On October 16, 2012, the Federal Deposit Insurance Corporation (“FDIC”) issued the final rule implementing §210(c)(16) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), codified as 12 U.S.C. § 5390(c)(16).
Section 210(c)(16) addresses the FDIC’s authority, as receiver of a covered financial company under the Orderly Liquidation Authority, to enforce certain subsidiary and affiliate contracts. More specifically, §210(c)(16) provides for enforcement of contracts that are guaranteed, supported by, or linked to the covered financial company, notwithstanding any contractual right of the counterparty to terminate, accelerate, or invoke any other remedy based upon the insolvency, financial condition, or receivership of the covered financial company. However, the FDIC’s right to enforce only arises if one of two conditions is satisfied —either (1) the guarantee or support and all related assets and liabilities are timely transferred to a bridge financial company or qualified third party, or (2) the FDIC has provided adequate protection (as understood in the Bankruptcy Code) for the obligations.
The FDIC’s final rule clarifies the reach of §210(c)(16) and defines key statutory terms, but largely adopts the rule as proposed in the FDIC’s Notice of Proposed Rulemaking issued on March 20, 2012 (and discussed in detail in an earlier entry on this blog). The FDIC reported that only four parties submitted critical comments on the proposed rule. The notice of the final rule includes a detailed discussion of these comments and the FDIC’s responses, however, the FDIC dismissed most of the suggestions as inconsistent with its interpretation of §210(c)(16) and its policies. For example, the FDIC found that expanding the meaning of “support” to include nonfinancial support (e.g., an agreement to provide specific performance) would contradict the phrase in §210(c)(16) “guaranteed or otherwise supported,” which the FDIC interpreted as strongly suggesting a reference to financial support. Nonetheless, some of the comments prompted changes in the final rule.
One commentator objected that the proposed rule went beyond the reach of §210(c)(16) by extending the ability to enforce the specified contracts to not only the FDIC, but also to transferees such as the bridge holding company or a third party acquirer. The FDIC noted that granting such power to a transferee was not inconsistent with the language of §210(c)(16), but found that such a grant was unnecessary and removed that authority from the final rule. In addition, commentators were concerned with the possibility that the rule would be applied to disable contractual terms conditioned on ordinary defaults by a subsidiary or affiliate (e.g., the failure to make a payment). The FDIC responded that this was not its intention and added clarifying language to the rules’ preamble.
Other comments similarly elicited clarifying statements by the FDIC, but did not result in a change in the rule. For example, commentators were concerned that contractual rights (e.g., the right to terminate or make a margin call) might be infringed under the rule even when the exercise of the right is unrelated to the financial condition or receivership of the covered financial company. These commentators urged that any interference with contractual rights be accompanied with an inquiry into whether the demand is related to a default by the covered financial company. In response, although the FDIC did not provide any mechanism for such an inquiry, it did clarify that the rule is only intended to restrict actions taken on account of the status of the covered financial company. The FDIC also noted that analysis under the rule would look at subjective reasons for the exercise of a contractual right – rights exercised based on the status of the covered financial company would be unenforceable, while rights based on unrelated factors would be enforceable. A related comment expressed concern that the rule would prevent a counterparty from calling margin against a subsidiary or affiliate based upon a change in the rating of the covered financial company once a receiver has been appointed, and that margin levels would be frozen. The FDIC agreed that margin levels would be locked in place, but only to the extent they are based on the rating of the covered financial company, and noted that provisions altering a subsidiary’s or affiliate’s margin requirements for reasons other than the financial condition of the covered financial company would remain unhindered by the rule.
Another important change is the inclusion of an additional definition of “specified financial condition clause” and, therefore, an additional type of clause that will be covered by the rule. The rule now covers provisions that give rise to the specified remedies upon “[t]he transfer of assets or interests in a transferee bridge financial company or its successor in full or partial satisfaction of creditors’ claims against the covered financial company,” which encompasses some potential steps in the resolution process. The FDIC explains that this new definition was added to make it “unmistakably clear” that that the final rule and §210(c)(16) protect covered contracts “until completion of the resolution process.”
Other changes to the rules were relatively minor, including the relocation of several defined terms (“subsidiary,” “affiliate,” and “control”) to a general definitions provision, the addition of two new defined terms (“successor,” in the provision’s definitions section, and “business day,” in the general definitions provision), tightening of internal references, and miscellaneous formatting and other changes.
In the end, the FDIC’s final rule is substantially similar to the proposed rule. The FDIC now holds a trump card over counterparties of subsidiaries and affiliates of covered companies in FDIC receivership under the Orderly Liquidation Authority.