- Success Fee of Creditors Committee's Financial Advisor Must Be Paid from Recovery of Committee's Constituents
- April 19, 2005
- Law Firm: Weil, Gotshal & Manges LLP - New York Office
In Official Committee of Unsecured Creditors v. Farmland Industries, Inc. (In re Farmland Industries, Inc.), the United States Court of Appeals for the Eighth Circuit held that where there are two statutory committees representing competing classes of creditors, the success fee paid to the unsecured creditors committee's financial advisor must be paid out of the amount recovered by the committee's members.
The Retention and Payment of Professionals by Statutory Committees
Section 328(a) of the Bankruptcy Code permits a creditors committee appointed pursuant to section 1102 of the Bankruptcy Code to employ a professional person "on any reasonable terms and conditions of employment," provided that the committee obtains court approval to do so. Section 330 of the Bankruptcy Code governs the compensation of retained professionals and pursuant to section 330(a)(4)(A)(ii), a court may not allow compensation of a professional retained pursuant to section 328 if the services provided were not "reasonably likely to benefit the debtor's estate" or "necessary to the administration of the case." Compensation awarded pursuant to section 330 qualifies as an allowed administrative expense under section 503(b)(2) of the Bankruptcy Code.
Farmland Industries and its affiliated debtors filed for chapter 11 relief. The United States Trustee in the chapter 11 cases appointed two creditors committees to represent the two large groups of unsecured creditors with competing claims -- the Official Committee of Unsecured Creditors to represent trade creditors (the "Unsecured Creditors Committee") and the Official Committee of Bondholders to represent bondholders (the "Bondholders Committee"). Each committee retained a separate financial advisor -- the Bondholders Committee retained Ernst & Young Corporate Finance ("Ernst & Young") and the Unsecured Creditors Committee retained Houlihan Lokey Howard & Zukin Financial Advisors ("Houlihan Lokey"). Both committees agreed to pay their respective financial advisor a flat monthly fee plus a "success fee" based on the recovery received by the members of their respective committee. The agreement between the Bondholders Committee and Ernst & Young provided that any success fee to be paid to Ernst and Young was to be paid from the bondholders' recovery. The agreement between the Unsecured Creditors Committee and Houlihan Lokey, however, provided that Houlihan Lokey's transaction or success fee would be a general administrative expense to be paid by all creditors out of the general funds of the debtors' estates.
Upon objections by both the debtors and the Bondholders Committee, the bankruptcy court approved the retention of Houlihan Lokey, but found that because "Houlihan Lokey was engaged to work specifically for the benefit of the trade creditors," any success fee should be paid out of the trade creditors' recovery, rather than out of the general funds of the debtors' estates.
On appeal by the Unsecured Creditors Committee, the bankruptcy appellate panel found that the bankruptcy court did not abuse its discretion in finding that Houlihan Lokey's success fee should be paid out of the trade creditors' recovery and affirmed the bankruptcy court's decision on the grounds that (i) Houlihan Lokey was working for the benefit of the trade creditors, (ii) Houlihan Lokey's success fee was negotiated by the Unsecured Creditors Committee, and (iii) the bondholders should not have to pay additional contingent fees beyond the success fee to be paid to their financial advisor, Ernst & Young. The Unsecured Creditors Committee appealed the decision arguing that the bankruptcy court's decision was based on clearly erroneous findings of fact.
The Eighth Circuit's Decision
The Unsecured Creditors Committee argued that "the bankruptcy court's order was based on clearly erroneous findings of fact because there was insufficient evidence that (a) Houlihan Lokey was working solely for the benefit of the trade creditors, and (b) the fee agreement between the Bondholders Committee and Ernst & Young 'is fairer and more equitable to all creditors.'" The Eight Circuit concluded these arguments were meritless.
The Unsecured Creditors Committee also argued that because sections 330 and 503 of the Bankruptcy Code require that Houlihan Lokey's services benefit the estates, all payments for those services should come from the estates' general funds. The committee further argued that not paying Houlihan Lokey's transaction fee from the estates' general funds would violate the priority granted to administrative expenses under the Bankruptcy Code. The Eighth Circuit disagreed, finding that neither section 330 nor section 503 identifies the specific source from which professionals must be paid. The court noted that, in a case where there is a single committee that retains a single financial advisor, the corresponding administrative expense claims are typically paid out of the debtor's general funds. However, such practice merely represents "a sensible way to proceed," rather than a statutory mandate. Where, as in the instant case, there are multiple committees that have retained separate advisors, the Eighth Circuit concluded that section 330(a)(4)(A)(ii) does not prohibit "the court from providing at the outset that the contingent portion of each advisor's fees will be paid out of the creditors' recovery that was enhanced by that advisor's services." The court further held that proceeding in this manner is consistent with the authority granted to the court in section 328(a) to approve the employment of a professional on "any reasonable terms and conditions of employment" and clearly within the court's discretion.
Finally, the Eighth Circuit found that the priority requirements of section 507 of the Bankruptcy Code were satisfied. The court noted that Houlihan Lokey would only be entitled to a transaction fee if the debtors have sufficient funds to pay the claims of trade creditors in full. According to the court, the priority requirements of section 507 provide that "administrative claims must be paid in their entirety before lower priority claims may be paid. [Section 507] does not mean that the amounts to be paid to lower priority claimants may not be calculated before the administrative expense claims are paid."
The Farmland Industries court established that, at least in the Eighth Circuit, where there are competing classes of unsecured creditors, the success fee charged by a financial advisor should be paid out of the recovery obtained by the creditors who benefited from the services of that financial advisor, rather than out of the general funds of the debtor's estate. It remains to be seen whether, when confronted with a similar situation, other courts will adopt the same approach.
Official Comm. of Unsecured Creditors v. Farmland Indus., Inc. (In re Farmland Indus., Inc.), 397 F.3d 647 (8th Cir. 2005).