The Case for Bankruptcy Court Discretion to Shift Attorney’s Fees

By | August 16, 2021

My recent paperFee-Shifting in Bankruptcy, examines the circumstances under which courts permit and refuse parties’ recovery of bankruptcy-related attorneys’ fees as costs. It turns out that, in bankruptcy, most of the major parties are not bearing their own attorney’s fees. In this context, it is fatuous to treat the American Rule as a basic point of reference for allocating attorney fees among the parties in bankruptcy. Fee-shifting is pervasive; the bankruptcy court and US Trustee are directly involved in reviewing the fees; sometimes it is almost impossible to figure out who is actually footing the bills. Neither the American Rule nor the English Rule is the baseline or background principle in insolvency cases. This is as true today in US courts, which still generally purport to adhere to the “American Rule” as their baseline, as it is in the United Kingdom, which, of course, generally purports to follow the “English Rule.” And it is also true historically in both countries where equitable principles, born in the ancient chancery courts that once administered insolvency cases, permitted appropriate discretionary fee shifting in light of the collective nature of insolvency proceedings.

            Unfortunately, we also observe that in occasionally clinging to the American Rule, some US courts, including the US Supreme Court, have unnecessarily created perverse incentives that disrupt the efficient functioning of the reorganization process. Two leading examples are the Supreme Court’s decisions in Baker & Botts and Midland Funding, both critiqued in Fee-Shifting in Bankruptcy along with other cases.

            Abandoning the American Rule and authorizing a discretionary version of the English Rule as the default rule in bankruptcy for recovery of attorneys’ fees is no radical step. Empirical work is limited, but in general supports the conclusion that shifts between the American Rule and various versions of the English Rule will have only a modest impact. In bankruptcy cases, there is already now, and always has been, an enormous amount of explicit and implicit fee shifting. The bankruptcy courts have a well-developed set of procedures for regulating and allowing reasonable attorneys’ fees. Their control over fee allowances is an important constraint on those employing bullying and hold-out tactics calculated to confer leverage in bankruptcy negotiations by pressing weak claims and imposing costs on adversaries. And the bankruptcy courts, in adjudicating the matters before them, are well-positioned to exercise sound discretion in the award of attorney’s fees calculated to control such behavior when the claims and objections being pressed are meritless. We can identify a series of factors that will cabin the exercise of the court’s discretion in an appropriate way designed to advance sound administration of bankruptcy cases and equitable considerations that have long been recognized. All the examples of fee-shifting regimes that we observe suggest courts will exercise discretion under a modified English Rule cautiously.

            Accordingly, the central issue concerning recovery of attorneys’ fees in insolvency cases is not the selection of a default rule. The proper default rule is that the bankruptcy court should decide when and to what extent attorneys’ fees should be recovered and from whom. The challenge is to identify the factors relevant to fee shifting in bankruptcy litigation that should inform this exercise of discretion. In moving toward full-throated acceptance of a discretionary fee-shifting regime, the following list of fifteen factors is a starting place:

1. Whether the prevailing party or its adversary has a right to recover fees in non-bankruptcy litigation over the same issues.

2. Whether the bankruptcy code itself expressly provides for recovery of attorney’s fees as part of the party’s damages.

3. The amount of the fees sought to be shifted and whether the litigation is cost justified in light of the stakes.

4. How close the case was on the merits as to the issues upon which the prevailing party seeks fees. As the merits case for the prevailing party becomes stronger the case for fee-shifting does as well. The English Rule is widely thought to encourage the prosecution of meritorious claims of all sizes and the moral case for augmenting the recovery of the holder of a meritorious claim by an award of attorney’s fees increases in proportion to the strength of that claim.

5. Whether the circumstances of the case and the actions of the non-prevailing party suggest its litigation position was a tactic by which it played the part of bully, hold-out, or squeaky wheel, litigating to gain leverage to extract concessions or advantages they are not entitled to or that others similarly situated eschewed.

6. Whether a systemic asymmetry exists between the parties allowing one party to implicitly shift fees whether it prevails or not and regardless of the court’s fee award. Systemic asymmetries of this nature abound in bankruptcy. As noted in the preference discussion, litigants represented by estate professionals can effectively shift fees to the extent the estate is administratively solvent, win or lose. When such parties prevail, the case for further fee-shifting weakens. On the other hand, if the losing party can effectively fee-shift regardless of its loss the case for allowing the prevailing party to also force the estate to pay its reasonable legal fees strengthens. An asymmetry also exists in reciprocal fee shifting if one of the parties is execution proof or if the claim for recovery of the attorneys’ fees is treated as a dischargeable general unsecured claim against an insolvent bankruptcy estate.

7. Whether the prevailing party’s success in litigation will economically benefit others similarly situated to the prevailing party, or creditors generally, or other constituents interested in the bankruptcy case either by maximizing the value of the estate or altering the distribution of value in a manner that benefits creditors generally or other constituents similarly situated to the prevailing party, especially to the extent that such situations fit comfortably within the traditional common fund and substantial benefit exceptions to the American Rule.

8. Whether the public interest in equitable and efficient administration of bankruptcy cases generally will be advanced or undermined by an award of fees in these circumstances. 

9. The extent to which a given fee award may be so onerous to the non-prevailing party that it would unreasonably deter similarly situated litigants from the voluntary use of the bankruptcy courts. The threat of a fee award against an objecting party in the context of a confirmation hearing is particularly problematic on this basis. A confirmation objector will generally face an array of well-represented and well-funded parties who have closed ranks behind the plan. The expenses of the confirmation hearing are likely to be grossly disproportionate to the claim of an isolated objecting party. Moreover, the “confirmation express” dynamic may mean that even an objector with a good objection faces long-odds of prevailing at confirmation. In that context, the threat of an award of prevailing party fees may well be a bullying tactic employed by the plan proponents against the objector.

10. Vexatious and unreasonable conduct by either (or both) of the litigants in the course of the proceedings conducted before the bankruptcy.

11. The extent to which the fees incurred by the prevailing party suggest that they had been influenced by considerations apart from the case at bar because of its status as a repeat player in bankruptcy. Parties that bring litigation that would not otherwise be brought to set a precedent or build a reputation should bear the cost of doing so even if they prevail. Parties facing such a litigant may have a particularly strong equitable case for fee shifting if they defeat the repeat player.

12. The extent to which the party seeking recovery of fees practically prevailed in the litigation by comparing the result relative to the parties’ contending litigation positions. Courts administering the English Rule often struggle with determining what it means to “prevail” when the litigated result lies somewhere between the contending positions of the parties. The closer the litigated result is to the litigation position of the prevailing party the stronger the case for fee-shifting.

13. Whether the prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity. In general, the odds are stacked against natural persons and minor private parties in bankruptcy litigation. When they prevail the moral case for making them whole by an award of attorney’s fees is stronger than for major parties, bankruptcy estates, and governments that have lots of fee-shifting and loss spreading capacity, win or lose.

14. Whether the non-prevailing party is a natural person, a minor private party, a major party, the bankruptcy estate, or a governmental entity. For the same reasons noted immediately above, an award of attorneys’ fees stings less, and is less likely to deny anyone access to the court, when it is made against a major party, the bankruptcy estate, or government.

15. An assessment of whom, among the various constituencies in the bankruptcy, will practically bear the economic incidence of fees initially borne by the estate.

            Interestingly, the United Kingdom, starting from the tradition of the English Rule, has created a discretionary fee-shifting regime applicable to insolvency cases that resembles the discretionary approach advocated here. We see in the most recent UK insolvency cases under Part 26A of the Companies Act of 2006 the continuing push-pull among (i) the desire to socialize the costs of the reorganization effort that benefit third parties (ii) the concern about unduly discouraging participation by all affected constituents in that effort and (iii) the problems posed by hold-outs, bullies, and excessive litigiousness. In this respect the recent opinion of Mr. Justice Snowden in the Matter of Virgin Active Holdings Ltd is most instructive. Whether one’s legal system comes from a tradition starting with the English Rule or the American Rule, the realities of insolvency practice impel both the English and American systems towards a court-supervised discretionary fee-shifting regime in the bankruptcy arena.

            The damage being done by the American Rule in insolvency cases, though real, may be at the margins only given how pervasive fee-shifting already is in bankruptcy. Fully embracing a discretionary rule authorizing recovery of attorney’s fees by a prevailing party in the bankruptcy court, therefore, may be a modest improvement in the bankruptcy process, but it is low-hanging fruit that we should promptly gather in.

Daniel J. Bussel is a Professor of Law at the UCLA School of Law

This post is adapted from his paper, “Fee-Shifting in Bankruptcy” available on SSRN.

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