Chapter 11 Examiner When Why What and How Part I

Journal Issue

Mar 2005

Column Name

Straight & Narrow

Bankruptcy Code

1104

Topic Tags

Practice and Procedure

Journal HTML Content

Editor's Note:
In this issue, Straight & Narrow is proud to present an excellent
article by Krista Fuller, a law student member of ABI, on the important
topic of examiners in chapter 11 cases. Straight & Narrow is proud
to highlight the quality of ABI's law student members and hopes to
publish more law student articles in the future.

</blockquote>

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.

<h4>Potential Benefits</h4>

Chapter 11 provides for the intervention of independent third parties
when the need arises.<a href="#2" name="2a">2</a> If the need is present, a bankruptcy court
may appoint either an examiner or a trustee.<a href="#3" name="3a">3</a> 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.<a href="#4" name="4a">4</a>

The examiner position has similarities to a trustee,<a href="#5" name="5a">5</a> 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.<a href="#6" name="6a">6</a> If the
court appoints an examiner, the debtor is not displaced and continues to
remain in control of his business.<a href="#7" name="7a">7</a> 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.<a href="#8" name="8a">8</a>

Another difference is the nature of an examiner's position,
which is "unique and has evolved over time."<a href="#9" name="9a">9</a> 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

<blockquote>
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.<a href="#10" name="10a">10</a>
</blockquote>

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.<a href="#11" name="11a">11</a>

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.<a href="#12" name="12a">12</a> 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.<a href="#13" name="13a">13</a> 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."<a href="#14" name="14a">14</a> 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."<a href="#15" name="15a">15</a>
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.<a href="#16" name="16a">16</a> 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."<a href="#17" name="17a">17</a>

<h4>Appointment of an Examiner</h4>

The grounds and reasons for the appointment of an examiner are found
in 11 U.S.C. §1104(c), which provides:

<blockquote>
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.<a href="#18" name="18a">18</a>
</blockquote>

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.<a href="#19" name="19a">19</a> 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.<a href="#20" name="20a">20</a> 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.<a href="#21" name="21a">21</a>

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."<a href="#22" name="22a">22</a> This "best interests" test is
flexible and discretionary.<a href="#23" name="23a">23</a> 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.<a href="#24" name="24a">24</a> Second, an examiner shall be appointed
if "the debtor's fixed liquidated, unsecured debts," excluding certain
types, exceed $5 million.<a href="#25" name="25a">25</a> Most courts construe this as a mandatory
test due to the statutory language "shall order."<a href="#26" name="26a">26</a> 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.<a href="#27" name="27a">27</a>

If an examiner is deemed appropriate, the U.S. Trustee usually
nominates a person for the court's consideration.<a href="#28" name="28a">28</a> 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.<a href="#29" name="29a">29</a> 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.<a href="#30" name="30a">30</a> A
court may also find it helpful to look at the experience and background
of the person nominated.

<h4>Duties of an Examiner</h4>

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.<a href="#31" name="31a">31</a> 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.<a href="#32" name="32a">32</a>

The specific duties are listed in the Code and include certain
responsibilities that are also given to trustees.<a href="#33" name="33a">33</a> 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."<a href="#34" name="34a">34</a> 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."<a href="#35" name="35a">35</a> 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."<a href="#36" name="36a">36</a> However, the appointing judge can
restrict even these statutory duties.<a href="#37" name="37a">37</a>

The court will issue an order, which will provide the scope and
nature of the particular duties for that examiner.<a href="#38" name="38a">38</a> For example, a court can
order an examiner to run the debtor's business or otherwise control the
reorganization, including filing the reorganization plan.<a href="#39" name="39a">39</a> 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,<a href="#40" name="40a">40</a>
to facilitate the claims-resolution process,<a href="#41" name="41a">41</a> to assist the court in understanding
principles,<a href="#42" name="42a">42</a> to
prosecute causes of action on behalf of the debtor,<a href="#43" name="43a">43</a> to review applications for
compensation in large cases,<a href="#44" name="44a">44</a> or to sue to recover preferences or
fraudulent conveyances.<a href="#45" name="45a">45</a> 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."<a href="#46" name="46a">46</a> 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.<a href="#47" name="47a">47</a> 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.<a href="#48" name="48a">48</a> For
his violations, the court ordered the disgorgement of all fees paid to
the examiner and his law firm.<a href="#49" name="49a">49</a>

First, examiners have a duty to initially be and to remain neutral
and disinterested.<a href="#50" name="50a">50</a> 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."<a href="#51" name="51a">51</a> 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.<a href="#52" name="52a">52</a>

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.<a href="#53" name="53a">53</a> Thus, this requirement "does
not merely prohibit [an examiner] from acting upon materially
adverse interests, it prohibits [him] from having
them."<a href="#54" name="54a">54</a>

Second, "examiners have several disclosure obligations, including the
obligation to disclose all payments made or promised to
them."<a href="#55" name="55a">55</a> This
means "they must disclose in all fee applications any understandings
they believe they have reached with anyone regarding
compensation."<a href="#56" name="56a">56</a>

This affirmative duty applies throughout the entirety of the bankruptcy
proceeding.<a href="#57" name="57a">57</a>
Each time an examiner files a fee application or an interim fee
application, he has a duty to make such disclosures.<a href="#58" name="58a">58</a> 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.<a href="#59" name="59a">59</a>

Third, "examiners owe the creditors and shareholders a duty of
loyalty."<a href="#60" name="60a">60</a> This
requires examiners to forbear all opportunities that would advance their
self-interest.<a href="#61" name="61a">61</a>

Just as a trustee owes this duty, an examiner "owes single-minded
devotion to the interests of those on whose behalf the trustee
acts."<a href="#62" name="62a">62</a>
Everything that an examiner does must be done with loyalty to the
creditors, the shareholders and to the judicial process.<a href="#63" name="63a">63</a>

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.<a href="#64" name="64a">64</a> In addition, he functions by default as
the eyes and ears of the court and of the creditors.<a href="#65" name="65a">65</a> The examiner, as a creature
of the court, must get his authority to act from the Bankruptcy Code or
from the court's order.<a href="#66" name="66a">66</a> The examiner owes a fiduciary duty to
shareholders, creditors<a href="#67" name="67a">67</a> and the court.<a href="#68" name="68a">68</a> 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.<a href="#69" name="69a">69</a> 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.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> 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. <a href="#1a">Return
to article</a>

<a name="2">2</a> See 11 U.S.C.
§1104 (West 2004); Zaretsky, Barry L., "Symposium on Bankruptcy:
Chapter 11 Issues: Trustees and Examiners in Chapter 11," 4 S.C. L. Rev.
907, 910 (Summer 1993). <a href="#2a">Return to article</a>

<a name="3">3</a> 11 U.S.C. §1104. <a href="#3a">Return to article</a>

<a name="4">4</a> Id.; Zaretsky,
supra note 1 at 907. <a href="#4a">Return to article</a>

<a name="5">5</a> See 11 U.S.C.
§§1104, 1106(b). For example, both a trustee and an examiner
investigate into the debtor's actions and file reports with the court.
Id. §1106(a)(3)-(4). <a href="#5a">Return to article</a>

<a name="6">6</a> 4 Norton Bankr. L. &
Prac. §79:23 (2004). <a href="#6a">Return to article</a>

<a name="7">7</a> Zaretsky, supra
note 1 at 908. <a href="#7a">Return to article</a>

<a name="8">8</a> Id. <a href="#8a">Return to article</a>

<a name="9">9</a> 4 Norton Bankr. L. &
Prac. §79:23. <a href="#9a">Return to article</a>

<a name="10">10</a> 46 B.R. 314, 316
(Bankr. S.D. Ohio 1985). <a href="#10a">Return to article</a>

<a name="11">11</a> See Zaretsky,

supra note 1 at 909. <a href="#11a">Return to article</a>

<a name="12">12</a> Id. at 936-37.
<a href="#12a">Return to article</a>

<a name="13">13</a> Id. at 937. <a href="#13a">Return to article</a>

<a name="14">14</a> Id. <a href="#14a">Return to article</a>

<a name="15">15</a> Id. <a href="#15a">Return to article</a>

<a name="16">16</a> Id. <a href="#16a">Return to article</a>

<a name="17">17</a> Zaretsky, supra
note 1 at 937. <a href="#17a">Return to article</a>

<a name="18">18</a> 11 U.S.C.
§1104(c). <a href="#18a">Return to article</a>

<a name="19">19</a> 4 Norton Bankr. L.

& Prac. §79:22 (2004). <a href="#19a">Return to article</a>

<a name="20">20</a> Id. at
§79:23. <a href="#20a">Return to article</a>

<a name="21">21</a> 9 Am. Jur. 2d
Bankruptcy §293 (2004). <a href="#21a">Return to article</a>

<a name="22">22</a> 11 U.S.C.
§1104(c)(1). <a href="#22a">Return to article</a>

<a name="23">23</a> 4 Norton Bankr. L.
& Prac. §79:22. <a href="#23a">Return to article</a>

<a name="24">24</a> 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). <a href="#24a">Return to
article</a>

<a name="25">25</a> §1104(c)(2). <a href="#25a">Return to article</a>

<a name="26">26</a> 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). <a href="#26a">Return to article</a>

<a name="27">27</a> Id.; see, e.g., In
re GHR Cos., 43 B.R. 165 (Bankr. D. Mass. 1984). <a href="#27a">Return to article</a>

<a name="28">28</a> 4 Norton Bankr. L.
& Prac. 2d §79.22. <a href="#28a">Return to article</a>

<a name="29">29</a> Id. <a href="#29a">Return to article</a>

<a name="30">30</a> 9 Am. Jur. 2d
Bankruptcy §325. See Bank. R. 5002; U.S. Dep't. of Justice,
Chapter 11 Trustee Handbook (May 2004), available at <a href="http://www.usdoj.gov/ust/library/chapter11/Ch11Handbook-200405.pdf">htt…;.
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." <a href="#30a">Return to article</a>

<a name="31">31</a> Kaplan, Stanley A.,
"The Role of the Examiner: Some Observations," 4 Bank. Dev. J. 439, 440
(1987). <a href="#31a">Return to article</a>

<a name="32">32</a> Id. at 441. <a href="#32a">Return to article</a>

<a name="33">33</a> See 11 U.S.C.
§1106. <a href="#33a">Return to article</a>

<a name="34">34</a> Id. <a href="#34a">Return to article</a>

<a name="35">35</a> Id.
§1106(a)(3). <a href="#35a">Return to article</a>

<a name="36">36</a> Id.

§1106(a)(4). <a href="#36a">Return to article</a>

<a name="37">37</a> See Id.
§1106(a)(3)-(4) (providing "except to the extent the court orders
otherwise"). <a href="#37a">Return to article</a>

<a name="38">38</a> 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 <a href="http://www.elaw4enron.com">http://www.elaw4enron.com</a>, docket
entry no. 2836. <a href="#38a">Return to article</a>

<a name="39">39</a> 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. <a href="#39a">Return to article</a>

<a name="40">40</a> See In re UNR
Indus., 72 B.R. 780 (Bankr. N.D. Ill. 1987). <a href="#40a">Return
to article</a>

<a name="41">41</a> See In re Apex Oil
Co., 92 B.R. 843, 844-45 (Bankr. E.D. Mo. 1988). <a href="#41a">Return to article</a>

<a name="42">42</a> See In re Public
Serv. Co., 99 B.R. 742 (Bankr. D. N.H. 1989) (ordering examiner to
assist the court in understanding complex utility rules). <a href="#42a">Return to article</a>

<a name="43">43</a> See In re Carnegie
Intern. Corp., 51 B.R. 252 (Bankr. S.D. Ind. 1984). <a href="#43a">Return to article</a>

<a name="44">44</a> In re Continental
Airlines, 138 B.R. 439 (Bankr. D. Del. 1992). <a href="#44a">Return
to article</a>

<a name="45">45</a> Williamson v.
Roppollo, 114 B.R. 127 (Bankr. W.D. La. 1990). <a href="#45a">Return
to article</a>

<a name="46">46</a> See Tighe, 62
B.R. at 1001; see, also, 9 Am. Jur. 2d Bankruptcy §381. <a href="#46a">Return to article</a>

<a name="47">47</a> 6 Bankr. Serv. L. Ed.
§52:321 (2004). <a href="#47a">Return to article</a>

<a name="48">48</a> In re Big Rivers
Elec. Corp., 355 F.3d 415, 422 (6th Cir. 2004). <a href="#48a">Return to article</a>

<a name="49">49</a> Id. <a href="#49a">Return to article</a>

<a name="50">50</a> Id. at 428-29;
the term "disinterested" is defined at 11 U.S.C. §101(14). <a href="#50a">Return to article</a>

<a name="51">51</a> Id. at 433. <a href="#51a">Return to article</a>

<a name="52">52</a> 11 U.S.C.
§§321(b), 327(f). <a href="#52a">Return to article</a>

<a name="53">53</a> In re Roger J. Au

& Son Inc., 64 B.R. 600, 604 n.8 (Bankr. N.D. Ohio 1986); In
re Watson, 94 B.R. 111, 116 (Bankr. S.D. Ohio 1988). <a href="#53a">Return to article</a>

<a name="54">54</a> Big Rivers, 355
F.3d at 434 (emphasis in original). <a href="#54a">Return to article</a>

<a name="55">55</a> Id. at 433. <a href="#55a">Return to article</a>

<a name="56">56</a> Id. <a href="#56a">Return to article</a>

<a name="57">57</a> See Id. at 435.

<a href="#57a">Return to article</a>

<a name="58">58</a> See Id. <a href="#58a">Return to article</a>

<a name="59">59</a> See Id. <a href="#59a">Return to article</a>

<a name="60">60</a> Big Rivers, 355
F.3d at 434. <a href="#60a">Return to article</a>

<a name="61">61</a> Id. <a href="#61a">Return to article</a>

<a name="62">62</a> See Id.

(citing Collier Bankr. §1108.09[1]). <a href="#62a">Return
to article</a>

<a name="63">63</a> See Id. 435-36.
<a href="#63a">Return to article</a>

<a name="64">64</a> Collier Comp.,
Employment & Appointment of Tr. & Prof'l. in Bankr. Cases, P.
1A.09 (2003). <a href="#64a">Return to article</a>

<a name="65">65</a> Ch. 11 Reorg. 2d ed.
§7.9 (2004). <a href="#65a">Return to article</a>

<a name="66">66</a> In re Patton's Bee
Disposal Serv. Inc., 182 B.R. 681, 686 (Bankr. W.D.N.Y. 1995). <a href="#66a">Return to article</a>

<a name="67">67</a> Big Rivers, 355
F.3d at 435-36. <a href="#67a">Return to article</a>

<a name="68">68</a> 8A C.J.S. Bankruptcy
§376 (2004). <a href="#68a">Return to article</a>

<a name="69">69</a> Baldwin, 46 B.R.
at 316. <a href="#69a">Return to article</a>

Journal Authors

Krista Renee Fuller

Journal Date

Tuesday, March 1, 2005 - 12:00

Bankruptcy Rule

2005

none