Ch. 11 Professionals Don't Have to Disgorge Collected Fees

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By Diane Davis

Sept. 20 — Chapter 11 professionals in a bankruptcy case that is later converted to Chapter 7 due to insolvency don't have to share a portion of their collected fees with an unpaid professional, a bankruptcy court in New Mexico held Sept. 15 ( In re Santa Fe Med. Grp., LLC, 2016 BL 304831, Bankr. D.N.M., No. 15-11247-ta7, 9/15/16 ).

Judge David T. Thuma of the U.S. Bankruptcy Court for the District of New Mexico concluded that bankruptcy courts don't have the authority to order disgorgement of fees upon insolvency.

In a typical “disgorgement upon insolvency” case, “a debtor attempts to reorganize in chapter 11, fails, converts to chapter 7, and is administratively insolvent,” the court said. Chapter 11 allows companies (or individuals) to enjoy protections from creditors while they seek to reorganize their debt or liquidate pursuant to a plan which must be approved by the bankruptcy court. In Chapter 7 bankruptcy, however, a debtor's nonexempt assets are liquidated by a trustee, and the proceeds are distributed to creditors.

In these cases, the Chapter 7 trustee may ask the court to order Chapter 11 professionals to “disgorge” a portion of their paid fees so the recovered fees can be redistributed pro rata among all estate professionals. Courts are divided on whether disgorgement is possible: some hold that they have discretion to order disgorgement, others that they must order disgorgement, and others that they lack the authority to order disgorgement. This court sided with the latter approach.

Debtor Santa Fe Medical Group, LLC, and three other affiliates employed numerous professionals in their Chapter 11 case, including Tal Young; Lewis Roca Rothgerber Christie; Sturm & Associates; Candice Lee Owens; and Hanlon & Hudson. The bankruptcy court approved employment applications for all of them, which allowed the debtors to make periodic payments to professionals before the fees had been allowed.

Divide Up Fees?

Susan N. Goodman, RN JD, was appointed the Patient Care Ombudsman for each debtor by the court and had combined fees and costs for all four cases of $62,425 in her final application for compensation. She then asked the court for an equitable apportionment of fees to include her fees. The U.S. Trustee's office supported the motion, but the other Chapter 11 professionals opposed it.

The court found that nothing in the Bankruptcy Code gives the court authority to order Chapter 11 professionals to disgorge upon insolvency. Congress deliberately omitted such a remedy in Bankruptcy Code Sections 726(b) and 330, the court said.

Although some courts use Section 105(a) as a broad license to do equity and create a disgorgement remedy, Law v. Siegel, 134 S.Ct. 1188 (2014), prevents the court from “just doing equity,” the court said. The court found it “troubling” that courts use Section 105 to correct a perceived omission by Congress.

The court said it was “sympathetic to Goodman's plight,” who would receive nothing for her valuable professional services to the estate, but most of the options offered wouldn't help in this case. The orders approving the professionals' fee applications are all final orders, and that final nature precludes considering ordering disgorgement of fees paid under interim orders, the court said. Two firms also had pre-petition retainers, which would prevent Goodman from reaching those funds, the court said.

Scott Kent Brown, II, Justin J. Henderson, Lewis Roca Rothgerber Christie LLP, Phoenix, Ariz., Steven Tal Young, Albuquerque, N.M., represented debtor Santa Fe Medical Group; Spencer Lewis Edelman, Modrall Sperling Roehl, Harris & Sisk PA, Albuquerque, N.M.; Paul M. Fish, Albuquerque, N.M.; Trustee Philip J. Montoya, Albuquerque, N.M.; represented trustee Philip J. Montoya; Alice Nystel Page, Office of U.S. Trustee, Albuquerque, N.M., represented U.S. trustee Ronald Andazola, Assistant U.S. trustee, Albuquerque, N.M.; Scott Kent Brown, II, Lewis Roca Rothgerber Christie LLP, Phoenix, Ariz., represented The Owens Law Firm P.C., Special Counsel; Spencer Lewis Edelman, Modrall Sperling Roehl, Harris & Sisk PA, Albuquerque, N.M.,; Paul M. Fish, Albuquerque, N.M., represented Unsecured Creditors Committee, Creditor Committee.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com

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