Shearman & Sterling LLP

The U.S. Department of the Treasury released its report and recommendations regarding the Orderly Liquidation Authority established under Title II of the Dodd-Frank Act.  The report proposes a “bankruptcy first” approach to the resolution of financial institutions, recommending the establishment of a new chapter of the U.S. Bankruptcy Code.  This new Chapter 14, which has been the subject of academic and industry debate for several years, would generally involve placing the top-tier parent of a financial group into bankruptcy proceedings and transferring the subsidiaries to a new bridge company and would also include procedural features tailored to address specific nuances in respect of the resolution of financial institutions.  Under this framework—and similar to existing bankruptcy processes—shareholders, management, and specified creditors would bear all losses.  The report highlights that resolution through bankruptcy would provide clear, predictable and impartial adjudication of competing claims, and that the creation of this new Chapter 14 process would further reduce the likelihood that the OLA would have to be utilized to resolve a failing financial institution.  The report does not, however, recommend the full repeal of Title II of the Dodd-Frank Act.  Instead, Treasury recommends that reforms be made to the OLA, including limiting the discretion afforded to the U.S. Federal Deposit Insurance Corporation and further tailoring the OLA process.  The report notes that under the current formulation of the OLA, the FDIC is granted overly broad discretion on several issues, including the treatment of creditors.  The reforms proposed by Treasury would require that only critical vendors be eligible for favored treatment, rather than the current framework that allows the FDIC to treat similarly situated creditors differently on an ad hoc basis.  The report further recommends that while the FDIC should manage the initial transfer and disposition of the bridge company under the OLA framework, claims should ultimately be adjudicated by a bankruptcy court.  The report also recommends that the tax-exempt status of the bridge company be repealed and that the FDIC’s single-point-of-entry strategy, which involves the “bail-in” of long-term creditors of the holding company, be clarified and circumstances when this strategy would not be used be identified.  The Treasury report also recommends changes to the Orderly Liquidation Fund, including giving priority to private loan guarantees over direct lending from the government.  The report recommends that the FDIC only lend funds or provide loan guarantees if premium rates of interest or guarantee fees be charged and that any direct lending by the FDIC be done on a fully secured basis and be limited to a fixed term.  Moreover, the Treasury report recommends that the industry backstop assessment process in the event that an OLF loan is not fully repaid be imposed as soon as reasonably practicable.  Many of the recommendations made by Treasury would require Congress to act, although a smaller subset of recommendations could be implemented by the federal financial regulators.

View full text of the Treasury report.