Benchnotes Dec/Jan 1999

Benchnotes Dec/Jan 1999

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Fee Application Reduced

In In re Northeast Express Regional Airlines Inc., 235 B.R. 695 (Bankr. D. Me. 1999), Bankruptcy Judge James A. Goodman addressed the final fee application of counsel employed by a chapter 7 trustee to pursue certain claims against a third-party airline. An adversary proceeding had settled for a net recovery to the estate of $650,000, a waiver by the defendant of a $1.2 million claim for administrative expenses and a waiver of a $2 million unsecured claim. Noticing that the waiver of the unsecured claim was essentially a waiver of a worthless claim and that the waiver of the administrative claim only benefited administrative claimants such as the law firm seeking the payment, the court found that the fee application sought a recovery of $15,000 more than the net recovery from the adversary proceeding. While counsel are not required to guarantee success, the court said, "They must still exercise reasonable judgment in the positions they take." The court reached the conclusion that it was unreasonable to spend almost 4,000 hours on the litigation, particularly after the defendant filed a "suggestion of fraud" that, if true, would have hampered the trustee's case because of the lack of requisite "clean" hands. The court also noted that some months earlier it had granted a motion for summary judgment that severely eroded the foundation on which the trustee's "monumental" claims were founded. The applicant asserted that the decision in In re National Gypsum Co., 123 F.3d 861 (5th Cir. 1997), was pertinent to the application. Judge Goodman disagreed, stating that all applications and pleadings filed with the court specifically noted that all fees were subject to court approval. Thus, having considered all of the elements of the lodestar factors, the court approved fees through mediation as well as those incurred in connection with the settlement, and disallowed all other fees. The court also noted that the cumulative effect of this ruling was that the applicant received more than 70 percent of the net recovery from the litigation.

Special Counsel Disgorgement Fees

In In re Chute, 235 B.R. 700 (Bankr. D. Mass. 1999), the chapter 7 trustee had a case that became administratively insolvent and sought to compel disgorgement fees that had been paid to special counsel retained to prosecute a legal malpractice claim on behalf of the estate. Counsel had been engaged on a contingency-fee basis, successfully brought $12,500 into the estate and received a payment of $4,409.67. The trustee also had employed a second set of counsel to pursue a personal injury action on a contingency-fee basis. However, this suit was unsuccessful. In fact, significant discovery and experts' expenses totaled $29,160.20, and the defendants had an administrative expense claim in the amount of $4,254.98 for total allowed administrative expense claims exceeding $36,000. However, the estate had less than $8,000, the net recovery from the legal malpractice action pursued by the first counsel. The court agreed that it was within its power to order disgorgement in order to achieve pro rata distribution to administrative claimants in administratively insolvent cases, but circumstances did not warrant such disgorgement. The court noted that perhaps the trustee was "improvident" when it sought and obtained approval of fees and expenses immediately following resolution of the first litigation, further noting that a potential disgorgement might have a chilling effect on a chapter 7 trustee's ability in the future to retain special counsel to prosecute claims on behalf of the estate.

Constructive Trusts

In In re U.S. Lan Systems Corp., 235 B.R. 847 (Bankr. E.D. Va. 1999), Bankruptcy Judge Stephen S. Mitchell addressed a claim by former employees asserting that amounts withheld from their salary that should have been (but were not) paid into a 401(k) plan created an express statutory trust pursuant to 29 U.S.C. §§1104 and 1106. Relying on In re College Bound, 172 B.R. 399 (Bankr. S.D. Fla. 1994), the court held that the funds held in the debtor's operating account on the filing date were held in trust for the benefit of the employees to the extent of the plan contributions withheld from the employees' salaries. The court then went on to address the issue where, during the bankruptcy case, the debtor's operating account had become completely depleted. The debtor had subsequently sold all of its assets and the cash proceeds of the sale were being held in escrow subject to various liens and claims that, if allowed, would entirely consume the proceeds of the sale. The former employees argued that a constructive trust should be imposed upon the escrowed funds. The court noted that in a normal situation, in order to impose a constructive trust, the funds must be "distinctly traced" into the fund or the property that is to remain the subject of the trust. While troubled with the imposition of a constructive trust on assets of the debtor other than traceable proceeds, the court nonetheless followed In re Cardian Mortgage Corp., 122 B.R. 255 (Bankr. E.D. Va. 1990), and held that the necessity for tracing ends when the bankruptcy petition is filed‹provided, however, that the constructive trust could not attach to encumbered assets.

In re Leitner, 236 B.R. 420 (Bankr. D. Kan. 1999), also involved the imposition of a constructive trust. In this case, there was a pre-petition, pre-judgment attachment entered by the state court less than 90 days prior to the commencement of the debtor's chapter 7 case. Post-petition, the stay was lifted to allow the state court action to proceed. The state court entered a final judgment imposing a constructive trust against a home that the debtor/ex-employee had purchased with funds he had embezzled from his employer. The chapter 7 trustee unsuccessfully sought to avoid the constructive trust. Bankruptcy Judge John T. Flannagan held that the fact that the pre-judgment attachment was entered less than 90 days prior to the bankruptcy did not create an avoidable transfer or permit use of strong-arm powers to bring the property back into the estate since the debtor had no equitable interest in the home as a result of the constructive trust. While the trust was formally imposed by the state court post-petition, it arose on the date of the debtor's "bad act." Therefore, it was not an asset of the estate as of the date of the filing of the bankruptcy.

Patent License Assignment

In In re Access Beyond Technologies Inc., 237 B.R. 32 (Bankr. D. Del. 1999), Bankruptcy Judge Mary F. Walrath held that a chapter 11 trustee has the standing to seek court approval of the debtor's assumption and assignment of a patent license agreement, and that the patent owner has standing to object to such assignment. In the case before the court, the patent license was silent on the question of assignability, and thus, under federal law, the court held that the license was non-transferable because applicable non-bankruptcy law‹federal patent law‹would bar the chapter 11 debtor/licensee's assignment of the rights and patent license to a third-party over the patent owner's objection. In reaching this conclusion, the court rejected the "actual test" approach, which reasons that where the contract is "merely being assumed by the debtor," the policy behind the non-bankruptcy law that prohibits assignment is still upheld. The court noted that the majority of the circuit courts that have addressed this issue have concluded that the plain language of §365(c)(1) requires the application of a hypothetical test that provides that a debtor-in-possession (DIP) may not assume an executory contract over the non-debtor's objection if applicable law would bar assignment to a hypothetical third-party, even where the DIP has no intention of assigning the contract in question to any such third party, citing In re Catapult Entertainment Inc., 165 F.3d 747, 750 (9th Cir. 1999); In re James Cable Partners L.P., 27 F.2d 534, 537, reh'g denied, 38 F.3d 575 (11th Cir. 1994); In re West Electronics Inc., 852 F.2d 79 (3rd Cir. 1998); In re Pioneer Ford Sales Inc., 729 F.2d 27 (1st Cir. 1984); and In re Braniff Airways Inc., 700 F.2d 935, 943 (5th Cir. 1983).

Post-petition Patent Infringement

In In re Telegroup Inc., 237 B.R. 87 (Bankr. D. N.J. 1999), Bankruptcy Judge William F. Tuohey addressed the ability to pursue an action against a DIP, irrespective of the automatic stay, pursuant to 28 U.S.C. §957(a), which generally provides that trustees, "including debtors-in-possession, may be sued, without leave of the court appointing them, with respect to any other acts or transactions in carrying on business connected with such property" in the context of an alleged post-petition patent infringement action by the debtor. The court held that to the extent a party is merely seeking to liquidate a post-petition claim for damages arising out of the debtor's alleged patent infringement, and where a proof of interest for an administrative claim arising out of such patent infringement has been filed, the court may exercise its discretion to prohibit litigation from going forward to liquidate such claim.


Journal Date: 
Wednesday, December 1, 1999