Empty Manipulation: Bankruptcy Procedure Rule 2019 and Ownership Disclosure in Chapter 11 Cases

Abstract

Debtors, creditors, and equity holders in Chapter 11 proceedings are waging war with one another over the application of Federal Rule of Bankruptcy Procedure 2019 (“Rule 2019”). Rule 2019 is the latest weapon in the arsenals of debtors facing increasingly aggressive distressed investors and traders who speculate in the debt and equity of bankrupt companies. Bankruptcy judges and scholars have begun to recognize the ability of distressed investors to greatly influence the reorganization process while reducing or eliminating their economic risk. All parties risk confusion, delay, and waste if a consistent and rule-based disclosure scheme is not developed. In a decision that rattled the distressed investor community, the bankruptcy in the Northwest Airlines case mandated, under Rule 2019, that an ad hoc committee of hedge funds disclose the specific prices paid for their claims and interests, as well as the dates on which they were acquired. The Court in Northwest recognized the broader issue: hedge funds and distressed investors have the potential to manipulate and frustrate the Chapter 11 process through hedging and arbitrage strategies that reduce or eliminate economic risk. However, an adequate solution providing for ownership disclosure in bankruptcy has not been developed or proposed. This Note explores the issue of investor disclosure of bankruptcy claims and interests (“ownership disclosure”). It concludes that potential conflicts of interest resulting from the separation of control rights and economic rights in bankruptcy warrants a new, broad ownership disclosure rule for Chapter 11 cases. This Note proposes that the Bankruptcy Code adopt a mandatory ownership disclosure rule that would require investors to reveal economic incentives that may frustrate a debtor’s reorganization.