Evergreen Retainers for a Debtors Professionals A Market-driven Approach
It's a problem common to professionals who represent debtors in chapter 11 cases: how to protect against the risk of non-payment by a client already in financial distress. Certain "risk-minimization" devices, such as monthly fee orders and carve-outs from a secured creditor's collateral, are already widely used. In a series of recent decisions, bankruptcy judges in the District of Delaware have permitted debtors' professionals to hold (and not draw down) "evergreen retainers" throughout the course of chapter 11 proceedings, thereby adding another tool for professionals to reduce their financial exposure in representing chapter 11 debtors.
As discussed in detail below, bankruptcy courts have not always embraced evergreen retainers. Concerns that such an arrangement favors professionals over other administrative creditors, or imposes a burden on a debtor's post-petition cash flow, have led some courts to reject the whole notion of evergreen retainers. In re Fitzsimmons Trucking Inc., 124 B.R. 556, 558 (Bankr. D. Minn. 1991) ("Locking substantial funds into escrow for the benefit of counsel...deprives the debtor" of flexibility in meeting emergencies). In addition, it has been suggested that an evergreen retainer may encourage professionals to keep a reorganization effort alive longer than circumstances warrant because the professional is not at risk for payment. In re Cal-Inland Inc., 124 B.R. 551, 553 (Bankr. D. Minn. 1991) (denial of evergreen retainer "firmly accords with the undeniable premise that a chapter 11 case is not to be prosecuted solely, or even partially, as an instrumentality to generate work and fees for counsel").
Recent law in Delaware effectively balances these competing concerns and sets forth a framework for determining whether evergreen retainers are permissible in a particular case. At bottom, the availability of evergreen retainers, under appropriate circumstances, should benefit struggling companies by maximizing their ability to engage competent and committed professionals.
The "Reasonableness" Standard for Retention and Compensation
The Bankruptcy Code's provisions governing the compensation of professionals are found in §§328 through 331. In sum, the Code imposes a reasonableness standard to evaluate the terms and conditions of professional retentions. See 11 U.S.C. §328(a) ("the trustee...may employ...on any reasonable terms and conditions of employment"); see, also, Id., §330(a)(1)(A) ("the court may award to a trustee, an examiner, a professional person employed under §327 or 1103 reasonable compensation for actual, necessary services rendered....") (emphasis supplied).
With the published Insilco decision and the consistent ruling in CTC Communications, professionals representing debtors now have an analytical framework for proposing evergreen retainers.
Recent case law from the Third Circuit Court of Appeals makes clear that the starting point for the inquiry is the general market for legal services. See United Artists Theatre Co. v. Walton, 315 F.3d 217, 229 (3d Cir. 2003) ("reference to the market is not out of place when considering whether terms of the retention are 'reasonable' in the bankruptcy context"). Against this backdrop, Judge Kevin J. Carey1 addressed the request of a collection of the debtors' professionals in In re Insilco Technologies Inc., et al., Ch. 11 Case No. 02-13672 (KJC) (Bankr. D. Del. 2002), to hold their retainers for the duration of the case.
In re Insilco
The debtors in Insilco were manufacturers and developers of electronic components and systems for, among other things, the telecommunications market. The collapse of the telecom industry in 2001 and 2002 led the debtors to a liquidity crisis and the commencement of chapter 11 proceedings in December 2002. The debtors' bankruptcy strategy consisted of promptly conducting a series of §363 sales and, ultimately, pursuing a consensual plan of liquidation.
At the outset of the case, the U.S. Trustee objected to the retention of five debtors' professionals on the limited ground that the professionals requested authority to hold their retainers intact until the end of the case. The court approved each of the retentions early in the case, but specifically reserved judgment on the evergreen retainer issues pending a briefing and an evidentiary hearing.
In opposing the evergreen retainers, the U.S. Trustee argued that immediate draw-down of the retainers was necessary to ensure that chapter 11 professionals did not receive treatment more favorable than that accorded to other administrative creditors. See Fitzsimmons Trucking, 124 B.R. at 561 (requiring draw-down of a retainer "embodies a balancing of rights among the various constituencies which have claims against the debtor's post-petition cash and revenues"). In addition, and perhaps more significantly, the U.S. Trustee contended that the professionals in question were already sufficiently protected against the risk of non-payment by (1) a $1.8 million carve-out agreed to by the secured lenders and (2) an administrative order authorizing monthly payment of professional fees.
In response, the debtors' professionals argued that well-established precedent in the Third Circuit required an analysis of whether evergreen retainers were common in the legal market; if so, they reasoned, then the court should approve the evergreen retainers in the present case. As a practical matter, the professionals also suggested that evergreen retainers are appropriate to avoid a situation where a debtor's professionals are effectively required to finance a failing entity's reorganization efforts.
Judge Carey noted that the permissibility of an evergreen retainer was a question of first impression both in Delaware and within the Third Circuit. After observing that applicable case law required some review of what standards prevailed in the market, the court found that the "taking of evergreen retainers is a practice now common in the marketplace." In re Insilco Tech. Inc., 291 B.R. 628, 634 (Bankr. D. Del. 2003). However, because market conditions are probative but not dispositive of what is reasonable under the Code, the court articulated a series of factors to assist in that determination. Id. (citing United Artists, 315 F.3d at 230 (that certain fee arrangements are "now common in the marketplace does not automatically make them 'reasonable' under §328.")). Specifically, Judge Carey developed five factors to weigh in considering the appropriateness of evergreen retainers:
- whether terms of an engagement agreement reflect normal business terms in the marketplace;
- the relationship between the debtor and the professionals, i.e., whether the parties involved are sophisticated business entities with equal bargaining power who engaged in an arm's-length negotiation;
- whether the retention, as proposed, is in the best interests of the estate;
- whether there is creditor opposition to the retention and retainer provisions; and
- whether, given the size, circumstances and posture of the case, the amount of the retainer is itself reasonable, including whether the retainer provides the appropriate level of "risk minimization," especially in light of the existence of any other "risk-minimizing" devices, such as an administrative order and/or a carve out.
Applying these factors, Judge Carey approved the retentions with the requested evergreen retainers. In particular, the court found that evergreen retainers are indeed common and had been agreed to in Insilco as a result of arm's-length negotiations between the debtors and their professionals. Moreover, approval of the evergreen retainers would be of "great advantage to the estate" by allowing the debtors to continue to utilize their existing professionals. Id. at 35. The court also appeared to place special emphasis on the lack of creditor opposition, noting that there were no objections from "[t]he parties whose economic interests are at stake and, arguably, might be most adversely affected by the proposed terms of retention." Id.
Finally, because Insilco presented a liquidation scenario with no guarantee of available funding, the existence of the carve-out and the administrative fee order did not preclude approval of the evergreen retainers as an additional protection for the professionals. Id.; but, see In re Pan Am. Hosp. Corp., 312 B.R. 706, 712 (Bankr. S.D. Fla. 2004) (citing Insilco and approving evergreen retainer, but rejecting addition risk-minimization device of shortened fee-application period).
The last section of the Insilco opinion provides some further guidance for professionals considering evergreen retainers. At argument, the U.S. Trustee raised for the first time the issue of whether the professionals had adequately disclosed their intent to keep their retainers. While the court did not find that such notice concerns were fatal in the instant case, it did find that there was "room for improvement" in the future:
[T]he court found that evergreen retainers are indeed common and had been agreed to in Insilco as a result of arm's-length negotiations between the debtors and their professionals.
Nonetheless, the UST's position illustrates that there is a need for greater clarity in engagements the terms of which are intended to include evergreen retainers. There is also room for improvement in how disclosure of such a term can be made in an application for employment. Henceforth, if the terms of a proposed engagement include a provision for an evergreen retainer, such term should be highlighted and summarized in the application; moreover, a copy of the engagement agreement should be attached as an exhibit to the application containing language which makes it clear that the applicant intends to hold such retainer until the end of the case (or until such other time as the parties have agreed).Insilco, Id. at 636.
An Application of the Insilco Decision: In re CTC Communications Corp.
Just a month after Judge Carey's decision in Insilco, Judge Peter J. Walsh considered the identical issue of evergreen retainers for debtor's professionals in In re CTC Communications Group Inc., et al., Ch. 11 Case No. 02-12873 (PJW). As in Insilco, the U.S. Trustee in CTC Communications objected to those provisions of proposed professional retentions that provided for evergreen retainers.
After a briefing and an evidentiary hearing, Judge Walsh approved the evergreen retainers and adopted the reasoning and analysis set forth by Judge Carey in his Insilco opinion. See In re CTC Comm. Group Inc., et al., Ch. 11 Case No. 02-12873 (PJW) (Bankr. D. Del. 2002), transcript of May 22, 2003, hearing [Docket No. 752] ("I agree and adopt wholeheartedly Judge Carey's decision in the Insilco case").
Judge Walsh also observed, as an additional factor or consideration in permitting evergreen retainers, that such arrangements will actually serve to foster a productive relationship between a debtor and its professionals:
And I would add to [the Insilco factors] an additional factor, and that is that I think the evergreen retainer...has the potential for producing a very positive relationship between the professionals and particularly lawyers and the debtor. And that is that I believe the professional's advice to the client by reason of these arrangements is not influenced by a concern about the full payment of the fees being at risk. In other words, with the retainer, I think the professional, in my view, is more apt to be focused on the estate's best interest and not partially focused on that and partially focused on whether he is going to run up fees that are not going to be compensated for.Transcript of May 22, 2003, hearing at p. 43.
The court also raised a concern for professionals discussed only indirectly in InsilcoÑthe issue of whether a professional could terminate its relationship when it became clear that the estate would not be able to pay the freight. While this concern necessarily relates to the whole "risk minimization" analysis and the prospect of divergent interests for counsel and client, Judge Walsh found that counsel's inability to withdraw from the representation provides its own justification for evergreen retainers:
I can tell you from that experience that I think [the debtor's witness] is absolutely right, that withdrawing from a case is very difficult for two reasons: Number one, it's difficult to present your case to the judge and receive a sympathetic ear, and number two, youÑafter you've developed a relationship with the debtor/client, I think you feel a personal obligation to see it through to the end, and I think that with the evergreen retainer discharging that obligation is made more effective.Id. at 44.
With the published Insilco decision and the consistent ruling in CTC Communications, professionals representing debtors now have an analytical framework for proposing evergreen retainers. While it's clear that not every case will merit evergreen retainers and professionals will be required to highlight such a request in their retention applications, attorneys and other professionals representing a financially troubled corporation will be well advised to consider an evergreen retainer to protect themselves (and their partners) from the risk of non-payment.
1 Judge Carey currently sits as a visiting bankruptcy judge for a limited number of cases in Delaware. He is a visiting bankruptcy judge from the U.S. Bankruptcy Court for the Eastern District of Pennsylvania. Return to article