Strategic Uses of a Rule 2004 Exam

Tool for Discovery

The Rule 2004 exam is one of three basic tools for discovery in bankruptcy cases: the ' 341 meeting, the Rule 2004 examination, and civil discovery conducted within an adversary proceeding or contested matter. Judge Leif M. Clark discussed the roots of the ' 41 meeting and the Rule 2004 exam in In re Muy Bueno Corp., 257 B.R. 843 (Bankr. W.D. Tex. 2001). The ' 341 meeting serves 'as a sort of preliminary investigation in the debtor's estate, sometimes negating further inquiry while at other times giving rise to additional suspicions that could be more fully explored in a Rule 2004 examination.' Id. at 850. A Rule 2004 exam is therefore intended to be a more extensive supplement to the ' 341 meeting, with the burden of the examination justified by the basic information gleaned through the
' 341 meeting.

While the scope of a Rule 2004 exam is 'inquisitory,' the scope of civil discovery is 'accusatory.' Because it is normally requested before the filing of a complaint or contested matter, and is independent of a complaint or contested matter, the examination need not be tied to specific factual allegations beyond the broad scope set forth in the rule. Accordingly, a Rule 2004 exam is subject to fewer objections on grounds of relevance than would burden discovery filed in a lawsuit or contested motion. Because of the pre-litigation, as opposed to pre-trial, character of a Rule 2004 exam, once an adversary proceeding or contested matter has been initiated, discovery relating to the facts at issue in the adversary proceeding or contested matter should be pursued through the civil discovery rules, although even then the Rule 2004 exam remains a viable tool for discovery by any debtor, trustee, or party-in-interest that is not a party to the adversary proceeding or contested matter or for discovery by any relevant party on facts not at issue in the adversary proceeding or contested matter.

Obtaining Leave to Conduct a Rule 2004 Examination and Compelling the Exam

The terms of the Rule expressly provide that leave to take a Rule 2004 exam is obtained by motion. Fed. R. Bankr. P. 2004(a). The advisory committee notes further contemplate the bankruptcy court hearing the motion on an ex parte basis or 'on notice.' The ex parte and 'on notice' features indicate that arguments and objections concerning the propriety of a Rule 2004 exam are not likely to be played out during a hearing on whether the exam may be taken, but later in the process. After obtaining leave to take a Rule 2004 exam, the typical next step is for the examining party to issue a subpoena to the examinee. Fed. R. Bankr. P. 2004(c).

A subpoena issued under the Federal Rules of Civil and Bankruptcy Procedure can command the person to whom it is directed to give testimony, i.e., sit for a deposition (a/k/a subpoena ad testificandum), or to produce and permit inspection and copying of designated documents or materials in that person's possession, custody, or control (a/k/a subpoena duces tecum). Fed. R. Civ. P. 45(a)(1)(C). A subpoena can also command the inspection of certain premises by the issuer at a designated time and place. The command to appear for a deposition and to produce for inspection and copying can be made jointly or separately. The person to whom a subpoena is directed need not appear for a production unless the subpoena also compels a deposition. Fed. R. Civ. P. 45(c)(2)(A). In addition to specifying a procedure for the examiner to lay out the time and place of the exam and designate who and/or what will be examined, the incorporation of the subpoena powers into Rule 2004 empowers the court to enforce compliance with a Rule 2004 exam. See Fed. R. Civ. P. 45(e).

The rules provide that the clerk shall issue the subpoena to the party requesting it, or, as is now common practice, '[a]n attorney as officer of the court may ' issue and sign a subpoena on behalf of (A) a court in which the attorney is authorized to practice or (B) a court for a district in which a deposition or production is compelled by the subpoena, if the deposition or production pertains to an action pending in a court in which the attorney is authorized to practice.' Fed. R. Civ. P. 45(a)(3). Today this generally means the attorney properly filling out and signing the official form subpoena as modified for the jurisdiction in question.

The court of issuance is important because the rules place strict limits on the geographic reach of individual courts' powers to compel the attendance of a witness or production of materials. With a few exceptions, a subpoena may only be served within the district of the issuing court or at any place outside that district if it is within 100 miles of the place of the deposition or production. Fed. R. Civ. P. 45(b)(2). A subpoena violating these geographical limits, e.g., a subpoena directed to a witness located in the Northern District of Illinois issued by the U.S. Bankruptcy Court for the Eastern District of Virginia, would most likely be found to be defective on its face. Such a subpoena likely need not be complied with although, as discussed below, it is still important to serve a timely written response and/or objection because those objections may otherwise be waived.

Limitations on the Subpoena Power

Although the allowed scope of a Rule 2004 exam is broad, there are limitations to a court's subpoena power. Rule 45(c)(3)(A) provides that the court of issuance shall quash or modify the subpoena if it: 1) fails to allow a reasonable time for compliance; 2) requires a person who is neither a party nor an officer of the party to travel more than 100 miles from that person's residence or place of business or employment; 3) commands disclosure of privileged or otherwise protected material; or 4) subjects the examinee to 'undue burden.' The issue of 'undue burden' often turns on the cost burden imposed by the subpoena. Courts will generally protect examinees from costly compliance with a Rule 2004 exam. Courts will also typically only require that documents be produced and not require that they be compiled or analyzed. In addition to these protections of the subject of a subpoena, an attorney issuing a subpoena has an affirmative duty to take reasonable steps to avoid imposing undue burden or expense. The rule provides for sanctions for costs incurred as a consequence of breaches of this duty, including lost earnings and reasonable attorneys' fees.

Responding to the Subpoena

Rule 45(c)(2)(B) provides that a person subject to a subpoena duces tecum, or for the inspection of premises, may object within the earlier of 14 days from service or the time specified for performance. The objection is to be in writing and served on the party issuing the subpoena or the attorney designated therein. The rules do not provide for this objection to be filed with the court, although local practice may differ. Once an objection has been made, the burden shifts to the issuing party to move for an order compelling the production. The issuing party can also move to compel if the party to whom the subpoena is directed fails to comply. Raising a Rule 45(c)(2)(B) objection can be a critical step in responding to a subpoena because there is case law holding that a failure to object in a timely fashion may constitute a waiver. See, e.g., In re DB Acquisition Corp., 151 F.3d 75 (2d Cir. 1998).

Another response to a subpoena is to move to quash or modify the subpoena as violating one or more of the restrictions found in Rule 45(c)(3)(A). Any motion to quash must be 'timely' filed. While the case law interpreting 'timely' varies, filing a motion to quash prior to the time set for compliance to the subpoena is likely to be found to be timely. The moving party bears the burden of proving that the subpoena is improper and mere assertions are not sufficient. While the motion to quash or modify is typically brought by the subject of the subpoena, a third party may have standing to so move if the third party can show some personal right or privilege with regard to the production or testimony sought. The court has a significant flexibility in dealing with objections to subpoenas, including the authority to modify the subpoena to render it unobjectionable or require the issuing party to advance costs. If the motion to quash is successfully opposed and the court finds that the objection was not justifiable, the issuer of the subpoena may request attorneys' fees related to the motion to quash.

Conclusion

The Rule 2004 exam is a broad discovery device available in every bankruptcy case that empowers all parties-in-interest in seeking to explore ways to maximize the value of the debtor's estate or to marshal evidence of improper conduct necessary to bar the debtor's discharge. While the broad concepts underlying this device are commonly known, the procedural details involved in obtaining, conducting, and opposing a Rule 2004 exam are extremely important and offer many pitfalls for the unprepared. Knowing how to properly obtain and object to a Rule 2004 exam can be critical to attaining a goal in a bankruptcy case or safeguarding a client from needless expense or inappropriate or otherwise damaging disclosure.

David Lee Tayman is an attorney in the bankruptcy and creditors' rights department of Dickstein Shapiro LLP. He has significant experience representing clients (including secured and unsecured lenders, creditors, debtors, trustees, financial sponsors, and equity holders) in a wide variety of bankruptcy, commercial litigation and troubled company transactional engagements. He can be reached at 202-420-4728 or [email protected].

While most bankruptcy practitioners are familiar with the basic concepts behind the Rule 2004 exam, some are less familiar with the procedural intricacies of obtaining, conducting, and responding to the exam ' intricacies that often involve practices and procedures adapted from civil discovery that are beyond the scope of pure bankruptcy practice. Rule 2004 of the Federal Rules of Bankruptcy Procedure provides a broadly construed discovery device that allows debtors, trustees, or any other party-in-interest in a bankruptcy case to examine 'any entity' as long as the examination relates to the 'acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor's estate, or to the debtor's right to a discharge.' Fed. R. Bankr. P. 2004(b).

A Rule 2004 examination is not limited to seeking discovery against the debtor, trustee, or parties-in-interest in the bankruptcy case. The broad phrase 'any entity' clearly includes any third parties who possess knowledge of the debtor's acts, conduct, or financial affairs relating to the bankruptcy case. A Rule 2004 exam may not be used for purposes of abuse or harassment and may not go into matters not relevant to the broad scope set for the in Rule 2004(b). However, this scope is significantly greater than that typically allowed in civil discovery. This difference is so great that Rule 2004 exams are routinely referred to as 'fishing expeditions.'

The ability to examine 'any entity' on matters relating to the bankruptcy case is the real key to obtaining maximum value from a Rule 2004 exam. For instance, if there is some reason to believe that the debtor secretly transferred assets prior to bankruptcy, Rule 2004 provides a device to compel the alleged transferee to sit for a deposition or produce relevant documents. Depending on the circumstances of the alleged transfers, this could mean pursuing a Rule 2004 exam against an affiliate, business associate, or even a family member of the debtor. If there is a belief that examining a person or entity 'friendly' to the debtor will not yield helpful results, the transfers can be investigated by compelling the production of account records from the debtor's or from the alleged transferee's bank. A Rule 2004 exam could also potentially as a pre-litigation tool to explore whether the debtor has claims that are worth pursuing. If there are valuation concerns, third parties can also be compelled to produce documents in their possession relating to key assets of the debtor.

Tool for Discovery

The Rule 2004 exam is one of three basic tools for discovery in bankruptcy cases: the ' 341 meeting, the Rule 2004 examination, and civil discovery conducted within an adversary proceeding or contested matter. Judge Leif M. Clark discussed the roots of the ' 41 meeting and the Rule 2004 exam in In re Muy Bueno Corp., 257 B.R. 843 (Bankr. W.D. Tex. 2001). The ' 341 meeting serves 'as a sort of preliminary investigation in the debtor's estate, sometimes negating further inquiry while at other times giving rise to additional suspicions that could be more fully explored in a Rule 2004 examination.' Id. at 850. A Rule 2004 exam is therefore intended to be a more extensive supplement to the ' 341 meeting, with the burden of the examination justified by the basic information gleaned through the
' 341 meeting.

While the scope of a Rule 2004 exam is 'inquisitory,' the scope of civil discovery is 'accusatory.' Because it is normally requested before the filing of a complaint or contested matter, and is independent of a complaint or contested matter, the examination need not be tied to specific factual allegations beyond the broad scope set forth in the rule. Accordingly, a Rule 2004 exam is subject to fewer objections on grounds of relevance than would burden discovery filed in a lawsuit or contested motion. Because of the pre-litigation, as opposed to pre-trial, character of a Rule 2004 exam, once an adversary proceeding or contested matter has been initiated, discovery relating to the facts at issue in the adversary proceeding or contested matter should be pursued through the civil discovery rules, although even then the Rule 2004 exam remains a viable tool for discovery by any debtor, trustee, or party-in-interest that is not a party to the adversary proceeding or contested matter or for discovery by any relevant party on facts not at issue in the adversary proceeding or contested matter.

Obtaining Leave to Conduct a Rule 2004 Examination and Compelling the Exam

The terms of the Rule expressly provide that leave to take a Rule 2004 exam is obtained by motion. Fed. R. Bankr. P. 2004(a). The advisory committee notes further contemplate the bankruptcy court hearing the motion on an ex parte basis or 'on notice.' The ex parte and 'on notice' features indicate that arguments and objections concerning the propriety of a Rule 2004 exam are not likely to be played out during a hearing on whether the exam may be taken, but later in the process. After obtaining leave to take a Rule 2004 exam, the typical next step is for the examining party to issue a subpoena to the examinee. Fed. R. Bankr. P. 2004(c).

A subpoena issued under the Federal Rules of Civil and Bankruptcy Procedure can command the person to whom it is directed to give testimony, i.e., sit for a deposition (a/k/a subpoena ad testificandum), or to produce and permit inspection and copying of designated documents or materials in that person's possession, custody, or control (a/k/a subpoena duces tecum). Fed. R. Civ. P. 45(a)(1)(C). A subpoena can also command the inspection of certain premises by the issuer at a designated time and place. The command to appear for a deposition and to produce for inspection and copying can be made jointly or separately. The person to whom a subpoena is directed need not appear for a production unless the subpoena also compels a deposition. Fed. R. Civ. P. 45(c)(2)(A). In addition to specifying a procedure for the examiner to lay out the time and place of the exam and designate who and/or what will be examined, the incorporation of the subpoena powers into Rule 2004 empowers the court to enforce compliance with a Rule 2004 exam. See Fed. R. Civ. P. 45(e).

The rules provide that the clerk shall issue the subpoena to the party requesting it, or, as is now common practice, '[a]n attorney as officer of the court may ' issue and sign a subpoena on behalf of (A) a court in which the attorney is authorized to practice or (B) a court for a district in which a deposition or production is compelled by the subpoena, if the deposition or production pertains to an action pending in a court in which the attorney is authorized to practice.' Fed. R. Civ. P. 45(a)(3). Today this generally means the attorney properly filling out and signing the official form subpoena as modified for the jurisdiction in question.

The court of issuance is important because the rules place strict limits on the geographic reach of individual courts' powers to compel the attendance of a witness or production of materials. With a few exceptions, a subpoena may only be served within the district of the issuing court or at any place outside that district if it is within 100 miles of the place of the deposition or production. Fed. R. Civ. P. 45(b)(2). A subpoena violating these geographical limits, e.g., a subpoena directed to a witness located in the Northern District of Illinois issued by the U.S. Bankruptcy Court for the Eastern District of Virginia, would most likely be found to be defective on its face. Such a subpoena likely need not be complied with although, as discussed below, it is still important to serve a timely written response and/or objection because those objections may otherwise be waived.

Limitations on the Subpoena Power

Although the allowed scope of a Rule 2004 exam is broad, there are limitations to a court's subpoena power. Rule 45(c)(3)(A) provides that the court of issuance shall quash or modify the subpoena if it: 1) fails to allow a reasonable time for compliance; 2) requires a person who is neither a party nor an officer of the party to travel more than 100 miles from that person's residence or place of business or employment; 3) commands disclosure of privileged or otherwise protected material; or 4) subjects the examinee to 'undue burden.' The issue of 'undue burden' often turns on the cost burden imposed by the subpoena. Courts will generally protect examinees from costly compliance with a Rule 2004 exam. Courts will also typically only require that documents be produced and not require that they be compiled or analyzed. In addition to these protections of the subject of a subpoena, an attorney issuing a subpoena has an affirmative duty to take reasonable steps to avoid imposing undue burden or expense. The rule provides for sanctions for costs incurred as a consequence of breaches of this duty, including lost earnings and reasonable attorneys' fees.

Responding to the Subpoena

Rule 45(c)(2)(B) provides that a person subject to a subpoena duces tecum, or for the inspection of premises, may object within the earlier of 14 days from service or the time specified for performance. The objection is to be in writing and served on the party issuing the subpoena or the attorney designated therein. The rules do not provide for this objection to be filed with the court, although local practice may differ. Once an objection has been made, the burden shifts to the issuing party to move for an order compelling the production. The issuing party can also move to compel if the party to whom the subpoena is directed fails to comply. Raising a Rule 45(c)(2)(B) objection can be a critical step in responding to a subpoena because there is case law holding that a failure to object in a timely fashion may constitute a waiver. See, e.g., In re DB Acquisition Corp., 151 F.3d 75 (2d Cir. 1998).

Another response to a subpoena is to move to quash or modify the subpoena as violating one or more of the restrictions found in Rule 45(c)(3)(A). Any motion to quash must be 'timely' filed. While the case law interpreting 'timely' varies, filing a motion to quash prior to the time set for compliance to the subpoena is likely to be found to be timely. The moving party bears the burden of proving that the subpoena is improper and mere assertions are not sufficient. While the motion to quash or modify is typically brought by the subject of the subpoena, a third party may have standing to so move if the third party can show some personal right or privilege with regard to the production or testimony sought. The court has a significant flexibility in dealing with objections to subpoenas, including the authority to modify the subpoena to render it unobjectionable or require the issuing party to advance costs. If the motion to quash is successfully opposed and the court finds that the objection was not justifiable, the issuer of the subpoena may request attorneys' fees related to the motion to quash.

Conclusion

The Rule 2004 exam is a broad discovery device available in every bankruptcy case that empowers all parties-in-interest in seeking to explore ways to maximize the value of the debtor's estate or to marshal evidence of improper conduct necessary to bar the debtor's discharge. While the broad concepts underlying this device are commonly known, the procedural details involved in obtaining, conducting, and opposing a Rule 2004 exam are extremely important and offer many pitfalls for the unprepared. Knowing how to properly obtain and object to a Rule 2004 exam can be critical to attaining a goal in a bankruptcy case or safeguarding a client from needless expense or inappropriate or otherwise damaging disclosure.

David Lee Tayman is an attorney in the bankruptcy and creditors' rights department of Dickstein Shapiro LLP. He has significant experience representing clients (including secured and unsecured lenders, creditors, debtors, trustees, financial sponsors, and equity holders) in a wide variety of bankruptcy, commercial litigation and troubled company transactional engagements. He can be reached at 202-420-4728 or [email protected].