Dear constituency list members of the Insolvency Law Committee, the following is a case update written by Michael J. Riela, a senior investments attorney at Genworth North America Corporation, analyzing a recent case of interest:
In Bennetti et al. v. Oxford Restructuring Advisors LLC et al. (In re CPESAZ Liquidating, Inc.), No. CC-22-1090, 2022 WL 18067792 (B.A.P. 9th Cir. Dec. 29, 2022), the Ninth Circuit Bankruptcy Appellate Panel (the “BAP”) affirmed the bankruptcy court’s award of fees to the debtors’ law firm over the objection of certain participants in the debtors’ employee stock ownership plan (the “ESOP Participants”).
In objecting to the law firm’s fee application, the ESOP Participants asserted that (a) the firm had failed to disclose an alleged disqualifying conflict of interest and (b) the amount of the requested fees was excessive. The BAP affirmed the bankruptcy court’s fee award, stating that the bankruptcy court’s factual findings were logical, plausible and supported by the record.
To read the full decision, click here.
The debtors’ outstanding equity interests were held in the ESOP for the benefit of their employees. Before the debtors’ bankruptcy filing, the law firm advised the debtors regarding potential sale and restructuring options. Around this time, the debtors were looking for a replacement trustee for the ESOP. The law firm’s partner in charge of the engagement suggested that the debtors consider hiring Miguel Paredes for the role and facilitated an interview. The law firm had a lengthy pre-existing relationship with Mr. Paredes and had represented him in dozens of other unrelated ESOP cases.
Shortly before the petition date, the debtors’ board appointed Mr. Paredes to serve as the replacement trustee for the ESOP.
After the debtors filed their chapter 11 petitions, they filed an application to retain the law firm as their general bankruptcy counsel. However, in its Rule 2014 declaration in support of the debtors’ retention application, the law firm did not disclose its relationship with Mr. Paredes or that it had represented him in unrelated ESOP matters. Later, the law firm acknowledged that it did not run a firm-wide conflict check on Mr. Paredes’s name or on Mr. Paredes’s firm’s name.
The law firm later had Mr. Paredes and the debtors’ CEO sign a conflicts waiver. The debtors did not seek bankruptcy court approval for the post-petition waiver, and the law firm did not disclose the conflicts waiver to the bankruptcy court until much later.
The ESOP Participants objected to the law firm’s final fee application on two grounds: (a) the law firm had a disqualifying conflict of interest because of its past relationship with Mr. Paredes, which the law firm had failed to disclose and (b) the law firm’s requested fees were unreasonable for a variety of reasons (e.g., certain time entries were “block-billed,” other time entries were vague, some time entries reflected non-compensable clerical work, and the law firm should not receive fees for “unsuccessful or incomplete tasks.”)
In ruling on the law firm’s final fee application and the ESOP Participants’ motion to disqualify, the bankruptcy court held that the law firm did not properly conduct a conflict check and had violated Rule 2014 by failing to disclose its relationship with Mr. Paredes. In connection with the ESOP Participants’ separate motion to disqualify the law firm, the U.S. Trustee concluded that the facts did not merit disqualification, but that the law firm should have disclosed the information pertaining to Mr. Paredes. The law firm and the U.S. Trustee agreed to a $120,000 fee reduction. The bankruptcy court held that the facts did not warrant disqualification, and that a $120,000 reduction in fees was appropriate as a sanction for violating Rule 2014.
In reviewing the law firm’s final fee application under Section 330 of the Bankruptcy Code, the bankruptcy court held that some of the law firm’s time entries were inadequate, such that the court could not “make a real meaningful assessment about what the services were or whether they were actual, reasonable, beneficial to the estate.” The bankruptcy court also found instances of block billing. Because of these deficiencies in timekeeping, the bankruptcy court reduced the fee award by an additional $126,500.
Moreover, the bankruptcy court allowed the law firm to receive only half of the 20% of its fees that had been held back with respect to the firm’s interim fee application. The court’s decision to allow only half of the holdback to be paid meant that the law firm suffered the disallowance of an additional approximately $135,000 of fees. In all, the law firm suffered a fee reduction of just over $410,000.
The ESOP Participants appealed the bankruptcy court’s orders approving the fee application (with the court-ordered reductions noted above), arguing that the $410,000 was insufficient.
THE BAP’S RULING
Key to the BAP’s analysis was the standard of review it accords the bankruptcy court’s decisions. Here, the ESOP Participants simply requested that the BAP review the time records and award fees in a lesser amount. The BAP, however, concluded that reviewing the adequacy of the deductions was not its role.
The BAP noted that the correct standard of review is “abuse of discretion,” and that the bankruptcy court has broad discretion in determining an award of attorneys’ fees. To determine whether the bankruptcy court abused its discretion, the Ninth Circuit conducts a two-step inquiry: (1) review de novo whether the bankruptcy court “identified the correct legal rule to apply to the relief requested” and (2) if it did, consider whether the bankruptcy court’s application of the legal standard was illogical, implausible or without support in inferences that may be drawn from the facts in the record. See, e.g., U.S. v. Hinkson, 585 F.3d 1247, 1262 (9th Cir. 2009) (en banc).
When a bankruptcy court makes an award of attorneys’ fees, it must explain how it came up with the amount. The explanation need not be elaborate, but it must be comprehensible. The explanation must be concise but clear. See, e.g., Moreno v. City of Sacramento, 534 F.3d 1106, 1111 (9th Cir. 2008). The bankruptcy court does not need to “show its work” or go line-by-line through the law firm’s billing records.
The job of the appellate court is to determine whether the bankruptcy court’s findings regarding the reasonableness and necessity of the law firm’s work were illogical, implausible, or without support in the record.
The BAP affirmed the bankruptcy court’s fee award, concluding that the bankruptcy court carefully reviewed the billing records and proffered an understandable and comprehensive explanation of its various reductions.
Because the court had earlier considered and rejected similar arguments by the ESOP Participants in another proceeding, the BAP did not address the conflict-of-interest issue with respect to the law firm in this opinion. Nevertheless, the BAP concluded that the law firm violated Rule 2014. The BAP also noted its “surprise” that the law firm requested conflicts waiver letters from the debtors and Mr. Paredes, but nevertheless failed to disclose the relationship to the bankruptcy court.
This case is another reminder to professionals whose retention is subject to bankruptcy court approval to (a) run a proper (firm-wide) conflicts check and (b) disclose all known connections. When in doubt, these professionals should disclose any matter that could even potentially be seen as a conflict of interest or a lack of disinterestedness. Remember, it is not the professional’s job to determine whether or not a connection is a conflict of interest or results in a lack of disinterestedness, but rather the job of the bankruptcy court.
Furthermore, like the law firm in this case, a professional can still be sanctioned for failure to disclose a connection, even if there ultimately is no disqualifying conflict.
I also share the BAP’s surprise that the law firm requested conflict waiver letters, but still failed to disclose the connection to the bankruptcy court. The mere execution of conflict waiver letters does not mean that a disqualifying conflict actually exists. Indeed, the firm was smart to request those waiver letters. What boggles the mind is that the request for waiver letters did not cause anyone at the firm to conclude that disclosure to the bankruptcy court was also necessary.
This case is also a reminder to professionals whose fees are subject to court approval (particularly those professionals that bill on an hourly basis, and whose fees are subject to Section 330 “after-the-fact” review) to maintain detailed, clear and concise time entries, and to avoid block-billing.
These materials were written by Michael J. Riela at Genworth North America Corporation in Stamford, Connecticut (Michael.Riela@genworth.com). Editorial contributions were provided by Maggie E. Schroedter of Robberson Schroedter LLP (maggie@theRSfirm.com).