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.