On June 28, 2012, Judge Allan Gropper of the United States Bankruptcy Court for the Southern District of New York declined to appoint an official committee of equity holders in Kodak's chapter 11 cases. The bankruptcy court determined that the appointment of an official committee was not warranted at that time, given that the costs to the bankruptcy estates would be substantial and equity's interests were already represented by other constituencies seeking to maximize value and by a sophisticated ad hoc group of shareholders. In re Eastman Kodak Company, Case No. 12-10202 (June 28, 2012).
Background
The United States Trustee may appoint an official committee of equity holders pursuant to section 1102(a)(1) of the Bankruptcy Code. If, however, the United States Trustee determines that appointment of a committee is not appropriate, the bankruptcy court, on request of any party in interest, may order the appointment "if necessary to assure adequate representation of . . . equity security holders." 11 U.S.C. § 1102(a)(2).
Although ad hoc and "unofficial" committees of equity holders are frequently organized in chapter 11 cases, obtaining the appointment of an official committee pursuant to section 1102 of the Bankruptcy Code confers a significant benefit – the fees and expenses of the committee's counsel and other professionals are paid out of the bankruptcy estate.
Kodak filed for chapter 11 protection in January 2012. Soon thereafter, certain of Kodak's shareholders petitioned the United States Trustee to form of an official committee of equity holders. After considering extensive information provided by the shareholders and certain parties in opposition, the United States Trustee denied the shareholders' request.
On March 9, the shareholders moved the bankruptcy court to order the appointment of an official committee of equity holders, arguing that the possibility of a return to equity justified the appointment and that without an official committee, shareholders would be denied a meaningful opportunity to participate in Kodak's restructuring. Kodak, the United States Trustee, the official committee of unsecured creditors, and an ad hoc second lien noteholders' committee all opposed the shareholders' motion, arguing that the bankruptcy estates should not bear the legal fees of an additional committee when the shareholders' interests were already adequately represented by other constituencies that shared the common goal of maximizing the value of the debtors' estates.
Analysis
The bankruptcy court began its analysis by noting that the term "adequate representation" is not defined in the Bankruptcy Code, and accordingly, courts evaluate the issue on a case by case basis as informed by a number of factors. These factors include the number of shareholders of the debtor(s), the complexity of the case, the likely cost of an additional committee to the estate, whether equity is already adequately represented by existing stakeholders, the timing of the motion relative to the status of the chapter 11 case, and whether there appears to be a substantial likelihood that equity will receive a meaningful distribution in the case.
Although no single factor controls, the bankruptcy court was mindful that section 1102(a)(2) of the Bankruptcy Code requires a court to find that the appointment of an official committee is "necessary" for equity's interests to be adequate protected, and observed that this is a "high standard that is far more onerous than . . . merely useful or appropriate." Kodak, at *4. The bankruptcy court also noted that, while courts have interpreted "necessary" with varying degrees of stringency, there appears to be "uniform recognition that [appointment of an official committee of equity holders] constitutes extraordinary relief and is the exception rather than the rule in chapter 11 cases." Id. at *5 (citations omitted).
Applying these principles, Judge Gropper determined that the shareholders had not shown that the appointment of an official committee was necessary to ensure that their interests would be adequately represented. First, the court found that all of the other constituencies in the case – most notably Kodak and the unsecured creditors' committee – shared the goal of maximizing the value of the bankruptcy estate.
With respect to Kodak, the court stated that a debtor in possession has a fiduciary duty to maximize value for its creditors, but emphasized that the insolvency of a company does not absolve the board of directors from its fiduciary duties to shareholders. Further buttressing the court's determination that Kodak would adequately represent equity's interests, the court noted that Kodak's directors and officers collectively own over 10 million shares of Kodak stock, and thus, there was "no reason to think that the interests of shareholders will be ignored in these cases." Id.
The court was equally unconvinced that the unsecured creditors' committee would not sufficiently represent equity's interests. Similar to a debtor in possession, an official committee of unsecured creditors has a duty to maximize the value of the debtor's bankruptcy estate, and the court determined that this duty would inure to the benefit of creditors and shareholders alike. The court also rejected the shareholders' unsubstantiated argument that the unsecured creditors' committee would only work to maximize value up to the point that all creditors would be paid in full, dismissing the notion that it was even possible to divine the value break point at such an early stage in the cases and deeming it sufficient for present purposes that creditor and shareholder interests were "generally" aligned.
In addition, the court cited the high quality of the legal counsel representing the shareholders as another reason why the appointment of an official committee was unnecessary, concluding that the shareholders could be represented ably through an ad hoc or unofficial committee.
Significantly, in reaching this conclusion, the court was keenly aware of the appropriate allocation of risk as between the bankruptcy estates on the one hand, and the shareholders on the other. Specifically, the court was quick to point out that if the shareholders ultimately make a substantial contribution to Kodak's reorganization, they will be able to seek reimbursement of their professional fees and expenses pursuant to section 503(b)(3)(D) of the Bankruptcy Code. If the shareholders do not contribute substantially to the debtors' reorganization, Kodak's estates will not be forced to fund a constituency that is likely out of the money.
The court dispensed with the shareholder's other arguments – namely, that the court should conduct a mini-trial to confirm Kodak's solvency and that the court's previous appointment of an official committee for Kodak retirees justified the appointment of an official committee for equity holders.
Taking each in turn, the court summarily dismissed the shareholders' request for a mini-trial, finding that any potential benefit was outweighed by the considerable time and expense it would impose on Kodak, particularly during the critical, early months of the chapter 11 cases. Additionally, based on the current record, the court found no substantial evidence that equity would be entitled to a meaningful distribution in the cases.
With respect to the shareholder's "me too" argument, the court rejected any comparison to the official committee for Kodak retirees, given that section 1114 of the Bankruptcy Code expressly mandates the appointment of retired employees if the debtor seeks to modify its retiree obligations. 11 U.S.C. § 1114(d). Since Kodak had already publicly announced its intention to modify retiree benefits, the appointment of the committee of the debtors' retirees was clearly justified.
Conclusion
Given the additional expense to the bankruptcy estate, equity holders face an uphill battle when seeking the appointment of an official committee to represent their interests. Kodak highlights these challenges, and serves as a reminder that courts are unlikely to find an official committee necessary to assure the adequate representation of equity's interests when equity holders are likely out of the money and their interests are generally aligned with other constituents in the case.
The decision also suggests that in cases like Kodak where the debtor's value has yet to be determined, equity holders would, as a practical matter, likely benefit from the efforts of the general unsecured creditors' committee notwithstanding the fact that the committee otherwise has no fiduciary obligations to equity. The underlying assumption being that, without a clear delineation of the value break, the committee would seek to maximize value ad infinitum to the benefit of creditors and junior constituents alike. Thus, no additional committee would be necessary to look out for the interests of equity.
However, this raises critical questions. Given that the general unsecured creditors' committee has no duty to equity, where does the committee's obligation to maximize value end? If value is fixed more clearly than in Kodak, does the committee have any obligation to push for greater recoveries after unsecured creditors are paid in full? In cases where there is meaningful evidence that equity is in the money, the interests of the general unsecured creditors' committee and equity are less closely aligned, providing greater justification for the appointment of an additional committee to represent equity holders.
Additionally, Kodak may incentivize equity holders to seek the appointment of an official committee prior to organizing an ad hoc committee, as this could defuse some of Judge Gropper's conclusions that ad hoc committees adequately serve the needs of equity.
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