Representation of Small-Business Concerns on Creditors Committees

Journal Issue

Jun 2006

Column Name

Last in Line

Citation

ABI Journal, Vol. XXV, No. 5, p. 20, June 2006

Bankruptcy Code

Topic Tags

Small Business

Journal HTML Content

In many instances, a bankruptcy can have a greater
impact on the debtor's smaller business creditors than some of the
larger creditors. However, due to the sheer size and power of the
larger creditors, very often the smaller claimants are frozen out in
the committee-selection process. The Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005 (BAPCPA) adds new §1102(a)(4) to
the Code to remedy this situation. This section resolves a split among
the courts on the issue of whether or not the bankruptcy court has the
power to increase the membership of a creditors' committee appointed
by the U.S. Trustee (UST).1 It allows judges to direct the
UST to increase the size of creditors' committees to include certain
creditors who qualify as "small business concerns." This
article briefly examines the new §1102(a)(4). It continues with an
overview of nonbankruptcy law relating to the Small Business Act and
small-business concerns, as well as a discussion of what constitutes a
"disproportionately large" claim. The focus of what
constitutes "adequate representation" is outside the scope
of discussion of this article. Section 1102(a)(4) of the Code

BAPCPA's revisions to the Code provide certain additional protections
to smaller creditors. The second sentence of §1102(a)(4) of the
Code provides that: <blockquote> [t]he court may order the U.S.
Trustee to increase the number of members of a committee to include
a creditor that is a small business concern (as described in
§3(a)(1) of the Small Business Act2) if the court
determines that the creditor holds claims (of the kind represented
by the committee) the aggregate amount of which, in comparison to
the annual gross revenue of that creditor, is disproportionately
large. </blockquote>The revised Code raises two issues that are
worthy of discussion and elaboration—first, whether creditors
qualify as "small-business concerns," and second, whether a
claim is disproportionately large as compared to the gross annual
revenue of a creditor. While the first of these issues is easily
resolved, the second is more troublesome. The following discussion
will examine these two components of §1102(a)(4) in greater
detail. Small Business Concerns under the Small Business Act
The Small Business Act (SBA), 15 U.S.C. §631 et seq.,
sets forth the criteria for an enterprise to qualify as a
"small-business concern" in §632. The business must
inter alia be an enterprise that is (1) independently owned and
operated, and (2) not dominant in its field of operation. A
small-business concern may also be engaged in the business of
agriculture or farming. However, to be deemed a small-business
agricultural concern, the enterprise must have annual gross receipts
that are less than $750,000.3 Additionally,
§632(a)(2) of the SBA provides that the administrator4

may "specify detailed definitions or standards by which a
business concern may be determined to be a small business
concern." Under the statute, the agency can promulgate
regulations that take into account the size and additional criteria
such as "employees, dollar volume of business, net worth, net
income, a combination thereof or other appropriate factors" when
determining whether an enterprise qualifies as a small-business
concern. The cases address several issues such as whether an
affiliated company is deemed to be part of a larger group, and whether
the regulations are enforceable. Regarding the affiliation issue, in
American Electric Company v. United States, 270 F. Supp. 689,
691-92 (D. Ha. 1967), a disappointed bidder brought an action for a
judgment declaring that it qualified as a small-business concern. The
company had annual sales in excess of $7.5 million—the amount at
the time that was determined to be the ceiling for a company to
qualify as a small-business concern in the particular industry at
issue. However, the company had 18 affiliates. It argued that the
Small Business Administration could not promulgate regulations that
required the annual sales of all affiliates to be aggregated for
purposes of determining size qualifications. The court sided with the
government, ruling that large corporate concerns with small affiliates
could otherwise reap the benefits of the Small Business Act. Later, in
Aloha Dredging and Construction Co. v. Heatherly, 661 F. Supp.
738, 740 (D. D.C. 1987), the district court ruled that the
determination of whether a company was affiliated with another for
purposes of determining whether it was a small business concern would be
determined under "the totality of all circumstances." As
to the enforceability of the regulations, in Otis Steel Products
Corp. v. United States, 316 F.2d 937, 940 (Ct. Cl. 1963), the
claims court ruled that since the administrator had the authority
under the Small Business Act to define a small business concern,
regulations that contained such a definition had the full force and
effect of law. In effect, the Otis Steel case confers the
authority of statute upon these regulations. In Jones Truck Lines
Inc. v. Republic Tobacco Inc., 178 B.R. 999, 1006 (Bankr. N.D.
Ill. 1995), the bankruptcy court correctly noted that the Code of
Federal Regulations "sets forth standards in the table of Standard
Industrial Classification (SIC) for what qualifies as a small-business
concern under the SBA." Therefore, an examination of the
regulations is necessary to make the final determination of whether or
not an entity qualifies as a "small-business concern."
The regulations promulgated by the Small Business Administration in
13 C.F.R. §121.101 provide that the SBA sets forth size standards
for determining whether an enterprise qualifies as a small-business
concern. The regulation references the North American Industry
Classification System (NAICS) that provides industry codes. 13 C.F.R.
§121.201 sets forth size standards in either millions of dollars
of annual receipts or by number of employees, depending upon the
particular industry. The regulation provides this information in
excruciating detail and makes excellent reading for insomniacs.

Case Law Addressing Disproportionately Large Claims and
Transfers Unfortunately, qualifying as a small-business concern
is not enough to get a small-business creditor a seat on a creditors'
committee. The debt owed to the creditor must be
"disproportionately large" in comparison to its annual gross
income. The case law on this point is not particularly instructive.
Indeed, there is no reported authority that defines the term
"disproportionately large." That being said, there are a few
cases that use this terminology, including several within the context
of bankruptcy filings. In Inland Security Company v. Estate of
Kirshner, 382 F. Supp. 338, 350 (W.D. Mo. 1974), the district
court considered the predecessor to §548 of the current Code. It
held that when property is transferred or obligation incurred for
purposes of security, it is only necessary that its value not be
disproportionately large as compared with the amount of advance or debt
secured for purposes of determining whether to avoid the transfer. The
debtor in Kirshner gave a creditor with an unsecured claim of
$12,354.97 a secured note of equal value. This, the court held, was
"disproportionately large." Another area in bankruptcy
where the term "disproportionately large" has come into play
is in the context of determining when to commence litigation. A
trustee should not commence litigation if the cost of litigation is
disproportionately large in relation to the probable recovery that
would result therefrom.5 However, Bean provides
little insight into the parameters of this term, merely citing a case
that holds that when the cost of litigation exceeds the recovery, or
when the anticipated recovery is a used car worth $1,300, the said
litigation costs are "disproportionately large" compared to
the recovery. A case interpreting New York state law provides more
defined boundaries. In Troll v. Chase National Bank of City of New
York, 257 F.2d 825 (2nd Cir. 1958), the Second Circuit considered
the term "disproportionately large" in the context of New
York's fraudulent conveyance statute then in force. The debtor pledged
bonds as collateral to a bank in exchange for a loan. The pledge was
43 percent greater than the amount of the debt. Citing a 1939 state
court case, the Second Circuit held that within the context of the
subject statute, a pledge of 52 percent more than the outstanding debt
was not disproportionately large. However, it is unlikely that the
percentages used in the Troll case will provide any meaningful
guidance when interpreting §1102(a)(4). Finally, in Musetter
v. Lyke, 10 F. Supp.2d 944 (N.D. Ill. 1998), the court held that
an award of $50,000 in exemplary damages was not disproportionately
large in a case where compensatory damages exceeded $450,000. It is
anticipated that litigation over the issue of whether the claim of a
small-business concern is "disproportionately large" compared
to its annual revenues for purposes of §1102(a)(4) will be
considered on a case-by-case basis. To date, the courts have simply
failed to set forth a bright-line rule to provide guidance.

<blockquote><blockquote>
<hr>
<big><center>
[B]eing a small creditor in and of itself is not enough to require
committee membership under §1102(a)(4).
</center></big>
<hr>
</blockquote></blockquote>

Conclusion Section 1102(a)(4) of the Code demonstrates that
while BAPCPA is perceived as legislation enacted primarily for the
benefit of larger institutions, it does contain provisions that
benefit smaller concerns as well. It clears up any confusion over the
issue of whether or not courts may direct the UST to increase the
membership of creditors' committees to include certain smaller
creditors. In order to determine whether such creditors qualify as
"small business concerns" under §1102(a)(4), one must
look to the Small Business Act and regulations promulgated thereunder.
The issue of whether or not a creditor's claim is
"disproportionately large" compared to its annual gross
revenues as required under §1102(a)(4) is less clear and probably
will need to be resolved on a case-by-case basis. One thing is clear,
however; being a small creditor in and of itself is not enough to
require committee membership under §1102(a)(4). The practitioner
should work through the various requirements of the statute to assure
that his client qualifies for committee membership as a statutory
"small-business concern" with a claim that is
disproportionately large to its annual gross revenues before
presenting such an argument to the bankruptcy court. Lastly, it
should be kept in mind that the language of the statute is not
mandatory. The decision of whether or not a qualifying small-business
concern should be added as a member of a creditors' committee is
ultimately left to the discretion of the sitting bankruptcy judge.
<h3>Footnotes</h3> 1 As discussed in the April 2006 Last in Line
column by Deborah L. Thorne, "Creditors' Committees: Maximizing
Creditor Recoveries," ABI Journal, Vol. XXV, No. 3, p. 20,
April 2006, BAPCPA returned the bankruptcy court's ability to review
the contents and make-up of creditors' committees by resurrecting the
pre-1986 §1102(c) in new §1102(a)(4). For the first time in
many years, courts, practitioners and creditors have a more lucid
understanding of the bankruptcy court's role in the
committee-appointment process. Under the post-1986 revision,
bankruptcy courts struggled with and failed to present a seamless web
of continuity on the issue. The case law was more of a disjointed
patchwork of decisions that could not be easily reconciled. See

Klee, Kenneth N. and Shaffer, K. John, "Creditors' Committees
under Chapter 11 of the Bankruptcy Code," 44 S.C.L.Rev. 995, 1032
(Summer, 1993). 2 The Small Business Act is set forth in 15 U.S.C.
§631 et seq.; §3(a)(1) of the Small Business Act is
set forth in 15 U.S.C. §632(a)(1). 3 See 15 U.S.C.
§632(a)(1). 4 See 15 U.S.C. §662(2); the term
"administrator" means the Administrator of the Small
Business Administration. 5 See In re Bean, 251 B.R. 196
(E.D.N.Y. 2000).

Journal Authors

Daniel Morman

Jonathan T. Brand

Journal Date

Thursday, June 1, 2006 - 12:00

Bankruptcy Rule

2006

none