In a recent Chapter 11 case and subsequent Chapter 7 case, Judge Timothy Barnes of the N.D. of Illinois allowed counsel for an assignee (“Assignee”) in an Illinois assignment for the benefit of creditors (“ABC”) to recover attorneys’ fees and expenses incurred pre-petition and post-petition. The decision is noteworthy because it addresses a custodian’s counsel’s entitlement to the recovery of both pre- and post-petition fees and expenses as an administrative expense. It also provides a comprehensive guide on the relevant standards that a bankruptcy court should employ to review expenses incurred in various stages of an out-of-court restructuring that is interrupted by a superseding bankruptcy case.
In In re Stainless Sales Corp., 2018 WL 1604628 (Bankr. N.D. Ill. Mar. 30, 2018), the debtor voluntarily subjected itself to an ABC, but creditors filed an involuntary Chapter 11 case before the Assignee could complete a sale of all the debtor’s assets. The debtor had already assigned all of its assets to the Assignee as part of the ABC and chose not to actively participate in the bankruptcy proceedings. As a result, the Assignee and his counsel were forced to take a more active, ongoing role to preserve the assets prior to the appointment of a bankruptcy case trustee who would administer the assets for the benefit of the bankruptcy estate. The involuntary petition was not contested and an order for relief was entered, however the Chapter 11 case failed due to the absence of participation by the debtor. The case was eventually converted to Chapter 7 and a case trustee (“Trustee”) was appointed.
The Assignee’s counsel sought payment of its fees and expenses as an administrative expense from a $155,000 retainer paid to it in connection with the commencement of the ABC for the work performed during three distinct time periods:
Pre-petition during the ABC.
Post-petition from the filing of the involuntary Chapter 11 petition throughout the pendency of the Chapter 11 case.
In the proceedings during the Chapter 7 case.
The dispute centered on four points of contention raised by the Trustee:
The Assignee’s counsel could not recover its fees and expenses as an administrative expense claim because counsel did not seek prior approval from the Bankruptcy Court.
Administrative expenses recoverable by counsel for a pre-petition custodian are limited to claims for pre-petition services.
The services rendered by counsel were unreasonable and not sufficiently described, resulting in vague, duplicative and excessive time entries.
Services rendered by counsel for preparing and defending its fee application were unreasonable and should be reduced.
The legal framework
The legal framework of the case concerns the treatment of an administrative expense claim by a custodian for the legal fees and expenses of its counsel under alternative theories based on Sections 503(b)(1), 503(b)(3), 503(b)(4) and 543 of the Bankruptcy Code. The Assignee was awarded its fees as a custodian under Section 503(b)(3)(E), but the court ruled that counsel was plainly not a custodian and could not recover a claim under that statute. The court reconciled the nuances between and among the statutory bases for relief in part because the statutes apply different standards of review based on whether the source of payment of the compensation is estate property or some other source.
To the extent the compensation requested by a custodian’s counsel is to be paid from estate property, the heightened standard of “actual and necessary” [as set forth in Section 503(b)(3)(E)] should be applied. To the extent compensation is from another source, the “reasonableness” standard [in Section 543(c)(2)] should apply. The parties did not dispute that the pre-petition retainer was property of the bankruptcy estate, so the court employed the heightened standard of “actual and necessary” contained in Section 503(b)(3)(E).
The court ruled that the Assignee’s counsel was not required to seek retention as a professional under Section 327 because the Assignee is a custodian and does not fall within the scope of the statute as a “trustee” or debtor in possession. Consequently, the provisions of Section 330 do not explicitly apply to the compensation of a custodian’s counsel. The court concluded that the compensation standards are contained solely within Sections 503(b) and 543.
The court overruled the Trustee’s contention that the Assignee’s counsel could only be compensated for pre-petition services; clearly, Sections 543 (c)(1) and 543(c)(2) provide authority for payment of pre-petition services rendered by a custodian’s counsel. With respect to the post-petition services, the scope of Section 503(b)(4) does not differentiate between pre-petition and post-petition expenses. The court explained that administrative expenses under Section 503(b) by nature arise post-petition, and a plain textual reading of the statute formed the basis for the recovery of the Assignee’s post-petition attorneys’ fees and expenses.
Judge Barnes’ analysis
One of the most important attributes of Stainless Sales is Judge Barnes’ extensive analysis of the reasonableness of the Assignee’s counsel’s fees and expenses. First, the court dispelled the argument advanced by the Assignee that counsel’s fees and expenses were per se reasonable because they “fused” with the allowed fees of the custodian. The court distinguished In re R.L. Adkins Corp., 505 B.R. 770, 779 (Bank. N.D. Tex. 2014), which held that services performed at the behest of a custodian must be compensated if the custodian's services are compensated. Judge Barnes ruled that a court is statutorily compelled to apply the reasonableness requirement to the compensation under 11 U.S.C. § 503(b)(4) because Adkins is limited to fees recovered on a substantial contribution theory under Section 503(b)(3)(D), which is not implicated in Section 503(b)(3)(E).
Next, the court examined the reasonableness of the fee application using the same analysis employed when reviewing the fee application of a professional retained by the estate under Section 330(a)(3). As context for examining the reasonableness of counsel’s fees and expenses, the court noted that the unusual circumstances of the case—the Assignee and his counsel were forced to undertake extraordinary supervisory and administrative activities to maintain and preserve the assets of the estate, because the debtor abdicated its duties as the owner and manager of the corporation and its assets. The court found under the unique nature of the case counsel’s fees and expenses were reasonable.
The Trustee argued that compensation for the preparation and litigation of custodian fee applications is limited to a proportionate amount of the compensation awarded for the total hours in the main case, usually three to five percent. The court found that the unusual circumstances warranted allowing a ten percent cap on the fees associated with the preparation and litigation of the fee application. Relying on In re 29 Brooklyn Ave., LLC, 548 B.R. 642, 647 (Bankr. E.D.N.Y. 2016), the court observed that services rendered in litigating the fee application was “labor performed for” and “disinterested service” to the custodian and compensable under Section 503(b)(4). Consequently, counsel’s fees for preparing and litigating the fee application in Stainless Sales were distinguishable from fees not allowable under Section 330 and the Supreme Court’s ruling in Baker Botts LLP v. ASARCO LLC.
Stainless Sales is a critically useful guide for professionals navigating through troublesome situations involving failed out-of-court liquidation proceedings such as ABCs and receiverships. Attorneys and other professionals employed by assignees and receivers can utilize the analysis in Stainless Sales to assert the right to obtain compensation for services rendered to a “custodian” if pressed into service after the commencement of a bankruptcy.