Contributed by Sylvia Mayer, Brian Wells and Kathlene Burke
Absent this statutory provision, counterparties to contracts of subsidiaries and affiliates could exercise contractual rights to terminate their agreements based upon the insolvency of the covered financial company. As a result, otherwise viable affiliates of the covered financial company could become insolvent, thereby inciting the collapse of interrelated companies and potentially amplifying ripple effects throughout the economy. Preamble to the Notice of Proposed Rulemaking implementing section 210(c)(16) of the Dodd-Frank Act
Notice of Proposed Rulemaking:
On March 20, 2012, the Federal Deposit Insurance Corporation (“FDIC”) issued its Notice of Proposed Rulemaking (the “Notice”) setting forth the proposed rule (the “Proposed Rule”) to implement section 210(c)(16) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which has been codified as 12 U.S.C. § 5390(c)(16). Section 210(c)(16) addresses the ability of the FDIC, as receiver, to enforce certain subsidiary and affiliate contracts in a proceeding under the Orderly Liquidation Authority (“OLA”). The OLA, which was created by Title II of the Dodd-Frank Act and is codified, generally, as 11 U.S.C. §§ 5381-94, authorizes the FDIC to take receivership of, and liquidate, a financial company that poses a significant risk to the financial stability of the United States (a “Covered Financial Company”).
The Long Arm of the FDIC Receiver:
In addition to the receiver’s control over the Covered Financial Company itself, section 210(c)(16) prohibits counterparties of a Covered Financial Company’s subsidiaries and affiliates from exercising “any remedy under a contract simply as a result of the appointment of the receiver and the exercise of its orderly liquidation authorities as long as the receiver complies with the statutory requirements.” The Proposed Rule sets forth the scope and effect of the authority granted under section 210(c)(16), clarifies the contracts protected by section 210(c)(16), details the conditions and requirements to exercise this authority, defines key terms, and addresses notice requirements for certain affected counterparties.
“Supported By” v. “Linked To” Contracts:
Under section 210(c)(16), the FDIC, as receiver, can enforce two types of contracts of a Covered Financial Company’s affiliates and subsidiaries, notwithstanding the presence of a “specified financial condition” clause. Specifically, the receiver can enforce: (a) subsidiary or affiliate contracts that are guaranteed or supported by the Covered Financial Company, and (b) subsidiary or affiliate contracts that are linked to the Covered Financial Company. There is an important distinction between these two types of contracts. For the second group, the “linked to” contracts, no further action is required by the receiver to prevent or stay counterparties’ exercise of a specified financial condition clause. In contrast, for the first group, the “guaranteed or supported by” contracts, the receiver must take an additional step to ensure enforceability.
Extra Step Required to Enforce “Supported By” Contracts:
In order to have the authority to enforce affiliate and subsidiary contracts that are guaranteed or supported by the Covered Financial Company, the receiver must either (a) transfer any supporting obligations, as well as related assets and liabilities, to a bridge financial company or a third-party transferee, or (b) provide adequate protection to the contractual counterparties. With respect to a transfer, the transfer must occur within one business day. Additional time is allowed for provision of adequate protection so long as notice of the intent to provide adequate protection is given within one business day.
Applies to All Contracts, Including QFCs:
The Proposed Rule makes clear that the authority under section 210(c)(16) applies to all contracts, including qualified financial contracts, thus the breadth of application can range from real estate leases to swaps to any other contract containing a specified financial condition or similar type of clause. Further, not only does the receiver have the ability to enforce the contracts, but so do the affiliates or subsidiaries, any bridge bank or a third party transferee.
The Proposed Rule clarifies the definition of the following terms: adequate protection, affiliate, control, linked, qualified transferee, related assets and liabilities, specified financial condition clause, subsidiary and support. In doing so, the FDIC drew some definitions from existing banking and bankruptcy law and created some anew. For example, adequate protection is to be interpreted consistent with the definition in section 361 of the Bankruptcy Code and includes a cash payment, periodic cash payments, a guaranty or providing the indubitable equivalent. On the other hand, the concept of “linked to” is a new term. Under the Proposed Rule, a contract is “linked to” a Covered Financial Company if the contract includes a specified financial condition clause referencing the Covered Financial Company.
In a hybrid approach, the definition for a specified financial condition clause borrows some concepts from bankruptcy law, but the result is starkly different than that under the Bankruptcy Code. A specified financial condition clause includes, among other things, ipso facto clauses (clauses triggered by insolvency, an insolvency proceeding or appointment of a receiver that allow the counterparty to terminate, accelerate, liquidate or exercise similar remedies) and walkaway clauses (clauses similarly triggered that allow the non-defaulting party to walk away from the contract). (For a more complete definition of a “walkaway” clause, click here for the text of section 210(c)(8)(F), codified as 12 U.S.C. § 5390(c)(8)(F).) While the Bankruptcy Code similarly prohibits enforcement of ipso facto clauses, there are special exceptions for qualified financial contracts, thus allowing these contracts to be terminated, accelerated and/or liquidated. In contrast, section 201(c)(6) includes qualified financial contracts within the receiver’s enforcement authority, thus staying any such actions.
By nullifying the effect of specified financial condition clauses in all contracts, the intent is to allow a Covered Financial Company to smoothly transition into receivership, including lessening the impact on its subsidiaries and affiliates, thereby reducing any systemic impact on U.S. financial markets. However, the devil is always in the detail and the comment period is sure to elicit input on such details.
Rule is Subject to Comment:
The FDIC has submitted the Proposed Rule for public comment. The comment period concludes 60 days following publication of the Proposed Rule in the Federal Register. As a result, the final rule may or may not contain the same provisions as the Proposed Rule. For more information on how to submit a comment, please consult the Notice. In addition, the description above provides only a summary of the Proposed Rule. To review the complete Notice and Proposed Rule, click here.