Finding a pocket for payment when your corporate customer files chapter 11: A creditors' committee's right to sue the debtor's principals. (Legal Corner).

Your new customer, a family-owned corporation, to whom you have made a six-figure credit sale files Chapter 11 bankruptcy. The debtor's statement of financial affairs reveals several significant payments by the debtor within weeks of the bankruptcy filing to the company's officers and family members for supposed payback of loans and special bonuses. It appears that the proceeds from the sale of your company's inventory went to the debtor's family members as extraordinary payments-and not to repay your open account.

Upon a Chapter 11 filing, the debtor company's principals retain their positions and are permitted to continue to operate the business and attempt to restructure the financial obligations. However, the principals do not operate unrestricted. In Chapter 11, an official creditors' committee is appointed (usually) which has various duties and powers and has the right to investigate--and sue--the debtor's principals in certain jurisdictions.

Your company is scheduled by the debtor as holding one of the 20 largest unsecured claims. You receive a Creditors' Committee Solicitation Form from the Office of the United States Trustee (OUST) inviting your company to serve on the creditors' committee. You complete the form and the OUST appoints your company to serve on the creditors' committee, and you are designated to serve as the company's representative.

You raise the issue of the extraordinary payments made to the debtor's insiders with the creditors' committee, and they agree to investigate. What is the creditors' committee's next step? In a recent bankruptcy court ruling', the court spelled out a creditors' committee's right to sue the debtor's principals after the debtor had failed to do so.

Appointment of the Creditors' Committee

Upon the filing of a bankruptcy petition, payments to unsecured creditors are suspended. Vendors pursuing payment must suspend their collection efforts. Because a typical Chapter 11 bankruptcy often involves hundreds, sometimes thousands, of unpaid vendors, many of whom hold claims of relatively modest amounts, a creditors' committee is an efficient device to represent these interests. The creditors' committee deals with the debtor in a more manageable fashion than would be possible if each vendor represented itself. Additionally, the creditors' committee ensures representation of smaller vendors who would otherwise be unable to effectively participate in a bankruptcy case. The bankruptcy estate comprises the assets and liabilities of the Chapter 11 debtor.

Powers of the Creditors' Committee