RATT S OURNAL OF B L - Hunton & Williams LLP · p ratt’s journal of bankruptcy law volume 8 number 7 october 2012 headnote steven a. meyerowitz 581 could reform of bankruptcy venue

PRATT’S JOURNAL OF BANKRUPTCY LAW

VOLUME 8 NUMBER 7 OCTOBER 2012

HEADNOTE

Steven A. Meyerowitz 581

COULD REFORM OF BANKRUPTCY VENUE AND COMPENSATION

RULES ADDRESS GROWING CONCERNS REGARDING

PROFESSIONAL COMPENSATION IN BANKRUPTCY CASES?

Kevin M. Eckhardt and Matthew Mannering 583

RENT ASSIGNMENTS IN BANKRUPTCY: AN ELEVENTH CIRCUIT ANALYSIS

Jonathan M. Sykes 603

MASSACHUSETTS IMPOSES ADDITIONAL RESTRICTIONS ON

RESIDENTIAL MORTGAGE FORECLOSURES; MAY NOW REQUIRE

LOAN MODIFICATION IN LIEU OF FORECLOSURE

Russell P. Plato and David G. Thomas 618

BANKRUPTCY COURT HOLDS THAT VENUE OF HOUGHTON MIFFLIN

CASE IS IMPROPER, BUT DELAYS TRANSFER

Chri stopher J. Updike and Thomas J. Curtin 630

JUDGE GROPPER DENIES THE APPOINTMENT OF AN OFFICIAL

COMMITTEE OF EQUITY HOLDERS IN KODAK’S CHAPTER 11 CASES

Audrey Aden Doline and Matthew J. Oliver 637

SECTION 546(E): DEFENDANT’S BEST FRIEND IN FRAUDULENT

TRANSFER LITIGATION

Ronald R. Sussman, Seth Van Aalten, and Michael Klein 643

SECOND CIRCUIT UPHOLDS THE DESIGNATION OF CLAIM

PURCHASER’S VOTE ON DBSD PLAN

Gregory G. Hesse and Justin F. Paget 648

NEW ITALIAN MEASURES FACILITATE DEBT RESTRUCTURING

AND PROTECT DIP FINANCING

Bruno Cova, Antonio Azzarà, Bernadette Accili, Paolo Manganelli, and Anteo Picello 654

ELEVENTH CIRCUIT RULES “NO-ACTION” CLAUSE BARS

NOTEHOLDERS’ FRAUDULENT-TRANSFER CLAIMS

Dan T. Moss 666

AN OVERSECURED LENDER’S RIGHT TO DEFAULT INTEREST

AND LATE PAYMENT PENALTIES

Marc B. Roitman 672

EDITOR-IN-CHIEF

Steven A. MeyerowitzPresident, Meyerowitz Communications Inc.

ASSISTANT EDITOR

Catherine Dillon

BOARD OF EDITORS

PRATT’S JOURNAL OF BANKRUPTCY LAW is published eight times a year by A.S. Pratt & Sons, 805 Fif-teenth Street, NW., Third Floor, Washington, DC 20005-2207, Copyright © 2012 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this journal may be reproduced in any form — by microfi lm, xerography, or otherwise — or incorporated into any information retrieval system without the written permission of the copyright owner. Requests to reproduce material contained in this publication should be addressed to A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207, fax: 703-528-1736. For permission to photocopy or use material electronically from Pratt’s Journal of Bankruptcy Law, please access www.copyright.com or contact the Copyright Clearance Center, Inc. (CCC), 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400. CCC is a not-for-profi t organization that provides licenses and registration for a variety of users. For subscription information and customer service, call 1-800-572-2797. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Meyerowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, [email protected], 631.331.3908 (phone) / 631.331.3664 (fax). Material for publication is welcomed — articles, decisions, or other items of interest to bankers, offi cers of fi nancial insti-tutions, and their attorneys. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns refl ect only the present considerations and views of the authors and do not necessarily refl ect those of the fi rms or organiza-tions with which they are affi liated, any of the former or present clients of the authors or their fi rms or organiza-tions, or the editors or publisher. POSTMASTER: Send address changes to Pratt’s Journal of Bankruptcy Law, A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207.

ISSN 1931-6992

Scott L. BaenaBilzin Sumberg Baena Price &

Axelrod LLP

Leslie A. BerkoffMoritt Hock & Hamroff LLP

Ted A. BerkowitzFarrell Fritz, P.C.

Andrew P. BrozmanClifford Chance US LLP

Kevin H. BuraksPortnoff Law Associates, Ltd.

Peter S. Clark II Reed Smith LLP

Thomas W. CoffeyTucker Ellis & West LLP

Michael L. CookSchulte Roth & Zabel LLP

Mark G. DouglasJones Day

Timothy P. DugganStark & Stark

Gregg M. FicksCoblentz, Patch, Duffy & Bass

LLP

Mark J. FriedmanDLA Piper

Robin E. KellerLovells

William I. Kohn Schiff Hardin LLP

Matthew W. LevinAlston & Bird LLP

Alec P. OstrowStevens & Lee P.C.

Deryck A. PalmerPillsbury Winthrop Shaw

Pittman LLP

N. Theodore Zink, Jr.Chadbourne & Parke LLP

583

Could Reform of Bankruptcy Venue and Compensation Rules Address Growing

Concerns Regarding Professional Compensation in Bankruptcy Cases?

KEVIN M. ECKHARDT AND MATTHEW MANNERING

The authors discuss and analyze proposed reforms regarding the “apparently persistent problem of overcompensation of estate

professionals” in large Chapter 11 bankruptcy cases.

For years, commentators, bankruptcy lawyers, and even a few bankruptcy judges have expressed concerns regarding the apparently persistent problem of overcompensation of estate

professionals in large Chapter 11 bankruptcy cases. Recently, Congress and the Offi ce of the United States Trustee appear to have taken these concerns seriously and have proposed reforms that might address the overpayment issue. Large creditors, whose interests appear superfi -cially aligned with those opposing these reforms, should consider the positive effects these reforms might have for the legitimacy and fl exibil-ity of the bankruptcy system before expressing their own opposition.

Kevin M. Eckhardt and Matthew Mannering are senior associates in the Charlotte

offi ce of Hunton & Williams, LLP. They specialize in bankruptcy, restructuring, and

creditors’ rights cases, focusing on representation of creditors. The authors can be

reached at [email protected] and [email protected], respectively.

Published by A.S. Pratt in the October 2012 issue of Pratt’s Journal of Bankruptcy Law.

Copyright © 2012 THOMPSON MEDIA GROUP LLC. 1-800-572-2797.


584

BANKRUPTCY COURTS, EQUITY, EFFICIENCY, AND THE

DECLINE IN FILINGS

Bankruptcy judges often refer to theirs as a “court of equity,” especially when utilizing a novel solution not otherwise contemplated by the explicit provisions of the Bankruptcy Code and Federal Rules of Bankruptcy Procedure. Section 105 of the Bankruptcy Code codi-fi es the equitable origins of the bankruptcy courts, providing that “[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”1 Bankruptcy courts “are courts of equity and ‘appl[y] the principles and rules of equity jurisprudence.’”2 “The bankruptcy courts have exercised these equitable powers in passing on a wide range of problems arising out of the administration of bankruptcy estates. They have been invoked to the end that fraud will not prevail, that substance will not give way to form, that technical considerations will not prevent substantial justice from being done.”3 “[I]n the exercise of its equitable jurisdiction the bankruptcy court has the power to sift the circumstances surrounding any claim to see that injustice or unfairness is not done in administra-tion of the bankrupt estate.”4

These equitable powers are intended to secure a prompt, effi cient, and fair resolution of all fi nancial issues facing each debtor and its creditors. “[T]his Court has long recognized that a chief purpose of the bankruptcy laws is ‘to secure a prompt and effectual administra-tion and settlement of the estate of all bankrupts within a limited period.’”5 Further, not only should bankruptcy cases be quick, they should also be “inexpensive in (their) administration.”6

Congress has established this specialized nationwide bankruptcy court system in order to avoid the unfairness, delay, and expense of litigating debtor-creditor disputes in state courts and “regular” federal courts. The equitable powers of the bankruptcy courts should afford a respite from the adversary clamor of replevin and foreclosure actions, the messy squalor of visiting a local clerk of court to secure a writ of garnishment to serve on an unwitting bank or employer, the pleas that a local sheriff executes on personal property resting unmaintained in a

REFORM OF BANKRUPTCY VENUE AND COMPENSATION RULES

585

carport behind a padlocked chain link fence. By offering an effi cient and expeditious route to reorganization or discharge, bankruptcy should offer debtors and creditors relief and fi nality, respectively – an end to the potentially interminable and expensive cycle of forbearance and refi nancing, the limbo of “extend and pretend.” At a minimal cost, the debtor cleans up its balance sheet, and transfers assets to new management hopefully better able to realize their full value; the credi-tor cleans its hands of another mess, freeing its own assets from the cost of special asset management for use in more profi table investments.

Recently, however, more and more debtors – and, in business cases, the creditors with leverage to dictate the direction of the “next stage in a debtor’s business” – have chosen to avoid subjecting themselves to the equitable jurisdiction of the bankruptcy courts, notwithstanding these advantages. According to a report issued by the United States Courts on August 3, 2012, both consumer and business bankruptcy fi lings continue to decline. According to the August 3, 2012 report, for the 12-month period ending June 30, 2012, total bankruptcy fi lings were down 14 percent from the 12-month period ending June 30, 2011.7 Chapter 7 fi lings, which constitute 70 percent of all fi lings, fell 16 percent. Chapter 11 fi lings fell 14 percent, from 12,714 to 10,921. In 2011, 86 publicly traded companies fi led for bankruptcy, compared to 106 fi lings in 2010 and 211 fi lings in 2009.8

It is possible, of course, that fewer individuals and corporations have fi led for bankruptcy in 2012 than in 2011 because the fi nancial health of individuals and corporations has improved to the point where potential bankruptcies have been averted.9 It is also possible, however, that there is something systematically wrong with the bank-ruptcy system – the courts and the rules that guide the courts’ applica-tion of their much-vaunted equitable powers to ensure prompt, effectual, and inexpensive administration. Bankruptcy court generally is an elective forum – either a debtor or its most important creditors choose to fi le or force a fi ling in order to take advantage of the central-ized, purportedly more effi cient bankruptcy process or substantive remedies available only in bankruptcy court (such as asset sales free and clear of claims or non-debtor releases in Chapter 11 plans).


586

Thus, bankruptcy courts rely to some extent on the perceived legiti-macy and advantages of their administrative expertise. In exchange for these advantages, debtors and creditors that consent to bankruptcy jurisdiction (e.g. those that agree to use of cash collateral in bank-ruptcy, provide debtor-in-possession fi nancing, and refrain from seek-ing dismissal or conversion of cases) agree to pay a “toll” – the added cost of monitoring bankruptcy administration by specialized bank-ruptcy professionals and, often, a “carve out” for payments to unse-cured creditors and their professionals in order to secure plan confi rmation. Some academic commentators, practitioners and judges have argued that the professional expenses element of this “toll” have grown excessive and have begun to erode confi dence in the bankruptcy courts and their legitimacy. Reform proposals have recently arisen to address these concerns.

A POTENTIAL SYSTEMATIC WEAKNESS IN BANKRUPTCY

ADMINISTRATION: PROFESSIONAL COMPENSATION

The massive compensation paid to professionals in large Chapter 11 cases has, in the opinion of some commentators, resulted in a perception of collusion amongst the bankruptcy judges and bar in the Southern District of New York and the District of Delaware, the “magnet districts” that almost exclusively handle these cases. Bankruptcy practitioners, judges, and commentators have over the years become very familiar with the criticisms of Professor Lynn LoPucki of the UCLA College of Law. In numerous articles, Professor LoPucki has argued that the system for approval of compensation applied by the magnet courts in large cases has exacerbated the “per-sistent problem” of overpayment of compensation in bankruptcy cases dating back to the Bankruptcy Act enacted by Congress in 1898.10 Although Professor LoPucki’s criticisms have long seemed to fall on deaf ears, Congress and regulators recently have appeared to heed Professor LoPucki’s warnings about excessive professional compensa-tion in bankruptcy cases and have advanced reform proposals that they believe will address the perceived abuses.


587

THE EXISTING STATUTORY AND REGULATORY FRAMEWORK

FOR APPROVAL OF COMPENSATION IN BANKRUPTCY CASES

The statutory framework governing professional compensation in bankruptcy cases has remained largely unchanged since the enactment of the current Bankruptcy Code in 1978. Section 327 of the Bankruptcy Code, which applies to all bankruptcy cases, empowers debtors-in-possession to retain professionals, including attorneys, accountants and investment bankers, upon prior approval of the bankruptcy court.11 Section 328 of the Bankruptcy Code provides that estate professionals may be retained, with the bankruptcy court’s approval, “on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fi xed or percentage fee basis, or on a contingency fee basis.”12 Section 330 of the Bankruptcy Code pro-vides that “[a]fter notice to the parties in interest and the United States Trustee and a hearing … the court may award to a trustee … or a pro-fessional person employed under section 327 or 1103 … reasonable compensation for actual, necessary services rendered by the trustee … professional person, or attorney [and] reimbursement for actual, nec-essary expenses.”13 Section 1103 of the Bankruptcy Code, which applies to Chapter 11 cases, applies these rules to compensation of professionals for offi cial committees appointed in bankruptcy cases.14

One of the underlying motivations for these statutory provisions was the elimination of the aforementioned persistent problem of over-payment of estate professionals in bankruptcy cases. In “Routine Illegality,” Professor LoPucki quotes the House Report on a 1963 fee regulation reform bill:

In bankruptcy, the motivations which normally prevent overcharge are often absent. It matters very little to a bankrupt whether his attorney’s fee is large or small since it will be paid out of assets which in any event will normally be completely consumed in distribution.15

According to Professor LoPucki, the managers of a company in bank-ruptcy rarely bother to carefully monitor or police professional fees


588

and costs because these fees and costs will be borne by creditors rather than the bankrupt entity. “[T]he managers rarely have signifi cant inter-ests in the estate. When they spend money on professionals they spend other people’s money - usually creditor’s money.”16

To assist creditors in taking over management’s normal, non-bankruptcy role in keeping legal fees to a minimum, the Federal Rules of Bankruptcy Procedure require that estate professionals fi le and serve applications requesting approval of their retention, compensa-tion arrangements, and particular compensation requests. Specifi cally, Rule 2014 of the Federal Rules of Bankruptcy Procedure provides a basic procedure for evaluation of proposed retention and compensa-tion arrangements for estate professionals. Rule 2014(a) provides that “[a]n order approving the employment of attorneys, accountants, appraisers, auctioneers, agents, or other professionals pursuant to §327 [or] § 1003 … of the Code shall be made only on application of the trustee or committee.”17 Rule 2014(a) further requires that such application:

shall state the specifi c facts showing the necessity for the employ-ment, the name of the person to be employed, the reasons for the selection, the professional services to be rendered, any proposed arrangement for compensation, and, to the best of the applicant’s knowledge, all of the person’s connections with the debtor, credi-tors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the offi ce of the United States trustee. The application shall be accompanied by a verifi ed statement of the person to be employed setting forth the person’s connections with the debtor, creditors, any other party in interest, their respective attorneys and accoun-tants, the United States trustee, or any person employed in the offi ce of the United States trustee.18

Further, Rule 2016 of the Federal Rules of Bankruptcy Procedure provides a similar procedure for evaluation of specifi c compensation requests by an estate professional.19 Specifi cally, Rule 2016 requires that:


589

An entity seeking interim or fi nal compensation for services, or reimbursement of necessary expenses, from the estate shall fi le an application setting forth a detailed statement of (1) the services rendered, time expended and expenses incurred, and (2) the amounts requested. An application for compensation shall include a statement as to what payments have theretofore been made or promised to the applicant for services rendered or to be rendered in any capacity whatsoever in connection with the case, the source of the compensation so paid or promised, whether any compensa-tion previously received has been shared and whether an agree-ment or understanding exists between the applicant and any other entity for the sharing of compensation received or to be received for services rendered in or in connection with the case, and the particulars of any sharing of compensation or agreement or under-standing therefor.…20

In evaluating a specifi c application for compensation of an estate professional under the statutory standards of §§ 330 or 1103, a bank-ruptcy court “must conduct an objective inquiry ‘based upon what services a reasonable lawyer or legal fi rm would have performed in the same circumstances.’”21 A bankruptcy court should consider:

(i) the nature of the services provided,

(ii) the extent of the services,

(iii) the value of the services,

(iv) the time spent on the services, and

(v) the cost of comparable services in non-bankruptcy cases.22

The analysis should begin with the bankruptcy judge’s “experience with fee petitions and his or her expert judgment pertaining to appro-priate billing practices, founded on an understanding of the legal pro-fession.”23 The bankruptcy court should conduct a two-step inquiry: fi rst, “the court must be satisfi ed that the attorney performed actual and necessary services”; second, “the court must assess a reasonable


590

value for those services.”24 “The applicant bears the burden of proving that the fees and expenses sought are reasonable and necessary.”25

PERCEPTION OF “CORRUPTION” AND PROPOSALS

FOR REFORM

Firms that serve as estate professionals in bankruptcy cases under-standably believe that the existing statutory framework and disclosure requirements of the Bankruptcy Code and Federal Rules of Bankruptcy Procedure have solved the persistent problem of overpayment to pro-fessionals in bankruptcy cases. These professionals have no problem accepting that the approximately $383 million paid to debtors’ counsel in the Lehman liquidation, and the approximately $1.6 billion in total professional fees paid prior to confi rmation in that case, were “reasonable and necessary” under the circumstances.

Commentators such as Professor LoPucki, however, vehemently disagree. According to Professor LoPucki, the statutory underpin-nings for the compensation regulation system are sound, but the com-pensation regulation system is currently failing in large Chapter 11 bankruptcy cases due to certain bankruptcy courts’ adoption of prac-tices that violate and undermine the statutory framework. Professor LoPucki cites three “illegal” practices through which friendly bank-ruptcy courts allow the overcompensation of estate professionals in large Chapter 11 cases: (i) “the ordinary-course-professionals practice,” by which large debtors secure payment of purportedly “de minimis” fees of professionals without any court scrutiny, despite the massive cumulative amounts of these fees; (ii) “the prior-payment-disclosure practice,” by which professionals in large cases are exempted from dis-closing the fees paid to them prior to the fi ling of the bankruptcy case; and (iii) “the disburse-fi rst practice,” by which professionals are paid monthly, without court approval, pursuant to limited invoices sent only to select “notice parties” and not fi led with the bankruptcy court.26

Professor LoPucki attributes the prevalence of these abusive practices in large cases to the venue rules governing big Chapter 11 bankruptcy


591

cases and a resulting “race to the bottom” by bankruptcy courts com-peting for big case fi lings. Section 1408(a) of Title 28 of the United States Code, which governs venue for fi ling bankruptcy cases, provides that a Chapter 11 bankruptcy case may be commenced in the district where the debtor has its “domicile,” its principal place of business, or where its “principal assets” are located.27 This allows a debtor to fi le bankruptcy either where it is incorporated (often Delaware for large debtors) or where it has its principal place of business. Further, § 1408(b) provides that a Chapter 11 case may be commenced in the district where “there is a pending case under title 11 concerning such person’s “affi liate.”28 This allows a debtor to fi le bankruptcy in any district where one of its affi liates can fi le, even if the affi liate is a small or inactive part of the enterprise. Such venue “bootstrapping” allows large corporations with small affi liates located in New York or incorporated in Delaware to fi le in these friendly jurisdictions – a “tail wagging the dog” venue rule.

Taken together, the provisions of § 1408(a) and (b) allow a pro-spective bankruptcy debtor to fi le in a number of different jurisdic-tions, and thus give the prospective debtor the opportunity to “forum shop” its bankruptcy case. According to Professor LoPucki, this opportunity for forum shopping has led directly to “competition among the bankruptcy courts to attract large cases.”29 Bankruptcy judges tailor their decisions in order to attract big cases, which can bring publicity, intellectual challenges, and full employment for the local bankruptcy bar, whose opinion carries signifi cant weight in the bankruptcy judge reappointment process. “[B]ig bankruptcy reorgani-zation is a multi-billion-dollar-a-year industry and a single, aggressive court can hope to attract nearly the entire industry.… Failure can bring a judge derision, ostracism, and adverse comment from the bar if the judge seeks reappointment.”30

Further, according to Professor LoPucki, this race to the bottom forces judges from competing districts to adopt more and more lenient procedures and standards for oversight of bankruptcy administration in order to attract large cases – especially oversight of the compensation system, which is understandably important to the estate professionals


592

that actually control the venue decision. As a result, according to Professor LoPucki, virtually all large Chapter 11 cases are now fi led in Delaware and New York, where the judges have been most willing to bend the law to please the large fi rms that control almost all big Chapter 11 debtor work and their allied accounting fi rms and invest-ment bank partners.

Professor LoPucki’s criticism of the venue and compensation practices currently governing big Chapter 11 cases has not gone unno-ticed. In the wake of public criticism regarding the professional com-pensation being paid by bankruptcy estates in cases such as Lehman Brothers,31 both Congress and the Offi ce of the United States Trustee (a division of the Department of Justice with oversight responsibility in Chapter 11 bankruptcy cases) have proposed action that might ame-liorate the perceived excesses of estate professional compensation in large bankruptcy cases.

CONGRESS’ REFORM PROPOSAL: LIMITATIONS ON

BANKRUPTCY VENUE

In July 2011, Representative Lamar Smith, the chair of the House Committee on the Judiciary, introduced H.R. 2533, a bill that would amend §§ 1408(a) and (b) of Title 28. The bill was co-sponsored by two Democrats (Representatives John Conyers and Steve Cohen), and has the support of the top two ranking Democrats and Republicans on the Judiciary Committee. H.R. 2533 would require that corporations fi le a Chapter 11 case only in the district in which they have had their prin-cipal place of business, or where their principal assets have been located, for at least one year prior to fi ling. H.R. 2533 would also amend § 1408(b) to limit “affi liate venue” to those affi liates which directly or indirectly own or control the debtor at issue – in other words, only a fi ling by a corporate parent would allow for “bootstrapping” of venue for affi liates.

According to Representative Smith’s September 8, 2011 statement on H.R 2533, submitted in connection with public hearings held by the Judiciary Committee, the unique venue rules for bankruptcy cases


593

“allow many corporations to forum shop for a venue with favorable judicial precedent for the business … [c]hapter 11 debtors should not be able to leave their home districts and shop for a forum whose judicial precedent on bankruptcy law they happen to prefer.”32 Representative Smith decries forum shopping as “predicated upon an assumption that some judges are ‘fairer’ than others.” He explains that he introduced H.R. 2533 to limit this forum shopping and to protect stakeholders that “feel out of touch with the reorganization process” in a distant magnet court. In his statement to open the September 8, 2011 Judiciary Committee public hearing on H.R. 2533, Representative Howard Coble, a Republican, decried the “inequities” of the current magnet venue system, whereby “small business creditors oftentimes are left in the dust when a reorganization takes place in a faraway district.”33

Neither Representative Smith nor Representative Coble mentioned Professor LoPucki’s concerns regarding the effect of forum shopping on professional compensation in bankruptcy cases in their statements, but Professor David Skeel, an opponent of H.R. 2533, highlighted Professor LoPucki’s “race to the bottom” argument in his testimony in opposition to H.R. 2533 for the purpose of disagreeing with Professor LoPucki’s argument that “Delaware and New York attract cases by … paying high fees to bankruptcy lawyers, permitting the debtor’s man-agers to keep their jobs, and simply rubber-stamping the company’s proposed reorganization plan or asset sale.” Professor Skeel argued that his research shows large debtors fi le in the magnet courts because these courts are more experienced and have “developed the adminis-trative capacity and expertise to handle the very largest cases.” Professor Skeel indicated that, according to his research, 90 percent of Chapter 11 cases are fi led in the district where the debtor has its prin-cipal place of business. Representative Trey Gowdy, a Republican, aggressively cross-examined Professor Skeel on his position that the magnet courts have special expertise in large bankruptcy cases or that such expertise justifi es the existing unique bankruptcy venue provi-sions, challenging Professor Skeel to name bankruptcy judges “who are currently doing bankruptcy work that you think are too inexperienced


594

or have no business doing it.” Representative Gowdy pointed out that “maybe bankruptcy attorneys are different, but usually you pick a venue not based on the experience and expertise of the judge, but whether or not you think you will get a more favorable outcome. It might be that bankruptcy attorneys are just different and they are more interested in fairness than winning, but they would be unique among attorneys if that is what they are motivated by.”

UNITED STATES TRUSTEE’S REFORM PROPOSAL: ADDITIONAL

DISCLOSURE BY PROSPECTIVE PROFESSIONALS

Second, in addition to the skeptical attention of Congress, the bankruptcy compensation system is under scrutiny by the United States Trustee in its role as propagator of guidelines for professional compensation in Chapter 11 cases. Specifi cally, on November 4, 2011, the Offi ce of the United States Trustee, a division of the Department of Justice responsible for overseeing the Chapter 11 process, submitted for public comment proposed new compensation guidelines requiring additional disclosure by debtors and estate professionals in large bank-ruptcy cases (defi ned by the UST as cases with more than $50 million in combined assets and liabilities).34 The proposed guidelines imple-ment six key changes to the current UST guidelines. Most importantly, the proposed new guidelines require prospective estate professionals to disclose information regarding their hourly rates for partners, counsel and associates for bankruptcy cases and for non-bankruptcy matters, as well as disclosing whether higher or lower rates were charged in bankruptcy and non-bankruptcy matters. Additionally, the guidelines require that estate professionals and clients prepare budgets at the beginning of cases and explain subsequent failure to adhere to those budgets.

The requirement for disclosure of rates in non-bankruptcy matters relates specifi cally to the requirement that bankruptcy courts evaluating applications for estate professional compensation consider “the cost of comparable services in non-bankruptcy cases.”35 “In enacting the Bankruptcy Code provisions which allow compensation to attorneys,


595

Congress sought to encourage qualifi ed attorneys to develop bank-ruptcy expertise by assuring that they would be compensated at the same level as their peers in other practice areas. ‘Section 330(a) does not entitle debtors’ attorneys to any higher compensation than that earned by non-bankruptcy attorneys’ and the Court must ensure that the applicant ‘exercises the same ‘billing judgment’ as do non-bankruptcy attorneys.’”36 “[T]he hourly rates of bankruptcy practitio-ners must be commensurate with the hourly rates charged by their peers in other practice areas.”37

This “comparable services” standard has been rarely applied in bankruptcy cases, however, for the simple reason that bankruptcy lawyers and judges seem unaware of the hourly rates charged by non-bankruptcy lawyers. According to a survey conducted by the American Bankruptcy Institute:

With respect to attorneys’ fees, the judge respondents were asked how familiar they were with the hourly rates for local attorneys specializing in areas other than bankruptcy law. Only 13 percent reported that they have a complete and current knowledge of those rates. A sizeable majority (60 percent) of judges reported that they have a fair amount of knowledge of those rates. However, a size-able minority of 27 percent reported that they have little or no knowledge of those rates....

Many judges do not appear to have the information needed to reach an informed decision on fee requests, with a substantial per-centage even admitting as much. Further, the judges appear to be quite dissatisfi ed with the fee presentations made by professionals. And, if the accountants’ responses to the application question are any indication, the professionals haven’t a clue as to what the prob-lem may be. The obvious solution to the information problem is for the professionals to devote more energy to teaching the judges about the market forces at work in their respective practice areas.38

In the Fleming Companies case, one bankruptcy court specifi cally directed Kirkland & Ellis to “provide a schedule of the hourly rates of


596

all its attorneys and paralegals in all practice areas and offi ces.”39 The proposed UST guidelines attempt to impose a less onerous disclosure requirement on estate professionals early in every large case.

During the UST’s comment period, virtually every major law fi rm in the United States with a bankruptcy practice40 responded negatively to the proposed UST guidelines. Criticisms of the proposed guidelines from practitioners are best summarized in a January 31, 2012 letter submitted by the Business Bankruptcy Committee of the American Bar Association.41 The ABA committee argued that the proposed guidelines are “unnecessary as the existing professional fee guidelines that are in existence adequately address issues in large cases.” The ABA committee denied the existence of any fee overpayment issue in large Chapter 11 cases. The ABA committee argued that oversight of fees by secured creditors in big cases is suffi cient to prevent compensa-tion abuse; that the proposed fee disclosure rules “improperly require attorneys to disclose information about their internal fee and billing arrangements that may be trade secrets”; and that disclosure of bud-gets worked out between estate professionals and their clients might violate the attorney-client privilege.

On June 4, 2012, the UST held public hearings on the proposed new guidelines. The public hearing was widely reported on by the media.42 Coverage focused on the purported abuses committed by estate professionals, including discussion of “limousine rides and clothing put on expense accounts,” as well as the amounts paid to estate professionals in large cases such as Lehman Brothers.43 Representatives of fi rms with large bankruptcy practices, primarily those with signifi cant practices in the magnet districts, testifi ed against the proposed guidelines, but did themselves few favors. For example, Richard Levin of Cravath, Swaine & Moore, in testimony widely quoted by the media, stated that additional disclosure would be use-less, as legal billing records are often inaccurate because lawyers failed contemporaneously to record time spent on particular tasks. Levin also testifi ed that lawyers are “notoriously bad at administrative tasks, including putting data in properly.” Damian Schaible of Davis Polk & Wardwell testifi ed that the budgeting process would be useless as well.


597

Attorneys at smaller boutique bankruptcy fi rms (who appear to benefi t from greater restrictions on larger fi rms) attacked these argu-ments. Albert Togut, in his widely quoted testimony, stated that big law fi rms tend to throw scores of lawyers at a single case, and cannot resist feasting on major bankruptcy cases. “It’s in their DNA that, when they approach a project, they bring every resource at their disposal.”

ANALYSIS

Advocates of bankruptcy venue reform in Congress have attempted to frame their efforts as an attempt to rebalance the bankruptcy system away from dominance by large, New York-based professional fi rms and creditors toward a more equitable system that provides equal con-sideration for the concerns of smaller creditors located in the debtor’s principal place of business. For example, in his testimony before the Judiciary Committee at the public hearing on H.R. 2533, Judge Frank J. Bailey, a bankruptcy judge in the District of Massachusetts, stated that he believes the current venue statute “undermines confi dence in the bankruptcy system” by allowing “iconic companies” to fi le bank-ruptcy in a “magnet court rather than in the place where they did busi-ness for many years.” Judge Bailey bemoaned the trouble such a fi ling presents for the “employees, small vendor creditors, retirees [and] former employees” who cannot afford to attend hearings or otherwise participate in far-off magnet courts, and testifi ed that he believes the procedure for seeking a transfer of venue of a magnet court-fi led case is too expensive for these small creditors.

However, it is diffi cult to avoid the conclusion, as indicated by Professor Skeel’s testimony at the same hearing, that one of the pur-poses behind the venue reform proposal is the reduction of professional expenses in large cases. At a time when the pressures placed by private clients on law fi rms to “rationalize” their rate structures and even adopt alternative fee arrangements such as project or fi xed-fee pricing are at their highest, bankruptcy practitioners in large Chapter 11 cases seem to be immune to this rate pressure, receiving compensation in amounts


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that to some appear to be fundamentally inconsistent with the equita-ble principals underlying the bankruptcy system. The bankruptcy system increasingly seems tilted toward benefi ting the professionals rather than creditors or the general economy, which assumes the exis-tence of a functioning bankruptcy system to rehabilitate enterprises and reallocate poorly deployed but valuable assets to those who might better use them. Even at the margins, where the perception exists, it brings doubt upon the legitimacy of the whole bankruptcy system.

The large creditor – the fi rst-lien lender, the institutional noteholder – might wonder how the proposed reform could possibly benefi t them. They stand to lose power to smaller creditors, whose inexpert meddling in matters in which they have a small interest might slow down the smooth operations of the magnet court bankruptcy machines. And they have an effective voice in professional compensa-tion already, by virtue of their power to set cash collateral or debtor-in-possession budgets and assist in selection of counsel.

However, all creditors – large and small – have a vested interest in the legitimacy of the bankruptcy system. According to Professor Skeel and other opponents of venue reform, the magnet courts have become popular because they process bankruptcy cases quickly. As Professor Skeel stated in his testimony before the Judiciary Committee, the magnet courts have developed an “administrative effi ciency” that would be lost if large debtors could no longer fi le in these courts, resulting in an increase in administrative costs and a decline in the “overall effectiveness of the bankruptcy system.” It is possible that the venue change proposed by H.R. 2533 would result in even fewer bank-ruptcy fi lings, as creditors chose to pursue out-of-court restructuring or state court remedies rather than place their interests at the whim of local bankruptcy courts in the provinces more used to handling bank-ruptcy cases involving individuals and smaller enterprises. Perhaps these local courts would simply ape the abusive procedures employed in the magnet courts and derided by Professor LoPucki.

But it is worth considering whether even large creditors might be better off with a bankruptcy system that seems more equitable to Congress and the public, without dismissing the reform proposals out


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of hand as a sop to populist anti-corporate and anti-lawyer sentiment. H.R. 2533, after all, appears to enjoy broad bipartisan support, at least on the Judiciary Committee. Whether the new venue regime is intended to remedy “corruption” in the professional compensation process or to provide grist for the populist mill, all stakeholders in the bankruptcy process need to consider whether these measures might be better than a compromised system vulnerable to populist attacks that are starting to stick. If the bankruptcy court loses its right to assert the power and fl exibility of equity, it might compromise its role as the restructuring and liquidation venue of choice, leaving local state court judges to consider the vagaries of corporate fi nance and restructuring – a truly frightening thought.

There are other potential benefi ts of freeing up the bankruptcy system from the current domination by a few magnet courts and few practitioners. Filing large bankruptcy courts in local courts that have not already fashioned their own solutions to common bankruptcy problems could give rise to new, better solutions to these problems. The involvement of a more diverse group of judges and practitioners, responding to the demands of local conditions, could inject more creativity and innovation into the legal aspect of the restructuring process. After all, this is one of the fundamental justifi cations for the federal system – sometimes problems should be considered and solu-tions tested at a local level, without centralized control, in order to allow new ideas and solutions to be considered and tested. These new solutions would benefi t not just large debtors and their large creditors, but could trickle down to smaller Chapter 11 cases and might then infl uence out-of-court restructuring strategies. The current system dis-courages new thinking and new ideas, preferring the certainty and speed of the magnet courts, at a very high price in professional com-pensation. Such certainty may be desirable, but must be balanced against the demands of equity and the possibility for innovation. A more localized, more transparent system would not only close the growing divide between the rules in large bankruptcy cases and those in smaller cases; it could br ing about better rules in all cases.


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NOTES

1 See 11 U.S.C. § 105(a). 2 Young v. U.S., 535 U.S. 43, 50, 122 S.Ct. 1036, 1041, 152 L.Ed.2d 79, 86 (2002) (quoting Pepper v. Litton, 308 U.S. 295, 304, 60 S.Ct. 238, 287, 84 L.Ed. 281, 287 (1939)). 3 Pepper, 308 U.S. at 304-05. 4 Id. at 307-08. 5 Katchen v. Landy, 382 U.S. 323, 328, 86 S.Ct. 467, 472, 15 L.Ed.2d 391, 396 (1966). 6 Id. 7 See “Bankruptcy Filings Continue Decline,” U.S. Courts, (August 3, 2012), http://news.uscourts.gov/bankruptcy-fi lings-continue-decline.8 See “2011 Corporate Bankruptcy Recap: Average Asset Counts Rise – Further Increase Anticipated in 2012,” http://www.bankruptcydata.com, (January 6, 2012), http://www.bankruptcydata.com/product_fi les/PR_010612.pdf.9 According to bankruptcydata.com’s 2011 Corporate Bankruptcy Recap, although well down in 2011 from the post-boom peak of 211 fi lings in 2009, publicly traded company fi lings remain higher than the 2006 pre-crash number of 66 and equal to the 86 fi led in 2005. Further, the post-tech bubble crash years of 2000, 2001, 2002, and 2003 experienced considerably higher publicly-traded company fi lings – 187, 265, 229, and 176, respectively, before a lull in 2004 (93 fi lings) similar to the number in 2011. This suggests some correlation between economic conditions and publicly-traded company fi lings.10 See Lynn M. LoPucki and Joseph W. Doherty, Routine Illegality in Bankruptcy Court, Big-Case Fee Practices, 83 Am. Bankr. L.J. 423, 424 (2009). 11 See 11 U.S.C. §327 (2011). 12 See 11 U.S.C. §328 (2011). 13 See 11 U.S.C. §330 (2011). 14 See 11 U.S.C. §1103 (2011). 15 LoPucki, supra note 10, at 424. 16 Id.17 See Fed. R. Bankr. P. 2014(a). 18 Id.19 See Fed. R. Bankr. P. 2016.


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20 Id.21 In re Fleming Companies, Inc., 304 B.R. 85, 89 (Bankr. D. Del. 2003) (quoting In re Cenargo Int’l, PLC, 294 B.R. 571, 595 (Bankr. S.D.N.Y. 2003)).22 See Fleming Cos., 304 B.R. at 89.23 Id. at 89-90 (quoting In re Busy Beaver Building Centers, Inc., 19 F.3d 833, 854 (3d Cir. 1994)). 24 Id. at 90 (quoting In re Gencor Industries, 286 B.R. 170, 176-77 (Bankr. M.D. Fla. 2002)). 25 Id. at 89.26 LoPucki, supra note 10, at 430-469. 27 See 28 U.S.C. §1408(a) (2011).28 See 28 U.S.C. §1408(b) (2011).29 LoPucki, supra note 10, at 426. 30 Id. 31 See e.g. Jacqueline Palank, $1,000/Hour Bankruptcies: Attorneys Justify Their Fees, WALL ST. J., June 3, 2012, http://online.wsj.com/article/SB10001424052702303506404577444374260079502.html. (“[B]ig legal bills often don’t sit well with creditors or employees whose jobs may be at stake in the restructuring”).32 Chapter 11 Bankruptcy Venue Reform Act of 2011: Hearing on H.R. 2533 Before the H. Comm. On the Judiciary, 112th Cong. (2011) (statement of Rep. Lamar Smith, Chairman, H. Comm. On the Judiciary) http://judiciary.house.gov/news/09082011.html.33 Chapter 11 Bankruptcy Venue Reform Act of 2011: Hearing on H.R. 2533 Before the H. Comm. On the Judiciary, 112th Cong. (2011) http://judiciary.house.gov/hearings/hear_09082011.html.34 U.S. Trustee Program, Guidelines for Reviewing Applications for Compensation & Reimbursement of Expenses Filed Under 11 U.S.C. § 330 by Attorneys in Larger Chapter 11 Cases: http://www.justice.gov/ust/eo/rules_regulations/guidelines/docs/proposed/proposed_guidelines_and_exhibits.pdf.35 See Fleming Cos., 304 B.R. at 89. 36 Id. at 92-93 (quoting Busy Beaver, 19 F.3d at 855–56). 37 Id. at 93. 38 American Bankruptcy Institute, American Bankruptcy Institute National Report on Professional Compensation in Bankruptcy Cases (1991)


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available at http://www.abiworld.org/Content/NavigationMenu/NewsRoom/BankruptcyResearchCenter/BankruptcyReportsResearchandTestimony/ABI/ch9-3.html.39 See Fleming Cos, 304 B.R. at 93. 40 Full disclosure: the objecting fi rms include Hunton & Williams LLP, the authors’ employer.41 Comment Letter from Patricia A. Redmond, Chair of the Business Bankruptcy Committee of the Business Bankruptcy Section of the American Bar Association, to Offi ce of the U.S. Trustee (Jan. 31, 2012), available at http://www.justice.gov/ust/eo/rules_regulations/guidelines/docs/proposed/ABA_Subcommittee_Comment.pdf.42 Transcript of the Public Meeting on the United States Trustee Program’s Proposed Guidelines for Attorney Compensation in Larger Chapter 11 Bankruptcy Cases, June 4, 2012 available at http://www.justice.gov/ust/eo/rules_regulations/guidelines/docs/proposed/Transcript_June4_Public_Meeting.pdf.43 David Ingram, US Bankruptcy Lawyers Resist Scrutiny Over Fees, Reuters, June 4, 2012, http://www.reuters.com/article/2012/06/04/bankruptcy-fees-idUSL1E8H43NY20120604.

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RATT S OURNAL OF B L - Hunton & Williams LLP · p ratt’s journal of bankruptcy law volume 8 number 7 october 2012 headnote steven a. meyerowitz 581 could reform of bankruptcy venue