To the bankruptcy practitioner, it comes as no surprise that the telephone has been ringing off the hook lately. Distressed companies, trade creditors, bondholders, shareholders and indenture trustees have been scrambling for legal and financial representation. The onslaught may become even more feverish than the most recent cycle dating back to the late 1980s and early '90s, when airlines, oil and gas, heavy industry and retailing were most severely hit. Law firms have been realigning their groups clamoring for "franchise players." Financial advisors have likewise beefed up their staffs with highly talented professionals with significant bench strength by the way of big-time MBAs.

So what else is new, (other than formalities like amendments to the Bankruptcy Code)? How about the committee, (the general unsecured variety)? This is an ever-evolving entity. Personal experience as an indenture trustee (team members have participated on more than 50 committees over the last 10 years) has shown that public debt bankruptcies have varied significantly in their committee make-up. Most notably is the participation by the professional institutional investor. Before discussing this creditor type, it may be helpful to understand the indenture trustee's perspective.

The indenture trustee's approach is shaped in large part by the Trust Indenture Act of 1939 (TIA), as amended. The TIA provides minimum standards by which an indenture trustee administers a debt obligation. Indentures are crafted in such a way so that all actions required of the trustee prior to a default are specifically defined. It is generally agreed that most of the complications begin post-default. Because no two defaults or their circumstances are exactly alike, the TIA does not specifically define the post-default role of the trustee. It does, however, impose the "prudent person" standard upon the trustee.¹ Against the backdrop of this standard, the indenture trustee might often determine that participation on the committee is, in most cases, appropriate. Accordingly, experienced indenture trustees are quite comfortable seeking membership on committees and thereafter assuming an active role.

Armed with an understanding of the indenture trustee and its role, consider the issuing entity's source of funds. The institutional investor must consider a myriad of issues in determining whether to serve on the committee. The indenture trustee, and for that matter all creditors, must appreciate the fact that many of these considerations are unique to each investor, thus making the "unbiased" representation of all bondholders somewhat difficult. Among these issues, in no particular order, are:

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...each institutional investor must assess a number of variables in determining the extent of its role on each creditors' committee for each defaulted debt instrument within its portfolio.

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• size of the investor's holdings
• bank groups and other competing stakeholders (trade, senior, junior, equity)
• conflicts of interest
• cost basis
• prospects for recovery
• value of collateral, if any
• management competence, integrity and motivation
• knowledge of the debtor's business
• litigation
• restrictions on trading
• other investors willing to serve and balance of interests on the committee
• district where the debtor filed
• the investor's overall fund performance and the filing's impact
• pre-existing bondholder committees
• access to information

If, after having considered the foregoing, the decision has been made to join the committee, you're off to the races—and another whole article!

Deciding not to participate creates a situation where the institutional investor does not have access to the committee's professionals. Or does it? How long is a professional's work product considered to be privileged? Can the investor have conversations with committee professionals? Given that formally appointed committees have a duty to represent the entire unsecured class of creditors, do these same professionals and committee members have any obligation to discuss the case with investors who are not on the committee? This would require lifting the heavy blanket of confidentiality that covers the process—an outcome not at all common and generally not done without a court hearing.

Sources of information available to the institution that elects not to join a committee (or, for that matter, any institutional investor) are:

• publicly filed financial statements (which are frequently postponed or terminated)
• business plans that become public by virtue of their inclusion in disclosure statements or plans of reorganization (rare)
• press releases by the debtor or creditors' committee (not common)
• monthly operating reports (generally not detailed enough to be useful)
• debtor or committee professional's work product that becomes public information (very rare)
• conversations with committee members, the debtor or professionals representing either constituency (risky).

So does the value of participating on a formal committee make sense?

Experience has shown that:

1. Investors willing to serve are scarce.
2. None of them wishes to be restricted in trading their bonds, and the time commitment is substantial.
3. Without sufficient bondholder participation, trade creditors frequently are disproportionately represented. They can have quite different objectives.
4. Below-par investors are more active in seeking representation than original par holders. For better or worse, their interests, like those of trade creditors, are often radically different than the "par" investor.
5. Without strong creditor committee representation, debtors sometimes prolong the bankruptcy in order to shelter themselves from the demands of debt service, adverse litigation and removal by stockholders and creditors.
6. The bankruptcy process is adversarial by its nature. Weak committees and their professionals can get "steamrolled" by management, equity and creditors.

According to Herb Stiles of T. Rowe Price, "Generally speaking, most investors experienced in the bankruptcy process would conclude that the creditors' committee role is essential. The question remains 'Who should serve?' The U.S. Trustee, to whom the responsibility falls to select an effective and unbiased creditors committee, often has little to work with. Committee members perform a public service by agreeing to serve the required long hours without compensation."

In the end, each institutional investor must assess a number of variables in determining the extent of its role on each creditors' committee for each defaulted debt instrument within its portfolio. Only then will the portfolio manger be able to decide whether the value makes sense or, perhaps more accurately said, does the value make cents?

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Footnotes

¹ Landau, Corporate Trust Administration and Management, Columbia University Press, New York (1985), at 22. Return to article