In re US Bentonite, Inc., 536 B.R. 948

Background

Three related Chapter 11 cases (U.S. Bentonite, Inc.; Rock Springs Mineral Processing; Rock Springs Properties) were jointly administered; Winship & Winship, P.C. was court‑approved bankruptcy counsel.
Lead Winship attorney Bradley Hunsicker accepted an associate position with Markus Williams (counsel for the Collateral Agents) on March 11, 2015 but did not disclose that employment change to the court until June 16, 2015.
During the nondisclosure period, settlement negotiations occurred among Debtors, the Collateral Agents, First Interstate Bank, and PAB Good resulting in a documented Settlement Agreement allocating sale proceeds and resolving administrative claims; the Court initially (and then vacated) approval of the settlement.
The U.S. Trustee moved to disqualify Winship, deny fees, and require disgorgement based on the nondisclosure; Winship conceded the supplemental disclosure was late and agreed not to seek compensation for some of the relevant period.
The Court found the nondisclosure violated Rule 2014 and § 327(a)’s continuing duty, penalized Winship by denying specific fees and barring fee requests over a defined period, but declined full disqualification and approved the Settlement Agreement (with a small amendment reducing Winship’s administrative claim).

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Whether Hunsicker/Winship’s failure to disclose Hunsicker’s new employment created an actual conflict requiring disqualification and full denial/disgorgement of fees	UST: the undisclosed connection to creditor’s counsel tainted representation and warrants disqualification and disgorgement of all fees	Winship: disclosure was late but inadvertent; full disgorgement/disqualification is excessive given services performed and the stage of the cases	Court: nondisclosure violated Rule 2014 and warranted penalty, but not full disqualification; limited denial/disgorgement imposed and Winship may continue as counsel (Hunsicker is screened)
Proper remedy/extent of fee denial under § 328(c) for failure to disclose connections	UST: total denial and disgorgement of all Winship fees and expenses	Winship: narrow denial only for the short period of nondisclosure; otherwise fees appropriate	Court: exercised discretion—denied $5,640.00 in fees and $412.10 expenses (Mar 11–Apr 30, 2015) and barred seeking fees Apr 30–Aug 20, 2015; allowed other pre‑March 11 fees in part
Whether the Settlement Agreement must be rejected as tainted and not in estate’s best interest	UST: settlement negotiated during the nondisclosure; process was tainted and it harms USB unsecured creditors	Debtors/Winship/other creditors: settlement avoids costly litigation, resolves administrative claims, and was negotiated at arms‑length among multiple parties	Court: settlement was fair and in estates’ best interest; approved it but reduced Winship’s defined administrative claim by $6,052.10 to reflect denied fees
Whether counsel’s Rule 2014 disclosure duty is continuing after initial employment approval	UST: failure to supplement is violation; court must act	Winship: acknowledged continuing duty but urged leniency	Court: confirmed continuing disclosure obligation; failure to supplement deprived the court of the opportunity to assess conflict and justified sanctions

Key Cases Cited

In re 7677 East Berry Ave. Assoc., LP, 419 B.R. 833 (Bankr.D.Colo. 2009) (discusses § 327 standards and employment propriety)
In re Cook, 223 B.R. 782 (10th Cir. BAP 1998) (addressing disclosure duties under Rule 2014)
In re Crivello, 134 F.3d 831 (7th Cir. 1998) (on disinterestedness and conflict analysis)
In re Interwest Bus. Equip., Inc., 23 F.3d 311 (10th Cir. 1994) (failure to disclose connections can warrant denial of compensation)
In re Smitty’s Truck Stop, Inc., 210 B.R. 844 (10th Cir. BAP 1997) (counsel’s fiduciary duty and consequences of failing to exercise independent professional judgment)
Gray v. English, 30 F.3d 1319 (10th Cir. 1994) (supports court discretion to deny compensation when conflicts exist)
Official Comm. of Unsecured Creditors v. Western Pacific Airlines, Inc. (In re Western Pacific Airlines, Inc.), 219 B.R. 575 (D.Colo. 1998) (factors for evaluating Rule 9019 settlements)
In re Hermitage Inn, Inc., 66 B.R. 71 (Bankr.D.Colo. 1986) (standards for settlement approval)