R. KIMBALL MOSIER, Bankruptcy Judge.
The plaintiff, Kenneth A. Rushton, chapter 7 trustee (Trustee) in the bankruptcy case of C.W. Mining Company (Debtor) filed a Motion for Partial Summary Judgment (Summary Judgment Motion) asking the Court to require Woodbury & Kesler, P.C. (Woodbury), and Russell S. Walker (Walker), an attorney and shareholder of Woodbury to (1) disgorge all fees paid to Woodbury and Walker (collectively Defendants) during the pendency of the bankruptcy case, and (2) turnover certain documents the Defendants claim are privileged. This memorandum decision addresses the Trustee's Summary Judgment Motion with respect to disgorgement of all fees paid to the Defendants during the pendency of the above-captioned bankruptcy case and the Court will grant, in part, and deny, in part, the Trustee's Summary Judgment Motion on this issue.
This Court has jurisdiction under 28 U.S.C. §§ 1334 and 157(a), and venue is appropriate under 28 U.S.C. §§ 1408 and 1409. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (B), (E), (H) and (O) and the Court may enter a final order.
Federal Rule of Civil Procedure 56(c), incorporated into this adversary proceeding by Federal Rule of Bankruptcy Procedure (Rule) 7056, makes summary judgment appropriate "if the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law."
This bankruptcy case was commenced by the filing of an involuntary chapter 11
The Summary Judgment Motion seeks an order requiring Defendants to disgorge all payments they received in connection with the bankruptcy case regardless of the source of payment. The Trustee contends that under §§ 327, 328, and 329 and Rules 2014 and 2016, the Defendants suffered from a conflict of interests, failed to disclose payments received, failed to disclose the source of payments, willfully violated the automatic stay, and paid themselves without the Court's permission. The Trustee further asserts that the payments received by Defendants from third parties Standard Industries, Inc. (Standard) and Hiawatha Coal Company, Inc.
Defendants argue that they were permitted to be paid without court order prior to the Order for Relief, that Defendants did not suffer from a conflict of interest, that the compensation paid to Defendants was not excessive, that no violation of the automatic stay occurred, that the fees paid by Standard and Hiawatha were not the Debtor's funds, and that the Trustee lacks standing to recover funds paid to Defendants by third parties.
The Summary Judgment Motion and oral arguments were presented to the Honorable Judith A. Boulden on April 5, 2010. The Summary Judgment Motion was taken under advisement and on April 20, 2009, Judge Boulden recused herself in the C.W. Mining bankruptcy case. As a result, the bankruptcy case and all related adversary proceedings were reassigned to this Court. A renewed hearing on the Trustee's motion for partial summary judgment was set for May 14, 2010, and the matter was taken under advisement.
An involuntary chapter 11 petition was filed against the Debtor on January 8, 2008. On January 29, 2008, the Defendants filed an Ex Parte Motion for Order Authorizing Employment of Special Counsel (Employment Application) for the Debtor. The Defendants' Employment
The Defendant's Employment Application stated the following:
Mr. Walker's affidavit in support of the Debtor's Employment Application further stated that the Defendants
On March 7, 2008, Debtor filed a supplemental memorandum in support of the appointment of Defendants as special litigation counsel. On March 13, 2008, the Court entered an order authorizing the employment of Defendants as special counsel. The Order appointing Defendants provided that in the event the Court enters an order for Relief in the involuntary chapter 11 case, Defendants may reapply for appointment as Special Counsel for the Debtor or debtor in possession. On September 25, 2008, the Court entered an order for relief under chapter 11 of the Bankruptcy Code.
Defendants filed Official Form B203, Disclosure of Compensation of Attorney for Debtor, on October 31, 2008. In the Disclosure, Defendants represented that they agreed to accept $0.00 for legal services, received $0.00 prior to the filing of the Disclosure, that the balance due was $0.00, the source of the compensation was hourly, and that the source of compensation to be paid is hourly.
On November 13, 2008, the Debtor's bankruptcy case was converted to a case under chapter 7 of the Bankruptcy Code. No amended application for appointment of counsel or supplement to application for appointment of counsel has been filed.
The same day this matter was argued to the Court, April 5, 2010, Defendants filed a Disclosure of Compensation Paid to Attorney for Debtor.
Defendants have never filed a fee application or provided any type of information to this Court to enable the Court to consider the reasonableness of the compensation paid to the Defendants. Defendants have also failed to file any type of description of services to enable this Court the determine whether they were disinterested or represented an interest adverse to the estate or whether they represented or held any interest adverse to the debtor or the estate with respect to the matters on which they were employed during the pendency of the chapter 11 case.
The Defendants' involvement in this case began with an affirmative representation to this Court that they were professionals qualified to represent the Debtor under § 327 and that they would remain qualified to represent the Debtor in chapter 11 if an order for relief were entered. Defendants' involvement metamorphosed from this affirmative representation that they were, and would be, free of conflicts, into an affirmative misrepresentation to this Court regarding the payments they received and a failure to disclose conflicts and payments they received.
The Bankruptcy Code and Rules of Bankruptcy Procedure are replete with provisions relating to employment and payment of professional persons, in particular attorneys. Attorneys for debtors are not only subject to provisions applicable to
The Defendants assert that there is no requirement that they comply with § 327 and that "[d]uring the `gap'
The Defendants position is premised on the notion that § 303(f) eliminates the debtor's duties and any scrutiny and oversight imposed by the Bankruptcy Code. The Defendant's reliance on § 303(f) and their assertion that a debtor in an involuntary chapter 11 case is free to retain and pay attorneys without court approval is misplaced. The definitions and provisions in the Bankruptcy Code clearly provide that if no trustee has been appointed, a debtor in an involuntary chapter 11 case is a debtor in possession, even during the "gap" period.
An involuntary chapter 11 case is commenced when the petition is filed.
Defendants attempt to create ambiguity or inconsistency by arguing that § 303(f) allows a debtor, during the "gap" period, to conduct business as though no bankruptcy had been filed and may therefore employ and pay attorney's without court approval. Section 303(f) is similar to § 363(c)(1) but § 303(f) applies specifically to involuntary cases during the "gap" period. Section 363(c)(1) authorizes a trustee to "enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice or a hearing." Although § 363(c)(1) authorizes the trustee, or debtor in possession, to enter into transactions and use, sale or lease property of the estate without notice and a hearing, it does not nullify other Bankruptcy Code provisions including those applicable to employment and compensation of attorneys for the trustee, or debtor in possession, and does not authorize payment of professional fees without court approval. Similarly, although § 303(f) does not use the term "ordinary course of business," it authorizes the debtor, or debtor in possession, to continue its business operations "as if an involuntary case concerning the debtor had not be commenced;" it does not nullify other Bankruptcy Code provisions including those applicable to employment and compensation of attorneys for the debtor or debtor in possession.
A debtor in possession has the rights, other than the right to receive compensation, and shall perform all the functions and duties of a trustee serving in a chapter 11 case.
The commencement of a case under § 303 creates an estate.
Adopting Defendant's argument would allow debtors in possession to employ attorneys who may not be disinterested or may represent an interest adverse to the estate and pay their fees without any court oversight or approval. The Defendants attempt to create a void where attorneys for an involuntary debtor in possession are not subject to the standards clearly imposed by the Bankruptcy Code. In an involuntary chapter 11 case, the debtor in possession has little or no interest in being in bankruptcy and may have little incentive to act openly and candidly with a court and parties in interest. The court and parties in interest in an involuntary case have a great interest in seeing that debtors in possession fulfill their fiduciary duties. Due to the lack of alignment of incentives, a court must ensure compliance by all parties with the Bankruptcy Code.
The Defendants argue that they were private attorneys for the Debtor and their employment and receipt of fees was not subject to this Court's approval. Even if the Defendants' current position were supported by the Bankruptcy Code it is contrary to the Defendants' affirmative representations to this Court and the actual events in this case. Defendant's were employed pursuant to § 327.
The case authority relied on by Defendants is distinguishable from the facts in this case. In the Rundlett case, counsel represented the debtor in an involuntary chapter 7 case which was voluntarily converted to a chapter 11 case before the order for relief was entered. Counsel for the debtor was paid during the chapter 7 "gap" period. Debtors in an involuntary chapter 7 case are not debtors in possession, are not authorized to employ professionals, and are not restricted by §§ 327 and 330. Permitting debtors to employ and compensate attorneys without court approval during the "gap" period in a
The standards of disinterestedness required by bankruptcy courts for professionals who choose to represent debtors in bankruptcy are well established and are described in In re Roberts
Cook: goes on to state that § 328(c) authorizes a penalty for failing to avoid a disqualifying conflict of interest. Section 328(c) states
The court has no duty to investigate a prospective attorney's actual or potential conflicts. Disgorgement of all fees is warranted even though attorneys provide a significant benefit to the estate where the attorney's application for appointment failed to disclose a fee arrangement with a creditor.
In the present case it is undisputed that Defendants had a fee agreement with at least one significant creditor of the Debtor. The Defendants have not yet disclosed the terms of that agreement or any facts relating to Defendants' communications with the creditors who paid their fees. Even though the Defendants assert they held no disqualifying interest, the assertion is without factual support and is entirely devoid of substance.
Even if §§ 327, 328 and 330 were not applicable to Defendants in this case, § 329(a) and Rule 2016(b) are applicable to all attorneys representing a debtor in a case under the Bankruptcy Code. Section 329(a) provides
Section 329(a) clearly provides that, beginning one year prior to the bankruptcy petition, and continuing thereafter, an attorney representing a debtor must disclose to the court all fees it is paid or agrees to be paid in connection with the case. The statute could not be clearer. Simply put, a debtor's attorney is required to disclose to the court all fees it is paid or agrees to be paid during the year prior to the petition date and all fees it is paid or agrees to be paid after the petition date. The legislative history for § 329 makes clear why attorneys should be subject to scrutiny. "Payments to a debtor's attorney provide `serious potential' for both `evasion of creditor protection provisions of the bankruptcy laws' and `overreaching by the debtor's attorney.'"
Rule 2016(b) establishes the procedure for filing the statement required by § 329(a). Rule 2016(b) states:
In the present case, Defendants should have filed a 2016(b) statement on or before October 13, 2008.
Defendants filed an Official Form B203, Disclosure of Compensation of Attorney for Debtor (Disclosure), on October 31, 2008, disclosing their receipts from the Debtor of $0.00. Defendants argue that the Disclosure is accurate because "the form of Compensation Statement clearly asks for the compensation paid `within one year before the petition in bankruptcy....'"
If the compensation that is paid or agreed to be paid to a debtor's attorney exceeds the reasonable value of the services provided, § 329(b) authorizes the court to cancel the agreement and order return of the return of excessive payments to the debtor or the party that made such payment. Section 329(b) states
Because the Defendants have failed to offer the Court any information regarding the services it has rendered for the Debtor, it is impossible for the Court to determine the reasonableness of the compensation it has received. Defendants refusal to offer any evidence regarding the reasonableness of the compensation it has received must create the presumption that all of the compensation is excessive.
Additionally, "`reasonable compensation for services rendered' necessarily implies loyal and disinterested service in the interest for whom the claimant purported to act."
Finally, "an 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.... The Court may sanction failure to disclose `regardless of actual harm to the estate.'"
Concerning that portion of Trustee's motion for summary judgment that seeks disgorgement of fees paid by the Debtor to Defendants, while each of the Trustee's stated grounds for relief are separate and discreet causes of action, the facts and circumstances that give rise to the Trustee's complaints focus on the same actions and/or failure to act on the part of the Defendants.
The Defendants affirmatively requested, and received, Court authorization to be employed under § 327. The Defendants, not withstanding their employment under § 327, now argue that they are not required to obtain court approval for payment of their fees. As discussed above,
If a debtor's attorney is paid by a creditor of the estate, a presumption must arise that the attorney is not disinterested. The Defendants have not offered any evidence to rebut this presumption. The Defendants received payments from Standard and Hiawatha who were party to contracts with the Debtor and have asserted numerous claims against the Debtor. Under the circumstances of this case and the record before the Court, the Court finds that the Defendants were not disinterested and held an interest adverse to the estate with respect to the matters for which they were employed. The Court finds that terms and conditions of Defendants' employment were improvident in light of developments that were not anticipated at the time of Defendants' employment. Therefore, the Court disallows any fees to Defendants for representing the Debtor prior to the conversion of the bankruptcy case to a case under chapter 7 and orders disgorgement of all fees paid to Defendants by the Debtor.
Defendants failed to disclose, or affirmatively misrepresented, the compensation paid, or agreed to be paid, after one year before the date of the petition in connection with the case. The Defendants' failure to fully and honestly disclose all compensation it has been paid, particularly compensation from creditors, justifies a reduction in fees under § 329(b). Because of the Defendants' failure to account to this Court for any of their services, and failure to even address the presumption that they had a conflict of interest in representing the Debtor, the Court can only conclude that the value of the services provided by the Defendants to the Debtor have no value and the compensation paid by the Debtor exceeds the value of the services by the full amount.
Defendants' Disclosure supplies the type of limited information or misinformation that demands a response by the Court. Under the circumstances of this case, the Court finds that the Defendants failed to comply with § 329(a) and Rule 2016(b) and failed to disclose or misrepresented the compensation it had been paid and had agreed to be paid. The Defendants failed to provide loyal and disinterested service to the Debtor and the Defendants' services to the Debtor in possession have no value. In the disclosure of October 31, 2008, Defendants state that "[p]rior to the filing of this statement Defendants have received $0.00."
With respect to the Trustee's assertion that the payments that Defendants received from Standard and Hiawatha should be treated as loans from Standard and Hiawatha to the Debtor and therefore as payments from the Debtor to Defendants, Trustee offers nothing to support the allegation that the payments made directly from Standard and Hiawatha to Defendants were, in fact, disguised loans to the Debtor, nor
Further, without joining Standard and Hiawatha, the parties that are statutorily entitled to any fees ordered returned under § 329(b)(2), that portion of the Trustee's adversary proceeding which seeks turnover of payments made by Standard and/or Hiawatha to the trustee is subject to dismissal under Rule 19. Rule 19 does not require the absent party to actually possess an interest; it only requires that the absent party claim an interest relating to the subject of the action.
Pursuant to §§ 328 and 329 the Court will disallow any fees payable to the Defendants by the Debtor. Because the Court is disallowing any fees to the Defendants, all payments the Defendants have received from the Debtor must be disgorged. The Court's findings and conclusions in this case are based, in part, on the Defendants' failure to (1) provide this Court with any accounting of time or services rendered on behalf of the Debtor, and (2) provide this Court with any information regarding its agreement with Standard and Hiawatha for payment of fees. Because the Defendants have failed to provide this information to the Court, the Court can only conclude that the compensation received by Defendants from the Debtor exceeded the value of the services rendered to the Debtor in possession, the Defendants held an interest adverse to the estate and were not disinterested with respect to the matters for which they were retained, and that the Defendants' failure to comply with Rule 2016 justifies disgorgement of fees paid to Defendants by the Debtor.
If Defendants believe that they have not been afforded a fair opportunity to disclose to this Court the nature of the services they have rendered for the Debtor and provide this Court with a detailed description of services rendered to the Debtor which would enable this Court to determine that the Defendants did not represent an interest adverse to the estate and were disinterested with respect to the matters for which they were retained, the Defendants may, within 30 days from the date of this decision, file an application for compensation and any additional disclosure they deem appropriate. In order for the Court to determine that Defendants did not represent an interest adverse to the estate and were disinterested, the application for compensation must detail all services the Defendants have rendered in connection in this case, including services for which they are not seeking compensation, and must disclose all agreements they have with Standard and Hiawatha.
For legal services, I have agreed to accept........ $ 0.00
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Prior to the filing of this statement I have
received....................................... $ 0.00
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Balance Due....................................... $ 0.00
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The record before the Court establishes that Defendants received payments as attorney for the Debtor follows:
------------------------------------------------------Date Deposit/Payment Draw Source ------------------------------------------------------ 1/24/2008 $12,000 Debtor ------------------------------------------------------ 2/1/3/2008 $ 3,000 Debtor ------------------------------------------------------ 3/25/2008 $12,135 ------------------------------------------------------ 5/13/2008 $ 7,000 Debtor ------------------------------------------------------ 6/11/2008 $ 4,075.98 ------------------------------------------------------ 7/10/2008 $ 7,000 Standard ------------------------------------------------------ 7/10/2008 $ 1,957.02 ------------------------------------------------------ 7/21/2008 $ 3,903.41 ------------------------------------------------------ 9/3/2008 $ 1,139.57 ------------------------------------------------------ 9/25/2008 Order for Relief Signed (Entered 9/26/2008) ------------------------------------------------------ 9/26/2008 35,000.00 Standard ------------------------------------------------------ 9/26/2008 $17,182 ------------------------------------------------------ 9/26/2008 $ 7,817.69 ------------------------------------------------------ 10/21/2008 $ 4,782.78 ------------------------------------------------------ 11/13/2008 Case Converted to Chapter 7 ------------------------------------------------------ 11/20/2008 $ 5,517.22 ------------------------------------------------------ 3/9/2009 $33,874.78 Standard ------------------------------------------------------ 6/15/2009 $10,000 Hiawatha ------------------------------------------------------ 7/6/2009 $20,000 Hiawatha ------------------------------------------------------ 7/27/2009 $20,360.72 Hiawatha ------------------------------------------------------ 10/27/2009 $27,955.49 Standard ------------------------------------------------------ 12/29/2009 $20,000.00 Standard ------------------------------------------------------ 1/13/2010 $25,000.00 Hiawatha ------------------------------------------------------ 1/25/2010 $25,000.00 Standard ------------------------------------------------------ 2/18/2010 $20,000.00 Standard ------------------------------------------------------
Defendants' argument is inconsistent with the facts in this case. The Defendants were employed pursuant to this Court's order so the argument that they did not need to comply with § 327 is not apposite.
