Chapter 15: Class Action Issues Affecting Chapter 11 Reorganizations

Chapter 15: Class Action Issues Affecting Chapter 11 Reorganizations

by Kenneth H. Eckstein
Kramer Levin Naftalis & Frankel, New York

In the more than three decades since the enactment of title 11 of the United States Code (the "Bankruptcy Code"), a number of the largest and most complex chapter 11 bankruptcies have involved companies facing significant pending or potential class action liabilities.  The recent financial crisis and downturn in the economy resulted in a surge in the number of large companies filing for protection under chapter 11 of the Bankruptcy Code.  Given that large public companies generally have large bodies of creditors and shareholders and frequently are subject to creditor and shareholder litigation, the issue of how pending and putative class actions are dealt with in bankruptcy cases has been and will continue to be a major issue facing chapter 11 debtors.                                               

The standards governing the treatment of class actions in bankruptcy have important implications for debtors and plaintiffs alike.  Plaintiffs in class actions (or putative class actions) brought against a corporate debtor that seeks relief under the Bankruptcy Code will likely be concerned about how the debtor's bankruptcy case will affect their pending or contemplated class actions.  At the forefront of these concerns will be the rules governing the allowance of class proofs of claim in bankruptcy, including whether the class's class representative will be allowed to file a proof of claim in the debtor's bankruptcy case on behalf of all class members or whether individual class members will be required to file individual proofs of claim in order to preserve their claims against the debtor's estate.  Assuming that a class claim is permitted, class members will then be subject to the bankruptcy court's treatment of the class action during the bankruptcy case and in a chapter 11 plan of reorganization - which will prompt unique issues as well.

Likewise, chapter 11 debtors face a multitude of issues relating to the allowance and treatment of class actions during the pendency of their bankruptcy cases.  If a class claim is permitted, the debtor will need to determine how the class claim will be classified and treated in a plan of reorganization, and whether the class will be given one or multiple votes for purposes of plan confirmation.  In addition, if a class claim needs to be estimated or liquidated, this could require the implementation of methods to estimate the claim, or lifting the stay to allow for liquidation in another forum.

There is longstanding conflict over whether class proofs of claim will even be permitted in bankruptcy cases.  Recent trends suggest that most courts do not find such claims to be impermissible per se; rather, most courts find that they are, in fact, permissible under appropriate circumstances.  As discussed throughout this chapter, whether a court permits the use of the class claim device can have major implications for a chapter 11 debtor, as a class action and class claim can affect numerous aspects of a bankruptcy case - from the claims resolution process, to claims estimation, classification, and treatment in a plan of reorganization - all of which have the potential to impact or delay the efficient administration of the debtor's estate.

Underlying all of the issues presented by class actions in chapter 11 cases is the inherent conflict between the policies of class actions, on the one hand, and the Bankruptcy Code, on the other.  The purpose of chapter 11 is generally to provide a safe haven for the debtor, allowing the debtor to rehabilitate and reorganize expeditiously, while providing for fair and equal treatment among creditors.   The purpose of class actions is generally to allow a representative member of a group of claimants too numerous to be joined to litigate claims on behalf of the other members of the class, and obviate the need for the defendant corporation to be subject to a multitude of similar or identical lawsuits.   These policies may come in to conflict, though, when a class action in bankruptcy threatens to hinder a debtor's reorganization.   There is, too, the simple fact that bankruptcy also provides a forum for the resolution of voluminous amounts of creditor claims-arguably eliminating the need for a class action altogether.  Courts have struggled with these conflicting policies, and the case law on this issue is continuing to develop.  While unanimity is still lacking, recent case law suggests that trends may be emerging in this field.

Chapter 15 provides an overview of class action issues that arise in chapter 11 reorganizations.  Specifically, this chapter will provide an overview of class actions as a foundation for their role in bankruptcy cases.  This chapter will also address the relevant provisions of the Bankruptcy Code and Bankruptcy Rules (or lack thereof) that provide guidance as to how class claims should be treated in bankruptcy.  The main focus of Chapter 15 is on the permissibility of class proofs of claim, the history of the case law leading up to modern trends, and the treatment of class claims once allowed in a case (including estimation, classification and issues regarding confirmation).

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