In the recently decided case of In re Residential Capital (ResCap), Judge Glenn approved a $2 million success fee to the court-approved chief restructuring officer (CRO or Kruger).[1] In doing so, the court overruled the sole objection, which had been filed by the U.S. Trustee, and found that the debtors appropriately exercised their business judgment and met the reasonableness standard for use of estate assets found in §§ 330 and 363. “[I]f a debtor’s proposed use of its assets pursuant to § 363(b) of the Bankruptcy Code represents a reasonable business judgment on the part of the debtor, such use may be approved.”[2] The court concluded that the debtors’ board was “fully informed” and exercised appropriate business judgment when setting the amount of the Kruger success fee as well.[3]
The ResCap debtors were a leading residential real estate finance company and the fifth-largest servicer of residential mortgages in the United States. The debtors filed a motion to retain the CRO;[4] no party objected. Shortly thereafter, the chief executive officer resigned and the CRO took on additional duties. Six months after the CRO’s employment was approved, the debtors filed a motion to amend the engagement agreement to provide for a $2 million success fee, subject to a subsequent reasonableness determination under § 330.[5] Again, no party in interest objected. Following confirmation of a plan of reorganization, the debtors then moved to pay the success fee to the CRO (the success fee motion). While the creditors’ committee and other major stakeholders supported the payment of the success fee, the U.S. Trustee lodged multiple objections, including: (1) the success fee would result in an hourly rate in excess of $2,300 per hour, which, in the U.S. Trustee’s opinion, violated the reasonableness standard; (2) the success fee would be a “sum above the $1.2 million in compensation” to be paid to the CRO at $895 an hour, the hourly rate approved in the original retention order; and (3) the court should delay the review of the reasonableness of the success fee until such time as the final fee applications were heard (intimating that the success fee should be analyzed under the professional fee/hourly rate “reasonableness standard”).[6]
The Rescap court rejected the U.S. Trustee’s objection as to timing, noting that its review of other fee applications would have no determination on the issues raised in the success fee motion.[7] The court then analyzed the “reasonableness” of the requested payment of the success fee pursuant to § 330,[8] and stated that a review of a success fee is not an application of a strict formula or a calculation of the hours worked or the billing rates of a professional.[9] In the Second Circuit, professionals cannot claim entitlement to a success or completion fee under § 328(a) without the court first approving the standard by which the fee requested will be determined. If a standard for determining a fee request is not pre-approved under § 328(a), the court must use the standards outlined under § 330.[10] The ResCap court recognized that the reasonableness analysis is also market-driven, not from a prospective viewpoint, but rather based on the facts that existed when the services were rendered.[11]
The court invoked In re Lionel and In re Integrated Resources Inc. as to the applicability of the business judgment rule.[12] That rule requires evidence that the debtors’ board had acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the debtor. The business judgment rule has been a part of our legal system for more than 150 years and has changed very little throughout this period:
[I]n making a business decision, the directors are presumed to have acted independently, on an informed basis, in good faith, and in the honest belief that the decision is in the best interests of the corporation. In the corporate world, a business decision will normally be sustained unless the presumption is rebutted in either of two ways: (i) the process, independence, or good faith of the directors is compromised; or (ii) the decision cannot be attributed to a rational business purpose.[13]
This business judgment rule is not really a rule at all but rather a standard for judicial review. It has been used in the corporate world to define a compensation structure for successfully “closing” a transaction and is usually calculated as a percentage of the company's enterprise value. By way of example, success fees are generally a percentage of the company’s enterprise value (CEV), with success fee percentages ranging from 8 percent (CEV of $1 million or less) to 1.5 percent (CEV above $500 million).[14]
Bankruptcy courts look to the reasonableness standard found in §§ 330 and 363 when reviewing success fees and require that a debtor must show that the requesting party provided a benefit to the bankruptcy estate. The debtors’ analysis, in explaining the reasonableness of the requested success fee, was that if the success fee was based on the debtors’ assets as of the filing date, it would have been $4.1 million, not $2 million.[15] Thus, under any objective analysis, the debtors’ business judgment was good business judgment, especially since the CRO was able to increase the value of the estate and otherwise lead the parties in interest toward consensual confirmation of a plan of reorganization.[16]
The court rejected the U.S. Trustee’s reliance on the Northwest Airlines trilogy of cases, noting that unlike the facts in Northwest, the CRO had played a “vital and indispensable role” in the debtors’ achievements, including reorganization.[17] The court pointed out that § 330 does not require a finding that the CRO be solely responsible for the debtors reaching its milestones, but it made a specific finding that the CRO’s contributions and services were both necessary and beneficial to the estates at the time that they were rendered.
The ResCap case is an outline of how to meet and surpass both the business judgment rule and reasonableness standard by selecting an experienced CRO, providing sufficient notice to all parties of the parameters of the CRO or equivalent “crisis manager” as well as the milestones to be reached in order to seek the approval of the payment of a success fee. What seemingly won the day in ResCap was Judge Glenn’s ability to review evidence by which the success fee was and could be calculated, as well the specific market data that the debtors’ board relied upon in deciding that the proposed success fee was in the best interest of the debtors’ estate. The ResCap case is a road map and comparison of the court’s application of business judgment and reasonableness standard to the approval of a success fee, as opposed to the approval of professional fee applications.
[1] 504 B.R. 358 (Bankr. S.D.N.Y. 2014).
[2] Id. at 366 (quoting Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel), 722 F.3d 1063, 1070 (2d Cir. 1983) (Lionel)).
[3] John Dempsey, a partner at Mercer (U.S.) Inc., and William Nolan, a Senior Managing Director at FTI Consulting, Inc., submitted declarations explaining their respective analyses. See ResCap, Case No. 12–12020 (Bankr. S.D.N.Y.), Docket Nos. 5229 and 5230.
[4] The debtors’ board sought a CRO candidate who understood the nature of the claims to be settled and was able to look at the facts and law in an objective fashion in order to resolve issues between the debtors’ board and the debtors’ parent corporation. See ResCap, Motion for Entry of an Order Approving Payment of Success Fee to Debtors’ Chief Restructuring Officer, Lewis Kruger, Docket No. 6172 (Motion), ¶¶ 4-5.
[5] ResCap, 504 B.R. at 362.
[6] Id. at 364-65. The UST objection argued that while in “technical compliance” with the court’s case management order, the debtors filed the motion to amend “with no advance warning during a holiday week,” and noted that the court had accommodated the creditor committee’s prior requests to adjourn a final hearing on an examiner’s fee application. Id.
[7] Id. at 365.
[8] Under § 330(a), the court may allow "reasonable compensation for actual necessary services." 11 U.S.C. § 330(a).
[9] See id. at 366 (citing In re XO Commc’ns Inc., 398 B.R. 106, 113 (Bankr. S.D.N.Y. 2008)).
[10] In re Nw. Airlines Corp., 382 B.R. 632 (Bankr. S.D.N.Y. 2008).
[11] See ResCap, 504 B.R. at 369 (citing § 330(a)(2), which provides that "the court shall consider the nature, the extent, and the value of such services").
[12] See id. at 366 (citing Lionel, 722 F.2d at 1070; In re Integrated Res., 147 B.R. 650,656 (S.D.N.Y. 1992)).
[13] E. Norman Veasey, “The Defining Tension in Corporate Governance in America,” 52 Bus. Law. 393, 394 (1997) (footnote omitted).
[14] Divestopedia – Success Fee definitions (available at www.divestopedia.com/dictionary).
[15] See Motion at ¶ 45.
[16] See id. at ¶ 46.
[17] See ResCap, 504 B.R. at 367-68 (discussing In re Nw. Airlines Corp. 382 B.R. 632 (Bankr. S.D.N.Y. 2008); In re Nw. Airlines Corp., 399 B.R. 124 (S.D.N.Y. 2008); and on remand to the bankruptcy court, In re Nw. Airlines Corp., 400 B.R. 393 (Bankr. S.D.N.Y. 2009)).