The 5th Circuit Court of Appeals, in January of this year, allowed a Chapter 7 bankruptcy debtor’s objection to the application for compensation of an attorney working for the Chapter 7 Trustee. In doing so, the Court overruled the Bankruptcy Court and District Court.
Sylvester v Chaffee McCall, LLP: The Facts of the Case
The case, Sylvester v Chaffee McCall, LLP, involved a debtor, Sylvester, whose assets were not fully exempted and protected from liquidation in the Chapter 7 bankruptcy process.
The Trustee, accordingly, set about the business of liquidating Sylvester’s non-exempt assets. To accomplish this, the Trustee retained a law firm, Chaffee McCall, LLP (“Chaffee”). Chaffee then performed its duties on behalf of the Trustee, including the sale of real estate.
At the end of the case, Sylvester’s creditors were fully paid from the proceeds, the Trustee received a percentage-based fee as provided by the US Bankruptcy Code (“the Code”). Enough proceeds were generated from the liquidation of these assets that, after this, funds remained for final distribution to Sylvester.
Note this important fact. In a Chapter 7 bankruptcy, a debtor lacks standing to object to a fee application unless he or she has a “pecuniary” interest in the outcome. That is, unless the debtor stands to receive funds from the pool generated by the liquidated property. Or more funds than he or she would receive without the court’s intervention.
Because Sylvester did not lack “standing,” she objected when Chaffee filed its own application for compensation from that same pool of funds.
Chaffee’s fee application included billing for services that, Sylvester argued, were required to be performed by the Chapter 7 Trustee per requirement of the Bankruptcy Code.
Chaffee argued otherwise, and the Bankruptcy Court and, on first appeal, the Federal District Court agreed. Sylvester’s appeals were denied.
However, she appealed again to the Fifth Circuit Court of Appeals—and the Circuit Court overruled the lower courts and sent the dispute back to the Bankruptcy Court to be re-decided properly.
Why did the Fifth Circuit rule against Chaffee?
This Article will discuss the rules regarding the compensation of professionals employed by Chapter 7 Trustees.
It will go on to then explain the Fifth Circuit’s reversal and, finally, to discuss what result Sylvester might have obtained here in the Detroit, Michigan Bankruptcy Court system, within the Sixth Circuit Court of Appeals.
Compensation of Professionals Employed by Chapter 7 Bankruptcy Trustee: The Rules of the Road
- 704 of the Bankruptcy Code governs the duties of Chapter 7 Trustees. Trustees perform, among others, the following essential duties pursuant to this provision:
- Collect and reduce to money the (non-exempt) property of the debtor;
- Account for all property received;
- Investigate the financial affairs of the debtor.
- 327 of the Code allows the Chapter 7 Bankruptcy Trustee to employ professionals to assist with these duties. These professionals can be attorneys, accountants, realtors, appraisers, and others.
- 330(a) governs the manner and extent to which these professionals are paid for their work.
This statutory provision states that a Bankruptcy Court may award “ … a professional person employed under section 372 … reasonable compensation for actual, necessary services rendered.”
Chapter 7 Trustees, meanwhile, are themselves compensated with a percentage amount of the funds distributed to creditors pursuant to §326(a) of the Bankruptcy Code.
What the Fifth Circuit Decided
The Fifth Circuit essentially decided that allowing Chaffee’s fee application would have resulted in the Chapter 7 Trustee “double-dipping” fees from Sylvester’s bankruptcy liquidation proceeds.
On one hand, the Trustee would receive his or her percentage-based “commission” under §326(a). On the other hand, the Trustee’s professional, Chaffee, would be paid for those same proceeds on top of that percentage-based “commission.”
The reason that the Fifth Circuit disapproved it in this case centered on the exact work performed by Chaffee.
It’s important to note that a Circuit Court of Appeals is not a “fact-finding” court. This is what happens at the trial level (at the Bankruptcy Court, in this case). An appellate court reviews the record of the lower proceedings and considers whether lower courts made good decisions or bad decisions based on what it sees in that record.
Here, the Fifth Circuit decided that the lower courts had applied the wrong standard of review, based upon the statutory provisions noted above.
In particular, the Court noted that the Bankruptcy Court had approved Chaffee’s fee application because the duties performed by Chaffee did result in a “successful” bankruptcy case resolution.
Likewise, the Bankruptcy Court, in reviewing Chaffee’s services, decided that the application should be approved simply because the services performed might arguably be those for which a professional can be properly paid.
The Fifth Circuit held that this was the wrong standard for the lower court to rely on. Whether or not the bankruptcy case is successful is not the correct question for a court reviewing a professional’s fee application, the Court held.
The right question is whether the tasks performed by Chaffee were or were not simply the administrative duties that the Chapter 7 Bankruptcy Trustee him- or herself is statutorily required to perform. In particular, given that Chaffee is a law firm employed by the Trustee to provide legal services, the specific question for the court was whether the tasks performed by Chaffee required an attorney’s expertise.
Further, the Fifth Circuit noted that the lower courts had entirely ignored the fact that the burden of proof in any bankruptcy fee application controversy lies with the applicant.
Upon Sylvester’s objection to Chaffee’s application, the burden was on Chaffee to prove that each of the tasks it performed for the so-called bankruptcy estate was non-administrative, requiring the expertise of an attorney, and reasonable in terms of the amount billed per hour relative to the time consumed by each task.
The Bankruptcy Court here did not require that Chaffee prove its burden.
Because the Bankruptcy Court failed to ask the right questions, the Fifth Circuit vacated the attorney’s fee award to Chaffee and remanded the case back to the Bankruptcy Court for review under the right standard.
Chapter 7 Trustee’s Professional Fees In Detroit Bankruptcy Cases
How would this play out in the Eastern District of Michigan Bankruptcy Court?
In the Sixth Circuit—which includes Michigan’s Eastern and Western Districts—bankruptcy fee applications are governed by a case called In Re Boddy. The Court, in this case, mandated the use of a standard called “the lodestar method” in determining whether a fee application may be granted.
The lodestar method is a standard of judicial review that essentially requires that a Bankruptcy Court judge to multiply “… the attorney’s reasonable hourly rate by the number of hours reasonably expended” in the furtherance of a specific task.
Thus, in Detroit and elsewhere in Michigan, a bankruptcy judge will first ask whether the attorney’s hourly rate is “reasonable” in light of his or her level of experience and as compared to similarly experienced local professionals.
Next, the tasks for which the attorney wishes to be compensated will be reviewed:
- Was a given task a non-compensable administrative task that a Trustee should have done him- or herself?
- Was the task so administrative in nature that it could have been performed by a legal assistant or secretary at a lower hourly rate?
- Is the amount of time the applicant claims was expended in furtherance of the task reasonable?
That is, even if a task is non-administrative and compensable, is the time expended being “puffed” by the applicant? Is the Trustee’s professional claiming that review of a standard form took 30 minutes when any other lawyer would have reviewed it in, say, 6 minutes?
Courts in the Sixth Circuit will finally adjust the result of the above examination based on a variety of factors, including the applicant’s special skills and, yes, based upon the results obtained. (For example, a debtor’s attorney requesting exorbitant fees for a Chapter 13 bankruptcy that is dismissed prior to its confirmation will face an uphill battle before the Bankruptcy Court in Detroit.)
In the Sixth Circuit, the applicant bears the burden of proving that the fees are reasonable and that the fee request is commensurate with fees for similar professional services in non-bankruptcy cases in the local area.
Judges have the discretion to review a fee application sua sponte (without a motion or objection by any party) and to deny or reduce a fee application in the Sixth Circuit.
Bankruptcy Trustee’s Professional Fees: The Bottom Line
The bottom line is that a Chapter 7 bankruptcy case involving any level of potentially non-exempt asset or property can become very complicated very fast.
Even if you own no other valuable assets, your home alone can be at risk of liquidation in a Chapter 7 bankruptcy, given today’s skyrocketing real estate market.
If you are considering filing for bankruptcy and are a homeowner, business owner, or own any other property of note, you should never file a Chapter 7 bankruptcy without first consulting with and retaining an experienced Detroit bankruptcy lawyer.
Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has successfully represented thousands of Metro Detroit Chapter 7 and Chapter 13 clients for over 30 years.
Contact us now to schedule your free, initial consultation.