Reproduced with permission from BNA’s Bankruptcy Law Reporter, 29 BBLR 116, 1/26/17. Copyright 2017 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
In the Relativity Media Chapter 11 case in the Southern District of New York, Bankruptcy Judge Michael E. Wiles definitively shot down challenges brought by the fee examiner Robert Keach and Relativity Secured Lender LLC (together with the reorganized debtor, "RSL") to transaction fees earned by Houlihan Lokey Capital, Inc. and PJT Partners. Judge Wiles opined that not only did the fee examiner not have the power he thought he had to challenge the transaction fees earned by Houlihan Lokey and PJT in accordance with their retention by the debtors under Section 328 of the Bankruptcy Code, but he also called into question the efficacy of the so-called "Blackstone Protocol," which affords Section 330 "reasonableness" review to the Office of the United States Trustee. Bench Decision Regarding Objections to Final Fee Applications of PJT Partners L.P. and Houlihan Lokey Capital Inc., In re Relativity Fashion, LLC, et al., 2016 BL 419222, No. 15-11989 (MEW) (Bankr. S.D.N.Y. Dec. 16, 2016) [ECF No. 2194] (Op.).
On September 21, 2015, the bankruptcy court approved
PJT’s retention under Section 328, nunc pro
tunc to the petition date. On February 2, 2016, the bankruptcy
court entered an order approving Houlihan
Lokey’s retention under Section 328, nunc pro tunc to
November 25, 2015. Both retention orders provided that
"[t]he United States Trustee (...) retain[s] all rights to
respond or object to (...) expenses on all grounds, including,
but not limited to, reasonableness pursuant to
section 330." Houlihan Lokey’s order also granted this
right to the official committee of unsecured creditors by
agreement of the parties.
At the suggestion of the plan sponsor, on April 5,
2016, Judge Wiles entered an order appointing the fee
examiner, although he noted at the hearing that in doing
so, he did not intend to change the standards that
would govern the review and approval of any of the professionals’
fees. Accordingly, the court did not "so order"
the stipulation appointing the fee examiner and instead
entered a separate order reiterating the foregoing
caveat and declining to make the fee examiner an officer
of the court. The fee examiner subsequently contacted
Houlihan Lokey and PJT to request additional
detail regarding their work in the Chapter 11 case.
Houlihan Lokey and PJT provided the fee examiner
with extensive and detailed documentation supporting
their work. Nevertheless, the fee examiner filed objections
to their final fee applications arguing that Houlihan
Lokey and PJT should each be deprived of their entire
transaction fee because they could not satisfy the
"reasonableness" requirements of Section 330 by demonstrating
a clear "nexus" between the work they performed
and the Debtors’ restructuring. (RSL objected to
Houlihan Lokey’s and PJT’s transaction fees on the
same grounds as the fee examiner. The court found that
they did not have standing to bring those challenges.)
After a hearing held on December 8, 2016, Judge
Wiles roundly rejected the challenges to the transaction
fees earned by Houlihan Lokey and PJT. In doing so, he
distinguished between retention standards under Section
328 and Section 330 of the Bankruptcy Code, eloquently
articulated the justification for treating negotiated
transaction fees as an ordinary and important
piece of investment bankers’ compensation, and described
the history - and questioned the legitimacy - of
the so-called Blackstone Protocol. He also brought to
bear his own observations and experiences, including
his "own sense of the results that were achieved and the
role of the professionals in achieving [them]." Op. at 3.
First, the Court distinguished the standards that apply
to Section 328 retention and Section 330 retention.
Section 328 of the Bankruptcy Code is a prospective
analysis in which a determination of reasonableness is
made at the time of retention based upon the available
information and there is no opportunity to revisit that
determination unless it proves "improvident." "Reasonableness
is judged in advance, and the issue is not revisited
except in the very narrow circumstances permitted
by the statue." Op. at 4.
Section 330 retention, on the other hand, approves
reasonableness, "to some extent (...) after-the-fact" and
enables the court to review "all ‘relevant’ factors, including
time spent, rates charged, whether services
were necessary or beneficial at the time such services
were rendered, whether the services were performed in
a reasonable amount of time, and whether the compensation
is reasonable based on a customary compensation
charged by comparably skilled practitioners in
nonbankruptcy cases. 11 U.S.C. § 330(a)(3)(A-F)." Id.
Citing Donaldson Lufkin & Jenrette Securities Corp.
v. National Gypsum Co. (In re National Gypsum Co.),
123 F.3d 861 (5th Cir. 1997), Judge Wiles went on to explain
that "[s]ection 328(a) reflects the view that professionals
are entitled to know what they are likely to be
paid for their work." Op. at 4-5. Parties retained on a
flat-fee or percentage-fee basis under Section 328
should have "some comfort that the [negotiated] compensation
will be paid and that a court will not simply
impose a new and different deal after all the work has
been done." Id. at 5.
Second, the court clarified some misconceptions "regarding
investment banker compensation in general,
and in particular about so-called transaction fees, because
there is often a lot of confusion about just what
they represent." Id. Noting that "[i]nvestment bankers’
main compensation is through transaction fees" both in
and out of bankruptcy, the court wrote to address "a
problem of labels that are loosely applied." Id. at 6. The
court emphatically distinguished the cases in which a
party was seeking "a discretionary fee enhancement or
success fee which is equivalent to a bonus" from "cases
in which ordinary transaction fees are sought. Transaction
fees are part of the standard, negotiated, base
compensation for the investment banker." Id. at 7 (emphasis
added). Cases like In re Residential Capital, LLC
and In re Northwest Airlines (which were relied upon
by the objectors) "address requests for extra compensation,
beyond what is provided for in the retention agreement,
[and] really deal with entirely different matters."
Op. at 7 (discussing In re Residential Capital, LLC.
2014 BL 32411, 504 B.R. 358, 366 (Bankr. S.D.N.Y.
2014), and In re Northwest Airlines, 2009 BL 24155, 400
B.R. 393, 400 (Bankr. S.D.N.Y. 2009)). In no uncertain
terms, the court stated that "the transaction fee is not a
bonus, and there is no reason why allowance of the
transaction fee should be subject to the same standards
as a request for payment of a bonus." Id. at 8 (emphasis
added). The court further rejected as "wrong" the
suggestion that an investment banker cannot be paid its
transaction fee "unless it makes the same showing that
a professional would have to make in order to receive a
discretionary extra-contractual bonus." Id. Thus,
"[c]ourts that consider applications for the payment of
transaction fees should not be confused by the labels
that people apply and should instead look at exactly
what compensation is sought and the terms under
which it is being sought." Id. at 8-9. The court also rejected
"this same misunderstanding" in the context of
attempting to calculate an investment banker’s compensation
based on inferred hourly rates from monthly
fees alone. Id. at 9.
Third, the court offered some history and commentary
on the so-called Blackstone Protocol because the
fee examiner relied on it heavily in his objection. Id.
The Blackstone Protocol developed as a "negotiated
truce" between investment banks and the Office of the
U.S. Trustee for the Southern District of New York. In
effect, the Blackstone Protocol "creates a hybrid situation"
in which Section 330 "reasonableness" standards
apply only to an objection made by the U.S. Trustee;
others are bound by Section 328(a)’s "improvident"
standard. Id. at 11.
However, "it is not at all clear that Congress contemplated
this kind of hybrid approach." Id. In Judge
Wiles’s view, Section 328 approval and Section 330 approval
cannot co-exist, as such a scenario "would completely
undermine Section 328(a)." Id. at 12. "A court
cannot after-the-fact change the standards that apply to
objections filed by other parties (...) Once the arrangement
is approved and becomes part of the approved
terms of employment, it is locked in." Id. (discussing
Riker, Danzig, Scherer, Hyland & Perretti v. Official
Committee of Unsecured Creditors (In re Smart World
Techs., LLC). 2009 BL 1076, 552 F.3d 228 (2d Cir. 2009)
(emphasis added). Thus, "[e]xactly what it means for
the United States Trustee to reserve rights to object under
Section 330 is, frankly, not clear." Op. at 12.
Turning to the fee applications at issue, the court rejected
the fee examiner’s view that he had succeeded to
the U.S. Trustee’s right to review the reasonableness of
the investment bankers’ fees under Section 330, which
was contained in the Section 328(a) retention orders.
Id. at 15. First, the court noted that it had specifically
declined to so-order the stipulation among the debtors,
the official committee of unsecured creditors and the
United States Trustee appointing the fee examiner and
had instead added a paragraph to a separate order stating
that the stipulation would not change the standard
of review to which the professionals previously were
subject. Id. In the court’s view, granting additional
rights of review to parties other than the U.S. Trustee
impermissibly would change the standard of review. Id.
Second, it would not be fair to the investment bankers
to allow the fee examiner to assume this mantle pursuant
to a stipulation to which neither banker was a party.
Id. at 16. In sum, under the terms of Section 328(a) and
Smart World, the court believed it "had no power to
give anyone else the right to assert objections based on
Section 330 standards. Doing so, in effect, would have
changed the retention from a Section 328(a) standard to
a Section 330(a) standard, which Smart World
The fee examiner and RSL conceded at the hearing
that if the Section 328 standard applies, there would be
"no issue" with Houlihan Lokey’s transaction fee. Id. at
18. With respect to PJT, however, the objectors contended
that even if Section 328 applies, there remained
a question whether PJT had met the terms of its approved
retention agreement that would entitle it to a
transaction fee. Id. The court ultimately found that PJT
had met the terms of its agreement and was contractually
entitled to its transaction fee. Id. at 18-21.
The recent Relativity decision provides important
and well-reasoned clarification in the area of professional
retention and compensation. It ameliorates a persistent
"problem of labels," eliminates the misconception
that a negotiated transaction fee is a success fee or
a bonus and emphasizes that transaction fees are in fact
commonplace and "standard" in investment banker
compensation. Judge Wiles’s position with respect to
the continuing viability of the "hybrid" Blackstone Protocol
is also noteworthy. It will be interesting to see this
decision put into practice in the new year.
NOTE: The authors successfully defended Houlihan
Lokey Capital, Inc. in the subject litigation.