Bankruptcy Behind Closed Doors

Disclosure Obligations

In the absence of a statutory or regulatory requirement to disclose business information publicly, common sense, as well as the potential for legal exposure to the officers and directors, dictates that the only time a business will disclose otherwise non-public information is when it suits a legitimate business purpose. Typical instances where there may be non-mandatory disclosure might relate to marketing or publicity opportunities. It is certainly not unusual for businesses to have confidential information which can range from highly sensitive information that, if disclosed to the business's competitors, would damage the business, to information that, while not particularly sensitive, is not legally required to be disclosed and which disclosure would serve no legitimate business purpose.

Under the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure there are numerous mandatory disclosure requirements. Among them is the requirement to file schedules of assets and liabilities, a statement of financial affairs, a listing of executory contracts and other information required by Bankruptcy Rule 1007. The submission of monthly operating reports to the United States Trustee is required pursuant to Bankruptcy Rule 2015. Bankruptcy Rule 3016(b) provides that a “disclosure statement” must accompany the filing of a plan of reorganization.

Much of this information would not have to be disclosed but for the dictates of the Bankruptcy Code and Bankruptcy Rules. Moreover, some of this information could be viewed as sensitive. For example, a competitor may be unaware of who the debtor's key vendors or customers are, but that information may be contained in the schedule of liabilities or an executory contract list. Weaknesses as to cash position may give a competitor some advantage where a business is particularly cash intensive.

Once a business complies with the mandates in the Bankruptcy Code and the Bankruptcy Rules, the business is free to operate in much the same manner with respect to the disclosure of information as it would outside of bankruptcy, at least when dealing with transactions in the ordinary course of business which do not require bankruptcy court approval. Pursuant to section 363(b) of the Bankruptcy Code, of course, the sale, use or lease of estate property outside of the ordinary course of business requires court approval. Accordingly, the business will have to provide in its motion seeking court approval a convincing explanation as to why the transaction should be approved. In a Chapter 11 case, section 1109(b) provides that a party in interest “may appear and be heard on any issue in a case under [Chapter 11].” In order to have a meaningful opportunity to be heard on an issue, a party in interest needs to be able to evaluate the debtor's explanation for why the relief sought is necessary and logically should be entitled to the requisite information to make that evaluation. Thus, there is potential tension between a party in interest and its right to be heard on any issue, and the desire for the debtor to limit access to sensitive information that a party in interest may seek to make its evaluation of the issue.

The 'Fishbowl' of Bankruptcy Reorganization

One of the burdens of a bankruptcy filing is that, to a degree, the debtor's affairs become an open book. This openness has been accurately described as operating in a “fishbowl.” See King LP et al.: Collier on Bankruptcy ' 9018.04 (15th ed.). See also, Bloom MD, Olenczuk DM, Wynne RL: Reorganizing in a Fish Bowl: Public Access vs. Protecting Confidential Information. 73 Am. Bankr. L.J. 775 (1999). Additionally, the advent of electronic filing and the Internet has added a whole new level of what it means for bankruptcy documents to be filed publicly. With the PACER system available in most major filing venues, public access is no longer limited to those with the wherewithal and patience to dig through courthouse records during normal business hours and make copies at 50 cents a page. Id. at 776-77. A few mouse clicks and any document that has been electronically filed can be yours for a nominal charge in a matter of minutes without ever leaving the chair in front of your computer.

Section 107 and Bankruptcy Rule 9018

There is a longstanding American tradition of open access to the courts and to court records. This tradition is founded in common law and the First Amendment. See Nixon v. Warner Communications, Inc., 435 U.S. 589, 597-98 (1978). In the bankruptcy courts, section 107(a) of the Bankruptcy Code provides that “a paper filed in a case under this title and the dockets of a bankruptcy court are public records and open to examination by an entity at reasonable times and without charge.”

In bankruptcy cases, the openness provided by section 107 takes on an even greater importance because, as explained by the Ninth Circuit, open access to bankruptcy court records “fosters confidence among creditors regarding the fairness of the bankruptcy system.” In re Crawford, 194 F.3d 954, 960 (9th Cir. 1999). See also, In re PRS Ins. Group, Inc., 274 B.R. 381, 385 (Bankr. D. Del. 2001) (“The Bankruptcy Code is designed to bring the Debtor's affairs to light, not to hide them.”); In re Bell & Beckwith, 44 B.R. 661, 664 (Bankr. N. D. Ohio 1984) (“Public scrutiny is the means by which the persons for whom the system is to benefit are able to insure its integrity and protect their rights … [and] is fundamental to the operation of the bankruptcy system and is the best means of avoiding any suggestion of impropriety that might or could be raised.”). Put more directly, section 107 is a codification of the idea that “sunlight is … the best of disinfectants.” Brandeis LD: Other People's Money 92 (1932).

The Bankruptcy Code does, however, provide exceptions to this general rule. Specifically, section 107(b) requires that “[o]n request of a party in interest, the bankruptcy court shall … (1) protect an entity with respect to a trade secret or confidential research, development, or commercial information.” Parroting the language of section 107, Bankruptcy Rule 9018, which provides the procedure for invoking the court's power under section 107, provides that “[o]n motion or on its own initiative, with or without notice, the court may make any order which justice requires (1) to protect the estate or any entity in respect of a trade secret or other confidential research, development, or commercial information.” The categories listed in section 107(b) are mutually exclusive. Because Congress chose to use the word “or” in section 107(b), the confidential commercial information one seeks to protect need not rise to the level of a trade secret. In re Orion Pictures Corp., 21 F.3d 24, 28 (2d Cir. 1994).

Commercial Information

Orion Pictures is a leading case on the issue of what constitutes “confidential commercial information.” There, Orion granted McDonald's Corporation a license to manufacture, distribute and sell videocassettes of three films, including the Kevin Costner film, “Dances with Wolves.” As a Chapter 11 debtor, Orion sought bankruptcy court approval of the McDonald's license, moving to file the licensing agreement and related documents under seal. The Bankruptcy Judge granted the motion relying on Bankruptcy Code section 107(b) and Bankruptcy Rule 9018. Subsequently, the Video Software Dealers Association, whose members had purchased 500,000 videocassettes of “Dances With Wolves” at $64 more per copy than McDonald's was selling them for, moved to unseal the court's record. The Bankruptcy Court denied the Association's motion holding that disclosing the terms, conditions and even the overall structure of the McDonald's transaction would impair Orion's ability to negotiate additional promotion agreements –thus giving an unfair advantage to Orion's competitors. Id. at 26. The District Court affirmed the Bankruptcy Court's denial of the Association's motion.

In affirming the District Court, the Second Circuit began noting the presumptive right of access to court records. It then went on to discuss section 107(b) of the Bankruptcy Code, its special rule for sealing trade secrets, and confidential research, development and commercial information, and held that “if the information fits any of the specified categories, the court is required to protect a requesting interested party and has no discretion to deny the application.” Id. at 27 (emphasis in original). The Second Circuit further observed that the burden was on Orion, as the party in interest, to show that the information under seal was confidential and commercial in nature. Id. The Second Circuit also made clear that, in meeting this burden, the party need not demonstrate “good cause” as is required under Fed. R. Civ. P. 26(c). Id. at 28.

Examining the Orion/McDonald's agreement, the Second Circuit adopted and applied the definition used by the 9th Circuit Bankruptcy Appellate Panel in In re Itel Corp., 17 B.R. 942, 944 (9th Cir. B.A.P. 1982), holding that “commercial information” is information that would cause an unfair advantage to competitors by providing them information as to the commercial operations of the debtor. Orion Pictures, 21 F.3d at 27.

Since the Second Circuit's decision in Orion Pictures, bankruptcy courts have continued to wrestle with the question of what constitutes confidential commercial information for purposes of section 107(b). In reaching the decision to allow UAL to file its section 1110(b) stipulations and financing modifications under seal, the court was persuaded, at least in part, by the judgment of UAL's professionals who believed that keeping the extension terms confidential would allow UAL to obtain the most economical price — a benefit to the estate. See BA Leasing Parties v. UAL Corp., 2003 WL 22176068 at *2 (N.D. Ill., Sept. 15, 2003).

The Bankruptcy Court for the Southern District of New York reasoned that, for retailers, commercial information might include pricing formulae, market strategies and the terms of agreements with suppliers. See In re Barney's, Inc., 201 B.R. 703, 709 (Bankr. S.D.N.Y. 1996). A Missouri bankruptcy court ruled that a debtor could seal an amendment to its DIP credit agreement where that amendment contained information on the debtor's liquidity as well as dates by which the debtor was required to sell certain assets. The court opined that knowledge of the debtor's deadlines and liquidity might create leverage for potential buyers — driving down the amounts that potential buyers would be willing to pay. See In re Farmland Indus., Inc., 290 B.R. 364, 369 (Bankr. W.D. Mo. 2003). Another court found that a list of physicians' names — a list that constituted the debtor's primary asset – was confidential commercial information that warranted a sealing order. If given access to the list, competitors would be able to recruit the debtor's member physicians. See In re The Frontier Group, LLC, 256 B.R. 771, 774 (Bankr. E. D. Tenn. 2000). See also, In re Nunn, 49 B.R. 963, 965 (Bankr. E.D. Va. 1985) (authorizing the sealing of a customer list which was the debtor's only significant asset).

Conclusion

Defining the limits of confidential commercial information can also be aided by reviewing cases decided both prior to and after Orion Pictures where courts have refused to seal court records. Next month, we discuss this in depth, in addition to how to draw the line, and meeting the burden under section 107(b).

Part One of a Two-Part Article

There has been a perceptible increase in the number of bankruptcy transactions taking place with the underlying arrangements being placed under seal. In other instances, the debtor indicates in its motion seeking approval of the transaction that it will not be providing the underlying agreement on which the transaction is based except to the major parties in the case (typically the judge, the creditors' committee, the DIP lenders and the United States Trustee). The burden then shifts to parties in interest to seek to obtain the information if they desire to review it.

For example, the court overseeing the Chapter 11 cases of UAL Corporation and its affiliates entered an order authorizing UAL to file section 1110(b) stipulations and aircraft financing modification agreements under seal. Similarly, the court overseeing the reorganization of WorldCom, Inc. (now MCI) has authorized the sealing of settlement agreements, fee applications, and certain of WorldCom's bankruptcy schedules. These efforts have not been met without protest. Numerous parties objected to UAL's efforts to keep the terms of the section 1110(b) stipulations and aircraft financing modification terms confidential. See BA Leasing Parties, et al. v. UAL Corp., 2003 WL 22176068 at *1 (N.D. Ill., Sept. 15, 2003). Whether there has been an actual increase in the number of documents sealed or matters handled in this manner, or whether the high profile nature of these cases has simply highlighted the issue, we believe it is useful to review the applicable standards in this area and to discuss what bankruptcy courts will and will not allow when a debtor seeks to keep information away from public view.

Disclosure Obligations

In the absence of a statutory or regulatory requirement to disclose business information publicly, common sense, as well as the potential for legal exposure to the officers and directors, dictates that the only time a business will disclose otherwise non-public information is when it suits a legitimate business purpose. Typical instances where there may be non-mandatory disclosure might relate to marketing or publicity opportunities. It is certainly not unusual for businesses to have confidential information which can range from highly sensitive information that, if disclosed to the business's competitors, would damage the business, to information that, while not particularly sensitive, is not legally required to be disclosed and which disclosure would serve no legitimate business purpose.

Under the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure there are numerous mandatory disclosure requirements. Among them is the requirement to file schedules of assets and liabilities, a statement of financial affairs, a listing of executory contracts and other information required by Bankruptcy Rule 1007. The submission of monthly operating reports to the United States Trustee is required pursuant to Bankruptcy Rule 2015. Bankruptcy Rule 3016(b) provides that a “disclosure statement” must accompany the filing of a plan of reorganization.

Much of this information would not have to be disclosed but for the dictates of the Bankruptcy Code and Bankruptcy Rules. Moreover, some of this information could be viewed as sensitive. For example, a competitor may be unaware of who the debtor's key vendors or customers are, but that information may be contained in the schedule of liabilities or an executory contract list. Weaknesses as to cash position may give a competitor some advantage where a business is particularly cash intensive.

Once a business complies with the mandates in the Bankruptcy Code and the Bankruptcy Rules, the business is free to operate in much the same manner with respect to the disclosure of information as it would outside of bankruptcy, at least when dealing with transactions in the ordinary course of business which do not require bankruptcy court approval. Pursuant to section 363(b) of the Bankruptcy Code, of course, the sale, use or lease of estate property outside of the ordinary course of business requires court approval. Accordingly, the business will have to provide in its motion seeking court approval a convincing explanation as to why the transaction should be approved. In a Chapter 11 case, section 1109(b) provides that a party in interest “may appear and be heard on any issue in a case under [Chapter 11].” In order to have a meaningful opportunity to be heard on an issue, a party in interest needs to be able to evaluate the debtor's explanation for why the relief sought is necessary and logically should be entitled to the requisite information to make that evaluation. Thus, there is potential tension between a party in interest and its right to be heard on any issue, and the desire for the debtor to limit access to sensitive information that a party in interest may seek to make its evaluation of the issue.

The 'Fishbowl' of Bankruptcy Reorganization

One of the burdens of a bankruptcy filing is that, to a degree, the debtor's affairs become an open book. This openness has been accurately described as operating in a “fishbowl.” See King LP et al.: Collier on Bankruptcy ' 9018.04 (15th ed.). See also, Bloom MD, Olenczuk DM, Wynne RL: Reorganizing in a Fish Bowl: Public Access vs. Protecting Confidential Information. 73 Am. Bankr. L.J. 775 (1999). Additionally, the advent of electronic filing and the Internet has added a whole new level of what it means for bankruptcy documents to be filed publicly. With the PACER system available in most major filing venues, public access is no longer limited to those with the wherewithal and patience to dig through courthouse records during normal business hours and make copies at 50 cents a page. Id. at 776-77. A few mouse clicks and any document that has been electronically filed can be yours for a nominal charge in a matter of minutes without ever leaving the chair in front of your computer.

Section 107 and Bankruptcy Rule 9018

There is a longstanding American tradition of open access to the courts and to court records. This tradition is founded in common law and the First Amendment. See Nixon v. Warner Communications, Inc. , 435 U.S. 589, 597-98 (1978). In the bankruptcy courts, section 107(a) of the Bankruptcy Code provides that “a paper filed in a case under this title and the dockets of a bankruptcy court are public records and open to examination by an entity at reasonable times and without charge.”

In bankruptcy cases, the openness provided by section 107 takes on an even greater importance because, as explained by the Ninth Circuit, open access to bankruptcy court records “fosters confidence among creditors regarding the fairness of the bankruptcy system.” In re Crawford, 194 F.3d 954, 960 (9th Cir. 1999). See also, In re PRS Ins. Group, Inc., 274 B.R. 381, 385 (Bankr. D. Del. 2001) (“The Bankruptcy Code is designed to bring the Debtor's affairs to light, not to hide them.”); In re Bell & Beckwith, 44 B.R. 661, 664 (Bankr. N. D. Ohio 1984) (“Public scrutiny is the means by which the persons for whom the system is to benefit are able to insure its integrity and protect their rights … [and] is fundamental to the operation of the bankruptcy system and is the best means of avoiding any suggestion of impropriety that might or could be raised.”). Put more directly, section 107 is a codification of the idea that “sunlight is … the best of disinfectants.” Brandeis LD: Other People's Money 92 (1932).

The Bankruptcy Code does, however, provide exceptions to this general rule. Specifically, section 107(b) requires that “[o]n request of a party in interest, the bankruptcy court shall … (1) protect an entity with respect to a trade secret or confidential research, development, or commercial information.” Parroting the language of section 107, Bankruptcy Rule 9018, which provides the procedure for invoking the court's power under section 107, provides that “[o]n motion or on its own initiative, with or without notice, the court may make any order which justice requires (1) to protect the estate or any entity in respect of a trade secret or other confidential research, development, or commercial information.” The categories listed in section 107(b) are mutually exclusive. Because Congress chose to use the word “or” in section 107(b), the confidential commercial information one seeks to protect need not rise to the level of a trade secret. In re Orion Pictures Corp., 21 F.3d 24, 28 (2d Cir. 1994).

Commercial Information

Orion Pictures is a leading case on the issue of what constitutes “confidential commercial information.” There, Orion granted McDonald's Corporation a license to manufacture, distribute and sell videocassettes of three films, including the Kevin Costner film, “Dances with Wolves.” As a Chapter 11 debtor, Orion sought bankruptcy court approval of the McDonald's license, moving to file the licensing agreement and related documents under seal. The Bankruptcy Judge granted the motion relying on Bankruptcy Code section 107(b) and Bankruptcy Rule 9018. Subsequently, the Video Software Dealers Association, whose members had purchased 500,000 videocassettes of “Dances With Wolves” at $64 more per copy than McDonald's was selling them for, moved to unseal the court's record. The Bankruptcy Court denied the Association's motion holding that disclosing the terms, conditions and even the overall structure of the McDonald's transaction would impair Orion's ability to negotiate additional promotion agreements –thus giving an unfair advantage to Orion's competitors. Id. at 26. The District Court affirmed the Bankruptcy Court's denial of the Association's motion.

In affirming the District Court, the Second Circuit began noting the presumptive right of access to court records. It then went on to discuss section 107(b) of the Bankruptcy Code, its special rule for sealing trade secrets, and confidential research, development and commercial information, and held that “if the information fits any of the specified categories, the court is required to protect a requesting interested party and has no discretion to deny the application.” Id. at 27 (emphasis in original). The Second Circuit further observed that the burden was on Orion, as the party in interest, to show that the information under seal was confidential and commercial in nature. Id. The Second Circuit also made clear that, in meeting this burden, the party need not demonstrate “good cause” as is required under Fed. R. Civ. P. 26(c). Id. at 28.

Examining the Orion/McDonald's agreement, the Second Circuit adopted and applied the definition used by the 9th Circuit Bankruptcy Appellate Panel in In re Itel Corp., 17 B.R. 942, 944 (9th Cir. B.A.P. 1982), holding that “commercial information” is information that would cause an unfair advantage to competitors by providing them information as to the commercial operations of the debtor. Orion Pictures, 21 F.3d at 27.

Since the Second Circuit's decision in Orion Pictures, bankruptcy courts have continued to wrestle with the question of what constitutes confidential commercial information for purposes of section 107(b). In reaching the decision to allow UAL to file its section 1110(b) stipulations and financing modifications under seal, the court was persuaded, at least in part, by the judgment of UAL's professionals who believed that keeping the extension terms confidential would allow UAL to obtain the most economical price — a benefit to the estate. See BA Leasing Parties v. UAL Corp., 2003 WL 22176068 at *2 (N.D. Ill., Sept. 15, 2003).

The Bankruptcy Court for the Southern District of New York reasoned that, for retailers, commercial information might include pricing formulae, market strategies and the terms of agreements with suppliers. See In re Barney's, Inc., 201 B.R. 703, 709 (Bankr. S.D.N.Y. 1996). A Missouri bankruptcy court ruled that a debtor could seal an amendment to its DIP credit agreement where that amendment contained information on the debtor's liquidity as well as dates by which the debtor was required to sell certain assets. The court opined that knowledge of the debtor's deadlines and liquidity might create leverage for potential buyers — driving down the amounts that potential buyers would be willing to pay. See In re Farmland Indus., Inc., 290 B.R. 364, 369 (Bankr. W.D. Mo. 2003). Another court found that a list of physicians' names — a list that constituted the debtor's primary asset – was confidential commercial information that warranted a sealing order. If given access to the list, competitors would be able to recruit the debtor's member physicians. See In re The Frontier Group, LLC, 256 B.R. 771, 774 (Bankr. E. D. Tenn. 2000). See also, In re Nunn, 49 B.R. 963, 965 (Bankr. E.D. Va. 1985) (authorizing the sealing of a customer list which was the debtor's only significant asset).

Conclusion

Defining the limits of confidential commercial information can also be aided by reviewing cases decided both prior to and after Orion Pictures where courts have refused to seal court records. Next month, we discuss this in depth, in addition to how to draw the line, and meeting the burden under section 107(b).