Delaware Bankruptcy Court Denies "Fees on Fees" Provision in Retention Application

The Facts of the Case
On June 9, 2015, Boomerang Tube, LLC, and its debtor affiliates filed their petitions for relief under Chapter 11 of the bankruptcy code. On June 19, 2015, the U.S. Trustee for the District of Delaware (UST) appointed the committee. That same day, the committee selected Brown Rudnick LLP and Morris, Nichols, Arsht & Tunnell LLP (collectively, committee counsel) as its proposed co-counsel. Within each retention application, committee counsel sought to be paid “from the Debtors’ estates, subject to approval by the Court pursuant to 11 U.S.C. §§ 330 and 331, for any fees, costs or expenses, arising out of the successful defense of any fee application by [committee counsel] . . . in response to any objection to its fees or expenses. . . .” In re Boomerang, No. 15-11247, ECF No. 271, ¶ 16; ECF No. 273, Exhibit. A, Annex 1, at 4. The UST objected to the retention applications on three principle grounds: (1) ASARCO is a direct bar against the fee defense provisions, (2) section 328(a) creates no exception to the American Rule’s prohibition on fee shifting, and (3) the fee defense provisions cannot be approved under section 328(a) because they are unreasonable and seek to compensate professionals for work not within the scope of their employment.

Analysis

ASARCO applied to section 328(a). The court first examined whether ASARCO, which came under the context of section 330, provides the standard to approve fee provisions under section 328(a). In ASARCO, the Supreme Court was tasked to decide whether debtors’ counsel could recover fees for defending its fee applications against a challenge by the debtors. There, the Supreme Court stated that “any statutory departures from the American Rule must be [1] specific and explicit and [2] must authorize the award of a reasonable ‘attorney’s fee,’ ‘fees,’ or ‘litigation costs,’ and usually refer to a ‘prevailing party’ in the context of an ‘adversarial action.’”ASARCO, 135 S. Ct. at 2164 (internal quotations omitted). In holding that section 330(a) did not meet this two-part test, the Supreme Court found that the text of section 330(a) does not include any conspicuous authority to “shift costs of adversarial litigation from one side to the other” and therefore does not create an exception to the American Rule.

Here, the UST argued that ASARCO is binding precedent requiring the court’s approval of the fee defense provisions. The committee disagreed, distinguishingASARCO as an opinion governing only section 330(a) and inapplicable to section 328(a). Further, the committee argued that because section 328 is expressly excepted from section 330(a)—see 11 U.S.C. § 330(a)(1) (section 330(a)(1) is “subject to sections 326, 328, and 329”)—the court has the authority to grant the fee defense provisions without performing the ASARCO analysis.

After considering each side, the court adopted ASARCO’s ruling as a means of interpreting section 328. Because that section, like section 330(a), does not include a specific and explicit exception to the American Rule, it, like section 330(a), cannot provide authority for approval of the fee defense provisions. The court found it “significant” that several sections of the Bankruptcy Code other than section 328(a) create an express exception to the American Rule. See, e.g., 11 U.S.C. § 303(i)(1)(B) (the court may order unsuccessful involuntary petition filers to pay reasonable attorney fees); 11 U.S.C. § 362(k)(1) (creditor that violates automatic stay could be compelled to pay debtor actual damages, including costs and attorney fees).

Contract exception to the American Rule. The court next turned to whether the committee could contract around the American Rule by including the fee defense provisions in their retention applications. To this end, the court agreed that section 328, like section 330, does not prohibit the fee defense provisions but instead merely does not provide authority to pay such fees. Further, ASARCO specifically acknowledged the existence of a contract exception to the American Rule. As a result, the committee argued, the fee defense provisions could be approved under section 328 as an exception by contract to the American Rule.

The court disagreed. Although it stated that the retention applications were a form of contract, it held “the parties cannot, by contract, violate another provision of the [Bankruptcy] Code.” The court noted that the retention applications are not bilateral and therefore are subject to approval and modification by the court. For that reason, “it is the obligation of the [court] to approve the terms of employment of professionals,” and if the court finds the terms therein impermissible, the court “may not approve it or modify it.” As discussed below, the court found the payments were not within the scope of section 328(a), and therefore the contract itself could not override that provision of the Bankruptcy Code.

Moreover, the contracts here do not fit into the typical contractual exception to the American Rule in that they are not a contract between two parties providing that each will be responsible for the other party’s legal fees if it loses a dispute. Instead, it is a contract between the committee and committee counsel that binds a third party (the estate) to pay fee defense costs. To this end, the court found it compelling that the estate was not a party to the retention application and therefore should not be bound by it.

Scope of section 328(a). The court also ruled the fee defense provisions were not “reasonable terms and conditions of employment” that may be approved under section 328(a) because they fall outside the scope of what is otherwise approvable under that section of the Bankruptcy Code. As noted by the court, defending retention applications is not a service for the committee but is a service performed by committee counsel only for their own interests.

Similarly, the court dispelled the committee’s argument that the fee defense provisions are similar to exculpation and indemnification clauses that may be approved if reasonable. The case law that supports this position, the court noted, all predates ASARCO and none of the cases cited address the American Rule issue. The committee also argued, albeit unsuccessfully, that the fee defense provisions are common in the non-bankruptcy market and are therefore reasonable. The court rejected this argument as well, stating that ASARCO “expressly rejected” the market-driven approach for purposes of section 330 and ruling that the same standard applies in the context of section 328 approval.

Defense fees as expenses. Finally, the court rejected the argument that the defense fees may be reimbursed as expenses rather than costs. The court found no distinction between costs and expenses because both payments by the estate are subject to the American Rule and to the ASARCO decision. To this end, section 330(a)(1), as interpreted in ASARCO, governs both fees and expenses and therefore governs the standard for approval of both types of payments. The court also reiterated that the services performed here would be for the benefit of committee counsel and therefore may not be otherwise approved as reimbursable expenses in performing services for the committee.

Extension of ruling to debtors’ counsel. Although the opinion focuses on retention applications of the committee, the court conspicuously states that it would apply the same rationale to retention agreements between debtors and their counsel. In re Boomerang, slip op. at 22 n.6 (“The Court would reach the same conclusion if the fee defense provisions were in a retention agreement filed by any professional under 328(a)—including one retained by the debtor.”). Judge Shannon and Judge Sontchi have adopted Judge Walrath’s ruling in full since the issuance of this opinion. See In re New Gulf Res., LLC, No. 15-12566 (BLS) (Bankr. D. Del. Mar. 17, 2016), ECF No. 395 (applying holding in Boomerang to “fee premium” request by debtor’s counsel); In re Taylor-Wharton International LLC, No. 15-12075 (BLS) (Bankr. D. Del. Feb. 1, 2016), ECF No. 405 (applying holding in Boomerang to defense fee provisions in committee retention agreements); In re Samson Res. Corp., No. 15-11934 (CSS) (Bankr. D. Del. Feb. 8, 2016), ECF No. 641 (applying holding inBoomerang to defense fee provisions contained in retention agreements of counsel to the debtors).

Conclusion
Ultimately, the court agreed with the UST on each of its objections to the fee defense provisions. In doing so, the court fully adopted the ASARCO opinion as precedent for interpreting section 328. This decision deals a harsh blow to estate professionals, who, pursuant to this decision, must bear their own costs associated with objections to their fees filed by any party in the case. It remains to be seen, however, whether a bankruptcy court would decide differently based on different contractual language in an arm’s-length agreement between a debtor and its counsel for the payment of such fees. Nevertheless, for now, this decision stands as the only published post-ASARCO opinion on recovery of fee-defense-related fees and should be considered by counsel seeking retention by an estate fiduciary. See In re New Gulf, No. 15-12566 (BLS)(letter ruling to counsel); In re Taylor-Wharton, No. 15-12075 (BLS)(same); In re Samson, No. 15-11934 (CSS) (same).

Keywords: bankruptcy and insolvency litigation, fees on fees, section 328; retention application