IN RE CENTRAL VALLEY PROCESSING, INC. (Bankr.E.D.Cal. 2005)

RICHARD LEE, Bankruptcy Judge

The Application for Payment of Chapter 11 Final Fees and/or Expenses (the "Second WLG Fee Application") filed by the Walter Law Group ("WLG") and the Joint Motion for Authority to Surcharge Collateral under 11 U.S.C. § 506(c) (the "Second Surcharge Motion") filed by WLG and Michael McGranahan (the "Trustee") were heard on April 28, 2004. The parties were given an opportunity to submit supplemental briefs and the matters were taken under submission effective May 28, 2004. The court deferred ruling on these matters pending the outcome of Objecting Creditors' appeal of a prior ruling in favor of WLG. That appeal was dismissed on March 30, 2005.

This Second WLG Fee Application seeks final approval pursuant to 11 U.S.C. § 330 for services rendered by WLG as counsel for the Growers' Committee, during the time this case was in chapter 11. The Second Surcharge Motion seeks authority to have WLG's fees paid from a segregated fund referred to herein as the Grower Proceeds. The court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334 and 11 U.S.C. §§ 330, 331, 506 105. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A). For the reasons set forth below, the Second WLG Fee Application will be treated as an interim application pursuant to 11 U.S.C. § 331, and will be approved. The Second Surcharge Motion will also be granted on an interim basis.

Background. The Growers' Committee.

This bankruptcy case commenced with a voluntary petition under chapter 11 on February 21, 2003. The Debtor was in the business of processing and selling almonds which the Debtor purchased from numerous entities. At commencement of this case, the Debtor owed money to approximately 64 persons and entities who had grown and delivered almonds to the Debtor in the 2002 crop year (the "Growers"). The Debtor was also in possession of approximately four million pounds of unprocessed almonds which the Debtor had purchased from the Growers (the "Almond Inventory"). Prior to commencement of the case, the Debtor had been selling processed almonds without paying the Growers as required by the California Food and Agricultural Code. The Debtor's lender, American Ag. Credit ("AAC"), had a lien on the Debtor's accounts receivable and it appeared that the Debtor had been using proceeds from the sale of almonds to, inter alia, make debt service payments to AAC.

Early in the case, the Debtor brought a motion for use of AAC's cash collateral, the pre-petition accounts receivable. The Debtor also sought permission to, in essence, continue selling the Almond Inventory and to use those proceeds to pay operating expenses. The Debtor proposed to give AAC a replacement lien against the Almond Inventory as "adequate protection" for the used cash collateral. This court denied the cash collateral motion without prejudice. However, through that proceeding it became apparent to the court that the Growers, as a group, had priority lien rights against the Almond Inventory pursuant to California Food and Agricultural Code section 55631 (the "Grower Liens"). It also became apparent that (1) many Growers would suffer serious financial hardship if the Almond Inventory was not liquidated and the proceeds distributed to the Growers as soon as possible, and (2) the Growers' rights under State law were not being recognized, honored, or protected by the Debtor.

Objecting Creditors are former shareholders and directors of the Debtor. Prior to commencement of the bankruptcy, they sold their shares to an outside investor and resigned from the Debtor's board of directors. Objecting Creditors apparently sold almonds to the Debtor and claimed Grower Lien rights along with the other Growers.

As secured creditors, the Growers had common interests which were adverse to both the Debtor, Debtor's management, and the unsecured creditors. Each Grower had an undivided equal priority interest in a common asset, the Almond Inventory, which was not large enough to satisfy all of the Grower claims. Because of the size and disparity of the Grower group, the common nature of the Grower Liens, and the possibility of other rights and remedies available to the Growers under State law, the court determined that it was neither practical nor prudent to require each Grower to hire independent counsel to protect its rights in this case. Further, the court concluded that the common interests of the Growers could not be effectively represented by either the Debtor, a trustee, or a committee of unsecured creditors. For that reason, the court sua sponte ordered the appointment of the Growers' Committee pursuant to 11 U.S.C. § 1102 (a)(2) and the court's inherent authority under 11 U.S.C. § 105(a) to represent and protect the Growers' rights under, inter alia, the Cal. Food and Agric. Code. The Growers' Committee was appointed on March 13, 2003. On April 4, 2003, the court authorized the Growers' Committee to employ WLG as its counsel.

11 U.S.C. section 1102(a)(2) states in pertinent part:

On request of a party in interest, the court may order the appointment of additional committees of creditors . . . if necessary to assure adequate representation of creditors. . . . The United States trustee shall appoint any such committee.

11 U.S.C. § 105(a) states in pertinent part:

The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.

The Segregated Grower Proceeds.

On June 5, 2003, the court authorized the Debtor to process and sell the Almond Inventory. That effort generated net proceeds of approximately $3.1 million. However, the court ordered the Debtor to segregate the proceeds pending a determination of how to distribute those funds in compliance with applicable law (the "Grower Proceeds"). The court also ordered that the statutory Grower Liens would attach to the Grower Proceeds, subject to further order of the court. The processing costs were to be financed with AAC's cash collateral. The court authorized in advance a surcharge of the Grower Proceeds, not to exceed 5.68 cents per pound of unprocessed almonds, to reimburse AAC for the expenses associated with liquidation of the Almond Inventory.

The Chapter 11 Trustee.

On August 12, 2003, the court ordered the appointment of a chapter 11 trustee based upon a showing that the Debtor's management had conflicts of interest and was unable to properly administer the estate. Michael McGranahan was appointed to serve as the chapter 11 trustee. By that time, the Growers' Committee, by default, had become actively involved in administrative activities which were not being handled by Debtor's management. The Growers' Committee assisted the U.S. Trustee in its effort to remove the Debtor's management from control. The court authorized the Trustee to continue processing and selling the remaining Almond Inventory subject to the Growers' Committee's oversight and protection of the Grower Liens. The Committee also undertook the investigation of claims asserted by the individual Growers themselves, including those of the Objecting Creditors. The Committee worked to confirm the amounts of the Growers' claims and whether they qualified to be on the Growers' Committee and to participate in any distribution of Grower Proceeds.

On November 26, 2003, the case was converted to chapter 7 pursuant to 11 U.S.C. § 1112(b) on motion of the U.S. Trustee. Michael McGranahan was reappointed to continue as the chapter 7 trustee. The Grower Proceeds had not yet been distributed and the court also authorized the Growers' Committee to continue functioning with WLG as its counsel.

WLG's First Interim Fee Award and Surcharge Order.

On October 3, 2003, this court approved WLG's first interim application for fees in the amount of $45,906.50 and expenses in the amount of $3,316.48 (the "First Interim Fee Award"). The chairman of the Growers' Committee and the Trustee supported WLG's fee application. The Objecting Creditors opposed it. The First Interim Fee Award was interlocutory and non-appealable.

In a companion motion, WLG also sought to surcharge the First Interim Fee Award against the Grower Proceeds (the "First Surcharge Motion"). The First Interim Fee Award expressly prohibited the actual payment of any fees until the court ruled on the First Surcharge Motion. Again, the Committee and the Trustee supported the First Surcharge Motion; the Objecting Creditors opposed it.

The Trustee and the Growers' Committee completed their evaluation of the Growers' claims and prepared a schedule showing their calculation of how much each Grower had already been paid and how much each Grower was still owed for its 2002 crop. On December 11, 2003, this court approved the Trustee's request to distribute some of the Grower Proceeds. The Trustee was authorized to make an interim distribution of $2,642,092.90 to Growers, such that they would each realize a minimum 50% payment of their claims (the "First Grower Distribution Order"). Objecting Creditor Dill received $125,267.95 in the First Distribution. Objecting Creditor Crafton apparently also received some payment, although his name is not on the distribution list. Objecting Creditors Pursley and Torrano were not paid anything under the First Grower Distribution Order because they had already been paid in excess of 50% of their claims.

The First Grower Distribution Order was structured to assure that each Grower received at least 50% of its claim for the 2002 crop. Some of the Growers, who had already received more than 50% for their crop, objected to the proposed distribution. They demanded that the money be distributed to all Growers based on the unpaid balance of their claims. The court overruled that objection and not all Growers received a distribution of Grower Proceeds.

On December 29, 2003, the court ruled that WLG's First Interim Fee Award could be paid from the Grower Proceeds (the "First Surcharge Order"). The Trustee made the disbursements as directed in the First Grower Distribution Order and the First Surcharge Order. The court is informed that there are about $370,000 of remaining Grower Proceeds. The surcharge paid to WLG represented approximately 1.5% of the total distribution.

The Appeal.

The Objecting Creditors appealed the First Surcharge Order to the U.S. District Court on December 31, 2003 (the "Surcharge Appeal"). The First Surcharge Order was still on appeal when the court heard oral argument on this Second WLG Fee Application. The Surcharge Appeal potentially affected the court's ability to further surcharge the Grower Proceeds and the court was not persuaded that WLG's fees should be paid from the general estate. The court therefore deferred ruling on this matter until the Surcharge Appeal was resolved.

The Surcharge Appeal was dismissed by the District Court for lack of subject matter jurisdiction on March 30, 2005 (the "Appeal Dismissal Order"). In the Appeal Dismissal Order, the District Court held that the First Surcharge Order was interlocutory and non-appealable. The District Court also held that Objecting Creditors Pursley and Torrano did not have standing to object to surcharge of the Grower Proceeds because they were not entitled to receive any payment under the First Grower Distribution Order — the Debtor had already paid Pursley and Torrano more than 50% for their 2002 crop. The District Court observed, "Appellants Pursley and Torrano thus did not have an interest in the funds to be distributed, to which the surcharge applied."

The Second Fee Application and Surcharge Motion.

In this Second WLG Fee Application, WLG seeks an additional award of $61,069.50 for fees, plus $7,433.30 for costs incurred in the period between its first application and conversion of the case to chapter 7. WLG also seeks to have its fees and costs paid from the remaining Grower Proceeds. The chairman of Growers' Committee, Jim Frazier, filed a statement affirmatively approving both requests. The Trustee also filed a statement affirmatively approving WLG's fees, at least to the extent of those services rendered after the Trustee's initial appointment. The Trustee stated, "[WLG's] services significantly aided the Trustee's efforts to distribute the proceeds from the sale of Debtor's post-petition almond inventory. Applicant zealously represented the interests of the grower body throughout that process. . . ." The Trustee joined WLG in the Second Surcharge Motion.

WLG requests compensation for 223.7 hours of legal service. This calculates to a blended hourly rate of $273. WLG's fees are allocated in "project categories" as follows:

Project Total Fee Charged

Case Administration $ 5,443.50 Claims Administration and Objections $ 1,422.00 Estate/Business Operations $ -0- Fee/Employment Application $ 4,770.00 Financing $ 1,170.00 Litigation/Other Contested Matters $40,011.00 Plan and Disclosure Statement $ 210.00 Relief From Stay/Adequate Protection $ 322.50 Sales, Leases Dispositions $ 7,720.50

Creditor Objections.

Objecting Creditors and Zehrung filed objections to the Second WLG Fee Application. The principal objection raised by both goes to the proposed treatment of the Second WLG Fee Application as a final fee application. Objecting Creditors also objected to the Second Surcharge Motion. They argued that the court could not make a final ruling because of the then pending Surcharge Appeal. However, dismissal of the Surcharge Appeal while this matter was under submission makes that objection a moot issue.

Objecting Creditors also object on procedural grounds that they were not given sufficient opportunity to respond to the Second Surcharge Motion. However, they did respond fully to the Second Surcharge Motion in their Additional Points and Authorities. Further, the court's decision to treat both the Second WLG Fee Application and the Second Surcharge Motion as motions for interim relief, makes this objection a moot issue as well.

The various objections are summarized generally as follows:

(1) WLG's overall fees are excessive for the work performed by WLG in comparison with the work performed by Debtor's counsel;

(2) The hourly billing rate charged by Riley Walter is excessive in relation to the prevailing rate charged for similar services by other attorneys in the area. They also complain that WLG raised its billing rate during the billing period "without giving notice to anyone but the Committee";

(3) Objecting Creditors object to fees charged in an unstated amount for "litigation"; fees totaling $13,254 relating to engagement of the Drummond Law Firm; work done early in the case totaling $2,480 to recruit and support the appointment of a chapter 11 trustee; work performed totaling $720 to bring the First Surcharge Motion; expenses totaling $576 relating to WLG's support of "criminal" matters; services totaling $1,380 for opposing conversion of the case to chapter 7; and services rendered in an unstated amount outside of the scope of WLG's appointment; and

(4) Objecting Creditors raise 15 "miscellaneous" objections to specific time entries on WLG's billing records totaling $2,288; and

(5) That WLG has not made a showing sufficient to support surcharge of the Grower Proceeds under 11 U.S.C. § 506(c).

WLG's Response.

In reply to the above objections, WLG responds in summary as follows:

(1) The Objecting Creditors were insiders of the Debtor, they participated in the Debtor's demise and are themselves targets of the Committee's litigation activities undertaken for the benefit of the Growers who were not paid in compliance with California law;

(2) Over 60 of the members of the Growers' Committee did not object to WLG's fees, or to surcharge of the Grower Proceeds;

(3) WLG makes an offer of proof that Growers holding over 54% of the Grower claims have affirmatively consented to approval of WLG's fees and payment of those fees from the Grower Proceeds. (The court notes that those consents are not part of the record.);

(4) The Trustee supported the Second WLG Fee Application and actually joined in the Second Surcharge Motion;

(5) Objecting Creditors lack standing to object to surcharge of any Grower Proceeds other than the pro-rata portion which they will receive upon further distribution, if any;

(6) WLG offered to waive the portion of its fees which would be otherwise surcharged against the Objecting Creditor's share of the Grower Proceeds. Objecting Creditors refused to accept the waiver and purport to prosecute their objections on behalf of all Growers;

(7) That much of the allegedly "excessive" work performed by WLG was the direct result of Objecting Creditors' efforts to interfere with the Committee's activities, including the investigation of Objecting Creditors' claims;

(8) That much of the "litigation" work performed by WLG was performed at a time when the Debtor was disabled from performing its duties as a debtor-in-possession. The product of WLG's litigation activities was passed on to the Trustee for use in litigation to be pursued by the Trustee;

(9) That the Drummond Firm was brought into the case to prosecute State court claims against AAC and third parties, relating to non-payment of the Growers, for the benefit of all Growers who chose to join in that litigation;

(10) That the Objecting Creditors opposed the prosecution of claims against AAC because they had personally guaranteed the debt to AAC; and

(11) That activities related to a potential criminal investigation were appropriate because the non-payment of Growers has potential criminal implications under California law.

Analysis. WLG is Entitled to An Interim Award and Surcharge of Its Fees.

The real difficulty with these motions lies in the fact that WLG brought them as motions for final relief; for final approval and payment of a chapter 11 administrative expense. However, after much review and consideration of the moving and opposing papers, and the record of this case, it is the court's conclusion that the issues raised herein cannot be finally adjudicated at this time. At the time WLG filed its Second Fee Application, the case had recently been converted to chapter 7 and it was not clear if the Growers' Committee had much left to do in the case. Ordinarily, upon conversion of a case from chapter 11, the appointed committees are dissolved and final approval of chapter 11 professional fees is appropriate. However, the Growers' Committee continues to function in this case, WLG continues to provide services for the Committee, and activities are ongoing in an effort to get the Growers paid. Indeed, WLG has a third fee application set for hearing in this court on September 29, 2005. Objecting Creditors and others have again filed objections to WLG's third application on many of the same grounds raised here, including allegations that WLG's services did not benefit the Growers. Based on the court's preliminary review of WLG's third application, and the related objections, it is now clear that the ultimate purpose behind formation of the Growers' Committee, payment of the Grower claims, will not be fully realized, and the results of WLG's employment cannot be fully evaluated, until the conclusion of the case, or at least until termination of the Growers' Committee.

If this were a final motion for fees, under 11 U.S.C. § 330, the court would have to consider, inter alia, "whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under [Title 11]." 11 U.S.C. § 330(a)(3)(C). However, the court cannot effectively distinguish between the "necessity and benefit" of WLG's services in the chapter 11 and the "necessity and benefit" of those services rendered after conversion to chapter 7. Much of the work which the Committee did in the chapter 11 continued through to the chapter 7 — presumably, it is the foundation for results which may not be realized until conclusion of the case. Litigation activities are proceeding for the benefit of Growers and creditors in both the State and Federal Court. It appears that WLG is working on these activities in cooperation with the Trustee. If some of WLG's services benefitted the general estate more than the Committee, then the value of those services can be quantified and charged to the estate at the conclusion of the case. If the Growers ultimately get fully paid from other sources, the issue of surcharging the Grower Proceeds will become moot.

For the same reasons, the court must also treat the Second Surcharge Motion as a motion for interim relief. This result is consistent with the Appeal Dismissal Order where the District Court observed that the subject of the appeal, the First Surcharge Order, did "not represent a final determination of a discrete issue because the issue of payment to WLG . . . will be ongoing. The final amount to be paid [to] WLG will not be determined until the conclusion of this case; if the surcharge orders are viewed as final, it will result in multiple appeals. Such appeals are offensive to all notions of finality, both conventional and pragmatic."

In light of the substantial amount of fees at issue, the complexity of the issues, and the relatively sparse admissible evidence actually presented by either side in relation to these issues, it is clear to the court that a full evidentiary hearing may be required before the court can make a final determination of (1) how much WLG should be paid for its services, and (2) how to allocate that cost between the Growers and the general estate. Only through a full evidentiary hearing can this court make the findings it will be required to make as to what fees and costs were necessary and beneficial ( 11 U.S.C. § 330) and whether WLG's services provided a quantifiable benefit to the objecting parties. Debbie Reynolds Hotel Casino, Inc. v. Calstar Corporation, Inc. (In re Debbie Reynolds Resorts, Inc.), 255 F.3d 1061, 1068 (9^th Cir. 2001) (citation omitted).

At the same time, the court does not believe it is appropriate to deny WLG the right to receive interim compensation for its services. The objections come from only five creditors, two of which did not even have standing to object to the First Surcharge Order. The Committee and the Trustee support the relief sought in both motions. WLG has made an offer of proof regarding affirmative consent from many of the Growers. As the District Court noted in the Appeal Dismissal Order, the actual monetary impact of the surcharge against each objecting creditor is relatively small. The court does not have enough evidence to make an interim apportionment of WLG's fees against the general estate at this time. There are other pending claims against the remaining Grower Proceeds and the court cannot authorize any further distribution to Growers until those claims are resolved. The rights of the objecting parties will be protected so long as any award of fees to WLG remains subject to subsequent disgorgement at the conclusion of a final hearing. An interim fee award pursuant to § 331 is interlocutory; it is always subject to reexamination and future adjustment. Interim fee awards are not disfavored. "The limited purpose of [§ 331] is to provide financial relief to court-appointed officers engaged in protracted bankruptcy litigation, so that these officers do not have to wait for what may be years before receiving compensation" (citations omitted) Leichty v. Neary (In re Strand), 375 F.3d 854, 858 (9^th Cir. 2004).

Creditor Ken Spagnola has filed an adversary proceeding against the Trustee and all Growers asserting a claim in excess of $240,000 against the remaining Grower Proceeds.

Scope of Future Surcharge Proceedings.

Before concluding this memorandum, it is appropriate to comment on the Appeal Dismissal Order and the affect it will be given by this court in future proceedings. The Appeal Dismissal Order resolves two of the issues raised by WLG in its reply to Objecting Creditors, those of their standing and the scope of their authority. The District Court held in the Appeal Dismissal Order that Objecting Creditors Pursley and Torrano lacked standing to appeal the First Surcharge Order, "because neither was entitled to any of the monies to which the [First] surcharge order applied. . . . Appellants Pursley and Torrano thus did not have an [direct and immediate pecuniary] interest in the funds to be distributed, to which the surcharge applied."

This portion of the Appeal Dismissal Order defines the rules for review of future surcharge motions in two respects. First, the District Court's determination that Pursley and Torrano lacked standing to object to surcharge of the Grower Proceeds, because they did not have a direct and immediate pecuniary interest in the fund, is now the law of the case. As such, it must be followed in both this ruling and in all subsequent proceedings in the same case. American Express Travel Related Services Company, Inc. v. Fraschilla (In re Fraschilla), 235 B.R. 449, 454 (9^th Cir. BAP 1999). Unless an objecting party can show that surcharge of the Grower Proceeds has or will directly, immediately and materially reduce the payment which that party has or will receive from the fund, then it is not appropriate for this court to consider that party's objection to a surcharge request — such party will lack standing.

Second, the District Court's holding against Pursley and Torrano on the standing issue means, by clear implication, that each Grower may only object to surcharge of its ratable share of the Grower Proceeds. Objecting Creditors purport to represent the interests of all Growers with regard to surcharge of the Grower Proceeds, even those who did not object and who may even consent. The District Court apparently rejected that argument.

This court appointed the Growers' Committee because the Growers stood in a unique position; by California law they all had an undivided, equal priority interest in a common asset, the Almond Inventory. Further, not all eligible Growers had received the same level of payments from the Debtor prior to bankruptcy. Some Growers, such as Pursley and Torrano had, for one reason or another, already received a substantially higher percentage of payment for their 2002 crop than did the others. In the prior proceedings, this court tried to distribute the Grower proceeds in a fair and equitable manner to (1) minimize the obvious financial hardship to the unpaid Growers and (2) prevent some Growers from realizing an economic advantage over the others. The Growers' Committee was appointed to protect and to advocate the interests that are common to all of the Growers. That does not mean, however, that all Growers necessarily have the same interests. Neither does it mean that any one Grower, nor a subgroup of Growers, may usurp the authority of the Committee's chairman to speak on matters relating to governance of the Committee itself. Compensation of the Committee's counsel is an administrative matter subject to this court's jurisdiction, but in this case, it is also a matter of Committee governance, at least to the extent that the members of the Committee, and not the general estate, are being asked to pay that cost from their collateral.

To the extent that any surcharge of the Grower Proceeds materially reduces the distribution of money to an individual Grower, that Grower is certainly entitled to object and be heard; the consensus of the Committee cannot be forced on any individual member. However, this court will only consider that objection in relation to the objecting party's ratable share of the Grower Proceeds. If the Committee otherwise approves the fees and the surcharge request, and the court is otherwise satisfied that surcharge of the Grower Proceeds is fair, equitable and appropriate under the Bankruptcy Code, it will rule accordingly.

Conclusion.

Based on the foregoing, the court finds and concludes that the Second WLG Fee Application and the Second Surcharge Motion shall be deemed to be motions for interim relief, subject to final adjudication at the conclusion of this case, or whenever the court terminates the Growers' Committee and the full effect of the Committee's activities can be known. The Second WLG Fee Application shall be APPROVED. The Second Surcharge Motion shall be GRANTED. The Trustee shall distribute from the available Grower Proceeds to WLG the sum of $61,069.50 for legal fees and $7,433.30 for reimbursement of costs. All fees and costs paid to WLG prior to a final hearing shall be subject to disgorgement, if appropriate. All objections to the Second WLG Fee Application shall be OVERRULED without prejudice to renewal at a final hearing. Pursley and Torrano's objections to the Second Surcharge Motion shall be OVERRULED for lack of standing. All other objections to the Second Surcharge Motion shall be OVERRULED without prejudice to renewal at a final hearing, if necessary.