IN RE ANDERSON (Bankr.E.D.Va. 2005)

Case No. 04-11437-RGM.United States Bankruptcy Court, E.D. Virginia, Alexandria Division.
March 18, 2005

MEMORANDUM OPINION
ROBERT MAYER, Bankruptcy Judge

This case is before the court on debtor’s counsel’s application for compensation. The United States Trustee objected to the application. After considering the issues raised by the United States Trustee, the court will not allow any fees for the period on and after September 3, 2004, when counsel effectively ceased to represent the debtor-in-possession and began to represent the individual debtor.

This case was filed as a chapter 11 case on March 31, 2004. The debtor remained in possession. Debtor’s original counsel withdrew and an order authorizing the employment of debtor’s present counsel was entered on May 11, 2004. On August 16, 2004, the United States Trustee filed a motion to convert the case to a case under chapter 7 or to appoint a chapter 11 trustee alleging prepetition and post-petition misconduct. The hearing on the motion was set for September 14, 2004.

On September 3, 2004, as reflected on counsel’s time records, counsel began to draft a motion captioned “Motion to Approve Sale of Real Estate” that sought to sell unimproved real property of the estate. The motion recited that the debtor was the sole owner of the property and that he had entered into a contract dated July 7, 2004, for a sales price of $22,500. What the motion did not state was that settlement had occurred on July 23, 2004. The motion was filed five days before

Page 2

the hearing on the United States Trustee’s motion and scheduled initially for October 5, 2004. The hearing date was changed to November 9, 2004.

Because of the involved nature of the United States Trustee’s motion to convert or appoint a chapter 11 trustee, at the initial September 14, 2004, hearing, the motion was set for an evidentiary hearing for October 21, 2004. The motion to appoint a chapter 11 trustee was granted.

The debtor’s motion to sell the real property was adopted by the chapter 11 trustee and granted. Debtor’s counsel filed a report of the sale on November 17, 2004. A copy of the settlement statement, dated July 23, 2004, was attached to the report.

The debtor did not file his required monthly reports timely. The March, April, May and June 2004 reports were filed on July 13, 2004, and the July 2004 report was filed on August 12, 2004. No further monthly reports were filed until December 16, 2004, when the debtor filed the August, September, October and November 2004 reports. The August report was signed by the debtor on September 8, 2004; the September report on October 9, 2004; the October report on November 10, 2004; and the November report on December 12, 2004. The August 2004 report stated that the real property was sold during the reporting period.[1]

The United States Trustee objected to counsel’s application for compensation. She argued that the timing of the events suggested that counsel delayed filing the monthly reports which would have disclosed the unauthorized sale until after the motion to appoint a chapter 11 trustee was heard. She further argued that the debtor-in-possession owed a fiduciary duty to the estate and not to the debtor individually; that counsel had an obligation to be candid with the court; and that some of the

Page 3

time billed benefitted debtor individually, not the estate. She requested that a portion of the fees be denied.

Debtor’s counsel admitted the facts alleged by the United States Trustee. He became aware of the unauthorized sale of the real property in early September 2004, and filed the motion to approve the sale “within days.” He continues:

Upon learning of the sale and settlement, [counsel] determined that the sale was an arms length transaction, that the sale price was a fair and reasonable price for the undeveloped lot and that the net proceeds of sale were properly secured in a savings account separate from the DIP account in order to ensure that the funds were not expended on daily requirements of the Debtor.

Response to Trustee’s Objection to Fee Application Filed by Debtor’s Counsel, ¶ 4 (Docket Entry 137) (“Response”). He sought to justify the delayed filing of the monthly reports, stating:

7. At the time the motion to approve sale was filed, the Office of the United States Trustee had filed a Motion for conversion of this case or for the appointment of a Trustee. Counsel for Debtor was of the view that knowledge of the prior sale and settlement would be used against the Debtor at the hearing on the motion held on October 21, 2004. This belief was confirmed in conversation between the Office of the United States Trustee and Debtor’s counsel. Under the circumstances, it was not inappropriate to defer disclosure of the actual date of the sale and settlement.
8. This information would have also become public knowledge if the monthly reports of the Debtor had been filed. The Debtor prepared the monthly reports for filing so that they could be promptly filed once a report of sale had been filed with this court.

Response at ¶¶ 7-8.

Counsel argues that “Debtor has been candid with this court”; that “There was no absence of disclosure or attempt to thwart the filing of the settlement statement as part of the report of sale”; and that “There was full disclosure to the court; creditors’ interests in the net proceeds were not in

Page 4

any way unprotected at any time; and at the same time, the rights of the Debtor personally were protected.” Response at ¶¶ 3, 5 and 9.

Counsel is mistaken. Candor is the timely disclosure of all relevant information. Counsel notes that the fact that there was an unauthorized sale would have been a factor in determining whether to appoint a chapter 11 trustee or convert the case. Unilaterally withholding that information because it could have a bearing on the outcome of a hearing is not candor. In a chapter 7 context, a bankruptcy court stated:

It should be emphasized that the relationship between a trustee and a debtor is not supposed to be adversarial. The duties imposed by § 521 are affirmative obligations. A trustee is not required to play detective or to chase the debtors into court to gain their cooperation.

In re Sowers, 97 B.R. 480, 487 (Bankr.N.D.Ind. 1989). The same principle applies in chapter 11 cases. A debtor-in-possession must be forthcoming with information about the case.[2]
While it is true that from time to time publicly divulging certain information may be detrimental to the bankruptcy estate, there are procedures available to protect such sensitive information. The decision, though, is no more the debtor’s to make than it is debtor’s counsel right to determine that delayed disclosure of an unauthorized sale is justified because the unauthorized sale was armslength, the sales price was fair and reasonable and the cash proceeds were adequately protected.

There was not full disclosure in the motion to sell the real property. The motion appeared on its face to be a routine motion to sell real property. There were no statements in the motion that alerted a reader to the fact that the motion soughtretroactive approval of a completed, but unauthorized transaction. While it is true that a copy of the sale contract was attached to the motion

Page 5

as an exhibit and that it contained a proposed settlement date that had passed, there was no indication in the motion that the settlement had occurred. The natural and fair reading of the motion is that the settlement would occur after court approval.

Counsel effectively ceased representing the debtor-in-possession, that is, the bankruptcy estate, and began representing the individual debtor when he became aware of the unauthorized sale and failed to disclose it. He ought to have disclosed it in the motion to sell, candidly setting out the transaction and explicitly seeking retroactive approval. He should not have concealed the unauthorized transaction by failing to timely file monthly reports that were completed, signed by the debtor and delivered to him on a timely basis. These actions served only one purpose: to improve the individual debtor’s chances of remaining in possession of the bankruptcy estate. They served no beneficial purpose for the bankruptcy estate itself.

All debtors’ counsel have an unenviable role in chapter 11 reorganizations, particularly where the debtor is an individual . Debtors’ counsel must distinguish between representing the individual debtor and the bankruptcy estate. The line is not always clear. When the individual debtor cannot or will not distinguish between his two roles, it is time for the two roles to be separated and a chapter 11 trustee appointed. Until that happens, counsel must carefully distinguish between the two roles and must represent the bankruptcy estate with complete fidelity. In this case, counsel clearly crossed the line.

The court cannot accept counsel’s assertion that he acted appropriately. Response at ¶ 2. The court believes that he intended to act appropriately but made a significant mistake by failing to distinguish the individual debtor from the debtor-in-possession and by failing to recognize their conflicting interests. Rather than deny the fee application in its entirety, his fee application for the

Page 6

period when he represented the debtor-in-possession will be approved, but the bankruptcy estate will not compensate him for any services rendered on or after September 3, 2004. It was on that date that he effectively ceased representing the bankruptcy estate and commenced representing the individual debtor. Any services rendered on or after that date primarily benefitted the individual debtor and counsel must seek compensation from the individual debtor, not the bankruptcy estate. Counsel’s application to have his fees paid by the bankruptcy estate will be approved in the amount of $10,519.00 for fees and $460.01 for expenses. The balance of the application in the amount of $15,248.50 will be denied without prejudice to counsel seeking payment from the individual debtor.