Opinion
Case No. 02-00508
December 20, 2002
Kelly Greene McConnell, Brad v. Sneed, GIVENS PURSLEY, LLP, Boise, Idaho, for Debtor.
Larry E. Prince, Andrea P. Patterson, HOLLAND HART, LLP, Boise, Idaho for U.S. Bank National Association.
Gary L. McClendon, Office of the U.S. Trustee, Boise, Idaho.
MEMORANDUM OF DECISION (LIEN/RETAINER)
I. INTRODUCTION
In this case, a number of issues are presented regarding the nature, terms and costs of legal representation in a chapter 11 proceeding. The issues involve the construction and treatment of a retainer paid to counsel for the chapter 11 debtor prior to debtor's filing the petition, including: (1) debtor's counsel's claims that they hold a common law lien in the retainer; (2) the nature of the disclosures required regarding the lien as a precondition to employment; (3) counsel's eligibility to be employed as debtor's counsel; and (4) debtor's counsel's receipt of certain additional sums of money post-petition that enhanced the retainer, and the required disclosures regarding those funds.Additionally, the attorneys involved have requested compensation for services performed and reimbursement of costs and expenses incurred. These requests exceed $72,000.00 for a period of slightly under three months. Objections to the allowance of fees and costs have been filed in addition to objections regarding the lien, retainer, disclosure and disqualification issues.
Resolution of these issues has required extended analysis, and this disposition is unfortunately lengthy. The Court has therefore decided to issue its Decision in two segments. This present Memorandum of Decision (Lien/Retainer) addresses the group of issues identified in the opening paragraph of this introduction. A separate Memorandum of Decision (Fees/Costs) addresses the compensation issues summarized in the second paragraph of this introduction. A single Order shall be issued in regard to both Decisions.
II. BACKGROUND AND FACTS
On February 21, 2002, Dearborn Construction, Inc. ("Debtor") filed a voluntary petition for relief under chapter 11. Debtor provided construction and construction management services. Its business had a twenty year history in the western U.S., and it had offices in five states. At the time of filing, Debtor was engaged in forty-two ongoing construction projects in six states. Debtor represented that the ongoing projects had a cumulative value of over $25 million. See Doc. No. 46, at Exhibit A(1). The magnitude and complexity of the case was evident from the first hearings which were held almost immediately upon filing. See, e.g., Doc. No. 3 (motion to approve interim use of cash collateral); Doc. No. 6 (affidavit of Dan Dearborn, alleging monthly operating expenses in excess of $267,000). The schedules showed assets approaching $4 million and liabilities in excess of $5 million. See Doc. No. 20.
On February 25, 2002, Debtor filed an application pursuant to § 327(a), Doc. No. 9 ("Application"), requesting that the Court approve employment of attorney Kelly Greene McConnell and her law firm, Givens Pursley, LLP (collectively "Counsel"). The Application and Ms. McConnell's Rule 2014(a) affidavit, Doc. No. 10 ("Affidavit"), asserted that Counsel did not represent or hold any interest adverse to the interests of Debtor's estate and was disinterested. Application at 2; Affidavit at 2.
Section 327(a) provides in pertinent part that "the trustee, with the court's approval, may employ one or more attorneys . . . 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." In turn, the Code defines disinterested person in § 101 (14) as, inter alia, one who is not a creditor. § 101 (14)(A).
A chapter 11 debtor in possession asserts the rights of a trustee under § 327(a) by virtue of § 1107. In addition, § 1107(b) specifically provides that "[n]otwithstanding section 327(a) . . . a person is not disqualified for employment under section 327 of this title by a debtor in possession solely because of such person's employment by or representation of the debtor before the commencement of the case."
The Application disclosed that Debtor and Counsel had entered into a retainer agreement ("Agreement") under which Debtor submitted a $50,000.00 retainer to be held in the law firm's trust account. Counsel proposed to bill attorneys' fees on an hourly basis with actual payment "as approved by the Court." Application at 3. The Agreement, attached as Exhibit A to the Application, provided in part:
As to our prior discussions regarding a retainer, we are in receipt of Dearborn's $50,000.00 deposit into our trust account. This money will be held in Dearborn's name in our firm's trust account. After securing approval of payment from the Court, the firm will submit a monthly bill to Dearborn for its review and payment. The firm will not draw money from the submitted retainer as long as Dearborn pays its monthly bills. Please be advised that this matter may ultimately cost much more than $50,000.00, causing Dearborn to incur charges over and above the previously submitted retainer. When Givens Pursley's representation of Dearborn in this matter ceases, the funds remaining in the trust account will be disbursed to Dearborn once all outstanding invoices are settled by Dearborn.
Id at 2.
On March 5, the Court entered an order approving Debtor's employment of Counsel. See Doc. No. 14. This order indicated, among other things, that fees could be paid to Counsel only on prior approval of the Court. On March 7, 2002, Counsel filed the Disclosure of Compensation of Attorney for Debtor required under § 329(a) and Rule 2016(b). See Doc. No. 21 ("Disclosure"). Counsel represented that, in addition to the $50,000.00 retainer, it had been paid $5,712.63 pre-petition and that Debtor owed nothing more at the time of filing. Id
The order approving Counsel's employment was prematurely entered; the Court as a rule refuses to consider entry of § 327 employment orders in the absence of any required § 329/Rule 2016(b) disclosure. In re Combe Farms, Inc., 257 BR. 48, 53, 01.1 I.B.C.R. 7, 9, at n. 11 (Bankr. D. Idaho 2001).
This $5,712.63 was but a small part of some $55,700.00 paid to Counsel within the year prior to filing, as indicated in Debtor's response to question no. 9 on its statement of financial affairs. See Doc. No. 20.
On April 23, 2002, Counsel requested interim compensation pursuant to § 331 in the amount of $19,414.00 in attorneys' fees and $2,335.25 in costs (a total of $21,749.25) for the seven-day period between the February 21, 2002 petition date and February 28, 2002. See Doc. No. 44, Doc. No. 46. Counsel had initially sought attorney fees in the amount of $29,014.50 and costs of $3,191.01 (a total of $32,205.51) for the period from January 30, 2002 to February 28, 2002. See Doc. No. 31. This request, however, was amended and suspended by Doc. No. 46 which removed the charges for the period prior to the petition's February 21 filing. As can be seen from the totals, this reduced the request by $10,456.26.
Doc. No. 46 amended Doc. No. 44. It added a nunc pro tunc request but asserted an identical fee request. For simplicity, reference will hereafter be made to Doc. No. 46 only.
The Court's independent review of Counsel's earlier application, Doc. No. 31, found entries totaling $9,600.50 in fees for the prebankruptcy time frame, and costs of $855.76 for that same period. This confirms a total of $10,456.26 for prebankruptcy fees and costs. Though withdrawn in Doc. No. 46, the fact that this amount may have been owed and unpaid for the period from January 30 to February 21, 2002 raises two concerns: the accuracy of Counsel's Disclosure, which affirmatively stated Debtor owed Counsel nothing at the time of bankruptcy, and the representations in the Application and Counsel's Affidavit regarding Counsel's disinterestedness. These matters are addressed later in this Decision.
In addition to the request for interim fees and costs in Doc. No. 46, Counsel sought amended approval of its employment nunc pro tunc to the date the petition was filed (February 21) rather than the date Debtor filed and served the § 327(a) Application (February 25). In an earlier hearing, the Court approved Counsel's four-day nunc pro tunc request, however, issues related to Counsel's fee request were continued for further hearing.
L.B.R. 2014.1(c) makes approval of employment effective as of the date the Application was served.
On May 6, 2002, Debtor voluntarily converted its case to a chapter 7 liquidation. This followed Debtor's April disclosure that reorganization was not viable, due primarily to the loss of major contracts in California.
Though coming before the Court in late April and early May, the question of a "possible conversion" to chapter 7 or a liquidating plan arose much earlier. See Doc. No. 63 (entry for 3/4/02)
Counsel subsequently filed a "Motion and Supporting Memorandum for Order Allowing Administrative Expenses for Professional Services Rendered to Debtor." See Doc. No. 63 ("Motion"). The Motion requested allowance of attorneys' fees in the amount of $44,624.50 and reimbursement of costs in the amount of $5,870.72 for the period from March 1, 2002 to May 13, 2002.
This request therefore includes one week of post-conversion services. The Court's review of Counsel's submissions reflects that the charges for these post-conversion services are in the amount of $3,806.50. Costs asserted in the post-conversion period include $71.92 in charges identified by date, and some portion of a charge characterized as "client electronic research" for the period 4/1/02 through 5/13/02 in an "estimated" amount of $3,296.97.
The fees and costs requested in the Motion were in addition to Counsel's prior application, Doc. No. 46, which requested $19,414.00 in fees and $2,335.25 in costs for February 21 through February 28. Thus, the total claimed from the February 21 petition date through May 13 was $72,244.47, consisting of fees of $64,038.50 and costs of $8,205.97.
The Motion disclosed that Counsel held a total of $95,000.00 (and not $50,000.00) in its trust account, which was the first such disclosure in the Court's record. When responding to question 1-B posed by the United States Trustee's fee guidelines which requires a fee applicant to "[i]dentify the existence and terms controlling the use of any retainer received from any party for providing services in this case," Counsel stated:
A later affidavit of Ms. McConnell indicates that U.S. Bank and the U.S. Trustee were orally advised of the additional $45,000.00 on April 29, at or about the time of its receipt by Counsel, even though no pleading containing the disclosure was filed until the May 14 Motion.
$95,000.00 retainer held in trust account, to be drawn on only upon Order of the Court; $45,000.00 of this total was originally given by the Debtor pre-petition to Debtor's non-bankruptcy counsel, who thereafter remitted this amount to Givens Pursley when they failed to timely apply to the Court to be hired as non-bankruptcy counsel and their services were not required.
See Exhibit A to the Motion. In the body of the Motion, Counsel proposed that payment of the $64,038.50 in attorney fees and $8,205.97 in costs come from the retained $95,000.00.
In addition, Counsel in the Motion claimed a common law possessory lien in the retainer, the first such assertion in the case. Counsel contended that, by virtue of this lien, it should be paid from the retainer funds prior to such funds being used for payment of any other administrative expenses. Motion, at 2-3.
A creditor, U.S. Bank National Association ("USB"), objected to Counsel's Motion, arguing Counsel's fee request was unreasonable and Counsel's services did not benefit the estate. See Doc. No. 73. USB's suggested reductions total $27,586.98 and would result in a proposed allowance to Counsel of $46,657.49. Id at 2-5.
USB also argued that Counsel's receipt of the $45,000.00 was an unauthorized and undisclosed post-petition transfer, and that this $45,000 was USB's collateral or the proceeds of its collateral. Id at 5. USB further disputed the contention that Counsel had a valid and enforceable lien in any retainer. It also argued that Counsel's potential § 503(b)(2) administrative expense claims for compensation would ultimately be junior to the protection USB believed it was entitled to under § 507(b). Id at 6.
The United States Trustee ("UST") also objected to the reasonableness of Counsel's fee request, adopting the arguments advanced by USB. See Doc. No. 77 at 5. The UST further argued, however, that all fees should be denied and the entire retainer disgorged because: (1) Counsel, by asserting the lien, was not a disinterested party but, rather, a creditor that held an interest adverse to the estate; (2) Counsel failed to properly and fully disclose the lien at the time of the § 327(a) Application and Rule 2014(a) Disclosure; (3) Counsel failed to timely disclose the $45,000.00 post-petition transfer under Rule 2016(b); and (4) Counsel's attempt to assert the lien post-petition violated § 364.
While notice was provided to all creditors and parties in interest in this case, only the UST and USB have objected to Counsel's compensation requests.
The Court held a hearing on the Motion and objections on June 3, 2002. At this hearing, and in a memorandum filed the same day, Counsel advised the Court that it had transferred the $45,000.00 to the chapter 7 Trustee on May 31, 2002 and that it no longer claimed any lien therein. See Doc. No. 83, at 8-9. This resolved only a few of the objections, and the parties proceeded to debate many points, including whether Counsel had an enforceable lien in the original $50,000.00 retainer or whether it was required to turn its retainer over to the chapter 7 Trustee and seek payment of any allowed compensation as a second tier administrative expense claimant.
The parties acknowledged that Rule 7001(2) required an adversary proceeding in order "to determine the validity, priority, or extent of [Counsel's] lien" in the retainer. The parties, however, agreed to address this issue under Counsel's Motion as a contested matter. See Doc. No. 85.
Even if Counsel prevailed on the lien claim, only $50,000.00 of the requested compensation would be secured by the lien. Thus, $22,244.47 of Counsel's total compensation request, if fully allowed, would be at best a § 503 chapter 11 administrative expense, rendered junior to chapter 7 administrative expenses by reason of § 726(b), and payable only if the estate is administratively solvent.
The Court took these multiple, related matters under advisement. Post-hearing briefing has been filed and reviewed. This Memorandum of Decision (Lien/Retainer) and the companion Memorandum of Decision (Fees/Costs) constitute the Court's findings of fact and conclusions of law under Rules 7052 and 9014.
III. DISCUSSION AND DISPOSITION
A. Introduction
A series of intertwined issues are presented. A threshold question is whether Counsel holds a valid common law lien in the retainer. The answer leads to further questions involving disclosures, and the possible lack of disinterestedness or the existence of an adverse interest. These issues, in turn, are relevant to disqualification and to whether any compensation can be awarded to Counsel. Even if Counsel successfully navigates these obstacles, issues remain as to the reasonableness and allowance of the requested compensation under the standards of § 330(a), including the several objections of the UST and USB. These latter matters are addressed in the companion Decision.
B. Counsel's claim to a possessory lien in the retainer
1. Attorneys' liens under Idaho law
Idaho state law recognizes that an attorney may hold or gain liens to secure payment of attorneys' fees. See Frazee v. Frazee, 660 P.2d 928 (Idaho 1983). The lien can be either a possessory lien (sometimes characterized as a retaining lien) or a charging lien. Counsel argues that it holds a common law possessory lien. See, eg, Doc. No. 83, at 4. It has expressly denied that it is asserting a charging lien, which has been codified by statute at Idaho Code § 3-205. Id
A charging lien is a lien for the attorney's "services rendered in procuring a judgment, decree, or a ward for his client, which attaches to the client's cause of action, verdict and judgment and the proceeds thereof." Frazee v. Frazee, 660 P.2d 928, 930 (Idaho 1983) (quotations omitted). This Court has previously considered, and in general rejected, the assertion of a statutory charging lien against estate funds. See, e.g, In re Harris, 258 B.R. 8, 13-14 (Bankr. D. Idaho 2000) (funds in the estate were not created by counsel's efforts); see also Elsaesser v. Raeon (In re Goldberg), 235 B.R. 476, 484, 99.2 I.B.C.R. 63, 66 (Bankr. D. Idaho 1999) (trustee could avoid attorneys' charging liens where (1) the fund was not created by counsel's efforts and (2) the attorney did not properly perfect the lien by judgment).
In Frazee, the Idaho Supreme Court stated:
A lien for attorney's fees can be either possessory or a charging lien. The possessory or retaining lien is of common law origin and allows an attorney to keep possession of documents, money or other property obtained in his professional capacity until he receives payment for his professional services. Such a retaining lien is passive and not enforceable by foreclosure and sale.
660 P.2d at 929 (emphasis added).
While Frazee and other Idaho cases voice the concept that an attorney may assert a possessory lien in "money" as well as in files, documents or other property coming into the attorney's possession during the course of representation, none of the decisions expressly discusses a possessory lien in fee "retainers." The Court observes, however, that neither of the objectors has provided authority holding that such a lien could not be obtained or deemed to exist in a consensual fee retainer. Nor has the Court located any such authority.
See, e.g, Defendant A v. Idaho State Bar, 2 P.3d 147, 151-52 (Idaho 2000).
While determination of property of the estate under § 541, treatment of liens and similar issues are matters of federal law, bankruptcy courts must look to state law to determine the nature and extent of interests in property. In re Pettit, 217 F.3d 1072, 1078 (9th Cir. 2000); see also In re Hasset, Ltd, 283 B.R. 376, 381 (Bankr. E.D.N.Y. 2002); In re For-Rose Plumbing, Inc., 99.2 I.B.C.R. 69, 72 (Bankr. D. Idaho 1999) (citing Butner v. United States, 440 U.S. 48, 54 n. 9 (1979)). The Idaho courts have announced that attorneys are provided a special common law lien, dependent on possession, in a client's property, files or "money." This Court is constrained to recognize that grant.
Though the lien exists, Idaho cases provide little if any guidance as to how this "passive" lien is to be enforced or how such a lien holder exercises its rights. In order to determine how this passive lien would or should operate in the context of a bankruptcy case, it is helpful to turn to the general limits and conditions imposed on compensation for professionals and, in particular, the treatment of retainers.
2. Retainers in bankruptcy cases
The Code allows a debtor in possession to employ professional persons on "any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, or on a contingent fee basis." § 328(a) (emphasis added). Thus, the Code expressly acknowledges a professional might receive a cash retainer. However, not all cash retainers are alike. A leading treatise notes:
The most common fee arrangements in bankruptcy cases are made pursuant to retainer agreements. Retainers are typically classified as either "security," "advance payment," "earned on receipt," "evergreen" or "classic." The nature of a retainer will determine whether these funds are considered property of the debtor's estate which will, in turn, define the professional's right and interest in such funds.
3 L. King, Collier on Bankruptcy ¶ 328.02[1][c], p. 328-6 (rev. 15th ed. 2002).
Collier continues:
A "security retainer" is defined as one held by attorneys to "secure payment of fees for future services that the attorneys are expected to render." The funds do not constitute a present payment for future services but, rather, remain the property of the estate until the attorney applies charges for services rendered against the retainer. The unearned portion of the retainer must be returned by the attorneys.
Id. ¶ 328.02[1][c][i], pp. 328-6 to 328-7.
For contrast, an "advance payment" retainer is defined "as one in which the debtor pays for all or a portion of the services to be rendered by the attorney in advance" or, in other words, a "flat fee" arrangement. Collier, ¶ 328.02[1][c][ii], p. 328-7. See also, In re McDonald Bros. Constr. Inc., 114 BR. 989, 1000 (Bankr. N.D. III. 1990). This Court has observed: "[R]etainers prepaying legal services to be rendered in the future belong to the attorney when transferred to the attorney. However, the attorney is obliged to earn the fees prepaid and make an accounting of such fees and costs to the client." For-Rose Plumbing, 99.2 I.B.C.R. at 72 (citations omitted). When representation ceases, to the extent the fees have not been earned, the unearned portion of the retainer again becomes property of the client; further, the client always retains the equitable right to an accounting and to a refund or reimbursement of any unearned portion of the prepaid fee. Id The Court also retains the ability to evaluate the reasonableness of such prepayment. § 329(b); F.R.Bankr.P. 2017(a).
The "earned on receipt" or "classic" retainer is intended "to insure the attorney's availability over time on behalf of the client regardless of whether the attorney actually renders services to the client." Collier ¶ 328.02[1][c][vi], p. 328-9. The retainer is entirely earned upon payment, with the client retaining no interest in the money. McDonald Bros. Constr., 114 B.R. at 998. Classic retainers frustrate the court's supervision of professional fees because they impermissibly circumvent the requirements for compensation of professionals, especially debtor's attorneys. In re NBI, Inc., 129 B.R. 212 (Bankr. D. Colo. 1991); see also In re Hawkins, 89 I.B.C.R. 266, 268-69 (Bankr. D. Idaho 1989).
Finally, "evergreen" retainers provide security for the payment of fees and contemplate preserving the entire pre-petition retainer so it can be applied toward the final payment of fees at the conclusion of the case. Interim funding of fees comes from operating cash or, if drawn from the retainer, operating cash is used to replenish the retainer. See Collier, ¶ 328.01 [1][c][iv], p. 328-8. Such arrangements have also been criticized. See In re Perrysburg Marketplace Co., 176 B.R. 797, 799-800 (Bankr. N.D. Ohio 1994); In re Pannebaker Custom Cabinet Corp., 198 BR. 453, 462 (Bankr. M.D. Pa. 1996). A variation of an evergreen retainer was rejected by this Court In re Lakeside Mgmt., L.L.C., Case No. 01-20661, Doc. No. 24 (Memorandum of Decision, August 2, 2001).
This Court has previously concluded that security retainers "are estate property which can only be used by the professional upon compliance with the entire fee application process including court approval[.]" In re Leypoldt, 95 I.B.C.R. 220, 226 (Bankr. D. Idaho 1995); see also, In re Hawkins, 89 I.B.C.R. 266, 271 (Bankr. D. Idaho 1989).
The prevailing view among bankruptcy courts is consistent. An attorney holding a security retainer is treated as a "secured creditor" with the retained funds remaining property of the estate at all times but subject to the attorney's claims to payment to the extent the Court allows the fees. Court approval of compensation pursuant to § 330 and § 331 is required before the professional may collect fees or reimburse expenses by drawing from the retainer. Since the retainer only secures payment for fees and costs specifically allowed by the Bankruptcy Court, any excess amounts in the retainer are property of the estate subject to turn over.
See, e.g, In re Equio. Servs. Inc., 290 F.3d 739, 746 (4th Cir. 2002); Indian Motorcycle Assocs. III Ltd P'Ship v. Massachusetts Hous. Fin. Agency, 66 F.3d 1246, 1255 (1st Cir. 1995); Shapiro Buchman LLP v. Gore Bros. (In re Monument Auto Detail, Inc.), 226 BR. 219, 225 (9th Cir. BAP 1998); United States Trustee v. Garvey, Schubert Barer (In re Century Cleaning Services, Inc.), 215 B.R. 18, 21-22 (9th Cir. BAP 1997) (holding that Chapter 7 debtor's attorney held a valid possessory lien in a pre-petition retainer and could be compensated from the retainer), rev'd on other grounds, 195 F.3d 1053 (9th Cir. 1999); In re Prod Assocs., Ltd, 264 B.R. 180, 188 (Bankr. N.D. III. 2001); In re Printcrafters, Inc., 233 B.R. 113, 116-17, (Bankr. D. Cob. 1999); Pannebaker Custom Cabinet, 198 BR. at 460; In re North Bay Tractor, Inc., 191 BR. 186, 187 (Bankr. ND. Cal. 1996); In re Printing Dimensions, Inc., 153 B.R. 715, 719 (Bankr. D. Md. 1993); In re K R Mining, Inc., 105 BR. 394, 398 (Bankr. N.D. Ohio 1989); see also Collier, ¶ 328.02[1][c][iii], p. 328-7.
See Monument Auto Detail, 226 B.R. at 225.
Counsel in many ways manifested the intention to treat the funds as a security retainer. The funds have consistently been held in Debtor's name in Counsel's client trust account. Debtor clearly retained an interest in the funds. These funds were designed to operate as security for payment of Counsel's future claims to compensation. Counsel's Agreement acknowledged that compliance with the Code and Court approval were prerequisites to drawing on the retainer.
There is also an aspect of "evergreening." Apparently Counsel and Debtor anticipated that funding of allowed interim compensation in the chapter 11 case would come from Debtor's cash flow, and that the $50,000 would not be invaded until, perhaps, the conclusion of representation. But the question of preserving the retainer while paying compensation from other sources never arose given the rather swift denouement of the reorganization effort. Typically in chapter 11 cases similar to that presented here, the source of payment of any allowed interim compensation (i.e., from unencumbered cash flow, a retainer, or a combination thereof) is an issue determined at the time of the § 331 hearing and that determination is dependent on the facts then extant. Accord, Lakeside Mgmt., L.L.C, supra. But the present case fell into a liquidating posture before the § 331 requests were ever heard. Further, the Court was at no time presented with a request to authorize a "monthly billing" approach as alluded to in the Agreement. The Agreement correctly noted that Court approval of such a mechanism was required.
Under the facts of this case and the foregoing authority, the Court concludes that Counsel obtained and held a security retainer. This authority, as indicated, places several restrictions on Counsel's ability to exercise any rights to that security, perhaps most notably the requirement of judicial review and allowance of compensation under § 330 and § 331 before the funds can be utilized to pay for Counsel's services.
Collier and some bankruptcy courts have concluded that the provisions of Article 9 of the Uniform Commercial Code can also be satisfied by an attorney's retainer agreement. See, e.g, Collier ¶ 328.02[1][c][i], p. 328-7 (citing McDonald Bros. Constr., 114 B.R. at 999); In re Carolina Premier Med Group, PA., 2001 WL 1699220 at *4 (Bankr. M.D.N.C. 2001) (security retainer constitutes a security interest under the UCC in the funds, perfected by the attorney's possession); In re IPS Systems, Inc., 205 B.R. 88, 89 (Bankr. S.D. Tex. 1997) (same); In re Matthews, 154 B.R. 673, 676 (Bankr. W. D. Tex. 1993) (same); In re Goco Realty Fund I, 151 B.R. 241, 252 (Bankr. N.D. Cal. 1993) (same).
However, Counsel does not here urge a consensual security interest as an alternative to the common law lien. And the assertion that a "lien" arose in the retainer does not require a conclusion that an Article 9 interest was negotiated or implicated. Compare § 101 (37) with § 101 (51). The Court therefore renders no opinion on the subject except to observe that an attorney's negotiation of a consensual security interest prior to filing raises a number of additional concerns. See n. 22, infra.
In this Court's view, these authorities are helpful in considering how Counsel's possessory lien in the retainer should be treated. As noted, Idaho precedent characterizes this possessory lien as "passive" and not enforceable by foreclosure. Frazee, 660 P.2d at 929. A lien's assertion against a retainer is a matter which supports, if not requires, judicial review or oversight. This Court concludes that, in the bankruptcy context, the assertion of an Idaho attorney's common law possessory lien in funds would be and is subject to the same conditions and restrictions as the security retainer, as set forth above.
Under Frazee, a possessory lien can also be claimed in other property of a client, for example, in files or documents. Different or additional provisions may apply to such an assertion. See, e.g, § 542(e).
C. Disqualification issues
The UST argues that if Counsel obtained or held the position of a lien creditor, it ran afoul of the requirements of disinterestedness and lack of adverse interest. See § 327(a). The UST correctly notes that § 327(a)'s prohibitions are reinforced by § 328(c) which provides that, if at any time during the case an attorney is not disinterested or gains or represents an adverse interest, the Court may deny the attorney's compensation.
There are two material and complimentary aspects to § 327(a): the requirement that the professional be disinterested, and the requirement that the professional not hold or represent an adverse interest.
1. Disinterestedness
A "disinterested person" is one that "is not a creditor" and "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." § 101 (14)(A), (E). The Code defines a creditor as an "entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor." § 101 (10)(A). In turn, the Code defines a claim as the "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured." § 101(5)(A).
This Court has evidenced through countless decisions its obligation and willingness to enforce the disinterestedness standard. However, this Court has also taken a practical approach to the question of whether the debtor's attorney is a disqualified creditor. The Court stated:
[a]t first blush, . . . [Section 327(a)] would seem to foreclose the employment of an attorney who is in any respect a "creditor." But such a literalistic reading defies common sense and must be discarded as grossly overbroad. After all, any attorney who may be retained or appointed to render professional services to a debtor in possession becomes a creditor of the estate just as soon as any compensable time is spent on account. Thus to interpret the law in such an inelastic way would virtually eliminate any possibility of legal assistance for a debtor in possession, except under a cash and carry arrangement. It stands to reason that the statutory mosaic must, at the least, be read to exclude as a "creditor" a lawyer, not previously owed back fees or other indebtedness . . . notwithstanding that the lawyer will almost instantaneously become a creditor of the estate with regard to the charges endemic to current and future representation.
In re Leypoldt, 95 I.B.C.R. at 222 (quoting In re Martin, 817 F.2d 175, 180 (1st Cir. 1987)). Collier is consistent:
With respect to "secured" retainers, courts generally hold that a professional with such a pre-petition retainer is a "secured creditor" and has a security interest in the retainer, noting that professionals receiving pre-petition retainers to insure payment of fees to be earned in the chapter 11 case (or post-petition retainers authorized by the court) become secured creditors, by virtue of a possessory interest in the cash. The professional's status as a secured creditor by virtue of the retainer does not disqualify the professional from being retained by the estate as required by section 327 of the Code.
Collier, ¶ 328.02[1][c][iii], at 328-7 (emphasis added).
The Court here concludes that, like a security retainer, Counsel's possessory lien was not in and of itself a disqualifying factor, provided that no debt existed at filing and only future obligations were secured.
In Leypoldt, Chief Judge Pappas held that an attorney was not a "creditor" within the meaning of § 101 (14)(A) and noted that "[t]he presence of a lien that secures no existing obligation does not make Counsel a creditor." 95 I.B.C.R. at 222 (citing In re Escalera, 171 B.R. 107, 110 (Bankr. ED. Wash. 1994)).
The Court must therefore deem Counsel's inclusion of pre-petition charges in Doc. No. 31 to have been an error. If claims existed as of the date of the bankruptcy petition and were neither paid nor irrevocably waived, the Application and Disclosure (which affirmatively represented no outstanding debt was owed and upon which the Court was asked to enter an order approving employment) would have been materially false and misleading. And nothing short of such a waiver would cure the obvious lack of disinterestedness. The withdrawal of these charges from the amended application, Doc. No. 46, is thus viewed by the Court as evidencing Counsel's recognition of its mistake in including amounts which had been so waived.
2. Adverse interest
In Leypoldt, the Court considered whether a security interest — an Article 9 interest taken in a snowmobile and trailer owned by the debtors — constituted a disqualifying adverse interest. There, the Court held that the attorney's security interest was materially adverse because counsel would have to monitor whether debtors were preserving the value of the collateral and because the seasonal nature of the collateral could prompt counsel to press for its surrender in order to maximize its value. 95 I.B.C.R. at 226.
The Court emphasized the ethical pitfalls facing attorneys who negotiate security agreements with their own clients. Leypoldt, 95 I.B.C.R. at 224-25. See also In re Parkhurst, 02.1 I.B.C.R. 57, 57-59 (Bankr. D. Idaho 2002) (addressing, inter alia, Idaho Rule of Professional Conduct 1.8); accord, American Bar Association Formal Ethics Opinion, No. 02-427 (May 31, 2002) (addressing Model Rule of Professional Conduct 1.8).
However, Leypoldt distinguished the situation of security in a cash retainer, concluding that the purpose of § 327(a)'s proscription was not served by a bright-line rule precluding an attorney at all times and under any circumstances from having security in a debtor's property to safeguard the payment of fees. 95 I.B.C.R. at 224, 226. Accord, Printcrafters, Inc., 233 B.R. at 119-20 (counsel's secured interest in a cash retainer is a conflict which "the Code recognizes and generally tolerates as an exception [to § 327(a)], so long as fully disclosed and subjected to the Court's scrutiny in making such determination"); Escalera, 171 BR. at 111 (holding a security retainer in cash and in trust "does not create an interest adverse to the estate"); Collier, at ¶ 328.02[1][c][iii] p. 328-7 (a professional's status as a secured creditor by virtue of a retainer does not disqualify the professional from being retained by the estate).
Accordingly, this Court concludes that the lien interest in the cash retainer was alone insufficient to create or reflect a disqualifying adverse interest. D. Disclosure issues
Both the "disinterested" and "no adverse interest" conclusions are specifically premised upon the waiver of any pre-petition claim of Counsel, as discussed supra. In the absence of such a waiver, Counsel had a lien interest and an outstanding debt secured by that lien, which combined constitute a prima facie violation of § 327(a). See In re Overacker, 02.1 I.B.C.R. 55 (Bankr. D. Idaho 2002) (unless attorney files an unconditional and irrevocable waiver of pre-petition claim, application to employ will be rejected). Accord Leypoldt, 95 I.B.C.R. at 222 (lawyer "not previously owed back fees or other indebtedness" is not a creditor solely by reason of retainer). See also McCutchen, Doyle, Brown Enersen v. Official Comm. of Unsecured Creditors (In re Weibel, Inc.), 176 B.R. 209, 213 (9th Cir. BAP 1994) ("professional . . . must show that it is disinterested before any compensation is to be paid the professional from assets of the estate").
The UST argues that, even if not disqualifying, Counsel did not disclose its possessory lien pursuant to Rule 2014(a) and, as a consequence, the firm's fees should be reduced or disallowed in full. Counsel's response, in briefing and at hearing, is that it had no duty to disclose something that arose solely by operation of Idaho common law, i.e., that the taking of a cash (security) retainer had the effect of automatically giving rise to a possessory lien.
The state of the law is clear: anything less than strict compliance with the requirements of the Code and Rules regarding professional disclosure can result in denial of all fees and costs. There must be full, candid and complete disclosure of all the professional's connections to the debtor and other parties in interest. In re Combe Farms, Inc., 257 BR. 48, 54-55, 01.1 I.B.C.R. 7, 9-10 (Bankr. D. Idaho 2001) (addressing Rule 2014(a) obligations); For-Rose Plumbing, 99.2 I.B.C.R. at 70-71. "Even a negligent or inadvertent failure to disclose fully relevant information may result in a denial of all requested fees." Neben Starrett, Inc. v. Chartwell Fin. Corp. (In re Park-Helena Corp.), 63 F.3d 877, 882 (9th Cir. 1995).
In Park-Helena, the Ninth Circuit upheld a bankruptcy court's denial of all fees when an attorney's disclosure failed to provide sufficient detail, commenting that the "disclosure rules are applied literally, even if the results are sometimes harsh". Id; accord Parkhurst, 02.1 I.B.C.R. at 59 (same, in regard to § 329(a)). "`The duty of professionals is to disclose all connections with the debtor, debtor-in-possession, insiders, creditors, and parties in interest. . . . They cannot pick and choose which connections are irrelevant or trivial. . . . No matter how old the connection, no matter how trivial it appears, the professional seeking employment must disclose it.'" Park-Helena, 63 F.3d at 882 (quoting In re EWC Inc., 138 B.R. 276, 281-82 (Bankr. W.D. Okla. 1992)).
Counsel said nothing whatsoever about a possessory lien interest at the time of the Application, Disclosure and Affidavit, all filed in support of judicial approval of employment. It should have. The claim of possession or entitlement to a lien position is a material and relevant factor, and must be disclosed under § 327(a) and Rule 2014(a). Park Helena, 63 F.3d at 882; see also Printcrafters, 233 B.R. at 120 (stating that a secured interest in a retainer is "tolerate[d] . . . so long as fully disclosed and subjected to the Court's scrutiny").
The record provides a possible explanation for Counsel's lack of comment about the lien when making its other disclosures. The itemization of services attached to the Motion, Doc. No. 63, includes post-conversion entries stating:
5/6/02 Chapter 7 research re: handing over funds in trust account; do we have a lien against the funds?
5/7/02 Chapter 7 research.
5/7/02 Chap. 7 research.
5/9/02 Begin researching whether we have lien on money in retainer.
5/9/02 Continue research re: lien on pre-petition retainer.
5/9/02 Continue research regarding retaining liens.
5/10/02 Continue research re: retaining liens.
5/10/02 Continue lien research.
These entries total 10.70 hours at a suggested rate of $120.00 per hour ($1,284.00). Issues regarding allowance of compensation for such services are discussed in the Memorandum of Decision (Fees/Costs).
These time entries support a conclusion that Counsel did not at the time of the engagement understand that a lien might exist under Idaho common law or intend to assert such an interest, and that Counsel's position was formed only at the time of conversion, as the risk of nonpayment increased and several parties started to covetously eye the $50,000.00 retainer. This might explain why Counsel strenuously asserted an Idaho possessory lien post-conversion but failed to unambiguously disclose or even mention such a claim at the time it sought the Court's approval of employment.
But Counsel does not argue that it should avoid sanction because it merely failed to disclose a position it did not yet know it had. Counsel instead asserts that it was not required to disclose that it had or would assert a "right" to the lien. However, Counsel has not provided persuasive authority or argument in support of this proposition.
Counsel's assertion that In re Century Cleaning Services, Inc., 209 B.R. 149 (Bankr. D. Or. 1996) supports its view, see Doc. No. 83 at 11, is not well taken.
The Court today, consistent with the authorities noted above, makes clear that there is an affirmative duty to disclose, at the time counsel is seeking approval of employment under § 327(a), whether a lien position is believed to exist or will be asserted against a retainer or any other property of a debtor. Disclosing only that a retainer exists does not necessarily disclose a possible lien interest or whether such an interest will be asserted. As the earlier discussion reflects, not all retainers are alike and may not give rise to lien interests. An attorney might also waive such an interest if in fact one is created. Therefore, the disclosure regarding a lien interest is in addition to the other required disclosures regarding the existence, nature and terms of any retainer. This disclosure is necessary to allow the Court and interested parties to evaluate the entirety of the relevant facts and circumstances. Failure to meet any of these obligations exposes the professional to consequences which may include reduction or denial of compensation.
Counsel failed to meet the duty of full and complete disclosure. The Court has broad discretion in designing appropriate remedies to deal with violations of Rules 2014 and 2016. Combe Farms, 257 BR. at 55, 01.1 I.B.C.R. at 10, n. 15 (citing Park-Helena, 63 F.3d at 882; and In re Film Ventures Int'l Inc., 75 B.R. 250, 253 (9th Cir. BAP 1987)). The Court concludes that Counsel's failure to mention the lien, when viewed in the context of its other disclosures regarding the cash security retainer and the facts indicating that its assertion of the lien right might have been based only on a post facto awareness or discovery, does not warrant denial of all compensation, though such a result is authorized by the Ninth Circuit decisions and sought by the UST.
Counsel fully disclosed the existence and amount of the retainer in its § 327 Application and its Rule 2014(a) and Rule 2016(b) Disclosures. The Affidavit also attached the Engagement Letter explaining the terms of the agreement. In addition, all of Counsel's requests for compensation disclosed the retainer. See Doc. No. 21 at Ex. A; Doc. No. 31 at Ex. A; Doc. No. 63. The original balance was not invaded, and Counsel has consistently accepted the fact that approval of compensation was prerequisite to any draw against the retainer.
Combe Farms assessed a 10% reduction, approximately $2,500.00, for a debtor's attorney's Rule 2014 violations. 257 B.R. at 55, 01.1 I.B.C.R. at 10. The Court concludes that a similar financial consequence is appropriate here. A 5% sanction will be imposed and deducted from Counsel's § 330 allowed compensation. Therefore, the Court will grant the UST's objection to the extent it argues Counsel's inadequacy of disclosure merits a reduction of Counsel's allowed fees. The reduction will be calculated and assessed in the Memorandum of Decision (Fees/Costs).
E. The additional $45,000.00 transfer
There are two issues concerning the additional $45,000.00 Counsel obtained. The first involves Counsel's treatment and handling of these funds. The second concerns the required disclosure regarding the receipt of additional funds and the claim Counsel would later assert against those funds.
The July 11 Affidavit of Ms. McConnell, Doc. No. 89, indicates that Debtor made a pre-petition deposit of $50,000.00 with its non-bankruptcy law firm as a retainer for that firm. But only $45,000.00 was returned to Counsel. Id at ¶ 6. What happened to the other $5,000.00 is unexplained. Since employment of the other firm was never authorized in bankruptcy, there would be no apparent basis for that firm's retention of the $5,000.00 from this "retainer."
1. The funds
In the instant case, Debtor retained, at a bare minimum, an equitable interest in the unearned retainer held by its non-bankruptcy counsel. When that firm failed to gain approval for employment in bankruptcy, there was no basis for treating the funds as a security retainer or any other sort of retainer.
Regardless of Counsel's argument that this was money "earmarked for legal services," see Affidavit, Doc. No. 89, at ¶ 4, the entire amount should have been returned to Debtor. The lawyers were not at liberty to decide that the money should be transferred from Debtor's non-bankruptcy attorneys to Counsel to enhance Counsel's retainer. See For-Rose Plumbing, 99.2 I.B.C.R. at 72.
In For-Rose, the debtors were initially represented by an attorney who received a pre-petition retainer of $5,000.00. Debtor subsequently terminated that attorney's representation, and engaged substitute counsel. The first attorney transferred $2,500.00 of the retainer, representing "unearned" fees, to the second. The Court ordered the substituting attorney to fully disgorge the $2,500.00 noting that no one, including the attorneys, was free to decide that the unearned portion of the $5,000.00 should go to the new attorney, and that the unearned portion of the retainer was property of the client, and hence property of the estate.
The remedy in For-Rose was to require the "transferred" retainer to be delivered to the Trustee, and not made available to the receiving attorney. That is, in essence, what has already occurred here. Counsel belatedly, but ultimately, did what was required, which was to turn over the money to the Chapter 7 Trustee. The Court concludes that, under the entirety of the circumstances, this is sufficient resolution of this aspect of the matter.
2. The disclosure
The Code provides that debtor's counsel "shall file with the court a statement of the compensation paid or agreed to be paid . . . for services rendered or to be rendered in contemplation of or in connection with the case by such attorney, and the source of such compensation." § 329(a). Rule 2016 implements this provision of the Code. Rule 2016(b) requires the initial written disclosure form to be filed within 15 days after commencement of the case. It also requires a supplemental statement to be filed within fifteen days after receipt of "any payment or agreement not previously disclosed." Rule 2016(b).
The UST contends that Counsel failed to properly disclose the additional $45,000.00 within 15 days of its April 29 receipt as required by Rule 2016(b), and that as a result all requested fees should be denied. Franke v. Tiffany (In re Lewis), 113 F.3d 1040, 1045 (9th Cir. 1997) (upholding a bankruptcy court's order of disgorgement of fees when an attorney failed to file supplemental statements and failed to disclose that it had received a portion of its retainer post-petition); Hale v. United States Trustee (In re Basham), 208 B.R. 926, 931 (9th Cir. BAP 1997) (affirming this Court's decision to reduce fees as a sanction for failure to timely file 2016(b) disclosures), aff'd sub nom. In re Byrne, 152 F.3d 924 (9th Cir. 1998) (unpublished).
Counsel argues that the reference in Exhibit A to its May 14 Motion, made fifteen days after the transfer, was sufficient disclosure for purposes of Rule 2016(b). See Doc. No. 83, at 8.
This response to question 1-B of the UST's fee guidelines, set forth earlier, provided some of the information required by Rule 2016(b): that Counsel had received funds from Debtor ( via Debtor's non-bankruptcy counsel), revealing the source and amount of those funds; that the funds were held by Counsel; and that Counsel asserted an interest in and an intent to use those funds in payment of compensation. In addition, the timing of the Motion's disclosure fell within the command of Rule 2016(b) even though it was filed after the UST and USB learned of and filed objections to Counsel's receipt and proposed use of the funds. See Doc. Nos. 73, 77.
The Court appreciates that Counsel rather quickly retreated from its assertion of interest, and surrendered the funds to the chapter 7 trustee. And it appears the UST and USB were orally advised at or about the time Counsel received the money. But while some disclosure was timely made, it was not made through the preferred and encouraged form. Thus, Counsel's manner of "disclosure" was not readily identifiable by all parties in interest as a supplementing Rule 2016(b) disclosure, nor would it be docketed as such or capable of being located and reviewed by an inquiring party. Instead, the "disclosure" was imbedded in the attachments to a fee application.
See n. 9, supra.
The information required by Rule 2016(b) is generally provided on a form consistent with Procedural Form B 203. Use of Procedural Forms is encouraged but, unlike Official Forms, is not required. See F.R.Bankr.P. 9009. Counsel's initial Rule 2016(b) Disclosure, Doc. No. 21, was on such a form.
The Court did not reach the disclosure question in For-Rose. 99.2 I.B.C.R. at 72. However, it did consider violation of Rule 2016(b) in Combe Farms. 257 BR. at 53-54, 01.1 I.B.C.R. at 9. That decision stated:
[T]he requirements of these provisions of the Code and Rules are not merely aspirations or goals; timely and strict compliance by counsel is mandatory. No more forceful manner of emphasizing the importance of these rules to attorneys should be needed than to remind them that a failure to timely file an adequate disclosure form alone constitutes a sufficient reason for the Court to reduce, or even completely deny, compensation to the debtor's attorney.
. . .
As unpleasant as the task is, this Court is responsible to ensure proper disclosure is made by attorneys representing debtors in bankruptcy cases. Because the integrity of the bankruptcy system is at stake, it is absolutely essential that the Court not simply "excuse" counsel when compliance falls short of that required by the Code and Rules.
Id Accord In re Boise Delivery Transfe, Inc., Case No. 01-01334 (Memorandum of Decision, April 25, 2002).
In balancing the entirety of these facts and circumstances, and in consideration of the case law in this District and Circuit on the point, the Court cannot "simply excuse" Counsel for its failure to forthrightly disclose receipt of the additional funds in the manner and form contemplated under Rule 2016(b). An additional 5% sanction will be imposed, and the same will be calculated and assessed in the Memorandum of Decision (Fees/Costs).
F. Violation of § 364
The UST argues that Counsel failed to comply with § 364 in securing its post-petition services with a lien in the retainer. A similar argument was advanced in In re K R Mining, Inc., 105 B.R. 394 (Bankr. N.D. Ohio 1989), which rejected the application of § 364 to the employment of professionals under a security retainer. 105 BR. at 398. Additionally, it appears any possessory lien would have attached prior to bankruptcy, when the funds were deposited, even though the amount potentially secured by that lien would be dependent on post-petition events. The recent decision in Beeler v. Harrison Jewell (In re Stanton), 303 F.3d 939 (9th Cir. 2002), would seem to indicate that "§ 364(c) is therefore beside the point" since the asset "was encumbered before the bankruptcy." Id at 942.
This objection will be overruled.
IV. CONCLUSION
Based on the foregoing, the Court validates Counsel's claim to a common law possessory (or retaining) lien under Idaho law. The property subject to such lien is the $50,000.00 placed in trust before the inception of the case.
Under the circumstances of this case, the existence of the possessory lien and security retainer did not render Counsel not disinterested nor did it create a materially adverse interest such that Counsel was or should be disqualified from representing Debtor in the chapter 11. These conclusions, however, are expressly based on the finding that any and all of Counsel's pre-petition claims, already withdrawn from its compensation requests, were irrevocably waived and released. This finding is essential because, otherwise, Counsel would be disqualified and would be allowed no compensation at all.
The Court further concludes that the disclosure requirements of § 327(a) and Rule 2014(a) were not fully satisfied. Even though Counsel revealed and described the existence and nature of the retainer, and included a copy of the Agreement in its Application, it said nothing whatsoever of the lien. A sanction of 5% of Counsel's final § 330 fee allowance will be imposed for this violation of the Code and Rules, and will be calculated and incorporated in the Memorandum of Decision (Fees/Costs).
The Court also concludes that, while Counsel's post-petition acceptance of the additional $45,000.00 for a brief period does not justify sanctions given the specific circumstances of this case, the failure to file an appropriate Rule 201 6(b) disclosure regarding that event does warrant an additional 5% sanction. It, too, will be assessed in the Memorandum of Decision (Fees/Costs).
Other than as set forth above, the objections of the UST and of USB as to these matters and issues will be overruled. The Court will separately consider their objections to the magnitude of compensation properly allowable to Counsel.