On April 26, 2011, the Supreme Court of the United States adopted amendments to Rule 2019 of the Federal Rules of Bankruptcy Procedure (Amended Rule 2019) and submitted the proposed amendment to Congress for approval. Amended Rule 2019 was approved by Congress and became effective on December 1, 2011. The rule governs certain disclosure requirements for groups consisting of multiple creditors or equity security holders acting in concert in Chapter 9 or Chapter 11 cases. In the last several years, Rule 2019 has been the subject of intense professional and scholarly debate as judges, practitioners and academics have argued about, among other things, the importance of the underlying and purported purpose of the rule, the role of creditors and groups of creditors in the bankruptcy process, and the necessity for debt and claims traders to protect certain proprietary information and trading strategies.
Background
In its pre-December 1, 2011 form, Rule 2019 required any entity or unofficial committee representing more than one creditor or equity security holder in a bankruptcy proceeding to disclose:
(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) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefore, and any sales or other disposition thereof.
Fed. R. Bankr. P. § 2019(a) (2010) (amended 2011).
In practice, Rule 2019 had been administered, applied and followed inconsistently. Legal precedent established by bankruptcy courts demonstrates that the application of the rule was in conflict both across and within jurisdictions. For example, certain bankruptcy courts in both the Southern District of New York and the District of Delaware held that ad hoc committees of equity security holders and noteholders were subject to the Rule 2019 disclosure requirements.1 In contrast, bankruptcy courts in other jurisdictions, and one in the District of Delaware, issued contrary opinions, holding specifically that steering groups and ad hoc committees of noteholders were not required to make disclosures under Rule 2019.2 Courts were also inconsistent in the amount of information that they required to be disclosed; some required only the names and addresses of the members of the disclosing group, while others demanded detailed disclosure more consistent with the requirements of the rule.
Amendment Process
In late 2009, in response to the growing body of conflicting case law, the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States (the Rules Committee) proposed amendments to Rule 2019. Under the initial proposal, a verified statement would be required to set forth all "disclosable economic interests" of each member of any entity, committee or group, regardless of whether the body represented each such disclosable economic interest, as well as the name of the members of the body and the nature and amount of each disclosable economic interest held in relation to the debtor. The initial proposal also required entities subject to Rule 2019 to disclose the price paid for each disclosable economic interest and the date of purchase of each disclosable economic interest.
On February 5, 2010, the Rules Committee held a public hearing at which several witnesses commented on the proposed amendments. Commentators generally fell into two camps. First, industry groups and distressed debt investors focused on the consequences of sharing proprietary price information, arguing that the disclosure of such information is unnecessary, would allow the public to "reverse engineer" their investment strategies and would persuade entities to exit the secondary markets, or, at the very least, prevent them from joining ad hoc groups during the bankruptcy process. Additionally, presenters pointed out that price information could be more appropriately addressed and sought under Bankruptcy Rule 2004.
The second camp supported the proposed amendments, arguing that they properly addressed the ambiguities existing under the then-current Rule 2019 and existing legal precedent. These parties noted that the primary concerns in amending the rule were (i) the efficacy and purpose of the bankruptcy system, and (ii) avoiding exploitation of the bankruptcy process by and for the benefit of parties that choose to enter the process for their own financial gain.
Following the public comment period, the Rules Committee incorporated comments from both groups into the amendments to Rule 2019.
Amended Rule 2019
Effective as of December 1, 2011, the amendments to Rule 2019 provide some clarification on the ambiguities of the former Rule 2019; yet, they still leave certain issues unresolved and ripe for potential confusion. Amended Rule 2019 states:
a) Definitions. In this rule the following terms have the meanings indicated:
1) "Disclosable economic interest" means any claim, interest, pledge, lien, option, participation, derivative instrument, or any other right or derivative right granting the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest.
2) "Represent" or "represents" means to take a position before the court or to solicit votes regarding the confirmation of a plan on behalf of another.
b) Disclosure by groups, committees, and entities.
1) In a chapter 9 or 11 case, a verified statement setting forth the information specified in subdivision (c) of this rule shall be filed by every group or committee that consists of or represents, and every entity that represents, multiple creditors or equity security holders that are (A) acting in concert to advance their common interests, and (B) not composed entirely of affiliates or insiders of one another.
2) Unless the court orders otherwise, an entity is not required to file the verified statement described in paragraph (1) of this subdivision solely because of its status as:
A) an indenture trustee;
B) an agent for one or more other entities under an agreement for the extension of credit;
C) a class action representative; or
D) a governmental unit that is not a person.
c) Information required. The verified statement shall include:
1) the pertinent facts and circumstances concerning: A) with respect to a group or committee, other than a committee appointed under § 1102 or § 1114 of the Code, the formation of the group or committee, including the name of each entity at whose instance the group or committee was formed or for whom the group or committee has agreed to act; or
B) with respect to an entity, the employment of the entity, including the name of each creditor or equity security holder at whose instance the employment was arranged;
2) if not disclosed under subdivision (c)(1), with respect to an entity, and with respect to each member of a group or committee:
A) name and address;
B) the nature and amount of each disclosable economic interest held in relation to the debtor as of the date the entity was employed or the group or committee was formed; and
C) with respect to each member of a group or committee that claims to represent any entity in addition to the members of the group or committee, other than a committee appointed under § 1102 or § 1114 of the Code, the date of acquisition by quarter and year of each disclosable economic interest, unless acquired more than one year before the petition was filed;
3) if not disclosed under subdivision (c)(1) or (c)(2), with respect to each creditor or equity security holder represented by an entity, group, or committee, other than a committee appointed under § 1102 or § 1114 of the Code:
A) name and address; and
B) the nature and amount of each disclosable economic interest held in relation to the debtor as of the date of the statement; and
4) a copy of the instrument, if any, authorizing the entity, group, or committee to act on behalf of creditors or equity security holders.
d) Supplemental statements. If any fact disclosed in its most recently filed statement has changed materially, an entity, group, or committee shall file a verified supplemental statement whenever it takes a position before the court or solicits votes on the confirmation of a plan. The supplemental statement shall set forth the material changes in the facts required by subdivision (c) to be disclosed.
e) Determination of failure to comply; sanctions.
1) On motion of any party in interest, or on its own motion, the court may determine whether there has been a failure to comply with any provision of this rule.
2) If the court finds such a failure to comply, it may:
A) refuse to permit the entity, group, or committee to be heard or to intervene in the case;
B) hold invalid any authority, acceptance, rejection, or objection given, procured, or received by the entity, group, or committee; or
C) grant other appropriate relief.
Fed. R. Bankr. P. 2019 (2011).
Amended Rule 2019(b)(1) broadens its scope by requiring disclosure from any entity, group or committee that consists of or represents multiple creditors or equity security holders that are (i) acting in concert to advance their common interests, and (ii) are not composed entirely of affiliates or insiders of one another. Unlike under the former rule, official committees appointed by the US Trustee will be subject to certain provisions in Amended Rule 2019, including the requirement to disclose committee members' disclosable economic interests. Without further court involvement, the rule does not require disclosure by indenture trustees, agents for one or more other entities under an agreement for the extension of credit (e.g. an agent bank), a class action representative and most governmental units.3
The amended rule also seeks to clarify certain ambiguities surrounding its scope by adding the defined terms "disclosable economic interest" and "represents." The broad definition of "disclosable economic interest" covers any economic interest that could impact the legal and strategic positions a stakeholder would take whether or not such economic interests are related or connected to a particular group's or committee's purpose for organization. Although not expressly included in the definition of "disclosable economic interest," the Committee Notes to Amended Rule 2019 make clear that the definition "extends beyond claims and interests owned by a stakeholder and includes, among other types of holdings, short positions, credit default swaps, and total return swaps."
The definition of "represents" clarifies that representation requires active participation in the case or in a proceeding on behalf of another entity— either by taking a position on a matter before the court or by soliciting votes on the confirmation of a plan. An attorney who is retained by several creditors or equity security holders to monitor a case, but who does not advocate any position before the court or engage in solicitation activities, does not represent his or her clients for purposes of Rule 2019 and, thus, would not have to make Rule 2019 disclosures.
Groups or committees subject to the disclosure requirement of Amended Rule 2019 must file a verified statement containing certain information surrounding the facts and circumstances regarding the formation of the group or committee. In particular, official committees must report the name, address, and nature and amount of each disclosable economic interest held (not in the aggregate) in relation to the debtor of both the entity representing the group or committee and each member of the particular group or committee represented by such entity, as of the date that such entity was employed or the group or committee was formed, whether or not the disclosable economic interest is related to the group or committee.
Most notably, Amended Rule 2019 does not require parties to disclose the price paid for a disclosable economic interest or, in most cases, the date of acquisition of such interests.4 However, the amendment makes clear that the rule does not preclude either the discovery of that information or its disclosure when ordered by the court under its authority outside of the rule. This departure from the initial proposal appears to thread the needle between the arguments made by industry commentators and those who were proponents of the initial proposed amendments.
Finally, on motion of a party in interest, or upon a court's motion, the court may determine whether there has been a failure to comply with Amended Rule 2019. In the event of noncompliance, the court may: (i) refuse to permit the entity, group or committee to be heard in court or to intervene in the case; (ii) hold invalid any authority, acceptance, rejection or objection given, procured or received by the entity, group or committee; or (iii) grant other relief if deemed appropriate.
Accordingly, a failure of an entity, group or committee to comply with Amended Rule 2019 could cause serious repercussions. Even in the absence of a motion by a party in interest, the court may, sua sponte, prevent a noncomplying party from taking certain desired actions during the bankruptcy proceeding or bar it completely from participating in cases.
Strategic Implications
While the amendments were intended to clarify a number of issues that gave rise to litigation, Amended Rule 2019 raises several potential areas of confusion and concern:
- Despite the attempt to clarify which parties will be subject to Amended Rule 2019, the answer remains uncertain. The new definition of "represents" states that a party must "take a position before the court" or solicit votes in support of confirmation of a plan to fall under the scope of the amended rule; however, this vague definition suggests potential ambiguities. For example, has a party who has filed a notice of appearance in a bankruptcy case taken a position before the court, or must a party have filed a pleading before the court to be subject to the disclosure requirements? Will Amended Rule 2019 apply where a party files a joinder to another party's pleading? Will a party that has expressly supported a plan, but has not formally solicited votes in support of confirmation of that plan, be required to make a Rule 2019 disclosure?
- It is unclear how Amended Rule 2019 applies to affiliates of those entities that are members of a committee or group. Does the new definition of "represents" include actions taken by affiliates of an entity that are directly members of a committee or group? If a subsidiary takes a position before the court or solicits votes regarding the confirmation of a plan, will its parent or affiliate entities be required to make the requisite disclosures?
- It is also unclear what those entities representing a committee or group must disclose. For example, what are the "pertinent facts and circumstances" required to be disclosed by entities representing multiple creditors or equity security holders under Amended Rule 2019(c) (1)(B)? Does this require the disclosure of the qualifications and fee rates of attorneys representing committees?
- The language of Amended Rule 2019(b)(1) also raises questions. It provides that disclosure must be made "by every group or committee that consists of or represents . . . multiple creditors or equity security holders that are (A) acting in concert to advance their common interests, and (B) not composed entirely of affiliates or insiders of one another" (emphasis added). The inclusion of the phrase that consists of seems to render moot the reference to representation. Could disclosure possibly be required by every group that merely consists of multiple creditors or equity security holders acting in concert?
- Will parties to a "lock up" agreement supporting a plan or other strategy for the bankruptcy proceedings be required to make disclosures under Amended Rule 2019? Such a determination may depend on whether such a group engages common legal counsel or not.
- Will creditors who have each retained separate counsel but occasionally coordinate common positions constitute a "group"?
- Will lenders who act in concert to create a new company as part of a credit bid be required to make disclosures?
Will any party that has entered into a common interest agreement or joint defense agreement be considered a group or committee and be required to disclose its economic interests under Amended Rule 2019? What about co-defendants?
These issues and questions will likely remain unanswered until they are tested in court. Once again, parties in interest will be forced to rely on developing case law to determine the true breadth of the disclosure requirements.
As such, stakeholders will need to consider carefully if and how their interests will be represented in bankruptcy proceedings. Each such stakeholder will need to determine if it is best served by (i) joining a group or committee that is represented in the proceedings, thus becoming subject to Amended Rule 2019 disclosure requirements, (ii) securing separate and independent counsel while incurring the expense of its own representation in the bankruptcy process, or (iii) remaining a passive player in the bankruptcy process without any formal representation. Likewise, investors considering the purchase of a stake in a debtor through the secondary market will need to consider what form of involvement is necessary for the investor to protect its investment and whether the concomitant disclosure requirements are appropriate for that investment.
Footnotes
1 See In re Washington Mutual, Inc., 419 B.R. 271, 274 (Bankr. D. Del. 2009) (requiring an ad hoc committee of noteholders to meet Rule 2019 disclosure requirements); In re Northwest Airlines Corp., 363 B.R. 701, 703 (Bankr. S.D.N.Y. 2007) (ad hoc committee of equity security holders required to make Rule 2019 disclosures).
2 See In re Premier Int'l Holdings, Inc., 423 B.R. 58, 63 (Bankr. D. Del. 2010) (holding that an informal ad hoc committee of bondholders was not required to make Rule 2019 disclosure); In re Philadelphia Newspapers LLC, et al., Case No. 09-11204 (Bankr. E.D. Pa. June 29, 2010) (holding that a steering group of prepetition lenders was not subject to Rule 2019 disclosure requirements); In re Scotia Development LLC, Case No. 07-20027 (Bankr. S.D. Tex. Apr. 18, 2007) (holding that ad hoc noteholder group was not subject to Rule 2019).
3 These entities may represent multiple creditors or equity security holders; however, they do so under formal legal arrangements of trust or contract law that precludes them from acting on the basis of conflicting economic interests.
4 Amended Rule 2019 only requires a committee to disclose the time of acquisition if the committee represents an entity that is not actually a member of the committee. Where such disclosure is required, only the calendar quarter in which the claims or interest were acquired need be disclosed, not the precise date. No disclosure of the time of acquisition is required for claims or interests acquired more than a year before the commencement of the bankruptcy case or cases.
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