On March 15, 2011, the FDIC's Board of Directors approved a Notice of Proposed Rulemaking (the “NPR”) that would implement certain provisions of its orderly liquidation authority (“OLA”) under Title II of the Dodd-Frank Act. The NPR addresses the following issues: (1) recoupment of compensation from senior executives and directors in certain circumstances; (2) the definition of a “financial company” subject to resolution under Title II; (3) application of the power to avoid fraudulent or preferential transfers; (4) the priorities of expenses and unsecured claims; and (5) the administrative process for initial determination of claims and the process for judicial determination of claims disallowed by the receiver.
Recoupment of Compensation. The NPR proposes criteria for the circumstances under which the FDIC as receiver will seek to recoup from senior executives and directors who are deemed to be “substantially responsible” for a covered financial company’s failure any compensation that they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or during an unlimited time period in the case of fraud. Pursuant to the NPR, in determining whether to seek to recoup compensation, the FDIC as receiver would investigate whether the senior executive or director performed his or her duties and responsibilities with the requisite degree of skill and care, and whether such person caused any loss to the covered financial company that materially contributed to its failure.
However, the NPR further provides that the most senior executives, including, but not limited to, the chief executive officer, president, chief financial officer and the chairman of the board of directors, will be subject to a rebuttable presumption that they are “substantially responsible” and thus subject to recoupment. Individuals hired within the two years preceding the appointment of the FDIC as receiver specifically for the purpose of improving the covered financial company’s financial condition are exempted from this presumption but are still subject to clawbacks if their actions establish substantial responsibility for a failure.
Definition of “Financial Company.” The NPR helps clarify which companies may be subject to resolution under OLA by providing additional information on the definition of “financial company” under Title II. Pursuant to Section 201(a)(11) of the Dodd-Frank Act, any company that is “predominantly engaged in activities that the [FRB] has determined are financial in nature or incidental thereto for purposes of section 4(k) of the Bank Holding Company Act” is a “financial company” that may be subject to OLA. Section 201(b) of the Dodd-Frank Act provides that, for the purposes of defining the term “financial company” under Section 201(a)(11), “no company shall be deemed to be predominantly engaged in [such] activities…if the consolidated revenues of such company from such activities constitute less than 85 percent of the total consolidated revenues of such company as the [FDIC], in consultation with the Secretary [of the Treasury], shall establish by regulation.”
The NPR defines the term “predominantly engaged” and creates a new definition of “financial activity” to encompass the activities the Dodd-Frank Act includes in the 85 percent calculation. More specifically, the NPR defines a company as being “predominantly engaged” in activities that the FRB has determined are financial in nature or incidental thereto for purposes of Section 4(k) of the Bank Holding Company Act if: “(1) at least 85 percent of the total consolidated revenues of the company for either of its two most recent fiscal years were derived, directly or indirectly from financial activities or (2) based upon all the relevant facts and circumstances, the [FDIC] determines that the consolidated revenues of the company from financial activities constitute 85 percent or more of the total consolidated revenues of the company.” The NPR notes that, as required, the FDIC consulted with the Secretary of the Treasury during the development of this portion of the proposed rule.
The NPR further defines “financial activity” to include: (a) any activity, wherever conducted, described in Section 225.86 of the FRB’s Regulation Y; (b) ownership or control of one or more depository institutions; and (c) any other activity, wherever conducted, determined by the FRB, in consultation with the Secretary of the Treasury, under Section 4(k) of the Bank Holding Company Act, to be financial in nature or incidental to a financial activity.
Treatment of Fraudulent and Preferential Transfers. Section 209 of the Dodd-Frank Act provides that, to the extent possible, the FDIC shall seek to harmonize rules and regulations promulgated under its OLA with the insolvency laws that otherwise would apply to a covered financial company. In that regard, the NPR addresses the powers granted to the FDIC as receiver to avoid certain fraudulent and preferential transfers and seeks to ensure that such powers are implemented consistently with the corresponding provisions of the Bankruptcy Code.
The NPR notes two areas in which there is a potential for inconsistent treatment of transferees under OLA as compared to a Chapter 7 bankruptcy liquidation. The first issue relates to the standard used in determining whether the FDIC can avoid a transfer as fraudulent or preferential under OLA. In order to harmonize OLA with the Bankruptcy Code, the NPR makes clear that the FDIC may not avoid as preferential the grant of a security interest perfected by the filing of a financing statement in accordance with the provisions of the Uniform Commercial Code (UCC) or other non-bankruptcy law where a security interest so perfected could not be avoided in a case under the Bankruptcy Code.
The second issue relates to the 30-day grace period, in the preferences provisions of the Bankruptcy Code, in which a security interest in transferred property may be perfected after such transfer has taken effect between the parties. Although Title II of the Dodd-Frank Act does not contain any such express grace period, in order to harmonize OLA regulations with otherwise applicable insolvency law to the extent possible, the NPR provides that the OLA avoidance provisions would apply the 30-day grace period as provided in the Bankruptcy Code, including any exceptions or qualifications contained therein.
Priorities of Expenses and Unsecured Claims. The NPR would add a new Subpart A regarding the priorities of expenses and unsecured claims in the receivership of a covered financial company. The proposed rule lists each of the eleven priority classes of claims established under the Dodd-Frank Act in the order of its relative priority: (1) claims with respect to post-receivership debt extended to the covered financial company where such credit is not otherwise available (generally borrowings from the FDIC to manage receivership costs); (2) other administrative costs and expenses; (3) amounts owed to the U.S. (primarily consisting of money that the FDIC draws from the Treasury’s orderly liquidation fund to cover liquidation expenses); (4) wages, salaries and commissions earned by an individual within 6 months prior to the appointment of the receiver up to a specified amount; (5) contributions to employee benefit plans due with respect to such employees up to a specified amount; (6) claims by creditors who have lost setoff rights by action of the receiver; (7) other generally unsecured creditor claims; (8) subordinated debt obligations; (9) wages, salaries and commissions owed to senior executives and directors; (10) post‑insolvency interest, which shall be distributed in accordance with the priority of the underlying claims; and (11) distributions on account of equity to shareholders and other equity participants in the covered financial company. Pursuant to the NPR, each above class will be paid in full before payment to the next priority, and if funds are insufficient to pay any class of creditors, the funds will be allocated among creditors in that class pro rata.
Administrative Claims Process and Judicial Determination Procedures. The NPR also would add a new Subpart B to clarify how creditors can file claims against the receivership estate, how the FDIC as receiver will determine those claims, and how creditors can pursue their claims in federal court. Generally, creditors must file their claims with the FDIC as receiver by a “claims bar date.” The FDIC will determine whether to allow or disallow a claim no later than 180 days after the claim is filed (subject to any extension agreed to by the claimant). If the FDIC disallows the claim, the claimant may seek judicial review of the claim within 60 days. This judicial review would be a de novo determination of the claim by the court on its merits and not just a review of whether the FDIC abused its discretion in disallowing the claim.
It is important to note that no court has jurisdiction to hear any claim against either the covered financial company or the receiver unless the claimant has first obtained a determination of the claim from the receiver or otherwise exhausted the administrative claims process. As noted in the NPR, the administrative claims process under OLA is closely modeled after the claims process set forth in the Federal Deposit Insurance Act for receiverships of insured depository institutions and is designed to maximize efficiency while reducing the delay and additional costs that could be incurred in a different insolvency regime.
Comments on the NPR are due to the FDIC no later than 60 days after its publication in the Federal Register.