Even if a debtor’s counsel was not required by Section 504 to disclose a fee sharing agreement, nondisclosure may nonetheless violate Section 329, according to Bankruptcy Judge John T. Dorsey of Delaware.
Because it was the firm’s second nondisclosure offense — and because the second offense entailed nondisclosure of a fee sharing arrangement — Judge Dorsey disqualified the firm in a September 4 opinion. He also ordered disgorgement of fees.
The Prior Nondisclosure Sanction
In two opinions about one year ago, Judge Dorsey sanctioned the same firm $55,000 for failing to disclose that it was actually two law firms doing business under a fictitious name, and thus was sharing compensation without disclosure.
At the time, Judge Dorsey declined to impose more severe sanctions because they were not bankruptcy lawyers and thus were “not accustomed to the stringent disclosure requirements mandated by the Bankruptcy Rules.” NNN 400 Capital Center LLC v. Wells Fargo Bank NA (In re NNN 400 Capital Center LLC), 18-50384, 2019 BL 388754 and 2019 BL 298715, 2019 Bankr. Lexis 2485 (Bankr. D. Del. Aug. 9 and Oct. 9, 2019). To read the ABI report, click here.
After the sanctions a year ago, Judge Dorsey ordered the firm to file accurate disclosures. It turned out that the new disclosures were inaccurate, too. He opened his new opinion by saying that the “integrity of the bankruptcy system . . . is dependent in large part on the ethical conduct of lawyers, their adherence to the law, and their compliance with the rules of the courts before which they appear.”
Nondisclosures the second time around again came to light in a lawsuit the firm was prosecuting on behalf of the debtor against several defendants. The defendants and the U.S. Trustee filed a motion asking Judge Dorsey to disqualify the firm and order disgorgement of fees.
The Second Nondisclosures
Judge Dorsey held two days of hearings in July and found that the firm failed to disclose a fee sharing arrangement with a “finder” hired to obtain financing for the debtor.
On top of the failure to disclose the fee sharing agreement, Judge Dorsey found that the firm had caused the debtor to pay the finder’s expenses without court approval. As if that wasn’t enough, Judge Dorsey also found that the firm failed to disclose that it represented one of the debtor’s largest unsecured creditors.
In response to defenses the firm proffered at the hearing, Judge Dorsey three times said that the testimony lacked credibility. Twice, he said the testimony “lacks all credibility.”
Judge Dorsey ruled that the failure to disclose the representation of the creditor violated Section 327(e) and Bankruptcy Rule 2014.
Finding a disclosure violation with regard to the fee sharing arrangement was more complicated. With two exceptions not applicable, Section 504(a) provides that “a person receiving compensation or reimbursement under section 503(b)(2) or 503(b)(4) of this title may not share or agree to share (1) any such compensation or reimbursement with another person; or (2) any compensation or reimbursement received by another person under such sections.”
In Judge Dorsey’s understanding of Section 504(a), a violation turned on whether the firm was sharing compensation with a professional whose employment required court approval under Section 327(a). Judge Dorsey decided that the sharing was with a “finder” whose retention was not required under Section 327(a). The finder’s fees would be paid as an expense of administration, he said, not as allowances of compensation.
Although there was no violation of Section 504(a), Judge Dorsey said that the firm “is not out of the woods.” He ruled that the firm still “had an affirmative duty under the Code to notify the Court of its fee splitting arrangement.”
Why? Because Section 329 requires disclosure of fees paid “or agreed to be paid . . . in connection with the case . . . .” Judge Dorsey said that the duty to disclose applies “even though the payment would not come from the estate.”
But wait, there’s more. Nondisclosure of the fee sharing agreement also violated Section 327(e) and Rule 1.8(a) of the Model Rules of Professional Conduct.
Why? Because the fee sharing agreement gave rise to an interest adverse to the debtor or the estate.
Judge Dorsey said there was an adverse interest because the firm had a “bias” to favor the approval of financing located by the finder “over other brokers to the potential detriment of the estate.”
The firm raised several defenses. One was based on the lack of a written agreement to share fees. Judge Dorsey rejected the argument, saying, “Nothing in the Code or Rules regarding disclosure under section 329 requires that there be a formal written agreement.”
Judge Dorsey ruled, among other things, that (1) failure to disclose a prepetition sharing agreement violated Section 328 and Rule 2014; (2) failure to disclose the post-petition sharing agreement violated Section 329 and Rule 2016(b); (3) the sharing agreement created an adverse interest in violation of Section 327(e); and (4) failure to disclose representation of the creditor violated Section 327 and Rule 2014.
Judge Dorsey disqualified the firm from representing the debtor. Within 30 days, he ordered the firm to disgorge within 30 days fees paid or to be paid, and directed the firm to refund $11,400 in expenses paid to the finder. He said that the fee sharing agreement “itself” rendered the firm ineligible to serve as special counsel.
Judge Dorsey was appointed to the bankruptcy bench in Delaware in June 2019 after 16 years as a partner at Young Conaway Stargatt & Taylor LLC in Wilmington, Del.
Even if a debtor’s counsel was not required by Section 504 to disclose a fee sharing agreement, nondisclosure may nonetheless violate Section 329, according to Bankruptcy Judge John T. Dorsey of Delaware.
Because it was the firm’s second nondisclosure offense — and because the second offense entailed nondisclosure of a fee sharing arrangement — Judge Dorsey disqualified the firm in a September 4 opinion. He also ordered disgorgement of fees.
The Prior Nondisclosure Sanction
In two opinions about one year ago, Judge Dorsey sanctioned the same firm $55,000 for failing to disclose that it was actually two law firms doing business under a fictitious name, and thus was sharing compensation without disclosure.
At the time, Judge Dorsey declined to impose more severe sanctions because they were not bankruptcy lawyers and thus were “not accustomed to the stringent disclosure requirements mandated by the Bankruptcy Rules.” NNN 400 Capital Center LLC v. Wells Fargo Bank NA (In re NNN 400 Capital Center LLC), 18-50384, 2019 BL 388754 and 2019 BL 298715, 2019 Bankr. Lexis 2485 (Bankr. D. Del. Aug. 9 and Oct. 9, 2019).