FULL STORY: A customer of your company has filed for Chapter 11 bankruptcy protection. Your company is one of the debtor’s larger creditors and has been invited to serve on the creditors’ committee to represent the interests of all general unsecured creditors. What would serving on the committee entail? And how should your company decide whether to serve?
Function of the Creditors’ Committee
The creditors’ committee is a group of general unsecured creditors appointed to represent the interests of all general unsecured creditors. The committee acts to protect and promote the interests of general unsecured creditors by monitoring the debtor’s business operations, investigating its business and financial affairs, and negotiating the terms of the plan that is the ultimate goal of Chapter 11.
The creditors’ committee can play a critical role in a Chapter 11 reorganization. The committee has the right to be heard on any issue that arises during the Chapter 11 reorganization. To promote its interests, the committee might decide to align itself with one or more parties such as the debtor, a secured creditor, or even a prospective acquiror of the debtor’s business. The committee’s recommendation of a proposed plan of reorganization can carry great weight with general unsecured creditors, who typically will rely on the committee’s recommendation for or against a plan of reorganization. The goals identified by the committee, and the manner in which it pursues them, can have a great influence on the ultimate outcome of a Chapter 11 case.
Selection and Organization of the Committee
The creditors’ committee is appointed by the United States Trustee, an official with administrative duties in Chapter 11 cases. Shortly after a Chapter 11 petition is filed, the U.S. Trustee will typically send notice to the 20 largest unsecured creditors, inquiring as to their interest in serving on a creditors’ committee and inviting them to attend an organizational meeting. The committee will ordinarily consist of unsecured creditors holding the largest claims against the debtor who wish to serve on the committee, although the United States Trustee may select creditors with smaller claims who are representative of a significant creditor constituency. A creditors’ committee will generally include three to seven members. In smaller Chapter 11 cases, where there may be insufficient creditor interest, the United States Trustee may decline to appoint a committee.
Once appointed by the United States Trustee, the creditors’ committee will typically have an organizational meeting at which it will select a chairperson and take at least initial steps to engage counsel to represent the committee in the Chapter 11 case. The committee may also engage a financial advisor. Professionals who serve the creditors’ committee are compensated from funds of the debtor’s estate.
Issues before the committee are decided by majority vote, with each member having a single vote regardless of the size of its claim. The committee may operate informally, but better practice is to adopt bylaws governing such matters as meetings, voting, subcommittees, confidential information, dealing with potential conflicts of interest, and reports to the creditor body.
Powers and Duties of the Committee
The creditors’ committee is authorized by bankruptcy law to investigate the debtor’s assets and liabilities, the operation of its business (and the desirability of the continuance of such business), and its business and financial affairs. Exercise of these powers can help to educate the committee about the operational and financial problems besetting the debtor and the manner in which such problems might be remedied, the parameters within which a successful plan of reorganization might be negotiated, whether there are fraudulent or preferential transfers that might be avoided, and whether any other litigation should be commenced. Often, the debtor will provide requested information to the committee voluntarily, but a committee faced with an uncooperative debtor may generally obtain a bankruptcy court order providing reasonable access to information.
In any Chapter 11 case, the overarching goal of the creditors’ committee is to maximize value for general unsecured creditors. What constitutes maximum value may differ from one creditor to another. For example, one creditor might prefer immediate liquidation of the debtor to obtain a significant cash payment, while another creditor might prefer a reorganization that would ensure a continued business relationship with the debtor. Reconciling differing opinions and competing interests into a cohesive agenda may require discussion and negotiation among committee members. The creditors’ committee is required to provide information to and consult with its constituents; who are the unsecured creditors of the debtor.
An important challenge for the creditors’ committee is to develop an effective strategy for achieving its goals. For example, should the committee cooperate with the debtor, or take a more antagonistic approach in hopes of gaining leverage in plan negotiations? Should the committee press for liquidation of the debtor or advocate reorganization? Should the enterprise be left in the hands of its current managers and owners, or should alternatives be pursued? Should the committee consider aligning itself with one or more secured creditors? Should the committee cooperate with a potential acquiror of the debtor’s business in order to create competition for enhancing the return to creditors? Should the committee pursue litigation, including possibly claims against current and/or former directors and officers of the debtor? These issues need to be carefully considered by the committee in consultation with its advisors. The strategy adopted by the committee, and the skill with which it is pursued by the committee’s professionals, can make a huge difference in the outcome of the Chapter 11 case as a general matter, and for the return to the unsecured creditors in particular.
Fiduciary Duty of Committee Members
Members of a creditors’ committee have a fiduciary duty to all creditors represented by the committee. This fiduciary duty requires committee members to act with loyalty to their constituents and to avoid any conflict of interest that would impair such loyalty. A committee member also has a duty to maintain confidentiality of confidential or sensitive information obtained from the debtor under a legal obligation of confidentiality or where such confidentiality is in the best interest of the creditors. While individual committee members are generally free to conduct their separate relationship with the debtor as they see fit—for example, a committee member may decline to extend postpetition credit—a committee member would generally need to resign from the committee in order to engage in activities that may conflict with the interests of other creditors, such as buying claims or seeking to acquire assets of the debtor.
Potential Liability of Committee Members
While members of a creditors’ committee can be held liable for breaches of fiduciary duty, they enjoy a qualified immunity from legal actions arising out of their good faith performance of their duties as committee members. Accordingly, an aggrieved party must establish that the committee or its members engaged in willful misconduct or acted outside of the committee’s authority before liability will attach. Typically, any such suit would need to be brought in the bankruptcy court, which tends to be very protective of committees that have acted in good faith. Often, the Chapter 11 plan will provide for release of liability of committee members for actions undertaken in connection with the Chapter 11 case.
Reimbursement of Committee Expenses
Committee members may receive reimbursement of out-of-pocket expenses incurred in fulfilling their duties, including reimbursement of travel expenses for attending committee meetings. Committee members do not receive separate compensation for the time and effort of serving on the creditors’ committee.
Potential Advantages or Disadvantages of Serving on a Committee
Serving on a creditors’ committee can permit a creditor to play a significant role in shaping the outcome of a Chapter 11 case. Information and perspectives concerning the debtor’s business and financial affairs may prove useful to the committee members in their business relationships with the debtor, although care must be taken to use confidential information in a manner consistent with the committee member’s fiduciary duty to all general unsecured creditors. When the Chapter 11 company’s obligation is material from the creditor’s point of view, a credit manager may consider it essential to serve on the creditors’ committee.
Potential disadvantages to serving on a committee are the expenditure of time and effort needed to serve in a responsible fashion. Furthermore, as noted above, committee members are restricted from activities such as buying claims against the debtor or seeking to acquire assets of the debtor. There is also, despite the protective standards adopted by the courts, the possibility of being sued.
If a creditor has a good relationship with the debtor company, serving on the committee may provide the opportunity to enhance that relationship through influencing the committee to have a cooperative relationship with the debtor. Conversely, creditors with antagonistic relations with the debtor may find in committee membership a forum in which to “play hardball” or otherwise contest the debtor’s actions in a way that benefits the committee’s constituency. In either case, care must be taken that the committee member’s actions do not interfere with such member’s good faith discharge of its fiduciary duty to all creditors. The creditor must ensure that its actions as a committee member are taken with a view towards what is best for all creditors, not just the individual committee member.