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General Growth ruling places the bankruptcy remoteness of SPEs into question
Practical Law UK Legal Update 0-501-8603 (Approx. 4 pages)
General Growth ruling places the bankruptcy remoteness of SPEs into question
by Michael H. Torkin, Edmund M. Emrich and W. Fraser Hartley, Shearman & Sterling LLP
| Published on 26 Mar 2010 • USA (National/Federal) |
This article is part of the PLC Global Finance March 2010 e-mail update for the United States.
Speedread
Rule 2019 of the Federal Rules of Bankruptcy has been the subject of three recent conflicting decisions of Third Circuit bankruptcy courts. The decisions - examined here - have garnered attention from financial institutions and investment funds because they deal with whether creditors acting as a group in a chapter 11 case must divulge information about the nature and amount of their debt holdings, including when such holdings were acquired and at what price – information that is often a closely guarded secret.
Rule 2019 of the Federal Rules of Bankruptcy (Rule 2019) has been the subject of three recent conflicting decisions of Third Circuit bankruptcy courts. The decisions have garnered attention from financial institutions and investment funds because they deal with whether creditors acting as a group in a chapter 11 case must divulge information about the nature and amount of their debt holdings, including when such holdings were acquired and at what price – information that is often a closely guarded secret.
Whether to compel disclosure implicates two competing interests:
- Courts' needs to be sufficiently informed of stakeholders' interests and motivations to effectively administer cases.
- Not unduly deterring deep sources of capital – the institutions and funds – from participation in a debtor's restructuring or from efficient collective action because of onerous disclosure requirements.
In the relevant part, Rule 2019 provides that "every entity or committee representing more than one creditor or equity security holder… shall file a verified statement setting forth" various information, including "the nature and amount of the claim or interest and the time of acquisition thereof… ."
Before the current trio of cases, Rule 2019's application to ad hoc committees was unclear; requests for disclosure of individual members' confidential information were granted in two bankruptcy cases, while, in another, a similar request was denied. (See In re Northwest Airlines Corp., 363 B.R. 701 (Bankr. S.D.N.Y. 2007) and In re Northwest Airlines Corp., 363 B.R. 704 (Bankr. S.D.N.Y. 2007) (collectively Northwest) (ordering disclosure). See also In re Scotia Development LLC, No. 07-20027 (Bankr. S.D. Tex. 2007) (Scotia Pacific) (disclosure not required) and In re Accuride Corporation, No. 09-13449 (Bankr. D. Del. 2009) (Accuride) (ordering disclosure). Since written opinions were not issued in either Scotia Pacific or Accuride, most scrutiny has centred on the Northwest, WaMu, Six Flags and Philadelphia decisions.)
Unfortunately, Rule 2019's application is no clearer today following the three latest decisions.
In re Washington Mutual, Inc., et al (WaMu)
In the first of the three decisions, In re Washington Mutual, Inc., et al., 419 B.R. 271 (Bankr. D. Del. 2009) (WaMu), Judge Walrath of the Delaware bankruptcy court, on 2 December 2009, compelled Rule 2019 disclosure from members of a group of noteholders. The noteholder group argued that it was "neither an entity nor an ad hoc committee within the meaning of [Rule 2019] because the [g]roup is: simply a loose affiliation of… creditors who, in the interest of efficiency, are sharing the cost of advisory services… each [n]oteholder acts in its own right and on its own behalf… ."
The court, however, held that the noteholder group, as it described itself, possessed "virtually all the characteristics typically found in an ad hoc committee" and that its conduct – the noteholder group filed multiple pleadings and its counsel appeared at multiple hearings without specifying that individual creditors and not the group were being represented – meant that under the "plain language" of Rule 2019, it was a committee to which the rule applied.
While the WaMu court found the text of Rule 2019 sufficiently clear upon which to rule, it made two significant observations in dicta:
- First, in examining the legislative history of Rule 2019 and its predecessors, it rejected the noteholders' assertion that the intent of the rule was to compel disclosure only from "protective committees" and other fiduciary groups. (Protective committees were a product of "equity receivership" reorganisations that predated modern bankruptcy law. Investments banks that had underwritten bonds of an insolvent company would form protective committees and ask bondholders to deposit their bonds with the committee. The committee would then negotiate and vote on a reorganisation plan on behalf of the depositing bondholders. This system was criticised as unfairly favouring insiders, who invariably controlled the committees.) In doing so, it also suggested that ad hoc committees, because of their potential influence on a case, may owe fiduciary duties to other similar creditors who are not members of the committee.
- Second, the court discussed the proposed amendments (published, for comment, by the Federal Rules committee, these included an expansion of the disclosure requirements by requiring disclosure from all groups or committees consisting of more than one creditor, as well as bodies representing more than one creditor) designed to broaden Rule 2019 and their rationale. These were, namely, the increasingly complicated capital structures of debtors and the broadening field of sophisticated players participating in one or more layers of a debtor's capital structure, coupled with the court's desire to understand the true economic interests of creditors using collective action to assert leverage. But the court noted the current rule still mandates disclosure from groups such as the WaMu noteholder group.
In re Premier International Holdings., et al (Six Flags)
On 20 January 2010, in a departure from WaMu, Judge Sontchi of the Delaware bankruptcy court issued an opinion denying a creditors' committee's request to compel an informal committee of noteholders to comply with Rule 2019 in In re Premier International Holdings., et al., (Bankr. D. Del.) (Six Flags).
The relevant facts of Six Flags essentially follow WaMu. The informal committee argued that it was not a "committee representing more than one creditor" under Rule 2019. The court agreed with WaMu, finding a plain meaning analysis to be the first point of inquiry. But the court, examining the plain definitions of "committee" and "representing" found that Rule 2019 applied only to a committee "representing the interests of a larger group with that larger group's consent or by operation of law."
Therefore, Rule 2019 was inapplicable, since the informal committee was self-appointed and did not represent anyone other than its members, either by consent or by operation of law. In other words, applying the same canon of statutory interpretation, the Six Flags court came to the opposite conclusion as the WaMu court.
The opinion also concluded that it was incorrect to focus on actions taken by a committee during a case to determine the rule's applicability, writing that Rule 2019 is a "prophylactic rule designed to provide information to the Court and others at the inception of a case to preserve the integrity of the reorganization process to follow." (The Six Flags court appeared to be somewhat swayed by the timing and motives behind the request to compel disclosure. It noted that the official committee, which filed the motion to compel roughly six months into the chapter 11 case, was "clearly engaged in a litigation tactic to apply pressure" to the noteholder committee that was a proponent of a plan of reorganisation that the official committee opposed.)
Finally, the Six Flags court undertook its own legislative history analysis, concluding that the protective committees it was designed to protect against were relics of the past and that the rule was not intended to apply to modern ad hoc groups: "Rule 2019 is also, for all intents and purposes superfluous – the problem it was designed to address by requiring certain disclosures simply no longer exists."
In re Philadelphia Newspapers, LLC, et al (Philadelphia)
The most recent of the three Third Circuit decisions (In re Philadelphia Newspapers, LLC, et al., (Bankr. E.D. Pa.) (Philadelphia)) was handed down on 4 February 2010. The relevant facts of the case are familiar. Another party (in this case the debtor) sought to compel a creditor group (a steering group of prepetition lenders) to comply with Rule 2019.
The Philadelphia court, surveying the existing case law and noting the split between the WaMu and Six Flags decisions, ultimately denied the debtor's motion.
The court, as in the earlier decisions, found the plain meaning of Rule 2019, to be dispositive and then adopted the interpretation set out in Six Flags in finding the rule inapplicable to the steering group. In dicta, the court observed that the proposed amendment to Rule 2019 "is expressly intended to extend coverage of the rule to a body such as the [s]teering [g]roup" and that, despite the WaMu court's view that "this is a refutation of the hedge fund industry position that Rule 2019 has become unimportant and obsolete" it was also "logical to infer that if the rule already covered the Steering Group, there would be no need to expand the [r]ule to do so."
Comment
Can the three decisions be reconciled? Certainly not easily, because none is binding on the others. Institutions and funds should be aware that membership in ad hoc groups carries with it the risk of Rule 2019 disclosure and, as WaMu observed, the spectre of fiduciary duties. Some comfort can be taken because the two most recent decisions, Six Flags and Philadelphia, have not ordered disclosure, although the total body of decisions (including Accuride and Scotia Pacific) stands evenly split 3-3.
Greater clarity on this issue may be coming; the Philadelphia decision is currently set for appeal at the district court level and the proposed amendments to Rule 2019 are currently under review. In the interim, however, creditors should balance the risk of disclosure against the efficiencies and increased leverage of collective action when considering joining an ad hoc committee.