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«Understanding Failure: Examiners and the Bankruptcy Reorganization of Large Public Companies by Jonathan C. Lipson* “An examiner’s legal status ...»

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Understanding Failure: Examiners and

the Bankruptcy Reorganization of

Large Public Companies


Jonathan C. Lipson*

“An examiner’s legal status is unlike that of any other courtappointed officer which comes to mind.”1

“While we are examining into everything we sometimes find

truth where we least expected it.”2


How do we learn from—and about—our mistakes?

When a business succeeds, it will be in a position to tell the world how and why it built a better mousetrap. Success has a thousand parents. Failure, however, is an orphan—for good reason. Business failures reflect mistakes of judgment, timing, execution, serious wrongdoing, or simple bad luck.

Whatever the reason, few of us want to crow about our defeats. Even fewer would want to pay someone to do it for us. Yet, chapter 11 of the United *Peter J. Liacouras Professor of Law (2009-2014), Temple University—Beasley School of Law. This paper has benefitted from the comments and suggestions of Jane B. Baron, Christina L. Boyd, Scott Burris, Margaret Clements, Hon. Robert Gerber, David Hoffman, Kathleen Noonan, Robert Lawless, Lynn LoPucki, Stephen Lubben, Andrew Martin, David Rubin, M.D., Jonathan Scott, Hon. Mary Walrath, Ray Warner, Elizabeth Warren, Hon. Eugene Wedoff, Jay Westbrook, and Bill Whitford. Administratively, Assistant Deans Deborah Feldman and Shyam Nair, librarians John Necci and Noa Kaumeheiwa, and legal assistants Erica Maier and Michael Foley, all of Temple Law School, were of great help. Temple Law School students Katherine Malia, Anna Pikovsky, Susan Tull and Chris DiVirgilio provided excellent research and data collection assistance.

Earlier versions of this paper were presented at the Harvard/Texas Commercial Realities Workshop and a joint program of the National Conference of Bankruptcy Judges and the Association of American of Law Schools. The research for this paper was funded in major part by the Endowment of the National Conference of Bankruptcy Judges (the “Endowment”). In funding the grant, the Endowment does not endorse or express any opinion about the methodology utilized, or any conclusions, opinions, or results contained herein. The data used in this paper are available from the author, at jlipson@temple.edu. All errors or omissions are the author’s.

In re Baldwin United Corp., 46 B.R. 314, 316 (Bankr. S.D. Ohio 1985).

MARCUS FABIUS QUINTILIAN, INSTITUTES OF ORATORY XII.8.10 (Lee Honeycutt ed., John Selby Watson trans., Iowa State University 2006) (1856), available at http://honeyl.public.iastate.edu/quintilian (“for, by searching into every particular, we sometimes discover truth where we least expected to find it”).

–  –  –

States Bankruptcy Code, the principal legal mechanism for resolving business distress under U.S. law,3 was predicated in part on creating a mechanism for doing just that, through the role of the “examiner.” Examiners are private individuals appointed by the United States Trustee at the direction of a bankruptcy court to investigate and report on alleged acts of pre-bankruptcy mal- or mis-feasance when a company seeks protection under chapter 11.4 Congress created examiners to provide “special protection for the large cases having great public interest... to determine fraud or wrongdoing on the part of present management.”5 Examiners have played important, often controversial, roles in many of our most recent, high-profile bankruptcy cases, including Enron,6 Worldcom,7 Refco,8 Mirant,9 New Century,10 Lyondell Chemical,11 and Lehman Brothers.12 Their investigations on occasion have cost millions of dollars13 and resulted in major lawsuits or settlements.14 The central questions about examiners are, in a sense, existential: When will they be sought and appointed? Many read the Bankruptcy Code to mean that an examiner must be appointed if sought in a case with a “large” debtor. Bankruptcy Code § 1104(c)(2) provides that “on request of a party in interest... the court shall order the appointment of an examiner to conThe current version of the Bankruptcy Code was originally enacted in 1978, (Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549), and has been amended several times, including in 2005, in ways that indirectly affect the appointment of examiners. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Pub. L. No. 109-8, 119 Stat. 23 (codified as amended in scattered sections of 11, 18, 28 U.S.C.). These amendments are discussed in Part 1.5, infra.

This paper analyzes examiners appointed under Bankruptcy Code § 1104(c)(2), not so-called “fee examiners” appointed to monitor the costs of professionals in certain large cases.

124 CONG. REC. S17403-34 daily ed., Oct. 6, 1978 (quoted in COLLIER ON BANKRUPTCY, App.

14.4(f)(iii) (15th ed., Rev 2002)) [hereinafter COLLIER] (statement of Senator DeConcini).

In re Enron Corp., No. 01-16034 (Bankr. S.D.N.Y. 2001).

In re Worldcom, No. 02-13533 (Bankr. S.D.N.Y. 2002).

In re Refco, Inc., No. 05-60006 (Bankr. S.D.N.Y 2005).

In re Mirant Corp., No. 03-46591 (Bankr. N.D. Tex. 2003).

In re New Century TRS Holdings, Inc., No. 07-10416 (Bankr. D. Del. 2007).

Transcript of Hearing Before the Honorable Robert E. Gerber, at 35, In re Lyondell Chemical Co., No. 09-10023 (REG) (Oct. 26, 2009) (docket no. not available)(transcript on file with author) [hereinafter, Lyondell Transcript].

In re Lehman Brothers Holdings, Inc., No. 08-13555 (Bankr. S.D.N.Y.). The 9-volume, 2000+page examiner’s report in Lehman Brothers was released as this article was going to press. It was not possible to review that report for this discussion. See Report of Anton R. Valukas, Examiner, In re Lehman Brothers Holdings, Inc., No. 08-13555 (Bankr. S.D.N.Y. Mar. 11, 2010), available at http://lehmanreport.jenner.com (last visited Mar. 15, 2010).

See Anthony Lin, Enron Examiner Billed Estate for $100 Million: Batson Seeks End of Appointment for Inquiry, N.Y.L.J., Dec. 5, 2003, at 1. See infra text at Part 2.2.5.

The Enron examiner’s fee application describes billions of dollars worth of claims discovered and notes subsequent litigation involving over a billion dollars of such claims. Examiners’ Fee Application, at 4n. 5, In re Enron Corp., No. 01-16034, (Bankr. S.D.N.Y. Oct. 29, 2004) (No. 21686). Examiners’ fees in R the Enron case are discussed in note 214, infra.

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duct such an investigation of the debtor as is appropriate... if... the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5 million.15 Senator DeConcini, addressing the legislation that became the Bankruptcy Code, said he believed that examiners would be appointed “automatically” in any large case in which a trustee was not appointed.16 The only U.S. Court of Appeals to have considered the issue apparently agreed,17 and other courts have followed suit.18 It is thus not surprising that some commentators claim that examiners are “routinely” sought and appointed in large cases.19 Yet, judges are often reluctant to appoint an examiner if there is no apparent benefit to the estate or if a party requests one for transparently strategic

reasons.20 Judge Gerber recently railed against the seemingly mandatory lanU.S.C. § 1104(c)(2) (emphasis supplied) provides in full as follows:

(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.

See S. 17404 (daily ed. Oct. 6, 1978) (“There will automatically be appointed an examiner in [large cases], but not a trustee.... I am convinced that debtor and creditor interests, as well as the public interest, will be preserved and enhanced by these provisions”) (statement of Sen. DeConcini).

In re Revco D.S., Inc., 898 F.2d 498, 501 (6th Cir. 1990); (“Section 1104(b)(1), which governs the appointment of an examiner when the total unsecured debt is less than $5 million, follows the language of § 1104(a) [the appointment of a trustee]; in both cases the appointment is left to the bankruptcy court’s discretion. The contrast with § 1104(b)(2) could not be more striking. When the total ‘fixed, liquidated, unsecured’ debt is greater than $5 million, the statute requires the court to appoint an examiner.”).

See, e.g., In re Loral Space & Commc’ns, Ltd., 2004 WL 2979785 (S.D.N.Y., Dec. 23, 2004) (holding appointment mandatory) rev’g 313 B.R. 577 (Bankr. S.D.N.Y. 2004); In re UAL Corp., 307 B.R. 80 (Bankr.

N.D. Ill. 2004) (same); In re Schepps Food Stores, Inc., 148 B.R. 27 (S.D. Tex. 1992) (same); In re Mechem Fin. of Ohio, Inc., 92 B.R. 760 (Bankr. N.D. Ohio 1988) (same); In re The Bible Speaks, 74 B.R. 511 (Bankr.

D. Mass. 1987) (same); In re 1243 20th St., Inc., 6 B.R. 683 (Bankr. D.D.C. 1980) (same); In re Lenihan, 4 B.R. 209 (Bankr. D.R.I. 1980) (same).

See, e.g., A. Mechele Dickerson, Privatizing Ethics in Corporate Reorganizations, 93 MINN. L. REV.

875, 903 (2009) (“Whether or not examiners must be appointed in large business Chapter 11 reorganizations, they routinely are appointed in these cases....”); Stanley A. Kaplan, The Role of Examiner: Some Observations, 4 BANKR. DEV. J. 439, 439 (1987) (claiming that examiners were “being appointed in most major reorganizations and [that] the role of the examiner [became] a rather significant one.”). See also Elizabeth Warren & Jay L. Westbrook, Examining the Examiners, 24 AM. BANKR. INST. J. 34 (May 2005) (“Reading recent cases about examiners, we were having trouble finding a standard by which to understand the analysis, so we cheated and looked at the relevant provisions of the statute. We came away thinking that the courts and the academics may have lost track of just what Congress said.”).

See, e.g., In re Bradlees Stores, Inc., 209 B.R. 36 (Bankr. S.D.N.Y. 1997) (waiver of right to appoint an examiner by delay in seeking appointment); In re Am. Home Mortgage Holdings, Inc., No. 07-11047 (CSS) \\server05\productn\A\ABK\84-1\ABK101.txt unknown Seq: 4 29-MAR-10 7:17 4 AMERICAN BANKRUPTCY LAW JOURNAL (Vol. 84 guage of the statute. “[M]andatory appointment [of examiners] is terrible bankruptcy policy,” he noted in the Lyondell Chemical case, “and the Code should be amended, forthwith, to delete § 1104(c)(2), and to give bankruptcy judges (subject to appellate review, of course) the discretion to determine when an examiner is necessary and appropriate, and whether a request for an examiner is merely a litigation or negotiating ploy.”21 Many would agree with the view that one should not be able to “cry ‘examiner’ in a crowded case, [and] get one.”22 Although there is a wealth of empirical data on business bankruptcy,23 there has been no attempt to understand the pattern in the appointment of examiners. This paper helps to fill that gap. A review of dockets from 576 of the largest chapter 11 cases commenced between 1991 and 2007 indicates that examiners were requested in only eighty-seven cases, or about 15% of the sample.24 The motions were granted in only thirty-nine cases, less than half of cases where sought, and about 6.7% percent of all cases in the sample.25 The takeaway point is clear: Examiners are neither “routinely” sought nor “automatically” appointed in large cases.

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