Watching Sausage Being Madethe Supreme Court Not the FDA Lamie v. U.S. Trustee

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May 2004

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Professional fees are the literal lifeblood of the bankruptcy profession. Recently, the U.S. Supreme Court issued an
important opinion addressing compensation of professionals from chapter 7 bankruptcy estates and resolving the
serious split among the circuits as to the interpretation of 11 U.S.C. §330(a)(1).

<h4>Big Decisions Come in Small Packages: The Lamie Decision</h4>

The case addressed in this article is the U.S. Supreme Court's decision in Lamie v. U.S. Trustee,<a href="#2" name="2a">2</a> which resolved
the split among the circuits<a href="#3" name="3a">3</a> on the issue of whether 11 U.S.C.§330(a)(1) permits compensation to a debtor's
attorney from the assets of a bankruptcy estate, absent that attorney being employed under 11 U.S.C.§327 or 1103.
This issue primarily involves fee requests from both attorneys hired by debtors to file chapter 7 bankruptcies and
chapter 11 attorneys for work done for a chapter 7 estate after the chapter 11 was converted to a chapter 7 case.

In Lamie, the debtor, Equipment Services Inc., filed a chapter 11 petition on Dec. 24, 1998. The debtor's
counsel promptly sought approval of his retention as counsel for the chapter 11 estate, and his employment was
approved on Jan. 26, 1999. The debtor's counsel also properly disclosed that he received $1,000 from the debtor for
fees and expenses related to the filing of the chapter 11, and a $5,000 retainer. Less than three months into the
bankruptcy, the chapter 11 was converted on motion of the U.S. Trustee to a chapter 7 proceeding. Counsel for the
chapter 11 debtor continued to provide services to the debtor after the chapter 11 case was converted to a chapter 7
proceeding without "the trustee's authorization to do so"<a href="#4" name="4a">4</a> and without being retained by the chapter 7 bankruptcy
estate under 11 U.S.C. §327. The debtor's counsel requested fees for both its pre- and post-conversion work and
that his fees be paid from his pre-petition retainer.

The bankruptcy, district and Fourth Circuit courts in Lamie all ruled that (1) the debtor's counsel was
entitled to his pre-conversion fees and (2) 11 U.S.C. §330(a)(1) prohibited a debtor's attorney from being paid from
the chapter 7 estate for his post-conversion fees, absent being retained by the chapter 7 estate under 11 U.S.C.
§327.<a href="#5" name="5a">5</a>

[W]hat may or may not have been a scrivener's error led to nearly 10 years of litigation and ultimately the changing of over 100 years of bankruptcy practice.
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<hr>
</blockquote></blockquote>

<h4>Blending the Meats: The Issue and Resolution</h4>

The question presented to the Supreme Court arose from a change in 11 U.S.C. §330(a), which
occurred as part of the 1994 amendment to the Bankruptcy Code made by the Bankruptcy Reform Act of
1994 (1994 Act). Prior to the passage of the 1994 Act, §330(a) read:

<blockquote>
(a) After notice to any parties in interest and to the U.S. Trustee and a hearing, and subject to §§326, 328 and 329

of this title, the court may award to a trustee, to an examiner, to a professional person employed under §327 or
1103 of this title, or to the debtor's attorney—"(1) reasonable compensation for actual, necessary services rendered
by such trustee, examiner, professional person or attorney...and by any paraprofessional persons employed by such
trustee, professional person or attorney... and (2) reimbursement for actual, necessary expenses." (emphasis added)
</blockquote>

The language "or to the debtors' attorney" was critical for chapter 7 debtor's counsel and estate counsel of
former chapter 11 debtors to be paid by bankruptcy estates under 11 U.S.C. §330(a) when they were not employed
as counsel for the chapter 7 estate<a href="#6" name="6a">6</a> under 11 U.S.C.§327.

The 1994 Act amended §330(a) to read:

<blockquote>
(a)(1) After notice to the parties in interest and the U.S. Trustee and a hearing, and subject to §§326, 328 and 329,
the court may award to a trustee, an examiner, a professional person employed under §327 or 1103—"(A) reasonable
compensation for actual, necessary services rendered by the trustee, examiner, professional person or attorney and
by any paraprofessional person employed by any such person; and (B) reimbursement for actual, necessary
expenses."

</blockquote>

The phrase "or to the debtor's attorney" was deleted from this section for no clear reason.

The Second, Third and Ninth Circuits, in reviewing the strange wording of §330(a)(1) after the 1994 Act's
amendment, held that 330 (a)(1) was ambiguous<a href="#7" name="7a">7</a> and that the deletion of the phrase "or to the debtor's attorney"
was a scrivener's error and should not be given any effect. See, generally, 3 Collier on Bankruptcy 330 LH[5]
330-75 to 330-76 (Rev. 15th ed. 2003).

However, courts in the Fourth Circuit in the Lamie decision, as well as the Fifth and Eleventh Circuits, in
reviewing the same text, determined that despite the statute's inconsistent and somewhat confusing wording, the
statute was plain and unambiguous and that absent approval of employment under either 11 U.S.C. §327 or 1103
by a court, a professional, including counsel for a debtor, could not be paid their final professional fees or expenses
under §330(a)(1).<a href="#8" name="8a">8</a>

In Lamie, the Supreme Court sided with the Fourth, Fifth and Eleventh Circuits and held that although 11
U.S.C. §330(a)(1) was "awkward and ungrammatical," it was not ambiguous and its meaning was reasonably
plain.<a href="#9" name="9a">9</a> The Supreme Court rejected arguments also advanced by debtors' counsel that (1) 11 U.S.C. §330 (a)(1), by
its use of the term "attorney," when read with 11 U.S.C. §331 permitted debtors' attorneys to be paid from the
debtor's estates; (2) that a literal reading of 11 U.S.C. §330(a)(1) would be absurd; (3) that the otherwise
unexplained change in bankruptcy practice showed the deletion of the phrase "or to the debtors' attorneys" was a
scrivener's error;<a href="#10" name="10a">10</a> and (4) that the legislative history of 11 U.S.C. §330(a)(1) supported the contention that no
change in the past practice of permitting the debtor's attorney to apply for compensation from a bankruptcy estate
was intended by the 1994 amendment "debtor's attorney" language was inadvertent.<a href="#11" name="11a">11</a>

<h4>Adding the Spices: Some Potential Consequences of Lamie</h4>

The most important consequence of Lamie is that it unequivocally resolves the interpretation of 11 U.S.C.
§330(a)(1). Now if either a former chapter 11 debtor's counsel in a converted case or a chapter 7 debtor's counsel
wants to be compensated from a chapter 7 estate for work performed for a chapter 7 estate, they must first be
retained by the estate under 11 U.S.C. §327.<a href="#12" name="12a">12</a> However, there are additional consequences and questions that
might arise from Lamie.The first issue raised by Lamie is whether nunc pro tunc retention of estate professionals for a significant
amount of time after they begin work is permissible. While several courts<a href="#13" name="13a">13</a> have allowed, under limited
circumstances, professionals to be retained nunc pro tunc and paid for their services performed prior to the court
approving their retention, in light of the Supreme Court statements in Lamie that retention under §327 is a
prerequisite for payment of professional persons, such decisions may be questionable.

Second, professionals who work for debtors or committees and whose retention is either not approved or
whose retention is revoked after an initial approval may be required to forfeit the right to any compensation for their
work. While some courts<a href="#14" name="14a">14</a> have held that such a professional can receive limited compensation, the validity of
those opinions may be in question in light of the courts' interpretation of 11 U.S.C. §330.<a href="#15" name="15a">15</a>

Finally, in Lamie, the Court's discussion of how chapter 7 debtors' attorneys are generally paid<a href="#16" name="16a">16</a> and its
adherence to the "plain meaning rule" may practically overrule decisions by various courts<a href="#17" name="17a">17</a> that have allowed
chapter 7 debtors' attorneys to file "no money down" chapter 7 cases and have the debtors' pre-petition obligations
to their attorneys escape discharge.

In summary, Lamie once again proves the wisdom of the famous statement attributed to German
Chancellor Otto Bismark that "there are two things one should not watch: the making of sausage and the passage of
legislation." Here, what may or may not have been a scrivener's error led to nearly 10 years of litigation and
ultimately the changing of over 100 years of bankruptcy practice. While Lamie is a correct result from a statutory
interpretation standpoint, its result from a policy standpoint is far from clear.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Board Certified in Business Bankruptcy Law by the American Board of Certification. <a href="#1a">Return to article</a>

<a name="2">2</a> Lamie v. U.S. Trustee, _U.S._, 124 S.Ct. 1023 (Jan. 26, 2004). <a href="#2a">Return to article</a>

<a name="3">3</a> The Fourth, Fifth and Eleventh Circuits had held that the plain meaning of 11 U.S.C. §330 did not permit the payment of professional fees unless a professional was employed
under either 11 U.S.C. §327 or 1103, including fees to a debtor's attorney. See In re Equipment Services Inc., 290 F.3d 739 (4th Cir. 2002), aff'd., Lamie v. U.S. Trustee, U.S.,
124 S.Ct. at 1023; In re American Steel Products Inc., 197 F.3d 1354 (11th Cir. 1999); In re Pro-Snap Distributors Inc., 157 F. 3d 414 (5th Cir. 1998). The Second, Third and
Ninth Circuits held that due to drafting errors in 11 U.S.C. §330(a), an attorney for chapter 7 debtors and for chapter 11 debtors' attorneys could be compensated by a bankruptcy
estate without being employed pursuant to 11 U.S.C. §327. See In re Ames Dept. Stores Inc., 76 F.3d 66 (C.A. 2 1996); In re Top Grade Sausage Inc., 227 F.3d 123 (C.A. 3 2000);

In re Century Cleaning Services Inc., 195 F.3d 1053 (C.A. 9 1999). <a href="#3a">Return to article</a>

<a name="4">4</a> 124 S.Ct. at 1029. It is unclear from the lower court decisions and the Supreme Court decision whether any of this work was performed at the request of the chapter 7 trustee.
However, the Fourth Circuit noted that the U.S. Trustee also objected to the post-conversion fee request on the ground that it did not benefit the estate but only the debtor,
Equipment Services Inc., 290 F.3d at 743. See, also, Judge Michael's concurrence at 290 F.3d at 747. <a href="#4a">Return to article</a>

<a name="5">5</a> A second issue addressed by the lower courts in Lamie but not addressed by the Supreme Court in its decision was whether the post-confirmation fees could be paid by the
counsel's retainer. The Fourth Circuit ruled that the portion of the retainer not earned pre-conversion was property of the estate and could not be used to pay post-confirmation
fees. 290 F.3d at 746. The bankruptcy and district courts in Lamie permitted the debtor's counsel to be paid his post-conversion fees from his retainer. The Fourth Circuit reversed
the lower court's decision on this issue. The Supreme Court did not address the Fourth Circuit's decision on this issue. <a href="#5a">Return to article</a>

<a name="6">6</a> There is some academic dispute as to whether an attorney or other professional is employed by a bankruptcy estate or a debtor-in-possession or trustee in chapter 7 and 11
proceedings. See, generally, Rappoport and Bowles, "Has the DIP's Attorney Become the Ultimate Creditors' Lawyer in Bankruptcy Reorganization Cases?" 5 Am.B.Inst. L.R.
47 (1997). For purposes of this article, it will be assumed that the bankruptcy estate, either chapter 7 or 11, employs the professionals under 11 U.S.C. §327. <a href="#6a">Return to article</a>

<a name="7">7</a> By finding that a statute is ambiguous, courts may then consider the legislative history of the statute to determine Congress's intent. See In re Top Grade Sausage, 227 F.3d at 129. <a href="#7a">Return to article</a>

<a name="8">8</a> As noted by the Supreme Court in Lamie, 11 U.S.C. §331's plain language permits a debtor's attorney to receive interim payments of professional fees. The Supreme Court
interpreted this provision as only applying to debtor's attorney employed by the estate under 11 U.S.C. §327. <a href="#8a">Return to article</a>

<a name="9">9</a> Lamie, 124 S.Ct. at 1030. <a href="#9a">Return to article</a>

<a name="10">10</a> The Supreme Court did have some sympathy for the contention that the change in bankruptcy practice caused by 11 U.S.C. §330's amendment was not adequately explained by
Congress. See 124 S.Ct. at 1032 ("it is fair to doubt that Congress would so reward [debtor's attorneys'] longstanding role without announcing the change in the congressional
record."). <a href="#10a">Return to article</a>

<a name="11">11</a> Indeed the Supreme Court used the muddled legislative history of 11 U.S.C. §330(a)(1) to highlight "the difficulty of relying on legislative history here and the advantage of our
determination to rest our holding on the statutory text." <a href="#11a">Return to article</a>

<a name="12">12</a> There is an interesting question as to whether a debtor's attorney could be compensated under 11 U.S.C. §330(a)(1) if a trustee authorized their work, but their employment was
not approved by the court under 11 U.S.C. §327. Compare "a debtor's attorney not engaged as provided by §327 is simply not included within the class of persons eligible for
compensation," 124 S.Ct. at 1030, with "§327's limitation on debtors incurring debts for professional services without the chapter 7 trustee's approval is not absurd" (emphasis
added), 124 S.Ct. at 1032 and "the deletion at issue furthered this reform by ensuring that chapter 7 debtor's attorney would receive no estate compensation absent the trustee's
authorization of their work." 124 S.Ct. at 1033. <a href="#12a">Return to article</a>

<a name="13">13</a> See, generally, In re Arkansas Co., 798 F.2d 645 (3rd Cir.1986); In re 245 Assocs., 188 B.R. 743 (Bankr. S.D.N.Y. 1995). <a href="#13a">Return to article</a>

<a name="14">14</a> See, generally, In re Crivello, 134 F.3d 831 (7th Cir. 1998), requiring us to treat the text as if it were ambiguous. <a href="#14a">Return to article</a>

<a name="15">15</a> See 124 S.Ct. at 1032: "If the attorney is to be paid from estate funds under §330(a)(1) in a chapter 7 case, he must be employed by the trustee and approved by the Court." See,
also, In re Federated Department Stores Inc., 44 F.3d 1310 (6th Cir. 1995). <a href="#15a">Return to article</a>

<a name="16">16</a> "Section 330(a)(1) does not prevent a debtor from engaging counsel before a chapter 7 conversion and paying reasonable compensation in advance to ensure that the filing is in
order. Indeed, the Code anticipates these arrangements. See, e.g., §329 (debtors' attorneys must disclose fees they receive from a debtor in the year prior to its bankruptcy filing
and courts may order excessive payments returned to the estate.)." 124 S.Ct. at 1032. <a href="#16a">Return to article</a>

<a name="17">17</a> See In re Hines, 147 F.3d 1180 (9th Cir. 1998). <a href="#17a">Return to article</a>

Journal Authors

C. R. Bowles

Journal Date

Saturday, May 1, 2004 - 12:00

Bankruptcy Rule

2004