The compensation of a debtor’s attorneys in Chapter 11 bankruptcy is a balancing act. There are two issues to consider. First, for every dollar paid to an attorney, the size of the debtor’s estate decreases, meaning unsecured creditors recover less of their claims. Second, if attorneys do not represent the estate because they are not being adequately compensated then the effectiveness of the bankruptcy system would crumble. The Bankruptcy Code (the “Code”) accounts for this by doing two things; first, attorneys are considered an administrative expense under 11 U.S.C. § 507; furthermore as a result of being an administrative expense, attorneys are entitled to priority status under 11. U.S.C. § 503(b), meaning that attorneys are one of the first parties to get their unsecured claim paid by the estate. Second, 11 U.S.C. §330(a) governs what may be paid to attorneys, which is essentially all the fees reasonably necessary to administer the estate. Additionally, in order for attorneys to get paid for work under Title 11, the attorneys must file a fee application and the court must approve the fee.1 With these statutory safeguards in place, the Code incentives attorneys to take bankruptcy work and provides judicial supervision to prevent abuse.
The Code, though, is not exhaustive in terms of what can and cannot be paid to an attorney. On issue at the Supreme Court last month was Baker Botts v. ASARCO, No. 14-103, dealing with one such ambiguity. The question the Supreme Court wrestled with was, if a client challenges an attorney’s aforementioned fee application, can the attorney be compensated by the estate for defending herself? The Supreme Court’s answer to this question has the potential to change the bargaining positions of debtor’s counsel by giving the other parties to the bankruptcy significant leverage.
Baker Botts v. ASARCO was argued before the Supreme Court on February 25th, 2015. At issue is one section of the Code, 11. U.S.C. § 330(a), the attorney compensation provision. Baker Botts litigated the most successful fraudulent conveyance action in the history of bankruptcy, recovering approximately $ 7 billion for ASARCO’s estate.2 The litigation took roughly five years to complete and the bankruptcy court awarded Baker Botts $117 million in compensation. Baker Botts further asked for a 20% fee enchantment of nearly $22 million.3 Fee enhancements are rare and usually only awarded for unusually successful litigation. The bankruptcy court agreed with Baker Botts’s motion for the fee enhancements on account of such a large recovery. ASARCO challenged the awarded fees on appeal to the district court and ultimately lost.4 To add insult to injury, Baker Botts was entitled to its reasonable attorney’s fees for defending itself in the fee dispute litigation. For their efforts Baker Botts added another $5.2 million to their marvelous payday, but the success was short lived.5
ASARCO appealed the bankruptcy court’s ruling with respect to the fee enhancements. On appeal, the district court found the fees resulting from pursuing the fee enchantments were unwarranted. On remand, the bankruptcy court found that all the fees were related to the defense of Baker Botts’s fee application and upheld all the fees.6 The district court affirmed on a second appeal; however, the Fifth Circuit overturned the fees for defending the fee applications while allowing the fee enhancements, to which Baker Botts petitioned for Certiorari.
The issue is incredibly important for Chapter 11 attorneys. As a general rule, any party in the bankruptcy case, the estate, trustee or a creditor, can challenge the fees of the debtor’s attorney. An affirmation of the Fifth Circuit’s ruling which disallows fees for defending an attorney’s fees opens the door to vexatious litigation, though. If the debtor’s attorney cannot be compensated for defending its fees it will have its work diluted. Baker Botts put over $5 million worth of work in to defending itself and if the Fifth Circuit’s ruling stands that money and time is lost, meaning that $5 million is dead money, reducing the overall return on Baker Botts’s investment in the case. That loss also doesn’t consider the opportunity cost of Baker Botts’s attorney’s time that they could have spent elsewhere. Such a ruling would provide every party, except the debtor’s attorney, with an incredible amount of leverage in discussing fee arrangements going into and during the administration of the estate.
In complex cases involving thousands of creditors and billions of dollars, debtor’s attorneys would become exposed to numerous fee attacks. The problem with a ruling that affirms the Fifth Circuit arises because if the debtor is not entitled to compensation for expending its time on its own defense then the attorney has no incentive to litigate and is at the mercy of the bankruptcy judge. One can imagine that if the debtor’s attorney would not even expend the time to defend itself in fee litigation that a bankruptcy judge may be initially inclined to side with the party challenging the fee.
The decision will likely be split, with the more functional judges wanting to reverse the Fifth Circuit, and the more conservative, text based judges upholding the Fifth Circuit. Both parties have good arguments. Baker Botts focuses on how much leverage debtor’s counsels would lose if such a ruling were upheld. Further, based on the text, 11. U.S.C. § 330(a) doesn’t preclude fees from being awarded for defending a fee application. Baker Botts also advances an Expressio unis argument that only duplicative work and work unlikely to benefit the estate are not compensable and because defending one’s fees is excluded from prohibition they are thus compensable.7. Last, as a matter of effective estate administration, Baker Botts argues that identifying the correct cost for attorneys and professionals in necessary to finalize appropriate costs for the estate. The argument is not without case law support as the court in In re Worldwide reached a similar conclusion.8.). ASARCO counters with the reverse reading of 11. U.S.C. § 330(a), arguing that because preparation of a fee filing is compensable that the exclusion of defense fees necessarily means defending fees cannot be compensable. ASACRO also argues that nonmeritorious fee litigation, the primary concern of Baker Botts and arguably most other corporate debtor’s counsels, can be addressed with effective case management.
The question will likely be decided based on how the court interprets “the benefit to the estate” language of 11. U.S.C. § 330(a)(4)(A)(ii)(I) . If Baker Botts can convince the court that there is in fact a benefit to paying attorneys for defending their fees, then Baker is likely to prevail; conversely, if the court views defending fees as only supporting the attorneys and detracting from the value of the estate, look for Baker Botts to go home without their $5.2 million fee.