In a Chapter 11 bankruptcy case, the creditors have many options to resolve or dispose the case. The creditor can file a dismissal of the case or convert the case to liquidation or to enforce state law remedies to relieve the automatic stay on the secured debt collateral or move for the appointment of a Chapter 11 trustee. Chapter 11 provides statutory provisions for appointment of trustee or examiner.
The appointment or election of a trustee in Chapter 11 is purely a court decision. Chapter 11 statutory provisions enable the creditor or any interested party to file a motion for the appointment of a trustee. There are two major reasons that cause the appointment of a trustee or examiner. They are:
- For reasons such as fraud, dishonesty, incompetence, gross mismanagement either before or after filing of the bankruptcy case; and
- For the interests of creditors, any equity security holders and any other interest of the real estate.
In most bankruptcy cases, the court has tolerance in identifying the level of fraud, incompetence or mismanagement and the level of interest by creditors or any other party. In other words, the court will appoint a trustee only in extraordinary situations. The court presumes that the current management is a better choice to rehabilitate the business and the appointment of a trustee is not an apt substitute to entertain the interests of creditors or their involvement in the business. However, the court appoints a trustee, if the court determines that the situation that does not permit the creditor to avail a relief from automatic stay or a conversion or dismissal of the bankruptcy case or the status quo is detrimental to the interests of its creditors.
If the creditors acquire the order for appointment of a trustee, the debtor’s exclusive right to file a reorganization plan is terminated. Seeking appointment of trustee enables the creditors to contemplate their own plan. At this stage, the court considers the level of business damage through the disclosure statement and plan confirmation process. There are some drawbacks in the appointment of a Chapter 11 trustee. They are:
- The newly appointed trustee gets ample time period to understand the bankruptcy case and this results to delay the disposal of pending matters.
- The most of the trustees are appointed from the US Trustee’s panel and most of them lack time or skills to operate the business. It is general practice that, most of the trustees convert the bankruptcy case to liquidation.
- The secured creditors have a security interest in all of the real assets of the debtor. On appointment of a trustee, the creditors have to bear the expense of the trustee. Moreover, the trustee may dispose the collateral at a lower price if liquidation happens.
The appointment of a trustee in Chapter 11 is an unusual remedy. In certain situations, it is not a valuable instrument especially where the incompetent or dishonest management damages a viable business.