BANKRUPTCY AND BILLABLES

Let’s replace a recent Am Law Daily headline — “Judge Slashes Fees in Dewey Bankruptcy” — with this: “Golden Age for Bankruptcy Professionals Continues.”

In bankruptcy proceedings, lawyers get paid ahead of everyone else. If they didn’t, insolvent debtors would go without representation. But that doesn’t explain why high-profile bankruptcies have become increasingly lucrative for lawyers. An absence of accountability does.

Professional compensation in bankruptcy matters comes from a dying entity’s estate. As the client disappears, so does close scrutiny of its legal bills. In its place, the United States Trustee reviews bankruptcy fee petitions, as does the supervising judge who eventually approves them. But both offices have limited capabilities and a restrictive mandate.

Low-hanging fruit

The limited capabilities arise from an understandable reluctance to second-guess lawyers’ strategies and, more importantly, the deployment of manpower to execute them. As a result, post-facto review of fee petitions usually focuses on obvious abuses.

For example, at the recent Dewey & LeBoeuf fee hearing, Judge Martin Glenn criticized $550 per night stays at the Waldorf-Astoria, private car expenses for driving around Manhattan, and excessively vague time entries. But the sanctions were minimal. According to the article, the court reduced a restructuring expert’s $250,000 request by “$4,455 in fees and $9,175 in expenses in addition to the amount Glenn axed [$4,400] during the hearing.”

Dewey’s lead bankruptcy attorney, Al Togut, wasn’t in court for a tongue-lashing over certain of his firm’s “excessively vague time entries” and “a page of expenses related to car rides,” according to the Am Law Daily. But at the end of the day, Togut, Segal & Segal’s $4.7 million bill for five months of work emerged largely unscathed, save for “$57,139 in fee cuts and $1,378 in expense cuts after consultation with the U.S. Trustee’s office, which had objections to several of the fee requests.”

The real money

The real story isn’t unique to Dewey’s professionals. In fact, small boutique firms such as Togut’s probably conduct their cases more efficiently than big firms that can throw armies of bodies at any problem. But all such attorneys benefit from extraordinarily high hourly rates that result from the absence of a competitive market and the perverse incentives of a billable hour regime.

That’s where the restrictive legal standard for approval enters the picture. In particular, the fees sought must be reasonable for the services rendered. However, law firms in the select club of prominent bankruptcy practitioners use publicly available information, including other firms’ fee petitions, to set hourly rates for their own personnel. Voila! The relative uniformity of such rates makes them “reasonable” — including the $700 an hour associate and the $300 an hour legal assistant.

The key players in this tautological circle don’t compete on hourly rates. What economists call conscious parallelism is far more lucrative for them. Because there’s no paying client searching for better value in response to rising legal costs, that potential market-driven constraint disappears. When Weil Gotshal submitted a $430 million fee petition for the Lehman bankruptcy, it listed 40 partners with hourly rates of $1,000 and some senior associates at $800 to $900 an hour.

The market gone awry

Defenders argue that complicated restructuring matters require talent and skill comparable to trying a big case or guiding a large transaction. After all, in 1978 Congress specifically made that determination in adopting a new compensation standard for bankruptcy lawyers. Today, they say, the market sets everybody’s rates. That position would be more compelling if hourly rates for bankruptcy attorneys were the result of a well-functioning market, but they aren’t.

If big law firms already competed on price in bankruptcy cases, they wouldn’t fear the transparency that the U.S. Trustee proposed last summer. The Trustee wanted firms to disclose whether they use a differential fee schedule — charging one rate for attorneys working on bankruptcy cases and a lower rate for the same attorneys working on other matters. More than 100 big firms united in strenuous opposition to that idea.

It’s easy to see why they objected. Especially in recent years, paying clients have demanded discounts and alternative fee arrangements to reduce legal costs. In bankruptcy, it’s not happening. Where else can firms charge more than $400 an hour for first-year associates, which Weil Gotshal sought for many such newbies in the Lehman case?

Add incentives for inefficiency and abuse that accompany the billable hour regime generally and the consequences become even more ironic: one of the most lucrative pockets of the profession reaps outsized rewards from the carcasses of distressed enterprises (and those enterprises’ creditors).

The entire system is uniquely vulnerable to creative innovation. Someday, it will arrive. But then again, for those currently reaping the greatest rewards, someday always seems to be somebody else’s problem.

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