Article preview
The New Wave of Equity Committees in Bankruptcy: What Are They and Are They Here to Stay?
Bob Rajan, Director, PricewaterhouseCoopers Corporate Advisory and Restructuring LLC, New York, USAIntroduction
In recent months, several high-profile bankruptcy cases have involved the appointment of a formal equity committee.
Historically very rare, the formation of an ad hoc and/or appointment of a formal equity committee appears to have recently taken the US bankruptcy world by storm and will likely impact how future restructurings are handled.
Since 2000, equity committees have formally been appointed in several US bankruptcies, including Mirant Corporation, Loral Space & Communications Limited, Trump Hotels and Casinos, Kmart Corp., USG Corp., Interstate Bakeries Corporation, Calpine Corporation, Oneida Ltd., OCA, Inc., Dana Corporation and Delphi Corp. The formation of these equity committees has acted and may continue to act as an obstacle in any consensual restructuring plan developed by a debtor for itself and its creditors.
Generally speaking, Chapter 11 is a mechanism whereby an overleveraged debtor will utilise the US Bankruptcy Code (the ‘Code’) to settle or compromise its debts and emerge stronger as a healthier and hopefully viable entity. Chapter 11 allows a debtor-in-possession to obtain relief from its creditors, negotiate its past due obligations, typically in the form of cash and/or future equity of the reorganised debtor, and rehabilitate itself. Consequently, if bankruptcy is a tool that creditors use to protect their interests, should shareholders, who typically receive nothing in a restructuring, have similar rights in these proceedings?
The reason and rationale for equity committees
It is well established that the board of directors of a solvent corporation has a fiduciary duty to its shareholders.
However, when a company enters the ‘zone of insolvency’, it is primarily due to the fact that a company may not be able to pay its debts as they become due and accordingly, the fiduciary duty now extends to its creditors. Pursuant to the absolute priority rule in the Code, shareholders are forced to the bottom of the hierarchy and in most cases are forgotten in the process.
Since the end game is for all stakeholders to obtain some value of the reorganised entity, the introduction of an equity committee has the potential to promote conflicts regarding the valuation of an enterprise and its future ownership structure. Many shareholders use this conflicting fiduciary duty of when a solvent corporation enters the zone of insolvency and the resulting change of fiduciary duty, as its first and foremost basis for the immediate appointment of an equity committee. Equity participants believe that their interests are not adequately protected upon insolvency and therefore feel it necessary to have a formal seat at the negotiating table.
Notwithstanding the above reasoning, it is unclear and somewhat confusing why equity committees were appointed in certain cases and not in others. For example,the US Bankruptcy Court declined the formation of equity committees in such mega-cases as WorldCom Inc., Enron Corp., Global Crossing Ltd., UAL Corporation and Lernout & Hauspie Speech Products N.V. Whilst it goes without saying that the appointment of formal equity committees include costs that will be borne by the debtor and, if the equity ultimately receives no distribution, by the creditors, some professionals argue that the majority of distressed equity players are large institutions and/or distressed funds who can afford their own advice and, for that reason, their associated professional fees should not be charged to the bankrupt estate at all.
Copyright 2006 Chase Cambria Company (Publishing) Limited. All rights reserved.