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BANKRUPTCY LAW
Retention Agreements
T
URNAROUND MANAGERS and
investment bankers are often engaged
by companies for the purpose of find-
ing a business partner that will infuse
capital as part of a reorganization or,
failing that, finding an entity to purchase the
company’s assets as a going concern. During the
recent high-tech meltdown and overall negative
economic climate, boards of directors have turned
to these professionals as a means of gracefully
exiting a sinking ship. As third parties,
turnaround managers and investment bankers
are typically not entirely familiar with a client’s
financial condition or the extent of its problems
at the outset of their engagement.
In many situations, a Chapter 11 filing will be
necessary to facilitate a reorganization or, more
commonly in recent years, a sale transaction.
While turnaround managers and investment
bankers tend to be familiar with the principal
provisions of the Bankruptcy Code that
help corporate debtors reach their business
objectives, they are typically less familiar
with some of the more technical statutory
provisions relating to the administration of a
bankruptcy estate. These provisions may have
a significant impact on how much, or even
whether, such professionals may be paid by a
company in bankruptcy, despite the terms of a
retention agreement entered into before the
bankruptcy filing.
Craig M. Rankin is a partner at the Los Angeles-
based bankruptcy boutique Levene, Neale, Bender,
Rankin and Brill. Christopher Alliotts is of counsel
to the Menlo Park, Calif., office of Los Angeles-
based Sulmeyer Kupetz. They can be reached at
cmr@lnbrb.com and calliotts@sulmeyerlaw.com
WWW.NLJ.
By Craig M. Rankin
and Christopher Alliotts
Craig M. Rankin Christopher Alliotts
Bankruptcy filing can
affect a professional’s
contract
The last thing a professional wants, after
being retained and performing most, if not all,
of the contractual services, is a dispute over the
payment of fees. In order to avoid such
disputes, it is necessary for turnaround
managers and investment bankers to avoid any
negative consequences that a bankruptcy could
have on their right to contractual compensa-
tion. Here are some suggestions:
■ Retain separate counsel. Because
a bankruptcy filing is not completely
unforeseeable, a professional needs to
anticipate a potential filing and plan
accordingly. Professionals will often be tempted
to rely on the company’s insolvency counsel in
an attempt to avoid paying legal fees, but such
a decision is risky. Although the professional
may well be on the same “team” as company
counsel, counsel may have a conflict of interest
with the professional’s personal interests and
may be constrained in the advice its provides.
Thus, fees paid for advice from separate counsel
on structuring the retention agreement will be
well spent, as such advice will often prevent or
limit compensation disputes at the conclusion
of the project.
■ Plan for a bankruptcy filing at the outset.
Advice on the structuring of a professional’s
compensation should be obtained at the outset
of the engagement, even if a bankruptcy filing
seems remote. The reason for this precaution is
that any subsequent modification could be
attacked in a later bankruptcy case. The
strong-arm powers set forth in the Bankruptcy
Code, including the right to avoid and recover
preferences, fraudulent transfers and other
transactions, can be applied to the restructur-
ing of a professional-services contract, especial-
ly when the restructuring was done to avoid the
negative consequences of the bankruptcy filing
on the professional.
■ Promptly obtain court approval of employ-
ment. In all bankruptcy cases, a professional
needs to obtain approval from the court in
order to be compensated by the company’s
bankruptcy estate. See 11 U.S.C. 327. While a
turnaround manager hired as an employee will
generally not be considered a profes- sional
whose retention needs to be approved, the
professional should seek approval of any special
compensation provisions, such as a bonus or
success fee. A professional needs to submit an
application early in the case for two reasons.
First, a professional will probably have the most
leverage early on because of the knowledge of
the client’s business he or she has gained over
time and the disruption that the loss of such
knowledge would have on reorganization efforts.
Second, any delay in seeking such approval can
be a basis for denying compensation.
THE NATIONAL LAW JOURNAL
■ Limit bankruptcy court review of fees. In
bankruptcy, professional fees are generally
subject to review by the bankruptcy court
under a standard of reasonableness. See 11
U.S.C. 330(a). Unlike some other professionals
that are employed under § 327 of the
Bankruptcy Code, financial advisors are
typically retained pursuant to § 328, which
recognizes the contingent nature of fee
agreements earned by investment bankers. See
In re Federal-Mogul Corp., 348 F.3d 390 (3d Cir.
2003). That type of arrangement will often
insulate a subsequent review of compensation
from attack as unreasonable. See In re Drexel,
Burnham & Lambert Group Inc., 133 B.R. 13
(Bankr. S.D.N.Y. 1991); In re United Artists
Theatre Co., 315 F.3d 217 (3d Cir. 2003).
■ Understand the nature of retention
agreements in bankruptcy. One of the more
unfortunate situations in which turnaround
managers and investment bankers find them-
selves comes about when a Chapter 11 filing is
required after most of their work is done. With
all energies focused on closing the deal, the
professionals may proceed with the Chapter 11
filing without understanding the potentially
harsh consequences to their compensation.
Retention agreements are generally
considered “executory contracts” for purposes
of § 365 of the Bankruptcy Code. When a
debtor assumes an executory contract, the
debtor’s performance of the contract becomes a
post-petition obligation of the bankruptcy
estate entitled to administrative priority, which
provides significant assurance that it will be
paid. If, on the other hand, the contract is
rejected, then the debtor’s obligation under the
retention agreement is rendered a pre-petition
unsecured claim, which will be paid on a pro
rata basis with other general unsecured claims.
Clearly, whether a contract is assumed or not
will have a significant impact on the amount
that the professional will be paid.
Prepetition, a turnaround manager or
investment banker can get the client to agree
to assume the retention agreement in the event
of a Chapter 11 proceeding, but a professional
should not rely upon such a promise for two
reasons. First, if the client reneges after the
bankruptcy case is commenced, that breach,
like the underlying contract itself, will
generally only be accorded the status of a
general unsecured claim. Second, and more
commonly, an official committee of unsecured
creditors is often formed as a countervailing
force to the company in a Chapter 11 case. If
the debtor seeks to have its retention agree-
ment with a professional assumed, the commit-
tee can, and may have a fiduciary duty to,
oppose the assumption when most services
were performed before the bankruptcy filing.
Certain code
provisions may have
a significant impact
on how much, or
even whether,
outside financial
advisors are paid.
This development could be extremely
unfair to the professional who, for example,
agreed to forgo a significant portion of
compensation until the closing of a transac-
tion. When little remains to be done
post-filing, the committee and/or the company
may be able to close the deal without the
professional’s services and may seek to have the
professional’s contract rejected in order to
avoid the payment of fees that are largely
attributable to prepetition services. While
certain judges might be sympathetic to the
professional’s predicament, it is a matter best
not left to a court’s discretion.
Two approaches may
reduce nonassumption risk
The risk of nonassumption under
§ 365 that comes with working for a client that
subsequently files for bankruptcy cannot be
entirely ameliorated. However, two approaches
may minimize this risk. They may not always be
feasible, but should nonetheless be considered
MONDAY, MAY 17, 2004
in every engagement in which the client is in
or near the zone of insolvency.
First, when there is an organized creditor
body existing before the bankruptcy filing, the
professional should get the approval of the
creditor body to the professional’s retention
agreement and the assumption of it in the
bankruptcy case. The debtor and/or the
committee may still try to back away from this
agreement in the bankruptcy case, but the
professional can then make the argument that
such parties should be estopped from reneging
on their promise, when the professional worked
in reliance on it and provided a substantial
benefit to the bankruptcy estate.
Second, using letters of credit in commer-
cial deals not involving international
shipments of goods has emerged as a new
phenomenon. The effectiveness of this
expanded use on employment or retention
agreements was illustrated in In re Condor
Systems Inc., 296 B.R. 5 (B.A.P. 9th Cir. 2003).
In that case, the 9th U.S. Circuit Court of
Appeals Bankruptcy Appellate Panel essential-
ly held that the use of letters of credit insulated
severance and other payments from attack.
As in life, there are few absolutes in
bankruptcy. There are factual nuances upon
which the Condor court relied in reaching
its conclusion, and such nuances should
be evaluated on a case-by-case basis. Still,
letters of credit, particularly at the inception
of the relationship, can be very helpful in
ensuring that professionals receive the com-
pensation for which they bargained at the
beginning of the engagement. And while
some clients may be unwilling or unable to
provide a letter of credit, it is a protection that
should be explored.
By taking the foregoing precautions, turn-
around managers, investment bankers and
other professionals will have a better chance of
recovering their bargained-for compensation in
bankruptcy cases. NLJ
This article is reprinted with permission from the
May 17, 2004 edition of THE NATIONAL LAW
JOURNAL. © 2004 ALM Properties, Inc. All rights
reserved. Further duplication without permission is
prohibited. For information, contact American
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