Sidney Levinson Speaks on Transparency in the Bankruptcy Process

Sidney Levinson

During the four-plus decades since enactment of the Bankruptcy Code in 1978, the rules and practices governing disclosure of information have evolved over time to address the competing needs of debtors and other parties in interest, as well as the bankruptcy courts.  When chapter 11 was originally enacted, the primary source of transparency was the disclosure statement, required to accompany every plan of reorganization, and designed to provide creditors and shareholders with “adequate information†to evaluate whether or not to vote in favor of such plan.  It soon became apparent that the rights of various parties in interest can be heavily impacted by relief granted at the outset of a bankruptcy case, under first day orders or otherwise.  This led not only to changes in local rules and practice designed to spotlight the potential impact of such relief, but also the filing of detailed “first-day declarations†that provide parties in interest with an immediate and more detailed description of the debtor’s business and capital structure.

Some of the current debate over transparency is rooted in the trading of debt instruments and other claims, which provides a substantial benefit to creditors that prefer to liquidate their claims (at a discount) rather than await distribution under a plan of reorganization or otherwise.  Not surprisingly, potential buyers and sellers of claims generally prefer access to more information, while debtors generally prefer to keep such information confidential—whether out of fear that competitors will access such information, vendors will not extend trade credit, or employees will depart.  At the same time, debt investors are themselves reluctant to disclose their own trading information to competing investors who might seek to acquire such debt.  All of the above are legitimate concerns that require appropriate balancing.   

Perhaps a more controversial subject of debate as to transparency concerns the timely and complete disclosure of a party in interest’s “agenda.† Given that a majority of creditors (two-thirds in amount, more than one-half in number) in a class under a plan can bind a minority of creditors within that class, and that Section 1122 of the Bankruptcy Code requires claims within a class to be “substantially similar,†the threat that a minority of creditors could be bound by other creditors with competing, hidden agendas poses an existential threat to confidence in the fairness of the bankruptcy process.  The changes to Rule 2019 enacted in 2011, including the obligation of creditors and shareholders to report “disclosable economic interests,†were beneficial in this regard.  That said, the increasing spate of so-called “creditor-on-creditor violence†that has occurred in recent years, including the use of backstop fees and other incentives to disproportionately benefit certain creditors in a class over others, highlights the need for additional transparency as to the potential effect of such actions on minority creditors who may not otherwise be attuned to such risks.