Chapter 11 Not Safe Harbor for Debtor to Delay Creditors, Bankruptcy Court Rules

A ruling by a federal bankruptcy judge in New York denying attorney’s fees to a debtor’s counsel sends a startling reminder to attorneys and clients alike.
Bankruptcy is designed to provide relief to debtors in legitimate cases with the ultimate goal of providing a fair and equitable distribution of assets to creditors. The Chapter 11 process is not intended to be a safe harbor for a debtor solely to delay creditors or circumvent other legal proceedings.
The bottom line: The lawyer must give back $27,600 of a $30,000 upfront retainer. He can keep $2,400 in costs.
Judge Robert E. Grossman of the U.S. Bankruptcy Court in New York’s Eastern District chastised the lawyer, ruling he “failed to comprehend its fundamental duties to the debtor, to the estate, and to this court.”
According to the ruling, a property owner hired a law firm to file under Chapter 11 to prevent a state foreclosure action by a secured creditor. The attorney told the court the owner would seek to refinance or sell the property but provided “no legal theory or viable plan to emerge from bankruptcy in this case,” Grossman wrote. “The automatic stay is the most powerful tool in a bankruptcy lawyer’s arsenal, and this court will not allow it to be used in the manner.”
The judge made a strong distinction between a debtor’s estate and the debtor’s principal. He ruled:
“Debtor’s counsel represents the interests of the estate not the principals. (The lawyer) provided no benefit to the estate in terms of helping to formulate a reorganization or liquidation plan to emerge from bankruptcy.”
The judge also pronounced that the role of a debtor-in-possession’s counsel involves not only protecting the debtor but administering the case and protecting the Chapter 11 process.
“The Bankruptcy Code is designed to provide relief to debtors of all sizes who are presumed to be honest and in need of help. Bankruptcy judges and the professionals that practice in the bankruptcy courts … strive on a daily basis to provide all parties an honest forum to resolve complex problems,” the judge said. “In the roles we play, it is our shared responsibility to do all in our power to reduce or eliminate any improper use of the bankruptcy process.”
And while the debtor’s counsel argued it was entitled to legal fees because it “complied with and satisfied each and every procedural and statutory obligation,” Grossman ruled that dotting “I’s” and crossing “T’s” is not enough.
“There is more to representing a Chapter 11 debtor than aiding the debtor in complying with its statutory duties and appearing at hearings. … Counsel must have a firm understanding of the law and how to apply it,” he ruled.
The takeaway for anyone intending to appear in the bankruptcy courts: Invoking the automatic stay solely to frustrate a secured creditor with no legitimate legal plan or exit strategy is not a service a lawyer should be compensated for by a bankruptcy court.