Creditors wishing to play an active role in the restructuring of a Chapter 11 debtor often are faced with a series of impediments. Management may be incompetent or corrupt. Almost certainly it will be entrenched and many aspects of Chapter 11 that serve to protect a debtor must be overcome.

Accordingly, to disentangle an estate from the clutches of inadequate management, creditors must be aggressive when seeking to advance their vision of how the reorganization process ought to unfold.

There are three points in the typical Chapter 11 case where creditor impact may be maximized, and where resolution of disputes in one manner or another may have controlling influence over the case’s disposition. These events are:

• Debtor-in-possession (“DIP”) financing motions
• Key employee retention program (“KERP”) approval motions • Motions to extend (or terminate) exclusivity.

Recently, in the Sleepmaster Chapter 11 case in Wilmington, Delaware, Anderson Kill represented the Official Creditors’ Committee and successfully took control of the case by terminating the debtor’s exclusive right to file a plan and thereafter proposing and confirming a creditors’ committee plan pursuant to which the debtor’s assets were sold to its largest competitor.

DIP Financing Motions

The most common objections to a DIP facility will include opposition to any terms purporting to prematurely validate liens, provide excessive fees, and impose improper rates or other terms. However, to establish that the committee intends to be active in the reorganization process, special focus should be brought upon terms in the DIP that serve to entrench management. For example, many DIP facilities have onerous “change in control” clauses that treat the replacement of senior management as an “event of default.”

Similarly, while it may be reasonable for a DIP facility to provide that the appointment of a trustee constitutes an event of default, the committee might argue that a loan approved by the bankruptcy court ought to allow for continuance of the lending arrangement for thirty days so the trustee either can obtain financing from another source, or negotiate appropriate terms with the existing DIP lender. Such an objection will establish the tone of the case, make the bankruptcy judge aware of the view of the committee respecting management, and avoid the expense and dislocation associated with litigating the appointment of a trustee at the outset of a case.

In Sleepmaster, the Committee focused upon the fees being generated by the DIP, and questioned the need for the facility at such high cost. Indeed, the amount of the fees, and management’s willingness to pay them, became a mantra that counsel employed to establish a theme for the case

KERP Approval Motions

KERP programs have been extremely controversial. Some commentators have suggested that they be banned outright from Chapter 11 cases. The theoretical benefit of a KERP—the necessity and value associated with maintaining managerial stability during the outset of a case by providing incentives for management continuity—is speculative in most cases, and an absurd concept in many others. Where a committee seeks wholesale replacement of management, the KERP motion presents an opportunity to identify for the court a history of the plagues visited upon the estate by existing management. Generally, courts are disinclined to listen to tales of managerial incompetence; it is a common denominator of many Chapter 11 cases. But, in the case of KERP motions, demonstrable incompetence is highly relevant.

In Sleepmaster, the Committee was able to express its concerns respecting management and limit the scope of the benefits obtained by them. The court was reminded that the committee was dissatisfied with management’s performance and the foundation was laid for more significant confrontations that lie ahead.

Exclusivity Extension Motions

Termination of a Debtor’s exclusive right to file a plan is often the turning point of a Chapter 11 case. In Sleepmaster, utilizing the positions it had staked out throughout the case, the Committee was able to obtain termination of the Debtor's exclusive right to file a Chapter 11 plan. Thereafter, the Committee commenced negotiations with the Debtor’s largest competitor, and the terms of a sale were agreed upon. The Committee then proposed a plan, obtained approval of a disclosure statement, and sought confirmation of the plan. After solicitation of votes, virtually all creditors voted to accept the treatment proposed to them under the Committee's plan, and the plan was confirmed.

Conclusion

In any Chapter 11 case, a Committee must decide as soon as possible whether or not to “ride out the storm” with existing management. Old management often cannot properly operate the debtor’s business and must be removed. Accordingly, termination of exclusivity and the successful proposal of a committee plan may provide the best recovery to unsecured creditors in Chapter 11 cases with unsatisfactory management. Sleepmaster provided an example of how that strategy can benefit unsecured creditors