ABI Journal

Lessons from Fas Mart: Examiner Must Have Industry Expertise

By: Roy M. Terry, Jr. and Elizabeth l. Gunn

Examiners are often-discussed, but seldom- understood, players in chapter 11 cases. An examiner’s role, scope and powers can be, and are, as different as each chapter 11 debtor. An article in the May 2014 issue of the Journal described the following as the primary criteria used by the U.S. Trustee’s office in selecting a chapter 11 trustee: (1) the candidate must have the needed skill set; (2) the candidate must be independent, including in the exercise of his/her judgment; and (3) the candidate must have experience, qualifications and ability to muster the necessary expertise.1 The article stated that the U.S. Trustee’s process for appointment of an examiner is identical. While identifying this criteria is helpful, however, the true significance for chapter 11 practice lies in how they are interpreted and applied.

Enhancing the Selection Process

The scope of an examiner’s duties is outlined by 11 U.S.C. § 1106(b), but a bankruptcy court has the discretion to tailor an examiner’s duties, powers and requirements to fit the circumstances of the case. As a result, with guidance from the court, examiners are often in a unique position in which they can help shape and determine the details of their role. In this manner, examiners are often thought to be the “eyes and ears” of the court and of the various interested parties. As the U.S. Bankruptcy Court for the Southern District of Ohio noted in In re Baldwin United Corp., “[a]n Examiner’s legal status is unlike that of any other court-appointed officer [that] comes to mind. He is first and foremost disinterested and nonadversarial. The benefits of his investigative efforts flow to the debtor and to its creditors and shareholders, but he answers solely to the Court.”

Pursuant to 11 U.S.C. § 1104(c), the U.S. Trustee or a party in interest may request that an examiner be appointed. If an examiner is appointed, the U.S. Trustee usually nominates a person for the court’s consideration pursuant to the process described in the May 2014 Journal article.

In most cases, the U.S. Trustee confers with the primary parties in the case as to which individual should be considered, but the final individual selected, absent other orders from the court, is solely within the discretion of the U.S. Trustee.3 In many cases, there is no disclosure of the evaluation process used by the U.S. Trustee, only a disclosure of the parties “consulted” in the consideration of candidates. The lack of (1) a transparent selection process and (2) established, formal and public guidelines or standards create the potential for undue influence and/or candidates being presented for reasons other than being appropriately qualified.

The importance placed on the examiner’s report, combined with the typically short turnaround time for the examiner to conduct his/her investigation and prepare

his/her report, highlights the importance and need for an examiner to have the “right” experience, qualifications and ability necessary to evaluate the issues identified in the court’s appointment order.

Most important among the qualifying factors for an examiner, especially from the debtor’s perspective, may be that he/she (or, at minimum, a member of his/her professional team) have specific knowledge and experience in the debtor’s industry. Therefore, an examiner who can quickly, accurately and effectively report on the debtor’s business necessitates the selection of a candidate with knowledge and experience regarding the debtor’s industry.

Thus, even in cases when the debtor remains in possession, those directly involved with the operation of the debtor’s business (i.e., the debtor and members of the creditors’ committee) will still be, in the majority of cases, the most competent sources for examiner candidates with industry experience and expertise. Secured lenders, particularly in the circumstances where a loan has been sold post-closing or post-default, might not be in a position to adequately pinpoint the expertise required.

The need for in-depth experience in the debtor’s industry highlights the need for the selection process to be transparent and open. In sum, in selecting examiners, the focus should be on “what they know,” not “who they know.”

Roy M. Terry Jr.
Sands Anderson PC
Richmond, VA.

Elizabeth L. Gunn
Sands Anderson PC
Richmond, VA.

The Case of Fas Mart Convenience Stores

The chapter 11 case of Fas Mart Convenience Stores Inc. is an interesting and telling example of how an apparent lack of industry knowledge and experience can impact the outcome of an examiner’s report and of the case. Fas Mart filed for chapter 11 relief in the Eastern District of Virginia on March 9, 2001. At the time of its bankruptcy filing, Fas Mart operated 170 convenience stores with a consolidated annual revenue of $500 million. As is common in the convenience store industry, the consolidated debtor and nondebtor Fas Mart entities were vertically integrated. Affiliated nondebtor entities included a jobber, which purchased fuel from an oil company and delivered it to the convenience stores. All of the debtor and nondebtor entities were owned and/or controlled by Owais A. Dagra.

Prior to the company’s financial difficulties, the story of Fas Mart typified the “American dream.” In less than 10 years, Mr. Dagra had turned an initial investment of $500 into a $500 million success story, garnering him a Virginia Entrepreneur of the Year Award in 1999. However, in the third quarter of 1999, convenience stores generally experienced an unexpected downturn resulting from an unprecedented OPEC (Organization of the Petroleum Exporting Countries) oil crisis. Cash flow from gas sales plummeted, resulting in difficulties in servicing debt. Commencing in 1997, Fas Mart had financed much of its expansion through Franchise Mortgage Acceptance Company LLC (FMAC). In the fall of 2000, Fas Mart approached FMAC to discuss a restructuring of the debt outside of bankruptcy, which FMAC declined. Chapter 11 filings ensued.

The chapter 11 cases began favorably for Fas Mart. However, after FMAC lost its motion for adequate protection, it filed a motion to appoint a chapter 11 trustee or examiner, basing its argument in part on the allegation that the debtor’s petroleum supply agreements with the jobber resulted in a conflict of interest. The debtor and creditors’ committee opposed FMAC’s motion to appoint a chapter 11 trustee; instead, the committees proposed the appointment of an examiner. Prior to the hearing on FMAC’s motion, the debtor, committee and FMAC, inter alia, entered into a consent order appointing an examiner. The consent order established that the appointed examiner was to address all of the issues raised in FMAC’s motion, principally the pre- and post-petition transactions that took place among the debtor entities, the related nondebtor entities and Mr. Dagra. Shortly after the consent order was entered, the U.S. Trustee appointed a respected and disinterested bankruptcy attorney as examiner. In the notice of appointment, the U.S. Trustee noted that he had conferred with the debtor, the committee, FMAC and other interested parties on the selection of the examiner. There was no further disclosure as to the examiner’s “experience, qualifications and ability” or to the factors considered in his selection. The examiner was instructed to provide the court with oral reports once every two weeks and to issue a written report within 60 days.

Given the importance and impact that the expertise of an examiner can have upon a case, as evidenced by Fas Mart, there is a significant benefit to all parties (including the court) for candidates to be subject to guidelines or requirements, including as to knowledge and experience regarding the debtor’s industry, as part of a transparent and open selection and appointment process.

Prior to issuing his written report, the examiner received information from the debtor’s financial adviser (also filed with the court by the debtor) regarding intercompany transactions that had occurred — primarily pre-petition — as a result of the integrated nature of the companies. Based primarily on this information, the examiner sought an emergency hearing at which he forcefully advocated for the immediate appointment of a chapter 11 trustee. Despite opposition from the debtor, the committee and Mr. Dagra, the court accepted the examiner’s oral recommendation, and the U.S. Trustee was ordered to appoint a trustee. In his written report, published approximately two weeks after the appointment of the trustee, the examiner did not advocate as forcefully for the appointment of a trustee as he did in his oral presentation.

The primary concerns raised by the examiner in both his oral presentation and his later written report revolved around certain intercompany transactions. The examiner was especially troubled by the relationship between the debtor and the jobber. The statements made by the examiner as to the jobber make it clear that the examiner was not only unaware that vertically integrated jobber relationships are common in the convenience store industry, but also that they appropriately address valid business, licensing and legal requirements. In the instance of Fas Mart, a separate jobber entity was also contractually required by both FMAC and the oil companies. The jobber serviced 62 independent dealers other than Fas Mart and charged those independents more per gallon than it charged Fas Mart.

Notably, prior to the emergency hearing, the examiner never interviewed, deposed or otherwise consulted with the one person who had intimate and extensive knowledge of all the companies, their agreements, the business, licensing and legal justifications for the integrated structure, and the background for each transaction: Mr. Dagra. As a result, it appears that the examiner made his recommendations without obtaining all of the relevant information. A review of the analysis prepared by the examiner makes it clear that either (1) prior knowledge and experience regarding the convenience store industry or (2) an interview of Mr. Dagra would have been especially beneficial to discerning the vertical nature of the convenience store industry and the need and role of the jobber. In fact, a better understanding of the convenience store industry could have explained, alleviated or otherwise resolved many of the concerns raised by the examiner.

The appointment of the trustee in Fas Mart generated additional lawsuits costing the debtors’ estate millions in administrative expenses with minimal or no recovery to the estate. Mr. Dagra prevailed in all cases brought against the nondebtor entities or him by successfully resolving each case and obtaining releases and/or dismissals with prejudice.6 In a stipulation and order resolving a preference complaint, the court found that the “Trustee ha[d] not presented evidence of any claim against Mr. Dagra and the Trustee ha[d] not presented evidence that Mr. Dagra received any avoidable transfers.”7 In Fas Mart, if the examiner’s advocacy for the appointment of a trustee, at the emergency hearing, had not been based on an uninformed understanding of the convenience store industry, then the case would have been resolved faster and significantly less administrative costs would have been incurred, which would have allowed for a higher return to creditors.

The completion of a successful sale of Fas Mart and confirmation of a liquidation plan, without conversion to chapter 7, is a testament to the dedication and good judgment of the chapter 11 trustee, the skilled counsel involved for all of the parties,8 and Mr. Dagra’s commitment to the success of Fas Mart. Mr. Dagra arranged for the jobber to continue supplying fuel to Fas Mart on credit terms and continued to provide debtor-in-possession and other financing to the debtor. Ultimately, Mr. Dagra supported and facilitated the sale of Fas Mart by the trustee.9 While many private middle-market companies do not survive chapter 11 and the odds were certainly stacked against Fas Mart, these responsible actions by the trustee, counsel and Mr. Dagra resulted in a successful sale of the company as a going concern that continues today.

Conclusion

Although an examiner’s report is not intended to be used as evidence by parties to a case, the reports are intended to provide all parties with an analysis and key information regarding the issues investigated by the examiner. The information contained in a report often forms the basis for subsequent motions to appoint trustees (as in the Fas Mart case), adversary proceedings or criminal proceedings. Further, as the “eyes and ears” of the court, judges rely on examiners and their reports for information and analysis as to the debtor and their business.

In any other circumstance, a party providing a report to the court must be qualified as an expert in a transparent and open process prior to providing an opinion. As the Baldwin United court stated, an examiner’s unique position allows for a legal status unlike that of any other court officer. Given the importance and impact that the expertise of an examiner can have upon a case, as evidenced by Fas Mart, there is a significant benefit to all parties (including the court) for candidates to be subject to guidelines or requirements, including as to knowledge and experience regarding the debtor’s industry, as part of a transparent and open selection and appointment process.

Lessons From Fas Mart