Issuing its third bankruptcy ruling in a month, the Supreme Court held, by a 6-3 margin, that the Bankruptcy Code does not permit awarding fees to debtor’s counsel, when counsel incurred those fees defending its own fee application.  The Court held that services defending fee applications were not rendered to the debtor’s estate, and therefore the fees did not constitute “actual, necessary services”  payable under section 330(a)(1) of the Bankruptcy Code as reasonable compensation.  This decision could increase leverage on parties seeking to rein in bankruptcy litigation by threatening to challenge attorney’s fees.  Baker Botts L.L.P. et al. v. ASARCO LLC, No. 14-103, 2015 WL 2473336 (S. Ct. June 15, 2015) (hereinafter, the “Opinion”).

Background.

ASARCO, a copper mining, smelting and refining company, filed for bankruptcy relief in 2005.  The Debtor retained Baker Botts and another firm as counsel under section 327(a) of the Bankruptcy Code.  ASARCO emerged from bankruptcy in 2009 with over $1.4 billion in cash, little debt and resolution of its key environmental claims.  Baker Botts and its co-counsel filed final fee applications requesting approximately $120 million in fees plus a $4.1 million enhancement for “exceptional performance.”  The bankruptcy court approved the fees and the enhancement, as well as over $5 million in fees for time spent litigating the fee applications themselves.

On appeal, the Fifth Circuit reversed and held that the “American Rule,” which requires each side to pay its own attorney’s fees, applies “absent explicit statutory authority” to the contrary.  The Fifth Circuit cited the failure of the Bankruptcy Code to include any provision expressly permitting the recovery of fees incurred defending a fee application, holding The Court of Appeals held that section 330(a)(1) of the Bankruptcy Code permits recovery of fees only if the services are “likely to benefit a debtor’s estate or are necessary to case administration.”  Here, because the attorneys—not the estate—benefit from the fee application, the Court of Appeals held that section 330(a)(1) does not permit recovery.

Analysis. 

Justice Thomas, writing for the Supreme Court, first reviewed the American Rule, which, as noted, requires that each “litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise.”  Op. at *4.  The Court held that “Congress did not expressly depart from the American Rule to permit compensation for fee-defense litigation.”  Op. at *5.  Section 327(a) authorizes retention of professionals by the debtor to “represent or assist [it] in carrying out [its] duties.”  Op. at *5.  Section 330(a)(1) provides that the court may authorize “reasonable compensation” of those professionals for “actual, necessary services rendered by the” professional.  This phrase does not specifically or explicitly authorize “courts to shift the costs of adversary litigation from one side to the other – in this case, from the attorneys seeking fees to the administrator of the estate.”  Op. at *5.

The law firms and the U.S. government each argued for payment of fees to the professionals, arguing that section 330(a)(1) expressly trumps the American Rule.  The Court rejected these arguments.  The law firms argued that their own fee defense constituted “services rendered” to the estate.  The Court, including the dissent, observed that this interpretation could require a court to compensate counsel even for an unsuccessful defense of a fee application.  The Court held that there was “no indication that Congress departed from the American Rule in § 330(a)(1) with respect to fee-defense litigation, let alone that it did so in such an unusual manner.”  Op. at *6.

The U.S. government made a slightly different argument, taking the position that the fee application defense should be viewed as “part of the compensation for the underlying services in the bankruptcy proceeding.”   The government argued that “if an attorney is not repaid for his time spent successfully litigating fees, his compensation for his actual ‘services rendered’ . . . will be diluted.”  Op. at *7.

Thus, the government argued that the fee-defense work constitutes a component of “reasonable compensation.” The Court held that section 330(a)(1) does not authorize fees for any “reasonable compensation” but only for “reasonable compensation for actual necessary services” rendered by the professional.  Here, the work was not a “service” to the debtor and thus the estate was not obligated to compensate the professional could not be compensation for such a service.  Op. at *7-8.

The government also made a policy-based argument that awarding fees for defense of a fee application is a “judicial exception” necessary for the functioning of the Bankruptcy Code.  Failure to award fees for fee defense litigation will, it argued, dilute attorney’s fees and result in bankruptcy lawyers receiving less compensation than non-bankruptcy lawyers, which is contrary to Congress’ intent.  The Court held that “no attorneys, regardless of whether they practice in bankruptcy, are entitled to receive fees for fee-defense litigation absent express statutory authorization.”  Op. at *11 (emphasis in original).

The government also argued that in bankruptcy uncompensated fee litigation could be more burdensome because multiple parties may object to fee applications – rather than just the attorney’s client.  The Court rejected the argument, stating that it “rests on unsupported predictions of how the statutory scheme will operate in practice.”  The Court noted further that the government itself reversed course in this case, arguing in the Fifth Circuit that requiring attorneys to bear their own costs for fee defense “dilutes a bankruptcy fee award no more than any litigation over professional fees.”  Op. at *9 (internal citation omitted).

Conclusion.

This ruling could hamstring estate professionals (and potentially their clients), exposing them – as the government argued – to potential objections from parties at any place in the capital structure.  This could give those creditors significant leverage throughout the case.  Justice Thomas’ comment that the policy argument rests on “unsupported predictions of how the statutory scheme will operate in practice”  may indicate that this ruling does not mean that a fee dispute between a third-party creditor and debtor’s counsel would come out the same way.

While the Court focused largely on Congress’ ability to modify the “American Rule” statutorily – and its failure to do so in the Bankruptcy Code – the Court dropped one other potentially significant hint.  In describing the American Rule, Justice Thomas quotes Hardt v. Reliance Standard Life Ins. Co., 560 U.S. 242, 252-53 (2010), stating: “Each litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise”  (emphasis added).  Thus, the majority may believe that parties could contract around this ruling and the American Rule.  In such a case, it is not clear whether fees incurred defending a fee application would constitute reasonable compensation for “actual, necessary services”—assuming, of course—that the bankruptcy court approved such an engagement when agreeing to the employment of the estate professional.