Court Opinion

ID: 9689815
Source: CourtListenerOpinion
Date Created: 2023-08-24 18:47:43.073786+00
Date Added: 2024-06-11T18:15:42.163938
License: Public Domain

MARLAR, Bankruptcy Judge,
dissenting.
I must respectfully dissent.
The majority’s premise is that an insolvent chapter 11 debtor’s counsel’s security retainer is tenable under the Code in the first place. It is with this fundamental view that I disagree.
Congress did not intend for chapter 11 professionals (especially the debtor’s counsel) to favor themselves over other professionals by obtaining employment as a “secured” creditor and thereby bootstrapping an alleged superpriority for themselves.
One of the Code’s fundamental concepts is “equitable distribution.” “Bankruptcy law accomplishes equitable distribution through a distinctive form of collective proceeding. This is a unique contribution of the Bankruptcy Code that makes bankruptcy different from a collection of actions by individual creditors.” Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198, 1203 (9th Cir.2005), cert, denied,—U.S.-, 126 S.Ct. 397, 163 L.Ed.2d 275 (2005).
Notwithstanding this well-settled principle, the opinion in this case elevates normal state law concepts for obtaining a “secured” retainer above the bankruptcy scheme. In so doing, the majority alters the long-established statutory and case-law authority which, for generations, has adhered to the fundamental precepts of bankruptcy’s equality principles.
For an attorney seeking fees, the principle of equitable distribution begins with Section 327 compliance. The Supreme Court has stated that “[t]he plain meaning of legislation should be conclusive, except in the ‘rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.’ ” United States v. Ron Pair Enters., 489 U.S. 235, 242, 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989) (alteration in original) (citation omitted).
Section 327(a) provides that a debtor in possession, “with the court’s approval, may employ one or more attorneys ... that do not hold or represent an interest adverse to the estate, and that are disinterested persons ....” 11 U.S.C. § 327(a). See Movitz v. Baker (In re Triple Star Welding, Inc.), 324 B.R. 778, 790 (9th Cir. BAP *7432005) (valid employment under § 327(a) is a prerequisite to compensation). A “ ‘disinterested person’ means [a] person that— (A) is not a creditor, an equity security holder, or an insider; ... 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 for any other reason[.]” 11 U.S.C. § 101(14) (emphasis added).
A “creditor” is an “entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor[.]” 11 U.S.C. § 101(10).
Clearly, under Section 327(a), an attorney who receives a prepetition security retainer, and who becomes a “secured creditor” pursuant to state law, is not “disinterested” under the Code’s plain terms. See In re Lackawanna Med. Group, P.C., 323 B.R. 626, 630 (Bankr.M.D.Pa.2004).
If, as here, a bankruptcy court has determined such an attorney to be disinterested initially, it may revisit the issue, for the Section 327(a) requirements apply not only at the time of retention but also throughout the case. See Sec. Pac. Bank Wash. v. Steinberg (In re Westwood Shake & Shingle, Inc.), 971 F.2d 387, 391 (9th Cir.1992) (Section 327 orders are preliminary and not conclusive due to the bankruptcy judge’s continuing supervision); In re Plaza Hotel Corp., 111 B.R. 882, 891 (Bankr.E.D.Cal.1990), aff'd mem., 123 B.R. 466 (9th Cir. BAP 1990) (bankruptcy court may revisit issues such as conflicts whenever appropriate). See also § 328(c) (court may deny compensation “if, at any time during such professional person’s employment under section 327 ... such professional person is not a disinterested person .... ”).
Thus, even assuming, arguendo, that the disinterestedness component is not implicated per se upon an attorney’s retention of a prepetition security retainer, it definitely arises when a case is converted from chapter 11 to chapter 7. Section 726(b) provides that the chapter 7 administrative expenses have a priority of payment over the chapter 11 administrative expenses. If the chapter 7 estate cannot pay all chapter 11 administrative expenses in full, they are then paid pro rata. It is illogical to pretend that a professional who enjoys a preferred security interest in the retainer received- — above all other professionals in the chapter 11 or any chapter 7 case which follows — -is “disinterested.”
In addition to the disinterestedness requirement, the Code attempts to treat claimants of the same class equally. Chapter 11 debtors’ attorneys must apply for and obtain approval of their fees under Section 330, notwithstanding the existence of a retainer agreement or attorney’s lien. See DeRonde v. Shirley (In re Shirley), 134 B.R. 940, 943 (9th Cir. BAP 1992) (“Court approval of the employment of counsel for a debtor in possession is sine qua non to counsel getting paid.”); Lamie v. United States Trustee, 540 U.S. 526, 537-39, 124 S.Ct. 1023, 157 L.Ed.2d 1024 (2004) (chapter 7 debtor’s attorney must be employed under § 327 in order to be compensated from the estate under § 330); Shapiro Buchman LLP v. Gore Bros. (In re Monument Auto Detail, Inc.), 226 B.R. 219, 224 (9th Cir. BAP 1998); 3 Collier on Bankruptcy ¶ 330.02[l][c], at 330-9 (15th ed. rev.2005) (“Absent compliance with the Code or Bankruptcy Rules, there is no right to compensation.”).
When their fees are approved, attorneys thereby become administrative claimants. See § 503(b)(2). Thus, although a “retainer” may be authorized under § 328(a), a “security retainer,” which elevates the at*744torney to the level of a “secured creditor,” is inconsistent with § 330.11 Furthermore, Section 330 does not expressly grant an attorney holding a security retainer a su-perpriority, and therefore such attorney is on a par with all other chapter 11 administrative claimants.
Which brings us once again to Section 726, the Code’s distribution priority scheme. This statute provides superpriority status only for the so-called “burial expenses” incurred in the administration of the superseding chapter 7 case in order to encourage trustees and other professionals to participate in the liquidation and maximize the benefit for creditors of the estate. In re Hers Cosmetics Corp., 114 B.R. 240, 246 (Bankr.C.D.Cal.1990); § 726(b). It cannot be reconciled that the Code’s priority scheme is meant to do more than it does. In a case converted from chapter 11 to chapter 7, that scheme (§ 726(b)) gives first priority to chapter 7 administrative expenses, then to chapter 11 administrative expenses, and then to the other creditors. Each group shares pro rata unless there is enough cash to pay each group in full. Nowhere does the Code imply that a chapter 11 debtor’s counsel may receive a different and preferred treatment.
This equality-of-treatment philosophy has prevailed even where creditors have actually held superpriority administrative claims but have been subordinated to the Section 726(b) scheme. See Temecula v. LPM Corp. (In re LPM Corp.), 300 F.3d 1134, 1138 (9th Cir.2002) (“Although Congress gave post-chapter 11 rent administrative priority in chapter 11 proceedings, it did not authorize super-priority over other administrative expenses in the event the case is converted to a chapter 7. To the contrary, Section 726(b) gives Chapter 7 administrative claims priority over Chapter 11 administrative claims.”); Citibank, N.A. v. Transam. Commercial Fin. Corp. (In re Sun Runner Marine, Inc.), 134 B.R. 4, 6 (9th Cir.BAP1991) (a superpriority claim granted for lack of adequate protection was necessarily an administrative expense claim, and did not take priority over chapter 7 administrative expenses, pursuant to § 726(b)).
I have no quarrel with California’s concept of security retainers within the boundaries of California law and the usual two-party dispute regimen. But state law must take a back seat to federal law. The Supreme Court has held that the bankruptcy court’s jurisdiction over fees is “paramount and exclusive.” Brown v. Gerdes, 321 U.S. 178, 183-84, 64 S.Ct. 487, 88 L.Ed. 659 (1944) (Bankruptcy Act), and this policy remains intact.
Therefore, a state statute which purports to disrupt bankruptcy law’s major goal of equitable distribution is plainly preempted by federal law. Sherwood Partners, 394 F.3d at 1203-05 (California law appointing a general assignee to recover a preferential transfer was preempted by Code). Cf. Shearson Lehman Mortgage Corp. v. Laguna (In re Laguna), 114 B.R. 214, 216 (9th Cir. BAP 1990) (holding that ruling contrary to state law also impedes the bankruptcy goal of equitable *745distribution among creditors unless there is a “clear statutory mandate” for such ruling).
The policy underlying the bankruptcy distribution scheme in a converted chapter 7 case is crystal clear: “Those who must wind up the affairs of a debtor’s estate must be assured of payment, or else they will not participate in the liquidation or distribution of the estate.” H.R.Rep. No. 95-595, at 186-87 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6147.
The flaw in the majority’s opinion, in my view, is that a cash retainer for chapter 11 services, by merely calling it a “secured” retainer under California law, and complying with the requirements to create the security interest, can thereby immunize it from disgorgement attack if the reorganization fails and the case converts to chapter 7. The parties, who then potentially suffer, are the very parties to whom Congress granted the first priority on available cash — the chapter 7 professionals— while the chapter 11 debtor’s counsel, who voluntarily took the case when it came in the door, and who had to pass the “disinterestedness” test in order to be counsel in the first place, gathers up all the acorns because he or she was clever enough to call the retainer “secured.”
The majority fears that invalidating security retainers will “chill” representation for chapter 11 debtors. This theory has a flip side. If we now change the rule to prefer chapter 11 professionals over chapter 7 professionals, it would seem that the chapter 7 professionals will lose their incentive to administer what is left of the estate. In other words, the “chill” now transfers to the chapter 7 professionals.
I therefore disagree with my bankruptcy judge colleagues who also believe that anything less than a “secured” retainer will “chill” many professionals from representing chapter 11 debtors. In my professional judgment and experience, such fear is unfounded. Chapter 11 debtors have enjoyed a vast stable of qualified professionals — without “secured” retainers, I might add — since the memory of man runneth not to the contrary. On the other hand, allowance of secured creditor status or su-perpriority for chapter 11 attorneys will definitely “chill” efforts in any later chapter 7 liquidation.
Like it or not, every bankruptcy professional, because of these long-settled, equality of distribution principles, takes a case with the understanding that full payment of any fee is always dependent upon a debtor’s or trustee’s financial successes and/or available resources. Chapter 11 debtors’ counsel are risk takers, just the same as other administrative creditors, whose awareness of possible disgorgement in the event of conversion merely encourages them to attain a fruitful reorganization. See Specker Motor Sales Co. v. Eisen, 393 F.3d 659, 664 (6th Cir.2004).12
*746I believe the opinion breaks new ground in the employment of bankruptcy professionals, and leads down a path that I, for one, am unwilling to tread. If we endorse the concept espoused by the majority, we will no doubt enjoy immense popularity among bankruptcy professionals — especially chapter 11 debtors’ counsel (the only ones fortunate enough to be able to grab a “secured” retainer before placing the debt- or into chapter 11 in the first place). In so doing, however, we do a grave injustice to other bankruptcy professionals who are not so fortunate as to dictate their terms of repayment, including over whom they have priority once the case goes south.
We also turn our backs on a clear Congressional statutory mandate, lead bankruptcy law in the wrong direction, and enable nonbankruptcy state law concepts to obtain unwarranted supremacy over federal law.
I therefore respectfully DISSENT.

. Several courts have opined that § 330 trumps nonbankruptcy law in other contexts. For example, in Monument Auto Detail, we held that "the Code and Rules preclude fee awards for services performed on behalf of a bankruptcy estate based on state law theories not provided for by the Code, such as quantum meruit.” Monument Auto Detail, 226 B.R. at 224. Another eourt has held that "bankruptcy policy must hold sway over the policies of the Federal Arbitration Act as to disputes involving § 327 through § 330.” Home Express, Inc. v. Alamo Group, LLC (In re Home Express, Inc.), 226 B.R. 657, 659 (Bankr.N.D.Cal. 1998).

. The majority states that Specker, on which the bankruptcy court relied, did not discuss whether the attorney's prepetition retainer was a security retainer which protected it from disgorgement under § 726(b). They are correct, but miss the larger picture.
In Specker, the attorney's $10,000 retainer was not categorized, however the Sixth Circuit applied the general rule that retainers are considered to be property of the estate and subject to disgorgement. Specker, 393 F.3d at 663. It is generally recognized that only "security retainers” and "advance retainers” are property of the estate, whereas "classic retainers” are not. See S.E.C. v. Interlink Data Network of Los Angeles, Inc., 77 F.3d 1201, 1205 (9th Cir.1996); see generally, C.R. Bowles Jr., "Your Retainer: Pocket Aces or a 7-2 Off Suit?” 24-May Am. Bankr. Inst. J. 28 (2005).
The facts in Specker were that, after conversion and completed liquidation, only five chapter 11 administrative claims remained. Specker Motor Sales Co. v. Eisen, 300 B.R. *746687, 688 (W.D.Mich.2003), aff'd, 393 F.3d 659 (6th.Cir.2004). Even though the attorney had a retainer, the Sixth Circuit held that § 726(b) mandated pro rata distribution among the administrative claimants. In order to accomplish that, the attorney was ordered to disgorge his interim fees, and the Sixth Circuit affirmed the disgorgement order. Specker, 393 F.3d at 661.
Clearly, the import of this opinion was that § 726(b) trumps an attorney's interest in a retainer that is property of the estate. See In re Raynard, 327 B.R. 623, 631 (Bankr. W.D.Mich.2005) (citing Specker for the proposition that "attorneys who represent Chapter 11 debtors must disgorge interim compensation received in order to equalize distribution among Chapter 11 administrative claimants.”)