SupCt2

 (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 JeanSpecifically, 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?

The way we read Baker Botts, the “reimbursable v. non-reimbursable” debate is resolved this way:

Employment Applications/Compensation Procedure Motions

There’s nothing in Baker Botts suggesting that fees related to prosecuting § 327 employment applications aren’t reimbursable. A professional benefits from employment matters, but it’s difficult to argue that employment matters aren’t “actual, necessary services.” At bottom, employment applications are the first services rendered to a trustee. That rationale also applies to compensation procedure motions under § 331, as such motions establish a review process that benefits all constituencies and promotes administration.

However, that’s not to say that someone will not try to use Baker Botts to challenge typical “first day” employment or compensation procedure matters.

Fee Statements and Fee Applications

For purposes of Baker Botts, interim fee statements that are served under a procedures order should be treated like interim and final fee applications. Therefore, Baker Botts likely impacts statements and applications as follows: (i) under § 330(a)(6), the cost of preparing, serving, and filing them (as applicable) are recoverable; but (ii) the cost of correcting them and of reviewing and responding to information requests or objections are not recoverable because such costs are in the prohibited “defending” category.

Non-preparation fees and expenses likely amount to “defending” the applicant’s fees and, thus, are not recoverable. They include fee-related corrections, explanations, negotiations, research, and responses occurring after a fee application is served.

Hearings on Compensation Requests

We can argue about whether “after notice and a hearing” requires a hearing when no objection is filed, but our judges, at least, tend to require a hearing unless, under Rule 2002(a)(6), the requested compensation doesn’t exceed $1,000. Under Rule 9014, those hearings fall into 2 categories: (i) uncontested hearings without objections and (ii) contested hearings with objections. Under Baker Botts, preparing for, traveling to, or participating in any contested (“adversarial”) fee hearing is not recoverable.

However, do uncontested hearings fall outside of Baker Botts’ prohibitions? Can the court award compensation for defense costs related to a courtordered fee hearing as long as the applicant merely presents his application, summarizes his fees, and the answers questions to establish a record? We hope so, but probably not.

Baker Botts is not clear. On the one hand, the dissent asserted that the “majority does not believe that preparing for or appearing at [an uncontested hearing]–an integral part of fee-defense work–is compensable.” On the other hand, Robert Keach pointed out that “[u]nder the majority opinion, apparently you can now attend the hearing, but if you do any defending while you’re there, you can’t be paid for that time.” Ultimately, the majority speaks for itself: A court can’t award fees “for work performed in defending a fee application in court.” Therefore, we don’t see a definitive basis for treating uncontested hearings differently (but see Question 18 re: limiting Baker Botts).

Arguing about Baker Botts

Under the Court’s “benefit theory,” applicants will likely bear the expense of obtaining answers to any questions that Baker Botts leaves unanswered.

18. That’s an awfully strict reading of Baker Botts. Can we work around it?

Limiting Baker Botts to its Facts

We might be able to limit Baker Botts to adversarial litigation between the applicant and the debtor (based on the following language that we’ve emphasized):

  • The court can’t “shift the costs of adversarial litigation from one side to the other” (i.e., from “attorneys” to the “administrator“).
  • “Time spent litigating a fee application against the administrator” isn’t “labor performed” for or “disinterested service to” the administrator.
  • The term “services” doesn’t “encompass adversarial fee defense litigation.”
  • Even in the mechanic’s invoice analogy, the Court speaks only of a “battle over a bill.

In other words, the Court emphasizes (1) adversarial litigation (2) between two sides (3) where one side (the applicant) is seeking to have the other side (the applicant’s client) pay its defense fees. That only occurs when the debtor or trustee objects because the shifting of fees, if any, can only be to the debtor or the trustee. Compare that to a dispute between an applicant and a creditor: The applicant is not seeking to transfer the fees to the creditor–the estate bears them or it doesn’t.

Therefore, we might limit Baker Botts in 2 ways, such that the prohibition on defense costs only applies:

  1. When the applicant’s client (i.e., the debtor) objects; or
  2. When an objection leads to litigation (regardless of who objects).

In the former, a pretty aggressive limitation, the “substantially prevails” standard would still apply to non-debtor objections.

In the latter, a less aggressive limitation, uncontested fee hearings would be compensable.

Implementing Contractual Workarounds

Two problematic reactions to Baker Botts might be “I’ll just increase my hourly rate” or “I’ll just get the debtor to agree to pay fee-defense costs.”

Increasing Rates. Although the Supreme Court didn’t mention it, the Fifth Circuit made the rather incredible suggestion that bankruptcy professionals can address fee dilution by “anticipat[ing]” it “in their hourly rates.” As the amicus judges explain, this “rate-padding scheme will make the fee award process less transparent.” Worse, the suggestion should fail the reasonableness test out of the gate.

Finally, how is it fair or loyal to burden all clients with padded fees that are otherwise not compensable just because a few clients might embroil the professional in fee litigation? The New York Bar stated it best: “It would be an odd system indeed that allowed professionals to be compensated for defending fee applications indirectly through their hourly rates instead of directly through compensation for reasonable actual defense fees.”

Modifying Engagement Letters. The Court held that the American Rule applies “unless a statute or contract provides otherwise” (emphasis added). Therefore, can having debtors agree to pay for defense costs displace the American Rule as a matter of contract? Probably not. First, does an attorney have an ethical duty on the front-end to disclose Baker Botts? How would that conversation go? “The Supreme Court just held that you aren’t required to pay for defense costs, but I’d like you to pay them anyway.” Second, even if the debtor agrees to pay for defense costs, wouldn’t the attorney simply be setting himself up for a § 327 employment objection when he discloses the terms to the court?

Freedom of contract is important, but we aren’t sure how it can trump the Code on compensation limitations and reasonableness.

Applying for Employment under Section 328

Some, including those on the ABI Panel Discussion, have wondered whether § 328(a) provides a workaround. Under § 328(a), a court may approve in advance “reasonable terms and conditions of employment” for a professional. A § 328(a) compensation arrangement cannot be altered after the conclusion of the employment unless it proves “improvident in light of developments not capable of being anticipated.” Typically, § 328 issues arise with investment bankers and the like, and the reasonableness of their retainers.

We also don’t see how § 328 helps. After all, the court still has a duty to determine whether the terms are “reasonable.” We’d think that Baker Botts will bear on that determination. Such an arrangement might also be an improper attempt to contract around § 328(a)’s disinterestedness requirement.

Of course, if (and it’s a big “if”), the court approves payment of fee-defense costs on the front-end, then § 328 likely is a solution.

Seeking Sanctions under Rule 11

The majority remarked that if the “United States harbors any concern about the possibility of frivolous objections to fee applications,” then Rule 9011 “authorizes the court to impose sanctions for bad-faith litigation conduct.” However, as the amicus judges explained, the “standard for imposing sanctions is too high for bankruptcy judges to prevent dilution with that rarely used cudgel” (citing a Delaware bankruptcy case holding that the “stringent” Rule 9011 standard demands “exceptional circumstances” where a claim is “patently unmeritorious or frivolous”). Even ASARCO’s objections weren’t patently frivolous. Finally, even a successful Rule 9011 movant will be lucky to break-even on the cost and burden of litigating Rule 9011.

19. Does Baker Botts impact the award of “fee enhancements”?

No. The issue of enhancements was a big issue below, but the parties didn’t take it up. Some might say that the lower court decisions advance the cause for fee enhancements. Others might say that a fee enhancement from “probably the most successful Chapter 11 of any magnitude in the history of the Code” is hardly helpful precedent in (surely) more humble cases.

20. What are others saying about Baker Botts? Have courts gotten involved yet?

What Others are Saying

Law360 collected various reactions to Baker Botts here, including one from Dechert’s Eric Brunstad Jr. (a Supreme Court bankruptcy star in his own right):

“Bankruptcy is a highly specialized context, and reliance on general fee-shifting principles is at odds with the purpose, policy, and reality behind the supervision and award of fees in Chapter 11 cases. Unfortunately, this decision will create problems in the administration of Chapter 11 matters.”

Similarly, Prof. Stephen Lubben, one of the amici and a frequent Credit Slips contributor, observed that:

“The majority seems to be totally out of touch with the reality of bankruptcy practice, and its opinion seems to be an open invitation for bomb throwers who stop just short of Rule 11.”

You can find additional commentary by listening to the excellent ABI Panel Discussion.

What the Courts are Saying

So far, 6 courts have cited Baker Botts, but not on the fee-defense issue. As an aside, we couldn’t help but notice that one of our S.D.G.A. judges cited it on the general issue of statutory interpretation. We’ll keep our eyes on other cases.

CONCLUSION

Our knee-jerk reaction to Baker Botts was that it represents another example of the Supreme Court’s disdain for bankruptcy practice. Perhaps we’ve been recovering fee-defense costs for so long that we can’t imagine bankruptcy practice any other way. Nevertheless, Baker Botts is now controlling law. The most that we can probably hope for is that lower courts will limit Baker Botts to fee litigation rather than fee presentation, such that the cost of court-ordered, uncontested fee hearings is still compensable.