Third Circuit Orders Independent Examiner in FTX Bankruptcy (1)

An outside investigation into FTX Group is mandatory under the US bankruptcy code, a federal appeals court ruled Friday, reversing a Delaware judge’s original order denying an independent examiner.

The Third Circuit ordered US Bankruptcy Judge John Dorsey to appoint an examiner to investigate the collapse of the FTX crypto exchange. FTX commenced Chapter 11 bankruptcy in November 2022 amid widespread fraud allegations.

The decision will bring additional disclosures about FTX’s operations because examiners have a mandate to make their investigative findings public. Courts often appoint examiners in big, multi-billion dollar cases such as past bankruptcies of Enron and Lehman Brothers.

Dorsey last February rejected a request by the US Trustee, the federal watchdog that monitors corporate bankruptcies, to appoint an examiner, saying such a probe would likely cost creditors more than $100 million and interfere with FTX’s effort to repay debts. The trustee appealed Dorsey’s decision, arguing that an independent probe was necessary for the public to get a more complete picture of FTX’s downfall.

A three-judge panel on the Third Circuit found that the plain text of the US bankruptcy code demanded that Dorsey fulfill the US Trustee’s request. A court must appoint an examiner if requested by a US Trustee or interested party and the debtor’s fixed, liquidated and unsecured debt exceeds $5 million, the panel wrote, citing the statute.

“In addition to providing much-needed elucidation,” the panel wrote, “the investigation and examiner’s report ensure that the bankruptcy court will have the opportunity to consider the greater public interest when approving the FTX Group’s reorganization plan.”

The independence of an examiner is relevant, the circuit panel said, given the law firm Sullivan & Cromwell’s work for FTX prior to the bankruptcy and the conflict of interest issues that have been raised over it. The US Trustee has also pushed for an outside investigation to determine whether any employees or officers of FTX who engaged in wrongdoing are still with the company.

FTX, once one of the largest crypto exchange’s in the world, entered Chapter 11 bankruptcy as it faced a liquidity crisis spurred by reports that it was financially compromised. Sam Bankman-Fried, its former chief executive, in November was found guilty of seven counts of fraud and conspiracy.

The case is In re FTX Trading Ltd. , 3d Cir., No. 23-02297, ruling 01/19/24