Chapter 11 Working Group Proposal #14: Elimination of Prohibition on Nonvoting Equity
Securities
In its list of mandatory contents of a plan of reorganization, section 1126(a) of the
Bankruptcy Code requires that the reorganized debtor’s charter contain a provision that
prohibits the debtor from issuing nonvoting stock. [
FN: 11 U.S.C. §1123(a): "Notwithstanding any otherwise applicable
nonbankruptcy law, a plan shall - . . . (6) provide for the inclusion in the charter of the debtor, if
the debtor is a corporation, or of any corporation referred to in paragraph (5)(B) or (5)(C) of this
subsection, of a provision prohibiting the issuance of nonvoting equity securities, and providing,
as to the several classes of securities possessing voting power, an appropriate distribution of such
power among such classes, including, in the case of any class of equity securities having a
preference over another class of equity securities with respect to dividends, adequate provisions
for the election of directors representing such preferred class in the event of default in the
payment of such dividends. "] This provision has been the subject of
criticism and appears to serve no useful function in the present system.
The Recommendation
Congress should amend section 1123(a)(6) to eliminate the requirement that the charter
of the reorganized corporate debtor prohibit the issuance of nonvoting equity securities.
Section 1123(a)(6) should otherwise remain unchanged.
Reasons For The Change
Section 1123(a)(6) had its roots in a similar provision in the Bankruptcy Act of 1898.
[ FN: In re Acequia Inc., 787 F.2d
1352 (9th Cir. 1986) (noting that section 1123(a)(6) was derived from 11 U.S.C. §616 of
Bankruptcy Act of 1898 and copied almost verbatim), citing S.Rep. No. 95 - 989, 95th Cong., 2d
Sess. 119, reprinted in 1978 U.S. Code Cong. & Ad.News 5787, 5905 (indicating interest in
ensuring that investors were able to maintain voice in selection of management of reorganized
firm).] In the 1930s, Congress and the Securities and Exchange
Commission feared that insiders retained too much control over reorganization to the exclusion of
public stockholders. [ FN: See 7 Collier on
Bankruptcy ¶ 1123.01[f][6] (1996); S.E.C. Report on the Study and Investigation of the
Work, Activities, Personnel and Functions of Protective Committees, Part I, 903 (1937), Part
VIII 156 (1940).] The prohibition on nonvoting stock was intended to
promote the fair distribution of voting power to elect managers of a reorganized debtor. While
this provision may have served that function in the 1930s, the multiplicity of corporate structures
used today, along with the active participation of classes of creditors negotiating for equity
participation, leave the provision with little relevance in the modern corporate world. [ FN: Accord, Ginsberg & Martin on Bankruptcy,
§13.09[H] (Supp. 1997) ( "These provisions, which are a carryover from old chapter X and
represent the thinking of the Securities and Exchange Commission in the 1930s about how large
publicly held corporate debtors are reorganized, are archaic ").] The
inclusion of this provision in the Bankruptcy Code has been thesubject of much question, [ FN: See, e.g., Letter of May 8, 1997 to Brady
Williamson from L.E. Creel, III (deeming the provision ’s inclusion to be a "glitch "); 7
Collier on Bankruptcy ¶ 1123.01[f][6] (1996) ( "It is suggested that the inclusion of section
1123(a)(6) was not well considered and represents an intrusion of the paternalistic hand of
chapter X into practice under chapter 11 of the Bankruptcy Code "); Kenneth N. Klee, "Adjusting
chapter 11: Fine Tuning the Plan Process, " 69 Am Bankr. L. J. 551, 555 (1995) (noting that this
"anomalous " provision was retained as political concession).] and there
seems to be little evidence that this prohibition has been beneficial. First, it is easily circumvented;
for example, a debtor might create a voting trust or issue preferred stock with limited voting
rights and still be in compliance with the law. [
FN: See Richard L. Epling, "Fun with Nonvoting Stock, " 10 Bankr. Dev. J. 17, 20
(1993/1994) (noting existence of case law permitting creation of restrictive voting trusts in
connection with plan, and describing other methods that comply with the section 1123(a)(6)
restrictions but potentially disenfranchise common shareholders); The National Bankruptcy
Conference, Reforming the Bankruptcy Code: The National Bankruptcy Conference ’s
Code Review Project 290 (1994); Kenneth N. Klee, "Adjusting chapter 11: Fine Tuning the Plan
Process, " 69 Am Bankr. L. J. 551, 555 (1995) (noting confusion over whether securities with
only limited voting rights satisfy the section 1123(a)(6) requirement).]
Second, chapter 11 specifically provides tools that deal with the earlier concerns of Congress and
the S.E.C. For example, the remainder of section 1123(a)(6) and 1123(a)(7) [ FN: 11 U.S.C. §1123(a)(7) provides that a plan
shall "contain only provision that are consistent with the interests of creditors and equity securities
holders and with public policy with respect to the manner of selection of any officer, director, or
trustee under the plan and any successor to such officer, director, or trustee.
"] more effectively address the concern of excessive insider control over
management, as do the Code’s disclosure and confirmation requirements, which provide
parties with more direct means to prevent disenfranchisement. Some commentators also have
noted that a literal reading of the charter provision requirement is especially problematic when the
debtor is being acquired by a pre-existing corporation that was not organized for the purpose of
making this acquisition. [ FN: See Ginsberg
& Martin on Bankruptcy, §13.01[H] at 13-61 (Supp. 1997).]
There also may be valid reasons to make nonvoting stock available to parties in interest. This
is an issue that arises in large cases, where all parties will be benefitted by the availability of a full
panoply of corporate ownership tools, and becomes particularly crucial when the debtor proposes
to issue new stock to the unsecured creditors in full or partial satisfaction of their claims. [ FN: See Richard L. Epling, "Fun with Nonvoting
Stock, " 10 Bankr. Dev. J. 17 (1993/1994).] Some creditors, such as
banks, are not permitted to hold voting securities. [
FN: 12 U.S.C. §1843.] The workout process also would be
facilitated if there were greater flexibility in dealing with a debtor’s securities. [ FN: Letter of May 8, 1997 to Brady Williamson from
L.E. Creel, III. See also Epling, at 21 (noting that primary issue should be whether creditor class
votes to accept nonvoting stock).]
Competing Consideration
Some parties might believe that Congress’ concerns in the 1930s regarding insider
control may hold true today and warrant protections against disenfranchisement. Even if one
thinks that this is the case, however, other requirements of chapter 11 are more responsive to this
concern than this provision in section 1123(a)(6), which seems to be an easily-circumvented and
ineffective solution to the alleged insider control problem.
|
|
