Vol 4 (2007) - Issue 1

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The Microeconomics of Chapter 11 – Part 1

The argument that chapter 11 professional fees are too high is largely dead, at least in academic circles.1 Several recent studies, admittedly based on rather humble sample sizes, have put the level of fees in large chapter 11 cases at about 2.5 percent of assets or less.2 This compares favourably with other significant corporate transactions.
But little attention has been given to the issue of how professional fees are allocated within chapter 11 cases. As several of the prior studies have noted, while it is easy to think that chapter 11 professional fees are all bankruptcy related, in fact all debtors would some incur some amount of professional fees even in the absence of financial distress.4
Further, even those professional fees that are related to the firm’s financial distress are not necessarily related to professionals with bankruptcy-specific expertise. For example, with or without chapter 11, a firm that wants to sell its assets will need the services of corporate attorneys who can document the transaction.
Examining these issues is of vital importance 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.5 In particular, these theorists employ the long-recognised 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.6 But if most of the supposed costs of chapter 11 are in fact exogenous to the Bankruptcy Code, this entire body of scholarship may be hollow, inasmuch as changes to chapter 11 will be of slight consequence to the overall ex ante costs of debt finance. 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 analyse 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. For example, I look at the relationship between an attorney’s hourly rate and their contribution to the monthly costs of chapter 11. I look for evidence of staffing decisions that favour the professionals – do the cases seem to be staffed with a high number of senior attorneys with high hourly rates? I also examine the departments involved in the chapter 11 cases, and their proportional contribution to the overall fees in the cases.