The opinion of the court was delivered by: Josephine Staton Tucker United States District Judge
ORDER AFFIRMING IN PART AND REVERSING IN PART BANKRUPTCY COURT
Shahriar Yazdani, Kathy Yazdani (collectively "Debtors") and the Law Offices of Raymond H. Aver, APC (the "Aver Firm") appeal an order by the bankruptcy court granting George Balanis ("Appellee") (i) $35,000 that the court ordered disgorged from the trust account of the Aver Firm and (ii) an administrative claim for the remainder of the $75,000 escrow deposit made by Appellee to purchase property belonging to the Debtors' estate. Debtors and the Aver Firm (collectively, "Appellants") also appeal the order denying their motion to reconsider those rulings. Having considered the briefs and supporting documentation submitted by the parties, heard oral argument, and taken the matter under submission, the Court AFFIRMS in part and REVERSES in part.
On May 26, 2009, Debtors filed a voluntary bankruptcy petition under chapter 13 of the Bankruptcy Code. (Appellants' Opening Brief ("App. Br.") at 3, Doc. 17.) The Debtors' chapter 13 case was converted to one under chapter 11 on July 15, 2009, and then converted again to one under chapter 7 on January 21, 2011. (Id.)
The Debtors' residential property located at 18460 Coastline Drive, Malibu, California (the "Coastline Residence") was a significant asset to their bankruptcy estate. (Appellant's Appendix ("App. Appx.") at 358, Doc. 18; Jan. 24, 2011 Tentative at 4.) On August 2, 2009, Appellee and his wife entered into a California Residential Purchase Agreement and Joint Escrow Instructions along with various addendums, counter offers, and supplemental and amended escrow instructions (collectively, the "Purchase Agreement") for the Coastline Residence. (App. Br. at 3.) At that time, the Debtors were debtors in possession under chapter 11 of the bankruptcy code. (Appellees' Reply Brief ("App'ee Reply") at 2, Doc. 19.) When Appellee signed the Purchase Agreement, he made two deposits, one for $75,000 and one for $6,000, for a total deposit of $81,000 into an escrow account with All Cities Escrow. (Id. at 3.) Under the Purchase Agreement, the deposit would become nonrefundable "upon written release of all Buyer's contingencies which shall expire on August 28, 2009." (App. Appx. at 120.)
Thereafter, on August 28, 2009, the parties executed an addendum to the Purchase Agreement and Amended Escrow Instructions, pursuant to which the Debtors and Appellee agreed "that Buyer release $75,000.00 of Buyer's good faith deposit, being held by escrow, to Seller." (Id. at 130.) Under the addendum, if "escrow [did] not close, through no fault of [the] buyer" the funds were refundable "and seller and/or seller's trustee [were required] to immediately return (within 2 business days) buyer's $75,000 earnest money deposit that was released." (Id. at 131.) Pursuant to these instructions, the escrow funds were released to the Debtors. Upon release of the funds, the Debtors transferred $25,000 to the Aver Firm's client trust account for the purpose of paying a post-petition retainer. Appellants conceded at oral argument that an additional $10,000 from Appellee's deposit was also transferred to the Aver Firm's trust account, for a total retainer of $35,000. The Debtors assert that much of the remainder of the deposit was used to make various changes to the Coastline Residence and pay certain personal expenses of the Debtors. (Id. at 294-95.)
On September 11, 2009, the Aver Law Firm filed its application for employment under 11 U.S.C. § 328. (Id. at 64.) The application set forth the terms of the firm's proposed engagement, including that it would be paid a $25,000 retainer from the released escrow funds:
The Yazdanis are currently in the process of selling their residence located at 18460 Coastline Drive, Malibu, California 90265. An escrow has been opened with regard to this sale and the purchaser has deposited $75,000.00 with escrow. Under the terms of the Residential Purchase Agreement and Joint Escrow Instructions, this $75,000 deposit has become non-refundable. The Aver Firm will be paid $25,000.00 from the deposit as a post petition retainer which will be deposited in the Aver Firm's attorney-client trust account. The Aver Firm may draw upon the retainer for post petition attorneys' fees and costs incurred by the Yazdanis following the filing of professional fee statements with the Office of the United States Trustee.
(Id. at 68.) On October 5, 2009, the court entered an order for employment based on the representations made in the application. (Id. at 172-73.)
On October 9, 2009, the bankruptcy court issued an order authorizing the sale of the Coastline Residence as a sale outside the ordinary course of business, under 11 U.S.C. § 363(b). (App. Br. at 5.) Around mid-November 2009, the sale failed to close. (Id.) The bankruptcy court, by its order on January 8, 2010, granted Appellee's request for the return of the $81,000 deposit ("January 8th Order"), explaining that "[s]ince the escrow [failed to close] through no fault of Appellee, they [sic] are entitled to the money back." (App. Appx. at 286.) The Debtors filed a Motion for Reconsideration of the January 8th Order, which the bankruptcy court denied because the Amended Escrow Instructions characterized Appellee's deposit as refundable. The Debtors did not appeal that order.
Despite the bankruptcy court's order, the Debtors returned only $6,000 of the total $81,000 to Appellee. (App'ee Reply at 4.) Accordingly, Appellee moved for an order:
(1) requiring the Aver Firm to disgorge that portion of Appellee's deposit held in its client trust account, and (2) granting Appellee an administrative priority claim for the remaining balance of Appellee's deposit ("Appellee's December Motion"). (App. Appx. at 1-10.) On December 14, 2010, the bankruptcy court issued an order directing Debtors' counsel to pay Appellee all money in the Aver Firm's client trust account that was paid from the released escrow deposit, and granting Appellee's request for an administrative claim for the balance of the $75,000 not paid by the Aver Firm ("December 14th Order"). (Id. at 254-57.) The Debtors subsequently filed a Motion to Reconsider, which was denied by the bankruptcy court on February 9, 2011 ("February 9th Order"). (Id. at 358-60.)
Appellants appeal the December 14th Order and February 9th Order to this Court, raising the following issues: (1) whether the bankruptcy court abused its discretion in ordering disgorgement of the Aver Firm's $35,000 retainer and return of the funds to Appellee; (2) whether Appellee is entitled to an administrative claim for the remaining balance of the $75,000 deposit less amounts paid out of the Aver Firm client trust ...