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Considering D&O Claims in a Liquidation Analysis

Under the “best interest of creditors” test set forth in section 1129(a)(7) of the Bankruptcy Code, the Bankruptcy Court may not confirm a plan of reorganization unless the plan provides each holder of an allowed claim or interest that does not vote in favor of the plan with property of a value, as of the effective date of the plan, that is not less than the amount that such holder would receive or retain if the debtor was liquidated under Chapter 7 of the Bankruptcy Code. To analyze whether the proposed Plan satisfies the “best interest of creditors” test, a Debtor in conjunction with their Financial Advisor will prepare a hypothetical liquidation analysis (the “Liquidation Analysis”), which is based upon various assumptions on the liquidation value of all assets held by the estate. The value of these assets are then burdened by liquidation costs which include Trustee Fees, Trustee legal and advisory fees, and costs associated with winding down the case. The resulting net liquidation proceeds available for distribution then flow through the various classes of secured and unsecured claims as outlined in the Plan of Reorganization based on security rights and collateral that secures the various claim classes thus illustrating projected recoveries for each claim class in a liquidation scenario.

To prevent a UCC and advisors from attempting to poke holes and uncover value to unsecured classes it is important to disclose any and all potential value available to unsecured creditors, specifically unencumbered assets. The proceeds of the liquidation of unencumbered assets are first used to pay Chapter 7 trustee fees and expenses, unpaid administrative Claims and priority Claims, before any recovery is available to the various classes of unsecured creditors, but any and all potential value on top of these amounts falls to unsecured creditors. If it is likely that unsecured claimants, who will receive minimal recovery on their claims under the plan, will pursue causes of action against the officers and directors of the company due to negligence or breach of fiduciary duty it may make sense to show potential recovery on the Debtor’s Director and Officers Liability Insurance Policy (“D&O Policy”) as an unencumbered asset. Using a $3 million D&O policy as an example, below is a description of how a Debtor can disclose unencumbered asset value in their D&O Policy in the Liquidation Analysis:

“For the purpose of illustration only in this Liquidation Analysis, a potential net recovery of $2 million has been listed for potential Claims which might be asserted against directors and officers for breach of corporate duties to the Company. The recovery of $2 million is net of attorney’s fees. We have assumed that the attorneys prosecuting directors & officers Claims will do so on a one-third (1/3) contingency fee basis.”

By showing recovery in the D&O policy as an unencumbered asset available to unsecured classes, a Debtor can demonstrate how little value there is available to unsecured classes in the event of a Chapter 7 Liquidation and prevent tedious, costly objections to the Disclosure Statement.