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In the battle of experts, who bears the cost? The answer to this question was given in a memorandum opinion issued by the U.S. Bankruptcy Court for the District of Delaware in an opinion dated May 13. The issue was decided in the case In re Northwestern Corporation Chapter 11. The facts in the case are relatively simple. On Sept. 14, the debtor filed a voluntary petition for relief under Chapter 11 and continued to operate its business pursuant to �� 1107 and 1108 of the Bankruptcy Code. The Office of the U.S. Trustee appointed an official committee of unsecured creditors within two weeks of the filing date. A hearing on the adequacy of the disclosure statement was scheduled for May 17. On March 24, Carpathia Master Fund Ltd., et al., filed a motion to appoint an equity security holders committee. The debtor, unsecured creditors’ committee and the U.S. Trustee as well as the indentured trustee filed responses, and a hearing was scheduled for April 4 but was continued to May 17. The committee’s motion was filed several months after the U.S. Trustee, on Dec. 4, refused movant’s Nov. 18 request to form a committee. Two of the movants filed a motion for permission to present testimony and submit pretrial statements in connection with their motion for the appointment of an official equity security holders committee. The evidentiary motion was scheduled on special notice and a hearing was held on May 12. The request by the movant seeking the appointing of an equity security holders committee to represent the common stockholders was filed pursuant to � 1102(a)(2) of the Bankruptcy Code. Section 1102(a)(2) states, “On request of a party in interest, the court may order the appointment of additional committees of creditors or of equity security holders if necessary to assure adequate representation of creditors or of equity security holders. The U.S. trustee shall appoint any such committee.” The court pointed out that a determination as to whether or not a committee should be formed is made on a case-by-case basis. Bankruptcy Judge Charles G. Case in his memorandum and order indicated that in making such determination, several factors should be considered. They are: � Solvency of the debtors. � Timing. � The number of shareholders. � The complexity of the Chapter 11 case. � Whether the cost of an additional equity committee significantly outweighs the concern for adequate representation. Case pointed out, citing In re Williams Communications Inc., that “appointing an official committee ‘should be the rare exception’ and an equity committee ‘should not be appointed unless equity holders establish that (i) there is a substantial likelihood that they will receive a meaningful distribution in the case under a strict application of the absolute priority rule, and (ii) they are unable to represent their interests in the bankruptcy case without an official committee.’” The gravaman of the dispute is the value of the debtor’s enterprise. The debtor, through its experts and with the support of the unsecured creditors committee, asserts that the estate is hopelessly insolvent and that equity is approximately $700 million out of the money. The debtor, the committee and the U.S. Trustee argue that the request should be denied but that if the court is to consider it further, an evidentiary hearing is required. The movants assert that the debtor’s valuation fails even a minimal test of reasonableness and state that their expert is of the view that there is at least $200 million in value for equity. The court pointed out that the real issue is whether a party should bear the cost of the valuation. The real issue, as the court pointed out, is which party should bear the cost of a valuation battle — the estate or the movants. The movants argue that it is appropriate for the estate to fund the costs of protecting the interests of the equity holders given the size and complexity of the case and the possibility that value exists for equity. On the contrary, the objectors point out that the movants have every right to raise their arguments in the context of plan confirmation, but the estate should not bear the upfront costs where a favorable outcome is dubious. Furthermore, the objectors argue that if the movants are successful, then they can file a claim for reimbursement of their fees and costs under � 503(b)(3)(D) of the Bankruptcy Code. Against this background, the initial question for the court to consider is whether an evidentiary hearing is appropriate. The courts conclude not. As Case pointed out, assume the best outcome for the movants that their expert’s testimony was sufficiently compelling to create a credible argument that a higher value may be appropriate and that the testimony of the debtor’s expert is sufficiently suspect to put the debtor’s valuation in doubt. Does this fact alone justify the appointment of a committee? The court thinks not. This testimony would only place the issue of value in play. The court pointed out that there is a $700 million shortfall that needs to be overcome before there is any value for equity. While this is not an impossible task, it is a relatively steep hill to climb. Indeed, the court could eventually accept nearly 80 percent of the additional value urged by the movants and equity that would still be out of the money. Thus, the test of “substantial likelihood that equity will receive a meaningful distribution” set forth in the In re Williams case has not been met. The court indicated in its opinion that under these circumstances, the best interests of the estate or its constituents are not served by shifting the costs of this valuation dispute from the movants to the estate. Another factor that may have motivated the court is that the movants acquired their equity position post-petition and therefore understood the risk of their undertaking. They can decrease this risk by recruiting other equity holders to be part of an unofficial committee, thereby spreading the upfront costs. Again, as the court pointed out, if they are correct in their valuation position, they are protected by � 503(b)(3)(D) of the Bankruptcy Code. The court concluded that this admittedly speculative nature of their position does not warrant the appointment of an equity committee and that the risk should be borne by the movants, not by the estate. This opinion clearly sets forth a test for the formation of an equity committee and the fate as to whether or not the estate or unofficial committee should pay the costs of expert testimony. However, one of the moving factors in this opinion that the court considered was the disparity of the values — the burden the expert would have to overcome in order to establish some distribution to equity shareholders. The opinion did not refer to the fact that the equity holders purchased the equity position after the Chapter 11 petition was filed. While the court relied on the decision of the bankruptcy court in In re Williams, it clearly sets forth the standard by which the court should be guided in appointing an additional committee and directing the U.S. Trustee to appoint such a committee. Charles M. Golden is a partner with Obermayer Rebmann Maxwell & Hippel (www.obermayer.com). He is chairman of the firm’s creditors’ rights, bankruptcy and financial reorganization department. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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