The Litigation Trustee A Major New Tool for Creditors Committees

Journal Issue

Mar 2001

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Creditors' committees are increasingly turning to litigation trustees to handle complex
litigation in chapter 11 proceedings. Although not expressly authorized in the
Bankruptcy Code, litigation trustees have been appointed in several recent cases,
including <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Pintlar, 175 B.R. 379 (Bankr. D. Idaho 1994)</a>, and
In re Rincon Island Ltd. Partnership (Bankr. C.D. Cal. 2000).

The position of a litigation trustee is a relatively new tool for creditors' committees
(and shareholders) when the debtor's assets include potential claims against third
parties, such as the failed company's former officers and directors. This article
discusses the most effective utilization of a litigation trustee to maximize assets for
creditors, as well as the duties and powers of the litigation trustee.

<h3>Uses of a Litigation Trustee</h3>

A litigation trustee is usually appointed by the bankruptcy court upon the
recommendation of one or more creditors' committees after a reorganization plan has been
confirmed by the court. As part of the reorganization plan, a trust is formed, and
assets of the debtor or the bankruptcy estate (such as all claims, rights or causes
of action, as well as money to fund the litigation trustee's efforts) are transferred
to the trust. The litigation trustee's mandate is to pursue various claims, through
litigation or settlement, against third parties on behalf of the trust and its
beneficiaries, and to distribute, pursuant to the plan, any net proceeds of such
litigation or settlement. Usually, a post-confirmation creditors' committee will work
with the trustee on strategic and settlement issues.

Creditors' committees involved in complex chapter 11 proceedings whose assets include
legal claims against third parties should consider selecting a litigation trustee to
maximize recoveries from these claims. A potential trustee should have considerable
experience in prosecuting and administering major litigation (and not exclusively
bankruptcy experience, since claims against third parties may involve fraud, breach of
trust, fraudulent conveyances or intellectual-property issues). A litigation trustee
is often called upon to bring actions in both state and federal courts and to manage
numerous cases on behalf of the committee. The committee often interviews several
candidates and then recommends one person to the bankruptcy court.

The litigation trustee's powers and duties are defined in the trust agreement and are
governed indirectly by the Bankruptcy Code. The trust agreement should spell out the
purpose of the trust, who the beneficiaries are, the trustee's powers and
responsibilities, how the trust will be treated for tax purposes, how the trustee will
be compensated, the duration of the trust, removal or resignation of the trustee,
and the powers and responsibilities of the beneficiaries.

To minimize challenges to the litigation trustee's powers, and to ensure that the
litigation trustee is in the best position to effectively pursue claims on behalf of
creditors, the trust agreement should contain provisions that expressly grant the trustee
certain powers. For example, the trust agreement should explicitly authorize the
litigation trustee to apply to the bankruptcy court overseeing the bankruptcy proceeding
to take Rule 2004 examinations. (A Rule 2004 examination is a discovery
mechanism authorized by the Bankruptcy Rules that allows a party to take depositions
and may require the production of documents from those individuals who potentially have
knowledge important to the claims at issue.) Although the trustee may be able to
take such examinations without an express provision in the trust agreement, the
inclusion of such a clause may strengthen a litigation trustee's argument that such
examination should be permitted.<a href="#2" name="2a">2</a>

The agreement should also include provisions setting forth how the litigation trustee
will be compensated. The litigation trustee can be compensated at an hourly rate or
receive compensation based on a percentage of the distributions made to the beneficiaries
of the trust.

Because the litigation trustee is typically an independent party brought into the
case near the end of the chapter 11 proceedings, he or she should consult
extensively with the creditors' committee and debtor, as well as their attorneys and
accountants. By doing so, the trustee can get a better idea of the potential claims
against third parties that the litigation trustee can pursue. This type of cooperative
effort allows a litigation trustee to conduct a shorter, more efficient pre-lawsuit
investigation of potential targets and causes of action.

<h3>Trustee's Powers</h3>

To date, very few decisions have interpreted a litigation trustee's powers.
However, the proceedings in In re Lomas (Bankr. D. Del. 1999) yielded
several noteworthy rulings regarding the scope of the litigation trustee's powers.

Lomas Financial Corp. was once one of the nation's largest mortgage service
providers, with a mortgage servicing portfolio valued at more than $40 billion. At
the conclusion of the Lomas chapter 11 cases, a litigation trust was created.
Shortly thereafter, the litigation trustee filed a complaint against certain former Lomas
directors and officers, alleging that the defendants drove Lomas into bankruptcy by
their own misconduct and gross negligence, thus breaching their fiduciary duties.

During the prosecution of the suit, the litigation trustee determined that documents
created or acquired by Lomas's former law firm were essential to the pending prosecution,
and he instituted an action under Rule 7056 of the Federal Rules of Bankruptcy
Procedure for entry of a "turnover" order pursuant to §542 of the Code. Section
542(a) reads in part: "An entity...in possession, custody or control, during
the case, of property...shall deliver to the trustee...such property..." Section
542(e) reads in part: "Subject to any applicable privilege, after notice and a
hearing, the court may order an attorney...that holds recorded information, including
books, documents, records and papers, relating to the debtor's property or financial
affairs, to turn over or disclose such recorded information to the trustee."

In the resulting litigation, Pollner v. Locke Purnell Rain Harrell, (Bankr. D.
Del. 1999), the bankruptcy judge was asked to determine whether the litigation
trustee had standing to institute the turnover action against Lomas's former attorneys.
The defendants argued that because the litigation trustee is not a trustee defined in
the Code, and because Code-defined trustees have the exclusive right to bring turnover
actions under §542, then the litigation trustee lacked standing to bring the action.
The litigation trustee countered that §1123(b)(3)(B) of the Code provides that
a "representative of the estate" appointed by the plan for the purpose of bringing
turnover actions has standing under the Code to do so.

Judge Peter Walsh of the U.S. Bankruptcy Court in Delaware noted that the statute
requires that there be "specific and unambiguous language" transferring turnover actions to
the litigation trustee. Reviewing the language in the plans, the judge concluded that
"any and all claims, rights or causes of action...without limitation" encompasses
turnover actions. He therefore granted the litigation trustee's motion for summary
judgment, ordering that the documents be turned over to the litigation trustee.

Another issue that arose involved the litigation trustee's interest in and right to
assert and waive attorney-client and other privileges held by creditors' committees or
others who have contributed assets to the trust. Following the ruling giving the
litigation trustee standing to request a turnover of documents, Lomas's former attorneys
asserted a work-product privilege in some of the documents. Obtaining unfettered access
to all documents in Lomas's files was obviously of significant value to the litigation
trustee. Judge Walsh ruled, in a further proceeding, that the privilege does not apply
when a client seeks access to documents created or amassed by his attorney during the
course of the representation. Since Lomas was a client, and since the bankruptcy estate
includes all property in which the debtor has a legal, equitable or possessory interest,
Judge Walsh ruled that Lomas's former attorneys could not assert a work-product privilege
in documents that are property of the estate (Pollner v. Locke Purnell Rain Harrell,
(Bankr. D. Del. 1999)).

<h3>Conclusion</h3>

For those creditors' committees that must decide how to handle potential causes of
action against third parties such as former officers and directors, the creation of
a litigation trust may be worth consideration. Given the proper powers and resources,
a litigation trustee may be able to help achieve significant recoveries for creditors.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Martin R. Pollner is a senior litigation partner in the New York office of Loeb & Loeb LLP. Mr. Pollner was previously a federal
prosecutor and Director of Law Enforcement in the U.S. Treasury Department. Over the years, he has been appointed chapter 11 trustee
in various cases and was appointed litigation trustee in the Lomas Financial Corp. bankruptcy proceedings in Delaware in 1997. Brian
R. Socolow is a partner in the litigation department at Loeb & Loeb LLP. <a href="#1a">Return to article</a>

<a name="2">2</a> The following is a sample clause describing the trustee's powers:

<blockquote>
The trustee is hereby authorized and directed to take all reasonable and necessary action to hold, conserve and protect the trust assets
and to collect on, sell or otherwise liquidate or dispose of the trust assets and distribute net proceeds in a prompt, efficient and
orderly fashion. Specifically, the trustee shall have the power to institute, join or defend actions or declaratory judgments and to
take such other action, including settlement of any such action and any terms deemed reasonable by the trustee in his or her discretion,
to investigate with respect to and enforce any instruments, contracts, agreements or causes of action relating to or forming part of
the trust, including, but not limited to, the right to apply to the bankruptcy court for authority to conduct examinations and require
the production of documents pursuant to Rule 2004 of the Bankruptcy Code. <a href="#2a">Return to article</a>
</blockquote>

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Journal Authors

Brian R. Socolow

Martin R. Pollner

Journal Date

Thursday, March 1, 2001 - 12:00

Bankruptcy Rule

2001