SUZANNE H. BAUKNIGHT, UNITED STATES BANKRUPTCY JUDGE.
Debtor filed this Chapter 11 case on February 9, 2016. On May 27, 2016, Debtor's counsel filed the First Application of Hodges, Doughty & Carson, PLLC, for Compensation and Reimbursement of Expenses ("First Application") [Doc. 62], seeking total compensation in the amount of $26,659.33, representing fees of $25,873.50 and expenses of $785.83, for the period of January 27, 2016, through April 30, 2016. Notice and the opportunity for hearing were provided pursuant to Rule 2002(a) of the Federal Rules of Bankruptcy Procedure and E.D. Tenn. LBR 9013-1(h). Notwithstanding that no objection was filed, on July 13, 2016, the Court set a hearing on the First Application [Doc. 71] in order to undertake its "fundamental, independent duty to review fee applications for reasonableness." In re Parsons, No. 02-65780, 2006 WL 3064085, at *2 (Bankr.N.D.Ohio Oct. 24, 2006). On July 19, 2016, Debtor's counsel filed a Motion Amending First Application of Hodges, Doughty & Carson, PLLC, for Compensation of Fees and Expenses Nunc Pro Tunc to Date of Petition ("Amended Application") [Doc. 80], amending the First Application to seek fees nunc pro tunc to the petition date.
The Court held a hearing on the First Application and the Amended Application on July 28, 2016, at which the United States Trustee raised concerns about the failure of Hodges, Doughty & Carson, PLLC ("HD & C") to disclose in either the Application to Employ Counsel, filed on February 9, 2016 [Doc. 9]; the Amended Application to Employ Counsel, filed on February 11, 2016 [Doc. 18]; or HD & C's Disclosure of Compensation of Attorney for Debtor(s), filed on March 3, 2016 [Doc. 45] that pre-petition legal fees and expenses had been incurred. Because of the Court's independent concern about the pre-petition fees sought by HD & C and the United States Trustee's concerns about non-disclosure, the Court asked for briefing. The matter is now ripe for adjudication.
The Court specifically asked for briefing on whether pre-petition fees may be awarded post-petition when the service provider took a retainer pre-petition and
As a result, the focus of the briefing was the opposing viewpoints for the question of whether a law firm that performs pre-petition bankruptcy-related services for the debtor is disinterested under § 327 as that term is defined by § 101(14) because the firm is a pre-petition creditor as defined by § 101(10). A strict interpretation of these Code sections results in an unquestionably harsh result that "would virtually eliminate any possibility of legal assistance for a debtor in possession, except under a cash-and-carry arrangement or on a pro bono basis." In re Martin, 817 F.2d 175, 180 (1st Cir.1987).
Although the Court has surveyed the law on both sides of this issue (and summarizes it below), the circumstances of the instant fee application do not require the Court to pick a side in this particular legal argument. The Court reaches this conclusion on a finding that § 329 is dispositive to the determination of whether to grant the request for pre-petition bankruptcy-related fees sought by HD & C. Because HD & C failed to disclose the fees related to the pre-petition services it performed for Debtor, whether or not bankruptcy-related, and because such non-disclosure is a violation of § 329, the Court will deny HD & C's application for pre-petition fees as a sanction.
The parties and the Court having spent significant time to survey the landscape of cases concerning the pre-petition fee issue, notwithstanding that it is not ruling on that issue, the Court will address the differing positions to provide guidance for HD & C and other debtors' counsel appearing before this Court.
The starting point, of course, is the Code. Section 327 authorizes employment of professional persons with the court's approval if such professionals "do not hold or represent an interest adverse to the estate ... and are disinterested persons." 11 U.S.C. § 327(a). "Disinterested person" is defined by § 101(14) as a person who "is not a creditor, an equity security holder, or an insider." Section 101(10)(A) defines "creditor" as an "entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor." Also pertinent is § 1107(b), which provides: "Notwithstanding section 327(a) of this title, a person is not disqualified for employment under section 327 of this title by a debtor in possession solely because of such person's employment by or representation of the debtor before the commencement of the case."
Only one circuit court of appeals has addressed the question of whether debtor's counsel loses disinterestedness as a creditor when counsel is owed on the petition date for pre-petition bankruptcy-related services. Although the First Circuit squarely stated its position on this issue, such was dictum in its decision in In re Martin, in which the exact question before the court was the propriety of a lawyer taking security for payment of attorneys' fees to be incurred while representing the client in connection with the bankruptcy proceedings. 817 F.2d 175, 176 (1st Cir.
Debtors' counsel in In re Martin, 817 F.2d at 176, made very clear in their pre-employment filings the full terms of their arrangement with the debtors. The bankruptcy court authorized the engagement of the firm as debtors' counsel, and the issue of the mortgage-retainer did not arise until the case converted to Chapter 7 and the trustee sought to abandon the mortgaged property, to which the creditors' committee objected. Id. at 176-77. The bankruptcy court invalidated the note and mortgage but allowed in large part the firm's application for compensation, resulting in cross appeals by the debtors, who disagreed with the court's set-aside of the mortgage, and the creditors' committee, who objected to the award of partial compensation to debtors' counsel. Id. Only the debtors' appeal was before the First Circuit. Id. at 177.
The First Circuit vacated the bankruptcy court's finding that the mortgage-retainer was impermissible per se as an interest adverse to the bankruptcy estate under § 327(a). Id. at 183. In so holding, the court addressed the question of whether unpaid pre-petition fees create a problem under § 327(a):
Id. at 180 (citations omitted).
For this dictum proposition, the In re Martin court relied in part on a decision by the Bankruptcy Court for the District of Utah, In re Roberts, 46 B.R. 815 (Bankr. D.Utah 1985), which stated (also in dictum):
Id. at 849.
In another case relying on In re Martin, the bankruptcy court for the Southern District of Ohio ruled against a debtor's attorney, holding that a lawyer's "status as a creditor holding a prepetition security interest in Debtors' assets, taken as security for the payment of fees for prepetition nonbankruptcy work, disqualifies him from appointment under § 327 and from continuing as Debtors' unappointed Chapter 12 counsel." In re Watson, 94 B.R. 111, 116 (Bankr.S.D.Ohio 1988) (Cole, J.). As in In re Roberts and In re Martin, the court, in dictum, stated its position against a strict interpretation of § 327(a) that would bar "any counsel from appointment who asserted a claim for any services provided to the debtor prior to the filing of the petition." Id. at 114. The court found that the reasoning of the Roberts court "reflect[ed] a realistic interpretation of § 327(a) and the legislative history behind it." Id. at 114-15.
Although the proclamations of these three courts are dicta, other courts have disagreed when squarely faced with the issue. In 2004, the Bankruptcy Court for the Middle District of Pennsylvania sua sponte
Id. at 633-34 (quoting In re Roberts, 46 B.R. at 850).
Another decision in which a bankruptcy court refused to award fees for pre-petition, case-related services is Kun v. Mansdorf (In re Woodcraft Studios, Inc.), 464 B.R. 1 (N.D.Cal.2011) (affirming the bench decision of the bankruptcy court), aff'd, 558 Fed.Appx. 755 (9th Cir.2014) (unpub. op.). There, debtor's counsel disclosed a $5,000.00 pre-petition retainer but did not disclose pre-petition case-related services. Id. at 5. Counsel filed a fee application that first disclosed the pre-petition services, and the bankruptcy judge denied all fees and required disgorgement of the retainer because the disclosure was inadequate under § 327 and Rule 2014.
Id. at 5-6.
In In re Madera Roofing, Inc., No. 13-16954-B-11, 2014 WL 4796758, at *5-8 (Bankr.E.D.Cal. Sept. 25, 2014), the bankruptcy court found that the debtor's attorneys'
Indeed, several other courts also have expressly acknowledged the typical practice for counsel to draw down on a pre-petition retainer to pay pre-petition case-related fees or, alternatively, to waive the pre-petition fees in order to avoid being considered a pre-petition "creditor" and, thus, not "disinterested" under the Code. See, e.g., In re Fresh Choice, LLC, No. 12-46157 RLE, 2014 WL 929018, at *4 (Bankr.N.D.Cal. Mar. 10, 2014); In re Sundance Self Storage-El Dorado LP, 482 B.R. 613, 627 n. 37 (E.D.Cal.2012); In re SBMC Healthcare, LLC, 473 B.R. 871, 879 n. 8 (Bankr.S.D.Tex.2012); In re 7677 East Berry Ave. Assocs., L.P., 419 B.R. 833, 852-53 & n. 92 (Bankr.D.Colo.2009); In re Printcrafters, Inc., 208 B.R. 968, 977 (Bankr.D.Colo.1997); cf. In re Old Summit Mfg., LLC, 323 B.R. 154, 157-58, 161 (Bankr.M.D.Pa.2004); In re Fibermark, Inc., No. 04-10463, 2004 WL 2418317, at *6 (Bankr.D.Vt. Oct. 22, 2004). At least one court even has a local rule that requires an application for employment to "disclose all pre-petition fees and expenses drawn down against the retainer, and any written retainer agreement shall be attached to the application." In re Ridgerunner, LLC, No. 11-20369-TLM, 2011 WL 2112038, at *1 n. 1 (Bankr.D.Idaho May 26, 2011).
Courts that fall on the side of requiring either waiver of pre-petition fees or drawing down of a pre-petition retainer to pay for pre-petition, case-related services are strictly construing the Code. The Sixth Circuit Court of Appeals has not ruled on the issue; however, as the bankruptcy court for the Eastern District of Kentucky recently noted:
In re Licking River Mining, LLC, No. 14-10201, 2015 WL 5601284, at *6 (Bankr. E.D.Ky. Sept. 22, 2015).
The Middleton Arms court also made clear that "the section 1107(b) exception does not apply to all interested persons, but only to those who fail to be disinterested solely because of prior employment." Id. Thus, based on prior Sixth Circuit precedent on related issues, it appears that the court might strictly construe § 327 in a way that would require either waiver of pre-petition case-related fees or application of a retainer as payment for pre-petition case-related fees in order for debtors' counsel to avoid being treated as a "creditor" under the Code.
HD & C argues that a pre-petition draw on the pre-petition retainer to credit case-related pre-petition services puts the firm at risk of having to litigate its disinterestedness because of a possible preference claim. The Third Circuit case that is oft cited for the proposition that bankruptcy courts may not authorize appointment of counsel without first determining whether a preference exists is In re Pillowtex, Inc., 304 F.3d 246 (3d Cir.2002). Critically, the holding in Pillowtex does not prohibit appointment of counsel on the mere specter of a preference claim: "We hold that when there has been a facially plausible claim of a substantial preference, the district court and/or the bankruptcy court cannot avoid the clear mandate of the statute by the mere expedient of approving retention conditional on a later determination of the preference issue." Id. at 255 (emphasis added). As the court explained in In re Roberts, however, "even without obtaining such a pre-service retainer, a law firm that bills regularly and is paid in the ordinary course of its business and the business of the debtor, would obtain its fees as part of a contemporaneous exchange." 46 B.R. at 850. The District of New Jersey agreed when it found that a pre-petition payment from a retainer for prospective case-related services "cannot constitute avoidable preferential transfers as they were not made on account of an antecedent debt." In re Rockaway Bedding, Inc., No. 07-14898, 2007 WL 1461319, at *4 n. 4 (Bankr. D.N.J. May 14, 2007) (citing 11 U.S.C. § 547(b)(2); In re Pillowtex, 304 F.3d at 246
Considering all of this, debtors' counsel appearing before this Court who take the route of billing the client for pre-petition preparation prior to filing the case and drawing down the pre-petition fees from any retainer funds held in escrow — while disclosing such to the Court — will most likely pass scrutiny by this Court.
Whether or not a retainer is provided and drawn from for pre-petition, case-related services, counsel absolutely must disclose to the Court the amount (or estimated amount) of any pre-petition services provided and the status of the fees charged or to be charged for such services. Here, this Court need not reach the controversial question of whether professionals are required to draw down from pre-petition retainers for pre-petition, case-related services or waive fees for such services when filing a petition for their clients in order to be appointed and paid as debtors' counsel in a bankruptcy case. This is so because HD & C violated the disclosure requirements of § 329 and Rule 2016 by failing to disclose that it had performed thirteen days of pre-petition services for which it intended to seek payment post-petition.
Section 329 of the Bankruptcy Code provides:
11 U.S.C. § 329(a) (emphasis added). Federal Rule of Bankruptcy Procedure 2016(b), which implements § 329(a), specifies:
As explained by the Sixth Circuit Court of Appeals in Henderson v. Kisseberth
The bankruptcy court in Kisseberth explained that Congress's inclusion of § 329 expressed "an intent that all fees incurred by an attorney in connection with a bankruptcy case be disclosed, regardless of whether or not such fees were actually paid at the time the Compensation Statement was filed with the bankruptcy court." Id. at *6. The statutory text requiring disclosure of any compensation "agreed to be paid ... for services rendered" would be superfluous if not read to require disclosure of fees agreed to be paid for pre-petition services rendered even if, as HD & C argues, such fees would not be paid until approved by the Court following a post-petition appointment and application for compensation. See id. In affirming the bankruptcy court, the district court held:
In re Kisseberth, 2000 WL 1177443, at *4.
In another case in which counsel failed to disclose his fee agreement with debtors for pre-petition services in contemplation of their bankruptcy petitions, even though such fees had been waived, and additionally failed to disclose merchandise transfers from debtors to counsel during the preference period, the Eastern District of Michigan observed that "Rule 2014(a) requires mandatory disclosure [and] imposes upon those professionals who are appointed under § 327(a) a duty to fully and completely disclose any and all connections with debtors, and precludes them from exercising any discretion in deciding which connections merit disclosure. Significantly, negligence regarding disclosure is no excuse." Halbert v. Yousif, 225 B.R. 336, 346 (E.D.Mich.1998). No less is true for the disclosure required under Rule 2016(b).
Notably, debtors' counsel in In re Martin, which HD & C asks the Court to follow, filed an application for employment that "made a clean breast of the terms and conditions of the retainer and other accoutrements of the fee arrangement as required by Bankruptcy Rule 2016(b)," including the details about the mortgage that secured future fees. 817 F.2d 175, 176 (1st Cir.1987). In deciding whether the security interest taken by the firm was appropriate, the court indicated that the "inquiry is of necessity case-specific. There must be at a minimum full and timely disclosure of the details of any given arrangement."
As explained by the Sixth Circuit,
In re Kisseberth, 273 F.3d at 721.
Here, HD & C filed its initial application for employment as Debtor's counsel on the day that the petition was filed. The application itself contained the following information:
Application to Employ Counsel [Doc. 9] ("Employment Application"), p. 2.
Twenty-five days later, on March 3, HD & C filed its Rule 2016 Disclosure of Compensation of Attorney for Debtor(s) ("Disclosure") [Doc. 45], shown below.
More significantly, the Disclosure is not accurate in that it shows only "N/A" concerning the agreement with Debtor, the retainer or other amount received, and the balance due. This Court finds inadequate the reference in section 6 to the Employment Application and Affidavit, especially since neither the Affidavit nor the Employment Application reveal the pre-petition services
HD & C further argues that "it was not a creditor at the time of the petition, that it did not lack disinterestedness, and that it did not hold an adverse interest to the Bankruptcy Estate for rendering pre-petition legal services in connection with and in preparation of filing the bankruptcy petition." [Doc. 107 at p. 7.] Such is for the Court to decide, not HD & C. Full disclosure is the only way that the Court can make such a decision. See In re Roberts, 75 B.R. 402, 407, 411 (D.Utah 1987), aff'g in part 46 B.R. 815 (Bankr. D.Utah 1985) ("The role of the courts in maintaining the integrity of a legal system cannot be abdicated and left to the Bar.... In re Estes, 57 B.R. 158, 162 (Bankr.N.D.Ala.1986).... [T]he law firm should have disclosed the debt owed to it by the corporation, made its arguments, and allowed the bankruptcy judge to apply the law.").
As stated by the Ninth Circuit in In re Park-Helena Corp., 63 F.3d 877, 882 (9th Cir.1995), cited in In re Kisseberth, 273 F.3d at 721, "[e]ven a negligent or inadvertent failure to disclose fully relevant information [in a Rule 2016 statement] may result in a denial of all requested fees." Further, "failure to comply with the disclosure rules is a sanctionable violation even if proper disclosure would have shown that the attorney had not actually
The Court here will exercise its discretion and deny HD & C's request in its First Application for those services provided pre-petition. The Court does so as a sanction for HD & C's failure to disclose the pre-petition fees as required by § 329 and Rule 2016. Accordingly, the pre-petition fees incurred from January 27, 2016, through February 8, 2016, are disallowed, reducing the total amount of the application by $5,938.00.
As for the remainder of HD & C's fee application, the Court is authorized to award "reasonable compensation for actual, necessary services rendered" pursuant to 11 U.S.C. § 330(a)(1). When making a determination if requested fees are reasonable, the Court considers, inter alia, "whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case," 11 U.S.C. § 330(a)(3)(C), and compensation is disallowed for "services that were not reasonably likely to benefit the debtor's estate or necessary to the administration of the estate." 11 U.S.C. § 330(a)(4)(A)(ii). After consideration of the attachment to the First Application reflecting post-petition services rendered and for the reasons set forth below, the application is granted and fees are awarded to the extent allowed in accordance with the following determinations.
The Court first determines that the following entries are clerical in nature and not compensable as reasonable and necessary under § 330(a)(1):
As such, the 1.6 hours billed by the paralegal at her $95.00 hourly rate ($152.00) and the 0.20 hours billed by Mr. Farmer at his $300.00 hourly rate ($60.00) are disallowed.
The Court also finds that the following entries are excessive based on the length as well as the formulaic nature of each document and/or service and shall be reduced from the time reflected in the entry to the time reflected in the end column:
Accordingly, the fees shall be further reduced by $199.50, representing 2.1 hours reduced from the paralegal's time at her $95.00 hourly rate, and $150.00, representing 0.50 hours reduced from Mr. Farmer's time at his $300.00 hourly rate.
The Court additionally finds that the following entries consist of "lumped" services
The fees shall again be reduced by $690.00, representing the 2.30 hours billed by Mr. Farmer at his $300.00 hourly rate, and by $80.00, representing the 0.40 hours billed by Mr. Williams at his $200.00 hourly rate.
Finally, the Court shall disallow the $210.00 in fees billed by Mr. Farmer on April 22, 2016, for 0.70 hours to "Review issues relative to drafting statements and schedules," because the statements and schedules were filed on March 3, 2016, and have not been amended. The Court will likewise disallow the $60.00 in fees billed by Mr. Farmer on February 11, 2016, for 0.20 of an hour to "Review Application to Employ HDC" at his $300.00 hourly rate. This entry refers to an amended application to employ HD & C, which was filed
In summary, for the reasons stated herein, after deducting $5,938.00 for pre-petition, non-disclosed services and the additional $1,601.50 for clerical, excessive, and lumped billing entries, the Court determines that the Amended Application shall be granted in part, and HD & C shall be allowed fees in the amount of $18,334.00 and expenses in the amount of $785.83. An Order consistent with this memorandum opinion shall be entered.