Brad B. Erens & Kelly M. Neff, Confidentiality in Chapter 11

JurisdictionUnited States,Federal
Publication year2011
CitationVol. 22 No. 1


Brad B. Erens

Kelly M. Neff**

Chapter 11 provides companies with powerful legal tools to restructure their business operations and debts. Upon commencement of a chapter 11 bankruptcy case, a debtor is entitled to the automatic stay pursuant to Sec. 362(a) of the U.S. Bankruptcy Code ("Bankruptcy Code").1Creditor enforcement actions are immediately halted, and creditors typically must await the end of the bankruptcy proceeding to receive consideration on account of their prebankruptcy claims. Further, the debtor is given the ability to impair the state law contract rights of creditors under a plan of reorganization. Secured creditor payment schedules may be stretched out or their interest rates altered, and unsecured creditors may be required to accept less than the face amount of their claims in the form of either cash, notes, or stock of the reorganized debtor.2In addition, the debtor may reject prebankruptcy executory contracts and leases and relegate the resulting damages to unsecured claims in the bankruptcy proceeding.3

However, the sweeping power of a chapter 11 debtor to alter its creditors' state law contract rights comes at a certain price. Most importantly, it is likely that the shareholders of the debtor will receive nothing under the debtor's chapter 11 reorganization plan. Instead, the reorganized company likely will be owned by its pre-bankruptcy creditors or some entity that funds the reorganization plan in exchange for the post-reorganization equity. In addition, the entire bankruptcy proceeding will be conducted under the auspices of a federal bankruptcy court. Part of the tradeoff for the debtor having the unilateral power to modify the state law rights of its creditors is that such modification must occur in an open judicial forum. Bankruptcy is an "open book" process. Most key decisions, such as rejecting contracts and leases and selling assets, must be implemented through a filing with, and subsequent approval from, the bankruptcy court. The debtor's business plans, results of operations, and strategies will also be fully available to an official committee of creditors appointed to represent the creditors in the case. Other information about the debtor will generally be available to creditors through filings with the bankruptcy court and, therefore, available to the public at large.4This open book approach to reorganization is part of the tradeoff of chapter 11. The debtor that desires to impair creditor state law rights must do so in a public forum.

Unfortunately, proceeding in such an open fashion is not always in the best interest of the reorganization for either the debtor or its creditors. In fact, companies often find themselves in chapter 11 because they are the more vulnerable players in competitive industries. With little margin for operational error and typically being fairly leveraged, a few underperforming quarters can quickly land these companies in chapter 11. Once in chapter 11, however, the debtor's reorganization may not benefit by having the results of its business operations, decisions, and strategies open to the general public. Competitors of the debtor, believing that the debtor is on the verge of collapse, may already be planning action to attempt to put the debtor permanently out of business. Having greater access to the debtor's competitive information will only make it easier for the debtor's competitors to pursue such a course of action.

For the chapter 11 reorganization to be meaningful, the major creditor constituencies of the debtor, such as its official committee of unsecured creditors and its bank group (if any), must have full access to the debtor's financial and other information. These creditors are the major stakeholders in the debtor and likely will have significant ownership and other interests in the reorganized company. They need the debtor's information to assess, among other things, its capital structure, opportunities for the restructuring of its business in chapter 11, the results of any revised operations in the bankruptcy case, and the debtor's overall prospects for reorganization under a chapter 11 plan. It is often less clear, however, why other creditors need access to the debtor's information until asked to vote on a reorganization plan. In addition, often it is not clear why the public needs access to the debtor's business information. Again, such broad access may be diametrically opposed to the very purpose of the chapter 11 case-namely, the maximization of the value of the debtor's business and its prospects for reorganization.

The proposition that a chapter 11 reorganization proceeding be an open book process, however, is heavily ingrained in bankruptcy jurisprudence. As a result, it is not likely that there will be any effort to modify the openness of such a proceeding anytime in the near future.5Additionally, it is not the purpose of this Article to suggest that such an effort be made. Instead, the purpose of this Article is to explain the various confidentiality issues that arise in a chapter 11 case and to discuss how a company contemplating chapter 11 can best prepare itself to address those issues. A company that is fully informed as to how its information may become publicly available in a chapter

11 case and how it can prevent such information from being misused by competitors or others will be in a better position to maximize its prospects for a successful reorganization.

This article is divided into seven parts. Part I discusses confidentiality issues arising as a result of the existence of the Office of the United States Trustee ("OUST"). This office, which is an arm of the U.S. Justice Department, is given standing in every chapter 11 case. The mandate of OUST is to some extent self-determined and shifts from time to time. However, in a chapter 11 business case, where there is likely to be an active creditors' committee (which is appointed by the U.S. Trustee), the office's main function in relation to the debtor will likely be to require that certain standard business reports be filed with the bankruptcy court on a periodic basis. These reports are described in Part I.

Part II discusses confidentiality issues relevant to the public company chapter 11 debtor. Particular emphasis is placed on how a public company debtor can satisfy both its reporting requirements under the Bankruptcy Code and its obligation not to selectively disclose material non-public information under Regulation FD of the Securities Act of 1934.6

Part III discusses the main option available to chapter 11 debtors to avoid the public disclosure of sensitive information-filings with the bankruptcy court "under seal." Among other things, Part III discusses the circumstances under which a debtor is entitled to make a filing under seal (so only the bankruptcy court, and likely the creditors committee and U.S. Trustee, actually see the filing).

Part IV discusses special discovery rules that exist in a chapter 11 case, and, in particular, Bankruptcy Rule 2004,7which gives a party broad power to obtain discovery from a chapter 11 debtor beyond the powers typically available in civil litigation. Both the contours of Rule 2004 and the ability of a debtor to resist or limit Rule 2004 discovery are described.

Part V discusses a debtor's interactions with its official creditors' committee appointed by the U.S. Trustee. As noted above, typically the creditors' committee will be entitled to almost all information relevant to the debtor. However, the prospective debtor will need to understand how it can prevent members of a creditors' committee from potentially misusing its sensitive business information. This issue is discussed in detail.

Part VI discusses the attorney-client privilege issue in chapter 11. Upon a bankruptcy filing, the operation of the privilege becomes more complex. In addition, the bankruptcy process itself requires disclosure of certain information that arguably is privileged. These issues are explored, along with methods to avoid the disclosure of privileged information in the bankruptcy case.

Finally, Part VII discusses which business decisions a debtor must submit for approval to the bankruptcy court and which business decisions are "in the ordinary course of business," and, as such, can be implemented without court approval. The ability to implement certain business decisions without court approval allows the debtor to avoid disclosing those decisions publicly through a filing with the bankruptcy court.


OUST is a central feature of the bankruptcy system that Congress created in 1978 as part of a complete overhaul of the bankruptcy laws, which resulted in the enactment of the current U.S. Bankruptcy Code. The Office was created by statute8in 1978 as part of the U.S. Department of Justice with the express purpose of overseeing the administration of bankruptcy cases. Pursuant to

Sec. 307 of the Bankruptcy Code, the U.S. Trustee "may raise and may appear and be heard on any issue in any case or proceeding" under the Bankruptcy Code, although the U.S. Trustee may not file a plan of reorganization in chapter 11.9In addition, pursuant to Bankruptcy Rule 9034, the U.S. Trustee is entitled to receive most of the key filings in a bankruptcy case, and it is common practice in chapter 11 cases to serve the U.S. Trustee with all pleadings in the case.10

While the U.S. Trustee often takes an active role in bankruptcy cases for natural persons under chapters 7 and 13, its role typically becomes more limited in a chapter 11 business case. At the beginning of the case, the U.S. Trustee appoints one or more official committees of unsecured creditors.11

The committee is entitled to retain legal counsel and other professionals to represent them during the chapter 11 case at the expense of the debtor's estate. As such, the debtor's creditors...

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