The historic financial reform legislation moving toward passage in Congress is expected to require that all financial organizations deemed "too big to fail" have a "living will." Living wills would be written at a time when an organization's principal responsibilities are to its shareholders and bondholders, but the purpose of a living will would be to facilitate the liquidation of the organization if the government was appointed as receiver. Current battles among the Federal Deposit Insurance Corporation (FDIC), shareholders and creditors arising from the failures of Washington Mutual, Downey, Colonial and other banks and thrifts suggest that drafting a living will that takes into account the rights of all interested parties will be a difficult task.

As an important precursor to this requirement, the FDIC published for comment on May 17, 2010 a proposed regulation that would require the largest US depository institutions to develop contingent resolution plans (75 Fed. Reg. 27464). These plans would (i) describe a depository institution's relationships with its holding company and affiliates, (ii) identify its material business lines, exposures and other risks that pose obstacles to its orderly resolution in receivership and (iii) set forth the steps that a receiver may take to avoid or overcome those obstacles. The proposed regulation would apply only to depository institutions that have more than $10 billion of total assets and that are owned by companies that have more than $100 billion of total assets. As of December 31, 2009, there were 40 such institutions, which accounted for approximately 48% of all FDIC-insured deposits.

The purpose of a contingent resolution plan would be to maximize the ability to separate a depository institution and its subsidiaries from its holding company and affiliates in the event of financial stress. A plan would address, at a minimum:

(i) Organizational structure (both legal and functional);

(ii) Business activities (including relationships affecting an institution's ability to operate on a stand-alone basis);

(iii) Capital structure and corporate financing arrangements;

(iv) Systemically important functions; and

(v) Foreign-based or foreign-located entities, operations and assets.

A depository institution would be able to apply for a modification or waiver of these requirements based on its size, lack of complexity or other factors demonstrating that its resolution would not present material challenges or risks. Failure to provide the required information would subject a depository institution to enforcement actions.

If the proposed regulation is adopted, or its provisions are replicated in the requirements for a living will for systemically significant financial companies, all covered depository institutions, holding companies and financial companies should be aware of the delicate issues that such plans may raise, including:

(i) What impact will the regulatory objective of making business units safer and easier to separate from their parent in liquidation have on the regulation of an open organization's operations, capital allocations, liquidity and risk management?

(ii) What impact will a living will have on current corporate governance with regard to business decisions that may increase an organization's risk profile or may alter the assumptions that underlie its living will?

(iii) What process should an organization use to create a living will? What input in the process should the management and boards of directors at various levels of an organization have? How and when should a living will be amended?

(iv) What conflicts may arise between (a) the interests and duties of a depository institution and its parent company, (b) the parent company and its shareholders and (c) its shareholders and its creditors?

(v) Does a director have a duty to preserve a company's opportunity to reorganize rather than be liquidated, and how does that duty impact the plan?

(vi) What assumptions may or should an organization make in developing a living will? How should a living will be tested in view of the fact that its efficacy can be determined only under the most difficult of financial circumstances?

(vii) What liabilities may arise for directors and officers when a living will is implemented and it is determined to be effective or ineffective?

(viii) What impact will a living will have on D&O insurance, indemnification and the advancement of expenses?

Contingent resolution plans and living wills will create a new set of obligations, management objectives and, potentially, liabilities for depository institutions, holding companies, systemically significant financial companies and their directors and officers. The development and adoption of such plans will require critical analysis by directors, officers, legal counsel, financial advisors and consultants at all levels of larger and more complex organizations and possibly, over time, at many other financial institutions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.