Proposed Revisions to Rule 2019

Currently, Rule 2019 provides that any “committee” representing more than one creditor in a bankruptcy proceeding must publicly disclose information about: 1) the members represented; 2) the amount and nature of each member'fs claims; 3) the dates the members acquired their claims; and 4) the amounts paid for the claims.

“Ad hoc committees” or “ad hoc groups” typically have not disclosed detailed information about their members or the investments of their members. In an effort to curtail the power of ad hoc committees and/or seek to gain negotiating leverage, debtors or other parties in interest have pressed judges to require full Rule 2019 disclosures by ad hoc groups. In the recent past, the court in Northwestern Airlines Corporation, 363 B.R. 701 (Bankr. S.D.N.Y. 2007) held that Rule 2019 required ad hoc committee members to disclose, among other things, the dates of all claim and equity acquisitions and the amounts paid for such
acquisitions and refused a request by the members to file the 2019 statement under seal. But shortly thereafter, the court in Scotia Development LLC, 2007 Bankr. Lexis 4731 (Bankr. S.D. Tex. 2007) declined to follow the Northwestern court'fs reasoning and ruled that an ad hoc group was not a committee and therefore Rule 2019 did not apply.

Recent Case Law

Rule 2019 returned to the spotlight in several recent bankruptcy court decisions in Delaware. In Washington Mutual, Judge Mary F. Walrath followed the reasoning of Northwestern and held that because an ad hoc “group” of noteholders was in reality an “ad hoc committee,” Rule 2019 required disclosure by each committee member. Judge Walrath continued that “collective action by creditors in a class implies some obligation to other members of that class,” suggesting that even though members of an ad hoc committee or group act only for themselves, by virtue of their collective action, committee members may undertake obligations to other similarly situated creditors.

However, in Premier Int'fl Holdings, Judge Christopher S. Sontchi expressly declined to follow the reasoning of Northwestern and Washington Mutual and ruled that an ad hoc or informal committee was not a committee representing more than one creditor and therefore was not subject to the disclosure requirements of Rule 2019. Similarly, the court in In re Philadelphia Newspapers, LLC, Case No. 09-11204 (Bankr. E.D. Pa. Feb. 4, 2010) declined to require an ad hoc group of creditors to comply with the disclosure requirements of Rule 2019.

Proposed Rule 2019 Revisions

Running in parallel with recent judicial interpretations of Rule 2019, the Rules Committee has drafted and published for public comment proposed revisions to Rule 2019 (“Revised Rule 2019″), a copy of which is available at www.uscourts.gov/rules/. A public hearing was held on Feb. 5, 2010 in New York City at which, among others, Elliot Ganz of The Loan Syndications and Trading Association (the “LSTA”), Judge Robert E. Gerber, of the Bankruptcy Court for the Southern District of New York, as well as the authors of this article testified and submitted written statements.

As currently proposed, Revised Rule 2019 would broaden the disclosure requirement to apply: 1) to every “entity, group, or committee” that represents or consists of more than one creditor; and 2) upon a motion of a party in interest or on the court'fs own motion, to any entity that seeks or opposes the granting of any relief. In addition, Revised Rule 2019 broadly defines the “disclosable economic interests” that would be required to be disclosed to include a “participation, derivative instrument, or any other right or derivative right that grants the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest.” Finally, Revised Rule 2019 requires parties to disclose the date a member acquired each economic interest and, if required by a court, the price paid for such interest.

Public Hearing

The authors, along with the LSTA and several other witnesses, submitted written statements and testified at the public hearing. The thrust of the testimony was that, while the broader goals of disclosure and transparency promoted by Revised Rule 2019 are not controversial, the requirement in Revised Rule 2019 that each entity, group or committee member disclose proprietary and confidential information such as the dates of purchase, and, if required by the court, the price paid for its claims or interests is problematic and will have a significant impact on the willingness of hedge funds, institutional investors and other distressed investors to participate (or even appear) in a bankruptcy proceeding.

Although on its face, Revised Rule 2019 does not require disclosure of prices paid absent court order, Elliot Ganz testified that requiring a party to disclose “dates of purchase“ is tantamount to requiring a party to disclose the price, given the ease of determining the market price of bonds, syndicated loans or securities on any given day and the widespread availability of real time information concerning the prices bid by potential buyers, asked by potential sellers and paid in recent transactions for both bank debt and bond debt.

The bedrock principles of distressed investing are: 1) a claim in the hands of a secondary market purchaser has the same rights and disabilities as it did in the hands of the original claimant; and 2) “the price paid for a claim does not affect the amount of the creditor'fs claim, or the creditor'fs voting power.” See Fairfield Executive Associates, 161 B.R.595, 602-603 (D.N.J. 1993).

Requiring disclosure of jealously guarded pricing information and investment strategies, may lead to debtors and other creditors attempting to use pricing information when negotiating claim recoveries with secondary market debt purchasers, despite the legal principle that a claim purchased in the secondary market is the legal equivalent of an original claim. This would tend to erode the bedrock principles. Moreover, the requirement to disclose dates of purchase and, in effect, pricing information is not likely to further any public policy goals and will only serve to discourage distressed investors from participating in bankruptcy proceedings or in ad hoc committee groups.

Indeed, the overwhelming evidence to date demonstrates that Rule 2019 is not being used for its intended purpose of providing transparency and disclosure, but rather is being used as a sword or as leverage in disputes among different classes of creditors or between debtors and certain of its creditors as evidenced by the Philadelphia Newspapers, Washington Mutual, Northwest Airlines and Scotia Development cases.

Benefits of Ad Hoc Committees

Bankruptcy proceedings have greatly benefited from the participation of ad hoc committees, which: 1) allow creditors with smaller claims to join together to advance a common position in bankruptcy proceedings where it would not be economical for them to appear on their own; 2) eliminate the need for each creditor to file its own duplicative pleading and for all other constituents in the proceedings to review and respond to each individual pleading, and 3) provide debtors and other constituents with a common “address” to direct inquiries and negotiate critical business and legal issues and avoid having to conduct negotiations with important creditors on an individual basis.

Conclusion

If distressed investors retreat from active participation in bankruptcies, the benefits and efficiencies supported by ad hoc committees will markedly decrease. Moreover, recoveries for all constituencies will likely suffer if active investors — that invest in the companies they believe will emerge from bankruptcy stronger and more viable ” are less willing to invest their time, ingenuity and money and are less willing to invest in DIP loans, exit financings or backstop rights offerings. Therefore, Revised Rule 2019, if adopted as currently proposed, is likely to have a significant impact on future reorganizations.

Although the Rules Committee has not released any statement or proposed changes to Revised Rule 2019, we are hopeful that the ongoing “comment“ process will yield a Revised Rule 2019 that: 1) addresses the legitimate needs for transparency in modern bankruptcy proceedings, 2) respects the bedrock principle of distressed investing ” that a claim in the hands of a secondary purchaser is just as good as it was in the hands of the original claimant; 3) does not provide debtors with unfair negotiating leverage by directly or indirectly disclosing the price paid for a distressed claim; 4) encourages formation of ad hoc committees as an efficient driver in the modern bankruptcy process; and 5) encourages stakeholders (including distressed investors) to participate in the process.

Jon Kibbe and Michael Friedman are partners in the New York office of Richards Kibbe & Orbe LLP. Mr. Kibbe'fs practice concentrates on legal issues surrounding credit structures and credit risk in the fixed income markets. Mr. Friedman is co-head of the bankruptcy and restructuring group. He represents secured and unsecured creditors, lenders and ad hoc bondholder groups. Kibbe and Friedman testified at the Feb. 5, 2010 hearing on the proposed amendments to Bankruptcy Rule 2019. They can be reached via e-mail at [email protected] and [email protected] respectively.

Bankruptcy Rule 2019, an often-ignored pivotal procedural rule in U.S. bankruptcies, has returned to the public eye. This reemergence stems from two recent decisions from the influential Bankruptcy Court for the District of Delaware (In re Washington Mutual, Inc., Case No. 08-12229 (Bankr. D. Del. Dec. 2, 2009) and In re Premier Int'fl Holdings, Inc., Case No. 09-12019 (Bankr. D. Del. Jan. 20, 2010)), as well as the controversial pending amendments to Rule 2019 proposed by the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States (the “Rules Committee“). The amendments were the subject of a public hearing held in New York City on Feb. 5, 2010.

The evolving judicial interpretations of Rule 2019 and the Rules Committee'fs proposed revisions will have a substantial impact on the landscape of distressed investing. If courts continue to require members of ad hoc groups or committees to disclose proprietary pricing information about their claims, or the proposed revisions to Rule 2019 become effective without change, distressed investors may be less willing to participate in ad hoc committees.

Rule 2019 Currently

Currently, Rule 2019 provides that any “committee” representing more than one creditor in a bankruptcy proceeding must publicly disclose information about: 1) the members represented; 2) the amount and nature of each member'fs claims; 3) the dates the members acquired their claims; and 4) the amounts paid for the claims.

“Ad hoc committees” or “ad hoc groups” typically have not disclosed detailed information about their members or the investments of their members. In an effort to curtail the power of ad hoc committees and/or seek to gain negotiating leverage, debtors or other parties in interest have pressed judges to require full Rule 2019 disclosures by ad hoc groups. In the recent past, the court in Northwestern Airlines Corporation, 363 B.R. 701 (Bankr. S.D.N.Y. 2007) held that Rule 2019 required ad hoc committee members to disclose, among other things, the dates of all claim and equity acquisitions and the amounts paid for such
acquisitions and refused a request by the members to file the 2019 statement under seal. But shortly thereafter, the court in Scotia Development LLC, 2007 Bankr. Lexis 4731 (Bankr. S.D. Tex. 2007) declined to follow the Northwestern court'fs reasoning and ruled that an ad hoc group was not a committee and therefore Rule 2019 did not apply.

Recent Case Law

Rule 2019 returned to the spotlight in several recent bankruptcy court decisions in Delaware. In Washington Mutual, Judge Mary F. Walrath followed the reasoning of Northwestern and held that because an ad hoc “group” of noteholders was in reality an “ad hoc committee,” Rule 2019 required disclosure by each committee member. Judge Walrath continued that “collective action by creditors in a class implies some obligation to other members of that class,” suggesting that even though members of an ad hoc committee or group act only for themselves, by virtue of their collective action, committee members may undertake obligations to other similarly situated creditors.

However, in Premier Int'fl Holdings, Judge Christopher S. Sontchi expressly declined to follow the reasoning of Northwestern and Washington Mutual and ruled that an ad hoc or informal committee was not a committee representing more than one creditor and therefore was not subject to the disclosure requirements of Rule 2019. Similarly, the court in In re Philadelphia Newspapers, LLC, Case No. 09-11204 (Bankr. E.D. Pa. Feb. 4, 2010) declined to require an ad hoc group of creditors to comply with the disclosure requirements of Rule 2019.

Proposed Rule 2019 Revisions

Running in parallel with recent judicial interpretations of Rule 2019, the Rules Committee has drafted and published for public comment proposed revisions to Rule 2019 (“Revised Rule 2019″), a copy of which is available at www.uscourts.gov/rules/. A public hearing was held on Feb. 5, 2010 in New York City at which, among others, Elliot Ganz of The Loan Syndications and Trading Association (the “LSTA”), Judge Robert E. Gerber, of the Bankruptcy Court for the Southern District of New York, as well as the authors of this article testified and submitted written statements.

As currently proposed, Revised Rule 2019 would broaden the disclosure requirement to apply: 1) to every “entity, group, or committee” that represents or consists of more than one creditor; and 2) upon a motion of a party in interest or on the court'fs own motion, to any entity that seeks or opposes the granting of any relief. In addition, Revised Rule 2019 broadly defines the “disclosable economic interests” that would be required to be disclosed to include a “participation, derivative instrument, or any other right or derivative right that grants the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest.” Finally, Revised Rule 2019 requires parties to disclose the date a member acquired each economic interest and, if required by a court, the price paid for such interest.

Public Hearing

The authors, along with the LSTA and several other witnesses, submitted written statements and testified at the public hearing. The thrust of the testimony was that, while the broader goals of disclosure and transparency promoted by Revised Rule 2019 are not controversial, the requirement in Revised Rule 2019 that each entity, group or committee member disclose proprietary and confidential information such as the dates of purchase, and, if required by the court, the price paid for its claims or interests is problematic and will have a significant impact on the willingness of hedge funds, institutional investors and other distressed investors to participate (or even appear) in a bankruptcy proceeding.

Although on its face, Revised Rule 2019 does not require disclosure of prices paid absent court order, Elliot Ganz testified that requiring a party to disclose “dates of purchase“ is tantamount to requiring a party to disclose the price, given the ease of determining the market price of bonds, syndicated loans or securities on any given day and the widespread availability of real time information concerning the prices bid by potential buyers, asked by potential sellers and paid in recent transactions for both bank debt and bond debt.

The bedrock principles of distressed investing are: 1) a claim in the hands of a secondary market purchaser has the same rights and disabilities as it did in the hands of the original claimant; and 2) “the price paid for a claim does not affect the amount of the creditor'fs claim, or the creditor'fs voting power.” See Fairfield Executive Associates, 161 B.R.595, 602-603 (D.N.J. 1993).

Requiring disclosure of jealously guarded pricing information and investment strategies, may lead to debtors and other creditors attempting to use pricing information when negotiating claim recoveries with secondary market debt purchasers, despite the legal principle that a claim purchased in the secondary market is the legal equivalent of an original claim. This would tend to erode the bedrock principles. Moreover, the requirement to disclose dates of purchase and, in effect, pricing information is not likely to further any public policy goals and will only serve to discourage distressed investors from participating in bankruptcy proceedings or in ad hoc committee groups.

Indeed, the overwhelming evidence to date demonstrates that Rule 2019 is not being used for its intended purpose of providing transparency and disclosure, but rather is being used as a sword or as leverage in disputes among different classes of creditors or between debtors and certain of its creditors as evidenced by the Philadelphia Newspapers, Washington Mutual, Northwest Airlines and Scotia Development cases.

Benefits of Ad Hoc Committees

Bankruptcy proceedings have greatly benefited from the participation of ad hoc committees, which: 1) allow creditors with smaller claims to join together to advance a common position in bankruptcy proceedings where it would not be economical for them to appear on their own; 2) eliminate the need for each creditor to file its own duplicative pleading and for all other constituents in the proceedings to review and respond to each individual pleading, and 3) provide debtors and other constituents with a common “address” to direct inquiries and negotiate critical business and legal issues and avoid having to conduct negotiations with important creditors on an individual basis.

Conclusion

If distressed investors retreat from active participation in bankruptcies, the benefits and efficiencies supported by ad hoc committees will markedly decrease. Moreover, recoveries for all constituencies will likely suffer if active investors — that invest in the companies they believe will emerge from bankruptcy stronger and more viable ” are less willing to invest their time, ingenuity and money and are less willing to invest in DIP loans, exit financings or backstop rights offerings. Therefore, Revised Rule 2019, if adopted as currently proposed, is likely to have a significant impact on future reorganizations.

Although the Rules Committee has not released any statement or proposed changes to Revised Rule 2019, we are hopeful that the ongoing “comment“ process will yield a Revised Rule 2019 that: 1) addresses the legitimate needs for transparency in modern bankruptcy proceedings, 2) respects the bedrock principle of distressed investing ” that a claim in the hands of a secondary purchaser is just as good as it was in the hands of the original claimant; 3) does not provide debtors with unfair negotiating leverage by directly or indirectly disclosing the price paid for a distressed claim; 4) encourages formation of ad hoc committees as an efficient driver in the modern bankruptcy process; and 5) encourages stakeholders (including distressed investors) to participate in the process.

Jon Kibbe and Michael Friedman are partners in the New York office of Richards Kibbe & Orbe LLP. Mr. Kibbe'fs practice concentrates on legal issues surrounding credit structures and credit risk in the fixed income markets. Mr. Friedman is co-head of the bankruptcy and restructuring group. He represents secured and unsecured creditors, lenders and ad hoc bondholder groups. Kibbe and Friedman testified at the Feb. 5, 2010 hearing on the proposed amendments to Bankruptcy Rule 2019. They can be reached via e-mail at [email protected] and [email protected] respectively.