(courtesy of Dave’s iPhone on June 18, 2015)

As a recap of Part 1, on June 15, 2015, a 6-3 Supreme Court held in the Chapter 11 case of Baker Botts, L.L.P. v. ASARCO, LLC that bankruptcy professionals employed under Section 327(a) of the Bankruptcy Code may not, under Section 330(a)(1) of the Bankruptcy Code, recover as compensation fees incurred in defending their bankruptcy fee applications.

Baker Botts did not draw nearly as much attention as Obergefell v. Hodges (the same-sex marriage case and subject of the above photo) or King v. Burwell (the Obamacare tax subsidies case). And since we posted Part 1 two weeks ago, the Supreme Court finished the term by issuing additional front-page decisions. Although Baker Botts was caught in the undertow of those decisions, it’s still important, especially for bankruptcy professionals whose compensation depends on § 330(a)(1).

For example, take the mega Lehman Brothers Chapter 11. Our review shows that Weil Gotshal spent over 21,387 hours and over $6.4 million in fees (i.e. an average of 2100+ hours and $641,000+ per fee application) preparing and litigating its fee applications. Whereas Weil’s compensation-related charges were less than 1.5% of the overall bill, it’s not unusual, especially in small consumer Chapter 7 cases (where frivolous fee objections are most common) for a trustee or professional to spend 10%-20% on fee defense. And after Baker Botts, many of those charges aren’t recoverable. Therefore, Baker Botts bears emphasis for all bankruptcy professionals.

Part 1 covered the background and the majority opinion. Part 2 emphasizes the dissent, possible errors in the decision, and the decision’s potential impacts on bankruptcy practice.

[Unless noted otherwise, quotations are from the opinion.]

[Additionally, SCOTUSblog has collected all of the briefs, with a link to Oyez for the oral argument audio.]

11. How did the dissent come down on the issue?

The dissent agrees with the majority that fee-defense is not a “service” under § 330(a)(1). However, unlike the majority, the dissent agrees with the Government that fee-defense work is simply part of the compensation for the “underlying services.” Therefore, the dissent hinges on recognizing a bankruptcy court’s “broad discretion” to determine “reasonable compensation” based on all “relevant factors” (including the possible need to award defense costs to maintain compensation parity between bankruptcy and non-bankruptcy professionals). For the dissent, that need is no different than other factors warranting “increased compensation” (e.g., “exceptionally protracted litigation”).

The thrust of the dissent is best summarized by the dissent’s fee dilution example: What if a professional has fees of $50,000, but spends another $20,000 defending them “against meritless objections”? Arguably, that effective payment of $30,000 is “unreasonable” and warrants additional compensation in the court’s discretion. Indeed, wonders the dissent, how is that form of fee dilution any different than the fee dilution that the Supreme Court rejected in Jean under the Equal Access to Justice Act?

The dissent concludes that interpreting “reasonable compensation” any other way “would undercut a basic objective of the statute.” Therefore, courts should retain broad discretion to award defense costs.

12. Does the dissent believe that § 330(a)(1) displaces the American Rule? 

Yes. The dissent claims that in Alyeska Pipeline, the Supreme Court “recognized that through § 330(a),” Congress “displaced the American Rule.”

However, rather than focusing on how § 330(a) displaces the American Rule, the dissent focuses on Jean. Specifically, it argues argues that if Court found that the Equal Access to Justice Act displaced the American Rule even though it doesn’t explicitly mention fee-defense work, then it’s inconsistent for the majority to find that § 330(a) doesn’t displace the American Rule simply because it doesn’t explicitly mention fee-defense work. Compare the EAJA (“fees,” “prevailing party,” and “civil action”) to § 330(a) (“reasonable compensation for actual, necessary services rendered”). Neither explicitly mentions fee-defense, but the Court treated them differently.

Given that § 330 is arguably the most comprehensive statutory fee regime in all of federal law, we wonder whether the American Rule applies at all. As the amicus fee examiners explained, a “Chapter 11 reorganization proceeding is not inherently or pervasively adversarial.” Thus, the “American Rule is inapposite” to fee-defense costs in bankruptcy. As they suggest, “courts exercise two very different functions” in bankruptcy: adjudication and administration. For the former, the court determines “specific rights through motions, objections, and adversary proceedings.” For the latter, the court ensures that “the progression of the case” follows the Code. Finally, they explain that, unlike in a fee-shifting case, “where the award of fees is part of the litigation itself,” all bankruptcy fees require court review, regardless of whether there is litigation.

In short, associating fee-defense costs with a “winning side” via the American Rule makes no sense in bankruptcy.

13. How does the dissent address § 330(a)(6) regarding fee application preparation?

The dissent doesn’t read § 330(a)(6) as making prep work compensable. Rather, § 330(a)(6) merely clarifies how to calculate reasonable prep work when it’s requested. Further, the dissent rejects the majority’s “mechanic’s invoice” analogy (see Part 1 Q9). Specifically, it criticizes the majority’s argument that, because a fee app is not a condition for payment outside of bankruptcy, a fee app is a service in bankruptcy. If its status as a bankruptcy-specific requirement is what makes it compensable, then shouldn’t the “time that a professional spends at a hearing defending his or her fees” also be compensable? Neither are required outside of bankruptcy. Therefore, both should be compensable under the majority’s view.

In short, the dissent believes that “preparing for or appearing at” a fee hearing is “an integral part of fee-defense work” that should be compensable.

14. Did anyone else come to the defense of bankruptcy professionals?

12 amicus curiae briefs were filed: 10 in favor of Baker Botts; only 1 in favor of ASARCO; and 1 neutral.

15. That’s a lot of support for an ultimately losing position. Did the Court depart from a “majority” view?

Possibly. Some suggest that the Court took the case to resolve a split between the Fifth Circuit (the case on appeal), Eleventh Circuit, and Ninth Circuit. If there was a split, then the Court resolved it in favor of the Fifth and Eleventh Circuits without saying so. In fact, it’s notable that the majority cites only 2 bankruptcy cases that are even remotely close to the issue (Alyeska and Laime) and only 4 bankruptcy cases overall. After the Court’s significant praise of bankruptcy court wisdom in May’s Bullard v. Blue Hills Bank, one would think that the Court would have turned more to the lower courts for direction. Nope.

For point of reference, Robert Keach, Co-Chair of the ABI Commission, summarized the pre-Baker Botts views during the ABI Panel Discussion. The “majority view” was that defense costs aren’t recoverable unless the applicant “substantially prevails” in defending his fees. The “minority” view was that defense costs don’t benefit the bankruptcy estate and, thus, are never recoverable, per se.

See also United States Trustee Large Case Fee Guidelines (recognizing “substantially prevails” exception); amicus brief of Florida Bar (starting at .pdf p. 18) (collecting cases, especially in the 11th Circuit).

 16. Which side got it right? 

The dissent. Although we disagree with the dissent’s conclusion that fee-defense is not a “service,” we agree that the majority erred by adopting a per se prohibition on defense costs rather than leaving them to the court’s discretion under § 330’s comprehensive scheme.

The first possible error is the Court’s insistence on forcing an American Rule discussion on § 330–a “talk about what we know” approach; a “round hole, square peg” sort of error. The Court sidesteps that error (mostly) because, although it talks a lot about the American Rule, the Court ultimately doesn’t base the holding on that rule. Rather, it construed the statute itself (albeit erroneously) by focusing on the intersection of § 327(a) (disinterested persons assisting the trustee) and § 330(a)(1) (necessary services rendered).

The second possible error is the Court’s refusal to use § 330(a)(6) to make defense costs recoverable. At first, it appears that the Court held that defense costs aren’t recoverable because § 330(a)(6) explicitly references fee preparation, but not fee-defense. After all, many of the briefs addressed whether § 330(a)(6) authorizes prep work or merely clarifies how to calculate reasonable prep work when it’s requested. However, the Court dodges those arguments altogether, holding, correctly, that § 330(a)(6) “does not presuppose that courts are free to award compensation based on work that does not qualify as a service to the estate administrator” (i.e., § 330(a)(6) is neither here nor there on compensability).

That gets us to the heart of the Court’s error: It splits § 330 into separate analytical parts rather than recognizing that § 330 works as a whole to calculate reasonable compensation. In the process, the Court adopts a per se prohibition on defense costs that robs courts of the discretion to determine when they benefit the bankruptcy case and/or are necessary for its administration. Thus, the Court ends-up sanctioning the very form of fee dilution that it rejected in Jean.

Specifically, the Court appears to treat § 330 as requiring 2 steps: (1) a threshold § 330(a)(1) determination of whether something is a compensable “service” and (2) a follow-up § 330(a)(3) determination of whether the professional charged the compensable service reasonably. However, we believe that §330(a)(3) and § 330(a)(4) actually inform the threshold “compensable service” determination under § 330(a)(1):

• § 330(a)(3)(C) emphasizes “whether the services were necessary to the administration of, or beneficial…toward the completion of” the bankruptcy case.
• § 330(a)(4) emphasizes only paying for services that were (i) “reasonably likely to benefit the debtor’s estate” or “necessary to the administration of the case.”

And by focusing so much on (a)(1) and so little, if at all, on (a)(3) and (a)(4), the Court commits 3 real errors.

Error #1: Court adopts an overly narrow, mutually exclusive view of “benefit.”

The Court adopts an overly narrow, mutually exclusive view of “benefit.” The Court’s view is too narrow because it focuses only on the relationship between the trustee and the professional. For example, the Court recognized that fee preparation is a “service” to the administrator because it “allows the customer to understand–and, if necessary, dispute his expense.” If one looks just at § 330(a)(1), then one might conclude that the administrator is the sole customer. However, (a)(3) and (a)(4) suggest that the “customer” is, in fact, the administrator, the United States Trustee, the constituencies who have claim against the estate, the constituencies that have an obligation to help administer the estate (e.g., committees, fee examiners, etc.), and the court itself.

The Court views “benefit” in a mutually exclusive manner because it doesn’t recognize that a service can benefit the professional and other constituencies without forfeiting disinterestedness. In fact, the compensation process contemplates a certain level of self-interest because it has the estate bearing a professional’s reasonable compensation. For example, preparing a fee application benefits the professional because it’s a condition for payment; it benefits other constituencies because it permits them to satisfy their duty to the estate to “understand” and even “dispute” fee applications. How is fee-defense any different? The Court doesn’t tell us.

Error #2: Court fails to consider if fee-defense is necessary for case administration.

The Court also ignores the alternative basis for compensation: whether a service is “necessary to the administration” or “completion of” the bankruptcy case. After all, the Code requires a detailed and itemized fee application that’s unknown outside of bankruptcy. It requires notice to the United States Trustee and other parties-in-interest. At a minimum, the court must review the application for compliance with § 330. Finally, the trustee can’t satisfy its duty to complete the case until there’s a resolution (not just an assertion) of all claims against the estate, including § 503(b)(2) administrative claims for compensation. And with limited exceptions, such resolution is impossible without a hearing. As Baker Botts argued, “fee-defense litigation is necessary to a case’s completion because it is an indivisible part of a complex fee-assessment process that the Code specifically mandates.”

If “compensability” is the sole province of § 330(a)(1), then it makes no sense for § 330(a)(1) to require that services be “necessary” (and for the Court to read “benefit” into the term “services”) and for (a)(3) and (a)(4) to also emphasize benefit and necessity. In other words, if (a)(1), (a)(3), and (a)(4) don’t work together as a whole, then (a)(3) and (a)(4) are superfluous. 

Error #3: Court flip-flops on fee parity and fee dilution.

Eventually, Jean comes back to haunt the Court. It’s not the language that the majority quotes from Jean (i.e., “We find no textual or logical argument for treating so differently a party’s preparation of a fee application and its ensuing efforts to support that same application.”). After all, there was no doubt in Jean that the EAJA extended to core fees and fee-defense. Rather, it’s the language from Jean that the majority doesn’t quote: “Denying attorneys’ fees for time spent in obtaining them would dilute the value of a fees award by forcing attorneys into extensive, uncompensated litigation in order to gain any fees.”

That brings us to the bottom line: Almost all of the parties argued extensively that a per se prohibition on defense work, without regard to whether the defense is meritorious, could dilute compensation and, thus, contravene Congress’ intent that there be compensation parity between bankruptcy and non-bankruptcy professionals. The parties even screamed that argument from the roof-tops in at least 16 separate briefs. Nevertheless, the Court wasn’t buying it. Relying on its flawed invoice analogy and unsupported assertions about what motivates attorneys, the Court simply dismissed the dilution argument as a “flawed and irrelevant policy argument.” Unfortunately, that’s that.

17. After Baker Botts, which fees and costs are reimbursable and not reimbursable?