Whether debtor’s retained counsel could be compensated for the fees and expenses incurred in the defense of its bankruptcy fee application.
The Southern District of Texas Bankruptcy Court awarded Baker Botts, LLP, along with Jordan, Hyden, Womber, Culbreth & Holzer, PC, approximately $120 million in fees for representing ASARCO, LLC, one of the leading copper producers in the U.S., who filed for Chapter 11. As the bankruptcy court noted in its initial fee award order, the DOJ described the ASARCO case as “the largest environmental bankruptcy in U.S. history.” In 2009 ASARCO emerged with a reorganization plan that would pay its creditors in full, $1.4 billion in cash and resolution of its environmental liabilities.
Baker Botts filed for a final fee request, which ASARCO contested. After extensive discovery and a 6-day trial, the Bankruptcy Court overruled the objections and awarded $120 million in compensation, $4.1 million as an “enhancement for exceptional performance,” and $5 million in fees for defending the applications. The district court affirmed. The U.S. Court of Appeals for the Fifth Circuit held that the Bankruptcy Code did not allow the firms to recover $5 million spent defending the fee request against Asarco’s opposition. The Fifth Circuit held that (i) the American Rule (discussed below) controls absent explicit statutory authority providing reimbursement of defense fees and (ii) defense fees fall outside of §330(a)(1)’s requirement that services are only compensable “if they are likely to benefit a debtor’s estate or are necessary to case administration” because the professional, not the estate, is the “primary beneficiary of a professional fee application.” The Supreme Court then granted certiorari and heard oral argument on February 25, 2015.
On June 15, 2015, the Supreme Court affirmed the judgment of the Fifth Circuit in finding that fee defense costs were not recoverable. Justice Thomas wrote the opinion for a six Justice majority (Justice Sotomayor concurring for purposes of the outcome). Justice Breyer dissented, joined by Justices Kagan and Ginsburg. The Supreme Court’s review of the language of Bankruptcy Code §330(a)(1) led the Court to conclude that it did not provide the sort of “explicit statutory authority” necessary to override the American Rule and therefore bankruptcy professionals employed under §327(a) of the Bankruptcy Code may not, under §330(a)(1) of the Bankruptcy Code, recover as compensation fees incurred in defending their bankruptcy fee applications. The Court’s majority stated, “[t]he word ‘services’ ordinarily refers to ‘labor performed for another.’” Since Baker Botts was litigating to defend its own fees, the Court reasoned that it was not providing an “actual, necessary service” to the bankruptcy estate and therefore was not entitled to compensation for such time.
Following the issuance of the Baker Botts opinion, bankruptcy professionals have raised concerns that the ruling will lead to litigants tactically using fee objections to pressure debtors and their retained professionals. However, since the Baker Botts decision questions have been raised whether there is a possible workaround. That question has been tested in cases since Baker Botts. For example, in the Delaware cases In re Boomerang Tube, LLC, et al. Case No. 15-11247 (MFW) and In re Northshore Mainland Services, Inc., et al. (15-11402-KJC) (a/k/a the Baha Mar case), the bankruptcy court declined to allow Baker Botts ruling to be avoided by contract.
In the Boomerang case, the law firm for the official committee of unsecured creditors asked for the fee approval order to include a provision that would entitle it to be compensated from the bankruptcy estate for fees incurred in defending its fees against any challenges. The law firm relied upon §328 of the Bankruptcy Code, which allows for the retention of estate professionals “on any reasonable terms and conditions” arguing that the Supreme Court in Baker Botts recognized that parties could and regularly did contract around the American Rule.
The Boomerang Court denied the request and held that §328 does not create a statutory exception to the American Rule, because it does not mention awarding fees or costs in the context of an adversarial proceeding. In support of the court’s ruling, the Boomerang Court rejected the law firm’s argument that §328 permitted a contractual agreement for the payment of defense fees because the retention agreement was between the law firm and the official creditors’ committee, but it would be Boomerang Tube’s bankruptcy estate, a non-party to such agreement, that would bear the costs. Finally, the Boomerang Court determined that the proposed fee shifting provisions were not “reasonable” terms of employment of professionals with the meaning of §328.
However, decisions in two other cases, In re Nortel Networks, 2017 Bankr. LEXIS 674 (Bankr. D. Del. Mar. 8, 2017) and in a New Mexico case, In re Hungry Horse LLC, Case No. 16-11222, distinguished Boomerang Tube and permitted contractual provisions that allow payment for the defense of fees.
Nortel Networks that Baker Botts and Boomerang Tube did not apply to a fee dispute between an indenture trustee and certain bondholders, and permitted the trustee to recover its attorneys’ fees for defending against the challenge. Although this case is not directly on point as it did not involve an estate professional, and Judge Gross was not opining on whether Section 328 would permit such an agreement, he held that the bond indenture qualified as a contractual exception to the American Rule, noting that, unlike the retention agreement in Boomerang Tube, it was an agreement directly between the debtor and the trustee.
In Hungry Horse New Mexico Bankruptcy Judge David Thuma looked to Nortel Networks for support in holding that a retention agreement in a chapter 11 case between proposed debtor’s counsel and the debtor could pass muster under Section 328, thereby permitting a contractual work-around to Baker Botts. Judge Thuma first determined that nothing in Baker Botts prevented a bankruptcy court from finding a fee defense provision in a retention agreement to be “reasonable” within the meaning of Section 328. In his reading of Baker Botts, the Court simply limited the compensation an estate professional could receive under Section 330 to fees for services to the client, rather than on its own behalf, and noted that Section 328 had no applicability to that issue.
He then considered various other provisions typical of retention agreements, and observed that several were “reasonable” under Section 328 even if they were intended to favor the professional, rather than the client. He pointed to provisions, among other things, setting out retainer requirements, permitting an attorney to withdraw under certain conditions, and granting a lien on certain recoveries. “A typical employment agreement between a lawyer and a client has many terms; some benefit the client, while others benefit the lawyer. Considered together, they may be reasonable.” The overall effect, he noted, is that “the client obtains the services of needed, able professionals.”
Judge Thuma concluded that Section 328 therefore can permit contractual exceptions to the American Rule, and outlined the terms of a fee defense provision in a retention agreement that he believed was “reasonable” and “violat[ed] neither the letter nor spirit of [Baker Botts].” He stated that, among other things, it needed to be agreed to by the bankruptcy estate, in order to avoid the issue highlighted by Judge Walrath in Boomerang Tube, and provided also that it extended to the creditors’ committee’s professionals, in order to “level the playing field.” He suggested sample language that he believed could be acceptable under Section 328:
Fee Defense. The Client agrees to pay all reasonable legal fees and expenses incurred by the Firm, and also by any counsel retained by the unsecured creditors’ committee (if one is formed in the Client’s bankruptcy case) for successfully defending their respective fee applications. The bankruptcy court must approve all of such fees as reasonable. The Client will have no obligation to pay for any fees or expenses the Firm incurs defending fees that are not allowed.
The pragmatic approach taken in Hungry Horse in particular offers a template that other courts will likely be urged to adopt.
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