Lamenting Lamie and the Appointment of the Chapter 11 Trustee

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Nov 2004

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Lamie v. U.S. Trustee has
implications for chapter 11 cases that bear consideration.<a href="#1" name="1a">1</a> Chip Bowles's excellent
discussion of Lamie in the May issue of the ABI Journal reviewed the
facts of the decision, the circuit courts' split on the issue and the
decision's implications when a case is converted from chapter 11 to
chapter 7.<a href="#2" name="2a">2</a>

Clearly, Lamie presents significant compensation issues for counsel
representing debtors in chapter 11 cases that are converted. These
impacts are perhaps even more significant where a chapter 11 trustee has
been appointed and there is no conversion. Although Lamie specifically
dealt with a chapter 7 conversion, the decision also applies to chapter
11 cases where a trustee has been appointed. The triggering event on
which loss of the right to compensation is based is not conversion;
rather, it is the appointment of a trustee.<a href="#3" name="3a">3</a>

Lamie holds that after the appointment of a trustee, counsel
for the former debtor-in-possession (DIP) cannot be compensated by the
estate under the provisions of 11 U.S.C. §§330 and 327.
Specifically, the estate may not compensate counsel not appointed by the
trustee under 11 U.S.C. §327 and paid pursuant to 11 U.S.C.
§330. In Lamie, as in virtually all the cases that will be
subjected to this doctrine, counsel seeking compensation will have
complied with the requirement of appointment by a "trustee." This occurs
when the DIP exercises the power of a trustee under 11 U.S.C. §1107
to employ professionals. Even though the debtor's counsel in Lamie had
already complied with the requirements of 11 U.S.C. §327, the
Supreme Court denied counsel's modest request for compensation for
services rendered after the appointment of the trustee.<a href="#4" name="4a">4</a>

The concept of the DIP is unique to our bankruptcy system and is
apparently based on the precept that familiarity with the business of
the debtor and its industry is a positive factor that outweighs the
benefit of a fully independent trustee. The Bankruptcy Code provides
numerous protections to ensure that the integrity of the system and the
interests of creditors are not adversely affected by this policy. Among
those protections is the appointment of a trustee, either through
conversion to chapter 7 (trustee automatic) or appointment of a chapter
11 trustee on motion (trustee discretionary).

The offices of DIP and trustee are mutually exclusive. Section 1101
(1) provides that DIP "means Ôdebtor' except when a person that has
qualified under §322 of this title is serving as trustee." Thus,
upon the appointment and qualification of a trustee in chapter 11, the
DIP ceases to exist, and the debtor's responsibilities are thereafter
defined under §521, "Debtor's duties," and not under §1107,
"Rights, powers, and duties of debtor-in-possession." Even if the debtor
remains in "possession" of certain assets after the appointment of the
trustee, this does not make it a DIP.

Upon appointment of the chapter 11 trustee, the attorney for the DIP
has lost his or her client. The DIP has simply ceased to exist. In most
cases, DIP counsel then simply transition to representing the debtor. If
there are ethical or conflict issues in such a practice, they are
usually not raised, particularly in individual cases.<a href="#5" name="5a">5</a>

There might well be a practical basis for a distinction between a
conversion to chapter 7 and appointing a trustee in the chapter 11. In
the former situation, the reorganization effort has ended and the entire
enterprise becomes one of liquidating assets for distribution to
creditors. Where a trustee is appointed and the chapter 11 continues,
the effort commenced by the DIP, whether to reorganize or liquidate, has
been deemed the better path for the case than conversion. Appointment of
a trustee can be the product of a negotiated compromise between the
debtor's camp and distrustful creditors.

Often, a trustee's appointment remedies a unique or difficult dynamic
with an individual debtor or the insiders of the debtor
organization.<a href="#6" name="6a">6</a> The
continued service of debtor's counsel can often be very helpful in
tempering the actions of the difficult debtor and obtaining cooperation
of the debtor perhaps now inclined to become more hostile and
adversarial, §521 notwithstanding. Often the creditors'
representatives will conclude that conversion to chapter 7 will result
in increased costs, delay, loss of flexibility in the U.S. Trustee's
consideration of trustee candidates, loss of positive momentum in the
case or a variety of other case-specific factors.

The Lamie impacts are unfortunate when a chapter 11 trustee is
appointed, because the continued assistance of the former DIP counsel
can be very helpful. Often, trustees require significant transition
services by the debtor and his counsel. Lamie appears to curtail such
services. Nevertheless, some judges recognize the value of an effective
transition and will compensate former counsel for the DIP for transition
services rendered after the bright-line event of the appointment and
qualification of the trustee.<a href="#7" name="7a">7</a>

Counsel for the chapter 11 trustee should consider the benefits of
retaining former DIP counsel as special counsel, at least as may be
constructive in transition. Again, there may be ethical issues to
resolve, but disinterestedness is not required of special counsel
appointments. That said, where former DIP counsel and potential special
counsel for the trustee are to simultaneously represent the debtor, the
conflicts may well overcome the practical advantages to be obtained by a
smooth transition.<a href="#8" name="8a">8</a>

Assuming that there is value added by the continued services of
former DIP counsel, counsel could consider the application of
§§503(b)(3) and (4). If the equity security-holder (or, in the
individual case, the debtor, as the arguable equivalent of an equity
security-holder) makes a contribution to the case, then its counsel can
be compensated. But keep in mind that the showing for a §503(b)
award is "substantial contribution" rather than simply "reasonable and
necessary." Meeting this higher burden is sometimes not enough to
prevail against the opposition of the trustee. Thus, the cooperation and
support of the trustee's counsel and perhaps some early consideration by
the court on this approach would be prudent for counsel considering use
of §503(b).

In summary, DIP counsel's right to compensation is lost when a
trustee is appointed. Where the chapter 11 continues under a trustee,
the need for continued services from former DIP counsel is probably
greater than in the conversion situation. However, the strategies for
seeking compensation from the estate after appointment of a trustee are
limited and only apply to efforts consistent with the interests of the
estate. But such strategies need to be considered and explored by
counsel early in the process.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Lamie v. U.S.
Trustee, 124 S.Ct. 1023, 157 L.Ed 2d 1024 (2004). <a href="#1a">Return to article</a>

<a name="2">2</a> Bowles, C.R. Jr.,
"Watching Sausage
Being Made—the Supreme Court, Not the FDA," 23 Am. Bankr. Inst. J.
30 (2004). <a href="#2a">Return to article</a>

<a name="3">3</a> None of the statutes in
question by the Supreme Court or analyzed by the circuits that took the
contravening approach deal with conversion. 11 U.S.C. §1112. <a href="#3a">Return to article</a>

<a name="4">4</a> The decision states that
the attorney conceded that he was not hired by the trustee under 11
U.S.C. §327. The decision then proceeds to the legislative
interpretation ("drafting error") analysis. The decision does not
reflect an argument by counsel to the effect that he was appointed under
§327, and thus his work did comply with the requirements of the
statute. <a href="#4a">Return to article</a>

<a name="5">5</a> The representation that
such a practice exists, particularly in smaller cases, is not intended
to condone ignoring ethical issues where they exist. However, if counsel
at that juncture is cut off from court review and approval of fees under
§330; the principal concern would be complying with state ethical
rules. <a href="#5a">Return to article</a>

<a name="6">6</a> The dynamic being that
they are dirtbags. <a href="#6a">Return to article</a>

<a name="7">7</a> While this specific
aspect was not discussed in the Bowles article, the author did state
that Lamie may herald a more restrictive approach to
compensation issues. Whether bankruptcy judges will consider this as
restricting his discretion on compensating transition services, without
a formal special counsel appointment, remains to be seen. <a href="#7a">Return to article</a>

<a name="8">8</a> Where it is in the best
interest of the estate to obtain a full and complete briefing on all of
the issues confronting the trustee, such as the status of sales
negotiations, useful employees, details of ongoing litigation, etc., the
practical approach would be to compensate only for transition services
and not for actions as an advocate for the debtor. It is simply
short-sighted and unrealistic to believe that where substantial time is
required for an effective transition, this time will be "donated." <a href="#8a">Return to article</a>

Journal Authors

Dillon E. Jackson

Journal Date

Monday, November 1, 2004 - 12:00

Bankruptcy Rule

2004