SE Prop. Holdings, LLC v. Stewart (In re Stewart)

970 F.3d 1255

IN RE: David A. STEWART; Terry P. Stewart, Debtors.

SE Property Holdings, LLC, Appellant,

v.David A. Stewart; Terry P. Stewart; Douglas Gould, Chapter 7 Trustee; Ruston C. Welch ; Welch Law Firm, P.C. ; Kirkpatrick Bank, Appellees.

Nos. 19-6103 & 19-6104

United States Court of Appeals, Tenth Circuit.

FILED August 14, 2020

Richard M. Gaal, McDowell Knight Roedder & Sledge, LLC, Mobile, Alabama (S. Fraser Reid, III, McDowell Knight Roedder & Sledge, LLC, Mobile, Alabama, Mark B. Toffoli, The Gooding Law Firm, Oklahoma City, Oklahoma, with him on the briefs), for Appellant.

David Cheek, Cheek & Falcone, PLLC, Oklahoma City, Oklahoma (Ruston C. Welch, Welch Law Firm, P.C., Oklahoma City, Oklahoma, with him on the brief) for Appellees.

Before HARTZ, BALDOCK, and EID, Circuit Judges.

HARTZ, Circuit Judge.

Attorney Ruston Welch received $348,404.41 in fees for representing David and Terry Stewart in their Chapter 7 bankruptcy proceedings. This appeal arises out of his failure to disclose his fee arrangements and payments, as required by 11 U.S.C. § 329(a) and Federal Rule of Bankruptcy Procedure 2016(b), until ordered to do so by the bankruptcy court more than two years after he should have disclosed his fee agreement and more than a year after he should have disclosed the payments. For these violations the bankruptcy court sanctioned Mr. Welch by requiring him to pay $25,000 to the bankruptcy estate.

The bankruptcy appellate panel (BAP) affirmed the sanction after the Stewarts’ largest creditor, SE Property Holdings (SEPH), which had initiated the proceedings as an involuntary bankruptcy, challenged the sanction as so inadequate as to constitute an abuse of discretion. SEPH appeals that decision. Exercising jurisdiction under 28 U.S.C. § 158(d), we agree with SEPH and reverse and remand for further consideration. The presumptive sanction for a violation of § 329(a) is forfeiture of the entire fee. For good reason the bankruptcy court can impose a lesser sanction. But the court thus far has not provided good reason. It assumed facts that were not in evidence and, most importantly, apparently assumed good faith without examining the possible motives for nondisclosure.

I. ATTORNEY DISCLOSURE REQUIREMENTS UNDER BANKRUPTCY LAW

Attorneys for debtors perform an essential role in bankruptcy proceedings. But when it comes to compensation, they play second fiddle to creditors. In a Chapter 7 proceeding, such as the one before us, the attorney can be paid out of the bankruptcy estate only if first employed by the trustee and approved by the bankruptcy court. See Lamie v. U.S. Tr. , 540 U.S. 526, 538–39, 124 S.Ct. 1023, 157 L.Ed.2d 1024 (2004). As a check on debtor attorneys, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure require them to promptly disclose their fee arrangements and all payments for their bankruptcy services. Section 329(a) of the Bankruptcy Code states:

Any attorney representing a debtor in a case under this title, or in connection with such a case, whether or not such attorney applies for compensation under this title, shall file with the court a statement of the compensation paid or agreed to be paid, if such payment or agreement was made after one year before the date of the filing of the petition, for services rendered or to be rendered in contemplation of or in connection with the case by such attorney, and the source of such compensation.

Rule 2016(b), which implements § 329, states:

Every attorney for a debtor, whether or not the attorney applies for compensation, shall file and transmit to the United States trustee within 14 days after the order for relief [see 11 U.S.C. § 303(h) (requirements that must be satisfied before issuance of order for relief after filing of a petition for involuntary bankruptcy) ], or at another time as the court may direct, the statement required by § 329 of the Code including whether the attorney has shared or agreed to share the compensation with any other entity. The statement shall include the particulars of any such sharing or agreement to share by the attorney, but the details of any agreement for the sharing of the compensation with a member or regular associate of the attorney's law firm shall not be required. A supplemental statement shall be filed and transmitted to the United States trustee within 14 days after any payment or agreement not previously disclosed.

These provisions "require[ ] every attorney representing a debtor in bankruptcy to file with the court [within 14 days of the order for relief] a statement of all compensation received during the preceding year, or to be received, in connection with the bankruptcy." Bethea v. Robert J. Adams & Assocs. , 352 F.3d 1125, 1127 (7th Cir. 2003). The disclosure obligation is a continuing one. Rule 2016(b) requires attorneys to submit supplemental statements "within 14 days after any payment or agreement not previously disclosed."

The disclosure requirements enable bankruptcy judges to perform their core and traditional role of overseeing lawyers who represent bankrupt debtors. See 3 Richard Levin & Henry J. Sommer, Collier on Bankruptcy ¶ 329.LH, at 329–34 (16th ed. 2020) ("Under prior law, as under the modern Bankruptcy Code, compensation of the attorney for the debtor was scrutinized more closely than the compensation of other officers and professional persons."). The oversight is justified by two significant concerns. Debtors can be exploited by overreaching lawyers who overcharge for their services. And creditors can be denied their proper share of the bankruptcy estate if debtors (particularly those who believe they will net nothing from the nonexempt assets of the estate) direct money to their attorneys in preference to other creditors. See Bethea , 352 F.3d at 1127 (when facing bankruptcy, "[d]ebtors may not care who gets what money remains (if the attorney gets more, other creditors get less), and, when clients do not haggle over price, some attorneys will be tempted to divert the funds to themselves by charging excessive fees"); In re Redding , 263 B.R. 874, 878 (B.A.P. 8th Cir.) ( § 329 "reflects Congress’ concern that payments to attorneys in the bankruptcy context might be the result of evasion of creditor protections and provide the opportunity for overreaching by attorneys"), revised on rehearing on other grounds , 265 B.R. 601 (B.A.P. 8th Cir. 2001) ; H.R. Rep. No. 95–595, at 329 (1977) (Congress adopted § 329 because "[p]ayments to a debtor's attorney provide serious potential for evasion of creditor protection provisions of the bankruptcy laws, and serious potential for overreaching by the debtor's attorney, and should be subject to careful scrutiny"); S. Rep. No. 95–989, at 39 (1977) (same). The required disclosures are necessary for that oversight. See Bethea , 352 F.3d at 1127 (disclosures "enable[ ] the court to determine whether the lawyer has received a preferential transfer"); Law Offs. of Nicholas A. Franke v. Tiffany (In re Lewis) , 113 F.3d 1040, 1045 (9th Cir. 1997) (court must be able to rely on attorney's disclosures).

II. THE RELATIONSHIP BETWEEN SEPH AND THE STEWARTS

SEPH has complained that Mr. Welch, through arrangements not timely disclosed to the bankruptcy court, has been paid large sums that should have gone to SEPH and other creditors. To understand this issue, we must review the relationship between SEPH and the Stewarts.

SEPH is the largest creditor in the Stewarts’ bankruptcy, with a claim exceeding $20 million. It has loaned millions of dollars to businesses that were controlled and largely owned by the Stewarts, in particular Neverve, LLC, in which David Stewart owned at least a 50% interest. The Stewarts personally signed or guaranteed the loans.

As the maturity date of a $16 million note approached, SEPH agreed to extend it in return for additional security. The security was the assignment by the Stewarts and companies they controlled of an interest in claims against British Petroleum (BP) arising out of the disastrous 2010 "Deepwater Horizon" oil spill in the Gulf of Mexico. According to SEPH, the assignment document gave SEPH a security interest in the BP claims of all entities that David Stewart owned directly or indirectly.

The new maturity date came but the note was not paid. SEPH therefore filed on September 30, 2014, a petition in the United States Bankruptcy Court for the Southern District of Alabama to place the Stewarts in involuntary Chapter 7 bankruptcy. On March 18, 2015, the court ordered entry of orders for relief, and it entered an order on April 24 for joint administration of the cases for the two Stewarts.

The case was moved on June 12, 2015, to the United States Bankruptcy Court for the Western District of Oklahoma. Mr. Welch, who had not entered an appearance in Alabama, entered his appearance as attorney for the Stewarts in the Oklahoma proceedings on June 17.

III. WELCH'S FEE ARRANGEMENT AND PAYMENTS

On the same day that Mr. Welch entered an appearance, he executed a representation agreement with the Stewarts. The engagement included general representation, debt counseling, and corporate-structure and bankruptcy representation to the Stewarts and certain named business affiliates. Also at that time, the named affiliates, including Neverve, guaranteed Mr. Welch's legal fees in connection with the bankruptcy representation.

The BP claims were settled in spring 2016. By that time Mr. Welch had obtained an interest in the settlement proceeds. Under a fee-sharing agreement executed on April 19, 2016, the total attorney fee was 40% of the proceeds; that amount was split three ways with 52% of it going to the chief attorney, 32% to Mr. Welch, and 16% to the person who referred the matter to the chief attorney. Mr. Welch's fee would therefore be about 13% of the amount recovered on the claims. There had been a previous attorney-compensation agreement governing the BP claims. But according to Mr. Welch, it could not be found; and the...