In Re Bayou Group LLC, 06-22306 (RDD).

• Decision Date: 05 April 2010
• Docket Number: No. 06-22306 (RDD).,06-22306 (RDD).
• Citation: 431 B.R. 549
• Parties: In re BAYOU GROUP, LLC, et al., Debtors.
• Court: U.S. Bankruptcy Court — Southern District of New York

431 B.R. 549

In re BAYOU GROUP, LLC, et al., Debtors.

No. 06-22306 (RDD).

United States Bankruptcy Court,

S.D. New York.

April 5, 2010.

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MorrisonCohen LLP, by Joseph T. Moldovan, Esq., for the Unofficial Committee of Bayou OnShore Funds.

The United States Trustee for Region 2, by Andrew Velez-Rivera, Esq. Cahill Gordon & Reindell, LLP, by Kevin J. Burke, Esq., for DB Structured Products, Inc.

Sonnenschein Nath & Rosenthal LLP, by Carole Neville, Esq., for certain investor defendants/judgment debtors.

MEMORANDUM OF DECISION ON MOTION OF UNOFFICIAL COMMITTEE PURSUANT TO 11 U.S.C. §§ 503(b)(3)(D) and (b)(4)

ROBERT D. DRAIN, Bankruptcy Judge.

The members of the Unofficial Creditors Committee of the Bayou OnShore Funds (the “Unofficial Committee” or “Committee”) ¹ have requested the entry of an order under section 503(b)(4) of the Bankruptcy Code, 11 U.S.C. §§ 101 et seq., allowing, as administrative expenses, the fees and expenses of counsel to the Committee for pre-bankruptcy services (the “Motion”). The Motion seeks payment by the estate of $677,829.17. The United States Trustee objected to the Motion, as have certain judgment debtors-generally known as the “Sonnenschein Defendants”-of the debtors herein (the “Debtors” or the “OnShore Entities”). A creditor, DB Structured Products, Inc., joined in the Sonnenschein Defendants' objection.²

The Court has reviewed the pleadings filed in connection with the Motion as well as the exhibits thereto, including the contemporaneous time and expense records of the Unofficial Committee's counsel, and considered the record of the March 5, 2010 hearing on the Motion. This Memorandum of Decision states the Court's basis for substantially granting the Motion and, except as noted, overruling the objections.

Background

Notwithstanding the rationale in Samuel Israel III's July 26, 2005 letter to investors that he was closing the Bayou family of funds to devote more time to his family and personal life, it became clear in the late summer of 2005 that the Bayou funds (including the OnShore Entities) were a Ponzi scheme, their earnings fraudulently reported and largely fictitious, and, therefore, that they were doomed to collapse. Soon thereafter, federal authorities raided the funds' Connecticut offices and seized their contents, and the funds' principals were placed in federal custody and their assets were subjected to seizure and forfeiture. (Eventually certain cash of the Debtors and/or their principals also was turned over by Arizona regulators to the Department of Justice.) Nevertheless, apparently because of disagreements among the SEC, the CFTC and the Department of Justice, the governmental authorities did not actively seek the appointment of an equity receiver for the OnShore Entities.³

When it became clear that the appointment of an equity receiver might not be forthcoming, various investors in the OnShore Entities who had been unable to redeem their investments before the funds' collapse and, therefore, were looking for ways to make good their losses, contacted each other. Although still operating largely in the dark, by January 2006, several of them determined, with the advice of counsel to individual investors, to form the Unofficial Committee to represent the interests of defrauded investors as a whole.

The largest investor, Silvercreek sent a notice of the proposed formation of the Unofficial Committee to all creditors with whom it or other investors were in contact, and the United States Attorney's office also agreed to include a notice of the Committee's proposed formation in a general notice to Bayou fraud victims, which apparently was mailed on February 2, 2006. Declaration of Jonathan J. Fisher in Support of the Unofficial On-Shore Creditors' Committee of the Bayou Family of Companies' Motion to Appoint a Receiver ¶¶ 4-5. Forty-two creditors with in excess of $109 million of unpaid investments responded. On February 7, 2006, six of the largest investors agreed to sit on the Unofficial Committee and to retain counsel for the Committee, the cost of which they agreed to share pro rata based on the amount of their unpaid investments. Id. ¶¶ 5-6.

Actually the Unofficial Committee retained two firms: Preston Gates Ellis & Rouvelas Meeds LLP (now K & L Gates LLP), on February 22, 2005, and Kasowitz, Benson, Torres & Friedman LLP (“KBLT & F”), on March 1, 2005.

With K & L Gates' assistance, the six investors further publicized and organized the Unofficial Committee's formation and held the Committee's first official meeting, which took place on February 28, 2005.

Based on the March 5, 2010 hearing record and on the Unofficial Committee's Bylaws, which were approved at a March 14, 2005 meeting, it appears that the Committee was indeed established to represent the collective interests of all unsecured creditors of the OnShore Entities, the vast majority of which were defrauded investors. The Unofficial Committee's overarching goal was “to represent the interests of creditors holding unsecured claims against one or more of the on-shore entities comprising the Bayou family of companies ... by facilitating the marshalling of assets of Debtor and prompt distribution to creditors.” By-laws of the Unofficial On-Shore Creditors' Committee of the Bayou Family of Companies (“Bylaws”) Art. II. This goal was inconsistent with interests that the individual Committee members may have had to increase their own recovery at the expense of other similarly situated creditors. Given the Unofficial Committee members' cost sharing agreement, it also was in their interest to add to the voting membership of the Committee and thus reduce their pro rata share of the costs. The Unofficial Committee sought wide participation in its activities, not only encouraging investors to become voting members but also inviting investors to participate as non-voting ex officio members.

It was clear even before the Unofficial Committee's formation that a significant source of creditor recovery (and perhaps the primary source, given that the Bayou funds' hard assets and the assets of its principals had been seized and were subject to criminal forfeiture) was the Debtors' potential claims against investors who had redeemed or partially redeemed their investments before the OnShore Entities' collapse. The Sonnenschein Defendants, so-called “full redeemers,” turned out to be such a target; DB Structured Products, Inc., a so-called “partial redeemer” (that is, an investor who was repaid some but not all of its investment before the OnShore Entities' collapse) was another.

DB Structured Products, Inc. has contended that the Unofficial Committee ignored its legitimate concerns as a creditor in respect of its claim for the portion of its investment that was not redeemed, and, in fact, after the commencement of the bankruptcy case the official committee of unsecured creditors, which substantially overlapped with the prepetition Unofficial Committee, may have favored strategies to exert litigation leverage on DB and other similarly situated partial redeemers that gave short shrift to those entities' rights as creditors. However, review of counsel to the Unofficial Committee's time records and the other pleadings filed in connection with the Motion establish that the Unofficial Committee did not engage in such conduct prepetition. Moreover, members of the Unofficial Committee included other partial redeemers, and the United States Trustee has not asserted any undue parochialism on the Unofficial Committee's part as a basis for objecting to the Motion (or as a basis, for that matter, for objecting to the fees of counsel to the official unsecured creditors committee). The Sonnenschein Defendants' contention that the Unofficial Committee was unduly hostile to them is not relevant, given that the Sonnenschein Defendants were solely litigation targets and not creditors at all.

In addition to its goal of representing all creditors, it also is clear that from its inception the Unofficial Committee expressly laid the groundwork for what became this chapter 11 case, including the means for administering the case. The Bylaws state that to achieve its purpose the Unofficial Committee may engage in the following:

(1) Evaluate the need to seek support for and implementation of a process for judicial appointment of a receiver/ trustee to marshal assets and make distributions to creditors;

(2) Evaluate prospects and make recommendation for the selection of a receiver/ trustee;

(3) Monitor and work with the receiver/ trustee or other fiduciary acting on behalf of the creditors to facilitate an efficient and timely forensic investigation, pursuit of claims, and, if appropriate the commencement of a bankruptcy proceeding;

(4) Negotiate and formulate a liquidation plan to facilitate prompt distribution of Debtor's assets with adequate reserve to finance the pursuit of additional assets, including claims of the Debtor or the Debtor's creditors; and

(5) Any other acts determined by the Committee to be reasonable or necessary to achieve the overall objective.

Bylaws Art. II (emphasis added). Moreover, the Bylaws recognized that

In its pursuit of the above described objectives, the Committee intends, to the extent practicable and except as otherwise determined to constitute itself in conformity with Federal Rule of Bankruptcy Procedure 2007(b) so that the Committee is well situated to be appointed as the Official Unsecured Creditors' Committee, pursuant to 11 U.S.C. § 1102(b)(1)⁴ in any case filed by or with respect to the Debtor under Title 11 of the United States Code.

Id. (emphasis added).⁵ As will be discussed in more detail below, when the Committee sought the appointment of a receiver, it also requested that the receiver's duties include, in the receiver's capacity as sole managing member of the OnShore entities, (a) petitioning to commence a case under the Bankruptcy Code and (b)...