Contributed by Sunny Singh
On September 30, 2010, in the chapter 11 cases of Innkeepers USA Trust, Bankruptcy Judge Chapman of the United States Bankruptcy Court for the Southern District of New York was presented with, but determined she did not have to decide, the issue of whether section 1104(c)(2) of the Bankruptcy Code mandates the appointment of an examiner.  The decision is the latest in a series of decisions in which bankruptcy courts have interpreted the statute in a manner that brings flexibility to a seemingly rigid standard.

Section 1104(c)(2) provides that “the court shall order the appointment of an examiner to conduct 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 $5,000,000.”  One district judge in the Southern District Court of New York has held that, on its face, section 1104(c)(2) mandates the appointment of an examiner if the $5 million unsecured debt threshold is satisfied.  In re Loral Space & Communications Ltd., 2004 U.S. Dist LEXIS 25681, at *12-14 (S.D.N.Y. Dec. 23, 2004).  The Loral court acknowledged, though, that the bankruptcy court has considerable discretion in designing the examiner’s role.
Two recent decisions from the Delaware bankruptcy court, however, have held that section 1104(c)(2) does not automatically require the bankruptcy court to appoint an examiner if the $5 million unsecured debt threshold is met.  See In re Spansion, Inc., 426 B.R. 114, 128 (Bankr. D. Del. 2010), and In re Visteon Corp., Case No. 09-11786 (Bankr. D. Del. May 12, 2010).  These decisions note that the statute requires the appointment of an examiner “to conduct an investigation of the debtor as is appropriate.”  Under these cases, the bankruptcy court always retains the discretion to refuse to appoint an examiner whether or not the $5 million unsecured debt threshold has been satisfied.
Other courts have reconciled the seemingly mandatory language “shall order” with the discretionary language “as is appropriate” and found that examiners with no duties may be appointed.  See In re Erickson Retirement Communities, LLC, 425 B.R. 309, 317 (Bankr. N.D. Tex. 2010); In re Asarco, LLC, Case No. 05-21207 (Bankr. S.D. Tex. Mar. 4, 2008) [Docket No. 7081].  Those cases hold that the appointment of an examiner is mandatory where the $5 million unsecured debt threshold is satisfied, but the scope of the examiner’s duty, i.e., what is appropriate, is discretionary.  Consequently, although the court must appoint an examiner, it may assign no duties where it finds that there is no appropriate investigation to be conducted.
The mandatory appointment of an examiner can have serious consequences in a large chapter 11 case where the $5 million unsecured debt threshold would almost always appear to be satisfied.  Not only is an examiner an expensive proposition, but the time that will be needed to allow the examiner and his or her professionals to conduct a thorough investigation and prepare a meaningful report could significantly interfere with the case and delay a debtor’s exit from bankruptcy.  Generally, the purpose of an examiner is to investigate prior acts of the debtor, not to monitor a debtor’s administration of the case or play a role in plan issues.  Where no fraud, misconduct, mismanagement or irregularity in the operations of the debtor is evident, a motion seeking the appointment of an examiner is often less about investigation and information than it is a means of one or more creditors or equity interest holders obtaining leverage in a case.
In  Innkeepers, a group of preferred shareholders moved for the appointment of an examiner.  In addition to requesting an investigation of the prior acts of the debtors, the preferred shareholders requested that the examiner investigate how value for the preferred shareholders and unsecured creditors could be maximized, which is not a typical role for examiners.  The debtors and other parties raised many of the arguments in opposition to the motion that have been adopted recently by courts outside the S.D.N.Y.  Because of the Loral decision, though, Judge Chapman faced a more difficult issue.  In Innkeepers, she concluded that she did not need to address the existing S.D.N.Y.  precedent because the preferred shareholders had failed to establish that the debtors had fixed, liquidated, and unsecured debts, other than trade debt and insider debt, exceeding $5 million.
Although the Innkeepers debtors had non-trade debt in excess of $1.2 billion, all such debt was secured by prepetition security interests.  The debtors’ chief financial officer stated in a declaration that “the debtor’s fixed, liquidated, unsecured debts other than debts for goods, services, or taxes do not exceed $5,000,000.”  The preferred shareholders did not proffer any evidence in support of their motion, but, instead, argued that, because section 506(a) of the Bankruptcy Code limits secured claims to the value of the debtor’s interest in the collateral, it would be reasonable to assume that the debtholders would have unsecured deficiency claims in excess of $5 million.  Judge Chapman rejected this argument.  She concluded that, although deficiency claims are unsecured, section 1104(c)(2) unambiguously requires that the debts also be “fixed and liquidated.”  At this juncture in the Innkeepers cases, the deficiency claims of the secured creditors are contingent until the court determines them, or the parties agree on value.
Colorable arguments may be made for both interpretations of the statute.  The better policy for the efficient administration of chapter 11 cases is that the appointment of an examiner should not be mandatory, but rather for good cause.  If the appointment of an examiner were mandatory, where a court does not believe that an examiner is necessary and could possibly prejudice the interests of all stakeholders, the only avenue appears to be to appoint an examiner with little or no duties or one that has a limited budget for his or her investigation.  While such a solution appears to be an exercise in futility that could not have been intended by Congress, another chapter 11 case in the S.D.N.Y. may force the bankruptcy court to address the Loral decision head on in a case where the $5 million unsecured debt threshold is satisfied.  The Innkeepers debtors cited authority for the proposition that the bankruptcy court was not bound by a decision of a single district judge in a multi-judge district unless all judges in that district have ruled consistently on the same issue or if the Second Circuit or Supreme Court have addressed the matter.  See In re Jamesway Corp., 235 B.R. 329, 337 n. 1 (Bankr. S.D.N.Y. 1999); In re Finley, Kumble, Wagner, Heine, Underberg, Manley, Meyerson & Casey, 160 B.R. 882,898 (Bankr. S.D.N.Y. 1993).  Innkeepers shows, though, that so long as parties are able to limit the effect of Loral while staying within the “mandatory” provisions of the statute, such a direct challenge to Loral may not be likely.