How can you be an effective trustee appointed in a chapter 11 case if you cannot retain counsel when the case first begins? Well one bankruptcy court in North Carolina explained that a trustee’s retention of counsel is not an automatic right in some chapter 11 cases. First, let me lay the predicate.

The New Act. There is a new category of chapter 11 trustees statutorily appointed under the Small Business Reorganization Act of 2019 (the “Act”), which created Subchapter V of chapter 11 of the Bankruptcy Code. The Act, enacted into law on February 19, 2020, came in the nick of time. Subchapter V was enacted to simplify the bankruptcy process for the smaller businesses and reduce the costs of filing bankruptcy and confirming a plan. Then in response to the COVID-19 crisis, Congress through the CARES ACT, expanded eligibility for small businesses and increased the cap for eligibility purposes, making it an option for larger businesses struggling from the widespread pandemic.

How Does the Act Help Small Businesses. For those readers who aren’t familiar with this Act, it makes the appointment of a trustee mandatory in every chapter 11 Subchapter V case just as it is mandatory in chapter 7, 12 and 13 cases. Also, it (i) shortens the timetable for filing a chapter 11 plan, (ii) dispenses with the disclosure statement step, (iii) precludes competing chapter 11 plans, (iv) stretches the payment of administrative expense claims beyond the effective date of a plan, (v) dispenses with the statutory requirement of paying quarterly US Trustee’s fees which can be significant over the life of the chapter 11 case, (vi) eliminates the appointment of a statutory creditors’ committee, and (vii) permits a debtor to retain its interest in the reorganized entity even when senior creditors are not paid in full.

Role of a Trustee. The Act requires the appointment of a trustee in every case. Unlike in a traditional chapter 11 case, the trustee is not charged with operating the debtor’s business. Rather the trustee has the limited role of assisting the debtor with proposing and confirming the plan and overseeing distributions under the plan. The term of the trustee depends on whether the plan is contested or consensual. The trustee’s role ends when the plan is substantially consummated. The debtor is required to notify the trustee when the plan is substantially consummated. In a non-consensual plan, the trustee is obligated to make distributions to creditors as contemplated in the plan until all distributions are made. The trustee files with the court a final report accounting for all distributions.

However, the trustee is held accountable for all funds received from the debtor and is charged with objecting to claims that are improper. In addition, the trustee is the resource to parties seeking information, and may opposed the discharge of a debtor, if appropriate. Despite this statutory guidance, it is not clear how a trustee will be compensated, whether the trustee must meet the statutory qualifications under Section 322 of the bankruptcy code and whether the trustee may retain counsel. Section 326(b) does appear to apply to trustees in Subchapter V cases which limits compensation to five percent of the distributions made. Certain statutory functions imposed on a Subchapter V trustee cannot be performed without counsel, such as objecting to claims and objecting to a debtor’s discharge, if appropriate.

Hiring Counsel. Setting aside the issue of how a professional hired by a trustee will be paid, and whether Sections 327 and 330 apply to the retention of an attorney seeking to be retained by a Subchapter V trustee, there is nothing in the Act that prohibits the hiring of an attorney by the Subchapter V trustee.

Nonetheless, one court put the kibosh on a trustee seeking to retain counsel. In a June 11, 2020, decision issued by a North Carolina bankruptcy court in Penland Heating and Air Conditioning, Inc., Case No. 20-1795 (Bankr. E.D. N. Car. June 11, 2020), the Honorable David M. Warren denied the application of a trustee to retain counsel in a Subchapter V case. The Debtor in this case operated a heating and air conditioning business that performed services throughout the state of North Carolina. The debtor was winding down its business affairs and intended to file a plan to provide for the liquidation of its assets after completing all unfinished jobs.

Citing to In re Ventura, 615 B.R. 1, 6 (Bankr. E.D.N.Y. Apr. 10, 2020), Judge Warren adopted the Ventura court’s summary of a Subchapter V trustee’s duties under Section 1183(b). The Subchapter V trustee acts as a fiduciary for creditors, in lieu of an appointed creditors’ committee. The Subchapter V trustee is also charged with facilitating the Subchapter V debtor’s small business reorganization and monitoring the Subchapter V debtor’s consummation of its plan of reorganization. Ventura, at 7. The role of a Subchapter V trustee is like that of a trustee in chapters 12 and 13, and a Subchapter V debtor remains in possession of assets and operates its business. Id.

Then, citing to the Honorable Paul W. Bonapfel’s article, A Guide to the Small Business Reorganization Act of 2019, 93 Am. Bankr. L.J. 571, 582-83 (2019), Judge Warren concluded that while the Act does not restrict a Subchapter V trustee from employing attorneys and other professionals under Section 327(a), the employment of attorneys or other professionals has the potential to substantially increase the administrative expenses of the case, which in his view contradicts the purposes of the Act which is to streamline and reduce costs. Id. at 591.

Finally, citing to the Department of Justice’s handbook for Subchapter V trustees, Judge Warren concluded that the employment of professionals by a Subchapter V trustee is especially important in cases in which the debtor remains in possession and the debtor has already employed professionals to perform many of the duties that the trustee might seek to retain its professionals to perform. Judge Warren stated that the trustee should keep the statutory purpose of the Act in mind when carefully considering whether employment of the professional is warranted under the specific circumstances of each case. U.S. Dep’t of Justice, Handbook for Small Business Chapter 11 Subchapter V Trustees 3-17-18 (2020).

At the hearing, the trustee stated that he filed the Application as a matter of course but did not have any current need for legal representation in the Debtor’s case. The court denied the request stating that to be consistent with the Act, the trustee has to have a specific purpose for counsel. The court left open the possibility that if during the case the trustee identifies a specific need for the employment of an attorney or other professional, then the court will consider another request.
The court recognized that routinely it allows chapter 7 panel trustees and chapter 11 trustees to hire themselves and their law firms to provide legal services on behalf of the trustee. The court stated that allowing trustees to employ themselves or their firms provides an economical efficiency to case administration. Consistent with Section 330 of the bankruptcy code, the court cautioned that overzealous and ambitious Subchapter V trustees that perform unnecessary or duplicative services may not be compensated, and other fees incurred outside of the scope and purpose of the Act may not be approved.

Takeaway. The direction from the North Carolina court is not necessarily a troublesome decision. A trustee has to be mindful of the purposes for which counsel will be hired and articulate it to bankruptcy court in its application. Simply put, a trustee has to establish necessity not only seeking to pay counsel but also when hiring counsel. It is a good practice anyway.