In This Issue Volume 7, Number 6 / August 2010 New Decision Bars Debtor's Choice of Counsel Despite the Retention of Conflicts Counsel It's in the Contract: Allowance of Post-Petition Claims for Attorneys' Fees by Unsecured Creditors Caveat Creditor: Section 506(b) Limits Recoverable Fees, Costs and Charges The Co-Chairs' Corner - News About the Newly Combined Ethics and Professional Compensation Committee ABI's 7th Annual Complex Financial Restructuring Program Comes to New York ABI Joins NYU for Bankruptcy & Business Reorganization Workshop in September Caveat Creditor: Section 506(b) Limits Recoverable Fees, Costs and Charges by Richard P. Carmody[1] Committee Officers Upcoming Events Adams and Reese LLP; Birmingham, Ala. Contribute to the Newsletter You have been hired to represent a secured lender in a ABI World bankruptcy case. Thankfully, the lender took a lien on collateral with a value greatly exceeding the amount of the debt, and the Newsletter Archives loan documents provide coverage for legal fees and expenses. It looks as though this gives you plenty of room to participate in this case and have your fees and expenses reimbursed out of the proceeds of the collateral. There are some issues to consider that will not be addressed in this article such as whether your client will be able to recover default interest, late charges and pre-payment penalties as well as whether the specific language of the loan documents allows recovery of fees and expenses for the work performed in the bankruptcy proceeding. Be mindful that the client can only be reimbursed for the fees and expenses actually paid to you for services rendered. This article will discuss how the other parties who will be impacted by the amount of the lender s secured claim (debtor, trustee and unsecured creditors) may use 11 U.S.C. 506(b) to limit the amount of that secured claim. General Requirements Section 506 governs the definition and treatment of secured claims in bankruptcy. Subsection (b) is concerned specifically with oversecured claims and allows a holder of an oversecured claim to enhance its claim with interest as well as recover, in addition to the prepetition amount of the claim, attorney s fees costs and charges as long as the underlying agreement upon which the claim is based provides for such fees: To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim,
interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement under which such claim arose. 11 U.S.C. 506(b). Bankruptcy courts generally require that interest fees, costs and charges are appropriately granted under 506(b) only when the creditor satisfies four elements: (1) the creditor s claim is an allowed secured claim; (2) the creditor is oversecured (after 506(c) recoveries); (3) the fees, costs and charges are reasonable; and (4) the fees, costs and charges are provided for under the agreement. See generally, In re Staggie, 255 B.R. 48, 51 (Bankr. D. Idaho 2000), superseded on other grounds by statute; In re Vladez, 324 B.R. 296, 299-300 (Bankr. S.D. Tex. 2005); In re Woods Auto Gallery Inc., 379 B.R. 875, 884 (Bankr. W.D. Mo. 2007). What are Reasonable Fees? Did the Creditor Act Prudently? With respect to the issue of the reasonableness of attorney s fees and expenses, the ultimate burden of persuasion is on the secured creditor seeking payment. In re Cushard, 235 B.R. 902, 906 (Bankr. W.D. Mo. 1999) (citing Matter of Kennedy Mortgage Co., 23 B.R. 466, 474 (Bankr. D. N.J. 1982)). Furthermore, the reasonableness of the fees and expenses to be allowed under 506(b) is a question of federal law. Id. (citing In re Lederman Enterprises Inc., 106 B.R. 674, 678 (Bankr. D. Colo. 1989)). The Cushard court further held that [i]n determining the reasonableness of the fees, the Court must undertake a two-part analysis. First, the Court must determine whether the actions taken by the creditor were reasonable and prudent in the circumstances. If the actions were not reasonable and prudent, the fees should be disallowed. On the other hand, if the actions were reasonable and prudent, then the Court must determine whether the itemized fees are reasonable, and in that regard, the Court should consider the factors set out by the Eighth Circuit Court of Appeals in Winter v. Cerro Gordo County Conservation Board, 925 F.2d 1069, 1074, n.8 (8th Cir. 1991). Id at 906-7. (Note that these same factors are also referred to by other courts as the Johnson factors.) Johnson v. Georgia Highway Express Inc., 488 F.2d 714 (5th Cir. 1974). The court further stated that [u]nder 506(b), attorneys fees are reasonable only if they are incurred in protecting the creditor s rights in its collateral. Fees for taking appropriate actions in a bankruptcy proceeding have been found to be reasonable where the mortgagee had been stymied by repeated bankruptcy filings in its efforts to collect the debt owed; where there was a dispute regarding the value of the property and the creditor s interest in the property was in jeopardy, and when the debtor has failed to comply with a confirmed plan or reorganization. Id. at 907. (internal citations omitted). The court in Cushard determined that the key criterion in determining whether the fees incurred are reasonable is whether the creditor acted prudently under the circumstances in seeking to protect its interest in its collateral. Id. In this case, (1) neither the debtors nor any other party in their bankruptcy schedules challenged the validity or priority of the creditor s deed of trust, and (2) there was an equity cushion of at least $200,000. Therefore, the court found no sound reason for the creditor to object to the debtor s use of cash collateral since the creditor was terminated and creditor had no interest in the cash collateral. In addition, the court found other examples of imprudent and unnecessary fees
including (1) fees for an attorney from St. Louis to attend the 341 meeting of creditors in Joplin, Mo., when a local counsel could have covered the hearing for half the cost; (2) fees for an associate to attend the debtors depositions in Ft. Scott, Kan.; (3) fees for the lead attorney to review the deposition with the associate and report to the client; and (4) fees for lead counsel to prepare for and participate in a hearing in Joplin on the use of cash collateral, when the creditor had no cash collateral involved. Id. at 907-8. Are the Itemized Fees Reasonable? In determining the amount of attorney s fees to be awarded under the second step of the analysis under 506(b), the court applied the Johnson factors adopted by the Eighth Circuit Court of Appeals: the time and labor required; (1) the novelty and difficulty of the questions; (2) the skill requisite to perform the legal services properly; (3) the preclusion of employment by the attorney due to acceptance of the case; (4) the customary fee; (5) whether the fee is fixed or contingent; (6) time limitations imposed by the client or the circumstances; (7) the amount involved and the results obtained; (8) the experience, reputation and ability of the attorneys; (9) the undesirability of the case; (10) the nature and length of the professional relationship with the client; and (11) awards in similar cases. In re Cushard, 235 B.R. 902, 909 (Bankr. W.D. Mo. 1999) (citing Winter v. Cerro Grodo County Conservation Board, 925 F.2d at 1074, n.8) (8th Cir. 1991)). (Note that these are the same factors usually used to evaluate the allowable fees of counsel under 330). This court reviewed the creditors request for fees and attorney s itemizations in light of these factors. Id. at 910. First, the court noted that the hourly rate charged by the lead counsel for the creditor were higher than the established customary hourly rate for attorneys involved in routine chapter 7 and chapter 13 cases. Thus, the court limited the lead counsel to the hourly rate to that of an experienced local bankruptcy lawyer. Id. Second, the court specifically disallowed fees for attending the trustee s auction of the creditor s collateral as totally unnecessary given the fact that the trustee had agreed not to sell the property for less than the amount owed to the creditor and there was no risk to the creditor and no justification for the lead counsel to attend the auction. Id. Next, the court did not allow fees included in the itemization for the preparation of the fee application and activities associated with presenting the fee application to the court. The court held that preparing and presenting a fee application was unwarranted and an expense that should not be borne by the creditor. The court held that [i]t is inherently unreasonable to ask a debtor to reimburse attorney s fees incurred by a creditor that are not cost-justified either by the economics of the situation or necessary to preservation of the creditor s interest in light of the legal issues involved. Id at 910 (quoting Matter of Nicfur-Cruz Realty Corp., 50 B.R. 162, 169 (Bankr. S.D.N.Y. 1985)). The court also disallowed charges for wire transfers incurred when the trustee wired the payoff amount to the creditor. The court held that expenses were not allowed by the underlying agreement and that a wire transfer charge was simply a cost of doing business. Id.
Consequently, the court concluded that many of the actions taken were not the kind of actions that similarly situated creditors might reasonably have concluded should be taken under the circumstances. The court only allowed $2,000 of attorney s fees pursuant to 506(b). All other fees incurred during the period were allowed only as a general unsecured claim. Id. at 909. You Can t Just Run the Meter. In another case, In re Staggie, the bankruptcy court stated that the reasonableness requirement in 506(b) was intended to prevent creditors from fail[ing] to exercise restraint in the attorneys fees and expenses they incur, perhaps exhibiting excessive caution, overzealous advocacy and hyperactive legal efforts. In re Staggie, 255 B.R. 48, 54 (Bankr. D. Idaho 2000) (citing In re Gwyn, 150 B.R.150, 156 (Bankr. M.D.N.C. 1993)) superseded on other grounds by statute. Further, this court stated that [i]f proper restraint is not exercised, the costs of any overlawyering should be borne by Creditor, rather than Debtors. Id. at 54 (citing In re Ward, 190 B.R. 242, 250 (Bankr. D. Md. 1995)). Nevertheless, the court must determine the reasonableness of the creditor s attorneys fees based on all relevant factors and whether the creditor reasonably believed that the steps taken were necessary to protect its interests in the debtor s property. A court must view a creditor s decision objectively to see that an oversecured creditor is not given a blank check to incur fees and costs which will automatically be reimbursed out of its collateral. Id. (quoting In re Pope, 91 I.B.C.R. 141, 143 (Bankr. D. Idaho 1991). In this case, the creditor was owed about $20,000 in principal and about $3,000 in accrued interest. The creditor s claim was secured by a first-priority trust deed on the debtor s home valued in the bankruptcy at $85,000 to $90,000 and ultimately sold for $105,000. The court held that given such an equity cushion, the creditor s claim for more than $3,200 in fees did not seem justified. Furthermore, the court held that the creditor bears the burden of proving that the attorney s fees paid in this instance were reasonable. Although the counsel s billing summaries were sufficiently detailed, it failed to break down each day s tasks into corresponding time entries. Instead, each day s time entries were listed together and a block of time was assigned for the entire day. The court states that this type of billing practice known as lumping is universally disapproved by bankruptcy courts because it not only permits an applicant to claim compensation for rather minor tasks which, if reported individually, would not be compensable, but also prevents the court from determining whether individual tasks were expeditiously performed within a reasonable period of time because it is impossible to separate into components the services which have been lumped together. As a consequence of the lumping, the court held that the creditor had not met its burden of proving that all claimed fees are reasonable. In addition, the court held that the creditor should not be compensated for nonprofessional tasks, such as drafting and revising cover letters to the clerk or preparing the affidavits of mailing, all of which should be delegated to the clerical staff. The court also disallowed entries for reviewing or calculating payoff amounts, reviewing title documents and preparing the proof of claim, tasks which can be performed by the creditor s own staff. Id. at 55-56. Furthermore, the court determined that the creditor's claim was not in serious jeopardy of nonpayment and therefore, while the creditor was justified in moving for stay relief and protecting its interest under debtor s proposed plan, there was no real need for other significant involvement by the lawyers. Thus, the court concluded that the amount of
attorney s fees were unreasonable under 506(b) and held that creditor should not be compensated for more than 15 hours of attorney time at a prevailing hourly rate. The creditor was also entitled to recover any out of pocket expenses. Id. at 57. In a similar case, In re Riker Industries Inc., the bankruptcy court held that the oversecured creditor was (1) not entitled to compensation for its attorney s telephone conversations, conferences and research for which the attorneys did not provide detailed entries; (2) the oversecured creditor was not entitled to compensation for payments to attorneys hired to represent the debtor in negotiations for sale of the debtor s assets; (3) preparation of creditor matrix was not a reasonable and necessary cost of preserving the oversecured creditor s claim, and thus was not compensable. In re Riker Industries Inc., 122 B.R. 964 (Bankr. N.D. Ohio 1990). Eleventh Circuit Approach Utilizes 502 As Well The prevailing analysis of a fee determination for an oversecured creditor in the Eleventh Circuit is represented by Welzel v. Advocate Realty Invs., LLC (In re Welzel), 275 F.3d 1308 (11th Cir. 2001). In Welzel, the Eleventh Circuit articulated an additional step to the traditional analysis under 506(b) for over-secured creditor. The court articulated a two-part approach whereby as a threshold matter, a court must determine whether the claim is allowed pursuant to 11 U.S.C. 502 and, if so, only then a court must consider whether the fees claimed are reasonable, pursuant to the analysis enunciated by 11 U.S.C. 506(b). Id. at 1318. After the court has considered the first step under 502, an oversecured creditor s claim for attorney s fees can be bifurcated into to reasonable fees (to be treated as allowed secured claim) and unreasonable fees (to be treated as an allowed unsecured claim) under 506(b). Id. In reading and interpreting the two statues, the Welzel court found that 506 deals with whether a claim is secured or not, as opposed to the larger question of whether the claim is allowed or disallowed, which is addressed by 502. The court explained that because 506(b) simply determines, by analyzing the reasonableness of the fees, whether the fees are secured or not, when 502 deals with allowance, section 506(b) should be read against the backdrop of general instructions enunciated in 502. Id. at 1317. As a result, 506(b) is meant not to displace the general instructions laid down in 502, but to read together with 502 in a complementary manner. Id. Thus, the Eleventh Circuit concluded that the [l]language and structure thus demonstrates that 502 and 506 should be read in tandem with one another, for they address complementary but different questions. Id. In a more recent case, In re Reorganized Lake Diamond Associates, LLC, the Bankruptcy Court in Florida applied the Welzel analysis. In this case, the creditor was significantly oversecured and a majority of the creditor s fees were incurred in conjunction with its opposition to the approval of the Bid Procedure. The court thus found that such claims were not ones that a creditor protecting its debt and securing repayment would incur. In addition, the court also found duplicative services and therefore, disallowed such attorneys fees under 502(b)(1) rather than under 506(b). Of the attorney s fees that the court allowed under 502(b)(1) the court made a reasonableness determination under 506(b). The court analyzed the reasonableness under the Johnson factors and deemed all the allowed fees as reasonable under 506(b). In re Reorganized Lake Diamond Associates, LLC, 367 B.R. 858 (Bankr. M.D. Fla 2007).
Although, the Eleventh Circuit applies a slightly different analysis than the rest of the circuits, it still engages in the general two step approach, albeit through 502, which first looks at the entire claim and whether the claim was reasonable and next determines whether the specific attorney s fees and expenses under that particular claim are reasonable. In either case, the burden for proving reasonableness remains with the oversecured creditor. The Moral of the Process: Prudence and Restraint As counsel for an oversecured creditor, you must protect a client s position but, at the same time, not abuse the ability to recover your fees. At the end of the case, you want your client to be made whole (that is why it took the collateral to secure the debt). You do not want to have to explain that only 50 percent of your fees and charges were found reasonable under 506(b). If the client insists on you pursuing issues that you believe may not be prudent upon court review, be sure to advise the client up front that the expense of pursuing such a course of action may not be allowed as part of its secured claim. 1. The author thankfully acknowledges the contributions made to this article by Neeli G. Shah, also of Adams and Reese LLP in Birmingham.