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This paper describes several proposed changes to the Bankruptcy Code that are designed for—and limited to—the reorganization or liquidation of the nation’s largest financial institutions. The proposed changes create a new Chapter 14 of the Bankruptcy Code and incorporate features of liquidations under Chapter 7 as well as reorganizations under Chapter 11. In addition, the proposed Chapter 14 contains a number of substantive and procedural changes designed especially for the complexity, and potential systemic consequences, of the failure of these large financial institutions. Through these changes, we believe it is possible to take advantage of a judicial proceeding—including explicit rules, designated in advance and honed through published judicial precedent, with appeals challenging the application of those rules, public proceedings, and transparency—in such a way as to minimize the felt necessity to use the alternative government agency resolution process recently enacted as a part of the Dodd Frank Wall Street Reform and Consumer Protection Act. The new chapter could be adopted either in addition or as an alternative to the new resolution regime of Dodd Frank.
Much of the impetus for the financial reform legislation came from the view, correct or not, that when Lehman Brothers failed and had to go into bankruptcy, disaster ensued because it could not be taken over like a failed bank. Therefore, the Dodd-Frank Act in Title II created a new procedure (“Orderly Liquidation Authority”) to seize even nonbank financial companies whose default would, in the view of the Secretary of the Treasury, have serious adverse effects on financial stability. This procedure gives unprecedented power and discretion to an administrative official, going far beyond banking law to the point of posing serious Constitutional problems.