On March 12, 2012, the US Bankruptcy Court for the Northern District of Illinois issued an opinion in the Chapter 11 bankruptcy case of In re ShoreBank Corp. (ShoreBank), ruling that the US Trustee does not need to reconstitute the creditors' committee despite a conflict of interest of certain committee members with the interests of the general body of unsecured creditors.

Section 1102(a)(4) of the Bankruptcy Code provides that courts can order changes to official committees if necessary to ensure adequate representation of creditors or equity security holders. The Court held that speculative arguments that a conflict of interest may lead to future breaches of fiduciary duty and a lack of adequate representation are not enough to warrant reconstituting a committee.

Jointly administered Chapter 11 cases at issue were filed on January 9, 2012. On February 15, 2012, the US Trustee held a meeting to form an official committee of unsecured creditors. Six unsecured creditors expressed interest in serving on the committee:

The US Trustee initially formed a three-member committee consisting of the TruPS creditors and Brown. Before the US Trustee could give formal notice of the committee's formation, Brown resigned. Ultimately the committee was formed with the TruPS creditors and Moore.

The plan proposed several classes of unsecured creditors. Senior note holders were placed in Class 4, Brown, Moore, Gryzwinski and Houghton were placed in Class 5 and the TruPS creditors were placed in Class 6. Under the plan, the TruPS creditors will only receive their pro rata share if the senior note holders in Class 4 are paid in full. The expected recovery of the TruPS creditors is zero.

Moore, Gryzwinski and Houghton (movants) filed a motion with the Court to direct the US Trustee to reconstitute the committee. They argued that the structure of the plan and the committee's makeup gives the committee an incentive to act primarily in the TruPS creditors' economic interest. The movants contended that interest would involve pursuing high-risk strategies because it is the only way the TruPS creditors could receive any recovery on their claims. According to the movants, those high-risk strategies would run the risk of depleting the estate of resources. The committee argued that the movants were not really concerned about adequate representation, but instead about the prospect that it may sue former officers and directors as one of its high-risk strategies.

Section 1102(a)(4) of the Bankruptcy Code provides that courts can order changes to official committees if necessary to ensure adequate representation of creditors or equity security holders. The issue for the Court was therefore whether because of the conflict of interest the membership of the existing committee must be changed to ensure adequate representation of all unsecured creditors.

The Court held that it did not need to order the US Trustee to reconstitute the creditors' committee. In reaching its holding, the Court distinguished between conflicts of interests and breaches of fiduciary duties.

According to the Court, the mere presence of a conflict of interest was insufficient to show lack of adequate representation. The Court asserted that because creditors' committees represent all unsecured creditors and individual creditors inevitably have different interests, conflicts of interests are inherent in any committee. Committees need not be formulated to reflect the exact composition of a creditor body or some perfect equilibrium of creditor interests.

The Court said there must be specific evidence that the committee members with the conflict have breached or are likely to breach their fiduciary duties before a conflict of interest necessitates reconstitution of a creditors' committee. For an arguable case for a breach of fiduciary duties by the TruPS creditors, the Court held that the movants would have needed to show that both:

However, the committee had not yet announced whether it planned to sue former officers and directors and it was far from clear that the theoretical suit would adversely affect the unsecured creditors. The Court ruled speculative arguments of the movants were not enough to warrant reconstituting the committee.

This case highlights several important aspects of creditors' committees, including:

For more information on committees in bankruptcy proceedings, see Practice Notes, Chapter 11 Creditors' Committees and Finance Fundamentals: Ad Hoc Committees v. Official Committees.