The Rule 2019 Battle: When Hedge Funds Collide with the Bankruptcy Code

Federal Rule of Bankruptcy Procedure 2019 imposes certain disclosure requirements on committees representing more than one creditor or equity security holder in Chapter 9 and Chapter 11 bankruptcy cases. Although the disclosure requirements of Rule 2019 have existed in bankruptcy reorganization proceedings for nearly seventy years, they had been virtually ignored until hedge funds began to actively participate in bankruptcy cases. Hedge funds have become major participants in bankruptcy proceedings, often forming unofficial or ad hoc committees. These ad hoc committees share the expenses of participating in bankruptcy cases by hiring legal counsel and other professionals to represent them throughout the process. By acting as a group, they are also able to exert greater influence and increase their leverage, since together they control a greater percentage of the company's claims. While this arrangement is especially beneficial to hedge funds, it raises unique disclosure issues. These disclosure issues have been the subject of two recent bankruptcy court decisions involving ad hoc committees and the application of Rule 2019. In February 2007, in In re Northwest Airlines Corp., the United States Bankruptcy Court for the Southern District of New York held that an ad hoc committee failed to fulfill the disclosure requirements of Rule 2019 and ordered the committee to file a modified 2019 statement. Pursuant to the Rule's requirements, the court required each member of the committee to disclose the amounts of claims and interests owned, when the claims and interests were acquired, the amounts paid for the claims and interests, and any sales of the claims and interests. The committee then filed a motion requesting the court to permit the additional Rule 2019 statement to be filed under seal. The court denied the motion. Conversely, in April 2007, in In re Scotia Development LLC, the United States Bankruptcy Court for the Southern District of Texas denied a similar motion to compel an ad hoc committee to comply with the disclosure requirements of Rule 2019. The judge in that case decided that the ad hoc committee was not a committee for the purposes of Rule 2019. This Note focuses on whether ad hoc committees comprised of hedge funds or private equity firms should be required to comply with the disclosure requirements of Rule 2019. It argues that Rule 2019 in its current form was enacted to address abuses by protective committees in the 1930s, and does not contemplate the types of investors or committees that exist today. Further, if required to comply with the current Rule 2019, investors like hedge funds and private equity firms will likely stop trading in distressed claims, which would be inefficient for the market for distressed securities. However, while efficiency is important to the financial markets, transparency is important to bankruptcy cases, and a proper balance must be struck to address these competing interests. Therefore, Rule 2019 should be amended to facilitate market efficiency while still allowing for disclosure of the information that is necessary to administer a bankruptcy case.