The Third Circuit has reversed a February 2023 Delaware Bankruptcy Court ruling and decided that an Independent Examiner is appropriate in the FTX bankruptcy matter. The three-judge panel sided with the U.S. Trustee’s Office in its position that the appointment of an examiner was necessary for a case of this size, and that the Bankruptcy Court erred last February when it decided that the appointment was discretionary and thus denied the request. The FTX bankruptcy was commenced in Delaware in November 2022 amid allegations of widespread fraud. FTX was a company led by convicted Sam Bankman-Fried and was involved in the cryptocurrency industry.

The U.S. Trustee, in appealing the Bankruptcy Court’s ruling, argued that the Bankruptcy Code required the appointment of an examiner at its request in any Chapter 11 involving fixed, liquidated, unsecured debts—other than debts for goods, services or taxes, or owing to an insider—exceeding $5 million. Further, the U.S. Trustee expressed the need for the appointment of an examiner to investigate fraud and mismanagement that it believed occurred at FTX before its collapse, saying that it was “too important” to leave to its creditors and current management. In the appeal, FTX’s counsel argued that an examiner was unnecessary, saying that new management brought in after its November 2022 collapse had produced “substantial” reports on its finances and that multiple government agencies were involved and pursuing their own investigations. Further, FTX counsel noted its concern that such a probe could cost $100 million. This concern was met by the argument that there were allegations of misappropriation of $10 billion of customer assets.

The Third Circuit agreed with the U.S. Trustee in reversing the lower court ruling, saying the law states the court “shall” appoint an examiner under these circumstances and that the appointment here was mandatory. Judge Restrepo, writing for the Third Circuit, said that there was value to having a fully independent investigation, as concerns were raised about FTX’s bankruptcy counsel’s pre-bankruptcy role as an FTX adviser and the possibility that officers and employees who engaged in wrongdoing before the bankruptcy are still with the company. The Court was also concerned that “the collapse of FTX caused catastrophic losses for its worldwide investors but also raised implications for the evolving and volatile cryptocurrency industry.” The Court also said that, unlike FTX, the examiner will be required to make their report public, which it said was appropriate considering the “catastrophic” losses of FTX’s investors and the implications its collapse has for the cryptocurrency industry as a whole. Per Judge Restrepo, “sometimes highly complex cases give rise to straightforward issues on appeal. Such is the case here.”

To discuss the issues raised here or any other issues involving creditors rights and bankruptcy, please contact Leslie Beth Baskin, Esquire at 215-241-8926 or at lbaskin@sgrvlaw.com.