Janice D. Loyd, U.S. Bankruptcy Judge.
For more than two years after being retained by the Debtors to represent them in this bankruptcy case and numerous adversary proceedings associated with it, Debtors' Counsel Ruston Welch ("Welch") failed to disclose the amount, source or agreement for the payment of any attorney's fees to him. The question before the Court is whether Welch's failure to comply with the fee disclosure obligations imposed by the Bankruptcy Code and Rules constitutes sufficient grounds for the Bankruptcy Court to exercise its inherent power and discretion to deny some or all fees and costs paid to Welch and to direct Welch to disgorge fees and costs already received. Before the Court for consideration are the Motion for Disgorgement of Compensation Paid to Welch Law Firm P.C., Denial of Unpaid Compensation and Reimbursement of Property of the Estate Transferred to Third Parties Pursuant to 11 U.S.C. § 329(a) and Fed. R. Bankr. P. 2016, 2017, and 9014, filed on October 20, 2017 by SE Property Holdings, LLC ("SEPH") (the "Motion"), the Response of Ruston C. Welch and Welch Law Firm P.C. to SE Property Holdings, LLC's Motion for Disgorgement, filed on December 4, 2017 (the "Response"), the Reply to Ruston C. Welch and Welch Law Firm's, P.C. Response to Motion for Disgorgement, filed by SEPH on December 18, 2017, and Kirkpatrick Bank's Response to SEPH's Motion to
The Court has jurisdiction pursuant to 28 U.S.C. §§ 1334, 157(a) and the Order of Reference issued by the United States District Court for the Western District of Oklahoma as Local Rule LcvR 81.4(a). Venue is proper pursuant to 28 U.S.C. § 1409. This contested matter is procedurally governed by Rule 9014. The statutory predicate lies in 11 U.S.C. § 329(a).
This case was commenced by SEPH's filing of an Involuntary Petition under Chapter 7 in the United States Bankruptcy Court for the Southern District of Alabama on September 30, 2014. After several months of litigation related to the allegations in SEPH's Involuntary Petition, in which Debtors were represented by Alabama counsel, on March 18, 2015, the Bankruptcy Court entered Orders for Relief. [Does. 57 & 58].
On September 14, 2017, Welch filed his Disclosure of Compensation of Attorney for Debtor reflecting that as of July 31, 2017, he had been paid $348,404.41 for his bankruptcy services to Stewart and the non-debtor related entities involved in adversary proceedings. [Doc. 461]. The Disclosure did not reflect the source of the payments. On September 20, 2017, Welch filed his Amended Disclosure of Compensation of Attorney For Debtor which added a separate schedule detailing the receipt of BP settlement proceeds, the sources of compensation paid to Welch for bankruptcy services and the dispersal of settlement proceeds to other parties, including Kirkpatrick Bank. [Doc. 464]. This Amended Disclosure of Compensation of Attorney for Debtor indicated Welch had been paid the sum of $178,943.38 for 2016 and $169,461.03 for 2017. [Doc. 464, pg. 3]. On December 4, 2017, Welch filed his Supplemental Statement to Amended Disclosure of Compensation of Attorney. [Doe. 522]. The Supplement, consisting of twenty (20) pages, provided a detailed, chronological narrative concerning Welch's financial dealings with Stewart, the related entities, family members and other counsel.
It is not disputed that Welch never filed a Rule 2016(b) Disclosure of Compensation of Attorney for Debtor from the time he undertook representation of the Debtors (and their thirteen (13) affiliated limited liability companies) in June 2015 until the Court ordered him to do so at the in camera proceeding on August 30, 2017. During this two year time period Welch paid himself fees and expenses for the bankruptcy case and adversaries a total of $348,404.41. [Doc. 464, pg. 3].
Resolution of the issues raised in SEPH's Motion involve the interplay between Bankruptcy Code §§ 329-330 and Rules 2016 and 2017. These statutes and rules work together to provide a framework for the systemic oversight of administrative costs, reasonableness of fees, and any questionable relationships of third-party payors to the debtor and the attorney in bankruptcy cases.
The starting point for analysis is § 329(a), which states:
Rule 2016(b) provides the following procedure for implementing § 329:
Stated concisely, Rule 2016(b) requires debtor's attorneys to disclose at the outset all fees paid or agreements regarding fees to be paid, and thereafter they must disclose post-petition transactions within fifteen days. These disclosures enable the Bankruptcy Court to carry out its traditional role of scrutinizing carefully the compensation paid to the debtor's attorney, and "to prevent overreaching by an attorney and provide protection for creditors." Jensen v. United States Trustee (In re Smitty's Truck Stop, lnc.), 210 B.R. 844, 848 (10th Cir. BAP 1997); In re C. W. Mining Co., 440 B.R. 878, 885 (Bankr. D. Utah 2010) ("Attorneys representing debtors are required and expected to fully and candidly disclose all their agreements relating to compensation, the amount of compensation paid or agreed to be paid, and the source of payment.").
The fact that the source of the funds to pay Stewarts' legal fees was from third-party payors rather than from Stewart did not alter Welch's obligation for proper disclosure of the fees. The language of § 329(a) makes it clear that it requires a debtor's attorney to disclose "the source of such compensation." See In re The Harris Agency, LLC, 468 B.R. 702, 707 (Bankr. E.D. Pa. 2010) ("[I]t being settled that `under section 329 and Bankruptcy Rule 2016(b) [an attorney's disclosure statement] must disclose the source of ... compensation, even if the source is not the debtor but a third-party entity.'" (quoting 3 Collier on Bankruptcy ¶ 329.03 (15th Ed. 2009)); In re Frye, 570 B.R. 21, 31 (Bankr. D. Vt. 2017); In re Greco, 246 B.R. 226, 229-30 (Bankr.E.D. Pa. 2000).
Welch argues that the contingent fees he received for representing the affiliates in the BP claims were not for services rendered "in connection with" the bankruptcy case and therefore not subject to disclosure as required by § 329(a). [Response, pg. 6]. Welch misreads the statute. Section 329 requires disclosure "of the compensation paid or agreed to be paid... for services rendered or to be rendered in contemplation of or in connection with the case by such attorney, and the source of such compensation." (Emphasis added). When Welch elected to take the proceeds from the BP claims and apply them to pay the hourly fees earned by him in the bankruptcy, those proceeds became payments made "in connection" with the bankruptcy case. It is irrelevant whether or not the proceeds for services rendered related to the BP claims on behalf of the affiliates, prior to their application to the payment of Welch's bankruptcy fees, could be denominated as not "in connection with" the bankruptcy. The fact that Welch "gratuitously" took proceeds from the contingency fees earned in BP claims to be applied for his bankruptcy fees doesn't change the fact that they were the source of his payment for the bankruptcy and had to be disclosed. Had Welch not applied the proceeds from the BP claims of the non-debtor affiliates to pay his bankruptcy fees
Welch also argues that he performed valuable services for the estate, and that disgorgement of fees received would be inequitable. The Court disagrees for two reasons. First, while the Court recognizes that Welch is a very talented attorney and has represented Stewart and the affiliates extremely well, "the law is clear that the failure to properly disclose compensation received is in and of itself grounds for disgorgement". In re Investment Bankers, Inc., 4 F.3d at 1565. Second, even if the Court did not question the reasonableness of the 8348,000 charged by Welch, "the fact that the fee may or may not have been reasonable or have been yarned does not justify a disregard for the rules of disclosure." In re Woodward, 229 B.R. 468, 475 (Bankr. N.D. Okla. 1999). Welch also argues because the funds which paid his fees were not "property the estate" there was no harm to the estate resulting from such payments. Even if the funds used to pay the fees were not property of the estate, the court would still have the authority to review them under Section 329(a). In re W.T. Mayfield Sons Trucking Co., Inc., 225 B.R. 818 (Bankr. N.D. Ga. 1998). Furthermore, contrary to that argued by Welch, the Court may sanction failure to disclose "regardless of actual harm to the estate." In re Smitty's Truck Stop, Inc., 210 B.R. at 849.
Neither is it determinative as to whether any disgorgement should be ordered that Welch acted with a "pure heart" and had no subjective intent to violate the Code and the Rules in failing to disclose what and from whom he had been paid. The purpose behind § 329(a) would be defeated if counsel were permitted to make a "covert decision that the undisclosed fee was so unrelated to the bankruptcy case that its disclosure was not required, and eliminating the possibility of Court review in the process." In re Woodward, 229 B.R. 468, 475 (Bankr.N.D. Okla. 1999); In re Mayeaux, 269 B.R. 614, 628 (Bankr. E.D. Tex. 2001). Furthermore, failure to comply with the disclosure rules is sanctionable "even if proper disclosure would have shown that the attorney had not actually violated any Bankruptcy Code provision or any Bankruptcy Rule". In re Park-Helena Corp., 63 F.3d 877, 880 (9th Cir. 1995); In re Campbell, 259 B.R. 615 (Bankr. N.D. OH. 2001).
For all the above reasons, the Court's inescapable conclusion is that Welch's failure to disclose the amount and source of his fees and expenses for the bankruptcy and related adversary proceedings for over two years and making such disclosures only after directed by the
The law is clear that the failure to comply with § 329 and Rule 2016(b) constitute sufficient grounds, under appropriate circumstances, for the Court to exercise its inherent power and discretion to deny all fees and costs paid to Welch and to direct disgorgement of up to all fees and costs already received. Smitty's Truck Stop, Inc., 210 B.R. at 848 ("[A]n attorney who fails to comply with the disclosure requirements of § 329 and Rule 2016(b) forfeits any right to receive compensation for services rendered on behalf of the debtor and may be ordered to return fees already received."); Investment Bankers, 4 F.3d at 1565 ([A]n attorney who fails to comply with the requirements of § 329 forfeits any right to receive compensation for services rendered on behalf of the debtor, (citations omitted), and a court may order an attorney sua sponte to disgorge funds already paid to the attorneys (citations omitted)."); Henderson v. Kisseberth (In re Kisseberth), 273 F.3d 714, 721 (6th Cir. 2001)("Bankruptcy courts have broad and inherent authority to deny any and all compensation an attorney fails to satisfy the requirements of the Code and Rules."). In re Wood, 408 B.R. 841 (Bankr. D. Kan. 2009).
Many courts adopt a rigid, "zerotolerance" approach commanding denial of fees and disgorgement where counsel has failed to make proper disclosure under § 329(a) and Rule 2016. See e.g. Downs, 103 F.3d at 477; Kisseberth, 273 F.3d at 721. However, it is also true that when a bankruptcy court exercises its inherent power to deal with an attorney's noncompliance with disclosure obligations imposed by the Bankruptcy Code and Rules, the court may choose to temper that power with reasonable discretion under the circumstances of the case. In re Brown, 371 B.R. 486, 499 (Bankr. N.D. Okla. 2007) ("Disgorgement of fees as a result of inadequate disclosure by counsel is a matter left to the sound discretion of the bankruptcy court."); In re Woodward, 229 B.R. at 473. The imposition of the disgorgement order should be "`commensurate with the egregiousness of the conduct' and will depend on the particular facts of each case." In re Hackney, 347 B.R. at 443 (citing Mapother & Mapother, P.S.C. v. Cooper, (In re Downs), 103 F.3d 472, 479-80 (6th Cir. 1996)); Smitty's Truck Stop, Inc., 210 B.R. at 846.
This Court considers factors determining the degree of sanctions for non-disclosure on a case-by-case basis to include, without limitation: (1) the attorney's experience level in the subject area of practice, (2) the attorney's willfulness or recklessness, (3) whether the violation is a mere technical violation, (4) the attorney's level of cooperation with parties in interest to rectify the noncompliance, (5) the reason for the noncompliance, (6) harm to the estate and mitigation of any harm, (7) prior instances of noncompliance and the circumstances surrounding the those circumstances, (8) the promptness of any cure of the subject noncompliance, (9) steps taken by the attorney to prevent similar conduct in the future, (10) the excessiveness of compensation and expenses charged by the attorney and — although alone the means cannot justify the ends — results obtained for the estate. In re Howard Avenue Station, LLC, 568 B.R. 146, 153-154 (Bankr. M.D. Fla. 2017). The Court also considers the Tenth Circuit general law applicable to attorney sanctions, not necessarily involving non-disclosure under the bankruptcy
Welch is an attorney with more than thirty years experience with an emphasis on civil litigation, transactional matters and bankruptcy. He is regarded by this Court as one of the most able bankruptcy practitioners that appear before it. Given his skill and experience, the Court finds it incredulous that Welch would pay himself $348,404 in fees related to the bankruptcy over a two year period and not deem it appropriate to make any disclosure of the same before being ordered to do so by the Court. This non-disclosure cannot be regarded as a mere technical violation. As discussed above, the non-disclosure cannot be justified on the basis that the
The Court cannot help but view the non-disclosure of the attorney's fees not as an isolated event but one within the broader context and history of this case, in particular with regard to the lack of candor and veracity of the Debtors. Much, but admittedly not all, of the genesis of this seemingly interminable litigation lies in SEPH's distrust of the Debtors as a result of what SEPH perceives as a grand scheme to conceal assets. The Court has also openly expressed its concern as to whether the Debtors have been forthcoming in disclosing all of their and the non-debtor affiliates' assets and an accurate value of those assets. This lack of candor has extended to the attorney's fees which Welch has been paid. An issue has also been raised with regard to the Debtor's, non-affiliates and Kirkpatrick Bank's "transfer of interests" alleged by SEPH to be in violation of this Court's Preliminary Injunction of January 5, 2017. In this atmosphere of distrust between the parties, the last thing that was needed was more suspicion and distrust generated by the perception that the Debtors and/or their counsel were concealing the payment of more than a third of a million-dollars in attorney's fees for services rendered in this bankruptcy. But the seriousness of the non-disclosure of attorney's fees is further compounded by evidence of additional lack of candor concerning the fees.
On August 3, 2016, Welch received $144,591.95 representing his contingency attorney's fee for representing the Stewart related entities Neverve, LLC, Shimmering Sands Development Company, LLC, S & S, LLC, and Zeke's Lady, LLC's. These sums were applied to the then outstanding hourly-rate fees and expenses incurred for his representation in the bankruptcy case and related adversaries. Also on August 3, 2016, Welch received $528,394.39 representing his clients' shares (which did not include the contingent attorney fee portion) of the BP claims settlements. Neverve's share of $203,812.56 was subsequently applied to the payment of the Debtors' and the affiliates' attorney's fees due Welch in the bankruptcy and adversaries.
The non-disclosure of Welch's fees, and importantly the source of those funds, has also raised an issue as to whether potential assets of the Debtor estates have been properly handled. David Stewart holds a 50% membership interest in Shimmering Sands Development Company, LLC. At the December 10, 2015, hearing on the Debtor's Motion to Abandon Stewart testified that Kirkpatrick Bank did not have a security interest in the Shimmering Sands BP tort claim. [Tr., Doc. 243, pg. 60-61]. At the continued hearing on the Motion to Abandon on January 20, 2016, when the Trustee heard that Kirkpatrick might not have a security interest in the BP claim, the Trustee testified that "this is the first time I've — I've analyzed all the BP claims, and this is the first I've heard that, in fact, one of the BP claims might be unencumbered-and if that's the case, well, then there are significant additional value there...." [Tr., Doc. 270, g. 187 pg. 187]. In closing argument on the same day, January 20, 2016, Welch stated as to "the $600,000 BP claim, if the court or Mr. Gould, believes it has any value, we welcome him to retain it or transferred to him, but it's an opt-out claim which for years has never been heard ... (and) if the claim amount is fully valid and to pay $600,000 that may be years down the road." [Tr., Doc. 270, pg. 201].
There is little doubt that as of January 20, 2016, Kirkpatrick did not hold a valid security interest, let alone a perfected security interest, in the Shimmering Sands BP claim.
The Court points out the matters pertaining to Mr. Stewart's testimony as to his knowledge of the payment of attorney's fees and the encumbering of the Shimmering Sands BP claims solely to demonstrate that there are serious collateral consequences of the obligation of full disclosure of attorney fees under Rule 2016. The failure to make proper disclosure is not a mere technical violation of the Bankruptcy Code and Rules, but can have real consequences. In this case, the failure to make proper disclosure has engendered even greater suspicion and mistrust than already existed that the Debtors have been, less than forthcoming.
While this Court undoubtedly has the authority, should it so decide to exercise it, to deny Welch any compensation and order disgorgement of all of Welch's fees received, that authority does not compel that it must do so. The Court is guided by the overriding principle in applying sanetions that "the appropriate sanction should be the least severe sanction adequate to deter and punish" the offender and deter future violations of the rules. White v. General Motors, Inc., 908 F.2d 675, 684 (10th Cir. 1990). In mitigation of the imposition of sanctions is that, to this Court's knowledge, Welch has not been previously sanctioned. While Welch is a seasoned bankruptcy practitioner, the bulk of his practice has been representing creditors or debtors in Chapter 11 cases which require applications for court approval for employment of counsel and applications for court approval of all fees. It appears that he has not had much experience representing debtors in Chapter 7 in which court approval is not required for either employment or payment of counsel. It may well be that Welch, although he would have been wrong in doing so, overlooked the attorney fee disclosure requirements imposed upon counsel in all chapters of the Bankruptcy Code.
There is also a practical impediment in ordering Welch to disgorge any significant amount of funds which he received and applied to his bankruptcy fees. The source of these funds was from the settlement of the BP claims of four non-debtor entities, all of which, with the exception of Shimmering Sands, are not even alleged by SEPH to be targets to be substantively consolidated into the Stewarts' bankruptcy estate. As noted above, the funds allocable to Shimmering Sands were not kept by Welch but passed through to Kirkpatrick Bank. The Court does not believe it has the authority to order the funds from three of the four non-debtors which became the property of Welch to be paid into the debtor's estate which never had an interest in them. If anything, the Court
The Court also believes that by its pronouncements from the bench and in this Order Welch has been sufficiently chastened so as to deter him from failing to make all required disclosures in future matters both in this and other bankruptcy cases. The Court also believes that ordering disgorgement of all fees as sought by SEPH (or even a substantial portion of such fees) would be financially catastrophic to someone as Welch engaged in a largely solo practice. The Court finds denial or disgorgement of all Welch's fees would be unduly harsh in light of the beneficial successful work he performed for the Debtors, and the fact the Debtor estates were not the source of the payments for his bankruptcy work.
