A corporate bankruptcy filing can now mean hundreds of dollars in dry-cleaning bills, hotel rooms costing $700 a night, and hundreds of thousands of dollars in photocopying fees. In a mega-bankruptcy case like Lehman Brothers, total fees can top $1 billion.

The enormous bills from professional services firms that bankrupt companies often have to pay were the subject of an April 19 panel by the American Bankruptcy Institute (ABI).

Several bankruptcy professionals speaking at the hearing on bankruptcy reform said the widespread perception is correct: lawyers’ and other professionals’ fees in bankruptcy cases are steep, so high that they are damaging the filing company’s value and hence investor recoveries.

At the hearing, Wilbur L. Ross, the famed leveraged buyout and distressed asset investor, said that professional fees in bankruptcies are “frequently excessive. As someone who for many years was an active financial adviser to various constituencies but who now instead invests in bankruptcy claims and 363 sales, perhaps I am in the category of being a reformed sinner.”

Dan Dooley, chief executive of turnaround firm MorrisAnderson, also took issue with rapidly rising fees: “There is little or no discipline in mega-cases. It simply costs what it costs.”

For CFOs of bankrupt companies, fee escalation is alarming. The company can control some of the costs of the professionals it hires directly, but it is at the mercy of the courts and the U.S. Trustee when it comes to expenses from creditor committees. If the bankruptcy court says so, the debtor company incurs the fees. 

The proliferation of creditor committees is one reason professional fees for bankruptcy cases have exploded. More creditors want a piece of the recovery. Bankruptcy courts routinely recognize three or four unsecured creditor committees, whereas one used to be the norm. That has a multiplier effect on the costs of a case, explained Ross.

While sometimes the court can cap costs from these secondary groups, “this still leaves the problem that whatever motions are filed by such committees require responses from other committees and from the debtor, and add to the billable hours of all participants in contested hearings,” Ross said in his prepared testimony.

“Chapter 11 is a game of perverse economic incentives for the professionals because when one stakeholder’s attorney throws a hand grenade into the room on an issue, all the other professionals at the bargaining table collect chips courtesy of the hand grenade thrower,” said Dooley. “That’s because the chips or payments come from this amorphous pot of money of the debtor.”

Claims by single large creditors or ad-hoc groups of creditors can also drive up costs. Ross described a case in which his firm won a bidding contest for assets sold by a bankrupt firm. A single creditor opposed the sale. “Between motions and responses filed and the 30 attorneys and five financial advisers involved with the several-hour hearing, hundreds of thousands of dollars were spent and there was literally no benefit to the estate because the judge ultimately approved the original sale at the original price,” Ross said in his prepared testimony.

A flawed compensation system for lawyers and other experts is partly to blame, since it’s based on time instead of results, Ross said. The system “channel[s] professional behavior toward the direction of hyperactivity and consequently [inflates] costs.” Professional firms also over-staff bankruptcies, he said.

Current controls in place to keep fees reasonable don’t work, said Ross and other panelists. The United States Trustee, an arm of the Justice Department, is supposed to monitor professional fee applications in corporate bankruptcies. But “huge stacks” of detailed time reporting submitted by professional firms cause examiners to “get lost in the data,” according to MorrisAnderson’s Dooley. And because fee examiners are usually bankruptcy professionals themselves, they tend to “nibble around the edges because no one in this industry would ever get employed again if he or she really attacked a peer’s fees.”

John Haggerty, a principal of Argus Management Corp., said control over professionals’ should start with the debtor. But the problem is no one person in the organization is usually responsible for supervising professional firm’s fees.

“Most competent CFOs can tell when problems arise,” Haggerty said in his pre-hearing statement. “The CFO or someone of equivalent level of the company should be required to review bills of the debtors’ professionals and sign off on their reasonableness.”

Dooley and Ross had suggestions for cracking down on exorbitant and excessive bankruptcy fees. Dooley recommended requiring firms to submit weekly, two-page reports to the court listing the prior week’s fees and expenses and describing what was accomplished. Timely reporting and publicizing of the fees would cause costs to drop quickly, Dooley said.

Ross would go further. If a party initiates litigation but does not prevail, the time incurred by its professionals would be automatically disqualified as billable, he suggested. The U.S. could also set ceilings for the fees billable by each creditor class, based on the percentage of their total recovery. To set the benchmark fee levels, Ross suggested the ABI and U.S. Trustees could compile data from the previous two years and set the guideline “at a modest discount from the median fee.”

A bankruptcy court judge would have the power to go above the guidelines if a case was unusually complex, like that of Lehman Brothers, Ross added.

By 2014, the ABI’s commission expects to generate a detailed proposal on changes to bankruptcy  in the hope it leads to legislative reform.

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