Third Circuit: Bankruptcy Code Mandates Appointment of Examiner In Chapter 11 Cases

As background, Samuel Bankman-Fried (SBF) was the founder and majority owner of both FTX, a cryptocurrency exchange platform, and Alameda Research, a cryptocurrency hedge fund. Since its formation in 2019, FTX had grown to a staggering $32 billion valuation in just a few years. In early November 2022, however, questions emerged alleging a conflict of interest between the two ostensibly independent companies, and investors began cashing out at an alarming rate after discovering that Alameda Research had used funds from FTX customers to inflate its own balance sheet, among other questionable activities. On Nov. 11, 2022, following a massive liquidity crisis that saw customers collectively lose billions of dollars in investments and put the legitimacy of the entire cryptocurrency industry in question, FTX filed for bankruptcy and SBF appointed John J. Ray III as replacement CEO for FTX and its affiliates. Ray's own investigations of the company confirmed "unacceptable management practices" including "the use of software to conceal the misuse of customer funds," and ultimately "located and secured only a fraction of the digital assets."

In the bankruptcy court, the U.S. Trustee (US) filed a motion to appoint an examiner to investigate FTX's management, citing 11 U.S.C. Section 1104(c)(2), which, according to the UST, mandates the appointment of an examiner if requested by the UST or a party in interest, and if "the debtor's total fixed, liquidated, unsecured debts" exceeds $5 million. The UST stated its belief that "a public report of the examiner's findings could reveal the 'wider implications' that FTX's unprecedented collapse had for the cryptocurrency industry." The opposing parties, including the Unsecured Creditors' Committee and the debtor in possession, argued that the phrase "as is appropriate" in Section 1104(c) indicates the appointment of an examiner is a permissive duty, subject to the bankruptcy court's discretion. They argued that granting the UST's motion would be "highly inappropriate" in this case, given that further investigation would "create an unjustifiable cost for creditors, interfere with their efforts to stabilize FTX Group, duplicate their findings of management wrongdoing, and pose a security risk to cryptocurrency codes."