Although the Bankruptcy Code is silent with respect to the right of a creditors' committee to file an adversary proceeding, almost all of the courts that have considered this issue have been unanimous in recognizing that such a right exists. However, most courts have required that the committee obtain prior court approval as a condition precedent to the initiation of suit. A debtor may have a number of valid reasons why it believes that a suit should not be instituted, particularly within the context of a reorganization. These reasons, however, must be balanced against the creditors' interests in recovering property of the estate, which implies that the committee must establish some "benefit to the estate" in pursuing the claims. Assuming bankruptcy court approval, there have been few challenges to the committee's institution of suit.

Creditors' Committee Standing to File Adversary Proceedings Refined

In a recent case, In re Together Development Corp.,¹ the debtor and the creditors' committee entered into a stipulation authorizing the committee to institute preference and other claims against the debtor's principals. This arrangement was approved by the bankruptcy court after proper notice. After the committee filed suit, the defendants filed a motion to dismiss, contending, among other things, that the Supreme Court's decision in Hartford Underwriters Ins. Co. v. Union Planters Bank N.A. (the Hen House case),² which conferred standing to recover a surcharge under §506(c) of the Code only on "the trustee," precluded the committee from continuing to prosecute its action.

The bankruptcy court, in rejecting the defendants' argument, noted that the Supreme Court, in a footnote to its Hen House opinion, stated that it was not addressing the issue of allowing other parties to act on the trustee's behalf under provisions other than §506(c). Bankruptcy Code §§1103(c)(5) and 1109(b) allow bankruptcy courts to pragmatically deal with conflicts arising between insiders and corporate bankruptcy debtors. Secondly, the court stated that the situation where a creditors' committee had brought an action could be distinguished from Hen House. In the former instance, the action was being brought on behalf of all creditors, not merely on behalf of a sole creditor seeking a recovery for its own benefit. Finally, the court concluded that to hold that only a "trustee" could bring an action would allow insiders to easily manipulate the bankruptcy process to limit their own exposure. Such manipulation, the court reasoned, would run contrary to the "utilitarian, time-tested process which has evolved in bankruptcy law and under the Bankruptcy Code in order to ensure that appropriate lawsuits proceed in cases where debtor's counsel has some reason not to pursue all potential assets of the estate due to a conflict of interest, be that conflict real or perceived." The court asserted that the creditors' committee must guard against "gaps" created by conflicts of interest in the handling of the debtor's estate.

In In re Commodore International Ltd., et al.,³ the Second Circuit Court of Appeals considered the standing of a creditors' committee to institute an adversary proceeding where foreign liquidators had approved and stipulated to the committee's action, and the bankruptcy court had initially granted its approval. The liquidators of two Bahamian corporations, which had also filed for chapter 11 protection in the United States, originally consented to an order authorizing the unsecured creditors' committee to file suit against the debtor's former officers to recover substantial funds that had allegedly been improperly transferred to them. The debtor's former officers then contended, in the Bahamian court, that the liquidators had breached their statutory duties by authorizing the U.S. creditors' committee to institute suit against them. Upon a determination by the Bahamian court that the liquidators had breached their statutory duties by authorizing the creditors' committee's suit against the former officers, the liquidators instituted an almost identical suit against the same defendants in the Bahamian court.

The defendants then sought to dismiss the suit instituted by the creditors' committee, contending that, based on the decision in In re STN Enterprises,⁴ a creditors' committee only has standing to sue when the debtor unjustifiably fails to bring suit or abuses its discretion in not bringing suit. The creditors' committee contended that it had standing based on the debtor's consent and bankruptcy court approval. The bankruptcy court held that the liquidator's subsequent suit acted to divest the creditors' committee of standing to pursue claims against the debtor's former officers. On appeal, the Second Circuit concluded, in a matter of first impression, that a debtor-in-possession may stipulate to the institution of litigation by an unsecured creditors' committee "so long as the bankruptcy court exercises its judicial oversight and verifies that the litigation is indeed necessary and beneficial and in the best interest of the bankruptcy estate." The court said "this approach permits a reasoned and practicable division of labor between the creditors' committee and the debtor-in-possession or trustee, while also providing the bankruptcy courts with significant authority both to manage the litigation and to check any potential for abuse by the parties." The court reasoned that, since the liquidators in Commodore had instituted suit, the creditors' committee action was no longer "necessary and beneficial" to the estate, and accordingly, the case was dismissed.

Commodore is troubling since it did not require the bankruptcy court to revisit its earlier decision in light of the liquidator's change in position. The mere existence of the initial stipulation indicates that the liquidators originally believed that the creditors' committee could more effectively pursue the litigation. The bankruptcy court should have been directed to determine whether continuing the creditors' committee's suit was "necessary and beneficial to the estate." The committee's suit, for example, may have been more beneficial to the estate by including counts that were absent from the liquidators' suit. Further, the creditors' committee's suit may have been ready for trial, while the liquidators' suit may not have been. The liquidators' trial preparations may have been duplicative and may have unnecessarily diminished the estate. The Commodore court should have remanded the matter to the bankruptcy court to determine which party's suit, considering all the circumstances, was in fact more beneficial to the estate and allowed that party to proceed.

Nature and Extent of a Committee Member's Fiduciary Duty

While case law clearly recognizes that a member of a creditors' committee owes a "fiduciary duty" while performing his or her committee responsibilities, recent court decisions have articulated the nature and extent of that fiduciary duty and to whom the fiduciary duty is owed.

In Westmoreland Human Opportunities Inc v. Walsh,⁵ a chapter 11 trustee of a nonprofit housing facility instituted suit against a member of the unsecured creditors' committee. The trustee contended that the committee member's failure to disclose its status as the successor recipient of the debtor's grant from the Department of Housing and Urban Development constituted a breach of that member's fiduciary duty, resulting in liability of that member in the amount of $135,000. The committee member had defended the suit on the basis that it did not violate its fiduciary duty since the interest in the grant relationship was not property of the debtor's bankruptcy estate. The Third Circuit Court of Appeals, after an extensive discussion, concluded that while the debtor's grant relationship was not property of the estate, that fact alone was not an absolute defense to the charge that the committee member had breached its fiduciary duty. The court remanded the case to determine whether the member's failure to disclose the existence of the interest in the grant relationship to either the bankruptcy court or to the creditors' committee materially undermined the ability of the bankruptcy court to take the grant relationship into account in formulating a comprehensive chapter 11 plan for the debtor's reorganization.

In Picciotto v. Schreiber,⁶ an unhappy unsecured creditor instituted a proceeding against participants in an earlier bankruptcy case, including counsel for the unsecured creditors' committee and a member of the unsecured creditors' committee. The unsecured creditor contended that those parties had breached their fiduciary duties to the creditor. In dismissing the action, the court held that committee members and counsel for the committee owe no fiduciary duty to any specific unsecured creditor. The court stated, in a footnote, that "...holding an unsecured creditor and member of an unsecured creditors' committee personally liable for breach of a 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."

In In re Dow Corning Corp.,⁷ the district court considered not only the nature of the fiduciary duty owed by a member of a creditors' committee, but also the propriety of plan provisions that released the committee members from liability for any actions undertaken as a member of the committee. The court, citing from several cases, held that the fiduciary duty required of a creditors' committee member extends to the class of unsecured creditors as a whole and not to its individual members. The court stated that creditors' committee members have a qualified immunity from suit that corresponds to and is intended to further the performance of the committee's statutory duties. To overcome the immunity, the party alleging a breach of fiduciary duty must prove that the committee or committee members engaged in willful misconduct or in "ultra vires activities." The court found that no evidence of any misconduct had been introduced.

Committee Member Legal Fees Disallowed

In First Merchants Acceptance Corp. v. J.C. Bradford & Co.,⁸ the Third Circuit Court of Appeals considered whether the 1994 amendment to §503 of the Bankruptcy Code allowed a creditor to obtain administrative expense reimbursement for professional services performed by its personal counsel with the knowledge of, and at the request of, the committee's counsel and members of the committee. The court held that the plain meaning of §§503 (b)(3)(F) and 503(b)(4) expressly permits a member of the creditors' committee to recover reasonable compensation for professional services incurred in its capacity as a member of the committee. The court noted that §503(b)(4) authorized claims for attorneys' and accountants' fees incurred by all entities who are allowed to claim administrative expenses under §503(b)(3). The court held that, under the plain meaning of the statute, a member of a creditors' committee was a §503(b)(3) "entity" entitled to recover as administrative expenses its actual and necessary expenses.

In response, the trustee argued that a plain meaning interpretation of the statute would allow committee members to retain, in effect, private committee counsel without prior review by the court and without notice to the committee or other creditors. The court, while admitting that there was a "potential for abuse," discounted the trustee's argument by reasoning that the bankruptcy court would retain its "power to ensure that only those fees that are demonstrably incurred in the performance of the duties of the committee...are reimbursed." The bankruptcy court, as required by statute, must in each case conduct a review of the fee application to determine whether the fee was reasonable and whether the services were necessary.

In light of the holding in First Merchants Acceptance Corp, it might be imagined that lower courts in the Third Circuit would be more likely to approve legal fees submitted by individual members of the creditors' committee. In practice, however, lower courts appear to be taking the view that such fees are almost never reasonable or necessary. In In re Worldwide Direct Inc.,⁹ for example, the court found that, in the absence of unusual circumstances, it would be "difficult to conclude that it is necessary for committee members to hire individual counsel to assist them in the performance of their duties as committee members when committee counsel and other committee professionals are available to assist them." The court stated that performing a committee task by a professional retained by an individual member might be justified where there was a conscious and restricted division of labor that would not result in inappropriate duplication of effort. In such a case, the fees incurred by counsel for the members would be a necessary expense of the committee.

Some other courts have disagreed completely with the holding in First Merchants. In In re First Plus Financial Inc.,¹⁰ for example, the court held that fees of an attorney for an individual member of a creditors' committee were not compensable despite the language in §503(b)(4) because they were for services that solely benefited the creditor and did not benefit the estate or the committee. While acknowledging that the literal language of §503(b)(4) appears to permit such a result, the court stated that the Supreme Court has made an exception to the "plain language" construction tool in rare cases where the "literal application of a statute will produce a result demonstrably at odds with the intention of its drafters, and those intentions must be controlling." To hold otherwise would unduly burden the debtor and decrease the return to creditors. Relying on the same legislative history that the Third Circuit refused to consider in First Merchants, the court held that Congress did not intend in the 1994 amendment to the language of §503(b)(4) to include the expenses and fees of an attorney that may be hired by each individual member of the committee in addition to the fees and expenses awarded to the committee's counsel.

Committee Counsel Legal Fees Incurred Before Appointment of Unsecured Creditors' Committee Allowed

In In re S.W.G. Realty Assoc. II L.P.,¹¹ a law firm filed an involuntary chapter 7 petition on behalf of certain creditors. Subsequently, the debtor successfully moved to convert the chapter 7 case into a chapter 11 proceeding. Eventually, the same law firm received court approval to represent the creditors' committee. After the debtor's reorganization plan was approved, committee counsel filed an application for allowance of fees charged throughout the course of its representation of the creditors. The application included fees for services connected with the involuntary filing and other work done prior to the conversion to chapter 11 and the formation of the creditors' committee.

The debtor argued that §330, the Code provision that authorizes the payment of fees to attorneys who represent the creditors' committee, only contemplates the payment of fees for services rendered to the creditors' committee in connection with the performance of the committee's functions. The debtor argued that it was impossible for the committee counsel to collect fees for services before the committee was formed. However, the court, following Third Circuit precedent, held that under the proper interpretation of §330, the test is not whether the services rendered benefitted the committee, but rather whether the services rendered were for the benefit of the estate. Here, the court accepted the applicant's reasoning that, but for counsel's initiation of the bankruptcy proceedings, the estate would not have existed and no creditor would have received relief.

Release Provisions in Plan Approved

In In re PWS Holding Corp.,¹² the Third Circuit considered the propriety of release provisions in a debtor's plan, which released committee members and their professionals from any liability except for willful misconduct or gross negligence. Two creditors appealed the order confirming the reorganization plan, which included provisions releasing committee members. They contended that the inclusion of the release violated §524(e) of the Bankruptcy Code. Section 524(e) provides that a debtor's proceeding does not affect the liability of a third party for a debtor's debt. The court, applying current interpretations of §1103(c), which grants the committee broad authority to formulate a plan and provide "such other services as are in the interest of those represented," held that creditors' committee members have a fiduciary duty to committee constituencies and to committee members that gives them a limited grant of immunity from claims arising from actions within the scope of their duties. As a result, the liability of a committee member is limited to willful misconduct or ultra vires acts. This limited immunity protects committee members and the entities that provide services to the committee in the event that they are sued for their participation in the reorganization plan. The court found that the contemplated release did not affect the liability of another entity on a debt of the debtor within the meaning of §524(e). In fact, the release provision in the debtor's plan was no more expansive than that suggested by §1103(c). As a result, the court concluded that the release in the debtor's reorganization plan was proper and outside the scope of §524(e) of the Code.

In In re Dow Corning, supra, the court also considered whether it could approve release provisions in a debtor's plan. The court, using the same statutory interpretation suggested by PWS Holding Corp., approved release provisions pertaining to attorneys' activities on behalf of a tort claimants' committee. The court concluded that it had the authority to approve release provisions for committee members since any claims against the committee would most likely give rise to indemnification or contribution claims against the debtor. These claims, the court reasoned, would implicate the debtor's assets. Therefore, court approval of committee release provisions was justified.

The U.S. Trustee's Power to Appoint Committees

In In re Pacific Gas & Electric Co.,¹³ the U.S. Trustee (UST), in addition to appointing an Official Committee of Unsecured Creditors, appointed an Official Committee of Ratepayers in order to protect the interest of the utility ratepayers and give them a voice in the chapter 11 proceeding. Shortly after, the debtor filed a motion to vacate the appointment of this committee. The trustee argued, under §1102(a) of the Code, that the court lacked the authority to review the trustee's discretionary appointment of the ratepayers' committee.

The court, following the majority view as elaborated in In re Pierce,¹⁴ held that despite the fact that it lacked specific statutory authority to review the trustee's discretionary committee appointments, it had general authority, under §105(a), to review the trustee's appointment under an abuse-of-discretion standard. The court reasoned that appointments by the trustee, an administrative officer, must be reviewable in some manner, otherwise "there would be no means for judicial review of the UST's actions, even if the UST exceeded her authority and acted contrary to law."

The court, interpreting §1102(a), the Code provision granting the trustee the power to appoint committees, held that the ratepayers were not "creditors holding unsecured claims" as contemplated under that provision. The court noted that a "creditor," under §101(10), is an entity that has a "claim against the debtor that arose at the time of or before the order for relief." Here, the ratepayers had no claim on the petition date that could justify the creation of a creditors' committee composed of ratepayers. The ratepayers were not "creditors" for §1102(a) purposes, therefore, their appointment to a creditors' committee was an abuse of discretion by the trustee.

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Footnotes

¹ 262 B.R. 586 (Bank. D. Mass. 2001). Return to article

² 530 U.S., 120 S.Ct. 1942, 147 L.Ed. 2d1 (2000). Return to article

³ ___F. 3d ___, 2001 WL 897138, (2nd Cir. 2001). Return to article

⁴ 779 F. 2d 901 (2nd Cir. 1995). Return to article

⁵ 779 F. 2d 901 (2nd Cir. 1995). Return to article

⁶ 260 B.R. 242 (D. Mass. 2001). Return to article

⁷ 255 B.R. 445 (E.D. Mich. 2000). Return to article

⁸ 198 F.3d 394 (3rd Cir. 1999). Return to article

⁹ 259 B.R. 56 (D. Del. 2001). Return to article

¹⁰ 254 B.R. 888 (N.D. Tex. 2000). Return to article

¹¹ 265 B.R. 534 (E.D. Pa. 2001). Return to article

¹² 228 F.3d 224 (3rd Cir. 2000). Return to article

¹³ Bankruptcy Case No. 01-30923DM, Memorandum Decision Regarding Motion for Order Vacating Appointment of Committee of Ratepayers (May 18, 2001). See Resnick, Alan N. and Scheler, Brad Eric, "From the Bankruptcy Courts, Limitations on the U.S. Trustee's Power to Appoint Committees: Lessons from PG&E," From the Bankruptcy Courts, 34 UCC L.J. 215 (2001). Return to article

¹⁴ 237 B.R. 748 (Bankr. E.D. Cal. 1999). Return to article