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").