Fees on Fees

On June 15, 2015, the U.S. Supreme Court handed down its ruling in Baker Botts LLP et al. v. ASARCO LLC, No. 14-103, 2015 BL 187887 (June 15, 2015), in which it considered whether a bankruptcy court has the power to award fees to a law firm for defending its fee application for services performed on behalf of a chapter 11 debtor.

The dispute concerned a $124 million base fee award for a law firm’s work on mining giant ASARCO LLC’s bankruptcy. The firm also received a $4 million merit enhancement for “rare and extraordinary” work. The Fifth Circuit upheld the enhancement bonuses but reversed the $5.2 million in fees awarded for defending the “core” fee, ruling that the Bankruptcy Code “does not authorize compensation for the costs counsel or professionals bear to defend their fee applications.” See ASARCO LLC v. Jordan Hyden Womble Culbreth & Holzer, P.C. (In re ASARCO LLC), 751 F.3d 291 (5th Cir. 2014),cert. granted sub nom. Baker Botts LLP v. ASARCO LLC, 135 S. Ct. 44 (2014). The Eleventh Circuit and a handful of lower courts have also disallowed “fees on fees,” whereas the Ninth Circuit and a number of lower courts have permitted recovery of such professional fees. See In re Smith,317 F.3d 918 (9th Cir. 2002); Grant v. George Schumann Tire & Batt. Co., 908 F.2d 874 (11th Cir. 1990); see generally Collier on Bankruptcy ¶ 330.03[16][a][ii] (16th ed. 2016).

The Supreme Court affirmed the Fifth Circuit’s ruling in a 6-3 decision. Writing for the majority, Justice Clarence Thomas explained that, in accordance with the “American Rule,” each litigant pays its own attorneys’ fees, win or lose, unless a statute or contract provides otherwise.

Justice Thomas further explained that section 327(a) of the Bankruptcy Code authorizes the employment of professionals by a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP”), and section 330(a)(1), in turn, authorizes payment to such professionals of “reasonable compensation for actual, necessary services rendered” to the trustee or DIP.

According to Justice Thomas, the text of section 330(a)(1) “cannot displace the American Rule with respect to fee-defense litigation.” The phrase “reasonable compensation for actual, necessary services rendered,” he wrote, “neither specifically nor explicitly authorizes courts to shift the costs of adversarial litigation from one side to the other—in this case, from the attorneys seeking fees to the administrator of the estate.”

Justice Thomas rejected the argument that fee-defense litigation is part of the “services” rendered to the estate administrator under section 330(a)(1). Reading “services” in this manner, he wrote, “could end up compensating attorneys for the unsuccessful defense of a fee application,” which would be both an “unnatural interpretation” of the term and a “particularly unusual deviation from the American Rule.”

Justice Thomas also rejected the argument that compensation for defending fees should be viewed as part of the compensation for the underlying services in the bankruptcy case. According to Justice Thomas, this interpretation simply cannot be reconciled with the text of section 330(a)(1) and rests on a “flawed and irrelevant policy argument . . . that awarding fees for fee-defense litigation is a ‘judicial exception’ necessary to the proper functioning of the Bankruptcy Code.”

Justice Breyer, joined by Justice Ginsburg and Justice Kagan, dissented.

According to Justice Breyer, “[W]hen a bankruptcy court determines ‘reasonable compensation,’ it must take into account the expenses that a professional has incurred in defending his or her fee application.” A contrary interpretation of the term, he explained, “would undercut a basic objective” of the Bankruptcy Code in ensuring that high-quality professionals are available to assist trustees in administering bankruptcy estates. Justice Breyer emphasized that additional fees, such as compensation for fee defense, may be necessary “in order to maintain comparability of compensation.”

Justice Breyer concluded that, given these considerations, section 330(a) should be read to authorize compensation for defending fees as part of a professional’s “reasonable compensation” and, accordingly, that the provision displaces the American Rule.

Lien Stripping

On June 1, 2015, the U.S. Supreme Court handed down its ruling in a pair of related bankruptcy cases, Bank of Am., N.A. v. Caulkett, No. 13-421, 2015 BL 171240 (June 1, 2015), and Bank of Am., N.A. v. Toledo-Cardona, No. 14-163, 2015 BL 171240 (June 1, 2015), where it considered whether, under section 506(d) of the Bankruptcy Code, a chapter 7 debtor may “strip off” a junior mortgage lien in its entirety when the outstanding debt owed to a senior lienholder exceeds the current value of the collateral.

“Claim” is generally defined in section 101(5) of the Bankruptcy Code as a “right to payment” from the debtor. Under section 506(a) of the Bankruptcy Code, a claim is secured only to the extent of the value of the collateral securing the debt. Any deficiency is deemed to be an unsecured claim.

Subject to certain exceptions, a claim filed by a creditor is deemed “allowed” under section 502(a) of the Bankruptcy Code if no interested party objects to the claim or, in the case of an objection, if the bankruptcy court determines that the claim should be allowed under section 502(b).

Section 506(d) provides that, with certain exceptions, “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” Prior to 1992, some courts reasoned that section 506(d) permits a chapter 7 debtor to either: (i) “strip down” a partially secured claim to the value of the collateral, with the remaining debt treated as an unsecured claim; or (ii) “strip off” a junior mortgage lien entirely, in both cases because the claim in question is “not an allowed secured claim” by operation of section 506(a).

In Dewsnup v. Timm, 502 U.S. 410 (1992), the Supreme Court ruled that a chapter 7 debtor could not strip down a partially secured lien under section 506(d). Prior to the Court’s recent rulings, several courts determined thatDewsnup should be read to preclude a chapter 7 debtor from stripping off a wholly unsecured junior lien. Seee.g., Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001); Talbert v. City Mortg. Serv., 344 F.3d 555 (6th Cir. 2003). The Eleventh Circuit ruled to the contrary both prior to and after Dewsnup (see Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989), and McNeal v. GMAC Mortg., LLC (In re McNeal), 735 F.3d 1263 (11th Cir. 2012)), stating in McNeal that it rejected this extrapolation of Dewsnup to apply in a context which is factually and legally distinguishable.

The Eleventh Circuit reiterated this position in Bank of Am., N.A. v. Caulkett (In re Caulkett), 566 Fed. App’x 879 (11th Cir. 2014), and in Bank of Am., N.A. v. Toledo-Cardona, 556 Fed. App’x 911 (11th Cir. 2014). The Supreme Court granted certiorari on November 17, 2014.

The Supreme Court reversed the rulings below. Writing for the unanimous court (with three justices declining to join in the opinion’s footnote noting that Dewsnup has been the target of criticism since its inception), Justice Clarence Thomas explained that in Dewsnup, the Court defined the term “secured claim” in section 506(d) to mean “a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” Under this definition, he wrote, “§506(d)’s function is reduced to ‘voiding a lien whenever a claim secured by the lien itself has not been allowed.’ ”

Because the lender’s claims in the Bank of America cases were secured by liens and allowed under section 502, Justice Thomas ruled, they cannot be voided in accordance with Dewsnup’s definition of the term “allowed secured claim.” The Court rejected the argument that Dewsnup should be limited to partially—as distinguished from wholly—underwater liens. “Given the constantly shifting value of real property,” Justice Thomas wrote, “this reading could lead to arbitrary results.”

On June 8 and June 22, 2015, the Court vacated the judgments in 13 Eleventh Circuit bankruptcy cases addressing the same issue as Caulkettand Toledo-Cardona and remanded each case to the Eleventh Circuit for further consideration in light of the rulings.