In a bankruptcy, the parties that often have the most to lose and the least leverage in protecting their interests are unsecured creditors. Their claims against the debtor are low priority, falling at the bottom of the list, after ...

secured creditors;
administrative expense claims - debts incurred in the ordinary course of the debtor's post-petition operation or liquidation;
prepetition priority claims, including debts incurred between the date of an involuntary petition and the date an order for relief is entered (called "gap" claims), certain prepetition wage and benefit claims, and certain tax claims.

The only creditor class lower than unsecured creditors is shareholders and other "interest holders".

Rationale for the Formation of the Creditors' Committee

Understanding that, without statutory intervention, it was unlikely that any party would look out for the interests of unsecured creditors, Congress incorporated into the Bankruptcy Code a mandate in Section 1102(a)(1) for the establishment of a committee representative of this creditor class. (See "Small Business Bankruptcy" below for an instance when a Creditors' Committee may not be formed.)

The Committee was also mandated to achieve economies for this class of creditors, as unsecured creditors cannot usually justify the expense of individual representation.

Organization of Unsecured Creditors' Committee

The formation, powers and responsibilities of the Unsecured Creditors' Committee are outlined in the U.S. Bankruptcy Code 11 U.S.C. Sections 1102 and 1103.

The Committee is formed as soon as practicable after the order of relief, and usually during or soon after the first meeting of creditors (called the 341 Meeting).

Members are appointed by the United States Trustee and usually selected based on answers to a questionnaire sent to the 20 largest unsecured creditors. If a Prepetition Committee exists, and it was fairly chosen and is representative of the various claims presented -- then the Code requires the Trustee to give strong consideration to appointing members of the Prepetition Committee to the Unsecured Creditors' Committee [Sec. 1102(b)(1)].

The law does not set the number of participants, but committees typically consist of 3-9 members. Participation is strictly voluntary and there is no remuneration other than reimbursement of actual, necessary and reasonable out of pocket expenses [Sec. 503(b)(3)(F)]. The makeup of the Committee is subject to ongoing review by the US Trustee as circumstances in the case change.

Responsibilities of the Members

Creditors' Committee members are required to represent the interests of all unsecured creditors, not just their own interests or the interests of the members of the committee. They are considered to have a fiduciary responsibility, which is the highest obligation a person can owe to another person.

The extent of participation on the Creditors' Committee is up to each member. There is no requirement to attending hearings. However, it is in the member's best interests to stay informed and participate in the progress of the reorganization.

Powers and Duties of the Creditors' Committee

The first items of business for a Creditors' Committee are:

Selecting one or more chairpersons.
Adopting procedural rules or by-laws. The Committee has flexibility as to how formally or informally it conducts its business.
Discussing employment of an attorney, accountant or other agent. The selected firms must be disinterested parties and are subject to the approval of the Court [Sec. 1103(a)].
Determining the allowance of member expenses - travel, mail and copy costs, telephone charges, etc. Prior to the Bankruptcy Reform Act of 1994, there was no statutory allowance for expenses incurred by members of the Creditors' Committee. These expenses are now allowable per Sec. 503(b)(3)(F).

Per the Bankruptcy Code [Sec. 1103(c)] the Committee has the powers to:

Consult with the debtor concerning the administration of the case.
Review and investigate the acts, conduct and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of that business. This includes the right to examine the debtor's officers and managers under oath and review the debtor's ledgers, accounting or tax approaches, as well as salaries, benefits and general business practices.
Participate in the formulation of a plan of reorganization and/or file acceptance or rejection of a plan submitted by the debtor. Note that unless an independent trustee is appointed to operate the business, the debtor generally has exclusive right to file a plan for the first 120 days after the bankruptcy filing date. After 120 days (unless the Court extends the exclusive period), any other party, including a creditor or the Unsecured Creditors' Committee, is allowed to file a plan.
Request the appointment of an independent Chapter 11 trustee to run the business in place of the debtor-in-possession (DIP) or examiner [Sec. 1104], or seek conversion of the case to Chapter 7.
Perform other services in the interest of the creditors.

The Committee also has the rights to:

Appear and be heard in any matter brought before the bankruptcy court.
Intervene in any lawsuit involving the debtor filed in the Bankruptcy Court.
Form subcommittees.

Qualified Immunity of Committee Members

According to Bernstein Law Firm P.C., several courts have held that Creditors' Committee members enjoy a "qualified immunity." Thus, they cannot be sued for acts related to the authority of the Committee as conferred by statute or by the court, unless their actions amount to willful misconduct.

Termination of the Creditor's Committee

Although it's generally presumed that the Creditor's Committee terminates at the conclusion of the Chapter 11, the Bankruptcy Code does not contain any provision regarding termination. According to Bernstein Law Firm P.C., the courts have differing opinions on this issue. One recent opinion held that a Committee continues beyond confirmation of the plan through to consummation. Another opinion stated that the Committee may continue to exist and perform services, under certain circumstances, following a conversion to Chapter 7.

Where the plan of reorganization proposes treatment for unsecured creditors that will not be fully consummated on the effective date, the Bernstein web site states: "The prudent practice is for the committee to insist upon some provision to be written into a plan providing for a description of its [Creditors' Committee's] post-confirmation powers and duties and its right to continue to be represented by counsel."

Small Business Bankruptcy

Under the Bankruptcy Reform Act of 1994, Congress established a fast track for small business reorganizations. The purpose was to make Chapter 11 less complex and expensive for small businesses. In these bankruptcies, the Creditors' Committee can be dispensed with -- under certain conditions:

The debtor must elect to be considered a small business as defined by Sec. 101(51C), which states that the aggregate noncontingent 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" [Sec. 1102(a)(3)]. Although apparently difficult to establish, based on recent court rulings, 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.
The creditors opposed to dispensing with the committee could adequately protect their interests individually.

Resources on Creditors' Committees

An excellent resource for information on the Bankruptcy Creditors' Committee is provided on the web site of the Bernstein Law Firm, P.C.: Background Information for Chapter 11 Committees of Unsecured Creditors.

*****

Disclaimer: This article is not intended to be legal advice and is not a substitute for competent legal advice on the referenced subject.

Information provided by ABC-Amega Inc. Since 1929, providing first party accounts receivable collections outsourcing and third party debt collection for management of your commercial receivables portfolio. For further information on our receivable management services, email info@abc-amega.com.