Retention Matters in Chapter 11

Retention is the process of hiring the professionals a company needs to guide its Chapter 11 reorganization, such as lawyers, accountants, and financial advisors. This step is central to how bankruptcy cases unfold. Without court-approved professionals, companies in financial distress can’t navigate a complex legal and financial landscape.

Retention goes beyond paperwork. It ensures that professionals can be paid, that potential conflicts are disclosed, and that the court can rely on the integrity of those advising the debtor. Chapter 11 also imposes fiduciary duties on debtors-in-possession, which means the hiring and supervision of these professionals must meet strict statutory and ethical standards.

Lesson 1: Who Counts as a ‘Professional Person’?

Section 327 of the Bankruptcy Code sets out which professionals need court approval in a Chapter 11 case.

The statute specifically names attorneys, accountants, appraisers, and auctioneers, but it doesn’t stop there. It also includes a broader category of ‘other professional persons,’ a catch-all that can cover financial advisors, restructuring consultants, and other experts whose work directly impacts the estate.

This language is intentionally broad. If a professional is exercising independent judgment or shaping the debtor’s future, chances are they’ll be considered a ‘professional person’ who must be retained with court approval. Companies that try to treat these roles as ordinary business expenses risk later challenges and potential clawbacks.

Lesson 2: The Disinterestedness Requirement

Bankruptcy doesn’t just ask if a professional is qualified. It asks if they’re free from conflicts. Section 327(a) requires that professionals be ‘disinterested’ and not hold an interest adverse to the estate.

Disinterestedness is defined in Section 101(14). In short, the professional can’t be a creditor, insider, or otherwise have ties that compromise neutrality.

Matt Christensen of Johnson May explains that the term may sound confusing, but in practice, it means that a professional cannot be a creditor or insider of the debtor, cannot have been an insider within the two years before the bankruptcy filing, and must not hold any interest materially adverse to the estate.

These standards ensure fairness and transparency in multi-party proceedings where conflicts are inevitable. The rule may feel harsh, but it exists to protect creditors and the integrity of the process.

Lesson 3: Special Counsel and Exceptions

The Section 327(e) exception allows debtors to retain attorneys who represented them before the filing in non-bankruptcy matters, even if they don’t meet the disinterestedness criteria. This is useful when specialized counsel, like for complex litigation or IP, should stay on board.

Doug Flahaut of Echo Park Legal, APC explains that this is especially important because many Chapter 11 cases are prepared with a full professional team before filing. Normally, those same advisors could be disqualified under Section 327 because of their prepetition connections. The Section 1107 carves out an exception for Chapter 11 debtors-in-possession, allowing them to keep using those professionals postpetition, provided they make the required disclosures.

Section 327(e) can technically apply to any type of attorney, but most often comes into play with litigation counsel. This is because intellectual property or corporate counsel are usually paid current, so they don’t face disinterestedness issues. By contrast, litigation firms often build up large unpaid bills when a bankruptcy is filed right before or after trial. If those firms can’t be paid and won’t waive their fees, Section 327(e) is what allows them to continue representing the debtor, despite technically being creditors. The trade-off is that they can only serve in a limited role, while disinterested bankruptcy counsel manages the overall case.

Lesson 4: Section 328 and Fee Arrangements

While Section 327 governs who can be retained, Section 328 focuses on how professionals are compensated. On its face, the statute allows professionals to be retained on ‘any reasonable terms and conditions,’ giving courts the power to pre-approve fee arrangements ranging from contingency agreements to flat or percentage-based fees.

Flahaut cautions that the US Trustee’s Office often resists this broad reading. In practice, the US Trustee’s Office tends to argue that Section 328 should only apply to contingency or other alternative fee arrangements, not hourly billing. This isn’t grounded in the statute itself, but reflects longstanding US Trustee Office policy.

Bankruptcy judges also vary in their willingness to approve Section 328 applications. Some judges push back on contingency arrangements if they view the case as relatively straightforward and better suited for hourly billing.

The result is a tension between the flexibility provided in Section 328 and the narrower way it is often applied in practice.

Lesson 5: Retainers and Litigation Funding

Retainers: Who Pays and How?

Trustees and judges scrutinize both the amount and source of retainers. Ideally, the debtor itself covers the retainer from its own accounts. If the funds originate from an insider, it must be made clear whether that payment is a loan or a contribution, since the US Trustee carefully reviews such arrangements. Full disclosure is essential to avoid objections.

Matt Grimshaw of Grimshaw Law Group, P.C. cautions that added complications arise when insiders fund retainers, especially if those insiders are also potential targets of avoidance or fraudulent transfer claims. Even if their involvement is limited to providing funds, the potential for conflicts remains and must be carefully managed during the Chapter 11 process.

Litigation Funding in Bankruptcy

Third-party litigation funding has grown significantly, but raises unique challenges in Chapter 11, especially around transparency and control.

Pre-confirmation litigation funding arrangements are particularly sensitive. Funders usually insist on confidentiality, and courts often face tension between the bankruptcy system’s emphasis on full disclosure and the funders’ reluctance to reveal economic terms. This conflict plays out in motions for approval, where judges must weigh the estate’s need for funding against the requirement that stakeholders understand how those deals are structured.

Litigation funding can provide a lifeline for cash-strapped estates, but courts and trustees continue to scrutinize disclosure and conflicts carefully.

Lesson 6: Disclosure and Conflicts

The overriding principle in retention is clarity. Whether it’s retainers, fee structures, prior relationships, or litigation funding, full disclosure is the safest route.

Jonathan Friedland of Much Shelist, P.C. emphasizes that while professionals may prefer to seek approval under Section 328 to gain certainty about their fees, the US Trustee often resists those applications.

This pushback underscores why thorough disclosure is critical. Professionals who are transparent about their arrangements are far less likely to run into objections or sanctions.

Another practical risk is what happens when Chapter 11 cases fail. Many cases are either dismissed or converted to Chapter 7, and when that occurs, debtor’s counsel can be left handling significant additional work without compensation. This reality shapes how professionals weigh the risks of taking on bankruptcy cases in the first place.

Retention as the Key to Fairness in Chapter 11

Retention in Chapter 11 is far more than a formality. It’s the framework that ensures both expertise and integrity within the reorganization process.

By requiring court-sanctioned professionals, defining clear standards of disinterestedness, and insisting on transparent compensation and funding structures, the system safeguards trust among debtors, creditors, and the court.

While the mechanisms may feel technical, they serve to balance priorities in a realm where conflicting claims and financial pressures are ever-present. Ultimately, retention is about fairness. It ensures confident decision-making, responsible estate management, and a system where every participant can be sure the process is honest and reliable.

To learn more about this topic, view The Nuts and Bolts of Retention. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about Chapter 11.

This article was originally published here.

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