After Woerner, Courts Look for "Good Gambles"

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

After the Fifth Circuit’s opinion in Barron & Newburger, P.C. v. Texas Skyline Ltd. (Matter of Woerner), 783 F.3d 286 (5^th 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.

Supreme Court to Hear Dispute Over Fees for Defending Fee Application

The Supreme Court doesn't take many cases on bankruptcy issues.  It has only ruled on attorney's fees in bankruptcy once since the Code was adopted and that ruling was on the narrow issue of whether a chapter 7 debtor's attorney could recover fees from the estate.    As a result, it was big news when the Court granted cert in  No. 14-103, Baker Botts, LLP v. ASARCO, LLC on October 2, 2014.    The issue in ASARCO is whether an attorney can recover fees for defending his fee application or whether those expenses are merely "a cost of doing business" as held by the Fifth Circuit.   The issue matters in the particular case because Baker Botts spent $5 million in time defending its $113 million application.   

What Happened

I have previously written about the ASARCO case at length here.   This was a case where the Debtor's law firms obtained a judgment against the Debtor's parent company for somewhere between $7 and $10 billion which was "the largest fraudulent transfer judgment in Chapter 11 history."    As a result of the adverse judgment, the Debtor's parent company decided to fund a plan which paid the creditors in full and left the Debtor with $1.4 billion in cash.   

Given this incredible result, the Debtor's law firms should have had an easy time recovering their fees.  After all, when you are measuring results in the billions, what's a hundred million in fees?   However, under the Plan, ASARCO's parent regained control of the Debtor.   They were apparently not happy about paying Baker Botts and Jordan Hyden for having sued them.   

 

The Debtor submitted a discovery request to Baker Botts which required it to produce every document it had prepared in 52 months of bankruptcy.    This amounted to 2,350 boxes of hard copy documents and 189 GB of electronic data.   In case you were wondering, 1 GB of data translates into between 65,000 to 165,000 pages of documents depending upon whether the documents were Microsoft Word documents, Excel spreadsheets or emails.   Assuming 100,000 pages per GB of electronic data, that means that Baker Botts produced about 18.9 million pages of electronic documents.   (Imagine being the associate who had to review all that!)  

Notwithstanding ASARCO's efforts to contest its firms' fees, the Bankruptcy Court awarded Baker Botts $113 million in fees, an enhancement of $4.1 million and $5 million for defending its application and awarded Jordan Hyden $7 million in core fees, an enhancement of $125,000 and $15,000 for prosecuting the application.

On appeal, the Fifth Circuit upheld the fee enhancements but struck down the cost of defense fees.   ASARCO, LLP v. Jordan Hyden Womble Culbreth & Holzer, P.C. (In re Asarco, LLC), 751 F.3d 291 (5th Cir. 2014), cert. granted, 2014 U.S. LEXIS 4913 (10/2/14).   

Having been mostly successful, Baker Botts decided to go to the Supreme Court for the last $5 million which was withheld.    In filing their petition, Baker Botts was supported by the State Bar of Texas Bankruptcy Law Section and the Business Law Section of the Florida Bar.  

Why It Matters

In its opinion, the Fifth Circuit made a brief though cogent examination of section 330(a) in denying the cost of defense fees.  In particular, it ruled that section 330(a)(3) and (4) require that services be likely to benefit the estate or necessary to the administration of the estate in order to be compensated.  

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.

Opinion, p. 13.   The Court also concluded that because section 330(a)(6) allows fees for preparing a fee application but not for litigating one, that cost of defense fees must be denied.   

This case has both the statutory interpretation questions mentioned above and the policy question of whether one party can impose litigation costs upon another party with impunity.   Here, there is a strong hint that ASARCO's parent, now in control of the Debtor, sought to get payback against Baker Botts by running up the cost of getting compensated.   It seems curious that the Debtor would have needed to request every piece of paper created by the firm in order to judge whether their fee request was reasonable.    While the Fifth Circuit raised the prospect that fees could be awarded for vexatious fee objections, it also suggested that fees were not litigated often enough, stating:

“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.”

Opinion, p. 18.

The result in this case is likely to be important beyond the narrow issue presented for the following reasons:

• Supreme Court watchers have noted that the Court's bankruptcy decisions tend to swing between strict textual analysis and a functional approach.   If the Court goes with the textual approach, it will be likely (though not guaranteed) to uphold the Fifth Circuit, while a functional approach would support Baker Botts.
• The Court will be required to address the meaning of likely to benefit the estate and necessary to case administration.    Because these terms are critical to interpretation of section 330, the court's opinion will provide valuable guidance on awarding fees.   While the Fifth Circuit's view that defending a fee application was for the benefit of counsel is plausible, I believe that the better answer is that it is part of the process of administering the estate.
• The Fifth Circuit's opinion relied on one of the multiple rationales of the Pro-Snax case.  While the Court's interpretation of Pro-Snax in ASARCO was consistent with the statute, the mere fact that the case is before the Supreme Court may encourage the Fifth Circuit to walk back Pro-Snax's most aggressive holding that only actual results may be compensated.   In its amicus brief in support of the petition for cert, the State Bar of Texas Bankruptcy Law Section raised the Pro-Snax "results only" holding and mentioned my firm's case of Matter of Woerner, 758 F.3d 693 (5th Cir. 2014), which is currently the subject of a pending request for rehearing en banc.    

The importance of the case is also underscored by the fact that representatives from two state bars weighed in on the dispute.   In my experience, it is highly unusual for a section of the Texas State Bar to file an amicus brief.  I am not aware of any other case in which it has been done.   While I am speculating here, I have to believe that the Bankruptcy Section must have convinced the State Bar that this was an issue of importance to lawyers in general.    Otherwise, they would just have been taking sides in a dispute between different groups of lawyers.    This will be an interesting case to watch.

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.

Will the Fifth Circuit Clarify Pro-Snax?

For chapter 11 debtor's lawyers, Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998) is like the sword of Damocles--constantly hanging over counsel's head and threatening to deny compensation when a case goes south.   While 11 U.S.C. Sec. 330(a)(3) makes results one of several factors to consider in awarding compensation, Pro-Snax makes "identifiable, tangible and material" results a pre-requisite to getting paid.    

While several Bankruptcy Judges have pushed back against Pro-Snax, there has not been a publi-shed decision from the circuit construing Pro-Snax since it came down.   However, that may change soon.

My firm was on the receiving end of a Pro-Snax ruling (please don't tell anyone), which finally made it to the Fifth Circuit last week.    In oral argument, the Court indicated that this was not the only Pro-Snax case they were considering.   Here are some excerpts from the oral argument in No. 13-50075, Barron & Newburger, P.C. v. Texas Skyline Interests, Ltd., et al:

Mr. Sather:   Since 1998 when a panel of this court decided the Pro-Snax case the lower courts have struggled with the meaning of Pro-Snax . . .

Judge Owen:   So have we.

Mr. Sather:  . . . a case that they have described as "difficult to apply" and "having clouded the issue."  Today the court has the opportunity to clarify whether the Pro-Snax court intended to modify Title 11 and in effect reverse Congress and intended to modify this Court's prior precedents on attorney's fees in bankruptcy or whether Pro-Snax can be harmonized with the statutory text and this court's prior precedents.   In case it's not obvious, we're taking the latter position.   We believe Pro-Snax can be harmonized with the other rulings from the Fifth Circuit as well as the statutory text.

Judge Prado:  Our opinion could be the opinion that clarifies it for everyone? 

Mr. Sather:  There is another case pending before the court on the same issue that was argued in November.  Ironically, with Pro-Snax having been out for fifteen years, the two cases pending before the Court right now are, to what I can see, the first ones to say please tell us what the heck you were thinking when you decided that.    

Judge Owen:  I've seen it four times this year at least, so why is it all of a sudden Pro-Snax is bubbling up in so many cases?

Mr. Sather:  I think that when you get a bad ruling (against your own firm), there is a reluctance to appeal.   In this case, our firm was stubborn enough to bring it up.   But the strange thing is, Judge Gargotta, who heard the case said that in his five or six years on the bench, it was the first time the issue had come up.   So I think what happens is that the case is honored more in the breach than in the day to day operation of chapter 11 because most chapter 11 cases fail and you would expect therefore that most chapter 11 lawyers would have their fees denied.

The take-away here is that the Fifth Circuit seems to definitely be thinking about Pro-Snax, which is a good thing.   The other thing is that it's really weird hearing your own voice on a recording. The argument can be accessed on the Fifth Circuit's oral argument page.

Note:   After re-reading this post, I realize that quoting my own oral argument sounds like shameless self-promotion.   I typically do not write about my own cases, much less what I have to say in them.   However, in this case, it was the comments from the court that I felt were noteworthy as opposed to anything I had to say.

Pilgrim's Pride Opinion Allows Enhancements in Bankruptcy, Offers Comprehensive Overview of Bankruptcy Fees

The Fifth Circuit has affirmed a $1 million fee enhancement to a chief restructuring officer who achieved results described as “rare and exceptional.”  Matter of Pilgrim’s Pride Corp., No. 11-10774 (5^th Cir. 8/10/12).   The opinion can be found here.   The Court rejected the argument that a recent Supreme Court opinion on fee shifting precluded enhancements and, in the process, set forth a comprehensive framework for allowance of professional fees in bankruptcy.   Curiously, the opinion did not mention the Court’s opinion in Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5^th Cir. 1998).

What Happened

When Pilgrim’s Pride Company filed for chapter 11 relief in December 2008, its prospects did not look good.   It had lost about $1 billion the previous fiscal year and was incurring negative cash flow of $300 million a year.   The Debtors anticipated that unsecured creditors would receive, at best, a debt for equity swap, and that equity would be cancelled. 

  

CRG Partners, LLC was engaged as chief restructuring officer.    Just over a year later, the company confirmed a plan which paid all secured and unsecured creditors in full and distributed equity interests valued at $450 million to the pre-petition shareholders.   

After the plan was confirmed, CRG requested that it be allowed compensation of $5.98 million plus an enhancement of $1 million.    The Debtor’s Board of Directors supported the enhancement.   The U.S. Trustee objected to the enhancement on the basis that CRG had already been adequately compensated through its lodestar-calculated fee.   The Bankruptcy Court denied the request for enhancement based on Perdue v. Kenny A. ex rel. Winn, 130 S.Ct. 1662 (2010).   The District Court reversed, finding that Perdue was not binding in the bankruptcy context.

On remand, the Bankruptcy Court approved the enhancement and the U.S. Trustee appealed.    The UST argued that Perdue precluded the enhancement.   The Fifth Circuit rejected the Trustee’s position and affirmed the Bankruptcy Court order approving the additional award.

An Overview of Professional Fees

In reaching its conclusion that enhancements remained viable, the Court of Appeals provided an extensive discussion of the history of awards of professional fees in the Fifth Circuit.   Under the Bankruptcy Act, courts in the Fifth Circuit applied the twelve Johnson factors, which included such requirements as the time and labor required, the novelty and difficulty of the questions, skill required, undesirability of the case and reputation of the attorneys.    In re First Colonial Corp. of America, 544 F.2d 1291, 1298-99 (5^th Cir. 1977), quoting Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5^th Cir. 1974).   (Attorneys of a certain level of experience will remember preparing fee applications reciting the twelve Johnson/First Colonial factors even though many of them were usually irrelevant to the specific case).   While Johnson was a civil rights case, the First Colonial court found the factors to be “equally useful whenever the award of reasonable attorneys’ fees is authorized by statute.”     Id. at 1299.   While the same factors might be applicable, bankruptcy courts were advised to make awards at the lower end of the spectrum in light of the “strong policy of the Bankruptcy Act that estates be administered as efficiently as possible.”    Id.

The lodestar method was recommended by another Act case, In re Lawler, 807 F.2d 1207 (5^th Cir. 1987).    Under the lodestar method, the Court determines a reasonable number of hours multiplied by a reasonable rate and then adjusts the resulting fee up or down based upon the other Johnson factors.

When section 330(a) was adopted as part of the Bankruptcy Code, it retained the overall framework of compensation under the Act, but rejected the “economy of the estate” limitation.   This meant that bankruptcy lawyers could be compensated at the same rate as other skilled professionals.   

Section 330(a) was amended in 1994 to include a list of six non-exclusive factors to be considered in awarding compensation and two instances in which the court should deny compensation.    Notwithstanding the statutory definition, the Fifth Circuit found that the prior case law and the statutory provisions provided a complimentary framework.

Following the Bankruptcy Code’s enactment, we made clear that the lodestar, Johnson factors, and §330 coalesced to form the framework that regulates the compensation of professionals employed by the bankruptcy estate.   (citation omitted).   Under this framework, bankruptcy courts must first calculate the amount of the lodestar.   (citation omitted).    After doing so, the courts “then may adjust the lodestar up or down based on the factors contained in §330 and [their] consideration of the factors listed in Johnson.”   (citation omitted).    We have also emphasized that bankruptcy courts have “considerable discretion” when determining whether an upward or downward adjustment of the lodestar is warranted.

Opinion, at p. 8.   

The Court also conducted an historical analysis of fee enhancements in bankruptcy, finding that, although they were extraordinary, they had been allowed under both the Bankruptcy Act and the Code.    The Court noted that 

(I)f enhancements were possible when fees were awarded “at the lower end of the spectrum of reasonableness,” then they surely remained possible after that ceiling was removed and the statutory text was otherwise unchanged.

Opinion, at p. 13.    The Court’s point is that because the Bankruptcy Act allowed enhancements despite the focus on economy of administration that it would be reasonable for enhancements to be allowed under the more liberal provisions of the Bankruptcy Code.

In conclusion, the Court ruled that enhancements were a part of the process of upward or downward adjustment of the lodestar and remained available in extraordinary situations.

In sum, we have consistently held that bankruptcy courts have broad discretion to adjust the lodestar upwards or downwards when awarding reasonable compensation to professionals employed by the estate pursuant to § 330(a). However, this discretion is far from limitless. Upward adjustments, for instance, are still only permissible in rare and exceptional circumstances--such as in Rose Pass Mines and Lawler, where the applicants had provided superior services that produced outstanding results--that are supported by detailed findings from the bankruptcy court and specific evidence in the record.

Opinion, at 15.

Sub Silentio and the Rule of Orderliness 

Having concluded that enhancements remained viable, the Court turned its attention to whether the Supreme Court had “unequivocally, sub silentio overruled our circuit’s bankruptcy precedent.”   Opinion, p. 15.  

 

In Perdue, the Supreme Court rejected a request for an enhancement in a civil rights case.   In interpreting the term “reasonable fees” under 42 U.S.C. §1988, the Supreme Court noted that the courts had initially applied the twelve Johnson factors, but had transitioned to a lodestar approach in order to “cabin() the discretion of trial judges.”    The Supreme Court concluded that enhancements could be allowed under section 1988, but only where the hourly rate used in the lodestar calculation did not adequately measure the attorney’s true market value, where the litigation involved an “extraordinary” outlay of expenses and where there was an “exceptional delay” in payment, especially where that delay was due to the defense.    The Court also noted that in civil rights cases, the presumption should be against an enhancement because defendants would be less likely to settle if faced with an open-ended fee request and because civil rights judgments were often paid by the public rather than the defendant. 

  

The Fifth Circuit found that Perdue did not apply in the bankruptcy context.   Relying on the rule of orderliness, as recently articulated in Technical Automation Services Corp. v. Liberty Surplus Insurance Corp., 673 F.3d 399 (5^th Cir. 2012)(which held that Stern v. Marshall did not implicate the authority of Magistrate Judges), the Fifth Circuit found that Perdue was not directly on point and therefore did not compel the Court to abandon its prior precedent.   Among other things, the Court found that bankruptcy fee requests did not entail the same settlement considerations as civil rights cases and that the bankruptcy estate rather than the taxpayer would be paying the fees. 

 

The Court also noted that while the term “reasonable fees” in section 1988 offered little guidance to courts, that section 330(a) of the Bankruptcy Code contained detailed criteria for awarding fees.   

As a result, the Court concluded that until rescinded by a higher authority, fee enhancements were still possible in bankruptcy.   As a result, the Court affirmed the bankruptcy court’s enhanced fee award to CRG Partners.

What It Means

In the particular case, Pilgrim’s Pride means that a particular professional was recognized for doing an extraordinary job.    In the larger context, Pilgrim’s Pride is significant for what its historical analysis said for what it left unsaid.    

From an historical perspective, Pilgrim’s Pride evidences the development of bankruptcy law as its own discipline.    As of 1977, both bankruptcy law and civil rights law followed the twelve Johnson factors.   In the intervening 35 years, bankruptcy has developed its own body of fee jurisprudence.    While both bankruptcy law and civil rights law moved from the Johnson factors to a primarily lodestar based approach, Congress saw fit to define bankruptcy standards in more detail.     The Pilgrim’s Pride decision recognizes that bankruptcy fees fulfill a different role than fees in civil rights cases.    While the Court did not fully articulate it, I believe the difference is this.   Bankruptcy is inherently a collective process in which scarce resources are marshaled for the benefit of the creditor body and (in some cases) equity.    Allowing enhanced fees in rare cases provides incentives for professionals to take on difficult cases and be recognized when they deliver superior results.   Civil rights cases, on the other hand, are focused on compensating a harm and are a zero sum proposition.   Every dollar paid to the plaintiffs and their attorneys is a dollar taken away from the defendants and, by extension, the taxpayers.    While civil rights actions should incentivize government actors to obey the law in future cases, this function is secondary to compensating the wronged individual.    In a bankruptcy case, the professional may not only allocate scarce resources according to an ordered scheme of priorities, but may actually increase the pool of resources.   In a civil rights case, it seems that counsel is focused on obtaining an equitable transfer of resources from one party to another.    

Pilgrim’s Pride also curious because it does not mention the requirement that a professional demonstrate an “identifiable, tangible and material benefit to the bankruptcy estate” as required by In re Pro-Snax Distributors, Inc. in order to be compensated.   There is a tension between Pro-Snax and section 330(a)(4)(A)(i)(I) which mandates denial of fees for services not “reasonably likely to benefit the debtor’s estate.”   There is a significant difference in requiring that services be “reasonably likely” to benefit the estate as opposed to actually yielding an “identifiable, tangible and material benefit.”    In the one instance, compensation is based on whether the services appeared to be reasonable at the time, while the other makes compensation contingent on results.    Pilgrim’s Pride discusses the Johnson factors, the lodestar test and the statutory provisions of section 330(a), but does not discuss Pro-Snax.  Judge Carl Stewart, who authored Pro-Snax, was on the panel that decided Pilgrim’s Pride.

It is certainly possible that the panel did not see the need to discuss Pro-Snax for the reason that Pilgrim’s Pride was a case involving not just an “identifiable, tangible and material benefit,” but an extraordinary one at that.    However, given the Court’s comprehensive discussion of the framework for fees in bankruptcy and its contrast with fees in civil rights cases, the actual results requirement would seem to be a reasonable thing to mention.   

My personal opinion (which is partially motivated by self-interest) is that the Pro-Snax panel never intended to impose an actual results requirement.    The Pilgrim’s Pride opinion discusses how “the lodestar, Johnson factors, and §330 coalesced to form the framework that regulates the compensation of professionals employed by the bankruptcy estate.”    Under Johnson, results were one of twelve factors to be considered.   Under section 330(a), the court is instructed to examine whether the services were “beneficial at the time” and whether they were “reasonably likely to benefit the debtor’s estate.”   The lodestar may be adjusted upwards or downwards based upon the results.    Given that results are a factor to be considered under each of these approaches, it is much more reasonable to conclude that the Pro-Snax panel meant to emphasize the importance of results but not to make them an absolute requirement.   At the very least, it will make for an interesting argument when the Court is asked directly to reconcile Pilgrim’s Pride, Pro-Snax and the language of section 330(a).

Disclosure:   I have a case pending on appeal that raises the application of Pro-Snax.

New Opinion Makes Sense of "Identifiable, Tangible and Material Benefit" Language From Pro-Snax

In Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5^th Cir. 1998), a panel of the Fifth Circuit made the uncontroversial ruling that a chapter 11 debtor’s attorney could not recover attorney’s fees from the bankruptcy estate after appointment of a trustee.   However, the court went one step further and stated that in order to recover fees for the period prior to appointment of the trustee, the applicant must demonstrate an “identifiable, tangible and material benefit to the estate” in order to be compensated.   Most courts to consider this standard have concluded that when a case does not generate results notwithstanding the best professional efforts of the attorney that compensation may not be allowed except for certain mandatory services.   That consensus was broken when Judge Michael Lynn ruled that an “identifiable, tangible and material result to the estate” means that an attorney acted at the behest of his client acting in the exercise of its business judgment.   In re Broughton Ltd. Partnership, No. 10-42327 (Bankr. N.D. Tex. 4/25/12), a copy of which can be found here.   Judge Lynn’s ruling transforms the standard for compensation from a one-sided contingency fee to a professional judgment standard and is consistent with the text of 11 U.S.C. §330.    (Disclosure:  I am currently appealing a Pro-Snax ruling and will be relying upon the Broughton Ltd. Partnership case.).

What Happened

The facts are straightforward.  The debtors’ business was “the development of high-end residential subdivisions and sales of the developed lots.”  Special counsel was retained to negotiate the sale of 22 lots to a specific purchaser.     The purchaser required that a homeowners association waive certain rights.   When the homeowners association refused, the contract fell through notwithstanding counsel's efforts.  When     the sale fell through, the case ultimately converted.    When special counsel applied for its fees, the U.S. Trustee objected based upon Pro-Snax.  

The Ruling

 The Court noted that bankruptcy courts within the Fifth Circuit following Pro-Snax had required that fees be reasonable on both a prospective basis and based on a retrospective review.    The prospective test is based on section 330(a)(3)(C)  which provides that “the services (be) necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, [the bankruptcy case].”   The retrospective or hindsight test incorporates the Pro-Snax requirement that the services actually result in an “identifiable, tangible and material benefit to the estate.”

Prospective Test

The U.S. Trustee argued that it was not even necessary to apply the retrospective test since the attorney should have realized early on that the proposed transaction would not result in a benefit to the estate.   The Court disagreed, noting that “(t)he proposed sale to SPOT was viewed in late 2010, not only by the court, but by the various parties, as the keystone of Debtors’ potential reorganization.”   Opinion, p. 5.   The Court went on to state that: 

That the transaction was a difficult one to put together and that the idiosyncrasies of the parties might frustrate the efforts of counsel does not mean that counsel was required to cease work and give up. Rather, so long as a professional is doing its principal’s bidding and there is a reasonable prospect of success, the professional is entitled to work in the expectation of being paid.

 Opinion, p. 6.   It is nice to see that the Court did not adopt the position that when the going gets tough, those who want to get paid give up.   

Retrospective Test

The Court approached the question of what constituted an “identifiable, tangible and material benefit to the estate” from several angles.  First, the Court noted that a literal application of the phrase could result in absurd results. 

The problem posed by Pro-Snax is that use of the word “benefit” suggests a positive contribution is required. An “identifiable, tangible, and material” benefit to the estate at first blush would appear to be something that augments the estate. Yet it seems clear that professionals serving a debtor or other fiduciary in a chapter 11 case cannot be limited in their compensation to those activities that actually add to the estate. First, such a determination would exclude from compensation many critical functions performed by professionals in the course of a chapter 11 case. Administrative matters, operational oversight, disputes respecting control, steps in the plan process such as extensions of exclusivity and many other matters dealt with by professionals covered by Pro-Snax do not increase the debtor’s estate or reduce the claims against it – yet the chapter 11 case could not work if professionals did not perform services in connection with these functions.

 

Second, as with the Firm’s work, that work which a professional undertakes doesn’t always lead to success.16 Deals – as with SPOT – fall through. Litigation on behalf of the estate may offer the prospect of substantial recoveries, but will not necessarily be won. It may be that counsel representing Stern, the estate representative in Stern v. Marshall, --- U.S. ----, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011), was unsuccessful, ultimately losing the estate’s case in the United States Supreme Court in a 5-4 decision. It is unthinkable that that counsel’s work leading to that result should be uncompensated.   The very fact that section 328(b) permits (but does not require) retention of professionals on, inter alia, a contingency basis demonstrates that Congress did not intend all professional services to be compensable only on that basis. Yet, as some courts have noted, to apply Pro-Snax as requiring estate augmentation would be tantamount to doing so. 

Opinion, pp. 10-11.

 Digging deeper, the Court looked at the Pro-Snax case itself.   The only clue that the Fifth Circuit gave as to the meaning of “identifiable, tangible and material” was a citation to In re Melp, Ltd., 179 B.R. 636 (E.D. Mo. 1995).   That case in turn referred to: 

In undertaking a “benefit analysis,” a court should consider: (1) whether the debtor’s attorney’s actions duplicated the duties of the trustee or the trustee’s counsel under 11 U.S.C. § 1106; (2) whether the services have in fact, obstructed or impeded the administration of the estate; and (3) whether the debtor’s attorney’s actions are consistent with the debtor’s duties under 11 U.S.C. § 521.

 In re Melp, 179 B.R. at 640.    Since the Fifth Circuit relied on Melp in formulating its test, it is only reasonable to see what the Melp Court meant.

Judge Lynn also examined the construction given to “identifiable, tangle and material benefit” by District Judge Jane Boyle in Kaye v. Hughes & Luce, LLP, (In re Gadzooks, Inc.), 2007 WL 2059724, at *9 (N.D. Tex. Jul.13, 2007).   I have previously written about the Gadzooks case here, here and here. 

The Gadzooks court, which applied the benefit test to counsel representing an equity committee, struggled with how to reconcile the Pro-Snax requirement of an “identifiable, tangible, and material benefit” to the estate, including its suggestion of a retrospective review of counsel’s work, with section 330(a)(3)(C) which indicate a professional’s efforts should be assessed prospectively, as of the time they were to be performed. Judge Boyle, in Gadzooks, concluded that the requirement set by the Court of Appeals of a benefit to the estate constituted a gloss on the provision in section 330(a)(1)(A) that counsel be awarded “reasonable compensation for actual, necessary services rendered by the…professional person.” See In re Gadzooks¸ 2007 WL 2059724, at *9. That is, services will benefit the estate if they are actual and necessary. 

Opinion, pp. 14-15.    

The Court also looked to how similar language in section 503(b)(1) has been interpreted. 

As it happens, the term “actual, necessary” is found not only in section 330(a)(1)(A) but as well in section 503(b)(1)(A), where it modifies the words “costs and expenses of preserving the estate” and limits what costs and expenses are entitled to priority payment as administrative claims. As used in section 503(b)(1)(A), “actual, necessary” clearly does not mean administrative expenses are limited to only those that enhance or at least preserve a debtor’s estate. It has been black letter law since the Supreme Court rendered its decision in Reading Co. v. Brown, 391 U.S. 471, 478, 88 S.Ct. 1759, 20 L.Ed.2d 751 (1968), that torts committed by an estate representative in the course of performing his, her or its duties give rise to claims entitled to administrative priority. This is because, as the Court reasoned in Reading, a bankruptcy estate, just like any other participant in the business world, must pay those costs necessarily incident to its operations, including satisfying claims arising from torts attributable to the estate.

 

Similar reasoning can be applied to the efforts of the professionals of a debtor in possession (or other statutory bankruptcy fiduciary). It is the duty of a debtor in possession –like any estate representative – to realize any possible value from assets of the estate. If it eventually proves true that an asset cannot be realized upon, that does not mean it should not be investigated and its liquidation (or other means of realization) pursued, so long as, as the Pro-Snax court observed, “the chances of success…outweigh the costs of pursuing the action.” 157 F.3d at 426. Thus, for example, in Stern v. Marshall, pursuit of Stern’s counterclaim was appropriate and compensable, since the chances of success were good. That the case ultimately was lost 5-4 in the Supreme Court (on the basis of the bankruptcy court’s constitutional inability to enter a final judgment on Stern’s counterclaim) does not change the fact that the estate representative and estate professionals were doing their duty in pursuing it. 

Opinion, pp. 15-16.

The Conclusion

Having considered all of these factors, the Court reached its ultimate conclusion that a professional confers an identifiable, tangible and material benefit to the estate when it performs services at the direction of the representative of the estate which is acting within its business judgment. 

The court today holds that a professional provides an “identifiable, tangible and material benefit” to a bankruptcy estate within the meaning of Pro-Snax through assisting the estate representative in administering an asset of the estate, whether or not the effect of administration of the asset is enhancement of the estate, so long as the professional’s services are performed at the direction of the estate representative and the estate representative is acting in accordance with the Code and its sound business judgment.  In doing so, the court focuses on the nature of the benefit provided but also takes account of public policy and an estate representative’s decision making authority in bankruptcy.

 

With regard to the latter, the court relies on an estate representative’s sound business judgment in approving acts outside the ordinary course of business.  (citation omtted).Unless the manner in which an estate representative arrives at a decision is seriously flawed, the court will defer to the estate representative.  (citation omitted). A professional should similarly be able to rely on its client’s business judgment in acting in accordance with the client’s instructions.

 

As to public policy, professionals are retained by an estate representative to advise and assist the representative in carrying out his, her or its duties under the Code. To burden professionals by making their compensation contingent upon the result of the estate representative’s decisions must necessarily skew the regime intended in the Code and will surely create conflicts where a professional believes its client’s decision, though arrived at through due diligence, is not the right one. Had Congress wished professionals retained under section 327 of the Code to second-guess and perhaps veto decisions of a trustee or debtor in possession, it surely would have said so. 

Opinion, pp. 17-18.

What It Means

While I acknowledge my own bias, I think that Broughton Ltd. Partnership should change the way that Courts in the Fifth Circuit interpret Pro-Snax.     Judge Lynn’s interpretation allows courts to follow the language used in Pro-Snax without doing violence to the language or the logic of the Code.

Unlocking the Code    

Section 330(a) contains several criteria for allowing compensation in bankruptcy, but does not use the words identifiable, tangible and material benefit.   In fact, it expressly adopts a prospective analysis.

The statute reads:

§ 330.  Compensation of officers

(a) (1) After notice to the parties in interest and the United States Trustee and a hearing, and subject to sections 326, 328, and 329, the court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103--       (A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and      (B) reimbursement for actual, necessary expenses.

***

      (3) In determining the amount of reasonable compensation to be awarded to an examiner, trustee under chapter 11, or professional person, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including--       (A) the time spent on such services;      (B) the rates charged for such services;      (C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;       (D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;       (E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and       (F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.    (4) (A) Except as provided in subparagraph (B), the court shall not allow compensation for--          (i) unnecessary duplication of services; or          (ii) services that were not--             (I) reasonably likely to benefit the debtor's estate; or             (II) necessary to the administration of the case.

***

     (6) Any compensation awarded for the preparation of a fee application shall be based on the level and skill reasonably required to prepare the application.   

***

 (emphasis added).

Interpreting Pro-Snax to require a positive result in order to get paid would be to eliminate the words “at the time at which the services were rendered” and “reasonably likely to benefit the debtor’s estate” from section 330(a).  Such a view (even though it has been the prevailing one) effectively accuses the panel of negligence at best or judicial activism at worst.   

This tension was acknowledged by Judge Frank Monroe in In re Weaver, 336 B.R. 115 (Bankr. W.D. Tex. 2005), when he stated: 

Applicant Borsheim argues that Pro-Snax is at odds with the statute and misinterprets it since the statute plainly authorizes fees "for actual, necessary services"-as well as services that are "reasonably likely to benefit the debtor's estate".    Even if such be true, this Court is constrained to follow the 5th Circuit's interpretation. 

Weaver, at 119. 

Judge Lynn, by following Judge Boyle’s conclusion that “identifiable, tangible and material benefit” was merely a gloss upon “actual, necessary services,” has tethered Pro-Snax to the language of the Code and has consistently followed the underlying authority relied upon by the Pro-Snax panel.

 

With all respect to Judge Monroe (who was a venerable and well-respected judge), it is far better to follow the Fifth Circuit and follow the language of the Code at the same time.   Judge Lynn has succeeded in doing both.

(In fairness to Judge Monroe, he had a subsequent opinion in In re Spillman Development Group, Ltd., 376 B.R. 543 (Bankr. W.D. Tex. 2007),  in which he which took a more nuanced approach to Pro-Snax.) 

When the Going Gets Tough

The Broughton Ltd. Partnership opinion is also good for the system.    The English common law system adopted in the United States relies upon an adversarial system in which opposing parties are represented by zealous advocates.    Bankruptcy is a multi-party process.   If the most aggressive creditor can threaten debtor's counsel with not getting paid, debtor's counsel will have an incentive to placate that party at the expense of everyone else.   Moreover, if the court increases the risk of not getting paid, then either lawyers will demand higher fees to compensate for that risk or will forego those representations altogether, leaving them to less qualified lawyers.    In order for the system to work, good lawyers need to have a reasonable opportunity to be compensated without being a guarantor of the success of their client's case.  While some debtors may be less than deserving scoundrels who use bankruptcy to escape payment of their just debts, the opposite is also true.   Some creditors are more interested in using their position to prevent debtors from paying their debts, either so that they can foreclose and reap a windfall or simply to crush another party out of malice and spite.    While the bankruptcy court cannot grant equal resources to all parties, it can at least avoid penalizing one side.