Dodd-Frank's 'Orderly Liquidation' Is Out of Order

September 26, 2012

The Wall Street Journal

Scott Pruitt and Alan Wilson

'The tendency of the law must always be to narrow the field of uncertainty." Justice Oliver Wendell Holmes wrote that more than a century ago, but the sentiment runs all the way to our nation's roots. Under our Constitution, the rule of law provides the certainty and transparency necessary to protect individual liberty and support economic growth.

But the 2010 federal financial-reform law known as Dodd-Frank continues to undermine economic growth and the rule of law by injecting immense uncertainty into our economy. As law professor David Skeel demonstrated recently in these pages, the law's Title II gives the Treasury secretary and the Federal Deposit Insurance Corp. unprecedented authority to "liquidate" financial companies. This grants immense power to a handful of unelected federal bureaucrats, empowering them to pick winners and losers among a liquidated company's investors. This arrangement destroys rights long protected by bankruptcy law.

For that reason and others, the attorneys general of South Carolina, Oklahoma and Michigan last week joined a federal lawsuit challenging Dodd-Frank's unconstitutional "orderly liquidation" provisions. Dodd-Frank's elimination of investors' rights directly harms our states because state pension funds are partly invested in financial companies. We must raise these constitutional objections now because once a company is liquidated, it will be too late.

Title II eliminates all meaningful judicial review and due process. Once the Treasury secretary orders the liquidation of a financial company, the company has only 24 hours to convince a federal court to overturn that order. Unless the court somehow manages to decide the entire case in the company's favor before the clock expires, the government wins by default and can begin to liquidate the company even as appeals are pending. Dodd-Frank further limits the authority of the courts by prohibiting them from reviewing whether the Treasury secretary's decision was constitutional, or whether the liquidation is actually necessary to protect financial stability.

The Treasury secretary's largely unaccountable decisions in these cases will put investments at risk, and creditors won't know until it is too late. Dodd-Frank prohibits the company from disclosing the liquidation threat before the district court decides the case. Once the liquidation goes forward, the creditors' only recourse will be to plead their case before the FDIC, with minimal judicial review—meaning that creditors' recoveries are "likely to be close to zero," as bankruptcy scholars Douglas Baird and Edward Morrison have put it.

Even more disturbing is the possibility that a company might agree to be "liquidated" and rebuilt under a new banner—like "New Chrysler" replacing "Old Chrysler"—leaving its creditors no right to block the reorganization. Instead, creditors not favored by federal bureaucrats will have little choice but to accept the deal offered to them by the government in a black-box process.

When the federal government replaced "Old Chrysler" with "New Chrysler" in 2009, it told one set of Chrysler's creditors (Indiana's state pension funds) to swallow $6 million in losses. Indiana attempted to defend its employees' pensions in court, but the government shuttered "Old Chrysler" before the Supreme Court could hear Indiana State Police Pension Trust v. Chrysler. Our states face the same threat because they have invested in the debt of financial companies that can be liquidated under Dodd-Frank.

We have taken an oath to uphold the rule of law and defend the Constitution. We are determined to uphold that oath, including defending the Constitution against the overarching power of the federal government.

Our lawsuit attempts to defend the very heart of our Constitution's structure: By committing such broad power to federal bureaucrats and nullifying critical checks and balances, Dodd-Frank's "orderly liquidation" authority violates the Constitution's separation of powers, the Fifth Amendment's guarantee of due process, and the guarantee of "uniform" bankruptcy laws.

The president and Congress can easily repair these constitutional violations by amending Dodd-Frank, restoring the rights long protected by federal bankruptcy law and reaffirming the Constitution's checks and balances. Until then, we will vigorously defend the rule of law through this litigation. The hard-earned pension contributions and tax payments of our citizens deserve nothing less.

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