the final rule also clarifies that the claims process does not affect the contractual rights of netting and set-off with respect to qualified financial contracts that are protected by the Dodd-Frank Act. However, in the preamble to the final rule, the FDIC indicates that if a party to a qualified financial contract has an unsecured claim after terminating the contract and liquidating the collateral, such claim will be subject to the claims process.
The final rule also narrows the late-filed claims exception by providing that the FDIC as receiver will consider a claim filed after the claims bar date only if the claimant did not have notice of the appointment of the receiver in time to file its claim or the claim is based on an act or omission of the receiver that occurs after the claims bar date. The notice of proposed rulemaking had supplemented this exception to address claims that did not accrue until after the claims bar date. In the preamble to the final rule, the FDIC indicates that it determined such supplement was too broad because it could encompass contingent claims which the final rule addresses separately.
The final rule modifies the provisions in the notice of proposed rulemaking regarding the rights of secured claimants to provide that collateral securing claims against a financial company will be valued at the time of any proposed disposition or use of the collateral. The notice of proposed rulemaking provided that such collateral would be valued as of the date of the appointment of the FDIC as receiver. The FDIC indicates that the modification is intended to conform the approach to collateral valuation to that in the Federal Bankruptcy Code.
In another change from the notice of proposed rulemaking, a secured claimant may request the FDIC's consent, as receiver, to exercise its rights against the collateral. The FDIC is required to grant such consent unless it decides to use, sell or lease the collateral, in which case the FDIC must provide adequate protection of the claimant's security interest in the property. However, this provision will not apply in cases where the FDIC repudiates or disaffirms the secured contract.
The other provisions of the final rule - including those relating to personal service agreements, insurance company subsidiaries, liens on insurance company assets, post-insolvency interest, bridge financial companies and similarly situated creditors - remain substantially unchanged from the notice of proposed rulemaking and interim final rule.
In a clarification that will be of particular interest to participants in the asset-backed securities and secured lending markets, the final rule (like the notice of proposed rulemaking) conforms the treatment of fraudulent and preferential transfers to that under the Federal Bankruptcy Code, including by making clear that the FDIC, as receiver, does not have greater authority than a trustee in bankruptcy under the Federal Bankruptcy Code to set aside as preferential transfers security interests perfected by financing statements rather than by possession. This essentially codifies a December 2010 opinion letter of the FDIC's acting general counsel on the subject.
The final rule does not, as some had expected, codify a separate acting general counsel opinion issued in January 2011 stating that until the FDIC adopts a regulation, the FDIC will not exercise its OLA repudiation authority to reclaim, recover or re-characterise as property of a financial company assets transferred by the financial company prior to the end of the transition period contained in such a regulation, provided that such transfer satisfies the conditions for exclusion from the property of the estate of the financial company under the Federal Bankruptcy Code. The January 2011 opinion also indicated that nothing in the Dodd-Frank Act changes existing law governing the separate existence of separate entities under other applicable law, or changes the enforceability of standard contractual provisions meant to foster the bankruptcy-remote treatment of special purpose entities established in connection with structured finance transactions. Apparently, this topic will be addressed in future rulemaking. Until such time, it appears that the January 2011 opinion letter continues to apply.
For further information on this topic please contact Daniel M Rossner at Sidley Austin LLP by telephone (+1 212 839 5300), fax (+1 212 839 5599) or email ([email protected]).
(1) The final rule is available at http://www.gpo.gov/fdsys/pkg/FR-2011-07-15/pdf/2011-17397.pdf.
(2) Summarised versions of the notice of proposed rulemaking and the interim final rule are available at http://www.sidley.com/sidleyupdates/Detail.aspx?news=4763; and http://www.sidley.com/sidleyupdates/Detail.aspx?news=4682.