Should Bankruptcy Professionals Be Compensated for Defending Their Fee Applications?

In ASARCO, the Supreme Court considered whether the Bankruptcy Code permits a professional to be paid for work performed in defending a fee application in court. The debtor (ASARCO) had retained certain law firms to represent it under section 327(a), which sought approval of their fees under section 330. The law firms had prosecuted fraudulent transfer claims against the debtor's parent company, and obtained a judgment worth between $7 billion and $10 billion. 135 S. Ct. at 2163. However, upon exit from bankruptcy, ASARCO was once again controlled by its parent, and upon the filing of fee applications by debtor's counsel, ASARCO objected. Id. (“ASARCO, controlled once again by its parent company, challenged the compensation requested in the applications.”) Ultimately, the professionals were successful in defending their fee applications. On appeal before the Supreme Court, the issue was whether the law firms could recover their fees for defending their applications. Id.

The Court held that the “American Rule” applied: that each litigant pays its own attorneys' fees ' win or lose ' unless a statute or contract provides otherwise. 135 S. Ct. at 2164. The Court found that Bankruptcy Code does not deviate from this rule, noting that: 1) section 327 authorizes the retention of counsel “to serve the administrator of the estate for the benefit of the estate”; and 2) section 330 authorizes compensation for professionals for “work done in service of the estate administrator” and for “actual, necessary services rendered.” Id. at 2164-65.

Because fees incurred in defense of a professional's fees were not on account of services performed for the estate, the Court held that the Bankruptcy Code did not permit deviation from the American Rule. The Court specifically noted that “[t]ime spent litigating a fee application against the administrator of a bankruptcy estate cannot be fairly described as 'labor performed for' ' let alone 'disinterested service to' ' that administrator.” Id . at 2165. Because no contract was involved, the Court did not address that exception to the American Rule.

A Different Tactic

The Bankruptcy Court for the District of Delaware then undertook an analysis of this second question ' whether professionals can “contract” for reimbursement of their fees in defense of a fee application ' in In re Boomerang Tube, Inc., Case No. 15-11247, 2016 WL 385933 (Bankr. D. Del. Jan. 29, 2016).

In Boomerang, counsel for the official committee of unsecured creditors attempted to circumvent the ASARCO decision by including an express provision in their retention application (which was brought under section 328) that entitled them to compensation for any fees incurred in defense of their fee applications. The United States Trustee objected, arguing that ASARCO prohibited compensation to a professional for the defense of fees. The committee argued: 1) that it was seeking retention under section 328 of the Bankruptcy Code, which permits retention of professionals on terms that would not otherwise be available under section 330; and 2) that its retention agreement was a contract that itself was an exception to the American Rule.

The bankruptcy court disagreed and ruled that section 328, like section 330, is not a specific and explicit statute that authorizes the award of attorneys' fees, and does not provide a statutory exception to the American Rule. The bankruptcy court further found that the retention agreement was not an exception to the American Rule as it was not a contract between two parties providing that each would be responsible for the other's legal fees if one lost a dispute against the other. 2016 WL 385933, at *4. Instead, the retention agreement was a contract between two parties (the committee and committee counsel) providing that, in the event the committee's counsel won a challenge to their fees, a third party (the bankruptcy estate) would pay committee counsel's defense costs.

The bankruptcy court went further and held that the defense provisions were not permissible under the Bankruptcy Code at all because they did not relate to the services to be rendered by the professionals (as they were not services for the benefit of the committee and its interests) and could not be considered a reasonable term of employment.

Distinctions Worth Noting

The combination of ASARCO and Boomerang would appear to apply the American Rule to preclude an award of attorneys' fees incurred in defense of a fee application (with the caveat that Boomerang is a Delaware decision and not binding on bankruptcy courts from other jurisdictions). However, these two cases fail to consider the fundamental differences between estate professionals retained and paid subject to the Bankruptcy Code and court approval, and attorneys retained and paid in the private sector. The American Rule does not translate so easily to estate professionals in the bankruptcy context. Private-sector counsel simply send a bill to a client for the latter's review and payment. In stark contrast, bankruptcy estate professionals must send their invoices not only to their client (the estate or the committee), but generally to all parties in interest in the bankruptcy case and to the United States Trustee (each of which can object), and must obtain approval of the court itself. Under the Bankruptcy Code itself, the very process by which payment is sought is always adversarial.

Such is not the process for attorneys in the private sector. Sending a bill and discussing it with a client is not even remotely close to the process a bankruptcy professional must endure in order to be paid through the estate. The only way a private sector attorney would be in litigation over his or her fees is if the fees were not paid and the attorney sued to recover those fees. In contrast, in bankruptcy, a court-involved process is the only basis on which fees are awarded and paid.

The relevant inquiry is not whether the “American Rule” applies. Bankruptcy professionals are not asking an adversary to pay their fees at the conclusion of an adversarial process: Bankruptcy professionals work for the benefit of the estate or a major constituency of the estate (for which the estate is mandated by the Bankruptcy Code to pay fees) and are retained and paid pursuant to statute and court approval. It simply is not the same as whether an opposing party in typical litigation is entitled to fees from his adversary. As the dissent in ASARCO properly noted, in this situation, “compensation for fee-defense work 'is properly viewed as part of the compensation for the underlying services in a bankruptcy proceeding.'” 135 S.Ct. at 2169. In ignoring this fundamental difference, these courts fail to acknowledge the unique position of bankruptcy professionals.

Moreover, in ASARCO, the objecting party was the debtor's parent. The Supreme Court expressly noted that the objection to the fee petition was brought only after the parent had resumed control over the debtor'the very parent corporation that had been found liable for $7 billion to $10 billion in fraudulent transfers. All of ASARCO's creditors were paid in full. 135 S. Ct. at 2163. A key premise of the Supreme Court's ruling was that “time spent litigating a fee application against the administrator of a bankruptcy estate cannot be fairly described as 'labor performed for,' let alone 'disinterested service to,' that administrator.” 135 S. Ct. at 2165. However, this premise does not entirely apply to either the case before it ' in which the parent company and objecting party was not the entity for whose benefit the professionals' services were performed ' or any case in which a party other than the debtor (or committee as appropriate) is objecting to the fees in question. This avenue should at least be open to exploration by future professionals involved in fee disputes, and has been suggested by at least one court.

Other Results

In In re Macco Properties, Inc.,'540 B.R. 793 (Bankr. W.D. Okl. 2015), counsel that had represented the Chapter 11 trustee in the case filed its fee petition. The objecting party was not the Chapter 11 trustee, but the equity holder of the debtor, who stood to benefit from a disallowance of fees. The bankruptcy court distinguished ASARCO , noting in that case, it was the estate that was objecting to debtor's counsel's fees. The court held:

There is no issue as to loyalty of Counsel to Trustee and the estate, or of Counsel's disinterestedness. Counsel and Trustee are not adversaries. Counsel is instead defending itself, and its fees, from baseless claims of malfeasance asserted by Price and McGinnis, who argue that Counsel is not entitled to any compensation for representing Trustee and assisting him in, among other things, disposing of over $70 million in claims against the estate.

540 B.R. at 878.

The inequity of ASARCO is evident in In re River Road Hotel Partners, LLC, 536 B.R. 228 (Bankr. N.D. Ill. 2015). In River Road, the professional whose fees to the debtors were in question was a financial adviser, FBR Capital Markets & Co. (FBR). The debtors had retained FBR under section 328, and the terms of FBR's engagement provided for a specific restructuring fee that was expressly approved and not subject to the standards of review in section 330. At issue initially was whether the terms of FBR's retention entitled it to a restructuring fee of approximately $2.5 million; FBR prevailed on this issue (after appeal to the district court and remand to the bankruptcy court). The final bankruptcy court decision on the matter addressed: 1) a motion to reconsider the bankruptcy court's previous ruling that FBR was entitled to a restructuring fee; and 2) whether FBR was entitled to its attorneys' fees incurred in defending its right to the restructuring fee, which amounted to $1.7 million.

It is important to note the posture of the case at the point the fee objections were being litigated. The debtors had retained FBR. However, the debtors' quest to confirm a plan had failed, and the court confirmed a plan proposed by the debtors' secured creditor. The creditor plan created Bletchy Hotel at O'Hare LLC as the “plan transferee,” which was responsible for the payment of all administrative expenses. 536 B.R. at 233. It was Bletchy that objected to FBR's request for a restructuring fee, not the debtors. The bankruptcy court felt bound by the Supreme Court's ASARCO decision, and denied FBR's request for attorneys' fees. Forcing a professional to incur $1.7 million to obtain fees of $2.5 million, necessitated by a zealously prosecuted objection brought by a “plan transferee,” can certainly be seen to be inequitable.

Conclusion

The applicability of the American Rule in the context of the retention and payment of bankruptcy professionals is not nearly so clear as the majority opinion in ASARCO paints it. Nevertheless, in light of ASARCO, avenues left open to bankruptcy professionals disputing fees are limited and include: 1) whether the objecting party is in fact the debtor or trustee; and 2) (at least outside of Delaware) attempting to negotiate retention under section 328 that allows for the payment of fees incurred in a successful defense of a fee petition. In taking on any estate representation, professionals must consider the very real possibility (in the absence of legislative action or further guidance from the Supreme Court) that in the event of an objection to their fees, they may well incur substantial costs in defending those fees.

Rosanne Ciambrone is a partner in the Chicago office of Duane Morris LLP and focuses her practice on business reorganization, financial restructuring, bankruptcy law and commercial litigation. She represents both borrowers and lenders in all facets of bankruptcy as well as in out-of-court restructurings. She can be reached at [email protected].