Law Donut

I mentioned in Branded Part 2: Donuts and Carnivals, that I was pleased to be a contributor to the Law Donut blog.

My first post for that blog, Avoid April Showers, was a timely reminder for employers to regularly review their employment policies and contracts.  My most recent post for that blog, Licensed to thrill?, is another reminder for employers, but this time with reference to the different licences which are required in a workplace which plays music, television or radio whether for the benefit of its staff or customers.

There are more regular contributors to the Law Donut than me, and they successfully make the Law Donut an excellent source of know-how and discussion on the nitty-gritty of what law and regulation actually means for employers and small businesses.

Volcano Policy

Since the volcanic ash hit the skies of the UK, things have been getting a little dusty. With all those Britons stranded abroad, and at the end of the Easter holidays, this week there’ll have been a few empty desks across the offices of GB.

So employers, what’s your Volcano Policy? Will you require your employees stranded abroad to take the time off work as holiday, paid leave or unpaid leave? What lengths will your company go to return stranded staff back to the UK to increase the work force? Will it depend on whether those staff are currently stranded on business trips or personal trips abroad?

The issue for management of staff absence during Ashgate, are very similar to the issues faced by employers at the beginning of the year with Snowgate. Simple solution is to dust off your Snow Policies and re-brand them, Volcano Policy.

Job done.

Judge to Investment Bankers: Pigs Get Fat and Hogs Get Their Employment Denied

Eye-popping professional fees have become more commonplace as larger and larger firms enter bankruptcy. However, one judge has drawn the line at a request to employ two investment banking firms with guaranteed upfront fees of $1 million to supplement the two valuations already obtained in the case. The opinion contains equal amounts outrage at the professionals' chutzpah and measured analysis of the record required to justify employment under 11 U.S.C. Sec. 328 in light of Pro-Snax. While the judge's colorful language is startling in its boldness, it offers substantial guidance in distinguishing between a routine application to employ and an extraordinary one and the record necessary to meet the higher burden. In re Energy Partners, Ltd., No. 09-32957 (Bankr. S.D. Tex. 7/28/09). The opinion is here.

The Lead-Up to the Opinion

Energy Partners, Ltd. is a publicly traded company which filed chapter 11 in Houston this year. The Debtor obtained a valuation which showed no value for equity. An equity holder offered a valuation schowing substantial value for equity and this valuation was included in the disclosure statement. At the point that the disclosure statement had been approved, the Equity Committee and the Unsecured Noteholders' Committee wanted to hire their own investment bankers rather than using the existing valuations.

The Equity Committee sought to employ Tudor Pickering for compensation including: (a) a $500,000 non-refundable advisory fee; (b) an extended engagement fee of $100,000 per month if its services were still required as of September 1, 2009: (c) a fee of $25,000 per day for any day in which its employees were required to testify; and (d) reimbursement of expenses. Employment was sought under Sec. 328, so that the fees could not easily be re-examined based on the actual results in the case.

The Unsecured Noteholders' Committee sought to engage Houlihan Loukey on the following terms: (a) an upfront non-refundable fee of $500,000; (b) a non-refundable fee of $100,000 for August 1-15, 2009; (c) a non-refundable fee of $100,000 for August 16-31, 2009; and (d) reimbursement for out of pocket expenses. This employment was also sought under Sec. 328.

In contrast, the Debtor's investment banker, Parkman Whaling, charged the relatively modest fee of $75,000 per month with no upfront fee. (While this is not insignificant, it always helps to be the party with the lowest bill when trying to get compensated).

Bank of America objected on the grounds that: (a) the fees were too high; (b) the fees were non-refundable; (c) the fees were to be paid from Bank of America's cash collateral; and (d) the proposed payments violated the budget in the cash collateral order. The Unsecured Creditors' Committee objected as well. The Debtor did not object, but expressed concern about the $25,000 per day fee expert witness fee.

The Court heard from three witnesses at the employment hearing: a representative from each investment banking firm and a member of the Equity Committee.

The Court orally denied the applications for employment and followed up with its memorandum opinion.

The Opinion

The introduction to Judge Bohm's opinion sets the tone for what follows:

Oblivious to recent congressional and public criticism over executives of publicly-held corporations who are paid monumental salaries and bonuses despite running their companies into the ground, two investment banking firms now come into this Court requesting that they be employed under similarly outrageous terms. They do so because two committees in this Chapter 11 case have filed applications to employ these investment banking firms to perform valuation services even though two other independent firms have already performed similar valuations. These investment bankers, who wish to have their fees and expenses paid out of the debtor's estate, have sworn under oath that they will render services only if they immediately receive a nonrefundable fee aggregating $1.0 million. This Court declines the opportunity to endorse such arrogance. The purse is too perverse.

The committees' request to hire the most expensive investment bankers at virtually nondisgorgable and astronomically high fees is tantamount to a debtor chartering a private jet to travel to a meeting ofcreditors. While this hypothetical debtor may well need transportation in order to attend the meeting, just as the committees in the case at bar may legitimately believe they each need an independent valuation consultant, both have requested the most inordinately expensive means by which to achieve their objectives. To approve such a request runs contrary to a fundamental principle of bankruptcy: that a debtor and all professionals associated with the case should act with a measure of frugality in order to preserve the estate's assets and thereby maximize the chances for a successful reorganization.

Memorandum Opinion, pp. 1-2.

Section 328 & Pro-Snax

Section 328 allows the court to employ a professional "on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or percentage basis, or on a contingent fee basis." The court may allow different compensation only "if such terms and conditions prove to hae been improvident in light of deelopments not capable of being anticipated at the time of the fixing of such terms and conditions." Thus, if the court approves employment under Section 328 on a non-refundable, flat fee basis, as proposed here, the court would be relatively powerless to change the fee absent something incapable of being anticipated. Thus, if the investment bankers wrote their valuation in crayon on a Big Chief tablet or showed up for court but slept through the proceedings, both of those possibilities were capable of being anticipated and would not allow a change in the fees. On the other hand, if the bankruptcy court sunk into the Gulf of Mexico preventing the hearing from taking place, that would probably be something not capable of being anticipated.

Judge Bohm noted that courts have identified the following factors for determining whether to approve employment under Section 328:

(1) whether terms of an engagement agreement reflect normal business terms in the marketplace; (2) the relationship between the Debtor and the professionals, i.e., whether the parties involved are sophisticated business entities with equal bargaining power who engaged in an arms-length negotiation; (3) whether the retention, as proposed, is in the best interests of the estate; (4) whether there is creditor opposition to the retention and retainer provisions; and (5) whether, given the size, circumstances and posture ofthe case, the amount ofthe retainer is itselfreasonable, including whether the retainer provides the appropriate level of "risk minimization," especially in light ofthe existence of any other "risk-minimizing" devices, such as an administrative order and/or a carve-out.

Memorandum Opinion, p. 19, (quoting In re Insilco Techs., Inc., 291 B.R. 628, 633 (Bankr. D. Del. 2003).

The Court also noted that some courts have imposed specific requirements for investment bankers, quoting the following language from an opinion in the District of Massachusetts which relied upon an opinion from the Southern District of New York:

Any investment banker/advisor retention application submitted to this court must present the scope and complexity of the assignment, its anticipated duration, expected results, required resources, the extent to which highly specialized skills may be needed and the extent to which they have them or may have to obtain them, projected salaries ofparticipating professionals, billing rates and prevailing fees for comparable engagements, current retentions in bankruptcy by the retained firm, and any estimated lost opportunity costs due to time exigencies ofthe job. In addition, the actual retention agreement between the investment banker/advisor and the client must be attached to the retention application and, the party retaining the professional must describe the process by which the financial banker/advisor has been selected. This latter requirement is aimed specifically at offsetting what we perceive as a lack of competitiveness in the selection process. Finally, the application must explain how the investment banker/advisor will eliminate, or at least reduce, the duplication of effort[s] .... We liken our requirements to a financial impact statement on the estate. Only with an advance picture of the job to be accomplished will we be able to measure the results (or lack thereof) achieved.

Memorandum Opinion, pp. 30-31, quoting In re High Voltage Engineering Corp., 311 B.R. 320,333-334 (Bankr. D. Mass. 2004).

On top of all this, Judge Bohm noted the requirement in the Fifth Circuit that a professional generate a tangible, identifiable and material benefit to the estate in order to be compensated. This stems from the Fifth Circuit's Pro-Snax decision. In the context of a Section 328 application, Judge Bohm found that the applicant must show in advance that they will provide a tangible, identifiable and material benefit.

Given all of these requirements and the scant record, it was highly improbable that the applications would withstand objection. However, Judge Bohm entered a lengthy analysis as to why the factors were not met. Among other things, the applicants failed to prove that their rates reflected normal business terms in the market. The only evidence of market conditions consisted of the fact that the debtor's investment bankers were willing to work for $75,000 per month, while the two committees' advisors wanted $500,000 upfront in order to begin work. Judge Bohm was particularly offended by the $25,000 per day expert witness fee, noting that many Americans performing valuable services, such as military policemen and nurses, make that much money in a year. He found that the terms and conditions were insufficiently spelled out. One of the firms completely failed to spell out the terms of what it would do in its engagement agreement. They also failed to explain why a non-refundable fee was necessary to obtain a qualified professional. Additionally, the Court noted the opposition from creditors and the fact that the upfront fees would shred the cash collateral order. (Note: This is a very abbreviated summary of the factors discussed in the opinion).

The Conclusion

After all these pages of analysis, Judge Bohm, channeling Howard Beale*, proclaimed:

At some point, this Court must draw the line between what is reasonable and what is not. To quote the Fifth Circuit: "'[W]hen a pig becomes a hog it is slaughtered. '" (citation omitted). "As the finder of fact, the bankruptcy court has the primary duty to distinguish hogs from pigs." (citation omitted). Although the Fifth Circuit expressed this sentiment under a different set of facts than those in the case at bar,this Court sees good reason why this maxim applies here with equal force. These two investment banking firms have become hogs. Indeed, the investment bankers in the case at bar appear to have embraced the outlook expressed by Michael Douglas's character, Gordon Gekko, in the film Wall Street that "Greed-for lack of a better word-is good. Greed is right. Greed works. That may be how Wall Street views the world, but it is not how this Court sees things. In this Court, Greed is not good; Greed is wrong; and Greed does not work. Rather, the Court refers the parties to the words of Frederick Douglass, a prominent and compelling figure in American history who knew something about hard work: "People might not get all they work for in this world, but they must certainly work for all they get."

The exorbitant fees requested by Houlihan Lokey and Tudor Pickering are similar to the "appearance fees" which certain of the world's top athletes-for example, Tiger Woods-are able to command. However, unlike Tiger Woods, whose presence does guarantee a financial benefit at any event where he appears, neither of these two investment banking firms introduced any testimony or exhibits guaranteeing some benefit to the estate in this case. They expect to be paid an appearance fee for simply showing up-not only do they not guarantee success; they do not even guarantee they will work a minimum number of hours in order to try to achieve success. This Court will therefore not approve the payment of their requested "appearance fees." Tudor Pickering is not Tiger Woods. Nor is Houlihan Lokey.

Memorandum Opinion, pp. 37-38.

After the employment under Sec. 328 was denied, the investment bankers indicated that they would be willing to be employed under the traditional Sec. 330 standards. The Court confirmed the Debtor's plan on August 3, 2009.

How Did This Happen? What Does It Mean?

The Memorandum Opinion makes the court's strong feelings quite clear. In retrospect, it seems obvious that the committees and the investment bankers badly misread what would fly. How did this happen? Part of the answer lies in the unusual nature of the case. This was the case of a publicly traded company which went from filing to plan confirmation in just 90 days, an accomplishment that GM and Chrysler achieved only by shortcutting the plan process. This was a case with three committees: an Unsecured Creditors' Committee, an Unsecured Noteholders' Committee and an Equity Committee. It is natural for a committee to want to hire a professional. After all, a committee without a professional is like a combatant who brings a knife to a gun fight. It would be a daunting task given the fact that the investment bankers would be coming in after the debtor's expert had done its work with only a short time to prepare their own. Given the circumstances, it seems likely that the investment bankers felt justified in asking for a premium rate and the committees felt like they had few other options. In the hustle and bustle of a case, it is easy to get tunnel vision and lose sight of what a transaction looks like to the outside world. In this case, the usual way of doing things ran smack into a brick wall of a judge requiring strict compliance.

So what does this all mean? Were these investment bankers a new incarnation of Gordon Gekko? Will this opinion deter big cases from filing in Houston? In the words of Dr. Ian Malcolm**, nature will find a way. Notwithstanding Judge Bohm's strong language about greed, it is still possible to get employed and compensated in Houston. This opinion gives some good guidelines as to what needs to be proven. If these standards look too difficult, it is not necessary to rely on Sec. 328. Applicants might also keep in mind that they are appearing before a bankruptcy judge who works long hours and earns $160,000 per year. When the fees for a month's work start adding up to a multiple of the judge's annual salary, you need to have a really good story as to why you are the Tiger Woods of your profession.

*--Howard Beale was the character in the movie Network who proclaimed, "I'm mad as hell and I'm not going to take it anymore."

**--Dr. Ian Malcolm was the chaos theory mathematician in Jurassic Park.

10th Circuit Affirms Denial of Employment of Attorneys Who Were Too Expensive

In these days of exponentially increasing hourly rates, a bankruptcy court told a creditors' committee that its proposed counsel was too expensive when there were local firms competent to do the work for half the cost. That decision was recently affirmed by the 10th Circuit Court of Appeals. In re Southwest Food Distributors, No. 08-5160 (10th Cir. 3/31/09).

The Debtor filed a chapter 11 petition in Tulsa, Oklahoma. The Unsecured Creditors Committee sought to employ Bell, Boyd & Lloyd, a Chicago firm, and to also employ Gable & Gotwals of Tulsa as its local counsel. Bell Boyd sought to charge rates ranging from $250 to $505 per hour. A large unsecured creditor objected on the basis that there was no need to bring in a national firm when there were local firms available at half the cost. The Bankruptcy Court agreed and approved employment of the local counsel only.

On appeal to the 10th Circuit, the Court of Appeals ruled that the Bankruptcy Court is not required to rubberstamp a party's choice of counsel even when that counsel meets the requirements of 11 U.S.C. Sec. 1103 and Fed.R.Bankr.P. 2014. The court noted that close scrutiny is required when more than one attorney is sought to be employed.

Several thoughts come to mind after reading this opinion. Many, if not most, courts require that out of district firms retain local counsel. If retaining both primary counsel and local counsel is looked upon with disfavor, this is almost a de facto rule that outside attorneys need not apply. Was the bankruptcy court engaging in protectionism here or was this simply a case which could not afford the extra attorneys? The bankruptcy court's decision to promote the committee's local counsel to lead counsel raises an interesting issue. If local counsel was chosen purely to satisfy the requirement to have a local attorney and not because they had the expertise to represent the committee, should the committee be saddled with counsel who was not their first choice? Of course, in this case, the court found that local counsel was perfectly competent and that no one had objected to their qualifications. Perhaps the committee should have selected less qualified local counsel in order to obtain their choice of lead counsel. Finally, the objection stated that qualified local attorneys could be hired at half the cost of Bell Boyd's rates of $250-$505. Does this mean that the going rate for creditors' counsel in Tulsa is $125.00-$252.50 per hour? If that is the case, the Tulsa bankruptcy bar may find itself in demand elsewhere where the going rates are much higher.

The Sad Case of John Gellene or What It Feels Like to Get Hit By Lightning

One of the interesting features of this year’s State Bar of Texas Bankruptcy Section Meeting was a lunch time presentation by Milton C. Regan, Jr., author of Eat What You Kill: The Fall of a Wall Street Lawyer (The University of Michigan Press 2006). This is the story of John Gellene, the only attorney ever to go to jail for submitting an incomplete Rule 2014 disclosure. Although the book is a bit of a difficult read (you can read more about that in my review on Amazon.com), it is an interesting case study in the dangers of cutting corners. (The book does a really good job of documenting the pressure to cut corners, so I won’t discuss that in any detail here).

A Lawyer Walks Into A Minefield

For those who don’t remember the story from the newspaper, here is what happened. Milbank, Tweed was hired to represent Bucyrus –Erie Corporation in its bankruptcy proceeding. The bankruptcy was very contentious because the largest unsecured creditor, Jackson National Life, had accused the company’s investment banker, Goldman Sachs, with manipulating the company’s financial affairs to their own benefit. Things got worse when a Goldman Sachs partner, Mikael Salovaara, started his own firm, South Street Fund, and that firm made a deal with Bucyrus-Erie which put them ahead of all the other creditors. In order to avoid limits on debt which the company could incur, South Street engineered a sale-leaseback of the company’s principal assets. The sale-leaseback left South Street in control of the company’s principal assets and subjected the company to outrageous payments.

All this happened before bankruptcy lawyer John Gellene entered the picture. However, it created an adversarial situation between the company and the different factions. The debtor’s attorney would be caught in the middle of this conflict and would have to navigate it in order to successfully reorganize the company. One example of these pressures was Jackson National Life’s demand that every major creditor but itself should have its debt written off or subordinated.

Connections vs. Conflicts

John Gellene began representing Bucyrus-Erie a year before its bankruptcy at a time when his law firm was not representing either Salovaara or South Street. However, before the case was filed, Milbank, Tweed began representing South Street in another bankruptcy and also represented Salovaara in a dispute with his partner. Both of these were “connections” with creditors. However, Gellene failed to disclose these relationships in either of two affidavits filed with the court.

Disclosing these “connections” should have been a no-brainer. However, there were probably a lot of reasons why he could rationalize not doing it (as brought out in his subsequent criminal trial). First, Salovaara was not a creditor himself. He was just a partner of a creditor. Therefore, his representation should not be disclosed. Second, Milbank, Tweed represented South Street as a small player in a completely unrelated matter. This was not a conflict.

If this was Gellene’s thought process, he made the mistake of focusing on the purpose of the Rule 2014 disclosure rather than its language. Rule 2014 requires disclosure of “connections” with the debtor, creditors, attorneys and accountants for the debtor and creditors and employees of the U.S. Trustee. This is a requirement honored more in the breach. The requirement to disclose connections could be taken to absurd levels. For example, in a case with IRS debt, the attorneys should disclose the “connection” that they pay taxes to the IRS. In a case with credit card debt, the attorneys should disclose which attorneys hold credit cards issued by creditors in the case. However, the connections in this case were a bit more obvious. They involved major players who were at odds with Jackson National Life, the company’s main antagonist. However, if Gellene focused on conflicts, then there was an argument that they did not have to be disclosed.

Gellene may have also reasoned that disclosing the connection to South Street and Salovaara would merely provide leverage to Jackson National Life. If the case was to be concluded successfully, it would need to be confirmed quickly. Having a lengthy delay over employment of counsel would endanger the case’s prospects. If that were Gellene’s thinking, he made the mistake of (to use Joe Martinec’s phrase) pledging his loyalty to the deal rather than any other obligation.

It is also possible that Gellene made a quick cost-benefit analysis. In the recent Leslie Fay case, Weil Gotshal had made a very big failure to disclose. They were allowed to continue to represent the debtor and had to forfeit a “mere” $1 million out of their fees. They certainly did not go to jail. If Gellene had weighed the likely consequence of being caught against the possibility of being disqualified on the front end, he likely would have chosen to take the risk.

It is also possible that the failure to disclose was inadvertent. Gellene began working on the Bucyrus-Erie case in February 1993. However, the case was not filed until February 2004. The representations of Salovaara and South Street did not come up until December 2003. Therefore, it is possible that disclosures were drafted before the connection arose and were never updated during the hustle and bustle to prepare the case for filing.

From Triumph to Tragedy

Gellene successfully guided Bucyrus-Erie through its reorganization and his firm was paid nearly $2 million in fees for doing so. Unfortunately, his successful plan put the company’s old adversary, Jackson National Life, in control of the company. Years later, Jackson found out about the failure to disclose and sued Milbank, Tweed to return its fees and for malpractice. This proved to be very costly for Milbank, Tweed but it was worse for John Gellene. The publicity spawned by the fee litigation prompted the U.S. Attorney to file criminal charges against Gellene. A deal to plead to a misdemeanor fell through and the case went to trial. The prosecution sought to portray the failure to disclose as black and white, the while the defense attempted to put the statement in context. The jury sided with the U.S. Attorney and Gellene was convicted and sentenced to 15 months in prison. Gellene went from being a highly respected bankruptcy attorney to a convicted felon in a relatively short period of time.

Why John Gellene?

So, what happened? In some respects, Gellene was the victim of extremely bad luck. The Asst. U.S. Trustee in the case had previously been the U.S. Attorney (not an Asst. U.S. Attorney, but the U.S. Attorney). Therefore, he was more likely to look at the case from a criminal viewpoint than with bankruptcy eyes. He was also likely to have the informal clout needed to get a criminal referral taken seriously. Additionally, the Bucyrus-Erie case was filed in Wisconsin rather than New York or Delaware. Here, a big firm came swooping into Wisconsin, took a respected company into bankruptcy and walked away with nearly $2 million in fees. There had to be a little bit of jealousy of and distrust toward the outsiders. (Let’s face it, no one likes it when big firms poach all the good cases). Finally, Gellene’s own work product was part of his undoing. The confirmed plan left Jackson National Life in control of the company and allowed it to prosecute claims on behalf of the estate. Jackson National Life was still plenty upset toward Goldman, Sachs, Salovaara, South Street and Milbank, Tweed. Being left in a position to investigate the claims while having control of the company’s attorney-client privilege, made it likely that they would discover the non-disclosure and would be unhappy. This case proves that just because lightning may only strike one in a million times, doesn’t mean that it won’t hurt the person who gets hit.

Lessons to Be Learned

The lessons to be learned may be fairly simple. As Jay Westbrook is quoted as saying in the book, “Disclosure should be like voting in Chicago—early and often. Disclose, disclose, disclose. It’s hard to get in trouble when you follow that rule.” Eat What You Kill, p. 228. Attorneys rarely have to make statements under penalty of perjury. Since Rule 2014 is one of the few cases, it should be treated seriously. However, there is a significant temptation not to. The Rule 2104 disclosure is filed toward the beginning of the case. As a result, there is a temptation to get it on file quickly and to copy the disclosure from the previous case with a few modifications. This would be a mistake. As I have read 2014 again recently, I was surprised to learn not only that it required disclosure of connections rather than conflicts, but that it required disclosure of connections to other attorneys and accountants in the case. Sometimes it is easy to get so familiar with something that you respect for it. That would be a mistake.

Another lesson would be that it is better to tattle on yourself than to get caught. John Gellene could have submitted an amended disclosure at any point during the case, but did not. Even if he had brought it up at the hearing on his own fees, he probably would have received little more than a slap on the wrist. Instead, the issue didn’t come up until Jackson National Life brought it up and by that time, they were plenty mad so that the time for a slap on the wrist was gone.