In re BIG RIVERS ELECTRIC CORPORATION, Debtor.
United States of America, On Behalf of the Rural Utilities Service of the Department of Agriculture and the United States Trustee, et al., Appellees,
v.
J. Baxter Schilling, Appellant.
No. 02-6212.
No. 02-6213.
No. 02-6338.
No. 02-6340.
No. 02-6341.
No. 02-6344.
No. 02-6347.
United States Court of Appeals, Sixth Circuit.
Argued: September 10, 2003.
Decided and Filed: January 8, 2004.
Appeal from the United States District Court for the Western District of Kentucky, Avern Cohn, J. COPYRIGHT MATERIAL OMITTED COPYRIGHT MATERIAL OMITTED COPYRIGHT MATERIAL OMITTED COPYRIGHT MATERIAL OMITTED COPYRIGHT MATERIAL OMITTED Donald L. Cox (argued and briefed), Lynch, Cox, Gilman & Mahan, Louisville, KY, for Appellant.
Michael E. Robinson (argued and briefed), U.S. Department of Justice, Civil Division, William Kanter (briefed), U.S. Department of Justice, Civil Division, Washington, D.C., Alan C. Stout (briefed), Stout Law Office, Marion, KY, for Appellees.
Michael A. Fiorella (argued and briefed), Sullivan, Mountjoy, Stainback & Miller, Owensboro, KY, for Debtor.
James M. Miller (briefed), Sullivan, Mountjoy, Stainback & Miller, Owensboro, KY, for Debtor.
Before GIBBONS and SUTTON, Circuit Judges; MILLS, District Judge.*
OPINION
SUTTON, Circuit Judge.
At issue in this case are the duties of disinterest and disclosure of an examiner appointed to facilitate a reorganization under Chapter 11 of the Bankruptcy Code. The issues arise from the appointment of J. Baxter Schilling to serve as the examiner in the reorganization of Big Rivers Electric Corporation, which was unable to meet obligations on $1.2 billion in debt and whose September 1996 bankruptcy petition represented the largest Chapter 11 case filed in Kentucky history.
As an examiner, Schilling did much to advance the successful reorganization of Big Rivers, which emerged from Chapter 11 in June 1997 through a consensual plan of reorganization approved by the bankruptcy court. During his tenure as examiner, however, Schilling sought privately to negotiate a success fee with three of the estate's unsecured creditors, by which they would pay him a percentage of their increased recovery on top of the hourly fee authorized by the bankruptcy court for his services. Schilling did not disclose the negotiations, or the agreements he believed he had reached with these creditors, to the debtor in possession, to the other creditors or to the court until many months later. When Schilling's conduct came to light, several parties objected to his actions, as did the United States Trustee which is responsible for appointing bankruptcy examiners and trustees. In view of his conduct, they argued that Schilling and his law firm should disgorge all of the fees dispensed to them during the case — totaling nearly $1 million. The district court agreed, and we now affirm.
I.
Unable to meet the continuing obligations on more than $1.2 billion in debt, the Big Rivers Electric Corporation filed a petition to reorganize the company under Chapter 11 of the Bankruptcy Code and to remain as a debtor in possession during the reorganization. Filed on September 26, 1996, the petition represented the largest bankruptcy case ever filed in Kentucky and at the time was one of the largest bankruptcy cases in the country. A publicly-regulated utility, Big Rivers owed $1.1 billion of its debt to the Rural Utilities Service of the United States Department of Agriculture (the "Utilities Service"), which held a perfected security interest in all of Big Rivers' assets. See In re Big Rivers Elec. Corp.,
On October 7, 1996, Bluegrass Containment, Inc., a smaller unsecured creditor, moved the bankruptcy court to appoint a trustee or an examiner in the Big Rivers case. Id. In a Chapter 11 case, a trustee replaces the debtor in possession and takes immediate control of the business and the reorganization effort. See 11 U.S.C. §§ 1104(a), 1106(a). Examiners, by contrast, assume a more limited role. They typically investigate the debtor's business and handle other duties specifically assigned by the bankruptcy court, but do not replace the debtor in possession in handling the day-to-day affairs of the business. See id. §§ 1104(c), 1106(b).
The bankruptcy court decided that an examiner should be appointed and ordered the United States Trustee to select one. In addition to the tasks expressly required of examiners under the Bankruptcy Code — investigating the debtor's affairs and filing a report, see id. § 1106(b) — the bankruptcy court ordered the examiner to "[w]ork with Big Rivers and its creditors in ... resolving various disputes with creditors, ... and [] if feasible, attempt to negotiate a global settlement of the disputes in this case and the development of a consensual plan of reorganization." JA 81. The court did not specify the terms of the examiner's compensation.
The United States Trustee selected J. Baxter Schilling, a Kentucky bankruptcy practitioner, as the examiner. At the time of his appointment, Schilling had frequently served as a Chapter 7 trustee, had twice served as a Chapter 11 trustee, but had never served as an examiner. On October 18, 1996, the bankruptcy court entered an order approving Schilling's selection but again did not specify the terms of the examiner's compensation.
Soon after his selection, Schilling signed a document entitled "Affidavit of Examiner that He is Disinterested," in which he attested that he was "a disinterested person in this case" and did not "have an interest materially adverse to the interest of the estate or of any class of creditors." Id. at 585-86. Schilling also submitted a separate verified statement that he had "no connections with the ... Debtor, creditors, or any other interested parties." Id. at 586.
On October 31 and November 1, 1996, Schilling held meetings in Washington, D.C. with the major secured and unsecured creditors. In the course of the meetings, Schilling sought to mediate a dispute between the Utilities Service and some of the unsecured creditors regarding the priority of their claims so that the parties could submit a consensual plan of reorganization to the court. Id. at 586. When the initial negotiations did not bear fruit, Schilling reached the conclusion that the parties would never agree on a plan of reorganization unless someone found a way to bring new value into the estate. To that end, Schilling decided to undertake the task himself, performing in his words "trustee duties, including the principal duty of a trustee to maximize the value of the debtor's estate, as well as examiner duties." JA 499. Because he effectively would function as a trustee in this new role and because he customarily had received a percentage-based fee as a Chapter 7 trustee, Schilling believed he should be paid like a Chapter 7 trustee for his work as the examiner in the Big Rivers case.
Near the conclusion of these meetings — and at times when the Utilities Service's representatives were not in the room — Schilling discussed these views with some, but not all, of the unsecured creditors. Schilling initially told Chase and Bank of New York representatives that he wanted them to pay him a percentage fee based on the "success" he brought to the estate in the form of "new value."
Schilling left the Washington meetings believing that, subject to bankruptcy court approval, Bank of New York, Chase and Mapco would pay him three percent of their increased recovery. As later communications reveal, however, none of these three creditors believed they had reached such an agreement with Schilling — at least not at that time. Id.
By November 13, 1996, the Utilities Service learned that Schilling had made statements about his desire to seek compensation based on the new value added to the estate. According to the bankruptcy court, "one or more interested persons," including the Utilities Service, spoke to a member of the bankruptcy court's staff the morning of November 13, 1996 and requested an in camera hearing regarding the examiner's compensation. Id. at 587. These "persons," unidentified except for the Utilities Service, expressed concern about Schilling's statements that he would seek compensation based upon new value added to the estate during his tenure. The bankruptcy judge instructed his staff member to tell the parties that they could raise the issue at a hearing if they wished, but that he would not hold an in camera hearing. No one raised the issue in court during the hearing on November 13, 1996. Id.
A few days later, on November 15, 1996, the bankruptcy court entered an order providing for Schilling's interim compensation. Id. With the Utilities Service's consent, the bankruptcy court allowed the examiner to receive interim compensation of $180 per hour in 1996 and $185 per hour in 1997, all of which Big Rivers would pay from its "cash collateral" — i.e., cash in which the estate and another entity (here, the Utilities Service) had an interest. See 11 U.S.C. § 363(a). The court's order did not alter Schilling's ongoing obligation to "compl[y] with all applicable provisions of the Bankruptcy Code." JA 148.
In the meantime, Schilling learned that Chase would not support his success-fee proposal. He called Chase and accused the company of "going behind his back and not being an honest dealer."
On December 3, 1996, Schilling had a similar conversation with representatives from Bank of New York. Having heard that the Bank's local counsel had objected to the United States Trustee about Schilling's proposed success fee, Schilling called the Bank to inquire. The Bank's representatives assured Schilling that if local counsel had registered any such complaint, she had no authorization to do so.
On January 22, 1997, Big Rivers filed its proposed plan of reorganization. The next day, according to Schilling, he sought and received the bankruptcy judge's approval to "begin to negotiate [his] percentage-based fee with the Banks [Chase and Bank of New York] and Mapco." Id. This conversation, to the extent it in fact took place, was ex parte, was off-the-record and was not the subject of discovery, and it did not include at any rate the court's approval to seek such a fee directly from the three creditors. Id. at 587-88.
The following day, January 24th, Schilling telephoned Bank of New York, Chase and Mapco to confirm his fee arrangements. And the following week, Schilling sent each of these creditors a letter to "confirm [their] telephone conversation" and to request written confirmation of the agreement they had reached during the Washington meetings to pay him three percent of their increased recovery. JA 441-43 (Schilling's letter to Bank of New York); JA 436-38 (Schilling's letter to Chase); JA 439-40 (Schilling's letter to Mapco).
Schilling's letter to Chase stated that the bank and Schilling "had an oral agreement reached during the Washington conference that [Schilling] would receive compensation of 3% of the new value that Chase received in the case." "It is this figure of $835,335.00," the letter continued, "which was discussed [on the telephone] last Friday [January 24th] and which we agreed was reasonable compensation for the Examiner to receive from Chase at the closing of the plan." JA 436-37.
Schilling's letter to Mapco reflected a similar understanding. Schilling reported that Mapco's share of the three-percent fee amounted to $180,000 and added that he "agreed with the suggestion of [Chase's representative] that the payments from MAPCO and the Banks be deposited into an escrow account on the closing date under the plan." JA 439.
The letter to Bank of New York likewise asserted that Schilling and the Bank had reached an agreement in Washington. The Bank's success-fee obligation, Schilling reported, came to $589,665. In the letter Schilling added that the Bank had made this promise not only at the Washington meetings but also during a December 3, 1996 meeting between Schilling and the Bank's employees — proving that the parties had "two oral agreements." JA 441-42.
Bank of New York and Mapco responded with letters of their own, each denying that they had reached such an agreement. Bank of New York "strongly [took] issue with [Schilling's] continuous references to `agreements' that ha[d] allegedly been reached between [Schilling] and [Bank of New York] concerning compensation," JA 372, and reminded Schilling that "[it] is inappropriate [] for any court-appointed fiduciary to seek compensation directly from individual creditors." JA 373. Mapco insisted that it had "never previously approved or even considered any compensation agreement with [Schilling]," and that Schilling's compensation "would be determined by the Bankruptcy Court under the Bankruptcy Code." JA 452.
Chase took a different tack. In a phone call with Schilling in response to his letter, it acknowledged that Schilling and Chase had reached an oral agreement regarding a success fee, but said that they had struck the agreement during their January 24, 1997 telephone call, not during the Fall 1996 Washington meetings.
While Schilling and the three unsecured creditors engaged in a considerable number of communications about what agreement was reached and when the agreement occurred, one thing is clear: Neither Schilling nor these unsecured creditors initially disclosed any of these communications — the private discussions in Washington, the telephone calls, the letters — to the Utilities Service, to the United States Trustee, or to the other parties involved in the Big Rivers bankruptcy.
On March 26, 1997, Schilling filed his first interim fee application. In making bankruptcy fee applications, Bankruptcy Rule 2016(a) requires applicants, including examiners, to disclose "what payments have theretofore been made or promised to the applicant for services rendered or to be rendered in any capacity whatsoever in connection with the case." Fed. R. Bankr. P.2016(a). In his application Schilling included a "Rule 2016(a) Disclosure Statement," asserting that he was a "disinterested person" and did not "represent or hold an interest adverse to the interests of the estate with respect to the matters about which the Examiner was appointed."
On June 5, 1997, Schilling filed a "Request For Payment of Administrative Expenses," which explained to the bankruptcy court that he might seek $4.41 million in compensation based on new value he had brought into the estate.
A few days later, on June 9, 1997, the bankruptcy court confirmed Big Rivers' consensual plan of reorganization. Id. As Schilling had earlier predicted, new value enabled the parties to develop a consensual plan of reorganization. In contrast to the plan initially proposed by Big Rivers, the approved plan included an additional $147 million in new value for the creditors.
No one denies that Schilling played a significant role in the negotiations leading to the approved plan. Most significantly, Schilling supported the auctioning of Big Rivers' assets and opposed accepting a pre-petition lease deal that Big Rivers had negotiated with PacificCorp Energy Company. Big Rivers and the Utilities Service opposed the auction. The bankruptcy court ultimately ordered an auction on the condition that the bidders compete with the PacificCorp agreement. Louisville Gas and Electric in the end submitted the highest bid, which added considerable value to the estate and which laid the groundwork for the consensual plan of reorganization that the court eventually confirmed.
On July 24, 1997, Schilling filed a second interim fee application. He again included a Rule 2016(a) disclosure disclaiming any improper interest. And he again failed to report the promise that Chase had made to him and the promises that he believed Bank of New York and Mapco had made to him.
The first written confirmation of an agreement between Schilling and one of the creditors came in the form of a letter from Chase to Schilling dated July 31, 1997. JA 291-92. In the letter, Chase "confirm[ed]" its support for Schilling's application for a three-percent fee enhancement and, subject to bankruptcy court approval, formally agreed to be responsible for up to $835,335 of the fee enhancement. Id.
Schilling filed the Chase letter with the bankruptcy court the same day. He attached it to a pleading entitled "Preliminary Pleading Regarding Application for Allowance of Compensation and Reimbursement of Expenses," in which Schilling noted: (1) "[a]s previously stated in pleadings, and as disclosed to the Court," Bank of New York, Chase and Mapco agreed during the Washington meetings to a percentage-based approach, and (2) "the [Utilities Service] stated, at that time, it would not agree or disagree with a percentage compensation to the Examiner." JA 288. Schilling further claimed that the court had "instructed the parties on July 1, 1997 to attempt to negotiate the Examiner's fee request," that "the Examiner has begun additional negotiations," but that "those negotiations have concluded only with Chase," as evidenced by the "agreement attached hereto." Id. This constituted the first public disclosure of Schilling's intention and efforts to have his percentage-based compensation paid by these three creditors as opposed to the estate.
In response to the pleading, Mapco's attorney wrote privately to Schilling that the statement was "incorrect, at least as to my client." JA 456. Schilling persisted, claiming that the statement was "correct" and that all three creditors had agreed to his proposal.
Spurred by the public disclosure of Schilling's agreement with Chase, the Utilities Service and the United States Trustee requested discovery into Schilling's fee arrangement. In view of the Chase agreement, the Utilities Service objected to the continued use of its cash collateral to pay Schilling and, along with the United States Trustee, asked the court to order Schilling to disgorge the fees he and his law firm had already received. The bankruptcy court rejected both requests and enjoined further court filings and discovery concerning the examiner's fees.
Not until one year later, in September 1998, did the bankruptcy court revisit the issue of Schilling's compensation. The court permitted the parties to submit pleadings on the examiner's fees, but continued a ban on discovery and refused to hear any evidence. At this point Schilling claimed for the first time, in open court, that he "ha[d] never said there was a side agreement with" Mapco. Id. at 592. Soon after Schilling made this statement, Mapco filed with the bankruptcy court copies of Schilling's earlier letters to the company in which he had insisted that they had reached such an agreement. Bank of New York also filed with the court a copy of its letter from Schilling asserting a similar agreement. Id. at 592-93.
Schilling filed his final fee application in October 1998, requesting approximately $4.41 million in compensation to "be paid by the debtor, various creditors of th[e] estate as the Court equitably determines is appropriate, or a combination thereof." JA 485. This figure combined Schilling's hourly fees (which totaled $530,928.74) with an enhancement of three percent of the new value brought into the estate during Schilling's tenure as examiner (which came to $3,879,071.25).
On October 23, 1998, in response to this application, the United States Trustee filed a motion to disgorge all of Schilling's fees because he had improperly negotiated secret side agreements for his compensation. Schilling responded that he had never truly believed that he and Bank of New York, Chase and Mapco had reached such agreements and that his statements claiming otherwise were intentionally untrue.
A common tactic used in negotiations is to make a statement, as if it were fact, even though the statement is incorrect and is known to be incorrect. The Examiner used this common place tactic in his January, 1997 letters to Chase and counsel for Bank of New York and MAPCO, asserting, as a fact, that an agreement had been reached at the Washington settlement conference, wherein these creditors would pay the Examiner 3% on any new value their clients received.
JA 400.
Shortly thereafter, the bankruptcy judge disqualified himself from hearing the fee issues and transferred the case to another bankruptcy judge. The new judge continued the ban on discovery and without an evidentiary hearing issued a decision on Schilling's fee application, awarding Schilling $2,638,205 — which covered his hourly compensation plus an enhancement of four times that amount — to be paid by Big Rivers. In re Big Rivers Elec. Corp.,
On appeal, the district court affirmed in part and reversed in part. It affirmed the bankruptcy court's order regarding Schilling's base compensation, reversed the order granting Schilling an enhancement and remanded the case to the bankruptcy court to consider the disgorgement issue as an initial matter because the bankruptcy court had not reached the issue. See In re Big Rivers Elec. Corp.,
On March 8, 2001, the bankruptcy court, on remand, transferred the case to the district court asking it to consider whether to withdraw the order of reference. On March 25, 2001, the district court withdrew the order of reference, which meant that the district court rather than the bankruptcy court thereafter would have original jurisdiction over the case. When all of the district court judges in the Western District of Kentucky recused themselves from hearing the case, the Chief Judge of the Sixth Circuit assigned the case to Judge Avern Cohn of the Eastern District of Michigan.
On August 13, 2002, Judge Cohn granted the joint motion of the Utilities Service and the United States Trustee for disgorgement, granted Big Rivers' motion for partial disgorgement, and ordered Schilling and his counsel to disgorge all fees paid to them.
The Bankruptcy Code and Rules mandate that a professional, such as an Examiner, be a neutral, disinterested party in the case. The moment that the Examiner approached three of Big Rivers' largest unsecured creditors and broached the subject of his compensation, suggesting that they pay him a percentage-based fee based on the "success" or "new value" he brought them to the estate, he was no longer a disinterested party. Whether or not such an agreement was reached or whether an agreement was subject to the approval of the bankruptcy court is irrelevant. What is relevant is that the Examiner sought to have his compensation tied to the enhanced value brought to the estate and, in particular, tied to what [Bank of New York], Chase and Mapco received on their claims from the estate.
The court also held that Schilling failed to disclose his fee arrangements as required under 11 U.S.C. § 329 and Bankruptcy Rule 2016. Section 329(a) requires "[a]ny attorney representing a debtor" to disclose his fee arrangements. Rule 2016(a) applies broadly to any "entity seeking interim or final compensation" and requires disclosure of any "payments ... made or promised to the applicant." The district court concluded that Schilling violated both provisions by failing to disclose his "fee discussions with Mapco, Chase, and [Bank of New York]."
II.
Because the district court was exercising original rather than appellate jurisdiction when it ordered Schilling and his law firm to disgorge all compensation, we review its order for abuse of discretion. See Michel v. Federated Dep't Stores, Inc. (In re Federated Dep't Stores, Inc.),
A.
In considering the district court's resolution of these issues, we start with the statutory framework. In a typical Chapter 11 reorganization, the debtor remains in possession of and operates the business at the same time that it manages the reorganization effort. Less typically — when, for example, the debtor's management is guilty of fraud or gross mismanagement — a bankruptcy court orders the appointment of a trustee to replace the debtor in possession and to take control over the business and the reorganization effort. See 11 U.S.C. §§ 1104(a), 1106(a). The appointment of an examiner, as happened here, straddles these options, as an examiner performs some of the functions of a trustee but does not replace the debtor and does not take on the day-to-day task of running the company. See id. §§ 1104(c), 1106(b).
The Bankruptcy Code expressly requires examiners to perform two duties normally required of trustees and authorizes the court to assign other duties as well. Id. § 1106(b). First, the Code requires examiners to perform an investigation, which means they must "investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan." Id. § 1106(a)(3). Second, the Code requires examiners to file a report, which means they must identify and memorialize "any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate." Id. § 1106(a)(4)(A). In addition to these mandatory duties, a bankruptcy court may order an examiner to perform "any other duties of the trustee that the court orders the debtor in possession not to perform." Id. § 1106(b).
Given the sensitivity of these tasks and the objectivity required to perform them, the Code requires all examiners, like all Chapter 11 trustees, to be "disinterested." Id. § 1104(d). A defined term, "disinterested person" means a person who:
(A) is not a creditor, an equity security holder, or an insider;
(B) is not and was not an investment banker for any outstanding security of the debtor;
(C) has not been, within three years before the date of the filing of the petition, an investment banker for a security of the debtor ...;
(D) is not and was not, within two years before the date of the filing of the petition, a director, officer, or employee of the debtor or of an investment banker specified in subparagraph (B) or (C) of this paragraph; and
(E) does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor or an investment banker specified in subparagraph (B) or (C) of this paragraph, or for any other reason.
Id. § 101(14).
While examiners and trustees perform some of the same duties and while each of them must remain disinterested, the Code distinguishes examiners from trustees in other ways. In contrast to earlier practices, the Code now prohibits an examiner from serving as a trustee or as counsel for the trustee in order to ensure that examiners may not profit from the results of their work. Compare Bankruptcy Reform Act of 1978, §§ 321(b) ("A person that has served as an examiner in the case may not serve as trustee in the case."), 327(f) ("The trustee may not employ a person that has served as an examiner in the case.") with Bankruptcy Act of 1898, as amended, § 45, reprinted in Collier on Bankruptcy App. A pt. 3(a) (15th ed. rev.2003) (including no such prohibition). See 124 Cong. Rec. H11,103 (daily ed. Sept. 28, 1978), reprinted in 1978 U.S.C.C.A.N. 6473 ("In order to ensure that the examiner's report will be expeditious and fair, the examiner is precluded from serving as a trustee in the case or from representing a trustee if a trustee is appointed."); 124 Cong. Rec. S17,420 (daily ed. Oct. 6, 1978), reprinted in 1978 U.S.C.C.A.N. 6542; Collier ¶ 327.04[10] ("The purpose of section 327(f) is to ensure that examiners discharge their investigatory duties in a purely objective fashion."); Leonard L. Gumport, The Bankruptcy Examiner, 20 Cal. Bankr.J. 71, 152 (1992) ("In the interest of fairness to the subject of the investigation, Congress rejected the historical practice of permitting the examiner to profit from its report by becoming the trustee or an employee of the trustee.").
Nor may examiners play a role in a Chapter 7 proceeding. In a Chapter 7 liquidation, which occurs (among other times) at the end of an unsuccessful effort to reorganize a company under Chapter 11, a trustee always replaces the debtor in possession, and the Code prohibits the use of an examiner when a trustee has already been appointed. Id. § 1104(c). See also 11 U.S.C. § 1109(b) (giving a trustee, but not an examiner, the right to "raise and [] appear and be heard on any issue in a [Chapter 11] case"); In re Baldwin United Corp.,
The Bankruptcy Code neither expects nor requires examiners to volunteer their time. Like other officers and professionals appointed in a Chapter 11 case, examiners may request "reasonable compensation for actual, necessary services" and "reimbursement for actual, necessary expenses." 11 U.S.C. § 330(a)(1)(A) & (B). Only "[a]fter notice to the parties in interest and the United States Trustee and a hearing," however, may "the court [] award" examiners these fees and expenses. Id. The bankruptcy court "may, on its own motion or on the motion of the United States Trustee ... or any other party in interest, award compensation that is less than the amount of compensation that is requested." Id. § 330(a)(2). These same standards apply to interim compensation, which the Code also authorizes. Id. § 330(a)(5).
Rule 2016(a) of the Federal Rules of Bankruptcy Procedure provides additional details about the procedure that "[a]n entity," such as an examiner, "seeking interim or final compensation ... from the estate" must follow. "An application for compensation," the Rule says, "shall include a statement as to what payments have theretofore been made or promised to the applicant for services rendered or to be rendered in any capacity whatsoever in connection with the case" and "the source of the compensation so paid or promised." Fed. R.Bankr.P.2016(a) (emphasis added).
B.
In enumerating the duties of examiners and trustees, the drafters of the Code also invoked the more-generalized equitable duties applicable to these positions of trust. See Young v. United States,
By linking trustees and examiners in this respect — by making them equally obligated to remain "disinterested" — Congress also signaled that examiners must satisfy the unbending standards of fiduciary duty that the law and society long have come to expect of trustees in general and that the Supreme Court has required of bankruptcy trustees in particular. See Commodity Futures Trading Comm'n v. Weintraub,
Finally, the Code not only says that examiners and trustees must remain "disinterested," but it also says that they may receive only "reasonable compensation." 11 U.S.C. § 330(a)(1)(A). The compensation phrase, the Supreme Court has reasoned, suggests that trustees and examiners must remain loyal to all relevant parties in the bankruptcy and must act as fiduciaries in doing so. See Wolf,
In incorporating the equitable duties of trustees into the Bankruptcy Code and in applying them to bankruptcy trustees and examiners, Congress followed a well-trodden path. The National Legislature frequently legislates against the backdrop of common law and equitable principles, and the federal courts have often looked to these traditions in determining the contours of a trustee's or another fiduciary's duties. See Young,
When Congress enacted the Bankruptcy Act of 1898, ch. 541, 30 Stat. 544, which became the basis for modern bankruptcy law, it assuredly meant to incorporate similar common-law duties as the original Act nowhere defined, much less mentioned, a duty of disinterestedness or any equivalent concept. When Congress substantially modified the 1898 Act through the Chandler Amendments in 1938, ch. 575, 52 Stat. 840, it did the same thing in adopting a requirement of "disinterest," which was broadly defined as an "adverse interest" "for any reason." See Chandler Amendments of 1938, Pub.L. No. 75-696, § 158(4), 52 Stat. 840 (1938) ("A person shall not be deemed disinterested ... if — it appears that he has ... for any reason an interest materially adverse to the interests of any class of creditors or stockholders.") And in 1978, when the current Bankruptcy Code was adopted, Congress embraced a similar definition of "disinterest." See 11 U.S.C. § 101(14)(E) ("[D]isinterested person ... does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to ... the debtor ... or for any other reason.").
In each of these forty-year increments — in 1898, in 1938, in 1978 — Congress legislated against the backdrop of centuries of common-law decisions about the duties of trustees and other fiduciaries as well as against the backdrop of courts construing statutes in the context of similar common-law traditions. And in each instance, Congress incorporated these principles and traditions. Cf. Wolf,
C.
An examiner's duties in a bankruptcy proceeding, then, flow from the Code, the Federal Rules of Bankruptcy Procedure and the common law, including the once-distinct principles of equity. All of these sources considered, a bankruptcy examiner has three general duties. First, consistent with the statutory requirement of "disinterest," the examiner may not have a "material adverse" interest to any party to the bankruptcy "for any... reason," either at the time of appointment or during the course of the bankruptcy. See In re Marvel Entm't Group,
Second, consistent with the Federal Rules of Bankruptcy Procedure, examiners have several disclosure obligations. They must disclose all "payments ... made or promised" to them, meaning they must disclose in all fee applications any understandings they believe they have reached with anyone regarding their compensation. See Henderson v. Kisseberth (In re Kisseberth),
Third, consistent with the statutory requirement for receiving "reasonable compensation" and with the common-law standards of fiduciary duty, examiners owe the creditors and shareholders a duty of loyalty. In imposing this duty on examiners and trustees, bankruptcy law "seeks to avoid such delicate inquiries ... into the conduct of its own appointees by exacting from them forbearance of all opportunities to advance self-interest." Mosser v. Darrow,
III.
Schilling's conduct as an examiner in the Big Rivers bankruptcy failed to live up to these standards. First, he violated his duty to remain "disinterested." An agreement with a single creditor that links the examiner's compensation to the creditor's recovery qualifies as such an interest because it creates the risk that the examiner will favor one creditor at the expense of other creditors, to say nothing of all equity holders. Given the zero-sum realities of most bankruptcies, every dollar recovered by a favored creditor becomes a dollar lost to a disfavored creditor. Opportunities abound, moreover, for bankruptcy examiners paid in this manner to benefit selected creditor patrons. They might decline to investigate and report any "cause[s] of action available to the estate" against the favored creditor (say, for a fraudulent conveyance). See 11 U.S.C. § 1106(a)(4). They might file, or threaten to file, a report that harms a disfavored creditor unless it accepts a settlement that increases the recovery of a favored creditor. They might stall or obstruct confirmation of a plan that represents the best interests of the estate if it contains no recovery for the favored creditor (and no commission for the examiner).
Whether as a matter of fact an individual examiner chooses to do any of these things does not alter the "disinterestedness" inquiry. That self-interest might lead examiners to act in these ways suffices to disqualify them, because the Code does not merely prohibit trustees and examiners from acting upon materially adverse interests, it prohibits trustees and examiners from having them. See Woods, 312 U.S at 268,
Schilling undeniably had such an agreement — an oral one — with Chase no later than January 24, 1997. Had Schilling reached such an agreement before his appointment, the bankruptcy court could not have allowed him to serve as a trustee or examiner because he would not have been disinterested. See Michel,
Second, Schilling violated his disclosure obligations. Each time Schilling filed an interim fee application, Rule 2016(a) required him to disclose "payments... made or promised" to him "for services rendered or to be rendered in any capacity whatsoever in connection with the case." Schilling's January 1997 oral agreement with Chase regarding his compensation constituted a "payment[]" "promised" within the meaning of the rule, whether or not the promise was subject to bankruptcy court approval. Yet Schilling did not disclose the agreement in his March 1997 and July 1997 interim fee applications, each time in violation of the rule. See Henderson v. Kisseberth (In re Kisseberth),
Rule 2016(a) also required Schilling to disclose the promises for payment that Schilling believed Bank of New York, Chase and Mapco had made to him at the Fall 1996 conference in Washington. When a court-appointed fiduciary believes a party has promised him payment, he may not use later disputes over the existence or enforceability of the promise to excuse an earlier failure to disclose it. See In re BH & P Inc.,
Third, Schilling violated his duty of loyalty — not just by entering into the oral agreement with Chase, but by misrepresenting his actions to the court and to the parties during his negotiations with the parties and during his efforts to backtrack from them. Schilling did so on multiple occasions: when he filed documents claiming to have no adverse interest; when he filed documents claiming to have received no promises for payment; when he claimed that he "never said there was a side agreement with [Mapco],"
In each of these instances, it bears repeating, the issue was not whether Schilling would be compensated for his efforts. Absent violations of the Code and his fiduciary obligations, he would be, and indeed the court early on provided that he would be compensated at his standard hourly rate of $180 per hour in 1996 and $185 per hour in 1997. Perceiving an opportunity to be paid still more, however, Schilling negotiated, and in some instances consummated, compensation arrangements for his personal benefit (and ostensibly for the benefit of some creditors but not others). All the while, he did so secretively and outside of the traditional mechanisms for permitting fiduciaries to identify and pursue matters of self-interest — notice to all parties and a hearing before the court. Where the law demanded "[n]ot honesty alone, but the punctilio of an honor the most sensitive," Meinhard v. Salmon,
IV.
Having concluded that Schilling violated his duties to remain disinterested and loyal and having concluded that he violated his duty to disclose payments promised to him, we must consider whether the sanction imposed by the district court was appropriate. Cf. Wolf,
No abuse of discretion occurred here. Because the Code permits only "reasonable compensation" and because that requirement "`necessarily implies loyal and disinterested service in the interest of those for whom the claimant purported to act,'" Wolf,
That Schilling breached these duties at some point after his appointment does not change matters. In In re Downs we held that a bankruptcy court abused its discretion by allowing a party to retain fees who had exhibited a "willful disregard" of Rule 2016 and of § 329 (requiring a debtor's attorney to report compensation arrangements) and who did so after an appointment.
What is true of Schilling is also true of "The Law Firm of J. Baxter Schilling," the sole member of which is J. Baxter Schilling. JA 287. The district court did not abuse its discretion in concluding that, for these purposes, Schilling and his counsel (Schilling) were one and the same, and that Schilling's firm must also disgorge all fees.
No doubt the sanction in this case is a harsh and unforgiving one. Schilling's efforts, he claims, brought approximately $145 million of new value into the estate. Rather than the thanks of a grateful court and the thanks of grateful parties, he received an order to reimburse the debtor nearly $1 million in fees. Steep as the sanction may be, it represents the price of disloyalty, a price the courts have not hesitated to charge in dealing with similar breaches of trust. Serving as an examiner, as with "trusteeship," "is serious business and is not to be undertaken lightly or so discharged." Mosser,
Nor are examiners and trustees without recourse when these issues arise in the course of a bankruptcy. Mosser's advice on the point remains as sound today as it was a half-century ago: "seek instructions from the court, given upon notice to creditors and interested parties." Id. at 274,
V.
Schilling makes several contentions to the contrary, all of which amount to variations on a few points and none of which is persuasive.
A.
First and foremost, Schilling argues that merely negotiating a fee arrangement with creditors does not make an examiner improperly interested or disloyal. Appellant Br. at 38; Reply Br. at 1, 3, 7. Saving for later the question whether this argument has a mistaken factual premise — that until July 1997 Schilling merely negotiated with the three creditors and had not reached any fee agreement — we disagree with its legal premise.
As the district court properly concluded, the law does not allow a court-appointed fiduciary to engage in secret and self-interested negotiations so long as the parties stop short of a formal agreement.
Schilling's conduct during the "negotiations" illustrates the point. When Schilling proposed a fee arrangement in secret to Bank of New York, Mapco and Chase at the Fall 1996 Washington conference, he threatened that he would not perform his mediation duties without such a deal. When a Chase representative denied that a deal existed, he accused Chase of not being an honest broker. In January 1997 Schilling sent letters to Bank of New York, Mapco and Chase — creditors of the estate to whom he owed a duty of loyalty — asserting that each of them had agreed at the Washington conference to pay him a percentage of their recovery. In an August 1997 letter to Mapco, Schilling continued to insist that he and the three creditors had reached a compensation agreement at the Washington conference. Schilling later claimed, at a September 1998 court hearing, that "he never said there was a side agreement with [Mapco],"
The core problem with Schilling's contrary position is his apparent view that he was just another party seeking to maximize his personal recovery, failing to realize that "many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties." Meinhard,
Nor is Schilling correct in arguing that this overlooks § 1129(a) of the Code, which provides that a court may not confirm a plan of reorganization unless "[a]ny payment made or to be made by the proponent, by the debtor, or by a person ... acquiring property under the plan, for services or for costs and expenses in or in connection with the case ... has been approved by, or is subject to the approval of, the court as reasonable." It is true that this section makes most fees incurred in a Chapter 11 case subject to court approval. And it is true that this section refers to court approval of fees that in some instances may be paid directly by creditors, indicating that creditors like Bank of New York, Chase and Mapco may pay professionals' fees themselves (including, to use one obvious example, their own professionals' fees). Yet § 1129(a) does not, as Schilling argues, authorize an examiner to negotiate an agreement to share in a creditor's recovery so long as the agreement is ultimately subject to court approval. The provision by no means eliminates the examiner's duty to remain loyally disinterested and to comply with pertinent disclosure requirements at each stage of the case.
Neither Leiman v. Guttman,
Both cases, notably, involved fee arrangements among parties who, unlike an examiner, are not required to remain disinterested. Compare 11 U.S.C. § 1104(d) (trustees and examiners must be "disinterested") and id. § 327(a) (professionals employed by a trustee or a debtor in possession must be "disinterested"), with id. § 1103(b) (professionals employed by committees need not be "disinterested"). And neither case suggests that § 1129(a)(4) excuses an examiner from other requirements under the Code. In re Cajun, in point of law, states just the opposite, reasoning that it is "Congress's express provision for pre-payment judicial review of payments" in "[§] 330, provid[ing] for the award of `reasonable compensation' to ... an examiner,'" and in "§ 331[,] provid[ing] that ... an examiner ... may apply for interim compensation," that "renders its silence with respect to the timing of the judicial determination of the reasonableness of a payment subject to § 1129(a)(4) meaningful." Id. at 515. These cases, in short, do not support Schilling's claim (Appellant Br. at 38) that he "could have been paid a fee by the Banks and Mapco" without violating the Code "as long as before the plan was confirmed the payment was subject to approval by [the bankruptcy court]."
B.
Schilling next argues that two sections of the Bankruptcy Code — § 326 and § 328(a) — permit an examiner to receive a percentage-based fee. Section 326 provides in pertinent part that "reasonable compensation" for a trustee may "not [] exceed 3 percent of such moneys in excess of $1,000,000 upon all money disbursed or turned over in the case by the trustee to parties in interest." As Schilling correctly observes, some bankruptcy courts read § 326 of the Code to allow trustees to receive compensation in the form of a percentage of the assets distributed, at least in small Chapter 7 cases. See, e.g., In re Ohio Ind., Inc.,
Neither provision advances Schilling's cause. Even though § 326 has been construed by some bankruptcy courts to permit a percentage-based fee in Chapter 7 cases and even though § 328(a) permits counsel for a trustee to seek a contingency-fee arrangement, these provisions do not authorize Schilling's distinct conduct. They do not permit a trustee (or counsel for a trustee) to solicit percentage-based compensation from some but not all of the creditors, to reach an agreement with one of them, to do so secretively without disclosure to the court or the other parties, or to deceive the other parties about the undertaking.
The argument also overlooks the distinct obligations of trustees and examiners on the one hand and counsel for trustees on the other. The former owe fiduciary obligations to the estate and its myriad interests and thus serve multiple masters. The Code, accordingly, does not allow their compensation to be tied to a particular party's recovery. The latter owe fiduciary duties to their client (the trustee) and serve only one master. No conflict, accordingly, is created by tying the attorneys' compensation to recoveries in the very matters for which they were hired.
Schilling's reliance on Architectural Bldg. Components v. McClarty (In re Foremost Mfg. Co.),
C.
Schilling also contends that his oral agreement with one creditor and his negotiations with three creditors to receive a percentage of their recovery created no conflict of interest with the other creditors or with the estate. In Schilling's words, his "interests were wholly and congruently aligned with those of the estate." Appellant Br. at 44. Schilling analogizes his circumstances to a Chapter 7 trustee being paid a percentage of the assets distributed. No one would suggest that the trustee has an improper interest, he adds, just because the more the creditors and equity holders recover the more the trustee earns. If everyone benefits, in other words, no conflict can exist.
The argument, however, does not square with reality or with what Schilling in fact did. Schilling secretly negotiated compensation tied to some creditors' recovery; he did not openly ask the court to award him a percentage of the estate's growth or of all creditors' and equity holders' recovery. While a rising tide may indeed lift all boats, the deal he set out to negotiate gave him an incentive to lift only four boats — three unsecured creditors' and his own — which is exactly the problem of divided loyalties that the Code and the common law have long worked to avoid.
Schilling next argues that this reasoning rewrites the Code to require something that it does not — that an examiner remain "neutral." As Schilling observes, the district court several times referred to the requirement that an examiner remain "neutral," a requirement nowhere found in the Code or Rules. By "neutral and disinterested," however, the district court clearly meant "impartial and disinterested," which the Code does require. See 11 U.S.C. § 101(14); Wissman v. Pittsburgh Nat'l Bank,
D.
Schilling also takes issue with many of the district court's factual findings. He asserts, for instance, that he had no agreements, only negotiations, with the creditors before July 31, 1997, when he received Chase's written agreement and promptly filed it with the court. The district court, however, found that "[i]n the January 27, 1997 telephone call from the Examiner to Mr. Daniello of Chase, they reached an agreement in principle ... whereby Chase agreed to pay [] him a fee calculated according to how much he increased its recovery or decreased its exposure."
Schilling further asserts that he did not solicit Bank of New York, Mapco and Chase to pay his fees from their funds, only to support his request for a percentage fee to be paid by the estate. The record does not clearly reflect whether Schilling indicated whom he expected to pay this fee when he first raised the issue at the Washington meetings. One possibility is that he proposed that the three creditors pay him three percent of the increased amount that they received from Big Rivers. Another possibility, as Schilling now argues and as representatives of the three creditors recalled in their deposition testimony, is that Schilling merely suggested that he should receive three percent of the new value without indicating who would foot the bill. In view of the light cast by the later January 1997 letters, in which Schilling says that the three creditors would pay the fee, we cannot conclude that the district court committed reversible error in making this finding.
Schilling also claims that he did not negotiate his percentage fee in secret. "The possible fee arrangement," he asserts, "was broadly disclosed." "In fact," says Schilling, "the discussions were known to Bankruptcy Judge Roberts, the [United States Trustee], Big Rivers and all creditors then actively involved in the case not later than November 13, 1996." Appellant Br. at 53. In making this argument, however, Schilling omits several important details. The bankruptcy court, the United States Trustee and some creditors, it is true, were aware that Schilling might seek an enhanced fee and specifically one that turned on a percentage of new value created for the estate. But the record supports the district court's finding that only Schilling and the three creditors (Bank of New York, Mapco and Chase) knew that he was negotiating to have the three creditors pay him a percentage of their recovery. And this fact, no one argues, was ever disclosed.
E.
Schilling lastly argues that several procedural impediments barred the district court from reaching the disgorgement issue. His principal objection is that no one had standing to raise the disgorgement issue — not the Utilities Service, not the United States Trustee, not Big Rivers, not any of its member cooperatives. Some of the parties lacked a sufficient financial stake in the outcome to have standing, Schilling argues, and others waived their challenges to the fee. The district court disagreed, and so do we. Even if the Utilities Service, the United States Trustee, Big Rivers and its member cooperatives all lacked standing (a doubtful proposition), the district court would still have standing to raise the issue on it own. Section 105(a) of the Bankruptcy Code itself provides ample authority: "No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to... prevent an abuse of process." See In re Busy Beaver Bldg. Ctrs., Inc.,
Schilling responds that § 105 does not allow a court to override contrary provisions elsewhere in the Code and accordingly "Section 105 cannot trump Section 1129(a)(4)." Reply Br. at 18. But this point goes to the merits of the disgorgement issue, not to whether anyone has standing to raise it. He also notes — correctly — that the district court did not rely on § 105. But since we review judgments, not reasoning, the contention is unavailing. See Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc.,
Schilling next contends that the district court exceeded the scope of the remand order and disregarded "the law of the case." Appellant Br. at 26. The bankruptcy court, recall, initially granted the examiner's fee application (without the benefit of the evidence at Judge Cohn's disposal). Several parties appealed to the district court, which, acting as an appellate court, affirmed in part and reversed in part. Concluding that the issue of disgorgement was not decided by the bankruptcy court, District Court Judge McKinley "remand[ed] the case to the Bankruptcy Court for proper resolution of this issue," including "whether the Examiner negotiated and obtained certain side compensation agreements with various creditors." In re Big Rivers Elec. Corp.,
Schilling argues that by using the conjunctive — "negotiated and obtained" — Judge McKinley established the "law of the case," which on remand allowed Judge Cohn to order disgorgement "only if" he found both that "(1) negotiations occurred between the Examiner and creditors (which was undisputed) and (2) an agreement was reached between the Examiner and these creditors." Appellant Br. at 27. But these few words do not bear the weight Schilling places on them. The remand order concerned the "proper resolution" of the "issue of disgorgement," and had no other strings attached.
Nor, contrary to Schilling's position, did the "law of the case" make it an abuse of discretion for the district court to deny Schilling's counsel fees on the ground that Schilling and his counsel were "essentially the alter ego" of one another. Id. at 583. According to Schilling, an earlier district court decision, which held that for purposes of a jurisdictional issue "there is a distinction between [Schilling and his law firm]," JA 492, established the law of the case. We disagree. Until the district court ordered Schilling and the "Law Firm of J. Baxter Schilling" to disgorge all fees, no court had ever decided whether to hold both Schilling and his law firm (sole member, Schilling) accountable for the conduct at issue here. Schilling in the end may not retain what Schilling must disgorge.
* * * * *
As this case illustrates, being a bankruptcy examiner, like being a bankruptcy trustee, "is serious business and is not to be undertaken lightly." Mosser,
VI.
For these reasons, we affirm the district court's judgment.
Notes:
Notes
The Honorable Richard Mills, United States District Judge for the Central District of Illinois, sitting by designation