“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:
“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):
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.
– 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 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
“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.
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
“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.
©All Rights Reserved. July, 2021. DailyDACTM, LLC
Thomas Salerno is a bankruptcy attorney at Stinson LLP. He brings thirty-five years' experience to resolving complex issues in commercial corporate restructurings and recapitalizations, advising lenders, distressed companies, committees and acquirers of assets in both out of court restructurings and in bankruptcy cases.
Clarissa Brady is an bankruptcy attorney at Stinson LLP. Bringing experience from the U.S. Bankruptcy Appellate Panel for the First Circuit, Clarissa has trial experience throughout the U.S. and has conducted extensive legal research on issues involving the bankruptcy code.
Recruiting Post-Bankruptcy Board Directors in the Pandemic Aftermath
Third-Party Litigation Funding (TPLF) and Issues It Creates In Bankruptcy
The Chief Restructuring Officer (CRO): From Restructuring to Stakeholder Management, They Can Do It All
The Independent Director Role in Optimizing Corporate Workouts and Bankruptcy Outcomes
There Ought to Be a Law, and There Is: When the Insolvent LLC’s Manager Distributes Cash But Does Not Pay Creditors
Legacies of the Jevic Case: Structured Dismissals Five Years after the Fall
Please log in again. The login page will open in a new tab. After logging in you can close it and return to this page.