By Taylor Ey

Chapter 11 Attorney vs. Bankruptcy Trustee

Today, the Fourth Circuit issued its published opinion in the civil case, In re Anderson.  In this case, the debtor, Mr. Henry L. Anderson, Jr., filed for Chapter 11 bankruptcy in February 2010 and was represented by Stubbs & Perdue, P.A.  Subsequently, Anderson’s Chapter 11 bankruptcy case converted to a Chapter 7 case.  James B. Angell was appointed as the Chapter 7 Trustee. Anderson had two outstanding debts: approximately $200,000 in legal fees related to the bankruptcy proceedings owed to Stubbs & Perdue, P.A., and nearly $1 million in secured tax claims owed to the IRS.  Anderson’s estate had insufficient funds to pay both of the outstanding debts.  Stubbs & Perdue sued the bankruptcy estate trustee, Angell, seeking the attorneys’ fees granted by order during the Chapter 11 proceedings.  Thus, the issue was whether the attorneys’ fees claim or the secured tax claims take priority in a Chapter 7 liquidation under the Bankruptcy Code.

Governing Law: Changes in the Bankruptcy Code Lead to Confusion as to Which Version Applies

Generally under the Bankruptcy Code (“the Code”), secured claims take priority over unsecured claims, such as the unsecured claim for attorneys’ fees from the bankruptcy proceedings.  There is a limited exception to this general rule under 11 U.S.C. § 724(b)(2) for “administrative expenses.”  Until 2005, the Code was relatively straightforward.  It provided that all holders of claims for administrative expenses had the right to subordinate secured tax creditors.  In 2005, Congress redrafted the language in the exception to narrow it, but this change created confusion.  Congress again amended the Code in 2010, clarifying that § 724(b)(2) did not subordinate Chapter 11 administrative expense claims to secured tax claims.

Competing Arguments

Stubbs argued that the prior version of the § 724(b)(2) exception, before 2010, should apply and thus his claims for attorneys’ fees should subordinate the secured tax claims.  Angell argued that the law in effect at the time at the time of the decision should apply, that is the 2010 revision that clearly states that Chapter 11 administrative expense claims cannot subordinate secured tax claims.

Governing Principles: The Law in Effect at the Time of the Decision Governs and Retroactivity Is Disfavored

The Fourth Circuit stated that, unless the law in effect at the time of a decision would have retroactive effect, the law in effect will govern.  Therefore, in this case, because the 2010 version of the Code would not have retroactive effect, the Court applied the 2010 law.  The Court favored this outcome because it is clear and easy to administer.  This clarity is especially important in the bankruptcy context, said the Court, because the bankruptcy trustee has a fiduciary duty to repay the debtor’s creditors in an expeditious manner.

The Court Affirmed the District Court.

The district court applied the 2010 version of the Code, deciding that the secured tax claims had priority over the Chapter 11 administrative expenses.  The Fourth Circuit affirmed this decision.