Letter to the Advisory Committee on Bankruptcy Rules re: Proposed Amendment to R

January 29, 2010

Advisory Committee on Bankruptcy Rules c/o Peter G. McCabe, Secretary
Committee on Rules of Practice and procedure
Administrative Office of the United States Courts
Washington, DC 20544

To the Members of the Advisory Committee:

I write on behalf of the National Bankruptcy Conference (the “Conference”) to express the views of the Conference regarding the proposed amendment of Rule 2019 of the Federal Rules of Bankruptcy Procedure.¹ I have attached a description of the Conference as Appendix “A”. At the outset, the Conference would like to commend the Advisory Committee for what is clearly a thoughtful and well-considered revision of Rule 2019 that is far more compatible with current economic realities, and provides far more transparency in the reorganization process, than Rule 2019 in its current form.

This is not the first time that the Conference has written to the Advisory Committee regarding potential amendments to Rule 2019. By letters dated September 22 and December 10, 2008, copies of which are attached as Appendix “B”, the Conference opposed the request of certain trade associations that Rule 2019 be repealed and recommended that Rule 2019 be broadened in a number of respects to increase disclosure and transparency in the chapter 11 process.

The proposed amendment of Rule 2019 mirrors the Conference’s recommendations in many respects. The proposed amendment does, however, depart from the Conference’s recommendations on a number of material points. Nevertheless, on balance, the Conference supports the adoption of the proposed amendment (but suggests the changes outlined below), based on the Conference’s view that the proposed amendment represents a material improvement in disclosure and transparency over Rule 2019 in its current form.

The Conference would, however, like to raise three issues that are implicated by the proposed amendment, as to which the Conference believes that further clarification or modification is necessary. Though we hope that implementation of clarifications or modifications based on these suggestions does not delay the adoption of the proposed amendment to Rule 2019, we nevertheless believe that the importance of these suggestions outweighs the potential cost of a one-year delay in the implementation of the amendment.

I. Limiting the Overbroad Application of Rule 2019 to Require Law Firms’ Disclosure of Client Information in Certain Circumstances.

The Rule as proposed to be amended would impose on each “entity . . . that . . . represents more than one creditor or equity holder,” the obligation to disclose certain information, including economic holdings, as to each creditor or equity holder that is “represented.” Without some clarification or modification, this language could be read in an overly broad fashion to require a law firm that is retained concurrently by more than one client with respect to a bankruptcy case to disclose the firm’s retention by, and the “disclosable economic interest” of, every one of the clients, including: (i) a client that has separately retained the law firm and is not acting in concert with any other client of the law firm to advance a common interest; and (ii) a client on whose behalf the law firm does not appear in court to seek or oppose the granting of relief. The Conference believes that the application of Rule 2019 to require disclosure by law firms as to clients who fall into either of these categories is unwarranted. If a client of the firm is not acting in concert with other clients, the client should be subject only to discretionary (in the court’s discretion) disclosure under subdivision (b) as an “entity that seeks or opposes the granting of relief,” rather than subjecting the law firm to the mandatory disclosure imposed on an “entity . . . that . . . represents more than one creditor or equity holder.” Moreover, the law firm should not be required to make any disclosure as to a client on whose behalf the firm does not seek or oppose the granting of relief. Requiring Rule 2019 disclosure with respect to a client by a law firm in either of these circumstances places an undue burden on the law firm and the client and creates ethical problems for the law firm, without any corresponding benefit to the reorganization process.

To illustrate the point, two or more clients with a common interest may jointly retain a law firm to advise them on issues relating to a chapter 11 case (for example, so that they can determine whether to buy or sell certain debt, or whether to object or not to object to certain motions), without appearing in court to seek or oppose the granting of relief. There is simply no reason to require the public disclosure of the holdings of creditors or equity holders who elect to play a passive role in a case but seek advice from the same counsel (and even share costs), simply because they happen to use the same counsel.

In a similar vein, two or more existing clients of a law firm (e.g., a landlord and a trade creditor) may each separately engage the law firm to advise them with respect to a particular chapter 11 case (possibly for unrelated matters) without electing to appear and be heard in the case; and the law firm may even set up an “ethical wall” so that the attorneys advising one of the clients do not advise the others or share information about the case with attorneys on the other “side” of the “wall.” In such a situation, there is no interest to be served by requiring the law firm to disclose the respective holdings of the separate clients.

Even if one of the two clients in this illustration does elect to appear and take positions in court and subject itself to the court’s discretionary power under subdivision (b) to impose the disclosure requirements of the proposed rule on a creditor who elects to seek or oppose the granting of relief in court, there is still no reason to require the law firm to disclose publicly its retention by, or holdings of, the other client who does not so appear.

The broad application of the proposed amendment to the circumstances in these illustrations can create awkward ethical problems for a law firm with multiple clients. An entity that retains a law firm to advise it in connection with a chapter 11 case, but elects not to appear in that case, may not want the law firm to disclose publicly the fact of the retention or the client’s interest in the case—let alone client holdings, which are disclosed to the law firm in confidence. Forcing a law firm to disclose its representation of such a client (and its holdings)—when the client has elected not to appear in court and thereby publicize its involvement in the case—essentially forces the law firm to disclose a client confidence, over the objection of the client. In theory, this problem might be resolved by law firms not representing more than one of their clients in any particular chapter 11 case (even with the informed consent of both clients); however, such a Hobson’s choice (i.e., the creditor must either retain counsel other than its first choice of counsel, or be forced to disclose the creditor’s holdings even though it does not elect to appear in the case) seems to be an unwarranted intrusion on a client’s right to counsel of its choice and client confidentiality— an intrusion that is not offset by any countervailing benefit to the reorganization process.

Moreover, in large chapter 11 cases, a single law firm may represent a number of unaffiliated clients as a matter of necessity, since most, if not all, business bankruptcy practitioners within the jurisdiction may already have positions in the case. This may be particularly true in less populated judicial districts, but can be the case in any judicial district. There is no basis under these circumstances to require Rule 2019 disclosures, when identically situated clients that hired different law firms are not required to do so.

Finally, there are also instances in which a law firm may represent two related entities that should be treated as a single client for purposes of Rule 2019. For example, a husband and wife, or parent company and its subsidiary, may jointly hold claims against a chapter 11 debtor and hire a single law firm to represent them. There is no reason why these creditors and their counsel should be subject to broader disclosure requirements than a single, similarly situated creditor. Joint representation by affiliated entities does not raise any of the concerns that traditionally have supported Rule 2019 disclosures.

The Conference recommends three modifications to proposed amendment to address the problems highlighted by the foregoing illustrations. These changes are reflected in the accompanying blackline included as Appendix “C”.

First, the proposed amendment should be augmented by language to the effect that for purposes of the Rule, an attorney is deemed to “represent” a creditor or equity holder only if the attorney seeks or opposes the granting of relief on behalf and in the name of such creditor or equity holder. In other words, a law firm does not “represent” a creditor or equity holder for purposes of this rule unless it seeks or opposes the granting of relief on behalf of the creditor or equity holder. This would be accomplished by adding a new definition of “represent” in subdivision (a).

Second, the Conference recommends that an exception to the disclosure requirements be included for joint representations of affiliates or insiders. This would be accomplished by adding language to this effect in subdivision (b).

Third, the proposed Committee Note to amended Rule 2019 recognizes that the principal purpose of the rule is to address entities “that are acting in concert to advance common interests.” The Conference agrees and accordingly recommends that the proposed amendment make clear that those entities that are not “acting in concert” and that do not act to “advance common interests” should not be subject to the Rule, unless the Court specifically so orders under subdivision (b) as to an entity that seeks or opposes the granting of relief. This would also be accomplished by adding “acting in concert” language to subdivision (b).

II. Refining the Application of Rule 2019 To Indenture Trustees and Agent Banks

As now written, the proposed amendment to Rule 2019 could be read to require: (i) every indenture trustee to disclose the “disclosable economic interest” of every holder of bonds issued under the applicable indenture; and (ii) every agent bank or other creditor agent (referred to collectively as “agent”) to disclose the “disclosable economic interest” of every holder of debt under the applicable credit agreement. In the case of indenture trustees, subdivision (c)(3) of the proposed amendment provides that the verified statement required under Rule 2019 “shall include,” among other information, “if not disclosed under subdivision (c)(1) or (c)(2), with respect to each creditor or equity security holder represented by the . . . indenture trustee,” the listed information which follows (emphasis added). Thus, while it is not clear to the Conference that such a result was intended, the proposed amendment could be read to require indenture trustees to list all of the holdings of individual bondholders whom the indenture trustee is deemed to “represent,” for no reason other than that the bonds were issued under an indenture.

The proposed amendment to Rule 2019 might also be read to require (again, perhaps inadvertently) that every agent in a bankruptcy case, as an “entity” that arguably “represents more than one creditor,” i.e., every holder of debt under the applicable credit agreement, disclose the individual economic positions of each holder of claims under the credit agreement (and provide constant updates), whether or not any individual bank debt holder is acting collectively with other holders or elects to seek or oppose relief in court. The Conference can discern no reason to require such public disclosure with respect to holders of debt under a credit agreement simply on the basis that there is an agent, without more.

Reading the proposed amendment to impose such a requirement on agents is not the only plausible interpretation of subdivision (b): It is arguable that, because individual lenders are free to be adverse to the agent, and the agent is not really an “agent” in a traditional sense, an agent does not “represent” each holder of claims under the applicable creditor facility, as the term “represents” is used in Rule 2019. However, if the latter interpretation is intended, then the language of the Rule should be clarified to avoid an unintended interpretation of subdivision (b) that would require public disclosure of the holdings of every lender under a credit facility with an agent, simply because there is an agent.

In any event, there is no policy reason to require an indenture trustee or agent to disclose the holdings of every individual bondholder under an indenture or holder of debt under a credit agreement, simply because the debt issuance involves an indenture trustee or agent. To avoid such an interpretation of amended Rule 2019, the Conference recommends the following changes, which are reflected in the blackline included in Appendix “C”: (i) the phrase “or by the indenture trustee” at the end of the introductory paragraph of subdivision (c)(3), immediately preceding clause (A), should be deleted; and (ii) clarifying language should be added, either to the Committee Note, or to the text of the proposed amendment itself, to the effect that an agent will not be deemed to “represent” holders of debt under the applicable credit agreement. To be clear, if the agent and certain holders of bank debt become part of a “group” that is acting in concert to advance common interests (for example, by forming a bank steering committee), the disclosure requirements for Rule 2019 would still apply—but this would occur, not because the agent “represents” any other lender, but because the agent and certain lenders have formed a “group.”

The Conference also believes, however, that an agent that seeks or opposes the granting of relief from the court, or takes any position before the court with respect to a request for, or opposition to, the granting of relief, should be required to make the disclosures set forth in subdivision (c) (in lieu of making such disclosures simply discretionary with the court, as contemplated under proposed subdivision (b) with respect to “an entity that seeks or opposes the granting of relief”). This is because when an agent appears in court, it is viewed (rightly or wrongly) as speaking not merely for its own individual interest as a creditor, but in the interest of holders of debt under the applicable credit agreement. Accordingly, an agent that seeks or opposes relief from the court should be required to make disclosure under Rule 2019, without the need for case by case litigation, so that other lenders in whose interest the agent may purport to speak and the court are aware of the agent’s actual economic interest. (In contrast, if an agent chooses to remain passive and not appear in court, the Conference sees no reason to require disclosure under Rule 2019 where the agent has not become part of a “group” or “committee”). To accomplish the foregoing, the Conference recommends that the following language be added to subdivision

• (b)
  (as reflected in the accompanying blackline): “, every agent that seeks or opposes the granting of relief, or takes any position before the court with respect to a request for, or opposition to, the granting of relief . . .”

III. Disclosure of Purchase Price/Date of Purchase Information.

The third issue which the Conference would like to raise relates to the disclosure of purchase price and date of purchase information. In its December 10, 2008 letter, the Conference recommended that disclosure of purchase price information and date of purchase be required only of members of ad hoc or unofficial committees² or groups (however denominated) and individual creditors or equity holders that claim to be representative of (or to speak on behalf of) claims or interests similar to those represented on the committee or group or held by the individual. The Conference saw no need to require the disclosure of purchase price or date of purchase information from individual creditors or creditor groups that do not purport to speak for or on behalf of others. Further, because purchase price information can often be extrapolated from the date of purchase (at least by parties who are active in the distressed debt market),³ the Conference recommended against requiring the disclosure of date of purchase information from any creditor or “group” that was not also required to disclose purchase price information.

The proposed amendment of Rule 2019 differs from the Conference’s recommendation in two important respects. First, it would expressly empower the court to order the disclosure of purchase price information from any creditor, equity holder or “group” that is covered by Rule 2019, without limitation. The Conference recommends against including such a broad power to order the disclosure of purchase price information in Rule 2019, because such a provision would encourage collateral litigation over the disclosure of purchase price information in cases when it is irrelevant to any issue before the court and lend itself to abuse by parties seeking to use the threat that a creditor or “group” will be forced to disclose the purchase price paid for its claims as leverage to pressure the targeted creditors toward some desired end, without any benefit to the reorganization process.

To place the Conference’s concern in context, the bankruptcy court already has the power to order the disclosure of purchase price information when it is actually relevant to an issue that is before the court. For example, if a fiduciary is alleged to have purchased claims in violation of its fiduciary duties, the court has the power, in the course of related litigation, to order disclosure of relevant information, including purchase price. Because the court already has the power under existing discovery rules to order the disclosure of such information when it is relevant to an issue before the court, the addition to Rule 2019 of a provision that expressly authorizes the court to compel the disclosure of purchase price information from all parties who are subject to Rule 2019 could easily be read to mean something more—i.e., that the court can order the disclosure of purchase price information from any entity that is subject to Rule 2019 even if such information is irrelevant to any issue before the court. Otherwise, why add this provision to the Rule? There is nothing in the language of the proposed amendment or the Committee Note to negate such a broad interpretation. As a result, bankruptcy courts could become embroiled in collateral litigation over whether the disclosure of purchase price information should be required, in situations where that information is otherwise irrelevant to any issue before the court. The Conference can discern no benefit to the reorganization process that would result from broadly inviting such tactically-motivated litigation.

Second, the purposed amendment would require the disclosure of date of purchase information even where the disclosure of the purchase price itself is not required by the Rule or the court. In many cases, however, requiring the disclosure of the date of purchase is tantamount to requiring the disclosure of the purchase price, because the purchase price can often be derived (at least by sophisticated market participants and their counsel) from the date of purchase. Thus, making the disclosure of purchase date information mandatory makes the “discretionary” nature of the court’s power to order the disclosure of purchase price information illusory.

To the extent that it is important to know the period of time during which the disclosable economic interests were acquired, Rule 2019 can require the disclosure of such more general information, without requiring further specificity as to the date of purchase. Beyond this point, Rule 2019 should not make the disclosure of date of purchase information for each specific purchase mandatory. This is not to say that the bankruptcy court should not have the power to order the disclosure of more specific date of purchase information when it is be relevant to an issue before the court; rather, it is simply that a “one size fits all” rule that requires such disclosure in every case is unnecessary and unwarranted.

Accordingly, the Conference recommends that the inclusion in the proposed amendment to Rule 2019 of an express grant of power to the court to order the disclosure of purchase price information be limited to individual holders of “disclosable economic interests” and “groups” or “committees” that claim to act on behalf or in the interest of a larger group of creditors or equity holders. The Committee Note should further clarify that the Rule does not affect any power of the court under existing law to order such disclosure by other creditors, equity holders, committees or groups. The disclosure of date of purchase information should be mandatory only to the extent of requiring the disclosure of the general period of time during which the disclosable economic interests were acquired. However, the court should also be authorized, in its discretion, to order the disclosure of more specific date of purchase information from creditors, equity holders, “groups” and “committees” that claim to act on behalf or in the interests of a larger group.

Granting the court the discretion to direct the disclosure of purchase price information by this narrower group of parties is consistent with one of the major purposes of Rule 2019 (and its predecessors)—to require transparency on the part of committees and similar creditor and equity holder groups that purport to represent the interests of a class, and not just to speak for the interests of individual stakeholders who jointly retain counsel. Once a group of creditors or equity holders elects to seek greater credibility by portraying themselves as an “ad hoc committee” that is looking out for the economic interests of a class of claims or interests, rather than merely the parochial interests of individual members, greater transparency on their part is appropriate because of the greater credibility and influence they seek by acting as a “committee.” The same can be said for individual stakeholders who claim to be looking out for the interests of those similarly situated. Cf. In re Northwest Airlines, 363 B.R. 704. 707 (Bankr. S.D.N.Y. 2007) (noting that Rule 2019 “requires unofficial committees that play a significant public role in reorganization proceedings and enjoy a level of credibility and influence consonant with group status to file a statement containing certain information”) (emphasis added). As explained by the Bankruptcy Court in Northwest Airlines:

Ad hoc or official committees play an important role in reorganization cases. By appearing as a “committee” of shareholders, the members purport to speak for a group and implicitly ask the court and other parties to give their positions a degree of credibility appropriate to a unified group with large holdings. Moreover, the Bankruptcy Code specifically provides for the possibility of the grant of compensation to “a committee representing creditors or equity security holders other than a committee appointed under section 1102 of this title [an official committee], in making a substantial contribution in a case under chapter 9 or 11 of this title.” 11 U.S.C. § 503(b)(3)(D). A committee purporting to speak for a group obviously has a better chance of meeting the “substantial contribution” test than an individual, as a single creditor or shareholder is often met with the argument that it was merely acting in its own self-interest and was not making a “substantial contribution” for purposes of § 503(b)(3) . . . In re Northwest Airlines, 363 B.R. at 703 (citations omitted). When “ad hoc” and “unofficial” committees or other “groups” seek greater credibility and influence by styling themselves as such and claiming to act for the benefit of a larger group, it is appropriate to empower the court to require greater disclosure of the actual economic interest of their members in and relating to the debtor, so that the court and parties in interest can understand their motives and verify whether their economic interests are aligned with those of the larger group for whom they purport to speak: [T]he other [stakeholders] have a right to information as to Committee member purchases and sales so that they can make an informed decision whether this Committee will represent their interests or whether they should consider forming a more broadly-based committee of their own. It also gives all parties a better ability to gauge the credibility of an important group that has chosen to appear in a bankruptcy case and play a major role. Id. At 709. In contrast, the Conference does not believe that specific purchase date or purchase price information is an appropriate subject of inquiry where creditors, equity holders, “committees” and “groups” do not claim to be acting for the benefit of a larger class; in such a situation, the disclosure of specific purchase date and purchase price information should be limited to situations where it would otherwise be discoverable under some other applicable rule or principle.

To facilitate the Advisory Committee’s consideration of these recommendations, attached as Appendix “C” is a blackline of the proposed amendment and the accompanying Committee Note that reflects their incorporation. The Conference appreciates your consideration of our views.

Very truly yours,
/s/ Isaac M. Pachulski
Isaac M. Pachulski
Vice Chair
Chapter 11 Committee
(310) 228-5655

ipachulski@stutman.com

National Bankruptcy Conference

A non-profit, non-partisan, self-supporting organization of approximately sixty lawyers, law professors and bankruptcy judges who are leading scholars and practitioners in the field of bankruptcy law. Its primary purpose is to advise Congress on the operation of bankruptcy and related laws and any proposed changes to those laws.

History. The National Bankruptcy Conference (NBC) was formed from a nucleus of the nation’s leading bankruptcy scholars and practitioners, who gathered informally in the 1930’s at the request of Congress to assist in the drafting of major Depression-era bankruptcy law amendments, ultimately resulting in the Chandler Act of 1938. The NBC was formalized in the 1940’s and has been a resource to Congress on every significant piece of bankruptcy legislation since that time. Members of the NBC formed the core of the Commission on the Bankruptcy Laws of the United States, which in 1973 proposed the overhaul of our bankruptcy laws that led to enactment of the Bankruptcy Code in 1978, and were heavily involved in the work of the National Bankruptcy Review Commission (NBRC), whose 1997 report initiated the process that led to significant amendments to the Bankruptcy Code in 2005.

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