For equity’s sake: the appointment of equity committees in bankruptcy cases

Over the last several years, equity security holders have increasingly requested the appointment of official equity committees to represent their interests in bankruptcy cases. The increased frequency of these requests has been particularly noticeable in recent oil and gas bankruptcy cases where equity security holders have used fluctuations in commodity prices to advocate for valuations greater than the debtor’s valuation in support of greater recoveries to equity security holders. This article examines the bases for appointment of an official equity committee and the standard that courts apply in evaluating requests for the appointment of an official equity committee.

Statutory and judicial authority to appoint an equity committee

Section 1102(a)(1) of the Bankruptcy Code provides that the United States Trustee may appoint committees of creditors or equity security holders as the United States Trustee deems appropriate. Typically, a United States Trustee considers whether there is enough equity in the estate (i.e., value over and above all liabilities) to justify the burden and expense of an equity committee. Accordingly, the United States Trustee has some degree of discretion in the appointment and composition of an official equity committee. Ordinarily, an equity committee is composed of the seven largest equity security holders of the debtor that are willing to serve.

If the United States Trustee declines to appoint an official equity committee, section 1102(a)(2) of the Bankruptcy Code allows a party in interest to request that the bankruptcy court order the appointment of an equity committee. If the court orders the appointment of an equity committee, the United States Trustee no longer has discretion and is required to appoint an equity committee.

To determine if an official equity committee is necessary, courts often consider: (i) whether the debtor is likely to prove solvent; (ii) whether equity is adequately represented by stakeholders already at the table; (iii) the complexity of the debtor’s case; (iv) the likely cost to the debtor’s estate of an equity committee; and (v) whether, given the existing constituencies in the case, the appointment of an official equity committee would add value to the case.

With respect to solvency, a party or party in interest moving for the appointment of an official equity committee has the burden of proof to show the debtor is “solvent or nearly solvent.” In re Pilgrim’s Pride Corp., 407 B.R. 211, 217 (Bankr. N.D. Tex. 2009). The burden of proof does not require an absolute showing of solvency or return to equity security holders, only that a distribution to equity security holders is a possibility. Often courts will balance the possibility of a return to equity security holders against the likely burden of additional costs on the debtor’s estate. A court may instruct the United States Trustee to appoint an exploratory group of equity holders to evaluate if an equity committee is economical and consensual between parties in interest.[1] Appointment of an equity committee would generally be inappropriate if there is no possibility of a distribution to equity security holders under a plan of reorganization.

When a debtor’s valuation is subject to price fluctuations, such as with oil and gas or other commodities, an increase in the commodity price can result in a corresponding increase in valuation and bolsters the possibility of a distribution to equity security holders. Solvency, however, is often a significant hurdle for equity security holders to overcome. The analysis of possible solvency is fact-specific and requires evidence of the value of the debtor’s assets and enterprise to show that the value may justify a distribution to equity security holders.

The absence of adequate representation may be easier for equity security holders to demonstrate the insolvency of the debtor. In response to a request for an equity committee, a debtor may allege that equity security holders are adequately represented by the debtor’s board of directors because a board of directors has a fiduciary duty to equity security holders. A board of directors, however, is generally regarded as having a duty to the enterprise as a whole including its creditors, which may not be aligned with the interests of equity security holders. It follows that creditors generally maintain a rather pessimistic valuation while equity security holders will generally maintain a more optimistic valuation of the debtor’s estate. It is in the court’s discretion to determine which perspective is more credible.

There is an inverse relationship between the complexity of a case and the ability of a party in interest to adequately represent itself. Courts consider the issue of complexity to involve more than just a complicated capital structure. Moreover, courts frequently note that the difficulty in valuing a debtor parallels the difficulty a debtor’s management experiences in advocating for the fair treatment of creditors and a distribution to equity security holders.

The cost of an equity committee does not prevent the appointment of a committee, but it often leads a court to impose restrictions on the equity committee’s involvement. In imposing restrictions on an equity committee, a court may, for example, limit the committee’s budget to ensure it does not duplicate efforts on issues where equity security holders are already adequately represented. A court may dissolve an equity committee if it becomes clear that equity security holders will not be able to participate in a distribution under a plan of reorganization. If the United States Trustee and the court decline to appoint an official equity committee, equity security holders may unite and form an unofficial or ad hoc committee to represent their interests. Such an unofficial committee may be able to recover its costs as an administrative expense claim if it can demonstrate that the committee made a “substantial contribution” to the estate.

How an equity committee can play a role

An official equity committee’s role is governed by section 1103(c) of the Bankruptcy Code:

            (c) A committee appoint under section 1102 of this title may—

(1) consult with the trustee or debtor in possession concerning the administration of the case; (2) investigate the acts, conduct, assets, liabilities, and financial condition of the debtor’s business and the desirability of the continuance of such business, and any other matter relevant to the case or the formulation of a plan; (3) participate in the formulation of a plan, advise those represented by such committee of such committee’s determinations as to any plan formulated, and collect and file with the court acceptances or rejection of a plan; (4) request appointment of a trustee or examiner under section 1104 of this title; and (5) perform such other services as are in the interest of those represented.

Sections 1102 and 1103 grant an equity committee broad authority to participate in a debtor’s bankruptcy case. Similar to other parties in interest, an equity committee may propose a plan if the debtor’s exclusive period to propose and confirm a plan has expired or has been terminated. Despite this broad ability to participate in a debtor’s bankruptcy case, an equity committee’s participation is often limited to areas and issues where equity security holders otherwise lack adequate representation. A court typically enforces the limitations upon an equity committee by requiring budgets for the committee’s professional fees and employing a discerning eye when approving a committee’s professional fees.

Paying equity committee professionals

With the court’s permission, an official equity committee may retain attorneys, accountants, and other professionals to assist the committee in its role. 11 U.S.C. § 1103. Such professionals may be awarded “reasonable compensation for actual, necessary services rendered.” 11 U.S.C. § 330(a)(1)(A) (After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award . . . a professional person employed under section 327 or 1103 . . . (A) reasonable compensation for actual, necessary services rendered . . . ; and (B) reimbursement for actual, necessary expenses.”). Official equity committee professionals should be aware of the limitation in section 330(a)(4), which provides a “court shall not allow compensation for . . . unnecessary duplication of services; or . . . services that were not reasonably likely to benefit the debtor’s estate; or . . . necessary to the administration of the case.” 11 U.S.C. § 330(a)(4).

Often times a court will apply a “material benefit” standard when evaluating whether professional services were necessary. Under the “material benefit” standard, a professional’s efforts must have resulted in an identifiable, tangible, and material benefit to the debtor’s estate. Alternatively, a court may employ the “reasonably likely to benefit the estate” standard so equity committee professionals do not risk non-payment of their fees in the absence of a distribution to equity under a plan of reorganization. Sometimes, a professional may be willing to represent an official equity committee on a contingency fee basis if the debtor and other parties in interest agree to reimburse the professional’s budgeted expenses.

In addition, the members of an official equity committee can assert an administrative expense claim for their “substantial contribution” to the debtor’s case. Consequently, a committee member may be able to recover the actual and necessary expenses it incurred as a result of performing its equity committee duties.

Equity Committee in Adeptus Health Inc.

Background

Adeptus Health Inc. was a publicly listed company. Adeptus Health, Inc. and 139 of its affiliates (collectively, “Adeptus”) was the largest operator of free-standing emergency rooms in the US On April 19, 2017, Adeptus filed Chapter 11 cases in the United States Bankruptcy Court for the Northern District of Texas (Dallas). Wexford Spectrum Investors, LLC and Debello Investors, LLC (collectively, “Wexford”) were equity security holders of Adeptus Health Inc., holding approximately 10% of its stock.

Appointment

Wexford filed an Expedited Motion to Appoint an Official Committee of Equity Security Holders for Adeptus arguing that the traditional factors to appoint an official committee were satisfied. After a heavily contested evidentiary hearing on June 5 and 6, 2017, the bankruptcy court granted the motion and directed the United States Trustee to appoint an equity committee. In her oral ruling, Bankruptcy Judge Stacey G.C. Jernigan held that various factors should be considered, which include: the ability to prove solvency; whether equity security holders are represented adequately by stakeholders who are already at the table; the complexity of the debtor’s case; the likely cost of an equity committee to the debtor’s estate; and to what extent the debtor’s shares are widely held and actively traded. The court further held that an absolute showing of solvency, or even a likely showing of solvency, was not necessary. Here, however, the court found significant indicia of solvency in a rather complicated, widely held publicly traded company. Moreover, the court in Adeptus was not convinced that the unsecured creditors’ committee would adequately represent the interests of the widely held equity were there to be litigation against insiders. Accordingly, the court appointed an equity committee to represent the interest of all equity security holders.

Payment

Judge Jernigan’s oral ruling appointing an equity security holder committee warned against the equity committee retaining “some bomb thrower who’s in it to get paid” and noted that the court would watch for duplicative actions or actions that would slow the case down. Counsel to the equity committee submitted a final fee application in the amount of US$2,846,311 for the period of June 19, 2017 through October 1, 2017. On December 12, 2017 the court heard counsel to the equity committee’s fee application. The court issued an oral ruling granting the fee application with a reduction of US$120,347.30. The court noted that while appointment of the equity committee was to challenge valuation of a complex enterprise, the proportionality of retained counsel’s fees to other counsel in the case was problematic considering the equity committee reneged on a settlement, thereby causing excessive fees. The court also reserved the right to supplement its oral ruling with a detailed final order “with pages and pages of details” if a party in interest chose to appeal. No party appealed the court’s decision.

Conclusion

Ultimately, the appointment of an official committee of equity security holders hinges on two main factors: the valuation of a debtor to determine if a debtor is solvent and the cost an official committee would incur. With the same authority and power as an official unsecured creditors’ committee, the possibility that an official equity committee can run up a mountain of professional fees means a debtor is unlikely to support the formation of another official committee and a court is generally hesitant to approve an official committee unless it is a necessity.

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[1] The court in In re ATP Oil & Gas Corporation, Case No. 12-36187 [ECF No. 663] created an innovative process by ordering the United States Trustee to select five current equity holders to serve as members of an exploratory group to determine whether an equity security holders committee could be appointed in a manner that was economical and on a consensual basis. The group was to serve without compensation, would have no authority to bind any person or group, and the group could enter into preliminary negotiations with potential committee professionals, but could not bind any future committee.