Chapter 11

Working Group Proposal #4: Court Review of Appointments to Creditors’ Committees

Prior to the 1986 amendments to the Bankruptcy Code, [ FN: Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986, Pub. L. 99-554.] courts appointed committees of creditors. Now, the U.S. Trustee selects members of creditors’ committees. It presently is unclear whether the Code authorizes a court to review the U.S. Trustee’s committee appointments, and if so, what standard of review is appropriate. Courts have reached disparate conclusions on the issue. A creditor that is not on a committee and is not represented adequately by the committee as constituted might be precluded from effective representation without an opportunity for review. Yet, section 1102(a)(2) permits courts to order the appointment of additional committees to ensure adequate representation and can make this determination de novo, even if inadequate representation might be remedied with less burden to the bankruptcy estate by altering the composition of the existing creditors’ committee.

The Recommendation

The chapter 11 Working Group recommends that the Commission propose the following amendment to section 1102(a)(2):

11 U.S.C. §1102. Creditors’ and equity security holders’ committees

(a)(1) Except as provided in paragraph (3), as soon as practicable after the order for relief under chapter 11 of this title, the United States trustee shall appoint a committee of creditors holding unsecured claims and may appoint additional committees of creditors or of equity security holders as the United States trustee deems appropriate.

(2) On request of a party in interest and after notice and a hearing, the court may order a change in membership of a committee appointed under subsection (a) of this section if necessary to ensure adequate representation of creditors or of equity security holders. On request of a party in interest, the court may order the appointment of additional committees of creditors or of equity security holders if necessary to assure adequate representation of creditors or of equity security holders. The United States Trustee shall appoint any such committee.

Background

In a chapter 11 case under the current bankruptcy laws, the United States Trustee appoints a committee of creditors to represent and protect unsecured creditors in the reorganization process.

Originally under the 1978 Bankruptcy Code, courts were responsible for appointing committees of creditors. [ FN: Under the Bankruptcy Act, creditors selected the members of their representative committees. See , e.g. , 11 U.S.C. §609 ( repealed 1978); 5 Collier on Bankruptcy ¶ 1102.01 (15th ed. 1996).] Courts could revisit their own appointment decisions upon requests of parties in interest and could change the size or membership of committees. [ FN: "On request of a party in interest and after a notice and a hearing, the court may change the membership or the size of a committee appointed under subsection (a) of this section if the membership of such committee is not representative of the different kinds of claims or interests to be represented. " 11 U.S.C. §1102(c) ( repealed 1986).]

When the U.S. Trustee program was initiated on a nationwide basis, courts retained their express authority to consider whether additional committees would be necessary for adequate representation of unsecured creditor or equity interests. [ FN: 11 U.S.C. §1102(a)(2).] A party was authorized to petition the court for the appointment of an additional committee without first pursuing the issue with the U.S. Trustee. [ FN: 11 U.S.C. §1102(a)(1), (a)(2); 5 Collier on Bankruptcy ¶ 1102.02 (15th ed. 1996).]

At the same time, Congress transferred the "administrative task" of the actual appointment of committee members from the courts to the U.S. Trustee. Congress did this, in part, to reduce the appearance of impropriety that sometimes resulted when judges made appointments. [ FN: "Congress intended to ‘separate the administrative duties from the judicial tasks, leaving bankruptcy judges free to resolve disputes untainted by knowledge of administrative matters unnecessary and perhaps prejudicial to an impartial judicial determination. ’ " In re Barney ’s Inc. , 197 B.R. 431, 438 (Bankr. S.D.N.Y. 1996), quoting H.R. Rep. No. 99-764, 99th Cong., 2d Sess. 18 (1986). See also 5 Collier on Bankruptcy ¶ 1102.01 (15th ed. 1996); In re Texaco Inc. , 79 B.R. 560 (Bankr. S.D.N.Y. 1987).] Congress also repealed section 1102(c), the provision that had authorized courts to review their own committee appointments, and did not replace the section with a reasonably analogous substitute.

Therefore, the current statutory provision explicitly permits the court to order the appointment of additional committees to remedy inadequate representation, but it does not explicitly permit the court to take the more modest step of ordering the alteration of the existing committee. To exacerbate the confusion, the Federal Rules of Bankruptcy Procedure provide guidelines for court review of appointments to creditors’ committees that were formedprepetition. [ FN: See Fed. R. Bankr. P. 2007 .] The 1991 Advisory Committee Notes state that the rule was not intended "to preclude judicial review under Rule 2020 regarding the appointment of other committees." [ FN: See 8 Collier on Bankruptcy ¶ 2007.01 (15th ed. 1996). Fed. R. Bankr. P. 2020 provides that a proceeding to contest an act or failure to act by the U.S. Trustee is treated as an adversary proceeding under Rule 9014.] However, neither Rule 2007 nor Rule 2020 can be construed as creating a substantive right where none exists. [ FN: 28 U.S.C. §2075 (Bankruptcy rules shall not abridge, enlarge, or modify any substantive right).]

While ten years have elapsed since the passage of the amendments to section 1102, it remains unclear whether courts can review the U.S. Trustee’s committee appointment decisions. Courts have reached a variety of results. A few courts have held that section 1102 does not authorize court review of creditors’ committees appointments. [ FN: In re Victory Markets Inc. , 195 B.R. 9 (N.D.N.Y. 1996) (dismissing appeal because creditor had no standing to appeal bankruptcy court determination that section 1102 precludes bankruptcy court authority to add creditors to committee); In re Hills Stores Co. , 137 B.R. 4, 8 (Bankr. S.D.N.Y. 1992) (declining to order appointment of subcommittee for subordinated bondholders who already are on committee because Bankruptcy Code no longer authorizes the court to add or delete members of committees by court "except in circumstances not relevant here "); In re Drexel Burnham Lambert Group Inc. , 118 B.R. 209, 210 (Bankr. S.D.N.Y. 1990) (denying request of liquidators to be appointed to committee because Code does not authorize and because liquidators failed to make any allegations of inadequate representation); In re McLean Industries Inc. , 70 B.R. 852, 856, n. 2 (Bankr. S.D.N.Y. 1987) (stating in dicta that court no longer has option to change committee membership). See also In re Gates Engineering Co. Inc. , 104 B.R. 653, 654 (Bankr. D. Del. 1989), in which the court seemed to hold that it was not empowered to review appointments to committees, but same court later referred to this decision as holding that it could review for abuse of discretion under 11 U.S.C. §105(a). In Gates , the state of Tennessee had requested state and local government entities to serve on warranty claimants committee or on a separate government entities committee.] According to this view, the only recourse to remedy inadequate representation would be the creation of an additional committee, which may not be appropriate under many circumstances. [ FN: "Understandably, the courts in Texaco and [Public Service Company of New Hampshire] were concerned with the costs attendant to an additional committee. We share those concerns and in other cases have required separate committees to share accountants. But section 1102(a) provides that inadequate representation is to be addressed by a court through the creation of another committee. That is what Congress wrote. Its words are not to be ignored. Perhaps it should change the statute, perhaps the cost could [be] ameliorated, or perhaps Congress contemplated relief under other statutes not cited or analyzed by the [petitioning creditors]. " In re The Drexel Burnham Lambert Group Inc. , 118 B.R. 209, 211 (Bankr. S.D.N.Y. 1990); In re Victory Markets Inc. , No 95-CV- 1619, 1996 WL 365675 (N.D.N.Y. June 21, 1996).]

Other courts have noted the unreasonableness of imposing the burden and expense of creating additional committees when altering the composition of an existing committee would be asuitable remedy. [ FN: See , e.g. , In re Public Service Co. of New Hampshire , 89 B.R. 1014, 1019 (Bankr. D. N.H. 1988) (declining to appoint additional committee due to expense and adequacy of lesser remedy of expanding existing committee).] The confusion multiplies, however, because these courts have applied different standards in reviewing the U.S. Trustee’s committee appointment decisions. The courts that have applied deferential standards, i.e. "abuse of discretion" or "arbitrary or capricious," have derived their authority principally from section 105(a). [ FN: See , e.g. , In re Barney ’s Inc. , 197 B.R. 431, 439 (Bankr. S.D.N.Y. 1996) (U.S. Trustee did not arbitrarily and capriciously refuse to remove union employees fund from committee upon debtor ’s motion) ; In re Columbia Gas System Inc. , 133 B.R. 174, 175 (Bankr. D. Del. 1991) (denying committee ’s motion to adjourn hearing on gas company ’s motion to be appointed to committee because court is empowered under section 105(a) to review U.S. Trustee ’s decisions for abuse of discretion); In re First Republicbank Corp. , 95 B.R. 58 (Bankr. N.D. Tex. 1988) (U.S. Trustee ’s refusal to remove creditor was not arbitrary and capricious). Section 105(a) provides that the "court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process. "] The courts in these decisions essentially have required that the movant provide substantial evidence that the U.S. Trustee acted arbitrarily and capriciously in its appointment decisions. [ FN: In re Barney ’s , 197 B.R. at 439.]

Some courts have exercised plenary review over the committee composition decisions of the U.S. Trustee. [ FN: In re Sharon Steel Corp. , 100 B.R. 767 (Bankr. W.D. Pa. 1989) (vacating U.S. Trustee notices that undermined court ’s order to reconstitute committee); In re Public Service Co. of New Hampshire , 89 B.R. 1014, 1021 (Bankr. D.N.H. 1988)(ordering U.S. Trustee to appoint debenture holders to committee to provide adequate representation rather than creating separate committee as requested by debenture holders); In re Texaco Inc. , 79 B.R. 560, 566 (Bankr. S.D.N.Y. 1987) (on motion of debtor, ordering that two committees be merged because there no longer was justification for two separate committees). See also In re Dow Corning Corp. , 194 B.R. 121, 133 (Bankr. E.D. Mich. 1996) (dissolving tort claimant committee sua sponte), stay pending appeal denied , 194 B.R. 147 (Bankr. E.D. Mich. 1996), stayed pending appeal , 96 CV-71456 (E.D. Mich. April 4, 1996); In re Plabell Rubber Products , 140 B.R. 179 (Bankr. N.D. Ohio 1992) (court empowered under section 105(a) to review appointments and direct appointment of union to committee).] Because the adequacy of representation is a legal issue, these decisions hold that courts have the inherent power to determine the adequacy of committees de novo, [ FN: In re Texaco , 79 B.R. at 566; In Dow Corning , 194 B.R. at 132 ( "[U.S. Trustee] failed to explain how a request for alteration of a committee can arise other than by a showing that the committee does not adequately represent [creditors]) "; In re Public Service Co. , 89 B.R. at 1020.] and this in no way undermines Congressional intent to delegate administrative or ministerial functions to the U.S. Trustee. Some of these courts have reasoned that the power to order the appointment of a new committee necessarily includes the less drastic remedy of directing the expansion of an existing committee. [ FN: Id. , at 1021.] Moreover, at least one of these decisions has noted that even if the U.S.Trustee constitutes an "agency" under the Administrative Procedure Act, the "arbitrary and capricious" review standards established by that Act are inapplicable to the U.S. Trustee’s informal appointment process. [ FN: See , e.g. , In re Sharon Steel , 100 B.R. at 786; but see Kenneth N. Klee & K. John Shaffer, "Creditors ’ Committees Under chapter 11 of the Bankruptcy Code, " 44 S.C. L. Rev. 995, 1035 (1993) (arguing that formal hearing procedures are not prerequisite to judicial deference to administrative decisions), citing In re Vance , 121 B.R. 181 (Bankr. N.D. Okla. 1990).]

Reasons for the Proposal

The Commissioners who comprise the chapter 11 Working Group agreed that section 1102(a) should be clarified to permit courts to review creditor committee composition to ensure that the committees are adequately representative, just as courts were entitled to do prior to the 1986 amendments. This change would ameliorate unnecessary uncertainty on this important creditors’ committee issue. [ FN: "No issue involving creditors ’ committees has been the subject of as much concern as the ability to alter the composition of a committee. Unfortunately, no other body of law governing creditors ’ committees appears to be in such a current state of disarray. " Kenneth N. Klee & K. John Shaffer, "Creditors ’ Committees Under chapter 11 of the Bankruptcy Code, " 44 S.C. L. Rev. 995, 1032 (1993); see also Daniel J. Bussel, "Coalition-Building Through Bankruptcy Creditors ’ Committees, " 43 U.C.L.A. L. Rev. 1547, 1596, n. 204, 1597 (1996) (noting that access to court review can be important "safety valve " in committee appointment process).] Upon motion of a party in interest and after notice and hearing, a court would render an independent decision on whether the creditors’ committee was adequately representative.

The Working Group implicitly recognized that the establishment and composition of creditors’ committees raise issues that go beyond those administrative responsibilities that fall within the province of the U.S. Trustee. Committee composition invokes a significant question of law, i.e., whether the creditors’ interests are represented adequately by the committee. Although the U.S. Trustee might consider this factor when making committee selections, the U.S. Trustee does not conduct specific or formal procedures and is required to establish only that the potential member is an unsecured creditor and is willing to serve on the committee. [ FN: 5 Collier on Bankruptcy ¶ 1102.01 (15th ed. 1996). While section (b) of 1102 states that the committee "ordinarily " should consist of the seven largest creditors, this language is advisory and non-binding.]

Under these circumstances, the chapter 11 Working Group found that plenary review of the U.S. Trustee’s committee composition decisions would be entirely appropriate. A legal issue such as adequate representation generally invokes de novo consideration by a judicial body. [ FN: In its handbook prepared for U.S. Trustees in 1993, the Department of Justice acknowledged that "the issue of adequate representation is a question of substantive law and may be determined by the court de novo. " U.S. Department of Justice, "U.S. Trustee program; chapter 11 Policy Initiative, " at 97 (March 1993). However, the Department of Justice takes the position that this only refers to the courts ’ power to order the creation of additional committees and that existing committee membership only can be reviewed using the "arbitrary and capricious " standard. Id. See also In re Plabell Rubber Products , 140 B.R. 179 (Bankr. N.D. Ohio 1992) (U.S. Trustee arguing for abuse of discretion standard); accord In re Dow Corning Corp. , 194 B.R. 121, 133 (Bankr. E.D. Mich. 1996), stay pending appeal denied , 194 B.R. 147 (Bankr. E.D. Mich. 1996), stayed pending appeal , 96 CV-71456 (E.D. Mich. April 4, 1996). "Because compliance with section 1102 is a question of both fact and law, a court ordinarily would consider such a matter de novo, relying on its own fact finding and interpretation of the appropriate legal standards. " Kenneth N. Klee & K. John Shaffer, "Creditors ’ Committees Under chapter 11 of the Bankruptcy Code, " 44 S.C. L. Rev. 995, 1034 (1993 ).] Denovo review is the level of scrutiny exercised by courts when they consider the necessity of additional committees, [ FN: "There is nearly unanimous agreement that the bankruptcy court has de novo power to order the United States trustee to appoint one or more additional committees. " In re Dow Corning , 194 B.R. at 129; see also In re McLean Industries Inc. , 70 B.R. 852 (Bankr. S.D.N.Y. 1987), citing H.R. Rep. No. 764, 99th Cong., 2d Sess. 28 (1986). Accord In re McLean Industries Inc. , 70 B.R. 852 (Bankr. S.D.N.Y. 1987) ( "legislative history confirms that bankruptcy judges are to determine de novo, as they had previously, whether an additional committee is necessary to achieve adequate representation).] and the Commissioners on the chapter 11 Working Group perceived it to be the most reasonable standard to apply when considering existing committees. There should not be a presumption of deference when the U.S. Trustee makes no specific findings in any formal procedures as to adequate representation, either with respect to the number of committees or the composition of the committees. This proposal should not be construed as promoting any diminution in the role of the U.S. Trustee; the proposal is consistent with the intent of Congress to vest the U.S. Trustee with responsibility for ministerial matters associated with creditors’ committees while courts retain primary responsibility for legal matters.

Moreover, a review of the case law and commentators’ views indicates that there should be only a nominal difference, if any difference at all, in the expenditure of judicial time and resources between application of the de novo standard and more deferential standards when assessing the issue of adequate representation. [ FN: " There have been few reported decisions demonstrating how the ‘arbitrary and capricious ’ standard applies in the bankruptcy context, or how it differs in application from de novo review. One example of arbitrary and capricious judgment on the part of the U.S. Trustee might be the failure to remove a committee member who has a clear conflict of interest. [citation omitted] However, such a situation probably would lead to the same result under either standard of review. In practice, the distinction between the two standards may be analogous to the difference between evidentiary standards of preponderance and clear and convincing- the difference being shades of gray rather than black and white. " See Klee & Shaffer, 44 S.C.L.R. at 1066, n. 164; see also In re Dow Corning , 194 B.R. at 132 ( "it makes no real sense to say that a court is ‘reviewing the U.S. Trustee ’s action ’ in appointing a committee under one or the other standard of review when the only issue is adequacy of representation, a question which the statute assigns to the court in the first place "). .] It would be difficult for a court to determine if the U.S. Trustee acted arbitrarily and capriciously in refusing to appoint a creditor to a committee without looking at all the facts and circumstances, especially considering that a U.S. Trustee has few procedural restrictions to follow in this regard. In addition, courts could consolidate challenges to committee composition and requests for additional committees, which involve similar, if not identical, legal and factual issues.

Competing Considerations

Most commentators seem to endorse the notion of court review of U.S. Trustee decisions on committee composition. There is some difference of opinion on the appropriate standard of review to be exercised by the courts. Some have suggested that de novo review would give too little deference to U.S. Trustee decisions and would consume substantial judicial time and resources. The Working Group felt that the de novo standard was appropriate because of the underlying legal issues, because the U.S. Trustee would remain responsible for the actual appointment of committee members, and because plenary review would not be significantly more cumbersome for the courts than the abuse of discretion standard. These issues are addressed in the preceding section of this proposal.

Aside from the aforementioned point regarding standard of review, there are some other considerations that commentators might raise. Any opportunity for judicial review increases potential for delay, and consequently for increased costs. Even a specious motion might result in increased costs and would hinder the progress of a case if the court did not address such a motion quickly and definitively. An adequately represented creditor might use the threat of bringing a motion in court to increase its leverage. It also has been argued that a debtor should not be empowered to appeal the composition of a committee because the debtor might only have strategic goals in mind, i.e. a debtor might appeal an adverse decision and request an extension of the exclusivity period on the basis that the debtor does not have a suitably selected creditors’ committee with which it can seriously negotiate a plan. The Commissioners who comprise the chapter 11 Working Group opted not to limit a debtor’s ability to raise issues regarding the composition of committees, reasoning that courts would be able to recognize instances in which review was sought for strategic reasons.

Others might be concerned about the ethical implications of reestablishing court influence over appointments through the proposed review powers. However, the threat of any ethical dilemmas would be constrained by the continuing involvement of the U.S. Trustee in the process. Although courts would have the power to review, they would remain removed from the actual appointment process.