California Creditor's Rights & Business Bankruptcy Lawyer & Attorney : Robert Eisenbach : Business Bankruptcy Blog

The First Two Delaware Decisions. In the past two months, I have reported on decisions by two Delaware bankruptcy judges in the In re Washington Mutual, Inc. case and in In re Premier International Holdings, Inc. (aka, the Six Flags case), taking opposing views on whether Federal Rule of Bankruptcy Procedure 2019 requires ad hoc committees and informal groups to disclose their trading activities. The Court in the Washington Mutual case held that it does, while the Court in the Six Flags case came out strongly with the opposite view. Follow the links in the prior sentence for more on both decisions, including copies of the respective opinions, as well as the earlier Northwest Airlines and Scotia Pacific decisions from the Southern Districts of New York and Texas, respectively.

A Third Delaware Decision. Two days after the Six Flags opinion was issued, Delaware Bankruptcy Judge Brendan L. Shannon issued a short order granting a motion to compel an Ad Hoc Noteholder Group in the In re Accuride Corporation Chapter 11 case to disclose details of their trades. A copy of Judge Shannon's two-page order is available by clicking on the link in this sentence. The ruling reflects the Court's comments from the bench agreeing with the conclusions in the Northwest Airlines and Washington Mutual decisions, although Judge Shannon stated that he did not necessarily concur that fiduciary obligations arise in this context, as the Washington Mutual opinion had stated.

The Philadelphia Newspapers Court Weighs In. Then last week, on February 4, 2010, Judge Stephen Raslavich, Chief Judge of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania, issued another opinion on the issue, this time involving a "Steering Group of Pre-petition Lenders" in the In re Philadelphia Newspapers, LLC Chapter 11 bankruptcy case. After reviewing the analysis in each of the prior decisions from the Delaware, New York, and Texas courts, Chief Judge Raslavich held that Rule 2019 does not require such disclosure by the Steering Committee, essentially agreeing with the reasoning of Delaware Bankruptcy Judge Sontchi in the Six Flags case. Follow the link in this sentence for a copy of Chief Judge Raslavich's 28-page opinion in the Philadelphia Newspapers case.

More To Come? We have now had six opinions or orders on the Rule 2019 issue involving ad hoc committees or informal groups, with three judges holding disclosure is required (Northwest Airlines, Washington Mutual, and Accuride Corporation) and three holding it is not (Scotia Pacific, Six Flags, and Philadelphia Newspapers). Although the issue may gain more clarity on appeal or the question may be superseded by an amended version of Rule 2019, now under consideration by the Advisory Committee, in the meantime more courts will likely be asked to decide this thorny Rule 2019 issue. Given the split in authority -- with each judge finding that the "plain meaning" of Rule 2019 supports its view -- it has become even more difficult to predict how the next court will rule.

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Last month, I reported on a decision from Delaware Bankruptcy Judge Mary Walrath in the In re Washington Mutual, Inc. case ("WaMu") holding that informal creditor groups must disclose details of their trades under Federal Rule of Bankruptcy Procedure 2019. The WaMu ruling, a first from Delaware, came nearly three years after rulings from the Southern District of New York in the Northwest Airlines case, and the Southern District of Texas in the Scotia Pacific case, took different sides on the issue.

A New Decision And Proposed Revision To Rule 2019. Now, little more than a month later, a second Delaware Bankruptcy Court judge has issued an opinion on the same issue -- and has forcefully come out the other way. These decisions are playing out against the backdrop of a proposed revision of Rule 2019 which, if adopted, would expand disclosures by ad hoc committees and other groups of creditors and equity security holders as discussed in more detail near the end of this post.

Before turning to the new decision, here are several links to follow for more about the earlier Rule 2019 decisions and the overall context:

• Do Hedge Funds Have To Disclose Their Trades If They Form A Bankruptcy Committee?
• In New Ruling, Northwest Airlines Court Decides Whether Ad Hoc Committee Of Hedge Funds May File Details Of Their Trades Under Seal
• Scotia Pacific Court Rules On Motion To Compel Group Of Hedge Funds To Disclose Their Trading Details
• The Return Of The Rule 2019 Question: Delaware Bankruptcy Court Weighs In On Whether Creditor Groups Must Disclose Trading Data

The New Delaware Decision. On January 20, 2010, Delaware Bankruptcy Judge Christopher Sontchi issued an opinion in In re Premier International Holdings, Inc., more commonly known as the Six Flags case, explaining his reasons for denying a motion to compel an informal committee of noteholders, known as the SFO Noteholders Informal Committee, from complying with Rule 2019. Follow the link in this sentence for a copy of Judge Sontchi's new 34-page Six Flags opinion.

The Six Flag Court's Plain Meaning Analysis. In his opinion, Judge Sontchi discussed but respectfully declined to follow the Northwest Airlines and WaMu decisions referenced above. Instead, he held that under the plain meaning of Rule 2019, an informal committee of noteholders was not a "committee representing more than one creditor" described in the current Rule 2019. In reaching this conclusion, Judge Sontchi explained as follows:

    The question here is whether the SFO Noteholders Informal Committee is 'a committee representing more than one creditor.' If so, its members are subject to Rule 2019. The starting point of the analysis or 'default entrance' is plain meaning.

    A committee” is a 'body of two or more people appointed for some special function by, and usu. out of a (usu. larger) body.' The use of the word 'appointed' clearly contemplates some action be taken by the larger body. Thus, a self-appointed subset of a larger group - whether it calls itself an informal committee, an ad hoc committee, or by some other name – simply does not constitute a committee under the plain meaning of the word. In order for a group to constitute a committee under Rule 2019 it would need to be formed by a larger group either by consent, contract or applicable law -- not by 'self-help.' This construct is supported by the rule’s applicability to indenture trustees, which are delegated with certain rights and obligations on behalf of all holders of the debt by operation of contract, i.e., the indenture. Similarly, official committees under section 1102 of the Bankruptcy Code (although exempted from Rule 2019) receive their authority from federal law, i.e., the Bankruptcy Code.

    The meaning of 'represent' is: 'take the place of (another); be a substitute in some capacity for; act or speak for another by a deputed right.' A deputed right is one that is assigned to another person. Thus, the plain meaning of 'represent' contemplates an active appointment of an agent to assert deputed rights. It is black letter law that a person cannot establish itself as another’s agent such that it may bind the purported principal without that principal’s consent unless the principal ratifies the agent’s actions. Thus, under the plain meaning of the phrase 'a committee representing more than one creditor,' a committee must consist of a group representing the interests of a larger group with that larger group’s consent or by operation of law. As the SFO Noteholders Informal Committee does not represent any persons other than its members either by consent or operation of law, it is not a 'committee' under Rule 2019 and, thus, its members need not make the disclosures required under the rule.

(Footnotes omitted; emphasis in original.)

The Six Flag Court's Review Of Legislative History. After concluding that the plain meaning of Rule 2019 did not require disclosures by the SFO Noteholders Informal Committee, the Court then examined the legislative history of the rule at some length as a "reality check" on the plain meaning decision. In this part of the opinion, Judge Sontchi traced the legislative history back to the Chandler Act of 1938 and subsequent rule making creating Rule 10-211, which later became Rule 2019. The Court then placed the Chandler Act in context by reviewing the perceived abuses of "protective committees" and "reorganization committees" involved in pre-1930s railroad reorganizations through equity receiverships. Judge Sontchi then concluded that the purposes for which Rule 2019 was adopted do not apply to today's informal committees:

    The nub of the question is how the legislative history of Rules 10-211 and 2019 applies to the informal and ad hoc committees of today and, more specifically, the Informal Committee of SFO Noteholders. Certainly there are parallels between the 'protective committees' under equity receivership and the informal committees of today. For example, both are usually composed of Wall Street banks and institutional investors. Both are formed for the purpose of obtaining leverage in the reorganization that would not be available to disparate creditors. Both are involved in the negotiation and formulation of a plan of reorganization.

    The differences, however, far outweigh the similarities. The 'protective committees' that were the target of the reforms under the Chandler Act were able to control completely the entire reorganization – from inception to formulation to solicitation to implementation. They were granted the authority to negotiate on behalf of and to bind creditors through the use of deposit agreements. They were so intimately involved with management so as to be virtually in control of the business. They could force disparate treatment of similarly situated creditors. Finally, they were able 'to steal' the company for an inadequate 'upset price' at a foreclosure sale by credit bidding their debt.

 

    The informal and ad hoc committees of today have none of these expansive powers. Indeed, the Chandler Act so effectively curbed the power of protective committees that they virtually ceased to exist within a few years of the Act’s passage. Rule 10-211 was, for all intents and purposes, superfluous almost immediately after its passage. There was nothing left to regulate.

    The Bankruptcy Code continues to limit the powers of committees, albeit in other ways. For example, the debtor is given exclusive authority to propose and to solicit a plan of reorganization; claims and interests may only be classified with substantially similar creditors; creditors in the same class must be treated equally; a trustee or examiner can be appointed for cause. Even if an informal committee were to try to exercise the powers formerly available to protective committees, it would be prevented by the Bankruptcy Code. Thus, Rule 2019 is also, for all intents and purpose, superfluous – the problem it was designed to address by requiring certain disclosures simply no longer exists.

    In any event, the Informal Committee of SFO Noteholders has not attempted to invoke the powers previously wielded by protective committees. Certainly, the committee has actively participated in the reorganization process both pre-petition and post-petition. The committee vigorously opposed the Debtors’ Initial Plan and now vigorously supports the Revised Plan that it negotiated post-petition. But, the Informal Committee of SFO Noteholders has gone no farther. It doesn’t have the ability to bind its members – they can vote any way they please. It cannot force disparate treatment of the SFO creditors. The list goes on. Based upon the legislative history, Rule 2019 is not intended to nor does it apply to the Informal Committee of SFO Noteholders in this case.

(Footnotes omitted; emphasis in original.)  Finally, Judge Sontchi considered the analysis in the Northwest Airlines and WaMu decisions and declined to follow those rulings for a number of reasons detailed in the Six Flags opinion.

The Proposed Revisions To Rule 2019. The core holding of the Six Flags opinion -- that under the plain meaning of Rule 2019 the term "committee" applies only to a committee that is appointed by or represents a larger group -- could be rendered moot by a proposed revision to Rule 2019 now under consideration by the Advisory Committee.

• The proposed amendment to Rule 2019 would change the language of the rule to include not only representative committees but also "every entity, group, or committee that consists of or represents more than one creditor or equity security holder." (Emphasis added.)
• Follow the link in this sentence for a copy of the proposed Federal Rules of Bankruptcy Procedure amendments under active consideration by the Advisory Committee, including proposed Rule 2019.
• The proposed version of Rule 2019 would require these newly defined groups or committees to disclose each "disclosable economic interest." That term would be defined to mean "any claim, interest, pledge, lien, option, participation, derivative instrument, or any other right or derivative right that grants the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest."
• The bankruptcy court would also have the authority to order the disclosure of amounts paid for these positions, but pricing disclosure would not be required absent a court order.
• The proposed rule has now gotten the attention of the financial media, and it will be the subject of a hearing in early February with testimony expected from various interested parties.

Conclusion. To say the least, a lot is going on in the world of Rule 2019, informal committees and creditor groups, and the potential for disclosure of trading data by hedge funds and other distressed investors. It's likely that more courts will be asked to decide these issues in the months ahead, and advocates on both sides of the issue now have new Delaware opinions to cite for their position. On top of that, if ultimately adopted, a proposed -- and significantly revised -- Rule 2019 could resolve some of these questions.  For now, however, the final language of any revised Rule 2019, like the application of the current Rule 2019, remains unclear. 

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It's been a few years since decisions from the United States Bankruptcy Courts for the Southern District of New York, and later from the Southern District of Texas, examined whether hedge funds and other investors could be required to disclose the details of their trades when they form an ad hoc committee or group in a Chapter 11 case.  Last week, Judge Mary Walrath of the United States Bankruptcy Court for the District of Delaware issued a decision in the Washington Mutual, Inc. Chapter 11 case, for the first time giving us a Delaware bankruptcy judge's views on the subject. Before turning to the new decision, a copy of which is available below, let's first put the issue in context.

Ad Hoc Committees and Groups. In recent years, hedge funds and other investors in distressed debt or the equity securities of bankrupt companies have taken active roles in Chapter 11 bankruptcy cases. Often, these investors form unofficial or "ad hoc" committees.

• Much like official committees of unsecured creditors, equity security holders, retirees, or other constituencies, unofficial or ad hoc committees typically hire counsel and file motions and other pleadings during the course of a bankruptcy case.
• Sometimes these creditors call themselves a committee but more recently the more informal term "group" has been used.
• By acting as a committee or group, the creditors not only share the costs of participating in the bankruptcy case but also have the ability to wield greater influence by acting collectively instead of on an individual basis.

The Rule 2019(a) Statement. After making an appearance in a bankruptcy case, these groups or committees, their counsel, or both will typically file what's known as a "Rule 2019(a) Statement." This is a public filing required by Rule 2019(a) of the Federal Rules of Bankruptcy Procedure, the set of procedural rules which, together with the United States Bankruptcy Code itself, govern the conduct of bankruptcy cases. Rule 2019(a) provides, in part, as follows:

[E]very entity or committee representing more than one creditor or equity security holder . . . shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof. 

The Northwest Airlines And Scotia Pacific Decisions. In early 2007, first in the Northwest Airlines case, and then in the Scotia Pacific Company LLC ("Scotia Development") case, two bankruptcy judges reached opposite conclusions on the question of whether groups of investors had to comply with Rule 2019.

• In February and March of 2007, Judge Allan L. Gropper of the U.S. Bankruptcy Court for the Southern District of New York, presiding over the Northwest Airlines Chapter 11 case, required an ad hoc committee of hedge funds and other stockholders to disclose publicly full details of their trades in Northwest Airlines claims and stock. This was big news because hedge funds and other distressed debt investors carefully guard their trading data. Follow the links in this sentence for copies of Judge Gropper's first decision requiring the disclosure and second decision ordering that the trading data not be filed under seal. You can find earlier posts on these decisions and their aftermath here, here, here, here, and here.
• Then in April 2007, Judge Richard S. Schmidt of the U.S. Bankruptcy Court for the Southern District of Texas issued an order denying Scopac's motion to compel disclosure of the details of trades in Scotia Development's secured timber notes. In his two-page order, Judge Schmidt ruled that a noteholder group that had formed in the Scopac case was not a "committee" within the meaning of Rule 2019 and, as such, the disclosure requirements of that rule did not apply. Following the links in this sentence will lead you to a copy of Judge Schmidt's two-page order in the Scotia Development case and to an earlier post on the case.

The Delaware Bankruptcy Court's Decision In The Washington Mutual Case. On December 2, 2009, more than two and a half years since the Scotia Development decision, Judge Walrath of the Delaware bankruptcy court faced the same issue in the Washington Mutual, Inc. case.  J. P. Morgan Chase Bank moved to compel a group of creditors calling themselves the "Washington Mutual, Inc. Noteholders Group" ("WMI Noteholders Group") to provide trading and other information required by Rule 2019. The WMI Noteholders Group argued, among other points, that they were not an ad hoc committee but only a loose affiliation of creditors who came together on at at-will basis to share the cost of advisory services as a matter of efficiency.

In her decision, Judge Walrath rejected that argument, siding with Judge Gropper's analysis in Northwest Airlines and declining to follow the two-page order issued by Judge Schmidt in the Scotia Development case. Specifically, she held:

Here, the WMI Noteholders Group possesses virtually all the characteristics typically found in an ad hoc committee, save the name. The WMI Noteholders Group consists of multiple creditors holding similar claims. The members of the WMI Noteholders Group filed pleadings and appeared in these chapter 11 cases collectively, not individually. The WMI Noteholders Group retained counsel, which takes its instructions from the Group as a whole. While counsel contends that it speaks only for the members of the WMI Noteholders Group that agree with the filing of each pleading or position taken in each appearance, counsel for the Group has never advised this Court that it is representing less than all the Group. Rather the pleadings and appearances by counsel demonstrate that the Group and counsel represent not each individual member in its individual capacity, but rather the Group as a whole. In fact, it is the collective $1.1 billion in holdings of the members of the Group that counsel uses to argue in favor of the Group’s position, not each individual’s separate holding.

Under the plain language of Rule 2019, therefore, the Court finds that although the WMI Noteholders Group call themselves a Group, they are in fact acting as an ad hoc committee or entity representing more than one creditor. The WMI Noteholders Group, therefore, must comply with Rule 2019.

Follow the link for a copy of Judge Walrath's 20 page Washington Mutual decision.

Another Issue: Do Groups Owe Fiduciary Duties? One of the most interesting parts of Judge Walrath's decision came in response to the WMI Noteholders Group's argument that Rule 2019 was not intended to apply to the Group because it does not speak for other noteholders. Judge Walrath not only rejected this argument but in doing so also suggested that creditor or shareholder groups may owe fiduciary duties to others in the same class:

The WMI Noteholders Group contends, however, that the Rule was only intended to apply to 'a body that purports to speak on behalf of an entire class or broader group of stakeholders in a fiduciary capacity with the power to bind the stakeholders that are members of such a committee.' The WMI Noteholders Group’s argument is premised on the erroneous assumption that the Group owes no fiduciary duties to other similarly situated creditors, either in or outside the Group. The case law, however, suggests that members of a class of creditors may, in fact, owe fiduciary duties to other members of the class.

Judge Walrath, however, deferred any further decision on the issue, noting:

It is not necessary, at this stage, to determine the precise extent of fiduciary duties owed but only to recognize that collective action by creditors in a class implies some obligation to other members of that class.
 

With this decision, ad hoc committees and other groups are on notice that, at least in Delaware, they may be found to owe duties to other members of their respective class of creditors or investors.

Conclusion. This new decision means that Delaware now joins the Southern District of New York in holding that ad hoc committees and investor groups will be required to comply fully with Rule 2019, including the requirement to disclose details of their trades in the debtor's claims or interests. In addition, the Washington Mutual decision goes another step and suggests that these groups may be held to owe fiduciary duties to other members of their class, whether or not they have joined the group or ad hoc committee. With judges in the two most active jurisdictions for Chapter 11 bankruptcy cases now applying Rule 2019 more broadly, it will be interesting to see how creditors, investors, and debtors react in future cases.

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In February and March of this year, Judge Allan L. Gropper of the U.S. Bankruptcy Court for the Southern District of New York, presiding over the Northwest Airlines Chapter 11 case, required an ad hoc committee of hedge funds and other stockholders to disclose publicly full details of their trades in Northwest Airlines claims and stock. This was big news because hedge funds and other distressed debt investors carefully guard their trading data. The decision raised questions about whether these very active parties would continue to form ad hoc committees, choose to act independently, or limit their participation in bankruptcy cases altogether.

The Big Question: Would Other Courts Follow Northwest Airlines? As with most new decisions of note, this one had many people wondering whether other courts would follow it and require ad hoc committees to make such disclosures. This week we got the first answer to that question, albeit in a somewhat different context, in the Scotia Pacific Company LLC (Scopac) Chapter 11 case pending in Corpus Christi, Texas. The Scopac court's answer: not in its case. Keep reading below to see how the court got to that decision.

A Bit Of Background. First, for those new to the disclosure issue, you can read more about it in a series of earlier posts on this blog (here, here, here, here, and here). If you follow the links in this sentence you can also find copies of Judge Gropper's first decision requiring the disclosure and second decision refusing to allow the information to be filed under seal. Both decisions were based on Federal Rule of Bankruptcy Procedure 2019(a). As a reminder, here's the key part of Rule 2019(a):

[E]very entity or committee representing more than one creditor or equity security holder . . .  shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

Scopac's Rule 2019 Motion. With that background, here's the Scopac disclosure story. Not long after the Northwest Airlines decisions, Scopac filed a motion to compel an Ad Hoc Group Of Timber Noteholders (which originally called itself an Ad Hoc Committee and now refers to itself as the Noteholder Group) to file an amended version of its previously filed Rule 2019 statement. Relying on the Northwest Airlines decisions, Scopac argued that the Noteholder Group should be required to file detailed information about the amounts of the claims or stock owned by the Group's members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings.

The Noteholder Group's Objection. The Noteholder Group objected to the motion, arguing that it was merely a group of noteholders and not a "committee" as that term is used in Rule 2019. Specifically, it said that it didn't represent or purport to represent any noteholders beyond those who were already members of the Noteholder Group. The Noteholder Group also contended that, even if it were a committee, the purpose of the rule is to protect others in the class it represents and here any non-member noteholders were welcome to join the group directly.

Friends Of The Court Join In. As they had in the Northwest Airlines case, the Securities Industry and Financial Markets Association (SIFMA) and the Loan Syndications and Trading Association (LSTA) filed an amici curiae "friend of the court" brief in opposition to the Scopac Rule 2019 motion. They argued that forcing disclosure of trading details would have a detrimental impact on the market for the debt and securities of distressed companies and the willingness and ability of sophisticated parties to participate in Chapter 11 cases.

Scopac's Reply. Scopac filed this reply arguing that the Noteholder Group, which originally called itself an "Ad Hoc Committee" and only began to describe itself as an informal "group" after the motion was filed, was a Rule 2019(a) committee and should be compelled to make additional disclosure. Scopac also argued that the Noteholder Group was acting as a representative and thus fit squarely within the rule's requirements.

The Scopac Court's Rule 2019 Order. On Wednesday, April 18, 2007, Judge Richard S. Schmidt of the U.S. Bankruptcy Court for the Southern District of Texas issued this order denying Scopac's motion to compel disclosure of the details of trades in Scopac's secured timber notes. In his two-page order, Judge Schmidt ruled that the Noteholder Group was not a "committee" within the meaning of Rule 2019 and, as such, the disclosure requirements of that rule did not apply. The DealBook blog on the New York Times website reported on the decision here.

What's Next? The Scopac decision represents a step back from the Rule 2019 view taken by the Northwest Airlines court, but for at least two reasons the issue remains far from settled. First, the Noteholder Group in Scopac successfully argued that it was not a committee at all because it didn't represent anyone other than its own members. This apparently persuaded the Scopac court to draw a distinction between the Noteholder Group and the Ad Hoc Committee in Northwest Airlines. It's unclear whether other courts would do the same. Second, many more large Chapter 11 cases are filed in the Southern District of New York than in Texas these days. As a result, Judge Gropper's decision may have a bigger impact on future cases than the Scopac decision. That said, we'll have to wait for additional cases to see which of these two approaches courts find more consistent with the language and purpose of Rule 2019.

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As reported last week, the Ad Hoc Committee of Equity Security Holders in the Northwest Airlines case, a group made up chiefly of hedge funds, recently complied with the Bankruptcy Court's earlier orders and filed a Rule 2019 statement disclosing details of their trades. Having made the filing, it wasn't clear whether the Ad Hoc Committee would continue to appeal from the Bankruptcy Court's decisions compelling the disclosure. An answer to that question came late in the day on Monday, March 26.

New Appeal Filed. Late Monday, the remaining membership of the Ad Hoc Committee of Equity Security Holders filed a second notice of appeal, this time from the Bankruptcy Court's original February 26, 2007 decision requiring the detailed statement to be filed. A copy of the new notice of appeal is available here. An earlier notice of appeal was filed from the Bankruptcy Court's March 9, 2007 order denying a motion to file the Rule 2019 statement under seal. It appears that the earlier appeal will be pursued as well.

No Stay Pending Appeal. As previously reported, at a March 15, 2007 hearing the Bankruptcy Court also denied the Ad Hoc Committee's motion for a stay pending appeal. However, the Ad Hoc Committee got until March 25, 2007 to seek a stay from the United States District Court for the Southern District of New York. (Here's the Bankruptcy Court's order on the stay issue, which was filed only last Friday.) Despite the temporary reprieve, the Ad Hoc Committee apparently decided against seeking a stay pending appeal and instead went ahead and filed the updated Rule 2019 statement and then a new appeal.

The Disclosure Issue Moves To Another Court. With the new appeal filed Monday, this issue should be headed to the District Court for briefing and argument in the coming months. It'll be interesting to see whether the District Court, sitting as an appellate court, has any different reaction to the disclosure issue. Stay tuned for future developments.

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As reported last week, the Bankruptcy Court in the Northwest Airlines Chapter 11 bankruptcy case ordered the Ad Hoc Committee of Equity Security Holders to make public detailed information about the claims and stock they own and the amounts they paid for them. For those who missed it, here's the Bankruptcy Court's first decision on the Rule 2019 disclosure issue back on February 26, 2007. If you want the full story on the hedge fund disclosure issue, check out these two earlier posts, which you can find here and here.

Ad Hoc Committee Discloses Trades. After failing to persuade the Bankruptcy Court to reconsider its decision or to allow the disclosure to be filed under seal, a noticeably smaller Ad Hoc Committee filed this Rule 2019 disclosure on Wednesday, March 21, 2007, providing details on the amounts of claims or stock held, the dates purchased, and the amounts paid. The Ad Hoc Committee's membership appears to have been reduced by at least four, currently standing at nine, although the Rule 2019 statement does not explain the change in membership or include any disclosure by the former members.

Although Smaller, Ad Hoc Committee Is Still Intact. The filing answers at least one question -- whether the hedge funds involved would decide to disband the ad hoc committee to avoid disclosing their trading information. While four dropped out, it seems that the nine remaining Ad Hoc Committee members concluded that the benefits of collective action outweighed the burdens of making the required disclosure.

Appeal Status Unclear. The Ad Hoc Committee had previously filed a notice of appeal from the Bankruptcy Court's decision, seeking review by the United States District Court for the Southern District of New York. With the disclosure actually filed, it's not clear whether the Ad Hoc Committee plans to drop the appeal and an accompanying motion for leave to appeal, which it had originally filed in the Bankruptcy Court, and whether the appeal would be moot if continued. Should the Ad Hoc Committee or its former members pursue the appeal effort, I'll post updates as developments warrant. 

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The Rule 2019 Decisions. As I reported in a post earlier this week, after first ruling that members of an Ad Hoc Committee of Equity Security Holders were required to disclose detailed information about the claims or stock they own and the amounts they paid for them, on March 9, 2007, the Bankruptcy Court in the Northwest Airlines case issued a second decision holding that this Rule 2019 information must be filed publicly.

The Motion for Reconsideration. Three hedge funds that are members of the Ad Hoc Committee filed a motion for reconsideration of the Bankruptcy Court's first decision. In addition, the Loan Syndications and Trading Association (LSTA) and the Securities Industry and Financial Markets Association (SIFMA) filed an amicus curiae brief in support of the motion for reconsideration, arguing as follows:

LSTA and SIFMA are very concerned that the Rule 2019 Decision will have a serious detrimental impact on the willingness and ability of many stakeholders to participate in future chapter 11 cases. Although the Debtors and certain equity holders are at odds in these cases, there are countless examples in other cases where groups of stakeholders have cooperated, many times in the guise of 'ad hoc' committees to create imaginative and strikingly successful solutions. The Rule 2019 Decision, by requiring the disclosure of proprietary and highly confidential information, will in all likelihood erect a substantial obstacle to the participation of many stakeholders – in particular, those sophisticated stakeholders that are the most likely to have the means and the experience to make a positive contribution toward reorganization.

The Court Rules On The Motion For Reconsideration. The hearing on the motion for reconsideration took place on March 15, 2007. As reported by the Associated Press here, the Bankruptcy Court denied the reconsideration motion, describing it as "totally frivolous" and observing that it did not advance any new arguments.

Motion for Leave To Appeal. Given that the Ad Hoc Committee had filed a notice of appeal of the Bankruptcy Court's decision on March 14, 2007, at the March 15, 2007 hearing the Bankruptcy Court apparently agreed to stay its ruling for ten days. The stay is designed to permit the Ad Hoc Committee the opportunity to pursue a motion for leave to appeal, which it had also filed on March 14, 2007, in the United States District Court for the Southern District of New York. The motion seeks leave to appeal on the following basis:

[T]he bankruptcy court ordered the Ad Hoc Committee to disclose to the world detailed trading data, including all individual purchases and sales of any interest in the Debtors (whether it be stock, bonds, claims or any other interest), including purchase and sales prices. The Ad Hoc Committee hereby seeks to appeal the decision refusing to allow the filing to be made under seal. As an initial matter, the order at issue is a final order within the meaning of 28 U.S.C. § 158(a)(1). Likewise, the order satisfies the collateral order doctrine also making the decision appealable now. Nevertheless, the cases vacillate between characterizing such an appeal under the collateral order doctrine as one of right or one requiring leave. Accordingly, and so as to avoid any doubt as to the validity of the appeal, the Ad Hoc Committee also seeks leave in addition to having filed its notice of appeal as of right.

More Action Ahead. With Bankruptcy Judge Gropper's latest decision and the motion for leave to appeal, it looks like the disclosure issue will now shift to the District Court. The Bankruptcy Court reportedly has also deferred decision on the Ad Hoc Committee's motion for appointment of an examiner, apparently until the Rule 2019 statement is filed or the appeal is resolved. I'll plan to provide additional updates as developments warrant.

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The Northwest Airlines Disclosure Decision. In a post last week, I discussed the Bankruptcy Court's decision in the Northwest Airlines Chapter 11 case requiring the members of an Ad Hoc Committee of Equity Security Holders to disclose detailed information about the amounts of claims or stock owned by the Committee's members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings.

Rule 2019: Not So Arcane Anymore. The Bankruptcy Court based its decision on Federal Rule of Bankruptcy Procedure 2019. The rule, rarely discussed in articles or blogs, provides in part:

[E]very entity or committee representing more than one creditor or equity security holder . . .  shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

Something Of A Bombshell. As a number of articles have discussed (for example, here and here), the decision was significant because hedge funds and other investors in distressed debt and equity securities have been taking major roles in some of the largest Chapter 11 bankruptcy cases, including through ad hoc committees. Loathe to disclose their trading information, some wonder whether hedge funds will continue to be as active in bankruptcy cases. Hedge funds have been such important players in distressed situations that any retreat from their often leading role could have a big impact on Chapter 11 cases.

Decision Results In A Flurry Of Paper. The Bankruptcy Court's decision set in motion a series of additional court filings. (You can access these pleadings by clicking on the following links.)

• In response to the Bankruptcy Court's decision, the Ad Hoc Committee filed a motion for permission to file the trading information under seal rather than publicly, including not disclosing it to the Debtors or the Official Committee of Unsecured Creditors. They strenuously argued that their trading information was trade secret and confidential commercial information that should be protected under Section 107(b) of the Bankruptcy Code and Bankruptcy Rule 9018, two provisions that permit the sealing of the record under certain circumstances. 
• A number of other parties weighed in with objections or responses to the Ad Hoc Committee's motion. These included the Debtors, the Official Committee of Unsecured Creditors, and the United States Trustee. These parties argued against sealing the Rule 2019 statement, contending that it was essential for the parties in the case to know what claims and interests the Ad Hoc Committee members held and the details of their acquisition costs.
• In addition, Bloomberg News successfully moved to intervene in the case. Bloomberg contended that the Northwest Airlines case was of public significance and that "all aspects of it should be open to public scrutiny to the fullest extent possible." It argued that hedge funds "have become major sources of capital for distressed companies and now play a significant role in bankruptcy proceedings such as this one. The nature of the positions being taken by these key financial players, and the potentially conflicting interests they may hold in any given situation, raise the potential for precisely the types of abuse that led to adoption of Rule 2019 as a procedural device to 'help foster fair and equitable plans free from deception and overreaching'" (quoting from the Bankruptcy Court's prior decision).
• The Ad Hoc Committee then filed a reply, continuing to argue for the sealing of the information, asserting that similar to real estate or car sales, the price paid is "probably the most confidential piece of information regarding the purchase of anything." 

The Court's Ruling On The Motion To Seal. The Bankruptcy Court held a hearing on the motion on Wednesday, March 7, 2007, and announced that it would issue a ruling by Friday, March 9, 2007.  Friday afternoon, the Bankruptcy Court issued this decision, denying the motion to file the Rule 2019 disclosure under seal and requiring that it be filed within three business days. In reaching its decision, the Bankruptcy Court held as follows:

The Committee members do not advance their position when they compare themselves to car or real estate salesmen. It bears recalling that this Committee purports to control 27 percent of the outstanding stock of the Debtors and that it has repeatedly asked the Court to give credibility to its claims that the Debtors’ equity has substantial value, that the Debtors’ management has wrongfully undervalued the equity, and that it intends to mount a contest as to the valuation of these Debtors. By acting as a group, the members of this shareholders’ Committee subordinated to the requirements of Rule 2019 their interest in keeping private the prices at which they individually purchased or sold the Debtors’ securities. This is not unfair because their negotiating decisions as a Committee should be based on the interests of the entire shareholders’ group, not their individual financial advantage. Their counsel admitted at oral argument of this motion that in negotiations between a committee and other parties in interest, the question is whether a tranche is being treated fairly, not the price at which individual members might be induced to sell. If that is so, and it should be, it cannot harm the legitimate interests of members of an ad hoc committee to put pricing information on the table.

In any event, any interest that individual Committee members may have in keeping this information confidential is overridden by the interests that Rule 2019 seeks to protect. Rule 2019 protects other members of the group – here, the shareholders – and informs them where a committee is coming from by requiring full disclosure of the securities held by members of the committee and the respective purchases and sales. This Committee contends that it did not take on any fiduciary responsibility to the shareholders as a group when it appeared in these cases. Assuming, arguendo, for purposes of this motion that the Committee does not act as a fiduciary, Rule 2019 is based on the premise that the other shareholders have a right to information as to Committee member purchases and sales so that they make an informed decision whether this Committee will represent their interests or whether they should consider forming a more broadly-based committee of their own. It also gives all parties a better ability to gauge the credibility of an important group that has chosen to appear in a bankruptcy case and play a major role.

The utility to other shareholders of information as to the purchases and sales made by members of this Committee is underscored by two facts of record. First, it has been disclosed that Committee members own a very significant amount of debt, as well as stock. Rule 2019 is based on the premise that other shareholders have a right to know whether the debt purchases were made at the same time as the purchases of stock, a fact that might raise questions as to divided loyalties. Second, each of the three representative Committee members admits in his declaration that he might decide to sell out at any time. [record references omitted] The possibility that members of an ad hoc committee will sell and leave a group without a representative is exactly why there are disclosures required under Rule 2019. Rule 2019 gives other members of the class the right to know where their champions are coming from. Granting the motion to seal would scuttle the Rule.

Hedging Your Bets. Over the past several years, hedge funds, like other creditors and equity investors, have been able to play an even more significant role in Chapter 11 cases by participating in ad hoc and official bankruptcy committees. The Bankruptcy Court's decision will certainly give hedge funds, and perhaps claims buyers generally, pause before they agree to form unofficial committees or join official ones. Although it's possible that these investors will become more comfortable disclosing this information over time, that seems unlikely.

• Hedge funds with large stakes in the debt or equity of a particular company will likely still act aggressively to advance their interests, but those with smaller positions may not find the expense of individual representation justified.
• Even those with big stakes may be more likely to act on their own, rather than through a committee, to avoid facing the prospect of full Rule 2019 disclosures. 
• If these investors step back from participating in committees, it could in turn reduce their collective influence in bankruptcy cases -- one of the reasons they formed committees in the first place.
• While it's still too early to tell, if followed by other courts, this decision has the potential to lead to major changes both in how hedge funds and other investors participate in Chapter 11 bankruptcy cases and in the impact they have on them.

It Might Not Be Over. In what could be a sign of things to come, the Bankruptcy Court also granted a separate motion by the Ad Hoc Committee extending its time for filing an appeal from the earlier ruling. In addition, certain members of the Ad Hoc Committee filed their own motion for reconsideration of the Bankruptcy Court's Rule 2019 order from last week, asking for a hearing on that motion sometime after a March 19, 2007 response deadline. To add to the mix, although the Ad Hoc Committee withdrew its motion for an official equity committee, it has separately filed a motion for appointment of an examiner.

Stay Tuned. With this much going on, I plan to make additional posts on the disclosure issue as events warrant. You're welcome to subscribe to the blog to receive updates directly via email or RSS.

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In recent years, hedge funds and other investors in distressed debt or the equity securities of bankrupt companies have taken active roles in Chapter 11 bankruptcy cases. Often, these investors form unofficial or "ad hoc" committees. This post reports on a recent decision by a New York bankruptcy court in the Northwest Airlines case which, if ultimately enforced, could have a major impact on hedge funds, ad hoc committees, and Chapter 11 cases.

Ad Hoc Committees. Unofficial or ad hoc committees, much like official committees of unsecured creditors, equity security holders, retirees, or other constituencies, typically hire counsel and file motions and other pleadings during the course of a bankruptcy case. By acting as a group, the committee's members not only share the costs of participating in the bankruptcy case but also have the ability to wield greater influence by acting collectively instead of on an individual basis.

The Rule 2019(a) Statement. After making an appearance in a bankruptcy case, these committees, their counsel, or both will typically file what's known as a "Rule 2019(a) Statement." This is a public filing required by Rule 2019(a) of the Federal Rules of Bankruptcy Procedure, the set of procedural rules which, together with the United States Bankruptcy Code itself, govern the conduct of bankruptcy cases. Rule 2019(a) provides, in part, as follows:

[E]very entity or committee representing more than one creditor or equity security holder . . .  shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

The Ad Hoc Committee In Northwest Airlines. While seemingly a dry and arcane bankruptcy rule, it has recently become anything but in the Northwest Airlines Corporation Chapter 11 case. In January 2007, an Ad Hoc Committee Of Equity Security Holders first made an appearance in the case. Its thirteen members include hedge funds and other investment entities that collectively own more than 19 million shares of Northwest Airlines stock and approximately $265 million in claims. The Ad Hoc Committee sought discovery in the case and asked that an official committee of equity security holders be appointed (a request it recently withdrew). 

The Debtors Seek Additional Disclosure. In the course of litigating certain disputes, Northwest Airlines filed a motion seeking, among other relief, an order under Rule 2019 requiring the Ad Hoc Committee to disclose more detailed information about the amounts of claims or stock owned by the Committee's members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings. In support, Northwest Airlines made this argument:

The Ad Hoc Committee remains a mystery to the Debtors and to all the other constituencies in the Debtors’ cases, yet it seeks to make an impact at this late stage of the Debtors’ reorganization. Without the proper disclosures, the Court should refuse to allow the Ad Hoc Committee to continue to cause serious delays to the Debtors’ reorganization efforts, and operate outside of the Bankruptcy Code and the Bankruptcy Rules.

The Ad Hoc Committee Opposes The Motion. The Ad Hoc Committee opposed the motion on several grounds, including that its Rule 2019 statement was proper in form, that the purpose of the rule is only to ensure that plans of reorganization are negotiated and voted on by those authorized to act for the real parties in interest, and that this purpose was satisfied by the form of the statement already filed.

The Northwest Airlines Court's Rule 2019 Decision. On February 26, 2007, Judge Gropper issued his decision requiring the Ad Hoc Committee to file a Rule 2019 statement that provided the detailed information the Debtors had sought in their motion. The Court ruled that Rule 2019 applies to ad hoc or unofficial committees and rejected the Ad Hoc Committee's argument that the prior Rule 2019(a) statement, which did not give detailed information about dates of trades and prices paid, was adequate.

The Ad Hoc Committee's Further Motion. On March 1, 2007, the Ad Hoc Committee filed a motion for an order allowing the additional Rule 2019 statement to be filed under seal but asking that the Court stay its prior order pending further hearing. The Ad Hoc Committee argued that the trading information required under the Court's order represented trade secrets and confidential commercial information and that, to its knowledge, no other committee or party had been required to file such information publicly in any other Chapter 11 case. The Ad Hoc Committee contended that requiring its members to make that disclosure would irreparably damage them, as other investors were not required to make such disclosures but some might use that information to inform their own trades.

The Court Grants The Ad Hoc Committee's Motion. Later that same day, the Court granted the Ad Hoc Committee's motion. The Court set a fast briefing schedule and a further hearing for March 7, 2007. I will plan to report on the resolution of that motion after the Court makes its decision.

Why This Matters. While disputes over disclosure are not always worthy of motions, multiple hearings, and blog postings, this case is different. Hedge funds and other buyers of distressed debt or stock in bankrupt companies carefully guard their trading information, especially the price they've paid. If ad hoc committee members will be required to disclose this information publicly, or perhaps even privately, they may choose not to participate in unofficial committees or generally may be dissuaded from becoming active participants in Chapter 11 cases. Hedge funds and other distressed debt traders have been deploying enormous amounts of money through second lien lending in distressed situations and directly in bankruptcy cases through the purchase of claims and stock. They have also regularly taken very active roles in major Chapter 11 cases. Any ruling with the potential to reverse or impact this trend would be big news indeed.

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