The opinion of the court was delivered by: CARTER
On May 14, 1973, Arlan's Department Stores, Inc. ("Arlan's") filed a petition for an arrangement under Chapter XI of the Bankruptcy Act ("Act"). By order of Bankruptcy Judge Roy Babitt, Arlan's was permitted to continue operation of its business as a debtor in possession. Arlan's Chapter XI petition was followed in June and July by similar petitions from 40 of the company's wholly-owned subsidiaries. These entities, like their parent, were authorized to continue operations as debtors in possession.
Arlan's was a multi-state chain store selling general retail merchandise. In 1970 it had some 119 stores, but during that year it began to experience heavy losses which continued unabated until its reported losses for 3 1/4 fiscal years ending in April, 1973 reached $ 65 million. During this period it liquidated 39% Of its stores, and when the Chapter XI petition was filed, it had reduced its stores to 70 and at the time had on its payroll approximately 4,000 employees. The business appeared to be substantial despite these recent setbacks. However, a huge indebtedness had been incurred. It owed $ 35 million to about 15,000 creditors in the trade, some $ 21 million to institutional lenders and faced a potential liability of about $ 15 million for breaches of lease agreements with various landlords. It had outstanding public securities of 2,775,414 shares of common stock held by some 6,000 shareholders, and 6% Convertible subordinated debentures in the principal amount of $ 15 million held by roughly 725 debenture holders.
The dreary downturn in business continued during the Chapter XI phase, and Arlan's decided that only drastic measures would turn the tide. Without court authorization, it hired Rollin Binzer as a promotional consultant. He proposed a project called "Mission Impossible" which involved altering the physical layout of the stores, offering new and different types of merchandise, and undertaking substantial advertising and promotional efforts to attract business. The project was aimed at reaping considerable profits during the 1973 Christmas shopping season. Despite the huge expenditure of funds, time and effort, the project failed.
In mid-November, 1973, counsel for the Securities and Exchange Commission ("Commission") advised Arlan's general counsel, Ballon, Stoll & Itzler, that it would seek to transfer the matter from Chapter XI to Chapter X. Counsel persuaded the Commission to defer that move until after Christmas on the representation that the upcoming Christmas season was crucial to Arlan's rehabilitation and the transfer from Chapter XI to Chapter X might be harmful to Arlan's efforts during that critical period. Not having advised the court, neither counsel nor the debtor felt the need to advise the Commission about the "Mission Impossible" project.
In early January, 1974, the Commission moved for the transfer to Chapter X. That motion was granted in February, 1974. In its memorandum opinion granting the Commission's motion, reported at 373 F. Supp. 520, the court unknowingly made a prophetic announcement: "Hopefully, the proceedings can go forward expeditiously and with minimal expense and if the debtor is not suffering from terminal financial ills, a successful rehabilitation will occur." Id. at 526.
However, Arlan's was at that point terminally ill and could not be saved. An amended petition was filed in March, 1974, to meet Chapter X requirements. Irving Bernstein was appointed and confirmed as trustee, and Rosenman, Colin, Kaye, Petschek, Freund & Emil, now succeeded by Rosenman, Colin, Freund, Lewis & Cohen, was appointed counsel to the trustee.
When the Chapter X proceedings began, the operating stores, without authorization of the Chapter XI court, had been reduced to 35, and the debtor had already decided to make a further retrenchment to 22 stores. That latter decision was concurred in by the trustee. In April, 1974, the court ordered the 13 stores closed, and subsequent closings were authorized reducing the operating stores to only 10 by the 1974 Christmas shopping season. The 1974 Christmas season sales were below projections. In January, 1975, low inventories, cash shortages and inability to secure normal credit terms left the trustee with no option but to recommend a complete shut down and liquidation of the debtor's business. On January 29, 1975, the court authorized the sale of the assets of all the 10 remaining stores and declared the debtor insolvent. The inventory and fixtures in the 10 stores and the debtor's interest in real property were disposed of. A plan of orderly liquidation was approved and confirmed. The estate now consists of $ 3.7 million in cash assets against $ 170 million in liabilities, and funds are available only for payment of administrative claims, priority wage claims and a small dividend on priority tax claims.
The Commission has been a party to this action since the transfer to Chapter X pursuant to section 208 of the Act, 11 U.S.C. § 608. Its help and guidance and that of the counsel to the trustee has been of great assistance to the court throughout these protracted proceedings. Both could be relied upon, when requested, to provide a disinterested perspective of the events about which the court needed to be informed.
The court now faces the exceedingly graceless task of deciding upon fee allowances being sought. Because of the unsavory nature of the activities of some of the fiduciaries in this case, the task facing the court becomes even more disspiriting than usual. At the court's request, the Commission studied all the final allowance applications, including those of the trustee, his counsel, special attorneys and accountants, and attorneys and accountants and a creditors' committee for the debtor. The request made for services rendered is in excess of $ 2 million which includes retainers and court authorized interim compensation of $ 301,994, leaving a total of $ 1 3/4 million being applied for at this time. In addition, there is a request for $ 30,946.33 in reimbursements. The Commission recommends final allowances of $ 1,105,117 of which $ 75,000 has already been paid as an interim allowance. In addition, it recommends that $ 313,082.53 previously received by the trustee and attorneys for the debtor be ordered returned to the estate with interest.
The Commission has made a thorough examination and careful analysis of all the applications. As a disinterested agency skilled and experienced in reorganization matters, its recommendations are ordinarily entitled to great weight. In re Farrington Mfg. Co., 540 F.2d 653 (4th Cir. 1976); In re Imperial "400" National, Inc., 432 F.2d 232 (3d Cir. 1970); In re Coast Investors, Inc., 388 F.2d 622 (9th Cir. 1968); Finn v. Childs Co., 181 F.2d 431, 438 (2d Cir. 1950); In re Investors Funding Corp., 422 F. Supp. 461 (S.D.N.Y.1976) (Bonsal, J.), Modified, 547 F.2d 13 (2d Cir. 1976). In the main the Commission's recommendations are sufficiently documented and supported by the case law so that there is no basis for disagreement, and in such instances the agency's recommendations have been adopted.
However, there have been divergences from the Commission's recommendations, for in the final analysis the determination is the court's responsibility. The court has been accorded broad discretion to accomplish the unpleasant task which must now be faced, Dickinson Industrial Site v. Cowan, 309 U.S. 382, 60 S. Ct. 595, 84 L. Ed. 819 (1940), and its decision is subject to interference only on a showing of an abuse of discretion or the application of incorrect legal principles. See In re First Colonial Corp. of America, 544 F.2d 1291 (5th Cir. 1977), Cert. denied, 431 U.S. 904, 97 S. Ct. 1696, 52 L. Ed. 2d 388 (1977).
The court's determination is controlled by the following considerations: the level of skill and time required to perform the work that had to be done; the value of the required services; the results achieved; the size of the estate and the burden the latter can safely bear; the professional standing, ability and experience of the applicant and the reasonableness of the award in the context of the size and value of the estate as measured pursuant to a concept of reasonable economy of administration. See e.g., Surface Transit, Inc. v. Saxe, Bacon & O'Shea, 266 F.2d 862, 865 (2d Cir.), Cert. denied, 361 U.S. 862, 80 S. Ct. 120, 4 L. Ed. 2d 103 (1959); In re the First Colonial Corp. of America, supra. The awards must be fair, neither so high that the res the proceedings is designed to protect is consumed nor so parsimonious as to discourage the active participation of competent counsel. See In re Farrington Mfg. Co., supra; In re Mabson Lumber Co., 394 F.2d 23 (2d Cir. 1968).
With respect to the Commission's recommendation as to the final allowance for the trustee's general counsel, it seems to the court that the scale has been tipped too far towards parsimoniousness and that the Commission's recommendations in this instance are flawed by inconsistency. It recommends an hourly rate of $ 51 and $ 50 for several other applicants, but would limit the trustee's general counsel to $ 42.50. This inconsistency occurs because the Commission was looking at the total award involved, and it recommended the higher hourly rate for other applicants because so little was being sought, while the trustee's counsel is seeking a substantial fee. While the total applied for cannot be discounted, it would be unfair to penalize counsel because it was called upon to expend so much time in fulfilling the obligations it was asked to assume.
Irving Bernstein, who served as trustee from March 18, 1974, until his resignation was accepted and a successor appointed by order dated May 12, 1978, seeks a final allowance of $ 250,000 which includes $ 72,000 already paid as interim allowances. At the beginning of his assignment Bernstein worked to save the business, and his application, although unsupported by time records, indicates that he spent 40 hours a week in the first year trying to make a go of the business. Between March, 1974, and January, 1975, the court is convinced that the trustee's claim of 40 hours per week is accurate. Thereafter, however, he was concerned solely with the orderly wind up of the estate, and it is difficult to understand how the claimed 40 hours per week from March 1, 1975, to November 30, 1975, and an average of 25 hours a week from December 1, 1975, through September 30, 1977, were required in respect of the needs of the estate. In any event, the excess of time spent or claimed is not the critical issue here. A far more unpleasant issue must be aired.
From the very commencement of his role as trustee on March 18, 1974, through March 2, 1978, Bernstein paid substantial sums to himself out of Arlan's estate as reimbursement for expenses. None of these reimbursements was authorized by the court. No authorization was ever sought, and the trustee did not disclose these payments in his four applications for interim allowances of $ 18,000, awarded by orders dated June 21, September 20 and December 20, 1974, and March 21, 1975. Indeed, the purpose for the interim allowance was to reimburse the trustee for expenses and out-of-pocket disbursements, for which, as is now revealed, reimbursement had already been received by unauthorized dipping into the funds of the estate. The trustee's counsel in reviewing the records came across various payments which seemed unrelated to the estate and included family vacation trips and personal expenditures and brought the matter to the court's attention. Touche, Ross & Co. was employed at the direction of the court and at Bernstein's expense, as special accountants. Their review, which was not an in-depth examination, revealed that some $ 63,935.85 had been taken from the estate by the trustee without proper authorization. While the trustee does not concede that the total amount constituted unauthorized funds taken, he has returned $ 63,935.85 to Arlan's, and I understand will not contest the validity of the Touche, Ross findings. Unfortunately, the return of the funds, even assuming that a more thorough investigation may not reveal additional improprieties, does not suffice.
A trustee, particularly one appointed by the court, occupies a position of public trust. The estate for which he is given responsibility is being administered by him under court aegis. The court is required to rely on his judgment, his integrity and honesty. In taking unauthorized and undisclosed funds from the estate and converting them to his own use, Bernstein committed a grave breach of his fiduciary obligations. Not only has his conduct fallen below the exacting standard applicable to fiduciaries, it cannot be squared with the lower yardstick of the marketplace. The funds of the estate were not for Bernstein's personal use, but only for authorized purposes in connection with the administration of the debtor's property. Even if there had been no question concerning misapplication to the trustee's personal use and the funds had been shown to have been properly spent, the fact that the taking had been unauthorized and undisclosed would, itself, constitute a breach of Bernstein's fiduciary obligation. In that hypothetical situation the breach might only have been considered a technical one, but where a limited investigation reveals diversion of monies to the trustee's personal use, as here, there is actual and active wrongdoing.
The court, of course, may deny all compensation to the trustee since any award is within the court's discretion, See e.g., Dickinson Industrial Site v. Cowan, supra; In re Barry Yao Co., 175 F. Supp. 726 (S.D.Cal.1959), Rev'd on other grounds, 286 F.2d 299 (9th Cir. 1961); In re J. H. Newport Co., 84 F. Supp. 13 (E.D.Pa.1949), and it seems appropriate to do so in this case. In connection with the court's power to confirm a plan of reorganization, section 221(4) of the Act, 11 U.S.C. § 621(4) subjects all compensation to court approval. Implicit in that authority is the power to order funds already paid out to be returned. See 6A Collier on Bankruptcy P 11.09 at pp. 244-48 (14th ed. 1977). See also Leiman v. Guttman, 336 U.S. 1, 5-8, 69 S. Ct. 371, 93 L. Ed. 453 (1949). It seems appropriate that the latter be done as well. The trustee, on four separate occasions, came to the court seeking and receiving interim allowances of $ 18,000 each. On none of these occasions was it disclosed that the trustee had been taking funds from the estate to meet purported expenses which was the stated purpose of the applications for interim allowances. The interim allowances were thus obtained under false pretenses. Had all the facts been known to the court at the time, the interim allowance would not have been approved. Accordingly, the trustee's application for a final allowance of $ 250,000 is denied. He is denied any award as trustee and is ordered to restore to the estate with interest the $ 72,000 in interim allowances heretofore received.
The Application of Ballon, Stoll & Itzler, Attorneys for the Debtor
Applicant was retained by order dated May 14, 1973, of Bankruptcy Judge Babitt as Arlan's general counsel in the Chapter XI proceedings. Applicant applies for a final allowance of $ 250,000 to which it credits payment already received of $ 129,993.98 leaving a balance of $ 120,006.02 now being sought, plus $ 4,352.24 in reimbursement for expenses.
One day prior to the filing of the Chapter XI petition, that is on May 13, 1973, applicant states that it received a $ 124,993.98 retainer in cash. Payment of this retainer on the eve of the filing of the Chapter XI petition was made in cash collected from the cash registers of various of the debtor's stores in the Detroit, Michigan area. In January, 1975, the Chapter X trustee moved under section 60(d) of the Act, 11 U.S.C. § 96(d) to recover the portion of the cash retainer payment exceeding a reasonable amount for pre-petition services in contemplation of the filing of the Chapter XI petition.
At the final allowance hearing on November 18, 1977, counsel for the Chapter X trustee introduced a handwritten receipt signed by Ronald S. Itzler, Esq., the applicant's partner in charge of the Arlan's matter, acknowledging payment by Arlan's of $ 104,992 in cash, and a May 14, 1973 receipt by Itzler acknowledging payment of $ 124,993.98 was also introduced at the hearing. According to Itzler's recollection recounted at the November 18, 1977 hearing, the money was delivered to him by representatives of Arlan's at his office on Sunday evening, May 13, 1973. He stayed at his office with an armed guard and counted the money, arriving at the $ 104,000 figure. The next morning the money was delivered to the bank and its count came to $ 124,993.98 which is the sum relied upon. (See pp. 746-47 Transcript, Nov. 18, 1977 hearing).
Applicant neglected to disclose receipt of the retainer in the Chapter XI petition or in its affidavit annexed thereto. General Order in Bankruptcy 44, in effect at the time, requires that all attorneys' connections with the debtor be disclosed and Bankruptcy Rule 215 which superseded General Order 44 continues this requirement. Chapter XI, Rule 11-22 makes applicable Rule 215 to Chapter XI cases. The Commission finds the manner in which the retainer was paid a basis for adverse comment. In a March 22, 1978 letter to the court, the applicant explains that when the necessity for filing the Chapter XI petition became apparent, the law firm advised Arlan's that it would require a $ 125,000 retaining fee to file the petition. I find nothing untowards Per se in the fee, its size or the manner of its payment. Lawyers are not held to a standard of self-sacrifice. They are entitled to ensure payment for use of their professional skills. The payment, however, should have been disclosed to the court at the onset of the Chapter XI proceedings. It was disclosed some six months later in Arlan's ...