Protecting Professional Fees from Disgorgement Obtaining Carve-Outs from Secured Creditors to Safeguard Against Uncertainties Part II
Protection of Carve-Outs under §364(e)
While §364(e) was not considered in U.S. Flow, some courts have found that this Code section may also protect carve-outs from disgorgement. In In re Cooper Commons, the Ninth Circuit dismissed a challenge to the payment of the trustee and his professionals under a post-petition financing agreement. Weinstein, Eisen & Weiss v. Gill (In re Cooper Commons), 430 F.3d 1215 (9th Cir. 2005).
In this case, a law firm that had served as general counsel to the debtor objected to approval of the proposed post-petition financing agreement because, while the agreement set aside funds for payment of the trustee and his professionals, it failed to set aside funds for the law firm. The court rejected the law firm's argument that the proposed agreement granted the trustee a superpriority treatment over the law firm contrary to 11 U.S.C. §507(a)(1), which places the professionals on equal priority. The court ruled that because the agreement was a post-bankruptcy extension of credit, 11 U.S.C. §364(e) broadly protects the agreement and funds advanced in "good faith" thereunder.
Thus, if the retention agreement is deemed to constitute a post-petition extension of credit under §364, not only will the agreement to advance funds to pay the carve-out be protected, but the funds paid to professionals will similarly not be subject to disgorgement and redistribution.
Some jurisdictions have found that pre-petition security retainers do not have to be returned or are not subject to disgorgement when an estate is rendered administratively insolvent. This line of authority is based on a determination that the professional has a security interest in the retainer for future services based on its possession of the funds. See Bowles, supra; see also In re Printcrafters Inc., 233 B.R. 113, 120 (D. Colo. 1999) (finding that, pursuant to Colorado law, law firm had a possessory lien in retainer that had been paid pre-petition and was entitled to immediate payment from retainer without having to wait to see if sufficient funds existed to pay other administrative claims); In re Pannebaker Custom Cabinet Corp., 198 B.R. 453 (Bankr. M.D. Pa. 1996) (holding that pre-petition security retainer debtor paid to its attorneys prior to filing for chapter 11 relief was not subject to disgorgement simply for purpose of obtaining parity among administrative claimants where funds on hand were not sufficient to permit full payment of administrative claims, absent any evidence as to excessive or unreasonable nature of retainer); In re North Bay Tractor Inc., 191 B.R. 186 (Bankr. N.D. Cal. 1996) (stating that a rule requiring attorneys to disgorge their retainers so that other claimants of equal priority receive equal dividends would undermine the purpose of retainers and chill the willingness of many professionals to undertake representation of chapter 11 debtors); In re Cottrell International, 2000 WL 1180282 at *4 (Bankr. D. Col.) (ruling that the Printcrafters decision equally applies to pre- and post-petition retainers); In re Printing Dimensions Inc., 153 B.R. 715 (Bankr. D. Md. 1993) (finding that debtor's counsel was not required to share pre-petition retainer pro rata with other administrative claimants if either retainer is treated as security or retainer is held in trust). A "security retainer" secures payment for future services of the attorney and the attorney is said to have a security interest in the payment. In re Renfrew Center of Florida Inc., 195 B.R. 335, 338 (Bankr. E.D. Pa. 1996).
Some courts have even gone further and distinguished between pre-petition retainers and administrative expense claims, stating that a pre-petition retainer is entitled to superpriority treatment. See, e.g., In re Hohenberg, 191 B.R. 694, 701 (Bankr. W.D. Tenn. 1996) (distinguishing pre-petition retainer from administrative expense claim). Unlike these cases, however, most courts have not distinguished between administrative versus superpriority treatment. See, e.g., Bowles, supra, and cases cited therein.
At the same time, courts have, depending on the nature of the retainer, required disgorgement of the unused portion of pre-petition retainers. See, e.g., In re Prudoff, 196 B.R. 64, 66-67 (Bankr. E.D. Va. 1995) (requiring disgorgement of unused portion of retainer based on state law that gave debtor equitable interest in any unused portion of a retainer).
It is unclear whether, or how, the Specker decision affects this area of law. First, that decision did not discuss whether the attorney acquired a security interest in the retainer as the Ninth Circuit Bankruptcy Appellate Panel (BAP) acknowledged in In re Cepek in distinguishing Specker. Rus, Miliband & Smith v. Yoo (In re Cepek), 2006 WL 851188 (9th Cir. BAP) (holding that a professional with a valid pre-petition security retainer that has been properly documented, disclosed and approved by the bankruptcy court cannot be required to surrender it in the interest of equal treatment under §726(b)). Presumably, having found that the retainer was granted post-petition and without authority for the granting of a security interest post-petition, the Sixth Circuit would have ruled that no such security interest was granted or arose. On the other hand, it is not clear how the Sixth Circuit would have ruled if it found, like Judge Gregg, that the retainer had been given pre-petition. As previously noted, the Sixth Circuit did not address the significance, if any, between receipt of a pre-petition and a post-petition retainer. Therefore, while Specker appears to apply only to cases in which post-petition retainers are at issue, it is unclear whether the Sixth Circuit would apply the same reasoning in the case of a pre-petition retainer.
Ultimately, how a court deals with the issue of whether a security interest is created by virtue of the payment of a pre-petition retainer will largely depend on the particular state law involved. Law in this area differs significantly from state to state. Moreover, the language of the specific retainer agreement at issue may also influence how the retainer is treated and how it is applied. Therefore, at the onset of a matter, practitioners must ensure that their jurisdiction recognizes a security interest in a pre-petition retainer before relying upon it for payment and a security interest.
An attorney-charging lien is an equitable interest in money or property awarded or recovered through the attorney's services. Property interests are determined by state law, and therefore, the nature and extent of attorney liens vary from state to state. Whether the retainer constitutes property of the estate, and under what circumstances the retainer can be "protected" from the claims of other creditors and/or a trustee, will depend on state law. For example, under Georgia law, the automatic stay did not allow a post-petition attorney lien for post-petition services. In re Chewning & Frey Security Inc., 328 B.R. 899 (Bankr. N.D. Ga. 2005). However, another state's law may allow a lien perfected post-petition to relate back to a pre-petition date and cause the property subject to the lien to be considered separate from property of the estate. Id. Furthermore, it is unclear whether an attorney lien attaches merely to the file or also to the funds held by the attorney. Thus, the result may likewise vary from state to state. Therefore, practitioners must be cognizant of the law of their jurisdiction and the possibility and/or implications of obtaining a charging lien prior to undertaking the representation or taking a retainer.
Are Fees Awarded in a Confirmed Chapter 11 Case Subject to Attack in Subsequently Filed Case?
Generally, once the final order granting allowance and payment of professional fees is entered and funds are distributed in payment of such fees under a confirmed chapter 11 plan that has become effective and substantially consummated, most professionals believe that the fees they received are inviolate and beyond attack. However, a motion recently filed in a Massachusetts bankruptcy case may now give rise to second thoughts before professionals breathe a sigh of relief.
In In re High Voltage Engineering Corp., Case No. 05-10787 (Bankr. D. Mass. 2005), the chapter 11 trustee appointed in a subsequent case filed by the debtor filed a motion asking the court to reconsider the administrative expense claims of professionals that had been paid in the debtor's prior chapter 11 bankruptcy case as part of a confirmed plan. A short time after the plan was confirmed and professionals had been paid, the debtor found that it was in need of additional bankruptcy relief. In lieu of seeking to reopen the prior chapter 11 or to modify the plan post-confirmation,2 the debtor filed a new chapter 11 case and a trustee was appointed.
Rather than seeking to reopen the prior chapter 11 case in order to set aside and challenge the fee awards, the trustee filed a motion in the debtor's second chapter 11 case. The trustee alleged that the professionals may have been aware that the debtor's plan was not feasible at the time of confirmation and, therefore, they may not be entitled to their fees. The trustee thus sought reconsideration of the order(s) allowing the professionals' claim(s) for payment in the prior bankruptcy pursuant to 11 U.S.C.§502(j) and Federal Rule of Civil Procedure 60(b), made applicable in bankruptcy proceedings by Rule 3008 of the Federal Rules of Bankruptcy Procedure. The motion is currently stayed, as the trustee has twice assented to a motion to stay proceedings while he further investigates the claims.
The filing of such a motion presents significant issues for professionals. First, should professional fees be subject to attack after confirmation of a plan of a solvent estate? If the High Voltage court believes that they should, professionals can never be assured that payment of their fees is final. Second, once fees are approved pursuant to a confirmed plan that has been substantially consummated, should a trustee or other interested party be able to challenge those professional fees in the subsequent bankruptcy case (assuming they are not subject to avoidance under another applicable provision of the Bankruptcy Code or otherwise procured by fraud)? While from a procedural perspective it may be appropriate for such fees to be challenged by reopening the prior bankruptcy case, it remains to be seen how the court will deal with this issue in High Voltage. On the other hand, to allow such a process to go forth in the absence of fraud or an avoidance action essentially makes the professional a guarantor of the success of a confirmed plan, or risk potential disgorgement of its fees and expenses incurred and approved in the case.
The book is certainly not closed on the sanctity of previously awarded attorneys' (and other professionals') fees. When a case becomes administratively insolvent, unpaid post-petition creditors—be they trade creditors, landlords or other professionals—may very well look to a previously paid professional to share some of the wealth, as well as the pain. Only time, and the specific facts of the case, may tell how successful their efforts will be.
1 The authors wish to give special thanks to Richard M. Meth, Pitney Hardin, LLP, for his review and editorial comments of this article.
2 It is unclear whether the plan had been substantially consummated by the time the new case was filed or whether the debtor would have had the right to seek to modify the plan post-confirmation under §1127 of the Bankruptcy Code.