Court Opinion

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Opinions of the United
2002 Decisions                                                                                                             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Precedential or Non-Precedential: Precedential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

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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.

                                3

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.

                                7

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

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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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