Business Law

Reminder Lessons:  Jurisdiction and Due Process Issues involving Employment and Compensation in Chapter 11 Cases (including Those Affecting Non-Debtor Affiliates) and Fed. R. Civ. P. Rule 60(b)

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The following is a case summary written by Kathleen A. Cashman-Kramer regarding the recent U.S. Bankruptcy Court decision in In re U.S.A. Dawgs, Inc., 657 B.R. 98 (B.A.P. 9th Cir. 2024). To view the published opinion, click here.

SUMMARY AND FACTUAL BACKGROUND

In 2024, the United States Bankruptcy Appellate Panel of the Ninth Circuit issued a decision in the case of In re U.S.A. Dawgs, Inc. (the “Debtor”), a footwear company that filed for bankruptcy in Nevada in 2018.  

As is often the case, the Debtor needed legal counsel in order to assist it in its Chapter 11 bankruptcy proceedings, which included a plan to attempt to sell assets. However, due to financial constraints, it lacked the resources to pay legal fees.  Double Diamond Distribution, Ltd. (“Diamond”), an affiliate of the Debtor, agreed to provide an ongoing monthly retainer of $10,000 to Debtor’s chosen counsel Garman Turner Gordon LLP (“Garman”). This arrangement was documented in an engagement letter, and the bankruptcy court approved the arrangement.

After the Debtor’s assets were sold in the bankruptcy case – Diamond was served with the sale motion and was actively involved in the sale process – Garman applied to the bankruptcy court for approval of its fees . Diamond was served with the application and did not file opposition.  (The only opposition was filed by the secured lender who argued that Garman should not be paid by the Debtor from the sale of its collateral, but instead should only be paid by Diamond.)  The bankruptcy court approved the application for fees and costs, with Debtor and Double Diamond jointly and severally liable for payment, finding: (a) the court has jurisdiction under 28 U.S.C. §§ 157 and 1334, and it was a core proceeding under 28 U.S.C. § 157(b), and venue was proper under 28 U.S.C. §§ 1408 and 1409; (b) Diamond and others were afforded a reasonable opportunity to object and to be heard with respect to the Application and the relief requested; (c) through its execution of the Engagement Letter, Diamond unconditionally guaranteed the payment of all fees and expenses incurred by Garman in its representation of Debtor and, pursuant to the terms of the Engagement Letter, Debtor and Diamond are therefore jointly and severally liable for payment of the Allowed Fees and Costs to Garman; and (d) the allowed fees and costs are immediately due and payable to Garman.  Id., at 105-106. 

Diamond did not appeal the fee order.  Garman pursued collection efforts against Diamond in Canada, where Diamond had assets. When those efforts were exhausted, Diamond sought to reopen the bankruptcy case and it filed a motion for relief from the fee order under F.R.C.P. Rule 60(b)(4) and (6).  Id., at 106.   

The bankruptcy court denied the Rule 60(b) motion, and Diamond appealed to the BAP.

Result and Reasoning

The BAP rejected Diamond’s arguments, maintaining that it had jurisdiction to determine liability and that Diamond’s due process rights were not violated. It affirmed the bankruptcy court’s fee order, holding Diamond liable for Garman’s unpaid fees and expenses.

It also noted that Diamond did not attack the fee order until approximately three and a half years after entry of the fee order, at which time it contended that: “(i) the Fee Order was void because the bankruptcy court lacked subject matter jurisdiction to determine Double Diamond jointly and severally liable for immediate payment of [Garman’s] fees and costs; (ii) Double Diamond was a guarantor, not a surety, such that the bankruptcy court could not order Double Diamond to “immediately” pay [Garman’s] fees and costs or hold Double Diamond jointly and severally liable with Debtor; and (iii) the proposed order improperly requested relief beyond what was requested in the Fee Application.”  Id., at 106. 

The BAP analyzed Diamond’s motion under Federal Rules of Civil Procedure 60(b)(4) and (6) and applicable Ninth Circuit law. The BAP concluded that the fee order, which imposed liability on Diamond, was not void and the bankruptcy court had subject matter jurisdiction.  The BAP discussed the language of the Bankruptcy Code and the meanings ascribed to terms therein, and reminded the reader that “the basis and scope for the jurisdictional grant over proceedings in bankruptcy cases depends on the relationship between those proceedings and the overall objective of achieving a readjustment of the debtor-creditor relationship. As articulated in 28 U.S.C. § 1334, the bankruptcy courts exercise jurisdiction over matters that (i) “arise under” the Code (i.e., where the Code creates or determines the cause of action); (ii) “arise in” a bankruptcy case (i.e., the proceeding would not exist outside of the bankruptcy case); or (iii) are “related to” a bankruptcy case (i.e., the outcome of the proceeding could conceivably have an effect  on administration of the estate).”  Id., at 108-109 (citations omitted). 

The BAP then discussed these concepts in connection with 11 U.S.C. §§ 327-331 pertaining to the employment and compensation of counsel, noting that a bankruptcy court’s “obligations include the duty to assess whether counsel is “disinterested,” a concept that is specific to bankruptcy and distinct from nonbankruptcy conflict of interest laws. § 327(a). [footnote omitted.] This analysis requires bankruptcy courts to analyze and, if appropriate, approve both the debtor’s selection of counsel and the terms of payment to counsel in accordance with the particular mandates of the Code.”  Id., at 109.  Thus, the bankruptcy court properly concluded that it had “arising in” and “related to” jurisdiction over the dispute between Garman and Diamond, and thus had subject matter jurisdiction.

The BAP also rejected Diamond’s contention that, despite being a signatory to the engagement agreement over which the bankruptcy court had subject matter jurisdiction and which served as a basis for its approval of employment and ultimately the Fee Order, its obligations under the Engagement Agreement constituted a separate guaranty agreement over which the bankruptcy court lacked even “related to” subject matter jurisdiction.  The BAP easily rejected this argument, reasoning that “arises in” jurisdiction is present in a case under the Code “if it is an administrative matter unique to the bankruptcy process that has no independent existence outside of bankruptcy and could not be brought in another forum, but whose cause of action is not expressly rooted in the Bankruptcy Code.” Battle Ground Plaza, LLC v. Ray (In re Ray), 624 F.3d 1124, 1131 (9th Cir. 2010) (citation omitted).  The BAP also reminded Diamond that the chapter 11 case would not have existed but for Diamond’s agreement to fund the attorney’s fees incurred by Garman. Id., at 110. 

The BAP similarly found that the bankruptcy court properly concluded that it had “arises under” jurisdiction over the dispute, finding that “matter ‘arises under’ the Bankruptcy Code if its existence depends on a substantive provision of bankruptcy law, that is, if it involves a cause of action created or determined by a statutory provision of the Bankruptcy Code.” In re Ray, 624 F.3d at 1131 (citations omitted).  Id., at 111-112.  Because the dispute arose directly from the application of 11 U.S.C. §§ 327-331 – very specific to bankruptcy – Diamond’s argument was without merit.  It further cited the case In re Neben & Starrett, Inc. vs. Chartwell Financial Corp. (In re Park Helena Corp.), 63 F.3d 877 (9th Cir. 1995), concluding that bankruptcy courts have jurisdiction over counsel’s recovery of fees and costs despite the fact that a nondebtor third party funded counsel’s retainer. Id., at 880-881.  The BAP went on to cite to a litany of Ninth Circuit authority consistent with, and which mandated, the bankruptcy court’s holding.  Id., at 113-114. 

The BAP also found that the bankruptcy court had “related to” jurisdiction over this dispute, defining “related to” jurisdiction “if the outcome of the proceeding could conceivably alter the debtor’s rights, liabilities, options or freedom of action (either positively or negatively) in such a way as to impact the administration of the bankruptcy estate. Fietz v. Great W. Sav. (In re Fietz), 852 F.2d 455, 457 (9th Cir. 1988) (adopting Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3d Cir. 1984)).”  Id., at 114.   The BAP then went on to similarly dispose of  Diamond‘s argument that the bankruptcy court lacked subject matter jurisdiction, returning to the Supreme Court’s decision in Stern v. Marshall, 564 U.S. 462 (2011).  It noted that, as in Stern, Diamond’s arguments regarding the bankruptcy court’s “power” are distinct from the question of whether the bankruptcy court had subject matter jurisdiction.  It ultimately concluded that most of Diamond’s argument did not truly invoke subject matter jurisdiction; thus, the bankruptcy court did not err when it found that it had a basis to assert subject matter jurisdiction and denied Diamond’s request for relief under Civil Rule 60(b)(4). Id., at 117-118. 

Next, the BAP rejected Diamond’s argument that the bankruptcy court had violated Diamond’s due process rights by depriving it of notice or the opportunity to be heard, citing Mullane v. Cent. Hanover Bank & Tr. Co., 339 U.S. 306, 314 (1950) and other cases.  Specifically,  Diamond argued that Garman’s request in its fee application that Diamond be found jointly and severally liable for its fees, and for “immediate” payment of its fees, was buried in an attachment to the Fee Application instead of in the body of the application itself, and thus Diamond did not have proper notice or an opportunity to object.  The BAP found that Diamond was indeed on notice, and there was nothing improper; this was especially true since Diamond never raised in the bankruptcy court that it did not receive the Fee Application and the Notice of Fee Application and that, as a result, “even if the failure to prominently state the relief requested in the body of the Fee Application was procedural error, the error did not rise to the level of a constitutional due process violation.”  Id., at 119. 

Finally, that BAP concluded that, because Civil Rule 60(c)(1) required that “[a] motion under Rule 60(b) must be made within a reasonable time–and for reasons (1), (2), and (3) no more than a year after the entry of the judgment or order or the date of the proceeding,” and since it took Diamond more than three years to move for relief under Civil Rule 60(b), its request for relief under Civil Rule 60(b)(6) was untimely.  Id., at 120. 


AUTHOR’S COMMENTARY

Although at first blush this seems to be a case about compensation to debtor’s counsel from a source other than the debtor in a Chapter 11 case, its focus is really on jurisdictional and due process issues as applied in the context of Section 327-330 and the standards of motions brought under Rule 60(b)(4) and (6) for relief from long-final court orders.  A significant part of the BAP’s opinion reiterates the standards for such motions in theNinth Circuit, with its focus on the fact that review of the denial of a motion under Civil Rule 60(b)(4) is done de novo (Hasso v. Mozsgai (In re La Sierra Fin. Servs., Inc.), 290 B.R. 718, 726 (9th Cir. BAP 2002), and this includes subject matter jurisdictional challenges like those raised by Diamond, citing Montana v. Goldin (In re Pegasus Gold Corp.), 394 F.3d 1189 (9th Cir. 2005) and due process arguments raised under Civil Rule 60(b)(4).  It also reviewed a trial court’s decision to deny a Civil Rule 60(b) motion for abuse of discretion. Cmty. Dental Servs. v. Tani, 282 F.3d 1164, 1167 n.7 (9th Cir. 2002), as amended on denial of reh’g and reh’g en banc. As stated above, the BAP undertook to weave in the standards under Bankruptcy Code Sections 327-300, especially on the subject of jurisdiction, and ultimately concluded that the bankruptcy court arrived at the correct – and only – conclusion.   

These materials were authored by Kathleen A. Cashman-Kramer, Of Counsel at Fennemore LLP (KCashman-Kramer@Fennemorelaw.com), with editorial contributions from ILC member Maggie E. Schroedter (maggie@theRSfirm.com).


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