By: Daniel J. Carollo
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Recently, the United States Bankruptcy Court for the Southern District of Texas in In re Energy Partner’s Ltd.[1] held that employment agreements for professionals and other agents in a bankruptcy re-organization under 11 U.S.C. § 328 are subject to a heightened reasonableness standard because once a fee is approved by the court it will not be subject to review absent unforeseeable circumstances.[2] Energy Partners Ltd., an offshore oil and gas exploration company, and its affiliates filed a petition for relief under chapter 11 in May of 2009.[3] Two creditors committees appointed by the United States Trustee filed applications under section 328 requesting court approval to employ investment banking firms to provide two separate valuation reports on the bankrupt debtor corporation.[4] Each investment banking firm had requested a non-refundable fee of $500,000, plus various other administrative fees.[5] The court rejected the applications to employ the investment banks because the court determined that neither firm would provide a material benefit to the estate.[6]
The heightened reasonableness standard developed in In re Energy Partners Ltd., which requires that the professional’s employment provide a material benefit to the estate,makes it much more difficult for investment bankers, and potentially all other professionals within the meaning of section 328,[7] to have their fee arrangements preapproved within the context of a corporate re-organization. Under section 328, a trustee, a creditors’ committee, or an equity security holders’ committee can employ certain designated professionals to assist in the administration of the estate, but only if the conditions of employment are reasonable and the employment request is pre-approved by the bankruptcy court.[8] According to section 328, once the bankruptcy court approves the proposed compensation and the hired professionals complete their engagement, a court generally may only modify the agreement “[i]f such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.”[9] Because of this limitation on a judge’s ability to adjust compensation after performance has been completed absent unforeseeable circumstances, courts are especially critical when deciding whether to approve the employment of investment bankers or other professionals.
Courts called upon to approve compensation agreements for professionals under section 328 analyze five factors to determine whether they should grant approval.[10] The analysis of one factor, whether the retention of the professional is in the best interest of the estate, was recently modified in In re Energy Partners.[11] The court modified the traditional analysis by applying a higher level of scrutiny to determine whether the employment of a professional under bankruptcy proceedings will materially benefit the estate.[12] In deciding the proper way to apply this factor, the court took into consideration the analysis applied to employment applications under section 330 of the Bankruptcy Code, because under section 330 the court has the benefit of making a hindsight determination as to whether the employment agreement provided a material benefit to the estate.[13] Section 330 is similar to section 328 in that they both set forth the requirements for employing professionals during bankruptcy proceedings, but differs since the court under section 330 considers whether the employment provided a material benefit to the estate after the employment is completed.[14] The In re Energy Partners court noted that under section 328 a court does not have the benefit of this hindsight and thus must make a “preemptive determination” regarding whether the employment will materially benefit the estate.[15] The court, therefore, closely scrutinized this factor to account for this disadvantage.
In re Energy Partners raises the issue whether investment bankers, and potentially other professionals, seeking employment approval under section 328 will be subject to heightened scrutiny. In light of the recent economic downturn, it appears courts are tightening their belts and trying to preserve the estate as much as possible by applying heightened scrutiny to professional compensation.
[1] 409 B.R. 211 (2009).
[2] Id. at 225–26.
[3] Id. at 217.
[4] Id. at 219.
[5] Id. at 218–19.
[6] Id. at 238–39.
[7] See 11 U.S.C. § 327 (2006) (stating term professional includes attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold an interest adverse to the estate).
[8] 11 U.S.C. § 328 (2006).
[9] Id.; see also 3 Collier On Bankruptcy, ¶ 123, at 328–1 (Alan N. Resnick et al. eds., 15th ed. Rev. 2006) (noting that a court may not conduct a reasonableness review after approval of professionals’ fee arrangement).
[10] See In re High Voltage Eng’g Corp., 311 B.R. at 333 (citing In re Insilco Techs. Inc., 291 B.R. 628, 634 (Bankr. D. Del. 2003) (stating that the five factors are: 1) whether the terms of the engagement agreement reflect normal business terms in the marketplace; 2) whether the parties involved are sophisticated business entities with equal bargaining power who engaged in an arm’s-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 of the case, the amount of the retainer provides the appropriate level of “risk minimization,” especially in light of the existence of any other “risk-minimizing” devices, such as an administrative order and/or a carve-out.
[11] See In re Energy Partners, 409 B.R. at 229 (“Although Pro–Snax is typically applied after the professionals’ services have already been rendered, the Court should, under § 328, make a pre–emptive determination of the benefit that the professionals’ services will provide to the estate.”).
[12] Id.
[13] Id. at 228 –29 (“A bankruptcy court within the Fifth Circuit must review not only the reasonableness of the services rendered and value associated with those services at the time the services were rendered, but also consider whether, in hindsight, the professionals’ services provided a tangible, identifiable, material benefit to the estate.” (citing Andrews & Kurth LLP v. Family Snacks Inc. (In re Pro-Snax Distributors Inc.), 157 F.3d 414 (5th Cir. 1998)).
[14] 11 U.S.C. § 330 (2006).
[15] In re Energy Partners, 409 B.R. at 229.
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