Fee-Shifting in Bankruptcy.

• Author: Bussel, Daniel J.

ABSTRACT

This Article examines attorney fee-shifting practices in bankruptcy from theoretical, historical, caselaw, statutory, empirical and comparative perspectives. Although the Supreme Court has insisted the American Rule remains the applicable background principle in insolvency cases as elsewhere, insolvency law, for sound equitable and systemic reasons, has always rejected strict application of the American Rule. Fee-shifting among the parties has been, and remains, pervasive in bankruptcy cases. Against this background, the Supreme Court's position has led to anomalous and untoward results in discrete areas where the American Rule continues to apply. This Article argues for a forthright rejection of what little remains of the American Rule in bankruptcy and proposes a modified English Rule giving bankruptcy courts discretion over the award of attorney's fees. I go on to identify a set of non-exclusive factors that properly inform the exercise of the bankruptcy court's discretion over the award of fees. Interestingly, the United Kingdom, starting from the tradition of the English Rule, has created a discretionary fee-shifting regime applicable to insolvency cases that mirrors the discretionary approach advocated here. Despite their disparate starting points, the realities of insolvency practice are impelling both the English and American systems toward a court-supervised discretionary fee-shifting regime in the bankruptcy arena.

CONTENTS

1. Introduction II. Analyses of The English and American Rules in Civil Litigation A. The Alaskan Experience B. The Florida Medical Malpractice Experiment C. The Eisenberg/Miller Study D. Intermediate Solutions 1. One Way Fee-Shifting 2. Discretionary Fee-Shifting III. Attorney's Fees in Bankruptcy A. Fee-Shifting in Bankruptcy Today B. The Historical Equitable Exceptions to the American Rule Undergirding Fee Shifting in Bankruptcy IV. The American Rule in Bankruptcy A. Fee Objection Litigation B. Time-Barred Claims C. Preferences V. Lessons From Penrod VI. Moving to a Discretionary Prevailing Party Regime for Recovery of Attorneys' Fees A. A Modified English Rule for Bankruptcy Cases B. A Look at Fee-Shifting in Bankruptcy in England VII. Conclusion I. Introduction

   "Our basic point of reference when considering the award of attorney's fees is the bedrock principle known as the American Rule: Each litigant pays his own attorney's fees, win or lose, unless a statute or contract provides otherwise"

   Baker & Botts LLP v. AS ARCO LLC (1)

   The general default rule in civil litigation in the United States, the so-called "American Rule" is that each party bears its own attorney's fees. The general default rule in the United Kingdom, and in most of the rest of the world, is the "English Rule," that is the prevailing party in civil litigation may recover its attorney's fees from its adversary as a cost of litigation. As we shall see in the discussion that follows, no system applies a pure version of either the American Rule or the English Rule in all circumstances. The thesis of this Article is that in the insolvency context we should expressly eschew reliance on the pure form of either the American Rule or English Rule, and that bankruptcy courts should authorize fee-shifts informed by a series of factors sensitive to the realities of insolvency generally and the particular case before it.

   The modern Supreme Court is on unfamiliar ground when it decides bankruptcy cases. Reflexive application of general jurisprudential rules in bankruptcy cases can yield poor results. Bankruptcy is a special context where pervasive fee-shifting is already occurring, and judicial expertise in shifting and fixing attorney's fees is historically-rooted and well-developed. In that setting, reliance on the American Rule as the default rule is ahistorical and not otherwise appropriate. Moreover, it creates or exacerbates conflicts with underlying bankruptcy policy.

   The discussion starts in Part II with a brief overview of the critiques and defenses of the English and American Rules respectively. Part III discusses the general fee shifting dynamics in bankruptcy and describes bankruptcy's rejection of the American Rule. Part IV identifies some areas where the American Rule's persistence has caused continuing problems in bankruptcy cases. Part V discusses the implications of the Ninth Circuit's Penrod decision and its progeny for fee-shifting in bankruptcy. Part VI proposes a generalized discretion in the bankruptcy court to shift prevailing party attorney fees as an appropriate corrective. Interestingly, the United Kingdom, starting from the tradition of the English Rule, has created a discretionary fee-shifting regime applicable to insolvency cases that mirrors the discretionary approach advocated here. The realities of insolvency practice are impelling both systems toward a court-supervised discretionary fee-shifting regime notwithstanding their disparate starting assumptions. A brief conclusion follows.

2. ANALYSES OF THE ENGLISH AND AMERICAN RULES IN CIVIL LITIGATION

   At the simplest conceptual level, the choice between the English and American Rules comes down to a tradeoff between providing greater incentive to assert weak claims, especially ones that carry a potential for large damages, and greater incentive to assert meritorious claims, especially small-dollar ones. (2) The English Rule in theory deters the holder of a long-shot claim because in the likely event the claim fails, the losing litigant incurs an additional financial penalty: responsibility for its adversary's legal fees. The American Rule deters the holder of all relatively small-dollar claims, (3) regardless of merit, because even if the claimant prevails the net value of the claim will be diminished by the amount of the attorney's fees incurred to win the case. (4) In addition, it is generally agreed that at the margins the English Rule tends to increase legal costs in the aggregate because of the litigants' optimism bias. (5) Cases go to trial because the plaintiff's assessment of the likelihood of success exceeds the defendant's assessment of the likelihood of the plaintiff's success. The English Rule makes it harder to settle cases because each side over-discounts the risk that by going to trial it will end up having to pay both sets of lawyers. Litigant optimism tends to both increase the plaintiff's settlement demand and decrease the defendant's offer. Fewer settlements of meritorious claims drives up the aggregate cost of resolving them. The English Rule may also drive up legal fees because clients have less incentive to constrain them, believing that the cost will be shifted to their adversaries. (6)

   The English Rule is thus thought to decrease the burden of resolving weak claims (by deterring their prosecution) and to increase the burden of resolving meritorious claims (by encouraging their prosecution, raising their legal costs, and deterring their settlement). (7) At least that is what theory, as a first approximation, predicts. Most of the world, in considering that balance, has chosen the English Rule, opting to conserve judicial resources in respect of likely meritless claims, and concentrate them on the just resolution of likely meritorious claims. (8)

   To the extent that United States jurisdictions continue to cling to the American Rule, (9) they implicitly place a premium on providing access to the judicial system for large dollar claims over smaller ones, and encouraging settlement over trial. In addition, in many contexts, defendants are significantly less likely to be able to successfully collect shifted fees from plaintiffs than vice-versa, because plaintiffs as a class tend to be impecunious. (10) In those situations, the English Rule may do little to deter weak claims and may operate only to increase the cost of resolving meritorious ones. In such contexts, the American Rule may have a decisive advantage over the English Rule. Finally, in light of the "moral hazard" associated with fee-shifting (clients who expect their adversaries to bear their legal costs have less incentive to contain them to a reasonable amount), successful implementation of the English Rule is generally thought to require either legislative or administrative regulation of legal fees or court supervision of their reasonableness. The English Rule therefore implies that the system will have to bear the burden of these administrative costs. (11)

   The net result of the theoretical examination of the policy advantages and disadvantages of the English and American Rules is, accordingly, indeterminate. (12) The practical answer to the question of when it makes sense to fee-shift is "sometimes depending on the circumstances." And just as the American Rule applies to only a small subset of cases in the United States, jurisdictions in the rest of world, while purporting to adopt the English Rule, in fact fee-shift only to a limited extent and in some circumstances. (13)

   The policy implications of fee-shifting have been explored empirically in three places. These empirical studies reach conclusions broadly consistent with the summary above but also suggest the predicted effects of moving from the American Rule to the English Rule are muted in practice, only marginally affecting filing rates, settlement behavior, and litigation cost. The first place is Alaska, unique among United States jurisdictions in adopting the English Rule as a general default. Alaska's fee-shifting practices have been explored empirically in connection with reform efforts. Second, Florida undertook a much studied experiment with the English Rule in the 1980s in the context of medical malpractice litigation. Finally, Professors Eisenberg and Miller studied the incidence of prevailing party fee-shifting in significant commercial contracts filed with the Securities and Exchange Commission by reporting public companies. I summarize below what we have learned from...