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Navigating Ethical Challenges in Contested Restructurings: When Stakeholders Employ Ethics as a Sword November 28, 2011 Eighteenth Annual Distressed Investing.

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Presentation on theme: "Navigating Ethical Challenges in Contested Restructurings: When Stakeholders Employ Ethics as a Sword November 28, 2011 Eighteenth Annual Distressed Investing."— Presentation transcript:

1 Navigating Ethical Challenges in Contested Restructurings: When Stakeholders Employ Ethics as a Sword November 28, 2011 Eighteenth Annual Distressed Investing 2011 Maximizing Profits in the Distressed Debt Market

2 Navigating Ethical Challenges in Contested Restructurings: When Stakeholders Employ Ethics as a Sword Van E. Conway Chief Executive Officer Conway MacKenzie Lois R. Lupica Maine Law Foundation Professor of Law University of Maine Law School Michael A. Feder Managing Director AlixPartners LLP Edward T. Gavin Principal NHB Advisors, Inc. Panel Moderator John Wm. (“Jack”) Butler, Jr. Partner Skadden, Arps, Slate, Meagher & Flom LLP

3 Page 2 Discussion Topics Defining ethics and why it matters The differences between connections, differing interests and materially adverse interests Applying ethics rules to non-lawyers Update on the ABI National Ethics Task Force Selected ethics rules and revisiting the Universal Building Products decision Commentary on Amended Bankruptcy Rule 2019 effective December 1, 2011 – Disclosures regarding creditors and equity security holders Deconstructing the Code: Ethics as a Sword Topic 5

4 Page 3 Defining “Ethic” noun, \e-thik\ “a set of moral principles; a theory or system of moral values (as in, ‘the present-day materialistic ethic’); the principles of conduct governing an individual or group (as in ‘professional ethics’).” Assumes that a group has decided upon a specific moral code by which to be commonly bound.

5 Page 4 Restructuring Stakeholders Company Equity Committee Official Committee of Unsecured Creditors Unsecured Creditors Shareholders Ad Hoc Committee Members of Ad Hoc Committee Steering Committee/ Agent Secured Creditors Indenture Trustee Bondholders

6 Page 5 Range of “Connectivity” Interest Adverse to the Estate Differing Interest Connection Differing Interest Connection No Connection Materially Adverse Interest to the Estate (not disinterested) Disqualified Fed. R. Bankr. P requires disclosure of all connections that are not de minimis. A lawyer shall not represent a client if such representation involves a “differing interest” unless certain waiver requirements are met. Debtors’ counsel must be attorneys “that do not hold or represent an interest adverse to the estate, and that are disinterested persons.” 11 U.S.C. § 327(a). Section 101(14)(C) defines a “disinterested person” as a person that “does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason. ” The Bankruptcy Code specifically authorizes an attorney to concurrently represent a debtor-in-possession and a creditor (in an unrelated matter). 11 U.S.C. § 327(c) (“[A] person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.”).

7 Page 6 Applying Ethics to Members of Trade Associations (including non-lawyers) Example, the Turnaround Management Association has three broad sections: %Canon I – Obligations to Professionalism –Ethical Standard 1.4 – Human Rights %Canon II – Obligations to the Client –Ethical Standard 2.2 – Independence –Ethical Standard 2.4 – Candor & Truthfulness –Ethical Standard 2.7 – Ownership %Canon III – Obligations to the Profession –Ethical Standard 3.1 – Prohibition on Referral “Consideration”

8 Page 7 The Rules of Professional Conduct The TMA Code of Ethics draws from the ABA Model Rules for Lawyers: %Model Rule 1.10 – Conflicts of Interest %Model Rule 1.4 – Communications %Model Rules 7.3 & 8.4, taken together Established by the American Bar Association (ABA) as “Model Rules”. Adopted in some form by individual states as ethics rules.

9 Page 8 ABI National Ethics Task Force Consider ethics issues in bankruptcy practice and make recommendations for uniform standards where appropriate Why a Task Force at all? %Bankruptcy practice has significantly evolved since the MRPC and many local rules were promulgated %Bankruptcy is now a multi-jurisdictional, if not multi-national, practice %ABA standards, “developed primarily for nonfederal, nonbankruptcy courts by unelected and nonjudicial parties, are ill- adapted to federal bankruptcy proceedings.” (Ninth Circuit Court of Appeals, In re Nguyen) %Increased discussion, nationally, regarding adoption of civility guidelines (such as those adopted in E.D. NY)

10 Page 9 ABI National Ethics Task Force Initial Focus: %Competence to practice bankruptcy law %Conflicts of interest %Disclosure Issues %Fee arrangements %Supervision of legal and non-legal staff %Limited representation %Volume practice issues %Multi-jurisdictional practice %Committee solicitation & representation %Fiduciary duties owed by professionals

11 Page 10 ABI National Ethics Task Force Committees established to address areas of focus: %Conflicts of Interest %Retention, Disclosure & Fee Arrangements %Creditors’ Committees %Consumer %Limited Representation/Multijurisdictional Practice %Discipline, Sanctions & Competence

12 Page 11 ABI National Ethics Task Force Proposal for consideration of the need for a “National Bankruptcy Bar” %Response to the growing number of instances of attorneys sanctioned for ethics and/or civility lapses, including: –Insulting the Court; –Fee-related lapses and violations of fiduciary duties; –Sloppy paperwork; –Unlawful practice of law by non-attorneys; –Impermissible limitations on scope of representation %Could use Fed. R. Bankr. P as a basis %Ability to practice in Bankruptcy Court of any District would be subject to a set of national standards in addition to Local Rules and underlying State Rules %Taken up by Federal Rules Committee for consideration

13 Page 12 ABA Model Rule 1.10 CONFLICTS OF INTEREST –1.10(a) states generally that a firm of many professionals is essentially one professional for purposes of establishment of conflicts of interest (i.e., a conflict on the part of a single professional is a conflict to the entire firm) unless: »the professional with the conflict is timely screened from the conflict, and »written notice is promptly given to the other client to enable them to ascertain compliance with this Rule %Doesn’t apply to non-attorneys, but is a good thing to keep in mind in restructuring practice

14 Page 13 ABA Model Rule 1.4 COMMUNICATIONS –(a)(2) [A lawyer shall] reasonably consult with the client about the means by which the client’s objectives are to be accomplished; –(a)(3) [A lawyer shall] keep the client reasonably informed about the status of the matter; –(a)(5) [A lawyer shall] consult with the client about any relevant limitation on the lawyer’s conduct when the lawyer knows that the client expects assistance not permitted by the Rules of Professional Conduct or other law –(b) A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.

15 Page 14 ABA Model Rules 7.3 & 8.4 RULE PROFESSIONAL CONTACT WITH PROSPECTIVE CLIENTS A lawyer shall not by in-person, live telephone or real-time electronic contact solicit professional employment from a prospective client when a significant motive for the lawyer’s doing so is the lawyer’s pecuniary gain, unless the person contacted: (1) is a lawyer; or (2) has a family, close personal, or prior professional relationship with the lawyer. RULE PROFESSIONAL CONTACT WITH PROSPECTIVE CLIENTS It is professional misconduct for a lawyer to: (a) violate or attempt to violate the Rules of Professional Conduct, knowingly assist or induce another to do so, or do so through the acts of another…

16 Page 15 Retention Risks When Soliciting Potential Committee Members A recent Delaware Bankruptcy Court opinion, In re Universal Building Products, provides a cautionary example to professionals seeking committee representation In Universal Building Products, the court found that counsel had used a proxy to solicit potential members of a creditors’ committee The court denied counsel’s retention application based on both ethical grounds and lack of disclosure

17 Page 16 Retention Risks When Soliciting Potential Committee Members The Court found that counsel had violated a rule of professional conduct prohibiting certain forms of direct solicitation of prospective clients %In particular, the court focused on counsel’s lack of a prior relationship with the creditors %Counsel and some commentators have argued that this impinges on counsel’s First Amendment rights due to the sophistication of the parties

18 Page 17 Retention Risks When Soliciting Potential Committee Members The court also found that disqualification of counsel was appropriate because counsel failed to provide adequate disclosure regarding connections with the proxy who solicited potential committee members %The court emphasized the importance of complete disclosure of all contacts %Counsel’s subsequent disclosure of relationship with proxy did not cure the initial defective disclosure

19 Page 18 Rule 2019 – Where We Are Now 2007 – Northwest Airlines – Court applies Rule 2019 to ad hoc committee of equity security holders Scotia Development – Court finds Rule 2019 in applicable to ad hoc committee of noteholders 1930s to 2007 – Relative quiet in 2019 Litigation 2009 – LyondellBasell – Court orders an ad hoc group to disclose members’ bond and credit default swap positions Washington Mutual - Court applies Rule 2019 to ad hoc committee of noteholders 1937 – Original Rule 2019 Enacted Aug Significant revisions to Rule 2019 announced – Revisions to Rule 2019 proposed and comments solicited 2007 to 2010 – Rash of conflicting decisions regarding application of Rule – Six Flags - Court holds ad hoc group is beyond the scope of Rule 2019 Accuride – Court compels ad hoc group of noteholders to make Rule 2019 disclosures but denies sanctions pending disclosure 2008 – Sea Containers - Court orders group of investment managers to disclose aggregate holdings and acquisition dates but not individual noteholders or prices Dec. 1, Amended Rule 2019 takes effect

20 Page 19 Key Elements -- Amended Rule 2019 The amended rule includes the term “disclosable economic interest,” which is intended to clarify and expand the scope of the rule beyond direct claims or interests to include derivatives, participations, pledges, options and other indirect interests held by entities, committees and groups that fall within the disclosure obligations of the rule The amended rule defines the meaning of “represent” in connection with a case under chapter 9 or chapter 11 of the Bankruptcy Code, which definition clarifies that representation requires active participation in the case or in a proceeding on behalf of another entity — either by taking a position on a matter before the court or by soliciting votes on the confirmation of a plan The amended rule modifies the disclosure requirements under the current rule by reducing the level of specificity of information required concerning the prices and dates of acquisition of claims and interests in the debtor The amended rule does not require the disclosure of price paid for a disclosable economic interest However, nothing in the amended rule precludes either the discovery of purchase prices and other similar information when it is relevant or its disclosure when ordered by the court pursuant to authority outside of the amended rule

21 Page 20 Former vs. Amended Rule 2019 Former Rule 2019 Amended Rule 2019 Title: Representation of Creditors and Equity Security Holders... Title: Disclosure Regarding Creditors and Equity Security Holders... Adds new subsection (a): “disclosable economic interest” means any claim, interest, pledge, lien, option, participation, derivative instrument or other right or derivative right granting the holder an economic interest that is affected by the value, acquisition or disposition of a claim or interest” Coverage: Covers every entity or committee representing more than one creditor or equity security holder and (unless otherwise directed by the court) every indenture trustee Excludes official committees under sections 1102 and 1114 Coverage: Covers every entity, group or committee that consists of or represents, and every entity that represents (by taking a position before the court or soliciting votes for or against a plan), multiple creditors or equity security holders that are acting in concert to advance their common interests, and not composed entirely of affiliates or insiders of one another. Excludes official committees under sections 1102 and 1114, indenture trustees, agents under loan agreements, class action representatives and governmental units

22 Page 21 Former vs. Amended Rule 2019 Former Rule 2019 Amended Rule 2019 Required Disclosures: (1)Name and address (2)Nature and amount of claims or interests (3)Time of acquisition (unless acquired more than 1 year pre-petition) (4)Pertinent facts and circumstances in connection with the employment of the entity (5)In the case of a committee, the name or names of the entities at whose instance the employment was arranged or the committee was organized (6)the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, any sales or other disposition thereof (7)The instrument, if any, empowering the entity, committee or indenture trustee to act on behalf of creditors or equity security holders Required Disclosures: (1)Name and address of each entity and each member of a group or committee (2)For the entity and each member, the nature and amount of each disclosable economic interest held in relation to the debtor as of the date the entity was employed or the group or committee was formed and as of the date of the verified statement (3)with respect to each member of a group or committee that claims to represent any entity in addition to the members of the group or committee, the date of acquisition by quarter and year of each disclosable economic interest, unless acquired more than one year before the petition was filed (4)Pertinent facts and circumstances in connection with the employment of the entity and the name or names of the entities at whose instance the group committee was formed or has agreed to act (5)The instrument, if any, empowering the entity, committee or indenture trustee to act on behalf of creditors or equity security holders

23 Page 22 Debate Over Amended Rule 2019 The general argument in support of the amended rule was expressed by Judge Gerber of the S.D.N.Y.: “When anyone in the case professes to speak on what is best for the estate... and/or to influence the outcome of the case, its private agenda can matter. If it does not want to reveal basic information as to its holdings in the case (which are an important indicator of ‘where it is coming from’ in connection with the position it advocates), it should not be trying to influence the court” The general argument against the amended rule is that the disclosures required by the amended rule, while less onerous than the original proposed rule, will decrease participation in distressed markets, to the detriment of creditors and debtors alike. Critics argue that courts should make determinations based on the merits of a party’s argument without regard to the party’s motivation, or “where it is coming from”

24 Page 23 Deconstructing the Code -- How does an ethical turnaround professional negotiate and collect a “success fee” in an engagement? Does it matter if the “success fee” is expressed as a percentage or share of proceeds from a transaction such as a financing or a sale? -- Is it ethical for the principals of a firm that provides the entire spectrum of “restructuring work” to have a separate fund that provides capital and/or buys troubled clients? In what circumstance would this be ethical? Unethical? -- Is it ethical for a person to use applicable ethics rules as a “sword” for tactical/strategic purposes? It is ethical for an attorney or other restructuring professional to assist a principal to execute such a tactic?

25 Navigating Ethical Challenges in Contested Restructurings: When Stakeholders Employ Ethics as a Sword November 28, 2011 Eighteenth Annual Distressed Investing 2011 Maximizing Profits in the Distressed Debt Market


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