Blistering Opinion from Local Judge re Chapter 11 Attorney’s Duties and Performance

I have taken out the names of the parties but this is a well known and well regarded bankruptcy boutique law firm.  This is the Judge’s Tentative Ruling.

Tentative Ruling:

This is the first and final application for allowance of fees and costs of [the Firm], debtor’s former counsel.  The application is opposed in part by the Chapter 11 trustee, and is opposed in whole by both the UST and the debtor.

This is a disturbing case on several levels.  First, the case under the DIP was a disaster.  A trustee was ultimately appointed for several reasons but most prominently, the MORS were incorrect and seriously misleading, and not only slightly but by a factor of hundreds of thousands.  This led to a grave concern whether anything the DIP said or reported could be relied upon.  Further, the case appeared to languish for an extended period without tangible progress being made toward reorganization.  A disclosure statement was finally provisionally approved, but never amounted to anything because no exhibits were filed as required and ultimately the estate under the trustee’s direction abandoned the entire approach described in the plan.  It also developed after the fact that some basic rules were either misunderstood or ignored, including that substantial amounts of cash collateral were spent without consent or authority in violation of §363(c).  Cash collateral may have been used in substantial part to pay [the Firm] $57,010 toward its interim fees under a Knudsen order. The lame excuse is offered that counsel thought Bank of America was adequately protected by equity cushion in any event, so apparently decided not to bother with this most basic of Chapter 11 requirements.  In addition, apparently substantial amounts of estate property were deposited in Mrs. [debtor’s] account and expended without disclosure at all or any authority under §363.  Again, such behavior casts the DIP in the most unfavorable light and makes a consensual plan unlikely.

The court understands that blame is not due only on counsel, and the court accepts that the DIP may have in some ways exacerbated his own problems.  But as the court has stated before, the reorganization system depends heavily on the competence and diligence of counsel because laymen cannot be expected to understand all that is required in such a rule-intensive environment, and their credibility in any event has to be considered marginal.  So the parties and the court rely in some degree on the reputation of counsel.  Moreover, counsel owes a duty of diligence also to the court.  At some level it should have been obvious that something was dreadfully wrong here when the MORS did not match the expected income that was the cornerstone of the proposed reorganization, and by such a large factor.  It is not enough to sit a paralegal down with a debtor and file these important MORS and simply go through the motions on a rote basis, without more careful analysis at an attorney level.  The result which happened here can only be expected under such an approach.

But there’s more. The court is extremely concerned about this episode concerning Mr. [attorney’s] daughter’s honeymoon (and whatever Mr. [other atty] thought he was doing) reserving the estate’s rental units as some kind of compensation in lieu of the authorized fee.  The court does not accept for a minute that because everything was cancelled after it was discovered by the trustee that this is a small matter or “no harm, no foul.”  [The Firm] should well know that any and all transactions and promises of compensation concerning fees must be approved ahead of time and fully disclosed, and not after the fact.  See FRBP 2014 and 2016(b); In re Lotus Properties, 200 B.R. 388, 391 (Bankr. C.D.Cal. 1996) citing In re Park-Helena Corp., 63 F. 3d 877, 880 (9th Cir. 1995). The court will give [the Firm] the benefit of the doubt that at some point approval would have been sought and the debtor’s characterization as to this being a “secret” was mere hyperbole; if the court thought otherwise, all fees would be disallowed and [the Firm] would find difficulty in obtaining another Chapter 11 employment order from this court.  The court cautions [the Firm] (and Mr. [other atty] too, for that matter) that it should adopt a far more guarded approach in dealing with estates regarding anything that could be construed as unauthorized compensation, and even if hypothetically authorized, it is just a plain bad idea, the court suggests, to have any kind of barter system with a bankruptcy estate regarding fees (or any other reason), as this is fraught with peril, provides opportunity for second guessing and criticism, as well as it looking really bad from the standpoint of creditors.

Concerning the fees sought for services rendered after the trustee’s appointment, the answer is simple; it is not authorized under Lamie v. United States Trustee, 540 U.S. 526, 527 (2004).  The court will not go so far as to say that there might not be some situations in equity or under §105 that require a departure from a strict rule, as [the Firm] has argued, but the court will say this is definitely not that case. Regarding [the Firm’s] argument that displaced counsel would under this rule be discouraged from cooperating with the trustee, the court reminds [the Firm] that this is also a profession not only a business, and that officers of this court owe some transcendent duties to the system and to the court as provided in the analogous FRBP 1019(5) and in common decency. In any event, the sum of $94,242.50 is grossly excessive even under the most generous standards of equity.  The recourse is to seek an order of the court at the behest of the trustee if such a large amount of post-appointment services is required in the unusual case.

Then there is the question, despite the time records submitted, was any value conferred upon the estate?  [the Firm] argues vaguely that it laid important groundwork, or that it kept the case from getting even worse, presumably by reining in the debtor.

Well, maybe, but looked at on a category by category basis value is hard to see even under this reduced standard.  No compensation whatsoever should be granted for work spent on preparing and analyzing MORS, as we have learned that they were less than worthless.  $46,758 is sought for work on the plan and disclosure statement, but this is tough to justify since although a disclosure was ultimately approved provisionally, it was never backed up by supporting exhibits and never disseminated, and ultimately the plan was abandoned altogether.  The $44,504.50 sought for “asset disposition” is also hard to support since none of the transactions regarding the [rental] property were ever consummated, and at least two motions were filed and then withdrawn.  $17,817 of this was non-compensable in any event since it was incurred after the appointment of the trustee.

In sum, and with regret, a very substantial reduction of the fee is in order.  [The Firm] must know that mere recording of time does not equate with value conferred.  The court believes that a line by line analysis is not required, and the exercise would not be productive in any event since the debtor will argue that more damage than value was done.  Only the roughest approximation of actual (and net) value conferred must do under these unfortunate circumstances.

Allow total fees and costs of $50,000. All amounts received above this will be disgorged to the trustee.

Update:

For the benefit of the viewing public, at the hearing Mr. [other atty] established to the court’s satisfaction that he is blameless in this episode and did not have any reason to know that he was dealing with a bankruptcy estate.

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