Official Committees of Unsecured Creditors: Why You Should (Or Should Not) Serve

19 September 2019 NACM Commercial Services Publication

Over the course of the credit manager’s career, they will likely have opportunities to serve as a member of an official committee of unsecured creditors in a bankruptcy case. Any creditor representative presented with such an opportunity should carefully weigh the pros and cons. Committees are important parties in interest in Chapter 11 bankruptcies, and members of a committee are given a front-row opportunity to steer the course of the case. In addition, costs directly related to the committee – including paying counsel retained by the committee – are borne by the bankruptcy estate. However, committee participation may give rise to complicated conflicts of interest, requires an understanding of fiduciary duties, and can involve a fairly significant time commitment. All of these issues should be carefully weighed before making a decision.

Unsecured creditor committees arise in the context of large to medium-sized Chapter 11 bankruptcies and are designed, in part, to deal with the hierarchy of creditor claims. Creditors in bankruptcy cases are sorted into different groups based on the type of claim and whether the creditor has a valid lien. Secured creditors reside near the top of the hierarchy, followed by administrative expense claimants (that is, claims related to the administration of the case such as professional fees), priority claims, and general unsecured claims. The “absolute priority rule” is a bedrock principle of bankruptcy law and provides that a creditor at a particular rung of the claim priority hierarchy must be paid in full before any money flows down to junior creditors. In many bankruptcy cases, there is insufficient money to pay secured creditors in full, thus leaving general unsecured creditors with no recovery at all. In other cases, the funds flowing down to general unsecured creditors are sufficient to pay only pennies on the dollar.

Because of this dynamic, it may not make economic sense for every general unsecured creditor to hire bankruptcy counsel and to actively participate in the bankruptcy case. For example, if a creditor is owed $100,000 and the best estimate of recovery to unsecured creditors is five percent, the cost of participating in the case could quickly surpass any realistic prospect for recovery. If each creditor were to come to the same conclusion based on such a cost/benefit analysis, it could lead to a very important creditor class having no role in the case. To address this dynamic, the Bankruptcy Code provides for the appointment of a committee of unsecured creditors that appears in a bankruptcy case and advocates for the interest of the entire unsecured creditor class.

Creditor committees are appointed early in a Chapter 11 case by the United States Trustee. The U.S. trustee program is a branch of the Department of Justice, and U.S. trustee attorneys are authorized to appear in any bankruptcy case. Generally speaking, the role of the U.S. trustee is to ensure the integrity of the bankruptcy process. More colloquially, U.S. trustees are often seen by other parties as the “bankruptcy cop.” Among the first filings made by any bankrupt company (known as the debtor) is a list of unsecured creditors with the largest claims. The U.S. trustee will use this list to contact creditors to ask whether they are interested in serving on a committee. Based on the responses, the U.S. trustee will form a committee, typically ranging from five to seven members. The first task taken up by a committee will be to interview and hire counsel who will advise the committee and appear in the bankruptcy case on the committee’s behalf. The process of selecting committee counsel is commonly known as a “beauty contest” and often involves short in-person presentations to the committee by various attorneys at the U.S. trustee’s office.

Once the committee has been formed and hired counsel, the day-to-day business of drafting pleadings, appearing in court, and negotiating on behalf of the committee will be conducted by committee counsel. However, committee counsel works for the committee, and the committee will be the ultimate decision-maker on what positions to take. The committee will meet periodically to receive updates from committee counsel and to make decisions. With very rare exception, committee meetings are conducted by conference call. The time commitment for serving on a committee can vary widely depending on how difficult or contentious the case may be. Generally speaking, committee meetings are relatively common during the first few weeks of the case. Committee members may find it necessary to set aside a few hours a week for such meetings. As the case progresses, meetings usually become less common. In addition, a significant amount of committee business may be conducted via e-mail updates from committee counsel. It bears repeating that the debtor’s bankruptcy estate is responsible for committee costs, including paying committee counsel. Other reasonable expenses incurred by the committee, such as travel expenses for a committee member to participate in mediation during the bankruptcy case, are also covered by the estate

As part of their service, committee members take on a fiduciary duty to the entire unsecured creditor class. Committee members, therefore, are not permitted to use their service to further their interests. As an example, a committee member should not try and convince the committee to support a motion to pay one committee member’s claim in full (for example, via a “critical vendor” motion) if other unsecured claims are not receiving the same treatment. That said, committee service does not require a creditor to forget about its individual interests. If a conflict of interest arises, committee counsel may ask a conflicted member not to participate in making particular decisions. Alternatively, a committee member may choose to resign if the conflict becomes too onerous to address with the other members of the committee. It is very common for committee counsel to create written committee bylaws that specifically address issues such as approved modes of communication, voting procedures, and methods for dealing with conflicts.

Committee confidentiality may also be a critical issue in the case. Because the committee is an active participant in the bankruptcy case, the committee is often provided with financial information that is not otherwise available to the public. For example, if the debtor is seeking to obtain from the committee a recommendation that unsecured creditors vote in favor of a plan of reorganization, the debtor may provide the committee with detailed financial projections showing why the plan makes economic sense. Such non-public information could be very valuable to competitors of the debtor. Committee members must understand this dynamic and should respect the terms of any non-disclosure agreement executed by the members. Even though committees represent the interests of all unsecured creditors, committee members may be prohibited from sharing information with creditors who are not members of the committee.

A committee will continue in existence throughout the bankruptcy case. If the case involves a plan of reorganization or a plan of liquidation, the committee will dissolve upon confirmation of the plan. But, it is common for plans to set up creditor trusts and for committee members to be selected to sit on a trust committee to assist with how the trust distributes assets to creditors. In that circumstance, committee service – including both during the case and afterward – may constitute several years from start to finish. Again, however, creditor trusts are generally operated to prevent overburdening committee members. Meetings for such trusts can be as infrequent as a few times a year.

Given the various pros and cons related to committee service, creditor representatives have a lot to think about when they receive a letter from the U.S. trustee inquiring as to their interest in serving. While serving on a committee for the first time may require a committee member to climb a steep learning curve, it usually is necessary to do that climb only once. Serving again on new cases then becomes much less of a challenge. Many creditor representatives find that the ability to actively participate in the case and to have a significant voice on behalf of unsecured creditors easily outweighs the time commitment and duties shouldered by committee members.

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