In Re Pillowtex

Opinions of the United

2002 Decisions States Court of Appeals

for the Third Circuit

9-23-2002

In Re Pillowtex

Precedential or Non-Precedential: Precedential

Docket No. 01-2775

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PRECEDENTIAL

Filed September 23, 2002

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 01-2775

IN RE: PILLOWTEX, INC.

PATRICIA A. STAIANO, the UNITED STATES TRUSTEE,

Appellant

On Appeal from the United States District Court

for the District of Delaware

(D.C. No. 00-cv-04211)

District Judge: Hon. Sue L. Robinson

Argued June 10, 2002

Before: SLOVITER, ROTH and McKEE, Circuit Judg es

(Filed: September 23, 2002)

Robert D. McCallum, Jr.

Assistant Attorney General

Joseph A. Guzinski

Acting General Counsel

P. Matthew Sutko

Attorney, Office of General Counsel

Anne Murphy (Argued)

William Kanter

United States Department of Justice

Washington, D.C. 20530

Attorneys for Appellant

Eric D. Schwartz

William H. Sudell, Jr.

Morris, Nichols, Arsht & Tunnell

Wilmington, DE 19899

Fordham E. Huffman (Argued)

David G. Heiman

Jones, Day, Reavis & Pogue

Columbus, OH 43215

Gregory M. Gordon

Daniel P. Winikka

Jones, Day, Reavis & Pogue

Dallas, TX 75201

Attorneys for Appellees

In Re: Pillowtex, Inc. and its

Affiliated Debtors

John D. McLaughlin, Jr.

Pauline K. Morgan

Young, Conaway, Stargatt & Taylor

Wilmington, DE 19899

Fred S. Hodara (Argued)

Akin, Gump, Strauss, Hauer & Feld

New York, NY 10022

Attorneys for Appellee

Official Committee of Unsecured

Creditors

OPINION OF THE COURT

SLOVITER, Circuit Judge.

The U.S. Trustee appeals from the District Court’s order

authorizing the retention of Jones, Day, Reavis and Pogue

("Jones Day") as Pillowtex, Inc.’s Chapter 11 bankruptcy

counsel. The U.S. Trustee argues that payments of fees by

Pillowtex to Jones Day within the 90 days before

bankruptcy may have constituted an avoidable preference

and that the receipt of such a preference by Jones Day

would constitute a conflict of interest with Pillowtex’s

2

creditors and its bankruptcy estate. The U.S. Trustee

maintains that because the Bankruptcy Code provides that

debtor’s counsel may not "hold or represent an interest

adverse to the estate" or "an interest materially adverse to

the interest of . . . any class of creditors," Jones Day may

have been disqualified from serving as Pillowtex’s

bankruptcy counsel. Without ruling on the U.S. Trustee’s

preference allegation, the District Court approved Jones

Day’s retention on condition, proposed by Jones Day, that

if Jones Day is determined to have received a preference, it

return the amount of the preference to Pillowtex’s

bankruptcy estates and waive any resulting claim. On

appeal, the U.S. Trustee argues that the District Court

erred in authorizing Jones Day’s retention as counsel

without making a determination whether Jones Day

received a preference and asks this court to remand and

direct the District Court to make such a determination

promptly.

I.

FACTS AND PROCEDURAL POSTURE

Pillowtex Corporation and its subsidiaries (referred to

collectively as Pillowtex) manufacture pillows, blankets,

towels and other textiles. Jones Day has represented and

advised Pillowtex since 1996 in a variety of matters,

including corporate, financial, securities, real property,

litigation, environmental, intellectual property, labor,

employee benefits and tax affairs. Prior to filing its

bankruptcy petition, Pillowtex retained Jones Day to assist

it with contingency planning and bankruptcy preparation.

Pillowtex declared bankruptcy on November 14, 2000 by

filing a petition under Chapter 11 of the Bankruptcy Code.

At the time of filing, Pillowtex had approximately

$1,000,000,000 in trade debt, about $750,000,000 in

senior secured debt, and roughly $400,000,000 in

subordinated debt. For fiscal year 1999, Pillowtex’s gross

revenues exceeded $1,500,000,000, and as of July 1, 2000

its assets were valued at approximately $1,700,000,000.

3

On November 16, 2000, Pillowtex filed an application

with the Bankruptcy Court to retain and employ Jones Day

as its bankruptcy counsel pursuant to section 327 of the

Bankruptcy Code. Pillowtex also applied to retain other

professionals to assist it in its restructuring, including

KPMG LLP (KPMG) as an independent auditor and

consultant. As part of Jones Day’s retention application,

Jones Day set forth the date and amount of each payment

that Pillowtex made to the firm during the year immediately

preceding the filing for bankruptcy. The disclosure by Jones

Day showed that Pillowtex made the following payments to

Jones Day for services rendered:

11/29/99 $ 203,520.69

12/27/99 450,573.79

12/30/99 155,912.06

2/23/00 181,550.01

3/31/00 67,482.73

4/30/00 146,520.71

6/30/001 180,585.22

7/7/00 132,299.71

9/11/00 78,652.94

11/3/00 40,759.09

11/10/00 778,157.33

11/13/00 300,000.00 (retainer--approx.

$100,000 toward pre-

petition fees)

The last payment listed, that on November 13, 2000, was

made the day before Pillowtex filed its petition for

bankruptcy and was a retainer of $300,000 for services

rendered or to be rendered by Jones Day and for

reimbursement of expenses.2 Including the applied portion

_________________________________________________________________

1. In the Disclosure of Compensation that Jones Day filed as part of

Pillowtex’s retention application, Jones Day listed this payment as

having been made on 6/30/99, but its placement in an otherwise

chronological listing of payments suggests that date is a scrivener’s

error. In its brief, the U.S. Trustee lists the payment as having been

made in the year 2000.

2. Although Jones Day initially represented that it had applied $100,000

of that retainer as payment of fees through November 13, 2000, it now

explains that it inadvertently failed to transfer that sum from its trust

account into a non-trust account as of that date.

4

of the retainer, Pillowtex paid Jones Day $2,516,014 in the

year before it declared bankruptcy. Of those payments

$997,569.36 were made in the ninety days before Pillowtex

filed its petition for bankruptcy.

The U.S. Trustee3 filed an objection to the application by

Jones Day and KPMG for retention, arguing that both

KPMG and Jones Day had received payments which

constituted voidable preferences under section 547 of the

Bankruptcy Code. According to the U.S. Trustee, Jones Day

"received payments before the filing of the petition which

were voidable as preferences . . . . As a result of these

payments, Jones Day is not a disinterested person and

cannot be retained to represent the debtors in possession

[Pillowtex]." App. at 125. Eventually, the U.S. Trustee

withdrew his objection to KPMG’s retention pursuant to

stipulation, but continues to press its objection as to Jones

Day and requested a hearing.

Before the District Court, Jones Day argued that

Pillowtex’s payments to it "were substantially within the

historical pattern of payments between Jones Day and the

Debtors, which included wide swings in the timing of

payments." App. at 133. Jones Day opposed the requested

hearing, arguing that it was "not necessary or appropriate

for the Debtors’ estates to incur the time and expense of

litigating the preference issue." App. at 133. It proposed

instead that "if a preference action against the firm is

initiated and a final order is entered determining that Jones

Day in fact received a preference, Jones Day will return to

the Debtors’ estates the full amount of the preferential

payment and waive any related claim." App. at 133. Jones

Day noted that "the U.S. Trustee has previously adopted"

the same approach "with respect to Debtors’ accountants,"

KMPG, but "[i]nexplicably, the U.S. Trustee will not agree to

this resolution with Jones Day." App. at 133.

The District Court did not definitively determine whether

Jones Day had received a preference from Pillowtex.

_________________________________________________________________

3. The reference is to the United States Trustee authorized to supervise

the administration of bankruptcy cases in "[t]he judicial districts

established for the States of Delaware, New Jersey, and Pennsylvania,"

28 U.S.C. S 581(a)(3), also known as "Region 3."

5

Instead, the court adopted Jones Day’s suggestion that it

authorize the firm’s retention on condition that if Jones Day

was determined to have received preferential transfers,

"Jones Day shall promptly return the same to[Pillowtex’s]

estate[ ] and waive any unsecured claim it has by virtue

thereof." App. at 3. According to the District Court, "Subject

to the provisions of this Order, Jones Day does not hold or

represent any interest adverse to the Debtors’ estates and

is a ‘disinterested person,’ as defined in section 101(14) of

the Bankruptcy Code and as required by section 327(a) of

the Bankruptcy Code." App. at 2. The U.S. Trustee timely

filed this appeal of the retention order.

The bankruptcy proceeding continued while this appeal

proceeded. In the interim, no party has brought a

preference action against Jones Day. The District Court

ultimately confirmed Pillowtex’s Second Amended Joint

Plan of Reorganization by an order entered May 2, 2002. At

oral argument before this court, Fred Hodara, an attorney

for the Official Committee of Unsecured Creditors of

Pillowtex which joined in Pillowtex’s brief on appeal, agreed

with the U.S. Trustee that under Pillowtex’s confirmed plan

of reorganization the unsecured creditors only receive

pennies on the dollar for their claims.

II.

JURISDICTION AND STANDARD OF REVIEW

This is a core proceeding pursuant to 28 U.S.C.

S 157(b)(2). The District Court exercised jurisdiction over

this matter pursuant to 28 U.S.C. SS 157 and 1334. That

court’s determination of Pillowtex’s application for retention

of counsel is a final order, see, e.g., United States Trustee

v. First Jersey Secs., Inc. (In re First Jersey Secs., Inc.), 180

F.3d 504, 508 (3d Cir. 1999), which this court has

jurisdiction to review pursuant to 28 U.S.C. S 1291, see,

e.g., In re Marvel Entm’t Group, Inc., 140 F.3d 463, 470-71

(3d Cir. 1998). The confirmation of Pillowtex’s plan of

reorganization does not moot this appeal. See, e.g., Citicorp

Venture Capital Ltd. v. Committee of Unsecured Creditors,

160 F.3d 982, 986 (3d Cir. 1998) (exercising jurisdiction

6

over appeal despite confirmation of a Chapter 11 plan);

Michel v. Federated Department Stores, Inc. (In re Federated

Department Stores, Inc.), 44 F.3d 1310, 1315-17 (6th Cir.

1995) (holding appeal not moot despite confirmation of plan

because bankruptcy court had power on remand to deny

pending fee requests and order disgorgement of previously

awarded fees).

The U.S. Trustee has standing to appeal the retention

order. The U.S. Trustee has statutory responsibility to

monitor applications for retention of professional persons in

bankruptcy cases, and, "whenever the United States trustee

deems it appropriate, [to file] with the court comments with

respect to the approval of such applications." 28 U.S.C.

S 586(a)(3)(H). The relevant statute addresses the U.S.

Trustee’s standing by explicitly providing that"[t]he United

States trustee may raise and may appear and be heard on

any issue in any case or proceeding under this title." 11

U.S.C. S 307. See also United States Trustee v. Price

Waterhouse, 19 F.3d 138, 141 (3d Cir. 1994).

Although Jones Day argues that it is significant that

none of the parties in interest to the bankruptcy objected to

its retention as counsel, the House Report to the legislation

expanding and implementing the U.S. Trustee program on

a national scale, embodied in 11 U.S.C. S 307, expressly

puts the U.S. Trustee on the level of a party, as it states:

"The U.S. Trustee is given the same right to be heard as a

party in interest, but retains discretion to decide when a

matter of concern to the proper administration of the

bankruptcy laws should be raised." H.R. Rep. No. 764, 99th

Cong., 2d Sess. 27 (1986), reprinted in 1986 U.S.C.C.A.N.

5227, 5240. See also In re Columbia Gas Sys. Inc., 33 F.3d

294, 296 (3d Cir. 1994). Accordingly, we proceed to

consider the issues presented.

III.

DISCUSSION

We review a bankruptcy court’s decision to approve an

application for employment for abuse of discretion. See In

re Marvel Ent’mt Group, Inc., 140 F.3d 463, 470 (3d Cir.

7

1998) ("An abuse of discretion exists where the district

court’s decision rests upon a clearly erroneous finding of

fact, an errant conclusion of law or an improper application

of law to fact.") (quoting ACLU v. Black Horse Pike Reg’l Bd.

of Educ., 84 F.3d 1471, 1476 (3d Cir. 1996)).

A debtor in possession, such as Pillowtex, may, with

bankruptcy court approval, employ one or more attorneys

to represent it and to assist it in fulfilling its duties. See 11

U.S.C. S 327(a). The attorneys selected may not be persons

who "hold or represent an interest adverse to the estate,"

and must be "disinterested persons." Id. The Bankruptcy

Code includes as a "disinterested person," someone who

"does not have an interest materially adverse to the interest

of the estate or of any class of creditors or equity security

holders, by reason of any direct or indirect relationship to,

connection with, or interest in, the debtor . . . , or for any

other reason." 11 U.S.C. S 101(14)(E). Prior representation

of the debtor does not, of itself, merit disqualification. See

11 U.S.C. S 1107(b) ("[A] person is not disqualified for

employment under section 327 of this title by a debtor in

possession solely because of such person’s employment by

or representation of the debtor before the commencement of

the case.").

We have considered the statutory requirements for

retention of counsel in several opinions. In In re BH & P,

Inc., 949 F.2d 1300 (3d Cir. 1991), the bankruptcy court

had disqualified counsel after finding that the law firm had

an actual conflict of interest by representing both the

trustee for the debtor in its chapter 7 proceeding and the

two principals of the debtor who had also filed chapter 7

proceedings. In affirming the disqualification of counsel (as

well as the trustee), we stated that a conflict is actual, and

hence per se disqualifying, if it is likely that a professional

will be placed in a position permitting it to favor one

interest over an impermissibly conflicting interest. See id.

at 1315. We noted that, "[t]he term ‘actual conflict of

interest’ is not defined in the Code and has been given

meaning largely through a case-by-case evaluation of

particular situations arising in the bankruptcy context." Id.

We again considered the standards applicable to

retention of trustee’s counsel in In re Marvel Entertainment

8

Group, Inc., 140 F.3d 463 (3d Cir. 1998). Because the

parties urged "conflicting interpretations of BH&P, we

expressly reiterat[ed]" our earlier holding that:

(1) Section 327(a), as well as S 327(c), imposes a per se

disqualification as trustee’s counsel of any attorney

who has an actual conflict of interest; (2) the district

court may within its discretion -- pursuant toS 327(a)

and consistent with S 327(c) -- disqualify an attorney

who has a potential conflict of interest and (3) the

district court may not disqualify an attorney on the

appearance of conflict alone.

Id. at 476 (emphases added). In Marvel Entertainment, we

reversed the district court’s disqualification of the trustee

and trustee’s counsel because it was predicated only on the

appearance of a conflict. We held that under section 327(a)

the district court could disqualify counsel "only if it had an

actual or potential conflict of interest." Id. at 477.

Although the retention of counsel for the trustee was at

issue in both BH&P and Marvel Entertainment, the same

standards apply to the retention of counsel for the debtor in

possession. See 11 U.S.C. S 1107(a) ("Subject to any

limitations on a trustee serving in a case under this

chapter, and to such limitations or conditions as the court

prescribes, a debtor in possession shall have all the rights,

other than the right to compensation under section 330 of

this title, and powers, and shall perform all the functions

and duties, except the duties specified in sections

1106(a)(2), (3), and (4) of this title, of a trustee serving in a

case under this chapter.").

In In re First Jersey Securities, Inc., 180 F.3d 504 (3d Cir.

1999), the U.S. Trustee objected to retention of the counsel

proposed by the debtor in possession on the ground that

counsel had received a preferential payment, constituting

an interest adverse to the estate. Notwithstanding that both

the bankruptcy court and the district court had approved

counsel’s retention, this court reversed. We stated that

"[w]here there is an actual conflict of interest . . .

disqualification is mandatory." Id. at 509 (citing In re

Marvel Entertainment, 140 F.3d at 476). Then, in language

that the U.S. Trustee here emphasizes, we stated that "[a]

9

preferential transfer to [debtor’s counsel] would constitute

an actual conflict of interest between counsel and the

debtor, and would require the firm’s disqualification." 180

F.3d at 509 (emphasis in original).

We held that counsel was disqualified because within 90

days of the filing for bankruptcy it had received from the

debtor stock in payment of a bill of $250,000 in settlement

for antecedent legal work. Counsel had argued that the

stock payment was made in the ordinary course of business

and therefore not subject to avoidance, but we rejected that

contention because payment of fees in unregistered

restricted securities was a method of payment inconsistent

with the parties’ prior course of dealings. See id. at 513.

The U.S. Trustee relies on the authority of First Jersey

Securities in pointing to Pillowtex’s payment of substantial

fees to Jones Day as a possible preference.

In this case, the District Court never decided whether

Jones Day received an avoidable preference from Pillowtex

when it accelerated billing for and received payment for

past due bills during the ninety days before Pillowtex

declared bankruptcy. An avoidable preference is defined in

section 547(b) of the Bankruptcy Code as

any transfer of an interest of the debtor in property --

(1) to or for the benefit of a creditor; (2) for or on

account of an antecedent debt owed by the debtor

before such transfer was made; (3) made while the

debtor was insolvent; (4) made -- (A) on or within 90

days before the date of the filing of the petition; . . . (5)

that enables such creditor to receive more than such

creditor would receive [in a Chapter 7 distribution]

11 U.S.C. S 547(b).

The preference rule prevents debtors from depleting the

estate to pay favored creditors with assets that otherwise

would have been apportioned among creditors according to

the prioritization scheme of the Bankruptcy Code. See, e.g.,

George M. Treister et al., Fundamentals of Bankruptcy Law

S 4.03(c), at 169 (noting that S 547"is designed to achieve

the policy of fostering equality of distribution among the

creditors of an insolvent debtor"). When the debtor becomes

insolvent, a payment to one creditor from the estate’s

10

limited assets is necessarily paid at the expense of another

creditor. The receipt of a preference by a creditor thus

creates a conflict with unpaid creditors, whose share of the

remaining assets is diminished by the payment.4

In this court, Jones Day explained that it sought

payment from Pillowtex of its outstanding bills in order that

it would not be a creditor at the time of the bankruptcy, as

that would have disqualified it from retention as counsel.5

The record does not show how much of the fee Jones Day

received within the 90 days before bankruptcy was for

bankruptcy preparation, how much was for legal work done

years earlier, and what the ordinary practice was in Jones

Day’s billings to Pillowtex and Pillowtex’s payments. Jones

Day did not make a proffer of such information. Instead, it

argued merely that a hearing was expensive and

unnecessary, and proposed that the court could avoid any

possible conflict by authorizing retention of Jones Day

subject to the conditions that (1) Jones Day return any

_________________________________________________________________

4. Section 327(a) sets forth two relevant standards for disqualification,

one applicable to conflicts with the debtor’s estate and one governing

conflicts with other creditors. The first prohibits a professional from

"hold[ing] or represent[ing] an interest adverse to the estate." 11 U.S.C.

S 327(a). The second, contained in the definition of "disinterested

person," requires that a professional be free of"an interest materially

adverse to the interest of . . . any class of creditors." 11 U.S.C.

S 101(14)(E). Thus, a professional may not have any conflict with the

estate, while a conflict with creditors must be"material."

It is unclear whether, as the U.S. Trustee argues, the receipt of a

preference will always create a conflict with the debtor. "Preference law

. . . is not part of the arsenal of rights and remedies between a debtor

and his creditors. . . . preference law focuses on relationships among

creditors in light of the advantages of a collective proceeding, not on

relationships between creditors and the debtor ." Thomas H. Jackson,

Avoiding Powers in Bankruptcy, 36 Stan. L. Rev. 725, 757 (1984)

(emphasis in original). We reserve the U.S. Trustee’s argument for future

resolution.

5. The Bankruptcy Code prohibits retention of a professional who is a

prepetition creditor of the debtor. See 11 U.S.C. S 101(14)(A) (stating that

a disinterested person "is not a creditor"); Price Waterhouse, 19 F.3d at

141. If Jones Day were determined to have received a preference, its

resulting claim for fees would transform it into a prepetition creditor,

which would pose a disqualifying conflict.

11

preference it is determined to have received, and (2) Jones

Day waive any claim resulting from the preference.

We agree with the U.S. Trustee that the court’s order

incorporating the two conditions does not resolve the

question whether Jones Day received an avoidable

preference and was therefore not disinterested and whether

it should have been disqualified. If payments to Jones Day

were determined to be preferences, Jones Day would, in

any event, be obliged to return the funds to the estate. See

11 U.S.C. S 550 ("[T]o the extent a transfer is avoided under

section . . . 547 . . . of this title, the trustee may recover,

for the benefit of the estate, the property transferred, or . . .

the value of such property.").

Nor does its undertaking to waive the claims resulting

from the preference resolve the issue of its possible

disqualification if the fee payment was an avoidable

preference. Jones Day cites a series of cases to illustrate

that a professional can eliminate an adverse interest by

waiving any claim it has against the estate, but it is not in

the same position as the professionals in these cases. See,

e.g., In re Princeton Medical Mgmt., Inc. , 249 B.R. 813, 816

(Bankr. M.D. Fla. 2000); In re Fulgham Enters., Inc., 181

B.R. 139, 142 (Bankr. N.D. Ala. 1995); In re E. Charter

Tours, Inc., 167 B.R. 995, 996 (Bankr. M.D. Ga. 1994); In

re Adams Furniture Indus., Inc., 158 B.R. 291, 297 (Bankr.

S.D. Ga. 1993); In re Watervliet Paper Co., Inc. , 96 B.R. 768,

774 (Bankr. W.D. Mich. 1989).

In each of the cited cases, the professional waived its fees

prior to being approved for retention under section 327 (a).

See, e.g., Princeton, 249 B.R. at 816 (noting requirement

that retention be denied absent waiver); Fulgham , 181 B.R.

at 142 ("Unless Mr. Beck waives his prepetition claim he

may not be employed by the Debtor"); Charter , 167 B.R. at

998 (denying retention absent waiver); Adams, 158 B.R. at

297 (approving law firm’s retainers in light of waiver);

Watervliet, 96 B.R. at 774 (permitting retention as debtor’s

counsel upon waiver). Here, Jones Day has not actually

waived any fees as there has been no determination that

there was a preference and its amount, but Jones Day was

retained nonetheless.

12

Jones Day points to the decision in In re Midland Food

Servs., LLC, No. 00-4036 (Bankr. D. Del. Dec. 14, 2000)

(oral order granting retention), where a bankruptcy court,

despite a creditor’s claim that the proposed counsel had

been paid a preference, granted a retention petition by

debtor’s counsel based on a conditional waiver similar to

that approved in the District Court’s order in this case. The

bankruptcy court permitted retention based on the court’s

conclusion that a conflict was only potential until the

preference was definitively adjudicated. App. at 186, 189-

90. That decision was not appealed to this court and

appears to be inconsistent with the decision we reach

today.

At the heart of the U.S. Trustee’s objection to retention of

Jones Day as counsel before the preference issue was

decided is the improbability that Jones Day, as counsel to

the debtor-in-possession, would bring an action against

itself to recover any preference. As the U.S. Trustee states

in its brief, "[b]ecause Jones Day has taken and retained

payments that may be preferential and it ‘will not be

advising the Debtors to seek to recover payments made to

Jones Day’ . . . the conflict of interests, if any, has been in

place since Jones Day’s retention was approved and is an

actual conflict of interest today." Appellant’s Reply Br. at 6-

7.

Jones Day responds that there are other creditors who

could raise the preference issue, if it is a matter of concern.

However, the relationship between a debtor and its

creditors is not always adversarial.6 In such a situation, the

U.S. Trustee can play an important role in assuring

adherence to the requirements of the Bankruptcy Code.

Of course, Jones Day does not concede that it received a

preference. It argues that the $997,569.36 it received

within the 90-day period was in the ordinary course of

business, and therefore not an avoidable preference under

section 547(c)(2). Moreover, it argues that any conflict

_________________________________________________________________

6. See generally In the Matter of Arkansas Company, Inc., Debtor, 798

F.2d 645, 649 (3d Cir. 1986) (discussing conduct of some attorneys for

creditors as one of bases for requirement of court approval of counsel for

creditors committee).

13

created by that preference was not material, and notes that,

"once a court concludes the debtor paid a preference to a

professional, it must evaluate whether the preference

creates an "interest materially adverse to the interest of . . .

any class of creditors." S 101(14)(E). See note 4, supra.

According to Jones Day, given the uncertainty over whether

it was paid a preference, let alone a preference constituting

a materially adverse interest to other creditors, the District

Court was well within its discretion to order its retention.

It is true that "historically, bankruptcy courts have been

accorded wide discretion in connection with . . . the terms

and conditions of the employment of professionals."

Appellee’s Br. at 10 (quoting BH & P, 949 F.2d at 1316).

Jones Day argues that therefore a court sitting in

bankruptcy also enjoys considerable discretion in

determining how to address an allegation of a conflict of

interest.

Although a bankruptcy court enjoys considerable

discretion in evaluating whether professionals suffer from

conflicts, that discretion is not limitless. A bankruptcy

court does not enjoy the discretion to bypass the

requirements of the Bankruptcy Code. For example, we

held in United States Trustee v. Price Waterhouse, 19 F.3d

138 (3d Cir. 1994), that, based on the language of the

Code, a bankruptcy court that approves the retention of a

prepetition creditor of the estate necessarily abuses its

discretion. Id. at 141 ("These provisions[of the Bankruptcy

Code], taken together, unambiguously forbid a debtor in

possession from retaining a prepetition creditor to assist it

in the execution of its Title 11 duties.").

At the oral argument, Jones Day contended that all

bankruptcy lawyers find themselves with past due bills

from putative debtors on the eve of bankruptcy and seek to

clear the accounts so that they are qualified to serve as

counsel for the debtor. It suggested that if this court were

to hold that such payments may be avoidable preferences

which must be determined before retention can be

approved, we will disrupt the already hectic period after

bankruptcy filing when the bankruptcy court is occupied

with first day orders and the parties are meeting to form

creditors committees. We believe that some accommodation

14

can undoubtedly be made between the need of counsel for

payment of appropriate fees and the explicit provisions of

the Code. The U. S. Trustee agrees that counsel are entitled

to receive fees for the bankruptcy preparation, although we

reserve the issue how this can be done consistently with

the provisions of the Code. The U.S. Trustee maintained

before the District Court that "professionals entering

bankruptcy cases protect themselves from the preference

issue by obtaining a retainer, and they . . . draw down on

the retainer during the 90 day period so as to avoid raising

the issue of whether or not they received preferential

payments." App. at 207. It also argues that many

preference claims may be insubstantial and that

bankruptcy counsel typically waive past fees due. The U.S.

Trustee focuses on Jones Day’s receipt of payments for past

bills which enabled it to receive 100% of all past due bills

rather than waiving those for earlier work. It argues that

"[p]aying hundreds of thousands of dollars of accrued fees

on the eve of bankruptcy was not typical." Appellant’s Br.

at 18-19.

The record does not show which view is accurate. The

parties may choose to present evidence at the hearing on

remand that would permit the District Court to make a

finding of fact on the matter.

Because there has never been a judicial determination

whether Jones Day received a preference, it is unclear at

this time whether the preference, if there were one,

presents a conflict which would require Jones Day’s

disqualification. We hold that when there has been a

facially plausible claim of a substantial preference, the

district court and/or the bankruptcy court cannot avoid the

clear mandate of the statute by the mere expedient of

approving retention conditional on a later determination of

the preference issue.

The District Court in this case could not adequately

evaluate the alleged conflict and was not in a position to

conclude that any preference did not pose a conflict with

Pillowtex’s estate or a material conflict with the other

creditors. We therefore agree with the U.S. Trustee that the

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District Court must hold a hearing on whether Pillowtex

received a preference, and will remand for that purpose.7

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

_________________________________________________________________

7. There was some confusion at oral argument about whether the U.S.

Trustee has standing to pursue the preference action below. Although we

leave the question to the District Court on remand in the first instance,

we call to its attention our discussion in U.S. Trustee v. Columbia Gas

Sys. Inc. (In re Columbia Gas Sys. Inc.), 33 F.3d 294 (3d Cir. 1994),

where we observed of section 307 of the Code, "[i]t is difficult to conceive

of a statute that more clearly signifies Congress’s intent to confer

standing." Id. at 296.

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