Subchapter V Trustee’s Facilitation Role (Part 5)—INVESTIGATION DUTIES

By: Donald L Swanson

“(b) Duties.—The [Subchapter V] trustee shall— . . . (7)facilitate the development of a consensual plan of reorganization.”

• From 11 U.S.C § 1183(b)(7)(emphasis added).

Facilitation is, by statute, a duty of every Subchapter V trustee—something a Subchapter V trustee must do.  But the nature and boundaries of the facilitation role have always been fuzzy and, therefore, misunderstood. 

My purpose in this multi-part series is to provide observations on the facilitation role.

This article focuses on the Subchapter V trustee’s duties to investigate.  Such duties are:

• essential for facilitation—can’t facilitate resolution of a dispute without knowing applicable facts and law; and
• essential for other statutory duties—e.g., can’t “appear and be heard” without knowing applicable facts and law.

Two Duties & A Conundrum

A Subchapter V trustee has two separate duties that, at first glance, appear to be at odds:

1. The Subchapter V trustee may “investigate” the debtor’s conduct, business operations and financial affairs—but only when the bankruptcy court “so orders” (§§ 1183(b)(2) & 1106(a)(3))[Fn. 1]; and
2. A Subchapter V trustee must “appear” before the court “and be heard” on specified types of issues (§ 1183(b)(3)).

So . . . we have a Subchapter V conundrum:

• how can the trustee “appear and be heard” in a meaningful way without first conducting an investigation of the facts and law on the issue before the court; but
• doesn’t the trustee have a duty to seek and obtain court authorization before investigating an “appear and be heard” issue?

Hypothetical Illustration

Here’s a hypothetical Subchapter V illustration of the conundrum:

• a real estate value issue is before the court to determine the extent of a creditor’s allowed secured claim (i.e., an issue upon which the Trustee must “appear and be heard” under § 1183(b)(3)(A));
• two competing appraisal amounts, presented by each of the competing parties, vary widely;
• Trustee reviews the appraisals and decides that something must be wrong with at least one of them;
• so, Trustee decides that an investigation of the competing appraisals and their comparable sales would be helpful;
• without first seeking authorization from the court, Trustee:
  • drives past (and takes photos of) Debtor’s real property and its surrounding properties;
  • drives past (and takes photos of) each of the comparable sales cited in the appraisals and the surrounding properties for each;
  • reviews public records for Debtor’s real property and for each of the comparable sales, to get available details on each;
  • determines that one appraisal uses sales that aren’t actually comparable and presents an unreliable value; and
  • files a written report of such findings and presents a verbal report at the valuation hearing.  

Two Questions

• Is the Subchapter V trustee’s investigation, in this hypothetical, proper? 
• Or should the Subchapter V trustee have sought and obtained court authorization before doing the investigation? 

In answering these two questions, let’s look at the statutes involved (emphases below are added).

–Regular Chapter 11

Under § 1106(a)(3), a trustee in a regular Chapter 11 case “shall . . . except to the extent that the court orders otherwise, investigate”:

• “the acts, conduct, assets, liabilities, and financial condition of the debtor”;
• “the operation of the debtor’s business and the desirability of the continuance of such business”; and
• “any other matter relevant to the case or to the formulation of a plan.”

–Subchapter V

Under § 1183(b)(2), a Subchapter V trustee “shall— . . . perform the duties specified in paragraphs (3)  . . . of section 1106(a) [i.e., investigate] . . . , if the court, for cause . . . so orders” (emphasis added).

–Primary Distinction

The primary distinction between the two statutory investigation duties quoted above is this:

• in regular Chapter 11, investigation must occur—“except to the extent that the court orders otherwise”; whereas,
• in Subchapter V, investigation is not to occur—unless “the court, for cause . . . so orders.”

In one, investigation must happen, unless otherwise ordered.  In the other, investigation must not happen, without explicit authorization.

The reason for such a statutory distinction is this:

• in regular Chapter 11, a trustee is appointed only for “cause” (e.g., because of debtor’s fraud, dishonesty, incompetence or gross mismanagement)—such wrongful conduct typically needs investigating; but
• in Subchapter V, a trustee is automatically appointed in every case, so there is no immediate need to investigate—and such a need may never arise.

–“Appear and be Heard” Duty

A Subchapter V trustee must “appear and be heard” on specified issues (§ 1183(b)(3)). 

To “appear and be heard,” the trustee must first investigate facts and law on the issue at hand, as the basis for taking a meaningful position on the issue before the court.

Answer to Two Questions

So, the answer to both question above is: “Yes” and “No”:   

• “Yes”—the Subchapter V trustee’s investigation, in the hypothetical, is proper; and 
• “No”—the Subchapter V trustee did not need to seek court authorization before doing that investigation. 

–Here’s why. 

The investigation required of a Subchapter V trustee, to develop a position for the “appear and be heard” duty, is limited in scope—to the precise issue at hand:

• such an investigation may require a significant number of hours and related fees; but
• its scope is still limited to specified issues.

By contrast, an investigation under §§ 1106(a)(3) and 1183(b)(2) is broad and expansive.  It’s nature and scope are similar to both:

• an examiner’s investigation under § 1106(b); and
• a Rule 2004 “fishing expedition.”[Fn. 1] 

The Subchapter V trustee’s investigation duty, when court authorization is required, is rarely limited to a single issue.  Instead it focuses on such broad and expansive issues as:

• debtor’s bad conduct and any claims of the estate that may arise therefrom;
• debtor’s business operations and financial condition, to determine whether the business should continue; and
• anything else that might affect debtor’s Subchapter V case or plan.  

An Illustrating Contrast

So . . . let’s say a creditor asks the Subchapter V trustee to investigate potential avoidance claims. That would be a fishing expedition. So the trustee should say something like:

• “that would be an investigation requiring a court order under § 1183(b)(2)”; and
• “the court might not grant such an order because you could use Rule 2004 to do the investigation at your expense–and not the estate’s.”

On the other hand, let’s say the same creditor objects to debtor’s plan for failure to account for the value of the same avoidance claims, with supporting details. Now, the Subchapter V trustee must look into those claims and their merits to fulfill two separate, statutory duties:

• the duty to appear and be heard on plan confirmation issues (§ 1183(b)(3)(B)); and
• the duty to facilitate a consensual plan of reorganization (§ 1183(b)(5)).

Conclusion

A Subchapter V trustee needs bankruptcy court authorization to do a broad investigation into debtor’s conduct to see if any claims might arise therefrom, into debtor’s business and financial condition to determine whether operations should continue, and into other broad-based issues.

On the other hand, a Subchapter V trustee does not need bankruptcy court authorization to investigate facts and law on an issue before the court, in fulfilling the trustee’s duty to “appear and be heard” in a meaningful way.

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Footnote 1.  The “fishing expedition” characterization is from In re Drexel Burnham Lambert Group, Inc., 132 B.R. 702, 711 (Bankry. S.D.N.Y. 1991), which declares that a Rule 2004 process “can be legitimately compared to a fishing expedition.”

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