Strategic Considerations in Bankruptcy Discovery: Rule 2004’s Limitations in Light of the Pending Proceeding Rule

The power to commence a Rule 2004 examination, commonly compared to a “fishing expedition,” is not unchecked. The principal limitation is the so-called pending proceeding rule, which prevents a party from using Rule 2004 to obtain discovery that would not be available under the Federal Rules of Civil Procedure.

Federal Rule of Bankruptcy 2004 provides interested parties in a bankruptcy proceeding with the ability to obtain prelitigation discovery that is generally broader in scope than what the Federal Rules of Civil Procedure allow. The power to commence a Rule 2004 examination, commonly compared to a “fishing expedition,” is not unchecked. The principal limitation is the so-called pending proceeding rule, which prevents a party from using Rule 2004 to obtain discovery that would not be available under the Federal Rules of Civil Procedure. Recognizing this limitation at the outset of a case will enable all parties to strategize about how best to deploy Rule 2004 in the context of a bankruptcy case.

Unlike in traditional civil litigation, obtaining discovery in a bankruptcy proceeding does not require the existence of a dispute. Once a bankruptcy case is filed, any party in interest may file a motion asking the court to order a Rule 2004 examination to obtain information on the “acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor’s estate, or to the debtor’s right to a discharge.” Fed. R. Bankr. P. 2004(b). Although the rule does not specifically define who constitutes a “party in interest,” courts have interpreted the phrase liberally to include the trustee, creditors, the debtor and related entities, and other parties who have an interest in the administration of the estate. See, e.g., In re Hammond, 131 B.R. 78, 82 (Bankr. S.D. Ohio 1991); In re Ecam Pubs., 131 B.R. 556, 559 (Bankr. S.D.N.Y. 1991); In re Summit, 891 F.2d 1, 5 (1st Cir. 1989). Rule 2004 discovery can thus be preferable to discovery under the Federal Rules of Civil Procedure, which limits the scope of discovery to matters that are relevant to any party’s claim or defense and proportional to the needs of the case, and further balances the benefits of the proposed discovery against its burden and expense. Fed. R. Civ. P. 26(b). That said, the scope of discovery under Rule 2004 has its limitations.

Chief among the limitations is the pending proceeding rule, which applies both to adversary proceedings, which are certain types of lawsuits defined in Bankruptcy Rule 7001, and to contested matters. A contested matter is any actual dispute, other than an adversary proceeding, before the bankruptcy court, such as a contested §363 sale or the filing of an objection to a proof of claim or to a disclosure statement. See 1983 Advisory Committee Note to Federal Rule of Bankruptcy Procedure 9014. When an adversary proceeding or contested matter has been commenced during the bankruptcy, those matters become pending proceedings, subject to the pending proceeding or pending litigation rule. See In re Sunedison, 572 B.R. 482, 490 (Bankr. S.D.N.Y. 2017). The rule exists to prevent an interested party to the bankruptcy from using discovery obtained pursuant to a Rule 2004 examination in a concurrent adversary proceeding or contested matter. See In re Enron, 281 B.R. 836, 841-42 (Bankr. S.D.N.Y. 2002). Once a pending proceeding commences, New York bankruptcy courts have held that parties seeking discovery should follow Federal Rules of Bankruptcy Procedure 7026-7037, which mirror Federal Rules of Civil Procedure 27-37. See id.

The question of when the switch occurs, however, is muddled. The pending proceeding rule does not extend to parties uninvolved in or issues that were not raised in the adversary proceeding. See In re Buick, 174 B.R. 299, 306 (Bankr. D. Colo. 1994). Creditors may still conduct Rule 2004 examinations regarding issues outside the scope of the pending proceeding, and individuals not party to a pending litigation may continue submitting Rule 2004 discovery requests. See id.

Another limitation of Rule 2004 discovery is that courts may use their discretion over whether to permit an examination under the rule. Courts frequently express concern that parties could use Rule 2004 examinations to circumvent the safeguards provided by the Federal Rules of Civil Procedure, and thus will scrutinize those Rule 2004 requests more seriously when a pending proceeding exists. See In re Enron, 281 B.R. at 841. These limitations seek to prevent the potential for abuse or harassment by parties seeking to use Rule 2004 discovery for unwarranted purposes. See id. at 840-41.

The U.S. Bankruptcy Court for the Southern District of New York in In re Cambridge Analytica, 600 B.R. 750 (Bankr. S.D.N.Y. 2019), solidified a standard that courts should deny Rule 2004 requests if an “improper purpose” behind the request is unveiled. In that case, the court found a Rule 2004 request improper where it was likely made for use in a derivative court action. Id. at 753. The movant was also a plaintiff in an ongoing derivative action that the debtor was not specifically involved in. Id. at 751. However, the movant had purchased a nominal claim in the debtor’s bankruptcy and subsequently filed her Rule 2004 request to access documents that could benefit her in the pending state action because the debtor had some relation to the parties involved in the matter. Id. at 751-52. Worried about the potential that future parties would be incentivized to purchase a claim in a debtor’s bankruptcy to extend their own reach of discovery, the court denied the movant’s motion with the hope of preventing future parties, who may have agendas lying outside the bankruptcy, from making similar requests. Id. at 753.

The discretion bankruptcy judges possess to permit Rule 2004 examination requests gives attorneys in bankruptcy litigation more to think about; in addition to making strategic decisions on what discovery requests to draft, parties to pending proceedings must differentiate between the issues existing in the bankruptcy and the issues existing in the concurrent pending proceeding.

Parties conducting Rule 2004 examinations must carefully consider when to initiate adversary proceedings that relate to the same topic of the examination. While parties who feel wronged may be quick to protect their rights and file a complaint with the claims known to them, this may prematurely cut off a Rule 2004 investigation where there are further areas for examination. A party conducting a Rule 2004 examination should be sure that all information that is needed has been gathered, within the broad scope of that rule, prior to filing an adversary complaint. In practice, where there is an agreed-upon or court-created challenge deadline by which to bring an adversary complaint regarding prepetition claims, this means that there might be a limited amount of time in which to conduct a rapid-pace Rule 2004 investigation.

Parties considering the use or impact of Rule 2004 discovery should not consider its impact in a linear fashion. For instance, the prospect of serving Rule 2004 discovery may lead to voluntary compliance with informal requests for discovery, requests which can be more expeditious and less expensive for the estate. On the other hand, expediting case milestones may curtail the ability of parties to use Rule 2004 and/or may force the examining party to compromise on the scope or timetable for the requests.

There is no debate that when available, Rule 2004 examinations are more expansive and effective than discovery under the Federal Rules of Civil Procedure. But too often Rule 2004 examinations are viewed through the myopic lens of discovery. The application of Rule 2004 is not limitless, and its utility should not be limited to traditional search for claims and causes of action. For this reason, litigating a bankruptcy case requires understanding not just of the limitations described above, but also of the nuances that arise during a case—some which are expected and others that are not.

Reprinted with permission from the February 10, 2021, edition of the New York Law Journal. © 2021 ALM Media Properties, LLC. All rights reserved.