Web prepared, posted and Copyright © November 10, 1999, by the American Bankruptcy Institute.

Update on 203 N. LaSalle

By: Deborah L. Thorne
Fagel & Haber

In the July 1999 issue of News & Views, the feature article discussed the U.S. Supreme Court's ruling in Bank of America National Trust and Savings Association v. 203 N. LaSalle Street Partnership, 119 S. Ct. 1411 (1999) (203 N. LaSalle). In 203 N. LaSalle, the Supreme Court reversed an order confirming a plan of reorganization, finding that the plan could not be confirmed because it did not satisfy the requirements of the absolute priority rule—that is to say, the plan did not provide full payment to all creditors, yet the debtor's general partners would retain their ownership of the debtor by paying in some new value to fund the plan. The Supreme Court did not specifically state that the new value exception to the absolute priority rule is still available, but did determine that even if the exception does exist, the plan could not be confirmed because the debtor's general partners had proposed a plan that gave them the exclusive right to maintain ownership of the debtor at a price set by them, without any outside measure of value and without paying all creditors in full. The Supreme Court indicated that some outside measure of value was required, such as allowing creditors to file a plan or an auction of the equity interest, to ensure that owners of a debtor pay market value to retain their ownership in a debtor that does not pay creditors in full.

After 203 N. LaSalle was decided, the case was sent back to the bankruptcy court to comply with the Supreme Court's ruling. The bankruptcy court concluded that the order of confirmation had to be vacated as it related to the debtor and the bank. However, the bankruptcy court refused to vacate the portion of the confirmation order that authorized the payment in full of unsecured trade creditor claims or the transactions between the debtor and its tenants. The effect of the vacation of the confirmation order was to put the debtor and the bank in the same positions they would have been in had the confirmation of the debtor's plan been denied. Further, exclusivity was terminated. Therefore, the bankruptcy court may consider competing plans. It is possible there will be further developments in this case, so stay tuned.

Several courts have already cited 203 N. LaSalle in reported decisions. Notably, one bankruptcy court has applied and extended its holding in another bankruptcy context. In re Mama's Original Foods Inc., 234 B.R. 500 (Bankr. C.D. Cal. 1999), was a case involving a sale of personal property by a chapter 7 trustee. The bankruptcy court cited 203 N. LaSalle as support for the proposition that any sale of assets in bankruptcy must be conducted in a commercially reasonable manner. The chapter 7 trustee in Mama's Original Foods brought a motion to sell personal property to the debtor's former president. The bankruptcy court held that the proposed sale was not commercially reasonable because the trustee did not give notice to all of the creditors and did not advertise the property widely enough. Moreover, the sale procedures required that other bidders make bids in substantial increments, which the bankruptcy court held would chill other bids. The trustee was required to advertise the sale and provide notice to all creditors before seeking an order approving the sale.

At the National Conference of Bankruptcy Judges Annual Meeting, held Oct. 6-8, the 203 N. LaSalle case was featured in several seminars and included in much of the written material presented there. Likewise, the case will be a topic of a seminar to be presented at ABI's Winter Leadership Conference, Dec. 2-4. Please plan to attend the conference to make sure you are adequately prepared to meet the challenges posed by this case.

1999 Winter Leadership Conference UTC Committee Meeting Agenda

The UTC Committee will meet at the 1999 Winter Leadership Conference in La Quinta, Calif., on Saturday, Dec. 4, 8:00-9:15 am. The agenda for the meeting follows below:

I. Ad Hoc Task Force—Tom Grace, Locke Liddell & Sapp LLP, Dallas
II. Assignment for the Benefit of Creditors (ABC) Project—Geoffrey Berman, Development Specialists Inc., Los Angeles
III. Reclamation Project—Bruce Nathan, Davidoff & Malito LLP, New York
IV. Report on Publications—Lynnette Warman, Jenkens & Gilchrist P.C., Dallas
V. NACM Legislative Conference Plans—Sandra Schirmang, Kraft Foods Inc., Northfield, Ill.
VI. Preference Project Update—Judy D. Thompson, Poyner & Spruill, Charlotte, N.C.
VII. CLE Presentation: "Revisions to Article 9 Affecting Unsecured Trade Creditors: A Review of Selected Provisions"
Lynnette Warman; Mark V. Bossi, Thompson & Coburn, St. Louis

Notice: New Rule Regarding Asset Sales

By: Deborah L. Thorne
Fagel & Haber

Federal Rule of Bankruptcy 6004, which applies to asset sales in bankruptcy cases, has been amended. Effective Dec. 1, 1999, a new section, §(g), will be added, which states as follows:

An order authorizing the use, sale or lease of property other than cash collateral is stayed until the expiration of 10 days after entry of the order, unless the court orders otherwise.

As a result of this amendment, persons buying assets from an estate will not only have to wait 10 days for a final order (which is what they do now), but under the new rule, they won't even have an order for 10 days. The Committee Notes state that the property may be used, sold or leased immediately in accordance with the court order. While this is not a drastic change to the rules, it is important to keep this in mind.

The "Nuts & Bolts Creditors' Forum" is a feature that contains questions relating to credit issues and their suggested solutions. Questions or comments to be included in future newsletters are welcome. Question: Can members of a creditors' committee sell their claims or buy additional claims against an estate? Answer: There is no clear answer as to whether a committee member can buy or sell claims against the bankruptcy estate. Prior to the enactment of the Bankruptcy Code, under §§212 and 249 of the old Bankruptcy Act, committee members were restricted in their ability to trade claims of a debtor entity. However, when Congress enacted the Bankruptcy Code, these sections were not included in the new code. Instead, Rule 3001(e) of the Federal Rules of Bankruptcy Procedure was put in place. Although designed to govern the transfer of claims, this Rule does not restrict claims trading by committee members. As a result, claims trading by committee members is no longer clearly restricted. But is it permissible? It is clear that every member of a creditors' committee has a duty to balance the pursuit of its own interests with its efforts to maximize distributions to the creditors represented by the committee. As a result, members of the creditors' committee, as fiduciaries for the creditors represented, are prohibited from using their position to advance their own individual interests. In re Haskell-Dawes Inc., 188 B.R. 515, 522 (Bankr. E.D. Pa. 1995); In re Enduro Stainless Inc., 59 B.R. 603 (Bankr. N.D. Ohio 1986). See, also, Committee of Creditors v. Citicorp Venture Capital Ltd., 160 F.3d 982 (3d. Cir. 1998) (accepting, arguendo, that the purchase of notes at a discount by a fiduciary of a debtor is not improper under all circumstances). Each committee member also has a legitimate right to look out for its own interests, both in the capacity as a creditor with a claim against the estate and in the role as a representative of his or her employer, which imposes a fiduciary duty to that company's shareholders. Without freedom of action, few creditors would be willing to serve on a creditors' committee. Such freedom of action is particularly important for institutional investors, whose resources, both financial and human, make them ideal candidates for committee membership. One recent case provides some guidance to committee members faced with this issue. In In re Nationwide Sports Distributors Inc., 227 B.R. 455 (Bankr. E.D. Pa. 1998), the debtor filed a motion seeking approval of a settlement with the seven creditors who had filed an involuntary petition against the debtor. After an order for relief was entered, the petitioning creditors and two other creditors were appointed as members of the official committee of unsecured creditors. As part of the proposed settlement, the petitioning creditors agreed to sell their claims to an insider of the debtor in return for a payment of 71 percent of their claims. In contrast, other unsecured creditors could expect to receive a payment of only 40 percent of their claims under a liquidating plan. The trustee and certain creditors objected to the proposed settlement, contending that the settlement terms violated the fiduciary duties of the committee members. The bankruptcy court refused to approve the settlement, noting that the claims assignment might make it appear to other creditors that a participating committee member was using information available only to committee members or was using its status to further its own interests at the expense of those creditors. In re Nationwide Sports Distributors Inc., 227 B.R. at 465. The court noted that "[o]nce a creditor becomes a committee member, its fiduciary obligations may constrain its behavior from that which might otherwise be permissible." In re Nationwide Sports Distributors Inc., 227 B.R. at 464. "[A] committee member must be mindful of this fiduciary responsibility and must avoid acting upon any matter which may result in a benefit to him in particular as opposed to the members of the class which he represents..." Id. at 464, quoting DeNatale, "The Creditors' Committee under the Bankruptcy Code—A Primer," 55 Am. Bankr. L.J. 43, 56-57 (1981). The court stated that, based on the evidentiary record and the issue before it, no conclusions could be reached as to "whether the petitioning creditors would breach any duties were they to act in accordance with their proposed settlement..." Id. at 465. However, because the debtor proposed a much smaller dividend to unsecured creditors than to the petitioning creditors, among other things, "to the extent that the proposed compromise would permit a breach of fiduciary duties," the court noted that the settlement should not be approved, as it could not be in the best interests of all creditors and of the estate. As a guideline for testing actions by committee members, another court has utilized a three-part test for usurpation of a corporate asset by a corporate fiduciary—the "corporate usurpation test." In re El Paso Refinery L.P., 196 B.R. at 58, 74 (Bankr. W.D. Texas 1996) (but noting that the rule should not be applied in a way that would chill active participation on committees). Under the corporate usurpation test, a corporate fiduciary must (i) disclose the proposed transaction, (ii) obtain the consent of the represented parties and (iii) demonstrate that the proposed act is not detrimental to the corporation. In a bankruptcy setting, the test might be modified such that a committee member contemplating the sale or purchase of claims against the debtor must (i) disclose the proposed transaction to the committee and the court, (ii) establish that the proposed transaction is in the best interests of the creditors represented and of the estate and (iii) obtain the court's approval of the transaction. Cases suggest that courts tend to look more favorably on a committee member's efforts to sell, rather than buy, claims. However, both transactions engender a perception that the member is trading on insider information. But presumably, a member would sell its claims into a market available to other similarly situated creditors. Under this scenario, other creditors are afforded the same opportunity to "profit" as the selling committee member. On the other hand, a committee member who buys claims from fellow creditors probably does so with the knowledge and expectation that the actual value of the claim exceeds the consideration paid. In doing so, the committee member/purchaser may profit, or appear to profit, at the expense of creditors for whom he or she is a fiduciary. In sum, these situations demand that a committee member engage in careful thinking and legal analysis before selling its claim, in order to protect that committee member from even the appearance of impropriety. Answer provided by Joseph M. Coleman and Robert J. Taylor Kane, Russell, Coleman & Logan P.C., Dallas.

UTC Committee Meeting Calendar

The UTC Committee will meet at the following upcoming conferences:

• Dec. 4, 8:00 am: ABI Winter Leadership Conference, La Quinta Resort & Club, La Quinta, Calif.
• March 2000: NACM Legislative Conference, Washington
• April 27-30, 2000: ABI Annual Spring Meeting, J.W. Marriott, Washington

The next issue of News & Views will be published in February. Call Lynnette Warman at (214) 855-4792 or send an e-mail message to lwarman@jenkens.com for more information.