In the second attempted reorganization of LTL Management, a/k/a Johnson & Johnson (J&J), a decision from the district court allows professionals to be retained and paid a “discretionary fee” to avoid the strictures of paying a “bonus.”

Evidently, the discretionary fee had the virtue of being based on the business judgment of the client.

Three Stabs at Chapter 11

A newly formed subsidiary of J&J, called LTL Management, filed a chapter 11 petition in North Carolina in October 2021 designed to release the entire family of companies from liability for traces of asbestos allegedly contained in products containing talc. The North Carolina court transferred venue to New Jersey because J&J was headquartered there. In re LTL Management, LLC, Case No. 21-30589, 2021 WL 5343945 (Bankr. W.D.N.C. Nov. 16, 2021). To read ABI’s report, click here.

Ultimately, the Third Circuit dismissed the first chapter 11 effort for lack of “financial distress.” In re LTL Mgmt. LLC, 64 F.4th 84 (3d Cir. Jan. 30, 2023). To read ABI’s report, click here.

Hours after dismissal of the first case, the J&J subsidiary filed a second chapter 11 petition in New Jersey. Still finding financial distress, the bankruptcy court dismissed the second filing under the Third Circuit’s authority. The Third Circuit upheld dismissal in July. In re LTL Mgmt. LLC, 23-2971, 2024 BL 255940, 2024 WL 3540467 (3d Cir. July 25, 2024). To read ABI’s report, click here.

Although not relevant to the opinion we report today, J&J is currently involved in a third attempt at dealing with talc lability by having filed another chapter 11 petition, this time in Houston. The debtor in the new case is named Red River Talc LLC.

The Financial Advisor’s Retention

A prominent financial advisory firm, which we shall refer to as “the firm,” was retained with court approval in the first North Carolina/New Jersey case to serve as financial advisor for the official committee of talc claimants. Among other services, the firm provided expert testimony that led to the dismissal of the first case.

In the second case, the official talc committee again retained the firm, this time as an investment banker tasked with analyzing the newly restructured business. The retention order did not provide for compensation on an hourly basis.

Rather, the firm was to be paid a flat fee of $400,000 a month for the first four months and $175,000 a month thereafter. There was also a $3 million deferred fee payable on confirmation of a chapter 11 plan, which, of course, did not occur.

Of significance in the December 31 opinion by District Judge Michael A. Shipp of Trenton, N.J., the retention agreement provided for an appropriate “discretionary fee based on the [talc committee’s] business judgment.” The retention order said that the discretionary fee was not a bonus or fee enhancement.

The retention agreement went on to provide that any discretionary fee approved by the bankruptcy court would be reduced by half of the monthly fees that the firm was paid. Naturally, the discretionary fee was subject to bankruptcy court approval and objection by any party in interest.

The Firm’s Services and Allowed Compensation

In the four-day trial leading to dismissal of the second case, the firm provided testimony and analysis, which the bankruptcy court saw as credible.

After the second case was dismissed, the firm filed a final fee application, including a $2 million discretionary fee that had been negotiated with the talc committee. The debtor was not a party to the negotiations.

In total, the final fee application sought almost $3.4 million, including about $1.4 million in monthly fees plus the $2 million discretionary fee. The only objection came from the debtor.

At the hearing on the fee application, Judge Shipp said that Bankruptcy Judge Michael B. Kaplan had expressed “concerns” and said he hoped that the firm would suggest a “voluntary reduction.”

Subsequently, the firm and the committee voluntarily reduced the discretionary fee request to $1.8 million, a reduction of $200,000. At the ensuing hearing, Bankruptcy Judge Kaplan further reduced the original discretionary fee request by another $50,000 to $1.75 million, for a total allowance of some $3.1 million.

The debtor appealed.

It Wasn’t a ‘Bonus’

On appeal, Judge Shipp said that the debtor’s core argument rested on the idea that the discretionary fee was a bonus or an impermissible fee enhancement.

Judge Shipp criticized the debtor for finding no caselaw suggesting that a discretionary fee must be considered a bonus as a matter of law, fact or discretion. For that reason, he found “no reason to fault the Bankruptcy Court for treating the Discretionary Fee as part of a bundle of agreed-to fees in the Retention Agreement as opposed to a separate bonus.”

Holding that the discretionary fee was not a bonus, Judge Shipp pointed to the “express terms of the Retention Order [that] itself provided that the Discretionary Fee was not a bonus.” [Emphasis in original.]

Not Unreasonable

Even if it was not a bonus, the debtor contended that the discretionary fee was unreasonable under Section 330. Primarily, Judge Shipp said, the discretionary fee was allegedly unreasonable because it did not employ a lodestar analysis.

Judge Shipp found no abuse of discretion. He said that Section 330 employs “a more fluid reasonableness assessment.” He said that the debtor’s “general disagreement with the Bankruptcy Court’s final figure is not a valid basis for an abuse of discretion finding.”

Waiver of Objection to ‘Business Judgment’

The debtor argued that it was error for the bankruptcy court to base an award on the committee’s business judgment.

Judge Shipp noted that the debtor had not objected to the retention order’s inclusion of business judgment to underlie the discretionary fee. To challenge the bankruptcy court’s approval of the retention agreement as written, he said that the debtor “needed to appeal or otherwise adequately preserve an appeal of the Retention Order itself.”

Monthly Fees Were Accounted For

The debtor contended that the bankruptcy court had erred by not deducting half of the monthly fees, some $680,000, from the $1.75 million discretionary award. “The record suggests otherwise,” Judge Shipp said.

Judge Shipp found “adequate reasoning” for the final fee award in the bankruptcy court’s decision and cited the Third Circuit for having ruled that adequate reasoning does not require a precise computational breakdown. He “rejected” the debtor’s contention that the bankruptcy court failed to take the 50% credit into consideration.

Judge Shipp affirmed the bankruptcy court.

Observations

Prof. Nancy B. Rapoport provided ABI with the following commentary:

In terms of a business judgment rule for fees, the world outside of bankruptcy cases (and other fee-shifting arrangements) assumes that clients can push back against fees that are, in the client’s mind, too high relative to the value that the professional provided.

But in a universe in which fees get paid collectively out of estate funds, one of the problems I see is that there are few real checks and balances for the value-for-fees calculation. In very large, bet-the-company situations (such as large chapter 11s), everyone is so focused at the outset on the goal of potential success that factors like hourly rates, number of professionals engaged on a matter, monitoring expenses and the like appear to get less scrutiny than in days past. 

Based on what I’ve seen of alternative payment sources, such as carveouts from collateral, I’m still not seeing the kinds of “push the bill back across the table” behavior that I’d have expected.

So maybe the point of this case is that it’s important to think at the front end of what “value” looks like for a given engagement and to take a moment to consider what payment structure will create the right incentives to provide that value.

One of the country’s leading experts on compensation and ethics in bankruptcy cases, Prof. Rapoport is a UNLV Distinguished Professor and the Garman Turner Gordon Professor of Law at the University of Nevada, Las Vegas William S. Boyd School of Law.