Appointment Of Independent Directors On The Eve Of Bankruptcy: Why The Growing Trend?

Regina Stango Kelbon, Michael DeBaecke, and Jonathan Cooper

The following is a summary of a paper prepared for the American Bar Association and later submitted to the Pennsylvania Bar Institute. The full article can be found at the link below.

Regina Stango KelbonMichael D. DeBaeckeJonathan CooperIn recent years, companies in financial distress have found “independent” directors to be useful to achieve protections for their board members. An independent director is a director – usually with no prior affiliation to the company – who has no personal interest or relationship that would render him or her incapable of acting solely in the best interests of the business. These individuals, typically selected on the basis of their business acumen and/or restructuring experience, bring not only expertise, but a desirable level of impartiality and objectivity to the corporate management scheme.

The appointment of an independent director can benefit a company in a number of ways, particularly when the business is struggling. From a practical standpoint, independent directors may be used for investigative purposes or to negotiate transactions involving insiders. The role of the independent director can mirror that of a bankruptcy examiner, a chief restructuring officer, or both, depending on the circumstances and strategic purposes.

Some companies have used independent directors in bankruptcy to stave off the appointment of an examiner or to derail a committee’s derivative standing to pursue litigation against corporate insiders.

Additionally, the presence of properly functioning independent directors can make it more difficult for a plaintiff shareholder to establish breach of fiduciary duty claims against the company and the board members. Under the typical business judgment rule, a board’s decisions are presumed reasonable and the burden to prove a breach of duty rests with the plaintiffs. In “conflict” situations, such as when a director or controlling shareholder stands on both sides of a deal, a more onerous standard (entire fairness review) may be triggered.

The presence of independent directors may afford the directors the business judgment presumption and/or allow the ultimate burden of proof to remain with the plaintiffs.

This article examines the fiduciary duties of directors and how independent directors have been used in certain bankruptcies.

“Appointment Of Independent Directors On The Eve Of Bankruptcy: Why The Growing Trend?” was formerly prepared and published in connection with the American Bar Association Business Law Section Spring Meeting held in Los Angeles, California, April 10-12, 2014. To read the full article, please click here.

River Road: A Cautionary Tale for Chapter 11 Financial Advisors

Leon Barson and Brandon Shemtob

6A471D42F6C801AD8D54571B3981426Dshemtobb1 (2)The United States Bankruptcy Court for the Northern District of Illinois recently handed down an opinion, In re River Road Hotel Partners LLC, 2014 WL 5488259 (Bankr. N.D. Ill. 2014), dealing with the issue of a financial advisory firm’s entitlement to a $2.6 million “restructuring fee” following confirmation of a Chapter 11 plan of reorganization proffered by the Debtors’ secured creditor. The opinion sheds light on the importance of clear drafting in engagement letters as well as the need to closely monitor a debtor’s proposed retention application for its financial advisor.

This Chapter 11 case concerned River Road Hotel Partners LLC and its affiliates in connection with their ownership of the Intercontinental Hotel at Chicago’s O’Hare Airport. After filing for bankruptcy in 2009, the Debtors sought to retain FBR Capital Markets & Co. to perform financial advisory services in connection with the reorganization effort. The parties negotiated an engagement letter, which provided for, among other things, a “restructuring fee” that compensated FBR in the event of a successful reorganization of the Debtors. The term “restructuring” was broadly defined in the engagement letter in order to encompass “any restructuring, reorganization and/or recapitalization…that involves all or a significant portion of the [Debtors’] outstanding obligations….”

After entering into the engagement letter, the Debtors filed a retention application with the Court seeking authorization to employ FBR. The initial application provided that FBR’s compensation would be determined based upon the terms of the engagement letter. However, the proposed form of order approving the retention application was modified prior to its approval by the Court to address an issue raised by the creditor’s committee. The revised order stated: “the ‘restructuring fee’ described…in the application is expressly contingent upon the consummation of a restructuring contemplated by the engagement letter.” The Court approved the modified form of order.

The Debtors were ultimately unsuccessful in their attempts to confirm a plan of reorganization. The secured lender, however, proposed and obtained confirmation of its own plan of reorganization. Following confirmation, FBR sought payment of the restructuring fee. The plan transferee (successor to the Debtors) objected, claiming that when read together, the engagement letter and retention order were ambiguous and parol evidence proved that FBR was only entitled to a restructuring fee if a debtor-sponsored plan was confirmed.

FBR filed a motion for summary judgment in which it argued that the engagement letter and the retention order were unambiguous and therefore created a clear entitlement to payment of the restructuring fee. The Bankruptcy Court, relying in large part on the declaration of Debtors’ counsel,[1] denied FBR’s motion and instead granted summary judgment sua sponte for the plan transferee. FBR appealed the decision to the District Court, which affirmed in part, reversed in part and remanded the matter for trial.

On remand, the Bankruptcy Court was tasked with determining whether FBR was entitled to the restructuring fee despite the fact that the confirmed plan was sponsored by a third party. The Court’s first hurdle was to determine whether consideration of parol evidence was appropriate in the matter sub judice. The Court concluded that while the engagement letter was unambiguous on its face, the language of the retention order created a latent ambiguity that necessitated consideration of parol evidence. Specifically, the Court found that this latent ambiguity arose when trying to square the engagement letter with the modified language in the retention order. Because the retention order made the restructuring fee “contingent upon the consummation of a restructuring contemplated by the Engagement Letter,” the Court concluded that it was entirely possible that a form of restructuring existed which would fall outside the purview of the engagement letter.

In considering parol evidence, the Bankruptcy Court next sought to ascertain the intent of the parties. After taking into account the evidence presented, the Court found that there was no evidence indicating the Debtors had ever advised FBR that the modification to the retention order was intended to change the definition of a restructuring from what was negotiated in the engagement letter (indeed, the financial advisor’s position was that the modification effected no substantive change to the terms of its engagement letter). Ultimately, the Court concluded that no credible evidence existed to show that the retention order materially changed FBR’s right to receive a restructuring fee. In view of this, the Court upheld FBR’s entitlement to a restructuring fee, notwithstanding the fact that the confirmed plan was sponsored by a third party.

The takeaway from FBR’s battle to recover its multi-million dollar restructuring fee is two-fold. First, it is imperative that financial advisors’ engagement letters are carefully drafted so as to avoid any potential ambiguity in terms of the entitlement to any form of compensation. Second, advisory firms must take care to monitor the debtor’s proposed retention order to ensure that it reflects, and is consistent with, the terms of their engagement. To be sure, a heightened attention to detail may serve to prevent post hoc disagreements as to the proper interpretation of what otherwise should have been viewed as a customary provision in a professional’s engagement letter.

Leon Barson is a partner in Blank Rome’s Finance, Business Restructuring & Bankruptcy group in Philadelphia, Pennsylvania.

Brandon Shemtob is an associate in Blank Rome’s Finance, Business Restructuring & Bankruptcy group in Philadelphia, Pennsylvania.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general informational purposes and is not intended to be and should not be taken as legal advice.

[1] Interestingly, counsel for the Debtors (who drafted the modified retention order) testified that it was his understanding that FBR would only be entitled to a restructuring fee if the Debtors’ plan was confirmed.

Creditor Didn’t Look Before It Leaped: Loses Right To Stop 363 Sale and Credit Bid

Linor Shohet

shohetl (2)A June 2013 decision from the United States Bankruptcy Court for the Eastern District of North Carolina Greenville Division, In re L.L. Murphrey Company, 2013 WL 2451368 (Bankr. E.D.N.C. June 6, 2013), highlights the importance of due diligence in connection with assignments of security interests.

L.L. Murphrey Company (the “debtor”) filed a voluntary Chapter 11 petition on June 8, 2000.  In 2000, the debtor was in default to Wachovia Bank, N.A. (“Wachovia”) for approximately $12,800,000 secured by the debtor’s real property and personal property by appropriate loan documents (“PreBankruptcy Loan Documents”).

In July 2001, the court confirmed a plan of reorganization, which restructured the debt  into two notes and provided that:

  1. The debtor and Wachovia will enter into amended and restated loan documents consistent with the plan of reorganization;
  2. The debtor shall execute and deliver such additional agreements, instruments and documents as may reasonably be requested by Wachovia;
  3. The Reorganization required that amended and restated loan documents be executed consistent with the confirmation of the plan; and
  4. All liens in favor of any creditor would be deemed released upon confirmation of the plan.

Post confirmation, Wachovia didn’t redocument the loan. Wachovia sold the loans and assigned the PreBankruptcy Loan Documents to CadleRock Joint Venture, L.P. (“CadleRock”) and CadleRock subsequently sold the loans and assigned the PreBankruptcy Loan Documents to D.A.N. Joint Venture Properties of North Carolina (“DAN”).  DAN relying on the assigned documents filed the requisite notices of assignment, amendments and continuation statements.  When the debtor filed a voluntary Chapter 7 petition in 2012, DAN filed a proof of claim for over $6,000,000 and claimed that over half of such amount was a secured claim.

In January and February 2013, the trustee filed motions requesting the court’s approval to conduct a sale of the debtor’s real and personal property pursuant to Section 363 of the Bankruptcy Code, free and clear of liens, with any such liens transferred to the proceeds of the sale.  DAN tried to block  the trustee’s sale motion, arguing that the trustee failed to establish any of the five separate grounds required under Section 363(f) which would permit a sale free and clear of liens. The Trustee argued that he met the requirements of 363(f)(4), which permits the sale of property free and clear of any interest in the property if the interest is in “bona fide dispute.”

DAN argued that its security interest was not subject to a legal or factual dispute because there were no pending objections to its proof of claim and because the debt underlying its claim and the related liens was explicitly reaffirmed by an order entered by the court in a related proceeding. Further, DAN argued that the confirmed plan only required delivery of amended and restated loan documents reasonably requested by Wachovia, and Wachovia never made any such requests of the debtor.

The court disagreed, determining that the trustee had established the existence of a bona fide dispute as to the validity of DAN’s liens because the confirmed plan explicitly required the parties to execute amended and restated loan documents as a condition precedent for setting the implementation date of the new notes.  Therefore, the court permitted the trustee to sell the property free and clear of any liens pursuant to Section 363(f)(4) of the Bankruptcy Code.

Having allowed the 363 sale, the court then turned to the issue of whether DAN could credit bid at the public sale.  The trustee asserted that the questionable validity of DAN’s liens constituted the requisite cause for the court to revoke DAN’s right to credit bid under Section 363(k) of the Bankruptcy Code and the Bankruptcy Court agreed. In re L.L. Murphrey Company serves as a reminder to debt purchasers that as they rarely get any representations from debt sellers they need to undertake appropriate e due diligence before purchasing.   DAN may well end up with an unsecured claim for the entire amount due. That result could have been avoided  had it performed the proper diligence.