When the Committee Is Not and When the Committee Is No More

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Dec/Jan 2003

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Recent decisions have focused on whether and under what conditions, given limitations in the statutory language, a
creditors' committee can assert causes of action normally belonging to the estate, such as avoidance actions.<a href="#2" name="2a">2</a>

Despite momentary panic following the first Cybergenics decision in the Third Circuit, order appears restored and
committees may bring causes of action of the estate, as the estate's representative, provided the conditions for
"derivative standing" are met.<a href="#3" name="3a">3</a>

The discussion engendered by Cybergenics implicates the "flip side" of the argument raised in that case: that
outside of the concept of derivative standing, the creditors' committee (or another statutory committee, such as an
equity committee) does not represent the interests of the bankruptcy estate, a fact with implications regarding the
committee's standing in various contexts. Moreover, the §1102/1103 committee is a creature of chapter 11: No
chapter 11, no committee. A recent decision of the U.S. District Court for the District of Maine, sitting as a
bankruptcy appeals court in the Great Northern Paper case, highlights the committee's role—or lack thereof—at
different stages of the case and the importance to all parties of understanding when the committee is the committee,
when the committee is the estate representative, and when the committee is no more.<a href="#4" name="4a">4</a>

<h3>The Typical Role of the Committee</h3>

The committee serves as a fiduciary only for the holders of general, unsecured claims<a href="#5" name="5a">5</a> and not for the
estate or the holders of other types of claims.<a href="#6" name="6a">6</a> (The term "estate" is not synonymous with "general unsecured
creditors.")<a href="#7" name="7a">7</a> A creditors' committee need not take the best interests of the estate into consideration,<a href="#8" name="8a">8</a> but should
vigorously pursue only the interests of general unsecured creditors.<a href="#9" name="9a">9</a> Moreover, the fact that acts of the committee
and its professionals may benefit other interests of the estate does not make the committee an estate representative.
While much is made of the committee's "watchdog function," this function again does not confer the status of
representative of the estate. To the extent that the committee is a "watchdog," it is so only to benefit its
constituency: "The function of a creditors' committee is to act as a watchdog on behalf of the larger body of
creditors which it represents."<a href="#10" name="10a">10</a>

<h3>Derivative Standing</h3>

A committee can obtain authority to act for the estate in a limited context, such as the pursuit of avoidance actions,
provided that the appropriate conditions are met. If the debtor-in-possession unjustifiably refuses to act on behalf
of the estate, and the committee seeks and obtains permission and authority from the court to act on behalf of the
estate in pursuing the action refused by the DIP, then the committee acts for the estate and assumes the mantle of a
fiduciary for the estate in that limited context.<a href="#11" name="11a">11</a> Under more recent authority, the committee can also obtain
derivative standing to act for the estate if the DIP consents and the court enters an order allowing the committee to
so act.<a href="#12" name="12a">12</a> Outside of these contexts and conditions, however, the committee does not represent the estate.

<h3>The Committee Upon Conversion</h3>

The committee—as a creature of §§1102 and 1103 of the Code—dissolves upon conversion of the debtor's
chapter 11 case to a case under chapter 7.<a href="#13" name="13a">13</a> Moreover, upon conversion, the trustee succeeds to the rights of the
debtor-in-possession (DIP) (or chapter 11 trustee, if one has been appointed), not to the "rights" or positions of the
committee, and the chapter 7 trustee is bound by prior actions of the DIP (to the extent approved by the court or
otherwise within the DIP's authority). During a chapter 11 case, in the absence of the appointment of a chapter 11
trustee, the debtor entity, as the "debtor-in-possession," acts as the sole representative of the bankruptcy estate and
assumes the fiduciary duties of a trustee and substantially all of the powers of a trustee.<a href="#14" name="14a">14</a> Upon conversion of a
chapter 11 case to a case under chapter 7, an appointed chapter 7 trustee steps into the shoes of the chapter 11 DIP
with respect to all rights, responsibilities, and liabilities.<a href="#15" name="15a">15</a> Thus, it is "axiomatic" that the chapter 7 trustee, as
successor to the DIP, is bound by acts of the DIP that are authorized by the court in prior proceedings during the
chapter 11 case, despite the trustee's absence at those proceedings.<a href="#16" name="16a">16</a> Any result to the contrary would result in
chaos among DIPs and their creditors, who must be able to deal freely with DIPs within the confines of bankruptcy
laws and without fear of retribution or reversal at the hands of a later-appointed trustee.<a href="#17" name="17a">17</a> The only exception to the
principle that the trustee does not succeed to the committee's rights and positions (to the extent contrary to the
positions taken by the DIP and approved by the court, for example) would be where the committee had sought and
obtained derivative standing.<a href="#18" name="18a">18</a>

<h3>The Committee's Standing to Appeal</h3>

Because the committee is not a representative of the estate, except in the case of derivative standing, it also
cannot appeal from rulings that prejudice rights or interests of the estate (or other claimants not represented by the
committee), and not the interests of general unsecured creditors. To have standing to bring an appeal from a final
bankruptcy court order, an appellant must be a "person aggrieved."<a href="#19" name="19a">19</a> As such, standing exists only where the order
directly and adversely affects an appellant's pecuniary interests.<a href="#20" name="20a">20</a> Such pecuniary interests are affected if the order
diminishes the appealing party's property, increases its burdens or detrimentally affects its rights.<a href="#21" name="21a">21</a>

In Spenlinhauer, a debtor in a converted chapter 7 bankruptcy case sought to appeal a final order of the
bankruptcy court approving the sale of the chapter 7 estate's interest in a trust, as well as the release of any
potential causes of action against the purchasers of the trust interest arising from the purchasers' pre-sale
administration of the trust. See Spenlinhauer, 261 F.3d at 116. One of the debtor's primary contentions was that the
sale price was inadequate. See Id. at 116-17. The First Circuit ruled that the debtor had no standing to object to the
final order of the bankruptcy court, since (a) title to property of the estate no longer resides in the chapter 7 debtor,
and the debtor therefore typically lacks any pecuniary interest in the chapter 7 trustee's disposition of that property,
and (b) the debtor failed to adduce sufficient evidence to demonstrate that the challenged order directly and adversely
affected the debtor's pecuniary interests notwithstanding the fact that the debtor no longer had title to the property.

See Id. at 118, 119. Thus, the debtor had no standing to object to the order because, whether or not the sale of the
trust property took place, the debtor stood to gain nothing. See Id. In other words, the debtor in Spenlinhauer had
no pecuniary interest that was adversely affected by the challenged order. Id.

In Kehoe, the debtors in a converted chapter 7 sought to appeal a final order of the bankruptcy court
certifying the election of a trustee pursuant to 11 U.S.C. §702. See Kehoe, 221 B.R. at 286-87. The First Circuit
BAP ruled that the debtors had no standing to appeal the order certifying the trustee's election because (as in

Spenlinhauer), (a) chapter 7 debtors ordinarily lack standing to challenge orders affecting the assets of the estate, and
(b) the debtors failed to advance specific arguments as to how the elected trustee's identity directly and adversely
affected their pecuniary interests, such as the generation of a surplus or their right to discharge or exemptions. See
Id. at 288-89. The committee, like the chapter 7 debtor, does not represent the estate and must assert some harm to
its constituency—the holders of non-priority unsecured claims—in order to appeal.

<h3>The Great Northern Paper Case</h3>

Against this backdrop of case law, the district court decided the appeal in Great Northern Paper. Some
detailed development of the facts is required.

Great Northern Paper Inc. filed a voluntary petition for relief under chapter 11 on Jan. 9, 2003. After filing
its petition, the debtor remained in possession of its assets, including two pulp and paper mills. Both before and
after the bankruptcy filing, the debtor actively pursued a sale of its assets, including the mills. Despite efforts by the
debtor and its investment banker, no commitment or agreement for a purchase of the assets was obtained prior to the
bankruptcy filing.

After the bankruptcy filing, the debtor's mills were not in operation. Rather, with financing provided by,
among others, BCC Equipment Leasing Corp. (BCC), the debtor maintained the mills in a "warm stasis" mode to
preserve them for sale. The case was a liquidating chapter 11 case from the outset. Specifically, with regard to the
BCC financing, on Feb. 5, 2003, the bankruptcy court entered its interim order (a) authorizing secured post-petition
financing from BCC Equipment Leasing Corp. on a super-priority basis, (b) granting relief from the automatic stay
and (c) scheduling a final hearing regarding the motion (BCC interim financing order). The BCC interim financing
order established certain milestones for the completion of the sale of the mills, including a deadline by which the
debtor was to have accepted a bid for its assets. Failure to meet any of those milestones would have left the debtor
without sufficient financing to preserve the mills. The official unsecured creditors' committee did not object to the
entry of the BCC interim financing order or the sale milestones required by that order, and in fact was active in the
negotiations leading to such order. To secure the payment of loans made under the BCC interim financing order,
BCC was granted a super-priority claim pursuant to 11 U.S.C. §§364 and 507(b). BCC was also granted a lien on
substantially all of the debtor's assets.

Following substantial arm's-length negotiations with the debtor, a bidder, Belgravia Paper Co. (BPC)
delivered, on Feb. 10, 2003, a letter of intent outlining the material terms and conditions of its offer to acquire all
or substantially all of the debtor's assets to the debtor. The letter of intent required, among other things, that the
bankruptcy court approve the debtor's payment of a break-up fee to BPC and certain costs incurred by BPC in
connection with the potential transaction.

On or about Feb. 11, 2003, the debtor filed a motion seeking an order establishing bid procedures and
approving the break-up fee and the expense reimbursement. Several parties, including the committee, filed
objections to the bid-procedures motion.

On Feb. 18, 2003, the bankruptcy court conducted a hearing on the bid-procedures motion. After hearing
the evidence and arguments of counsel, the bankruptcy court granted the bid-procedures motion. The bankruptcy
court held that the debtor's agreement to pay the break-up fee and the expense reimbursement was, under the
circumstances, a proper exercise of the debtor's business judgment as a fiduciary for its chapter 11 bankruptcy estate.
The bankruptcy court also held that the payment of the break-up fee and the expense reimbursement, on the
conditions set forth in the BPC offer, was in the best interests of the debtor's estate. At the conclusion of the
hearing, the bankruptcy court entered an order approving both the break-up fee and the expense reimbursement.

On or about Feb. 28, 2003, the committee filed its notice of appeal of the bid procedures order.
Recognizing that the order was not yet a final order, the committee sought leave to pursue an interlocutory appeal.
In that appeal, the committee challenged the break-up fee and expense reimbursements as excessive and also
predicted that the bid procedures approved therein would have a chilling effect on the sale process, preventing other
potential bidders from participating in the sale process.

The district court denied without prejudice the committee's motion for leave to appeal, ruling that to grant
the motion for interlocutory appeal would disrupt the bidding process when the bankruptcy court had already
accepted the debtor's judgment that BPC's bid would actually encourage other bidding.<a href="#22" name="22a">22</a> Moreover, the district
court ruled that the committee's motion for interlocutory appeal was premature, since the effect of the bid procedures
order on the sale process could only be observed after the entire process had reached a conclusion.

On March 21 and 24, 2003, the bankruptcy court conducted a hearing to consider the debtor's request
for authority to sell its assets to BPC and to conduct an auction of those assets in the event that there were
qualified, competing bids. At the hearing, Brascan Corp. (Brascan) presented a late competing bid to
purchase the debtor's assets. As a result of intense negotiations, various parties, including BPC, entered
into a stipulation whereby BPC consented to a reopening of the bidding to accept Brascan's late bid, and
that bid was declared to be the highest and best bid, despite BPC's legitimate objections to the Brascan bid
under the bid-procedures order. In addition, the stipulation provided, as a condition to BPC's consent and
other obligations thereunder, that BPC was to receive the break-up fee and the expense reimbursement from
the debtor, as well as an additional payment from each of BCC and Brascan. Based on the stipulation, the
bankruptcy court declared that Brascan was the successful bidder for the debtor's assets. On or about April
3, 2003, the court entered an order approving the sale to Brascan. The sale order specifically bound a
later-appointed trustee:

<blockquote>
The terms and provisions of...this order shall be binding in all respects upon, and shall inure to the benefit of
Brascan and its affiliates, the debtor and its affiliates, and the successors and assigns of each of the foregoing, any
affected third parties, and any trustee appointed in this chapter 11 case or any subsequent chapter 7 case for the
debtor (emphasis supplied).
</blockquote>

On or about April 11, 2003, the committee filed its notice of appeal from the sale order with the
bankruptcy court. The committee did not seek a stay of the sale order. While the appeal was pending, the sale to
Brascan closed. The break-up fee and expense reimbursement, as well as the additional payments that were due from
Brascan and BCC, were paid to BPC at the closing.

On or about May 13, 2003, the debtor moved to convert or dismiss its case, arguing that, in light of the
sale and current status of the proceedings, it was necessary and appropriate to dismiss or convert the debtor's chapter
11 reorganization to a case under chapter 7. In its response to the motion, the committee argued for dismissal, given
that there "appear[ed] to be no unencumbered assets from which there [could] be a distribution to general unsecured
creditors in [the debtor's] case."

On or about May 22, 2003, following a hearing and arguments of counsel, the bankruptcy court entered an
order converting the debtor's case to one under chapter 7. Following conversion, the trustee obtained an assignment
of claims from the committee's counsel. The assignment purported to transfer "all of [the committee's] right, title
and interest, if any," in the appeal of the bankruptcy court's order approving the break-up fee and expense
reimbursement to the trustee. The assignment was executed several months after the conversion to chapter 7.

BPC moved to dismiss the committee's appeal based on the grounds that the committee had dissolved, the
committee had never had standing to appeal, and the appeal was statutorily and equitably moot. When the chapter 7
trustee moved to substitute himself as the party appellant, in place of the committee, BPC additionally objected on
the basis that the trustee was bound by the sale order and that the assignment was invalid, as it had been given, if at
all, after the dissolution of the committee.

<h3>The District Court Decision</h3>

The district court posed the question on appeal as follows: "What happens to a pending appeal by the
[committee] when the bankruptcy court converts a chapter 11 proceeding to a chapter 7 proceeding during the
appeal?"<a href="#23" name="23a">23</a> Finding that the trustee did not succeed to the committee's interest in the appeal as a matter of law or by
virtue of the purported assignment, the court denied the trustee's motion to substitute and granted Belgravia's
motion to dismiss the appeal.<a href="#24" name="24a">24</a>

The district court first found that the purported assignment of the committee's appellate rights was void,
because "[o]nce the chapter 11 case was converted to a chapter case, the creditors' committee ceased to exist; the
creditors' committee's attorney therefore had no authority to make an assignment, nor did the creditors' committee
have any rights to assign."<a href="#25" name="25a">25</a>

The court next held that the chapter 7 trustee did not succeed to the rights of the creditors' committee as a
matter of law. Rather, the chapter 7 trustee succeeded to the broader rights and responsibilities of the DIP and,
critically to the outcome of this appeal, was bound by agreements made by the DIP and approved by the bankruptcy
court. Thus, when the DIP agreed to pay the break-up fee and expense reimbursement in exchange for the agreement
allowing the late, second bid, and the court approved that stipulation, the later-appointed chapter 7 trustee could not
challenge that stipulation, or the break-up fee, through the vehicle of "succeeding" to the committee's pending
appeal.<a href="#26" name="26a">26</a> As the court stated, "one of the [DIP]'s acts that now binds the trustee is the agreement to [BPC's]
stalking-horse bid."<a href="#27" name="27a">27</a> The court emphasized that the chapter 7 trustee could not fit into both roles at the same time:
"Thus, in his [DIP] hat, the trustee is seeking to maintain the...sale. Yet, the trustee is also trying to wear the
creditors' committee's hat, challenging the bid procedures order—the foundation on which the sale is built. The two
positions are flatly inconsistent."<a href="#28" name="28a">28</a> The court noted that the terms of the sale order explicitly bound the trustee,
while preserving whatever rights the committee had to appeal, suggesting that the trustee could not assert the rights
of the committee.<a href="#29" name="29a">29</a> The court further emphasized that allowing the trustee to attack the bid-procedures order and the
sale order through the back door of the committee's appeal, despite the language of the sale order, would have a
chilling effect on a DIP's ability to make critical agreements during the case, as parties would not know if they
could rely on such agreements, even if approved by the court.<a href="#30" name="30a">30</a> Last, the court noted that the case might have been
different if—as in Rachles—the committee had been pursuing a claim pursuant to derivative standing and thus
acting for the estate, as opposed to challenging a position taken for the estate by the DIP.<a href="#31" name="31a">31</a>

<h3>Implications of the Great Northern Paper Decision</h3>

The decision in Great Northern Paper should provide a measure of comfort to parties dealing with the
DIP, particularly in the case of agreements—such as DIP financing agreements, cash-collateral agreements, bid
protections in asset-purchase agreements and settlement agreements—entered into, with court approval, over the
committee's objection. Such agreements, if properly drafted, will bind a subsequently appointed trustee or chapter 7
trustee upon conversion, even if the committee's rights (to appeal, to challenge security interests, etc.) remain
"open" as of the appointment or conversion. The decision emphasizes the importance of not allowing a subsequent
challenge by the DIP's successor—the trustee—to the DIP's court-approved agreements. The decision also clarifies
the committee's role: The committee represents the constituency of unsecured creditors, not the estate, except in the
case of derivative standing. The committee, upon conversion, is no more, and no entity (except in the case of
derivative standing) "succeeds" to the committee's "rights"—they simply go away.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Board-certified in business bankruptcy by the American Board of Certification. <a href="#1a">Return to article</a>

<a name="2">2</a> See, generally, The Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3rd. Cir. 2003). <a href="#2a">Return to article</a>

<a name="3">3</a> Id. <a href="#3a">Return to article</a>

<a name="4">4</a> In re Great Northern Paper Inc., 299 B.R. 1 (D. Me. 2003). <a href="#4a">Return to article</a>

<a name="5">5</a> See In re SPM Mfg. Corp., 984 F.2d 1305, 1315-16 (1st Cir 1993). <a href="#5a">Return to article</a>

<a name="6">6</a> Id. <a href="#6a">Return to article</a>

<a name="7">7</a> Id. <a href="#7a">Return to article</a>

<a name="8">8</a> Id. <a href="#8a">Return to article</a>

<a name="9">9</a> Id. <a href="#9a">Return to article</a>

<a name="10">10</a> In re AKF Foods Inc., 36 B.R. 288, 289 (Bankr. E.D.N.Y. 1984) (emphasis supplied). See, also, In re Daig Corp., 17 B.R. 41, 43 (Bankr. D. Minn. 1981) ("The committee...will
aid, assist and monitor the debtor pursuant to its own self-interest."). <a href="#10a">Return to article</a>

<big><a name="11">11</a></big> See, generally, The Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery (In re Cybergenics Corp.), 330 F.3d at 568-69. <a href="#11a">Return to article</a>

<a name="12">12</a> See Id. at 566 (citing In re Commodore Int'l. Ltd., 262 F. 3d 96, 100 (2nd Cir. 2001)). See, also, Glinka v. Murad (In re Housecraft Indus. USA Inc.), 310 F. 3d 64 (2nd Cir. 2002);

In re Commodore Int'l. Ltd., 262 F.3d 96 (2nd Cir. 2001); Statutory Committees of Unsecured Creditors v. Motorola Inc. (In re Iridium Operating LLC), 2003 WL 21507196
(S.D.N.Y.); In the Matter of iPCS Inc., 297 B.R. 183 (Bankr. N.D. Ga. 2003). <a href="#12a">Return to article</a>

<a name="13">13</a> See In re Parks Jaggers Aerospace Co., 129 B.R. 265, 268 (M.D. Fla. 1991) (ruling that the creditors' committee in a chapter 11 proceeding is permanently dissolved when the
proceeding is dismissed or converted to a chapter 7 action); In re Kel-Wood Timber Prods. Co., 88 B.R. 93, 94 (Bankr. E.D. Va. 1988) (holding that award of attorney's fees from
the debtor's estate for post-conversion services rendered to creditors' committee was prevented by the dissolution of the creditors' committee upon conversion of the debtor's
chapter 11 case to a case under chapter 7); In re Freedlander Inc. The Mortgage People, 103 B.R. 752, 758 (Bankr. E.D. Va. 1989) (holding that award of attorney fees for
services rendered to creditors' committee was precluded when legal services were performed in the face of imminent conversion). <a href="#13a">Return to article</a>

<a name="14">14</a> See, e.g., 11 U.S.C. §§1107, 1108, 323 and 541. <a href="#14a">Return to article</a>

<a name="15">15</a> See In re S. Rachles Inc., 131 B.R. 782, 785 (Bankr. D. N.J. 1991). <a href="#15a">Return to article</a>

<a name="16">16</a> See Armstrong v. Norwest Bank, 964 F.2d 797, 801 (8th Cir. 1992); Paul v. Monts, 906 F.2d 1468, 1473 (10th Cir. 1990); In re Superior Toy & Mfg. Co., 1994 WL 811537, *2
(Bankr. N.D. Ill. 1994). <a href="#16a">Return to article</a>

<a name="17">17</a> See Armstrong, 964 F.2d at 801. <a href="#17a">Return to article</a>

<a name="18">18</a> In re S. Rachles Inc., 131 B.R. at 785 (chapter 7 trustee succeeded to committee's appeal from adverse ruling in cause of action where committee was pursuing action on behalf
of the estate with standing to do so). <a href="#18a">Return to article</a>

<a name="19">19</a> Spenlinhauer v. O'Donnell, 261 F.3d 113, 117 (1st Cir. 2001). Accord, Kehoe v. Schindler (In re Kehoe), 221 B.R. 285, 287 (1st Cir. B.A.P. 1998); Murphy v. Howison, 288 B.R.
1, 4 (D. Me. 2002). <a href="#19a">Return to article</a>

<a name="20">20</a> Spenlinhauer, 261 F.3d at 117; Kehoe, 221 B.R. at 287. <a href="#20a">Return to article</a>

<a name="21">21</a> Kehoe, 221 B.R. at 287. <a href="#21a">Return to article</a>

<a name="22">22</a> In re Great Northern Paper Inc., 289 B.R. 497, 499 (D. Me. 2003). <a href="#22a">Return to article</a>

<a name="23">23</a> Great Northern, 299 B.R. at 2. <a href="#23a">Return to article</a>

<a name="24">24</a> Id. at 3. <a href="#24a">Return to article</a>

<a name="25">25</a> Id. at 5. <a href="#25a">Return to article</a>

<a name="26">26</a> Id. at 5-6. <a href="#26a">Return to article</a>

<a name="27">27</a> Id. at 6. <a href="#27a">Return to article</a>

<a name="28">28</a> Id. at 6-7. <a href="#28a">Return to article</a>

<a name="29">29</a> Id. at 7. <a href="#29a">Return to article</a>

<a name="30">30</a> Id. <a href="#30a">Return to article</a>

<a name="31">31</a> Id. at 7-8. <a href="#31a">Return to article</a>

Journal Authors

Michael A. Fagone

Robert J. Keach

Journal Date

Monday, December 1, 2003 - 12:00

Bankruptcy Rule

2003