Compensation for Debtors Counsel After a Chapter 11 Trustee Is Appointed When Should Debtors Counsel Stop Working
For bankruptcy practitioners, there is one question that laymen always ask: "If your client is bankrupt,
how do you get paid?" The reply is a confident, "We get paid first." Occasionally, one might
continue and explain that the Bankruptcy Code provides for payment of professional fees on a
"priority basis," which equates to payment before other unsecured creditors. <em>See</em> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C.
§507(a)(1) (1999)</a>. Before you count your chickens, however, make sure the eggs have hatched. A
recent Fifth Circuit opinion changes bankruptcy law as to debtor's counsel compensation. <em>See</em>
<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… & Kurth L.L.P. v. Family Snacks Inc.,</em> 157 F.3d 414 (5th Cir. 1998)</a> ("<em>Family Snacks</em>"); <em>see, also,</em> 3 Lawrence P.
King, Collier on Bankruptcy §330.LH[5] at 330-76 (15th ed. 1998).</p>
<p><em>Family Snacks</em> demonstrates that mere court approval of debtor's counsel
employment does not ensure the payment of attorney's fees.<font size="-1"><sup><a href="#1">1</a></sup></font> Accordingly, in
analyzing debtor's counsel compensation, it is important to know (a) Code
requirements, (b) the <em>Family Snacks</em> holding, (c) alternate case law, and (d) the
potential of working for free.</p>
<h3>The Code and Debtor's Counsel Compensation</h3>
<p>To receive a priority claim under §507(a)(1), by virtue of a §503(b) administrative claim, debtor's counsel must comply
with two prerequisites. First, counsel must seek and obtain approval under §327.<font size="-1"><sup><a href="#2">2</a></sup></font> Section 327 states that the trustee, or
debtor-in-possession (DIP) pursuant to §1107, may employ an attorney or other professional person to represent or assist
the trustee or <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 11 U.S.C. §327(a) (1999)</a>.</p>
<p>Second, after approval of employment and incurring fees, counsel must obtain approval of compensation under §330(a)(1).
Section 330(a)(1) states that "the court may award to a trustee, an examiner, a professional person employed under §327 or
1103Šreasonable compensation for actual, necessary services rendered by the trustee, examiner, professional person or
attorney, and by any paraprofessional person employed by any such person."<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; 11 U.S.C. §330(a)(1)(A) (1999</a>). Section
330(a)(1) thus provides the means for compensating debtor's counsel, just as §327 provides for the employment of debtor's
counsel.</p>
<p>Accordingly, to receive compensation as debtor's counsel, one must first be employed and second apply for compensation
under §330. Not so fast! Noticeably missing from the current version of §330(a)(1) is the "to the debtor's attorney"
language that followed "a trustee, an examiner, a professional person" prior to the 1994 Amendments. Moreover, <em>Family
Snacks</em> interprets the discrepancy as intentional, thereby altering the availability of compensation for debtor's counsel.</p>
<h3>The Family Snacks Opinion</h3>
<p>In <em>Family Snacks,</em> the Fifth Circuit held that a bankruptcy court cannot award compensation to debtor's counsel from estate
assets for work performed after the appointment of a chapter 11 trustee. However, the Fifth Circuit's opinion contains an
incomplete analysis and focuses on statutory construction of the 1994 Amendments.</p>
<p>Specifically, the Fifth Circuit stated that "by deleting 'to the debtor's attorney,' Congress indicated that the debtor's counsel
may not be compensated from the estate after the appointment of a chapter 11 trustee."<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; <em>Family Snacks,</em> 157 F.3d at 42</a>4.
However, the Fifth Circuit was silent as to the fact that §330(a)(1) still contains the term "professional" and that
§330(a)(1)(A) refers to compensation for "an attorney." <em>See</em> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Snacks,</em> 157 F.3d 414</a>;<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; 11 U.S.C. §§330(a)(1)</a> and
(a)(1)(A) (1993).</p>
<p>Further, the Fifth Circuit conducted no analysis regarding §330(a)(1)'s retention of "professional person." After all, a
trustee, examiner and/or professional person is not the same individual because of the different usage of these terms
throughout the Bankruptcy Code. <em>See, e.g.,</em> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §§327, 330 (1999)</a>. Also, Congress erred in at least one regard by
omitting the disjunctive "or" between "examiner" and "professional person." <em>See</em> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §330(a)(1) (1999)</a>. Instead, the
Fifth Circuit focused on the omission of "to a debtor's attorney" and determined no vagueness existed, thus completing its
analysis.</p>
<p>Consequently, based on the Fifth Circuit's ultimate ruling, the bankruptcy community must assume that the Fifth Circuit
interpreted §§327, 330 and 1107 as allowing compensation for either the trustee's counsel or debtor's counsel, but not both,
based on the termination of DIP status after chapter 11 trustee appointment. However, the Fifth Circuit did not include such
a discussion in its actual holding, even though, as that court mentioned, the creditor/appellees raised exactly this point.<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…;
<em>Family Snacks,</em> 157 F.3d at 424-26</a>.</p>
<p>Further, the Fifth Circuit overlooked Congress' intent in enacting §330(a)(1)(A)'s safeguards. Specifically, §330(a)(1)(A)
requires that the court compensate only for "actual, necessary services." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §330(a)(1)(A) (1999)</a>. However, actual
and necessary services often exist after chapter 11 trustee appointment, and often non-estate assets do not exist to otherwise
compensate debtor's counsel. This result, as discussed more fully below, is inequitable to counsel who must now work for
free due to other imposed duties. Fortunately for some, <em>Family Snacks'</em> ruling applies only in the Fifth Circuit, thereby
allowing compensation to counsel in other jurisdictions who perform post-appointment services to the debtor.</p>
<h3>Alternate Case Law</h3>
<p>The Fifth Circuit's interpretation of the current version of §330(a)(1) appears to be in the minority. In fact, several courts
examined this issue and determined that, to the contrary, if debtor's counsel efforts were reasonably likely to benefit the
debtor's estate, they should be compensated. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Ames Department Stores Inc.,</em> 76 F.3d 66, 71 (2d Cir. 1996</a>); <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Miller,</em>
211 B.R. 399, 401-03 (Bankr. D. Kan. 1997</a>); <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Stroudsburg Dyeing & Finishing Co.,</em> 209 B.R. 648, 650 (Bankr. M.D.
Pa. 1997)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Melp Ltd.,</em> 179 B.R. 636, 639 (E.D. Mo. 1995</a>).</p>
<p>These courts held opposite to <em>Family Snacks,</em> finding a lack of congressional intent and an underlying public policy in
compensating debtor's counsel for work performed after the appointment of a chapter 11 trustee. The only caveat put on
debtor's counsel compensation is that it must comply with the other provisions of §330. Thus, the alleged change in
§330(a)(1) may or may not be an issue, depending upon the particular jurisdiction, in determining whether debtor's counsel
works for free.</p>
<h3>Working for Free</h3>
<p>Perhaps the most detested of all work is free work.<font size="-1"><sup><a href="#3">3</a></sup></font> Even worse, however, is when free work benefits the bankruptcy estate.
<em>Family Snacks</em> increases the potential of working for free because <em>Family Snacks</em> does not absolve debtor's counsel from
post-appointment service.</p>
<p>After all, the Bankruptcy Code requires approval prior to employment, and therefore, most courts require approval prior to
withdrawal. Thus, the lawyer remains counsel for the debtor. Furthermore, state law ethical obligations may require an
attorney to continue to perform as counsel, regardless of the potential prohibition of payment. Thus, the attorney works for
free.</p>
<p>Such a potential for free work creates not only an ethical dilemma, but also an economical dilemma that could lead to
debtor's counsel's withdrawal or unwillingness to perform any services after trustee appointment. Thus, due to such
potential fallout, Congress should amend the Code and, if nothing else, clarify its intent in §330(a)(1).</p>
<p>Until such time, however, debtor's counsel has several post-appointment options. First, consider obtaining court approval
prior to performing additional work for the debtor. Although such approval may not prevent subsequent reversal on an
objecting party's appeal, it would secure payment if no party objects.</p>
<p>Also, if the necessary work does not create a conflict of interest, consider trustee representation when such representation
furthers the debtor's goals. The conflict-of-interest issue is pertinent here to prevent ethical as well as fiduciary problems.
When debtor's counsel is hired for a special purpose, however, the code actually supports such employment. <em>See</em> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C.
§327(e) (1999)</a>.</p>
<p>Additionally, remember that <em>Family Snacks</em> applies only to compensation from estate assets. Thus, if non-estate assets
exist, debtor's counsel may still receive compensation. Regardless of the means, however, alternate compensation exists
that may prevent working for free.</p>
<h3>Conclusion</h3>
<p><em>Family Snacks</em> creates many problems for debtor's counsel and has potentially negative ramifications for the bankruptcy
community. In addition to the obvious economic ramifications, there are ethical and legal ramifications, not to mention the
reluctance of debtor's counsel to perform any service after the appointment of a chapter 11 trustee.</p><hr>
<p></p>
<h3>Footnotes</h3>
<p><font size="-1"><sup><a name="1">1</a></sup></font> An Objection to a Fee Application is always a potential hurdle, but is not the scope of this article. <a href="#1a">Return to article</a> </p>
<p><font size="-1"><sup><a name="2">2</a></sup></font> Notwithstanding §327's importance, this article focuses on §330(a)(1). <a href="#2a">Return to article</a> </p>
<p><font size="-1"><sup><a name="3">3</a></sup></font> Excluding, of course, pro bono activity, which the authors strongly support. <a href="#3a">Return to article</a>