Federated Dept. Stores, Inc., In re

Citation44 F.3d 1310
Decision Date17 January 1995
Docket NumberNos. 93-3745,93-4186,s. 93-3745
Parties, 32 Collier Bankr.Cas.2d 1391, 26 Bankr.Ct.Dec. 749, Bankr. L. Rep. P 76,336 In re FEDERATED DEPARTMENT STORES, INC.; Allied Stores Corporation, Debtors. M. Scott MICHEL, United States Trustee, Plaintiff-Appellant, v. FEDERATED DEPARTMENT STORES, INC.; Shearson Lehman, Inc., Defendant-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (6th Circuit)

Neal J. Weill, Cincinnati, OH, Jennifer H. Zacks (argued), William Kanter (briefed), Civil Div., Appellate Staff, Martha L. Davis, Civil Div., Bruce G. Forrest (briefed), Civil Div. Appellate Staff, U.S. Dept. of Justice, Washington, DC, Lawrence J. Hackett, Columbus, OH, Jeanne M. Crouse, U.S. Dept. of Justice, Executive Office for U.S. Trustees, Washington, DC, for M. Scott Michel in No. 93-3745.

David G. Heiman, Cory Lipoff, Jones, Day, Reavis & Pogue, Cleveland, OH, for Federated Dept. Stores, Inc. in No. 93-3745.

Mark Thompson (argued and briefed), I. Scott Gottdiener, Michael P. Graney, Simpson, Thacher & Bartlett, New York City, for Shearson Lehman Bros., Inc. in No. 93-3745.

Jennifer H. Zacks (argued and briefed), U.S. Dept. of Justice, Appellate Staff, Civil Div., Washington, DC, for M. Scott Michel in No. 93-4186.

Mark Thompson (argued and briefed), Simpson, Thacher & Bartlett, New York City, for Shearson Lehman Bros., Inc. in No. 93-4186.

Before: KEITH, WELLFORD, and DAUGHTREY, Circuit Judges.

WELLFORD, Circuit Judge.

These consolidated appeals involve Lehman Brothers' 1 request for compensation for services rendered to the debtor, Federated Department Stores, Inc., ("Federated") during its Chapter 11 reorganization. The bankruptcy court approved Lehman Brothers' appointment as a financial advisor to Federated over the strong objections of the United States Trustee ("Trustee"). 2 The Trustee argued that Lehman Brothers was disqualified from serving in that capacity because it was not a "disinterested person" as required under the United States Bankruptcy Code ("Code"). While Lehman Brothers' appointment was on appeal from the bankruptcy court to the district court, Lehman Brothers continued to serve as Federated's financial advisor. After Federated's plan of reorganization was confirmed and Lehman Brothers was no longer employed, Lehman Brothers filed its final application for fees and expenses which was approved by the bankruptcy court. The Trustee appealed the bankruptcy court's award of fees on the grounds that Lehman Brothers never should have been retained in the first instance and, therefore, was not entitled to compensation. After Federated completed its reorganization, the district court, having not yet ruled on the propriety of Lehman Brothers' retention, held that the Trustee's appeal of the retention order was moot. Further, the district court concluded that the bankruptcy court did not abuse its discretion in awarding fees to Lehman Brothers despite the fact that Lehman Brothers was an "interested person" within the meaning of the Code.

The Trustee has appealed both district court orders, and the appeals have been consolidated. Appeal No. 93-3745 is the Trustee's objection to the district court's determination that the retention order appeal was moot, and appeal No. 93-4186 is the Trustee's objection to the district court's affirmance of the bankruptcy court's order granting Lehman Brothers compensation for services rendered during the pendency of Federated's Chapter 11 reorganization. For the reasons stated below, we DENY the defendants' motion to dismiss as moot Appeal No. 93-3745, and we REVERSE the bankruptcy court's decision approving the appointment of Lehman Brothers as Federated's financial advisor. As for Appeal No. 93-4186, we REVERSE, in part, the bankruptcy court's order granting Lehman Brothers compensation and REMAND to the district court with instructions to disallow compensation for all services rendered after this court's decision in In re Middleton Arms, Ltd. Partnership, 934 F.2d 723 (6th Cir.1991).

I. PROCEDURAL HISTORY

On January 15, 1990, Federated, Allied Stores Companies and numerous other debtors filed sixty-six separate reorganization cases in the United States Bankruptcy Court for the Southern District of Ohio. The reorganization of Federated was the one of the largest in United States history, and due to the highly complex nature of the bankruptcy, Federated sought to hire a financial advisor to aid it in developing an effective reorganization plan. On February 6, 1990, Federated and Lehman Brothers entered into a Retention Agreement. Pursuant to the agreement, Lehman Brothers agreed to provide "financial advisory services" to Federated during the pendency of the Chapter 11 case in exchange for a fee of $250,000.00 per month subject to the bankruptcy court's approval. Lehman Brothers' services included evaluating Federated's debt and equity structures, formulating and negotiating the structures of any new securities' offerings, and developing the actual plan of reorganization.

On March 16, 1990, Federated asked the bankruptcy court for approval of its Retention Agreement with Lehman Brothers. The Trustee objected on the grounds that Lehman Brothers was disqualified from serving as the debtor's financial advisor because it was not a "disinterested person" as required by 11 U.S.C. Sec. 327(a). Section 327(a) allows a trustee, or debtor-in-possession like Federated, to employ financial advisors such as Lehman Brothers if the advisor "do[es] not hold or represent an interest adverse to the estate," and is a "disinterested person" within the meaning of 11 U.S.C. Sec. 101(14). See 11 U.S.C. Sec. 327(a). Section 101(14) defines a "disinterested person" as someone who:

(A) is not a creditor, an equity security holder, or an insider;

(B) is not and was not an investment banker for any outstanding security of the debtor;

(C) has not been, within three years before the date of the filing of the petition, an investment banker for a security of the debtor, or an attorney for such an investment banker in connection with the offer, sale, or insurance of a security of the debtor;

(D) is not and was not, within two years before the date of the filing of the petition, a director, officer, or employee of the debtor or of an investment banker specified in subparagraph (B) and (C) of this paragraph, or for any other reason; and

(E) does not have an interest materially adverse to the interest of the estate or of any class of creditors or security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor or an investment banker specified in subparagraph (B) and (C) of this paragraph, or for any other reason.

Id. Sec. 101(14). The Trustee argued that Lehman Brothers appointment as Federated's financial advisor violated both the adverse interest and disinterested person requirements of Sec. 327(a).

As evidence of Lehman Brothers' interest, the Trustee pointed to Lehman Brothers' numerous holdings of Federated securities as well as debt and equity instruments held by some of Lehman Brothers' clients, over which Lehman Brothers possessed discretionary trading authority. As required by Bankruptcy Rule 2014(a), Lehman Brothers disclosed to the bankruptcy court all prior and current financial contacts with Federated. In addition to holding a substantial amount of Federated's debt and preferred equity, Lehman Brothers also served as Federated's lead underwriter in a public offering of over $200,000,000.00 of debt. Moreover, Lehman Brothers served as Federated's investment banker during the ill-fated Campeau Corporation's leveraged acquisition (LBO) of Federated. In all, Lehman Brothers listed twenty-one separate areas of financial connections with Federated dating back to the mid-1980s.

Before the bankruptcy court, Federated conceded that Lehman Brothers' past service as its investment banker was a technical obstacle to Lehman Brothers' appointment under Sec. 101(14) and Sec. 327(a). Federated noted, however, that "a denial of the Application would unjustly disadvantage the Debtors by denying it the assistance of the most uniquely qualified financial advisor, and by unduly burdening the estate ... with additional and unnecessary expense and causing significant delay in the reorganization process." Federated also argued that because the number of investment banking firms which had previously represented it was extensive, "the Debtors may effectively be precluded from engaging a major investment banking firm to assist in their reorganization." Despite the Trustee's reliance on the literal and seemingly unambiguous language of the Code, the bankruptcy court held that equitable principles and the need for a quick and effective reorganization warranted a departure from the strict language of the statute. See 114 B.R. 501, 504-05 (Bankr.S.D. Ohio 1990). The bankruptcy court explained that

[w]hile some courts do interpret Sec. 327(a) literally, the better analysis is to balance the risk and gravity of the potential conflict of interest with the costs that the estate and perhaps the public would incur in the event of disqualification of the professional [Lehman Brothers]. Some of these costs include the additional expense and delay in getting a substitute professional up to speed and the loss of the original professional's superior expertise that the substitute professional cannot replace.

Id. at 504. Accordingly, the bankruptcy court approved Federated's application.

On May 31, 1990, the Trustee appealed the bankruptcy court's decision to the United States District Court for the Southern District of Ohio. The district court, however, did not resolve the appeal immediately. In fact, for reasons that are not entirely clear, the district court did not rule on the Trustee's appeal for almost three years until after the reorganization was completed.

One reason for the delay was that...

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