Imagine that you receive a notice that your best customer, who owes you more than $250,000.00 on an unsecured basis, just filed a Chapter 11 bankruptcy case. You are now faced with a decision as to what involvement you want to have in the case. You can choose simply to file a proof of claim and wait to see if there will be funds for distribution. If, however, you wish to be more proactive, especially if you have a substantial claim, there might be an opportunity for you to serve as a member of an unsecured creditors' committee.

Formation of the Unsecured Creditors' Committee

A case filed under Chapter 11 of the United States Bankruptcy Code is generally referred to as a case for reorganization. Chapter 11 cases are most often filed by a corporation or a partnership. The usual goal of the entity filing a Chapter 11 case is to keep its business alive and to formulate a plan to pay its creditors over time.

The involvement of an unsecured creditors' committee can have a significant impact on the outcome of a Chapter 11 case. Section 1102 of the Bankruptcy Code provides for the appointment by the United States Trustee of a committee of unsecured creditors willing to serve. The entity filing a Chapter 11 case is required to file a list of its 20 largest unsecured creditors; however, in larger Chapter 11 cases, a list of the 30 or 40 largest unsecured creditors is often filed. The unsecured creditors' committee ordinarily consists of unsecured creditors who hold the seven largest unsecured claims against the debtor. Whenever possible, the United States Trustee will try to appoint a committee that is representative of the various types of claims against the debtor.

Powers and Duties of the Unsecured Creditors' Committee

Section 1103 of the Bankruptcy Code sets forth the powers and duties of unsecured creditors' committees. Among other things, the committee consults with the debtor concerning the administration of the Chapter 11 case; investigates the acts, conduct, assets and liabilities, and financial condition of the debtor and the operation of the debtor's business; and, of utmost importance, participates with the debtor in the formulation of a plan of reorganization. Section 1103 of the Bankruptcy Code also authorizes the unsecured creditors' committee to employ one or more attorneys, accountants or other agents to assist the committee in the performance of its duties. The fees of the professionals employed by the committee are allowable as administrative expenses of the Chapter 11 case, and committee members are not responsible for payment.

One of the most important powers granted to an unsecured creditors' committee is to request the appointment of a trustee or examiner, if cause exists, under Section 1104 of the Bankruptcy Code. The typical grounds for the appointment of a trustee or examiner in a Chapter 11 case are fraud, dishonesty, incompetence or gross mismanagement of the affairs of the debtor by current management.

The unsecured creditors' committee may be authorized, subject to court approval, to pursue fraudulent or preferential transfers if for some reason the debtor refuses or is not in a position to pursue those claims. Often, the committee will bring actions to generate funds for the bankruptcy estate or will use the ability to pursue these actions as a negotiating tactic in formulating a plan of reorganization.

Responsibilities and Advantages of Membership on an Unsecured Creditors' Committee

An unsecured creditors' committee is required to provide access to information for creditors who hold claims of the kind represented by the committee and are not appointed to the committee. If you are considering being a member of an unsecured creditors' committee, you should be aware that the committee has a fiduciary duty to represent, and take into account the best interests of, all creditors rather than just the interests of the individual committee members.

Some advantages of serving as a member of an unsecured creditors' committee include the opportunity to have a voice in the direction of the Chapter 11 case, the ability to participate in the formulation of a plan of reorganization, and to obtain information about the debtor for purposes of determining the potential recovery on the member's claim. Members of an unsecured creditors' committee are entitled to receive copies of the periodic financial reports filed by the Chapter 11 debtor, as well as other reports that might be prepared by other professionals involved in the case.

Although there is a fiduciary responsibility and a time commitment involved in serving as a member of an unsecured creditors' committee, a creditor holding a substantial unsecured claim against a Chapter 11 debtor can have a significant impact on the outcome of the case by serving as a member of the committee. In negotiations with a Chapter 11 debtor, especially in the formulation of a plan to repay creditors, having a seat at the table can be very beneficial to an unsecured creditor.