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Supreme Court Grants Cert on, of all Things, the Standard of Review for Determining Non-Statutory Insider Status

April 26, 2017

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Last December, we updated you that the Supreme Court was considering whether to grant review of In re The Village at Lakeridge, LLC, 814 F.3d 993 (9th Cir. 2016). Our original post is here.  On March 27, 2017, the Supreme Court granted review of Village at Lakeridge, but only as to one question presented, the most boring one in our view.  (Seems like after giving us bankruptcy professionals a thrill with a deep, insightful, and important ruling like Jevic, the Supreme Court is going back to bankruptcy matters that range from the esoteric to the downright irrelevant; oh well.)

In The Village at Lakeridge, a non-statutory insider acquired a $2.76 million claim against the debtor from an insider for $5,000.  Id. at 997.  The debtor attempted to confirm its plan (which included a cramdown of U.S. Bank’s claim) by arguing that the assignee of the insider claim provided the debtor an impaired consenting class.  U.S. Bank moved to designate the assignee’s claim on the basis that he was both a statutory and non-statutory insider, and that the assignment was made in bad faith.  Id. at 997-98.  The bankruptcy court designated the claim and ruled that the assignee was not entitled to vote because, when the claim was assigned, he acquired the insider status of the assignor as a matter of law.  Id. at 998.  However, the bankruptcy court ruled that the assignee was not himself an insider and the assignment was not made in bad faith.  Id.

The United States Bankruptcy Appellate Panel for the Ninth Circuit reversed the bankruptcy court’s ruling that the assignee acquired insider status by way of assignment and affirmed the bankruptcy court’s determinations that the assignee was not himself an insider and the assignment was not made in bad faith. Id.  Three years later (!!), the Ninth Circuit affirmed.

As we advised you in December, U.S. Bank presented three questions that it urged merited review.  Its second question was:  “Whether the appropriate standard of review for determining non-statutory insider status is the de novo standard of review applied by the Third, Seventh, and Tenth Circuit Courts of Appeal, or the clearly erroneous standard of review adopted for the first time by the Ninth Circuit Court of Appeal in this action.”  U.S. Bank’s Petition for a Writ of Certiorari, at i.

U.S. Bank argued a circuit split exists on the standard of review that should be applied to a determination of insider status.  Id. at 19.  U.S. Bank alleged that the Ninth Circuit’s review of the bankruptcy court’s determination of non-statutory insider status for clear error directly conflicts with the standard of review employed by the majority of circuit courts in the Third, Seventh, Tenth, and Eleventh Circuits, which hold that questions of insider status are mixed questions of law and fact to be reviewed de novo.  Id. at 19-20 (citing Schubert v. Lucent Tech. Inc. (In re Winstar Comm’ns., Inc.), 554 F.3d 382, 395 (3d Cir. 2009); In re Longview Aluminum, L.L.C., 657 F.3d 507, 509 (7th Cir. 2011); In re Krehl, 86 F.3d 737, 742 (7th Cir. 1996); Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1275 (10th Cir. 2008); Miami Police Relief & Pension Fund v. Tabas (In re The Florida Fund of Coral Gables, Ltd.), 144 Fed. Appx. 72, 74 (11th Cir. 2005).

On March 27, 2017, the United States Supreme Court granted U.S. Bank’s petition for writ of certiorari, but only as to the question of the proper standard of review.  Case updates for In re The Village at Lakeridge, LLC are available here.

Potential Ramifications

Affirming the appellate rulings in Village at Lakeridge could increase efforts by debtors to confirm plans by assigning insider claims to friendly non-insiders who will vote for the plan.

On the other hand, a ruling in this case could add some clarity to the other little circuit split on whether an assignee of a claim (such as a claims buyer) takes a claim subject to impediments such as potential disallowance due to the claim seller’s receipt of a preference, or whether the assignment frees the claim of such impediments (which is a huge windfall to the claimant, we think).   A great summary of this split – which is far more interesting, in the view of the Bankruptcy Cave – can be found here in an very good article by Simon Fraser of Cozen O’Connor and Benjamin Klehr of Cohen Pollock.

Stay tuned for more developments on this case.

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Tenth Circuit Joins Missouri River to Divide Kansas City Over What Constitutes A Stay Violation

March 22, 2017

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On February 27, 2017, the United States Court of Appeals for the Tenth Circuit joined a minority approach followed by District of Columbia Circuit:  failing to turn over property after demand is not a violation of the automatic stay imposed by 11 U.S.C. § 362.  WD Equipment v. Cowen (In re Cowen), No. 15-1413, — F.3d —-, 2017 WL 745596 (10th Cir. Feb. 27, 2017), opinion here.

In Cowen, one secured creditor (WD Equipment) repossessed a vehicle in need of repairs for which the debtor (Cowen) could not pay.  Id. at *1.  Another secured creditor (Dring, the debtor’s father-in-law who is likely no longer welcome at Thanksgiving) repossessed a separate vehicle through the use of false pretenses, a can of mace, and five goons helpful colleagues:

“Mr. Dring lured Mr. Cowen under false pretenses to his place of business to repossess the Kenworth [truck].  Mr. Dring asked Mr. Cowen, who had brought along his young son, to leave the keys in the ignition, engine running, and to step out of the truck.  As Mr. Cowen exited the vehicle, Mr. Dring jumped in, grabbed the keys, and declared the truck ‘repossessed.’  When Mr. Cowen asked what was going on, Mr. Dring told him to take his son and leave—immediately.  A group of five men gathered around Mr. Dring while he brandished a can of mace above his head and threatened to use it if Mr. Cowen did not leave.  Mr. Cowen pushed his young son behind him to protect him, and the two left the lot on foot.” Id.

(Editor’s Note from the Bankruptcy Cave:  You can’t find these stories anywhere in the judicial system except in Bankruptcy Court; we love it.  Here is also a Bankruptcy Cave rendering of what we think these fine young lads looked like.)

Dangerous zone

 

 

Within days of the repossessions, Cowen filed for chapter 13 bankruptcy protection in the Bankruptcy Court of the District of Colorado and demanded the return of both trucks, but WD Equipment and Dring both refused.  Id.  Cowen then obtained a show cause order from the bankruptcy court, which ordered the Defendants to “immediately turn over” the trucks to Mr. Cowen; “[c]ontinuing failure to turn over the Truck[s],” the bankruptcy court warned, “may result in the imposition of monetary damages against the Creditors for willful violation of the automatic stay.”   Id. at *2.

After the Defendants failed to comply with the bankruptcy court’s show cause order, Cowen instituted an adversary proceeding against Defendants WD Equipment and Dring for willful violation of the automatic stay.  Id.  During the adversary proceeding, the Defendants argued that Cowen’s rights in the trucks had been properly terminated by Defendants before the bankruptcy petition was filed.  But the bankruptcy court did not find the Defendants’ testimony credible, found that Defendants likely manufactured and forged documents regarding transfer of title, and found that because Defendants’ actions contravened Colorado law, Defendants did not effectively terminate Cowen’s ownership interest in the Trucks.  The bankruptcy court ultimately concluded, “[f]ailing to return the Trucks violated § 362(a)(3) of the Bankruptcy Code,” and it imposed actual and punitive damages under 11 U.S.C. § 362(k)(1). Id.

The district court affirmed, noting that the bankruptcy court had applied the majority rule followed by the Second, Seventh, Eighth, and Ninth Circuits: “that the act of passively holding onto an asset constitutes ‘exercising control’ over it, and such action violates section 362(a)(3) of the Bankruptcy Code.” Id. at *4 (citing Thompson v. Gen. Motors Acceptance Corp., 566 F.3d 699, 703 (7th Cir. 2009); Weber v. SEFCU (In re Weber), 719 F.3d 72, 81 (2d Cir. 2013), California Emp’t Dev. Dep’t v. Taxel (In re Del Mission Ltd.), 98 F.3d 1147, 1151 (9th Cir. 1996), Knaus v. Concordia Lumber Co. (In re Knaus), 889 F.2d 773, 775 (8th Cir. 1989), Unified People’s Fed. Credit Union v. Yates (In re Yates), 332 B.R. 1, 4 (10th Cir. BAP 2005).

The Tenth Circuit reasoned that the majority approach relied too much on legislative history and “practical considerations.”  Id.  In choosing to follow the minority approach followed by the D.C. Circuit (see United States v. Inslaw, 932 F.2d 1467, 1474 (D.C. Cir. 1991)), the Tenth  Circuit stated as follows:

Here again is § 362(a)(3), in relevant part: a bankruptcy petition “operates as a stay … of … any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” Breaking down the sentence, “any act” is the prepositive modifier of both infinitive phrases.  In other words, § 362(a)(3) prohibits “any act to obtain possession of property” or “any act to exercise control over property.”  “Act”, in turn, commonly means to “take action” or “do something.” New Oxford American Dictionary 15 (3d ed. 2010) (primary definition of “act”).  This section, then, stays entities from doing something to obtain possession of or to exercise control over the estate’s property. It does not cover “the act of passively holding onto an asset,” Thompson, 566 F.3d at 703, nor does it impose an affirmative obligation to turnover property to the estate.  “The automatic stay, as its name suggests, serves as a restraint only on acts to gain possession or control over property of the estate.”  Inslaw, 932 F.2d at 1474.  Stay means stay, not go.

Id. The Tenth Circuit concluded: “[a]nd so, adhering to the text of the statute, as we must, we adopt the minority rule: only affirmative acts to gain possession of, or to exercise control over, property of the estate violate § 362(a)(3).  Id. at *5.

Despite the reversal, the Defendants were not absolved of liability.  While simply refusing to turn over the trucks did not constitute affirmative acts of the Defendants, the Tenth Circuit stated that the Defendants’ manufacturing of paperwork, forging of documents, potentially perjured testimony, and coaching of witnesses, “would qualify as post-petition acts to exercise control over the debtor’s property in violation of the automatic stay.”  Id. at *6.

Potential Ramifications

Cowen could prove useful to banks and credit card companies who are faced with allegations that account freezes violate the automatic stay.   Cowen will also necessitate that lawyers practicing on the borders of the D.C. or Tenth Circuits (such as in Kansas City, which is divided between the Eighth and Tenth Circuits) be mindful of the location of repossessions and turnover demands and denials.

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Supreme Court Weighs Granting Cert on Bankruptcy Issues Involving Surcharge and Voting Rights of Assignee of Insider Claim

December 5, 2016

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The Supreme Court is considering whether to grant review of two bankruptcy cases.  On October 3, 2016, the Supreme Court invited the Solicitor General to file briefs expressing the views of the United States.  Because the Supreme Court’s justices normally give significant weight to the federal government’s recommendations regarding interpretations of federal statutes (here, the Bankruptcy Code), the Solicitor General’s forthcoming briefs could influence whether the Supreme Court grants cert. on the two notable bankruptcy cases.

Southwest Securities v. Segner

The first case under consideration is Southwest Securities v. Segner (In re Domistyle, Inc.)811 F.3d 691 (5th Cir. 2015).  At the commencement of this case, the trustee believed the debtor possessed equity in certain real property that could benefit unsecured creditors.  Id. at 693-94.  The property was encumbered by Southwest Securities’ lien.  After marketing the property for a year, the trustee was unable to sell the property and ultimately abandoned it to Southwest and moved to surcharge Southwest for the expenses paid in maintaining the property from the start of the case.  Id. at 694-95.  The Bankruptcy Court for the Eastern District of Texas approved the surcharge over Southwest’s objection that the expenses were incurred to benefit unsecured creditors, and not Southwest.

To surcharge a lender for expenses under 11 U.S.C. sec. 506(c), the trustee bears the burden of proving that: “(1) the expenditure was necessary, (2) the amounts expended were reasonable, and (3) the creditor benefitted from the expenses.”  Id. at 695 (quoting In re Delta Towers, Ltd., 924 F.2d 74, 76 (5th Cir.1991)).  Southwest argued the surcharge was improper because, among other things, the bankruptcy court incorrectly found that the expenses were incurred “primarily” for its benefit simply because it ended up being the only creditor who received any payment from the property.  Id. at 695-96.

Southwest relied on language in Delta Towers that “require[ed] that the claimant incur the expenses primarily for the benefit of the secured creditor.” 924 F.2d at 77 (emphasis added).  In rejecting Southwest’s arguments, the Fifth Circuit reasoned that the word “primarily” is absent from the statute and Section 506(c) did not include an express requirement that funds be spent with any particular beneficiary in mind.  811 F.3d at 696.  The Fifth Circuit affirmed the surcharge because there was a direct relationship between the expenses and the collateral, evidenced by the fact that all of the surcharged expenses related only to preserving the value of the property and preparing it for sale.  Id. at 696.  The Fifth Circuit also noted the equitable nature of the statute, and that there was no evidence that Southwest could have sold the property earlier and thereby avoided the ongoing property preservation and maintenance expenses for which it was surcharged.  Id. at 699.

Finally, in weighing whether to grant cert., the Supreme Court will consider whether a circuit split exists.  Southwest argues that the Fifth Circuit’s opinion conflicts with In re Trim-X, Inc., 695 F.2d 296 (7th Cir. 1982) (holding that “expenses incurred prior to the time the trustee determined [the estate] had no equity in the assets were not for the benefit” of the secured creditor) and split panels from at least two other courts of appeals.  See Loudoun Leasing Dev. Co. v. Ford Motor Credit Co. (In re K&L Lakeland, Inc.), 128 F.3d 203 (4th Cir. 1997); Brookfield Prod. Credit Ass’n v. Barron, 738 F.2d 951 (8th Cir. 1984).

The trustee argued that there is no circuit split because the surcharge was to reimburse for benefits to Southwest itself, not potential benefits to unsecured creditors.  Response of Milo H. Segner, Jr., Trustee, in Opposition to Petition for a Writ of Certiorari, at 18-19.

U.S. Bank v. Village at Lakeridge

In The Village at Lakeridge, a non-statutory insider acquired a $2.76 million claim against the debtor from an insider for $5,000.  In re The Village at Lakeridge, LLC, 814 F.3d 993, 997 (9th Cir. 2016).  The debtor attempted to confirm its plan (which included a cramdown of U.S. Bank’s claim) by arguing that the assignee of the insider claim provided the debtor an impaired, consenting class.  U.S. Bank moved to designate the assignee’s claim on the basis that he was both a statutory and non-statutory insider, and that the assignment was made in bad faith.  Id. at 997-98.  The bankruptcy court designated the claim and ruled that the assignee was not entitled to vote because, when the claim was assigned, he acquired the insider status of the assignor as a matter of law.  Id. at 998.  However, the bankruptcy court ruled that the assignee was not himself an insider and the assignment was not made in bad faith. Id.

The Bankruptcy Appellate Panel for the Ninth Circuit reversed the bankruptcy court’s ruling that the assignee acquired insider status by way of assignment and affirmed the bankruptcy court’s determinations that the assignee was not himself an insider and the assignment was not made in bad faith.  The Ninth Circuit then affirmed the BAP.  Id.

In its Petition for a Writ of Certiorari, U.S. Bank urged that review is warranted for three fundamental reasons.  First, U.S. Bank argued that the Ninth Circuit’s ruling allows an insider claim to be transferred to a third party for the purpose of circumventing the Bankruptcy Code’s statutory prohibition against insider voting under 11 U.S.C. § 1129(a)(10).  U.S. Bank’s Petition for a Writ of Certiorari, at 7-8.  U.S. Bank argued that the Ninth Circuit’s holding ignores the general law of assignment, which holds that an assignment transfers all disabilities of the assignor (here, insider status) to the assignee.  Id. at 8.  (By the way, we at The Bankruptcy Cave would absolutely love it if, assuming cert is granted, the opinion can also resolve whether as assignee of a claim take it subject to disallowance impediments under Section 502(d) of the Code, or if an assignee cannot have its claim disallowed due to prior fraudulent transfers or preferences paid to the assignee.  This split is discussed here, courtesy of a post by our friends at Andrews & Kurth.)

Second, U.S. Bank argues a circuit split exists on the standard of review that should be applied to a determination of insider status.  Id. at 19.  U.S. Bank alleged that the Ninth Circuit’s review of the bankruptcy court’s determination of non-statutory insider status for clear error directly conflicts with the standard of review employed by the majority of circuit courts in the Third, Seventh, Tenth and Eleventh Circuits, which hold that questions of insider status are mixed questions of law and fact to be reviewed de novo.  Id. at 19-20 (citing Schubert v. Lucent Tech. Inc. (In re Winstar Comm’ns., Inc.), 554 F.3d 382, 395 (3d Cir. 2009); In re Longview Aluminum, L.L.C., 657 F.3d 507, 509 (7th Cir. 2011); In re Krehl, 86 F.3d 737, 742 (7th Cir. 1996); Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1275 (10th Cir. 2008); and Miami Police Relief & Pension Fund v. Tabas (In re The Florida Fund of Coral Gables, Ltd.), 144 Fed. Appx. 72, 74 (11th Cir. 2005)).

Third, U.S. Bank argued a circuit split also exists on the proper test for determining nonstatutory insider.  Id. at 24.  Specifically, U.S. Bank argued the Supreme Court should resolve whether courts are to conduct an “arm’s length” analysis as applied by the Third, Seventh and Tenth Circuit Courts of Appeal, or apply a “functional equivalent” test which looks to factors comparable to those enumerated for statutory insider classifications as applied by the Ninth Circuit in this action.  Id. at 24-27 (citations omitted).

The debtor disputes that any circuit split of authority exists, and alleges that the Ninth Circuit applied all appropriate standards for determining insider status.  The Village at Lakeridge, LLC Brief in Opposition, at 6-11.

Potential Ramifications

Denying cert. in Southwest could both increase the risk of a surcharge of a secured creditor and dissuade a trustee from promptly abandoning assets.

Denying cert. in Village at Lakeridge could increase efforts by debtors to confirm plans by assigning insider claims to friendly non-insiders who will vote for the plan.

Stay tuned for more developments on both cases.

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ASARCO’s Revenge: Do Estate Professionals Now Have to Charge the Same Fees to an Estate or Committee that They Would Charge a Similar Client in an Out-of-Court Matter?

May 16, 2016

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Either from our prior posts here and here, or from the great posts from Stone and Baxter’s Plan Proponent blog or from Bracewell’s Basis Points blog, we all know the Supreme Court’s holding in ASARCO[1]/: a strict interpretation of Section 330(a) of the Bankruptcy Code[2]/ allows professionals to charge for the preparation of a fee application per Section 330(a)(6).  But as there is no express statutory authority to charge the estate for defense of a fee application, the “American rule” prevails, requiring professionals to bear their own defense costs if a third party objects to the fees.[3]/

The cases following Asarco have all been sad days for bankruptcy professionals.  As we have written, the Delaware Bankruptcy Court has rejected all arguments that Section 328 of the Bankruptcy Code, which allows the Court to approve reasonable contractual terms, could allow a contractual term (instead of Section 330(a)(6)) requiring the estate to bear the costs of defending a fee application.[4]/  Moreover, estate professionals cannot charge a fee of $X if there is no fee objection, and then an “upcharge” to $X plus $Y more if there is a fee objection.[5]/

The New Gulf Resources “upcharge” argument had the benefit of candor – it was precisely geared to prevent expensive fee disputes that punish innocent estate professionals who would not be paid for defending their fee applications.  Judge Shannon acknowledged the “creative approach” but ruled there was no meaningful distinction between a “Fee Premium” upcharge and the attempted use of Section 328 that was rejected by Judge Walrath in In re Boomerang Tube, Inc.[6]/

But what about a more circuitous way around ASARCO?  That is, a pre-petition fee structure of X, and a post-petition fee structure that charges more?  The post-petition fee structure is not geared toward preventing fee disputes, but rather, simply compensates the professional more for all the problems of representing a company (or committee) in bankruptcy: delays in getting paid, holdbacks that seemingly last forever, risk of non-payment, and, of course, the risk of fee dispute.  You readers, and we at the Bankruptcy Cave, know all too well that while representing an estate fiduciary is a wonderful experience, the months (years?) of nail-biting as to whether or how much you will be paid is a serious problem.

But do we instead have ASARCO’s revenge?  That is, if New Gulf Resources rejects an upcharge in the event of a fee challenge, do ASARCO/New Gulf Resources extend to prevent an overall, generalized, non-specific increase in rates or a higher fee structure simply due to the fact of bankruptcy?  We are about to see this play out in the In re SunEdison bankruptcy case.

In SunEdison, debtor’s counsel had a pre-petition engagement letter providing the client with substantial percentage discounts as fees crossed certain hurdles.[7]/  However, upon filing for bankruptcy, a new engagement letter was written, charging the same hourly rates but eliminating the discounts.[8]/  The Office of the U.S. Trustee has hinted that it will cry foul, although noting that its objections may wait for the fee application stage, instead of requiring resolution at the time of approval of the retention application.[9]/  At least for now, the court has approved the retention of debtor’s counsel at the stated rates.[10]/

The U.S. Trustee’s objection has some appeal, we must say.  If New Gulf Resources rejects an upcharge solely for fee objections, then how can an upcharge for any reason (or for no reason) be permissible simply due to the debtor filing for bankruptcy?  At the same time, the U.S. Trustee’s approach concerns us greatly.

There are ample reasons to charge an estate fiduciary more than you would charge in the pre-petition period, or in an out-of-court workout, due to the added risks to estate professionals in bankruptcy.[11]/  Some of those are described above – the lack of a bankruptcy filing means you get paid on a schedule you and your client work out, not a schedule dictated by Section 331 and your local practice.  Holdbacks are not customary outside bankruptcy. Hearings are not required to be paid.  Clients will sometimes do you a solid and pay before year end, while courts move at their own pace.  In addition, rather than having to satisfy the complaints and queries of many creditors, interested parties, or the Court (as you must in bankruptcy), outside of bankruptcy you only have to satisfy the client (and perhaps a lender that must approve expenditures) of the value and good purpose behind your services.  And finally, assisting the client in a workout could lead to future work from that client, meriting a discount or alternative fee arrangement.

Inside bankruptcy, however, the debtor or committee will rarely be a future customer – a modern, hell-bent for leather, 363 sale case almost always mean your client is gone for good once the case is over.  This is not the stuff that warrants discounts, and so we fully understand the position of debtor’s counsel in In re SunEdison.

This is a serious issue, and a potentially slippery slope.  The position of the U.S. Trustee in In re SunEdison is a few dangerous steps away from arguing that the debtor (or committee) is entitled to “most favored nation” pricing from your law firm or advisory firm.  Section 330 of the Bankruptcy Code requires bankruptcy fees to be commensurate with non-bankruptcy fees.  But “commensurate” does not mean “identical,” by any means.

We will be watching this unfold, real time, in In re SunEdison, and then get back to you.  In the meantime, if you sign up a distressed client, and offer it a discount, alternative fee, or other financial accommodation, expect the Office of the U.S. Trustee to argue that such structure must carry through a bankruptcy case as well, despite the enhanced payment risks and ongoing payment delay that in-court engagements entail.

[1]/          Baker Botts v. ASARCO, 135 S. Ct. 2158 (2015).

[2]/          11 U.S.C. § 330(a).

[3]/          ASARCO, 135 S. Ct. at 2164-65.

[4]/          See, e.g., In re Boomerang Tube, Inc., Case No. 15–11247, 2016 WL 385933 *4 (Bankr. D. Del. Jan. 29, 2016) (holding, committee professionals cannot include 328 terms in an engagement agreement that side-step ASARCO); In re Samson Resources Corp., Case No. 15-11934 (CSS), letter opinion dated Feb. 8, 2016, at Docket No. 641 (holding, debtor professionals can’t do this either).

[5]/          In re New Gulf Resources, LLC, Case No. 15-12566, letter opinion dated March 16, 2016, at Docket No. 395 (acknowledging “creative approach” but rejecting “Fee Premium” upcharge in retention agreement) (Bankr. D. Del. Mar. 16, 2016); id. at Order dated March 21, 2016, at Docket No. 408 (Bankr. D. Del. Mar. 21, 2016) (order denying same).

[6]/          In re New Gulf Resources, LLC, Case No. 15-12566, letter opinion dated March 16, 2016, at Docket No. 395.

[7]/          In re SunEdison, Inc., Case No. 16-10992, Reservation of Rights by United States Trustee, at Docket No. 196 (Bankr. S.D.N.Y. May 5, 2016).

[8]/          Id.

[9]/          Id.

[10]/         Id. at Order Authorizing Employment and Retention of Debtor’s Counsel, at Docket No. 260 (Bankr. S.D.N.Y. May 12, 2016)

[11]/         But see, e.g., Burgess v. Klenske (In re Manoa Fin. Co., Inc.), 853 F.2d 687, 690 (9th Cir. 1988) (“Congress did not intend to authorize higher compensation than attorneys would receive for comparable non-bankruptcy services”).

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Delaware Bankruptcy Court Holds, Twice: “ASARCO is Here to Stay” (But Your Authors Have Hatched Another Plan; Read Below!)

March 10, 2016

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You may recall the holding and analysis of ASARCO [1]/ from Jay’s previous post, here. At bottom, ASARCO  followed a strict interpretation of Section 330(a) of the Bankruptcy Code,[2]/ holding that professionals are allowed to charge certain fees for the preparation  of a fee application per Section 330(a)(6). But as there is no express statutory authority to charge the estate for defense  of a fee application, the “American rule” prevails, requiring professionals to bear their own defense costs if a third party objects to the fees.[3]/

The efforts to get around ASARCO  are well underway, primarily in the venue of the Delaware Bankruptcy Court. So far, the score is ASARCO  (two wins), to frustrated estate professionals (zero). And, even as your authors were writing this post, there is another means underway, using the “upcharge” principal – the hourly rates will be $x if no one objects to the fees, but 10% more than $x if someone does object to the professional fees. This bevy of cases, and our own proposed solution, are discussed below.

The first effort to side-step ASARCO  was In re Boomerang Tube.[4]/ In that case, certain creditors’ committee professionals argued that their engagement letters required, as a contractual  matter, the payment of fee application defense costs. Because Section 328 of the Bankruptcy Code allows the approval of any “reasonable term[] and condition[] of employment,”[5]/ the Court could avoid ASARCO’s  limited reading of Section 330(a), the professionals argued. The Boomerang Tube  Court, via Judge Walrath, rejected that. First, the Court held that an engagement letter is a contract between a professional and its client (here, a creditors’ committee), yet the professional fee defense provision seeks to bind the estate – and under Section 330 of the Code, there is no authority for the estate to be forced to cover such costs.[6]/ Moreover, the Boomerang Tube  Court held, any argument that similar market-based provisions are permitted in bankruptcy cases — such as exculpation and indemnity clauses for estate financial advisors and investment bankers[7]/ — must yield to the more specific ruling of ASARCO, which rejected a market-based approach to reasonableness.[8]/

A few weeks later came In re Samson Resources.  In that case, the Delaware Bankruptcy Court, this time through Judge Sontchi, agreed that Boomerang Tube’s  analysis would apply equally to debtor professionals, and not just committee professionals.[9]/

Not to be dissuaded, a third effort is underway in Delaware (and this time Judge Shannon gets to weigh in). In that case,[10]/ debtors’ counsel is not seeking to use Section 328 to assert that fee application defense costs can be allowed. Instead, debtors’ counsel argues that estate professionals should be allowed to charge one rate if there is no objection to the fees, but then also a 10% premium if there is an objection. In short, it is an upcharge, like substituting a yummy Caesar salad at your fav bistro for the wilted garden salad it usually serves you.[11]/ Your authors love  the creativity, but have their doubts that this will work; stay tuned.[12]/

Anyway, now that we have seen what unique ideas don’t  work, your authors have another! (Let it not be said that we just blog about goings-on in the esoteric world of restructuring – we are here to solve  problems, not just describe them!) And the idea is this – if a professional thinks it may be subject to second-guessing later in the case from disgruntled creditors, then don’t wait until the end of the case to seek allowance. Instead, smoke out those objectors, while the case is ongoing. Thus, once a discrete portion of the case is done – such as first days, a 363 sale, a major piece of litigation, perhaps even the first round of exclusivity and stability of the case – seek final  allowance of the fees and expenses incurred for that portion of the case. If an objection is raised, you still cover your own costs, but at least then you can learn it early, adjust your case strategy, and perhaps get a ruling from a judge directing such malcontents to stand down, lest their own positions in the case come under attack.

We know this is a weird option. But it is no weirder than trying to use Section 328’s generality to get around Section 330’s specificity, or seeking to impose an upcharge to recover fees which ASARCO  says you cannot get. Let the arguments continue further!

[1]/          Baker Botts v. ASARCO, 135 S. Ct. 2158 (2015).

[2]/          11 U.S.C. § 330(a).

[3]/          ASARCO, 135 S. Ct. at 2164-65.

[4]/          In re Boomerang Tube, Inc., Case No. 15–11247, 2016 WL 385933 (Bankr. D. Del. Jan. 29, 2016).

[5]/          11 U.S.C. § 329(a).

[6]/          In re Boomerang Tube, Inc., 2016 WL 385933 at *4. The Court also noted that the result is the same if the professional incurs fees to defend its fees, or if the costs to defend a fee application are set forth as expenses (such as where the professional hires another professional to defend its fees). Id. at *8.

[7]/          See, e.g., In re United Artists Theatre Co., 315 F.3d 217. 234 (3d Cir. 2003) (permitting tailored financial advisor indemnity provisions in bankruptcy cases, based on market evidence that such provisions are customary outside of bankruptcy).

[8]/          In re Boomerang Tube, Inc., 2016 WL 385933 at *7. This is concerning to your authors – does this mean exculpation and indemnity clauses for FAs and IBS, long the norm in most courts under United Artists and many other cases, could be in doubt? Wow.

[9]/          In re Samson Resources Corp., Case No. 15-11934 (CSS), letter opinion dated Feb. 8, 2016, at Docket No. 641.

[10]/         In re New Gulf Resources, LLC, Case No. 15-12566 (BLS), Brief in Support of Retention Application, dated March 2, 2016, at Docket No. 344.

[11]/         The foregoing sentence was brought to you by Mark Duedall.

[12]/         And aside from loving the creativity, we also sympathize with Baker Botts, and other estate professionals (like our beloved Bryan Cave!), that face the risk of objections to fees from disgruntled creditors with an axe to grind. The facts of ASARCO  (in which the estate professional was Baker Botts) are worth noting again here – an incredibly complicated case, in which the estate had to sue its parent company for very serious matters. The suit was successful to the tune of at least $7 billion, and creditors were paid in full – an amazing result. When Baker Botts filed its fee application and sought a fee enhancement, the parent company which Baker Botts sued was right there ready to object to virtually everything about the fees. ASARCO  is an unfair result, and a poster child for the mischief that results when cranky creditors object to fees. That being said, ASARCO  is now the law, and will remain so absent Congressional action (unlikely) or a creative lower court ruling (unlikely too). So deal with it we must.

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Supreme Court Rules No Fees for Defending Fee Applications

July 20, 2015

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The Supreme Court of the United States recently addressed whether estate professionals could recover fees expended in defending fee applications. Baker Botts L.L.P. v. ASARCO LLC, 576 U.S. _____ (2015). A divided court ruled that the plain language of 11 U.S.C. § 330(a)(1) allowed compensation only for “actual, necessary services rendered[,]” and that to allow fees for defending fee applications would be contrary to the statute and the “American Rule” that each litigant pay her own attorneys’ fees unless a statute or contract provides otherwise.
Procedural Background

In 2005, ASARCO, a copper mining, smelting, and refining company, filed for Chapter 11 bankruptcy protection. ASARCO obtained the Bankruptcy Court’s permission to hire two law firms, Baker Botts L.L.P. and Jordan, Hyden, Womble, Culbreth & Holzer, P.C. Among other services, the firms prosecuted fraudulent-transfer claims against ASARCO’s parent company and ultimately obtained a judgment against it worth between $7 and $10 billion. This judgment contributed to a successful reorganization in which all of ASARCO’s creditors were paid in full.

After ASARCO’s counsel filed fee applications under § 330(a)(1), ASARCO, controlled again by its parents company, objected to the compensation requested. After extensive discovery and a 6-day trial on fees, the Bankruptcy Court rejected ASARCO’s objections and awarded the firms approximately $120 million for their work in the bankruptcy proceeding plus a $4.1 million enhancement for exceptional performance. The court also awarded the firms over $5 million for time spent litigating in defense of their fee applications.

The Court of Appeals for the Fifth Circuit ultimately reversed the award of fees for defending the fee application, observing that §330(a)(1) provides “that professional services are compensable only if they are likely to benefit a debtor’s estate or are necessary to case administration.” In re ASARCO, L.L.C., 751 F.3d 291, 299 (5th Cir. 2014).

The Supreme Court’s Rationale

The Supreme Court’s affirmance of the Fifth Circuit was rooted in the “American Rule”: Each litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise. Slip Op. at 3 (citing Hardt v. Reliance Standard Life Ins. Co., 560 U. S. 242, 252–253 (2010)). In a textual analysis, the Court reasoned that defending a fee application against a client was simply not a “service rendered” on behalf of the client. In so concluding, the Court rejected the law firms’ argument that the estate does benefit from lawyers defending fee applications.

The Court also rejected arguments by the United States as amicus curiae, which urged the Court to allow fees incurred defending fee applications on policy reasons and because such fees were part of the “reasonable compensation” awardable under § 330(a)(1). Justice Breyer’s dissent additionally argued that the “reasonable compensation” provision of § 330(a)(1) allows an award of fees incurred defending fee applications because in some cases, unless such fees are allowed, the fee award would be artificially low and, therefore, not “reasonable.” The Court rejected these arguments and stated in passing that Federal Rule of Bankruptcy Procedure 9011 could be used to militate against the risk of frivolous objections to fee applications.
Potential Ramifications

An increase in objections to fee applications should be anticipated. Because defense fees will be unrecoverable, debtor’s counsel may be inclined to efficiently resolve objections rather than engage in protracted litigation.
We anticipate the most likely avenue bankruptcy professionals will employ will be to include a provision in engagement letters that fees incurred defending fee applications are expressly recoverable. This would address the American Rule by expressly providing, in a contract, that fees are recoverable. However, courts could refuse to uphold such provisions based on an argument that the Bankruptcy Code evidences Congress’s intent to preempt state law regarding compensation of bankruptcy professionals. Ultimately, congressional intervention and amendment of the Bankruptcy Code would be the most certain way to ensure fair compensation for bankruptcy professionals.

[1] Justice Thomas delivered the opinion of the Court, in which Justices Roberts, Scalia, Kennedy, and Alito joined, and in which Justice Sotomayor joined as to all but Part III-B-2. Justice Sotomayor filed an opinion concurring in part and concurring in the judgment. Justice Breyer filed a dissenting opinion, in which Justices Ginsberg and Kagan joined.

[2] The Government alleged that requiring bankruptcy professionals to pay the cost of defending their fee applications would dilute fees awarded and result in bankruptcy lawyers receiving less compensation than nonbankruptcy lawyers, thereby undermining the congressional aim of ensuring that talented attorneys will take on bankruptcy work.

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Managing Property Managers — A Guide for Lenders

November 16, 2014

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Lenders are frequently confronted with questionable lender-liability claims not only from borrowers (usually in connection with collection or foreclosure procedures) but also from property managers unable to recover from borrowers. Claims property managers assert directly against lenders include those for breach of oral or written contract, fraud, and unjust enrichment (particularly if the lender has foreclosed its interest in the borrower’s property). Lenders can hedge against the risk of claims by property managers through a variety of methods, both pre- and post-borrower default.

 

As part of origination (or any subsequent review of the borrower’s property management agreement), the lender should ensure that the property management agreement clearly defines that the property manager can turn solely to the borrower for satisfaction of the property manager’s fees and expenses. Thorough property management agreements will also cap expenses the property manager is allowed to incur absent approval, which can help avoid successful assertion of contractor liens.

 

The lender can also obtain a three-party subordination agreement among the lender, borrower and property manager that subordinates the property manager’s rights to those of the lender and allows the lender to, among other things, (i) seize rents immediately upon default, and (ii) terminate the property management agreement and appoint its own property manager. Termination of the property manager and appointment of the lender’s desired property manager is preferred to the lender directing the actions of the borrower’s property manager, as a lender should take care to avoid a direct relationship with the borrower’s property manager.

 

Post-default, the lender should send a reservation of rights letter that defines the parties’ relationships and limits a property manager’s authority. This is particularly true where a property manager has exceeded the scope of mere management and may have undertaken an ownership role at a property or asserted liens against the property, potentially relying on credit support from a lender for repayment of expenses.

 

Lenders should also consider seeking a court-appointed receiver to operate the property and act as a buffer. The court can grant a receiver the authority to terminate the existing property manager and appoint a new property manager, often of the lender’s choosing. Because a receiver is cloaked with a certain level of immunity (although acts of gross negligence or wilful misconduct are often excepted), a receivership offers a prudent method through which a lender can eliminate a troublesome property manager. A receivership also offers a lender a trial period during which the lender can examine the performance of a property manager of the lender’s choosing that it may decide to retain following foreclosure or a receivership sale. For example, Bryan Cave has extensive experience in obtaining receivers, as well as drafting and revising property management agreements, all of which can protect a lender before meritless claims are asserted.

 

In the event that a property manager asserts claims directly against a lender, such claims are commonly derivative of claims properly held by the borrower (the property manager’s principal) and, if based in contract, are often not properly memorialized. For example, among other successfully asserted defenses, Bryan Cave has obtained summary dismissal of property manager’s claims against lenders due to (i) failure to comply with the statute of frauds (which requires certain contracts to be in writing); (ii) lack of privity between the lender and the property manager; and (iii) the property manager’s lack of standing to assert the principal’s claims. Although unpaid property managers will always try to look to a deep pocket for recompense, judicious planning can reduce the risk and merit of any such claims.

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