Recently, in In re Northwest Airlines Corp.,1 Bankruptcy Judge Allan Gropper issued an opinion requiring a group of hedge funds that had formed an ad hoc committee of equity security holders (the “Ad Hoc Equity Committee”) to disclose “the amounts of claims or interests owned by the members of the committee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof” in order to comply with Rule 2019 of the Federal Rules of Bankruptcy Procedure (the “Bankruptcy Rules”).

Background

On January 11, 2007, approximately sixteen months after the Chapter 11 petition was filed, Kasowitz, Benson, Torres & Friedman LLP (“KBT&F”) filed a notice of appearance on behalf of “the Ad Hoc Committee of Equity Security Holders.” Shortly thereafter, KBT&F filed the “Verified Statement of Kasowitz, Benson, Torres & Friedman LLP Pursuant to Bankruptcy Rule 2019(a)” (the “2019 Statement”). The 2019 Statement identified the eleven (11) members of the Ad Hoc Equity Committee and disclosed that, “[t]he members of the Ad Hoc Equity Committee own, in the aggregate, 16,195,200 shares of common stock of Northwest and claims against the Debtors in the aggregate amount of $164.7 million.”2 The 2019 Statement also disclosed that KBT&F has been retained as counsel to the Ad Hoc Equity Committee, that KBT&F did not own any claims against or interests in the Debtors and that the members of the Ad Hoc Equity Committee were responsible for the firm’s fees “subject to their right to have the Debtors reimburse KBT&F’s fees and disbursements and other expenses by order of the Court.”3 By an amendment to the 2019 Statement, KBT&F later disclosed that there were thirteen (13) Ad Hoc Equity Committee members with an aggregate of “19,065,644 shares of common stock of Northwest and claims against the debtors in the aggregate amount of $264,287,500.”4

The debtor filed a motion to compel the individual members of the Ad Hoc Equity Committee to disclose information in compliance with Bankruptcy Rule 2019. Rule 2019(a) provides, in relevant part:

In a Chapter 9 municipality or Chapter 11 reorganization case, except with respect to a committee appointed pursuant to §1102 or 1114 of the Code, every entity or committee representing more than one creditor or equity security holder...shall file a verified statement setting forth

(1) the name and address of the creditor or equity security holder;

(2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition;

(3) ...in the case of a committee, the name or names of the entity or entities at whose instance, directly or indirectly, the employment was arranged or the committee was organized or agreed to act; and

(4) with reference to the time of...the organization or formation of the committee...the amounts of claims or interests owned by...the members of the committee...the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

The Initial Ruling

The Bankruptcy Court found that Bankruptcy Rule 2019 requires disclosure of “the amounts of claims or interests owned by the members of the committee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.” The Bankruptcy Court concluded that the 2019 Statement failed to disclose this information and was insufficient on its face.5

In reaching this conclusion, the Bankruptcy Court rejected the argument of the Ad Hoc Equity Committee that Bankruptcy Rule 2019 applies only to “every entity or committee representing more than one creditor or equity security holder.” In other words, KBT&F argued that no member of the Ad Hoc Equity Committee represented any party other than itself, that only KBT&F as counsel represented “more than one creditor or equity security holder,” and that KBT&F did not have any claims or interests in the Debtors or anything to disclose. The Bankruptcy Court noted that KBT&F’s clients had appeared in the Chapter 11 case as a “committee,” and filed multiple pleadings as the “ad hoc committee” — including moving for the appointment of an official shareholders’ committee and actively litigating issues in numerous hearings. Further, as the retention agreement made clear, KBT&F was retained by the “Committee” and is compensated by the “Committee” on the basis of work performed for the Committee (and not each individual member). KBT&F did not represent the separate interests of any Committee member, but rather took its instructions from the Committee as a whole. The Bankruptcy Court distinguished the foregoing situation from one where a law firm represents several individual clients, quoting from Wilson v. Valley Electric Membership Corp.,6 where Judge Sear, chairman of the Advisory Committee at the time the Bankruptcy Rules were amended in 1986, commented in dicta,

“Rule 2019 more appropriately seems to apply to the formal organization of a group of creditors holding similar claims, who have elected to consolidate their collection efforts....”7 The Bankruptcy Court concluded that the Ad Hoc Equity Committee fit that situation precisely, except that the ad hoc committee was comprised of shareholders rather than creditors.

Next, the Bankruptcy Court noted that ad hoc or unofficial 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.”8 Moreover, appearing as a “committee” can have advantages for a group of creditors. For example, the Bankruptcy Code specifically provides for the possibility of the grant of compensation to a committee under section 503 of the Bankruptcy Code.9 As the Bankruptcy Court noted, a committee purporting to speak for a group 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 section 503(b)(3).

Finally, the Bankruptcy Court turned to the history of Bankruptcy Rule 2019, noting that although they made many other changes to the law and rules relating to reorganizations, the drafters of the 1978 Bankruptcy Code and the rules thereunder retained the substance of former Rule 10-211 in Bankruptcy Rule 2019 as “a comprehensive regulation of representation in Chapter 9 and Chapter 11 reorganization cases.”10 The Court also found that, although Bankruptcy Rule 2019 has been frequently ignored or watered down, the rule is long-standing and there is no shortage of cases applying it.

Based on the foregoing, the Bankruptcy Court granted the debtor’s motion and required the Ad Hoc Equity Committee to file an amended 2019 Statement within three days.

Request For Confidentiality Denied

Following entry of the foregoing order, the Ad Hoc Equity Committee immediately filed a motion seeking to file the disclosures concerning their purchases and sales under seal, arguing that this information was confidential and that the forced public disclosure would have a chilling impact on the hedge fund trading market. By order dated March 9, 2007, the Bankruptcy Court denied this request on the grounds that permitting the Ad Hoc Equity Committee to file the information under seal would “scuttle” Bankruptcy Rule 2019, which “gives other members of the class the right to know where their champions are coming from.”11

Denouement

The Ad Hoc Equity Committee is currently appealing this ruling to the United States District Court for the Southern District of New York. After its request for a stay pending appeal was denied, the Ad Hoc Equity Committee filed a compliant 2019 Statement.

Comment

The Northwest decision, if followed by other courts, may impact the organization of and participation by “unofficial” committees in Chapter 11 cases. Under Northwest, each individual member of an unofficial committee must disclose in a publicly filed pleading all purchases and sales of a debtors’ securities in accordance with Bankruptcy Rule 2019. The Ad Hoc Equity Committee argued that the full transparency required by the interpretation of Bankruptcy Rule 2019 by the Northwest court will “chill” participation by unofficial committees in the future.