Restructuring

Contributed by Doron P. Kenter.
The United States Bankruptcy Court for the Northern District of Texas has provided bankruptcy lawyers with additional guidance on whether they can be paid in situations where their efforts don’t result a win for the debtor’s estate.  In light of the Fifth Circuit’s heightened standard for approving professionals’ fees, the court’s decision provides renewed comfort to bankruptcy professionals, assuring them that they can expect payment so long as the estate representative believed that the professionals’ actions were likely to have benefited the estate.
In In re Broughton Ltd. P’ship, the debtors had retained special counsel in connection with their attempts to sell real property to a third party.  The special counsel attempted to negotiate a satisfactory contract with a potential purchaser, but the agreement was contingent upon a release of claims of a homeowners’ association.  Special counsel attempted to obtain those releases, but the debtors’ deal with the potential purchaser ultimately fell through.
When the special counsel sought court approval of its fees, the United States Trustee objected, arguing that the special counsel’s work did not result in an “identifiable, tangible, and material benefit to the estate,” as is required under Fifth Circuit precedent, as set forth in Andrews & Kurth L.L.P. v. Family Snacks, Inc. (In re Pro-Snax Distribs., Inc.).  Pro-Snax (in contrast with prevailing standards in most other circuits) requires bankruptcy courts to determine that the professional seeking compensation rendered an actual benefit to the estate before allowing such compensation from estate funds.  Though courts in the Fifth Circuit have interpreted this “identifiable, tangible, and material benefit” standard in different ways, many courts have interpreted Pro-Snax to require bankruptcy courts to assess the benefits conferred with the benefit of hindsight.  That is, if the representation results in no gain to the estate, no compensation is allowed.
Despite the fact that some courts have read Pro-Snax to require debtors’ professionals to show that their service resulted in actual material benefit to the estates, the bankruptcy court instead chose to perform the retrospective analysis in a way that would minimize the differences between binding Fifth Circuit precedent and the prevailing law in other circuits.
First, the court noted that bankruptcy professionals simply cannot be limited in their compensation to those activities that actually add value to the debtor’s estate.  Such a standard would exclude many essential functions performed by bankruptcy professionals – including administrative matters, operational oversight, and steps in the plan process (such as extensions of exclusivity), all of which are necessary but don’t add any quantifiable value to the estate.  Even though these tasks do not “add” to the debtor’s estate, the bankruptcy court noted that “a chapter 11 case could not work” if professionals did not perform these essential functions.
Second, the bankruptcy court recognized that tasks undertaken by bankruptcy professionals do not always lead to success.  The court noted that section 328(b) of the Bankruptcy Code permits, but does not require, contingency arrangements in bankruptcy cases – and that Congress therefore could not have intended for all services rendered in a chapter 11 case to be compensable only where the professional’s efforts had been successful.  Had Congress intended payments to all bankruptcy professionals to be contingent on outcome, it surely would have provided accordingly in the Bankruptcy Code.  By way of example, the court noted that counsel representing Stern (the estate representative) in Stern v. Marshall, a recent bankruptcy case that went all the way to the United States Supreme Court, was ultimately unsuccessful in that case, yet it would be “unthinkable” that the result of the Supreme Court’s 5-4 decision would mean that counsel should go uncompensated.
Turning to the leading cases interpreting Pro-Snax, the bankruptcy court noted that, in assessing whether a professional’s services resulted in a “material benefit” to the estate, courts should consider whether the professional’s actions (i) were duplicative of the actions of a trustee or other counsel; (ii) actually impeded the administration of the estate; or (iii) were inconsistent with the Bankruptcy Code.  The bankruptcy court also noted that a bankruptcy professional’s services should be “actual” and “necessary” pursuant to section 330(a)(1)(A) of the Bankruptcy Code.  The court noted that such services need not add to the size of the estate, but, like administrative claims under section 503(b)(1)(A) of the Bankruptcy Code, include services that are necessarily incident to the debtor’s operations – even if those services do not add any monetary value to the estate itself.
In harmonizing its decision with the Pro-Snax “identifiable, tangible, and material benefit” standard, the bankruptcy court held that bankruptcy professionals need not assess the value of the services that they will be providing to the estate, and need not even be successful in undertaking those actions.  Instead, the burden is placed squarely on the estate representative (i.e., the trustee or the debtor in possession) to determine whether a professional’s actions are likely to benefit the estate – even if those actions do not ultimately prove fruitful – so long as the professional is acting in accordance with the Bankruptcy Code and the estate representative’s direction.  In applying this standard, the bankruptcy court noted that it should be the estate representative that is charged with carrying out its duties, and that bankruptcy professionals should not be required to second-guess or veto the estate representative’s decisions for fear of losing the right to be paid for their services.