Restructuring

Section 1104(a)(2) of the Bankruptcy Code provides for the appointment of a chapter 11 trustee “if such appointment is in the interests of the creditors, any equity security holders, and other interests of the estate . . . .”  While it is not often that we see a court displace management pursuant to section 1104(a)(2), it does happen on occasion.  One such recent case is In re China Fishery Group Limited. Case No. 16-11895 (Bankr. S.D.N.Y. Oct. 28. 2016), where Judge James L. Garrity, Jr. determined the circumstances warranted the appointment of a chapter 11 trustee. 
Background
China Fishery Group Limited, together with its debtor and non-debtor affiliates (the “CF Group”), collectively comprise a “small part” of the Pacific Andes Group, the world’s twelfth largest seafood company.  Pacific Andes was founded in 1986 by the Ng family as a small frozen seafood trading business.  Today, it is a fully integrated global seafood and fishing enterprise consisting of over 150 entities and continues to be majority-owned and managed by the Ng family.  The debtors themselves consist principally of holding and other non-operating entities, and their value is derived primarily through their direct and indirect ownership of three non-debtor Peruvian operating companies (the “Peruvian Companies”).  Through the Peruvian Companies, the debtors possess the rights to a substantial portion of the total yearly allowable catch of anchovy in Peru, which is used to produce fishmeal and fish oil.
CF Group’s troubles began in early 2014 when a significant El Niño event interrupted the first of several consecutive anchovy fishing seasons, resulting in decreased revenue at the Peruvian Companies and liquidity problems for the parent companies.  What followed was a contentious back-and-forth between CF Group and its creditors, with CF Group defaulting on several credit facilities, including a $650 million facility agreement with certain financial institutions (the “Club Lenders”).  In November 2015, HSBC, as a Club Lender acting on its own, filed winding up petitions and related applications for the appointment of provisional liquidators to take control of the Peruvian Companies.  Finally, in December 2015 and January 2016, CF Group entered into Deeds of Undertaking with the other Club Lenders and HSBC respectively, and the winding up petitions were dismissed.
Pursuant to the Deeds of Undertaking, CF Group agreed to pursue a sale of the Peruvian Companies with a target completion date of July 15, 2016.  In April 2016, information about the sale was sent to prospective purchasers.  By June 1, seven bids had been received.  At least four of these bids were sufficiently high that all CF Group creditors would have been paid in full; however, no sale was consummated.  Instead, on June 30, the debtors commenced their chapter 11 cases in the Bankruptcy Court for the Southern District of New York.  That same day, the Peruvian Companies were entered into involuntary insolvency proceedings in Peru and, shortly thereafter, the chapter 11 debtors filed chapter 15 petitions on their behalf.
Appointment of a Chapter 11 Trustee
The Club Lenders filed a motion for appointment of a chapter 11 trustee, contending that the debtors were not committed to pursuing restructuring plans or sales processes that were in the best interests of the parties.  More specifically, the Club Lenders asserted that the Ng family, as indirect owners and managers of the debtors, were unwilling to sell the Peruvian Companies because they viewed them as an essential part of the family business.  The Club Lenders further argued that entering into the Deeds of Undertaking was merely a stalling tactic designed to prevent the Club Lenders from enforcing their contractual rights while the Ng family determined the best course of action for holding onto the Peruvian Companies.
In essence, the Club Lenders argued that a trustee was necessary for four reasons:

(i) the debtors were not trustworthy;
(ii) the Club Lenders had lost confidence in management;
(iii) the debtors had little prospect of rehabilitation under current management; and
(iv) the estate would realize significant benefits from the appointment of a trustee.

The court granted the motion and appointed a chapter 11 trustee, holding that, while the Club Lenders had not established that the current management was untrustworthy, they had demonstrated that they had “justify[ably] and understanbl[y]” lost confidence in management, and that the debtors’ prospects for rehabilitation under the current management were “problematic, if not dim.”
In reaching its holding, the court also rejected the Ng family’s argument that appointing a trustee would result in a “fire sale” of the Peruvian Companies to satisfy the interests of a few creditors over the interests of the other parties, including their own as equity holders.  In addressing this equity holder argument, the court acknowledged that the “best interests” test under 1104(a)(2) does contemplate the best interests of “any equity security holder;” however, the court explained that, in this case, the Ng family were not just equity holders of the debtors, but also their managers and directors with personal and financial stakes in their success.  According to the court,

the Ng Family . . . are plainly disincentivized from selling the Peruvian Business, even at a purchase price that reflects the current company valuation, because (i) there will be no return for the benefit of their equity positions, (ii) the sale will gut the Pacific Andes Group, and the family’s business, its most valuable assets, and (iii) the sale may impact the financial accommodations made by the family.

The court ultimately concluded that a trustee would be in a better position to maximize the use and value of the Peruvian Companies, a fact made all the more important by the courts finding that “the debtors have no prospect of rehabilitation if they cannot realize value from their interests in the Peruvian [Companies].”
Conclusion
The “debtor in possession model,” where existing management stays in place during the chapter 11 case, is a cornerstone of the chapter 11 system and one of the reasons it has worked so well for almost 40 years.  Nevertheless, there are circumstances where the appointment of a chapter 11 trustee to displace management may be appropriate. While the appointment of a chapter 11 trustee remains the exception, rather than the rule, China Fishery provides a reminder that there are occasions where a bankruptcy court will find that a chapter 11 trustee is in a better position than existing management to rehabilitate the business and maximize value.