Purchase and Sale of Assets

Interim Fee Awards in Final Fee Petitions

Bankruptcy Update

By Myron A. Bloom
Special to the Legal

Last week, the 9th U.S. Circuit Court of Appeals addressed an issue often confronted by professional people retained by fiduciaries, whether they be Chapter 7 trustees, debtors-in-possession or committees? Namely, to what extent can interim fee awards under Section 331 of the Bankruptcy Code be revisited at the time of filing a final fee petition?

Leichty v. Neary (In re Strand) involved an appeal by counsel for a Chapter 7 trustee of a final fee award. The debtors, a husband and wife, filed a voluntary Chapter 7 case. The Chapter 7 trustee sought, and obtained, authorization to retain counsel, Leichty. Leichty filed three adversary proceedings, including one against the Internal Revenue Service, which, post-petition, offset a $28,000 overpayment made by the debtors pre-petition against a penalty assessed by the IRS against Strand in the amount of $40,000.

The adversary filed against the IRS was predicated on the service's alleged violation of the automatic stay and the trustee's position that because the overpayment was a joint overpayment and the penalty was assessed only against the husband, no mutuality of debt (a requirement for a Section 553 offset) existed. The bankruptcy court granted summary judgment to the IRS, holding that even though there had been a technical violation of the automatic stay, the setoff was proper so that it made little sense to require the IRS to reverse the setoff and return the funds to the estate, only to have the IRS later claim the very same money in a request for setoff, a request that would have been granted.

While the IRS litigation was pending, Leichty filed an interim fee petition, requesting $22,000 for services rendered. The bankruptcy court awarded Leichty the amount requested, but limited payment to only $16,500. After summary judgment was entered in the IRS adversary proceeding, and at the conclusion of the case, Leichty filed his final fee request, asking for an award of an additional $12,400, bringing the total fee request to approximately $34,400. Of the total, $19,000 was attributable to the IRS litigation.

The U.S. Trustee, arguing that the trustee and his counsel had utilized "poor judgment" in aggressively pursuing the IRS litigation, sought to have almost $12,000 of the fees incurred in the IRS litigation disallowed. The bankruptcy court agreed with the U.S. Trustee but believing that the reduction sought was "drastic," allowed one-half of the fees attributable to this piece of litigation. Leichty appealed, first to the district court (which affirmed the bankruptcy court's decision) and then to the 9th Circuit.

After discussing briefly the standard of review (findings of fact are to be reviewed for "clear error," conclusions of law are to be reviewed de novo), the 9th Circuit took up each of Leichty's arguments.

First, Leichty argued that the effect of the interim award was to create in a vested interest in the amount that had then been awarded, something akin to an account receivable, and that when the final award in essence decreased that award, the bankruptcy court had caused a forfeiture of his interest even though it found no conflict of interest, fraud, or other misconduct.

The 9th Circuit noted that it had never before squarely addressed the issue of whether interim fee awards can be revisited at the time of a final fee application. It thus undertook a review of the prevailing law, noting that in other circuits, an interim award is "interlocutory in nature" and is always subject to a court's reexamination and adjustment during the course of a case. The court observed that the purpose of Section 331 of the Bankruptcy Code, governing interim fee applications, was to provide financial relief to court-appointed officers so that they do not have to wait for what may be many years before receiving compensation. The interim award, accordingly, does not create a "vested interest," as Leichty alleged, because it is not a final determination. Thus, the lower courts did not err in reconsidering, under Section 330, "the nature, extent and value" of the IRS litigation in its entirety.

Second, Leichty argued that the bankruptcy court abused its discretion in making its final award. He raised three issues, which in his view pointed to such an abuse.

Initially, Leichty stated that he was "penalized" for bringing the IRS litigation but that the Chapter 7 trustee was not. The court did not agree. It stated that ultimately, Leichty was responsible for his actions. If, as Leichty inferred, the trustee was to embark on a less-than-effective collection strategy, then his professionals should either resign or recommend to the trustee that another opinion should be secured. Certainly, at the very least, Leichty acquiesced in the decision to bring the litigation. No evidence was introduced to show that Leichty discussed with the trustee the risks of litigation or provided the trustee with a cost-benefit analysis.

Next, Leichty stated that his theory of recovery against the IRS based on a lack of mutuality was well grounded in law, citing to the 9th Circuit a California state court case that, argued Leichty, the bankruptcy court should have adopted. The circuit court had two reactions, neither of which was particularly helpful to Leichty. One was that the proper place to have raised the applicability of the state court case was in an appeal of the bankruptcy court's grant of summary judgment to the IRS. Second was that the bankruptcy court at the time of the final fee award did in fact take note of the decision, stating that the theory was "interesting and somewhat novel" but that in the end, the only beneficiaries of the litigation would have been the IRS and another priority creditor whose debt was non-dischargeable in any event. And in a segue into Leichty's final point, the circuit court stated that because of this fact, there was only a modest beneficial result to be gained from pursuing the IRS litigation.

Finally, and as noted above, Leichty argued that the finding of only a "modest" benefit to the estate was an abuse of the bankruptcy court's discretion. In viewing this issue, the circuit court first reviewed Section 330. The bankruptcy court in evaluating Leichty's final fee request appropriately posed five questions:

Were the services authorized?

Were the services necessary or beneficial to the administration of the estate at the time they were rendered?

Were the services adequately documented?

Are the fees reasonable?

Did the professional exercise reasonable billing judgment.

The 9th Circuit agreed with the lower courts' conclusions that the potential benefit to the estate was "modest, since realistically, the most the estate would have recovered in the IRS litigation was $28,500, the amount of the setoff." And since the 9th Circuit does not permit awards of counsel fees under Section 362(h) against entities other than individuals (here, it was the bankruptcy estate), the fees incurred in obtaining this money would be charged to the estate and were wholly disproportionate to the potential recovery. Also, as noted above, the only beneficiaries of a recovery would have been the IRS and a priority creditor whose debt was non-dischargeable in any event. These factors, when taken as a whole, lead to a conclusion that the benefit at best would have been "modest." This fact, stated the court, demonstrated the logic behind a reduction in the award. The reduction, therefore, was not an abuse of discretion.

This case on its face seems to make a great deal of sense. One should never spend two dollars of estate funds to collect but one. Yet without knowing beforehand the result of litigation, how should professionals conduct themselves if instructed to bring questionable actions? Resign a representation? Bring in another professional (at additional expense to the estate) to give a second opinion? Abandon questionable causes of action? All possibilities.

This article is reprinted with permission from the July 16, 2004 issue of The Legal Intelligencer.  Copyright 2004 ALM Properties, Inc.  Further duplication without permission is prohibited.  All rights reserved.