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Creditor Groups Under Attack: The WaMu Double Whammy
December 7, 2009
In an Opinion issued on December 2, 2009 in the Washington Mutual, Inc. ("WaMu") Chapter 11 case, the Delaware Bankruptcy Court held that Bankruptcy Rule 2019 clearly applies to "ad hoc committees," regardless of how they might try to disclaim collective action. As a result, the members of an informal group of WaMu bondholders must now provide detailed information concerning their holdings, including a history of when they bought and sold their bonds and the prices paid. Perhaps more importantly, the Opinion packs a second bombshell. According to the Court, members of an ad hoc creditor group owe a fiduciary duty to other creditors holding the same class of claims but who are not members of the group. The WaMu Opinion can be found here.
We have written extensively on the historical underpinnings of Bankruptcy Rule 2019 and the split of authority as to whether Rule 2019 applies to "ad hoc committees" such as noteholder and lender groups, and we have come down squarely on the side that Rule 2019 does not apply to ad hoc committees or, at least, it should not apply. Here are links to four articles that we have written: 2019 Article 1, 2019 Article 2, 2019 Article 3 and 2019 Article 4. Regardless of the ultimate resolution of that split, however, the new concept that members of an informal group owe fiduciary duties to other creditors is stunning and it is the latest and possibly most potent weapon available to those desiring to silence the views of potentially dissident creditors.
Syndicated loans, public note issuances and private note placements invariably involve multiple debt holders with varying economic interests, and when defaults ensue, the debt often trades at varying discounts over time. As a result, when such financings must be restructured, efficient organization of informal groups of the debt holders is crucial in order to ensure broad input from a cross-section of par and secondary holders, including institutional investors and hedge funds. Indeed, outside of bankruptcy it is often the borrower/issuer that seeks the formation of informal groups in order to seek to achieve broad consensus on a restructuring approach.
At the same time, whether outside of or within bankruptcy, no informal group has ever insisted that it has the ability to bind any creditors other than the group members themselves on a voluntary basis. Out-of-court exchange offers and consent solicitations, and in-court restructuring proposals, still need to be voted on and accepted by the requisite majorities of all creditors of the same class, not just by the members of the informal group. Ascribing fiduciary duties to group members therefore represents a double whammy – the group members do not have (and do not want to have) any control over non-group members and yet the WaMu Opinion opines that they owe duties to those non-group members. In the words of the Court:
It is not necessary, at this stage, to determine the precise extent of fiduciary duties owed but only to recognize that collective action by creditors in a class implies some obligation to other members of that class.
With all due respect to the Court, this is a frightening conclusion. The law traditionally imposes fiduciary duties only in limited circumstances where the dynamics of a special relationship justify imposing a standard of conduct upon certain parties to the relationship. For example, a board of directors is a fiduciary to a corporation's shareholders and an official committee of unsecured creditors appointed under section 1102 of the Bankruptcy Code owes a fiduciary duty to the larger body of unsecured creditors whose interests it "represents" in the bankruptcy case.
Conversely, two or more creditors seeking to coordinate their actions in a Chapter 11 reorganization by appearing through common counsel simply have no special relationship to other creditors who hold the same investment but are not part of the creditor group. Such creditors should not be held to any special standard of conduct and, in the particularly litigious atmosphere of today's Chapter 11 cases, creditors should not be exposed to potential liability to other investors for no reason other than that they have sought to coordinate efforts and reduce legal costs.
It bears noting that the Opinion's statement about fiduciary duties appears to be dicta and therefore should not be treated by other courts as a substantive ruling given that it was not necessary for the court to reach a "fiduciary duty conclusion" in order to decide the broader Rule 2019 issues. After all, the litigation was about disclosure issues, not a claim about fiduciary duties. Nonetheless, creditors should be aware of this development as they seek to protect their interests in Delaware bankruptcies and potentially elsewhere.
Debtors may welcome the WaMu decision as a substantial weapon at their disposal, but they should be careful what they ask for. In most large cases these days, the official creditors' committee seldom includes representatives with a material economic interest in public bond classes or loan syndicates. The WaMu decision makes it less likely that informal bondholder and lender groups will form, for fear of incurring duties to other creditors. In that case, how can the debtor engage in meaningful discussions with its largest creditor constituencies? Is it really the desire of debtors to silence the voices of the very creditors whose input they need in order to propose a plan that will likely be acceptable to those creditors with the greatest economic interests? If this is truly the import of Bankruptcy Rule 2019, then Rule 2019 urgently needs amendment.