Opinion
Case No. 96-12037-H7.
December 19, 2005
MEMORANDUM DECISION
Scott A. McMillan ("McMillan"), special counsel for the chapter 7 trustee, filed his application seeking approval of compensation pursuant to a court approved contingency agreement. Debtor Vern D. Blanchard objected.
At issue is whether McMillan's fees should be denied in their entirety because he failed to make all the necessary disclosures under Federal Rule Bankruptcy Procedure ("FRBP") 2014 and was not disinterested at the time he was employed. Also at issue is the reasonableness of his fee request.
This Court has jurisdiction to determine this matter pursuant to 28 U.S.C. §§ 1334 and 157(b)(1) and General Order No. 312-D of the United States District Court for the Southern District of California. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A).
I. FACTS
On or about June 2, 1999, James L. Kennedy, the chapter 7 trustee, filed an adversary complaint (Adversary No. 99-90357) (the "adversary") against the debtor and others seeking, inter alia to avoid fraudulent transfers and alleging a conspiracy to effect fraudulent transfers. On December 18, 2001, the trustee filed an ex parte application to employ McMillan as special counsel to litigate the adversary after prior counsel withdrew its representation. The trustee's ex parte application stated that McMillan was currently representing a creditor, Apex Wholesale, Inc. ("Apex"), and that such representation did not appear to present a potential or actual conflict. In connection with the application, McMillan filed a declaration regarding his disinterestedness and disclosed that he would continue representing Apex, but made no other disclosures regarding his involvement with Apex.
On December 20, 2001, an order was entered approving McMillan's employment as special counsel. The order provided, among other things, that McMillan's compensation was "subject to further court approval after due notice and hearing, and subject to the provisions of Bankruptcy Code sections 328 and 330. . . ." [See Order ¶ 3].
After many discovery disputes and several appeals, McMillan obtained a default judgment against the debtor and other defendants on February 3, 2005, in the amount of $14,631,640. The judgment was entered on March 8, 2005.
Thereafter, McMillan began locating assets and executing on the judgment. As part of his collection efforts, he successfully recovered almost one million shares of GameTech stock and real estate, the total value of which exceeds the amount of claims in this estate.
The trustee moved for an order determining the liquidation of assets and petitioned the Court for instructions regarding the same. In that motion, the trustee sought to obtain court approval to liquidate only those assets which were necessary to pay the claims in the estate because McMillan's collection efforts resulted in a solvent estate. After the trustee noticed his motion, McMillan objected on the grounds that the trustee had improperly calculated his fees pursuant to his contingency agreement. McMillan maintains that under his contingency agreement he is entitled to 50% of the value of the recovered assets as his fee, regardless of whether they are needed to pay the claims of this estate. McMillan further contends that his contingency agreement is subject to Bankruptcy Code section 328 and, therefore, the Court does not have discretion to review his fees for reasonableness. The trustee's motion was continued to November 17, 2005, to allow McMillan time to file his fee application.
The Court granted the trustee's motion to liquidate only those assets necessary to pay claims in this estate.
The debtor objected to McMillan's fee application on several grounds. He contends that McMillan breached his fiduciary duty because he represented an interest adverse to the estate. Debtor bases his argument on the fact that McMillan was/is an employee of creditor Apex, was/is on the Board of Directors, and was/is an owner or shareholder of Apex, all of which was not disclosed to this Court. Thus, debtor alleges that McMillan is not disinterested. Debtor also points out that subsequent to his employment by the trustee, McMillan entered into a contingency agreement with Apex whereby he would be paid by Apex in the event of a recovery. Next, debtor contends that McMillan's fees should be denied because he engaged in bad faith and egregious conduct. Lastly, debtor contends that McMillan's fees should be denied because there was no benefit to the estate and no new assets were recovered.
The Court does not discuss debtor's arguments regarding whether the assets collected by McMillan are property of this estate because the default judgment is now a final order.
After considering the pleadings and oral argument regarding McMillan's fees, the Court took the matter under submission.
The Court does not consider the brief filed by the debtor on November 21, 2005, because it was submitted without leave from this Court and after the hearing on this matter. This Court's local rules do not authorize additional briefing beyond what is delineated in BLR 9014. Accordingly, the Court grants McMillan's motion to strike the debtor's supplemental pleading. Even if the Court did consider the debtor's brief, it simply repeats arguments he has already made.
II. DISCUSSION
A. DEBTOR'S STANDING TO OBJECT TO McMILLAN'S FEES
As an initial issue, it is undisputed that this estate is solvent. As a result, the debtor has standing to challenge McMillan's fee application. See Stoll v. Quintanar (In re Stoll), 252 B.R. 492, 495 at n. 4 (B.A.P. 9th Cir. 2000).
Defendant CJB Family Trust also filed an objection to McMillan's fee application. CJB Family Trust is not a creditor of this estate and, therefore, does not have standing.
B. CONFLICT OF INTEREST — DUTY OF FULL DISCLOSURE
Section 327(a), which governs the trustee's employment of professionals, provides:
(a) Except as otherwise provided in this section, the trustee, with the court's approval, may employ one or more attorneys . . . 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.
The disinterested requirement of section 327(a) is subject to two limited exceptions. The first exception applies to a trustee employing a professional that represents a creditor. Section 327(c) permits a trustee to employ as counsel non-disinterested persons, if the only reason for the lack of disinterestedness is the attorney's representation of a creditor. Section 327(c) provides:
(c) In a case under chapter 7, 12, or 11 of this title, a person is not disqualified for employment under this section solely because of such person's employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.
The other exception occurs in section 327(e) whenever a trustee seeks to employ a debtor's former counsel for a specified special purpose by providing that:
(e) 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 interest 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.
McMillan, who is a creditor's attorney representing a trustee as special counsel for a limited purpose, does not squarely fit within either exception of the disinterestedness requirement under section 327(a). While section 327(e) contemplates employing counsel for a limited purpose, it makes reference only to a debtor's former attorney and does not mention attorneys who represent creditors. Similarly, even though section 327(c) encompasses employing a creditor's attorney as counsel for the trustee, it does not explicitly provide guidance for retaining such an attorney as special counsel.
Courts have filled this gap by utilizing the standard found in section 327(e), thereby permitting a creditor's law firm to simultaneously serve as special counsel to the trustee if it does not hold an adverse interest "with respect to the matter on which such attorney is to be employed." Fondiller v. Robertson (In re Fondiller), 15 B.R. 890, 892 (B.A.P. 9th Cir. 1983), appeal dismissed, 707 F.2d 441 (9th Cir. 1983). The Ninth Circuit has stated that "where the trustee seeks to appoint counsel only as `special counsel' for a specific matter, there need only be no conflict between the trustee and counsel's creditor client with respect to the specific matter itself." Stoumbos v. Kilimnik, 988 F.2d 949, 964 (9th Cir. 1993) (citations omitted).
It is undisputed that with respect to the fraudulent transfer action against the debtor and other defendants, the interests of Apex and the estate coincide: if money is recovered for the estate, Apex would be entitled to its pro rata share. Therefore, there is no conflict between the trustee and McMillan, Apex's counsel.
Nonetheless, the debtor argues that McMillan should be denied his fees in their entirety because he did not make complete disclosures regarding his relationship with Apex. Federal Rule Bankruptcy Procedure 2014(a), which requires a verified statement by the professional to be employed, implements section 327. Rule 2014(a) provides:
The application shall state the specific facts showing the necessity for the employment, the name of the person to be employed, the reasons for the selection, the professional services to be rendered, any proposed arrangement for compensation, and, to the best of the applicant's knowledge, all of the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee. The application shall be accompanied by a verified statement of the person to be employed setting forth the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee.
"This rule assists the court in ensuring that the attorney has no conflicts of interest and is disinterested, as required by [section] 327(a)." Neben Starrett, Inc. v. Chartwell Fin. Corp. (In re Park-Helena Corp.), 63 F.3d 877, 881 (9th Cir. 1995). "The disclosure rules are applied literally, even if the results are sometimes harsh. Negligent or inadvertent omissions `do not vitiate the failure to disclose.'" Id. McMillan's alleged failure to make complete disclosures regarding his connections with Apex is a ground for denial of compensation wholly apart from the act of representing conflicting interests.See Film Ventures Int'l, Inc. v. Asher (In re Film Ventures Int'l, Inc.), 75 B.R. 250, 252 (B.A.P. 9th Cir. 1987) (citation omitted). The court has discretion whether to deny fees when there is a lack of disclosure. Id. at 253.
Prior to McMillan's employment in the fraudulent transfer adversary, the trustee noticed his intent to settle the adversary with the debtor. Apex objected. In his declaration in support of Apex's objection, McMillan states that "I am an officer of creditor Apex Wholesale Inc. . . ." He also declares that he conveyed his willingness to take over the litigation efforts of the trustee's prior special counsel. The debtor filed a reply brief supporting the settlement with the trustee and argued that he had standing to oppose McMillan's employment as special counsel. [See docket #63 in Adversary No. 99-90357]. Debtor argued that McMillan was not disinterested because Apex was a creditor and McMillan was on the Board of Directors. According to debtor, because McMillan was on the Board of Directors, he had a personal stake in estate matters. Debtor argued that in essence, McMillan was the creditor (as opposed to Apex). In response, McMillan maintained that his ownership interest and control in Apex did not create a conflict because he was acting only as special counsel for the trustee. He reiterated that his interests were aligned with those of the estate and other creditors.
The Court held several hearings regarding the trustee's motion to compromise the fraudulent transfer adversary and gave the parties additional time to brief several issues. At the November 20, 2001, hearing, the Court found that debtor did not have standing to object to McMillan's employment as special counsel. Nonetheless, all the parties and this Court were aware of McMillan's relationship to Apex at that time due to the various pleadings and declarations submitted by both McMillan and the debtor.
Even if McMillan failed to make the disclosures alleged by the debtor, those disclosures are irrelevant as to whether McMillan was disinterested or whether he held an adverse interest to the estate when he was being employed as special counsel. There need only be no conflict between the trustee and counsel's creditor client with respect to the specific matter. McMillan's role as a shareholder, officer or employee of Apex would not change the fact that Apex's interests paralleled that of the estate.
Moreover, notwithstanding the alleged inadequate disclosures, this Court can exercise its discretion not to deny McMillan's fees on this ground. Film Ventures Int'l, Inc., 75 B.R. at 253. The debtor's position, besides being legally unsound, does not carry much weight with the Court this late in the day. If the Court disallowed McMillan's fees, his efforts to get 100% recovery for the debtor's creditors, besides Apex, would result in a windfall to the debtor since this is a solvent estate. Such a result would be unfair given the circumstances of this case. The adversary has been pending since 1999. There are numerous examples on the docket that show debtor's failure to cooperate with the discovery process which ultimately resulted in the Court granting the default judgment against him. It is only through McMillan's diligence and persistence that he obtained a judgment and collected assets that will result in the debtor's creditors, including Apex, being paid 100%, plus interest, on their claims.
With respect to McMillan's subsequent contingency agreement with Apex, McMillan has made clear that he is not getting paid for his work in this matter by Apex. There will be no double recovery for McMillan. The Court therefore cannot find that the agreement with Apex creates a conflict.
The Court concludes that McMillan is disinterested and did not, and does not, hold an adverse interest to the estate in his special counsel role. Further, the Court finds his disclosures were proper and adequate.
C. BAD FAITH AND EGREGIOUS CONDUCT
With respect to debtor's arguments regarding McMillan's bad faith and egregious conduct, this Court made several evidentiary rulings at the hearing which will not be repeated here. None of the debtor's evidence offered in support of these arguments was admissible.
D. REASONABLENESS OF FEES
McMillan contends that section 328 controls his employment and, therefore, the Court may not change the agreement or delve into the reasonableness of his fees. McMillan also argues that he is entitled to 50% of the recovery under his contingency agreement regardless of whether the liquidation of all the assets he recovered will result in a surplus with some monies being returned to the debtor.
First, as pointed out at the hearing on this matter, the trustee's ex parte employment application is silent with respect to section 328. The order authorizing the trustee's employment of McMillan states that his compensation is "subject to court approval after due notice and a hearing, and subject to the provisions of Bankruptcy Code sections 328 and 330, . . . ." Thus, the order while purporting to base the fees on section 328, also provided the Court discretion to review the reasonableness of the fees pursuant to section 330. Because the order is ambiguous as to which Code section applies, it is subject to review under section 330. See The Circle K Corp. v. Houlihan, Lokey, Howard Zukin, Inc. (In re Circle K Corp.), 272 F.3d 1150 (9th Cir. 2001) opinion amended and superseded on denial of rehearing by, 279 F.3d 669 (9th Cir. 2002) (finding that unless a professional's retention application unambiguously specifies that it seeks approval under section 328, it is subject to review under section 330); see also In re Campos, 166 B.R. 914, 916-17 (N.D. Cal. 1994) (Where it is ambiguous whether the parties intended to limit the bankruptcy court's authority in awarding attorneys' fees, the bankruptcy court is permitted to authorize a reasonable fee pursuant to 11 U.S.C. section 330). Therefore, the Court can exercise its discretion and review the reasonableness of McMillan's fees.
McMillan's argument that he is entitled to fees totaling 50% of the total value of the assets recovered is unreasonable for several reasons. Section 704(1) of the Code specifies that two of the Chapter 7 trustee's primary duties are to liquidate assets of the estate and to close the estate as expeditiously as is compatible with the best interests of parties in interest. This Court has previously found that the trustee's duty to expeditiously close the estate is his "main" duty. In re Riverside-Linden Inv. Co., 85 B.R. 107, 111 (Bankr. S.D. Cal. 1988) aff'd 925 F.2d 320 (9th Cir. 1991). According to the trustee, the liquidation of the GameTech stock will be sufficient to pay all claims and administrative expenses. In fact, in a competitive bidding process in this Court on November 17, 2005, the trustee sold the stock to three purchasers, some for over the initial bid. Therefore, it is likely that there may be a surplus estate. The debtor's entitlement to surplus property or equity is not a claim under section 101(5). Thus, any further liquidation of assets recovered by McMillan will be beyond the trustee's duties.
Further, the Court must evaluate the reasonableness of McMillan's fees under the standards set forth in section 330(a)(3). Under section 330(a)(3)(C) the Court should examine whether McMillan's services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title. Those assets recovered whose value exceeds that of the claims in this case aren't necessary to the administration of the estate.
McMillan was employed by the trustee who represents the interests of the estate. An attorney for the trustee is not working to recover assets simply to pay his own fees. Implicit in the contingency agreement between the trustee and McMillan is that he is entitled to fees only for that property which is being liquidated for the benefit of the creditors of this estate.
The Court finds that a reasonable fee for McMillan would equal 50% of the proceeds necessary to pay creditor claims, with interest, exclusive of McMillan's own fees. Further, the amount of $11,000 which was previously awarded in favor of a third party and against this estate because of McMillan's actions regarding the improper filing of a lis pendens should be deducted. The Court leaves it up to the trustee to calculate the exact dollar amount.
The Court finds that debtor's arguments regarding no benefit to the estate are without merit. McMillan was successful in his efforts in the fraudulent transfer adversary by receiving a judgment and collecting assets which are sufficient to pay 100%, plus interest, of the claims in this estate. This outcome is the direct result of McMillan's efforts.
III. CONCLUSION
For the reasons noted above, the Court finds that McMillan did not, and does not, hold an adverse interest to this estate and has at all times throughout this adversary proceeding remained disinterested. The Court also finds that McMillan made the appropriate disclosures under FRBP 2014(a).
The Court finds that McMillan's fees are subject to a reasonableness review because the order authorizing his employment is ambiguous as to whether section 328 or section 330 applies. After reviewing the fees, the Court finds that McMillan is entitled to receive 50% of the proceeds necessary to pay creditor claims plus interest and administrative expenses exclusive of his own fees, minus $11,000.
This Memorandum Decision constitutes findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052. Counsel for the trustee is directed to file with this Court an order in conformance with this Memorandum Decision within ten (10) days from the date of entry hereof.