This article was first published in the June 2007 issue of Financier Worldwide magazine
Official committees play a critical role in US bankruptcy cases. In a Chapter 11 case, a committee is the US Trustee appointed, court anointed, concerted voice of all creditors within a class. (See 11 U.S.C. § 1102.) Because a committee represents all creditors, the position a committee takes on a motion can influence a court’s decision. Since debtors must seek court approval of their actions by motion or application, predictably, a debtor often seeks committee support before acting and may compromise with the committee to obtain that support. Thus, the committee is key to shaping a reorganisation and committee membership is, therefore, viewed as a coveted opportunity.
The committee’s powers and duties are expansive: it may consult with the debtor concerning estate administration, investigate acts, conduct, assets and liabilities of the debtor, participate in the formulation of a plan and hire professionals at the debtor’s expense. (11 U.S.C. § 1103.) To fulfil its duties, committee members are provided with access to non-public information, including the debtor’s detailed financial data and plans for reorganising. Members also have access to senior officers and directors of the debtor at regular weekly or monthly meetings. This information and access to the debtor is vital to members with ongoing business relationships with the debtor, including members who hope to provide debtor-in-possession and exit financing (increasingly popular with private equity and hedge fund committee members). Additionally, the committee elects board members of the reorganised debtor where the reorganisation plan contemplates distribution to creditors of stock in the reorganised entity, which creates ongoing benefits after the debtor’s emergence from bankruptcy.
While membership on a committee confers many benefits, members have fiduciary duties to the creditors they represent "to maximize their recovery of the Estate’s assets."(Iridium Operating LLC v. Official Comm. of Unsecured Creditors, 478 F.3d 452, 466 (2d Cir. 2007).) These duties prohibit committee members from using information they acquire to advance their individual interests. (See In re Haskell-Dawes, Inc., 188 B.R. 515, 519 (Bankr. E.D. Pa. 1995).) Committee members can face harsh penalties for breaching their fiduciary duties, including removal from the committee and subordination or disallowance of their claims. (See Robert A. Benjamin, Note: Fiduciary Responsibilities of Creditors’ Committee Members with Respect to Securities and Commodities Transactions, 10 Am. Bankr. Inst. L. Rev. 493, 495 (2002).)
Fiduciary duties may restrict activities in which members may otherwise engage. For instance, because members have access to confidential information, they are generally prohibited from trading in the debtor’s securities. Of course, trading on non-public information also violates US securities laws. (See 17 C.F.R. § 240.10b-5.) This prohibition is particularly resonant in modern day bankruptcy cases where financial institutions, hedge funds and private equity firms are committee members and their businesses include trading the debtor’s securities and/or purchasing creditor claims.
The recently reported alleged insider trading by Barclays highlights this issue. Barclays reported in its Annual Report on Form 20-F filed with the US Securities and Exchange Commission (SEC) that the SEC commenced an investigation into its trading activity between 2002 and 2003 by a proprietary trading desk while desk personnel were serving on bankruptcy committees. (See Barclays Annual Report on Form 20-F for 2006 at 62.) Barclays reported that it is cooperating with the SEC during its investigation and attempting to resolve the matter, though the SEC could bring an enforcement action if it has evidence that Barclays profited from advance knowledge of market-moving developments that its analysts and traders received from serving on creditors committees.
How does a committee member serve on a committee and avoid forfeiting its right to trade in the securities of the debtor? This is not a novel conundrum. Because lenders can be invaluable committee members, courts may approve the creation of ethical or screening walls, giving those claimants comfort that if they follow the approved procedures, trading in the debtor’s securities will not breach their fiduciary duties. Approved ethical walls can include any means of preventing a creditor’s trading personnel from using (or misusing) non-public information obtained by the committee member engaged in committee-related activity, including employment of different personnel to perform certain functions, physically separating office and file space, locking committee files and using separate telephone and facsimile lines. Various screening procedures have been approved in large US bankruptcies. Indeed, members who trade in securities and claims should consider creating their own internal protections and obtaining court approval of such ethical screens.
Groups of creditors may also form ad hoc committees, i.e., groups of like-minded creditors acting in concert without the approval of or im-primatur of the bankruptcy court. Ad hoc committees may be formed for many reasons, including (i) to remedy the official committee’s failure to adequately address the concerns of a particular group of creditors (e.g., trade creditors, lenders, unions) and (ii) to avoid the burden of having fiduciary duties imposed by membership on an official committee. Under the Federal Rules of Bankruptcy Procedure (the ‘Bankruptcy Rules’) an entity representing a committee or more than one creditor must file a statement disclosing, inter alia, "the amounts of claims or interests owned by the members of the committee, the times when acquired, the amounts paid therefore, and any sales or disposition thereof." (Fed. R. Bankr. P. 2019.) Thus, while ad hoc committee members may not be subject to fiduciary duties, they are subject to disclosure requirements.
Recently, in the Northwest Airlines bankruptcy, a group of Northwest equity holders filed a motion seeking, inter alia, access to non-public information regarding Northwest’s merger negotiations with other air lines. The group filed a 2019 statement without the information required by the Bankruptcy Rules. The debtor moved to compel the stockholders to file the required information, but they resisted on the basis that disclosure would reveal confidential trading strategies, irreparably injure the ad hoc committee members and give their counterparties in negotiations an unfair advantage, i.e, knowledge of their basis or acquisition cost of the stock. The court resolved the dispute by ordering the group to produce the required information, holding that the rule is intended to protect the constituents of the class who have a right to "know where their champions are coming from." (In re Northwest Airlines Corp., Case No. 05-17930, Memorandum of Opinion and Order, March 9, 2007.) The result was that members of the group dropped out and let others, who were willing to disclose the required information, take the lead.
Serving on a committee is a tremendous opportunity to help shape a debtor’s reorganisation and gain valuable access to and information from a debtor with which the committee member may be engaged in ongoing business. With benefits, however, comes burdens and responsibilities creditors must consider before agreeing to serve. As a committee member, (i) assume your activities will be viewed under a microscope, (ii) create internal safeguards to avoid accusations of misuse of information and (iii) where possible and appropriate, seek court approval of internal safeguards.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
