After the Sale: What You Need to Disclose About Selection of Liquidating Trustees and the Role of Liquidating Trusts

In our current bankruptcy regime, sales under § 363 of the Bankruptcy Code are by far the norm, followed by conversion or dismissal, and sometimes, instead, a liquidating plan. Liquidating plans can be a favorable way to wrap up a bankruptcy case, freeing the debtor from many of the filing, procedural and disclosure burdens of the Bankruptcy Code and simplifying the wind-down process. In In re Affordable Med Scrubs LLC,[1] Judge Whipple of the U.S. Bankruptcy Court for the Northern District of Ohio provided some valuable guidance as to potentially required disclosures on the murky ways in which liquidating trustees are selected, what claims liquidating trustees will pursue, and on what post-confirmation plan oversight committees will do.

Factual Background

The Affordable Med Scrubs case featured an inability of the debtor and its secured creditor to get along. Exclusivity had expired, and the secured creditor has filed its own plan and disclosure statement that would wind down the debtor’s operations under the guidance of a “liquidating trustee” and a “plan oversight committee,” which would distribute proceeds of the liquidation in accordance with the priorities under the Bankruptcy Code. The debtor, the U.S. Trustee and several creditors objected.

Nothing is very unusual about this — until we get to the bankruptcy court’s ruling on the secured creditor’s proposed disclosure statement.

Holding

The court did not approve the disclosure statement. In essence, the court found that the disclosure statement was so deficient it did not comply with Bankruptcy Code § 1125(a)’s requirements that it provide adequate information to the creditors in soliciting their acceptance or rejection of the secured creditor’s proposed plan. In particular, the court found that based on the information in the disclosure statement, no creditor could accurately determine the benefit of the plan over a chapter 7 liquidation.

The key deficiencies were as follows:

1. Disclosure Must Be Provided about the Liquidating Trustee: While the secured creditor’s disclosure statement did state who the liquidating trustee would be, it provided no disclosures about the putative trustee’s connections to the secured creditors, other key creditors and other parties in interest. There are few guidelines regarding required disclosures about a proposed liquidating trustee or plan administrator. The selection of a liquidating trustee or plan administrator is a murky process; it is often based on undisclosed considerations related to pricing and the experience of the individual or company that will serve in this role. In some cases, selection of a liquidating trustee or plan administrator may reek of “payola,” favors being returned, or other inappropriate (and also undisclosed) factors. Here, the disclosure statement revealed that the liquidating trustee would receive a flat fee in the range of $45,000-$90,000. The bankruptcy court noted that it is not much to ask for any proposed post-confirmation parties to make a full disclosure under Bankruptcy Rules 2014 and 2016.

2. The Same Disclosure Must Be Made About any “Plan Oversight Committee”: See above: The bankruptcy court stated that the same rules apply to all of the members of any plan oversight committees or other parties involved in supervising post-confirmation actions.

3. Better Disclosure of Litigation Claims Against Key Parties: The Affordable Med Scrubs disclosure statement also did not clearly deal with potential claims against the largest creditor (which is not terribly surprising, as the largest creditor was the party submitting the disclosure statement). The bankruptcy court explained that references, cross-references and unclear descriptions of claims don’t help anyone; plan proponents should carefully and plainly describe in one place in the disclosure statement what they know about various claims, and whether they plan on pursuing them or recommending that the liquidating trustee pursue them (or not pursue them). No one should be surprised later that a claim is brought, or that a claim against a key party is not brought, by the liquidating trustee (see above in relation to the risk that side deals may be involved in the selection of liquidating trustees or oversight committees).

4. The Liquidating Trust Agreement and Other Key Documents Should be Filed with the Disclosure Statement, Not on the Eve of Confirmation: The Affordable Med Scrubs court was not pleased with the failure of the parties to file the proposed liquidating trust agreement with the disclosure statement.[2] This is apparently something the Office of the U.S. Trustee is increasingly objecting to as well. This is particularly important, as such agreements often have key terms on the authority of the liquidating trustee, fees to be paid to the liquidating trustee and disclosure and fees of his or her professionals, and other items about which creditors should be aware (some or all of which, such as post-confirmation professional fees, may be shielded from future court or creditor scrutiny altogether, which can be very troubling).

Key Implications

This is an important case on issues that are not typically addressed. This case may signal a raising of the bar requiring professionals to provide more disclosure of post-confirmation parties, how they came to be chosen, their connections with creditors and other parties in interest, and expected post-confirmation events and prosecution (or non-prosecution) of claims. Next time you are working on a liquidating plan, consider adding a great deal more in terms of the connections of post-confirmation fiduciaries to the debtor, creditors or other parties in interest. Likewise, if there is an expectation as to whether certain claims will be brought or won’t, that should be disclosed; under the Bankruptcy Code, that is required information that creditors need to know in order to vote or not vote for a plan.