Court Finds that ASARCO Does Not Foreclose Approval of Fee-Defense Provision and Upholds Contractual Provision

The U.S. Bankruptcy Court for the District of New Mexico in In re Hungry Horse LLC[1] recently indicated that under certain circumstances it would approve the retention agreement of a chapter 11 debtor’s counsel, over the objection of the unsecured creditors’ committee, containing a contractual provision obligating the debtor to pay its retained counsel’s fees and costs incurred in defending its fee applications, by ruling that notwithstanding the U.S. Supreme Court’s decision in Baker Botts L.L.P. v. ASARCO LLC,[2] which held that a law firm or other professionals retained by a debtor or appointed committee could not be awarded legal fees for work performed in defending their fee application, that the contract exception to the American Rule remains viable in bankruptcy cases, and that ASARCO does not foreclose bankruptcy courts from approving fee-defense provisions in retention agreements as a “reasonable term and condition” under § 328(a).

The bankruptcy court held that under certain circumstances, a properly drafted fee-defense provision could be a “reasonable term” under 11 U.S.C. § 328(a) without violating either the letter or spirit of ASARCO, so long as the provision (1) is agreed to by the bankruptcy estate, (2) allows the bankruptcy court to review and approve the reasonableness of any fee defense to the fees sought, (3) provides that the estate will also agree to a similar provision for committee counsel (so as to level the playing field between the parties), and (4) provides that no fees will be allowed for unsuccessful fee-defense work. While not explicitly approving the language of the fee-defense provision before the bankruptcy court, in so doing it provided an example of such a provision that it would approve as reasonable under § 328(a):

Fee Defense. The Client agrees to pay all reasonable legal fees and expenses incurred by the Firm, and also by any counsel retained by the unsecured creditors’ committee (if one is formed in the Client’s bankruptcy case) for successfully defending their respective fee applications. The bankruptcy court must approve all of such fees as reasonable. The Client will have no obligation to pay for any fees or expenses the Firm incurs defending fees that are not allowed.

This case reminds us that counsel may, through the use of a carefully written contract, limit, or overcome, the obstacles often imposed by what is perceived as a negative Supreme Court decision.

ASARCO

The Supreme Court in ASARCO had based its decision on the American Rule by which each litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise, and its reading of 11 U.S.C. § 330(a), which provides that a bankruptcy court “may award ... reasonable compensation for actual, necessary services rendered by professionals hired under § 327(a).” In denying compensation to debtor’s counsel for defending its own fee applications, the ASARCO Court found that the defense of counsel’s own fee applications were not services rendered for the benefit of the estate, but rather for counsel’s own benefit.

Because the Supreme Court in ASARCO based its opinion solely on one statutory provision in the Bankruptcy Code and not on any contractual arrangement between the debtor and its counsel, the Hungry Horse court, like others before it in the post-ASARCO world, had to face the issue of whether a debtor could contractually obligate itself to pay for its counsel’s defense of its own fee application, which has now become the norm for bankruptcy professionals to require, by including fee-defense provisions in their retention agreements. Such provisions, it was hoped by bankruptcy professionals, would come within the contract exception to the American Rule, since ASARCO had foreclosed the statutory exception.

The Delaware Court Decisions

The leading post-ASARCO cases that addressed whether fee-defense provisions would work to allow the reimbursement of defense-related fees came out of the Delaware Bankruptcy Court, the first of which was In re Boomerang Tube Inc.,[3] in which the U.S. Trustee objected to a fee-defense provision included within a retention agreement of proposed counsel for the unsecured creditors’ committee. In sustaining the trustee’s objection, the Boomerang court rejected the committee’s counsel’s argument that the contract provision came within the contract exception to the American Rule because it was akin to indemnification provisions commonly approved under § 328 on the basis that (1) § 328 was not sufficiently “specific or explicit” to fall within the statutory exception to the American Rule; (2) the committee’s counsel’s engagement was not in privity with the debtor, the party responsible for paying the defense-related fees; (3) such fee-application defense fees would not be reasonable under § 328 because they did not involve services provided to the committee; and (4) prior case law deeming defense fees reasonable under § 328 were inapplicable as having predated ASARCO.

However, the Delaware Bankruptcy Court recently held in In re Nortel Networks Inc.,[4] that, in different circumstances, such as in that case where an indenture trustee sought attorneys’ fees against a bankruptcy estate and additional fees for defending such a claim, a fee-defense provision can come within the “contract exception” to the American Rule, with the exception being that in Nortel, unlike in Boomerang, the relevant indenture trustee agreement was in privity with the debtor, thereby binding the bankruptcy estate to the obligation. In Nortel, because the circumstances differed from both Boomerang and ASARCO, the “contract exception” to the American Rule was applicable, so that the Nortel court never addressed the issue of whether § 328(a) afforded a statutory exception to the American Rule.

Compensation Approved Under § 328 Controls over the Language of § 330

The bankruptcy court sought to answer the question as to whether § 328(a) would allow a fee-defense provision within the “contract exception” to the American Rule, and did so first by discussing the interplay between 11 U.S.C. §§ 328 and 330. The court noted that a retention agreement approved under § 328 did not contain the same “reasonable compensation for services rendered” language found in § 330(a)(1)(A). Therefore, once a professional’s retention is approved under § 328(a), its compensation thereafter is governed solely by the terms approved by the bankruptcy court, and not § 330, unless the bankruptcy court later finds “the original terms to have been improvident in light of developments not capable of being anticipated at the time of fixing such terms and conditions.”

ASARCO Does Not Foreclose Fee-Defense Provision Under § 328(a)

In this practitioner’s humble opinion, the bankruptcy court correctly disagreed with the Boomerang court in Delaware by finding that ASARCO did not foreclose approval of a fee-defense provision under § 328(a) and could fall within an exception to the American Rule. In reaching that conclusion, the bankruptcy court noted that the Supreme Court based its decision in ASARCO solely on § 330, limiting an attorney to compensation for services rendered to its client, and because no compensation, however reasonable, can ever be awarded to an attorney under § 330 unless it is for services rendered to its client, the Supreme Court held that fee-defense fees were not compensable under § 330(a).

Yet, as deftly pointed out by the bankruptcy court, (1) the bankruptcy court in ASARCO had not considered approval of a fee-defense provision in a retention agreement under § 328(a), (2) the Supreme Court in ASARCO never held that a fee-defense provision can never be a “reasonable term” under § 328(a), (3) there is nothing in the Bankruptcy Code requiring that an employment term must benefit the estate to be reasonable, and (4) typical employment agreements between a lawyer and client, including the one before the bankruptcy court, have many terms, some of which benefit the client while others benefit the lawyer, that when considered together often are considered reasonable.

The bankruptcy court soundly noted that while certain terms may not directly benefit the debtor-client and clearly directly benefit the lawyer, the debtor-client nonetheless indirectly benefits by agreeing to the terms in obtaining the services of needed able professionals, and for that reason, terms that don’t directly benefit the client nonetheless are still reasonable under § 328(a).

Citing to the positive benefits and process that it has experienced in its jurisdiction in allowing fees for successfully defending fee applications, the bankruptcy court found, and this author agrees, there is no need to change the system unless ASARCO requires it, and since ASARCO does not mandate such a change, the bankruptcy court, and hopefully other courts around the country, will follow this decision by holding that a properly drafted defense-fee provision (including requiring that the same be provided for committee professionals), as an employment term of a bankruptcy professional’s retention agreement, should be approved as is reasonable under § 328(a) under the contract exception to the American Rule.