Two Opinions on Disallowance of Compensation After Appointment of a Trustee

One ill-fated reorganization spawned opinions on successive days from the Ninth Circuit Bankruptcy Appellate Panel and Bankruptcy Judge Christopher M. Klein on esoteric issues regarding objections to fee applications.

The debtor manufactured photovoltaic cells and filed a chapter 11 case that lasted six months before the creditors’ committee filed a motion and Judge Klein appointed a chapter 11 trustee. Eventually, the chapter 11 trustee agreed to liquidate and confirmed a liquidating plan. The plan created a post-confirmation liquidating trustee.

While the debtor was in the driver’s seat as debtor in possession, the debtor retained a law firm as special counsel to represent the company in five lawsuits. After the debtor in possession was ousted, the chapter 11 trustee decided not to pursue the lawsuits.

After confirmation of the liquidating plan, special counsel filed an application for a final allowance of some $450,000 in compensation. The U.S. Trustee and the liquidating trustee objected.

Judge Klein on Conflict Preemption

Sitting in Sacramento, Calif., Judge Klein said that special counsel “took so much umbrage at the objections” that the firm sued the chapter 11 trustee, the liquidating trustee and their lawyers on a multitude of state law claims, including abuse of process, fraud, conspiracy and breach of contract. Special counsel demanded a jury trial and punitive damages.

In his June 27 opinion, Judge Klein said that the “doctrine of conflict preemption spells doom for special counsel,” because “Congress has preempted all of the common-law causes of action alleged in the pleadings.” He explained that the doctrine of preemption is derived from the Supremacy Clause.

Preemption comes in two forms: express preemption and implied preemption, Judge Klein said. Implied preemption has two incarnations: conflict preemption and field preemption. The case at hand involved conflict preemption.

There is conflict preemption when state and federal law conflict, making it impossible to comply with both, or when state law is an obstacle to the accomplishment of objectives of Congress.

In Section 330(a) together with Bankruptcy Rules 2016(a) and 9014, Judge Klein said that Congress created a “comprehensive . . . scheme for employing and compensating professionals in bankruptcy cases . . . intended to provide mandatory standards for compensation awards.” He said that allowing special counsel to pursue the state law claims would erect an obstacle to the accomplishment of the congressional objectives.

Judge Klein held that the claims in special counsel’s adversary proceeding “conflict with the comprehensive scheme of Congress for compensating such professionals and are preempted,” and that counsel’s “exclusive remedy is by way of its contested fee application under § 330,” where “it will be able to present all of the facts that it believes support the adversary proceeding that is preempted.”

Judge Klein dismissed the complaint for lack of subject matter jurisdiction, mentioning Rule 9011 and saying that special counsel were not “without redress.”

The Ninth Circuit BAP on Lamie

The day before Judge Klein wrote on conflict preemption, the Ninth Circuit BAP dealt with an appeal from an order where Judge Klein cited Lamie v. U.S. Trustee, 540 U.S. 526 (2004), and disallowed some $25,500 in compensation for work by the debtor’s primary counsel after appointment of a chapter 11 trustee.

The BAP’s nonprecedential opinion on June 26 characterized Lamie as holding “that § 330(a) prohibits an award of compensation to a debtor’s attorney after a chapter 7 trustee is appointed, unless the attorney is employed by the trustee under § 327,” because conversion to chapter 7 terminated the debtor’s status as a debtor in possession and thus also terminated counsel’s services.

The BAP reasoned that “Lamie is equally applicable to appointment of a chapter 11 trustee” and thereby terminates the “attorney’s service under § 327.”

The BAP affirmed Judge Klein’s denial of the debtor’s counsel’s compensation for the period after appointment of the chapter 11 trustee.