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Bankruptcy Corner Partner with the Law Firm of Young Conaway Stargatt & Taylor, LLP, in Wilmington, Delaware

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Bankruptcy Corner Partner with the Law Firm of Young Conaway Stargatt & Taylor, LLP, in Wilmington, Delaware VINCENT C. THOMAS, Esq., is a Bankruptcy Corner Partner with the law firm of Young Conaway Stargatt & Taylor, LLP, in Wilmington, Delaware. Utilizing Delaware Statutory Trusts as JUSTIN P. DUDA, Esq., is an Associate Chapter 11 Liquidating Trusts with Young Conaway Stargatt & Taylor, LLP. By Vincent C. Thomas and Justin P. Duda Introduction Every year, thousands of companies seek protection under chapter 11 (“Chapter 11”) of Title 11 of the U.S. Code (the “Bankruptcy Code”) in the U.S. Bankruptcy Courts in New York, Delaware, Texas, and other jurisdic- tions around the country (such companies, the “Debtors”). While some of these Debtors might seek to utilize Chapter 11 to effect a restructuring of their operations, the majority of Debtors simply cannot service their secured debt facilities and are seeking predominantly to right-size their balance sheets. Other Debtors file for Chapter 11 protection in the midst or on the eve of overwhelming litigation—often related to asbestos, toxic torts, products liability, or environmental contamination. Regardless of the impetus for filing, Chapter 11 provides a centralized, efficient process for these Debtors to both determine the scope of their liabilities and maximize the value of their assets for the benefit of their stakeholders. Part of the Chapter 11 process for many Debtors—whether following a sale of all or substantially all of their assets in a Bankruptcy Court-supervised auction or in connection with a global settlement among various parties in interest—is the proposal, solicitation, and confirmation of a plan of reorga- nization or liquidation (a “Plan”) that provides for, among other things, an orderly distribution of the Debtors’ assets. While some Plans contemplate that the Debtors themselves will continue in existence to determine the scope of their liabilities, liquidate their assets, and distribute the proceeds to their various stakeholders, other Plans often provide for the creation of a trust (a “Liquidating Trust”) to handle such matters, with the various creditors of the Debtors as the beneficiaries. Whether or not the relevant Chapter 11 case was administered in the U.S. Bankruptcy Court for the District of Delaware, Plans that contemplate a Liquidating Trust may, and often do, utilize a Delaware Statutory Trust in connection with their implementa- tion. This column describes Delaware Statutory Trusts in general, briefly explains some tax and securities implications of such trusts, and provides some practical drafting tips. JULY–AUGUST 2019 © 2019 CCH INCORPORatED AND its AFFiliatES. ALL Rights RESERVED. 11 BANKRUptcy CORNER Delaware Statutory Trusts Generally (ii) the name and address in the State of Delaware of at least one trustee which, if an individual, shall be a person Generally, a Delaware Statutory Trust is a trust entity who is a resident of Delaware or, if not an individual, has formed pursuant to Chapter 38 (“Chapter 38”) of Title its principal place of business in Delaware (such trustee, 12 of the Delaware Code (“Title 12”) and governed by the “Delaware Trustee”)4; (iii) a date of effectiveness, if the applicable governing documents (collectively, the the certificate of trust is not effective upon filing; and (iv) “Trust Documents”), which, in the case of a Liquidating any other information the trustees determine to include.5 Trust formed in connection with a Chapter 11 case, often While the trustee most commonly handles the admin- include the Plan, the order of the Bankruptcy Court con- istrative duties in connection with a trust under Delaware firming the Plan (the “Confirmation Order”), a certificate Trust Law, with regard to Delaware Statutory Trusts (and of trust in compliance with Section 3810 of Chapter 38 Delaware common law trusts), there is a long history (a “Certificate of Trust”), and a trust agreement, which may of having persons in addition to trustees administer or be accompanied by related trust distribution procedures monitor a Delaware Statutory Trust or represent the (collectively, the “Trust Agreement”). In addition to Chapter interests of one or more classes of a trust’s beneficiaries.6 38, except to the extent set forth in the relevant Trust Similarly, Delaware Trust Law provides that if a trustee Documents, the other provisions of Delaware statutory of a Delaware Statutory Trust—notably including the law applicable to common law trusts, including Chapters Delaware Trustee—is a directed trustee with regard to 33 and 35 of Title 12 (collectively, with Chapter 38 and certain actions, including without limitation investment Delaware common law regarding trusts, “Delaware Trust and distribution decisions, then such directed trustee will Law”), will be applicable to a Delaware Statutory Trust.1 not be liable for following such direction in the absence Two fundamental (and interrelated) concepts of of willful misconduct.7 Delaware Trust Law—applicable to both Delaware Depending on the needs of a particular Debtor and the Statutory Trusts and Delaware common law trusts—are terms of its Plan, a Liquidating Trust may have a number of the primacy of the settlor’s intent when creating a trust and fiduciaries, including an administering trustee, a Delaware the settlor’s contractual freedom to reflect this intent in Trustee, a trust protector or committee (which may be the the governing documents and administration of the trust.2 successor of the Creditors’ Committee) with regard to one Specifically, with regard to Delaware Statutory Trusts, or more classes of beneficiaries, an investment adviser, and Section 3825(b) of Chapter 38 provides that “[i]t is the a distribution adviser, among others. With its freedom of policy of this subchapter to give maximum effect to the contract principles, Delaware Trust Law provides a broad principle of freedom of contract and to the enforceability ability to define and limit the scope of the duties of each of governing instruments.”3 In the case of a Liquidating of the persons engaged in the administration or monitor- Trust formed pursuant to a confirmed Plan, which Plan ing of a Delaware Statutory Trust.8 This feature may be effectively reflects a settlement among the various parties exploited, for example, by Trust Documents governing a in interest, there can be considered multiple settlors of Liquidating Trust set up in connection with a confirmed the trust (including, without limitation, the Debtors, the Plan that uses a channeling injunction under Section Official Committee of Unsecured Creditors (theCreditors’ “ 524(g) of the Bankruptcy Code to channel asbestos-related Committee”), the relevant secured lenders, the Debtors’ liabilities to the Liquidating Trust. Such Trust Documents insurers, et al.), and, in the event of an ambiguity in the typically will provide that the general administration of Trust Agreement, the intent of all such parties must be the Liquidating Trust will be performed by the trustee, considered in interpreting such documents. and that a committee or certain persons will monitor such performance and have consent and consultation rights to be utilized in favor of various classes of beneficiaries The Creation and Administration of the Liquidating Trust (i.e., personal injury claimants of a Delaware Statutory Trust as a vs. property damage claimants, or current claimants vs. future claimants). Liquidating Trust In a Liquidating Trust context, the Trust Documents often will limit the Delaware Trustee’s scope of duties solely To create a Delaware Statutory Trust to be utilized as a to the filing of the Certificate of Trust and, when appro- Liquidating Trust, there must be filed with the Secretary priate, the certificate cancelling the Liquidating Trust,9 of State of the State of Delaware a Certificate of Trust, and the receipt of service of process on the Liquidating which sets forth (i) the name of the Liquidating Trust; Trust. Notwithstanding this limited scope of duties, in 12 JOURNAL OF PASSTHROUGH ENTITIES JULY–AUGUST 2019 addition to being statutorily mandated, the presence of declared purpose of liquidation can be said to be lost or the Delaware Trustee of a Delaware Statutory Trust in abandoned, the status of the organization will no longer Delaware ensures that Delaware Trust Law regarding the be that of a liquidating trust.”16 administration of trusts will apply to the Liquidating Pursuant to Rev. Proc. 94-45 issued by the Internal Trust, regardless of the location of the other trustees or Revenue Service (the “IRS”), the IRS will issue advance fiduciaries.10 rulings classifying Delaware Statutory Trusts utilized as The trustees and other fiduciaries of a Delaware Liquidating Trusts under a Plan as liquidating trusts for Statutory Trust acting as a Liquidating Trust often will purposes of Reg. §301.7701-4(d).17 Such a ruling will act in a fiduciary capacity with regard to one of more be issued if the following requirements, among others, classes of beneficiaries, but the relevant Trust Documents are met: may provide that such parties may act in a non-fiduciary ■■ The Liquidating Trust is created pursuant to a con- capacity.11 If such a party is a fiduciary, her standard of firmed Plan for the primary purpose of liquidating care in the conduct of her duties, absent any changes to the relevant transferred assets. the default in the relevant Trust Documents, will be to ■■ The Plan explains how the Debtor’s estate will treat conduct her actions pursuant to the reasonably prudent the transfer of its assets to the trust for federal income person standard.12 However, Delaware
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