By: Donald L Swanson
Debtor’s Chapter 11 counsel cannot be compensated for services performed after a trustee is appointed and the debtor removed from possession.
- That’s the rule of law in the Fifth Circuit and in a not-for-publication decision of the Ninth Circuit’s Bankruptcy Appellate Panel, based on a U.S. Supreme Court ruling.
So . . . the question is, what about Subchapter V? Does that same no-compensation rule apply in Subchapter V when the debtor is removed from possession?
Ninth Circuit BAP Opinion
In Gonzalez & Gonzalez Law, P.C. v. United States Trustee (In re Sunergy California LLC), the Ninth Circuit BAP decides (on June 26, 2023) this question in a standard Chapter 11 case:
- Did the bankruptcy court abuse its discretion by denying the fee application of Debtor’s counsel for services rendered after appointment of the Chapter 11 Trustee?
The Ninth Circuit BAP makes these determinations:
- “Upon the chapter 11 trustee’s appointment, the debtor ceases to be a debtor in possession, and its attorney’s service under § 327 terminates”[fn. 1];
- Debtor’s attorney “was not employed by Trustee under § 327”; and
- So, the post-appointment services of Debtor’s attorney “are not compensable by the estate under § 330″[fn. 2].
In reaching such determinations, the Ninth Circuit BAP relies upon the U.S. Supreme Court opinion of Lamie v. United States Trustee, 540 U.S. 526 (2004), like this:
- in Lamie, the Supreme Court holds 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;
- Lamie reasons that conversion to chapter 7 terminates debtor’s status as debtor-in-possession and so terminates its attorney’s service under § 327; and
- the Lamie reasoning is equally applicable to appointment of a Chapter 11 trustee—upon such appointment:
- debtor ceases to be a debtor in possession; and
- its attorney’s service under § 327 terminates.
The Ninth Circuit BAP’s ruling is not the first circuit-level opinion on that compensation question.
Two Fifth Circuit Opinions
The Fifth Circuit previously addresses the same question and reaches the same conclusion—twice:
- In In re Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998), the Court denies compensation to a Chapter 11 debtor’s counsel, after removal of the debtor from possession by appointment of a Chapter 11 trustee, like this:
- “In this case, we are faced with a statute which is clear on its face. It excludes attorneys from its catalog of professional officers of a bankruptcy estate who may be compensated for their work after the appointment of a Chapter 11 trustee” (157 F.3d at 425 (reversed on other grounds)); and
- Then, after the U.S. Supreme Court issues its Lamie opinion in 2004, the Fifth Circuit Court of Appeals addresses the same compensation question, again, and reaches the same conclusion in In re Woerner, 783 F.3d 266, 273 (5th Cir. 2016), like this:
- “We first took up the issue [in Pro-Snax] of ‘whether a Chapter 11 debtor’s attorney may be compensated for work done after the appointment of a trustee under § 330(a) of the Bankruptcy Code’”;
- “§ 330, on its face, precludes any award of fees to a debtor’s attorney for that attorney’s work performed after a Chapter 11 trustee has been appointed”; and
- “The Supreme Court later vindicated this holding in Lamie v. U.S. Trustee.”
U.S. Supreme Court Opinion
Between the time of the Fifth Circuit’s 1998 Pro-Snax opinion and its 2016 Woerner opinion, the U.S. Supreme Court decides Lamie v. U.S. Trustee—in 2004.
In Lamie, the U.S. Supreme Court denies compensation to a Chapter 11 debtor’s counsel for services performed after conversion of the case to Chapter 7. It does so under the “plain meaning” of Bankruptcy Code provisions, like this:
- “Section 330(a)(1) . . . regulates court awards of professional fees, including fees for services rendered by attorneys in connection with bankruptcy proceedings”;
- debtor’s bankruptcy attorney is seeking compensation under § 330(a)(1) “for legal services he provided to a bankrupt debtor after the proceeding was converted” to chapter 7; and
- in Chapter 7, §330(a)(1) “does not authorize payment of attorney’s fees unless the attorney has been appointed under §327 of the Code.”
The U.S. Supreme Court’s Lamie opinion cites the Fifth Circuit’s Pro-Snax decision as authoritative, like this:
- “The Courts of Appeals for the Fifth and Eleventh Circuits, when asked to interpret current §330(a)(1), concluded that . . . fees may be awarded to attorneys for services rendered only to the extent they are payments to ‘a professional person employed under §327’ . . . See In re Pro-Snax Distributors, Inc., 157 F. 3d 414 (CA5 1998)”; and
- “If we add to all this the apparent sound functioning of the bankruptcy system under the plain meaning approach, petitioner’s arguments become unconvincing. Seemingly, order has attended the rule’s application for five years in the Fifth Circuit and for four years in the Eleventh Circuit. See . . . In re Pro-Snax Distributors, Inc., 157 F. 3d 414 (CA5 1998).”
Application to Subchapter V
The Fifth Circuit’s rulings and rationale in both Pro-Snax and Woerner are in standard Chapter 11 cases where the debtor in possession is displaced by appointment of a Chapter 11 trustee.
Such Fifth Circuit rulings and rationale are not only consistent with the Supreme Court’s ruling and rationale in Lamie’s conversion of a Chapter 11 case to Chapter 7, they could also have the same effect for Subchapter V cases in which the debtor in possession is removed and displaced by the Subchapter V trustee. Here’s why:
- a debtor in possession has the powers, rights, functions and duties of a “trustee” in both standard Chapter 11 (see § 1107) and Subchapter V (see § 1184);
- appointment of a trustee in standard Chapter 11 displaces the debtor—i.e., removes debtor from possession (under § 1101(1))[fn. 3] and puts the newly appointed trustee in charge of the bankruptcy estate (under § 1106);
- removal of a Subchapter V debtor from possession (under § 1182(2))[fn. 4] has the same displacing effect—removes debtor from possession and puts the Subchapter V trustee in charge of the bankruptcy estate (under § 1183(b)(5))[fn. 5]; and
- § 327 authorizes employment of professional persons . . . but only by a “trustee” (not by the debtor).
Moreover, the only difference of significance in powers and duties between the appointed trustee in a standard Chapter 11 case and a Subchapter V case is this:
- the Subchapter V trustee cannot file a plan (see § 1189(a))[fn. 6]; but
- an appointed trustee can file a plan in a standard Chapter 11 case (see § 1106(5))[fn. 7].
Notably, in both standard Chapter 11 and Subchapter V, a debtor that is displaced from possession:
- can be reinstated as debtor in possession (see § 1185(b)[fn. 8] and § 1105[fn. 9]); and
- can still file a plan (see § 1189(a) and § 1121(a)[fn. 10].
Conclusion
Probabilities seem high that the no-compensation rationale for debtor’s counsel, after appointment of a trustee in standard Chapter 11, will apply with equal effect after removal of a Subchapter V debtor from possession.
Opinions from the Fifth Circuit and Ninth Circuit BAP seem to have significance, particularly in light of their foundation in a U.S. Supreme Court opinion.
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Footnote 1. § 327(a) provides (emphasis added): “(a) Except as otherwise provided in this section, the trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title.
Footnote 2. § 330(a)(1) provides (emphasis added): “(a)(1) . . . the court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103—(A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and (B) reimbursement for actual, necessary expenses.”
Footnote 3. § 1101(1) provides, “In this chapter—(1) ‘debtor in possession’ means debtor except when a person that has qualified under section 322 of this title is serving as trustee in the case.”
Footnote 4. § 1182(2) provides, “The term ‘debtor in possession’ means the debtor, unless removed as debtor in possession under section 1185(a) of this title.”
Footnote 5. § 1183(b)(5) provides, “(b) Duties.—The trustee shall . . . (5) if the debtor ceases to be a debtor in possession—(A) perform the duties specified in section 704(a)(8) and paragraphs (1), (2), and (6) of section 1106(a) of this title; and (B) be authorized to operate the business of the debtor.”
Footnote 6. § 1189(a) provides, “(a) Who May File A Plan—Only the debtor may file a plan under this subchapter.”
Footnote 7. § 1106(a)(5) provides, “(a) A trustee shall— . . . (5) as soon as practicable, file a plan under section 1121 of this title, file a report of why the trustee will not file a plan, or recommend conversion of the case to a case under chapter 7, 12, or 13 of this title or dismissal of the case.”
Footnote 8. § 1185(b) provides, “(b) Reinstatement.—On request of a party in interest . . . the court may reinstate the debtor in possession.”
Footnote 9. § 1105 provides, “At any time before confirmation of a plan, on request of a party in interest or the United States trustee, . . . the court may terminate the trustee’s appointment and restore the debtor to possession and management of the property of the estate and of the operation of the debtor’s business.”
Footnote 10. § 1121(a) provides, “(a) The debtor may file a plan with a petition commencing a voluntary case, or at any time in a voluntary case or an involuntary case.”
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