Basic Introduction to Unsecured Creditors’ Committee

This article is a quick introduction to unsecured creditors’ committees.

When an individual or company files bankruptcy, there are generally two routes it can take (for the purpose of this discussion, Chapter 13, a limited form of reorganization for individuals, is omitted.)

The first route is Chapter 7 liquidation where assets are liquidated for payment to creditors.

A Chapter 7 bankruptcy is structured as follows: a Chapter 7 Trustee is appointed; the trustee is a professional whose job is to maximize the value of the assets (referred to as the Estate) and to pay creditors as much as possible. The Department of Justice oversees the Chapter 7 Trustee. Creditors may participate in this process but since the Chapter 7 Trustee is a professional, experienced and neutral, the role of creditors is limited. They may seek to protect themselves but generally stay out of the Chapter 7 Trustee’s business.

The second route is Chapter 11 reorganization where assets are either liquidated to pay creditors or the company/individual’s debt is restructured and a payment plan is formulated where creditors are repaid some portion of their claims.

The major difference is that upon commencement of a Chapter 11 bankruptcy, a professional trustee is not appointed to the case. The company’s management remains in control as “debtor-in-possession” (called a DIP) with virtually all the powers and responsibilities as a professional trustee. The Department of Justice continues to oversee the DIP but creditors are allowed to, and should monitor the case more closely since the individuals responsible for the company’s financial situation continue to operate it.

Congress realized that if individual creditors each have to monitor the Chapter 11 case, the cost to each creditor will be burdensome. Furthermore, having 150+ creditors’ attorneys in a single hearing would be impractical.

To solve this problem, the Unsecured Creditors’ Committee was invented. The Committee is supposed to represent a cross section of unsecured creditors. However, most of the time, it is comprised of the three to seven creditors who hold the largest claims. The idea is for the Committee to be the voice of all unsecured creditors so smaller creditors are allowed to be committee members if the Department of Justice believes it is proper. Since a committee provides significant judicial economy and operates as an additional watchdog over the Debtor, Congress decided that the Debtor should pay for the Committee’s attorneys, accountants and other professionals.

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