Examination Day: Third Circuit Orders Appointment of Examiner for FTX

A recent decision by the Third Circuit Court of Appeals has reversed a Delaware bankruptcy court decision and directed the appointment of an examiner over the objection of the debtors and the official committee of unsecured creditors. The decision, In re FTX Trading Ltd., will provide a public accounting of the implosion of FTX, gives clarity regarding the circumstances in which an examiner will be appointed in cases, and could lead to significant complications in the FTX case.

Background

The United States Trustee filed a motion early in the FTX chapter 11 case seeking the appointment of an examiner under section 1104(c)(2) of the Bankruptcy Code. This section provides: “at any time before the confirmation of a plan, on request of a party in interest or the United States trustee … the court shall order the appointment of an examiner to conduct such an investigation of the debtor as is appropriate … if — (2) the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5,000,000.” The US Trustee argued that the appointment of an examiner was mandatory because the two statutory predicates were satisfied, as the relevant unsecured debts exceeded $5 million and a request had been made.

The debtors and the creditors committee did not dispute that both conditions were satisfied but argued that an examiner would be inappropriate and involve unnecessary cost. They noted that John Ray, an independent FTX CEO untainted by Sam Bankman-Fried and prepetition management, had been appointed to operate the debtors and was conducting his own investigation of Bankman-Fried, prepetition management and FTX’s assets. The Bankruptcy Court agreed with the objectors, finding that the statute’s “as is appropriate” provision in effect gave the court discretion to decline to appoint an examiner if it found that the appointment was not appropriate and creditors would be better served by not having an examiner appointed. The decision was appealed directly to the Court of Appeals.

The Decision

The Third Circuit reversed. It ruled that “the court shall order the appointment of an examiner” means that an examiner must be appointed if the conditions are satisfied, and that “as is appropriate” applies merely to the scope of the examiner’s appointment. It justified its conclusion by noting that an examiner’s investigation would differ from the Ray investigation in significant ways: the examiner would be disinterested (unlike the CEO of the debtors), and the examiner’s report would be made public. In addition, the examiner would be able to determine if there were any issues to be considered around the appointment of Mr. Ray or the retention of Sullivan & Cromwell as counsel to the debtors.

Analysis

The opinion contains a detailed summary of the history of the crash of FTX and the ensuing chaotic start of the case. This history might seem to be irrelevant to the opinion’s straightforward statutory plain language analysis, but it is important in buttressing the court’s policy discussion. The court appears to have appreciated the value of a public report that an examiner will provide, as distinguished from the selective disclosure from a debtor that has an interest in confirming a plan of reorganization and assembling a coalition of supporting creditors. In particular, the court noted that the examiner represents a neutral perspective and not that of any particular constituency. As the opinion stated, in what may be an oblique rebuke to the Bankruptcy Court: “In addition to providing much-needed elucidation, the investigation and examiner’s report ensure that the Bankruptcy Court will have the opportunity to consider the greater public interest when approving the FTX Group’s reorganization plan.”

This decision is likely to settle the legal question of whether an examiner must be appointed on request in large cases. As noted in the decision, there are no examiners in most large cases, mostly because no request for the appointment of an examiner is made. One way that the FTX case was unusual was that the request for the appointment of an examiner was contested, litigated and appealed.

It is too soon to know how this decision will affect the ongoing FTX case. The debtors had recently announced their intention to seek approval of a plan of reorganization in the coming months, which would require, among other things, their obtaining court approval of a disclosure statement. While the FTX opinion specifically notes that the bankruptcy court can continue with the confirmation process without waiting for the examiner’s findings or public report, it would not be surprising if the pendency of the examiner’s report casts a shadow on any proposed disclosure statement, possibly leading to delay.

Now that the decision has been rendered the focus will shift to the scope of examination and a budget. The debtors and the US Trustee are already jousting regarding the scope of the examiner’s investigation. Bankruptcy Judge Dorsey has stated that his preliminary inclination is to have the examiner start by reviewing the results of other investigations to determine what further investigations may be appropriate. This process will likely play out in the near future after which the scope of the examiner’s investigation, as well as the time frame, will be known.