Author: Charles M. Golden Posted: August 17, 2007
Does the bankruptcy court have authority to adjust the fee of a professional that has a court approval fixed rate contract? The answer to this question was determined by the 11th U.S. Circuit Court of Appeals in In re Miller Buckfire & Co., LLC, v. Citation Corporation, decided on July 26. The facts of the case are that Citation appealed the district court's reversal of the bankruptcy court's order awarding an adjusted fee for the investment banking services of Miller Buckfire & Co. In addition, the debtor appealed the district court's affirmance of the bankruptcy court's finding that Miller Buckfire's failure to disclose potential conflicts did not violate Federal Rule of Bankruptcy Procedure 2014 or harm the bankruptcy estate. The court of appeals reversed the district court in part and concluded the bankruptcy court did not abuse its discretion by adjusting the fee for Miller Buckfire's services. It did, however, remand to the bankruptcy court for a determination of whether or not the failure of Miller Buckfire to disclose the potential conflict violated Rule 2014 and whether or not a penalty would be appropriate. On July 30, 2004, Citation hired, pre-petition, Miller Buckfire pursuant to an engagement letter to provide financial advisory and investment banking services necessary for potential restructuring. In the letter, Citation agreed to pay Miller Buckfire $150,000 upon execution of the letter and a restructuring fee of $3.5 million. According to the terms, Miller Buckfire would receive monthly payment of $150,000, which the parties agreed would be credited against the restructuring fee. Approximately 60 days later, on Sept. 18, Citation filed a Chapter 11 petition in the U.S. Bankruptcy Court for the Northern District of Alabama. As the same time, Citation filed a retention application to retain Miller Buckfire as an employed professional of the estate. The bankruptcy court entered a retention order allowing Citation to retain Miller Buckfire under the terms of the engagement letter with one important caveat: the court specifically reserved the right to review the overall fee subject to the reasonableness standard codified in 11 U.S.C. Section 330. Miller Buckfire agreed to the retention order, including the reservation of the bankruptcy court's right to thorough review of its fee under 11 U.S.C. Section 330. Within five months of retaining Miller Buckfire, the bankruptcy court confirmed Citation's Chapter 11 restructuring plan. In its final fee application, Miller Buckfire sought approval of its restructuring fee of $3.5 million plus expenses. Specifically, Miller Buckfire sought approval of all fees Citation had paid Miller Buckfire to date ($1,189,622.90), and all expenses paid ($180,215.26), and the balance of $2,291,128.45. At the hearing on the fee application, the debtor argued that Miller Buckfire had a conflict of interest in its representation of Citation. Specifically, Citation alleged that Miller Buckfire failed to disclose its prior dealing with Kelso & Company, a private equity firm with a large equity interest in Citation. Furthermore, the debtor argued the services provided were much less extensive than originally expected and, as a result, Miller Buckfire's fee should be reduced. Regarding the conflict of interest, the bankruptcy court found Miller Buckfire did not suffer under a conflict of interest because it lacked final decision-making authority and was insulated from any potential influence by the unsecured creditors committee and its counsel. Regarding the fee, the bankruptcy court thoroughly reviewed 16 factors provided by the statute and relevant precedent and found "(1) the services originally anticipated were not actually required; (2) the hours expended were slightly excessive; and (3) the resulting hourly rate was also excessive." The court considered all the factors, including the lodestar, which requires a court to find a reasonable rate and then multiply that rate by the hours actually expended to benefit the estate to calculate an appropriate fee. The court approved fees in the amount of $2,137,500, or $750 per hour. On appeal, the district court affirmed the bankruptcy court's finding on the conflict of interest issue, but it reversed the court's determination of Miller Buckfire's fee. It found that the bankruptcy court was correct to consult the factors set out in 11 U.S.C. Section 330, but erred as a matter of law when it factored Miller Buckfire's hourly lodestar into its decision. The district court said, "[t]he bankruptcy court . . . is not free to transform a fixed rate contract, knowingly entered into by knowledgeable parties at arms length, into an hourly rate contract." The court instructed the bankruptcy court on remand to reconsider Miller Buckfire's fee application with the understanding that "the contract was a product of free and equal bargaining by sophisticated, knowledgeable parties, fixed rate contract are typical of the financial advisory and investment banking business, and the fixed-fee contract market rate for investment bankers in similar transactions is the appropriate benchmark." The court further instructed that the only circumstance that would warrant a reduction from contracted-for fee would be evidence that Miller Buckfire did not perform its duties under the contract. Citation appealed. The appellate court should reverse the bankruptcy court's decision if it applied an incorrect legal standard, failed to follow property procedures or made factual findings that were clearly erroneous. The court pointed out the distinction between the determination of fees under 11 U.S.C. sections 327-330. In particular, Section 327 allows the trustee, with the bankruptcy court's approval, to employ a professional who has represented the debtor "for a specified special purpose . . . if in the best interest of the estate." Section 328 provides that the trustee employ a professional under Section 327 "on any reasonable terms and conditions of employment, including a retainer, on an hourly basis, or on a fixed percentage fee basis, or on a contingent fee basis." Section 328 further points out that the bankruptcy 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." Absent pre-approval under Section 328, the bankruptcy court awards a professional "reasonable compensation for actual, necessary services rendered" based on "the nature, the extent, and the value of such services," and considering the time spent on such services, and the cost of comparable services. The distinction between sections 328 and 330 affect the timing and process of the court's review of fees. Under Section 328, the bankruptcy court reviews the fee at the time of the agreement and departs from it only if some unanticipated circumstance makes the terms of the agreement unfair. Under Section 330, the court reviews the fees after the work has been completed and looks specifically at what was earned, not at what was bargained for at the time of the agreement. Bankruptcy professionals are aware that the amount of any professional's fees will be less certain if the bankruptcy court awards fees under Section 330. Such uncertainty prompted Congress to enact Section 328 to allow professionals greater certainty as to their eventual payment. In this case, the bankruptcy court specifically reserved the right to ward Miller Buckfire fees pursuant to Section 330. The parties sought retention under the more deferential Section 328, but the court specifically noted that Section 328 would not allow it "the opportunity to fairly review [Miller Buckfire's] application and to pay them as they ought to be paid." Miller Buckfire objected, but it still entered into the agreement to continue to provide services. The court of appeals stated that the district court put too much emphasis on the existing contract as entered into the time of retention. The court should not place the same emphasis on the contract when the bankruptcy court is reviewing the fee pursuant to Section 330. The contract with the trustee specifically reserved the court's right to review the fee request pursuant to Section 330. Miller Buckfire choose to perform its service with knowledge that its fee be reviewed for reasonableness pursuant to Section 330. Therefore, the district court was incorrect to attach such weight to the original contract. The appellate court pointed out that the ultimate issue is whether it was appropriate for the bankruptcy court to consider a lodestar analysis in determining what Miller Buckfire earned when it reviewed fees under Section 330. The Statute instructs the court to look at: "the nature, the extent, and the value of such services," as well as the time spent on such services, and the cost of comparable services in other cases. Specifically, the relevant factors in making such a determination include the following: The time spent on such services; The rates charged; Whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a case under this title; Whether the services were performed within a reasonable amount of time commensurate with the complexity, importance and nature of the problem, issue or task address; and Whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title. Four of the five required statutory factors direct a bankruptcy court to examine the amount of time spent on either the project as a whole or to examine the time spent on individual units of the professional's work. The lodestar method is one way to ensure every unit of the professional's work is valuable to the completion of the Chapter 11 case. Therefore, it is appropriate for a bankruptcy court to use a lodestar analysis to review an investment bank's fees for reasonableness. The 10th Circuit agreed in a factually similar decision discussing Section 330's applicability to investment banks, Houlihan Lokey Howard & Zukin Capital v. Unsecured Creditor's Liquidating Trust (In re Commercial Fin. Services Inc.) In reviewing the bankruptcy court's decision, the 10th Circuit looked to the text of Section 330, which requires bankruptcy courts to "consider the nature, the extent, and the value of such services." The court agreed with the 10th Circuit in that the Section 330 factors require a court to examine the amount of time spent on either the project as a whole or on individual units of the professional's work. Therefore, it held an "adjusted lodestar analysis" was an appropriate way to determine an investment bank's reasonable fee. The court pointed out that Section 330 and the Bankruptcy Code as a whole have an "overriding concern for keeping administrative expenses to a minimum so as to preserve as much of the estate as possible for the creditors." Because the lodestar methodology is aimed at uncovering which specific activities benefited the estate, it is not improper to consider it in awarding a professional a reasonable fee pursuant to Section 330. Having decided that using a lodestar analysis to determine a reasonable fee under Section 330 is not inappropriate, the only other objection to the bankruptcy court's fee award is that it is unreasonable. The fee award is reviewed because of an abuse of discretion. The bankruptcy court's refusal to award Miller Buckfire a fee of over $1,000 per hour when it found "(1) the services originally anticipated were not actually required; (2) the hours expended were slightly excessive; and (3) the resulting hourly rate was also excessive" did not constitute an abuse of discretion. Its findings of fact were not clearly erroneous, it followed proper procedures, and it applied a correct legal standard, so the bankruptcy court determination of a reasonable fee was affirmed. In the issue of conflict, it was admitted that Miller Buckfire failed to disclose its past dealing with certain members of Citation's board of directors, a violation of Bankruptcy Rule 2014(a), which states, "The application shall be accompanied by a verified statement of the person to be employed setting forth the person's connections with the debtor, creditors, any other party in interest, their respective attorney's and accountants . . . ." There was no specific finding that the failure to disclose this information rose to the level of actual conflict or posed a threat of a potential conflict. The court of appeals emphasized that it is the bankruptcy court, not the professionals, that must determine which prior connections rise to the level of an actual conflict or pose the threat of a potential conflict. To the extent Miller Buckfire failed to disclose its prior dealing, it violated Rule 2014. However, it is not clear what type of penalty should be applied. Neither Rule 2014 nor the Bankruptcy Code mandates a sanction for the rule's violation. The decision to impose a penalty and the nature and extent of the penalty is generally a matter left to the bankruptcy court. Since the bankruptcy court did not specifically address the violation, the matter was remanded to that court for further consideration. Clearly, a professional would rather have its fee fixed under Section 328 as opposed to Section 330. Under the present case, the professional allowed the order to be entered to give the bankruptcy court authority to review the fee under Section 330. Obviously, this was a decision that did not favor the professional. The issue of potential conflict of interest and violation of Rule 2014 was and is a matter of concern for Bankruptcy Court. Most professionals fail to understand the continuing obligation to disclose the potential conflicts and conflicts do not cease upon the court approval of employment. The bankruptcy court has broad latitude in determining the effect of the violation of Bankruptcy Rules of Procedure. Professionals and their counsel should be vigilant during the case to make the parties and the court aware of any potential problems.
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