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United States Government Accountability Office: 

Report to Congressional Committees: 

July 2011: 


Complex Financial Institutions and International Coordination Pose 


GAO Highlights: 

Highlights of GAO-11-707, a report to congressional committees. 

Why GAO Did This Study: 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) created the Orderly Liquidation Authority (OLA) that can be 
used to resolve failed systemically important financial institutions. 
However, questions continued to be raised about the effectiveness of 
the U.S. Bankruptcy Code (Code) and current mechanisms for 
international coordination in bankruptcy cases. The Dodd-Frank Act 
requires GAO to report on the effectiveness of the Code in resolving 
certain failed financial institutions on an ongoing basis. Among its 
objectives, this report addresses (1) the effectiveness of Chapters 7 
and 11 of the Code for facilitating orderly resolutions of failed 
financial institutions; (2) proposals for improving the effectiveness 
of liquidations and reorganizations under the Code; and (3) existing 
mechanisms that facilitate international coordination under the Code 
and barriers to coordination of financial institution bankruptcies. 
GAO reviewed laws, judicial decisions, regulations, data, and academic 
literature on resolutions, and spoke with relevant government 
officials, industry representatives, and experts from the legal and 
academic communities about the effectiveness of the Code. 

GAO makes no recommendations in this report. GAO provided a draft for 
comment to the Administrative Office of the United States Courts, the 
Treasury, and the federal financial regulators, among others. All 
provided technical comments that GAO has incorporated as appropriate. 

What GAO Found: 

The effectiveness of the Bankruptcy Code in resolving failed complex 
financial institutions is unclear for several reasons, including that 
criteria are not well-developed, a paucity of data, and the complex 
activities and organizational structures of financial institutions. 
Experts agreed that maximizing asset values and minimizing systemic 
impacts are potential criteria for judging effectiveness, but the Code 
does not directly address systemic factors in bankruptcies. Even if 
criteria were established, few complex financial institutions have 
filed for bankruptcy, and those that have, have done so recently, 
making measuring effectiveness difficult. Nonetheless, experts 
generally agreed that certain attributes of complex financial 
institutions—highly liquid funding sources; use of derivatives; 
complex legal structures, including regulated and unregulated 
entities, that do not correspond to integrated, interconnected 
operating structures; and international scope of operations—complicate 
bankruptcy proceedings. 

Financial, legal, and regulatory experts have made proposals to modify 
the Code, but they do not agree on specifics. These proposals 
generally focus on or combine several types of actions: (1) increasing 
opportunities for bankruptcy planning, (2) providing for regulatory 
input in the bankruptcy process, (3) modifying the safe harbor for 
certain financial contracts, (4) treating firms on a consolidated 
basis, and (5) improving court expertise on financial issues. For 
example, experts generally agree that changes need to be made 
regarding the safe harbor treatment of certain financial contracts. 
The Code exempts these contracts from the automatic stay that, in a 
bankruptcy, preserves assets and generally prevents creditors from 
taking company assets in payment of debts before a case is resolved 
and assets are distributed in a systematic way. However, the experts 
do not agree on whether the types of contracts receiving this safe 
harbor treatment need to be changed or whether, as with regulatory 
processes, a temporary stay should be adopted. 

Efforts to improve international coordination continue, but existing 
mechanisms are not comprehensive, and international coordination 
generally is limited—often because national interests can play a 
determining role in resolution outcomes. For example, Chapter 15 of 
the Code promotes coordination between U.S. bankruptcy courts and 
foreign jurisdictions when the debtor in a U.S. bankruptcy proceeding 
is a company with foreign operations. However, national interests and 
other factors limit its effectiveness during bankruptcies of financial 
institutions. When national interests are aligned, even during a 
financial crisis, courts and regulators find ways to coordinate, but 
when they diverge, the need to safeguard those interests takes 
priority. Variations in countries’ insolvency laws, differences in 
definitions and factors that trigger insolvencies, and limits on 
information sharing also constrain international coordination. 
Proposals have been made to improve international coordination for 
financial institution resolutions, but most efforts focus on 
regulatory, rather than judicial, processes. 

View [hyperlink,] or key 
components. For more information, contact Alicia Puente Cackley at 
(202) 512-8678 or 

[End of section] 




D.C. District Court Has Issued Rules to Implement Required Judicial 
Review under the Orderly Liquidation Authority: 

The Effectiveness of the Bankruptcy Code in Resolving Complex and 
Internationally Active Financial Institutions Is Unclear: 

Bankruptcy Proposals Address Some Financial Institution Challenges, 
but There Is No Consensus on Specifics: 

Courts and Regulators Have Mechanisms for International Coordination, 
but National Interests and Other Factors Limit Coordination: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Local Civil Rule 85: 

Appendix III: CIT Group Bankruptcy: 

Appendix IV: Lehman Bankruptcy: 

Appendix V: Washington Mutual Bankruptcy: 

Appendix VI: Other Financial Institution Failures: 

Appendix VII: Safe Harbors for Contracts under the Bankruptcy Code: 

Appendix VIII: Some Characteristics of Insolvency Systems in Selected 

Appendix IX: Organizational Affiliations of Experts: 

Appendix X: GAO Contact and Staff Acknowledgments: 

Related GAO Products: 


Table 1: Chapter 11 Mega Bankruptcy Filings, by Total Filings and 
Financial Institution Filings, 2000-2009: 

Table 2: Thirty of the Largest International Financial Institutions 
(Ranked by Size) and Their Subsidiaries and Branches: 

Table 3: Timeline of Selected Events Related to the CIT Bankruptcy, 
from April 2007 through December 2009: 

Table 4: Timeline of Selected Events Related to the Lehman Bankruptcy, 
from September 2008 through April 2011: 

Table 5: Timeline of Selected Events Related to the Washington Mutual, 
Inc. Bankruptcy, from September 2008 through July 2011: 

Table 6: Repayment Rankings of Selected Countries: 


Figure 1: Chapter 11 Bankruptcy Process for a U.S.-Headquartered 
Financial Institution as of June 2011: 



AOUSC: Administrative Office of the United States Courts: 

AIG: American International Group, Inc. 

BIA: Bankruptcy and Insolvency Act: 

BHC Act: Bank Holding Company Act: 

BCCI: Bank of Credit and Commerce International: 

BIS: Bank of International Settlement: 

BNY: Bank of New York Mellon Corporation: 

Herstatt: BankHaus Herstatt: 

Barclays: Barclays PLC: 

BNY trustee: BNY Corporate Trustee Services Limited: 

CDIC: Canada Deposit Insurance Corporation: 

CDIC Act: Canada Deposit Insurance Corporation Act: 

CIT: CIT Group, Inc. 

CCCA: Companies' Creditors Arrangement Act: 

Co-Co: contingent convertible bonds: 

CDS: credit default swap: 

DIP: debtor-in-possession: 

Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection 

Drexel: Drexel Burnham Lambert Group, Inc. 

EU: European Union: 

FDI Act: Federal Deposit Insurance Act: 

FDIC: Federal Deposit Insurance Corporation: 

FRBNY: Federal Reserve Bank of New York: 

Federal Reserve: Board of Governors of the Federal Reserve System: 

Fortis: Fortis Bank, SA/NV: 

G10: Group of Ten: 

G20: Group of 20: 

IMF: International Monetary Fund: 

ISDA: International Swaps and Derivatives Association: 

JPMC: JPMorgan Chase and Co. 

LBF: Lehman Brothers Finance: 

LBHI: Lehman Brothers Holdings, Inc. 

Lehman: Lehman Brothers Holdings, Inc. and subsidiaries: 

LBI: Lehman Brothers, Inc. 

LBIE: Lehman Brothers International Europe: 

LBSF: Lehman Brothers Special Financing, Inc. 

LTCM: Long-Term Capital Management: 

MOU: memorandum of understanding: 

Nordea: Nordea Group: 

Nortel: Nortel Networks, Inc. 

NAFTA: North American Free Trade Agreement: 

NPR: notice of proposed rulemaking: 

OTS: Office of Thrift Supervision: 

OLA: Orderly Liquidation Authority: 

Perpetual: Perpetual Trustee Company Limited: 

P&A agreement: Purchase and Assumption Agreement: 

QFC: qualified financial contracts: 

Saphir: Saphir Finance Public Limited Company: 

Section 23A: Section 23A of the 1913 Federal Reserve Act: 

SEC: Securities and Exchange Commission: 

SIPA: Securities Investor Protection Act: 

SIPC: Securities Investor Protection Corporation: 

Swedbank: Swedbank AB: 

TLGP: Temporary Liquidity Guarantee Program: 

TARP: Troubled Asset Relief Program: 

UK: United Kingdom: 

UNCITRAL: United Nations Commission on International Trade Law: 

Code: U.S. Bankruptcy Code: 

D.C. District Court: U.S. District Court for the District of Columbia: 

Washington Mutual: Washington Mutual, Inc. 

WMPF: Washington Mutual Preferred Funding LLC: 

WURA: Winding Up and Restructuring Act: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

July 19, 2011: 

Congressional Committees: 

The recent financial crisis and its attendant bailouts and 
bankruptcies of complex financial institutions led lawmakers and other 
government officials to question the adequacy of the then existing 
U.S. and international frameworks for resolving complex financial 
institutions and addressing systemic risk. In response, Congress 
created a new Orderly Liquidation Authority (OLA) in the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), 
enacted in July 2010, that can be used when certain insolvent 
financial companies pose a risk to the financial stability of the 
United States.[Footnote 1] Under certain circumstances, the Dodd-Frank 
Act authorizes the Secretary of the Treasury to appoint the Federal 
Deposit Insurance Corporation (FDIC) as a receiver, and requires FDIC 
to liquidate such financial companies so as to maximize the value of 
the company's assets, minimize losses, mitigate systemic risk, and 
minimize moral hazard. Since the passage of the Dodd-Frank Act, FDIC 
has not been appointed receiver of any failing financial company as 
part of OLA; OLA has not yet been tested. 

Leading up to the passage of the Dodd-Frank Act, some members of 
Congress and some legal and financial experts had raised (and continue 
to raise) questions about the effectiveness of the U.S. Bankruptcy 
Code (Code) in providing for orderly liquidations or reorganizations 
of financial institutions that qualify as debtors under the Code. 
[Footnote 2] In addition, the Lehman bankruptcy proceedings, which 
began in September 2008 and included the bankruptcy of Lehman Brothers 
Holdings, Inc. and a number of its subsidiaries, have highlighted 
inconsistencies in laws and regulations across countries and 
limitations on the ability of countries to coordinate effectively 
during the reorganization or liquidation of a financial institution 
that operates across national borders. 

Consequently, the Dodd-Frank Act requires that GAO report on issues 
relating to OLA's judicial review process, the effectiveness of the 
Bankruptcy Code, and international coordination in bankruptcies of 
financial companies. As required under section 202 of the Dodd-Frank 
Act, this report examines (1) actions taken by the U.S. District Court 
for the District of Columbia (D.C. District Court) in response to the 
judicial review provision of the OLA; (2) the effectiveness of 
Chapters 7 and 11 of the Code in facilitating orderly liquidations or 
reorganizations of financial institutions; (3) proposals for improving 
the effectiveness of liquidations and reorganizations under the Code; 
and (4) mechanisms that facilitate international coordination and any 
barriers to coordination of financial institution bankruptcies. 
[Footnote 3] 

To address these objectives, we reviewed a rule issued by the U.S. 
District Court under the OLA judicial review provision. We also 
monitored proposed rules issued by U.S. regulators charged with 
implementing OLA and legal developments in selected other countries. 
To assess the effectiveness of the Code, the strengths and weaknesses 
of proposals, and the extent of international coordination, we 
reviewed laws, judicial decisions, regulatory proceedings, and 
academic literature. During that review, we focused on identifying 
potential criteria for determining the effectiveness of bankruptcy 
proceedings, factors that complicate or facilitate bankruptcies, or 
those that limit or facilitate coordination during bankruptcies or 
insolvencies of internationally active institutions. Also, we 
interviewed experts including law professors, practicing attorneys, 
bankruptcy judges, economists, and regulators both in the United 
States and in selected other countries and the European Union (EU). 
The countries included Canada, Germany, Mexico, the Netherlands, 
Switzerland, and the United Kingdom (UK) and were chosen because of 
their importance to the U.S. financial system and their geographic 
scope. To supplement these activities, we developed information from 
court documents, including examiner and Securities Investor Protection 
Act (SIPA) Trustee reports, and interviews about the three largest 
financial institution bankruptcies in the United States--CIT Group 
(CIT), Lehman Brothers Holdings, Inc. and its subsidiaries (Lehman), 
and Washington Mutual, Inc. (Washington Mutual). In addition, we 
collected information from prior GAO reports, court and regulatory 
documents, and academic studies on a number of other financial 
institution failures or near failures. Finally, we analyzed available 
data on U.S. bankruptcies and determined that they were sufficiently 
reliable to provide some background information on the number of large 
financial institution bankruptcies that occurred between 2000 and 
2010. See appendix I for more information on our objectives, scope, 
and methodology for this report. 

We conducted this performance audit from August 2010 to July 2011, in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 


Bankruptcy is a federal court procedure conducted under rules and 
requirements of the U.S. Bankruptcy Code. The goal of bankruptcy is to 
give individuals and businesses a "fresh start" from burdensome debts 
by eliminating or restructuring debts they cannot repay and help 
creditors receive some payment in an equitable manner through 
liquidation or reorganization of the debtor. The filing of a 
bankruptcy petition operates as an "automatic stay" that stops 
lawsuits, foreclosures, and most other collection activities against 
the debtor. Under the Code, secured creditors--those with liens or 
other secured claims against the debtor's property--are more likely to 
get some portion of their debt repaid than unsecured creditors. In 
addition, creditors typically receive payment of their debts before 
shareholders receive any return of their equity. 

Business debtors that are eligible for protection under the Code may 
qualify for liquidation, governed by Chapter 7 of the Code, or 
reorganization, governed by Chapter 11. A Chapter 7 proceeding is a 
court-supervised procedure by which a trustee takes over the assets of 
the debtor's estate, reduces them to cash, and makes distributions to 
creditors, subject to the rights of secured creditors to the 
collateral securing their loans to the debtor. Debtors that are 
commercial enterprises desiring continuation of some or all of the 
debtor's operations ordinarily seek to reorganize under Chapter 11 as 
a way to satisfy creditor claims. Under Chapter 11, typically the 
debtor remains in control of its assets, and is therefore called a 
debtor-in-possession (DIP). If, however, the bankruptcy court 
determines that this is not in the best interest of creditors, the 
court can appoint a trustee to oversee the debtor. The reorganization 
is consummated when the reorganization plan developed by the debtor 
(or other interested party) is confirmed by the court. The plan sets 
forth the means by which it will be implemented, including disposition 
or retention of property, mergers, and issuance of securities. 
[Footnote 4] The plan also, among other things, divides creditors into 
classes and sets forth the manner in which the creditor classes will 
be paid. The debtor also can terminate burdensome contracts and 
leases, recover assets, and rescale its operations in order to return 
to profitability. Chapter 11 proceedings often involve financing under 
what is called DIP financing.[Footnote 5] Proceedings under both 
Chapters 7 and 11 can be voluntary (initiated by the debtor) or 
involuntary (generally initiated by at least three creditors and 
infrequent).[Footnote 6] Since 2001, the courts have overseen nearly 
350,000 Chapter 7 and Chapter 11 business cases (those with primarily 
business debt). Almost all of the debtors that were larger businesses--
those with assets of at least $100 million--initially filed under 
Chapter 11; however, because smaller businesses often file under 
Chapter 7, Chapter 7 cases made up almost 75 percent of all business 

The U.S. bankruptcy system involves multiple federal entities. 
Bankruptcy courts are located in 90 federal judicial districts; 
however, the Southern District of New York (which includes Manhattan) 
and the District of Delaware adjudicate a majority of larger corporate 
or business bankruptcy cases, many of which constitute "mega cases" 
involving companies with assets of at least $100 million and at least 
1,000 creditors.[Footnote 7] The Judicial Conference of the United 
States serves as the judiciary's principal policymaking body and 
recommends national policies and legislation on all aspects of federal 
judicial administration.[Footnote 8] In addition, the Administrative 
Office of the United States Courts (AOUSC) serves as the central 
administrative support entity for the Judicial Conference and the 
federal courts, including bankruptcy courts. For example, AOUSC 
provides administrative, legal, financial, management, and information 
technology functions for the federal courts. The Federal Judicial 
Center is the education and research agency for the federal courts and 
assists bankruptcy courts with reports and assessments relating to the 
administration and management of bankruptcy cases. Finally, the U.S. 
Department of Justice's Trustee Program and the Bankruptcy 
Administrator Program oversee bankruptcy trustees and promote 
integrity and efficiency in the bankruptcy system by overseeing the 
administration of bankruptcy estates.[Footnote 9] 

Financial Institutions and the Bankruptcy Code: 

Large financial institutions operating in the United States engage in 
a broad range of financial services including commercial banking, 
investment banking, and insurance.[Footnote 10] Many of them are 
organized as holding companies with a variety of subsidiaries, 
including regulated subsidiaries such as depository institutions, 
insurance companies, broker-dealers, and futures commission merchants, 
as well as other nonregulated subsidiaries that engage in a wide 
variety of financial activities. Many of these businesses have 
centralized business functions that may be housed in the holding 
company. Smaller banking institutions also are organized as holding 
companies, but many of these hold few, if any, assets outside a 
depository institution and generally engage in a narrower range of 

Certain financial institutions, specifically insured depositories, 
domestic insurers, and branches and agencies of foreign banks may not 
file as debtors under the U. S. Bankruptcy Code, and other entities 
face special restrictions in using the Code. These institutions are 
resolved through regulatory processes or face some restrictions, as 

* Under the Federal Deposit Insurance Act (FDI Act), FDIC serves as 
the conservator or receiver for insured depository institutions placed 
into conservatorship or receivership under applicable law.[Footnote 
11] FDIC, as receiver, is charged with liquidating these failed 
depository institutions' assets. Often, FDIC will arrange for all or 
part of the assets and liabilities of the failed depository 
institution to be purchased and assumed by a single or several other 
financial institutions. To the extent such a purchase and assumption 
is not possible or the assuming institution or institutions do not 
purchase all of the assets of the failed depository institution, FDIC 
will liquidate such assets over time. 

* Insurers are generally subject to oversight by state insurance 
commissioners, who have the authority to place them into 
conservatorship, rehabilitation, or receivership. 

* Broker-dealers can be liquidated under SIPA or under a special 
provision of Chapter 7 of the Code. However, broker-dealers may not 
file for reorganization under Chapter 11.[Footnote 12] Similarly, 
commodity brokers, also known as futures commission merchants, are 
restricted to using only a special provision of Chapter 7 for 
bankruptcy relief. 

* Covered financial companies--those financial companies that the 
Secretary of the Treasury determines meet the conditions specified 
under OLA, including that their failure would pose a threat to the 
financial stability of the United States--are to be resolved under an 
FDIC receivership, generally similar to that currently used to resolve 
insured depositories.[Footnote 13] Under this receivership, FDIC can 
create a bridge financial institution and can divide the company's 
assets so they can be sold, liquidated, or transferred to such a 
bridge institution. 

Other financial institutions that have not been determined to pose a 
threat to the financial stability of the United States may qualify as 
debtors under the Code. These would include holding companies that own 
insured depository institutions or other firms, such as broker-
dealers, that are not permitted to be debtors under Chapter 11. Large 
complex financial institutions that are eligible to file for 
bankruptcy generally file under Chapter 11 of the Code. A financial 
institution going through a Chapter 11 bankruptcy generally will pass 
through several stages, ranging from the filing of a petition and 
implementation of the automatic stay, through "first-day motions," to 
submission of a written disclosure statement and judicial approval of 
a reorganization plan, as shown in figure 1.[Footnote 14] The most 
common first-day motions relate to the continued operation of the 
debtor's business and involve matters such as requests to use cash 
collateral--liquid assets on which secured creditors have a claim--and 
obtaining DIP financing, if any. The disclosure statement filed after 
the filing of the bankruptcy petition must include information on the 
debtor's (financial institution's) assets, liabilities, and business 
affairs sufficient to enable creditors to make informed judgments 
about the debtor's plan of reorganization.[Footnote 15] Creditors need 
to understand the reorganization plan because the court may not 
confirm the plan unless, among other things, a sufficient proportion 
of allowed creditors has either accepted the plan or is not impaired 
by the plan.[Footnote 16] The court's approval also depends on whether 
or not there are dissenting classes of creditors. The possible 
outcomes of a Chapter 11 bankruptcy, which can be used in combination, 
include liquidating the assets of the company with the approval of the 
court (as opposed to liquidation by a bankruptcy trustee under Chapter 
7), sale of the company, in whole or in part, which is sometimes 
called a section 363 sale because that is the section of the Code that 
applies to sales that are free and clear of creditor claims, and 
actual reorganization of the company in which it emerges from 
bankruptcy with new contractual rights and obligations that replace or 
supersede those it had before filing for bankruptcy. During the 
bankruptcy proceeding, the debtor, or one or more creditors with an 
allowed claim, and other interested parties, may initiate adversary 
proceedings--in effect, a lawsuit within the bankruptcy case. Debtors 
initiate adversary proceedings to preserve or recover money or 
property for the estate; for example, property that may have been 
transferred in the resolution of a regulated entity such as an insured 
depository. Creditors may initiate adversary proceedings to 
subordinate a claim of another creditor to their own claims or for 
other similar reasons. 

Figure 1: Chapter 11 Bankruptcy Process for a U.S.-Headquartered 
Financial Institution as of June 2011: 

[Refer to PDF for image: illustration] 

Holding company: 

1) Unregulated legal entities: 
Chapter 11 bankruptcy; 
Debtor voluntarily files for bankruptcy; or: 
Creditors initiate involuntary bankruptcy. 
Automatic stay for all assets except qualified financial contracts 
(QFC); (Closing and netting of QFCs). 
Ancillary proceedings: 
Adversary proceeding (U.S. debtor and creditor, two U.S. creditors,
Chapter 15 proceeding; 
First day motions; 
Disclosure statement; 
Confirmation of plan: 
Ladder of unsecured creditor priorities: 
- DIP financers; 
- Taxing authorities; 
- Unsecured creditors; 
- Shareholders. 

Potential outcome(s) (any single one or combination is possible): 
Assets liquidated; 
Company sold in 363 sale; 
Company reorganized. 

2) Broker-dealer: 
SIPA proceeding or special provision of Chapter 7; 
Commodity broker: 
Special provision of Chapter 7. 

3) Foreign subsidiary: 
Insolvency or regulatory process (varies by location); 
A foreign proceeding may be tied to a U.S. proceeding through a
Chapter 15 filing. 

4) Insured depository institution: 
FDIC process. 

5) Insurance company: 
State resolution process. 

Source: GAO analysis of U.S. Court information 

Note: Qualified Financial Contracts are contracts specified in the 
Bankruptcy Code as exempt from the automatic stay. These contracts are 
discussed in more detail throughout the body of this report and in 
appendix VII. Chapter 15, which is also discussed throughout this 
report, governs judicial cross-border coordination and foreign 
subsidiaries may be engaged in Chapter 15 cases. 363 sales are denoted 
as such because they are governed by section 363 of the Bankruptcy 

[End of figure] 

As shown in table 1, only a few large financial institutions--those 
with assets of at least $100 million and at least 1,000 creditors or 
more--actually filed for bankruptcy under Chapter 11 from 2000 through 

Table 1: Chapter 11 Mega Bankruptcy Filings, by Total Filings and 
Financial Institution Filings, 2000-2009: 

Year: 2000; 
Chapter 11 mega filings: Total number of filings: 63; 
Chapter 11 mega filings: Number of financial institution filings: 2. 

Year: 2001; 
Chapter 11 mega filings: Total number of filings: 101; 
Chapter 11 mega filings: Number of financial institution filings: 1. 

Year: 2002; 
Chapter 11 mega filings: Total number of filings: 88; 
Chapter 11 mega filings: Number of financial institution filings: 2. 

Year: 2003; 
Chapter 11 mega filings: Total number of filings: 73; 
Chapter 11 mega filings: Number of financial institution filings: 1. 

Year: 2004; 
Chapter 11 mega filings: Total number of filings: 54; 
Chapter 11 mega filings: Number of financial institution filings: 0. 

Year: 2005; 
Chapter 11 mega filings: Total number of filings: 31; 
Chapter 11 mega filings: Number of financial institution filings: 2. 

Year: 2006; 
Chapter 11 mega filings: Total number of filings: 25; 
Chapter 11 mega filings: Number of financial institution filings: 0. 

Year: 2007; 
Chapter 11 mega filings: Total number of filings: 13; 
Chapter 11 mega filings: Number of financial institution filings: 4. 

Year: 2008; 
Chapter 11 mega filings: Total number of filings: 79; 
Chapter 11 mega filings: Number of financial institution filings: 4. 

Year: 2009; 
Chapter 11 mega filings: Total number of filings: 118; 
Chapter 11 mega filings: Number of financial institution filings: 6. 

Year: Total; 
Chapter 11 mega filings: Total number of filings: 645; 
Chapter 11 mega filings: Number of financial institution filings: 22. 

Sources: GAO analysis of AOUSC and New Generations Research, Inc. data. 

[End of table] 

Financial Institutions Can Be Parties to Contracts That Receive Safe 
Harbor Protection: 

Although the automatic stay is one of the central provisions of the 
Code, it is subject to exceptions, one of which can be particularly 
important in a financial institution bankruptcy.[Footnote 17] Commonly 
referred to as a "safe harbor," this exception pertains to certain 
financial and derivative contracts, often referred to as "qualified 
financial contracts" (QFC), that are defined in the Code.[Footnote 18] 
They include derivative financial products, such as futures contracts 
and swap agreements that financial institutions, as well as 
individuals and nonfinancial institutions, use to hedge against losses 
from other transactions or to speculate on the likelihood of future 
economic developments. Repurchase agreements, collateralized 
instruments that provide short-term financing for financial 
institutions and others, also receive safe harbor treatment. 

Under these provisions, counterparties that entered into a transaction 
with the debtor that qualifies for safe harbor treatment under the 
Code may exercise their contractual rights even if doing so would 
otherwise violate the automatic stay.[Footnote 19] Typically these 
contractual rights are described in an ipso facto clause, which gives 
the parties to a contract the right to terminate it or modify its 
terms upon a counterparty's insolvency or the commencement of 
bankruptcy proceedings.[Footnote 20] Such an occurrence constitutes a 
default, and the nondefaulting party may liquidate, terminate, or 
accelerate the contract, and may offset (net) any termination value, 
payment amount, or other transfer obligation arising under the 
contract when the debtor files for bankruptcy.[Footnote 21] 

As with the Code, the FDI Act and the Dodd-Frank Act permit QFC 
counterparties to move quickly to enforce their contractual rights, 
notwithstanding the appointment of a receiver.[Footnote 22] After its 
appointment as receiver, FDIC has three options in managing the 
institution's QFC portfolio. FDIC can retain the QFCs in the 
receivership; transfer the QFCs to another financial institution; or 
repudiate (reject) the QFCs. Subject to some requirements described 
below, FDIC can apply different options to QFCs with different 

FDIC's first option is similar to the safe harbor provisions under the 
Code. If FDIC retains QFCs in the receivership, the counterparty may 
terminate the contract and exercise any contractual right to net any 
payment the counterparty owes to the institution against the payment 
the institution owes to the counterparty on a different QFC.[Footnote 
23] While this right is immediate under the Code's safe harbor, the 
QFC counterparty generally cannot exercise it against a failed insured 
depository institution in FDIC receivership until after 5:00 p.m. 
(eastern standard time or eastern daylight time) on a normal business 
day following the date of appointment of FDIC as receiver.[Footnote 
24] Because bank regulators almost always close depository 
institutions on Fridays, the stay remains in effect until 5:00 p.m. 
the following Monday. The second option involves FDIC's transfer of 
QFCs to another financial institution or permissible entity. If FDIC 
transfers a QFC to another financial institution, the counterparty 
cannot exercise its contractual right to terminate the QFC solely as a 
result of the transfer, the insolvency, or the appointment of the 
receiver.[Footnote 25] Under the third option, FDIC may repudiate 
(reject) a QFC, within a reasonable period of time, if FDIC determines 
that the contract is burdensome.[Footnote 26] However, FDIC must pay 
actual direct compensatory damages, which may include the normal and 
reasonable costs of cover or other reasonable measure of damages used 
in the industry for such claims, calculated as of the date of 
repudiation. If FDIC decides to transfer or repudiate (reject) a QFC, 
all other QFCs entered into between the failed institution and that 
counterparty, as well as those QFCs entered into with any of that 
counterparty's affiliates, must be transferred to the same financial 
institution or repudiated at the same time.[Footnote 27] 

Safe harbor treatment was first added to the Code in 1982 for forward 
contracts, commodity contracts, and security contracts, and over time 
the Congress has expanded the types of contracts and counterparties 
covered.[Footnote 28] The most recent changes to the treatment of safe 
harbor contracts under the Code in 2005 and 2006 expanded the safe 
harbor treatment to contracts related to mortgage-backed securities 
and repurchase agreements, an overnight source of funding used by 
financial institutions, and included provisions to strengthen and 
clarify the enforceability of such contracts.[Footnote 29] According 
to legislative history and FDIC regulations, the purpose of these safe 
harbors and the QFC provisions in the FDI Act is to maintain market 
liquidity and reduce systemic risk, which we define as the risk that 
the failure of one large institution would cause other institutions to 
fail or that a market event could broadly affect the financial system 
rather than just one or a few institutions.[Footnote 30] 

Chapter 15 of the Bankruptcy Code Governs Judicial Cross-Border 

In 2005, the United States adopted Chapter 15 of the U.S. Bankruptcy 
Code.[Footnote 31] Chapter 15 is based on the United Nations 
Commission on International Trade Law (UNCITRAL) Model Law on Cross-
Border Insolvency, which is intended to promote coordination between 
courts in different countries during insolvencies and has been adopted 
in 19 jurisdictions.[Footnote 32] Over 450 Chapter 15 cases have been 
filed since its adoption, with over half filed in the Southern 
District of New York and the District of Delaware. 

Promoting cooperation between U.S. and foreign parties involved in a 
cross-border insolvency case, providing for a fair process that 
protects all creditors, and facilitating the rescue of a distressed 
firm, are among the stated objectives of Chapter 15.[Footnote 33] In 
pursuit of these goals, Chapter 15 authorizes several types of 
coordination including: 

* U.S. case trustees or other authorized entities operating in foreign 
countries on behalf of a U.S. bankruptcy estate; 

* foreign representatives having direct access to U.S. courts, 
including the right to commence a proceeding or seek recognition of a 
foreign proceeding; and: 

* U.S. courts communicating information they deem important, 
coordinating the oversight of debtors' activities, and coordinating 

Chapter 15 excludes the same financial institutions that are generally 
not eligible to file as debtors under the Code (such as insured 
depository institutions and U.S. insurance companies), with the 
exception of foreign insurance companies. It also excludes broker- 
dealers that can be liquidated under SIPA or a special provision of 
Chapter 7 of the Code and commodity brokers that can be liquidated 
under a different special provision of Chapter 7. Based on the 
UNCITRAL model law, Chapter 15 contains a public policy exception that 
allows a U.S. court to refuse cooperation and coordination if doing so 
would be "manifestly contrary to the public policy of the United 
States."[Footnote 34] 

D.C. District Court Has Issued Rules to Implement Required Judicial 
Review under the Orderly Liquidation Authority: 

OLA provisions establish a process for judicial review when a 
financial company's board of directors (or the functional equivalent) 
does not accept the appointment of FDIC as receiver following a 
determination by the Secretary of the Treasury.[Footnote 35] Under 
OLA, the Secretary is to make the determination, in consultation with 
the President, based on seven factors, three of which are that the 
company is a financial company, its insolvency would pose a threat to 
the financial stability of the United States, and it is or is likely 
to be "in default or in danger of default" (insolvent).[Footnote 36] 
After making this determination, the Secretary must appoint FDIC as 
receiver for the company unless the company refuses to "acquiesce or 
consent" to the appointment. In that case, the Secretary must file a 
petition with the D.C. District Court for an order authorizing the 
Secretary to appoint FDIC as receiver.[Footnote 37] The court has 24 
hours to review the petition and provide an opportunity for a hearing. 
The court may decide only whether the Secretary acted arbitrarily or 
capriciously in finding either that the company was a financial 
company under OLA or that the company was in default or in danger of 
default. The law does not authorize the court to review other aspects 
of the Secretary's determination, such as whether the company posed a 
threat to the financial stability of the United States (the systemic 
risk determination). Although the D.C. District Court's decision can 
be appealed on an expedited basis to the U.S. Court of Appeals for the 
District of Columbia Circuit and thereafter to the Supreme Court, the 
District's decision is not subject to any stay or injunction while any 
appeal is pending. 

The judicial review provision requires the D.C. District Court to 
establish rules and procedures "as may be necessary" to ensure the 
orderly conduct of the proceeding and to publish them and transmit 
them to specific Congressional Committees--the Senate Committees on 
the Judiciary and on Banking, Housing, and Urban Affairs and the House 
Committees on the Judiciary and Financial Services--within 6 months of 
the enactment of the Dodd-Frank Act.[Footnote 38] On January 19, 2011, 
the D.C. District Court issued a rule (Local Civil Rule 85) in 
response to this requirement, which is printed in its entirety in 
appendix II of this report. Generally the rule reiterates the 
procedural requirements in the Dodd-Frank Act. It provides for a 24-
hour review, during which the financial institution has the right to 
oppose the Secretary's petition. The rule also defines the possible 
outcomes. If the court does not rule on the petition within the 24-
hour period, or rules in favor of the Secretary, the receivership goes 
forward immediately. If the judge rules that the Secretary's 
determination was arbitrary and capricious with respect to one of the 
two elements, the Secretary has the right to amend the petition and 
file it again. The rule also acknowledges that the receivership will 
go forward immediately even if the financial company decides to take 
its opposition to it to a higher court, such as the U.S. Court of 
Appeals. However, the rule also contains a mechanism not specified in 
the law that may make the process more efficient and effective. It 
requires the Secretary of the Treasury to notify the D.C. District 
Court under seal at least 48 hours before the filing of a petition, 
which would give the court time to prepare for the review. However, in 
March 2011, FDIC and Treasury sent letters to the D.C. District Court 
expressing concern that the 48-hour requirement would be impossible to 
meet and could threaten U.S. financial stability. As of June 2011, the 
D.C. District Court was considering comments on the rule. 

The court has not yet tested the effectiveness of the rule because, as 
of the time of FDIC's March 23, 2011, notice of proposed rulemaking 
(NPR) the Secretary had not yet appointed FDIC as receiver, and FDIC 
said that it did not have any expectation that it would be appointed 
as receiver for any covered financial company in the near future. 
[Footnote 39] Additionally, FDIC remains engaged in a rulemaking 
relating to whether an institution is a financial company subject to 
OLA, which the court might consider during its judicial reviews. FDIC 
addressed the definition of a financial company for OLA purposes in 
its March 23, 2011 NPR. Under Title II of the Dodd-Frank Act, the 
definition of a financial company includes a bank holding company, a 
nonbank financial company supervised by the Board of Governors of the 
Federal Reserve System (Federal Reserve), and a company that receives 
at least 85 percent of its consolidated revenues from activities that 
are financial in nature or incidental under the BHC Act. In the March 
NPR, FDIC proposed to rely primarily on the consolidated financial 
statements of a company over a 2-year period to determine if 85 
percent of revenues in either year came from financial activities. As 
stated in the Dodd-Frank Act, the consolidated revenues are to include 
revenues from subsidiary depository institutions, which are excluded 
from the definition of covered financial companies. The comment period 
for this NPR closed on May 23, 2011. As of July 8, 2011, FDIC had not 
proposed rules to further define insolvency. However, under the Dodd-
Frank Act, a financial company shall be considered to be in default, 
or in danger of default, if the company has filed or is likely to file 
promptly for bankruptcy, has depleted or is likely to deplete its 
capital, has assets that are less than or likely to be less than its 
liabilities, or is or is likely to be unable to pay its debts. 
[Footnote 40] 

The Effectiveness of the Bankruptcy Code in Resolving Complex and 
Internationally Active Financial Institutions Is Unclear: 

Potential Criteria for Judging Effectiveness Include Maximizing Asset 
Value but Not Minimizing Duration of Bankruptcy: 

Most experts we interviewed agreed that maximizing asset values was 
the most important criterion for judging the effectiveness of the 
bankruptcy process. Under Chapter 7, in which a bankruptcy trustee 
liquidates the debtor's assets and disperses the proceeds according to 
a strict ladder of creditor and shareholder priorities, experts told 
us that maximizing the return for creditors was the most important 
criterion for judging the effectiveness of the process. Under Chapter 
11, in which the debtor and its creditors negotiate a reorganization 
plan, experts agreed that the goal is to maximize the value of a 
business as a going concern, or a functioning entity. In either case, 
having to sell assets at "fire sale" prices--below the asset's 
fundamental value--would reduce returns to creditors and going concern 
values.[Footnote 41] However, as we have noted in a previous report, a 
substantially lower asset price may be consistent with the fundamental 
value of that asset.[Footnote 42] 

Various stages of the bankruptcy process can affect the ultimate value 
of the debtor's assets. Some experts told us that having a plan for 
proceeding with a bankruptcy is important; the time and resources 
spent planning for the possibility of bankruptcy could increase 
returns to creditors and thus improve the effectiveness of the 
process. Some experts with whom we spoke highlighted the importance of 
prebankruptcy planning by noting the bankruptcy of CIT--a bank holding 
company engaged in small business lending and leasing. In the CIT 
case, CIT reached an agreement with creditors before filing the 
bankruptcy petition, which led to what some experts considered an 
orderly bankruptcy process and reorganization. On July 5, 2011, CIT 
was valued at $9.0 billion. In contrast, some experts described the 
Lehman bankruptcy as disorderly, in part, because the institution did 
not plan sufficiently for the possibility of bankruptcy.[Footnote 43] 
Attorneys in the Lehman bankruptcy said management did not seriously 
consider bankruptcy until about a week before filing, and an official 
of the Securities and Exchange Commission (SEC) told us that Lehman 
did not try to arrange for the sale of various components of the 
institution until the week before its collapse. In part because of 
Lehman's rush to sell certain assets, Lehman later claimed that the 
buyer underpaid for those assets and sought additional compensation. 
See appendixes III and IV for more information about the CIT and 
Lehman bankruptcies, respectively. 

Bankruptcy experts also told us that the automatic stay frees debtors 
from creditor actions that could further deplete a firm's asset 
values. The stay allows parties to gain control over the distribution 
of assets. In a Chapter 7 bankruptcy, the bankruptcy trustee has full 
control over the liquidation of the firm's assets. Legal experts told 
us that, although control may be dispersed among different parties 
under Chapter 11, the process is still considered predictable because 
it follows a long-standing legal tradition, transparent because it 
occurs under judicial review, and equitable because assets are 
distributed either according to a strict ladder of creditor priorities 
or through negotiated settlements in which all parties can 
participate. Some legal experts stated that control over assets in a 
bankruptcy is similar to that gained when a regulator--FDIC or a state 
insurance commissioner--becomes the receiver of a depository 
institution or insurer. However, some legal experts said that FDIC's 
processes are less predictable and less transparent than the 
bankruptcy processes, because FDIC resolutions do not operate under 
court supervision. 

Because a debtor's estate faces costs--such as attorneys' fees--during 
a bankruptcy, the longer the company spends in bankruptcy, the higher 
the costs are likely to be, reducing the value of a firm's estate. 
However, the experts with whom we spoke generally agreed that 
minimizing the overall time spent in bankruptcy was not an important 
criterion for judging the effectiveness of a bankruptcy. Some 
bankruptcies of financial institutions take a long time to resolve, 
but a longer bankruptcy can lead to increased creditor recoveries. For 
example, Bank of Credit and Commerce International (BCCI), a 
multinational financial institution that failed in 1991, had not been 
fully resolved as of June 2011. Despite this 20-year process, 
creditors have benefited from increasing recoveries. Some experts we 
interviewed also said that professional costs are likely too high, and 
debtors' estates pay not only the fees of professionals assisting the 
estate but also for attorneys and other professionals used by 
creditors' and shareholders' committees. Nonetheless, an expert said 
that these costs were relatively small compared with the overall value 
of the assets at stake in a bankruptcy. This view that the overall 
time in the bankruptcy may not be an important criterion for judging 
the effectiveness of the process is supported by a study conducted by 
research staff at the Federal Reserve. The study found that the value 
of creditors' claims (bonds) in a bankruptcy tended to increase over 
time up to a point and then tended to decrease.[Footnote 44] However, 
this study did not specifically address financial institution 
bankruptcies or consider a time of financial crisis when the time 
frames for resolving insolvent financial institutions could be of 
greater importance. Experts also noted that complex companies that 
rushed through the bankruptcy process might file for bankruptcy again 
if their reorganizations were not well conceived. As a result, experts 
said that the total length of time of a bankruptcy should not be a 
main focus in judging the Code's effectiveness. 

Potential Criteria for Judging Effectiveness Also Include Systemic 
Impacts, Which the Code Does Not Directly Address: 

Systemic impacts are one reason that regulators supervise financial 
institutions and have often been the rationale for providing 
government assistance for certain markets or failing financial 
institutions. Certain financial institutions--sometimes designated as 
systemically important financial institutions--play a central role in 
key financial markets and thus affect general credit availability or 
have an effect on credit availability through their impact on other 
financial institutions. For example, the Lehman failure affected 
credit availability by lowering values in the commercial paper market, 
which is used by employers throughout the economy to finance 
payrolls.[Footnote 45] According to researchers at the Federal Reserve 
Bank of New York (FRBNY), market participants saw the failure of 
Lehman, an active commercial paper issuer, as a signal that the risks 
of what had been perceived as a relatively safe, low-cost investment 
had increased and no longer was consistent with the low interest rates 
offered by issuers.[Footnote 46] The Lehman bankruptcy also had an 
impact through its effect on money market funds. Because money market 
funds hold large quantities of commercial paper, Lehman's bankruptcy 
led the Reserve Primary Fund, a large money market fund with $65 
billion of assets under management, to lose $785 million in holdings 
of Lehman commercial paper and, for the first time, caused a retail 
money market fund's shares to fall below one dollar. This caused 
investors in money market funds to lose confidence and begin to remove 
their money from this and similar funds. In response, the Department 
of the Treasury extended a temporary government guarantee to eligible 
participating money market funds. In addition, the Federal Reserve 
authorized the Commercial Paper Funding Facility and the Asset-Backed 
Commercial Paper Money Market Mutual Funding Liquidity Facility. 
[Footnote 47] 

As noted, the government often has provided assistance to offset or 
prevent systemic effects and has also taken action to prevent firms 
whose failure might have systemic effects from filing for bankruptcy. 
For example, in 1998, Long-Term Capital Management (LTCM)--a hedge 
fund that held $1.4 trillion in derivatives whose largest creditors 
and counterparties were major domestic and foreign banking 
institutions and investment firms--faced major liquidity problems. 
Thus, its failure likely would have had a broad impact on other 
financial institutions and the availability of credit throughout the 
economy. As a result, FRBNY called together 14 of LTCM's 
counterparties, and these industry participants organized a gradual 
liquidation of LTCM outside of the bankruptcy process.[Footnote 48] At 
the time, Federal Reserve officials expressed concern that the rapid 
closing out of derivative contracts with LTCM would have led not only 
to LTCM's insolvency but possibly to the insolvency of other firms as 
well. More recently, after noting that the American International 
Group, Inc. (AIG) faced the imminent prospect of declaring bankruptcy, 
the Federal Reserve authorized the extension of emergency credit to 
AIG, citing that its failure would have been disorderly and likely to 
have systemic effects on already fragile financial markets.[Footnote 

Economists and regulators have expressed the view that systemic 
factors--such as the extent to which a financial institution's failure 
has an impact on other firms' asset values or on broader economic 
stability--should be used to judge the effectiveness of the bankruptcy 
process. Some economists with whom we spoke explained that, if failed 
financial institutions were forced to sell assets at fire sale values, 
the market value of those assets would decrease. Under current mark-to-
market accounting rules, which require that firms change the value of 
the assets on their balance sheets to reflect changes in the market 
prices of the assets, other financial institutions holding similar 
assets could be forced to mark down their asset values as well. The 
Department of the Treasury also has noted that during the financial 
crisis, asset sales made in a highly leveraged environment led to a 
vicious cycle in which declining asset prices triggered further 
deleveraging and reductions in market liquidity, which in turn led to 
further asset price declines.[Footnote 50] However, as noted earlier, 
lower asset prices may be consistent with the prevailing fundamental 
values of those assets. Those in the legal community that are involved 
in financial institution bankruptcies, and those working with 
economists and others on proposals to improve the Code's ability to 
handle financial institutions, also recognized the importance of 
considering systemic factors in judging the effectiveness of the Code 
in facilitating the orderly liquidation or reorganization of financial 
institutions. The Congress also recognized the importance of systemic 
factors when it adopted OLA, which includes minimizing systemic risk 
as one of its goals. 

Nevertheless, the Code does not directly address systemic risks. 
According to some legal experts, the practice of bankruptcy courts is 
to deal only with the matters before them; systemic issues are not 
considered. When asked about the impact of a bankruptcy on other 
firms, legal experts who did not have significant experience with 
financial institutions said that they did not think it relevant to 
judging the effectiveness of a bankruptcy. However, the Code does 
address systemic risks indirectly by providing safe harbor treatment, 
such as protection from the automatic stay, for certain contracts--
QFCs--widely used by financial institutions (see app. VII). Financial 
and legal experts have noted that to offset some systemic factors, 
such as those associated with the LTCM failure, safe harbor treatment 
was expanded in 2005 to include additional types of contracts--such as 
repurchase agreements. 

Several Factors Add to the Difficulty of Measuring Effectiveness of 
the Code for Resolving Failures of Complex, Internationally Active 
Financial Institutions: 

Measuring the effectiveness of the Code for facilitating orderly 
liquidations or reorganizations of complex and internationally active 
financial institutions is difficult because few of these firms have 
filed for bankruptcy and many of the more complex and global 
institutions have filed only recently. 

Few large-scale bankruptcies. The paucity of complex or 
internationally active financial institutions among large-scale 
bankruptcies has resulted, in part, from (1) alternative resolution 
requirements and (2) governmental assistance to complex and 
internationally active financial institutions. Depository institutions 
and insurance companies cannot file for bankruptcy protection, and 
broker-dealers cannot file for reorganization under Chapter 11, as 
noted earlier. In addition, the government often has provided 
financial or other assistance, such as facilitating industry action, 
to complex financial institutions, such as LTCM and AIG, that 
otherwise might have declared bankruptcy, because they posed systemic 
risks. Assessing the bankruptcies that have occurred is also 
difficult, because many of the most complex cases are recent, and 
their outcomes are still unclear. One bankruptcy expert told us that 
if a firm still were operating effectively 2-3 years after emerging 
from bankruptcy, he would say the proceedings had been successful. The 
two largest financial institution bankruptcy cases in the United 
States--Washington Mutual and Lehman--still are ongoing, so it is 
difficult to provide a definitive assessment of the effectiveness of 
these cases at this time. 

Lack of data. For those financial institutions that have declared 
bankruptcy, data are not readily available for evaluating the 
effectiveness of the Code. AOUSC has collected some data on bankruptcy 
outcomes, such as the closing date for large cases. But it neither 
specifically collects information on cases involving financial 
institutions, nor does it track the value of creditor returns or the 
value of firms emerging from bankruptcy. The bankruptcy courts only 
collect data on the type of business in which an institution is 
engaged if the data are pertinent to provisions of the Code. Thus, the 
court tracks whether a bankruptcy involves a broker-dealer because it 
needs to know whether the bankruptcy courts would be operating under 
SIPA or specific provisions of the Code relative to liquidating broker-
dealers. It does not track financial institutions beyond those cases 
because no special legal considerations arise. In addition, because 
data come directly from filings by the firms' attorneys, the courts 
generally rely on self-reported data, and AOUSC staff said they would 
do the same for other potential data that could be collected such as 
whether the firm is a financial institution. AOUSC staff said that, 
while they generally rely on self-reported data, they do perform 
certain data checks, including looking for outliers. Some 
organizations and researchers have taken the court data and augmented 
it with other kinds of data that might allow users to identify 
financial institutions, but researchers have not used these data to 
study how bankruptcies of financial institutions differ from other 
types of bankruptcies or how a systemic market event could impact the 
effectiveness of the bankruptcy process. However, researchers have 
studied the impact of certain factors on the effectiveness of 
bankruptcies, including the Federal Reserve study of the impact of 
time and studies of the effect of filing in particular courts on the 
effectiveness of bankruptcies.[Footnote 51] 

Government involvement. Even when the government does not step in to 
prevent complex financial institutions from filing for bankruptcy, 
evaluating the bankruptcy process is difficult. Even in cases where 
financial institutions have declared bankruptcy, the government often 
has provided assistance either before or during the bankruptcy. In two 
of the three largest bankruptcies of financial institutions--CIT and 
Lehman--the government provided financial assistance. In the case of 
CIT, the debtor was able to emerge as a going concern and come through 
reorganization quickly (within 1 month), which some said indicated a 
successful resolution. However, the success of this bankruptcy was, in 
part, facilitated by CIT receiving government assistance in the form 
of Troubled Asset Relief Program (TARP) funding. Although CIT received 
this funding 10 months before declaring bankruptcy, and at a time when 
it hoped to avoid doing so, the funding allowed CIT the time to more 
effectively plan for the bankruptcy, including time to negotiate with 
its creditors to develop an acceptable restructuring plan. Because 
TARP assistance was structured in a way that gave the government low 
priority in case of a bankruptcy, it received no repayment in the 
bankruptcy process.[Footnote 52] Similarly, the Federal Reserve 
authorized FRBNY to provide assistance to broker-dealers through its 
Primary Dealer Credit Facility. Under that facility, FRBNY extended 
$28 billion in credit to Lehman Brothers, Inc. (LBI), the broker-
dealer and commodity broker subsidiary of Lehman Brothers Holding, 
Inc. (LBHI), on September 15, 2008, the same day the parent company 
filed for bankruptcy.[Footnote 53] However, the terms of the facility 
provided FRBNY with a position as a secured creditor of the firm, 
giving it higher priority in the event of a bankruptcy. LBI continued 
to borrow under the Primary Dealer Credit Facility for 2 more days, 
and, on September 18, 2008, the day before Barclays PLC assumed many 
of LBI's accounts, Barclays borrowed more than $47 billion through the 
same facility.[Footnote 54] This additional liquidity allowed LBI, the 
broker-dealer subsidiary, to remain a going concern until some of its 
assets and liabilities could be sold to Barclays and, thus, affected 
the value of the estate more broadly. The remaining parts of LBI are 
the subject of a SIPA proceeding. According to the Federal Reserve, 
LBI and Barclays repaid their overnight loans with interest. 

Complex Financial Institutions Pose Challenges for Liquidations or 

Our review of literature on bankruptcies and financial institutions, 
as well as interviews with experts in these fields, identified several 
characteristics of complex financial institutions that pose challenges 
for liquidations and reorganizations. Some of the legal and economic 
experts we interviewed told us that large financial institutions would 
not necessarily be any more difficult than other large firms to take 
through bankruptcy. Complex financial institutions, regardless of 
their size, were viewed as more difficult because of the nature of 
their businesses and their interconnected organizational structures. 
Specifically, the characteristics of complex financial institutions 
that make their liquidation or resolution through bankruptcy difficult 
include the highly liquid nature of financial institutions' funding 
sources, their use of derivatives and other financial contracts not 
subject to the Code's automatic stay, and institutions' separate yet 
interconnected legal structures (separate entities often created to 
gain tax and regulatory advantages) that are not congruent with their 
integrated operational structures. 

Funding Sources and Use of Derivatives: 

Some financial institutions are dependent on short-term, highly liquid 
funding sources to finance assets that have longer-term maturities and 
are not easy to sell. When depositors, lenders, counterparties, or 
investors lose confidence in an institution, the institution may be 
subject to a run--a sudden removal of its liquid funding sources--that 
will force the institution to sell assets at fire sale prices, 
impairing its solvency in a way that could ultimately lead to its 
failure. The existence of runs in retail depository institutions has 
long been acknowledged, but the 2008 financial crisis demonstrated 
that complex financial institutions that lend money to other financial 
institutions in what is referred to as the wholesale market also are 
subject to runs. Although deposit insurance is designed to limit these 
runs, for larger institutions, runs continued to play a role during 
the 2008 crisis. Runs created by the loss of depositor confidence 
contributed, in part, to the failures of IndyMac, FSB, and Washington 
Mutual Bank, and fear of a depositor run was one of the reasons the 
government cited for providing assistance to Citigroup Inc. during the 
crisis. Similarly, in 2008, uncertainty about the financial condition 
and solvency of financial institutions caused other financial 
institutions to raise the prices they charged for short-term funds in 
wholesale markets, and interbank lending slowed substantially. For 
example, in 2008 after Bear Stearns and Co.--an investment firm 
participating in wholesale markets--failed, the then-SEC Chairman 
noted that the firm failed when many lenders, concerned that the firm 
would suffer greater losses in the future, stopped providing funding, 
even on a fully secured basis with highly-rated assets as collateral. 
[Footnote 55] Lehman also faced a liquidity crisis when banks refused 
to lend money for its brokerage and other services. An official 
familiar with Lehman's bankruptcy proceedings said that just before 
the institution declared bankruptcy, Lehman had to roll over borrowing 
of about $100 billion dollars every day to pay off maturing commercial 
paper and other commitments. 

Complex financial institutions are principal users of derivative 
contracts, and this is another factor that makes their bankruptcy 
proceedings more challenging. The exemption from the automatic stay 
for these QFCs was designed to help ensure that financial markets and 
institutions remained liquid during bankruptcies. The concern is that, 
if these markets froze, credit would not be available in the economy 
generally. However, when a financial institution itself is the debtor, 
the exemption can negatively affect it and lead to a number of 
adversary proceedings related to the safe harbor treatment. For 
example, a bankruptcy attorney familiar with the Lehman bankruptcy 
case told us that much of the value in Lehman declined after the 
institution's counterparties used the safe harbor to terminate 
contracts where they stood to gain (and Lehman lose) and keep those 
alive where they would have experienced losses (and Lehman gains). 
Approximately 80 percent of the derivative counterparties to Lehman's 
primary U.S. derivatives entity terminated their contracts within 5 
weeks of Lehman's bankruptcy filing. Questions have also arisen over 
the course of the bankruptcy about the setoff rights of QFC 
counterparties. For example, Swedbank AB, a Swedish bank, that was a 
creditor of Lehman Brothers Holdings, Inc., sought to offset Lehman's 
payment obligations under prepetition swaps with deposits Lehman had 
made at Swedbank after filing for bankruptcy. The Bankruptcy Court of 
the Southern District of New York ruled against Swedbank, concluding 
that offset rights under the Code only exist when, among other things, 
"mutuality" exists. That is, mutuality would exist when the debtor's 
claim against the creditor and the debt owed to the creditor are 
mutual, as determined under principles of bankruptcy and contract law. 
However, the court held that no mutuality existed because the funds in 
the Swedbank account were deposited after the bankruptcy petition was 
filed, while Lehman's payment obligations under the swaps arose before 
the petition was filed.[Footnote 56] In another proceeding involving 
the Lehman bankruptcy, a lender, Bank of America, seized the debtor's 
account funds, which were unrelated to any safe harbor transaction. 
The court ruled that the bank's use of the funds to set off the 
transactions violated the automatic stay.[Footnote 57] Also, experts 
have noted that the exemption from the stay could weaken market 
discipline because creditors do not stand to lose as much from 
bankruptcy as they would with other types of financing. 

Organizational Structures and Interconnectedness: 

Financial institutions often have complex legal structures that do not 
reflect their operational and strategic alignment and include both 
regulated and unregulated subsidiaries.[Footnote 58] To the extent 
that institutions' operating structures increase their value through 
economies of scope and scale, splitting them up by legal entity likely 
would lower their value. However, the complex arrangement of the legal 
entities and various regulatory insolvency processes can pose 
significant challenges in bankruptcy, as judges and regulators must 
attempt to resolve pieces of an interconnected institution separately. 
These challenges are especially evident when regulators become 
involved in the resolution of nonregulated entities. 

The organizational structure, including the number and types of 
subsidiaries in a financial institution, usually develops over time 
for different business reasons, but it typically does not coincide 
with the institution's operational or strategic business functions, as 
economists, government officials, and financial institution executives 
have noted.[Footnote 59] Instead, the legal entities often are set up 
to benefit from tax or regulatory differences or to obtain higher 
credit ratings. For example, institutions obtain tax advantages by 
setting up a holding company structure that allows subsidiaries to 
transfer tax savings to the parent company.[Footnote 60] And, at some 
failed institutions, regulatory advantages were gained by placing 
subprime mortgage assets that had been securitized in an off-balance 
sheet vehicle that was not subject to regulatory capital adequacy 
requirements imposed on the consolidated entity, although the entity 
retained significant risk.[Footnote 61] Institutions also set up legal 
entities called special purpose vehicles, legally separate from the 
parent entity, to issue specific structured finance products such as 
asset backed securities. As a result, rating agencies could rate 
products higher than the parent institution's debt.[Footnote 62] 
Because the financial institution usually operates its businesses 
without regard for the legal separateness of these entities, breaking 
it up along legal entity lines for the purposes of bankruptcy likely 
would lower the value of the consolidated entity. 

Although some bankruptcy cases are administered together in what is 
called procedural consolidation, the courts still must separate assets 
so that creditors of a given legal entity receive payouts only on the 
basis of that entity's assets. For example, in the Lehman bankruptcy, 
many legal entities in the United States filed separate cases, which 
have been procedurally consolidated under a single judge in the 
Southern District of New York. However, the complex interrelationships 
among Lehman's entities have to be unwound so that the claims of 
creditors of the different entities can be addressed. Reports by the 
Lehman bankruptcy examiner and SIPA trustee reports document the many 
ways in which the parent company--Lehman Brothers Holdings, Inc.--and 
its subsidiaries were linked.[Footnote 63] For example, the examiner 
had to map Lehman's centralized cash management system to determine 
which legal entities were entitled to claim certain assets. 

In unusual cases, the interconnectedness of the debtor's estate with 
related entities can lead to a bankruptcy court's use of a doctrine 
known as "substantive consolidation." The doctrine, developed by case 
law, permits a court in a bankruptcy case involving one or more 
related corporate entities to disregard the separate identities of 
entities and to consolidate and pool their assets and liabilities in 
order to treat them as though held and incurred by one entity. The 
process creates a single estate for the benefit of all creditors for 
all the consolidated corporations and combines the creditors into one 
consolidated body.[Footnote 64] For example, in the early 1990s, the 
court applied the doctrine in confirming the Chapter 11 reorganization 
plan of Drexel Burnham Lambert Group, Inc. (a holding company for an 
investment group) and certain of its eligible subsidiaries.[Footnote 
65] In the Lehman bankruptcy, some creditors maintain that because the 
parent company guaranteed the trades for different entities, 
distributions should be made across all parties equally, according to 
the ladder of creditor priorities. Other creditors argue that there is 
no legal rationale for not respecting the separate corporate status of 
the individual Lehman debtors. On June 29, 2011, the holding company 
provided a new plan, agreed to by the creditors, which includes a 
compromise on substantive consolidation. The plan's settlement takes 
into account the different outcomes that would occur if either the 
proconsolidation or anticonsolidation plans were approved, and 
subsequent litigation that would likely follow if one of those plans 
were adopted. (For more detail on these issues, see appendix IV). 

The complexity of a liquidation or reorganization of a consolidated 
financial institution likely would be even greater if the institution 
has regulated subsidiaries that do not qualify as a debtor under the 
Code, such as depository institutions or state-regulated insurance 
companies. When these regulated entities fail and are liquidated by 
regulators, the prospects for reorganization of their holding 
companies may be limited. In cases where the holding company's main or 
major assets consist of one or more regulated subsidiaries, the 
holding company likely will be forced to declare bankruptcy when the 
subsidiary fails. The subsidiaries' insolvencies, which are resolved 
outside of the bankruptcy process, leave fewer assets available for 
the holding company's creditors to recover in liquidation or for use 
in reorganizing the remaining parts of the firm. For example, after 
its primary asset--Colonial Bank--was placed into FDIC receivership, 
Colonial BancGroup--the parent holding company--reported liabilities 
of $380 million and assets of only $45 million in its bankruptcy 
filing. In the case of Washington Mutual, legal practitioners familiar 
with the case told us that holding company executives were generally 
unaware that FDIC was being appointed as receiver of their subsidiary 
until the day the announcement was made and, within hours, the 
depository institution, Washington Mutual Bank, was transferred to a 
third party, leaving the holding company unprepared to file for 

For some complex financial institutions with regulated subsidiaries, 
the regulator may become a creditor in the bankruptcy proceedings. 
FDIC is often a creditor in bank holding company bankruptcies when 
FDIC seeks to recover amounts associated with its role in resolving 
the depository institution subsidiary.[Footnote 66] Issues can arise 
over the ownership of assets (i.e., whether assets such as tax refunds 
belong to the depository institution or the holding company) and the 
status of FDIC's claim as a creditor. Additionally, an issue can arise 
concerning the parent's financial responsibility, if any, for the 
bank. The Washington Mutual bankruptcy is an example of disputes over 
the ownership of the assets. In that proceeding, the debtor has sued 
FDIC to regain certain of its deposits that had been placed at the 
depository institution before they were transferred to JPMorgan Chase 
and Co. (JPMC). As of June 2011, the parties had reached an agreement 
over these and other assets, but shareholders have not accepted the 
agreement, and the judge is continuing to hear their claims before 
approving a final reorganization plan.[Footnote 67] In the other two 
cases at which we looked in depth--CIT and Lehman--the holding 
companies and some affiliates have gone through bankruptcy while their 
subsidiary depository institutions continued to operate.[Footnote 68] 
Experts familiar with these cases said the estates have worked with 
FDIC to show that keeping insured depositories open and well- 
capitalized was a lower-cost solution than placing them in 
receivership. Officials at FDIC said that it was not common for a 
holding company to declare bankruptcy while its depository institution 
subsidiaries continued to operate. They said that, in the case of the 
CIT and Lehman depositories, FDIC used cease and desist orders to 
insulate the institutions it oversees from the bankruptcies of their 
respective holding companies.[Footnote 69] The cease and desist orders 
required prior FDIC approval for any affiliate transactions, the 
declaration or payment of dividends, and any other payment 
representing a reduction in capital. 

Broker-dealers may file a petition for liquidation under Chapter 7 of 
the Code or may be subject to proceedings under SIPA for the 
protection of customers. Their parent companies and eligible 
affiliates may qualify for reorganization under Chapter 11; however, 
the interrelationships among affiliates in complex financial 
institutions complicates these cases. In the case of Lehman's broker-
dealer, for example, determining whether affiliates of the broker-
dealer were entitled to SIPA protections has posed substantial 
challenges for the SIPA trustee.[Footnote 70] In addition, when 
affiliates of a broker-dealer or its holding company file for 
bankruptcy, the broker-dealer is likely to experience some negative 
impacts as well and may need to be liquidated. For example, when 
Drexel Burnham Lambert Group declared bankruptcy in the 1990s, market 
participants and creditors lost confidence in Drexel's solvent 
subsidiaries, including its large broker-dealer, and were unwilling to 
enter into new transactions. Following that, SEC and other regulators 
transferred the broker-dealer's customer accounts and wound it down. 

Internationally Active Financial Institutions Pose Additional 
Challenges for the Bankruptcy Process: 

Financial institutions can have assets and customers throughout the 
world. Similar to domestic institutions, they may locate subsidiaries 
in particular countries to gain tax and regulatory advantages. As a 
result, subsidiaries, assets, and creditors may be subject to separate 
insolvency regimes in various countries. Differences in laws and 
insolvency systems and the national interests of the countries add to 
the complexity of bankruptcy proceedings. Several legal experts 
pointed out that even one contract, such as a derivative, may be 
written in New York and hedged in London so that a bankruptcy pulls 
the two-sided contract apart and subjects it to two different legal 
regimes--that of the United States and of England. Many of the 
complexities in the Lehman bankruptcy have come about because Lehman 
operated subsidiaries in 21 countries. These complexities included (1) 
having all of the cash in New York when its bankruptcy was declared, 
leaving foreign subsidiaries with no cash to retain employees needed 
to help liquidate or reorganize subsidiaries in those countries; (2) 
the failure to share needed information across countries; and (3) 
different decisions being rendered in the United States and England 
regarding the same securities. Similarly, in assessing the problems at 
AIG, economists faced challenges understanding how and to what extent 
its myriad U.S. and foreign subsidiaries were viable.[Footnote 71] At 
the end of 2008, AIG comprised at least 223 companies and had 
operations in over 130 countries and jurisdictions worldwide.[Footnote 
72] Table 2 documents the extent to which large international 
financial institutions operate across international borders. 

Table 2: Thirty of the Largest International Financial Institutions 
(Ranked by Size) and Their Subsidiaries and Branches: 

Dollars in thousands (U.S.): 

Financial institution[A]: BNP Paribas SA; 
Total assets, year end 2010: $2,680,292,421; 
Country of headquarters: France; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Deutsche Bank AG; 
Total assets, year end 2010: $2,556,177,062; 
Country of headquarters: Germany; 
Number of countries with operations, most recent available: 74. 

Financial institution[A]: HSBC Holdings plc; 
Total assets, year end 2010: $2,454,689,000; 
Country of headquarters: UK; 
Number of countries with operations, most recent available: 87. 

Financial institution[A]: Barclays PLC; 
Total assets, year end 2010: $2,332,673,035; 
Country of headquarters: UK; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Royal Bank of Scotland Group plc; 
Total assets, year end 2010: $2,276,191,669; 
Country of headquarters: UK; 
Number of countries with operations, most recent available: 39. 

Financial institution[A]: Bank of America Corporation; 
Total assets, year end 2010: $2,264,909,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Mitsubishi UFJ Financial Group, Inc.; 
Total assets, year end 2010: $2,183,944,247; 
Country of headquarters: Japan; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Crédit Agricole SA; 
Total assets, year end 2010: $2,137,530,516; 
Country of headquarters: France; 
Number of countries with operations, most recent available: 70. 

Financial institution[A]: JPMorgan Chase & Co.; 
Total assets, year end 2010: $2,117,605,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Mizuho Financial Group, Inc.; 
Total assets, year end 2010: $1,671,913,220; 
Country of headquarters: Japan; 
Number of countries with operations, most recent available: 
Approximately 30. 

Financial institution[A]: Citigroup Inc.; 
Total assets, year end 2010: $1,913,902,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: 160. 

Financial institution[A]: ING Groep N.V.; 
Total assets, year end 2010: $1,667,128,102; 
Country of headquarters: Netherlands; 
Number of countries with operations, most recent available: 49. 

Financial institution[A]: Banco Santander SA; 
Total assets, year end 2010: $1,633,133,042; 
Country of headquarters: Spain; 
Number of countries with operations, most recent available: 28. 

Financial institution[A]: Lloyds Banking Group plc; 
Total assets, year end 2010: $1,554,083,934; 
Country of headquarters: UK; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Société Générale SA; 
Total assets, year end 2010: $1,518,540,577; 
Country of headquarters: France; 
Number of countries with operations, most recent available: 83. 

Financial institution[A]: UBS AG; 
Total assets, year end 2010: $1,410,932,948; 
Country of headquarters: Switzerland; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Wells Fargo & Company; 
Total assets, year end 2010: $1,258,128,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: 36. 

Financial institution[A]: UniCredit SpA; 
Total assets, year end 2010: $1,246,797,525; 
Country of headquarters: Italy; 
Number of countries with operations, most recent available: 
Approximately 50. 

Financial institution[A]: Credit Suisse Group AG; 
Total assets, year end 2010: $1,105,403,813; 
Country of headquarters: Switzerland; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Commerzbank AG; 
Total assets, year end 2010: $1,011,802,817; 
Country of headquarters: Germany; 
Number of countries with operations, most recent available: 50. 

Financial institution[A]: AXA Group; 
Total assets, year end 2010: $981,425,889; 
Country of headquarters: France; 
Number of countries with operations, most recent available: 60. 

Financial institution[A]: Goldman Sachs Group, Inc.; 
Total assets, year end 2010: $911,332,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: 34. 

Financial institution[A]: Intesa Sanpaolo SpA; 
Total assets, year end 2010: $883,644,534; 
Country of headquarters: Italy; 
Number of countries with operations, most recent available: 39. 

Financial institution[A]: Allianz Group; 
Total assets, year end 2010: $838,289,738; 
Country of headquarters: Germany; 
Number of countries with operations, most recent available: 70. 

Financial institution[A]: Morgan Stanley; 
Total assets, year end 2010: $807,698,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: 28. 

Financial institution[A]: Nordea Bank AB; 
Total assets, year end 2010: $779,126,761; 
Country of headquarters: Sweden; 
Number of countries with operations, most recent available: 14. 

Financial institution[A]: Dexia SA; 
Total assets, year end 2010: $760,207,914; 
Country of headquarters: Belgium; 
Number of countries with operations, most recent available: 34. 

Financial institution[A]: Banco Bilbao Vizcaya Argentaria SA; 
Total assets, year end 2010: $741,432,036; 
Country of headquarters: Spain; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: MetLife, Inc.; 
Total assets, year end 2010: $730,906,000; 
Country of headquarters: United States; 
Number of countries with operations, most recent available: More than 

Financial institution[A]: Royal Bank of Canada; 
Total assets, year end 2010: $712,665,358; 
Country of headquarters: Canada; 
Number of countries with operations, most recent available: 52. 

Financial institution[A]: Average; 
Total assets, year end 2010: $1,532,063,476; 
Number of countries with operations, most recent available: 
Approximately 53. 

Sources: GAO analysis of SNL Financial and publicly available company 

[A] Because of their specialized function and treatment, Fannie Mae 
and Freddie Mac are not included in this list. The source also does 
not include financial institutions in certain countries such as China. 

[End of table] 

Whether the Bankruptcy Code Is More or Less Effective Than 
Alternatives Is Also Unclear: 

Whether resolving financial institutions through bankruptcy would be 
more or less effective--that is, maintain asset values and minimize 
systemic risk--than resolving institutions through other processes 
such as FDIC receivership under OLA is not clear. Both the bankruptcy 
courts and FDIC have had some experience addressing the failures of 
complex, internationally active financial institutions and have dealt 
with fluctuating numbers of failures, which could be important during 
a financial crisis. The bankruptcy courts have a long-standing 
tradition of administering bankruptcy cases including a number of 
complex cases, such as those of Enron Corp. and WorldCom, Inc. In 
addition, the courts have dealt with variation in the volume of 
bankruptcies over economic cycles (see table 1). Because FDIC has been 
resolving insured depositories over a long period of time, it also has 
some experience addressing the issues posed by financial institutions 
and is familiar with the dramatic variation in failure rates brought 
on by market events. For example, FDIC dealt with the large number of 
failures during the savings and loan crisis in the 1980s and1990s and 
has handled more than 300 depository failures since 2007, following a 
period from 2004 to 2007 when failures had fallen to zero.[Footnote 73] 

However, both the bankruptcy courts and FDIC lack experience in 
handling failures of large numbers of complex, internationally active 
institutions during a financial crisis. As noted earlier, bankruptcy 
courts have not dealt with a large number of bankruptcies involving 
such institutions for a number of reasons. These reasons include the 
government's ability and willingness to provide assistance to 
systemically important financial institutions, a practice that the 
Dodd-Frank Act restricts, and the majority of the assets in these 
institutions sometimes being in regulated subsidiaries subject to 
regulatory resolution processes. Similarly, while FDIC has resolved 
large numbers of small institutions, it has had limited experience 
resolving institutions with foreign subsidiaries and often has 
resolved a depository institution by selling it to another 
institution--a solution that may be less practical when large, complex 
financial institutions fail, especially when they fail in a short time 
span. Some legal experts and policymakers have noted that these 
acquisitions create even larger institutions, making future 
insolvencies more difficult to resolve. Although FDIC has not been 
appointed receiver for any institution under OLA, it has analyzed how 
it would have handled the Lehman failure under OLA. FDIC's analysis 
includes more effective planning by Lehman leading up to a resolution 
and Barclays' willingness to buy Lehman's distressed assets.[Footnote 
74] However, critics have noted that both of these options were 
available under the Code and that the analysis does not acknowledge 
the widespread weakness in financial markets that affected many 
financial institutions during the financial crisis. Because FDIC has 
not yet dealt with an actual failure under OLA, it might not be 
appropriate to compare its analysis of Lehman with the actual 
experience under the Code. However, in commenting on this report, FDIC 
officials noted that the OLA has several advantages over the current 
Code that likely would have preserved Lehman's value including the 
requirement to plan for a resolution and FDIC's ability to transfer 
QFCs to a bridge entity. 

Bankruptcy Proposals Address Some Financial Institution Challenges, 
but There Is No Consensus on Specifics: 

Questions about the effectiveness of the bankruptcy process for 
liquidating or reorganizing financial institutions have prompted some 
financial and legal experts--sometimes working in interdisciplinary 
groups--as well as government officials to propose changes to the 
Code, or to the supervisory process leading up to a bankruptcy filing. 
These proposals generally focus on or combine several types of 
actions: (1) increasing opportunities for bankruptcy planning, (2) 
providing for regulatory input in the bankruptcy process, (3) 
modifying safe harbor exceptions to the automatic stay for QFCs, (4) 
treating firms on a consolidated basis, and (5) improving court 
expertise on financial issues. Experts sometimes agree on the need for 
a particular type of action to address challenges posed by financial 
institutions, but they often do not agree on the effectiveness of 
specific proposals. 

Improving Bankruptcy Planning May Help Maintain Going Concern Value or 
Avoid Bankruptcy: 

Many of the experts with whom we spoke noted that a lack of planning 
in the Lehman bankruptcy contributed to its disorderliness and that 
better planning would improve the effectiveness of liquidations and 
reorganizations under the Code. Better planning would lessen the 
likelihood of precipitous declines in asset values and thus might 
increase the returns to creditors, enhance the likelihood that a 
financial institution could be successfully reorganized, and lessen 
the systemic impact of a financial institution bankruptcy. 
Nonetheless, there was little consensus on specific actions needed to 
achieve these desired outcomes. 

The Dodd-Frank Act has created a process for the prudent supervision 
of large financial institutions that regulators believe will 
facilitate resolution planning for those institutions. Large bank 
holding companies and nonbank financial companies supervised by the 
Federal Reserve now must formulate and submit a resolution plan known 
as a "living will."[Footnote 75] Financial institutions with the 
potential to be systemically important are required to submit and 
maintain resolution plans, as well as other periodic reports, in order 
to allow for the rapid and orderly resolution of the company. The 
Federal Reserve and FDIC issued a joint proposed rule on the 
requirements for the plans on April 22, 2011; according to agency 
officials, the agencies expect to issue the final rule by January 21, 
2012.[Footnote 76] Under the proposal, companies subject to the rule 
would have to submit a resolution plan within 180 days of the 
effective date of the final rule; however, this may change as a result 
of comments on the rule. As described in the preamble, the proposed 
rule would require a strategic analysis by the covered company of how 
it could be resolved under Title 11 of the U.S. Code in a way that 
would not pose systemic risk to the financial system. According to 
some experts, one purpose of these resolution plans is to guide 
regulators and institutions through the complex legal structures of 
large, complex financial institutions in the event of financial 
distress. The plans also may be used to encourage or require financial 
companies to simplify their legal structures and business lines so 
that any resolution in case of failure would be more orderly. Some 
regulatory and industry experts contend that effective resolution 
planning will help ensure the continuance of companies' critical 
functions, which would maintain the company's value and reduce 
disruptions to the wider economy. Additionally, a Pew Research report 
setting out standards for the plans has acknowledged that these plans 
might be useful in a bankruptcy case itself.[Footnote 77] However, 
some experts have noted that the plans themselves have drawbacks, and 
when facing an actual bankruptcy, might be of limited use. 
Institutions and trade associations have responded to the planning 
requirements by noting that breaking up institutions or otherwise 
changing their structure would decrease their value. In addition, some 
financial and legal experts said that although resolution plans might 
help institutions and regulators increase their understanding of the 
complexities of financial institutions, the plans (which would 
generally be revised annually or within 45 days of a material event) 
might not be as helpful as hoped during times of financial distress 
because so much of a company's contracts, assets, and liabilities 
could change dramatically from day to day. 

Two related proposals, which could improve planning, and perhaps avoid 
bankruptcy, are to either allow or require firms to hold contingent 
convertible capital. Contingent convertible bonds, sometimes known as 
"Co-Cos," are bonds that convert to equity at a contractually 
determined trigger point, typically when a company falls below capital 
requirements or otherwise experiences some measure of financial 
distress. The required version of the proposed convertible bond 
instruments, sometimes called "bail-ins," convert from debt to equity 
when a regulatory triggering event occurs. The purpose of requiring 
systemically important financial institutions to hold these 
instruments is to create a class of bondholders that share the burden 
of rescuing a company in financial distress and give these creditors 
an incentive to push a distressed financial institution to make 
changes, such as replacing management, before the trigger event. 
Financial experts suggest that contingent convertible capital bonds 
could provide a financial cushion that would give financial 
institutions facing bankruptcy more time to recover from their 
difficulties or to prepare for bankruptcy. Some institutions in 
Europe--Credit Suisse Group AG and Lloyds Banking Group plc--have 
introduced such bonds, and European regulators are considering 
requiring institutions to hold contingent capital for regulatory 
purposes. Critics of Co-Cos and bail-ins question who would purchase 
such instruments or whether they could be sold only at a premium (high 
interest rates). Some experts noted that the most likely holders of 
these securities would be insurance companies, but insurance 
regulators may require conservative regulatory treatment of these 
investments or, in some cases, may prohibit their purchase. However, 
experts expect that the holders of these debt securities likely would 
be other financial institutions. As a result, weaknesses at one 
financial institution may be transmitted to others, and this would be 
particularly problematic during a financial crisis, when having many 
institutions converting debt to equity at the same time could have a 
widespread systemic impact. 

Another proposed action to improve planning is to require failing 
financial institutions to notify regulators at least 10 days before 
filing a petition for bankruptcy. This notice period is intended to 
provide the regulator with some time to facilitate actions to minimize 
the systemic impact of the bankruptcy. During this time, the regulator 
may be able to find ways to maintain critical functions, facilitate an 
asset sale, or identify potential creditors that would provide 
financing for the debtor during the bankruptcy proceeding--DIP 
financing. This extra time for preparation could help to maintain the 
going concern value of the institution and reduce disruptions to the 
wider economy. However, during the rapidly developing financial 
crisis, some institutions' financial conditions deteriorated so 
rapidly that a 10-day notification would not have been possible. For 
example, the senior management of Bear Stearns gave FRBNY a 1-day 
notification when they said that Bear Stearns would file for 
bankruptcy protection the following day unless it received an 
emergency loan. 

Actions to Increase the Role of Regulators May Better Account for 
Systemic Risk in the Bankruptcy Process: 

The Code does not explicitly address systemic risk. As a result, legal 
and financial experts have proposed bringing regulators or other 
government officials who are currently outside the court system into 
the bankruptcy process to address issues related to systemic risk. 
However, some legal experts believe that such a move could weaken the 
role of debtors and creditors in the bankruptcy process. 

Proposed actions to increase the role of regulators in the bankruptcy 
process include allowing a financial institution's primary regulator 
to file an involuntary petition for bankruptcy and to do so prior to 
actual insolvency. Currently, only creditors can initiate an 
involuntary petition for bankruptcy.[Footnote 78] Some regulatory and 
legal experts suggest that early intervention by regulators such as 
allowing regulators to file for bankruptcy would help to place the 
institution into bankruptcy before its value was depleted and thus 
help to preserve its going concern value. In addition, providing 
regulators with this authority would thereby allow them to take into 
account the potential disruption to other companies, and the economy 
as a whole, that would be caused by the timing of the decision to file 
for bankruptcy. Currently the debtor or creditors of a financial 
institution only take into account the value of the firm or the risk 
to creditors in the decision to file for bankruptcy. If a regulator 
was to have standing, despite its lack of creditor status, and the 
debtor institution was reluctant to file for bankruptcy, the regulator 
could choose to file an involuntary petition if a later bankruptcy 
filing would pose a greater threat to the greater economy or the going 
concern value of the institution. Some bankruptcy experts said this 
would weaken the role of debtors and creditors in the bankruptcy 
process, and some experts have also noted that regulators have not 
always been able to determine when financial institutions are likely 
to fail or have a systemic impact. 

A second proposal to increase the bankruptcy role of government 
officials currently outside the court system would be to allow the 
government to provide DIP financing by serving as a lender to the 
estate. DIP financing for large systemically important financial 
institutions in bankruptcy necessarily would be substantial, and few 
outside the government may have adequate resources. Allowing the 
government to provide DIP financing might make filing for bankruptcy a 
more viable option for systemically important financial institutions. 
In addition, depending on the nature of the financing, as a DIP 
financer, the government would have super priority--it would be near 
the top rung of the creditor priority ladder--for any assistance 
provided, and would therefore be among the creditors receiving the 
first repayment of their loans. This contrasts with the assistance 
provided to CIT, where the government received no repayment. However, 
the assistance to CIT was part of widespread government assistance to 
financial institutions aimed at maintaining financial stability, not 
assistance narrowly aimed at a specific institution, and therefore 
might not be strictly comparable. Some experts have suggested that 
allowing the government to provide DIP financing ultimately would 
minimize the costs to taxpayers of a financial institution failure, 
because an adequately funded debtor in bankruptcy would have less 
systemic impact than an underfunded one. However, following the 
financial crisis, there has been widespread opposition to adopting 
resolution mechanisms that would place the government at risk of 
future financial losses. 

One group of experts also has proposed allowing regulators, in 
addition to debtors and creditors, to propose plans of reorganization. 
They argue that, in the case of financial institutions, those who were 
managing the institution before the bankruptcy usually have been 
replaced by firms specializing in resolution management and, as a 
result, the institution no longer has an interest in continuing as a 
going concern. In addition, a regulatory plan could better take 
account of systemic factors. However, in this system, as opposed to a 
purely regulatory system, the judge in the case also would consider 
proposals by the creditors, preserving their due process. Because this 
proposal was not made until recently, other experts have not yet 
commented on it. 

Proposals to Modify the Safe Harbor Treatment for QFCs May Affect 
Systemic Risk and Market Discipline: 

Legal and financial experts have made a number of proposals to change 
the treatment of QFCs. These contracts are exempt from the automatic 
stay in bankruptcy and allow counterparties access to posted 
collateral, including cash, as soon as the debtor defaults or declares 
bankruptcy. This safe harbor treatment can create significant losses 
to the debtor's estate, particularly for financial institution debtors 
that often are principal users of these financial products. In 
addition, a variety of experts expressed concern about counterparties 
not imposing market discipline, such as monitoring the 
creditworthiness of their counterparties, or signatories on certain 
contracts, because they are less likely to suffer the consequences of 
a bankruptcy. 

Proposed actions to modify safe harbor treatment for QFCs include 
changing the types of exempted contracts and protected counterparties. 
These proposals vary greatly and include retaining protections for 
contracts backed by the most liquid collateral assets, excluding 
certain types of counterparties, or eliminating all QFC exceptions and 
subjecting each contract's protection to judicial discretion. Some 
experts with whom we spoke suggested that modifying the safe harbor 
treatment may help to avoid or mitigate the precipitous decline of 
assets typical in financial institution bankruptcies. For example, 
some have suggested that the treatment of QFCs in the Lehman 
bankruptcy contributed to a significant and rapid loss of asset values 
to the estate. Some experts also suggested that the current treatment 
contributes to systemic risk and lessens market discipline because it 
removes the incentive for fully collateralized counterparties to 
monitor each other's risk-taking behavior. However, some experts said 
determining which counterparties or contracts should be protected 
would be difficult. In addition, some experts argued that modifying 
the current exceptions would exacerbate systemic risk when a financial 
institution enters bankruptcy. These experts assert that subjecting 
any QFCs to the automatic stay in bankruptcy would freeze many assets 
of the counterparties of the failed financial institution, causing a 
chain reaction and subsequent systemic financial crisis. Officials at 
the Commodity Futures Trading Commission also noted that the safe 
harbor provisions uphold market discipline through margin, capital, 
and collateral requirements. They said that the requirement for 
posting collateral limits the amount of risk counterparties are 
willing to undertake. 

A second proposal to modify safe harbor treatment for QFCs would 
preserve current exceptions for financial institutions deemed 
systemically important and remove all such exceptions for other 
companies. Some experts suggest that the nondefaulting counterparties 
of systemically significant financial institutions also are likely to 
be systemically significant. Thus, to avoid spreading losses from one 
financial institution to another and ultimately to the rest of the 
economy, these counterparties need the safe harbor protections. These 
experts further assert that nonfinancial and nonsystemic financial 
institutions do not need this same safe harbor protection, because 
their being subject to the automatic stay would not have an effect on 
credit markets throughout the economy. However, other financial 
experts argue that preserving safe harbor treatments for certain 
financial institutions only raises equity concerns, giving an unfair 
advantage to systemically important financial institutions that could 
lead to those institutions gaining even larger shares of the market 
for financial services. 

A third proposed action to modify safe harbor treatment for QFCs would 
provide a limited stay for these contracts. The length of these 
proposed stays varies, from 1 day to 30 days. Imposing a limited stay 
for QFCs in bankruptcy would align this resolution process with other 
regulatory insolvency processes. For example, the new OLA and the 
resolution process for banks under the FDI Act use a 1 business-day 
stay.[Footnote 79] One legal expert has noted that providing a limited 
stay would allow debtors enough time to determine which contracts to 
assume and which to terminate and this would, in part, effectively 
reverse advantages that nondefaulting counterparties now have over the 
debtor. Other experts have argued, however, that it is difficult to 
determine how long a stay may be necessary to make these 
determinations, and that any stay for these contracts would cause 
considerable market disruption and increase the cost, and reduce the 
availability, of capital. 

Although Proposals to Treat Institutions on a Consolidated Basis in 
Bankruptcy May Improve Efficiency, Challenges Exist: 

As noted throughout this report, large financial institutions are 
legally, structurally, and financially complex, and they often operate 
both regulated and unregulated subsidiaries in multiple jurisdictions. 
To the extent that these structures increase value through economies 
of scope and scale, splitting them up likely will lower their value. 
As a result, proposals have been made to treat firms on a more 
consolidated basis to better address the significant challenges faced 
in bankruptcies, where judges and regulators currently attempt to 
resolve only one piece of an interconnected institution. The proposals 
are as follow: 

Eliminate existing exclusions. Proposed options to treat financial 
institutions on a consolidated basis include eliminating existing 
bankruptcy exclusions for insured depositories, insurance companies, 
broker-dealers, or commodity brokers. As discussed previously, insured 
depositories and insurance companies have separate and distinct 
resolution processes--FDIC resolves insured depositories, and state 
insurance regulators resolve domestic insurance companies. Broker- 
dealers may be debtors only in Chapter 7 or SIPA liquidations, while 
commodity brokers can be debtors only under Chapter 7. By eliminating 
these exclusions under the Code for systemically important financial 
institutions, a financial institution could enter bankruptcy as one 
consolidated entity, and a judge with appropriate authority could 
involve the corresponding regulators and regulatory procedures under 
his or her authority. For example, one proposal says that, to the 
extent possible, insurance policyholders should be treated in the same 
way they are treated under regulatory resolution practices. In 
addition, this proposal calls for maintaining SIPC and the Commodity 
Futures Trading Commission's ability to participate in the bankruptcy 
proceeding. Some experts suggested that eliminating these exclusions 
could reduce the potential for conflicts among different resolution 
authorities with competing interests. However, regulatory experts 
expressed doubt that the resolution of their jurisdictional entities 
under a bankruptcy judge would remain as effective. In addition, some 
regulatory experts expressed concern about the ability of a bankruptcy 
process to protect bank depositors, insurance policyholders, and 
customers of commodity brokers, who have special protections under 
current processes. U.S. insurance regulators specifically noted that 
insurance policyholders rely on state insurance commissioners' 
abilities to wall off insurer's assets from bankruptcy claims so they 
can be used to meet policyholders' claims rather than those of other 
unsecured creditors. They said that eliminating these assurances would 
likely disrupt insurance markets. 

Require procedural consolidation. A second proposed option is to 
require procedural consolidation, which currently may be ordered by 
the court for cases pending in the same court. Procedural 
consolidation, also known as joint administration, involves assembling 
together all bankruptcy proceedings for each entity within a financial 
institution for administrative purposes, so that one judge ultimately 
has authority over all such related cases. Under the Federal Rules of 
Bankruptcy Procedure, the court may order consolidation of cases if 
two or more petitions "by or against the same debtor" are pending in 
the same court. Also, if a joint petition, or two or more petitions, 
are pending in the same court against a debtor and an affiliate, the 
court may order joint administration of the estates.[Footnote 80] Some 
experts suggest that mandating procedural consolidation for financial 
institutions predetermined as systemically important would minimize 
the cost of the proceeding. 

Substantive consolidation. A third proposed option is to treat 
financial institution groups on a consolidated basis through 
substantive consolidation. Unlike procedural consolidation, in 
substantive consolidation, the intercompany liabilities of related 
companies are eliminated, the assets of these companies are pooled, 
and the companies' liabilities to third parties are satisfied from the 
single pool of assets. No direct statutory authority exists for 
substantive consolidation; the courts have developed the doctrine 
through case law. The courts have stated that this doctrine should be 
used rarely, and only in specific instances--when, prior to a 
bankruptcy filing, the institution acted on an integrated basis that 
led creditors to assess risks across legal entities or after a 
bankruptcy filing, the assets and liabilities of the legal entities 
were so intermingled that separating them would be prohibitive and 
hurt all creditors. Although pooling assets could increase the value 
of the consolidated entity and encourage creditors to assess 
consolidated risks, legal and economic experts said that creditors can 
and do monitor the risk being taken by individual legal entities. And, 
they said, consolidating assets in a bankruptcy likely would drive up 
the cost of capital because creditors would be less willing to provide 
funds to financial institutions if they could not distinguish the 
legal entities receiving the funds from other more risky entities in 
the consolidated institution. Substantive consolidation has been 
proposed in the Lehman case, where one of the two creditors' 
reorganization plans proposes it; other creditors have filed a 
competing plan. On June 29, 2011, the debtor issued a new plan based 
on an initial agreement with the competing creditors. The agreement, 
which lays out the factors that support consolidated supervision and 
those that argue against it, may be modified. Nonetheless, the plan 
asserts that although the majority of the factors indicate that Lehman 
operated as a centralized business, certain critical factors, such as 
the ease of segregating the assets and liabilities of each entity, 
argue against substantive consolidation. 

Measures to Improve Court Expertise Have Been Proposed, but Some 
Experts Said They Are Not Necessary: 

Some experts contend that bankruptcy courts require more expertise to 
conduct financial institution bankruptcy proceedings than they 
currently have. As we discussed earlier in this report, the complex 
legal structures, innovative products, regulatory requirements, and 
internationally active business lines of systemically important 
financial institutions pose considerable challenges for the bankruptcy 
process. If court officials do not have specialized knowledge related 
to financial institutions, the time needed to acquire that knowledge 
could be especially detrimental in a financial institution case 
because assets may lose value quickly. 

Proposed options to improve court expertise on financial issues 
include creating a specialized panel of judges or a standing group of 
financial experts. Some academic and legal experts have suggested 
establishing a special panel of judges technically trained on both 
bankruptcy and financial institution issues, although opinions vary on 
the process for assigning cases and what effect their rulings should 
have on other courts. These experts contend that the limited number of 
systemically important financial institution bankruptcies warrant a 
dedicated group of special masters who would best understand how to 
equitably and efficiently resolve such complex financial institutions. 
However, other experts with whom we spoke expressed concerns that the 
rare occurrence of these bankruptcies would prevent such special 
masters from gaining or utilizing their expertise. In addition, 
experts commented that some current complex financial bankruptcies are 
in courts with highly qualified judges. A related proposal would 
create a standing group of financial experts to serve the court during 
a financial institution bankruptcy case. Some experts noted that 
courts already have the right to appoint examiners as they did in the 
Washington Mutual and Lehman cases. As with the proposal for a special 
panel of judges, the rare occurrence of these bankruptcies may argue 
against creating such a standing group. 

Another proposal would grant special standing to regulators to be 
parties or otherwise participate in bankruptcy court proceedings on 
matters relevant to regulatory issues. While regulators currently may 
be involved in bankruptcies--such as FDIC's role in Chapter 11 
bankruptcies of bank holding companies--no regulator has a special 
role in these bankruptcies. Experts contend that regulated 
institutions have more complicated legal structures and products than 
others. Thus, having regulatory expertise would provide more timely 
information to the judge and could lead to resolutions that better 
preserve asset value. Some legal experts expressed doubt that the 
bankruptcy process required further financial expertise. A few 
bankruptcy judges stated that increasing court expertise is 
unnecessary. Although financial institutions do present unique issues 
in bankruptcy, they explained that the judge's role is to hear the 
facts of the case as presented by both sides before entering judgment 
and, ultimately, the burden of educating the judges as to the unique 
issues of the institution's structure or products falls on the 
attorneys representing the debtors, creditors, shareholders, or any 
other parties in the case. 

These proposals generally aim to address some potential criteria for 
assessing the effectiveness of the Code, including maximizing asset 
values and minimizing the impact of one type of systemic event. 
However, we (and others) have identified at least two types of events 
that could have a systemic impact on the financial system and thus 
destabilize the U.S. economy. First, the failure of a single financial 
institution could have a systemic impact on other institutions that 
are counterparties or creditors of the failing institution. Second, a 
market event, such as the crisis in the subprime mortgage market, can 
have a systemic impact by threatening the stability of a large number 
of financial institutions at a point in time. The proposals described 
here address primarily the first type of systemic event, even though 
the recent financial crisis that generated these proposals is 
associated more broadly with the second type of event--a market event 
that affects many financial institutions and markets at the same time. 
Some government officials and industry participants have also noted 
that OLA is not likely to address fully a widespread financial crisis 
involving the possible failure of multiple institutions.[Footnote 81] 
In addition, a group of law professors and economists who have created 
a proposal for a new chapter of the Code told us that this new chapter 
would be designed to address the first type of systemic event but not 
the second type. They told us that their group may consider proposals 
to address widespread systemic impacts caused by market events after 
it addresses another difficult issue encountered in resolving 
systemically important financial institutions--the global nature of 
those institutions. 

Courts and Regulators Have Mechanisms for International Coordination, 
but National Interests and Other Factors Limit Coordination: 

In a prior report on assistance provided to financial and other 
companies during the recent financial crisis, we noted that widespread 
financial problems, such as those that occurred in the crisis, require 
comprehensive, global actions that must be closely 
coordinated.[Footnote 82] Efforts to improve international 
coordination in the resolution of financial institutions continue, but 
coordination mechanisms are not currently comprehensive, and 
international coordination generally is limited--often because 
national interests can play a determinant role in resolution outcomes. 
Differences in countries' insolvency and resolution systems also can 
limit coordination. These include diverse terminologies, disparate 
treatment of contracts, limits on information sharing, and the 
exclusion of various types of financial institutions from judicial 
bankruptcy proceedings. These differences were evident in a number of 
financial institution failures during the crisis. Proposals for 
improving coordination call for harmonizing definitions, insolvency 
triggers, and other aspects of judicial and regulatory systems. 
However, most of the efforts to promote harmonization following the 
2008 financial crisis have centered on activities that could be 
undertaken outside a judicial system. 

Countries' Insolvency or Regulatory Systems Combine Models: 

Countries often differ in the extent to which their insolvency or 
regulatory systems combine universalism or territorialism. In a 
universal system, all the operations of a company would be subject to 
the legal process and resolution system of the country in which the 
company is headquartered. In a bankruptcy proceeding, the debtor's 
home country would consolidate the debtor's worldwide assets into a 
single pool and treat creditors from any country equally under the 
home country's priority scheme. Similarly, in a universal system, a 
financial institution would be regulated under its home country's 
rules regardless of asset or customer location. By contrast, in a 
territorial system, each country would segregate or "ring fence" 
companies' assets in its country, regardless of the headquarters' 
location. Then, if a company declared bankruptcy, each country in 
which it operated would reserve the assets located there for that 
country's creditors. Similarly, each country would use its own rules 
to regulate financial institution activities occurring there 
regardless of company structure. Territorial systems sometimes require 
financial institutions headquartered abroad to set up separate legal 
entities to operate in their country. 

The EU's method for overseeing and resolving banking institutions and 
their branches follows a universal system. Any institution with a 
banking license in an EU country can operate branches in other 
countries while following the rules of its home country. Thus, if the 
institution fails, the institution, including its branches in other EU 
countries would be resolved under the home country's rules; however, 
branches in non-EU countries may be subject to territorial systems in 
those countries. In contrast, in the United States, which some experts 
consider more territorial, the State of New York may seize a local 
branch of a financial institution headquartered in another country and 
all of its assets if the foreign parent becomes insolvent.[Footnote 
83] Most internationally active financial institutions headquartered 
abroad maintain branches in New York because of its importance as a 
financial center. Similarly, a U.S. subsidiary of a financial 
institution headquartered abroad has to maintain assets sufficiently 
in excess of liabilities or it risks FDIC resolution. For example, 
when a UK institution, the Royal Bank of Scotland, failed and was 
partially nationalized, its U.S. depository subsidiary, Citizens Bank, 
was able to continue operations in the United States because it was 
well-capitalized independently of its UK parent. 

Mechanisms to Coordinate Internationally during Insolvencies Are Not 

Because institutions can operate across these divergent legal and 
regulatory models, nations, and their regulators have adopted 
different mechanisms, such as the UN Model Law, in an attempt to 
facilitate international coordination on bankruptcies. The UNCITRAL 
Model Law on Cross-Border Insolvency is one of the main mechanisms 
governing such coordination. Chapter 15 of the Code incorporates the 
Model Law.[Footnote 84] Generally, under Chapter 15, U.S. court 
officials may communicate directly with foreign court officials to 
obtain information or assistance. To facilitate coordination, the 
courts also may appoint personnel, communicate information by any 
appropriate means, coordinate administration and supervision of the 
debtor, approve or implement coordination agreements, and coordinate 
concurrent proceedings. Chapter 15 cases allow foreign representatives 
to sue or be sued in a U.S. court and apply for relief such as a stay 
against U.S. creditors seizing the assets of a foreign debtor in a 
U.S. court. In addition, foreign representatives can apply to a U.S. 
court to have a foreign proceeding recognized as the main case--the 
foreign case would take precedence over a U.S. case. 

Chapter 15 was used in the Lehman Bankruptcy. For example, in February 
2009, administrators for Lehman Brothers Finance (LBF) filed for 
dismissal of a Chapter 11 proceeding in the Southern District of New 
York and petitioned under Chapter 15 for recognition of an ongoing 
insolvency proceeding in Switzerland. The administrators argued that 
LBF's registered office was in Switzerland, and it had no offices or 
employees in the United States. In March 2009, the U.S. Bankruptcy 
Court recognized the Swiss proceeding as a foreign main proceeding and 
dismissed the Chapter 11 proceeding. The court noted that this would 
promote the efficient administration and maximization of LBF's assets. 
[Footnote 85] 

[Side bar: 
A Chapter 15 proceeding is available in one of four circumstances: (1) 
when a bankruptcy proceeding is taking place in a foreign country, a 
representative of that country’s legal system or courts may apply to a 
U.S. court for assistance in obtaining assets held in the United 
States, or when an issue in the case involves a U.S. creditor; (2) 
when a party in the United States seeks assistance from a foreign 
court in connection to a U.S. bankruptcy case; (3) when a foreign and a
U.S. bankruptcy case concern the same debtor; or (4) when foreign 
parties seek to participate in a U.S. bankruptcy case. 11 U.S.C. § 
1501. End of side bar] 

The typical Chapter 15 case begins when a foreign representative files 
a petition for recognition.[Footnote 86] Recognition is the entry of 
an order conferring status on the foreign representative to proceed 
before the U.S. court.[Footnote 87] Once the court grants recognition, 
that representative may commence a bankruptcy case under the U.S. 
Bankruptcy Code. In such a case, foreign creditors would have the same 
rights as U.S. creditors. Foreign representatives can intervene in any 
proceeding, state or federal, in which the debtor is a party. Under 
Chapter 15, a court may authorize a person from the United States, 
such as a trustee or examiner participating in a U.S. bankruptcy case, 
to operate as a representative of the debtor's estate in a foreign 
country under that country's laws.[Footnote 88] In August 2009, the 
U.S. Bankruptcy Court authorized the debtors' estate of the parent 
company of Lehman, LBHI, to act as foreign representatives for that 
estate in the UK. As a result, debtors could seek recognition of their 
U.S. Chapter 11 case in the UK and request that the UK courts assist 
in protecting LBHI's assets. 

Some experts from the legal community here and abroad told us that 
Chapter 15 and the Model Law have had a positive impact on 
international coordination. One legal expert said that, before several 
countries adopted the Model Law, international recognition did not 
really exist. A foreign court official also told us that Chapter 15 
has allowed him to operate effectively in U.S. bankruptcy courts. 
Several experts pointed to the bankruptcy of Nortel Networks, Inc. 
(Nortel), a telecommunications company headquartered in Canada, which 
filed for bankruptcy along with 14 of its subsidiaries in January 
2009, as a successful Chapter 15 case. The U.S. courts recognized the 
Canadian proceeding as a foreign main proceeding under Chapter 15. In 
June 2009, the U.S. courts also recognized a petition by a 
representative of a UK subsidiary to have the English proceeding for 
that subsidiary recognized as a foreign main proceeding. However, the 
Nortel bankruptcy was still ongoing as of June 2011. 

Some legal experts believe that the international framework based on 
the Model Law has some drawbacks, especially as it relates to 
financial institutions.[Footnote 89] Among those countries that have 
adopted the Model Law, some experts said that determining the home 
country or center of main interest for a financial institution that 
has subsidiaries in a number of countries is difficult and can reduce 
the effectiveness of the Model Law.[Footnote 90] For example, in the 
Lehman case, there are multiple centers of main interest, each 
determined by the home country of the various subsidiaries. For the 
parent and many of the subsidiaries that filed for bankruptcy in the 
Southern District of New York, the United States is the center of main 
interest. For Lehman Brothers Finance, Switzerland is the center of 
main interest. The effectiveness of Chapter 15 for financial 
institutions is further limited because it exempts many companies 
engaged in financial activities, including U.S. state-regulated 
insurance companies, U.S.-insured depositories, foreign banks that 
have branches in the United States, entities subject to a SIPA 
proceeding, broker-dealers, and commodity brokers. In addition, an 
academic expert told us that since the Model Law had not been widely 
adopted, its effectiveness is limited worldwide. Only 19 countries 
have adopted the Model Law. For instance, Germany, France, and the 
Netherlands--significant financial centers with strong connections to 
U.S. financial markets--have not implemented the Model Law.[Footnote 

[Side bar: 
The American Law Institute guidelines state that if there is an 
insolvency proceeding in one of the NAFTA countries, all NAFTA 
countries should recognize that proceeding and once the courts 
recognize the proceeding, they should impose a stay on creditors in 
the other countries. The guidelines also state that all parties should
disclose information about insolvency cases, allow foreign 
representatives the same rights to obtain information as domestic 
representatives, and have courts communicate directly with each other or
through administrators. The guidelines further advise courts not to 
discriminate against foreign representatives when seeking possession 
of debtors’ assets or when seeking to transfer those assets to another
country. General Principle 3, Procedural Principle 4. End of side bar] 

Courts overseeing a bankruptcy with international components can 
augment coordination by permitting adoption of insolvency protocols. 
[Footnote 92] Protocols aim to promote certainty, clarify 
expectations, reduce disputes, prevent jurisdictional conflict, 
facilitate restructuring, reduce costs, and maximize value. For 
instance, they could assign court responsibility for certain matters 
to avoid duplication of effort or address the sharing of information. 
Guidelines exist for drawing up effective protocols. Some experts 
directed us to the American Law Institute's guidelines for 
facilitating coordination in the North American Free Trade Agreement 
(NAFTA) country bankruptcies.[Footnote 93] The Lehman Brothers Cross-
Border Insolvency Protocol and Order issued by the U.S. Bankruptcy 
Court for the Southern District of New York includes approval and 
adoption of the American Law Institute's "Guidelines for Court-to-
Court Communications in Cross-Border Cases."[Footnote 94] 

However, experts disagreed on the effectiveness of insolvency 
protocols. Some experts pointed out that protocols have been used 
successfully to coordinate proceedings, allow communication between 
courts, and conduct joint proceedings. In addition, a group of legal 
experts said that protocols could be more useful in facilitating 
coordination than Chapter 15 because they do not require that the 
courts determine a main proceeding. As a result, financial 
institutions, which encompass many different subsidiaries and business 
lines, may benefit more from protocols than from proceedings under 
Chapter 15. Other experts were skeptical about the effectiveness of 
protocols. One court official told us that aside from the sharing of 
information they were ineffectual. In his experience entities may 
refuse to participate in a protocol due to legal differences or only 
if they seek to maximize returns for creditors in their country. If a 
protocol is not comprehensive--all of the important countries do not 
participate--its usefulness will likely be limited. 

Official representatives from nine countries involved in the Lehman 
bankruptcy have signed a protocol to cover issues that arise from the 
international nature of the Lehman case.[Footnote 95] The protocol's 
goals include facilitating the coordination of the proceedings and 
enabling cooperation in the administration of the various estates. 
Among other things, the protocol gives representatives the right to 
appear in all proceedings and states that the representatives should 
keep each other informed of all relevant information. Beginning in 
July 2009, the official representatives from these countries have held 
regular meetings. Initially, the intent of these meetings was to 
discuss broad issues of administering estates, sharing information 
such as private client information, and how to deal with intercompany 
claims. A legal expert told us that, currently, these meetings focus 
on the Chapter 11 reorganization plan in the United States. However, 
the effectiveness of the protocol is limited because London-based 
Lehman Brothers International Europe has not signed on to the 
protocol. Instead, this London-based unit is opting to participate in 
bilateral agreements with individual affiliates. Many of the creditors 
from nations that signed the protocol dealt primarily with Lehman 
Brothers International Europe, which entered insolvency administration 
in the UK. 

In addition to the mechanisms discussed above, regulators have signed 
various memorandums of understanding (MOU) to promote international 
coordination. A number of federal U.S. regulators have MOUs with their 
counterpart agencies in other countries. For example, the Commodity 
Futures Trading Commission and SEC both have MOUs with several 
countries important to the U.S. financial system, such as Canada, 
China, France, Germany, Japan, the Netherlands, Switzerland, and the 
UK. According to officials at the Federal Reserve, these MOUs have 
typically dealt with information sharing; however, more recently they 
have focused on crisis management and resolution of institutions. For 
example, regulators from Sweden, Denmark, Norway, and Finland have 
signed an MOU specifically designed for the resolution of Nordea Group 
(Nordea)--a universal bank with branches and subsidiaries in multiple 
Nordic countries. The MOU specifies how supervisors may share 
sensitive or confidential information and grants Swedish authorities 
leadership responsibilities among the supervisors. The MOU directs 
authorities to monitor the potential for a crisis in their countries, 
plan for a crisis situation, and facilitates close cooperation during 
a crisis. 

However, experts generally felt that MOUs were not effective 
mechanisms for international insolvency coordination because they 
would break down in a crisis. According to a report on international 
insolvency by the Basel Committee on Banking Supervision, supervisors 
generally enter MOUs with the goals of cooperating and sharing 
information during the course of their regular oversight roles rather 
than to resolve an entity.[Footnote 96] An expert familiar with the 
Nordea MOU further cautioned that, although the Nordic countries have 
similar legal regimes, national interest provisions in the MOU still 
might impede its effectiveness in a crisis. 

National Interests May Take Precedence over Efforts to Coordinate in a 

Although the importance of international coordination is generally 
recognized, national interests may take precedence over coordination 
during resolutions of insolvent financial companies and often did 
during the recent financial crisis. For example, when an international 
financial institution fails, regulators in each country generally look 
to protect entities in their own countries and focus on minimizing 
losses to their citizens and legal entities, as well as preventing 
national economic instability. During the recent global economic 
instability, countries took actions to mitigate impacts in their own 
countries. For instance, under EU laws, Iceland had full authority to 
resolve its banks that failed in 2008 (including UK branches) as a 
single entity. However, the UK government invoked antiterrorism laws 
that allowed it to seize and ring fence assets in UK branches of the 
Icelandic banks for the benefit of local depositors, local creditors, 
and UK commitments for deposit insurance. 

The Fortis Bank, SA/NV (Fortis) failure further illustrates the 
difficulty of overcoming national interests in a financial institution 
failure. According to an academic expert, the Dutch and Belgians had 
good relations, including a strong relationship between their central 
banks, before the 2008 economic crisis. However, when Fortis--a 
financial institution with operations in Belgium, the Netherlands, and 
Luxembourg--nearly failed during the 2008 crisis, national interests 
kept regulators and other officials from cooperating to maintain the 
value of the bank. Belgian and Dutch officials both considered Fortis 
to be systemically important in their countries and proposed 
conflicting resolution plans. According to a report by the 
International Centre for Monetary and Banking Studies on the failure, 
the Belgians favored a joint solution that would keep Fortis as a 
consolidated entity, headquartered in Belgium. [Footnote 97] However, 
Fortis recently had participated in a joint acquisition of the Dutch 
financial institution, ABN AMRO Holding, NV (ABN AMRO). The Dutch 
wanted ABN AMRO operations to remain in country and favored a solution 
that split the company. In the end, Fortis was broken up, with the 
Dutch nationalizing 100 percent of the Dutch banking subsidiaries, and 
the Belgians initially nationalizing the Belgian banking subsidiary 
and, ultimately, selling 75 percent of it to French bank BNP Paribas. 
An expert familiar with the Fortis failure said that the ultimate cost 
might have been lower under a consolidated solution. See appendix VI 
for more information about the Fortis failure. 

However, when national interests align, authorities find ways to 
coordinate. When Dexia faced a liquidity crisis in 2008, Belgium and 
France, with minor participation by Luxembourg, orchestrated a 
coordinated rescue by establishing a joint guarantee mechanism. Dexia 
was a key provider of municipal finance, especially in France, and was 
a key depository in Belgium. Thus, it was in France's interest to 
ensure continued finance for local governments and in Belgium's 
interest to prevent the failure of an important financial institution. 
As a result, Dexia emerged from the crisis relatively intact. 

According to experts with whom we spoke, insolvency laws in some 
countries limit the ability of bankruptcy estate administrators to 
cooperate. These experts noted that bankruptcy administrators in some 
countries could be found liable for malpractice if they did not 
attempt to ring fence or otherwise protect domestic creditors while 
resolving subsidiaries of companies headquartered in other countries. 
Experts familiar with the Lehman case said that the UK had not signed 
the Lehman insolvency protocol because Lehman Brothers International 
Europe administrators had certain duties under UK law that limited 
their participation. As a result, parties in other countries said they 
could not obtain needed information because Lehman Brothers 
International Europe maintained the books and records for European and 
Asian operations. Nonetheless, in a recent SIPA trustee report, the 
trustee noted that Lehman Brothers International Europe had provided 
him with vast amounts of information. 

Furthermore, national laws and regulations may restrict supervisors 
from sharing information with foreign entities. While there may be 
good reasons for the restrictions, they can prevent the timely sharing 
of information. Additionally, other national rules, such as privacy 
laws, can limit agreements to share information. Some supervisors' 
resolution systems also may not empower them to share information or 
may allow them to share information that does not have the specific 
details needed to coordinate the resolution of a large, global 
financial institution. Regulators also may not want to share bad or 
embarrassing news with foreign entities. For example, foreign 
regulators discovered that a trader in the New York office of a 
foreign firm lost $1.2 billion over the course of a decade due to 
improper actions, but they did not promptly share that information 
with U.S. regulators. 

Differences in Insolvency Systems, such as Definitions and Priority 
Structures, Also Limit International Coordination: 

In addition to national interests, differences between insolvency 
systems can limit international coordination of bankruptcies or 
resolutions. This includes differences in the mandated 
responsibilities of various actors involved in the proceedings; 
payment rankings for creditors; definitions of certain terms; 
treatment of contracts; and the extent to which judicial bankruptcy 
codes cover certain financial institutions.[Footnote 98] Differences 
in legal traditions can also limit coordination. Civil law systems 
tend to rely on codes and not on case law, as in common law systems, 
such as in the United States.[Footnote 99] Thus, judges may play a 
different role in insolvency proceedings depending on the legal system 
of the country. A legal expert explained that the effectiveness of 
international coordination mechanisms and agreements is limited in 
Mexico, a civil law country, due to its legal tradition that 
discourages courts from coordinating. In the Netherlands and Germany 
(civil law countries), judges are less active than in the United 
States and Canada (common law countries), leaving the resolution of 
the company to court-appointed administrators. A German court official 
said that a U.S. judge probably would have to coordinate with an 
administrator in Germany. These differences may complicate efforts to 
coordinate during insolvency proceedings, in particular proceedings in 
which time is critical. In another example, ladders of priority in 
insolvency proceedings differ. In the United States, wage claims 
generally rank below secured creditors, while in some European 
countries, such as Luxembourg and France, employee wage claims rank 
ahead of secured creditors. In France, employee wage claims are 
prioritized ahead of any other class. See table 6 in appendix VIII for 
more information on countries' payment priorities. 

Differences in definitions and standards for commencing insolvency or 
resolution proceedings between countries also can limit coordination. 
Different countries may have different definitions for terms such as 
debtor, center of main interest, proceeding, and relief. The following 
are some of the examples given by experts. The Dutch system does not 
have a term that means "relief" as exists in the U.S. bankruptcy 
system. The closest equivalent to the U.S. "stay" is the idea of a 
"cooling off period." Only recently could a debtor apply for an ad hoc 
"stay" similar to the U.S. automatic stay. In other parts of Europe, 
what might be a "liquidator" in one country is an "administrator" in 
another. Different countries may have different thresholds for when to 
take action to resolve a failing bank. Some countries intervene when a 
bank is no longer solvent or liquid. In other countries, such as the 
United States, regulators can intervene before a bank technically is 
considered insolvent. Countries also define banks differently. In the 
United States, the term "bank" often refers only to an insured 
depository institution, but in European countries with universal 
banks, the term would apply to an institution offering insurance, 
broker-dealer, and other investment firm services as well. 

Provisions of contracts between creditors and debtors often dictate 
how issues are to be resolved in a bankruptcy; however, contract law 
differs across countries. An English case related to the Lehman 
bankruptcy proceeding illustrates how these differences can play out 
in a bankruptcy case. One London-based Lehman subsidiary, Lehman 
Brothers International Europe, had issued a series of notes under 
Saphir Finance Public Limited Company (Saphir), a special purpose 
legal entity. Saphir was also counterparty to a series of swap 
agreements. Another Lehman subsidiary, Lehman Brothers Special 
Financing (LBSF), was the other counterparty for the series of notes 
in question. Normally, the contracts were written to give the swap 
counterparty, LBSF, priority to the collateral over the noteholder, 
Perpetual. However, a special clause in the contracts, sometimes 
called a flip clause, specified that if LBSF, the swap counterparty, 
defaulted, the priorities would flip so that Perpetual, the 
noteholder, would have rights to the collateral ahead of LBSF. 
Following LBSF's bankruptcy filing in October 2008, the English courts 
ruled that the flip clause was valid and in effect. However, the U.S. 
Bankruptcy Court ruled that the flip clause was unenforceable because 
it violated U.S. bankruptcy law.[Footnote 100] In his ruling, the U.S. 
bankruptcy judge stated that the English courts appeared not to take 
into account principles of U.S. bankruptcy law and that those courts 
understood that the outcome of the dispute might be different under 
U.S. law. Observing that the "courts will not extend comity to foreign 
proceedings when doing so would be contrary to policies or prejudicial 
to the interests of the United States," the judge noted that the 
United States has a strong interest in having U.S. bankruptcy courts 
resolve issues of bankruptcy law. However, the judge also recognized 
the uncertainty created by conflicting U.S. and English rulings, and 
he recommended that given the complexity of the case, it would be 
better if all parties involved could find a way to harmonize and 
reconcile the decisions. On December 16, 2010, the U.S. court approved 
a settlement between the parties. For more information on these cases 
see appendix IV. 

All of these limitations are only relevant to the extent that 
financial institutions are resolved under a judicial code. Whether 
this is the case or not varies across countries. As noted earlier, in 
the United States, insured depositories and state-regulated insurance 
entities are exempt from the Code, and broker-dealers cannot file 
under Chapter 11. In addition, the United States has now adopted OLA, 
which, if triggered, will exempt certain systemically important 
companies from the bankruptcy process. Similarly, Canadian law 
provides separately for the reorganization or restructuring of 
federally insured depository institutions and for the resolution of 
insolvent financial institutions.[Footnote 101] Some countries have 
not traditionally exempted financial institutions from their corporate 
insolvency systems, but in response to the 2008 crisis the UK and 
Germany have increased the role of regulators and regulatory processes 
in the resolution of certain financial institutions. For example, UK 
regulators now can resolve depository institutions in ways that are 
similar to FDIC's rules in the United States. However, any assets 
remaining after a purchase and sale agreement or the creation of a 
bridge bank would be resolved under corporate bankruptcy laws. The UK 
is considering extending these rules to investment firms. In addition, 
the UK government can temporarily take ownership of certain financial 
institutions if, among other factors, it is necessary to resolve or 
reduce a serious threat to the stability of the financial systems of 
the UK. Germany's special resolution regime grants regulators several 
options when dealing with a distressed bank. At first, the regulator 
can facilitate voluntary debt restructuring or the provision of new 
financing. If that does not work, the regulator can put the bank 
through a judicial process similar to Chapter 11. Finally, the 
regulators can take the bank into conservatorship. 

Experts Have Proposed Harmonized Standards and Use of Existing 
Supervisory Coordination Mechanisms to Improve International 

In response to the financial crisis, a number of international 
organizations--those addressing economic and regulatory issues, as 
well as those addressing judicial issues--have been considering 
regulatory reforms that include improving international coordination 
during insolvencies. Some of these organizations have established 
general principles for improving international coordination, and some 
have proposed harmonizing specific standards for resolving 
institutions, such as insolvency triggers, and have also proposed 
using existing coordination mechanisms, such as colleges of 
supervisors, in resolving these institutions. The experts with whom we 
spoke agreed that these were key elements for improving coordination. 
For example, they noted that having a few key countries, such as the 
United States, UK, Germany, France, and Japan, adopt similar 
procedures might be sufficient to create meaningful coordination. 

In support of the Group of 20 (G20) countries, the Financial Stability 
Board has released a set of high-level principles for international 
coordination for future financial crises.[Footnote 102] The principles 
include developing common tools for crisis management, having 
authorities meet regularly to discuss possible resolutions of specific 
firms, sharing information across countries on specific firms, and 
having firms develop resolution plans. The work of the Financial 
Stability Board is part of a larger G20 financial reform agenda that 
seeks to establish a new financial regulatory framework, including new 
bank capital and liquidity standards, as well as measures to better 
regulate and effectively resolve systemically important financial 
institutions. For example, the G20 stated in September 2009, and again 
in November 2010, that internationally active, systemically important 
institutions should be subject to a sustained process of international 
recovery and resolution planning that includes institution-specific 
crisis cooperation agreements developed within crisis management 

In addition, the United States and the EU have worked on the 
convergence of U.S. and international accounting systems through the 
ongoing U.S.-EU dialogue and could work within the dialogue or other 
forums to harmonize certain insolvency and regulatory resolution 
features. This would likely be successful only if the EU managed to 
harmonize features within the EU through directives that create 
minimum standards for its member countries. Although the EU hopes 
eventually to create a single European Resolution Authority, its 
shorter-term goal is to harmonize resolution powers across EU 
countries. As a first step in promoting harmonization, it has released 
consultation papers. A foreign expert said that European reform is 
moving at two speeds. While the EU has been moving more slowly on its 
reports and proposals, some member states have been moving more 
quickly. For example, Germany, the Netherlands, and the UK all have 
enacted new special resolution regimes for financial institutions. 

Specific proposals for harmonization of judicial systems have focused 
on a few key areas, such as similar treatment of creditors and 
financial collateral and common triggers for, or definitions of, 
insolvency. Through colloquia held by INSOL, judicial experts also 
have begun to consider whether and how to modify the Model Law to make 
it more useful when dealing with corporations that have subsidiaries 
in a number of different countries.[Footnote 103] UNCITRAL has 
recommended that insolvency laws recognize the existence of 
consolidated corporate entities, which it calls "enterprise groups," 
and allow for courts to coordinate enterprise group insolvencies in 
the same manner as insolvencies of a single, international debtor 
entity. As noted earlier in this report, having multiple main 
proceedings can create conflicting rulings and otherwise limit 
coordination. Judicial experts also pointed to the International 
Insolvency Institute's draft guidelines on enterprise groups.[Footnote 
104] These guidelines suggest that courts allow all parts of an 
enterprise group, such as subsidiaries incorporated in various 
countries, and other affected parties to be heard in determining the 
group's center of main interest. The court can choose to determine the 
"coordination center" and recognize a coordination center 
representative who will have standing in any matter involving the 

Experts also recommended harmonization of any special resolution 
regimes for financial institutions, whether combined or separate from 
the judicial system. However, most of the efforts to promote 
international harmonization following the 2008 financial crisis have 
centered on activities that could be undertaken outside a judicial 
system. The proposals generally specify a number of activities that 
government officials should be allowed to undertake, including: 

* intervening prior to actual insolvency as with the prompt corrective 
action in the United States,[Footnote 105] 

* establishing a bridge institution,[Footnote 106] 

* ensuring that creditors receive at least the compensation they would 
have had if the institution had failed and been liquidated instead of 

* restructuring an institution's capital structure or merging it with 
another entity, 

* transferring certain assets and liabilities to other entities, 

* nationalizing an institution temporarily, and: 

* imposing a temporary stay on the termination of financial contracts. 

The principles the G20 and others have been establishing, as well as 
the opinions of experts with whom we spoke, stressed the importance of 
having regulatory authorities coordinate on financial institution 
resolution before crisis situations developed because the value of 
such institutions deteriorates rapidly during insolvencies, leaving no 
time to set up structures for coordinating. For example, experts such 
as officials at the International Monetary Fund (IMF) have recommended 
building on the framework created under the Basel Committee on Banking 
Supervision, in which supervisors from various countries meet 
regularly to better coordinate supervision of an ongoing financial 
institution.[Footnote 107] And some have recommended a college of 
resolution authorities that would use companies' required resolution 
plans to develop a more cohesive plan, promote effective coordination, 
and determine how the burden of financing such actions would be shared 
across countries. However, some legal experts were concerned that 
financial and regulatory officials have not been relying on court 
insolvency officials who are more familiar with existing bankruptcy 
proceedings and unnecessarily have been creating duplicative systems. 

Both international organizations focusing on judicial issues and those 
focusing on economic and regulatory issues continue to work on 
improving international coordination regarding the resolution of 
insolvent firms operating across national borders. However, much of 
the specific focus on financial institutions has taken place in those 
organizations focusing on economic and regulatory, rather than 
judicial, issues. Some experts noted that there is a tradition for 
agreeing voluntarily to regulatory harmonization that was established 
originally at Basel. However, after the passage of the Dodd-Frank Act, 
which intended to limit assistance to individual financial 
institutions, there is continued debate as to whether governments will 
individually provide assistance to specific failing financial 
institutions or will ring fence assets when possible insolvencies 
threaten the stability of their national economies. And, countries 
such as the UK, continue to provide for the possibility of such 
assistance through a temporary public ownership provision in their 
recently enacted banking laws. Although some experts told us that a 
comprehensive treaty would help to ensure that countries have 
coordination mechanisms that are strong enough to withstand another 
global financial crisis, prospects for a treaty in this area appear 

Agency Comments and Our Evaluation: 

We provided a draft of this report to the AOUSC, Commodity Futures 
Trading Commission, Departments of the Treasury and State, Federal 
Deposit Insurance Corporation, Federal Judicial Center, Federal 
Reserve, National Association of Insurance Commissioners, SEC, and 
SIPC for review and comment. We received technical comments from the 
AOUSC, Commodity Futures Trading Commission, Departments of the 
Treasury and State, Federal Deposit Insurance Corporation, Federal 
Judicial Center, Federal Reserve, National Association of Insurance 
Commissioners, SEC, and SIPC, which we incorporated as appropriate. We 
also requested comments and received technical comments and 
perspectives on drafts of the case studies from relevant legal experts 
and the judges associated with the cases, which we incorporated as 

We are sending copies of this report to the appropriate congressional 
committees, Director of the Administrative Office of the U.S. Courts, 
the Chairman of the Commodity Futures Trading Commission, the 
Secretary of the Treasury, the Secretary of State, the Chairman of the 
Federal Deposit Insurance Corporation, the Director of the Federal 
Judicial Center, the Chairman of the Board of Governors of the Federal 
Reserve System, the Chief Executive Officer of the National 
Association of Insurance Commissioners, the Chairman of the Securities 
and Exchange Commission, and the Chairman of the Securities Investor 
Protection Corporation, and other interested parties. The report also 
is available at no charge on the GAO Web site at [hyperlink,]. 

If you or your staff members have any questions about this report, 
please contact Alicia Puente Cackley at (202) 512-8678 or Contact points for our Offices of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. Major contributors to this report are listed in appendix X. 

Signed by: 

Alicia Puente Cackley: 
Director, Financial Markets and Community Investment: 

List of Committees: 

The Honorable Tim Johnson: 
The Honorable Richard C. Shelby: 
Ranking Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate: 

The Honorable Patrick Leahy: 
The Honorable Charles E. Grassley: 
Ranking Member: 
Committee on the Judiciary: 
United States Senate: 

The Honorable Spencer Bachus: 
The Honorable Barney Frank: 
Ranking Member: 
Committee on Financial Services: 
House of Representatives: 

The Honorable Lamar Smith: 
The Honorable John Conyers, Jr. 
Ranking Member: 
Committee on the Judiciary: 
House of Representatives: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

As required under section 202 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act), this report examines (1) 
actions taken by the U.S. District Court for the District of Columbia 
(D.C. District Court) in response to the judicial review provision of 
the Orderly Liquidation Authority (OLA) of the Dodd-Frank Act; (2) the 
effectiveness of Chapters 7 and 11 of the U.S. Bankruptcy Code (Code) 
in facilitating orderly liquidations or reorganizations of financial 
institutions; (3) proposals for improving the effectiveness of 
liquidations and reorganizations under the Code; and (4) mechanisms 
that facilitate international coordination and any barriers to 
coordination of financial institution bankruptcies.[Footnote 108] 

To address all of our objectives, we reviewed relevant laws such as 
the Code and the Dodd-Frank Act as well as GAO reports that addressed 
bankruptcy issues and financial institution failures. We also reviewed 
economic and legal research on bankruptcies, especially bankruptcies 
of financial institutions. As part of this review, we conducted two 
literature searches, one on federal government documents, and one on 
published research on bankruptcy effectiveness, especially as related 
to financial institutions. The latter search relied on Internet search 
databases (including EconLit and Proquest) to identify studies 
published or issued after 2000. We reviewed these articles to further 
determine the extent to which they were relevant to our engagement, 
that is, whether they discussed criteria for effectiveness of the 
bankruptcy process, key features of the bankruptcy process, proposals 
for improving the bankruptcy process, or international coordination. 
The search of the published research databases produced 106 articles. 
A little over half of these documents were relevant to our objectives. 
Specifically, among the documents written by authors we did not 
interview, 15 documents discussed issues related to criteria for 
judging effectiveness, 11 discussed issues related to the treatment of 
qualified financial contracts and proposals for modifying the Code, 10 
discussed issues related to international coordination, and 4 
discussed the Lehman bankruptcy. We augmented this research with 
articles provided by those we interviewed or obtained from 
conferences. In addition, we reviewed a number of prior GAO reports 
related to bankruptcy issues, financial institutions, and the 
financial crisis. These are listed in "Related GAO Products" at the 
end of this report. 

To provide explicit examples throughout our report, we conducted in- 
depth reviews of three bankruptcy cases of financial institutions and 
developed some information on the bankruptcies or failures of another 
11 companies. We chose three companies for in depth reviews--CIT 
Group, Inc. (CIT), Lehman Brothers Holdings, Inc. and subsidiaries 
(Lehman), and Washington Mutual, Inc.--on the basis of their size and 
the variety of experiences and structures such as the types of 
businesses in which they engaged, amount of planning for bankruptcy, 
their organizational structures included regulated subsidiaries, the 
extent of their international operations, and their having entered 
bankruptcy after 2005 when the Code was revised. These cases represent 
the three largest financial institution bankruptcies as measured by 
consolidated asset levels in their most recent 10-K filing before 
filing for bankruptcy.[Footnote 109] They also represent a range of 
company types and experiences. For example, CIT, which became a bank 
holding company only in 2008, provided commercial lending and leasing 
products, management advisory services, and small and mid-market 
business finance. Lehman provided a range of investment banking and 
broker-dealer services that involved it in a number of contracts that 
received safe harbor treatment under bankruptcy law. Washington Mutual 
was a thrift holding company whose major holdings were insured 
depository institutions. The companies also had a range of bankruptcy 
experiences--CIT was a prepackaged bankruptcy, while Lehman and 
Washington Mutual had engaged in little planning before their filings. 
In addition, the Lehman bankruptcy involved extensive activities in 
other countries.[Footnote 110] The Lehman and Washington Mutual cases 
also help to elucidate the role of the special resolution regimes for 
broker-dealers and insured depositories. We did not include a company 
that was engaged primarily in insurance activities because few holding 
companies with extensive insurance operations have gone through the 
bankruptcy system in recent years. For these case studies, we reviewed 
judicial proceedings including examiner reports, confirmation 
opinions, and disclosure statements, and conducted interviews with 
experts familiar with the cases. We concluded that the quantitative 
information in these sources were sufficiently reliable for our 
purposes. Appendixes III, IV, and V cover these cases in detail. 

In addition to these case studies, we chose a number of financial 
institution failures or near failures that provided examples of 
specific aspects of the bankruptcy process or other aspects of 
financial institution failures. These were examples provided by those 
we interviewed or had been used in research articles. The examples 
include American International Group, BankHaus Herstatt, Bank of 
Credit and Commerce International, Bernard L. Madoff Investment 
Securities, Colonial Bancgroup, Drexel Burnham Lambert Group, Inc., 
Dexia SA, Fortis Bank SA/NV, the Icelandic banking crisis, Long Term 
Capital Management, and Nextbank. Appendix VI includes information on 
these examples that we use throughout the report. 

During our review, we conducted structured interviews with private 
sector experts, including practicing attorneys, law professors, 
economists, accountants, and trade associations, who have expertise on 
bankruptcy and financial institutions (see app. IX for the 
organizational affiliations of those we interviewed). These experts 
were chosen because they best met certain criteria--they had published 
multiple articles on relevant issues, made proposals to modify the 
Bankruptcy Code, been involved in the bankruptcies we chose for our 
case studies, testified before Congress, and been recommended by 
agency officials. We also conducted similar in-depth interviews with 
U.S. and foreign government officials, including regulators, judges, 
and other court officials. Specifically, we met with officials at the 
Administrative Office of the U.S. Courts (AOUSC), Commodity Futures 
Trading Commission, Federal Deposit Insurance Corporation (FDIC), 
Board of Governors of the Federal Reserve System (Federal Reserve), 
Federal Judicial Center, National Association of Insurance 
Commissioners, SEC, Securities Investor Protection Corporation, U.S. 
Department of State, and U.S. Department of the Treasury, and at the 
Southern District of New York and Delaware District Bankruptcy Courts. 
We conducted in-depth interviews with these officials and with 
practicing attorneys, economists, and law professors to help develop 
criteria for effectiveness, determine critical factors in the 
bankruptcy system, determine what company characteristics complicate 
bankruptcies, identify mechanisms for and limitations on international 
coordination, and collect views on proposals to change the bankruptcy 
process and improve international coordination. Because each of the 
experts with whom we spoke had differing experiences with bankruptcy 
and resolution of failed financial institutions, we generally did not 
aggregate their responses. Because the Dodd-Frank Act mandated AOUSC 
and the Federal Reserve to conduct reviews similar to those we were 
conducting, we met regularly with these agencies throughout the 

We also undertook a number of activities specific to each objective: 
To address the first objective to examine the actions taken by the 
D.C. District Court under section 202 of the Dodd-Frank Act, we met 
regularly with AOUSC. We contacted staff of the relevant congressional 
committees to determine whether they had received the D.C. Federal 
District Court's rule under the Dodd-Frank Act provision requiring 
publication and submission of the rule to the Congress.[Footnote 111] 
We also searched the Federal Register and monitored the Web sites of 
FDIC and the Federal Reserve to determine whether relevant rules--
those that defined financial companies and those that defined the 
conditions for default--had been issued. During this process we also 
observed industry roundtables held by FDIC to help develop rules to 
implement OLA. 

To address the second objective, we analyzed the results of the 
literature review and expert interviews to determine criteria for 
effectiveness of the Code, key elements in the bankruptcy process that 
pose issues for financial institutions, and characteristics of 
financial institutions that pose challenges for the bankruptcy 
process. We also collected and analyzed available data on financial 
institution bankruptcies to determine if the data were useful for 
assessing the effectiveness of financial institution liquidations or 
reorganizations. We collected data from the AOUSC and New Generations 
Research, Inc. a company that takes data from the U.S. bankruptcy 
filings and augments it with industry-specific data, and from a law 
professor at the University of California, Los Angeles who also 
collects bankruptcy data. The AOUSC provided lead case data on mega 
cases (involving assets of more than $100 million and more than 1,000 
creditors) that included date and location of filing and some 
information on how closed cases were concluded (such as by sale, 
liquidation, or reorganization). By matching data from the New 
Generations with the AOUSC-provided data, we were able to provide some 
context on the number of Chapter 11 mega cases that represented 
financial institutions, and we decided the data were sufficiently 
reliable for that purpose. However, as noted in the report, we found 
that the data were not sufficient for measuring the effectiveness of 
the bankruptcy process for liquidating and reorganizing financial 
institutions because they did not provide information on returns to 
creditors. In addition, only a small proportion of mega cases were 
financial institutions. To show the extent to which large financial 
institutions operate across national borders, we developed information 
from SNL Financial and publicly available company information on 30 
large financial institutions relative to their size and international 
operations. We concluded that these data were sufficiently reliable 
for our purposes. 

To address the third objective, we reviewed the literature, as 
described earlier, to determine the range of proposals that had been 
made to reform the bankruptcy process for financial institutions. We 
categorized some of the proposals into groups, such as those that 
included a role for the regulators or modified the treatment of 
qualified financial contracts and then asked the experts looking at 
these categories and these specific proposals to tell us which they 
considered had merit and should be included for further consideration 
and why. We also discussed their opinion on any additional proposals. 
Another academic group--including some of the experts we had 
previously contacted--that had a multipart proposal for reforming the 
bankruptcy process contacted us about their proposal when interviewed 
by another GAO team. This occurred after we had completed our expert 
interviews. To the extent that this proposal for reforming the 
bankruptcy process included new elements, these were not included in 
our earlier expert interviews. We analyzed the results of the academic 
research and our expert interviews to determine whether the proposals 
addressed the criteria specified in our second objective and to 
determine reasons for adopting or not adopting the various proposals. 

To address the fourth objective, we supplemented our domestic 
interviews by interviewing international experts on resolving failed 
financial institutions, including economists, attorneys, court 
officials, and regulators from Canada, Germany, the European 
Union(EU), Mexico, the Netherlands, Switzerland, and the UK. We also 
reviewed information they provided on some key characteristics of the 
bankruptcy processes in 10 countries, detailed in appendix VIII. We 
chose these countries because of their importance to the U.S. 
financial system and their geographic scope. We did not independently 
analyze these laws or procedures; instead, we relied on assessments 
provided by international legal experts and country court and 
regulatory officials. 

We conducted this performance audit from August 2010 to July 2011, in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Local Civil Rule 85: 

United States District Court For The District Of Columbia: 

Voting: Judges Kollar-Kotelly, Kennedy, Roberts, Huvelle, Walton, 
Bates, Hogan, Urbina, Friedman and Kessler. 

It is this 19th day of January, 2011 ordered that effective 
immediately that Local Civil Rule 85 has been adopted by the Court. 

LCvR 85: 

Filings Under The Dodd-Frank Wall Street Reform & Consumer Protection 

This rule governs petitions by the Secretary of the Treasury 
("Secretary") under the Dodd-Frank Wall Street Reform and Consumer 
Protection Act ("Act"), Pub.L. No. 111-203, 124 Stat. 1376, 1444 (Jul. 
21, 2010), 12 U.S.C. § 5382(a)(1), for orders authorizing the 
Secretary to appoint the Federal Deposit Insurance Corporation as 
receiver for financial companies. 

(a) Filing Of The Petition: 

A petition under this Act must contain all relevant findings and 
recommendations under the Act, and must be filed under seal. The 
original and one copy of the petition and a PDF version on a CD-ROM 
shall be tendered to the Clerk. The original and copy of the petition 
and all related documents shall be submitted securely in an 
envelope/box appropriate to accommodate the documents. The 
envelope/box containing such documents shall have a conspicuous 
notation as follows: "Document Under Seal." 

(6) Notice To The Court: 

At least 48 hours prior to filing the petition, the Secretary shall 
provide written notice under seal to the Clerk of the Court that a 
petition will likely be filed with the Court. 

(c) Notice To The Financial Company: 

A petition shall be accompanied by a certificate of counsel or other 
proof satisfactory to the Court, stating (1) that actual notice of the 
time of filing the petition, and copies of all papers filed to date or 
to be presented to the Court at any hearing, have been furnished to 
the financial company; or (2) the efforts made by the Secretary to 
give such notice and furnish such copies. The certificate shall also 
contain the name and contact information of the individual at the 
financial company to whom notice was given and upon whom service was 

(d) Opposition To The Petition: 

(e) The financial company named in the petition may file an opposition 
to the petition under seal and may appear at a hearing to oppose the 
petition. The opposition shall be served on the Secretary by the most 
expeditious means available. 

(e) Proposed Order: 

Each petition and opposition shall be accompanied by a proposed order. 

(f) Assignment Of The Petition: 

The petition shall be assigned to the Chief Judge or Acting Chief 

(g) Consideration Of Petition: Notification Of Decision: 

In considering a petition, the Court shall, on a confidential basis 
and without public disclosure, determine whether the Secretary's 
decision that the covered financial company (1) is in default or in 
danger of default and (2) satisfies the definition of a financial 
company under the Act is arbitrary and capricious. 

(1) Upon a finding that the Secretary's determination is not arbitrary 
and capricious, the Court shall issue an order immediately authorizing 
the  Secretary to appoint the Corporation as receiver of the covered 
financial company. 

(2) Upon a finding that the Secretary's determination is arbitrary and 
capricious, the Court shall provide immediately for the record a 
written statement of each reason supporting the determination of the 
Court, and shall provide copies thereof to the Secretary and the 
covered financial company, and must afford the Secretary an immediate 
opportunity to amend and refile the petition. 

(h) Timing Of Decision: 

The Court shall attempt to rule on a properly filed petition within 
twenty-four (24) hours of receipt of the petition. In the event that 
the Court does not do so, the petition is deemed granted by operation 
of law under the Act. 

(I) Maintaining Petitions And Subsequent Filings Under Seal: 

The petition and subsequent filings must be maintained under seal 
pending further order of the Court. Upon the granting of a petition, 
the Secretary shall promptly notify the Court of the appointment of 
the receiver. The Court shall then issue an Order to Show Cause to the 
Secretary as to why the proceedings, or any part thereof, shall not be

(j) Stay Pending Appeal: 

The decision of the Court on a petition shall not be subject to a stay 
or injunction pending appeal. 

For The Court: 

Royce C. Lamberth: 
Chief Judge: 

[End of section] 

Appendix III: CIT Group Bankruptcy: 

This appendix describes selected aspects of the CIT bankruptcy. The 
items discussed here provide more detail on certain aspects of the 
bankruptcy than we cover in the main body of the report. This appendix 
does not attempt to summarize the case or fully capture its 
complexities. Table 3 provides a timeline of selected events related 
to the CIT bankruptcy. 


Before filing for bankruptcy, CIT--a 100-year old, New York-based 
lender--had changed its business focus. According to CIT's filings 
with the SEC, CIT had been involved in consumer finance before 2008, 
when losses in mortgage-related businesses caused it to change its 
business model to focus exclusively on its core businesses of 
commercial lending and leasing products, management advisory services, 
and small and mid-market-business finance. At that time, CIT was 
active in more than 30 industries and 50 countries. In the first 
quarter of 2007, CIT reported record quarterly earnings of $271.4 
million or $1.37 per common share. The market capitalization of the 
common shares of the company peaked in February 2007 at $12.17 
billion. CIT relied extensively on both secured and unsecured debt 
capital markets for funding. The company had accessed global capital 
markets issuing notes denominated in euros, British pounds, Canadian 
dollars, and Swiss francs as well as borrowing directly from a bank in 
Japanese yen. In December 2008, CIT received approval from the Federal 
Reserve to become a bank holding company. CIT's bank holding company, 
CIT Group, Inc., was incorporated in Delaware. At that time, CIT 
Group, Inc. had a bank subsidiary, CIT Bank, and more than 400 nonbank 
subsidiaries, including special purpose entities and other regulated 
subsidiaries in the United States and abroad. CIT Bank, based in Salt 
Lake City, Utah, had been a state-chartered, industrial loan company 
but changed its charter to a state-chartered commercial bank in 2008. 
CIT Bank is subject to regulation by both FDIC and the Utah Department 
of Financial Institutions. 

From the second quarter of 2007 through the third quarter of 2009, CIT 
lost money in every quarter for a total of $6.3 billion. According to 
the company's filings with SEC, disruptions in the credit markets 
combined with the global economic deterioration that began in 2007 
materially worsened CIT's liquidity situation. Successive downgrades 
by the rating agencies of debt issued by CIT to below investment grade 
in 2008 and 2009 compounded CIT's problems, leaving the company 
without access to unsecured debt markets. According to CIT's SEC 
filings, during the period of 2008 through its bankruptcy, CIT 
obtained interim secured financings, such as the senior credit 
facility detailed below, and reduced its financing needs through 
balance sheet contraction. 

Because CIT had changed its structure to that of a bank holding 
company--upon receiving approval from the Federal Reserve on December 
22, 2008--it was eligible to participate in the Capital Purchase 
Program under the Troubled Asset Relief Program (TARP). On December 
31, 2008, CIT received $2.33 billion from TARP. In exchange, the 
Office of Financial Stability in the Department of the Treasury 
received preferred equity stock and a warrant to purchase CIT's common 

According to CIT's filings with SEC, as part of its overall plan to 
transition to a bank-centric business model, CIT had applied to 
participate in FDIC's Temporary Liquidity Guarantee Program (TLGP). 
Participation in this program would have enabled CIT to issue up to 
$10 billion in government-guaranteed debt. However, CIT did not 
receive approval to issue TLGP backed debt. CIT also applied for 
exemptions under Section 23A of the 1913 Federal Reserve Act (Section 
23A) and the Federal Reserve's implementing regulation to transfer a 
significant portion of its U.S. assets to its subsidiary, CIT Bank. 
This transfer enabled CIT to generate liquidity by leveraging the 
deposit-taking capabilities of CIT Bank. In April 2009, the Federal 
Reserve granted CIT a partial waiver from Section 23A requirements, 
which govern transactions between affiliated bank and nonbank 
companies, to transfer $5.7 billion of government-guaranteed student 
loans to CIT Bank.[Footnote 112] In connection with this transaction, 
CIT Bank assumed $3.5 billion in debt and paid $1.6 billion in cash to 
CIT Group, Inc. On July 15, 2009, CIT was advised that there was no 
appreciable likelihood of receiving additional government support in 
the near term, either through participation in TLGP or further 
approvals of asset transfers under its remaining pending Section 23A 
exemption request. Following this announcement, CIT experienced higher 
customer usage of prior financing commitments, accelerating the 
degradation of its liquidity position. This liquidity situation, its 
continued portfolio deterioration, and the generally weak economic and 
credit environment all weighed heavily on CIT's financial performance. 

To meet its near-term liquidity needs, CIT entered into a $3 billion 
senior secured term loan facility on July 20, 2009--which was amended 
and restated on August 3, 2009--provided by a syndicate comprised of 
certain of CIT's preexisting creditors. By August 4, 2009, CIT had 
drawn the entire $3 billion in financing under this senior credit 
facility. Both CIT Group, Inc. and certain subsidiaries were borrowers 
under this facility. CIT Group, Inc. and all of its U.S.-based, wholly 
owned subsidiaries--with the exception of CIT Bank and other regulated 
subsidiaries, such as wholly owned banks in Brazil, France, Germany, 
Sweden, and the UK, special purpose entities, and immaterial 
subsidiaries--were guarantors of this senior credit facility. At the 
same time as announcing this facility, CIT announced that it was 
beginning to attempt to restructure its liabilities to improve its 
liquidity and capital position. This involved an offer by which 
certain senior notes maturing in August would be repaid by CIT at a 20 
percent discount on the face value with a 2.5 percent premium payable 
to those who agreed to these terms by the end of July. This offer was 
subject to approval by holders of 90 percent of the $1 billion in 
these notes outstanding. On August 3, 2009, CIT announced that only 
64.97 percent of the debt holders agreed to the tender offer. Then, 
CIT increased the offered payout to 87.5 percent while lowering the 
minimum debt holder approval hurdle to 58 percent. Debt holders with 
59.8 percent of the outstanding notes agreed to the tender offer and 
were paid out the discounted amount. The remaining 40 percent of debt 
holders were paid the full face value on their notes. 

The Bankruptcy: 

By the end of the third quarter of 2009, CIT was negotiating with a 
group of its largest creditors to secure interim financing and develop 
a restructuring plan that included a plan to exchange debt on a 
voluntary basis or to serve as a prepackaged bankruptcy plan, 
according to an expert involved in the negotiations.[Footnote 113] The 
restructuring plan would need approval from almost all the creditors, 
while a prepackaged bankruptcy plan would need approval only from a 
majority of the creditors, which would in turn provide it with 
emergency financing. CIT also adopted a strategy to help ensure that 
it would be able to preserve the deferred tax assets associated with 
the more than $6 billion in operating losses it had borne over the 
prior two and a half years. On October 1, 2009 CIT announced its 
restructuring plan had been approved by a steering committee of the 
company's creditors. The plan included a series of voluntary exchange 
offers where existing debt holders would exchange their existing notes 
for a series of five newly issued securities. The plan was then 
presented to CIT creditors to be voted on pursuant to securities laws. 
Eligible creditors were asked to vote on the exchange offer and a 
prepackaged bankruptcy plan. The exchange offer included voluntarily 
replacing certain unsecured notes with secured notes at 70 cents on 
the dollar. The prepackaged bankruptcy plan which has a lower 
threshold for approval than an exchange plan, was offered in the event 
that creditors did not vote for the exchange offer in a high enough 
percentage to be binding. For the vote, creditors and equity holders 
were organized into 18 classes. Only Classes 6 through 13 
(representing lower-priority creditors) were entitled to vote and they 
were subject to a partial impairment of the debt owed to them by CIT. 
Classes 1 through 5 and Class 17, representing senior creditors and 
secured creditors, as well as some unsecured creditors, holders of 
guarantees by CIT and CIT entities owed money by other CIT entities, 
were not entitled to vote; the plan called for paying their claims in 
full so they were deemed to have accepted the plan. Classes 14 through 
16 and Class 18 primarily representing preferred and common equity 
shareholders were not entitled to vote and were deemed to reject the 
plan and received no payment. In addition, the new common equity 
shares in CIT were to be distributed to those creditors that were 
scheduled to receive principal payback less than full par value. 

CIT did not receive adequate approval for the exchange plan; however, 
it received approval from 92 percent of the 83 percent (based on the 
principal balance owed) of creditors that voted on the prepackaged 
bankruptcy plan for a restructuring framework. CIT Group and one other 
financing subsidiary filed for Chapter 11 protection on November 1, 
2009, in the bankruptcy court of the Southern District of New York. 
CIT requested that the prepetition vote be deemed a vote on a Chapter 
11 plan pursuant to section 1126(b) of the Code, which provides that a 
prepetition vote may be binding in a prepackaged Chapter 11 if the 
solicitation of the vote were applicable and in compliance with 
securities law. CIT's plan guaranteed significant recoveries to 
creditors and canceled or extinguished all of the existing equity 
classes, including the U.S. Treasury's preferred shares acquired 
through its $2.33 billion TARP capital injection. Holders of equity 
interests were not entitled to retain any property or interest in the 
new company. On December 10, 2009, CIT canceled and deregistered its 
old common stock, which had been delisted from the New York Stock 
Exchange on November 2, 2009, but had continued to trade. On December 
11, 2009, CIT issued 200 million shares of new stock to debt holders 
and other creditors and began trading on the New York Stock Exchange 
under the old CIT ticker symbol. CIT had effectively reduced its debt 
by approximately $12.5 billion (from $64.1 billion to $51.6) at the 
end of the third quarter of 2009. In addition, it preserved its 
deferred tax assets that stemmed from prebankruptcy losses. Its 
depository institution, CIT Bank, had preserved its well-capitalized 
status, and it and other operating subsidiaries continued to conduct 
business throughout the bankruptcy. There were no new adversary 
proceedings filed after November 2009. Several adversary proceedings 
were voluntarily dismissed.[Footnote 114] 

Table 3: Timeline of Selected Events Related to the CIT Bankruptcy, 
from April 2007 through December 2009: 

Key date: Apr. 18, 2007; 
Event or activity: CIT reports record earnings of $271.4 million or 
$1.37 a share for the first quarter of 2007. 

Key date: Dec. 22, 2008; 
Event or activity: CIT receives approval on its application to become 
a bank holding company from the Federal Reserve. 

Key date: Dec. 31, 2008; 
Event or activity: CIT receives Capital Purchase Program investment of 
$2.3 billion from U.S. Treasury. 

Key date: July 15, 2009; 
Event or activity: CIT is advised by regulators that there is no 
appreciable likelihood of receiving any further government assistance. 

Key date: July 20, 2009; 
Event or activity: Initial CIT Restructuring Announcement. 

Key date: Oct. 1, 2009; 
Event or activity: Exchange offer announced, prepackaged plan 

Key date: Oct. 29, 2009; 
Event or activity: Exchange offer closed. 

Key date: Nov. 1, 2009; 
Event or activity: Voluntary petition for bankruptcy filed. 

Key date: Nov. 2, 2009; 
Event or activity: New York Stock Exchange delists common and 
preferred stock. 

Key date: Dec. 7, 2009; 
Event or activity: Debtors file Modified Second Amended Prepackaged 
Reorganization Plan. 

Key date: Dec. 8, 2009; 
Event or activity: Plan confirmed. 

Key date: Dec. 9, 2009; 
Event or activity: Registration of 600,000 new CIT common shares and 
100,000 new preferred shares. 

Key date: Dec. 10, 2009; 
Event or activity: CIT files disclosure statement and emerges from 
Chapter 11 deregisters old stock. 

Key date: Dec. 11, 2009; 
Event or activity: New stock starts trading on the New York Stock 
Exchange at $29.64 per share. 

Sources: GAO review of SEC filings, CIT bankruptcy filings, regulatory 
filings, and other official company documents. 

[End of table] 

[End of section] 

Appendix IV: Lehman Bankruptcy: 

This appendix describes selected aspects of the Lehman bankruptcy. The 
items discussed here provide more detail on certain aspects of the 
bankruptcy that we cover in the main body of the report. This appendix 
does not attempt to summarize the case or fully capture its 
complexities. Table 4 provides a timeline of selected events related 
to the Lehman bankruptcy. 


Lehman was an investment banking institution that offered equity, 
fixed-income, trading, investment banking, asset management, and other 
financial services. According to the bankruptcy examiner appointed by 
the bankruptcy court, Lehman originated mortgages, securitized them, 
and then sold the securitized assets. Although headquartered in New 
York, Lehman operated globally. Lehman had $639 billion in total 
assets and $613 billion in total debts as of May 31, 2008, the date of 
its last audited financial statements. According to Lehman's 2007 
annual 10-K filing with SEC, the firm had 209 registered subsidiaries 
in 21 countries. Lehman included several regulated entities including 
Lehman Brothers, Inc (LBI), a broker-dealer subject to SEC oversight, 
and one state-chartered bank and one federally chartered thrift whose 
primary regulators at the federal level were the FDIC and the Office 
of Thrift Supervision, respectively.[Footnote 115] Until it filed for 
bankruptcy, Lehman also was subject to SEC supervision at the 
consolidated level.[Footnote 116] Although Lehman comprised numerous 
subsidiaries, it operated as an integrated entity. 

Investment banks such as Lehman generally rely on short-term financing 
and engage in derivative activities. Much of what constituted Lehman's 
borrowings was secured with collateral, including securities. 
According to a legal expert, even before the financial crisis Lehman 
needed to refinance about $100 billion on a daily basis. According to 
the Lehman bankruptcy examiner's report, as of August 31, 2008, Lehman 
had a net receivable (asset) of $46.3 billion and a liability of $24.2 
billion arising from its derivatives activity.[Footnote 117] Its 
derivative position represented a net positive of $22.2 billion. 
However, according to a legal expert, Lehman also was the guarantor to 
the majority of International Swaps and Derivatives Association (ISDA) 
derivatives contracts--an association of derivative market 
participants--with about 1.7 million trades and more than 10,000 
counterparties.[Footnote 118] 

The examiner attributes Lehman's decline and bankruptcy to aggressive 
investing in areas such as commercial real estate and to exceeding 
internal risk controls. Starting in 2006, Lehman invested the firm's 
capital in real estate lending and began holding mortgages on its 
balance sheet rather than selling the loans to other investors. In 
February 2007, Lehman stock traded at a record high of $85 per share, 
and its market capitalization exceeded $45 billion; however, according 
to the examiner's report, by September 2008 the stock had lost around 
95 percent of its value. And, in the months leading up to its 
bankruptcy filing, Lehman faced liquidity strains, worsened by 
increased collateral requirements from its clearing banks. For 
example, JPMC required Lehman to post additional collateral, also 
called a margin, worth more than the money it received from the bank. 
In February 2008, JPMC began increasing Lehman's margin requirements. 
By June 2008, JPMC required Lehman to post an additional $5 billion. 
On September 9, 2008, JPMC requested another $5 billion. Lehman agreed 
to post $3 billion the next day. JPMC also requested that Lehman agree 
to a new arrangement giving JPMC increased authority to request and 
seize collateral. On September 11, JPMC again requested $5 billion. 

The Bankruptcy: 

The Bankruptcy Filings: 

After government officials and those in the industry were unable to 
find a private-sector solution to Lehman's likelihood of defaulting on 
its obligations, Lehman Brothers Holdings, Inc (LBHI) filed for 
Chapter 11 bankruptcy on the morning of September 15, 2008. According 
to experts on the case, the abruptness of Lehman's filing contributed 
to many of the ensuing issues raised by creditors. According to its 
petition, LBHI had more than 100,000 creditors, with the largest being 
Citibank, N.A., which as indenture trustee for LBHI's senior notes 
held an unsecured claim of approximately $138 billion, and the Bank of 
New York Mellon Corporation (BNY), which had claims of approximately 
$12 billion and $5 billion as indenture trustee of LBHI's subordinated 
debt and junior subordinated debt, respectively. Between LBHI's 
bankruptcy filing on September 15 and September 17, LBI continued to 
borrow funds from the New York Federal Reserve Bank.[Footnote 119] 

Between September 16 and October 5, 2008, several other Lehman 
subsidiaries filed for Chapter 11 bankruptcy. On October 16, the 
Bankruptcy Court procedurally consolidated 15 subsidiaries into the 
main case.[Footnote 120] In the ruling, the court explicitly declined 
consideration of substantive consolidation at that time, which would 
have pooled the assets and liabilities of each subsidiary or other 
legal entity into one fund. The procedural consolidation was intended 
to reduce duplication of effort. For example, the court would not have 
to maintain separate dockets and files, and the debtors would not have 
to file redundant documents. 

Reorganization Plans: 

On March 15, 2010, the Lehman debtors (the debtors) filed their 
proposed Chapter 11 plan. On December 15, 2010, an ad hoc group of 
LBHI senior creditors (the ad hoc group) filed an alternative plan 
based upon a substantive consolidation of the debtors' cases. On 
January 25, 2011, the debtors filed their first amended joint Chapter 
11 plan. On April 25, 2011, a group of creditors opposed to that plan 
and the ad hoc group plan (the nonconsolidation creditors) filed an 
alternative counterplan (the nonconsolidation plan). On April 27, 
2011, the ad hoc group filed an amended second counterplan. At issue 
was the amount of substantive consolidation of the various debtors' 
assets and liabilities under each plan. The debtors' plan rejected 
complete substantive consolidation; instead claims against specific 
debtors would be "satisfied primarily" by that debtor's assets and 
compromises among creditors would satisfy additional claims. The 
nonconsolidation plan rejected the debtors' compromise plan and the 
complete substantive consolidation of the ad hoc group. 
Nonconsolidation creditors argued that no legal rationale exists for 
not respecting the separate corporate status of the individual Lehman 
debtors. They stated that LBHI "expressly advised its creditors of…
corporate separateness." The ad hoc group's plan was based on 
judicially ordered substantive consolidation. The group stated that 
creditors considered Lehman to be a unified economic entity and that 
Lehman operated as a single business entity in global markets. 

On June 29, 2011, Lehman filed a disclosure statement that set out the 
plan for distribution of assets to the claimants of 23 Lehman debtor 
entities. This plan was made after extensive negotiations with 
representatives of major creditor groups including those that 
supported substantive consolidation and those that did not. The plan 
asserts that although Lehman operated as a centralized business 
enterprise, certain critical factors such as the ease of segregating 
each individual entity's assets and liabilities support an argument 
against substantive consolidation. It should be noted that although 
representatives of the major constituencies believe that they have 
reached an agreement in principle to the terms of this plan, as of 
June 29, 2011, there were still conditions under which the plan could 
be amended. The plan separated the claims against each of the 23 
debtor entities and the shareholders of each debtor into classes based 
on the nature of the claims and the claimants' related legal rights. 
Allowed claims across the 23 entities totaled $361 billion. The estate 
estimates that recovered assets will total nearly $84 billion prior to 
total administrative expenses of $3.2 billion, amounts due to 
intercompany entities of nearly $2.9 billion, and operating 
disbursements of approximately $1.9 billion for a net distributable 
amount of $76.3 billion or a claim payout ratio of 21.1%. It should be 
noted that the plan estimates that 7 of the 23 entities will fully pay 
all of their claims and have remaining funds for their shareholders. 
These include two separately capitalized AAA rated subsidiaries 
through which Lehman conducted fixed income derivatives transactions. 
Recoveries to general unsecured derivatives creditors of three Lehman 
subsidiaries through which Lehman conducted equity derivatives, 
commodity and energy derivatives, and foreign exchange forward 
contracts and options business will receive payouts of 29.6 percent 
(equity), 50.8 percent (commodity), and 35.8 percent (foreign 
exchange). Creditors of the holding company, LBHI, will receive 16 
percent of their claims. 

Table 4: Timeline of Selected Events Related to the Lehman Bankruptcy, 
from September 2008 through April 2011: 

Key date: Sept. 15, 2008; 
Event or activity: LBHI files for bankruptcy. 

Key date: Sept. 17, 2008; 
Event or activity: Motion to sell LBI to Barclays, PLC (Barclays) 

Key date: Sept. 19, 2008; 
Event or activity: Liquidation of LBI under Securities Investor 
Protection Act (SIPA) commences. 

Key date: Sept. 20, 2008; 
Event or activity: Sale of certain assets and liabilities of LBI to 
Barclays authorized. 

Key date: Sept. 22, 2008; 
Event or activity: Sale of certain assets and liabilities of LBI to 
Barclays closed. 

Key date: Oct. 3, 2008; 
Event or activity: Lehman Brothers Special Financing (LBSF) files for 
bankruptcy along with Lehman Brothers OTC Derivatives, Inc. and Lehman 
Brothers Commodity Services, Inc. 

Key date: Oct. 5, 2008; 
Event or activity: Nine other Lehman entities file for bankruptcy. 

Key date: Oct. 16, 2008; 
Event or activity: Procedural consolidation of Lehman case. 

Key date: May 12, 2009; 
Event or activity: Lehman insolvency protocol signed. 

Key date: Sept. 22, 2009; 
Event or activity: Bar Date for claims against the Debtors. 

Key date: Mar. 11, 2010; 
Event or activity: Lehman Examiner's Report filed. 

Key date: Aug. 25, 2010; 
Event or activity: Securities Investor Protection Act Trustee's 
preliminary report released. 

Key date: Jan. 25, 2011; 
Event or activity: Debtors file the first amended joint Chapter 11 

Key date: Apr. 25, 2011; 
Event or activity: Nonconsolidation creditors file Chapter 11 plan. 

Key date: Apr. 27, 2011; 
Event or activity: Ad hoc group files amended Chapter 11 plan. 

Sources: Judicial filings and decisions from the U.S. Bankruptcy Court 
of the Southern District of New York. 

[End of table] 

Liquidation of Lehman Broker-Dealer: 

On September 19, 2008, Lehman's broker-dealer, LBI, was placed into 
liquidation under the SIPA in the Southern District of New York. The 
court appointed a SIPA trustee to oversee the liquidation of LBI's 
estate.[Footnote 121] According to the trustee, his main role was to 
"maximize the return of customer property to customers of LBI as 
defined by the law, while at the same time maximizing the estate for 
all creditors." 

The LBI resolution is the largest in SIPA history. As of April 22, 
2011, the trustee handled approximately 125,000 customer claims 
involving potentially $180 billion. Nearly 10,000 claims were 
investigated, denied customer status, and closed. More than 110,000 
claims, worth over $92 billion, were resolved through account 
transfers to other entities, including Barclays and Neuberger Berman, 
a Lehman subsidiary. Another 10,000 claims, worth about $46 billion, 
were resolved by SIPC. The amount of intercompany claims revealed the 
level of interconnectedness in Lehman. The other Lehman entities filed 
630 claims worth about $19.9 billion against LBI. These claims came 
not only from LBHI and Lehman Brothers International Europe (LBIE) but 
also from entities in Bermuda, the Dutch Antilles, Germany, Hong Kong, 
India, Japan, Luxembourg, the Netherlands, Singapore, Switzerland, and 
the UK. More than 14,000 claims with a face value of over $88 billion 
remained unresolved as of April 22, 2011, including 1,143 claims by 
clients of LBIE for over $22 billion. 

Selected Proceedings: 

The following cases are not intended to represent a complete legal 
history of the Lehman bankruptcy but to highlight certain issues 
presented in this report. The Lehman Brothers Special Financing (LBSF) 
case illustrates how a conflict between U.S. and UK law can create 
uncertainty. The Barclays case highlights the issues that can arise 
from a hurried financial institution bankruptcy. Finally, the Swedbank 
AB case illustrates the limits of safe harbors for qualified financial 

Lehman Brothers Special Financing Case: 

At issue were competing payment priorities between Perpetual Trustee 
Company Limited (Perpetual), an Australia-based asset management 
company, and LBSF regarding collateral held by BNY Corporate Trustee 
Services Limited (BNY trustee). The cases were heard in U.S. and 
English courts. On November 6, 2009, the English Court of Appeal 
upheld a lower court decision in favor of Perpetual. On January 25, 
2010, the U.S. court ruled in favor of LBSF and called for all parties 
to work together to reach an agreement.[Footnote 122] 

In 2002, LBIE had begun to issue a series of structured notes. 
Perpetual had bought two series of the notes, issued by Saphir Finance 
Public Limited Company (Saphir)." The two series of notes were issued 
in the UK and written so that English law would govern their dealings. 
Each note was backed by collateral and included a swap agreement with 
LBSF, which was guaranteed by LBHI and also backed by collateral. The 
collateral was held by BNY trustee as a trustee for Saphir. Normally, 
LBSF as the swap counterparty would have priority rights to the 
collateral over Perpetual. However, a "flip" clause in the contracts 
specified that, if LBSF defaulted, the priorities would flip, and 
Perpetual would have rights to the collateral ahead of LBSF. 

LBSF filed for bankruptcy on October 3, 2008. On December 1, 2008, 
Saphir exercised its termination rights on the swap agreements with 
LBSF. On May 20, 2009, LBSF filed a complaint against the BNY trustee 
for the collateral in U.S. Bankruptcy Court claiming that the flip 
clause was unenforceable. The U.S. Bankruptcy Code prohibits clauses 
(called ipso facto clauses) that modify a contract based on a 
bankruptcy filing. LBSF argued that the flip clause violated the Code 
because it modified the payment structure based on LBSF's default. The 
BNY trustee countered that the contracts were agreed to and valid 
under English law, and the U.S. courts should defer to the English 
courts. The BNY trustee further argued that even if the flip clause 
normally would be unenforceable, safe harbor provisions (that is, the 
Code's exemptions of qualified financial contracts from an automatic 
stay) protected the agreement. The BNY trustee also argued that the 
flip clause was a "subordination agreement" and enforceable under the 
Code.[Footnote 123] 

At the same time, Perpetual filed suit in the UK against the BNY 
trustee for the collateral to enforce the flip clause. On November 6, 
2009, the English court ruled that the flip clause was valid and in 
effect. The court ruled that LBSF's claim on the collateral was 
"always limited and conditional" and no reason existed to override the 
contract. On January 25, 2010, the U.S. court ruled that the flip 
clause was an unenforceable ipso facto clause. In his ruling, the 
judge noted that U.S. courts were not obligated to recognize a foreign 
court's decisions and that the English court did not take into account 
the Bankruptcy Code in making its decision. He added that courts did 
not have to extend recognition to a foreign court when doing so would 
be contrary to U.S. policy. The U.S. court also ruled that the safe 
harbor provisions of the Code did not apply to the flip clause, 
reasoning that the provisions referred to the "acceleration" of 
rights, not the "alteration" of rights; thus, they did not protect the 
priority changes of the flip clause. Finally, the U.S. court ruled 
that, even as a subordination agreement, the flip clause was 
unenforceable. Under normal circumstances LBSF could agree to have its 
priority rights subordinated to another party and this would be 
enforceable. However, since the subordination was triggered by a 
bankruptcy filing it still represented an ipso facto clause and 
remained unenforceable. 

Further, the U.S. court noted the complex and international nature of 
the case. It noted that the BNY trustee was in an unfavorable position 
since the English courts ruled for Perpetual's rights to the 
collateral while the U.S. ruled for LBSF. The U.S. court recommended 
that given the complexity of the case it would be better if all 
parties could settle the dispute. On December 16, 2010, the U.S. court 
approved a settlement. 

Barclays Sale Case: 

The Barclays sale case illustrates the difficulties and complexities 
of an expedited sale of a large financial institution during 
bankruptcy and the finality of sale orders under the Code. At issue 
was Lehman's sale of LBI to Barclays on September 22, 2008. LBHI and 
the committee of unsecured creditors (the committee) moved to have 
parts of the sale invalidated. On February 22, 2011, the U.S. 
Bankruptcy Court denied the motion to invalidate the sale order. 
[Footnote 124] 

In the week following its bankruptcy filing, Lehman wanted to sell 
assets, including LBI, to Barclays. Barclays had been in talks to 
acquire all of Lehman before the bankruptcy. On September 20, 2008, 
the court approved a sale of LBI to Barclays and the order was 
finalized on September 22. As part of the sale, the parties agreed to 
a "clarification letter" that clarified certain aspects of the sale 
and made some modifications to the agreement. 

LBHI and the committee argued that this sale order should be 
overturned, and Barclays should be liable for multibillion dollar 
claims for underpayments. They argued that Barclays withheld critical 
information from the court: a multibillion dollar discount in 
financial assets or that Barclays would not assume LBI's obligations 
to the Federal Reserve Bank of New York. Furthermore, they argued that 
certain executives were not acting in the interests of the company and 
were operating on behalf of Barclays as Barclays had made job offers 
to key decision makers. Due to these factors, the Lehman estate 
claimed that Barclays unfairly took advantage of LBHI and bought the 
assets at well below their fair value. Barclays countered that it gave 
the court all the information it needed. Barclays further argued that 
LBHI and the committee were happy to accept the deal at the time, but 
now regretted the sale, but that this regret was not grounds for 
overturning the sale order. 

On February 22, 2011, the court ruled that LBHI and the committee had 
not established a right to relief. The new information about the deal 
structure, while important, would not have changed the court's 
previous decision allowing the sale order. The court stated that it 
recognized that Barclays was the only buyer available to LBHI at the 
time given the uncertainty in financial markets and that since LBHI 
was in an unfavorable bargaining position compared to Barclays, it was 
not unreasonable to assume that Barclays would get the better end of 
the deal. The sale, while profitable to Barclays, also was needed to 
potentially stave off further financial disaster. Furthermore, the 
court ruled that the Lehman estate did not prove that former Lehman 
executives were acting in bad faith due to future employment prospects 
at Barclays. 

In another aspect of the Barclays Sale case, the SIPA Trustee (the 
trustee) disputed Barclays' claim to certain classes of assets, the 
15c3-3 assets, the margin assets, and the clearance box assets. 
[Footnote 125] The trustee argued that Barclays' claims for additional 
assets held by LBI, and the retention by Barclays of assets obtained 
as a result of the transfers of accounts and acquisition by Barclays 
of certain Lehman businesses, would reduce protection of LBI customers 
under applicable laws. Specifically, the trustee argued that $769 
million in assets held by LBI in the special account maintained 
pursuant to SEC Rule 15c3-3, known as the "Customer Protection Rule," 
and $507 million in assets held at the Options Clearing Corp., (these 
assets formed part of LBI's regulatory customer reserve formula) must 
be available to LBI to satisfy claims of LBI's customers, rather than 
provided to Barclays. In addition, the trustee argued that the terms 
of the Asset Purchase Agreement did not provide Barclays the right to 
acquire certain margin assets estimated to value $3.5 billion, or 
assets valued at approximately $1.9 billion held in LBI's clearance 
box account at the Depository Trust & Clearing Corporation. Barclays 
disputed the trustee's interpretation of the Asset Purchase Agreement 
and demanded all of the above assets in addition to those already 

The court ruled that the trustee was entitled to relief regarding the 
$769 million in assets held in LBI's 15c3-3 account, and the $507 
million held at the Options Clearing Corp, and that the trustee was 
entitled to the significant margin assets valued at approximately $3.5 
billion. With regard to the 15c3-3 account and reserve formula assets 
held at the Options Clearing Corp, the court ruled that Barclays' 
"self-interested construction of the language" runs counter to the 
deal's specific terms that such asset transfer be effected "to the 
extent permitted by applicable law," and that the trustee's 
interpretation of the deal was consistent with the broad principles 
underlying SIPA and its objective of giving priority treatment to 
customers. With regard to the margin assets, the court ruled that the 
specific terms of the Asset Purchase Agreement excluded these assets, 
and that representations made to the court at the Sale Hearing were 
unambiguous in meaning that no such margin assets were acquired by 
Barclays. As to the clearance box assets held at Depository Trust & 
Clearing Corporation, the court agreed with Barclays that despite 
conflicting language in the controlling documentation of the deal, the 
balance of the evidence favored that transfer of these assets to 

Swedbank AB Case: 

The Swedbank AB (Swedbank, a Swedish financial institution) case 
illustrates the limits of safe harbors for qualified financial 
contracts in bankruptcy. At issue was a dispute over a deposit account 
LBHI had at Swedbank and whether Swedbank could exercise set-off 
rights (essentially, rights to balance mutual claims between parties) 
in connection with its liability as a derivatives guarantor against 
LBHI's funds in the account. On May 5, 2010, the U.S. Bankruptcy Court 
ruled for LBHI granting its motion for an enforcement of the automatic 
stay against Swedbank. On January 26, 2011, the U.S. district court 
upheld the Bankruptcy Court's decision.[Footnote 126] 

LBHI and Swedbank were counterparties in several financial derivative 
transactions under various ISDA master agreements. LBHI also had a 
regular deposit account at Swedbank's Stockholm branch. On September 
15, 2008, LBHI had 2.1 million Swedish Kronor or approximately 
$310,000 in the Swedbank account. Once LBHI filed for bankruptcy, the 
account was frozen by Swedbank, thus preventing LBHI from withdrawing 
any funds. However, LBHI and other entities were able to deposit 
additional funds into the account. By November 12, 2009, LBHI had 
deposited an additional 82.8 million Swedish Kronor or approximately 
$10 million. 

Provisions in the ISDA master agreements into which LBHI and Swedbank 
had entered allowed for certain rights in case one party defaulted. 
Specifically, the master agreements could be terminated, and the 
nondefaulting party could set off mutual obligations. Swedbank claimed 
that LBHI owed it approximately $13.9 million or 97.5 million Swedish 
Kronor. On November 27, 2009, Swedbank announced that it would set off 
the obligations LBHI owed it with the money in the Swedbank account. 
The Lehman debtors contested this decision and filed suit on January 
22, 2010, to force Swedbank to return the funds to the Swedbank 

The main issue was whether the setoff violated the Code. More 
specifically, whether the safe harbor provisions in sections 560 and 
561 permitted Swedbank to set off according to the master agreement or 
whether the mutuality provision in section 553 prohibited Swedbank's 
action. LBHI argued that Swedbank violated the automatic stay because 
it seized money LBHI had deposited after filing for bankruptcy. As 
such, the deposits lack mutuality with LBHI's prebankruptcy debts. 
Swedbank argued that the setoff rights in the master agreement, and 
the safe harbors in the Bankruptcy Code provided an exemption from the 
automatic stay in this case. 

The Bankruptcy Court ruled that for Swedbank to set off debts with the 
deposits in the Swedbank account, the amount owed by LBHI to Swedbank 
had to be a "prepetition debt," LBHI's claim on Swedbank also had to 
be prepetition, and the two claims had to be mutual. The court ruled 
that because the funds in the Swedbank account were postpetition while 
the LBHI obligation to Swedbank was prepetition, no mutuality existed. 
Swedbank countered that even if no mutuality existed, it still could 
set off due to safe harbor protections in the Code. However, the court 
ruled that safe harbor provisions did not allow Swedbank to bypass the 
mutuality requirement. The court found no support to the claim that 
safe harbor provisions were intended to override the mutuality 
requirement, or any other underlying requirement, for setoff. 
Therefore, the court ruled that Swedbank had to return all funds 
deposited after the bankruptcy filing. 

[End of section] 

Appendix V: Washington Mutual Bankruptcy: 

This appendix describes selected aspects of the Washington Mutual, 
Inc. (Washington Mutual) bankruptcy. The items discussed here provide 
more detail on certain aspects of the bankruptcy than we cover in the 
main body of the report. This appendix does not attempt to summarize 
the case or fully capture its complexities. Table 5 provides a 
timeline of selected events related to the Washington Mutual 


Washington Mutual was a thrift holding company that had 133 
subsidiaries. These subsidiaries included Washington Mutual Bank, 
which was the largest savings and loan association in the United 
States prior to its failure, with more than 2,200 branches and $188.3 
billion in deposits, according to the confirmation opinion of the U.S. 
Bankruptcy Court of the District of Delaware.[Footnote 127] Washington 
Mutual Bank conducted most of Washington Mutual, Inc.'s primary 
banking activities. Washington Mutual Bank had more than $300 billion 
in assets at the time of its failure and a large subsidiary of its 
own, called Washington Mutual Bank, FSB.[Footnote 128] The Office of 
Thrift Supervision (OTS) was the primary regulator for Washington 
Mutual Bank and Washington Mutual Bank, FSB.[Footnote 129] Washington 
Mutual also had several nonbanking subsidiaries, including two captive 
reinsurers, several mortgage companies, and several real estate 
companies. At the time of filing, Washington Mutual had approximately 
$32.9 billion in total assets and total debt of approximately $8.1 
billion. Washington Mutual's common stock was listed on the New York 
Stock Exchange and traded at its highest level of $46.55 per share in 
January 2006 for a total market capitalization at that time of $44.9 

Washington Mutual Bank was the largest bank failure in U.S. history. 
According to the joint report of the Offices of Inspectors General for 
the Department of the Treasury and FDIC on regulatory oversight at 
Washington Mutual Bank, Washington Mutual Bank had weak risk 
management and pursued a strategy to pursue growth through 
originating, acquiring, securitizing, and servicing nontraditional 
loan products and subprime loans.[Footnote 130] This strategy broke 
down when housing and mortgage markets began to collapse in mid-2007. 
Until late 2007, Washington Mutual Bank remained profitable, but loan 
losses caused earnings to decrease 73 percent from the second to third 
quarter of 2007. Further loan losses and chargeoffs caused Washington 
Mutual Bank to post $1 billion in losses in both the fourth quarter of 
2007 and the first quarter of 2008. 

In March 2008, Washington Mutual began seeking additional capital. 
According to the report of the court-appointed examiner for the 
bankruptcy case and the Inspectors General's report, the holding 
company received a capital infusion of about $7 billion from TPG 
Capital (formerly known as the Texas Pacific Group) in April 2008, 
part of which went to Washington Mutual Bank and part of which was 
used to pay down Washington Mutual's debt.[Footnote 131] However, 
Washington Mutual Bank continued to suffer from significant depositor 
withdrawals as the housing market further deteriorated and IndyMac, 
FSB failed in July 2008. Washington Mutual Bank was a member of the 
Federal Home Loan Bank of San Francisco, which also began to limit 
Washington Mutual Bank's borrowing capacity.[Footnote 132] Following 
company share price declines, Washington Mutual appointed a new chief 
executive officer on September 7, 2008. However, after the collapse of 
Lehman on September 15, 2008, Washington Mutual Bank had a net deposit 
outflow of $16.7 billion (or more than 9 percent of total deposits) 
and experienced a second liquidity crisis. According to the Inspectors 
General's report, the bank was further hindered by its borrowing 
capacity limits, share price decline, portfolio losses, and other 
restrictions tied to the $7 billion capital investment. 

By September 23, 2008, OTS had found that Washington Mutual Bank had 
$4.6 billion in cash to meet its liquidity obligations, and its 
expected earnings would be insufficient to supplement its cash base. 
OTS began preparations to take over Washington Mutual Bank and appoint 
FDIC as the receiver. FDIC opened its Web site for potential bids for 
the bank. On September 24, JPMorgan Chase and Co. (JPMC), Citigroup, 
Inc., and Wells Fargo & Company each submitted bids to purchase 
Washington Mutual Bank, but both Citigroup's and Wells Fargo's bids 
did not meet FDIC's bid requirements. At the same time, the holding 
company's management was pursuing other alternatives to gain liquidity 
without a buyout, including using other assets to pledge as collateral 
to receive funding from the San Francisco Federal Home Loan Bank and 
the Federal Reserve Bank of San Francisco, according to the examiner's 
report. On September 24, Washington Mutual staff presented these 
alternatives to OTS but did not get a response. On Thursday, September 
25, OTS found Washington Mutual Bank to be unsafe and unsound and 
appointed FDIC as receiver. FDIC then sold substantially all of 
Washington Mutual Bank's assets to JPMC through a purchase and 
assumption agreement for $1.88 billion.[Footnote 133] 

The Bankruptcy: 

On September 26, 2008, Washington Mutual, Inc. filed a petition for 
relief pursuant to Chapter 11 of the Code. The filing for bankruptcy 
was completed the day after the closure of Washington Mutual Bank. 
Washington Mutual filed for bankruptcy to receive automatic stay 
protection against the seizure or dissipation of the holding company's 
remaining assets. The holding company's representatives maintain that 
they did not know which assets were transferred to JPMC when the bank 
was sold because they did not have access to the purchase and 
assumption agreement between FDIC and JPMC, so they wanted to maintain 
control over the remaining assets. The holding company's subsidiary 
WMI Investment Corp. also filed for Chapter 11 protection on September 
26, and these cases were administratively consolidated into one case. 

After filing its bankruptcy petition in September 2008, Washington 
Mutual's estate sought to recover $4 billion in deposits and other 
assets from FDIC that it said were on deposit with a subsidiary of 
Washington Mutual Bank (Washington Mutual Bank, FSB). FDIC denied all 
of Washington Mutual, Inc.'s claims in a letter dated January 23, 
2009. The holding company sued FDIC to return its deposits, among 
other reasons, while JPMC also sued Washington Mutual, seeking 
judgment that the funds (and other disputed assets) belonged to them 
as a cash infusion the holding company made to the bank to maintain 
the depository institution's capital levels. When the depository 
institution and holding company became eligible for more than $5 
billion in tax refunds as the result of a change in federal tax law 
related to the carrying forward of more than $14 billion in past 
losses, Washington Mutual, JPMC, and FDIC were able to come to an 
agreement in 2010 on how to split those proceeds, which would provide 
the holding company with value from the refunds.[Footnote 134] This 
agreement is discussed in greater detail later in this appendix. 

Nevertheless, Washington Mutual's shareholders were not satisfied with 
the settlement and sought review by a court-appointed examiner. The 
shareholders expressed disapproval of the global settlement plan and 
raised concerns about the failure of Washington Mutual Bank, including 
whether it was improperly assessed as unsafe and unsound or sold to 
JPMC for less than fair market value. In January 2010, the U.S. 
Trustee's Office appointed the official Committee of Equity Security 
Holders. In April 2010, the committee filed a motion for the 
appointment of an examiner because the debtors and the creditors' 
committee refused to provide equity holders with information. On July 
28, 2010, the bankruptcy court approved the appointment of an 
examiner, selected by the U.S. Trustee's office, to investigate the 
claims of various parties that were addressed by the global 
settlement. The examiner's report reviewed key issues related to the 
global settlement agreement including the disputed assets as part of 
the sale and was issued on November 1, 2010. While the examiner's 
findings supported a determination that the settlement agreement was 
fair and reasonable, the Bankruptcy Court for the District of Delaware 
did not allow the report as evidence because the judge found the 
report to be based mostly on hearsay, and officials commenting in the 
report were not available to testify.[Footnote 135] 

In January 2011, the bankruptcy judge in the Washington Mutual 
proceeding entered an order denying confirmation of the proposed plan 
of reorganization, which incorporated the global settlement.[Footnote 
136] Although finding that the global settlement of claims was fair 
and reasonable and provided a basis for confirmation, the judge 
concluded that the plan did not adequately address the terms of a 
global settlement of various claims by creditors and some 
shareholders. The judge also found that the plan was not confirmable 
unless certain deficiencies were corrected. After the order was 
issued, the interested parties pursued a revised plan. Confirmation 
hearings in the case have been repeatedly delayed, but could take 
place as early as July 2011. 

Table 5: Timeline of Selected Events Related to the Washington Mutual, 
Inc. Bankruptcy, from September 2008 through July 2011: 

Key date: Sept. 25, 2008; 
Event or activity: OTS finds Washington Mutual Bank to be unsafe and 
unsound and appoints FDIC as receiver. FDIC facilitates the sale of 
Washington Mutual Bank to JPMC for $1.8 billion and assumption of 

Key date: Sept. 26, 2008; 
Event or activity: Washington Mutual, Inc. files for bankruptcy 
protection in the U.S. Bankruptcy Court in Delaware. 

Key date: Oct. 3, 2008; 
Event or activity: First day of bankruptcy court hearing. 

Key date: Dec. 30, 2008; 
Event or activity: Washington Mutual, Inc. files proof of claim with 
FDIC related to the Washington Mutual Bank receivership. 

Key date: Jan. 23, 2009.; 
Event or activity: FDIC denies all of the debtors' claims. 

Key date: Mar. 20, 2009; 
Event or activity: Washington Mutual (debtor) files suit in the D.C. 
District Court against FDIC regarding $4 billion in assets FDIC 
transferred to JPMC. 

Key date: Mar. 24, 2009; 
Event or activity: JPMC files suit against Washington Mutual in U.S. 
Bankruptcy Court in Delaware over disputed assets in an adversary 

Key date: Nov. 6, 2009; 
Event or activity: Enactment of the Worker Homeownership and Business 
Assistance Act of 2009 permits businesses to use 2008 net operating 
losses to receive refunds on taxes paid in prior years.[B] 

Key date: Mar. 12, 2010; 
Event or activity: Washington Mutual, FDIC, and JPMC announce that 
they have reached a settlement regarding the disputed property and 
claims (called the global settlement). 

Key date: Apr. 12, 2010; 
Event or activity: Parties displeased with the global settlement 
(which included allocation of the tax refunds) file an adversary 
proceeding in the U.S. Bankruptcy Court in Delaware. 

Key date: May 21, 2010; 
Event or activity: Washington Mutual, Inc. files amended plan of 
reorganization and disclosure statement reflecting agreements reached 
with FDIC and JPMC. 

Key date: July 6, 2010; 
Event or activity: Parties displeased with the global settlement file 
a different adversary proceeding in the U.S. Bankruptcy Court in 
Delaware (known as the Trust Preferred Securities adversary 

Key date: July 28, 2010; 
Event or activity: The U.S. Bankruptcy Court in Delaware approves the 
U.S. Trustee's selection of an examiner to conduct an investigation 
into the merits of the various claims of the estate, JPMC, and FDIC 
which were being resolved by the global settlement. The examiner 
completed his report on November 1, 2010. 

Key date: Oct. 6, 2010; 
Event or activity: Modification of global settlement plan. 

Key date: Jan. 7, 2011; 
Event or activity: Denial of summary motion April 12, 2009, adversary 

Key date: Mar. 30, 2011; 
Event or activity: Approval of disclosure statement and solicitation 
procedures for revised plan. 

Key date: July 13, 2011; 
Event or activity: Scheduled date of confirmation hearing for plan. 

Sources: Judicial filings and decisions from the U.S. Bankruptcy Court 
of the District of Delaware, FDIC, and OTS. 

[A] The sale resulted in a closed bank transaction with no losses to 
the deposit insurance fund. 

[B] Pub. L. No. 111-92 § 13 (2009) allows firms to apply losses in 
2008 and 2009 to their taxable income for up to 5 prior years (with a 
limited amount for the fifth prior year), instead of the 2 years 
otherwise generally allowed. 

[End of table] 

Adversary Proceedings: 

Washington Mutual, Inc. and JPMC: 

Shortly following the sale of Washington Mutual Bank to JPMC, 
Washington Mutual filed a proof of claim with FDIC as receiver to 
recover about $4 billion in deposits allegedly held by the holding 
company in a subsidiary of Washington Mutual Bank. According to 
representatives of the holding company, the holding company was the 
largest creditor for the receivership and followed timelines for an 
appeal of FDIC's decision to transfer the holding company's assets. 
FDIC denied the claim in a letter dated January 23, 2009, and 
Washington Mutual then sought an appellate review. 

As discussed earlier, on March 20, 2009, Washington Mutual filed suit 
in D.C. District Court against FDIC, asserting that FDIC: (1) should 
review its denial of Washington Mutual's claims; (2) wrongfully 
dissipated Washington Mutual Bank's assets; (3) took Washington 
Mutual, Inc.'s property without just compensation; (4) should convert 
Washington Mutual, Inc.'s property back to the holding company; and 
(5) should void its prior disallowance of Washington Mutual, Inc.'s 
claim to the deposits. This filing became known as the WMI action. 
Representatives of the holding company told us the holding company 
took a portion of the funds it raised in April 2008 and put it in a 
deposit account at a subsidiary of Washington Mutual Bank, called 
Washington Mutual Bank FSB, which also was seized by regulators. By 
the end of the second quarter of 2008, $5 billion of the funds from 
TPG Capital went into Washington Mutual Bank. Representatives of 
Washington Mutual told us they filed in the D.C. District Court 
because FDIC's main office is located there, and the challenged action 
occurred there. 

Four days later, JPMC filed a complaint in bankruptcy court against 
Washington Mutual, Inc. (known as the JPMC adversary proceeding) 
seeking a declaratory judgment that JPMC owned the deposited funds 
contested by Washington Mutual, Inc. JPMC maintained that the funds 
were a capital contribution to the bank rather than a deposit. 
[Footnote 137] JPMC and FDIC further questioned whether the deposits 
were a fraudulent transfer.[Footnote 138] On May 29, 2009, Washington 
Mutual, Inc. filed an answer and counterclaims to this adversary 
proceeding asserting ownership of the disputed assets in the deposits 
made to Washington Mutual Bank. Additional claims and counterclaims 
were made during this period both in D.C. District Court and in the 
Bankruptcy Court (District of Delaware). In the meantime, Washington 
Mutual, Inc.; JPMC; and FDIC entered into discussions on a settlement 
to resolve the distribution of assets. 

In November 2009, the Congress passed the Worker Homeownership and 
Business Assistance Act of 2009, which allowed companies like 
Washington Mutual to use their losses in 2008 to offset income on 
which taxes had been paid in the prior five years.[Footnote 139] As a 
result, the bank was entitled to receive refunds from federal income 
taxes paid in 2001-2008 of approximately $5 billion. There were 
competing claims to these tax refunds; however, on March 12, 2010, 
Washington Mutual, Inc., JPMC, and FDIC announced that they had 
reached a settlement of all the issues regarding the disputed property 
and related claims (known as the global settlement).[Footnote 140] The 
plan set forth the allocation of the tax refund among all of the 
parties: up to $2.2 billion to the holding company, up to $2.2 billion 
to JPMC (new owner of the bank), up to $850 million to FDIC, and $335 
million to the bank's bondholders. 

Other Adversary Proceedings: 

Two other groups filed adversary proceedings claiming that the 
transfer of certain assets under the global settlement to JPMC free 
and clear of all claims was improper. First, holders of trust 
preferred securities, issued in private placements from a holding 
company subsidiary called Washington Mutual Preferred Funding LLC 
(WMPF) and based on portfolios of home mortgage loans, filed an 
adversary proceeding against Washington Mutual, Inc. and JPMC on July 
6, 2010.[Footnote 141] The bankruptcy court ruled against the trust 
preferred securities holders.[Footnote 142] The second adversary 
proceeding stems from holders of litigation tracking warrants--
securities that track and pay-off based on outcomes of litigation--
from the proceeds of an ongoing lawsuit of one of Washington Mutual, 
Inc.'s former subsidiaries.[Footnote 143] The court denied the motion 
for summary judgment for the litigation tracking warrants holders 
because of disputed issues of material fact. 

[End of section] 

Appendix VI: Other Financial Institution Failures: 

This appendix describes a number of international and domestic 
financial institution failures and near failures that were chosen due 
to their historic significance, as well as their usefulness in 
illustrating the complications in resolving financial institution 

International Failures and Near Failures: 

BankHaus Herstatt. The 1974 failure of BankHaus Herstatt (Herstatt), 
which was based in Cologne, Germany, is cited as a major catalyst to 
several developments in international banking regulation and 
infrastructure.[Footnote 144] Although ranked only the thirty-fifth 
largest bank in Germany (by total assets), Herstatt was active in 
foreign exchange markets, where it had large and risky positions, 
according to Bank of International Settlement (BIS) reports. Further, 
according to these reports, German regulators forced it into 
liquidation on June 26, 1974, after the 3:30 p.m. German close of 
business. At that time (10:30 a.m. in New York), Herstatt's New York 
correspondent bank suspended outgoing U.S. dollar payments from 
Herstatt's account to Herstatt's counterparties that had already 
delivered the corresponding German currency to Herstatt. There were 
reports of similar difficulties with a correspondent bank in London. 
In part due to the Herstatt failure, the Group of Ten (G10) central 
bank governors in December 1974 established the Basel Committee on 
Banking Regulations and Supervisory Practices.[Footnote 145] The 
failure also stimulated other enhancements to the international 
payments system, including moving to same day settlement. 

Drexel Burnham Lambert Group, Inc. The 1990 failure of the Drexel 
Burnham Lambert Group (Drexel) provides an example of a bankruptcy of 
a complex financial institution that was relatively orderly, resulted 
in significant recoveries to creditors, and was completed within a 
relatively short time frame. Drexel was an investment bank that 
operated with a holding company structure that had subsidiaries 
including a large securities affiliate and broker-dealer (Drexel 
Burnham Lambert, Inc.) that had been active in the leveraged buy out 
and junk bond markets in the 1980s. Drexel filed for Chapter 11 
bankruptcy protection in February 1990 after experiencing severe 
liquidity strains. This was the result of legal issues during the late 
1980s, which culminated in it pleading guilty to six counts of 
securities and mail fraud and having to pay large civil disgorgement 
and penalty payments in the year prior to its bankruptcy filing. The 
unsecured creditors of Drexel Burnham Lambert, Group, Inc. organized 
into a committee with 18 members within 2 weeks of the bankruptcy 

Subsequent to Drexel's bankruptcy filing, market participants and 
creditors lost confidence in Drexel's solvent subsidiaries, including 
Drexel Burnham Lambert, Inc. and were unwilling to enter into new 
transactions with the firm. As a result, according to the estate's 
disclosure statement, the Drexel bankruptcy estate, with assistance 
from SEC, National Association of Securities Dealers (now the 
Financial Industry Regulatory Authority), and the Federal Reserve Bank 
of New York (FRBNY), transferred the customer accounts of Drexel 
Burnham Lambert, Inc., its securities affiliate and broker-dealer 
subsidiary, to other broker-dealers. This was necessary due to the 
legal prohibition against a stockbroker filing under Chapter 11 of the 
Bankruptcy Code. A stockbroker is defined as an entity that has 
customers and executes transactions either for the accounts of other 
securities industry participants or for the general public. As a 
stockbroker (or broker-dealer) the alternative would have been to use 
a SIPC process for liquidation. However, Drexel believed this would 
have created greater losses for Drexel and its creditors because the 
SIPC trustee would have liquidated the assets very quickly. Once 
Drexel Burnham Lambert, Inc.'s customer accounts were transferred, it 
effectively ceased being a stockbroker. Drexel, Burnham Lambert, Inc. 
then was able to file for Chapter 11 reorganization on May 29, 1990. 
Also in May 1990, another Drexel subsidiary, Drexel Burnham Lambert 
Trading Corporation, was forced into bankruptcy by creditors. Separate 
creditor committees formed for each of the two additional cases. 

The bankrupt entities--Drexel and its two subsidiaries--had 13 
additional legal entity subsidiaries, but the cases were procedurally 
consolidated into a single case. As a result, the creditor and equity 
committees worked with the bankruptcy estates and the court to 
negotiate and draft a single plan for distributing the assets of the 
three bankrupt entities. The plan called for the creditor and equity 
classes to be substantively consolidated across the bankrupt entities. 
This led to the creation of three new asset pools with a total of 25 
creditor and equity classes. In January 1992, this plan was 
distributed to creditors for a vote by the end of February. In early 
March 1992, upon approval by the majority of the creditors and less 
than 25 months after Drexel's initial filing, the judge confirmed the 
plan that detailed the payments to be made on claims to all creditor 
classes and resulted in warrants being given to equity class members 
in a successor entity named New Street Capital, which emerged from 
bankruptcy as a going concern.[Footnote 146] 

Bank of Credit and Commerce International. The 1991 failure of the 
Bank of Credit and Commerce International (BCCI) illustrates how the 
complicated organizational structure of a financial institution with 
multiple entities based in different sovereign jurisdictions can slow 
the resolution process. BCCI failed on July 5, 1991, affecting more 
than a million depositors across the world, many in developing 
countries in which deposit insurance was not available. At the time of 
its demise, BCCI was a London-based branch of a Luxembourg-
incorporated bank headquartered in Abu Dhabi (United Arab Emirates). 
Its majority shareholder was the government of Abu Dhabi, with another 
principal bank subsidiary incorporated in the Cayman Islands. BCCI had 
branches in at least 69 countries, including the United States. 
Specifically, BCCI secretly controlled seven commercial banks in six 
states and the District of Columbia through a bank holding company 
structure. U.S. and state regulators seized certain of these banks on 
July 5, 1991. The causes of BCCI's failure were significant accounting 
fraud discovered by an external auditor, poor performance, and 
substantial nonperforming loans made to large shareholders and 
employees. Also in July 1991, the Bank of England triggered the 
liquidation of the Luxembourg-based bank in a petition to the UK High 
Court, which appointed a liquidator. Later in the month, a receiver 
was appointed for the Cayman Islands bank by the Grand Court of the 
Cayman Islands. In the United States, FDIC mitigated its losses by 
ringfencing the assets of several of BCCI's U.S. 
subsidiaries.[Footnote 147] Doing so allowed FDIC to pay domestic 
creditors, including uninsured depositors, in full. For example, 
Independence Bank of Encino California was placed into receivership 
with FDIC in January 1992 upon discovery that BCCI management had 
fraudulently and secretly acquired ownership and control over the bank 
along with First American Bankshares, which was also a subsidiary of 
Independence Bank's holding company (First American Corporation, based 
in Washington, D.C.). To avoid a run on the deposits of the larger 
First American Bankshares, FDIC paid off more than 33,000 Independence 
Bank domestic creditor accounts the next day, including insured and 
uninsured depositors. Ultimate payouts totaled more than $500 million, 
of which at least $21 million were to uninsured depositors. 

On an international level, the liquidation for the four main BCCI 
entities was to a certain extent consolidated, with a pooling 
agreement and cost and recovery sharing agreements put in place by 
1993 covering entities in seven different countries. The view was that 
the affairs of BCCI's principal companies were intermingled to such an 
extent that it would have been impracticable to determine their 
respective assets and liabilities without considerable expense and 
delay. These agreements set out the proportions of the costs to be 
borne and recoveries to be received by the English, Luxembourg, 
Japanese, Cypriot, Bahraini, United Arab Emirates, and Chinese 
estates. The UK-based liquidators since have made recoveries through 
successful legal claims against parties that either previously failed 
to repay loans owed to BCCI entities, committed fraud against BCCI, or 
been negligent in the discharge of professional duties to BCCI. As of 
January 2011, the BCCI liquidation still was active and had collected 
a total $8.6 billion since July 1991 compared with total claims of 
$8.5 billion (creditors were entitled to make claims through March 
2010). The liquidators expect that processing claims will take several 
more years. However, as of January 2011, $6.5 billion had been paid 
out to secured and unsecured creditors in a series of seven dividends 
between December 1996 and December 2008. According to a February 2011 
report issued by the BCCI liquidators, the liquidating company is 
committed to making at least one additional payment and currently 
expects the final recovery amount to reach nearly 90 percent of all 
nominal claims, with the potential for further recoveries beyond this 
level. Total costs to the estate were $1.7 billion through January 

Long-Term Capital Management. The 1998 near collapse of Long-Term 
Capital Management (LTCM) illustrates coordinated private-sector 
action in response to the threat of failure of a relatively small, but 
systemically interconnected, financial institution. This potential 
systemic failure led to a Federal Reserve Bank of New York-organized, 
private sector-funded solution. In 1998, LTCM was one of the largest 
U.S. hedge funds, which specialized in arbitrage--"market-neutral" 
fixed-income trades--intended to take advantage of what it viewed as 
market inefficiencies to make money, regardless of the direction of 
the broader markets.[Footnote 148] As we have previously reported, 
LTCM's strategy used leverage or borrowing to amplify its arbitrage 
returns.[Footnote 149] Prior to its crisis, LTCM held $1.4 trillion in 
notional value of off-balance-sheet derivatives contracts of which 
$500 billion were traded on futures exchanges, and at least $750 
billion were over the counter derivatives. In August 1998, following 
the announcement of the Russian debt moratorium, investors began to 
seek superior credit quality and higher liquidity, and credit spreads 
widened in markets around the world, creating losses for LTCM. It soon 
lost 90 percent of its capital. FRBNY officials said they became aware 
of LTCM's problems in early September 1998 through their routine 
market surveillance activities, which included discussions with 
industry officials about current market conditions and developments. 
On September 18, 1998, LTCM officials contacted FRBNY officials about 
their financial problems and invited a team to visit LTCM to discuss 
the situation. During the resulting September 20, 1998, visit, LTCM 
officials informed FRBNY and Department of the Treasury 
representatives of the extent of LTCM's problems and the size and 
scope of its positions in markets around the world. 

Concerned about potential systemic implications if a rapid and 
potentially disruptive liquidation of LTCM were to occur, FRBNY 
officials said they invited Goldman Sachs Group, LP; Merrill Lynch & 
Co. Inc; and JPMC--the three firms the FRBNY believed had the greatest 
knowledge of the situation--to their office to discuss LTCM's 
situation and possible ways to resolve it. This core group of three 
was later expanded to include UBS AG. Ultimately, the discussions were 
expanded to include 12 of LTCM's other major creditors and 
counterparties. Bear Stearns and Co. and Credit Agricole were included 
in these discussions, but they later declined to participate in the 
recapitalization consortium. 

On September 23, 1998, 14 major domestic and foreign banks and 
securities firms agreed to recapitalize LTCM through the creation of a 
consortium. On September 28, 1998, they contributed about $3.6 
billion, representing 90 percent of the net asset value of the fund on 
that date leaving 10 percent of the equity with the LTCM partners. The 
14 firms were Chase Manhattan Corporation; Goldman Sachs Group, LP; 
Merrill Lynch & Co. Inc.; JPMC; Morgan Stanley Dean Witter & Co.; 
Salomon Smith Barney (Travelers Group); Credit Suisse First Boston 
Company; Barclays PLC; Deutsche Bank AG; UBS AG; Bankers Trust 
Corporation; Société Generale; BNP Paribas AB; and Lehman. These firms 
appointed a smaller group of employees from several of the firms to 
manage LTCM's resolution. The portfolio was slowly wound down with 
oversight from a committee representing the 14 institutions. According 
to an announcement that was made in early 2000, LTCM closed down and a 
final payment of $925 million was distributed to the 14 institutions. 

American International Group. The 2008 American International Group, 
Inc. (AIG) near-failure illustrates the complications presented by the 
prospect of the failure of an extremely complicated global financial 
firm. These complications include regulatory and international issues 
accentuated by the complexities posed by dealing with a large and 
opaque derivatives portfolio. The Federal Reserve authorized FRBNY to 
extend credit to AIG after determining that AIG faced the imminent 
prospect of declaring bankruptcy, according to the minutes of a 
Federal Reserve meeting on September 16, 2008, the date it approved 
the initial Federal Reserve extension of credit to AIG. The Federal 
Reserve determined that a failure would have been disorderly and would 
be likely to have systemic effects on financial markets that already 
were experiencing a significant level of fragility. AIG, a 
multinational insurer that was a major participant in the financial 
derivatives market, ran into significant financial difficulty during 
the severe market disruptions of the first 2 weeks of September 2008. 
[Footnote 150] As we have reported previously, these difficulties 
arose from two sources: securities lending and credit default swaps 
(CDS), which are insurance-like contracts that offer credit protection 
against specified credit events. AIG had been an active seller of CDS 
with large exposures to complex, structured securities and had written 
CDS contracts with a large number of counterparties, including 
domestic and foreign-based financial institutions. According to 
FRBNY's bankruptcy counsel, in a bankruptcy, the CDS contracts would 
have been treated as qualified financial contracts (QFC) because they 
would have been considered "swap agreements" as defined under the 
Bankruptcy Code. Thus, according to FRBNY's bankruptcy counsel, 
following a bankruptcy of either AIG or the subsidiary through which 
it conducted its CDS business, counterparties would have had the right 
to liquidate, terminate, or accelerate each of the CDS contracts. And 
according to the International Swaps and Derivatives Association, 
counterparties could determine the early termination amount AIG owed. 
This amount was subject to the determination of the appropriate date 
("early termination date") for calculating the market value of the 
contract. The counterparty would have been able to choose either the 
bankruptcy filing date or any other date thereafter for determining 
the closeout payment AIG owed. However, as occurred with Lehman 
Brothers Holdings, Inc., had AIG filed for bankruptcy protection, it 
likely would not have been able to pay the aggregate mark-to-market 
early termination amounts for all its positions due to the aggregate 
size of its derivatives exposures. Counterparties that had collateral 
agreements likely would have fared better than those without such 
agreements. Those counterparties that did not have collateral 
agreements that entitled them to instant payment would likely have 
been treated as creditors in the bankruptcy process and faced delayed 
payments. Considering the number and geographic diversity of AIG's 
counterparties and ongoing disruptions in credit markets worldwide, 
these delays might have posed systemic problems. 

FRBNY's bankruptcy counsel identified an additional complication that 
could have arisen under an AIG bankruptcy scenario: the likely 
commencement of legal insolvency proceedings against non-U.S. 
subsidiaries in overseas jurisdictions. As of the end of 2007, 37 
percent of AIG's consolidated assets were located outside of the 
United States and Canada in approximately 100 different countries. 
Within the United States, AIG had wholly owned subsidiaries in at 
least 25 states as well as Puerto Rico. Because many overseas 
jurisdictions have laws that prohibit "trading while insolvent," the 
filing of bankruptcy proceedings would have had implications for the 
ability of subsidiaries in these countries to continue operations as 
going concerns, which in turn could have had a significant negative 
impact on the ability of management to maximize the value of the 
estate. According to the FRBNY's bankruptcy counsel, it is not 
uncommon for the non-U.S. subsidiaries and the U.S. parent to become 
adversaries in legal proceedings. Each has a duty to maximize the 
value of its own estate, notwithstanding the many and complex inter-
company transactions and arrangements and different treatments across 
international jurisdictions. AIG had material intercompany accounts 
and transactions. Further complicating the insolvency according to 
experts with whom we spoke, the state-regulated insurance subsidiaries 
likely would not have been included in the bankruptcy. 

Fortis Bank SA/NV. The 2008 nationalization of Fortis is an example of 
how differences in national interests can limit international 
coordination even between closely linked nations. In 2008 at the time 
of its crisis, Fortis was a financial institution with banking and 
insurance subsidiaries and significant operations in Belgium, the 
Netherlands, and Luxembourg, nations that had a long history of 
economic cooperation dating to at least the 1950s. 

According to our analysis of the company's annual report to investors 
and a report on Fortis by the Bank of International Settlements, 
Fortis's problems were precipitated by a combination of factors. The 
first was excessive leverage, which Fortis gained as one of three 
partners in the large acquisition of Dutch banking group ABN AMRO 
Holding NV (ABN AMRO) in October 2007. In addition, Fortis held a 
large portfolio of structured credit spread products, asset-backed 
securities, and collateralized debt obligations that experienced 
significant drops in market value during the financial crisis in 
2008.[Footnote 151] These factors and the general deterioration in 
global financial conditions led to a liquidity crisis for Fortis in 
September 2008 as clients began to withdraw large deposits, and the 
overnight interbank lending market, which is essential to short-term 
bank financing, stopped dealing with Fortis. 

The legal segregation of ABN AMRO into three parts by Fortis and the 
UK and Spanish banks that had joined it in the acquisition complicated 
an effective international regulatory resolution; the acquisition was 
not scheduled to be completed until the second half of 2009, and the 
integration of ABN AMRO into Fortis was not near completion when 
Fortis started experiencing problems. In September 2008, the 
Netherlands, Belgium, and Luxembourg (viewing the pieces of Fortis in 
their jurisdictions as systemically important) separately injected 
capital--but only into their regulated subsidiaries of the larger 
holding company. In October, somewhat coordinated action between the 
Dutch and Belgian governments led to 100 percent nationalization of 
the Dutch banking subsidiaries and the nationalization and subsequent 
sale of 75 percent of the Belgian banking subsidiary to French bank 
Paribas. Fortis also sold 100 percent of its Belgian insurance company 
to the same French bank. These moves left Fortis, the holding company, 
with (1) Fortis Insurance International; and (2) a 66 percent share in 
an entity set up to hold the problematic structured credit portfolio, 
with a 24 percent interest going to Paribas, and the remaining 10 
percent held by the Belgian government. Fortis shareholders 
successfully challenged the sales agreement for the Belgian banking 
subsidiary in a Belgian court. They claimed Belgian law required their 
approval for the sale to proceed. The transaction was renegotiated to 
more favorably treat Fortis equity holders before being allowed to 
close. Fortis, the holding company, subsequently changed its name to 
Ageas N.V. However, Ageas continues to have ongoing legal issues 
related to the seizure. They include cases involving ABN AMRO Group NV 
and its owner, the Dutch government, as well as cases brought by 
Fortis shareholders. 

Fortis was ultimately bailed out by the French, Belgian, and 
Luxembourg states, but the initial lack of coordination and inward-
looking response by the respective national authorities point to the 
limits of current cross-border resolution mechanisms, and the reality 
that complexities of cross-border organizational structures and 
differences in national laws can impede orderly and effective 
resolution of systemically important financial institutions. In 
addition, according to European experts with whom we spoke, even in a 
case of two countries with strong regulatory relationships and closely 
aligned national interests, small divergences in these interests 
dominated, preventing a coordinated solution. Prior to Fortis being 
split up, Belgium, the Netherlands, and Luxembourg all provided 
financial support but only to the parts that were in their country. 
This illustrates the countries' willingness to support the company in 
a coordinated, although national, manner. However, Dutch concern over 
ABN AMRO, (which was still the brand name for many Dutch retail bank 
branches of Fortis at the time of its nationalization) prevented a 
consolidated solution. A report by the Basel Committee on Banking 
Supervision concluded that Fortis demonstrated that the complexity of 
the international financial groups and national resolution systems led 
to fragmentation and break downs along national lines.[Footnote 152] 

Dexia SA. The 2008 Dexia example illustrates how aligned national 
interests and joint exposure by entities domiciled in more than one 
country can help facilitate cooperation. Dexia, a bank headquartered 
in Belgium, had significant operations in Belgium, France, and 
Luxembourg. It specialized in providing financing to local governments 
globally but concentrated in France and other European countries. 
Dexia also had a New York branch and a U.S.-based monoline bond 
insurance subsidiary.[Footnote 153] Dexia faced significant liquidity 
stress in 2008 arising from issues with its longer-term bond 
investments, nonperforming loans, and as a bond insurer. In order to 
strengthen its capital, the Belgian, French, and Luxembourg 
governments coordinated in September 2008 a nearly €10 billion capital 
infusion and replaced the Chairman and Chief Executive of Dexia. When 
these actions did not result in an improvement in market sentiment 
about the bank, the three nations coordinated the creation of a joint 
guarantee mechanism whereby the governments of Belgium, France, and 
Luxemburg guaranteed 60.5 percent, 36.5 percent and 3 percent, 
respectively, of Dexia's obligations in excess of the bank's ability 
to fulfill them up to €150 billion. The nations' shares of the 
guarantee were based on the proportional share of the company's equity 
and debt held by institutional investors residing in the three 
countries. In 2008, Dexia drew only €12.3 million under this 
guarantee. This example of coordination in order to avoid an 
international insolvency was driven by the unique nature of the 
company's business and shareholder base. In France, Dexia was a key 
provider of municipal finance. In Belgium, the bank was a key 
depository institution. Thus, the governments could reach a joint, 
coordinated solution that served the interests of France, which was 
able to ensure that municipalities were able to keep a key provider of 
funds, and those of Belgium, which avoided the costly and systemically 
risky failure of one of its key banks. This coordinated action allowed 
Dexia time to access financing and gave the bank time to sell certain 
operations and shrink others and avert bankruptcy. 

Icelandic banking crisis. The United States was not greatly affected 
by the Icelandic banking crisis, but the issues it raised point to the 
difficulties in resolving systemically significant financial 
institutions with large international relationships. The three largest 
Icelandic banks, which accounted for 85 percent of the nation's 
banking system, collapsed in early October 2008 after growing 
exponentially over the past decade to have total assets peak at more 
than 1,000 percent of Iceland's gross domestic product. Part of this 
growth was funded by deposits raised in at least nine other European 
countries, of which both Great Britain and the Netherlands were large 
contributors. The crisis led to investors and depositors pulling 
assets out of Icelandic banks simultaneously with a 70 percent 
depreciation in the krona (Icelandic currency) in which most of the 
bank's assets were priced. Those assets included significant equity 
stakes in other Icelandic banks, which were further impaired as the 
local stock market lost 80 percent of its value. As the three big 
Icelandic banks and their European branches and subsidiaries had 
significant liabilities denominated in euros and British pounds, the 
declines in asset values overwhelmed the banks' equity and the banks 
were not able to meet the huge demand for deposit withdrawals in the 
panic. The Icelandic government then guaranteed all domestic Icelandic 
deposits but did not extend the same protection to depositors in other 
countries. The subsequent insolvencies led to losses being borne by 
foreign creditors and initially by British and Dutch depositors, as 
the Icelandic government was unable to make them whole. Both the 
British and Dutch governments became involved in attempts to force the 
Icelandic government to make depositors in their countries whole at 
the same time as paying depositors some portion of their guaranteed 
deposits. The British government later decided to pay out all retail 
depositors in whole, although commercial depositors only received the 
guaranteed portion of the account. In order to freeze Icelandic bank 
assets, the UK government invoked provisions of the Antiterrorism, 
Crime and Security Act of 2001 stating the move was done to prevent 
harm to the UK economy. This move was not well received in Iceland and 
complicated subsequent efforts to resolve the dispute about who should 
repay the depositors. Nevertheless, the UK was able to transfer the 
bulk of the deposits to a Dutch bank. Agreements were eventually 
concluded between the Icelandic and both the UK and the Netherlands 
governments detailing Iceland's repayment to the governments for the 
amount of losses borne by their respective deposit schemes. These 
agreements were approved by the Icelandic parliament, but the 
President of Iceland refused to sign the bill into law unless it 
passed a referendum. On two occasions, most recently in April 2011, 
Icelandic voters have voted against ratifying these agreements to pay 
back the full amounts. Multilateral efforts to resolve the crisis have 
been slowed and complicated by differences of opinion about who bears 
the responsibility for the losses. 

Bernard L. Madoff Investment Securities. The still active 2008 Bernard 
L. Madoff Investment Securities, LLC (BLMIS) case demonstrates the 
complications that can arise from the presence of fraud, especially in 
an international context. BLMIS, an internationally active broker- 
dealer, had three principal lines of business: market making, 
proprietary trading, and investment advisory services. BLMIS filed for 
bankruptcy protection on December 15, 2008, after the founder revealed 
that his investment management firm was in fact a Ponzi scheme through 
which he had stolen customer funds for years. As part of this scheme, 
the founder had sent fraudulent statements to clients falsely claiming 
that their invested assets had grown in value, as detailed in reports 
by the BLMIS bankruptcy and SIPA trustees. At the time of failure, 
BLMIS customers believed that they had an aggregate of $65 billion in 
assets managed by BLMIS. BLMIS was a member of SIPC pursuant to its 
registration as a broker-dealer. BLMIS led to losses to investors of 
invested capital of at least $17 billion. This amount excludes "gains" 
that investors falsely believed their investments had earned due to 
the fraudulent account statements. In addition to his own investment 
advisory business, Madoff had utilized a global network of "feeder 
funds" to collect "investments" from wealthy individuals around the 
globe.[Footnote 154] Several of these feeder funds also were forced 
into liquidation with the individuals in charge of liquidating these 
funds filing claims against the BLMIS estate. On the same day as the 
bankruptcy filing, the broker-dealer was placed into liquidation under 
the Securities Industry Protection Act, and a SIPA trustee was 
appointed to resolve claims. The bankruptcy court later combined the 
processes for resolving the BLMIS estate with the SIPA process, 
placing them under the direction of the SIPA trustee. Since his 
appointment, the trustee has located assets in the Bahamas, Bermuda, 
the British Virgin Island, Canada, the Cayman Islands, England, 
Gibraltar, Ireland, Italy, Luxembourg, Panama, Spain, and Switzerland. 

As of July 15, 2011, the trustee reported a total of 16,518 claims had 
been made to the trustee, and 2,414 of these claims for a total of 
$6.9 billion had been allowed. Of these 2,414 claims, SIPC coverage of 
$500,000 per account (including up to $250,000 for cash) resulted in 
claims of $795 million. Due to the nature of the fraud, over the 
years, certain customers had withdrawn funds from their accounts that 
were greater than their initial investments with the firm. The trustee 
in the case chose to pursue claims against at least eight such 
investors to recover funds that could be distributed to other victims 
of the fraud. As of May 2011, the trustee had made $13.7 billion in 
such claims against various feeder funds, friends, and family of the 
founder, and other related parties. In May 2011, an agreement was 
reached between the largest feeder fund and the BLMIS trustee to align 
their interests and jointly pursue recovery of billions of dollars in 
claims against the owners and management of this failed feeder fund. 

According to the trustee, as of May 4, 2011, the trustee had recovered 
more than $7.6 billion. However, more than $5 billion of these 
recoveries were not available for distribution to BLMIS customers 
pending the outcome of appeals by claimants of significant settlements 
the trustee had made with some of the customers of BLMIS, who had 
withdrawn funds in excess of their capital contributions, leaving $2.6 
billion available for customers. Of this amount, the trustee expects 
to distribute $272 million to the defrauded holders of 1,224 customer 
accounts in the near term. 

Domestic Case Studies: 

Colonial BancGroup, Inc. (Colonial). The Colonial proceeding is 
significant due to the issues raised regarding the holding company's 
financial responsibility for an insolvent insured depository 
institution. Colonial was a bank holding company that owned Colonial 
Bank. On August 14, 2009, the Alabama State Banking Department closed 
Colonial Bank and appointed FDIC as the bank's receiver. FDIC, in its 
corporate capacity and as receiver of Colonial Bank, then executed a 
Purchase and Assumption Agreement (P&A agreement) with Branch Banking 
and Trust Company (BB&T), under which BB&T purchased substantially all 
of Colonial Bank's assets, and assumed all of its deposit accounts. 
This left Colonial (the bank holding company) with less than 1 percent 
of the consolidated assets. Colonial filed for Chapter 11 bankruptcy 
in the Bankruptcy Court for the Middle District of Alabama (Alabama 
Bankruptcy Court), on August 25, 2009. Colonial Bank was closed 
following a liquidity crisis caused by poor management of credit risk 
related to an over-concentration in commercial real estate, 
nonperforming loans, and fraudulent conduct by some of the officers in 
its mortgage warehouse lending unit, which provided short-term funding 
to mortgage originators for loans that would be sold into the 
secondary market. 

In connection with Colonial's bankruptcy, FDIC filed a motion seeking 
a court order allowing FDIC's $905 million capital maintenance claim 
as a priority claim and requiring Colonial to cure the claim under 11 
U.S.C. § 365(o), or convert the case to a case under Chapter 
7.[Footnote 155] FDIC based its claim on the amount of capital 
necessary for Colonial Bank to comply with its capital requirements at 
the time it was closed. FDIC also based its claim on the following 
prepetition agreements entered into by Colonial with its regulators: a 
memorandum of understanding (MOU) with the Federal Reserve Bank of 
Atlanta and the Alabama Banking Department, an agreement with the 
Federal Reserve Bank of Atlanta and the Alabama Banking Department and 
a Cease and Desist Order with the Federal Reserve and the Alabama 
Banking Department. Although these agreements referred to Colonial 
Bank's separate agreements with its regulators, Colonial Bank was not 
a party to the agreements. The Bankruptcy Court denied FDIC's motion 
because it found that the language contained in the agreements entered 
into by Colonial with its regulators did not obligate Colonial to 
maintain the capital of Colonial Bank within the meaning of 11 U.S.C. 
§ 365(o).[Footnote 156] 

FDIC also filed a separate motion for relief from the automatic stay 
to exercise its rights under the P&A agreement to exclude Colonial's 
deposit accounts from the definition of "Assumed Deposits" and setoff 
its claims against Colonial's deposit accounts, which had been 
transferred to BB&T under the P&A agreement. The bankruptcy court 
denied FDIC's motion, holding that FDIC could not exercise its rights 
after Colonial filed for bankruptcy, and, therefore, FDIC did not have 
mutuality for setoff purposes.[Footnote 157] FDIC has appealed the 

NextBank. The 2002 failure of NextBank, NA, and its subsequent 
resolution is an example of how the failure of a relatively simple 
bank can lead to complex legal questions that take many years to 
resolve even outside of the bankruptcy context. In addition, 
NextBank's resolution points to how the way a holding company is 
structured can lead to challenges for FDIC in resolution. NextBank was 
a Phoenix, Arizona-based, Internet only credit-card bank that failed 
on February 7, 2002, with total assets of approximately $700 million 
and deposits of $554 million. FDIC lost between $300 million and $350 
million on the failure, while 2,075 depositors that held $29.4 million 
in uninsured deposits were subject to losses. FDIC's seizure of the 
bank left NextBank's parent, NextCard, Inc., with assets on its 
balance sheet of only 25 percent of their preseizure size. Due to 
NextBank's unique corporate structure, the workers who supported 
NextBank's credit card servicing were employees of NextCard. After the 
failure, NextCard and FDIC agreed that NextCard would provide certain 
administrative services, licenses to NextCard's intellectual property, 
and give FDIC access to NextCard's proprietary systems while FDIC 
looked for a purchaser of NextBank's credit card portfolio. In 
addition, 465 of NextCard's 610 employees were transferred to a third-
party contractor working for FDIC to service the credit card 
portfolio. FDIC agreed to reimburse NextCard for these services. When 
these services terminated with the transfer of receivables and closure 
of credit card accounts (discussed later), NextCard was unable to find 
any viable business prospects and on November 14, 2002, NextCard filed 
for Chapter 11 in the Delaware Bankruptcy Court. 

In July 2002, FDIC sold $190 million of NextBank's credit card 
receivables that had not been securitized but were held wholly on 
NextBank's balance sheet. They then closed credit card accounts with 
outstanding balances of $1.4 billion in credit card receivables that 
had been securitized and were still being serviced by NextBank at the 
time of failure. While these securitized accounts were closed, the 
cardholders still were responsible for paying off their balances at 
the original terms. The securitizations had four classes of 
noteholders (A-D), with each lower level (B-D) exposed to increasing 
levels of risk. Before the receivership, the stream of cardholder 
payments (monthly principal, interest, and fee payments) were used to 
make interest payments on the notes first with all remaining cash 
divided into two accounts. One was for "collateral," which would pay 
principal on the notes according to the priority schedule that had 
been set forth in the securitization's prospectus, and the other was 
for "transferor interest," which would pay NextBank as servicer and 
then, after the bankruptcy, FDIC. However, the credit performance on 
the closed accounts was poor. FDIC, as servicer, and Bank of New York 
the trustee in the securitization, applied all delinquent payments to 
the collateral account, thus depriving bondholders of principal 
payback, while all payments received from cardholders went to the 
transferor interest to which FDIC, now the owner of NextBank, was 
entitled.[Footnote 158] But, the securitization offering documents 
stated that, in the event of a receivership, noteholders were entitled 
to accelerated payment of principal compared with the slower schedule 
without a receivership. While the Class A and B noteholders were paid 
in full, the Class C noteholders stopped receiving principal payments 
and the Class D noteholders never received any principal as of the 
start of litigation in June 2003. 

The Bank of New York (now BNY), as trustee, sued FDIC in the District 
of Columbia federal district court (a nonbankruptcy court) on behalf 
of the Class C and D noteholders, claiming that FDIC was not entitled 
to the transferor interest because the receivership was an ipso facto 
trigger for the accelerated payment of principal and this took 
priority over the payments of the transferor interest to FDIC. 
[Footnote 159] After some claims were dismissed by the court and 
others were dismissed pursuant to a settlement, the D.C. Court ruled 
against BNY on its remaining claim that FDIC had violated federal 
banking law and unlawfully converted funds that should have been paid 
to note holders. Despite this and several subsequent judicial 
proceedings in both D.C. and New York, not all of the claims 
associated with NextBank were settled. Following disposition of the 
D.C. Court proceedings, certain Class C and D noteholders demanded 
that BNY turn over transferor interest assets for principal repayment. 
BNY, in its capacity as a trustee, instituted a lawsuit in New York, 
known as an "interpleader" action, so that competing claims to assets 
it held in trust could be resolved by a court. Applying principles of 
contract law, the U.S. District Court for the Southern District of New 
York held that the noteholders, and not FDIC, were entitled to the 
money held in the transferor interest account.[Footnote 160] FDIC 
appealed. In June 2010, the U.S. Court of Appeals for the Second 
Circuit upheld the Southern District Court ruling.[Footnote 161] 

[End of section] 

Appendix VII: Safe Harbors for Contracts under the Bankruptcy Code: 

On the filing of a bankruptcy petition, the Code provides for an 
automatic stay, or freeze, of any action by creditors to recover 
assets from the debtor in possession. A debtor-in-possession (DIP) or 
trustee, as the case may be, may, subject to the court's approval and 
certain provisions in the Code, assume or reject any executory 
contracts or unexpired leases, and may "avoid" any prepetition 
preferential payments given to creditors within 90 days of the 
filing.[Footnote 162] However, the DIP or trustee may not use any 
"cash collateral," such as cash, securities, documents of title, or 
other cash equivalents, without the consent of secured creditors and 
the court. Secured creditors of the debtor receive payment from the 
proceeds of the collateral, and if the collateral is insufficient to 
pay the claim in full the balance becomes an unsecured claim. 

Certain contracts, sometimes referred to as qualified financial 
contracts (QFC), receive "safe harbor" protections from the automatic 
stay by allowing counterparties to choose whether or not to terminate, 
or "close-out," contracts underlying QFC transactions with a debtor. 
If a collateralized QFC counterparty closes-out a contract, it can 
remove and liquidate the collateral used to secure the transaction 
before that collateral becomes part of the bankruptcy estate. Also, 
the counterparty has the option, but is not obligated, to apply the 
proceeds of the collateral liquidation to any amounts owed to the 
debtor, a process called "netting." After netting, if the counterparty 
is owed money by the debtor, it awaits payment under a reorganization 
plan with the unsecured creditors. If it owed money to the debtor 
after netting, the debtor would collect what it was owed and include 
those funds in the estate for payment to creditors according to the 
established order of priority. 

In addition, the safe harbor for QFCs allows the QFC counterparty to 
keep prepetition preferential payments, which can be understood by the 
example of a CDS. A CDS is generally a contract between two parties 
where the first party promises to pay the second party if a third 
party experiences a credit event such as failing to pay a debt. If the 
third party suffers a credit event, then the first party would be 
required to post increased collateral to assure the second party that 
it could meet its contractual obligation. On a bankruptcy filing of 
the first party, without the safe harbor, the second party would 
normally be required to return the increased collateral to the first 
party's estate as a prepetition preferential payment. Instead, under 
the safe harbor, the second party could close-out the CDS, liquidate 
the collateral, and net the proceeds against its debts to the first 

[End of section] 

Appendix VIII: Some Characteristics of Insolvency Systems in Selected 

As insolvency and resolution is primarily handled at the national 
level, different countries will have different approaches. We 
interviewed experts and reviewed publications regarding aspects of 
insolvency and resolution systems in Canada, China, the EU, France, 
Germany, Luxembourg, the Netherlands, Switzerland, and the UK. This 
appendix illustrates some of the differences across these 
jurisdictions' systems, but it is not a comprehensive examination of 

Netting of Financial Obligations: 

Generally, counterparties are allowed to close out and net financial 
contracts when one of the parties becomes insolvent. As described 
earlier in this report, in the United States, netting is allowed as 
determined by the safe harbor provisions of the U.S. Bankruptcy Code. 
According to experts we interviewed, all the jurisdictions we examined 
allowed for netting of mutual financial obligations. However, the 
exact treatment may differ across countries as follows: 

* Under Canadian insolvency law, derivatives generally qualify as 
"eligible financial contracts" and receive special treatment under the 
Winding-Up and Restructuring Act (WURA), the Companies' Creditors 
Arrangement Act (CCCA), and the Bankruptcy and Insolvency Act (BIA). 
[Footnote 163] According to a legal expert, the treatment of 
derivative contracts under Canadian insolvency law is similar to that 
in the United States. Under the CCCA and BIA, which apply to entities 
other than federally insured depository institutions and certain other 
specialized entities, and the WURA, which governs the restructuring or 
reorganization of federally insured depository institutions, eligible 
financial contracts counterparties may terminate the contracts and net 
amounts payable to or by the insolvent debtor. 

* According to a legal expert, netting of financial obligations is 
allowed in China. 

* Under Articles 7 and 8 of the EU Directive on Financial Collateral, 
the enforceability of close-out netting arrangements is explicitly 
protected notwithstanding the insolvency of the parties to the 
arrangement. Further, EU members are prohibited from applying their 
national insolvency rules to the arrangements. A regulatory expert 
told us that the EU is considering incorporating a temporary stay on 
close-outs and netting in the proposal resolution procedures in a 
manner similar to the provisions of the Orderly Liquidation Authority 
(OLA) created in the Dodd-Frank Act.[Footnote 164] The stay would be 
48 hours rather than the 24-hour stay under OLA. 

Special Resolution Regimes for Financial Institutions: 

Some countries have special resolution regimes for certain financial 
institutions, similar to those employed by FDIC. Some countries have 
recently proposed or enacted such regimes as a result of the 2008 
crisis. Canada, France, Germany, Japan, Luxembourg, the Netherlands, 
Switzerland, and the UK all have special resolution regimes. China and 
the EU are currently considering some type of regime for their 

* In Canada, several laws can apply to the resolution of insolvent 
financial institutions. Similar to the United States, Canadian 
resolution laws differentiate between banks, insurance companies and 
other specialized financial institutions on the one hand, and other 
types of entities, which include the holding companies of those 
specialized institutions. Generally, most business entities are 
subject to the Bankruptcy and Insolvency Act (BIA) and, if the 
aggregate amount of claims is large enough, the Companies' Creditors 
Arrangement Act (CCAA). Depository institutions insured by Canada's 
federal government are subject to restructuring and/or reorganization 
by the Canada Deposit Insurance Corporation (CDIC) under the Canada 
Deposit Insurance Corporation Act (CDIC Act). Provincial loan and 
trust corporations whose deposits are CDIC-insured also may be subject 
to the act if the relevant province has entered an agreement with the 
federal government. WURA applies to federal and provincial banks, loan 
companies, and insurance corporations. The WURA in effect provides a 
liquidation regime for these financial institutions. According to a 
paper written by a Canadian law professor, WURA allows the Canadian 
court to appoint a liquidator, who can take control of the firm. 
[Footnote 165] This liquidator has broad powers to resolve the company 
and distribute proceeds to the creditors. 

* According to a legal expert, China is considering an FDIC-like 
regime for its banks. Under the Enterprise Bankruptcy Law, the Chinese 
bankruptcy regime allows creditors, debtors, and the regulatory body 
of financial institutions to file a bankruptcy application. The 
regulatory body may also require reorganization proceedings. The 
Enterprise Bankruptcy Law also allows the state flexibility to 
implement more detailed regulations, if necessary. According to a 
legal expert, the regulatory body generally places a problematic 
financial institution in a trusteeship and monitors the institution. 
[Footnote 166] If the regulatory body determines that an institution 
can be saved, the body may petition the court to suspend bankruptcy 
proceedings. However, the expert said that, since the government 
already owns the banks, it has a wide range of options available in 
case of insolvency. 

* The EU is working on a new resolution regime for financial 
institutions, including developing a European Supervisory 
Authority.[Footnote 167] A legal expert told us that the first stage 
would be to establish a general resolution and recovery framework. The 
EU may consider a uniform set of liquidation policies in the future. 

* According to a foreign court official, until recently in Germany 
financial institutions were resolved under standard insolvency law. 
Following the 2008 crisis, the German government approved the German 
Act on the Orderly Restructuring and Liquidation of Banks ("Bank 
Reorganization Act"), the German Act on the Establishment of a Bank 
Restructuring Fund, and the German Act for the Extension of Time 
Limitations Barring Management Liability (collectively, the "Bank 
Restructuring Act"). The laws provide for two types of reorganization 
procedures and a conservatorship procedure, both through BaFin, the 
German supervisory body.[Footnote 168] The conservatorship allows the 
government to transfer the systemically important parts of the firm to 
a bridge institution.[Footnote 169] 

* According to an academic expert, the Netherlands recently enacted a 
new resolution regime in the wake of the financial crisis. The new 
regime includes liquidation and reorganization procedures, as well as 
an "emergency plan" provision for financial institutions to be used 
prior to liquidation. The regime allows for the appointment of a 
formal trustee, who can transfer assets and clients' accounts to a 
bridge institution. [Footnote 170] 

* The UK made changes to its insolvency system following the failure 
of Northern Rock. The Banking Act of 2009 provides for a special 
resolution regime. According to a regulatory expert, in the case of a 
financial institution failure, authorities now can transfer assets, 
establish a bridge bank, and, as a last resort, assume "temporary 
public ownership" of an institution. The special resolution regime 
only will apply to institutions with "eligible" or insured deposits. A 
firm that does not have any insured deposits will continue to be 
resolved under the regular insolvency system. 

Liability for Corporate Managers: 

Some countries can impose liabilities on corporate officers if their 
firm becomes insolvent, as follows: 

* According to French legal practitioners, in France, a court may 
determine that the corporate officers have committed an "actionable 
fault," which leads to an insolvency. In this case, the officers may 
be liable for the amount of liabilities in excess of the amount of 

* According to a foreign court official, in Germany, corporate 
officers must file for insolvency promptly. Otherwise, the officers 
face civil and possibly criminal liability. The officers also may be 
liable for any payments made to creditors while insolvent. 

* According to a legal analysis, in Luxembourg, the court can order 
the officers liable for the company's debts if the insolvency is due 
to "gross negligence." 

* According to a report by a group of international insolvency 
experts, in the Netherlands, corporate officers can face liability if 
their actions were "severely reproachable." 

* According to a report by a group of international insolvency 
experts, in the UK, corporate officers can face liability for 
transactions made prior to an imminent insolvency filing. 

Insolvency Definitions and Triggers: 

Countries can have different definitions of "insolvency" and thus 
different triggers to commence insolvency proceedings. Some countries 
use a "cash-flow" test, in which insolvency would mean an inability to 
pay debts as they come due. Others use a "balance-sheet" test, in 
which insolvency would mean that liabilities exceed assets. Countries 
can use either or both to trigger resolution or insolvency 
proceedings. The U.S. Bankruptcy Code defines "insolvent" as a 
"financial condition such that the sum of such entity's debts is 
greater than all of such entity's property, at a fair valuation." 

* According to Canadian practitioners, under Canadian insolvency law, 
a company is insolvent if it has acknowledged its inability to pay its 
debts. Once a company is insolvent, a court also can commence a 
proceeding if the shareholders passed a resolution requiring the 
company to be resolved or if the court opined that it is "just and 
equitable" that the company be resolved. As discussed previously, 
insolvency proceedings for financial institutions are governed by the 

* In China, a debtor must be both balance-sheet insolvent and cash-
flow insolvent before it can file for insolvency. 

* In France, cessation of payment, meaning the inability to make 
payments with available assets as they become due, triggers court- 
supervised procedures for companies in financial difficulty. 

* In Germany, the law defines three types of insolvency, "over- 
debtedness," inability to pay debts, and "imminent illiquidity." If 
one of the two first types is met, the directors must file for 
insolvency. In the third situation, management may file for 
insolvency, but it is not required. 

* In Japan, insolvency is defined as an excess of liabilities over 
assets. However, insolvency proceedings are triggered by the inability 
to pay debts. 

* In Luxembourg, insolvency proceedings begin when a debtor is both 
unable to pay its debts as they come due and unable to raise credit. 

* In the Netherlands, a debtor can apply for insolvency protection 
when it determines it cannot pay its debts as they come due. The 
Netherlands District Court can also declare the debtor bankrupt if it 
has ceased to pay debts. The Netherlands does not have a balance-sheet 

* In Switzerland, a company may file for insolvency protection if (1) 
it cannot pay its debts, (2) it has ceased to pay its debts, or (3) 
its liabilities exceed its assets. 

* In the UK, both the cash-flow and balance-sheet tests are used to 
determine insolvency. 

Payment Priorities: 

The order in which creditors are repaid from an insolvent estate 
varies among various countries. These repayment rankings can represent 
the social and political priorities of the jurisdiction. The rankings 
in table 6 are general rankings and may not apply in all bankruptcy 

Table 6: Repayment Rankings of Selected Countries: 

United States: 

1. Secured claims.
2. Claims for debts to spouse or children for court-ordered support.
3. Administrative expenses of the bankruptcy.
4. Unsecured, postpetition claims in an involuntary case.
5. Wage claims of employees and independent salespersons up to $10,000 
per claim.
6. Unpaid contributions to employee benefit plans up to $10,000 per 
7. Claims of grain farmers and fishermen against debtors operating 
storage or processing facilities.
8. Layaway claims of consumers who did not get the item on which the 
deposit was made.
9. Taxes outside of bankruptcy.
10. Debtor's commitment to maintain capital of a federally insured 
depository institution.
11. Claims for death or personal injury from a motor vehicle that 
occurred while the debtor was driving it and was intoxicated. 


1. Secured creditors.
2. Funeral and testamentary expenses.
3. Administrative expenses.
4. Superintendent expenses.
5. Unpaid wages for services rendered during bankruptcy.
6. Municipal taxes owed.
7. Rent owed.
8. Fees and costs associated with process against the bankrupt's 
9. Workers' compensation, unemployment insurance, or taxes.
10. Claims resulting from injuries to employees of the bankrupt not 
covered by workers' compensation.
11. Claims of the Crown not mentioned above. 


1. The creditor's right with guaranty on the debtor's particular assets.
2. The wages, subsidies for medical treatment and disability and 
comfort and compensatory funds as defaulted by the debtor, fundamental 
old-age insurance premiums, fundamental medical insurance premiums 
that shall have been transferred into the individual accounts of 
employers, as well as the compensation for the employees as prescribed 
by the relevant laws and administrative regulations.
3. Social insurance premiums and taxes as defaulted by the debtor.
4. The common creditor's right. 


1. Employee wage claims.
2. Legal costs including court appointees.
3. Priority for "new money," in which a party brings in money or 
provides goods or services without demanding cash payment after the 
commencement order.
4. Secured creditors.
5. Wage claims of employees arising after the commencement order.
6. Claims arising from current contracts, in which the party has 
agreed to defer receipt of payment for its services.
7. Amounts advanced by the wage guarantee fund.
8. Claims arising after the commencement order.
9. Claims arising prior to the commencement order and secured by 
general liens.
10. Claims arising before the commencement order.
11. Unsecured creditors. 


1. Estate obligations: 
* the costs of the proceedings; 
* those obligations created by activities of the administrator or the 
temporary administrator to whom the debtor's right to transfer was 
* obligations under mutual contracts, if their performance either is 
claimed by the administrator or has to take place after the opening of 
the proceedings, and; 
* obligations due to unjust enrichment of the estate.
2. Normal insolvency claims.
3. Lower-ranking claims: 
* the interest accruing on the insolvency claims from the opening of 
the proceedings; 
* costs incurred by creditors due to their participation in the 
* fines and similar claims, and; 
* claims to the debtor's gratuitous performance. 


1. Receiver's fee.
2. Liquidation expenses.
3. Employee wage claims.
4. Social security contributions.
5. Outstanding taxes.
6. Lower-ranking privileges.
7. Secured creditors.
8. Unsecured creditors. 

Netherlands; General principle: paritas creditorum, by which all 
creditors have an equal right to payment and proceeds of the estate 
shall be distributed in proportion to the size of their claims, 
applies to all creditors except secured creditors and creditors who 
have a preference under the Dutch Civil Code or other relevant act; 
1. Secured creditors (paritas creditorum does not apply).
* creditors who hold a mortgage; 
* creditors who hold a right of pledge; 
2. Preferred creditors (paritas creditorum does not apply).
* creditors who have a statutory priority; 
* creditors who have a nonstatutory priority; 
3. Unsecured creditors (paritas creditorum applies). 


1. Secured creditors.
2. Class 1: 
* salary claims of employees before the bankruptcy ruling; 
* claims resulting out of obligatory accident insurance; 
* claims resulting out of nonobligatory pension plans; 
* claims of pension funds for premiums against employers; 
* alimony claims of dependants and partners; 
3. Class 2: 
* certain claims of marital partners; 
* premiums for social security insurance; 
* premiums for accident insurance; 
* premiums for unemployment benefits insurance; 
* premiums and contributions to health insurance; 
* contributions to family burdens equalization fund; 
4. Class 3: 
* all other debts. 

1. Return of deposit on petition; 
2. Payment of petition costs.
3. Distribution to preferential creditors.
4. Dividend to ordinary unsecured creditors.
5. Payment of statutory interest to ordinary unsecured creditors.
6. Deferred creditors; for example, payment of any spouse's or civil 
partner's claim in respect of "credit provided". 

Sources: GAO analysis of country bankruptcy laws and analysis provided 
by legal experts we interviewed. 

[End of table] 

[End of section] 

Appendix IX: Organizational Affiliations of Experts: 

During the course of our work, we interviewed experts from the 
following organizations: 

Administrative Office of the U.S. Courts: 
Allen & Overy LLP: 
Alvarez & Marsal: 
American Bankruptcy Institute: 
American Bar Association: 
American Council of Life Insurers: 
American Insurance Association: 
American International Group: 
Cleary Gottlieb Stein & Hamilton LLP: 
Commodity Futures Trading Commission: 
Congressional Research Service: 
Davis Polk & Wardwell LLP: 
Department of the Treasury: 
Department of State: 
Duisenberg School of Finance: 
European Commission: 
Federal Deposit Insurance Corporation: 
Federal Judicial Center: 
Federal Reserve Board: 
Financial Services Roundtable: 
Financial Stability Board: 
HM Treasury (UK): 
Hoover Institution, Stanford University: 
Hughes Hubbard & Reed LLP: 
Institute of International Bankers: 
Institute of International Finance: 
International Insolvency Institute: 
International Monetary Fund: 
International Swaps and Derivatives Association: 
Jenner & Block LLP: 
Nabarro LLP: 
National Association of Insurance Commissioners: 
New York University: 
Reinsurance Association of America: 
Securities and Exchange Commission: 
Securities Industry and Financial Markets Association: 
Securities Investor Protection Corporation: 
University of California, Los Angeles: 
University of Pennsylvania: 
University of Texas: 
U.S. Bankruptcy Court: 
Wake Forest University: 
Weil, Gotshal & Manges LLP: 

[End of section] 

Appendix X: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Alicia Puente Cackley, (202) 512-8678 or 

Staff Acknowledgments: 

In addition to the individual named above, Debra Johnson, Assistant 
Director; Nancy S. Barry; Rudy Chatlos; Phil Curtin; Kate Bittinger 
Eikel; Nate Gottfried; Dean Gudicello; Marc Molino; Tim Mooney; 
Barbara Roesmann; Susan Sawtelle; and Paul Thompson made key 
contributions to this report. William Jenkins, Thomas Melito, and 
Thomas McCool also made contributions to this report. Technical 
assistance was provided by JoAnna Berry, Joyce Evans, David Martin, 
Jena Sinkfield, and Cynthia S. Taylor. 

[End of section] 

Related GAO Products: 

Bank Regulation: Modified Prompt Corrective Action Framework Would 
Improve Effectiveness. [hyperlink,]. Washington, D.C.: June 23, 

Troubled Asset Relief Program: Update of Government Assistance 
Provided to AIG. [hyperlink,]. 
Washington, D.C.: April 27, 2010. 

Federal Deposit Insurance Act: Regulators' Use of Systemic Risk 
Exception Raises Moral Hazard Concerns and Opportunities Exist to 
Clarify the Provision. [hyperlink,]. Washington, D.C.: April 15, 

Troubled Asset Relief Program: The U.S. Government Role as Shareholder 
in AIG, Citigroup, Chrysler, and General Motors and Preliminary Views 
on Its Investment Management Activities. [hyperlink,]. Washington, D.C.: December 
16, 2009. 

Troubled Asset Relief Program: Status of Government Assistance to AIG. 
[hyperlink,]. Washington, D.C.: 
September 21, 2009. 

Financial Regulation: Financial Crisis Highlights Need to Improve 
Oversight of Leverage at Financial Institutions and across System. 
[hyperlink,]. Washington, D.C.: 
July 22, 2009. 

Federal Bankruptcy Judges: Measuring Judges' Case-Related Workload. 
[hyperlink,]. Washington, 
D.C.: June 16, 2009. 

Federal Financial Assistance: Preliminary Observations on Assistance 
Provided to AIG. [hyperlink,]. 
Washington, D.C.: March 18, 2009. 

Financial Regulation: A Framework for Crafting and Assessing Proposals 
to Modernize the Outdated U.S. Financial Regulatory System. 
[hyperlink,]. Washington, D.C.: 
January 8, 2009. 

Bankruptcy: Judiciary Should Take Further Steps to Make Bankruptcy 
Data More Accessible. [hyperlink,]. Washington, D.C.: December 18, 

Financial Marker Regulation; Agencies Engaged in Consolidated 
Supervision Can Strengthen Performance Measurement and Collaboration. 
[hyperlink,]. Washington, D.C.: 
March 15, 2007. 

Financial Regulation; Industry Changes Prompt Need to Reconsider U.S. 
Regulatory Structure. [hyperlink,]. Washington, D.C.: October 6, 

Long-Term Capital Management: Regulators Need to Focus Greater 
Attention on Systemic Risk. [hyperlink,]. Washington, D.C.: October 
29, 1999. 

Bankruptcy Administration: Case Receipts Paid to Creditors and 
Professionals. [hyperlink,]. Washington, D.C.: July 
13, 1994: 

Bankruptcy Administration: Justification Lacking for Continuing Two 
Parallel Programs. [hyperlink,]. Washington, DC: September 
28, 1992: 

[End of section] 


[1] OLA may be used when, among other things, a financial company is 
in "default or in danger of default," a condition we refer to in this 
report as "insolvent." See Dodd-Frank Act, Pub. L. No. 111-203 § 203. 

[2] As discussed later in this report, insured depository institutions 
and insurance companies may not be debtors under the Code, and broker- 
dealers qualify for liquidation, but not reorganization. 

[3] Pub. L. No. 111-203 §§ 202(e), (f). The mandate requires that we 
report on the judicial review for OLA and the effectiveness of the 
Code annually for 3 years after the passage of the act and every fifth 
year thereafter. The Administrative Office of the U.S. Courts is also 
required to address Pub. L. No. 111-203 § 202(e), and the Board of 
Governors of the Federal Reserve System (Federal Reserve) has mandates 
to address issues similar to those GAO is addressing in Pub. L. No. 
111-203 §§ 216, 217. 

[4] See 11 U.S.C. § 1123. 

[5] DIP financing is available under 11 U.S.C. § 364. 

[6] Voluntary cases are permitted under 11 U.S.C. § 301. Involuntary 
cases are subject to 11 U.S.C. § 303. 

[7] The Administrative Office of the U.S. Courts defines a "mega" 
Chapter 11 case as a single case or set of jointly administered or 
consolidated cases that involve $100 million or more in assets and 
1,000 or more creditors. See GAO, Federal Bankruptcy Judges: Measuring 
Judges' Case-Related Workload, GAO-09-808T (Washington, D.C.: June 16, 

[8] See [hyperlink,]. 

[9] See [hyperlink,]. The program 
covers 84 of the 90 bankruptcy courts and consists of the Executive 
Office for U.S. Trustees, which provides general policy and legal 
guidance, oversees operations, and handles administrative functions; 
the program includes 95 field offices and 21 U.S. Trustees-
-federal officials charged with supervising the administration of 
federal bankruptcy cases. Bankruptcy Administrators, who are employees 
of the federal judiciary, perform the functions of the U.S. Trustees 
in the remaining six bankruptcy courts, located in Alabama and North 

[10] Section 201(a)(11) of the Dodd-Frank Act defines a financial 
company as an entity organized under federal or state law that is (1) 
a bank holding company as defined in the Bank Holding Company Act of 
1956, as amended (BHC Act); (2) a nonbank financial company supervised 
by the Federal Reserve, as defined in section 102(a)(4)(D) of the Dodd-
Frank Act: (3) any company (other than a bank holding company or 
nonbank financial company supervised by the Federal Reserve) 
predominantly engaged in activities the Federal Reserve has determined 
to be financial in nature or incidental thereto under the BHC Act; or 
(4) any subsidiary (other than an insured depository institution or an 
insurance company) of one of the three types of entity if the 
subsidiary is predominantly engaged in such financial activities. To 
be "predominantly engaged" in financial activities, the company's 
revenues from those activities must constitute 85 percent or more of 
its total consolidated revenues, as FDIC, in consultation with the 
Department of the Treasury, establishes by regulation. Insured 
depositories, federally chartered Farm Credit System institutions, and 
certain other governmental or regulated entities are not financial 
companies for purposes of OLA. Throughout this report we use the term 
financial institutions to refer more broadly to institutions engaged 
in financial activities. 

[11] 12 U.S.C. § 1821(c). 

[12] The limitation of stockbrokers and commodity brokers to Chapter 7 
proceedings is set forth at 11 U.S.C. § 109(d) of the Bankruptcy Code. 
Chapter 7 contains special provisions for the liquidation of stock 
brokers and commodity brokers. 11. U.S.C. §§ 741-753 (Stockbroker 
Liquidation), 753, 761-767 (Commodity Broker Liquidation). Under SIPA, 
the Securities Investor Protection Corporation (SIPC) initiates a 
liquidation proceeding, the primary purpose of which is to protect 
investors against financial losses arising from the insolvency of 
their brokers. Once a protective decree has been applied under SIPA, 
any other pending bankruptcy proceeding involving the debtor 
stockbroker is stayed, and the court where the application is filed 
has exclusive jurisdiction of that stockbroker. SIPC participation can 
displace a Chapter 7 liquidation pending the SIPA liquidation, but 
provisions of the Code apply in a SIPA liquidation to the extent they 
are consistent with SIPA. See 15 U.S.C. §§ 78eee(b)(2)(B), 78fff(b). 
Because many of the stockbrokers discussed in this report are also 
dealers registered with the Securities and Exchange Commission as 
broker-dealers, we generally use the term broker-dealer rather than 
stockbroker in this report. The Code contains special provisions for 
commodity broker liquidation (11 U.S.C. §§ 753, 761-767), and the 
Commodity Futures Trading Commission's rules relating to bankruptcy 
are set forth at 17 C.F.R. Part 190. 

[13] See Dodd-Frank Act, Pub. L. No. 111-203 §§ 204, 210. FDIC's 
receivership authority is set forth mainly at 12 U.S.C. §§ 1821, 1822, 
and 1823. 

[14] Financially distressed firms seeking to restructure may file 
prepackaged bankruptcies or conduct out-of-court restructurings. In a 
prepackaged bankruptcy, the firm files a plan of reorganization at the 
same time as its Chapter 11 petition, with the reorganization plan 
negotiated out-of-court. The plan is subject to the court's approval. 

[15] Requirements for the content of a disclosure plan filed after the 
filing of a bankruptcy petition are set forth at 11 U.S.C. § 1125. A 
debtor generally has an exclusive right to file a plan of 
reorganization within 120 days of filing the petition, with the 
possibility of extending the period up to 18 months. After this 
exclusivity period has ended, creditors may file plans as well. 
Generally, the debtor has 180 days after the petition date to obtain 
acceptance of its plan from certain creditors; however, the court may 
extend (up to 20 months) or reduce this acceptance period for cause. 
See 11 U.S.C. § 1121(b) and (d). 

[16] 11 U.S.C. § 1129(a). An entire class of claims, such as secured 
creditors, unsecured creditors, or shareholders, is deemed to accept a 
reorganization plan if it is accepted by claimants that hold at least 
two-thirds in amount and more than one-half in number of the allowed 
claims in the class. See 11 U.S.C. § 1126(c) and (d). 

[17] The automatic stay provision is 11 U.S.C. § 362. 

[18] These safe harbors are primarily located in the following 
sections of the Code, which list types of contracts and instruments 
exempt from the automatic stay: 11 U.S.C. §§ 362(b)(6), (b)(7), 
(b)(17), 546, 556, 559, 560. Related definitions are set forth in 11 
U.S.C. § 101. This same class of contracts is defined in the FDI Act 
(and FDIC regulations, see 12 C.F.R. 360.5) and under the OLA 
authority as "qualified financial contracts." See 12 U.S.C. § 
1821(e)(8)-(10) (FDI Act); Dodd-Frank Act, Pub. L. No. 111-203 § 
210(c)(8)-(10). Financial industry participants typically refer to 
these instruments generally as QFCs. Because safe harbor contracts and 
QFCs generally refer to the same types of contract, in the remaining 
discussion we use the term "QFC" to refer both to contracts under the 
safe harbor provisions of the Code and to the instruments defined as 
QFCs under the FDI Act and the Dodd-Frank Act. Although a specific 
type of instrument might not be covered under both sets of provisions, 
this general reference is consistent with industry practice. 
Additionally, the FDI Act and the Dodd-Frank Act treat QFCs in an 
analogous manner to the Code, with one notable exception--the ability 
of FDIC to prevent the termination of these QFCs by transfer within 1 
business day--this will be discussed later in this report. 

[19] The Code defines the types of entities that can benefit from the 
safe harbor ("counterparty limitations"). See 11 U.S.C. §§ 362(b), 
101(22A), (46), (53C). 

[20] Ordinarily, an ipso facto clause in an executory contract is 
unenforceable against a debtor in bankruptcy due to the automatic 
stay, and the exercise of the right to recover property or act against 
the property of the debtor is prohibited by the automatic stay. 11 
U.S.C. §§ 365(e), 362. In bankruptcy, an executory contract is one in 
which both parties to the contract have future performance obligations 
that, if unperformed by either party, would result in a material 
breach. See Regen Capital I, Inc., v. Halperin, 547 F.3d 484 (2d Cir. 
2008); Olah v. Baird, 567 F.3d 1207 (10TH Cir. 2009). 

[21] An offset provision enables the nondefaulting party to offset 
(net) obligations owed against collateral pledged to the debtor. 11 
U.S.C. § 553. The safe harbors include "master netting agreements" for 
cross-product netting. 11 U.S.C. §§ 101(38A), (38B), 362(b)(27), 
546(j), 561. The debtor and the counterparty presumably would arrive 
at a net sum owed either to or from the debtor. 

[22] As discussed previously, the Code does not apply to insured 
depository institutions. The OLA provisions of the Dodd-Frank Act 
state that "the provisions of this title shall exclusively apply to 
and govern all matters relating to . . ." an institution placed into 
receivership under the OLA authority. Pub. L. No. 111-203 § 202(c)(2). 
For QFCs involving a bank in receivership, see 12 U.S.C. § 1821(e)(1), 
(8); for those involving an institution in OLA receivership, see Pub. 
L. No. 111-203 § 210(c)(1), (8). 

[23] See e.g., 12 U.S.C. §§ 1821(c)(8)(E), 4403, concerning the 
netting of bilateral netting rights between financial institution 

[24] See FDI Act, 12 U.S.C. § 1821(e)(8)-(10); Dodd-Frank Act, Pub. L. 
No. 111-203 § 210(c)(8)-(10). 

[25] 12 U.S.C. § 1821(e)(10)(B)(i)(II). Under the Code, the assignment 
and assumption of QFCs not terminated by their counterparties may be 
assigned if approved by the court. See, e.g., In re Lehman Brothers 
Holdings, Inc., (Bankr. S.D.N.Y. 08-13555(JMP)) "Order Approving 
Consensual Assumption and Assignment of Prepetition Derivative 
Contracts," Jan. 28, 2009. 

[26] See FDI Act, 12 U.S.C. § 1821(e)(11); see also Dodd-Frank Act, 
Pub. L. No. 111-203 § 210(c)(11). 

[27] 12 U.S.C. § 1821(c)(9),(11); see also Dodd-Frank Act, Pub. L. No. 
111-203 § 210(c)(9), (11). 

[28] See H.R. Rep. No. 97-420 at 2 (1982), 1982 U.S.C.C.A.N. 583, 584- 
85; H.R. Rep. No. 101-484 (1990), reprinted in 1990 U.S.C.C.A.N. 223. 

[29] Bankruptcy Abuse Prevention and Consumer Protection Act (2005), 
Pub. L. No. 109-8 (BAPCPA); Financial Netting Improvements Act of 
2006, Pub. L. No. 109-390; see H.R. Rep. No. 109-648, pt. 1 at 2 
(2006). Because safe harbor contracts and QFCs generally refer to the 
same types of contract, in the remaining discussion we use the term 
"QFC" to refer both to contracts under the safe harbor provisions of 
the Code and to the instruments defined as QFCs under the FDI Act and 
the Dodd-Frank Act. Although a specific type of instrument might not 
be covered under both sets of provisions, this general reference is 
consistent with industry practice. 

[30] See, e.g., H.R. Rep. No. 101-484 at 1-3 (1990) (regarding Code 
safe harbor); see 73 Fed. Reg. 78162 (Dec. 22, 2008) (FDIC depiction 
of purpose of pertinent QFC provisions in FDI Act). 

[31] BAPCPA, Pub. L. No. 109-8. 

[32] See, H.R. Rep. No. 109-31, pt. 1 at 105-07 (2005). As of the end 
of 2010, legislation based upon the UNCITRAL Model Law had been 
enacted in Australia (2008); the British Virgin Islands (2003); Canada 
(2009); Colombia (2006); Eritrea (1998); Greece (2010); Japan (2000); 
Mauritius (2009); Mexico (2000); Montenegro (2002); New Zealand 
(2006); Poland (2003); the Republic of Korea (2006); Romania (2003); 
Serbia (2004); Slovenia (2008); South Africa (2000); UK (2006), and 
the United States (2005). 

[33] 11 U.S.C. § 1501(a). 

[34] 11 U.S.C. § 1506. 

[35] Dodd-Frank Act, Pub. L. No. 111-203 § 203(b),(c)(4). The OLA 
defines a company subject to the determination as a "covered financial 

[36] The factors to be addressed are set forth in section 203(b) of 
the Dodd-Frank Act. Before the Secretary of the Treasury, in 
consultation with the President, makes a decision to appoint FDIC as 
receiver of a covered financial company, at least two-thirds of those 
serving on the Board of Governors of the Federal Reserve System and at 
least two-thirds of those serving on the Board of Directors of FDIC 
must vote to make a written recommendation to the Secretary of the 
Treasury to appoint FDIC as receiver. In the case of a broker-dealer, 
the recommendation must come from the Federal Reserve and the 
Securities and Exchange Commission, in consultation with FDIC, and in 
the case of an insurance company from the Federal Reserve and the 
Director of the Federal Insurance Office, in consultation with FDIC. 

[37] Dodd-Frank Act, Pub. L. No. 111-203 § 202(a). The Secretary of 
the Treasury must file the petition under seal to ensure 

[38] Dodd-Frank Act, Pub. L. No. 111-203 § 202(b). 

[39] FDIC's proposed rule sets standards for determining whether a 
company is "predominantly engaged in activities that are financial in 
nature or incidental thereto." 76 Fed. Reg. 16324 (Mar. 23, 2011). 

[40] Dodd-Frank Act, Pub. L. No. 111-203 § 203(c)(4). 

[41] See appendixes III-VI for additional information about many of 
the financial institutions discussed in this objective and information 
on other failed financial institutions. 

[42] GAO, Financial Markets Regulation: Financial Crisis Highlights 
Need to Improve Oversight of Leverage at Financial Institutions and 
across System, [hyperlink,] 
(Washington, D.C.: July 22, 2009). 

[43] By contrast, some academics disagreed that the Lehman bankruptcy 
was disorderly and believed instead that difficulties in the markets 
during the fall of 2008 were the result of government actions. 

[44] Daniel M. Covitz, Song Han, and Beth Ann Wilson, "Are Longer 
Bankruptcies Really More Costly?" Federal Reserve Working Paper No. 
2006-27 (Washington, D.C.: February 2006). 

[45] Commercial paper is a promissory note with a term of 270 days or 
less issued in the open market that represents the obligation of the 
issuing corporation. Large corporations (financial and nonfinancial) 
with strong credit ratings issue commercial paper as an alternative to 
bank borrowing. To pay off holders of commercial paper, issuers 
generally use the proceeds obtained by selling new commercial paper. 
Most commercial paper is issued by financial institutions and mutual 
funds purchase a large amount of the commercial paper issued. 

[46] Adrian, Tobias, Karin Kimbrough, and Dina Marchioni, "The Federal 
Reserve's Commercial Paper Funding Facility," Economic Policy Review 
17, no.1 (May 2011): 25-39. 

[47] GAO, Federal Reserve System: Opportunities to Strengthen Policies 
and Processes for Managing Emergency Assistance, [hyperlink,] (forthcoming). 

[48] For more information on the failure of LTCM, see GAO, Long-Term 
Capital Management: Regulators Need to Focus Greater Attention on 
Systemic Risk, [hyperlink,] 
(Washington, D.C.: Oct. 9, 1999). 

[49] See GAO, Troubled Asset Relief Program: Status of Government 
Assistance to AIG, [hyperlink,] 
(Washington, D.C.: Sept. 21, 2009). 

[50] Treasury, Public-Private Investment Program, $500 Billion to $1 
Trillion Plan to Purchase Legacy Assets, White Paper. 

[51] See Covitz et al. 

[52] Under TARP, the Department of the Treasury assisted institutions 
holding troubled assets by purchasing preferred shares in those 
institutions. As a shareholder, the government would rank below 
secured and unsecured creditors during a bankruptcy proceeding. 
Existing shareholders rarely receive any compensation in a bankruptcy. 

[53] [hyperlink,]. 

[54] See [hyperlink,] (listing of 
all borrowers under the Primary Dealer Credit Facility by name, date, 
amount, and other information). 

[55] See Senate Committee on Banking, Housing and Urban Affairs, 
Testimony Concerning Recent Events in the Credit Markets (testimony of 
Christopher Cox, Chairman, Securities and Exchange Commission, 110th 
Cong., 2d sess., Apr. 3, 2008); and SEC Office of Inspector General, 
SEC's Oversight of Bear Stearns and Related Entities: Broker-Dealer 
Risk Assessment Program, Report No. 446-B (Washington, D.C.: Sept. 25, 

[56] In re Lehman Bros. Holdings, Inc., 2010 WL 1783395 (Bankr. S.D. 
N.Y. May 5, 2010) ("Memorandum Decision Granting Debtors' Motion 
Pursuant to Sections 105(a) and 362 of the Bankruptcy Code for an 
Order Enforcing the Automatic Stay Against and Compelling Payment of 
Post-Petition Funds by Swedbank AB"). 

[57] Bank of America, N.A. v. Lehman Brothers Holdings, Inc., 439 B.R. 
811 (Bankr. S.D. N.Y. 2010). 

[58] We have been highlighting this feature of financial institutions 
for some time. See for example GAO, Financial Regulation: A Framework 
for Crafting and Assessing Proposals to Modernize the Outdated U.S. 
Financial Regulatory System, [hyperlink,] (Washington, D.C.: Jan. 8, 
2009); GAO, Financial Regulation: Industry Changes Prompt Need to 
Reconsider U.S. Regulatory Structure, [hyperlink,] (Washington, D.C.: Oct. 6, 

[59] See, for example, C. Cumming and R. Eisenbeis, "Resolving 
Troubled Systemically Important Cross-Border Financial Institutions: 
Is a New Corporate Organizational Form Required?" Working paper: 
February 8, 2010. 

[60] Pretax dividends transferred from subsidiary banks can be used by 
bank holding companies to pay debts, so that corporate taxes would not 
have to be paid on those funds. 

[61] US-headquartered bank and financial holding companies are subject 
to capital adequacy requirements at the holding company level for on- 
balance sheet assets. By moving assets into off-balance sheet 
vehicles, the capital requirement for the consolidated entity is lower. 

[62] These special purpose entities are called "bankruptcy remote" 
because if the parent company failed, neither trustees, debtors-in- 
possession, nor creditors could gain access to the assets contained in 
the vehicle, providing a safer (and higher-rated) investment for 

[63] In re Lehman Brothers Holdings, Inc., Case No. 08-13555, Report 
of Anton Valukas, Examiner; In re Lehman Brothers, Inc., Case No. 08- 
01420. Trustees Preliminary Investigation Report and Recommendations. 

[64] See In re Drexel Burnham Lambert Group, Inc., 138 B.R. 723, 764 
(Bankr. S.D. N.Y. 1992) (citation omitted). 

[65] In the Drexel proceeding, referenced above, the court listed the 
substantive consolidation factors established under case law, 
observing that they "must be evaluated within the larger context of 
balancing the prejudice resulting from the proposed consolidation 
against the effect of preserving separate debtor entities." 138 B.R. 
at 764-65 (citations omitted). 

[66] Section 13 of the FDI Act, authorizes FDIC to undertake various 
actions or provide assistance to a failing institution. FDIC is 
obligated to pursue a course of resolution that is the least costly to 
the insurance fund, except in cases involving systemic risk. 12 U.S.C. 
§ 1823(c). See GAO, Bank Regulation: Modified Prompt Corrective Action 
Framework Would Improve Effectiveness, [hyperlink,] (Washington, D.C.: June 23, 
2011) for more information. 

[67] See In re Washington Mutual, Inc, 442 B.R. 314 (Bankr, D. Del.) 
(2011) (although the global settlement of claims was fair and 
reasonable and provided a basis for confirmation, modifications were 
found necessary before confirmation would be granted). 

[68] See In re: CIT Group, Inc., Case No. 09-16565, Findings of Fact, 
Conclusions of Law and Order (confirming reorganization plan) (Bankr. 
S.D. N.Y. Dec. 8, 2009); In re: Lehman Brothers Holdings, Inc., 08- 
13555 (S.D. N.Y.) (pending). 

[69] FDIC issued cease and desist orders for one of Lehman's 
institutions and CIT's bank. The Office of Thrift Supervision also 
issued a cease and desist order for Lehman's thrift. 

[70] See, e.g., In re Lehman Brothers Inc., No. 08-01420 SIPA. 
"Trustee's Third Interim Report for the Period November 12, 2009 
through May 10, 2010." 

[71] See Cumming and Eisenbeis. 

[72] [hyperlink,]. 

[73] [hyperlink,]. 

[74] FDIC, "The Orderly Liquidation of Lehman Brothers Holdings Inc. 
under the Dodd-Frank Act," FDIC Quarterly 5, no. 2 (May 2011). 

[75] Dodd-Frank Act, Pub. L. No. 111-203 § 165(d). This provision 
requires each nonbank financial company supervised by the Federal 
Reserve and each bank holding company with total consolidated assets 
of $50 billion or more to submit periodically to the Federal Reserve 
or FDIC, respectively, and to the Financial Stability Oversight 
Council a plan for the company's rapid and orderly resolution in the 
event of material financial distress or failure. Such a company also 
must submit a report on the nature and extent of credit exposures the 
company has to significant bank holding companies and significant 
nonbank financial companies and the same types of exposures such 
companies have to the reporting company. 

[76] 76 Fed. Reg. 22648 (Apr. 22, 2011). The comment deadline was June 
10, 2011. 

[77] Pew Financial Reform Project, Standards for Rapid Resolution 
Plans (Washington, D.C.: May 2011). 

[78] See 11 U.S.C. § 303. 

[79] Under the OLA and the FDI Act, in the case of an FDIC 
receivership, a QFC counterparty generally cannot exercise a right to 
terminate or offset under an "ipso facto" provision until after 5:00 
p.m. (eastern standard time or eastern daylight time) following the 
date of appointment of FDIC as receiver. Dodd-Frank Act, Pub. L. No. 
111-203 § 210 (c)(8)(F); 12 U.S.C. § 1821(e)(10)(B)(i)(II). This 
allows FDIC to transfer the QFCs so as to prevent their termination by 
the counterparty. 

[80] Fed. R. Bankr. P. 1015(a), (b). 

[81] See, for example, Office of the Inspector General for the 
Troubled Asset Relief Program, Quarterly Report to Congress, January 
26, 2011 (Wash., D.C.). 

[82] GAO, Financial Assistance: Ongoing Challenges and Guiding 
Principles Related to Government Assistance for Private Sector 
Companies, [hyperlink,] 
(Washington, D.C.: Aug. 3, 2010). 

[83] See, e.g., In the Matter of the Liquidation of the New York 
Agency and Other Assets of Bank of Credit and Commerce International, 
S.A. 683 N.E. 2d 756 (1997). 

[84] H.R. Rep. No. 109-31, pt. 1 at 105-07 (2005). 

[85] In re Lehman Brothers Finance, AG, in Liquidation, Case No. 09- 
10583; In re: Lehman Brothers Holdings, Inc., Case No. 08-13555, Order 
Dismissing Chapter 11 Case of Lehman Brothers Finance AG, (Bankr. S.D. 
N.Y. 2009). 

[86] 11 U.S.C. § 1504. The Code defines a "foreign representative" as 
a person or body "authorized in a foreign proceeding to administer the 
reorganization or the liquidation of the debtor's assets or affairs or 
to act as a representative of such foreign proceeding." 11 U.S.C. 

[87] 11 U.S.C. § 1502(7). The Code permits a foreign representative to 
make a limited appearance in an involuntary case without being 
submitted to the U.S. court's jurisdiction. 11 U.S.C. § 306. Also, the 
Code permits a bankruptcy court to dismiss a case, after notice and a 
hearing, if, among other things, recognition of a foreign proceeding 
has been granted under Chapter 15. 11 U.S.C. § 305. 

[88] 11 U.S.C. § 1505. 

[89] 11 U.S.C. §§ 1525, 1526. 

[90] Section 1516 of the Code states that "in the absence of evidence 
to the contrary, the debtor's registered office is presumed to be the 
center of the debtor's main interests." 11 U.S.C. § 1516(c). However, 
this presumption has been contested, and courts look to credible 
indicators of the center of main interest. See Louise DeCarl Adler, 
"Managing the Chapter 15 Cross-Border Insolvency Case," A Pocket Guide 
for Judges (Federal Judicial Center: 2011). 

[91] Note that eight of the largest financial institutions listed in 
table 2 are located in these countries. 

[92] An informative discussion of protocols and other aspects of cross-
border insolvency cooperation can be found in the United Nations, 
UNCITRAL Practice Guide on Cross-Border Insolvency Cooperation (New 
York: 2010). 

[93] American Law Institute, Transitional Insolvency: Cooperation 
among the NAFTA Countries, Principles of Cooperation among the NAFTA 
Countries (Philadelphia, Pa: 2003). 

[94] In re Lehman Brothers Holdings, Inc., Docket No. 08-13555, Order 
Approving The Proposed Cross-Border Insolvency Protocol For the Lehman 
Brothers Group of Companies (June 17, 2009). See American Law 
Institute, Guidelines Applicable to Court-to-Court Communications in 
Cross-Border Cases (Washington D.C.: 2000). 

[95] "Cross-Border Insolvency Protocol for The Lehman Brothers Group 
of Companies," execution copy, as of May 12, 2009. 

[96] Basel Committee on Banking Supervision, Report and 
Recommendations of the Cross-border Resolution Group (Basel, 
Switzerland: March 2010). 

[97] The International Centre for Monetary and Banking Studies (ICMB) 
is an independent, nonprofit foundation to foster exchanges of views 
between the financial sector, central banks, and academics on issues 
of common interest. It is financed through grants from banks, 
financial institutions, and central banks. In association with The 
Centre for Economic Policy Research--a network of over 700 research 
fellows and affiliates throughout Europe--the ICMB produces the Geneva 
Reports on the World Economy. ICMB, A Safer World Financial System: 
Improving the Resolution of Systemic Institutions, Geneva Reports on 
the World Economy 12 (Geneva, Switzerland: 2010). 

[98] See appendix VIII for some detailed information on insolvency 
systems in selected countries. 

[99] A common law system gives broad discretion to the judge so that a 
body of law is developed through court decisions in addition to law 
enacted through legislation. A civil law system is one that places 
emphasis on the language of the statute and predictability. See Robert 
Adriaansen, "At the Edges of the Law: Civil Law v. Common Law," A 
Response to Professor Richard B. Capalli, Temple Int'l & Comp. L.J. 
107 (1998). For bankruptcy purposes, one legal writer described the 
difference as follows: "Whereas the U.S. bankruptcy court is a court 
of equity and a U.S. judge asks under the concept of common law 
whether there is anything in the Code that restrains him from granting 
the order, the German judge needs under civil law principles a 
provision in the Act which allows him to grant the action in 
question." See "Lies, Sale of a Business in Cross-Border Insolvency: 
The United States and Germany." Am. Bankr. Inst. L.10 Rev. 363 no. 65 
(spring 2002). 

[100] In re Lehman Brothers Holdings, Inc., Case No. 08-13555, Lehman 
Brothers Special Financing Ince. V. BNY Corporate Trustee Services, 
LTD, Adversary Proceeding 09-01242, Memorandum Decision Granting 
Motion for Summary Judgment and Declaring Applicable Payment 
Priorities (Bankr. S.D. N.Y. Jan. 25, 2010). 

[101] Depository institutions insured by Canada's federal government 
are subject to restructuring and/or reorganization by the Canada 
Deposit Insurance Corporation (CDIC) under the Canada Deposit 
Insurance Corporation Act (CDIC Act). Provincial loan and trust 
corporations whose deposits are CDIC-insured also may be subject to 
the act if the relevant province has entered an agreement with the 
federal government. The Winding Up and Restructuring Act (WURA) 
applies to federal and provincial banks, loan companies, and insurance 
corporations. The WURA in effect provides a liquidation regime for 
these financial institutions. 

[102] The Group of 20 (G20) is a group of finance ministers and 
central bank governors from 19 countries--including the United States--
and the EU. The Financial Stability Board brings together from the G20 
countries central banks officials, finance and treasury officials, and 
financial institution regulators; officials of the International 
Monetary Fund and World Bank, and representatives from non-G20 
countries to address issues related to global financial stability. 
Originally authorized by the Group of Seven countries--Canada, France, 
Germany, Italy, Japan, UK, and United States--in 1999 as the Financial 
Stability Forum, in April 2009, the G20 changed its name to the 
Financial Stability Board and strengthened and broadened its 
authority. The mandates of the board currently includes promoting 
coordination among authorities responsible for financial stability and 
contingency planning for cross-border crisis management, particularly 
for systemically important financial institutions. Financial Stability 
Forum, FSF Principles for Cross-border Cooperation on Crisis 
Management (Apr. 2, 2009). 

[103] INSOL is a global group of national associations of insolvency 
experts, including attorneys and accountants. 

[104] International Insolvency Institute, Judicial Guidelines for 
Coordination of Multinational Enterprise Group Insolvencies (2009). 
The International Insolvency Institute is a global organization of 
insolvency experts. 

[105] Prompt corrective action is the requirement that regulators take 
increasingly intensive actions as an institution's capital situation 
worsens. See 12 U.S.C. § 1831o. 

[106] A bridge institution is an institution established to facilitate 
the transfer of assets and liabilities from one institution to another. 

[107] The IMF, an organization of 184 countries, works to help foster 
global monetary cooperation and secure financial stability, among 
other aims. The staffs of these institutions have also conducted 
research related to these activities. 

[108] Pub. L. No. 111-203,§§ 202(e), (f). The mandate requires that we 
report on the judicial review for OLA and the effectiveness of the 
Code annually for 3 years after the passage of the act and every fifth 
year thereafter. The Administrative Office of the U.S. Courts is also 
required to address Pub. L. No. 111-203,§ 202(e), and the Board of 
Governors of the Federal Reserve System (Federal Reserve) has mandates 
to address issues similar to those GAO is addressing in Pub. L. No. 
111-203,§§ 216, 217. 

[109] A 10-K filing is the Form 10-K filed with the Securities and 
Exchange Commission (SEC). The 10-K is an annual report required by 
SEC of every issuer of a registered security, every exchange-listed 
company, and any company with 500 or more shareholders or $1 million 
or more in gross assets. The form provides for disclosure of total 
sales, revenue, and pretax operating income, as well as sales by 
products for each of a company's separate lines of business. The Form 
10-K becomes public information when filed with the SEC. 

[110] Prepackaged bankruptcies are those where creditors and others 
necessary for approval of a plan accept a reorganization plan before 
the company files for bankruptcy. The provisions of any applicable 
nonbankruptcy law such as federal securities law governing 
communication with shareholders of public companies must be complied 
with, and those solicited must have been provided with "adequate 
information" in connection with the solicitation of their vote. See 11 
U.S.C. 1126. 

[111] Dodd-Frank Act, Pub. L. No. 111-203 § 202(b)(2). 

[112] See Letter to William J. Sweet, Jr. (April 13, 2009). Section 
23A is codified, as amended, at 12 U.S.C. § 371c. Regulation W is set 
forth at 12 C.F.R. part 223. 

[113] Prepackaged bankruptcies are generally those where the required 
number of creditors and other parties of interest accept a 
reorganization plan before the company files for bankruptcy, as long 
as the solicitation of such acceptance was in compliance with any 
applicable nonbankruptcy law, rule, or regulation governing the 
adequacy of disclosure in connection with such solicitation. 11 U.S.C. 

[114] See In re CIT Group Inc., and CIT Group Finding Company of 
Delaware LLC, Case No. 09-16565, Findings of Fact, Conclusions of Law 
and Order (1) Approving (A) The Disclosure Statement Pursuant to 
Sections 1125 and 1126(c) of The Bankruptcy Code, (B) Solicitation of 
Votes and Voting Procedures, and (C) Forms of Ballots, and (II) 
Confirming the Modified Second Amended Prepackaged Reorganization Plan 
of CIT Group Inc. and CIT Group Funding Company of Delaware LLC 
(Bankr. S.D. N.Y., Dec. 8, 2009). 

[115] As of July 21, 2011, the Office of the Comptroller of the 
Currency will begin supervising all federal thrifts, and the Office of 
Thrift Supervision will cease operations 90 days later. 

[116] In the United States, consolidated supervision generally is 
equated with holding company supervision at the top tier or ultimate 
holding company in a financial enterprise. 

[117] According to Lehman's accounting, a "derivative asset" is one 
that will yield "probable future economic benefits," and a "derivative 
liability" is one that will yield "probable future sacrifices of 
economic benefits." That is, a derivative asset is one in which Lehman 
was owed money and would have been paid if the counterparty wanted to 
close out the position. With a derivative liability, Lehman would have 
owed money and would have to pay current market value to close out the 

[118] The expert also estimated the notional value of these contracts 
at $60 trillion, although authoritative information about the actual 
size of the market is generally not available. Notional value means 
the amount underlying a financial derivatives contract. 

[119] LBI borrowed funds from the Primary Dealer Credit Facility, 
which offered short-term collateralized loans, following the LBHI 
bankruptcy. LBI borrowed $28 billion on September 15 against $31.7 
billion of collateral, $19.7 billion on September 16 against $23 
billion of collateral, and $20.4 billion on September 17 against $23.3 
billion of collateral. 

[120] Two of these debtors (Fundo de Investimento Multimercado Credito 
Privado Navigator Investimento No Exterior and Lehman Brothers 
Finance) later would have their Chapter 11 cases dismissed. 

[121] The SIPA statute requires that a SIPA proceeding be conducted in 
accordance with, and as though it were being conducted under the 
appropriate sections of Chapter 7. 

[122] The procedural history of these proceedings is described in 
Lehman Brothers Special Financing Inc. (Adv. Proc No. 09-01242), In re 
Lehman Brothers Holdings Inc., Case No. 08-13555 (Bankr., S.D. N.Y.), 
Memorandum and Decision Granting Motion for Summary Judgment and 
Declaring Applicable Payment Priorities (Jan. 25, 2010). 

[123] See 11 U.S.C. § 510. 

[124] In re Lehman Brothers Holdings Inc., Case No. 08-13555, In re 
Lehman Brothers Inc., Case No. 08-01420 (Bankr. S.D. N.Y.), Opinion on 
Motions Seeking Modification of the Sale Order Pursuant to Rule 60(B), 
The Trustee's Motion for Relief Under the SIPA Sale Order, Barclay's 
Cross-Motion to Enforce the Sale Orders and Adjudication of Related 
Adversary Proceedings (Feb. 22, 2011). 

[125] 15c3-3 assets are securities held in reserve pursuant to Rule 
15c3-3, the Customer Protection Rule promulgated by the SEC. Clearance 
box assets are securities held in LBI's "clearance box" accounts at 
the Depository Trust & Clearing Corporation. These assets facilitated 
securities trading by providing collateral to secure open trading 

[126] In re Lehman Brothers Holdings Inc., Case No. 08-13555 (Bankr. 
S.D. N.Y.), Memorandum Decision Granting Debtors' Motion Pursuant to 
Sections 105(a) and 362 of the Bankruptcy Code for an Order Enforcing 
the Automatic Stay Against and Compelling Payment of Post-Petition 
Funds by Swedbank AB (May 5, 2010). 

[127] In Re Washington Mutual, Inc. Debtors. Chapter 11. Case No. 08- 
122229 (MFW) Jointly Administrated. January 11, 2011. 

[128] Washington Mutual Bank was headquartered in Henderson, Nevada 
and Washington Mutual Bank FSB was headquartered Park City, Utah. 

[129] As of July 21, 2011, OTS will transfer its authority over thrift 
holding companies to the Federal Reserve. The Office of the 
Comptroller of the Currency then will supervise all federal thrifts. 
OTS will cease operations 90 days later. 

[130] Department of the Treasury and FDIC Offices of Inspector 
General, Evaluation of Federal Regulatory Oversight of Washington 
Mutual Bank. Report No. EVAL-10-002. (Washington, D.C.: April 2010). 

[131] Joshua R Hochberg. Final Report of the Examiner. In re 
Washington Mutual, Inc. et al. Case No. 08-12229 (MFW). 

[132] The Federal Home Loan Banks are 12 regional cooperative banks 
that member financial institutions use to access credit and liquidity. 
Washington Mutual Bank FSB was also a member of the Federal Home Loan 
Bank of Seattle. 

[133] Purchase and assumption agreements are an FDIC resolution 
mechanism that involves transferring some or all of the failed 
institution's deposits, certain other liabilities, and some or all of 
its assets to an acquirer. 

[134] On March 16, 2011, FDIC filed a complaint in the U.S. District 
Court in the Western District of Washington at Seattle against three 
former executives of Washington Mutual, Inc. and their spouses, 
seeking to recover damages for gross negligence, ordinary negligence, 
breaches of fiduciary duties, and for assets FDIC said were 
fraudulently transferred conveyances. 

[135] The examiner also found that: (1) JPMC was the only potential 
purchaser of Washington Mutual Bank that did not want government 
assistance or guarantees, and the institution had an advantage in 
calculating the value of the bank because of its work in the spring of 
2008; and (2) FDIC could be more transparent in its actions, better 
inform potential purchasers of the value of assets, and should require 
better documentation of assets being sold. 

[136] In re Washington Mutual, Inc., 442 B.R. 314, 322 (Bankr. D.Del, 

[137] A detailed discussion of the disputed accounts can be found in 
the Examiner's report. 

[138] A fraudulent transfer could imply the holding company was trying 
to hinder, delay, or defraud creditors (such as FDIC) and would have 
to be unwound. The fraudulent transfer provision of the Bankruptcy 
Code is 11 U.S.C. § 548. 

[139] Pub. L. No. 111-92 § 13. 

[140] See, e.g., In re Washington Mutual, Inc., 442 B.R. 314, 321 
(Bankr. D. Del. 2011). 

[141] Trust preferred securities are securities having characteristics 
of both debt and equity that often are issued by bank holding 
companies through a trust. In this case, the trust preferred security 
holders own a preferred equity interest in Washington Mutual, Inc. 

[142] In the proceeding brought by trust preferred securities (TPS) 
holders, Black Horse Capital LP v. JPMorgan Chase Bank, N.A., 442 B.R. 
297 (Bankr. D. Del. 2011), the court granted the defendants' motions 
for summary judgment and denied the TPS holders' motion for summary 
judgment, finding that the TPS holders no long have any interest in 
the TPS because the interests were converted to interest in preferred 
stock of Washington Mutual, Inc. 

[143] In the litigation tracking warrant proceeding, known in the 
context of the WMI bankruptcy as the "Anchor Litigation," the court 
ruled that although a genuine dispute remained concerning the status 
and valuation of the claims, the holders' interests are adequately 
protected by the debtor's Chapter 11 plan. See In re Washington 
Mutual, Inc., 442 B.R. 314 at 324-25, 339-341 (Bankr. D. Del, 2011). 

[144] Bank of International Settlements, History of the Basel 
Committee and its Membership, (Basel, Switzerland, August 2009), and 
BIS Chronology - 1970 to 1979, (Basel, Switzerland, August 2009), and 
Federal Reserve Bank of New York, "Developments on the Management of 
Foreign Exchange Settlement Risk" Remarks by Ernest T. Patrikis, First 
Vice President, Federal Reserve Bank of New York before the Bankers 
Association for Foreign Trade, the 74TH Annual Convention Tucson, 
Arizona, April 30, 1996. 

[145] The Group of Ten comprised Belgium, Canada, France, Germany, 
Italy, Japan, the Netherlands, Sweden, and Switzerland, the UK, and 
the United States. The Basel Committee on Banking Supervision, as it 
is known, provides a forum for regular cooperation on banking 
supervisory matters. Its objective is to enhance understanding of key 
supervisory issues and improve the quality of banking supervision 
worldwide. It seeks to do so by exchanging information on national 
supervisory issues, approaches and techniques, with a view to 
promoting common understanding. At times, the committee uses this 
common understanding to develop guidelines and supervisory standards 
in areas where they are considered desirable. In this regard, the 
committee is best known for its international standards on capital 
adequacy; the Core Principles for Effective Banking Supervision; and 
the Concordat on cross-border banking supervision. The committee's 
current members come from Argentina, Australia, Belgium, Brazil, 
Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, 
Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, 
Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, 
Turkey, the UK, and the United States. 

[146] New Street Capital was acquired in December 1993 by Green 
Capital Investors, L.P. 

[147] Ring fencing refers to the practice by which local authorities 
set aside or shield assets of a local subsidiary from the failed 
institution and insist that local creditors get paid first, prior to 
any funds being transferred to satisfy claims made against the failed 

[148] Although no statutory definition of hedge funds exists, the term 
commonly is used to describe private investment vehicles that often 
engage in active trading of various types of securities and 

[149] See [hyperlink,] and 

[150] We have issued several reports on federal assistance to AIG, 
including GAO, Federal Financial Assistance: Preliminary Observations 
on Assistance Provided to AIG, [hyperlink,] (Washington, D.C.: Mar. 18, 
2009); Troubled Asset Relief Program: Status of Government Assistance 
Provide to AIG, GAO-09-975 (Washington, D.C.: Sept. 21, 2009); 
[hyperlink,]; and Troubled 
Asset Relief Program: Update of Government Assistance Provided to AIG, 
[hyperlink,] (Washington, D.C.: 
Apr. 27, 2010). 

[151] A collateralized debt obligation is a security backed by a pool 
of bonds, loans, or other assets. 

[152] Basel Committee on Banking Supervision, Report and 
Recommendations of the Cross-border Resolution Group (Basel, 
Switzerland: 2010). 

[153] Monoline insurers usually write a single type of insurance 
contract, such as for bond issuances. 

[154] A feeder fund is an investment fund that conducts virtually all 
of its investing through another fund (called the master fund). The 
master-feeder fund structure is a common way that hedge funds are set 
up to accept assets from both foreign and domestic investors in the 
most tax and trading efficient manner possible. The master fund is 
often located offshore. 

[155] Due to the size of the claim and Colonial not having enough 
assets to pay FDIC the full amount, granting FDIC's claim likely would 
have forced the debtor into Chapter 7 liquidation (partially) to meet 
FDIC's claim. 

[156] In re The Colonial BancGroup, Inc., 436 B. R. 713 (Bankr. M.D. 
Ala. 2010). 

[157] In re The Colonial BancGroup, Inc., 2011 Bankr. LEXIS 275 
(Bankr. M.D. Ala. 2011). 

[158] The Bank of New York merged with Mellon Financial Corporation on 
January 1, 2007, to form The Bank of New York Mellon Corporation (BNY). 

[159] The Bank of New York v. FDIC, 453 F. Supp. 2d 82 (D.D.C. 2006), 
aff'd, 508 F.3d 1 (D.C. Cir 2007), reh. denied, Bank of New York v. 
FDIC, 2008 U.S. App LEXIS 1582, 1586 (D.C. Cir. 2008). 

[160] Bank of New York v. First Millenium, Inc., 958 F. Supp. 2d 550 
(S.D. N.Y. 2009). 

[161] Bank of New York v. First Millennium, Inc., 607 F. 3d 905 at 910-
915 (2d Cir. 2010). The decision contains a description of the 
NextBank receivership and subsequent lawsuits. 

[162] 11 U.S.C. §§ 365, 547. In bankruptcy, an executory contract is 
one in which both parties to the contract have future performance 
obligations that, if unperformed by either party, would result in a 
material breach. See Regen Capital I, Inc., v. Halperin, 547 F. 3d 484 
(2d Cir. 2008); Olah v. Baird, 567 F. 3d 1207 (10TH Cir. 2009). 

[163] A general description of these laws is set forth in the 
following discussion about special resolution regimes. 

[164] Dodd-Frank Act. Pub. L. No. 111-203 § 210(c)(8)(F)(II) 
(suspending QFC counterparty's payment or delivery obligations during 
the time from when FDIC is appointed receiver until the earlier of the 
party's receiving notice that the contract has been transferred to 
another entity or 5:00 p.m. (eastern standard time or eastern daylight 
time) on the business day following the appointment). 

[165] Bank Bankruptcy in Canada: A Comparative Perspective, supra 
note, at 66-67. 

[166] Jingxia Shi, Twelve Years to Sharpen One Sword: The 2006 
Enterprise Bankruptcy Law and China's Transition to a Market Economy, 
16 J. Bankr. L. & Prac. 5 (October 2007). 

[167] See European Parliament and Council, 2010, Regulation on 
Establishing a European Supervisory Authority (European Banking 
Authority) Reg. No. 1093/2010. 

[168] Jan D. Bayer, German Bank Restructuring Act: Impact on Investors 
in Debt, Hybrid and Equity Securities Issued by German Banks, 
available at [gyperlink, 
http://www.binghamcom/Media.aspx?MediaID=11986] (Feb. 9, 2011). 

[169] A bridge institution is an institution established to facilitate 
the transfer of assets and liabilities from one institution to another. 

[170] The International Comparative Legal Guide to Corporate Recovery 
and Insolvency 2010: Netherlands, page 147. 

[171] These rankings are based on information from secondary sources 
and, in some cases, the laws themselves. The priorities for unsecured 
creditors under U.S. law are set forth at 11 U.S.C. § 507. 

[End of section] 

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