Oct. 3, 2022

Bankruptcy Trustee's Attorney Fees Under Attack—When Hourly Rate Agreements Become Contingent

As Published in the Daily Business Review

A recent decision from the U.S. Court of Appeals for the Sixth Circuit may be creating a tsunami of concern to those attorneys and law firms that regularly represent bankruptcy trustees. The decision, in essence, takes an hourly fee arrangement between the trustee and the trustee’s attorneys and adds a results-based contingency to the approval of any fee payment authorization by the bankruptcy court.

The case of In re Village Apothecary, 21-1555 (6th Cir. Aug. 16, 2022), addresses whether a bankruptcy court may consider “results obtained” when determining whether fees are reasonable under Section 330(a)(3) of the Bankruptcy Code. Ultimately, the Sixth Circuit decided yes it could.

Village Apothecary, a pharmacy in Ann Arbor, Michigan, filed for Chapter 7 bankruptcy in 2015. The court appointed a trustee and trustee’s special counsel (a law firm) to investigate potential causes of action totaling $1.6 million that would potentially benefit the estate. The special counsel undertook a year-long investigation into these potential causes of action and eventually drafted a complaint against Village Apothecary’s president, Garry Turner. Although the complaint was never filed, it was used as leverage to settle with Turner for $38,000. Notably, the estate’s assets totaled $40,710.87.

The trustee’s special counsel, the trustee, and the trustee’s attorneys all filed a fee application under Section 330. The trustee’s special counsel alone sought just over $37,000 in fees, or a little over 90% of the estate’s assets. The bankruptcy court subsequently held a hearing to determine whether the fee amounts should be reduced “given the amount of the benefit to the estate.”

Since the professional fees would leave nothing to be distributed to creditors, the bankruptcy court held that the fees should be reduced by half. The district court affirmed, leading special counsel to appeal to the Sixth Circuit. The court of appeals affirmed. In arguing that the bankruptcy court erred in considering “results obtained” as a factor in determining the reasonableness of fees, Judge John Nalbandian opined that “the text of Section 330(a)(3) permits courts to consider factors not listed, including ‘results obtained.’” As such, the Sixth Circuit determined the court may take “into account all relevant factors,” including results obtained, and further determined that a 50% reduction in fees was not an abuse of discretion.

While there are those in the business and legal community that will applaud the “results obtained” test to curtail what is perceived to be the proliferation of unjustified avoidance actions being brought on behalf of bankruptcy trustees (the authors take no position on the reality of the perception), the expanded use of the results obtained measure of compensation to be awarded on a broad brush basis may act to inhibit excellent attorneys and other professionals from being willing to assist in the recovery of assets of a debtor’s estate.

Traditionally, attorneys for trustees, as fiduciaries of the bankruptcy court, have not been restricted in their investigation and pursuit of claims on behalf of bankruptcy estates. Yet, there has been increased scrutiny of the legal fee claims of trustee’s attorneys when there have been little-to-no results obtained on behalf of the state. This has been particularly focused upon for those claims asserted by liquidating trustees appointed under confirmed Chapter 11 plans (again, the authors take no position on this assertion). 

Rules 9011 and 7012 of the Bankruptcy Rules of Procedure, which mimic in most respect Rules 11 and 12 of the Federal Rules of Civil Procedure, can and do act as a gatekeeper to weed out and eliminate claims brought in the bankruptcy court that have no legal or factual basis or justification for relief. A broad brush adoption of the “results obtained” standard may inhibit counsel’s full pre-litigation review and investigation of a claim that can be brought by an estate. Since it is the creditors of the bankrupt estate that benefit from any recoveries made on behalf of a trustee, wholesale perceived roadblocks to the investigation of potential claims may have a detrimental effect on ultimate distributions to creditors.

The legal community for the parts of the country not covered by the Sixth Circuit will be awaiting local bankruptcy court or appellate court rulings in order to see if the results obtained test will be broadly applied around the country. Until then, attorneys for bankruptcy trustees may be uncertain as to being paid for work done.

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