The Role of Creditors' Committees in CRE Bankruptcies

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LOS ANGELES—The cyclical nature of the real estate industry has resulted in periods where numerous commercial real estate businesses resort to bankruptcy protection in order to survive. Chapter 11 of the Bankruptcy Code has allowed many of these businesses to restructure debt and reorganize. In virtually all chapter 11 cases involving assets of significant value, such as commercial real estate connected with a business operation, an unsecured creditors' committee will be appointed. The committee plays an important role, and gives the creditor-member a significant voice in the case.

The function of a creditors' committee is to assist and monitor the debtor to ensure that the unsecured creditors' views are heard and their interests protected. For instance, if the owner and operator of a hotel or other CRE-related business is in chapter 11 bankruptcy, the role of the creditors' committee would be to investigate the company's affairs and negotiate a chapter 11 plan, which provides for the payment or other treatment of the debt and for whether and how the company will emerge from bankruptcy. This would typically involve determining the viability of the company's management and business plan. If a company's plan were not feasible, the committee could recommend that the company be liquidated, or seek to file its own chapter 11 plan.

Creditors' committees are appointed by the United States Trustee, an agency within the Department of Justice. The UST decides upon the size and composition of a committee, balancing manageability and representativeness. The Bankruptcy Code provides that ordinarily the creditors' committee will consist of the unsecured creditors, willing to serve, holding the seven largest claims. However, the committee may have more or fewer than seven members and a creditor holding one of the seven largest claims does not have an absolute right to sit on the committee. The UST generally solicits participation from the twenty largest unsecured creditors listed in the debtor's bankruptcy petition.

Because many chapter 11 cases require that significant issues be addressed early on, it is important that a creditors' committee be convened as soon as practicable after the committee is appointed. Meetings should be scheduled on a regular basis to allow members to arrange in advance to participate, and the meetings themselves need to be conducted in an efficient manner. Additionally, to be effective, a committee needs adequate and meaningful guidance and representation.

At its initial meeting, the committee will likely consider employing counsel and other professionals, and will ordinarily select counsel at or shortly following the initial meeting. The meeting will likely also address some substantive matters such as whether to seek the appointment of a trustee.

A creditors' committee has several duties and powers. In the case of our distressed CRE business, for example, the committee would have the duty/power to investigate the company's acts, conduct, assets, liabilities and financial condition as well as the operation of the company's business and the desirability of continuing such business. This duty would be most extensive if the company was a debtor in possession and ownership and management were substantially the same. In these circumstances, the investigation will focus not only on issues related to the case's administration and the formulation of a plan, but also on whether management is capable of reorganizing the company.

A committee also has the duty/power to participate in the formulation of a plan. The goal would generally be that the committee negotiates with the real estate company to agree on a plan acceptable to both. Presentation by a committee of its own plan frequently signals that the process has not functioned effectively.

The Bankruptcy Code authorizes a creditors' committee to request that a trustee or examiner be appointed. Grounds for such appointment frequently include fraud, dishonesty, incompetence or gross mismanagement of the real estate company's affairs by current management, or severe conflicts of interest held by current management.

Because members of a creditors' committee represent the creditor class from which they are selected, they have a fiduciary responsibility to protect their constituents' interests. This does not mean the member may not take action independent of the committee's general position, but when acting as a committee member, they must put their constituency's interests first. While committee members can be liable for breaches of fiduciary duty, they are not otherwise liable for actions within their authority as committee members.

Creditors' committee members are able to participate in and help direct chapter 11 cases, including those related to the real estate industry. While being careful to put their constituency's interests first, they play an important role in monitoring the case, investigating, negotiating a plan and/or otherwise determining the case's disposition. Committee members can take satisfaction in knowing that their participation is an important part of ensuring the chapter 11 process works.

David S. Kupetz is a partner with the law firm SulmeyerKupetz, focusing on financial restructuring, business reorganization, bankruptcy and other insolvency solutions and related transactions and litigation. He can be reached at dkupetz@sulmeyerlaw.com. The views expressed here are the author's own.