House Panel OKs Bankruptcy Path for Big Bank Failures

WASHINGTON (The Deal) -- The House Judiciary Committee in a bipartisan manner on Wednesday approved legislation amending the bankruptcy code for large financial institutions as part of an ongoing response to Lehman Brothers infamous Chapter 11 bankruptcy filing in the midst of the 2008 financial crisis.

Lawmakers voted to approve an amendment to the bankruptcy code with a provision known as Subchapter V that Republican backers argue will ensure that a big bank's failure won't cause collateral damage to the global financial markets while at the same time maintaining creditor priority and transparency in the process. The measure was approved by a voice vote.

"The Financial Institution Bankruptcy Act is a bipartisan, balanced approach that increases transparency and predictability in the resolution of a financial firm," Judiciary Committee Chairman Bob Goodlatte, R-Va., told the panel. "It ensures that shareholders and creditors bear the losses related to the failure of a financial company."


Republican backers of the bill contend that it is superior to the system to dismantle a failing big bank set up by the Dodd-Frank Act, known as the Orderly Liquidation Authority, or OLA. They argue that OLA gives regulators and politicians too much discretion pick winners and losers among junior and senior creditors when a failing institution is unraveled and that it also ensures that billions of taxpayer dollars will be employed in dismantling a big failing bank.

However, supporters of the OLA argue that it gives regulators the flexibility to provide critical and quick injections to systemically risky big bank creditors of the failing firm to stem a growing crisis and that any taxpayer costs will be covered with assessments on big banks after a crisis abates.

Republican backers of the bill argue it would significantly limit taxpayer exposure at the same time that it would help maintain priority among creditors. Goodlatte argued that the measure would speed up the bankruptcy process, partly, by setting up an expedited judicial review by judges trained to preside over complex financial cases. It also allows for a speedy transfer of operating assets of the firm to a bridge company, which seeks to preserves the enterprise without having a significant impact on employees, suppliers and customers.


The goal of speeding up Chapter 11 is to avoid the kind of lengthy bankruptcy process that took place when Lehman Brothers filed for bankruptcy in September, 2008 and helped drive the financial crisis. The liquidating trustee for Lehman Brothers in August said he would distribute about $4.6 billion to unsecured creditors of the former mega-bank on or around Sept. 10th, a move that takes place roughly six years after the institution filed for Chapter 11.

In a key post-crisis move, the House bill would give a bankruptcy court judge 48 hours to decide whether derivatives contracts should be transferred to the bridge bank, a move that backers argue would help stem a future financial crisis. Current law allows derivatives counterparties to automatically net out or terminate their swaps contracts immediately at the beginning of an insolvency process, a move at Lehman Bros. that helped drive the financial crisis. A person familiar with the Judiciary Committee bill said that the 48 hour prohibition on cancelling a derivatives contracts would allow for a healthier recapitalized operating business to be set up and alleviate concerns among nervous counterparties seeking to terminate their swaps deals.

In related action, Federal Deposit Insurance Corp. Chairman Martin Gruenberg, pointed out Tuesday at a Senate Banking Committee hearing that banks must revise their derivatives contracts so that they don't automatically terminate in bankruptcy as part of so-called living wills large financial institutions are working on. However, banks will have until 2017 or longer to meet this and other living will requirements before regulators can force them to divest assets. The final bill doesn't include a provision giving a failing bank access to the Federal Reserve's so-called emergency lender-of-last resort authority, a spokeswoman told The Deal.

The central bank had previously provided over $13 trillion in taxpayer-backed loans through the lending authority, as part of its effort to stem the 2008 financial crisis. She noted that the Judiciary Committee does not have jurisdiction over the Fed's authority. One observer familiar with the situation pointed out that the House Financial Services Committee, which has jurisdiction over Fed lending, would make the ultimate decision about whether that access would be made available.


Rep. Spencer Bachus, R-Ala., who is a member of the judicial and financial services panels, told The Deal in July that the Fed's lender-of-last-resort authority could be an important part of the bankruptcy process. "I wouldn't rule it out," he told The Deal. Nevertheless, the House Financial Services Committee has no bill under consideration related to this type of government lending and a person familiar with the Judiciary bill said the next step for the legislation is the House floor. Two Senate Republicans have a similar bill under consideration, but Democrats have yet to back any bankruptcy reform legislation.

Gruenberg also argued that a major "challenge" to the U.S. bankruptcy code reform effort involves whether it could be set up in a way that could foster global cooperation with regulators in other jurisdictions. He also said it was "unclear" whether traditional debtor-in-possession financing in bankruptcy would be sufficient to meet the liquidity needs of a large failing bank. A person familiar with the Judiciary bill argues that it would only put the U.S. holding company into bankruptcy, allowing foreign units to continue as operating businesses.

As expected, Gruenberg, defended the OLA system. He said that the FDIC and Bank of England have been working together to set up compatible systems for the failure of a big bank that has operations in the U.K. and U.S., noting that of the 28 largest global banks designated by regulators as systemically important, 12 are in the U.S. and U.K.

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