What is the Role of Creditor Committees in Chapter 11 Bankruptcies?
In Chapter 11 bankruptcies, Creditor Committees are formed to represent the interests of a particular group of creditors and ensure the represented claims are protected.
The Official Committee of Unsecured Creditors (UCC) is often called the “watchdog”, as the UCC has an integral role in monitoring debtor filings and compliance in post-petition operations.
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Under Chapter 11 bankruptcies, the U.S. Trustee holds the responsibility of appointing the committees of creditors and has the authority to appoint additional committees of creditors if deemed necessary. The number of committees affiliated with the restructuring case is directly tied to the prepetition capitalization and the different types of claims on the debtor.
For a committee to receive formal approval and recognition by the Court, the claims being represented must be valid and the holders must have incurred adverse impacts directly connected to the particular interest.
On behalf of their participating members, creditor committees like the aforementioned UCC voluntarily embrace the role of representing the interests of their committee and are entrusted with navigating them through pressing matters.
Official Committee of Unsecured Creditors (UCC)
By actively engaging stakeholders earlier in the bankruptcy, the interests of the grouped creditors are positioned to achieve a more favorable outcome.
The UCC operates on behalf of unsecured creditors and can have an important role in setting the direction of a bankruptcy case.
The formation of the UCC is authorized by the Bankruptcy Code as it would be inconvenient and costly for each unsecured creditor to have separate legal representatives and file individual objections.
Compared to senior secured creditors, the recoveries of unsecured creditors carry considerably more uncertainty of outcome.
This makes collaboration among these unsecured creditors of lower standing paramount to protect their aligned interests.
The general process of appointing representatives for the UCC is as follows:
But while the process generally does follow the structure shown above, it deviates case-by-case. For example, the number of representatives can range from three to seven.
In addition, being one of the seven largest claim holders does not automatically mean selection to be a representative. At the end of the day, it is up to the U.S. Trustee to determine the number of representatives and the specific stakeholders that get to serve.
The creditors being represented are likely bondholders with lower priority in comparison to holders of senior secured debt (e.g., term loans, revolving credit facility).
All “parties in interest” have the right for their matters to be heard as long as the reasoning for the committee has a clear basis – the committee consists of impaired claim holders with commonalities in their claims and the desire to protect specific interests pertinent to each member.
Unlike senior secured creditors, unsecured creditors hold claims without collateral pledged as part of the lending agreement, and thereby have lower priority among the numerous debt tranches in the capital structure of the debtor.
Since unsecured debt claims have no underlying security interests in the assets belonging to the debtor, the recovery rates can vary and are more uncertain, which is why negotiations and proper representation can be a determining factor in achieving a positive outcome.
The committee of unsecured creditors represents claims characterized by:
| Lower Implied Rate of Recoveries |
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| Larger Spread in Potential Range of Recovery Rates |
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| Uncertainty in Treatment of Claims |
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Ad Hoc Committees
Likewise, “ad hoc” committees of creditors can be approved, but the appointment procedure is more informal, as well as the type of participants. As a broad generalization, the ad hoc committee could be defined as a group of stakeholders seeking to collaborate on the shared pursuit involving the protection of similar claims/interests.
Ad hoc committees can often consist of lenders of low-priority bondholders such debt instruments categorized as mezzanine financing, but it can also include distressed debt investors, financial institutions such as corporate lenders, and other claimants.
The takeaway is that any group of stakeholders could join an ad hoc committee to pursue their common interests – and being a member does not suggest lower seniority relative to other unsecured creditors, but rather points towards the existence of a particular interest requiring separate attention. Otherwise, it would remain unaddressed in the official committee of unsecured creditors.
In the majority of cases, an ad hoc committee holds substantially less influence than the official committee of unsecured creditors – although there are exceptions when the committee can play a crucial role in the plan of reorganization (POR).
The ability to offer “value” to the debtor and actively participate in its reorganization could make the ad hoc committee become a pivotal player in the bankruptcy.
J.Crew Chapter 11: Ad Hoc Committee Example
A recent, real-life example was seen in the case of J. Crew’s emergence from Chapter 11.
Anchorage Capital, a prepetition lender and an active member of an ad hoc committee, led the $400mm debtor in possession (DIP) financing credit facility for the struggling clothing retailer, as well as the exit financing required to emerge from bankruptcy.
Contributions of Anchorage Capital to the Chapter 11 Emergence of J.Crew (Source: PR Newswire)
To expand further on how the influence of an ad hoc committee tends to increase directly in tandem with the amount of potential value it can provide to the benefit of the debtor and fulfill its needs, common reasons for ad hoc committees becoming influential stakeholders in Chapter 11 are from the contribution of capital in the form of equity injections, DIP financing, and exit financing.
At the bottom of the capital structure, prepetition equity security holders can also be represented by a committee. The appointment procedure is based on similar standards as unsecured creditors (i.e., the seven most sizable equity stakes). But in practice, the creation of equity committees is a very rare occurrence in Chapter 11.
Creditor Committee Bylaws
If committee members are in a state of disagreement, the establishment of bylaws on the day of formation helps resolve the dispute in a systematic manner that feels fair to all parties involved.
Once appointed by the U.S. Trustee, the creditors’ committee normally holds an organizational meeting, in which a chairperson is selected and the committee rules and bylaws are presented (and discussed) to lessen the risk of conflict and impaired relations caused by internal disagreements.
The chosen representatives of a creditors’ committee, following the approval and appointment by the Court, now have a fiduciary duty to the committee members.
Therefore, the representatives have an obligation to protect their constituents’ interests to the best of their ability and act in “good faith” to avoid conflicts of interest (i.e., actions should be undertaken on the basis of being in the best interests of the represented constituents).
The adoption of committee bylaws can also make meetings more productive, in addition to enabling the committee to reach decisions faster. Considering the high stakes, conflicting viewpoints on the specific actions to undertake are often unavoidable – therefore, risk measures such as bylaws must be addressed prior to the occurrence of any major event in the bankruptcy.
Hiring Professional Representatives
Restructuring, Consulting & Legal Advisory Services
Utilizing the guidance of various professionals, committees can perform their duties and protect their interests more optimally due to the expertise provided.
If Court approval is received, one benefit of committee participation is the creditor committees can hire professionals like legal attorneys, turnaround consultants, and restructuring advisors.
The Bankruptcy Court requires such engagements to be subject to formal approval by the Court after a meeting where all committee members are present.
By virtue of being able to receive advisory services from experts in their respective fields, the guidance from professionals improves the performance of the committee’s duties.
The chosen representatives may engage professionals around the time when committees are beginning to operate to establish them as vital members of the committee from the start. This is because an unbiased opinion can come become necessary in resolving discrepancies among members – allowing the committee to settle disputes and come to decisions based on an objective review from third-party advisors.
Professional Fees: Who Pays for the Services?
One of the reasons why the U.S. Trustee cannot freely approve any committee without justification is because many of these committees intend on employing professionals such as Restructuring Investment Bankers (“RX”), turnaround consultants, accountants, and Legal Attorneys.
The decision on approving or denying the application should be carefully reviewed because the professional fees stemming from the employment of professionals by creditors are paid out by the debtor’s estate, which means the committee members and constituents are not personally liable for the fees related to services they benefit from. Thus, costs determined to be unreasonable or unnecessary by the Court and Trustee should subsequently be denied.
Concerning the treatment of these claims, the fees are recognized as administrative fees and are required to be paid in full to emerge from Chapter 11.
While the debtor pays for legal attorneys and other professionals to advise the UCC, individual unsecured creditors must pay for their own attorneys to be heard in Court.
But despite making a formal recommendation to their members on whether to vote in favor or against the POR, each participating unsecured creditor makes its own independent decision in the voting process.
Responsibilities of Creditor Committees
Debtor Monitoring & Influence on POR Draft
Creditors’ committees act as a “safeguard” to ensure behavior by the debtor is in accordance with the Bankruptcy Code, as well as voicing objections to the inclusion of certain remedies in the POR draft.
The main responsibility of the committee is to make sure each of their decisions is well-informed and to be able to offer more convincing arguments for restructuring remedies favorable to them.
In effect, the successful performance by the creditor committee leads to more recoveries post-emergence from Chapter 11.
From a differing perspective, the responsibility mentioned above can be interpreted as preventing wrongdoings by the debtor (i.e., breaches of bankruptcy laws) and removing unfavorable outcomes currently under consideration to be proposed as part of the reorganization plan.
To provide some examples, the debtor could bring up potentially partaking in distressed M&A such as an asset sale or distressed buyout from a financial buyer.
Once the Chapter 11 bankruptcy continues to progress and negotiations between the debtor and creditor committees representing specific interests are underway, the committees can present their side of the outcome they desire from the reorganization, respond to any initial proposals made by the debtor for the POR, and make any requests to address concerns.
Review of Financial Data of Debtor
The members of creditor committees can obtain highly sensitive, material information – and thus, be amongst the confined list of creditors in possession of the documents before disclosure to the public.
Due to the debtor’s desire to obtain approval from creditor committees, especially those groups consisting of more influential creditors, the debtor often shares more financial information and projections with these specific committees.
The extra documentation shared typically requires the signing of a non-disclosure agreement (NDA) as a considerable portion of the files are related to sensitive information as well as forward-looking projections.
On a confidential basis, the files and insider information shared extend beyond the Court requirements and the data available to the general public (and non-active creditors unaffiliated with any committee).
As a result, the creditors’ committee is able to review the debtor’s solvency based on the assessment of its Credit Metrics, proposed capitalization, and financial projections using more comprehensive data points and information – all received on an earlier date and paving the way for a more detailed review of the financial health and viability of the debtor.
Section 341 Meeting
Referred to as the “Section 341” meeting, creditors are given the opportunity to directly ask the debtor questions regarding the estate of the debtor (i.e., financials, the current balance of assets and liabilities) and for concerns about management’s administration of the case to be addressed in a rather high-pressure meeting for the debtor.
Standard practice for In-Court Bankruptcies, the U.S. Trustee monitors all meetings to make sure discussions remain in compliance with the Bankruptcy Code.
For example, each question asked to the debtor should pertain to the bankruptcy such as its financial performance, the progress made towards reaching an amicable POR, and the conduct by management – as the purpose of the meeting is not to humiliate or coerce the debtor.
One important feature of the meeting is that the debtor is under oath to respond to questions truthfully – which is a legal requirement that applies to all bankruptcies.
Without advance preparation or a script, management must clarify ambiguous or yet to be addressed concerns by the creditor and confirm the accuracy of past statements under pressure.
Creditor Committees: POR & Disclosure Statement
Powers and Duties of Creditor Committees
Clearly, in order to obtain enough votes in favor of the proposed plan as part of the POR Approval Process, a reasonable debtor would:
- File the legally required documentation to receive Court approval
- Provide additional documentation to address valid concerns brought up by creditors during negotiations
The higher the amount associated with the claims of the creditor committee, the more their interests are considered. For instance, if an unsecured claim holder has offered to provide the exit financing to emerge from Chapter 11 – the focus would shift towards appealing to those specific claim holders (but within the legal parameters).
U.S. Bankruptcy Code: Powers and Duties of Committees
Formal Description of the “Powers and Duties of Committees” (Source: Legal Information Institute)
Besides closely watching over the conduct of the debtor, the creditor committee also examines all Prepetition Claims and the coinciding behavior of management to confirm no violations were made.
Examples of misconduct would include:
- Fraudulent Conveyance: The transfer of assets with the intent to harm creditors
- Preferential Repayments: Forms of payment to lower priority creditors that violate the Absolute Priority Rule, or APR (e.g., issuance of payments to Suppliers without Court approval of the Ch. 11 “Critical Vendors Motion”)
These types of occurrences could be very impactful on the relationship and level of trust found among the debtor and its creditors.
In closing, the creditor committee can often hold an instrumental role in drafting the POR and disclosure statement, as well as influence critical decisions like the appointee of a Chapter 11 Trustee or conversion into Chapter 7 Liquidation. But the duties of creditor committees go far beyond participating in negotiations alongside the debtor and contributing to the structure of the POR. The list of tasks also includes monitoring the administration of the case by the debtor in possession, overseeing the day-to-day operations of the estate, and ensuring strict compliance with Court-mandated obligations.
