We have talked about committees in the past, but this month I want to talk about creating committees in addition to the official committees appointed in Chapter 9 and 11 cases. When is an additional committee appropriate? What problems are created with another committee? How might those problems be addressed?
Under Chapter 9 or Chapter 11 of the Bankruptcy Code1 the United States Trustee is charged with the duty of forming a committee (or committees in multi-debtor cases) to represent the interests of unsecured creditors.2The United State Trustee may also appoint – or be ordered by the court to appoint – additional committees of creditors or equity owners.3 Generally the trustee will respond to indications of interest by members of the class that seeks to be represented. If the United States trustee is not responsive, resort to the court will be necessary. Because of the problems discussed below, the debtor and (or) the statutorily-mandated unsecured creditors committee may resist the formation of multiple committees.
Who, then, might seek an independent committee to represent their interests? Leaving equity owners aside for the moment, creditor groups that might feel a need to have their own representatives come in two categories. First, the debtor may have a constituency of creditors whose interests are antithetical – or at least not the same as – those of the creditors acting on the originally appointed committee. Tort victims, bond holders, and trade creditors – among others – all have their own agendas. Tort victims may be interested in insurance or alternative dispute resolution programs. Bond holders may see liquidation or a quick sale as the central thrust of a proceeding, whereas trade creditors may be interested in keeping a customer alive. If these agendas are not in serious conflict, the solution to a lack of representation may be to add new members to an existing committee.4If, however, the creditor groups are in too strenuous opposition, adding members of different constituencies may simply make a committee unworkable.
Moreover, there may be divisions within these classes. Senior and subordinated bonds may manifest such rights in tension that their differences will affect the whole case. Product liability tort victims and slip-and-fall tort victims may seriously dispute access to insurance coverage or the structure of an alternative dispute resolution facility. So called “trade” creditors will be dependent of a debtor’s business in varying degrees and they will therefore have different views of how to work with the operating debtor during the bankruptcy case. If these tensions are severe, multiple committees may be necessary.
The other situation where creditor constituencies may be at odds is where more than one debtor in a corporate family has accumulated a meaningful amount of debt. If the debt-heavy entities are at different levels in the corporate structure, this can present problems for the cohesion of the entire creditor group. Thus, if a parent corporation owes many creditors and its subsidiary does as well, because value from the subsidiary often must reach the parent’s creditors through the parent’s equity in the subsidiary, there is an obvious basis for dispute between the creditors of each entity. The dispute is likely to be exacerbated due to inter-company debt, guarantees, and other financing devices that could adjust the rights of the parent and subsidiary vis-à-vis each other.
This situation – like that of subordinated debt – can also raise a question common when equity seeks representation: is junior debt – or equity – “in the money?” It may be that a constituency’s interests are not represented by an existing committee. However, if the constituency is clearly “out of the money” – that is, the debtor’s value is insufficient to reach them – those interests need no advocacy.
The question of whether there is an economic stake to protect arises most often in the context of equity. That brings me to the two basic questions that will determine whether another committee is appropriate: First, does the constituency need representation? Second, is it already adequately represented?
The first question is one of value. We have discussed value in the past. If the petitioning constituency has no right to receive value from a Chapter 11 case, then it does not need representation. It is likely that the need to decide whether a constituency needs a representative committee will precede any determination of enterprise value. Given that balance sheets do not provide a fair measure of value5 – generally accepted accounting practices not being designed to capture an enterprise’s ability to generate earnings – the parties and the court will often face difficulty in assessing whether equity or junior debt is, in fact, in the money. Operating results will allow a rough estimate of likely future cash flow, but the distortions occurring on the eve and during the early days of bankruptcy will cast doubt on the reliability of such a valuation unless the resulting solvency determination is absolutely clear.
Moreover, the methodology for predicting enterprise value involves many variables that allow a valuation expert to be “conservative” or “liberal” in value assessments. I don’t propose to review this area again, but it is clear that a senior class is likely to value an enterprise at the low end while the junior class adopts a more optimistic view consistent with the need to be “in the money.”6 The trustee – or debtor – must be more neutral in its approach due to its fiduciary duties.
This suggests that, to balance the pessimism of senior debt – which, after all, will not object to being overcompensated due to undervaluation – junior classes need an opportunity and means to persuade others and the court to give them seats at the table. Put another way, in a close case, the juniors deserve a representative.
This brings up the second question: Is the junior class already represented? This question comes up where an existing committee purportedly represents the interests of the concerned constituency, but this issue arises most often in cases where an equity committee is sought. Other parties will claim that the current management of the debtor, especially if its members are equity owners, will represent equity adequately.7 But, besides the problem that management’s fiduciary duties may inhibit its ability to act for equity owners, as discussed above, management will have other concerns – their jobs, for example – that may incentivize it to be at odds with equity owners. On the other hand, the court may, through a neutral like an examiner, or by appointment of its own experts pursuant to Federal Rule of Evidence 706, exercise oversight of the valuation process sufficient to protect equity. An ad hoc committee or a large shareholder (or, with junior debt, an indenture trustee) may also look out for the interests of equity owners adequately.
While a committee – unlike such a device – will directly represent the junior constituency, it will also create other problems. It will add substantially to costs: counsel, experts, and committee expenses all add up. Further, it will complicate decision making. Besides the debtor and the original committee, there is likely to be a principal lender involved in the case, and perhaps other specially-situated creditors (e.g., a franchisor). An added committee presents one more party that will take positions in a case on operating and administrative issues. This necessarily complicates the process of arriving at a consensus on these issues and results in more complex trials (including discovery) of such matters before the court.
There are other problems too. Committees make demands on a debtor and its management. The more of them, the more burdens already stressed executives will face. They cause more litigation and provide another potential place where information can be leaked.
Some of these problems can be addressed. I have put a committee on a budget.8 I have also directed that multiple committees avoid duplication of the efforts of each.9 To a great extent, all committees will have common interest in administrative or operating matters. Not all committees need be overly active on these matters.
Years ago, when I was in private practice, in an oil and gas case where committees had proliferated (as they often do in such cases), the parties agreed to create an executive committee made up of representatives of the many committees. It seemed to work well for monitoring the debtor’s operations. A similar approach might be used for investigations.
I have also seen single committees broken down into subcommittees to better recognize the needs of different constituencies. I think parties might also consider sharing investment advisors and other professionals – though for some (like lawyers) this would pose ethical problems.
The bottom line is that creating additional committees can be a mixed blessing. Counsel should consider whether such an additional committee can be justified to the court and how its costs, economically and in efficiency of administration, can best be managed. Counsel must use the tools afforded them to these ends as well as to ensure adequate representation.
D. Michael Lynn has served as United States Bankruptcy Judge for the Northern District of Texas in Fort Worth since 2001. During his tenure on the bench, he has presided over such large Chapter 11 cases as Texas Rangers Baseball Partners, Mirant Corporation and Pilgrim’s Pride Corporation, as well as thousands of consumer cases. Prior to his appointment to the bench, he spent 29 years practicing bankruptcy law, specializing in corporate reorganizations. Judge Lynn was a Visiting Professor of Law at Southern Methodist University’s Dedman School of Law for 15 years and now serves as Adjunct Professor of Law at Texas Wesleyan University, where he teaches courses in corporate reorganization law, legal drafting, and legal ethics. He has served as a contributing author for Collier on Bankruptcy and the Collier Bankruptcy Practice Guide and as co-author of The Collier Handbook for Trustees and Debtors in Possession, and has spoken frequently at continuing legal education events. He can be reached at firstname.lastname@example.org.
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