Chapter 6 Defining the Liquidation Trust

• Jurisdiction: United States

Chapter 6 Defining the Liquidation Trust

This chapter focuses on defining the liquidation trust and compares its advantages and disadvantages. It surveys the key questions to ask when assessing whether a liquidation trust can be designated as a grantor trust under the Internal Revenue Code and other Internal Revenue Service requirements.

Liquidation trusts in bankruptcy matters are vehicles that enable a debtor to segregate, pursue and ultimately distribute otherwise illiquid assets to creditor claimants. These trusts are utilized by the debtor to wrap up its affairs pursuant to a confirmed chapter 11 plan. In a stricter interpretation, these trusts are post-confirmation grantor trusts as defined by the Internal Revenue Service. They are created under a chapter 11 plan to receive liquid assets and pay claims with the proceeds of those assets. The trust liquidates and distributes the debtor's remaining assets to creditors and other parties that hold an interest in the trust's assets, with the primary goal of maximizing the recoveries for creditors.

A. Beneficiaries of the Trust

Post-confirmation matters are governed by the Bankruptcy Code. Section 1141 specifies the effect of confirmation, vests all of the property of the bankruptcy estate in the debtor, discharges the debtor from pre-petition claims with certain exceptions, and terminates the rights of pre-petition equityholders.

Chapter 11 plans may provide for the creation of one or more post-confirmation trusts. Each trust is a legal construct into which the debtor transfers defined assets. The assets are transferred for the benefit of holders of allowed claims against the debtor. Creditors are deemed to have transferred their rights to the assets into the trust in exchange for receiving beneficial interests in the trust. In effect, the creditors are both grantors and beneficiaries of the trust, but their interests are proportional, rather than specific, to any asset.³⁵

B. Benefits of a Liquidation Trust

There are many benefits associated with the use of a liquidation trust or similar vehicle. In small cases, a single trust may be established to marshal and liquidate assets, pursue litigation, reconcile claims and make distributions to creditors. In more complex cases, such as General Motors, Enron or Refco, multiple trusts may be established to handle specific assets, specific litigation, or to make distributions on allowed claims. There are many advantages and disadvantages to using liquidation trusts. Some key benefits are discussed below.

1. Increased Speed

Use of a liquidation trust permits a more rapid exit from chapter 11 bankruptcy proceedings by eliminating issues involving the debtor's exclusivity period and enabling the debtor to rapidly and aggressively pursue lawsuits and sell assets by hiring an unbiased trustee. Liquidation trusts also eliminate the time pressure of plan-confirmation deadlines required by BAPCPA. These benefits can lead to quick confirmation, especially in prepackaged plans of reorganization or plans of liquidation. Shortening the case duration should help to reduce the overall costs of the main bankruptcy case. In addition, these factors should permit the reorganized debtor to move forward without the stigma of a protracted bankruptcy proceeding or a lengthy battle between stakeholders regarding non-operating issues. Increased speed can protect the value of the debtor's operation and other assets by quickly removing these assets from the bankruptcy proceedings. A fast emergence or sale of operating assets can preserve the business's reputation, stabilize or reduce the risk of customer attrition, help maintain vendor support, and ensure ongoing support from internal management and staff.

2. Improved Timing

Separating the value of operating assets (through a plan of reorganization or § 363 sales) from the more speculative recoveries to be received from illiquid assets, or from the uncertainty of complex litigation, permits the stakeholders to more quickly resolve many of the issues present in an operating chapter 11 case. Stakeholders may receive interim distributions from these assets more quickly. Stakeholders can then wait for the liquidation and distribution of proceeds from more illiquid assets, which may not occur for an extended period as the trust works to recover the maximum value for those remaining assets with sufficient marketing and flexible timing of asset sales. Interim distributions will permit the distribution of litigation recoveries as they are liquidated, providing a way to receive these proceeds in a more timely manner.

3. Greater Efficiency

Liquidation trusts provide efficient vehicles for centralized liquidation management and oversight. The trust agreement normally establishes a central authority or decision-maker who can litigate and settle claims. Attorneys, financial advisors and others retained by the various stakeholders can be replaced by one trustee and his professionals. A single central authority, the trustee, can then facilitate the marketing and sale of illiquid assets much more efficiently. The trust therefore enables the remaining assets of the estate to be pooled into one vehicle, which results in a streamlined distribution to trust beneficiaries.

Efficiencies are further enhanced through dedicated focus. An operating debtor may simply be too distracted by managing the greater business to handle illiquid assets or to stay involved with complex litigation. A dedicated trustee should bring greater focus and responsiveness, thereby saving time...