At the ABI Winter Leadership Conference in December 2007, the Financial Advisors Committee, in concert with the Investment Banking Committee, the Public Company and Claims Trading Committee, and the Professional Compensation Committee had the pleasure of presenting a joint educational session following the presentation of ABI’s landmark Professional Fee Study by Professor Stephen Lubben of Seton Hall University School of Law.
The following is a brief synopsis of the study’s methodology and findings, as well as Mr. Shapiro’s take on what the practical implication of the study is to the financial advisory community.
The joint session was assembled to provide a multi-disciplinary forum for the continuation of questions after Professor Lubben’s presentation. The fee study was funded by the ABI Endowment Fund and was implemented with significant assistance by ABI staff and industry practitioners. The impetus for the study, among other factors, was the need to provide a factual basis and backdrop to determine if the substantial speculation in the marketplace about the high costs and real benefits of Chapter 11 bankruptcy were accurate. The purpose was not to refute those allegations, but rather to determine if they are merited.
There is no way to get a real feel for the thoroughness of Prof. Lubben’s work unless you go through the study in detail. What follows is a brief synopsis of the study’s methodology and findings, as well as my take on what the practical implication of the study is to the financial advisory community.
In a nutshell, in 2005 Prof. Lubben began a very large investigation and data gathering task (he was likely the largest PACER user by far) to study bankruptcy flings in 2004, across all U.S. judicial districts to determine if any biases or predictors exist that would color or otherwise predict if the bankruptcy process is affected by case size, venue, and a host of other factors cited by critics as predictive of results. While the ABI has undertaken other fee studies, this is by far the largest and most comprehensive to date.
The choice of 2004 as the base year for the study assured that a large majority of the cases would have winded there way to conclusion and would afford a significant cadre of completed cases and analyzable data.
In the end, Prof. Lubben and his team investigated cases from 33 judicial Districts (three from each Circuit) including 40 cases from each District. As with all datasets, there were outliers, so in the end he examined just over 1,000 cases ranging from small to mega-filings. And, he kept a separate sub-set of 99 large cases for analysis, as those large cases are the ones most subject to assertions of uncontrolled cost and/or special treatment.
The difference between the two datasets is stark. The smaller company dataset of 945 cases had average assets and liabilities of $21 million and $27 million, respectively while the large cases had average assets of $423 million and average liabilities of $776 million.
The smaller cases averaged just under a year in Chapter 11 with about one-quarter converting to Chapter 7, half being dismissed and only one-quarter resulting in a confirmed Plan and a true restructuring. The large cases averaged only about 1.1 years in bankruptcy but had 70 percent resulting in confirmed Plans, and only about 17 percent in conversions and dismissals. Consistent with higher conversion rates, over a third of the smaller cases resulted no payment whatsoever to the professionals in the case.
Other differences emerged in the analysis. As might be expected, larger cases employed more professionals by a factor of almost four to one reflecting greater complexity, hiring more and more diversified professionals, and appointment of official committees. Also, objections to Debtor counsel fee applications were significantly more prevalent in the large cases.
Popular belief is that total costs in bankruptcy escalate markedly with an increase in asset size at filing, making large case much more “expensive” than smaller cases. The fee study found, however, that when professional fees were measured as a percentage of total assets plus total liabilities at filing, there was no discernable difference between the relative total costs of large and small case datasets - both samples averaged between 4 and 4.5 percent of total assets plus total liabilities.
Once the data was gathered, Prof. Lubben performed numerous regression analyses, testing a host of variables to determine which, if any, were predictive of total cost. As the models evolved, the one chosen as most representative depended on variables including:
- total assets plus liabilities,
- the number of professionals employed,
- appointment of official committees
- length of time in bankruptcy,
- if the case was converted,
- choice of debtor counsel,
- choice of filing venue,
- appointment of a fee examiner,
- top hourly rate of debtor counsel,
- and existence and complexity of first day motions.
As you are likely aware, there have been contentions that the choice of debtor counsel (Weil Gotshal and Skadden, in particular) and filing venue (SDNY and Delaware) are predictors of excessive costs in bankruptcy. Interestingly, Prof. Lubben tested those factors and ultimately concluded that, of the factors listed above, case size, number of professionals employed, appointment of an official committee, hourly rates, and existence of first day motions were in and of themselves sufficient to predict the ultimate cost of bankruptcy, thereby taking the stigma of filing venue and choice of lead counsel out of the equation.
While this analysis goes a long way to defending the inherent “levelness” of the bankruptcy process, some of the results are not surprising to many of us. It is difficult for anyone who makes their living in the process to tell if a fee examiner puts a rein on fees or reduces fees once filed. One can also ask if filing in the busy Delaware and SDNY venues creates higher costs or precludes reinventing wheels. For the first time, these arguments appear moot-these are not factors in determining ultimate cost. Certainly, there are differences in professional costs across various geographic regions of the U.S. Haven’t we all pitched cases in and out of bankruptcy where the ultimate hiring decision was made on cost and the “local” guys had an edge?
The proven dependence on assets plus liabilities as a predictor of complexity and hence cost is something that Financial Advisors have certainly sensed over the years as larger cases with more complicated capital structures tend to take a lot more effort to understand and fix. Prof. Lubben has now provided a framework to explain what we all have “known”.
I believe Prof. Lubbens findings strengthen the financial advisor’s mandate to stabilize, control and help grow the business they work on by potentially reducing challenges (and ultimately, cost) in what everyone agrees is a complicated process. My read is that the overall impact of the ABI fee study on financial advisors is likely to be minimal. Our job has been and continues to be providing advice, identifying paths to improvement, leading by example and/or mentoring to implement that improvement, and exiting as quickly as we can to allow a rehabilitated management to operate what, hopefully is a revitalized business.