Restructuring

Contributed by Doron P. Kenter.

“[W]hat I do have are a very particular set of skills, skills I have acquired over a very long career…”
– Bryan Mills (Liam Neeson), Taken

In complex bankruptcy cases (or even in simple, but contentious, ones), mediation can serve a useful purpose. It can streamline the issues, bring parties to agreement, and ease the burden on busy bankruptcy courts. Indeed, mediators have assisted in the resolution of key disputes in several recent large chapter 11 cases. But even though mediation itself lies outside formal court proceedings, the appointment of a mediator (and compensation for her services) is subject to review and approval by the bankruptcy court. A recent decision from the United States Bankruptcy Court for the Southern District of Texas highlights some of the concerns inherent in appointing a mediator – particularly when that mediator is a former bankruptcy judge.
Background
In In re Smith, the chapter 7 trustee and the other members of a partnership in which the debtor was a partner scheduled a mediation with a retired bankruptcy judge to resolve certain disputes regarding the trustee’s efforts to obtain a cash distribution from the partnership. The parties did not seek court approval of the mediation or the selection of the mediator, and did not mention those plans to the bankruptcy court. Instead, in reviewing the trustee’s motion to toll the time to file pleadings for post-judgment remedies, the bankruptcy court noticed that the mediation had already been scheduled (and, indeed, was the basis for requesting the extension of time). The bankruptcy court subsequently sought clarification from the parties as to whether the trustee intended to use estate funds to pay the mediator, and whether the trustee himself would participate in the mediation and thereafter seek payment and reimbursement from the debtor’s estate therefor. The bankruptcy court denied the pending motion to toll deadlines and ordered the parties not to proceed with the mediation without first obtaining court approval.
Mediators Are Estate Professionals
The bankruptcy court, recognizing that this issue was likely one of first impression, held that a mediator is an “other professional person[],” the employment of whom is subject to prior court approval. Section 327(a) of the Bankruptcy Code provides that “the trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons . . . to represent or assist the trustee in carrying out the trustee’s duties….” (emphasis added). Bankruptcy Rule 2014(a) reiterates that principle, providing that orders approving the employment of estate professionals under section 327 “shall be made only on application of the trustee…” (emphasis added). Noting that commentators have offered differing opinions regarding the treatment of mediators in bankruptcy cases, the bankruptcy court set forth several considerations to be used in determining whether someone qualifies as a “professional person” under section 327(a):

1. A person must be a professional “in the ordinary sense of the word.” In other words, the person must perform “high-level, specialized services requiring discretion or autonomy.”
2. Even if a person is “normally considered” a professional under the ordinary sense of the term, section 327(a) applies only to professionals who “represent or assist the trustee in carrying out the trustee’s duties under [the Bankruptcy Code].” Accordingly, the professional’s employment must specifically relate to administration of the bankruptcy case, rather than the ordinary course of the debtor’s business.
3. The professional’s specific skills must be used to “impact the administration of the case.” In other words, the professional’s skills must not only assist the trustee in administering the case – they must have an actual bearing on the case itself. In considering this factor, the bankruptcy court suggested that courts look to “[t]he significance of the professional’s task and the amount of discretion the professional has in performing it . . . to determine the overall importance of the professional’s services.”

Applying these factors to the case before it, the bankruptcy court concluded that mediators require court appointment as “estate professionals” because they (i) are generally professionals in the ordinary sense of the word; (ii) “play[] a central role” in resolving bankruptcy disputes; and (iii) have substantial discretion to help resolve disputes, which is “sufficiently significant to the overall administration of the estate” to warrant designating the mediator an estate professional, and subject to court approval. As further support for this conclusion, the bankruptcy court cited to several courts with standing orders requiring estate representatives to obtain court approval before employing a mediator. Lastly, the bankruptcy court observed that under the circumstances, the parties’ attorneys were more than qualified to negotiate a settlement, and that it therefore saw no need to appoint a mediator to resolve their disputes.
Even if Mediators Are Not Subject to Section 327, Appointment of Former Judges Requires Court Approval
The bankruptcy court then noted that even if section 327 did not apply to mediators generally, that section’s requirements should be extended, pursuant to section 105(a) of the Bankruptcy Code, to apply where parties are seeking to appoint a former bankruptcy judge as a mediator. Section 105(a) authorizes bankruptcy courts to “tak[e] any action . . . to prevent an abuse of process.” This includes the power to modify or extend existing provisions of the Bankruptcy Code to avoid abuse (or the appearance of abuse).
The bankruptcy court, after an examination of the history of the current bankruptcy regime, concluded that the balance of responsibility between bankruptcy judges and bankruptcy trustees “is intended to check overreaching by both” the trustee and the bankruptcy court. The bankruptcy court then concluded that a former bankruptcy judge is “the ultimate insider,” in light of his or her relationship with the presiding judge in the bankruptcy case, and that he or she is therefore not “disinterested” as would be required under section 327. The bankruptcy court expressed concern with the “opportunity for sitting judges to bestow favored positions on friends and former colleagues, evoking the incestuous referee-trustee relationship rampant under the old Bankruptcy Act.” At the very least, it would create the “appearance of cronyism” in allocating estate funds to a former judge, potentially at the expense of the debtor’s unsecured creditors. The bankruptcy court therefore ordered the parties to file a motion discussing the concerns set forth in its decision and to demonstrate the necessity for appointing a (disinterested) mediator, at which time it would decide whether to allow mediation to proceed.
Analysis
The Smith decision is an interesting one, and raises serious concerns with the appointment of former bankruptcy judges in pending bankruptcy cases. And although it did not discuss the issue of sitting bankruptcy judges as mediators, one would assume that the bankruptcy court would be even more troubled by such an appointment. Indeed, if the bankruptcy court was concerned with the appearance of cronyism in appointing a former bankruptcy judge from a different district, one would imagine that a sitting judge – or a judge sitting in the same district as the pending case – would raise even greater concern. Of course, it should be noted that the bankruptcy court in Smith admitted that it “does not belong to the school of mediation romantics” and will not “routinely rubber-stamp” requests for mediators. This general attitude toward mediation and preference for attorneys and client to resolve disputes amongst themselves likely colored the bankruptcy court’s decision and pronouncements.
Moreover, the bankruptcy court in In re Smith did not address any of the recent large chapter 11 cases in which current and former bankruptcy judges have been appointed as mediators (the most prominent of which might be Residential Capital, which involved a sitting bankruptcy judge from the same district in which the case was pending). And even though we cannot know whether the bankruptcy court was aware of – or responding to – those appointments of current or former bankruptcy judges as mediators, the bankruptcy court’s ostensible disapproval of those appointments is self-evident.
On the other hand, the bankruptcy court’s conclusion – that mediators must be appointed by the bankruptcy court so as to avoid the appearance of cronyism – yields a somewhat paradoxical outcome. If court approval is required, then the bankruptcy court must become involved with the appointment of any mediator, which could itself create concerns regarding the appearance of impropriety. To wit, the bankruptcy judge in Smith specifically noted that he and the proposed mediator are fellows in the American College of Bankruptcy, have made presentations together, and have worked together to coach teams in moot court competitions. This “close collegial relationship between consummate bankruptcy insiders” is not necessarily limited to sitting and former bankruptcy judges. In the small world of bankruptcy, the likelihood that a bankruptcy judge will know a proposed mediator is particularly high. And perhaps it should be immaterial whether that relationship stems from the judge’s time in private practice, teaching CLE courses, participating in trade organizations, or any other contacts between professionals in the world of bankruptcy. Indeed, would a former judge be better equipped to understand the need for impartiality in mediation? Or should mediators be appointed by the United States Trustee, as is the case with bankruptcy trustees and examiners?
The issue of disinterestedness of estate professionals is (you’ll pardon the expression) an interesting one, and is particularly pronounced in appointing mediators, who often have wide latitude to guide disputes that form the crux of bankruptcy cases. (Some degree of concern may also apply to the appointment of current or former judges as examiners, but such concerns may be mitigated or resolved by the fact that it is the United States Trustee who appoints examiners, while bankruptcy judges themselves enter orders appointing mediators.) The Smith decision may not be the end of the discussion, but it raises some very serious questions. We look forward to seeing what (if any) responses Smith generates going forward.