Examining the Examiner
Section 1104(c) concerns the appointment of an examiner in a chapter 11 case where no trustee has been appointed.2 Section 1106(b) defines the role of an examiner primarily in terms of the duties of the trustee in bankruptcy under §1106(a)(3)-(4), which is very broadly written. Section 1106(b) then gives the court added discretion to assign still more duties to an examiner. In the years since the adoption of the Code, examiners have been appointed for a host of different purposes. No very clear idea of their proper role has been developed, and no real limits on that role have been articulated. The broad discretion apparently lodged in the courts seems anomalous in light of the statutory language and structure, especially in those larger cases where appointment of an examiner is mandated by the statute. What would it mean to say appointment of an official is mandatory, but that official can be given whatever duties the court pleases? Some cases decided this past year have stated limits on the roles examiners may be assigned. We are not sure those results square with the statute, either.
By way of background, the ancient ones among our readers will recall that the examiner entered the Code by way of replacement for the Securities and Exchange Commission (SEC). After the scandals in public companies in the 1930s,3 the Chandler Act required the appointment of a trustee in the reorganization of public companies, and the SEC was given a powerful role in those cases. Unhappiness with that system was a major impetus to the adoption of the 1978 Code, which introduced the debtor-in-possession (DIP) for large cases as well as "mom-and-pop" affairs and virtually eliminated the role of the SEC. Under the Chandler Act, the SEC had served two functions in public cases: It investigated (or supervised the trustee's investigation of) past wrongdoing, and it looked out for the treatment of the public debt-holders and shareholders in the reorganization process. The banks and others argued that the latter role was inappropriate, but the SEC disagreed. Even many who generally agreed with the banks nonetheless believed that an independent investigator remained necessary in at least some cases. The examiner was born as a compromise. At the SEC's insistence, appointment of an examiner under the Code was made mandatory in cases where more than $5 million in debt was in play; in smaller cases, appointment was within the discretion of the court if a party in interest or the U.S. Trustee sought an examiner.
Two major questions should be asked about the role of examiners under the Code: What are the legal limits on the role of an examiner? Within any such legal limits, should the courts have complete discretion in assigning duties to an examiner in each case?
The examiner's statutory powers have been little discussed in the cases. Section 1106(b) gives the examiner all of the powers of a trustee in bankruptcy under §1106(a) (3)-(4), which includes investigation of the debtor's conduct and financial condition, the operation of the business and whether its continuation is desirable, and "any other matter relevant to the case or the formulation of a plan."4 The examiner "shall perform" all these duties "except to the extent the court orders otherwise" (emphasis supplied). In addition, the examiner exercises any other powers "that the court orders the DIP not to perform" unless the court orders otherwise.
The examiner is not given the trustee's power to operate the business or to file a plan. Those key functions are left to the DIP under §1107(a). But the examiner is given very broad authority to investigate the business and to take positions about its future.5 In a case where a trustee is not appointed, yet the DIP may be seen as unreliable in some respects, the statute divides the traditional roles of the trustee into two parts. The DIP will operate the business and negotiate a plan, but the examiner will perform the trustee's duties of investigating past conduct and the current operations of the business and make recommendations relevant to a plan.
The courts seem to have paid little attention to this statutory structure in appointing examiners. On the one hand, they have assumed they could appoint an examiner to perform a remarkable range of duties, all the way from acting as the U.S. negotiator in a worldwide bankruptcy case6 to performing as a mediator and facilitator to help the parties agree on a plan.7 On the other hand, the courts have regularly assumed, without much discussion, that they could define and limit the examiner's powers pretty much as they chose. Three recent cases illustrate the point.
The first case is In re Gliatech Inc., 305 B.R. 832 (Bankr. N.D. Ohio 2004). It was apparently too small a case for a mandatory appointment, so appointment was at the discretion of the court. An equity-holder asked for the examiner to investigate the valuation of intellectual property being given to a creditor under the plan. The holder claimed that the debtor undervalued the property and therefore the creditor was being paid more than 100 percent of its claim. If the property were found to be more valuable, some value might be left for the subordinated debt-holders and even for equity. The terms of the deal had been negotiated with the creditors' committee, and the court clearly felt the examiner request was a negotiating ploy. The request was denied and perhaps should have been. But both the request and the denial arguably reflected a misunderstanding of the examiner's role.
If an examiner is appointed, the statute says he or she is to investigate and report on a broad range of things, including past conduct of the business, the operation and future of the business and "any other matter relevant to the case or to the formulation of a plan." Thus the request for a valuation here is clearly within the ordinary functions of an examiner under the statute. On the other hand, the request for an examiner was misplaced insofar as it sought an examiner to do one discrete job, which is not what is contemplated by the statute. The statute clearly contemplates that the examiner will conduct a broad-ranging investigation, "except to the extent the court otherwise directs." The statute does not contemplate an examiner with a discrete portfolio, but rather a neutral investigator with broad powers, subject only to exceptions established by the court. Thus the idea that the court should appoint an examiner for the specific purpose of valuation is simply wrong. The request could and probably should have been denied for failing to show the need for a broad investigation, which might include the problem of valuing the property in question.8 Presumably, the showing required might be to the effect that the debtor had engaged in insider transactions, that management had a strong personal interest in undervaluation, or something of the sort justifying a general investigation. Absent such a showing, the court would be quite right to deny the request.
The distinction we raise might seem like quibbling, but it changes the focus of the examiner request 180 degrees. The history and structure of the statute make it clear that the examiner is not like the plumber or carpenter who is called in to check for a leak or a rotten board, but an engineer charged with examining the entire structure and making recommendations about what to do about it. The courts have dealt with this provision as if the examiner were a sort of special counsel appointed to do some discrete job rather than to provide a replacement for the investigation and recommendations of a trustee in an appropriate case. The court's job in smaller cases is to determine whether the case is appropriate for that treatment. In a case with more than $5 million in debt, its job is to order appointment of the examiner. In both instances, the court has the further discretion to exclude certain of the examiner's duties under §1106(a)(3)-(4) or to expand them under §1107(b), but that is very far from defining those duties starting at zero—an approach that has been typical up to now.
The point becomes patent when mandatory appointment is on the table, which was the situation in the second recent case we've read on this subject, In re Loral Space & Communications Ltd., 313 B.R. 577 (Bankr. S.D.N.Y. 2004). Loral was, of course, the kind of large company at which the mandatory provision was aimed. An ad hoc equity committee sought an examiner to investigate the valuation of the company. The court denied the request, despite the mandatory language of §1104(c)(2). As in Gliatech, the court clearly believed that the request was a ploy. It specifically suggested that valuation was not an appropriate purpose for an examiner, although, as noted above, it is hard to square that conclusion with the language that specifically requires the examiner, unless restrained by a court order, to investigate "the operation of the debtor's business...and any other matter relevant to...the formulation of a plan."9 What could be more relevant to the formulation of a plan than valuation of the business if the valuation is open to legitimate question? If the court meant to hold that valuation was an insufficient reason for an appointment, it was wrong because the appointment was mandatory under the statute; if the court meant to hold that valuation was a power an examiner could not ordinarily exercise, it was wrong because of the broad language in the statute. All the burdens should have been the other way: In this large case, it was up to the opponents to show some extraordinary reason that an examiner should not be appointed and, if appointed, should not be allowed to consider the value of the company in relation to the plan.
It is not to say that the court could not legitimately refuse to appoint an examiner in Loral. The movant had waited until late in the game to make the request, seemingly just throwing it up to replace earlier maneuvers that had already been thoroughly heard and rejected. Absent any new circumstances, the court might easily have found waiver or estoppel on these facts. But if the same request were made in good faith and in a timely way, it should be granted. To refuse for any other reason is to violate the clear injunction of the Code: Ask and ye shall receive. Once appointed, the examiner might report back promptly that an initial investigation suggested no need for a full-blown one, but the appointment would have served the statutory purpose of obtaining some independent review such as a trustee would have done under the old chapter X.10
The third case was In re UAL Corp., 307 B.R. 80 (Bankr. N.D. Ill. 2004), in which the United flight attendants asked for the appointment of an examiner concerning the DIP's decision to modify its retirement plan. The court held that in a large case an examiner must be appointed under the statute, but that the court retained discretion to determine the scope of the examiner's duties. It then granted the request—presumably limited to this subject—because it felt a third party's investigation could help to clear the air between labor and management. Obviously, this decision reflects a willingness to understand the possible uses of an examiner much more broadly than in Loral. If valuation for plan purposes is not a legitimate use of an examiner, it is hard to see how clearing the air as to management's motives could be. But this decision suffers from the same myopia as the other two: seeing the examiner as a Mr. or Ms. Fixit brought in to address a specific issue or series of issues, not to exercise the powers of an examiner as established by §§1106 and 1107.
The practical reader may say at this point, "Yes, yes—all well and good, but the courts have been doing this sort of thing for 25 years, so why think they should or would change now?" It is worth insisting upon the distinction between the narrow view of an examiner and the obvious thrust of the statute for at least two reasons. One is that ignoring the statutory structure leaves the courts with no plausible statutory or policy guide for appointing examiners. An express statutory structure and clear statutory policy has yielded to a purely ad hoc exercise of discretion that must necessarily be inconsistent and without standards. The second reason the actual statutory structure is important is that some observers claim that certain creditor groups are increasingly taking control over large chapter 11 cases,11 the very cases in which an examiner is mandatory. To have reorganization cases controlled by collusion between management and the largest creditors was the precise evil that chapter X of the Chandler Act was designed to prevent. The examiner provisions of the 1978 Code were meant to preserve that function even while leaving the operation of a large public debtor to its management.
The two cases denying examiners for valuation purposes go to the heart of the matter. In a large chapter 11 case, systematic undervaluation of the debtor could be a very serious and unfair consequence of DIP control. Just such manipulation has been alleged in a number of cases. If it is happening, it should be stopped. If it is not happening, a thorough investigation in a few cases would lay the myth to rest. It is just those sorts of benefits—safeguards and transparency—for which the examiner remedy was fashioned and made mandatory in large cases. Similarly, in smaller cases, where misconduct or a weak bargaining position may make the DIP unwilling or unable to attack transactions, make full disclosures or propose a reasonable plan, an examiner with full statutory powers may be just what is needed.12
A proper application of the statute would impose a heavier burden on one requesting an examiner in non-mandatory cases because it would require a more general showing of need. But once examiners were appointed, they would have much broader powers except insofar as the courts pulled specific ones away from the statutory bundle. As to specific jobs that need to be done, special counsel may be the answer, with a role tailored to each case, although under §327 that approach raises new difficulties to be discussed another day.
1 These thoughts, like most in this column, were first presented at the University of Texas Annual Bankruptcy Conference. Return to article
2 §1104. Appointment of trustee or examiner—
(c) 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. Return to article
3 We should note that some academics have revised history to suggest that Douglas and that crowd exaggerated the amount of chicanery that went on in that era in order to promote excessive regulation of the markets. We assume that their grandchildren will explain someday that Enron, WorldCom, Adelphia and the rest were just unfortunate misunderstandings exaggerated by Sarbanes and Oxley. Return to article
4 §1106. Duties of trustee and examiner—
(3) except to the extent that the court orders otherwise, 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;
(4) 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;(b) An examiner appointed under §1104(d) 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. Return to article
5 Whether there are any limits on the powers that can be assigned to an examiner under the final, broadest provision of §1106(b) is unclear. For example, can the court forbid the DIP to file a plan (§§1106(a)(5) and 1107) and give that power to an examiner under §1106(b)? Questions of that scope are beyond the current discussion. Return to article
6 See In re Maxwell Communication Corp., 93 F.3d 1036, 1051 (2d Cir. 1996). Return to article
7 See, e.g., In re Big Rivers Electric Corp., 233 B.R. 754 (Bankr. W.D. Ky. 1999). Return to article
8 Naturally, a strong showing that an independent valuation is required could be an important part of such a showing. Return to article
9 The court only cited §§1106-07 in a footnote, "see also." Return to article
10 The court mentions the possibility of an investigation as to whether to investigate, but that is not quite the same thing as an initial investigation. Return to article
11 See, generally, Baird, Douglas G. and Rasmussen, Robert K., "The End of Bankruptcy," 55 Stan. L. Rev. 751 (2002); Westbrook, Jay L., "The Control of Wealth in Bankruptcy," 82 Tex. L. Rev. 795 (2004); Miller, Harvey R. and Waisman, Shai Y., "Does Chapter 11 Reorganization Remain a Viable Option for Distressed Business for the Twenty-First Century?," 78 Am Bnakr. L. J. 153, 184 (2004). Return to article
12 Note that the assignment of a DIP's powers to an examiner, as explicitly contemplated by §1106(b), may also be a solution to the Cybernetics problem. Under that section, the court can remove the power to bring an avoidance action from the DIP and give it to the examiner. Note also that the Cybernetics issue is alive and well, despite the en banc decision in the Third Circuit. See In re Fox, 305 B.R. 912 (BAP 10th Cir. 2004). Even in circuits where the court can empower the creditors' committee to exercise an avoiding power, in some cases the court will not be sure that the creditors' committee is sufficiently neutral and disinterested as to be the appropriate investigator or pursuer with regard to the issue presented. An examiner might be just the ticket. Return to article