A. Oversight of the Case
8. Costs in Chapter 11 Cases
Recommended Principles:
• The Bankruptcy Code should be clarified to expressly permit professionals retained pursuant to section 327 or 1103 of the Bankruptcy Code to seek the court’s approval, at the outset of the engagement or of a particular matter, of alternative fee arrangements in lieu of the traditional hourly billing model. Such alternative fee arrangements could include the following: fixed fees, flat fees, task- specific fees, and contingent fees. Courts should assess the reasonableness of, and the potential benefits to the estate from, a professional’s proposed alternative fee arrangement at the time that the court is evaluating the professional’s original retention application or at the outset of the matter or engagement that will be subject to the proposed alternative fee arrangement. The professional seeking an alternative fee arrangement should bear the burden of proving by a preponderance of the evidence that the arrangement is reasonable, has been thoroughly reviewed with the client, and is reasonably likely to be beneficial to the estate. Section 328 should be clarified to incorporate this approval standard.
• Once a court has approved an alternative fee arrangement, it should not alter the approved arrangement once the matter or engagement has terminated unless, in accordance with section 328 as it currently provides, the “terms and conditions [of the arrangement] prove to [be] improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.” Courts should not review alternative fee arrangements under the lodestar method, which is applicable to the hourly billing model.
• Congress should amend sections 328 and 330 to clarify that alternative fee arrangements based in whole or in part on non-hourly billing models are permitted and subject to review solely under section 328, in accordance with the changes proposed in these principles.
200 Such beneficial modifications to section 326(a) might include limiting the exclusionary language of that section to “chapter 7 debtors and individual chapter 11 debtors” (rather than “the debtor”) and expanding the concept of disbursements to moneys, property, or other value disbursed or turned over to parties in interest.
Costs in Chapter 11 Cases: Background
A common critique of chapter 11 is that it is too expensive: distressed companies cannot afford to file for bankruptcy and engage in the process of reorganizing under the protections of the Bankruptcy Code.201 Although commentators debate the accuracy of this statement, the perception persists that chapter 11 is cost-prohibitive for many distressed companies.
The chapter 11 process is not free. It introduces costs into a company’s budget that do not exist
outside the bankruptcy context.202 The debtor in possession also must retain and compensate
bankruptcy professionals to assist with its chapter 11 case.203 Importantly, the debtor’s estate is also responsible for paying the fees and expenses of bankruptcy professionals that are retained by any statutory committees, examiners, and trustees that are appointed in the debtor’s chapter 11 case.204 The estate’s administrative outlay for professionals’ fees is often the focal point of debates concerning the costs of chapter 11.205 Headlines such as Extra! Extra! Tribune Fees Top $150 Million,206 and
American Airlines Bankruptcy Advisors Seek $400 Million in Fees, Expenses207 catch the attention of
201 One prominent bankruptcy attorney at a major law firm observed that “bankruptcy has become so expensive that, ironically, poor companies or businesses with no cash cannot afford to go through the procedure.” Natalie Posgate & Mark Curriden,
American Airlines Insiders Provide Exclusive Behind-the-Scenes Recap of Historic Bankruptcy and Merger, Texas Lawbook (2014), available at http://www.law.smu.edu/getmedia/7430e732-144d-4fbf-ba3a-3273d2be862b/American-Airlines-Insiders-Reprint.
Another seasoned turnaround consultant opined that “the cost of bankruptcy has gotten so high — because of professional and other costs — that the ability to continue the company under current ownership has reached almost zero.” Ian Mount, Adviser to
Businesses Laments Changes to Bankruptcy Law, N.Y. Times (Feb. 29, 2012).
202 For example, currently a company must submit a filing fee of $1,717.00 to the bankruptcy court along with its petition to commence a chapter 11 case. During the pendency of its chapter 11 case, a debtor in possession also must remit quarterly fees to the Office of the U.S. Trustee, which are calculated each quarter based on the amount the debtor disbursed during such quarter. These fees currently range from $325 (for disbursement of $0 to $14,999.99) up to $30,000 (for disbursements of $30,000,000 or more). Pursuant to 11 U.S.C. § 1930(b), the Judicial Conference prescribes filing fees in all cases under the Bankruptcy Code. The current schedule of fees effective as June 1, 2014 is available at http://www.uscourts.gov/FederalCourts/Bankruptcy/ BankruptcyResources/BankruptcyFilingFees.aspx. Bankruptcy courts enforce these filing fees. See, e.g., Fee Schedule, United States of Bankruptcy Court, District of Delaware (effective June 1, 2014), available at http://www.deb.uscourts.gov/fee-schedule; Fee Schedule, United States of Bankruptcy Court, Southern District of New York (effective June 1, 2014), available at http://www. nysb.uscourts.gov/sites/default/files/pdf/filingFees.pdf.
203 The Administrative Office of the U.S. Courts on behalf of the Federal Judiciary advises that “[c]orporations and partnerships must have an attorney to file a bankruptcy case. While individuals can file a bankruptcy case without an attorney or ‘pro se,’ it is extremely difficult to do it successfully.” Filing for Bankruptcy Without an Attorney, http://www.uscourts.gov/FederalCourts/ Bankruptcy/BankruptcyResources/FilingBankruptcyWithoutAttorney.aspx.
204 Bankruptcy Code section 330 provides for compensation of all professionals — not just professionals retained by the debtor — whose retention was approved by the court. Specifically, section 330(a) provides, in relevant part:
[T]he court may award to a trustee, a consumer privacy ombudsman appointed under section 332, an examiner, an ombudsman appointed under section 333, or a professional person employed under section 327 or 1103 —
(A) reasonable compensation for actual, necessary services rendered by the trustee, examiner, ombudsman, professional person, or attorney and by any paraprofessional person employed by any such person; and
(B) reimbursement for actual, necessary expenses.
11 U.S.C. § 330(a). A 2007 comprehensive study of professionals’ fees in bankruptcy revealed that “[c]ommittee professionals cost the estate about two-fifths of what the debtor’s professionals cost.” Jesse Greenspan, Time Spent In Chapter 11 Doesn’t
Affect Costs: Study, Law 360 (Dec. 7, 2007, 12:00 AM), http://www.law360.com/articles/41896/time-spent-in-chapter-11-doesn-
t-affect-costs-study.
205 But see Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44, at 144 (“[T]oo much of the debate about chapter 11 costs rests on a false premise . . . that professional fees in bankruptcy represent nothing more than wealth transfers, taking value from creditors and giving it to bankruptcy professionals”). A recent study of professionals’ fees found that “[i]n almost 35% of [chapter 11] cases, professionals received no payment whatsoever,” and typically these cases were smaller and were often converted to chapter 7 or dismissed. Greenspan, supra note 204. Based on a 2008 study of professionals’ fees, Professor Lubben concluded that factors like the size of the debtor, the number of professionals retained, and whether a committee is appointed, which are all proxies for the complexity of the case, have much more significant effects on costs, as compared to the time spent in chapter 11, and that professionals’ fees in chapter 11 are subject to economies of scale, especially in larger cases. Stephen J. Lubben, Corporate Reorganization & Professional Fees, 82 Am. Bankr. L.J. 77, 79–80 (2008).
206 Eric Morath, Extra! Extra! Tribune Fees Top $150 Million, Wall St. J. Blog (May 25, 2011, 3:54 PM), http://blogs.wsj.com/ bankruptcy/2011/05/25/extra-extra-tribune-fees-top-150-million/.
207 Sara Randazzo, American Airlines Bankruptcy Advisers Seek $400 Million for Fees, Expenses, Wall St. J. (June 26, 2014, 4:20 PM), http://online.wsj.com/articles/american-airlines-bankruptcy-advisers-seek-400-million-for-fees-expenses-1403814038.
policymakers and the public alike, but a look behind the numbers cited in these headlines may reveal a different story.208 In fact, empirical studies show that the total amount in professionals’ fees in a chapter 11 case is generally a modest percentage of the debtor’s assets, revenues, and distributions to creditors.209 But these studies do not change the perception — whether or not accurate — that every dollar an estate pays in chapter 11 costs is one less dollar available to pay creditors.210 As pointed out by one professor who has studied professionals’ fees extensively, this perception necessarily ignores the value that professionals add to the estate during the pendency of a chapter 11 case for the benefit of all parties in interest.211
The U.S. Trustee and some commentators have criticized not only the overall amount of professionals’ fees, but also the hourly rates of bankruptcy professionals, particularly in large chapter 11 cases.212 The Office of the U.S. Trustee, for example, has raised concerns about lawyers charging hourly rates of $1,000 or more in some of the larger chapter 11 cases.213 These and other compensation concerns recently led the Office of the U.S. Trustee to propose and ultimately adopt fee guidelines specifically applicable to professionals in chapter 11 cases involving $50 million or more in assets or liabilities.214
208 It is noteworthy that the court-appointed fee examiner recommended that the bankruptcy court approve the fees and expenses for 47 professional firms in the American Airlines case in the amount of nearly $400 million, noting that these professionals engineered “perhaps the most efficient airline reorganization case on record.” Id. (The fee examiner in the American Airlines case was Robert Keach, Co-Chair of the Commission. In addition, several other Commissioners were involved in the American
Airlines case.) Indeed, the value created in the merger of American Airlines and US Airways as part of American Airlines’
reorganization plan resulted in all of American Airlines’ creditors receiving full value on their claims and American Airlines’ shareholders receiving shares amounting to approximately 40 percent of the merged company — at a market cap that exceeded the stand-alone value of American Airlines at any prior point in its history. Scholars have not analyzed whether the cost of fee examiners exceeds their benefit to the estate.
209 Professor Lubben’s study revealed that across all bankruptcy cases, and even across large chapter 11 cases specifically, professionals’ fees totaled 4.0 percent to 4.5 percent of the sum of the debtor’s assets and debts. Lubben, Corporate Reorganization & Professional
Fees, supra note 205, at 103. See also Greenspan, supra note 204. These results are consistent with earlier fee studies. Based on a
2004 study of large chapter 11 reorganization cases filed from 1980 through April 2003, Professors LoPucki and Doherty found that some of the largest debtor cases expended less than 3 percent of their total assets to pay for professionals’ fees. Lynn M. LoPucki & Joseph W. Doherty, The Determinants of Professional Fees in Large Bankruptcy Reorganization Cases, 1 J. Empirical Legal Stud. 111, 140 (2004) (“For a group of 48 firms with assets ranging from about $65 million to $7.5 billion, and averaging $881 million, we found that total fees and expenses were 1.4 percent of total assets reported in the court file at the beginning of the bankruptcy case, and that firms expended, on average, 2.2 percent of assets on professional fees (1.9 percent after the removal of a single outlier).”). Professors LoPucki and Doherty explained that economies of scale were at play in large chapter 11 cases, such that the larger the debtor, the lower the ratio of restructuring fees and expenses the debtor incurred relative to its assets.
Id. at 126. Earlier, Professor Baird also observed that the direct costs of bankruptcy for large, publicly traded companies was
relatively small, between 0.9 percent and 7.0 percent, and an average of 2.8 percent, of the book value of the assets before the filing of the bankruptcy petition, which was comparable to or less than the costs of an initial public offering, private placement, or leveraged buyout. Douglas G. Baird, The Hidden Virtues of Chapter 11: An Overview of the Law and Economics of Financially
Distressed Firms, Coase-Sandor Inst. for L. & Econ. Working Paper No. 43, 1997, at 11–12, available at http://chicagounbound.
uchicago.edu/law_and_economics/527/.
210 Under Bankruptcy Code section 503(b)(2), “compensation and reimbursement awarded under section 330(a) of [the Bankruptcy Code]” are classified as “administrative claims.” 11 U.S.C. § 503(b)(2). Section 507, which sets forth the priority order for the payment of unsecured creditors, elevates the payment of “administrative expenses allowed under section 503(b)” above the payment of all other unsecured debts (except domestic support obligations). 11 U.S.C. § 507(a)(1). Therefore, in a chapter 11 case that cannot support full recoveries to all creditors, administrative claims reduce the amount of funds that will be available for distribution to unsecured creditors.
211 “Being in chapter 11 means that creditors’ recovery on their claims becomes higher than zero. The professional fees are the cost of moving to that higher recovery. The notion that money paid to professionals belongs to creditors is true only if the creditors could realize that value without the professionals.” Lubben, What We “Know” About Chapter 11 Cost is Wrong, supra note 44, at 144. “The cost paid to chapter 11 professionals is an example of the old truism that sometimes you have to spend money to make money. In chapter 11, creditors have to spend some money to recover some of what is due to them. In the main, the value of chapter 11 professionals’ time was never a value that creditors could capture. Pretending that fees paid to professionals represents a real loss to the creditors demonstrates little more than muddled thinking.” Id. at 145.
212 Nancy B. Rapoport, Rethinking Professional Fees in Chapter 11 Cases, 5 J. Bus. & Tech. L. 263, 270–271 & n. 28 (2010), available
at http://digitalcommons.law.umaryland.edu/jbtl/vol5/iss2/5 (summarizing published criticisms of professionals’ fees in chapter
11 context).
213 Jacqueline Palank, $1,000/Hour Bankruptcies: Attorneys Justify Their Fees, Wall St. J. (June 3, 2012, 6:29 PM) (“The Justice Department has grown increasingly restless with attorney fees — often exceeding $1,000 an hour — paid by companies going through a bankruptcy reorganization.”).
214 The new fee guidelines became effective for cases filed on or after November 1, 2013. Appendix B — Guidelines for Reviewing Applications for Compensation and Reimbursement of Expenses Filed Under 11 U.S.C. § 330 by Attorneys in Larger Chapter 11 Cases, 78 Fed. Reg. 36,248, 36,249 (June 17, 2013), available at http://www.justice.gov/ust/eo/rules_regulations/guidelines/docs/ Fee_Guidelines.pdf [hereinafter UST Fee Guidelines]. “Generally, the final guidelines provide for a showing that rates charged
The stated goals of the new fee guidelines are to, among other things, “ensure that bankruptcy professionals are subject to the same client-driven market forces, scrutiny, and accountability as professionals in nonbankruptcy engagements;” “increase disclosure and transparency in the billing practices of professionals seeking compensation from the estate;” and “increase public confidence
in the integrity and soundness of the bankruptcy compensation process.”215 Notably, only a small
number of chapter 11 cases fall within these new fee guidelines.216
Additionally, the increasing cost of chapter 11 has had a significant impact on the perceived ability — and perhaps actual ability — of small and middle-market companies seeking restructuring options
to invoke chapter 11.217 One commentator observed that, based on a small sampling of cases filed
in 2010 in the Southern District of New York, “professional fees for the middle-market Chapter
11 cases typically approached or exceeded $1 million.”218 This commentator suggested that high
professionals’ fees, among other factors,219 have encouraged lawyers representing middle-market
companies to pursue alternatives to traditional chapter 11 reorganization, such as section 363 asset sales on an expedited basis, followed by a liquidating plan, or to invoke alternatives under state law, including general assignments for the benefit of creditors and composition agreements to restructure debt.220 Although this particular study was limited in size and geographic area, the commentator’s findings mirror the testimony and anecdotal evidence presented to the Commission during its study process.221
reflect market rates outside of bankruptcy; the use of budgets and staffing plans; the disclosure of rate increases that occur during the representation; the submission of billing records in an open, searchable electronic format; and the use of fee examiners and ‘efficiency’ counsel.” Statement of Clifford J. White III, Director, Executive Office for United States Trustees, U.S. Department of
Justice, before the Subcomm. on Regulatory Reform, Commercial and Antitrust Law of H. Comm. on the Judiciary, at 10 (Sept. 19,
2014) [hereinafter White Statement]. For a one-page summary of the UST Fee Guidelines prepared by the U.S. Department of Justice, see Summary of Material Differences from 1996 Guidelines, http://www.justice.gov/ust/eo/rules_regulations/guidelines/ docs/One_Page_Summary_AppxB_Guidelines.pdf. See also Marina Fineman, For Lawyers Only: New Fee Application Guidelines
for Attorneys in Large Chapter 11 Cases, ABI Ethics & Professional Compensation Committee News, Vol. 10, no. 4, available at
http://www.abiworld.org/committees/newsletters/ethics-and-professional-compensation/vol10num4/lawyers.html.
215 UST Fee Guidelines, supra note 214, at 36,251–36,254. See also White Statement, supra note 214, at 10 (explaining objectives underlying study of fees leading to new fee guidelines as including “(1) ensur[ing] that fee review is subject to client-driven market forces, accountability, and scrutiny; (2) enhance[ing] meaningful disclosure and transparency in billing practices; (3) decreas[ing] the administrative burden of review; (4) maintain[ing] the burden of proof on the fee proponent; and (5) increase[ing] public confidence in the integrity and soundness of the bankruptcy compensation process”).
216 The UST Fee Guidelines apply only to the so-called mega-chapter 11 cases, which are referred to as “larger chapter 11 cases.” A “larger chapter 11 case” is defined as “a chapter 11 case with $50 million or more in assets and $50 million or more in liabilities, aggregated for jointly administered cases and excluding single asset real estate cases as defined in 11 U.S.C. § 101(51B).” UST
Fee Guidelines, supra note 214, at 36,249. See also Fee Guidelines for Attorneys in Larger Chapter 11 Cases, http://www.justice.
gov/ust/eo/rules_regulations/guidelines/; White Statement, supra note 214, at 10 (“To date, 61 cases have been filed to which the guidelines apply, and we are monitoring them closely.”).
217 With respect to small and middle-market companies, “if they have to go into Chapter 11, the odds of the owners keeping the business are much lower. So there’s no incentive for the owners to enter Chapter 11 and reorganize. Why save a company for somebody else?” Mount, supra note 201.
218 Jeffrey A. Wurst, Is Chapter 11 Still a Viable Option or Has High Cost Rendered the Process Unaffordable?, ABJ Journal, Mar. 2013, at 57.
219 “There are several reasons why traditional reorganizations have been sparse. Amongst them are: 1.) the high cost of professional fees; 2.) uncertainty as to the outcome; 3.) lack of availability of unencumbered assets that otherwise may be utilized to secure a DIP lending facility or to fund post-petition obligations under a plan of reorganization; and 4.) alternatives such as out-of-court restructurings and assignments for the benefit of creditors.” Id. at 56.
220 “Liquidating Chapter 11 cases, for better or worse, have been the rule and not the exception in this Court and others over the last decade, if not longer.” Id. (quoting In re Applied Theory Corp., Case No. 02-11868 (Bankr. S.D.N.Y. Apr. 24, 2008) (Gerber, J.)). A study of approximately 60 chapter 11 cases filed in 2010 in the U.S. Bankruptcy Court for the Southern District of New York concluded that alternatives to chapter 11 proved to be more affordable for middle-market debtors. For example, although professionals’ fees typically approached or exceeded $1 million for a chapter 11 reorganization, “sales of assets pursuant to § 363 of the Bankruptcy Code, coupled with a structured dismissal, resulted in significantly lower fees, especially in those cases where the sale was conducted very early in the proceedings.” Id. at 57. “Out-of-court restructurings have become a more favorable alternative by streamlining the restructuring process allowing cost savings to be passed down to the creditor body.” Id. Assignments for the benefit of creditors (“ABCs”) as well as composition agreements to restructure debt have become low-cost alternatives to chapter 11 reorganization, and in some cases, even alternatives to section 363 sales. Id.
221 See, e.g., John Haggerty, Written Statement to the Commission (Apr. 19, 2013) (“In the last ten years, there has been an increase in the use of out-of-court alternatives . . . because the process is too time consuming and complex, and as a result, too costly.”),