Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019

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994 Norton Journal of Bankruptcy Law and Practice [Vol. 16] leading debtor law firm proclaimed that the Northwest Airlines decision “may signal the beginning of the end of certain of today’s influential ad hoc committees.” 43 Implicit in the position favoring the Northwest Airlines approach is the assumption that secondary market investors are destructive participants in the Chapter 11 process and, therefore, should be silenced whenever possible. However, as discussed below, each of the rationales supporting this anti-hedge fund bias is fundamentally flawed and simply cannot change the plain meaning of a 70-year old procedural rule. Reason # 1: Rule 2019 will curb the “influence” of hedge funds in the bankruptcy process This overgeneralization is then coupled with one or more of the other reasons discussed below, which are viewed as being “hedge fund specific.” Nobody can seriously argue that Rule 2019 only applies to hedge funds, or to hedge funds acting as a group. The language of the rule does not support any such construction nor does its legislative history, which predates the modern hedge fund phenomenon. The language applies to any aggregation of “more than one creditor or equity security holder,” whether par or secondary investor, regulated or unregulated, legal person or natural, institutional or private. The language applies equally to (among others) banks, insurance companies, mutual funds, pension funds, employees, retirees, trade creditors, regulatory authorities and individuals. Moreover, firmly embedded in this logic is an assumption that hedge funds are somehow a corrosive influence on the bankruptcy process. The flaws in this assumption far exceed the limited scope of this article, but it is worth noting that it ignores the fact that hedge fund participation in the distressed markets provides an essential source of liquidity for investors seeking to exit investments in financially distressed companies. The secondary market also ensures that participants in the Chapter 11 process consist of those persons who desire to participate, rather than legacy creditors who often want to exit as quickly as possible and will remain silent in the meantime. The truth is, there are only two major participants in the bankruptcy process (not including judges or U.S. Trustees) who often argue that hedge funds are corrosive. The first is the debtor, who would often like nothing more than to chart its own restructuring course on its own terms and timetable with the complicity of a conflicted creditors’ committee. 44 Debtors sometimes resent hedge funds because they are true economic creatures who focus on maximizing the value of the business as it exists today, rather than seeking to protect the “sacred cows” of the past,
Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019 995 to preserve credit relationships going forward, or to maintain management’s employment in the future. The second are existing par creditors who paid face value for their claims and are still involved in the process. Their concerns are far more understandable – will a hedge fund be more interested in making a quick buck based on the discounted price it paid rather than in seeking a higher recovery over time However, this must be balanced against two factors; first, that those same existing creditors greatly welcome the liquidity of their claims that the secondary market provides, and second, that not all hedge funds are alike. To be sure, some hedge funds are short-term investors looking for a quick recovery, and some hedge funds cane, in fact, be disruptive players. Other hedge funds, however, are medium term investors looking for a recovery over time and still others are long-term investors looking to convert their debt into equity. Regardless of their investment strategy, however, hedge funds all look to maximize recovery just as institutional investors do, and the issue is not what they paid for their claim but what they can get for it, whether that means a 10% return or a 200% return (or 90% loss). The fact that they are some disruptive apples should not mean that the full barrel is rotten—quite the opposite. Thus, in reality, there is plenty of room at the table for institutional investor, commercial lender, trade creditor, and hedge fund alike, and it is really the debtor that primarily opposes the participation of secondary market investors in the reorganization process. Reason # 2: Rule 2019 protects other investors’ rights in the same investment Inherent in this rationale is an assumption that ad hoc groups can somehow bind other investors in the same securities. However, in contrast to the “protective committees” that Rule 2019 was designed to regulate, a central feature of ad hoc groups is that they act only in the interest of their members and do not (and cannot) purport to represent any other stakeholder’s interests. Unlike “official” committees that serve in a fiduciary capacity, ad hoc groups are not agents or fiduciaries. Investors outside the group cannot justifiably rely upon the group to protect their interests. That is what the bankruptcy process is for. Ample notice, an opportunity to be heard, and the right to vote one’s own claim are afforded to all stakeholders, regardless of whether an informal group is active in the case. In fact, in the case of an ad hoc group of public noteholders (a/k/a “bondholders,” a common type of ad hoc group), the law is abundantly clear that the group has no ability to bind other bondholders. TIA § 316(b) clearly mandates that no bondholder’s right to repayment can be affected
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Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019

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