Partner Bob Gayda and associate Catherine LoTempio co-authored an article in Law360 titled, “Independent Director Investigations Can Benefit Creditors.”
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Independent Director Investigations Can Benefit Creditors
By Robert Gayda and Catherine LoTempio
Investigations conducted by independent directors[1] of distressed companies have become common in recent years. Some commentators view these “internal” investigations as infringing on the role of unsecured creditors’ committees, which had historically reviewed and analyzed prepetition conduct of a debtor and the debtor’s management/ownership for potential causes of action. Undoubtedly, there is often friction between independent directors and creditors’ committees regarding the investigation (and related settlements).
However, there are advantages to independent director investigations, particularly in the current bankruptcy environment, where speed to exit is paramount. These advantages can also serve to benefit unsecured creditors. This article reviews some of the advantages independent director investigations may provide and surveys several recent cases where independent directors investigated prepetition conduct, including the dynamics between constituencies and the ultimate results.
Potential Advantages of Independent Director Investigations
A company considering bankruptcy will often appoint new members, unaffiliated with the company and its prior management, to its board of directors in the months leading up to its bankruptcy petition. Such independent directors often are highly experienced restructuring professionals. While independent directors serve alongside the other members of the board, they may also be directly delegated (often through the appointment to a special committee) the responsibility of investigating and potentially prosecuting or settling claims against the company’s insiders, sponsors and/or affiliates relating to certain transactions that occurred prior to the bankruptcy filing.
There are certain practical advantages to independent director investigations. As newly appointed members of a board with significant restructuring expertise, independent directors are generally well positioned to investigate claims.
Independent directors often hire their own legal and financial advisers to assist with the investigation. Once appointed, independent directors can immediately commence their investigation, in many instances prior to the company’s bankruptcy filing and the appointment of a creditors’ committee. Independent directors, as an extension of the debtor, may also obtain early access to many key parties and documents through informal means, without being limited by privilege concerns or the need for court intervention.
In addition, it is possible that a special committee of independent directors, acting on behalf of a debtor, would have standing to prosecute certain causes of action where creditors might not.[2]
These advantages can help expedite an investigation and thus a bankruptcy case, resulting in reduced cost and increased certainty, which, among other things, may encourage additional investment from parties of interest that might lead to a successful case. Creditors’ committees can shadow an in-progress investigation, and benefit from information already collected, while retaining the right to act if not satisfied with the process or the pace at which it is being conducted.
A Survey of Recent Cases
The significant number of bankruptcy cases in recent years that involve independent director investigations exhibit their prevalence and utility. The following cases are just three examples of such cases (there are several major cases involving independents pending), which illustrate some of the case dynamics created and the ultimate results achieved.[3]
Shopko
The disinterested directors of Specialty Retail Shops Holding Corp., or “Shopko,” were appointed to the board of directors in December 2017. On Nov. 26, 2018, the board authorized the formation of a special committee comprised of the independent directors, which commenced an investigation of, among other things, certain dividends to Shopko’s equity owners, including Sun Capital Partners Inc. Shopko and its affiliates filed for bankruptcy in Nebraska on Jan. 16, 2019, and filed a disclosure statement and plan of reorganization, which contained standard releases.
The special committee supported the approval of the disclosure statement, provided that any proposed plan releases remained subject to their active investigation. After the Feb. 28, 2019, approval of the disclosure statement, disputes arose between the debtors and the creditors’ committee regarding the investigation. On March 13, the creditors’ committee filed a motion for standing to prosecute claims that were the subject of the special committee investigation, arguing that the debtors unjustifiably refused to bring such claims, and that the debtors were “hopelessly conflicted.”
The hearing on this motion, as well as the confirmation hearing, were adjourned several times as the parties negotiated. On April 26, 2019, the creditors’ committee filed a motion to convert the Chapter 11 cases to Chapter 7, arguing that the cases were administratively insolvent and that a Chapter 7 trustee would be better situated to bring claims against insiders, and a hearing was set for May 28.
On May 1, the cases shifted course as the special committee announced that it had reached a settlement with Sun Capital, whereby Sun Capital would pay $15 million to satisfy the insider claims. The creditors’ committee filed a motion to compel discovery regarding its reasonableness. On May 21, 2019, the parties, including the creditors’ committee and the debtors, filed a notice indicating that they had reached a global settlement, which increased the settlement amount to $15.5 million and included other substantive changes to the plan. The plan was ultimately confirmed on June 7, 2019, although confirmation was denied once.[4]
Mission Coal
In September 2018, Mission Coal Company LLC appointed two independent members to its board of directors. On Oct. 14, 2018, Mission Coal and certain affiliates filed for bankruptcy in the U.S. District Court for the Northern District of Alabama. Thereafter, in late October 2018, the independent directors began investigating Mission Coal’s prepetition activity, including payments made to sponsors, affiliated entities and third parties, and loans made to insiders and affiliated parties.
The unsecured creditors’ committee concurrently conducted its own investigation of estate causes of action. To coordinate and streamline the investigations, the parties agreed to a discovery stipulation, which was filed on Nov. 15, 2018. Pursuant to the stipulation, the parties agreed to share copies of any document productions received and to permit both parties’ attendance at all interviews conducted or depositions taken.
On Jan. 2, 2019, the debtors filed a plan of reorganization and an accompanying disclosure statement. At that time, the independent directors’ investigation remained ongoing and the releases contained in the plan were made subject to the conclusion of the investigation. The independent directors completed their investigation in late February 2019 and began negotiating the resolution of potential estate claims. Around the same time, the unsecured creditors’ committee filed a motion for standing to prosecute and settle certain causes of action on behalf of the debtors’ estates, including claims for recovery of alleged transfers from the debtors of approximately $76.15 million.
On March 27, 2019, the independent directors announced a settlement of estate claims with certain current and former equity owners of the debtors and their affiliated nondebtor entities. The settlement provided for, among other things, $15 million in cash, the assumption by certain of the settling parties of up to $12 million in liabilities, a $1 million note payable to the debtors, and waiver of certain deficiency claims. The proposed settlement was incorporated into an amended plan filed on March 30, 2019. Given the settlement, the debtors also opposed the unsecured creditors’ committee’s standing motion.
A hearing on confirmation of the plan began on April 3, 2019, with the unsecured creditors’ committee objecting to the plan. After four days of hearings on confirmation, the debtors announced a settlement requiring the unsecured creditors’ committee to support the plan, provided that, among other things, certain of the settlement proceeds would be earmarked for unsecured creditors. The settlement with the unsecured creditors’ committee was incorporated into a further amended plan, which was confirmed by the Bankruptcy Court on April 15, 2019.
Nine West
In August 2017, the board of directors of Nine West Holdings Inc. and certain of its affiliates appointed two independent members. In October 2017 the independent directors began investigating causes of action related to Nine West’s 2014 going-private transaction and related purchase of certain businesses from Nine West by equity sponsor-affiliated entities. On April 6, 2018, Nine West and certain affiliates filed for bankruptcy in the U.S. District Court for the Southern District of New York. The independent directors’ investigation continued after the bankruptcy filing, while the unsecured creditors’ committee pursued a parallel investigation.
On June 18, 2018, the debtors and the unsecured creditors’ committee agreed to a “standstill agreement” that provided, among other things, that the debtors would not seek to settle any estate claims under investigation until the expiration of a standstill period, which was originally set to expire on Aug. 14, 2018, but was subsequently extended until Sept. 13, 2018.
In turn, the unsecured creditors’ committee agreed not to file a motion seeking derivative standing to pursue estate causes of action during the standstill period. The goal of the standstill agreement was to allow the parties to continue their respective investigations and pursue negotiations around the settlement of any related claims.
After the expiration of the standstill period, on Oct. 4, 2018, the unsecured creditors’ committee filed a motion seeking standing to pursue estate causes of action. Subsequently, on Oct. 17, 2018, the debtors filed a plan of reorganization incorporating a settlement of the claims subject to the independent director investigation for $105 million in settlement proceeds to be distributed to unsecured creditors. Anticipating a dispute, the bankruptcy judge ordered the parties into mediation.
While a global resolution was not achieved in mediation, the debtors and the unsecured creditors’ committee agreed to terms of a revised plan that provided for, among other things, the creation of a litigation trust, an additional $10 million cash contribution with respect to the settlement, and changes to the distribution of the settlement proceeds. Certain unsecured creditors, however, continued to seek standing to pursue estate causes of action and objected to the debtors’ amended plan.
Ultimately, the debtors announced a global resolution on Feb. 8, 2019, providing for further changes to the allocation of settlement proceeds, as well as an additional settlement contribution of $5 million, resulting in aggregate proceeds of $120 million under the settlement. The debtors’ plan incorporating the global settlement was confirmed on Feb. 25, 2019.
Conclusion
Independent director investigations are likely to remain prevalent in the restructuring landscape. While it is difficult to determine exactly what drove the result in any given case, there are certainly some practical advantages to independent investigations. Where required, these investigations can help a case progress, which can result in tangible benefits to the bankruptcy estate, including unsecured creditors.
Even though a creditors’ committee may view the use of an independent investigation as usurping its role, creditors’ committees retain traditional remedies (standing motions, etc.) and will employ them irrespective of the appointment of independent directors. The cases above highlight this push and pull between constituencies. Like any other restructuring tool, restructuring professionals must acknowledge the trend, and consider the utility of these investigations on a case by case basis.
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Robert J. Gayda is a partner and Catherine V. LoTempio is an associate at Seward & Kissel LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] This article refers only to investigations conducted by independent “directors” of corporations. This reference, however, is also intended to include independent “managers,” which would be appointed to govern limited liability companies.
[2] CML V, LLC v. Bax , 6 A.3d 238, 242 (Del. Ch. 2010) (holding that under the plain language of the Delaware LLC statute, creditors of an insolvent LLC are denied standing to bring derivative actions on behalf of the company), aff’d 28 A.3d 1037 (Del. 2011); see also Official Comm. of Unsecured Creditors of HH Liquidation, LLC v. Comvest Grp. Holdings, LLC (In re HH Liquidation, LLC), 590 B.R. 211, 283 (Bankr. D. Del. 2018) (citing Bax).
[3] The summaries included in this article are based solely on publicly available information.
[4] An individual creditor has filed a notice of appeal with respect to confirmation (mainly related to the treatment of professional fee claims).
