Alternative Debtor Management? Discharge Your Fiduciary Duty at $1,155 Per Hour!

Examining the “Fiduciary for Hire” and the NRA’s Bad Faith Bankruptcy

“When in doubt, mumble, when in trouble, delegate, when in charge, ponder.”

– James H. Boren, When In Doubt, Mumble: A Bureaucrat’s Handbook (1972)

Business entity debtors in chapter 11 cases come in all shapes and sizes, with varying degrees of integrity and competence in managing those entities. Debtor’s professionals, while arguably also fitting those parameters, must play the cards they are dealt—usually in financially urgent circumstances—and make real-time strategic decisions with real-world consequences. When questions arise as to integrity and competence of debtor’s management on the verge of (or already in) restructuring proceedings, there are always at least three competing goals:

1. Keeping the business as a going concern to maximize revenue—so the fewer disruptions, the better;
2. Discharging fiduciary duties by estate fiduciaries (be they a debtor-in-possession (“DIP”), committee members, estate professionals, etc.); and
3. Navigating a path to maintain some semblance of DIP control over the restructuring process, particularly when management may be “tainted,” thereby potentially requiring the debtor to clean its own house.

Alternatives to Debtor Management Found in the Bankruptcy Code

“There can be only one!”

– The Kurgan, Highlander (1986)

The Bankruptcy Code has a pretty simple menu of mutually exclusive alternatives in a chapter 11 bankruptcy to deal with questionable management: the DIP, an examiner (maybe an examiner with “special powers”), or Trustee. Bottom line, “there can be only one” with ultimate control in a chapter 11 case from the debtor’s side.

Under the Code, debtor’s counsel with the less than a snow white clean DIP is confronted with two equally unpalatable choices, either of which ultimately takes away a measure of control (by design):

1. Fight against or allow for a trustee; or
2. Fight against or allow for an examiner, including an examiner with “expanded powers” (again, not defined in the Code).

While the DIP continues with an examiner, it is still undeniably an intrusion into the DIP role as the examiner roots about investigating whatever it is they are empowered to examine. Examiners are often viewed as the opening act in the trustee appointment drama as the examiner report is used as the “road map” for trustee appointments.¹

Clever bankruptcy professionals have never been folks to simply choose from the Code’s menu. Hence, the early creation of the “channeling injunction plan trusts.”² So, it should come as no surprise that bankruptcy professionals would pioneer ways to open new avenues for managing chapter 11 cases.

“Fiduciary for Hire” (aka the CRO)

“I cheated.”

– Adm. James T. Kirk, Star Trek II: The Wrath Of Kahn (1982)

Faced with a few less than ideal choices, seasoned bankruptcy professionals created their own alternative, and bankruptcy courts have largely bought into it. One such invention coming into vogue over the last 10-15 years is the Chief Restructuring Officer (“CRO”) or the establishment of “independent” board seats or committees to put some distance between the debtor’s management that may have done questionable things and scrutiny going forward.³ For ease of reference we shall refer to both of these as the “CRO” as the concepts are the same. The CRO is not a creature mentioned in the Code, and not the subject to any Code section.

Upon filing a voluntary petition under chapter 11, the debtor automatically assumes an additional identity as the debtor in possession (DIP). DIP refers to a debtor that keeps possession and control of its assets and operates its own business while undergoing a reorganization under chapter 11, without the appointment of a trustee.

A debtor will remain a DIP until:

• The debtor’s plan of reorganization is confirmed;
• The debtor’s case is dismissed or converted to chapter 7; or
• A chapter 11 trustee is appointed.

The DIP is a general position, not a person per se, but is usually represented by the CEO or a member of the management team who assumes the separate role as a fiduciary to the bankruptcy estate with the rights and powers to perform the duties of the chapter 11 trustee. The concept of a DIP in chapter 11 cases, unsupervised formally (other than the inherent checks and balances of the system), is a unique concept in US bankruptcy law.⁴

While it’s the norm to allow the debtor to assume identity as the DIP, there are circumstances that will require the appointment of a trustee to keep possession and control operations of the business. The court, on motion by a party in interest or the U.S. Trustee, will order the appointment of a chapter 11 trustee when there is evidence of fraud, dishonesty, incompetence, or gross mismanagement, or if such an appointment is in the best interest of creditors, any equity security holders, and other interests of the estate. Not just incompetence or mismanagement, mind you. It has to be “gross” mismanagement.⁵

So how does the chapter 11 business enterprise, whose management has not exactly earned the Lee Iacocca Award for Governance Excellence, navigate the trustee/examiner minefield? Like in jiu jitsu, rather than meet an opponent’s move by resistance, proactive debtors learn to move in the direction of the parry to stay ahead of it. Hence, faced with rumblings about dishonest or grossly incompetent management, the proactive debtor files its application to employ its own hand-picked CRO. Better the devil you know, after all!

The CRO appointment, as part of the first day applications in a chapter 11 restructuring, is commonplace. Appointment is routinely granted unless there is substantial objection. They are so commonplace that many commentators view them critically as “private trustees for hire” that have no place in the Code.⁶

While academia can engage in this theoretical debate, in actual cases, there is a real-world necessity to avoid uncontrolled liquidations and maximize value for the benefit of all stakeholders. Oftentimes, appointing a trustee throws the proverbial baby out with the bathwater, with the remedy being economically much worse off than the problem it was intended to remediate.⁷

A Cautionary Tale—The Fiduciary “Gun for Hire” in the NRA Case

“Are there going to be facts that are moderately cringeworthy? The answer is yes.” 

– Gregory Garman, Esq., April 5, 2021⁸

On January 15, 2021 the National Rifle Association (“NRA”) filed voluntary petitions for relief under chapter 11 in Dallas.⁹ The filing was in response to lawsuits filed by the Attorneys General for both the District of Columbia and the State of New York, which asserted claims of misappropriation of funds, failure to provide oversight, and breach of fiduciary duty.¹⁰ The lawsuits alleged that the NRA improperly paid excessive compensation to its management and funded a series of excessive perks for the benefit of the Debtors’ insiders. These perks included paying for purely personal travel costs, the use of luxury yachts for security purposes after school shootings, and other services sometimes “gratuitously” offered to the insiders by the Debtors’ vendors, who in turn would receive above-market contracts from the Debtors.¹¹

Shortly after the NRA filed for bankruptcy, it became clear that many parties, including NRA members, donors, creditors, and vendors, were concerned by the allegations of dishonesty, incompetence, disregard of corporate governance principles, insider self-dealing, and gross mismanagement and their effects on the NRA’s reputation and ability to fulfill its organizational purpose.

“Moderately cringeworthy facts” was perhaps an understatement. For example, neither the full board nor its general counsel were advised of the chapter 11 filing until after it happened. Less than a month after the bankruptcy petition was filed, a state court judge, a longtime member, donor, and director of the NRA, filed a motion seeking the appointment of an examiner with special duties and powers under section 1104(c) of the Bankruptcy Code to investigate the governance of the NRA and the actions of its management.¹² In his motion, the judge stated:

[The] Debtors have plainly announced that the goal of these bankruptcy cases is to terminate the NRA’s corporate existence in New York and reconstitute the organization under Texas law. If successful, the Debtors wish to avoid the ongoing challenges to its corporate charter brought by the State of New York and other ongoing litigation.¹³

The judge was not opposed to the NRA moving to Texas, however, but rather filed his motion seeking to appoint an examiner out of concern “that the underlying managerial and operational problems of the NRA . . . will continue to hinder the NRA’s mission of defending and celebrating the Second Amendment of the United States Constitution.”¹⁴

Additionally, Ackerman McQueen, a former vendor and litigation adversary of the NRA, filed a motion to dismiss the  chapter 11 case or, in the alternative, appoint a chapter 11 trustee pursuant to section 1104(a) due to the NRA’s bad faith intent for initiating the chapter 11 case.¹⁵ Similar motions were filed by the NY Attorney General, District of Columbia Attorney General, and a former executive director of the NRA Institute for Legislative Action.¹⁶

On the other hand, the Official Committee of Unsecured Creditors (“Committee”) took the position that while the NRA needed changes to its governance, its current management should not be displaced by a chapter 11 trustee. However, the Committee also took the position that the NRA should retain a CRO and the appointment of an examiner was not necessary, because the Committee was already fulfilling that role.¹⁷

To top it off, amicus briefs were filed (in support of the NRA) by the States of Arkansas, Alabama, Alaska, Georgia, Idaho, Kentucky, Louisiana, Mississippi, Missouri, Montana, Ohio, Oklahoma, South Carolina, South Dakota, Utah, and West Virginia!¹⁸ The third ring of the circus was thus complete.

The NRA opposed all of the motions, but it eventually proposed (as a way to avoid the unpleasantness) the appointment of a CRO. During the trial on the motion to dismiss the case, the NRA filed an application to employ a CRO, claiming that no outside oversight of a trustee was necessary.¹⁹ The CRO contract not only proposed to pay the CRO an hourly rate of a whopping $1,155 per hour, but it also indicated that most of the authority at the NRA would remain with NRA Executive Vice President Wayne LaPierre and special management committee. (The committee comprised individuals who were the engineers of the bankruptcy filing without letting the other board members in on it. Some of them—particularly LaPierre—were purported culprits of the allegations of fraud in the pending lawsuits.) Trial testimony showed that the proposed CRO left LaPierre responsible for just about all of the business operations, including fundraising, membership, program, political and legislative affairs, and litigation matters.

The NRA’s proposed CRO retention application was essentially a fiduciary for hire at $1155 per hour. But ultimately, it was a straw man, as the CRO had no independence and continued to report to the same management team accused of malfeasance. It was in all respects a transparent attempt of the fox applying for a position as guard of the henhouse. The confidentiality requirements of the CRO contract made it impossible for the CRO to actually report any fraud or dishonesty he discovered to anyone other than the perpetrators of that misconduct. Additionally, the attorney-client privilege protected those matters from disclosure.²⁰

The CRO proposed by the NRA was in all respects a toothless watchdog—subordinate and answerable to the same people that were being accused of all the governance and financial improprieties. The CRO application was the NRA’s tactical machination to avoid the reality that management was conflicted, incompetent, and dishonest. To put it more simply, the CRO was being sent into battle with only blanks in his gun—and by design. Lots of noise and smoke, but no punch.

As pointed out by the UST, the CRO, or even an examiner, is not the same as a trustee. The powers/obligations of a trustee are statutorily imposed and cannot be delegated to a “private trustee.”²¹ This is an understandable position by the UST. That said, the CRO can, as a member of management of a debtor in chapter 11, exercise the same powers (and be subject to the same obligations) as any DIP. Properly used, the CRO becomes the embodiment of the DIP. In the NRA case, however, there was no denying what this CRO embodied. He was a shill to provide the illusion of credibility for a hopelessly conflicted management team. The attempt by the NRA was too cute by half, a clear attempt at a straw man transaction that fooled no one.²² The NRA attempted to apply lots of lipstick on the bovine, but in the glaring light of scrutiny, it was still just a cow.

The bankruptcy court ultimately dismissed the case and found the NRA’s petition in bad faith as it was filed to gain an unfair litigation advantage (in an action by the NY Attorney General to dissolve the NRA) and to avoid a state regulatory scheme.²³ As such, the CRO motion became moot. Given the judge’s ruling in the case, it is hard to believe that the CRO proposal advanced by the NRA would be likely to have succeeded even if the case was allowed to remain in bankruptcy.

Aim for the Truly Independent DIP

The NRA’s CRO motion is a cautionary tale—you cannot have your cake and eat it too. In the view of the authors, there is nothing inherently wrong with “fiduciaries for hire.” That said, they must be independent and have real authority. A CRO with the appropriate authority and scope of responsibility can serve as a good middle ground between potentially conflicted management and the business disruption of a full-blown trustee. There are many cases in which courts have relied on section 363(b) to authorize debtors to retain management consultancy firms or outside contractors, including where a firm’s personnel were expected to fill key officer roles and manage the debtor’s day-to-day business, as long as there was an independent CRO with oversight.²⁴

For example, Enron Corp., a company involved in world class fraud, was able to achieve a truly independent DIP through a CRO, and no trustee was appointed in that case. There, the CRO agreement contained a “success fee” rather than an hourly payment schedule, employed an independent professional to provide management service, and ultimately sold off Enron’s businesses as going concerns.²⁵

Half Measures Just Won’t Cut It

“The era . . . of half measures, of soothing and baffling expedients . . . is coming to its close. In its place we are entering a period of consequences.”

– Winston S. Churchill, November 12, 1936

If a debtor does not have workable debtor management options available under the Code, or the debtor is facing a motion to appoint a trustee or an examiner and wishes to still have some input and control over business operations (and/or the performance of chapter 11 related activities), then the debtor must employ a truly independent CRO with a legitimate overseer and direction powers. Anything less will create, at best, ancillary litigation, and at worst, destroy any modicum of credibility the debtor (and perhaps its professionals) might have with the court.

No half measures indeed.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following webinars: Help, My Business is In Trouble! And The Nuts & Bolts of a Chapter 11 Plan.]

©All Rights Reserved. July, 2021.  DailyDAC^TM, LLC

1. See, e.g. Salerno & Schnelling, “The Examiner in Corporate Restructurings: Burden or Benefit?,” Financier Worldwide at 10 (April 2008); Mayer, et al., “What Do You Do With A Completed Bankruptcy Examiner’s Report?”, Report From Section Of Litigation Expert Witnesses Committee (ABA, Spring/Summer 2011).
2. A type of injunction pioneered in the early Code mass tort cases barring claimants from asserting claims against insurance carriers, or other third parties providing consideration under the plan by directing proceeds of insurance policies, or other debtor or third party funds into a segregated fund, to be used for distribution to creditors. 11 U.S.C. §§ 105(a), 24(g).
3. See Kenneth Rosen, et al., Avoiding Independent Director Challenges In Ch. 11 Litigation, Law360 (July 13, 2021).
4. In Chapter 13 or Subchapter V cases there is a trustee, but they act more in an “observer” mode and do not take over business operations or decisions.
5. As it is often said, every family is dysfunctional (and it’s really just a matter of degree), the same can be said about every Chapter 11 filing. The events that led there almost always have an element of some mismanagement. Hence, Congress made sure we were all aware that the standard for displacing a DIP is “gross mismanagement.” Let’s not be too judgmental here.
6. Most of the criticism comes from academia, with dire warnings of the slippery slope leading to the Earth spinning off its axis into the sun if the practice is allowed to continue (written tongue firmly planted in cheek, of course). See e.g. Elizabeth Warren, et al., The Law Of Debtors And Creditors 743-49 (7th ed. 2014) (yes, that is Senator Elizabeth Warren) (“the idea of the private trustee as the DIP circumvents the statutory procedure and gives both control persons [e.g., large shareholders or secured creditors] and the judge a role in trustee selection that the Code drafters ostensibly sought to avoid. . . .The [Code] was meant to eliminate the ‘bankruptcy ring’ scandals of the past by separating the bankruptcy judge’s judicial role from administrative (or patronage) duties . . .”); see also A. Mechele Dickerson, Privatizing Ethics In Corporate Reorganizations, 93 Minn. L. Rev. 875 (2009); see also Jared A. Ellias, et al., The Rise Of Bankruptcy Directors, European Corporate Governance Institute – Law Working Paper No. 593/2021, UC Hastings Research Paper Forthcoming (June 14, 2021) (advancing the interesting proposition that the bankruptcy courts should only consider “independent directors” independent if all creditors support their appointment—a true recipe for disaster in the authors’ opinions).
7. Consider if you will the rampant fraud leading up to the Chapter 11 cases for Enron, Worldcom, and numerous others. None of those cases went through the process with trustees. Those debtors (and their professionals) did not need a magnifying glass to read the large neon writing on the wall, and proactively “cleaned house” by having truly independent CROs in place and approved as part of first day motions as needed. The perpetrators of the fraud faced the consequences of their actions (both civil and criminal repercussions), but the disposition of the assets and remedying the economic issues occurred without that fight at the outset of cases that were already mired in contentious litigation. See infra note 28 and accompanying text.
8. Greg Garman, NRA’s bankruptcy counsel, at the start of the hearing on the motion to dismiss or alternatively appoint a Chapter 11 trustee or examiner. This statement wins the 2021 award for both candor and understatement.
9. In re Nat’l Rifle Ass’n of Am., No. 21-30085 (HDH), 2021 WL 1970738, at *1 (Bankr. N.D. Tex. May 11, 2021). All documents cited to in the footnotes will refer to this case docket. The NRA, based in Virginia and a New York non-profit corporation, created a wholly owned limited liability company, Sea Girt, LLC, formed in Texas a month or so before the filing to establish jurisdiction in Texas.
10. District of Columbia v. NRA Foundation, Inc., and National Rifle Association of America, Inc.; People of the State of New York, by Letitia James, Attorney General of the State of New York v. The National Rifle Association of America, et al., Supreme Court of the State of New York, Case No. 451625/2020.
11. Order Granting Motions to Dismiss [Docket No. 740].
12. Motion for Appointment of Examiner [Docket No. 114].
13. Id.
14. Id.
15. Ackerman McQueen, Inc.’s Motion to Dismiss the Chapter 11 Bankruptcy Petition, or, in the Alternative, Motion for the Appointment of a Chapter 11 Trustee, and Brief in Support [Docket No. 131].
16. The State of New York’s Motion to Dismiss, or, in the Alternative, to Appoint a Chapter 11 Trustee [Docket No. 155]; The State of New York’s Motion to Dismiss, or, in the Alternative, to Appoint a Chapter 11 Trustee [Docket No. 163]; The District of Columbia’s Motion in Support in the State of New York’s Motion to Appoint Chapter 11 Trustee [Docket No. 214]; The District of Columbia’s Motion in Support in the State of New York’s Motion to Dismiss [Docket No. 429]; Christopher W. Cox’s Joinder to (I) the Motions to Dismiss or, in the Alternative, to Appoint a Chapter 11 Trustee Filed by Ackerman McQueen, Inc. and the State of New York, or (II) the Motion of Phillip Journey for Appointment of an Examiner [Docket No. 172].
17. The Official Committee of Unsecured Creditors’ Omnibus Response to (I) Ackerman McQueen, Inc.’s Motion to Dismiss the Chapter 11 Bankruptcy Petition, or, in the Alternative, Motion for the Appointment of a Chapter 11 Trustee, and Brief in Support, (II) the State of New York’s Motion to Dismiss, or, in the Alternative, to Appoint a Chapter 11 Trustee, and (II) the District of Columbia’s Motion in Support in the State of New York’s Motion to Appoint Chapter 11 Trustee [Docket No. 368].
18. Docket No. 439. In addition, the NRA filed a plan in the middle of the lengthy evidentiary hearings to further bolster its illusion of actually being a debtor in need of Chapter 11 despite the numerous public pronouncements that it was financially sound and had no need for economic restructuring. See Plan of Reorganization Of The National Rifle Association And Sea Girt LLC, filed undated but on May 2, 2021 [Docket 719].
19. Application of the Debtors for an Order Authorizing the Retention and Employment of Ankura Consulting Group, LLC and Appointment of Louis E. Robichaux IV as the Debtors’ Chief Restructuring Officer [Docket No. 519].
20. The Ankura NRA engagement Letter (the CRO contract) [Docket No. 519-2].
21. United States Trustee’s Statement Regarding Motions Seeking Appointment of Examiner, Trustee, or Case Dismissal [Docket No. 405].
22. See, e.g. Rosen, supra note 4. When it comes to the use of independent directors appointed pre-filing, to the extent it is used as a defense to appointment of a trustee or examiner, the debtor must provide full disclosure and show the court that the independent directors were truly acting independently.  See Elliot Ganz, Fixing Chapter 11, Loan Syndications & Trading Association (July 13, 2021) (arguing that ostensibly independent directors or CROs can never be independent because they are beholden to the people that hired them for the “lucrative assignment”). Certainly the CRO candidate in the NRA case, at over $1100 per hour, would undoubtedly consider that a highly lucrative gig!
23. See In re Nat’l Rifle Ass’n of Am., No. 21-30085 (HDH), 2021 WL 1970738, at *1 (Bankr. N.D. Tex. May 11, 2021).
24. See e.g., In re Enron Corp., No. 01-16034, 2006 WL 1030421, at *2 (Bankr. S.D.N.Y. Apr. 12, 2006) (authorizing debtors to retain a management consulting firm to provide a chief executive and chief restructuring officer and additional individuals to serve as personnel during the chapter 11 cases); In re Ajubeo LLC, No. 17-17924, 2017 WL 5466655, at *4 (Bankr. D. Col. Sept. 27, 2017) (approving retention of management consulting firm to provide a chief restructuring officer); In re Copenhaver, Inc., 506 B.R. 757, 764-65 (Bankr. C.D. Ill. 2014) (holding that the retention of a current director as consultant and chief restructuring officer would be appropriate given the “unique and compelling circumstances” of the case, but subject to modification of the court’s oversight of the officers’ fees).
25. In re Enron Corp., 2006 WL 1030421, at *2.