In re Crafts Retail Holding Corp.

• Decision Date: 16 November 2007
• Docket Number: No. 107-42272-jf.,107-42272-jf.
• Citation: 378 B.R. 44
• Parties: In re CRAFTS RETAIL HOLDING CORP., et al., Debtors.
• Court: U.S. Bankruptcy Court — Eastern District of New York

378 B.R. 44

In re CRAFTS RETAIL HOLDING CORP., et al., Debtors.

No. 107-42272-jf.

United States Bankruptcy Court, E.D. New York.

November 16, 2007.

Michael L. Cook, Esq., Schulte Roth & Zabel LLP, New York, NY, for Duff and Phelps Securities LLC Financial Advisor to the Debtors.

Valerie Millman, Esq., Office of the United States Trustee, Brooklyn, NY, Trial Attorney.

Jil Mazer-Marino, Esq., Rosen Slome Marder, LLP, Uniondale, NY, for the Debtors.

Jeffrey L. Cohen, Esq., Cooley Godward Kronish LLP, New York, NY, for the Official Committee of Unsecured Creditors.

DECISION AND ORDER DENYING THE REQUEST OF DUFF & PHELPS SECURITIES LLC FOR REIMBURSEMENT OF ATTORNEY FEES

JEROME FELLER, Bankruptcy Judge.

Duff & Phelps Securities LLC ("DPS") served as a court authorized financial advisor to the Debtors during the Chapter 11 phase of the above-captioned bankruptcy cases. Upon completion of their services, DPS sought and were granted final compensation of $150,000 for their financial advisory services and reimbursement of expenses totaling $4,577.16. But this did not end the matter. DPS had engaged the services of the law firm of Schulte Roth & Zabel LLP ("SRZ") for assistance in connection with its retention by the Debtors. Judicial approval of the employment of SRZ was not obtained. Before the Court for determination is a request by DPS for reimbursement of SRZ's attorney fees in the sum of $35,000. The United States Trustee ("U.S.Trustee") and the Official Committee of Unsecured Creditors ("Creditors' Committee") oppose this request.

Based upon review of all papers filed, consideration of oral argument, our own legal research, and the interests of prudent and sound bankruptcy administration, we conclude that DPS is precluded, as a matter of law, from being paid the attorney fees of SRZ as reimbursement of expenses. Furthermore, assuming that the request is not barred as a matter of law, we find that DPS failed to demonstrate that the attorney fees were a necessary expense under 11 U.S.C. § 330(a)(1)(B). Accordingly, DPS's request for reimbursement of attorney fees is denied.

I.

Prior to the conversion of their bankruptcy cases to Chapter 7 on November 7, 2007, the Debtors operated some 61 retail stores in five states located on the East Coast of the United States. Known as the "Rag Shops", these retail stores sold principally miscellaneous arts and crafts products, and provided customized framing and other services.

On May 2, 2007, the Debtors filed petitions for reorganization under Chapter 11 of the Bankruptcy Code and continued to operate their businesses and manage their properties as debtors in possession. By May 25, 2007, the Debtors were before Court, in a severe crisis mode and under heavy pressure from a secured creditor with a lien on virtually all their assets, seeking approval of a well-planned, methodical and orderly strategy to sell substantially all its assets.

There was no opposition to the Debtors' liquidation program and the Debtors, with Court approval, embarked upon the program and proceeded swiftly to sell substantially all their assets in Chapter 11 under 11 U.S.C. § 363(b).¹

II.

On May 11, 2007, the Debtors filed an application seeking authorization to employ DPS as their financial advisor pursuant to 11 U.S.C. §§ 327(a) and 328(a) ("Retention Application") (ECF Docket No. 37). Annexed to the Retention Application was an agreement between the Debtors and DPS in the form of a detailed engagement letter, dated May 10, 2007 ("DPS Engagement Letter"). The proposed retention was sought pursuant to provisions of the DPS Engagement Letter. The DPS Engagement Letter sets forth both the agreed upon financial advisory services to be rendered and the terms and conditions of the compensation to be paid for those services. In the event of any disputes arising under and in connection with the agreement, the Debtors and DPS agreed to have such disputes resolved by arbitration under the rules of the American Arbitration Association in New York City.

Invoking 11 U.S.C. § 328(a), the parties contemplated a pre-approved compensation package. DPS was to be paid $85,000, in advance, for the first month of the engagement and $50,000, payable in cash in advance, each month thereafter. DPS was not required to maintain time records. The agreement also provided for a "success fee" under certain circumstances. In addition, paragraph 3(e) of the DPS Engagement Letter, captioned "Expense Reimbursement", provided that DPS shall be entitled to monthly reimbursement of reasonable out-of-pocket expenses, and that out-of-pocket expenses included attorney fees which shall not exceed $35,000 without the Debtors' prior consent. The Retention Application sought authorization to compensate and reimburse the out-of-pocket expenses of DPS in accordance with the DPS Engagement Letter, without even the necessity of DPS filing fee applications. Retention Application & 14.

The U.S. Trustee and the Creditors' Committee filed objections to the Retention Application. ECF Docket Nos. 96 and 116, respectively. Negotiations ensued between the U.S. Trustee, the Creditors' Committee, DPS, and the Debtors. As a result, DPS agreed to major revisions to the terms of the engagement and the parties presented to the Court a form of consensual proposed retention order reflecting those revisions.

Ultimately, the Court entered an order on June 7, 2007, authorizing the employment of DPS with yet further wide-reaching modifications ("Retention Order") (ECF Docket No. 173). The employment of DPS was explicitly made subject to the provisions and limitations of the Retention Order. The Retention Order radically changed the compensation arrangement that was originally envisioned by DPS and the Debtors. The Retention Order included provisions, i() eliminating any reference to 11 U.S.C. § 328(a) and characterizing the retention as solely under 11 U.S.C. § 327(a); ii() limiting the retention to a two month period, May and June 2007; iii() allowing monthly compensation of $75,000 for each of the foregoing two months, payable upon the filing of a final fee application for fees and reimbursement of expenses; iv() eliminating any notion of a "success fee"; v() requiring DPS to maintain time records and to provide a narrative description of its services in connection with the filing of its final fee application; and vi() subjecting the fees and expenses of DPS to judicial review under applicable provisions of the Bankruptcy Code.²

Upon expiration of the term of its employment on June 30, 2007, DPS filed an application for compensation and reimbursement of expenses under 11 U.S.C. § 330 (ECF Docket No. 260) and a supplement to that application on July 26, 2007 (ECF Docket No. 362) (collectively, "Fee Application").

The Fee Application sought $150,000 in compensation for professional services rendered as financial advisor to the Debtors plus reimbursement of expenses, the bulk of which represented $35,000 in attorney fees incurred by SRZ. The legal services performed by SRZ related to negotiating, documenting and drafting the DPS Engagement Letter, preparing the Retention Application, negotiating and drafting proposed retention orders, and preparing the Fee Application, as supplemented, including legal research regarding reimbursement from the estate of its legal fees.³

The Creditors' Committee and the U.S. Trustee objected to that part of the Fee Application seeking the reimbursement of attorney fees of SRZ. ECF Docket Nos. 380 and 382, respectively. DPS filed a reply and amended reply to the objections filed by the Creditors' Committee and the U.S. Trustee. ECF Docket Nos. 388 and 408, respectively. Hearings on the Fee Application were held on August 2, 2007 and August 16, 2007. The Court granted the $150,000 final compensation request of DPS,⁴ authorized the reimbursement of undisputed out-of-pocket expenses in the sum of $4,577.16, reserved decision on the request of DPS for reimbursement of $35,000 in attorney fees and on August 27, 2007, entered an order to that effect. ECF Docket No. 453.

III.

Although the $35,000 legal bill in dispute is not substantial in the context of these bankruptcy cases, the propriety of compensating a professional person whose employment was not authorized by the bankruptcy court from estate assets raises issues important to case administration under the Bankruptcy Code. The Bankruptcy Code provides that the trustee (or a debtor-in-possession under 11 U.S.C. § 1107) and the official creditors' committee may employ an attorney or other professional person, with the approval of the bankruptcy court. 11 U.S.C. §§ 327(a) and 1103(a). Further, 11 U.S.C. § 330(a) dictates that a bankruptcy court cannot award compensation or reimbursement of expenses, unless it has authorized the attorney's employment-under 11 U.S.C. §§ 327 or 1103.⁵ See 11 U.S.C. § 330(a). It is therefore essential that the bankruptcy court formally approve an attorney's employment before that attorney renders services compensable by the estate. In re Rainbow Press of Fredonia, 197 B.R. 428, 429 (Bankr.W.D.N.Y.1996); In re Robotics Res. R2, Inc., 117 B.R. 61, 62 (Bankr. D.Conn.1990); In re Sapolin Paints, Inc., 38 B.R. 807, 817 (Bankr.E.D.N.Y.1984).

The rule forbidding compensation to a professional person for services rendered absent employment of that professional by an order of the bankruptcy court is not a new one. It was already well established under the former Bankruptcy Act. See, e.g., Futuronics Corp. v. Arutt, Nachamie & Benjamin (In re Futuronics Corp.), 655 F.2d 463, 469 (2d Cir.1981), cert. denied, 455 U.S. 941, 102 S.Ct. 1435, 71 L.Ed.2d 653 (1982); Smith v. Winthrop, Stimson, Putnam & Roberts (In re Sapphire S.S. Lines, Inc.), 509 F.2d 1242, 1245-46 (2d Cir.1975); In re Progress Lektro Shave Corp., 117 F.2d 602, 604 (2d Cir.1941); In re H.L. Stratton, Inc., 51 F.2d 984 (2d Cir.1931), cert. denied, 284 U.S. 682, 52 S.Ct. 199, 76 L.Ed....