• "Totality of the Circumstances" Test Should Be Applied in Determining Whether Fee Arrangements Have Been Pre-Approved
  • December 17, 2004
  • Law Firm: Weil, Gotshal & Manges LLP - New York Office
  • In Nischwitz v. Miskovic (In re Airspect Air, Inc.), the United States Court of Appeals for the Sixth Circuit considered whether the bankruptcy court abused its discretion in declining to award attorneys fees to debtor's counsel under section 328 of the Bankruptcy Code, notwithstanding the bankruptcy court's approval of the terms of the professional's engagement, and instead awarding fees in a substantially reduced amount under section 330 of the Bankruptcy Code. The Sixth Circuit held that a determination of whether a fee arrangement, like the one at issue, has been pre-approved under section 328 of the Bankruptcy Code should be judged by the "totality of the circumstances." Having applied this standard, the Sixth Circuit concluded that the attorney's contingency fee agreement had not been pre-approved by the bankruptcy court.

    Sections 327, 328 and 330 of the Bankruptcy Code

    Section 327(e) of the Bankruptcy Code authorizes the trustee (or debtor in possession), with the court's approval, to employ an attorney to represent the debtor for a specified special purpose, other than to represent the trustee in "conducting the case," so long as the attorney does not represent or hold any interest adverse to the debtor or the estate with respect to the matter on which such attorney is to be employed. Section 328(a) requires that the terms and conditions of employment of any professionals engaged under section 327 be "reasonable," including an engagement entered into on a retainer or contingency fee basis. Section 330(a) of the Bankruptcy Code provides that, subject to section 328, the court shall allow reasonable compensation for actual, necessary services rendered by professional persons. A court which has approved the terms and conditions of a professional's employment under section 328 may authorize fees under an arrangement, under section 330(a), other than that previously approved under section 328 if the court finds that the arrangement under section 328 proves to be "improvident" under the circumstances.

    Factual Background

    Airspect Air, Inc. ("Airspect") entered into a lease with the City of Akron (the "City") to operate a "fixed-based operation" at Akron-Fulton International Airport (the "Lease"). Pursuant to the terms of the Lease, Airspect constructed a building, hanger, ramp and fuel farm (the "Improvements"). Due to many disputes regarding the terms of the Lease, Airspect withheld lease payments from the City.

    Airspect sued the City in June 1994 asserting claims for breach of contract, constructive eviction, misrepresentation and sought $10 million in compensatory damages and rescission of the Lease (the "State Court Action"). The City alleged that Airspect has materially breached the Lease and sought to evict Airspect from the premises, recover damages and recover the Improvements. In 1995, counsel representing Airspect in the State Court Action withdrew their representation and as a result, Airspect retained Jeffrey Nischwitz ("Nischwitz").

    In March 1996, Airspect filed for relief under chapter 11 of the Bankruptcy Code. By operation of the automatic stay (a stay that is triggered upon the filing of a bankruptcy case that prohibits the commencement or continuation of certain actions against a debtor), the State Court Action was stayed and then transferred to the bankruptcy court as an adversary proceeding (the "Adversary Proceeding").

    In May, 1996, Airspect filed an application with the bankruptcy court seeking authorization to employ Nischwitz as special counsel for the sole purpose of prosecuting the Adversary Proceeding. Airspect sought approval of the proposed fee arrangements with Nischwitz -- a $7,000 retainer and a contingency fee arrangement, the details of which were set forth in Airspect's application. The bankruptcy court approved Nischwitz's retention, including the payment of the $7,000 retainer and ordered Nischwitz to submit fee applications to the court for approval.

    Thereafter, the City filed a motion in the bankruptcy court for termination of the automatic stay arguing that by operation of law, the Lease had been terminated pursuant to section 365(d)(4) of the Bankruptcy Code due to Airspect's failure within the 60-day statutory deadline to assume or reject the Lease. The bankruptcy court agreed with the City and held that the Lease was rejected by operation of law. However, the bankruptcy court denied the City's motion for relief from the automatic stay and allowed Airspect to remain in possession of the Improvements, in which Airspect had a significant equity interest. The City appealed to the district court which reversed the bankruptcy court's decision and held that the City was entitled to immediate possession of the property because the Lease was rejected by Airspect. Airspect appealed the district court's decision, but the parties settled the issue pending such appeal.

    During this time, the Adversary Proceeding went forward and in 1997, the matter was transferred from the bankruptcy court to the district court. In 1999, the parties reached a settlement with respect to the Adversary Proceeding, whereby the City agreed to either allow Airspect to sell its assets to a new fixed based operator or pay Airspect $575,000 in exchange for Airspect's turnover of the leased premises, including the Improvements. The City elected to pay Airspect $575,000 in exchange for Airspect's turnover of the premises and the Improvements. The bankruptcy court approved the settlement and dismissed the Adversary Proceeding.

    In 2000, Nischwitz filed a fee application with the bankruptcy court seeking $189,750 pursuant to the contingency fee arrangement. The sole interest holder in Airspect, Spasoje Miskovic ("Miskovic"), objected to the fee application. The bankruptcy court approved reduced fees for Nischwitz in the amount of $37,500, awarding only what it deemed to be reasonable compensation under section 330(a) of the Bankruptcy Code. The bankruptcy court denied Nischwitz's request for payment pursuant to the contingency fee arrangement because the court determined that the "contingency" had not been met. The court reasoned that the settlement of the Adversary Proceeding did not occur in the manner described in the contingency fee arrangement previously disclosed to the court. Rather, the settlement was "incidental to a 'sale' of the lease and the Improvements as part of a 'global settlement' between the parties." The bankruptcy court determined that only that portion of the services rendered on behalf of Airspect prior to the rejection of the Lease conferred a benefit to the estate. Accordingly, Nischwitz was awarded fees in the amount the court deemed to be reasonable compensation.

    The Bankruptcy Appellate Panel for the Sixth Circuit (the "BAP") reversed and held that the "contingency" had been satisfied and that the bankruptcy court had previously approved the contingency fee arrangement pursuant to section 328 of the Bankruptcy Code. The BAP concluded that the bankruptcy court was "required to honor the agreement unless it proved 'improvident' in light of subsequent events." On remand, the bankruptcy court again denied Nischwitz's total request for compensation and held that it "improvidently approved the contingency fee arrangement in light of the lease rejection by operation of law." The bankruptcy court reasoned that because it did not approve Nischwitz's retention under section 328 of the Bankruptcy Code, it evaluated Nischwitz's compensation under section 330 of the Bankruptcy Code. The BAP again reversed and held that the Lease rejection did not render the contingency fee arrangement improvident "because it was 'irrelevant' since 'the damages that [Nischwitz] had been retained to recover were actionable whether the lease was terminated or not.'" The BAP concluded that the bankruptcy court had approved the contingency fee arrangement under section 328 of the Bankruptcy Code. Miskovic appealed the BAP's decision.

    The Sixth Circuit's Decision

    On appeal, Miskovic argued that the contingency fee arrangement was never pre-approved and alternatively, that the agreement was improvident. The Sixth Circuit began its analysis by examining the interplay between sections 327, 328 and 330 of the Bankruptcy Code. The court first noted that pursuant to sections 327 and 328 of the Bankruptcy Code, a trustee (or debtor) may employ an attorney on "any reasonable terms and conditions of employment, including on a contingency basis." The court further noted that if "a particular rate or means of payment" has not been approved under section 328 of the Bankruptcy Code, a court shall approve reasonable compensation for "actual, necessary services rendered" by an attorney pursuant to section 330 of the Bankruptcy Code. However, if "a particular rate or means of payment" has been pre-approved by a court, a court can approve an attorney's fees under section 330 only if the terms and conditions of the pre-approved arrangement prove to be improvident due to unanticipated circumstances.

    In proceeding with its analysis, the Sixth Circuit next turned its attention to two circuit court cases, Zolfo, Cooper & Co. v. Sunbeam-Oster Co. and Circle K Corp. v. Houlihan, Lokey, Howard & Zukin, Inc. (In re Circle K Corp.), where the Third Circuit and Ninth Circuit, respectively, each set forth certain criteria that must be satisfied before a court will "pre-approve" a fee arrangement under section 328 of the Bankruptcy Code.

    In Zolfo, Cooper & Co., the Third Circuit was asked to determine whether the bankruptcy court improperly reduced certain requested fees and expenses where it had approved a contingency fee retention arrangement. In challenging the court's reduction of its fees and expenses, Zolfo, Cooper & Co. argued that section 328(a) of the Bankruptcy Code applied and that the court could not change the terms of employment as set forth in their retention motion without finding that such terms were improvident. The Third Circuit looked at the language used in the retention order (which was not specific) and stated that the language only established the nature and range of services to be performed and "cannot bind the court to particular terms and conditions of compensation." The Third Circuit held that if a retention order does not specifically state the terms and conditions upon which the professional is being retained as set forth in section 328(a) of the Bankruptcy Code, than the terms and conditions that apply are those under section 330, which apply absent a specific arrangement.

    In Circle K Corp., the bondholder committee's financial advisor submitted an amended final fee application to the bankruptcy court and upon a determination under section 330 of the Bankruptcy Code of the reasonableness of the amounts requested, the bankruptcy court first awarded the financial advisor one-half of its requested fees and expenses, and on remand, awarded the financial advisor the full amount of the fees and expenses requested. On appeal, the Ninth Circuit held that where a professional is retained in a chapter 11 case and the retention application fails to unambiguously specify that section 328 of the Bankruptcy Code governs the retention, a review of such retention under section 330 of the Bankruptcy Code is appropriate under the circumstances. The Ninth Circuit further recommended that the retention order specifically confirm that the professional has been retained under section 328, but stopped short of requiring such reference in the order.

    While the Sixth Circuit concluded that the standards set forth in the Third and Ninth Circuits are too rigid, the court concluded that "a finding of pre-approval based on less than the bankruptcy court's affirmative authorization of payment terms would be too lax." The Sixth Circuit noted that the Bankruptcy Code does not mandate that a retention application specifically cite to section 328 or that a retention order expressly state specific terms and conditions. The court held that whether a court "pre-approves" a fee arrangement under section 328 should be judged under the "totality of the circumstances," including the language set forth in the retention application and corresponding order. The Sixth Circuit concluded that when asked to "pre-approve" a fee arrangement, the court should look at certain factors including whether the retention application specifically requested pre-approval for the fee arrangement, whether the court assessed the reasonableness of the fee, and whether the retention application or order specifically invoked section 328 of the Bankruptcy Code.

    Nischwitz relied on the reference to the terms of the contingency fee arrangement in Airspect's application to employ him. The Sixth Circuit did not find this one factor conclusive. The Sixth Circuit looked to Nischwitz's retention application and order. There was only "one reference" to the contingency fee arrangement between the parties in the application (but the terms of the arrangement were recited therein) and no reference was made to section 328 of the Bankruptcy Code in either the application or order. The court further noted that both documents failed to discuss the reasonableness of the fee, which the court found to be the foundation of a section 328 inquiry. Additionally, the order required Nischwitz to submit fee applications to the court for approval. Based on all these factors, the Sixth Circuit held that under the "totality of the circumstances," the bankruptcy court did not pre-approve the contingency fee arrangement under section 328 of the Bankruptcy Code and a determination of the reasonableness of the fees requested by Nischwitz under section 330 was appropriate.

    Conclusion

    The Sixth Circuit's decision is an important one, because it departs from the more objective tests established in the Third and Ninth Circuits that provide more concrete guidelines for the professional applying for contingency fees. In contrast, the Sixth Circuit's approach seems to bring a measure of uncertainty into the equation, and the BAP decisions seem more correct. In view of the Sixth Circuit's decision, applicants for contingency fees are advised to state the specific terms of retention in the application, establish the reasonableness of the fee arrangement, specifically invoke section 328 and make sure the order specifically recites section 328. The retention order should not require the submission of future fee applications.

    Nischwitz v. Miskovic (In re Airspect Air, Inc.), 385 F.3d 915 (6th Cir. 2004).
    Circle K Corp. v. Houlihan, Lokey, Howard & Zukin, Inc. (In re Circle K Corp.), 279 F.3d 669 (9th Cir. 2002).
    Zolfo, Cooper & Co. v. Sunbeam-Oster Co., 50 F.3d 253 (3d Cir. 1995).