October 2000

Beware When Your a Client is Debtor in Possession: Getting and Staying Employed in Bankruptcy Cases

by David S. Kupetz

Courts uniformly recognize that "[t]he Bankruptcy Code imposes particularly rigorous conflict-of-interest restraints upon the employment of professional persons in a bankruptcy case."1 Moreover, "the bankruptcy court has broad and inherent authority to deny any and all compensation when an attorney fails to meet the requirements" of the Code.2 However, an attorney’s representation of a debtor in possession is complicated by the reality that there may be confusion regarding who the client is and what related obligations counsel owes.3 

In all circumstances, in order to minimize the risk of not being paid and/or having to disgorge payments previously received, counsel for a debtor must comply with the disclosure requirements imposed under the Code and the Federal Rules of Bankruptcy Procedure.4 While it is necessary that counsel for the debtor obtain court approval of its employment, the disclosure obligation constitutes a continuing duty that does not terminate when the professional’s employment is approved.5 Disclosure for the sake of disclosure alone is a necessity. That is, "failure to comply with the disclosure rules is a sanctionable violation, even if proper disclosure would have shown that the attorney had not actually violated any Bankruptcy Code provision or any other Bankruptcy Rule."6 

"The Bankruptcy Code and Federal Rules of Bankruptcy Procedure contain various provisions to ensure the impartiality of professionals in their representation of clients in bankruptcy cases."7 Section 327(a) of the Code, in pertinent part, provides:

Except as otherwise provided in this section, the trustee,[8 ] with the court’s approval, may employ one or more attorneys, ... or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title.9 

Further, Section 330 of the Code provides, in pertinent part, that "the court may award to a ... professional person employed under section 327... reasonable compensation for actual, necessary services...."10 Many courts have held that the debtor’s failure to obtain court approval of the employment of a professional precludes the payment of fees to the professional.11 Moreover, it has been "held that the Code and Rules preclude fee awards for services performed on behalf of the bankruptcy estate based on state law theories not provided for by the Code, such as quantum meruit."12 

Some courts, however, have allowed counsel to circumvent the employment requirements of sections 327 and 330 of the Code. For example, where legal services were rendered out of necessity while an application for appointment was pending, and before such application was disapproved, courts taking a flexible approach might approve compensation pursuant to section 503(b)(1)(A) of the Code as an actual, necessary cost of preserving the bankruptcy estate.13 Other courts have taken a more rigid view and have concluded that a bankruptcy court may not approve compensation for an attorney for services rendered without a court order having been entered approving the attorney’s employment.14 Nonetheless, under "extraordinary circumstances" bankruptcy courts may entertain and approve post facto (frequently referred to as nunc pro tunc approval) applications for authority to employ professionals by a bankruptcy estate representative.15 

B. Disinterestedness and Adverse Interest

Section 327(a) of the Code creates a two-part requirement for retention of counsel: 1) counsel must "not hold or represent an interest adverse to the estate," and 2) counsel must be a "disinterested person." In actuality, "the two requirements of disinterestedness and lack of adversity telescope into a single hallmark."16 This overlap becomes evident by examining the definition of "disinterested person" set forth in the Code. The Code defines a "disinterested person" as one who is not a creditor, an equity security holder, or insider, and who "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...."17 Thus, to be "disinterested" under the Code, counsel for the debtor cannot hold an equity security in the debtor.18 A "disinterested" person must be a person who is not a creditor of the debtor.19 An "insider" of the debtor is not a "disinterested person." 20 Further, the catch-all clause in the definition of disinterested person is broad enough to include any professional with an "interest or relationship that would even faintly color the independence and impartial attitude required by the Code."21 

What it means to "hold or represent an interest adverse to the estate" is not defined in the Code. Numerous courts, however, have adopted the definition that to hold an adverse interest means either 1) the possession or assertion of any economic interest that would tend to lessen the value of the bankruptcy estate or that would create either an actual or a potential dispute with the estate as a rival claimant, or 2) a predisposition of bias against the estate.22 The majority view is that the determination of whether an adverse interest exists is an objective determination that is concerned with the appearance of impropriety.23 While a minority of courts has held or implied that only "actual" and not "potential" conflicts of interest are disabling, the majority view is that even potential conflicts are fatal.24 Moreover, the debate over the question of actual versus potential conflicts "may be more semantic than substantive" since, ultimately, the determination of counsel’s disinterestedness is "largely driven by the facts of each case."25 "Potential conflicts, no less than actual ones, can provide motives for attorneys to act in ways contrary to the best interests of their clients."26 

"What is clear is that undivided loyalty is central to disinterestedness."27 However, as discussed below, in the context of representing an entity that serves as a fiduciary, it may not always be clear to whom counsel owes undivided loyalty. In any event, "the attorney takes the risk that the court will finally determine that a conflict exists and deny the employment of the attorney by the debtor and, consequently, deny any compensation for services already provided."28 

There are many reported decisions setting forth examples of conflicts of interest engaged in by counsel for the debtor which violated the disinterestedness and/or lack of adverse interest requirements of the Code. For example, in In re Leslie Fay Companies, Inc.,29 it was found that the law firm represented interests that were materially adverse to its chapter 11 debtor client where it was retained to complete a fraud investigation for the debtor, and the firm also had significant ties to three potential targets of that investigation. In In re Occidental Financial Group, Inc.,30 disgorgement of attorney’s fees for prepetition and postpetition services was compelled as a result of the attorney’s conflict of interest in representing the debtor and the debtor’s principals. In In re Angelika Films 57th, Inc.,31 the court found that the chapter 11 debtor’s attorneys had engaged in egregious conduct by representing the interests of the debtor’s principal over those of the debtor in a situation where a motion to assign the debtor’s lease of a single-screen movie theater and concession stand to the debtor’s principal for the sum of $100,000 was filed shortly after the lease had been valued at $500,000 or more. In Interwest Business Equipment, Inc. v. U.S. Trustee (In re Interwest Business Equipment, Inc.),32 the court found that it was necessary for three interrelated chapter 11 debtors in possession, where intercompany debts placed each estate in creditor/debtor relationships with one another and where a prepetition management contract existed between one debtor and another, to have separate counsel who could fairly and fully advise each debtor as to its rights and responsibilities. Moreover, it has been held that regardless of a client’s ability to waive a conflict of interest under the rules of professional conduct, the Code does not permit a debtor in possession to negate a conflict by signing a waiver.33 

The disinterestedness requirement of section 327(a) of the Code is subject to two limited exceptions. The first exception applies only under the following circumstances: 1) the attorney is to be employed for a specific special purpose approved by the court; 2) the attorney previously represented the debtor; 3) the employment will be in the best interest of the estate; and 4) the attorney does not represent or hold any interest adverse to the debtor or the estate concerning the matter for which she is to be employed.34 The second exception allows a person not to be disqualified for employment under section 327(a) "solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.35 Moreover, courts have allowed a creditor’s law firm to simultaneously serve as special counsel to the trustee if it does not hold an adverse interest "with respect to the matter on which such attorney is to be employed."36 

The duty to avoid conflicts of interest is an ongoing obligation of debtor’s counsel.37  The most obvious potential penalty for failure to satisfy this obligation is explicitly set forth in section 328(c) of the Code which provides, in pertinent part, as follows:

[T]he court may deny allowance of compensation for services and reimbursement of expenses of a professional person employed under section 327… if, at any time during such professional person’s employment … such professional person is not a disinterested person, or represents or holds an interest adverse to the interest of the estate with respect to the matter on which such professional person is employed.38 

Courts have found that the plain language of section 328(c) provides that the bankruptcy court has discretion in determining whether to deny compensation.39 This discretion may be exercised harshly. That is, "if its fact-specific inquiry leads the bankruptcy court to conclude that an impermissible conflict of interest looms or exists, available sanctions include disqualification and the denial or disgorgement of all fees."40 

The Code and the Rules contain procedural mechanisms designed to enforce the statutory requirements of disinterestedness and no interest adverse to the estate. Rule 2014 requires that a request for approval of the employment of a professional in a bankruptcy case include an application and an accompanying verified statement "setting forth the person’s connection with the debtor, creditors, or any other party in interest…."41 "Though this provision allows the fox to guard the proverbial hen house, counsel who fail to disclose timely and completely their connections proceed at their own risk because failure to disclose is sufficient grounds to revoke an employment order and deny compensation."42 Thus, the duty to disclose under Rule 2014(a) is a self-policing one.43 Accordingly, courts strictly construe the Rule 2014 disclosure requirements.44 

"[A] misstatement in a Rule 2014 statement by an attorney about other affiliations constitutes a material misstatement."45 "All facts that may have any bearing on the disinterestedness of a professional must be disclosed."46 "So important is the duty of disclosure that the failure to disclose relevant connections is an independent basis for the disallowance of fees or even disqualification."47 Moreover, there is little doubt that "nothing would inflame a court’s anger more than the belief that a party has intentionally failed to disclose.…"48 

The failure to adequately disclose all connections with the debtor and the estate has haunted numerous lawyers who have subsequently found what must have seemed like their surreal nightmares published in reported decisions. In large part, the genesis of John Gellene’s travails in his firm’s representation of Bucyrus-Erie Company in its chapter 11 case was his failure to disclose his firm’s representation of a group of investment entities which held senior secured notes and leasehold interests/secured claims against his firm’s chapter 11 debtor client.49 

In Rome v. Braunstein,50 the debtor’s counsel failed to make full and spontaneous disclosure of financial transactions between the debtor, the debtor’s sole shareholder and president, and the shareholder’s family members that occurred shortly before counsel filed the debtor’s chapter 11 petition. Additionally, counsel’s failure to obtain explicit court authorization to represent the shareholder’s former secretary in her efforts to purchase the debtor’s assets led to the court’s denial of compensation to counsel.

In In re Leslie Fay Companies, Inc.,51 the debtor’s counsel failed to make the required disclosure of potential conflicts by not revealing that it represented companies whose principals were potential targets in a fraud investigation the firm would be called upon to complete.52 Moreover, the court held that boilerplate language contained in papers filed with the court stating that the law firm might represent claimants of the chapter 11 debtor did not constitute adequate disclosure.53 Finally, the court concluded that the failure of the debtor’s counsel to disclose potential conflicts which might have impaired its investigation into fraud by the debtor’s upper management warranted monetary sanctions in the amount of the cost of investigating counsel’s performance (approximately $800,000 or more), even though counsel actually performed the investigation competently and in a manner consistent with its fiduciary obligations to the estate.54 

An attorney representing a debtor in a bankruptcy case must also file a statement disclosing all compensation paid or agreed to be paid for services rendered in contemplation of or in connection with the case.55 Under section 329 of the Code and Rule 2017, "the compensation of attorneys employed by debtors to provide services in contemplation of or in connection with bankruptcy is subject to review for reasonableness."56 Section 329 provides statutory authorization for the bankruptcy court to order disgorgement, in certain circumstances, of fees paid for prepetition services.57 The denial of fees to attorneys who willfully fail to disclose all their connections with the debtor, creditors, and any other party in interest is appropriate.58 Moreover, an attorney’s failure to obey the disclosure and reporting requirements of the Code and the Rules gives the bankruptcy court the discretion to order disgorgement of attorney’s fees.59 

In In re Park-Helena Corp.,60 the 9th Circuit held that a fee applicant must disclose the precise nature of his fee arrangement with his debtor client. In that case, failure of counsel to accurately and precisely disclose the source of his prepetition retainer, which was paid not from the corporate accounts of the chapter 11 debtor, but from money which the debtor’s president had borrowed from the debtor and deposited in his personal checking account, was found to have violated the attorney’s obligation to disclose all connections with the debtor, the debtor’s officers, creditors and any other parties in interest.61 Further, the 9th Circuit held that, even if it had been determined that the retainer at issue was properly and appropriately paid to the debtor’s counsel by the debtor, counsel had failed to describe the circumstances of the payment in violation of Rule 2014’s disclosure requirements and, accordingly, the court’s denial of all fees was appropriate.62 

In re Lewis63 is another case where the 9th Circuit addressed egregious facts. The debtor’s counsel falsely represented that an entire $40,000 retainer was paid prepetition, when $30,000 was actually paid postpetition. Because of his misrepresentations and his deliberately delayed and incomplete disclosure, counsel was ordered to disgorge $37,000 of the $40,000 payment he had previously received.64 

It has been held that the Code and the Rules "do not provide authority for the court to prohibit a professional from working for any client it chooses."65 The 10th Circuit has stated that it is not a question of the court either permitting or prohibiting unapproved representation, but rather "any professional not obtaining approval is simply considered a volunteer if it seeks payment from the estate."66 At the same time, the 9th and 4th Circuits have held that the bankruptcy court may order the disgorgement of any payment made to an attorney representing the debtor in connection with the bankruptcy case, irrespective of the payment’s source.67 Further, section 329(b) of the Code, contemplating that retainers may be paid to counsel for the debtor from sources other than the debtor, provides that if the court determines that the compensation paid exceeds the reasonable value, the court may order the return of such payment to the entity that made such payment.68 

"Generally, courts discuss conflicts of interest and disinterestedness in the same breath."69 In order to avoid conflicts of interest and remain disinterested, it has been held that counsel for the debtor in possession must "tender undivided loyalty and provide untainted advice and assistance in furtherance of their fiduciary responsibilities."70 Unquestionably, "an attorney owes fiduciary duties of loyalty and care to his/her client."71 However, for attorneys who are retained to assist in the administration of a fiduciary entity, the initial question of "who is the client?" may be more than an academic inquiry.72 

Obviously, pre-bankruptcy, counsel’s client is the corporation (in the case of a corporate debtor). But who is the client after commencement of the bankruptcy — the debtor-in-possession or the estate? Is the debtor-in-possession the client entity or is it just the decision-making constituent of the client estate?73 

It has been held that "[a]n attorney authorized to represent a debtor in a bankruptcy proceeding has a duty to represent the best interests of the debtor and its creditors."74 In Hansen, Jones & Leta, P.C. v. Segal,75 the court discusses at length its view that the client of counsel for a debtor in possession is the debtor in possession and not an "estate" consisting of a collection of various property interests. Further, the court explains that, as a general principle, attorneys owe no duty to non-clients and, thus, counsel for the debtor in possession would not have any fiduciary duty to the beneficiaries of the bankruptcy estate because they are not his/her clients.76 Ultimately, the court in Hansen, Jones & Leta, P.C. v. Segal determines that the provisions of the Code adequately govern the conduct of counsel for the debtor in possession without the need to impose an unclear fiduciary duty to the estate and its beneficiaries on counsel, stating:

Imposing an undefined fiduciary duty to the estate and its beneficiaries on counsel for debtor-in-possession is confusing, unhelpful and unnecessary to insure that counsel is independent and aware of his/her duty under the Bankruptcy Code and Model Rules [of Professional Conduct] to represent and assist the debtor-in-possession in the performance of its duties. In virtually all the cases which rely on counsel’s fiduciary duty to the estate in sanctioning counsel, the same result would be reached by finding a breach of counsel’s fiduciary duty to the client debtor-in-possession, violations of Sections 327, 328, or 329, and/or a failure to provide services which benefit the estate under Section 330.77 

Section 330(a) sets forth a non-exclusive, five-factor test for determining reasonable compensation to be awarded counsel for the debtor, as follows:

In determining the amount of reasonable compensation to be awarded, the court shall consider the nature, the extent, and the value of said services, taking into account all relevant factors, including

a) the time spent on such services;

b) the rates charged for such services;

c) 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 under this title;

d) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance and nature of the problem, issue or task addressed; and

e) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.78 

There is a "strong presumption" that payment of one’s standard hourly rates for actual and necessary services constitutes "reasonable compensation."79 "The 9th Circuit standard for adding a bonus to counsel’s full hourly rate requires powerful evidence and detailed findings."80 In order to overcome the presumption against an enhancement above the standard hourly rates, specific evidence must be provided in two categories. First, the fee applicant must show why the results obtained were not reflected in either the standard hourly rate or the number of hours allowed. Second, the applicant must show that the bonus is necessary to make the award commensurate with compensation for comparable non-bankruptcy services.81 Section 330(a) of the Code was revised in 1994. However, "[t]he controlling factor in Manoa Finance — compensation for comparable nonbankruptcy services — is unchanged in new § 330(a)."82

In Zolfo, Cooper & Co. v. Sunbeam-Oster Co., Inc.,83 the 3rd Circuit recognized that "[t]he baseline rule is for firms to receive their customary rates."84 However, it found that the bankruptcy court had erred in taking the market rate for services in Western Pennsylvania (the location where the debtor’s bankruptcy case was pending) as a starting point for fees for a firm based in New York. The 3rd Circuit held, however, that this error was not material because the bankruptcy court had based its reductions on other appropriate factors, stating:

The idea that a firm should be restricted to the hourly rate typical in the locale of the case is unduly parochial particularly in this age of national and regional law firms working on larger more complex bankruptcy cases of more than local import. … The bankruptcy court here should have looked first to Zolfo, Cooper’s customary market (New York) and then made reductions based on the other factors [duplicated effort, use of too many high-level personnel, sharp rate increases during the course of the case, etc.]. But this error does not require reversal because the bankruptcy court achieved substantially the same result. While the bankruptcy court erroneously started with Western Pennsylvania as its baseline, it properly raised the hourly rates as close to the New York rates as it determined was warranted given its findings regarding Zolfo, Cooper’s improper billing.85 

It is imperative that counsel for a debtor disclose all connections with the debtor, the estate, creditors, and other parties in interest at the inception and throughout the course of his/her employment. If there is any doubt as to whether an initial or supplemental disclosure should be submitted, the doubt should be resolved in favor of submission. Otherwise, counsel for the debtor risks waking up to the nightmare of the denial of compensation for work done, disqualification from continuing representation, and/or disgorgement of fees previously received.

1 Rome v. Braunstein, 19 F.3d 54, 57 (1st Cir. 1994). See also Franke v. Tiffany (In re Lewis), 113 F.3d 1040, 1044-46 (9th Cir. 1997); Neben and Starrett, Inc. v. Chartwell Financial Corp. (In re Park-Helena Corp.), 63 F.3d 877, 880-82 (9th Cir. 1995); Kravit, Gass & Weber v. Michel (In re Crivello), 134 F.3d 831, 835-41 (7th Cir. 1998); Beal Bank, S.S.B. v. Waters Edge Ltd. Partnership, 248 B.R. 668, 694 (D. Mass. 2000). All references in this article to the "Code" are to the Bankruptcy Code, 11 U.S.C. § 101, et seq. This article focuses on representation of debtors in possession. The term "debtor" is used interchangeably in this article with the term debtor in possession.

2 In re Lewis, 113 F.3d at 1045, citing In re Downs, 103 F.3d 472, 479 (6th Cir. 1996), Matter of Prudomme, 43 F.3d 1000, 1003 (5th Cir. 1995), and In re Chapel Gate Apartments, Ltd., 64 B.R. 569, 575 (Bankr. N.D. Tex. 1986).

3 See Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. 434, 447-67 (D. Utah 1998).

4 See 11 U.S.C. § 329; Fed. R. Bankr. P. 2014 & 2016; In re Park-Helena Corp., 63 F.3d at 880. All references in this article to the "Rules" are to the Federal Rules of Bankruptcy Procedure.

5 In re Keller Financial Services of Florida, Inc., 243 B.R. 806, 813 (Bankr. N.D. Fla. 1999).

6 In re Park-Helena Corp., 63 F.3d at 880.

7 In re Keller Financial Services of Florida, Inc., 243 B.R. at 811.

8 Section 327 applies to debtors in possession as well as trustees. See 11 U.S.C. §§ 1101(1) and 1107(a).

9 11 U.S.C. § 327(a) (emphasis added).

10 11 U.S.C. §330(a) (emphasis added).

11 See, e.g., Shapiro Buchman, LLP v. Gore Brothers (In re Monument Auto Detail, Inc.), 226 B.R. 219, 224-25 (Bankr. 9th Cir. 1998) ("[T]he Firm’s failure to obtain court authorization for its employment was fatal to its ability to obtain payment for its chapter 11 services."); In re W. T. Mayfield Sons Trucking Co., Inc., 225 B.R. 818, 824 (Bankr. N.D. Ga. 1998) ("Because Mr. Reuss was not approved as counsel for the Debtor, even if due to inadvertence rather than design, he is not entitled to any compensation from the Debtor for serving as its counsel."); Land West, Inc. v. Coldwell Banker Commercial Group, Inc. (In re Haley), 950 F.2d 588, 590 (9th Cir. 1991) ("Control by the bankruptcy court is necessary to enable the court to contain the estate’s expenses and avoid intervention by unnecessary participants." Otherwise, the person rendering services may be an officious intermeddler or a gratuitous volunteer.).

12 In re Monument Auto Detail, Inc., 226 B.R. at 224. In In re Monument Detail, Inc., the 9th Circuit’s Bankruptcy Appellate Panel held that possession of an attorney’s lien under state law did not obviate counsel’s obligation to satisfy the employment and compensation requirements of the Code and Rules. Id. at 227.

13 See, e.g., In re Milwaukee Boiler Manufacturing Co., 232 B.R. 122, 125-27, where the court stated:

This is not a case of attorneys seeking to do an "end run" around a specific exclusive Code provision. It is also not a case of performing services as officious intermeddlers. Based upon the overriding equities of this case, ... [counsel] is entitled to compensation under § 503(b)(1)(A) as an administrative claim.

14 See Atkins v. Wain, Samuel & Co. (In re Atkins), 69 F.3d 970, 973 (9th Cir. 1995) ("In bankruptcy proceedings, professionals who perform services for a debtor in possession cannot recover fees for services rendered to the estate unless those services have been previously authorized by a court order."). See also In re Milwaukee Engraving Co., Inc., 2000 U.S. App. Lexis 16044 (7th Cir. 2000); In re Keren Ltd. Partnership, 189 F.3d 86, 88 (2nd Cir. 1999); In re F/S Airlease II, Inc., 844 F.2d 99, 108-09 (3rd Cir. 1988).

15 See In re Atkins, 69 F.3d at 973 ("The bankruptcy courts in this circuit possess the equitable power to approve retroactively a professional’s valuable but unauthorized services."); see also In re Jarvis, 53 F.3d 416, 419-22, where the 1st Circuit Court of Appeals stated: [W]e hold that under 11 U.S.C. §327(a) and Fed. R. Bankr. P. 2014(a), a bankruptcy court may, in its discretion, consider an application to approve the employment of a professional even though the professional person’s services have already been rendered. But the court should grant the authorization only if it can be shown that the professional person meets all the requirements of Section 327(a) and that the untimeliness of the application results from extraordinary circumstances. Because the lack of punctuality in this case was attributable entirely to inadvertence, the district court did not err in affirming the bankruptcy court’s denial of the trustee’s post facto application. Mere oversight does not fall within the realm of extraordinary circumstances for these purposes.

Id. at 422. The 9th Circuit has held that "[t]o establish the presence of exceptional circumstances, professionals seeking retroactive approval must satisfy two requirements: they must 1) satisfactorily explain their failure to receive prior judicial approval; and 2) demonstrate that their services benefitted the bankruptcy estate in a significant manner." In re Atkins, 69 F.3d at 974. A non-exclusive checklist of factors that may be considered when evaluating whether the circumstances are extraordinary include the following: 1) whether the applicant or some other person bore responsibility for applying for approval; 2) whether the applicant was under time pressure to begin service without approval; 3) the amount of delay after the applicant learned that initial approval had not been granted; and 4) the extent to which compensation to the applicant would prejudice innocent third parties. See F/S Airlease II, 844 F.2d at 105-06; In re Jarvis, 53 F.3d at 420-21.

16 In re Martin, 817 F.2d 175, 181 (1st Cir. 1987); In re Leslie Fay Companies, Inc., 175 B.R. 525, 532 (Bankr. S.D.N.Y. 1994).

17 11 U.S.C. §§ 101(14)(A) & (E). See also 11 U.S.C. § 101(31) for the Code’s definition of "insider."

18 11 U.S.C. § 101(14)(A). See United Mechants & Manufacturers, Inc. v. Skadden, Arps, Slate, Meagher & Flom, 1999 U.S. App. Lexis 24381 (2nd Cir. 1999) (law firm’s fee award reduced by $225,000 where partner in firm owned stock in debtor client during part of representation); Merrimac Assocs., Inc. v. Daig Corp. (In re Daig Corp.), 799 F.2d 1251 (8th Cir. 1986).

19 11 U.S.C. § 101(14)(A). See U.S. Trustee v. Price Waterhouse, 19 F.3d 138, 141 (3rd Cir. 1994). Proposed counsel must be careful to ensure that it is not a creditor of its debtor client at the time a chapter 11 petition is filed for the client. However, some courts have recognized that application of this requirement to ordinary retainer arrangements may go too far. In reversing a bankruptcy court decision, a Colorado district court held that the security interest possessed by the chapter 11 debtor’s attorneys in their prepetition retainer was a conflict which the Code recognized and generally tolerated as an exception in assessing attorneys’ disinterestedness, and did not disqualify attorneys from being retained as counsel to the debtor, as long as a security interest was fully disclosed and subject to the court’s scrutiny. Weinman, Cohen & Niebrugge v. Peters (In re Print Crafters, Inc.), 233 B.R. 113 (D. Colo. 1999).

20 11 U.S.C. §§ 101(14)(A) & 101(31). See also W.F. Development Corp. v. U.S. Trustee (In re W.F. Development Corp.), 905 F.2d 883 (5th Cir. 1990) ("In a bankruptcy proceeding, limited and general partners do hold materially adverse positions … we … adopt here a clear rule. When one attorney represents both limited and general partners in bankruptcy, there will always be a potential for conflict, and disqualification is proper."). In a recent decision, the 9th Circuit affirmed the decisions of the lower courts in a case where one of the partners of Gibson, Dunn & Crutcher LLP (Gibson, Dunn) had resigned as the debtor’s assistant secretary two weeks before the debtor filed its chapter 11 petition. In that case, Gibson, Dunn, nevertheless, asserted that it was a "disinterested person" under 11 U.S.C. § 101(14). The U.S. trustee objected to the debtor’s application to employ Gibson, Dunn. The bankruptcy court and the Bankruptcy Appellate Panel concluded that the interest of its partner was not attributable to Gibson, Dunn and that, under the circumstances, Gibson, Dunn could serve as the debtor’s counsel. Interestingly, the Bankruptcy Appellate Panel reached this ruling although it did find that the Gibson, Dunn partner was not a disinterested person and, thus, was himself disqualified to act as the debtor’s counsel. Ultimately, Gibson, Dunn was paid fees and expenses pursuant to court approval and, after objecting to all of these fees, the U.S. trustee brought an appeal contending that Gibson, Dunn was not a disinterested person, should never have been employed as the debtor’s counsel, and that all court-approved payments received by Gibson, Dunn had to be disgorged. The 9th Circuit found numerous factors weighing in favor of holding that it would be inequitable to require Gibson, Dunn to disgorge the bankruptcy court’s award of fees and expenses, including that there had been full and timely disclosure, the partner’s lack of any involvement in Gibson, Dunn’s representation of the debtor, that Gibson, Dunn acted properly, and the failure of the UST to seek a stay order. S.S. Retail Stores Corp. v. Ekstrom (In re S.S. Retail Stores Corp.), 2000 Daily Journal D.A.R. 7151, 7151-52 (9th Cir. 2000).

21 In re Crivello, 134 F.3d at 835. See also In re Angelika Films, 57th, Inc., 227 B.R. 29, 38 (Bankr. S.D.N.Y. 1998); Winship v. Cook (In re Cook), 223 B.R. 782, 789 (Bankr. 10th Cir. 1998).

22 In re Angelika Films 57th, Inc., 227 B.R. at 38; In re Cook, 223 B.R. at 789; In re Granite Partners, L.P., 219 B.R. 22, 33 (Bankr. S.D.N.Y. 1998); In re Roberts, 46 B.R. 815 (Bankr. D. Utah 1985), aff’d in part and rev’d in part on other grounds, 75 B.R. 402 (D. Utah 1997 (en banc).

23 In re Angelika Films 57th, Inc., 227 B.R. at 38, citing Rome, 19 F.3d at 58.

24 See In re Leslie Fay Companies, Inc., 175 B.R. at 532. "Congress [in drafting and enacting the Code] sought to disqualify professionals with the appearance of a conflict of interest as well as those who have an actual conflict of interest." Michel v. Federated Department Stores, Inc. (In re Federated Department Stores, Inc.), 44 F.3d 1310, 1319 (6th Cir. 1995).

25 In re Leslie Fay Companies, Inc., 175 B.R. at 532; In re Angelika Films 57th, Inc., 227 B.R. at 39.

26 In re Leslie Fay Companies, Inc., 175 B.R. at 533. In In re Leslie Fay Companies, Inc., the court continued by stating: Rather than worry about the potential/actual dichotomy it is more productive to ask whether a professional has either a meaningful incentive to act contrary to the best interests of the estate and its sundry creditors — an incentive sufficient to place those parties at more than acceptable risk — or the reasonable perception of one. … In other words, if it is plausible that the representation of another interest may cause the debtor’s attorneys to act any differently than they would without that other representation, then they have a conflict and an interest adverse to the estate. 175 B.R. at 533.

27 In re Angelika Films 57th, Inc., 227 B.R. at 39.

28 In re BBQ Resources, Inc., 237 B.R. 639, 642 (Bankr. E.D. Ky. 1999).

29 175 B.R. 525 (Bankr. S.D.N.Y. 1994).

30 40 F.3d 1059 (9th Cir. 1994).

31 227 B.R. 29 (Bankr. S.D.N.Y. 1998), 246 B.R. 176 (S.D.N.Y. 2000).

32 23 F.3d 311 (10th Cir. 1994).

33 In re Perry, 194 B.R. 875, 880 (E.D. Cal. 1996) ("This is because the ultimate party at interest is the creditors of the bankruptcy estate.... [S]ection 327(a) has a strict requirement of disinterestedness and absence of representation of an adverse interest which trumps the rules of professional conduct."). See also In re Amdura, 121 B.R. 862, 866 (Bankr. D. Colo. 1990) ("The activities and multiple representation that may be acceptable in commercial settings, particularly with the informed consent of clients, may not be acceptable in bankruptcy ... when those entities are insolvent and there are concerns about intercompany transfers and the preference of one entity and its creditors at, perhaps, the expense of another.").

3411 U.S.C. § 327(e). See In re Abrass, 200 Bankr. Lexis 737 (Bankr. M.D. Fla. 2000), where an attorney could not be employed as general counsel under § 327(a) because the firm was not disinterested and could not be employed as special counsel § 327(e) because the trustee sought to employ the firm for general representation purposes and the firm had not previously represented the debtor. See also Meespierson, Inc. v. Strategic Telecom, Inc., 202 B.R. 845, 846 (D. Del. 1996) ("The conflict of interest arising from the law firm’s prior representation of a shareholder and creditor of the debtor was not avoided, pursuant to the provisions of § 327(e), where the firm had engaged in no prior representation of the debtor.").

35 11 U.S.C. § 327(c).

36 Nisselson v. Wong (In re Best Craft General Contractor), 239 B.R. 462, 467 (Bankr. E.D.N.Y. 1999).

37 See In re Angelika Films 57th Inc, 227 B.R. at 39; Rome v. Braunstein, 19 F.3d at 59.

38 11 U.S.C. § 328(c).

39 See In re Crivello, 134 F.3d at 837; Gray v. English, 30 F.3d 1319, 1324 (10th Cir. 1994) ("The permissive ‘may deny’ language does not require the court to deny legal fees or disgorge previously paid fees in all cases."); In re Federated Dept. Stores, Inc., 44 F.3d 1310, 1319-20 (6th Cir. 1995).

40 Rome v. Braunstein, 19 F.3d at 58; Gray v. English, 30 F.3d 1319, 1324 (10th Cir. 1994) ("In exercising the discretion granted by [§ 328(c)] we think the court should lean strongly toward denial of fees, and if the past benefit to the wrongdoer fiduciary can be quantified, to require disgorgement of compensation previously paid that fiduciary even before the conflict arose."); Electro-Wire Products, Inc. v. Sirote & Permutt, P.C. (In re Prince), 40 F.3d 356 (11th Cir. 1994) ("The court held that denial of request for attorney’s fees and disgorgement of fees previously received was required in connection with law firm’s representation of chapter 11 debtor where conflicts of interest resulted from law firm’s prior representation of debtor and nondebtor’s spouse in estate planning matters, prior representation of debtor’s corporation, and postpetition representation of debtor’s spouse in suit brought against.").

41 Fed. R. Bankr. P. 2014(a).

42 In re Crivello, 134 F.3d at 836. See also Rome v. Braunstein, 19 F.3d 54, 59 (1st Cir. 1994) ("Absent the spontaneous, timely and complete disclosure required by section 327(a) and Fed. R. Bankr. P. 2014(a), court-appointed counsel proceed at their own risk.").

43 In re Crivello, 134 F.3d at 839, citing Rome, 19 F.3d at 59.

44 In re Leslie Fay Companies, Inc., 175 B.R. at 533.

45 U.S. v. Gellene, 182 F.3d 578, 588 (7th Cir. 1999). This case involved the penultimate non-disclosure nightmare for an attorney. In this case, attorney John Gellene, failed to disclose various conflicts of interest in connection with his firm’s representation of a chapter 11 debtor in possession, ultimately faced federal criminal charges (two counts of bankruptcy fraud and one count of perjury), and was convicted by a jury on all three counts. At his trial, Mr. Gellene testified, as the only defense witness, that his failure to disclose conflicts had been the result of "bad judgment" and was "stupid, but not criminal." The jury disagreed. U.S. v. Gellene, 182 F.3d at 584-85.

46 In re Leslie Fay Companies, Inc., 175 B.R. at 533 ("Consistent with the duty placed on the professional, it is the responsibility of the professional, not of the court, to make sure that all relevant connections have been brought to the light."). See also U.S. v. Gellene, 182 F.3d 578 (the disclosure requirements are not discretionary and professionals cannot pick and choose which connections are irrelevant or trivial).

47 In re Leslie Fay Companies, Inc., 175 B.R. at 533. See also In re Roger J. Au & Son, Inc., 71 B.R. 238, 242 (Bankr. N.D. Ohio 1986) (failure to disclose facts material to potential conflict may provide totally independent ground for denial of fees, quite apart from the actual representation of competing interests).

48 In re Crivello, 134 F.3d at 841.

49 See U.S. v. Gellene, 182 F.3d at 581-85.

50 19 F.3d 54 (1st Cir. 1994).

51 175 B.R. 525 (Bankr. S.D.N.Y. 1994).

52 Id. at 536 ("[W]here counsel is being retained to conduct an investigation into the actions of, among others, senior management and members of the board of directors, most assuredly connections with entities affiliated with board members that could cause pressure on investigating counsel must be disclosed.").

53 Specifically, the court stated: The boilerplate language to the effect that Weil Gotshal may have in the past represented, currently represents, and may in the future represent entities which are claimants of the debtors was insufficient to alert the court to Weil Gotshal’s representation of a creditor which was high on the list of the debtors’ twenty largest creditors (from which a creditor’s committee is normally selected). The boilerplate is reasonable to cover inadvertent failures to disclose insignificant connections; it is not an adequate substitute for disclosure of representation of known and significant creditors. To rule any other way would be to eviscerate the disclosure requirements of Rule 2014(a). In re Leslie Fay Companies, Inc., 175 B.R. at 537.

54 In re Leslie Fay Companies, Inc., 175 B.R. at 539.

55 11 U.S.C. § 329(a); Fed. R. Bankr. P. 2016(b).

56 In re Keller Financial Services of Florida, Inc., 248 B.R. 859, 877 (Bankr. N.D. Fla. 2000). See also 11 U.S.C. § 329 and Fed. R. Bankr. P. 2017.

57 Law Offices of Ivan Halperin v. Occidental Financial Group, Inc. (In re Occidental Financial Group, Inc.), 40 F.3d 1059, 1063 (9th Cir. 1994) ("Halperin’s [counsel’s] undisclosed conflict of interest and failure to disclose his representation of the Deckers [the principals of the debtor] deprived him of any equitable claim to a retention of the fees for prepetition services.").

58 In re Park-Helena Corp., 63 F.3d at 881 (A fee applicant must accurately disclose the source of its prepetition retainer. In this case, counsel failed to reveal that the funds came from the president of the debtor in possession, rather than the debtor in possession itself.).

59 In re Lewis, 113 F.3d at 1045 (In this case, counsel acted with "complete disregard" for the procedures and requirements of the Rules and the Code and made misrepresentations to the court.).

60 63 F.3d 877 (9th Cir. 1995).

61 In this regard, the 9th Circuit stated: Neben & Starrett’s failure to describe the transaction and indicate that Meyer paid the retainer out of his personal account constituted a violation of 11 U.S.C. § 329 and Fed. R. Bankr. P. 2016. Our holding does not impose any new or additional investigatory burdens on firms that represent a debtor. A law firm must at least disclose the facts of the transaction, as those facts were known to the firm. This Neben & Starrett failed to do. Because Neben & Starrett did not disclose known facts, we need not decide in this case whether the obligation should be even broader than that. In re Park-Helena Corp., 63 F.3d at 881.

62 Id. at 882.

63 113 F.3d 1040 (9th Cir. 1997).

64 Id. at 1045 ("Not only did Franke fail to supplement its Rule 2016(b) statements, but Franke included a false statement in its application for employment.").

65 In re Interwest Business Equipment, Inc., 23 F.3d at 318.

66 Id.

67 In re Lewis, 113 F.3d at 1046; In re Walters, 868 F.2d 665, 668 (4th Cir. 1989).

68 11 U.S.C. § 329(b).

69 In re Angelika Films 57th, Inc., 227 B.R. at 39.

70 Rome v. Braunstein, 19 F.3d at 58; In re Leslie Fay Companies, Inc., 175 B.R. at 532.

71 Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. 434, 449 (D. Utah 1998).

72 Id. (The question "is the beginning and end of a tautology which ultimately determines the nature and scope of the duty owed, and whether the duty has been breached.").

73 Id. at 449-50.

74 Beal Bank v. Waters Edge Ltd. Partnership, 248 B.R. 668, 694 (D. Mass. 2000), citing Rome, 19 F.3d at 57.

75 220 B.R. 434 (D. Utah 1998).

76 220 B.R. at 457.

77 Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. at 461.

78 11 U.S.C. § 330(a)(3).

79 Burgess v. Klenske (In re Manoa Finance Co.), 853 F.2d 687, 692 (9th Cir. 1988); Meronk v. Arter & Hadden, LLP (In re Meronk), 2000 Daily Journal D.A.R. 5969 (Bankr. 9th Cir. 2000).

80 In re Meronk, 2000 Daily Journal D.A.R. at 5971, citing Manoa Finance, 853 F.2d at 692. In Manoa Finance, the 9th Circuit stated: A compensation award based on a reasonable hourly rate multiplied by the number of hours actually and reasonably expended is presumptively a reasonable fee … [T]he following … factors are now considered subsumed within the lodestar and cannot serve as independent bases for an upward adjustment: (1) the novelty and complexity of the issues, (2) the special skill and experience of counsel, (3) the quality of representation, and (4) the results obtained … Because these factors ordinarily are accounted for in either the hourly rate or the number of hours expended, they can support an upward adjustment only when it is shown by specific evidence that they are not fully reflected in the lodestar. In re Manoa Finance Co., Inc., 853 F.2d at 691. See also Cedic Development Co. v. Warnicke (In re Cedic Development Co.), 2000 U.S. App. Lexis 17978 (9th Cir. 2000) ("We have recognized that the general principles applicable to fee-shifting statutes ‘may require some accommodation to the peculiarities of bankruptcy.’... [citing Manoa Finance] Moreover, the district court’s premise that the hourly rate set by the firm would indicate the lodestar amount was incorrect. The rates were bargain rates not incorporating the Kerr factors. Not to allow the $10,000 enhancement would be to pay below the lodestar.").

81 In re Manoa Finance Co., 853 F.2d at 692. In In re County of Orange, a municipal debt adjustment case pending under chapter 9 of the Code, counsel for the debtor requested a fee enhancement of approximately $49,000,000 above its "benchmark" hourly billing rates. However, this case was not governed by § 330 of the Code since that provision does not apply in a chapter 9 case. See 11 U.S.C. §§ 103 and 901. Moreover, the enhancement request was based upon the contract between counsel and its client which provided that the final fee would be determined by "benchmark" hourly rates, with possible adjustment down or up at the end of the representation based on results accomplished and other listed criteria. In that case, the court concluded that construing the contract against the attorneys as it was obliged to do, "the appropriate interpretation of the parties’ contract is an upward adjustment of the "benchmark" hourly rate fees … [by] an additional $3 million. …" 241 B.R. at 224 (Bankr. C.D. Ca. 1999).

82 In re Meronk, 2000 Daily Journal D.A.R. at 5971. In In re Meronk, the 9th Circuit’s Bankruptcy Appellate Panel denied counsel’s request for a bonus, stating: This … is a tale of a law firm that refused to be employed on a contingent fee and crowed about the economic efficiency of results it achieved on an hourly basis, only to turn around and request a bonus that eclipsed the difference between the hourly fees and the contingent fee it had rejected.

We conclude that the law firm did not prove that it shortchanged itself by charging its standard hourly fees. We further conclude that it was judicially estopped from seeking a bonus. 2000 Daily Journal D.A.R. at 5969.

83 50 F.3d 253 (3rd Cir. 1995).

84 Id. at 259.

85 Zolfo, Cooper & Co. v. Sunbeam-Oster Co., Inc., 50 F.3d at 260 (quotation marks, citation, and footnote omitted).

Back to table of contents >>