Earlier today, the FDIC announced that the FDIC Board of Directors voted on Friday, October 8, 2010 to approve the issuance of a notice of proposed rulemaking (NPR) regarding the treatment of certain creditor claims under the FDIC’s new orderly liquidation authority established under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act and a request for public comment on “broader questions to inform future rulemaking addressing other orderly liquidation issues.” The NPR was the subject of a briefing and discussion at the FDIC’s September 27, 2010 meeting, but was deferred.

The NPR proposes to bar additional payments to creditors holding long-term senior debt, subordinated debt, or equity interests that would result in those creditors receiving more than other creditors entitled to the same priority under specified law, that any additional payments would only be made where the FDIC Board of Directors determines that the payments meet certain statutory standards, and any payments that are made would be “subject to recoupment if ultimate recoveries are insufficient to repay any temporary government liquidity support provided as part of the orderly wind-down process,” which recoupment “must occur before imposition of a general industry assessment to cover any shortfalls.”

The proposed regulation would also clarify that secured creditors would be protected only to the extent of the fair value of their collateral, and that any undersecured portion of their claim will absorb losses along with other unsecured creditors.

It would also create incentives to collateralize obligations with U.S. government securities, as these would be valued at par. Both practices are aimed at discouraging the use of illiquid collateral to secure short term liabilities – which the FDIC characterized as “a major contributor to the freezing of credit markets during the financial crisis.”

Finally, the proposed rulemaking would address discrete issues in several broad areas, including:

  • the authority to continue operations by paying for services provided by employees and others (by clarifying the payment for services rendered under personal services contracts);
  • clarifying the measure of damages for claims based on contingent obligations, such as guarantees, letters of credit, loan commitments and similar credit obligations; and
  • the application of proceeds from the liquidation of subsidiaries (by reiterating the current treatment under corporate and insolvency law that remaining shareholder value is paid to the shareholders of any subsidiary).

The proposed regulation regarding the treatment of creditor claims is subject to a 30-day public comment period, while the broader set of questions about future rulemakings are subject to a 90-day public comment period.