Today's headlines are full of stories of corporate glut and abuse by officers and directors. Officers and directors are more often the subject of class action lawsuits based on corporate mismanagement, whether negligent or intentional. Often, such claims are without merit, and the officers and directors are taking the heat for industry-wide problems. Other officers and directors have helped themselves to the corporate coffers and purchased homes, golf courses, jets and small islands.

These extravagances are in addition to a typically enormous salary. And considering the millions of dollars of compensation already paid, it is hard to sympathize with the unfunded pension account and/or unpaid severance package.

Because of the circumstances surrounding their termination, such officers and directors may have large unsecured claims against their former employers. These claims stem from a variety of matters, including personal loans, unfunded severance packages and/or tort claims. Often such claims are quite large, placing them in the 20-largest unsecured creditors. As such, when committees are formed, a U.S. Trustee might appoint a former officer and director to the official committee of unsecured creditors. In fact, some former officers and directors have sought and obtained such appointment despite the U.S. Trustee's initial reluctance.

Apparently, some debtors take issue with their former fiduciaries' service on an official committee. These ungrateful debtors take issue with their former fiduciaries' special knowledge and insight, and even question the motives of former fiduciaries that serve on official committees. And due to the questionable motivations of some fiduciaries, one court has recently held that former officers and directors are not appropriate for service on an official committee of unsecured creditors.

Committee Formation

In drafting the Bankruptcy Code, Congress intended for unsecured creditors to have a role in a chapter 11 case. See 11 U.S.C. §§1102 and 1103. To give unsecured creditors a louder voice, Congress enacted provisions for the establishment of a committee of unsecured creditors. See 11 U.S.C. §1102. Pursuant to §1102(a)(1), the U.S. Trustee may form one or more committees of creditors. Such committees should include creditors with substantially similar claims, choosing among the largest of those creditors with such claims. See 11 U.S.C. §1102(b)(1).

After formation, the U.S. Trustee retains administrative authority over committee members. See 11 U.S.C. §1102(a)(1); see, also, In re First RepublicBank Corp., 95 B.R. 58, 60 (Bankr. N.D. Tex. 1988); In re Barney's Inc., 197 B.R. 431, 438-39 (Bankr. S.D.N.Y. 1996). As such, issues and disputes concerning committee membership, including removal for cause, are properly directed to the U.S. Trustee. See First RepublicBank., 95 B.R. at 60.

In fact, Congress intended for the U.S. Trustee to determine the removal and/or addition of committee members after formation as evidenced by the 1986 repeal of §1102(c). See Barney's, 197 B.R. at 438-39. Section 1102(c) authorized the bankruptcy court to change the membership or size of a committee if it determined that the existing committee members did not represent the different kinds of claims to be represented. See 11 U.S.C. §1102(c) (repealed); see, also, In re Salant Corp., 53 B.R. 158 (Bankr. S.D.N.Y. 1985). As part of the expansion of the U.S. Trustee program, Congress intended to sever much of the administrative duties in a bankruptcy case, such as the formation of creditors' committees, from judicial tasks. See Barney's, 197 B.R. at 438-39; citing H.R. Rep. No. 99-764, 99th Cong., 2d Sess. 18 (1986), reprinted in 1986 U.S.C.C.A.N. 5227, 5230.

In fact, the only express provisions for a bankruptcy court's review of a committee is for committees whose members were chosen prior to the petition date. See Fed. R. Bankr. P. 2007. Nonetheless, most courts have held that the U.S. Trustee's decision regarding committee formation and membership remains subject to review by the court's equitable powers granted by 11 U.S.C. §105(a). See In re Venturelink Holdings Inc., No. 02-80906-SAF-11, 2003 WL 22229410 (Bankr. N.D. Tex. Sept. 2, 2003); citing First RepublicBank Corp., 95 B.R. at 60. However, the court is not to substitute its judgment, but instead review the U.S. Trustee's actions to determine whether the U.S. Trustee acted arbitrarily and capriciously. See Venturelink, 2003 WL 22229410, at *2; citing In re Fas Mart Convenience Stores Inc., 265 B.R. 427, 431 (Bankr. E.D. Va. 2001); First RepublicBank, 95 B.R. at 60.

Among the various arbitrary and capricious actions that a U.S. Trustee may take is the refusal to remove a committee member that is also a former fiduciary of the debtor. See Venturelink, 2003 WL 22229410 at *2-3.

Venturelink Holdings

In Venturelink, the U.S. Trustee, at the urging of certain unsecured creditors, appointed an official committee of unsecured creditors. Among the members appointed to the committee in this multi-debtor, jointly administered case was a former officer of one debtor who was also a former director of certain other debtors. This officer was one of the largest unsecured creditors, asserting claims for payments due under an unfunded severance agreement, as well as a personal loan.

The debtors requested removal of the officer, asserting that the former officer and director had received millions of dollars in cash, as well as a house in Mexico, just prior to the petition date, but the U.S. Trustee refused. Instead, the U.S. Trustee expanded the committee by adding new members. Unsatisfied, the debtors sought relief from the bankruptcy court. The bankruptcy court determined that §105(a) empowered the bankruptcy court to review a U.S. Trustee's formation and/or addition and/or removal of members of a committee for arbitrary and capricious actions. Id. at *2.

In making its determination, the bankruptcy court took note of the status of current affairs in the bankruptcy community. Specifically, the court commented on the numerous high-profile cases where the actions of current and former officers and directors were the focal point of the bankruptcy case. Id. at *3.

In addition, since a committee will necessarily analyze the performance of both current and former officers and directors, an inherent conflict exists. Id. Indeed, a former officer/director will "tend to steer a committee's focus away from their performance," if at all possible. Id. Similarly, a committee will also scrutinize the receipt by officers and directors of large sums of money in connection with their positions, and the natural tendency of any person is to retain that money, potentially to the detriment of other creditors. Id.

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[O]ne court has recently held that former officers and directors are not appropriate for service on an official committee of unsecured creditors.

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Additionally, pursuant to Bankruptcy Rule 2004, current and former officers and directors are frequently a source of information for creditors regarding the administration of the estate. Thus, the conflict inherent in discovering information from oneself for the benefit of all creditors is unavoidable. Id.

Consequently, the fiduciary nature of the officer or director's former employment is at odds with the fiduciary duty that committee members owe their constituents. Id. While not all conflicts are disqualifying conflicts, which the bankruptcy court defined as those that call into question the creditor's ability to honor his fiduciary duty to all unsecured creditors, conflicting fiduciary duties create a disqualifying conflict. Disqualifying conflicts also include the appearance of a breach of that fiduciary duty, as the bankruptcy process must both be fair and appear fair. See Id.; citing In re Allied Texas Invs. Inc., No. 389-30056-SAF-11, 1989 WL 265432 at *1 (Bankr. N.D. Tex. Oct. 16, 1989).

Based thereon, the bankruptcy court held that a "U.S. Trustee would act arbitrarily and capriciously if he refused to remove a committee member who held a conflict of interest amounting to a breach of the fiduciary duty owed by the creditors to the creditors represented by the committee or who appeared to hold such a conflict." Id. Thus, as a matter of public policy, a former officer or director of a debtor should not be a committee member. Id.

Conclusion

Certainly, most officers and directors that are appointed to a committee act with the best interests of their constituents, and in full compliance with their fiduciary duties. Some, however, have ulterior motives such as revenge against their former employer, or in directing attention away from potential D&O claims and causes of action.

While Venturelink appears to be the only case of its kind, surely more will follow. With the current status of matters, and the daily news of wrongdoing by management, another former officer/director will find his/her way on to a committee while his former employer screams foul play.