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One of the characteristics which fundamentally distinguishes a “distress” M&A from the more traditional M&A among healthy enterprises is the importance and impact of the decision-making matrix: a distress M&A most often has multiple decision makers, with different agendas and increasingly different responsibilities. There is the company, acting through its board; there is often a creditors’ representative group; and if there is a secured lender, there may be active participation by that group as well. The rise of the ad hoc committee particularly underscores the multiple party point, because generally such a committee does not have fiduciary responsibilities, and remains free to pursue its own agenda. The multiple-party dynamic often arises before a Chapter 11 case is commenced. Most distressed companies recognize their responsibility to their creditors and, if they are sluggish in coming to that realization, activist well-advised creditors will accelerate the debtor’s recognition and insert themselves into any restructuring or sale process. After all, a debtor in financial distress may become vulnerable by missing an interest payment or defaulting under an indenture or credit agreement, exposing itself to creditor remedies or even an involuntary bankruptcy case. For that reason, well-advised companies often engage in discussions with responsible creditor constituents using Chapter 11 as the baseline for proposals, weighing alternatives against the benefits of a sale under �363 of the Bankruptcy Code as well as the requirements of a plan of reorganization under Chapter 11. Such a creditor dialogue is consistent with the key role of creditors in a Chapter 11, which, among other things, mandates the appointment of a creditors’ committee. But as important as the creditors’ committee, the voting rules of Chapter 11 define a zone of influence for creditors, whether secured or unsecured. In Chapter 11, claims are only secured to the extent of collateral value, with any deficiency being treated as a general unsecured claim. If the collateral value is adequate, each lien creditor is in a separate class. THE OFFICIAL CREDITORS’ COMMITTEE Section 1102 of the Bankruptcy Code mandates the appointment of a creditors’ committee in most cases. This committee is sometimes called the “Official Committee,” a shorthand that has taken hold in order to distinguish it from the other ad hoc committees that may form in a Chapter 11 case. In most jurisdictions, the members of the Official Committee are selected by the United States Trustee. The Office of the United States Trustee is part of the Department of Justice and tasked with, among other responsibilities in Chapter 11 cases, selection of the creditors’ committee. The U.S. Trustee will call an organizational meeting as soon as possible after a petition is filed, inviting creditors identified by the debtor to attend if they are interested in serving on the creditors’ committee. Given the frequency of debtors seeking “first day” early and immediate relief on multiple matters, getting the creditors’ committee organized and represented is a priority. While technically each debtor has its own creditors and, in theory, one might read the Bankruptcy Code as mandating the appointment of a creditors’ committee for each Debtor, generally only one committee is appointed — even in large complex cases involving multiple affiliates such as Enron or Delphi. Once formed, the creditors’ committee can retain legal and other advisors, which are funded by the debtor. Section 1103 of the Bankruptcy Code describes the role and duties of the creditors’ committee as a fiduciary for all unsecured creditors, traditionally taking up investigative and other responsibilities that the debtor does not pursue. While it is not a statutory requirement that debtors have the support of their creditors’ committee, there is no doubt that such an endorsement helps because the creditors’ committee is intended to be the focal point for the creditors in a Chapter 11 case as well as the counterbalance to the debtor. The creditors’ committee also will likely receive some deference from the Bankruptcy Court. Perhaps the most critical function of the creditors’ committee is the negotiation and prosecution of a plan of reorganization. To be effective in their fiduciary role in negotiating a plan, members of the creditors’ committee and their advisors often receive significant information to assist them in assessing proposals by the company. CREDITOR COMMITTEE TENSIONS Reconciling the goals of distress investors and their interest in serving on the creditors’ committee has presented some complexity. Many distressed investors want to continue trading in the debtors’ securities. They may also be the largest creditors that are critical to a successful reorganization. Hence, there may be “trading” orders which will permit a holder of a claim serving on a creditors’ committee to continue trading in the securities of the debtor; provided, however, that such a holder puts into place sufficiently strong information barriers to assure that neither the individual serving on the creditors’ committee nor the information obtained in such capacity plays any role in those trading activities. Nevertheless, the membership of a creditors’ committee may change as members “sell out” their claims. Similarly, in multiple debtor cases there may be difficulties in addressing the distinct interest of certain creditors in their particular debtor and their position vis-�-vis creditors of other debtors, such as the holding company creditors (generally financials) as against operating company creditors. This very problem confronted Enron as well as Adelphia. In some instances, creditors hold both secured and unsecured claims and want their unsecured claim to be represented on the creditors’ committee. The recent amendments to the Bankruptcy Code, now effective, added two new provisions to �1102 that presumably intended to address these tensions. The first empowers the court to change the membership of a creditors’ committee to ensure that it is representative. The second mandates that creditors’ committees “provide access” to information to the creditors they represent, solicit and receive comments from those creditors, as well as be subject to the court compelling the creditors’ committee to make such reports and disclosures. These tensions, taken in the context of (i) the voting rules of Chapter 11, (ii) the advent of distressed investors, which has changed the face of the claimholder, and (iii) the increasing use of junior lien debt structures, have produced a consequence: ad hoc committees operating in Chapter 11 cases. There has been a history of ad hoc committees in the out-of-court restructuring situation, where it served as a proxy for creditors and even the creditors’ committee in the event of subsequent Chapter 11 filing.[FOOTNOTE 1] Distress investors now hold trade and bank claims in addition to their traditional role as bondholders. As members of ad hoc committees they are not fiduciaries, but they can organize themselves to have a significant, if not dominant, role in Chapter 11 cases. Debtors should be responsive to the group of creditors that will assist in successfully confirming a plan of reorganization. The voting provisions of Chapter 11 are the touchstone for assessing the significance of creditor groups. The same maxim may apply to the bankruptcy courts’ perception of a creditors’ group. In Chapter 11, creditors’ claims are classified for voting as well as for plan treatment. In terms of voting, a class accepts a plan if two-thirds in amount and a majority in number of those creditors actually voting vote to accept the plan. Hence a distressed investor obtaining 25 percent or more, or a group holding 25 percent or more, of similar claims that are likely to be in their own class may have a blocking position.[FOOTNOTE 2] Interestingly, as the capital markets move companies into multiple lien structures, it is having an impact on the “zones of influence.” For Chapter 11 purposes, each tier of secured debt will be a separate class if there is sufficient collateral value to cover at least a portion of a tier’s claim. In addition to the creditors’ committee advisors, the debtor may also be required to fund the legal and other expenses of a secured creditor to the extent that its contract provides for such expenses, even ad hoc committees of junior secured bondholders. What is an ad hoc committee? Whatever the organizing creditors want, but generally it is designed to represent one or more of the following: (i) a group not otherwise represented, such as operating subsidiary creditors ; (ii) a group which asserts that there is a conflict with their representative, such as between the agent, who may have multiple roles with the debtors, and secondary holders of a syndicated loan whose sole interest is that loan claim; or (iii) a group which is calculated to be the dominant vote in creditor class, such as junior lienholders. When are they organized? An ad hoc committee can organize before or after a case is commenced. Who serves on ad hoc committees? Holders of similar claims who have determined that they are better served acting through a focused group, rather than relying on their individual efforts, generally constitute the membership. As a group, assuming they can agree on professionals, they will also benefit from sharing the expense of being active in a Chapter 11 case. Perhaps even in the case of an ad hoc committee of unsecured claims, such a group may improve their chances of being funded by the debtor, because the Bankruptcy Code provides for reimbursement of the expenses of those making a substantial contribution to the case.[FOOTNOTE 3] Obviously acquiring control of the debtor could be a shared objective of a number of claimholders. The change made by the recent bankruptcy amendments to limit the amount of time for which the debtor will have the exclusive right to file a plan of organization suggests that this route may be taken more often, as distressed investors can take control of a Debtor by way of a Chapter 11 plan, thereby avoiding an auction. There is little doubt that the ad hoc committee, free of fiduciary restrictions, has the potential to be a dominant decision maker in a Chapter 11 case or an out-of-court restructuring. The only significant restriction on ad hoc committees is found in Bankruptcy Rule 2019. By its terms that rule applies to the professionals representing any such ad hoc committee, and the rationale behind that rule is that sound prosecution of a Chapter 11 case and negotiation of a Chapter 11 plan require fair disclosure of the identity and claim holdings of creditor groups. Specifically, Bankruptcy Rule 2019 requires every entity representing more than one creditor, equity security holder or trustee in a Chapter 11 to provide the name and address of the party being represented, the nature and amount of the claim or interest represented, and if held for one year or less on the date the petition is filed, the time of acquisition also; a description of the relevant facts and circumstances surrounding the employment of the entity; and the identity of those who, directly or otherwise, brought about the representation arrangement.[FOOTNOTE 4] In addition, the report must also detail the amounts of claims or interests owned by the entity and members of the committee; when the claims or interests were acquired; the amounts paid for each acquisition; and any sales or other disposition of claims or interests.[FOOTNOTE 5] Thus the key inquiries are: identity of committee members and the extent of their holdings individually and in the aggregate. As a practical matter, there is tremendous sensitivity on the part of distressed investors to disclosing the price they paid for claims. Finally, the court can also require disclosure of the instrument empowering the committee to act on behalf of its members.[FOOTNOTE 6] Whenever material changes occur to the information contained in the report, the entity is obliged to promptly update its disclosure.[FOOTNOTE 7] Failing to follow Bankruptcy Rule 2019 can carry stiff consequences. Any party, and even the court sua sponte, can move for a determination as to whether there has been a failure to comply. If a failure is found, the offending party can be refused further participation or intervention in the case.[FOOTNOTE 8] There can be no doubt that Chapter 11 participants now include distressed investors who are well-funded, well-advised, and active. There is also little doubt that distressed investors may serve as a clear alternative to a sale under �363 of the Bankruptcy Code. These investors frequently have the financial strength to provide exit or other financing to the reorganized debtor. Due to that financial strength, the cooperation and influence of distressed investors can lead to using Chapter 11 for a stand-alone reorganization plan that transfers control of the debtor to the distressed investors. Distressed investors have funded debtors and their plans. While some schooled in the bankruptcies of the last century continue to criticize the impact of distressed investors, blaming them for interfering in the reorganization process and demanding �363 sales of debtors, the emerging reality may be that these same investors may serve as the key to the standalone reorganization and rehabilitation of debtors. The potential for a reorganization plan sponsored by distressed investors often raises the bar for an acceptable sale. Oftentimes it may serve as the real stalking horse in a proposed sale. However, yesterday’s critics should not be readily dismissed. Debtors may now have an alternative to a forced sale, but they are subject to increasing pressure from creditors, particularly organized, well-represented ones. For that reason, it is important that the requirements of Rule 2019 are enforced, and it is necessary that the fiduciaries in Chapter 11, creditors’ committee and debtor, are held to discharge their responsibilities in an appropriate manner.[FOOTNOTE 9] Debtors and, for that matter, their creditors, are entitled to know who they are dealing with, what impact they will have on the process and, by having such information, assess whether the agenda that any such ad hoc committee is pursuing is appropriate for maximizing the values available to all creditors, even equity holders. For the potential acquirer of a distressed business in Chapter 11, enforcement of such rules can provide critical information and insight into whether an opportunity should be pursued or has been preempted by distressed investors buying claims. Corinne Ball is a partner at Jones Day. William G. Karazsia, an associate, assisted in the preparation of this article. :::::FOOTNOTES::::: FN1 The role of pre-bankruptcy ad hoc committees in a subsequent Chapter 11 case is the subject of In re Stage Stores, Inc., 269 B.R. 343 (S.D. Tex. 2001). Even though the ad hoc committee had negotiated the reorganization plan being pursued in the subsequent Chapter 11 case, there were sufficient concerns about their ability to be fiduciaries for all unsecured creditors in the subsequently filed Chapter 11 case such that the ad hoc committee was not continued and appointed as the Official Committee. But see, In re Tri-State Outdoor Media Group, Inc., 283 B.R. 358, 361 (Bankr. M.D. Ga. 2002) (observing that the Official Committee of Unsecured Creditors consisted “mainly of former Ad Hoc Committee members”). FN2 A creditor group has to have a claim that is “in the money.” Hence, to be effective classes that receive nothing under a plan are deemed to reject. 11 U.S.C. �1126. FN3 11 U.S.C. �503(b)(3)(D). FN4 Fed. R. Bankr. P. 2019(a)(1)-(3). FN5 Fed. R. Bankr. P. 2019(a)(4). FN6 Fed. R. Bankr. P. 2019(a). FN7 Id. FN8 Fed. R. Bankr. P. 2019(b). FN9 Recently the Examiner in In re FiberMark, Inc. concluded that ours is a world “in which more or complete transparency in business affairs is mandated.” The Report of Harvey R. Miller, As Examiner, In re FiberMark, Inc., No. 04-10463, at 315 (Bankr. D. Vt. Aug. 16, 2005). He also expressed serious concern about Committee members and counsel who lack requisite amounts of objectivity, independence and disinterestedness in the discharge of their Committee duties, including the duty to act in the best interest of all they represent. Id. at 315-321.

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