Restructuring

Contributed by Dana Hall
We all know how great Hawaii is – beautiful weather, raging surf, luaus, tiki torches that don’t look out of place, Jack Johnson, longboards, and hula hoops – I mean really, what could possibly make it a better place to live?  Well, lo and behold, one bankruptcy court may have found the answer to this singular question that nobody is actually asking.  In In re Kahuku Hospital, the Bankruptcy Court for the District of Hawaii increased, sua sponte, debtor counsel’s hourly rate to $425 per hour after determining that such attorney’s usual hourly rate of $390 per hour was “unreasonably low.”  The court also ordered that the attorney be compensated for time spent preparing his fee application, even though the attorney had not even sought compensation for such time.
In Kahuku, the fortunate attorney represented a financially distressed, but socially useful, private hospital that filed a case under chapter 11 of the Bankruptcy Code to facilitate a sale of the hospital to the State of Hawaii.  The chapter 11 case was, by all measures, a success – the sale took place within less than a year, the hospital continued to operate, and, after paying all allowed claims in full (with interest), the estate was left with a $1 million surplus for equity.  The success of the case was, in no small part, due to the debtor’s reduction of the claim pool by over 40% through objection to and settlement of contested claims.  Notwithstanding the overall success of the case, the debtor’s counsel faced some risk of nonpayment during the case.  For instance, the debtor’s counsel took a very small retainer at the outset of the case, and it was not clear what the source of funds would be to operate the hospital until the State of Hawaii provided a grant to fund the hospital through the chapter 11 case about a month into the case.  Similarly, although the hospital sale did successfully close, the debtor’s cash reserves ran very low prior to closing.  In light of these facts, the debtor’s counsel applied to the bankruptcy court for a “fee enhancement” to account for the extraordinary success of the case and for the risk of nonpayment that confronted the debtor’s counsel at various points throughout the case.  As all other parties were paid in full as a result of the success of the case, who would object to such a request?  The United States Trustee.
Section 330 of the Bankruptcy Code permits a bankruptcy court to award “reasonable compensation for actual, necessary services” rendered by a debtor’s retained professionals during the course of the case.  Courts, in determining what constitutes “reasonable compensation,” generally rely upon what is commonly referred to as the “lodestar analysis.”  The lodestar analysis can be distilled down to two premises: (a) reasonable compensation is presumed to be the reasonable number of hours expended on a matter by a professional multiplied by the reasonable billing rate of such professional, and (b) a professional’s reasonable compensation may be adjusted only in those certain rare and exceptional circumstances where an attorney can provide specific evidence that such an adjustment is warranted.
The Kahuku court determined that the risk of nonpayment faced by the debtor’s counsel and the successful outcome in the case did not constitute “exceptional” circumstances sufficient to warrant a fee enhancement.  The court, relying on the Supreme Court decision in Pa. v. Del. Valley Citizens’ Council for Clean Air, found that an adjustment premised on the risk of nonpayment is only warranted in exceptional cases and that, among bankruptcy practitioners, the risk of nonpayment is generally understood, accepted, and subsumed in counsel’s hourly fees.  Finding the risk in Kahuku to be only minimal, the court declined to enhance counsel’s fees on such basis.  The court further determined that excellent results and the creation of a surplus in a bankruptcy case are rarely an appropriate basis for a fee enhancement.  Given that the success or failure of a bankruptcy case is generally measured by the percentage recovery to unsecured creditors and in rare instances, equity, the court’s determination not to award a fee enhancement in a case in which unsecured creditors were paid in full suggests that a favorable outcome, at least in the District of Hawaii, may never serve as a basis for a fee enhancement.
Notwithstanding its determination with respect to the requested fee enhancement, the bankruptcy court went on to determine, sua sponte, that counsel had understated its lodestar compensation and was, therefore, entitled to greater compensation than that sought in its fee application.  Counsel’s argument had essentially been that the lodestar did not result in “reasonable compensation” because counsel’s fees did not account for the risk of nonpayment and the exceptional results obtained in the case.  The bankruptcy court, on the other hand, determined that the lodestar itself was insufficient because debtor’s counsel had understated his hours and charged an unreasonably low fee for his services.  Based on debtor counsel’s timesheets, the court found that counsel had failed to charge for time incurred in both the preparation of his fee application and preparation of a reply memorandum filed in response to the U.S. Trustee’s objection to his fee request.  The court also determined that debtor counsel’s fees were too low when compared to the $500 to $1,000 per hour generally charged by “comparably experienced attorneys on the mainland” and the $425 per hour charged by another comparably experienced attorney in the case.  Accordingly, the court increased debtor counsel’s hourly fee to $425 and increased the total lodestar by $53,228.50 (debtor’s counsel had initially requested a fee enhancement of 10-15% of its total fees and expenses of $787,198.54).  Although the bankruptcy court believed that granting a fee enhancement would, given the facts of the case, run contrary to established precedent, it appears from the decision that the court nonetheless thought counsel entitled to a “bonus” of sorts and expressed that sentiment by increasing counsel’s lodestar.
So, although courts “on the mainland” can’t change slush into surf or snow into sunshine, perhaps, in keeping with the holiday spirit, such courts will follow the Kahuku court’s lead on fees and look for opportunities to generously compensate retained professionals . . . and if you think that’s likely, perhaps you should send a note to Santa.