The means by which creditors' committees are composed and the process by which changes are made to the membership of committees have been altered by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The bankruptcy court will have a more significant role in determining the composition of creditors' committees.

Moreover, creditors' committees will be required to disclose information to the constituencies that those committees represent and will be required to solicit and receive comments from creditors in the class represented by the committees. These latter changes will likely alter the current practice regarding delivery of material nonpublic information into the possession of the committee. It is likely that the courts will be required to address the competing policy interests in terms of the disclosure of the information to those creditors who are not on the creditors' committee. The amendments create a high level of complexity and additional costs for committees, and hence, chapter 11 debtors as well.

Committee Composition

BAPCPA will alter the way in which committees are formed. The court has a much more direct role in this process and can order changes to the committee membership and may also order the appointment of a small-business concern to the committee.

A. Judicial Power to Address Committee Composition Issues. Prior to its deletion in 1986, §1102(c) provided for the court to order a change in the membership or size of a committee appointed under §1102(a) if the court determined that the membership of the committee was not representative of the different kinds of claims or interests to be represented.¹ The 1986 amendments that repealed §1102(c) also expanded the role of the Office of the U.S. Trustee in chapter 11 cases and provided that the U.S. Trustee shall appoint a committee of creditors of unsecured claims and may appoint additional committees of creditors or equity security-holders as the U.S. Trustee deems appropriate.² The courts have reviewed the U.S. Trustees' decisions with respect to committee composition issues either de novo or under an abuse of discretion standard.³

BAPCPA now provides explicitly that the court may order the U.S. Trustee to change the membership of a committee appointed if the court determines that the change is necessary to ensure adequate representation of creditors or equity security-holders.⁴ Interestingly, in contrast to the prior version of §1102(c), the amendment does not address, at least explicitly, the issue of the size of the committee, nor does it address whether multiple committees would be appropriate.⁵

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The court has a much more direct role in this process and can order changes to the committee membership and may also order the appointment of a small-business concern...

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B. The Small-business Concern Provision. BAPCPA also adds an interesting wrinkle to committee composition. Pursuant to §1102(b)(1), the U.S. Trustee appoints the committee from the holders of the largest unsecured claims against the debtor.⁶ At times, depending on the pool of eligible committee members, the U.S. Trustee may appoint a smaller or larger committee (although typically an odd number is appointed in order to deal with voting issues and avoid stalemates). A committee will also have to work through the tensions between the holders of public debt and trade creditors, and one of the principal roles of committee counsel is to assist the committee members in working through those tensions and to advocate what is in the best interest of general, nonpriority, unsecured creditors. This can be difficult and may require some diplomacy, especially where committee counsel is "identified" with one particular constituency or another. BAPCPA now adds yet another wrinkle in that the bankruptcy 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" if the court determines that the creditor holds claims of the kind represented by the committee and the aggregate amount of the claims, in comparison to the annual gross revenue of that creditor, is disproportionately large.⁷ This type of creditor usually would not be appointed to a committee and may not have the experience or expertise with respect to the financial issues that come before a committee. This will add to the job of the committee counsel in terms of synthesizing the various points of view of the creditors on the committee and articulating a relatively consensual view to the court (and, as discussed below, to other creditors not on the committee).

Although the statute does not make this explicit, it is likely that the small business seeking to serve on the committee will initially contact the U.S. Trustee and request appointment. If the U.S. Trustee (who likely will consult with the debtors and the committee) does not appoint that creditor to the committee, the creditor would file a motion with the court seeking an order directing the U.S. Trustee to so appoint that creditor to the committee. As a tactical matter, the debtor and the committee may not want to make public their opposition to such a motion as they may have to live with the creditor on the committee going forward. Moreover, assuming there are a number of small-business concerns that are interested, it may be that the race goes to the swift and that there will be some jockeying for position on this issue.

All of this remains to be seen; however, this additional power of the bankruptcy court and the additional complexities raised by the different experience level, agenda and motivation of the small-business concern will add to the tasks of committee counsel.

C. Eligibility Issues. Without question, members of a committee owe a fiduciary duty to the constituencies that the committee represents. In certain cases, the courts have held that competitors may not sit on a committee as they could not discharge that fiduciary duty.⁸ Although at least one court has authorized a partially secured creditor to sit on the committee,⁹ in In re America West Airlines¹⁰ the court found that the U.S. Trustee's removal of a post-petition secured lender was not an abuse of discretion. The U.S. Trustee usually focuses on the ability of a creditor to discharge this fiduciary duty in determining whether to appoint that creditor to the committee.

These eligibility issues loom large in that the provisions of BAPCPA now provide for enhanced priority for pre-petition trade claims, which may reduce the eligible pool of potential committee members. For example, §503(b)(9) has been added to the Bankruptcy Code; it provides for an additional administrative expense priority for "the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor's business."¹¹ Because of the rather significant nature of this relief, one could expect a debtor to litigate the valuation issue in order to minimize what would be an additional administrative expense that would have to be paid at confirmation¹² (or sooner) and may impede the ability of a debtor in a chapter 11 case to obtain exit financing. In addition, §546(c) of the Code has been modified to expand the reclamation period to 45 days before the petition date.¹³ Given the additional administrative priorities for those trade vendors actively doing business with the debtor, a U.S. Trustee may have to do further due diligence with respect to potential trade vendor participants on committees in order to determine whether those trade vendors would have administrative claims that would be in conflict with the interests of general unsecured creditors.

To the extent that the U.S. Trustee does this additional due diligence and excludes from membership those creditors whose claims are entitled to administrative priority, this may shrink the eligible pool of trade vendors or may bias that pool toward those trade vendors who cut the debtor off more than 20 or 45 days before the petition date. Those trade vendors may be more inclined to advocate that the debtor move toward liquidation rather than reorganization. Of course, given the other provisions of the Code limiting exclusivity and the time for debtors to assume or reject leases of nonresidential real property, additional pressures will come to bear that may force more liquidating plans and/or asset sales earlier in the process.

Committee Operations to Change Under New Law

A. Disclosure Obligations. Section 1102(b)(2)(3) has been added to provide that a committee appointed under §1102 shall provide access to information for creditors that hold claims of the kind represented by the committee and are not appointed to the committee. At least two issues arise in the context of this new statutory disclosure directive. First, confidentiality concerns will be paramount as the creditors' committee will possess material, nonpublic information produced by the debtor to allow the creditors' committee to understand the debtor's business plan and reorganization strategy. Second, the disclosure obligation may create issues involving the disclosure of information otherwise protected by the attorney-client privilege between the committee counsel and the committee itself.

In many public-company cases, the debtor will condition the transmission of detailed financial information to the committee on the entry of a protective order and/or the execution of a confidentiality agreement by committee members (and, sometimes, the committee counsel). The debtor's rationale for these conditions is the protection of material nonpublic information from dissemination, and creditors on the creditors' committee will have a fiduciary duty to protect that information. Counsel for the debtor and the committee may well seek guidance from the court at the outset of the case, detailing the method and means by which this disclosure obligation is discharged by the committee. One would expect this request for guidance to include an attempt to deal with the confidential information of the debtor in order to keep creditors from attempting to gain access to this information.¹⁴

Moreover, the courts have recognized the existence of the attorney-client privilege between committee counsel and the committee.¹⁵ The court in In re Baldwin-United Corp. applied a balancing test to determine whether to require the committee to disclose privileged information to the constituent creditors.¹⁶ Diligent committee counsel will request guidance from the bankruptcy court at the outset on this issue to avoid any privilege disputes later in the case.

B. Solicitation and Receipt of Comments. Section 1102(b)(3)(B) adds an additional provision requiring the committee to "solicit and receive comments from creditors" of all kinds represented by the committee. While this certainly occurs on an ad hoc basis through the course of a typical chapter 11 case, this new affirmative duty will require committee counsel to put into place procedures to address the concerns of creditors that are not on the committee. One could see the use of a web page or other electronic media to solicit comments from creditors and to provide information to discharge the disclosure obligation discussed above. Again, one would expect that committee counsel would work with debtor's counsel to seek an order from the bankruptcy court at the outset of the case (to the extent that the case is sufficiently significant), which would include guidance as to the outlines of this particular duty.

Conclusion

Committee operations and composition will change in light of the amendments contained within BAPCPA. The bankruptcy court will be more involved in the process of committee composition, and smaller creditors will now have an opportunity to serve on the committee. In addition, the pool of eligible trade vendors may shrink, thus changing the motivations and dynamics within the committee, which may result in committees being more inclined to seek liquidation of a debtor. Committee operations will be affected as well, as the new disclosure and solicitation requirements will create some tension between disclosure to the committee's constituencies and the maintenance of confidential information reflecting candid discussion of issues between committee counsel, committee members and the debtors.

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Footnotes

¹ 11 U.S.C. §1102(c) (repealed). Return to article

² 11 U.S.C. §1102(a)(1). Return to article

³ Compare In re Sharon Steel Corp., 100 B.R. 767, 785 (Bankr. W.D. Pa. 1989), and In re Texaco, 79 B.R. 560 (Bankr. S.D.N.Y. 1987) (both suggesting that the de novo review is applicable), with In re FasMart Convenience Stores Inc., 265 B.R. 427 (Bankr. E.D. Va. 2001); In re First RepublicBank Corp., 95 B.R. 58, 60 (Bankr. N.D. Tex. 1988), and In re Columbia Gas Sys., 133 B.R. 174 (Bankr. D. Del. 1991) (suggesting that an abuse of discretion standard may apply). See, generally, White, Bruce H., "A Question of Authority: Can the Bankruptcy Court Alter the Composition of Creditors' Committees Appointed by the U.S. Trustees?", 16 Am. Bankr. Inst. J. 22 (July/Aug. 1997). The bankruptcy court in In re Victory Markets Inc., 196 B.R. 1 (Bankr. N.D.N.Y. 1995), determined that repeal of §1102(c) precluded bankruptcy court review of the U.S. Trustee's decision in appointing committee members. Two district courts, sitting as appellate courts, have rejected the argument that Congress precluded a review of U.S. Trustees' decisions by repealing §1102(c). See In re Voluntary Purchasing Groups Inc., No. 4:96CV396, 1997 WL 155407 (E.D. Tex. Mar. 21, 1997); In re Lykes Bros. Steamships Co. Inc., 200 B.R. 933 (M.D. Fla. 1996). Return to article

⁴ 11 U.S.C. §1102(a)(4). Return to article

⁵ With respect to multiple committees, the courts focused on the adequacy of representation of all interests concerned as well as the additional costs involved with multiple committees. See, e.g., In re Sharon Steel Corp., 100 B.R. at 776. Return to article

⁶ See 11 U.S.C. §1102(b)(1). Return to article

⁷ 11 U.S.C. §1102(a)(4). Return to article

⁸ See In re Tri Mfg. & Sales Co., 51 B.R. 178 (Bankr. S.D. Ohio 1985); In re Wilson Food Corp., 31 B.R. 272 (Bankr. W.D. Okla. 1983). But, see In re Map Int'l. Inc., 105 B.R. 5 (Bankr. E.D. Pa. 1989). Return to article

⁹ See In re Seascape Cruises Ltd., 131 B.R. 241 (Bankr. S.D. Fla. 1991). Return to article

¹⁰ 142 B.R. 901 (Bankr. D. Ariz. 1992). Return to article

¹¹ 11 U.S.C. §503(b)(9). Return to article

¹² See 11 U.S.C. §1129(a)(9)(A). Return to article

¹³ See 11 U.S.C. §546(c)(1)(A). Return to article

¹⁴ An alternative would be to require that each creditor receiving such disclosure from the committee execute a confidentiality agreement. This does not appear to be a practical solution, as the committee may need to obtain confidentiality agreements from scores of creditors. Moreover, at some point, nonpublic information may become public notwithstanding the existence of confidentiality agreements where the information is disseminated to a sufficiently broad group of actors in the bankruptcy case. The bankruptcy court will have to address the tension between the ability of the committee to have candid conversations with the debtor and with its counsel and the directive by Congress to provide "transparency" in committee operations. Return to article

¹⁵ See In re Baldwin-United Corp., 38 B.R. 802 (Bankr. S.D. Ohio 1984); see, also, Marcus v. Parker (In re Subpoena Duces Tecum dated March 16, 1992), 978 F.2d 1159 (9th Cir. 1992). Return to article

¹⁶ In this regard, the Baldwin-United court looked to the Fifth Circuit decision in the context of shareholder derivative litigation in Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970). Return to article