In re McDonald Bros. Const., Inc.

• Decision Date: 11 June 1990
• Docket Number: Bankruptcy No. 90 B 884.
• Citation: 114 BR 989
• Parties: In re McDONALD BROS. CONSTRUCTION, INC., Debtor.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

114 B.R. 989 (1990)

In re McDONALD BROS. CONSTRUCTION, INC., Debtor.

Bankruptcy No. 90 B 884.

United States Bankruptcy Court, N.D. Illinois, E.D.

June 11, 1990.

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Max Chill, Steven R. Radtke, Chill, Chill & Radtke, P.C., Chicago, Ill., for applicants.

MEMORANDUM OF DECISION

EUGENE R. WEDOFF, Bankruptcy Judge.

This Chapter 11 case has come before the court on an unusual application, filed by the attorneys for the debtor in possession, seeking "leave to apply" a retainer that they received from the debtor before the case was filed. Because the proper treatment of prepetition retainers is an area of developing law, the court requested briefs on the legal issues raised by the motion, and conducted an informal hearing regarding the circumstances under which the retainer was received. Now, having reviewed the law and the factual submissions made by debtor's counsel, the court concludes that counsel may treat the retainer as their own property without leave of court.

Factual Background

January 26, 1990, McDonald Bros. Construction, Inc. ("McDonald Bros."), as debtor in possession, presented an application to employ attorneys Max Chill, Steven R. Radtke, and John Loftus. As required by Bankruptcy Rule 2014(a), the application listed the professional services to be rendered and the connections between the attorneys and other entities involved with the case. The application did not set forth any proposed arrangement for compensation, stating simply that the attorneys would be employed "under a general retainer." The court approved this application.

Accompanying the application to employ counsel was a second application — the one now at issue — which disclosed that counsel had received, prior to filing the case, a $12,500 retainer. (Application, ¶ 2.) The application then sets forth what counsel propose to do with the retainer: (1) "apply the said retainer for the time they have spent ... and for further work that will be necessary in the future"; (2) "account to the Court for all time spent in and about the matter"; and (3) in the event the Court allows total fees in an amount less than the retainer, "turn over to the Debtor all such excess." (Application, ¶ 4.)

The brief submitted in support of the retainer application presents a fuller statement of the circumstances under which the retainer was received. According to the brief, there was a meeting on January 13, 1990, between the principal of McDonald Bros. (Kevin A. McDonald), and the attorneys. At the meeting, the brief asserts, the attorneys told McDonald that "if he wanted them to take his Chapter 11 case and devote their time, energies, and experience to the case, McDonald Bros. Construction, Inc. must pay them a retainer of $12,500.00 before they file the case," that "they undoubtedly would apply to the Court in the future for additional compensation," and that "the $12,500.00 was a fee paid for purposes of obtaining their services and getting them involved in the case." (Brief, 2-3.) The brief states that McDonald understood all of this and agreed to pay the retainer as requested. The brief concludes: "When the retainer was paid, it ceased to be the property of McDonald Bros. Construction, Inc. and therefore it is not property of Debtor's estate. The $12,500.00 was earned upon Applicants' receipt subject to further order to the Bankruptcy Court." (Brief, 6.)

In an informal hearing, conducted on April 16, 1990, counsel confirmed their position that the retainer was an advance payment for services to be rendered in the case.

Jurisdiction

This proceeding, dealing with proper treatment of funds received by debtor's counsel, "arises in" the debtor's bankruptcy case, and hence is within the jurisdiction of the district court pursuant to 28 U.S.C. § 1334(b). See In re Wood, 825 F.2d 90, 97 (5th Cir.1987) ("`Arising in' proceedings are those that are not based on any right expressly created by title 11, but nevertheless, would have no existence outside the bankruptcy"). Pursuant to 28 U.S.C. § 157(a) and General Rule 2.33(a), the district court has referred all such proceedings to the bankruptcy judges of this district. Because treatment of the retainer affects the administration of the estate, it is a core proceeding, as to which a bankruptcy judge may enter final orders. 28 U.S.C. §§ 157(b)(1), 157(b)(2)(A), (O). Cf. In re Hudson Shipbuilders, Inc., 794 F.2d 1051, 1054-55 (5th Cir.1986); In re Chas. A. Stevens & Co., 109 B.R. 853, 854 (Bankr. N.D.Ill.1990) (each dealing with fee awards).

Discussion

Although the relief sought by the pending application is stated somewhat subtly, the outcome sought by the debtor's counsel is clear: they want to be able to treat the retainer as their own money — i.e., to spend it — without first obtaining court approval of a fee application. Thus, when the application seeks leave to "apply" the retainer for "work that will be necessary in the future," the request is for court permission to use the retainer, or such portions of it as they see fit, before any review by the court.

A substantial number of recent bankruptcy court decisions have considered the proper treatment of retainers acquired by debtors' counsel before the bankruptcy was filed. In nearly all of these decisions, the bankruptcy judges concluded — contrary to the relief sought by the pending application — that the debtors' lawyers could only use their retainers after notice and hearing pursuant to Sections 330 or 331 of the Bankruptcy Code (Title 11, U.S.C., the "Code").¹ However, for the reasons set forth below, these decisions are either inapplicable to the present case or unpersuasive in their analysis of the Code.

1. The fee application procedure of Sections 330 and 331 must be followed whenever compensation is sought from the estate, but not when compensation has been obtained from another source.

Sections 330 and 331 of the Bankruptcy Code allow the court, after notice and hearing, to award compensation for services rendered and reimbursement of expenses to certain professionals, including counsel for the debtor. Section 331 deals with interim awards, and Section 330 deals with final awards. Bankruptcy Rule 2016(a) sets forth the procedure for obtaining such awards, including the requirement of a fee application: a "detailed statement of (1) the services rendered, time expended and expenses incurred, and (2) the amounts requested." Bankruptcy Rule 2002(a)(7) requires 20-day notice of the hearing on all fee applications totalling in excess of $500. This collection of Code sections and rules constitutes the "fee application process."²

Any professional seeking compensation from the estate must comply with the fee application process. Rule 2016(a) so provides: "An entity seeking interim or final compensation for services, or reimbursement of necessary expenses, from the estate shall file with the court an application ..." (emphasis added). Moreover, if a professional in possession of estate funds takes the funds as compensation without a court order, that professional would violate the automatic stay. 11 U.S.C. § 362(a)(3) (prohibiting "any act ... to exercise control over property of the estate"). Similarly, a debtor in possession who transferred estate funds to a professional without court order would violate Section 363(b), which requires court approval, after notice and hearing, before estate property is used outside of the ordinary course of the debtor's business (and the employment of bankruptcy professionals would presumably not be in the ordinary course of business).

The rationale for requiring court approval of a professional's compensation from the estate was set forth in In re Ross, 88 B.R. 471, 475 (Bankr.M.D.Ga.), remanded on other grounds, 94 B.R. 210 (M.D.Ga. 1988):

The funds of a bankruptcy estate are trust funds. The Court has a duty to see that these funds are administered in a manner consistent with the intent of the Bankruptcy Code. This duty exists independent of any objections that may be filed by parties in interest. Thus, an attorney for the trustee may only receive payment pursuant to a court order authorizing the trustee to disburse such funds.

At the same time, the fee application procedure only applies when a professional is seeking an award payable from the estate. Nothing in the provisions outlined above authorizes a court to award compensation or reimbursement of expenses from a source other than the estate. To the contrary, an award of compensation under Section 330 is necessarily payable from the estate, since it becomes an administrative expense pursuant to Section 503(b)(2), which is in turn a priority expense under Section 507(a)(1). Such expenses must either be paid directly from liquidation of the estate, pursuant to Section 726(a)(1), or, indirectly, after the estate vests in the debtor upon confirmation, through a plan that provides for the payment of the expenses in full, pursuant to Section 1129(a)(9), Section 1222(a)(2), or Section 1322(a)(2). Professionals who were fully compensated through non-estate funds would receive duplicate compensation if they obtained an award pursuant to Section 330.³ Thus, professionals who hold funds that do not belong to the estate need not, and should not, seek an award of those funds through the fee application process.

2. Counsel for a debtor who is compensated from a source other than the estate must comply with the monitoring procedure of Section 329, but this procedure does not require court approval of a fee application.

Most of the professionals retained by a debtor in bankruptcy may receive compensation without court scrutiny as long as they are paid entirely from sources other than the estate. Legal counsel for the debtor, however, must submit all of their compensation, regardless of source, to court scrutiny, pursuant to Section 329 of the Code.⁴ The rationale for this requirement is set forth in the...