CHAPTER 3-10: REVIEW OF DISCLOSURE STATEMENTS AND PLANS

3-10.1

INTRODUCTION Section 586(a)(3)(B) of title 28 provides that the United States Trustee shall monitor plans and disclosure statements filed in cases under chapter 11 and file with the court comments with respect to such plans and disclosure statements. The disclosure process is the heart of the reorganization provisions of the Bankruptcy Code. Full disclosure is required before solicitation of acceptances of a plan of reorganization, thereby enabling creditors to make an informed judgment in accepting or rejecting a plan. As stated in the legislative history of the Bankruptcy Code:

The premise underlying the consolidated chapter 11 of this bill is the same as the premise of the securities law. If adequate disclosure is provided to all creditors and stockholders whose rights are to be affected, then they should be able to make an informed judgment of their own, rather than having the court or the Securities and Exchange Commission inform them in advance of whether the proposed plan is a good plan. Therefore, the key to the consolidated chapter is the disclosure section.

H.R. Rep. No. 595, 95th Cong., 1st Sess. 226 (1977). Pursuant to 11 U.S.C. § 1125(b), acceptance or rejection of a plan may not be solicited unless accompanied by a disclosure statement found by the court to contain "adequate information" regarding the plan. The practical approach to disclosure embodied in 11 U.S.C. § 1125, however, is quite unlike the standardized approach to disclosure embodied in the federal securities laws. This is illustrated by 11 U.S.C. § 1125(a)(1), which qualifies the sufficiency requirement with the following reasonableness standard:

"adequate information" means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor's books and records, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan . . . .

11 U.S.C. § 1125(a)(1). Section 1125(d) elaborates by providing that "adequate information is not governed by any otherwise applicable nonbankruptcy law, rule, or regulation. . . ." The United States Trustee's review of disclosure statements focuses on the adequacy of disclosure. The role of the United States Trustee in reviewing disclosure statements is critical to the protection of creditors who have not directly participated in the negotiations, or when committees are inactive or have not been appointed. The Bankruptcy Code permits the court to "approve a disclosure statement without a valuation of the debtor or an appraisal of the debtor's assets." 11 U.S.C. § 1125(b). Congress recognized that the circumstances will vary widely from one chapter 11 case to the next and, therefore, the parameters of "adequate information" will also vary. The legislative history states:

The Supreme Court's rulemaking power will not extend to rulemaking that will prescribe what constitutes adequate information. . . . Precisely what constitutes adequate information in any particular instance will develop on a case-by-case basis. Courts will take a practical approach as to what is necessary under the circumstances of each case, such as the cost of preparation of the statements, the need for relative speed in solicitation and confirmation, and, of course, the need for investor protection. There will be a balancing of interests in each case. In reorganization cases, there is frequently great uncertainty. Therefore, the need for flexibility is greatest.

H.R. Rep. No. 595 at 409. A review of case law illustrates what courts consider "adequate information" based on the facts of each case. See In re Northwest Recreational Activities, Inc., 8 B.R. 10, 12 (Bankr. N.D. Ga. 1980) (perfunctory and modest disclosure statement approved because information already was available to all creditors, all five being lien holders); In re Bel Air Assocs., Ltd., 4 B.R. 168, 175 (Bankr. W.D. Okla. 1980) (no disclosure statement required where plan contained adequate information and movant, a limited partner in debtor, had other sources of information). Information may vary depending upon the sophistication of the class. See In re Bloomingdale Partners, 155 B.R. 961, 972 (Bankr. N.D. Ill. 1993); In re Egan, 33 B.R. 672, 676-77 (Bankr. N.D. Ill. 1983) (disclosure statement containing statements of opinion without factual support, along with lack of cooperation by the debtor, disapproved and petition dismissed); In re Adana Mortgage Bankers, Inc., 14 B.R. 29 (Bankr. N.D. Ga. 1981) (mere summary of the plan inadequate-the disclosure statement must discuss the plan as well as provide other information). But see In re Walker, 198 B.R. 476, 479-80 (Bankr. E.D. Va. 1996) (court held that the information need only be the best prediction that the debtor can make based upon information available). The process for obtaining approval of a disclosure statement and soliciting votes for a plan of reorganization has been simplified for small business debtors. A small business debtor may obtain conditional approval of a disclosure statement which can then be utilized to solicit votes regarding a plan. The conditionally approved disclosure statement can be mailed to creditors as few as ten days prior to the date of the hearing on confirmation of the plan. The court can then hold a single hearing to consider both final approval of the disclosure statement and plan confirmation. 11 U.S.C. §§ 105(d)(2)(B)(vi) and 1125(f)(3); Fed. R. Bankr. P. 3017.1.

3-10.2

THE CONCEPTUAL FRAMEWORK

3-10.2.1

Items to Include The United States Trustee should not advocate a "checklist approach to the review of disclosure statements. The disclosure statement certainly should discuss the elements set out in 11 U.S.C. § 1123 insofar as they are in the plan filed. Reference to case law regarding information to be included is essential. See, e.g., Hall v. Vance, 887 F.2d 1041, 1043 (10th Cir. 1989); In re Metrocraft Publ'g Servs., Inc., 39 B.R. 567, 568-69 (Bankr. N.D. Ga. 1984); In re Malek, 35 B.R. 443, 443-44 (Bankr. E.D. Mich. 1983); In re A.C. Williams Co., 25 B.R. 173, 176 (Bankr. N.D. Ohio 1982).

3-10.2.2

"Safe Harbor," 11 U.S.C. § 1125(e) Under 11 U.S.C. § 1125(e), a person who solicits acceptances or rejections of a plan in good faith and in compliance with the Bankruptcy Code is not liable on account of such solicitation for the violation of any applicable law, rule, or regulation governing the offer, issuance, sale, or purchase of securities. The purpose of this section is to protect creditors, creditors' committees, counsel for committees, and others involved in a case from potential liability for use of an approved disclosure statement. This safe harbor rule was intended to codify the result of Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), reh'g denied, 425 U.S. 986 (1976), which held that proof of scienter is a prerequisite to the imposition of civil liability under the antifraud provisions of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. It was also intended to extend the good faith safe harbor to the imposition of injunctive liability. See H.R. Rep. No. 595 at 229-31.

3-10.2.3

Factors Affecting Adequacy of Disclosure Several factors can affect the appropriate quantity and quality of disclosure in a given case, including: (1) the nature of the proposed plan of reorganization or liquidation; (2) the sophistication of the various holders of claims and interests and their familiarity with the debtor and its business; (3) whether the expense of the disclosure would substantially outweigh its anticipated benefit to creditors and stockholders; (4) the peculiarities of the debtor's business or financial condition; (5) the need for an expeditious resolution; and (6) the access of a plan proponent, other than the debtor, to factual information regarding the debtor. An inordinately long or complex disclosure statement may confuse rather than enlighten creditors. In such cases, the deletion of certain materials or the preparation of a summary may be suggested; however, care must be taken to ensure that significant material is not deleted.

3-10.3

CONDUCTING THE REVIEW

3-10.3.1

Standard Language The use of some standardized language in disclosure statements is appropriate. For example, all documents should indicate that any representations made in order to secure an acceptance of the plan that are not contained in the disclosure statement are to be reported to the debtor, the creditors' committee, the United States Trustee, and the bankruptcy court for such action as may be appropriate. Similarly, there should be a statement that the plan represents a legally binding arrangement and should be read in its entirety, as opposed to relying on the summary in the disclosure statement. Accordingly, creditors may wish to consult with their own lawyers and the creditors' committee and its lawyer to understand the plan more fully. The disclosure statement should also refer to "the right to vote for acceptance or rejection" of the plan or "the right to vote upon" the plan. While the disclosure statement may serve the parallel purpose of solicitation, the solicitation aspect of the statement should be clearly identified as such and kept distinct from the disclosure aspect. For example, the disclosure statement may state that "as a creditor, your acceptance is important" but such a statement should not be included in a paragraph describing voting procedures. It is permissible, however, for a discussion of the voting process to state that it is important for each creditor to vote. The disclosure statement should indicate that bankruptcy court approval of the disclosure statement is not a ruling by the bankruptcy court on the merits of the plan. The disclosure statement should indicate which classes are impaired and are, therefore, entitled to vote on the plan and should define impairment in plain language. The voting requirements under 11 U.S.C. § 1126 for acceptance must be set forth in the disclosure statement. Voters should be told where the ballots must be sent and the deadline for voting. The ballots should not be sent to the United States Trustee.

3-10.3.2

Description of the Debtor's Business The disclosure statement should describe the nature of the debtor's business. In cases in which the plan contemplates cash payments upon confirmation, a brief narrative description should suffice. If the plan contemplates deferred payments or the issuance of common or preferred stocks to creditors and, therefore, its implementation depends upon the future course of the business, the description should be more detailed. Items to look for in the latter case are: (1) material factors peculiar to the specific business of the debtor, such as seasonality, limited sources of supply, limited number of potential customers, patents or licenses, special capital needs, regulatory problems, or backlog; (2) principal product and services present, contemplated, or under development; (3) competitive conditions in the applicable market; and (4) material contracts and leases, including important terms such as expiration dates. Of course, if detailed information would have a detrimental impact on the debtor's competitive position, general terms may be permissible.

3-10.3.3

Reasons for Financial Difficulties and Correction of Those Factors The disclosure statement should give a brief narrative description of the factors leading to the debtor's financial difficulties, together with a listing of the steps already taken or to be taken by the debtor to correct the problems. This description should be reviewed from the standpoint of the assistance it will provide the holders of claims and interests in assessing the likelihood of any recurrence of prior difficulties and, thus, the feasibility of the proposed plan. In cases in which the plan has neither deferred payments nor issuance of common or preferred stock, an elaboration of the reasons for the debtor's financial difficulties and the correction of those factors are less important and may be dealt with summarily.

3-10.3.4

Historical and Current Financial Information Historical financial information, such as cash flow statements and profit and loss statements (statements of operation), should, where relevant, provide the holders of claims and interests some perspective regarding the debtor's financial situation and future prospects (as reflected in any projections included in the disclosure statements). See "Projections" infra. Current financial information, such as cash flow statements, profit and loss statements (statements of operations), and balance sheets, provide holders of claims and interests with important information about the debtor's performance during the pendency of the chapter 11 case. Of particular importance is the comparison of the current balance sheet with the balance sheet as of the commencement of the case. The disclosure statement should include, as an exhibit, a summary of the results of the operations during the pendency of the chapter 11 case. In re Merrimack Valley Oil Co., 32 B.R. 485, 488 (Bankr. D. Mass. 1983); In re Western Management, Inc., 6 B.R. 438, 442-43 (Bankr. W.D. Ky. 1980). The summary should be in a format consistent with the projections so that creditors can make a meaningful comparison of the past with future projections. The format of the summary and the projections should be consistent with regard to time and designation of income and expense items. The disclosure statement should also include a projection of the financial condition of the debtor upon confirmation of the plan. This information enables the court and creditors to determine if the debtor will need further financial reorganization or if the plan will be followed by a liquidation. 11 U.S.C. § 1129(a)(11). The extent to which financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") will vary. The period covered by historical financial information may vary based on the nature of the plan, the condition of the debtor's books and records (11 U.S.C. § 1125(a)(1) expressly recognizes this as a variable), and the nature of the debtor's business. Any financial statements that have not been prepared in accordance with GAAP due to the condition of the debtor's books and records should contain appropriate disclaimers and a brief explanation of the accounting methods employed. The American Institute of Certified Public Accountants issued Statement of Position (SOP) 90-7, on November 19, 1990. The statement provides guidance for the financial reporting of entities currently in chapter 11 which expect to reorganize as going concerns.

3-10.3.5

Material Postpetition Events The disclosure statement should briefly describe all material postpetition events including: (1) borrowings, (2) issuance of securities, (3) sales or transfers of assets other than in the ordinary course of business, and (4) lease assumptions and/or assignments or rejections (along with other executory contracts).

3-10.3.6

Outline of the Plan The degree of detail in which the proposed plan of reorganization should be outlined in the disclosure statement will vary greatly with the complexity of the plan. In some instances, cross-references in the disclosure statement to pertinent plan provisions will suffice. In other instances, complex features of the plan may need to be separately, but briefly, described in the disclosure statement. For example, if the plan contemplates deferred payments to unsecured creditors out of retained earnings in excess of a stated figure, look for some explanation of this feature in the disclosure statement. Similarly, complex plan provisions often involve definitional problems that should be clarified in the disclosure statement. For example, the amount of deferred payments to a particular class of creditors may be expressed as a percentage of "net sales," a term which should be defined. Any default provisions or affirmative and negative covenants contained in the plan (e.g., dividend restrictions, limitations on further borrowing, and board memberships) should be explained. Information on the amount of claims in each class should be provided in tabular form in order to allow computations of the possible distribution to be made under the plan. The disclosure statement should also predict when confirmation will occur.

3-10.3.7

Means of Effectuating the Plan Information relating to the source and application of funds to effectuate the proposed plan of reorganization should appear in the disclosure statement, including an estimate of the amounts necessary for the initial payments under the plan. This number should be compared to the cash on hand. If the amount needed to confirm is greater than the cash available, there should be an explanation concerning the source of the additional funds. There should also be a brief description of the structure of any transaction related to carrying out the plan (e.g., the sale of stock or of assets). There should be an indication as to whether there exists any avoidable transfers (preferences and/or fraudulent conveyances) and whether the debtor (or acquiring entity) intends to prosecute these claims. These potential causes of action should be factored into the estimated liquidation analysis. The disclosure statement should contain a brief description of the terms of any material agreements relating to the effectuation of the plan which the debtor has executed or proposes to execute (e.g., funding agreements, security agreements, guarantees, trust indentures, and agreements for the sale of stock or assets). For example, the plan may contemplate the use of a trust indenture in connection with deferred payments to creditors. In that event, the scope of discretionary authority lodged in the indenture trustee (e.g., the discretion to pledge assets to facilitate new financing or to subordinate the security interest granted to creditors) and the identity and affiliations of the indenture trustee should be disclosed. If there are to be guarantees for debtor's obligations under the plan , the guarantors should be identified and the nature and scope of guarantees described. In addition, the guarantor's ability to support the guarantee (e.g., a net worth statement in the case of an individual guarantor) should be discussed. If a third party (including debtor's principal ) is to provide the necessary funds for confirmation, there should be some financial information with respect to the third party. If the third party does not want to be disclosed or does not want to disclose its financial condition, there are acceptable alternatives. For instance, if the funds are deposited in an identifiable escrow account for confirmation or by an irrevocable letter of credit, financial disclosure about the third party may not be necessary. Terms of the advance loan or contribution to capital should also be set forth. This should also be reflected in a projection which assumes confirmation of the plan. The disclosure statement should indicate if there are any conditions that have to be met by any party in order for the plan to be confirmed. The disclosure statement should also state the likelihood of the requisite events occurring as scheduled.

3-10.3.8

Securities to be Issued In rare instances, a case will involve the issuance of securities. If such a case arises, the disclosure statement should provide information about any securities to be issued pursuant to the plan of reorganization, where applicable, as to: (1) dividend rights, management's dividend policies, and external constraints on the payment of dividends (e.g., a negative covenant in a loan agreement); (2) liquidation rights and preferences; (3) voting rights; (4) sinking fund payments; (5) conversion features; (6) preemptive rights; (7) redemption provisions; (8) provisions relating to interest, amortization, and maturity; (9) provisions restricting the issuance of additional securities; and (10) other special rights and preferences (e.g., the right to elect a majority of the board of directors in the event of defaults on payments in respect to debentures issued or the right to veto certain corporate changes, such as recapitalization, that could adversely affect the security holders' rights). The disclosure statement should indicate whether the issuance of the securities in question is exempt from the registration requirements of federal and state securities laws by virtue of 11 U.S.C. § 1145(a) or a different exemption, or whether it is contemplated that the securities will be registered. It may be appropriate for the disclosure statement to include information relating to the current and anticipated postconfirmation distribution of ownership of equity securities. This information could serve to inform the holders of claims and interests as to any dilution or changes in control likely to result from the issuance of securities contemplated by the plan of reorganization. Even in those cases where existing stockholders do not have preemptive rights, if the stock is being diluted, the existing stockholders are impaired. Cf. In re Barrington Oaks General Partnership, 15 B.R. 952 (Bankr. D. Utah 1981). If there is a market for the securities to be issued (or the securities into which they are convertible), the disclosure statement should identify the principal markets involved. If the securities are traded on an exchange, information as to high and low sales prices in the recent past should be included. If the principal market for such securities is not an exchange, there should be included information as to high and low bid quotations in the recent past (together with disclosure of the source of those quotations). If there is no market for such securities, the disclosure statement should so state, and should also state whether it is expected that a market will exist for securities distributed under the confirmed plan. If the securities are publicly held, but not traded because of past failure to disseminate public information (see Securities Exchange Act Rule 15c2-11), that fact should be disclosed. If it is expected that the disclosure being made will cure the deficiency so that trading can resume, then that expectation should be noted. Finally, the disclosure statement should briefly describe applicable law relating to the resale of the securities to be issued under the plan of reorganization. There is a limited exemption in 11 U.S.C. § 1145(d) from the provisions of the Trust Indenture Act of 1939.

3-10.3.9

Projections "[T]he essence of disclosure in a reorganization case, and the essence of valuation of a business as a going concern, is a projection of future earnings of the business." H.R. Rep. No. 595 at 230-31. If the plan of reorganization does not contemplate any deferred payments or the issuance of any equity security, such projections are unnecessary. In all other cases, projections are critical to the creditors' and shareholders' ability to assess the viability of the plan and of the debtor. It should be noted that the Securities and Exchange Commission encourages the use of projections of future economic performance. See Securities Act Release No. 33-5992 (November 7, 1978), 43 F.R. 53246. The projections should include both cash flow and earnings estimates. All payments contemplated under the plan should be factored into the cash flow projections. If earlier projections are available, they should be compared in the disclosure statement with actual results for the periods covered. Creditors will then be able to assess management's powers of projection. There may be instances in which payments under the plan are tied to specific financial measures (e.g., net sales, pre-tax profits, retained earnings, or other measures). In such circumstances, the projections should set forth estimates in terms of the appropriate measure. The United States Trustee should ensure that the underlying assumptions utilized by management in developing the projections are disclosed as specifically as possible. There may exist, however, legitimate reasons for a vague statement concerning such items as the introduction of a new product or the gearing down of operations. It should be understood that the disclosure of "adequate information" may conflict with the debtor's legitimate need to protect its competitive position. For example, the disclosure of market study results for a proposed new product, while of significant informational value to creditors, might not be appropriate. Where the assumptions made relate to the factors cited as reasons for the debtor's financial difficulties and are intended to correct those factors, the connection should be made clear. Cases may arise in which alternative sets of projections, or at least ranges of projections, would be appropriate. For example, the plan of reorganization may offer creditors two or more payment options. Alternative sets of projections or ranges of projections may be desirable to reflect the different results that would flow from the election of each option. Similarly, alternative sets of projections or ranges of projections may be appropriate when there is a reasonable prospect of a change affecting the debtor's business (e.g., regulatory changes, introduction of a new product, or new market entrants).

3-10.3.10

Management, 11 U.S.C. § 1129(a)(5) Even if the plan of reorganization contemplates exclusively cash payments upon confirmation, the disclosure statement must identify the anticipated postconfirmation directors and executive officers of the debtor, and indicate the extent to which this represents a change from preconfirmation management. The disclosure statement should contain a brief account of the business experience of each director and executive director, together with their age, tenure, and possible retirement where relevant. Information as to compensation arrangements with the debtor's directors and executive officers should also be disclosed. The disclosure statement should also include any other information relevant to the integrity and competence of management (e.g., criminal or regulatory proceedings and prior bankruptcies or receiverships).

3-10.3.11

Controlling Persons In the case of a plan of reorganization that will be implemented over time, the disclosure statement should identify any "persons" (as defined in 11 U.S.C. § 101(41)) that will "control" the debtor following confirmation of the proposed plan of reorganization. With respect to any "person" that is to "control" the debtor, the disclosure statement should provide at least the following information: (1) the nature and extent of "control" to be exercised; (2) a brief narrative description of the business of the controlling person; (3) the identity of persons that control such controlling person; (4) the identity and experience of management of the controlling person; (5) the identity of affiliates of the controlling person; (6) an outline of the transaction whereby control is to be acquired; (7) if known, the business plans of the controlling person for the debtor; and (8) pertinent financial information regarding the controlling person, if available.

3-10.3.12

Insider and Affiliate Claims The disclosure statement should list any claims held by "insiders" (as defined in 11 U.S.C. § 101(31)) or "affiliates" (as defined in 11 U.S.C. § 101(2)) of the debtor and should include: (1) the identity of the claimant; (2) the claimant's affiliation with the debtor; (3) the circumstances giving rise to the claim; (4) the amount of the claim; and (5) the treatment to be afforded the claim in accordance with the plan.

3-10.3.13

Transactions with Insiders and Affiliates The disclosure statement should contain a brief description of any present or proposed material transactions of the debtor in which "insiders" or "affiliates" of the debtor (as defined in 11 U.S.C. §§ 101(31) and (2), respectively) have any interest. The insider or affiliate should be identified, the affiliation with the debtor described, and the nature of the interest in the transaction explained. For example, rentals paid by or to the debtor should be compared to existing market rates. If any transactions have given rise to claims either on behalf of or against the debtor in the chapter 11 case, they should be disclosed.

3-10.3.14

Disputed Claims Any material claims that the debtor disputes or proposes to dispute, in whole or in part, should be listed and there should be a disclosure of: (1) the identity of the claimant; (2) the nature of the claim; (3) the full amount of the claim and the amount subject to dispute; and (4) the grounds of the debtor's challenge to the claim (e.g., voidable preference, fraudulent transfer, or lack of collateral value). It may also be appropriate for the disclosure statement to explain the effect upon the plan of reorganization (and the related projections, if any) of the allowance or disallowance of the disputed claim.

3-10.3.15

Legal Proceedings The disclosure statement should give a brief description of any material legal proceedings to which the debtor is a party, which the debtor contemplates instituting, or which are threatened against the debtor. This disclosure should include information as to: (1) the identity of the parties to the litigation; (2) the nature of the claims; (3) the factual basis alleged to underlie the proceedings; (4) the court in which the litigation is pending; (5) the relief sought; (6) the present status of the litigation; and (7) a statement as to whether a judgment adverse to the debtor might seriously affect the debtor's business or financial conditions or the debtor's ability to effectuate the plan of reorganization.

3-10.3.16

Tax Consequences In some instances, the proposed plan of reorganization will engender federal tax consequences for the debtor that may have a material affect upon the future financial prospects of the debtor. If material in their affect, these tax consequences should be explained. For example, the discharge of the debtor from indebtedness pursuant to the plan of reorganization may affect the debtor's net operating loss carryovers, investment tax credits, capital loss carryovers, or basis in assets. Similarly, a plan that contemplates a corporate reorganization (e.g., transfer of the debtor's assets to another corporation in exchange for stock) may or may not be tax-free at the corporate level. Information relating to the tax consequences upon the debtor of the plan of reorganization obviously will be relevant and feasible only in larger chapter 11 cases.

3-10.3.17

Trustee or Examiner If a trustee or an examiner has been appointed in a chapter 11 case, the identity and the reasons for the appointment of the trustee or examiner should be disclosed. Similar information regarding an elected trustee should be provided. If the trustee or the examiner has prepared a report regarding the operations of the debtor, and if it is not too voluminous, a copy should be attached to the disclosure statement. If it is not attached, it should be summarized in the disclosure statement, with directions on how to obtain a copy of the report.

3-10.3.18

Creditors' Committees and Equity Security Holders' Committees The disclosure statement should indicate whether there are any creditors' or equity security holders' committees, together with a list of the members of such committees, their addresses, and whether the proposed plan of reorganization has been negotiated with the committees. Any professionals retained by the committees should also be disclosed. The position of the committees on the plan should be disclosed and what role, if any, the committees will play after confirmation.

3-10.3.19

Information Regarding Plan Proponent Occasionally, a plan and disclosure statement may be offered by a party other than the debtor, the trustee, or the creditors' committee. The proponent must be a "party in interest" under 11 U.S.C. § 1121. In those situations, the disclosure statement should clearly describe the position of the proponent relative to the debtor (e.g., a supplier holding an unsecured claim against the debtor in the amount of $20,000), since it may affect the proponent's access to the information and, thus, the quality and quantity of disclosure. On the other hand, disclaimers by an "outside" plan proponent as to the absence of information regarding the debtor must also be scrutinized, since the formulation of a plan by the proponent necessarily involved certain assumptions, if not "hard" information, regarding the debtor. The standard of adequate information should not change depending upon the proponent of the plan. Any assumptions should be disclosed and the proponent should be compelled to obtain the necessary, existing information in order for the disclosure statement to be approved. See In re Civitella, 15 B.R. 206, 208 (Bankr. E.D. Pa. 1981) (disclosure statement for a plan proposed by three secured creditors denied approval because no factual information provided, only allegations and opinions). Where other plans have been proposed, their existence and the fact that they are on file with the court should be disclosed. These are potential alternatives to the plan that creditors/equity holders are being asked to vote upon.

3-10.3.20

Liquidation Analysis A creditor cannot make an informed judgment regarding a proposed plan of reorganization without information as to the available alternatives. The most obvious alternative is liquidation of the debtor under chapter 7. Any reference to liquidation should be prefaced with the term "estimated," since liquidation has not occurred. These statements of alternatives should be neutral. Other alternatives may have been considered by the proponent of the plan during the course of the chapter 11 case (e.g., a competing plan of reorganization) and, in that event, the disclosure statement could briefly describe the alternatives considered and the reasons for finding the proposed plan of reorganization preferable. In most cases an elaborate liquidation analysis should not be necessary. A brief tabular presentation, setting forth estimated administration expenses (including pre and postconfirmation United States Trustee quarterly fees; estimated priority, secured, and unsecured claims; and estimated asset values, together with disclosure of the source of those estimates) should suffice. The disclosure statement should indicate the percentage distribution, if any, to creditors on liquidation. The disclosure statement should enable the reader to determine what assumptions were made in connection with the estimate of claims and asset values (e.g., the assumptions regarding disallowance of certain claims, recoverable transfers, the book figures upon which the liquidation values are based, and the method employed in computing the book figures or the discount applied to accounts receivable and how this discount relates to the debtor's actual prepetition and postpetition collection experience). Certain assets, such as leases and real estate, may not be reflected accurately on the balance sheet, although quite valuable upon liquidation. Any adjustments that are made should be disclosed. If liquidation will not be immediate, an estimate of the length of time that would be required to liquidate the assets of the debtor should be included. If relevant, the liquidation analysis should factor in available exemptions provided by the Bankruptcy Code. If claims incorporated in the liquidation analysis are held by "insiders" or "affiliates" of the debtor, that fact should be mentioned. In the case of a partnership, the disclosure statement should include financial information about the partners so that creditors can determine if the plan is in their "best interest." 11 U.S.C. § 1129(a)(7); see also 11 U.S.C. § 723 (partnership distributions in chapter 7). Section 1112(c) of the Bankruptcy Code provides that the court may not convert the chapter 11 case of a "farmer" (as defined in 11 U.S.C. § 101(20)) or "a corporation that is not a moneyed, business, or commercial corporation" unless the debtor so requests. Arguably then, a liquidation analysis is unnecessary with respect to cases involving farmers or charitable institutions. There are, however, three factors that should be considered in determining whether a liquidation analysis should be included in such circumstances. First, there may be a legitimate question as to whether the debtor fits the definition of "farmer" in 11 U.S.C. § 101(20) or is a "corporation that is not a moneyed, business, or commercial corporation." Second, 11 U.S.C. § 1112(c) seems to prohibit involuntary conversion to chapter 7, but does not seem to prohibit dismissal of the chapter 11 case, and the ultimate effect of dismissal may be liquidation of the debtor. Finally, a creditor faced with the proposed plan may elect to reject the plan and seek to structure a competing plan which provides for partial or complete liquidation of the debtor. 11 U.S.C. § 1123(b)(4). Section 1125(b) of the Bankruptcy Code indicates that the court may approve a disclosure statement without a valuation of the debtor or an appraisal of its assets. Appraisals are, however, performed in most cases and their incorporation in the disclosure statement enhances the liquidation analysis. (Disclosure of information relating to an appraisal may be restricted.) If an appraisal is too voluminous, a summary and information on how to obtain a copy of the appraisal will generally suffice. In either event, the disclosure statement should (1) identify the appraiser, (2) identify the party who commissioned the appraisal, and (3) disclose the purpose of the appraisal. The proponent of the plan of reorganization may want to argue that one of the appraisals is especially reliable and the reasons for this conclusion.

3-10.3.21

Vote Required for Acceptance The disclosure statement should briefly describe the vote required for acceptance of the plan by the various classes of holders of claims and interests under 11 U.S.C. § 1126, and should specifically identify which classes are impaired and voting on the plan. The disclosure statement should also establish a record date for voting on the plan of reorganization by holders of equity securities.

3-10.3.22

"Cram Down" Although the application of 11 U.S.C. § 1129(b) is essentially a question for confirmation, the discussion in the disclosure statement of "cram down" raises a difficult problem. The term "cram down" is used to describe the power of the bankruptcy court to confirm a reorganization plan even though one or more impaired classes of creditors does not accept the plan. 5 Lawrence P. King, Collier on Bankruptcy, ¶ 1111.02 (15th ed. rev. 1998). At a minimum, if the debtor intends to invoke the "cram down" provisions against a dissenting class, that intention should be disclosed. Moreover, if the invocation of "cram down" is intended, the disclosure statement should contain a brief summary of the operation of 11 U.S.C. § 1129(b) as it would affect the class in question, as well as a brief outline of the "fair and equitable" standard that would be applied should "cram down" be invoked. The disclosure problem is further complicated to the extent there may be, as a legal matter, significant doubt as to the availability of "cram down" in a given case. For example, although a plan of reorganization proposes that stockholders will receive cash payments in exchange for their shares, the disclosure statement may state (or at least suggest) that 11 U.S.C. § 1129(b) "may be" invoked against unsecured creditors as a class. The availability of "cram down" in those circumstances may be questionable. It is misleading to even suggest to creditors that the debtor may invoke 11 U.S.C. § 1129(b) without an explanation. Thus, in every case in which the debtor states or suggests that "cram down" is contemplated, the United States Trustee should analyze the legal issue and formulate a judgment as to the availability of "cram down" under the circumstances. If the United States Trustee questions the availability of "cram down," an objection to the disclosure statement should be made. The remedy may be deletion or the inclusion of an explanation of the legal issues involved. Moreover, the disclosure statement should include a statement to the effect that, if a senior class of creditors rejects the plan, the court may find that the junior class (or classes) may not receive a distribution under the plan or retain its interests in the reorganized debtor unless they satisfy the "new value exception" which would require that the junior class (or classes) contribute new value to the debtor that is new, substantial, money, or money's worth; necessary for a successful reorganization; and in an amount reasonably equivalent to the value of the interest or distribution that they are retaining or receiving. In re One Times Square Assocs. Ltd. Partnership, 159 B.R. 695, 706-08 (Bankr. S.D.N.Y. 1993).

3-10.3.23

Miscellaneous Matters The disclosure statement should identify the leases or executory contracts being assumed or rejected under the plan. To the extent a lease or executory contract is being rejected, a claim for damages may arise. An estimate of these damage claims should be set forth and factored into the estimated amount of claims in each class. The disclosure statement should set forth any default provisions under the plan and the consequences attendant to a default. For example, a default could trigger an acceleration of the total future payments under the plan or an immediate conversion to chapter 7.

3-10.3.24

Summary and Table of Contents If the disclosure statement is voluminous, the inclusion of a table of contents and a brief summary of the plan, of alternatives to the plan, and of the debtor's future prospects may be appropriate.

3-10.3.25

Notice The notice of the hearing on a disclosure statement must be sent to all creditors. Fed. R. Bankr. P. 2002(b)(1). This may be only a one-page notice and need not include the proposed disclosure statement. The notice should indicate that copies are available, if requested, and that the original is on file with the court. In a small business case, a conditionally approved disclosure statement need only be mailed to creditors ten days prior to the hearing on confirmation of the plan. 11 U.S.C. § 1125(f)(2). After a disclosure statement is approved, it must be sent to all creditors along with the plan, a ballot, and the order approving the disclosure statement. That order should indicate the date by which ballots must be received, the persons to whom they must be sent, the date of the confirmation hearing, and the date by which any objections to confirmation must be filed. On the subject of notice, see Fed. R. Bankr. P. 3017(d) (giving the court discretion to direct that disclosure statements, plans, and notices of time for filing ballots not be sent to unimpaired classes of creditors or equity security holders); In re Douglas Hereford Ranch, Inc., 76 B.R. 781, 783 (Bankr. D. Mont. 1987) (the affirmative vote of one impaired class was necessary to invoke cram down; deemed acceptance was not enough); In re Russell, 44 B.R. 452, 453 (Bankr. E.D.N.C. 1984) (the deemed acceptance of an unimpaired class is different from the affirmative acceptance of an impaired class required by section 1129(a)(10)). The United States Trustee should ensure that classes are described properly so that adequate notice is given.

3-10.4

PREPETITION SOLICITATION A plan proponent may wish to utilize acceptances to its plan that were solicited and obtained prior to the commencement of the case during an "out of court composition" or "work out" arrangement--the so-called prepackaged plan. These ballots may be used if the prepetition solicitation was in compliance with "applicable nonbankruptcy law, rule, or regulation" pursuant to 11 U.S.C. § 1126(b)(1) and if the procedures set forth in Fed. R. Bankr. P. 3018(b) were followed. There is general agreement that the securities laws constitute "applicable nonbankruptcy law." In re Southland Corp., 124 B.R. 211, 225 (Bankr. N.D. Tex. 1991) was the first significant decision dealing with prepackaged plans.

3-10.5

PLAN MODIFICATION The plan proponent may wish to modify the plan either prior to or after confirmation. 11 U.S.C. § 1127. To the extent that the change is not a "material" modification, additional disclosure and a re-solicitation may not be necessary. See 11 U.S.C. § 1127(c) and the legislative history. Obviously, any downward change in the amount of distribution or the payment schedule would constitute a material modification requiring a re-solicitation. Such a procedure may be in the form of a "negative solicitation," i.e., members of the class may be given an opportunity to (1) change their vote, (2) vote if they had not already done so, or (3) do nothing and their vote could be counted as originally cast. The United States Trustee should review any modification and make such recommendation to the court as is appropriate.

3-10.6

REVIEW OF PLAN AND CONFIRMATION The United States Trustee should ensure that the party proposing the plan and disclosure statement has the authority to do so. For example, in In re New Haven Radio, Inc., 18 B.R. 977, 979 (Bankr. D. Conn. 1982), the court held that a sole stockholder had no authority to file a disclosure statement in the absence of any corporate resolution, minutes, correspondence, or any other document attached to the disclosure statement. The court stated that there must be "credible evidence" that the person submitting the plan is a duly authorized agent of the debtor in order to file a plan while the debtor's period of exclusivity is in effect. The United States Trustee should review the plan to determine that it meets the requirements of 11 U.S.C. § 1129. Confirmation issues that may concern the United States Trustee include: the inappropriate classification of claims and interests; administrative solvency or insolvency (whether the administrative and priority claims can be paid in full or properly deferred); a request for discharge in contravention of 11 U.S.C. § 1141(d); provisions for the release of, or injunctions in favor of, guarantors, partners, or non-debtor entities in contravention of 11 U.S.C. § 524(e); inappropriate exculpatory clauses releasing professionals and disbursing agents from liability beyond the scope of 11 U.S.C. § 1125(e); the bonding of escrow or disbursing agents where appropriate; and ensuring that the plan includes a provision for payment of any outstanding quarterly fees on the effective date of the plan and for the payment of postconfirmation quarterly fees. Objections premised upon lack of feasibility should be filed in cases where a debtor's financial projections are totally unrealistic, as, for example, if unsupported by experience of the entity or the industry. While the United States Trustee has the discretion to file objections to confirmation, confirmation issues should generally be left to creditors after full and fair disclosure, absent egregious circumstances. If creditors are not active or are unrepresented, as when a committee could not be appointed, the United States Trustee's role is more important.

3-10.7

POSTCONFIRMATION MONITORING The minimum duties of the United States Trustee in this area are set forth in a Memorandum of Understanding ("MOU") with the Administrative Office of the United States Courts dated October 1991. Pursuant to the MOU, the United States Trustee must review all final reports and motions for final decrees filed in chapter 11 cases and object if appropriate. In addition, in cases where no such pleadings have been submitted, the United States Trustee must initiate action to compel the filing of a final report. After confirmation of the plan, the reorganized debtor is required to "file such reports as are necessary or as the court orders." 11 U.S.C. § 1106(a)(7). If no such reports are required by local rule or guideline, the United States Trustee should require the reorganized debtor to file and serve postconfirmation reports on a periodic basis (monthly or quarterly) sufficient for the United States Trustee to determine the amount of the debtor's receipts and disbursements and to collect all postconfirmation quarterly fees that are owing. In addition, the reports should contain sufficient information for the United States Trustee to determine whether the reorganized debtor has substantially consummated the plan and whether the debtor is entitled to a final decree pursuant to 11 U.S.C. § 350 and Fed. R. Bankr. P. 3022. If necessary, the United States Trustee should interpose an objection to the plan of reorganization to require such reporting, along with appropriate language to confirm the reorganized debtor's continued obligation to pay quarterly fees until case dismissal, conversion, or closure. Often parties in interest will move to dismiss or convert a confirmed case. Because the grounds for conversion or dismissal listed under 11 U.S.C. § 1112(b) include the inability to effectuate substantial consummation of a confirmed plan (11 U.S.C. § 1112(b)(7)) and material default by the debtor with respect to a confirmed plan (11 U.S.C. § 1112(b)(8)), it is clear that the courts retain jurisdiction to hear such motions postconfirmation. The United States Trustee may be requested to state his/her position at such hearings. The United States Trustee should review carefully the reported decisions within the applicable jurisdiction, if any, as the courts are divided over whether dismissal or conversion is the appropriate remedy in such situations. Some courts hold that unless the plan or order of confirmation provides otherwise, the property permanently revests in the reorganized debtor and, absent revocation pursuant to 11 U.S.C. § 1144, dismissal is the appropriate remedy since a chapter 7 trustee would have no estate property to administer for the benefit of creditors. In re K & M Printing, Inc., 210 B.R. 583, 586 (Bankr. D. Ariz. 1997); In re H.R.P. Auto Ctr., Inc., 130 B.R. 247, 257 (Bankr. N.D. Ohio 1991); In re T.S.P. Indus., Inc., 117 B.R. 375, 377-78 (Bankr. N.D. Ill. 1990). Other courts hold that regardless of the plan or order of confirmation, conversion is an effective remedy for postconfirmation defaults by the reorganized debtor because the chapter 7 trustee can administer the debtor's property for the benefit of creditors. In re Smith, 201 B.R. 267, 271 (D. Nev. 1996); In re Calania Corp., 188 B.R. 41, 42-43 (Bankr. M.D. Fla. 1995); In re Midway, Inc., 166 B.R. 585, 590 (Bankr. D.N.J. 1994). Still other courts hold that conversion is appropriate where the trustee may pursue certain claims on behalf of creditors such as avoidance actions, partnership claims, or other claims for relief. In re T.S. Note Co., TFC, 140 B.R. 812, 813-14 (Bankr. D. Kan. 1992) (case converted to allow trustee to investigate potential avoidance actions). Before taking a position, the United States Trustee also should review the plan and disclosure statement, order of confirmation, and the reorganized debtor's postconfirmation reports, if any. The United States Trustee also should determine whether any postconfirmation fees are owing and consider whether case closure is preferable to dismissal or conversion. To the extent that the United States Trustee becomes aware of cause to revoke the order of confirmation pursuant to 11 U.S.C. § 1144, the United States Trustee should pursue such action. For example, if there is a material misrepresentation in the disclosure statement discovered within six months after confirmation or there was a concealment of assets, the United States Trustee should move to revoke confirmation. Revocation of confirmation requires the filing of an adversary complaint and a specific showing of fraud. See In re Longardner & Assocs., Inc., 855 F.2d 455, 460 (7th Cir. 1988), cert. denied, 489 U.S. 1015 (1989); In re Gross, 121 B.R. 587, 592 (Bankr. D.S.D. 1990); In re Nyack Autopartstores Holding Co., Inc., 98 B.R. 659, 663 (Bankr. S.D.N.Y. 1989).