Creditors Committees Maximizing Creditor Recoveries

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Apr 2006

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Last in Line

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ABI Journal, Vol. XXV, No. 3, p. 20, April 2006

Bankruptcy Code

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Practice and Procedure

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he Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)
incorporated significant changes for creditors' committees in chapter 11 cases.1
BAPCPA clarifies bankruptcy court authority in reviewing committee composition,
supplies non-committee creditors greater access to committee information and
requires committees to solicit and receive comments from their constituencies.
Congress provided very little insight, however, into how its mandates should
be carried out by leaving little legislative history. Now, nearly six months
after the effective date of Oct. 17, 2005, attorneys and courts are struggling
to carry out the changes made to §1102 of the Bankruptcy Code. The precedent
set by these cases will impact committee members, counsel, debtors, constituents
of committees and the courts for years to come.
This article will address the two most significant changes affecting committees
under BAPCPA and will examine the post-effective date cases to see how the parties
and the courts have interpreted Congress's mandates.
Committee Composition
BAPCPA affords the bankruptcy court greater authority to address committee
composition. Prior to the Bankruptcy Act of 1986, §1102 gave bankruptcy
courts the power to appoint the committee of unsecured creditors. The 1986 revisions
amended §1102 to transfer the authority for this administrative function
to the U.S. Trustee. In doing so, the 1986 revisions deleted subsection (c)
of §1102, which granted the courts power to change the membership of the
committee upon motion if the committee composition did not reflect the creditor
body. Although the deletion of §1102(c) caused confusion as to the authority
of the court to alter a committee's composition after the appointment of members
by the U.S. Trustee, the majority of courts held that bankruptcy courts could
review the U.S. Trustee's decisions and that a court's authority was not limited
by §105(a). These courts held that §1102 allowed them to modify the
composition of a committee when its members did not adequately represent the
parties in interest and allowed the court to appoint additional committee members
or even an additional committee if necessary. See In re SPM Mfg. Corp.,
984 F.2d 1305 (1st Cir. 1992); In re Mercury Finance Co., 240 B.R. 270
(N.D. Ill. 1999); In re Lykes Bros. Steamship Co., 200 B.R. 933,939-40
(N.D. Fla. 1996); Columbia Gas Sys. Inc., 133 B.R. 174, 175 (Bankr. D.
Del. 1991) (the deletion of the former §1102(c) was a "housekeeping
matter" and "does not address" the issue of the court's power
to review U.S. Trustee's selection process). Some courts also noted that Rule
2020 of the Federal Rules of Bankruptcy Procedure states that a proceeding to
contest any act or failure to act by the U.S. Trustee is governed by Rule 9014.
In re Barney's Inc., 197 B.R. 431, 437-38 (Bankr. S.D.N.Y. 1996). Thus,
the majority of courts found that they held the authority to review the U.S.
Trustee's decision for an abuse of discretion and if, under that standard, a
court found that the U.S. Trustee acted arbitrarily and capriciously in forming
the committee, it could enter an order to rectify the situation. In re Mercury
Finance Co. at 278.

BAPCPA provides clarification by inserting §1102(a)(4), explicitly authorizing
the bankruptcy court to order the U.S. Trustee to alter the membership of an
appointed committee if the court determines that the change is necessary to
ensure adequate representation of creditors or equity security-holders.2 In
order to appoint a committee representative of the unsecured creditor constituency,
the U.S. Trustee must consider, among other things, whether potential members
will trade their claims, thus no longer remaining a creditor, whether the potential
members are likely to be representative of other creditors, whether existing
members already represent similar creditors or whether the failure to place
a creditor on a committee jeopardizes the reorganization.
Although the author is not aware of any reported decisions addressing amended
§1102(a)(4), the composition of the committee in the Delphi Corp.
case (filed just prior to the BAPCPA effective date) has raised the issue as
to whether the committee adequately represents the creditor body. In re Delphi
Corp., Case No.05-44481(RDD) (Bankr. S.D.N.Y.). In the Delphi case,
the U.S. Trustee's office sent 100 solicitations to potential committee members,
57 of whom responded. After considering information of the 57 respondents, the
U.S. Trustee appointed a representative of small institutional investors, four
trade creditors, a labor union and the indenture trustee for the senior noteholders
to the committee. Almost immediately after appointment of the Delphi
committee, the UAW and the PBGC sought orders from the court directing the U.S.
Trustee to appoint them to the committee.3 Recently, General Motors filed a
motion seeking appointment to the committee. GM argues that appointment is warranted
because of the unique nature of its claims and that it is the only major constituent
in the case not appointed to the committee. Furthermore, GM argues that as the
committee is currently configured, the committee is GM's adversary rather than
a statutory representative of it.4 GM also contends that the committee does
not and cannot provide GM with adequate representation with financial information
and thereby "creates the concomitant suspicions and unlevel negotiating
positions that only exacerbate the monumental problems that must be resolved."
GM believes that as the "debtors' largest and most important customer"
with enormous pre-petition warranty/product recall claims against Delphi, overpricing
claims and legacy costs that flow to GM, it should be able to participate as
a committee member. Finally, GM argues that the U.S. Trustee's decision to exclude
it from the committee was "arbitrary and capricious" and based on
an erroneous conclusion of law. Accordingly, the court will be required to determine
whether GM's exclusion was arbitrary and capricious and whether GM actually
represents other similar creditors that also need representation on the committee.
If a creditor is truly unique, does that mandate a seat on a committee?

In determining whether GM should have a seat on the committee, the court must
consider whether GM or any creditor with a stake as large as GM is capable of
being a fiduciary to other creditors. GM's future is intertwined and dependent
on Delphi's future, and GM is both a creditor and debtor to Delphi. Despite
this, is GM capable of participating as a committee member and fiduciary to
other creditors?
Committee Duty to Disclose and Solicit Information
Under BAPCPA, §1102(b)(3)(A) has been added to require committees to solicit
feedback from, and provide access to, information to noncommittee creditors
that hold claims of the kind represented by the committee.5 Section 1102(b)(3)(A)
does not indicate how a creditors' or equity committee should provide access
to such information, and more importantly does not indicate the nature, scope
or the extent of the "information" that a committee must provide to
its constituency. Unfortunately, Congress has not adequately revealed its legislative
intent related to the §1102(b)(3)(A) changes, thus leaving debtors and
courts struggling to implement the change. A number of courts during the last
several months have had the opportunity to consider exactly how the disclosure
and solicitation required under §1102(b) (3)(A) should be carried out by
committees.
One of the first cases filed after the BAPCPA effective date was Independence
Air (FLYi Inc.), filed Nov. 7, 2005, in the U.S. Bankruptcy Court
for the District of Delaware. In Independence Air, the debtor aggressively
sought a first-day order from the court providing guidelines limiting the dissemination
of information from the committee to its constituencies. Basing its request
on §§105(a), 107(b) and 1102(b)(3)(A), Independence argued that because
it was a participant in a very competitive industry, the dissemination of its
confidential information to parties not bound by a confidentiality agreement
could be disastrous for it. Specifically, Independence contended that the disclosure
of compensation levels and business strategies would provide its competitors
with an unfair advantage that would likely cause its demise. In addition, Independence
stressed the risk that confidential information would be obtainable by its competitors
and other adverse parties, and this would deter the debtor from sharing any
meaningful strategies or planned initiatives with the committee. According to
Independence, without the comfort order, the committee would face inherent conflict
between its duty under §1102(b)(3)(A) and the confidentiality agreements
made with the debtor, not to mention bylaws likely to be adopted by the committee.
To further compound the problems the debtor and committee would face, Independence
emphasized that it is a public company and subject to the requirements of federal
securities laws, including Regulation FD, which requires fair disclosure of
"material nonpublic information." Specifically, Regulation FD requires
that whenever a company discloses "material nonpublic information"
to certain persons, the company must publicly disclose that same information
(a) simultaneously for intentional disclosures, or (b) promptly for nonintentional
disclosures.6 Under Regulation FD, two options exist for disseminating information
to the public: (1) filing Form 8-K with the Securities and Exchange Commission
(SEC) or (2) through a combination of methods "that [are] reasonably designed
to provide broad, nonexclusionary distribution of the information to the public."7
The SEC has made certain exceptions to these requirements where a public company
discloses material nonpublic information to an entity that has expressly agreed
to maintain the disclosed information in confidence.8 As a result, committees
have historically been able to review material nonpublic information under the
protection of confidentiality agreements with the debtor.

Congress's mandate in §1102(b) (2)(C), if taken to its extreme, would
require a publicly traded debtor to file numerous 8-K disclosures with the SEC
or seek some form of protection from the bankruptcy court in order to exchange
material nonpublic information with committees. A committee unable to accept
meaningful material information without disclosing it publicly to its constituents
also requires protection from the bankruptcy court. In light of these competing
duties, Independence Air asked for a first-day order providing protection and
defining the obligations of the debtor and committees. Judge Mary F. Walrath
entered an order defining "Confidential Information" and providing
that any creditors' committee would not be "authorized or required under
§1102(b)(3)(A) of the Code to provide access to any confidential information
of the debtors to any creditor it represents."9 The Delaware court's order
required that the committee respond to written and telephonic inquires and comments
received from the creditors it represents. Moreover, in an emerging trend, the
committee was encouraged to use a Web site to allow creditors to access public
documents and other materials that the committee believed "in its reasonable
business judgment" would provide information to the creditor body.10 The
committee was also protected from having to reveal attorney-client or other
privileged information to any party if the privileged information was not confidential
information and the relevant privilege was held and controlled solely by the
committee.
In the Refco case, the first reported opinion addressing committee disclosure
requirements, Judge Robert Drain of the Southern District of New York
set forth certain conditions for dissemination of information and concurrent
obligations of a committee to solicit input from its constituency.11 Refco and
its related entities filed voluntary petitions on Oct. 17, 2005, and thereafter
a committee was appointed. After the committee analyzed the proposed sales of
the debtors' assets and the sales were successfully consummated, the committee
focused its attention on issues raised by certain customers, as well as the
allegedly fraudulent actions that resulted at least in part in Refco's bankruptcy
filing.

In light of the enormous investigation that it would be required to undertake
and because REFCO was regulated by securities law, the committee moved three
days after its appointment for the approval of a protocol for complying with
§1102(b)(3)(A). An interim order was negotiated by the debtor and the U.S.
Trustee that ultimately became a final order. In light of the quickly moving
case and the lack of guidance provided by Congress, Judge Drain issued the published
decision to provide guidance and a comfort order for the committee.
 In explaining the protocol order,12 the court examined three sources
for construing committee obligations to provide "access to information"
under §1102(b) (3)(A). According to the court, the Code has long contained
a similar disclosure requirement for bankruptcy trustees in §704(7), which
applies under §§1106 (a)(1) and 1107(a) to chapter 11 trustees and
debtors-in-possession and states that a "trustee shall...unless the court
orders otherwise, furnish such information concerning the estate and the estate's
administration as is requested by a party in interest."13 The
duty to provide information under §704(7) is not unlimited, however, as
a trustee may obtain a protective order against disclosure of information under
§704(7), if disclosure would result in waiver of the attorney-client privilege
or if information is proprietary and confidential.14 The trustee's
obligation derives from its fiduciary duty owed to creditors and the estate.15
If a creditor's request for information furthers the exercise of that duty,
the request should be honored; if it does not further that interest, it should
be denied. If a trustee does not believe that disclosure is in the best interest
of the estate, it is incumbent on the trustee to point to a countervailing fiduciary
duty, such as protecting creditors and the estate from diminution in value of
assets or other particular harm. The court also discussed the similar provisions
that existed under the Bankruptcy Act of 1898, which required committees to
report to creditors on the progress of the proceedings under Bankruptcy Act
Rule 11-29. Few cases interpreted this provision. One that did, however, stated
that "[i]t is clear that the creditors' committee is not required to forward
to each creditor all of the raw data it receives and considers in the process
of carrying out its duties." In re Gilchrist Co., 410 F.Supp. 1070
(E.D. Pa. 1976). Thus, in balancing the many competing interests of abiding
by the securities law, protecting attorney-client privilege and providing meaningful
information to creditors, the Refco court adopted an order that allowed
disclosure of specified information to creditors while restricting the dissemination
of information that would violate securities laws, breach attorney-client privilege
or prohibit meaningful discussions with the debtor. Finally, the order provides
exculpation for the debtors, the committee and related parties from liability
for any act taken in connection with the dissemination of the information to
be provided to the creditor body. The order provides for (1) dissemination of
information via Internet-accessed Web site that provides general information
regarding the case, (2) monthly committee written reports summarizing recent
proceedings and public financial information, (3) highlights of significant
events in the case, (4) a calendar with upcoming significant events, (5) access
to the claims docket, (6) general overview of chapter 11 process, (7) press
releases issued by the committee and the debtor, (8) a nonpublic registration
form for creditors to request "real-time" case updates via e-mail,
(9) a nonpublic form to submit creditor questions, responses to creditor questions,
comments and requests for access to information, (10) answers to frequently
asked questions and (11) links to other relevant Web sites.16

Unfortunately, BAPCPA fails to explain whether a committee may actually delegate
its obligations to a third party to disseminate and solicit information. In
certain mega cases, Web sites providing information are built and operated by
claims-management companies. Is this delegation proper and in compliance with
the Code? Should a committee provide information directly to creditors and solicit
the input of its constituency itself? The Refco order allows certain
confidential information to be disseminated to creditors executing confidentiality
agreements. Neither the Code nor the Refco opinion explain what happens
if a party authorized to receive confidential information passes the information
on or shares the password with another party or the public. Who has liability
for this breach of the confidentiality agreement – the committee? All
who have the password? What is the penalty if the wrongly disclosed information
diminishes the value of the debtor's estate and hurts other creditors? In a
world where technology becomes increasingly sophisticated, how can information
be provided in a safe manner that promotes reorganization and respects mandates
of securities law?
The need for creditors to receive meaningful information during a reorganization
is critical, just as the ability of the debtor to maintain strategic advantage
in its industry and generally retain value for its estate. This balancing act
between these interests will continue to create tension in future cases.
<hr>
<h3>Footnotes</h3>

1 The author wishes to thank John T. Gregg, an associate in the Grand Rapids,
Mich., office of Barnes & Thornburg LLP, for his valuable insight, comments
and assistance on this article. 
2 Section 1102(a)(4) states: On request of a party in interest and after notice
and a hearing, the court may order the U.S. Trustee to change the membership
of a committee appointed under this subsection, if the court determines that
the change is necessary to ensure adequate representation of creditors or equity
security—holders. The court may order the U.S. Trustee to increase the
number of members of a committee to include a creditor that is a small—business
concern (as described in §3(a)(1) of the Small Business Act); if the court
determines that the creditor holds claims (of the kind represented by the committee)
the aggregate amount of which, in comparison to annual gross revenue of that
creditor, is disproportionately large.

3 Sometime after the UAW filed its motion with the court, by agreement of the
debtors, the committee, UAW, PBGC and the U.S. Trustee, the UAW and PBGC were
appointed as ex officio members of the committee. 
4 Motion for Order Directing Appointment of General Motors Corp. to Statutory
Creditors' Committee filed Feb. 17, 2006, as docket number 2443, In re Delphi
Corp., et al., Case Number 05-44481, (Bankr. S.D.N.Y.). 
5 Section 1102(b)(3) states, in relevant part, that a creditors' committee
appointed under §1102(a) of the Code shall "provide access to information
for creditors who (i) hold claims of the kind represented by that committee
and (ii) are not appointed to the committee." 11 U.S.C. §1102(b)(3)(A).

6 Regulation FD, 17 C.F.R. §243.100(a). 
7 17 C.F.R. §243.101(e)(1), (2). 
8 17 C.F.R. §243.100(b)(2)(ii). 
9 In re FLYi Inc., Case No. 05-20011 (Bankr. D. Del.), Docket No. 145

10 A number of cases currently have Web sites, including Delphi Corp.
(www.delphidocket.com, maintained by Kurzman Carlson consultants under the direction
of Delphi Corp.), Delta Airlines (www.deltadocket.com, maintained by
Bankruptcy Services LLC) and Calpine Corp. (kccllc.net/calpine). None
of these Web sites appear to be maintained on or on behalf of a committee. 
11 In re Refco Inc., 336 B.R. 187 (Bankr. S.D.N.Y. Jan. 20, 2006). 
12 The order regarding creditor access to information is attached to the published
opinion and may prove useful to other committees and debtors negotiating similar
orders in the future. Id. at 199.

13 Id. at 192. 
14 In re Grabill Corp., 109 B.R. 329, 333 (N.D. Ill. 1989); In re
Refco at 193. 
15 In re Refco at 193—194. 
16 The Web site can be viewed at www.refcodocket.com.

Journal Authors

Deborah L. Thorne

Journal Date

Saturday, April 1, 2006 - 12:00

Bankruptcy Rule

2006

none