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PRESS RELEASE: Baddett Corp. Inc. Files Plan of Reorganization Anytown, U.S.A. — Baddett Corp. [a fictional company] announced today that it has filed a plan of reorganization in its Chapter 11 bankruptcy case. Through financing provided by Big Bank, Baddett proposes to restructure its debt and continue operations after the confirmation of its plan. Pursuant to the terms of its plan of reorganization, and in order to maintain healthy relationships for continued growth, Baddett expects that general unsecured creditors will receive 90% distribution on account of their claims. Moreover, through the spinoff of unprofitable businesses and reduction in operating expenses, Baddett expects profits to increase at an annual rate of 30% for the next five years. Baddett is an international manufacturer of widgets and other products used in the ever-growing sales and marketing arena. Baddett Corp., like many other public companies subject to the cyclical woes of the economic tide, was faced with exorbitant debt and the inability to pay its debts as they came due. Furthermore, Baddett’s secured creditor threatened to foreclose on Baddett’s assets. Baddett’s board of directors determined that reorganization under the protection of the Bankruptcy Code would be in the best interests of the company. During the pendency of the bankruptcy, Baddett unloaded unprofitable segments of its business while continuing to cut costs and increase profitability. Upon obtaining the necessary financing to reorganize successfully and emerge from bankruptcy, Baddett promptly filed a plan of reorganization. Baddett’s board wanted to publicize this promising development in order to renew interest in Baddett and its worldwide operations. Consequently, the board issued the above press release. This article addresses the potential liability to companies that issue press releases while in bankruptcy proceedings. BEWARE WHEN ISSUING A PRESS RELEASE The securities markets are highly sensitive to press releases. A business reorganizing through a Chapter 11 bankruptcy can benefit from the media coverage generated from a press release. On the other hand, investors who are not familiar with the intricacies of the bankruptcy process may be harmed by what, to them, are incomplete statements issued by officers or directors of the debtor regarding the bankruptcy case. Under the Bankruptcy Code, a debtor in possession is the equivalent of a trustee (11 U.S.C. 1107(a)), and is therefore a fiduciary of the bankruptcy estate and its creditors. In re Republic Financial Corp., 128 B.R. 793, 802 (Bankr. N.D. Okla. 1991). Any and all acts taken by the debtor during a bankruptcy case, including the dissemination of information to the public, are subject to high scrutiny by the bankruptcy judge, the creditors in the case and the Office of the U.S. Trustee, a branch of the Department of Justice that oversees the bankruptcy process. In addition to complying with the requirements of the Bankruptcy Code and the federal and local bankruptcy rules, the debtor must also comply with all applicable securities regulations in connection with issuing press releases. Press releases usually include current factual statements and expressions about the future of the corporation. It is usually the latter — so-called forward-looking statements — that cause legal problems for corporations. When a company is in Chapter 11, however, it is what is not said that can create liability issues. Violations of the Securities Exchange Act of 1934 occur when statements contained in a press release are “materially misleading.” In re Apple Computer Securities Litigation, 886 F.2d 1109 (9th Cir. 1989). A statement violates the act if it contains undisclosed facts tending to seriously undermine the accuracy of the statement. Hanon v. Dataproducts Corp., 976 F.2d 497 (9th Cir. 1992). BANKRUPTCY FILING HAS NEGATIVE CONNOTATION Generally, the filing of a bankruptcy case is very beneficial for a struggling company, primarily because, upon filing, the automatic stay is in effect to essentially freeze all pre-petition litigation and collection actions, giving the company breathing room to assess its condition and develop a plan for restructuring. Notwithstanding this benefit, the public’s general view is that filing for bankruptcy connotes financial instability, bringing with it a negative view of the corporation and its management. This is based, in part, on legitimate concerns that the result of the bankruptcy filing will be a liquidation of the company’s assets, with no distribution to equity. The bankruptcy process can be beneficial to a corporation, by allowing it to restructure its secured and unsecured debt, eliminate unwanted and unproductive assets, sell other assets free and clear of all liens and encumbrances, and infuse new capital for continued operation and possible expansion. Ideally, bankruptcy results in a stronger and leaner corporation that will survive long into the future. But how does a company in bankruptcy confer its reorganization message to the public? Often, a debtor, like Baddett, sends out a press release advising the public that it has filed a plan of reorganization pursuant to which the debtor will restructure its debt for continued operations and that it anticipates a distribution to creditors. The release may also state that the debtor, upon reorganization, expects to increase revenues and future return on equity. Sounds promising. But for whom? These questions puzzle and confuse many investors in bankruptcy cases. It is important for investors to understand that “restructuring debt” and “distributing to creditors” do not mean that the debtor’s current shareholders will retain their shares. In bankruptcy, shareholders cannot retain their interest in the debtor unless all creditors are paid in full or the classes of creditors who are not paid in full consent to the shareholders retaining an interest in the debtor. Often, to maintain the value of having a public company, creditors will agree to a plan of reorganization that allows those owning equity to keep an interest in the debtors, albeit a substantially diluted one. For example, in a case the authors were involved in, involving Advanced Gaming Technology Inc. (AGTI), the reorganization plan provided for those owning equity to receive 7% of the reorganized entity — the remaining ownership went to creditors and to people who infused new capital into the company. The substantial dilution to equity should have caused the price of the stock to plummet. Instead, on news of confirmation of a plan of reorganization, the stock price more than doubled. Within a month, as investors knowledgeable about the bankruptcy proceedings happily sold off all their stock, the price dipped far below the price at which it traded before the news of the plan’s confirmation. In a bankruptcy proceeding, there is no guarantee that equity holders will receive anything on the basis of their shares. However, in light of the current aggressive investment market, which includes millions of nonexpert online traders, it seems impossible to prevent the market from reacting to press releases that, although positive for creditors, mean nothing to investors. In the case of the fictional Baddett, the most important aspect of its press release is what is missing from the release: that is, reference to the fact that existing equity will be extinguished as part of the plan of reorganization. Is the debtor’s press release materially misleading because it does not advise investors that their interest in the debtor will be wiped out upon the plan’s confirmation? SEC LOOKS FOR MATERIALLY MISLEADING STATEMENTS There is nothing wrong with a corporation’s making, in a press release, educated predictions about the company’s future that turn out to be wrong. Such information is not considered materially misleading. The Securities and Exchange Commission, however, reviews the facts of each case, and a press release is likely to be viewed as materially misleading if the statements it contains are false or if the projections violate one of the following three requirements: (1) that the statement is genuinely believed by the party making the statement; (2) that there is a reasonable basis for that belief; and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement. See Hanon v. Dataproducts Corp., 976 F.2d 497 (9th Cir. 1992). Does Baddett’s press release fall into this category? It can easily be argued that the Baddett press release is misleading to investors. Although it may be true that each statement made in the press release is accurate, that the writer genuinely believes such statements and that there is a reasonable basis for such belief, an essential ramification of the plan — that existing equity will be wiped out — has been omitted. A court may view this omission as an undisclosed fact that seriously undermines the accuracy of the statement, which would violate SEC rules. Courts have held that the character of a press release must be viewed “in the light of the facts existing at the time of the release, by applying the standard of whether a reasonable investor, in the exercise of due care, would have been misled by it.” Securities & Exch. Comm’n v. Texas Gulf Sulfur Co., 401 F.2d 833, 863 (2d Cir. 1968). Investors are presumed to have a general understanding of the business world when determining whether a statement is misleading. Symington Wayne Corp. v. Dressler Industries Inc., 383 F.2d 840, 843 (2d Cir. 1967). In the case of a bankruptcy, however, it is questionable whether it is reasonable to assume that an investor will understand general bankruptcy laws. Press releases target investors. A public company that knows that its shareholders’ interest in the company is likely to be eliminated or substantially diluted as a result of bankruptcy proceedings should be careful in issuing positive press releases concerning its operations. SEC ALLOWS FORWARD-LOOKING STATEMENTS IN RELEASES The SEC offers protection to issuers of press releases concerning the forward-looking aspect of their releases. Specifically, investors cannot hold the issuer of a press release responsible when future results vary from what is projected in the press release if the release contains the following language: “Certain of the statements contained in our press releases are forward-looking statements. While these statements reflect the Corporation’s current beliefs, they are subject to uncertainties and risks that could cause actual results to differ materially. These factors include, but are not limited to, the demand for the Corporation’s products and services, economic and competitive conditions.” However, there is no bankruptcy-specific “safe harbor” provision. The authors suggest inclusion of the following language in all press releases issued by companies involved in bankruptcy proceedings: “The Corporation is currently in a bankruptcy proceeding. All documents filed with the bankruptcy court are available to the public. The bankruptcy proceedings may affect the interest of shareholders in the Corporation. The Corporation advises you to seek the assistance of professionals knowledgeable about the bankruptcy proceedings when making investment decisions concerning the Corporation.” Inclusion of the above, or similar language, will likely protect the debtor and its management from allegations of withholding material facts in connection with its press releases. In the end, everyone involved in issuing press releases for companies in bankruptcy proceedings should carefully scrutinize every statement contained in the release to make sure that the information is as accurate as possible and is not misleading. What often is not said in a release is what is most important to investors. In today’s litigious world, one must take all steps to protect oneself, which necessarily includes a review of not only the statements made, but also the omitted facts. Although it is unrealistic to detail all facts in a press release, the debtor should, at the least, include a disclaimer and cautionary language to protect itself from lawsuits brought by investors and the SEC — the type of suits that could land the company right back in a bankruptcy proceeding. Craig M. Rankinis a partner at the Los Angeles-based bankruptcy boutique Levene, Neale, Bender & Rankin L.L.P.and formerly clerked for a bankruptcy judge. David B. Golubchikis an associate at the firm.

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