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 that
Dewsnup should be read to preclude a chapter 7 debtor from
stripping off a wholly unsecured junior lien.
See, e.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
Caulkett and Toledo-Cardona and remanded each
case to the Eleventh Circuit for further consideration in light of
the rulings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
