Chapter 11

Proposal #16 Elimination of Mandatory Appointment of Examiners When Unsecured Debts Exceed $5,000,000

Under section 1104(c) of the Bankruptcy Code, the court must order the appointment of an examiner if an independent investigation would be in the interests of parties in the bankruptcy case, especially in a situation that potentially involves fraud, dishonesty, incompetence, or misconduct in the debtor’s management of the estate’s affairs. However, under section 1104(c)(2), the court also is required to order the appointment of an examiner on the request of a party in interest if the debtor’s fixed, liquidated, unsecured debts to non-insiders exceed $5,000,000, regardless of whether there is any indication of mismanagement or wrongdoing or whether an investigation would further the interests of creditors and other parties. This mandatory provision triggered only by debt is arbitrary and unnecessary because it duplicates the substantive triggers already in place. Rather than helping to protect the estate, it more likely serves as a strategic tool to cause delay and to increase costs.

The Recommendation

Congress should eliminate section 1104(c)(2), which requires the court to order appointment of an examiner upon the request of a party in interest if the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes or owing to an insider, exceed $5,000,000.

Reasons for the Change

At best, this provision is superfluous of the requirement to order appointment of an examiner in the interest of the estate and the estate’s creditors, particularly when an investigation of potential fraud or mismanagement is necessary. At worst, however, this provision permits parties to seek the appointment of an examiner in the absence of any need for an examiner to make an investigation. Such requests can be used as leverage and delay tactics by a few creditors seeking to serve their own interests rather than furthering the interests of the estate and the creditor body overall. A creditor who can threaten to demand an examiner and know that its demand will be granted without any showing of a legitimate purpose can enhance its own treatment in exchange for withdrawing its demand. For this reason, some courts observing misuse of this provision have denied relief based on waiver or laches when a request is made very late in the case without a legitimate reason for the delay and when there is no evidence that a third-party investigation is warranted. [ FN: See, e.g.In re Bradlees Stores Inc. 95 B 42777, Slip Op. (Bankr. S.D.N.Y. June 4, 1997) (creditors waived right to seek appointment of examiner by waiting until conclusion of thirteen month investigation by debtor ’s professionals); see alsoIn re Schepps Food Stores Inc., 148 B.R. 27, 30 (S.D. Tex. 1992) (party in interest may waive right to seek appointment of examiner);In re Shelter Resources Corp., 35 B.R. 304 (Bankr. N.D.Ohio 1983) (refusing to appoint examiner under this provision after court approved settlement of action at issue).] However, a literal reading of section 1104(c)(2) does not leave roomfor discretion when the debt floor is satisfied. [ FN: SeeIn re Revco D.S. Inc., 898 F.2d 498 (6 th Cir. 1990) (because provision is mandatory and automatic, reversing lower court decision denying motion for appointment of examiner under this provision as duplicative of other investigative efforts), rev ’g 93 B.R. 119 (Bankr. N.D. Ohio 1988).] Particularly in large chapter 11 cases, creditors’ committees and their professionals provide a check on management and serve routine investigative functions until a particular situation is suspected that would justify the appointment of an independent examiner.

The participants in the June plenary session unanimously agreed that section 1104(c)(2) is neither helpful nor necessary to preserve the authority of the court to order the appointment of an examiner in instances when the appointment would serve the interests of parties in the case.

Competing Considerations

This proposal appears to enjoy overwhelming support, and no competing considerations are immediately apparent.