Stephen J. Lubben, the Chapter 11 Financial Advisors

• Jurisdiction: United States,Federal
• Publication year: 2011
• Citation: Vol. 28 No. 1

THE CHAPTER 11 FINANCIAL ADVISORS

Stephen J. Lubben*

It has been observed that large chapter 11 cases have become increasingly “professionalized.”1 In particular, while debtor’s counsel might once have handled the bulk of the reorganization, the debtor now routinely retains specialized professionals to address specific aspects of its case.2

Among the most controversial of these non-legal professionals have been the financial advisors, as they often earn transaction fees based on either the sale or reorganization of the debtor.3 Financial advisors are typically compensated with a combination of flat monthly fees and outcome-contingent

transactional fees, and thus fit uneasily into the chapter 11 system, which is largely dominated by lawyers and former lawyers acting as judges, both of whom are most accustomed to billing hourly rates plus expenses.4 And then, of course, the most vocal commentators on professional fees are also lawyers, in the form of law professors.5

* Daniel J. Moore Professor of Law, Seton Hall University School of Law. This paper is based on my dissertation prepared for the Ph.D. program at the University of Groningen, Department of Law and Economics, which is in turn based in part on data gathered by the author as part of the ABI Chapter 11 Professional Fee Study, funded by a grant from the American Bankruptcy Institute, the ABI Endowment Fund, and the National Conference of Bankruptcy Judges. I am grateful for the ABI and NCBJ’s assistance with this project. All conclusions are my own and do not necessarily reflect the views of the ABI, the NCBJ, or their members.

1. See Jo Ann Brighton et al., For Better or Worse: Chapter 11 in the Post-BAPCPA Downturn, 7

   DEPAUL BUS. & COM. L.J. 555, 578–79 (2009).

2. Id.

3. See, e.g., In re Hillsborough Holdings Corp., 125 B.R. 837 (Bankr. M.D. Fla. 1991) (disapproving interim fee applications submitted by Bear Sterns Co., Inc., the Committee’s financial advisor); Linda Sandler, Lehman Pays Its Bankruptcy Advisers $262.6 Million for 9 Months, BLOOMBERG, July 9, 2009, 12:01 AM, http://www.bloomberg.com/apps/news?pid=20601087&sid=apzbxu6eOxik (describing the lucrative fees paid to the financial advisors of Lehman Brothers Holdings, Inc.).

4. Michael L. Cook & Stephen J. Lubben, Retention, Payment, Ethical and Other Obstacles for Non- Legal Professionals in Chapter 11 Reorganizations, in ETHICS IN CONTEXT, at 175, 181–82 (PLI N.Y. Practice Skills, Course Handbook Ser. No. 66, 1999) (“Courts throughout the country differ in their views of non-legal professionals. Retention arrangements that are routinely approved in Manhattan and Wilmington may be met with skepticism, if not outright hostility, in Los Angeles, Denver, or Tampa.”).

5. See, e.g., LYNN M. LOPUCKI & JOSEPH W. DOHERTY, PROFESSIONAL FEES IN CORPORATE

   BANKRUPTCIES: DATA, ANALYSIS, AND EVALUATION 120 (2011) (“Financial advisors often do a substantial portion of their work prior to the filing of the petition. In some instances, they seek payment for that work after the filing of the petition. That practice is improper, both because the estate has no right or obligation to pay

   It may be that attorneys are poor observers of other professionals’ fee structures and general business practices. But given the increasing importance of financial advisors in chapter 11 and other reorganization schemes, the need for some evidence of how these advisors influence chapter 11 costs is increasing as well.

   
   

   This short Article begins the discussion by considering a sample of financial advisors involved in chapter 11 cases filed in 2004. Part I of the Article describes the dataset and the types of financial advisors that routinely appear in chapter 11 cases. Part II provides some basic descriptive statistics regarding these financial advisors, and it also provides a brief discussion of the types of professionals that routinely appear in chapter 11 cases beyond bankruptcy counsel. Among other things, Part II shows that financial advisors, although receiving much attention and criticism, actually cost slightly less, on average, than the debtor’s bankruptcy attorneys.

   
   

   Part III then models the costs of financial advisors. In this Part, I find that cost increases if both the debtor and the committee retain financial advisors. Costs also increase with the contentiousness of the case, which I suggest reflects a tendency to focus on the large, lump-sum fees earned by financial advisors in such cases.

   
   

   Part IV of the Article then turns to look at the specific issue of debtor- retained financial advisors, as they make up the bulk of financial advisor cost in chapter 11.6 Here, the most interesting finding is that the size of the debtor matters, whereas it does not seem to matter when financial advisors are

   considered in the aggregate. This again suggests the importance of a finer understanding of the workings of financial advisors and what they actually “do.”

   
   

   Part V of the Article wraps up by considering the legal and policy implications of these findings. In particular, I note how poorly the Bankruptcy Code, as drafted in 1978, is suited to the types of compensation structures that financial advisors and turnaround consultants typically receive. Looking specifically at § 328(a), I argue that it may be time to revamp large parts of the Code to reflect the reality of modern chapter 11 practice.

   
   

   pre-petition unsecured debt and because the court can award compensation only to ‘a professional employed under [§] 327.’” (footnote omitted)).

6. See infra Table 3.

   1. THE DATASET

      
      

      I begin with the dataset I collected for the American Bankruptcy Institute’s (ABI) Chapter 11 Fee Study.7 This dataset includes cases that were originally filed in 2004, and the data within each case comes from publicly available court filings that were primarily collected from Public Access to Court Electronic Records (PACER).8

      
      

      The dataset is non-random, comprising of nearly all 2004 bankruptcy cases listed in the “Major Bankruptcies” database on BankruptcyData.com.9 Excluded from the dataset are all cases initially filed under chapter 7 and never converted to chapter 11, along with all cases filed under former § 304 of the Bankruptcy Code.10

      
      

      Two broad types of professional fee data were collected: debtor professional expenses and committee professional expenses. In particular, under § 330 of the Bankruptcy Code and under Federal Rule of Bankruptcy Procedure 2016, all professionals retained by either the debtor or an official committee (most often a creditors’ committee) must file fee applications with

      the court before they can be paid from estate funds.11 A similar rule applies to

      professionals retained by examiners or trustees,12 and the datasets also include

      
      

7. The American Bankruptcy Institute’s Chapter 11 Fee Study is available online. Stephen J. Lubben, ABI Chapter 11 Fee Study (Seton Hall Pub. Law Research Paper No. 1020477, 2007), available at http://ssrn. com/abstract=1020477. The study is extensively discussed in Stephen J. Lubben, Corporate Reorganization & Professional Fees, 82 AM. BANKR. L.J. 77 (2008) [hereinafter Lubben, Corporate Reorganization].

8. PACER is available at http://pacer.psc.uscourts.gov/. For more on conducting empirical research of

   bankruptcy cases through PACER, see Jay Lawrence Westbrook, Empirical Research in Consumer Bankruptcy, 80 TEX. L. REV. 2123, 2148 (2002).

9. New Generation Research, Bankruptcy Search, BANKRUPTCYDATA.COM, www.bankruptcydata.com/

   findabrtop.asp (last visited Aug. 12, 2011).

10. See 11 U.S.C. § 304 (2000), repealed by Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, § 802(d)(3), 119 Stat. 23, 146. Section 304 was repealed in 2005 as part of the enactment of the new chapter 15. See Jay Lawrence Westbrook, Chapter 15 at Last, 79 AM. BANKR. L.J. 713, 718–20 (2005). Both § 304 and the new chapter 15 deal with the recognition of foreign bankruptcy proceedings in the United States. See generally id.

11. 11 U.S.C. § 330(a)(1) (2006) (permitting a bankruptcy court to compensate professionals who have

    previously been retained by the estate); FED. R. BANKR. P. 2016(a) (“An entity seeking interim or final compensation for services, or reimbursement of necessary expenses, from the estate shall file an application setting forth a detailed statement of (1) the services rendered, time expended and expenses incurred, and (2) the amounts requested.”).

12. 11 U.S.C. § 330(a)(1) (permitting fees for a professional person employed by a trustee subject to

    § 327). The Code does not expressly provide for an examiner to retain professionals, but courts have typically assumed they have such powers. 7 COLLIER ON BANKRUPTCY ¶ 1106.05[3] (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2011); see also In re Mirant Corp., 354 B.R. 113, 147–48 (Bankr. N.D. Tex. 2006); In re Southmark Corp., 113 B.R. 280, 281–82 (Bankr. N.D. Tex. 1990).

    that information. Bankruptcy-related professional fees incurred in the days just before the bankruptcy filing are reported on the debtor’s statement of financial affairs and thus are also included in the dataset. Professional fees incurred by creditors who have a contractual right to charge such fees to the debtor—such as secured lenders—are not included in the dataset, inasmuch as these sorts of reimbursement obligations are not subject to § 330 and are therefore not

    subject to express disclosure.13

    
    

    The present study modifies the original ABI dataset in several key respects. For example, in the original study, each case was followed for two years or until it ceased to be in chapter 11 because either a plan was confirmed, the case was converted to chapter 7, or the case was dismissed.14 I took this approach

    with the data due to the required timeline for producing the final report for the ABI Chapter 11 Fee Study.

    
    

    To examine whether this censoring had any effect on the data, I revisited the cases that were still pending in chapter 11 when the original study was completed and re-coded them to include their final resolution and all professional expenses...