Arlan's Dept. Stores, Inc., Matter of

• Decision Date: 05 November 1979
• Docket Number: 53,Nos. 52,D,s. 52
• Parties: , Bankr. L. Rep. P 67,253 In the Matter of ARLAN'S DEPARTMENT STORES, INC., Debtor. ockets 79-5017, 79-5018.
• Court: U.S. Court of Appeals — Second Circuit

Page 925

615 F.2d 925

5 Bankr.Ct.Dec. 973, Bankr. L. Rep. P 67,253

In the Matter of ARLAN'S DEPARTMENT STORES, INC., Debtor.

Nos. 52, 53, Dockets 79-5017, 79-5018.

United States Court of Appeals, Second Circuit.

Argued Sept. 13, 1979.

Decided Nov. 5, 1979.

Simon H. Rifkind, New York City (Paul Weiss, Rifkind, Wharton & Garrison, Edward N. Costikyan and Mark C. Morril, New York City, of counsel), for appellant Ballon, Stoll & Itzler.

Arthur H. Christy, New York City (Christy & Viener, Leonard J. Colamarino and Wayne Charles Matus, New York City, of counsel), for appellant Lappin, Rosen, Goldberg, Slavet, Levenson & Wekstein, Inc.

Ambrose Doskow, New York City (Rosenman, Colin, Freund, Lewis & Cohen, William W. Golub, Jane S. Solomon, and Grace Goodman, New York City, of counsel), for appellee Jack C. Auspitz, Trustee of the Debtor.

David Ferber, Sol. to the Securities and Exchange Commission, Washington, D.C. (Douglas J. Scheidt, Atty., Washington, D.C., Marvin E. Jacob, Associate Regional Administrator of the Securities and Exchange Commission, and Jerome Feller, Sp. Counsel, New York City), for appellee Securities and Exchange Commission.

Before MULLIGAN, VAN GRAAFEILAND and MESKILL, Circuit Judges.

MULLIGAN, Circuit Judge:

Two law firms which acted respectively as general counsel and special counsel to a debtor-in-possession in a proceeding under Chapter XI of the Bankruptcy Act, 11 U.S.C. §§ 701-99, appeal from an order of the United States District Court for the Southern District of New York, Hon. Robert L. Carter, Judge, which denied both firms any fees and ordered the return to the estate of fees and disbursements which had been paid together with interest. The opinion of Judge Carter was filed on December 6, 1978, and is reported in 462 F.Supp. 1255. For the reasons set forth in this opinion we affirm the order of the district court.

The debtor is Arlan's Department Stores, Inc. (Arlan's), which filed a petition for an arrangement under Chapter XI of the Bankruptcy Act (Act) on May 14, 1973. By order of Referee Roy Babitt, Arlan's was permitted to continue the operation of its business as a debtor-in-possession. In June and July 1973, similar petitions were filed by forty of Arlan's wholly-owned subsidiaries which were also authorized to continue business. The Securities and Exchange Commission (Commission) moved pursuant to section 328 of the Act, 11 U.S.C. § 728, to dismiss the Chapter XI proceedings and to require proceedings under Chapter X of the Act. The motion was granted for the reasons set forth in Judge Carter's opinion of February 20, 1974 which is reported in 373 F.Supp. 520. The Chapter X Trustee was a party in the proceedings below and by order of this court dated May 21, 1979, has filed a brief in support of the decision of the district court. The Commission is also a party to these proceedings pursuant to section 208 of the Act, 11 U.S.C. § 608 and has filed a brief on behalf of the appellee. The law firm which represented the debtor in the Chapter XI proceedings as general counsel is Ballon, Stoll and Itzler (Ballon), a New York firm with extensive bankruptcy experience. Special counsel for the debtor was Lappin, Rosen, Goldberg, Slavet, Levenson and Wekstein, Inc. (Lappin), a Boston firm which claims no bankruptcy experience but was retained because of its real estate and securities background. Both firms were authorized to file these appeals by order of this court on March 29, 1979.

I. The Facts

Arlan's, incorporated in New York in 1957, was engaged in the business of conducting a retail discount store chain which by 1970 had grown to a peak of 119 stores in numerous states. In that year, Arlan's began to experience heavy operating losses. By the end of April 1973, it reported losses of approximately $65 million for the preceding 3 1/4 fiscal years. By May 1973, it had closed 39% of its stores and had reduced its payroll by about 4000 employees. Cash flow was clearly inadequate and its cash position became critical. Arlan's institutional lenders were owed some $21 million and refused to honor checks drawn on its accounts. Arlan's was further indebted to the extent of $35 million to its trade creditors and faced potential claims of $15 million by the landlords of its subsidiary stores for rent defaults. On the advice of Ballon, Arlan's filed a Chapter XI petition on May 14, 1973, and in the following two months similar petitions were filed by forty of its subsidiaries. During the Chapter XI proceedings Arlan's economic condition continued to worsen. By late January 1974, some thirty-eight additional stores were closed and liquidated, operating losses of some $9.5 million dollars had been incurred and net losses of approximately $70.8 million had been suffered. A particularly disastrous project, prophetically called "Mission Impossible", was undertaken without court approval in an effort to reap profits during the 1973 Christmas shopping season. Judge Carter found that it involved "huge expenditures of funds, time and effort". 462 F.Supp., supra, at 1259.

These events prompted the Commission to seek Chapter X relief and, as we have indicated, Judge Carter granted the Commission's motion in February 1974 over the strenuous objection of Arlan's and its counsel. On January 29, 1975, the debtor was declared insolvent and the assets of all the ten remaining stores were liquidated. Ballon sought a total fee of $250,000 plus disbursements of $4,352.24. Judge Carter denied any allowance for compensation and directed that Ballon return to the estate, with interest, $129,993.98 which it had received from Arlan's. Id. at 1266. Lappin applied for an allowance of $93,440 for fees and disbursements of $21,088.50. The court denied any fee and ordered that Lappin return to the estate, with interest, the sum of $111,088.50 which it had received in connection with the case. Id. at 1267.

II. The Ballon Appeal

The denial of the Ballon fee was based essentially on three grounds which we shall separately discuss.

(a) The Prior Representation

In 1971, about two years prior to the May 1973 filing by Arlan's, Ballon had been retained by Arlan's to determine whether a petition for an arrangement under Chapter XI of the Act should be filed. After a comprehensive review, Ballon determined that a petition at that time was not in the interest of Arlan's or its general creditors. The propriety of that advice is not before us and is not an issue in these proceedings. For these services Ballon was paid a fee of $5,000. The parties have taken issue, however, with the fact that when Arlan's Chapter XI petition was filed on May 14, 1973 seeking court authorization for the retention of Ballon as its general counsel, it was accompanied by an affidavit of Ballon's partner Ronald S. Itzler which stated: "Neither your deponent nor any member of the firm has any connection with the above named debtor, its creditors, or any other party in interest, or their respective attorneys." Itzler further indicated in the affidavit that "your deponent's firm has never represented the debtor and has never represented any of the principals of the debtor."

In view of Ballon's representation of Arlan's two years before the affidavit was submitted in a matter which involved the very subject of the petition, the possibility of a Chapter XI proceeding, it is indisputable that the Ballon firm misrepresented its prior relationship with Arlan's. Ballon suggests on this appeal that the prior dealing constituted a "consultation" and not a "representation." This is a semantic quibble in which prospective counsel seeking confirmation by the court should not have indulged and which cannot be countenanced. The prior retention was not only concealed but positively denied in the affidavit. The misrepresentation is particularly disturbing since the Itzler affidavit alleges that the deponent and the Ballon firm "(have) had considerable experience in similar proceedings, and (have) on various occasions, in these matters, represented both creditors and debtors . . . ." We would expect that its familiarity with Arlan's affairs would certainly have prompted Ballon to disclose the prior relationship and certainly not to deny that any such representation ever existed.

There is another facet to Ballon's prior representation of Arlan's in 1971 which is particularly troublesome. On April 12, 1971, Ballon entered into a letter agreement with Finley, Kumble, Underberg, Roth & Grutman (Finley), a New York firm then acting as general counsel to Arlan's. The agreement provided that in the event of a Chapter XI filing by Arlan's, Finley would use its best efforts to cause Ballon to be retained by Arlan's as its general counsel in those proceedings, and Ballon in turn would use its best efforts to cause Finley to be appointed as special counsel if such services were reasonably required. In addition Finley would retain all its fees as special counsel, but the Ballon fees would be shared with Finley. Ballon would perform approximately 2/3 of the services and keep 2/3 of the fee. Finley would perform 1/3 of the work and take 1/3 of the Ballon fee. The text of this mutual assistance pact is set forth in the margin. ¹ The agreement was not disclosed in Arlan's Chapter XI petition or in the Itzler affidavit. Judge Carter stated that had the agreement been disclosed, Ballon "would not have been confirmed as the debtor's general counsel in the Chapter XI proceedings." 462 F.Supp. at 1264. The court found that Ballon was obliged to disclose its prior representation of Arlan's as well as the Finley letter when Arlan's sought Ballon's appointment as its general counsel.

We reject at the outset Ballon's position that the petitioner was Arlan's and not Ballon and that the firm had no obligation to report anything to the court. The petition of Arlan's was prepared by Ballon and the firm billed Arlan's for its preparation. Moreover, the Itzler affidavit...