The Tenth Circuit in Southwest Food Distributors, LLC, 561 F.3d 1106 (10th Cir. 2009), affirmed the denial of the proposed retention of “national” counsel by the committee of unsecured creditors. “While the right to select counsel of one’s own choice is an undeniable right afforded to participants in bankruptcy, that right is not without boundaries. We cannot say that the court abused its discretion in deciding that the case did not merit the appointment of two sets of counsel, and that the [local law firm] could adequately perform the job.” Id. at 1113. In so holding, the Tenth Circuit addressed and rejected a series of arguments traditionally made by applicants in seeking Bankruptcy Court approval of counsel and professionals. We review those arguments in this article.
Background Facts
Southwest Foods filed for chapter 11 protection with assets of $1,157,651 and liabilities of $12,240,882 with the U.S. Bankruptcy Court in the Northern District of Oklahoma on Jan. 8, 2008. The debtor scheduled unsecured creditors located in Texas, Illinois, Pennsylvania, Nebraska, Minnesota and Georgia. The U.S. Trustee appointed an unsecured creditors’ committee comprised of five entities, each represented by an individual located outside the Northern District of Oklahoma. The committee then selected a Chicago law firm (the “national firm”) and a local law firm (the “local firm”) to represent the committee. The two firms filed applications to be retained and made the traditional disclosures about qualifications, rates and connections. Nothing appeared to be controversial in these pleadings.
The major undersecured creditor filed an objection to both applications. In its objection, the creditor pointed out that (1) the rates of the professionals for the national firm were twice the rates of the local firm, and that (2) the local firm alone was adequate and competent to represent the committee. The U.S. Trustee also filed comments. “If the [national firm] were to cap all fees at the applicable rates set out in the Local Fee Survey for 2008, and if both firms...minimize duplication of services with clear task division and minimal inter-office conferences and administrative support functions, the expense to the estate would be reduced, and, if results at the end of the case warranted, the Court could consider an application for a bonus at that time.” Id. at 1110.
At the hearing on the applications, the committee asserted that the national firm had met the standard for retention of counsel set out in Bankruptcy Code §1103, and that the objections raised were to compensation, rather than retention of counsel by the committee. The bankruptcy court first questioned whether “we really need to have two firms.” The undersecured creditor argued that it had significant exposure and it had a significant economic stake in the case. The local firm, the undersecured creditor argued, could adequately represent the committee. As the largest unsecured creditor, the undersecured objecting creditor requested that the bankruptcy court deny the retention of the national firm by the committee. The U.S. Trustee argued that the case was not a complex case and expressed concern over the cost of administration of the case.
For its part, the national firm established that (1) the case had predominantly national creditors, (2) the firm had met the adverse interest test under Bankruptcy Code §1103, (3) the national and local firm had discussed and agreed to a strict division of work, and (4) while the national firm could not agree, if the court ruled that prevailing local rates should apply, the national firm stated that “if that’s the way Your Honor rules then we will certainly abide by that and stay in the case.”
The court then denied the application to retain national firm and approved the retention of the local firm. The court based its ruling on the following: (1) The case is neither complex nor difficult or national in scope, and no compelling evidence was presented that the local firm could not adequately represent the committee; (2) the committee failed to present evidence that the committee required two firms; (3) two of the largest unsecured creditors objected to the application to retain the national firm; and (4) the committee failed to present any evidence that that the debtor was incapable of fulfilling its duties as a debtor-in-possession. “Accordingly, the Court concludes that at this juncture in this case it is not necessary or appropriate to approve more than one law firm to represent the Committee, nor is it necessary for the estate to absorb unnecessary costs and expenses related to employment of counsel from outside this region.”
On Oct. 16, 2008, the district court issued an order affirming the order of the bankruptcy court. The committee appealed the decision to the Tenth Circuit Court of Appeals.
Review of Arguments Made to the Tenth Circuit
A. Bankruptcy Court Has Discretion Above and Beyond Bankruptcy Code §1103 and Bankruptcy Rule 2014
The Tenth Circuit rejected the committee’s argument that upon meeting the requirements under Bankruptcy Code §1103 and Bankruptcy Rule 2014, no further inquiry is necessary and the bankruptcy court must appoint such counsel. Id. at 1112. The committee’s “interpretation of the statute and rule is too narrow, and we therefore disagree.” Id. If the bankruptcy court lacked such discretion, it would turn the court into a “rubber stamp” for the selection of counsel or other professionals and would deprive such court of its ability to control administrative expenses.
B. Controlling Costs at the Fee-Application-Process Stage Is Not Persuasive
The committee argued, and the Tenth Circuit rejected, the contention that if
the denial of the national firm was motivated by “national” rates as opposed to “local” rates, such issues could be addressed later when fee applications are submitted. Id. at 1112. “While there is some merit to that argument, it does not absolve the bankruptcy court from the necessity of considering the wisdom of appointing more expensive counsel at the outset... Denial of that joint employment in the first instance avoids the entire problem.” Id.
C. Local Firm Was Not Erroneously Retained
The committee also argued that the bankruptcy court “forced” upon the committee the local firm when it denied the application to retain the national firm. The Tenth Circuit rejected this argument: “This argument mischaracterizes the Bankruptcy Court’s analysis. The Court did not simply conclude that insufficient cause had been shown for the retention of two law firms; rather, it also concluded that local less expensive counsel was adequate for the job, and that the Committee’s application to retain such counsel should accordingly be granted.” Id. at 1113.
What Are the Take-aways from Southwest Food Distributors?
Evidence to Adduce for Retention of National Counsel in Local Cases
While we will never know, this case is instructive on the type of evidence that should be adduced if a committee seeks to hire more than one firm. In many jurisdictions, the local rules require that out-of-state or district firm retain local counsel, and hence, that requirement could be met easily in some districts. But in districts where such a requirement does not exist, Southwest Food Distributors teaches that, at a minimum, a committee should have its chairman discuss the rationale as to why two law firms are being proposed to be retained.
National vs. Local Rates
Unfortunately, Southwest Food Distributors opens up the specter of the debate of national vs. local rates. I recall with the filing of Enron in 2001, many firms (especially, the large bankruptcy shops) adopted “national” rates, which were in many instances nothing more than hiking their traditional regional rates and matching them up with New York rates. This served many firms well, especially on the profit front, when they had cases in New York or Delaware. The logic of this approach made sense when corporate bankruptcies dried up, and the same firms had to go back and work in the local markets. For many, the local markets could not support the higher “national” rates.
At my last firm, we had a range of rates for any particular year, and it was left to the discretion of the billing partner to charge the client depending on, among other factors, the complexity of the matter, the size of the matter and other factors bearing on the wisdom of the rates. In some instances, the range of rates allowed us to be competitive in different markets. Often, though, it did not.
The one question I always had was whether one could still make the declaration in the disclosure of compensation as to whether a local rate in Houston at $550/hour was still your “standard” rate if you went to Louisiana and worked on a case in which you reduced your hourly rate to $300/hour. I think it certainly raises a few questions that should be disclosed.
Does It Matter Where You File?
Clearly, one consequence of such a decision may be that a future case that should be filed in Tulsa will get filed in New York or Delaware. The cascading effect of Southwest Food Distributors is that counsel for debtors may divert to districts in which the “national” rate is the norm and the risk of not getting paid the national rate is minimized. Another unintended consequence of Southwest Food Distributors is that it may provide a secured lender another arrow in the secured creditor arsenal in debtor’s choice of counsel, advancing some of the same arguments that were made by the undersecured creditor against the national firm to the debtor’s counsel in another case. This of course then creates the vicious cycle where chapter 11 cases that rightfully should be filed in a district other than Delaware and New York are not filed in districts other than Delaware and New York.
Make Sure You Have Support from the Unsecured Creditors
After Southwest Food Distributors, I think it would be safe to say that if a major constituent objects to your retention and a choice exists between a national and local firm, you need to get that creditor on your side. While this point is obvious, it appears that the role of the “undersecured” creditor was given some prominence by the lower courts in the Tenth Circuit decision.