Restructuring

Contributed by Doron P. Kenter.

“I’ll be representing, representing” – Ludacris feat. Kelly Rowland

Section 1129 of the Bankruptcy Code is chock full of requirements for confirming a plan of reorganization. Most plan proponents are aware of the requirement that they must identify any individuals expected to serve as a director, officer, or voting trustee of the reorganized debtor, as set forth in section 1129(a)(5)(A)(i) of the Bankruptcy Code. Often taken for granted, however, is subsection (ii), which mandates that any such appointments (or proposed continuation of service) be “consistent with the interests of creditors and equity security holders and with public policy.” But what exactly does this mean? Under what circumstances would the proposed leadership of the reorganized debtor be so problematic as to warrant a denial of confirmation?
In a recent decision, Chief Judge Bohm of the United States Bankruptcy Court for the Southern District of Texas was faced with this very question. Given the relative paucity of case law on point, Judge Bohm explored the contours of this requirement and offered a series of factors to be considered in determining whether the proposed post-confirmation management would call for rejection of an otherwise confirmable plan.
In In re Digerati Technologies, Inc., the debtor proposed a plan of reorganization pursuant to which the debtor’s CEO and CFO would continue to serve as the sole officers and directors of the debtor, a publicly-traded holding company. Two of the debtor’s other shareholders objected to the plan, arguing that the debtor’s self-dealing necessitated better oversight and that the continued employment of the CEO and CFO was not in the best interest of the estate and failed to satisfy public policy. Moreover, the proposed plan did not propose to appoint any new independent directors, and the plan proposed to assume the officers’ lucrative employment agreements, which the shareholders argued was inconsistent with their interests.
In addressing the shareholders’ objection, Chief Judge Bohm recognized the paucity of case law dealing with the “public policy” requirement in connection with the appointment of the reorganized debtor’s directors and officers. Indeed, even the decisions that did address this requirement did not include extensive analysis of what this “public policy” requirement actually means.
Importantly, one of the cited cases, In re Machne Menachem, Inc. recognized the specific requirement that the appointment of the reorganized debtor’s new leadership – and not just the overarching plan of reorganization – be consistent with public policy. For example, in that case, the bankruptcy court specifically concluded that it would be in the public’s overall interest to confirm the proposed plan and reopen the debtor, a children’s summer camp with a “noble purpose” and which enjoyed great support from the community. Because, however, the plan’s proposed procedures for appointment of new board members conflicted with the New York law governing not-for-profit corporations, the court concluded that the plan conflicted with public policy and could not be confirmed.
Also of note, the court in Machne Menachem cited to legislative history regarding the term “public policy,” noting that the Senate Report accompanying the Chandler Act (i.e., the Bankruptcy Act of 1938) commented that the revisions to the Bankruptcy Act “direct[ed] the scrutiny of the court to the methods by which the management of the reorganized company is to be chosen, so as to ensure, for example, adequate representation of those whose investments are involved in the reorganization.”
Given the minimal case law discussing when the appointment of proposed directors and officers would conflict with public policy, Chief Judge Bohm, guided by the existing case law and the legislative history cited in Machne Menachem, concluded that public policy mandates that any proposed post-confirmation directors and officers must adequately represent the reorganized debtor’s stakeholders and must be likely to run the company competently and without self-dealing, and that for the reasons noted above, he could not confirm the debtor’s plan because the continued service by the CEO and CFO would violate public policy. Moreover, the appointment and service of the directors and officers must not conflict with existing state law. In light of these public policy goals, Chief Judge Bohm proposed that courts considering this public policy requirement in section 1129(a)(5)(A)(ii) be guided by the following nine non-exhaustive factors:

• Would the proposed plan keep the debtor in existence as a going concern?
• Is the debtor publicly-held or privately-held?
• Would continue service by the debtor’s leadership “perpetuate incompetence, lack of direction, inexperience, or affiliations with groups inimical to the best interests of the debtor?”
• Would the individual provide adequate representation of all creditors and equity holders?
• Does the proposed retention violate state law?
• Is the individual “disinterested”?
• Is the individual “capable and competent to serve” in the proposed capacity?
• Are salaries and benefits reasonable based on the debtor’s circumstances?
• Are any new independent directors being appointed?

To be sure, this nonexclusive list of factors may yet be supplemented, revised, or ignored by other courts. And, as with any multi-factor balancing test, application of these questions is more of an art than a science. But plan proponents would be well-advised to consider these questions in determining who is proposed to lead the reorganized debtor and in whose interest’s management should act when establishing a path out of chapter 11.