Saturday, August 30, 2014

Fifth Circuit's Bankruptcy Opinions From August 2014

There are more bankruptcy decisions that come out of the Fifth Circuit each month than I could ever write about.   I am going to try to provide at least a brief blurb for each one.  Here are five cases from the Fifth Circuit that came out during August.   They deal with discharge, dischargeability, jurisdiction and Stern issues, lien claims and preferences.

Graham Mortgage Company v. Goff (In re Goff),No. 13-41148 (5th Cir. 8/22/14)(unpublished).   Fifth Circuit affirmed denial of discharge for failure to keep records under § 727(a)(3).  Opinion here.

Galaz v. Galaz (In re Galaz), No. 13-50781 (5th Cir. 8/25/14).   Court found no jurisdiction over claims brought by non-debtor against non-debtor.   Debtor's fraudulent transfer claims against non-debtor were non-core claims for which Bankruptcy Court could not enter final judgment but could submit proposed findings and conclusions here.   Opinion here.

McClendon v. Springfield (In re McClendon), No. 13-41030 (5th Cir. 8/26/14).   Court affirmed judgment of non-dischargeability for defamation claim under § 526(a)(6).   Employee who was fired brought claims for defamation against president of employer who accused him of theft.   Court did not give collateral estoppel effect to jury verdict but conducted trial.    Court found objective certainty of harm from statements.

Endeavor Energy Resources, LP v. Heritage Consolidated, LP (In re Heritage Consolidated, LLC), No. 13-10969 (5th Cir. 8/27/14).    Court affirmed summary judgment against drillers for constructive trust and equitable lien claims.   Court reversed and remanded on summary judgment on drillers' mineral subcontractor lien claims.    Opinion here.

Flooring Systems, Inc. v. Chow (In re Poston), No. 13-41050 (5th Cir. 8/28/14).   Court affirmed judgment to recover preference from creditor.    Transfer occurred when state court receiver served certified copy of receivership order on bank, not when turnover receiver was appointed.   Opinion here.  


Fifth Circuit Provides Valuable Guidance on Jurisdiction and Authority Post-Stern

Many cases deal with debtors who fraudulently convey away their assets before filing bankruptcy.   But what about the situation where the debtor is the victim of a fraudulent conveyance rather than the perpetrator?    In Galaz v. Galaz (In re Galaz), No. 13-50781 (5th Cir. 8/25/14), which can be found here, the Fifth Circuit answers important jurisdictional and Stern questions about the debtor's quest to recover wayward assets.   

What Happened

Lisa and Raul Galaz were once married to each other.   One of their assets was an interest held by Raul in Artist Rights Foundation, LLC ("ARF"), a company which owned the rights to the Ohio Players music catalog.    The other owner of ARF was Julian Jackson.   When Lisa and Raul were divorced in 2002, Raul assigned Lisa 50% of his 50% interest in ARF.   Because the transfer was made without Julian's consent, Lisa received a 25% economic interest in the company but was not a member.    While it is not really relevant to the opinion, another significant occurrence in 2002 was that Raul pled guilty to mail fraud and surrendered his California law license.    

From 1998 to 2005, the Ohio Players catalog was not generating any revenue.   While the opinion describes the Ohio Players as "a former funk band," a little more explanation is justified.   The Ohio Players were formed in 1959 and had gold records with "Funky Worm," "Skin Tight," "Fire" and "Love Roller Coaster."   Their heyday was between 1973 and 1976, when they had seven Top 40 hits.  Their last studio album was released in 1998 and they were inducted into the Official R & B Music Hall of Fame in 2013.  

On June 3, 2005, Raul transferred all of ARF's rights to the Ohio Players to Segundo Suenos, which was nothing more than a name at the time, but was later established as a Texas limited liability company.  According to the Fifth Circuit, when Segundo Suenos is spelled with the tilde (⁓--an accent mark used in Spanish), it means "Second Dreams" in Spanish.   Raul did not get permission from Lisa or Julian before embarking on his second dream of exploiting the Ohio Players music in an entity which excluded them.  Shortly after this transfer, the catalog began to make money, about a million dollars over five years.    The opinion does not say why the catalog started making money.   However, it is worth noting that the song "Love Rollercoaster" appeared in the film Final Destination 3 in 2006.  

In 2007, Lisa filed chapter 13 in the Western District of Texas.   She brought an adversary proceeding against Raul, his father, Alfredo, and Segundo Suenos.   The Defendants brought a third party complaint against Julian, who counterclaimed against them.   After a five day trial, Chief Bankruptcy Judge Ronald B. King found that the transfer to Segundo Suenos was invalid and that Raul had breached his fiduciary duty to Julian but not Lisa.   The Bankruptcy Court awarded $250,000 in actual damages and $250,000 in exemplary damages to Lisa and $500,000 in actual damages and $500,000 in exemplary damages to Julian.   After an appeal to the District Court, the fraudulent transfer judgment was affirmed but the case was remanded for a recalculation of damages.    The Bankruptcy Court reduced the actual damages slightly to reflect taxes incurred by Segundo Suenos, but otherwise left the award intact.   The District Court affirmed the second judgment and the case was appealed to the Fifth Circuit.

 Jurisdiction and Authority

The Fifth Circuit considered two important issues in its opinion:  whether the Bankruptcy Court had jurisdiction over the claims and whether it had authority to enter a final judgment.    These are very different concepts.   Jurisdiction looks at whether the federal courts have authority to consider a matter, while the authority question looks at whether the Bankruptcy Court or the District Court has authority to render a final judgment.

With regard to Lisa, the Fifth Circuit had no trouble finding jurisdiction.   The test for "related to" jurisdiction, which is the most expansive source of bankruptcy jurisdiction, is whether the dispute could "'conceivably' have any effect on the estate being administered in bankruptcy."   See Opinion, p. 5.  Since Lisa's suit could increase the size of the estate, there clearly was jurisdiction.   Julian was another matter.   He was a non-debtor suing another non-debtor.   That is the scenario that was struck down by the Supreme Court in Northern Pipeline.   Even though Julian was unwillingly dragged into the suit, there was ultimately no jurisdiction for his claims and so they went away.   Julian may have recognized this reality before the Fifth Circuit did, since he did not bother to file a brief in the appeal despite being ordered to.  

Although the Bankruptcy Court had jurisdiction to consider Lisa's claims, it did not have authority to enter a final judgment.    This was not a difficult question in 2014 (although it was much less obvious in 2010 when the case was originally tried).    The Fifth Circuit dutifully noted that
when a debtor pleads an action that would augment the bankruptcy estate, but not necessarily be resolved in the claims process, then the bankruptcy court is constitutionally prohibited from entering final judgment.
 Opinion, pp. 7-8.  The Bankruptcy Court had attempted to justify its final judgment on implied consent.   However, the Fifth Circuit's Frazin and BP RE decisions have eliminated consent as a ground for authority in the circuit.   The Supreme Court recently considered and dodged the consent issue in Bellingham and has granted cert to consider the issue again in Wellness International Network.   Nevertheless, the Court noted that "Until the Supreme Court decides, we are bound by controlling circuit precedent."  Opinion, p. 8.

Thus, the Bankruptcy Court had jurisdiction to consider Lisa's claims but not authority to enter a final judgment.    Where does that leave the case?  
The failure of the consent rationale does not vitiate the lower courts’ work altogether, however. As the Supreme Court recently held, claims designated for final adjudication in the bankruptcy court as a statutory matter, but prohibited from proceeding in that way as a constitutional matter, may still “proceed as non-core within the meaning of § 157(c).” (citation omitted). Because Lisa’s claim is “related to a case under title 11,” 28 U.S.C. § 157(c)(1), the bankruptcy court may still hear it and “submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.” (citation omitted). Accordingly, the district court’s judgment on Lisa’s TUFTA claim must be vacated and remanded for de novo review of the bankruptcy court’s decision as recommended findings and conclusions.
Opinion, pp. 8-9.   Thus, the District Court which has already reviewed the case twice will get to take a third look at it.   This time, the District Court will consider the Bankruptcy Court's opinion as proposed findings of fact and conclusions of law which it may accept or reject on a de novo basis.  What this means is that the District Court is free to disregard the Bankruptcy Court's factual findings rather than being bound by the clearly erroneous rule.    However, given the Bankruptcy Court's greater familiarity with the facts and the District Court's workload, it is highly likely that the District Court's review will be very deferential.    

The Galaz opinion highlights the silliness of all of the attention paid to Stern and its progeny.  Notwithstanding Stern, Bankruptcy Courts can still hear cases within their jurisdiction.   If a case is non-core (or is designated as core but is outside of the Bankruptcy Court's authority), the Bankruptcy Court can still submit proposed findings of fact and conclusions of law to the District Court.  While the District Court could hear more evidence and re-open the record, the District Courts already have a pretty full docket.   As a result, my guess is that they will review proposed findings and conclusions in much the same manner as they have traditionally reviewed bankruptcy appeals.   However, if the District Courts are faced with a high volume of Bankruptcy Court reports and recommendations, they may be tempted to give them even more deferential review.   The District Courts have substantial experience reviewing reports and recommendations from their Magistrate Judges and, although I have not done the research, I suspect that the normal procedure is to approve them.   To quote the Talking Heads, the practical reality may be "same as it ever was."

Even though the Fifth Circuit sent Lisa back for another round of procedural hell, they did give her a parting gift by answering a substantive legal issue.   Lisa had filed suit under the Texas Uniform Fraudulent Transfer Act which allows a creditor to file suit to avoid a transfer.   Raul claimed that Lisa was not a "creditor" because he didn't owe her any money.    However, the Fifth Circuit concluded that a "creditor" under TUFTA means someone who has a "claim" which means a right to "payment or property."   Because Lisa had the right to a share of ARF's assets upon its dissolution, she had a right to property and was thus a creditor with standing to pursue a TUFTA claim.  



 
  

Saturday, August 23, 2014

Texas Homesteads Sold Post-Petition Take Another Hit

Texas bankruptcy judge Jeff Bohm has ruled that a chapter 7 debtor who sold his homestead over a year after filing bankruptcy could not keep the portion of the proceeds when he failed to reinvest them within six months.  In re Smith, 2014 Bankr. LEXIS 3344 (Bankr. S.D. Tex. 8/4/14).    The case concerns the intersection between bankruptcy law, which determines exemptions as of the petition date, and Texas law, which requires reinvestment to maintain the exemption and is part of a continued trend of homestead proceeds at risk

What Happened

 The Debtor filed a chapter 7 petition on March 20, 2012 and claimed his homestead as exempt.   No party objected to the exemption.   The Trustee did not close the case.   On June 21, 2013, the Debtor sold his homestead and received net proceeds of $813,935.77.    The Debtor did not reinvest the proceeds within six months.   On April 11, 2014, the Trustee filed an adversary proceeding seeking to recover the remaining homestead proceeds in the amount of $700,349.09 from the Debtor.   The Debtor filed a Motion to Dismiss.  

The Fifth Circuit and the Vanishing Exemption

The Fifth Circuit has two reported and one unreported decisions dealing with proceeds from sale of a homestead in bankruptcy.  In re Zibman, 268 F.3d 298 (5th Cir. 2001) involved a debtor who sold his homestead, then filed chapter 7 without reinvesting the sales proceeds.   The Fifth Circuit held that the Debtor's exemption was contingent on reinvesting the proceeds and allowed the trustee to recover the funds when they were not reinvested.  In Studensky v. Morgan, 481 Fed.Appx. 183 (5th Cir. 2012), a chapter 7 debtor sold his homestead and paid some of the proceeds to his brother.  When the Trustee sought to recover the funds, the Debtor amended his exemptions to claim the funds as exempt.  The Bankruptcy Court and District Court ruled that the proceeds were exempt, but the Fifth Circuit reversed.  In Frost v. Viegelahn, 744 F.3d  384 (5th Cir. 2014), a chapter 13 debtor sold his homestead during the pendency of the chapter 13 case and did not reinvest the proceeds.   Once again, the Fifth Circuit held that the Debtor lost the exemption when the proceeds were not reinvested.    I wrote about Frost here.  

The difficulty with cases allowing proceeds to lose their exempt status is that exemptions are determined as of the petition date.    An absolutist approach to the snapshot rule would say that if the homestead or the proceeds were exempt on the petition date, they left the estate and could not re-vest.   That is what many of us thought that Taylor v. Freeland & Kronz, 503 U.S. 638 (1992) meant.

However, both cases could be reconciled with the "snapshot" approach.   In Zibman, the asset to be exempted was the proceeds rather the homestead itself.   The exemption of proceeds was a conditional one which depended upon reinvesting them within six months.   As a result, the conditional nature of the exemption was not necessarily at odds with the snapshot.   Frost was a chapter 13 case.  In chapter 13, property which the Debtor acquires post-petition is included in the estate under section 1306(a).    Thus, Frost could have been decided based on section 1306, even though the opinion did not say this.   


Judge Bohm's Ruling

The Smith Trustee could not rely on either of these saving devices.    Because the Debtor had a homestead and not just proceeds on the petition date, the Trustee could not rely on the idea that proceeds were different than the actual property itself.    Because the case was a chapter 7, the after-acquired property provision of section 1306(a) did not apply.   Instead, the Trustee had to argue that a Texas homestead exemption was never really final and could be clawed back if the Debtor sold the property and didn't reinvest the proceeds.     The Trustee made this argument and the Court agreed with him.  

In denying the Motion to Dismiss, the Court ruled that the Six-Month Rule applied to a chapter 7 case and that on the 181st day, "title to the Proceeds automatically passed from the Debtor to the Trustee and the Debtor had a duty to turnover over the Proceeds to the Trustee."   Opinion, at *34.   The Court rejected the arguments that property once exempted remains exempt and that the six-month rule does not apply to chapter 7 cases.  

The Court held that the six-month rule did apply in a chapter 7 case based on the fact that the Frost case did not limit its effect to chapter 13 cases and because Zibman and Morgan applied the rule in chapter 7 cases.    The Court stated:

There is a further point undermining the Debtor's argument that Frost is limited to Chapter 13 cases: Frost never mentioned § 1306(a)(1) as the basis for its decision. Rather, the Fifth Circuit focused on § 41.001 of the Texas Property Code in rendering its ruling. The Debtor, and at least one outside commentator, seem to be at a loss to understand why the Fifth Circuit did not cite § 1306(a)(1) to justify its ruling in Frost and to limit the ruling to Chapter 13 cases. A review of certain pre-Frost opinions from the Fifth Circuit underscores why there should be no surprise that the Fifth Circuit, in Frost, did not use § 1306(a)(1) to limit its holding to Chapter 13 cases.

***
These two cases—Zibman and Morgan—thus underscore why the Fifth Circuit, in Frost, did not rely on § 1306(a)(1) to justify its holding in that case and to limit§41.001(c) to Chapter 13 cases. The Fifth Circuit had already held that the 6-Month Rule applies in Chapter 7 cases.
Opinion, at *25-26, 29.  

The Court went on to write:
This Court declines the Debtor's invitation to exempt the Proceeds from the bankruptcy estate on the basis that Frost is inapplicable to Chapter 7 cases. Rather, this Court is bound by Fifth Circuit precedent and concludes that Frost applies in this Chapter 7 case. Moreover, § 41.001 sets forth both the scope and limitations of a Texas homestead exemption, and the "snapshot rule" in bankruptcy law instructs courts to apply the law applicable at the time of the filing. As the Fifth Circuit in Zibman noted, when a debtor avails himself of the Texas homestead law, the debtor has to take the "fat with the lean." In re Zibman, 268 F.3d at 304. Here, the Debtor availed himself of the generous Texas homestead exemption, and is therefore bound by both its provisions and its limitations, including the 6-Month Rule. Accordingly, when the Debtor failed to reinvest the Proceeds in a new homestead within six months of selling the Property, the Proceeds lost their exempt status. The Debtor's argument of "once exempt, always exempt" is simply incorrect.
Opinion, at *35-36.

The Court sought to dispel the concern that trustees could lurk in the shadows indefinitely waiting for the Debtor to some day sell his homestead.
Does this Court's holding mean that Chapter 7 trustees can forever make a claim on the proceeds from the sale of a debtor's homestead after six months has passed without the debtor reinvesting those proceeds in a new homestead? The answer is no. Once a Chapter 7 case is closed, any property that the trustee has not administered at the time of closing is abandoned to the debtor under § 554(c). The effect of abandonment is that "the trustee is... divested of control of the property because it is no longer part of the estate... Property abandoned under [§] 554 reverts to the debtor, and the debtor's rights to the property are treated as if no bankruptcy petition was filed." (citation omitted).   For example, if the case at bar had been closed after the Debtor had sold the Property but before six months had expired, the Trustee would have automatically abandoned any future right to the Proceeds after the expiration of six months, and the right to the Proceeds would have reverted to the Debtor on the date of the closing of the case.
 Opinion, at 32-33.

Thus, the Court held that even if the property is properly claimed as exempt and no party objects, the exemption allowed is a conditional one.   If the Debtor sells the property and does not reinvest the proceeds within 180 days while the case remains open, the exemption evaporates.  

What Does It Mean?

I am the outside commentator referenced in Judge Bohm's opinion.   I had argued that the Fifth Circuit should have clarified the Frost decision to limit it to the chapter 13 context.   I had previously written:
The Fifth Circuit might want to take another look at this one.   For one thing, the opinion completely fails to appreciate the case's unique procedural posture which could have provided a more coherent basis for the Court's ruling.  It also seems to fumble the intersection between the Bankruptcy Code and Texas exemption law.   This could result in major mayhem in future cases.
This was a chapter 13 case.   As a result, property acquired post-petition is included in the estate.   11 U.S.C. Sec. 1306.   The proceeds from sale of the homestead could have been analogized to property acquired post-petition which would only be exempt if re-invested in a new homestead within six months.    As a result, the timing that would matter is whether the homestead was sold during the case or subsequently.    The expanded definition of property of the estate in a chapter 13 case could justify the result in the Frost case.   However, this was not discussed by the Court.  How would it be applied in a chapter 7 case?    Judge Tony Davis rejected the application of Zibman to a post-petition sale of a homestead in a chapter 7 case in a well-reasoned opinion in In re D'Avila, 498 B.R. 150 (Bankr. W. D. Tex. 8/21/13), which can be found here.   Hopefully the Circuit would agree with Judge Davis when faced with a Chapter 7 case.    However, like I said, the Frost decision does not make this clear.
My concern that Frost could result in "major mayhem in future cases" appears to have come true.  Judge Bohm followed what he considered to be binding precedent.   I would have distinguished Zibman and Frost based on Taylor v. Freeland & Kronz, 503 U.S. 638 (1992) where the Court stated:
Davis claimed the lawsuit proceeds as exempt on a list filed with the Bankruptcy Court. Section 522(l), to repeat, says that "unless a party in interest objects, the property claimed as exempt on such list is exempt." Rule 4003(b) gives the trustee and creditors 30 days from the initial creditors' meeting to object. By negative implication, the Rule indicates that creditors may not object after 30 days "unless, within such period, further time is granted by the court." The Bankruptcy Court did not extend the 30-day period. Section 522(l) therefore has made the property exempt. Taylor cannot contest the exemption at this time whether or not Davis had a colorable statutory basis for claiming it.

Deadlines may lead to unwelcome results, but they prompt parties to act and they produce finality. In this case, despite what respondents repeatedly told him, Taylor did not object to the claimed exemption. If Taylor did not know the value of the potential proceeds of the lawsuit, he could have sought a hearing on the issue, see Rule 4003(c), or he could have asked the Bankruptcy Court for an extension of time to object, see Rule 4003(b). Having done neither, Taylor cannot now seek to deprive Davis and respondents of the exemption.
Taylor, at 644.   In my view, Taylor mandates the "once exempt, always exempt" position advocated by the Debtor and rejected by Judge Bohm (among others).

In Zibman, the Debtor sold their home on November 27, 1998 and filed bankruptcy on February 9, 1999.   They claimed the proceeds from sale of their homestead as exempt.  The Court extended the deadline to object to exemptions until July 6, 1999.   The Trustee filed a timely objection to exemptions on June 3, 1999.    Thus, Zibman was not a failure to object case.    It was simply a case where the Trustee filed a timely exemption to funds which had lost their exempt status as of the date of the objection.  

Frost was more complicated for the reason that the Trustee did not object to the exemptions but at least raised the six month deadline in a written pleading before the deadline had run.    The Debtor filed a chapter 13 petition on November 30, 2009.    He claimed his homestead as exempt at that time.    On March 3, 2010, the Debtor filed a Motion to Sell Property Free and Clear of Liens.   This motion was filed after the exemption had become final.    The Trustee filed a timely objection to the Motion to Sell Free and Clear.    The Trustee argued that "if Debtor is not using proceeds to purchase a new home within the six month exemption period, the proceeds should be paid into the plan to increase the base."    On March 26, 2010, the Court approved the sale but ordered the remaining proceeds deposited with the Chapter 13 trustee.    On January 3, 2011, in connection with the Debtor's proposed chapter 13 plan, the Court released $40,000.00 to the Debtor and allowed the Trustee to retain sufficient funds for a 100% distribution to creditors.   On May 11, 2011, the Court entered a Final Order Regarding Trustee's Objection to Debtor's Motion to Sell Real Property Free and Clear of All Liens and Interests.   The Court ruled that the Debtor would be granted six months to reinvest the $81,108.67 proceeds into a new homestead beginning on January 27, 2011 minus $23,000.00 which had already been spent by the Debtor for non-homestead purposes.   The Debtor moved to vacate the order based upon Taylor v. Freeland & Kronz.   The Court denied this motion and the Debtor appealed.   The Court of Appeals affirmed the Bankruptcy Court's ruling on murky grounds.
 
While I was troubled by Frost, it can be explained away on several grounds that are at least plausible (even if they are not necessarily compelling).     First, Frost was a chapter 13 case.    Under 11 U.S.C. Sec. 1306, post-petition property, such as homestead proceeds which are not reinvested, are added to the estate.   Second, the Debtor sought the benefits of chapter 13 in order to obtain time to sell his home.    The Chapter 13 Trustee, Mary Viegelahn, essentially argued that if the Debtor wanted to get the benefits of Chapter 13 that he should have to either reinvest the proceeds as provided by Texas law or use them to provide a 100% plan to his creditors.    If the Debtor didn't like that deal, he could have simply exercised his absolute right to dismiss his case and have sold his property outside of bankruptcy.    

However, Smith is the case which completely slides down the slippery slope.    Rather than looking for a clever distinction, Judge Bohm applied what he considered to be a straightforward reading of the precedent. The problem with Smith is that the Debtor will potentially lose his homestead proceeds due to the Trustee's two-fold inaction.   First, the Trustee did not object to the homestead exemption which duly became final.    Second, the Trustee left the case open while the Debtor proceeded to sell his home.    Had the Trustee closed the case, we wouldn't be having this discussion.   Instead, because the Trustee chose to lurk in the shadows waiting for the Debtor to make a mistake the Debtor will potentially lose one of the most valuable rights available to him under Texas law.    In my view, Judge Davis's opinion in  In re D'Avila, 498 B.R. 150 (Bankr. W. D. Tex. 2013) has the better side of the argument. 
 
Is the Proceeds Provision A Limitation or an Expansion on the Homestead?

I would like to throw out one more issue for discussion.   The recent cases interpreting the six months to reinvest provision have assumed that it was a limitation on the homestead exemption.  What if they are wrong?   What if it is actually an expansion of the exemption?   If the proceeds provision adds to the rights otherwise available, then it would be a mistake to consider it to be grounds for eviscerating the exemption.   In Frost, the Fifth Circuit stated that "a change in the character of the property that eliminates an element required for the exemption voids the exemption."    Opinion, p. 11.   Where did they get that from?   Section 522(l) states that "Unless a party in interest objects, the property claimed on the list is exempt."   It does not state that unless the property retains its character until the case is closed, it is exempt.  In my view, the Fifth Circuit has re-written the statute.

Protection of proceeds under Texas law is the exception rather than the rule.   The only provisions that I am aware of under Texas law are the six month provision allowing for reinvestment of homestead proceeds and the provision in the Insurance Code stating that proceeds from a life insurance policy are exempt.    Every other Texas exemption says that the thing itself is exempt.   Normally, when Texas exempt property is converted into cash, it loses its exempt character.   For example, current wages are exempt while money obtained from depositing your paycheck is not.   The six month provision adds to what would normally be exempt.   Your homestead is exempt and if you sell it, the proceeds remain exempt for six months.   During that six months, you can reinvest it in a new home or blow it on wild living.    Any money left over after six months becomes subject to claims of creditors.    Thus, homestead proceeds unlike wages deposited into the bank retain their exempt for an extended period of time.
 
The normal rule with exempt property is that once property is exempt, it remains exempt.  Section 522(c) and (l) state that whatever property is claimed as exempt is not liable for any claims that arose prior to the petition date.   What the Debtor does with the exempt property after it leaves the estate is irrelevant.  If the Debtor decides to sell his $50,000 Mercedes and use the money to pay living expenses while he stays home and plays video games, the money is still exempt because the asset giving rise to the proceeds left the estate.  

Under the rationale of Frost and Smith, no exemption is final until the case is closed.   If the Debtor has a yard sale and sells his used yard furniture, that money belongs to the Trustee.   If the Debtor wrecks his car and receives a check from his insurance company, that money is not exempt and belongs to the Trustee.   This is madness because it means that there would never be any finality to any exemption ever.    

Let's go back to Taylor v. Freeland & Kronz.   In that, case the Debtor claimed something that was not exempt and no one made a timely objection.   The Supreme Court said sorry, you missed your chance to object.   However, under Frost and Smith, property only remains exempt if it retains its exempt character throughout the case.   As a result, property that should never have been claimed as exempt could be recovered at any time.    In my opinion, there is a serious problem with using a provision intended to grant additional protection to homesteads to gut the homestead exemption.   This is wrong, wrong, wrong and someone (other than me) needs to say so.        

Final Thoughts

I have known Judge Bohm since he was in private practice in Austin.  He is a very smart guy with a lot of integrity.   While I have been free about disagreeing with him here, opinions of judges have more weight than opinions of bloggers.   Judge Bohm did not engage in judicial activism, but rather tried to follow in the direction the Circuit was pointing.    The error comes from above and that's where it needs to be remedied. In my view, the Circuit has dangerously drifted away from the principle of finality in exemptions and should give this issue another look.   Seriously, Fifth Circuit, I'm saying this as a friend.   



Wednesday, July 16, 2014

Read My Competitor: Fifth Circuit Holds That Bankruptcy Court Retains Jurisdiction Over Foreclosure Proceeds

The Weil Bankruptcy Blog has a good posting on Goldsby v. 804 Congress, LLC, No. 12-50382 (5th Cir. 6/23/14).    In short, this was a case where the Court lifted the automatic stay and a third party bid in more than the amount of the debt.  The bank and the substitute trustee argued that they should be allowed to distribute the funds as provided by the deed of trust, while the Debtor contended that the Bankruptcy Court had authority over the funds.    The Fifth Circuit ruled that Section 506(b) controlled over the deed of trust.   However, the Court remanded for a determination of whether unreasonable fees and charges could be recovered as unsecured claims under Section 502.     You can read Debra McElligott's posting here.   I represented the Debtor.

Tuesday, July 15, 2014

Fifth Circuit Panel Urges Re-Examination of Pro-Snax

The Fifth Circuit ruled today that a bankruptcy court following Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1997) did not abuse its discretion in substantially reducing fees requested by counsel in a failed chapter 11 case.   The Debtor's counsel argued that Pro-Snax was subject to multiple interpretations such that a pure results test was not mandated.   The Court did not accept this argument.   Nevertheless, the interesting part of the opinion was the special concurrence written by Judge Prado and joined in by the other members of the panel, which stated, "I write separately to note that the Pro-Snax standard may be misguided."   Barron & Newburger, P.C. v. Texas Skyline Limited, No. 13-50075 (5th Cir. 7/15/14), p. 15.   The opinion can be found here.  

This is my firm's case and there will be additional proceedings.   As a result, I am not going to offer any commentary on the ruling at this time.   As a result, I quote the special concurrence in its entirety.

Even though we find no error in the bankruptcy court’s use of the Pro–Snax standard to resolve the attorney fee application in this case, I write separately to note that the Pro–Snax standard may be misguided. It appears to conflict with the language and legislative history of § 330, diverges from the decisions of other circuits, and has sown confusion in our circuit.

The plain language of § 330 runs counter to Pro–Snax’s holding that only services that produce an actual benefit are compensable. Section 330 gives a bankruptcy court discretion to determine the amount of reasonable compensation. But the statute also constrains that discretion by requiring the court to “tak[e] into account” a set of listed factors, including “whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered.” 11 U.S.C. § 330(a)(3)(C) (emphasis added).

The statute reinforces this point in an accompanying section: a court must disallow any compensation when “the services were not reasonably likely to benefit the debtor’s estate or necessary to the administration of the case.” § 330(a)(4)(A)(ii)(I); see In re ASARCO, L.L.C., 751 F.3d 291 (5th Cir. 2014) (“Section 330 states twice, in both positive and negative terms[,] that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration.” (citation omitted)); In re Ames Dep’t Stores, Inc., 76 F.3d 66, 71 (2d Cir. 1996) (referring to “reasonably likely to benefit the debtor’s estate” as an “inverse construction” of § 330(a)(3)(C)), abrogated on other grounds by Lamie v. U.S. Trustee, 540 U.S. 526 (2004). Read together, a court may compensate an attorney for services that are “reasonably likely to benefit” the estate and adjudge that reasonableness “at the time at which the service was rendered.”

Section 330, then, explicitly contemplates compensation for attorneys whose services were reasonable when rendered but which ultimately may fail to produce an actual benefit. “Litigation is a gamble, and a failed gamble can often produce a large net loss even if it was a good gamble when it was made.” In re Taxman Clothing Co., 49 F.3d 310, 313 (7th Cir. 1995). The statute permits a court to compensate an attorney for any activities that were “necessary,” but also for any good gambles—that is, services that were objectively reasonable at the time they were made—even when those gambles do not produce an “identifiable, tangible, and material benefit. What matters is that, prospectively, the choice to pursue a course of action was reasonable.

The legislative history of § 330 provides additional support for this reading. When Congress enacted § 330 in 1978, it relaxed the previously stringent standard bankruptcy courts applied in reviewing professional fee awards. 3 Collier on Bankruptcy ¶ 330.LH[4] (16th ed. 2014). Under the old regime, our court enforced a “strong policy . . . that estates be administered as efficiently as possible.” In re First Colonial Corp. of Am., 544 F.2d 1291, 1299 (5th Cir. 1977) (citations omitted), superseded by statute, 11 U.S.C. § 330. This policy originated in the idea that “[s]ince attorneys assisting the trustee in the  administration of a bankruptcy estate are acting not as private persons but as officers of the court, they should not expect to be compensated as generously for their services as they might be were they privately employed.” Id. (citation omitted); see also Mass. Mut. Life Ins. Co. v. Brock, 405 F.2d 429, 432–33 (5th Cir. 1968) (holding that the interest of the public—especially the debtor and creditors—could limit compensation to a debtor’s counsel), superseded by statute, 11 U.S.C. § 330.

But “[i]n enacting section 330, Congress intended to move away from doctrines that strictly limited fee awards” and instead provide compensation “commensurate with the fees awarded for comparable services in non-bankruptcy cases.” In re UNR Indus., Inc., 986 F.2d 207, 208–09 (7th Cir. 1993) (citing, inter alia, H.R. Rep. No. 95–595, at 329–30 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, 6286); see also 3 Collier on Bankruptcy ¶ 330.03[a][3]. To that end, § 330 instructed courts to award “reasonable compensation” for “actual, necessary services” “based on the nature, the extent, and the value of such services, the time spent on such services, and the cost of comparable services other than in a case under [the Code].” 11 U.S.C. § 330(a). Congress took a further step in 1994 when it “codif[ied] many of the factors previously considered by courts in awarding compensation and reimbursing expenses.” 3 Collier on Bankruptcy ¶ 330.LH[5]; see Pub. L. No. 103-394, § 224, 108 Stat. 4106 (1994).3 In particular, Congress added the language at issue here: 11 U.S.C. §§ 330(a)(3)(C) & 330(a)(4)(A).

The drafting history of those provisions suggests that Congress considered and specifically rejected an actual benefit test. The Senate version contained the seed of the eventual guidelines for reasonable compensation under § 330. See S. 540, 103d Cong. § 309 (as reported by S. Comm. on the Judiciary, Oct. 28, 1993). The Bill reported out of the Senate Judiciary Committee differed in at least one important respect from the eventual Act, however. That Senate draft only instructed courts to consider “whether the services were necessary in the administration of or beneficial toward the completion of a case under [the Bankruptcy Code].” Id. After adopting a floor amendment, however, the Senate added the words “at the time at which the service was rendered” after “beneficial.” See 140 Cong. Rec. 8383 (1994) (setting out amendment 1645 to S. 540, April 21, 1994); S. 540, 103d Cong. § 310 (as passed by Senate, April 26, 1994); see also Lamie, 540 U.S. at 539–40 (discussing amendment 1645).

Besides contravening the plain effect of § 330’s language, the actual benefit test of Pro–Snax has put our circuit in unnecessary conflict with our sister circuits. In light of the plain language of § 330(a)(4)(A), the Second, Third, and Ninth Circuits have rejected the actual benefit test required by Pro–Snax. In In re Ames Department Stores, Inc., the Second Circuit specifically rejected an approach that would make fee award “contingent upon a showing of actual benefit to the estate,” opting instead to give effect to the statute’s “reasonably likely to benefit the estate” standard. 76 F.3d at 71. The Third Circuit rejected the very approach our court adopted in Pro–Snax, concluding that it departed from the statute by imposing a “heightened standard” and requiring evaluation “by hindsight.” In re Top Grade Sausage, Inc., 227 F.3d 123, 132 (3d Cir. 2000) abrogated on other grounds by Lamie, 540 U.S. 526. Finally, the Ninth Circuit held that § 330(a)(4)(A) superseded its past precedent, which had “requir[ed] that the services actually provide an ‘identifiable, tangible and material benefit to the [debtor’s] estate.’” In re Smith, 317 F.3d 918, 926 (9th Cir. 2002) (quoting In re Xebec, 147 B.R. 518, 523 (B.A.P. 9th Cir. 1992)). In addition, the Seventh Circuit has applied a similar rule, without specifically relying on the post-1994 guidelines. See In re Taxman Clothing Co., 49 F.3d at 314–16 (holding that the bankruptcy court abused its discretion in granting a fee award to an attorney whose preference action did not have a reasonable likelihood of benefiting the estate).

While Pro–Snax purported to consider the post-1994 guidelines of § 330(a), its lone citation for its actual benefit test, In re Melp, interpreted the pre-1994 version of § 330. See 179 B.R. at 639 (quoting pre-1994 language). Indeed, the only other circuit precedents to apply an actual benefit requirement came to that conclusion prior to 1994 or based entirely on pre-1994 precedent for determining “reasonable compensation.” See In re Kohl, 95 F.3d 713, 714 (8th Cir. 1996) (“[A]n attorney fee application in bankruptcy will be denied to the extent the services rendered were for the benefit of the debtor and did not benefit the estate.” (quoting In re Reed, 890 F.2d 104, 106 (8th Cir. 1989)); In re Lederman Enters., Inc., 997 F.2d 1321, 1323 (10th Cir. 1993) (“An element of whether the services were ‘necessary’ is whether they benefited the bankruptcy estate.”); Grant v. George Schumann Tire & Battery Co., 908 F.2d 874, 883 (11th Cir. 1990) (interpreting pre-1994 § 330 as requiring that attorney’s appeal bring a benefit to the estate). As discussed above, though, whereas the pre-1994 language did not provide guidance on whether to consider the reasonable likelihood a service would benefit the estate, the post-1994 language clearly foreclosed an actual benefit test by requiring that the court evaluate the likelihood of benefit to the estate at the time the service was rendered.

The Pro–Snax actual benefit test has led to confusion among the courts of our circuit. According to one Fifth Circuit bankruptcy practitioner, “the Pro–Snax decision is of constant discussion and concern.” William L. Medford, Further Evolution of Professional Compensation Under Pro-Snax the New and Improved Standard for Getting Paid, Am. Bankr. Inst. J., July 2012, at 16. As one bankruptcy court observed in its survey of post–Pro–Snax rulings:
[A]ll courts interpreting Pro–Snax have reached the conclusion that some sort of retrospective analysis is required. Lower courts have adopted differing views of what type of retrospective analysis should be employed and have disagreed whether a prospective analysis may be considered in determining whether Pro–Snax is satisfied.
 In re Broughton Ltd. P’ship, 474 B.R. 206, 209–10 n.5 (Bankr. N.D. Tex. 2012) (collecting cases). So, for example, one district court interpreted the Pro–Snax requirement as a threshold issue of entitlement to compensability under § 330(a)(1)(A), not a gloss on the guidelines for reasonable compensation under § 330(a)(3) and (a)(4). Kaye v. Hughes & Luce, LLP (In re Gadzooks, Inc.), No. 3:06-CV-0186-3 B, 2007 WL 2059724, *9 (N.D. Tex. July 13, 2007). Yet Pro–Snax did not purport to alter the threshold compensability of services by interpreting “necessary” services to include only those that result in an actual benefit to the estate. By contrast, in In re Broughton characterized Pro–Snax as a practical “problem” and contorted Pro–Snax to conclude that it permits a fee award to “a professional [who] was justifiably pursuing a legitimate, realizable goal of the fiduciary client.” 474 B.R. at 213, 218. The splintered approaches to applying Pro–Snax underscore the difficulty of squaring that decision with the statute, and the practical importance of doing so.

We note that application of the § 330(a) standard without Pro–Snax would probably lead to the same result in this case. The only fees that B & N adequately challenge on appeal—amending schedules and statements of financial affairs—were not reasonably likely to benefit the estate even when counsel rendered those services. We also note that overturning the holding on attorney’s fees in Pro–Snax would not alter that case’s principal holding, affirmed by the Supreme Court in Lamie, that debtor’s attorneys may not recover fees for services rendered after the case was converted to an involuntary Chapter 7 bankruptcy.

For these reasons, we urge reconsideration of the standard in Pro–Snax by this court sitting en banc.

Thursday, July 03, 2014

Supreme Court Prepares for Stern v. Marshall Round 3

When the Supreme Court struck down the Bankruptcy Reform Act's grant of authority to bankruptcy judges in 1982, it took it took them 29 years to return to the issue.    This allowed bankruptcy law to develop and mature without constantly fretting about whether the whole system would collapse.   However, since Stern v. Marshall, 131 S.Ct. 2594 (2011), the high court has shown renewed concern with how our nation's courts of financial last resort function.   While this term's unanimous decision in Executive Benefits Insurance Agency v. Arkison, No. 12-1200 (6/9/14) was notable for what it didn't decide (see my prior post here), the Supreme Court is going to try again.   On July 1, 2014, the court granted cert in Wellness International Network Limited v. Sharif, 727 F.3d 751 (7th Cir. 2013).   

What Happened

The Seventh Circuit case began when Richard Sharif sued Wellness International (WIN), claiming it was a pyramid scheme.   Sharif did not cooperate in discovery and ended up on the receiving end of a judgment for $650,000.   When he filed bankruptcy, WIN objected to his discharge and also sought a declaration that a trust was Sharif's alter ego.   After Sharif failed to fully respond to discovery once again, the Bankruptcy Court entered default judgment against him on all counts.   The Seventh Circuit affirmed the Bankruptcy Court's denial of discharge, but found that it lacked authority to enter a final judgment on the alter ego claim.  

The Issues on Cert

The Supreme Court granted cert on two points:
(1) Whether the presence of a subsidiary state property law issue in a 11 U.S.C. § 541 action brought against a debtor to determine whether property in the debtor’s possession is property of the bankruptcy estate means that such action does not “stem[] from the bankruptcy itself” and therefore, that a bankruptcy court does not have the constitutional authority to enter a final order deciding that action; and 

(2) whether Article III permits the exercise of the judicial power of the United States by the bankruptcy courts on the basis of litigant consent, and if so, whether implied consent based on a litigant’s conduct is sufficient to satisfy Article III.
What It Might Mean

If this case produces a direct answer on the issues granted (unlike Executive Benefits), it could be earthshaking.   If the Supremes find that Bankruptcy Courts lack authority to determine state law issues necessary to find whether assets are property of the estate, it would be a crippling blow to the ability of the system to function.   If the court gives a clear answer on consent/waiver, it will provide the answer missing in Executive Benefits.  

Bankruptcy practitioners will be watching with great interest and trepidation as the Supreme Court examines both whether and how our unique courts will be allowed to function  (or not) for the third time this decade.  The fact that the court is taking a second crack at the consent issue suggests that there are some justices on the court who were not satisfied with this term's non-answer.   

Saturday, June 28, 2014

The Trustee's Artistic Metaphor

Recently I attended a CLE seminar in which the learned professor discoursed on the difference between a metaphor and a simile.   A metaphor is a statement which is not literally true (for example, you never see a wolf actually wearing sheep's clothing) but conveys a truth through comparison.     This discussion came in handy when I came across the following pleading filed by Western District of Texas Trustee John Patrick Lowe who used Whistler's first nocturne as an extended metaphor for the disclosure provided to him in the case.  I provide the pleading for you in its entirety.

Case Summary


It's Whistler's first "nocturne", created in 1871 when he was only 37 years old.  The viewer is on the Battersea bank of the river Thames in London at night looking across to Chelsea on the other bank. A stylized barge is on the river. Lights on the far side of the river reflect across the river surface. And a figure, also stylized, appears on the near bank. An example of what Whistler called "art for art's sake". No lesson of any sort, religious, moral, ethical or otherwise, nothing informative, nothing historical.

Only something created for the thrill of it. And for the thrill created in certain viewers. It's also an example of the manipulation of facts, the suppression of some facts and the enhancement of others. Suppressed were the range of a normal pallette, what with blue, blue, blue but with minor hints of black to distinguish outlines and yellow to depict the reflection of lights on the river Thames. A hundred years later and without the detail it could very well be a "Blue Rothko". Also suppressed were details, something which would enable the viewer to tell where we are, what time of day it is or what's we're looking at. None of the bustle or activity of the day. No buildings really. And one's sense of proportion is put off by the size of the figure in relation to the barge and to objects on the far bank. Enhanced were color, mood, atmosphere. The picture is nothing if not atmospheric.

Paragraph 10 of the Debtor's Statement of Financial Affairs discloses her transfer of interests in real property in Orange and Tyler Counties, Texas to her daughters in May and August of 2012, less than two years prior to the commencement of the case.  Those statements and her testimony at the meetings of creditors were also an example  in the enhancement and suppression of facts. Suppressed were evidence of the value of the interests, the presence in the chains of title of, not necessarily oil and gas leases, but instruments disclosing oil and gas companies' intent to engage in seismic activity with respect to some of the interests, the brutal and extremely material fact that her daughters had peddled on most of what they'd acquired from their mother, the Debtor, shortly after having acquired those interests. Enhanced were her medical condition and the medical conditions of several family members, financial hardship, divorce and the so-called lack of any value to the interests, their extreme "sentimental value" to the family. The interests had been in the family for years and should stay in the family for years, the Trustee was told.

The Trustee had to interpret these stylized facts; adjust his point of view; use his imagination. He discovered the facts which had been suppressed: oil and gas activity; real objective value attributable to the mineral estates; real objective value attributable to the surface estates; the lack of sentimental value as perceived by the Debtor's daughters; the recent resale of most of the interests for dramatically increased prices.  And ignored the facts which had been emphasized. And at the end of the day, the Trustee had settled the estate's claims to avoid the transfers and recover the transferred interests for an amount sufficient to pay all allowed creditors claims a 100% dividend plus post-petition interest.

The Trustee's final report before distribution also proposes a small surplus distribution to the Debtor, her fee, as it were, for having created this beguiling work. Art for art's sake.
 John Patrick Lowe, Case No. 13-11741, Dkt. #25 (Bankr. W.D. Tex. 6/5/14).

Saturday, June 21, 2014

Lessons on Fees from the Fifth Circuit's ASARCO Decision

While the Fifth Circuit has yet to definitively address the quirky Pro-Snax opinion, a new decision provides some helpful guidance on recovering attorneys' fees in bankruptcy.    ASARCO, LLC v. Jordan Hyden Womble Culbreth & Holzer, P.C. (Matter of ASARCO, LLC), No. 12-40997 (5th Cir. 4/30/14).    You can read the opinion here

What Happened

ASARCO was a copper mining, smelting and refining company.  It used to have a really big smokestack in my home town of El Paso, but that's another story. Two years before bankruptcy, ASARCO's parent, Americas Mining Corporation (AMC), directed ASARCO to transfer a controlling interest in Southern Copper Corporation to it.   After ASARCO filed chapter 11 in 2005, its attorneys, Baker Botts and Jordan Hyden Womble Culbreth & Holzer, filed a fraudulent transfer action against the parent company.    The attorneys did a really good job.   They recovered a judgment valued at between $7-$10 billion which, according to the Fifth Circuit "was the largest fraudulent transfer judgment in Chapter 11 history."    When ASARCO sought to monetize its judgment, AMC decided that it would be cheaper to fund the company's reorganization instead.   As a result, ASARCO emerged from bankruptcy after just  52 months with "little debt, $1.4 billion in cash, and the successful resolution of its environmental, asbestos and toxic tort claims."    

You would think that everyone would be very happy with the work done by the attorneys.    The two firms applied for their lodestar fees plus a 20% enhancement as well as their expenses for preparing and litigating their fee applications.    ASARCO, which was now under the control of its parent, challenged the fees.   One discovery request sent to Baker Botts requested every document that the firm had produced during the bankruptcy case.   This resulted in production of 2,350 boxes of documents plus 189 GB of electronic data.   

After a six day trial, the Bankruptcy Court awarded Baker Botts $113 million in fees plus an enhancement of $4.1 million for the work performed on the fraudulent conveyance case.   Jordan Hyden recovered $7 million in fees as well as an enhancement of $125,000.   The Court also awarded fees for defending the fee applications, which amounted to $5 million for Baker Botts and $15,000 for Jordan Hyden.  

The District Court affirmed.

The Fifth Circuit's Ruling

The Fifth Circuit affirmed the enhancements but denied the fees for defending the fee applications.   Its analysis recapped the three-pronged approach adopted by the Court in In re Pilgrim's Pride Corp., 690 F.3d 650 (5th Cir. 2012) in which the Court held that fees should be determined under a combination of the lodestar approach, the factors specified in 11 U.S.C. Sec. 330(a) and the twelve factors from Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974).    The Court explained that
Section 330(a), the lodestar method, and the Johnson factors work in conjunction with each other to guide the court's discretion.
Opinion. p. 6.   The Court further explained that the lodestar calculation (reasonable rates multiplied by a reasonable number of hours) provides the starting point for the analysis and that the lodestar amount can be adjusted up or down based upon the other factors.    The fact that the lodestar can be adjusted up provides the analytical basis for fee enhancements in "rare and extraordinary cases."   

The Court rejected challenges from ASARCO that fee enhancements could never be allowed, that enhancements had to be approved by the client and that enhancements could only be allowed where there was a "plus factor" in addition to extraordinary results.  

The Court also considered whether Baker Botts's fees were "below market" as found by the Bankruptcy Court.   The firm's blended rate was $353.98 per hour with partners charging $365-$800 per hour and associates billing $$195-$525 per hour.   The Court ruled that because "reasonable attorneys' fees in federal court have (not) been 'nationalized,'" it was improper to look at fees charged in other circuits.   Opinion, p. 10.   Nevertheless, the Court found that the Bankruptcy Court's finding was supported by enough evidence to survive clear error review.   Indeed, the rates charged by Baker Botts were less on a blended rate basis than any of the other firms in the case.   See In re ASARCO, LLC, 2011 Bankr. LEXIS 5487 (Bankr. S.D. Tex. 2011).

However, the Court was not persuaded by the award of fees for defending the fee application.   The Court stated:
We conclude that, correctly read, Section 330(a) does not authorize compensation for the costs counsel or professionals bear to defend their fee applications.
Opinion, p. 13.   The Court based this ruling on the language of section 330(a), which expressly allows fees for preparing a fee application but not for defending one.  
Parties in interest as well as the United States Trustee are entitled to receive notice and the opportunity for a hearing to question bankruptcy professional fees. Section 330(a)(1). Implicit in this procedure is the possibility of fee litigation. Nevertheless, Section 330 states twice, in both positive and negative terms paraphrased above, that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration. Matter of Pro-Snax Distributors, Inc., 157 F.3d 414, 418 n.7 (5th Cir. 1998). The primary beneficiary of a professional fee application, of course, is the professional. While the debtor’s estate or its administration must have benefitted from the services rendered, the debtor’s estate, and therefore normally the creditors, bear the cost. This straightforward reading strongly suggests that fees for defense of a fee application are not compensable from the debtor’s estate. The Eleventh Circuit adopted this interpretation in a factually similar case, holding that “. . . the issue is whether the services rendered were reasonable and necessary to the administration of the estate. [internal citation omitted] The answer to this question is no. The subject of the [appeal and cross-appeal] was the fee to be paid to [the professional] for his services rendered in the administration of the estate. The appeals brought absolutely no benefit to the estate, the creditors, or the debtor.”(citation omitted).  

Further supporting this interpretation is Section 330(a)(6), which limits potential professional fees in two ways. First, the specification of an award for “preparation of a fee application” is clearly different from authorizing fees for the defense of the application in a court hearing. Second, tailoring the award to the “level and skill reasonably required to prepare the application” emphasizes scrivener’s skills over other professional work. It is untenable to construe this language alone to encompass satellite litigation over a fee application. Had Congress intended compensation for professional fee applications to be allowable as “reasonable and necessary” under Section 330(a)(3)(C), there would have been no need to create the limits specified in subdivision (4). The broad reading of Section 330(a)(3)(C) urged by Baker Botts would render Section 330(a)(4) superfluous.
Opinion, pp. 13-14.   The Court then explained how the American rule weighed against fees for defense.
Because Congress designed fee shifting provisions in express derogation of the American Rule that each party to litigation bears its own costs, the losing party should bear the full costs of counsel for the winner. In bankruptcy, the equities are quite different. Both the debtor and creditors have enforceable rights, and there is a limited pool of assets to satisfy those rights and compensate court-approved professionals; in certain cases, moreover, professionals paid from the debtor’s estate represent competing interests. No side wears the black hat for administrative fee purposes. In the absence of explicit statutory guidance, requiring professionals to defend their fee applications as a cost of doing business is consistent with the reality of the bankruptcy process. The perverse incentives that could arise from paying the bankruptcy professionals to engage in satellite fee litigation are easy to conceive.  (emphasis added).
Opinion, p. 16.

The Court dismissed the argument that denying fees for defense of a fee application would encourage excessive fee litigation with the comment that
Too frequently, court-appointed counsel for debtor[’s] and the official creditor committees’ interests in a case, sharing the mutual goal of securing approval for their fees, enter into a conspiracy of silence with regard to contesting each other’s fee applications. (citation omitted).
Opinion, p. 18.  Nevertheless, the Court allowed that fees for defense could be allowed where "an adverse party has acted in bad faith, vexatiously, wantonly, or for oppressive reasons."   Opinion, p. 19.

Thus, the final result was that Baker Botts was able to retain its enhancement of $4.1 million but lost its fees for defense of $5 million.   Jordan Hyden fared slightly better, retaining its enhancement of $125,000 while having $15,000 in cost of defense fees cut.   The Court tried to place this loss in context, stating:
In this case, the huge cost of defending Baker Botts's core fees seems a drastic reduction in absolute terms, but it amounts to only about 4.4% of the core fee.
Opinion, p. 17.   Thus, the message to Baker Botts from the appellate court was you did an amazing job, but you still have to pay the cost of proving that you did an amazing job.

Take-Aways from the Opinion

While this opinion addresses two very discrete issues, the extensive discussion contains some important lessons about attorneys' fees in bankruptcy.

  1. The accolades heaped upon Baker Botts are a measure of respect for the bankruptcy profession.   Even though Baker Botts plays in a more rarified world than the average bankruptcy practitioner, recognition for one bankruptcy professional is approval for the profession as a whole, just as incompetent, dishonest or mercenary behavior by bankruptcy lawyers tends to diminish it.    
  2. The Fifth Circuit has re-affirmed the unique amalgamation of three tests first announced in Pilgrim's Pride.   Professionals litigating attorneys' fees in the Fifth Circuit cannot simply rely on the language of the statute, but should consider whether the other two tests enhance or detract from their position.
  3. The Court's comments about national vs. regional fees reflect a compromise position between the efficiency of administration standard under the Bankruptcy Act and the "greed is good" mantra of Gordon Gecko.    While bankruptcy is no longer the poor stepsister of the legal practice, professionals cannot charge amounts exceeding the local prevailing rate simply because that is what they charge in some other, more expensive jurisdiction.
  4. The Fifth Circuit mentioned Pro-Snax, but not for its most infamous holding.   While the lower courts have struggled to implement the "tangible, identifiable and material benefit" standard, the Fifth Circuit has not revisited this language since its 1998 debut.   In this opinion, the Court mentioned one of Pro-Snax's less controversial statements that fees must be likely to benefit the estate or necessary to administration in order to be compensable.  This may be a signal from the Circuit that it will focus on the parts of the opinion that are uncontroversial while de-emphasizing the questionable language.     
  5. The Court recognized that challenging another professional's fees, while distasteful, is an important part of the process.   The Court's warning against the "conspiracy of silence" as well as its no black hats in fee litigation suggest that professional fees should be exposed to the same adversary process as other facts required to be determined by the courts.   While it may be easier to let the U.S. Trustee or the bankruptcy court do the heavy lifting, the parties will often have the most knowledge and incentive to develop the record.