Several recent bankruptcy decisions rendered in the Third Circuit address whether the disclosure requirements of Rule 2019 of the Federal Rules of Bankruptcy Procedure apply to informal or “ad hoc” committees.1 Although these courts base their reasoning on the “plain meaning” of Rule 2019, their ultimate holdings are inconsistent and have generated renewed interest in this topic among lenders and the investing community. This article provides a brief summary of these recent decisions and examines their inconsistencies.
Overview of Bankruptcy Rule 2019
Bankruptcy Rule 2019 requires certain disclosures by “every entity or committee representing more than one creditor or equity security holder . . . .”2 Specifically, Rule 2019 requires these entities to disclose “amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.”3
In one of the most-cited decisions interpreting Rule 2019, Judge Allen L. Gropper of the United States Bankruptcy Court for the Southern District of New York held, in the Northwest Airlines bankruptcy case, that an ad hoc committee of equity security holders was required to comply with the disclosure requirements of Rule 2019.4 In that case, counsel to the ad hoc equity committee filed a statement with the court pursuant to Rule 2019 that only disclosed the firm’s individual interests in the debtors’ estates.5 On motion, the debtors argued that the 2019 statement was insufficient for failing to disclose the committee members’ individual interests.6 In response, the ad hoc equity committee argued that because no member of the committee represented any member other than itself, the information sought by the debtors was not required.7 The court disagreed and held that Rule 2019 applied to the ad hoc equity committee.8
In so holding, the court noted that during the case, the committee filed a notice of appearance as a “committee,” referred to itself as the “Ad Hoc Committee,” and retained counsel to represent the committee’s interests.9 The court further reasoned that based on legislative history and prior case law, Rule 2019 “‘appropriately seems to apply to the formal organization of a group of creditors holding similar claims, who have elected to consolidate their collection efforts . . . .’”10
Notably, subsequent to the Northwest decision, the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States has proposed amendments to Rule 2019 that would require disclosure by all groups or committees that consist of more than one creditor or equity holder and the representatives of such groups or committees.11 The amendments, if approved, would require disclosure of every economic interest that could affect a stakeholder’s position in a bankruptcy case, and would authorize courts to order disclosure by an individual if that individual’s stake in the debtor would aid in the court’s assessment of that party’s arguments.12
Recent Decisions in the Third Circuit
In re Washington Mu, Inc. (“WaMu”)
On December 2, 2009, the Delaware bankruptcy court citing the Northwest decision, held that a noteholders’ group was required to comply with Rule 2019 and disclose its members’ interests. 13 In WaMu, JP Morgan Chase, the prepetition purchaser of substantially all of the debtor’s assets, moved to compel the noteholders’ group to comply with Rule 2019.14 In opposing the motion, the noteholders’ group argued that Rule 2019 did not apply to it because it was simply a “loose affiliation of creditors . . . sharing the cost of advisory services” and not a committee.15
Judge Mary Walrath rejected this argument and found, based upon her plain reading of Rule 2019, that the noteholders’ group was by all accounts the same type of group as the ad hoc committee in Northwest.16 The WaMu court also found that the noteholders’ group constituted an “entity representing more than one creditor” for purposes of Rule 2019 based on the definitions of “entity” (“‘an organization . . . that has a legal identity apart from its members’”), 17 “representative” (“‘[o]ne who stands for or acts on behalf of another’”)18 and “represent” (“to take the place of in some respect [or] to act in the place of or for usually by legal right”) in Black’s Law Dictionary and Merriam- Webster’s Collegiate Dictionary.19 The court held that the noteholders’ group was certainly an organization with an identity apart from its individual members, which, through counsel, made appearances and filings representing the constituent members.20
Although the WaMu court based its decision on the plain meaning of Rule 2019, it reasoned that the legislative history of the Rule supported its decision as well.21 The noteholders’ group had argued that Rule 2019, in its initial form, was enacted solely to combat the abuse of deposit agreements by unofficial, protective committees in equity receiverships, the vehicles used for corporate reorganizations prior to chapter X’s enactment.22 These agreements involved creditors, most commonly bondholders, depositing their securities or interests with the protective committee in exchange for the committee’s representation during the debtor’s reorganization.23 Examining Rule 2019’s legislative history, the court found that although deposit agreements were one of the evils the Rule was intended to remedy, “[t]he predecessor of Rule 2019 was designed to ‘provide a routine method of advising the court and all parties in interest of the actual economic interest of all persons participating in the proceedings.’”24 The court also cited its concern that “[t]he proliferation of short-selling and the advent of myriad derivative products now allow creditors to take multiple stakes in the capital structure of debtors,” which “have the potential to create complex, conflicting incentives for large creditors.” 25 In this context, the court suggested that “members of a class of creditors may, in fact, owe fiduciary duties to other members of the class,” thus justifying disclosure.26 Lastly, the court added that the proposed amendments to Rule 2019 confirmed the court’s expansive reading of the Rule.27
In re Premier Int’l Holdings, Inc. (“Six Flags”)
One month later, Judge Christopher Sontchi of the United State Bankruptcy Court for the District of Delaware declined to follow the Northwest and WaMu decisions and held that a noteholders’ committee in the Six Flags bankruptcy case did not have to disclose its members’ interests pursuant to Rule 2019.28 In Six Flags, the official unsecured creditors’ committee moved to require a noteholders’ committee to comply with Rule 2019.29 The court determined that the noteholders’ committee was not a “committee,” which, although not defined in the Bankruptcy Code or Bankruptcy Rules, is defined in the Oxford Shorter English Dictionary to include a “‘body of two or more people appointed for some special function by, and usually out of a (usually larger) body.’”30 Thus, because the self-appointed noteholders’ committee did not represent any larger group other than its own members, it could not constitute a committee under the court’s plain reading of the term.31 Similarly, the court found that the noteholders’ committee did not “represent” more than one creditor because that term, as defined in the Oxford Shorter English Dictionary, requires “an active appointment of an agent to assert” assigned rights, which Judge Sontchi determined not to be the case.32
The Six Flags court also engaged in a lengthy review of Rule 2019’s legislative history and determined that ad hoc committees, as they exist today, are completely different from the protective committees that Rule 2019’s predecessor was designed to regulate.33 Moreover, the court reasoned that Rule 2019 has been rendered “superfluous” because other sections of the Bankruptcy Code, such as Section 1121 (the debtor’s exclusive right to propose and solicit a reorganization plan) and Section 1123 (the requirement that claims and interests only be classified under a chapter 11 plan with substantially similar claims), work to curb the influence of creditor or equity holder committees in bankruptcy cases.34 The court added that “there is nothing neither nefarious nor problematic, in and of itself, in disparate parties banding together to increase their leverage. Indeed, enabling such is one of the primary rationales for the existence of the Bankruptcy Code.”35
Notably, the court viewed the official committee’s motion as a litigation tactic and an “end run” around a previous order by the court denying the official committee’s request for discovery of the same information, a conclusion supported by the official committee’s failure to move for disclosure by a separate ad hoc committee of noteholders that was allied with the official committee.36 The court also discounted the import of pending amendments to Rule 2019, stating that the existence of a proposed amendment “is of no moment with regard to whether the rule applies in the first place.”37
In re Philadelphia Newspapers, LLC
Most recently, on February 4, 2010, Judge Stephen Raslavich of the United States Bankruptcy Court for the Eastern District of Pennsylvania encountered an identical issue in In re Philadelphia Newspapers 38 and followed the logic of Six Flags. In Philadelphia Newspapers, the debtors moved to have the steering group of prepetition lenders, with whom the debtors had engaged in extensive and highly contentious litigation throughout the chapter 11 cases, comply with Rule 2019.39 In addition, the debtors argued that absent the steering group’s compliance, the court should preclude the steering group from further participation in the chapter 11 cases.40
Judge Raslavich also began his analysis by examining the plain meaning of Rule 2019.41 Relying on Black’s Law Dictionary, the court found that the steering group did not constitute an “entity” because it had no legal identity apart from its members.42 The court noted that the steering group did not represent any creditors other than its members, no document existed authorizing the group to act on behalf of non-member creditors, and its members, who could join and withdraw on their own accord, were not bound by any decisions of the majority of the group.43 The court also held that the group was not a “committee” because it was self-appointed and not appointed by a larger body.44 The court agreed with the Six Flags court that “representing more than one creditor” requires active appointment as agent for that creditor and the steering group instead had been self-appointed.45
The court found further support for its decision in the proposed amendments expanding the scope of Rule 2019, which Judge Sontchi in Six Flags found unpersuasive.46 Indeed, the court observed that “it is logical to infer that if the rule already covered the [s]teering [g]roup, there would be no need to expand the rule to do so.”47
The WaMu, Six Flags and Philadelphia Newspapers decisions demonstrate the evolving nature of case law concerning the applicability of Rule 2019. While Rule 2019 was not controversial (or regularly enforced) until relatively recently, Rule 2019 is now frequently raised by parties seeking to use the threat of compliance with Rule 2019 as a strategic tool in bankruptcy negotiations. However, courts have reached varying and, in the case of the decisions discussed in this article, conflicting conclusions on the applicability of the Rule. Thus, analysis of the Rule is mostly fact- and case-specific, and there exists little certainty as to how courts that have not yet addressed the issue will interpret Rule 2019 in the future.
In addition to this present uncertainty, it is also not clear how Rule 2019 might be modified going forward. On February 5, 2010, the Advisory Committee on Bankruptcy Rules considered testimony from various sources with respect to proposed modifications to the Rule. Although the new form of Rule 2019 is not yet known, any revisions will hopefully serve to clarify the circumstances under which creditors that have banded together in a bankruptcy case will be required to disclose their individual positions. These potential changes could have a profound impact on the involvement of ad hoc committees and other informal groups in bankruptcy cases, and thus should be closely monitored.
A bankruptcy court’s potential interpretation of the scope of Rule 2019 may affect the collective decision of similarly situated creditors and equity holders to participate as an ad hoc group in a bankruptcy case. Although appearing as a committee or group can create additional leverage when negotiating with the debtor and other constituents, participation in such a group may require the disclosure of sensitive, and perhaps confidential, information. Unfortunately, the three recent decisions from courts in the Third Circuit have created considerable uncertainty as to what entities are required to comply with the disclosure requirements of Rule 2019. The Six Flags and Philadelphia Newspapers decisions are currently on appeal, and hopefully the respective appellate courts will provide more clarity on this contentious issue. Moreover, if Congress acts on the proposed amendments to Rule 2019, much of the uncertainty regarding the scope of Rule 2019 may be resolved.