You've got to know when to hold 'em
Know when to fold 'em
Know when to walk away
And know when to run
--Kenny Rogers, The Gambler
Know when to fold 'em
Know when to walk away
And know when to run
--Kenny Rogers, The Gambler
After the Fifth Circuit’s opinion in Barron & Newburger, P.C. v. Texas Skyline Ltd. (Matter of Woerner), 783 F.3d 286 (5th Cir. 2015), lawyers for bankruptcy estates breathed a sigh of relief, knowing that they could still be compensated for “good gambles” gone awry. However, how would the courts measure a “good gamble” in the context of a case that didn’t quite work out? Two decisions issued on the same day help answer that question. In Case No. 13-33264, Digerati Technologies, Inc. (Bankr. S.D. Tex. 8/21/15), a highly contentious case resulted in a confirmed plan but only after an initial plan proposed by management was rejected. In Case No. 10-11365, In re Woerner(Bankr. W.D. Tex. 8/21/15), the Bankruptcy Court that ruled in the case that was eventually reversed by the en banc Fifth Circuit reconsidered its ruling following remand. In both cases, debtor’s counsel received some but not all of the fees requested.
Judge Jeff Bohm described the new regime following the death of Pro-Snax in these words:
The Court issues this opinion in the wake of the Fifth Circuit's issuance of In re Woerner,783 F.3d 266 (5th Cir. 2015), a watershed case because of its rejection of the 17-year-old holding of Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998). Now, the law in the Fifth Circuit is that bankruptcy courts should evaluate fee applications under a "good gamble" approach rather than the "identifiable, tangible, material benefit" retrospective standard. The debtors' bar is breathing a sigh of relief in the wake of this change in the law. However, as this opinion shows, merely because Pro-Snax is gone does not necessarily mean that fee applications will more easily be approved in their entirety.
Digerati Technologies, Inc., p. 1. This post will look at what the new cases tell us about how courts will look at compensation in less than successful cases.
Digerati Technologies, Inc. involved a publicly held company with over 6,000 shareholders. At the time the case was filed, two factions contended that they were the rightfully constituted board of directors. The management group that filed the bankruptcy was opposed by a creditor group consisting of individuals who had sold their oilfield services companies to the Debtor.
In its opinion, the Court detailed several motions put forward by Debtor’s counsel that were denied, a discovery dispute and a plan that was denied because the continued participation of management was not in the best interest of creditors. Ultimately, the Debtor proposed a joint plan with the principal creditor group which was confirmed.
Debtor’s counsel filed a final fee application seeking fees in the amount of approximately $1.2 million. The fee application was opposed by the creditor group. The Court conducted hearings on the fee application over parts of eight days. Three witnesses testified, two attorneys from the applicant and one attorney for the objectors. The Court found that each of the attorney-witnesses were credible and accorded their testimony equal weight.
In the Woerner case, an individual filed chapter 11 bankruptcy following an adverse ruling in a state court case involving claims of fraud and breach of fiduciary duty. Two creditors took an extremely active role in the case, both of whom had been partners with the Debtor in different partnership ventures. The Texas Skyline parties ultimately recovered a judgment in the amount of $1,308,000. John T. Baker, Jr., a partner in different ventures, asserted unliquidated claims. Both Texas Skyline and Baker, as well as a third creditor, filed complaints to determine dischargeability.
The Texas Skyline parties stated an interested in reaching a negotiated settlement. The parties conducted a mediation before a sitting Bankruptcy Judge. Although the mediation was not successful, the parties continued to negotiate throughout the case. Baker filed a Motion to Convert the case based on the fact that the Debtor had omitted certain brass statues from his schedules. Debtor’s counsel amended the schedules to disclose the statues, as well as additional assets the Debtor had failed to schedule. Shortly thereafter, the Debtor and Baker reached a settlement which was documented in a Motion to Compromise and Settle filed with the Court. However, Baker reneged upon the settlement and insisted on proceeding with the hearing on the Motion to Convert. The Court granted the Motion to Convert based primarily on the failure to disclose. Although the Debtor had filed a proposed plan, the Court did not allow the plan to go forward.
After conversion, the firm filed a fee application in the amount of approximately $140,000. Both the Texas Skyline parties and the U.S. Trustee objected to the fee application. The Court conducted a hearing at which two attorneys for the applicant, as well as the Debtor’s state court counsel testified. The objecting parties did not offer any witnesses. Based on the Pro-Snax decision, the Court denied 85% of the requested fees.
Debtor’s counsel appealed to the District Court and the Fifth Circuit, both of which affirmed the Bankruptcy Court’s decision. However, the Fifth Circuit panel took the unusual step of issuing a concurrence recommending that the en banc court reconsider the Pro-Snax decision. In a unanimous en banc opinion, the Court of Appeals reversed Pro-Snax and remanded the case to the Bankruptcy Court for further proceedings.
Following remand, the Bankruptcy Court allowed the parties to submit additional briefing and took the matter under advisement.
The Digerati Ruling
Judge Bohm described the standard after Woerner as follows:
Woerner reversed the Fifth Circuit's prior retrospective test, under which professionals could only be compensated for services that actually resulted in a tangible, identifiable, and material benefit to the estate. See Pro-Snax, 157 F .3d at 426. Instead, under the new, prospective test, "[ w ]hether the services were ultimately successful is relevant to, but not dispositive of, attorney compensation." Woerner, 783 F.3d at 276 (emphasis added). In sum, the Fifth Circuit held that when read in its entirety, § 330 "permits a court to compensate an attorney not only for activities that were 'necessary,' but also for good gambles-that is, services that were objectively reasonable at the time they were made-even when those gambles do not subsequently (or eventually) produce an 'identifiable, tangible, and material benefit.'" Id. at 273-74. If professional services were either "'necessary to the administration' of a bankruptcy case or 'reasonably likely to benefit' the bankruptcy estate 'at the time at which [they were] rendered,' see 11 U.S.C. § 330(a)(3)(C), (4)(A), then the services are compensable." 5 Id. at 276. However, the Fifth Circuit emphasized that its Woerner ruling "is not intended to limit courts broad discretion to award or curtail attorney's fees under § 330, 'taking into account all relevant factors.'" Id. at 277 (quoting § 330) (emphasis added).
Digerati Opinion, p. 21. The Court went on to explain that the lodestar approach continued to be the standard for assessing attorney’s fees. Applying the lodestar approach, the Court took a three step approach. First, it looked at the hours billed to see whether they were reasonable. Second, it looked at the hourly rates charged. Finally, the Court looked at “all other factors.”
Lodestar: Reasonable Hours
In determining the amount of reasonable hours, the Court looked at two basic factors: whether they were properly documented and whether the services themselves were reasonable or necessary, i.e., whether they were good gambles. The Court denied some fees because the time entries describing them were too vague or because the time entries contained lumping. The Court stated that “(t)ime entries that do not provide sufficient detail to determine whether the services described are compensable may be disallowed due to vagueness.” Opinion, p. 24. The Court noted that the vagueness could have been cleared up through testimony at the hearing but was not. (Query: How would the attorney know which time entries the Court thought were vague so as to provide the testimony?). The Court pointed out that lumping time entries violates the U.S. Trustee Fee Guidelines. The Court also pointed out that Board Certified attorneys should have been aware of the Court’s stance on lumping. The amounts deducted for failure to properly document the time entries totaled about 6% of the requested fees.
Next the Court went through the twenty categories within the fee application to determine “whether the services rendered were reasonable or necessary.” The Court complained that in some instances the applicant did not provide testimony as to why the services performed were reasonable or necessary. In several instances, the Court identified services performed which did not represent a “good gamble.” Pleadings which were not filed or which were filed and then withdrawn drew the Court’s attention. The Court was also critical of a motion for post-petition financing which was denied due to “the poor preparation and paucity of relevant and convincing testimony that the Applicant adduced at the hearing.” The Court denied approximately 7.5% of the requested hours for services that were not reasonable or necessary.
Finally, the Court ruled that the hours spent on some tasks which were reasonable or necessary were nevertheless excessive. In some cases, the Court compared the number of pages of a particular document filed to the number of hours spent to produce it. This resulted in a deduction of just under 1% of the hours.
The Court’s extensive review of the hours billed resulted in a total reduction of just under 15% of the total requested.
Lodestar: Hourly Rates
In the next step, the Court reviewed the hourly rates billed. While the attorneys did not provide specific testimony as to the rates charged by other attorneys in the jurisdiction, the Court took judicial of rates charged by other similarly skilled practitioners. As a result, the Court approved the hourly rates of $400.00 per hour and $275.00 per hour charged by the two principal attorneys on the file. (Note: I have performed a fee survey of rates charged in the Western District of Texas which indicated that these rates are below market in my District).
Applying the Johnson Factors
The Court did not make any adjustment to the fees based upon the Johnson factors, finding that these factors were largely subsumed within the lodestar analysis.
All Other Relevant Equitable Factors
The Court’s final analysis concerned “all other relevant equitable factors.” This language is taken from Judge Jolly’s concurring opinion in Woerner where he stated:
(1) a court is permitted, but not required, to award fees under § 330 for services that could reasonably be expected to provide an identifiable, material benefit to the estate at the time those services were performed (or contributed to the administration of the estate); and (2) courts may consider all other relevant equitable factors, as stated in § 330(a)(3), including as one of those factors, when appropriate, whether a professional service contributes to a successful outcome.
783 F.3d at 278 (Jolly, J., concurring) (emphasis added).
The Court adjusted the fees downward based upon three additional considerations: failure to disclose a prior relationship with an investment banker, preferring the interest of management and litigation tactics.
The Court noted that under In re American International Refinery, Inc., 676 F.3d 455 (5th Cir. 2012), the Court could deny all compensation based upon failure to make adequate disclosure. In this case, the attorneys failed to disclose that they had previously represented the proposed investment bankers in appealing one of Judge Bohm’s orders. The law firm did not disclose its prior representation of the investment banker. The Court found that the failure to disclose the relationship was “related to the limited success of the Debtor’s case, because this relationship led—at least in part—to the employment of an investment banker . . . whose services were woeful and did not come within hailing distance of providing the benefit to the estate that” was initially promised. Opinion, p. 70. Because the failure to disclose was not as egregious as in American International Refinery where the Fifth Circuit approved a 20% deduction and because the case resulted in a “fairly successful reorganization,” the Court ordered a reduction of 5%.
The Court also found that the attorneys had initially proposed a plan which retained the Debtor’s existing management as the sole officers and directors “with excessive compensation packages” which rendered the plan “patently unconfirmable.” Because of the “overly cozy” relationship with management, the Court deducted an additional 5% from the fee request.
Finally, the Court made a deduction for “unsavory” litigation tactics. After the record was closed on the fee application but prior to closing arguments, the firm filed a Supplement to its fee application. The first section informed the Court of the decision in the Woerner case and was “entirely appropriate.” However, the second section included a discussion of the arrest of one of the objecting parties with copies of relevant documents. The Court found that this was “blatantly beyond the scope of the authorized briefing” and “irrelevant to the issues before the Court.” Based on “this ‘Rambo’ conduct,” the Court deducted an additional 2.5% from the fee request.
In the final analysis, the Court awarded $835,014.57 out of a total request of $1,155,321.50 amounting to about 72% of the original amount sought. While a 28% reduction is no doubt painful, receiving compensation of over $800,000 is still a good pay day. Given the contentious nature of the case and the fact that the first plan was shot down, this could even be viewed as making a silk purse out of a sow’s ear. The Debtor’s attorneys have appealed and the objecting parties have cross-appealed. As a result, there may be another addition to the Fifth Circuit’s growing jurisprudence on attorney’s fees in bankruptcy.
The Woerner Remand
The Court described the history of the case and the ruling by the en banc Fifth Circuit in detail. It noted that the Court of Appeals had given it the following instructions:
Because our opinion today announces a new legal rule, and out of an abundance of caution given the complex facts of the case before us, we remand this matter for the bankruptcy court to evaluate whether B &N is entitled to fees under the prospective, ‘‘reasonable at the time’’ standard.
Opinion, p. 8. Following remand, Barron & Newburger and the U.S. Trustee submitted additional briefing to the Court while the Texas Skyline parties merely referred the court to its prior briefing. The U.S. Trustee contended that the filing of objections to dischargeability "should have alerted Applicant to the problems that their clients had created and continued to foster by their lack for candor during the case." Essentially, the U.S. Trustee argued that Debtor's counsel had a duty to give up at the first sign of trouble.
The Court did not accept the U.S. Trustee's position that no additional compensation should be granted, although it did not award as much as Barron & Newburger had requested either.
The Court found that fees incurred under the category of Asset Analysis and Recovery should have been allowed with the exception of fees related to a constructive trust on Debtor's homestead.
The Court increased the amount that it awarded for Case Administration from $5,000.00 to $20,751.50. The Court allowed fees for providing required reporting and responding to discovery requests from creditors. The Court found that "B&N had a duty to represent the Debtors" with regard to a motion to convert and motion to compromise that was filed, but found that the amount was excessive. The Court allowed approximately one-third of the fees incurred in conducting discovery and litigating the unsuccessful effort to prevent conversion.
Under the category of claims determination, the Court allowed all of the fees except for those which were for the benefit of the individual debtor.
The firm did not fare as well with regard to the fees spent preparing a plan and disclosure statement. The Court explained:
This is the most difficult aspect of B&N’s fees to resolve. The undersigned judge presided over all of the proceedings through conversion to chapter 7 and adjudicated four dischargeability actions against Debtors. The Court had the definite conclusion early in the case that, notwithstanding B&N’s efforts, there was never going to be a consensual plan. While the Court commends B&N’s efforts at mediation, Debtors’ pre-existing misappropriation of partnership assets that precipitated the filing of chapter 11 case, coupled with the repeated misrepresentations in schedules and Debtors’ lack of credibility, leads this Court to the firm conclusion that this case was doomed from the start.
As such, this Court must balance the professional duty of the lawyer to represent the chapter 11 individual debtor against whether the services were reasonably necessary at the time they were rendered. In doing so, the Court believes that it should not reach the merits of whether a chapter 11 plan could be confirmed, but rather, could the case have proceeded to confirmation hearing in the context of a motion to convert the case to chapter 7. Under the circumstances of this case, the Court concludes that, based on the record before it, the services related to the Disclosure Statement and Plan were not reasonably necessary at the time they were incurred. The Court understands the argument that the filing of a chapter 11 plan afforded creditors the prospect of repayment; however, that possibility is not supported by the record recognizing the lack of creditor support at the time of conversion to chapter 7.
Opinion, pp. 18-19.
The Court allowed fees incurred in connection with employment of professionals finding that these services were reasonable at the time rendered.
The Court declined to award any additional fees with regard to preparing the schedules and statement of financial affairs. The firm charged $5,000.00 for preparing the original schedules and for two amendments. In both of its rulings, the Court allowed $2,500.00 in this category. The Court found that preparing schedules in an individual chapter 11 case should not be that much greater than in a chapter 13 proceeding.
Simply put, schedules and a statement of financial affairs are customary in all bankruptcy cases. Moreover, the preparation of schedules in a chapter 13 individual case and those in an individual chapter 11 case are not that different. What distinguishes chapter 13 and individual chapter 11 cases is many times the amount of debt involved. The Court recognizes that the cost of a chapter 11 case is more than a chapter 13, but questions why it cost over $5,000.00 to get accurate schedules and a statement of financial affairs. The only explanation that B&N provided was that it had to independently verify Debtors’ valuations of their own assets and that further inquiries were necessary when it became apparent that Debtors had not accounted for all their assets. Here, the Court remains convinced that the time expended on filing the amended schedules and SOFAs was attributable to Debtors’ conduct. Neither the creditors nor the estate should have to bear the additional expense. Under the facts of this case, the Court finds that original fee award of $2,500.00 is appropriate and will not award any additional fees in this category.
Opinion, pp. 20-21. This ruling highlights a seeming inconsistency in priorities. The Court and creditors expect that schedules and the statement of financial affairs will be accurate. Indeed, the Court's primary complaint was that the Debtors omitted approximately $10,000 in assets from the original schedules. However, the Court also expects that counsel will not spend any more than would be done in a consumer chapter 13 case.
In the final analysis, the firm received $46,311.00 out of $130,656.50. This represented nearly three times the amount of fees initially approved under Pro-Snax, but was still only 35% of the total. Two factors offer some solace. The allowed fees will consume much of the estate. A higher award would have been gratifying but ultimately uncollectible. Additionally, the Court approved a Motion to Clarify which allowed the firm to seek the disallowed fees from the individual debtor.
Disclosure: The Woerner case involved my firm. As a result, my objectivity might not be the same as when I discuss someone else's case. However, I felt it was important to provide the final act in a drama that had been widely followed by the bar. Also, I frequently write about the courts judge other lawyers and clients. Turnabout is fair play when it is our turn to be in the spotlight.
Lessons to Be Learned
1. Results still matter. In the Digerati case, the Court said some uncomplimentary things about the lawyers but awarded them 78% of their requested fees. In the Woerner case, the Court had nothing bad to say about the lawyers but they only recovered 35% of their fees. The difference is that Digerati had a confirmed plan while Woerner had a conversion and waiver of discharge.
2. Following Woerner, if you find your fees challenged, be sure to explain why you thought the action you took was a good gamble. In the Digerati opinion, the Court repeatedly stated that there was no explanation of why it seemed like a good idea at the time.
3. There is a randomness to the fee application process. Judge Bohm wrote an 83 page opinion with 400 pages of supporting exhibits (thanks to his dedicated law clerks and interns). He took the time to sift through a massive fee application and document things like lumping and vague time entries. In the Woerner case, the U.S. Trustee appeared to take a visceral dislike of the law firm and made it their mission to say as many bad things as possible. These are both unusual cases. In the typical instance, fees are approved without objection. Thus, fee requests which could have been dramatically cut in one case pass through without objection in another.
4. In these two cases, there was no reward for exercising billing judgment. Hoover Slovacek clearly charged a below market rate in the Digerati case. If they had charged rates that were 20% higher, they would have still billed a market rate and would have recovered as much as they initially requested. In Woerner, Barron & Newburger aggressively no-charged time and charged a reduced rate where multiple attorneys were involved. However, in both cases, the starting point for the analysis was what the firms actually charged rather than what they could have charged. This seems to be a necessary consequence of the lodestar approach. The lesson here appears to be to bill high so that more of your fees will survive a challenge.