New Jersey District Court Holds that No Evidentiary Hearing is Necessary to Appoint Chapter 11 Trustee

In MicroBilt Corporation v. Ranger Specialty Income Fund, L.P. et al. (In re Princeton Alternative Income Fund, LP), Case No. 3:18-CV-16557 (D.N.J. Nov. 27, 2019), the District Court for the District of New Jersey recently affirmed a bankruptcy court’s decision to appoint a chapter 11 trustee, without conducting a traditional evidentiary hearing.  The holding reinforces that a bankruptcy court has broad discretion to grant extreme remedies in a case.

Facts

Princeton Alternative Income Fund, LP (“PAIF“) is an open-ended debt fund that makes loans to consumer finance companies, which, in turn, loan money to consumers.  Along with its general partner, Princeton Alternative Funding, LLC (collectively with PAIF, the “Debtors“), PAIF filed bankruptcy on March 9, 2018.

Shortly after the filing, two of PAIF’s major investors, Ranger Specialty Income Fund, LP and Ranger Direct Lending Trust (collectively, “Ranger“), moved for the appointment of a chapter 11 trustee, based, in large part, on substantial fiduciary duty litigation commenced prepetition, which ultimately resulted in an arbitration award in favor of Ranger postpetition (after limited stay relief was granted).  The Debtors and MicroBilt Corporation, a reporting agency that provided office support and infrastructure for PAIF, opposed the appointment of a trustee.

Since its commencement, the bankruptcy case was heavily litigated by Ranger, attempting to cast doubt on management’s ability to independently administer the case.  The bankruptcy court warned the parties early on that concessions needed to be made by both sides as to the various litigation matters or else extreme remedies would be considered by the court.  After 8 months of extensive litigation during the bankruptcy case, ignored warnings by the bankruptcy judge, an arbitration award (in favor of Ranger) and multiple motions to dismiss, convert or appoint a trustee, the bankruptcy court ordered the appointment of a chapter 11 trustee, upon only hearing oral argument on the pending motions.  A resulting appeal to the District Court ensued.

Analysis

Section 1104(a) of the Bankruptcy Code provides, in relevant part, that a bankruptcy court must appoint a trustee “. . . if such appointment is in the interest of creditors, any equity security holders, and other interests of the estate . . . .”

Under Third Circuit precedent, “[t]he party moving for appointment of a trustee . . . must prove the need for a trustee . . . by clear and convincing evidence.”   In re G-I Holdings, Inc., 385 F.3d 313, 317-18 (3d Cir. 2004) (quoting In re Marvel Ent. Grp., 140 F.3d 463, 473 (3d Cir. 1998)).  A court generally considers the totality of the circumstances in deciding whether a trustee is necessary. See In re Grasso, 490 B.R. 527-28 (Bankr. E.D. Pa. 2013).  The appointment of a trustee is reviewed on appeal under the abuse of discretion standard.   See In re Sharon Steel Corp., 871 F.2d 1217, 1226 (3d Cir. 1989).

Ranger’s primary argument on appeal was that the bankruptcy court did not hold an evidentiary hearing before appointing a trustee.  The District Court found, however, that there was no controlling case law in the Third Circuit requiring an evidentiary hearing and, in fact, controlling case law leaves such decision-making within the discretion of the bankruptcy court. See Marvel, 140 F.3d at 474.   Moreover, many courts outside the Third Circuit expressly take the position that no evidentiary hearing is required due to the wide discretion afforded under section 1104(a)(2).   See In re Casco Bay Lines, Inc., 17 B.R. 946 (B.A.P. 1st Cir. 1982); In re Basil St. Partners, LLC , 477 B.R. 856, 867 (Bankr. M.D. Fla. 2012); In re Ionosphere Clubs, Inc., 113 B.R. 164, 167 (Bankr. S.D.N.Y. 1990).

While the bankruptcy court was not required to conduct an evidentiary hearing, it was required to base its decision on evidence.  Here, the District Court found that the bankruptcy court possessed “the quantum of evidence necessary to support its finding.”  In particular, the bankruptcy court took judicial notice of the intense level of acrimony between the parties in deciding what was in the best interest of creditors.  See Marvel, 140 F.3d at 474 (“deep-seeded conflict and animosity between a debtor and its creditors” justifies the appointment of a trustee).  This animosity included frequent discovery disputes, ongoing litigation in multiple jurisdictions (arbitration and bankruptcy), and numerous accusations of wrong-doing both pre- and post-petition.  Left unfettered, such animosity would cause exceeding delays and drain the estate of administrative expenses.

Having observed the hallmarks of acrimony in the case, the District Court held that the bankruptcy court had not abused its discretion in appointing a trustee.

Takeaway

While the appointment of a chapter 11 trustee is an extreme remedy, PAIF was a classic case where significant, prepetition fiduciary duty litigation was allowed to spill over into the bankruptcy case.  The bankruptcy court eventually lost its patience (after many months of extensive litigation) when the Debtors were not able to instill confidence that they could efficiently manage the postpetition litigation through the confirmation of a plan. The specter of doubt as to management’s independence, given the postpetition arbitration award (finding breach of fiduciary duty) in favor of Ranger, added ammunition to the relief requested by Ranger.  The case reminds practitioners not to test the patience of a bankruptcy judge, because he or she has wide discretion to grant relief on many fronts, including displacing existing management from operating the debtor.

 

 



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