Billing for Billing: When Do Retained Professional’s Outside Counsel Fees Constitute a Reimbursable Expense?

Contributed by Dana Hall
In In re Borders Group, Inc., Judge Glenn of the United States Bankruptcy Court for the Southern District of New York recently held that a retained professional may seek reimbursement of its own outside counsel’s fees and expenses incurred in connection with the professional’s retention or preparation of the professional’s fee applications.  Judge Glenn’s decision suggests, however, that such fees and expenses are only likely to be reimbursed where the retained professional’s engagement letter and retention order provide for the reimbursement of outside counsel’s fees by the debtor, the services performed by outside counsel are actual, reasonable, and necessary, and such services are not performed on behalf of the debtors.  Although other bankruptcy judges in the Southern District of New York have recently ruled on this very issue and reached differing conclusions, Judge Glenn’s decision constitutes the first published opinion in the Southern District of New York to address this issue.
In Borders, the debtors retained Mercer Inc., a compensation consultant, to assist in the development of, among other things, a key employee incentive plan.  The engagement letter between the debtors and Mercer provided that Mercer was entitled to bill the debtors for legal fees associated with its retention and subsequent fee applications.  The Borders court subsequently approved the terms of the engagement letter in its order approving Mercer’s retention.  Mercer proceeded to hire outside counsel to provide such services and, in Mercer’s fee application, Mercer requested an expense reimbursement on account of fees charged by its outside counsel.  The United States Trustee objected to such expenses on the basis that Mercer could not receive expense reimbursement to pay an attorney that had not been retained pursuant to section 327 of the Bankruptcy Code.
S.D.N.Y. bankruptcy courts are currently divided with regard to the issues raised by the U.S. Trustee’s objection.  Prior to reaching its decision in favor of Mercer, the court considered two hearing transcripts discussing this same issue in recent S.D.N.Y. chapter 11 cases: In re Blockbuster Inc., pending before Judge Lifland, and In re Sbarro, Inc., pending before Judge Chapman.  In Blockbuster, Judge Lifland refused to approve a retention application containing a provision providing for the reimbursement of outside legal counsel.  Judge Lifland ruled that such outside counsel would need to be separately retained and apply to the court for compensation pursuant to sections 327, 328, and 330 of the Bankruptcy Code.  In Sbarro, Judge Chapman disagreed with Judge Lifland’s interpretation of section 327 and approved the professional’s retention pursuant to the terms of an engagement letter containing language permitting, subject to the bankruptcy court’s review, reimbursement of outside counsel fees for services rendered to the retained professional and not the estate.  Judge Chapman also pointed out that if the bankruptcy court were to prohibit retained professionals from obtaining reimbursement of outside counsel fees, such professionals would likely build that cost into their monthly fees.  If, however, the outside counsel fees are billed as a line item expense, the court at least has the opportunity to request a detail report and review the fees asserted to determine whether such fees are reasonable in light of the work performed.
In the Borders opinion, Judge Glenn found that nothing in the language of section 327 of the Bankruptcy Code requires counsel providing services to a retained professional, as opposed to the debtor, to be retained under section 327 and that it was unlikely that such counsel could even be retained under section 327 as they would not be performing services for the debtor’s estate.  Furthermore, the language of section 327 provides no reason to think that such expenses should not be considered “necessary” where the services are required to comply with the Bankruptcy Code, Bankruptcy Rules, or applicable court orders.  Judge Glenn went on to explain that, notwithstanding the foregoing, bankruptcy courts could refuse to approve the expenses where such expenses are not “actual” and “necessary” as required under section 330 of the Bankruptcy Code or where such expenses are not billed “at rates and in accordance with practices customarily employed by the applicant and generally accepted by the applicant’s clients,” as required by S.D.N.Y. Bankruptcy Court General Order M-389.
Additionally, unless a retained professional’s engagement letter with the debtor contemplates that the professional will bill the debtor for outside legal fees, bankruptcy courts are not likely to approve the reimbursement of such expenses.  In Borders, Judge Glenn found it significant that Mercer’s engagement letter with the debtors, which had been approved by the retention order, specifically included a provision permitting Mercer to bill the debtors for outside counsel expenses.  Judge Glenn stated that because such a provision had been included in the engagement letter, it was clear that such expenses had not already been accounted for by the parties in determining Mercer’s compensation.  Judge Glenn admonished future applicants, however, that “[a]bsent an approved expense reimbursement provision, a court may well conclude … that such expenses are a cost of doing business already built into the compensation structure and not separately compensable as expense reimbursement.”  Accordingly, professionals planning to seek reimbursement for such expenses should be sure to include appropriate language in their engagement letters with the debtors.
Although Judge Glenn permitted reimbursement of expenses for time billed by outside counsel on account of “fee application and review” and “retention matters,” Judge Glenn did not grant all of the expenses sought by Mercer.  Judge Glenn denied reimbursement of certain time billed by outside counsel on account of certain items deemed to constitute “overhead” such as “setting up a teleconference” and, significantly, denied reimbursement for time billed by outside counsel for reviewing Mercer’s time records.  Judge Glenn cited his 2011 decision in In re Mesa Air Group, Inc. and Judge Bernstein’s 2010 decision in In re CCT Commc’ns, Inc.,for the proposition that time spent reviewing and editing time records, as opposed to retention and fee applications, is not compensable.  Although this may not be new news for those practicing in S.D.N.Y. bankruptcy courts, practitioners should nonetheless be aware of the distinction and the increasing swell of cases supporting this position.