In a bankruptcy case filed 91 years ago (and reopened 85 years later), the U.S. Bankruptcy Court for the Western District of Virginia recently denied creditors’ counsel’s motion for a fee enhancement under the "common fund doctrine," finding it could not award the requested fees absent statutory authority. In particular, the court determined it would be an abuse of its equitable powers to award fees beyond the scope of applicable bankruptcy law in In re Yellow Poplar Lumber, Case No. 605 B.R. 416 (Bankr. W.D. Va. 2019).
In July 1928, White Oak Lumber Co. filed an involuntary Chapter 7 petition in the U.S. District Court for the Western District of South Carolina, seeking to have Yellow Poplar Lumber Co., Inc. "adjudged a bankrupt" under the Bankruptcy Act of 1898. n 1931, the district court adjudged Yellow Poplar as bankrupt and closed the case.
In 2013, the case was reopened in connection with a dispute over ownership rights in certain gas estates on parcels of land in Virginia, and it ultimately found its way to the U.S. Bankruptcy Court for the Western District of Virginia. The dispute resulted in a settlement whereby Yellow Poplar’s bankruptcy estate stood to receive approximately $2 million in gas royalties. The Chapter 7 trustee appointed in the reopened case, with the assistance of a genealogist, identified several of the original creditors’ existing heirs or successors-in-interest. The bankruptcy court, in turn, directed the trustee to file a brief addressing the appropriate interest rate on the anticipated distribution to creditors, and invited any other party-in-interest to do the same. While the trustee contended that the interest rate should be 2.4%, counsel for the heirs of two creditors advocated a 7% rate, which reflected the legal rate in effect in South Carolina when Yellow Poplar’s bankruptcy case was filed. The court ultimately ordered the application of a rate of 3.6%.
Creditors’ counsel, however, successfully appealed the court’s ruling, which resulted in general unsecured creditors receiving 7% interest on their distributions, and increasing the asset pool to be distributed to general unsecured creditors by approximately $740,000. Notably, the efforts of creditors’ counsel did not increase the amount of funds in the bankruptcy estate, but rather increased just the proportion of estate funds going to the class of general unsecured creditors, effectively diverting funds from one class of constituents to another. Creditors’ counsel then filed a motion with the bankruptcy court seeking a fee enhancement of $164,164.90 under the "common fund doctrine." The trustee opposed the motion, arguing, among other things, that the common fund doctrine does not apply in bankruptcy cases.
Common Fund Doctrine
The common fund doctrine is an exception to the American Rule, i.e., the general rule prevailing in the United States that each litigant is responsible to pay its own attorney fees. The doctrine generally applies where a litigant, acting to recover on its own claim, recovers property from which others may satisfy their claims as well, entitling the litigant to payment of attorney fees and costs from the "common fund" used for payment of all claims.
Based upon principles of equity, the common fund doctrine recognizes that one who benefits from a lawsuit without contributing to its cost is unjustly enriched at the expense of the successful litigant who bore the costs. In addition to payment of a litigant’s attorney fees and costs, the doctrine also allows the litigant’s attorney to collect an extra award of fees from the common fund, even if the attorney is merely performing services for his client per the terms of his engagement.
The court determined that the operative question was not whether the common fund doctrine applies, but rather whether the court had authority to grant the requested fee enhancement from estate assets. To that end, the court considered precedent under both the Bankruptcy Act of 1898 and the Bankruptcy Code currently in effect: although the Bankruptcy Act governed Yellow Poplar’s case, the court considered cases applying the Bankruptcy Code for additional guidance.
Quoting at length from In re Fesco Plastics, 996 F.2d 152 (7th Cir. 1993), a case filed under the Bankruptcy Code that denied a fee request under the common fund doctrine, the court highlighted the central problem with counsel’s requested fee enhancement: a bankruptcy court cannot award attorney fees without statutory authority, such as that found in Bankruptcy Code Sections 327-330, 1103 and 503(b)(4). The court concluded that an award of fees outside the context of applicable statutory provisions is beyond a bankruptcy court’s mandate. In the words of the Fesco Plastics court, "a bankruptcy court is simply not authorized to do whatever is necessary to reach an equitable result; it may only do whatever is necessary to enforce the Code."
The court noted that prevailing case authority decided under the Bankruptcy Act was in accord with Fesco Plastics. In particular, the court highlighted Cox v. Elliott (In re Calhoun Beach Club Holding), 122 F.2d 851 (8th Cir. 1941), which rejected the argument that a bankruptcy court "has inherent equitable power" to authorize payment of a creditor’s attorney fees from estate assets. As the U.S. Court of Appeals for the Eighth Circuit explained in Cox, the Bankruptcy Act "carefully regulates the compensation and expenses that may be allowed in bankruptcy," and contains an implied exclusion of other fee allowances not expressly set out in the Bankruptcy Act.
After considering Fesco Plastics, Cox and several other cases under both the Bankruptcy Act and the Bankruptcy Code, the court concluded it could not "abuse the equitable power Congress bestowed upon it to award fees for services outside the scope of applicable bankruptcy law." The bankruptcy court noted that, even were it to conclude that it had the authority to award fees under the common fund doctrine, counsel might nonetheless remain ineligible for the additional fees: as noted above, counsel’s efforts did not increase funds flowing into the bankruptcy estate, but rather reallocated estate funds among classes of creditors.
Although acknowledging that the common fund doctrine might apply in exceptional circumstances, the court confirmed that a fee award or enhancement would still have to be made pursuant to statutory authority, such as section 64(b)(3) of the Bankruptcy Act, allowing a "reasonable attorney fee" to petitioning creditors in an involuntary case, or section 64(b)(2), allowing for payment of "reasonable expenses" of creditors who recover property transferred by a bankrupt.
Here, however, no provision of the Bankruptcy Act or the Bankruptcy Code existed to authorize "fees for creditor’s attorneys whose actions incidentally benefited some creditors, to the detriment of others, while pursuing their clients’ best interests." The court noted, moreover, that counsel had not identified any provision of the Bankruptcy Act or the Bankruptcy Code that authorized the fee award, and the authorities it did cite were either distinguishable, were not on point, or supported the court’s analysis. Accordingly, the court denied counsel’s motion for a fee enhancement.
Viewed through the equities of the case, it is arguably unfair that all members of the general unsecured creditor class benefited without having to contribute to the legal fees and expenses incurred by just a few creditors in the class. Indeed, the court confessed that it was "not unsympathetic" to counsel’s fee request. Nevertheless, Yellow Poplar provides valuable guidance to creditors seeking payment of attorney fees from estate funds: asserting equitable theories such as the "common fund doctrine" may engender judicial sympathy, but they are no substitute for statutory authority. Consequently, creditors’ counsel seeking any fee enhancement should make their request pursuant to a Bankruptcy Code section that explicitly authorizes such an enhancement.
Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.
Geoffrey A. Heaton, special counsel at the firm, practices in the area of business reorganization and financial restructuring, concentrating on representation of secured creditors, Chapter 11 and Chapter 7 trustees, creditors’ committees and unsecured creditors.
This article also appeared in The Bankruptcy Strategist.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.