Restructuring

Contributed by Katherine Doorley
Like many of our readers, we at the Bankruptcy Blog spent our holiday breaks curled up with our copies of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 Final Report and Recommendations, which by now are quite dog-eared. For those of you who had more exciting plans and (still nursing your eggnog hangovers?) have only a vague recollection of what we are talking about, we refer you to our post announcing the release of the report on December 8, 2014. In this post, we discuss some of the more interesting findings and recommendations relating to the first topic tackled in the report, the less-exciting, but nevertheless important, topic of management and oversight of chapter 11 cases. See Section IV. A.1 -8. Next week, we will discuss the somewhat more controversial issues relating to professionals and compensation.
Debtor in Possession Model
Not surprisingly, the ABI Commission recommended keeping the debtor in possession model, where a debtor’s prepetition board and management continue to run the company in chapter 11 and retain the powers of a trustee—a feature of chapter 11 that has been the envy of distressed companies around the world. It also decided not to recommend creating a new fiduciary standard under federal bankruptcy law for the board and officers who manage a business in chapter 11 and instead recommended that those fiduciaries should remain subject to state law fiduciary duties.
Trustees
The ABI Commission determined that the current grounds for the appointment of a chapter 11 trustee in section 1104(a) should be retained, because the current framework strikes an “appropriate balance” between the benefits and drawbacks of appointing a trustee. Noting the seeming rareness with which chapter 11 trustees are appointed, however, the ABI Commission thought it was advisable to encourage parties to seek the appointment of a chapter 11 trustee more often by formalizing a lower burden of proof for such motions—the lower “preponderance of the evidence” standard rather than the “clear and convincing evidence” standard. This change would also resolve a split in the courts.
The ABI Commission also concluded that the general framework for the U.S. Trustee selecting a trustee pursuant to section 1104(d) should be retained, but that the rarely used ability to select a trustee through election at a meeting of creditors under section 1104(b) should be deleted. The Commission did suggest changes to the Bankruptcy Code relating to the court’s approval of the person selected to serve as trustee including specifying clearer and more specific grounds for disapproval and providing a process for parties to object to the selection of the trustee.
The ABI Commission further proposed that a chapter 11 trustee should retain their powers to act for the estate under section 1106 without the consent of the debtor’s board, management, or shareholders. It also recommended that section 1121(c)(1) be deleted so that the appointment of a chapter 11 trustee does not automatically terminate the debtor’s exclusivity to file, or the time to solicit acceptances of, a plan of reorganization. Instead, the exclusive periods should be preserved solely for the benefit of the trustee.
Examiners and Estate Neutrals
Examiners have played an important role in some of the largest chapter 11 cases, including Lehman Brothers, ResCap and Dynegy. When appointed, these neutral parties are given a mandate by the bankruptcy courts to examine and investigate a wide range of claims and issues, and their reports have the potential to drive plan negotiations and settlements. They also come at a cost. With those thoughts in mind, the ABI Commission proposed eliminating the concept of examiners under section 1104(c) entirely and replacing it with a more flexible court-appointed “estate neutral” in situations where a bankruptcy court determines that cause exists or the best interests of the estate would be served by such appointment. This would also mean eliminating the mandatory appointments of examiners, which the Bankruptcy Code seemed to mandate in certain situations, much to many parties’ (and often courts’) chagrin. The estate neutral would be selected by the U.S. Trustee and approved by the court in a similar manner to chapter 11 trustees. The order appointing the estate neutral (or estate neutrals) would specify the scope of each estate neutral’s duties and the duration of the appointment, but an estate neutral would not be permitted to: (i) propose a chapter 11 plan for the debtor; (ii) act as a mediator in any matter affecting the chapter 11 case, unless such action is the primary purpose of the individual’s original appointment; (iii) initiate litigation on behalf of the debtor or the estate, unless such action is within the scope of the individual’s original appointment and the individual was not previously engaged to investigate or examine matters relating to the litigation or the debtor’s chapter 11 case; or (iv) operate the debtor’s business (with certain exceptions for smaller cases).
The ABI Commission contemplated that the estate neutral would be appointed more frequently, and for a broader range of reasons, than an examiner. For example, the estate neutral could be appointed to further negotiations when parties are at an impasse. This recommendation was based on the Commission’s view that an estate neutral-like appointee would be the only party uniquely situated to provide an independent and neutral perspective in a case. This is in contrast to other parties, including the debtor, who have potentially diverging interests and may be motivated purely by self-interest. The ABI Commission determined that an estate neutral could therefore serve a useful role in facilitating dispute resolutions and reducing information asymmetries. Notably, the ABI Commission voted against recommending the concept of a “statutory reorganization executive,” who would be similar to an examiner with expanded powers or a court-appointed Chief Restructuring Officer.
Statutory Committees
One of the major changes in bankruptcy practice since the enactment of the Bankruptcy Code has been the increase in secured debt. In fact, oftentimes the fulcrum security is a secured debt instrument and unsecured creditors are out of the money. This situation has led some to question the mandatory appointment of an unsecured creditors’ committee in every case. Nevertheless, after considering other proposals, the ABI Commission ultimately concluded that the mandatory appointment of a committee of unsecured creditors in all cases (with some exceptions for smaller cases) should be retained. The ABI Commission did, however, recommend allowing a court to determine otherwise for “cause,” which would include circumstances where the appointment of a statutory committee would not be in the best interests of the estate, or where the interests of general unsecured creditors do not need representation in a case, for example where creditors are being paid in full or where unsecured creditors will not be receiving distributions (because they are “out of the money”). The ABI Commission additionally supported allowing the court sua sponte, the U.S. Trustee, or a party in interest to initiate a hearing to determine whether the appointment or continuation of an unsecured creditors’ committee would be in the best interests of the estate.
Valuation Information Packages
One of the more creative proposals in the “Oversight of the Case” section were those relating to Valuation Information Packages or “VIPs”—additional disclosures required by debtors. The ABI Commission recommended that debtors be required to compile (but not necessarily to file):
(i) tax returns for the previous three years;
(ii) annual financial statements for the prior three years;
(iii) the most recent independent appraisals of any of the debtor’s material assets (including valuations of equity if available); and
(iv) to the extent shared with prepetition creditors and existing or potential purchasers, investors or lenders, all business plans or projections prepared within the previous two years.
The Report recommends that a list of this information be filed with the bankruptcy court in connection with any motion filed under sections 361, 362, 363, or 364 of the Bankruptcy Code or any chapter 11 plan filed within 60 days after the petition date. This would essentially require almost all chapter 11 debtors to file such a list on or shortly after the petition date.
Parties-in-interest would be able to request copies of the documents included in the VIP. To receive any information, however, the requesting party would need to execute a confidentiality agreement, and, to the extent that the VIP contains material, non-public information, agree to restrict its trading activities in the debtor’s claims, interests, and equity. The debtor would also be able to redact or withhold information that would otherwise be included in the VIP to the extent that the debtor determines in good faith that such redaction is necessary to prevent harm to the estate.
The ABI Commission reasoned that such additional disclosure regarding valuation may help reduce information asymmetries and allow parties in interest to make better-informed decisions regarding the impact of the debtor’s proposed exit strategy on their recoveries in the case. It also posited that such disclosures could facilitate more meaningful discussion regarding the debtor’s viable reorganization options earlier in the chapter 11 case. However, after balancing those benefits against concerns regarding protecting confidential information and chilling chapter 11 filings, the proposal would not require full disclosure of the information in the VIP in every case and provides other checks on parties’ ability to obtain and disclose the information.
Conclusions
Although the proposals discussed above may not cover the most enthralling of topics, such as financing requirements or the proper cramdown rate of interest, estate administration is nonetheless an important topic. While most of the ABI Commission’s recommendations are not drastic departures from current practice, the proposals related to the estate neutral and the VIP could, in our opinion, have an impact on bankruptcy practice. We have seen courts urge parties to use mediators and appoint independent directors with seemingly increased frequency lately, and it may be that the estate neutral could fill a similar role. Given how often valuation appears to be an issue in chapter 11 cases, having the information in a valuation information package available to interested parties could play an important role early in chapter 11 cases and move cases along more quickly if it avoids time-consuming and extensive discovery. It remains, of course, to be seen if Congress will adopt any of these recommendations and we here at the Bankruptcy Blog will be sure to keep you updated.