In recent months, several high –profile bankruptcy cases saw a high involvement from shareholders represented by a formal Equity Committee. The formation of an ad hoc committee representing the owners of the Company appears to have recently taken the US bankruptcy world by storm and will likely impact how future restructurings are handled. If bankruptcy is a tool that creditors use to protect their interest, should shareholders have similar rights in these proceedings?
Rational for an Equity Committee
According to the absolute priority rule in the Bankruptcy Code, shareholders are forced to the bottom of the capital structure. However, if the Debtor still maintains a viable business, all stakeholders want to obtain some value from the reorganized entity. Equity participants believe that their interest are not adequately protected in bankruptcy and therefore feel it necessary to appoint a formal Committee. The US Bankruptcy Code doesn’t provide any assurance of “adequate protection” and the degree of protection for shareholders is determined on a case by case basis. Usually solvency is the “make-or-break” feature regarding the appointment of an Equity Committee.
The concept of solvency
The Board of Directors of a Corporation has a fiduciary duty to its shareholders. However, when a Company becomes insolvent, the fiduciary duty now extends to its creditors. Solvency is the most used applicable legal standard when deciding whether or not to appoint an Equity Committee. If the Debtor is hopeless insolvent, justification can be made that there is no need for shareholder representation, as the cost required and charged to the bankrupt estate for professional representation of the shareholders outweighs the adequate representation interest of the shareholders and it would be burdensome to the bankrupt estate. Usually an Equity Committee can only exercise a meaningful weight on the restructuring process when bankruptcy is not the result of insolvency.
Role of the Equity Committee
Similarly to the Creditors Committee, the Equity Committee participates in the restructuring process and communicates with the Debtor, Advisors and other stakeholders, negotiate specific terms and conditions relating to the Debtor’s Plan of Reorganization (POR) and participate in the confirmation of the POR. The goal of the Equity Committee, along with the Creditors Committee, is to maximize value and to divide that value in order to satisfy all stakeholders. To accomplish their goal, Equity Committees typically try to:
ü Be involved as early as possible in the case in order to have more negotiation power
ü Ensure an open communication with all stakeholders, specially the Debtor and its Advisors in order to limit litigation costs
ü Ensure the debtor is awarded the maximum value of the enterprise
Recent cases
The Equity Committee has the potential to promote conflicts regarding the valuation of the enterprise, assigning a higher valuation to the estate and therefore diluting the value to creditors. It can be argued that the increasing involvement of Equity Committees in the restructuring process has been a liability for Creditors. Let’s look at General Growth Property’s case for example; here the Equity Committee probably has more weight on the restructuring process than the Creditors, even if they are forced to the bottom of the capital structure. Another meaningful example is Accuride Carp case. On February 9, shareholders won a delay of the company’s reorganization schedule to develop an alternative plan that includes new $400 million exit loan. One major point of the dispute was valuation. The shareholders claimed the Company is worth about 823 mm, or 260 mm more than what was estimated by the Creditors. Shareholders would receive 26.5% of the new equity, instead of 2% under the original plan. The battle is still ongoing in court.