The Trump Administration and Bankruptcy Reform: What to (Possibly) Expect
Editors’ Note: The following is an interview with Stephen E. Hessler and Anthony Grossi of the restructuring group of Kirkland & Ellis LLP and Robert K. Rasmussen, former dean and current professor at the USC Gould School of Law. Grossi also is the former bankruptcy counsel to the U.S. House of Representatives Committee on the Judiciary. Hessler is the cofounder and Rasmussen and Grossi are members of the advisory board of the University of Pennsylvania Institute for Restructuring Studies, a multidisciplinary initiative intended to address topical corporate insolvency issues and influence the public policy debate in a manner that has practical application for investors, practitioners, regulators and academics. The views expressed herein are solely the authors’ own and not offered on behalf of any client or other organization.
What has the Trump administration signaled it wants to accomplish as to bankruptcy
Hessler: It is not yet fully clear. Most significantly, in 2010, in the wake of the Great Recession, Congress passed and President Obama signed into law the Dodd-Frank Act as a broad overhaul of the financial services industry. A key component of that legislation was Title II, which provided “orderly liquidation authority” (OLA) to the federal government to address through regulatory action - and thus not a judicial proceeding - the insolvency of any major bank whose failure would have “serious adverse effects on financial stability in the United States.”
President Trump has indicated he wants to overhaul, or at least to some extent scale back, Dodd-Frank - and last Friday issued an executive order to those general ends - but without discussing Title II specifically. The order does direct the Secretary of the Treasury to consult with key regulators and report within 120 days which existing laws promote or inhibit federal regulation of the U.S. financial system in a manner consistent with certain core principles, including, among other things, “prevent[ing] taxpayer-funded bailouts” and “foster[ing] economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry.”
So it remains to be seen whether this report, and any subsequent administration action, will seek the full or partial repeal of Title II - or prompt other related bankruptcy reforms.
Given that backdrop, what bankruptcy-related legislation do you anticipate this Congress will consider?
Grossi: Last Congress, Chairman Jeb Hensarling of the House Financial Services Committee
introduced and passed through his committee the “CHOICE Act,” which included both the Financial Institution Bankruptcy Act (or “FIBA”) and a repeal of Title II of Dodd Frank. FIBA is legislation that significantly amends the Bankruptcy Code to enhance the prospects for the expeditious resolution of large, distressed financial institutions through chapter 11. It would appear the CHOICE Act may be a vehicle to effectuate President Trump’s desire to amend and/or replace Dodd-Frank. Congress could also consider FIBA separately from the CHOICE Act, which may be a more viable path for FIBA’s enactment into law.
Can you briefly explain how FIBA operates?
Hessler: The central feature of FIBA is the “single point of entry” approach that would allow a major bank to file for chapter 11 to effect a quick separation of “good” assets from “bad” assets. This would happen through the rapid postpetition transfer of the good assets to a non-debtor bridge financial company whose equity is held by a trust that is managed by a special trustee for the benefit of creditors. The bad assets would then be liquidated by the debtor within the chapter 11 case - and both the transfer and liquidation are subject to Bankruptcy Court approval. Importantly, FIBA provides that these cases will be administered by a jurist selected from a pool of predetermined experienced Bankruptcy Court judges, within the established practice and precedent of the Bankruptcy Code.
How would a Dodd-Frank Title II procedure work?
Rasmussen: Title II and the OLA likewise are designed to be a single point of entry insolvency system but run by the FDIC. It covers large financial institutions, the type that government regulators had to devise solutions for on the fly during the onset of the Great Recession. The operation of the OLA is modeled on the Federal Deposit Insurance Act for banks. The parent company would be put into receivership and the subsidiaries would remain in operation, though the FDIC would have the power to put them into receivership if it decided such action was appropriate.
The FDIC, as with a failed bank, can transfer the valuable assets of the parent company into a bridge company or to a third party. The aspiration is that there would be sufficient long-term debt at the parent level to be able to absorb the losses.
Notable differences between the OLA and a bankruptcy proceeding include less judicial oversight in an OLA proceeding, differing finances, the ability to distinguish among unsecured creditors and the treatment of derivatives. The lower level of judicial oversight in the OLA stems from having the proceeding administered by a regulatory agency rather than a judge.
As to financing the restructuring, the stated goal of the OLA is that ultimately taxpayers would not fund a bailout, at least on a permanent basis. Federal money, however, would be used initially. The FDIC has the power to draw on the Treasury to fund the OLA. To the extent that these funds are not repaid at the end of the proceeding, other covered financial institutions would be assessed a fee to cover the shortfall.
The OLA departs from the Bankruptcy Code’s command to treat similarly situation unsecured
creditors the same. The FDIC can pay some unsecured creditors more than others when it
determines such action is necessary to maximize the value of the assets that it is administering.
On the derivative front, the OLA contains a one-day stay on derivatives to avoid counterparties from terminating their positions as soon as the proceeding is initiated. The FDIC has to decide in that day what part of the derivative book it wants to remain intact. It cannot, however, cherry-pick among contracts with the same counterparty. With each counterparty, it has to decide whether to take or terminate all the contracts with that counterparty.
The CHOICE Act passed out of committee last Congress. Has FIBA received Congressional consideration?
Grossi: FIBA passed the House of Representatives twice - first in the 113th Congress and then again in the 114th Congress. Each time, the House passed the bill with “unanimous consent” under “suspension of the rules,” which is a parliamentary procedure often used for widely bipartisan and strongly supported legislation. FIBA first passed the House in December of 2013 as Congress was winding down its two-year term. Consequently, the Senate had only days during which to consider the House-passed version before the legislation extinguished at the conclusion of the 113th Congress, and the Senate did not act during this short period. FIBA passed the House again in the following Congress on April 12, 2016. Senate inaction following House passage resulted in the bill expiring again at the conclusion of the last Congress.
Senator Reed introduced legislation near the conclusion of this last Congress. Can you briefly detail the legislation and discuss how it could impact consideration of FIBA?
Grossi: Senator Reed’s bill requires the generation of two principal studies. One study is to be performed by the federal judiciary and the second by the Office of Financial Research within the Treasury Department - an office that has released a single research report since its inception in 2010. Notably, Senator Reed was one of the principal architects behind the creation of the Office of Financial Research.
The bill requires the two studies to cover a broad range of topics focused on the key issues related to the resolution of a distressed financial institution. The bill’s impact on Congressional consideration of FIBA is unclear. It may provide cover for Congressional members who are hesitant to support FIBA. However, many of the issues to be examined under Senator Reed’s required studies have been explored and considered during the House process that produced FIBA. Should Senator Reed re-introduce this legislation, one possibility is that it could be incorporated into FIBA. Under this result, the studies would be conducted following FIBA’s enactment and may lead to further refinement of the legislation, if necessary, in a future Congress.
What’s your best guess as to what Congress will (or will not) do?
Grossi: While Republicans gained control of the Senate and the White House, Democrats maintain 48 votes including the two Independents in the Senate. Under its current parliamentary procedures, the Senate requires at least 60 affirmative votes to end debate and approve legislation. This provides Senate Democrats with a blocking position that confers significant leverage to prevent the enactment of conservative policies.
The repeal of Dodd-Frank’s Title II historically has been strongly opposed by Democrats.
Accordingly, it will be difficult to move any legislative proposal through the Senate that includes a Title II repeal. In contrast, FIBA has garnered significant bipartisan support in the House. Indeed, the House Judiciary Committee, which can be a battleground for bitterly partisan topics, approved the bill unanimously with a 25-0 bipartisan vote before it passed the full House under suspension of the rules.
Consequently, the Senate may consider FIBA as a standalone measure, without the repeal of Title II. However, either Senate or House Republicans or both may be unwilling to support FIBA without a Title II repeal. This group ultimately may be persuaded that FIBA sufficiently diminishes the prospect of utilizing Title II, which accomplishes their fundamental goal. Whether that argument is persuasive remains to be seen.
What would be the impact on the bankruptcy bench and bar of the Trump administration’s and Congress’s (in)action on these issues?
Hessler: Of course it’s impossible to make any definitive assumptions. But since Dodd-Frank’s enactment, there has never been an actual Title II proceeding. So a repeal of OLA would not upend established practice. And to the contrary, there are valid legal, practical and other reasons to be skeptical that politically sensitive regulators - as opposed to experienced and neutral Bankruptcy Court judges - are ideally positioned to administer a major bank failure. And given that FIBA augments and does not supplant existing chapter 11 and because at least quasi-analogous rapid “melting ice cube” asset sales already are occurring under section 363 of the Bankruptcy Code, we can be confident that Bankruptcy Courts are highly capable of implementing FIBA.
That said, based just on anecdotal information, meaningful awareness among restructuring
practitioners of the potential application and pros and cons of a Title II versus FIBA versus
conventional chapter 11 proceeding presently seems to be fairly low. This means that whichever legislative and regulatory framework(s) ultimately prevail, the learning curve may be steep if and when the next financial crisis hits systemically important financial institutions.
Aside from Title II/FIBA, are there any other significant bankruptcy reforms that we may see this Congress?
Rasmussen: The incoming administration has staked out an ambitious agenda. While repeal/reform of Dodd-Frank is usually mentioned in that agenda, other topics have yet to bubble up. Given that most recent bankruptcy-related reforms have been spurred by financial crisis - Dodd-Frank was spurred by the problems stemming from the financial sector during the Great Recession and PROMESA was motivated by the financial abyss that Puerto Rico faces - I would not expect systemic reform efforts to take hold until we encounter our next spate of financial dislocation. While I admire the time and effort that went into the ABI bankruptcy reform proposal, I would expect that it will stay on the shelf for the time being.
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