House of Representatives Passes “Financial Institution Bankruptcy Act of 2014” in an Attempt to Improve Big Bank Reorganization Process

                    Overview 

                    On Monday, December 1, 2014, the U.S. House of Representatives unanimously passed the Financial Institution Bankruptcy Act of 2014 (“FIBA” or “the Act”). The Act, which garnered bipartisan support as well as the approval of financial regulators, seeks to facilitate the recapitalization of financial institutions by reforming the bankruptcy process, while maintaining financial stability in U.S. markets. The Act now must be approved by the Senate and then signed into law by the President.

                    Drafted with the collapse of Lehman Brothers, Washington Mutual Inc., and others in mind, FIBA amends title 11 of the United States Code by, amongst other things, adding “Subchapter V – Liquidation, Reorganization, or Recapitalization of a Covered Financial Corporation.” A covered financial corporation (“Covered Financial Corporation”) is defined in the Act as (i) a bank holding company, or (ii) a “corporation that exists for the primary purpose of owning, controlling and financing its subsidiaries,” that has total consolidated assets of $50,000,000,000 or greater,” and for which annual revenues are derived by “activities that are financial in nature,” including but not limited to lending, investing for others, insuring or indemnifying against loss, providing financial advisory services, and underwriting securities. The new subchapter introduces several new players and lays out several key provisions designed to simplify chaotic liquidations, avoid market panic, and eliminate the use of government funds to bail out distressed firms.

                    Key Provisions 

 • Commencement: Under FIBA, a case may be commenced either voluntarily by a covered financial institution filing a petition, or involuntarily by the Federal Reserve if the ‘Fed’ declares that the debtor, a qualifying covered institution, is insolvent or has no reasonable prospect to avoid a depletion of substantially all its assets, and insolvency proceedings are necessary for the financial stability of the nation.

• Single Point of Entry: The new legislation incorporates a “single-point-of-entry” approach, whereby a covered financial institution could place its holding company into Chapter 11, where the loss bearing debt would remain. The debtor’s operating subsidiaries would remain outside of the bankruptcy process as subsidiaries of a new bridge company.

• Bridge Company: FIBA also contains provisions that would allow a covered institution to transfer property of the estate, including assets, rights, subsidiaries, and liabilities, in as little as a 24 hours after filing a petition, to a new bridge company with new governing documents and officers and directors. The bridge company could then recapitalize, and continue operations outside of bankruptcy almost immediately.

• Automatic Stay: The filing of a petition under FIBA sets the automatic stay in place, which operates in a similar manner to the automatic stay housed in § 362, but has key distinctions. Under § 1187, in order to allow debtor and bankruptcy court involvement in the transfer of certain qualified financial contracts not usually subject to the automatic stay, the Act temporarily stays counterparties from terminating these qualified financial contracts and enforcing their rights against the debtor for a 48 hour period. This would allow debtor subsidiaries to enter and exit the reorganization process swiftly (through the new bridge company), while a debtor institution would remain protected under the stay.

• Financial Stability: §1192 of FIBA further states that “[t]he court may consider the effect that any decision in connection with this subchapter may have on financial stability in the United States.” 11 U.S.C. §1192. Additionally, all pleadings, transcripts, hearings, and orders would be sealed “if their disclosure could create financial instability in the United States.”

• New Players

• Special Trustee: A Special Trustee would be responsible for managing the transfer of assets, namely the equity securities from the financial institution, from the debtor into the new bridge company. The special trustee would then later disburse the assets per a confirmed plan.

• Government Agencies: The Federal Reserve could involuntarily put a covered institution into bankruptcy to avoid an adverse effect on financial stability in the U.S. Additionally, the SEC, the FDIC, the Department of the Treasury, and the Office of the Comptroller, along with the Federal Reserve, “[could] appear and be heard on any issue in any case or proceeding under this subsection.”

• Select Judges: The Chief Judge of the United States would designate at least 10 experienced bankruptcy judges to be available to preside over FIBA cases, as well as at least 3 judges in courts of appeals in at least four circuits.

• Appeals Process: If the Federal Reserve Board involuntarily places a Covered Financial Institution into bankruptcy, the bankruptcy court would be compelled to hold a hearing on the petition within 16 hours of the filing of the petition. The Covered Financial Institution, the Federal Reserve Board, the FDIC, and other agencies would be allowed to participate at the hearing. The proposed legislation would further require the bankruptcy court to either grant or dismiss the Federal Reserve Board’s petition within 18 hours of the filing of the petition.

        The Bottom Line

               With FIBA being approved by the House of Representatives and moving on to review in the Senate, interested parties will be closely monitoring the Act’s progress. Should FIBA be enacted into law, financial institutions and creditors alike will keep a close eye on the application and interpretation of the new sections of the Bankruptcy Code – particularly §1192, allowing courts to consider the implications that any decision may have on the “financial stability of the United States.” With a broad purpose, how FIBA cases play out in practice will shape the future of financial institution bankruptcies.