United States: Section 328 And Its 'Two-Way Ratchet'

In the recent decision in the In re FAH Liquidating (f/k/a Fisker Automotive Holdings), No. 13-13087 (KG) (Bankr. D. Del. Jan. 21, 2015), case, the court addressed whether professionals retained by the Official Committee of Unsecured Creditors were entitled to receive a fee enhancement in addition to their normal hourly rate. Fisker is by now well-known among practitioners, as it garnered significant attention last year when the court limited the rights of an assignee of a secured creditor to credit bid pursuant to Section 363(k) of the Bankruptcy Code.

In Fisker, the committee's professionals sought in excess of 50 percent over and above their incurred professional fees as fee enhancements for their work in the case. While the court stated that it did not intend to "minimize its respect for the professionals' work," the court found that the requested fee enhancements, if allowed, would result in excessive compensation; as such, the court denied the request.

Prior to the issuance of the Fisker decision last year, the committee was formed and selected the professional firms of Brown Rudnick, Saul Ewing and Emerald Capital Advisors Corp. to serve as its professionals during the course of the case. As noted by the court, these professionals "did everything that the court would expect of them in a case of this size and complexity." In addition, the committee also requested that the court cap the assignee's right to credit bid under Section 363(k) of the Bankruptcy Code, a "controversial" request that the court ultimately granted. As a result of these actions, an open auction was held and the successful bidder made a cash purchase, rather than a credit bid purchase, thereby resulting in proceeds that benefited the debtors' estates and their creditors.

In addressing the fee enhancement request, the Fisker court first noted that any analysis of the fee enhancement request had to be made pursuant to Sections 327, 328 and 330(a) of the Bankruptcy Code. In particular, the court opined that Sections 327 and 328 of the Bankruptcy Code authorize debtors and debtors-in-possession to employ professionals on reasonable terms and conditions of employment, including paying a retainer and/or fees on either an hourly or contingent basis. The court further opined that pursuant to Section 328 of the Bankruptcy Code, "the court may allow compensation different from the compensation provided under such terms and conditions after the conclusion of such employment if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions." According to the court, Section 328(a) thus "operates as a two-way ratchet: it may preclude reduction of compensation that in hindsight appears excessive, but it also may preclude an increase of compensation that in hindsight appears inadequate."

The court then turned its attention to Section 330 of the Bankruptcy Code and noted that "the benchmark for an award under Section 330 is that the fee must be reasonable," citing Pennsylvania v. Delaware Valley Citizens' Council for Clean Air, 478 U.S. 546, 562 (1986). The Fisker court then noted that within the Third Circuit, the test for determining the reasonable fee awards is based on the lodestar formula, and that under this approach: "The number of hours expended on a case is multiplied by the reasonable hourly rate of compensation, and then using this 'lodestar' amount as a starting point, a court may adjust fees based on (1) the contingent nature of the case, specifically the investment of hours and expenses without any assurance of compensation; and (2) the quality of work performed, as evidenced by the nature and complexity of the issues and the recovery obtained," citing Merola v. Atlantic Richfield, 515 F. 2d 165, 168 (3d Cir. 1975).

With this in mind, the court then turned its attention on whether the fee enhancement requested by the committee's professionals should be approved. While noting that courts have afforded bankruptcy courts "discretion to enhance an attorney's fee," the Fisker court found that those circumstances were in "the rare and exceptional case where counsel accomplishes a substantial recovery for the client that would not have otherwise occurred without his or her efforts," citing CRG Partners Group LLC v. Neary (In re Pilgrim's Pride), 690 F.3d 650, 652-53 (5th Cir. 2012). In addition, "performance warranting a fee enhancement is most evident when all creditors receive full recovery."

With this backdrop, the court then examined whether the services performed by the committee's professionals warranted an enhancement. Unlike some of the other cases cited by the Fisker court in its opinion, the court noted that in this case, the U.S. Trustee's Office had objected to the fee enhancement, arguing that the results of the case were not "rare and exceptional" and that unsecured creditors only received 40 cents on the dollar as opposed to payment in full. The trustee further argued that any risk undertaken by the committee's professionals was a normal risk of doing business as committee professionals, and certainly was a risk that any professional assumes when unsecured creditors may be out of money. Finally, the trustee also noted that the committee's professionals insisted on full market rates when they were retained under Section 328 and, as such, because they performed the job that they were hired to do, they should not be awarded any fee enhancement.

Adopting many of the arguments set forth in the trustee's objections, the Fisker court found that the committee professionals were not entitled to a fee enhancement under Section 328 of the Bankruptcy Code. First, the court rejected the committee professionals' contentions and ruled that there was nothing in the record to support a fee enhancement under Section 328. In particular, the court found that there was no evidence that the amount of work was unexpected nor was the abbreviated timeframe of the case unexpected. Furthermore, the fact that the professionals attracted another bidder to the auction was also not unexpected since that bidder was the successful bidder in another case in which these same professionals represented the creditors committee and, as such, was a market player in this industry.

In particular, the court found that the "professionals' contribution, while laudatory, was hardly the result of an arduous undertaking." Furthermore, the court found that because the unsecured creditors only received a 40 percent recovery, a fee enhancement was not warranted, especially since 40 cents is a "far cry from full recovery." Simply put, the Fisker court found that the committee's professionals "did their job and were paid for it on the terms they requested, pursuant to the limitations of Section 328 of the Bankruptcy Code, and are not entitled to receive a fee enhancement." The court also found that having being retained under Section 328 of the Bankruptcy Code, the committee's professionals should be forced to accept all of the burdens and obligations imposed by that section.

In addition, the Fisker court found that even if the committee's professionals sought payment under Section 330 of the Bankruptcy Code, the court would still deny the enhancement. In particular, the court found that the time spent on services was what would normally be expected for a case of this type, the rate charged for such services was expected for the work performed, and while the services were necessary and performed competently, they were not extraordinary. In conclusion, the court also noted that it was disinclined to award a fee enhancement in cases where "professionals had been paid handsome market-rate hourly fees and creditors had received less than full recovery. Some of the attorneys in this case charged and were paid over $1,000 per hour. When attorneys are paid at that rate, the court expects that work performed will be exceptional."

In sum, unless creditors are paid in full, a fee enhancement over and above one's hourly rate seems very unlikely in the District of Delaware.

Originally published by Delaware Business Court Insider

Lawrence J. Kotler is a partner at Duane Morris who practices in the area of reorganization and finance, representing Chapter 11 debtors-in-possession, Chapter 11 trustees, Chapter 7 trustees, liquidating trustees, creditors committees, secured creditors and large institutional unsecured creditors in all facets of bankruptcy.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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