Bankruptcy Litigation Committee

Volume 6, Number 6 / October 2009

In This Issue

• The Trouble of the $1,000 Billable Hour in Bankruptcy - Limitations of Professional Compensation by the Bankruptcy Court under 11 U.S.C. §328
• Lien Preservation Does Not Give Trustee All Rights of a Lienholder
• Committee Session at ABI's 21st Annual Winter Leadership Conference

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The Trouble of the $1,000 Billable Hour in Bankruptcy - Limitations of Professional Compensation by the Bankruptcy Court under 11 U.S.C. §328

by: Taejin Kim
Emory University School of Law; Atlanta

Editor's Note: The following article, "The Trouble of the $1,000 Billable Hour in Bankruptcy - Limitations of Professional Compensation by the Bankruptcy Court under 11 U.S.C. §328," won the prize for third place in the First Annual ABI Bankruptcy Law Student Writing Competition. The article examines the court's ability to modify compensation arrangements and reviews the statutory provisions and policy considerations surrounding the issue. The author, Taejin Kim, is a member of the Emory University School of Law class of 2009. In addition to recognition and publication of his article in the Bankruptcy Litigation Committee Newsletter, Mr. Kim received a cash award of $500 and a one-year ABI membership.

The First Annual ABI Bankruptcy Law Student Writing Competition was headed by the Honorable Judith K. Fitzgerald, U.S. Bankruptcy Court for the Western District of Pennsylvania, who is the Special Projects/Task Force Leader for the Bankruptcy Litigation Committee, with assistance from the leadership and members of the Bankruptcy Litigation Committee. Please visit papers.abiworld.org for information regarding the second annual competition, with a submission deadline of March 31, 2010.

On Dec. 26, 2008, the Tribune Company, as the debtor-in-possession (DIP) of the estate, submitted an application for an order authorizing the employment and retention of Chicago-based firm Sidley Austin as its chapter 11 attorney. The application contained terms for, among other things, proposed compensation to Sidley Austin calculated on an hourly basis, with partner billing rates listed at $575 to $1,100 per hour. However, a second supplemental affidavit to the application, filed on Feb. 19, 2009, by James Conlan, co-chair of Sidley’s reorganization and bankruptcy group, contained a curious adjustment. Conlan stated that the highest billing rate charged by any Sidley partner was not to exceed $925 per hour.[1] Did the attorneys at Sidley Austin lower their billing rates in 2009 in response to the downturn in the economy? Had they simply had a change of heart? Or was it something else?

On Feb. 20, 2009, Chief Judge Kevin J. Carey of the U.S. Bankruptcy Court in the District of Delaware made clear that it was he who denied Sidley Austin the $1,100-per-hour billing rate. Judge Carey flatly stated in a hearing that “[t]o the extent that this applicant or any other hits [the $1,000] mark, I will require evidence in support of that rate.”[2] Somehow Judge Carey was able to wrestle the Sidley attorneys off of their $1,100 billing rate to a mere $925 per hour. What gave Judge Carey the authority to modify Sidley’s compensation arrangement? This article will examine that question, including a review of both the statutory provisions (and judicial interpretations of those provisions) and policy considerations surrounding the issue of fee adjustments by the courts. 

Background
Without knowing exactly what occurred between the parties, Judge Carey’s decision to lower Sidley’s maximum fee was likely based within the bankruptcy court’s power to regulate retention and compensation of professionals per §§327, 328, 329 and 330 of the Bankruptcy Code.[3] Bankruptcy Rule 2014 provides the means by which a trustee can seek an order of the court approving the employment of professionals such as attorneys, accountants and financial advisors pursuant to §§327(a) and 1107(a) of the Code.[4] Section 327(a) permits the trustee, or the DIP per §1107, to employ one or more disinterested professional persons that do not hold or represent an interest adverse to the estate to represent or assist the trustee in its bankruptcy proceedings.[5] The application for an order authorizing employment of the professional is filed by the trustee or DIP and must state, among other things, the specific facts showing the necessity for the employment, the professional services to be rendered and any proposed arrangement for compensation.[6]

Sections 328 and 330 of the Code are the statutory pillars that allow for the examination of professionals’ fees by the bankruptcy court. Section 328 allows the trustee, with the court’s approval, to employ the professional, “on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or percentage fee basis, or on a contingent fee basis.”[7] Section 330 gives the bankruptcy court the discretion to award to the professional any reasonable compensation and reimbursement for actual and necessary services provided and expenses incurred per those terms.[8]

The two main policy rationales for the bankruptcy court’s supervision of employment and compensation include the economy of the estate and maintaining public confidence in the integrity and fairness of the bankruptcy system.[9] Professional fees enjoy administrative expense status under §503(b)[10] in that every dollar paid to a professional is a dollar taken away from those further down in the bankruptcy pecking order, including creditors. As in the instant case with Sidley and the Tribune Company, an attorney representing the DIP has a duty to act in the DIP’s best interest, whose duty, in turn, is to the estate.[11] There is a tension in the attorneys’ representation of the DIP. On one hand, the attorney works to best preserve the estate, but every dollar the attorney is awarded by the court is withdrawn from the estate. Judges are also keenly aware that fees paid to attorneys must come from the estate and therefore are careful not to appear to “lavish monies upon a brethren of the cloth.”[12] As such, while the Code grants considerable latitude to a trustee and its professionals in setting their fee arrangements under a reasonableness standard, it is necessary for the court to maintain a measure of control over the compensation process.

Judicial Interpretation of §§328 and 330
Although bankruptcy judges have great discretion and a wealth of precedent under §330 in the awarding of compensation during and after representation,[13] neither §330, nor §328 on their faces provide the bankruptcy court with explicit statutory authority to modify compensation arrangements prior to the representation. Like §330, §328 allows the court to modify compensation arrangements different from the approved terms and conditions only after the conclusion of employment, but only if such terms and conditions 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.[14] Under §328, the court must foresee and anticipate circumstances before approving any terms and conditions of employment.[15] Although the legislative history of §328 supports the notion that the court’s power includes the authority to increase or decrease the compensation agreed upon by the trustee and the professional,[16] nothing in the Bankruptcy Code specifically allows for modification at approval; it appears that it is simply up to the judge to deny approval of the application for employment until it is made “reasonable” in his or her opinion. There is, however, a growing body of §328 case law that is outlining the bounds of the bankruptcy court’s power to regulate the terms and conditions of professionals’ employment.

Although §§328 and 330 may seem to do the same things, courts have made clear that the two work in separate spheres. Under §328, an attorney or professional can avoid uncertainty on matters of compensation by obtaining approval of her representation and fee arrangement.[17] Once such an arrangement is approved by the court per §328, the court can only modify the compensation under the tougher “improvident” standard and not the “reasonable” standard under §330. In other words, it is a widely-accepted general rule that a bankruptcy court does not have the power to make a reasonableness review under §330 if the court has already “approved” the professionals’ employment under §328.[18]

What Is “Reasonable”?
First, we reach the issue of what constitutes “reasonable” terms and conditions of employment per §328. In United Artists Theatre Co. v. Walton, the Third Circuit weighed whether it was a reasonable term of employment for the debtors to indemnify its financial advisors despite its own negligence.[19] The court disagreed with the debtor’s argument that such terms were common in the marketplace and automatically made reasonable under §328.[20] The Third Circuit announced that the bankruptcy court’s approach was to be “market-driven,” not “market-determined,” especially in the realm of bankruptcy, where courts play a “special supervisory role.”[21] The bankruptcy court’s inquiry into what is “reasonable” must be tailored to Bankruptcy Code requirements, including the particular circumstances of a chapter 11 proceeding, the court’s supervisory role and the interests of the various constituents.[22]

Judge Carey, writing for the Delaware Bankruptcy Court in In re Insilco Technologies, clarified some of the factors to be considered in the reasonableness analysis, which is to include, but not be limited to:

(1) whether terms of an engagement agreement reflect normal business terms in the marketplace; (2) the relationship between the Debtor and the professionals, i.e., whether the parties involved are sophisticated business entities with equal bargaining power who engaged in an arms-length negotiation; (3) whether the retention, as proposed, is in the best interests of the estate; (4) whether there is creditor opposition to the retention and retainer provisions; and (5) whether, given the size, circumstances and posture of the case, the amount of the retainer is itself reasonable.[23]

Despite laying out these factors, Judge Carey noted that each case must be “decided upon its own circumstances.”[24] The Delaware approach therefore allows a bankruptcy judge to maintain wide discretion in its determination of the reasonableness of terms and conditions of employment of a professional.

When Are Terms and Conditions of Employment “Approved?”
Although the terms and conditions of employment may be reasonable, it is up to a judge to approve them. Various circuits have applied different standards by which to judge whether a compensation arrangement has been deemed “approved” by the bankruptcy court. The general rule here is that an order authorizing a professional’s employment that contains no specific employment terms and conditions generally does not bind the bankruptcy court to any particular terms and conditions of compensation.[25]

The Ninth Circuit has applied the strictest standard, holding that “unless a professional's retention application unambiguously specifies that it seeks approval under §328, it is subject to review under §330.”[26] The Sixth Circuit has held that whether a court preapproves a fee arrangement under §328 should be judged by the totality of the circumstances, looking at both the application and the bankruptcy court's order.[27] Factors in the determination may include whether the debtor or trustee specifically requested fee preapproval, whether the court’s order assessed the reasonableness of the fee, and whether either the order or the motion expressly invoked §328.[28]

The Third Circuit has held that if an order does not “expressly and unambiguously state specific terms and conditions (e.g., specific hourly rates or contingency fee arrangements) that are being approved pursuant to the first sentence of §328(a), then the terms and conditions are merely those that apply in the absence of specific agreement.”[29] If the order does not make such terms and conditions explicit, the court is free to review compensation under §330 standards, unfettered by the second sentence of §328(a).[30] Otherwise, the Third Circuit notes, a bankruptcy court’s duty to conduct an independent examination of fee applications would be unduly restricted if employment authorization orders were routinely construed as binding the court to particular terms of employment.”[31]

Accordingly, bankruptcy court approval under §328 should not be implied; it must be explicit. Further, as below, the Third Circuit has made clear that the bankruptcy court has great flexibility in examining and, if necessary, modifying proposed compensation terms prior to granting approval under §328.

Judicial Modification of Fee Arrangements under In re Federal Mogul-Global
In In re Federal Mogul-Global Inc., the latest case from the Third Circuit interpreting §328, the equityholders’ committee appealed the Delaware bankruptcy court’s decision granting an application to employ a professional that the bankruptcy court modified by adding a monthly cap on the advisor’s compensation.[32] The committee argued to the Third Circuit that the bankruptcy court was bound to approve its application because the amount of a professional’s compensation was not a “term or condition of employment” per §328(a); that is, its application proposed employment on an hourly basis that is reasonable by the plain text of §328(a).[33] The committee also argued that a bankruptcy court, when presented with an application to employ a professional, must either approve the application in toto without changes or it must reject the application.[34]

Then-Third Circuit Judge Samuel Alito made it clear that a bankruptcy court may approve some of the terms and conditions proposed in an employment application while rejecting others, finding this point implicit in Third Circuit precedent that held that a bankruptcy court’s approval of an application for employment does not imply approval of the hourly rate sought in the application.[35] Modification of terms by the court would produce the same result as a bankruptcy court rejecting an application, explaining why it found a term to be unreasonable and entertaining an amended application.[36] Judge Alito saw no need to jump through extra hoops to reach essentially the same result.

More importantly, Judge Alito found that because a bankruptcy court has the ability to review the terms and conditions of professional employment, it necessarily has the power to review the reasonableness of the way in which any proposed fee arrangement operates.[37] For example, just because a fee arrangement provides for billing on “an hourly basis,” it does not render the proposed terms reasonable.[38] If this were not the case, §328(a) would allow compensation on any hourly basis so that even a fee of $10,000 per hour would be reasonable.[39] Further, Judge Alito believed that the bankruptcy court should be able to institute a cap on fees.[40] Otherwise, if a court specifically approved an hourly rate without a cap, but wanted to later limit any excessive fees, it could not do so unless the need for a cap could not have been anticipated at the time of approval, per the “improvident” standard of § 328(a).[41]

Policy Implications of Fee Modifications
Judicial regulation of professional compensation arrangements can have several effects on the bankruptcy system. First, judicial setting of an attorney’s billing rates at below the market rate is in opposition to one of Congress’ principal policy considerations in compensation of professionals.[42] In determining the amount of reasonable compensation to be awarded under §330, the courts are to consider several factors, one of which is whether the compensation is reasonable, based on the customary compensation charged by comparably skilled practitioners in cases other than cases under the Bankruptcy Code.[43] This provision was inserted by Congress to overrule a case[44] that set an arbitrary limit on fees payable in a bankruptcy case.[45]

Congress believed that if professionals’ fees could be arbitrarily capped, professionals would be driven from the bankruptcy arena because they would be able to earn higher incomes in other fields; eventually, the bankruptcy field would be occupied by those who could not find other work and those that practice in bankruptcy only occasionally almost as a public service.[46] This policy rationale applies equally, if not more forcibly, to §328. If professionals were to be regularly denied market-rate fees for their services in bankruptcy cases, they would seek work in other more attractive areas without getting involved in bankruptcy cases in the first place.

Alternatively, if professionals were regularly denied market-rate fees in only certain bankruptcy courts, venue-shopping by debtors and their attorneys may become more problematic. In selecting a venue for a bankruptcy proceeding, petitioners may seek to avoid venues that could aggressively regulate attorneys’ fees.[47] In determining reasonableness of these fees, bankruptcy courts will typically look to prevailing market rates in their own localities.[48] However, in large chapter 11 cases, where many of the attorneys may be based in different localities, the question frequently arises as to whether the court should approve fees according to the rates in the local market or those in which the attorney ordinarily works.[49] For example, if a particular district limits fees to under $1,000 per hour, a debtor’s lawyer who can command more than that amount may be able to insist that the case be filed elsewhere.[50] A precedent of limiting professional fees to a certain amount may result in debtors like the Tribune Company filing their reorganization cases in hometown districts or other districts, such as the Southern District of New York, that may be more amenable to the engagement of professionals that charge higher fees.

Conclusion
Whether a $1,000-per-hour billing rate is truly unreasonable or only objectionable on its face, the determination of its reasonableness is wholly to be determined by the bankruptcy judge. Despite strongly stated legislative intent to provide for market compensation to professionals employed in the bankruptcy process, courts, particularly those in the Third Circuit, have interpreted §328 of the Bankruptcy Code to give the bankruptcy court discretion to modify the terms and conditions of employment. A definition of “reasonable” must take into particular account the unique concerns in bankruptcy, such as the preservation of the estate. Although a court’s ability to adjust compensation per §330 is constrained once it has approved terms and conditions of employment under §328, the bankruptcy court may modify terms and conditions of employment and place caps on fees before approving them. It remains to be seen what the effects of fee capping on the bankruptcy process will be. However, Judge Carey made one point clear: For the time being, if you plan on charging more than $1,000 for an hour of your time, you had better come prepared with a good reason why.