Creditors' committees serve an important role in chapter 11 cases. Notwithstanding the fact that committee members are not compensated, they are tasked with serving as representatives and fiduciaries for the general unsecured creditor body as a whole. Among the important functions, and one that is specifically enumerated in §1104(c)(3) of the Bankruptcy Code, is the formulation of a reorganization plan. Committees provide input and are often co-sponsors of a plan. A committee's support, or lack thereof, can determine whether a plan gets confirmed.

Action Against Former Committee Members

Robert A. Mark, Chief Judge of the U.S. Bankruptcy Court for the Southern District of Florida, recently decided Tae Il Media Co. Ltd. v. Maxtor Corp., et al. (the "Tae Il action"). A disgruntled creditor, Tae Il Media Co. Ltd. commenced the Tae Il action in state court against each of the former committee members just a few days short of four years after a plan was confirmed in the main chapter 11 case of Future Tech International, Case No. 99-14707-BKC-RAM. The Tae Il action alleged that the former committee members breached their fiduciary by supporting a plan that was confirmed by the bankruptcy court over Tae Il's objection. More specifically, the complaint alleged that the committee members approved and enthusiastically supported a reorganization plan that (1) impermissibly classified claims, (2) unfairly discriminated against Tae Il and (3) did not satisfy the best-interests-of-creditors test. Based on these allegations, Tae Il asserted that (1) the former committee members owed Tae Il a fiduciary duty, which was breached because the members did not honestly and fairly make determinations giving rise to their support for the debtor's plan and because the committee members made inaccurate and incorrect determinations negligently, and (2) as a result of the alleged breaches of fiduciary duties to Tae Il, the former committee members substantially enriched themselves to the detriment and loss of Tae Il (as well as certain of the several unsecured creditors), entitling Tae Il to damages. The defendant/former committee members removed the Tae Il's action to bankruptcy court.

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A committee's support or lack thereof can determine whether a plan gets confirmed.

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Confirmation of Plan Four Years Earlier

Four years before Tae Il sued the former committee members, it actively participated in the confirmation proceedings and objected to confirmation of the debtor's plan, asserting (1) improper classification of its claim and (2) that the plan (a) discriminated unfairly and was not fair and equitable in respect of its claim, (b) did not meet the best-interests-of-creditors test and (c) was not proposed in good faith.

After a multi-day contested evidentiary confirmation hearing, the bankruptcy court confirmed the debtor's plan. The court specifically found that (1) although creditors in two of the classes voted against and were impaired under the plan, the plan did not unfairly discriminate against those classes of creditors and the treatment of those classes was fair and equitable, as required by the Code; (2) the plan complied with the applicable provisions of the Code; (3) the debtor, as proponent of the plan, complied with the applicable provisions of the Code; (4) the plan was proposed in good faith and not by any means forbidden by law; (5) although the plan discriminated as to certain creditors, including the objecting creditor, the classification scheme had a reasonable basis and was appropriate under the facts and circumstances of the case and therefore the plan satisfied §1122 of the Code; (6) as to each impaired class under the plan, either each holder of a claim in such class has accepted the plan or would receive on account of such claims property of a value, as of the effective date, that is not less than the amount that such holder would receive or retain if the debtor were liquidated under chapter 7 of the Code on such date; and (7) the objecting creditor voted against the plan; however, the plan could still be confirmed because the plan was fair and equitable with respect to the objecting class of creditors and did not discriminate unfairly against these classes of creditors.

Tae Il appealed the confirmation order, but the appeal was dismissed as moot, and Tae Il failed to assert any additional appellate rights.

Committee Members Seek Dismissal of Action

The former committee members filed (or filed joinders to) several motions to dismiss the complaint for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The motions to dismiss collectively made the following arguments: (1) the doctrine of res judicata,¹ also known as "claim preclusion," barred the claims asserted by the disgruntled creditor; (2) the doctrine of collateral estoppel,² also known as "issue preclusion," barred the claims asserted by the disgruntled creditor; and (3) committee members have immunity for actions taken in their role as committee members.

Res Judicata (Claim Preclusion)

Similar to the standards in other circuits, in the Eleventh Circuit, where this action was commenced, a party seeking to invoke the doctrine of res judicata must establish the following elements: (1) the prior decision must have been rendered by a court of competent jurisdiction, (2) there must have been a final judgment on the merits, (3) both cases must involve the same parties or their privies and (4) both cases must involve the same causes of action.³

In this case, the first three elements were conceded. The fourth element, whether the matters involved the same cause of action, was disputed. Tae Il argued that its claim for alleged breach of fiduciary duty was distinguishable from the objections it asserted to confirmation of the plan. The former committee members argued that the creditor's cause of action was premised upon the same legal theories Tae Il advanced in support of its confirmation objections and arose out of the same nucleus of operative facts.

Collateral Estoppel (Issue Preclusion)

In the Eleventh Circuit, a party seeking to invoke the doctrine of collateral estoppel must show that (1) the issue was decided pursuant to a final judgment; (2) the issue at stake is identical to the one involved in the prior proceeding; (3) the issue was actually litigated in the prior proceeding; (4) the determination of the issue in the prior litigation must have been a critical and necessary part of the judgment; and (5) the party against whom the doctrine is asserted must have had a full and fair opportunity to litigate the issue in the prior proceeding. Christo v. Padgett, 223 F.3d 1324, 1338-39 (11th Cir. 2000) (citation omitted).

In this case, the former committee members argued that Tae Il's complaint was nothing more than a collateral attack on the long final order confirming the plan. Tae Il argued that collateral estoppel did not apply since the issue of whether the committee members breached their fiduciary duty was not litigated or decided at confirmation and was therefore not a critical or necessary part of the confirmation order.

Qualified Immunity of Committee Members

The former committee members argued that the acts by the former committee members of which Tae Il complained and their support of the debtor's plan were within the scope of their duties under §1103 of the Code. Section 1103 authorizes a committee appointed under §1102 to "participate in the formulation of a plan [and] advise those represented by such committee of such committee's determinations as to any plan formulated...." 11 U.S.C. §1103. Second, the former committee members argued that the complaint did not and could not allege that the former members' support of the plan constituted misconduct, let alone "willful misconduct," where the plan was confirmed over numerous objections to confirmation asserted by Tae Il and where Tae Il failed to and could not allege that the committee members knew that confirmation of the plan would probably result in an injury to Tae Il. To highlight this point, the former committee members argued that since the court determined that the plan met the best-interest-of-creditors test under §1129(a)(7) of the Code, Tae Il could not be injured by confirmation of the plan (or by the committee's support thereof) because it received at least as much under the plan as it would have received in a case under chapter 7. In addition, the former committee members argued that Tae Il's complaint did not and could not allege that the committee's support of the plan was an "ultra vires activity," since §1103 of the Code expressly authorized the committee to take a position on a plan and to advise its constituents of its position on such a plan.

Bankruptcy Court Dismisses Action with Prejudice

After extensive oral argument and briefing, the court granted the motions to dismiss on the three bases asserted by the former committee members: (1) the doctrine of res judicata, (2) the doctrine of collateral estoppel and (3) qualified immunity.

The court found, among other things, that "[f]atal to Tae Il's claims is the fact that the plan and those portions of i[t], which...supported an alleged breach of [the committee's] fiduciary duty to Tae Il, were vigorously objected to by Tae Il, litigated in front of this court and considered in the confirmation process."⁴ The court went on to recount findings of fact and conclusions of law made in the order confirming the plan as well as its oral ruling on confirmation and found that "[i]n sum, the plan was confirmed after full and fair consideration of all of Tae Il's objections and the confirmation order is final."⁵

The bankruptcy court also found "it to be absurd to believe that [Tae Il] could pursue a claim against committee members for supporting a plan that included [the elements required under the Code] and find it to be a breach of fiduciary duty without [Tae Il] arguing for and seeking to obtain a finding that [Tae Il] was collaterally estopped from seeking, namely a finding that the liquidation analysis was faulty, and so it was not in the best interest of creditors."⁶ The court went on to state, "[b]efore I reject [Tae Il's] argument that the cause of action alleged here could be brought because there is some distinction between wrongdoing based on negotiation efforts as distinct from the confirmation process itself, again, I don't believe that [Tae Il] could prove misconduct in the negotiation which led to the support of these objectionable elements without seeking a finding that they are collaterally estopped from seeking with respect to the elements of the plan."⁷

The court's final basis to dismiss the action was based on a finding that "creditor committee members have qualified immunity for acts within the scope of their duties. In order to overcome this immunity and hold the committee or any of its members liable, a party must show either willful misconduct or ultra vires activity by a committee member...."⁸ The court noted that "[t]he complaint on its face clearly does not allege any willful misconduct or ultra vires acts."⁹ The court went on to adopt the definition of willful misconduct used by the district court in the case of Pan Am Corp. v. Delta Air Lines Inc. (In re Pan Am Corp.), 175 B.R. 438 (S.D.N.Y. 1994), finding that "[w]illful misconduct requires a showing of either the intentional performance of an act with knowledge that the performance of that act will probably result in injury' or 'the intentional performance of an act in such a manner as to imply reckless disregard of the probable consequences' (citation omitted)... Ultra vires actions require a showing that the conduct was engaged in without any authority whatever (citation omitted)." Pan Am, p. 175 B.R. at 514, fn. 66.

The bankruptcy court also cited Collier on Bankruptcy, ¶1103.05[4], p. 1103-32-33 (15th ed. rev. 1996), which states:

Actions against committee members in their capacity as such should be discouraged. If members of the committee can be sued by persons unhappy with the committee's performance during the case or unhappy with the outcome of the case, it will be extremely difficult to find members to serve on an official committee... An active and involved committee is an important part of a chapter 11 case, and if a committee can be intimidated by the threat of legal action seeking personal liability of its members, it will not be able to play its role in the case."

Collier on Bankruptcy, ¶1103.05[4], p. 1103-32-33 (15th ed. rev. 1996).¹⁰ Tae Il appealed the bankruptcy court's dismissal of its action. The district court affirmed the bankruptcy court on all three grounds, and on March 4, 2005, Tae Il further appealed to the Eleventh Circuit, where it is currently pending.

Ramifications and Teaching Points

After prevailing in their efforts to get the Tae Il action against them dismissed with prejudice, the former committee members filed a consolidated application for reimbursement of the fees and costs they incurred in the defense of Tae Il's action, and they sought such fees and costs as administrative expenses of the chapter 11 case. The application was premised on §§503(b)(3)(F) and (b)(4) of the Code as well as the principle of fundamental fairness, which stems from the U.S. Supreme Court case of Reading Co. v. Brown, 391 U.S. 471 (1968), and the line of cases following it.¹¹ Future Tech Liquidating Corp. (FTLC), the successor to the debtor under the debtor's confirmed plan, argued that the fees and expenses were not "incurred in the performance of the duties of the committee" as contemplated in §503(b)(3)(F) of the Code because the fees and expenses were incurred in connection with litigation arising from the performance of the duties of the committee.

The bankruptcy court recognized that this case presented unusual circumstances¹² and was most troubled by the fact that the committee members were sued with respect to actions taken prior to confirmation and almost four years after the debtor's plan was confirmed and after the committee had been dissolved. The court was also troubled by the fact that, to the extent that an administrative expense claim was awarded to the former committee members, the distribution to general unsecured creditors other than Tae Il would be diminished.

The bankruptcy court ruled, however, that the former committee members were entitled to an award of attorneys' fees and expenses as an administrative expense claim in the chapter 11 case pursuant to §§503(b)(3)(F) and 503(b)(4) of the Code. More specifically, the court, focusing on when the actions giving rise to the alleged breach of fiduciary duty occurred, reasoned that the actions complained of by Tae Il stemmed from the execution of the former committee members' duties during the administrative period, and had the action been brought prior to confirmation, the court-appointed counsel for the committee would have defended them and would have been paid by the estate. Tae Il argued that the former committee members were not entitled to an administrative expense claim for the attorneys' fees and costs they incurred in defending the Tae Il Action for two primary reasons. First, Tae Il argued that no administrative expense claim should be awarded because former committee members' defense of Tae Il action did not benefit the debtor's estate. Second, Tae Il argued that the former committee members were not entitled to an administrative expense claim as a matter of law because the expenses they incurred and for which they sought an administrative expense claim occurred post-confirmation. The court rejected both of Tae Il's arguments. As to Tae Il's second argument, the court focused on when the actions giving rise to the claims against the former committee members were taken—in this case, during the administrative period and prior to confirmation, not on when the legal fees and costs were actually incurred.

The bankruptcy court rejected the argument that administrative expenses should be awarded based on the principle of fundamental fairness. The court found that the Reading line of cases was inapplicable, since the cases involved transactions with, or conduct by, a debtor-in-possession (DIP)or trustee.

In the chapter 11 case discussed herein, the court determined that the bankruptcy estate was liable for the fees and costs incurred by the former committee members in defense of Tae Il's lawsuit—nearly four years after the debtor's plan was confirmed. However, the ruling left open the determination of reasonableness of the fees and expenses sought. In addition, the bankruptcy court found that the bankruptcy estate may have a claim (or claims) against Tae Il for the damage caused by it in diminishing the dividend to general unsecured creditors.

In this case, it was fortuitous for the former committee members that the bankruptcy estate was still open and had unencumbered assets four years after confirmation of the debtor's plan. The Future Tech case teaches that it would be wise for committee members and their counsel to insure that the plan and the confirmation order (1) expressly provide for reimbursement to individual committee members that are forced to defend themselves against lawsuits alleging breach of fiduciary duty and the like for actions taken during the administration of the case where there is an ultimate determination that such committee members were not liable; (2) shorten of the statute of limitations (or establish a bar date) for bringing actions against the committee members and require that any such actions be brought in the bankruptcy court; as well as (3) require that lawsuits against committee members must be commenced prior to the making of final distributions in the case. While the suggested plan provisions may not prevent a creditor from suing former committee members, they could save former committee members the expense of defending the litigation if it is brought.

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Footnotes

¹ Res judicata bars parties to a prior action from re-litigating causes of action that were or could have been raised in prior litigation. See Allen v. McCurry, 449 U.S. 90, 94 (1980). A bankruptcy court order confirming a plan is res judicata as to all matters that were or could have been raised in connection with plan confirmation. See Wallis v. Justice Oaks II Ltd. (In re Justice Oaks II Ltd.), 898 F.2d 1544, 1550 (11th Cir. 1990) (citations omitted); see, also, CoreStates Bank N.A. v. Huls America Inc., 176 F.3d 187, 194 (3rd Cir. 1999) (citing Justice Oaks ("The principle of claim preclusion applies to final orders overruling objections to a reorganization plan in bankruptcy proceedings just as it does to any other final judgment on a claim"); see, also, In re Szostek, 886 F.2d 1405, 1408 (3d Cir. 1989) ("[A] confirmation order is res judicata as to all issues decided or which could have been decided at the hearing on confirmation"); see, also, Crop-Maker Soil Servs. v. Fairmount State Bank, 881 F.2d 436, 440 (7th Cir. 1989) ("Public policy supports res judicata generally, but in the bankruptcy context in particular"). Return to article

² Collateral estoppel "prohibits relitigation of any factual or legal issue that was actually decided in previous litigation between the parties, whether on the same or on different claim." Richards v. Public Service Co. of N.H. (In re Public Service Co. of N.H.), 848 F. Supp. 318, 325 (D. R.I. 1994) (citation and quotation omitted). Return to article

³ In re Piper Aircraft Corp., 244 F.3d 1289, 1296 (11th Cir. 2001), cert. denied, 534 U.S. 827 (2000); see, also, Israel Discount Bank Ltd. v. Entin, 951 F.2d 311, 314 (11th Cir. 1992); see, also, Justice Oaks, 898 F.2d at 1550. The court must then determine whether the claim in the new suit was or could have been raised in the prior action; if the answer is "yes," res judicata applies. See Piper Aircraft, 244 F.3d at 1296; see, also, Justice Oaks, 898 F.2d at 1552 (bankruptcy court's order of confirmation "is an absolute bar to the subsequent action or suit between the same parties...in respect of every matter which was actually offered and received to sustain the demand, but also as to every [claim] which might have been presented.") (citation omitted). Return to article

⁴ Transcript of oral ruling on motions to dismiss (hereinafter "transcript"), pp. 81-82. Return to article

⁵ Transcript, p. 89. Return to article

⁶ Transcript, p. 98. Return to article

⁷ Transcript, p. 99. Return to article

⁸ The bankruptcy court cited to Pan Am Corp. v. Delta Air Lines Inc., 175 B.R. 438, 514 (S.D.N.Y. 1994). See, also, Ludeke v. Delta Air Lines Inc., 159 B.R. 385, 392 (S.D.N.Y. 1993); Philip v. L.F. Rothschild Holdings Inc. (In re L.F. Rothschild Holdings Inc.), 163 B.R. 45, 49 (S.D.N.Y. 1994); ABF Capital Management v. Kidder Peabody Co. Inc. (In re Granite Partners LP), 210 B.R. 508, 516 (Bankr. S.D.N.Y. 1997); In re PWS Holding Corp., 228 F.3d 224, 246 (3rd Cir. 2000); In re Dow Corning Corp., 255 B.R. 445, 485 (E.D. Mich. 2000); In re WCI Cable Inc., 282 B.R. 457, 476-77 (Bankr. D. Ore. 2002). Return to article

⁹ Transcript, p. 101. Return to article

¹⁰ See, also, Picciotto v. Schreiber, 260 B.R. 242, 246 (D. Mass. 2001) (noting that "holding an unsecured creditor and member of an unsecured creditors committee personally liable for breach of fiduciary duty to another unsecured creditor would violate public policy, as it would discourage creditors from serving on the committee and would interfere with the committee's activities"). Return to article

¹¹ The Reading line of cases have recognized the bankruptcy court's inherent power to award administrative expenses against the bankruptcy estate based on the principle of fundamental fairness, even where there is no actual benefit to the estate. See, e.g., In re Healthco Int'l. Inc., 310 F.3d 9, 12 (1st Cir. 2002) (awarding litigation costs incurred by successful defendant as administrative expense claim); Yorke v. NLRB, 709 F.2d 1138 (7th Cir. 1983) (damages from failure to bargain with union as required by federal law awarded as administrative expense); In re Met-L-Wood Corp., 115 B.R. 133 (Bankr. E.D. Ill. 1990) (administrative claim awarded for attorneys' fees incurred in successful defense of meritless litigation brought by trustee). Return to article

¹² The unique circumstances presented included (1) the passage of time between confirmation of the plan and the commencement of the lawsuit by Tae Il, (2) request for administrative expenses in the main bankruptcy case by former committee members stemming from an action commenced by a creditor and (3) counsel for the creditor was simultaneously acting as chief executive officer of Future Tech Liquidating Corp., the successor to the debtor under the plan. Return to article