The Case for Bankruptcy Court Discretion to Shift Attorney’s Fees
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Reform, International and Comparative | 0

By Daniel J. Bussel (Professor of Law, UCLA School of Law)

Daniel J. Bussel

Neither the “American Rule” (each party pays its own attorney) nor the “English Rule” (loser pays both parties’ attorneys) is the baseline principle in insolvency cases.  Most major parties do not bear their own attorney’s fees, win or lose.  Fee-shifting is pervasive; the bankruptcy court is directly involved in reviewing the fees; sometimes it’s almost impossible to figure who actually foots the bills.  This is true in US courts, which still generally purport to follow the “American Rule,” and courts in the UK, which generally purport to follow the “English Rule.”  In both countries, theory notwithstanding, equitable principles, born in England’s ancient chancery courts, permit discretionary fee-shifting in light of the collective nature of insolvency proceedings.

Unfortunately, some US courts, including the Supreme Court, disregarding this history and practice, anomalously cling to the American Rule, creating perverse incentives that disrupt the efficient functioning of the reorganization process.  Two leading examples are the Supreme Court’s decisions in Baker & Botts and Midland Funding, both critiqued in my paper, Fee-Shifting in Bankruptcy.  In Baker & Botts, the American Rule denies full compensation to the prevailing debtor’s attorney from any source, disincentivizing the pursuit of meritorious estate claims.  In Midland Funding, the American Rule rewards strategic manipulation by the holder of meritless claims, disincentivizing clearly valid objections.         

Abandoning the American Rule and authorizing a discretionary version of the English Rule as the default rule in bankruptcy for recovery of attorney’s fees is no radical step.  Empirical work is limited, but supports the conclusion that shifting from the American Rule to a discretionary version of the English Rule will have only a modest impact. In bankruptcy cases, an enormous amount of explicit and implicit fee shifting already occurs.  The bankruptcy courts have a well-developed set of procedures for regulating and allowing reasonable attorney’s fees.  They are well-positioned to exercise discretion in awarding attorney’s fees to control bullying and holdout tactics calculated to confer leverage by pressing weak claims and imposing costs on others.  

Several factors can appropriately guide court discretion to award fees in insolvency cases, including: 

  1. Whether the prevailing party or its adversary has a right to recover fees in nonbankruptcy litigation over the same issues. 
  2. Whether the bankruptcy code expressly contemplates recovery of fees as a component of damages. 
  3. The amount of fees and whether the stakes justify them. 
  4. The strength of the prevailing party’s merits case.
  5. Whether the nonprevailing party played the part of bully, holdout, or squeaky wheel. 
  6. Whether a systemic asymmetry exists between the parties allowing one party to implicitly shift fees whether it prevails or not and regardless of the court’s fee award. 
  7. Whether the prevailing party’s success in litigation will economically benefit others similarly situated or creditors generally. 
  8. Whether a fee award will advance the public interest in equitable administration of bankruptcy cases. 
  9. The extent to which a given fee award may be so onerous to the non-prevailing party that it would unreasonably deter access to the courts.
  10. Vexatious and unreasonable conduct by either (or both) of the litigants. 
  11. The extent to which the prevailing party incurred fees for considerations apart from the case at bar because of its status as a repeat player. 
  12. The extent to which the party seeking recovery of fees practically prevailed in the litigation.
  13. Whether the prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  14. Whether the non-prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity.
  15. Assessing the practical economic incidence of fees initially borne by the estate.

The UK, starting from the English Rule, has created a discretionary fee-shifting regime in insolvency cases resembling the discretionary approach advocated here.  The English cases exhibit a continuing push-pull among (i) the desire to socialize costs of reorganizations that benefit third parties; (ii) concern about unduly discouraging participation by all affected constituents; and (iii) the problems posed by hold-outs, bullies and excessive litigiousness. See Matter of Virgin Active Holdings Ltd (Snowden, J.).  The realities of insolvency practice are impelling both the English and American systems towards court-supervised discretionary fee-shifting.

The damage done by the American Rule is limited by how pervasive fee-shifting already is in bankruptcy.  Fully embracing discretionary fee-shifting in favor of prevailing parties, however, is low-hanging fruit we can promptly gather in to facilitate sound administration of insolvent estates.

The full paper is available here.

Second Circuit Fumbles Tribune on Reconsideration
by | posted in: Avoidance, Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors, fraudulent transfer, Statutory Interpretation | 0
Daniel J. Bussel

By Daniel J. Bussel (UCLA School of Law)

The Second Circuit recently issued its revised opinion in Tribune Company Fraudulent Conveyance Litigation, determining that a debtor-transferor that effectuates a transfer involving a securities contract in its capacity as the customer of a commercial bank is itself a “financial institution” within the meaning of the Bankruptcy Code section 101(22)(A) and therefore the transfer is protected under section 546(e).

This ruling has critically important implications for the avoiding powers of the bankruptcy trustee. Section 546(e) insulates all transfers involving securities by or to a financial institution from avoidance except as an “actual fraud” under section 548(a)(1)(A). Virtually all transferors are customers of commercial banks and almost any transfer can be effectuated with funds transferred through the agency or in the possession of a commercial bank. The result is the virtual repeal of the avoiding powers as to any transfer involving securities that is not an actual fraud on creditors, undoing centuries of fraudulent transfer and preference law.

These considerations are powerful enough that the Second Circuit, if necessary in light of the statute’s plain language, should have striven mightily to avoid interpreting the term “financial institution” so as to include the customers of commercial banks. The Code’s avoiding power sections read as a whole make no sense if limited only to cases involving transfers by entities that are not customers of commercial banks. Moreover, such a reading of section 101(22) flies in the face of Merit Management, the recent, directly applicable, Supreme Court precedent.

The full article is available here.

For more posts on the scope of section 546(e), see Ralph Brubaker, Understanding the Scope of the § 546(e) Securities Safe Harbor Through the Concept of the “Transfer” Sought to Be Avoided.

Corporate Governance, Bankruptcy Waivers and Consolidation in Bankruptcy
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Corporate Governance, Cramdown and Priority, Workouts and Pre-Packs | 0

By Daniel J. Bussel (UCLA School of Law)

Bankruptcy law—once the vanguard of enterprise liability —has increasingly tended to kowtow to formalities of corporate law standing in the way of effective reorganization.

In two areas in particular, corporate law is seen by some courts and commentators as imposing rigid and substantive limitations on bankruptcy rights.

First, although bankruptcy courts have long held that access to bankruptcy relief may not be waived in a contract, recent decisions have enforced state corporate law’s choice to defer to contractual governance arrangements baked into corporate charters that hinder or preclude an entity from filing for bankruptcy relief.

Second, influential appellate decisions have pushed bankruptcy courts to respect the legal boundaries between affiliated entities within a corporate group for substantive insolvency law purposes, even as those boundaries are routinely ignored for operational, financial, tax and regulatory purposes.

Professors Baird and Casey, expanding upon earlier work by Professor LoPucki, have noted and embraced this judicial trend toward respecting corporate law formalities.  They have coined the term “withdrawal rights” to describe the phenomenon of prebankruptcy contractual arrangements enforceable under state corporate law that operate to allow a particular creditor to opt-out of the bankruptcy process by segregating key operating assets in entities that are effectively precluded from obtaining bankruptcy relief without the creditor’s express consent.

In CORPORATE GOVERNANCE, BANKRUPTCY WAIVERS AND CONSOLIDATION IN BANKRUPTCY, I argue that these techniques, however clever, run smack into traditional and still vibrant bankruptcy doctrines that find contractual waivers of access to bankruptcy relief void as against public policy, and that permit consolidation of entities whose formal separateness is inconsistent with the actual and effective operation of the corporate enterprise under reorganization.

Thus “Golden Share” arrangements in which a creditor is issued a special class of equity (the Golden Share) and the debtor’s charter is amended to preclude bankruptcy filing absent the Golden Shareholder’s consent, fail as unenforceable contractual waivers of bankruptcy rights.

Moreover, constituents with claims against affiliated companies in bankruptcy proceedings that effectively operate as a unified enterprise should not be surprised when they are treated as a claimant against that unified enterprise, except to the extent that the bankruptcy equities themselves demand otherwise, and so long as the value of their rights in property are adequately protected, even if the formalities of entity separateness are otherwise respected.  The restrictive approach to substantive consolidation adopted by some appellate courts, notably the Third Circuit in Owens-Corning, that encourages reliance on formal entity separation, should be rejected.

Bankruptcy courts are destined to struggle with the problem of withdrawal rights forever. Powerful creditors have never fully accepted the concept that they can be compelled to participate in a collective proceeding in the event of the common debtor’s insolvency and have sought ways to opt out of those proceedings when it is to their advantage to do so. They show no signs of flagging in efforts to structure bankruptcy-remote relations through statutory exceptions and preferences, the creation of property rights in their favor, and contractual strictures. If they have the political strength to carve out express exemptions in the Bankruptcy Code, courts may have little flexibility to prevent the opt-out.

But absent a federal statutory exemption, to the extent that state law corporate formalities manipulated to the advantage of certain constituencies through special contractual arrangements become impediments to effective bankruptcy reorganizations, those formalities are quite properly overridden by bankruptcy law.  Bankruptcy law limits the efficacy of the “Golden Share” and other contractual arrangements incorporated into company charters, and the entity partition techniques observed by LoPucki, Baird and Casey (among others).  Those limits should be factored into market expectations surrounding asset securitization and other structuring techniques designed to avoid the ordinary operation of bankruptcy law upon a particular creditor’s claim. If they are properly factored in, it is difficult to believe that securitization of core assets of non-financial operating companies will remain a cost-effective alternative to more traditional financing arrangements. The market should place little value on a bankruptcy withdrawal right that is likely to prove illusory when it matters most.

The full article is available here.