Liquidating Trust Structure Is Key to Maximizing Payouts

The use of liquidating trusts in Chapter 11 reorganizations or other restructurings continues to grow. By segregating into a trust specific assets available for liquidation and eventual payment on creditors' claims, practitioners have created an effective tool for streamlining the confirmation of a plan of reorganization or an out-of-court restructuring.

Maximizing the recovery for unsecured creditors is the primary goal of every liquidating trustee. However, not every liquidating trust is structured in a manner that allows its trustee to achieve that goal easily. Recently, the liquidating trust created at the confirmation of the liquidating plan of Farmland Industries, Inc., paid out more than 100 percent of the allowed claims of unsecured creditors. The company's unsecured creditors received about 20 cents on the dollar more than anticipated at the time of confirmation.

However, that was not a result of uncovered assets, a "mega-judgment" in favor of the liquidating trustee, or just plain luck. Rather, several structural factors and initial strategies played crucial roles in maximizing the payout for the beneficiaries of the liquidating trust. This article highlights those factors, which turnaround practitioners should consider in structuring and negotiating a liquidating trust to facilitate a trustee's ability to maximize recoveries for creditors.

Most large corporate Chapter 11 cases or restructurings are very contentious. Consensus among the debtor, the creditors' committee, and other parties in interest is often difficult to achieve, resulting in more time and money being spent to obtain a resolution. However, with the creation of a liquidating trust and the appointment of a liquidating trustee, that adversarial environment can change immediately, provided that certain structural enhancements are incorporated into the governance provisions for the liquidating trust.

First, the trustee should report to a governing committee that is representative of the beneficiaries of the liquidating trust. Generally in a Chapter 11 scenario, the governing committee is comprised of former members of the creditors' committee(s), but at a substantially reduced number. In Farmland Industries, for example, representation of the two former creditors' committees on the governing committee was limited to four members (two from each committee). Reducing the number of members on the governing committee, while maintaining a representative balance, allows the governing committee and the liquidating trustee to operate, deliberate, and make decisions more efficiently.

Second, a liquidating trust's structure should provide that, absent a conflict, the governing committee and the liquidating trustee may be represented by the same counsel and other professionals. This should assist in the common goal of maximizing value for the beneficiaries of the liquidating trust. The liquidating trustee's administrative efforts in obtaining necessary approvals from the governing committee will not be hampered or delayed by the logistics of obtaining the consensus of a large number of people. Additionally, regularly scheduled in-person meetings among the governing committee, liquidating trustee, and counsel fosters good working relationships and are instrumental in keeping all parties well informed and on task so that decisions can be made promptly when circumstances require.

Another essential component to preserving and maximizing the value of the liquidating trust's assets is the trustee's access to key employees of the debtor. If the corporate debtor is to be dissolved, the liquidating trustee should be given power to retain and manage key employees to perform specific tasks related to the preservation of assets. In the case of Farmland Industries, the liquidating trustee retained about 25 former Farmland employees through the first six months of administration. Specific functions necessary for the effective administration of the liquidating trust's assets should be identified at the outset, and former employees with extensive historical knowledge and appropriate skills should be matched to those functions.

A liquidating trustee also should have authority, subject to approval of the governing committee, to provide appropriate retained employees with performance incentives tied to the recoveries of the trust's beneficiaries. The contributions of the former Farmland employees in assisting the liquidating trustee in resolving $120 million in disputed claims, preserving and managing volumes of documents and records material to pending litigation, and otherwise winding down the business of the debtors benefited the beneficiaries and more than offset the cost and expense of their continued temporary employment.

Another critical point for laying the groundwork for a liquidating trustee's success is the decision of which professionals to retain. The overall strategy to maximize the recovery for beneficiaries in an efficient and cost-effective manner should be predicated on the liquidating trustee's ability to retain the professionals, usually those already involved in the restructuring or bankruptcy proceedings. This is a core strategy that will allow the liquidating trustee not only to hit the ground running, but also to maintain that momentum in achieving the liquidating trust's goals. If conflicts arise or existing professionals simply decline to continue their involvement in the matter, other appropriate professionals and experts should be retained.

The parties involved in establishing and negotiating the structure and terms of the governing trust documents must ensure that sufficient funds are provided to administer the liquidating trust properly. With Farmland, an amount equal to the budgeted operating expenses and professional fees for the liquidating trustee was fully funded in a separate reserve account from day one. Although this may segregate a significant portion of money from the funds initially transferred to the liquidating trust that otherwise might be available for immediate distribution to beneficiaries, the long-term administrative requirements and goals of the trustee require that the trust be fully funded at the outset. Having adequate reserves allows the liquidating trustee, the governing committee, and their professionals to avoid having their thoughtful strategies limited or their reasoned decision making unduly influenced by the need for immediate operating liquidity.

Finally, a suggestion about the mechanics of actually liquidating assets in today's economy is in order. The challenge for every liquidating trustee is locating—or more often, creating—the "market" that results in maximum proceeds for the beneficiaries. Although most governing trust agreements empower a liquidating trustee to liquidate assets through private sales, one also should consider the potential benefits of using Section 363 of the U.S. Bankruptcy Code if it is available.

Presently, a liquidating trustee may easily create a market for an asset by selecting a stalking horse bidder, noticing the asset for sale by auction to qualified bidders under Section 363, and obtaining court approval for the sale with clear title. The expediency of Section 363 sales, coupled with the unprecedented amount of capital seemingly available today, may expand what previously was perceived as potentially limited markets for certain assets and thereby materially increase the anticipated liquidation value. Admittedly this strategy may not result in a "home run" sale price; however, it may result in a consistent series of "doubles" that can add up over the term of the liquidating trustee's administration.

This article represents the views of the author and not those of JPMorgan.


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