Prior to the enactment of the Bankruptcy Code in 1978, the Fifth Circuit took a stringent approach to the payment of attorney’s fees – holding that public policy supported restricting attorney compensation in bankruptcy cases and that attorneys should not expect to receive the same compensation as if working for a non-bankrupt concern.  Congress enacted section 330 of the Bankruptcy Code to address this policy and to allow bankruptcy attorneys to receive reasonable compensation comparable to compensation allowed in non-bankruptcy cases.  Congress, however, did not initially provide guidance on what constituted reasonable compensation, and courts developed the actual, or material, benefit standard under which compensation was awarded if the services provided actually resulted in an identifiable benefit to the bankruptcy estate. 

Congress stepped in, again, in 1994, amending section 330 to foreclose the actual benefit test.  Following the 1994 amendments to section 330, the Second, Third and Ninth Circuits all dropped the actual benefit standard.  On the other hand, in the 1998 In re Pro-Snaxdecision, the Fifth Circuit adopted the actual benefit standard and, since that decision, applications for compensation under section 330 of the Bankruptcy Code in the Fifth Circuit have been evaluated retrospectively under the “hindsight” or “material benefit” standard.

Recently recognizing that In re Pro-Snax conflicts with the plain language of section 330 and has “sown confusion” in lower courts within the circuit, the Fifth Circuit overturned the material benefit standard in In re Pro-Snax.  Going forward, following the Fifth Circuit’s recent decision in Barron & Newburger, P.C. v. Texas Skyline Ltd., et al. (In re Woerner), attorney compensation will be evaluated prospectively based on, among other factors, whether the services rendered were reasonably likely to benefit the estate at the time the services were performed.

Background

Facing an imminent state court judgment against him, Clifford Woerner, with the assistance of Barron & Newburger, P.C. (“B&N”), filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code.  For the next eleven months, B&N, among other things, filed mandatory disclosure documents with the bankruptcy court, defended Woerner in various adversary proceedings, identified additional estate assets, and assisted Woerner in negotiating with his creditors – services for which B&N sought approximately $130,000 in fees and $6,000 in expenses following the conversion of Woerner’s bankruptcy case to chapter 7.

Applying the Pro-Snax standard, the bankruptcy court awarded only 15% of the fees sought by B&N, finding that most of B&N’s services did not reflect an identifiable benefit to the estate and denying B&N’s fees due to lack of success in the case.  On appeal, the district court affirmed the bankruptcy court’s findings that B&N’s fees were unreasonable under section 330 and Pro-Snax.

On further appeal, a panel of the Fifth Circuit affirmed the district court’s ruling, but called for an en banc review of the Pro-Snax decision.

Reconsideration of Pro-Snax

In the en banc decision In re Woerner, the Fifth Circuit overturned the retrospective, material benefit standard from In re Pro-Snax, recognizing that the standard “conflicts with the language and legislative history of [section] 330, diverges from the decisions of other circuits, and has sown confusion in our circuit.”

The Fifth Circuit first looked to the language of the Bankruptcy Code regarding compensation of professionals.  Under section 330, professionals, including attorneys, employed by a debtor under section 327 of the Bankruptcy Code may be awarded reasonable compensation for actual and necessary services and reimbursement for actual and necessary expenses.  In determining reasonable compensation, courts are required by section 330(a)(3) to weigh all relevant factors including the skill and experience of the practitioner; the time spent on, and the rate charged for, the services; and, “whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of,” the bankruptcy case.  Moreover, section 330(a)(4)(A) specifies that compensation should not be allowed for services that were not reasonably likely to benefit the estate or necessary for administration of the bankruptcy case.  Taking these sections together, the Fifth Circuit held that “a court may compensate an attorney for services that are ‘reasonably likely to benefit’ the estate and adjudge that reasonableness ‘at the time at which the service was rendered.’”  Notably, the Fifth Circuit now recognizes that attorneys can be compensated for “good gambles” – choices to pursue courses of action that may not ultimately be successful, but that were reasonable at the time they were made.

In addition to the statutory language, the Fifth Circuit also found support for the more lenient standard in the legislative history of section 330.  Before 1994, section 330 provided little guidance on what constituted reasonable compensation.  The 1994 amendments to section 330 included a codification of many of the relevant factors that had been considered by courts in determining reasonable compensation.  Critically, the Senate specifically added the language “at the time at which the service was rendered” to section 330(a)(3)(C).  Based on this legislative record, the Fifth Circuit found that the inclusion of “at the time at which the service was rendered” in the 1994 amendments strongly suggests that Congress did not intend for attorney compensation to be viewed through a retrospective, material benefit standard.

Finally, the Fifth Circuit recognized that overturning the material benefit standard and adopting the prospective view would bring the Fifth Circuit in step with the Second, Third and Ninth Circuits.  In addition to adopting the prospective standard, the Fifth Circuit, relying on decisions in the Second, Third and Ninth Circuits, further articulated the method for applying the standard.   Specifically, in determining the likelihood that the services will benefit the estate, the Fifth Circuit notes that courts applying the prospective standard should consider, among other things, the probability of success, the reasonable cost of pursuing a particular course of action and the potential benefit to the estate.  Now, instead of being largely dispositive, success in pursuing a particular course of action is only one factor in the analysis.

Conclusion

On remand, the bankruptcy court will determine whether B&N’s services were for “good gambles” or ultimately unreasonable at the time they were provided.   In re Woerner is a significant decision that brings the Fifth Circuit in line with other powerhouse bankruptcy circuits on the issue of reasonable compensation for attorneys.  For every attorney advising on a particular course of action in a Fifth Circuit bankruptcy case, In re Woerner finally provides much needed clarity.