IN RE: MORROW IMAGE TECHNOLOGIES, INC. CASE NO. 96-50238

The debtor filed a petition for relief under chapter 7 of the Bankruptcy Code on February 9, 1996. The fee disclosure statement of counsel for the debtor indicated he had been paid $2,500 for preparation of the petition and for "post-petition work in regard to the auction."

On March 6, 1996 the debtor filed a notice of conversion of this case to a case under chapter 11 of the Bankruptcy Code, accompanied by a converter petition. 11 U.S.C. § 706(a). With the converter petition counsel for the debtor filed a new fee disclosure statement revealing he had received a $10,000 retainer for legal services rendered or to be rendered in the chapter 11 case. The disclosure statement indicated that "if counsel has not incurred 100% of his fees from the chapter 7 bankruptcy of $2,500, then the surplus will be applied to his fees in the chapter 11 bankruptcy."

Thereafter, on April 18, 1996, the court on its own motion directed the debtor to show cause why the case should not be reconverted to a case under chapter 7. Following a hearing on May 15, 1996, the court on May 24, 1996 entered a memorandum opinion and order directing that the case be reconverted to a case under chapter 7.

Stephen Palmer was appointed chapter 7 trustee at the outset of this case. His services were terminated when the case was converted to a case under chapter 11. 11 U.S.C. § 348(e). Upon reconversion of the case to a case under chapter 7 Mr. Palmer was reappointed as chapter 7 trustee.

On April 18, 1996, the same date the court entered its show cause order, James B. Morrow, the president and sole shareholder of the debtor, filed an individual petition for relief under chapter 13 of the Bankruptcy Code. The chapter 13 case was filed in his behalf by counsel for the debtor herein, Morrow Image Technologies, Inc., the corporation through which Mr. Morrow did business.

The case is before the court on the motion of the chapter 7 trustee in this case, the Morrow Image Technologies, Inc. case, for an order compelling counsel for the debtor to turn over to the trustee the $10,000 retainer counsel received for services rendered or to be rendered in the aborted chapter 11 case. Counsel opposes the motion on several grounds.

Counsel for the debtor reiterates an argument made at the hearing held pursuant to the court's order directing the debtor to show cause why this case should not be reconverted to a case under chapter 11. Counsel asserts that rather than liquidation of the assets of the debtor by auction, as originally contemplated, as evidenced by his initial fee disclosure statement, he and Mr. Morrow concluded that a more orderly liquidation of the debtor's assets under their supervision in a chapter 11 case would maximize recovery for both secured and unsecured creditors. In its memorandum opinion of May 24, 1996, for the reasons set out therein, the court rejected this argument. The debtor had terminated its business prior to bankruptcy and had no prospect of future income.

Mr. Morrow individually owns the building at 1014 South Main Street, Nicholasville, Kentucky in which Morrow Image Technologies, Inc., the debtor herein, conducted its business. Schedule B-15 to Mr. Morrow's chapter 13 petition indicates he has a claim against Morrow Image Technologies, Inc. for salary and rent in the amount of $80,500. Schedule F to the petition of Morrow Image Technologies, Inc. likewise indicates that James B. Morrow is owed $80,500 (salary $52,000; rent $28,500) by the debtor corporation.

The schedules to Mr. Morrow's chapter 13 petition do not indicate that prior to the commencement of the case he waived any claim he may have against Morrow Image Technologies, Inc. In response to the motion of the chapter 7 trustee in the Morrow Image Technologies, Inc. case for an order requiring counsel to turn over to him the $10,000 fee he received for representation of the debtor in the aborted chapter 11 case, counsel and Mr. Morrow have filed affidavits stating that Mr. Morrow waived his personal claim against the debtor corporation thereby eliminating any conflict of interest on the part of the law firm in representing the corporate debtor and Mr. Morrow individually in his chapter 13 case. Mr. Morrow's affidavit states that he was "informed by Matthew B. Bunch that due to subordination that he was highly unlikely to be repaid from the Morrow Image chapter 11 because of Affiant's status as an insider/shareholder;" and that "affiant then waived and still waives any and all claims he has against Morrow Image of its debt to him in the amount of $80,500 and did so to eliminate any allegation of a conflict of interest by Bunch & Brock representing both the corporate and personal entities."

The court is not aware of any provision of the Bankruptcy Code that would have required "subordination" of Mr. Morrow's wage and rent claim. A claim may normally be subordinated only if the holder is guilty of misconduct. 11 U.S.C. § 510(c). Perhaps counsel's advice was based on priorities in distribution under 11 U.S.C. § 507 rather than the concept of equitable subordination.

There are other facts which indicate the waiver on which counsel relies may not solve the conflict of interest problem.

Mr. Morrow's chapter 13 petition listed the $80,500 claim against Morrow Image Technologies, Inc. as an asset of his chapter 13 estate. His individual creditors in the chapter 13 case have a right to look to this receivable as a source of payment of their claims. The waiver affected not only Mr. Morrow's rights to the claim but the rights of his creditors as well.

Moreover, the estate of Morrow Image Technologies has a claim against Mr. Morrow. By amended schedules filed July 26, 1996 the corporate debtor indicated that on February 6, 1996, three days prior to filing its February 9, 196 petition for relief under chapter 7 of the Bankruptcy Code, it paid James B. Morrow $7,865 for rent for the month of February 1996. It is not apparent how the $7,865 could have been for the February rent in view of the fact the debtor owed Mr. Morrow back rent in the amount of $28,500 at the time of filing. The debtor had terminated the business it operated in the premises leased from Mr. Morrow. However, the business fixtures, equipment and inventory of the debtor were located in the rented premises. Thus, Mr. Morrow has a postpetition administrative claim for rent which enjoys priority status and is an asset of the estate in his chapter 13 case. 11 U.S.C. § 365(d)(3). Mr. Morrow cannot waive this postpetition claim.

The chapter 7 trustee of Morrow Image Technologies, Inc. moved for an order directing Mr. Morrow to refund the $7,865 rent payment to the bankruptcy estate. The court overruled this motion without prejudice on the grounds the recovery of funds sought by the trustee should be requested by complaint. The trustee has since filed a claim for $7,865.00 in Mr. Morrow's chapter 13 case. The claim has not been objected to. Apparently the chapter 7 trustee believes the payment of rent by the corporate debtor under the circumstances described is avoidable as a preferential transfer. If this payment to Mr. Morrow is determined to be preferential, his $80,500 claim for salary and rent against Morrow Image Technologies, Inc. is not allowable unless and until he disgorges the preference, 11 U.S.C. § 502(d), which in this instance may not occur until the claim is paid in full in the chapter 13 case.

The response to the chapter 7 trustee's motion for an order requiring the law firm of Bunch & Brock to turn over the $10,000 retainer the firm received for filing the Morrow Image Technologies, Inc. chapter 11 converter petition is accompanied by the affidavit of James B. Morrow. Mr. Morrow states the "$10,000 was obtained from the sale of Affiant's personally-owned vehicle." He further states that the $10,000 payment "was not intended to be and never was construed to be a loan, but was paid personally by Affiant to obtain legal services that would ultimately benefit him personally for corporate taxes owed by Affiant as an individual." Apparently this refers to the fact that Mr. Morrow may be held liable as the responsible party for substantial withholding taxes owed by Morrow Image Technologies, Inc.

According t Items 9 and 10 of the Statement of Financial Affairs accompanying Mr. Morrow's chapter 13 petition, in "Jan/Feb, 1996" he paid the law firm of Bunch & Brock "$10,000 for Morrow Image Technologies, Inc. Chapter 11." In "1995" he sold a 1987 Corvette to his wife, Martha Morrow, for $10,000. The source from which the wife obtained the $10,000 to purchase the automobile is not disclosed. The affidavit is not accompanied by a certificate of title showing when the transfer of legal title to the motor vehicle to the wife occurred.

Schedule I to Mr. Morrow's chapter 13 petition indicates his wife has been employed for approximately 15 years as a waitress at Keeneland and at Springs Inn, Lexington, Kentucky. Her total net take home pay is listed as $1,935.00 per month and his as $140.00 per month, for a combined monthly income of $2,075.00. Their expenses are estimated as $1,875.00 per month, leaving disposable income of $200 per month which Mr. Morrow proposes to pay to the chapter 13 trustee. This would result in payment of only $12,000 to the chapter 13 trustee during the 5-year duration of the plan. The feasibility of the plan depends on liquidation of the business building owned by the debtor and the imaging equipment of Morrow Image Technologies, Inc. at the values placed on the real and personal property in the schedules to the petitions in these two cases. The debtor's chapter 13 plan has not been confirmed.

In his affidavit accompanying the response to the chapter 7 trustee's motion for a turnover order, Matthew B. Bunch states that the $10,000 retainer fee for professional services to be rendered in the chapter 11 proceeding of Morrow Image Technologies, Inc. was received from James B. Morrow, was not an asset of Morrow Image Technologies, Inc. and should not be turned over to the corporate chapter 7 trustee. The affiant states that he has performed 35.10 hours of professional work in the corporate case and has incurred expenses of $346.83. He claims the right to compensation and reimbursement of expenses in all totaling $3,856.83 to be charged against the $10,000 retainer.

The court may deny allowance of compensation for services and reimbursement of expenses of a professional person employed under section 327 or 1103 of title 11 if at any time during such professional person's employment under either of those sections, such professional person is not a disinterested person, or represents or holds an interest adverse to the interest of the estate with respect to the matter on which such professional person is employed. 11 U.S.C. § 328(c).

The court is of the opinion that when, after having accepted appointment as attorney for the debtor in possession in this case, Matthew B. Bunch undertook the representation of James B. Morrow, the president and sole shareholder of the debtor, in Mr. Morrow's chapter 13 case, Mr. Bunch thereby forfeited his status as a disinterested person, and is not entitled to any compensation or reimbursement of expenses in this case. The waiver on which counsel relies was and is potentially detrimental to the creditors of Mr. Morrow and, in any event, did not and does not cure the conflict of interest problems evident from the facts of this case.

The court does agree that the $10,l000 should not be turned over to the chapter 7 trustee in this case. The court shall order the fee remitted to the standing chapter 13 trustee handling Mr. Morrow's chapter 13 case. 11 U.S.C. §§ 105 and 329; Rule 2017, Federal Rules of Bankruptcy Procedure.

An order shall be entered accordingly.

Dated:

By the court -

___________________________

JOE LEE, CHIEF JUDGE

Copies to:

Matthew B. Bunch, Esq.

23. Thomas Bunch, Esq.

Sidney N. White, Esq.

Stephen Palmer, Esq.

U.S. Trustee

UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

IN RE:

MORROW IMAGE TECHNOLOGIES, INC. CASE NO. 96-50238

DEBTOR