When an individual is the chapter 11 debtor in possession, Bankruptcy Judge Christopher G. Bradley of Austin, Texas, explained why the usual rules for retention of counsel do not apply when the attorney is representing the debtor personally and not the interests of the estate.

An individual was planning to file for chapter 11 reorganization but evidently recognized there was likely to be a complaint seeking a declaration that a particular debt was not subject to discharge under Section 523(a).

Two days before filing, the debtor hired an attorney to serve as special counsel by providing defense in the contemplated dischargeability action. From personal funds, the debtor paid the attorney a $60,000 non-refundable fee. The attorney filed the necessary disclosures and sought approval of retention under Sections 327(e) and 328(a), with compensation subject to approval of a final fee application under Section 330.

Judge Bradley wrote his February 19 opinion to explain why the usual rules of retention did not apply because counsel would not be representing the interests of the estate.

In bankruptcy, Judge Bradley said that a “crucial distinction” exists between the debtor and the estate. In chapter 11 with an individual debtor, he said that the distinction is “more difficult to draw.” He observed that an individual debtor may need to protect itself in a tax matter, for instance, where there would be no benefit for or effect on the estate.

As another example, Judge Bradley said that courts “have long struggled, for instance, with how and to what degree individual debtors’ divorce counsel may benefit the estate and therefore be retained under section 327.”

If services do not benefit the estate, Judge Bradley said that the “general rule” is that “they cannot be paid from estate assets.” For chapters 12 and 13, though, he cited Section 330(a)(4)(B) and said that Congress “softened the rule.”

When services did not benefit the estate and were not necessary for administration, the subsection says that in a chapter 12 or 13 case, “the court may allow reasonable compensation to the debtor’s attorney for representing the interests of the debtor in connection with the bankruptcy case based on a consideration of the benefit and necessity of such services to the debtor and the other factors set forth in this section.” However, the subsection does not apply in chapter 11 cases.

In a chapter 11 case with an individual debtor, Judge Bradley nonetheless saw the answer as “relatively clear: debtors do not need to run the full retention and compensation gauntlet when retaining counsel to represent themselves and not the estate.” He went on to say that “such a retention is permitted even without the Court’s approval; indeed, denial of the debtor’s ability to obtain counsel under those circumstances would be a remarkable deprivation.”

To Judge Bradley’s way of thinking, “The Code’s retention requirements . . . do not . . . regulate the debtor’s retention of counsel for its own sake.”

Regarding nondischargeability where there is not an effect on the estate, Judge Bradley said that the “Court is unlikely to be able to approve [special counsel’s] fees under section 330.” Although an individual chapter 11 debtor has fiduciary duties to the estate, he said that “debtors-in-possession are entitled to vigorously litigate any proceedings in which they are personally entangled.”

Concerned that making special counsel’s fees subject to approval under Section 330 might leave the court unable to approve fees, Judge Bradley said that he “doubts that approval under section 330 is necessary or indeed proper.” Moreover, he said it “is also doubtful that [special counsel] needs to be retained under section 327(e) of the Code,” because it too “nonetheless requires a demonstration of benefit to the estate.”

At the upcoming hearing for approval of special counsel’s retention, Judge Bradley directed parties in interest to challenge the idea that the attorney need not be retained under Section 327(e) and that the court is not required to identify benefit to the estate.

Judge Bradley said he was also prepared to rule that special counsel’s “compensation is not [subject to approval] under section 328 or subject to review under section 330 of the Bankruptcy Code but rather is subject only to the limited review provided under section 329 of the Bankruptcy Code.”