AgFeed's Bankruptcy Proceedings: Design of Allocation Mechanism and Assistance with Negotiations on Distribution of Residual Funds

The Situation

A company in liquidation under chapter 11 of the United States Bankruptcy Code obtained sufficient proceeds from its assets sale to meet its creditors’ obligations in full and have remaining funds for shareholders. Several groups of stakeholders made claims on the remaining funds–including investors asserting class action claims pursuant to Section 10-b5 of the Exchange Act, the Securities and Exchange Commission in an enforcement action against the company for securities violations, current equity holders, and the individual defendant indemnity claimants. There were two significant complications to these conflicting pools of claims: The first related to a dispute over priority of treatment between the stakeholders groups–including the extent to which the claims held by these groups of stakeholders were to be treated on a pari passu basis under Section 510(b) of the Bankruptcy Code. The second complication related to the substantial overlap in membership between the securities class action investors, the former shareholders represented by the SEC, and the current equity holders.

NERA's Role

NERA was retained by the equity committee to provide economic analysis of the residual funds and assist with the allocation of the funds among competing claims, taking into account the disputed priority issues and overlapping membership of the competing groups. The analysis included (1) estimation of alleged damages incurred by the 10-b5 shareholders and estimating the likely settlement value, (2) design of a methodology for a pari passu distribution of the competing claims, (3) evaluation of the overlap of shareholder holdings between the current equity holders and interests of damaged investors represented by the SEC, and (4) examination of expected recovery to be received by the shareholders as a percentage of their claims and the required reserves to fund the litigation expenses of individual defendants with potential indemnification claims.

NERA advised the equity committee in its negotiations with the securities class actions claimants and the SEC. The NERA team analyzed the damages estimated by the Plaintiffs’ expert in the securities class action and used its proprietary database to estimate the likely range of a potential settlement of the securities class action litigation. In addition, NERA identified and analysed available data on securities class action settlements for companies in bankruptcy which made distributions to shareholders, and demonstrated that in that scenario, most of the funds for the settlements came from third party sources, such as accounting firms and insurers, and not the residual funds of the bankrupt company.

Next, NERA designed a proposed pari passu distribution mechanism that took into account the complexities of overlapping pools of shareholders from competing claimants.

In this case, the SEC asserted a right to the residual funds on behalf of shareholders who held and perhaps sold shares before the company was delisted, with a priority over current shareholders. To facilitate the equity committee’s negotiation with the SEC, NERA used its proprietary shareholder trading model to estimate the percentage of shareholders that the SEC alleged were damaged prior to delisting that still retain their shares in the company, and therefore would benefit from a distribution to equity holders. As a result of NERA’s analysis, the equity committee convinced the SEC that the membership of the two competing stakeholder groups substantially overlapped, which led to a successfully negotiated settlement with the SEC for the benefit of both former and current shareholders. NERA’s estimate of shares retained was included in the disclosure statement pursuant to section 1125 of the US Bankruptcy Code.

NERA also filed an affidavit in the bankruptcy proceeding to assist the Court in estimating the recovery received by shareholders as a percentage of its claims. This shareholder recovery rate informed the amount that should be reserved to fund the litigation defense costs of individual defendants.

The Result

Client reached satisfactory settlements with the securities class action claimants and the SEC, which settlements were keys to approval of a chapter 11 plan of liquidation.