This article originally appeared in the New York Law Journal.

This article discusses the circumstances that may necessitate the appointment of an examiner or trustee in a chapter 11 case. The article provides an overview of important tasks that an examiner or trustee performs and how the appointment of an examiner or trustee may benefit a debtor’s estate or creditors.

A debtor that files for Chapter 11 is referred to as a “debtor in possession.” Bankruptcy Code section 1107 empowers a debtor with the rights and powers of a trustee.

A debtor in possession will be responsible for marshaling assets, administering the business of the estate, proposing and seeking confirmation of a plan of reorganization, asserting avoidance actions to claw back property of the debtor’s estate, and distributing assets to creditors.

Courts have regularly held that a Chapter 11 corporate debtor in possession is a statutory fiduciary.

However, where a debtor is suspected of having engaged in fraud or other misconduct, parties-in-interest may not trust the debtor’s existing management to continue operating the business. As a result, parties-in-interest may move for the appointment of a trustee to replace management and take control of the debtor’s business.

Bankruptcy Code section 1104(a) permits the appointment of a Chapter 11 trustee “for cause,” including fraud, dishonesty, incompetence, or gross mismanagement either before or after the petition date or where such appointment “is in the interests of creditors, any equity security holders, and other interests of the estate.” 11 U.S.C. §1104(a).

The U.S. trustee is also required to seek the appointment of a Chapter 11 trustee when there are “reasonable grounds to suspect that current members of the governing body of the debtor, the debtor’s chief executive or chief financial officer, or members of the governing body who selected the debtor’s chief executive or chief financial officer, participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or the debtor’s public financial reporting.” 11 U.S.C. §1104(e).

In some circumstances, the court may even consider if a trustee should be appointed without waiting for a party in interest or the U.S. trustee to raise the issue. See In re U.S. Mineral Products Co., 2004 WL 1758499 (3d Cir. Aug. 6, 2004).

If a court orders the appointment of a Chapter 11 trustee, the U.S. trustee will make the appointment, subject to consultation with parties in interest. Alternatively, a party in interest may move to convene a meeting of creditors in order to elect a trustee. See 11 U.S.C. §1104(b).

Once appointed, a Chapter 11 trustee has various responsibilities. In addition to running the debtor’s business, the Chapter 11 trustee may file a plan of reorganization or recommend the Chapter 11 case be converted to a Chapter 7 liquidation or dismissed. A court can also direct the trustee to investigate and report on certain relevant matters.

A Chapter 11 trustee’s greatest responsibility is preserving the assets of the bankruptcy estate. When taking over the business for management, a Chapter 11 trustee essentially becomes the acting chief executive officer of a corporate debtor.

Accordingly, a trustee has the same discretionary authority to exercise his or her business judgment as officers and directors of any other corporation.

In addition, a Chapter 11 trustee should carefully consider the continued role (if any) of prepetition management and employees. It is generally in the best interests of the estate for a business to continue operating, so the Chapter 11 trustee should strive for a smooth transition of power.

Although the Chapter 11 trustee will want to remove all individuals involved in any misconduct, some current employees may be needed to keep the business running.

In fact, in one case in Georgia, the bankruptcy court found evidence of dishonesty and mismanagement by the debtor’s principal but allowed the principal to continue serving in an operational role—subject to the trustee’s oversight—because of the principal’s specialized knowledge and expertise. See In re Intercat, Inc., 247 B.R. 911 (Bankr. S.D. Ga. 2000).

To help discharge these duties, a Chapter 11 trustee will ordinarily retain professionals such as lawyers, accountants, bankers, and other advisors.

But a Chapter 11 trustee is not authorized to delegate all or virtually all of his or her duties. See In re Lowry Graphics, Inc., 86 B.R. 74, 76 (Bankr.S.D.Tex.1988) (holding that a trustee may not “delegate virtually all of his chief executive officer duties, or any of his specific duties as a representative of the court, without prior notice to creditors and without leave of court.”).

In sum, the appointment of a Chapter 11 trustee can be very useful when a corporate debtor’s existing leadership cannot be trusted to continue running the business. However, the actual appointment of a trustee is the exception not the rule in Chapter 11 cases.

There is a strong presumption against a trustee’s appointment, in part because it will force the estate to incur additional expenses, including the retention of outside individuals and professionals in place of existing management.

The remedy of replacing existing management is considered extraordinary, and the evidence supporting the appointment must be clear and convincing.

In the alternative, a party in interest in a Chapter 11 case may seek the appointment of an examiner.

Although the appointment of an examiner is also uncommon, bankruptcy judges must appoint an examiner upon the request of a party in interest when the debtor has more than $5 million in fixed, liquidated unsecured debt. See 11 U.S.C. §1104(c); In re FTX Trading Ltd., 91 F. 4th 148 (3d Cir. 2024).

This statutory mandate means it can be easier for a creditor to obtain the appointment of an examiner than the appointment of a Chapter 11 trustee.

The role of an examiner, however, is usually much more limited than the role of a Chapter 11 trustee. Instead of taking over management of the debtor’s business, an examiner will be tasked with investigating and reporting on allegations of fraud, mismanagement, or other irregularities within a debtor’s business.

An examiner will not prevent any ongoing misconduct, but the examiner’s independent review will seek to (i) uncover any such misconduct so it can be properly remedied, and (ii) recommend claims that can be brought to compensate the estate for misconduct.

Courts have broad discretion to determine the scope, duration, degree, and cost of an examiner’s investigation. The court may authorize wide-reaching investigations or may limit the examiner’s investigation to a narrow set of issues. The court will also approve the examiner’s budget and timeline.

In some cases, the court may require the examiner to submit a proposed workplan for approval. Parties in interest will have the right to object and seek to modify, supplement, or amend these aspects of the examiner’s investigation.

An examiner can use Rule 2004 of the Federal Rules of Bankruptcy Procedure to subpoena relevant documents and information. In many courts, a party seeking to obtain rule 2004 discovery must first file a motion with the bankruptcy court.

This can be a time-consuming process, particularly if the examiner needs to subpoena many different parties. Instead of filing separate motions, an examiner can seek blanket authority from the court to serve rule 2004 discovery. The examiner can also serve informal discovery requests to see if relevant parties will voluntarily produce documents and information.

The results of the examiner’s investigation will be made public through one or more reports filed on the court’s docket. This is a key aspect of an examiner’s appointment because while other groups, including an unsecured creditors’ committee or an independent board committee, may conduct their own investigations into the debtor’s conduct, only the examiner’s report must be made public.

The report will reveal the examiner’s investigatory conclusions, the basis for those conclusions, and sometimes recommend if claims should be brought against various parties, including the debtor’s current or former insiders.

Given the public nature of the examiner’s report, examiners regularly enter into stipulations with producing parties that preserve the producing parties’ claims of privilege and confidentiality.

If information in the examiner’s report is subject to a claim of privilege or confidentiality, the examiner may negotiate appropriate redactions with the relevant party or parties, subject to court approval.

In some cases, an examiner may also consider anonymizing certain subjects of investigation or sources of information to avoid unnecessary reputational harm.

Although the role of a Chapter 11 trustee is much broader than that of an examiner, both can have a meaningful impact on the success of a corporate debtor’s Chapter 11 case.

Anyone appointed to serve as either a Chapter 11 trustee or an examiner should carefully consider the implications of their role and the best way to execute their duties.

Mr. Lowenthal and Ms. Black represented the examiner in the FTX Bankruptcy case.