When a business's prospects take a turn for the worse, its bankruptcy may be in the offing. But the road to bankruptcy can be a lengthy journey. Even when a restructuring proceeding is necessary, Chapter 11 debtors and sophisticated parties in interest may have engaged in extensive pre-bankruptcy negotiations in order to execute a plan restructuring agreement (sometimes referred to as "lockup agreements") that will govern the parties' conduct in the case. Do creditors forfeit their right to participate in the Chapter 11 proceedings or receive committee representation by entering into such agreements? In In re Enviva Inc. et al., Judge Brian Kenney of the U.S. Bankruptcy Court for the Eastern District of Virginia has concluded that they do not.
Debtors are typically responsible for directing the course of a Chapter 11 proceeding. But there are significant guardrails for creditors. One such guardrail is found in §1102(a)(1), which requires the U.S. Trustee overseeing the case to appoint a creditors' committee. The U.S. Trustee's creation of a committee is an act of significance in the case. Committees are entitled to raise and be heard on any issue, and their attorneys are paid from the debtor's assets. The creditors' representatives appointed to serve on the committee also owe fiduciary duties to the entire creditor body. Representation on a committee, therefore, can be vital to achieving a favorable outcome in the case.
In Enviva, the U.S. Trustee had appointed a committee consisting of three creditors. None of the committee's members were representatives of the bondholders, who held the "overwhelming majority" of the debt owed by the bankruptcy estate. Each bond pool was represented by an indenture trustee. The indenture trustee for largest of these bondholders moved for representation on the committee pursuant to §1102(a)(4), which allows a party in interest to ask the bankruptcy court to reconstitute the committee when the U.S. Trustee has failed to give "adequate representation" to a constituency impacted by the proceedings. The U.S. Trustee objected to the motion, arguing that some of the bondholders involvement with a pre-petition lockup agreement disqualified their indenture trustee from appointment to the committee. The Court disagreed.
A lockup agreement is a contract entered into by the debtor and its key constituents, often its secured creditors. It will typically obligate the debtor to provide specific treatment for the parties to the lockup agreement while requiring those parties to support confirmation of a proposed plan which provides that treatment. These agreements can significantly streamline a Chapter 11 proceeding, and also reduce its costs. But a lockup agreement is ultimately subject to the bankruptcy court's review under §1126(b). That approval had not been granted in Enviva, and the indenture trustee was not a party to the lockup agreement. It therefore had no bearing upon the indenture trustee's qualifications to serve on the committee.
The agreement which did govern the indenture trustee was the indenture trust, which obligated the indenture trustee to comply with applicable law. Upon appointment to the committee, the bankruptcy court concluded that "applicable law" would encompass the fiduciary duties imposed by the Code. Because the indenture trust obligated the trustee to act in accordance with those duties and the bondholders were a material class of creditors in the case, the bankruptcy court concluded that the committee's composition was inadequate with respect to the bondholders' interests. Accordingly, the U.S. Trustee was ordered to appoint one or more indenture trustees to the committee.
Stites & Harbison's attorneys are ready to help with your questions regarding bankruptcy and restructuring cases which may impact you. If your rights are inadequately represented in a bankruptcy case and you are interested in seeking representation on a committee, we may be able to help protect your rights in such proceedings.
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