What’s it worth to learn from prior mistakes or misdeeds?
For interested parties in most large Chapter 11 cases, apparently not much.
Bankruptcy “examiners” are private individuals appointed by the Office of the Unites States Trustee at the direction of a Bankruptcy Court to investigate and report on the causes of a company’s failure.
Chapter 11 of the Bankruptcy Code provides that examiners “shall” be appointed if requested in any case involving, among other things, more than $5 million in certain types of unsecured debt. In creating this position, Congress apparently expected examiners to be ubiquitous in the reorganization of large, public companies.
Nevertheless, it simply ain’t so. Anyone with restructuring experience can attest to the truisim that examiners are a rarity in Chapter 11 cases.
Earlier this month, Temple University Professor Jonathan Lipson posted statistical analysis on the appointment of bankruptcy examiners – and why, despite the mandatory language addressing their appointment in the Bankruptcy Code – so few are, in fact, actually appointed.
In “Understanding Failure: Examiners and the Bankruptcy Reorganization of Large Public Companies,” Lipson – whose work will appear in a forthcoming edition of the American Bankruptcy Institute Law Journal – observes that examiners are rarely sought in Chapter 11 cases, and even less frequently appointed. Lipson’s docket-level analysis of 576 of the largest chapter 11 reorganizations from 1991 to 2007 shows they were requested in only 15% of cases. Despite the seemingly mandatory language of the Bankruptcy Code, examiners were appointed in fewer than half of the cases where sought, or less than 7% of the sample.
So what does it take to get an examiner appointed? Lipson summarizes the article’s findings as follows:
- Size matters. Cases in which examiners are sought are huge. The average case in which an examiner was sought was almost twice as large as the sample measured by median asset values and more than four times larger measured by mean asset values. Holding other things equal, a request for an examiner was three times more likely in a case with a debtor having at least $100 million in net assets. Cases in which examiners were appointed had mean liabilities twice the size of cases where the motions were not granted.
- Conflict matters. Cases in which examiners were sought or appointed were much more likely to be contentious, as measured by docket size and requests for chapter 11 trustees, than were cases without. Holding other things equal, a request for a chapter 11 trustee in a large case increases the odds of an examiner request by a factor of five.
- Venue matters. Examiners are much more likely to be sought—although not necessarily appointed—in the two districts that tend to have the largest cases, Delaware and the Southern District of New York (SDNY). Together, Delaware and the SDNY had forty-six (52%) of requests for an examiner, but actually appointed an examiner in only seventeen cases (about 43%). By contrast, examiners were appointed in twenty-two cases (about 57% of appointments) when requested in other districts.
- Fraud matters—somewhat. Although requests for an examiner correlated with allegations of pre-bankruptcy fraud—the paradigm grounds for an examiner—they were nevertheless rare even when a bankruptcy was precipitated by that form of wrongdoing: Of the thirty-one cases in the sample that allegedly involved fraud, examiners were sought in only nine and, of those, were appointed in only five.
- Strategy matters—somewhat. There is evidence that examiners will sometimes be sought for strategic, not information-seeking, reasons. Requests to appoint an examiner were withdrawn in fourteen cases (about 17% of requests in the sample) and rendered moot by subsequent events (e.g., plan confirmation) in sixteen cases (about 20% of requests). Judges and system participants interviewed for [Lipson's] paper indicated that they believed that, in many cases, the arguably “mandatory” language of the Bankruptcy Code produces gamesmanship,not enlightenment.
- Investors do not matter much. Notwithstanding a purported goal of protecting the “investing public,” individual investors made only eighteen requests for examiners. Far more likely to request an examiner (thirty-two cases) were individual creditors whose claims did not arise from investment securities (such as bonds) or fraud, but who apparently held claims for unpaid goods or services.
Lipson’s work provides empirically grounded insight on this little-used feature of Chapter 11, and is well worth a read.