Introduction
Representing a Chapter 11 debtor and being compensated for such representation, is a multi-step process. First, the so-called “bankruptcy professional” 1For purposes of this analysis only, a bankruptcy professional is one whose retention must be approved by the bankruptcy court, such as bankruptcy counsel, investment bankers, accountants, etc., and whose fees and expenses will be paid out of estate funds. The term, however, does not include “ordinary course” professionals used in the everyday operation of the business. must be retained by the client (debtor, committee, trustee, etc.). Second, that retention must be blessed by the bankruptcy court. Third, once the work is done, the bankruptcy professional must seek court approval of its fees. Further, each of the foregoing steps has its own multi-step process. Getting retained is the “dog” in this process; allowance of fees is the “tail” that wags the dog. What fees are and are not compensable from the estate? What should a bankruptcy professional do when it is faced with an objection to allowance of its fees? Confronted with an objection, the bankruptcy professional must decide whether to settle or litigate. If the bankruptcy professional believes the objection to be meritorious or the amount in question is de minimus, settlement may be the right approach. On the other hand, if the bankruptcy professional believes that the objection is in error, litigation challenging the objection may be the appropriate course.
This article is intended to alert bankruptcy professionals that there is another factor that may not be readily apparent, but is crucial in deciding whether to settle or litigate. Unlike fees incurred for preparing fee applications, the question of whether fees for defending a fee application are recoverable has not yet been finally answered. There is a split of authority as to whether such fees are allowable under the Bankruptcy Code under any circumstances. Even in those jurisdictions where such defense fees may be allowed, there are restrictions on what particular fees may be allowed. The bankruptcy professional should be aware of the applicable rules governing recovery of defense fees in the jurisdiction in which its cases are pending before challenging an objection.
Fees Under the Bankruptcy Code
Under the Bankruptcy Code, a bankruptcy professional that expects to be compensated out of estate assets must have its retention approved by the bankruptcy court (the “Court”). 2See section 327 of title 11 of the United States Code, 11
U.S.C. §101 et seq. (the “Bankruptcy Code”). Similarly, in order to be awarded compensation for its services, it must apply to the court for approval of its fees (and expenses). 3See 11 U.S.C. §330(a)(1). Section 330(a)(1)(A) provides, in pertinent part, that after notice and a hearing, the court may award to a professional person retained under Section 327 “reasonable compensation for actual, necessary services” rendered by the professional. In determining whether the bankruptcy professional should be awarded its fees, the Court must first determine if the requested fees are “reasonable.” In doing so, the court must take into account certain factors, including, but not limited to, (a) the time spent on such services, (b) the rate charged, (c) whether the services were necessary or beneficial to the estate, (d) whether the services were performed in a timely fashion, and (e) whether the compensation was reasonable based on the compensation charged by non-bankruptcy practitioners. 4
Section 330(a)(3) provides as follows:
In determining the amount of reasonable compensation to be awarded to an examiner, trustee under chapter 11, or professional person, the court shall consider the nature, the extent, and the value of such services, taking into account all relevant factors, including –
(A) the time spent on such services;
(B) the rates charged for such services;
(C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title;
(D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;
(E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and
(F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.
11 U.S.C. §330(a)(3)
In 1994, Section 330 of the Bankruptcy Code was amended by,
inter alia, adding Section 330(a)(6), which provides for the allowance of fees for preparing fee applications.
5Section 330(a)(6) provides, in pertinent part, that “[a]ny compensation awarded for the preparation of a fee application shall be based on the level and skill reasonably required to prepare the application.” 11 U.S.C. §330(a)(6). It should be noted, however, that some courts will “limit” the amount of fees allowable for preparation of fee applications. See, e.g., In re Mesa Air Group, Inc., 449 B.R. 441, 445 (Bankr. S.D.N.Y. 2011) (“The Court need not and does not adopt a fee cap on the amount charged for preparing fee applications, but the 3-5% range is a useful metric.”). It did not, however, explicitly provide for the allowance of fees for defending fee applications.
In a recent decision, the Bankruptcy Court for the Middle District of Pennsylvania ruled that fees for the defense of a fee application, even when the fees were meritorious and the objections were overruled, were not compensable from the estate. See In re Wireless Telecommunications Inc., 2011 Bankr. LEXIS 1430 (Bankr. M.D. Penn. April 18, 2011). In Wireless, Pepper Hamilton, LLP (“Pepper”) had been retained as debtor’s counsel. One of the debtor’s major creditors, Vermont Telephone, Inc. (“Vtel”) filed an objection, challenging Pepper’s entitlement to fees in incurred in connection with, inter alia, negotiating a settlement that was ultimately withdrawn, (ii) preparing fee applications for another law firm retained by the debtor, (iii) preparing fee applications for a principal of the debtor ostensibly acting as an independent consultant, and (iv) defending the foregoing objections to its fees. 6Each of these requests and objections had already been raised as part of interim fee requests; thus, Pepper’s fees for defending its fee application had already been incurred.
Vtel maintained that the estate received no benefit from Pepper’s efforts in connection with the failed attempt at settlement. Therefore, Pepper’s fees for those efforts provided no benefit to the estate and should be disallowed. 72011 Bankr. LEXIS 1430 at * 6-7. The Wireless court rejected this argument, holding that “it is the prospective likelihood of benefit to the estate that is critical, not the actual results.” (citations omitted). 8Id. at *7-8. Thus, the critical time in determining benefit to the estate is the time at which the service was rendered, not based on hindsight after the service was performed. Using this standard as a guide, the Wireless court granted Pepper’s fees incurred in connection with the settlement, but denied its fees for preparing the fee applications for the other law firms retained by the debtor and for the debtor’s principal. 9There were certain other fees requested by Pepper for work done that the court believed were of no benefit to the estate. For the sake of expediency, we have not included them in this analysis.
Pepper’s fees for defending against Vtel’s objections were another matter. The Wireless court denied those fees, noting that although the 1994 amendments to the Bankruptcy Code specifically provided for the allowance of fees for preparation of fee applications, 1011 U.S.C. §330(a)(6) there is no corresponding language referring to defending fee applications. Thus, there is insufficient authority for allowing such fees. 112011 Bankr. LEXIS 1430 at *20. Further, as noted above, one of the factors set forth in Section 330 to determine if compensation is reasonable is the customary compensation of practitioners in non-bankruptcy cases. 12See 11 U.S.C. 330(a)(3)(F). The Wireless court noted that outside of bankruptcy, attorneys generally do not receive compensation for litigating the collection of their fees, thus there was no rationale for allowing them to collect such fees in bankruptcy. 13See 2011 Bankr. LEXIS 1430 at *22-23.
The Wireless court based this interpretation of Section 330(a)(3)(F) solely on In re St. Rita’s Assocs. Private Placement, L.P., 260 B.R. 650 (Bankr. W.D.N.Y. 2001). In St Rita’s, the court denied, as a matter of law, the applicant’s fees for defending its fee application, even though the applicant’s fees were only partially disallowed. 14The Wireless court, however, noted that fees for defending a fee application may be appropriate when the objection is so egregious that the objecting party is subject to sanctions. See 260 B.R. at 652 (“Nothing in this decision should be viewed as precluding an award of legal fees in situations where sanctions are appropriate.”). In doing so, the court rendered the following analysis: (i) section 330(a)(3)(F) provides that compensation for bankruptcy practitioners should be based on compensation paid to non-bankruptcy practitioners; (ii) outside bankruptcy, when a client refuses to pay a disputed bill, the attorney has a choice either to write-off the amount or litigate; (iii) under the “American Rule,” the cost of such litigation would be borne by the attorney notwithstanding the outcome 15Under the so-called “American Rule,” each party is responsible for its own attorney fees, absent express statutory authority, contractual provisions or grounds for equitable relief. See, e.g., Buckhannon Bd. & Care Home v. W. Va. Dep’t of Health & Human Res., 532 U.S. 598, 602 (2001) (Courts follow a general practice of not awarding fees to a prevailing party absent explicit statutory authority.) (citations omitted); see also Steven Gilford and Rochelle Outlaw, Recovering Attorney Fees in Coverage Litigation May Depend on the State, The Insurance Coverage Law Bulletin (May 30, 2006) (as reprinted at www.law.com/jsp/cc/PubArticleCC.jsp?id=1148634335367). It should also be noted that while other courts have cited the American Rule as a reason not to award fees for defending a fee application, they did so only when there were other reasons for such denial. See, e.g., In re Brous, 370 B.R. 563, 572 (Bankr. S.D.N.Y. 2007) (applicant failed to justify a departure from the American Rule; the objection was asserted in good faith and the objector prevailed). ; (iv) a fortiori, bankruptcy practitioners, by law, are not entitled to compensation for defending objections to their fee applications, no matter what the merit of their fees. 16Id. at 652.
The author believes that the analysis in St. Rita’s is seriously flawed and fails to take into account real world situations. Section 330(a)(3)(F) was never intended to be used to limit compensation to bankruptcy professionals to that available to non-bankruptcy professionals or to impose on bankruptcy professionals rules governing collection of fees applicable outside of bankruptcy. Rather, it was intended to ensure that bankruptcy professionals were compensated as well as their non-bankruptcy colleagues. 17See 1 COLLIER ON BANKRUPTCY ¶ 330.03[12], p. 330-25, 26 (2010) (“By enacting section 330, Congress sought to attract bankruptcy specialists to the system to operate it more smoothly and efficiently. [T]he Code requires that compensation allowed in a bankruptcy case should not be below the level allowed for comparable services in a nonbankruptcy case.”). See also, e.g., Smith v. Edwards & Hale, Ltd. (In re Smith), 317 F.3d 918, 928 (9th Cir. 2002) (“Failure to grant fees for successfully defending challenges to an authorized fee application would dilute fee awards, in violation of section 330(a), and this would reduce the effective compensation of bankruptcy attorneys to levels below the compensation available to attorneys generally.”) (citing In re Nucorp Energy, Inc., 764 F.2d 655, 651 (9th Cir. 1995)). Clearly, applying non-bankruptcy rules governing fees to fees in bankruptcy or visa versa may lead to absurd results. There is a marked difference between the system for payment of fees to bankruptcy professionals and the system for payment of fees to their non-bankruptcy counterparts. Outside of bankruptcy, the only party that can object to an attorney’s fees is his client and generally only as part of a claim for malpractice. 18The reader should note that this analysis applies primarily to representing private litigants. There are numerous fee-shifting statutory schemes, where the prevailing party is entitled to recover its fees subject to allowance by the court. In many of those cases, the relevant governmental agency generally has standing to object and the court will go through an allowance process similar to that conducted by a bankruptcy court as to the merits of the applicant’s fees. See, e.g., State of Michigan Dep’t of Environ. Quality v. U.S. Environ. Prot. Agency, 254 F.3d 1087, 1090-97 (D.C. Cir. 2001) (court disallowed in part or in full fees for (i) inadequately detailed descriptions of tasks performed, (b) clerical tasks, (c) staff overtime, (d) document production, and (e) travel, and long-distance expenses and local transportation). A bankruptcy professional, however, may face objections to its fees not just from its client, but a variety of sources including, but not limited to, the Court, the Office of the United States Trustee (the “U.S. Trustee”) 19The U.S. Trustee may have an institutional bias against allowance of fees for defending fee applications. On January 30, 1996, the Department of Justice, Office for United States Trustees issued an order entitled “United States Trustee Guidelines for Reviewing Applications for Compensation and Reimbursement of Expenses Filed Under 11 U.S.C. §330” (the “Guidelines”). Bankruptcy professionals, unfortunately, are intimately familiar with one part of the Guidelines, the so-called “Project Categories,” which must be used to record time and prepare fee applications. There are two different categories dealing with fee applications. The first is entitled “Fee/Employment Applications,” which pertains to “[p]reparations of employment and fee applications for self or others; motions to establish interim procedures.” The second, is entitled “Fee/Employment Objections,” which pertains to “[r]eview of and objections to the employment and fee applications of others.” See Guidelines at Exhibit A. The absence of the phrase “for self” is telling., the debtor’s secured and unsecured creditors, and any other party in interest, 20As noted above, in Wireless both the U.S. Trustee and Vtel, a creditor, filed objections. No objection was filed by the bankruptcy professional’s client, the debtor. each of whom may assert a variety of objections to different aspects of the bankruptcy professional’s fee application.
Fortunately, Wireless and St. Rita’s are but two of a number of cases dealing with allowance of fees incurred for defending fee applications (so-called “defense fees”). A majority of courts have rejected the Wireless and St. Rita’s view of Section 330(a), finding instead that Section 330(a) was intended to cover fees for preparing and defending fee applications. 21See, e.g., Boyd v. Engman, 404 B.R. 467, 482 (W.D. Mich. 2009) (finding that Section 330(a) was intended to compensate bankruptcy petitioners for both preparing and defending fee applications, rejecting the holding in St. Rita’s); accord Hennigan v. Goldin Assocs. L.L.C. (In re Worldwide Direct Inc.), 334 B.R. 108, 111 (D. Del. 2005); In re On Tour, 276 B.R. 407, 418 (Bankr. D. Md. 2002). Further, the courts in Wireless and St. Rita’s appeared to make no distinction or allocation between defending fees that were ultimately allowed and defending fees that were not. This distinction, however, is crucial and has become the bright-line test for allowance of defense fees: (i) where the underlying fees are allowed, the defense fees are allowed; and (ii) where the underlying fees are not allowed, the defense fees are not allowed. 22See Big Rivers Elec. Corp. v. J. Baxter Schilling (In re Big Rivers Elec. Corp.), 252 B.R. 670, 675 (W.D. Ken. 2000) (court denied fees for defending fee application where fees sought were found to be unreasonable and awarded fees for defending fee application where underlying fees were approved by the court); In re Hutter Construction Co., Inc., 126 B.R. 1005, 1019 (Bankr. E.D. Wis. 1991) (same). Compare, e.g., In re CCT Communications, Inc., 2010 Bankr. LEXIS 2947, *20-24 (Bankr. S.D.N.Y. Aug. 24, 2010) (holding that while objections were interposed in good faith, the applicant substantially prevailed and thus denial of his fees would dilute his award) and In re Ahead Communications Sts., Inc., 2006 Bankr. LEXIS 2473 (Bankr. D. Conn. Sept. 21, 2006) (“The court concurs with the courts which have allowed the compensation of attorney’s fees incurred in successfully defending fee applications against objections.”) with Brous, 370 B.R. at 572 (denying defense fees when objections asserted in good faith and objector substantially prevailed on objections) and In re Terraforce Tech. Corp., 347 B.R. 838, 867 (Bankr. N.D. Tex. 2006) (denying fees for defending fee applications where objections were filed in good faith and “were meritorious in significant part”).
The author believes that this type of approach not only eliminates erroneous interpretations of the Bankruptcy Code but is far more equitable in application. It rewards meritorious fee requests and punishes frivolous or overreaching fee requests. 23In In re Riverside-Linden Invest. Co., 945 F.2d 320 (9th Cir. 1991), the Ninth Circuit held that a bright-line rule allowing fees for defending fee applications “could encourage attorneys to assert meritless fee requests. Regardless of whether or not they were awarded the requested fees, the attorneys could recover fees incurred in opposing objections to the meritless request.” Id. at 323 (citations omitted). The Riverside-Linden Court, however, affirmed the lower court’s denial of fees because the applicant was unsuccessful in defending its application. Simple rule; simple result.
Conclusion
It is unlikely, but not impossible, that a bankruptcy professional would submit a frivolous or meritless fee application in the hopes of making money by defending that application. Bankruptcy professionals are in a unique position. Unlike most of their non-bankruptcy colleagues (often in the same firm), their fees are on public display. Everyone knows what bankruptcy professionals charge their debtor or committee clients. Retention agreements, individual time entries, how much was spent on taxis, are all open for perusal by the world. There are simply too many eyes to sneak through a meritless fee application.
Thus, any bright-line rule that defense fees are not recoverable under any circumstances is counter-productive and punishes bankruptcy professionals who are compelled to expose themselves and their fee requests to public examination. The majority view appears to be that a simple “fairness” standard is more workable: The cost of defending legitimate fees against attack shall be borne by the estate. Bankruptcy professionals will know that challenging objections to borderline frivolous or overreaching fee requests will be at their own financial risk, while the opposite will hold true for U.S. Trustees and other parties in interest.
