KEVIN R. ANDERSON, Bankruptcy Judge.
The matters before the Court are: (1) the First and Final Application for Allowance of Attorney Fees and Costs (the "Special Counsel's Application") filed by Prince, Yeates & Geldzahler; (2) the Chapter 7 Trustee J. Kevin Bird's Proposed Final Report ("Final Report"); and (3) the Trustee's Application for Compensation and Reimbursement of Expenses (the "Trustee's Application").
On January 22, 2018, the Court held an evidentiary hearing on Special Counsel's Application, the Trustee's Application (the "Applications"), and the Final Report. Adam S. Affleck appeared for the Trustee and Prince, Yeates & Geldzahler. The Court received the proffer of testimony from Special Counsel. At the conclusion of the hearing, the Court took the matter under advisement.
For the reasons set forth herein, the Court denies the compensation requested in Special Counsel's Application except for $2,896.00 in fees and $853.44 in costs, for a total of $3,749.44. The Court grants the Trustee's Application in the requested amount of $4,519.72. The Trustee is to amend and resubmit the Final Report for Court approval.
In this case, the Trustee collected a tax refund and sold two recreational lots that netted $18,019.72 to the estate. However, the Trustee and his counsel are seeking compensation totaling $27,594.66. Thus, unless otherwise adjusted, professional fees will empty the estate leaving nothing for unsecured creditors.
This was not a difficult case, and it did not involve complex legal issues, transactions, or assets. So how did the estate become administratively insolvent by over $9,500? From the Court's perspective, there are four reasons. First, the Trustee and Special Counsel did not accurately assess the value of the lots at the beginning of the case. Second, the Trustee did not budget and monitor Special Counsel's legal expenses. Third, Special Counsel performed tasks that should have been done by the Trustee or the realtor. And fourth, the time spent by Special Counsel performing services was unreasonable given the routine nature of the tasks and the results achieved. For these reasons, the Court makes the following adjustments to the Applications.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334(a). Special Counsel's Application, the Trustee's Application, and the Final Report are core proceedings within the meaning of 28 U.S.C. § 157(b)(2)(A). Venue is appropriate in this District under 28 U.S.C. § 1408 and § 1409.
The facts arise in an unremarkable Chapter 7 consumer case. The Debtors filed their case on March 16, 2016, and J. Kevin Bird was appointed as the Trustee. The assets administered by the Trustee consisted of a tax refund
Just before the petition date, the Debtors sold Lot #9 to Gary Black for $1,000.
The Trustee initially hired his law firm as general counsel.
In June 2016, the Debtors provided the Trustee and Special Counsel with material information regarding the nature and value of the Lots. Specifically, the Debtors provided the 2015 property tax assessments showing Lot #11 with a value of $25,000 and Lot #9 with a value of $660.
From July through September 2016, Special Counsel attempted to determine the value of the Lots by consulting with a realtor and communicating with Gary Black. Pre-petition, Mr. Black had unsuccessfully listed the Lots for sale, and he later purchased Lot #9 for $1,000.
During the rest of 2016 and into 2017, Special Counsel conducted discovery as to the recovery of Lot #9 and engaged in multiple communications and actions to sell the Lots.
The Final Report discloses net receipts of $2,394.35 in tax refunds and $15,846.34 from the Lots, less bank fees of $220.97, resulting in a present balance on hand of $18,019.72.
The Court has an independent duty to review applications under § 330(a)(2) without regard to whether any party objects.
When an estate is administratively insolvent, the Court's duty to review applications for compensation is particularly purposeful.
The trustee has the ultimate responsibility to see that estates are economically administered for the benefit of unsecured creditors. This includes supervising and managing estate professionals to verify that their services are necessary and reasonably likely to benefit unsecured creditors. As stated by Judge Leif M. Clark:
Judge Steven Rhodes observed that the trustee's duty to maximize the estate includes the duty to minimize administrative costs:
This duty includes knowing when to abandon an asset or action if the present or anticipated administrative costs will exceed the asset's net value to unsecured creditors.
The United States Trustee also provides clear guidance: "A trustee shall not administer an estate or an asset in an estate where the proceeds of liquidation will primarily benefit the trustee or the professionals. . . .
The duty to economically administer estates includes a trustee's appropriate use of legal counsel. Trustees may employ counsel to advise on complex legal matters, or to represent the trustee in contested matters or adversary proceedings.
When counsel assumes too many of the trustee's responsibilities, it can result in a denial of compensation.
The Court concurs with these standards. Before delegating a task to counsel, trustees should first analyze whether the value of the task, less projected legal and administrative costs, is reasonably likely to benefit unsecured creditors.
The Court has previously expressed its concern to both the Trustee and to Special Counsel when their administration of estate assets did not benefit unsecured creditors.
In other words, like a private client, a trustee should regularly review, question, and if appropriate, contest the legal fees of counsel to ensure that the estate receives fair value for the administrative cost of services rendered.
In summary, as part of their duty to economically administer estates, trustees must manage their professionals to ensure the services are not duplicative of trustee duties and are necessary to estate administration or reasonably likely to benefit unsecured creditors. When a trustee fails to conduct a cost-benefit analysis; to prepare a prospective budget for a task assigned to counsel; to regularly monitor counsel's fees; to regularly assess the advisability of pursuing an asset; and, when administrative fees render an estate insolvent, to take appropriate curative action, then the trustee has not economically managed the estate.
Chapter 7 professionals are entitled to "reasonable compensation for actual, necessary services."
"If a bankruptcy court determines a proposed fee is unreasonable, it may `award compensation that is less than the amount of compensation that is requested.'"
In reviewing fees, the court should objectively assess the benefit to the estate based on facts known, or that should have been known, to the applicant at the time of the services.
In making this objective assessment, a court should determine whether it was, or should have been, "reasonably obvious" that the administrative costs of pursuing an asset would render the estate insolvent.
The Tenth Circuit specifically requires the Court to consider § 330(a)(3) and the "Johnson Factors" to assess the reasonableness of attorney's fees.
The Johnson Factors are somewhat duplicative of § 330(a)(3): (1) the time and labor required; (2) the novelty and difficulty of the questions; (3) the skill requisite to perform the legal service properly; (4) the preclusion of other employment by the attorney due to acceptance of the case; (5) the customary fee; (6) whether the fee is fixed or contingent; (7) time limitations imposed by the client or the circumstances; (8) the amount involved and the results obtained; (9) the experience, reputation, and ability of the attorneys; (10) the "undesirability" of the case; (11) the nature and length of the professional relationship with the client; and (12) awards in similar cases.
The Johnson Factors focus on whether the fee is reasonable relative to the skill of the attorney, the difficulty of the task, the market rate for similar services, and the results obtained. Applying these factors, the Court finds that the legal issues were neither novel nor difficult, the tasks did not require extraordinary legal skill, they did not involve undesirable work, and there were no time limitations, other than the motion to extend the objection to discharge deadline. The Court is not taking issue with Special Counsel's ability or customary fee. Rather, its focus is on the Johnson Factors relating to the time required, the amount involved, and the results obtained.
The Court's primary concern is that Special Counsel began incurring significant fees without first performing appropriate due diligence to determine whether its services relating to the Lots were reasonably likely to benefit the estate. As previously stated, the Chapter 7 trustee and his or her professionals "must prospectively analyze whether an asset will provide a net benefit, after payment of necessary secured claims and costs of administration, that will be distributable to unsecured creditors."
The Debtors' bankruptcy papers disclosed that they sold Lot #9 for $1,000, and that Lot #11 was worth $25,000 but subject to a lien of $35,550. Early in the case, the Debtors provided the 2015 property tax assessments that valued Lot #9 at $660 and Lot #11 at $25,000. The Debtors also provided a plat map showing that a main access road cut Lot #9 in half, along with a detailed list of the building issues with Lot #9. The Debtors, through their former realtor, explained that these factors created significant access and construction impediments making Lot #9 worth much less than Lot #11. The Trustee also knew that in the year before the bankruptcy filing, the Debtors had unsuccessfully attempted to sell the Lots for $74,900.
Not that the Trustee should have unquestionably accepted the Debtors' representations, but the reported problems with Lot #9 were specific, supported by objective documentation, and subject to easy verification. This information, coupled with the materially lower tax value of Lot #9, should have put the Trustee and Special Counsel on notice that there was indeed something problematic with Lot #9.
At the second hearing on the Application, Special Counsel proffered that the Trustee thought each Lot was worth $40,000 because the plat map showed them to be the same size,
Further, the Trustee had sufficient facts to run a hypothetical sale of the Lots using different values to calculate possible net proceeds. This analysis would have shown the need to monitor Special Counsel's fees to ensure they were not rendering the estate insolvent. The Court ran such a hypothetical sale calculation based on information available to the Trustee during the first few months of the case.
In addition, Special Counsel billed considerable time (anywhere from $3,500 to $4,300) attempting to determine the value of the Lots.
Again, what the Court finds most concerning is that Special Counsel began incurring significant fees without a prudent analysis as to whether its services were reasonably likely to benefit the estate. And when the cost of those services turned out to far exceed the predictable net proceeds from the sale, Special Counsel unabashedly petitioned the Court for the full amount of its fees with no exercise of billing judgment and little justification for such an outcome.
For the reasons stated above, the Court finds that with reasonable due diligence, Special Counsel and the Trustee could have accurately valued the Lots at the beginning of the case. With such a valuation, the Trustee and Special Counsel should have projected the total administrative costs to recover and sell the Lots. They then should have monitored their administrative fees to avoid billing the estate into insolvency.
While it is true the Lots netted $15,846.34 to the estate, the $27,500 in administrative expenses consumes any benefit to unsecured creditors. Under the facts of this case, if the Court awarded all net proceeds to the Trustee and Special Counsel, it would be contrary to the directives of the Code, applicable caselaw, and the U.S. Trustee guidelines that estates should not be administered for the sole, or even primary, benefit of professionals, and that a trustee should only sell an asset if it will result in a meaningful distribution to creditors. Thus, other than the allowances set forth below, the Court finds no basis to award compensation to Special Counsel for its services relating to the recovery and sale of the Lots.
In addition to no return to unsecured creditors, the Court is troubled that the estate's insolvency was not disclosed in the motion to sell the Lots.
However, the motion does not disclose that at this time accrued attorney's fees alone totaled $20,303. Obviously, the estate's insolvency was known or reasonably knowable at the time of the motion, and this fact should have been acknowledged and addressed in the sale motion. As noted in the similar case of In re Jiminez:
This failure to disclose a material fact regarding the status of the estate at the time of the sale is additional cause for the Court to deny compensation for services relating to the sale of the Lots. As noted in Jiminez, unsecured creditors are not the guarantors of a professional's fees. Special Counsel had the most control over keeping its fees commensurate with the reasonably projected benefit from selling the Lots. Under these circumstances, the Court finds that shifting 100% of the loss to unsecured creditors, while paying 100% of Special Counsel's requested fees, is inconsistent with the intent of § 330(a)(3) and (4).
Further, the First Circuit has held that the underlying authority for Chapter 7 asset liquidation is the realization of equity for the benefit of unsecured creditors.
Thus, going forward, Utah trustees should include in a motion to sell under § 363 an analysis of the projected benefit to unsecured creditors, after deducting secured claims, costs of sale, trustee's commission, and accrued attorney's fees. If the trustee does not or cannot provide such an analysis, the Court will question the propriety of the sale. If the estate is administratively insolvent, that fact should be fully disclosed in the motion with an explanation and, if appropriate, a proposed carve-out from professional fees to ensure a meaningful return to unsecured creditors.
Special Counsel seeks compensation for services that the Trustee should have performed. Trustee's counsel is "never entitled to compensation for performing duties which the [Code] imposes upon the trustee."
The Application requests $8,493.50 under the category "Sale of Property."
Included in this category is $2,306 for Special Counsel to employ the real estate agent. Much of this time involves the attorney and paralegal reviewing and revising the application and order. However, there is nothing novel about the application or order, and much of the language is boilerplate. Indeed, in simple cases, trustees should prepare applications to employ realtors or accountants as they are seldom contested and routinely granted.
In short, none of the services to effectuate the actual sale of the Lots involved contested or complex legal matters that required the assistance of legal counsel. Indeed, when a sale of property is routine and uncontested, the Trustee should directly handle the administrative aspects of its liquidation.
In the "Administration" category, Special Counsel billed approximately $400 to review motions for relief from stay and to seek the Trustee's direction on further action.
The Application seeks $5,059 for services categorized as "Resolution of Gary Black Lien" that relate to the recovery of Lot #9. It was reasonable for the Trustee to employ counsel to pursue this matter. But as set forth above, the Trustee should first have exercised more due diligence in valuing Lot #9 and then monitored Special Counsel's fees to ensure they did not create a net loss to the estate. Furthermore, the Court finds that the time spent on the "resolution of the Gary Black Lien" is not commensurate with the complexity of the matter or the results obtained. Many of the time entries in this category are duplicative and excessive. Approximately one-third of the fees billed in this category are attributed to a paralegal.
The services in this category evidence Special Counsel's excessive time spent on matters that are not complex and should be routine for counsel that regularly represents an experienced Chapter 7 Trustee, such as drafting a demand letter for the turnover of property or prosecuting an uncontested motion to approve a settlement agreement. For example, the time entries reveal that Special Counsel billed $758.50 (3.7 hours) to draft a demand letter to Gary Black in April 2017.
In addition, 25% of the time entries in this category, equaling $1,329.50, are for Special Counsel's work preparing and prosecuting the uncontested motion to approve the settlement agreement with Gary Black.
For these reasons, and because the combined sale of the Lots did not result in a benefit to unsecured creditors, the Court allows $1,045.00 in compensation but denies the balance requested under this category.
Special Counsel argued that the integrity of the bankruptcy system required it to investigate and recover Lot #9 because the $1,000 sale price strongly suggested fraud.
The Application shows $3,561.50 billed under the category, "Investigation of Assets."
Further, over half of the entries in this category, or $2,021.50 spanning an 8-month period, relate to drafting an ex parte motion for a Rule 2004 examination of the Debtors and for the production of documents ostensibly relating to the Lots.
Included in Special Counsel's Application under "Administration" are charges for obtaining an extension of time to object to the Debtors' discharge.
However, the Court denies fees of $860 (4.3 hours)
The matter was set as a preliminary hearing on the law and motion calendar along with many other Chapter 7 hearings. Matters on this calendar are preliminary hearings scheduled at five-minute intervals. Special Counsel knows this is the Court's practice.
Finally, Special Counsel's Application fails to exercise billing judgment in that it seeks compensation for every six minutes spent on this case. Evidence of appropriate billing judgment is "an absolute requirement of fee applications in bankruptcy."
In its supplement to the fee application, Special Counsel proposed a "voluntary reduction" of $22,221.50 to $12,646.56.
When trustees and their professionals seek fees in administratively insolvent estates, they should exercise billing judgment with voluntary reductions sufficient to create a return to unsecured creditors. If the professionals believe the estate's insolvency was not reasonably foreseeable, they should come forward with evidence of due diligence such as how and when the assets were valued; evidence of a prospective budget estimating the costs of avoiding, recovering, and/or liquidating assets; evidence of trustee management and supervision of counsel to scale back, settle, or terminate unprofitable litigation or collection efforts; and explanations as to why the trustee's valuations and cost projections did not result in a distribution to unsecured creditors.
In summary, the Court allows $1,258.00 for services regarding the motion to extend time to object to the Debtors' discharge; $380.00 for drafting the demand letter to Mr. Black; $665.00 for preparing the motion to the approve the settlement with Mr. Black; $338.00 for time spent on the initial case review; and $255.00 for time preparing the fee application. Thus, the Court awards Special Counsel $2,896.00 in fees and $853.44 in costs, for a total of $3,749.44.
The Court has expressed its concerns about the Trustee's oversight and management of this case. The Trustee is seeking a commission of $4,484.72. Based on the Final Report, the maximum compensation permitted under § 326(a) is $6,394.72. Thus, the Trustee has reduced his commission by $1,910. While the Tenth Circuit has not specifically addressed § 326(a) since the 2005 amendments to the Bankruptcy Code,
For the reasons set forth above, the Court finds that Special Counsel provided some services that the Trustee should have done and other services that were unnecessary, duplicative, or excessive. The Court finds that other services were not reasonably likely to benefit the estate when they were performed. The Court also finds that the services were not reasonable given the amount of time expended, the amount of money at issue, the absence of difficulty, and the results obtained. Considering the information available at the beginning of the case, and in the absence of a valid assessment of the value of the Lots and a cost-benefit analysis of administering the Lots, the Court finds that Special Counsel should have known that the excessive extent of its services was not reasonably likely to benefit the estate.
Finally, the Court is particularly troubled by the following: (1) Special Counsel knew or should have known that the estate was insolvent at the time of filing the motion to sell the Lots, yet did not disclose that fact in the motion; (2) when it filed its Application, Special Counsel knew that its services had rendered the estate insolvent, yet it still sought 100% of its fees without adequate justification; and (3) after two hearings wherein the Court expressed its concerns about the administration of estates for the sole benefit of professionals, Special Counsel did not exercise meaningful billing judgment or adequately explain what steps were taken to avoid billing the estate into insolvency.
Absent extraordinary circumstances that are not reasonably foreseeable, trustees and counsel should avoid rendering estates administratively insolvent from the pursuit of assets. The Court is cognizant that the litigation of complex transactions that have the potential for significant returns to the estate also involve significant risk. The Court will balance those factors in such cases. But this estate involved a straight-forward, prepetition transfer and the sale of recreational lots. The problem here is the over-lawyering of an elementary Chapter 7 case that rendered the estate administratively insolvent. If Special Counsel had been conservative and circumspect in the time it put into this case, this outcome may have been avoided — even with the Lots selling for $60,500.
The national Chapter 7 reports for 2016 show that, on average, for every dollar collected by Chapter 7 trustees, 33 cents went to administrative fees and costs while 20.7 cents went to nonpriority, unsecured creditors.
Therefore, the Court awards Special Counsel $2,896.00 in fees and $853.44 in costs, for a total of $3,749.44 but denies all other fees requested in the Application. The Court allows the Trustee's requested commission of $4,484.72 and costs of $35.00 for a total of $4,519.72. This results in total administrative costs of $8,269.16 leaving an estimated balance of $9,750.56 to be distributed to creditors. Thereafter, the Trustee shall file an amended final report. The Court will enter an Order consistent with this Memorandum Decision.
