On April 28, 2005, the Bankruptcy Appellate Panel for the Ninth Circuit issued an opinion in Movitz v. Baker (In re Triple Star Welding) that seemingly adopts the decision of the Third Circuit Court of Appeals in In re Pillowtex, Inc., 304 F.3d 246 (3rd Cir. 2002), which held that when a facially plausible preference claim exists with respect to prepetition payments received by a professional, the Bankruptcy Court must determine the merit of the preference claim, and the professional’s disinterestedness, before approving its retention.
In Movitz v. Baker, after the debtor’s case was converted to Chapter 7, the Chapter 7 trustee objected to the application of the debtor’s Chapter 11 counsel for payment of professional fees. The trustee asserted that counsel was not disinterested because, among other things, he had failed to disclose the existence of allegedly preferential payments on account of prepetition legal services rendered to the debtor. The Bankruptcy Court stated that it could not determine preference issues?which are in the nature of adversary proceedings?in the context of a fee application, and it awarded the requested fees and costs over the trustee’s objection. An appeal to the BAP ensued.
Citing Pillowtex, the BAP observed that, since the existence of the preference was a threshold question, the Bankruptcy Court should have either deferred its findings regarding disinterestedness until resolution of any adversary proceeding or combined the two proceedings. The BAP elaborated by stating that a professional has the initial burden of establishing its eligibility for employment or compensation notwithstanding the possible receipt of a prima facia preference. If the professional meets this initial burden, the trustee must then be given an opportunity to resolve the preference issue before compensation may be awarded. And if the professional is found to have actually received an avoidable preference, the professional will probably be ineligible for employment, “at least until he returns the preference” or until the preference claim is otherwise satisfactorily resolved.
A professional who received payments from the debtor during the preference period may be able to avoid running afoul of the disinterestedness requirement by returning the potentially preferential payments. If disgorgement is not feasible, or desirable, then Movitz v. Baker suggests a finding of disinterestedness is not possible in the Ninth Circuit absent full and timely disclosure and a prompt determination regarding facially plausible preference claims.