By: Nicolas Berg
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
In certain instances, a professional, such as a financial advisor, may contract the right to receive a “success fee” from a debtor in bankruptcy.[1] The courts have established different tests for awarding a success fee.[2] In In re Valence Technology, the United States District Court in the Western District of Texas held that KPMG was entitled to a success fee from Valence Tech for closing a $50 million dollar debt-equity conversion, but it was not entitled to a similar fee for closing a $20 million capital loan.[3] After filing for chapter 11 bankruptcy, Valence Tech hired KPMG to assist with necessary financial restructuring advice.[4] Pursuant to their agreement, if KPMG’s work resulted in “any consideration” from Valence Tech’s primary financier, Berg & Berg, KPMG would be entitled to a “success fee” of 1.25% of the value of that consideration or no less than $500,000.[5] Valence Tech received two payments from Berg & Berg: (1) a $50 million debt-to-equity conversion and (2) a $20 million capital loan.[6] While KPMG contended that it was entitled to the 1.25% success fee for both payments, Valence Tech argued that it should not have to pay the success fee for either payment.[7] The bankruptcy court concluded that under the agreement KPMG was entitled to the success fee for the debt-to-equity conversion.[8] The court, however, denied KPMG’s request for the success fee for the capital loan.[9] Valence Tech appealed the bankruptcy court’s ruling to the district court maintaining that KPMG was not entitled to a success fee for either transaction while KPMG cross-appealed to argue for payment of the success fee in connection with the capital loan.[10] To settle the dispute, the district court analyzed the agreement to determine whether the capital loan should be included in the meaning of “any consideration.”[11] Noting the sophistication of the parties, the district court found the contract described two potential scenarios: (1) a “Private Placement” coming from any party other than Berg & Berg resulting in a 2.5% fee for KPMG, and (2) a “Private Placement” coming from Berg & Berg reducing KPMG’s fee to 1.25%.[12] The district court reasoned that either way the contract defined “Private Placement” as having “Private Placement Value,” which necessarily included equity linked financing.[13] Therefore, according to the district court, the $50 million debt-equity conversion qualified as a “Private Placement,” which entitled KPMG to the agreed upon 1.25% “success fee.”[14] The $20 million capital loan did not qualify because it was not linked to any equity.[15]
The Bankruptcy Court for the Southern District of New York established a test in In re Drexel Burnham Lambert Group for determining the reasonableness of contingency agreements for professionals, including financial advisors and investment bankers.[16] According to In re Drexel, a court should consider: (1) a presentation of the scope and complexity of the assignment, its anticipated duration, expected results, and required resources; (2) a description of the extent to which highly specialized skills may be needed and the extent to which such professional has them or may be able to obtain them; (3) a statement of the professional’s projected salary, billing rate, and prevailing fees for comparable services; (4) a copy of the actual retention agreement between the investment banker or advisor must be attached to the retention application; (5) a description by the party retaining the professional of the process by which the investment banker or financial advisor has been selected; and (6) a statement in the application explaining how the investment banker or advisor will eliminate, or at least reduce, the duplication of effort among armies of professionals.[17] The agreement between the parties is at the center of each requirement.[18] A court should interpret the reasonableness of a success fee agreement by examining the contract, especially when the parties involved are highly sophisticated.[19] This was exemplified in In re High Voltage Engineering Corporation, which not only adopted the In re Drexel requirements but specifically analyzed whether the parties were “sophisticated business entities of equal bargaining power.”[20] Nevertheless, the In re High Voltage Court still considered the terms of the agreement to determine its reasonableness.[21]
The Court in In re Valence Technology did not explicitly follow the requirements set out in In re Drexel and supported in In re High Voltage.[22] Nevertheless, the court focused on the terms of the agreement to determine the appropriate fee amount.[23] Indeed, according to the court because the parties were “sophisticated [and] well counseled,” the court’s ability to read in terms to the wording of the contract was limited.[24] Therefore, parties, including the professional designated to receive the success fee, should use due diligence while contracting a success fee agreement.[25]
[1] See e.g. In re Enron Corp., 2004 Bankr. LEXIS 2549, 222 (Bankr. S.D.N.Y. 2004) (“Subject to Court approval and pursuant to their respective engagement agreements, certain professionals of the Debtors and the Creditors, may seek a success fee.”).
[2] See e.g. id.
[3] In re Valence Tech. Inc., 2015 WL 1507765, at *5 (W.D. Tex. 2015).
[4] Id. at *1.
[5] Id. at *3–*4.
[6] Id. at *1.
[7] Id. at *5.
[8] Id.
[9] Id. at *2.
[10] Id.
[11] Id.
[12] Id. at *5.
[13] Id. at *3.
[14] Id. at *5.
[15] In re Valence Tech. Inc., *5.
[16] 133 B.R. 13, 29 app. n. 1 (Bankr. S.D.N.Y. 1991) (“These guidelines shall apply to all professionals seeking compensation pursuant to 11 U.S.C. §§ 327, 328, 330 and 331, including investment bankers and real estate advisors, unless the Court, in the order of retention, provides otherwise.”).
[17] Id. at 29–34.
[18] See id.
[19] See In re Valence Tech. Inc., 2015 WL 1507765, *4 (quoting Worcester Creameries Corp. v. City of New York, 861 N.Y.S.2d 198, 201 (App. Div. 3d Dep’t 2008) (quoting Vermont Teddy Bear Co. v. 538 Madison Realty Co., 1 N.Y.3d 470 (2004) (“The Agreement was ‘negotiated by sophisticated and well-counseled parties’ and in such situations, ‘courts may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing.’”).
[20] In re High Voltage Eng'g Corp., 311 B.R. 320, 333 (Bankr. D. Mass. 2004) (“Factors to be considered, include . . . 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.”).
[21] See id. at 335.
[22] See In re Valence Tech. Inc., 2015 WL 1507765, at *3–*5.
[23] See id. at *5 (“The payment terms of the Agreement are derived strictly from the four corners of the Agreement.”).
[24] Id. at *4.
[25] See Clear Lake Ctr., L.P. v. Garden Ridge, L.P., 416 S.W. 3d 527, 543 (Tex. App. Houston 14th Dist. 2013) (“Due diligence requires that contracting parties protect their own interests.”); see also In re Leatherland Corp., 302 B.R. 250, 264 (Bankr. N.D. Ohio 2003) (“The Court finds that the contract language is clear and unambiguous regarding the nature of the ‘Success Fee.’”).