In In re Hungry Horse, LLC, Adversary Proceeding No. 16-11222 (Bankr. D. N.M. September 20, 2017) (“Hungry Horse”), the New Mexico Bankruptcy Court reminded us that many U.S. Supreme Court opinions can be limited in scope and do not necessarily dispose of all potential remedies to an issue.
The issue in Hungry Horse—as in many bankruptcy cases—was whether a law firm or other professionals retained by a debtor or appointed committee could be awarded legal fees for work performed in defending their fee application. Previously, in Baker Botts L.L.P. v. Asarco LLC, 135 S.Ct. 2158 (2015) (“Asarco”), the Supreme Court answered this question in the negative.
But, the Supreme Court appeared to base its opinion in Asarco solely on one statutory provision in the Bankruptcy Code—section 327—and not on any contractual arrangement between a debtor and its counsel. This gap has prompted lawyers to try find a workaround the Asarco opinion. The Hungry Horse case is one example where the Court agreed that Asarco did not foreclose the ability of debtor’s counsel to be awarded defense-related fees, based on a contractual arrangement and other provisions in the Bankruptcy Code.
In Asarco, after a 4 year-long bankruptcy case, which was successful by all measures, counsel for the debtor (Asarco) sought final approval of their fees of approximately $120 million, pursuant to section 330(a)(1) of the Bankruptcy Code.
The reorganized debtor, which after exiting bankruptcy was again controlled by its parent, filed objections to the fee applications of the debtor’s counsel, two law firms. After extensive discovery and a 6-day trial on the fee applications, the bankruptcy court awarded the law firms their fees, plus $5.2 million in additional fees for defending their fee applications.
After a couple of appeals, the Fifth Circuit Court of Appeals affirmed the $120 million fee award, but reversed the award of additional compensation for defending the fee applications. The fee dispute eventually wound up in the Supreme Court, but the sole issue on appeal was whether debtor’s counsel could collect fees for defending their fee applications.
The Supreme Court started its analysis by noting that:
Our basic point of reference when considering the award of attorney’s fees is the bedrock principle known as the American Rule: Each litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise.
Asarco, 135 S. Ct. at 2164 (emphasis added). But, the dispute in Asarco only involved whether section 330(a)(1) of the Bankruptcy Code provided a statutory exception to the American Rule. With respect to this issue, the Supreme Court held that:
[T]he phrase “reasonable compensation for actual, necessary services rendered” [under section 330(a)(1)] permits courts to award fees to attorneys for work done to assist the administrator of the estate, as the Bankruptcy Court did here when it ordered ASARCO to pay roughly $120 million for the firms’ work in the bankruptcy proceeding. No one disputes that § 330(a)(1) authorizes an award of attorney’s fees for that kind of work . . . But the phrase “reasonable compensation for actual, necessary services rendered” neither specifically nor explicitly authorizes courts to shift the costs of adversarial litigation from one side to the other—in this case, from the attorneys seeking fees to the administrator of the estate—as most statutes that displace the American Rule do.
Id. at 2165.
In Asarco, because no party argued that the “contract exception” to the American Rule was applicable, the Supreme Court did not determine whether this exception could allow the award of defense-related fees in future bankruptcy cases. As a result, after Asarco, bankruptcy professionals began to include fee defense provisions in their retention agreements.
The leading post-Asarco case that addressed whether fee defense provisions would work to allow the reimbursement of defense-related fees is In re Boomerang Tube, Inc., 548 B.R. 69 (Bankr. D. Del. 2016) (“Boomerang”). In Boomerang, the United States Trustee objected to a fee defense provision included in a retention agreement with proposed counsel for the unsecured creditors’ committee.
Committee counsel argued that provision came within the “contract exception” to the American Rule and such provision was similar to indemnification provisions that are commonly approved pursuant to section 328 of the Bankruptcy Code.
The Boomerang court disagreed with committee counsel, because (a) section 328 was not sufficiently “specific or explicit” to fall within the statutory exception to the American Rule; (b) the committee counsel’s engagement was not in privity with the party (i.e., debtor) who would be responsible for paying the defense-related fees; (c) defense fees could never be deemed reasonable under section 328, because they did not involve services provided to the creditors’ committee; and (d) prior case law deeming defense fees reasonable under section 328 predated the Asarco opinion.
A Delaware case decided earlier this year, however, found that, in different circumstances, a fee defense provision can come within the “contract exception” to the American Rule. See In re Nortel Networks, Inc., 2017 WL 932947 (Bankr. D. Del. March 8, 2017) (“Nortel”). In Nortel, an indenture trustee sought $8.1 million in attorneys’ fees against a bankruptcy estate and additional fees for defending such a claim. However, unlike Boomerang, the relevant agreement was in privity with the debtor, thereby binding the bankruptcy estate to the obligation.
The Nortel Court held that, since the circumstances differed from Boomerang and Asarco, the “contract exception” to the American Rule did apply. Unfortunately, the Court’s decision did not turn on whether section 328(a) provided a statutory exception to the American Rule.
Hungry Horse Opinion
In Hungry Horse, decided this month, the Court was asked to revisit the Boomerang opinion on whether section 328(a) could be used to bring a fee defense provision within the “contract exception” to the American Rule.
The Hungry Horse Court first discussed the interplay between sections 328 and 330 of the Bankruptcy Code. The Court noted that it was well-established that a retention approved under section 328 did not contain the same “reasonable compensation for services rendered” language found in section 330(a)(1)(A) of the Code and therefore once retention is approved under section 328(a), compensation is governed by the terms approved by the court unless the 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.”
The Court next addressed whether Asarco foreclosed approval of a fee defense provision under section 328(a). Disagreeing with Boomerang, the Court found that Asarco did not provide that an engagement agreement approved under section 328 could not fall within an exception to the American Rule. According to the Court:
Nothing in the Code says that an employment term must benefit the estate to be reasonable. A typical engagement agreement between a lawyer and client has many terms, some benefit the client, while others benefit the lawyer. Considered together, they may be reasonable.
The Court then listed several terms in a typical engagement letter that do not directly benefit a client and yet are normally deemed reasonable.
Significantly, the Court recognized the fact that in smaller bankruptcy cases, such as those filed in New Mexico, defense-related fees can be a sizeable percentage of the total fees billed. Therefore, estate’s counsel’s compensation could be substantially reduced if it were not allowed to recover such fees.
The Court finally set forth the following example of a model fee defense provision that could be approved under section 328 and fall within the exception to the American Rule:
Fee Defense. The Client agrees to pay all reasonable legal fees and expenses incurred by the Firm, and also by any counsel retained by an 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.
While the Court did not specifically approve the fee defense provision in the debtor’s counsel’s agreement, it did hold that it would consider approving language similar to the above model in an order approving retention.
In deciding the Asarco case, Justice Thomas clearly stated at the beginning of his opinion that “[t]he question before [the Supreme Court] is whether § 330(a)(1) permits a bankruptcy court to award attorney’s fees for work performed in defending a fee application in court.” 135 S. Ct. at 2162. Justice Thomas later re-emphasized that “[w]e decline to adopt a reading of § 330(a)(1) that would allow courts to pay professionals for arguing for fees they were found never to have been entitled to in the first place” and “[t]here is no indication that Congress departed from the American Rule in § 330(a)(1) with respect to fee defense litigation . . .” Id. at 2166.
In Boomerang, the Delaware Court similarly stated that “the Court agrees with the [c]ommittee’s argument that the contract exception to the American Rule is not precluded by a ruling in Asarco.” 548 B.R. at 73. The Court nonetheless ruled against committee counsel’s fee defense provision because it felt that “a party cannot, by contract, violate another provision of the Code.” Id.
While the Boomerang appears to have extended the Asarco opinion to cases where fees are approved under section 328—instead of section 330—that Court appeared to focus on the fact that committee counsel’s engagement did not involve a typical bilateral agreement with a debtor, as is generally the case where the “contract exception” is found to be applicable.
Because Hungry Horse involved an agreement approved under section 328 and a bilateral agreement between the debtor and its counsel, both Asarco and Boomerang left that Court with some room to reason that the “contract exception” is viable for retentions involving debtor’s counsel and approved under section 328. This ruling was analogous to the Delaware court’s ruling in Nortel, where the indenture involved a contract between the debtor and the indenture trustee and thus was deemed to fall within the “contract exception.”
Whether other courts will join in the reasoning of Hungry Horse remains to be seen. But, the logic demonstrated by that Court’s opinion is compelling and persuasive—at least in the eyes of this practitioner.