CLS Blue Sky Blog

The Future of Financial Institution Resolution

One of the principal lessons learned from the 2007-2009 financial crisis was the need for new legal regimes to facilitate the rapid and orderly resolution of systemically important financial institutions without a government bailout.  In the final part of a six-part article that has just been published, I trace the development of these new legal regimes.[1]  The United States was itself a first mover in this regard with the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).[2]

The Dodd-Frank Act contains two provisions of singular importance to the resolution of systemically important U.S. financial institutions.  The first is the resolution plan (or “living will”) requirement in Title I.  The resolution plan requirement provides that large bank holding companies and nonbank financial companies designated by the Financial Stability Oversight Council as systemically important must periodically file with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the Federal Deposit Insurance Corporation (the “FDIC”) a plan for a “rapid and orderly resolution in the event of material distress or failure.”[3]  The Federal Reserve Board and the FDIC are directed to determine whether the resolution plan as submitted is credible and would facilitate an orderly resolution of the company under the Bankruptcy Code.

The second provision is Title II of the Dodd-Frank Act, which provides for a new regime, the so-called Orderly Liquidation Authority, to facilitate the resolution of a financial company whose failure and resolution under the Bankruptcy Code would have serious adverse effects on U.S. financial stability.  If invoked, Title II would be used instead of the Bankruptcy Code to resolve the troubled financial company.[4]  The Orderly Liquidation Authority involves an administrative receivership process, modeled on the existing bank receivership process in the Federal Deposit Insurance Act,[5] with the FDIC serving as receiver for the company.  Title II is designed to permit a rapid resolution of a large financial institution, over a “resolution weekend,” assisted by special features, such as the use of a “bridge” financial company to maintain the critical functions of the failed company and its operating subsidiaries and an “orderly liquidation fund” at the Treasury to provide liquidity to the company in resolution.

At the time of the passage of the Dodd-Frank Act, Title II garnered much greater attention than the resolution plan requirement in Title I.  Over time, however, the Federal Reserve Board and the FDIC implemented an increasingly robust guidance and review program for the resolution plans of the largest U.S. bank holding organizations and the largest foreign banking organizations operating in the United States.  A progression of robust resolution plans, aided by the development of the new single-point-of-entry (“SPOE”) strategy, support agreements that contractually require the parent holding company to support its operating subsidiaries, and the related requirement for total loss absorbing capacity (“TLAC”), have provided encouragement that an orderly bankruptcy process might be possible even for some of the largest U.S. banking institutions.[6]

Title II, on the other hand, was controversial at the time of its enactment, and it remains controversial today.  Critics find particular fault with the provision in Title II that allows the Treasury Department to use taxpayer funds from the orderly liquidation fund to assist a resolution.  To the critics, this funding authority invites a bailout of the creditors of the failing company, even though Title II provides that any taxpayer losses would ultimately be borne by the industry.  The Republican-controlled House of Representatives in 2017 passed legislation that would add a new subchapter to Chapter 11 of the Bankruptcy Code specifically designed for financial institutions, but at the same time would repeal Title II.[7]  In 2017, President Trump issued his own Presidential Memorandum directing the secretary of the Treasury to undertake a review of Title II.[8]  The Presidential Memorandum said that the existence of the Orderly Liquidation Authority might actually encourage excessive risk taking by creditors, counterparties, and shareholders of a large financial company because Title II authorizes the use of taxpayer funds to carry out a liquidation.[9]  The Presidential Memorandum directed the secretary of the Treasury to consider whether a new chapter to the Bankruptcy Code for resolving a failing financial institution would be a superior method for resolving financial firms as compared with Title II.[10]

Supporters of Title II were concerned that the report being prepared by the secretary of the Treasury would endorse the approach taken in the 2017 House-adopted legislation, i.e., adding a new subchapter to Chapter 11 of the Bankruptcy Code for financial institutions and repealing Title II.[11]  In February 2018, the Department of the Treasury issued its much anticipated report on Title II.[12]  To the surprise (and relief) of many observers, the Treasury Report did not recommend a repeal of Title II.  Instead, the Treasury Report called for certain amendments to Title II but for the retention of an amended Title II as a backstop to the Bankruptcy Code.  Perhaps unwittingly influenced by a prevailing political trope, the authors of the Treasury Report proclaimed their approach as “Bankruptcy First.”[13]

The Treasury Report cited “serious” defects in the original design of the Orderly Liquidation Authority and recommended certain legislative and administrative changes to the Orderly Liquidation Authority to address these problems.[14]  The changes recommended by the Treasury Report, such as the provision of funding to a bridge company only on a secured basis with high quality collateral and additional restrictions on the authority of the FDIC to treat similarly situated creditors differently, however, are relatively modest and would not affect the core provisions of the Orderly Liquidation Authority.

While the Treasury Report concluded “unequivocally” that bankruptcy should be the resolution method of first resort, it recognized at the same time that the current Bankruptcy Code was not designed to address the financial distress of a debtor engaged in activities such as significant derivatives transactions and short-term borrowing.[15]  Accordingly, the Treasury Report recommended changes to the Bankruptcy Code as well to make it a more effective option for financial firms.  A proposal to add a new subchapter V to Chapter 11 of the Bankruptcy Code specifically for financial institutions passed the House in 2014, 2016, and 2017.  A similar proposal in the form of a new Chapter 14 to the Bankruptcy Code has previously been considered in the Senate.  The Treasury Report offers suggestions on changes to these proposals to amend the Bankruptcy Code to better address the failure of a financial institution.  These proposals are specifically intended to facilitate an SPOE strategy under the Bankruptcy Code, and they would add to the Bankruptcy Code certain of the features contained in Title II that would facilitate a rapid reorganization of a failing financial firm over a resolution weekend by transferring substantially all the assets of the failing firm to a bridge company.  The SPOE strategy was originally developed under the planning process for Title II.  It has now been adopted by seven of the eight systemically important U.S. banking institutions in their resolution plans filed under Title I.  The eight systematically important U.S. banking institutions are also subject to a TLAC requirement, which is a financial predicate to the use of an SPOE strategy.

Enactment of a bankruptcy bill for financial institutions in the form of the proposed subchapter V to Chapter 11 or the proposed Chapter 14 would certainly be useful.  It would facilitate the use of the Bankruptcy Code, particularly for the large bank holding companies that have developed detailed resolution plans using an SPOE approach and that are subject to a TLAC requirement.  Several caveats are nonetheless in order even if a bankruptcy bill for financial institutions were to be enacted.  First, enactment of a bankruptcy bill for financial institutions cannot substitute for the need to retain Title II as a backstop to a bankruptcy process.  As the Treasury Report acknowledges, one of the most significant challenges to the resolution of a large financial company in a bankruptcy process is the availability of sufficient private financing to fund its operations and the operations of its material subsidiaries.[16]  As the Treasury Report recognizes, the Treasury funding authority in Title II can be used to stabilize the resolution of a large firm if significant customer runs occur at the operating subsidiaries.  Perhaps the greatest unknown in an SPOE resolution is how the creditors and customers of the operating subsidiaries will respond to the actions taken over a resolution weekend.  To cope with the risks presented by this unknown, the Treasury Report recommends that Title II with its funding authority (subject to several proposed changes) be retained as an option of last resort.[17]

Another significant unknown is how the regulators of the foreign subsidiaries will respond to the resolution of a large U.S. banking organization under the Bankruptcy Code.  It has generally been assumed that foreign regulators will have more confidence in a Title II resolution process administered by their U.S. regulatory peers than in a bankruptcy process administered by an unknown judge.  One of the challenges recognized by the Treasury Report is maintaining robust coordination with foreign regulators in advance of any bankruptcy process to minimize the risk that the foreign regulators will feel compelled to intervene and ring-fence the operations of the U.S. firm in their country.[18]  The concern among foreign regulators in relying on an unfamiliar bankruptcy process would be compounded by the lack of any government liquidity backstop in a bankruptcy process (unlike the situation in a Title II process).  It might actually lead foreign regulators to impose ex-ante ring-fencing requirements, such as higher capital and liquidity measures, on the operations of a U.S. firm in their country.[19]  For this reason as well, the Treasury Report recommends the retention of Title II as a backstop.

The final caveat is perhaps the most important.  Neither Title II nor an enhanced Bankruptcy Code is designed to address the effects of a pandemic crisis like that of 2008.  Both Title II and an enhanced Bankruptcy Code approach represent a response only on an individual institution basis.  Even from that perspective, the failure of several large financial institutions close in time would strain the capacity of the bankruptcy courts and the regulators to respond.  In any event a pandemic crisis requires a response on the macro level, including broad-based liquidity support measures for the financial system as a whole.  The Treasury and the regulators mounted a number of broad-based support programs in 2008 and 2009.  Ironically, the Dodd-Frank Act has imposed additional constraints on the ability of the Treasury, the Federal Reserve Board, and the FDIC to design future support measures in response to a pandemic crisis.  These constraints introduce yet another unknown to the analysis of the options that will be available to the U.S. government in the next financial crisis.


[1]      Cross-Border Resolution of Banking Groups:  International Initiatives and U.S. Perspectives, Part I, 9 Pratt’s J. of Bankr. L. 391 (2013), Part II, 9 Pratt’s J. of Bankr. L. 583 (2013), Part III, 10 Pratt’s J. of Bankr. L. 291 (2014), Part IV, 11 Pratt’s J. of Bankr. L. 59 (2015), Part V, 13 Pratt’s J. of Bankr. L. 395 (2017), and Part VI, 15 Pratt’s J. of Bankr. L. 125 (2019).

[2]      Pub. L. No. 111-203, 124 Stat. 1376 (2010).

[3]      12 U.S.C. § 5365(d)(1).  As originally enacted, the resolution plan requirement in Title I applied to any bank holding company, and to the U.S. operations of any foreign banking organization, with $50 billion or more in total consolidated assets.  In May 2018 Congress amended Title I to raise the $50 billion threshold in various sections of Title I to $250 billion.  See Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. 115-174 (2018).  In April 2019 the Federal Reserve Board and the FDIC proposed a further stratification of the filing requirement for resolution plans.  See Proposal to Amend and Restate the Jointly Issued Regulation Implementing the Resolution Planning Requirements of Section 165(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (April 8, 2019).   Under this proposal, 12 large U.S. bank holding companies would remain subject to a full resolution plan requirement.  Nine large foreign banking organizations would remain subject to a full resolution plan requirement, and 53 smaller foreign banking organizations would remain subject to a reduced resolution plan requirement.

[4]      Title II can be invoked with respect to a financial company if the secretary of the U.S. Treasury (upon the recommendation of the applicable federal regulatory agencies and after consultation with the president) makes the key determination that the failure and resolution of the company under the Bankruptcy Code (or other applicable resolution regime) would have serious adverse effects on financial stability in the United States.  12 U.S.C. §5383.

[5]      See 12 U.S.C. §§ 1821(d)-(q) & 1823(c)-(e).

[6]      An SPOE strategy envisions that only the top-tier company in a holding company structure would enter a bankruptcy process while its operating subsidiaries would ideally remain out of any bankruptcy or other insolvency process.  As a necessary financial predicate to an SPOE approach, the top-tier company would have to have sufficient equity and long-term debt, i.e., TLAC, to absorb the losses at its operating subsidiaries and recapitalize those subsidiaries.  For further background on the SPOE strategy and the TLAC requirement, see Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important U.S. Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations, 80 Fed. Reg. 74,926 (Nov. 30, 2015).  To address the problem of derivative counterparties exercising cross-default rights and thereby impeding an SPOE resolution strategy, the Federal Reserve Board, the FDIC and the Office of the Comptroller of the Currency have also issued regulations that would restrict cross-default rights in subsidiary qualified financial contracts based on the parent or an affiliate becoming subject to insolvency proceedings.  See Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 82 Fed. Reg. 42,882 (Sept. 12, 2017).

[7]      Financial CHOICE Act of 2017, H.R. 10 § 111, 115th Cong. (2017).

[8]      Administration of Donald J. Trump, Memorandum on Orderly Liquidation Authority (Apr. 21, 2017),

[9]      Id. at 1.

[10]     Id.

[11]     Financial CHOICE Act of 2017, H.R. 10, §111, 115th Cong. (2017).  The versions of a bankruptcy bill for financial institutions previously passed by the House did not include a repeal of Title II.  See Financial Institution Bankruptcy Act of 2014, H.R. 5421, 113th Cong. (2014); Financial Institution Bankruptcy Act of 2016, 114th Cong. (2016); and Financial Institution Bankruptcy Act of 2017, H.R. 1667, 115th Cong. (2017).

[12]     U.S. Department of Treasury, Orderly Liquidation Authority and Bankruptcy Reform (Feb. 21, 2018) [hereinafter Treasury Report], pdf.

[13]     Id. at 2.

[14]     Id.

[15]     Id.

[16]     Id. at 2 & 27.

[17]     Id. at 28.

[18]     Id. at 22.

[19] Id. at 2, 23.

This post comes to us from Paul L. Lee, of counsel to Debevoise & Plimpton LLP and a member of the adjunct faculty of Columbia Law School. It is based on his recent article, “Cross-Border Resolution of Banking Groups: International Initiatives and U.S. Perspectives-Part VI,” available here.

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