Insight Center: Publications

Success Fees Under Section 328: Be Reasonable and Specific

Author: Francis J. Lawall

Copyright 2008, ALM Properties, Inc. Reprinted with permission from The Legal Intelligencer.

In complex business reorganizations, debtors and other major parties-in-interest (including trustees, examiners and creditors committees) will typically retain a small army of professionals, such as attorneys, financial advisors, accountants and the like, to assist in the case.  Not surprisingly, such professionals are entitled to be compensated by the bankruptcy estate. 

Under the Bankruptcy Code, 11 U.S.C. §§ 101 – 1532, et seq., there are varying standards by which the court may review a retained professional’s compensation request.  For example, professionals retained under section 330(a) of the Bankruptcy Code, must periodically submit applications for compensation, typically on an hourly rate basis, which the court will then review under a reasonableness standard.  On the other hand, professionals retained under section 328 will have their compensation pre-approved at the time of their retention, such as on a fixed fee, percentage fee, contingent fee and/or monthly fee basis.  When a professional is employed under section 328, as opposed to section 330, the court will usually not revisit terms of compensation that it has pre-approved unless “such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.”  11 U.S.C. § 328(a). 

To the dismay of the committee’s financial advisors in the Northwest Airlines case (In re Northwest Airlines Corp., 2008 WL 542193 (Bankr. S.D.N.Y. 2008), however, the United States Bankruptcy Court for the Southern District of New York applied the section 330 “reasonableness” standard to their requested multi-million dollar success and completion fees, despite their argument that the fees had been pre-authorized by the Court under section 328.

The professionals at issue were the financial advisors to the Official Committee of Unsecured Creditors.  In their respective retention applications, they each arranged for payment of a monthly fixed fee and also reserved the right to request a success fee or completion fee.  Their employment applications provided that the success fee requests would be subject to review by the court, but failed to articulate the events or occurrences that would constitute ‘success’ or ‘completion’ entitling them to the fees.  The court approved their employment under section 328.  Further, the Orders approving their retention provided that their monthly fixed fees and expenses could only be challenged under section 328, and not 330, other than with respect to the Office of the United States Trustee which was permitted to review the monthly fees for ‘reasonableness.’  Like the retention applications, however, the retention Orders neither defined nor specifically required payment of the success fees.

In their final applications, the financial advisors, respectively requested a success fee in the initial amount of $1.5 million and a completion fee in the amount of $3.25 million.  The court denied both requests.  The court found that the success fees had not been “pre-approved” in the retention orders pursuant to section 328 and that such fees failed to meet the “reasonableness” standard of Bankruptcy Code section 330(a).

The professionals argued that the ‘reasonableness’ standard should not be applied to the success fees given that their retention had been authorized under section 328 of the Bankruptcy Code rather than under section 330.  The court did note that “pre-approval” of employment terms under section 328 “affords the professional assurances the amount of compensation approved will not be modified by the court unless it is proven that the amount was improvident in light [of] developments not [capable] of being anticipated at the time.”  However, the court held that section 330 scrutiny was appropriate because neither the Orders authorizing the retention of the professionals, nor their respective retention applications, set forth any standard of compensation that would set the level of the requested success fees.  The court held “Bankruptcy Code section 328 applies when the bankruptcy court approves a particular rate or means of payment, and section 330 applies when the court does not do so.”  If a professional seeks success or completion fees under section 328, it must set forth the elements under which such compensation will be awarded in its retention application.  Because the financial advisors did not do this, the court determined that the requested completion fees were in the manner of “fee enhancements” that had to withstand reasonableness scrutiny under section 330 of the Bankruptcy Code.

The court then determined that payment of the success fees would not be reasonable.  In analyzing the success fees under section 330(a) of the Bankruptcy Code, the court applied the “lodestar” analysis which contemplates a comparison of a fee request to what would be a reasonable fee for comparable services in the industry, which is derived by multiplying a “reasonable” billing rate by a “reasonable” number of hours expended.  This analysis, the court noted, takes into account, among other factors, customary compensation charged by other professionals in similar cases, whether the services rendered were necessary, beneficial and “performed within a reasonable amount of time commensurate with the complexity, importance and nature of the problem, issue... addressed.”  Once the ‘lodestar’ amount is figured, the court held, “[e]nhancements to the lodestar amount are proper only in rare and exceptional cases...” 

The professionals pointed to several areas in which they had specifically contributed to the success of the debtor’s reorganization, including their analyses leading to more profitable fuel hedging and regional carrier agreements, reduction in labor costs for non-union employees, identifying for the debtor provident financing opportunities, and assisting with developing restructuring strategies, among other contributions.  In addition, they offered uncontradicted evidence that they did a ‘very good’ job in the case that fully satisfied their client.  Finally, the financial advisors argued that the court should take the “market approach” to analyzing the reasonableness of their success fees and directed the court’s attention to several cases in which success fees had been awarded to financial advisors.  The court, however, held that it would not be “reasonable” to award success fees to the professionals.  “It is unclear to the court whether, with reasonable certainty, the ‘successes’ being claimed are solely attributable to either professional.”  The court expressed discomfort in awarding substantial success fees to professionals in a case where the rights of unsecured creditors, employees and equity interests were being compromised.  Under the standard of section 330(a), “the court is not convinced that evidence of a successful reorganization automatically rewards professionals with additional fees.”

In spite of the court’s holding in Northwest, success fees under section 328 can remain a valuable and sometimes necessary incentive to encourage professionals to achieve better than anticipated results.  Although, as a practical matter, the United States trustee may reserve the right to revisit such fees at the end of the case under a reasonableness standard, any professional that is retained pursuant to section 328 with a fixed fee and significant potential success fee, should within its retention application establish clear standards so that the court can easily understand up front how to calculate the scope of such success fees the professional will later seek to recover.

Francis J. Lawall and James C. Carignan

The material in this publication is based on laws, court decisions, administrative rulings and congressional materials, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.