Unsecured creditors and other stakeholders sometimes challenge the reasonableness of fees incurred by estate professionals in a bankruptcy case.  Whether this is to augment unsecured creditor recoveries or serve as a check on the private bar is in the eye of the beholder.  Whatever the reason, fee litigation in bankruptcy caused many professionals to seek payment from the bankruptcy estate for any fees incurred defending against an objection to their fees. This practice was eventually challenged and, in 2014, the Supreme Court ruled that the Bankruptcy Code does not permit it.[1]  The Court’s holding was grounded in the American Rule, which provides that “[e]ach litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise.”[2]  Section 330(a)(1)’s provision for “reasonable compensation for actual, necessary services rendered,” the Court announced, “neither specifically nor explicitly authorizes courts to shift the costs of adversarial litigation from one side to the other—in this case, from the attorneys seeking fees to the administrator of the estate—as most statutes that displace the American Rule do.”[3]

With the statutory route apparently closed off, estate professionals have looked to their engagement letters to find a contractual basis for abrogation of the American Rule.  But, in 2016, Delaware Bankruptcy Judge Mary Walrath ruled that a provision in the retention agreement between the Creditors’ Committee and its counsel that would require payment of any fees incurred by the law firm in the defense of its fee applications was also precluded by ASARCO.[4]  The Court was troubled that the contract at issue in this case was not “between two parties providing that each will be responsible for the other’s legal fees if it loses a dispute between them. Rather, here there is a contract between two parties (the Committee and Committee Counsel) that in the event Committee Counsel win a challenge to their fees, a third party (the estate) will pay their defense costs even if the estate is not the party who objected.  [T]his is not the typical contract modifying the American Rule.”[5]  But, even if it was typical, the Court determined that such a provision simply is not permissible under the Bankruptcy Code in light of ASARCO:  “[t]he fee defense provisions are not reasonable terms for the employment of Committee Counsel because they do not involve any services for the Committee.  Rather, they are for services performed by Committee Counsel only for their own interests.”[6]

More recently, however, some courts have appeared more receptive to contractual fee shifting in bankruptcy.  Earlier this year, we reported on the result in In re Nortel Networks Inc., in which Bankruptcy Judge Gross determined that an indemnification provision in a corporate indenture allowed the indenture trustee to exercise its charging lien to secure payment of legal fees that were incurred in defense of an objection to the underlying fees the indenture trustee had  incurred during the bankruptcy case.[7]  Because the indenture trustee’s counsel was not an estate professional, the Nortel decision was not based on Section 328 or 330 of the Bankruptcy Code and therefore is not entirely at odds with Boomerang Tube or ASARCO.  However, just last month, a New Mexico Bankruptcy Court relied on Nortel (among other things) to approve an agreement between a debtor and its lawyer that the debtor would pay any fees incurred in the defense of the lawyer’s fee applications. 

In In re Hungry Horse, LLC, Judge David Thuma concluded that ASARCO does not prohibit a bankruptcy court from concluding that an indemnification provision in a retention agreement is reasonable under Section 328 of the Bankruptcy Code.[8]  Recognizing that “the contract exception to the American Rule remains viable in bankruptcy cases,” the Hungry Horse Court concluded that “a properly drafted fee defense provision could be a ‘reasonable term’ under § 328(a), violating neither the letter nor spirit of ASARCO.”[9]  Unlike Judge Walrath’s decision in Boomerang Tube, which suggested that a fee defense provision benefits only the lawyer and therefore is not reasonable under Section 328, Judge Thuma took a holistic view of the engagement letter to determine reasonableness:  “[a] typical employment agreement between a lawyer and client has many terms; some benefit the client, while others benefit the lawyer. Considered together, they may be reasonable. [. . . ]  By agreeing to the terms, the client obtains the services of needed, able professionals.”[10]  The Court also offered guidance for practitioners crafting such a provision, observing that it should be agreed to by the bankruptcy estate (to avoid one of the Boomerang Tube problems), provide for Bankruptcy Court review and approval of the reasonableness of any fee defense fees, provide that the estate will agree to the same provision for committee counsel (to “level the playing field”), and provide that no fees will be allowed for unsuccessful fee defense work.[11]

Hungry Horse is a helpful addition to the case law from the perspective of estate professionals seeking some measure of protection against costly fee litigation.  But it may not be the last word:  it remains to be seen how other Bankruptcy Courts will construe ASARCO in light of these recent decisions.