FDIC Assures That Creditors, Not Taxpayers, Bear Risk of Failures

The FDIC on Tuesday approved an interim final rule under the Dodd-Frank Wall Street Reform and Consumer Protection Act that Chairman Sheila Bair said furthers the statutory intent that “creditors bear the losses of any failure.” The rule clarifies how the agency will treat certain creditor claims under the new orderly liquidation authority established under Dodd-Frank.


“Shareholders and unsecured creditors should understand that they, not taxpayers, are at risk,” Bair said in a press release. “This rule represents a significant narrowing of the discretion provided under Dodd-Frank for differentiation among creditors, consistent with the law’s overarching public policy objectives to maximize market discipline and make clear that all equity and unsecured debtholders are at risk of bearing loss.”


The FDIC’s press release further emphasized: “ In no event may taxpayer money be used to cover losses associated with the failure of a large financial firm.


Title II of Dodd-Frank provides a mechanism for appointing the FDIC as receiver for a financial company if the failure of the company and its liquidation under the Bankruptcy Code or other insolvency procedures would pose a significant risk to the financial stability of the United States.


The interim final rule differs from the Notice of Proposed Rulemaking (NPR), which was released in October 2010, by clarifying the standard for valuation for collateral on secured claims and by clarifying the treatment of contingent claims. One aspect of the NPR elicited a number of comment letters: The availability of additional payments to creditors under the authority of Dodd-Frank.


The interim final rule does not change this proposal from the NPR. The FDIC said many people who submitted comments said it was important to limit any “additional payments” as a means of reducing moral hazard and instilling market discipline. Others were concerned with the prohibition of any additional payments to holders of long-term debt, which is defined as debt with an original term of more than 360 days, based on the misapprehension that shorter-term creditors are likely to receive such payments.


The FDIC said in its press release that, under the standards of Dodd-Frank and the interim final rule, the concern is unwarranted. Short-term debtholders are highly unlikely to meet the criteria set forth in the statute for permitting payment of additional amounts. In virtually all cases, holders of shorter-term debt will receive the same pro rata share of their claim that is being provided to the long-term debtholders.


Under the interim final rule, no creditor can receive any additional payment unless the FDIC Board of Directors has determined, by recorded vote, that the payments meet the statutory standards. In addition, such payments are subject to recoupment if ultimate recoveries are insufficient to repay any temporary government liquidity support provided as part of the orderly wind-down. This recoupment must occur before imposition of a general industry assessment to cover any shortfalls. The interim final rule also addresses discrete issues within the following broad areas:

  1. The authority to continue operations by paying for services provided by employees and others (by clarifying the payment for services rendered under personal services contracts);
  2. The treatment of creditors (by clarifying the measure of damages for contingent claims); and
  3. The application of proceeds from the liquidation of subsidiaries (by reiterating the current treatment under corporate and insolvency law that remaining shareholder value is paid to the shareholders of any subsidiary).

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