Creditors' committees are increasingly turning to litigation trustees to handle complex litigation in chapter 11 proceedings. Although not expressly authorized in the Bankruptcy Code, litigation trustees have been appointed in several recent cases, including In re Pintlar, 175 B.R. 379 (Bankr. D. Idaho 1994), and In re Rincon Island Ltd. Partnership (Bankr. C.D. Cal. 2000).

The position of a litigation trustee is a relatively new tool for creditors' committees (and shareholders) when the debtor's assets include potential claims against third parties, such as the failed company's former officers and directors. This article discusses the most effective utilization of a litigation trustee to maximize assets for creditors, as well as the duties and powers of the litigation trustee.

Uses of a Litigation Trustee

A litigation trustee is usually appointed by the bankruptcy court upon the recommendation of one or more creditors' committees after a reorganization plan has been confirmed by the court. As part of the reorganization plan, a trust is formed, and assets of the debtor or the bankruptcy estate (such as all claims, rights or causes of action, as well as money to fund the litigation trustee's efforts) are transferred to the trust. The litigation trustee's mandate is to pursue various claims, through litigation or settlement, against third parties on behalf of the trust and its beneficiaries, and to distribute, pursuant to the plan, any net proceeds of such litigation or settlement. Usually, a post-confirmation creditors' committee will work with the trustee on strategic and settlement issues.

Creditors' committees involved in complex chapter 11 proceedings whose assets include legal claims against third parties should consider selecting a litigation trustee to maximize recoveries from these claims. A potential trustee should have considerable experience in prosecuting and administering major litigation (and not exclusively bankruptcy experience, since claims against third parties may involve fraud, breach of trust, fraudulent conveyances or intellectual-property issues). A litigation trustee is often called upon to bring actions in both state and federal courts and to manage numerous cases on behalf of the committee. The committee often interviews several candidates and then recommends one person to the bankruptcy court.

The litigation trustee's powers and duties are defined in the trust agreement and are governed indirectly by the Bankruptcy Code. The trust agreement should spell out the purpose of the trust, who the beneficiaries are, the trustee's powers and responsibilities, how the trust will be treated for tax purposes, how the trustee will be compensated, the duration of the trust, removal or resignation of the trustee, and the powers and responsibilities of the beneficiaries.

To minimize challenges to the litigation trustee's powers, and to ensure that the litigation trustee is in the best position to effectively pursue claims on behalf of creditors, the trust agreement should contain provisions that expressly grant the trustee certain powers. For example, the trust agreement should explicitly authorize the litigation trustee to apply to the bankruptcy court overseeing the bankruptcy proceeding to take Rule 2004 examinations. (A Rule 2004 examination is a discovery mechanism authorized by the Bankruptcy Rules that allows a party to take depositions and may require the production of documents from those individuals who potentially have knowledge important to the claims at issue.) Although the trustee may be able to take such examinations without an express provision in the trust agreement, the inclusion of such a clause may strengthen a litigation trustee's argument that such examination should be permitted.²

The agreement should also include provisions setting forth how the litigation trustee will be compensated. The litigation trustee can be compensated at an hourly rate or receive compensation based on a percentage of the distributions made to the beneficiaries of the trust.

Because the litigation trustee is typically an independent party brought into the case near the end of the chapter 11 proceedings, he or she should consult extensively with the creditors' committee and debtor, as well as their attorneys and accountants. By doing so, the trustee can get a better idea of the potential claims against third parties that the litigation trustee can pursue. This type of cooperative effort allows a litigation trustee to conduct a shorter, more efficient pre-lawsuit investigation of potential targets and causes of action.

Trustee's Powers

To date, very few decisions have interpreted a litigation trustee's powers. However, the proceedings in In re Lomas (Bankr. D. Del. 1999) yielded several noteworthy rulings regarding the scope of the litigation trustee's powers.

Lomas Financial Corp. was once one of the nation's largest mortgage service providers, with a mortgage servicing portfolio valued at more than $40 billion. At the conclusion of the Lomas chapter 11 cases, a litigation trust was created. Shortly thereafter, the litigation trustee filed a complaint against certain former Lomas directors and officers, alleging that the defendants drove Lomas into bankruptcy by their own misconduct and gross negligence, thus breaching their fiduciary duties.

During the prosecution of the suit, the litigation trustee determined that documents created or acquired by Lomas's former law firm were essential to the pending prosecution, and he instituted an action under Rule 7056 of the Federal Rules of Bankruptcy Procedure for entry of a "turnover" order pursuant to §542 of the Code. Section 542(a) reads in part: "An entity...in possession, custody or control, during the case, of property...shall deliver to the trustee...such property..." Section 542(e) reads in part: "Subject to any applicable privilege, after notice and a hearing, the court may order an attorney...that holds recorded information, including books, documents, records and papers, relating to the debtor's property or financial affairs, to turn over or disclose such recorded information to the trustee."

In the resulting litigation, Pollner v. Locke Purnell Rain Harrell, (Bankr. D. Del. 1999), the bankruptcy judge was asked to determine whether the litigation trustee had standing to institute the turnover action against Lomas's former attorneys. The defendants argued that because the litigation trustee is not a trustee defined in the Code, and because Code-defined trustees have the exclusive right to bring turnover actions under §542, then the litigation trustee lacked standing to bring the action. The litigation trustee countered that §1123(b)(3)(B) of the Code provides that a "representative of the estate" appointed by the plan for the purpose of bringing turnover actions has standing under the Code to do so.

Judge Peter Walsh of the U.S. Bankruptcy Court in Delaware noted that the statute requires that there be "specific and unambiguous language" transferring turnover actions to the litigation trustee. Reviewing the language in the plans, the judge concluded that "any and all claims, rights or causes of action...without limitation" encompasses turnover actions. He therefore granted the litigation trustee's motion for summary judgment, ordering that the documents be turned over to the litigation trustee.

Another issue that arose involved the litigation trustee's interest in and right to assert and waive attorney-client and other privileges held by creditors' committees or others who have contributed assets to the trust. Following the ruling giving the litigation trustee standing to request a turnover of documents, Lomas's former attorneys asserted a work-product privilege in some of the documents. Obtaining unfettered access to all documents in Lomas's files was obviously of significant value to the litigation trustee. Judge Walsh ruled, in a further proceeding, that the privilege does not apply when a client seeks access to documents created or amassed by his attorney during the course of the representation. Since Lomas was a client, and since the bankruptcy estate includes all property in which the debtor has a legal, equitable or possessory interest, Judge Walsh ruled that Lomas's former attorneys could not assert a work-product privilege in documents that are property of the estate (Pollner v. Locke Purnell Rain Harrell, (Bankr. D. Del. 1999)).

Conclusion

For those creditors' committees that must decide how to handle potential causes of action against third parties such as former officers and directors, the creation of a litigation trust may be worth consideration. Given the proper powers and resources, a litigation trustee may be able to help achieve significant recoveries for creditors.

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Footnotes

¹ Martin R. Pollner is a senior litigation partner in the New York office of Loeb & Loeb LLP. Mr. Pollner was previously a federal prosecutor and Director of Law Enforcement in the U.S. Treasury Department. Over the years, he has been appointed chapter 11 trustee in various cases and was appointed litigation trustee in the Lomas Financial Corp. bankruptcy proceedings in Delaware in 1997. Brian R. Socolow is a partner in the litigation department at Loeb & Loeb LLP. Return to article

² The following is a sample clause describing the trustee's powers:

The trustee is hereby authorized and directed to take all reasonable and necessary action to hold, conserve and protect the trust assets and to collect on, sell or otherwise liquidate or dispose of the trust assets and distribute net proceeds in a prompt, efficient and orderly fashion. Specifically, the trustee shall have the power to institute, join or defend actions or declaratory judgments and to take such other action, including settlement of any such action and any terms deemed reasonable by the trustee in his or her discretion, to investigate with respect to and enforce any instruments, contracts, agreements or causes of action relating to or forming part of the trust, including, but not limited to, the right to apply to the bankruptcy court for authority to conduct examinations and require the production of documents pursuant to Rule 2004 of the Bankruptcy Code. Return to article

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Journal Date:  Thursday, March 1, 2001 © American Bankruptcy Institute. All rights reserved. ABI is a (501)(c)(3) non-profit business (52-1295453)