• Requesting a Trustee in a Debtor's Bankruptcy Case: When Does It Make Sense?
  • January 26, 2012 | Author: Jeffrey L. Gansberg
  • Law Firm: Much Shelist, P.C. - Chicago Office
  • Is your Chapter 11 debtor acting contrary to the best interest of its creditors? Is your Chapter 11 debtor failing to meet its fiduciary obligations to its estate or its creditors? If the answer to either of these questions is "yes," then you may want to consider requesting the appointment of a bankruptcy trustee.

    The appointment of a trustee wrests control of the debtor entity from its existing management and places it with that trustee, who then takes over the debtor's business operations. This includes the ability to determine whether the business should continue to operate, whether the case should be converted to a Chapter 7 bankruptcy or whether the entity should be liquidated in Chapter 11. The appointment of a trustee is a drastic remedy that should be requested only in the most extreme circumstances. For example, a trustee is often requested when a debtor's actions (or its inaction) are not in the best interest of the creditors and the bankruptcy estate. This may include circumstances when the debtor's insiders are taking actions to benefit themselves or when management is making high-risk decisions because they no longer have anything to lose.

    Although a drastic remedy, the appointment of a trustee is addressed in the U.S. Bankruptcy Code. Section 1104 provides for the appointment of a trustee under the following conditions: (1) for cause; and (2) if the appointment is in the interest of creditors, equity security holders or other interests of the estate. Similarly, Section 1112 allows for the appointment of a trustee when grounds exist to dismiss the case or convert it to one under Chapter 7, but the court determines that the appointment of a trustee is in the best interest of the creditors and the estate. Although none of these conditions are explained in significant detail in the Bankruptcy Code, "cause" includes "fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor either before or after the commencement of the case." However, many courts will be willing to give the debtor the benefit of the doubt if the "cause" occurred pre-petition.

    As you might expect, debtors will typically contest a creditor's motion to appoint a trustee. Therefore, if you file this type of request, be aware that you may incur significant legal fees to secure the relief requested, and there is no guarantee of success. However, if your request is granted, the removal of the debtor as a debtor-in-possession may lead to a better outcome for all creditors once a trustee is appointed and can investigate the affairs of the debtor and begin running the debtor for the benefit of the creditors.

    Because requesting the appointment of a bankruptcy trustee involves significant legal and factual issues, creditors should consult legal counsel before deciding to take this extreme—but often effective—course of action.