Why Banks Are Not Allowed in Bankruptcy

Table of ContentsI. Introduction 986II. Bankruptcy and Bank Insolvency 993A. Dispersed Control in Bankruptcy 993B. Bank Insolvencies and the Purchase and Assumption Agreement 998III. The Case for FDIC Control of Bank Insolvencies 1006A. The Benefits of Speed and Secrecy 1007B. The FDIC as Residual Claimant 10121. The FDIC as the Largest Creditor 10162. FDIC Losses on Failure 1021IV. Limits of the Case for FDIC Control 1025A. Agency Costs in Bank Resolutions 1027B. The Liability Structure of Large Banks 1031C. Self-Financed Restructuring: Debt Conversion 1036V. Bank Holding Companies and Nonbank Financial Companies 1044VI. Conclusion 1051I. IntroductionMost nations resolve failed banks with the same procedures they apply to other insolvent firms.1 American law is different. American banks and thrifts do not receive bankruptcy protection.2 Instead, regulators seize insolvent or unsound banks or thrifts and give the Federal Deposit Insurance Corporation (FDIC) the authority to resolve them. Almost always the FDIC chooses to resolve seized institutions through a receivership.3 Very different rules govern the bankruptcy and bank receivership processes. These rules appear in different titles of the United States Code and have important substantive differences. The most important difference between the two procedures is the concentration of control over the disposition of the failed firm's assets. The traditional bankruptcy reorganization divides control among the various claimants and appoints a judge to supervise the process. The overwhelming majority of reorganizations are resolved consensually with the approval of each class of creditors and shareholders.4 Even when a debtor tries to cram down a plan over the objections of dissenting creditors, the debtor must win approval of at least some creditors, and the other creditors can ask the judge to reject the plan because it fails to comply with tests of horizontal and vertical equity or it is not in the best interests of the creditors.5Debtors sometimes bypass the traditional reorganization with a relatively quick sale of many of the failed firm's assets or at least the assets necessary for some of the business to continue operating. Although this quick sale denies the creditors the ability to vote on the sale, the debtor must still seek approval of the bankruptcy judge,6 and the dissenting creditors can at least ask the judge to enjoin the sale. The recent Chrysler bankruptcy provides a nice illustration of this process. Within a few weeks of Chrysler' s bankruptcy filing, the debtor sold substantially all of its operating assets to a Chrysler owned by the UAW, Fiat and the U.S. and Canadian governments.7 New Chrysler emerged from bankruptcy and continued manufacturing and selling cars.8 The original corporate entities, and the few assets that New Chrysler did not want, stayed in bankruptcy, and Old Chrysler remains there over a year after its bankruptcy filing.9 Eventually the bankruptcy process will conclude, and these remaining assets and the proceeds of the sale to New Chrysler will be distributed to the creditors of Old Chrysler. …

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