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Reducing Collection Actions Through Effective Billing Practices

April 13, 2018

A recent Connecticut Law Tribune article by Shari Klevens and Alanna Clair, “Reducing Collection Lawsuits Through Effective Billing Practices,” reports on strategies for collecting unpaid legal fees.  This article was posted with permission.  The article reads:

Many attorneys will put off the decision of whether to pursue a client for unpaid legal fees until the end of the calendar year. With the second quarter of the year just beginning, the issue of unpaid fees may not be an immediate priority. After all, many clients will pay outstanding bills throughout the year. And repeatedly requesting that a client pay his or her bills can be an uncomfortable conversation for attorneys, especially for those with long-standing client relationships.

If an invoice (or invoices) go unpaid for too long, however, an attorney and law firm may be left to accept the loss of unpaid fees or, alternatively, to file a suit against the client. Either decision can create risk for the attorney that worked hard on the matter.

Many attorneys find that taking proactive steps throughout the year reduces the need of having to make that difficult decision. Enacting these strategies can help ensure that an attorney is paid on time, reduce exposure, increase fee collection, as well as promote positive client relationships.

Bill on Time Attorneys that expect their clients to pay on time may see better results if they send out timely bills. Some attorneys will avoid the work associated with preparing and issuing bills because it is not as enjoyable as the legal work. But sending out bills regularly not only helps attorneys meet their administrative and ethical obligations, but can also provide clarity to clients on the amount of their legal fees.

Untimely or irregular billing is one of the most prevalent and preventable causes of fee disputes. Issues can arise when a client is confronted with a substantial invoice all at once at the end of the representation. Providing clients with steady, manageable bills can help condition them to paying their legal fees, as well as ensure any issues concerning the amount of fees are addressed before they spiral out of control.

Honest and Regular Communication Determining the reason that the client is not paying a bill is important because it can dictate the appropriate and most effective course for an attorney to take. Generally speaking, clients may not pay a bill for one of four reasons. First, a client may have never actually received the bill or simply forgot. These unintentional oversights, which happen, can easily be remedied by a reminder. Addressing this circumstance early can help reduce the risk of a client mistakenly believing they paid the bill or deciding to contest the bill at a later date.

Another common reason that clients will not pay their bills is that they are unhappy with the amount that was charged, whether because the attorney billed at too high a rate or for what they deem too many hours. Some clients will also require strict adherence to onerous billing procedures. Nevertheless, addressing and understanding these constraints early in the representation can help ensure both parties are on the same page, and that bills are paid.

Unfortunately, some clients will not have the financial resources to pay the bill. This news may be especially troubling for a firm because it may be an uphill battle to recover the value of the services it rendered. Also, it generally means an end to the client relationship. In these instances a firm will still have to make a number of important decisions, such as whether to withdraw from or amend the scope of the representation. Although difficult to address, it is easier sooner than later in the representation.

Dissatisfaction with the attorney’s work or the outcome of the representation is a final reason that clients will refuse to pay. Unlike the first three reasons for nonpayment, this decision by the client may require the attorney to take additional steps to protect against future claims, including by reporting the circumstances to the attorney’s insurer.

Making the Decision Whether to File Suit The decision to sue a client is not an easy one. According to some sources, when attorneys sue their clients for unpaid fees, a little less than half of those cases will result in a counterclaim by the client for legal malpractice. Thus, a claim for unpaid fees can result in the firm being forced to defend the entire representation, rather than simply document their owed fees. Further, litigation costs time and money, and may result in a negative stigma for the firm with other potential clients.

Because of these risks, some firms decide as a matter of policy never to sue a client, no matter the circumstances. But for other firms that option may not be feasible or reasonable. When making that decision, the law firm can try to take steps to minimize the risks of that outcome.

Prelitigation Measures In lieu of filing suit against a client, there are other steps attorneys can take to attempt to recover unpaid fees.

The first option to consider is attending informal meetings and negotiation. In addition to hopefully resolving the dispute, these presuit meetings can also assist a law firm in gaining more information about the client’s position that could be beneficial if the matter proceeds to litigation.

A second step to consider is a more formal meeting, such as a mediation. An unbiased third party may help the parties reach an agreement.

Finally, another popular option is to resolve the fee dispute with the client through arbitration. One advantage to agreeing in advance to arbitration focused on the narrow issue of a fee dispute is that it can eliminate the risk of a counterclaim for legal malpractice in that forum. Others prefer arbitration for the privacy benefits. On the other hand, some firms find that they collect more fees in a litigation with a client than in arbitration.

The Connecticut Bar has a free Resolution of Legal Fee Disputes Program that “allows lawyers and clients with a dispute over the fees incurred for legal services to find a solution to their problem through mediation and/or arbitration, rather than litigation.” The program provides for mediation, with a volunteer attorney as mediator, or arbitration, with a hearing panel composed of two attorneys and one nonattorney.

Alanna Clair is a partner at Dentons US in Washington, D.C., and focuses on professional liability defense. Shari L. Klevens is a partner at Dentons US in Atlanta and Washington, D.C., and serves on the firm’s U.S. board of directors. She represents and advises lawyers and insurers on complex claims and is co-chairwoman of Dentons’ global insurance sector team. Klevens and Clair are co-authors of “The Lawyer’s Handbook: Ethics Compliance and Claim Avoidance.”

Strategies for Collecting Fees from Clients

April 11, 2018

A recent Texas Lawyer article by Shari Klevens and Alanna Clair, “Strategies for Collecting Fees from Clients,” reports on strategies for collecting unpaid legal fees.  This article was posted with permission.  The article reads:

Collecting legal fees can be just as important to a law firm’s success as effectively handling client representations. Although attorneys spend years honing their legal skills and may excel at advocating for their clients, some may find discomfort when pursuing fee collection.

While some firms put off the decision on how to address clients with unpaid fees until the end of the calendar year, confronting the issue earlier often yields more positive results. And if the firm waits too long, the firm might find that its options are fairly limited.

Suing a client is not an easy decision. The decision necessarily entails extra-judicial risks, such as harmful media exposure, negative word of mouth reputation, and bringing to light otherwise private information about the firm’s business practices, including rates and fee arrangements. Moreover, there are time and financial costs in litigation, and almost half of all suits filed by attorneys for unpaid fees result in the client asserting a counterclaim for legal malpractice.

Taking into account all of these risks, some firms make the decision to never sue a client. Other attorneys will only sue a client as a last resort. Having a carefully considered and effectively implemented collection plan can limit the number of times a firm must make that difficult decision.

Consistent Billing Cycles

Many attorneys agree that billing is one of their least favorite aspects of the practice of law. In addition to taking up time they would otherwise spend on client matters, most attorneys are not trained business managers and the practice can be outside of their comfort zone. But consistent billing is important because it satisfies client expectations and increases the likelihood of being paid.

Some common fee disputes result from untimely billing. Clients may have a harder time reconciling a large bill for multiple months of legal services submitted at one time. Indeed, clients may experience “sticker shock,” especially if the representation did not unfold as they anticipated.

Issuing timely and regular bills may help ensure that the client is satisfied with the services, but also increases the likelihood that the client will pay the bill in a timely manner. And if a client is one who is difficult and never intended to pay, an attorney can identify the issue before spending too much time working on the matter.

Communicate About Bills

As noted above, attorneys may find it uncomfortable to have to confront a client about an unpaid bill. Instead of avoiding the issue, reaching out to a client to understand why he or she has not paid may help remedy the non-payment.

There are some different reasons why clients may fail to pay the bills. The lack of payment may be an honest oversight. It is possible the client did not receive a bill because of technological error or other mishap. They may have had the payment slip their mind. If this is the case, a gentle reminder may be all it takes to receive payment, as well as maintain a positive attorney-client relationship. On the other hand, if the non-payment is intentional, communication can bring clarity to the dispute.

A second reason clients may not pay a bill is that they are unhappy with the outcome of the legal services they received or the perceived value of the representation. This reason can be one of the most difficult to remedy and may give rise to other obligations for the attorney, such as reporting the dissatisfaction internally at the firm or to the firm’s insurer.

Next, sometimes a client may be dissatisfied with an administrative issue. A common example is when attorneys charge a rate that is higher than the client expected or intended for the representation. Other times an attorney may have spent more hours on the matter than the client deemed necessary. Again, understanding and communicating about these issues early in the representation can ensure they are resolved for the majority of the representation.

Finally, some clients will not have the funds to pay their legal bills. This situation can also especially uncomfortable. Nevertheless, if the law firm decides to withdraw due to a client’s inability to pay, it is usually easier to do so early in the representation.

Handling Fee Disputes Prior to Litigation

There are generally three strategies attorneys use to resolve disputes before litigation.

The first step is to host an informal meeting between the firm and client to discuss the issue. At this meeting it is usually helpful to include an attorney that was not directly involved in the representation.

If the client and law firm cannot resolve the dispute informally, they may find it is more productive to attend a mediation with a third-party. A mediation can help both sides save on costs and time.

Arbitration limited to just the issue of fee recovery is another option that many attorneys and clients will use to resolve a dispute. This method of resolving the dispute can help with privacy concerns and malpractice claims that arise from formal litigation. In Texas, Bar Opinion 586 suggests that while arbitration clauses are permissible, the attorney may have to explain the effects of arbitration clauses to clients in accordance with Rule 1.03(b). This may mean explaining the cost and time savings associated with arbitration, the potential relaxation of the rules of discovery and evidence, and the lack of jury trial or appellate rights.

Making The Decision Whether to File Suit

Ultimately, a law firm may be left with the decision to either file suit or take a financial loss. This decision involves weighing the pros and cons of both options, which include the amount of outstanding fees and the likelihood of a malpractice claim. Implementing a consistent billing cycle, communicating with clients about their fees, and attempting alternative methods can, however, help reduce the number of instances in which this decision must be made.

Shari L. Klevens is a partner at Dentons and serves on the firm’s US Board of Directors. She represents and advises lawyers and insurers on complex claims and is co-chair of Dentons’ global insurance sector team.  Alanna Clair is a partner at Dentons and focuses on professional liability defense.  Shari and Alanna are co-authors of “The Lawyer’s Handbook: Ethics Compliance and Claim Avoidance.” 

Why Elite Law Firms Should Raise Hourly Rates

March 5, 2018

A recent Law.com article by Hugh A. Simons, “Why Elite Law Should Raise Rates,” reports on hourly rates at elite law firms.  This article was posted with permission.  The article reads:

Elite law’s self-confidence has taken a beating. First the great recession hit, and now talk of disruption abounds. But the recession is over and disruption is far from an existential threat. It’s time for elite law to rediscover belief in the value it provides and start to raise rates as it did before the recession. Specifically, elite firms should:

Raise rates across the board.
Discount from the higher rates where necessary.
Increase rates more for partners.
Increase rates more for more distinct practices.
Exit, or leverage up, practices where realized rates (i.e. after discounting) don’t rise.

Raise rates across the board

Billing rate increases have been on a roller coaster, see Figure 1. Before the onset of the great recession, standard rates rose 7 to 8 percent annually with realized (collected) rates rising 5 to 6 percent. When the recession hit, the standard rate increase dropped to between 1 and 2 percent and, as economics would predict, realized rates actually declined. Thereafter, things have steadily improved. The market now trundles along with standard rates rising at 3 percent and realized rates at 2.5 percent, comfortably above inflation at 1.5 percent.

The fact that realized rates have gone from declining to rising at a steady rate indicates that bargaining power has shifted back from clients to law firms. The question becomes: must the new steady-state rate of increase be lower than it was before the onset of the great recession? If law firms have the bargaining power to raise standard rates an average of 3 percent, and realize a rate increase of 2.5 percent, then do they have the power to raise rates at, say, 7 percent and realize a 5 percent increase?

Three conditions must be met for increasing rates to work for law firms. The first is that growth in the value clients derive from a firm’s offerings should exceed the increase in rates. On this, the value a client derives is formally equal to the change in the risk-weighted expected value of the outcome of a client’s business venture, or legal-proceeding, that results from the law firm’s services. As the business world grows more uncertain, complex, and volatile, then services which mitigate these new risks create greater value for clients. Mitigating these emerging risks is what the leading-edge offerings of elite law firms do. Hence, these firms are at liberty to raise rates.

The second condition required for raising rates to be effective relates to competition. If Firm A raises rates and Firm B offers the same service at the pre-increase rate then, in theory, clients turn to Firm B. However, in the elite law world, firms’ offerings are not that fungible—in the highly-specialized segments where elite firms play, there simply aren’t that many viable “Firm B” providers. Even where there are other technically-capable firms, different firms offer different levels of reassurance because of clients’ varying history and comfort with the idiosyncratic perspectives of individual lawyers. A related observation is that firms tend to raise rates at comparable rates. Thus, even where there is a viable Firm B, there may be little cost saving incentive for the client to switch firms.

The third condition is evidenced by the historical data: rate increases only stick when the economy is humming along. While there is always much uncertainty about the economy, and by historical standards we are overdue a recession, today’s economic fundamentals look fairly robust. Firms should be assertive in benefitting from today’s strong economic tailwinds, emboldened by the knowledge that they’ll be buffeted by the headwinds when the economy turns.

The reason elite law firms have not been increasing rates assertively may have more to do with the emotional than with the rational. Elite law firms’ belief in the value of the services they provide took a battering through the great recession, and gets beaten down daily by dire warnings of the industry’s imminent disruption. But the recession has ended and disruption is not an existential threat to elite law firms. Nor is it an existential threat to the differentiated service lines within the portfolio of services offered by the broader group of preeminent firms. Yes, it’ll hurt the commodity-only firms and commodity service lines within other firms, and it will require changes in how all firms operate, but it won’t destroy the core of the elite law firm profit engine: big bucks for bespoke mitigation of major risks.

Discount from the higher rates where necessary

When I suggest raising rates assertively some partners respond that their clients won’t pay any increase. True, some clients won’t. But many will and many more will bear part of the increase. Thus, it’s normal for an increase in standard rates to be accompanied by more discounting and hence a decline in realization (i.e. the ratio of realized, or collected, rates to standard, or rate card, rates). This is not of itself a problem as it’s realized rates that drive a firm’s economics. The important point is that, other than in the aftermath of a recession’s onset, the effect of an increase in standard rates is a significant, albeit lower, increase in realized rates. For example, standard rates rose by 33 percent from 2007 to 2017 and, although realization declined from 89 to 82 percent, realized rates still rose by a healthy 22 percent.

It’s instructive to take a closer look at the above realization decline. As shown in Figure 2, by far the biggest component of this decline was in the ratio of worked (i.e. negotiated or agreed) rates to standard rates—5 points of the 7-percentage point fall. This reflects growth of the volume of work being executed not at standard rates but at client or matter-specific discounted rates.

The dynamics of discounts are a competition between two irrationalities. On the one hand, clients have an irrational liking for discounts. They make clients feel they’re getting a bargain and they’re easy for the legal department to explain to management. The irrationality, of course, is that the focus should be on the discounted rate not on the distance between it and some putative standard rate.

On the other hand, firms have an irrational dislike for discounting. Too many firms still think of realization rate as a measure of profitability. It can be absurdly hard to get lawyers to internalize that, in order to assess profitability accurately, you have to look at the combined effect of leverage and realization using measures such as margin per partner hour.  Indeed, higher-leverage and higher-discount work is often more profitable than lower-leverage and zero-discount work. But partners have been conditioned to think of discounts as a demerit, and partners hate demerits. This unhelpful conditioning gets reinforced by finance departments reporting on hours and realization but not on leverage or margin per partner hour.

The look at realization in Figure 2 also shows that two percentage points of decline are due to increased billing write offs. These write offs reflect quality-of-work issues and budget overruns. As quality issues are probably fairly constant, it’s reasonable to attribute this increase to more budget overruns, in turn a reflection of more work being done under fixed, capped, or other alternative fee arrangements (AFAs). But here again, lower realization doesn’t mean lower profitability—increased leverage can more than offset the realization decline. Indeed, over 70 percent of firms say AFAs are as profitable, or more profitable, than work billed at hourly rates, (data source: Altman Weil’s 2017 Law Firms in Transition report).

Increase rates more for partners

Partners are often reticent to raise their own billing rates assertively. This is a problem of itself but also has severe second-order consequences. First, it effectively sets a cap on the billing rates of counsel and senior associates as there has to be headroom between their rates and those of partners. This becomes a constraint not just on revenue but on profitability. While typical businesses have their highest markup on their highest-value offerings, this billing rate cap leads many law firms to have a lower markup (i.e. the number of times a lawyer’s billing rate exceeds their comp on a cost-per-hour basis) on senior associates and counsel than they realize on their relatively low-value junior associates. By compressing markups in this way, firms are leaving money on the table. There’s consistent market feedback that indirectly corroborates this perspective: clients object most to the billing rates of junior lawyers.

Holding back on partner billing rates also makes it harder to raise leverage. Part of the reason some partners push back on raising their own rates is they feel some of the work they do is not truly partner level and hence shouldn’t be billed at full partner-level rates. This underlying failure to delegate is a disservice to clients (by not letting the work flow to the lowest-priced lawyer capable of doing it), to associates (who are left bereft of experience), and to other partners (who contribute disproportionately to a firm’s profit pool by leveraging more). Hence, part of the logic for raising partner rates is to realize the benefits of improved leverage.

Increase rates more for more distinct practices

If you offer customers something they need that you alone can provide then you can set the price close to the value they derive from your service. If, on the other hand, you offer customers something that many others offer, then you are constrained to pricing it at the level set by others. In reality, a law firm’s various offerings fall at different points along a spectrum between these theoretical extremes. This simple observation has a pricing implication that many law firms effectively ignore: billing rates, and hence billing rate increases, should vary markedly across the range of a firm’s offerings. In particular, the billing rates for a firm’s offerings that are most distinct from those competitors can provide should be priced more aggressively than those for its less-distinct offerings.

The low billing rate growth we’ve seen of late may well be a manifestation of firms adhering to a philosophy of a single firm-wide billing rate increase and having this increase be set by the rate that is appropriate for the less-distinct offerings. The reality is that market dynamics have evolved in recent years to the point that a firm’s pricing power varies sharply across its practices; adhering to a single increase set by the less-distinct offerings is now leaving serious money on the table. If internal firm harmony requires a single rate increase, then better to raise standard rates strongly across the board and discount from these as necessary for the less-distinct offerings.

Exit, or leverage up, practices where realized rates don’t rise

There is an old adage in strategy consulting: 80 percent of strategy is deciding what not to do. The ‘what not to do’ for elite law firms is offer commodity services. How does one recognize commodity services? By definition, commodity services are offerings that many other firms can provide. By extension, commodity services are those where a firm effectively cannot set the price but must adhere to the price level set by rivals. This translates to commodity offerings being those where the realized rates (i.e. after discounting) don’t rise following a standard rate increase.

To adhere to a strategy of differentiation, firms should exit practices where realized rates can’t be increased above the rate of inflation. In some circumstances, so doing is more than the fabric of a partnership can bear. Where this is the case, an alternative that may buy some time is to operate the practice at greater leverage than the rest of the firm. So doing mitigates the effect of a commodity practice on per-partner profitability. However, it is really only a holding measure as leverage can’t be increased indefinitely and managing businesses with dramatically different fundamental strategies requires an ambidexterity that few trained business leaders, let alone lawyers, possess.

Action implications

Most people make decisions based on objective facts interpreted through a lens of emotional biases and personal predispositions. Partners are alike most people in that they employ such a lens; partners are unlike most people in that they refuse to recognize they employ such a lens. There is nothing to be gained by leaders trying to get partners to recognize what they’re doing; however, there is value in leaders shaping the lens through which partners interpret the world.

At many firms today, this lens says lawyers are of declining value and the market is stagnating. While this is true perhaps at the middle and lower tiers, this is objectively untrue for elite firms and for the differentiated practices within the broader swath of preeminent firms. This lens issue needs to be addressed first before partners can analyze robustly the case for billing rate increases. Specifically, the lens should be reshaped by restoring and bolstering partners’ confidence in the value of their offerings. To this end, firm leaders should talk to clients (many of them really value you!), share more of the positive client feedback with partners, highlight firm recognition and awards, have clients come and speak at partner meetings, host alumni roundtable discussions of the value of outside counsel, etc. The forthcoming 2017 Am Law results will probably help too: despite the pervasive gloom and doom, the top end of the market is prospering; I suspect we’ll see double-digit percent increases in profitability at most elite firms.

Having reshaped the lens, the next step is to create opportunities for partners to discuss billing rate history, profitability, and future billing rate policy. The key here is to give partners the data and let them chew on it. Don’t lecture them or tell them what to do; rather give them the parameters and let them figure it out for themselves—so doing is the first step toward adoption of the desired changes.

Partners’ deliberations should perhaps start with a review of the firm’s billing rate history and dynamics, including firm-specific versions of Figures 1 and 2 here, supplemented with the same views for individual offices, practices and key clients. It would also be useful to profile how partner rates set a cap on rates for counsel and senior associates, leading to markup compression and, perversely, a firm having the lowest markups on the time of its highest value lawyers.

Partners should then discuss some of the less-obvious dynamics around billing rates. These could include, for example: the connection between leverage and partner billing rates (particularly how low partner rates suppress leverage); the pervasive observation that leverage varies more with individual partners than with practice or client type; and, in cultural contexts where it would help, partners could debate the relationship between compensation and billing rate—the two tend to correlate at professional services firms although it’s sort of misleading as it’s not a causal relationship; rather both are separately reflective of the economic value of a partner’s practice, so proceed with caution.

The final element is for partners to discuss the process by which billing rates are set. While most partners prefer control of their own rates, many recognize that having an abstract committee set the rate allows them some plausible deniability in conversations with clients.

All this is to say it’s a new billing rate world out there. Law firm leaders would do well to buy the option of increasing billing rates assertively at year end by starting to prepare partners for such increases now.

Hugh A. Simons, Ph.D., is a former senior partner and executive committee member at The Boston Consulting Group and the former chief operating officer at Ropes & Gray.

Two Key Provisions for Your Fee Agreement

February 27, 2018

A recent CEBblog article by Julie Brooks, “2 Key Provisions for Your Fee Agreement,” writes about two keep provisions in fee agreement.  This article was posted with permission.  The article reads:

In "The Contract that Binds: Your Fee Agreement", we noted that fee agreements should not be governed by simple boilerplate and formulaic thinking. This is true, but there are exceptions to this general advice: Here are two particular provisions that should be considered and likely added to every fee agreement you draft.

When you’re part of a law firm, your fee agreement should make clear that it’s the firm being retained, not you. Even if you’re likely to perform most or all of the work, this provision will support the firm’s continuing representation of the client and the transferring of responsibilities to another attorney if you die, become disabled, leave the firm, or are otherwise unavailable to handle all or some part of a client matter. Of course, the client will retain the absolute power to discharge the firm at any time, with or without cause.

Here is sample language you might use for this provision (when applicable, the bracketed language at the end may clarify the situation and assure the client):

RETENTION OF FIRM RATHER THAN PARTICULAR ATTORNEY. You are retaining the _ _[name of law firm]_ _, not any particular attorney, and the attorney services to be provided will not necessarily be performed by any particular attorney. _ _[It is anticipated, however, that the services will be performed principally by _ _[insert name(s) of attorney(s)]_ _.]_ _

If you’re being retained as counsel but may delegate performance of some of the services to other attorneys and legal professionals, you need to make that clear to the client at the outset. See California State Bar Formal Opinion No. 2004-165 (if attorney anticipates delegating services to outside contract attorneys, issue should be addressed in fee agreement). Under Cal Rules of Prof Cond 2-200, the client must specifically consent in writing to an attorney’s sharing part of a fee with another attorney who isn’t a partner or associate in the same law firm. An attorney who is “of counsel” to the firm is not considered a partner or associate (i.e., an employee) in the law firm. See California State Bar Formal Opinion No. 1994-138.

Here is sample language you might use for this provision:

DELEGATION OF ATTORNEY AND PARALEGAL SERVICES. You agree that we may delegate to other attorneys and legal professionals, such as contract attorneys and contract paralegals, some of the attorney services to be provided to you. Such services will be billed to you at the same hourly rates that we bill our services, and any such delegation will not affect your obligation to pay attorney fees as provided for in this agreement.

Approval of Attorney Fee Defense Provisions Post-Asarco

February 19, 2018

A recent Legal Intelligencer article by Rudolph J. DiMassa Jr. and Jarret P. Hitchings, “Approval of Fee Defense Provisions in Retention Agreements Post-ASARCO,” on recent approval of fee defense provision in retention agreements post-Asarco.  The article reads:

The Bankruptcy Code authorizes a debtor (or its bankruptcy trustee) to retain and compensate attorneys and other professionals during the course of the debtor’s bankruptcy case. Specifically, Section 327 allows a debtor, with bankruptcy court approval, to employ attorneys, accountants or other professionals to represent or assist the debtor in connection with its bankruptcy case. Section 328, in turn (and again subject to court approval), allows the debtor to retain such professionals “on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on a fixed or percentage fee basis or on a contingent fee basis.” Finally, Section 330 permits a court to award to a professional retained under Section 327 “reasonable compensation for actual, necessary services” and “reimbursement for actual, necessary expenses.” Given this framework, the retention and compensation of professionals in a bankruptcy case is often a routine affair. The debtor will seek, and usually receive, authority to retain its professionals on specified terms. Thereafter, professionals may periodically file applications seeking payment of fees and expenses incurred during the course of the bankruptcy case. If the court concludes that the requested compensation is reasonable, it will award payment by the debtor’s estate. However, if any party objects to a professional’s fee application, this process can take an unwelcome turn.

Contested fee application litigation can result in additional professional fees and expenses. Vexingly for the professional, these “fee defense” costs may not be payable from the debtor’s bankruptcy estate: In Baker Botts v. ASARCO (135 S. Ct. 2158 (2015)), the U.S. Supreme Court held that fees and costs incurred by a professional on account of fee-defense litigation are not compensable under Section 330. To mitigate this risk, bankruptcy professionals have begun to include fee-defense provisions in their retention agreements. While these types of provisions have been met with objection, the U.S. Bankruptcy Court for the District of New Mexico in In re Hungry Horse, Case No. 16-11222 (Bank. D.N.M. Sept. 20, 2017) recently approved a retention agreement between a debtor and its counsel that entitled counsel to payment of all reasonable fees incurred in defending its fee applications. Importantly, the bankruptcy court determined that such a provision was not barred by the Supreme Court’s holding in ASARCO.

In ASARCO, the Supreme Court began its analysis by recognizing the “bedrock principle known as the American Rule” which requires each litigant to pay its own attorney fees—win or lose—unless a statute or contract provides otherwise. Because none of the parties in ASARCO relied on the contract exception to the American Rule, the Supreme Court considered whether Section 330 of the Bankruptcy Code provides a statutory exception to the American Rule in the context of fee defense litigation. On this point, the Supreme Court concluded that nothing in Section 330 warranted an exception to the American Rule. Indeed, the Supreme Court recognized that Section 330(a)(1) authorizes compensation only for “actual, necessary services rendered” by the professional. The Supreme Court therefore concluded that because “litigation in defense of a fee application is not a ‘service’ [to the debtor’s estate] within the meaning of Section 330(a)(1),” fees and expenses incurred in connection therewith are not allowable as compensation under Section 330.

In response to ASARCO, bankruptcy professionals have incorporated fee defense provisions into their retention agreements. By including such provisions, the professionals hope to come within the contract exception to the American Rule. Unfortunately, this approach was analyzed—and rejected—by the Delaware Bankruptcy Court in In re Boomerang Tube, 548 B.R. 69 (Bankr. D. Del. 2016).

In Boomerang Tube, proposed counsel for the unsecured creditors’ committee included a term in its retention agreement that provided for payment of expenses incurred defending counsel’s fee applications. The U.S. trustee objected to the inclusion of this fee defense provision as contrary to Section 328 and ASARCO. The court sustained the trustee’s objection on several grounds. First, relying on ASARCO, the court concluded that Section 328 does not contain a statutory exception to the American Rule because it lacks any specific and explicit language awarding litigation fees or costs to a prevailing party. Second, the court determined that the retention agreement between the unsecured creditors’ committee and its counsel was insufficient to trigger the contract exception to the American Rule. The court noted that the retention agreement was “not a contract between two parties providing that each will be responsible for the other’s legal fees if it loses a dispute between them.” Rather, the court found, the retention agreement provided that a third party (i.e., the debtor’s estate) would pay counsel’s defenses, even if the estate were not the objecting party. Because the retention agreement could not bind the debtor’s estate, it failed to establish a contract exception to the American Rule. Finally, the court determined that fee defense provisions could not be approved under 328 because such a provision could never be deemed reasonable. According to the court, fee defense provisions are de facto unreasonable since they inure to the benefit of the professional and not the professional’s client.

The bankruptcy court in Hungry Horse considered a similar issue but reached a different conclusion. There, the debtor sought court authorization to retain bankruptcy counsel. The parties’ retention agreement expressly provided that the debtor agreed “to pay all reasonable legal fees incurred in obtaining court approval of all employment and fee applications including dealing with any objections to any of the applications.” The debtor’s unsecured creditors’ committee objected to the approval of this fee defense provision as contrary to ASARCO.

The Hungry Horse court overruled the objection and approved the fee defense provision. In doing so, the court concluded that nothing in ASARCO prevents approval of a fee defense provision in a retention agreement as a “reasonable term and condition” under Section 328(a). As the bankruptcy court pointed out, the Supreme Court in ASARCO construed Section 330 as limiting an attorney to compensation for services rendered to the client. However, the ASARCO court did not consider any contractual fee defense provision or consider whether such a provision could be approved under Section 328. The court also rejected the Boomerang Tube holding that a fee provision can never be a reasonable term under Section 328, since nothing in the Bankruptcy Code requires that all the terms of a professional’s employment directly benefit the estate.

The court distinguished Sections 328 and 330, noting that “if employment terms and conditions are approved by a bankruptcy court under Section 328(a), then the professional’s compensation is governed by those terms and conditions, rather than the general ‘reasonable compensation for services rendered’ language of Section 330(a)(1)(A).” The court specifically relied on the fact that the authority of the bankruptcy court to award compensation under Section 330 is expressly subject to the provisions of Section 328. As a result, the court held that Section 330 does not preclude payment of fee defense costs if the terms and conditions of a professional’s compensation include a fee defense provision approved under Section 328.

The court also considered practical realities to reach its conclusion. It recognized that in smaller bankruptcy cases with smaller fees, fee defense costs can become a sizeable percentage of the total amount of fees billed in a case. Consequently, “if estate counsel were forced to successfully defend its fees ‘on its own dime,’ the net compensation in a bankruptcy case could be substantially reduced,” minimizing the incentive for counsel to undertake a debtor representation. Moreover, allowing a professional to recover fee defense costs from the estate limits objections to fee applications to bona fide disputes.

In conclusion, the court in Hungry Horse offered an example of a fee defense paragraph that might be approved as reasonable under Section 328(a): “Fee Defense. The client agrees to pay all reasonable legal fees and expenses incurred by the firm, and also by any counsel retained by the unsecured creditors’ committee (if one is formed in the client’s bankruptcy case) for successfully defending their respective fee applications. The bankruptcy court must approve all of such fees as reasonable. The client will have no obligation to pay for any fees or expenses the firm incurs defending fees that are not allowed.”

Whether such language will be approved by other courts remains to be seen. In the meantime, in order to reduce the risk that they bear the expense of their own fee defense, bankruptcy professionals should consider specifically providing for the payment of such costs in their retention agreements.

4 Reasons to Get Help on a Fee Requests

November 24, 2017

A recent CEBblog article by Julie Brook, “4 Reasons to Get Help on a Fee Motion,” reports on attorney fee requests.  This article was posted with permission.  The article reads: Just because...

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