A recent federal appellate decision in New Orleans should give pause to any state court-appointed receiver who is contemplating involving himself or herself in a bankruptcy case. Szwak v. Earwood (In re Bodenheimer, Jones, Szwak & Winchell L.L.P.), decided by the United States Court of Appeals for the Fifth Circuit, arose from the 2006 petition for the dissolution of a law firm in Shreveport, Louisiana. After a state court receiver was appointed to serve as the liquidator, one of the name partners of the law firm filed an involuntary bankruptcy petition against the firm. In response, the receiver retained counsel and opposed the petition.

Subsequently, the receiver filed an application to recover his fees as the state court liquidator and as the superseded receiver in the bankruptcy case, including a request for payment of (1) his own pre- and post-petition fees and expenses and (2) the legal fees for his outside counsel in opposing the bankruptcy petition. The bankruptcy court authorized a partial interim payment to the receiver and stayed the remainder of the fee request.

Although the receiver and the Chapter 7 trustee ultimately reached a settlement regarding the remaining fee issues, one of the former partners opposed it. Despite that objection, the bankruptcy court approved the proposed settlement, a decision that was affirmed by the district court.

On appeal, the Fifth Circuit looked at the factual and legal ramifications of the filing of the bankruptcy petition while the receiver was in possession. The court first noted that once the receiver had knowledge of the bankruptcy case, he was (1) prohibited from taking any actions other than those necessary to preserve the property under his care, (2) required to turn over the property in his care to the Chapter 7 trustee, and (3) obligated to prepare an accounting of the property that he just turned over. Once that turnover occurred, the bankruptcy court was entitled to provide reasonable compensation to the receiver for services rendered, as well as actual, necessary costs and expenses incurred.

Although the receiver believed he was acting in the best interest of the property by opposing the bankruptcy, the Fifth Circuit determined that nowhere in the Bankruptcy Code "does it state that a superseded custodian is authorized to oppose a bankruptcy petition or employ the estate's resources in doing so." Rather, unless authorized by a court order to continue in possession, a receiver can only turn over the property in his or her care and prepare an accounting.

The Fifth Circuit determined that the receiver knew of his obligations and responsibilities and failed to fulfill them. The court stated that "[f]or [the receiver] to claim that he is entitled to compensation for the ultra vires 'service' of opposing the bankruptcy when he failed first to complete his statutorily-mandated service of winding up the estate borders on the absurd [fn omitted]." The court added that the receiver made no credible argument that his opposition to the bankruptcy filing was "necessary" to preserve the estate's assets. As such, the requested compensation for such action could not be considered "reasonable compensation" as required by the Bankruptcy Code.

The Fifth Circuit also took issue with the bankruptcy court's determination that the services rendered were not required to benefit the estate. The federal appellate court determined that the terms "actual and necessary" require a benefit to the estate, although that requirement is not explicitly set forth in the Bankruptcy Code. The court drew the parallel conclusion that if there was no benefit to the estate, then the services could not have been reasonable or necessary. Accordingly, it reversed the district court and bankruptcy court orders and remanded to the bankruptcy court for a further determination.

There are important lessons to be learned from the Szwak case. The most significant takeaway is that as soon as a receiver learns of a bankruptcy filing, he or she should (1) file a motion to remain in possession of the property (an even better option would be for the bank that placed the receiver in possession to file that motion), (2) be prepared to turn over the property and provide a full accounting, and (3) file a request for only those fees, costs and expenses that are actual and necessary to preserve the bankruptcy estate with the bankruptcy court.

As we are reminded by the Szwak case, a receiver is a disinterested entity whose limited role is to maintain the property in his or her charge. The receiver's role is not to oppose a bankruptcy filing or take other action outside of its state court-appointed mandate. If a receiver chooses to engage actively in a bankruptcy proceeding, he or she runs the risk that the related fees and expenses (and those of the receiver's chosen professional) may not be paid.