Opinion
CIVIL ACTION NO. 3:03 CV-77-S
August 5, 2003
MEMORANDUM OPINION AND ORDER
This matter is before the court on appeal from two decisions of the United States Bankruptcy Court for the Western District of Kentucky ("bankruptcy court"). Following a report by the United States Trustee ("U.S. Trustee"), the bankruptcy court determined that the appellant, J. Baxter Schilling, as trustee in the Chapter 7 bankruptcy case of Gerald A. Smith ("Smith"), held an interest adverse to the estate and was not a disinterested person, and reduced his fees. The U.S. Trustee moved to alter this determination, and the bankruptcy court denied all fees and expenses claimed by Schilling. Schilling now appeals both decisions to this court.
Background
Schilling served as trustee in Smith's bankruptcy case, and hired himself as counsel for the purpose of filing adversary proceedings.
On March 13, 2001, the bankruptcy court sent a document to Smith, his creditors and all interested parties entitled "Notice of Last Day to File Claims" (hereinafter "bar order"), which stated:
Pursuant to notification by the trustee, debtor's schedules indicate that assets exist in this case from which unsecured creditors may receive a dividend.
In order to preserve your right to receive a distribution from the above named debtor's estate, you must file a claim within 90 days of the date of this notice . . .
Any Claim not filed within 90 days will be barred from receiving any distribution of assets. Filing a claim with the trustee only is insufficient.
If a claim has been previously filed, it is part of the permanent court record. There is no reason to refile a claim unless you find it necessary to amend as to status or amount. (R. 2).
This document established June 11, 2001 as the last day to file proofs of claims ("bar date"). Only one timely claim, by MBNA American Bank ("MBNA"), had been filed before the bar date.
On October 31, 2001, Schilling filed a complaint against Smith objecting to discharge, and on February 20, 2002 filed a complaint against Smith's brother, seeking to set aside a fraudulent conveyance. During this period, Schilling sought interim attorney's fees of $16,543.50, and reimbursement of expenses. The debtor objected to the fee, and the bankruptcy court awarded Schilling, as counsel, $14,799.86, or $1,743.64 less than he had requested, after determining that the requested fee was excessive.
On April 8, 2002, the bankruptcy court approved a settlement agreement between Schilling, Smith, and Smith's brother ("settlement agreement"), which resolved both adversary proceedings for payment to the estate of $50,000.00. The settlement agreement contained the following provisions: (1) neither Smith nor his brother had standing to object to any matter or motion relating to the allowance of any claim; (2) all funds paid to the trustee were to be non-exempt assets of the estate and would be used to pay administrative and unsecured claims; and (3) Schilling would apply to the court for a final attorney fee and would request that the court reconsider the previously disallowed fee of $1,743.64 and Smith would support that request.
Schilling contends that the terms of the settlement agreement required distribution of the entire estate to Smith's administrative and unsecured creditors. However, the settlement provided only that the funds were to be non-exempt assets, not that the debtor was precluded from receiving any surplus funds. (R. 29).
On May 23, 2002, Schilling filed a second request for attorney's fees of $10,343.12, which included the previously disallowed amount of $1,743.64. hi his fee request, Schilling indicated that "tardily filed claims" would receive a substantial portion of the funds he held. At that time, there were no tardily filed claims.
On June 10, 2002, almost a year after the bar date, Schilling executed and filed seven claims on behalf of unsecured creditors, which were listed in Schedule F of Smith's petition ("tardy trustee claims").
On July 8, 2002, while Schilling's fee request was pending, the bankruptcy court ordered the U.S. Trustee to investigate and report to the court "on the propriety of the Trustee's (Schilling) fees as a material term of the settlement agreement involving an estate asset, if a conflict of interest existed and if so, did such conflict affect the negotiation of the Settlement Agreement." (R 34).
On August 6, 2002, the U.S. Trustee filed a report with the bankruptcy court concluding that (a) Schilling's attorney fees were not discussed in the settlement negotiations, (b) Schilling, as counsel, prepared the settlement agreement and motion and order approving same, (c) Smith's attorney first became aware that Schilling would require Smith to support Schilling's efforts for reconsideration of the disallowed attorney fees when he was faxed the draft settlement, (d) no conflict of interest existed in the negotiation of the settlement agreement because Schilling's fees were not discussed and Schilling actually collected more than the amount of money necessary to pay the administrative claims and MBNA, (e) given only one timely proof of claim, after payment of administrative expenses, nearly $20,000 should be returned to the debtor, and (f) on June 10, 2002, Schilling filed tardy trustee claims on behalf of seven creditors. The U.S. Trustee suggested that Schilling filed these claims, in violation of a November 30, 2001 directive of the Office of the U.S. Trustee, to avoid returning estate funds to Smith and to justify all of his attorney's fees. Schilling replied to the U.S. Trustee's report.
The bankruptcy court concluded that Schilling overreached and acted in his own self-interest during the course of preparing and tendering the settlement agreement to the court and in filing the tardy claims:
The Trustee used the Settlement Agreement to silence objections to his actions in execution of his duties as Trustee in this case, to garner support for his counsel fees, attempted to or believed he had effectively eliminated the Debtor as a potential beneficiary of the estate and used the terms of the Settlement Agreement in the instant motion in an attempt to slide through not only the current fees requested but also to encourage the Court to reconsider its prior Order, given the Debtor's alleged support of the disallowed fees. The Trustee further filed the Tardy Trustee Claims for the purpose of distribution of estate assets to nonfiling claimants in breach of his duty to the estate and the Debtor as a party in interest. All of the foregoing indicates that employment of the Trustee as his counsel was not in the best interests of the estate as he previously represented to the Court.
As a result of such misconduct, the bankruptcy court reduced Schilling's fees by 50% in an order entered September 17, 2002. On December 10, 2002, upon motion to alter by the U.S. Trustee, the bankruptcy court denied Schilling's fees altogether, and ordered that all previously awarded fees and expenses be disgorged. (R. 47). Schilling appeals both decisions.
Schilling's appeal raises three issues. First, did the bankruptcy court commit reversible error when it concluded that Schilling had acted so egregiously in the settlement agreement and the subsequent filing of seven unsecured claims that total disgorgement of fees was warranted? Second, did the bankruptcy court commit reversible error when it failed to afford Schilling a hearing? Third, did the bankruptcy court commit reversible error when it failed to approve counsel for the Trustee's pending fee application?
Standard of Review
This court's review of the bankruptcy court's retention and compensation orders is limited to abuse of discretion. In re Federated Dept. Stores, Inc., 44 F.3d 1310, 1315 (6th Cir. 1995). A bankruptcy court abuses its discretion in deciding fee matters when it fails to apply the proper legal standard, fails to follow the proper procedure in making its determination or bases its decision upon findings that are clearly erroneous. In re Smith, 256 B.R. 730, 734 (W.D.Mich. 2000).
Legal Analysis
The bankruptcy court's "authority to award fees is circumscribed by 11 U.S.C. § 330 (a), which provides that `the court may award [reasonable fees and expenses] . . . to a professional person employed under § 327.'" Michel v. Federated Dep't Stores (In re Federated Dep't Stores), 44 F.3d 1310, 1320 (6th Cir. 1995). Section 328(c) allows the court to completely deny compensation "if, at any time" during the appointment the professional is not disinterested within the meaning of § 327(a). Section 327(a) allows the trustee to employ attorneys who "do not hold or represent an interest adverse to the estate, and that are disinterested persons."
A "disinterested person" is defined in § 101(14) as a person that:
(E) does not have 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 or an investment banker specified in subparagraph (B) or (C) of this paragraph or for any other reason.
The bankruptcy court determined that Schilling was not a disinterested person, and did not act in the best interests of the estate when he prepared the settlement agreement and filed tardy claims on behalf of seven unsecured creditors.
The bankruptcy court found that Schilling used the settlement agreement to "silence objection to his actions in execution of his duties as Trustee in this case, to garner support for his counsel fees." The bankruptcy court further found that Schilling's use of the settlement agreement "evidences his self-interest in the outcome of the litigation and the estate itself," and "has no purpose other than to inappropriately influence this Court's evaluation of the requested fees and which solely serves the self-interest of the trustee." The bankruptcy court concluded that the settlement agreement was direct evidence of the Trustee's self-interest in the estate.
Schilling argues that because the bankruptcy court approved the settlement agreement on April 8, 2002, the order approving the settlement is the law of the case. However, a trustee is not authorized to contract with any party, including the debtor, for his compensation, and any such agreement is not binding on a reviewing court. See Carter v. Woods, 433 F. Supp. 291 (W.D.Mo. 1977). When he filed his fee application, Schilling brought the issue of his performance as trustee's counsel before the bankruptcy court. Under § 328(c), that court was authorized to deny him compensation if at any time during his employment as counsel he was not a disinterested person.
The bankruptcy court's determination that Schilling was not a disinterested person when he entered into the settlement agreement with Smith was not an abuse of discretion. As it pointed out, by procuring Smith's support for his fee application, Schilling effectively silenced all objections to his fees, and then attempted to use the agreement to gain approval of his renewed fee application.
We agree with the bankruptcy court's finding that the settlement agreement "is direct evidence of the Trustee's self-interest in his Trustee's attorney fees rather than the estate."
The bankruptcy court also found that Schilling "overreached and acted in his own self-interest" when he filed the seven tardy trustee claims for the purpose of justifying his own fees. The court found that Schilling had a duty to examine and object to these claims as improper under § 704(5), rather than filing late claims for the creditors.
Under § 501(c), Schilling was permitted to file a claim on behalf of a non-filing creditor. However Bankruptcy Rule 3004 only allows a trustee to file a claim for a creditor "within 30 days after expiration of the time for filing claims prescribed by Rule 3OO2(c) or 3OO3(c), whichever is applicable." Bankruptcy Rule, 3002(c)(5), the rule applicable here, provides that a proof of claim is timely filed if it is filed no later than 90 days after the clerk mails notice to the creditors that payment of a dividend appears possible. The clerk mailed notice to the creditors on March 13, 2001, and established June 11, 2001 as the bar date. Schilling did not file the claims for the seven unsecured creditors until June 10, 2002.
The bankruptcy court concluded that Schilling's conduct was a breach of his duty to object to the untimely claims, and that he knew or should have known that he exceeded the limits of the Bankruptcy Rules and his authority. The bankruptcy court found that Schilling as trustee, breached his duty to the estate, and to Smith, the debtor, as a party in interest, when he filed the untimely claims to justify his own fees.
Schilling makes several objections to these findings. First, he argues that the bar date notice was invalid because the language, "any claims not filed withing 90 days will be barred from receiving any distribution of assets," contradicts §§ 726(a)(2)(c) and (a)(3) which allow distribution to tardily filed claims. However, while a tardy claim filed by a creditor is entitled to a distribution, a tardy claim filed by the debtor or trustee on behalf of a creditor is not permitted. Bankruptcy Rules 3002 and 3004 limit the time during which the trustee may file claims on behalf of creditors. Although the notice to the creditors may not have been technically correct, the time in which Schilling, as trustee, could file claims on behalf of the creditors was established by the bankruptcy rules, not the bar date notice.
Second, Schilling argues that the notice to the creditors stated that creditors who had previously filed did not need to refile a claim. According to Schilling, such statement meant that creditors who had already filed claims in Smith's Chapter 13 case, did not need to refile in his Chapter 7 case. Schilling provides no authority for the proposition that claims filed in a prior Chapter 13 case survive dismissal of the case, and remain viable in a subsequent Chapter 7 case.
Finally, Schilling argues that the bankruptcy court erroneously concluded that he owed a duty to the debtor. He asserts that the primary duty of a Chapter 7 trustee is to maximize the value of the debtor's estate for the benefit of unsecured creditors, and that his actions were in furtherance of that duty. However, the trustee's duties are multi-faceted:
The trustee serves as an officer of the court, whose primary responsibility is to assist and promote the administration of the bankrupt estate. As such the trustee serves in a fiduciary capacity.
Embodied in the Code are certain powers vested in the trustee which enable him to perform the responsibilities necessary to (1) administer the estate; (2) protect the rights of creditors; and (3) invoke the court's jurisdiction and authority to process all issues.
Thus, the trustee in the performance of his duties serves three masters: (1) the court, in performing the estate administration; (2) the creditors, by recognition and appropriate action to their respective rights, and (3) the debtor, to the extent of setting aside exempt property and in certain other explicit areas. At no time does the trustee perform as a self-serving party unto himself for personal or pecuniary gain. Only after faithfully performing the trustee's responsibilities and in a remote, ancillary way is consideration given to trustee compensation.
The trustee is to serve in a totally objective posture. At no time must this clear and concise "line in the sand" be violated. At any time the trustee's pecuniary gain is at the sole expense of a party in interest to the estate, an unequivocal conflict of interest arises. In re Steele, 26 B.R. 233, 234-235 (Bkrtcy.Ky., 1982).
The bankruptcy court's determination that Schilling owed a duty to the bankruptcy estate and breached that duty when he filed the untimely claims, rather than objecting to them, was not an abuse of discretion. As the court in In re Steele pointed out, "the trustee must be scrupulously impartial, not manipulatively clever."
Based upon its findings that Schilling held an interest adverse to the estate and was not a disinterested person pursuant to § 327(a), the bankruptcy court first reduced his fees by half, and later disallowed them altogether. The court's denial was not an abuse of discretion as § 327(c) specifically allows a court to deny allowance of compensation if the professional seeking compensation is not disinterested. Having determined that Schilling was not disinterested, the bankruptcy court did not err in failing to approve his fee application.
In addition to his other objections, Schilling argues that we should reverse the bankruptcy court's denial of fees because due process requires a hearing before sanctions can be imposed. However, even if the denial of his fee could be considered a sanction against Schilling, he was on notice that both the U.S. Trustee and the bankruptcy court had concerns about his conduct, and specifically responded to those concerns in his reply to the U.S. Trustee's Report (R. 40).
For the above stated reasons, we AFFIRM the decision of the bankruptcy court to deny the fee request of appellant, J. Baxter Schilling. The bankruptcy court's findings were sound, and the denial of fees was not an abuse of discretion.
IT IS SO ORDERED
cc: Counsel of Record