July 15, 2010

Orderly Liquidation Authority

Purpose and Process

To address the notion that certain financial companies are "too big to fail," the Dodd-Frank Wall Street Reform and Consumer Protection Act authorizes the appointment of the FDIC as receiver to liquidate failing financial companies that pose a "significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard." If the Secretary of Treasury has determined that a financial institution is a "covered financial company" for which the FDIC has been appointed as receiver, then no other federal or state insolvency laws will apply except as provided in the Act.

  • A "covered financial company" is any company that (a) is a bank holding company, a nonbank financial company supervised by the Board of Governors of the Federal Reserve System, a company predominantly engaged in activities that the FRB has determined are financial in nature or incidental thereto (for example, insurance holding companies or securities brokers and dealers), or a subsidiary of any of the foregoing companies that is also predominantly engaged in activities determined to be financial in nature or incidental thereto (other than a subsidiary that is an insured depository institution or an insurance company), and (b) has been determined by the Secretary to, among other things:
    • be "in default or in danger of default" (i.e., bankrupt or insolvent or likely to be bankrupt or insolvent);
    • cause serious adverse effects on the financial stability of the U.S. if resolved under otherwise applicable state or federal insolvency law;
    • have no viable private sector alternative to prevent its default;
    • have an "appropriate" effect on the claims or interests of creditors, counterparties, shareholders and other market participants as a result of its liquidation under this Act, given the impact its liquidation would have on the financial stability of the U.S.; and
    • if resolved under this Act, be likely to avoid or mitigate adverse effects on the financial system of the U.S., costs to the general fund of the Treasury, and excessive risk taking on the part of creditors, counterparties and shareholders
  • A "covered subsidiary" is any subsidiary of a covered financial company, other than an insured depository institution (i.e., bank), insurance company, or broker or dealer that is a member of the Securities Investor Protection Corporation.
  • The Secretary will make its determination after receipt of a recommendation from the FRB and either the FDIC or, if the financial company is a broker or dealer, the SEC or CFTC that that the financial company should be placed into receivership under this Act.
  • Once the Secretary has determined that a financial company is a "covered financial company," the Secretary must notify the company and, if the governing board of the company agrees or consents, appoint the FDIC as receiver. If such governing board disagrees with the determination of the Secretary, the Secretary can petition the U.S. District Court for the District of Columbia under seal to determine whether, after notice and a hearing, the Secretary's determination is arbitrary and capricious. If not, then the Court must issue an order authorizing the Secretary to appoint the FDIC as receiver.
    • Within 24 hours of appointing the FDIC as receiver, the Secretary must provide notice to Congress, together with a summary of the basis and factors for its determination. Within 60 days of appointing the FDIC as receiver, the Secretary must also provide a plan for the winding down and liquidation of the covered financial company. The FDIC must post all plans to an online website maintained by the FDIC.
    • If the covered financial company or its largest U.S. subsidiary is a SIPC member broker or dealer, the FDIC must appoint SIPC as trustee. SIPC must then liquidate in accordance with the Securities Investor Protection Act any assets not transferred by the FDIC to a bridge financial company under the Act.
    • As receiver of a covered financial company, the FDIC can appoint itself as the receiver of a covered subsidiary of the covered financial company if the FDIC and the Secretary determine that the covered subsidiary is in default or in danger of default, such action would avoid or mitigate serious adverse effects on the financial stability or economic conditions of the U.S., and such action would facilitate the orderly liquidation of the covered financial company. If the FDIC appoints itself as the receiver for a covered subsidiary, then the covered subsidiary becomes a covered financial company.
    • Any receivership must terminate within three years after the initial appointment of the receiver, subject to limited extensions if necessary to, among other things, protect the stability of the financial system of the U.S.

Proceeds From Liquidation of the Covered Financial Company

Once appointed as receiver, the FDIC may borrower from the Treasury to finance the liquidation of a covered financial company. The proceeds from such borrowing, together with proceeds received from liquidation of the covered financial company, will constitute an "orderly liquidation fund" available to the FDIC to pay for expenses and other obligations incurred by the FDIC under the Act and preserve the value of the assets of the covered financial company and its covered subsidiaries.

If proceeds from liquidation are insufficient to repay obligations owed to the Treasury, the FDIC must, first, recover from creditors any amounts they received from the FDIC using proceeds of the Fund in excess of what they were entitled to receive solely from liquidation of the assets of the covered financial company and, second (and only to the extent necessary), levy assessments on financial companies with more than $50 billion dollars in consolidated assets and on nonbank financial companies supervised by the Board of Governors.

The FDIC will not levy all financial companies at the same rate. For example, those with greater assets and risks and those more likely to benefit from the orderly liquidation of the covered financial company will be assessed at a higher rate. The Act requires that taxpayers not bear any losses from the exercise of any authority under this Act, and prohibits the use of taxpayer funds to prevent the liquidation of any covered financial company.

FDIC Powers and Authorities

As receiver, the FDIC may use the Fund to, among other things, make loans to or purchase debt obligations of the covered financial company, and its covered subsidiaries, purchase the assets of the covered financial company or its covered subsidiaries, assume or guarantee the obligations of the covered financial company or its covered subsidiaries and make additional payments to claimants if the FDIC determines that such payments are necessary or appropriate to minimize the losses from the orderly liquidation of the covered financial company. The FDIC may also operate the covered financial company during the period of orderly liquidation, create a bridge financial company and to preserve the value of and liquidate the assets of the covered financial company, recover avoidable fraudulent and preferential transfers, and liquidate and otherwise wind up the affairs of the covered financial company.

  • The FDIC will specify a timeframe to file claims against the covered financial company in a notice to creditors. Creditors will have to prove claims to the satisfaction of the FDIC. A creditor of a covered financial company liquidated under the Act must receive amounts in respect of its claims at least equal to the amount such creditor would have received in a liquidation of the covered financial company under Chapter 7 of the Bankruptcy Code or, if applicable, SIPA.
  • The FDIC is subject to all legally enforceable and perfected security interests in the assets of the covered financial company, but any portion of a secured claim that exceeds an amount equal to the fair market value of the collateral will constitute an unsecured claim. Unsecured claims for wages and salaries of directors and senior executives of the covered financial company are to be subordinated to all other unsecured claims other than certain claims held by shareholders and other equity holders. Unsecured claims of shareholders and other equity holders that arise as a result of their status as shareholders or equity holders, will be subordinated to all other unsecured claims.
  • The FDIC may disaffirm or repudiate any contracts entered into by the covered financial company before the appointment of the FDIC as receiver if it determines, in its discretion, that performance under contract is burdensome and disaffirmance or repudiation will promote the orderly administration of the covered financial company.

Culpable Directors and Officers

The Act seeks to have management, directors and certain other third parties bear losses "consistent with their responsibility" for the failure of the covered financial company.

  • For example, the FDIC may hold directors and officers personally liable for monetary damages in any civil action for gross negligence or intentional tortious conduct.
  • The FDIC also may hold directors, officers, employees, and any other persons employed by or providing services to a covered financial company, including attorneys, accounts or appraisers, responsible for damages determined to result from "the improvident or otherwise improper use or investment of any assets of the covered financial company."
  • Finally, the FDIC may claw back certain compensation from directors and senior executives "substantially responsible" for the failed condition of the covered financial company, and the appropriate agency may prohibit such directors and officers from working in the financial sector for a period of not less than two years if they (a) violated any law, participated in any unsafe or unsound practice or breached their fiduciary duty, (b) received financial gain or other benefit by reason of such violation, practice or breach, and (c) such violation, practice or breach contributed to the failure of the company and involved personal dishonesty or willful or continuing disregard for the safety or soundness of such company.

Services and Industries

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