In a decision that has already prompted much discussion and debate amongst the bankruptcy bar, the Supreme Court held in Baker Botts LLP v. ASARCO that under section 330(a)(1) of the Bankruptcy Code, estate professionals are not entitled to fees for defending fee applications.  The Court found that in drafting the Bankruptcy Code, Congress had not expressly departed from the American Rule, which provides that each side must pay its own attorney’s fees, unless a statute or contract provides otherwise. 

Background:

ASARCO filed for bankruptcy in 2005.  The company retained Baker Botts LLP, among other firms, to provide legal representation during the bankruptcy.  Among other actions undertaken by Baker Botts on ASARCO’s behalf in the bankruptcy, Baker Botts prosecuted fraudulent transfer claims against ASARCO’s parent company, obtaining a judgment of roughly $10 billion, which contributed to ASARCO’s ability to pay all of its creditors in full.  Post-confirmation, ASARCO, now controlled again by the aforementioned parent company, objected to Baker Botts’s fee application.  After a 6-day trial, the bankruptcy court overruled ASARCO’s objections and awarded Baker Botts and other firms $120 million for their work in the bankruptcy case, plus a $4.1 million enhancement for “exceptional performance.”  The bankruptcy court also awarded approximately $5 million for fees incurred by the firms in defending the fee applications.  ASARCO appealed the decision, and the Fifth Circuit reversed as to the fees awarded for defense of the fee applications.

The Majority Opinion:

Justice Thomas authored the majority opinion.  In his opinion, Justice Thomas emphasized that Congress did not expressly depart from the American Rule, which provides that each litigant pays their own attorney’s fees, win or lose, unless a statute or contract provides otherwise, to allow for compensation for fee-defense litigation by estate professionals.

The majority noted that section 327(a) of the Bankruptcy Code authorizes employment of professionals to serve the administrator of the estate for the benefit of the estate.  Section 330(a)(1) authorizes compensation for those professionals including “reasonable compensation for actual, necessary services rendered.”  The Court further noted that the word “services” ordinarily refers to labor performed for another, and therefore the phrase “‘reasonable compensation for services rendered’ necessarily implied loyal and disinterested service in the interest of” a client.  Reasoning that time spent litigating fee applications could not fairly be described as “labor performed for” or “disinterested service to” the client, the Court concluded that Congress had not expressly displaced the American Rule with respect to fee-defense litigation.

The law firms and the United States government, which filed an amicus brief, each offered policy and other reasons for why section 330(a)(1) should be read to overrule the American Rule in this context.  The majority, however, rejected their arguments.  The law firms had argued that fee-defense litigation was simply a part of the services rendered to the estate administrator, a reading the majority declined to adopt.  The United States argued that compensation for fee-defense was properly viewed as part of the compensation for the underlying services in the bankruptcy.  The majority disagreed, finding that the government’s theory could not be reconciled with the text of the statute because the fees in question were clearly for the benefit of the professionals and not for any service provided to the administrator for the benefit of the estate.  The Court noted that while section 330(a)(6) clearly provides for compensation for time spent preparing fee applications, there is no similar provision providing compensation for time spent defending those fee applications.  The Court also rejected the policy argument that compensation for fee-defense litigation is necessary to ensure that bankruptcy attorneys are paid the same as other attorneys, finding it both unconvincing and irrelevant given the text of the statute.

The Dissent:

The dissent would have held that the Bankruptcy Code authorizes a court to award fees for fee-defense litigation as part of a firm’s compensation.  The dissent found that a contrary interpretation of the statute would undermine a key underlying reason for section 330, namely to ensure that high-quality attorneys and other such professionals would agree to handle bankruptcy matters.  As the dissent noted, attorneys representing parties outside of bankruptcy normally only face fee objections from their own clients, and those negotiations take place outside of a courtroom.  The process is comparatively speaking simple, and imposes fewer litigation costs.  To ensure that estate professionals are similarly compensated, the dissent asserted, the fees expended defending fee applications should be considered “reasonable compensation.” The dissent further noted an inconsistency in the majority’s position that the preparation of fee applications was compensable but their defense was not, due in part to the existence of a legal requirement specific to bankruptcy.  The dissent concluded that if the existence of a special legal requirement in bankruptcy was sufficient to make a particular service compensable, then fee-defense work should be compensable, because it is an often necessary requirement of the bankruptcy process.

So What Does This Mean?

The Supreme Court’s decision may result in an increase in meritless fee objections for strategic or tactical reasons, because there is no longer any obvious downside for creditors for pursuing such objections.  Previously, if creditors filed fee objections, the cost of defending those objections could have been recouped from the estate and would have diluted creditor recoveries.  This is no longer the case.  In addressing concerns about potential frivolous objections to fee applications, Justice Thomas pointed to Bankruptcy Rule 9011, which authorizes courts to impose sanctions for bad-faith litigation conduct.  However, it is unclear whether the threat of sanctions under the generally high bar of Rule 11 would be a full deterrent to creditors seeking to use fee application objections as part of an overall litigation strategy.

As bankruptcy professionals consider how to react to Baker Botts, it seems unlikely that there will be any sort of retreat from the practice or return to the pre-Bankruptcy Code days.  The Supreme Court did not rule that bankruptcy professionals are not entitled to fees at market rates or that professionals are not entitled to fees for the time spent preparing fee applications, or even that professionals are not entitled to fee enhancements for exceptional results, only that they are not entitled to recoup fees for defending their fee applications.

One potential consequence is that estate professionals could seek contractual language in their engagement letters and retention orders providing that the debtor will compensate the professionals for any fees associated with defending fee applications.  This would arguably fall into the contractual exception to the American Rule as stated by Justice Thomas.  It remains to be seen whether any contractual work-arounds will be upheld by the courts.