A bankruptcy judge is not required as a matter of law to order disgorgement of fees to effect a pro rata distribution among chapter 11 administrative claimants when the estate is administratively insolvent, according to District Judge Tanya Walton Pratt of Indianapolis.
The appeal entailed a typical case of administrative insolvency, which results when the unencumbered assets of the estate are insufficient to pay administrative claims in full.
A trustee had been appointed in a chapter 11 case. Counsel who represented the debtor before appointment of the trustee had been granted and paid two interim allowances of compensation totaling about $135,000.
The debtor’s counsel filed a third interim fee application seeking another $110,000. The chapter 11 trustee objected to the third application. Approving settlement of the objection, Bankruptcy Judge Basil H. Lorch, III granted the application, but his order provided that neither the trustee nor the estate would pay any of the fee allowance.
There was about $4 million in unpaid administrative claims, but the trustee was holding only $1 million to apply toward those claims. The unpaid claims included an administrative claim of $2.6 million owing to the Internal Revenue Service for unpaid trust fund taxes.
Later, the trustee proposed a so-called structured dismissal of the chapter 11 case, where the bankruptcy court would authorize distribution of the estate’s remaining funds, followed by a dismissal of the chapter 11 case without incurring the expense of a conversion to chapter 7.
In connection with dismissal, the trustee and the IRS asked Judge Lorch to order the debtor’s counsel to disgorge $60,000, which would evidently allow the court to close the case with a pro rata payment of administrative claims. Judge Lorch denied the motion, and the IRS appealed.
Judge Pratt affirmed in a 12-page opinion on September 26.
The IRS argued that the Supreme Court’s decision in Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), required the bankruptcy judge to order disgorgement to the extent necessary to result in a pro rata distribution among all of the chapter 11 administrative claimants, including the IRS. In Jevic, the Supreme Court held that a structured dismissal could not include a distribution that “deviate[s] from the basic priority rules” in Section 726(a). For ABI’s discussion of Jevic, click here.
Judge Pratt said that Jevic “does not mandate disgorgement of [the debtor’s counsel’s] fees to achieve ultimate pro rata distribution among administrative claimants in this chapter 11 structured dismissal case.” Similarly, she said that Jevic did not “concern whether a bankruptcy court can decline to order disgorgement where it has made, or makes, a final award of attorneys’ fees.”
Having concluded that Jevic did not require disgorgement, Judge Pratt asked whether the bankruptcy judge had authority to decline to order disgorgement. On that issue, she said, the case law is “relatively sparse.”
In terms of statutory imperatives, Judge Pratt said that Section 330 contains “no requirement or any mention . . . that disgorgement must (or even should) be made to achieve a pro rata distribution among administrative claimants in a chapter 11 . . . structured dismissal . . . .”
According to Judge Pratt, the bankruptcy judge said he would not order disgorgement, even if he had power to do so, because the law firm had provided value to the estate by making the “single most important recovery” of assets.
Like the bankruptcy judge, Judge Pratt said that the value of the services was relevant to the question of disgorgement. Indeed, the bankruptcy judge had said that he would have considered a fee enhancement if the estate had sufficient assets.
Judge Pratt found “no basis” to overturn the bankruptcy judge’s “weighing of the equities and his finding that [the law firm] had ‘more than earned’ a total fee of” $135,000.