Upon a chapter 11 filing, that fictional entity, the debtor in possession (DIP), is born. Distinct from the debtor itself, the DIP has duties, obligations and rights akin to the chapter 7 trustee. [1] All of the debtor’s property passes to the bankruptcy estate, with the DIP becoming a fiduciary of the estate, with a duty to creditors of the estate and a duty not to waste the estate’s assets. The DIP’s actions, including the DIP’s selection of counsel, are overseen by a bankruptcy court. [2] Typically, the DIP’s counsel is the same attorney who both prepared the petition and represents the Debtor in the bankruptcy. In most cases, attorneys face no real conflict of interest issues in representing both a debtor and the DIP. However, the line dividing the representation of the two is sometimes not so clear. This is especially the case in an individual chapter 11 filing.
It is relatively simple to explain to the owners of “debtor corporate company” that filing for chapter 11 creates a new abstract entity, “DIP company,” to which the owners now owe their loyalty and fiduciary duties. How does an attorney clearly explain to his or her individual chapter 11 client that, as a DIP, that client may no longer act in his or her own interest but must act for the benefit of those pesky creditors? Better yet, how does that attorney conceptualize his or her “dual” representation of the debtor and DIP? These questions become most troubling when the interests of the debtor and the DIP diverge. The In re Dixon [3] decision from Northern District of California may hold the answers.
The Ninth Circuit, in In re Perez, warned counsel for individual chapter 11 debtors that it is their responsibility to “help lead the estate on a just, speedy, inexpensive and lawful path out of bankruptcy. Failure to live up to this responsibility may result in a reduction in allowable fees and other sanctions.” [4] The Perez court admonished counsel to remember that “his client is the estate and not the debtor individually.” [5] The attorney in Dixon might not have heard these warnings, but certainly knows now, as the Dixon court made good on the threats of Perez when it denied the attorney’s fees for taking actions on debtor’s behalf that the court considered contrary to the interest of the estate.
The attorney in Dixon assisted his client, an individual, in filing a chapter 11 petition. Like most attorneys in his position, after the filing, the attorney moved that he be appointed as the DIP’s counsel . The trouble began when a creditor objected to the debtor’s exemption of more than $1 million in retirement funds. The attorney vigorously defended the million-dollar exemption on the debtor’s behalf. The court failed to specify whether the debtor’s attorney’s efforts were successful; regardless, he certainly came out behind when the court slashed his fees by $8,000, “the approximate amount [the attorney] billed for defending the claim of exemption.” [6] In Perez, counsel’s wayward actions amounted to proposing—and defending—three different chapter 11 plans despite a “clear understanding” that those plans did not satisfy the requirements of 11 U.S.C. § 1129(b)(2), [7] which the court noted, may well have helped the debtor as an individual, but were not in the best interest of the estate, and may have been contrary to the DIP’s fiduciary duty to his creditors.
Other courts have recognized that it is possible for a single attorney to represent both the debtor individually and the DIP. [8] Despite the DIP’s presence, a debtor still has some individual duties during the pendency of the bankruptcy case; for instance, filing schedules and completing tax returns as they come due. In dicta, the In re Bame court recognized that a single attorney can engage in certain actions that counsel, the DIP and certain other actions that counsel the debtor individually. The Bame court acknowledged that “it is clear that under certain circumstances it is perfectly acceptable for the attorney for the DIP to represent the Debtor individually.”
What is not so clear is under what circumstances an attorney might be prohibited from representing both the DIP and the debtor individually. If it is the debtor’s responsibility under § 521 to prepare schedules, which can permissibly be done post-filing, whose interest must the attorney have in mind when preparing Schedule C, the list of exemptions if such attorney has also been appointed as counsel for the DIP? The Dixon court ultimately held that it was a conflict of interest for the attorney to defend a claim of exemption. If so, is it likewise inappropriate for an attorney to claim those exemptions in the first place if schedule C is prepared post-filing?
Similar questions can also arise regarding an individual debtor’s monthly expenses, where for instance, the debtor desires to keep making monthly mortgage payments of $5,000 on his or her more-than-adequate home, or continue leasing a luxury car at $3,000 per month each and reaffirm these debts. Such expenses could certainly be considered a waste of the estate’s assets, and not in line with the DIP’s duty to act in the interest of the creditors.
If a conflict does arise between the DIP and debtor, should the debtor be forced to retain his or her own counsel? If all of the debtor’s post-petition income is an asset of the estate, how will the debtor pay for the new attorney? Maybe the answer is that these circumstances require the appointment of a trustee for the estate. If one thing is certain, after the Dixon case, it should weigh heavily on the minds of counsel for individual chapter 11 debtors that such attorney’s loyalties and responsibilities are to the estate; lest they forget, and find their purses weighing much less heavily in their pockets.