Rule 2014 of the Federal Rules of Bankruptcy Procedure provides that an order approving the employment of professionals pursuant to §327, §1103 or §1114 of the Bankruptcy Code shall be made only on application of the trustee or committee. See Fed. R. Bankr. P. 2014. Most bankruptcy courts have held that court approval of the retention of a professional must generally be made before the professional has been employed, but that the bankruptcy courts have general equitable powers to consider applications after the professional has been employed. See In re Jarvis, 53 F.3d 416 (1st Cir. 1995); Matter of Arkansas Co. Inc., 798 F.2d. 645 (3rd Cir. 1986); Fanelli v. Hensley (In re Triangle Chemicals Inc.), 697 F.2d 1280 (5th Cir. 1983); and Okamoto v. THC Financial Corp. (In re THC Financial Corp.), 837 F.2d 389 (9th Cir. 1988). Other courts have recognized a "per se" rule against retroactive approval of a professional's employment. See Futuronics Corp. v. Arutt, Nachamie & Benjamin (Matter of Futuronics Corp.), 655 F.2d 463 (2nd Cir. 1981), cert. denied, 455 U.S. 941, 102 S. Ct. 1435, 71 L.Ed. 2d 653 (1982), and Lavender v. Wood Law Firm, 785 F.2d 247 (8th Cir. 1986).

Although the two views expressed by the courts seem directly opposed to one another, in practice they are not. Even the jurisdictions applying the "per se" rule have held that applications may be approved retroactively in "limited" circumstances. See In re Bennett Funding Group Inc., 213 B.R. 234, 242 (Bankr. N.D.N.Y. 1997) and Lavender v. Wood Law Firm, 785 F.2d at 248-249. Rather, the real split in authority seems to be over what standards or factors apply to determine whether the circumstances warrant retroactive approval. This month's article addresses the various standards that have been applied by the courts.

The Extraordinary Circumstances Test

The test employed by most jurisdictions recognizes that retroactive approval should be limited to cases where extraordinary circumstances are present. These courts state that only delay caused by circumstances beyond the professional's control are excusable, and that a more lenient approach would reward laxity by counsel and might encourage circumvention of the statutory requirement. See In re Arkansas Co. Inc., 798 F.2d at 650.

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The decisions vary greatly among individual courts, sometimes even within the same circuit...

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Although several "extraordinary circumstances tests" exist, the majority of bankruptcy courts seem to recognize the extraordinary circumstances test that was set out in the Third Circuit decision of In re Arkansas Co. Inc., 798 F.2d at 645. According to the In re Arkansas Co. case, nunc pro tunc or retroactive approval is limited to cases where the statutory requirements of 11 U.S.C. §§327(a) and 1103(a) are met and where "extraordinary circumstances" are present. Id. at 648. The factors to be considered to determine if circumstances are extraordinary include whether the applicant or some other person bore responsibility for applying for approval, whether the applicant was under time pressure to begin service without approval, the amount of delay after the applicant learned that initial approval had not been granted, and the extent to which compensating the applicant will prejudice innocent third parties. Id. at 650. Extraordinary circumstances under this test do not include inadvertence or neglect. Id.

The Arkansas extraordinary circumstances test has been expanded by the Third Circuit in F/S Airlease II Inc. v. Simon, 844 F.2d. 99 (3rd Cir. 1988) (holding further that the time pressure factor relates solely to whether there was sufficient time to request court approval before the professional's services began and that whether the services performed were beneficial to the estate is irrelevant) and has been followed by other jurisdictions including the First Circuit (See In re Jarvis, 53 F.3d 416 (1st Cir. 1995) and In re Albert, 206 B.R. 636 (Bankr. D. Mass. 1997)), the Fifth Circuit (See Matter of Little Greek Restaurant Inc., 205 B.R. 484 (Bankr. E.D. La. 1996) and In re Diesel Power International Inc., 205 B.R. 66 (Bankr. E.D. La. 1996)), the Sixth Circuit (See In re EWI Inc., 208 B.R. 885 (Bankr. N.D. Ohio 1997), and In re Crescent Mfg. Co., 122 B.R. 979 (Bankr. N.D. Ohio 1990)), and the Tenth Circuit (See Land v. First National Bank of Alamosa (In re Land), 943 F.2d 1265 (10th Cir. 1991)).

Other courts have enumerated extraordinary circumstances factors based upon the 1983 decision in In re Twinton Properties Partnership, 27 B.R. 817 (Bankr. M.D. Tenn. 1983), in which the court held that an applicant for nunc pro tunc employment of a professional must demonstrate the following:

(1) that the debtor expressly contracted for the services rendered,

(2) that the party for whom the work was performed approves the entry of the nunc pro tunc order,

(3) that the applicant provided notice and the opportunity for the filing of objections,

(4) that no creditor offered a reasonable objection,

(5) that the professional satisfied all criteria for employment at or before the time services were commenced and remained qualified during the time services were provided,

(6) that the work was performed properly, efficiently, and to a high standard of quality,

(7) that no actual or potential prejudice will inure to the estate or other parties in interest,

(8) that the applicant's failure to seek pre-employment approval is satisfactorily explained, and

(9) that the applicant exhibits no pattern of inattention or negligence.

Id. at 819-820.

Some bankruptcy courts have relied on the Twinton factors or variations thereof to determine whether extraordinary circumstances exist to grant retroactive approval of employment. See In re McDaniels, 86 B.R. 128 (Bankr. S.D. Ohio 1988) and In re TJN Inc., 194 B.R. 396 (Bankr. D.S.C. 1996). The Ninth Circuit has considered the Twinton factors to be instructive in the determination of whether a nunc pro tunc application may be granted. See Atkins v. Wain, Samuel & Co. (In re Atkins), 69 F.3d 970, 974-976. In Atkins, the Ninth Circuit Court of Appeals held that the Twinton factors are permissive, not mandatory, and that two of the factors, the satisfactory explanation for the failure to receive prior judicial approval and the showing of a benefit to the bankruptcy estate, are more important than the others. Id. at 975-976. The court concluded that these two factors must be established to show "exceptional circumstances" as well as to satisfy employment criteria under §327 before an application will be retroactively granted. The other Twinton factors may be, but need not be, considered by the court in exercising its discretion. Id. at 976.

The Excusable Neglect Standard

Unlike the majority of jurisdictions, the Seventh Circuit and other courts have chosen not to adopt the extraordinary circumstances test in determining whether the retroactive approval of an employment application should be granted. See Matter of Singson, 41 F.3d 316 (7th Cir. 1994) and Matter of Concrete Products Inc., 208 B.R. 1000 (Bankr. S.D. Ga. 1996). Instead, these courts have adopted a more lenient excusable neglect standard.

In Singson, the Seventh Circuit Court of Appeals explained its divergence from the extraordinary circumstances test as follows:

Because bankruptcy is a mass-production operation, errors and oversights are inevitable. This counsels against adopting a powerful presumption against belated authorization. An "extraordinary situation" rule would encourage law firms and trustees to devote additional time to punctilious compliance with forms—time for which they would be entitled to compensation. If oversight led to the denial of compensation for significant work, law firms would increase their standard hourly fees, an ex ante response to the risk of orders denying compensation ex post. Debtors and creditors in the run of cases then would pay indirectly for the time that became unbillable because of record-keeping errors.

Id. at 319.

The Seventh Circuit then held that, based upon Fed. R. Bankr. P. 9006(b)(1) and the Supreme Court's decision in Pioneer Investment Services Co. v. Brunswick Associates Limited Partnership, __U.S.__, 113 S. Ct. 1489, 123 L.Ed. 2d 74(1993), it is possible to show "excusable neglect" without identifying any "extraordinary circumstances." Id. at 319.

In Concrete Products Inc. the bankruptcy court, unlike the Seventh Circuit, outlined the factors to determine whether "excusable neglect" under Pioneer and 9006(b) exists, holding that a court must consider all of the circumstances surrounding the parties' omission or negligence, including:

the danger of prejudice to the debtor, the length of the delay and the potential impact on judicial proceedings, the reason for the delay, including whether it was within the reasonable control of the movant, and whether the movant acted in good faith.

Matter of Concrete Products Inc., 208 B.R. at 1008.

The "Per Se" Rule

As stated above, the Second Circuit and the Eighth Circuit courts recognize a "per se" rule against the retroactive approval of a professional's employment. In fact, courts in these jurisdictions have denied compensation to professionals on this basis. See In re Futuronics Corp., 655 F.2d 463 (2nd Cir. 1981) and Albers v. Dickinson, 127 F.2d 957 (8th Cir. 1942). More recent decisions, however, have recognized that there are limited exceptions to the "per se" rule and have applied tests similar to the other tests discussed above. See Matter of Interco Inc., 135 B.R. 363 (Bankr. E.D. Mo. 1991) (applying Arkansas extraordinary circumstances test) and Coan v. Hutter (In re Hutter), 215 B.R. 308 (Bankr. D. Conn. 1997) (applying excusable neglect test). Thus, although these jurisdictions have a different standard in theory, in practice the outcome is very similar to the outcomes in other jurisdictions which recognize the court's discretion in approving an employment application retroactively.

Conclusion

At first glance, it would seem that the outcomes of cases in "per se" jurisdictions and in "non-per se" jurisdictions would vary greatly. In practice, however, the outcomes, with some exceptions, are actually very similar. The primary difference instead is between courts that apply varying extraordinary circumstances standards, and those that apply a more lenient excusable neglect standard. The decisions vary greatly among individual courts, sometimes even within the same circuit, so that unfortunately, it is not readily ascertainable what test a particular court will apply.