Counsel were not compensated for taking appeals in a Subchapter V case when the purpose was to deepen a circuit split or lay the groundwork for a certiorari petition to the Supreme Court, for reasons explained by Bankruptcy Judge René Lastreto, II, of Fresno, Calif.

Even though assumption of a franchise agreement was “vitally important to a successful reorganization,” Judge Lastreto also would not compensate the debtors’ counsel for filing a chapter 11 plan keeping alive the hope of assumption, after he had ruled that assumption was barred by Ninth Circuit precedent taking sides on the circuit split.

The Fast-Food Debtor

The corporate debtor was a franchisee of six fast-food restaurants. The debtor intended to confirm a chapter 11 plan and continue operating the restaurants by assuming the franchise agreement under Section 365(a). However, the franchisor was adamantly opposed.

The franchisor contended that Section 365(c)(1), combined with the Lanham Act and California’s Franchise Relations Act, allows a franchisor to nix the assumption of a franchise agreement, even if the debtor does not intend to assign or sell the business.

In an opinion in October, Judge Lastreto had denied the assumption motion, finding himself bound by Catapult Entertainment, Inc. v. Perlman (In re Catapult Enter.), 165 F.3d 747 (9th Cir. 1999). See Pinnacle Foods of California LLC, 24-11015, 2024 BL 362854 (Bankr. E.D. Cal. Oct. 10, 2024). To read ABI’s report on Judge Lastreto’s October opinion, click here.

Taking sides with Third, Fourth and Eleventh Circuits, the Ninth Circuit in Catapult adopted the “hypothetical test” and held that a debtor may not even assume a contract if the trademark holder objects, because the subsection says that the debtor “may not assume or assign.” [Emphasis added.]

On the other side of the fence, the First and Fifth Circuits and the majority of bankruptcy courts allow assumption by following the “actual test” and asking whether the nondebtor party to the executory contract is actually being forced to accept performance from a party other than the debtor. 

After denial of the assumption motion, the debtor filed and lost a motion for reconsideration and then filed an appeal to district court, which is pending. After denial of the reconsideration motion, the debtor filed an amended chapter 11 plan still based on assumption of the franchise agreement. Presumably, the plan called for assumption so the appeal would not become moot.

The debtor had general bankruptcy counsel and a large firm as special counsel to deal with assumption. Both firms filed applications for allowances of compensation covering the period before and after Judge Lastreto’s decision in October denying the assumption motion.

No Compensation for Work Contrary to Circuit Authority

Of course, the fee allowances were governed by Sections 330 and 331. Judge Lastreto said in his April 4 opinion that he would review the applications to decide “whether the services for which the attorney billed were truly necessary services that were beneficial to the estate.”

Conceding that “assumption of the leases was vitally important to a successful reorganization,” Judge Lastreto said it was “reasonable for [the debtor] to pursue their Motions to Assume the Franchise Agreements.” On the other hand, he said it “was not so clearly reasonable and certainly not beneficial to the three estates . . . to pursue a course the court had already rejected in light of controlling and well established Ninth Circuit precedent.”

Judge Lastreto denied the fee applications with regard to work performed after his opinion in October denying the assumption motion. He denied compensation for the reconsideration motion because counsel had presented “no persuasive authority criticizing or limiting Catapult in the Ninth Circuit.”

Regarding the plan that kept assumption alive, Judge Lastreto said he had been “very clear” after denying assumption “that any new plan must do something to change the trajectory of the cases.” Nevertheless, he said that the amended plan was “clearly just [a] placeholder” that was “utterly dependent on a reversal of the court’s ruling on assumption of the Franchise Agreements.” After denial of assumption, he said “it became unreasonable for the Debtors to continue beating the dead horse.”

Judge Lastreto said that the “Ninth Circuit decided Catapult roughly a quarter-century ago and has given no indication of a desire to revisit the issue.” After denying the assumption motion, he held that work on assumption “was neither necessary nor beneficial to the bankruptcy estate, and those billable hours will be excluded from any fee award.”

However, Judge Lastreto said he was “not reducing fees because applicants did not prevail.”

Counsel’s woes did not end with the denial of some compensation. Simultaneously, Judge Lastreto converted the chapter 11 cases to chapter 7. Since it was unclear whether chapter 7 administrative expenses would be paid in full, he did not direct payment of allowed compensation.