Delaware Bankruptcy Court Finds Contractual Workarounds to Asarco to Be Unworkable
The Business Advisor
March 30, 2016
In a string of rulings, three judges from the U.S. Bankruptcy Court for the District of Delaware recently issued opinions rejecting attempts by bankruptcy professionals to use contractual retention provisions to avoid the prohibition against fee shifting in Section 330 of the Bankruptcy Code as found by the Supreme Court in Baker Botts, L.L.P. v. ASARCO LLC, 135 S. Ct. 2158 (U.S. 2015) (hereinafter “Asarco”). In each case, the bankruptcy judge found that retention terms providing for payment of defense costs out of the bankruptcy estate are not “reasonable” terms of employment for estate professionals under the Bankruptcy Code.
The Asarco Decision
Generally, under sections 327(a) and 1103 of the Bankruptcy Code, as applicable, a trustee, debtor-in-possession, or a duly appointed committee may, with court’s approval, employ one or more professionals to represent them who do not hold or represent an interest adverse to the estate and who are disinterested persons. Fees and expenses incurred by such professionals are compensated under a reasonableness standard pursuant to section 330(a) of the Bankruptcy Code. Section 328(a), on the other hand, allows professionals, hired by the debtor, trustee, or a duly appointed committee to request an employment retention order that fixes upfront the terms and conditions of compensation, limiting or eliminating the reasonableness standard on the back end.
The dispute in Asarco stems from years of legal wrangling between Baker Botts L.L.P. (“Baker Botts”) and ASARCO LLC, which retained Baker Botts as its bankruptcy counsel under section 327(a) of the Bankruptcy Code. After ASARCO was forced into chapter 11 in 2005, Baker Botts, among other things, successfully prosecuted a fraudulent transfer action on behalf of the bankruptcy estate against ASARCO’s parent, Grupo Mexico, S.A.B. de C.V. (“GMexico”), which resulted in a judgment against GMexico worth between $7 billion and $10 billion.
After confirmation, Baker Botts filed its final fee application seeking, among other things, approximately $117 million it earned in fees while representing ASARCO. Now back under the control of its parent, GMexico, ASARCO challenged the fee request. After a six-day evidentiary hearing, the bankruptcy court approved Baker Botts’ fee application over ASARCO’s objection and awarded Baker Botts $117 million for its work in the bankruptcy case. The bankruptcy court also awarded Baker Botts approximately $5 million for fees the firm incurred defending ASARCO’s objection to its fee application. ASARCO appealed the award of fees to the district court, which held that the additional fees incurred by the firm in defending its fee application were recoverable. On appeal of the district court’s affirmation of the bankruptcy court’s decision, the Fifth Circuit Court of Appeals reversed, finding that fees incurred by attorneys in defending fee applications were not recoverable under the Bankruptcy Code.
In a June 2015 decision, the U.S. Supreme Court affirmed the judgment of the Fifth Circuit, holding that bankruptcy professionals employed under section 327(a) of the Bankruptcy Code may not recover fees incurred in defending their bankruptcy fee applications, because nothing in section 330(a)(1) of the Bankruptcy Code (which authorizes bankruptcy courts to award “reasonable compensation for actual, necessary services” to professionals retained by a bankruptcy estate) explicitly or specifically authorizes such recovery or refers to a prevailing party in the context of an adversarial action. Accordingly, the Court held that section 330(a)(1) was not a fee shifting statute, and, therefore, it did not displace the American Rule – that each party bears its own expenses.
In a gallant effort to contractually work around the Supreme Court’s decision some bankruptcy professionals began including indemnification provisions as part of the terms of their retention, requiring the bankruptcy estate to reimburse them for any fees they may incur arising out of their successful defense of an objection to their fee application and seeking approval of such retention under section 328(a). These indemnification provisions became a source of contentious litigation between estate professionals and the U.S. Trustee for Region Three (the “UST”) in two chapter 11 cases currently pending in the Delaware Bankruptcy Court. See e.g., In re Boomerang Tube, LLC, et al., and In re Samson Resources Corp., et. al.1
The professionals argued that, while the Supreme Court held that section 330 did not create an exception to the American Rule, the Court also noted that parties could and regularly did contract around the American Rule, and, therefore, section 328 of the Bankruptcy Code, which allows for the retention of estate professionals “on any reasonable terms and conditions,” provides such avenue for the parties to sidestep the implication of the Asarco decision. The UST argued, among other things, that retention applications and orders thereon are not contracts but are merely requests governed by statute, which a judge acting within the constraints of section 328(a) may authorize. The UST further argued that Section 328(a) does not overcome the American Rule, because nothing in section 328(a) “specifically” or “explicitly” allows a prevailing party to recover its fees from the other party in an adversarial action as required by the Supreme Court’s decision in Asarco. Accordingly, contended the UST, while the American Rule’s prohibition against fee shifting can be altered by statute and contract (a mutually agreeable contract), it cannot be altered by a contract (in this case, a retention application) that violates a statute (i.e., section 328(a)).
Bankruptcy Judges Mary Walrath and Christopher S. Sontchi, overseeing the Boomerang Tube and Samson Resources cases, respectively, agreed with the UST. In her January 29, 2016 opinion in the Boomerang Tube case, Judge Walrath found that, although section 328 is an exception to the reasonableness standard in section 330, it contains no specific and explicit statutory language authorizing the award of defense fees or litigation costs to a prevailing party in the context of an adversarial action. See Boomerang Tube, 2016 Bankr. LEXIS 273, *5 (Bankr. D. Del. Jan. 29, 2016). In support of her ruling, Judge Walrath found it significant that Congress provided for fee shifting in several other provisions of the Bankruptcy Code, but not in the retention provisions of sections 328 and 330. Id.
While Judge Walrath agreed with the argument of counsel to the Official Committee in finding that the retention agreement was a contract, she found that such contract was not an exception to the American Rule. Id. at *11. She reasoned that the retention agreement was not a typical contract because it was not a bilateral agreement between two parties with mutual payment obligations, was subject to objection by all parties-in-interest in the bankruptcy case and approval by the bankruptcy court, and required a non-party, the debtor, to pay the committee’s counsel, even if it was not the debtor who objected to the fees. Id. Judge Walrath further found that fee defense costs did not constitute fees and expenses for performing services for the committee or the estate. Id. at *13 (concluding that fee defense expenses are for “services performed by Committee Counsel only for their own interests”). Accordingly, Judge Walrath concluded that the indemnification provision was not a reasonable term of employment under section 328 of the Bankruptcy Code.
Soon after Judge Walrath’s decision, Judge Sontchi followed suit and advised co-counsel for the chapter 11 debtor in Samson Resources that he would not approve the fee defense reimbursement provisions included in the retention applications of said co-counsel. Judge Sontchi stated that Judge Walrath’s reasoning set forth in Boomerang Tube applied equally to the Samson Resources case, notwithstanding that the retention contract at issue was directly between the debtor and its counsel as opposed to between the appointed committee and its counsel. In support, Judge Sontchi cited to note 6 in Judge Walrath’s decision, where she noted that “the Court would reach the same conclusion if the fee defense provisions were in a retention agreement filed by any professional under section 328(a) – including one retained by the debtor. Such provisions are not statutory or contractual exceptions to the American Rule and are not reasonable terms of employment of professionals.” Boomerang Tube, 2016 Bankr. LEXIS 273 at p. *23, fn.6.
More recently, Delaware Bankruptcy Judge Brendan L. Shannon rejected another creative attempt by bankruptcy counsel – this time by the very same firm that was unsuccessful in Asarco. Baker Botts, as counsel to the debtors in the chapter 11 cases of New Gulf Resources LLC, et.al. (Case No. 15-12566 (BLS)), crafted a “fee premium” component to its retention application to get around the Asarco and Boomerang decisions.
Under the proposed terms of retention, Baker Botts’ aggregate fees incurred during the bankruptcy cases would be increased by ten percent (the “Fee Premium”) if the firm incurred material fees and expenses defending against any objection with respect to its interim or final fee applications. In support of its retention application, Baker Botts argued that the Fee Premium was not compensation for fee defense costs, and, as such, neither the Asarco nor Judge Walrath’s Boomerang Tube decision had any bearing on the court’s consideration of the Fee Premium because the only question before the court was whether, pursuant to sections 327 and 330, professional fees can include a market-driven premium that increases the hourly rates by ten percent. In a decision docketed March 17, 2016, Judge Shannon disagreed, finding that the Fee Premium “runs afoul of the holdings in Asarco and Boomerang Tube.”
There can be no doubt that Asarco was a blow to bankruptcy attorneys. While not binding on other bankruptcy courts, the recent decisions of Judges Walrath, Sontchi, and Shannon may certainly convince other courts to similarly conclude that contractual fee defense provisions are not “reasonable” terms of employment for estate professionals under the Bankruptcy Code. And while it is anticipated that bankruptcy attorneys will continue to seek creative ways to preserve and protect their market-driven attorneys’ fees, the Delaware Bankruptcy Court has made it clear that such creativity will be scrutinized to ensure that it does not run afoul of Asarco.
1 This issue also arose in the chapter 11 case of In re Northshore Mainland Services, Inc., et al. (a/k/a the Baha Mar) but that case was dismissed on January 12, 2016 before the issue could be resolved.