Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019

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986 Norton Journal of Bankruptcy Law and Practice [Vol. 16] Congress adopted the SEC Report’s recommendation to combat “protective committees” by adopting § 210 and § 211 of Chapter X of the Bankruptcy Act, which subsequently were combined in the form of Rule 10-211 (under Chapter X), the text of which is virtually identical to Bankruptcy Rule 2019. 13 BANKRUPTCY RULE 2019 Rule 2019 provides, in relevant part, that: every entity or committee representing more than one creditor... shall file a verified statement setting forth (1) the name and address of the creditor...; (2) the nature and amount of the claim or interest and the time of acquisition thereof...; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity or entities at whose instance, directly or indirectly, the employment was arranged or the committee was organized or agreed to act; and (4) with reference to the time of the employment of the entity, the organization or formation of the committee ... the amounts of claims or interests owned by the entity, the members of the committee ... times when acquired, the amounts paid therefore, and any sales or other disposition thereof. The statement shall include a copy of the instrument, if any, whereby the entity, committee, or indenture trustee is empowered to act on behalf of creditors or equity security holders. 14 AD HOC GROUPS AND RULE 2019—THE NORTHWEST AIRLINES DECISION Holders and purchasers of distressed securities frequently form unofficial or ad hoc groups in connection with Chapter 11 cases. These informal arrangements permit parties with similar interests to coordinate action and, where there is group consensus, to speak with one voice through common counsel. It also permits the group to share the professional fees and other costs of such participation, thus both achieving the economies of shared expense and avoiding the inefficiencies of separate counsel for similarly situated creditors. These ad hoc groups are often formed before a bankruptcy filing—very often at the debtor’s request— for the purpose of facilitating restructuring discussions that may or may not involve an eventual bankruptcy filing. The ad hoc nature of such groups typically means that they rarely involve any duties relating to group membership other than privilege, confidentiality and sharing expenses. Members are typically free to join and withdraw as they see fit and are not individually bound by any deci-
Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019 987 sion of the majority of the group. Unlike “protective committees” of the past, ad hoc groups cannot (and do not purport to) represent the rights of any party who is not a member of the group. Further, despite the fact that these groups are often referred to as ad hoc “committees,” many practitioners have always believed that Rule 2019 was not intended to apply to these informal groups because they do not act in a representative/fiduciary capacity. Nonetheless, counsel to ad hoc groups customarily file voluntary Rule 2019 statements disclosing the identity of the group’s members and their holdings in the aggregate so that other parties in the case can be assured of the make-up and size of the group. Because of this well-established practice, in the approximately 70 years since the promulgation of the predecessor to Rule 2019, only a few courts had addressed Rule 2019 in the context of a law firm representing multiple creditors, 15 and no court prior to the Northwest Airlines decision had issued a published decision applying Rule 2019 to an ad hoc committee. Thus, the Northwest Airlines decision’s sudden mandate of extensive public disclosures was a surprise. According to the Northwest Airlines decision, Rule 2019 requires each member of an ad hoc committee to publicly disclose its specific holdings as well as the timing and amount paid to acquire such holdings. In addition, Rule 2019 is a continuing disclosure rule that, when applicable, requires periodic updates of the disclosure as members of the group purchase or sell holdings. The Northwest Airlines court rejected the notion that Rule 2019 only applied to committees (like “protective committees”) that acted in a representative and fiduciary capacity. Instead, the court concluded that the rule applied to any collective action where the committee sought to be “taken seriously” in the bankruptcy process. The Northwest Airlines decision was heavily fact-specific, but the decision does not appear to be limited to the Northwest Airlines facts. Instead, read most broadly, the decision could apply to virtually any group of parties (clearly not just hedge funds) who act in a coordinated manner through common counsel. Needless to say, the Northwest Airlines decision “sent shock waves through the distressed debt community” 16 and led to concerns that it “is likely to be used by other debtors as a tool against ad hoc groups in future cases.” 17 THE SCOTIA DEVELOPMENT DECISION Investors’ concerns were quickly validated in In re Scotia Development where the debtor, Scotia Pacific Company LLC (Scopac), wasted no time in raising the Northwest Airlines decision against an organized group of its public noteholders.
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Ad Hoc Committees and the Misuse of Bankruptcy Rule 2019

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