In re Sundance Self-Storage El Dorado LP, ___ B.R. ___, 2012 WL 5471141 (Bankr. E.D. Cal. Nov. 6, 2012)
Summary: After finding that counsel for the chapter 11 debtor in possession had failed to disclose a lack of disinterestedness and disqualifying conflicts as required by Rule 2014(a) of the Federal Rules of Bankruptcy Procedure, the U.S. Bankruptcy Court for the Eastern District of California ordered counsel to disgorge all postpetition fees previously awarded in the present case, as well as prepetition fees the debtor had paid him in connection with this case and even fees the court had awarded counsel in the debtor’s prior bankruptcy case. To read the full Sundance decision, click (Sundance)
http://www.caeb.uscourts.gov/documents/Judges/Opinions/Published/Sundance(OSCHughes-Memo).pdf
Factual Background: Sundance filed a chapter 11 in 2010. Earlier that year, Sundance had filed a separate bankruptcy case, which was dismissed quickly due to the debtor’s failure to file its schedules.
Sundance’s principal asset was real property upon which it operated a self-storage business. Don Smith managed Sundance’s business in all respects. Smith’s principal source of personal income was from Sundance, although Smith also had an accounting practice. About the same time as Sundance filed its second bankruptcy case (in which this opinion was issued), Smith filed his own chapter 13 to try to save his home.
Counsel represented Sundance in both bankruptcy cases and also represented Smith in his personal bankruptcy case. In seeking approval of his employment in Sundance’s current bankruptcy case, counsel failed to disclose that Sundance still owed him fees from the first bankruptcy and that he was concurrently representing Smith in his personal chapter 13 (pending before a different judge).
After Sundance failed to confirm a plan, the court granted relief from stay to Sundance’s secured creditor to allow it to foreclose on Sundance’s real property. Just days before the foreclosure sale, Smith effectuated a transfer of the subject property to West Coast, an entity of which Smith was president.
West Coast then filed for bankruptcy six days later using one of the other lawyers recommended by counsel. One short-term effect of this strategy was to preserve for Smith the income from his employment in the business that Smith so desperately needed to comply with his chapter 13 plan.
Upon discovering the transfer of Sundance’s real property, the court issued an order to show cause regarding counsel’s involvement was in the transfer. In the course of the order to show cause proceedings, the court discovered the following facts that counsel failed to disclose in his application to be employed in this case or at any time during the course of his employment: (a) counsel held a prepetition claim against Sundance for unpaid fees from the first Sundance case and that those fees were paid as an administrative expense in the second case, (b) even if counsel may not have known about the transfer of Sundance’s property to West Coast before it occurred, he had reason to believe such a scheme was in the works and, in turn, was required, but failed, to advise against it, (c) counsel represented Sundance in the prior bankruptcy case, (d) counsel was representing Smith in his personal chapter 13 and (e) counsel had another business relationship with Smith in that counsel personally employed Smith to give him tax advice and prepare at least one tax return for him.
The Bankruptcy Court’s Ruling: As noted above, the court ordered counsel to disgorge not only all fees he had received in Sundance’s second case, but also all fees he received “in connection with” that case (that is, fees for prepetition work leading up to the case), in addition to all fees he had been paid in Sundance’s first case. Emphasizing the breadth of disclosure required under Rule 2014(a) and the importance of that rule to the actual and perceived integrity of the bankruptcy system, the court found that counsel had miserably failed to comply with that Rule. Based on the undisclosed facts identified above, the court also found that counsel was not disinterested and held and represented an interest adverse to the estate.
Author’s Commentary: The court’s legal analysis is unremarkable. Some of counsel’s transgressions are obvious (e.g., holding a prepetition claim against the estate, accepting payment of his prepetition claim). And even though it is not clear that counsel could have stopped the transfer to West Coast, it appears that, far from doing what he could to discourage it, at best he looked the other way and enabled it by failing to give express advice that such a transfer would be improper. Indeed, he could (and perhaps should) have threatened to withdraw unless he got assurances that there would be no such transaction. What is interesting about the case is that the court’s disgorgement order extended to Sundance’s previously-dismissed case, which was no longer before the court. Even then, the court’s sanctions seem mild compared to what they might have been.
The above write up done by the California State Bar Business Law Section Insolvency Law Committee