The Role of Creditors Committee in Bankruptcy
When a company is under bankruptcy, the question of who will operate the day to day operations of a firm becomes quite important. In most cases, courts allow the debtors to continue to remain in possession of their firms. This is because the general belief is that the people who are have been in control of the business for a long time are better suited to run it over the long term as compared to outsiders who have no experience in managing that particular business. This is why Chapter 11 bankruptcy allows the debtor in possession to make normal business decisions without the approval of the court.
However, in many cases, the creditors believe that the debtors are unfit and hence should not be in charge of the company. This may be the case when the debtors are overly influenced by any external party. This may also be the case when the top management of the firm may have left, and hence it may not be in a position to exercise sound business judgment. In such cases, the court has the power to create a creditors’ committee. This committee is a powerful body and has the authority to have a huge impact on the bankruptcy proceedings.
The details about the importance and powers of the creditors’ committee have been explained in detail in the remainder of this article.
What is a Creditors Committee?
Once the court decides that the company filing bankruptcy is not capable of managing its affairs, it starts approaching the creditors. Bankruptcy courts generally form a creditors committee, which is composed of seven largest creditors to the company. Many times creditors refuse to be a part of this committee. It is then that the opportunity is given to the next creditor.
Once the creditors’ committee is formed, the first task that this committee does is to hire legal counsel. This legal counsel then represents the committee and acts on its behalf. Creditors manage the bankruptcy proceedings indirectly via the legal counsel.
Why Do Creditors Join The Creditors’ Committee?
There are a lot of advantages to joining the creditors’ committee:
- Members of the creditors’ committee often have access to privileged information. When the debtor company is formulating its reorganization plan, it has to share the information with some creditors in order to prove that it makes financial sense. As a result, people on the creditors’ committee end up having access to better information
- Members of the creditors’ committee have the right to investigate the behavior of the directors and officers of the debtor company. If their conduct is found to be unsatisfactory, legal proceedings are brought in against such officers.
- The creditors’ committee has complete control over the debtor’s business. Hence, they are in a position to influence affairs as compared to the vast majority of creditors who are mere bystanders.
- Members of the creditors’ committee also have a say in which professionals are selected in order to revive the operations of the company. Once again, this provides more control, which in turn translates into greater financial benefits for the firm.
Why Do Some Creditors Opt Out Of the Creditor’s Committee?
The creditors’ committee is a powerful body that has informational advantages over the other creditors. Hence, theoretically, every creditor should be interested in being a part of this committee. Yet, in real life, many choose not to become a member. The reasons for this unusual decision have been listed below:
- The creditors who become a part of the creditors’ committee have to bear the cost of the legal counsel. If the firm undergoing bankruptcy, has very few assets, then the chances of recovery are less. In such cases, creditors already know that there isn’t much to be achieved in the form of recovered cash flow. Hence, the upfront outlay of hiring a legal counsel and paying for it seems like a needless charade that can be avoided. This is the reason why some creditors choose against joining the committee
- Also, when a creditor becomes a part of the creditors committee, they have certain fiduciary duties. This means that they cannot brazenly act in their own self-interest. Instead, they are also accountable to other creditors and other stakeholders. If they fail to act in the best interest of other creditors, a lawsuit can be brought in against them. This fiduciary duty is not acceptable to many creditors, particularly vulture funds. They want to continue to pursue their own interests. Hence, they avoid the legal conflict by opting out of the creditors’ committee.
- Lastly, a member of the creditors’ committee also has to face a lot of compliance norms. Other creditors can appoint legal counsel against them if they fail to disclose the right information at the right time. This can make being part of a creditors committee, a tedious and time-consuming affair.
The bottom line is that the creditors’ committee has rights as well as responsibilities. Some creditors’ are attracted towards rights, whereas others want to shun responsibility. This is the reason why some creditors choose to be a part of the creditors’ committee, whereas others do not.
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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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