Client Alert: Working With A Bankrupt Client
Recent Case Highlights Traps In Working For And Being Paid By A Client In Bankruptcy
Providing Advisory Services To A Debtor
As more banking organizations take advantage of the bankruptcy process to reorganize, liquidate or sell assets, it is important that professionals who routinely advise banking organizations understand how they will be paid both for work done during the bankruptcy and before. The consequences of not understanding this aspect of the bankruptcy process can be dire and may include having to disgorge fees earned prior to and during the bankruptcy case. In other words, if you don’t follow the rules, you may end up working for free.
In general, a professional employed by the debtor will not be paid for the services it provides without prior bankruptcy court approval. The retention process itself is fairly simple, but does require that a professional not “hold an interest adverse” to the debtor. This “disinterestedness” requirement means, at a minimum, that the professional holds no interest that conflicts with the interests of its debtor client. The bankruptcy rules also require that a professional’s fees and expenses be submitted to the bankruptcy court for approval. Although the fee approval process sounds cumbersome, it is a step that must be taken in order to ensure that you receive payment for services provided to the debtor during the bankruptcy.
Point of Interest
- A professional cannot be paid for services provided to a debtor unless the professional receives the approval of the bankruptcy court.
- A professional must be “disinterested” in order to represent a debtor in a bankruptcy proceeding.
Structuring Your Engagement
The requirement that a professional be “disinterested” also dictates how a professional should structure the payment of its fees and expenses prior to the bankruptcy. Fees paid to professionals prior to a bankruptcy filing can, in certain circumstances, constitute a preference and be subject to a claw-back action in the bankruptcy. This makes the professional a potential creditor of the debtor and, therefore, adverse to the debtor’s interest. Because the professional is now potentially adverse, it cannot be retained in the bankruptcy or paid for services performed during the bankruptcy unless it waives the fees that it earned prior to the bankruptcy. To avoid this problem, a professional may require an evergreen retainer as part of its engagement. The professional can draw down on the retainer as it accrues fees and expenses and require the client to replenish the retainer when it drops below a certain level. This allows the professional to qualify for an exemption from preference liability and remain free of any conflicts.
Point Of Interest
- If providing services to a client prior to a bankruptcy filing, consider requesting an evergreen retainer to avoid a conflict of interest.
Retention By The Bankruptcy Court
After the bankruptcy is filed, the debtor’s legal counsel is responsible for filing the motions necessary to retain professionals and should guide you through the retention process. However, debtor’s counsel is not your attorney, and – in light of the recent events in the Capitol Bancorp bankruptcy – it is important that you know the law and act to protect your rights. Your retention will be scrutinized not only by your client but by the bankruptcy court, the unsecured creditors committee and your client’s other creditors, and every dollar that is paid to professionals – both before and during the bankruptcy – is a dollar that is not paid to a debtor’s creditors. Professional fees are therefore low-hanging fruit, and it is relatively easy for creditors to increase their recoveries by objecting to professional fees. This is especially true if a professional was not properly retained or sought to avoid the requirement that it be retained while still providing services to a debtor.
Consequently, if you are providing services to a debtor, it is better to play by the rules and not attempt to structure your retention in a way that seeks to skirt bankruptcy court review. If the bankruptcy court finds that you should have been retained but weren’t, it may require that you disgorge all or a portion of your fees.
Point Of Interest
- Your client’s bankruptcy counsel is the primary party responsible for ensuring that you are properly retained in the bankruptcy case. However, consider retaining your own attorney to review your engagement and to guide you through the bankruptcy process.
While professionals may not be used to seeking legal counsel concerning their engagements, competent bankruptcy counsel can help guide you through the bankruptcy process and make sure you get paid for the services you provide to a debtor.
Bankruptcy & Financial Institutions Task Force
The bankruptcy issues and related solutions facing the financial services industry involve a complex application of the law involving bankruptcy, bank regulatory, corporate and litigation issues specific to the banking industry. To address this, Barack Ferrazzano has created a multi-disciplinary task force, which includes members of its bankruptcy, financial institutions, employment law and litigation practice areas.