The Bankruptcy Process Needs to be Refurbished
I recently participated in a bankruptcy proceeding where the facts and outcome were not legally disputed but very disputable.
Accordingly, I have developed a set of recommendations to improve the review process, as described below.
Basic Requirements for Disclosure Statements
In the bankruptcy proceeding that I was following, there was no valuation study or enterprise value in the Disclosure Statement. The Judge called for a valuation proffer at the hearing that was delivered orally, and accepted without discussion. The only valuation study available to the Court was excluded from the record for lack of standing. The result was a value that would not pass a 9th grade math test requiring the calculation of the present value of a stream of payments.
Other critical issues to the bankruptcy determination were similarly missing. A simple solution to this issue is that there should be a minimum set of issues required to be included in the Disclosure Statement of every Chapter 11 filing. These issues should include a detailed description of the reason for default, the Board minutes addressing the bankruptcy filing, the company’s five-year business plan after coming out of bankruptcy, the company’s enterprise value after coming out of bankruptcy along with the associated valuation study supporting that value, and the size and nature of the write-down.
Compensation for Services
The law requires that the professionals providing services must justify their fees. It is helpful that they are required to report individual contributors’ pay schedule such as the hourly rate, the specific work assignment, number of hours, and the project that they are supporting.
However, in the proceeding that I was following, the various firms used different project names for the same work product.
Some firms provided no project information.
Others labeled work assignments as projects.
Some didn’t provide the work product for which they were responsible.
No summary was provided along with the individual invoices.
The result was that there was a lot of unstructured information to process in a short period of time.
My first recommendation for billing is that before any work begins, a representative from each company providing professional services should be assigned to a “billing committee” (“BC”). The BC should set up the hierarchy for billing including definitions for each project. Each firm would be required to follow the BC’s format and definitions.
This approach would enable computerized summaries, by vendor, by person, by time period, and most importantly, by project.
Project cost summaries over time – along with the associated work output – would help tremendously in overcoming the information overload.
Additionally, billing itself should be a separate project and the hours spent compiling bills should not be billed at the top professionals’ hourly rates but at a more reasonable market rate such as $150-$250 per hour.
Assessing the Reasonableness of Professional Fees
The current method of assessing the reasonableness of professional fees in a bankruptcy is left to the U.S. Trustee program. The Trustee program is known to be underfunded. The Trustee’s representatives on the case I reviewed raised minor issues.
The facts of the case are that the professionals submitted $24 million in legal and finance expenses for the four-month period after the Plan of Reorganization was filed. There were $112 million in unexplained professional fees in the year the Plan was filed. The Company’s subsidiaries in bankruptcy had less than $700 million per year in revenue.
Despite these excessive fees in relation to the size of the bankrupt company, there was no discussion of these pre-filing expenses in the Disclosure Statement. Obviously, there should be a benchmark representing a zone of reasonableness for all bankruptcy-related expenses such as 1-2% of assets or revenues. The ratio should be reported on a cumulative basis at the end of every month.
To better balance the firepower on each side of the debate over fees, I recommend setting up a system where a qualified 3rd party be assigned by the Trustee to review the invoices and be compensated by taking 35% of any cutbacks in fees that the Judge accepts based on the 3rd party’s analysis and recommendations.
Legal standing generally provides the right to sue based on the harm caused by the defendant’s actions.
In the case at hand, I was not allowed to have my views entered into the record because I did not own stock on the day the creditors chose to file their Plan of Reorganization. It did not matter to the court that I owned stock in the company for fifteen years prior to the filing of the bankruptcy petition. Nor did it matter that I had contractual relationships to conduct business on behalf of the company.
The narrow application of the law in this case harms the public interest and undermines centuries of legal precedent underlying Section 107 of the U.S. Bankruptcy code. That is, an open system with checks and balances is the backbone of a democracy.
Clearly, an open system was not the objective of the Court in this case. During the hearing on the validity of professional fees, a shareholder with standing asked that the study proffering the enterprise value along with the cost to prepare it be put into the record. This request was summarily denied.
To enable a more open system, the requirement of legal standing should be waived for qualified individuals seeking to participate in Chapter 11 proceedings. Once qualified by the Trustee, such contributors should be allowed to participate unless they are being disruptive or otherwise disingenuous. At a minimum, submissions should be allowed into the record if they are filed on a timely basis and at least five minutes should be provided for oral argument.
The above recommendations would not be hard to implement. Without them, the bankruptcy processes are too easy for the law firms and finance firms to exploit for higher fees and to codify unjustified allocations.