Tuesday, October 31, 2006

Don't Mess With Judge Bohm

This column has devoted several articles to lawyers behaving badly in Houston. The Houston judges have been very proactive in writing about unprofessional conduct lately. Before beginning, two important caveats are important. First, these cases generally deal with the bottom 1% of the bar and are not representative of the bar in general. Second, these cases are presently coming out of Houston, but they could happen anywhere. The latest installment of Lawyers Behaving Badly involves an attorney-debtor who filed cases in bad faith, ignored court orders, failed to appear, evaded the U.S. Marshals and could not count.

A Brief Trip to Bankruptcy Court

In In re David Ortiz, No. 05-39982 (Bankr. S.D. Tex. 10/13/06), the attorney debtor filed an initial chapter 7 petition in January 2005 to avoid being evicted from his law office. The case was assigned to Judge Isgur. The Debtor received only a short delay since the stay was lifted early on. Once the eviction was allowed to go forward, he lost interest in his case. The case was dismissed for failure to attend the 341 meeting on May 31, 2005. Judge Isgur dismissed the case with prejudice to refiling for 180 days. Unfortunately, because the Debtor failed to update his address (most likely the one that he had been evicted from), he claimed that he never received the notice.

Return to Bankruptcy Court

Less than one month later, on June 29, 2005, the Debtor filed his second case, which was assigned to Judge Bohm. This case was filed for the same reason as the first case. In the space of six months, the Debtor had managed to find another landlord, fall behind on the rent and receive eviction papers.

Things Start to Get Bad—The First Sanctions Order

The U.S. Trustee promptly moved for sanctions. The Debtor appeared and pleaded ignorance of the prior order. The patient Judge Bohm agreed to abate the U.S. Trustee’s motion long enough to allow the Debtor to return to Judge Isgur and seek a modification of the prior order. When the parties returned to Court, Judge Bohm found that the Debtor had not sought to modify Judge Isgur’s order. He also determined that the Debtor had failed to file accurate schedules and did not have a good reason for failing to appear at the 341 meeting in the first case. At that point, Judge Bohm ordered the Debtor to pay attorney’s fees of $1,875 to each of his landlords and continued the matter to consider whether other sanctions might be appropriate. The Debtor finally retained an attorney at this point. At the continued hearing, Judge Bohm ordered that the Debtor pay $1,000 in sanctions to the Clerk within 60 days and barred him from filing again for a year without prior permission.

Things Get Worse--The Bench Warrant(s)

By the time of the first sanctions order on November 17, 2005, the Debtor had angered a federal bankruptcy judge. However, his problems could have been solved by paying $4,750. It would have been a really good idea to comply with this order through whatever means possible. The Debtor didn’t get the message. Some four months later, the U.S. Trustee filed a Certificate of Non-Compliance indicating that the Clerk had not been paid. Judge Bohm scheduled yet another hearing, which was continued to May 10, 2006. Neither the Debtor nor his attorney appeared at this hearing. The Debtor also failed to accept service from the U.S. Trustee’s process server after agreeing to do so. Judge Bohm issued a bench warrant that day.

In response to the bench warrant, an attorney who said she was acting merely as an intermediary contacted the U.S. Marshal and promised to inform the Debtor about the bench warrant. She gave the Marshal a non-working number for the Debtor. When the Debtor could not be located at his home or office, Judge Bohm issued a bench warrant for the intermediary attorney. This bench warrant met with more success and the “intermediary” appeared and testified that the Debtor was aware that there was a bench warrant out for him, but wanted to meet with his attorney first. Judge Bohm ordered the intermediary to check in with the U.S. Marshal twice a day until the Debtor was apprehended.

Judge Bohm Tries to Get the Debtor’s Attention—The Second Sanctions Order

On May 16, 2006, Judge Bohm, who had no doubt progressed from furious to livid, issued a second sanctions order which required the Debtor to pay $500 per day for each day that he failed to surrender and to pay $250 per day for each day that he failed to pay the $1,000 sanction to the clerk. The Court ordered the Debtor’s attorney to appear two days later to report whether he had informed the Debtor of the second sanctions order.

Melt-Down—The Third Sanctions Order

On May 18, 2006, the Debtor appeared with a new attorney (a respected bankruptcy attorney) and paid the $1,000 owing to the Clerk. The Debtor claimed that while he was aware of the May 10 hearing, that his attorney was scheduled to be out of the country and assured him that he would get the hearing re-set. The attorney did not do this. However, when the Debtor contacted the attorney’s office to see if any arrangements had been made, he was told that they were not aware of any, but that that the attorney would not have left town without having done something. The Debtor also testified that when he learned of the bench warrant, he checked into a hotel to avoid being found.

Judge Bohm was not amused. However, the order he entered was remarkably restrained. He ordered the Debtor to:

1. Write a letter apologizing to the U.S. Marshals for not turning himself in immediately;
2. Contact the Texas Lawyers Assistance Program to see if he would benefit from counseling;
3. Take 10 hours of bankruptcy continuing legal education (including three hours of ethics) if he ever planned to appear in the Southern District again;
4. Find other counsel for a client he was currently representing in a chapter 7 case; and
5. Either pay $750.00 or write “I will respect the judicial system, and such respect includes obeying all court orders” 750 times.

Judge Bohm gave the Debtor five days to comply.

When the Debtor returned five days later, he only tendered 700 sentences instead of 750, he had failed to pay the prior sanction to his landlords and he had failed to find alternate counsel for his client (whose case was subsequently dismissed by Judge Brown). However, he did complete his CLE.

The Judge gave the Debtor one more opportunity to comply and at the next hearing, he presented cashier’s checks to pay his landlords’ attorney’s fees and tendered the remaining 50 sentences. As a final sanction, the Court wrote a lengthy opinion chronicling the pattern of abuse which had led to his orders.

What Were They Thinking?

Attorneys make mistakes. Sometimes the difference between a good attorney and a disgraced attorney is the ability to engage in damage control. The attorney(s) here did not learn that lesson.

Mr. Ortiz’s motivations in filing bankruptcy to avoid eviction were not pure. Filing a second bankruptcy in violation of a court order that he arguably did not know about was bad but not fatal. At this stage, the Debtor/Attorney had a problem, but the court offered a way out (returning to Judge Isgur to modify the prior order of dismissal). This was a serious mistake.

When the Debtor missed his first opportunity to extricate himself, he could have begged or borrowed the money to pay the initial sanctions and limped away, humbled but not crushed. However, at the point that he failed to appear in court and then evaded the U.S. Marshal, he risked serious jail time. The fact that the ultimate consequences were so light may have been because the Debtor finally retained a competent bankruptcy attorney or perhaps because the court was happy just to have gotten his attention. However, it is clear that things could have been worse—much worse.

The Debtor’s first attorney and the “intermediary” attorney do not come off very well either. The opinion does not explain why the first attorney went off to Jordan without obtaining a continuance of the May 10 hearing. However, the attorney had to know that he was dealing with an extremely volatile situation. His absence caused a bench warrant to be issued for his client. The attorney who appeared only as an intermediary does not fare very well either. She was in contact with the Debtor on a regular basis, but somehow managed to provide the U.S. Marshal with a non-working number to contact him. The court found her testimony to be less than forthcoming.

When all was said and done, three attorneys found themselves named in an opinion which did not reflect well upon them. This opinion should be made required reading in legal ethics courses.

Friday, October 27, 2006

Don't Mess With Judge Jernigan

Stacey Jernigan is both the newest and the youngest bankruptcy judge in the State of Texas. However, in a recent opinion she made it clear that she is not one to be fooled by clever lawyers.

In Baker v. Sharpe, Adv. No. 06-3208 (Bankr. N.D. Tex. 9/28/06), a male debtor dressed to impress as he persuaded a recent divorcee to loan him large amounts of money. Having run through her money, he then filed chapter 7. She then sued to establish a non-dischargeable debt under Sec. 523(a)(2)(A) and 523(a)(6). The only problem was that most of her case revolved around verbal and implied statements concerning his solvency (including his statement that he could pay her out of the money he was hiding from his current wife).

Section 523(a)(2) draws a careful dichotomy between fraudulent statements of financial condition and other fraudulent representations. Section 523(a)(2)(A) expressly excludes statements of financial condition from its scope, while Section 523(a)(2)(B) only applies to written statements of financial condition. Thus, verbal statements of financial condition can never form the basis for a dischargeability action (at least not under Sec. 523(a)(2)).

The clever plaintiff's attorney tried to conceal this distinction from Judge Jernigan by omitting a few words when quoting the statute.

Judge Jernigan was not fooled. In a footnote, she stated:

"Indeed, Ms. Baker--or at least her attorney--knew there was this very large flaw in her argument, for in the Plaintiff's Brief in Support of Non-Dischargeability of Indebtedness Under Sec. 523(a)(2)(A) and (a)(6) filed with this court in advance of trial, the plaintiff quoted Section 523(a)(2)(A), but left out, with the convenient use of an ellipsis, the critical phrase 'other than a statement regarding the debtor's or an insider's financial condition.' Thankfully, the court has several copies of the Bankruptcy Code handy so it could consult the entire statutory provision in addressing this this question."

Memorandum Opinion, p. 26, n. 13 (emphasis added).

It is good to know that in these days of budgetary shortfalls that bankruptcy judges have not just one but several copies of the Bankruptcy Code available for use.

With the vigilant eye of the judge to protect him, the pro se defendant prevailed.

Thursday, October 26, 2006

Individual Involuntary Petitions Remain Viable Under BAPCPA

The Bankruptcy Abuse Prevention and Consumer Protection Act requires that an individual filing for relief under Title 11 obtain credit counseling within 180 days prior to filing bankruptcy. 11 U.S.C. Sec. 109(h). Some commentators have questioned whether this requirement would spell the end of involuntary bankruptcy cases against individuals (since they would not have completed credit counseling). Judge Monroe has recently held that involuntary cases are not subject to the credit counseling mandate. In re Sadler, No. 06-10091 (Bankr. W.D. Tex. 10/18/06).

In Sadler, the Cadle Company filed an involuntary petition against the debtor without the joinder of any other creditors. The alleged debtor moved to dismiss the case claiming that he was not eligible for chapter 7 relief because he had not completed credit counseling, that he was generally paying his debts as they came due and that he had more than 11 creditors requiring three petitioning creditors.

Judge Monroe parsed the statutory language of Sec. 109(h) and found that it referred to completing credit counseling within 180 days "preceding the filing of the petition by such individual." Since an involuntary case is not filed by the debtor, then the eligibility provision does not apply. This result seems to be consistent with both the statutory language and congressional intent. BAPCPA is all about shifting control from debtors to creditors. While some have questioned the benefits of credit counseling (See Opinions Regarding Failure to Seek Credit Counseling Underscore Dissatisfaction With Law, 7/18/06), its only efficacy would be in the case of a voluntary filing. If a creditor takes the unusual step of initiating a petition, it is unlikely that credit counseling by the debtor would change the creditor's mind about the need to seek relief.

The rest of the opinion is devoted to creditor counting for purposes of Sec. 303(b). Cadle took the gutsy step of filing the involuntary petition without the joinder of any other creditors. If the debtor could show that he had at least 12 creditors, then the petition would be required to be dismissed unless additional joining creditors could be found. The debtor, who clearly did not want to be in bankruptcy, came up with a list of 24 creditors. However, this was not sufficient to keep him out of bankruptcy.

After an initial pass, Judge Monroe eliminated 11 potential creditors from the calculus, allowed 10 and saved three for further scrutiny. The debts excluded on the first pass included several that were owed by other parties, one which was time barred and eight which were for current, recurring expenses. Judge Monroe excluded the recurring expenses, which included such items as the electric bill and insurance based on an old Fifth Circuit case, Denham v. Shellman Grain Elevator, Inc., 444 F.2d 1375 (5th Cir. 1971).

The court's initial ruling created high drama. If the debtor could include two out of the three remaining debts, then the case could be dismissed and the creditor would face potential sanctions. If the creditor could exclude at least two of the three debts, then the case would proceed. The Court excluded all three remaining debts for three different reasons.

First. the debtor claimed that he owed a judgment to First Financial Resolution for $156,000. Unfotunately, the debtor could not provide a copy of the judgment or even an address for the creditor. Bankruptcy Rule 1003(b) requires that a debtor claiming to owe more than 12 debts file a list of the names and addresses of his creditors. Because the debtor could not provide an address for the creditor or otherwise prove that the debt existed, it did not count.

Second, the debtor relied on a debt owed to company controlled by his wife and brother-in-law. This company loaned him $65,000 to settle a $3 million debt. Judge Monroe classified this creditor as an insider so that they did not count toward the number of creditors.

Finally, the debtor claimed that he owed money to the IRS. Since the debtor had not filed tax returns for several years, it was very likely that he did owe taxes. However, because he could not prove any specific liability, Judge Monroe did not count the debt.

Thus, the creditor count stalled out at 10 and the involuntary was allowed to stand with a single petitioning creditor.

Tuesday, October 17, 2006

One Year Since BAPCPA Took Effect

One year ago today the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect. This followed what can only be described as a period of insanity as potential debtors raced to file under the old law. One year later, consumer bankruptcy filings are a mere shadow of their former self. Congress has certainly succeeded in limiting the number of debtors seeking a quick discharge under chapter 7, but has dramatically decreased chapter 13 filings as well.

A Tale of Three Times

To make sense of the numbers, it is important to look at three periods of time. The year from April 17, 2004 to April 16, 2005 is the last record we have of what "normal" bankruptcy filings used to look like. (Technically this period should run through April 19, 2005, the day before BAPCPA was signed. However, for ease of comparison, I have used used months running from the 17th through the 16th to reflect the fact that BAPCPA took effect on October 17, 2005). The period from April 17, 2005 through October 16, 2005 reflects the "rush" period as debtors flocked to the bankruptcy courts in record numbers. Finally, the period since October 17, 2005 is the BAPCPA period.

During the "normal" period, there were 92,872 consumer bankruptcy cases filed in the State of Texas. Of these, 52,985 were chapter 7 liquidations, while 39,887 were chapter 13 liquidations. This reflects the trend prior to the new law for more people to choose liquidation over reorganization.

During the "rush" period, an astonishing 65,797 chapter 7 cases were filed. Thus, the cases filed in just six months represented 124% of the total for the entire previous year. Chapter 13 filings during the "rush" period numbered 22,118 representing only a slightly elevated level of filings.

Filings Anemic Under BAPCPA

Since BAPCPA, filings have been relatively anemic. For the past 12 months, there have been just 29,163 consumer bankruptcy cases filed statewide. This compares to 42,420 cases filed in just one month from September 17, 2005 to October 16, 2005. Under the new world of BAPCPA, chapter 13 cases predominate with 17,419 filings under chapter 13 and just 11,744 under chapter 7. Thus, chapter 13 is now the dominant form of consumer bankruptcy relief as opposed to practice under the old law. However, the newly dominant chapter 13 filings are themselves a mere shadow of filings under the old law.

The new chapter 13 filings of 17,419 represent a mere 44% of the filings during the "normal" period, while the 11,744 chapter 7 cases are just 22% of the "normal" period filings.

The trend shows a gradually increasing number of Texas consumer cases. In the first month after the effective date, there were a puny 743 cases filed statewide. After that, there were a series of ever increasing plateaus.

Month 1: 743
Months 2-3: 1,575 (avg.)
Months 4-5: 2,289 (avg.)
Months 6-9: 2,680 (avg.)
Months 10-12: 3,323 (avg.)

By comparison, the average filings during the "normal" year were 7,739 per month. The past seven months show an average increase of 92 cases per month. Rounding up, if filings increase by an average of 100 cases per month on a steady basis, it would take about 44 months for filings to return to their old levels.

Thus, the recap after one year is that chapter 13s are down, chapter 7s are way down, but the overall volume is slowly increasing.

Friday, October 13, 2006

Fourth Catholic Diocese Files Chapter 11

This week the Diocese of Davenport filed for chapter 11 protection in the Southern District of Iowa (Case No. 06-02229). At least three other Catholic Dioceses have filed for chapter 11 protection in response to sexual abuse lawsuits. Each of the three other cases was filed during 2004. Of the prior cases, the Roman Catholic Church of the Diocese of Tucson has successfully confirmed a plan (although that order is under appeal), while the cases for the Roman Catholic Archbishop of Portland and the Catholic Bishop of Spokane are pending with competing plans. Together, the four dioceses serve nearly 900,000 parishioners.

The Difficult Dynamic

The Catholic Diocese cases present an unusual dynamic for a chapter 11 case.

(1) The cases were prompted by waves of sexual abuse tort claims dating back decades. In each instance, the case was precipitated by sexual abuse tort claims. The underlying acts of abuse occurred anywhere from the 1930s to the 1980s. However, the lawsuit claims did not emerge until the late 1990s and early 2000s. Although several of the dioceses were able to settle an initial wave of cases, they found more cases coming out of the woodwork as publicity spread and claims averaged in the millions. As a result, the dioceses could not determine how many claims would ultimately be filed and could not rely upon insurance and current assets to resolve claims as they came in.

(2) The cases created a conflict between the betrayed and the faithful. The bad acts were performed by a limited number of bad actors (approximately 15 in the Spokane case) and were allegedly covered up by a finite number of persons in positions of authority. However, it was not possible to get justice from the bad actors and their facilitators, some of whom were already dead themselves. Instead, the major liability would be borne by the dioceses and their insurance companies. The insurance companies, many of whom were defending under a reservation of rights, were able to limit their exposure through their contracts. That left the dioceses themselves holding the final liability. However, a diocese is nothing more than the current and accumulated contributions of the faithful. As a result, the current faithful were in a position of having to pay for the sins of their church. This conflict between the faithful and the betrayed was especially apparent in Spokane and Portland where the courts ruled that property used by the parishes was owned by the dioceses rather than the individual congregations.

The challenge for the Catholic Dioceses and the lawyers for the tort claimants was to find a solution which would provide compensation and vindication to those who had been sexually abused without so alienating the parishioners that they lost faith and allowed the diocese to collapse.

A Learning Process

The Catholic Dioceses appear to be learning from experience. The Portland case, which was the first filed, was marked by acrimony from day one. While first day motions are normally routine, one pro se creditor objected to a motion to maintain cash management systems on the ground that the church should not be allowed to use a bank with Catholic officers due to the potential for conflict of interest. In the subsequent cases, the first day motions were used as a vehicle to tell the Diocese's story with descriptions of the historic background of the diocese, the ministries provided, the persons served and the church's response to the sexual abuse crisis. The first day motions in the recent Davenport case show a remarkable similarity to those in the Tucson and Spokane cases.

In the Portland case, the Debtor did not file a plan for sixteen months (by which time it was docket entry #2389) and drew a competing plan shortly thereafter. However, in the Tucson case, the Debtor filed a plan on the first day of the case, which was ultimately confirmed.

In the Portland and Spokane cases, the Debtor was faced with adversary proceedings determining that parish properties were property of the estate. In the Tucson and Davenport cases, the Debtor entered the case with a position as to why the parish properties were not included in the estate.

Based on a review of the lengthy docket in the Portland case, it appears that every issue that could be committed to paper and litigated was. In at least the Tucson case, the process appeared to be more focused and battles were chosen more selectively.

A Note About Fees

One feature common to all of the Catholic Diocese cases has been the relatively low billing rates charged by Debtor's counsel. The rates charged by principal counsel include $200 per hour in Spokane, $230 per hour in Davenport, $300 per hour in Tucson and $325 per hour in Portland. This contrasts with the eye-popping rates of $500-$600 per hour starting to appear in some large cases. Perhaps the church lawyers realized that there was already plenty that would appear obscene in their cases without obscene billings.

Tuesday, October 10, 2006

Judge Clark Attracts Attention With War on Terror Comments

Judge Leif Clark is a frequent source of colorful commentary. Whether he is skewering BAPCPA or illustrating the difficulty with multi-prong tests, his opinions make for interesting reading. He has even garnered the attention of NPR by quoting Adam Sandler in a footnote. He has been featured on NPR again, but this time, the subject is the war on terror. Judge Clark recently sent an email critical of comments by a Bush administration spokesman discussing enemy combatant rules. http://www.npr.org/templates/story/story.php?storyId=6195853. Now, according to an article carried in the Austin American Statesman, some are questioning whether Clark's comments went too far. See "Judge likens U.S. policy to that of Soviet Union," Austin American Statesman, October 10, 2006, p. B3.

The following email appears on NPR's web site:

'Can This Be America?'

Listening to John Yoo talk about this new legislation was chilling. I'm a federal judge, and have taught constitutional law for 16 years. The very idea of holding anyone without trial, without the right to see the evidence that was used to justify naming them an "enemy combatant," and depriving them of the ability to challenge why they are even there is so repugnant to a constitutional democracy that I am shocked that this man actually claims to be defending American values. These are the tactics of the old Soviet Union, not of a country that stands for freedom and the rule of law.

I also quibble with his contention that U.S. citizens still have the right to habeas review. I've read the law. The president can form his own tribunal, which can determine who is an "enemy combatant" (not just an alien enemy combatant), and the decision of that tribunal would not be subject to habeas review. Moreover, persons targeted by this tribunal would not even have access to the military tribunal trial created under this law.

How easy it would be for a president to use such a law to make his political enemies simply disappear. Can this be America? -- Leif Clark, San Antonio, Texas

According to the article carried in the American Statesman, some unnamed lawyers think that Judge Clark's "outburst" could subject him to discipline. Chief Judge Edith Jones of the Fifth Circuit acknowleged that "This is a very novel situation." Judge Jones said that she didn't know how the situation would be handled or if it would be handled at all.

A quick review of the Code of Conduct for United States Judges appears to support the judge's ability to speak out on legal issues. Canon 4(A) states that "A judge may speak, write, lecture, teach, and participate in other activities concerning the law, the legal system, and the administration of justice." To continue the theme, Canon 5(A) states that, "A judge may write, lecture, teach, and speak on non-legal subjects, and engage in the arts, sports, and other social and recreational activities, if such avocational activities do not detract from the dignity of the judge's office or interfere with the performance of the judge's judicial duties." Thus, the canons seems to protect the ability of a judge to write, lecture, teach or speak on legal or non-legal topics.

The canons which might limit judicial speech are more oblique when applied to this situation. Canon 1 requires a judge to uphold the "integrity and independence" of the judiciary, while Canon 2 requires a judge to obey the law and to "act at all times in a manner that promotes public confidence in the integrity and impartiality of the judiciary." Canon 7 states that a judge should refrain from political activity. However, the specifically prohibited conduct does not address speaking out on politically charged topics.

Thus, with all due respect to the anonymous lawyers quoted in the newspaper, and regardless of whether you agree with the substance of Judge Clark's statements, the judicial canons allow him to speak on both legal and non-legal topics so long as his comments do not detract from the dignity of his office. Unless it is considered just plain unseemly for a member of the judicial branch to criticize the executive branch, then it is hard to see how Judge Clark's comments detract from the dignity of his office.

The interesting thing here is because he is a bankruptcy judge, Judge Clark is unlikely to have these issues arise in his court. His email identified himself as a federal judge and constitutional law professor. However, because he is a very specialized federal judge, he has no jurisdiction over and thus no special expertise with respect to writs of habeas corpus. As a result, his status as a federal bankruptcy judge may be more of a red herring. Instead, his real standing to speak on the issue arises from his status as a private citizen and constitutional law professor. These are both capacities in which he should be free to speak his mind.

Thursday, October 05, 2006

Gadzooks! Northern District Judge Limits Impact of Pro-Snax

Judge Harlin Hale was just written an important opinion on attorney's fees in chapter 11. In re Gadzooks, Inc., No. 04-31486 (Bankr. N.D. Tex. 10/5/06). Judge Hale questions the applicability of the Fifth Circuit's Pro-Snax dicta in light of subsequent Supreme court precedent. Alternatively, he would limit the opinion to debtor's counsel in doomed cases.

A Little Background

Since the Bankruptcy Reform Act of 1978, bankruptcy has become big business. Large firms which once shunned bankruptcy as being beneath them now have large departments. As a result, issues relating to employing and compensating professionals are of keen interest to those who make their living in the bankruptcy world.

In 1998, the Fifth Circuit decided the narrow issue of whether the statutory language of 11 U.S.C. Section 330(a) allowed debtor's counsel to be compensated subsequent to appointment of a trustee. The Fifth Circuit followed the statutory language and said no. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998). That result was subsequently upheld by the Supreme Court in another case. Lamie v. U.S. Trustee, 540 U.S. 526, 124 S.Ct. 1023 (2004). Not surprisingly, the Supreme Court said that courts should follow statute as written.

However, Pro-Snax had a second component to it. Because the firm was going to be able to receive some compensation, the Fifth Circuit gave instructions on how that compensation should be determined. The Court stated that in order to be compensable, services must result in an "identifiable, tangible and material benefit to the estate." The Court rejected the argument that services "need only be reasonable to be compensable." This holding arguably re-wrote the statute. Section 330(a)(4)(A) states that services may not be compensable if they "were not … reasonably likely to benefit the debtor’s estate or …necessary to the administration of the estate.” Since services "not ...reasonably likely" to benefit the estate could not be compensated, by negative implication, services which were reasonably likely to benefit the estate should be compensated even if they did not ultimately turn out to yield a benefit. It could be argued that while Pro-Snax was uniformly harsh toward debtors' counsel, it was schizophrenic when it came to statutory language; the primary holding was based on a strict reading of the statute, while the dicta edited out part of the text.

At least one court has held that, regardless of whether Pro-Snax properly read the statute, that it was still the law in the Fifth Circuit and should be followed. In re Weaver, 336 B.R. 115 (Bankr. W.D. Tex. 2005).

The Gadzooks Case

The recent opinion by Judge Hale addresses the situation where an Equity Security Holders Committee performed services which were objectively reasonable at the time they were performed, but did not yield a benefit to the equity holders for reasons beyond the committee's control. Gadzooks was a publicly traded company which catered to women between the ages of 14-22. At the time that it filed, equity was still in the money and the U.S. Trustee appointed an equity committee. The equity committee proposed a plan which could have paid unsecured creditors as much as 75% on their claims and would have allowed equity to buy back in. Unfortunately, the Debtor's sales tanked over the 2004 holiday season. As a result, the Debtor defaulted on its DIP financing, the proposed investment transaction was canceled and the equity committee was dissolved.

Hughes & Luce, the counsel to the equity committee, filed a fee application for approximately one million dollars. Both the creditors' committee and the liquidating trustee under the subsequently confirmed plan objected based on Pro-Snax. The case set up a perfect opportunity to examine the apparent conflict between Pro-Snax and Section 330(a). First, all parties stipulated that the services were reasonably calculated to provide a benefit up through the point that the Debtor's performance crashed. Second, the failure to achieve results was a result of factors the committee could not control. Third, the party making the request was not the debtor.

The Ruling

After a lengthy analysis, Judge Hale allowed compensation up until the point of futility for two independent reasons. First, Judge Hale applied the traditional lodestar analysis used by the Fifth Circuit prior to Pro-Snax to determine how much compensation was allowable. This conclusion was based on the preceeding analysis which rejected hindsight as a basis for denying fees. Judge Hale quoted the following language from the Supreme Court's Lamie opinion: "It is well established that 'when the statute's language is plain, the sole function of the courts--at least where the disposition required by the text is not absurd--is to enforce it according to its terms." Judge Hale added his own conclusion that, "This Court finds that, based on the wording in Section 330(a)(3) and (4), professional fees are not to be judged in hindsight."

Judge Hale relied on the intervening Supreme Court decision overturn the inconsistency in Pro-Snax.The Supreme Court said to follow the text of Section 330(a). The Pro-Snax dicta strayed from the text. Thus, while the Supreme Court upheld the holding in Pro-Snax, it implicitly rejected the dicta.

Judge Hale acknowledged that his ruling might be a little bold. He stated, "This Court realizes that its understanding of Pro-Snax may be misplaced. Certainly, other courts in Texas have constured the decision as requiring a hindsight analysis for professionals." Consequently, he offered a second rationale, finding that "Nevertheless, the Pro-Snax opinion is directed at a debtor's professionals, for obvious reasons--usually they have far more control over the reorganization efforts and strategy in a bankruptcy case. At least in Pro-Snax, they controlled the conversion to chapter 11 and the failed plan process." In his concluding paragraph, Judge Hale characterized Pro-Snax as "directed to professionals for the debtor who knew that their efforts were futile."

Judge Hale's order (which preceded the opinion) has already been appealed. Therefore it is likely that the Fifth Circuit will have the opportunity to revisit Pro-Snax in light of a decision squarely on point. If Gadzooks holds up, it will mean that professionals in bankruptcy will be less likely to have their fees denied based on factors beyond their control, such as poor holiday shopping sales. Of course, Gadzooks can't fix the largest problem in professional compensation--estates with no cash to pay professionals. However, it does remove an artificial roadblock.


On appeal, U.S. District Judge Jane Boyle reversed the Bankruptcy Court's opinion in Gadzooks. William Kaye vs. Hughes & Luce, LLP, No. 3:06-CV-01863-B (N.D. Tex. 7/13/07). Judge Boyle found that although the Fifth Circuit's Pro-Snax discussion of the correct standard to apply in awarding attorney's fees under Sec. 330 was dicta, that it was judicial dicta rather than obiter dicta. Judical dicta is defined as an opinion on an issue which was directly briefed and argued by the parties, but which was not essential to the decision. Judge Boyle found that judicial dicta should not be lightly disregarded. The Court also questioned whether the Circuit's instructions on the test to be applied on remand was really dicta at all.

The District Court engaged in a curious discussion of whether Pro-Snax was inconsistent with the language of Sec. 330. On the one hand, the District Court noted that it was bound to apply Pro-Snax regardless of whether it was correct and that many courts had disagreed with its logic. On the other hand, the District Court found that Sec. 330 could possibly be construed consistently with Pro-Snax.

Finally, the District Court rejected the Bankruptcy Court's attempt to limit Pro-Snax to its original context of awarding fees to debtor's counsel. The District Court found that the language of Sec. 330 did not distinguish between different types of professionals.

The District Court ruling has been appealed to the Fifth Circuit.