Alert March 27, 2012

FDIC Proposes Rule to Implement Authority to Preserve Affiliate Contracts as Receiver of Systemically Important Financial Institutions

The FDIC issued a notice of proposed rulemaking (the “Proposal”) that would implement the FDIC’s authority to prevent termination of contracts as receiver of systemically important financial institutions (“SIFIs”). The Proposal would establish the scope and conditions of the FDIC’s power under section 210(c)(16) (“Section 210(c)(16)”) of the Dodd-Frank Act, as receiver for a SIFI or subsidiary of a SIFI, to enforce contracts of that SIFI’s subsidiaries or affiliates despite the presence of contract clauses that otherwise would terminate, accelerate or provide other remedies based on the financial institution’s failure. Specifically, the Proposal would establish the required notice to counterparties, provide certain defined terms and solidify the receiver’s obligation, if the SIFI has supported the affiliate contract with a guarantee or otherwise, to either provide adequate protection to the counterparty or transfer the supporting obligation to a qualified third party.

The purpose of Section 210(c)(16) and the Proposal is to maximize the value of a troubled SIFI’s assets and operations, and to provide for an orderly liquidation process. As the ability to continue key operations, transactions and services is essential to maximizing value and preventing the spread of systemic risk, the Proposal would preserve contracts in full force and effect to allow the FDIC, as receiver, to continue operating SIFI subsidiaries without triggering a cascading series of defaults, and without causing otherwise viable subsidiaries also to be placed into receivership. The Proposal thus reflects a desire to prevent destructive ripple effects on financial markets and the economy, by facilitating the continued operation of SIFI subsidiaries, which may otherwise be healthy businesses.

Section 210(c)(16) provides the FDIC with authority to invalidate “specified financial condition clauses,” which the Proposal defines as any provision granting a counterparty termination, acceleration or default rights in connection with the receiver’s appointment or its exercise of the orderly liquidation authority. The Proposal would confirm the FDIC’s duties when exercising this authority. If the counterparty on a contract with a SIFI subsidiary enjoys any “support” from the SIFI, which the Proposal defines as any guarantee or other financial assistance provided to or on behalf of the subsidiary, the receiver must choose one of two options in order to exercise its power under the statute. The receiver would have to (a) transfer the SIFI’s supporting obligations to a bridge financial company or qualified third-party transferee by 5:00 p.m. Eastern Time on the business day following appointment as receiver, or (b) provide adequate protection to the relevant counterparties. The Proposal explains that “adequate protection” may be provided in a number of ways, including cash payments to counterparties covering any shortfalls resulting from the failure to assign the contract, a guarantee of the relevant contractual obligations and any other relief that will provide the counterparties with the equivalent of the form of support provided by the SIFI. Finally, the Proposal requires the FDIC, as receiver, to promptly take steps to notify counterparties whenever it transfers “support” or provides “adequate protection,” although this requirement may be satisfied by a posting on the website of the FDIC or the SIFI, and actual notice is not a prerequisite to the receiver exercising its authority under Section 210(c)(16).

The FDIC is specifically requesting comments with respect to the clarity and mechanics of the Proposal, consistency with related regulations and the adequacy of notice to counterparties. Comments on the Proposal are due no later than May 29, 2012.