Category: Fees

Court Orders Sanctions for Non-payment of Accountants

by Bradley Lehman

A recent opinion from the Bankruptcy Court for the District of Delaware, In re Washington Mutual, Inc., et al., Case No. 08-12229 (MFW), 2018 WL 704361 (Bankr. D. Del. February 2, 2018), illustrates the value of unambiguous contractual provisions and the importance of timely compliance with court orders.

This matter evolved out of the failure of Washington Mutual Bank in 2008 and the resulting chapter 11 bankruptcy filings.  In early 2008, prior to the bankruptcy, Washington Mutual sought to challenge the constitutionality of certain California tax policy regarding taxation of interest on federal bonds.  Washington Mutual retained the accounting firm Grant Thornton LLP to develop the theory that California was required to tax federal and state bonds similarly and assist Washington Mutual in getting tax refunds based on the theory. Although Washington Mutual and other similarly situated taxpayers stood to receive very substantial tax refunds from California if a court deemed California’s taxes on federal bond interest unconstitutional, Washington Mutual’s principal motivation was to leverage the Treasury bond interest issue against the California Franchise Tax Board (“FTB”) in order to offset Washington Mutual’s other California tax liabilities.

On September 25, 2008, Washington Mutual closed its doors and was turned over to the FDIC as receiver, whereupon the FDIC immediately sold all of Washington Mutual’s assets to JPMorgan Chase. Washington Mutual’s unceremonious farewell remains the largest bank failure in U.S. history by a very large margin. On the following day, Washington Mutual and its affiliates filed Chapter 11 bankruptcy in the District of Delaware

Washington Mutual and Grant Thornton entered into a post-petition retainer agreement pursuant to which Grant Thornton was to continue developing the Treasury bond interest issue and was to be paid its hourly fees, subject to a twenty percent discount, plus ten percent of any “Economic Value” that Washington Mutual received from the FTB, capped at $5 million. Throughout the bankruptcy proceeding, Grant Thornton assisted with the preparation of tax returns, technical memos, and letters to the FTB, as well as continuing negotiations with the FTB regarding Washington Mutual’s tax liability and objecting to the FTB’s $280.5 million proof of claim.

The Bankruptcy Court confirmed Washington Mutual’s Chapter 11 plan of reorganization in early 2012, and a liquidating trust (the “Liquidating Trust”) was set up to handle the distributions to creditors. In August 2012, the Bankruptcy Court entered the final Omnibus Fee Order which included Grant Thornton’s contingent fee. Grant Thornton later learned by browsing the docket that Washington Mutual had reached a settlement with the FTB. Pursuant to the settlement, the FTB obtained a full and complete release in exchange for an immediate tax refund to Washington Mutual in the amount of $225 million, in addition to other deferred refunds. Upon learning of the settlement, Grant Thornton requested that the Liquidating Trust pay Grant Thornton’s contingent fee. The Liquidating Trust refused to pay on the basis that the FTB had always rejected the Treasury bond interest issue and that none of the settlement funds were in consideration for the Treasury bond interest issue. Thus, the Liquidating Trust believed that Grant Thornton was not entitled to the contingent portion of its fees. Grant Thornton moved for the imposition of sanctions against the Liquidating Trust in April 2015.

In granting Grant Thornton’s motion, the Court found that the contingent fee language in the retainer agreement was broad and unambiguous, that the contingent fee was not improvident under Section 328(a) of the Bankruptcy Code, and that Grant Thornton was entitled to sanctions because the Litigation Trust was in civil contempt of the Omnibus Fee Order. The Liquidating Trust had argued that there was a “mutual mistake” regarding the post-petition retention agreement in that the agreement erroneously expanded Grant Thornton’s contingency fee to all recoveries from FTB rather than just those related to the Treasury bond interest issue.  However, the Court determined that the terms in the retainer agreement were clear and intentionally broad, containing no qualification that funds not directly attributable to the Treasury bond interest issue were excluded. The parties had anticipated all along that the FTB might reject Washington Mutual’s position on the Treasury bond interest issue but still agree on a settlement in order to keep a court from ruling on it.

The Court found that § 328(a) sets a high bar for a finding of improvidence. After approving the terms of a professional’s compensation under § 328, a court will only allow different compensation “if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of” entry. In this case, the Court found that the parties could certainly have foreseen that the Court would enforce the agreement exactly as written. Further, the Court was not persuaded by the Liquidating Trust’s argument that there had been a mutual mistake regarding the contingent fee arrangement. The Court noted that even if “the Debtors were unilaterally mistaken,” such unilateral mistake would not be the basis for a finding of improvidence.

Finally, the Court found that the imposition of sanctions against the Liquidating Trust was appropriate where the Liquidating Trust continued to ignore the final fee order entered by the Court even despite Grant Thornton’s repeated requests for payment and despite the Court’s determination that the plain terms of the retainer agreement entitled Grant Thornton to the contingent fee. The Court found that the Liquidating Trust “demonstrated an inexcusable disregard for the Court’s order” that could not be “remedied by a pleading of good faith.” Thus, in addition to the recovery of its contingent fee, the Court concluded that Grant Thornton was also entitled to recover the costs associated with filing and prosecuting its motion as a sanction against the Liquidating Trust.

Although the Liquidating Trust may have had a legitimate disagreement as to the terms of the retention agreement with Grant Thornton, it appears that the repeated refusal to comply with the Court’s order based on the Liquidating Trust’s unilateral position that there was mutual mistake is what led to the ultimate imposition of the sanction.  The Court noted that the Liquidating Trust “could have either remitted the Contingency Fee or sought relief from the Court.” It did neither, and just refused to comply with the Court’s order which proved to be an expensive obstinacy.

RECAP OF NOTABLE 2015 SUPREME COURT DECISIONS

by Nicole Leonard

1.  Wellness International Network Ltd. v. Sharif[1] –Bankruptcy Court Jurisdiction

To hear the principal dissent tell it, the world will end not in fire, or ice, but in a bankruptcy court.”[2]

In Wellness, the Supreme Court addressed whether parties may consent to bankruptcy court jurisdiction over Stern claims and whether such consent must be express. The majority opinion determined the issue in favor of bankruptcy court jurisdiction when there is consent, even if such consent is implied.[3]  In so finding, the Court[4] found that in permitting bankruptcy courts, which operate under the purview of and assist in the workload of the district courts, to adjudicate claims for which the litigants have a right to adjudication by an Article III judge, if such litigants consent, it does not offend the separation of powers.  The court was unafraid of the principal dissent’s dire predictions to the contrary regarding the encroachment on the judicial power of Article III courts.

Facts:  Wellness International Network, Ltd. and its owners (“Wellness”), manufacturers of health products, entered into a contract with Richard Sharif (“Sharif”) whereby he would distribute the Wellness products.  The relationship soured and Sharif sued Wellness.  However, due to Sharif’s failure to comply with discovery requests, Wellness obtained a default judgment and Sharif was eventually sanctioned through an award to Wellness for attorneys’ fees of $650,000.  Sharif then filed a chapter 7 petition in the Northern District of Illinois.  Sharif failed to respond to Wellness’ requests to disclose his assets which allegedly included a valuable trust – though Sharif claimed he administered the trust for his Mother for the benefit of his sister.  Wellness filed an adversary complaint alleging that Sharif’s debts should not be discharged because he concealed property and that the trust was Sharif’s alter-ego and should be considered property of the estate (the “Trust Claim”).  Sharif answered the complaint, admitting the proceeding was core under 28 U.S.C. § 157(b) thus permitting the bankruptcy court to enter a final judgment and he requested that judgment be entered in his favor.  Sharif again failed to fully comply with discovery.  His discharge was denied and a default judgment was entered against him.  The court further issued a declaratory judgment on the Trust Claim, finding the trust part of the bankruptcy estate.

Sharif appealed the bankruptcy court decision. Six weeks before the deadline to file opening briefs in the appeal, Stern v. Marshall,  131 S.Ct. 2594 (2011) (“Stern”)  was decided Stern held that Article III precludes bankruptcy courts from entering final judgment when claims only seek to “augment” the bankruptcy estate and would otherwise exist outside the context of a bankruptcy proceeding. Id. at 1941.

Although Sharif did not mention Stern, at the close of briefing he moved to provide supplemental briefing on the case which request was denied and the bankruptcy decision was affirmed.  Sharif appealed to the Seventh Circuit Court of Appeals.  The Seventh Circuit was concerned with the structural issues raised by Sharif and determined that, although his objection was untimely, the structural “separation –of-powers considerations provided that “a litigant may not waive” a Stern objection” and  the Trust Claim was a Stern Claim for which the bankruptcy court did not have the constitutional authority to enter final judgment.

Analysis:  There are two premises in play in the Wellness decision – that of the common practice of adjudication by consent and the ability of a litigant to waive personal rights (such as to a jury trial) on one hand and, on the other, the constitutional requirement that there be a separation of powers, the so-called “structural” concerns.   Thus, despite litigants’ waiver of a personal right and consent to a decision by a non-Article III judge (i.e. a bankruptcy or magistrate judge), such consent may not be sufficient if there is a constitutional defect in such court entering a final order in the matter.

Said another way, Congress cannot, through the bankruptcy statute or otherwise, set up courts that will perform the duties of, or usurp the power and authority of, district courts established pursuant to Article III of the Constitution.  Indeed, to do so would violate the separation of powers between the branches of government and its system of checks and balances.   Thus, even if the litigants consent to have a non-Article III judge adjudicate a matter, that consent does not cure a structural separation of powers defect, if such defect exists.  So the matter before the Court was whether litigants with the right to have their claim heard by an Article III judge in the case of a Stern claim could consent to waive such right and permit the bankruptcy court to enter a final order or whether doing so would give the bankruptcy court impermissible authority in violation of the Constitution.  Citing prior holdings, the court found the following:

The entitlement to an Article III adjudicator is “a personal right” and thus ordinarily “subject to waiver,” . Article III also serves a structural purpose, “barring congressional attempts ‘to transfer jurisdiction [to non-Article III tribunals] for the purpose of emasculating’ constitutional courts and thereby prevent [ing] ‘the encroachment or aggrandizement of one branch at the expense of the other.’ ” … But allowing Article I adjudicators to decide claims submitted to them by consent does not offend the separation of powers so long as Article III courts retain supervisory authority over the process.[5]

The Court found that the institutional integrity of the judicial branch was not violated because bankruptcy judges: act as part of the district court, can be appointed and removed by Article III judges and hear matters based on the district court’s reference which can be withdrawn sua sponte.[6] Further, the claims in question are narrow: the bankruptcy court’s “ability to resolve such matters is limited to “a narrow class of common law claims as an incident to the [bankruptcy courts’] primary, and unchallenged, adjudicative function.”[7] The Court found no insidious purpose in Congress giving bankruptcy courts the ability to decide Stern Claims. The Court noted that Stern was a case in which there was no consent to bankruptcy court adjudication, and therefore did not address whether consent was possible.[8]

The Court said that implied consent, i.e. through actions instead of words, was permissible.  But, the Court did encourage bankruptcy courts to obtain express consent as a best practice:

Even though the Constitution does not require that consent be express, it is good practice for courts to seek express statements of consent or nonconsent, both to ensure irrefutably that any waiver of the right to Article III adjudication is knowing and voluntary and to limit subsequent litigation over the consent issue. Statutes or judicial rules may require express consent where the Constitution does not. Indeed, the Federal Rules of Bankruptcy Procedure already require that pleadings in adversary proceedings before a bankruptcy court “contain a statement that the proceeding is core or non-core and, if non-core, that the pleader does or does not consent to entry of final orders or judgment by the bankruptcy judge.” Fed. Rule Bkrtcy. Proc. 7008 (opening pleadings); see Fed. Rule Bkrtcy. Proc. 7012 (responsive pleadings). [9]

  1. Bank of America, NA v. Caulkett[10] – Lien Stripping

In Bank of America v. Caulkett, the Supreme Court addressed whether a chapter 7 debtor could strip off a wholly unsecured second mortgage.  The Court held[11]  that the lien could not be voided just because there was no equity in the property to which it could attach, applying its holding in Dewsnup v. Timm (“Dewsnup”)[12].

Facts:  The cases addressed by the Court had a typical fact pattern: the chapter 7 debtors each owned houses encumbered by two mortgages.  Bank of America (“BOA”) held the secured mortgage on each house.  The current market value of each house was less than the debt owed for the first mortgage and therefore there was no equity left to secure BOA’s mortgage liens.  Both debtors moved to void the wholly underwater BOA liens under 11 U.S.C. §506(d).[13] The bankruptcy court granted the motion in both cases and the decision was affirmed by the district court and the Eleventh Circuit Court of Appeals.  The focus of the Court was not whether the junior lien claims of BOA were “allowed” under Section 502– the parties conceded they were – but rather whether the claims were “secured” under Section 502(d).

Analysis:  The Court acknowledged that based on the language of section 506(a) it would seem that underwater claims like those of BOA would not be secured under Section 506(d):

Section 506(a)(1) provides that “[a]n allowed claim of a creditor secured by a lien on property … is a secured claim to the extent of the value of such creditor’s interest in … such property,” and “an unsecured claim to the extent that the value of such creditor’s interest … is less than the amount of such allowed claim.”[14]

However, the Court determined that its prior interpretation of “secured claim” under Section 506(d) in Dewsnup precluded such interpretation.  In Dewsnup, the debtor sought to reduce a secured claim to the value of the collateral under Section 506(d).  The Court described Dewsnup as follows:

[T]he debtor could not strip down the creditors’ lien to the value of the property under § 506(d) “because [the creditors’] claim [wa]s secured by a lien and ha[d] been fully allowed pursuant to § 502.” . In other words, Dewsnup defined the term “secured claim” in § 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Under this definition, § 506(d)’s function is reduced to “voiding a lien whenever a claim secured by the lien itself has not been allowed.”[15]

The debtors sought to restrict the Dewsnup holding only to circumstances when a lien is partially, rather than wholly, underwater. But the Court found that the Dewsnup definition was not dependent on whether there was some equity that could go to the junior lien-holder. The Court rejected an approach that could have a lien voided or not based on the difference of a dollar of market value:

Under the debtors’ approach, if a court valued the collateral at one dollar more than the amount of a senior lien, the debtor could not strip down a junior lien under Dewsnup, but if it valued the property at one dollar less, the debtor could strip off the entire junior lien. Given the constantly shifting value of real property, this reading could lead to arbitrary results. To be sure, the Code engages in line-drawing elsewhere, and sometimes a dollar’s difference will have a significant impact on bankruptcy proceedings. See, e.g., § 707(b)(2)(A)(i) (presumption of abuse of provisions of Chapter 7 triggered if debtor’s projected disposable income over the next five years is $12,475). But these lines were set by Congress, not this Court.[16]

  1. Bullard v. Blue Hills Bank[17] – Finality of Orders

            In Bullard v. Blue Hills Bank, the Supreme Court addressed the finality of a bankruptcy court’s denial of confirmation of a chapter 13 plan where leave was granted for the debtor to amend the plan.  The Court, by unanimous opinion[18], determined that an order denying confirmation where the debtor is permitted to amend the plan, unlike confirmation of the plan or dismissal of the case, is not a final order subject to appeal.

Facts:  Blue Hills Bank (the “Bank”) held a mortgage on debtor’s real property which property was worth less than the amount of the claim secured by the mortgage.  The debtor proposed a plan in which he would treat the bank’s claim as both partially secured and unsecured based on the market value of the property.  The debtor would maintain monthly mortgage payments and the secured claim would be paid in full long after the bankruptcy.  The unsecured portion would be treated the same as any other unsecured claims for which the debtor would pay a portion over the life of the plan and the remainder would be discharged.   The Bank objected and the bankruptcy court ordered debtor to file a new plan.  The debtor appealed to the Bankruptcy Appellate Panel of the First Circuit Court of Appeals (the “BAP”).  The BAP determined that the order in which plan confirmation was denied was not final because debtor could amend the plan.  However, the BAP still exercised jurisdiction under its ability to hear an interlocutory appeal with leave of court and determined the bankruptcy court was correct.   The debtor then appealed to the First Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction, finding that:

because the BAP had not certified the appeal under § 158(d)(2), the only possible source of Court of Appeals jurisdiction was § 158(d)(1), which allowed appeal of only a final order of the BAP. … And under First Circuit precedent “an order of the BAP cannot be final unless the underlying bankruptcy court order is final.”[19]

The First Circuit analyzed whether a bankruptcy court’s denial of plan confirmation constitutes a final order and found it did not “so long as the debtor remains free to propose another plan”.[20]

Analysis: The Supreme Court set up the issue by first acknowledging that in general most civil matters culminate in a final decision that can be appealed, and that permitting piecemeal prejudgment appeals goes against judicial efficiency.  But, the Court recognized bankruptcy cases and the rules that apply to them are different:

A bankruptcy case involves “an aggregation of individual controversies,” many of which would exist as stand-alone lawsuits but for the bankrupt status of the debtor. 1 Collier on Bankruptcy ¶ 5.08[1][b], p. 5–42 (16th ed. 2014). Accordingly, “Congress has long provided that orders in bankruptcy cases may be immediately appealed if they finally dispose of discrete disputes within the larger case.”… The current bankruptcy appeals statute reflects this approach: It authorizes appeals as of right not only from final judgments in cases but from “final judgments, orders, and decrees … in cases and proceedings.” § 158(a).[21]

The debtor argued that the relevant “proceeding” permitting appeal is each review by the court of a plan, such that every confirmation or denial of a plan is a separate proceeding that is final and appealable.   The Bank in contrast viewed the whole plan process resulting in the ultimate confirmation of the plan or the dismissal of the case upon failure of confirmation as the “proceeding”.   The Court agreed with the Bank, finding the following:

           The relevant proceeding is the process of attempting to arrive at an approved plan that would allow the bankruptcy to move forward. This is so, first and foremost, because only plan confirmation—or case dismissal—alters the status quo and fixes the rights and obligations of the parties. When the bankruptcy court confirms a plan, its terms become binding on debtor and creditor alike.[22]

In contrast to confirmation or case dismissal, the Court found that a denial of confirmation, when the debtor is permitted to amend the plan, did little to change the parties’ rights.    As a practical matter, the court also found that if the debtor’s view were accepted “each climb up the appellate ladder and slide down the chute can take more than a year. Avoiding such delays and inefficiencies is precisely the reason for a rule of finality.”[23]

             The court did acknowledge that its ruling could mean that if an order denying a plan is not final that there would then “be no effective means of obtaining appellate review of the denied proposal”. [24] However the Court determined that that risk is tolerable when compared to the burden of endless appeals:

[O]ur litigation system has long accepted that certain burdensome rulings will be “only imperfectly reparable” by the appellate process. … This prospect is made tolerable in part by our confidence that bankruptcy courts, like trial courts in ordinary litigation, rule correctly most of the time. And even when they slip, many of their errors—wrongly concluding, say, that a debtor should pay unsecured creditors $400 a month rather than $300—will not be of a sort that justifies the costs entailed by a system of universal immediate appeals.[25]

The Court further noted that there are avenues to appeal interlocutory orders that serve as a further safeguard.[26]

  1. Baker Botts L.L.P. v. ASARCO LLC[27] – Fees for defense of fee applications

In Baker Botts, the Supreme Court addressed whether a law firm can receive fees for the defense of its fee application.   The majority opinion ruled that it could not[28].  The Court focused primarily on two concepts – (1) the American Rule which provides that litigants pay for their own fees absent certain limited exceptions such as fee-shifting statutes and  (2) the language of 11 U.S.C. §330(a)(1)(A) permitting “reasonable compensation for actual, necessary services rendered”.  

Facts: ASARCO as debtor in possession (“ASARCO”) retained  Baker Botts L.L.P. and Jordan, Hyden, Womble, Culbreth & Holzer, P.C., to represent it during the bankruptcy pursuant to 11 U.S.C. §327(a).   These firms prosecuted fraudulent transfer claims against ASARCO’s parent company, resulting in a judgment in favor of the Debtor between $7 and $10 billion.   This result permitted all of ASARCO’s creditors to be paid in full, and ASARCO emerged from bankruptcy with cash and little debt.     The Debtor’s attorneys sought compensation for their efforts and filed fee applications which were objected to by ASARCO (under the control of its parent company.) Following “extensive discovery and a 6-day trial on fees”, the objections were overruled and Debtor’s attorneys were awarded “$120 million for their work in the bankruptcy proceeding plus a $4.1 million enhancement for exceptional performance” in addition to “over $5 million for time spent litigating in defense of their fee applications.”[29] ASARCO appealed and the district court affirmed the fees incurred in defending the objections to their fee applications.   However, on appeal to the Fifth Circuit, the award of fees in defense of the fee application was reversed. The Supreme Court affirmed the Fifth Circuit’s ruling.

Analysis: The Court noted that it has “recognized departures from the American Rule only in “specific and explicit provisions for the allowance of attorneys’ fees under selected statutes.”[30] The Court further acknowledged the following:

To be sure, the phrase “reasonable compensation for actual, necessary services rendered” permits courts to award fees to attorneys for work done to assist the administrator of the estate, as the Bankruptcy Court did here when it ordered ASARCO to pay roughly $120 million for the firms’ work in the bankruptcy proceeding. No one disputes that § 330(a)(1) authorizes an award of attorney’s fees for that kind of work. [31]

However it found that “the phrase ‘reasonable compensation for actual, necessary services rendered” neither specifically nor explicitly authorizes courts to shift the costs of adversarial litigation from one side to the other—in this case, from the attorneys seeking fees to the administrator of the estate—as most statutes that displace the American Rule do.”[32] The Court emphasized that Section 330 allows compensation for “work done in service of the estate administrator” which means work performed for another. [33] Thus, the Court reasoned that Section 330(a)(6) does not give courts the ability to award compensation for work that is not done in service of the estate administrator. [34] The Court distinguished fees for the preparation of a fee application for which compensation is permitted from fees in defense of such fee application through the following analogy:

it would be natural to describe a car mechanic’s preparation of an    itemized bill as part of his “services” to the customer because it allows a customer to understand—and, if necessary, dispute—his expenses. But it would be less natural to describe a subsequent court battle over the bill as part of the “services rendered” to the customer.[35]

________________________________________________

[1] 135 S.Ct. 1932 (2015).

[2] Id. at 1947.

[3] The opinion was delivered by Justice Sotomayor and joined by Justices Kennedy, Ginsburg, Breyer and Kagan.  Justice Alito joined in part and filed a concurring opinion in which he concurred in part and in the judgment.  Chief Justice Roberts filed a dissenting opinion in which Justice Scalia joined and Justice Thomas joined in part.  Justice Thomas also filed a dissenting opinion.  This summary only addresses the majority opinion.

[4] The “Court” shall refer to the justices comprising the majority opinion.

[5] Id. at 1944 (internal citations omitted).

[6] Id. at 1944-45.

[7] Id. at 1945.

[8] Id. at 1946.

[9] Id. at FN13.

[10] 135 S.Ct. 1995 (2015)

[11] The opinion was delivered by Justice Thomas and joined by Chief Justice Roberts and Justices Scalia, Ginsburg, Alito and Kagan.   Justices Kennedy, Breyer and Sotomayor joined the opinion except as to a footnote regarding Dewsnup.

[12] 502 U.S. 410 (1992)

[13] 11 U.S.C. §506(d) provides the following:

(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless–

(1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or

(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

[14] Id. at 1998-99.

[15] Id. at 1999 (citing Dewsnup, 502 US at 416-17).

[16] Id. at 2001.

[17] 135 S.Ct. 1686 (2015)

[18] Chief Just Roberts delivered the opinion.

[19] 135 S.Ct. at 1691(internal citations omitted).

[20] Id.

[21] Id. at 1692 (internal citations omitted).

[22] Id.

[23] Id. at 1693.

[24] Id. at 1695.

[25] Id. (internal citation omitted).

[26] Id. at 1695-96.

[27] 135 S.Ct. 2158 (2015)

[28] Justice Thomas delivered the opinion which was joined by Chief Justice Roberts and Justices Scalia, Kennedy and Alito.  Justice Sotomayor joined in all but Part III–B–2 and filed an opinion concurring in part and concurring in the judgment. Justice Breyer filed a dissenting opinion, in which Justices Ginsberg and Kagan joined.

[29] 135 S.Ct. at 2163.

[30] Id. at 2164.

[31] Id. at 2165.

[32] Id.

[33] Id.

[34] Id. at 2167.

[35] Id.