September 30, 2015 Top Story

Fees Incurred in Defending Fee Application Not Recoverable

SCOTUS says Bankruptcy Code does not exempt costs of fee-litigation from American Rule

Catherine R. McLeod

Attorneys seeking to recover fees incurred in defending a fee application in bankruptcy court may not do so, according to the United States Supreme Court. In a divided opinion, the majority held that the Bankruptcy Code does not expressly allow recovery for defending a fee application. Thus, the “American Rule,” which requires each litigant to pay its own attorney fees and costs unless a statute or contract provides otherwise, bars recovery. The decision highlights that only work that directly benefits the estate will be compensated.

The Fee Application

In Baker Botts L.L.P., et al. v. ASARCO LLC, the bankruptcy trustee retained two law firms on the debtor’s behalf pursuant to Section 327(a) of the Bankruptcy Code, which allows court appointment of attorneys to assist the trustee in representing the bankruptcy estate. When the debtor emerged from bankruptcy, the attorneys requested their fees pursuant to Section 330(a). That provision allows “reasonable compensation for actual, necessary services” rendered by appointed attorneys.

The U.S. Bankruptcy Court for the Southern District of Texas awarded the law firms $120 million in fees for work related to administering the estate, and an additional $5 million for time spent defending their fee applications from ASARCO’s objections. ASARCO appealed the $5 million fee award only, and the district court affirmed. The U.S. Court of Appeals for the Fifth Circuit reversed, holding that Section 330(a)(1) does not authorize fee awards for defending fee applications and only permits compensation of services that benefit the debtor’s estate. Because fee-defense litigation benefits only the attorney, the Fifth Circuit ruled that Section 330(a)(1) does not exempt such fees from the American Rule.

Majority Strictly Interprets Section 330(a)

In a majority opinion authored by Justice Thomas, the Court agreed with the Fifth Circuit’s strict interpretation of the Bankruptcy Code. In construing the Code, the majority observed that attorneys are to provide services benefiting the estate under Section 327(a). The Court further held that Section 330(a) allows only “reasonable compensation for actual, necessary services rendered,” which implies “loyal and disinterested service” to the estate. The majority declined to include subsequent fee-defense litigation in the definition of “services,” finding the adversarial process to be of no benefit to the estate administrator.

The Court further reasoned that such a reading could potentially compensate attorneys for unsuccessful fee-defense litigation, which would run counter to the idea that fee-shifting provisions usually compensate prevailing parties. The Court found that litigation of a fee application does not constitute compensable disinterested services to the estate administrator.

The majority further concluded that Congress did not intend to allow recovery for fee-defense litigation under Section 330(a) because other Bankruptcy Code provisions, such as Section 110(i), expressly provide for such fee-shifting. The majority also observed that the language of Section 330(a) did not track the language of other statutes with “clear” fee-shifting provisions, such as that found in the Equal Justice to Access Act.

The Act states, “a court shall award to a prevailing party other than the United States fees and other expenses . . . incurred by that party in any civil action (other than cases sounding in tort) . . .” Finally, the majority rejected arguments that its holding would unfairly force the bankruptcy bar to absorb the costs of challenges to their fees because it was bound to follow the statutory text.

Dissent Says Reasonable Compensation Encompasses Fee-Defense Litigation

The dissenting justices agreed that fee-defense litigation does not constitute compensable services to the estate under Section 330(a). Citing concerns of fee dilution, the dissent would have allowed recovery under the broad discretion of courts to consider “all relevant factors,” including work performed in defending a fee application, in determining what constitutes “reasonable compensation.” Specifically, the dissent rejected the majority’s distinction between the costs of fee preparation and fee litigation, arguing that fee-defense work should only be recoverable where necessary to secure payment for the underlying services.

The dissent reasoned that “[d]enying attorneys’ fees for time spent in obtaining them would dilute the value of a fees award by forcing attorneys into extensive, uncompensated litigation in order to gain any fees.” The dissent also argued that a contrary interpretation would undermine the statutory purpose of ensuring high-quality attorneys will represent bankruptcy estates.

ASARCO’s Effect on the Bankruptcy Bar Too Soon to Predict

ABA Section of Litigation leaders predict that the bankruptcy bar may attempt to circumvent the ruling by requiring payment of fee-defense litigation in the engagement agreement. Whether such provisions would be enforced remains to be seen.

“When you represent a commercial debtor, you are taking on an economic risk, and the ASARCO ruling has increased that risk,” says Ronald R. Peterson, Chicago, IL, chair of the ABA Section of Litigation’s Ponzi Scheme Task Force Subcommittee of the Bankruptcy & Insolvency Litigation Committee. Because of this increased risk, “judges may be more inclined than not to approve fee-defense clauses, at least in commercial bankruptcies,” he predicts.

Other Section leaders disagree, citing ethical concerns. Section 327(a) attorneys owe a fiduciary duty to the bankruptcy estate, and a fee-defense clause in an engagement letter could create a conflict of interest between the attorney and the estate. “There is a tension between attracting competent bankruptcy attorneys with the competing interest of maximizing recovery for the creditors. The more you spend for professionals, the less there is left to be distributed,” explains William S. Katchen, Florham Park, NJ, chair of the Section of Litigation’s Conflicts and Ethics Subcommittee of the Bankruptcy & Insolvency Litigation Committee. “The American Rule has an exception for contracts, but where a lawyer creates a potential that his loyalties are divided, I’m not sure the court would think it was proper,” he states.

Whether fee-defense clauses are upheld ultimately “will depend on the judge and the facts of the case. Only time will tell,” says Peterson. Despite the potential for more fee-dispute litigation, it is unlikely the ASARCO ruling will make bankruptcy cases more expensive. “If the courts refuse to approve fee-defense clauses and fee-objection litigation increases, then bankruptcy attorneys’ rates could go up, but you would have to have both of these elements,” Peterson states.

Catherine R. McLeod is a contributing editor for Litigation News.

Keywords: American Rule, bankruptcy, attorney fees, fee application, fee award, 11 U.S.C. § 327, 11 U.S.C. § 330

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