Senator Reed Introduces Study Bill to Assess Systemic Risk Impact of “Bankruptcy-for-Banks” Reforms

On December 6, Senator Jack Reed introduced a bill aimed at establishing a more informed basis for regulatory and policymaking action on financial institution bankruptcies. The bill would mandate bi-annual reports by financial regulators on key issues in the resolution of financial companies under the Bankruptcy Code, such as potential reforms to the safe harbors for repos and derivatives, strategies for mitigating the systemic impact of financial company bankruptcies, risks embedded in the “single point of entry” strategy (particularly if it is tried and fails), and sources of liquidity for a financial company in bankruptcy. Overall, the bill calls for regulators to make a big picture assessment of how various bankruptcy reforms would affect systemic risk, drawing attention to weaknesses in some of the policy proposals in this area.

The bill also would also amend bankruptcy court procedure for financial firm bankruptcies. Most notably, it would revise the Bankruptcy Code to give the Federal Reserve and other regulators standing to be heard in financial company bankruptcies. Additionally, the bill would provide for the Federal Reserve and the FDIC, jointly, to propose five potential trustees for the financial company, with the United States trustee selecting the final appointee from this list. Finally, the bill would require the Supreme Court to issue a rule establishing a procedure for appointing a bankruptcy or district court judge with appropriate expertise to preside over the bankruptcy resolution of a financial company.

The Roundtable’s full update on the bill is available here.

(This post was authored by Rebecca Green, J.D. ’17.)


Related posts on legislative reform proposals are available here and here. The Roundtable has also posted previously on policy issues surrounding “bankruptcy for banks” reforms. For example, see Morrison, Roe & Sontchi, “Rolling Back the Repo Safe Harbors“; Roe & Adams, “Restructuring Failed Financial Firms in Bankruptcy“; and Lubben & Wilmarth, “Too Big and Unable to Fail.”

Federal District Court Reinstates Fraudulent Transfer Challenge to Lyondell LBO

posted in: Avoidance | 0

By Richard G. Mason, David A. Katz, and Emil A. Kleinhaus (Wachtell, Lipton, Rosen & Katz)

In situations where leveraged buyouts prove unsuccessful, and the companies subject to the buyouts file for bankruptcy, it is not unusual for debtors or creditors’ committees to seek to challenge the LBOs on fraudulent transfer grounds.  In recent years, however, it is has become increasingly difficult to mount such challenges — at least in certain jurisdictions — as a result of judicial decisions that have broadly applied the Bankruptcy Code’s “safe harbor” for securities transactions to protect LBO participants from fraudulent transfer liability.

In a significant set of decisions, the District Court for the Southern District of New York has reinstated a fraudulent transfer claim to recover approximately $6.3 billion in distributions made to Lyondell Chemical shareholders in connection with Lyondell’s 2007 leveraged buyout. The decisions demonstrate that, despite the broad reach of the Bankruptcy Code’s “safe harbor,” LBOs may still be subject to challenge on fraudulent transfer grounds where the seller’s management is alleged to have acted with the actual intent to hinder, delay or defraud creditors.

The full memo is available here.

Awaiting the Second Circuit’s Decision in Marblegate

posted in: Workouts and Pre-Packs | 0

We anxiously await the Second Circuit’s decision in Marblegate, which was argued earlier this year. John Bessonette of Kramer Levin briefly summarizes the stakes:

“Section 316(b) of the Trust Indenture Act provides that ‘the right of any holder of any indenture security to receive payment of the principal of an interest on such indenture security . . . shall not be impaired or affected without the consent of such holder . . . .’ Various plaintiffs used this provision this past year to successfully challenge out-of-court restructurings in Marblegate and Caesars. In both cases, the Federal District Court for the Southern District of New York held that § 316(b) not only protects the formal legal right to receive payment under an indenture, but also restricts non-consensual out of court debt reorganizations, even where no express terms of the indenture are violated.

“However, neither case provided a limiting principle for when out-of-court restructurings violate § 316(b), and plaintiff firms are now taking advantage of this murkiness. In the last year, three lawsuits challenging distressed exchange offers have been filed by retail holders of unsecured bonds. Each lawsuit involves an exchange offer made to qualified institutional buyers by a distressed energy company, and retail bondholders who object to their bonds being subordinated to the secured bonds issued to QIBs as part of the exchange.

“The cases are still pending and it remains to be seen whether the courts will clarify the ambiguity around § 316(b). Meanwhile, this obscure provision of the TIA will occupy a more prominent role in out-of-court debt restructurings and serve as a new weapon for plaintiffs challenging such restructurings.”

His full memo is available here.

The Roundtable has issued multiple posts on the Marblegate litigation and the Trust Indenture Act. Mark Roe wrote what the appropriate limiting principle should be for courts when invalidating exit consent transactions under section 316(b) of the Act. He further argued that courts alone cannot solve the fundamental problems: The SEC must also act. The Roundtable also covered the 28-law-firm white paper on how courts should handle that section. See our archives for more.

Too Big and Unable to Fail

By Stephen J. Lubben (Seton Hall University School of Law) and Arthur E. Wilmarth, Jr. (George Washington University Law School)

Financial regulation after the Dodd-Frank Act has produced a host of new regulatory tools for resolving failures of systemically important financial institutions (SIFIs). The explicit goal of this new “resolution” regime is to enable SIFIs to go bankrupt without a government bailout, just like other businesses. In our paper, forthcoming in the Florida Law Review, however, we express significant doubts about the new regime’s ability to work as advertised.

The “single point of entry” (SPOE) strategy, which focuses all resolution efforts on a SIFI’s parent holding company, addresses a very stylized, even hypothetical sort of failure. We believe that it is unlikely to work during a global crisis that involves multiple failing SIFIs operating thousands of subsidiaries across dozens of national boundaries.

The Federal Reserve’s “total loss absorbing capacity” (TLAC) proposal is closely tied to SPOE. It would require SIFI holding companies to issue large amounts of debt securities that can be “bailed in” (converted into equity) in a resolution proceeding to make the holding company solvent again. In our view, TLAC debt will also create a new, more opaque way to impose the costs of SIFIs’ financial distress on ordinary citizens, because retail investors in brokerage accounts, mutual funds, and pension funds are likely to be the largest TLAC debtholders.

We propose several strategies for forcing SIFIs and their Wall Street creditors to internalize at least some of the costs of the enormous risks they create. Among other things, mutual funds and pension funds that invest in TLAC debt should disclose the bail-in risks to investors and should include in their offering materials “black box” warnings similar to those already used in selling junk bonds to investors. In addition, each SIFI should describe its resolution plan on a web page that also contains a straightforward discussion of the risks TLAC debtholders are taking on—risks that creditors and counterparties of operating subsidiaries are unwilling to assume. Only with such disclosures can the hazards of TLAC debt be appropriately priced by the market.

The full paper can be found here.