A voice for smaller claim holders in Chapter 11 proceedings
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In a Chapter 11 bankruptcy, unsecured creditors often have the most to lose. They also have the least amount of leverage in protecting their interests. Their claims against the debtor are low priority, falling to the bottom of a list that begins with:
- Secured claims: claims that are secured by property. Secured creditors receive either their collateral or the value of the collateral in cash. If the collateral is worth less than their claim, it is bifurcated into a secured claim (which must be paid in full) and an unsecured claim, which receives a share of the payments made to unsecured creditors.
- Priority unsecured claims: an unsecured claim that is given priority of payment by the Bankruptcy Code. They are grouped into 10 categories with descending levels of priority which cannot be modified or circumvented by state law. See 11 USC §507(a)(1)-(10).
The only creditor class lower than unsecured creditors is “shareholders and other ’interest holders’”.
Rationale for the Formation of the Creditors’ Committee
Without statutory intervention, it was unlikely that any party would look out for the interests of unsecured creditors. Given this understanding, Congress incorporated into the Bankruptcy Code a mandate in Section 1102(a)(1) for establishment of a committee representative of this creditor class.
Organization and Membership of the Unsecured Creditors’ Committee
Members of the Unsecured Creditors’ Committee are selected by the United States Trustee. Selection is made either at a Trustee-convened meeting of the largest creditors, or is based on answers to a questionnaire sent to the 20 largest unsecured creditors. While the committee is typically made up of those with the largest claims, it can also include smaller creditors who may suffer disproportionately from the bankruptcy filing.
The committee appointed in accordance with Section 1102 is deemed the “official Unsecured Creditors’ Committee”. However, there is nothing in the law that precludes creditors with similar interests from banding together into “unofficial committees”. Unofficial committees do not have the specific rights and powers of the official committee, but they still have standing in the case as parties in interest.
The law does not set the number of participants, but committees generally consist of 3 to 7 members. Participation is voluntary and there is no remuneration other than reimbursement of actual, necessary and reasonable out of pocket expenses.
If less than three of the 20 largest unsecured creditors are willing to participate in the Committee, the Trustee may decide not to convene the Committee. Occasionally, a Trustee will appoint committees larger than seven members where it is necessary to assure adequate representation, or where there is a great deal of interest in the bankruptcy.
Unsecured Creditors’ Committee members are required to represent the interests of all unsecured creditors, not merely their own interests or the interests of the other members. They have a fiduciary responsibility – the highest obligation one can owe to another person – requiring that they be loyal, honest, trustworthy, and free from conflicting interests.
Given the responsibilities of committee membership, potential members should carefully consider whether they want to be part of the process. Do they have the time and ability? Is the debtor important to their business? Is the outstanding debt significant to their business?
The extent of participation on the Unsecured Creditors’ Committee is up to each member. There is no requirement to attend hearings; however, it is in the member’s interest to stay informed and participate in the progress of the reorganization.
Powers and Duties of the Creditors’ Committee
At the first meeting of the Creditors’ Committee, members will:
- Select one or more chairpersons.
- Adopt procedural rules or by-laws. The Committee has flexibility as to how formally or informally it conducts its business.
- Discuss employment of an attorney, accountant or other agent. The selected representatives must be disinterested parties and approved by the Bankruptcy Court.
- Determine the allowance of member expenses, which may include travel, mail and copy costs, telephone charges, etc. Prior to the Bankruptcy Reform Act of 1994, there was no statutory allowance for member expenses. Such expenses are now allowable under 11 USC Section 503(b)(3)(F).
11 USC Section 1103(c) outlines the specific powers of the committee, which are:
- consulting with the debtor concerning the administration of the case;
- investigating the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan;
- participating in the formulation of a plan of reorganization and/or filing acceptance or rejection of a plan submitted by the debtor;
- requesting the appointment of an independent Chapter 11 trustee to run the business in place of the debtor-in-possession, or seeking conversion of the case to Chapter 7 (liquidation);
- performing other services in the interest of the creditors.
The Unsecured Creditors’ Committee and Small Business Bankruptcies
Under the Bankruptcy Reform Act of 1994, Congress established a fast track for small business reorganizations. The purpose was to make Chapter 11 easier and less expensive for small businesses. In this type of bankruptcy and under certain conditions, the Creditors’ Committee can be dispensed with. Those conditions are:
- The debtor must elect to be considered a small business as defined by Section 217(a), which states that the aggregate non-contingent liquidated secured and unsecured debts as of the date of the petition must not exceed $2 million.
- The debtor must request that the Creditors’ Committee not be formed for “cause” (Section 217(b)(3)). Although this is difficult to establish, bases for “cause” might be:
- The additional costs of a Creditors’ Committee and its professionals would unduly burden the debtor company.
- The type of plan proposed by the debtor does not require committee participation.
A well-represented Creditor’s Committee can have a huge impact on a bankruptcy case due to its official standing and the fact that it represents an entire class of creditors. While a court may not always follow its recommendations, it will give committee views deference. This Committee, therefore, is extremely important and potentially powerful.