Contributed by Jordan Bryk
The United States Bankruptcy Court for the Southern District of New York recently approved Berkshire Hathaway Inc.’s motion to appoint an examiner to investigate and report on the actions of the bankrupt mortgage lender Residential Capital, LLC, including its transactions with its non-debtor parent company, Ally Financial Inc. On May 14, 2012, ResCap, a wholly-owned subsidiary of Ally, filed for relief under chapter 11 of the Bankruptcy Code. According to Warren Buffet’s Berkshire Hathaway, which recently bid for ResCap’s mortgage business and loan portfolio, the prepetition transactions between ResCap and Ally transferred “a substantial share of ResCap’s operating assets to its parent.”
A bankruptcy examiner typically investigates allegations of fraud, dishonesty, or gross mismanagement of the debtor. The motion to appoint an examiner in ResCap’s case was opposed by both the creditors’ committee and ResCap but was supported by the U.S. Trustee. The parties did not dispute that an investigation was necessary. Instead, the dispute surrounded whether the investigation should be conducted by an independent examiner or by the creditors’ committee, which had already been granted permission to investigate ResCap.
Judge Martin Glenn’s decision in In re Residential Capital, LLC, No. 12-12020, 2012 WL 2328223 (Bankr. S.D.N.Y. June 20, 2012) addresses the issue of whether the appointment of an examiner is mandatory under section 1104(c)(2) of the Bankruptcy Code if the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5 million. Judge Glenn acknowledged a split in authority on this issue: some courts have held that section 1104(c)(2) provides a judge with discretion to refuse to appoint an examiner altogether, while others have held that it merely provides a judge with discretion to determine the nature and scope of the examiner’s investigation.
Judge Glenn held that there are, effectively, four elements inherent in section 1104(c)(2), which, if met, necessitate the appointment of an examiner: (i) no trustee has been appointed, (ii) a plan of reorganization has not been confirmed, (iii) the debtor’s fixed debts exceed $5 million, and (iv) an investigation is appropriate. According to Judge Glenn, if the first three elements are met and the appointment of an examiner is not inappropriate, a court must grant a motion of a party in interest to appoint an examiner.
The bankruptcy court found that the first three elements were easily met. No trustee had been appointed, a plan had not been confirmed, and ResCap’s fixed debts to non-insiders exceeded $5 million. The issue before the court was whether an investigation was “appropriate.” According to Judge Glenn, an examiner investigation would be inappropriate where the creditors’ committee or a governmental agency such as the SEC has already conducted its own lengthy investigation, where the motion is filed for an improper purpose such as a litigation tactic, or where there is no factual basis to conclude that an investigation is necessary. Judge Glenn cited the Washington Mutual bankruptcy as an example of circumstances under which the appointment of an examiner would have been inappropriate and was properly denied. In In re Washington Mutual Inc., No. 08-12229 (MFW) (Bankr. D. Del. May 5, 2010), Hr’g Tr. at 98:12-100:21 (ECF Doc. #3699), the United States Bankruptcy Court for the District of Delaware found that the debtor, Washington Mutual, had been “investigated to death,” and that the marginal benefit of an examiner investigation would not justify its excessive costs.
Judge Glenn found that, in ResCap’s case, “no one dispute[d] that an investigation of [ResCap’s] pre- and post-petition conduct [was] appropriate.” The creditors’ committee had alleged that ResCap structured a “complex constellation” of transactions to benefit Ally and ResCap’s secured creditors. These transactions included, among other things, the transfer to Ally of ResCap’s subsidiary federal savings bank, its healthcare financing business, and its resort financing business, as well as an extension of $1.1 billion in secured credit from Ally to ResCap. Moreover, there was no indication that Berkshire Hathaway’s motion to appoint an examiner was filed in bad faith. Although the creditors’ committee had already commenced an investigation into these areas, it had not yet had the opportunity to conduct a lengthy investigation.
Accordingly, the bankruptcy court concluded that an examiner must be appointed. Subsequently, on July 3, 2012, the court appointed Arthur J. Gonzalez, the former Chief Judge of the United States Bankruptcy Court for the Southern District of New York, as the examiner. Before retiring from the bench in March, Judge Gonzalez presided over several complex bankruptcies, including Chrysler, Enron, and Worldcom. The scope, timing, and budget for the investigation will be determined after Judge Gonzalez meets with the parties in interest.