Sections 327, 1103, and 1107 of the Bankruptcy Code govern the employment of professionals in connection with a chapter 11 case. For professionals employed by creditors' committees pursuant to 11 U.S.C. § 1103, see USTM 3-4.2.5. The following discussion is primarily directed at the employment of professionals by debtors in possession and chapter 11 trustees. Unless the professional comes within the limited exception provided for by 11 U.S.C. § 327(b), prior court approval of the employment of a professional person is necessary. The retention process is designed to ensure public confidence in the bankruptcy system, to prevent abuses, and to achieve some degree of economy in the administration of the case by limiting the retention of professionals only to those instances where it can be demonstrated that the services are necessary. Furthermore, the requirements of 11 U.S.C. § 327 "serve the important policy of ensuring that all professionals appointed pursuant to [the section] tender undivided loyalty and provide untainted advice and assistance in furtherance of their fiduciary responsibilities." Rome v. Braunstein, 19 F.3d 54, 58 (1st Cir. 1994). 28 U.S.C. § 586(a)(3)(H) specifically requires the United States Trustee to monitor employment applications and, when appropriate, to file with the court comments with respect to the approval of such applications.

Court approval of a professional person's employment is contingent upon a finding that the applicant has met a two-pronged test: (1) the professional must be disinterested, 11 U.S.C. § 327(a) (see USTM 3-6.2); and (2) must not hold an interest adverse to the estate. The question of whether a professional meets the standards of the law is one for the court to adjudicate after a full disclosure of the facts. In re Leslie Fay Cos., Inc., 175 B.R. 525 (Bankr. S.D.N.Y. 1994). A failure to disclose constitutes an independent basis for disqualification. In re Diamond Mortgage Corp., 135 B.R. 78 (Bankr. N.D. Ill. 1996).

A professional's conflict of interest may render him or her ineligible to serve as a professional under 11 U.S.C. § 327(a). Despite the requirements of that section and the definition of a "disinterested person" that appears in 11 U.S.C. § 101(14), a professional is not necessarily disqualified from employment because of representation of both the trustee and a creditor. 11 U.S.C. § 327(c) requires the presence of an actual conflict of interest; however, the statute does not define an actual conflict of interest. Whether the professional's representation is precluded is dependent on a detailed consideration of the relevant circumstances. Few per se rules exist in this area; however, case law can provide some guidance regarding specific situations. See In re W.F. Dev. Corp., 905 F.2d 883 (5th Cir. 1990), cert. denied, 499 U.S. 921 (1991) (holding that when one attorney represents both limited and general partners in bankruptcy, there will always be a potential for conflict and disqualification is proper).

Some courts require an actual conflict of interest to render counsel not disinterested. See In re Waterfall Village of Atlantic, Inc., 103 B.R. 340, 344 (Bankr. N.D. Ga. 1989); In re Stanford Color Photo, Inc., 98 B.R. 135, 137-38 (Bankr. D. Conn. 1989). Other courts find a potential conflict is disabling. See Matter of Codesco, Inc., 18 B.R. 997, 999 (Bankr. S.D.N.Y. 1982); In re Proof of the Pudding, Inc., 3 B.R. 645, 647 (Bankr. S.D.N.Y. 1980); see also In re Bohack Corp., 607 F.2d 258, 263 (2d Cir. 1979). Some courts find that there is no distinction between a potential or an actual conflict. See, e.g., In re Adams Furniture Indus., Inc., 158 B.R. 291, 301 (Bankr. S.D. Ga. 1993); see generally Comment, Bankruptcy Code Section 327(a) and Potential Conflicts of Interests - Always or Never Disabling?, 29 Hous. L. Rev. 433 (1992). Generally, a finding of actual conflict warrants disqualification of a professional under 11 U.S.C. § 327(a). See, e.g., In re Roberts, 46 B.R. 815, 847 (Bankr. D. Utah 1985), aff'd in part, 75 B.R. 402 (D. Utah 1987). For an extended discussion, see 5 ABI Law Review Number 1 (Spring 1997) and Smith, Conflicts of Interest in Workouts and Bankruptcy Reorganization Cases, 485 Case Law Review 794 (Summer 1997).

In addition, under the appropriate circumstance, the appearance of impropriety or an appearance of potential conflict can be grounds for disqualification of counsel. See, e.g., In re Braten, 73 B.R. 896, 899 (Bankr. S.D.N.Y. 1987) (citing Sapienza v. New York News, Inc., 481 F. Supp. 676 (S.D.N.Y. 1979)); In re Proof of the Pudding, Inc., 3 B.R. 645, 648 (Bankr. S.D.N.Y. 1980).

For example, in Codesco, the court stated that:

[t]here is no question that the purpose of the incorporation of the disinterest requirement in 11 U.S.C. § 327 was to prevent even the appearance of a conflict irrespective of the integrity of the person or firm under consideration. Certainly, a "disinterested" person should be divested of any scintilla of personal interest which might be reflected in his decision concerning estate matters.

18 B.R. at 999 (citing In re Realty Assoc. Sec. Corp., 56 F. Supp. 1007 (E.D.N.Y. 1944)). In TWI Int'l., Inc. v. Vanguard Oil and Service Co., 162 B.R. 672 (S.D.N.Y. 1994), the district court noted that given the parameters of sections 327(a) and 101(14):

[d]isqualification should be mandated when an actual, as opposed to hypothetical or theoretical, conflict is present. This in no way precludes disqualification for a potential conflict. The test is merely one of a potential actual conflict.

162 B.R. at 675 (quoting In re O'Connor, 52 B.R. 892, 897 (Bankr. W.D. Okla. 1985)).

In In re Marvel Entertainment Group, 140 F.3d 463 (3d Cir. 1998), the Third Circuit reversed the district court's denial of the trustee's retention of his law firm as trustee's counsel. In reversing the lower court, the circuit court emphasized that mere "horrible imaginings" could not rise to the level of a conflict requiring disqualification. In this case, the trustee hired his law firm to represent him in administering this large chapter 11 estate. The firm had earlier represented a creditor in an unrelated matter for which it had received $48,000 (less than 1 percent of firm revenues for the year). Additionally, the firm had obtained unconditional waivers and had disengaged from further representation of the creditor. In ruling for the trustee, the circuit court noted that an actual conflict would per se require disqualification and a potential conflict would require the trial court to exercise its discretion. However, in this particular case, neither of the disqualifying situations were present.

Pursuant to 11 U.S.C. § 328(c), the court may deny allowance of compensation for services and reimbursement of expenses to a professional employed pursuant to 11 U.S.C. § 327 or 1103 of that title if the court finds that at any time during the employment the professional was not a disinterested person or held or represented an interest adverse to the estate.

In In re Granite Partners, L.P., 219 B.R. 22 (Bankr. S.D.N.Y. 1998), the bankruptcy court found that the law firm retained by the chapter 11 trustee represented potentially adverse interests to the estate relating to investigative work undertaken at the trustee's request and that the law firm had failed to disclose same to the court. In admonishing the law firm, the court noted the necessitation of imposing a severe sanction, i.e., significantly reducing the requested compensation. Although the court acknowledged that an independent examiner concluded that no harm had been inflicted on the estate, the willfulness exhibited by the law firm's flagrant non-disclosure required the sanction.

The United States Trustee should examine the application for employment and its accompanying verified statement expeditiously to determine not only if the proposed professional service is necessary, but also for any disclosures suggesting questionable relationships, divided loyalties, or disqualifying adverse interests. Issues that may warrant closer scrutiny include multiple debtor representation, simultaneous representation of a limited partnership and a general partner, representation of a corporation and an affiliate or shareholder, receipt of a preference or unpaid fees, security interests taken to secure the payment of fees or other unusual arrangements for compensation, and prior or concurrent representation of a major creditor. Where appropriate, the United States Trustee should insist on further disclosure or comment on any unusual aspects of the application. The United States Trustee should object to the employment when the services are unnecessary or duplicative, the applicant is not disinterested, or representation of adverse interests warrants disqualification.

Fed. R. Bankr. P. 2014(a) requires that a copy of the employment application be transmitted to the United States Trustee, but it does not specify any additional parties that must be served. The issue of notice may be addressed by local rule or customary practice. When appropriate, however, the United States Trustee may suggest that only interim orders authorizing employment be entered ex parte pending notice and opportunity for objection by parties in interest before the order is permitted to become final.

The contents of an employment application are dictated by Fed. R. Bankr. P. 2014. It must contain all of the following elements:

1. specific facts showing the necessity of the employment;
2. the name of the person to be employed;
3. the reasons for the selection;
4. the professional services to be rendered;
5. any proposed arrangement for compensation; and
6. all of the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States Trustee, or any person employed in the Office of the United States Trustee.

Fed. R. Bankr. P. 2014 disclosure requirements are to be strictly construed. Rome v. Braunstein, 19 F.3d 54, 59 (1st Cir. 1994); In re Arlan's Dep't Stores, Inc., 615 F.2d 925, 933 (2d Cir. 1979) (decided under substantially similar predecessor to Fed. R. Bankr. P. 2014). All facts that may have any bearing on the disinterestedness of a professional must be disclosed. It is the responsibility of the professional, not of the court, to ensure that all relevant connections have been brought to light. See, e.g., Rome v. Braunstein, 19 F. 3d at 58-60; In re Glenn Elec. Sales, 99 B.R. 596, 599 (D.N.J. 1988); Diamond Lumber, Inc. v. Unsecured Creditors' Committee, 88 B.R. 773, 776 (N.D. Tex. 1988). Failure to disclose relevant connections is an independent basis for the disallowance of fees or disqualification. See In re Futuronics Corp., 655 F.2d 463, 469 (2d Cir. 1981), cert. denied, 455 U.S. 941 (1982); In re Arlan's Dep't Stores, Inc., 615 F.2d at 933; Rome v. Braunstein, 19 F.3d at 59; In re Leslie Fay Cos., Inc., 175 B.R. 525 (Bankr. S.D.N.Y. 1994); In re Granite Sheet Metal Works, Inc., 159 B.R. 840, 847 (Bankr. S.D. Ill. 1993); In re Envirodyne Indus., Inc., 150 B.R. 1008, 1021 (Bankr. N.D. Ill. 1993).

Until such time as an order is entered authorizing employment, professionals perform services at their peril. Some circuits enforce a rule denying compensation to professionals for work done prior to the filing of an application for employment unless, as a matter of fundamental fairness, the court approves a nunc pro tunc application. See Lavender v. Wood Law Firm, 785 F.2d 247 (8th Cir. 1986). Another line of cases, represented by In re Triangle Chemicals, Inc., 697 F.2d 1280 (5th Cir. 1983), superceded by 11 U.S.C. § 327 as stated in In re Sound Radio, Inc., 145 B.R. 193 (Bankr. D.N.J. 1992), limits entry of nunc pro tunc employment orders to extraordinary circumstances and not merely because the appointment requirement was overlooked. Mere oversight and inadvertence of counsel are not extraordinary circumstances. In re Jarvis, 53 F.3d 416 (1st Cir. 1995); In re F/S Airlease II, Inc., 844 F.2d 99 (3d Cir.), cert. denied, 488 U.S. 852 (1988); In re Arkansas Co., Inc., 798 F.2d 645 (3d Cir. 1986). See also In re Diamond Mort. Corp., 77 B.R. 597 (Bankr. E.D. Mich. 1987). In In re Triangle Chemicals, the court concluded that the bankruptcy judge, in the exercise of sound discretion and as a court of equity, may enter an order nunc pro tunc. 697 F.2d at 1289.

The more liberal line of cases is represented by In re Vlachos, 61 B.R. 473, 479 (Bankr. S.D. Ohio 1986) and In re Georgetown of Kettering, Ltd., 750 F.2d 536 (6th Cir. 1984).

The "liberal approach" would permit a nunc pro tunc order if:

1. the application would have been approved originally by the court;
2. evidence appears in the record that demonstrates that the court and other interested parties had actual knowledge of the services being rendered;
3. an application seeking an order nunc pro tunc has been filed as soon as the matter is brought to the applicant's attention; and
4. a sustainable objection has not been filed to the application for fees.

The better practice is to seek an order of employment prior to the commencement of services. The United States Trustee should enforce the requirement of prior court approval and object to the entry of nunc pro tunc orders, if appropriate.

Every attorney for a debtor must file the statement required by 11 U.S.C. § 329 within 15 days of the order for relief setting forth the compensation paid or agreed to be paid for services rendered or to be rendered in contemplation of or in connection with the bankruptcy case and the source of such compensation. Fed. R. Bankr. P. 2016(b) also requires disclosure of any agreement to share compensation with any other entity (other than a member or regular associate of the attorney's law firm). Fed. R. Bankr. P. 2017 permits the court on the motion of a party in interest or on its own initiative to determine whether any payment or transfer to an attorney is excessive. Pursuant to 11 U.S.C. § 329(b), the court may order the return of any excessive payments to the estate or the entity that made the payment.

The court must approve the retention of appraisers and auctioneers who must meet the same statutory requirements as other professionals. 11 U.S.C. § 327(a). Fed. R. Bankr. P. 6005 requires that the order of retention fix the amount or rate of compensation. The Rule further provides that no employee or officer of the judiciary or of the Department of Justice may act as an appraiser or auctioneer, and provides that no residence or licensing requirement is to be required, even though most states require an auctioneer to be licensed and bonded. It is not unusual for an appraiser to be compensated on a per diem basis and an auctioneer to be compensated at a percentage of the gross proceeds of sale. Local rules may govern the maximum allowable percentage to auctioneers. The appraiser and the auctioneer should not be one and the same person. An obvious conflict arises where the same person appraises items that he/she will be auctioning, and the United States Trustee should object if it is proposed that one person be employed in both capacities.

Auctioneers must be bonded since they handle significant amounts of cash belonging to estates. The amount may be set by local rules, but the United States Trustee should require a bond of an amount sufficient to protect the estate. The bonds are generally filed with the clerk of the court. All proceeds of an auction sale are to be delivered to the trustee or the attorney for the debtor in possession as soon as they are received.

All auction sales are to be noticed pursuant to Fed. R. Bankr. P. 6004(a), and the auctioneer must submit an itemized statement of the property sold, the name of each purchaser, and the price received. Fed. R. Bankr. P. 6004(f)(1).

An attorney who may be ineligible for employment under 11 U.S.C. § 327(a) may be hired under 11 U.S.C. § 327(e) if the employment is for a specified special purpose (other than general conduct of the case), provided that the employment is in the best interest of the estate and the attorney does not hold or represent an interest adverse to the estate with respect to the particular matter for which such attorney is employed. Note that 11 U.S.C. § 327(e) applies only to attorneys. Accountants and other professional persons are not eligible for employment pursuant to that section. Moreover, at least one district court in parsing the statute has required counsel to have been formerly employed by the debtor. See Meespierson v. Strategic Telecom, Inc., 202 B.R. 845 (D. Del. 1996).

An analysis of whether special counsel qualifies for employment under 11 U.S.C. § 327(e) should begin with an understanding of applicable ethical regulations. Certain potential conflicts are capable of being waived after full disclosure and consent. Most often, the question will become whether the conflicting interest that makes counsel ineligible for employment under 11 U.S.C. § 327(a) is such that counsel is rendered incapable of exercising independent professional judgment on behalf of the client. If the employment necessarily requires that one interest be served at the expense of the other, an adverse interest exists which should disqualify counsel for employment pursuant to 11 U.S.C. § 327(e).