Following a nearly-three-year study, on Dec. 8, 2014, the ABI Commission to Study the Reform of Chapter 11 published a 400-page report containing recommendation and principles for policymakers. This article focuses on chapter 11 reform relating to professional retention and compensation.
The Business Side of Bankruptcy Lawyering
As a business owner, the “business” of lawyering is as equally important as doing good work. Landing the client, obtaining a sufficient retainer, managing the client’s expectations, making sure the client replenishes a retainer, doing the work well at a reasonable cost, and, last but not least, collecting payment.
Bankruptcy Law: A Risky Business.
Our work as chapter 11 practitioners is risky. With the current rules regarding interim compensation generally resulting in getting fees approved and paid every quarter (instead of every month), a chapter 11 engagement can be a fretful endeavor of not only the debtor, but also debtor’s counsel. If you do not obtain a large front retainer, you may be fronting exorbitant expenses for a debtor for months at a time in a highly contentious case, all with the risk that the debtor could fold at any minute, leaving you in the hole by hundreds of thousands of dollars.
In the Report, the Commission addresses head-on the issue of the sometimes-exorbitant costs of filing a chapter 11 case. The Commission references studies that reveal that professionals’ fees have, on average, ranged from anywhere between 1.4 to 3 percent of a debtor’s total assets.[1] The Report also discusses the infamously high administrative costs of the City of Detroit, Tribune Co., American Airlines and Lehman Brothers bankruptcy cases.[2]
While in the midst of a chapter 11 engagement, your client, their secured lenders and perhaps disgruntled creditors may complain every month about the fees and expenses incurred by case professionals. But often, after the plan has been confirmed, these parties recognize the value of your efforts and costs savings to the bankruptcy estate. The professionals and creditors seem to recognize that these professional costs were the “cost of moving a creditors’ recovery higher than zero.”
Throughout its study, the Commission probed deeply into how professionals can deliver more cost-effective services so that debtors (and their counsel) can survive a restructuring. Following is a summary of the Commission’s recommended principles and findings regarding professionals and compensation.
Nonbankruptcy Professionals. The Commission recommends that the debtor’s professionals should be clearly identified as either “chapter 11 professionals” who work on matters relating to the chapter 11 cases or “non-bankruptcy professionals” who work in the ordinary course of business on the day-to-day operations of the debtor’s business. The Commission recommends that only chapter 11 professionals be subject to Code §§ 327 (regarding retention of disinterested professionals) and 330 (regarding reasonableness of compensation and necessity of expenses), as nonbankruptcy state law is sufficient to protect creditors and the estate’s interests in relation to such fees or expenses. Debtors should instead be required to file with the court a list of its “nonbankruptcy professionals” with its chapter 11 petition and then subsequently on a quarterly basis, disclosing enough information as to the nature of the services provided in order to determine whether those professionals should be reclassified as “chapter 11 professionals” subject to §§ 327(a) and 330 (in the event that such “professionals’ services directly affected, assisted, or were performed on behalf of the estate and when the requested compensation would be paid by the estate”). Such a classification would be imputed to an entire firm, rather than simply the individual attorney working with a debtor.
Under current law, debtors often seek court approval of procedures for retaining and compensating “ordinary course professionals” during the pendency of a chapter 11 case.[3] These procedures typically limit the amounts that can be paid to these professionals (usually on a quarterly basis). Such ordinary-course professionals may also be required to file Rule 2014(a) verified statements. This recommendation would streamline the process of a debtor retaining professionals after a chapter 11 filing.
The Report also recommends that to the extent professionals representing ad hoc committees, parties to any agreement or settlement, or secured creditors in the chapter 11 case would be paid their fees and expenses directly or indirectly (e.g., contractual provisions with junior creditors) from the bankruptcy estate (either through substantial contribution motions, creditors’ proofs of claim, chapter 11 plans or other order of court), the approval and payment of their fees and expenses should be subject to the reasonableness standards set forth in § 330(a), just like the debtor’s professionals and statutory committees.
Chapter 11 Trustee Who Is Not a Lawyer or Accountant. Section 327(d) of the Code “permits the court to authorize the Trustee, if qualified to act as his own counsel or accountant.” The Commission believes that this provision does not account for other professionals who may serve as trustees and who could add value to the estate by representing the estate in their professional capacities (e.g., management consultant) without incurring additional administrative costs employing additional professionals. The Commission believes “professional service provider” should be added to the list of authorized roles for the trustee.
Office of U.S. Trustee Guidelines: Transparency of Fees and Expenses. The Commission evaluated the Office of the U.S. Trustee’s recently promulgated Guidelines for Reviewing Applications for Compensation and Reimbursement of Expenses Filed Under U.S.C. 330 by Attorneys in Large Chapter 11 Cases (effective for cases filed on or after Nov. 1, 2013). Currently, these Guidelines are applicable only to large cases involving $50 million or more in assets or liabilities.
The Commission believes the Code should require increased disclosure and transparency with respect to all cases and all fees, whether paid to creditors or professionals, so as to “ensure that bankruptcy professionals are subject to the same client-driven market forces, scrutiny and accountability as professionals in nonbankruptcy engagements” and to “increase public confidence in the integrity and soundness of the bankruptcy compensation process.” The Guidelines provide for a showing:
- that rates charged reflect market rates outside of bankruptcy;
- the use of budgets and staffing plans;
- the disclosure of rate increases that occur during the representation;
- the submission of billing records in an open, searchable electronic format; and
- the use of fee examiners and “efficiency” counsel.
Alternative Fee Arrangements and Results-Oriented Fee Review. With respect to professional compensation and engagement, one of the most intriguing findings of the Commission has to do with alternative fee arrangements and result-oriented fee reviews. The Commission suggests that § 327 or 1103 of the Code should be clarified to expressly permit professionals to seek approval of alternative fee arrangements. The Commission encouraged courts and professionals to be creative and use alternative billing arrangements, such as:
- contingency-based fees (value billing or incentive billing);
- fixed fees;
- flat fees (based on tasks or percentage); and
- modifications to hourly billing (caps, budgets, discounts or phased billing).
The Commission provided the example that debtors’ counsel could unbundle services and price different aspects of the case in different ways. For example, counsel for the debtor could charge a standard fixed rate for monthly monitoring and administrative matters in a case, a fixed rate for claims administration matters, and an hourly rate (subject to lodestar review) for plan negotiation and confirmation matters.
The Commission suggested that a court should assess the reasonableness of such arrangements at the time that the professional seeks retention or at the outset of a matter that would dictate an alternative fee arrangement. Also, Congress should amend §§ 328 and 330 to clarify that alterative arrangements are permitted and to incorporate the reasonable approval standard of such arrangements. At the same time, the Commission recommends the use of backside protections (in the event of a development not capable of being anticipated) and the elimination of the lodestar method of fee review, which is applicable to the hourly billing model.
The Report also contained findings regarding “results-oriented” fee-review processes — i.e., granting supplemental fees for extraordinary results and requiring disgorgement or the reduction of requested fees for actions that dissipated the value of the estate. The Commissioners could not reach a consensus regarding such a process.
Factors that Contribute to Increasingly High Cost of Chapter 11. Lastly, the Commission revealed its thorough findings regarding the following factors that may contribute to the increasing cost of chapter 11:
- prolonged duration and complexity of case leading to inefficiencies;
- use of strategic or protective litigation in the case by the debtor or other stakeholders;
- inherent uncertainty about the outcome of certain processes or legal standards that become the subject of litigation; and, of course,
- professionals fees and expenses incurred in connection with the case.
The Commission considered ways to mitigate each of these factors:
- the identification of 16 specific splits in the case law, which Congress via legislation could resolve, to reduce the need for litigation and provide greater certainty about outcomes;
- the debtor’s identification and disclosure of information relevant to valuation earlier in the case;
- the appointment of an “estate neutral” to more cost-effectively investigate and resolve disputes and barriers to reorganization;
- enhanced procedures regarding a debtor’s request to modify or terminate a collective bargaining agreement;
- a clearer set of rules governing the sale of all or substantially all of a debtor’s assets;
- the ability of a debtor or plan proponent to cram down a chapter 11 plan without the need of an accepting impaired class; and
- the refinement of the absolute priority rule to permit distributions to junior creditors when supported by reorganization value and redemption option value, as well as the codification of the new value corollary.
Let’s wait and see what impact these findings will have on legislative reform. Hopefully, legislative changes will make the “business of bankruptcy lawyering” a less-risky endeavor.
[1] Report, p. 57, f. 209.
[2] Id. at 63, f. 255-259.
[3] Id. at 50.