A series of recent decisions brings clarity to issues involving retention of chapter 11 professionals. Chapter 11 counsel, financial advisors, investment bankers and accountants, as well as other professionals, should take note of a trio of recent decisions.
First, the recent Fifth Circuit decision in In re Barron, 325 F.2d 690 (5th Cir. 2003). In the case, the Fifth Circuit clarifies §328 of the Code such that bankruptcy judges are less likely to reduce fees under the "improvidence" exception to §328. Section 328 allows bankruptcy courts to approve in advance contingent fee or fixed fee arrangements (like success fees) and the amount of the fee will not be judged, after the fact, under §330's "actual and necessary" or "benefit" prongs. Under §328, a court may reduce a pre-approved fee (or a fee which is the product of a pre-approved fee formula or standard) only if "such terms and conditions [of employment/compensation] 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" (emphasis supplied). In Barron, the court had reduced a contingent fee award because the judgment was allegedly easier to obtain and collect than the court had anticipated. The Fifth Circuit reversed, holding that it was not enough that the court below had not, in fact, anticipated the ease of judgment and collection, because the possible ease of judgment and collection was foreseeable and capable of being anticipated at the time of approval of the contingent fee arrangement based upon facts that could have been anticipated or assumed at that time. The court below was found to have abused its discretion in reducing the award because "there appear to be no intervening circumstances that were incapable of anticipation by the bankruptcy court at the time it approved the award." Thus, under Barron, a §328 award should not be reduced due to the "benefit of hindsight." If other circuits follow this case, it emphasizes the benefit of getting certain non-hourly fee arrangements approved under §328 and not §330. This holding would prevent reduction of, for example, a success fee simply because the sale price was lower than hoped for or the result too easily obtained, in the eyes of other parties.
Second, in a case of apparent first impression in the Third Circuit and the District of Delaware, the court in In re Insilco Technologies, Inc., 291 B.R. 628 (Bankr. D. Del. 2003), approved the use of “evergreen” retainers under the facts and circumstances of that case. As the court explained, “in the case of an evergreen retainer, the funds are not intended to be used to pay approved fees until approval of the final fee application. Instead, the holder of an evergreen retainer intends to be paid its interim fees and expenses out of operating cash. Such a position is designed to minimize a professional’s risk of non-payment if a debtor’s financial position deteriorates, an estate becomes illiquid and does not have sufficient cash flow to pay professional fees.” Id. at 632. Only the U.S. Trustee had objected to the use of evergreen retainers in the case, arguing that professionals should be treated the same as all administrative creditors and that the professionals were already protected by a carve-out and a process for monthly billing with a holdback. Looking to §328, as well as the admonishment in United Artists that the bankruptcy court’s view on retention issues should be market-driven but not “market-determined,” the court identified five factors to be applied in determining if use of an evergreen retainer as a term of retention was reasonable:
Therefore, the court's further inquiry about 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. Factors to be considered, include, but are not necessarily 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, including whether the retainer provides the appropriate level of "risk minimization," especially in light of the existence of any other "risk-minimizing" devices, such as an administrative order and/or a carve-out. This list is not intended to be exhaustive, nor will every factor necessarily be of equal weight, depending upon the circumstances. Moreover, even if the terms of an engagement are approved, §328 provides that the court retains discretion to modify the retention "if such terms and conditions prove to have been improvident."
Id. at 634. Applying these factors to the facts of the case, the court approved use of the evergreen retainers over the UST’s objection. In particular, the court noted that the debtor was insolvent, that the chapter 11 was being used to implement going concern sales in part negotiated pre-petition, and that funding depended upon the senior lenders’ willingness to allow assets to be used to pay fees. The court did caution that—in the future—the fact that a retainer was “evergreen” should be highlighted in the application and a copy of the retention agreement attached to the retention application. Id. at 634-36.
The third case is an example of a bankruptcy court applying In re United Artists Theatre Co. v Walton, 315 F.3d 217 (3rd Cir. 2003), which held that indemnification of investment bankers and other financial advisors by chapter 11 debtors was not per se unreasonable under §328 of the Code. The decision, In re Baltimore Emergency Services II, LLC, 291 B.R. 382 (Bankr. D. Md. 2003), may leave bankers and advisors feeling that they got less out of United Artists than they originally thought. The retention agreement in Baltimore Emergency contained a standard indemnity provision with an exclusion to the extent losses “primarily resulted from bad faith, gross negligence or willful misconduct” of the advisor. After negotiations with the UST, the provision was changed to exclude losses arising “solely from [the advisors’] gross negligence or willful misconduct.” Examining United Artists, the court stated that testing the reasonableness of an indemnity provision for a financial advisor to a reorganizing debtor by principles akin to the business judgment rule makes sense because (1) the financial advisor would be culpable for breach of its duty of loyalty, which includes conflicts of interest and nondisinterestedness; (2) the financial advisor would be culpable for a breach of the duty of due care in the process by which it rendered advice to the reorganizing debtor; (3) the indemnification would not cover contractual disputes with the debtor, including disputes over the services the financial advisor had agreed to perform; and (4) limiting words, such as "solely," that would expand a reorganizing debtor’s indemnification are unacceptable and against public policy. 291 B.R. at 384. Applying these principles, the court found the amended clause unacceptable. Neither the word “primarily” or “solely” could be used to limit the exclusion. The exclusion for bad faith had to be restored. The provision had to be clarified to make it clear that contractual disputes were not within the indemnity. In addition, the provision had to be clarified to make it clear that a breach of the duty of loyalty—including conflicts of interest—was outside the indemnity. Id. at 385-386. Finally, the court cautioned that a “factual record to support findings that a particular indemnification provision is necessary as well as reasonable for a debtor’s reorganization is normally required.” The court dispensed with that requirement in this case in light of the parties', apparent agreement about the necessity of the provision. Id. at 386.