In Nortel Network’s (“Nortel”) chapter 11 case, In re: Nortel Networks Inc., et al., United States Bankruptcy Court for the District of Delaware, Case No. 09-10138(KG), Bankruptcy Judge Kevin Gross recently reduced the Indenture Trustee’s counsel fees by $913,936.00 in response to heavily litigated objections to the fees by noteholders, Solus Alternative Asset Management LP (“Solus”) and PointState Capital LP (“PointState”) (collectively the “Objecting Noteholders”). The court’s opinion has several important takeaways for indenture trustees and their legal counsel that go well beyond the reductions the indenture trustee’s two law firms received.

Nortel’s case was lengthy, complex and involved contemporaneous proceedings before Judge Gross and before the Ontario Superior Court of Justice. As part of the restructuring process, Nortel raised $7.3 billion through the sale of its assets. A dispute over the allocation of the sale proceeds followed. As part of the allocation dispute, the Objecting Noteholders sought to reduce the Indenture Trustee’s counsel fees.

In its March 8, 2017 Opinion[1], the U.S. Bankruptcy Court provides clear and unequivocal guidance for noteholders, indenture trustees and their counsel dealing with fee objections and avoiding future objections. Some of the most important takeaways are discussed below.

The Second Circuit Uses the Lodestar Method.

First, the court found that the indenture at issue required that disputes be decided under New York law and noted that the fiduciary duties of an indenture trustee are governed by a “prudent person” standard. This is not news. What is, however, useful for indenture trustees and their counsel, is the court’s determination that:

Whether the Indenture Trustee acted with prudence is not something the Court can readily review in hindsight. The Indenture Trustee is charged with acting with prudence at the time in question. In other words, the Trustee’s judgment must be informed at the time the Trustee acted.

Opinion at p. 8.

Citing the indenture and case law, the court identified the issue to be decided as “whether the Indenture Trustee acted prudently in assigning the Lawyers to their tasks, and whether the Lawyer’s work was reasonable.” One could conclude that from the court’s perspective an indenture trustee must prudently assign tasks to lawyers and that the lawyers must provide reasonable work product as reflected by the fees billed.

Bad Relationships Between Noteholders and Trustees Can Seed Fee Disputes

The court noted in detail the “poor relationship” between the Indenture Trustee and Solus. Solus issued a direction letter to the Indenture Trustee directing the Trustee to replace its counsel with counsel selected by Solus. Based on the court’s comments, the direction letter was defective as Solus failed to provide evidence of its majority ownership. The Indenture Trustee continued to retain the law firm of its choice.

These facts are important for indenture trustees and noteholders. First, noteholders need to take care to strictly comply with the governing indenture in issuing any direction letter. The failure to do so will result in the indenture trustee’s inability to accept and perform under the direction letter. It would not be prudent for any indenture trustee to accept a direction letter without proof that the directing noteholder currently has sufficient holdings to issue the direction. Second, it is important to recognize that while indenture trustees often retain counsel chosen by majority noteholders, this retention process requires the trustee’s determination that the directions being issued by the majority noteholder will not harm non-participating minority holders. Lastly, it is important to note that any direction letter may result in an indenture trustee requesting an indemnity for the acts being directed as provided for in the indenture. Relationships between indenture trustees and majority noteholders often break down over indemnity requests in response to direction letters. And, it often appears that directing majority noteholders are somewhat oblivious to the trustee’s fiduciary duties to all noteholders, not just the directing majority. Indenture trustees are duty-bound to follow the governing indenture and good relationships necessarily require that everyone understand and acknowledge that the indenture is the governing document.

Noteholders Should Not Wait to Ask Questions and Express Concern About Trustee Fees and Costs Until the End of the Case

The court noted that the Objecting Noteholders did not express concern about or object to the fees until the end of the case. It is important for noteholders to ask indenture trustees to regularly provide information regarding the trustee’s fees and expenses. There should be no surprises at the end of a case, and the more complicated and lengthy the case the greater the need for regular communications between the noteholders and the indenture trustee.

Charging for Legal Fees is Reasonable When an Indenture Trustee is Sitting on a Committee—Charging for More than One Lawyer Is Not

The Objecting Noteholders asserted claims regarding the legal fees charged by the Indenture Trustee for work done as a member of the creditors’ committee. The court found that the indenture specifically permitted the Indenture Trustee to act through agents or attorneys and to consult with the counsel of its selection. In denying the Objecting Noteholders’ objection, the Court stated:

… the Court is unwilling to speculate that the Lawyers’ attendance at Committee meetings in person or by telephone was imprudent. What was imprudent and unreasonable was having more than one attorney attending the meetings. One attorney attending meetings and reviewing Committee materials was sufficient to protect the Noteholders.

Id. at p. 15.

The court also rejected the Objecting Noteholders’ contention that for the Indenture Trustee’s fees to be considered reasonable, the fees must relate to work performed advancing the interests of the noteholders specifically and matters peculiar to their interests – separate and apart from their interests as general unsecured creditors. Responding to this contention, the court found:

It simply was implausible for the Indenture Trustee or the Lawyers to know whether at the time they were performing the work that the Noteholders’ interests did not need protection, or whether what they learned through the Committee would be of no benefit to the Noteholders.

Id. at p. 17.

Indenture Trustees Have a Contract Claim for Reimbursement of Fees and Costs Incurred in Responding to a Dispute Over Trustee Fees

The court quickly disposed of any arguments that Baker Botts L.L.P. v. ASARCO LLC[2] and In re Boomerang Tube, Inc.,[3] applied to preclude reimbursement of the Indenture Trustee’s fees incurred litigating the fee objections and found that the indenture expressly provided for the payment of the Indenture Trustee’s fees. After quoting the language from the indenture, the court held:

The Contract, i.e., the Indenture, provides for payment of the Indenture Trustee’s and its attorneys’ fees incurred in the fee dispute. Section 606(b) requires the Debtors, i.e., the Issuers, to indemnity the Indenture Trustee for “costs and expenses of defending itself . . . . Section 606(d) entitles the Indenture Trustee to exercise a charging lien against distributions to secure payment. The Indenture is clearly outside the circumstances of ASARCO and Boomerang. The Indenture Trustee and its lawyers are therefore awarded their fees for the fee dispute.

Id. at p. 25.

Takeaways For Noteholders

Judge Gross’ opinion has some good advice for noteholders. First, while the case is proceeding, noteholders should engage with the indenture trustee to discuss service on a creditors’ committee and ask about the number of lawyers involved in committee matters. Second, when indenture trustees are identified as a necessary or a core party, noteholders should ask for projections of fees and costs and coordinate with the indenture trustee to avoid duplicate work where possible. Third, noteholders need to seek information and raise questions about the indenture trustee’s fees and costs throughout the proceeding and not wait until the end to do so.

Takeaways for Indenture Trustees

Indenture trustees can take comfort that the indenture is a contract and the right to reimbursement and indemnity for legal fees and costs is enforceable in a chapter 11 case and that ASARCO and Boomerang do not apply.

While increasing communication with represented majority noteholders may be a wise strategy, asking for direction letters with appropriate indemnity may be more valuable to an indenture trustee who is managing a complicated chapter 11. Indenture trustees are faced with difficult challenges when noteholders seek to reduce legal fees and costs and avoid duplication without providing a direction letter with an appropriate indemnity as required by the indenture. Absent a direction letter and appropriate indemnity, the indenture trustee must take steps to ensure that its duties to the minority non-participating noteholders are discharged appropriately. The court was troubled by the difficult relationship between the Indenture Trustee and Solus and, while it was not dispositive, the tension likely sowed the seeds that grew into the full-blown fee dispute. Experience has shown that noteholders are often reluctant to give direction letters and even more reluctant to provide indemnity. An indenture trustee should not be shy in asking for what is needed when requested to stand down or reduce legal services.

The relationship between indenture trustees and majority noteholders is evolving and often includes better communication and coordination, particularly when noteholders reach out. When majority noteholders fail to communicate with the indenture trustee, the trustee is left with no choice but to continue actively to represent all of the noteholders making any reduction in fees and costs difficult at best. While more communication between noteholders and indenture trustees may be a worthy goal, the quality of the communication is key.