FDIC Finalizes Rule on Nullification of Subsidiary and Affiliate Cross-Defaults under OLA

October 17, 2012

On October 9, 2012, the Federal Deposit Insurance Corporation (“FDIC”) finalized its rule (the “Final Rule”) implementing section 210(c)(16) of the Orderly Liquidation Authority provisions of the Dodd-Frank Act (“OLA”) relating to the treatment of certain affiliate and subsidiary cross-defaults under OLA. The Final Rule is substantially similar to the rule proposed by the FDIC on March 20, 2012.

Once a company enters receivership under OLA (such company, a “covered financial company” or “CFC”), section 210(c)(16) and the Final Rule address when counterparties to contracts with subsidiaries or affiliates of the CFC may exercise contractual rights to declare a default, accelerate, terminate or take other actions based on the insolvency, financial condition or receivership of the CFC. Both the statute and the Final Rule are aimed at stabilizing a financial group during its resolution by preventing the exercise of cross-default clauses in contracts with potentially viable subsidiaries or affiliates. For example, these provisions address the situation where a subsidiary’s obligations are guaranteed by its parent and can be accelerated and terminated upon the parent’s insolvency. Absent section 210(c)(16) and the Final Rule making these cross-defaults unenforceable, the resulting cascade of failures would likely result in the unraveling of the financial group and in multiple subsidiaries entering insolvency proceedings, increasing the expense, complexity and potential systemic effects of such a resolution. Neither the statute nor the Final Rule interfere with a counterparty’s ability to terminate or exercise other remedies if a subsidiary or affiliate itself enters insolvency proceedings, fails to perform or make a payment as required under the applicable contract.

Although the power to nullify cross-defaults can help make a resolution more orderly and effective, it deprives creditors of bargained-for protections and has the potential to leave counterparties worse off than if the financial company had been resolved under ordinary insolvency law. The attached memorandum provides a summary of key provisions of the Final Rule and discusses the balance it attempts to strike between the competing goals of ensuring an orderly resolution and preserving the legitimate expectations of counterparties to contracts enforced under section 210(c)(16).