Friday, June 10, 2011

Hedge Fund Industry Says Dodd-Frank Liquidation Authority Should be Used Sparingly

Dodd-Frank’s creation of an entirely new liquidation regime with a far more “bare bones” statute than the Bankruptcy Code and a much less transparent process has created huge uncertainty in the markets, in the view of the hedge fund industry. In a letter to the FDIC, the Managed Funds Association said it is thus important that the new orderly liquidation authority be employed sparingly and only when doing so is essential to protect the overall financial markets. Limiting the companies that are potentially eligible for the liquidation authority to firms that are systemically important nonbank financial companies will create greater certainty, said the MFA, engender greater confidence in the regime, and serve the purposes Congress had in mind when it enacted Title II of Dodd-Frank.

The MFA urged the FDIC to narrowly construe the priority afforded unsecured claims for amounts due to the United States. Doing so will both further the general policy of treating unsecured creditors equally and help harmonize the liquidation authority with the Bankruptcy Code, under which the priorities for any unsecured claims are construed narrowly precisely because of the overall goal of treating all unsecured creditors equitably, citing the Supreme Court’s opinion in Begier v. IRS, 496 U.S. 53, 58 (1990) for the proposition that equality of distribution among creditors is a central policy of the Bankruptcy Code. According to that policy, said the Court, creditors of equal priority should receive pro rata shares of the debtor's property. The case presented the question of whether a trustee in bankruptcy could avoid from the IRS payments of withholding and excise taxes that the debtor made before it filed for bankruptcy. The Court held that the funds paid were not the property of the debtor prior to payment; instead, they were held in trust by the debtor for the IRS; and concluded that the trustee may not recover the funds.

In the letter, the MFA also said that it agrees with the FDIC’s determination not to include amounts owed to government-sponsored entities within the class of priority claims for amounts due to the United States. The association urged the FDIC to construe this priority narrowly so it does not extend to quasi-governmental bodies, for example the priority would not cover amounts owed to the Pension Benefit Guaranty Corporation.

There is a need for a provision comparable to Section 503(b)(4) of the Bankruptcy Code, which grants administrative expense status to claims for fees of attorneys and accountants of a creditor that makes a substantial contribution in a bankruptcy case. The MFA asked the FDIC to expand its proposed regulations to provide for the possibility, in appropriate circumstances, of the payment from the estate of the expenses of such a creditor itself, as an administrative expense, as provided in Section 503(b)(3) of the Bankruptcy Code

According to the MFA, the FDIC will engender greater confidence in the system, and the actual results of liquidations under the new regime will improve, if creditors with major stakes in the liquidation are encouraged to participate actively in the liquidation proceedings. In this spirit, the FDIC should permit the formation of creditors committees, with the potential for such committees to retain counsel and other professionals to work with the FDIC as receiver, and to obtain payment of the expenses of the committees out of the estate.