[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
H.R. 1667, THE FINANCIAL INSTITUTION BANKRUPTCY ACT OF 2017
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HEARING
before the
SUBCOMMITTEE ON
REGULATORY REFORM,
COMMERCIAL AND ANTITRUST LAW
of the
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
MARCH 23, 2017
Serial No. 115-12
__________
Printed for the use of the Committee on the Judiciary
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available on the World Wide Web: http://judiciary.house.gov
______
U.S. GOVERNMENT PUBLISHING OFFICE
25-702 WASHINGTON : 2017
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COMMITTEE ON THE JUDICIARY
BOB GOODLATTE, Virginia, Chairman
F. JAMES SENSENBRENNER, Jr., JOHN CONYERS, Jr., Michigan
Wisconsin JERROLD NADLER, New York
LAMAR S. SMITH, Texas ZOE LOFGREN, California
STEVE CHABOT, Ohio SHEILA JACKSON LEE, Texas
DARRELL E. ISSA, California STEVE COHEN, Tennessee
STEVE KING, Iowa HENRY C. ``HANK'' JOHNSON, Jr.,
TRENT FRANKS, Arizona Georgia
LOUIE GOHMERT, Texas THEODORE E. DEUTCH, Florida
JIM JORDAN, Ohio LUIS V. GUTIERREZ, Illinois
TED POE, Texas KAREN BASS, California
JASON CHAFFETZ, Utah CEDRIC RICHMOND, Louisiana
TOM MARINO, Pennsylvania HAKEEM S. JEFFRIES, New York
TREY GOWDY, South Carolina DAVID N. CICILLINE, Rhode Island
RAUL LABRADOR, Idaho ERIC SWALWELL, California
BLAKE FARENTHOLD, Texas TED LIEU, California
DOUG COLLINS, Georgia JAMIE RASKIN, Maryland
RON DeSANTIS, Florida PRAMILA JAYAPAL, Washington
KEN BUCK, Colorado BRAD SCHNEIDER, Illinois
JOHN RATCLIFFE, Texas
MARTHA ROBY, Alabama
MATT GAETZ, Florida
MIKE JOHNSON, Louisiana
ANDY BIGGS, Arizona
Shelley Husband, Chief of Staff & General Counsel
Perry Apelbaum, Minority Staff Director & Chief Counsel
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Subcommittee on Regulatory Reform, Commercial and Antitrust Law
TOM MARINO, Pennsylvania, Chairman
BLAKE FARENTHOLD, Texas, Vice-Chairman
DARRELL E. ISSA, California DAVID N. CICILLINE, Rhode Island
DOUG COLLINS, Georgia HENRY C. ``HANK'' JOHNSON, Jr.,
KEN BUCK, Colorado Georgia
JOHN RATCLIFFE, Texas ERIC SWALWELL, California
MATT GAETZ, Florida PRAMILA JAYAPAL, Washington
BRAD SCHNEIDER, Illinois
C O N T E N T S
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MARCH 23, 2017
OPENING STATEMENTS
Page
The Honorable Bob Goodlatte, Virginia, Chairman, Committee on the
Judiciary...................................................... 6
The Honorable Tom Marino, Pennsylvania, Chairman, Subcommittee on
Regulatory Reform, Commercial and Antitrust Law, Committee on
the Judiciary.................................................. 1
The Honorable David Cicilline, Rhode Island, Ranking Member,
Subcommittee on Regulatory Reform, Commercial and Antitrust
Law, Committee on the Judiciary................................ 4
WITNESSES
The Honorable Mary F. Walrath, Esq., U.S. Bankruptcy Judge
District of Delaware
Oral Statement............................................... 7
Prof. John B. Taylor, Ph.D, George P. Shultz Senior Fellow in
Economics, Stanford University's Hoover Institution
Oral Statement............................................... 9
Mr. Stephen E. Hessler, Esq., Partner, Kirkland & Ellis, LLP
Oral Statement............................................... 10
Prof. Bruce Grohsgal, Esq., Helen S. Balick Visiting Professor in
Business Bankruptcy Law, Delaware Law School
Oral Statement............................................... 12
OFFICIAL HEARING RECORD
Responses to Questions for the Record from Honorable Mary F.
Walrath, Esq., U.S. Bankruptcy Judge District of Delaware...... 16
Responses to Questions for the Record from Prof. John B. Taylor,
Ph.D, George P. Shultz Senior Fellow in Economics, Stanford
University's Hoover Institution................................ 15
Responses to Questions for the Record from Mr. Stephen E.
Hessler, Esq., Partner, Kirkland & Ellis, LLP.................. 14
Responses to Questions for the Record from Prof. Bruce Grohsgal,
Esq., Helen S. Balick Visiting Professor in Business Bankruptcy
Law, Delaware Law School....................................... 16
Additional Material Submitted for the Record
Statement submitted by the Honorable John Conyers, Jr., Michigan,
Committee on the Judiciary..................................... 28
H.R. 1667, THE FINANCIAL INSTITUTION BANKRUPTCY ACT OF 2017
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THURSDAY, MARCH 23, 2017
House of Representatives,
Subcommittee on Regulatory Reform,
Commercial and Antitrust Law,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to call, at 9:00 a.m., in
Room 2141, Rayburn House Office Building, Hon. Tom Marino
(Chairman of the Subcommittee) presiding.
Present: Representatives Marino, Goodlatte, Gaetz,
Cicilline, Conyers, and Schneider.
Staff Present: Ryan Dattilo, Counsel; Andrea Woodard,
Clerk; and Susan Jensen, Minority Counsel.
Mr. Marino. Good morning. And in the interest of saving
some time here, we're going to get started immediately, because
we do have some from each side here.
The Subcommittee on Regulatory Reform, Commercial and
Antitrust Law will come to order. Good morning, everyone.
Without objection, the Chair is authorized to declare recesses
of the Committee at any time.
We welcome everyone to today's hearing on H.R. 1667, the
Financial Institution Bankruptcy Act of 2017.
Mr. Marino. And I now recognize myself for an opening
statement.
Before I do that, again, I want to let you know that we're
going to--I'm going to do my best to stick to the 5-minute
rule, because we may be running in and out of here today, and I
really do not want you kind people who took your time to come
here to be sitting around waiting for us to come back. And I'll
keep my colleagues and myself in line to the 5-minute rule.
Last Congress, the ``Financial Institution Bankruptcy Act''
was reported favorably by this Committee and passed the House
under suspension of the rules. This week, I reintroduced this
important piece of legislation with Chairman Goodlatte, and
Ranking Members Conyers and Cicilline as cosponsors. Today, we
build on last year's record by taking one more opportunity to
further examine it.
In the wake of the financial crisis of 2008, Congress
enacted the Dodd-Frank Wall Street Reform and Consumer
Protection Act. That legislation was intended to address, among
other things, the potential failure of large financial
institutions. While the Dodd-Frank Act created a regulatory
process for such an event, the act states that the preferred
method of resolution for a financial institution is through the
bankruptcy process. However, the Dodd-Frank Act only called for
study of, and did not make any amendments to, the Bankruptcy
Code to account for the unique characteristics of a financial
institution. The legislation before us today fills that void.
The Financial Institution Bankruptcy Act is the product of
years of study by industry, legal, and financial regulatory
experts, as well as bipartisan review over the course of four
separate hearings before the Committee. The legislation
includes several provisions that improve the ability of a
financial institution to be resolved through the bankruptcy
process. It allows for a speedy transfer of a financial firm's
assets to a newly formed company. That company would continue
the firm's operation for the benefit of its customers,
employees, and creditors, and ensure the financial stability of
the marketplace.
This quick transfer is overseen by, and subject to, the
approval of experienced bankruptcy judges and includes due
process protection for parties-in-interest. The bill also
creates an explicit role in the bankruptcy process for the key
financial regulators. In addition, there are provisions that
facilitate the transfer of derivative and similarly-structured
contracts to the newly-formed company. This will improve the
ability of the company to continue the financial institution's
operation.
Finally, the legislation recognizes the factually and
legally complicated questions presented by the resolution of a
financial institution. To that end, the bill provides that
specialized bankruptcy and appellate judges will be designated
in advance to preside over these cases.
The bankruptcy process has long been favored as the primary
mechanism for dealing with distressed and failing companies.
This is due to its impartial nature, adherence to established
precedent, judicial oversight, and grounding in the principles
of due process and the rule of law.
We are here today as part of an effort to structure a
bankruptcy process that is better equipped to deal with the
specific issues raised by failing financial firms.
I look forward to hearing from today's expert panel of
witnesses on the merits of the Financial Institution Bankruptcy
Act and whether any further refinements to the bill are
necessary.
Mr. Marino. Now, since Mr. Cicilline is on his way, what
I'm going to do is introduce our witnesses. And then, when
David comes, he will make his opening statement.
So, again, good morning and thank you all for being here.
Judge Mary F. Walrath is a United States bankruptcy judge
for the District of Delaware. She was appointed in 1998 and
served as chief bankruptcy judge from 2003 to 2008. Prior to
her appointment, Judge Walrath worked at the Philadelphia law
firm of Clark Ladner Fortenbaugh & Young, concentrating in the
areas of debtor/creditor rights and commercial litigation.
Judge Walrath is a founding member and co-president of the
Delaware Bankruptcy American Inn of Court, a member of the
Delaware Chapter of the International Women's Insolvency and
Restructuring Confederation, a member of the American
Bankruptcy Institute, and a fellow of the American College of
Bankruptcy. She is also an editor of the Rutter Group
Bankruptcy Practice Guide and an adjunct professor at St.
John's Law School in Queens, New York.
Judge Walrath is also active in the National Conference of
Bankruptcy Judges and is currently the president-elect of the
National Conference of Bankruptcy Judges. Judge Walrath
graduated from Princeton University and earned her J.D. cum
laude from Villanova University. Judge Walrath clerked for the
Honorable Emil F. Goldhaber, the chief judge of the U.S.
Bankruptcy Court for the Eastern District of Pennsylvania.
Judge, welcome.
Judge Walrath. Thank you.
Mr. Marino. Dr. John B. Taylor is the Mary and Robert
Raymond Professor of Economics at Stanford University, a George
P. Schultz Senior Fellow in Economics at the Hoover
Institution, and is the director of the Stanford Introductory
Economics Center. Dr. Taylor also held positions of professor
of economics at Princeton University and Columbia University.
Dr. Taylor served as senior economist on the President's
Council of Economic Advisers, a member of the President's
Council of Economic Advisers, and was also a member of the
Congressional Budget Office's Panel of Economic Advisers.
Dr. Taylor also served as Under Secretary of treasury for
international affairs, where he was responsible for currency
markets, trade in financial services, foreign investments,
international debt and development, and oversight of the
International Monetary Fund and the World Bank.
Dr. Taylor received the 2015 Truman Medal for Economic
Policy, for extraordinary contributions to the formation and
conduct of economic policy; the Alexander Hamilton Award for
his overall leadership at the U.S. Treasury; the Treasury
Distinguished Service Award for designing and implementing the
currency reforms in Iraq--I would love to have a discussion
with you about that over lunch, because it would take us a
couple of hours; and the Medal of the Republic of Uruguay for
his work in resolving the 2002 financial crisis. He received
his B.A. in economics summa cum laude from Princeton
University, and a Ph.D. in economics from Stanford University.
Doctor, welcome.
Mr. Stephen Hessler is a partner in the restructuring group
of Kirkland & Ellis.
His practice involves representing debtors, creditors, and
investors in complex corporate Chapter 11 cases, out-of-court
restructuring, acquisitions, and related trial, and appellate
litigation.
In addition to practicing law, Mr. Hessler is an author and
frequent lecturer on a variety of restructuring-related topics,
including as a professor at the University of Pennsylvania,
where he teaches a restructuring class to both law school and
Wharton students.
Mr. Hessler has been recognized by both Chambers and
Turnarounds & Workouts as an outstanding restructuring lawyer.
Mr. Hessler received his B.A. and J.D. from the University of
Michigan, where he served as the managing editor of Michigan's
Law Review.
And just in case he needs any assistance, he has two
handsome young gentlemen behind him, his sons, here visiting us
today.
And welcome. And, Mr. Hessler, thank you for being here.
Mr. Hessler. Thank you, Mr. Marino.
Mr. Marino. Mr. Bruce Grohsgal is the Helen S. Balick
Visiting Professor in Business Bankruptcy Law. Prior to joining
Widener University, Mr. Grohsgal was a partner in the
Wilmington, Delaware, office of Pachulski--you're throwing some
good stuff here at me--Stang Ziehl & Jones LLP.
He has represented debtors, creditors, committees, and
trustees in Chapter 11 bankruptcy cases and litigation,
including the debtors in Solyndra, Global Home Products/Anchor,
Chi Chi's, and Trans World Airlines, the creditors' committee
in Freedom Communications, Orange County Register, and Jevic
Transportation, and the Chapter 11 trustee in Le-Nature's. He
previously was a partner in Wolf Block Schorr and Solis-Cohen
LLP in Wilmington and Philadelphia.
Professor Grohsgal was a senior fellow at Americans for
Financial Reform, Washington, D.C., and was the Chair of the
Bankruptcy Section of Delaware State Bar Association. He
received his B.A. from Brandeis University and his J.D. from
Columbia Law School, where he was a Stone Scholar.
Professor, welcome.
And I do have to add that the judge and Professor Grohsgal
are in my district, so to speak, in Pennsylvania's 10th
District. And you maybe need to do a throw out for----
Judge Walrath. Yes. I was born and raised in Wellsboro,
Pennsylvania, and I have a lot of family up there. So thank you
for representing their interests.
Mr. Marino. As the crow flies, that's about 30 minutes from
my place. And now it is my honor to look to my good friend,
Congressman Cicilline, the former mayor of Providence, Rhode
Island, and we're paisans.
So, Mr. Cicilline.
Mr. Cicilline. Thank you, Mr. Chairman. I wanted to stop
the shameless pandering of the panel to the Chairman at all
costs.
Thank you, Mr. Chairman.
In 2008, the United States economy nearly collapsed as a
direct result of lending practices in the housing market that
were predatory, unsafe, and in many cases fraudulent.
Investments in toxic securities created a cycle of failure in
the housing market. The declining health of the market
undermined the value of these securities, which, in turn,
devastated the housing market and caused the failure of several
of the Nation's largest financial institutions.
With the financial system in near collapse, large financial
institutions were essentially able to blackmail the government,
because these banks were so large that there was no way to
break them apart, as then FDIC Chair Sheila Bair testified in
2009.
Although the true hardship caused by this widespread fraud
is incalculable, we do know that it erased $10 trillion of
household wealth and caused eight million Americans to lose
their jobs and five million Americans to lose their homes.
Rhode Island, my home State, was hit particularly hard by this
recession. When I took office, the unemployment rate in Rhode
Island hovered at 11.2 percent, the fifth-highest in the
country.
In the wake of this economic disaster, the Dodd-Frank Act
was enacted to comprehensively reform the financial system.
Because of this law, which includes some of the strongest
consumer protections passed since the Great Depression, the
banking system is stronger, there is more transparency in
consumer lending, and the Consumer Financial Protection Bureau
continues to serve as an important watchdog to protect
Americans against predatory lending and fraud in the financial
system.
Title I of Dodd-Frank provides stability in markets by
requiring large financial institutions to have a living will,
to serve as a plan for the rapid and orderly resolution in the
event of material financial distress or failure.
Title II ends taxpayer bailouts of banks that are too big
to fail by providing financial regulators with orderly
liquidation authority where a bank's collapse would have
serious adverse effects on financial stability in the United
States and no viable private sector alternative is available.
This process expressly requires a finding by the Secretary of
Treasury that the bankruptcy process would not be appropriate
to resolve a distressed firm.
Leading commentators agree, however, that the U.S.
bankruptcy process is not designed to accommodate the orderly
resolution of a large financial institution that poses systemic
risk to the entire economy. H.R. 1667, the Financial
Institution Bankruptcy Act, addresses this concern by
establishing a single point of entry for the resolution of an
insolvent financial institution with assets exceeding $50
billion. The goal of this bill is to establish a process where
a distressed financial institution could voluntarily seek
bankruptcy relief while its subsidiaries continue to operate.
While I support H.R. 1667, make no mistake, I will strongly
oppose any effort to combine this measure with repeal of the
Dodd-Frank Act or any of its provisions.
Since this law was enacted, the economic recovery has led
to the creation of more than 15 million private sector jobs, a
60 percent increase in business lending, and record performance
by the Dow Jones Industrial Average. It is critical that we
build on this progress through education, training, and other
initiatives to promote economic opportunity. Too many Americans
are still unemployed or working two or even three jobs just to
get by, while Wall Street has never been better.
We must also preserve and advance the protections
established by the Dodd-Frank Act, to ensure transparency and
stability in the financial system, while protecting consumers.
The National Bankruptcy Conference agrees with this
assessment and has previously instructed that the Dodd-Frank
Act should, quote, ``continue to be available even if the
Bankruptcy Code is amended to better address the resolution of
SIFIs, because the ability of U.S. regulators to assume full
control of the resolution process, to elicit the cooperation
from non-U.S. regulators, is an essential insurance policy
against systemic risk and potential conflict and dysfunction
among the multinational components of SIFIs.''.
Moreover, should this legislation become law, Dodd-Frank
provides a valuable backstop to bankruptcy through its orderly
liquidation authority, which empowers the Federal Deposit
Insurance Corporation to act as the receiver for large
financial institutions that are too big to fail.
I thank the witnesses for appearing before us today and
very much look forward to hearing your testimony.
And with that, I yield back the balance of my time.
Mr. Marino. Thank you.
The Chair now recognizes the Chairman of the full Judiciary
Committee, Mr. Goodlatte of Virginia, for his opening
statement.
Chairman.
Chairman Goodlatte. Thank you, Mr. Chairman, and I
appreciate your holding this hearing.
Our Nation's financial system provides the lifeblood for
industry, small businesses, and our communities to develop,
grow, and prosper. Ensuring that this system functions
efficiently in both good times and bad is critical to the
ongoing vitality of our economy.
The 2008 financial crisis illustrated that the financial
system and existing laws were not adequately prepared for the
insolvency of certain institutions, which threatened the very
stability of the global economy and our financial industry.
There has been considerable debate over whether Congress' main
response to the financial crisis--the Dodd-Frank Wall Street
Reform and Consumer Protection Act--is adequate to respond to a
future crisis.
Today's hearing, however, is not focused on that debate.
Instead, we turn our attention to the private and public
efforts to strengthen the Bankruptcy Code so that it may better
facilitate the resolution of an insolvent financial firm, while
preserving the stability of the financial markets.
The subject of today's hearing, the ``Financial Institution
Bankruptcy Act of 2017'', is a reflection of these efforts. The
bill is calibrated carefully to provide transparency,
predictability, and judicial oversight in a process that must
be executed quickly and in a manner that is responsive to
potential systemic risk.
Additionally, the bill incorporates the ``single point of
entry'' approach, which facilitates a quick transfer of assets
and some of the liabilities of the financial institution's
holding company to a newly formed bridge company. The consensus
of experts in public and private industry believes this is the
most effective and feasible method to resolve a financial
institution that has a bank holding company.
The Judiciary Committee has a long history of improving the
Bankruptcy Code to ensure that it is properly equipped to
handle all failing companies. The Financial Institution
Bankruptcy Act adds to this history by enhancing the ability of
financial firms to be resolved through the bankruptcy process.
The development of the legislation before us today has been
a collaborative effort and included the financial and legal
communities, Members of Congress on both sides of the aisle,
the Federal Reserve, the FDIC, the courts, and the Department
of Treasury.
I applaud Chairman Marino for continuing this important
effort to strengthen the Bankruptcy Code and for holding
today's hearing.
I look forward to hearing from today's witnesses on the
Financial Institution Bankruptcy Act and whether there is a
need for any further revisions to the bill.
Thank you, Mr. Chairman. I yield back.
Mr. Marino. Thank you.
Each of the witnesses' written statements will be entered
into the record in its entirety. I ask that each witness
summarize his or her testimony in 5 minutes or less. To help
you stay within that timing, there are lights in front of you.
The lights will switch from green to yellow, indicating that
you have a minute left; and when it turns red, your time has
run out. I will politely raise the end of the gavel just to
give you a little indication, because I know you are
concentrating on your statement, and that's so we can get
through this so we don't have to keep you here today.
But first of all, I need to swear you in. And would you
please stand and raise your right hand?
Do each of you solemnly swear to tell the truth, the whole
truth, and nothing but the truth in your testimony before this
Committee today, so help you God?
Let the record reflect that the witnesses have answered in
the affirmative.
Judge, would you like to begin with your opening statement?
TESTIMONY OF THE HONORABLE MARY F. WALRATH, ESQ., U.S.
BANKRUPTCY JUDGE, DISTRICT OF DELAWARE; PROFESSOR JOHN B.
TAYLOR, PH.D., MARY AND ROBERT RAYMOND PROFESSOR OF ECONOMICS
AT STANFORD UNIVERSITY, GEORGE P. SHULTZ SENIOR FELLOW IN
ECONOMICS AT STANFORD UNIVERSITY'S HOOVER INSTITUTION; MR.
STEPHEN E. HESSLER, ESQ., PARTNER, KIRKLAND & ELLIS, LLP; AND
PROFESSOR BRUCE GROHSGAL, ESQ., HELEN S. BALICK VISITING
PROFESSOR IN BUSINESS BANKRUPTCY LAW, WIDENER UNIVERSITY,
DELAWARE LAW SCHOOL
TESTIMONY OF MARY F. WALRATH
Judge Walrath. Yes. Thank you, Mr. Chairman and members of
the House Judiciary Committee.
My name is Mary Walrath. I have been sitting as a
bankruptcy judge in the District of Delaware since 1998. I am
currently the president of the National Conference of
Bankruptcy Judges, which represents all 350 bankruptcy judges.
However, I am here in my personal capacity, and I can take
no position for or against any specific legislation pending
before Congress. But as a bankruptcy judge, I have had
experience dealing with large corporate bankruptcies and
presided over the case filed by the holding company of
Washington Mutual Bank.
A bill that allows for voluntary bankruptcy proceedings
involving holding companies of financial institutions, even
systemically important ones, before the financial institution
is seized and sold is a laudable goal. There are several
reasons why I believe this is good.
First, bankruptcy laws are familiar to the public. More
than any other part of the Federal judicial system, the general
public comes into contact most often with bankruptcy courts. In
this instance, there are between 800,000 and 1.6 million
bankruptcy cases filed annually, including more than 7,000
business bankruptcy cases.
In addition to the number of debtors who file bankruptcy,
however, hundreds of thousands of people come in contact with
the bankruptcy system, as creditors, employees, retirees,
landlords, customers, and vendors of debtors in bankruptcy.
The process has become so familiar to the public that a
large percentage of individuals who file bankruptcy do so
without the benefit of counsel. In addition, even in the
largest corporate bankruptcy cases, individuals with claims
against the debtor feel comfortable enough about the process to
proceed without counsel.
In contrast, few people and attorneys have ever been
involved in proceedings dealing with the Federal Deposit
Insurance Corporation. People just do not know what it is and
have never had any experience with it.
If Congress wants to instill confidence in the public about
the resolution of a systemically important financial
institution, it is wise to use a process with which the public
is familiar.
Second, in contrast to FDIC proceedings, bankruptcy cases
are largely transparent. Today, all bankruptcy pleadings are
filed electronically and are readily accessible to the public.
Bankruptcy hearings are open to the public and most courts
allow parties in interest, including small creditors and
shareholders, to appear and to listen telephonically, even to
appear and make their case without the benefit of counsel, and
many have done so successfully.
It is also important that the Bankruptcy Court provides a
forum for negotiation and consensual resolution without the
need for a contested hearing or trial, but with the assurance
that a court is available if there is not consensus. In fact,
plans of reorganization in Chapter 11 are premised largely on
consensus and agreement.
Third, bankruptcy courts are used to holding hearings on
short notice and making expeditious rulings. In large corporate
bankruptcy cases, even where assets exceed $100 million, first-
day hearings are held within a day or two of a Chapter 11
filing, to address emergency matters that will keep the
business operating.
The legislation before you has similar expedited notice
provisions. The Bankruptcy Court should be able to handle such
an expedited schedule with only minor adjustments. I would,
however, strongly urge Congress to consider requiring more
judges be designated to handle these matters, just to be sure
there is one available when the need arises.
The legislation also asks that the Bankruptcy Court should
consider the systemic risk to the markets in making its
rulings. While that is not always done, the courts are fully
capable of considering that factor and, if evidence is
presented, making a ruling appropriately.
In addition to the advantages of a voluntary bankruptcy
option, I understand the legislation seeks to avoid the
necessity to borrow funds from the Treasury, even on a
temporary basis. The holding company would be expected,
consistent with its living will, to have sufficient funds to
fund the operating entities, to assure they are viable in the
event of a bankruptcy filing.
In sum, I think that the legislation properly provides an
option for a holding company to either file a Chapter 11
petition, to file a Subchapter V petition, or to allow for
resolution under the FDIC regime.
So thank you very much for allowing me to express my views.
Judge Walrath's written statement is available at the
Committee or on the Committee Repository at: http://
docs.house.gov/meetings/JU/JU05/20170323/105758/HHRG-115-JU05-
Wstate-WalrathM-20170323.pdf.
Mr. Marino. Thank you, Judge.
Dr. Taylor, please.
TESTIMONY OF JOHN B. TAYLOR
Mr. Taylor. Thank you, Mr. Chairman, other Members of the
Committee, for inviting me to testify on the Financial
Institution Bankruptcy Act, which in my view is an essential
element of a good pro-growth economic program.
The act would make failure feasible under clear rules
without disruptive spillovers. It would help prevent bailouts.
It would diminish excessive risk-taking. It would remove
uncertainty about an inherently ad hoc bailout process. It
would also reduce the likelihood and severity of a financial
crisis going forward, and I think thereby would lead to
stronger economic growth.
As Judge Walrath has stated, Chapter 11 has many benefits,
including its basic reliance on the rule of law. But for large
complex financial institutions, it has some shortcomings. It is
too slow and cumbersome to deal with the possibility of runs on
failing financial institutions.
The Financial Institution Bankruptcy Act would also rely on
the rule of law and strip priority rules of bankruptcy, but it
would operate faster, over a weekend, and it will leave
operating subsidiaries outside of bankruptcy entirely. It would
do this by moving the original firm's financial operations to a
new bridge company that is not in bankruptcy. It would, thus,
let a failing financial firm go into bankruptcy in a
predictable, rules-based manner without spillovers.
To understand how a reformed Bankruptcy Code would resolve
a large financial institution, I think there is no substitute
for thinking about how it would have worked in past cases,
including the Lehman Brothers case. Emily Kapur of Stanford
University has provided this analysis for us, and I have
summarized it through her writings in my testimony that I've
attached.
The Financial Institution Bankruptcy Act would work better,
in my view, as a resolution device than Title II of Dodd-Frank.
In that case, the FDIC would exercise considerable discretion.
Even if the Title II process were used, bailouts would be
likely, in the sense that the FDIC might wish to hold some
creditors harmless in order to prevent spillovers. The perverse
incentive effects of bailouts occur whether or not the extra
payment comes from the Treasury, financed by taxpayers; from a
fund financed by financial institutions; or from smaller
payments for other creditors.
Moreover, under Title II, a government agency, such as the
FDIC and its bridge bank, would make the decisions. In
contrast, under bankruptcy reorganization, private parties,
motivated and incentivized by profit-and-loss considerations,
make key decisions about the direction of the new firm.
Another advantage of the Financial Institution Bankruptcy
Act is that it would facilitate resolution planning under Dodd-
Frank. Some of the resolution plans submitted by the large
financial firms have been rejected by the Fed and the FDIC.
With the Financial Institution Bankruptcy Act, the plans would
be more feasible.
The issue of liquidity should be considered if the
Financial Institution Bankruptcy Act were to replace Title II.
The new firm might need lender of last resort support. I
believe section 13(3) of the Federal Reserve Act would be
available in such circumstances. And I think, when combined
with the expectation of having to suffer losses imposed by a
bankruptcy, the additional expectations of possible new loans
afterwards would cause little moral hazard.
I think international arrangements should also be
considered if the Financial Institution Bankruptcy Act were to
replace Title II. For example, current European resolution
authorities contemplate a parallel authority abroad in the
United States. If Title II were repealed and there was no
parallel authority in the U.S., then some way to cooperate
internationally would have to be created.
In sum, in my view, reform of the bankruptcy law, such as
with the Financial Institution Bankruptcy Act, is essential for
ending government bailouts and for creating a robust financial
system, and it would also create economic stability and growth.
I think the Financial Institution Bankruptcy Act has clear
advantages over Title II of the Dodd-Frank Act and, in fact, it
would be a preferable resolution process even if Title II
remained.
Thank you very much. I'd be happy to answer your questions.
Prof. Taylor's written statement is available at the
Committee or on the Committee Repository at: http://
docs.house.gov/meetings/JU/JU05/20170323/105758/HHRG-115-JU05-
Wstate-TaylorJ-20170323.pdf.
Mr. Marino. Thank you, Doctor.
Mr. Hessler.
TESTIMONY OF STEPHEN E. HESSLER
Mr. Hessler. Thank you, Chairman Marino, Chairman
Goodlatte, Ranking Member Cicilline, Members of the Committee.
Thank you for inviting me to testify at today's hearing.
I am pleased to appear before this Subcommittee again
regarding the Financial Institution Bankruptcy Act of 2017,
also known as FIBA. It was my privilege to testify in both July
2014 and July 2015 in support of the prior iterations of FIBA,
which were passed by the Judiciary Committee in September 2014
and March 2016 and by the full House in December 2014 and April
2016.
Given the comprehensive record addressing FIBA, I will not
repeat my prior written and oral testimonies and will instead
focus in my opening remarks on a couple of the key issues that
I understand are presently the subject of particular scrutiny.
First, whether FIBA should shield a covered financial
corporation's board of directors from potential liability for
acting in good faith to authorize a filing and asset transfer.
And second, whether FIBA should provide the Federal Government
with the ability to initiate an involuntary case against a
failing covered financial corporation.
Turning to that first issue, director and officer
liability, section 1183(c) of FIBA provides that the board of
directors of a covered financial company, ``shall have no
liability to shareholders, creditors, or other parties in
interest for a good faith filing of a petition to commence a
case under the subchapter or for any reasonable action taken in
good faith in contemplation of, or in connection with, such a
petition or transfer under section 1185 or 1186, whether prior
to or after commencement of the case.''
This exculpation provision understandably may prompt some
to question whether FIBA is unwarrantedly shielding directors
and officers from potential liability for their actions or
inactions. In my view, for the following reasons, this
provision is highly justifiable.
In my experience as a practitioner representing very large
Chapter 11 debtors, the knowledge, expertise, and commitment of
the company's pre-petition directors and officers are
indispensable to effectuating a soft landing into and orderly
passage through bankruptcy. FIBA incentivizes such conduct by
removing the specter of legal liability for actions taken as
responsible fiduciaries.
The scope and language of section 1183(c) are both
appropriately limited. The only board decisions that FIBA
protects from potential liability are for a, ``good faith
filing of a petition to commence a case,'' and for, ``any
reasonable action taken in good faith in connection with the
filing or asset transfer decision.''
To that end, FIBA merely reinforces the existing
requirement that a Chapter 11 filing must be made in good
faith, and if it is not and the case is dismissed, FIBA offers
no added protection from liability. Moreover, I believe it is
manifestly sound public policy that any reasonable action taken
in good faith in contemplation of, or in connection with, the
filing or asset transfer decision should be protected. If it
can be shown that the challenged actions were taken in bad
faith or were unreasonable, the board can and should be held
liable.
Importantly, FIBA does not supplant any existing remedies,
both under the Bankruptcy Code or otherwise applicable law, for
any board malfeasance. Any legally cognizable director and
officer misconduct should be prosecutable to the fullest extent
of the law, and FIBA in no way impedes the ability of law
enforcement or interested parties from holding directors and
officers accountable.
Turning to the second issue, prior versions of FIBA allowed
the Federal Government to file an involuntary petition
commencing a Chapter 11 case without the covered financial
corporation's consent. I and others have testified that this
grant of authority was an unnecessary and unhelpful
distraction, and the version of FIBA that passed the House in
April 2016 did not include this provision. Ideally, the next
version of FIBA likewise will decline to give the Federal
Government this ability.
Most importantly for present purposes is that the Federal
Government, either through even only the threat of a Title II
proceeding or through the Federal Government's other general
regulatory powers, already has sufficient influence to compel a
covered financial corporation to commence a Chapter 11 case
without having to resort to a formal involuntary filing
trigger.
And regardless of whether Title II remains in place or
whether FIBA ultimately provides the Federal Government with an
involuntary filing right, it is exceedingly unlikely, in my
opinion, that there would ever be an involuntary case of a
covered financial corporation.
As its day of reckoning gets closer, an insolvent SIFI
already will be in active negotiations with its key creditor
and third-party constituencies over the timing and necessity of
a potential filing, and it will be highly motivated to file a
voluntary case before a creditor or regulator is able to
commence an involuntary proceeding.
I thank the Subcommittee for allowing me to share my views
on this legislation, and I welcome the opportunity to answer
any questions about my testimony.
Mr. Hessler's written statement is available at the
Committee or on the Committee Repository at: http://
docs.house.gov/meetings/JU/JU05/20170323/105758/HHRG-115-JU05-
Wstate-HesslerS-20170323.pdf.
Mr. Marino. Thank you, Mr. Hessler.
Professor Grohsgal.
TESTIMONY OF BRUCE GROHSGAL
Mr. Grohsgal. Thank you.
Good morning, Chairman Marino, Chairman Goodlatte, Ranking
Member Cicilline, Member Schneider, and the other Members of
the Committee. Thank you for inviting me to testify today with
respect to the Financial Institution Bankruptcy Act of 2017,
often referred to as FIBA.
The goal of FIBA is to facilitate the swift and transparent
resolution of a distressed financial institution under the
Bankruptcy Code, a goal that I applaud. However, there are
problems with this bill.
FIBA uses the special point of entry--the single point of
entry strategy developed by the FDIC under Dodd-Frank to
accomplish its goals. Under this strategy, as Chairman Marino
stated, only the top tier holding company will file for
bankruptcy. The debtor in the first 2 days of the bankruptcy
case will then transfer its good assets, including the
ownership interests in its solvent subsidiaries, to the newly
formed bridge company.
I will focus my testimony today on five issues:
First, the ``no liability'' safe harbor protection that Mr.
Hessler just referred to for directors under FIBA.
Second, the provisions of FIBA that will significantly
weaken the balance sheet of the bridge bank, making its
obtaining financing in the credit markets less likely and
making taxpayer bailouts more likely.
Third, the illusory and opaque nature of the restructuring,
all of which will occur within 48 hours, with most creditors
and other parties left out of the process and with minimal, if
any, knowledge of it or what happened in those 2 days.
Fourth, the fact that FIBA perpetuates the safe harbors for
repurchase agreements, derivatives, and other qualified
financial contracts, despite substantial evidence that the safe
harbors should be modified or eliminated.
And fifth, the necessity of retaining the orderly
resolution authority of Dodd-Frank Title II as a last but
crucial resort if the financial institution's bankruptcy
nonetheless poses substantial risk to the financial system. I
note with respect to that point that this bill does not end
Title II authority, but other bills that are being repeatedly
introduced before Congress do.
I will address these five points briefly in turn.
First, FIBA gives directors ``no liability'' safe harbor
protections from any liability for actions taken in
contemplation of the bankruptcy case or transfers to the bridge
company. The ``no liability'' safe harbor is highly likely to
encourage directors to take actions that are risky, self-
serving, and unnecessarily harm Main Street creditors.
In may safe harbor improvident actions taken over a
substantial period of time during which the directors of a
distressed financial institution are contemplating a possible
bankruptcy filing. This protection is unnecessary, because
directors already have strong incentives to file for bankruptcy
rather than risk a Title II Dodd-Frank proceeding, including
that they will be removed from office in a Title II proceeding
and that they run the risk under section 210(s) of Dodd-Frank
that they'll have to disgorge compensation and bonuses.
``Good faith,'' as used in the current Bankruptcy Code,
does not safe harbor directors, ``good faith,'' as used in U.S.
corporate law, does, and I think it is inappropriate to include
that in this bill.
Second, FIBA requires the transfer to the bridge company
and the assumption of liabilities by the bridge company within
48 hours of the case, prior to the expiration of the 48-hour
stay. The order of magnitude of this requirement can't be
overestimated. JPMorgan Chase has $50 trillion, double the GDP
of the United States in notional value of derivatives and other
qualified financial contracts that it assumes would take 18
months to unwind. Lehman Brothers had 1.2 million different
derivatives contracts with 65,000 counterparties.
The 48-hour deadline will result in the bridge company's
assuming many disadvantageous contracts and leaving many
advantageous contracts behind. Further, the bridge company must
assume the entire amount of any debt that's collateralized even
by a nominal amount of the debtor's property. These provisions
can be expected to weaken the balance sheet of the bridge
company, making financing in the credit markets less likely or
even impossible and making taxpayer bailouts more likely.
Third, the restructuring that will occur under FIBA is, to
a great extent, illusory. On the transfers to the bridge
company, the Bankruptcy Court loses its jurisdiction and
authority and no further restructuring will take place. And,
again, that is not a typical bankruptcy process whereby there
is transparency and creditor involvement, but one in which very
few parties will do things that people will not be aware of.
Fourth, FIBA perpetuates the safe harbors of qualified
financial contracts, which I urge Congress to reconsider.
And fifth and finally, we still need the orderly resolution
process of Title II of Dodd-Frank as a last, if crucial,
resort.
And I thank the Committee again for inviting me to testify
today. Thank you.
Prof. Grohsgal's written statement is available at the
Committee or on the Committee Repository at: http://
docs.house.gov/meetings/JU/JU05/20170323/105758/HHRG-115-JU05-
Wstate-GrohsgalB-20170323.pdf.
Mr. Marino. Thank you, Professor.
The Chair now recognizes the Chairman of the full
Committee, Congressman Goodlatte, for his questioning.
Chairman Goodlatte. Thank you, Mr. Chairman.
Mr. Hessler, I arrived late, so I may not have received all
the introductions, but I note that you have some advisers and
support staff behind you, and they have been very well behaved,
and I wonder if you would care to introduce them to us.
Mr. Hessler. Thank you very much, Mr. Chairman.
These are my two oldest children. Our twin 9-year-old sons
are presently on spring break. And I thank the Subcommittee for
providing them with what is almost certainly the most unique
civics lesson for anyone in their third grade class.
Chairman Goodlatte. I think it's great to have them here.
Mr. Hessler. Thank you.
Chairman Goodlatte. You had in the past had some
reservations regarding the single point of entry approach. Can
you take us through the evolution of your thought on that? Why
did your opinion change regarding this approach? And do you
believe it might be the right method to resolve a failing
financial institution in bankruptcy?
Mr. Hessler. Yes, sir. When I did testify in 2014, at that
point in time the thinking around single point of entry was
still evolving. I have since become very comfortable with the
construct and for a few reasons in particular.
As a threshold matter, to the extent that single-point-of-
entry may be an atypical Chapter 11 mechanism, SIFIs have
corporate structures that themselves do not comport with
conventional bankruptcy practice. There are certain of the
operating subs that actually either cannot file for bankruptcy
or that would be incapable of surviving a traditional
bankruptcy proceeding. So the single point of entry I think
actually the single point of entry approach actually
facilitates the unique corporate structure of SIFIs.
Secondly, while the discrete steps of single point of entry
may be a unique addition to Chapter 11, either if it's via a
Subchapter V amendment or through the creation of a Chapter 14,
I do think that the fact that the filing determination as well
as the transfer determination that are made under the single
point of entry approach, those are both subject to Bankruptcy
Court approval. I think that's a critical safeguard and a
critical protection that similarly is consistent with the
Bankruptcy Code.
Thirdly, Mr. Chairman, again, while single point of entry
would be a unique addition to the Bankruptcy Code, I think it's
actually analogous to practice that to some extent is already
occurring, which are rapid fire asset sales under section 363.
I believe that single point of entry can actually be understood
as sort of codifying an approach that's already taking place,
albeit under another name.
And lastly, I think from the perspective of secured
creditors and unsecured creditors and equity interest holders,
the priority scheme and the enforcement of creditor rights
under single point of entry is consistent with current
Bankruptcy Code practice.
So, for all of those reasons, I am comfortable with it.
Chairman Goodlatte. Thank you.
Dr. Taylor, we very much appreciate your being here today,
and your work is well known to many Members of Congress,
including on this Committee.
I wonder if you might give us your thoughts on this bill in
the context of something like the Lehman insolvency. If that
were to occur a year from now, after this law were in effect
and in operation would the bill improve the resolution process
for that firm?
And in that context, take some of Professor Grohsgal's
criticisms and let us know whether you think that the speed,
which to many of us seems essential, can be handled, given the
enormity of some of the financial institutions.
Mr. Taylor. So I think the answer to that question is most
important for this Committee and for any group thinking about
this reform. So quite a while ago, we, working at Stanford
Hoover Institution, thought about a counterfactual: What would
have happened in 2008 had this act been passed, in the case of
Lehman?
I was an extraordinarily good, thorough study by Emily
Kapur at Stanford. She just received her law degree and Ph.D.
in economics. She went through case by case, using a lot of the
reports on the data, and showed how smooth it could have worked
over the weekend. The new firm would have been operating on
Monday morning with virtually no contagion, no spread. And
there was enough at that point of what we call now loss-
absorbing capital to make this work with the data at the time.
So I think it's a very revealing study. I recommend every
Member of the Committee and others read it.
One thing about it is she was under the assumption when we
ran this--we've called this Chapter 14 in the past, because
there was no Chapter 14 code. We started working on this before
Dodd-Frank was passed, actually. And always had the notion that
it would be good to have a primary regulator available to file
in the first. I listened to Mr. Hessler's remarks.
So Emily assumed that the Fed would be the primary
regulator, which is how Dodd-Frank would write, and looked at
gauges, mechanisms, objective indicators that the Fed could use
to begin this filing.
So I think it's very important that if the bill goes back
or if the conference committee eventually wants to have the
primary regulator have the ability to begin the proceeding,
that it be done in the most objective way possible, looking at
indicators, looking at things that are--to be accountable, so
that it continues this very, I think, predictable kind of
process that we're all aiming for.
Chairman Goodlatte. Thank you very much.
Thank you, Mr. Chairman.
Mr. Marino. The Chair recognizes now the Ranking Member of
the full Judiciary Committee for his opening statement.
Mr. Conyers. Thank you, Mr. Chairman.
I would like consent to submit my opening statement and go
straight to the questions, if I can.
Mr. Marino. Without objection.
Statement submitted by the Honorable John Conyers Jr.,
Michigan, Ranking Member, Committee on the Judiciary. This
material is available at the Committee and can be accessed on
the Committee Repository at: http://docs.house.gov/meetings/JU/
JU05/20170323/105758/HHRG-115-JU05-MState-C000714-20170323.pdf.
Mr. Conyers. Thank you very much.
I wanted to start with Judge Walrath. I apologize for
missing your presentation. But Professor Grohsgal argues that
FIBA does not solve the problem of post-petition financing and
that it actually makes the problem worse. What do you think of
that?
Judge Walrath. I respectfully disagree with my colleague
from Delaware. I think that there are two aspects of FIBA that
are important here, and the first relates to his concern about
insulating the board of directors, because he suggested it
would cause risky behavior.
I disagree. I think it is very important in all bankruptcy
cases, but particularly in a case that would involve a
systemically important financial institution, it is important
for the board to act quickly. And for them to delay because
they may feel that they may have some liability by delaying
could be critical and could spell the death knell of the
filing. It is important in all bankruptcy cases that they get
counseled quickly, and if they need to restructure, to file
quickly.
I think that if they file quickly enough and they follow
this mechanism of transferring sufficient funds to keep the
financial institution itself viable, which I understand is a
construct of this legislation, it would assure that they are
viable, and the public would perceive them as viable without
additional financing.
Mr. Conyers. Thank you.
Professor Grohsgal, could you give us your response,
please?
Mr. Grohsgal. Thank you, Ranking Member Conyers. I would be
pleased to do so.
There is a narrow issue here and there is a broader issue.
The narrow issue is that section 210(s) of Dodd-Frank presently
is pretty much the only basis upon which directors can be held
accountable for excessively risky and often self-serving
decisions that were made in the process of dealing with the
problems of a distressed company.
I would expect, as a practicing lawyer for 30 years, that
if I represented one of those directors, one of the first
things I would say, if a bankruptcy turned into a Title II
proceeding, which it could, that pretty much any of those
decisions I made was made in the interest of propping up the
company in contemplation of the bankruptcy filing.
So there's nothing in this bill that doesn't make it clear
that the FDIC is still free to take actions to seek to disgorge
the compensation of bonuses of these executives who may have
harmed Wall Street, which is the reason for 210(s). That's the
narrow issue.
The broader issue, again, is that ``good faith'' is a term
of art used in U.S. corporate law which gives capacious
deference to directors of companies. The idea is to encourage
risk-taking that might make that business organization a
profit. It has a much different meaning in the Bankruptcy Code.
There is no counterpart to it in the Bankruptcy Code that
insulates directors. And, again, these directors are already
very much incentivized to file bankruptcy rather than risk a
Title II, the reasons being, first, that they stay in control
of the company, and second, that they don't run the risk of
having their compensation and bonuses disgorged.
Mr. Conyers. Thank you.
Mr. Grohsgal. Thank you, sir.
Mr. Conyers. While you're at it, you acknowledge that
current bankruptcy law is not optimally designed for orderly
resolution of large financial institutions. Are you convinced
of that?
Mr. Grohsgal. I actually am not convinced of it. I don't
think that all of the evidence is in on that. Harvey Miller,
the dean, I would say, of the New York Bankruptcy Bar, for whom
I had great respect and who passed away not that long ago,
actually thought that the Lehman bankruptcy worked quite well.
I think that that problem is overrated, frankly, or overstated.
I do think that there is something to be said for amending
the Bankruptcy Code to make it better able to address these
kinds of business failures. However, this bill in many ways
provides for bankruptcy in name only.
That 2-day process is not a sale that we're accustomed to
with respect to the sale of a business as a going concern in a
bankruptcy case, where there is notice to creditors, where they
have a chance to participate, where creditors committees can
weigh in about it. There's no testing of the market. It's not a
sale to anyone. It's simply a wholesale transfer of assets
determined by the debtor and by a bankruptcy judge within 2
days to a bridge company. There's no--it's not a traditional
sale at all. It's not like anything in bankruptcy.
So my problem with this, in part, is that, again, it's
bankruptcy in name only. It dresses the process up as a normal
bankruptcy proceeding, but it's not.
Mr. Conyers. Look, the collapse and subsequent bankruptcy
of Lehman Brothers had a catastrophic impact on the financial
marketplace. And on the other hand, you appear to strongly
oppose H.R. 1667. Do you think the bankruptcy law should be
changed to better accommodate future Lehman Brothers?
Mr. Grohsgal. I would note in passing that AIG also failed
without going into bankruptcy, as did Bear Stearns, as did many
other financial institutions, most of which did not go into
bankruptcy. And to attribute what happened during the financial
crisis to a single bankruptcy probably overemphasizes that
issue.
But to answer your question, I think that enhancing the
provisions of the Bankruptcy Code to enable a proper financial
institution bankruptcy is a very good idea, and I commend this
Subcommittee for--and the Committee--for attempting to do so.
There are a number of things that could actually accomplish
that, I think. One would be to extend the automatic stay longer
than 2 days. That would in and of itself accomplish a great
deal.
The second would be to address the issue which causes these
kinds of legislation to make the process happen within 2 days,
which is that there's no automatic stay with respect to
repurchase agreements, even those backed by mortgages. There is
no automatic stay for derivatives and other qualified financial
contracts, which drove the FDIC to come up with this 2-day
process and which I believe probably drove this Committee, in a
good faith effort to address this issue, to confront this
problem.
An easy solution would be to limit or eliminate the
automatic--the safe harbors for qualified financial contracts,
and then we would find ourselves back in a more realistic
bankruptcy environment and process.
Mr. Conyers. Professor Grohsgal, I appreciate your
comments.
And, Mr. Chairman, I yield back the balance of my time, if
any.
Mr. Marino. Thank you so much, Mr. Conyers.
The chair now recognizes the gentleman from Florida,
Congressman Gaetz.
Mr. Gaetz. Thank you, Mr. Chairman, for holding this
hearing.
And thank you all for being here.
Judge Walrath, I'd be very interested in your thoughts on
the role of transparency in the bankruptcy process, and
particularly the mechanisms by which appropriate transparency
measures can facilitate resolution in a Subchapter V scenario.
Judge Walrath. Yes. As I stated, pleadings generally are
public. The courtroom is open to everybody. There are a lot of
press reports.
I think the more information that the public has about what
is going on, the more confidence they will have in the process.
In addition, the ability for anyone who has an interest in the
proceeding, not just the FDIC, not just the secured lenders,
but everybody affected by it.
And one compelling story was in the Washington Mutual case,
a shareholder appeared in court because he felt that the plan
of reorganization just was not fair, because it treated him
differently from other people in his class. And he was allowed
to stand up and speak. And he was absolutely right; the
Bankruptcy Code is premised on fairness and equal treatment.
And he won that argument.
That is a very strong--it's the hallmark of our judicial
system that people will be heard. And it is clear that, even if
they lose, if they feel that they have been heard by a judge in
open court, they feel more confidence in the judicial system.
So that's why I think it is very important to have an open
system.
Mr. Gaetz. And, Your Honor, how can that transparency
facilitate resolution specifically, rather than simply lending
more trust to the process? Are there circumstances where that
transparency can facilitate more complete resolution of claims?
Judge Walrath. I think that, because bankruptcy is a
consensual process, by and large, a lot of what is discussed
and resolved happens outside of court. But it ultimately must
be revealed in court, must be presented. In bankruptcies, it is
subject to the vote of affected parties.
So all of that transparency is important, and it can assist
in the restructuring process. We've had multibillion-dollar
companies reorganize, companies that were critical to their
industry and to the American economy, all reorganized in the
public eye, and I think it's critical.
Mr. Gaetz. Mr. Taylor, you spoke in your testimony of the
impact of predictability on this area of law. How should we
remedy the predictability challenges that contributed to the
circumstances we found ourselves in in 2008?
Mr. Taylor. Well, I think that is a good example of the
lack of predictability, because there was a bailout in the case
of Bear Stearns, there was not in the case of Lehman, there was
in the case of AIG. People didn't know what to expect. And to
some extent, that's why we're here, to figure out a way to
replace that uncertainty.
That uncertainty is very damaging to the financial markets.
I think it was one of the reasons the crisis was worse than it
otherwise might have been.
I think it's also very important to limit, or prevent the
bailouts, and legislation like this goes a long way to doing
that. There is an alternative to a bailout now that's possible
so that, say, Lehman could be operating the next day without a
bailout. It's very important for risk-taking, proper risk-
taking.
And I think that the reliance on the rule of law that comes
from the Bankruptcy Code, as Judge Walrath has indicated, is
very important for establishing this. This is what's going to
happen. It's not subject to the whims of a particular
government agency. And I think that that's what I would stress.
And so that's the reason we got interested in it long ago.
Thank you.
Mr. Gaetz. Thank you for that answer. I agree
wholeheartedly.
Mr. Hessler, you spoke to the issue of the retention of
existing management for a newly formed bridge or a holding
company. Why is that important?
Mr. Hessler. Well, the expertise of management, of the
directors and officers, and the continuity that that provides
for the company as they continue to exercise their fiduciary
duties to maximize the value of the corporation, it's critical.
I think it's absolutely indispensable that----
Mr. Conyers. Turn on your mike, please.
Mr. Hessler. Excuse me. Thank you, sir.
In fact, I think maybe the best way to examine this is a
comparison of what FIBA would provide for versus what Title II
would provide for. In reverse order, Title II provides for
essentially just wholesale cleaning out directors and officers
upon the commencement of a proceeding by the FDIC.
I think that would be disastrous for an organization.
Having gone through multiple multibillion-dollar bankruptcies
as debtor's counsel, the initial days of a case, even the most
well-planned case, are relatively chaotic. There's a huge
amount of tumult upon a filing. And to lose the expertise of
the directors and officers immediately upon the commencement of
that proceeding I think would be disastrous.
For that reason, I think FIBA appropriately allows for the
continuation of management, which is actually consistent with
Chapter 11 in its present form, which embodies the concept of a
debtor in possession, which is management and the directors and
officers are allowed to continue to operate the corporation,
subject to existing Bankruptcy Code provisions that provide for
the removal of management if, in fact, there has been any
improper misconduct.
Mr. Gaetz. Thank you, Mr. Chairman.
Mr. Marino. Thank you.
I will ask my questions now. But before I get into mine,
Brad Schneider had to leave and get to somewhere else. All of
us have to be in three places at one time today. But Brad
wanted to know, Judge Walrath, you, in your opening statement,
said we needed more judges. Can you give Brad and this panel an
indication of how many more judges do you think we need?
Judge Walrath. Well, it does provide for a minimum of 10
only.
Mr. Marino. Yes.
Judge Walrath. Of course, the Chief Justice could appoint
more. But I think having a threshold of 20 is critical. We
need--at least 2 in each circuit. So 22, 20, I think would be
sufficient.
But we don't know what will happen. With only one
designated judge in a circuit, the legislation requires that
the hearing be held in the district where the filing occurs. To
get somebody there quickly enough. You can have procedures
where there's some notice that something is going to happen
without it being revealed publicly. But I think two in each
circuit would be critical.
Mr. Marino. Thank you.
Mr. Hessler, based on a response by the professor, I want
to ask you this. To the extent that there are bad managers,
does Bankruptcy Code provide for methods to remove those
managers? Number two, and are other remedies outside of
bankruptcy available to parties to address improper actions by
the board?
Mr. Hessler. Yes, Mr. Chairman. The Bankruptcy Code
presently expressly provides for creditors or other parties in
interest to seek for the appointment of an examiner, which can
conduct an investigation into the actions of management. It
also provides for the potential appointment of a trustee if, in
fact, the court finds that there has been improper managerial
misconduct, and that trustee can actually take over for
existing directors and officers and manage the case.
I have to say that is extraordinarily rare. Obstreperous
creditors often threaten to bring those motions and sometimes
bring those, but, you know, as Judge Walrath can probably
attest, the actual appointment of a trustee to supplant and
displace existing management is really extraordinarily rare.
And also, as I indicated in my testimony, in my experience,
the overwhelming--I'm not even sure I can put a high enough
percentage--99.9 percent of directors and officers take their
fiduciary duties extraordinarily seriously and they are very,
very responsible fiduciaries.
And that's why I actually think that FIBA appropriately
provides for them to--as does the current Bankruptcy Code--
provides for them to continue within the management of a
covered financial corporation, which, again, in contrast to
Title II, which provides they're all going to get fired if the
FDIC commences a proceeding, even the most meritorious conduct
by those fiduciaries. It's almost impossible to believe that
that otherwise can't influence their thinking as they pursue
responsible restructuring strategies.
Mr. Marino. Thank you.
Let's back up here a moment, because many people are not
aware of the purpose of bankruptcy and what is the upside, what
is the downside. So let's go back to a law school 101 course.
And would each of you, if you care to--and I'll start with the
judge--give me an explanation to tell my mother, who is 84
years old and keeps telling me that, ``You better do things
right there, that's why I voted for you.''
But explain to the public what bankruptcy is and what it
does and what would happen if we didn't have a bankruptcy
process, please.
Judge Walrath. I'll try.
I think some people view bankruptcy as somebody's going to
file bankruptcy and get out of paying their debts.
Mr. Marino. Yes.
Judge Walrath. And it's wrong and it's improper. And a lot
of people who file are humiliated because of that, because
they're hardworking and they got into situations where they
simply cannot deal with their situation.
But I think from the business perspective, bankruptcy was
passed--or has a very important position in our economy. It is
the escape valve. It's the steam, let-off-the-steam valve.
Without bankruptcy, there would be little innovation in
this country. Does anybody believe that Bill Gates would have
dropped out of Harvard to start his company if he felt that all
of his assets and his parents' assets would be forfeited and he
might go to debtors' prison if he failed?
Very few people would do anything to create an invention or
do an innovation, and that is what is the lifeblood of this
country. We always had the West. If you failed in the East, you
went a little further West. It is really what has helped build
America. Our innovation is what has made us succeed.
And we need a relief valve, and that is the Bankruptcy
Code, for people who do not succeed.
Mr. Marino. Doctor, if you care.
Mr. Taylor. So I never went to law school.
Mr. Marino. Congratulations.
Mr. Taylor. So I never took Bankruptcy 101. I've taught
Economics 1 for many years.
I think that to me the Bankruptcy Code is so important
because it provides a process when people get into a situation
where their debt is unsustainable for one form or another. It's
organized. The rule of law comes into action. You might not
have written everything down in your bond agreements, but
there's a way to take care of that. There's priorities that are
set, so people know what they're getting into.
So from an economic perspective, I think that's
extraordinarily important. Otherwise, things fall apart. You
don't know what to expect. And I would stress that very highly.
The word ``bankruptcy,'' of course, means different things
to different people. But for me, it's a way that the law is
being applied in situations which arise all the time. The
numbers that Judge Walrath gave are amazing, the number of
cases that these have handled. So it's a very important part of
our economy.
Mr. Marino. I was a prosecutor for most of my career, and I
sat next--my office was right next door to the bankruptcy
judge. And I saw the process. I had many discussions with them.
Thank you, Doctor.
Mr. Hessler.
Mr. Hessler. If I could just add very quickly, I agree with
everything Judge Walrath and Dr. Taylor said.
Let me focus now from a different perspective also, though,
which is from the creditor's perspective. Bankruptcy is
obviously essential for fixing companies.
But also what bankruptcy provides, the bankruptcy system
and the Bankruptcy Code, is a very orderly, structured,
transparent, and predictable set of mechanisms for creditors to
enforce their rights and for them to have an avenue to seek to
recover from a company what they are otherwise owed.
In my written testimony, I actually tried to address FIBA
from the perspective of incentives that the debtors face, but
also creditor incentives and also regulator incentives. And so
I think that's a critical aspect of the bankruptcy system that
shouldn't be overlooked as well, which is it's not just a
safety valve for the company, it's a safety valve for creditors
to otherwise seek to maximize repayment for the debts that they
owed.
Mr. Marino. Thank you.
Professor.
Mr. Grohsgal. Thank you, sir.
First of all, I'd like to state for the record that I took
my bankruptcy course when the Bankruptcy Code had been passed
but was not yet effective. And my professor speculated through
the whole class what all of it meant. And the miracle is he was
right about a lot of it. And I remember it from time to time. I
still am astonished at how predictive he was about all of this.
The Supreme Court has addressed this issue in numerous
cases, going back to the 1800s. The Bankruptcy Code does not
state what its purposes are, but the purposes that the Supreme
Court has stated should govern the decisions by bankruptcy
judges mostly are as follows.
First, the purpose of bankruptcy, especially in Chapter 11,
is to maximize distributions to creditors. Second, those
distributions should be made on an equitable basis in
accordance with the rules set forth in the bankruptcy.
And in the case of Chapter 11, the purpose is to preserve
going concerns so that businesses are preserved, their creditor
relationships are preserved, businesses that rely on their
custom stay in business, their employees are not fired, et
cetera. And that not only helps the counterparties to that
institution, to that business, but it also does maximize
returns to creditors.
So going back to the 1930s, that's been the major focus of
Chapter 11.
My major concern with this bill is that it could have done
that a lot better, and a few things concern me especially. The
first is that this wholesale transfer of qualified financial
contracts, which is likely to occur in the first 2 days, will
reduce distributions to creditors, because many disadvantageous
contracts can be expected to be assigned and assumed to the
bridge company, and many good contracts will probably be left
behind.
My second concern----
Mr. Marino. On that note, let me interrupt.
Mr. Grohsgal. Yes, sir. Yes.
Mr. Marino. How much time?
Mr. Grohsgal. The edge of the knife, Chairman Marino, is
that we have this thought that qualified financial contracts
should be protected in the sense that they are not subject
currently to the automatic stay anywhere.
My own view is that somewhere between 2 days and the 3
weeks that's afforded to most notice--for most motions--the
notice period for most motions in a Bankruptcy Court, would be
a vast improvement. The longer, the better. My own view is that
they should be subject to the automatic stay, I'll be blunt.
But understanding that I am in the minority here at this
hearing and I'm kind of standing up here for a position that I
appreciate is not accepted wholeheartedly by my colleagues here
or by all of you, however much longer than 2 days would vastly
improve the process.
I would emphasize that a 2-day process is not transparent.
A 2-day process is the inside players going in front of a
bankruptcy judge who won't even have time to consider the
propriety of assuming tens of thousands of qualified financial
products on such short notice. So some longer period of time
would be great, I think.
Mr. Marino. We have more time than I thought we would. If
you do not mind, the Ranking Member and I are going to keep you
a little longer, if it's okay with you.
So I'm going to recognize the Ranking Member, Congressman
Conyers.
Mr. Conyers. Thank you, Mr. Chairman.
I have only one question. I direct it to Professor
Grohsgal.
One of your main concerns about H.R. 1667 is that it
reduces moral hazard by absolving a financial institution's
directors from liability under a Subchapter 5 case filing.
Prior iterations of FIBA considered last Congress included, to
me, rather broad liability exculpation for a debtor's
directors. But the current version appears to narrow that
provision, as reflected in section 1183. I think you're onto
that.
What are your thoughts about the current version, and do
you have any recommendations for any further refinement, sir?
Mr. Grohsgal. Yes, I do. My first thought on reading this
in the prior legislation--and it appeared there too--is that if
I were defending a director of a failed company that had failed
twice--it first had failed because it filed a bankruptcy
petition, and then failed because that bankruptcy proceeding
still posed sufficient systemic risk that the FDIC and the
other authorities put it into a Title II receivership--that if
that happened, the first thing I would do if I was representing
that director would be to say: Well, how many of the decisions
were made in contemplation of the bankruptcy filing?
And my defense to the disgorgement proceeding from the FDIC
would be all of those decisions were made in contemplation of
the bankruptcy filing. For example, we needed to give that
senior executive a million-dollar bonus so he would stay with
the company and continue to work with us toward the bankruptcy
and preserve the company and hopefully even avoid the
bankruptcy. That would be the first thing I'd think of in
defending such a person.
There's nothing wrong with that. We are advocates as
lawyers to our clients. If I were on the other side
representing the FDIC, I'd be arguing the opposite.
But my first concern was the narrow one I expressed
previously, which is this provides a defense to that kind of a
proceeding. I don't think that was this Committee's intention
in writing this, but I think it's there.
My second concern is this. The bankruptcy process is
already a very redemptive process for the directors and
officers of a business organization. They're not held liable,
they're left in control, et cetera. We don't need this. They
have plenty of incentives to stay in power, to continue to
govern the company. And I agree with the concept of debtor in
possession. And they have a disincentive of letting the company
go into Title II. So we don't need it.
And, frankly, I think that there's something to be said for
the fact that Main Street was harmed by the financial crisis
much more than Wall Street. And I honestly think this sends
that message again, which is that the insiders are protected
and the family company that cut the lawn for that financial
institution is outside of the door and gets no protection at
all. They are second-ranked creditors and everybody else is in
on the game. That's my third concern.
Mr. Conyers. Thank you.
Attorney Hessler, would you add anything onto what has just
been said?
Mr. Hessler. I would. I would largely disagree, pursuant to
my remarks, and I don't want to belabor those too much.
I would say some narrowing of the language, I think, would
be fine. I mean, to the extent it's, you know, the reference to
in contemplation of or in connection with, I think some
additional drafting clarification around that perhaps would be
merited. I am comfortable with how it's drafted at the moment,
but to the extent that folks wanted additional clarity on that.
I will say, again, we can't just always look at this solely
from the perspective of the company, though. I think it's
important to look at it from the perspective of creditors. And
what I think 1183(c) is also helpful for is dissuading what I
would call sort of strike suits by creditors; that this being
in there is going to make it more difficult for them to come in
and try and throw sand in the gears of the bankruptcy process
by, you know, lobbing in all kinds of allegations and trying to
otherwise hold up management with lawsuits.
If I can just add one other thing also, which I feel
probably hasn't been addressed thus far this morning, but I
think is quite critical. The 48 hours that--for the first 48
hours of the case, that's post-filing, that's when the asset
transfer determination happens, the bankruptcy case is not over
in 48 hours. It's merely the transfer of the assets to the
bridge financial company. The equity in the bridge financial
company at that point is held by the special trustee for the
benefit of the creditors, who then go through a conventional
Chapter 11 case.
So a FIBA proceeding is not a 48-hour proceeding. The 48
hours, that's just the starting line. And once those assets are
transferred--and the 48-hour window is quite deliberately
designed, given the special nature of financial company assets,
which is they can't survive in bankruptcy longer than a
presumed 48 hours. At that point, though, a conventional
bankruptcy case does at that point occur, subject to all of the
transparency, predictability, creditor rights, a plan of
reorganization, the absolute priority rule, and exclusivity.
A conventional bankruptcy case then follows the transfer of
the assets. And, again, to the extent that there needs to be a
valuation of those assets, the equity of the bridge financial
company is being held for the benefit of creditors, and it will
ultimately be distributed pursuant to a plan of reorganization.
Thank you, sir.
Mr. Conyers. Judge Walrath, would you add anything?
Judge Walrath. I would agree with the remarks of Mr.
Hessler. And there was some mention of we have sales under
section 363 all the time in bankruptcy and often on a quick
deadline. This allows for the transfer of those assets in order
to protect them, but it's unlike the sales in bankruptcy that
we normally have where the whole value of that company goes to
the buyer.
Mr. Hessler is correct. The value of those transferred
assets remains with the bridge company, and if that value
remains, it is the creditors and the left-behind debtor who
benefit from it. So nothing is being transferred out of or away
from the creditors. If there is value there and it's preserved
by transferring outside of the bankruptcy case, it will be for
the benefit of creditors.
Mr. Conyers. Thank you.
Did you want to add anything, Professor Taylor?
Mr. Taylor. Thank you, Congressman. Two things.
On the idea of moral hazard being made worse by this, it's
completely opposite. The whole idea of bailouts is that people
get advantage and that it creates huge risk-taking and huge
moral hazard. So this is reducing it. And don't forget the
creditors that get bailed out. This is really trying to prevent
that. And even with the Title II, there's a possibility of that
happening.
Just quickly, on the safe harbor and the 2 days, you do
have to be concerned about the contagion effects if you go
beyond the 2 day. Two days is already kind of a compromise. And
I think--don't forget that there's a lot of concerns of the
spread of this if you don't treat some safe harbor for the
qualified financial contracts.
Mr. Conyers. Professor Grohsgal, I'll give you the last
word on this.
Mr. Grohsgal. Thank you, sir.
I would respond in a couple of quick ways.
Though I agree that the bankruptcy will proceed with
respect to the creditors left behind, my view is that the cake
is baked. By the time the assets are transferred to the bridge
bank, the damage has been done. The disadvantageous contracts
have been assumed, the good contracts have been left behind,
because there simply wasn't enough time to evaluate them in a
stressful situation.
And I would emphasize again that this is not a typical
bankruptcy and that the creditors here who are being favored,
again, unfortunately, will be disproportionately Wall Street
creditors over Main Street creditors.
And I want to mention one last thing which did not come up,
which is there is a provision here that undoes a very important
provision of Bankruptcy Code that also favors Wall Street over
Main Street, and that is a provision that says that if a
secured party's collateral is worth less than its claim, all it
gets is the value of its collateral.
Here, the bridge bank has to further weaken its balance
sheet by assuming that debt in full, again, in a way that
disadvantages Main Street creditors and also weakens the
balance sheet of the bank.
So I thank you for giving me the last word, sir.
Mr. Conyers. Well, I thank all of you for your additional
thoughts on this. It's a great panel of witnesses.
And I thank the chairman.
Mr. Marino. Judge Walrath, I'm not sure if I caught it, but
did you address the issue concerning the professor's issue with
the 2-day?
Judge Walrath. It would be great to have a lot more time,
but what needs to be done can be done in 48 hours. We are used
to dealing with debtor in possession financing, paying critical
vendors, paying employees. Lots of critical motions are filed
on this first day, and judges have to deal with them literally
within 48 hours of that filing. We have first days
approximately 24 hours after a case is filed, because we
recognize a business, an operating business needs to continue
to operate.
So I am not as concerned as Professor Grohsgal is about the
48-hour rule.
Mr. Marino. Professor, I'm assuming that you don't have a
problem with a bankruptcy action going to a Federal judge as
quickly as possible for oversight. Am I correct in my
assumption?
Mr. Grohsgal. I'm sorry, sir. I didn't precisely follow
your question.
Mr. Marino. In my legislation, we want to get a bankruptcy
case to a Federal judge as quickly as possible for oversight.
You do not have a problem with that, do you?
Mr. Grohsgal. No, Your Honor. I am a firm believer in a
quick, a swift, but deliberative process for a company that is
in distress, whether a regular business organization or a
financial institution. One thing that Delaware early on
recognized is the need for speed.
My issue is with the fact that this is so quick, with all
the moving parts and all of the assets in play, that what we
have is not a deliberative process. It's just too quick to do
that.
Mr. Marino. Dr. Taylor, do you want to respond to that? I
noticed a little concern.
Mr. Taylor. I think the speed is the goal and it's outlined
how it can be done. It hasn't been done yet, to be sure, but
testing it out on previous cases is important. The experience
of judges is important.
But the speed is essential to make this work. And the idea
of opening for business on Monday morning to take account of
the time zones is crucial.
Mr. Marino. Attorney Hessler, I think in Title I--and my
counsel here has been advising me on some of these issues that
he's very brilliant at--but discuss the living will aspect and
the benefit of that.
Mr. Hessler. Sure. The living will, it's interesting,
because part of the FIBA debate is also getting wrapped up in
the Title II debate and whether Title II should be repealed
from Dodd-Frank. The living wills that are found within Title I
of Dodd-Frank actually are very helpful for what is
contemplated by FIBA.
Again, the 48 hours that's been a lot of the focus of
today's hearing that is really fast. That, however, is preceded
by an extraordinary amount of planning. And the living wills
require even ostensibly healthy financial institutions to be
putting in place a blueprint and be putting in place a plan
that there could actually be an orderly 48-hour determination
for the transfer of contracts.
I actually think what's also contemplated by FIBA the way I
read it is, I think what's actually anticipated is the entire
book of qualified financial contracts are going to get
transferred.
So to say 48 hours is too short a time period to go through
what might be hundreds of thousands, if not millions of
qualified financial contracts and make individual
determinations, I think that is correct. I don't think that
that's realistic for 48 hours, but I don't think that's what's
anticipated. I think the entire book is likely to get
transferred.
Mr. Marino. Judge, what will the impact be on the 48-hour
aspect if we do not have more bankruptcy judges? Will we be
able to still stick to that schedule of 48 hours?
Judge Walrath. Well, if a procedure is put in place--in
Delaware, we have a procedure where if a large case is
contemplated to be filed, we get several weeks' advance notice.
The name of the company is never mentioned. But our clerk of
court is advised, and the clerk of court puts in procedures to
be sure that there is a judge available at the time that the
anticipated filing is done.
In those procedures are put in place, I understand the
circuit chief will be advised that a filing is anticipated. If
we can have a procedure where the designated bankruptcy judge
is advised that it is contemplated that there may be a filing,
you need to be available, then I think it could work.
I would be nicer to have more than one person. If somebody
is on vacation in Europe, for example, we might have a problem.
But since they have to have the hearing in that district, you
need time to get them there.
Mr. Marino. And a lot of that's going to depend, for the
most part, on the complexity and the size of that case.
Judge Walrath. Yes.
Mr. Marino. All right.
Well, lady and gentlemen, I want to thank you all very much
for being here today. We came in just slightly under the wire.
And this concludes today's hearing.
Once again, I can't tell you how much I learn from these
hearings. And each of you have--you've taught me well today,
and I appreciate that very much.
So without objection, all members will have 5 legislative
days to submit additional written questions for the witnesses
or additional materials for the record.
This hearing is adjourned.
Additional Material Submitted for the Record
Statement submitted by the Honorable John Conyers, Jr.,
Michigan, Committee on the Judiciary. This material is
available at the Committee and can be accessed on the Committee
Repository at:
http://docs.house.gov/meetings/JU/JU00/20170308/105660/
HHRG-115-JU00-20170308-SD002.pdf
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