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Fifth Circuit Sets Out a Prospective Standard for Compensation in Bankruptcy Cases

By: Chris Lindstrom

For years, attorneys, accountants, and other professionals retained to represent bankruptcy debtors or trustees were required to show that their work “resulted in an identifiable, tangible, and material benefit to the bankruptcy estate” if they wanted to be paid for their work.  In the case, In re Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998), the Fifth Circuit set out what was a standard that required professionals to do the work and then hope that it “resulted” in something the bankruptcy court would deem of “material benefit.”  The Pro-Snax decision caused angst for all those representing debtors and trustees, that they may end up working without compensation if they were not successful. 

However, in the case In re Woerner, No. 13–50075, 2015 WL 1591143 (5th Cir. April 9, 2015).    the Fifth Circuit unanimously reversed Pro-Snax and set out new guidelines for the compensation of professionals working for bankruptcy debtors. The new less-draconian standard is whether the work was “reasonably likely to benefit the estate” at the time it was done by the professional.

In Woerner, the debtor’s attorney spent almost a year developing a Chapter 11 reorganization plan.  However, the case was eventually converted to a Chapter 7 liquidation, so the reorganization plan was not needed.  The bankruptcy court and district court reduced the attorney’s requested fee by 85% based on the Pro-Snax standard because the work did not “result in” a material benefit.  Because the Chapter 11 reorganization plan was ultimately unsuccessful and the case had to be converted to Chapter 7, the law firm’s work was deemed to be of “no material benefit” to the debtor.  

The law firm appealed the decision, asking the Fifth Circuit to overturn its previous ruling in Pro-Snax.   The firm argued that the Fifth Circuit was the only court that analyzed the 1994 changes to the bankruptcy code and found the “resulted in” standard was appropriate.  The Second, Third, and Ninth Circuits all had held that the amended code provisions did not support that type of “hindsight” analysis.  Rather, a “prospective” view was appropriate.

The Fifth Circuit agreed, and reversed the district court and its own ruling in Pro-Snax.  The Court focused its opinion on 11 U.S.C. § 330, which gives bankruptcy courts discretion to take into account a variety of factors to determine whether the services rendered were “beneficial at the time at which the service was rendered toward the completion of, a case under this title.” 11 U.S.C. § 330(a)(3)(C).   Of particular importance to the Fifth Circuit was the language “at the time at which the service was rendered.”   

The Court explained that both the text and legislative history of 11 U.S.C. § 330 showed that a “prospective” standard, rather than a “hindsight” standard was appropriate.  If a fee applicant establishes that its services were “necessary to the administration” of a bankruptcy case or “reasonably likely to benefit” the bankruptcy estate “at the time at which [they were] rendered,” then the court should grant the payment of those fees.

Finally, the Court pointed out that in assessing the likelihood that legal services would benefit the estate, courts adhering to a prospective standard ordinarily consider, among other factors, (i) the probability of success at the time the services were rendered, (ii) the reasonable costs of pursuing the action, (iii) what services a reasonable professional would have performed in the same circumstances, (iv) whether the professionals services could have been rendered by the trustee and their staff, and (v) any potential benefits to the estate.

Under Pro-Snax, whether the services were ultimately successful was dispositive of the issue of compensation for professional fees.  After Woerner, whether the services were ultimately successful is now only one factor to look at in considering the “value” of those services when they were rendered.  

This new standard will have far reaching effects for attorneys, accountants and others working for debtors or trustees.  It will allow those professionals to better use their reasonable professional judgment without the fear of their hard work being unwillingly turned to pro bono because they were not successful.