Appointing An Examiner is not a Simple Task

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National Law Journal - April 30, 2012,

[authors: Jeremy W. Ryan, Ryan M. Murphy]

Appointing an Examiner Is Not a Simple Task
Three cases provide examples of situations in which the courts considered an outside overseer.

Allegations of impropriety by a bankrupt company's management can fuel heated litigation in bankruptcy cases — including requests to appoint an examiner to investigate causes of action. As contested as an examiner's appointment can be, often a more intense conflict results if an examiner finds that viable claims exist. Deciding which party should pursue these claims¬ — the debtor, a creditors' committee, an equity holders' committee or individual creditors — provides fertile ground for litigation. Frequently, the claims represent a significant or sole means of recovery for constituent classes. Several recent cases highlight the tension among competing stakeholders not only to wrest control of those claims, but ultimately to influence the trajectory of the entire bankruptcy case.

Appointment of an examiner is not routine and generally occurs when allegations exist concerning fraud, incompetence or mismanagement of a debtor. 11 U.S.C. 1104(a)(1),(c). An examiner's investigatory powers usually focus on impropriety involving a debtor's management, but can be expanded "as is appropriate" to probe other aspects of the debtor's business. See 11 U.S.C. 1104(c).

An examiner acts as a neutral fact-finder to investigate claims concerning a debtor's bankruptcy and reports the findings to the bankruptcy court. 11 U.S.C. 1106(a)(4). Given the need for objectivity, examiners are required to be disinterested with respect to all other parties in the bankruptcy. In re Big Rivers Elec. Corp., 355 F.3d 415, 428-29, 433 (6th Cir. 2004). Any interested party may request an examiner's appointment, and generally must demonstrate that the potential benefits outweigh the expense associated with appointment. See 11 U.S.C. 1104(c).

The report produced, usually after an exhaustive investigation, summarizes causes of action available to benefit the debtor's estate. An examiner's report often accounts for the likelihood of recovery by assessing the merits of a claim and potential defenses. The report can serve as a "blueprint" for recovery of claims on behalf of a debtor's estate.

STANDING TO BRING ACTIONS

Because an examiner must remain disinterested, courts are reluctant to authorize an examiner to pursue claims identified in the report to avoid blurring the independence of the investigation. See 11 U.S.C. 321(b) (examiner may not serve as trustee); 11 U.S.C. 327(f) (examiner may not be retained by trustee); In re WR Grace & Co., 285 B.R. 148, 156-57 (Bankr. D. Del. 2002). As an initial matter, causes of action that can be asserted on a debtor's behalf, including claims against a debtor's officers and directors, are included in the assets vested in a debtor's estate upon bankruptcy filing. 11 U.S.C. 541; In re RNI Wind Down Corp., 348 B.R. 286, 292-93 (Bankr. D. Del. 2006). As such, the debtor-in-possession or Chapter 11 trustee, if appointed, is the party authorized to initiate proceedings to recover on estate causes of action. See 11 U.S.C. 1108.

Reports typically focus on claims of fraud or mismanagement by a debtor's officers or directors. Given the nature of those claims, a debtor may be unable or unwilling to pursue litigation in certain circumstances. When the decision to forgo potentially valuable causes of action is unjustified, bankruptcy courts may authorize a nondebtor to bring the action derivatively to maximize recovery for all creditors. See Louisiana World Exposition v. Federal Ins. Co., 858 F.2d 233, 248-50 (5th Cir. 1988). This derivative standing may be granted to any stakeholder — namely, official committees of creditors or equity holders, or individual creditors. See In re Yes! Entm't Corp., 316 B.R. 141, 145 (D. Del. 2004). The requesting party generally must show a colorable claim and that the debtor unjustifiably refused to pursue the claim. See Fogel v. Zell, 221 F.3d 955, 965 (7th Cir. 2000).

In determining whether a "colorable claim" exists, courts look to a motion-to-dismiss standard. See In re America's Hobby Center Inc., 223 B.R. 275, 282 (Bankr. S.D.N.Y. 1998) (citation omitted). When a dispositive affirmative defense is clearly present, a colorable claim likely does not exist. In re G-I Holdings Inc., 313 B.R. 612, 631 (Bankr. D.N.J. 2004).

Whether refusal is unjustified is based on the circumstances following a formal demand by the interested party. Because a debtor is expected to exercise appropriate discretion in bringing estate causes of action, an unjustifiable refusal amounts to an abuse of that discretion. See In re LTV Steel Co. Inc., 333 B.R. 397, 428 (Bankr. N.D. Ohio 2005). The demand requirement may be excused if it can be shown that the debtor is conflicted, as it often will be with the types of claims identified by examiners. In re Louisiana World Exposition Inc., 832 F.2d 1391, 1397 (5th Cir. 1987).

Here are three recent cases addressing derivative standing:

Tribune Co. The examiner's report in In re Tribune Co., No. 08-13141(Bankr. D. Del.), concluded that certain transactions in connection with a leveraged buyout of the debtors might constitute fraudulent conveyances. The official committee of unsecured creditors obtained authority to commence causes of action related to the buyout. The committee elected to prosecute certain causes of action while forgoing certain other fraudulent conveyance claims investigated by the examiner.

In spite of the committee's derivative standing, certain unsecured creditors petitioned to bring fraudulent-conveyance claims that the committee did not pursue, even though all the claims arose from the buyout. The bankruptcy court allowed unsecured creditors to pursue these claims independently of the committee to avoid statute-of-limitations issues, while unequivocally leaving open the issue raised by many defendants of the propriety of splitting up causes of action. Nonetheless, in allowing individual creditors to assert additional claims in multiple proceedings, the bankruptcy court adopted a sort of "use it or lose it" approach to derivative standing that could open the door for parties to cherry-pick causes of action for prosecution.

Anderson News LLC. Following a two-year investigation in Anderson News LLC, No. 09-10695 (Bankr. D. Del.), the examiner's report identified tens of millions in potential claims involving transactions among the debtor and affiliates under common control. The U.S. trustee previously declined to appoint a creditors' committee, and the bankruptcy court denied a request to appoint a trustee. Due to the absence of a trustee or committee, an ad hoc group of creditors sought authority to prosecute claims set out in the examiner's report, all of which were against the debtor's affiliates.

Since the debtor's management largely overlapped with management of the target defendants and rendered the debtor conflicted, the petitioning creditors posited that formal demand for the debtor to pursue claims against its insiders was unnecessary. Both the debtor and certain target defendants objected, instead trying to retain control of the litigation by proposing to toll the claims rather than prosecute them. The bankruptcy court authorized the creditors to pursue those claims identified in the examiner's report which satisfied the "motion to dismiss-plus" standard employed by the examiner. Notably, as the unsecured creditors stood to receive nothing absent recovery on the estate causes of action, the retention of counsel for the ad hoc group of creditors was authorized on a contingent-fee basis on the ground that prosecuting the claims benefitted the debtor's estate.

Filene's Basement. The request for an examiner in Filene's Basement LLC, No. 11-13511 (Bankr. D. Del.), is unique in that it was made by the debtors in the early stages of the bankruptcy case. The debtors' request for an investigation into claims against its directors and officers was to provide information on a source of recovery to fund a plan of reorganization and to minimize duplicative efforts by committees representing creditors and equity holders. Both of these committees asserted that these potential causes of action would be a significant source of their constituents' recovery and wanted input on control over the litigation. The debtors' pre-emptive request has not been ruled on, as the principal parties have been engaged in negotiation of a reorganization plan that presumably will allocate authority to prosecute estate causes of action.

Given the significant stakes associated with recovery on causes of action investigated by examiners, competing stakeholders will continue to jockey for control over litigating these claims. An examiner's report provides a "sneak preview" for the primary if not sole source of recovery in many cases. Therefore, all stakeholders have a lot riding on which party is entrusted with turning these claims into actual recovery for creditors.

Jeremy W. Ryan is a partner, and Ryan M. Murphy is an associate, at Potter Anderson & Corroon. Partner Laurie Selber Silverstein and associate R. Stephen McNeill contributed to this article. The firm served as counsel to the ad hoc group of creditors in In re Anderson News LLC and as counsel to certain lenders in the Tribune Co. case.

Reprinted with permission from 4/30/2012 issue of the National Law Journal© 2012 ALM Media Properties LLC. Further duplication without permission is prohibited. All rights reserved.

 

Published In: Bankruptcy Updates, Business Torts Updates, Civil Procedure Updates, Civil Remedies Updates, Constitutional Law Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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