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2nd Circuit Sets 'High Hurdle' to Alter Fees in Bankruptcy
New York Law Journal
January 08, 2009
A federal appellate court has established a "high hurdle" for bankruptcy clients who seek to alter court-approved fees for professionals who have worked on a contingency basis.
In a case involving the rare instance of attorney fees, the 2nd U.S. Circuit Court of Appeals ruled in a case of first impression that clients seeking a reduction in contingent fees must show that the fees were "improvident in light of developments not capable of being anticipated."
The panel in In Re: Smart World Technologies v. Official Committee of Unsecured Creditors, 08-1721-bk, upheld a district judge's ruling restoring a firm's $2.2 million fee after it had been cut to $1.2 million by a bankruptcy judge.
Judges Robert D. Sack and Richard C. Wesley and Northern District of New York Judge Lawrence E. Kahn, sitting by designation, held that under U.S. bankruptcy statute 11 U.S.C. 328(a) -- which allows for preapproval of a professional's fees in a bankruptcy case -- fees cannot be changed unless an event occurs that was "incapable of anticipation."
The court rejected arguments by a committee for unsecured creditors of now-defunct dot-com Smart World Technologies that a number of unforeseen circumstances, including a larger-than-anticipated settlement, invalidated the fee arrangement.
"Simply because the size and scope of the settlement had not actually been anticipated, it does not follow that it was incapable of anticipation," Wesley wrote for the panel.
Smart World, which provided free dial-up Internet service, declared bankruptcy in 2000 in the Southern District of New York.
To generate money for its creditors, Smart World sold one of its most valuable assets, a list of subscribers, to Internet service provider Juno Online Services.
A dispute arose between Smart World and Juno over Juno's valuation of the subscriber list.
Smart World hired Riker, Danzig, Scherer, Hyland & Perretti as "special litigation counsel" to negotiate a higher price for the subscriber list, with the agreement that the firm would be paid a portion of the amount of the settlement, said J. Alex Kress of Riker Danzig in New Jersey, one of the attorneys who worked on the case.
After three years of negotiations, the parties agreed that Juno would pay $5.5 million for the list.
But Smart World's former executives and its committee of unsecured creditors objected to that figure. Further negotiations yielded a $6.5 million payment for the list. Riker Danzig applied for a fee award based on its pre-existing contingency arrangement, asking for around $2.2 million.
But U.S. Bankruptcy Judge James M. Peck reduced the fees to around $1.2 million, finding that events occurred that were "incapable of being anticipated," including an "unusually prolonged litigation; the divergence of positions between Smart World and its creditors;" the fact that Riker Danzig took instructions from the officers and majority shareholders of Smart World, which potentially benefited Smart World and not its creditors; and "the fact that Riker Danzig was an obstacle, not an asset, to the approval of the settlement," an assertion made by the committee of unsecured creditors.
Southern District of New York Judge Miriam Goldman Cedarbaum reversed the decision and awarded Riker Danzig approximately $2.2 million, noting "some degree of antagonism and animosity between debtor and creditor can be expected in any bankruptcy proceeding."
The circuit panel agreed with Cedarbaum.
"The prospect of prolonged litigation always exists. ... One need only glance at this Court's crowded docket to see that an appeal from an adverse ruling is not an event incapable of being anticipated," Wesley said.
In addressing other assertions made by the bankruptcy court, the panel held, "Riker Danzig was not pursuing frivolous litigation to extend the contest to increase its payday" and "it is undisputed that its successful appeal increased the total recovery from Juno by nearly 20 percent, benefitting the estate and its creditors alike."
Kress said it was relatively unusual for his firm, "or any firm," to provide services under a 328(a) compensation structure. The rules typically apply to nonattorney professionals, such as accountants or restructuring advisors, he said. Primary bankruptcy attorneys are usually compensated on an hourly basis, he explained.
The opinion gives "clarity and confidence to those types of engagements, specifically contingency-type engagements," Kress said. "It helps to make people feel more confident in taking on these representations, knowing that it will be honored."
Robert Rosenberg, a bankruptcy partner at Latham & Watkins who did not work on the Smart World case, said 328(a) compensation rules typically are "well understood" in bankruptcy cases.
"I think that this case will be applauded in that the 2nd Circuit has made it very clear that the statute means what it says," he said, specifically that a preapproved fee structure should be upheld unless extreme unforeseen circumstances arise.
Amy G. Pasacreta of Orrick, Herrington & Sutcliffe, who handles retention issues in bankruptcy cases but did not work on Smart World, said the decision affirms that 328(a) will be taken literally and "your fees are good." A 328(a) application might receive more scrutiny in the beginning, she said, but once approved, the court will be very strict about not upsetting the fee arrangement.
In addition to Kress, Glenn D. Curving and Kevin J. Larner of Riker Danzig represented Smart World.
Laurence May and Michele Cosenza of Cole, Schot, Meisel, Forman & Leonard in New York represented Smart World's committee of unsecured creditors.
