Chapter 11 Examiner When Why What and How Part I
The high-profile filings of WorldCom and Enron have brought the position of examiner to the forefront of interest in bankruptcy. This article focuses on the basics of examiners, including their appointment and duties, and suggests ideas for making a successful examination for the estate.
Chapter 11 provides for the intervention of independent third parties when the need arises.2 If the need is present, a bankruptcy court may appoint either an examiner or a trustee.3 Which one is appointed will depend on what is requested, the particular facts of the case and what creditors and other equity security-holders seek to accomplish.4
The examiner position has similarities to a trustee,5 but it also has several important differences. The trustee position is well known in bankruptcy, particularly because of its use in chapter 7. While a trustee is required in chapter 7, it is considered extraordinary for a trustee to be appointed in chapter 11 because of the importance of the debtor-in-possession (DIP), whose knowledge of the troubled business is usually critical to the success of the reorganization. If chapter 11 is filed by a business and a trustee is appointed, the trustee will usually take control of the business, thereby displacing the DIP. Therefore, one of the most important differences is the chief role of an examiner, which is to act as an investigator and reporter but not a manager.6 If the court appoints an examiner, the debtor is not displaced and continues to remain in control of his business.7 Allowing the debtor to remain in control encourages troubled businesses to file for reorganization, as opposed to liquidation, while there is still something left of the business to salvage.8
Another difference is the nature of an examiner's position, which is "unique and has evolved over time."9 In In re Baldwin United Corp., the Ohio bankruptcy court described the examiner's position as "unlike that of any other court-appointed officer" in that
His findings do not have the binding effect on the court or parties of those of a special master, arbitrator or magistrate; nor do they have the evidentiary character of an opinion by a court expert... An examiner performs the investigative duties of a trustee and may perform other trustee duties as the court directs, but he stands on a different legal footing than a trustee.10
The court can mold an examiner's duties to fit a particular case. The examiner can be ordered to simply investigate the debtor's conduct, or the duties can be expanded to include prosecuting actions on the estate's behalf or mediating between the parties. This flexible role results in the examiner being able to effectively assist in the reorganization because he is specifically tailored to the needs in that case.11
Examiners can also provide many other significant potential benefits to the parties in a case. First, an examiner can assist in an early determination of whether the debtor's business has a meaningful chance of reorganizing successfully.12 Second, an examiner's investigations can reduce the time and money that might have been later spent in investigation by multiple parties. This avoids duplicative efforts while also providing credible results because an impartial independent third party conducted the investigation.13 Third, an examiner's investigation can be concluded more quickly than another party's investigation, since the examiner is not "usually distracted by other aspects of reorganization."14 This is especially important because the parties receive "the benefit of the information obtained and the conclusions reached early in the case, before positions have hardened."15 Fourth, using an examiner can avoid disrupting the debtor's business since an examiner does not take control of the business as a trustee would.16 Finally, "an examiner may be able to diffuse tensions between the parties in several ways," including "mediating plan negotiations or other disputes, assisting the debtor with management or reorganization issues, or performing other tasks that are best performed by a party unconnected with any of the constituencies of the case."17
Appointment of an Examiner
The grounds and reasons for the appointment of an examiner are found in 11 U.S.C. §1104(c), which provides:
If the court does not order the appointment of a trustee under this section, then at any time before the confirmation of a plan, on request of a party in interest or the U.S. Trustee, and after notice and a hearing, the court shall order the appointment of an examiner to conduct such an investigation of the debtor as is appropriate, including an investigation of any allegations of fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in the management of the affairs of the debtor of or by current or former management of the debtor, if—(1) such appointment is in the interests of creditors, any equity security-holders, and other interests of the estate; or (2) the debtor's fixed, liquidated, unsecured debts, other than debts for goods, services or taxes, or owing to an insider, exceed $5 million.18
The appointment is not a routine procedure for every chapter 11 case. An examiner is probably not needed if no issue of fraud or mismanagement exists or if a committee can furnish sufficient information about the debtor's transactions.19 However, an examiner is appropriate if the case involves (1) allegations of fraud or mismanagement, (2) challenges regarding whether a discernable business continues to be operated, (3) concerns about disrupting the debtor's business or (4) where there has been no waste or depletion of the debtor's estate.20 A party that believes an examiner is needed must be able to provide supporting evidence, because mere allegations will not suffice to outweigh the expense and delay that an examiner would create.21
If a request for an examiner is made by the U.S. Trustee or a party in interest, and the bankruptcy court deems that an examination is needed, an examiner can be appointed on two grounds. First, an examiner may be appointed if it "is in the interests of the creditors, any equity security-holders and other interests of the estate."22 This "best interests" test is flexible and discretionary.23 Under this standard, the court engages in a cost-benefit analysis by determining whether the creditors would be best served by the appointment and whether the costs of an examiner are disproportionately high.24 Second, an examiner shall be appointed if "the debtor's fixed liquidated, unsecured debts," excluding certain types, exceed $5 million.25 Most courts construe this as a mandatory test due to the statutory language "shall order."26 However, some courts interpret the statute as "may order" by reasoning that the appointment can only be made on the request of a party in interest and that the duties of the examiner are only to investigate as appropriate.27
If an examiner is deemed appropriate, the U.S. Trustee usually nominates a person for the court's consideration.28 The Code is silent on an examiner's credentials; however, a court can use the examiner's duties as helpful tools in making the decision.29 A few examples of what a court must "find" in an examiner are disinterestedness, impartiality, the ability to meaningfully "review the books, records and transactions of the debtor," and the ability to fulfill all the duties assigned.30 A court may also find it helpful to look at the experience and background of the person nominated.
Duties of an Examiner
The duties of an examiner can be broad or narrow, simple or complex, restrictive or flexible. The court may tailor, at its discretion, the examiner's duties to fit the particularities of the case based on what the judge perceives to be the needs of the reorganization effort.31 In this respect, each examiner is unique from other examiners and thus, within the guidance of the court, must work out the details of his role for himself.32
The specific duties are listed in the Code and include certain responsibilities that are also given to trustees.33 Section 1106(c) provides: "An examiner appointed under §1104(c) of this title shall perform the duties specified in paragraphs (3) and (4) of subsection (a) of this section and, except to the extent that the court orders otherwise, any other duties of the trustee that the court orders the DIP not to perform."34 The examiner is to "investigate the acts, conduct, assets, liabilities and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan."35 The examiner must also "as soon as practicable—(A) file a statement of any investigation conducted under paragraph (3) of this subsection, including any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate; and (B) transmit a copy or a summary of any such statement to any creditors' committee or equity security-holders' committee, to any indenture trustee and to such other entity as the court designates."36 However, the appointing judge can restrict even these statutory duties.37
The court will issue an order, which will provide the scope and nature of the particular duties for that examiner.38 For example, a court can order an examiner to run the debtor's business or otherwise control the reorganization, including filing the reorganization plan.39 Furthermore, a court can allow an examiner to do numerous other duties if the circumstances warrant. For example, an examiner can be given the duty to mediate plan negotiations,40 to facilitate the claims-resolution process,41 to assist the court in understanding principles,42 to prosecute causes of action on behalf of the debtor,43 to review applications for compensation in large cases,44 or to sue to recover preferences or fraudulent conveyances.45 Finally, generally examiners can seek to employ other professionals to assist them where "failure to permit the examiner to employ other professionals would work a hardship on a reorganizing debtor's estate" or "where no examiner is available and able to discharge all of the examiner's court-ordered duties without some professional assistance."46 In sum, the examiner can perform a wide array of duties or be limited to just a few, depending on the needs of each particular case.
Above and beyond the specific working duties, an examiner has three general duties that arise from the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and common law.47 An examiner must keep the following duties in mind, because to ignore them can lead to grave consequences. For example, the examiner in In re Big Rivers was found to have violated three important duties: (1) the duty to be neutral and disinterested, (2) the duty to disclose and (3) the duty of loyalty.48 For his violations, the court ordered the disgorgement of all fees paid to the examiner and his law firm.49
First, examiners have a duty to initially be and to remain neutral and disinterested.50 An examiner "may not have a "material adverse" interest to any party to the bankruptcy "for any reason," either at the time of appointment or during the course of bankruptcy."51 An examiner's investigations and other work must be done in a "purely objective fashion," and he is not allowed to profit from the results of his work. For example, the Code prohibits an examiner from serving as a trustee or counsel for the trustee in the same case that he is an examiner.52 Several courts have strictly interpreted this requirement to mean that a person who has the slightest interest in a case, even a scintilla, cannot be an examiner because even that small amount of interest could affect that person's decisions regarding the estate.53 Thus, this requirement "does not merely prohibit [an examiner] from acting upon materially adverse interests, it prohibits [him] from having them."54
Second, "examiners have several disclosure obligations, including the obligation to disclose all payments made or promised to them."55 This means "they must disclose in all fee applications any understandings they believe they have reached with anyone regarding compensation."56 This affirmative duty applies throughout the entirety of the bankruptcy proceeding.57 Each time an examiner files a fee application or an interim fee application, he has a duty to make such disclosures.58 This duty is also strictly construed in that an examiner must disclose all discussions about payment or promises for payment, whether actually made or in existence or believed to be made or in existence.59
Third, "examiners owe the creditors and shareholders a duty of loyalty."60 This requires examiners to forbear all opportunities that would advance their self-interest.61 Just as a trustee owes this duty, an examiner "owes single-minded devotion to the interests of those on whose behalf the trustee acts."62 Everything that an examiner does must be done with loyalty to the creditors, the shareholders and to the judicial process.63
In sum, an examiner functions as a "one-person grand jury" to investigate the pre-petition affairs of the debtor and to report his findings to the court.64 In addition, he functions by default as the eyes and ears of the court and of the creditors.65 The examiner, as a creature of the court, must get his authority to act from the Bankruptcy Code or from the court's order.66 The examiner owes a fiduciary duty to shareholders, creditors67 and the court.68 The benefits of the examiner's investigation efforts flow solely to the debtor and to its creditors; however, the examiner answers directly to the court.69 An examiner must understand his duties and obligatons prior to acting as the examiner to be able to effectively investigate the debtor's affairs and to assist the court in such matters.
1 Krista Fuller is a third-year student at the University of Houston Law Center, J.D. Candidate 2005. She clerked for Judge Wesley Steen during law school. She also thanks Nancy Rapoport, Dean of the University of Houston Law Center, for her guidance and support. Return to article
24 Tabb, Charles J., The Law of Bankruptcy,
§11.7 (Foundation Press 1997); In re Gilman Servs. Inc., 46
B.R. 322, 327 (Bankr. D. Mass. 1985). Return to
26 Tabb, supra note
23 at §11.7; Morgenstern v. Revco D.S. Inc. (In re Revco D.S.
Inc.), 898 F.2d 498, 500-01 (6th Cir. 1990) (stating a court must
appoint an examiner under §1104(c)(2) if the U.S. Trustee requests
an examiner). Return to article
30 9 Am. Jur. 2d
Bankruptcy §325. See Bank. R. 5002; U.S. Dep't. of Justice,
Chapter 11 Trustee Handbook (May 2004), available at http://www.usdoj.gov/ust/library/chapter11/Ch11Handbook-200405.pdf.
The term "disinterested" is defined at 11 U.S.C. §101(14). Id.
See, also, In re Tighe Mercantile Inc., 62 B.R. 995 (Bankr. S.D.
Cal. 1986) (citing 3 Norton Bankr. L. & Prac. §53.10
(1981)). For more discussion on this point, see, infra, "Duties
of an Examiner." Return to article
38 See, e.g., Order
Pursuant to 11 U.S.C. §§1104(c) and 1106(b) "Directing
Appointment of Enron Corp. Examiner," In re Enron Corp., No.
01-16034 (Bankr. S.D.N.Y. 2002), available at http://www.elaw4enron.com, docket
entry no. 2836. Return to article
39 See In re Peterson
Motors Inc., 47 B.R. 551 (Bankr. D. Minn. 1985); In re Liberal
Markets Inc., 11 B.R. 742 (Bankr. S.D. Ohio 1981); In re Wilton
Realty Corp., 30 F. Supp. 486 (E.D. Mich. 1938). However, I believe
that a court would not order an examiner to take control unless it was
beyond a doubt absolutely necessary, because to allow an examiner such
control would defeat one of the benefits of an examiner, which is to not
disrupt the debtor's business. Return to article
26 Tabb, supra note 23 at §11.7; Morgenstern v. Revco D.S. Inc. (In re Revco D.S. Inc.), 898 F.2d 498, 500-01 (6th Cir. 1990) (stating a court must appoint an examiner under §1104(c)(2) if the U.S. Trustee requests an examiner). Return to article
30 9 Am. Jur. 2d Bankruptcy §325. See Bank. R. 5002; U.S. Dep't. of Justice, Chapter 11 Trustee Handbook (May 2004), available at http://www.usdoj.gov/ust/library/chapter11/Ch11Handbook-200405.pdf. The term "disinterested" is defined at 11 U.S.C. §101(14). Id. See, also, In re Tighe Mercantile Inc., 62 B.R. 995 (Bankr. S.D. Cal. 1986) (citing 3 Norton Bankr. L. & Prac. §53.10 (1981)). For more discussion on this point, see, infra, "Duties of an Examiner." Return to article
38 See, e.g., Order Pursuant to 11 U.S.C. §§1104(c) and 1106(b) "Directing Appointment of Enron Corp. Examiner," In re Enron Corp., No. 01-16034 (Bankr. S.D.N.Y. 2002), available at http://www.elaw4enron.com, docket entry no. 2836. Return to article
39 See In re Peterson Motors Inc., 47 B.R. 551 (Bankr. D. Minn. 1985); In re Liberal Markets Inc., 11 B.R. 742 (Bankr. S.D. Ohio 1981); In re Wilton Realty Corp., 30 F. Supp. 486 (E.D. Mich. 1938). However, I believe that a court would not order an examiner to take control unless it was beyond a doubt absolutely necessary, because to allow an examiner such control would defeat one of the benefits of an examiner, which is to not disrupt the debtor's business. Return to article