The Restructuring Report

The choice of a chapter 11 operating trustee can provoke a fight. Follow this guide for a smooth path through the process of displacing an interim chapter 11 trustee or challenging an election.

One central feature of the reorganization process under chapter 11 of the Bankruptcy Code is that the debtor’s existing management remains in control. The concept of the “debtor-in-possession” is a cornerstone for the efficient and effective use of the bankruptcy process by a distressed company. That control can be lost, however, and in certain circumstances a trustee may be appointed to take over the debtor’s operations and to determine the course of the bankruptcy case. But what happens when there is a dispute over who that trustee is?

At the outset, the Office of the United States Trustee (UST), after consultation with parties in interest, appoints a disinterested person to serve as trustee, whose appointment must then be approved by the court. 11 U.S.C. § 1104(d). However, creditors can instead elect a trustee if a party in interest timely requests that the UST hold an election. 11 U.S.C. § 1104(b). Bankruptcy Rule 2007.1(b)(2) provides that the election is to be conducted in the manner provided in Bankruptcy Rules 2003(b)(3) and 2006, which govern the meeting of creditors and election matters in a chapter 7 case. In other words, the election of a chapter 11 trustee is conducted in the same manner as the election of a chapter 7 trustee. The relevant rules provide the requirements for, among other things, how much notice must be provided of the meeting, where it shall be held, who has a right to vote and how proxies are to be handled. The UST, who appointed the interim trustee, has control over scheduling and presiding over the meeting.

Although the elections of a chapter 7 trustee and a chapter 11 trustee are governed by the same rules, disputes arising from those elections are governed by different rules and have one key difference. If a dispute arises with regard to an election of a trustee in a chapter 7 case, the UST is required to file a report stating that the election is disputed, informing the court of the nature of the dispute, and listing the name and address of any candidate elected under any alternative presented by the dispute. Bankruptcy Rule 2003(d)(2). Bankruptcy Rule 2007.1 contains an extra requirement for addressing any disputes that arise out of the election of a chapter 11 trustee. The UST must file the same report regarding the disputed election (and the rule enacts this requirement with identical language), but the report must be accompanied by a verified statement by each candidate “setting forth the person’s connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee.” Bankruptcy Rule 2007.1(b)(3)(B). This is the information that is necessary for the court to determine whether each candidate to be the chapter 11 trustee is “disinterested,” as is required by 11 U.S.C. § 1104(b).

In the chapter 11 context, that trustee must be disinterested, which is defined in the Bankruptcy Code as a person who is not a creditor, equity security holder or insider; is not a present or recent director, officer or employee of the debtor; and does not have an interest materially adverse to the interest of the estate or any class of creditors or equity security holders. See 11 U.S.C. § 101(14).

A failure to provide the court with the information necessary make such a determination and in the form required by Bankruptcy Rule 2007.1, i.e., a verified statement accompanying the UST’s report of disputed election, can be enough for the court to not take any action to resolve a dispute, which has the effect of allowing the interim trustee appointed by the UST to remain in control. Therefore, it is incumbent on a party seeking to displace an interim trustee to make sure their proposed trustee is disinterested and that the UST is provided with the verified statement to prove it.