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.”

House Advances Bipartisan Financial Institution Bankruptcy Act

By Stephen D. Adams, Editor, HLS Bankruptcy Roundtable

On September 10, 2014, the House Judiciary Committee approved H.R. 5421, the Financial Institution Bankruptcy Act of 2014, in a voice vote with bipartisan support. The bill would amend Chapter 11 of the Bankruptcy Code by adding Subchapter V, targeting large financial institutions.  Subchapter V reflects the principles of the Single Point of Entry framework developed for the Orderly Liquidation Authority, which include the following: 1) an expedited involuntary commencement process that may be initiated by a regulator (in addition to a voluntary process), 2) a special transfer of estate property, including an assignment of executory contracts, leases, swaps and the like, to a new holding company, and 3) a brief but broad automatic stay on a wide variety of instruments in order to enable the special transfer.  As a result, the subsidiaries of the bank holding company are in and out of bankruptcy quickly, but the parent holding company remains.  To enable this special transfer, Subchapter V transfers may assign licenses, permits, and registrations, and are exempt from most avoiding powers.  In addition, the prospective statute empowers judges to consider the effects of their decisions on financial stability, a power strengthened by authorization of the Federal Reserve, the SEC, the OCC, and the FDIC (but not the CFTC, it seems), to be heard on any issue in the case or proceeding.  Finally, the bill would create a special category of judges who would handle these cases.

The approval statement of the House Judiciary Committee is here.  The text of the bill can be found here, and you may track the bill’s progress here.  Previously, the Roundtable covered a draft of the bill in the Senate in connection with Bruce Grohsgal’s discussion of the limits of the proposal, then called Chapter 14.  David Skeel’s post today provides a comparison of an earlier (though substantially similar) proposal with the Single Point of Entry plan for the OLA.

The Case in Brief Against Chapter 14

Author: Bruce Grohsgal, Pachulski Stang Ziehl & Jones, LLP

Grohsgal-BruceResolution of a distressed financial company under Dodd-Frank Title II is a last – but crucial – resort.  Dodd-Frank, Title I, requires each large financial enterprise to file a “living will” that provides for its orderly resolution under the Bankruptcy Code.  Dodd-Frank Title II may only be used to liquidate a failing financial company that would “pose a significant risk to the financial stability of the United States” if resolved in a bankruptcy proceeding or under other federal or state law.  The FDIC must conduct a Title II resolution “in a manner that mitigates such risk and minimizes moral hazard.”  Dodd-Frank also expressly prohibits both a taxpayer-funded bailout and the Federal Reserve’s lending to a failing or failed financial firm.

Dodd-Frank has drawn fire, nonetheless, as encouraging, rather than preventing, bailouts.  Detractors urge repealing Title II of Dodd-Frank and amending the Bankruptcy Code to include a new Chapter 14 in its place.

The proposed Chapter 14’s central flaw is that it does nothing to reconcile Dodd-Frank’s purposes of mitigating systemic risk and minimizing moral hazard with the Bankruptcy Code’s starkly contrasting aims of reorganizing troubled companies, preserving going concerns and maximizing payments to creditors.

This article briefly summarizes Dodd-Frank’s orderly resolution regime and then addresses some of the core proposals for a new Chapter 14.  It concludes that the proposed Chapter 14 will not mitigate systemic risk, minimize moral hazard, or improve on Dodd-Frank’s prohibitions against bailouts, which are the primary purposes of Title II of Dodd-Frank.

The article is available here.

The Chapter 14 Proposal in the Senate

Author: Stephen D. Adams*

[This week the Roundtable looks at the Chapter 14 proposal in the Senate.  This post provides an overview of Chapter 14 as background to Bruce Grohsgal’s thoughtful piece from the ABI Journal available here.]

The Taxpayer Protection and Responsible Resolution Act of 2014 (S. 1861), commonly known as “Chapter 14”, aims to “end ‘too big to fail’ by repealing Dodd-Frank’s Title II” and “replacing it with a bankruptcy process” capable of safely resolving a Systemically Important Financial Institution.

The Chapter 14 proposal envisions a number of changes to the bankruptcy process, grouped into a new bankruptcy chapter (hence “Chapter 14”, a previously unused chapter) that would be available to bank holding companies. Chapter 14 would be run by a special group of financially experienced district judges, could allow for the FDIC to be appointed as trustee, and would have no period of plan exclusivity. In order to effect a quick sale similar to the FDIC’s single point of entry strategy for Title II, the Senate bill would add a two-day stay to bankruptcy’s swap safe harbors to give the trustee a chance to transfer the entire swap portfolio to a new company that is solvent. Repos, however, are treated like secured debt, but with the ability to immediately sell off high quality collateral (though not non-agency Mortgage-Backed Securities).

The Senate Bill draws on work from the Hoover Institution’s Resolution Project that proposed the original Chapter 14 in 2009 and 2010 and updated it recently.

Documents related to the original Chapter 14 proposal work, including proponents’ descriptions of the case for a new Chapter 14, can be found here. The text of S. 1861 can be found here. Professor Thomas Jackson’s Congressional testimony about Chapter 14 in 2014 can be found here.

*Editor, Harvard Law School Bankruptcy Roundtable, and Research Director, Harvard Law School Bankruptcy and Corporate Restructuring Project.

Practitioners, Academics, and a Judge Testify about Safe Harbors before Congress

Author: Stephen D. Adams

The House Judiciary Subcommittee on Regulatory Reform, Commercial, and Antitrust Law has held two sets of hearings in recent months on the bankruptcy safe harbors for repos and derivatives from the automatic stay, from preference and fraudulent conveyance law, and from the limitations on ipso facto clauses.

This past Wednesday, March 26, Judge Christopher Sontchi, Seth Grosshandler, Jane Vris, Thomas Jackson, and Michelle Harner testified. Last December, Jeffrey Lacker, Donald Bernstein, and Mark Roe testified.

Judge Sontchi argued that the 546(e)’s exception for all settlement transactions is too broad and also urged Congress to narrow the safe harbors for repos. Seth Grosshandler, of Cleary Gottlieb, reported on the work of the ABI safe harbors advisory committee (which includes both Judge Sontchi and Prof. Roe) and warned that the safe harbors are complex and potentially costly to alter.  Jane Vris, representing the National Bankruptcy Conference (NBC), and Thomas Jackson, professor at the University of Rochester, testified on bankruptcy of SIFIs as an alternative to Dodd Frank resolution of bail-out.  Michelle Harner, professor at University of Maryland School of Law, testified in her role as the Reporter to the ABI Commission on Bankruptcy Reform about the Commission.

Mark Roe, professor at Harvard Law School, testified that the safe harbors facilitate excessive short-term funding of financial institutions and impede effective resolution of large financial failures, like that of Lehman in 2008.  Donald Bernstein, of Davis Polk, a member of the ABI bankruptcy commission, testified about the bankruptcy adjustments needed to adapt bankruptcy law to the FDIC’s Single Point of Entry resolution mechanisms.  Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, testified about the importance of bankruptcy reform to reduce the problem of too-big-to-fail and reduce reliance on short-term debt.

The written testimonies are linked above, and the video of the oral testimonies for the March 26th hearing will be found here once it has been posted, and is here for the December 3rd hearing.

For more on the bankruptcy safe harbors for derivatives and repurchase agreements, please see the post by Steven L. Schwarcz and Ori Sharon summarizing their recent paper, The Bankruptcy-Law Safe Harbor for Derivatives: A Path-Dependence Analysis, and the post by Kathryn Borgeson, Mark Ellenberg, Lary Stromfeld, and John Thompson, entitled Lehman Bankruptcy Court Issues Safe Harbor Decision, summarizing a recent Lehman case decision on the safe harbors, both published Tuesday.