If the terms of retention of a professional were not “improvident” when the court approved the arrangement, Bankruptcy Judge Christopher S. Sontchi of Delaware explained the statutory authority beyond Section 328(a) for revising the terms later if it appears that counsel had an “actual conflict.”
The February 17 opinion by Judge Sontchi is an outgrowth of his decision on December 27, about a chapter 7 trustee who couldn’t afford to prosecute estate claims, so the trustee agreed for the secured lender to finance litigation.
As approved by Judge Sontchi not long after the outset of the case, the agreement gave the trustee a small cut of the recoveries. The agreement also allowed the lender’s $25 million claim secured by all assets, including lawsuit recoveries. See Carickhoff v. Goodwin (In re Decade SAC LLC), 19-50095, 2021 BL 491197, 2021 Bankr Lexis 3525 (Bankr. D. Del. Dec. 27, 2021).
Here’s the kicker: The agreement allowed the lender to choose and pay special counsel, who were not required to file fee applications nor to disclose what they were paid, not even to the U.S. Trustee.
And here’s the bigger kicker: The agreement precluded the trustee from settling claims without the lender’s consent.
Judge Sontchi approved the terms of the agreement and retention of special counsel.
After trial, the lawsuit brought by special counsel was a disaster for the estate. Judge Sontchi dismissed the trustee’s claims, finding that the defendant had been defrauded, not the other way around.
Judge Sontchi closed his opinion by directing the parties to hold a trial at the court’s “earliest convenience” to determine the compensatory and punitive damages to be awarded against the debtor and in favor of the defendant. The judge also said he would decide whether the lender’s allowed $25 million claim should be subordinated to the defendant’s claims. To read ABI’s report on the December 27 decision, click here.
The Next Shoe to Drop
A week after his December 27 decision, Judge Sontchi entered an order to show cause “as to why the terms and conditions of the employment of Special Counsel as set forth in the Stipulation should not be rescinded or modified in accordance with 11 U.S.C. § 328(a).” Judge Sontchi held the show cause hearing on February 16 and handed down his decision the next day. He said that special counsel had no conflict of interest at the time of retention.
Circumstances changed, however. Judge Sontchi said that special counsel was simultaneously representing the secured lender and the trustee, whose interests came in conflict later. He held that special counsel had developed “an actual, non-waivable conflict requiring Special Counsel’s disqualification.”
Still, the question remained: The result of the litigation conferred no benefit on the estate, but how could Judge Sontchi potentially require special counsel to disgorge fees when the original terms of retention gave him no authority to oversee compensation that was paid by the secured lender?
Section 328(a) permits the court to “allow compensation different from the compensation provided under [the retention order], if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.”
“[I]ndependent of the issue of whether the terms of Special Counsel’s employment were improvident . . . under 11 U.S.C. § 328(a),” Judge Sontchi found other statutory authority to change the terms of retention and review the fees paid to special counsel.
Section 327(c) provides that a professional “is not disqualified for employment . . . solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.”
Judge Sontchi worked under the assumption that Section 327(c) requires objection from a creditor or the U.S. Trustee, but there are other avenues to revisit the retention order. Section 327(a) “does not include similar language,” he said.
Where the Bankruptcy Code allows a party in interest to raise an issue, Judge Sontchi cited the Tenth Circuit for allowing the bankruptcy court to take action sua sponte to prevent an abuse of process. In re Interwest Bus. Equip., 23 F.3d 311, 317 (10th Cir. 1994).
Judge Sontchi therefore held that he could “consider the issue of whether Special Counsel has a disqualifying conflict of interest sua sponte and independent of the issue of whether the terms of Special Counsel’s employment were improvident at the time the parties entered into the Stipulation under 11 U.S.C. § 328(a).”
In a footnote he also cited Section 327(a), which allows the court to “deny allowance of compensation . . . if, at any time during such professional person’s employment . . . , such professional person is not a disinterested person, or represents or holds an interest adverse to the interest of the estate with respect to the matter on which such professional person is employed.”
Having found that special counsel developed an actual conflict, Judge Sontchi vacated his original order with prejudice, which had approved the agreement between the trustee and the lender and authorized the retention of special counsel.
Last, Judge Sontchi directed special counsel to file a fee application within 20 days. And here’s the last kicker: He said that “[a]ll fees and expenses already paid to Special Counsel that are not ultimately allowed by the Court, from whatever source, may be subject to disgorgement to the payor.”
More Shoes to Drop
Disallowance or disgorgement of fees may not be the end of the story. Now that the trustee once again has the right to sue and settle, does the trustee have affirmative claims against special counsel or the lender, given the finding of an actual conflict and the possibility that crucial information might have been withheld from the trustee at the outset? Does the defendant have affirmative claims against the lender, buttressed by Judge Sontchi’s decisions? Were there Rule 11 violations?
If there ever was a case where the parties should settle before it gets worse, this is it.
If the terms of retention of a professional were not “improvident” when the court approved the arrangement, Bankruptcy Judge Christopher S. Sontchi of Delaware explained the statutory authority beyond Section 328(a) for revising the terms later if it appears that counsel had an “actual conflict.”
The February 17 opinion by Judge Sontchi is an outgrowth of his decision on December 27, about a chapter 7 trustee who couldn’t afford to prosecute estate claims, so the trustee agreed for the secured lender to finance litigation.
As approved by Judge Sontchi not long after the outset of the case, the agreement gave the trustee a small cut of the recoveries. The agreement also allowed the lender’s $25 million claim secured by all assets, including lawsuit recoveries.