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Bankruptcy Courts Don’t Need to Hold an Evidentiary Hearing in Order to Appoint a Chapter 11 Trustee

The U.S. Bankruptcy Code allows debtors to stay in control of their businesses in chapter 11.  But the Code also empowers bankruptcy judges to replace a debtor’s management in certain circumstances with an outside trustee.  This will happen if either cause exists to expel management or appointing a trustee is in the best interests of creditors, any equity holders, and other interests of the estate.  11 U.S.C. § 1007.  Judges don’t need to hold an evidentiary hearing to appoint a trustee, but the decision to do so must be based on clear and convincing evidence.

An example of how courts can rely on evidence without holding an evidentiary hearing arose in a recent case in New Jersey.  MicroBilt Corp. v. Ranger Specialty Income Fund (In re Princeton Alt. Income Fund), No. 3:18-cv-16557, 2019 U.S. Dist. LEXIS 205745 (D.N.J. Nov. 27, 2019).

Princeton Alternative Income Fund, LP is a Delaware limited partnership that makes loans to consumer finance companies.  Princeton Alternative Funding, LLC is its general partner.  In March 2018, both entities filed for chapter 11.  An unsecured creditor filed a motion to appoint a chapter 11 trustee.  After the motion was granted, a trustee was appointed to replace management. 

Another creditor appealed the bankruptcy court’s ruling, arguing that there was insufficient evidence to support the decision.  The appellant also asserted that the bankruptcy court erred by granting the motion without holding an evidentiary hearing. The district judge affirmed the bankruptcy court, ruling that judges need not hold an evidentiary hearing in order to appoint a chapter 11 trustee.  Even so, the decision to replace management with a trustee must be based on sufficient evidence.

That the statute requires having sufficient evidence, but does not require an evidentiary hearing, is widely accepted in the case law.  The cases found and cited by the district court in the Princeton decision reached this conclusion.  2019 U.S. Dist. LEXIS, * 6-7.  A bankruptcy court can appoint a trustee after “notice and a hearing.”  11 U.S.C. § 1104.  And that means, “after such notice as is appropriate in the particular circumstances and such opportunity for a hearing as is appropriate in the particular circumstances.”  11 U.S.C. § 102(1)(A).  But an actual evidentiary hearing isn’t required by the statute.

A court considering a request to appoint a trustee must consider the “totality of the circumstances.’’ 2019 U.S Dist. LEXIS 205745, *6.  Courts have “wide discretion” but, as noted above, the evidence favoring the appointment of a chapter 11 trustee must be “clear and convincing.”  “[A] bankruptcy court must simply find in its discretion that appointment for a trustee is warranted.”  Id., *10.

In Princeton, the bankruptcy court cited the “history of the proceedings” and the “conduct of the parties.”  The court had seen “acrimony” between the parties – “deep-seated conflict and animosity,” “serious conflicts,” potential “gridlock,” “friction” and “legalistic bickering.” Id. More specifically, the debtors and creditors had shown “extreme animosity toward one another as evidenced by, among other things, their frequent discovery disputes, the ongoing litigation [in] many jurisdictions[,] and numerous accusations of wrongdoing both pre-and post-petition.”  Id.

The district court concluded that the “Bankruptcy Court properly took judicial notice of each of the items of evidence on which it relied to find that the appointment of a chapter 11 trustee would be in the creditors’ best interest.”  Id., *11.  In light of the factors cited, it was unnecessary for the bankruptcy court to hold an evidentiary hearing.  “The Bankruptcy Court possessed the quantum of evidence necessary to support its findings under § 1104(a)(2).”