Sutherland Legal Alert: Dodd-Frank Act Creates Significant Changes in Bankruptcy Law Affecting Derivatives and Other Trading Counterparties

by Sutherland's Regulatory Reform Task Force

After months of negotiations and conferences among key legislators, President Obama signed into law a final version of regulatory reform legislation on July 21, 2010. More than 2,000 pages long, the "Dodd-Frank Wall Street Reform and Consumer Protection Act" (the Act) provides new legal guidelines for both "financial companies" and non-financial companies and instructs federal agencies to develop a myriad of regulations to enforce the concepts provided in the Act. The Act also addresses the ability of federal regulators to step-in if state regulators fail to take action in certain liquidation and rehabilitation scenarios. Among the many areas in which companies now face a new legal and regulatory landscape, the Act makes a handful of significant changes to existing bankruptcy law. The Act creates new statutes that will arise infrequently, but that will likely have a significant effect on the rights of creditors and counterparties on the occasions when they are triggered.

The new statutes will become relevant only when insolvency threatens certain companies that could impact U.S. financial markets or the stability of such markets. Although years will likely pass with no activity under the new statutes, traders should be prepared to encounter new and different insolvency regimes in the event that a major counterparty faces financial difficulties. As discussed below, there are two general areas of change to bankruptcy law under the Act: (a) enforceability of key contractual provisions, such as termination rights and setoff found in derivatives and other trading agreements; and (b) the handling of customer accounts in the event that the affected financial company is a commodity broker. In effect, the changes mean that certain bank holding companies and nonbank financial companies supervised by the Board of Governors of the Federal Reserve System (the Board)1 and many of their subsidiaries will be subject to an insolvency regime akin to the Federal Deposit Insurance Act's treatment of banks, including the imposition of FDIC receivership.

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