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

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.