Request by Party in Interest

A court ordinarily will not proceed sua sponte to consider the appointment of a trustee.  Normally a request must be made by a party in interest.  Parties in interest include:

• Secured and unsecured creditors;
• Any equity security holders;
• The debtor; and
• Any representative committees appointed by the court under section 1102.

In the absence of an application by a party in interest requesting the appointment of a trustee to manage the bankrupt's estate, the debtor will continue in possession throughout the reorganization proceedings.

Timing of Request

Timing of the request is critical to its success or failure. Section 1104(a) allows for the appointment of a trustee "at any time after the commencement of the case but before confirmation of a plan."  Although the standard of appointment does not theoretically vary over time, particular care ought to be taken to avoid either premature or overdue requests.

Premature Filing

An application for trustee should not be submitted before a meeting of the creditors and various other parties in interest to examine the debtor pursuant to Bankruptcy Rule 2004.  Moreover, an attack upon the feasibility of reorganization under the debtor in possession will not succeed during the exclusive period of 120 days granted to the debtor by section 1121(b).  To be successful, counsel should proceed cautiously, taking pains to establish a thorough factual record through the procedural mechanisms afforded by the Code.

Overdue Filing

The closer the court comes to confirmation of a reorganization plan or a final disposition of the case the less likely it will be to find the cost of a trustee worthwhile.  In addition, a creditor may risk a further depletion of the estate's assets by waiting to request replacement of a suspect debtor.  Necessity often dictates expeditious action on the part of concerned parties anxious over diminishing returns on their investment.  A party moving for the appointment of a trustee must balance this risk of continued loss against the needs of presenting a clear and convincing case on its behalf.

Existence of Consensus

In considering its motion a party ought to anticipate the position of other parties in interest to the proceedings.  The perception of a single disgruntled individual unhappy with its treatment at the hands of the debtor in possession or at the hands of other more powerful parties is unlikely to move a court toward a position favorable to the appointment of a trustee.  In an effort to keep the costs of administration down and to avoid undue delay in resolving the uncertain status of the bankrupt the Code generally encourages consensus-building among parties.  Section 1129(b), the so-called cram-down provision, is just one example where the Code provides the court with the ability to override a dissenting party in the interests of expediency.  To be convinced of the "extraordinary remedy" of a trustee, the court prefers agreement among the parties as to its need.  It therefore behooves the moving party to establish the positions of the other parties in interest in advance of the motion and to attempt to form some consensus as to the need for a trustee.

The Nature of the Business

A party moving under section 1104(a) must consider also the nature of the debtor business, the degree of its complexity, and the ease with which control of the business can be transferred.  For instance, if the debtor business is so idiosyncratic and personal that it cannot be run by another, then a court, depending on the cause shown, will probably not appoint a trustee with managerial responsibilities.  Alternatively a court will not hesitate to appoint a trustee "for cause" when the business is a simple retail operation and when a trustee could be expected to run the business without difficulty.

Industry Complexity

Industry complexity is equally a deterrent to the appointment of a trustee.  The greater the degree of complexity in a debtor business, the greater the costs are of locating and training a trustee to run it.  Specialized fields may be particularly troublesome.  Finally, the logistics of the transfer of control itself must be such that it can be performed efficiently and with due speed.  Accordingly a party moving for the appointment of a trustee must have a thorough understanding of the debtor business to factor properly all the attendant costs of displacing management.

Presumption of Debtor's Continuing Possession

In a Chapter 11 case the presumption is that the debtor will continue in possession.  The theory is that the debtor knows the most about the business in which it is engaged and is best able to perform the duties of reorganization outlined by the Code.  The appointment of a trustee typically necessitates the displacement of current, experienced management with those presumably less familiar with the business situation.  The appointment of a trustee, occurring as it does at a time when the enterprise in itself is usually tottering on the brink of financial collapse, is generally considered an extraordinary remedy to be awarded judiciously.

Moving Party Bears Burden of Proof

A party moving for the appointment of a trustee therefore bears the burden of proof.  To displace current management the moving party must submit evidence at a hearing suggesting that the debtor in possession is either unable or unwilling to manage the estate according to the dictates of the Code.  Section 1104(a) can be read in part as policing those requirements of the Code pertaining to the role of the debtor in possession has substantially departed from its assigned role.

Duties of a Debtor in Possession

The debtor in possession does not operate as it did before the filing of the reorganization petition, unfettered and without restraint.  Pursuant to section 1107 the debtor in possession must perform the following functions:

• Continue the day-to-day operation of the business for the benefit of the creditors;
• Comply with the extensive information producing and disclosure provisions of the Code; and
• Formulate and file a plan of reorganization consistent with the requirements of section 1129.

In addition the debtor in possession becomes a quasi-fiduciary of the estate and is subject to the court's imposition of orders and duties.

Information Production

Perhaps the single most important task required of a debtor in possession is to keep its creditors and the court informed on the status of the business undergoing reorganization.  Full disclosure of the financial position of the debtor is necessary to determine whether the estate can operate profitably.  Information-sharing also insures against fraud in the proposal and acceptance of a plan of reorganization.  As such, it is an "absolute prerequisite" to confirmation.

The Bankruptcy Code and Rules provide that the debtor in possession make available, among other things:

• A complete list of the assets and liabilities of the estate;
• Records of receipts and the disposition of money and property; and
• Various reports concerning the progress made in the consummation of a plan.

Additionally the debtor in possession must produce any further information regarding the estate and its administration as requested by any party in interest unless the court orders otherwise.  The liberal disclosure provisions of the Code make it possible for a party in interest to lay bare the structure and organization of a debtor operating under Chapter 11 protection.

Failure To Properly File Information

The debtor in possession's repeated failure to properly file financial reports or to represent accurately its state of affairs may be grounds for cause to appoint a trustee.  At the very least any intentional or unexplained failure to file complete and accurate information is an omission contributing to cause for appointment of a trustee. Such a failure may be indicative of an underlying fraud or a possible conflict of interest.  Courts are therefore highly suspicious of inadequate books and records, sporadic filing of required financial reports, or an outright omission of relevant data.

Showing Cause To Appoint Trustee

A well-counseled party in interest will typically exhaust the discovery provisions of the Code before submitting a motion to the court for the appointment of a trustee.  Documentary evidence obtained by a party in interest may demonstrate the existence of fraud or self-dealing or the financial impossibility of reorganization.  Continued omissions may be used to show similar cause, including gross mismanagement.  Inasmuch as the record must contain "clear and convincing" proof to show cause, a party must make use of its unlimited access to all information regarding transactions involving estate assets.

Dishonest or Fraudulent Conduct

Besides the obligation to file accurate and timely financial reports, the debtor in possession also has the duty to continue the day-to-day operation of its business in the best interest of all creditors and in accordance with the orders of the court.  Although the courts are generally reluctant to displace management because of imprudent or unlucky business decisions detrimental to the interests of creditors, a court will respond swiftly when genuinely fraudulent or dishonest conduct is in evidence or when court orders are being systematically ignored.

Issues of self-interest and self-dealing on the part of the debtor in possession most often characterize the inquiry of a court.  A party in interest, therefore, ought to take particularly careful notice of the financial data of the debtor for any instances of interested transactions. Evidence of transactions or conduct that create a substantial doubt as to the loyalties of the debtor in possession, that evince a potential conflict of interest, or that fall short of a reasonable standard business management will likely move a court to appoint an independent trustee, especially in combination with evidence of failure to obey a court order.

Inability or Unwillingness To File Plan

Finally, a showing that the debtor in possession is either unwilling or unable to formulate and file a plan of reorganization may lead, in certain instances, to the displacement of current management in favor of a trustee.  Abuse of deadlines and repeated delays in filing a plan are clearly defaults of the debtor in possession's obligation to file "as soon as practicable."  An unwillingness to file may signal an underlying fraud on the creditors or a recalcitrant debtor.  An inability to file may signal the ultimate impossibility of reorganization under the debtor in possession either because reorganization is not financially possible or because the shortcomings of current management prevent it from rallying creditor support around a proposal or arrangement.  Note that the impossibility of reorganizing can also be cause for dismissal rather than displacement of management by a trustee.

Judicial Flexibility

Whether a particular case mandates the appointment of a trustee is above all a question of fact and circumstance to be answered based upon the record presented at a hearing.  N rule of law exists as to precisely where a court would or should draw the line between the appointment of a trustee and other similar remedies.  The grant of judicial flexibility and discretion under section 1104 constitutes one of the major changes in the reorganization reform of 1978.  A practitioner must therefore construct a case for the appointment of a trustee upon the needs of the situation backed by considerable documentary evidence.  A successful motion will characteristically create an overall sense of urgency or a perception that the debtor is "floundering," by building on multiple allegations of debtor misconduct.

Equitable Remedies

The bankruptcy court is a court of equity and as such eschews rigid absolutes.  Instead it looks to the practical realities involved in reconciling competing interests.  Equitable remedies, therefore, are "a special blend of what is necessary, what is fair, and what is workable."  A bankruptcy court can, for example, divide responsibilities and duties among various parties, including the debtor in possession.  When the present management is running the business at a profit and the court has reservations about whether a trustee could run the business of the debtor at all, the court may appoint a trustee only as a watchdog, reserving the managerial duties for the debtor in possession.

The Appointment of an Examiner

When a court believes that allegations of corporate fraud or misconduct are substantiated by credible evidence but believes that the expense and delay of a trustee is not fully warranted, it may appoint an examiner.  The role of the examiner is not as extensive as that of the trustee and includes none of the managerial or supervisory duties.  An examiner investigates the debtor and advises the court.  Although mere naked allegations are not enough to warrant the appointment of an examiner the court will often do so as an intermediate remedy in lieu of a trustee.

The appointment of an examiner in a reorganization proceeding is controlled by section 1104(b).  Under this provision the court will appoint an examiner:

• If "such appointment is in the interests of creditors, any equity security holders, and other interests of the estate"; or
• 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."

The "Mandatory" Appointment Clause

Commentators often refer to subsection (b)(2) as the "mandatory" appointment clause.  In fact courts enjoy very little discretion when a request for the appointment of an examiner has been made by a party in interest if the outstanding specified debts of the estates exceed $5 million.  Unlike the language of the Code governing the appointment of a trustee, subsection (b)(2) retains the so-called public company exception, thereby eliminating the need to satisfy any ostensibly judicial standard of appointment in the context of large public or private debt.

Timing of the Motion

The timing of a motion for the appointment of an examiner may not approach the importance it has in the context of a request for a trustee.  Nevertheless when some question over the extent of specified debt occurs the moving party may hold an advantage in postponing an application.  As the liquidation of claims continues over the course of the reorganization proceeding the necessary debt of the bankrupt may cross over the $5 million mark.  In addition it may not be possible at an early stage of the proceeding to prove that the cost of an examiner is in the interests of the parties.

On the other hand, as the confirmation hearing approaches a court may refuse the appointment of an examiner regardless of the amount of debt. There comes a time when an examiner would likely serve no useful purpose.  An examiner may not have sufficient time to conduct an investigation and to report its findings, and any delay of confirmation would be unwarranted.  Taken in conjunction with an unexplained lapse of time and other circumstances peculiar to the given bankruptcy proceeding, the appointment of an examiner could cause undue prejudice.  One commentator has suggested that failure to make a timely request would be a basis for denying the motion on the grounds of laches.

The examiner is a new creation brought to life by the Bankruptcy Reform Act of 1978.  Its appearance in the Code is a response to the changes made by Congress concerning the appointment of a trustee. Bankruptcy law has defined the role of the examiner to be of an investigatory and advisory nature, encompassing just those functions of the trustee under section 1106 related to the gathering, processing, and assessing of information about the bankrupt.  The examiner is essentially an independent vehicle for reinforcing and ensuring compliance with various other requirements of the Code, and by definition is a disinterested party concerned with the financial and legal viability of the debtor estate.

When an Examiner Is Needed

The need for the appointment of an examiner generally arises in two situations.  First, when important financial information is not forthcoming from the debtor in possession.  When there is no disinterested trustee in bankruptcy to supervise the flow of information among parties, and circumstances would not seem to support an appointment, an examiner may be required to correct this constructive monopoly over financial and other data that the debtor in possession controls.  A court may empower an examiner in any manner necessary to ensure information-sharing among parties.

Second, the need for an examiner may also arise when there persists any serious question over the health and long-term viability of the debtor estate.  With the broad investigatory powers vested in the examiner by the Code, a court may employ an examiner to look into the continuing financial state of the debtor, where for instance a party has recommended liquidation.  Most often courts use an examiner to investigate allegations of fraud and corporate mismanagement, and to ascertain whether the debtor ought to continue in possession.  In this context an examiner establishes an independent accounting for determining the future of the bankrupt.

When Debt Falls Below $5 Million

When the required debt of the bankrupt falls below $5 million the party moving for the appointment of an examiner must show that the appointment would be in the interests of all parties.  Although a hearing on the appointment of an examiner is typically limited in scope and not in the nature of a full adversarial proceeding, a request for an examiner must be substantiated by credible evidence.  A party requesting an examiner must present evidence - generally of some debtor misconduct in failing to comply with section 1107 - going to the needs of the specific case.

Alternatives to Examiner