Unsecured Creditors' Committees: What Are They and Should You Participate?

When a company you do business with owes you money and files for chapter 11 bankruptcy, you are a creditor and that company is a debtor. While being an unsecured creditor—with no security interest or claim to a higher payment priority—in a bankruptcy case can make you feel helpless, there are ways to protect your interests. One option is to seek membership on an unsecured creditors’ committee (UCC), which is a group of unsecured creditor representatives of the unsecured creditor body as a whole that has its own professionals and wields influence over nearly all aspects of the case. There are several advantages and disadvantages to consider in determining whether to participate in a UCC, many of which are detailed in this alert.

Unsecured Creditors’ Committee Formation and Eligibility: Section 1102 of the Bankruptcy Code

“As soon as practicable” following the commencement of a chapter 11 case, the United States Trustee (UST) “shall appoint a committee of creditors holding unsecured claims.” Despite this requirement, appointment of a UCC does not always take place. For example, a UCC may not be appointed when there is insufficient creditor interest. Or, in cases filed under Subchapter V of the Bankruptcy Code—a streamlined part of chapter 11 available to certain small business debtors—no UCC will be appointed unless the court for cause orders otherwise.

Typically, within about 10 days after a chapter 11 filing, the UST sends out committee solicitation materials to those that appear on a list of the debtor’s 20 or 30 largest creditors. Creditors outside of that list (such as landlords with contingent rejection damages claims) may also be eligible, and their selection may depend on the interest and nature of the claims of creditors that appear on the list. The solicitation materials include a questionnaire regarding the amount and nature of the creditor’s claim(s). If creditors want to be considered for selection, they must timely fill out and return the questionnaire to the UST.

In most instances, the next step in the process is a formation meeting at which the UST interviews prospective members of the UCC to gather information such as the nature, amount, and validity of the creditors’ claims. The UST will then select creditors—sometimes seven, per the Bankruptcy Code’s guidance, but at other times a different odd number—to serve on the UCC. Members of the UCC are selected to be representative of the general unsecured creditor body as a whole and typically include landlords, vendors, service providers, indenture trustees, unions, governmental bodies like the Pension Benefit Guaranty Corporation, litigation claimants, or all of those listed, although the UST has discretion in the selection process.

Role of an Unsecured Creditors Committee: Section 1103 of the Bankruptcy Code

The purpose of the UCC is to represent the interests of the entire class of unsecured creditors. The UCC’s tasks include consulting with the debtor regarding the case, investigating the conduct and financials of the debtor and its potential go-forward business, helping formulate a chapter 11 plan, and potentially requesting the appointment of a trustee or examiner or the conversion of the case to chapter 7 where a plan process is not viable. In carrying out its statutory role, the UCC serves as a check on the debtor, helps keep the judge and the unsecured creditor body informed and primes the chapter 11 process toward consensus, an aspirational, and sometimes attainable, goal. While the UCC does not control the debtor, its opinion may have significant influence. The UCC can use that influence to motivate the debtor and can often reach agreements or settlements regarding the treatment of unsecured creditors (e.g., the distribution (and timing) of claims and the payment (and timing) of certain priority claims of landlords and vendors), the pursuit or waiver of potential causes of action against the debtor and other parties, and the ultimate case outcome.

Pros and Cons of Participating on a UCC

In deciding whether to seek participation on a UCC, there are a number of considerations at play. One is that UCC members owe fiduciary duties to the unsecured creditor body as a whole—including the duties of care, loyalty, and confidentiality—as opposed to being able to act solely in their own self-interest.¹ However, this obligation does not prevent UCC members from acting in self-interest, as their interests and those of the creditor body often align, but it adds an additional layer to the decision-making process. On the other hand, UCC members are generally granted qualified immunity for matters relating to the performance of their duties and, as a practical matter, are often released or exculpated from matters regarding the debtor and its bankruptcy case under a chapter 11 plan. In rare instances, UCC members may be subject to scrutiny by parties asserting that the UCC and its members did not act in good faith or in the interests of the general unsecured creditor body, but there is a very high bar for liability.²

Some of the most common reasons to participate on a UCC include the increased knowledge of the debtor’s business and industry, input into the bankruptcy case, and receipt of better and more timely information on the case. Debtors are required to share information with UCCs such as a business plan, financial reports, and case and exit strategy, much or all of which is confidential and would not otherwise be shared with unsecured creditors. In order to take advantage of these benefits, UCC members must invest the time required to fulfill their duties. That typically includes attending periodic meetings, reviewing counsel’s recommendations, attending a debtor’s business plan presentation, and participating in negotiating sessions. While certain aspects of UCC participation have normally taken place by phone or video with other aspects in person (e.g., the UCC formation meeting and the business plan presentation), it is likely that in the aftermath of the COVID-19 pandemic more UCC business will continue to be conducted virtually.

Another important consideration for UCC participation is financial. The good news is that the UCC’s professionals (e.g., legal counsel, financial advisors) are paid by the debtor’s estate and expenses incurred by UCC members relating to the performance of their committee duties are reimbursed pursuant to section 503 (b) of the Bankruptcy Code. However, UCC members often have their own counsel as well, since the UCC’s counsel does not represent their individual interests; those fees and expenses are not reimbursed.

Depending on the nature and amount of their claims, the chapter 11 case outlook, and any other relevant factors, creditors should consider participating in UCCs. UCCs play an important role in chapter 11 cases and participating creditors may be able to gain valuable insight into the debtor’s business and industry, influence the ultimate outcome of the case, and potentially the creditor’s go-forward treatment and recovery. Irrespective of whether a creditor is a UCC member, it is critical for a creditor to consult with counsel who can provide guidance through the chapter 11 process and protect the creditor’s rights.

Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts on an ongoing basis to keep clients and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practice Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com, respectively; Robert Wonneberger, partner, at rwonneberger@barclaydamon.com; Kevin Newman, partner, at knewman@barclaydamon.com; or Scott Fleischer, counsel, at sfleischer@barclaydamon.com.  

¹ See Official Comm. of Unsecured Creditors of HH Liquidation, LLC v. Comvest Grp. Holdings, LLC (In re HH Liquidation, LLC), 571 B.R. 97, 102 (Bankr. D. Del. 2017); In re Refco Inc., 336 B.R. 187, 196 (Bankr. S.D.N.Y. 2006).

² See ABF Capital Mgmt. v. Kidder Peabody & Co. (In re Granite Partners, L.P.), 210 B.R. 508, 516 (Bankr. S.D.N.Y. 1997) and “Ex-BigLaw Atty Gets Prison for Conduct in Bankruptcy Case,” Law360, May 7, 2021.