A Third Way: Examiners as Inquisitors

There is a buzz in the air concerning bankruptcy examiners. Recently in such cases as ResCap, Dynegy and Tribune, and perhaps now in Caesars, examiners have played a decisive role in resolving major chapter 11 cases that turned on disputed litigation claims and avoiding power rights. Numerous commentators, and now the ABI Chapter 11 Study Commission, have called for their expanded use.

“Litigate or settle” is the dispute resolution choice generally available in American courts, including bankruptcy courts. But there is another way: An inquisitorial model of justice in which an active and informed neutral investigates the facts and then assesses and applies the law to resolve a legal dispute. The Bankruptcy Code by authorizing the appointment of a chapter 11 examiner provides a very specific procedural device peculiarly suited to introduce inquisitorial process into a chapter 11 case. Until recently, however, examiners were seldom employed, and even when employed were not a true inquisitorial alternative to “litigate or settle.” The conduct of examinations was heavily influenced by the landmark report of Barry Zaretsky, the examiner in the chapter 11 case of Revco. Following the Revco model, examiners would determine the legal sufficiency of a disputed claim but not opine on the merits or undertake to resolve factual disputes. Ken Klee’s service as examiner in the Tribune chapter 11 case, however, took a different approach to the examiner’s role. Klee’s primary charge was to investigate and assess the potential avoidability of obligations incurred and transfers made in Tribune’s complex multi-billion dollar pre-bankruptcy leveraged buy-out transaction. His Report on these issues presages a new approach to examinations, that while not quite fully embracing an inquisitorial alternative to traditional bankruptcy dispute resolution, points in that direction.

Klee’s investigative methodology began with his request that the parties submit comprehensive legal, financial, and factual analyses of the matters under investigation in opening and reply briefs along with any documents or analyses bearing on the factual or legal subject matter of the investigation. He also asked the parties to identify any individuals that the parties believed he should interview, and any discovery he should conduct.

The parties submitted hundreds of pages of briefing and tens of thousands of pages of supporting documents, raising dozens of complex claims and defenses, each with sub-issues. Notwithstanding the parties’ wide-ranging and factually-intensive allegations concerning, among other things, intentional fraudulent transfer, bad faith, breach of fiduciary duty, and aiding and abetting fiduciary duty breaches, the parties had conducted only seven depositions. Klee completed 38 additional witness interviews conducted in four cities in 46 days. Klee attended 33 interviews in person or by video conference to personally evaluate witness demeanor and credibility, and to actively participate in questioning. All interviewees were represented by counsel.

Witnesses were advised that the interviews were not depositions and that all objections to questions were preserved. Unlike a deposition (in which one party typically asks questions at any given time), Klee, and his counsel, posed the questions, though sometimes the witness’s counsel posed clarifying questions and offered perspectives to Klee on the answers given by the witness. The various contending parties, however, were not entitled to attend the interviews or have their questions asked. In some cases, Klee interviewed multiple witnesses at the same time which permitted interchange and discussion between the witnesses that facilitated the inquiry and clarified the record. He found this technique most helpful in clarifying expert testimony regarding technical matters such as valuation.

Klee evaluated numerous legal and factual questions in connection with this investigation. In addition, Klee’s financial advisor, LECG, working with his counsel developed a comprehensive financial analysis of the issues presented. LECG, building on prior work of the parties and their financial advisors, analyzed issues concerning solvency, unreasonable capital, the flow of funds, and matters pertaining to intercompany claims.

As authorized by the bankruptcy court, Klee requested authority to weigh the relative positions of the parties, and analyze the estates’ potential remedies should one or more transfers or obligations be avoided, and the resulting effect on various creditor constituencies. In addition, Klee undertook to draw conclusions with respect to the issues in dispute based on the factual record adduced and applicable law. This represented a significant departure from the practice of earlier investigative examiners. Adopting the Revco model, investigative examiners had limited themselves to determining whether particular claims or defenses failed as a matter of law assuming the parties’ factual allegations in support thereof were ultimately proven—akin to the standard governing a motion to dismiss a complaint. Klee set forth his independent merits conclusion as to each issue on the following continuum: (1) highly likely, (2) reasonably likely, (3) somewhat likely, (4) equipoise, (5) somewhat unlikely, (6) reasonably unlikely, and (7) highly unlikely.

Klee filed his four-volume Report less than three months after his appointment and it became public shortly thereafter. The Report contained over 1,400 pages of factual narrative and legal analysis with 4,600 footnotes. In addition to referencing Klee’s witness interviews, it cited some 600 case authorities and 1,100 exhibits in support of its findings and conclusions. The exhibits alone comprised over 21,000 pages. The total cost of the investigation was $12,053,834.

The Klee Report effectively mooted the then-pending Tribune reorganization plan. Klee had determined that aspects of Tribune’s pre-bankruptcy leveraged buyout transaction were vulnerable to attack as both actual and constructive frauds. Extensive mediation ensued culminating in the filing of competing plans. Approximately two years later, a fourth iteration of the Tribune plan—one that distributed an incremental $450 million in value to otherwise subordinated creditors was confirmed by the bankruptcy court. At confirmation, the court and the parties relied heavily on the Klee findings. The settlement embodied in the plan closely tracked the Klee analysis and fact finding and it won court approval because the bankruptcy court found the Klee analysis reasonable and a proper basis for approving the settlement between pre- and post-LBO creditors.

Critiques of modern American civil practice often focus on over-reliance on the adversarial model. Interestingly, inquisitorial investigation was the norm in the ancient English Chancery Court to which modern bankruptcy courts trace their roots. Recalling the possibility of cautiously employing a properly regulated inquisitorial model, when it makes sense, can be a healthy antidote to the ills of the adversary process. In particular, Tribune and a series of post-Tribune investigations have shown that inquisitorial methods make sense in certain large bankruptcy cases involving complex legal disputes (rather than financial or operational problems). Indeed a careful review of Klee’s methodology, and those of other post-Tribune examiners, suggests that the inquisitorial experiment has already begun.

If we are on the brink of embracing an inquisitorial mode of civil adjudication as an alternative to traditional civil litigation in resolving complex legal disputes in large chapter 11 cases then we must consider the comparative advantages and disadvantages of inquisitorial investigation and determine when and how best to employ inquisitorial examinations in bankruptcy.

A Third Way: Examiners As Inquisitors looks at historical and comparative law precedents for inquisitorial investigation and includes a qualitative empirical analysis starting with a detailed look at Tribune and then discusses the small universe of post-Tribune cases in which examiners have been appointed. It then assesses inquisitorial investigation’s comparative advantages (factfinding accuracy, use of non-partisan experts, freedom from artificial evidentiary constraints, transparency and legitimacy) and disadvantages (lack of finality, expense, delay, risks to reorganization efforts, risk of overzealousness, due process concerns) and suggests that the Tribune Model is most compelling when (i) the values served by transparency are high, (ii) the path to settlement appears difficult and adversary litigation likely, (iii) the interest in establishing precedent and appropriately channeling future behavior is high, (iv) the scope of the examiner’s investigation can be clearly defined, (v) important public, community and third party interests are implicated, and (vi) no reorganization is currently in prospect or the cost of deferring reorganization pending investigation is not preclusive.   These conditions may exist in very large reorganizations implicating significant public and community interests that involve claims against insiders or creditors, rather than third parties. In the absence of a countervailing business exigency demanding immediate and exclusive focus on the reorganization effort, in such cases, the Tribune Model may offer a superior alternative to resolution by the parties through a plan settlement or adjudication.

Indeed, large chapter 11 cases with these characteristics may be an ideal proving ground for inquisitorial methods. Examiners in such cases have ample resources for conducting thorough inquisitorial investigations relatively expeditiously. These assignments are profitable and prestigious enough to attract the most experienced and highly-reputed professionals. The peculiar history, culture and multi-party nature of bankruptcy gives examiners scope to employ novel and creative investigative techniques. Query whether our engrained adversarial legal culture can meaningfully export this mode of investigation, however successful in chapter 11, to other realms. The most likely next steps are into smaller bankruptcy matters and perhaps into adjacent fields also involving complex multiparty civil litigation.

The preceding post comes to us from Daniel J. Bussel, Professor of Law at UCLA School of Law, and is based on his recent article A Third Way: Examiners As Inquisitors, 90 Am. Bankr. L. J. __ (forthcoming 2016) which may be downloaded here.