Two Recent Bankruptcy Cases Highlight Questions Over Unsecured Creditors Committees

Both creditors and debtors need to know about unsecured creditors committees. These committees can help parties in a bankruptcy case, but they come with a cost. And most of the time, they’re appointed as a matter of course.

What is an unsecured creditors committee?

In Chapter 11 cases with unsecured creditors, the United States Trustees Office (UST) will often appoint an unsecured creditors committee. The committee is a smaller body of holders of unsecured claims that acts as the representative of the entire unsecured creditor class in negotiations and other matters.

How can a committee help unsecured creditors?

In most bankruptcy cases, unsecured creditors have the lowest priority claims and the most to lose. They also may have such small individual claims that hiring a professional to support each creditor’s interests is not cost-effective. Instead, the unsecured creditors committee hires professionals to represent the body as a whole. Best of all, these professional fees aren’t borne by committee members. The bankruptcy estate pays the committee professionals.

But what happens when these benefits aren’t present?

For instance, what if a debtor proposes to pay all unsecured creditors in full? What if every creditor is a vendor with a lien right? What if the committee doesn’t adequately represent the body of creditors? In these very real scenarios, there would seem to be no purpose to a unsecured creditors committee. This is obviously a concern for a debtor who has to pay the committee’s fees. On the flip side, creditors should also take note because the professional fees are paid in full, ahead of creditor claims.

What control do bankruptcy courts have over unsecured creditors committees?

The UST often appoints an unsecured creditors committee as a matter of course. Even though the committee could have major impacts on recoveries, its appointment generally goes unnoticed. The bankruptcy court has no role in the appointment process. And even if a party did notice, two recent cases highlight the bankruptcy court’s limited power to take action:

• In the Roman Catholic Church of the Archdiocese of New Orleans’ bankruptcy case, Judge Meredith Grabill of the Eastern District of Louisiana Bankruptcy Court held that the current unsecured creditors committee did not adequately represent the unsecured creditor body. The court chose an additional committee of unsecured creditors. Judge Grabill reviewed the legislative history of section 1102 and noted that the court’s limited powers were to ensure adequate representation on the committee. Here, the committee representation did not include any commercial creditors. It only included sexual abuse claimants, whose interests differ significantly from commercial creditors. Exercising her discretion, Judge Grabill ruled that adding commercial creditors to the committee would not achieve the goal of adequate representation. Instead, she ordered the appointment of an extra committee.
• In the National Rifle Association of America’s (NRA) bankruptcy case, Judge Harlin D. Hale of the Northern District of Texas Bankruptcy Court ruled that the current committee adequately represented the unsecured creditor body. The UST supported the makeup of the committee and said that it has no duty to share the basis for its decisions, other than to show the committee adequately represents the interests of all unsecured creditors. Judge Hale denied the motion to add two trade creditors to the committee. He noted that the creditors’ argument relied on math instead of actual need. Judge Hale stated that he did not think he had ever seen a motion to “reconstitute” an unsecured creditors’ committee, either as a judge or as a lawyer.

What should creditors take away from these cases?

The Archdiocese case demonstrates that a committee does not always reflect the creditor body, but the estate still bears the cost. Fortunately in the Archdiocese case, Judge Grabill used her authority to appoint another committee, at the expense of the estate. As shown in the NRA case, the outcome does not always go in the creditor’s favor. Creditors should take notice of the committee appointment and those listed as its members. Creditors have the right to challenge the makeup of the committee, especially if there is reason to believe it does not adequately represent the creditor body. At the same time, creditors should be mindful of whether the appointment of and participation on the committee is warranted by the case or ultimately a burden on the estate (at the expense of the creditor body).

What should debtors take away from these cases?

Because the estate bears the burden of committee cost, debtors should also take note. While section 1102 does limit a bankruptcy judge’s authority over the committee, Judge Grabill’s Archdiocese opinion notes case law supporting a debtor’s right to challenge committee appointment. The same idea holds for a debtor seeking to disband a committee that is a burden upon the estate. 

Committees serve an important role but come at a heavy cost. Both creditors and debtors should be careful not to overlook the appointment of a committee as a mere administrative function. And creditors, not just debtors, should take notice of the needs of the case. The Archdiocese and NRA cases are a welcome reminder that relief may be available.

Please contact Rick Shelby or any member of Phelps’ Bankruptcy team if you have questions or need help regarding bankruptcy committee participation.