Recent Decisions Regarding Creditors Committees

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Apr 1999

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Section 1102(a)(1) of the Bankruptcy Code directs the trustee in a chapter 11 case to appoint

an unsecured creditors' committee. The Code also provides that the committee must

"ordinarily" consist of the holders of the seven largest claims against the debtor who are

willing to serve on the committee and whose claims are representative of the claims against the

debtor's estate. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §1102(b)</a>. The trustee usually selects committee members from a

list of the debtor's 20 largest creditors that the debtor is required to file with the bankruptcy

court at the time that it files its chapter 11 petition. However, there are no statutorily

established criteria used by the trustee to appoint members of a creditors' committee, and

consequently the criteria vary from jurisdiction to jurisdiction.

When Congress amended

the Bankruptcy Code in 1986 to delegate committee selection to the trustee, §1102(c), which

had authorized bankruptcy courts to change the membership or size of committees was

eliminated. Because the delegation of the selection power to the trustee and the elimination of

§1102(c) occurred at the same time, some courts have concluded that they no longer have the

power to change or modify the size, membership or composition of a creditors' committee

after it has been selected by the trustee. However, other courts have decided that they have the

power to review committee composition, but have differed on whether they can order specific

changes to a committee's composition or whether the matter must be returned to the trustee

for reconsideration.

In 1997, the National

Bankruptcy Review Commission recommended that §1102 be amended again to explicitly

authorize bankruptcy courts to alter the membership of committees appointed by the trustee to

ensure adequate representation. The Next Twenty Years: National Bankruptcy Review

Commission Final Report (Oct. 20, 1997), Recommendation 2.4.8 at p. 455. The commission's

recommendation was incorporated into S. 1301, which the Senate passed 97-1 on Sept. 23,

1998, but which ultimately died at the end of the session. The following recent decisions

highlight the differing views and controversy.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Dow Chemical

Corp., 194 B.R. 121 (Bankr. E.D. Mich. 1996)</a>, the trustee appointed eight attorneys as

members of a tort creditors' committee. The bankruptcy court held sua sponte that the trustee

had improperly constituted the tort committee because §1102(a) specifically requires that the

trustee appoint a "committee of creditors holding unsecured claims," and the tort claimants'

attorneys did not hold claims themselves. As a result, the court entered an order disbanding the

original tort committee appointed by the trustee and directed the trustee to appoint a new

committee made up of persons who actually held claims against the debtor.

On appeal, the district

court reversed the bankruptcy court's order on the basis that the elimination of §1102(c)

precluded review by the court of the trustee's appointment of the tort committee. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Dow

Corning Corp., 212 B.R. 258 (E.D. Mich. 1997)</a>. Siding with the bankruptcy court for the

Southern District of New York, the district court held that the trustee had the sole authority to

appoint members to a committee. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Drexel Burnham Lambert Group Inc., 118 B.R. 209

(Bankr. S.D.N.Y. 1990)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Hills Stores Co., 137 B.R. 4 (Bankr. S.D.N.Y. 1992)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re

Texaco, 79 B.R. 560 (Bankr. S.D.N.Y. 1987)</a>. The district court also held that the bankruptcy

court lacked the authority to sua sponte alter the tort committee's composition.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Mercury

Finance Co., 224 B.R. 380 (Bankr. N.D. Ill. 1998)</a>, the bankruptcy court held that it had the

authority to review the composition of the committee formed by the trustee that included equity

holders and creditors whose claims were based on previously held equity interests. Equity

holders who had been excluded from the committee sought to have the committee disbanded and

reconstituted by challenging the validity of a committee consisting of both equity holders and

creditors. The trustee argued that the bankruptcy court did not have the authority to review the

composition of the committee.

Although the court

acknowledged that the Bankruptcy Code did not grant it specific authority to review the

composition of a committee or to modify membership on a committee, it held that such authority

is implicit in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Rule of Bankruptcy Procedure 2020</a> (providing that the review of trustee

actions by a court constitutes a "contested" matter) and is warranted under a bankruptcy

court's general equitable powers granted by §105(a) of the Bankruptcy Code. Having

determined that it had the authority to review the committee's composition, the bankruptcy

court dissolved the committee, holding that a "blended" committee that consisted of debt and

equity holders was contrary to the plain meaning of §1102.

In a more usual case, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…

re Doehler-Jarvis Inc., 1997 WL 827396 (Del. 1997)</a>, the trustee did not appoint Chrysler

to an unsecured creditors' committee even though Chrysler expressed its interest in serving on

the committee and was purportedly the seventh largest unsecured creditor of the debtor.

Chrysler filed a motion with the district court seeking an order directing the trustee to appoint

it to the committee, or alternatively direct the trustee to appoint Chrysler as an ex officio

member of the committee; they would be given the right to participate in all committee

decisions, but not the right to vote.

The district court held

that with the repeal of §1102(c), there was no statutory authority to order the appointment of

a particular creditor to an official creditors' committee. Nonetheless, the district court held

that if it determined that the committee was not representative of the unsecured creditor body,

it could refer the matter back to the trustee for corrective action or the court could appoint an

additional committee. After considering the selection process used by the trustee, the district

court held that the committee was representative of the unsecured creditor body, and therefore

it did not refer the matter back to the trustee. The court further held that it did not have the

authority under §1102 to appoint Chrysler as an ex officio committee member.

<h3>Committee's Authority to Participate in Appeals</h3>

Section 1109(b) of the

Bankruptcy Code specifically provides that a creditors' committee may raise, appear and be

heard on any issue in a chapter 11 case. However, the Code is silent on a committee's right to

appeal a bankruptcy court decision or participate in an appeal as an appellee. Appellate standing

is generally limited to persons that are "aggrieved" by a court's decision. The "person

aggrieved" standard limits the ability of appeal to those whose rights or interests are "directly

and adversely affected pecuniarily" by the bankruptcy court order. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Silver Wings

Aviation Inc., 881 F.2d 939 (10th Cir. 1989)</a>. Two recent cases concluded that the committees

involved had standing to appeal a bankruptcy court's adverse decision or to participate in an

appeal as an appellee.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Western

Pacific Airlines Inc., 219 B.R. 575 (D. Colo. 1998)</a>, the debtor filed a motion requesting

bankruptcy court approval of a settlement between it and certain third parties. The committee

objected to the settlement on the basis that it was "unfair, inequitable and not in the best

interest of the state." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 577</a>. Notwithstanding the committee's objection, the bankruptcy

court approved the settlement. The committee appealed, contending that the bankruptcy judge

had abused his discretion by approving the settlement based on legal arguments only and by

ignoring the committee's offer of proof regarding the unfairness of the settlement.

One of the settling

parties sought to dismiss the appeal on the basis that the committee would not be directly and

adversely pecuniarily affected because unsecured creditors were not projected to receive a

distribution in the case. Although the bankruptcy court's decision upholding the settlement was

ultimately affirmed on the merits, the district court concluded that the committee did have the

standing to appeal. The court stated that "...creditors' committees serve...a 'watchdog' function

in bankruptcy, and enjoy unique rights and responsibilities under the Code." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 578</a>. A rule

that would preclude a creditors' committee from appealing any decision of the bankruptcy court

in which it lacks a pecuniary interest would interfere with the committee's "watch dog"

function. The court stated that "the purpose of the 'persons aggrieved' standard is to avoid

endless appeals brought by a myriad of parties who are indirectly affected by every bankruptcy

court order. The dismissal of the committee's appeal is not necessary to affect this purpose." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…;

Accordingly, the court declined to dismiss the appeal for lack of standing.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Pacific

Transp. Co. v. Voluntary Purchasing Groups Inc., 227 B.R. 788 (E.D. Tex. 1998)</a>, the debtor

obtained confirmation of its plan over the objections of two railroad creditors (collectively, the

"Railroads"). The Railroads appealed the confirmation of the debtor's plan and filed a motion

with the district court seeking to limit the debtor and the committee, which supported

confirmation of the debtor's plan, to filing one appellee's brief on the basis that §1109(b),

which makes a committee a "party in interest," does not give a committee standing to

participate in an appeal of a bankruptcy court's order.

As an initial matter, the

district court questioned whether the issue raised by the Railroads was one of standing to appeal

since that issue normally arises in the context of a party's standing to take an appeal, rather

than to oppose an appeal. Nonetheless, the court held that the committee met the "person

aggrieved" standard since the plan proposed by the debtor directly impacted the distributions to

the constituents of the committee.

The court also found

support for its decision in the specific language of §1109(b). The court stated that a case does

not stop being a "case under chapter 11" merely because appellate jurisdiction has been

invoked. Therefore, the committee still had standing to "appear and be heard" under §1109(b).

The court also considered §1109(a), which specifically precludes the SEC from the right to

take an appeal. The court stated that:

<blockquote>Given that Congress proved itself capable of limiting a party's appellate rights under

§1109(a), one might reasonably conclude that the absence of such a limitation in

§1109(b) reflects an intent to not proscribe the appellate rights of parties in interest.

In other words, had the drafters of §1109(b) intended that provision to prohibit parties

in interest from appraising and being heard at the appellate stage of a chapter 11 case,

they very easily could have said so explicitly.</blockquote>

<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 793</a>.

<h3>Committees' Standing to Sue</h3>

While almost all of the

court decisions that have considered the issue have concluded that a creditors' committee has an

implied, qualified right to institute a suit, most courts require, as a condition preceding the

initiation of a suit, that the committee obtain prior court approval. The court in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re America's

Hobby Center Inc., 223 B.R. 275 (Bankr. S.D.N.Y. 1998)</a> followed existing precedent in holding

that the committee was not relieved of the requirement that it seek court approval prior to

instituting a lawsuit against the debtor's secured creditor, even where the committee was

subject to specific time constraints within which it could commence such a lawsuit pursuant to

an agreed cash collateral order between the debtor and its secured lender. The committee in

America's Hobby commenced a lawsuit against the debtor's secured creditor shortly before the

deadline for suing without first obtaining court approval. The court was not persuaded by the

committee's argument that the cash collateral order had implicitly granted it approval to

commence its lawsuit by setting a deadline for the commencement of such actions. Nonetheless,

the court granted nunc pro tunc approval to certain counts of the lawsuit based upon the debtor's

inability to bring the action by virtue of its waiver of its right to attack the secured creditor's

liens, the relatively low legal costs that would be incurred in pursuing the claims, and the

strength of the asserted merits of the claims. However, the court dismissed those counts of the

complaint that the court believed the committee was less likely to prevail upon without

prejudice to the committee, demonstrating later that it had a reasonable chance of prevailing on

the one count that the court held was not fatally flawed on its face.

A committee's right to

sue on behalf of a debtor's estate was also confirmed in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Valley Park Inc., 217 B.R. 864

(Bankr. D. Mont. 1998)</a>. In Valley Park, the committee sought authority from the bankruptcy

court to bring fraudulent transfer claims against a number of entities, most of which were

trusts where the beneficiaries were relatives of the debtor's president. One of the alleged

recipients of a fraudulent transfer challenged the committee's standing to sue on behalf of the

estate. The court held that the committee had demonstrated that (1) demand had been made on the

debtor, (2) the demand was declined, (3) the committee had asserted colorable claims that,

based on a cost-benefit analysis, would benefit the estate if successful, and (4) the debtor's

inaction constituted an abuse of discretion. Therefore, the committee was permitted to pursue

the fraudulent transfer claims on behalf of the estate.

<h3>Common Interest Privilege Between Committees and Debtors</h3>

A common interest

privilege has been recognized with respect to communications between debtors and unsecured

creditors. See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Steel Corp. v. Frates, 84 B.R. 202 (Bankr. D. Colo. 1988) cert. denied,

494 U.S. 1004 (1990)</a>. A common interest privilege exists between a creditors' committee and

a debtor where (1) communications are made in connection with a joint defense, (2) the

communications were made to further the joint defense, and (3) the privilege has not been

waived. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. DeNardi, 167 F.R.D. 680 (S.D. Cal. 1996)</a>. The purpose of the common

interest privilege between debtors and committees is to promote their sharing of information.

Without such a privilege, the flow of information between a debtor and a committee would be

hampered, which would make it difficult for a committee to fulfill its duties.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Imperial Corp.,

179 F.R.D. 286 (S.D. Cal. 1998)</a>, the court acknowledged that a common interest privilege

exists between a debtor and a committee, but was unwilling to extend that privilege to the facts

before it. The defendant in a legal malpractice lawsuit sought to discover certain documents from

the plaintiff. The plaintiff asserted a common interest privilege based upon the fact that the

documents were created in furtherance of the debtor's and unsecured creditors' committee

common interests during the debtor's bankruptcy case. According to the court, the interests of

the debtor and unsecured creditors' committee were later merged with the interests of the

plaintiff so that the plaintiff had arguably become the holder of the privilege. The court held that

it would not allow the plaintiff to assert the common interest privilege where the plaintiff had

put certain aspects of the documents requested at issue in the litigation, and where the interests

of the debtor and the committee had been merged with those of the plaintiff. Therefore, the court

granted the defendant's motion to compel the production of the documents.

Journal Authors

John J. Voorhees

Lawrence K. Snider

Journal Date

Thursday, April 1, 1999 - 12:00