Investment Banking Committee

Therefore, the first step an investment banking professional should take in his effort to minimize the likelihood that his fee will be reduced or contested is to include language in the retention application expressly indicating that §328(a), and not §330, will govern the compensation received by the investment banking professional. The purpose of §328 is to permit the pre-approval of those fixed terms of compensation arrangements recognized by the market as a method of insuring that the most competent professionals are available to provide services in bankruptcy cases. See In re Westbrooks, 202 B.R. 520, 521 (Bankr. N.D. Ala. 1996) (fixed percentage fee arrangements with law firms “comport with the Bankruptcy Code’s goal of attracting highly qualified professionals to the bankruptcy forum”); In re Olympia Holding Corp., 176 B.R. 962, 964 (Bankr. M.D. Fla. 1994). Many investment-banking firms seek payment for their work on a fixed monthly fee plus a fixed success fee payable if a plan is confirmed. Once the terms of a professional’s retention have been approved under §328(a), the judge’s award must follow the agreed-upon compensation and cannot be altered unless the terms “prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.” 11 U.S.C. §328(a) (emphasis added). The following cases illustrate the importance of this distinction.

In In re Gillett Holdings Inc., 143 B.R. 256 (Bankr. D. Colo. 1992), Smith Barney, Harris Upham & Co. Inc. (Smith Barney) filed an application with the bankruptcy court for the interim allowance of compensation and reimbursement of expenses for services the firm rendered to Gillett Holdings Inc. (Gillett) related to Gillett’s chapter 11 reorganization. In its order authorizing employment of Smith Barney, the court stated that the “compensation and reimbursement for expenses of Smith Barney [are] to be fixed by further order of the court.” In re Gillett Holdings Inc., 143 B.R. at 259. The total fees sought by Smith Barney came to $800,000.00 but the court, analyzing the fee request under the “reasonableness” standard of §330 rather than the fixed unless “improvident” standard of §328, slashed this amount by $501,656.75 and awarded Smith Barney only $298,343.25. The Gillett court stated that the “deference afforded under §328(a) does not apply unless the appointment order expressly and unambiguously state[s] specific terms and conditions … that are being approved pursuant to the first sentence of §328(a).” In re Gillett Holdings Inc., 143 B.R. at 259.

By not carefully specifying in its engagement letter and application to be employed that §328(a) was to control any review of compensation agreed to by the parties, Smith Barney left itself open to later reductions of its fees by the court under §330. Gillett thus warns that investment banks should take great care to ensure that fee applications, and the subsequent court orders approving those applications, include language unambiguously stating that the fees are subject to §328(a) and not §330. In contrast, the court held in In re B.U.M. Int’l Inc., 229 F.3d 824 (9th Cir. 2000), that “[t]here is no question that a bankruptcy court may not conduct a §330 inquiry into the reasonableness of the fees and their benefit to the estate if the court already has approved the professional’s employment under 11 U.S.C. §328.” In re B.U.M. Int’l Inc., 229 F.3d at 829. The question for the investment banking firm seeking to protect its fee arrangements thus becomes: what constitutes the preferred §328(a) pre-approval by a court?

Unhappily, the answer to this question is not a simple one. The Third Circuit Court of Appeals has held that if the judge’s order approving the investment banking firm’s fees does not expressly and unambiguously state the specific hourly rates or contingency fee arrangements that are subject to §328(a), then the reasonableness standard with its discretion for awarding less applies to those terms. Zolfo, Cooper & Co. v. Sunbeam-Oster Co. Inc., 50 F.3d 253, 261 (3d. Cir. 1995). The Ninth Circuit Court of Appeals utilizes even a slightly stricter standard, under which “unless a professional’s retention application unambiguously specifies that it seeks approval under §328, it is subject to review under §330.” In re Circle K Corp., 279 F.3d 669, 671 (9th Cir. 2002). The Sixth Circuit Court of Appeals, however, has adopted a less stringent test, holding that “whether a court ‘pre-approves’ a fee arrangement under §328 should be judged by the totality of the circumstances, looking at both the terms of the application and the bankruptcy court’s order. Factors in the determination may include whether the debtor’s motion for appointment specifically requested fee pre-approval, whether the court’s approval order assessed the reasonableness of the fee, and whether either the order or the motion expressly invoked §328.” In re Bean, 2007 WL 81795 (Bankr. E.D. Tenn.) (emphasis added).

Despite the split in authority as to what constitutes a court’s “pre-approval” of fees under §328(a), it appears clear that as long as the fee applications submitted by investment banks and financial advisors, and the court orders approving those fee applications, include language clearly stating that §328(a) applies, the fee will only be reviewable under the “improvident” standard of §328(a) and not the “reasonableness” standard of §330. However, the language that investment banks must exclude from applications and court orders can be just as important as the language they must include in such documents.

In the case of In re Olympic Marine Services Inc., 186 B.R. 651 (Bankr. E.D. Va. 1995), a law firm representing the trustee in a chapter 7 proceeding submitted a contingent fee application in reliance on §328(a). The court issued a retention order approving the firm’s role in the case, but the court’s order stated that the firm’s compensation would be subject to “further review.” The court ultimately reduced the firm’s fees by almost 20 percent, holding that “[n]otwithstanding the case authority under §328(a), since the retention order … provided that [the firm]’s compensation award would be subject to the court’s ‘further review,’ I do not consider the ‘improvident’ language of the statute strictly applicable.” In re Olympic Marine Services Inc., 186 B.R. at 654. In light of Olympic Marine, investment banks should consider resisting proposed approval orders containing phrases making the eventual award “subject to further court review” or similar language from their applications to approve their written engagement letters.

Section Two: Issues to Consider When Fee Disputes Arise

As the cases addressed in the previous section show, even the most carefully constructed fee application doesn’t guarantee that an investment-banking firm will be free from fee disputes. For example, even when §328(a) applies, a court may reduce the fees sought by an investment-banking firm if the original terms of the fee agreement “prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.” 11.U.S.C. §328(a). In plain English, this means that if the parties could have anticipated the occurrence of events that ultimately make the fee imprudent, the fee will stand. For example, in In re Barron, 325 F.3d 690 (5th Cir. 2003), the court refused to reduce a law firm’s fee despite the fact that the professional was able to obtain a substantial judgment in a short amount of time with relative ease. The court held that such an outcome was foreseeable, or anticipatable, at the time the parties entered the fee agreement. The recitals in the professional’s engagement letter might therefore enumerate a nonexhaustive listing of foreseeable outcomes observed at the time the fee is negotiated.

If, on the other hand, the parties to a fee agreement could not have reasonably anticipated the occurrence of events that ultimately render a professional’s fees improvident, a court is free under §328(a) to alter the fees. Yet, not all unanticipatable events will lead to a reduction in the investment bank’s fees. In In re Home Express Inc., 213 B.R. 162 (Bankr. N.D. Cal. 1997), the court allowed four professional firms to increase their fees by a total of approximately 15 percent, or $295,000. In Home Express, the turnaround team initially put in place quit after a few months, creating a “managerial vacuum” at the debtor that required the four professional firms to increase their labor and risks, thereby justifying the fee increase. 213 B.R. at 167. Because this managerial vacuum was not foreseeable at the time the court approved the parties’ fees, the court ruled that §328(a) applied and the fee increases requested by the professionals were granted.

Even with §328(a) protection, duplication of services is another factor courts have used to reduce the fees earned by investment banks, which are sometimes engaged by the DIP and by the committee appointed in the case by the U.S. Trustee. The theory is that if two investment-banking firms each provide the same service for a debtor corporation in a turnaround or reorganization, the debtor’s assets will be harmed by the inefficiency and redundant billings that would follow. However, as the ruling in In re Northwestern Corp., 332 B.R. 534 (Bankr. D. Del. 2005) illustrates, a comprehensive, well-worded engagement agreement delineating the respective duties of each investment banking firm can save an investment bank from seeing its hard-earned fees reduced. In In re Northwestern, Houlihan, Lokey, Howard & Zukin (Houlihan) and Lazard Freres & Co. LLC (Lazard) each provided services to debtor Northwestern. At the conclusion of the case, the bankruptcy court relied on §328(a) to support its holding that duplicated services performed by Lazard and Houlihan “rendered Houlihan’s previously-approved monthly fee improvident.” Id. at 537. As a result of such duplicated services, the bankruptcy court reduced Houlihan’s fee by 50 percent, from $2,275,000 to $1,137,500.

Houlihan appealed the reduction in fees to the U.S. District Court in Delaware, which reversed the bankruptcy court’s decision and awarded Houlihan the full $2,275,000. In so holding, the district court did not dispute that the services in question were duplicative, but instead applied §328(a) and ruled that the duplication was foreseeable based on the fact that the duplicated services “were clearly set forth in the respective engagement agreements of the two firms.” Id. at 537. Thus, the court continued, “whether or not those services were inappropriately duplicative, the potential for duplication was certainly not unforeseeable.” Id. at 537.

Conclusion

Investment-banking firms should be aware that courts have the authority to deny or reduce the fees a firm receives for services performed pursuant to a corporate reorganization. By explicitly stating in the retention agreement executed at the outset of an advisory relationship that U.S. Bankruptcy Code §328(a), and not §330, is the applicable standard by which a court should review the fees charged, an investment-banking firm may protect itself against court-imposed fee reductions later. In addition, carefully drafting the retention agreement to include a comprehensive list of the services to be performed by the firm may also protect the firm in the event a fee dispute arises.