July 20, 2010
Dodd-Frank Forum: Who Benefits from the New Resolution Authority?
Posted by Michelle Harner

Like many, I am skeptical that the Dodd-Frank Act accomplishes much of anything.  It does provide nice photo ops and plenty of ammunition (on both sides of the political spectrum) for the mid-term elections.  It also reminds us of the lobbyists' ability to influence legislation (see, e.g., Gordon’s post here and reference to auto dealer exemption here).  But does it fix all, or even some, of what contributed to the financial crisis?

Given the number of contributing factors and the breadth of the legislation, I am just going to say a few words about one piece of this puzzle—the resolution authority granted the federal government under the Act.  The resolution or “orderly liquidation” authority described in the Act sounds terrific. (Former Secretary Paulson reportedly commented that he “would have loved to have something like this for Lehman Brothers.”)  It basically allows the FDIC to place specified financial institutions—e.g., bank holding companies and broker-dealers determined to pose systemic risk to the U.S. economy—into receivership.  (See generally Title II of the Act; see concise summaries here and here.)  The Act grants the FDIC extensive authority to operate the business and liquidate the assets of, and resolve claims against, the financial institution.

At first glance, the orderly liquidation process set forth in the Dodd-Frank Act resembles a chapter 7 or a liquidating chapter 11 case under the U.S. Bankruptcy Code.  Indeed, in bankruptcy, a trustee, examiner or alternative management team can be imposed; assets can be sold (often free and clear of any claims, liens or encumbrances against the bankrupt company or its assets); and special provisions exist for the treatment of certain derivatives and counterparty obligations (I mention the derivative provisions because they also appear in the Act, not because they are necessarily effective, see here).  Notably missing from the Dodd-Frank Act but present under the Bankruptcy Code, however, is a concern for stakeholders’ rights.

Yes, the Dodd-Frank Act provides that the FDIC must observe certain claim priorities, but the ability of stakeholders to participate in the process—even the claims resolution process—is very limited and cumbersome.  For example, if a creditor wants to object to the treatment of its claim proposed by the FDIC, it must file suit in the district court where the financial institution’s principal place of business is located; a district court that will be unfamiliar with the company and the circumstances surrounding the case and the claim.  Likewise, the FDIC has the ability to assume, assign or reject the financial institution’s contracts, but the rights of the non-defaulting parties to those contracts are unclear.  Moreover, the FDIC can pursue fraudulent conveyance and preference claims, but again the process is murky.

Why create all of this uncertainty when we have a perfectly viable tool in the U.S. Bankruptcy Code?  Now, some of you may be scoffing and pointing to Lehman Brothers as Exhibit A in the case against the Bankruptcy Code.  I would simply suggest that the Bankruptcy Code did not fail in Lehman Brothers; rather, the parties failed to invoke the bankruptcy alternative in a timely and effective manner.  And at least in the bankruptcy context, all parties understand the process and can react in a manner that not only may further the debtor’s case, but also protects their own interests.  I worry that in focusing so intensely on those institutions that may pose a systemic risk to the U.S. economy, we may be creating a process that hamstrings the businesses and stakeholders who drive that very economy.  Perhaps this issue will be considered in the study on the bankruptcy of financial and non-financial institutions (one of the many studies) mandated by the Act.

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