Last June we covered the U.S. Supreme Court’s decision in Baker Botts LLP v. ASARCO, which held that the estate may not compensate professionals under section 330(a)(1) of the Bankruptcy Code for fees incurred in defending fee applications.  At the time, we suggested as a potential work-around that estate professionals could seek contractual language in their engagement letters and retention orders providing that the estate would compensate the professionals for any fees associated with defending fee applications.  A recent ruling by Judge Walrath of the United States Bankruptcy Court for the District of Delaware in In re Boomerang Tube, Inc., however, calls into question that proposed solution. 

Background:

Counsel to the Official Committee of Unsecured Creditors in Boomerang Tube included a provision in their retention applications indemnifying them for expenses incurred in any successful defense of their fees.  The United States Trustee objected to the inclusion of the fee defense provision in the retention applications on the grounds that such provision was precluded by Baker Botts, such fees were outside of the scope of the attorneys’ employment, and, therefore, any such fees were unreasonable under the Bankruptcy Code.

Argument:

In support of its objection, the United States Trustee argued that Baker Botts was binding precedent which mandated that the bankruptcy court reject the fee defense provisions in the retention applications.  The Committee responded that Baker Botts did not prohibit the fee defense provisions because the Supreme Court found only that section 330(a) of the Bankruptcy Code did not contain an express statutory exception to the American Rule.  The Committee argued that, because it was seeking approval of the fee defense provisions under section 328(a) of the Bankruptcy Code and not section 330 of the Bankruptcy CodeBaker Botts was inapplicable.

Judge Walrath concluded that section 328, like section 330 was not a “specific and explicit” statute authorizing the award of defense fees to a prevailing party.  Rather, section 328 only provides that with court approval a professional may be employed on “any reasonable terms and conditions.”  Accordingly, the court determined that section 328 does not provide a statutory exception to the American Rule and cannot provide authority for approval of the fee defense provisions.  Indeed, Judge Walrath found it significant that Congress did provide such express language necessary to create an exception to the American Rule in several other sections of the Bankruptcy Code.

Contractual Exception

The Committee argued that the Supreme Court acknowledged in Baker Botts that there could be a contractual exception to the American Rule.  Judge Walrath agreed that the Baker Botts decision acknowledged a contractual exception to the American Rule, but nonetheless determined that any such contract was required to be consistent with the other provisions of the Bankruptcy Code.

The bankruptcy court first determined that the retention applications were contracts, although the contracts were subject to objection by other parties and ultimately subject to approval, and, if necessary, modification by the bankruptcy court.  The bankruptcy court, however, also determined that the retention agreements were not contractual exceptions to the American Rule because the retention agreement was not a contract between two parties providing that each would be responsible for the other’s legal fees if it loses a dispute between them.  Rather, the retention agreement was a contract between two parties (the Committee and the Committee’s counsel) that in the event counsel won a challenge to their fees, a third party (the estate) would pay the fee defense costs, even if the estate is not the party objecting.  The bankruptcy court also found objectionable the fact that the retention agreement sought to bind a non-party, the estate, to that agreement.

The United States Trustee further argued that, even if Baker Botts did not directly preclude approval of the fee defense provisions, the provisions could not be approved because they were inconsistent with the Bankruptcy Code and were not “reasonable terms and conditions” of employment as required by section 328.  The bankruptcy court agreed with the United States Trustee, finding that the fee defense provisions were not reasonable terms of employment of counsel to the Committee because the provisions did not involve any services provided by the Committee.

The Committee asserted that the fee defense provisions were similar to the indemnification provisions typically approved in investment banker and financial advisor retentions and were generally approved by the market.  The United States Trustee countered that the Supreme Court’s ruling in Baker Botts precluded the bankruptcy court’s consideration of the market in determining the reasonableness of the fee defense or other indemnification provisions.  The bankruptcy court agreed with the United States Trustee and found that Baker Botts precluded the court from concluding that section 328 permitted defense fees even if they were routinely allowed by the market in bankruptcy or non-bankruptcy contexts prior to that ruling.

Conclusion:

Judge Walrath’s decision in Boomerang Tube adds another layer of complexity for professionals seeking to recover fees associated with defending fee applications.  The reasoning of the decision also would apply with equal effect to non-lawyer professionals, who routinely include indemnification provisions in their engagement agreements. Potential work-arounds may still exist, however.  For example, it should be noted that one of the bankruptcy court’s concerns with the fee defense provisions in question was that the provisions bound a third party, the estate, to pay costs under a contract to which the estate was not a party.  Professionals hired by the debtor in possession, unlike the committee professionals in Boomerang Tube, would be parties to contracts with the estate, although Boomerang Tube certainly signals that challenging these fee arrangements may well become standard operating procedure for the Office of the United States Trustee.  Moreover, it remains to be seen whether other bankruptcy judges in Delaware and bankruptcy courts outside of Delaware will follow the ruling in Boomerang Tube or whether other courts will determine that Baker Botts did not prevent contractual work-arounds.