In a decision that bankruptcy professionals are certain to applaud, the United States Bankruptcy Appellate Panel of the Sixth Circuit held that bankruptcy courts must not order disgorgement of attorneys’ retainers in bankruptcy cases if the attorney has perfected a lien in the retainer under state law. Prior to In re Two Gales, some bankruptcy courts had justified disgorgement as necessary to comply with 11 U.S.C. § 726(b), which requires administrative claimants to be compensated through pro rata distributions upon administrative insolvency. In re Two Gales confirmed what some other bankruptcy courts have already held: section 726(b) is not intended to serve as a basis for denying or disgorging an attorney’s fees, but rather serves as a priority scheme for dealing with distributions on allowed claims.
In re Two Gales most certainly comes as a relief to bankruptcy practitioners because it was only a few years ago, in Specker Motor Sales Co. v. Eisen, that the Sixth Circuit Court of Appeals held that disgorgement of professional fees was required when necessary to provide for pro rata distributions under 11 U.S.C. § 726(b). After that decision, bankruptcy attorneys were left scrambling to figure out how they could protect retainers and other approved payments from disgorgement. While some courts have held that disgorgement is discretionary under section 726(b), other courts, such as Specker, have held it to be mandatory, thus leaving bankruptcy professionals limited options when facing disgorgement of their retainers. In re Two Gales is a decision that can serve to unite the various court holdings; it clarifies that while section § 726(b) may indeed require mandatory disgorgement in the case of administrative insolvency, courts cannot force such a disgorgement when faced with a retainer that has been secured with a lien under state law. This memo attempts to provide bankruptcy practitioners with an understanding of the different types of retainers permitted by law and to advise them how they might ensure that their retainers are not disgorged in the case of administrative insolvency. Part I of this memo provides a background of 11 U.S.C. § 726(b) and caselaw surrounding its application to retainers. Part II then provides a summary of the various types of retainers available in bankruptcy cases. Finally, in Part III, this memo analyzes the implications of In re Two Gales, and explains how the decision will serve to ensure bankruptcy professionals rarely face disgorgement of their retainers.