WILLIAM T. THURMAN, Bankruptcy Chief Judge.
The matter before the Court is the First and Final Application for Allowance of Attorneys' Fees and Costs for Woodbury & Kesler, P.C., Attorneys for South Station, LLC pursuant to 11 U.S.C. §§ 329 and 330 and Fed. R. Bankr.P. 2016 ("Fee Application"). The Chapter 7 Trustee, Kenneth Rushton ("Chapter 7 Trustee") filed an Objection to the Fee Application ("Objection") on October 5, 2011 on the grounds that Woodbury and Kesler, P.C. ("Applicant") failed to comply with the disclosure requirements of Fed. R. Bankr.P. 2016. The United States Trustee ("UST") joined in the Chapter 7 Trustee's objection at the hearing.
The Court conducted an evidentiary hearing on this matter on October 17, 2011 and November 9, 2011 and the parties presented evidence and oral argument. At the hearing, David Williams appeared for the Applicant, Michael Zundel and Jennifer Korb appeared for the Chapter 7 Trustee, Scott Cummings appeared for the Chapter 7 Trustee of the JL Building estate, and Laurie Cayton and Vince Cameron appeared for the UST.
At the conclusion of the hearing, the Court took the matter under advisement.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334 and 157(a). Venue is appropriate under 28 U.S.C. § 1408(1). The Court finds that notice of this hearing is appropriate in all respects.
South Station filed a voluntary chapter
The five related entities sought bankruptcy counsel simultaneously because South Station had an outstanding debt with First Interstate Financial that held a collateral interest in all of South Station's property. The affiliated entities (JL Building, JL Building 2, HEP Development, and Dana Point) pledged their assets to secure the First Interstate Financial loan, although the affiliated entities were not obligors on the loan. The Applicant prepared and filed bankruptcy petitions on behalf of all of the related entities. It was not until April 27, 2009 that the Court authorized the employment of Russell Walker and the Applicant as counsel for the Debtor, South Station.
The South Station case was converted to a chapter 7 bankruptcy on January 19, 2010.
In the Declaration of Russell S. Walker
Between December 1, 2008 and August 13, 2010, the Applicant filed four "Disclosure[s] of Compensation of Attorney for Debtor" under Fed. R. Bankr.P. 2016 disclosing amounts paid to the Applicant from Steve and Dee Bates (the "Bates"), owners of Majestic Holdings, the owner of the Debtor. The four disclosures, disclosing a total of $33,000 in postpetition payments, are summarized in the chart below.
---------------------------------------------------------------------------------DISCLOSURE OF DATE OF COMPENSATION PAID PAYMENTS AMOUNT DISCLOSED --------------------------------------------------------------------------------- Docket 16 (December 1, 2008) 1 year prior to petition $ 0 --------------------------------------------------------------------------------- Docket 211 (April 16, 2010) March 19, 2010 $13,000 April 1, 2010 $ 5,000 --------------------------------------------------------------------------------- Docket 218 (June 7, 2010) May 5, 2010 $ 5,000 June 7, 2010 $ 5,000 --------------------------------------------------------------------------------- Docket 233 (August 13, 2010) July 20, 2010 $ 5,000 ---------------------------------------------------------------------------------TOTAL $33,000 ---------------------------------------------------------------------------------
As noted above, the Application to Employ stated that the Applicant had accepted $13,000 as a prepetition retainer "to represent the debtor."
There is no evidence that the Applicant held or is holding any of the other post-conversion payments in its trust account. None of the Applicant's filings, including the Fee Application, provide an accounting of how the $33,000 post-conversion payments were applied to the outstanding legal fees and costs incurred in the case.
South Station's Statement of Financial Affairs
-------------------------------------------------AMOUNT APPLIED TO PREPETITION DESCRIPTION FEES AND COSTS ------------------------------------------------- Prepetition Legal Services $5,636 ------------------------------------------------- Five Chapter 11 Filing Fees $5,195 ------------------------------------------------- Copy Costs $1.90 ------------------------------------------------- Appeal Filing Fee $255 -------------------------------------------------TOTAL $11,087.90 -------------------------------------------------
W & K Exhibit 1 outlines the amount held in Applicant's trust account. The exhibit shows $13,912 (which the Applicant derived from taking the $20,000 prepetition retainer, subtracting the $11,087.90 applied to prepetition legal fees and costs, and adding the $4,000 post-conversion payment of January 27, 2010).
JL Building filed a chapter 11 bankruptcy petition on November 3, 2008 and on April 29, 2011 the case was converted to one under chapter 7. On January 19, 2010, South Station's case was converted to a chapter 7 case and Kenneth Rushton was appointed the chapter 7 trustee. After the South Station case was converted, the Applicant applied to represent JL Building in the JL Building case and the Court entered an order granting the Applicant's employment on May 17, 2010.
On September 14, 2011 the Bates filed proof of claim number 12 in the JL Building case for $101,884.16, $14,620 of which was identified as "Accounting for the period of December 2008 to September 2011" for "Russ Walker."
In the South Station case a vast majority of the unsecured proof of claims were filed by entities bearing Steve Bates's signature as manager. Furthermore, Steve
-----------------------------------------------------------------------------PROOF OF SIGNATURE ON CLAIM CLAIMANT AMOUNT BEHALF OF CLAIMANT ----------------------------------------------------------------------------- 8 JL Building # 2, LLC $ 23,166.28 Steve Bates, Manager ----------------------------------------------------------------------------- 9 WV Building, LLC $ 386,856.02 Steve Bates, Manager ----------------------------------------------------------------------------- 10 JL Building # 2, LLC $ 446,662.47 Steve Bates, Manager ----------------------------------------------------------------------------- 11 HEP Development, LLC $1,493,045.74 Steve Bates, Manager ----------------------------------------------------------------------------- 12 RT Building, LLC $ 180,749.91 Steve Bates, Manager ----------------------------------------------------------------------------- 13 Steve Bates $ 2,551.72 Steve Bates ----------------------------------------------------------------------------- 14 Armtech Construction, LLC $ 123,084.75 Steve Bates, Manager ----------------------------------------------------------------------------- 15 Home Equity Plan, Inc. $ 41,267.45 Steve Bates, Manager -----------------------------------------------------------------------------
Accordingly, Steve Bates was involved with these entities which he claims to be creditors and he was an individual putative creditor of South Station as of the date of petition.
In the Fee Application, the Applicant seeks reimbursement for total compensation of $126,770.64 for services rendered and expenses incurred from November 2008 through January 2010.
On October 5, 2011, the Chapter 7 Trustee filed his Objection to the Fee Application alleging that the Applicant failed to comply with the disclosure requirements of Fed. R. Bankr.P. 2016 because Russell S. Walker demanded and accepted payment, in cash, throughout the chapter 11 portion of the case from the Bates. The Chapter 7 Trustee requests that the Fee Application be denied in its entirety and the $57,000 in payments made to the Applicant by the Bates be disgorged.
At the hearing on November 9, 2011 the UST joined in the Objection, stating that the Applicant has provided an incomplete disclosure and accounting of the monies paid to the Applicant by the Bates. The UST succinctly stated, "we don't know where the money went." Mr. Walker testified that all funds except for those remaining in the trust account had been applied to the South Station account. He also stated that there is time for which he has been paid that does not show on the summary of services provided. The UST pointed out the evidence showing a total of $57,000 paid to the Applicant by the Bates ($20,000 as a prepetition retainer and $37,000 post-conversion) but no accounting of whether and to what the money was applied to, other than the $13,912.10 held in the Applicant's trust account.
Mary Margaret Hunt, the Chapter 7 Trustee in the JL Building case, represented by Scott Cummings, appeared at the hearing on November 9, 2011 and
The Fee Application and Objection present two main issues: (1) whether there was a failure to disclose under Fed. R. Bankr.P. 2016 and § 329(a) and (2) whether the Applicant meets the requirements of disinterestedness under § 327(a).
The first issue is whether the Applicant failed to disclose compensation received under Fed. R. Bankr.P. 2016 and § 329(a) when: (1) Applicant stated that it received $0 prepetition in the December 1, 2008 disclosure statement, even though Applicant received a $20,000 prepetition retainer; and (2) Applicant failed to disclose a $4,000 payment received from the Bates on January 27, 2010.
Section 329 sets forth the obligations incumbent upon a debtor's attorney to disclose compensation paid within one year prepetition. § 329(a) states:
Any attorney representing a debtor in a case under this title, or in connection with
Fed. R. Bankr.P. 2016(b) provides the requirements for the statement of compensation paid referenced in § 329(a), stating that:
The Court finds the circumstances at issue here similar to the case considered in the Bankruptcy Appellate Panel's ("BAP") decision of Jensen v. United States Trustee (In re Smitty's Truck Stop, Inc.).
Although In re Smitty's Truck Stop, Inc. involved a debtor attorney's failure to disclose the receipt of a retainer paid from a creditor's cash collateral, the holding can be broadly applied to the current situation where the Applicant failed on several occasions to disclose the amount and source of funds received.
In this case, although the initial 2016 statement filed on December 1, 2008 shows that $0 had been paid to counsel, South Station's Statement of Financial Affairs stated that in October 2008 $20,000 was paid to the Applicant. The Applicant admits that the December 1, 2008 statement is inaccurate and asserts that the nondisclosure was the result of an error in recently acquired computer software. There may have been a computer glitch in the populating of information in the form for the disclosure statement, however, the disclosure statement bears the signature of Russell S. Walker. Noting the mandates of § 329, Fed. R. Bankr.P. 2016, and the plethora of case law on fee applications, counsel could and should have carefully examined the disclosure statement, discovered the mistaken figure of $0, and immediately corrected the error with an amendment or notice of errata. The Court finds the computer glitch argument unavailing, as attorneys are obligated to review all filings with the Court for accuracy and here, counsel apparently failed to adequately inspect the disclosure statement and signed it as correct.
It could be argued that South Station's Statement of Financial Affairs qualified as a "disclosure" when in question 9 the Applicant stated that it had received $20,000 in October 2008. However, the Statement of Financial Affairs did not disclose the correct source of the money received. The source of the funds was an important factor to disclose given that the funds did not come from the Debtor, but rather from the Debtor's principals.
There are other inconsistencies with regard to compensation of the prepetition retainer amount and the amount of the payments being held in the Applicant's trust account which raise questions as to the completeness of disclosure of all compensation paid. First, the Application to Employ stated that $13,000 was paid as a prepetition retainer to represent the Debtor. Second, the Statement of Financial Affairs stated that $20,000 was paid prepetition. Third, the Fee Application itself stated that $14,000 is being held in a trust account as a retainer for filing the South Station case. Lastly, there was an outright failure to disclose $4,000 paid by the Bates post-conversion in January 2010.
The Chapter 7 Trustee and the UST have also objected on the basis that there has been an incomplete disclosure of the accounting of the payments made by the Bates to the Applicant. In summary, the
At the hearing, the Applicant stated that it plans to credit amounts it has already been paid to the amount requested in the Fee Application. According to testimony, it appears that the Applicant will take the $121,382.50, credit the $33,000 paid post-conversion, credit the approximately $5,600 paid prepetition, and credit the payments remaining in the trust account. Thus, the balance owing would be the amount owing after those payments are applied or credited. However, Mr. Walker did state that some of the funds paid post-conversion have already been applied to the South Station account, but no credits are shown on the accounting before the Court.
The Court is persuaded by the UST's arguments. The Court finds and concludes that based on the evidence, there was inadequate disclosure of the accounting applied for at least $43,000 that was received by the Applicant. This lack of accounting falls within the failure to disclose principles of In re Smitty's Truck Stop, Inc. The Fee Application does not discuss whether the payments were already applied to the outstanding legal fee bill or whether the Fee Application is seeking a reimbursement of fees that have already been paid to the Applicant. Accordingly, the Court cannot make a finding of the reasonableness of the fees requested without an accurate and complete accounting. Based on the above findings, the Court concludes that there is enough evidence to disallow the request for fees and costs.
Another issue that should be addressed is whether the Applicant is disinterested under § 327(a) and whether this constitutes an independent basis for denial of fees. The evidence presented at the hearing indicated that the $20,000 prepetition retainer and $37,000 in post-conversion payments came from the Bates who were the principals of the Debtor and possibly creditors. This issue was only briefly discussed at the hearing, however, it deserves comment and a ruling as it caught the Court's attention.
Section 327(a) provides the requirements for the employment of professional persons and states:
Section 101(14)(C) provides the definition of "disinterested person," stating that a disinterested person "does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason."
Allegiance to the debtor's estate is paramount in a chapter 11 case. A professional employed under § 327(a) must be disinterested and have no interest that is adverse to the estate at the outset and remain so disinterested throughout the life of the chapter 11 case. Receiving direct payment from the equity owners, a creditor, or even the principals of a creditor at the outset of the case or after conversion neutralizes the disinterestedness requirements mandated by the Code.
Moreover, this conclusion is consistent with the decisions of In re Cook
Furthermore, Judge Mosier of this Court stated that the "term disinterested is broad enough to exclude an attorney with some interest or relationship that would even faintly color the independence and impartial attitude required by the Code and Bankruptcy Rules."
The Court is concerned about the disinterestedness and even the perceived lack of disinterestedness of the Applicant under the standards and case law cited above. The Debtor's schedules show a number of other entities, with the same mailing address as the Debtor, in which the Bates have an ownership interest, including: JL Building, Point Belleview, RT Building, and WV Building. This interrelatedness of the Debtor, the Debtor's principals, and creditors of the Debtor should have alerted
The Court elects to take notice of other court submissions on its docket, namely proofs of claims filed in this case that are signed by Steve Bates, one of the Debtor's principals.
The Court again finds In re Smitty's Truck Stop, Inc. helpful, where the BAP held that the failure to disclose a potential conflict of interest warranted denial of all compensation.
From this information, the BAP concluded that the bankruptcy court was correct in its holding that, whether the attorney realized it or not, he had received cash collateral belonging to a creditor as a retainer.
Similarly, here the Applicant did not disclose the source of the retainer in its Application to Employ, affidavit accompanying the Application to Employ, initial disclosure statement on December 1, 2008, or Fee Application. Upon a review of the docket, it appears that the retainer amount was not disclosed until the Application to Employ filed December 10, 2008 stated that the Applicant had received a $13,000 retainer to represent the Debtor.
Additionally, the Court finds the Ninth Circuit case Neben & Starrett, Inc. v. Chartwell Financial Corporation (In re Park-Helena Corp.)
The Applicant makes the argument that it complied with Utah's Code of Professional Conduct in receipting and applying all funds from the Bates. The Court is not persuaded that complying with the state law only is sufficient, as federal law governs in this situation. A bankruptcy court in the District of New Jersey stated: "Not only are state ethical laws imposed upon professionals in the bankruptcy context, but the Bankruptcy Code and Federal Rules of Bankruptcy Procedure contain specific references and directives imposing additional ethical obligations upon attorneys and other professionals."
Professionals in bankruptcy cases are placed under the microscope by various sections of the Bankruptcy Code. Here, the Applicant has unfortunately subjected itself to further scrutiny by accepting the initial retainer from the Bates directly. On one hand, the Applicant had court approval to represent South Station. On the other hand, the Applicant was being paid by the Debtor's equity owners, one of whom was a creditor in the case and both equity owners were controlling owners of creditors of the Debtor which had sizeable stakes in the outcome of this chapter 11 case. As a result, the Court cannot find or conclude that this arrangement meets the test of disinterestedness as mandated by §§ 327(a) and 328(c).
The Court does not approve the Fee Application due to the Applicant's failure to fully disclose all compensation received and because the Applicant accepted payment from a creditor in this case, Steve Bates, the co-principal of South Station and manager of numerous related creditor entities. Section 329(b) provides the remedy when compensation requested or paid
Furthermore, "`reasonable compensation for services rendered' necessarily implies loyal and disinterested service in the interest for whom the claimant purported to act."
Section 328(c) provides the consequences for a finding of a lack of disinterestedness under § 327:
Here, the Applicant attached invoices to the Fee Application detailing the work performed on behalf of South Station. However, the Court cannot award the Applicant its fees and costs requested where: (1) the Applicant failed to fully disclose prepetition and post-conversion payments to the Applicant; (2) the evidence provided to illustrate the remaining amount in the Applicant's trust account is unclear; (3) the Applicant failed to disclose the source of prepetition payments for over a year; and/or (4) a question exists as to the Applicant's disinterested service to the Debtor. Thus, the Court determines that all fees and costs requested in the Fee Application should be disallowed and denied.
The Chapter 7 Trustee argues for the disgorgement of all payments made by the Bates to the Applicant in addition to denying the Fee Application. It appears that the Trustee is relying on § 329(b) for that argument. Section 329(b) provides that "if such compensation exceeds the reasonable value of any such services, the court may cancel any such agreement, or order the return of any such payment, to the extent excessive ..." (emphasis added).
No evidence or argument was made that the requested fees were excessive. Further, the money paid came directly from the Bates and would not have been property of the estate. Accordingly, the Court denies the request to order any disgorgement but will address that issue if the Bates so request.
Based on the foregoing and the Court's analysis stated, the Fee Application should be denied in its entirety for failure to fully disclose the source and amount of compensation received; failure to provide an accurate accounting of compensation received; and/or failure to adhere to the requirements of disinterestedness mandated by the Bankruptcy Code. A separate order will accompany this Memorandum Decision.