When it Comes to Bankruptcy Fees, Size Matters

Time spent in Chapter 11 and where the case is filed have little effect on costs, a massive new study reveals.
David McCannDecember 7, 2007

The amount of time spent in Chapter 11 has relatively little effect on case costs, according to a new study on bankruptcy costs. Far more significant are the size of the corporation, the number of external professionals retained, and whether a special bankuptcy committee is appointed.

The American Bankruptcy Institute on Friday released what it claims is the largest-ever study on the costs of Chapter 11, with a total sample of 1,024 cases filed in 2004. Written by Seton Hall University law school professor Stephen Luben, the report contradicts some key findings of surveys done in the past.

While most prior studies have reported professionals’ fees relative to the asset size of the debtor corporation, Luben contends, his research found that assets are not an accurate measure of company size, especially for cases other than the very largest. Much more relevant, he asserted, is the sum of assets and debts. This total is subject to an economy of scale: On average, with every 1 percent increase in the size of a debtor, professional fees grow by less than half a percent, according to the study.

Other significant findings of the study included the following:

• Most of the regulation of professional fees provided by the Bankruptcy Code is valuable mainly for its deterrence effects. Applications to retain professionals are rarely denied and requested fees are rarely reduced.

• Almost 35 percent of Chapter 11 cases result in no payment whatsoever to professionals. These are typically smaller cases that are often converted to Chapter 7 or dismissed outright.

• The participation of a fee examiner or auditor has no effect on overall cost. The benefits of fee examiners, if any, come from administrative assistance they offer the bankruptcy court.

Previous studies of professional fees in chapter 11 cases over the past 20 years examined significantly smaller sample sizes, ranging from about 25 to 75 cases, according to the ABI. Of the 1,024 cases included in the new study, 99 were segregated into a “big-case” dataset, where the average corporation had assets of $423 million and liabilities of $776 million, compared to $21 million in assets and $37 million in liabilities in the “random-sample” dataset. For both samples, professional fees totaled 4 to 4.5 percent of the bankrupt firms’ assets and liabilities.

Probably the single factor that can drive up costs the most is appointing professional examiners. The costs for doing that averaged more than half a million dollars for the random-sample cases and almost $1 million for the large cases.