2002 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

9-23-2002

In Re Pillowtex

Precedential or Non-Precedential: Precedential

Docket No. 01-2775

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Recommended Citation

"In Re Pillowtex " (2002). 2002 Decisions. Paper 595.

http://digitalcommons.law.villanova.edu/thirdcircuit_2002/595
PRECEDENTIAL 

 Filed September 23, 2002 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

No. 01-2775 

IN RE: PILLOWTEX, INC. 

PATRICIA A. STAIANO, the UNITED STATES TRUSTEE, 

 Appellant 

On Appeal from the United States District Court 

for the District of Delaware 

(D.C. No. 00-cv-04211) 

District Judge: Hon. Sue L. Robinson 

Argued June 10, 2002 

Before: SLOVITER, ROTH and McKEE, Circuit Judg es 

(Filed: September 23, 2002) 

 Robert D. McCallum, Jr. 

 Assistant Attorney General 

 Joseph A. Guzinski 

 Acting General Counsel 

 P. Matthew Sutko 

 Attorney, Office of General Counsel 

 Anne Murphy (Argued) 

 William Kanter 

 United States Department of Justice 

 Washington, D.C. 20530 

 Attorneys for Appellant 

 

 Eric D. Schwartz 

 William H. Sudell, Jr. 

 Morris, Nichols, Arsht & Tunnell 

 Wilmington, DE 19899 

 Fordham E. Huffman (Argued) 

 David G. Heiman 

 Jones, Day, Reavis & Pogue 

 Columbus, OH 43215 

 Gregory M. Gordon 

 Daniel P. Winikka 

 Jones, Day, Reavis & Pogue 

 Dallas, TX 75201 

 Attorneys for Appellees 

 In Re: Pillowtex, Inc. and its 

 Affiliated Debtors 
 John D. McLaughlin, Jr. 

 Pauline K. Morgan 

 Young, Conaway, Stargatt & Taylor 

 Wilmington, DE 19899 

 Fred S. Hodara (Argued) 

 Akin, Gump, Strauss, Hauer & Feld 

 New York, NY 10022 

 Attorneys for Appellee 

 Official Committee of Unsecured 

 Creditors 

OPINION OF THE COURT 

SLOVITER, Circuit Judge. 

The U.S. Trustee appeals from the District Court’s order 

authorizing the retention of Jones, Day, Reavis and Pogue 

("Jones Day") as Pillowtex, Inc.’s Chapter 11 bankruptcy 

counsel. The U.S. Trustee argues that payments of fees by 

Pillowtex to Jones Day within the 90 days before 

bankruptcy may have constituted an avoidable preference 

and that the receipt of such a preference by Jones Day 

would constitute a conflict of interest with Pillowtex’s 

 2 

 

creditors and its bankruptcy estate. The U.S. Trustee 

maintains that because the Bankruptcy Code provides that 

debtor’s counsel may not "hold or represent an interest 

adverse to the estate" or "an interest materially adverse to 

the interest of . . . any class of creditors," Jones Day may 

have been disqualified from serving as Pillowtex’s 

bankruptcy counsel. Without ruling on the U.S. Trustee’s 

preference allegation, the District Court approved Jones 

Day’s retention on condition, proposed by Jones Day, that 

if Jones Day is determined to have received a preference, it 

return the amount of the preference to Pillowtex’s 

bankruptcy estates and waive any resulting claim. On 

appeal, the U.S. Trustee argues that the District Court 

erred in authorizing Jones Day’s retention as counsel 

without making a determination whether Jones Day 

received a preference and asks this court to remand and 

direct the District Court to make such a determination 

promptly. 

I. 

FACTS AND PROCEDURAL POSTURE 

Pillowtex Corporation and its subsidiaries (referred to 

collectively as Pillowtex) manufacture pillows, blankets, 

towels and other textiles. Jones Day has represented and 

advised Pillowtex since 1996 in a variety of matters, 

including corporate, financial, securities, real property, 

litigation, environmental, intellectual property, labor, 

employee benefits and tax affairs. Prior to filing its 
bankruptcy petition, Pillowtex retained Jones Day to assist 

it with contingency planning and bankruptcy preparation. 

Pillowtex declared bankruptcy on November 14, 2000 by 

filing a petition under Chapter 11 of the Bankruptcy Code. 

At the time of filing, Pillowtex had approximately 

$1,000,000,000 in trade debt, about $750,000,000 in 

senior secured debt, and roughly $400,000,000 in 

subordinated debt. For fiscal year 1999, Pillowtex’s gross 

revenues exceeded $1,500,000,000, and as of July 1, 2000 

its assets were valued at approximately $1,700,000,000. 

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On November 16, 2000, Pillowtex filed an application 

with the Bankruptcy Court to retain and employ Jones Day 

as its bankruptcy counsel pursuant to section 327 of the 

Bankruptcy Code. Pillowtex also applied to retain other 

professionals to assist it in its restructuring, including 

KPMG LLP (KPMG) as an independent auditor and 

consultant. As part of Jones Day’s retention application, 

Jones Day set forth the date and amount of each payment 

that Pillowtex made to the firm during the year immediately 

preceding the filing for bankruptcy. The disclosure by Jones 

Day showed that Pillowtex made the following payments to 

Jones Day for services rendered: 

 11/29/99 $ 203,520.69 

 12/27/99 450,573.79 

 12/30/99 155,912.06 

 2/23/00 181,550.01 

 3/31/00 67,482.73 

 4/30/00 146,520.71 

 6/30/001 180,585.22 

 7/7/00 132,299.71 

 9/11/00 78,652.94 

 11/3/00 40,759.09 

 11/10/00 778,157.33 

 11/13/00 300,000.00 (retainer--approx. 

 $100,000 toward pre- 

 petition fees) 

The last payment listed, that on November 13, 2000, was 

made the day before Pillowtex filed its petition for 

bankruptcy and was a retainer of $300,000 for services 

rendered or to be rendered by Jones Day and for 

reimbursement of expenses.2 Including the applied portion 

_________________________________________________________________ 

1. In the Disclosure of Compensation that Jones Day filed as part of 

Pillowtex’s retention application, Jones Day listed this payment as 

having been made on 6/30/99, but its placement in an otherwise 

chronological listing of payments suggests that date is a scrivener’s 

error. In its brief, the U.S. Trustee lists the payment as having been 

made in the year 2000. 

2. Although Jones Day initially represented that it had applied $100,000 

of that retainer as payment of fees through November 13, 2000, it now 

explains that it inadvertently failed to transfer that sum from its trust 
account into a non-trust account as of that date. 

 4 

 

of the retainer, Pillowtex paid Jones Day $2,516,014 in the 

year before it declared bankruptcy. Of those payments 

$997,569.36 were made in the ninety days before Pillowtex 

filed its petition for bankruptcy. 

The U.S. Trustee3 filed an objection to the application by 

Jones Day and KPMG for retention, arguing that both 

KPMG and Jones Day had received payments which 

constituted voidable preferences under section 547 of the 

Bankruptcy Code. According to the U.S. Trustee, Jones Day 

"received payments before the filing of the petition which 

were voidable as preferences . . . . As a result of these 

payments, Jones Day is not a disinterested person and 

cannot be retained to represent the debtors in possession 

[Pillowtex]." App. at 125. Eventually, the U.S. Trustee 

withdrew his objection to KPMG’s retention pursuant to 

stipulation, but continues to press its objection as to Jones 

Day and requested a hearing. 

Before the District Court, Jones Day argued that 

Pillowtex’s payments to it "were substantially within the 

historical pattern of payments between Jones Day and the 

Debtors, which included wide swings in the timing of 

payments." App. at 133. Jones Day opposed the requested 

hearing, arguing that it was "not necessary or appropriate 

for the Debtors’ estates to incur the time and expense of 

litigating the preference issue." App. at 133. It proposed 

instead that "if a preference action against the firm is 

initiated and a final order is entered determining that Jones 

Day in fact received a preference, Jones Day will return to 

the Debtors’ estates the full amount of the preferential 

payment and waive any related claim." App. at 133. Jones 

Day noted that "the U.S. Trustee has previously adopted" 

the same approach "with respect to Debtors’ accountants," 

KMPG, but "[i]nexplicably, the U.S. Trustee will not agree to 

this resolution with Jones Day." App. at 133. 

The District Court did not definitively determine whether 

Jones Day had received a preference from Pillowtex. 

_________________________________________________________________ 

3. The reference is to the United States Trustee authorized to supervise 

the administration of bankruptcy cases in "[t]he judicial districts 

established for the States of Delaware, New Jersey, and Pennsylvania," 

28 U.S.C. S 581(a)(3), also known as "Region 3." 

 5 

 

Instead, the court adopted Jones Day’s suggestion that it 

authorize the firm’s retention on condition that if Jones Day 

was determined to have received preferential transfers, 

"Jones Day shall promptly return the same to[Pillowtex’s] 

estate[ ] and waive any unsecured claim it has by virtue 

thereof." App. at 3. According to the District Court, "Subject 
to the provisions of this Order, Jones Day does not hold or 

represent any interest adverse to the Debtors’ estates and 

is a ‘disinterested person,’ as defined in section 101(14) of 

the Bankruptcy Code and as required by section 327(a) of 

the Bankruptcy Code." App. at 2. The U.S. Trustee timely 

filed this appeal of the retention order. 

The bankruptcy proceeding continued while this appeal 

proceeded. In the interim, no party has brought a 

preference action against Jones Day. The District Court 

ultimately confirmed Pillowtex’s Second Amended Joint 

Plan of Reorganization by an order entered May 2, 2002. At 

oral argument before this court, Fred Hodara, an attorney 

for the Official Committee of Unsecured Creditors of 

Pillowtex which joined in Pillowtex’s brief on appeal, agreed 

with the U.S. Trustee that under Pillowtex’s confirmed plan 

of reorganization the unsecured creditors only receive 

pennies on the dollar for their claims. 

II. 

JURISDICTION AND STANDARD OF REVIEW 

This is a core proceeding pursuant to 28 U.S.C. 

S 157(b)(2). The District Court exercised jurisdiction over 

this matter pursuant to 28 U.S.C. SS 157 and 1334. That 

court’s determination of Pillowtex’s application for retention 

of counsel is a final order, see, e.g., United States Trustee 

v. First Jersey Secs., Inc. (In re First Jersey Secs., Inc.), 180 

F.3d 504, 508 (3d Cir. 1999), which this court has 

jurisdiction to review pursuant to 28 U.S.C. S 1291, see, 

e.g., In re Marvel Entm’t Group, Inc., 140 F.3d 463, 470-71 

(3d Cir. 1998). The confirmation of Pillowtex’s plan of 

reorganization does not moot this appeal. See, e.g., Citicorp 

Venture Capital Ltd. v. Committee of Unsecured Creditors, 

160 F.3d 982, 986 (3d Cir. 1998) (exercising jurisdiction 

 6 

 

over appeal despite confirmation of a Chapter 11 plan); 

Michel v. Federated Department Stores, Inc. (In re Federated 

Department Stores, Inc.), 44 F.3d 1310, 1315-17 (6th Cir. 

1995) (holding appeal not moot despite confirmation of plan 

because bankruptcy court had power on remand to deny 

pending fee requests and order disgorgement of previously 

awarded fees). 

The U.S. Trustee has standing to appeal the retention 

order. The U.S. Trustee has statutory responsibility to 

monitor applications for retention of professional persons in 

bankruptcy cases, and, "whenever the United States trustee 

deems it appropriate, [to file] with the court comments with 

respect to the approval of such applications." 28 U.S.C. 

S 586(a)(3)(H). The relevant statute addresses the U.S. 

Trustee’s standing by explicitly providing that"[t]he United 

States trustee may raise and may appear and be heard on 

any issue in any case or proceeding under this title." 11 

U.S.C. S 307. See also United States Trustee v. Price 

Waterhouse, 19 F.3d 138, 141 (3d Cir. 1994). 
Although Jones Day argues that it is significant that 

none of the parties in interest to the bankruptcy objected to 

its retention as counsel, the House Report to the legislation 

expanding and implementing the U.S. Trustee program on 

a national scale, embodied in 11 U.S.C. S 307, expressly 

puts the U.S. Trustee on the level of a party, as it states: 

"The U.S. Trustee is given the same right to be heard as a 

party in interest, but retains discretion to decide when a 

matter of concern to the proper administration of the 

bankruptcy laws should be raised." H.R. Rep. No. 764, 99th 

Cong., 2d Sess. 27 (1986), reprinted in 1986 U.S.C.C.A.N. 

5227, 5240. See also In re Columbia Gas Sys. Inc., 33 F.3d 

294, 296 (3d Cir. 1994). Accordingly, we proceed to 

consider the issues presented. 

III. 

DISCUSSION 

We review a bankruptcy court’s decision to approve an 

application for employment for abuse of discretion. See In 

re Marvel Ent’mt Group, Inc., 140 F.3d 463, 470 (3d Cir. 

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1998) ("An abuse of discretion exists where the district 

court’s decision rests upon a clearly erroneous finding of 

fact, an errant conclusion of law or an improper application 

of law to fact.") (quoting ACLU v. Black Horse Pike Reg’l Bd. 

of Educ., 84 F.3d 1471, 1476 (3d Cir. 1996)). 

A debtor in possession, such as Pillowtex, may, with 

bankruptcy court approval, employ one or more attorneys 

to represent it and to assist it in fulfilling its duties. See 11 

U.S.C. S 327(a). The attorneys selected may not be persons 

who "hold or represent an interest adverse to the estate," 

and must be "disinterested persons." Id. The Bankruptcy 

Code includes as a "disinterested person," someone who 

"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 for any 

other reason." 11 U.S.C. S 101(14)(E). Prior representation 

of the debtor does not, of itself, merit disqualification. See 

11 U.S.C. S 1107(b) ("[A] person is not disqualified for 

employment under section 327 of this title by a debtor in 

possession solely because of such person’s employment by 

or representation of the debtor before the commencement of 

the case."). 

We have considered the statutory requirements for 

retention of counsel in several opinions. In In re BH & P, 

Inc., 949 F.2d 1300 (3d Cir. 1991), the bankruptcy court 

had disqualified counsel after finding that the law firm had 

an actual conflict of interest by representing both the 

trustee for the debtor in its chapter 7 proceeding and the 

two principals of the debtor who had also filed chapter 7 

proceedings. In affirming the disqualification of counsel (as 
well as the trustee), we stated that a conflict is actual, and 

hence per se disqualifying, if it is likely that a professional 

will be placed in a position permitting it to favor one 

interest over an impermissibly conflicting interest. See id. 

at 1315. We noted that, "[t]he term ‘actual conflict of 

interest’ is not defined in the Code and has been given 

meaning largely through a case-by-case evaluation of 

particular situations arising in the bankruptcy context." Id. 

We again considered the standards applicable to 

retention of trustee’s counsel in In re Marvel Entertainment 

 8 

 

Group, Inc., 140 F.3d 463 (3d Cir. 1998). Because the 

parties urged "conflicting interpretations of BH&P, we 

expressly reiterat[ed]" our earlier holding that: 

 (1) Section 327(a), as well as S 327(c), imposes a per se 

 disqualification as trustee’s counsel of any attorney 

 who has an actual conflict of interest; (2) the district 

 court may within its discretion -- pursuant toS 327(a) 

 and consistent with S 327(c) -- disqualify an attorney 

 who has a potential conflict of interest and (3) the 

 district court may not disqualify an attorney on the 

 appearance of conflict alone. 

Id. at 476 (emphases added). In Marvel Entertainment, we 

reversed the district court’s disqualification of the trustee 

and trustee’s counsel because it was predicated only on the 

appearance of a conflict. We held that under section 327(a) 

the district court could disqualify counsel "only if it had an 

actual or potential conflict of interest." Id. at 477. 

Although the retention of counsel for the trustee was at 

issue in both BH&P and Marvel Entertainment, the same 

standards apply to the retention of counsel for the debtor in 

possession. See 11 U.S.C. S 1107(a) ("Subject to any 

limitations on a trustee serving in a case under this 

chapter, and to such limitations or conditions as the court 

prescribes, a debtor in possession shall have all the rights, 

other than the right to compensation under section 330 of 

this title, and powers, and shall perform all the functions 

and duties, except the duties specified in sections 

1106(a)(2), (3), and (4) of this title, of a trustee serving in a 

case under this chapter."). 

In In re First Jersey Securities, Inc., 180 F.3d 504 (3d Cir. 

1999), the U.S. Trustee objected to retention of the counsel 

proposed by the debtor in possession on the ground that 

counsel had received a preferential payment, constituting 

an interest adverse to the estate. Notwithstanding that both 

the bankruptcy court and the district court had approved 

counsel’s retention, this court reversed. We stated that 

"[w]here there is an actual conflict of interest . . . 

disqualification is mandatory." Id. at 509 (citing In re 

Marvel Entertainment, 140 F.3d at 476). Then, in language 

that the U.S. Trustee here emphasizes, we stated that "[a] 
 9 

 

preferential transfer to [debtor’s counsel] would constitute 

an actual conflict of interest between counsel and the 

debtor, and would require the firm’s disqualification." 180 

F.3d at 509 (emphasis in original). 

We held that counsel was disqualified because within 90 

days of the filing for bankruptcy it had received from the 

debtor stock in payment of a bill of $250,000 in settlement 

for antecedent legal work. Counsel had argued that the 

stock payment was made in the ordinary course of business 

and therefore not subject to avoidance, but we rejected that 

contention because payment of fees in unregistered 

restricted securities was a method of payment inconsistent 

with the parties’ prior course of dealings. See id. at 513. 

The U.S. Trustee relies on the authority of First Jersey 

Securities in pointing to Pillowtex’s payment of substantial 

fees to Jones Day as a possible preference. 

In this case, the District Court never decided whether 

Jones Day received an avoidable preference from Pillowtex 

when it accelerated billing for and received payment for 

past due bills during the ninety days before Pillowtex 

declared bankruptcy. An avoidable preference is defined in 

section 547(b) of the Bankruptcy Code as 

 any transfer of an interest of the debtor in property -- 

 (1) to or for the benefit of a creditor; (2) for or on 

 account of an antecedent debt owed by the debtor 

 before such transfer was made; (3) made while the 

 debtor was insolvent; (4) made -- (A) on or within 90 

 days before the date of the filing of the petition; . . . (5) 

 that enables such creditor to receive more than such 

 creditor would receive [in a Chapter 7 distribution] 

11 U.S.C. S 547(b). 

The preference rule prevents debtors from depleting the 

estate to pay favored creditors with assets that otherwise 

would have been apportioned among creditors according to 

the prioritization scheme of the Bankruptcy Code. See, e.g., 

George M. Treister et al., Fundamentals of Bankruptcy Law 

S 4.03(c), at 169 (noting that S 547"is designed to achieve 

the policy of fostering equality of distribution among the 

creditors of an insolvent debtor"). When the debtor becomes 

insolvent, a payment to one creditor from the estate’s 

 10 

 

limited assets is necessarily paid at the expense of another 

creditor. The receipt of a preference by a creditor thus 

creates a conflict with unpaid creditors, whose share of the 

remaining assets is diminished by the payment.4 

In this court, Jones Day explained that it sought 

payment from Pillowtex of its outstanding bills in order that 

it would not be a creditor at the time of the bankruptcy, as 
that would have disqualified it from retention as counsel.5 

The record does not show how much of the fee Jones Day 

received within the 90 days before bankruptcy was for 

bankruptcy preparation, how much was for legal work done 

years earlier, and what the ordinary practice was in Jones 

Day’s billings to Pillowtex and Pillowtex’s payments. Jones 

Day did not make a proffer of such information. Instead, it 

argued merely that a hearing was expensive and 

unnecessary, and proposed that the court could avoid any 

possible conflict by authorizing retention of Jones Day 

subject to the conditions that (1) Jones Day return any 

_________________________________________________________________ 

4. Section 327(a) sets forth two relevant standards for disqualification, 

one applicable to conflicts with the debtor’s estate and one governing 

conflicts with other creditors. The first prohibits a professional from 

"hold[ing] or represent[ing] an interest adverse to the estate." 11 U.S.C. 

S 327(a). The second, contained in the definition of "disinterested 

person," requires that a professional be free of"an interest materially 

adverse to the interest of . . . any class of creditors." 11 U.S.C. 

S 101(14)(E). Thus, a professional may not have any conflict with the 

estate, while a conflict with creditors must be"material." 

It is unclear whether, as the U.S. Trustee argues, the receipt of a 

preference will always create a conflict with the debtor. "Preference law 

. . . is not part of the arsenal of rights and remedies between a debtor 

and his creditors. . . . preference law focuses on relationships among 

creditors in light of the advantages of a collective proceeding, not on 

relationships between creditors and the debtor ." Thomas H. Jackson, 

Avoiding Powers in Bankruptcy, 36 Stan. L. Rev. 725, 757 (1984) 

(emphasis in original). We reserve the U.S. Trustee’s argument for future 

resolution. 

5. The Bankruptcy Code prohibits retention of a professional who is a 

prepetition creditor of the debtor. See 11 U.S.C. S 101(14)(A) (stating that 

a disinterested person "is not a creditor"); Price Waterhouse, 19 F.3d at 

141. If Jones Day were determined to have received a preference, its 

resulting claim for fees would transform it into a prepetition creditor, 

which would pose a disqualifying conflict. 

 11 

 

preference it is determined to have received, and (2) Jones 

Day waive any claim resulting from the preference. 

We agree with the U.S. Trustee that the court’s order 

incorporating the two conditions does not resolve the 

question whether Jones Day received an avoidable 

preference and was therefore not disinterested and whether 

it should have been disqualified. If payments to Jones Day 

were determined to be preferences, Jones Day would, in 

any event, be obliged to return the funds to the estate. See 

11 U.S.C. S 550 ("[T]o the extent a transfer is avoided under 

section . . . 547 . . . of this title, the trustee may recover, 

for the benefit of the estate, the property transferred, or . . . 

the value of such property."). 

Nor does its undertaking to waive the claims resulting 

from the preference resolve the issue of its possible 
disqualification if the fee payment was an avoidable 

preference. Jones Day cites a series of cases to illustrate 

that a professional can eliminate an adverse interest by 

waiving any claim it has against the estate, but it is not in 

the same position as the professionals in these cases. See, 

e.g., In re Princeton Medical Mgmt., Inc. , 249 B.R. 813, 816 

(Bankr. M.D. Fla. 2000); In re Fulgham Enters., Inc., 181 

B.R. 139, 142 (Bankr. N.D. Ala. 1995); In re E. Charter 

Tours, Inc., 167 B.R. 995, 996 (Bankr. M.D. Ga. 1994); In 

re Adams Furniture Indus., Inc., 158 B.R. 291, 297 (Bankr. 

S.D. Ga. 1993); In re Watervliet Paper Co., Inc. , 96 B.R. 768, 

774 (Bankr. W.D. Mich. 1989). 

In each of the cited cases, the professional waived its fees 

prior to being approved for retention under section 327 (a). 

See, e.g., Princeton, 249 B.R. at 816 (noting requirement 

that retention be denied absent waiver); Fulgham , 181 B.R. 

at 142 ("Unless Mr. Beck waives his prepetition claim he 

may not be employed by the Debtor"); Charter , 167 B.R. at 

998 (denying retention absent waiver); Adams, 158 B.R. at 

297 (approving law firm’s retainers in light of waiver); 

Watervliet, 96 B.R. at 774 (permitting retention as debtor’s 

counsel upon waiver). Here, Jones Day has not actually 

waived any fees as there has been no determination that 

there was a preference and its amount, but Jones Day was 

retained nonetheless. 

 12 

 

Jones Day points to the decision in In re Midland Food 

Servs., LLC, No. 00-4036 (Bankr. D. Del. Dec. 14, 2000) 

(oral order granting retention), where a bankruptcy court, 

despite a creditor’s claim that the proposed counsel had 

been paid a preference, granted a retention petition by 

debtor’s counsel based on a conditional waiver similar to 

that approved in the District Court’s order in this case. The 

bankruptcy court permitted retention based on the court’s 

conclusion that a conflict was only potential until the 

preference was definitively adjudicated. App. at 186, 189- 

90. That decision was not appealed to this court and 

appears to be inconsistent with the decision we reach 

today. 

At the heart of the U.S. Trustee’s objection to retention of 

Jones Day as counsel before the preference issue was 

decided is the improbability that Jones Day, as counsel to 

the debtor-in-possession, would bring an action against 

itself to recover any preference. As the U.S. Trustee states 

in its brief, "[b]ecause Jones Day has taken and retained 

payments that may be preferential and it ‘will not be 

advising the Debtors to seek to recover payments made to 

Jones Day’ . . . the conflict of interests, if any, has been in 

place since Jones Day’s retention was approved and is an 

actual conflict of interest today." Appellant’s Reply Br. at 6- 

7. 

Jones Day responds that there are other creditors who 

could raise the preference issue, if it is a matter of concern. 

However, the relationship between a debtor and its 
creditors is not always adversarial.6 In such a situation, the 

U.S. Trustee can play an important role in assuring 

adherence to the requirements of the Bankruptcy Code. 

Of course, Jones Day does not concede that it received a 

preference. It argues that the $997,569.36 it received 

within the 90-day period was in the ordinary course of 

business, and therefore not an avoidable preference under 

section 547(c)(2). Moreover, it argues that any conflict 

_________________________________________________________________ 

6. See generally In the Matter of Arkansas Company, Inc., Debtor, 798 

F.2d 645, 649 (3d Cir. 1986) (discussing conduct of some attorneys for 

creditors as one of bases for requirement of court approval of counsel for 

creditors committee). 

 13 

 

created by that preference was not material, and notes that, 

"once a court concludes the debtor paid a preference to a 

professional, it must evaluate whether the preference 

creates an "interest materially adverse to the interest of . . . 

any class of creditors." S 101(14)(E). See note 4, supra. 

According to Jones Day, given the uncertainty over whether 

it was paid a preference, let alone a preference constituting 

a materially adverse interest to other creditors, the District 

Court was well within its discretion to order its retention. 

It is true that "historically, bankruptcy courts have been 

accorded wide discretion in connection with . . . the terms 

and conditions of the employment of professionals." 

Appellee’s Br. at 10 (quoting BH & P, 949 F.2d at 1316). 

Jones Day argues that therefore a court sitting in 

bankruptcy also enjoys considerable discretion in 

determining how to address an allegation of a conflict of 

interest. 

Although a bankruptcy court enjoys considerable 

discretion in evaluating whether professionals suffer from 

conflicts, that discretion is not limitless. A bankruptcy 

court does not enjoy the discretion to bypass the 

requirements of the Bankruptcy Code. For example, we 

held in United States Trustee v. Price Waterhouse, 19 F.3d 

138 (3d Cir. 1994), that, based on the language of the 

Code, a bankruptcy court that approves the retention of a 

prepetition creditor of the estate necessarily abuses its 

discretion. Id. at 141 ("These provisions[of the Bankruptcy 

Code], taken together, unambiguously forbid a debtor in 

possession from retaining a prepetition creditor to assist it 

in the execution of its Title 11 duties."). 

At the oral argument, Jones Day contended that all 

bankruptcy lawyers find themselves with past due bills 

from putative debtors on the eve of bankruptcy and seek to 

clear the accounts so that they are qualified to serve as 

counsel for the debtor. It suggested that if this court were 

to hold that such payments may be avoidable preferences 

which must be determined before retention can be 

approved, we will disrupt the already hectic period after 
bankruptcy filing when the bankruptcy court is occupied 

with first day orders and the parties are meeting to form 

creditors committees. We believe that some accommodation 

 14 

 

can undoubtedly be made between the need of counsel for 

payment of appropriate fees and the explicit provisions of 

the Code. The U. S. Trustee agrees that counsel are entitled 

to receive fees for the bankruptcy preparation, although we 

reserve the issue how this can be done consistently with 

the provisions of the Code. The U.S. Trustee maintained 

before the District Court that "professionals entering 

bankruptcy cases protect themselves from the preference 

issue by obtaining a retainer, and they . . . draw down on 

the retainer during the 90 day period so as to avoid raising 

the issue of whether or not they received preferential 

payments." App. at 207. It also argues that many 

preference claims may be insubstantial and that 

bankruptcy counsel typically waive past fees due. The U.S. 

Trustee focuses on Jones Day’s receipt of payments for past 

bills which enabled it to receive 100% of all past due bills 

rather than waiving those for earlier work. It argues that 

"[p]aying hundreds of thousands of dollars of accrued fees 

on the eve of bankruptcy was not typical." Appellant’s Br. 

at 18-19. 

The record does not show which view is accurate. The 

parties may choose to present evidence at the hearing on 

remand that would permit the District Court to make a 

finding of fact on the matter. 

Because there has never been a judicial determination 

whether Jones Day received a preference, it is unclear at 

this time whether the preference, if there were one, 

presents a conflict which would require Jones Day’s 

disqualification. We hold that when there has been a 

facially plausible claim of a substantial preference, the 

district court and/or the bankruptcy court cannot avoid the 

clear mandate of the statute by the mere expedient of 

approving retention conditional on a later determination of 

the preference issue. 

The District Court in this case could not adequately 

evaluate the alleged conflict and was not in a position to 

conclude that any preference did not pose a conflict with 

Pillowtex’s estate or a material conflict with the other 

creditors. We therefore agree with the U.S. Trustee that the 

 15 

 

District Court must hold a hearing on whether Pillowtex 

received a preference, and will remand for that purpose.7 

A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 
 for the Third Circuit 

_________________________________________________________________ 

7. There was some confusion at oral argument about whether the U.S. 

Trustee has standing to pursue the preference action below. Although we 

leave the question to the District Court on remand in the first instance, 

we call to its attention our discussion in U.S. Trustee v. Columbia Gas 

Sys. Inc. (In re Columbia Gas Sys. Inc.), 33 F.3d 294 (3d Cir. 1994), 

where we observed of section 307 of the Code, "[i]t is difficult to conceive 

of a statute that more clearly signifies Congress’s intent to confer 

standing." Id. at 296. 

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