Sometimes, a trustee and a trustee’s professionals can be paid more than the distribution to unsecured creditors.

Explaining when the phenomenon may occur, Bankruptcy Judge Robert J. Faris said in his May 7 opinion for the Ninth Circuit Bankruptcy Appellate Panel that paying a trustee and a trustee’s professionals more than unsecured creditors “does not necessarily justify a reduction of a chapter 7 trustee’s statutory commission or the professionals’ fees.”

The Secured Lender’s Carveout

The corporate debtor in chapter 11 owned valuable, although over-encumbered, property. Unable to sell the asset for more than the liens, the case converted to chapter 7.

The bankruptcy judge said that the litigious case was a “mess” and that unsecured creditors would have received nothing absent settlements negotiated by the chapter 7 trustee. Prominently, the senior secured lender agreed in a settlement to cap its claim at $70 million and to carve out 6.25 percent of the sale price to cover administrative expenses and a “meaningful distribution” for unsecured creditors.

Ultimately, the trustee arranged to sell the property to a third party for about $63 million, yielding a carveout of $3.75 million. At the cost of reducing their own compensation, the chapter 7 trustee and the professionals agreed that unsecured creditors would receive not less than $700,000. The junior secured lender, who would receive nothing from the sale, consented to the sale and the carveout while reserving the right to object to fees.

Filing final applications for compensation, the trustee sought statutory commissions of about $1.8 million. The trustee’s accountants and attorneys sought another $1.8 million.

The junior lender objected to the fees, contending that the trustee and professionals collectively should not receive more than unsecured creditors. The bankruptcy judge granted the requested commissions, fees, and expenses, reducing the total awards to about $3 million in view of the trustee’s and the professionals’ voluntary reductions to afford a $700,000 distribution to unsecured creditors.

The junior lender appealed to the BAP, which reviewed for abuse of discretion.

The Presumption of Reasonableness

Citing Ninth Circuit BAP opinions as precedent, Judge Faris said “that trustee compensation calculated under § 326(a) is presumptively reasonable and should be allowed absent extraordinary circumstances.” If there are extraordinary circumstances, the court must “determine whether there was a ‘rational relationship’ between the amount of the requested fees and the trustee’s work on the case.”

Although the BAP has not defined “extraordinary circumstances,” he said that the BAP has “provided one example of a circumstance that is not extraordinary per se: the mere fact that the trustee’s requested compensation exceeds the proposed distribution to unsecured creditors.”

Indeed, the bankruptcy court had found there were no extraordinary circumstances. Among other factors, the bankruptcy court said the case was a no-asset “mess” where unsecured creditors would have received nothing were it not for the settlements and efforts by the trustee and the trustee’s professionals.

The findings were not clearly erroneous, Judge Faris said. Furthermore, he said that the junior lender’s argument was a “back-door attack” on the carveout, to which the lender had consented. He therefore declined the lender’s “invitation to define or enumerate any circumstances that are extraordinary per se.”

Judge Faris upheld the allowance of the trustee’s commissions, because the lender “failed to offer the court any evidence to rebut the presumption of reasonableness” arising under Sections 330(a)(7) and 326(a).

Different Standard for Professionals

Regarding the allowances for the trustee’s professionals, the junior lender once again objected, because their compensation was more than twice the recovery by unsecured creditors. On account of Section 330(a), a “different standard governs compensation for the Trustee’s professionals,” Judge Faris said.

Regarding allowances to the professionals, Judge Faris found no abuse of discretion and no clearly erroneous findings of fact. He said that the bankruptcy judge “correctly rejected” the lender’s contention that the professionals’ compensation should not exceed the distribution to unsecured creditors.

Judge Faris affirmed the bankruptcy court’s allowances of commissions, compensation and expenses.