navigating ethical challenges in contested restructurings: when stakeholders employ ethics as a...

Navigating Ethical Challenges in Contested Restructurings:

When Stakeholders Employ Ethics as a Sword

November 28, 2011

Eighteenth Annual

Distressed Investing 2011Maximizing Profits in the Distressed Debt Market



Van E. ConwayChief Executive Officer

Conway MacKenzie

Lois R. LupicaMaine Law Foundation Professor of Law

University of Maine Law School

Michael A. FederManaging DirectorAlixPartners LLP

Edward T. GavinPrincipal

NHB Advisors, Inc.

Panel Moderator

John Wm. (“Jack”) Butler, Jr.Partner

Skadden, Arps, Slate, Meagher & Flom LLP

Discussion Topics

Defining ethics and why it matters The differences between connections, differing interests and

materially adverse interests Applying ethics rules to non-lawyers Update on the ABI National Ethics Task Force Selected ethics rules and revisiting the Universal Building Products

decision Commentary on Amended Bankruptcy Rule 2019 effective

December 1, 2011 – Disclosures regarding creditors and equity security holders

Deconstructing the Code: Ethics as a Sword

Topic 5

Defining “Ethic”

noun, \e-thik\“a set of moral principles; a theory or system of moral values (as in, ‘the present-day materialistic ethic’); the principles of conduct governing an individual or group (as in ‘professional ethics’).”

Assumes that a group has decided upon a specific moral code by which to be commonly bound.

Restructuring Stakeholders

Company

Equity Committee

Official Committee of

Unsecured Creditors

Unsecured Creditors

Shareholders

Ad Hoc Committee

Members of Ad Hoc

Committee

Steering Committee/

Agent

Secured Creditors

Indenture Trustee

Bondholders

Range of “Connectivity”

Interest Adverse to the

Estate

DifferingInterest

Connection

Differing Interest

Connection

No Connection

MateriallyAdverse Interest

to the Estate(not disinterested)

Disqualified

Fed. R. Bankr. P. 2014 requires disclosure of all connections that are not de minimis.

A lawyer shall not represent a client if such representation involves a “differing interest” unless certain waiver requirements are met.

Debtors’ counsel must be attorneys “that do not hold or represent an interest adverse to the estate, and that are disinterested persons.” 11 U.S.C. § 327(a). Section 101(14)(C) defines a “disinterested person” as a person that “does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason. ” The Bankruptcy Code specifically authorizes an attorney to concurrently represent a debtor-in-possession and a creditor (in an unrelated matter). 11 U.S.C. § 327(c) (“[A] person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.”).

Applying Ethics to Members of Trade Associations (including

non-lawyers) Example, the Turnaround Management Association

has three broad sections: Canon I – Obligations to Professionalism

– Ethical Standard 1.4 – Human Rights Canon II – Obligations to the Client

– Ethical Standard 2.2 – Independence– Ethical Standard 2.4 – Candor & Truthfulness– Ethical Standard 2.7 – Ownership

Canon III – Obligations to the Profession– Ethical Standard 3.1 – Prohibition on Referral

“Consideration”

The Rules of Professional Conduct

The TMA Code of Ethics draws from the ABA Model Rules for Lawyers: Model Rule 1.10 – Conflicts of Interest Model Rule 1.4 – Communications Model Rules 7.3 & 8.4, taken together

Established by the American Bar Association (ABA) as “Model Rules”.

Adopted in some form by individual states as ethics rules.

ABI National Ethics Task Force

Consider ethics issues in bankruptcy practice and make recommendations for uniform standards where appropriate

Why a Task Force at all? Bankruptcy practice has significantly evolved since the MRPC and

many local rules were promulgated Bankruptcy is now a multi-jurisdictional, if not multi-national,

practice ABA standards, “developed primarily for nonfederal,

nonbankruptcy courts by unelected and nonjudicial parties, are ill-adapted to federal bankruptcy proceedings.” (Ninth Circuit Court of Appeals, In re Nguyen)

Increased discussion, nationally, regarding adoption of civility guidelines (such as those adopted in E.D. NY)


Initial Focus: Competence to practice bankruptcy law Conflicts of interest Disclosure Issues Fee arrangements Supervision of legal and non-legal staff Limited representation Volume practice issues Multi-jurisdictional practice Committee solicitation & representation Fiduciary duties owed by professionals


Committees established to address areas of focus: Conflicts of Interest Retention, Disclosure & Fee Arrangements Creditors’ Committees Consumer Limited Representation/Multijurisdictional Practice Discipline, Sanctions & Competence


Proposal for consideration of the need for a “National Bankruptcy Bar” Response to the growing number of instances of attorneys

sanctioned for ethics and/or civility lapses, including:– Insulting the Court;– Fee-related lapses and violations of fiduciary duties;– Sloppy paperwork;– Unlawful practice of law by non-attorneys;– Impermissible limitations on scope of representation

Could use Fed. R. Bankr. P. 9029 as a basis Ability to practice in Bankruptcy Court of any District would be

subject to a set of national standards in addition to Local Rules and underlying State Rules

Taken up by Federal Rules Committee for consideration

ABA Model Rule 1.10

CONFLICTS OF INTEREST

– 1.10(a) states generally that a firm of many professionals is essentially one professional for purposes of establishment of conflicts of interest (i.e., a conflict on the part of a single professional is a conflict to the entire firm) unless:

» the professional with the conflict is timely screened from the conflict, and

» written notice is promptly given to the other client to enable them to ascertain compliance with this Rule

Doesn’t apply to non-attorneys, but is a good thing to keep in mind in restructuring practice

ABA Model Rule 1.4

COMMUNICATIONS

– (a)(2) [A lawyer shall] reasonably consult with the client about the means by which the client’s objectives are to be accomplished;

– (a)(3) [A lawyer shall] keep the client reasonably informed about the status of the matter;

– (a)(5) [A lawyer shall] consult with the client about any relevant limitation on the lawyer’s conduct when the lawyer knows that the client expects assistance not permitted by the Rules of Professional Conduct or other law

– (b) A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.

ABA Model Rules 7.3 & 8.4

RULE 7.3 - PROFESSIONAL CONTACT WITH PROSPECTIVE CLIENTS

A lawyer shall not by in-person, live telephone or real-time electronic contact solicit professional employment from a prospective client when a significant motive for the lawyer’s doing so is the lawyer’s pecuniary gain, unless the person contacted: (1) is a lawyer; or (2) has a family, close personal, or prior professional relationship with the lawyer.

RULE 8.4 - PROFESSIONAL CONTACT WITH PROSPECTIVE CLIENTS

It is professional misconduct for a lawyer to:(a) violate or attempt to violate the Rules of Professional Conduct, knowingly assist or

induce another to do so, or do so through the acts of another…

Retention Risks When Soliciting

Potential Committee Members

A recent Delaware Bankruptcy Court opinion, In re Universal Building Products, provides a cautionary example to professionals seeking committee representation

In Universal Building Products, the court found that counsel had used a proxy to solicit potential members of a creditors’ committee

The court denied counsel’s retention application based on both ethical grounds and lack of disclosure



The Court found that counsel had violated a rule of professional conduct prohibiting certain forms of direct solicitation of prospective clients In particular, the court focused on counsel’s lack of a

prior relationship with the creditors Counsel and some commentators have argued that this

impinges on counsel’s First Amendment rights due to the sophistication of the parties



The court also found that disqualification of counsel was appropriate because counsel failed to provide adequate disclosure regarding connections with the proxy who solicited potential committee members The court emphasized the importance of complete

disclosure of all contacts Counsel’s subsequent disclosure of relationship with

proxy did not cure the initial defective disclosure

Rule 2019 – Where We Are Now

2007 – Northwest Airlines – Court applies Rule 2019 to ad hoc committee of equity security holdersScotia Development – Court finds Rule 2019 in applicable to ad hoc committee of noteholders

1930s to 2007 – Relative quiet in 2019 Litigation

2009 – LyondellBasell – Court orders an ad hoc group to disclose members’ bond and credit default swap positionsWashington Mutual - Court applies Rule 2019 to ad hoc committee of noteholders

1937 – Original Rule 2019 Enacted

Aug. 2009 - Significant revisions to Rule 2019 announced

2009-2011 – Revisions to Rule 2019 proposed and

comments solicited

2007 to 2010 – Rash of conflicting decisions

regarding application of Rule 2019

2010 – Six Flags - Court holds ad hoc group is beyond the scope of Rule 2019Accuride – Court compels ad hoc group of noteholders to make Rule 2019 disclosures but denies sanctions pending disclosure

2008 – Sea Containers - Court orders group of investment managers to disclose aggregate holdings and acquisition dates but not individual noteholders or prices

Dec. 1, 2011 - Amended Rule 2019 takes effect

Key Elements -- Amended Rule 2019

The amended rule includes the term “disclosable economic interest,” which is intended to clarify and expand the scope of the rule beyond direct claims or interests to include derivatives, participations, pledges, options and other indirect interests held by entities, committees and groups that fall within the disclosure obligations of the rule

The amended rule defines the meaning of “represent” in connection with a case under chapter 9 or chapter 11 of the Bankruptcy Code, which definition 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

The amended rule modifies the disclosure requirements under the current rule by reducing the level of specificity of information required concerning the prices and dates of acquisition of claims and interests in the debtor

The amended rule does not require the disclosure of price paid for a disclosable economic interest

However, nothing in the amended rule precludes either the discovery of purchase prices and other similar information when it is relevant or its disclosure when ordered by the court pursuant to authority outside of the amended rule

Former vs. Amended Rule 2019

Former Rule 2019 Amended Rule 2019

Title: Representation of Creditors and Equity Security Holders . . .

Title: Disclosure Regarding Creditors and Equity Security Holders . . .

Adds new subsection (a): “disclosable economic interest” means any claim, interest, pledge, lien, option, participation, derivative instrument or 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”

Coverage:

Covers every entity or committee representing more than one creditor or equity security holder and (unless otherwise directed by the court) every indenture trustee

Excludes official committees under sections 1102 and 1114

Coverage: Covers every entity, group or committee that consists of or represents, and every entity that represents (by taking a position before the court or soliciting votes for or against a plan), multiple creditors or equity security holders that are acting in concert to advance their common interests, and not composed entirely of affiliates or insiders of one another.

Excludes official committees under sections 1102 and 1114, indenture trustees, agents under loan agreements, class action representatives and governmental units

Former vs. Amended Rule 2019

Former Rule 2019 Amended Rule 2019

Required Disclosures:

(1) Name and address

(2) Nature and amount of claims or interests

(3) Time of acquisition (unless acquired more than 1 year pre-petition)

(4) Pertinent facts and circumstances in connection with the employment of the entity

(5) In the case of a committee, the name or names of the entities at whose instance the employment was arranged or the committee was organized

(6) 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 therefor, any sales or other disposition thereof

(7) The instrument, if any, empowering the entity, committee or indenture trustee to act on behalf of creditors or equity security holders

Required Disclosures:

(1) Name and address of each entity and each member of a group or committee

(2) For the entity and each member, 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 as of the date of the verified statement

(3) 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, the date of acquisition by quarter and year of each disclosable economic interest, unless acquired more than one year before the petition was filed

(4) Pertinent facts and circumstances in connection with the employment of the entity and the name or names of the entities at whose instance the group committee was formed or has agreed to act

(5) The instrument, if any, empowering the entity, committee or indenture trustee to act on behalf of creditors or equity security holders

Debate Over Amended Rule 2019

The general argument in support of the amended rule was expressed by Judge Gerber of the S.D.N.Y.:

“When anyone in the case professes to speak on what is best for the estate . . . and/or to influence the outcome of the case, its private agenda can matter. If it does not want to reveal basic information as to its holdings in the case (which are an important indicator of ‘where it is coming from’ in connection with the position it advocates), it should not be trying to influence the court”

The general argument against the amended rule is that the disclosures required by the amended rule, while less onerous than the original proposed rule, will decrease participation in distressed markets, to the detriment of creditors and debtors alike. Critics argue that courts should make determinations based on the merits of a party’s argument without regard to the party’s motivation, or “where it is coming from”

Deconstructing the Code

-- How does an ethical turnaround professional negotiate and collect a “success fee” in an engagement? Does it matter if the “success fee” is expressed as a percentage or share of proceeds from a transaction such as a financing or a sale?

-- Is it ethical for the principals of a firm that provides the entire spectrum of “restructuring work” to have a separate fund that provides capital and/or buys troubled clients? In what circumstance would this be ethical? Unethical?

-- Is it ethical for a person to use applicable ethics rules as a “sword” for tactical/strategic purposes? It is ethical for an attorney or other restructuring professional to assist a principal to execute such a tactic?



November 28, 2011

Eighteenth Annual

Distressed Investing 2011Maximizing Profits in the Distressed Debt Market

navigating ethical challenges in contested restructurings: when stakeholders employ ethics as a...

Documents

professional ethics

connection differing

estate differing

committee members of

adverse interests

class of creditors

differing interests

meagher flom llp slide