Restructuring

Barnes Bay Development Ltd., owner of the Viceroy Anguilla Resort & Residences on the British West Indies island of Anguilla, and certain of its affiliates, sought bankruptcy protection in the District of Delaware on March 17, 2011 following a troubled development of its Caribbean luxury resort.  The debtors moved to dismiss the chapter 11 case in November 2011, four months after Starwood Capital Group, the debtors’ prepetition secured and DIP lender, conducted a sale by public auction of substantially all of the debtors’ assets (and as sole bidder at the auction, prevailed with a credit bid of $165,000,000).  Two months earlier, the bankruptcy court had denied confirmation of the debtors’ liquidation plan, granted automatic stay relief to Starwood, allowing Starwood to subsequently foreclose on the luxury resort.
At the hearing on the motion to dismiss the chapter 11 cases, three law firms involved in the cases — Akin Gump Strauss Hauer & Feld LLP, attorneys for the debtors, and Brown Rudnick LLP and Womble Carlyle Sandridge & Rice LLP, representing the official committee of unsecured creditors — unfortunately found themselves at the losing end of a fight over the legal fees they had incurred during the short-lived bankruptcy cases.
At issue was the carve-out provided for in the final DIP order and the DIP loan agreement of the liens of Starwood for the payment of certain fees, including the fees of professionals retained in the chapter 11 cases. A carve-out generally acts to protect the downside risk to estate professionals in the event a plan is not confirmed and the estate becomes insolvent and is typically granted by a secured creditor in recognition of its potential exposure to surcharge of its collateral under section 506(c) of the Bankruptcy Code.  This carve-out, which (broadly speaking) became relevant once the proposed plan of reorganization fell apart and the estate had no unencumbered assets to pay professionals, was structured to be an amount that was not to exceed the lesser of (1) a budget line item for professional fees incurred by the debtors and (2) the accrued and unpaid fees of such professionals as allowed pursuant to bankruptcy court compensation orders, in each case prior to an event of default or termination date.  Although the term “budget” itself was not defined, a budget was attached to the final DIP order, although the parties disputed whether this attachment was the correct one.
In a motion to determine the carve-out in their favor, the law firms argued that, pursuant to ordinary rules of contract interpretation, the total fees payable should be the sum of interim fees paid plus the lesser of either the budgeted amount and any amounts that were allowed in addition to what already had been paid.  They argued, among other things, that the $6,332,895 budget line item contained in the cash disbursement budget was not, in fact, the number to look at, as the term “budget” was not defined in the final DIP order.  The schedule attached to the final DIP order was, in fact, not the budget, but a fee accrual schedule, and represented only the fees that would accrue during the case, not the fees that would be paid throughout the case.  The bankruptcy court, therefore, had to look to another spreadsheet (not annexed to the final DIP order) to see what fees actually would be payable throughout the case.  Next, the law firms argued that the final DIP order did not provide that the carve-out was reduced by any fees paid by the debtors during the course of the chapter 11 cases. Finally, the law firms argued that the total fees payable in the cases amounted to approximately $10 million, and of that number, approximately $4 million had accrued. Therefore, when determining the lesser of the $6 million carve-out and the $4 million in accrued (and by definition, unpaid) fees, the $4 million number was the lesser one, and therefore the amount remaining to be paid.
Starwood (or, more precisely, SOF-VIII Hotel II Anguilla Holdings LLC) objected to the law firms’ motion to apply the carve-out in this way.  The lender opposed the debtors’ and committee’s attorneys’ attempts to be paid in full for the work performed during the case, on the basis that the carve-out contained in the final DIP order capped estate professionals’ fees to a budgeted amount ($6,332,895, of which approximately $6 million had already been paid pursuant to interim compensation orders), or, alternatively, the final amount allowed by the bankruptcy court, whichever was less.
Starwood’s position was that the carve-out should be solely payable from the proceeds of the DIP loan.  The lender argued that the plan had failed due to the flawed tiered structure created and promoted the committee, thereby necessitating reliance by the estate professionals on the carve-out.  Starwood argued that, although the term “budget” was not itself defined in the final DIP order, it would be hard to conclude that the spreadsheet attached to the final DIP order was not, in fact, the correct budget, and the debtors or the committee should have timely brought such concerns before the court and corrected this error, if indeed there was any error.  The lender further argued that the interpretation of the carve-out language in the final DIP order could not be read any other way than to construe the $6 million cap as what it was stated to be and that any other interpretation would allow “double dipping” from the carve-out.
All parties appeared to agree that the final DIP order was unambiguous, and as a result no party requested an evidentiary hearing, and no testimony was proffered before the bankruptcy court to provide additional context to the operative language.
Judge Peter J. Walsh of the Delaware bankruptcy court allowed the fees of the law firms in full, but denied the related motion by the law firms to enter an order determining the scope of the carve-out in their favor.  In doing so, Judge Walsh found that, while the attorneys’ fees had been properly incurred and could be allowed in full, the carve-out was effective in capping the additional fees to be paid to the law firms to approximately $27,802, rather than the $3-4 million amount being sought by the law firms.  Appeals to the district court ensued, with Starwood opposing the allowance of the fees of the law firms, and the law firms opposing the interpretation of the carve-out provision that capped their fees.
On appeal, the arguments largely remained the same, with the parties disagreeing with the bankruptcy court’s finding as a matter of law.
The Delaware district court cited two material issues that provided context for considering the law firms’ claims for more cash.  First, the carve-out was not going to come into play at all if a chapter 11 plan was confirmed; at the time the final DIP order was entered, there were prospects that a previously litigious chapter 11 case would become more amicable, to allow confirmation of a chapter 11 plan.  (Of course, this is always the case with carve-outs as a chapter 11 plan cannot be confirmed unless all allowed administrative expenses, including professional fees, are paid in full, in cash).  Second, under the law firms’ proposed interpretation, Starwood could end up having to pay professional fees of up to twice the budgeted amount
The law firms had no better luck with the district court than they had had with the bankruptcy court.  United States District Judge Richard G. Andrews, in a memorandum opinion, held that he did “not believe that it is reasonably susceptible to the interpretation that the law firms argue for, that is, that notwithstanding the clear intent to provide a cap on attorneys’ fees, the agreement should be interpreted so as to provide no meaningful cap on attorneys’ fees.”
The district court agreed with the bankruptcy court’s reading of the final DIP order, finding that the budgeted amount for professional fees was clearly $6,332,895.  This number also tallied with an extended forecast for the case annexed to the final DIP order, which, using the $6 million number, resulted in a negative cash flow of $12,521,709 for the duration of the chapter 11 cases, almost an exact match to the amount of the DIP Loan at $12.5 million.  The arguments deployed by the law firms that the actual budget was greater failed on two counts:  the final DIP order was clear and unambiguous, and any other numbers to which the law firms referred were not included in the final DIP order, and, therefore, were not relevant to the analysis.
Chapter 11 cases do fall apart, and professionals need to be mindful when agreeing to a cap on fees that, if worse comes to worst, the cap could result in them not being compensated for all of the work they perform.  Even in the scramble to put a deal together, careful drafting, forecasting, and close attention to the numbers, attachments to orders, and language in agreements and orders is necessary on all sides, especially when dealing with potentially contentious points such as caps on fees.  Although they didn’t end up being paid in full, the law firms might take heart from Gaston Monescu in Trouble in Paradise: “Everything will be all right again. Prosperity is just around the corner.” And if anyone is interested, Viceroy Anguilla has a special right now: stay for three nights and pay for only two.  See you on the beach.