Wed 11/08/2023 18:48 PM
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A three-judge panel of the U.S. Court of Appeals for the Third Circuit heard oral argument today in the appeal in the FTX Group cases by the Office of the U.S. Trustee of a bankruptcy court order denying its motion for the appointment of an examiner. The panel, consisting of Judges Luis Felipe Restrepo, Stephanos Bibas and Anthony Joseph Scirica, took the appeal under advisement without indicating the timing of their decision. The FTX Group debtors are seeking to confirm a plan in June 2024 and targeting a July 2024 effective date.

The appeal was certified by U.S. District Judge Colm Connolly in the absence of controlling precedent regarding whether the appointment of an examiner is mandatory if the debt threshold in section 1104(c)(2) of the Bankruptcy Code is met. The statute provides that a bankruptcy court “shall” appoint an examiner to investigate the debtor “as is appropriate” if the UST or a party makes such a request and the debtors’ fixed, liquidated, general unsecured debts exceed $5 million. The UST’s mandatory interpretation of the statute is challenged by the FTX group debtors and the official committee of unsecured creditors, which argue that the appointment of an examiner is discretionary.

Bankruptcy Judge John Dorsey found that he had discretion to deny the UST’s request for an examiner, citing to the “as is appropriate” phrase in the statute as the operative language. He decided that appointing an examiner would result in substantial costs and duplicate the parallel FTX investigations by the debtors, the UCC, federal prosecutors, regulators and Congress and thus denied the request.

At today’s hearing, Brian Springer, for the UST, said that Congress was “very clear” in fashioning a “shall command” in the statutory text and legislative history. He explained that bankruptcy courts retain discretion to appoint an examiner when it is in the interest of creditors in Bankruptcy Code section 1104(c)(1), whereas subsection (c)(2) “doesn’t do an interest balancing.” Because there is no dispute that subsection (c)(2)’s debt requirement is met in the FTX cases, Springer asserted that the bankruptcy court was required to appoint an examiner.

Judge Scirica questioned Springer about the “as is appropriate” language, to which Springer responded that the qualifier is solely attached to the scope, duration and cost of an investigation but does not “stretch back” to give the bankruptcy court discretion to not appoint an examiner in the first instance. Springer agreed with Judge Restrepo that the appellees’ reading of subsection (c)(2) would render the interest of creditors analysis under subsection(c)(1) “surplusage.” Springer said that Judge Dorsey’s concerns regarding costs and duplicative investigation efforts were the same factors considered in evaluating whether the appointment of an examiner would benefit creditors.

Springer said that “dueling narratives” regarding the replacement of FTX’s former management, impropriety of law firms and intercompany claims were potential topics for an examiner to investigate. He cited the examiner’s report in the Celsius Network crypto bankruptcy case as a model for the FTX cases.

James Bromley of Sullivan & Cromwell, counsel to the debtors, and Ken Pasquale of Paul Hastings, counsel for the UCC, defended the bankruptcy court’s decision. The panel questioned both counsel on how their statutory analysis avoided “making ‘shall’ into ‘may.’”

Bromley argued the “as is appropriate” language relates to both the proceedings to appoint an examiner and to setting the parameters of the investigation. The UST’s reading would “disconnect” these two steps, he said. According to Bromley, the UST had the burden of demonstrating to the trial court the need for an investigation within specific parameters. Instead, he said, the UST looked to “boil the ocean” with an unconstrained investigation estimated by the bankruptcy court to potentially cost $100 million.

Unlike other major, fraud-based bankruptcies such as Enron and Worldcom, said Bromley, the “entire head was cut off” of wrongdoing management at FTX. He added that the bankruptcy court had concluded that FTX’s replacement CEO, John Ray III, and the directors he appointed were independent and able to conduct an investigation without the assistance of an examiner.

Pasquale, for the UCC, affirmatively said that the “shall” of the statute could be read as “may” in order to avoid the absurd result of relieving movants of any need to demonstrate fraud, impropriety or mismanagement when requesting an examiner be appointed. He took “umbrage” at allegations raised regarding investigative topics, saying it is “as if the committee has done nothing” and adding that all topics, including professional misconduct, were being “looked at.”

Pushing back on the absurdity and administrative concerns raised by the appellees, Springer said that there has been no such “fallout” in the Sixth Circuit, which has adopted the UST’s position that appointment of an examiner is mandatory when the statutory criteria are met. He added that in 2023, the UST has made only approximately 10 requests to appoint an examiner.

Jonathan Lipson, a law professor at Temple University’s Beasley School of Law and a member of a group of amici law professors who filed a brief in support of the UST, also appeared today. He argued that the bankruptcy court’s decision should be reversed or else Judge Dorsey would have “single-handedly gutted” the examiner statute.

Congress, Lipson asserted, intended for examiners to be appointed to investigate and report on cases of public interest. FTX’s spectacular free-fall nature and level of fraud made the appeal an “inflection point,” Lipsion said, adding that “if an examiner is not appointed here, it is not appropriate in any case.”

Specifically, Lipson argued that an examiner should investigate FTX’s prebankruptcy “gatekeepers,” the “extraordinary secrecy” in which the cases are being conducted and the nature of the debtors’ cryptocurrency assets. Lipson focused particularly on Sullivan & Cromwell’s potential conflicts of interest in serving as debtors’ counsel and prepetition advisors for both FTX and its criminally convicted founder and former CEO Sam Bankman-Fried.

Lipson asked how Sullivan & Cromwell failed to “‘see’ governance problems” in the course of its prepetition representation and queried if the FTX estates could have causes of action against the law firm. Lipson also posited whether the firm “fraudulently induced” Bankman-Fried to give up control of the company to Ray. If so, he said, these actions could have potentially undermined the legal effectiveness of the change of control upon which the bankruptcy filings were based.

Bromley addressed Lipson’s attack on his firm, asserting that the alleged conflict of interest “doesn’t exist.” He said the bankruptcy court made factual findings entitled to res judicata to this effect when it approved the firm’s retention over the objection of FTX’s former chief legal officer, Daniel Friedberg. The panel questioned if these findings would instead be considered under the more “flexible” law of the case doctrine.

Springer, for the UCC, explained that although the UST withdrew its objection to Sullivan & Cromwell’s retention, the UST’s decision was “connected” with the request to appoint an examiner and the need for an independent examination.
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