Who's Really Feasting in Chapter 11 Cases? Professor Lubben Provides a New Perspective on This Perennial Question
Professor Stephen J. Lubben, a former Skadden Arps associate, now Seton Hall law professor, and no stranger to the phenomenon of "feasting" in bankruptcy, has just made available for the general public's review his latest working draft of a paper entitled "The Microeconomics of Chapter 11 and the Irrelevance of Ex Ante Costs," which is accompanied by the following abstract:
Several recent studies have put the level of professional fees in large chapter 11 cases at about 2.5 percent of assets or less. This compares favorably with other significant corporate transactions. But little attention has been given to the issue of how professional fees are allocated within chapter 11 cases. Examining this issue is important because a significant strain of bankruptcy scholarship is premised on the notion that chapter 11 is excessively expensive, notwithstanding the existing evidence that suggests otherwise. In particular, these theorists employ the long-recognized principle that lenders will recoup anticipated losses through higher ex ante interest rates to support the argument that altering or even replacing chapter 11 will reduce the costs of debt financing and thus promote efficiency. But if most of the supposed costs of chapter 11 are in fact exogenous to the Bankruptcy Code, reductions in the cost of chapter 11 may have only a modest correlation with reductions in the cost of financial distress.
This paper thus offers the first look at the intra-debtor distribution of professional fees. I analyze a new sample of almost 4,000 attorney time entries, from more than 30 law firms, in 27 very large chapter 11 cases filed between 2001 and 2003 to look at several basic questions regarding the allocation of attorney's fees within chapter 11 cases. I find that up to 60% of the professionals fees in a bankruptcy case may be exogenous to chapter 11. I then develop the broader argument that ex ante costs are virtually irrelevant to current discussions of chapter 11.
Professor Lubben's analysis provides a good summary of the current state of research on professional fees associated with chapter 11 cases, and adds a unique perspective by focusing his analysis on law firm microeconomics. I found especially interesting his analysis under the sub-heading, "Staffing in Chapter 11" at pages 26-33 (where he even quotes from a book by Sol Stein entitled A Feast for Laywers, referenced here).
According to Professor Lubben, the data he examined suggests a counterintuitive result: that is, the bulk of hours billed in a case is more concentrated among "mid-level" attorneys (whose average billable rate is between about $350 and $450 per hour) than their more senior or junior counterparts. These mid-level attorneys, the data suggests, bill 25%-30% more hours on average per month than more senior or more junior attorneys working on the case (whose average billable rate is around $625 for the more senior attorneys and $260 for the more junior attorneys). Professor Lubben says he had predicted the data would fall along a relatively straight upward sloping line, with the most senior attorneys working the least number of hours per month (to the far left of the graph) and the most junior attorneys slaving away the hardest (to the far right of the graph). Instead, Professor Lubben notes, the data suggests that legal fees in large chapter 11 cases actually form a horseshoe (or upside-down "U") shaped curve, with time most heavily concentrated in the middle (where fat often concentrates) among mid-level attorneys/associates.
Professor Lubben is not sure what all this means, or even whether his data is reliable because he didn't have complete access to law firm billing records. Still, he doesn't shy away from asking the tough questions suggested by the data, such as:
- Is the concentration of case staffing among mid-level attorneys in fact the most efficient because these attorneys provide the client with the "optimal combination of skill and hourly rates that may be more valuable than either high-priced partners or novice junior associates"? (p.31)
- Do junior attorneys bill too much "given their high cost to knowledge ratio"? (p.31)
- "Less optimistically," does staffing concentration among mid-level attorneys "simply reflect friction created by the traditional incentive structures within law firms" where mid-level associates work on tasks that could or should be delegated to junior associates, but aren't out of fear that a junior associate's mistake could adversely affect the mid-level attorneys' career aspirations? (p.32);
- Were the firms in the sample simply overwhelmed with cases such that work more suitable for junior attorneys was being handled by more senior attorneys, and if so, should junior creditors bear the costs of a firm's lean hiring strategies, or do straight-forward principles of supply and demand justify such creditors' bearing this added expense? (p.32)
- Should the "frequent focus by courts and the United States Trustee on the number of partners staffed on a case" be reexamined given that a "case's expense may actually come from the heavy use of mid-level attorneys"? (p.33)
Professor Lubben provides us with a fresh way of looking at the question of "feasting" in chapter 11 by focusing us on the microeconomics of law firm practice instead of the more macro approaches that focus on the aggregate fees as a percentage of assets administered (as to which, he notes, "[t]he argument that chapter 11 professional fees are too high is largely dead, at least in academic circles").
In the end, Professor Lubben's early review of the data suggests that even if legal fees in bankruptcy in the aggregate aren't "too high," it doesn't mean that the individual firm who's fees are under scrutiny couldn't afford to shed some excess pounds in its midriff.
My intuition tells me there's an important connection between law firm staffing in chapter 11 cases and law firm decisions on leverage generally. As to this latter topic, here's a link to a recent post I recommend from Bruce McEwan's highly acclaimed blog, Adam Smith, Esq.,: an inquiry into the economics of law firms.
Still, I hate walking away from a "dead" debate without one final look at the corpse. Here, my intuition says that fees are too high at the macro level, and I can verify from experience that a lot of people believe they are too, at least at the "micro" level. I personally think that fees are inflated most by (i) overbearing clients who demand unreasonable results and (ii) more significantly for purposes of this post, attorneys in charge who make bad strategic and staffing decisions.
There are obviously certain "fixed" costs in bankruptcy, regardless of how big the case is because the debtor's guts (i.e., assets, liabilities, contracts, causes of action, and the like) need to be inventoried, and decisions need to be made regarding their disposition whether by way of plan or asset sale and liquidation. My guess is that these costs are relatively consistent among clients and law firms alike, and that a curve could be created from existing data that would enable one to predict these "fixed" bankruptcy costs simply by fitting data representing the particular debtor's assets, liabilities, contracts, and other "fixed" factors into an appropriately developed multi-variate regression model.
By comparison, non-fixed costs in bankruptcy represented by decisions regarding what to fight, and how hard, likely fall within far broader (and hence unpredictable) ranges. In theory, these fees are really justifiable only in terms of whether the value of the services rendered, plus the gains realized from the work performed, exceed the value that would have been obtained had the parties simply done nothing (or something in between) and accepted what was on the table (or a modification thereof).
Examples of bad decision-making abound. For example, if the engagement partner decides to make copies of much of the client's files related to legal issues in the case, and then write memos to the client summarizing everything in those files, has anything really been accomplished that justifies payments at today's very high hourly rates (or put another way, do you really get anything from going in a circle, except a very large cab fare)? Similarly, if armies of young (and mid-level?) locust lawyers relatively clueless about what's required to prove a case in Court are dispatched to chomp down every tree in the forest in search of litigation relevance (while sleeping in the most expensive hotels and consuming hearty portions of the most expensive food and drink), has the estate really benefited? Frankly, the horror stories resulting from poor up-front strategic and staffing decisions by partners in charge, like those grimly retold by Sol Stein, don't get the attention they deserve. At the micro level, these are "life and death" decisions that have potentially monumental consequences for the players involved, even if at the macro level they have little overall effect on the whole.
Kudos to Professor Luebben for trying to scratch the surface of this beast and asking some tough, uncomfortable questions, and special thanks to the Legal Theory Blog for linking to this newly available working draft.
© Steve Jakubowski 2005