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.

Fifth Circuit Panel Urges Re-Examination of Pro-Snax

Update:  On November 6, 2014, the Fifth Circuit granted en banc review in Barron & Newburger, P.C. v. Texas Skyline Interests, et al..

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.

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.