On October 8, 2010, the FDIC approved a Proposed Rule that would implement certain provisions of its authority granted by Congress in Title II of the Dodd-Frank Act (“Title II”) to act as receiver for covered financial companies (failing financial companies that pose significant risks to the financial stability of the United States) when a Bankruptcy Code proceeding is found to be inappropriate. Prior to the enactment of the Dodd‑Frank Act on July 21, 2010, no unified statutory scheme for the orderly liquidation of covered financial companies existed. Rather, there was a disparate group of liquidation schemes: insured depository institutions were subject to receivership in accordance with the Federal Deposit Insurance Act administered by the FDIC, insurance companies were subject to individual state laws on insolvency, registered brokers and dealers were subject to the Bankruptcy Code and proceedings under the Securities Investor Protection Act, and other companies, including the parent holding companies of one or more insured depository institutions or other financial companies, were eligible for liquidation proceedings under the Bankruptcy Code.

Under the unified statutory scheme, certain designated Federal regulatory agencies will recommend to the Secretary of the Treasury that he/she make a determination that the troubled financial company qualifies as a covered financial company. Each recommendation to the Secretary shall include: (1) an evaluation of whether the subject company is in default or in danger of default, (2) a description of the effect that the company’s default would have on the financial stability of the United States, and (3) an evaluation of why a case under the Bankruptcy Code would not be appropriate. The recommendation to the Secretary will be made by (1) the Federal Reserve Board and the Securities and Exchange Commission if the company, or its largest U.S. subsidiary, is a broker or a dealer, (2) the Federal Reserve Board and the Director of the Federal Insurance Office if the company, or its largest U.S. subsidiary, is an insurance company, or (3) the Federal Reserve Board and the FDIC in all other cases. Prior to making a final determination, the Secretary is required to consult with the President.

If the Secretary makes such a determination, the FDIC has authority to continue business operations through a bridge financial company pursuant to which the FDIC would maintain daily operations of the failed financial company. In contrast to the Bankruptcy Code, Title II requires contracting parties to continue to perform under their contracts even after their contracts are transferred to the bridge financial company and for so long as the bridge financial company performs.

Title II generally seeks to create parity in the treatment of creditors to accord with existing insolvency laws, but the FDIC is permitted to pay certain creditors of a receivership more than similarly situated creditors. The FDIC may make such payments where necessary to (1) maximize the value of the assets, (2) initiate and continue operations essential to implementation of the receivership and any bridge financial company, (3) maximize the present value return from the sale or other disposition of the assets, or (4) minimize the amount of any loss on sale or other disposition. The Proposed Rule clarifies the discrete circumstances under which such payments to creditors may be made to underscore that all unsecured creditors should expect to absorb losses along with other creditors. The Proposed Rule would exclude holders of certain long-term unsecured senior debt (i.e., with a term of more than 360 days) from receiving any additional payments. The Proposed Rule also preserves the ability of the FDIC to make payments to general creditors such as general trade creditors or any general or senior liability of the covered financial company that are found necessary to effect an orderly liquidation.

The FDIC is seeking comment on the Proposed Rule, particularly on whether different types of covered financial institutions require different rules and regulations in the application of the FDIC’s powers and rules, and whether “long term senior debt” should be defined by reference to maturity and, if so, whether the threshold should be 360 days, 270 days or something else. Under the Dodd-Frank Act, secured creditors are paid in full to the extent of pledged collateral, and valuation of U.S. government and agency obligations is deemed to be par. The FDIC is also seeking comment on valuation parameters for other collateral.