Fifth Circuit Jettisons Pro-Snax Material Benefit Standard for Bankruptcy Professional Compensation
Professionals retained in a bankruptcy case by a trustee, a chapter 11 debtor-in-possession ("DIP"), or an official committee may be awarded "reasonable compensation" for "actual, necessary services" performed on behalf of their clients under section 330 of the Bankruptcy Code. In assessing whether particular services should be compensable, most courts, including the Second, Third, and Ninth Circuit Courts of Appeal, examine whether "the services were objectively beneficial toward the completion of the case at the time they were performed"—an approach sometimes referred to as the "reasonableness" test.
The Fifth Circuit, however, established a different standard for professional compensation in Andrews & Kurth LLP v. Family Snacks, Inc. (In re Pro-Snax Distribs., Inc.), 157 F.3d 414 (5th Cir. 1998). In Pro-Snax, the Fifth Circuit ruled that, to be compensable under section 330, services must result in "an identifiable, tangible, and material benefit to the bankruptcy estate." The "material benefit" test, which focuses on outcomes rather than reasonable expectations, endured for 17 years.
The Fifth Circuit finally abandoned the material benefit test in Barron & Newburger, P.C. v. Tex. Skyline, Ltd. (In re Woerner), 783 F.3d 266 (5th Cir. 2015). In Woerner, the court, after agreeing to a rehearing en banc of a previous panel ruling upholding Pro-Snax, reasoned that both the text of section 330 and its legislative history require a court to consider the reasonableness of services provided at the time the services were performed, rather than to evaluate the material benefit of the services with the assistance of hindsight.
Compensation for Professional Services in Bankruptcy
Under section 330(a)(1) of the Bankruptcy Code, the bankruptcy court may order payment by the estate of "reasonable compensation for actual, necessary services rendered" by, among others, professionals employed by a trustee, DIP, or official committee. Awards of compensation, however, are within the court's discretion. Thus, section 330(a)(2) provides that the court may "award compensation that is less than the amount . . . requested" by such professionals.
To determine whether requested compensation is "reasonable," section 330(a)(3) directs bankruptcy courts to consider "the nature, the extent, and the value" of the services provided, "taking into account all relevant factors," including:
- (A) the time spent on such services;
- (B) the rates charged for such services;
- (C) whether the services were necessary to the administration of, or beneficial at the time at which the service was rendered toward the completion of, a bankruptcy case;
- (D) whether the services were performed within a reasonable amount of time commensurate with the complexity, importance, and nature of the problem, issue, or task addressed;
- (E) with respect to a professional person, whether the person is board certified or otherwise has demonstrated skill and experience in the bankruptcy field; and
- (F) whether the compensation is reasonable based on the customary compensation charged by comparably skilled practitioners in cases other than cases under this title.
Section 330(a)(4) provides that, with certain exceptions, compensation cannot be awarded for unnecessary duplication of services, or for services which were not reasonably likely to benefit the estate or necessary to the administration of the case.
Sections 330(a)(3) and 330(a)(4) were added to the Bankruptcy Code in 1994. See Pub. L. No. 103-394, § 224 (1994). Prior to 1994, the leading cases regarding the factors to be considered in determining a reasonable allowance of compensation were Johnson v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974), a nonbankruptcy case, and In re First Colonial Corp. of America, 544 F.2d 1291 (5th Cir. 1977), a pre-Bankruptcy Code case that applied the Johnson approach in bankruptcy. Johnson articulated 12 factors to be considered in determining and awarding "reasonable" attorneys' fees. Most of those factors are now codified in section 330(a)(3).
In Pro-Snax (which was decided in 1995), creditors filed an involuntary chapter 7 bankruptcy case against the debtor. The bankruptcy court converted the case to chapter 11 but later appointed a chapter 11 trustee after denying the petitioning creditors' motion to reconvert the case to chapter 7. The court denied confirmation of a plan proposed by the debtor (prior to the trustee's appointment) and ultimately granted the petitioning creditors' renewed motion to convert the case to a chapter 7 liquidation.
A law firm provided legal services to the debtor both before and after the case was converted to chapter 11, including after the chapter 11 trustee was appointed. The bankruptcy court granted the firm's application for an allowance of $30,000 in fees and $7,500 in expenses. The district court reversed the award, ruling that section 330 of the Bankruptcy Code precluded the firm from being compensated from the assets of the estate for work performed after the chapter 11 trustee was appointed. However, because the petitioning creditors conceded on appeal that the firm could be compensated for services it had performed prior to appointment of the chapter 11 trustee, the district court remanded the case to the bankruptcy court for a recalculation of the fees requested.
The law firm appealed the ruling to the Fifth Circuit. In its decision, the Fifth Circuit examined, among other things, the appropriate standard to evaluate the firm's fee application for services rendered to the debtor before the trustee was appointed. It rejected the reasonableness test in favor of the hindsight approach advocated by the petitioning creditors, which, as noted, inquires whether the services "resulted in an identifiable, tangible, and material benefit to the bankruptcy estate."
The Fifth Circuit affirmed the district court's decision. In so ruling, the court of appeals adopted the stricter "hindsight," or "material benefit," approach, noting that "we are disinclined to hold that any service performed at any time need only be reasonable to be compensable."
Until Woerner, the material benefit test was the standard for bankruptcy professional compensation in the Fifth Circuit.
In 2006, Clifford Woerner ("Woerner") and Texas Skyline, Ltd. ("Texas Skyline") formed a limited partnership to pursue a real estate venture. Over the next three years, Woerner allegedly misappropriated partnership funds for personal use. Texas Skyline subsequently sued Woerner in state court for breach of the partnership agreement and for breach of fiduciary duties. After a bench trial, the state court held in favor of Texas Skyline. However, before the court could rule on potential remedies, Woerner filed for chapter 11 protection in the Western District of Texas.
Woerner was authorized by the bankruptcy court to retain the law firm of Barron & Newburger ("B&N") as counsel. However, the bankruptcy judge converted the chapter 11 case to a chapter 7 liquidation, in part because the court found that Woerner was not forthright in listing assets.
B&N filed an application for an allowance of approximately $130,000 in fees and $5,800 in expenses for the 11 months during which it acted as Woerner's counsel. According to B&N, those services included: (i) assisting with the filing of schedules, a statement of financial affairs, and other disclosures; (ii) defending Woerner in two adversary proceedings, including one brought by Texas Skyline seeking a denial of discharge; (iii) unsuccessfully defending against Texas Skyline's motion to lift the automatic stay to continue the state court litigation; (iv) negotiating with creditors and participating in mediation; (v) unsuccessfully seeking approval of a settlement; (vi) investigating potential causes of action against various parties; and (vii) drafting a disclosure statement and chapter 11 plan.
The United States Trustee and Texas Skyline objected to the fee application, arguing, among other things, that the requested fees were unreasonable because Woerner never had the means to fund a plan and that B&N's actions were dilatory and required creditors to incur unnecessary attorneys' fees.
After evaluating each category of fees, the bankruptcy court awarded only $19,409—an 85 percent reduction from the requested amount. In so ruling, the court applied the material benefit test set forth in Pro-Snax. B&N appealed to the district court, which affirmed.
The Fifth Circuit's Rulings
Initially, a three-judge panel of the Fifth Circuit affirmed the district court's judgment, noting that "Pro-Snax is still the governing standard." See In re Woerner, 758 F.3d 693, 702 (5th Cir. 2014), vacated on rehearing, 783 F.3d 266 (5th Cir. 2015). However, all three members of the panel specially concurred to call for en banc reconsideration of the ruling and, in particular, the viability of Pro-Snax. See In re Woerner, 771 F.3d 820 (5th Cir. 2014).
On en banc reconsideration, the Fifth Circuit cast Pro-Snax aside, concluding that the " 'material benefit standard' . . . conflicts with the text and legislative history of § 330 and unnecessarily places [the Fifth Circuit] at odds with [its] sister circuits."
The Fifth Circuit explained that both section 330(a)(3)(C) and section 330(a)(4)(A)(ii) of the Bankruptcy Code contemplate compensating professionals in situations where their services were reasonable when rendered but failed to produce a material benefit to the estate. In particular, as quoted above, section 330(a)(3)(C) states that a relevant factor in determining the amount of reasonable compensation to be awarded is whether the services were "beneficial at the time at which the service was rendered toward the completion of" the bankruptcy case (emphasis added). Similarly, section 330(a)(4)(A)(ii) directs the court to disallow compensation for services that "were not . . . reasonably likely to benefit the debtor's estate." "Read together," the Fifth Circuit observed, "a court may compensate an attorney for services that are 'reasonably likely to benefit' the estate and adjudge that reasonableness 'at the time at which the service was rendered.' "
According to the Fifth Circuit, section 330 "explicitly contemplates compensation for attorneys whose services were reasonable when rendered but which ultimately may fail to produce an actual, material benefit." The provision uses the term "reasonable," the court explained, to account for the risk inherent in any form of litigation:
The statute permits a court to compensate an attorney not only for activities that were "necessary," but also for good gambles—that is, services that were objectively reasonable at the time they were made—even when those gambles do not produce an "identifiable, tangible, and material benefit." What matters is that, prospectively, the choice to pursue a course of action was reasonable.
The Fifth Circuit found support for its conclusion in section 330's legislative history. When Congress enacted section 330 in 1978, it intended to relax both the prevailing "stringent standard" applied to professional fee awards under the former Bankruptcy Act and the mindset that estates should be administered with optimal efficiency. In part, lawmakers sought to align compensation for bankruptcy estate professionals with compensation provided to attorneys in nonbankruptcy cases.
According to the Fifth Circuit, Congress took additional steps toward a reasonableness standard for compensation when it added sections 330(a)(3)(C) and 330(a)(4)(A) to the Bankruptcy Code in 1994. Therefore, the Fifth Circuit concluded that Congress considered and rejected a compensation standard based solely on the actual benefit provided to an estate by professionals.
The Fifth Circuit also looked to precedent from its sister circuits for support. It noted that the Second, Third, and Ninth Circuits have rejected a hindsight approach which looks to the actual benefit derived for the estate by professionals. Instead, those circuits have adopted prospective standards that consider the reasonableness of the services provided at the time they were rendered. See In re Ames Dep't Stores, Inc., 76 F.3d 661 (2d Cir. 1996); In re Top Grade Sausage, Inc., 227 F.3d 123 (3d Cir. 2000), abrogated on other grounds, Lamie v. U.S. Trustee, 540 U.S. 526 (2004); In re Smith, 317 F.3d 918 (9th Cir. 2002); see also In re Taxman Clothing Co., 49 F.3d 310 (7th Cir. 1995) (applying similar rule without specifically relying on post-1994 amendments).
In determining reasonableness, the Fifth Circuit directed lower courts to consider, among other factors: (i) the probability of success at the time the services were rendered; (ii) the reasonable costs of pursuing a course of action; (iii) what services a reasonable professional would have performed under the same circumstances; (iv) whether the professional's services could have been rendered by the bankruptcy trustee; and (v) any potential benefits to the estate, as distinguished from the individual debtor. Most important, the Fifth Circuit emphasized that "[w]hether the services were ultimately successful is relevant to, but not dispositive of, attorney compensation."
Because the Fifth Circuit adopted a new legal standard for awarding compensation under section 330, the court remanded the case to the bankruptcy court to evaluate B&N's fee application under the new standard. On remand, the bankruptcy court allowed some fees previously disallowed under the Pro-Snax standard, although it continued to disallow certain other fees due to the lack of any likelihood of success of the legal strategy at the time the fees were incurred. See In re Woerner, 2015 BL 270736 (Bankr. W.D. Tex. Aug. 21, 2015).
Woerner is undeniably a positive development for professionals retained in Fifth Circuit bankruptcy cases. By aligning itself with many of its sister circuits, the Fifth Circuit has recognized that successful outcomes are not necessarily the litmus test for compensable professional services. For example, attorneys retained in a bankruptcy case on behalf of the estate must have the flexibility to take calculated litigation risks under appropriate circumstances. Even if a particular strategy fails, the associated services provided should be compensable so long as the "gamble," to use the Fifth Circuit's terminology, was a reasonable one.
Woerner does not mean that fee applications will be subjected to less exacting scrutiny in the Fifth Circuit. For example, in In re Digerati Technologies, Inc., 2015 BL 270718 (Bankr. S.D. Tex. Aug. 21, 2015), a post-Woerner case, the bankruptcy court noted that "merely because Pro-Snax is gone does not necessarily mean that fee applications will more easily be approved in their entirety." Applying the new standard to a fee application submitted in a case with a 100 percent dividend to unsecured creditors, the bankruptcy court reduced counsel's fees by 26 percent because of excessive charges, vague and repetitive time entries, and unnecessary services.
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