Two recent decisions by separate judges of the Delaware Bankruptcy Court have addressed the question of whether persons providing services to debtors relating to the disposition and monetization of inventory, real estate, intellectual property and other estate assets are “professionals” and must be retained under the strictures of Section 327(a) of the Bankruptcy Code. In both cases, the judges decided that the providers were neither auctioneers nor professionals within the meaning of Section 327(a) and did not have to comply the requirements of that section.

Section 327(a) governs the retention of general bankruptcy counsel, other attorneys, accountants, appraisers, auctioneers, and other professional persons, such as investment bankers and financial advisers, by trustees or debtors-in-possession to carry out their duties under the code. The retention of such persons must be requested and approved by the court based on a showing of the professional's disinterestedness and lack of interests adverse to the estate. This requires the estate and the professional to disclose all connections and potential conflicts-of-interests, both at the time of the original application and on an ongoing basis. The professionals must also satisfy all requirements of applicable professional codes of conduct on a continuous basis. Finally, professionals must submit periodic, detailed fee applications that are subject to bankruptcy court approval and may result in significant delays in payment.

The Bankruptcy Code does not define the “other professionals” that fall within Section 327(a). In In re Brookstone Holdings, Case No. 18-11780 (BLS) (Bankr. D. Del. Oct. 1, 2018), the debtor, Brookstone, a well-known manufacturing and retailing business, sought to assume a store closing agreement that had been entered in pre-petition with Hilco to perform certain services relating to going-out-of-business sales. Hilco and the debtor left open and expressly contemplated that Hilco might be called upon or invited to play other roles in the case as circumstances may require, such as buying estate assets or even serving as a lender to Brookstone.

The U.S. trustee (UST) argued that Hilco was serving as an auctioneer and so must be retained under Section 327(a). Alternatively, the UST argued that, given the nature of the services to be performed by Hilco for the debtor, Hilco was an “other professional” within the meaning of that term as used in Section 327(a) and must be formally retained.

Hilco and the debtor argued that Hilco and its peers have performed these services, without being retained under Section 327(a), in scores of retail bankruptcies stretching back decades. They argued that Hilco was not an auctioneer since it was not conducting an auction. They  contended that Hilco was not an “other professional” under Section 327(a) under the six-factor test laid down in In re First Merchants Acceptance, (D. Del. Dec. 15, 1997). Finally, they argued that any ruling that would require Hilco to be retained as a professional would have a significant and detrimental impact, not only in the instant case, but in most retail Chapter 11 cases by severely limiting the types of work and services Hilco could perform.

Judge Shannon easily disposed of the contention that Hilco was an auctioneer for purposes of section 327(a). Since the Bankruptcy Code does not define “auctioneer,” he looked to common usage and dictionary definitions of “auctioneer” and “auction” to refer to a public sale to the highest bidder. Under the agreement with Hilco, the inventory was not being sold to the highest bidder at a public sale, but instead, was being priced and sold at stores in a manner typical of a retail sale. The customer does not compete with other purchasers for items, but selects and buys pre-priced merchandise from the store.

In determining that Hilco was not an “other professional” for purposes of Section 327(a), Shannon looked to the six factors developed in First Merchants:

• Whether the employee controls, manages, administers, invests, purchases or sells assets that are significant to the debtor's reorganization.

• Whether the employee is involved in negotiating the terms of a Plan of Reorganization.

• Whether the employment is directly related to the type of work carried out by the debtor or to the routine maintenance of the debtor's business operations.

• Whether the employee is given discretion or autonomy to exercise his or her own professional judgment in some part of the administration of the debtor's estate, i.e., the qualitative approach.

• The extent of the employee's involvement in the administration of the debtor's estate, i.e. the quantitative approach.

• Whether the employee's services involve some degree of special knowledge or skill, such that the employee can be considered a “professional” within the ordinary meaning of the term.

Applying these factors to the facts, Shannon found that Hilco was not acting as an “other professional” when performing its duties pursuant to the store closing agreement. Some of the key considerations included the fact that the debtor remained in complete control of the going-out-of-business sales and Hilco neither controlled nor managed that process. The sales were to be conducted in the debtor's stores, run by the debtor's existing employees, with the debtor retaining control over the pricing strategies and the duration of the sales. Hilco was also not involved in negotiating the terms of the plan of reorganization, and was not given discretion to accomplish tasks that were within the fiduciary duties of the debtor. The only factor that weighed in favor of the U.S. trustee was that Hilco's services related to the debtor's restructuring activity and not the debtor's routine business operations.

Shannon was satisfied that Hilco's services, while valuable and important, were not sufficiently central to the development and implementation of the debtor's reorganization to support a finding that it was a “professional” within the meaning of Section 327(a). The established practice requires fulsome disclosure of the services to be provided and the compensation to be paid, followed by a hearing on the merits where a debtor must carry its burden under sections 365 and 363 of the Bankruptcy Code to demonstrate that it is proceeding in good faith and that its proposed course of action reflects the exercise of its reasonable business judgment. This was sufficient to address the U.S. trustee's legitimate desire for transparency and due process without imposing the additional requirements and restrictions required by Section 327(a).

Shannon found support for his decision in a recent opinion by another Delaware Bankruptcy Judge in In re Heritage Home Group, Case No. 18-11736 (KG) (Bankr. D. Del. Sept. 27, 2018). In that case, Judge Gross had to decide whether SB360 Capital Partners was a professional where it was acting in a role substantially similar to Hilco in the Brookstone case. After reviewing the applicable legal test derived from the First Merchants decision, Gross distilled the relevant analysis down to the following standard: “What is clear in First Merchants is that a 'professional' is limited to those occupations which control, purchase or sell assets that are important to reorganization, is negotiating the terms of a plan of reorganization, [and] has discretion to exercise his or her own personal judgment.”  Gross reviewed the responsibilities of SB360 under the terms of a disposition agreement and concluded that it had no discretion over business decisions, but was limited to making recommendations to the debtors and was not at the center of the debtors' reorganization. Its role was that of an adviser and not an “other professional” within the meaning of Section 327(a).

These two cases suggest the importance to the outcome of the detailed enumeration of the duties and responsibilities of the adviser/consultant, and the careful cabining of the adviser/consultant's discretion, both with respect to the specific role of the adviser/consultant in performing its duties and responsibilities and with respect to the plan of reorganization generally.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.