Business Bankruptcy Issues

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.

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. 

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.