Recent Updates on Reimbursing Creditors' Legal Fees Under a Chapter 11 Plan

by BakerHostetler

Unsecured creditors in chapter 11 cases face the prospect of two financial blows: the possibility of not receiving full payment of their claims and the cost of attorney's fees for defending their interests. But these creditors may be able to take comfort in a small but growing trend -- the ability to have the attorney's fees paid from the debtor's assets under the debtor's chapter 11 plan. This outcome occurs in only a small number of cases, and unsecured creditors would be advised to not assume their attorney's fees will be reimbursed by the debtor. But this trend, which was recently validated by a judge overseeing former Wall Street powerhouse Lehman Brother's bankruptcy, is developing credibility and may be an option for creditors to pursue under the right circumstances.

The general rule is that unsecured creditors are responsible for paying their own attorney's fees in chapter 11 cases. If a committee of unsecured creditors is appointed, the attorney representing the committee is paid by the debtor's bankruptcy estate, but individual creditors -- including members of the committee -- generally must pay their own legal bills for work done on behalf of that creditor. The Bankruptcy Code spells out an exception to this general rule, but that exception is fairly narrow: if a creditor can show that its actions constituted a "substantial contribution," to the debtor's reorganization, as detailed by Section 503(b)(3)(D) of the Bankruptcy Code, the creditor can apply for reimbursement of its attorney's fees. The "substantial contribution" standard is a somewhat high hurdle to clear, and is not often employed.

Earlier this year, however, Judge James M. Peck of the U.S. Bankruptcy Court for the Southern District of New York issued an opinion in Lehman Brothers Holdings Inc. ruling that an individual creditor's legal fees can be reimbursed so long as the chapter 11 plan includes a provision allowing for reimbursement. According to Judge Peck's decision, a chapter 11 plan provision reimbursing unsecured creditors' legal fees without a showing of "substantial contribution" does not violate any section of the Bankruptcy Code.

In addition to reimbursing fees for a "substantial contribution," the Bankruptcy Code details a limited number of creditors' expenses that qualify for reimbursement by the debtor's estate. Even though the Code does not explicitly allow for reimbursement of creditors' legal fees other than those that meet the "substantial contribution" standard, the Code does not explicitly prohibit this kind of reimbursement. What's more, the Code includes another provision that allows a chapter 11 plan to "include any other appropriate provisions not inconsistent with the applicable provisions of [the Bankruptcy Code]." Judge Peck characterized this section as a "green light" affording parties involved in plan negotiations "a great deal of flexibility" to craft a plan, so long as the plan does not otherwise violate the Code.

Judge Peck's Lehman Brothers decision is in line with a 2010 decision issued in Adelphia Communications' chapter 11 case that also held that a chapter 11 plan can call for reimbursing creditors' legal fees even if the creditor did not make a "substantial contribution" so long as the fees are "reasonable." Other courts have also approved plans with these kinds of provisions.

But these decisions do not necessarily mean creditors should assume their legal fees will be reimbursed. Judge Peck noted in Lehman Brothers that such fees can be reimbursed, but that reimbursement is not required. Additionally, the decision noted that these kinds of reimbursement provisions should be reserved for "those special occasions of exceptional justification" such as in Lehman Brothers, an incredibly complex case where creditors overwhelmingly supported the plan. Finally, Judge Peck's decision is currently being challenged on appeal by the U.S. Trustee. The U.S. Trustee is essentially arguing that there are very specific provisions that allow for reimbursement of expenses under the Bankruptcy Code, and because those provisions have not been satisfied, professionals should not be paid under an "alternative" procedure.

Though not a guarantee that all efforts at reimbursement will be successful, this emerging trend is one to watch and may be an avenue for creditors to consider pursuing.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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