[1]Bankruptcy professionals work in an area that, by its very nature, makes the fee process lengthily transparent, subject to rigorous oversight and, in some cases, highly contentious. Even if fees are awarded, collecting them can be difficult. In a few (thankfully) rare cases, even after fees have been awarded and paid on an interim basis, the bankruptcy case becomes administratively insolvent and the professionals may have to disgorge their previously paid fees.[2] It is with this background that we review a recent case on this potentially painful topic, with a pleasing pro-professional outcome.
The facts of Premier Healthcare[3] are straightforward. The debtors, operators of related health care businesses, filed chapter 11 cases in September 2013. The bankruptcy court approved counsel for the debtors and, under the terms of the employment order, allowed counsel to be paid on a monthly basis subject to a 20 percent fee holdback and the agreement to “disgorge and return such fees ... should the court so order.” Neither the U.S. Trustee (UST) nor any other party objected to the employment application or the monthly interim fee payments.
On Jan. 24, 2014, counsel for the debtors filed an interim fee application for $46,297.50 in fees and $5,862.09 in expenses (the “interim application”). Counsel also sought approval to apply its $30,000 pre-petition retainer to $9,800 in pre-petition fees and the balance to post-petition fees. No party objected to the interim application, and the court approved it on Feb. 19, 2014.
Shortly after the interim application was filed, the state health department terminated the debtors’ participation in the state’s health care programs and withheld payments that they were owed thereunder. This caused the debtors to cease operations and convert their cases to chapter 7s. The debtors’ estates were hopelessly insolvent after the conversion.
In December 2014, counsel filed its final compensation application (the “final application”), requesting approval of approximately $54,000 in fees and expenses. Counsel disclosed that it had received from the debtors total post-petition payments of $38,265.40 in fees and $311.83 in costs (collectively, the “paid interim fees”). The final application requested final approval of these fees and the allowance of the unpaid balance of its fees.
The UST objected to the final application not on the basis of the requested fees themselves, but pursuant to 11 U.S.C. § 726 and the estate’s administrative insolvency.[4] The UST argued that all paid interim fees should be turned over to the chapter 7 trustee for distribution pursuant to the priorities under the Bankruptcy Code.
The bankruptcy court first determined that all of the requested fees were reasonable both as to hourly rate and time expended under 11 U.S.C. § 330.[5] The court also found that there were no grounds to disallow any of the requested fees under the provisions of 11 U.S.C. §§ 328 or 330.[6] Indeed, the court noted that even the UST did not request the disallowance of any fees.
Turning to the UST turnover request, the court noted that there was no express Bankruptcy Code provision that required the disgorgement of fees and expenses paid to a professional with court authentication when an estate was administratively insolvent.[7] The court stated that while “some courts assert[ed that] implicit authority [existed] under the priority scheme of § 726 to either order disgorgement or order the return of compensation,” such implicit authority was discretionary.[8] The court noted that many other courts have refused to order disgorgement under similar circumstances.[9]
In considering the case before it, the bankruptcy court noted that all post-petition payments made to counsel were made pursuant to court order and local rule.[10] The court also noted that as the fees had already been transferred to the law firm, they were no longer property of the estate.[11] Therefore, the court declined to exercise any “discretionary authority” it had and order the disgorgement of the paid interim fees.[12]
In addition, the court stated that while there are express portions of the Bankruptcy Code that allowed for the return of paid fees, including 11 U.S.C. § 549[13] and turnover motions, the UST had failed to file any of these motions or complaints.[14] The court also ruled that 11 U.S.C. § 726(b) did not provide an express or implied basis for disgorgement of interim professional fees that are actually paid to professionals post-petition and that absent a motion or complaint for turnover, there was no basis for the court to order the turnover authorized and previously paid interim fees.[15]
Discussion
The essential holding of Premier Healthcare is that the Bankruptcy Code does not provide an express mechanism for the disgorgement of interim professional fees that have been paid post-petition after being authorized by appropriate court order. This decision is contrary to several U.S. Courts of Appeals decisions, including In re Taxman Clothing Co.[16] and Specker Motor Sales Co. v. Eisen.[17] The decision seems to follow the now-overruled Sixth Circuit BAP decision of In re Unitcast Inc.[18]
However, the court’s reasoning that there are no provisions in the Bankruptcy Code for disgorgement of already-paid professional fees, and that such broad equitable powers should not be inferred, finds support in the Supreme Court’s recent holding in the case of Law v. Siegel.[19] In this case, the Supreme Court overruled a longstanding line of cases that held that unethical debtors could either be denied exemptions or have their exemptions “surcharged” in order to pay estate expenses on equitable grounds (i.e., preventing fraud on the court). In rejecting these cases, the Supreme Court held that “whatever equitable powers remain in the bankruptcy courts, most can only be exercised within the confines of the Bankruptcy Code.”[20]
In light of this ruling, it is therefore possible that bankruptcy courts (at least outside of the Sixth and Seventh Circuits) could take a new look at disgorgement based on Premier Healthcare, and make life somewhat easier for estate professionals.
[1] “Reversal of fortune” is a term used in by professional eating contestants to describe the “disgorgement” of their “competition equipment.”
[2] See, e.g., In re Specker Motor Sales Co. v. Eisen, 393 F.3d 659, 664-65 (6th Cir. 2004) (“Compensation must be disgorged when necessary to achieve pro rata distribution of Chapter 7 bankruptcy estate.”).
[3] Case No. 13-44501, 13-44503, 13-44505, 13-44506, 2015 Bankr. LEXIS 865, 2015 WL 1221975 (Bankr. D. Minn. Mar. 17, 2015).
[4] Ironically, one of the unpaid Chapter 11 administrative expenses was approximately $4,500.00 in UST quarterly fees.
[5] Id. at *4. The court did disallow a small amount of post-conversion time under Lamie v. United States Trustee, 540 U.S. 526 (2004). Id.
[6] Id.
[7] Id. at *5.
[8] Id. (citing and discussing Specker Motor Sales Co. v. Eisen, 393 F.3d 659, 664-65 (6th Cir. 2004); In re Brick Hearth Pizza Inc., 302 B.R. 877, 883 (Bankr. D. Minn. 2003)).
[9] Id. (citing and discussing In re Next Generation Media Inc., 524 B.R. 824, 829-30 (Bankr. D. Minn. 2015); In re Headlee Mgmt. Corp., 519 B.R. 452, 458 (Bankr. S.D.N.Y. 2014); In re Hyman Freightways Inc., 342 B.R. 575, 578 (Bankr. D. Minn. 2006)).
[10] Id. at *6.
[11] Id.
[12] Id.
[13] The court noted in passing, however, that by negative implication, 11 U.S.C. § 549 would not work as the transfer of the paid interim fees was authorized by the court. Id. at *6.
[14] Id.
[15] Id.
[16] 49 F.3d 310 (7th Cir. 1995).
[17] 393 F.3d 659 (6th Cir. 2004).
[18] 219 B.R. 741, 752-54 (BAP 6th Cir. 1998), overruled by Specker Motor Sales Co., supra at note 17.
[19] , ___ U.S. ___, 134 S.Ct. 1188, 188 L.Ed.2d 146 (2014).
[20] Id. at 134 S.Ct. 1194 (citations omitted).