How would you like to be paid only for work which, in hindsight, unquestionably resulted in a material benefit to your employer? That unsuccessful sales call? Freebie. That account you spent hours trying to collect, but ultimately had to write off? That’s on your time. Thanks. Well, bankruptcy lawyers wouldn’t like that compensation arrangement any more than you. And on April 9, 2015, the Fifth Circuit issued an important opinion in Woerner v. Barron & Newburger, P.C. (“Woerner”) that overruled the Court’s prior decision in Pro-Snax Distributors, Inc. that had adopted a “hindsight” approach to awarding compensation to estate attorneys.
In Woerner, the Fifth Circuit returned to a “prospective” approach stating: “We now recognize that the retrospective, ‘material benefit’ standard enunciated in Pro-Snax conflicts with the language and legislative history of [11 U.S.C. § 330], diverges from the decisions of other circuits, and has sown confusion in our circuit.” Accordingly, the Court overturned Pro-Snax and adopted the prospective, “reasonably likely to benefit the estate” standard endorsed by other circuits.
The Pro–Snax bankruptcy began when creditors filed an involuntary Chapter 7 bankruptcy petition against the debtor. The bankruptcy court later converted the case to Chapter 11, and appointed a Chapter 11 trustee soon thereafter. The debtor proposed a plan of reorganization, but the bankruptcy court denied confirmation of the plan based largely on creditors’ objections. The court then converted the case back to a Chapter 7 proceeding.
The law firm Andrews & Kurth (“A&K”) provided legal services to the debtor both before and after the case had been converted to Chapter 11. When A&K filed its fee application, the bankruptcy court awarded A&K $30,000 in fees and $7,500 in expenses. The district court reversed the award on the ground that Bankruptcy Code section 330 precluded A&K from being compensated from the assets of the estate for work performed after the Chapter 11 trustee had been appointed. The district court remanded the case to the bankruptcy court, however, for a recalculation of fees in light of the creditors’ concession that A&K was entitled to compensation for the work it performed before the Chapter 11 trustee was appointed.
On appeal to the Fifth Circuit, the Court divided its discussion of the merits into two parts. In the second, briefer part of the Pro-Snax opinion, of relevance here, the Court discussed the applicable standard to evaluate A&K’s fee application for services it rendered to the debtor before the trustee was appointed. The Court considered two possible tests advocated by the parties. A&K urged the use of a “reasonableness” test, which asks “whether the services were objectively beneficial toward the completion of the case at the time they were performed.” The creditors, on the other hand, advanced a hindsight approach, i.e., whether the services “resulted in an identifiable, tangible, and material benefit to the bankruptcy estate.”
In the end, the Fifth Circuit adopted the stricter “hindsight” or “material benefit” measure, expressing its reluctance “to hold that any service performed at any time need only be reasonable to be compensable.” And that has been the standard for compensation in the Fifth Circuit – until the Woerner decision.
In Woerner, the debtor’s counsel, Barron & Newburger, P.C. (“B&N”) spent nearly a year working toward a Chapter 11 plan of reorganization. However, the case was subsequently converted to Chapter 7. After B&N filed its fee application, both the bankruptcy court and, on appeal, the district court, imposed a significant fee reduction on B&N under the Pro-Snax standard. Both courts concluded that “in hindsight,” much of B&N’s services to the Chapter 11 debtor provided no “material benefit,” given B&N’s overall lack of success in the case.
Fortunately for B&N, its success was better on appeal to the Fifth Circuit. There, the Fifth Circuit first noted that Section 330 gives a bankruptcy court discretion to determine reasonable compensation, but also constrains that discretion by requiring the court to “tak[e] into account” a set of listed factors, including “whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title.” 11 U.S.C. § 330(a)(3)(C) (emphasis added). The Court also pointed out that the statute reinforces this premise in an accompanying section: a court must disallow any compensation when the services “were not reasonably likely to benefit the debtor’s estate or necessary to the administration of the case.”
The Court reasoned that both the text and legislative history of Section 330 contemplate a prospective standard for the award of attorney’s fees relating to bankruptcy proceedings – one that looks to the necessity or reasonableness of legal services at the time they were rendered. Under this framework, if a fee applicant establishes that its services were “necessary to the administration” of a bankruptcy case or “reasonably likely to benefit” the bankruptcy estate “at the time at which [they were] rendered,” then the services are compensable.
Finally, the Court pointed out that in assessing the likelihood that legal services would benefit the estate, courts adhering to a prospective standard ordinarily consider, among other factors, (i) the probability of success at the time the services were rendered, (ii) the reasonable costs of pursuing the action, (iii) what services a reasonable lawyer or legal firm would have performed in the same circumstances, (iv) whether the attorney’s services could have been rendered by the trustee and his or her staff, and (v) any potential benefits to the estate (rather than to the individual debtor). Whether the services were ultimately successful is relevant to, but not dispositive of, attorney compensation.
The Court’s decision in Woerner is a positive step, and permits a court to compensate an attorney not only for activities that were “necessary,” but also for good gambles – that is, services that were objectively reasonable at the time they were made – even when those gambles do not produce an “identifiable, tangible, and material benefit.” The end of the Pro-Snax standard frees up professionals retained in a bankruptcy case to use their reasonable professional judgment in a given situation, without risking Monday morning quarterbacking.