Suge Knight’s hopes of maintaining control of Death Row Records
during its Chapter 11 reorganization were dashed on July 7, 2006, when
United States Bankruptcy Judge Ellen Carroll placed the company under
the management of a case trustee. Judge Carroll cited gross
mismanagement of the record company’s finances, stating, "it seems
apparent that there is no one at the helm." [1]
The Death Row case illustrates a pervasive tension in corporate
reorganizations: at what point does the interest of the creditors trump
the vested control of management, which may have driven the company
insolvent in the first place? Under certain conditions, the bankruptcy
court has the power to transfer control of the estate from the
debtor-in-possession to a trustee under section 1104(a) of the
Bankruptcy Code. [2]
The Death Row Records Bankruptcy
Rap mogul Marion "Suge" Knight epitomizes the life of ruthlessness
and violence glorified in the gangsta rap genre he worked so hard to
promote. Knight formed Death Row Records in 1991 and became one of the
most successful producers of all time, garnering multi-platinum hits
from his stable of rap and hip-hop artists, especially its early stars
Dr. Dre, Snoop Dogg, and Tupac Shakur. [3]
Knight and his label quickly lost both market share and credibility
following the departure of Dr. Dre and Snoop Dogg, the East Coast /
West Coast war, and the still-unsolved murder of Tupac (in 1996). [4]
Knight's series of incarcerations resulted in his prolonged absence
from operating Death Row: he served five and a half years of a nine
year sentence for assault and weapons violations from 1996-2001,
several months for associating with known gang members from 2001-2002,
and another sentence for assaulting a parking attendant, from 2003 to
April 2004. [5]
More recently, Knight and Death Row suffered a $107 million default
judgment arising from a 2002 civil lawsuit brought by former associate
Lydia Harris, who claimed that she was instrumental in the founding of
Death Row Records and was entitled to a share of the company. [6] The
judgment's high punitive damages component of $60 million reflected
Knight's consistent failure to appear at court-ordered hearings and
failure to provide required financial statements during discovery. [7]
Knight and Death Row are contesting the judgment, based on an alleged
settlement of the claim. [8]
On March 21, 2006, with the judgment amount still outstanding, the
company was ordered into receivership. [9] It was anticipated that the
receiver would sell off the master tape libraries of Dr. Dre, Snoop
Dogg, and Tupac, Death Row's most valuable assets. [10] In a last
minute bid to save his label from receivership, Suge Knight declared
bankruptcy for himself and Death Row under chapter 11 on April 4, 2006.
[11]
Appointment of a Trustee for a Chapter 11 Case
The Bankruptcy Code reflects a strong presumption in favor of
allowing the debtor-in-possession to continue to run the business
during its reorganization. Therefore, the appointment of a case trustee
under section 1104(a) is considered an "extraordinary remedy." [12]
Ultimately, the debtor-in-possession is a fiduciary of the estate, with
a duty to "protect and conserve property in his possession for the
benefit of creditors", and to "refrain[] from acting in a manner which
could damage the estate, or hinder a successful reorganization of the
business." [13] By law, the Bankruptcy Court exercises exclusive
jurisdiction over the property of the estate, with the inherent
authority to enforce the duties of its representative. [14]
A party in interest or the U.S. Trustee can request the appointment
of a case trustee at any time prior to the confirmation of a plan of
reorganization in a chapter 11 case. Under section 1104(a)(1), the
court, after notice and hearing, shall order the appointment of a
trustee for cause, including fraud, dishonesty, incompetence, or gross
mismanagement. [15]
It is often mismanagement that leads a company into insolvency in
the first place, but this alone is not usually sufficient for removing
the debtor-in-possession. "The philosophy of chapter 11 is to give the
debtor a 'second chance' and, consistent with such philosophy, current
management should be permitted to identify and correct its past
mistakes." [16] However, should the court find evidence of postpetition
conduct that rises to gross mismanagement, the appointment of a trustee
may be appropriate. [17]
Bankruptcy courts have broad discretionary powers to determine
whether the conduct complained-of warrants the appointment of a
trustee. Courts have found cause in a variety of circumstances,
including continued losses, [18] failure to follow Code and Rule
provisions, [19] failure to keep the affairs of the debtor separate
from individuals, [20] and failure to keep adequate books and records.
[21]
In its June 2006 Motion to Appoint a Chapter 11 Trustee, the United
States Trustee cited compelling evidence why Suge Knight should be
removed from management control over Death Row. [22] Recall that Knight
was jailed several times between 1996 and 2004 and could not have
effectively managed Death Row in his absence. While this occurred
prepetition, Knight acknowledged during the initial Debtor's 341(a)
hearing in May that he had not reviewed financial statements for Death
Row in over a decade. Further, a significant number of Death Row's
creditors are judgment creditors, including Ms. Harris and the I.R.S.
[23] The U.S. Trustee also alleged undisclosed insider payments by
Death Row to Knight and omissions and false statements in the
bankruptcy petition schedules. [24]
Given that Suge Knight is the sole owner, officer, and director with
any authority at Death Row, and in light of the evidence pointing to
his financial mismanagement, dishonesty, and past failure to comply
with court orders, Judge Carroll signed the order to appoint a trustee
on July 7, 2006. [25] Trustee Todd Neilson, appointed on July 19, is
now de-facto CEO of Death Row, responsible for the management of its
property for the benefit of its creditors, operation of the business,
and, if appropriate, filing a plan of reorganization.
The value of Death Row's assets have not been adequately determined,
but are shadowed by its $100 million plus debts. Should Mr. Neilson
determine that rehabilitation is simply not feasible, Suge Knight's
efforts to save his company from receivership by entering bankruptcy
may be worthless. Hard to imagine 15 years ago that Death Row, the
center of the gangsta rap revolution, would one day be run by an
accountant.
Sources
[1] Knight Loses Death Row, S.F. Chron., July 10, 2006, available at http://www.sfgate.com/cgi-bin/blogs/sfgate/detail?blogid=7&entry_id=6933; Judge Orders Bankruptcy Takeover of Death Row, Billboard, July 10, 2006, available at http://www.billboard.com/bbcom/news/article_display.jsp?vnu_content_id=1002802311. See also Order Granting Motion for Appointment of Chapter 11 Trustee, In re Death Row Records, Inc., No. 06-11205 (Bankr. C.D. Cal. filed Apr. 4, 2006) available at http://knight.pszyjw.com/folder.asp?main=Death%20Row%20Records,%20Inc (Under "Chapter 11 Trustee Documents, select the link "Order Granting USTs Motion to Appoint Cht 11 Trustee – DDR #075").
[2] See 11 U.S.C. § 1104(a) (West 2006).
[3] Wikipedia, Death Row Records, http://en.wikipedia.org/wiki/Death_Row_Records (last visited Sept. 10, 2006).
[4] Id.
[5] Wikipedia, Suge Knight, http://en.wikipedia.org/wiki/Suge_Knight (last visited Sept. 10, 2006).
[6] CBS News, ‘Suge’ Knight Ordered to Pay $107M, Mar. 31, 2005, http://www.cbsnews.com/stories/2005/03/30/entertainment/main684021.shtml.
[7] Id. See also Carl Chery, Suge Knight to Pay $107 Million to Former Death Row Founder, SOHH.com, Mar. 30, 2005, http://www.sohh.com/articles/article.php/6894.
[8] See Case Status Conference Report of Debtor, In re Death Row Records, Inc., No. 06-bk-11205 (Bankr. C.D. Cal. filed Apr. 4, 2006) available at http://knight.pszyjw.com/folder.asp?main=Death%20Row%20Records,%20Inc (Under "Chapter 11 Case" select the link "Case Status Conference Report of Debtor – DDR #038").
[9] Death Row Close to Court Takeover, Billboard, Apr. 3, 2006, available at http://www.billboard.com/bbcom/news/article_display.jsp?vnu_content_id=1002276110.
[10] Id. See also Suge Knight Squanders Last Chance to Save Death Row Records, CBC.ca, Apr. 2, 2006, http://www.cbc.ca/story/arts/national/2006/04/02/knight-deathrow.html.
[11] In re Death Row Records, Inc., No. 06-11205 (Bankr. C.D. Cal. filed Apr. 4, 2006); see also Knight, Death Row File for Bankruptcy, MSNBC.com, Apr. 4, 2006, http://www.msnbc.msn.com/id/12154439/.
[12] In re Ionosphere Clubs, Inc., 113 B.R. 164 (Bankr. S.D.N.Y. 1990)
[13] Id., citing In re Sharon Steel Corp., 86 B.R. 455, 457 (Bankr. W.D. Pa. 1988).
[14] See 28 U.S.C. § 1334e (West 2006).
[15] 11 U.S.C. § 1104(a)(1) (West 2006).
[16] In re Ionosphere Clubs, 113 B.R. at 168, citing H.R. Rep. 95-595, at 220 (1977).
[17] Id. See also In re William A. Smith Const.
Co., Inc., 77 B.R. 124 (Bankr. N.D. Ohio 1987) (proper standard is
gross mismanagement as opposed to mere mismanagement).
[18] See, e.g., In re Horn & Hardart Baking Co., 22 B.R. 668 (Bankr. E.D. Pa. 1982).
[19] See, e.g., In re Nautilus of N.M., Inc., 83 B.R. 784 (Bankr. D.N.M. 1988); In re Pappas, 17 B.R. 662, (Bankr. D. Mass. 1982).
[20] See, e.g., In re Great Ne. Lumber & Millwork Corp., 20 B.R. 610 (Bankr. E.D. Pa. 1982).
[21] See, e.g., In re Hotel Assoc., Inc., 3 B.R. 343 (Bankr. E.D. Pa. 1980).
[22] See Motion of U.S. Trustee for Appointment of Chapter 11 Trustee, In re Death Row Records, Inc., No. 06-11205 (Bankr. C.D. Cal. filed Apr. 4, 2006) available at http://knight.pszyjw.com/folder.asp?main=Death%20Row%20Records,%20Inc (Under "Chapter 11 Trustee Documents" select the link "USTs Motion to Appoint Chp 11 Trustee – DDR #027 (1 of 8)").
[23] Id. at 3.
[24] Id.
[25] See Order Granting Motion for Appointment of Chapter 11 Trustee, In re Death Row Records, Inc., No. 06-11205 (Bankr. C.D. Cal. filed Apr. 4, 2006) available at http://knight.pszyjw.com/folder.asp?main=Death%20Row%20Records,%20Inc (Under "Chapter 11 Trustee Documents" select the link "Order Granting USTs Motion to Appoint Cht 11 Trustee – DDR #075").