The Supreme Court’s decision last term in Baker Botts v. Asarco, in which the Court ruled that professionals that are paid from a debtor’s bankruptcy estate cannot be compensated for time spent defending their fee applications, continues to rankle bankruptcy practitioners.  Moreover, a recent decision in a Delaware bankruptcy case shows that the impact of Asarco will not be easily circumvented.

Attorneys and other advisors retained by a debtor, a trustee or an official creditors’ committee are known as “estate professionals,” because their retention in each case must be approved by the bankruptcy court, and their fees and expenses are paid out of the debtor’s bankruptcy estate and are subject to review and approval pursuant to Section 330 of the Bankruptcy Code.  Section 330(a)(1) of the Bankruptcy Code states, “After notice to the parties in interest and . . . a hearing . . . the court may award to . . . a professional person . . . reasonable compensation for actual, necessary services . . . .”

In Asarco, the law firm of Baker Botts was retained to represent the debtor in its chapter 11 bankruptcy case. During the case, Baker Botts sued Asarco’s parent company to recover improperly transferred assets, and won a huge recovery for the benefit of Asarco’s creditors. At the end of the chapter 11 case Baker Botts applied to the bankruptcy court for final approval of $120 million in fees and expenses, plus a performance bonus of $4.1 million.  Asarco, which wound up back under the control of its parent company after all of its creditors were paid in full, objected to Baker Botts’ fee application.  Following a multi-day trial, the bankruptcy court approved Baker Botts’ requested fees and also awarded it over $5 million to cover the costs incurred in defense of those fees. The Fifth Circuit reversed the award of fees for defending fees, and the Supreme Court upheld that reversal.

The Court’s analysis was straight-forward: under American jurisprudence, each side in a litigated dispute bears its own attorneys’ fees, unless there is an applicable statute or agreement that provides otherwise.  In the Court’s view, the plain text of Section 330(a) does not support a deviation from the “American Rule” regarding attorneys’ fees.  Citing to Webster’s New International Dictionary, the Court’s majority stated, “The word ‘services’ ordinarily refers to ‘labor performed for another.’”  Since Baker Botts was litigating to defend its own fees, the Court reasoned, it was not providing an “actual, necessary service” to the bankruptcy estate and therefore was not entitle to compensation for such time.

As many commentators have noted, the implications of Asarco in chapter 11 cases going forward could be substantial.  The requirement of bankruptcy court approval for all fees paid to estate professionals helps to maintain the fairness and integrity of the bankruptcy process, and is accepted as an inconvenient but necessary requirement by law firms and other professional firms that undertake such work.  That fees may only be allowed after a “hearing” necessarily implicates a contested process, and challenges from other parties have always been a recognized hazard for such firms.  A prohibition on compensation for costs incurred in fee disputes places estate professionals at a clear disadvantage.

Two weeks ago, Judge Mary Walrath, a well-regarded jurist in the influential Delaware bankruptcy court, denied an effort in the Boomerang Tube chapter 11 case to work around Asarco contractually.  Judge Walrath, in a carefully considered decision, makes her view clear that Asarco imposes a broad prohibition on fee-shifting into the Bankruptcy Code, one that estate professionals may not sidestep by contract.

Boomerang Tube filed for bankruptcy under chapter 11 last June. A short time thereafter, and right after the Asarco decision was handed down, the U.S. Trustee for the District of Delaware (a representative of the U.S. Department of Justice) appointed an official committee of unsecured creditors (the “Committee”), and the Committee selected Brown Rudnick LLP to represent it.

Brown Rudnick’s effort to render Asarco inapplicable to its applications for payment in Boomerang Tube was straight-forward.  In its motion to Judge Walrath to be approved as Committee counsel, the firm asked for the approval order to include a provision that would entitle it to be compensated from Boomerang Tube’s bankruptcy estate for any fees, costs or expenses incurred in defending its fees against any challenges.  In support of this provision, Brown Rudnick contended that Section 328 of the Bankruptcy Code allows for the retention of estate professionals “on any reasonable terms and conditions.” It further argued that Asarco had ruled only that Section 330 did not create an exception to the American Rule against fee shifting, and that the Supreme Court had noted that parties could and regularly did contract around the American Rule.  The U.S. Trustee objected, and Judge Walrath approved Brown Rudnick’s retention while reserving judgment on the fee defense provision.

The U.S. Trustee took issue with Brown Rudnick’s narrow interpretation of Asarco, and argued that estate professionals could not use Section 328’s retention provisions to avoid Section 330’s prohibition on fee shifting.  He further argued that fee defense provisions are not “reasonable” and cannot be approved under Section 328.

After requesting further briefing, Judge Walrath carefully weighed the arguments before coming down unequivocally on the side of the U.S Trustee on each one.

Judge Walrath first determined that Section 328 did not by itself create an exception to the American Rule, as it makes no mention of awarding fees or costs in the context of an adversarial proceeding. She noted by contrast that several discrete Bankruptcy Code provisions do contain express language providing for payment of fees to a prevailing party, and concluded that the absence of such express language was evidence of Congressional intent not to create an exception to the American Rule in Section 328.

She next considered Brown Rudnick’s argument that nothing in Section 328 prevented the Committee and Brown Rudnick from agreeing contractually in Brown Rudnick’s retention agreement for the payment of defense fees. She agreed that Section 328 contained no such prohibition, but rejected the argument that the retention agreement could, by itself, effect an exception to the American Rule, because in the end it would be Boomerang Tube’s bankruptcy estate, a non-party to the retention agreement, that would bear the costs.

Finally, Judge Walrath agreed with the U.S. Trustee’s argument that fee shifting provisions are not “reasonable” within the meaning of Section 328. Brown Rudnick contended that such provisions should be viewed as similar to the type of exculpation and indemnification provisions that are typically approved under Section 328 in retention agreements for investment bankers and financial advisors.  Judge Walrath found the analogy unpersuasive.  She noted that indemnification provisions are routine for investment bankers outside of bankruptcy, whereas lawyers are not commonly entitled to reimbursement for the costs of defending their fees.

Judge Walrath concluded her opinion by expressly warning other professionals not to parse her decision to find other possible ways to avoid Asarco: “Such provisions are not statutory or contractual exceptions to the American Rule and are not reasonable terms of employment of professionals.”

Judge Walrath’s decision in Boomerang Tube will undoubtedly be cited and followed by many other judges, but it will not resolve the issue.  Threats to contest estate professionals’ fees are an ingrained part of the hard-nosed negotiating process that is the hallmark of chapter 11 practice.  It is therefore inevitable that law firms will be making similar attempts to protect themselves in other districts.  As her opinion shows, these are not easy questions, and the strong likelihood is that there will be some courts that come out the other way.  This issue will probably come before the Supreme Court again.