Disgorgement by Professionals Is Not Required in an Administrative Insolvency

A bankruptcy judge is not required as a matter of law to order disgorgement of fees to effect a pro rata distribution among chapter 11 administrative claimants when the estate is administratively insolvent, according to District Judge Tanya Walton Pratt of Indianapolis. The appeal entailed a typical case of administrative insolvency, which results when the unencumbered assets of the estate are insufficient to pay administrative claims in full. A trustee had been appointed in a chapter 11 case. Counsel who represented the debtor before appointment of the trustee had been granted and paid two interim allowances of compensation totaling about $135,000. The debtor’s counsel filed a third interim fee application seeking another $110,000. The chapter 11 trustee objected to the third application. Approving settlement of the objection, Bankruptcy Judge Basil H. Lorch, III granted the application, but his order provided that neither the trustee nor the estate would pay any of the fee allowance. There was about $4 million in unpaid administrative claims, but the trustee was holding only $1 million to apply toward those claims. The unpaid claims included an administrative claim of $2.6 million owing to the Internal Revenue Service for unpaid trust fund taxes. Later, the trustee proposed a so-called structured dismissal of the chapter 11 case, where the bankruptcy court would authorize distribution of the estate’s remaining funds, followed by a dismissal of the chapter 11 case without incurring the expense of a conversion to chapter 7.

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