This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll cover the Commission’s recommendations regarding post-confirmation entities and claims trading.
The Commission addresses post-confirmation entities and claims trading in the context of disclosure. As a starting point, Section 1125 of the Bankruptcy Code requires a plan proponent to file a disclosure statement that contains “adequate information.” Section 1125(a) contains a rather exhaustive list of what constitutes adequate information. Additionally, courts tend to rely on 8 factors or so to assess the adequacy of a disclosure statement. As the Commission points out, the gist of Section 1125 (and such factors) is whether the “disclosure statement identifies and explains material aspects of the debtor’s business, chapter 11 case, and proposed plan so that creditors and other stakeholders can make an informed decision about voting on the plan.”
Although the Commission determined that plan proponents generally provide adequate information about events leading-up to and occurring during a Chapter 11 case, it determined that disclosure is “frequently insufficient with respect to the governance and operations of the reorganized debtor and any postconfirmation entity established in connection with the plan.” Examples of post-confirmation entities include litigation trusts, liquidation trusts, post-confirmation business trusts, or even the reorganized debtor itself (whether the reorganized debtor is operating or liquidating post-confirmation). Claims-resolution-related entities, in particular, are often proposed via Section 1123(b), which states that a plan may provide for the settlement, adjustment, or enforcement of a claim by a debtor or by some other appointed “representative of the estate.” Although not specifically cited by the Commission, Section 1123(a)(5) provides a similar basis for a post-confirmation, plan implementation entity.
Regardless of whether one views post-confirmation entities as a beneficial means of implementing a plan, the Commission’s primary concern with such entities relates to disclosure, particularly with respect to the entity’s “authority, governance, operation, and accountability” after confirmation. As the Commission points out, it is not uncommon for a plan proponent to address those matters in a trust or organizational document that is only made available at confirmation rather than at the disclosure statement stage.
For example, we usually provide a proposed trust instrument with the disclosure statement. However, the formation and documentation of a new operating entity occasionally ends-up as a post-confirmation afterthought. Again, it comes down to disclosure. Arguably, a very specific plan (a contract that should bind the post-confirmation entity) might make it unnecessary to supply those types of ancillary organizational documents on the front-end. In any event, such entities commonly administer the plan or a major component of the plan with minimal judicial supervision after confirmation, such that up-front disclosure is a condition for an informed plan vote.
Consistent with the Commission’s approach to other Chapter 11 issues, the Commission declined to adopt a “one-size-fits-all” approach via “statutory guidelines” for such entities.
Rather, the Commission views the post-confirmation entity issue as a disclosure issue–an issue that can be resolved with additional disclosure about the governance of such entities, the post-confirmation claims process, and the proposed role of the court in such governance and claims process.
Specifically, the Commission recommends amending Section 1125 to require the following additional disclosures:
- Governance: The plan proponent should identify the entity’s manager(s); the decision-making process for the entity; the procedures for changing management; the role of equity and other beneficiaries in governance, if any; and the assets of the reorganized debtor and/or post-confirmation entity.
- Claims Process: The plan proponent should disclose how claims/interests disputes, reconciliations, and distributions will be handled; and
- Role of the Court: The plan proponent should (i) describe how implementation disputes are to be brought to the attention of and handled by the court (if at all) and (ii) describe the entity with enough particularity to determine whether creditors/beneficiaries are sufficiently protected (as a condition for the approval of the entity).
Claims trading (i.e., the buying and selling of claims against a debtor) is now a significant part of the Chapter 11 process. For example, a Dow Jones publication cited by the Commission states that distressed investors bought and sold more than $41 billion worth of bankruptcy claims in 2012. Therefore, even though the Commissioners have “varying positions on the value of claims trading,” they “all recognized its increasing presence and arguable influence on chapter 11 cases.” To be sure, some believe that claims trading destabilizes the reorganization process, removes interested parties from the process, and even provides “arbitrage and takeover opportunities” for outsiders who can depress value and harm creditors. Others believe that claims trading can provide necessary liquidity, streamline the process for obtaining consensus, and even introduce better-financed creditors who can assist a debtor long-term.
With that in mind, the Commission considered whether increased regulation and increased disclosure would help resolve perceived problems with claims trading. Although the Commission acknowledges that the anecdotal evidence on the desirability of claims trading goes both ways, it also acknowledges that there is a “robust secondary market” for claims trading that can provide liquidity and an exit strategy for debtors and creditors alike. Therefore, the Commission sees little benefit to increased regulation of claims trading.
However, the Commission also addressed whether additional disclosure would be beneficial. Specifically, the Commission points to the potential tension between Rule 3001(e) and Rule 2019. On the one hand, Rule 3001(e) (which governs the formal transfer of claims) does not require the transferor to acknowledge the transfer or the consideration that it received for the transfer. Relevant or not, debtors, in particular, often want to know how much money the “new” creditor “has in the deal.” On the other hand, Rule 2019, as recently amended, generally requires disclosure of interests held by creditors or equity holders who are “acting in concert” in a Chapter 11 case. As the Commission points out, Rule 2019 does not apply to claims traders, per se, but it could, depending on the facts, extend to investors in claims who are attempting to influence a case.
The Commission considered recommending that Rule 2019 extend to all creditors (at least in the context of certain major administrative matters or exit-oriented events like 363 sales, plans, DIP financing, trustee appointments, etc.). It also considered recommending additional disclosures under Rule 3001(e).
However, the Commission ultimately concluded that additional disclosures for claims trading would only add “nominal value.”
That is because the Commissioners concluded that what an investor paid for a claim or why it bought a claim would usually be irrelevant to the merits or collection of the claim. Additionally, even when the price or motive might be relevant, courts have mechanisms for addressing price or motive issues, including “vote designation” under Section 1126(e) (a topic that we will discuss in a later post), equitable subordination of claims under Section 510, etc.
Generally, we agree that increased regulation of claims trading is probably unnecessary, if not inappropriate. After all, claims trading is substantially a matter of contract. The Code should hesitate to interfere with the ability of creditors to transfer claims freely. However, as mostly debtors’ attorneys, we are somewhat biased on the issue of increased disclosure (i.e., we favor increased disclosure) and, thus, are dissatisfied with the Commission’s hesitancy to recommend additional disclosure for claims trading. Then again, if we’re pressed on which additional disclosures should be required, the additional disclosures would probably fall into the “What’d ya pay? Why’d you buy it?” category. Therefore, our desire for more disclosure might just be our desire that the tools for policing DBSD-style bad faith (vote designation, subordination, etc.) be more clear-cut and established.
In our next post, we’ll delve into the first part of the Commission’s recommendations regarding “General Plan Content.”