A. Oversight of the Case
7. Professionals and Compensation Issues
Recommended Principles:
• The debtor’s professionals should be clearly identified as either working on matters relating to the chapter 11 case (“chapter 11 professionals”) or on matters unrelated to the chapter 11 case (“nonbankruptcy professionals”).
• The Bankruptcy Code should define a “nonbankruptcy professional” as an individual or firm of lawyers, financial advisors, accountants, consultants, or other professionals retained by the debtor prior to or after the petition date working exclusively on business or legal matters that arise in, or relate primarily to, the day-to-day operations of the debtor’s business and that could not have a material effect on the chapter 11 case.
• Only chapter 11 professionals should be subject to sections 327 and 330.
• The debtor should file with the court a list of its nonbankruptcy professionals with its chapter 11 petition and then subsequently on a quarterly basis. That filing should include the name of each professional and a general description of the work being performed by that professional. The court sua sponte, the U.S. Trustee, or a party in interest should be able to object to the classification of a professional as a nonbankruptcy professional. If the court, after notice and a hearing, sustains such objection, the professional should be subject to sections 327 and 330 only on a prospective basis. This principle does not obviate the trustee’s need to otherwise comply with the U.S. Trustee’s requirements for quarterly operating reports. • To the extent professionals representing ad hoc committees, parties to any
agreement or settlement, or secured creditors in the chapter 11 case would be paid their fees and expenses directly or indirectly (e.g., contractual provisions with junior creditors) from the estate under the Bankruptcy Code (either through a substantial contribution motion, the creditors’ proof of claim, the chapter 11 plan, or other order of the court), the approval and payment of their fees and expenses should be subject to the reasonableness standards set forth in section 330(a). • Professionals retained by the debtor in possession or any statutory committee
should not be considered fiduciaries of the estate. Rather, those professionals’ duties should run to their respective clients and be governed by applicable nonbankruptcy law.
• A court should be permitted to authorize a trustee or an estate neutral to act not only as an attorney or an accountant for the estate, but also as a professional service provider for the estate to the extent that such authorization is in the best interests of the estate. The employment of a trustee or an estate neutral to act as a professional service provider should remain subject to appropriate limitations and restrictions to avoid self-dealing or other action that is improper or not in the best interests of the estate. Section 327(d) should be amended accordingly.
Professionals and Compensation Issues: Background
Nonbankruptcy Professionals
A debtor in possession182 generally must seek court approval to retain professionals to assist it with the chapter 11 case. Specifically, section 327(a) of the Bankruptcy Code provides: “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.”183 The fees and expenses of professionals retained under section 327 are subject to court
approval under section 330 of the Bankruptcy Code.184
The Bankruptcy Code does not define “professional persons” or specifically address the debtor in possession’s ability to hire and pay professionals to assist with nonbankruptcy matters that arise in the operation of the debtor’s business. The one exception to this statement involves lawyers retained for a special purpose. Section 327(e) provides: “The trustee, with the court’s approval, may employ, for a specified special purpose, other than to represent the trustee in conducting the case, an attorney that has represented the debtor, if in the best interests of the estate, and if such attorney does not represent or hold any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed.”185 In general, courts tend to define “professional” in one of two ways, focusing on whether the entity either (i) plays a central role in the administration of the estate, or (ii) is allowed to exercise judgment and autonomy in matters concerning the administration of the estate.186 Accordingly, debtors in possession frequently seek clarification from the court concerning the scope of “professionals” retained by the debtor in possession and its ability to pay these professionals in the ordinary course of business.187
The disinterestedness standard generally requires that the professional not be a creditor or, within the two years before the petition date, a director, officer, or employee of the debtor. It also mandates that the professional not hold “an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor.”188 Some courts interpret disinterestedness strictly, disqualifying any professional holding actual or potential conflicts of interest with the debtor.189 Other courts take
182 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107 of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
183 11 U.S.C. § 327(a).
184 Id. § 330. In addition, the U.S. Trustee has formulated guidelines for reviewing professionals’ fees and expenses in the chapter 11 context. See Guidelines for Reviewing Applications for Compensation and Reimbursement of Expenses, 28 C.F.R. Part 58, Appendices A & B.
185 11 U.S.C. § 327(e).
186 See, e.g., In re Am. Tissue, Inc., 331 B.R. 169, 173 (Bankr. D. Del. 2005) (using six-factor test to evaluate role of entity in case, including those above); In re Fretheim, 102 B.R. 298, 299 (D. Conn. 1989) (focusing on autonomy and judgment factors); In re Seatrain Lines, Inc., 13 B.R. 980, 981 (Bankr. S.D.N.Y. 1981) (focusing on role of entity in administration of estate). But see In
re Metro. Hosp., 119 B.R. 910, 916 (Bankr. E.D. Pa. 1990) (defining professional as “someone with special knowledge and skill
usually achieved through study and educational attainments whether licensed or not”). See also In re New Orleans Auction Galleries, Inc., 2013 WL 1196680 (Bankr. E.D. La. Mar. 25, 2013).
187 A debtor in possession also may seek authority to pay service providers who are not characterized as professionals and who are retained outside the ordinary course of business under section 363(b) of the Bankruptcy Code. 11 U.S.C. § 327(a).
188 Id. § 101(14)(E).
189 See, e.g., Dye v. Brown (In re AFI Holding, Inc.), 530 F.3d 832, 838 (9th Cir. 2008) (“[B]ankruptcy court did not abuse its discretion in concluding removal was proper due to the Trustee’s past affiliations with insiders that created a potential for a materially adverse effect on the estate and an appearance of impropriety resulting in ongoing disharmony in the estate’s administration.”); In re Marvel Entm’t Grp., Inc.,140 F.3d 463, 476 (3d Cir. 1998) (“(1) Section 327(a), as well as § 327(c),
a more limited view and only disqualify the professional if it holds an interest that is “materially adverse” to the estate.190
Under the current law, debtors in possession will often seek court approval of procedures for retaining and compensating “ordinary course professionals” during the pendency of the chapter 11 case. These procedures typically require the debtor to identify the specific or general types of professionals or service providers covered by the motion and to establish a cap that limits the amounts that can be paid to these entities (usually on a quarterly basis) during the case. Such ordinary course professionals may be required to file a verified statement under Bankruptcy Rule 2014(a), although debtors generally agree to submit quarterly summaries of the fees paid to these professionals. Courts routinely approve motions related to ordinary course professionals to enable a debtor to continue its operations during the chapter 11 case as efficiently as possible.
Other Professionals
The ability of debtors in possession, trustees or other estate representatives, and statutory committees to retain professionals is subject to approval by the court under section 327 of the Bankruptcy Code; the court thereafter reviews and scrutinizes the compensation requests of professionals under section 330. Other parties in the chapter 11 case may also seek reimbursement for, or payment of, their professionals’ fees and expenses from estate funds. These parties include secured creditors, creditors who are parties to an agreement or settlement with the debtor or the trustee, parties to intercreditor
agreements, and ad hoc committees.191 In some instances, such as with ad hoc committees, a party
may seek payment for its professionals under section 503(b)(3)(D) of the Bankruptcy Code, which permits the payment of the reasonable fees and expenses of “a creditor, an indenture trustee, an equity security holder, or a committee representing creditors or equity security holders other than a committee appointed under section 1102 of this title, in making a substantial contribution in a case
imposes a per se disqualification as trustee’s counsel of any attorney who has an actual conflict of interest; (2) the district court may within its discretion — pursuant to § 327(a) and consistent with § 327(c) — disqualify an attorney who has a potential conflict of interest and (3) the district court may not disqualify an attorney on the appearance of conflict alone.”); In re Martin, 817 F.2d 175, 182 (1st Cir. 1987) (“The question is not necessarily whether a conflict exists — although an actual conflict of any degree of seriousness will obviously present a towering obstacle — but whether a potential conflict, or the perception of one, renders the lawyer’s interest materially adverse to the estate or the creditors.”) (citation omitted); In re Lease-A-Fleet, Inc., 1992 U.S. Dist. LEXIS 407, at *2 (E.D. Pa. Jan. 15, 1992) (“I reject [the] argument that § 327(e) requires disqualification whenever there is a potential conflict. While some courts hold that simultaneous representation of the debtor and its guarantors is prohibited under § 327(e), such is clearly not the rule in this Circuit.”) (citing In re G&H Steel Service, Inc., 76 B.R. 508, 510 (Bankr. E.D. Pa. 1987)).
190 See, e.g., Beal Bank, S.S.B. v. Waters Edge Ltd. P’ship, 248 B.R. 668, 695 (D. Mass. 2000) (quoting In re Martin, 817 F.2d 175, 182 (1st Cir. 1987)) (“[A]n inquiry does not have to ask ‘whether a conflict exists . . . but whether a potential conflict, or the perception of one renders the lawyer’s interest materially adverse to the estate or the creditors.’”) (citations omitted); In re Leslie Fay Cos. Inc., 175 B.R. 525, 536 (Bankr. S.D.N.Y. 1994) (“[R]etention under section 327 is only limited by interests that are ‘materially adverse . . . .’”) (citations omitted). Notably, section 327(a) of the Bankruptcy Code refers to “an interest adverse to the estate” while section 101(14)(E) refers to “an interest materially adverse to the interest of the estate.” 11 U.S.C. § 327(a). 191 “A lock-up agreement — sometimes referred to as a plan-support agreement or restructuring-support agreement — often serves
as an integral component of the bankruptcy process by allowing a debtor and its key creditors to memorialize the resolution of their legal and economic disputes and permit that debtor to attempt to confirm its plan and exit bankruptcy as expeditiously as possible.” Kristopher M. Hansen et al., Post-Petition Lock-Up Agreements and Designation Standards Clarified, Am. Bankr. Inst. J., Apr. 2013, at 30. Ad hoc or unofficial committees play an important role in reorganization cases. By appearing as a ‘committee’ of shareholders, the members purport to speak for a group and implicitly ask the court and other parties to give their positions a degree of credibility appropriate to a unified group with large holdings. Moreover, the Bankruptcy Code specifically provides for the possibility of the grant of compensation to “a committee representing creditors or equity security holders other than a committee appointed under section 1102 of this title [an official committee], in making a substantial contribution in a case under chapter 9 or 11 of this title.” In re Nw. Airlines Corp., 363 B.R. 701, 703 (Bankr. S.D.N.Y. 2007) (citing 11 U.S.C. § 503(b) (3)(D)).
under chapter 9 or 11 of this title.”192 In other instances, the operative loan documents, intercreditor agreement, or other agreement may provide for such payment.
Courts generally require a party making a request under section 503(b)(3)(D) to prove “extraordinary efforts” to benefit the estate.193 Some courts also require a showing that the party in fact intended to benefit the estate through such efforts.194 Moreover, if a party establishes a substantial contribution claim under section 503(b)(3)(D), it may also be entitled to reasonable compensation “for professional services rendered by an attorney or an accountant of an entity whose expense is allowable under subparagraph (A), (B), (C), (D), or (E) of paragraph (3) of this subsection, based on the time, the nature, the extent, and the value of such services, and the cost of comparable services other than in a case under this title, and reimbursement for actual, necessary expenses incurred by such attorney or accountant.”195
Trustee and Estate Neutral Issues
As suggested above, section 327 generally permits the trustee to retain lawyers, accountants, financial consultants, and other professionals to represent the estate and assist with the administration of the estate and the debtor’s reorganization. These professionals must be disinterested and may not hold interests adverse to the estate.196 Section 327(d), in turn, “permits the court to authorize the trustee, if qualified to act as his own counsel or accountant.”197 Notably, section 327(d) is limited to the trustee and to the trustee (or its firm) acting as lawyer or accountant. This provision does not account for other professionals who may serve as trustees and who could add value to the estate by representing the estate in their professional capacities.
In addition, a chapter 11 trustee is subject to the same compensation provisions applicable to chapter 7 trustees under sections 326(a) and 330. In a chapter 7 liquidation, the mechanics of section 326(a) work well198; a trustee is compensated based on a percentage of the moneys distributed to parties in interest other than the debtor. In a chapter 11 case, however, the limitations of section 326(a) might serve as a disincentive for a trustee to seek recoveries that would result in a return of funds to equity. In fact, some courts have denied compensation to chapter 11 trustees under section 326(a) when distributions are made to the debtor, or property or value other than money is distributed in the case.199
192 11 U.S.C. § 503(b)(3)(D).
193 See, e.g., In re Granite Partners, L.P., 213 B.R. 440, 445 (Bankr. S.D.N.Y. 1997) (“[C]ompensation is limited to those extraordinary actions . . . that lead to an ‘actual and demonstrable benefit to the debtor’s estate, the creditors, and to the extent relevant, the stockholders.’”) (citations omitted); In re White Motor Credit Corp., 50 B.R. 885, 892 (Bankr. N.D. Ohio 1985) (“‘Extraordinary efforts and remarkable results’ are required for consideration of a premium payment.”).
194 See, e.g., In re Lister, 846 F.2d 55, 57 (10th Cir. 1988) (“Administrative expenses incurred prior to the filing of a bankruptcy petition are compensable under 11 U.S.C. § 503(b)(3)(D), if those expenses are incurred in efforts which were intended to benefit, and which did directly benefit, the bankruptcy estate.”); In re Alert Holdings Inc.,157 B.R. 753, 758 (Bankr. S.D.N.Y. 1993) (court held that “[n]either [the creditor’s] asserted help in forming the ad hoc committee, nor his participation in the multidistrict litigation demonstrates an intent to substantially benefit the debtors’ estates, and any benefit that may have otherwise enured to the estates can be considered unintentional and incidental.”); In re 9085 E. Mineral Office Bldg., Ltd., 119 B.R. 246, 251–52 (Bankr. D. Colo. 1990) (“[T]his Court cannot find that [the creditor’s] efforts were in no way intended to confer a benefit upon the estate as a whole.”).
195 11 U.S.C. § 503(b)(4). 196 11 U.S.C. § 327(a).
197 S. Rep. 95-989, 38 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5824. See also 11 U.S.C. § 327(d).
198 See, e.g., Pritchard v. U.S. Trustee, 153 F.3d 232 (5th Cir. 1998) (“The section is consistent with the duty of a Chapter 7 trustee to collect and reduce the property of the bankrupt’s estate to money.”).
199 See, e.g., id. at 237 (declining to follow “bankruptcy courts [that] have interpreted the section to include disbursements other than money within the calculation of a trustee’s maximum compensation”) (collecting cases). In addition, some courts hold that
Professionals and Compensation Issues: Recommendations and Findings
Nonbankruptcy Professionals
Many professionals employed by a debtor in possession during the course of a chapter 11 case do not consult or work on bankruptcy-related issues. Rather, these professionals perform services that the debtor would have required outside the bankruptcy context and even if the chapter 11 case had not been filed. For example, the debtor may employ lawyers, forensic accountants, tax accountants, and other service providers to help with ordinary course business matters such as patent applications, regulatory compliance, or litigation relating to employee claims or disputes that are not material to the chapter 11 case. The Commission referred to these types of professionals as “nonbankruptcy professionals.”
The Commissioners debated the utility of subjecting nonbankruptcy professionals to the retention standards in section 327(a) and the disclosure and reasonableness standards for professionals’ fees and expenses in section 330 of the Bankruptcy Code. The Commissioners discussed the purpose underlying the retention standards of section 327(a). In the case of professionals working on bankruptcy matters that directly impact the estate, the relationships between the professionals and the debtor, creditors, and other stakeholders in the case are material and speak to potential conflicts that could bias the advice and actions of the professionals. Conversely, nonbankruptcy professionals generally do not work on matters that affect the rights of creditors and other stakeholders in the debtor’s estate and do not address the claims of these parties or the allocation of the estate’s assets. The debtor also would have likely retained these nonbankruptcy professionals even if it had not filed the chapter 11 case; the retention would have been governed by state law, including state ethical codes for lawyers that address conflicts of interest and fee arrangements. Consequently, the Commission agreed that nonbankruptcy state laws governing many professions are sufficient to protect the interests of the estate with respect to nonbankruptcy professionals.
The Commissioners, however, recognized that the work of nonbankruptcy professionals can impact the value of an asset of the estate or the debtor. The advice of nonbankruptcy professionals concerning a certain product or their assessment or management of a particular piece of litigation could underlie a substantial gain or loss by the debtor. The Commissioners discussed examples of nonbankruptcy litigation that could have a material effect on the chapter 11 case. They weighed the costs and benefits of setting a materiality threshold or compensation cap, and whether either such limitation would capture the significant matters with which they were concerned. On balance, the Commission agreed that requiring disclosure of the name of each nonbankruptcy professional and the nature of the services provided by such professional would provide the court, the U.S. Trustee, and parties in interest with sufficient information (and perhaps more meaningful information than that provided by a compensation cap) to determine if the professional should be reclassified as a chapter 11 professional subject to the requirements of sections 327, 328, and 330, even though the professional is not rendering bankruptcy-related services. In addition, the Commission determined that, with respect to professional firms, this classification should be made based on the firm as a whole, not based on the individual professionals in such firm (i.e., if a law firm or financial firm
a credit bid by a secured creditor is not moneys for purposes of section 326(a). See, e.g., In re Lan Assocs. XI, L.P., 192 F.3d 109, 116 (3d Cir. 1999); U.S. Trustee v. Tamm (In re Hokulani Square, Inc.), 460 B.R. 763, 777–78 (B.A.P. 9th Cir. 2011).
is providing bankruptcy-related services in a debtor’s chapter 11 case, the firm’s status is imputed to all professionals, such that all professionals within that firm should be considered chapter 11 professionals).
The Commission also considered whether the reasonableness standards of section 330 should apply to the compensation requests of all professionals. Section 330 sets forth a variety of factors that the court should consider in reviewing and approving professionals’ fees and expenses. The court’s review requires meaningful disclosures from the professionals concerning their fees and expenses. Each professional retained by the debtor, unsecured creditors’ committee, and any estate neutral or trustee (collectively, the chapter 11 professionals) is required to file detailed fee applications with the court to facilitate this review. The Commissioners believed that the disclosure and transparency demanded by section 330 was warranted when the professionals’ services directly affected, assisted, or were performed on behalf of the estate and when the requested compensation would be paid by the estate. In these instances, the court, the U.S. Trustee, and parties in interest should have an opportunity to review the specific services performed and whether they justified the use of estate resources.
After comparing the roles of chapter 11 professionals versus nonbankruptcy professionals, the Commission determined that only chapter 11 professionals should be subject to the retention and compensation standards of sections 327 and 330. The Commissioners did not believe that the types