192 Pages Posted: 23 Feb 2015 Last revised: 11 Aug 2016
Date Written: February 18, 2015
Chapter 11 of the Bankruptcy Code presumes that managers will remain in possession and control of a corporate debtor. This presents an obvious agency problem: these same managers may have gotten the company into trouble in the first place. The Bankruptcy Code thus includes checks and balances in the reorganization process, one of which is supposed to be an “examiner,” a private individual appointed to investigate and report on the debtor’s collapse.
We study their use in practice. Extending prior research, we find that examiners are exceedingly rare, despite the fact that they should be “mandatory” in large cases ($5 million in debt), and are recommended in all, if “in the interests of creditors.” Using a hand-collected dataset (n=1225) of chapter 11 bankruptcies from 1991-2010, we find that they are sought in less than 9% of cases (104), and appointed in fewer than half of those (48, or 3.9% of the sample).
We offer three observations about the under-use of examiners. First, regression modeling shows that the factors that predict when an examiner will be appointed have little to do with the agency problems that concerned Congress, such as fraud or mismanagement. Instead, the timing of an examiner request and case venue appear to be the most important factors in the rare cases where they appear. Second, governance in reorganization has changed significantly since Congress enacted chapter 11, yet agency problems persist. Rather than reorganize “in place” with operational management, troubled companies are increasingly captured by sophisticated distress investors (e.g., hedge funds), who use “turnaround managers” to enhance their recoveries. Examiners could tell us whether this change has net social costs or benefits — if they were used. Third, we offer preliminary evidence that examiners should be used more frequently, because the rare case with one is likely to be more “successful” in a variety of ways than a case without one.
Our findings inform looming fights about amending the Bankruptcy Code to eliminate the position of examiner entirely, and larger debates about how to define and achieve “success” in chapter 11 reorganizations. We borrow from literature on “experimentalism” in regulatory design to propose that bankruptcy courts use “mini-examinations” in order to learn more about examiners’ effects on the reorganization process. Sensitive to concerns about cost, we propose that some or all of these mini-examinations be funded out of bankruptcy court filing fees, which we estimate will be around $150 million in 2015.
Keywords: chapter 11, bankruptcy, corporate reorganization, bankruptcy examiners, examiners, agency costs, empirical legal research, shadow bankruptcy
JEL Classification: K22
Suggested Citation: Suggested Citation