Lamie v. U.S. Trustee has implications for chapter 11 cases that bear consideration.¹ Chip Bowles's excellent discussion of Lamie in the May issue of the ABI Journal reviewed the facts of the decision, the circuit courts' split on the issue and the decision's implications when a case is converted from chapter 11 to chapter 7.² Clearly, Lamie presents significant compensation issues for counsel representing debtors in chapter 11 cases that are converted. These impacts are perhaps even more significant where a chapter 11 trustee has been appointed and there is no conversion. Although Lamie specifically dealt with a chapter 7 conversion, the decision also applies to chapter 11 cases where a trustee has been appointed. The triggering event on which loss of the right to compensation is based is not conversion; rather, it is the appointment of a trustee.³

Lamie holds that after the appointment of a trustee, counsel for the former debtor-in-possession (DIP) cannot be compensated by the estate under the provisions of 11 U.S.C. §§330 and 327. Specifically, the estate may not compensate counsel not appointed by the trustee under 11 U.S.C. §327 and paid pursuant to 11 U.S.C. §330. In Lamie, as in virtually all the cases that will be subjected to this doctrine, counsel seeking compensation will have complied with the requirement of appointment by a "trustee." This occurs when the DIP exercises the power of a trustee under 11 U.S.C. §1107 to employ professionals. Even though the debtor's counsel in Lamie had already complied with the requirements of 11 U.S.C. §327, the Supreme Court denied counsel's modest request for compensation for services rendered after the appointment of the trustee.⁴

The concept of the DIP is unique to our bankruptcy system and is apparently based on the precept that familiarity with the business of the debtor and its industry is a positive factor that outweighs the benefit of a fully independent trustee. The Bankruptcy Code provides numerous protections to ensure that the integrity of the system and the interests of creditors are not adversely affected by this policy. Among those protections is the appointment of a trustee, either through conversion to chapter 7 (trustee automatic) or appointment of a chapter 11 trustee on motion (trustee discretionary).

The offices of DIP and trustee are mutually exclusive. Section 1101 (1) provides that DIP "means Ôdebtor' except when a person that has qualified under §322 of this title is serving as trustee." Thus, upon the appointment and qualification of a trustee in chapter 11, the DIP ceases to exist, and the debtor's responsibilities are thereafter defined under §521, "Debtor's duties," and not under §1107, "Rights, powers, and duties of debtor-in-possession." Even if the debtor remains in "possession" of certain assets after the appointment of the trustee, this does not make it a DIP.

Upon appointment of the chapter 11 trustee, the attorney for the DIP has lost his or her client. The DIP has simply ceased to exist. In most cases, DIP counsel then simply transition to representing the debtor. If there are ethical or conflict issues in such a practice, they are usually not raised, particularly in individual cases.⁵

There might well be a practical basis for a distinction between a conversion to chapter 7 and appointing a trustee in the chapter 11. In the former situation, the reorganization effort has ended and the entire enterprise becomes one of liquidating assets for distribution to creditors. Where a trustee is appointed and the chapter 11 continues, the effort commenced by the DIP, whether to reorganize or liquidate, has been deemed the better path for the case than conversion. Appointment of a trustee can be the product of a negotiated compromise between the debtor's camp and distrustful creditors.

Often, a trustee's appointment remedies a unique or difficult dynamic with an individual debtor or the insiders of the debtor organization.⁶ The continued service of debtor's counsel can often be very helpful in tempering the actions of the difficult debtor and obtaining cooperation of the debtor perhaps now inclined to become more hostile and adversarial, §521 notwithstanding. Often the creditors' representatives will conclude that conversion to chapter 7 will result in increased costs, delay, loss of flexibility in the U.S. Trustee's consideration of trustee candidates, loss of positive momentum in the case or a variety of other case-specific factors.

The Lamie impacts are unfortunate when a chapter 11 trustee is appointed, because the continued assistance of the former DIP counsel can be very helpful. Often, trustees require significant transition services by the debtor and his counsel. Lamie appears to curtail such services. Nevertheless, some judges recognize the value of an effective transition and will compensate former counsel for the DIP for transition services rendered after the bright-line event of the appointment and qualification of the trustee.⁷

Counsel for the chapter 11 trustee should consider the benefits of retaining former DIP counsel as special counsel, at least as may be constructive in transition. Again, there may be ethical issues to resolve, but disinterestedness is not required of special counsel appointments. That said, where former DIP counsel and potential special counsel for the trustee are to simultaneously represent the debtor, the conflicts may well overcome the practical advantages to be obtained by a smooth transition.⁸

Assuming that there is value added by the continued services of former DIP counsel, counsel could consider the application of §§503(b)(3) and (4). If the equity security-holder (or, in the individual case, the debtor, as the arguable equivalent of an equity security-holder) makes a contribution to the case, then its counsel can be compensated. But keep in mind that the showing for a §503(b) award is "substantial contribution" rather than simply "reasonable and necessary." Meeting this higher burden is sometimes not enough to prevail against the opposition of the trustee. Thus, the cooperation and support of the trustee's counsel and perhaps some early consideration by the court on this approach would be prudent for counsel considering use of §503(b).

In summary, DIP counsel's right to compensation is lost when a trustee is appointed. Where the chapter 11 continues under a trustee, the need for continued services from former DIP counsel is probably greater than in the conversion situation. However, the strategies for seeking compensation from the estate after appointment of a trustee are limited and only apply to efforts consistent with the interests of the estate. But such strategies need to be considered and explored by counsel early in the process.

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Footnotes

¹ Lamie v. U.S. Trustee, 124 S.Ct. 1023, 157 L.Ed 2d 1024 (2004). Return to article

² Bowles, C.R. Jr., "Watching Sausage Being Made—the Supreme Court, Not the FDA," 23 Am. Bankr. Inst. J. 30 (2004). Return to article

³ None of the statutes in question by the Supreme Court or analyzed by the circuits that took the contravening approach deal with conversion. 11 U.S.C. §1112. Return to article

⁴ The decision states that the attorney conceded that he was not hired by the trustee under 11 U.S.C. §327. The decision then proceeds to the legislative interpretation ("drafting error") analysis. The decision does not reflect an argument by counsel to the effect that he was appointed under §327, and thus his work did comply with the requirements of the statute. Return to article

⁵ The representation that such a practice exists, particularly in smaller cases, is not intended to condone ignoring ethical issues where they exist. However, if counsel at that juncture is cut off from court review and approval of fees under §330; the principal concern would be complying with state ethical rules. Return to article

⁶ The dynamic being that they are dirtbags. Return to article

⁷ While this specific aspect was not discussed in the Bowles article, the author did state that Lamie may herald a more restrictive approach to compensation issues. Whether bankruptcy judges will consider this as restricting his discretion on compensating transition services, without a formal special counsel appointment, remains to be seen. Return to article

⁸ Where it is in the best interest of the estate to obtain a full and complete briefing on all of the issues confronting the trustee, such as the status of sales negotiations, useful employees, details of ongoing litigation, etc., the practical approach would be to compensate only for transition services and not for actions as an advocate for the debtor. It is simply short-sighted and unrealistic to believe that where substantial time is required for an effective transition, this time will be "donated." Return to article