Creditors Committee Liability Revisited

Creditors Committee Liability Revisited

Journal Issue: 
Column Name: 
Journal Article: 
This column in the March 1997 ABI Journal discussed the potential liability facing creditors’ committees, limited immunity and whether it was feasible to address these concerns by way of insurance. Limited immunity has been attacked through various means, including a committee’s willful misconduct and ultra vires activities. The bankruptcy community has seen an increasing (and disturbing) trend in the lawsuits filed against committees, causing bankruptcy professionals once again to examine the potential for mitigating a committee’s exposure to litigation.

Recently, the U.S. District Court for the Northern District of California1 In re Paradigm Technology Inc. 94-52142 MM (N.D. Cal. 1996) in the sale of stock held for the benefit of the creditors, and ultimately for not recovering as much as the plaintiffs believed could be recovered. This allegation was made even though the unsecured creditors received in excess of 125 percent of their respective claims as a result of the sale of certain stock pursuant to the confirmed plan of reorganization for which three of the four plaintiffs voted. Furthermore, the plan included a grant of limited immunity for the committee members.

Despite what most would classify as an excellent performance, in negotiating both a pre-bankruptcy plan and a confirmed plan of reorganization, this committee became embroiled in costly litigation. The litigation took more than a year to complete, and more than $150,000 was spent on attorneys’ fees on the committee’s behalf. The cost of the litigation further points out the problems inherent in a potentially litigious situation that is not properly provided for at the outset. In this case, the committee requested indemnification from the debtor company, which declined, leaving the committee and its counsel to bear the ongoing costs. Ultimately the debtor company voluntarily contributed just less than half of the costs, but by then the relationship between the parties involved was severely strained, to say the least.

What about limited immunity? The district court opinion addressed the role of the committee as a fiduciary and limited immunity. "At the same time §1103(c) gives rise to ‘an implicit grant of limited immunity.’" In re Drexel Burnham Lambert Group Inc., 138 B.R. at 722. (Bankr. S.D.N.Y. 1992 and quoting In re Tucker Freight Lines Inc., 62 B.R. 213, 216 (Bankr. W.D. Mich. 1986).2 This immunity "corresponds to and is intended to further, the committee’s statutory duties and powers." Pan Am Corp. v. Delta Air Lines Inc., 175 B.R. 438, 514 (S.D.N.Y. 1994).3 The court also noted that

a release of liability may also be included in a plan of reorganization so long as it is consistent with §1103. (Cite omitted). Here, the confirmed plan contains a release provision insulating the committee from liability unless the committee’s actions amount to gross negligence or willful misconduct. By preserving liability for willful misconduct, this provision maintains the proper balance between the fiduciary obligations and the implicit immunity of §1103(c).4

The real issue here is whether the committee could have foreseen the potential of the litigation and what more it could have done to protect its members. The short answer is nothing, because at the time this litigation commenced, there was no vehicle available by which to transfer the remaining risk to a third party. Clearly, the committee acquitted itself well and incorporated the appro-priate protections in its plan, yet it was forced to endure the cost, uncertainty and strain of serious litigation.

Virtually all the costs associated with bankruptcy proceedings ultimately become the creditors’ burden. First, they have to have suffered a loss to find themselves in a bankruptcy setting; their respective exposures must be sufficient to warrant them sitting on a committee; then the creditor must allocate resources to act as a fiduciary for all creditors by serving on the committee and negotiating a recovery for the affected creditors. Finally, as in this instance, the committee must monitor the post-confirmation process to maximize the ultimate recovery for the creditors. If creditors are to be exposed to the additional burden of litigation in addition to all of the above, how could one reasonably expect anyone to be willing to serve on a committee?

Reorganizations under the Bankruptcy Code are premised upon the involvement of creditors’ committees to safeguard the interests of the creditors at large. It is difficult to imagine a better result by an unsecured creditors’ committee, yet it became the target of attack. The question remains, therefore, what is available to protect the committee and encourage participation? The Paradigm Technology committee made use of all the remedies available within statute and case law, and still remained vulnerable. It appears that insurance is the only protection that would have assisted the committee in this instance. Based on the reactions at the recent ABI Winter Leadership Conference to the forum discussion on creditors’ committee liability issues, this is a concept that is catching on.

The issue is, if limited immunity and plan provisions are not enough, how will we protect those willing to serve on committees, and continue to encourage the participation upon which the process depends? The same mechanism by which nearly every person reading this article presently protects him or herself from professional liability may be the answer: insurance. In this instance, for significantly less than just the debtor’s contribution to the costs, all parties could have benefited. The committee could have continued to function without the anxiety associated with finding itself under attach with no protection; the debtor company could have maintained a more productive relationship with its significant creditors; and the committee’s counsel could have focused on the reason it was retained in the first place, rather than spending its time defending a lawsuit. Insurance may not be the cure-all for every issue facing committees, but it could remedy the liability problems they face. At the very least it is an additional tool for creditors’ lawyers and committee counsel to ensure active participation by creditors in the bankruptcy process. That participation is important and necessary.


Footnotes

1In re Vasconi & Associates Inc. et. al. v. Credit Managers Association of California, et. al., Cal. Bankruptcy Court Rptr., Vol.1, No. 5, page 102. Return to Text

2Id. at 104. Return to Text

3Id. Return to Text

4Id. Return to Text

Journal Date: 
Sunday, March 1, 1998