Management of the Business Flashcards
Grounds for Appointing a Trustee: Burden of Persuasion (Tradex Corp v. Morse)
- The party seeking appointment of a trustee bears the burden of persuasion.
- The appropriateness of the decision to appoint a reorganization trustee under §1104 turns upon whether there was a sufficient showing of cause, including incompetence or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or in the alternative, a showing that the appointment would be in the best interests of the creditors and the estate.
- Standard of Proof:
1) Many courts require a showing of clear and convincing evidence supporting the motion
2) Others say preponderance of the evidence
3) Whether the party has met its burden has consistently been left within the discretion of the court
Grounds for Appointing a Trustee: Factors to Consider (In re Ionsophere Clubs)
- Factors to consider in appointment of a trustee (this falls under the best interest of creditors consideration). 1104
1) Trustworthiness of debtor
2) DIP’s past and present performance, prospects for rehab
3) Confidence of business community and creditor in present management
4) Benefits derived from trustee vs. the cost of the appointment
§ 1104: Appointment of Trustee or Examiner
- (a) A court shall appoint trustee or examiner after notice and a hearing on request of party in interest or by US Trustee between order for relief and before confirmation,…
a. (1) for cause - fraud, dishonesty, incompetence, or gross mismanagement, or similar cause, but not for the number of shareholders or the amount of assets/liabilities; or
b. (2) if it is in the interest of creditors, equity holders, and other interests of the estate. (cost/benefit test analysis) - (b) Within 30 days of court order, US trustee and creditors meet to elect one disinterested person to serve as trustee. (In reality, the US Trustee selects the trustee, and the court confirms. If a party requests it, the US Trustee must convene a committee of creditors to elect a trustee. This done so that a judge won’t show favoritism to a trustee he picked.)
i. Note: § 1109(b) defines a party in interest, and it doesn’t include the court. But recent amendment and case law allows the court sua sponte appointment power.
3.(c) Court shall appoint an examiner upon request of interested party and after notice and hearing for (1) best interest of creditors/equity holders/other interests of the estate, or (2) if unsecured debts > $5MM (other than debts for goods and services, taxes or owing to an insider).
Can a debtor become a DIP and serve along with the Trustee?
- It is impossible for a trustee and DIP to exist together. The debtor is the DIP (§ 1101(1)), and there can be a trustee and debtor, but not trustee and DIP together. §1121(c)
- Also, Appointment of a trustee terminates the exclusivity period of debtor to file plan w/in 120 days of order for relief.
What are some reasons that creditors may not want to get rid of management?
- Costs – appointing a trustee is expensive
- Also, if management knew that they would be replaced as soon as petition is filed, an incentive to not file until too late is created
- Belief that management is left in the hands of those who know the business the best, thus would know how to save it
What are some situations where the court has ordered the appointment of a Trustee?
i. Systematic siphoning of assets to other companies under common control
ii. Court lost confidence in management candor and ability to formulate confirmable plan
iii. Relationship of management and creditors is hostile
iv. Board of directors deadlocked
v. Failure to manage – no internal accounting controls, deceptive trade practices
vi. Failure to maintain books and records, paid expenses from funds withheld for taxes and union dues from employee payroll checks
vii. Failure to pay prop, sales and other taxes
viii. Failure to insure and maintain estate property
ix. Debtor concealed assets
x. Fraudulent transfers on eve of filing
What does the Trustee do?
i. Account for all property received – encompassing a duty to appear on behalf of the estate to assert or defend claims by or against the estate
ii. Examine proofs of claims and object to the allowance of improper claims
iii. Furnish info concerning the estate as requested by part in interest
iv. File periodic reports regarding the operation of the business to the court, the UST, and tax authorities
v. Make final report and file final account of the administration of the estate with the court and the UST
vi. File schedules required by §521(1) if the debtor has not done so (not applicable to DIP)
1. List of creditors
2. Schedule of assets and liabilities
3. Schedule of current income and expenditures
4. Statement of the debtor’s financial affairs
vii. Investigate and report on the acts of the debtor, operation of debtor’s business, and the desirability of the continuance of the business
1. DIP is exempt from investigating and reporting on its own affairs and conduct
2. Investigation may be undertaken by an examiner, or by creditors’ or equity holders’ committee
viii. File plan of reorganization as soon as practicable
ix. Furnish tax info to tax authorities for years in which the debtor filed no tax return
x. Meet and work with the creditors’ committees
xi. Collect and transmit withholding taxes
xii. Make diligent inquiry into facts that would require the court to deny an application for allowance of compensation to professionals
xiii. Appear and submit to examination under oath as ordered by court
i. Trustees fees are subject to approval by court and it has to be disinterested; But this doesn’t apply to DIP
What are the grounds for the appointment of an Examiner?
i.1104(c)- Even if the court does not appoint a trustee, at any time BEFORE the confirmation of a plan on request of a party in interest, AND after notice and hearing, the court shall order the appointment of an examiner when:
- The appointment is in the interest of creditors, equity holders, or other interests of the estate; or
- On motion of party where the debtor’s fixed, liquidated, unsecured debt exceeds $5mil (court must approve under this circumstance)
- to investigate any alleged 1) fraud, 2) dishonesty 3) incompetence 4) misconduct, 5) mismanagement 6) or irregularity in the management of affairs of current OR former management of the Debtor
Is there a Right for s/hs to elect directors while DIP is in place? (In re Johns Manville)
- Yes, but not unlimited .the right of calling an annual mtg should be constrained if those trying to call the mtg are engaging in substantial abuse.
- To block such a meeting, there must be a showing that the s/h’s desire to cal a mtg is motivated by some unwholesome goal ( to sabotage the plan or cause irreparable harm to the plan).
- Court disfavors called meetings with the goal of electing new board members for the sole purpose of disrupting a propose plan.
Is there a Right for s/hs to elect directors while DIP is in place? (In re Lifeguard Industries)
- Courts usually prefer to allow shareholders to control their corporations, but in ch. 11, courts consider the experience of the proposed directors and will disallow the election of new directors with no relevant experience in order to protect the interest of the creditors.
- Court seems to assume that the exclusive period belongs to management, so if management changes, the exclusivity would remain with whoever is in management
POWERS AND DUTIES OF TRUSTEES AND DIPS: § 1108
Trustee may operate the debtor’s business (unless there the court orders otherwise after a request, notice and hearing) . So technically, the trustee doesn’t have to operate the business - he can opt to liquidate it.
POWERS AND DUTIES OF TRUSTEES AND DIPS: § 1107a
DIP has all rights and powers of trustee (other than compensation of officers under §330), subject to court’s limitations.
POWERS AND DUTIES OF TRUSTEES AND DIPS: 28 USC § 959
Trustee must comply with State (non-bankruptcy) laws.
Authority to Operate the Business: Can the management structure regarding attorney-client privilege of a corporation stay in place with a Trustee?(CFTC v. Weintraub)
- No, The appointment of a Trustee stops the stockholder - board of directors - officers chain of command. All must go through the trustee. Directors no longer maintain control over the corporation when there is trustee. Trustee will work to best manage the debtor’s estate. Trustee has fiduciary duty to both creditors and shareholders.
- Management authority is transferred to the trustee, who plays the role most closely analogous to that of a solvent corp’s management (including ability to waive legal priviliges0 ;In contrast, when debtor remains in possession, the debtor’s directors retain their managerial role
