Rogue Committees or Rogue Judges: the Limits of a Bankruptcy Judge's Authority to Disband Chapter 11 Committees

• Publication year: 2019

Rogue Committees or Rogue Judges: The Limits of a Bankruptcy Judge's Authority to Disband Chapter 11 Committees

Mark D. Gensburg

ROGUE COMMITTEES OR ROGUE JUDGES: THE LIMITS OF A BANKRUPTCY JUDGE'S AUTHORITY TO DISBAND CHAPTER 11 COMMITTEES

ABSTRACT

When confronted with a misbehaving chapter 11 committee, bankruptcy courts have a limited list of remedies available to preserve equity. Universally, courts may address committee misbehavior through the disallowance of the committee's attorneys' fees, or through a modification of the committee's membership. The collective acceptance of these remedies was the result of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of2005. However, when these lesser remedies fail, the question of court authority becomes much more divisive. Recently, a split has emerged amongst the courts as to whether bankruptcyjudges have the authority to use the "judicial hammer" of disbanding a misbehaving committee.

This Comment argues that when a committee is engaged in severe misfeasance or malfeasance, bankruptcy judges must have the power to disband the committee. If a court determines that a less severe equitable remedy is insufficient to correct the misbehavior, only then should the bankruptcy judge proceed to disbanding the committee. Employing this Comment's three-factor test, bankruptcy courts can assure that this last resort remedy remains the exception, not the rule.

[Page 602]

INTRODUCTION

Bankruptcy courts are split on judicial authority to disband chapter 11 committees under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA").¹ The issue, although litigated rarely, constitutes a fundamental dispute over the actual authority of judges to control the conduct of litigious parties. In this debate some courts take the position that judges may eliminate committees,² while others ardently argue that Congress has delegated no such authority.³ Yet, the dominant position taken by courts that have mentioned the split is to take no side and to decide their specific cases on other grounds.⁴ As a result, the question of judicial committee disbandment has proven divisive enough to generate a circuit split, important enough to implicate a judge's authority, and daunting enough to force a slew of courts to punt on the issue.

This Comment argues that bankruptcy judges must have the authority to disband rogue committees for misfeasance or malfeasance. The reasons for this are twofold. First, rogue creditor committee misfeasance and malfeasance can unjustifiably harm the debtor-in-possession and the committee's constituent creditors. When a committee breaches its fiduciary duties, it creates an opportunity for the financial abuse of the debtor-in-possession and negatively impacts the return to creditors. Second, the court's 11 U.S.C. § 105(a) equitable powers should extend to disbanding a committee to allow the court to resolve inequities caused by rogue committees. This is evidenced by analogous exercises of § 105(a) court authority and parallels other court issued equitable remedies for party misbehavior. This Comment concludes by offering a three-step factor test to aid bankruptcy judges in determining when a committee ought to be disbanded.

[Page 603]

This Comment begins with a discussion of the history of chapter 11 creditor committees. Such a discussion highlights the goals of Congress in creating creditor committees and demonstrates Congress's thought process in balancing the equities between the debtor-in-possession and the creditors. Then the Comment defines a committee's duties and discusses what effect an abdication of those duties can have on the debtor and on the committee's co-creditors. Next, the Comment briefly describes the old circuit split regarding a judge's authority to modify a committee prior to the passage of BAPCPA which settled that debate in 2005. This is followed by a discussion of the current circuit split concerning the disbandment of a committee. The Comment then clarifies the debate, presents real world examples of rogue committee abuses, offers analogous areas of court authority, and answers the procedural question implicated by judicial disbandment. Finally, the Comment proposes a factor test to resolve the circuit split and provide guidance to the courts moving forward.

I. BACKGROUND

Before deciding the question of a bankruptcy judge's authority to disband a committee, it is necessary to understand the context surrounding the existence of committees and the responsibilities they have been assigned by Congress and the courts. This Section (1) describes the historical origins of chapter 11 committees, (2) discusses the legislative history surrounding modern committees, and (3) precisely defines the duties assigned to chapter 11 committees. This background reveals why Congress allowed committees to emerge, and contextualizes the misbehavior of committees that courts have disbanded.

A. Origins of Chapter 11 Committees

In a typical bankruptcy proceeding there are three represented parties. These parties are the debtor, the creditors, and the U.S. Trustee.⁵ Each of these parties play a unique and independently essential role in a bankruptcy proceeding. Typically, creditors solely bear the responsibility of advocating for their own financial interest.⁶ In doing so, creditors' duties are wide ranging, including objecting to property being classified as exempt from the estate.⁷ On the other

[Page 604]

hand, debtors must cooperate with the U.S. Trustee as is necessary for the trustee to perform his or her statutory duties.⁸

These "typical" bankruptcy proceedings are either chapter 7 or chapter 13 filings. In 2016, of the 833,407 total bankruptcy filings, 825,587 were either chapter 7 or chapter 13 filings.⁹ As such, 99.06 percent of bankruptcy petitions filed in 2016 were under chapter 7 or chapter 13. In these cases, the creditors, debtor, and U.S. Trustee each play their usual roles and have their normal responsibilities.

Statistically, chapter 11 filings are rare, accounting for only 0.88 percent of all bankruptcy filings.¹⁰ Importantly, in a chapter 11 case, the interested parties to the litigation are different, and their roles are unique, from that of the typical bankruptcy. These parties to a chapter 11 proceeding are the debtor-in-possession and the creditor committees.¹¹ Unlike in a chapter 7, a chapter 11 debtor remains in possession of his/her/its property. The debtor-in-possession steps into the shoes of the trustee by administering the property of the estate.¹² While there are still creditors in a chapter 11, these creditors uniquely have the opportunity to form committees.¹³

Creditor committees are created by the U.S. Trustee and normally consist of seven of the debtor's largest creditors.¹⁴ The responsibilities of the creditor committee are varied, but generally require acting in the interests of the constituent creditors represented by the committee.¹⁵ To fulfill these duties, creditor committees may hire attorneys, accountants, or any other agents who would aid the committee in performing these aforementioned duties.¹⁶ Importantly, the cost of hiring these professionals is considered an

[Page 605]

"Administrative Expense" and, to the extent allowed, must be paid in full by the debtor-in-possession prior to confirmation of the plan.¹⁷

Creditor committees began to see regular use in 1934 after Congress passed § 77B of the Bankruptcy Act. This allowed a two-thirds majority consensus of each creditor class to force the adoption of a repayment plan that scaled down the debtor's obligations.¹⁸ This provision created a wave of gamesmanship between creditors that precipitated the advent of "insider" committees of creditors.¹⁹ These "insider" committees worked with debtors to create coalitions of creditors that could force "insider favorable" plans through to confirmation.²⁰ In response to these "insider" committees, "protective" committees formed to negotiate with, and act as a check on, the "insider" committees.²¹

This remained the case until the Chandler Act of 1938. The Chandler Act created chapter X and chapter XI as two separate forms of business reorganization.²² Chapter X was intended for large businesses and, in response to the gamesmanship of § 77B, eliminated "insider" creditor control by the appointment of a disinterested trustee.²³ Chapter XI, on the other hand, was intended for small businesses, allowed for the debtor to remain in possession, and provided for the creditors to jointly elect a committee to represent their interests.²⁴

The creation of protective committees for non-insider unsecured creditors was a necessary maneuver due to the realities of bankruptcy disbursements. According to the Administrative Agency of U.S. Courts, between 1965 and 1968 creditors received sixteen percent of the total amount of claims on debtor assets in liquidation bankruptcies.²⁵ Of this, secured creditors received sixty-six cents on the dollar despite accounting for only eleven percent of allowed claims.²⁶ Priority unsecured creditors, accounting for only nine percent of claims,

[Page 606]

recovered thirty-five cents on the dollar.²⁷ Yet, unsecured creditors, who accounted for eighty percent of all claims on estate assets, received only seven cents on the dollar.²⁸

This dramatic discrepancy was not unique to liquidation bankruptcies, and indeed was similarly present in corporate reformations. According to a Brookings Institute report, in chapter XI reorganizations roughly sixty percent of an average corporation's debt was issued by unsecured creditors.²⁹ Despite this, secured creditors were paid eighty percent of the time and recovered thirty-one cents on the dollar.³⁰ Priority creditors recovered thirty-six percent of their claims, yet non-priority unsecured creditors only managed to get forty-four percent of their claims categorized as allowed claims.³¹ Of these, unsecured creditors only received a meager eight...