Baha Mar 2

(Some imagined or actual version of the Baha Mar Resort)

As we discussed in two prior posts (Part 1 and Part 2), 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. Here’s a link to the combined post: Click Here.

In pertinent part, we submitted that some view Section 328(a) of the Bankruptcy Code as a possible Baker Botts workaround. Under § 328(a), a court may approve in advance “reasonable terms and conditions of employment” for a professional. Thanks to a heads-up from the folks at Law360, it appears that the United States Trustee in Delaware objected to the reliance by two unsecured creditor committees on § 328(a) as a Baker Botts workaround in two pending Chapter 11 cases: In re Boomerang Tube, LLC, et al. and In re Northshore Mainland Services, Inc., et al. (a/k/a the Baha Mar case).

Specifically, in those two cases, the Unsecured Creditor Committees filed their respective Applications to Employ Counsel: Boomerang App and Baha Mar App.

United States Trustee’s Objections

In the Boomerang case, the Committee proposed that, as “part of the compensation payable to Brown Rudnick, the Committee agrees that Brown Rudnick shall be indemnified and be entitled to payment from the Debtors’ estates, subject to approval by the Court pursuant to 11 U.S.C. §§ 330 and 331, for any fees, costs or expenses, arising out of the successful defense of any fee application by Brown Rudnick in these bankruptcy cases in response to any objection to its fees or expenses in these Chapter 11 cases.”

In turn, the proposed order on the Application provided as follows: “Brown Rudnick shall be indemnified and be entitled to payment from the Debtors’ estates, for any fees or costs arising out of the successful defense of any fee application by Brown Rudnick in response to any objection to its fees or expenses in these cases pursuant to section 328(a) of the Bankruptcy Code.” In the Baha Mar case, the Committee proposed to retain Whiteford, Taylor & Preston, LLC on the same terms, almost verbatim, in both the application and the proposed order.

Andrew Vara, the Acting United States Trustee in Delaware, objected to both applications, here and here. His more recent objection in the Baha Mar case fully captures his argument. First, he argues that § 328(a), like § 330(a), does not overcome the presumption under the American Rule that each party is to pay its own fees for fee defense work. Second, he argues that, regardless of whether the American Rule precludes approval of the proposed fee defense provisions, they cannot be approved because fee defense falls outside of the scope of § 328(a) because fee defense falls outside of the scope of the professional’s proposed employment. In other words, § 1103(a) permits a committee to retain a professional to provide “services” for the committee, but, after Baker Botts, fee defense costs cannot be a “service.” Indeed, the UST points to § 328(a) as addressing “how the professional is paid” and not the services “for which the professional may be paid.” [We agree with the Committee that the UST offers little support for its reading of § 328(a).]

Third, and for similar reasons, the UST argues that the provisions fail the “reasonable terms and conditions” test under § 328(a) because, if the Committees are proposing compensation for something that is not a “service,” then the provisions are unrelated to what a professional may be compensated for and, thus, are not reasonable under § 328(a). Fourth, he argues that, regardless of what § 328(a) contemplates, § 330(a) is still the “exclusive provision authorizing the ‘award’ of compensation.” Therefore, because fee defense is not compensable under § 330(a) after Baker Botts, a court cannot award compensation for fee defense work, even for professionals “with pre-approved terms” under § 328(a). [We think that the better argument is that, by operation of Baker Botts, the proposed term never gets approved under § 328(a) in the first place.]

Fifth, the UST argues that consent by the Committee to reimburse its professionals for defense costs cannot overcome the statutory requirements (as interpreted definitively by the Supreme Court in Baker Botts). Essentially, the UST makes the same argument that we hinted at last month: If consent is all that it takes to circumvent Baker Botts, then what is stopping a party from circumventing the Bankruptcy Code in other, similar ways (e.g., by consenting to the payment of unnecessary or duplicative services)?

Response to United States Trustee’s Objections

Although the Baha Mar Committee has not yet responded to the UST’s objection, the Boomerang Committee responded here. Essentially, the Committee attempts to limit Baker Botts to § 327(a) and § 330(a) and then separate § 328(a) from § 330(a). First, the Committee articulates the “limited” holding in Baker Botts: (i) the American Rule is presumed to apply unless a statute or contract provides otherwise; (ii) § 330(a)(1) does not provide otherwise; and, thus, (iii) defense costs are not reimbursable under § 330(a)(1). However, argues the Committee, Baker Botts does not address whether § 328(a) provides an exception to the American Rule. Therefore, Baker Botts does not apply to § 328(a). Further, the Committee suggests in a footnote that an objection to a Committee fee app might not even invoke the American Rule if the objecting creditor would never be liable for the Committee’s defense costs. See Part 2 #18 of our prior post (suggesting that Baker Botts really only makes sense where the statutory fiduciary objects to its own professional’s fees).

Second, the Committee accuses the UST of superimposing, without any supporting authority, the requirements of § 330 on § 328 when, in fact, § 330(a)(1) explicitly provides that § 330(a)(1) is “subject to sections 326, 328, and 329” (not the other way around). With very little support of its own, the Committee then tries to separate the Supreme Court’s emphasis on compensable services under § 330 from the word “employment” in § 328. In a footnote, it even makes the strained argument that fee defense costs fall into the “actual, necessary expenses” language under § 330(a)(1)(B) (which doesn’t refer to “services”) instead of the “actual, necessary services” language in § 330(a)(1)(A) (which does refer to “services”). Defense costs, argues the Committee, are “more appropriately viewed as a contractual right to be reimbursed for costs and expenses related to challenges to the services actually rendered to the estates.”

Therefore, the argument goes, if a bankruptcy court approves a proposed § 328(a) employment term as being reasonable, then that approved term will trump any prohibitions under § 330(a)(1). The Committee then submits that the Boomerang court should approve the proposed indemnity provision because courts have, for decades, approved similar contractual indemnification provisions under § 328 using a “market-driven” approach rather than necessarily applying § 330(a)(1) to determine reasonableness under § 328. The Committee points to In re Energy Partners, Ltd., 409 B.R. 211 (Bankr. S.D. Tex. 2009) for the market factors for evaluating § 328 terms and conditions. In fact, submits the Committee, the UST approved an even broader indemnity provision for Lazard Frères (the Investment Banker in Boomerang) that covered all defense costs, regardless of the outcome.

The Boomerang Court Weighs-In (Sort of)

The Committee and the UST then filed supplemental briefs (here and here) to address a question that the Boomerang court asked at an initial hearing: Is it “an established practice for attorneys to obtain payment for their fees and expenses in defending fee applications”?

The Committee responded to the inquiry by providing the Court with examples of attorneys being reimbursed for defense costs in and outside of Chapter 11. The Committee also quoted against the UST the same language from the United States Trustee Large Case Fee Guidelines that we discussed in our prior posts (i.e., where the UST suggests that a judicial exception to the prohibition on reimbursing fee defense costs might be where an applicant “substantially prevails” in its fee defense). Ultimately, though, the Committee falls back on its main argument: Baker Botts does not address § 328. Therefore, if a post-ASARCO court finds a § 328 term (e.g., a fee defense provision) reasonable, then a court can approve it such that it’s compensable under § 330(a), despite Baker Botts.

The UST responded to the Committee’s supplemental brief by arguing that Baker Botts foreclosed on the “market approach” when the Supreme Court held that, because “no attorneys, regardless of whether they practice in bankruptcy, are entitled to receive fees for fee-defense litigation absent express statutory authorization,” requiring them “to pay for the defense of their fees thus will not result in any disparity between bankruptcy and nonbankruptcy lawyers.” In other words, argues the UST, the Committee misses the point by citing dozens of bankruptcy and non-bankruptcy cases where similar provisions were approved because “those cases are irrelevant and no longer good law after ASARCO.” [That’s quite a bold statement!]

Further, the UST rejects the Committee’s “contract theory.” The application and order thereon are not contracts. Rather, they reflect a “request that a judge, acting within the constraints of section 328(a), authorize the term or condition of employment.” Particularly in the context of a Committee engagement, the party who is to be liable for the defense costs (i.e., the debtor’s estate) is not even a party to the alleged “contract.” As the UST puts it, the “American Rule’s prohibition against fee shifting can be altered by statute, and it can be altered by contract. But the American Rule cannot be altered by a contract that violates a statute.” Therefore, the proposed terms cannot be saved by a contracts argument if they violate the Bankruptcy Code.

[Indeed, we can’t forget that the Committee is a creature of statute and, thus, inherits all of its powers, including its power to enter into contracts, and limitations thereon, from an order of the bankruptcy court that complies with the Bankruptcy Code.]

Finally, the UST rejects the Committee’s suggestion that defense costs are expenses as opposed to services–otherwise, argues the UST, Baker Botts could have hired outside counsel to litigate the fee objections in Baker Botts and then simply expensed that firm’s fees and costs under § 330(a)(1)(B) as a workaround.

Our Thoughts

Ultimately, the § 328 issue boils down to one question: Does the Supreme Court’s holding that professionals may not, under § 330(a)(1), recover their defense costs as compensation also extend to § 328? Unfortunately, we think that the UST gets it right. It’s difficult to argue that the Supreme Court would have (or that a bankruptcy court interpreting Baker Botts should) come to a different conclusion on § 328. That is because § 328 still applies to those employed under § 327 or § 1103 (just like § 330) and emphasizes “reasonable terms and conditions of employment.” In other words, why would the Supreme Court read § 327 and § 330 together to exclude defense costs from compensation, but then read § 328 and § 330 together to include defense costs in compensation?

To be sure, we think that Baker Botts is a bad decision because the American Rule makes no sense in the bankruptcy context. However, it’s now binding. Right or wrong, the main basis for Baker Botts is the assumption that defense costs never constitute “services” to the party who employs the professional and, thus, are never compensable under § 330. Therefore, as we suggested last month, a § 328 “workaround” simply fails at the employment application stage, rather than at the fee application stage. We don’t have any expectation that the Supreme Court would change its tune on defense costs just because a clever lawyer tried to slip defense costs in on the front-end of the case. [As an aside, though, could the Committee’s proposed professional get an indemnity agreement from the Committee members themselves? After all, their ability to contract is not a creature of statute.]

Arguably, the dozens of cases cited by the Committee showing courts approving defense cost provisions in the past might suggest that the Supreme Court erred in Baker Botts, but they don’t suggest that the Supreme Court would come down differently on § 328. In short, we read Baker Botts as the Supreme Court’s determination that employment terms proposing the payment of defense costs out of the bankruptcy estate are never reasonable. And that is consistent with the “subject to” language in § 330(a)(1) because § 330 would still be “subject to” the reasonable terms approved under § 328–it’s just that the particular term in question (reimbursement of defense costs) never makes it past § 328 in the first place.

The parties and the armchair bloggers have weighed-in; now it’s time for the Delaware Bankruptcy Court to weigh-in. Our money’s on the UST, but our hope lies with the Committees.