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The Upside of High Fees

posted by Troy McKenzie

Some of the comments to Stephen Lubben's post on "overhead" raised the longstanding complaint about high fee awards in New York and Delaware Chapter 11 cases. We all know the academic and political condemnations of Chapter 11 as merely a feast for lawyers.

It's important to remember, though, that the possibility of higher attorney's fees was considered a feature, not a bug, when the Code was enacted in 1978. Or, more precisely, the liberalization of fee awards was intended to attract lawyers (the elite bar) who had largely shunned bankruptcy practice after the New Deal-era bankruptcy reforms. There's no doubt that the overall quality of representation in business bankruptcy cases has increased markedly since 1978, along with the cost of that representation. That's why I don't understand those critics whose objections really seem to be about the presence of large, sophisticated (and expensive) national law firms in Chapter 11 cases.  

Of course, high fee awards come out of the pockets of unsecured creditors, who don't have much say in hiring the attorneys. The system needs an outsider monitor to take account of that inherent principal-agent problem, and that's where the US Trustee plays a crucial role. But anyone who has practiced in New York knows that the US Trustee's Office has not always been predictable in its fee objections. The overhead argument is an example.



You know, in 1978, there was a need to infuse more top legal talent into the bankruptcy system. The bankruptcy bar had never really developed because fees were low and the bar was insular.

That doesn't mean the pendulum can't swing back, now that an "elite bar" has been developed. The 'rule of economy' has always been lurking in the background, even though the Bankruptcy Code was supposed to banish it forever.

There are several problems with big time Chapter 11s as they are conducted today. One question is - do these elite and highly paid lawyers do any better job of improving bankruptcy than the elite and highly paid traders of Wall Street have done for improving the American economy.

When was the last time you looked at a Chapter 11 case and said - "damn, that artful stalking horse bid really got the unsecureds some extra cash there boy!" Or, "that carve out for critical vendors really saved everyone's bacon." Or "that defense of the reasonableness of officers' salaries and retention bonuses has put XYZ, Corp., DIP on the road to a 100% Plan baby!"

Let's do this thought experiment - "Thank you for inviting me here today to make a presentation to you on why Peppermill, Hambiltonian and Sweets should be your Chapter 11 DIP counsel. On this chart, you will see how our firm has managed to increase distributions to unsecured creditors through a strong fiduciary program of cutting executive compensation, benefits and perks. As you can see, based on rigorous statistics, our firm's methods return unsecured creditors 3% more than any other firm. Of course, as fiduciaries for creditors, I am sure you will be eager to employ us as your bankruptcy counsel."

The next Chapter 11 that firm would be participating in would be its own.

There is no immutable universal requirement that businesses in financial difficulty have to continue under the same management that got them into financial distress. And there is no rule that says debtor's counsel has to have any more of a role than they would have in a Chapter 7.

So, instead of pining for new and innovative ways to augment fees by lumping in overhead costs on top of $600 to $1,000 per hour attorney fees, perhaps the members of the "elite bar" should STFU and try not kill what is - for them, if not for unsecured creditors - the golden goose.

Just as consumer bankruptcy attorneys need to be wary of the perception problems that led to BAPCPA (and could go so far as to lead to the attorney-less "social securitization" of the bankruptcy process) Chapter 11 practitioners need to understand that they have a perception problem. There are other models for dealing with financially troubled businesses.

In Europe, secured creditor control is the predominant rule - with a corresponding liquidation bias. In the U.S., most bankruptcies involve a real trustee - not a "trustee" who wouldn't know a fiduciary duty from a Fig Newton. And complex resolutions - like the FDIC's actions with banks, and SIPC with brokerages - demonstrate that complex entities can be dealt with by outside agencies.

Yes, Chapter 11 has the mantra of being about saving jobs. That's what has kept it around, relatively unscathed, since the Code became effective in 1979. But if you look back, NACBA was pretty complacent about how things were going in 2003.

I'm not sure I understand your comment, AMC. Is it that charging market-rate fees for the services of leading members of the bar *is* bad or just *looks* bad?

If it's the latter, I'm skeptical that John Q. Public's perception will be much different if he hears that a lawyer charges $400 per hour or $800 per hour. Admittedly, those are both very big numbers to the average wage earner. I also don't think it makes sense to approach fee objections as a form of window dressing, in which the goal is to shave a bit here and there--again, for perception's sake.

To be sure, we could move to a system of much heavier regulatory control of corporate reorganization. That was a central part of the New Deal-era bankruptcy regime, with the SEC playing the role, and it was not an ideal scheme. Chapter 11 and the concept of debtor-in-possession responded to the perceived inadequacies of that pre-1978 world.

Wow, I thought AMC's comment was both clear and powerful.

And regarding Troy McKenzie's response: wow, so many fallacies of false alternatives, so little time.

Appearances matter very much in maintaining respect for, and rule of, law and it is erroneous/disingenuous to dismiss concerns about appearances as mere "window dressing." See "conflict of interest."

It doesn't at all follow that concern for appearances necessarily leads to cynical/paternalistic drawing of the Wizard's curtain.

John Q. Public does have some trouble finding Honduras on a world map but, for the most part, can do basic math and actually grasp that 800 is twice 400. For clarity, that means that 800 is more/bigger than 400.

AMC, the fictional Ch. 11 firm presentation nearly made me spit out my coffee. And yes, Virginia, there is such a thing as a competing Plan.

AMC has a number of good points, but BAPCA is not one of them. BAPCA was not a response to popular perceptions of anything. It was a special-interest bill, duly bought and paid for, pure and simple. BAPCA, btw, was designed to raise consumer bankruptcy attorneys' fees, not lower them.

I don't think this is a consistently true statement: "Of course, high fee awards come out of the pockets of unsecured creditors..."

Frequently, in overleveraged capital structures, the secured debt is underwater and it is that constituency that effectively pays the fees i those cases. Further, the unsecured creditors are often responsible for driving fees up with litigation in an effort to extract some holdup value.


Fair enough.

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