In a recent contested matter in the case Home Valley Bancorp., Inc., Case No. 11-65126-fra7, pending in the US Bankruptcy Court for the District of Oregon, the Bankruptcy Court validated the vote and election of a Chapter 7 trustee candidate by a security holder where (a) the Indenture Trustee for the debt issue declined to exercise its right under the Indenture to vote for a Chapter 7 trustee, (b) the security holder acted openly and actively with respect to the election of its Chapter 7 trustee candidate, and (c) the Indenture Trustee did not object to such actions by the security holder. The Court also agreed with the Indenture Trustee’s interpretation of the Indenture and confirmed that the Indenture Trustee’s rights to file proofs and claim and vote for a trustee were rights, not obligations, and that such rights did not preclude other parties, here, a security holder meeting the threshold requirements for action under the Indenture, from filing proofs of claim and electing to vote for a Chapter 7 Trustee on its own behalf.


On October 18, 2011, an involuntary petition for relief under Chapter 7 of the United States Bankruptcy Code was filed against Home Valley Bancorp, Inc. (“Home Valley”). Home Valley did not respond to the involuntary petition; thus, on November 29, 2011, the Bankruptcy Court entered an order granting Home Valley relief under Chapter 7 of the United States Bankruptcy Code.

Prior to the commencement of the bankruptcy case, Home Valley issued Junior Subordinated Debt Securities due 2034 (the “Debentures”) in the principal amount of $5,000,000, pursuant to an indenture (the “Indenture”). The Debentures were sold to a trust (the “Trust”) in accordance with the terms of a trust declaration (the “Trust Declaration”) to which Home Valley served as sponsor. The Trust then sold capital securities (the “Capital Securities”) to the public, with the interest payments on the Debentures passing through the Trust to the holders of the Capital Securities. Home Valley guaranteed all payments owed to the holders of the Capital Securities pursuant to a separate guarantee agreement (the “Guarantee,” together with the Indenture and Trust Declaration, the “Trust Documents”).

Home Valley’s bankruptcy case constituted an event of default pursuant to the Trust Documents; thus, the Debentures accelerated and became immediately due and payable. In accordance with the Trust Documents and commonly accepted practice, the indenture trustee (the “Indenture Trustee”) filed proofs of claim for principal and interest due under the Trust Documents, as well as claims for unliquidated fees and expenses. In addition, the owner of 100 percent of the Capital Securities (the “Holder”) filed its own proof of claim for the unpaid and outstanding principal and interest owed under the Trust Documents.

The Disputed Chapter 7 Trustee Election

After entry of the order for relief, Joseph M. Charter (“Charter”), was appointed as the interim Chapter 7 Trustee. At the meeting of creditors required by Section 341 of the Bankruptcy Code, the Holder, through its agent, sought to elect Michael Stephenson (“Stephenson”) as the Chapter 7 trustee and replace Charter in that role. The United States Trustee (the “UST”), unclear of the Holder’s standing and unsure what to do with its vote, filed the Report of Disputed Chapter 7 Election Based on 11 U.S.C. Section 702 and Fed. R. Bankr. P. 2003(d)(2) (the “Disputed Election Report”). In response to the Disputed Election Report, the Holder filed a motion to resolve the Disputed Election Report, requesting that the Bankruptcy Court resolve the disputed election and enter an order appointing Stephenson. Thereafter, Charter filed a response, primarily arguing there were significant questions regarding the Holder’s standing to elect a Chapter 7 trustee and the qualifications of Stephenson to serve as the Chapter 7 trustee in the case. Subsequent pleadings on this matter were filed addressing these issues.

Section 702 of the Bankruptcy Code

Promptly after an order for relief is entered, the UST must appoint one disinterested member of a panel of private trustees to serve as interim trustee. An interim trustee’s service thereafter terminates when a trustee is elected pursuant to Section 702 of the Bankruptcy Code. If no such election occurs, then the interim trustee continues to serve.

Pursuant to Section 702 of the Bankruptcy Code, the election process requires (a) that a requisite percentage of creditors eligible to vote must first request an election and (b) such creditors must cast sufficient ballots to elect a proposed trustee candidate. At the creditors’ meeting an election may be requested by creditors eligible to vote under Section 702(a) holding at least twenty percent (20 percent) of eligible claims. Section 702 of the Bankruptcy Code defines a creditor eligible to participate in a trustee election (and therefore those eligible to request an election) as (a) holding an allowable, undisputed, fixed, liquidated, unsecured claim that is not entitled to priority, (b) not an insider, and (c) does not have an interest materially adverse to other creditors.

If a trustee election is properly requested, then during the election, at least 20 percent of eligible creditors must vote. If the requisite percentage of creditors holding qualifying claims vote, a trustee is elected if a majority of such creditors vote for the candidate.

Finally, Rule 2003(b) of the Federal Rule of Bankruptcy Procedure provides that a creditor may vote at a meeting of creditors if, at or before such meeting, the creditor filed a proof of claim or other writing setting forth facts supporting its right to vote.

The Bankruptcy Court’s Ruling

The Bankruptcy Court ruled that the Holder’s vote of Stephenson to serve as Chapter 7 trustee was valid and confirmed the election of Stephenson.

In making its ruling, the Bankruptcy Court examined the language of the Indenture to determine whether the Holder had sufficient standing to vote for an election of the Trustee. Specifically, the Indenture contained language empowering and permitting the Indenture Trustee to take action with respect to a bankruptcy proceeding, including the right to file proofs of claim and to vote on behalf of holders of the Debentures in any election of a trustee. The Indenture also contained language prohibiting the Indenture Trustee from voting on a plan and binding holders to such plan. The Indenture was silent, however, on what rights holders of the Capital Securities had to act in the event the Indenture Trustee elected to not exercise its right under the Indenture to vote for a trustee. The Indenture also did not contain language precluding holders of the Capital Securities from filing proofs of claim.

Counsel for Charter attempted to argue that the Indenture Trustee was the sole party authorized under the Indenture to act on behalf of holders of the Capital Securities, including to vote and to file proofs of claim. Since here, the Indenture Trustee elected not to exercise its right to vote for a trustee, counsel for Charter argued such right was exclusive and non-delegable and that no other party, including the Holder, had such right.

Counsel for the Indenture Trustee argued that although the Indenture provided the Indenture Trustee with the right to file proofs of claim and to vote for a trustee, such right did not preclude other parties from doing so. Counsel for the Indenture Trustee explained the general accepted practice and rationale behind indenture trustees filing proofs of claim on behalf of bondholders, as distributions to bondholders must always be administered by the trustees. Counsel for the Indenture Trustee also wanted to make clear for the record that the right to elect a trustee was simply a right -- and not an obligation -- as the latter would have the affect of requiring the Indenture Trustee to act when the Indenture did not contain such a requirement. The decision to exercise such right remains with the Indenture Trustee and is within the sound discretion of the Indenture Trustee, whose standard of care is governed by Indenture.

The Bankruptcy Court ruled that the Holder’s vote for Stephenson was valid in accordance with the Bankruptcy Code’s provisions on the election of a trustee, one that reflects a Congressional policy that the liquidation and distribution of a Chapter 7 estate is ultimately for the creditors and such creditors should have a clear and effective voice in selecting a trustee who will carry out this process. The Court also found that the Holder was permitted to vote under the Indenture once it was clear the Indenture Trustee declined to exercise such right. The Court appeared to be persuaded by the facts that (a) the Holder held 100 percent of the underlying debt and (b) the Indenture Trustee was aware that the Holder was actively asserting itself by casting its vote to elect a trustee and did not object. For these reasons, the Court upheld the election of the Holder’s Chapter 7 trustee candidate.